On August 24, 2015, the U.S. Treasury Department’s Financial Crimes Enforcement Network (FinCEN) issued proposed rules (“Proposed Rules”) under the Bank Secrecy Act of 1970 (BSA) requiring certain investment advisers to develop and implement anti-money laundering (AML) policies and procedures and report suspicious activities to federal authorities. This is the second time FinCEN has issued proposed AML rules for investment advisers, having issued the initial proposed (but never adopted) rules in 2003. FinCEN argues that subjecting advisers to AML requirements closes certain “gaps in knowledge” of the financial system that “make it possible for money launderers to evade scrutiny” using investment advisory services. Covered investment advisers will face new AML policy, reporting and record-keeping requirements, with implications for money managers, as well as advisers to hedge, private equity, real estate and other funds.
Comments will be accepted for 60 days after the Proposed Rules are published in the Federal Register. After the comment period, the Proposed Rules will be finalized after review of the submitted comments.
Who is Covered?
FinCEN added the term “investment adviser” to the list of “financial institutions” subject to AML requirements. The definition of an “investment adviser” covers “[a]ny person who is registered or required to register” with the U.S. Securities and Exchange Commission (SEC) pursuant to the Investment Advisers Act of 1940 (Advisers Act). Generally speaking, this would include all advisers (including sub-advisers) that have $100 million or more in regulatory assets under management (AUM), as defined in the Advisers Act. This affects all types of advisers, such as financial planners, money managers, dual-registered broker-dealer/advisers, registered investment company advisers, pension consultants, private fund advisers and entities that provide only securities research reports and analyses.
At this time, the Proposed Rules do not include private fund advisers with less than $150 million in AUM that are exempt from registration with the SEC. However, FinCEN has specifically requested comments as to whether such “exempt reporting advisers” should also be subject to the BSA.
What AML Policies and Procedures Are Required?
The Proposed Rules require an adviser to implement an AML program “reasonably designed” to (i) “prevent the investment adviser from being used for money laundering or the financing of terrorist activities” and (ii) ensure compliance with BSA reporting and record-keeping requirements.
FinCEN specifically stated in the Proposed Rule that there is no “one-size fits all” program and cautioned that different types of advisers are subject to different levels of AML risk, depending on the nature of the services provided and the clients. Accordingly, the design of an AML program should be risk-based, addressing the particular hazards the adviser identifies after examining its business. For example, FinCEN views the AML risks inherent to providing advisory services to registered open-end funds (mutual funds) to be relatively low compared to advisory services provided to individuals or through separately managed accounts. Additionally, advisers to private funds may have increased AML risk due to the lack of transparency with respect to the entities that invest in such funds.
Proposed Rules expect an AML program to meet four minimum requirements:
1. Establish written internal policies, procedures and controls designed to address all the advisory activities of the adviser (whether acting as a primary adviser or sub-adviser);
2. Provide for independent testing of the AML program (by third parties or internal personnel not involved in the day to day operation of the AML program);
3. Designate a person or persons knowledgeable and competent regarding AML rules to be a compliance officer; and
4. Provide ongoing training for firm personnel with respect to the AML rules, the adviser’s AML program and the red flags that may give rise to a reporting obligation.
The AML program must be approved in writing by the board of directors or general partner of an adviser, or those persons with similar functions. AML compliance can be outsourced; however, FinCEN cautions advisers that they will be held responsible for the efficacy of the adopted AML program, regardless of the use of third parties.
FinCEN expects that many advisers will simply adapt their existing AML policies and procedures to comply with the Proposed Rules. Since it is highly likely that FinCEN will adopt the Proposed Rules with few changes, a best practice would be to begin examining current AML programs in light of these new requirements.
As a consequence of being included in the list of “financial institutions” subject to BSA and FinCEN’s AML rules, advisers for the first time will be required to report suspicious activity and maintain records in accordance with such rules. Advisers will need to report “suspicious transactions” involving $5,000 or more in cash or other assets by filing a Suspicious Activity Report (SAR) with FinCEN. Suspicious transactions include any transaction (or patterns of transactions of which a transaction is a part) that the adviser knows, suspects or has reason to suspect (i) involves funds derived from illegal activity or is intended to hide funds or other assets derived from illegal activity; (ii) is designed to evade BSA requirements; (iii) has no business or apparent legal purpose; or (iv) uses the adviser to facilitate criminal activity.
An SAR would be filed within 30 days of an adviser’s becoming aware of a suspicious transaction. Such a filing is mandatory; however, voluntary filings are also permitted if suspicious transactions are suspected by the adviser. Failure to adopt an AML program that provides for identification of suspicious transactions and prompt filing of SARs can result in both civil liability and criminal prosecution. Recent criticism by the SEC of inadequate SAR filings by broker-dealers indicates that the adviser should prepare to adopt robust programs to avoid penalty. The SAR filing must be kept confidential by the adviser, even from the client or prospective client that is the target of the SAR filing.
In addition to SAR filings, the Proposed Rules require an adviser to file Currency Transaction Reports (CTRs) for transfers of more than $10,000 in currency (in any single business day) by, through or to the adviser. Multiple transfers by or on behalf of the same person should be treated as a single transfer and reported. The CTR replaces the required Form 8300, and transactions involving negotiable instruments would no longer be required to be reported.
Subject to certain exemptions, the Proposed Rules require advisers to create and retain records of certain fund transmittals in excess of $3,000, as well as any extensions of credit and cross-border transfers of currency, monetary instruments, checks, investment securities and credit. Information concerning such transmissions must “travel” to the next financial institution.
The Proposed Rules also require advisers to maintain for five years records of the AML program, SAR and CTR filings and fund transmittals. Advisers are required to respond to information requests from U.S. law enforcement and identify dealings with any person about whom the information is sought.
An adviser’s AML program will need to accommodate these rules and provide training for appropriate personnel in order to meet the requirements in the Proposed Rules.
No CIP Requirements … Yet
Noticeably absent from the Proposed Rules is a requirement that advisers implement a Client Identification Program (CIP), such as those required of other “financial institutions.” A CIP requirement would necessitate verification of the identity of clients and the beneficial owners of clients/investors that are legal entities. Most advisers require new clients or fund investors to provide such information, and typically demand evidence of the identity of the client and the source of the funds. Needless to say, the application of a CIP requirement may require more extensive measures in verifying the provided identity especially if the risk factors associated with the advisory service, the investment or the client are higher. If a CIP is required, advisers may elect to hire a third-party vender to provide the verification services.
FinCEN states in the Proposed Rules notice that they are seeking comments on whether such a CIP requirement should be adopted for investment advisers. We will continue to monitor FinCEN’s actions and statements on this point as comments are received.
Duplication and Delegation
FinCEN notes that many advisers are either affiliated or work in tandem with other financial institutions subject to the BSA and the AML rules. If an adviser is dually registered as an investment adviser and broker-dealer, the entity can have a single AML program, provided that the program addresses all the services provided by and the risks inherent to both the advisory business and the broker-dealer.
An adviser may delegate contractually the implementation and operation of certain aspects of its AML program to another financial institution, provided that, as with a third-party service provider, the adviser remains ultimately responsible for the efficacy of the program with respect to the AML risks of its business.
FinCEN intends to delegate authority to the SEC to examine registered investment advisers to ensure compliance with the Proposed Rules and the requirements under the BSA.
Most investment advisers, both registered and unregistered, already have AML programs in place designed to identify clients and protect the adviser from being used for money laundering or terrorist financing. As FinCEN has suggested, adapting existing AML programs to accommodate new requirements under the BSA should prove easier than establishing a program from scratch. However, few advisers have historically contemplated SARs and CTR filings since those requirements did not apply. Investment advisers should begin to consider how their current AML programs can be revised to accommodate this new and fairly significant requirement imposed by FinCEN.
If you have any questions about the impact of the Proposed Rules or the AML requirements under the BSA generally, please contact us.
Myrna H. Rooks