Now that you’ve seen what ACA Insight has to offer, don’t be without it. Subscribe now!

The weekly news source for investment management legal and compliance professionals

Current subscribers - please log in to the website in the upper right-hand corner

News February 7, 2011 Issue

Broker-Dealers May Continue To Rely On Advisers For Certain AML Compliance, Provided New Conditions Are Met

SIFMA has once again successfully persuaded the SEC to extend relief permitting a broker-dealer to rely on an adviserís performance with respect to certain anti-money laundering (AML) obligations.

As part of a broker-dealerís AML procedures, it must maintain a customer identification program (CIP) under rule 31 CFR 103.122. Pursuant to the rule, a broker may rely on the practices of third party financial institutions and others to satisfy one or more procedures in the brokerís CIP provided certain conditions are met.

One of the conditions is that the third party be subject to its own AML rule. Advisers have not, and do not currently, meet this requirement. The Financial Crimes Enforcement Network (FinCEN) proposed AML rules for advisers in 2003, but never adopted them.

Since 2004, the SEC has granted or extended no-action relief that specifically allows a broker to rely on the CIP program of third-party advisers. The relief is conditioned on compliance with the CIP rule, including that the brokerís reliance must be reasonable under the circumstances and the adviser must have a contractual obligation to the broker to certify annually that it will perform the procedures as expected.

In 2008, FinCEN officially withdrew its AML rule proposal for advisers. While the regulatory gap remains, broker-dealers have returned to the SEC to obtain extensions of the no-action relief.

In a letter released January 11, the SEC again granted a requested extension and added two more years to the relief period, through January 11, 2013. However, as it has done in the past in consultation with FinCEN, the SEC also added a few more conditions to the relief.

Due diligence obligations.

Important among them, broker-dealers now have a specific due diligence obligation. Due diligence will be undertaken by the broker-dealer "commensurate with the broker-dealerís assessment of the anti-money laundering risk presented by the investment adviser and the investment adviserís customer base." The due diligence is to be performed at the beginning of the broker-dealerís relationship with the adviser, and updated periodically over the relationship, as appropriate.

Adviser record-keeping and reporting to authorities including SROs.

Under the new conditions, advisers must enter into a contractual obligation with the broker-dealer to produce records to entities with jurisdiction over the broker-dealer Ė the SEC, any relevant SRO, or authorized law enforcement agency Ė either upon request of the broker-dealer or upon direct request of any of those authorities. Advisers must keep books and records specific to the CIP rule compliance, and must report suspicious activity "promptly" to a broker-dealer so the broker-dealer can fulfill its obligation to file timely Suspicious Activity Reports.

Delayed implementation of new conditions.

To give all entities currently relying on the relief time to meet the modified conditions, the conditions that were previously in effect will continue to run through May 11. Thereafter, the modified relief will be in effect through the end of the term prescribed by the letter, in early 2013.

Current relief (no change).

Last year, the SEC imposed additional conditions on continuing the relief. Currently, and through May 11, a broker-dealer may treat an investment adviser as if it was subject to an AML Program Rule for the purposes of paragraph (b)(6) of the CIP Rule provided that:

  • the other provisions of the CIP Rule are met;
  • reliance on the investment adviser is reasonable under the circumstances;
  • the investment adviser is registered with the Commission;
  • the investment adviser enters into a contract with the broker-dealer requiring it to certify annually to the broker-dealer that it has implemented its own AML Program that is consistent with the requirements of 31 U.S.C. 5318(h); and
  • the adviser (or its agent) performs the specified requirements of the broker-dealerís CIP.

New relief.

This yearís extension of the relief fine-tuned some of the old conditions and added several more. After May 11, in accordance with the revised relief, a broker-dealer may treat an investment adviser as if it were subject to an AML Program Rule for the purposes of paragraph (b)(6) of the CIP Rule provided that:

  • the other provisions of the CIP Rule are met;
  • the broker-dealer' s reliance on the investment adviser is reasonable under the circumstances (detailed in the due diligence described above);
  • the investment adviser is a U.S. investment adviser registered with the Commission under the Investment Advisers Act of 1940; and
  • the investment adviser enters into a contract with the broker-dealer in which the investment adviser agrees that:
  • (a) it has implemented its own AML Program consistent with the requirements of 31 U.S.C. 5318(h) and will update such AML Program as necessary to implement changes in applicable laws and guidance;
    (b) it (or its agent) will perform the specified requirements of the broker-dealer's CIP in a manner consistent with Section 326 of the PATRIOT Act;

    (c) it will promptly disclose to the broker-dealer potentially suspicious or unusual activity detected as part of the CIP being performed on the broker-dealer's behalf in order to enable the broker-dealer to file a Suspicious Activity Report, as appropriate based on the broker-dealer's judgment;

    (d) it will certify annually to the broker-dealer that the representations in the reliance agreement remain accurate and that it is in compliance with such representations; and

    (e) it will promptly provide its books and records relating to its performance of CIP to the Commission, to an SRO that has jurisdiction over the broker-dealer, or to authorized law enforcement agencies, either directly or through the broker-dealer, at the request of (i) the broker-dealer, (ii) the Commission, (iii) an SRO that has jurisdiction over the broker-dealer, or (iv) an authorized law enforcement agency.

Advisers may still perform CIP functions for broker-dealers outside the relief.

The no-action relief, issued by the SECís Division of Trading and Markets, noted that some broker-dealers may cease to enter into reliance agreements pursuant to the modified terms of the relief. Any such broker-dealer, said the SEC, "may still contractually delegate the implementation and operation of its CIP to an investment adviser; however, the broker-dealer will remain solely responsible for assuring compliance with the CIP Rule, and therefore must actively monitor the operation of its CIP and assess its effectiveness."