FinCEN Proposes AML Program Rule for Investment Advisers

The Financial Crimes Enforcement Network (“FinCEN”), a bureau within the U.S. Treasury Department, has issued a proposed rule (the “Proposal”) that would subject certain investment advisers to anti-money laundering (“AML”) and countering terrorist financing (“CTF”) compliance requirements under the Bank Secrecy Act (the “BSA”). In proposing the rule, FinCEN cited concerns that investment advisers could be exploited by illicit actors to gain access to the U.S. financial system or by foreign governments to obtain access to or information about certain technologies and services with national security implications.

This client alert provides an overview of (i) which investment advisers would be subject to the Proposal, (ii) the AML program requirements investment advisers would become subject to under the Proposal, (iii) the reporting and recordkeeping requirements, including the suspicious activity report (“SAR”) requirements, investment advisers would need to comply with, and (iv) how investment advisers will be examined for compliance with these requirements.

Key highlights of the Proposal include:

• The Proposal would capture not only investment advisers registered with the Securities and Exchange Commission (the “SEC”) but also exempt reporting advisers.
• The Proposal would apply to non-U.S. SEC-registered investment advisers and non-U.S. exempt reporting advisers even if they only provide investment advice to non-U.S. private funds and other non-U.S. clients, which is a significant departure from the long-standing position of the SEC with respect to the extraterritorial application of the Investment Advisers Act of 1940 (the “Advisers Act”).
• The Proposal would require a written AML program approved by the board of directors (or equivalent), with a designated AML officer, independent testing by a person other than the AML officer, and ongoing training. 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.
• The Proposal would permit delegation of certain functions, but not ultimate responsibility, to a third party (such as a fund administrator) or an affiliate (for an enterprise-wide AML program), which will be particularly important for smaller investment advisers who lack the internal compliance personnel, particularly with respect to independent testing.
• The Proposal would require advisers to file SARs and currency transaction reports (“CTRs”), as well as related recordkeeping.
• The Proposal would delegate examination authority to the SEC.

Prior Rulemaking

FinCEN has previously proposed rules to address money laundering concerns related to the asset management industry. In 2002, it proposed rules that would have required certain private funds to adopt AML programs and separately published in 2003 a related proposal that would have required investment advisers to also adopt AML programs, but it withdrew these proposals in 2008. In 2015, FinCEN issued a proposed rule that would have included investment advisers registered with the SEC under Section 203 of the Advisers Act, within the definition of “financial institution” for purposes of its rules implementing the BSA. In connection with the Proposal, FinCEN formally withdrew the 2015 proposed rule.

Investment Advisers Subject to the Rule

The Proposal would apply to both SEC-registered investment advisers and exempt reporting advisers (i.e., investment advisers relying on the venture capital fund adviser exemption or the private fund adviser exemption) (this client alert refers to SEC-registered investment advisers and exempt reporting advisers collectively as “Covered Advisers”¹). The Proposal is broader in scope than the 2015 proposed rule because the 2015 proposed rule would not have covered exempt reporting advisers.  The Proposal would not apply to (i) state-registered investment advisers which are not eligible to register with the SEC, (ii) managers or advisers that are not “investment advisers” (e.g., certain  managers of real estate funds that do not invest in “securities”), and (iii) foreign private advisers (who do not have a U.S. place of business and have fewer than 15 U.S. clients and investors in private funds and less than $25 million in assets under management relating to such U.S. client and investors). Notably, the Proposal would apply to SEC-registered investment advisers and exempt reporting advisers with a principal place of business outside of the United States with respect to their non-U.S. clients, which is a notable departure from the positions the SEC has taken with respect to the applicability of the Advisers Act. FinCEN has requested public comment on whether other types of investment advisers or other entities that provide investment management services should be subject to an AML program requirement.

AML Program Requirements

If the Proposal is adopted, Covered Advisers would need to establish an AML program that meets the following requirements:

• Written AML Program. Each Covered Adviser would be required under the Proposal to develop a risk-based, written AML/CTF program (referred to herein as an “AML program”) reasonably designed to prevent the adviser from being used to facilitate money laundering or terrorist financing and to comply with applicable provisions of FinCEN’s regulations, including related policies, procedures and internal controls. 
  • Approval. The program would need to be approved by the Covered Adviser’s board of directors or, if the adviser does not have a board of directors, by its sole proprietor, general partner, trustee, or persons that exercise similar functions. 
  • Registered Funds. The AML program must cover all of the Covered Adviser’s advisory activity except for activities undertaken with respect to a registered, open-end mutual fund which is itself subject to an AML program requirement. Covered Advisers would need to consider risks related to registered closed-end funds, which are not themselves subject to an AML program requirement, but FinCEN noted that, in the absence of indicators of high-risk activity, AML risks related to such funds may be low to the extent that interests in a registered closed-end fund are traded through broker-dealers that are themselves subject to an AML program requirement and other regulatory oversight.
  • Private Funds. Investment advisers that provide advice to various types of funds, other than mutual funds, would need to take into account the money laundering risks of those relationships, including an assessment of the risks posed by investors in private funds. 
  • Sub-Advisory Services. The Proposal would include providing investment advice without managing client assets or acting as sub-adviser within the scope of investment advisory activities, which means that a Covered Adviser would need to address in its AML program relationships in which it acts as a sub-adviser even if there is another investment adviser with responsibility for the account that is subject to an AML program requirement. FinCEN has requested comment on whether certain sub-advisory activities should be excluded from the Proposal’s coverage.  
  • Delegation to Third Party or Affiliate. An investment adviser could delegate the performance of functions related to its AML program to a third party, including an affiliate, however, FinCEN has stated that the adviser will remain “fully responsible and legally liable for” for the effectiveness of its AML program. In the case of a Covered Adviser that is affiliated with one or more financial institutions subject to an AML program requirement under the BSA, FinCEN has stated that it does not intend to mandate that the institutions establish a single, enterprise-wide AML program, but it does expect the institutions to identify and mitigate risks arising across the organization, such as by assessing all information relating to a customer served by the affiliated financial institutions. 
  • Non-Advisory Services. A Covered Adviser’s AML program would not need to cover non-advisory activities, such as an employee of the adviser making managerial decisions about a portfolio company of a fund managed by the adviser in connection with that person’s role as a member of the portfolio company’s board of directors. 
• AML Officer. Covered Advisers would be required to designate a person or persons responsible for implementing and monitoring the AML program. The designated person or persons should be knowledgeable and competent regarding FinCEN’s regulatory requirements and the adviser’s business and money laundering risks. The designated person or persons responsible for AML compliance may have other responsibilities depending on the size and type of advisory services the adviser provides and the extent of those other responsibilities. 
• Independent Testing. Covered Advisers would be required to obtain independent testing of the AML program on a periodic basis. This testing need not be performed by an outside party and could be done internally, so long as it is not performed by persons responsible for overseeing or operating the AML program.
• Ongoing Training. The Covered Adviser’s employees would have to undergo AML training on a regular basis.
  Although some investment advisers may have voluntarily implemented an AML program, if the proposal is adopted, Covered Advisers that become subject to an AML program requirement may need to revise their existing programs to meet the requirements of the Proposal. 

Duty to Establish, Maintain, and Enforce AML Program by Persons in the United States

The Proposal would provide that the duty to establish, maintain, and enforce an AML program must remain the responsibility of, and be performed by, persons in the United States who are accessible to, and subject to oversight and supervision by, FinCEN and the appropriate Federal functional regulator (i.e., the SEC in the case of a Covered Adviser). This provision reflects the requirements of the BSA as set forth at 31 U.S.C. § 5318(h)(5). Covered Advisers should consider how this requirement may affect offshore outsourcing arrangements. 

As noted, above, the Proposal would also apply to Covered Advisers with a principal place of business outside of the United States (“non-U.S. advisers”). The SEC takes the position that most of the substantive provisions of the Advisers Act do not apply to non-U.S. advisers with respect to their non-U.S. clients, including non-U.S. private funds and other pooled investment vehicles, even if such funds or pooled investment vehicles have U.S. investors. The Proposal, if adopted, would represent a departure from this approach and would appear to impose, among other things, the AML program requirements on such non-U.S. advisers.

Customer Identification Programs

The Proposal would not require Covered Advisers to implement a customer identification program (“CIP”) or require investment advisers to identify beneficial owners of legal entity customers. However, FinCEN has stated that it anticipates addressing these requirements in separate rulemakings and noted that it intends to amend its existing customer due diligence rule to bring it into conformance with the Corporate Transparency Act. In addition, the notice that accompanied the release of the Proposal is silent on whether a bank or broker-dealer may rely on an investment adviser to perform certain procedures of the bank’s or broker-dealer’s CIP and does not address the circumstances in which reliance on an investment adviser may be reasonable (and existing SEC no-action guidance on that permitting a broker to rely upon an investment adviser to perform the broker’s CIP with respect to shared customers will by its terms be withdrawn upon the effectiveness of an AML program rule for investment advisers). However, since FinCEN has proposed including certain investment advisers within the definition of “financial institution” for purposes of its regulations implementing the BSA and has proposed exercising its authority under the BSA to require these investment advisers to implement AML programs, it appears that a bank or broker-dealer would be permitted to rely on a Covered Adviser required to implement an AML program if the Proposal is adopted, provided all of the other requirements for reliance are met. 

Reporting and Recordkeeping Requirements 

Since the Proposal would include investment advisers within the definition of “financial institution” for purposes of FinCEN’s rules implementing the BSA, investment advisers would become subject to certain reporting and recordkeeping requirements.

• Suspicious Activity Reports. The Proposal would require Covered Advisers to file a SAR with FinCEN with respect to any transaction that involves or aggregates at least $5,000 in funds or other assets when the Covered Adviser knows, suspects, or has reason to suspect that the transaction involves funds derived from illegal activity, is designed to evade reporting requirements, has no business or apparent lawful purpose, or involves the use of the investment adviser to facilitate criminal activity. A Covered Adviser must not disclose the existence or nonexistence of a SAR filing unless permitted to do so by law. Unlike with 2015 proposed rule, the Proposal would permit a Covered Adviser to share a SAR or information that would reveal the existence of a SAR within the Covered Adviser’s corporate organizational structure for purposes consistent with Title II of the BSA, as determined by regulation or in guidance. FinCEN has stated that FinCEN will consider permitting investment advisers to share SARs with certain U.S. affiliates, provided the affiliate is subject to a regulation providing for the confidentiality of SARs issued by FinCEN or by the affiliate’s federal functional regulator, and consistent with SAR-sharing guidance finalized in 2010 and applicable to other BSA-defined financial institutions, but FinCEN has also requested public comment on this issue. Covered Advisers would also be permitted to disclose the underlying facts, transactions, and documents upon which a SAR is based, including but not limited to, disclosures of such information to another financial institution or any director, officer, employee, or agent of a financial institution, for the preparation of a joint SAR, provided that no person involved in the reported transaction is notified that the transaction has been reported. SARs and related documentation must be kept on file for five years from the date of filing. In order to comply with the SAR requirement, the Proposal would require Covered Advisers to implement risk-based procedures for conducting customer due diligence to understand the nature and purpose of customer relationships for the purpose of developing a customer risk profile, conducting ongoing monitoring of customer activity in order to identify and report suspicious activity and updating customer information. This would include conducting sufficient information about investors in a private fund to develop a baseline for identifying suspicious activity related to the private fund. Further, FinCEN noted in the Proposal that suspicious activity related to a private fund could include an investor requesting access to detailed non-public technical information about a portfolio company that is inconsistent with an investor’s focus on economic return.   
• Currency Transaction Reports. A Covered Adviser would be required to file a currency transaction report (a “CTR”) with respect to any transaction involving a payment or transfer of more than $10,000 in currency by, through, or to the Covered Adviser (including such transactions in foreign currency having an equivalent value and including multiple transactions structured to avoid the reporting requirement). This requirement would replace the current obligation to file Form 8300 to report certain transactions involving currency and certain negotiable instruments having a value of more than $10,000.
• Recordkeeping and Travel Rules. A Covered Adviser would be required to create and retain records relating to transmittals of funds, and ensure that the transmittor’s name, address, and other information pertaining to the transmittal of funds “travel” with the transmittal to the next financial institution in the payment chain. These rules would also require a Covered Adviser acting as a transmittor’s financial institution or recipient’s financial institution to obtain or retain certain identifying information on the recipient. Also, Covered Advisers would have to create and retain records regarding cross-border transactions of currency, monetary instruments, checks, investment securities, and credit in amounts above $10,000. 
• Information Sharing Rules. Covered Advisers designated as financial institutions under the Proposal would become subject to the requirements in FinCEN’s rules implementing Sections 314(a) and 314(b) of the USA PATRIOT Act relating to information sharing between financial institutions and the government and information sharing among financial institutions. Section 314(a) permits FinCEN to require financial institutions to search their records for information related to accounts maintained by or transactions conducted with persons suspected by law enforcement of engaging in terrorist activity or money laundering. Section 314(b) provides a safe harbor from liability that enables two or more financial institutions and any association of financial institutions, subject to certain requirements, to share information with one another regarding individuals, entities, organizations, and countries suspected of possible terrorist or money laundering activities if the information is transmitted, received, or shared for the purposes of detecting, identifying, or reporting activities involving possible money laundering or terrorist activities. 
• Special Measures. Section 311 of the USA PATRIOT Act requires financial institutions to implement certain “special measures” if the Secretary of the Treasury finds that reasonable grounds exist to conclude that a foreign jurisdiction, institution, class of transaction, or type of account is a “primary money laundering concern.” Section 9714(a) of the Combatting Russian Money Laundering Act allows for similar special measures in the context of Russian illicit finance. The Proposal would generally require Covered Advisers to comply with special measures issued pursuant to these laws and would also require Covered Advisers to comply with certain due diligence requirements related to correspondent and private banking accounts.

SEC Examination Power

The Proposal would delegate FinCEN’s authority to examine Covered Advisers for compliance with FinCEN’s requirements to the SEC.

Transition

The Proposal, if adopted, would require Covered Advisers to implement an AML program not later than one year after the effective date of a final rule.

Comment Submission

Public comments on the Proposal may be submitted on or before April 15, 2024. A full copy of the Proposal can found in the Federal Register (89 FR 12108).

 

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^[1] For clarity, “Covered Advisers” includes general partners (and similar entities) who are SEC-registered investment advisers in reliance on the SEC staff no-action guidance, general partners (and similar entities) who are exempt reporting advisers in reliance on the SEC staff FAQ, and affiliated managers who are SEC-registered investment advisers because they are “relying advisers” in reliance on the Form ADV instructions.

 

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