FinCEN Again Proposes Sweeping AML Requirements for Registered Investment Advisers & ERAs
8 min read
On February 13, 2024, FinCEN proposed a long-awaited rule to combat illicit finance and national security threats in the asset management industry. The new rule would impose similar requirements on investment advisers that have existed for broker-dealers since 2001 and, if passed, would end a period of uncertainty for registrants in this area.
Background
A new proposed rule by the Financial Crimes Enforcement Network (FinCEN), a division of the Department of Treasury, would, if adopted, subject most investment advisers to comprehensive regulatory requirements to reduce risk of investment of illicit funds in the US economy. The proposed rule was released shortly after the publication of the Department of Treasury’s 2024 Investment Adviser Risk Assessment, which indicated that in some instances investment advisers “serve[] as an entry point into the US market for illicit proceeds associated with foreign corruption, fraud, and tax evasion” and noted that advisers and their advised funds, particularly venture capital funds, are being used by foreign states to “access certain technology and services with long-term national security implications through investments in early-stage companies.”1 However, unlike covered financial institutions, investment advisers have historically not been subject to comprehensive anti-money laundering (AML) and countering the financing of terrorism (CFT) requirements imposed on regulated institutions by the Bank Secrecy Act (BSA).2
Some investment advisers that operate in connection with banks (or bank subsidiaries) are currently subject to the jurisdiction of the Office of the Comptroller of the Currency (OCC), the Board of Governors of the Federal Reserve System (FRB), the Federal Deposit Insurance Corporation (FDIC), and the National Credit Union Administration (NCUA) and are accordingly also subject to applicable Federal Banking Agencies (FBA) regulations imposing AML/CFT requirements on banks.3 Other investment advisers are currently not subject to the same AML/CFT requirements. While many advisers implement AML/CFT programs on a voluntary basis, others have not yet implemented any comprehensive functions related to these issues.
The new proposed rule would change that. FinCEN proposed a rule that would require most investment advisers to follow AML/CFT requirements, including implementing risk-based AML/CFT programs, reporting suspicious financial and transaction activity to FinCEN (SARs), maintaining records concerning the transmittal of funds and other existing recordkeeping rules, and fulfilling other obligations applicable to financial institutions that are already subject to the BSA and FinCEN’s implementing regulations. In a release accompanying the proposed rules, FinCEN issued a Fact Sheet4 which summarizes and explains the rule.
Proposed Rule Expands BSA Requirements to Investment Advisers
The rule, if implemented in final form, would subject investment advisers to the BSA by expanding the definition of “financial institution” under the BSA to include both investment advisers registered with the Securities and Exchange Commission (SEC) as well as investment advisers that report to the SEC as exempt reporting advisers.5 This change would bring a vast majority of investment advisers within the ambit of the BSA and thus require significant overhauls at any investment adviser firm that does not currently have any AML/CFT compliance functions in place.
In addition to requiring implementation of an AML/CFT program, filing of SARs and other reports with FinCEN, and recordkeeping requirements, the proposed rule would also apply “information-sharing provisions between and among FinCEN, law enforcement government agencies, and certain financial institutions” to investment advisers, along with subjecting investment advisers to the special measures imposed by FinCEN pursuant to Section 311 of the USA Patriot Act which allows the Treasury Department to take specific actions to target money laundering and terrorist financing risks.
Notably, FinCEN clarified that the proposed rule does not include a customer identification program requirement, nor the collection of beneficial ownership data and information for legal entity customers of investment advisers. However, FinCEN predicted addressing these additional requirements in future rulemaking, some of which will be promulgated in joint rulemaking with the SEC. FinCEN further proposed to delegate its examination authority over investment advisers to the SEC, “consistent with FinCEN’s existing delegation to the SEC of the authority to examine brokers and dealers in securities and mutual funds for compliance with the BSA and FinCEN’s implementing regulations.”
Functionally, many investment advisers and other non-regulated financial entities have already adopted Know-Your-Customer (KYC) and Ultimate Beneficial Owner (UBO) policies in an effort to comply with routine BSA requirements even though they are not required to do so. Those who have commercial partnerships with banks and other financial institutions – particular investment advisers in the FinTech and digital assets space – may also have robust bank-like AML programs in place pursuant to their banking and payments partners’ commercial and regulatory pass-through requirements. Although various investment advisers may already have robust AML program in place, formalizing the process and mandating it as required under the BSA’s implementing regulations will reduce the ability of foreign bad actors to shop around for investment advisers with lax AML/CFT protocols and enforcement and require such advisers to review their compliance programs in light of their compliance covenants in their various commercial agreements.
Recommended Next Steps
The proposed rule would significantly expand the scope of the BSA to cover a much broader range of financial institutions. While these requirements have existed for broker-dealers since 2001,6 most investment advisers (aside from those regulated due their operation in connection with banks or bank subsidiaries) have implemented them only voluntarily or due to commercial requirements, if at all. Voluntary adoption of these functions has not been uniform across the investment advisory sector, nor has enforcement of these policies been subject to regulatory examination, economic sanction, or collateral consequences, such as changes in insurance coverage and premiums. If adopted, this rule would eliminate significant uncertainty in this area and require investment advisers to comply with the relevant provisions of the BSA.
Once the rules go into effect, SEC investment advisers should expect the SEC’s Examination Division to focus on these new requirements during examinations. As the Treasury Report specifically discussed, some foreign bad actors actively seek investment advisers with more lax AML/CFT policies in order to launder money in the US, and we believe that regulators will be interested in ensuring AML/CFT policies are robust. Accordingly, if the rule is adopted, examiners are likely to target and review the new compliance functions necessary to comply with the new AML/CFT requirements.
It will be critical that all investment advisers implement sufficient internal controls to address AML/CFT concerns and ensure their policies will be sufficient to meet the requirements imposed under the BSA, and that their senior officers and board members understand these processes and requirements. Further, the procedures best suited to investment advisers may vary from what have proven sufficient and appropriate for broker-dealers and other financial institutions. To that end, if this proposed rule is adopted, it will be important that investment advisers consult with counsel to ensure AML/CFT compliance programs are sufficient and will withstand regulatory examination based on the specific risk metrics of their unique circumstances, e.g., customer base, product, geographic exposure, etc.
Obligations under the current proposal include:
- development and implementation of an AML/CFT program that is risk based and 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 Bank Secrecy Act and other existing Treasury Regulations that apply to the same risks;
- adoption of policies and controls designed to prevent the investment adviser from being used for money laundering, terrorist financing, or other illicit finance activities and to achieve compliance with the relevant provisions of the BSA;
- performance of independent testing;
- designation of a person responsible for implementing the program;
- provision of for training of appropriate personnel; and
- implementation of risk-based customer due diligence.
The proposed rule also subjects investment advisers to reporting obligations with respect to currency transactions and SARs.
An investment adviser will have 12 months from the effective date of the final rule to implement these procedures.
For investment advisers who do not currently have an AML/CFT program, this compliance obligation will create a large shift in the way the investment adviser operates. This will require significant time and attention, but it will be time well spent considering potential regulatory exposure and likely indemnification obligations which flow through commercial agreements in favor of counterparties.
FinCEN has requested comment on many provisions of the proposed rule by April 15, 2024. We expect that there will be a large number of comments both in favor of the provisions, and against their implementation, particularly with respect to smaller advisers, those operating in the FinTech and digital asset industries, those with broad international exposures, and those who have avoided broker-dealer registration for what they have historically perceived as a more regulatory efficient investment adviser status.
1 Dep’t of Treasury, 2024 Investment Adviser Risk Assessment (“Treasury Report”), at 1 (February 2024), available here.
2 FinCEN previously proposed rules which would have covered investment advisers in 2003 and 2013, both of which were not adopted (see https://www.fincen.gov/sites/default/files/federal_register_notice/352investmentadvisers_fedreg050503.pdf and https://www.govinfo.gov/content/pkg/FR-2015-09-01/pdf/2015-21318.pdf)
3 See, e.g., 12 C.F.R. §§ 5.34(e)(3) and 5.38(e)(3) (OCC requirements governing operating subsidiaries of national banks and Federal savings associations).
4 Available at: https://www.fincen.gov/news/news-releases/fact-sheet-anti-money-laundering-program-and-suspicious-activity-report-filing.
5 The proposed rule will not apply to state-registered investment advisers.
6 Amendments to the BSA as part of the USA PATRIOT Act of 2001, see Title 3 of the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001, Pub. L. No. 107-56, 115 Stat. 296 (2001).
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This article is prepared for the general information of interested persons. It is not, and does not attempt to be, comprehensive in nature. Due to the general nature of its content, it should not be regarded as legal advice.
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