The Financial Crimes Enforcement Network ("FinCEN")—the Treasury Department office tasked with regulation and enforcement of U.S. money-laundering and terrorist financing laws—has published a Notice of Proposed Rulemaking ("Proposed Rule") that would require registered investment advisers to implement anti-money laundering ("AML") procedures under the Bank Secrecy Act ("BSA"). Below, we summarize the material aspects of the Proposed Rule and discuss the key takeaways for investment advisers. We will be following with an additional alert to provide greater detail to our non-U.S. adviser clients.
The Proposed Rule would apply to any investment adviser which is "registered or required to register with the SEC under section 203 of the Investment Advisers Act [("Advisers Act")]" ("Covered Advisers") and would delegate enforcement powers to the SEC. The Proposed Rule would not require Covered Advisers to adopt a customer identification program ("CIP") at this time, but would include them within the definition of "financial institutions" under the BSA. As such, Covered Advisers would be required to comply with Currency Transaction Report ("CTR") filing requirements, and the recordkeeping, transmittal of records, and retention requirements for the transmittal of funds under the Recordkeeping and Travel Rules. Covered Advisers would also be required to comply with information sharing requests pursuant to section 314(a) of the USA PATRIOT Act ("PATRIOT Act"). Although the Proposed Rule indicates that FinCEN may revisit the issue of CIPs in a subsequent rulemaking, FinCEN suggests that it believes that the Proposed Rule closes a significant gap, observing that "[a]s long as investment advisers are not subject to AML program and suspicious activity reporting requirements, money launderers may see them as a low-risk way to enter the U.S. financial system."
While many investment advisers already have AML policies and procedures in place, the Proposed Rule will require Covered Advisers to prepare for greater attention to this area by SEC examiners. The Proposed Rule also creates uncertainty for Covered Advisers who are subject to non-U.S. AML regulations, and who may therefore be required to integrate overlapping requirements under multiple regimes.
Who will be covered?
FinCEN, by limiting the application of the Proposed Rule to SEC-registered investment advisers, would effectively incorporate all exemptions and exclusions from registration available under the Advisers Act. Investment advisers exempt from registration under the Advisers Act (such as foreign private advisers, exempt reporting advisers, and family offices) would therefore not be subject to the new AML requirements.
Registered advisers who are not domiciled in the U.S. would, on the other hand, be required to adopt an AML compliance program, regardless of the scope of their U.S. operations. The Proposed Rule similarly makes no allowance for advisers’ compliance with non-U.S. AML regimes, even though these may have diligence and reporting requirements that deviate from U.S. rules and which may be stronger than the Proposed Rule in some respects. Regulating non-U.S. advisers based solely SEC registration status, without considering either the location of their client funds or those funds’ investors, may at the same time do little to advance the goals of the U.S. AML regime. We will be following up with an additional alert to provide greater detail on these and related issues to our non-U.S. adviser clients.
What will be required for compliance?
The Proposed Rule would require all Covered Advisers to (i) adopt an AML compliance program with certain specified features and (ii) comply with certain FinCEN reporting and recordkeeping requirements, such as suspicious activity reporting. The AML compliance program would need to include, at a minimum: (1) internal policies, procedures and controls; (2) the designation of a compliance officer; (3) an ongoing training program; and (4) an independent audit function. While the details of each Covered Adviser’s AML program would be tailored to its risk profile, the program as a whole would need to be "reasonably designed to prevent the investment adviser from being used to facilitate money laundering or the financing of terrorist activities" and to comply with applicable FinCEN rules under the BSA. Additionally, Covered Advisers would need to file certain FinCEN reports and to retain related records for five years. These include:
- CTRs for each client transaction, or series of transactions, that exceeds $10,000 in a given business day. (CTR reports must be made regardless of whether actual currency is involved or another electronic or physical monetary instrument.) CTR filings would replace advisers’ current IRS Form 8300 filings.
- Suspicious Activity Reports ("SAR"), a special filing that must be made for any transaction or series of transactions over $5,000 that involves suspicious activity. SAR filings are subject to strict secrecy requirements, and as a result they must often be insulated from regular reporting channels.
- FinCEN Information Requests under Sec. 314(a) of the PATRIOT Act, in response to which regulated entities must conduct a record search and send any matches to FinCEN.
- In the event they engage in originating, receiving, or forwarding wire transfers, Covered Advisers would be subject to the same Information Transfer Requirements as banks, also known as the "Travel Rule."
How would the Proposed Rule affect existing AML practices in the industry?
As FinCEN acknowledges, many investment advisers already have AML policies in place, whether as a compliance best practice, through associated broker-dealers, or to enable a broker-dealer to rely on the adviser’s CIP and Customer Due Diligence ("CDD") programs under the terms of the SEC’s 2004 No Action Letter ("No Action Letter"), last extended inJanuary 2015. Even for these advisers, the prospect of greater scrutiny by SEC exam staff should the Proposed Rule be adopted may add pressure to ensure that AML policies are appropriately tailored, consistently executed, and reflective of FinCEN filing obligations that were previously not obligatory for investment advisers, such as SAR filings. The Proposed Rule does not address whether compliance with its requirements would actually replace those standards set forth in the SEC’s No Action Letter. Considering that the Proposed Rule does not require Covered Advisers to adopt the CIP and CDD practices required of broker-dealers, these requirements would presumably continue in tandem, at least for an initial period. The Proposed Rule also leaves open the related question of whether future adviser CIP requirements might include beneficial owner identification requirements, such as those contained in an ongoing FinCEN rulemaking for other financial institutions subject to the BSA. See 79 FR 45151 (Aug. 4, 2014). The Proposed Rule states that these issues will be considered in future joint rulemakings with the SEC, and FinCEN’s past practice of following programmatic AML requirements with formal CIP requirements suggests that the eventual extension of these rules to investment advisers is likely.
Even absent explicit CIP and beneficial ownership diligence requirements, the Proposed Rule would oblige Covered Advisers to take a fresh look at their customer review practices. In particular, FinCEN’s view that risk-based compliance programs may need to consider risks "associated with the underlying investors of a client that is a private fund or other unregistered pooled investment vehicle" implies a requirement for advisers to "look through" a client fund to its investors in at least some cases. The adjacent discussion of elevated risks faced by advisers whose client funds are overseas or who advise funds in which the ownership of underlying investor entities is not transparent shows FinCEN’s concern for vulnerabilities in these areas. While the broadening of diligence to cover fund investors that do not have a customer relationship with the adviser may be appropriate in some cases, comments to FinCEN will need to emphasize how the inherent differences between providing investment management services to fund clients differs from providing other types of financial services might compel a distinct approach to AML regulation.
Key Issues During the Comment Period
Moving forward, FinCEN has solicited comments on a wide range of issues, including whether Exempt Reporting Advisers ought to be brought within the scope of Covered Advisers and whether certain classes of SEC-registered advisers ought to be excluded. These include, among others:
- Registered advisers based outside the United States;
- Registered advisers providing investment advice solely through sub-advisory arrangements; and
- Registered advisers whose services or clients may pose a low risk of money-laundering activity, e.g., advisers to registered funds.
Additionally, FinCEN has asked whether it would be appropriate to tailor individual compliance requirements to reflect different forms of advisory services. Interested parties will have 60 days, or until October 25, 2015, to submit comments on the draft rule.
A copy of the Proposed Rule may be found here.