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06 October 2015
On September 1 2015 the US Treasury's Financial Crimes Enforcement Network (FinCEN) published a notice of proposed rulemaking prescribing anti-money laundering (AML) requirements for investment advisers that are registered or required to be registered with the Securities and Exchange Commission (SEC).(1) The requirements include establishing an AML programme and reporting suspicious activity. In addition, FinCEN proposes to include investment advisers within the general definition of 'financial institution' in rules implementing the Bank Secrecy Act, which would require them to file currency transaction reports and maintain records relating to the transmittal of funds, among other things. The authority to examine investment advisers for compliance with these AML requirements would be delegated to the SEC.
The proposed rule addresses concerns that money launderers and other illicit actors seeking to access the US financial system may attempt to gain entry through an investment adviser because they are subject to fewer AML controls than other financial institutions, such as broker-dealers and banks. The proposed rule would subject investment advisers to rules similar to those affecting other financial institutions under the Bank Secrecy Act and would make it more difficult for criminals to evade scrutiny by operating through investment advisers.
The proposed rule does not include a customer identification programme requirement or the customer due diligence requirements for financial institutions that were proposed on August 4 2014.(2) These issues, as well as other potential AML requirements, are anticipated to be addressed by FinCEN in subsequent rulemakings, with the customer identification programme requirements addressed in a joint rulemaking with the SEC. Comments on the proposed rule are due on or before November 2 2015.
This update describes the basic requirements of the proposed rule and discusses some of the issues on which FinCEN has solicited comments. Investment advisers should consider the changes they might need to make to their existing AML programmes if the proposed rule is adopted as proposed. In addition to adding sections to cover new requirements, such as responding to Section 314(a) information requests from FinCEN, significant enhancements may be necessary in the areas of suspicious activity monitoring and reporting, employee training, independent testing and client risk assessments. Investment advisers that have delegated AML functions to third-party service providers may also need to re-evaluate whether these outsourced functions are being performed to FinCEN standards.
FinCEN is authorised to issue regulations to implement the Bank Secrecy Act, as amended by the USA Patriot Act, which would impose AML compliance obligations on financial institutions.(3) Pursuant to this authority, on May 5 2003, FinCEN published a proposed rule requiring certain investment advisers to establish AML programmes.(4) This rule followed another FinCEN proposed rule that was published on September 26 2002, requiring unregistered investors to establish AML programmes. These two proposed rules were eventually withdrawn by FinCEN in November 2008 due to the amount of time that had elapsed since the initial proposal of the rules, and to allow FinCEN to take a fresh look at potentially applicable Bank Secrecy Act regulations.
The regulatory landscape for investment advisers has since changed. As a result of the Dodd-Frank Act amendments to the Investment Advisers Act of 1940, formerly unregistered advisers to hedge funds, private equity funds and other private funds must now register with the SEC. Therefore, FinCEN believes that the two-prong approach of the previously proposed – and subsequently withdrawn – rules is no longer necessary. Most of the issuers captured under the previously proposed rule requiring unregistered investors to establish AML programmes will now be included in the AML programmes of investment advisers under the new single proposed rule.
The Bank Secrecy Act and its regulations do not expressly list 'investment adviser' among the entities that fall within the definition of 'financial institution'.(5) However, the secretary of the Treasury may include additional types of business within the definition of 'financial institution' if they engage in any activity that is similar or relating to, or a substitute for, any of the listed entities. In that regard, investment advisers offer services that are similar or relate to those offered by broker-dealers, banks and insurers, which are Bank Secrecy Act-defined 'financial institutions'. Such activities include:
The close relationship between investment advisers and other Bank Secrecy Act-defined 'financial institutions' is further evidenced by the fact that investment advisers are often dually registered as, or are affiliated with, broker-dealers. Accordingly, under the proposed rule, FinCEN proposes to add 'investment adviser' to the list of entities falling within the general definition of 'financial institution' that is set forth in the FinCEN regulations.(6) 'Investment adviser' would be defined as any person that is registered or required to be registered with the SEC under Section 203 of the Investment Advisers Act of 1940, including both primary advisers and sub-advisers.(7)
Large advisers with $100 million or more in regulatory assets under management are required to register with the SEC, unless an exemption from registration is available. Mid-sized advisers with $25 million or more but less than $100 million and small advisers with less than $25 million in regulatory assets under management are generally prohibited from registering with the SEC and are instead state-regulated (although some mid-sized advisers are required to register with the SEC). Therefore, large advisers are generally included in the proposed rule's definition of 'investment adviser' and mid-sized and small advisers are generally excluded. FinCEN may consider future rulemakings that expand the application of the Bank Secrecy Act to state-regulated investment advisers or investment advisers that are exempt from SEC registration.
The inclusion of investment advisers within the definition of 'financial institution' would subject them to:
Currency transaction reporting
All investment advisers are currently required to file Form 8300 to report the receipt of more than $10,000 in cash and negotiable instruments. The proposed rule replaces this requirement for investment advisers with a requirement to file currency transaction reports. A currency transaction report must be filed for any transaction involving a payment or transfer of more than $10,000 in currency by, through or to the investment adviser during any one business day. Multiple transactions must be treated as a single transaction if the financial institution knows that the transactions were conducted by or on behalf of the same person. Investment advisers will no longer be required to report applicable transactions involving certain negotiable instruments that were reportable on Form 8300.
Transmittals of funds and other record-keeping requirements
The Bank Secrecy Act imposes on financial institutions certain record-keeping and travel rules that apply to transmittals of funds equalling or exceeding $3,000. Under the proposed rule, investment advisers must create and retain certain records regarding each transmittal of funds of $3,000 or more and ensure that certain information travels with the transmittal to the next financial institution in the payment chain. The information required to be collected and retained depends on the financial institution's role in the particular funds transfer (eg, the transmitter's financial institution, an intermediary financial institution or the recipient's financial institution). A 'transmittal of funds' includes funds transfers that are processed by banks, as well as similar payments where one or more of the financial institutions processing the payment is not a bank.
In addition, the proposed rule requires investment advisers to create and retain records for extensions of credit and cross-border transfers of currency, monetary instruments, checks, investment securities and credit in amounts exceeding $10,000.
Information sharing with government and other financial institutions
The proposed rule subjects investment advisers to special information-sharing procedures to detect money laundering or terrorist activity pursuant to Sections 314(a) and 314(b) of the USA Patriot Act. On receiving a Section 314(a) request from FinCEN, investment advisers are required to search their records to identify accounts or transactions of named persons suspected by law enforcement agencies of engaging in money laundering or terrorist financing. Section 314(b) allows financial institutions to voluntarily share information with other financial institutions subject to an AML programme requirement in order to identify and report activities that may involve money laundering or terrorist activity. A financial institution that shares such information receives protections from civil liability and must file an annual notice of sharing with FinCEN.
The proposed rule requires investment advisers to establish a written AML programme. The programme must be approved in writing by the board of directors or trustees or if there is no such board, by the sole proprietor, general partner, trustee or other persons with functions that are similar to those of a board of directors. The programme must also be made available to FinCEN or the SEC on request.
Four minimum elements are required of an AML programme:
The AML programme should be tailored to address the specific risks of the investment adviser's advisory services and clients. FinCEN expects the programme to cover all advisory activities, including:
Client risk assessment
The investment adviser must assess the money-laundering and terrorist financing risks that are posed by a client by evaluating the relevant risk factors. For example, if the client is an individual, relevant factors may include the source of funds and jurisdiction in which the client is located. If the client is an entity, relevant factors may include the type of entity, jurisdiction of location and the statutory and regulatory regime of that jurisdiction. Other relevant factors, such as the investment adviser's historical experience with the client and references from other financial institutions, may also be considered. The policies, procedures and controls should be reasonably designed to manage clients that present higher risks.
The proposed rule also discusses FinCEN's expectations for risk assessments that are relevant to specific types of advisory client. For example, in the case of non-pooled investment vehicle clients, the risk assessment should consider the types of account offered (eg, managed accounts), the types of client opening such accounts and how the accounts are funded. Mutual fund clients that are subject to FinCEN's rules implementing the Bank Security Act may present lower risks. Advisory services to registered closed-end funds may also present lower risks since purchases and sales of fund shares are executed through banks and broker-dealers with established Bank Security Act or AML programmes. Where the investment adviser is the primary adviser to a private fund, the adviser must assess the risks that are presented by the underlying investors in the fund.
Comprehensive AML programmes
Investment advisers that are dually registered with the SEC as investment advisers and broker-dealers in securities are not required to establish multiple or separate programmes, provided that a comprehensive AML programme covers both activities and the respective AML obligations. Similarly, an investment adviser that is affiliated with, or a subsidiary of, an entity that is required to establish an AML programme may implement a single comprehensive AML programme covering all of the activities and businesses that are subject to the Bank Secrecy Act and its regulations.
Delegation of duties
An investment adviser may contractually delegate the implementation of certain aspects of its AML programme to other financial institutions that have separate AML programme requirements, or to agents or third-party service providers. However, the investment adviser will remain fully responsible for the effectiveness of the programme and for ensuring that FinCEN and the SEC have access to information and records relating to the AML programme. It is not acceptable to delegate responsibility for an AML programme in its entirety to a third party.
The proposed rule requires investment advisers to implement an appropriate AML programme on or before six months from the effective date of the final regulation. Some investment advisers have already implemented AML programmes – either voluntarily or as a result of the SEC no-action letter that permits broker-dealers to rely on investment advisers to perform some or all aspects of the broker-dealer's customer identification programme obligations.(8) These investment advisers should ensure that their existing policies and procedures are amended where appropriate to meet the new AML programme requirements.
The proposed rule requires investment advisers to report suspicious activity to FinCEN to provide useful information for investigations involving money laundering, terrorist financing, fraud and other financial crimes. Specifically, an investment adviser is required to report a transaction if:
In addition to such mandatory reporting, investment advisers may voluntarily report a suspicious transaction even if it does not meet the criteria for mandatory reporting (eg, in the case of a transaction that is below the $5,000 threshold). The proposed rule provides protection from civil liability for making either mandatory or voluntary reports of suspicious transactions.
Investment advisers must evaluate client activity and relationships and design a suspicious transaction monitoring programme that is appropriate for their money laundering and other financial crime risks. Investment advisers may therefore need to assess whether their monitoring systems and processes effectively detect all types of suspicious activity that must be reported under the new requirements.
Filing and notification procedures
A suspicious transaction is reported to FinCEN by filing a suspicious activity report (SAR) no later than 30 days after the date of initial detection by the investment adviser that the transaction is suspicious. If no suspect can be identified on the date of initial detection, the SAR may be delayed an additional 30 days to identify a suspect, but in no case may reporting be delayed for more than 60 days after initial detection. For situations requiring immediate attention, such as suspected terrorist financing or ongoing money laundering schemes, the investment adviser must immediately notify an appropriate law enforcement authority in addition to filing a timely SAR. Suspicious transactions that may relate to terrorist activity may also be voluntarily reported to FinCEN's Resource Centre in addition to filing a timely SAR.
The investment adviser should retain copies of filed SARs and the original (or business record equivalent) of any related supporting documentation for five years from the filing date. Supporting documentation must be made available to FinCEN or a federal, state or local law enforcement agency, or any federal regulatory authority that examines the investment adviser for compliance with the Bank Secrecy Act, on request.
In cases where more than one investment adviser or another financial institution with a separate suspicious activity reporting obligation is involved in the same transaction, only one report need be filed. Either the investment adviser or the other financial institution can file a single joint report, provided that it contains all relevant facts and each institution maintains a copy of the report and any supporting documentation.
Confidentiality of SARs
As a general rule, no investment adviser and no current or former director, officer, employee or agent of any investment adviser may disclose a SAR or any information that would reveal the existence of a SAR. Any person that is subpoenaed or otherwise requested to disclose a SAR or any information that would reveal its existence must decline the request and notify FinCEN. This general prohibition should not, however, be construed as prohibiting the following (as long as no person that is involved in the reported suspicious transaction is notified that the transaction has been reported):
Delegation of requirements
Investment advisers are permitted under the proposed rule to delegate their suspicious activity reporting requirements to an agent or a third-party service provider. However, the investment adviser remains responsible for compliance with the suspicious activity reporting requirements, including the requirements to maintain SAR confidentiality.
The suspicious activity reporting requirements would apply to transactions initiated after the implementation of the investment adviser's AML programme. However, investment advisers are encouraged to begin filing SARs as soon as practicable on a voluntary basis upon the issuance of the final rule.
In addition to the aspects of the proposed rule discussed above, FinCEN has specifically asked for comments on certain issues, including the following:
As noted above, all comments on the proposed rule must be submitted to FinCEN on or before November 2 2015.
For further information on this topic please contact Connie M Friesen at Sidley Austin LLP by telephone (+1 212 839 5300) or email (email@example.com). The Sidley Austin LLP website can be accessed at www.sidley.com.
(1) The proposed rule is available at http://www.gpo.gov/fdsys/pkg/FR-2015-09-01/pdf/2015-21318.pdf.
(2) See 79 Fed Reg 45151 (August 4 2014), available at http://www.gpo.gov/fdsys/pkg/FR-2014-08-04/pdf/2014-18036.pdf.
(3) See 31 USC 5311 et seq, 12 USC 1829b and 1951-1959; Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (USA Patriot Act), (Pub L No 107-56).
(7) Generally, the primary adviser contracts directly with the client and a sub-adviser has contractual privity with the primary adviser. With respect to such a shared client, an advisory contract may grant the primary adviser the discretionary authority to retain and dismiss a sub-adviser. Other advisory contracts may permit the primary adviser only to recommend a sub-adviser to such a client, with the client retaining the authority to hire or dismiss a sub-adviser.
(8) Under the SEC's no-action letter that was re-issued in consultation with FinCEN on January 9 2015, a broker-dealer in securities is permitted to rely on an investment adviser to perform all or part of its customer identification programme obligations with regard to shared clients as if the investment adviser were already subject to an AML programme rule, provided that the other requirements of customer identification programme reliance are met. For further details see SEC, Division of Trading and Markets, Request for No-Action Relief under Broker-Dealer Customer Identification Rule (31 CFR 1023.220), (January 9 2015).
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