The US Treasury issued proposed rules on Tuesday to subject certain investment advisers to anti-money laundering program rules, though it stopped short of extending such requirements to smaller operations below a key threshold.
The notice of proposed rulemaking (NPR) by the Financial Crimes Enforcement Network (FinCEN) would cover investment advisers that must be registered with the Securities Exchange Commission (SEC), including advisers to a range of hedge funds, private equity funds and other private funds. For the first time, these entities would be required to implement anti-money laundering (AML) program duties such as filing customer transaction reports (CTRs) and suspicious activity reports.
The proposed rule, however, does not include customer due diligence duties, and won’t extend to advisers that don’t have to be registered with the SEC, meaning those with assets under management of less than $100 million. To read the NPR, please click here.
The proposed rulemaking would “address money laundering vulnerabilities in the U.S. financial system,” according to FinCEN. Broker-dealers and futures commission merchants are covered by the rules.
FinCEN is likely to release several other new rules in the next few months to subject other sectors to AML rules or strengthen financial crime controls, including regulations for online funding portals and pushing banks to gather beneficial ownership information.
Those upcoming initiatives can be viewed at the bottom of this document, or in the original story by ACFCS here.
“There is one big gap in the proposal because, contrary to international standards, it gives a pass to smaller firms,” said Ross Delston, a Washington, D.C.-based AML compliance consultant. He added that because only SEC-registered investment advisers are covered, that leaves the door open to financial criminals that typically gravitate toward the weakest link.
“Money, like water, seeks its own level,” Delston said. “The size of the firm should not matter because you just gave a blueprint to the bad guys on how to get into the financial system. All they have to do is seek out smaller investment advisers because the controls required at larger operations won’t be place.”
Proposed rules were twelve years in the making
FinCEN issued proposed rules for investment advisers in 2003, but withdrew them in 2008, noting that, at the time, these advisers typically conduct business through other financial institutions, such as banks or broker-dealers, subject to AML rules.
FinCEN has “tiptoed” around the issue of AML rules for investment advisers for more than a decade, so it comes as no surprise that the proposed rule has some “curious omissions” that make expected compliance rules far weaker than what is required for other sectors considered financial institutions, Delston said.
The proposal is akin to allowing smaller banks, money services businesses (MSB) or casinos, with only $100 million or so in assets, to shirk their AML duties, something that in the current climate of heighted regulatory expectations would be unthinkable and nigh laughable, he said.
‘Gaps in knowledge,’ mean advisers must be covered
“Presently, illicit actors seeking to access the financial system may attempt to gain such access through an investment adviser as a means to avoid detection of their activity which might otherwise occur in dealings with financial institutions that have AML programs and suspicious activity reporting requirements,” FinCEN said in a statement.
FinCEN notes the need for investment adviser AML coverage, highlighting that as of June of last year, there were 11,235 investment advisers registered with the SEC, reporting approximately $61.9 trillion in assets for their clients.
Investment advisers provide advisory services to many different types of clients, including individuals, institutions, pension plans, corporations, trusts, foundations, mutual funds, private funds, and other pooled investment vehicles.
Some of the advisory services that investment advisers provide include portfolio management, financial planning, and pension consulting, according to FinCEN.
Even though advisers work with banks and broker-dealers which are subject to AML rules, these other entities may “not have sufficient information to assess suspicious activity or money laundering risk,” FinCEN stated in the proposed rule.
When an adviser orders a broker-dealer to execute a trade on behalf of an adviser’s client, the broker-dealer may not know the identity of the client. When a custodial bank holds assets for a private fund managed by an adviser, the custodial bank may not know the identities of the investors in the fund.
“Such gaps in knowledge make it possible for money launderers to evade scrutiny more effectively by operating through investment advisers rather than through broker-dealers or banks directly,” the proposed rule stated.
Lack of CDD requirements bodes ill for sector
But though FinCEN claims it’s trying to close gaps, the proposal itself is a bit threadbare, Delston said.
It’s also surprising FinCEN neglected to require registered investment advisers to perform customer due diligence duties – a core component of the broader AML program and the foundation of customer risk assessment, a hot button issue with examiners – because that is “really basic stuff,” Delston said.
Investment advisers are not part of a segmented broker-dealer trading network, with introducing brokers, executing and clearing brokers, which can add complexity to customer due diligence duties. Instead, they typically deal directly with the customer, so are in a prime position to acquire such details, said Delston.
“You would think there would be the same requirements to obey the rules as banks and other financial institutions,” he said, adding that it’s possible FinCEN had to balance the new rules against political and other economic considerations. “It’s inexplicable.”
As to how the industry will be able to adopt and comply with the new rules, there could be some challenges, even with some operations having already voluntarily created AML programs.
“The voluntary programs I have seen or hear about from compliance officers are at best deficient and, at worst, non-existent,” Delston said, adding that FinCEN used those efforts to justify in the proposed rule that the new duties for investment advisers would not be burdensome. “That, in reality, is a very thin veneer.”
Some advisers will be thankful for the lighter AML duties, thinking “well, it could be worse,” he said, while some others will “chafe at the suggestion that any additional regulation is necessary and, therefore, will oppose it strenuously.”
While the SEC does have exam duties, it could be months or years before they can examine firms for compliance, but the Paris-based Financial Action Task Force (FATF), which sets AML duties and will be arriving to evaluate the US early next year, will potentially ding the country for the remaining vulnerabilities for investment advisers, Delston noted.
“Investment advisers are on the front lines of a multi-trillion dollar sector of our financial system,” said FinCEN Director Jennifer Shasky Calvery. “If a client is trying to move or stash dirty money, we need investment advisers to be vigilant in protecting the integrity of their sector.”
Here is a list of the proposed and finalized rules FinCEN is scheduled to release in the next few months:
Rule: Customer due diligence requirements for financial institutions, commonly referred to as the beneficial ownership rule.
What it does: FinCEN is requiring customer due diligence requirements for entities subject to AML rules, including banks, broker dealers, mutual funds, futures commission merchants and introducing brokers in commodities, to identify the beneficial owners of legal entity customers, subject to certain exemptions.
The effort has been a harrowing one for FinCEN, which saw significant industry pushback when they put forth ideas on how best to collect beneficial ownership information, with states like Delaware, Nevada and others, lobbying to prevent them, or their company service providers, to collect that information or make it public.
The current solution: require banks to get the information from customers as part of the due diligence process, with the company self-certifying the information is correct, but with the bank having no real way to verify the details.
Timing: FinCEN put out an advanced notice of proposed rulemaking in 2012 and a notice of proposed rulemaking in August of 2014. The final rule was slated for August of this year, according to the Office of Information and Regulatory Affairs site.
Rule: Cross-border electronic transmittal of funds.
What it does: The rule would require banks to get information on anyone sending a cross-border wire, while money remitters, such as money service businesses, would have to do the same at $1,000. Currently, that is done at more than $10,000 for banks and $3,000 for money service businesses (MSBs).
Timing: The agency issued a notice of proposed rulemaking in September 2010 and was scheduled to issue a second proposal in August, with a comment period ending in October.
Rule: Amending the definition of broker dealer in securities to include funding portals
What it does: FinCEN wants to change the definition of broker dealer to “expand the current scope of the definitions to include funding portals,” and require them to comply with the same AML rules as brokers. The proposal is “intended to help prevent money laundering, terrorist financing, and other financial crimes,” according to the bureau.
Timing: The notice of proposed rulemaking was scheduled to be released in August.
Rule: Amendment to the regulations defining “monetary instruments,” such as coins, traveler’s checks, bearer securities and investments, and the international transport of currency and related reporting requirement, to include “tangible prepaid access devices.”
What it does: Currently, if someone has, in one form or in aggregate, more than $10,000, they have to fill out a form and declare that at a border crossing. But the definition does “not specifically include any types of prepaid access devices,” according to FinCEN. The amendment would capture these prepaid cards and require people to state if they have more than $10,000 in such cards.
Timing: FinCEN issued a proposed rule in October 2011 and is slated to issue a supplemental proposal in September.
Rule: AML rules for banks lacking a federal functional regulator
What it does: The proposed rule will remove the AML exemption for banks without a federal regulator, including but not limited to private banks, non-federally insured credit unions, and certain trust companies.
The proposed rule “would prescribe minimum standards for anti-money laundering programs and ensure that all banks, regardless of whether they are subject to Federal regulation and oversight, are required to establish and implement anti-money laundering programs.”
Timing: FinCEN was planning to issue a proposed rule in August with a comment period ending in October, Office of Information and Regulatory Affairs site.