Anti-Money Laundering: Don’t Wait for the Rule to Create a Program
After years of false starts, a Treasury Department rule requiring investment advisers to create an anti-money laundering program may be on its way, but that doesn’t mean you should wait before adopting anti-money laundering policies and procedures. Even without a rule, the SEC expects advisers to have anti-money laundering programs in place. If you haven’t created one yet, do so now.
The federal Office of Management and Budget recently concluded its review of a Treasury Department proposed rule, submitted by Treasury’s Financial Crimes Enforcement Network (FinCEN) in April. The proposed rule, which SEC staff at a recent conference said was created with their input, would set anti-money laundering requirements for investment advisers, and may be published in the near future, said IAA president and CEO Karen Barr.
Most financial institutions – banks, broker-dealers and others – were required by the 2001 Patriot Act to put in place robust anti-money laundering policies and procedures. Advisers were spared that requirement, in part because the Treasury Department initially received comments stating that the rules were more targeted to banks and brokerage firms, and that advisers necessarily conducted their transactions through these institutions subject to anti-money laundering, Barr said. In the intervening 10 years, creation of an anti-money laundering rule for advisers has been considered, but never actually formally proposed, until now.
The lack of a rule, however, has not stopped advisers from moving forward on their own.
Why advisers should move now
Many advisers already have policies and procedures in place to guard against money laundering, which can be defined as the concealment of the proceeds of a crime or any illegally obtained money. Here’s why many advisers have moved forward without a rule in place:
Financial partners require a program. Many brokerage firms and banks won’t do business with advisers that don’t have an anti-money laundering program. Since brokerage firms and banks are required to have a program, they want their financial partners to have them too, said Shearman & Sterling partner Russell Sacks. It may also be the case, as noted by Mayer Brown partner Jeffrey Taft, that many advisers are contractually obligated by third parties to have an anti-money laundering program in place.
No-action letter allows broker-dealers to rely on advisers’ anti-money laundering programs. This letter, most recently updated in January 2015, allows a brokerage firm to rely on an adviser’s anti-money laundering program, rather than replicate the customer identification onboarding work that has already been done by the adviser, as long as the adviser’s anti-money laundering program meets certain marks, Sacks said. As a result, broker-dealers will be checking to see that any advisory firm partners have a program in place. "Broker-dealers seeking to rely on the no-action position taken in this letter will undertake appropriate due diligence on the investment adviser that is commensurate with the broker-dealer’s assessment of the money laundering risk presented by the investment adviser and the investment adviser’s customer base," the letter states. "If another entity is relying on your anti-money laundering program and you are not doing your job, that will be noticed by regulators," said Taft.
Examiners will look for one. There may not be a rule in place, but "SEC staff will expect advisers to have programs in place, and will look for them during exams," said Sacks. "Advisers that don’t risk being written up." An SEC rule violation is not needed for an examiner to issue a deficiency letter – any adviser not following its own policies and procedures, even if the policies and procedures cover topics not required by the agency, can be issued a citation for violations. Without a specific rule to cite, examiners can simply write a "cautionary note" into the post-exam letter stating that the absence of an anti-money laundering program contributes to a weak compliance program, said Sacks. What this all means is that, even without a specific Commission rule requiring advisers to have anti-money laundering policies and procedures, "at present, investment advisers are expected to have anti-money laundering programs," he said.
Advisers may be part of affiliated organizations. Advisers that belong to larger financial groups, especially those with banks or broker-dealers, may already be part of an integrated anti-money laundering compliance program established by their parent organization, said Barr.
Know your customers
So what’s behind an effective advisory firm anti-money laundering program? "It really comes down to KYC – know your customer," said Sacks. "The core of the anti-money laundering program has to be customer identification."
Money laundering is not merely the act of money being laundered, in the sense of it being concealed, but an adviser taking money without knowing that it was criminal money and inadvertently contributing to money laundering, said Sacks. "I’ve never come across an adviser who was participating in money laundering directly," he said. "I have come across advisers who were criticized by the SEC for not having sufficient procedures in place to form a reasonable belief to know their customers and the source of their customers’ wealth."
What does getting to know your client entail? "Nothing major, but it does require the collection and review of organizational structure and ownership information," said Taft. "Much of it is well established and common sense, but may require additional inquiry or investigation if any ‘red flags’ are identified in the process." Have your clients provide you with information as to their identity and source of funds, then verify both through various reports and public records searches.
Consider the following best practices:
Determine your business and business model. Anti-money laundering programs for advisers should be risk-based, meaning they address those risks unique to your business. For instance, the risks faced by a client base comprised solely of pension funds is different from the risks faced by advisers with retail clients and accounts spread throughout the world, Sacks said. Anti-money laundering policies and procedures must also be tailored to your business, "meaning one size does not fit all," he said.
Create and maintain anti-money laundering procedures. There should be one set of procedures for general day-to-day customer identification and verification practices, and another set of procedures addressing how to handle anti-money laundering problems when they occur, or "event management."
Regularly check for sanctioned companies under the Treasury Department’s Office of Foreign Assets Control (OFAC). The OFAC Specially Designated Nationals List includes both companies and individuals, and can be searched by name, Sacks said. U.S. firms cannot do business with parties on this list.
Check third-party public sources. Don’t limit your search to OFAC. Sign up for any of several "world check" services that are more comprehensive than the Treasury Department, as they include "politically exposed persons" and those who have had negative press coverage, Sacks said. Finding someone who is politically exposed or who has had negative publicity doesn’t necessarily mean that person or fund should be avoided, unlike the situation with sanctioned individuals or firms, but you should know what is occurring with your clients, Sacks said. Once you have the information, then you can make a decision.
Mitigate due diligence based on red flags. "Not all companies will receive the same due diligence," said Taft. Overseas companies, for instance, may require more checking than domestic ones. Similarly, public companies, like IBM, probably require less monitoring than private limited partnerships. For those individuals and firms requiring attention, "pay more attention to their trades, what they are doing," said Sacks. For instance, said Taft, if one of your clients sent money outside the country, that is worth more of your attention than money simply transferred within the United States.
Know the red flags. FINRA publishes an anti-money laundering template that, although written for broker-dealers, lists red flags that may be helpful to advisers trying to determine what sorts of behavior to be on the lookout for, Sacks said.
Regularly visit the FinCEN site. While the site covers the entire financial industry and is not specific to advisers, there will be items that appear on the site from time to time involving advisers. In addition, the site will have up-to-date information about the principles underlying regulatory initiatives. "Read the site regularly, sign up for the alerts, understand what FinCEN is saying, and the anti-money laundering rules affecting the rest of the financial industry," said Sacks. "This will keep you on the leading edge of what’s going on with anti-money laundering."