City National, regulators in talks on bank secrecy laws.

City National Bank, known for its personal, discreet service to celebrities and other wealthy clients, is expected to enter an agreement with regulators for violating the Bank Secrecy Act and other anti-money laundering laws.

City National Corp., the parent of the Beverly Hills-based bank, disclosed in a Securities and Exchange Commission filing that it plans to sign an unspecified agreement "in the near term," though it does not know if a financial penalty will be assessed.

On a conference call with analysts, City National Chief Executive Russell Goldsmith said that the bank wanted to be "candid and forthcoming" about the probability of entering into an agreement with regulators.

"We will continue in 2005 to escalate and improve our execution of risk management and compliance," he said, adding that, "because these are confidential discussions and a number of the items are not clear, there's really not much more that I can say about it."

He declined to specify any time frame or dates related to the agreement, stating that it was "not entirely within our control."

Depending on the number of violations, banking analysts said they expect federal regulators will impose a cease-and-desist order that could restrict City National from opening bank branches or from acquiring other banks for a period of a year or less.

"The tact that they are announcing an agreement with regulators means they aren't far enough ahead of bolstering their systems and procedures," said Manny Ramirez, vice president of research at Keefe Bruyette & Woods Inc. in San Francisco. "They pitch themselves as a private bank, and that's their business model, so I imagine that would attract more scrutiny."

Anti-terrorism enforcement

Money-laundering and internal bank controls have received more attention from a variety of federal agencies that stepped up anti-terrorism enforcement activities after Sept. 11, 2001.

In the past two years, nearly a dozen banks have been slapped with cease-and-desist orders for violating the Bank Secrecy Act, including several Los Angeles-based banks: Cathay General Bancorp, Nara Bancorp and Pacific Union Bank, which was purchased by Hanmi Financial Corp. last year.

The act requires that banks keep basic data on their customers--including reporting their sources of income. This can be an especially sensitive subject for a financial institution like City National because it handles so many celebrities who deposit and withdraw large amounts of money. Banks also have to report any cash transactions of $10,000 or more.

Several executives at City National said the bank had a particularly tough time getting its customers to fill out forms explaining the sources of their incomes. Some customers have been miffed that the bank asked such personal questions, these executives said. Some threatened to close their accounts, even though City National informed them that they would have to fill out the same forms at any U.S. bank.

When the USA Patriot Act was enacted in 2001 in response to the Sept. 11 terrorist attacks, it gave added teeth to the Bank Secrecy Act by requiring that bank accounts of non-U.S. citizens receive extra scrutiny.

Many banks have purchased sophisticated software systems to catch so-called structured transactions--such as when a customer takes money out of several banks or ATMs in a short period of time that totals $10,000 or more.

City National disclosed the regulatory stumble at the same time it disclosed that it had doubled the number of compliance officials over the past few months. It also cited higher expenses for conforming to the Bank Secrecy Act and USA Patriot Act.

Though banks usually take a big hit to their stock when a regulatory action is announced, investors barely registered the news. When City National reported a 12 percent jump in fourth quarter profits, shares surged to a 52-week high of $71.35. As of Jan. 19, City National shares were trading at $69.40.

"Investors probably looked past it because they had a good quarter and the outlook was somewhat strong," said James O'Brien, a banking analyst at Standard & Poor's. "We don't have a lot of color on this situation, though I think people just are not that fazed because it's the new world we're living in. Obviously it's costing them a good chunk of change so that could be where it hits them hard."

For the fourth quarter, City National reported a 13 percent rise in non-interest expenses to $107.5 million, partly due to higher risk management costs for complying with the Bank Secrecy Act and USA Patriot Act. It posted net income of $49.7 million for the period ended Dec. 31, compared with $44.4 million for the like period a year earlier.

Monitoring suspicious activities

Some banks have paid stiff penalties for failing to file a "suspicious activity report," or SAR, describing their customers' actions, particularly if the customer later proved to be involved in terrorism, money laundering or fraud.

L. Richard Fischer, a partner at Morrison & Foerster LLP, said banks are "under a magnifying glass," particularly if they have deficient internal controls or lack policies to direct employees on how to spot suspicious activities.

Moreover, scrutinizing millions of dollars in daily transactions can be a logistical nightmare. Once the activity has been discovered, the individual violations can involve hundreds of transactions on one account, which ratchets up the federal fine.

"It's quite clear that the examinations that banks are undergoing right now are unlike anything they've ever experienced before," he said. "There is heightened concern and congressional focus, so the bank regulators have really cranked up the heat."

One unintended consequence has been that the Financial Crimes Enforcement Network, a small bureau of the Treasury Department, is being inundated with suspicious activity reports from banks anxious to avoid regulatory scrutiny and fines.

Banks have complained that they don't get enough guidance on what constitutes suspicious activity. Some of the guidelines are issued by the Office of Foreign Assets Control, another Treasury unit, which has the authority to freeze assets of terrorists, drug kingpins and their support networks.

The Office of Foreign Assets Control has identified specific countries, including Iraq, Liberia and Haiti, whose citizens and businesses are supposed to receive extra attention from banks. Also under watch are offshore territories with lax regulatory laws, such as the Cayman Islands.

Banking officials complain that they have become the latest battleground in the offensive against financial corruption. They are expected to lobby Congress for some relief.

Last year, officials at the Office of the Comptroller of the Currency, which regulates U.S. banking institutions, promised tougher enforcement of money-laundering laws after congressional testimony revealed that Washington D.C.-based Riggs Bank suppressed documents showing it managed accounts for former Chilean dictator Augusto Pinochet while he was under house arrest for human rights violations.

Testimony also found that Riggs had accepted suitcases filled with $3 million in cash deposited by officials from Equatorial Guinea that were not reported to the U.S. government, as required by law. Investigations on Riggs accounts held by Saudi Arabians are ongoing.

Though Riggs was slapped with a $25 million fine for its lapses, AmSouth Bancorp, of Birmingham, Ala., agreed to pay $50 million in penalties in October for a breakdown in its money-laundering controls. In that instance, AmSouth failed to catch a Ponzi scheme carried out by two businessmen who had persuaded investors to buy $15 million in fake promissory notes held at the bank.

City National Corp.

Stock Prices

YEAR (Dec. 31)                     2004    2003

Revenue (millions)               $604.3   $575.7
Operating Expenses (millions)      58.4     90.1
Loan Loss Provision (millions)        0       29
Net Income (millions)             206.3    186.7
Earnings Per Share                $4.04    $3.72

Quarterly Net Income (millions)

SUMMARY

Business: Banking
Headquarters: Beverly Hills
CEO: Russell Goldsmith
Market Cap: $3.4 billion Dividend Yield: 1.8%
Total Assets: $14.23 billion P/E Ration: 17.2
Long-Term Debt: $519.3 million