FinCEN Proposes New AML/CFT Program and Reporting Regulations for Certain Investment Advisers
[35627]
February 26, 2024
TO: ICI MembersInvestment Company Directors SUBJECTS: Anti-Money Laundering
Compliance
Intermediary Oversight
Investment Advisers
Operations
Risk Oversight
Transfer Agency RE: FinCEN Proposes New AML/CFT Program and Reporting Regulations for Certain Investment Advisers
The Financial Crimes Enforcement Network (FinCEN) has proposed new rules requiring SEC-registered investment advisers and exempt reporting advisers to establish anti-money laundering/countering the financing of terrorism (AML/CFT) programs and report suspicious activity to FinCEN, along with other related requirements.[1]
Comments are due to FinCEN on or before April 15, 2024.
Background
The Bank Secrecy Act (BSA) does not include "investment adviser" within its definition of "financial institution." Consequently, investment advisers are not currently subject to the same AML and reporting obligations as banks, broker-dealers, and mutual funds (among other financial institutions), although many advisers have implemented such programs. However, the BSA does authorize the Secretary of the Treasury to include additional types of business within its definition of "financial institution" if the Secretary determines that they engage in an activity that is similar to, related to, or a substitute for, any of the listed businesses.
In 2003 FinCEN published a notice of proposed rulemaking to require certain investment advisers to establish and implement AML programs.[2] FinCEN never finalized the proposal, and formally withdrew it in 2008.[3] In 2015, FinCEN released new proposed rules aiming to bring certain investment advisers within the definition of BSA-covered entities,[4] yet again did not adopt new rules. In connection with this latest 2024 proposal, FinCEN has withdrawn the 2015 proposal.
Summary of the Proposal
Broadly speaking, FinCEN proposes five regulatory changes affecting investment advisers that are registered or required to register with the SEC (RIAs) as well as investment advisers that report to the SEC as Exempt Reporting Advisers (ERAs, and together with RIAs, "investment advisers"). FinCEN is putting forth this proposal based on Treasury's assessment that investment advisers pose a material risk of misuse for illicit finance, and that applying comprehensive AML/CFT measures to these advisers is likely to reduce this risk.[5]
These five proposed changes for investment advisers include:
- Expanding the definition of "financial institution" to include "investment adviser" in the regulations implementing the BSA and adding a definition of "investment adviser;"
- requiring them to establish AML/CFT programs;
- requiring them to file suspicious activity reports (SARs) and maintain records of originator and beneficiary information for certain transactions;
- applying information sharing provisions between and among FinCEN, law enforcement agencies, and certain financial institutions;
- and requiring them to implement special measures and special due diligence requirements for correspondent and private banking accounts.
Many elements of the proposal are similar or identical to those in the 2015 proposal. Two main differences, however, are that (i) investment advisers would not be required to apply these new requirements to their mutual funds,[6] and (ii) these requirements would cover ERAs as well.
FinCEN has not proposed a customer identification program requirement for investment advisers and has not included an obligation to collect beneficial ownership information for legal entity customers; FinCEN has indicated that it expects to address these obligations in subsequent rulemakings.
Definition of "Investment Adviser" and Delegation of Examination Authority to SEC
FinCEN proposes to add "investment adviser" to the "financial institution" definition. It also proposes to define "investment adviser" as "[a]ny person who is registered or required to register with the SEC under section 203 of the Advisers Act . . . or any person that currently is exempt from SEC registration under section 203(l) or 203(m) of the Investment Advisers Act . . .." This definition captures any RIA (those registered or required to register) or ERA (those exempt from SEC registration under the listed provisions).
The definition would include certain non-U.S. advisers located abroad that nonetheless are registered or required to register with the SEC, or file Form ADV. State-regulated advisers would not be subject to the proposal. FinCEN notes, however, that it will continue to monitor activity involving state-registered investment advisers and may take steps to mitigate any such activity in the future.
FinCEN intends to delegate to the SEC its examination authority (with respect to FinCEN's rules) over investment advisers. FinCEN explains that this delegation is due to the SEC's regulatory expertise with respect to investment advisers and the SEC's existing delegated authority to examine broker-dealers and mutual funds for compliance with FinCEN's rules.
Proposed AML/CFT Program Rules
The proposal would require each investment adviser to develop and implement a written AML/CFT program, to be approved in writing by its board of directors and made available for inspection by FinCEN or the SEC upon request. Each adviser's program, at a minimum, would:
- Establish and implement policies, procedures, and internal controls reasonably designed to prevent the investment adviser from being used for money laundering, terrorist financing, or other illicit finance activities and to achieve and monitor compliance with the applicable provisions of the BSA and regulations thereunder;
- Provide for independent testing for compliance to be conducted by the adviser's personnel or by a qualified outside party;
- Designate a person or persons responsible for implementing and monitoring the operations and internal controls of the program;
- Provide ongoing training for appropriate persons; and
- Implement appropriate risk-based procedures for conducting ongoing customer due diligence, to include, but not be limited to: (i) understanding the nature and purpose of customer relationships for the purpose of developing a customer risk profile; and (ii) conducting ongoing monitoring to identify and report suspicious transactions and, on a risk basis, to maintain and update customer information.
FinCEN emphasizes the "risk-based and reasonably designed" nature of the proposed AML/CFT program requirement, which provides advisers the flexibility to design their programs to meet the specific risks of their services and customers. An adviser's program generally must cover all of its advisory activities (other than those undertaken with respect to mutual funds) and services, but the nature of this coverage will depend on the particular service (e.g., whether it involves management of customer assets). The proposal does not exclude sub-advisory services. FinCEN contemplates that investment advisers would be able to build upon existing policies, procedures, and internal controls to comply with the proposed AML/CFT requirements.
FinCEN also considers investment advisers dually registered as broker-dealers and explains that such advisers need not establish separate programs so long as their programs cover all of their advisory and broker-dealer activities and businesses.[7]
FinCEN recognizes that an investment adviser may conduct some of its operations through agents and third-party service providers (e.g., broker-dealers, custodians, transfer agents, and fund administrators). Consequently, FinCEN would permit advisers to delegate contractually some elements of their AML/CFT programs to these service providers but reminds advisers that they remain fully responsible and legally liable for compliance with all requirements.
FinCEN sets forth specific expectations for a risk-based program with respect to:
Proposed Reporting Rules
The proposal would require investment advisers to report suspicious activity by submitting SARs to FinCEN. It would not require advisers to file SARs with respect to mutual funds that they advise. This requirement is designed to provide useful information for investigations and proceedings involving domestic and international money laundering, terrorist financing, fraud, and other financial crimes.[11] The proposal addresses filing and notification procedures; retention of records; confidentiality of SARs; limitation of liability; and compliance.
Also, by including investment advisers within the definition of "financial institution," the proposal would subject advisers to Currency Transaction Report (CTR) filing requirements; the recordkeeping, transmittal of records, and retention requirements for the transmittal of funds under the Recordkeeping and Travel Rules;[12] and other related recordkeeping requirements. FinCEN proposes to eliminate the requirement of advisers to file Form 8300 on currency transactions and instead require them to file CTRs for transactions involving currency exceeding $10,000.
Information Sharing
The proposal would subject investment advisers to FinCEN's rules implementing the information-sharing procedures to detect money laundering or terrorist activity requirements of Sections 314(a) and 314(b) of the USA PATRIOT Act.[13]
Special Measures and Due Diligence Requirements
FinCEN proposes to require investment advisers to implement certain "special measures" if the Secretary of the Treasury determines that a foreign jurisdiction, institution, class of transaction, or type of account is "primary money laundering concern," pursuant to section 311 of the USA PATRIOT Act.
The proposal also would subject investment advisers to FinCEN's rules with respect to special due diligence requirements for private banking and correspondent accounts involving foreign persons pursuant to section 312 of the USA PATRIOT Act.[14] Specifically, the proposal would require that investment advisers maintain due diligence programs for correspondent accounts for foreign financial institutions and private banking accounts established for non-U.S. persons.[15]
Timing for Compliance
FinCEN proposes that an investment adviser develop and implement a compliant AML/CFT program on or before twelve months from the effective date of the regulation.
Matthew Thornton
Associate General Counsel
Kelly O'Donnell
Director, Transfer Agency and Operations
Daniel Wells
Associate - Ropes & Gray
Olivia Lanagan
Associate- Ropes & Gray
Notes
[1] Anti-Money Laundering/Countering the Financing of Terrorism Program and Suspicious Activity Report Filing Requirements for Registered Investment Advisers and Exempt Reporting Advisers, 89 FR 12108 (Feb. 15, 2024) (the "proposal"), available at https://www.govinfo.gov/content/pkg/FR-2024-02-15/pdf/2024-02854.pdf.
[2] Anti-Money Laundering Programs for Investment Advisers, 68 FR 23646 (May 5, 2003), available at https://www.govinfo.gov/content/pkg/FR-2003-05-05/pdf/03-10840.pdf. See Institute Memorandum No. 15974, dated April 29, 2003, for a summary of the 2003 proposal.
[3] Withdrawal of the Notice of Proposed Rulemaking; Anti-Money Laundering Programs for Investment Advisers, 73 FR 65568 (Nov. 4, 2008), available at www.sec.gov/about/offices/ocie/aml/73fr65568-69.pdf.
[4] Anti-Money Laundering Program and Suspicious Activity Report Filing Requirements for Registered Investment Advisers, 80 FR 52680 (Sept. 1, 2015), available at https://www.govinfo.gov/content/pkg/FR-2015-09-01/pdf/2015-21318.pdf. See Institute Memorandum No. 29323, dated September 8, 2015, for a summary of the 2015 proposal.
[5] See the proposal at 12111-12116 for a summary assessment of vulnerabilities. See also 2024 Investment Adviser Risk Assessment, Department of the Treasury, February 2024, available at https://home.treasury.gov/system/files/136/US-Sectoral-Illicit-Finance-Risk-Assessment-Investment-Advisers.pdf.
[6] "As a practical matter, we believe that any AML/CFT requirement imposed on an RIA to a mutual fund is already addressed by the existing AML/CFT requirements imposed on the mutual fund itself." Proposal at 12123. FinCEN's use of the term "mutual fund" includes open-end ETFs. ICI's 2015 comment letter recommended that advisers be allowed to exclude from these requirements services provided to BSA-regulated mutual funds to prevent overlap and redundancy.
[7] "Similarly, an investment adviser affiliated with, or a subsidiary of, another entity required to establish an AML/CFT program in another capacity would not be required to implement multiple or separate programs as one single program can be extended to all affiliated entities that are subject to the BSA, so long as it is designed to identify and mitigate the different money laundering, terrorist financing, and other illicit finance activity risks posed by the different aspects of the entity's business and satisfy each of the risk-based AML/CFT program and other BSA requirements to which the organization is subject in all of its regulated capacities, as for example an investment adviser and a bank or insurance company." Id. at 12124
[8] Unlike open-end funds, closed-end funds do not have an existing AML/CFT program or SAR requirements. FinCEN recognizes the lower risk profile of these customers because "[r]egistered closed-end funds . . . are subject to comprehensive SEC regulation and oversight and typically trade in the secondary market through broker-dealers who have AML/CFT obligations and where there are additional required disclosures and greater transparency" Id. at 12126.
[9] FinCEN suggests that advisers of private funds make a risk-based assessment of the risks presented by the investors in these funds by considering the same types of relevant factors as the adviser would consider for clients for whom the adviser manages assets directly. Id. at 12126-12127.
[10] FinCEN does not propose to exempt these programs but notes that the "program sponsor has the primary relationship with the customer, which means that the program sponsor is typically best positioned to recognize illicit financial activity in the program." Id. at 12127.
[11] The proposal requires an investment adviser to report a transaction that involves or aggregates to at least $5,000 in funds or other assets if the investment adviser knows, suspects, or has reason to suspect that such transaction: (i) involves funds derived from illegal activity or is intended or conducted to hide or disguise funds or assets derived from illegal activity; (ii) is designed to evade the requirements of the BSA; (iii) has no business or apparent lawful purpose, and the investment adviser knows of no reasonable explanation for the transaction after examining the available facts; or (iv) involves the use of the investment adviser to facilitate criminal activity. The proposal also includes a number of "red flags," to provide advisers with some indication of when filing a SAR might be appropriate. Id. at 12131-12132.
[12] Under the Recordkeeping and Travel Rules, financial institutions must create and retain records for transmittals of funds and ensure that certain information pertaining to the transmittal of funds "travels" with the transmittal to the next financial institution in the payment chain. FinCEN notes that investment advisers operate varying business models and therefore recognizes that there are certain circumstances in which an investment adviser would not conduct transactions within the scope of the Recordkeeping and Travel Rules' requirements.
[13] Section 314(a) provides for the sharing of information between the government and financial institutions and allows FinCEN to require financial institutions, upon a request from FinCEN, to expeditiously search their records to determine whether they have maintained an account or conducted a transaction with a person that law enforcement has certified is suspected of engaging in terrorist activity or money laundering. Section 314(b) provides financial institutions with the ability to share information with one another regarding parties suspected of terrorist or money laundering activities, under a safe harbor that offers protections from liability, in order to identify better and report potential money laundering or terrorist activities.
[14] FinCEN proposes to expand the definition of "covered financial institution" to include investment advisers and to amend the definition of "account," as applied to the meaning of "correspondent account," with respect to investment advisers to include "any contractual or other business relationship established between a person and an investment adviser to provide advisory services. The proposal carves out investment advisers from the requirements that "covered financial institutions" collect and verify beneficial ownership information, as FinCEN expects to address these items with respect to investment advisers in a future rulemaking.
[15] The proposal would require that such due diligence programs be reasonably designed to detect and report any money laundering, whether known or suspected, or suspicious activity in connection with any correspondent or private banking accounts. The proposal would also require enhanced due diligence for correspondent accounts for foreign banks and private banking accounts for senior foreign political figures.