In August 2015, the Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN) proposed regulations that would require investment advisers subject to SEC registration to establish anti-money laundering (AML) programs.1 The proposal also adds such investment advisers to the definition of “financial institutions” under the Bank Secrecy Act (BSA), which consequently requires them to report suspicious activity to FinCEN and subjects them to reporting and recordkeeping requirements under the BSA.
Background FinCEN has been contemplating AML regulations for investment advisers for over a decade. In 2003, FinCEN proposed regulations that would have required SEC-registered investment advisers and a significant number of unregistered advisers to establish AML programs.2 In 2008, FinCEN withdrew that proposal, stating that it would “continue to consider the extent to which BSA requirements should be imposed on investment advisors.”3 In subsequent years, FinCEN directors noted in public remarks that the agency was in the process of drafting new AML regulations covering investment advisers.4 In light of these developments, as well as SEC no-action relief permitting investment advisers to perform broker dealers’ customer identification program obligations,5 some investment advisers have already implemented voluntary AML programs.
FinCEN’s stated rationale behind this proposed rule relates to the apparent risk associated with the use of investment advisers to facilitate money laundering activity, due in part to investment advisers’ current lack of mandatory AML compliance and reporting obligations. From FinCEN’s perspective, investment advisers are prime targets for terrorist financiers looking to avoid heavily regulated banking institutions. According to FinCEN, asymmetric knowledge often exists in transactions involving advisory assets. For example, broker-dealers instructed by an investment adviser to execute a trade, or custodial banks holding assets managed by investment advisers, face a knowledge gap with respect to the identity and objective of the customer compared to the investment adviser, thereby making suspicious activity reporting more difficult for the broker-dealer or custodian. Investment advisers thus may be seen as a low-risk method for launderers to enter the U.S. financial market. FinCEN believes that investment advisers are “uniquely situated to appreciate a broader understanding of their clients’ movement of funds through the financial system because of the types of advisory activities in which they engage.”6 From FinCEN’s perspective, investment advisers are therefore positioned to be front-line AML vigilantes.
Investment Advisers Covered by Proposed Regulations The proposed regulations apply to all investment advisers that are registered or required to be registered with the SEC under the Investment Advisers Act of 1940 (Registered Investment Advisers). Generally, all “large” investment advisers with $100 million or more in regulatory assets under management must register with the SEC, unless an exemption from registration is available. Under the proposed regulations, FinCEN would delegate its authority to examine Registered Investment Advisers for AML compliance to the SEC. The proposal notes that FinCEN may apply AML regulations to state-regulated investment advisers or investment advisers that are exempt from SEC registration through future rulemaking.
FinCEN notes that under its proposed definition of investment adviser, a broad range of advisers would be covered, such as dual-registered investment advisers, financial planners, pension consultants, and entities that provide only securities newsletters and/or research reports. FinCEN advises in the proposed rule that the regulatory burden to establish an AML program would correspond with the risk associated with the program. In other words, investment advisers managing millions of dollars in assets will likely face tougher compliance burdens than others that engage only in lower-risk activities.
AML Program Requirements for Registered Investment Advisers Within six months of the effective date of the proposed regulations, the board of directors (or comparable governing body) of each Registered Investment Adviser would be required to approve a written AML program that includes the following minimum requirements: (1) AML policies, procedures and internal controls; (2) appointment of an AML compliance officer; (3) ongoing employee training; and (4) periodic independent testing of the program.
The proposal clarifies that a Registered Investment Adviser’s AML program would be required to cover all advisory activity, including subadvisory services and activity that does not involve the management of client assets. It also emphasizes that FinCEN expects advisers to analyze the money laundering risks of particular clients by using a risk-based evaluation of relevant factors, including the jurisdiction where the client is located, the client’s entity type (if applicable), the source of the client’s funds, the adviser’s historical experience with the client, and references from other financial institutions. FinCEN notes that while registered open-end and closed-end fund clients may present lower money laundering risks than other clients, private fund clients may present higher risks if there is a lack of transparency regarding the funds’ underlying investors. According to the proposal, under certain circumstances, a Registered Investment Adviser “may be required to assess the money laundering and terrorist financing risks associated with the underlying investors of a client that is a private fund.”7
Recognizing that Registered Investment Advisers are already required to implement written compliance programs pursuant to the Investment Advisers Act, the proposal contemplates that existing policies and procedures can be adapted to address the proposed regulations. In addition, Registered Investment Advisers that are dually registered as a broker-dealer or affiliated with an entity that is required to maintain an AML program in another capacity, such as a bank or an insurance company, are permitted (but not required) to establish enterprise-wide compliance programs. The proposal also permits a Registered Investment Adviser to contractually delegate certain aspects of its AML program to third-party service providers, so long as the adviser remains fully responsible for the effectiveness of the program.
Suspicious Activity Reports The proposal would require Registered Investment Advisers to file a Suspicious Activity Report (SAR) with respect to activity involving at least $5,000 if the adviser knows, suspects, or has reason to suspect that the transaction: (1) involves funds derived from illegal activity or is intended to hide funds derived from illegal activity; (2) is designed to evade the requirements of the BSA; (3) has no apparent lawful purpose; or (4) involves the use of the investment adviser to facilitate criminal activity. The proposed regulations would require Registered Investment Advisers to file a SAR within 30 days after becoming aware of a suspicious transaction. The proposal also permits Registered Investment Advisers to file SARs voluntarily (e.g., in connection with suspicious activity involving less than $5,000).
In order to align reporting requirements of all financial institutions, FinCEN incorporated into the proposed rule language from the suspicious activity reporting rules applicable to other financial institutions, such as banks, broker-dealers, mutual funds, casinos, and money services businesses.
Bank Secrecy Act Reporting and Recordkeeping The proposal defines Registered Investment Advisers as “financial institutions” for purposes of the BSA, thereby subjecting them to certain reporting and recordkeeping obligations. For example, Registered Investment Advisers would be required to comply with the BSA’s “Recordkeeping and Travel Rules,” requiring them to create and maintain records with respect to transmittals of funds in excess of $3,000. Registered Investment Advisers would also be required to file Currency Transaction Reports in connection with currency transactions in excess of $10,000.8
Comment Period and Future Rulemaking FinCEN is seeking comments on the proposed regulations until November 2, 2015. Notably, unlike banks, broker-dealers, and other financial institutions subject to BSA requirements, Registered Investment Advisers would not be required to implement customer identification programs under the proposed regulations. The proposal notes, however, that FinCEN anticipates addressing the application of customer identification program requirements to investment advisers pursuant to a future rulemaking with the SEC.