FinCEN proposes anti-money laundering rules for SEC-registered investment advisers

Citco and industry bodies seek clarification on key issues

In August 2015, the US Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN) issued a notice of proposed rulemaking (the “proposed rule”) which, if enacted, will require all SEC-registered investment advisers to establish anti-money laundering (AML) programs and report suspicious activity to FinCEN.

This article summarises the high level impact of the proposed rule and highlights some of the key issues and current AML practices which industry bodies have requested be clarified and/or adopted in the final rule. Citco provided input into the comment letters submitted to FinCEN by both the Managed Funds Association (MFA) and Alternative Investment Management Association (AIMA).

Issues to be addressed Delegation

The proposed rule requires SEC registered investment advisers (RIAs) to establish an AML program and allows RIAs to contractually delegate the implementation and operation of certain aspects of its AML program to “agents or third-party service providers, such as broker-dealers in securities (including prime brokers), custodians, and transfer agents”. Such delegation is broadly consistent with current industry practice where RIAs typically procure fund administrators to perform the AML work for their privately managed funds. Citco has provided investor AML services for our client funds for many years and has built up dedicated, specialist staff trained and experienced in implementing AML controls, identifying red flags and conducting due diligence on investors in funds.

Whilst the proposed rule refers to “transfer agents” as a permitted delegate, MFA has requested that, when issuing its final rule, FinCEN specifically refer to “administrators” as another example of permitted delegate, in order to dispel any possible doubt that delegation of these AML responsibilities to administrators is permissible. The MFA has also requested FinCEN confirm the permissibility of the delegation of the AML program to offshore administrators located outside the United States, noting that offshore administrators, like Citco, are generally located in jurisdictions with long-standing AML laws (for example, Cayman Islands and Ireland), and are regulated entities required to have their own AML policies, procedures and controls under the AML laws and regulations of their home country.

Risk-based approach

The proposed rule expressly endorses a “risk-based approach” to the AML program requirement and notes that an RIA AML program should take into account factors such as the source of investor funds and the jurisdictions where investors are located. Citco’s AML policies and procedures follow a risk-based approach which is consistent with the risk factors outlined in the proposed rule.

For purposes of assessing risk, MFA has requested that FinCEN acknowledge, in the adopting release or other guidance, the current industry practice that allows administrators (and RIAs) to take into consideration the AML procedures performed by financial institutions from which investor funds originate, including those located in Financial Action Task Force (FATF)-member jurisdictions. Such financial institutions are subject to significant AML controls and conduct customer identification verification and due diligence on account holders.

Accordingly, where an investor has already been approved from an AML perspective by a regulated financial institution located in a FATF-member jurisdiction under its own AML requirements and the subscription funds are wired from an account in the investor’s name at the institution, it is reasonable to categorise such an investor as low risk for money laundering and not require an RIA to carry out additional AML due diligence in the absence of any other facts suggesting that the investor presents a heightened risk for money laundering.

Investor intermediaries

The proposed rule states that if any of the investors in a fund are themselves private funds or other unregistered pools (for example, fund of funds) the RIA “will need to assess the money laundering or terrorist financing risks associated with these investing pooled entities using a risk-based approach”.

One of the issues for FinCEN to clarify, which reflects current industry practice, is whether to permit the “investor intermediary” to be viewed as the RIA’s customer for AML purposes so the RIA is not be required to look through the investor intermediary to the underlying investors and conduct due diligence on such underlying investors. MFA has suggested that FinCEN permit RIAs to rely on AML procedures performed by investor intermediaries in determining whether to accept an investment from an intermediary investor. The intermediaries, and not the RIAs, are in direct contact with the underlying investors and consequently are in the best position to “know the investor”.

This reflects the industry practice today where administrators typically rely on written representations by the investor intermediary regarding their AML procedures. It is to be hoped that FinCEN will recognize that permitting the RIA to treat the intermediary as its customer and rely on the intermediary’s own AML due diligence procedures is consistent with the proposed rule’s risk-based approach.

Extraterritorial concerns

The proposed rule extends to non-US RIAs notwithstanding where such non-US managers are already subject to AML rules in their country of origin. AIMA has requested that non-US RIAs which are located in FATF member countries should only have to comply with that country’s local AML laws and should not be subject to additional and/or different AML rules proposed by FinCEN. In the event FinCEN refuses to exempt non-US RIAs in such manner, AIMA has requested that the requirements under the proposed rule should only apply to the extent the non-US RIA’s transactions involve US persons and/or US domiciled financial institutions.

Grandfathering of existing investors

Another matter to be confirmed by FinCEN is whether RIAs will be required to re-evaluate the adequacy of their existing investor on-boarding process and reassess the due diligence conducted on investors which invested in a fund prior to the effective date of the proposed rule. MFA has requested that the risk assessment and due diligence requirements of the adopting release should apply to new investors in a fund after the effective date of the final rule and the application of the final rule to pre-existing investors in a fund could be adopted on an event-driven basis (i.e., additional subscriptions), as appropriate.

Scope of proposed rule

Another matter which various industry bodies have requested FinCEN clarify is that the intent of the proposed rule is to cover activities involving investors, and not other aspects of an RIA’s operations, such as investment activity.

Timing

The public comment period has closed and the proposed rule will be subject to additional review and revision before it is finalized by FinCEN. FinCEN is proposing that RIAs must develop and implement an AML program that complies with the requirements of the proposed rule no later than six months from the effective date of the regulation. In light of the fact that the new rule will require RIAs to, inter alia, designate an AML compliance officer, train relevant personnel on the final rule’s requirements and liaise closely with fund administrators or any other party engaged to implement an RIA AML program, various industry bodies have requested that the proposed implementation date be extended to eighteen (18) months after issuance of the final rule.

However, FinCEN has previously required financial institutions (for example, banks, broker dealers etc.) to comply with rules within a six month period so all stakeholders should be ready and prepared to implement the final rule within six months.

Conclusion

As noted herein, there are certain provisions of the proposed rule which require clarification and/or modification before it is possible to fully evaluate the impact FinCEN’s proposal will have on an RIA’s business and the wider alternative asset industry. Citco is staffed with qualified AML professionals experienced in both assessing money laundering risks presented by investors in funds and implementing risk-based AML compliance programs on behalf of funds.

Accordingly, assuming FinCEN provides the requested clarifications highlighted in this article and endorses the current risk-based industry practices, Citco is in a strong position to help our clients comply with the FinCEN proposals. We will continue to monitor developments and provide further updates in due course.

10th March 2016

Our contacts

Michael Regan

Michael Regan

General Counsel of Fund Services Division

T+1 201 793 5500
Emregan@citco.com
LNew York