The Financial Crimes Enforcement Network (FinCEN) has issued a proposed rule that would subject certain investment advisers to AML requirements under the Bank Secrecy Act (the BSA). In proposing the rule, FinCEN cited concerns that investment advisers could be exploited by money launderers to gain access to the U.S. financial system.
This client alert provides an overview of (i) which investment advisers would be subject to the proposed rule, (ii) the AML program requirement investment advisers would become subject to under the proposed rule, (iii) the reporting and recordkeeping requirements, including the suspicious activity report (SAR) requirement, investment advisers would need to comply with, and (iv) how investment advisers will be examined for compliance with these requirements.
Investment Advisers Subject to the Rule
The proposed rule would apply only to investment advisers that are registered or required to be registered with the SEC under Section 203 of the Investment Advisers Act of 1940, as amended. FinCEN has requested comment on whether other investment advisers should be subject to an AML program requirement.
AML Program Requirements
If the proposed rule is adopted, an investment adviser would need to establish an AML program that meets the following requirements:
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Written AML Program. Investment advisers would be required to develop a written AML program reasonably designed to prevent the investment adviser from being used to facilitate money laundering or terrorist financing and to comply with applicable provisions of FinCEN’s regulations. The program would need to be approved by the investment adviser’s board of directors or, if the investment adviser does not have a board of directors, by its sole proprietor, general partner, trustee or persons that exercise similar functions. The AML program must cover all of the investment adviser’s advisory activity, which means that an investment adviser would need to address in its AML program relationships in which it acts as a sub-adviser even if there is another investment adviser with responsibility for the account that is subject to an AML program requirement. In addition, investment advisers that provide advice to various types of funds, including registered investment companies and private funds, would need to take into account the money laundering risks of those relationships. FinCEN has stated that it expects that the money laundering risks associated with acting as an investment adviser to a registered, open-end investment company would be low since these types of mutual funds are subject to FinCEN’s rules implementing the BSA. Similarly, FinCEN has explained that acting as an investment adviser to a registered closed-end investment company would likewise present a low risk for money laundering since purchases and sales of shares of these types of closed-end funds are typically executed through a broker-dealer or other financial institution. However, investment advisers to private funds would need to make an assessment of the risks posed by investors in the funds. An investment adviser could delegate the performance of functions related to its AML program to a third party, including an affiliate, however, FinCEN has stated that the adviser will remain “fully responsible” for the effectiveness of its AML program.
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AML Officer. Investment advisers would be required to designate a person or persons responsible for implementing and monitoring the AML program. The responsible parties should be knowledgeable and competent regarding FinCEN’s regulatory requirements and the adviser’s business and money laundering risks. The officer responsible for AML compliance may have other responsibilities depending on the size and type of advisory services the adviser provides and the extent of those other responsibilities.
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Independent Testing. Investment advisers would be required to obtain independent testing of the AML program on a periodic basis. This testing need not be performed by an outside party but could be done internally, so long as it is not performed by persons responsible for overseeing or operating the AML program.
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Ongoing Training. The investment adviser’s employees will have to undergo AML training on a regular basis.
Although some investment advisers may have voluntarily implemented an AML program, if the proposal is adopted, advisers that become subject to an AML program requirement may need to revise their existing programs to meet these minimum requirements.
Customer Identification Programs
The proposed rule would not require investment advisers to implement a customer identification program (CIP) or require investment advisers to identify beneficial owners of legal entity customers. However, FinCEN has stated that it anticipates addressing these requirements in a separate rulemaking and has requested comment on whether investment advisers should be subject to a CIP requirement. In addition, the notice that accompanied the release of the proposed rule is silent on whether a bank or broker-dealer may rely on an investment adviser to perform certain procedures of the bank’s or broker-dealer’s CIP and does not address the circumstances in which reliance on an investment adviser may be reasonable. However, since FinCEN has proposed including certain investment advisers within the definition of “financial institution” for purposes of its regulations implementing the BSA and has proposed exercising its authority under the BSA to require these investment advisers to implement AML programs, it appears that a bank or broker-dealer would be permitted to rely on an investment adviser required to implement an AML program if the proposal is adopted, provided all of the other requirements for reliance are met. We expect that FinCEN will receive comments requesting clarification on this point.
Reporting and Recordkeeping Requirements
Since the proposed rule would include investment advisers within the definition of “financial institution” for purposes of FinCEN’s rules implementing the BSA, investment advisers would become subject to certain recordkeeping and reporting requirements.
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Suspicious Activity Reports. The proposed rule would require investment advisers to file a SAR with FinCEN with respect to any transaction that involves or aggregates at least $5,000 in funds or other assets when the investment adviser knows, suspects or has reason to suspect that the transaction involves funds derived from illegal activity, is designed to evade reporting requirements, has no business or apparent lawful purpose or involves the use of the investment adviser to facilitate criminal activity. An investment adviser must not disclose the existence or nonexistence of a SAR filing unless permitted to do so by law. Furthermore, the proposed rule would not permit investment advisers to share SARs within their corporate structure, such as with an affiliated bank or broker-dealer, but FinCEN has solicited comment on this topic and has acknowledged the need to issue additional guidance. SARs and related documentation must be kept on file for five years from the date of filing. In order to comply with the SAR requirement, investment advisers will need to implement customer due diligence procedures and monitor customer activity in order to identify suspicious activity.
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Currency Transaction Reports. An investment adviser will be required to file a currency transaction report (a CTR) with respect to any transaction involving a payment or transfer of more than $10,000 in currency by, through or to the investment adviser (including such transactions in foreign currency having an equivalent value and including multiple transactions structured to avoid the reporting requirement). This requirement will replace the current obligation to file Form 8300 to report certain transactions involving negotiable instruments having a value of more than $10,000.
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Recordkeeping and Travel Rules. An investment adviser would be required to create and retain records relating to transmittals of funds, and ensure that the transmittor’s name, address, and other information pertaining to the transmittal of funds “travel” with the transmittal to the next financial institution in the payment chain. These rules would also require an investment adviser acting as a transmittor’s financial institution or recipient’s financial institution to obtain or retain certain identifying information on the recipient. Also, investment advisers would have to create and retain records regarding cross-border transactions of currency, monetary instruments, checks, investment securities, and credit above $10,000.
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Information Sharing Rules. Investment advisers designated as financial institutions under the proposed rule would become subject to the requirements in FinCEN’s rules implementing Sections 314(a) and 314(b) of the USA PATRIOT Act relating to information sharing between financial institutions and the government and information sharing among financial institutions. Section 314(a) permits FinCEN to require financial institutions to search their records for information related to accounts maintained by or transactions conducted with persons suspected by law enforcement of engaging in terrorist activity or money laundering. Section 314(b) provides a safe harbor from liability that enables two or more financial institutions and any association of financial institutions to share information with one another regarding individuals, entities, organizations and countries suspected of possible terrorist or money laundering activities if the information is transmitted, received or shared for the purposes of detecting, identifying or reporting activities involving possible money laundering or terrorist activities.
SEC Examination Power
The proposed rule would delegate FinCEN’s authority to examine investment advisers for compliance with FinCEN’s requirements to the SEC.
Comment Submission
Anyone may submit comments on the proposed rule by mail or through the Federal E-rulemaking Portal (http://www.regulations.gov), referencing Docket Number FINCEN-2014-0003. Comments will be due 60 days after the notice of the proposed rule is published in the Federal Register.
