United States: FinCEN Issues Proposed Rule Requiring Investment Advisers To Establish Anti-Money Laundering Programs

On August 25, 2015, the Financial Crimes Enforcement Network (FinCEN) issued a notice of proposed rulemaking (NPRM) prescribing anti-money laundering (AML) program requirements for investment advisers required to be registered with the U.S. Securities and Exchange Commission (SEC). FinCEN, a bureau of the U.S. Treasury, administers regulations under the Bank Secrecy Act (BSA) requiring financial institutions to implement AML policies and procedures, keep records, and file reports on certain financial transactions.

The NPRM is not FinCEN's first attempt to establish AML requirements for investment advisers. Following enactment of the USA PATRIOT Act, which amended the BSA, FinCEN issued proposed rules in 2002 and 2003 to regulate certain investment advisers and unregistered investment companies, but subsequently withdrew the proposals in 2008 because, in part, the assets of investment advisers and unregistered investment companies were carried at financial institutions already subject to FinCEN rules.

According to the NPRM, however, the regulatory environment for investment advisers has changed since the passage of the Dodd-Frank Act in 2010, which required certain formerly unregistered advisers to hedge, private equity, and other private funds to register with the SEC. FinCEN therefore proposed the current NPRM within this new regulatory context out of continued concern that money launderers might seek out investment advisers as a way to enter the U.S. financial system (notwithstanding that many advisers provide services to FinCEN-regulated financial institutions).

We provide below a brief summary of the NPRM, which proposes three key regulatory changes: (1) including investment advisers within the scope of regulated entities, (2) requiring investment advisers to establish AML programs, and (3) requiring investment advisers to report suspicious activity to the U.S. government. Comments to the NPRM are due on or before November 2, 2015.

Scope of the NPRM—Defining Investment Advisers as Financial Institutions

Under the Bank Secrecy Act, FinCEN has the authority to establish AML requirements for "financial institutions." The NPRM proposes to define investment advisers registered with or required to be registered with the SEC pursuant to the Investment Advisers Act of 1940 as "financial institutions" subject to some—but not all—of FinCEN's AML requirements. Given SEC registration requirements, the rule would apply primarily to large-sized advisers—those with $100 million or more under management. Mid-sized and small-sized advisers are not permitted to register with the SEC, unless an exemption exists, and would therefore not be covered by the proposed rule. FinCEN has stated, however, that it reserves the power to extend the scope of the rule in the future to include other types of investment advisers, such as state-regulated investment advisers.

Investment advisers, as noted by FinCEN, provide advisory services to a variety of clients, including "individuals, institutions, pension plans, corporations, trusts, foundations, mutual funds, private funds, and other pooled investment vehicles." Covered investment advisers will include many different types of advisers, such as:

  • Dually registered investment advisers, and advisers that are affiliated with or subsidiaries of entities required to establish AML programs;
  • Certain foreign investment advisers;
  • Investment advisers to registered investment companies;
  • Financial planners;
  • Pension consultants; and
  • Entities that provide only securities newsletters and/or research reports.

According to the NPRM, investment advisers that already meet the definition of a class of financial institution (e.g., a broker-dealer) would not be required to establish a separate AML program "so long as a comprehensive AML program covers all of the entity's advisory" and other financial institution services.

Proposed AML Requirements for Covered Investment Advisers

The NPRM requires each covered investment adviser to implement a written AML program reasonably designed to prevent the investment adviser from being used to facilitate money laundering or terrorist finance, as outlined below.

AML Program Requirements. The written AML program must be approved by the adviser's board of directors, or if there is no board, the adviser's sole proprietor, general partner, trustee, or other person with authority similar to that of a board. The minimum requirements for a written AML program include:

  1. Development of internal policies, procedures, and controls;
  2. Designation of a compliance officer;
  3. An ongoing employee training program; and
  4. An independent audit function to test the program.

Of particular importance, FinCEN would require the AML program to be "risk-based," and tailored to the investment adviser's products and services. According to FinCEN, investment advisers should be able to adapt existing policies, procedures, and internal controls required by SEC rules to cover the additional AML requirements proposed in the NPRM. Thus, the NPRM concludes that investment advisers can build on their current SEC compliance programs. Given this goal, and the SEC's experience in this area, FinCEN proposes to delegate examination authority for compliance with such AML requirements to the SEC.

Suspicious Activity Reporting. The NPRM requires investment advisers to file SARs for "suspicious transactions that are conducted or attempted by, at, or through an investment adviser and involve or aggregate at least $5,000 in funds or other assets." Thus, investment advisers would be required to implement monitoring programs to review transactions for suspicious activity (such as a client account that shows a pattern of "inexplicable and unusual withdrawals, contrary to the client's stated investment objectives."). The SAR reporting requirements may present particular challenges for hedge funds and other, similar entities with active trading strategies.

Reporting and Recordkeeping. The NPRM also establishes a number of recordkeeping and reporting requirements for covered investment advisers:

  • Under FinCEN's Recordkeeping and Travel Rules, investment advisers must "create and retain records for transmittals of funds, and ensure that certain information pertaining to the transmittal of funds 'travels' with the transmittal to the next financial institution in the payment chain."
  • Whereas investment advisers were previously required to file Form 8300s for certain transactions, the NPRM would require advisers to file currency transaction reports (CTRs) instead for any transaction involving the transfer of more than $10,000 in currency during any one business day.

Key Considerations for Investment Advisers

The NPRM seeks comment on a number of specific issues as well as the proposed rule as a whole. In addition to addressing FinCEN's questions, we suggest that the following issues be considered when reviewing the NPRM.

Implementing a Risk-Based Program. One of the biggest challenges investment advisers will face under the proposed rule is designing and implementing an AML program that is appropriately tailored to address the AML risks of the adviser's geographic location, strategies, products, services, and customers. Although developing a "risk-based" program sounds simple in theory, the day-to-day application of this principle is difficult.

Under the rule, investment advisers must "risk-rate" their customers, and then design and implement controls to account for such risk. Applying rules originally drafted for banks will raise substantial issues when applied to investment advisers. For this reason, industry members subject to the proposed regulations should pay particular attention to definitions of "customers," "clients," and "investors."

While the NPRM does not require a formal customer identification program (CIP), the reality is that it will be difficult for investment advisers to implement risk-based programs without using a CIP to determine appropriate risk, except to the extent an investment adviser arranges to rely on the CIP used by an entity subject to the full AML program requirements, such as a bank or broker-dealer. Similarly, where the NPRM states that "the burden" of establishing an AML program will depend on the adviser's risk profile, many investment advisers will likely feel pressure to implement aggressive controls to minimize potential regulatory risk. The effect will be that investment advisers, like other regulated entities, may find it prudent for their AML compliance program to exceed what would otherwise be required by their actual risk profiles to avoid SEC scrutiny.

Delegation of Authority. The NPRM provides that an investment adviser may "delegate contractually the implementation and operation" of certain aspects of its AML program to agents or third-party service providers. The ability to delegate, however, which is also found in other FinCEN programs, has proved difficult to apply in practice. As explained by the NPRM, an investment adviser that delegates implementation of aspects of its program would remain "fully responsible for the effectiveness of the program." Thus, many financial institutions find that the ability to delegate provides limited benefit in terms of simplifying day-to-day operations and regulatory risk.

Costs of Implementation. The NPRM's regulatory analysis states that FinCEN expects investment advisers to spend an average of three hours establishing an AML program. This figure, in our estimation, greatly underestimates the time and effort that investment advisers will need to establish compliant AML programs. Proper implementation of an AML program includes a detailed analysis of business operations, identification of risk, careful tailoring of appropriate policies and procedures, and modifications or enhancements to current infrastructure, personnel, and technology. As noted above, "regulatory creep" will likely push investment advisers (especially larger ones) to implement comprehensive policies and procedures, including electronic monitoring software designed to monitor for suspicious activity. Establishing these programs will require the dedication of significant staff time and financial resources.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Check to state you have read and
agree to our Terms and Conditions

Terms & Conditions and Privacy Statement

Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

Use of www.mondaq.com

You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

Disclaimer

Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

Registration

Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.

Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

If you do not want us to provide your name and email address you may opt out by clicking here .

If you do not wish to receive any future announcements of products and services offered by Mondaq by clicking here .

Information Collection and Use

We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

Mondaq News Alerts

In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

Cookies

A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

Log Files

We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

Links

This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

Surveys & Contests

From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

Mail-A-Friend

If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

Security

This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

Correcting/Updating Personal Information

If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

Notification of Changes

If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

How to contact Mondaq

You can contact us with comments or queries at enquiries@mondaq.com.

If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.