On August 25, 2015, the Financial Crimes Enforcement Network (“FinCEN”), a bureau of the U.S. Treasury Department, issued aproposed rule requiring all financial institutions, including registered investment advisers, to implement and monitor anti-money laundering (“AML”) programs. Other types of financial institutions, such as banks and broker-dealers, have long been required to meet AML requirements. This program will close what FinCEN calls a “big hole” in the regulatory structure that would allow clients to move or deposit dirty money without attracting much attention. Examination and enforcement authority for the rule will be delegated to the Securities and Exchange Commission (“SEC”).
The proposed rule has 3 components:
- Include investment advisers within the general definition of “financial institution” in the regulations implementing the Bank Secrecy Act (“BSA”) and adding a definition of investment adviser;
- Requiring investment advisers to establish AML programs; and
- Requiring investment advisers to report suspicious activity.
Compliance with the proposed rule is required for any firm registered or required to register with the SEC under Section 203 of the Investment Advisers Act of 1940. This includes all advisers and subadvisers. Currently, firms that are exempt from SEC registration will also be exempt from this rule. Firms required to comply must establish an internal AML program; an effective program will include, at minimum:
- Development of internal policies, procedures and controls;
- Designation of a compliance officer;
- Implementation of an ongoing employee training program; and
- Independent audit function to test the effectiveness of these programs.
Previously, financial institutions with AML requirements were obligated to file FinCEN Form 8300. This form required financial institutions to report on the receipt of over $10,000 in cash or negotiable instruments. Under the proposed rule, this form would be replaced with a Currency Transaction Report (“CTR”). A CTR is required for transfers of more than $10,000 by, through or to a financial institution. Firms would also be required to create and retain records for extensions of credit and cross-border transfers of currency, monetary instruments, checks and investment securities over $10,000. Furthermore, any questionable transaction above the Suspicious Activity Report (“SAR”) threshold that involves, in the aggregate, at least $5,000 in funds or other assets would require advisers to file an SAR. Suspicious activities are transactions that an adviser knows or believes to:
- Involve funds from illegal activity or is intended to disguise funds or assets derived from illegal activity;
- Is designed to evade the requirements of the BSA;
- Has no business or apparent lawful purpose, and the investment adviser knows of no reasonable explanation for the transaction;
- Involves the use of the investment adviser to facilitate criminal activity; or
- A client who, among others:
- Exhibits unusual concern regarding the adviser’s compliance with government reporting requirements or is reluctant to provide information on its business activities;
- Appears to be acting as an agent for another entity and is reluctant to provide responses to questions about that entity;
- Shows a pattern of unusual withdrawals inconsistent with investment objectives; or
- Exhibits a total lack of concern for returns or risk.
Although it remains to be seen which parts of the proposed rule will make it into the final rule, there are a few things to note:
- Advisers that are required to comply will be burdened with additional compliance policies and programs, client background checking and recordkeeping and SEC/FinCEN reporting;
- Although advisers could argue that financial institutions subject to AML requirements carry and conduct all financial transactions for them, FinCEN counters that those financial institutions lack appropriate access to detailed client information required for a thorough check; and
- While the proposed rule may only apply to advisers required to register with the SEC currently, the amendment to include exempt and state registered advisers is believed to follow.