The September 30, 2018, deadline for funds formed in the Cayman Islands to comply with the new requirement to designate natural persons as anti-money laundering (AML) officers – i.e., Anti-Money Laundering Compliance Officer (AMLCO), Money Laundering Reporting Officer (MLRO) and Deputy MLRO (DMLRO) (together AML Officers, and each an AML Officer) – is quickly approaching. What steps do Cayman funds need to take to comply with this new requirement? In a recent interview with The Hedge Fund Law Report, Walkers partner Lucy Frew discussed the new requirement arising from the Cayman Islands Anti-Money Laundering Regulations (2018 Revision) (2018 AML Regulations) to designate AML Officers, practical considerations for deciding whom to appoint to serve in these roles and steps that funds should take to ensure they comply with this requirement.
See our two-part series "CIMA Regulator Discusses Key Issues for Advisers That Manage Cayman Funds": AML, Fund Governance and the Cayman LLC (Sep. 7, 2017); and AIFMD Marketing Passport, Whistleblowers and Administrative Fines Regime (Sep. 21, 2017).
For additional insight from Walkers attorneys, see "Annual Walkers Fundamentals Seminar Highlights Trends in Investor Sentiment, Governance, Side Letters, Fund Structures, Investment Vehicles and Restructurings" (Jan. 11, 2018).
HFLR: The 2018 AML Regulations ushered in a number of changes to the AML regulations, including the requirement for certain funds formed in the Cayman Islands to appoint an AMLCO, MLRO and DMLRO. Which funds are required to comply with this new requirement?
Frew: The requirement to designate AML Officers applies to both open-end funds – e.g., hedge funds – and closed-end funds – e.g., private equity-type funds. This requirement applies regardless of whether the fund is registered with the Cayman Islands Monetary Authority (CIMA); therefore, it captures both"registered funds" and"unregistered funds."The requirement applies equally to feeder and master funds, but in practice, from a cost perspective, service providers providing AML Officers appear to be treating a master and feeder fund as a single structure.
It should also be noted that, to the extent that a Cayman Islands fund has a manager entity in the Cayman Islands, that entity would also be subject to this requirement.
HFLR: In light of the fact that this requirement is applicable to funds, and that most funds do not have their own employees, who is typically taking the lead to ensure compliance with this new requirement?
Frew: In practice, it is typically the fund manager assuming the responsibility of considering how to comply with this new requirement, although the directors of the fund will also need to approve and be comfortable with the approach being taken by the manager.
HFLR: The 2018 AML Regulations permit funds to delegate the performance of the functions of these roles. Accordingly, what options are available to fund managers when deciding whom to select to fulfill these roles?
Frew: When CIMA announced earlier this year that funds were required to designate natural persons to take on these AML Officer roles, there was initially some suggestion that only an independent service provider could serve in these roles. CIMA has since publicly clarified that funds have a lot of flexibility in determining the approach that suits them best. Therefore, we are seeing a number of different approaches being adopted by fund managers, with no single approach overtaking the others.
There is no requirement for the AML Officers to be located in the Cayman Islands. Some fund managers prefer to designate their own employees to serve in these roles. Fund directors – both independent directors and manager-appointed directors – are also eligible to provide these services to the fund. Third-party service providers are also taking on these functions, including some – but not all – of the fund administrator entities.
HFLR: When deciding whether to delegate this function to a third-party service provider or perform this function in-house, what are the key factors that are influencing the manager's decision?
Frew: Two of the primary factors affecting this decision appear to be the size of the manager and its resources. In many cases, larger managers are designating their own employees to carry out these roles for the fund. Once these managers understand what these roles entail, many of them find that they are already performing these functions to a large extent in practice; therefore, it makes sense for employees – often those that perform compliance functions – to take on these roles. Some managers also prefer to retain control over these functions because employees of the manager are already working with the administrator on a day-to-day basis in relation to these matters, and it makes sense to continue this process without inserting a third party into the process.
Where employees of the manager are assuming these roles, we have been supporting our clients by reviewing their existing AML policies and procedures and adding additional Cayman provisions or appendices, as needed, or else providing a separate Cayman policies and procedures manual to assist those employees to carry out their roles in respect of their funds, as well as providing training and ad hoc advice.
It is really the emerging managers, and perhaps also the mid-sized managers, that are less likely to have the resources to fill these roles with their own employees. In these cases, managers are looking to their administrators – assuming those administrators are offering this service – and to other third-party service providers to provide individuals to fulfill these roles. We offer professional AML officers through an affiliate in response to client demand. For those managers, having the extra layer of support and oversight provided by compliance professionals can provide reassurance and comfort for the manager and the board of directors.
HFLR: What are the primary responsibilities of the AMLCO, MLRO and DMLRO?
Frew: I think it is worth examining this question from two perspectives: the criteria for which types of individuals can serve in those roles and the actual responsibilities associated with those roles.
In terms of the criteria, I already mentioned that these individuals can be directors of the fund or employees of the investment manager, administrator or a third-party service provider. They do, however, need to be individuals operating at the managerial level, and they need to have specific knowledge with the Cayman Islands AML requirements.
We have received questions from fund managers regarding which employees of the manager could carry out these roles in practice. One issue to consider is whether serving as an AML Officer will conflict with the individual's other day-to-day duties. For example, if an individual's daily responsibilities entail introducing fund investors, then he or she may not be the best person to also serve as the MLRO or DMLRO. This is more likely to be an issue at smaller fund managers, where the adviser is less likely to have a separate compliance team and where senior level employees may need to serve in multiple roles.
The MLRO in particular needs to be the final decision maker about whether to file a suspicious activity report. Therefore, while that individual is not required to be independent of the fund or the investment manager, that person needs to be autonomous in his or her decision making. The MLRO will also need to have access to relevant material to carry out this role. The AMLCO should have sufficient skills, experience, authority and resources to perform the function, as well as access to the fund's board of directors.
Duties of MLRO
In terms of the actual responsibilities, let's start with the MLRO role, because in most cases, that is hopefully going to be a fairly passive role. The MLRO is a person to whom reports are made by others. If a member of the investment manager's staff, for example, were to come across grounds for suspicion of criminal conduct in relation to an investor in the Cayman fund, he or she should report that information to the MLRO. At that point, the MLRO would consider the matter, potentially conduct further investigation and decide whether the matter required the filing of a suspicious activity report (SAR) with the Cayman Islands Financial Reporting Authority (FRA). The template used to file the SAR, as well as the filing process itself, is fairly straightforward, and MLROs are permitted to seek the advice of legal counsel and discuss the matter with other individuals at the investment manager when making this decision.
One issue that periodically arises in connection with filing SARs is whether it will suffice to only make a report to the U.S. authorities. While the sorts of matters that might give rise to suspicion would be similar in the Cayman Islands as in the U.S., CIMA has clarified that a SAR does need to be filed with the FRA.
The MLRO is also required to maintain a register of any reports made to the MLRO.
Duties of DMLRO
The DMLRO essentially serves as a backup to the MLRO. If the MLRO is unavailable, then the deputy would be the person to whom reports are made. That individual would then have to make the decision about whether to report a matter to the FRA.
Duties of AMLCO
The role of the AMLCO is to oversee the fund's AML and counter-terrorist financing program. The AMLCO should be communicating regularly with management so that it can be satisfied that the obligations of the fund in relation to AML are being met and may act on any recommendations made by the AMLCO to ensure that sufficiently robust measures are being taken to protect the fund against money laundering and terrorist financing. The AMLCO is also responsible for making sure that the fund has adequate systems and controls in place to comply with the 2018 AML Regulations.
The AMLCO also has recordkeeping obligations relating to any business or investor declined for AML reasons, as well as information relating to high-risk persons – e.g., politically exposed persons or those who come from geographically risky areas – that are invested in the fund. The AMLCO is also the key point of contact for any requests for information by the relevant authorities in the Cayman Islands, and he or she will report periodically to the fund's directors.
It is important to understand that, while the AMLCO is responsible for ensuring that these items are being carried out, the AMLCO is not required to actually perform all of these duties. In cases where the fund has engaged an administrator, many of these responsibilities are already being carried out by the administrator on a day-to-day basis. For example, administrators routinely compare prospective investors against the AML watch lists, keep records on high-risk investors and conduct ongoing monitoring of existing investors.
It is the AMLCO's job to oversee these processes and ensure that the administrator is carrying out its job properly. Thus, from a practical perspective, the AMLCO's functions are likely to be fairly well aligned with the oversight role that managers and funds already perform.
Another duty that will likely fall to the AMLCO is the requirement to conduct a risk assessment of the fund. The administrator to the fund will typically conduct a risk assessment of the fund's investors when onboarding those investors. There is also an element of assessing the risks of the fund as a whole, however, and that is something that will
likely be the responsibility of the AMLCO on a day-to-day basis, as the administrator will only be aware of the risks relating to investors. Generally speaking, it is the fund manager who is going to be aware of any risks that might arise in relation to the fund's investment strategy from an AML perspective. While the AMLCO does not necessarily have to conduct the risk assessment, he or she will to need to ensure that the assessment is being conducted by appropriate personnel.
[See "CIMA Enumerates Best Practices for Hedge Fund Manager AML Programs" (Mar. 17, 2017).]
HFLR: For funds that elect to delegate these functions to a third party, what factors should they take into consideration when selecting a service provider? Also, from the fund's perspective, what types of representations and warranties would it want to ensure are included in the service agreements?
Frew: It makes sense to start out by reviewing the biographical information and the expertise of the specific individuals that would be designated as AML Officers for the fund. I would also urge managers to seek clarity on how the AML Officers will carry out their responsibilities in practice and how they will work with the manager. For example, some managers may want to be party to all communications between the AML Officers and the administrator, whereas other managers may take a more "hands-off" approach. In addition to looking at the arrangements on day one, it is worth looking at the extent to which the service agreement permits changes to the individual AML Officers or fees in the future and also ensuring that any caps on liability are commensurate with the manager's expectations.
There also needs to be a good level of cooperation between the AML Officers and the administrator; therefore, it is worth discussing with both parties how they plan to work together. As long as the administrators have the necessary authority from the applicable fund and manager to work with the third- party service provider, they are happy to cooperate.
[See "Fund Managers Must Supervise Third-Party Service Providers or Risk Regulatory Action" (Nov. 16, 2017); and "How Fund Managers Can Develop an Effective Third-Party Management Program" (Sep. 21, 2017).]
HFLR: Are the individuals that assume these roles opening themselves up to additional liability? If so, how can they protect themselves?
Frew: It is important to understand that there is no direct regulatory liability for the manager itself arising from having its employees taking on these roles. With that said, it is an offence under the Cayman Islands Proceeds of Crime Law for any person to have knowledge or suspicion of criminal activity and fail to report it to the MLRO or the FRA, as the case may be, but that offence applies regardless of whether one is an AML Officer or not.
The other aspect to consider is the 2018 AML Regulations. Those regulations do include offences for persons who contravene the regulations, and"person" is defined to include an entity as well as a natural person. Any contravention of the regulations could lead to fines of up to CI$500,000 or even to imprisonment. The AMLCO has a specific obligation under the 2018 AML Regulations to comply with his or her duties, but the 2018 AML Regulations also create a more general liability regime for any director, manager, secretary or other similar officer if an offence under the AML Regulations was committed with the consent or connivance of that person or was attributable to his or her neglect.
There is the potential under the regulations, therefore, for not only the fund itself, but its directors or certain officers to also be regarded as liable for an offence. This liability, however, is not specific to AML Officers. In fact, although AML Officers have the word"officer" in their titles, they are not regarded as officers for the purposes of Cayman Islands company law, where an officer is defined as a manager or a secretary, and they are not expected to be listed on the fund's register of directors and officers.
The commercial reality is that the fund has the ultimate responsibility for complying with its obligations under these regulations, notwithstanding the fact that the fund delegates the performance of these functions to another person. In all likelihood, therefore, in the event that there was a contravention by the fund of the regulations, the regulators would pursue the fund – and potentially the directors of the fund. This is why fund directors are keen to make sure that AML Officers are being appointed appropriately and that the individuals who are being designated are qualified to carry out those roles properly, because it is the directors that will ultimately be on the hook for violations.
Of course, while the fund manager may not have direct exposure to the regulator on this front, if a manager is delegated the responsibility of designating employees as AML Officers for the fund and fails to effectively carry it out, the fund could have potential commercial recourse against the manager.
HFLR: When does this new requirement come into effect, and what practical steps do funds need to take to ensure that they are in compliance with this new regulation?
Frew: September 30, 2018, is the deadline for existing funds. If there are any new funds that are launched between now and then, then they should aim to have the AML Officers in place at the launch of the fund. From a planning perspective, once it has been decided who is going to carry out these roles, then the actual onboarding and documentation can be dealt with quite quickly. With that said, managers and funds should take steps now to finalize this process to ensure that they have AML Officers in place by September 30 if they have not already done so.
Those funds that are registered with CIMA will need to file certain basic details of their AML Officers with CIMA using its online electronic REEFS portal. Funds that are not registered with CIMA do not have that filing obligation, but they do need to ensure that they have AML Officers in place.
In terms of documentation, regardless of whether the directors, fund manager, administrator or a third-party service provider are providing the AML Officers, there should be an agreement in place between the fund and the relevant entity, and there should also be fund resolutions approving the designation of the AML Officers. In circumstances where the manager is providing its own employees to fulfill these roles, the documentation may take the form of an amendment to the existing investment management agreement or a short standalone agreement.
The other document that managers will need to think about is the fund's offering memorandum. There had been some discussion about whether the names of the AML Officers would need to be contained in the offering memorandum. The regulator has decided that the offering memorandum should reference the fact that the fund has designated AML Officers and that further details are available upon request. The AML Officers do not need to be named, however, nor do their biographical details need to be provided in the actual document. The reference to the fact that AML Officers have been designated should be included in the next update to the fund's offering memorandum.
Originally published in The Hedge Fund Law Report.
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