Investment Advisers: Get Ready for Potential New Anti-Money Laundering Rules

While banks and broker-dealers have faced increased regulatory scrutiny in recent years, investment advisers have not been required to comply with the Bank Secrecy Act and anti-money laundering rules and regulations. In the next few years, certain types of investment advisers could also face possible fines, sanctions and increased scrutiny by regulators if they fail to establish an anti-money laundering program and report suspicious activity to the Financial Crimes Enforcement Network.

On Aug. 25, FinCEN issued a notice of proposed rulemaking which, among other things, would include certain investment advisers in the general definition of financial institution in rules implementing the BSA. This could have huge implications for investment advisers.

FinCEN is a bureau of the U.S. Department of the Treasury that collects and analyzes information about financial transactions and disseminates data to law enforcement in order to combat domestic and international money laundering and terrorist financing. The Secretary of the Treasury has delegated to the director of FinCEN the authority to implement, administer, and enforce compliance with the BSA and associated regulations.

In its rule proposal, FinCEN said money launderers may see investment advisers as a “low-risk” entry point into the U.S. financial system. FinCEN acknowledges that investment advisers work with financial institutions such as broker-dealers and custodial banks that are subject to BSA requirements; however, FinCEN believes such broker-dealers and banks may not have sufficient information to assess suspicious activity or money-laundering risk.

For example, when an adviser asks a broker-dealer to execute a trade on behalf of the adviser’s client, the broker-dealer may not know the identity of the adviser’s client. Another example is when a custodial bank holds assets for a private fund managed by an adviser; the custodial bank may not know the identities of the underlying investors in the fund. According to FinCEN, such gaps in knowledge make it possible for a money launderer to potentially evade scrutiny by operating through investment advisers rather than directly through broker-dealers or banks.

Establishing a program

FinCEN’s proposed rule would require investment advisers registered with the Securities and Exchange Commission to establish an anti-money laundering program and comply with certain BSA provisions such as reporting suspicious activities. Investment advisers would need to develop and implement a documented AML program reasonably designed to mitigate the risk of the investment adviser being utilized to facilitate money laundering or terrorist financing activities. The AML program would be required to be approved by the adviser’s board of directors or someone in a similar role and, at a minimum, should include the following four pillars:

1. Written policies and procedures tailored to the adviser’s business
2. A designated AML compliance officer
3. Ongoing employee training
4. Independent test of the AML program

The proposed rule would also require advisers to report suspicious activities to FinCEN, which could provide useful information to law enforcement to combat money laundering and terrorist financing. This requirement could also help to make it more difficult for money launderers to access to the U.S. financial system.

Broad impact

The proposed rule could impact investment advisers across the country, including those in Florida, one of the top 10 states by number of advisers, according to a report by the Investment Adviser Association. Many of these advisers will have to implement an AML compliance program if the rule is passed.

Advisers outsourcing some compliance functions to a third party will be required to take steps to determine that the delegation is reasonable and that the third party can adequately implement the adviser’s AML program. In addition, investment advisers with services involving other financial institutions, such as broker-dealers and banks that have separate AML program requirements, may delegate some of the proposed AML obligations to those institutions. However, in both instances, the investment adviser would remain fully responsible for the effectiveness of the program.

FinCEN had proposed a similar rule for investment advisers back in 2003. However, in June 2007, FinCEN withdrew the proposal in anticipation of the Dodd-Frank Act amendment to the Investment Advisory Act of 1940 (i.e., unregistered advisers to hedge, private equity and other private funds are now required to register with the SEC).

Given today’s regulatory environment and increased focus on money laundering, the proposed rule may be more likely to become final, so SEC-registered investment advisers should start preparing for the potential new requirements.

_____

Bao Q. Nguyen, MBA, CFE, is a risk advisory services director at Kaufman Rossin, one of the Top 50 CPA and advisory firms in the U.S.  Bao can be reached at bnguyen@kaufmanrossin.com.