Associations Seek Changes in Proposed Anti-Money Laundering Rule
They all support anti-money laundering. They just differ with the government – and to some degree, with each other – on how to get there.
The Investment Adviser Association, the Managed Funds Association and the Private Equity Growth Capital Council, all organizations that represent key parts of the asset management industry, on November 2 sent separate comment letters to the Treasury Department’s Financial Crimes Enforcement Network (FinCEN) suggesting limits to various parts of its proposed anti-money laundering rule (ACA Insight, 8/31/15).
The approaches taken by the three organizations differed, perhaps based on the needs of each group’s membership and mission. The IAA, which represents registered investment advisers, called on FinCEN to reconsider the scope of the entire anti-money laundering proposed rule, and wants four key advisory services exempted. The MFA, which represents hedge funds, said it supported the proposed rule, but wanted certain specific changes made. The PEGCC, representing private equity firms, said it wants certain classes of funds and their advisers exempted.
"The concept of applying AML rules to the traditional investment advisory model has always been a bit like trying to fit a square peg in a round hole," said Ropes & Gray counsel and former IAA president David Tittsworth. "At its basic level, the traditional advisory model involves separate custodians that hold client securities and assets – typically banks and broker-dealers. Because those custodians are already subject to anti-money laundering requirements under the Bank Secrecy Act, forcing the adviser to do the same thing would be duplicative and not justified from a cost/benefit analysis."
"FinCEN has to take these types of arguments seriously, although it may determine that simply covering virtually all SEC-registered advisers is the best way to proceed, even if it results in overlapping and duplicative efforts," he said.
The proposed rule
FinCEN 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.
The anti-money laundering programs would need to 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 Bank Secrecy Act requirements. Under the suspicious activity reporting requirements, 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. If the rule is adopted, these provisions would need to be in place within six months of the regulation’s effective date.
The IAA made perhaps the most broad-reaching recommendations of the three associations, urging FinCEN to reconsider the scope of its proposal, rather than just suggest individual fixes, although it recommended some of those, as well.
"The Bank Secrecy Act does not need to be extended to all [emphasis IAA] investment advisers with respect to all [emphasis IAA] of their activities in order to have a comprehensive anti-money laundering regime in the United States," its comment letter said. "We recommend that FinCEN carefully consider the varying types of advisers and the diversity of their advisory activities and client bases, and seek to extend the Bank Secrecy Act only where doing so would fill a potential gap in our nation’s anti-money laundering regime."
The association said it took "particular issue" with what it described as FinCEN’s basic premise that as long as investment advisers are not subject to an anti-money laundering program, money launderers may see investment advisers as a low-risk way to enter the U.S. financial system. That premise, the association said, is "simply not true. … Advisers do not provide any way – much less a ‘low-risk way’ – for a client to bypass banks, broker-dealers, or any other financial institutions covered by the Bank Secrecy Act and enter the U.S. financial system."
"Many of the advisory activities that advisers engage in don’t raise any anti-money laundering risk," said IAA general counsel Bob Grohowski, who also wrote the comment letter.
Duplication and costs were the other two major themes in the comment letter, with the association asking that "certain other aspects of the proposal be tailored to avoid duplication of regulatory efforts where the costs of compliance will significantly outweigh potential benefits. … We are concerned that the cost-benefit analysis reflected in the proposal fails to correctly measure the substantial burden that these new programs would place on the industry, particularly with respect to smaller advisers, which constitute a majority of the advisers in the industry."
Specifically, the association recommended that FinCEN "carve out" four advisory services from any final anti-money laundering rule because they do not raise money laundering risks that need to be addressed by FinCEN’s proposed rules. These carve-outs would be for advisory services that:
Do not involve management of client assets;
Are provided to anti-money laundering regulated entities, including mutual funds and broker-dealer wrap accounts;
Are provided to other advisers; or
Are provided to low-risk clients, such as pensions, publicly traded corporations and government entities, such as state and municipal agencies.
Shearman & Sterling partner Russell Sacks noted that the IAA’s concern about redundancy in some of the proposed rule’s requirements is "reasonable from a practical point of view." After all, he said, why should an adviser go to the expense and incur the resource burden of meeting a requirement if another financial institution in the anti-money laundering chain, such as a broker-dealer or bank, has already provided that protection?
On the other hand, he noted, FinCEN’s actions for several years have made it clear that "it was going to use redundancy in regard to anti-money laundering, that it was not just going to rely on the initial contact. They have chosen to regulate every contact in the chain."
Separate from questions of redundancy and cost, the IAA made a number of suggestions for specific changes, including:
Allow a person from senior management to approve an adviser’s anti-money laundering program, since boards, trustees, owners and principals may be less familiar with the program;
Permit the firm’s chief compliance officer or another "sufficiently senior employee" to serve as the anti-money laundering compliance officer;
Provide greater flexibility in regard to independent testing of anti-money laundering programs;
Allow suspicious activity reporting to be shared within an adviser’s organizational structure; and
Extend the implementation of an anti-money laundering program from six months from the effective date of the final rule to 18 months from that date.
The MFA, in its letter, did not recommend that FinCEN reconsider the scope of its proposal, as the IAA did, choosing instead to say that it "strongly supports adoption of the proposed rule." It also made a number of specific recommendations, some of them in agreement with those offered by the IAA, including allowing a chief compliance officer to serve as the anti-money laundering compliance officer, permitting senior management to approve the anti-money laundering program, and extending the implementation date of an anti-money laundering program to 18 months.
Other recommendations included:
Not including sub-advisers in the definition of "investment adviser;"
Providing guidance as to what measures advisers should take to ensure effective AML program implementation by a third party;
Allowing advisers to take into consideration, for purposes of assessing risk, anti-money laundering procedures performed by financial institutions from which investor funds originate, and investor intermediaries, such as fund of funds or other investment vehicles;
Clarification that the intent of the Rule is to cover activities involving investors, "and not other aspects of an RIA’s operations, such as investment activity;" and
Not subjecting advisers to the Bank Secrecy Act’s recordkeeping and travel rules.
The council’s recommendations focused on the applicability of the proposed anti-money laundering rule to certain classes of investment advisers, particularly those, like pooled investment vehicles, that "do not offer investors an opportunity to redeem their interests," since, it said, such vehicles "present negligible risks of money laundering."
"Private equity funds are poor vehicles for money laundering and terrorist financing and, consequently, such funds and the investment advisers that manage such funds should be excluded from the final rules," the council said in its letter.
In addition, the PEGCC made the following recommendations:
FinCEN should provide "clear guidance regarding the advisory activities that are low risk and clarify how advisers’ anti-money laundering programs may be tailored accordingly,"
Extend the implementation period to at least one year, and
Clarify that activities outside the scope of advisory services would not trigger requirements under the anti-money laundering rules.