ARTICLE
7 March 2024

What Investment Advisers Should Know About FinCEN's Proposed AML Requirements

AP
Arnold & Porter

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On February 15, the Financial Crimes Enforcement Network (FinCEN) published on the Federal Register a notice of proposed rulemaking that would add "investment adviser"...
United States Government, Public Sector

On February 15, the Financial Crimes Enforcement Network (FinCEN) published on the Federal Register a notice of proposed rulemaking1 that would add "investment adviser" to the definition of "financial institution" under the regulations implementing the Bank Secrecy Act (BSA) and thereby subject certain covered investment advisers to anti-money laundering (AML) requirements, including reporting, recordkeeping, record retention, Know Your Customer (KYC), and AML programs (the Proposal). In many cases, investment advisers already have in place AML/KYC programs (e.g., where they are a dually registered broker-dealer, a subsidiary of a bank or bank holding company, have been contracted by a broker-dealer to perform parts of its KYC obligations, or were complying with communication by the U.S. Securities and Exchange Commission (SEC) of supervisory expectations of an AML/KYC program at registered investment advisers). FinCEN intends for the Proposal to fill-in a gap in the existing AML regulatory framework created by the lack of comprehensive and uniform regulations requiring investment advisers to maintain AML programs or records under the BSA.

Who Would Be Covered?

The Proposal would add to FinCEN's regulations a definition of "investment adviser" that would include two types of investment advisers: (1) those that are registered or required to register (RIAs) with the SEC and (2) those that report to the SEC as Exempt Reporting Advisers (ERAs) (collectively, Covered Advisers). Notably, FinCEN indicated that its definition would cover RIAs and ERAs whose principal offices and places of business are outside of the U.S. (i.e., do not have a branch, office, or staff in the U.S.) with respect to their non-U.S. clients.

The Proposal would not apply to (1) state-registered investment advisers that are not eligible to register with the SEC, (2) foreign private advisers (who do not have a place of business in the U.S., have fewer than 15 U.S. clients and investors in private funds, and have less than US$25 million in assets under management relating to such U.S. client and investors), or (3) managers or advisers that are not "investment advisers."

What Does the Proposal Mean for Covered Advisers?

If the Proposal is adopted by FinCEN in its current form, it would create a regime of AML requirements for Covered Advisers that largely mirrors the existing requirements for banks and other BSA-defined financial institutions. First, Covered Advisers would be required to establish an AML program that includes, at a minimum, internal policies, procedures and controls, the designation of a compliance officer, an ongoing employee training program, an independent audit function to test programs, and ongoing customer due diligence (CDD). The AML program would be required to cover all advisory relationships with all types of clients (excluding mutual funds), including registered closed-end funds, private funds, sub-advisory relationships, and non-discretionary advisory relationships. Covered Advisers would also be required to file suspicious activity reports and currency transaction reports, collect and retain information on certain funds transfers and transmittals of funds, and comply with information sharing obligations with government agencies. It also would allow Covered Advisors to participate in information sharing with other financial institutions under 314(b) of the Patriot Act.

FinCEN would delegate the authority to examine Covered Advisers for compliance with the proposed rules to the SEC, which is consistent with the authority delegated to it in respect of broker-dealers. The Proposal would require Covered Advisers to implement an AML program not later than one year after the effective date of a final rule.

Takeaways

The Proposal follows a long history of proposed AML regulations for investment advisers. In 2003 and 2015, FinCEN issued proposed rulemakings to require certain investment advisers to establish AML programs. Neither proposal was finalized. Further, as described in a previous Advisory, in 2022, a bipartisan group of lawmakers, through the Establishing New Authorities for Businesses Laundering and Enabling Risks to Security Act (ENABLERS Act), attempted to expand the definition of "financial institution" under the BSA to include investment advisers. Amendments to the ENABLERS Act, however, later removed investment advisers from the list of covered professions, and the ENABLERS Act ultimately failed to pass both chambers of Congress.

Below are several considerations and key takeaways from the Proposal:

  • The Proposal is broader in scope and more demanding than FinCEN's previous proposed rulemakings. The 2003 proposed rule would not have required covered investment advisers to report suspicious activity. While the 2015 proposed rule would have required RIAs to maintain AML programs, report suspicious activity, and comply with other travel and recordkeeping requirements, it would not have included ERAs as financial institutions under the BSA.
  • Coverage of the Proposal to non-U.S. RIAs and ERAs with respect to their non-U.S. clients departs from the SEC's longstanding position regarding the extraterritorial application of the Investment Advisers Act of 1940 (Advisers Act). The SEC has stated that substantive provisions of the Advisers Act do not apply to non-U.S. RIAs with respect to their non-U.S. clients.2 The Proposal, if adopted, would impose AML obligations on non-U.S. RIAs with respect to both their U.S. and non-U.S. clients.
  • The Proposal would require that for non-U.S. Covered Advisers the duty to establish, maintain, and enforce the AML program remain the responsibility of, and be performed by, persons in the U.S. who are accessible to, and subject to oversight and supervision by, FinCEN and the SEC. Covered Advisers should consider how this requirement may impact the structure and location of their compliance function.
  • The Proposal would not require Covered Advisers to apply AML program or suspicious activity reporting requirements to mutual funds they advise. FinCEN expressed that it believed that such a requirement would be redundant given the lack of independent operations of mutual funds and the existing AML requirements imposed on mutual funds. This exemption, however, would be permissive; an investment adviser could decide to include the mutual funds it advises in complying with the proposed rules.
  • In anticipation of the revisions to the CDD Rule required by the Corporate Transparency Act, the Proposal would not require Covered Advisers to establish a customer identification program (CIP) or collect beneficial ownership information for legal entity customers. FinCEN anticipates addressing CIP requirements for Covered Advisers through a future joint rulemaking with the SEC.
  • FinCEN recognized the importance and cost-effectiveness of an enterprise-wide AML program. The Proposal would permit Covered Advisers to delegate implementation and operation of their AML programs, but not ultimate responsibility, to a third party (such as a fund administrator) or an affiliate (for an enterprise-wide AML program). This will be particularly important for smaller investment advisers who lack the internal compliance personnel.

FinCEN has requested comments on several aspects of the Proposal, as well as the appropriateness of the Proposal, in light of the nature of investment adviser activities and money laundering, terrorism financing, and other illicit finance risks associated with investment advisers. Comments on the Proposal must be submitted to FinCEN by April 15, 2024. Industry stakeholders interested in discussing investment adviser issues, submitting a comment letter to FinCEN, or establishing an appropriate AML program should contact any of the authors of this Advisory.

Footnotes

1. 89 Fed. Reg. 12,108 (Feb. 15, 2024).

2. SEC, "Exemptions for Advisers to Venture Capital Funds, Private Fund Advisers With Less Than $150 Million in Assets Under Management, and Foreign Private Advisers," Final Rule, Investment Advisers Act Release No. 3222 (Jun. 22, 2011), 76 Fed. Reg. 39,645, 39,667 (Jul. 6, 2011).

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.

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