Anti-Money Laundering Rule for Advisers Proposed by FinCEN
After more than 12 years of false starts, an anti-money laundering rule for advisers may just get through this time.
The Treasury Departmentís Financial Crimes Enforcement Network on August 25†issued an 86-page proposed rule that, if adopted, would require investment advisers to join banks, broker-dealers and other financial organizations in adopting an anti-money laundering program and filing suspicious activity reports.
An anti-money laundering rule for advisers was first proposed in May 2003, but was never adopted. Since then, the subject has been much discussed, with many advisers moving on their own to create anti-money laundering programs (ACA Insight, 8/17/15). With FinCENís proposed rule issued and now at the beginning of a 60-day comment period, the process may be near an end.
What the proposed rule requires
Among the changes and obligations outlined in the proposed rule, which would apply to advisers registered with the SEC, are:
Addition of investment advisers to the general definition of a "financial institution" under the Bank Secrecy Act. This would have the effect of making the requirements of the BSA, currently applicable to banks and broker-dealers, applicable to investment advisers as well. These requirements include filing Currency Transaction Reports for transactions of more than $10,000.
Anti-money laundering programs for all advisers covered by the rule. These programs must include a number of elements, including policies, procedures and internal controls; independent testing for compliance; designation of a person or committee to implement and monitor the program; and ongoing employee training in BSA requirements. If the rule is adopted, these provisions must be in place within six months of the regulationís effective date.
Suspicious activity reporting. Advisers would have to report suspicious transactions that involve at least $5,000 in funds or other assets, regardless of whether the transaction involves currency. The reports would have to be kept confidential.
Advisers not registered with the SEC are not covered by the proposed rule, but FinCEN left the door open for them to be covered later. "Future rulemakings may†include other types of investment advisers, such as state-regulated investment advisers or investment
advisers that are exempt from SEC registration, that are found to present risks to the U.S. financial system of money laundering, terrorist financing and other types of financial crimes," it said.
"None of these requirements should be unexpected, and almost all are already part of investment advisersí lives in one form or another today," said Shearman & Sterling partner Russell Sacks, noting that many of the existing anti-money laundering programs at advisory firms contain these elements.
On the other hand, the decision of FinCEN not to include a Customer Identification Program requirement, which other financial institutions are required to have, means that the proposed rule omits "one of the cornerstones of the anti-money laundering program," he said.
FinCEN, in its commentary to the proposed rule, said it expects to address the issue of Customer Identification Program requirements in a future rule, most likely through a joint rulemaking effort with the SEC.
"FinCENís proposed rule has long been anticipated, and most advisers already have AML policies in place because brokerage firms and custodians often require advisers to have them," said Rogers & Hardin partner Stephen Councill. "Consequently, this may be an easy transition for most advisers. That said, all advisers will want to review their policies and procedures to make sure they are in compliance once the rule goes effective. Anti-money laundering was one of the top deficiencies cited in broker-dealer examinations a decade ago, and I suspect will be top of the list on the advisory side once this rule is effective."
The Investment Adviser Association issued a statement shortly after the proposed rule was issued, with IAA president and chief executive officer Karen Barr saying that the association "recognizes the importance of detecting and preventing money laundering. Many advisers, particularly those affiliated with banks or broker-dealers, have voluntarily implemented anti-money laundering procedures," even though she noted that "the advisory business poses little risk in this area."
"We will be looking at [the] proposed rules with an eye toward whether the expected benefits of the proposed regulation justify its compliance costs, particularly with regard to smaller firms," she said.
Ropes and Gray counsel and former IAA president David Tittsworth said that, "assuming the proposed rules are approved, my hunch is that the compliance burden will vary significantly from firm to firm. Some advisory firms have already implemented anti-money laundering policies and procedures even though there has not been a formal rule in place. But some firms will need to get up to speed and will have a much steeper curve to comply with these new rules."
Why an adviser rule?
FinCEN used the absence of an adviser anti-money laundering rule to justify the need for one. "As long as investment advisers are not subject to an anti-money laundering program and suspicious activity reporting requirements, money launderers may see them as a low-risk way to enter the U.S. financial system," FinCEN said in its commentary to the rule.
"It is true that advisers work with financial institutions that are already subject to BSA requirements, such as when executing trades through broker-dealers to purchase or sell client securities, or when directing custodial banks to transfer assets," FinCEN said. "But such broker-dealers and banks may not have sufficient information to assess suspicious activity or money laundering risk."
It suggested that when an adviser orders a broker-dealer to execute a trade for an advisory client, "the broker-dealer may not know the identity of the client." Similarly, it said that "when a custodial bank holds†assets for a private fund managed by an adviser, the custodial bank may not know the identities of the†investors in the fund. Such gaps in knowledge make it possible for money launderers to evade scrutiny more effectively by operating through investment advisers rather than through broker-dealers or banks directly."
IAA general counsel Bob Grohowski challenged this view. "Advisers are not presented with suitcases full of cash or travelers checks. Thatís not the way the business works. Itís not like taking bank deposits. When a client hires an adviser, it will transfer money from a bank account or broker, and those institutions already have anti-money laundering programs in place."
Tittsworth said the question he has is the same he had when discussing the asset management model and†anti-money laundering with FinCEN after September 11, 2001: "Does it really make sense to impose anti-money laundering rules on investment advisers, particularly when they do not have actual custody of client assets?"
Anti-money laundering program elements
Hereís what FinCEN wants advisers to do in creating their anti-money laundering program:
Establish and implement policies, procedures and internal controls. Each advisory firm should do so based on its assessment of the money laundering or terrorist-financing risk associated with its business, FinCEN said. "Generally, an investment adviser must review, among other things, the types of advisory services it provides and the nature of the clients it advises to identify its vulnerabilities to money laundering and terrorist financing activities, and the
adviserís policies, procedures and internal controls must be developed based on this review."
Provide for independent testing for compliance. FinCEN wants such testing performed by either company personnel or by a qualified outside party. "Employees of the investment adviser, its affiliates or unaffiliated service providers may conduct the†independent testing, so long as those same employees are not involved in the operation and oversight of the program," it said. The employees would need to be knowledgeable about BSA requirements. How often the testing should be performed would be up to each adviserís assessment of its own risks.
Designate a person or persons responsible for implementation and monitoring. This could be an†individual or a committee, as long as those in this role are "knowledgeable and competent" regarding both FinCENís regulatory requirements and the adviserís money laundering risks, FinCEN said in its commentary. Whoever is appointed should be given full†responsibility and authority to develop and enforce the appropriate policies. The person does not need to be fulltime, however Ė FinCEN leaves that determination to the adviser, depending on the "size and type of advisory services the adviser provides and the clients it serves."
Provide ongoing training. "Employee training is an integral part of any anti-money laundering program," FinCEN said. Employees must be trained in BSA requirements relevant to their functions and in recognizing possible signs of money laundering. "The nature, scope and frequency of the investment adviserís training program would be determined by the responsibilities of the employees and the extent to which their functions bring them in contact with BSA requirements or possible money laundering