Proposed Rule2024-02854
Financial Crimes Enforcement Network: Anti-Money Laundering/Countering the Financing of Terrorism Program and Suspicious Activity Report Filing Requirements for Registered Investment Advisers and Exempt Reporting Advisers
Primary source
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Published
February 15, 2024
Issuing agencies
Treasury DepartmentFinancial Crimes Enforcement Network
Abstract
FinCEN, a bureau of the U.S. Department of the Treasury (Treasury), is issuing this notice of proposed rulemaking (NPRM) to include certain investment advisers in the definition of "financial institution" under the Bank Secrecy Act (BSA), prescribe minimum standards for anti-money laundering/countering the financing of terrorism (AML/CFT) programs to be established by covered investment advisers, require covered investment advisers to report suspicious activity to FinCEN pursuant to the BSA, and make several other related changes to FinCEN regulations. FinCEN is proposing this action to address gaps in the existing AML/CFT regulatory framework in this sector. The proposed regulations will apply to investment advisers that may be at risk for misuse by money launderers, terrorist financers, or other actors who seek access to the U.S. financial system for illicit purposes via investment advisers and threaten U.S. national security.
Full Text
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<title>Federal Register, Volume 89 Issue 32 (Thursday, February 15, 2024)</title>
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[Federal Register Volume 89, Number 32 (Thursday, February 15, 2024)]
[Proposed Rules]
[Pages 12108-12193]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2024-02854]
[[Page 12107]]
Vol. 89
Thursday,
No. 32
February 15, 2024
Part V
Department of the Treasury
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Financial Crimes Enforcement Network
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31 CFR Parts 1010 and 1032
Financial Crimes Enforcement Network: Anti-Money Laundering/Countering
the Financing of Terrorism Program and Suspicious Activity Report
Filing Requirements for Registered Investment Advisers and Exempt
Reporting Advisers; Proposed Rule
Federal Register / Vol. 89 , No. 32 / Thursday, February 15, 2024 /
Proposed Rules
[[Page 12108]]
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DEPARTMENT OF THE TREASURY
Financial Crimes Enforcement Network
31 CFR Parts 1010 and 1032
RIN 1506-AB58
Financial Crimes Enforcement Network: Anti-Money Laundering/
Countering the Financing of Terrorism Program and Suspicious Activity
Report Filing Requirements for Registered Investment Advisers and
Exempt Reporting Advisers
AGENCY: Financial Crimes Enforcement Network (FinCEN), Treasury.
ACTION: Notice of proposed rulemaking.
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SUMMARY: FinCEN, a bureau of the U.S. Department of the Treasury
(Treasury), is issuing this notice of proposed rulemaking (NPRM) to
include certain investment advisers in the definition of ``financial
institution'' under the Bank Secrecy Act (BSA), prescribe minimum
standards for anti-money laundering/countering the financing of
terrorism (AML/CFT) programs to be established by covered investment
advisers, require covered investment advisers to report suspicious
activity to FinCEN pursuant to the BSA, and make several other related
changes to FinCEN regulations. FinCEN is proposing this action to
address gaps in the existing AML/CFT regulatory framework in this
sector. The proposed regulations will apply to investment advisers that
may be at risk for misuse by money launderers, terrorist financers, or
other actors who seek access to the U.S. financial system for illicit
purposes via investment advisers and threaten U.S. national security.
DATES: Written comments on this notice of proposed rulemaking (NPRM)
must be submitted on or before April 15, 2024.
ADDRESSES: Comments may be submitted by any of the following methods:
<bullet> Federal E-Rulemaking Portal: <a href="http://www.regulations.gov">http://www.regulations.gov</a>.
Follow the instructions for submitting comments. Refer to Docket Number
FINCEN-2024-0006 and RIN 1506-AB58.
<bullet> Mail: Policy Division, Financial Crimes Enforcement
Network, P.O. Box 39, Vienna, VA 22183. Refer to Docket Number FINCEN-
2024-0006 and RIN 1506-AB58.
Please submit comments by one method only.
FOR FURTHER INFORMATION CONTACT: The FinCEN Resource Center at (800)
767-2825 or email <a href="/cdn-cgi/l/email-protection#117763725177787f72747f3f767e67"><span class="__cf_email__" data-cfemail="7610041536101f1815131858111900">[email protected]</span></a>.
SUPPLEMENTARY INFORMATION:
I. Executive Summary
To address illicit finance risks in the investment adviser
industry, FinCEN is proposing to apply certain AML/CFT requirements to
certain investment advisers. Currently, there are no Federal or State
regulations requiring investment advisers to maintain AML/CFT programs
\1\ or records under the BSA, although some investment advisers may do
so, for example, if they are also licensed as banks (or are bank
subsidiaries), registered as broker-dealers, or advise mutual funds.\2\
This means that thousands of investment advisers overseeing the
investment of tens of trillions of dollars into the U.S. economy
currently operate without legally binding AML/CFT obligations.
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\1\ Section 6101 of the AML Act, codified at 31 U.S.C. 5318(h),
amended the BSA's requirement that financial institutions implement
AML programs to also combat terrorist financing. This NPRM refers to
``AML program'' when discussing the obligation prior to the
enactment of the AML Act, and to ``AML/CFT program'' in reference to
the current obligation contained in the BSA and the proposed rule.
\2\ See infra section IV.E3 and n. 51.
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These proposed regulations aim to close this gap by amending
chapter X of title 31 of the Code of Federal Regulations to add
``investment adviser'' to the definition of ``financial institution''
at 31 CFR 1010.100(t). FinCEN has statutory authority to define
additional types of businesses as financial institutions where it
determines that such businesses engage in any activity ``similar to,
related to, or a substitute for'' those in which any of the businesses
listed in the statutory definition are authorized to engage.\3\ FinCEN
proposes to make such a determination with respect to investment
advisers, which would be defined to include two types of advisers:
those that are (1) registered or required to register with the U.S.
Securities and Exchange Commission (SEC, and, such investment advisers,
RIAs) and (2) investment advisers that report to the SEC as Exempt
Reporting Advisers (ERAs) pursuant to the Investment Advisers Act of
1940, as amended (Advisers Act),\4\ and the rules thereunder.
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\3\ 31 U.S.C. 5312(a)(2)(Y).
\4\ 15 U.S.C. 80b-1 et seq.
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Accordingly, this proposed rule would establish AML/CFT
requirements for RIAs and ERAs. In full, the proposed rule would
require RIAs and ERAs to implement an AML/CFT program, file Suspicious
Activity Reports (SARs) with FinCEN, keep records relating to the
transmittal of funds (Recordkeeping and Travel Rule), and other
obligations of financial institutions under the BSA. The proposed rule
would also apply information-sharing provisions between and among
FinCEN, law enforcement government agencies, and certain financial
institutions, and would subject investment advisers to the ``special
measures'' imposed by FinCEN pursuant to section 311 of the USA PATRIOT
Act.
Concurrent with this proposal, FinCEN is withdrawing the 2015
proposed rule that would have applied AML program, SAR filing, and
other AML/CFT requirements to RIAs.\5\
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\5\ See FinCEN, Anti-Money Laundering Program and Suspicious
Activity Report Filing Requirements for Registered Investment
Advisers, 80 FR 52680 (Sept. 1, 2015).
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In this rulemaking, FinCEN is not proposing to include a customer
identification program (CIP) requirement, nor is it proposing to
include within the AML/CFT program requirements an obligation to
collect beneficial ownership information for legal entity customers at
this time. FinCEN anticipates addressing CIP via a future joint
rulemaking with the SEC and addressing the requirement to collect
beneficial ownership information for legal entity customers in
subsequent rulemakings.
Moreover, because mutual funds are already defined as ``financial
institutions'' under the BSA (31 CFR 1010.100(t)(10)), and because of
the regulatory and practical relationship between mutual funds and
their investment advisers, the proposed regulations would also not
require investment advisers to apply AML/CFT program or SAR reporting
requirements to mutual funds.\6\ The proposed regulations would also
remove the existing requirement that investment advisers file reports
for the receipt of more than $10,000 in cash and negotiable instruments
using the joint FinCEN/Internal Revenue Service Form 8300 (Form
8300).\7\ Investment advisers would instead be required to file a
Currency Transaction Report (CTR) for a transaction involving a
transfer of more than $10,000 in currency by, through, or to the
investment adviser, unless subject to an applicable exemption.
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\6\ As described below, FinCEN does not propose to permit
investment advisers to exempt mutual funds that they advise from the
requirements of 31 CFR part 1010, subparts E and F (31 CFR 1010.520,
540, 600-670) that FinCEN proposes to apply to covered investment
advisers in the proposed rule (e.g., certain information sharing,
special standards, prohibitions, and other requirements).
\7\ 31 CFR 1010.330(a)(1)(i), (e)(1); 26 CFR 1.6050I-1(e).
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Finally, FinCEN is proposing to delegate its examination authority
to the SEC given the SEC's expertise in the regulation of investment
advisers and
[[Page 12109]]
the existing delegation to the SEC of authority to examine brokers and
dealers in securities (broker-dealers) and certain investment
companies.\8\
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\8\ 31 CFR 1010.810(b)(6).
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This NPRM is divided into six main sections including this
executive summary in section I. Section II provides background on the
existing AML/CFT regulatory framework; the illicit finance risks that
this rulemaking will address; the SEC's regulatory framework for
investment advisers; the limited extent to which certain RIAs and ERAs
may already implement AML/CFT measures; and a summary of past proposed
rules to apply AML/CFT obligations with respect to investment advisers.
Section III discusses the scope of the proposed rule. Section IV
includes the section-by-section analysis of the elements of the
proposed rule. Section V lays out questions on which FinCEN seeks
comment, and section VI addresses the severability of the proposed
rule's requirements. Section VII includes the Regulatory Analysis
required by relevant statutes and executive orders.
II. Background
A. Current BSA Framework
Enacted in 1970, the Currency and Foreign Transactions Reporting
Act, generally referred to as the BSA, is designed to combat money
laundering, the financing of terrorism, and other illicit financial
activity, and to safeguard the national security of the United
States.\9\ This includes ``through the establishment by financial
institutions of reasonably designed risk-based programs to combat money
laundering and the financing of terrorism.''\10\ The Treasury Secretary
is authorized to administer the BSA and to require financial
institutions to keep records and file reports that ``are highly useful
in . . . criminal, tax, or regulatory investigations, risk assessments,
or proceedings'' or ``intelligence or counterintelligence activities,
including analysis, to protect against international terrorism.'' \11\
The Secretary delegated the authority to implement, administer, and
enforce the BSA and its implementing regulations to the Director of
FinCEN.\12\
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\9\ See 31 U.S.C. 5311. Certain parts of the Currency and
Foreign Transactions Reporting Act, its amendments, and the other
statutes relating to the subject matter of that Act, have come to be
referred to as the BSA. The BSA is codified at 12 U.S.C. 1829b, 12
U.S.C. 1951-1960, and 31 U.S.C. 5311-5314 and 5316-5336, and
includes notes thereto.
\10\ 31 U.S.C. 5311(3).
\11\ 31 U.S.C. 5311(1).
\12\ Treasury Order 180-01, paragraph 3(a) (Jan. 14, 2020),
available at <a href="https://home.treasury.gov/about/general-information/orders-and-directives/treasury-order-180-01">https://home.treasury.gov/about/general-information/orders-and-directives/treasury-order-180-01</a>.
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Pursuant to this authority, FinCEN may define a business or agency
as a ``financial institution'' if it engages in any activity determined
by regulation ``to be an activity which is similar to, related to, or a
substitute for any activity'' in which a ``financial institution'' as
defined by the BSA is authorized to engage.\13\ Additionally, the BSA
requires financial institutions to maintain programs to combat money
laundering and the financing of terrorism and authorizes the
Secretary--and thereby FinCEN--to issue regulations prescribing
``minimum standards'' for such AML/CFT programs.\14\ Similarly, under
the BSA, FinCEN may require financial institutions to ``report any
suspicious transactions relevant to a possible violation of law or
regulation.'' This provision authorizes FinCEN to require the filing of
SARs.\15\ FinCEN also has authority under the BSA to authorize the
sharing of financial information by financial institutions \16\ in
specified circumstances, and to require financial institutions to keep
records and maintain procedures to ensure compliance with the BSA and
its implementing regulations or to guard against money laundering.\17\
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\13\ 31 U.S.C. 5312(a)(2)(Y).
\14\ 31 U.S.C. 5318(h)(1), (2).
\15\ 31 U.S.C. 5318(g)(1).
\16\ See Uniting and Strengthening America by Providing
Appropriate Tools Required to Intercept and Obstruct Terrorism Act
of 2001 (USA PATRIOT Act), Public Law 107-56, sec. 314(a), (b).
\17\ See 12 U.S.C. 1953; 31 U.S.C. 5318(a)(2).
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B. Investment Adviser Industry and Regulation
1. Investment Adviser Industry
The investment adviser industry in the United States consists of a
wide range of business models geared towards providing advisory
services to many different types of customers.\18\ Some of the advisory
services that investment advisers may provide include portfolio
management, financial planning, and pension consulting. Advisory
services can be provided on a ``discretionary'' or ``non-
discretionary'' basis.\19\ Investment advisers provide their expertise
to a wide range of customers, including retail investors, high-net-
worth individuals, private institutions, and governmental entities
(including local, State, and foreign government funds).\20\ Investment
advisers often work closely with their customers to formulate and
implement their customers' investment decisions and strategies.
Investment advisers may be organized in a variety of legal forms,
including corporations, sole proprietorships, partnerships, or limited
liability companies.\21\
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\18\ This proposed rule uses the term ``customers'' for those
natural and legal persons who enter into an advisory relationship
with an investment adviser. This is consistent with the terminology
in the BSA and FinCEN's implementing regulations. FinCEN
acknowledges that the Advisers Act and its implementing regulations
primarily use the term ``clients,'' and so that term is used in
specific reference to Advisers Act requirements; otherwise, the term
``customers'' is used.
\19\ An adviser has discretionary authority or manages assets on
a discretionary basis if it has the authority to decide which
securities to purchase and sell for the client. An adviser also has
discretionary authority if it has the authority to decide which
investment advisers to retain on behalf of the client. See Glossary
to Form ADV, general Instructions at p. 28, available at <a href="https://www.sec.gov/about/forms/formadv-instructions.pdf">https://www.sec.gov/about/forms/formadv-instructions.pdf</a>. According to the
Investment Advisers Association (IAA), as of 2021, over 90 percent
of RIAs manage client assets on a discretionary basis. Investment
Adviser Association, Investment Adviser Industry Snapshot 2022, p.
53 (IAA Snapshot), available at <a href="https://investmentadviser.org/wp-content/uploads/2022/06/Snapshot2022.pdf">https://investmentadviser.org/wp-content/uploads/2022/06/Snapshot2022.pdf</a>.
\20\ See Part 1A, Item 5 of Form ADV for a list of examples of
different types of advisory clients.
\21\ See Part 1A, Item 3.A of Form ADV.
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The Advisers Act and its implementing rules and regulations form
the primary framework governing advisory activity, along with other
Federal securities laws and their implementing rules and regulations,
such as the Investment Company Act of 1940, the Securities Act of 1933,
and the Securities Exchange Act of 1934.\22\ Since the Advisers Act was
amended in 1996 and 2010, generally only investment advisers who have
at least $100 million in assets under management (AUM) or advise a
registered investment company \23\ may register with the SEC.\24\ Other
investment advisers typically register with the State in which the
adviser maintains its principal place of business.
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\22\ See generally 15 U.S.C. 80a-1 et seq. (Investment Company
Act of 1940 (Investment Company Act)); 15 U.S.C. 77a et seq.
(Securities Act of 1933); 15 U.S.C. 78a et seq. (Securities and
Exchange Act of 1934).
\23\ See 15 U.S.C. 80a-3 (defining investment company). If an
investment company meets the definition of an investment company
under 15 U.S.C. 80a-3 and cannot rely on an exception or an
exemption from registration, generally it must register with the SEC
under the Investment Company Act and must register its public
offerings under the Securities Act.
\24\ Investment advisers with more than $100 million assets
under management may register with the SEC, and investment advisers
with more than $110 million in assets under management must register
with the SEC, unless eligible for an exception. See 17 CFR 275.203A-
1.
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SEC-Registered Investment Advisers. Unless eligible to rely on an
exception,
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investment advisers that manage more than $110 million AUM must
register with the SEC, as well as submit a Form ADV and update it at
least annually.\25\ The SEC administers and enforces the Federal
securities laws applicable to RIAs. As of July 31, 2023, there were
15,391 RIAs, reporting approximately $125 trillion in AUM for their
clients.\26\
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\25\ See id.; 17 CFR 275.204-1. Investment advisers register
with the SEC by filing Form ADV and are required to file periodic
updates. Form ADV is available at <a href="https://www.sec.gov/files/formadv.pdf">https://www.sec.gov/files/formadv.pdf</a>. A detailed description of Form ADV's requirements is
available at <a href="https://www.sec.gov/oiea/investor-alerts-bulletins/ib_formadv.html">https://www.sec.gov/oiea/investor-alerts-bulletins/ib_formadv.html</a>.
\26\ The number of RIAs and corresponding AUM, and the number of
ERAs, are based on a Treasury review of Form ADV information filed
as of July 31, 2023. This Form ADV data is available at Frequently
Requested FOIA Document: Information About Registered Investment
Advisers and Exempt Reporting Advisers, <a href="http://www.sec.gov/foia/docs/invafoia.htm">http://www.sec.gov/foia/docs/invafoia.htm</a>. The $125 trillion in AUM includes approximately
$22 trillion in assets managed by mutual funds, which are advised by
RIAs and are subject to AML/CFT obligations under the BSA and its
implementing regulations.
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Exempt Reporting Advisers. An ERA is an investment adviser that
would be required to register with the SEC but is statutorily exempt
from such requirement \27\ because: (1) it is an adviser solely to one
or more venture capital funds; or (2) it is an adviser solely to one or
more private funds and has less than $150 million AUM \28\ in the
United States.\29\ Private funds are privately offered investment
vehicles that pool capital from one or more investors to invest in
securities and other investments.\30\ Private funds do not register
with the SEC, and advisers to these funds often categorize the fund by
the investment strategy they pursue. These include hedge funds, private
equity funds, and venture capital funds, among others. Even though they
are not required to register, ERAs must still file an abbreviated Form
ADV with the SEC, and the SEC maintains authority to examine ERAs. As
of July 31, 2023, there were 5,846 ERAs that were exempt from
registering with the SEC but had filed an abbreviated Form ADV.\31\
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\27\ An adviser that is eligible to file reports as an ERA may
nonetheless elect to register with the SEC as an RIA so long as it
meets the criteria for registration. An investment adviser that
relies on one of these exemptions must still evaluate the need for
State registration.
\28\ Form ADV uses the term ``regulatory assets under
management'' (RAUM) instead of ``assets under management.'' Form ADV
describes how advisers must calculate RAUM and states that in
determining the amount of RAUM, an adviser should ``include the
securities portfolios for which [it] provide[s] continuous and
regular supervisory or management services as of the date of
filing'' the form. See Form ADV, Instructions for Part 1A,
Instruction 5.b.
\29\ See sections 203(l) and 203(m) of the Advisers Act and 17
CFR 275.203(m)-1, respectively. ERAs are exempt from registration
with the SEC, but are required to file reports on Form ADV with the
SEC and are subject to certain rules under the Advisers Act.
\30\ Section 202(a)(29) of the Advisers Act defines the term
``private fund'' as an issuer that would be an investment company,
as defined in section 3 of the Investment Company Act (15 U.S.C.
80a-3), but for section 3(c)(1) or 3(c)(7) of that Act. Section
3(c)(1) excludes from the definition of investment company a
privately-offered issuer having fewer than a certain number of
beneficial owners. Section 3(c)(7) excludes from the definition of
investment company a privately-offered issuer the securities of
which are owned exclusively by ``qualified purchasers'' (generally,
persons and entities owning a specific amount of investments).
\31\ The number of ERAs is derived from a Treasury review of
Form ADV information filed as of July 31, 2023. See supra n. 26.
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<bullet> Private Fund Advisers. Private fund advisers, a type of
ERA, are exempt from registering with the SEC if they exclusively
advise private funds and have less than $150 million AUM in the United
States. As of July 31, 2023, there were approximately 4,400 exempt
private fund advisers, approximately 500 of which were also venture
capital advisers.\32\
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\32\ Based on a Treasury review of Form ADV information filed as
of July 31, 2023. See supra n. 26.
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<bullet> Venture Capital Advisers. Venture capital advisers,
another type of ERA, are exempt from registering with the SEC if they
provide services only to venture capital funds,\33\ regardless of the
amount of AUM.\34\ As of July 31, 2023, there were approximately 2,000
exempt venture capital advisers, approximately 500 of which were also
private fund advisers.\35\
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\33\ See 17 CFR 275.203(l)-1 (defining ``venture capital
fund'').
\34\ Certain venture capital advisers may be registered with the
SEC if they no longer satisfy the criteria to be ERAs (e.g., they no
longer pursue a venture capital strategy (by seeking to hold
securities in companies past the initial public offering stage or
pursuing hedge-fund like investment strategies)) or otherwise opt to
register with the SEC.
\35\ Based on a Treasury review of Form ADV information filed as
of July 31, 2023. See supra n. 26.
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State-Registered Investment Advisers. State-registered investment
advisers generally have less than $100 million in AUM. State-registered
investment advisers are generally prohibited from registering with the
SEC and instead register with and are supervised by the relevant State
authority, unless they meet certain exceptions or their State does not
supervise these entities.\36\ State-registered investment advisers also
file a Form ADV, which they submit to the relevant State regulator. As
of December 31, 2022, there were 17,063 State-registered investment
advisers who have approximately $420 billion in AUM.\37\
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\36\ See 17 CFR 275.203A-2. Other exceptions to the prohibition
on SEC registration include: (1) an adviser that would be required
to register with 15 or more States (the multi-State exemption); (2)
an adviser advising a registered investment company; (3) an adviser
affiliated with an RIA; and (4) a pension consultant. Persons
satisfying these criteria and the definition of ``investment
adviser'' may register as such with the SEC. Investment advisers
with a principal office and place of business in New York and over
$25 million AUM are required to register with the SEC.
\37\ See North American Security Administrators Association,
NASAA Investment Adviser Section 2023 Annual Report, p.3, <a href="https://www.nasaa.org/wp-content/uploads/2023/09/2023-IA-Section-Report-FINAL.pdf">https://www.nasaa.org/wp-content/uploads/2023/09/2023-IA-Section-Report-FINAL.pdf</a>.
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Non-U.S. Investment Advisers. Non-U.S. advisers whose principal
offices and places of business are outside the United States, but
solicit or advise ``U.S. persons,'' are subject to the Advisers Act and
must register with the SEC unless eligible for an exception. One of
those exceptions is the ``foreign private adviser'' exemption, and an
adviser relying on this exemption is not required to make any filing
with the SEC.\38\ For those non-U.S. advisers registered with the SEC,
the Commission states that it does not intend to seek to apply the
substantive provisions of the Advisers Act to a non-U.S. adviser that
is registered with the SEC with respect to its non-U.S. clients.\39\
Non-U.S. advisers may also report to the SEC as ERAs if they meet the
requirements to report as ERAs.
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\38\ The ``foreign private adviser'' exemption is available to
an adviser that (i) has no place of business in the United States;
(ii) has, in total, fewer than 15 clients in the United States and
investors in the United States in private funds advised by the
adviser; (iii) has aggregate assets under management attributable to
these clients and investors of less than $25 million; and (iv) does
not hold itself out generally to the public in the United States as
an investment adviser. See 15 U.S.C. 80b-2(a)(30), 80b-3(b)(3).
\39\ See SEC, Exemptions for Advisers to Venture Capital Funds,
Private Fund Advisers With Less Than $150 Million in Assets Under
Management, and Foreign Private Advisers, Final Rule, Investment
Advisers Act Release No. 3222 (Jun. 22, 2011), 76 FR 39645, 39667
(Jul. 6, 2011).
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2. Existing Regulatory Framework for Investment Advisers
Oversight of the investment adviser industry by Federal and State
securities regulators generally is focused on protecting investors and
the overall securities market from fraud and manipulation. Most
investment advisers are subject to certain reporting requirements and
the extent of those requirements depends on whether the investment
adviser is an RIA, registered at the State level, exempt from
registration as an ERA, or otherwise not required to register with a
Federal or State securities regulator.\40\ RIAs are subject to various
SEC rules and
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regulations governing, among other things, their marketing and
disclosures to clients, best execution for client transactions, and
disclosures of conflicts of interest and disciplinary information.
State-registered investment advisers may have similar requirements
under State securities laws and regulations.\41\ Investment advisers,
depending on their registration status, are also generally subject to
examination by the SEC or State securities regulators. In some
circumstances, Federal securities, tax, or other rules and regulations
may impose on investment advisers information collection or disclosure
obligations similar to some AML/CFT measures.
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\40\ For instance, an investment adviser may be exempt from both
Federal and State registration requirements if they had less than
$25 million AUM and fewer than six clients in a State. These
advisers are not required to register, nor are they ERAs.
\41\ See, e.g., Cal. Corp. Code, Ch.3, 25230-25238.
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However, these requirements are not designed to address money
laundering, terrorist financing, and other illicit financial activity
risks associated with investment advisers. Further, although some
investment advisers implement AML/CFT requirements in certain
circumstances or for certain customers, as described below in section
II.C, application of AML/CFT measures is not uniform across the
industry, and investment advisers' implementation of such measures is
not subject to comprehensive enforcement or examination. Providers of
the same financial services may be subject to different AML/CFT
obligations (if any), and an investor or customer seeking to obscure
the origin of its funds or identity can choose an investment adviser
that does not apply AML/CFT measures to its customers and
activities.\42\
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\42\ For instance, FinCEN research identified two investment
advisers with a focus on Russian customers that advertised
investment structures that would allow customers to avoid going
through ``know your customer'' procedures.
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Generally, RIAs, State-registered investment advisers, and ERAs are
required to file (and annually update) Form ADV with the SEC, the
relevant State securities regulator, or both.\43\ Form ADV collects
certain information about the adviser, including (depending on the
adviser's registration status) its AUM, ownership, number of clients,
number of employees, business practices, custodians of client funds,
and affiliations, as well as certain disciplinary or material events of
the adviser or its employees. ERAs who are not registered with the SEC
or a State securities regulator are only required to file an
abbreviated version of Form ADV--they are required to answer fewer
client-related questions and provide less information about the
services they provide. Form ADV does not require investment advisers to
disclose the names of individual clients or investors.\44\
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\43\ See 17 CFR 275.203-1 and 204-4.
\44\ Advisers to private funds are, however, required to name
their private fund clients on section 7.B.(2) of Schedule D of Form
ADV Part 1A. In some cases, those names may be coded.
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Some RIAs are also required to file a Form PF, which collects
information on private funds advised by the RIA.\45\ Information
collected on Form PF includes the approximate percentage of a fund's
equity that is beneficially owned by different types of investors,
including U.S. and non-U.S. investors. Some private fund advisers,
including ERAs, that are required to report on Form ADV are not
required to file Form PF.\46\ Unlike Form ADV, Form PF is non-public.
It is provided to both the SEC and the Financial Stability Oversight
Council (FSOC) and is intended to enhance investor protection and
provide the FSOC with data for use in assessing systemic risk.
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\45\ See 15 U.S.C. 80b-4(b). A Form PF must be submitted by any
RIA that manages one or more private funds and collectively (with
its related persons) had at least $150 million in private fund AUM
as of the last day of its most recently completed fiscal year. See
17 CFR 275.204(b)-1. ``Related person'' is defined in Form PF, which
is available at <a href="https://www.sec.gov/files/formpf.pdf">https://www.sec.gov/files/formpf.pdf</a>.
\46\ See 17 CFR 275.204(b)-1.
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C. Illicit Finance Risk Associated With Investment Advisers
As detailed below, Treasury assesses that RIAs and ERAs pose a
material risk of misuse for illicit finance. Including investment
advisers as ``financial institutions'' under the BSA and applying
comprehensive AML/CFT measures to these investment advisers are likely
to reduce this risk.
1. Illicit Finance Vulnerabilities
RIAs and ERAs are vulnerable to misuse or exploitation by criminals
or other illicit actors for several reasons. First, the lack of
comprehensive AML/CFT regulations directly and categorically applicable
to investment advisers means they, as a whole, are not required to
understand their customers' ultimate sources of wealth or identify and
report potentially illicit activity to law enforcement. The current
patchwork of implementation by some RIAs and ERAs may also create
arbitrage opportunities for illicit actors by allowing them to find
RIAs and ERAs with weaker or non-existent customer diligence procedures
when these actors seek to access the U.S. financial system. Second,
where AML/CFT obligations apply to investment adviser activities, the
obliged entities (such as custodian banks, broker-dealers, and fund
administrators providing services to investment advisers and the
private funds that they advise) do not necessarily have a direct
relationship with the customer or, in the private fund context,
underlying investor in the private fund. Further, these entities may be
unable to collect relevant investor information from the RIA or ERA to
comply with the entities' existing obligations \47\ (either because the
adviser is unwilling to provide, or has not collected, such
information). Third, the existing Federal securities laws are not
designed to comprehensively detect illicit proceeds or other illicit
activity that is ``integrating'' into the U.S. financial system \48\
through an RIA or ERA. Fourth, RIAs and ERAs routinely rely on third
parties for administrative and compliance activities, and these
entities are subject to varying levels of AML/CFT regulation. Fifth,
particularly for private funds, it is routine for investors to invest
through layers of legal entities that may be registered or organized
outside of the United States, making it challenging to collect
information relevant to understand illicit finance risk under existing
frameworks.
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\47\ See, e.g., FinCEN and Federal Functional Regulators
(including SEC,), Joint Release, ``Guidance on Obtaining and
Retaining Beneficial Ownership Information'' (Mar. 5, 2010) (noting
that customer due diligence procedures for legal entity customers
may include ``obtaining information about the structure or ownership
of the entity so as to allow the [financial] institution to
determine whether the account poses heightened risk.'')
\48\ Generally, money laundering involves three stages, known as
placement, layering, and integration. At the ``placement'' stage,
proceeds from illegal activity or funds intended to promote illegal
activity are first introduced into the financial system. The
``layering'' stage involves the distancing of illegal proceeds from
their criminal source through a series of financial transactions to
obfuscate and complicate their traceability. ``Integration'' occurs
when illegal proceeds previously placed into the financial system
are made to appear to have been derived from a legitimate source.
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(a) Lack of Comprehensive and Uniform AML/CFT Obligations
``Investment advisers'' is not presently included in the definition
of ``financial institution'' under the BSA or its implementing
regulations.\49\ This means that, although they have Form 8300
obligations to report cash transactions above $10,000, investment
advisers are typically not subject to most of the AML/CFT program,
recordkeeping, or reporting obligations that apply to banks, broker-
dealers, and certain other financial institutions.\50\ For example,
investment advisers are not required to maintain an AML/CFT program
[[Page 12112]]
(consisting of internal controls, an AML/CFT officer, independent
testing, and employee training), and do not have independent SAR
filing, customer due diligence (CDD), or CIP obligations. These are key
elements of AML/CFT compliance through which an investment adviser
would identify and report to law enforcement and regulators a customer,
investor, or transaction that may be associated with illicit finance
activity.
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\49\ See 31 CFR 1010.100(t).
\50\ Investment advisers are, like any other ``person,'' subject
to an obligation to file Form 8300. 31 CFR 1010.330(a)(1)(i),
(e)(1); 26 CFR 1.6050I-1(e).
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As noted above, some RIAs and ERAs may perform certain AML/CFT
functions if the entity is also a registered broker-dealer or is a bank
(i.e., a dual registrant), or is an operating subsidiary of a bank;\51\
other investment advisers are affiliates of banks or broker-dealers,
which may implement an enterprise-wide AML/CFT program that would
include that investment adviser. A Treasury analysis of Form ADV data
found that approximately three percent of RIAs were dually registered
as a broker-dealer or licensed as a bank, and that these entities held
about 10 percent of the AUM held by all RIAs. The same analysis found
that approximately 20 percent of RIAs, representing approximately 75
percent of the total AUM of RIAs, were affiliated with either a bank or
broker-dealer.
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\51\ Investment advisers that are banks (or bank subsidiaries)
subject to the jurisdiction of the Office of the Comptroller of the
Currency, the Board of Governors of the Federal Reserve System, the
Federal Deposit Insurance Corporation, and the National Credit Union
Administration (collectively, the FBAs) are accordingly also subject
to applicable FBA regulations imposing AML/CFT requirements on
banks. See, e.g., 12 CFR 5.34(e)(3) and 5.38(e)(3) (OCC requirements
governing operating subsidiaries of national banks and Federal
savings associations).
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In other circumstances, an investment adviser may perform AML/CFT
functions via contract with a broker-dealer (e.g., CIP for joint
customers) or other financial institution, such as when the adviser
advises an open-end registered investment company (e.g., mutual fund).
For instance, some RIAs have already implemented voluntary AML/CFT
programs pursuant to the Securities Industry and Financial Markets
Association (SIFMA) No-Action Letter under which the staff of the SEC's
Division of Trading and Markets stated that it would not recommend
enforcement action if a broker-dealer relies on RIAs to perform some or
all aspects of the broker-dealer's CIP obligations or the portion of
CDD requirements regarding beneficial ownership requirements for legal
entity customers, provided that certain conditions are met, including
that the RIA implements its own AML/CFT program.\52\ Mutual funds,\53\
which are advised by approximately 10 percent of RIAs \54\ and hold
approximately $22.1 trillion in assets,\55\ are also subject to AML/CFT
obligations under the BSA and its implementing regulations.\56\
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\52\ See SEC, Letter to Mr. Bernard V. Canepa, Associate General
Counsel, Securities Industry and Financial Markets Association
(SIFMA), Request for No-Action Relief Under Broker-Dealer Customer
Identification Program Rule (31 CFR 1023.220) and Beneficial
Ownership Requirements for Legal Entity Customers (31 CFR 1010.230)
(Dec. 9, 2022), <a href="https://www.sec.gov/files/nal-sifma-120922.pdf">https://www.sec.gov/files/nal-sifma-120922.pdf</a>
(SIFMA No-Action Letter). This request for No-Action Relief was
originally issued in 2004 and has been periodically reissued and
remains effective. Any SEC staff statements cited represent the
views of the SEC staff. They are not a rule, regulation, or
statement of the SEC. Furthermore, the SEC has neither approved nor
disapproved their content. These SEC staff statements, like all SEC
staff statements, have no legal force or effect: they do not alter
or amend applicable law; and they create no new or additional
obligations for any person.
\53\ As used in this NPRM, ``mutual fund'' has the same
definition as in FinCEN's regulations, and refers to an ``investment
company'' (as the term is defined in section 3 of the Investment
Company Act (15 U.S.C. 80a-3)) that is an ``open-end company'' (as
that term is defined in section 5 of the Investment Company Act (15
U.S.C. 80a-5)) that is registered or is required to register with
the SEC under section 8 of the Investment Company Act (15 U.S.C.
80a-8). See 31 CFR 1010.100(gg). Exchange-traded funds (ETFs) are a
type of exchange-traded investment product that must register with
the SEC under the Investment Company Act and are generally organized
as either an open-end company (``open-end fund'') or unit investment
trust. The SEC's ETF Rule (rule 6c-11 under the Investment Company
Act), issued in 2019, clarified ETFs are issuing ``redeemable
securit[ies]'' and are generally ``regulated as open-end funds
within the meaning of section 5(a)(1) of the [Investment Company]
Act.'' FinCEN's definition of a mutual fund under 1010.100(gg)
applies to an ETF that is registered as an ``open-end company'' (as
the term is defined in section 5 of the Investment Company Act).''
\54\ Information derived from a Treasury review of Form ADV
information. See supra n. 26.
\55\ According to the Investment Company Institute 2023
Investment Company Factbook, as of December 31, 2022, U.S. mutual
funds held approximately $22.1 trillion in AUM, while ETFs held
approximately $6.4 trillion in AUM. Investment Company Institute,
2023 Investment Company Factbook, p.2, <a href="https://www.ici.org/system/files/2023-05/2023-factbook.pdf">https://www.ici.org/system/files/2023-05/2023-factbook.pdf</a>.
\56\ See 31 CFR 1010.100(gg); 31 CFR part 1024.
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Outside of these circumstances, some investment advisers have
voluntarily implemented certain AML/CFT measures, such as CDD or other
CIP requirements. However, because these programs are not required by
any regulations under the BSA, advisers have wide discretion in what
information to request from their customers and private fund investors.
Additionally, RIAs and ERAs are not examined for compliance with
voluntary AML/CFT measures not required by law, so the adviser may not
be made aware of deficiencies or gaps in their programs via
examination, and thereafter make improvements, and there are more
limited enforcement mechanisms to pursue against the adviser for
failing to implement such measures.
While the programs discussed above provide some AML/CFT coverage
for parts of the investment adviser industry, they mean that RIAs and
ERAs providing the same financial services have differing AML/CFT
obligations. For example, depending on corporate policies and practice,
stand-alone RIAs or ERAs are likely subject to different AML/CFT
compliance approaches than RIAs or ERAs that are part of a bank or
financial holding company; and an investor or customer seeking to
obscure the origin of its funds or its identity can choose an RIA or
ERA that has limited or no AML/CFT obligations.
The fact that investment advisers are not currently BSA-defined
financial institutions also limits the ability of investment advisers
to provide highly useful information to law enforcement, regulators,
and other relevant authorities. For instance, unless they are BSA-
defined financial institutions, RIAs and ERAs would not be afforded the
protection from liability (safe harbor) that applies to financial
institutions when filing SARs.\57\ Even though investment advisers are
able to file voluntary SARs, they could face increased legal risk from
customers or other counterparties without the safe harbor. RIAs and
ERAs are also currently unable to receive and respond to law
enforcement requests for information under section 314(a) of the USA
PATRIOT Act as they are not BSA-defined financial institutions.\58\
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\57\ 31 U.S.C. 5318(g)(3)(A).
\58\ See 31 CFR 1010.520.
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Additionally, investment advisers, or associations of investment
advisers, that are not BSA-defined financial institutions cannot
voluntarily share information under section 314(b) of the USA PATRIOT
Act. Moreover, at present, existing BSA-defined financial institutions
are limited in their ability to share with RIAs and ERAs, or receive
from investment advisers, information potentially related to money
laundering or terrorist financing that are not themselves BSA financial
institutions.\59\ Becoming a BSA-defined financial institution would
allow RIAs and ERAs to share information potentially related to money
laundering or terrorist financing with, and receive requests from,
other financial institutions that already utilize section 314(b), such
as broker-dealers. This could help financial institutions gain
additional insight into their customers' transactions with RIAs and
ERAs and,
[[Page 12113]]
potentially, a more accurate and holistic understanding of their
customers' activities.
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\59\ See 31 CFR 1010.540.
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(b) Existing AML/CFT Obligations Often Apply to Intermediaries, But Not
the Customer-Facing Entity
Investment advisers engage in trading or transactional activities
on behalf of their customers through relationships with financial
institutions that are subject to AML/CFT obligations, such as broker-
dealers and banks, among others. For instance, Rule 206(4)-2 (the
Custody Rule) under the Advisers Act requires RIAs that have custody of
client funds or securities generally to maintain those funds and
securities with a qualified custodian, defined primarily to encompass
BSA-defined financial institutions.\60\
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\60\ 17 CFR 275.206(4)-2. 17 CFR 275.206(4)-2. The SEC recently
proposed amendments to the Custody Rule. See SEC, Safeguarding
Advisory Client Assets, Investment Advisers Act Release No. 6240
(Feb. 15, 2023), 88 FR 14672 (Mar. 9, 2023).
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While investment advisers often do not take possession of financial
assets, they nonetheless may have the most direct relationship with the
customers they advise and thus be best positioned to obtain the
necessary documentation and information from and about the customers
concerning their assets that the investment adviser is deploying in
public or private financial markets.\61\ If some of these assets
include the proceeds of illegal activities, or are intended to further
such activities, an investment adviser's AML/CFT program could help
discover such issues and prevent the customer from further using the
U.S. financial system, while reporting such information for law
enforcement purposes. For example, in some cases, an investment adviser
may be the only person or entity with a complete understanding of the
source of a customer's invested assets, background information
regarding the customer, or the objectives for which the assets are
invested.
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\61\ See SIFMA No-Action Letter supra n.52 (incoming letter to
SEC stating ``RIAs often have the most direct relationship with the
customers they introduce to broker-dealers and are best able to
obtain the necessary documentation and information from and about
the customers'').
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Other market participants may, for example, hold and trade assets
in an account controlled by an adviser, but these parties, as
intermediaries, often rely solely on the investment adviser's
instructions and lack independent knowledge of the adviser's customers.
Further, an investment adviser may use multiple broker-dealers or banks
for trading and custody services, making it difficult for one financial
institution in the chain to have a complete picture of an investment
adviser's activity or to detect suspicious activity involving the
investment adviser. Without complete information, such an institution
may not have sufficient information to file a SAR, or it may be
required to file a SAR that only has partial information concerning the
investment adviser's transactions on behalf of a particular customer.
This limits the ability of law enforcement to identify illicit activity
that may be occurring through investment advisers.
(c) Non-AML/CFT Regulations Do Not Fully Address Illicit Finance Risks
RIAs are subject to various SEC rules and regulations governing,
among other things, their marketing and disclosures to clients, best
execution for client transactions, and disclosures of conflicts of
interest and disciplinary information. In some circumstances, Federal
securities, tax, or other rules and regulations may impose obligations
similar to some AML/CFT measures by requiring the collection or
disclosure of certain information by RIAs and ERAs. However, these
regulatory requirements are not designed to explicitly address the risk
that an RIA or ERA may be used to move proceeds or funds tied to money
laundering, terrorist financing, or other illicit activity; they are
instead designed to protect customers against fraud, misappropriation,
or other illegal conduct by an investment adviser. Accordingly, even if
they require an RIA or ERA to report certain kinds of illegal conduct
or collect relevant information, they do not provide a comprehensive
framework that incorporates the AML/CFT and national security purposes
of the BSA, an understanding of relevant illicit finance risks and
activity, and a process to assess and report suspicious activity to law
enforcement and other appropriate authorities.
For example, the SEC's Custody Rule \62\ generally requires RIAs
with custody of client funds and securities to maintain client assets
at a qualified custodian and comply with other safeguards, subject to
certain limited exceptions. This rule is intended to protect advisory
client assets from loss, misuse, theft, or misappropriation by, and the
insolvency or financial reverses of, the adviser. Qualified custodians
may be able to detect and report certain suspicious activity involving
a RIA's customer, such as a high volume of trading or indications of
layering activity, but they often may lack identifying information
about the RIA's customer and their source of funds because that
customer is not their institution's customer. As a result, qualified
custodians can be limited in their ability to detect other types of
illicit proceeds associated with that RIA's customer.
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\62\ See 17 CFR 275.206(4)-2.
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Other financial intermediaries providing services to an investment
adviser or its customers, such as banks, clearing brokers, executing
brokers, and futures commission merchants, may have AML/CFT
obligations, but often, they may not be well-positioned to have a
complete understanding of the identity, source of funds, and investment
objectives of the adviser's underlying customer. For instance, some
investment advisers may be reluctant to have a broker-dealer contact
their customers because they view the broker-dealer as a
competitor.\63\
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\63\ See SIFMA No-Action Letter, supra n.520.
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Similarly, the Compliance Rule \64\ under the Advisers Act does not
require an RIA to implement AML/CFT-related policies and procedures.
Under the Compliance Rule, an RIA must adopt and implement written
policies and procedures reasonably designed to prevent violations of
the Advisers Act and its implementing rules and regulations and to
designate a chief compliance officer to administer the RIA's compliance
policies and procedures. These policies and procedures should take into
consideration the nature of that firm's operations and should be
designed to prevent, detect, and promptly correct any violations of the
Advisers Act or the rules thereunder. The Compliance Rule does not
address the requirements of the BSA. While the Compliance Rule
establishes a procedural and organizational framework that RIAs may be
able to build upon to implement AML/CFT measures, the rule does not
mandate that an RIA address AML/CFT in its policies and procedures.
Some investment advisers may have policies and procedures to comply
with Office of Foreign Assets Control (OFAC) sanctions, which similarly
may provide a framework for implementing certain AML/CFT measures
included in the proposed rule.\65\
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\64\ See 17 CFR 275.206(4)-7.
\65\ While OFAC sanctions requirements are separate from AML/CFT
requirements, investment advisers, like other U.S. persons, must
comply with OFAC sanctions. AML/CFT requirements and OFAC sanctions
also share a common national security goal, apply a risk-based
approach, and rely on similar recordkeeping and reporting
requirements to ensure compliance. For this reason, many financial
institutions view compliance with OFAC sanctions as related to AML/
CFT compliance obligations, and may include sanctions compliance and
AML/CFT compliance in a single enterprise-wide compliance program.
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[[Page 12114]]
(d) Investment Advisers to Private Funds Routinely Rely on Third-Party
Administrators Located Outside of the United States
Routine reliance on third-party administrators by investment
advisers to private funds for a range of administrative tasks,
including investor due diligence and identity verification, poses a
material illicit finance risk. While some third-party administrators
are located in the United States and may be affiliated with larger
financial institutions, others are located in offshore financial
centers where private funds are routinely domiciled, usually for tax or
other commercial reasons unrelated to AML/CFT regulation, such as the
Cayman Islands.\66\ The due diligence and verification practices of
these offshore fund administrators are not uniform, and may vary based
upon the requirements of the local regulatory regime as well as the
requirements of the fund's adviser. While some investment advisers may
rely on these administrators to manage their perceived risk or to
comply with local regulatory requirements, the piecemeal review of
investor information is not a substitute for comprehensive AML/CFT
compliance measures. These third-party administrators may also face
legal and regulatory challenges in receiving and verifying
documentation from foreign legal entity investors in funds they
service. Further, effective AML/CFT supervision of fund administrators
based outside the United States is often still nascent, with foreign
regulators taking few enforcement actions to date.\67\
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\66\ See Caribbean Financial Action Task Force Mutual Evaluation
of the Cayman Islands (Mar. 2019), p. 26, 30-31, <a href="https://www.fatf-gafi.org/media/fatf/documents/reports/mer-fsrb/CFATF-Cayman-Islands-Mutual-Evaluation.pdf">https://www.fatf-gafi.org/media/fatf/documents/reports/mer-fsrb/CFATF-Cayman-Islands-Mutual-Evaluation.pdf</a>. While a fund may be domiciled or registered
in the Cayman Islands, the adviser managing that fund may be located
in the United States and/or registered with the SEC.
\67\ Id. at pp. 135-140 (Cayman Islands received the lowest
possible rating for supervision). Additionally, fund administrators
in the Cayman Islands filed only 37 SARs in 2017. Id. at p. 117.
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(e) Use of Multiple Legal Entities for Cross-Border Investment
Structure
Some investment advisers provide advisory services to customers
that structure their investments through several layers of U.S. and
foreign legal entities or arrangements, such as limited liability
companies (LLCs) and trusts, often referred to colloquially as ``shell
companies.'' Such structures may be used for legitimate tax reasons,
but can be used to obfuscate the source of funds for either natural
person or legal entity investors and obscure unlawful conduct.
An additional challenge is the use of nominee arrangements, in
which an intermediary (often a foreign bank or overseas custodial
service provider) agrees to be identified as the nominal investor and
essentially acts as a ``shield'' for individuals who want to make
investments without disclosing their identities or source of funds.
These nominee arrangements can be used in connection with other
intermediaries in the ownership chain (e.g., the nominee may be acting
on behalf of a foreign asset manager, who in turn has the relationship
with an illicit actor or politically exposed person (PEP)). While these
nominee arrangements often can have legitimate purposes, if they are
not explicitly identified in required reports or records, they can be
abused to obscure potentially illicit funds and make it extremely
difficult (if not impossible) for regulators to identify and fully
understand the nature and extent of illicit finance risks in this
sector. As of Q4 2022, private fund advisers reporting on Form PF noted
that they did not know, and could not reasonably obtain information
about, the non-U.S. beneficial ownership of approximately $284 billion
in private fund AUM.\68\
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\68\ See SEC, Private Fund Statistics, Fourth Calendar Quarter
2022, <a href="https://www.sec.gov/files/investment/private-funds-statistics-2022-q4.pdf">https://www.sec.gov/files/investment/private-funds-statistics-2022-q4.pdf</a>.
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In addition, data privacy or other laws or regulations in effect in
offshore jurisdictions, or contractual obligations, may impact how
certain customer information is shared with investment advisers,
broker-dealers, and other financial institutions (and by extension,
U.S. law enforcement and regulators). While some investment advisers
are introduced to new foreign investors by foreign entities subject to
AML/CFT obligations (such as a broker-dealer), this practice is not
consistent, as other introducers or promoters may be individuals with
no AML/CFT obligations.
2. Illicit Finance Threats to Investment Advisers
Treasury, in coordination with Federal law enforcement and
consultation with the SEC, conducted a comprehensive assessment of
illicit finance risk in the investment adviser industry. Treasury's
review included an analysis of SARs filed between 2013 and 2021 that
were associated with RIAs and ERAs.\69\ That analysis found that 15.4
percent of RIAs and ERAs were associated with or referenced in at least
one SAR (i.e., they were identified either as a subject or in the
narrative section of the SAR) during this time. Further, the number of
SAR filings associated with an RIA or ERA increased by approximately
400 percent between 2013 and 2021--a disproportionately higher increase
than the overall increase in SAR filings, which was approximately 140
percent.\70\
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\69\ Information derived from an analysis of select BSA
reporting.
\70\ From a FinCEN review of the total number of SARs filed
between 2013 and 2021.
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This SAR analysis, along with a review of law enforcement cases and
other information available to the U.S. government, identified several
illicit finance threats involving RIAs and ERAs. First, in some
instances, the investment adviser industry has served as an entry point
into the U.S. market for illicit proceeds associated with foreign
corruption, fraud, and tax evasion. Second, certain advisers manage
billions of dollars ultimately controlled by Russian oligarchs and
their associates who help facilitate Russia's illegal and unprovoked
war of aggression against Ukraine. Third, certain RIAs and ERAs and the
private funds they advise are also being used by foreign states, most
notably the People's Republic of China (PRC) and Russia, to access
certain technology and services with long-term national security
implications through investments in early-stage companies.
(a) Laundering of Illicit Proceeds Through Investment Advisers and
Private Funds
Private funds can be a particularly attractive entry point for
illicit proceeds because they present a possibility of high returns, in
contrast to other, more costly forms of money laundering, such as
trade-based money laundering or informal value transfer systems. Like
other types of pooled accounts or legal entities, they can be used to
obscure the names of individual investors or beneficial owners so that
the investment fund is identified as the owner of a particular asset.
However, there are a wide variety of private funds, and some have
characteristics that have traditionally been seen as less attractive to
money launderers. For instance, some hedge funds may have lock-up
periods of more than a year while venture capital funds and private
equity funds may not permit any withdrawals due to the time it takes
for the private companies in which those funds invest to go public or
otherwise provide an exit strategy for these funds. While these
restrictions may deter criminals who need immediate access to illicit
[[Page 12115]]
proceeds, they are unlikely to deter wealthy corrupt foreign actors who
seek stable returns, and have a medium- to long-term investment
horizon, and do not need immediate access to capital.
The mechanisms for laundering illicit proceeds through investment
advisers and private funds vary, but generally consist of obscuring the
illicit origins of funds and pooling them with legitimate funds to
invest in U.S. securities, real estate, or other assets.
In one significant case involving funds stolen from the Malaysian
government, an RIA was used to launder illicit proceeds into the U.S.
financial system. In December 2012, investment funds affiliated with
Low Taek Jho (Low) laundered approximately $150 million diverted from
1Malaysia Development Berhad's (1MDB) 2012 bond issuance into the U.S.
financial system. Low was CEO of Jynwel Capital Limited, an investment
adviser to a private equity fund in Asia.\71\ Through a subsidiary of
Jynwel Capital Limited, Low purchased equity interests in a vehicle
managed by the Electrum Group, a private equity firm in the United
States ``whose offices are located in New York and Colorado, invests in
public and private companies involved in the exploration and
development of natural resources, precious metals, base metals, and oil
and gas.'' \72\ Electrum Group, LLC is registered with the SEC as an
RIA. To conceal their origin, the funds were moved through multiple
accounts owned by different entities on or about the same day in an
unnecessarily complex manner with no apparent business purpose. This
illustrates the general problem: without an obligation to determine the
source of wealth and purpose for a customer, an investment adviser may
unwittingly permit illicit funds to enter the U.S. financial
system.\73\
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\71\ Low represented to counterparties and potential business
partners that Jynwel Capital Limited was an investment adviser to a
private equity fund.
\72\ Verified Compl. for Forfeiture (Dkt. 3) ] 760, United
States v. Real Property Located in London, United Kingdom Titled in
the Name of Red Mountain Global Ltd., No. 19-cv-1326, (C.D. Cal.
Feb. 22, 2019), <a href="https://www.justice.gov/opa/press-release/file/1134376/download">https://www.justice.gov/opa/press-release/file/1134376/download</a>.
\73\ See id. ] 204-12.
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In some instances, the investment adviser or other financial
professional may form a private fund through which illicit proceeds can
be transferred as part of a money laundering scheme. While past
examples have featured investment advisers complicit in illegal
activity, an investment adviser may be unwittingly complicit in this
type of activity if they are not required to understand the origin of
funds or nature of their owner. A customer wishing to launder money
could ask an investment adviser to establish a private fund to certain
specifications without informing the adviser of the customer's broader
scheme. Without an obligation to report potential money laundering or
other illicit finance activity, the adviser could participate without
inquiring further.
In July 2018, U.S. law enforcement arrested two alleged
participants, Matthias Krull and Gustavo Adolfo Hernandez Frieri
(Hernandez), in a billion-dollar international scheme to launder funds
obtained through embezzlement, fraud, and bribery from Venezuelan
state-owned oil company Petroleos De Venezuela S.A. (PDVSA).\74\
According to the stipulated factual proffer filed in connection with
his plea agreement, Hernandez conspired to launder approximately $12
million in PDVSA bribe proceeds by creating a private fund, domiciled
in the Cayman Islands, and with a U.S. bank as custodian.\75\
Specifically, he admitted that he conspired to launder $7 million in
bribe payments related to a loan scheme, and $5 million in bribe
payments related to a separate currency exchange scheme, through his
investment advisory firm located in the United States. Separately, a
co-conspirator in the scheme set up fraudulent bond schemes in which
fake bonds would be issued, money transferred into the private fund,
and then the bonds would ``default.'' \76\ While in this instance the
adviser was complicit in the fraudulent scheme, a client could also
direct an unwitting investment adviser to create a private fund to
specifications that facilitate money laundering. In the absence of an
AML/CFT program requirement for investment advisers, the investment
adviser might not have any obligation to evaluate such risks.
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\74\ Department of Justice, ``Former Swiss Bank Executive Pleads
Guilty to Role in Billion-Dollar International Money Laundering
Scheme Involving Funds Embezzled from Venezuelan State-Owned Oil
Company,'' (Aug. 22, 2018), <a href="https://www.justice.gov/opa/pr/former-swiss-bank-executive-pleads-guilty-role-billion-dollar-international-money-laundering">https://www.justice.gov/opa/pr/former-swiss-bank-executive-pleads-guilty-role-billion-dollar-international-money-laundering</a>; Department of Justice, ``Two Members
of Billion-Dollar Venezuelan Money Laundering Scheme Arrested''
(Jul. 25, 2018), <a href="https://www.justice.gov/opa/pr/two-members-billion-dollar-venezuelan-money-laundering-scheme-arrested">https://www.justice.gov/opa/pr/two-members-billion-dollar-venezuelan-money-laundering-scheme-arrested</a>. In August 2018,
Krull pleaded guilty to one count of conspiracy to commit money
laundering, and in November 2019, Hernandez, a former investment
adviser, also pleaded guilty to conspiracy to commit money
laundering in connection with his role in the scheme. Plea Agreement
(Dkt. 163), United States v. Hernandez, (S.D. Fl. Nov. 26, 2019),
<a href="https://www.justice.gov/criminal-fraud/file/1316826/download">https://www.justice.gov/criminal-fraud/file/1316826/download</a>.
\75\ Factual Proffer (Dkt. 164), United States v. Hernandez, No.
18-cr-20685 (S.D. Fl. Nov. 26, 2019), <a href="https://www.justice.gov/criminal-fraud/file/1316831/download">https://www.justice.gov/criminal-fraud/file/1316831/download</a>.
\76\ Criminal Compl., United States v. Guruceaga ( ), 18-mj-3119
(S.D. Fl. Jul. 24, 2018), <a href="https://www.justice.gov/criminal-fraud/file/1119981/download">https://www.justice.gov/criminal-fraud/file/1119981/download</a>.
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(b) Russian Political and Economic Elites' Access to U.S. Investments
Investment advisers and private funds they advise have served as an
important entry point into the U.S. financial system for wealthy
Russians seeking to obscure their ownership of U.S. assets.\77\
Although many of these Russian individuals were not sanctioned by the
U.S. Government prior to Russia's full-scale invasion of Ukraine in
February 2022, their wealth was sometimes associated with corruption,
theft of state assets, or other illicit activity well before their
designation.
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\77\ See FinCEN Alert, FIN-2023-Alert002, FinCEN Alert on
Potential U.S. Commercial Real Estate Investments by Sanctioned
Russian Elites, Oligarchs, and Their Proxies, p.4 (Jan. 25, 2023).
In addition to Russian investors, investors tied to China and Saudi
Arabia have invested in U.S. private funds. See, e.g., The German
Marshall Fund of the United States, Policy Brief: An Effective
American Regime to Counter Illicit Finance (Dec. 2018), <a href="https://securingdemocracy.gmfus.org/wp-content/uploads/2018/12/An-Effective-American-Regime-to-Counter-Illicit-Finance.pdf">https://securingdemocracy.gmfus.org/wp-content/uploads/2018/12/An-Effective-American-Regime-to-Counter-Illicit-Finance.pdf</a>.
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A Treasury review of select BSA reporting filed between January
2019 and June 2023 identified more than 20 investment advisers located
in the United States advising private funds where the adviser was
identified as having significant ties to Russian oligarch investors or
Russian-linked illicit activities. This review also identified 60
additional investment advisers located in the United States who managed
private funds in which identified Russian oligarchs have invested,
although there was no indication the adviser was engaged in any illicit
activity.
According to information available to the U.S. government, often, a
member of the Russian elite or their trusted proxy invests in a public
or private U.S. company with the assistance of a wealth management
firm, which is usually located in an offshore jurisdiction such as
Bermuda, the Caymans, or Cyprus, but services primarily Russian
customers. The wealth management firm invests that money in dollars
through the U.S. financial system, often into U.S. technology companies
in fields including biotechnology and artificial intelligence. The
scale of these investments is significant and may include billions of
dollars invested for a single Russian oligarch. These investments are
sometimes made directly by the foreign wealth management firm, and in
other instances through a U.S.-based RIA or ERA.
[[Page 12116]]
In other instances, funds may be routed through a consulting firm
or other entity acting as an investment adviser but not registered with
or reporting to the SEC or State regulator. For instance, on September
19, 2023, the SEC announced charges against Concord Management LLC
(Concord) and its owner and principal, Michael Matlin, for operating as
unregistered investment advisers to their only client--a wealthy former
Russian official widely regarded as having political connections to the
Russian Federation.\78\ As of January 2022, Concord and Matlin
allegedly managed investments for their sole client with an estimated
total value of $7.2 billion in 112 different private funds.
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\78\ In March 2022, the United Kingdom and the European Union
sanctioned Matlin and Concord's client and the client's assets were
subsequently frozen. The SEC's complaint alleges that, a month
prior, in February 2022, Concord and Matlin assisted the client in
his attempts to redeem investments and/or sell his securities
portfolio. See SEC, Press Release 2023-186, SEC Charges New York
Firm Concord Management and Owner with Acting as Unregistered
Investment Advisers to Billionaire Former Russian Official (Sep. 19,
2023).
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(c) Foreign State Actors Exploiting Investment Advisers To Threaten
U.S. National Security
Some strategic nation-state competitors to the United States, most
notably the PRC, may see private funds as a back door to acquire assets
of interest in the United States, such as equity stakes in companies
developing critical or emerging technologies. While there are certain
transactions for which notice must be provided to the interagency
Committee on Foreign Investment in the United States (CFIUS),\79\ most
transactions reviewed by CFIUS are filed voluntarily.\80\ Where
transactions are not voluntarily submitted to CFIUS for review, CFIUS
agencies actively work to identify those transactions, including
whether such transactions may be a covered transaction under the CFIUS
regulations and may raise national security considerations, and assess
whether to request that the parties file with CFIUS.\81\
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\79\ CFIUS is an interagency committee authorized to review
certain transactions involving foreign investment in the United
States in order to determine the effect of such transactions on the
national security of the United States.
\80\ See Treasury, ``Remarks by Assistant Secretary for
Investment Security Paul Rosen at the Second Annual CFIUS
Conference,'' (Sept. 14, 2023), <a href="https://home.treasury.gov/news/press-releases/jy1732">https://home.treasury.gov/news/press-releases/jy1732</a>.
\81\ Id.
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Foreign state-funded investment vehicles may seek to hide their
involvement in foreign investments through offshore legal entities and
intermediaries in an effort to gain access to sensitive technology,
processes, or knowledge that can enhance their domestic development of
microelectronics, artificial intelligence, biotechnology and
biomanufacturing, quantum computing, and advanced clean energy, among
others. These state-funded investment vehicles could persuade an
investment adviser to a private fund to grant them access to granular
details about the technology or processes used by a company in which
the fund is invested, including information that a limited partner
investor seeking only an economic return may not typically request.
PRC. According to the Federal Bureau of Investigation (FBI), the
PRC government routinely conceals its ownership or control of
investment funds to disguise efforts to steal technology or knowledge
and avoid notice to CFIUS.\82\ According to a report by the Office of
the U.S. Trade Representative, State-guided PRC venture capital fund
activity in the United States is motivated by the Made in China 2025
plan and the military-civil fusion strategy, directing investments
towards developing technology with dual-use capabilities.\83\ In 2016,
the PRC government explicitly endorsed the use of overseas venture
capital funds to invest in ``seed-based and start-up technology,''
demonstrating the link between the funds and government priorities.\84\
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\82\ See Hearing Before the U.S.-China Economic and Security
Review Commission, p.139, ``Chinese Investments in the United
States: Impacts and Issues for Policymakers'' Jan. 26, 2017, <a href="https://www.uscc.gov/sites/default/files/transcripts/Chinese%20Investment%20in%20the%20United%20States%20Transcript.pdf">https://www.uscc.gov/sites/default/files/transcripts/Chinese%20Investment%20in%20the%20United%20States%20Transcript.pdf</a>;
see also Remarks by FBI Director Christopher Wray, ``Countering
Threats Posed by the Chinese Government Inside the U.S.,'' Jan. 31,
2022, <a href="https://www.fbi.gov/news/speeches/countering-threats-posed-by-the-chinese-government-inside-the-us-wray-013122">https://www.fbi.gov/news/speeches/countering-threats-posed-by-the-chinese-government-inside-the-us-wray-013122</a>.
\83\ Office of the United States Trade Representative,
``Findings of the Investigation into China's Acts, Policies, and
Practices Related to Technology Transfer, Intellectual Property, and
Innovation under section 301 of the Trade Act of 1974,'' Mar. 22,
2018, 14-15 & 95-96, <a href="https://ustr.gov/sites/default/files/Section%20301%20FINAL.PDF">https://ustr.gov/sites/default/files/Section%20301%20FINAL.PDF</a>.
\84\ PRC State Council, ``National 13th Five-Year Plan for the
Development of Strategic Emerging Industries,'' Nov. 29, 2016,
https://cset.georgetown.edu/publication/national-13th-five-year-
plan-for-the-development-of-strategic-emerging-industries/
#:~:text=During%20the%2013th%20Five%2DYear,healthy%20economic%20and%2
0social%20development.
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Russia. According to information available to the U.S. government,
Russian elites and government entities are moving hundreds of millions
of dollars annually through the U.S. financial system by using U.S. and
foreign venture capital firms to invest in U.S. technology companies. A
Treasury review of select BSA reporting identified several U.S. venture
capital firms with significant ties to Russian oligarch investors that
invested in firms developing emerging technologies with national
security applications. These include autonomous vehicle technology and
artificial intelligence systems, as well as contractors to the U.S.
military, intelligence, and other government agencies. Further,
according to information available to the U.S. government, the U.S.-
designated, state-owned Russian Venture Company, which is funded by the
U.S.-designated Russian Direct Investment Fund, endows Russian seed
funds to invest in emerging technology. The seed funds create a venture
capital company, often of a similar name to the seed fund and
registered outside of Russia, to invest in U.S. technology firms. The
U.S. government has also identified instances where the leadership of
certain investment firms has attempted to remove overt ties to Russia
or Russian names. Russian investors have obfuscated their connections
to Russia, including by relocating to other jurisdictions and changing
their names, to continue investing in U.S. technology companies through
venture capital vehicles.
D. Prior Rulemaking and Regulatory Guidance
FinCEN has previously proposed AML regulations for investment
advisers. On September 26, 2002, FinCEN published an NPRM proposing to
require that unregistered investment companies, to include private
funds, establish AML programs (Proposed Unregistered Investment
Companies Rule).\85\ This was followed by the May 5, 2003 NPRM
proposing to require certain investment advisers to establish AML
programs (First Proposed Investment Adviser Rule).\86\ Both of these
proposed rules would have defined these entities as ``financial
institutions'' under the BSA and required the implementation of AML
programs only; they did not propose suspicious activity reporting
requirements.
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\85\ See FinCEN, Anti-Money Laundering Programs for Unregistered
Investment Companies, 67 FR 60617 (Sept. 26, 2002).
\86\ See FinCEN, Anti-Money Laundering Programs for Investment
Advisers, 68 FR 23646 (May 5, 2003).
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In June 2007, FinCEN announced that it would be taking a fresh look
at how its broader AML regulatory framework was being implemented to
ensure that it was being applied effectively and efficiently across the
industries covered
[[Page 12117]]
by the BSA.\87\ In conjunction with this initiative, and given the
amount of time that had elapsed since initial publication of the
Proposed Unregistered Investment Companies Rule and the First Proposed
Investment Adviser Rule, FinCEN determined that it would not proceed to
apply AML requirements for these entities without undertaking further
public notice and comment, and therefore withdrew the proposed rules on
November 4, 2008.\88\
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\87\ See FinCEN, Withdrawal of the Notice of Proposed
Rulemaking; Anti-Money Laundering Programs for Unregistered
Investment Companies, 73 FR 65569 (Nov. 4, 2008); and FinCEN,
Withdrawal of the Notice of Proposed Rulemaking; Anti-Money
Laundering Programs for Investment Advisers, 73 FR 65568 (Nov. 4,
2008).
\88\ Id.
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On September 1, 2015, FinCEN published an NPRM ``to prescribe
minimum standards for . . . [AML] programs to be established by certain
investment advisers and to require such investment advisers to report
suspicious activity to FinCEN pursuant to the . . . BSA'' (Second
Proposed Investment Adviser Rule).\89\ This proposed rule would have
included RIAs within the definition of ``financial institution'' under
the BSA and required them to maintain AML programs, report suspicious
activity, and comply with other travel and recordkeeping requirements.
The Second Proposed Investment Adviser Rule would not have included
ERAs as financial institutions under the BSA.
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\89\ See FinCEN, Anti-Money Laundering Program and Suspicious
Activity Report Filing Requirements for Registered Investment
Advisers, 80 FR 52680 (Sept. 1, 2015).
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Since 2015, the investment adviser industry has seen substantial
growth in assets under management and the expansion of new products and
services. At the time the Second Proposed Investment Adviser Rule was
published, there were approximately 12,000 RIAs reporting approximately
$67 trillion in AUM.\90\ As of June 30, 2023, that number had grown to
more than 15,000 RIAs with approximately $125 trillion in AUM.\91\
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\90\ Based on a Treasury review of Form ADV data as of December
31, 2015.
\91\ See supra n. 26.
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Private funds play an increasingly important role in the financial
system and continue to grow in size, complexity, and number. For
example, hedge funds engage in trillions of dollars in listed equity
and futures transactions each month. Private equity and other private
funds are involved in mergers and acquisitions, non-bank lending, and
corporate restructurings through leveraged buyouts and bankruptcies.
Venture capital funds provide funding to start-ups and early-stage
companies. There are approximately 5,500 RIAs who advise more than $20
trillion in private fund AUM.\92\ Over the past five years alone, the
number of private equity funds advised by RIAs increased 60 percent to
more than 24,000, while the number of venture capital funds advised by
RIAs increased by almost 300 percent, to more than 3,300 funds.\93\
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\92\ Id.
\93\ IAA Snapshot, supra n. 19 at Table 5E.
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Since 2015, the U.S. Government has also developed a more detailed
understanding of the illicit finance risks associated with the U.S.
investment adviser industry. As described in section II, investment
advisers have been exploited by sophisticated criminals, Russian
oligarchs, and U.S. strategic competitors.
Although the Second Proposed Investment Adviser Rule was not
formally withdrawn,\94\ Treasury does not intend to issue a final rule
based on it and is hereby withdrawing the Second Proposed Investment
Adviser Rule. Treasury is issuing this new NPRM to ensure that changes
in the risk and factual context relevant to the rulemaking since the
Second Proposed Investment Adviser Rule was published are taken into
account.
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\94\ Treasury withdrew the proposal from the Fall 2020 Unified
Agenda. See Anti-Money Laundering Program and Suspicious Activity
Reporting Filing Requirements for Investment Advisers, available at
<a href="https://www.regulations.gov/docket/FINCEN-2014-0003/unified-agenda">https://www.regulations.gov/docket/FINCEN-2014-0003/unified-agenda</a>.
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III. Scope of Proposed Rule
For all the reasons described above, FinCEN is proposing to cover
both RIAs and ERAs as ``financial institutions'' subject to AML/CFT
requirements. FinCEN is not proposing to cover State-registered
investment advisers because the Treasury risk assessment found few
examples of State-registered investment advisers being misused for
money laundering, terrorist financing, or other illicit financial
activities.\95\ However, FinCEN will continue to monitor activity
involving State-registered investment advisers for indicia of money
laundering, terrorist financing, or other illicit finance activities,
and may take appropriate steps to mitigate any such activity.
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\95\ See Treasury, Investment Adviser Illicit Finance Risk
Assessment, <a href="https://home.treasury.gov/system/files/136/US-Sectoral-Illicit-Finance-Risk-Assessment-Investment-Advisers">https://home.treasury.gov/system/files/136/US-Sectoral-Illicit-Finance-Risk-Assessment-Investment-Advisers</a>.pdf.
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As discussed further below, this proposed rulemaking does not
impose a CIP requirement or a general requirement that investment
advisers identify and verify the beneficial ownership of legal entity
customers. Accordingly, the proposed rule would not subject investment
advisers to beneficial ownership information identification and
verification requirement under 31 CFR 1010.230.\96\ Under the BSA, any
CIP requirement for financial institutions that engage in financial
activities described in section 4(k) of the Bank Holding Company Act
``shall be prescribed jointly with each Federal functional regulator.''
\97\ This list of activities includes, among others, ``providing
financial, investment, or economic advisory services.'' \98\ Pursuant
to these provisions, any future application of CIP requirements would
be proposed jointly with the SEC in a separate rulemaking. In addition,
FinCEN intends to amend the CDD Rule to bring it into conformance with
the Corporate Transparency Act.\99\
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\96\ As described below, the proposed revised Sec.
1010.605(e)(1) would expressly provide that an investment adviser
would not be considered a ``covered financial institution'' for the
purposes of Sec. 1010.230. See infra section IV.H.1.
\97\ 31 U.S.C. 5318(l)(4).
\98\ 12 U.S.C. 1843(k)(4)(C).
\99\ FinCEN is required to revise the CDD Rule under the
Corporate Transparency Act. Sec. 6403(d)(1), AML Act. (``Not later
than 1 year after the effective date of the regulations promulgated
under section 5336(b)(4) of title 31, United States Code, as added
by subsection (a) of this section, the Secretary of the Treasury
shall revise the final rule entitled `Customer Due Diligence
Requirements for Financial Institutions' . . . .'').
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IV. Section-by-Section Analysis
FinCEN is proposing to: (1) include certain types of investment
advisers (both RIAs and ERAs) within the definition of ``financial
institution'' in the regulations implementing the BSA, and add a
definition of investment adviser to reflect those covered types; and
(2) require such investment advisers to (a) establish AML/CFT programs,
to include risk-based procedures for conducting ongoing CDD; (b) report
suspicious activity and file CTRs; (c) maintain records of originator
and beneficiary information for certain transactions; (d) apply
information-sharing provisions between and among FinCEN, law
enforcement, agencies, and certain financial institutions; and (e)
implement special due diligence requirements for correspondent and
private banking accounts and special measures under section 311 of the
USA PATRIOT Act. These proposals are discussed in greater detail below.
A. Definitions
FinCEN is proposing two changes to 31 CFR 1010.100, the general
definitions section of its regulations. First, this proposed rule would
amend 1010.100(t) to add ``investment adviser'' to the definition of
``financial institution.''
[[Page 12118]]
Second, it would add a new provision to 1010.100 defining the term
``investment adviser.''
1. Adding ``Investment Adviser'' to the ``Financial Institution''
Definition
The BSA expressly defines various entities as ``financial
institutions,'' \100\ while also providing Treasury with the authority
to define additional entities as financial institutions in its
regulations at 31 CFR 1010.100(t). Specifically, the BSA authorizes
FinCEN to define additional types of businesses as financial
institutions if FinCEN determines that such businesses engage in any
activity ``similar to, related to, or a substitute for'' activities in
which any of the enumerated financial institutions are authorized to
engage.\101\ Although ``investment adviser'' is not one of the
specifically enumerated financial institutions in the BSA, FinCEN is
proposing to make such a determination with respect to the defined set
of investment advisers, and thereby add investment advisers to Sec.
1010.100(t)'s definition of financial institution.
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\100\ 31 U.S.C. 5312(a)(2), (c)(1).
\101\ 31 U.S.C. 5312(a)(2)(Y). FinCEN may also designate
businesses ``whose cash transactions have a high degree of
usefulness in criminal, tax, or regulatory matters'' as financial
institutions. Id. 5312(a)(2)(Z).
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Investment advisers provide services that are similar or related to
services authorized to be provided by BSA-defined financial
institutions. Many investment advisers provide advice to clients who
have granted the adviser the power to manage assets on a discretionary
basis, which is similar or related to services provided by other BSA-
defined institutions, such as broker-dealers or banks. Indeed, many
investment advisers provide asset management services that are similar
to, and often substituted for, the asset management services that are
provided by banks and other financial institutions, such that advisers
may compete directly with asset management services provided by certain
banks. Investment advisers also often provide services that can
substitute for certain products offered by investment companies or
insurance companies. For example, investment advisers can sponsor and
provide advisory services to pooled investment vehicles such as private
funds. As another example, many investment advisers sponsor and provide
advisory services to mutual funds and advise on the purchase or sale of
mutual fund shares, similar to banks or broker dealers that provide
recommendations on mutual fund shares.
Moreover, investment advisers often work closely with, or are
otherwise closely associated with, BSA-defined financial institutions.
For example, investment advisers work closely with financial
institutions when they direct broker-dealers to purchase or sell client
securities, and therefore engage in activities that are closely related
to the activities of covered financial institutions. In addition,
investment advisers are frequently owned by or under common ownership
with banks, broker-dealers, and other financial institutions. For
example, approximately 20 percent of RIAs and seven percent of ERAs are
dually registered as a broker-dealer, licensed as a bank, or affiliated
with a bank or broker dealer.\102\ Investment advisers typically rely
on broker-dealers, banks, and other financial institutions to perform
vital functions for them, such as retaining custody of client funds or
executing trades of securities.\103\ Broker-dealers may recommend
securities transactions to customers as well.\104\ Accordingly, even
investment advisers that lack direct relationships with banks, broker-
dealers, or other types of financial institutions engage in activities
that are ``similar to'' the types of services authorized to be provided
by certain financial institutions.
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\102\ See supra n. 26.
\103\ See, e.g., SEC, Commission Interpretation Regarding
Standard of Conduct for Investment Advisers, Investment Advisers Act
Release No. 5248 (Jun. 5, 2019), 84 FR 33669, 33674-75 (Jul. 12,
2019) (discussing an investment adviser's duty to seek best
execution of a client's transactions where the investment adviser
has the responsibility to select broker-dealers to execute client
trades)
\104\ See 15 U.S.C. 80b-2(a)(11)(C) (excluding from the
definition of ``investment adviser'' under the Advisers Act any
broker or dealer whose performance of advisory services is ``solely
incidental to the conduct of his business as a broker or dealer and
[the broker or dealer] receives no special compensation therefor'');
see also SEC, Commission Interpretation Regarding the Solely
Incidental Prong of the Broker-Dealer Exclusion from the Definition
of Investment Adviser, Investment Advisers Act Release No. 5249
(Jun. 5, 2019), 84 FR 33681 (Jul. 12, 2019). 17 CFR 240.15l-1.
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Further, legislative history during drafting of the USA PATRIOT Act
indicates that RIAs are sufficiently similar to certain other financial
institutions that Treasury could require them to file SARs: ``The
Committee [on Financial Services] notes that, under the Bank Secrecy
Act, the Secretary currently has the authority to require Suspicious
Activity Reports for all entities similar to futures commission
merchants, commodity trading advisors, and commodity pool operators,
namely registered investment advisers and registered investment
companies.'' \105\
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\105\ House Report 107-250(I), Financial Anti-Terrorism Act of
2001, 2001 WL 1249988 at *66 (Oct. 17, 2001); see also Public Law
107-31, Title III section 321 (Oct. 26, 2001) (section of USA
PATRIOT Act adding futures commission merchants, commodity trading
advisors, and commodity pool operators to the definition of
``financial institutions'' for purposes of 31 U.S.C. 5312(a)).
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Accordingly, FinCEN hereby determines that investment advisers
engage in activities that are ``similar to, related to, or a substitute
for'' financial services that other BSA-defined financial institutions
are authorized to engage in and, therefore, may be properly included as
a ``financial institution'' subject to the requirements of the BSA.
2. Adding a Definition of ``Investment Adviser''
FinCEN is also proposing to add a definition of ``investment
adviser'' to 31 CFR 1010.100 to clearly define who qualifies as a
covered adviser--and thus as a ``financial institution'' under these
proposed amendments to FinCEN regulations. The proposed definition of
``investment adviser'' is: ``[a]ny person who is registered or required
to register with the SEC under section 203 of the Advisers Act (15
U.S.C. 80b-3(a)), or any person that currently is exempt from SEC
registration under section 203(l) or 203(m) of the Investment Advisers
Act (15 U.S.C. 80b-3(l), (m)).'' \106\ In other words, under this
proposed definition, an investment adviser would be any RIA (those
registered or required to register) or ERA (those exempt from SEC
registration under the listed provisions).
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\106\ See 15 CFR 275.203(l)-1; 15 CFR 275.203(m)-1.
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The proposed definition relies on well-established and understood
terms and definitions used in the Advisers Act and its implementing
regulations to define who would be an investment adviser under FinCEN
regulations. FinCEN believes that incorporating existing and well-
understood regulatory definitions into its definition of investment
adviser would simplify the investment advisers' determinations as to
whether they are subject to the proposed requirements. FinCEN requests
comment on whether the proposed definition of ``investment adviser'' is
sufficiently clear, or whether some other definition may be preferable.
FinCEN also requests comment on whether the proposed definition
includes classes of investment advisers or certain services or
activities provided by investment advisers that present a very low risk
for money laundering,
[[Page 12119]]
terrorist financing, or other illicit finance activity such that they
should be excluded from the definition, or whether the proposed
definition fails to include a type of adviser that presents a risk.
(a) Registered Investment Advisers
Including RIAs within the proposed definition of investment adviser
would align FinCEN's regulatory framework with the existing framework
under the Advisers Act and would also allow FinCEN to work with the SEC
to develop consistent application and examination of the AML/CFT
requirements to such advisers. Generally, an investment adviser's
amount of assets under management determine whether it is required to
register or is prohibited from registering with the SEC.\107\ In
implementing the Dodd-Frank Act amendments to the Advisers Act, the SEC
amended the instructions to Part 1A of Form ADV to further implement a
uniform method for an investment adviser to calculate its assets under
management in order to determine whether it is required to register or
is prohibited from registering with the SEC.\108\ Per the Dodd-Frank
Act and SEC rules, a ``large'' adviser has $110 million or more in
regulatory assets under management, and is required to register with
the SEC. These are RIAs that would be included in the investment
adviser definition in the proposed rule.\109\ FinCEN notes that large
advisers would comprise a substantial majority of the total number of
investment advisers that are included in the definition of investment
adviser for purposes of the proposed rule.\110\ FinCEN requests comment
on whether the definition of investment adviser should apply to non-
U.S. advisers registered or required to register with the SEC, or who
report to the SEC on Form ADV.
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\107\ See SEC, Rules Implementing Amendments to the Investment
Advisers Act of 1940, Investment Advisers Act Release No. 3221 (Jun.
22, 2011), 76 FR 42950, 42955 (Jul. 19, 2011).
\108\ See id.; see also Instructions for Part 1A, Item 5.F of
Form ADV.
\109\ An investment adviser that is registered with the SEC on a
basis other than its AUM would also be an ``investment adviser''
under the proposed rule and subject to the proposed requirements.
\110\ Generally, a mid-sized adviser has $25 million or more but
less than $110 million in regulatory assets under management and is
registered with the State where it maintains its principal office
and place of business. A small adviser has less than $25 million in
regulatory assets under management and is regulated or required to
be regulated in the State where it maintains its principal office
and place of business. See 15 U.S.C. 80b-3A(a)(1). Mid-sized and
small advisers are generally prohibited from registering with the
SEC, unless an exemption from the prohibition on SEC registration is
available (see 17 CFR 275.203A-2), and therefore are unlikely to be
covered by the proposed definition of ``investment adviser'' in the
proposed rule as RIAs.
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(b) Exempt Reporting Advisers
FinCEN is also including ERAs in the definition of investment
adviser under the proposed rule for the reasons described in section
II.C above. In addition, ERAs have less detailed reporting requirements
than RIAs, are not required to file Form PF, and are not examined by
the SEC on a regular basis.\111\ Further, exempt venture capital
advisers are able to rely on a registration exemption that is not
limited by the amount of AUM. FinCEN requests comment on whether ERAs
should be excluded from the proposed definition of ``investment
adviser,'' and if ERAs are excluded, how could FinCEN otherwise address
the money laundering, terrorist financing, and other illicit finance
risk associated with ERAs. FinCEN also requests comment on whether
there are differences in the risks associated with ERAs who advise
private funds versus those that advise venture capital funds.
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\111\ See 76 FR 42950, 42963, n.188.
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(c) Other Investment Advisers
FinCEN recognizes that different investment advisers included
within the proposed definition may have different degrees of money
laundering, terrorist financing, or other illicit finance risk. As
discussed at greater length below, the AML/CFT program requirement is
risk-based, and FinCEN anticipates that the burden of establishing an
AML/CFT program, filing SARs, and complying with the other requirements
of the proposed rule would be commensurate with an adviser's risk
profile. As noted, the proposed definition of ``investment adviser''
would include certain non-U.S. investment advisers that are physically
located abroad (i.e., do not have a branch, office, or staff in the
United States), but are nonetheless registered or required to register
with the SEC (for RIAs) or file Form ADV (for ERAs). Coverage of these
non-U.S. investment advisers is discussed further at section IV.E.7.
While FinCEN is limiting the proposed definition to RIAs and ERAs,
FinCEN recognizes that other types of investment advisers or other
entities that provide investment advisory services may present risks to
the U.S. financial system of money laundering, terrorist financing, and
other types of financial crimes, or otherwise pose a threat to U.S.
national security. FinCEN, therefore, may consider future rulemakings
to expand the application of the BSA to include other investment
advisers or similar entities not covered by the proposed definition.
FinCEN requests comment on whether other types of investment advisers
or entities should also be subject to the proposed rule.
B. Delegation of Examination Authority to the Securities and Exchange
Commission
FinCEN has overall authority for enforcement of compliance with the
BSA and its implementing regulations.\112\ FinCEN, however, may
delegate examination authority to appropriate agencies while retaining
authority for the coordination and direction of procedures and
activities of these agencies.\113\ FinCEN has previously delegated
examination authority for various financial institutions, as reflected
at 31 CFR 1010.810(b).
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\112\ Treasury Order 180-1, para. 3; 31 CFR 1010.810(a).
\113\ Treasury Order 180-1, paras. 3(b), 4(b); 31 CFR
1010.810(a); 31 U.S.C. 5318(a)(1).
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FinCEN is proposing to amend 31 CFR 1010.810(b) to add investment
advisers to the list of financial institutions for which the SEC has
the authority to examine for compliance with FinCEN's regulations
implementing the BSA. Persons and entities meeting the proposed
definition of investment adviser thus would fall under this provision
and be subject to SEC examination for compliance with FinCEN
regulations. The SEC has expertise in the regulation of investment
advisers. The SEC is the Federal functional regulator for certain
investment advisers and is responsible for examining investment
advisers for compliance with the Federal securities laws, including the
Advisers Act and the SEC rules promulgated under those laws.\114\
Moreover, FinCEN has delegated to the SEC examination authority for
broker-dealers in securities and certain investment companies, which
are BSA-defined financial institutions subject to FinCEN's regulations
and for which the SEC is the Federal functional regulator.\115\
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\114\ See 15 U.S.C. 6809(2)(F); 31 CFR 1010.100(r)(6); see also
15 U.S.C. 80b-1 et seq. and the rules thereunder, 17 CFR part 275.
\115\ See 31 CFR 1010.810(b)(6).
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Accordingly, the proposed rule would designate the SEC as examiner
of investment advisers for compliance with the proposed rule.
C. Investment Advisers' Proposed Obligation To File CTRs Instead of
Form 8300
Under FinCEN's regulations that apply to a broad range of persons--
not just financial institutions--investment
[[Page 12120]]
advisers are currently required to file reports for the receipt of more
than $10,000 in currency and certain negotiable instruments using joint
FinCEN/Internal Revenue Service Form 8300.\116\ By defining investment
advisers as ``financial institutions'' under the BSA, the proposed rule
would require investment advisers to file CTRs with FinCEN pursuant to
31 CFR 1010.311 instead of filing reports using Form 8300.\117\
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\116\ 31 CFR 1010.330; 26 CFR 1.6050I-1. ``Currency'' includes
cashier's checks, bank drafts, traveler's checks, and money orders
in face amounts of $10,000 or less, if the instrument is received in
a ``designated reporting transaction.'' 31 CFR
1010.330(c)(1)(ii)(A). A ``designated reporting transaction'' is
defined as the retail sale of a consumer durable, collectible, or
travel or entertainment activity. 31 CFR 1010.330(c)(2). In
addition, an investment adviser would need to treat the instruments
as currency if the adviser knows that a customer is using the
instruments to avoid the reporting of a transaction on Form 8300. 31
CFR. 1010.330(c)(1)(ii)(B).
\117\ See 31 CFR 1010.330(a) (stating that Sec. 1010.330 [the
BSA provision requiring the filing of the Form 8300] ``does not
apply to amounts received in a transaction reported under 31 U.S.C.
5313 and 31 CFR 1010.311.''). To the extent an investment adviser
conducts transactions other than in currency (as defined in 31 CFR
1010.100(m) for purposes of the CTR requirement), it would be exempt
from reporting such transactions because the Form 8300 requirement
does not apply to such transactions.
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The BSA authorizes FinCEN to promulgate regulations requiring
financial institutions to file reports when they participate in certain
types of financial transactions.\118\ Pursuant to this authority, 31
CFR 1010.311 requires ``financial institutions'' (other than casinos)
to file CTRs for ``each deposit, withdrawal, exchange of currency or
other payment or transfer, by, through, or to such financial
institution which involves a transaction in currency of more than
$10,000,'' unless subject to an applicable exemption. FinCEN seeks to
extend this requirement to investment advisers under the proposed rule.
This proposed rule would also add several provisions, Sec. Sec.
1032.310 to 1032.315, specifying how investment advisers should fulfill
their proposed CTR obligations.
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\118\ See, e.g., 31 U.S.C. 5313(a); 31 U.S.C. 5326.
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The threshold in 31 CFR 1010.311 applies to transactions in
currency of more than $10,000 conducted during a single business
day.\119\ A financial institution must treat multiple transactions
conducted in one business day as a single transaction if the financial
institution has knowledge that the transactions are conducted by or on
behalf of the same person.\120\ This same requirement would extend to
investment advisers.
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\119\ See 31 CFR 1010.311, 1010.313(b). Multiple transactions
must be treated as a single transaction if they are conducted by or
on behalf of the same person and result in cash in or cash out of
more than $10,000 during any one business day. A Form 8300,
meanwhile, must be filed when currency is received in one
transaction or two or more related transactions. Transactions
conducted between a payer (or its agent) and a recipient in a 24-
hour period would be treated as related. Furthermore, a distinction
is drawn between transactions and the receipt of payments.
Installment payments made within a period of 12 months may need to
be aggregated and reported on a Form 8300. See 31 CFR
1010.330(b)(3).
\120\ Id.
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To avoid duplicative requirements, investment advisers would no
longer have to report applicable transactions involving certain
negotiable instruments reportable on Form 8300. Moreover, since an
investment adviser would be required to report suspicious transactions
under the SAR rule proposed in this rulemaking, investment advisers
would no longer need to use Form 8300 to voluntarily report suspicious
transactions.\121\ Finally, imposing CTR and SAR requirements rather
than a Form 8300 requirement is consistent with the obligations of
certain other financial institutions, such as banks, broker-dealers,
and mutual funds.
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\121\ Currently an investment adviser can report a suspicious
transaction voluntarily by checking box 1(b) in the Form 8300. In
addition to the requirement that an investment adviser report on a
CTR, under the proposed rule, an investment adviser would also be
required to file a SAR if a suspicious transaction exceeds the
threshold amount.
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D. Proposed Recordkeeping Requirements for Investment Advisers
FinCEN has broad authority to impose recordkeeping requirements on
financial institutions under the BSA.\122\ Pursuant to this authority,
FinCEN has issued several recordkeeping regulations, codified as 31 CFR
part 1010, subpart D (Sec. Sec. 1010.400 to 1010.440), which apply
broadly to financial institutions, subject to specified exceptions. By
defining RIAs and ERAs as financial institutions, this proposed rule
would apply these recordkeeping regulations to investment advisers.
Specifically, 31 CFR 1032.410 (cross-referencing 31 CFR 1010.410) would
require investment advisers to comply with the Recordkeeping and Travel
Rules, which are codified at 31 CFR 1010.410(e) and 31 CFR 1010.410(f),
respectively, for the purposes of this proposed rule.\123\ The proposed
regulations would not require investment advisers to comply with these
recordkeeping requirements with respect to any mutual fund that it
advises.\124\
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\122\ See 12 U.S.C. 1953; 31 U.S.C. 5311; and 31 U.S.C.
5312(a)(2).
\123\ The Recordkeeping Rule is codified at 31 CFR 1010.410(e)
and 1020.410(a), but only 1010.410(e) is relevant here: 1020.410(a)
describes the recordkeeping requirements for banks, while those for
nonbank financial institutions are described in 1010.410(e). The
Travel Rule, as codified at 31 CFR 1010.410(f), applies to both bank
and nonbank financial institutions. See FinCEN, Board of Governors
of the Federal Reserve System, Amendment to the Bank Secrecy Act
Regulations Relating to Recordkeeping for Funds Transfers and
Transmittals of Funds by Financial Institutions, 60 FR 220 (Jan. 3,
1995); FinCEN, Amendment to the Bank Secrecy Act Regulations
Relating to Orders for Transmittals of Funds by Financial
Institutions, 60 FR 234 (Jan. 3, 1995).
\124\ Specifically, proposed 31 CFR 1032.400 would permit an
investment adviser to deem requirements in Subpart D to be satisfied
for any mutual fund it advises that is subject to these same
reporting requirements under another provision of Subpart D.
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Under the Recordkeeping and Travel Rules, financial institutions
must create and retain records for transmittals of funds and ensure
that certain information pertaining to the transmittal of funds
``travels'' with the transmittal to the next financial institution in
the payment chain.\125\ The Recordkeeping and Travel Rules apply to
transmittals of funds that equal or exceed $3,000. With certain
exceptions, ``transmittal of funds'' includes funds transfers processed
by banks, as well as similar payments where one or more of the
financial institutions processing the payment (e.g., the transmittor's
financial institution, an intermediary financial institution, or the
recipient's financial institution) is not a bank.\126\
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\125\ See 31 CFR 1010.410(e), (f); 31 CFR 1020.410(a). Financial
institutions are also required to retain records for five years. See
31 CFR 1010.430(d).
\126\ See 31 CFR 1010.100(ddd) (defining ``transmittal of
funds''); see also 31 CFR 1010.100(aa), (qq), (ggg) (defining
``intermediary financial institution,'' ``recipient's financial
institution,'' and ``transmittor's financial institution'' to
include both bank and nonbank financial institutions).
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When a financial institution accepts and processes a payment sent
by or to its customer, then the financial institution would be the
``transmittor's financial institution'' or the ``recipient's financial
institution,'' respectively. The Recordkeeping and Travel Rules require
the transmittor's financial institution to obtain and retain the name,
address, and other information about the transmittor and the
transaction.\127\ The Recordkeeping Rule also requires the recipient's
financial institution (and in certain instances, the transmittor's
financial institution) to obtain or retain identifying information on
the recipient.\128\ And the Travel Rule requires that certain
information obtained or retained ``travels'' with the
[[Page 12121]]
transmittal order through the payment chain.\129\
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\127\ See 31 CFR 1010.410(e)(1)(i), (e)(2).
\128\ See 31 CFR 1010.410(e)(1)(iii), (e)(3) (information that
the recipient's financial institution must obtain or retain).
\129\ See 31 CFR 1010.410(f) (information that must ``travel''
with the transmittal order); 31 CFR 1010.100(eee) (defining
``transmittal order'').
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Under the proposed rule, however, some transmittals involving
investment advisers would fall within an existing exception to the
Recordkeeping and Travel Rules designed to exclude transmittals of
funds from these Rules' requirements when certain categories of
financial institutions are the transmitter and recipient.\130\ The
proposed application of this exception to investment advisers is
intended to provide investment advisers with treatment similar to that
of banks, brokers or dealers in securities, futures commission
merchants, introducing brokers in commodities, and mutual funds.
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\130\ See 31 CFR 1010.410(e)(6), (f)(4); 31 CFR 1020.410(a)(6).
As relevant here, Sec. 1010.410(e)(6)(i) excludes from the
requirements of the Recordkeeping Rule ``[t]ransmittals of funds
where the transmitter and the recipient'' are certain types of
listed financial institutions. Section 1010.410(f)(4) excludes these
same transmittals from the Travel Rule. The proposed rule would
amend Sec. 1010.410(e)(6) to add ``investment advisers'' to its
list of financial institutions.
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Additionally, FinCEN recognizes that investment advisers operate
varying business models and, that in some circumstances, an adviser
would not conduct transactions that meet the definition of
``transmittal order.'' For example, in some advisory relationships,
when an investment adviser receives instructions from a customer, the
investment adviser would not ``be reimbursed by debiting an account of,
or otherwise receiving payment from,'' the customer, such that the
investment adviser's receipt of instructions from a customer would not
meet the definition of transmittal order.\131\
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\131\ See 31 CFR 1010.100(eee)(2).
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Because FinCEN is proposing to include investment advisers in the
definition of financial institutions, investment advisers would be
required to comply with the Recordkeeping and Travel Rules when they
engage in transactions that meet the definition of a transmittal order.
FinCEN understands that the collection of at least some of this
information would be required for accounting or other purposes and
seeks comment on the extent to which investment advisers or other BSA-
defined financial institutions regularly collect information that would
be required under the Recordkeeping and Travel Rules. Similarly, FinCEN
seeks comment on understanding the structures that investment advisers
use to be credited by customers who seek to wire funds out of their
accounts with the investment adviser. FinCEN seeks comment on how
investment advisers work with qualified custodians to maintain separate
accounts to manage customers' funds, including for wire transfers.
FinCEN is also seeking comment on whether investment advisers should be
required to comply with the Recordkeeping and Travel Rules as proposed,
or if the Recordkeeping and Travel Rules should only apply in certain
circumstances.
Finally, the proposed rule would subject investment advisers to
requirements to create and retain records for extensions of credit and
cross-border transfers of currency, monetary instruments, checks,
investment securities, and credit.\132\ These requirements currently
apply to transactions by other BSA-defined financial institutions in
amounts exceeding $10,000.\133\
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\132\ See 31 CFR 1010.410(a)-(c). Financial institutions must
retain these records for a period of five years. 31 CFR 1010.430(d).
\133\ See 31 CFR 1010.410(a)-(c).
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E. Anti-Money Laundering and Countering the Financing of Terrorism
Programs
The BSA requires financial institutions to establish reasonably
designed risk-based AML/CFT programs to combat the laundering of money
and financing of terrorism through the institution.\134\ The Annunzio-
Wylie Anti-Money Laundering Act of 1992 amended the BSA by authorizing
Treasury to issue regulations requiring financial institutions, as
defined in BSA regulations, to maintain ``minimum standards'' of an
anti-money laundering program.\135\ These anti-money laundering
programs must include, at a minimum, the development of internal
policies, procedures, and controls; the designation of a compliance
officer; an ongoing employee training program; and an independent audit
function to test programs.\136\ The USA PATRIOT Act further amended the
BSA to expand AML program rules applicable to banks to cover certain
other industries.\137\ The requirements for an anti-money laundering
program were further amended by section 6101(b) of the AML Act of 2020
(AML Act), which among other things, expanded the BSA's program rule
requirement to include a reference to CFT in addition to AML.\138\
FinCEN intends to implement more specific changes to AML/CFT program
requirements as a result of section 6101(b) of the AML Act through a
separate rulemaking process.\139\ FinCEN does not intend to address
those more specific changes as part of this rulemaking.
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\134\ 31 U.S.C. 5311(2), 5318(h)(1).
\135\ Annunzio-Wylie Anti-Money Laundering Act, Title XV of the
Housing and Community Development Act of 1992, Public Law 102-550.
\136\ 31 U.S.C. 5318(h)(1)(A)-(D).
\137\ Section 352(a) of the Act, which became effective on April
24, 2002, amended 31 U.S.C. 5318(h).
\138\ Public Law 116-283 (Jan. 1, 2021); see 31 U.S.C.
5318(h)(4)(D) (as amended by AML Act section 6101(b)(2)(C)).
\139\ See FinCEN Regulatory Agenda (Spring 2023), Establishment
of National Exam and Supervision Priorities, available at <a href="https://www.reginfo.gov/public/do/eAgendaViewRule?pubId=202304&RIN=1506-AB52">https://www.reginfo.gov/public/do/eAgendaViewRule?pubId=202304&RIN=1506-AB52</a>.
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The BSA authorizes FinCEN, after consultation with the appropriate
Federal functional regulator (for investment advisers, the SEC), to
further prescribe minimum standards for such AML/CFT programs.\140\ In
developing this proposed rule, FinCEN consulted and coordinated with
the SEC staff, including regarding the statutorily specified factors
set out in 31 U.S.C. 5318(h)(2)(B). These factors are:
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\140\ 31 U.S.C. 5318(h)(2)(A).
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<bullet> financial institutions are spending private compliance
funds for a public and private benefit, including protecting the United
States financial system from illicit finance risks;
<bullet> the extension of financial services to the underbanked and
the facilitation of financial transactions, including remittances,
coming from the United States and abroad in ways that simultaneously
prevent criminal persons from abusing formal or informal financial
services networks are key policy goals of the United States;
<bullet> effective anti-money laundering and countering the
financing of terrorism programs safeguard national security and
generate significant public benefits by preventing the flow of illicit
funds in the financial system and by assisting law enforcement and
national security agencies with the identification and prosecution of
persons attempting to launder money and undertake other illicit
activity through the financial system;
<bullet> anti-money laundering and countering the financing of
terrorism programs should be--
[cir] reasonably designed to assure and monitor compliance with the
requirements of the BSA and regulations promulgated under the BSA; and
[cir] risk-based, including ensuring that more attention and
resources of financial institutions should be directed toward higher-
risk customers and activities, consistent with the risk profile of a
financial institution, rather than toward lower-risk customers and
activities.
[[Page 12122]]
FinCEN has considered these factors in section 5318(h)(2)(B) in the
drafting of this proposed rule. In proposing this rule, FinCEN has
considered the fact that comprehensive AML/CFT requirements for
investment advisers, which would require investment advisers to have
effective AML/CFT programs and subject them to SAR reporting
requirements, would aid in preventing the flow of illicit funds in the
financial system and in assisting law enforcement and national security
agencies with the identification and prosecution of those who attempt
to launder money and undertake other illicit financial activity.
Additionally, FinCEN recognizes that AML/CFT programs at investment
advisers should be reasonably designed and risk-based consistent with
investment advisers' respective risk profiles, and therefore is
proposing an AML/CFT program rule that requires policies, procedures,
and internal controls reasonably designed to prevent the investment
adviser from being used for money laundering, terrorist financing, or
other illicit finance activities, as well as risk-based procedures that
consider an investment adviser's risk profile. Further, as discussed in
the Regulatory Analysis at section VII, FinCEN has analyzed the
financial costs to investment advisers in imposing AML/CFT obligations,
including AML/CFT program requirements and SAR filing requirements, and
has determined that the public and private benefit to this proposed
rule would outweigh the private compliance costs.\141\
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\141\ Further discussion relevant to each factor may be found
at: Factor (i): the regulatory impact analysis at section VII and
other discussions of the costs and benefits of the proposed rule;
Factor (ii): we believe that this factor is not relevant to the
proposed rule because investment advisers generally do not provide
services to the unbanked, process remittances, or participate in
informal financial networks. This may be inferred from the risk
discussion at section II.C and accompanying discussions of the
structure of the investment advisory industry; and Factor (iii): the
risk analysis at section II.C; Factor (iv): the risk analysis at
section II.C and the discussion of building upon existing
requirements and examination programs in this section and at section
IV.B.
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This proposed rule, by designating investment advisers as financial
institutions, would subject investment advisers to AML/CFT program
requirements, as reflected in proposed Sec. 1032.210.\142\
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\142\ Additionally, 31 CFR subpart B contains general provisions
applicable generally to financial institutions' AML/CFT programs.
Proposed Sec. 1032.200 would subject investment advisers those
general provisions in subpart B.
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Investment advisers are already subject to other regulations
similar in certain ways to the AML/CFT program requirements FinCEN is
proposing, and thus should be well-positioned to extend their practices
to incorporate proposed AML/CFT requirements. RIAs are currently
subject to Federal securities laws, which require the establishment of
a variety of policies, procedures, and controls. For example, the
Advisers Act requires an RIA to maintain certain books and records, as
prescribed by the SEC.\143\ Under 17 CFR 275.204-2, an RIA is required
to keep certain books and records that relate to its investment
advisory business.\144\ Under 17 CFR 275.203-1 and 275.204-4, RIAs and
ERAs, respectively, are also required to complete and submit Form ADV
to the SEC. The Advisers Act also prohibits an investment adviser from
engaging in fraudulent, deceptive, and manipulative conduct.\145\ SEC
rules further require RIAs to adopt and implement written policies and
procedures reasonably designed to prevent violations of the Advisers
Act and the rules that the SEC has adopted under that Act.\146\ RIAs
must conduct annual reviews to ensure the adequacy and effectiveness of
their policies and procedures and must designate a chief compliance
officer responsible for administering the policies and procedures.\147\
ERAs are also subject to Federal securities laws governing the
securities industry, required to complete and submit some sections of
Form ADV, and comply with other select requirements of the Advisers
Act.\148\ While ERAs may not have the full compliance infrastructure
that RIAs have, their existing compliance obligations nonetheless offer
a point of reference and relevant experience for implementing the AML/
CFT requirements in the proposed rule.
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\143\ See 15 U.S.C. 80b-4(a) (requiring investment advisers to
make and retain records as defined in section 3(a)(37) of the
Exchange Act and to make and disseminate reports as prescribed by
the SEC).
\144\ See 17 CFR 204-2 (books and records to be maintained by
investment advisers).
\145\ See, e.g., 15 U.S.C. 80b-6(1)-(2)), (4) (prohibiting any
investment advisers from engaging in any activity that would defraud
a client or prospective client). See also 17 CFR 275.206(4)-8
(prohibiting any investment advisers from making false or misleading
statements to, or otherwise defrauding, investors or prospective
investors to pooled investment vehicles).
\146\ 17 CFR 275.206(4)-7(a).
\147\ 17 CFR 275.206(4)-7(b), (c).
\148\ See, e.g., 15 U.S.C. 80b-6(1)-(2), (4); 17 CFR 275.204-4;
17 CFR 275.206(4)-5; 17 CFR 275.206(4)-8.
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As FinCEN has noted, the AML/CFT program requirement is not a one-
size-fits-all requirement but rather is risk-based and is intended to
give investment advisers the flexibility to design their programs to
identify and mitigate the specific risks of the advisory services they
provide and the customers they advise. As such, ERAs would be able to
tailor their AML/CFT programs to the specific risks, activities, and
operations associated with their advisory business. Accordingly, FinCEN
contemplates that investment advisers, as defined in the proposed rule,
would be able to build upon existing policies, procedures, and internal
controls, or the processes undertaken to establish those policies,
procedures, and internal controls, to comply with the proposed AML/CFT
requirements.
Moreover, some investment advisers have already implemented AML/CFT
programs either because they are dually registered as a broker-dealer,
licensed as a bank, or affiliated with a broker-dealer or bank, or in
conjunction with a SIFMA No-Action Letter permitting broker-dealers to
rely on RIAs to perform some or all aspects of broker-dealers' CIP
obligations.\149\ For instance, according to the 2016 Investment
Management Compliance Testing Survey of RIAs conducted by ACA
Compliance Group and the Investment Adviser Association, 76 percent of
participants had adopted AML policies, and 40 percent of participants
had adopted AML programs similar to the AML program requirements
proposed in the Second Proposed Investment Adviser Rule.\150\ FinCEN
requests comment on what CDD procedures RIAs and/or ERAs already have
in place to comply with the SIFMA No-Action Letter.
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\149\ See SIFMA No-Action Letter, supra n. 52. See also 31 CFR
1023.220(a)(6) (CIP rule permitting a financial institution to rely
on another financial institution to perform all or part of its
obligations to verify the identity of its customers as required by
31 U.S.C. 5318(h)).
\150\ See 2016 Investment Management Compliance Testing Survey
(2016 IMCTS Survey), p.21, <a href="https://www.investmentadviser.org/eweb/docs/Publications_News/Reports_and_Brochures/Investment_Management_Compliance_Testing_Surveys/2016IMCTppt.pdf">https://www.investmentadviser.org/eweb/docs/Publications_News/Reports_and_Brochures/Investment_Management_Compliance_Testing_Surveys/2016IMCTppt.pdf</a>.
This survey included responses from compliance officers at 730 RIAs
and is the most recent IMCTS survey to have asked detailed questions
about AML policies and programs.
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1. Overview of AML/CFT Program Requirement
Section 1032.210(a)(1) of the proposed rule would require each RIA
and ERA to develop and implement a written AML/CFT program that is
risk-based and reasonably designed to prevent the investment adviser
from being used for money laundering, terrorist financing, or other
illicit finance activities. Each RIA and ERA would also be required to
make its AML/CFT program available for inspection by FinCEN or the SEC.
The minimum requirements for the AML/CFT program are set forth in
[[Page 12123]]
Sec. 1032.210(b) and discussed in greater detail below.
FinCEN reiterates that the proposed AML/CFT program requirement is
not a one-size-fits-all requirement but is risk-based and must be
reasonably designed. The ``risk-based and reasonably designed''
approach of the proposed rule is intended to give investment advisers
the flexibility to design their programs so that they are commensurate
with the specific risks of the advisory services they provide and the
customers they advise.\151\ For example, large firms may assign
responsibilities of the individuals and departments carrying out each
aspect of the AML/CFT program, while smaller firms would be expected to
adopt procedures that are consistent with their (often) simpler, more
centralized organizational structures. This flexibility is designed to
ensure that all firms subject to FinCEN's AML/CFT program requirements,
from the smallest to the largest, and the simplest to the most complex,
have in place policies, procedures, and internal controls appropriate
to their advisory business to prevent the investment adviser from being
used to facilitate money laundering, terrorist financing, or other
illicit finance activities and to achieve and monitor compliance with
the applicable provisions of the BSA and FinCEN's implementing
regulations. FinCEN requests comment on whether existing requirements
under the Advisers Act or existing policies and procedures to implement
OFAC sanctions could assist investment advisers in complying with the
proposed AML/CFT requirements. FinCEN also requests comment on whether
any proposed requirements are duplicative of any existing requirements.
Finally, FinCEN requests comment on whether there are certain services
or activities provided by investment advisers where applying AML/CFT
requirements would result in information of limited value to law
enforcement and regulators.
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\151\ The legislative history of the BSA reflects that Congress
intended that each financial institution should have some
flexibility to tailor its program to fit its business, considering
factors such as size, location, activities, and risks or
vulnerabilities to money laundering. This flexibility is designed to
ensure that all firms, from the largest to the smallest, have in
place policies and procedures appropriate to monitor for money
laundering. See USA PATRIOT Act of 2001: Consideration of H.R. 3162
Before the Senate, 147 Cong. Rec. S10990-02 (Oct. 25, 2001)
(statement of Sen. Sarbanes); Financial Anti-Terrorism Act of 2001:
Consideration Under Suspension of Rules of H.R. 3004 Before the
House of Representatives, 147 Cong. Rec. H6938-39 (Oct. 17, 2001)
(statement of Rep. Kelly) (provisions of the Financial Anti-
Terrorism Act of 2001 were incorporated as Title III in the Act).
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2. Scope
As described above, the proposed rule would require all RIAs and
ERAs to develop an AML/CFT program, and that program would be required
to cover all advisory activities, with one exception: the program need
not cover activities undertaken with respect to mutual funds, which
have their own obligations under the BSA.\152\ As detailed below,
advisory activities with respect to mutual funds would be exempt from
the AML/CFT program requirements that would be applied in the proposed
rule.
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\152\ See 31 CFR part 1024.
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An investment adviser would apply an AML/CFT program to all
advisory activities other than with respect to mutual funds. Advisory
activities subject to an AML/CFT program would include, for example,
the management of customer assets, the provision of financial advice,
the execution of transactions for customers, as well as other advisory
activities. The requirements of the proposed rule would not apply to
non-advisory services. One example of this would be in the context of
private equity funds: fund personnel may play certain roles with
respect to the portfolio companies in which the fund invests.
Activities undertaken in connection with those roles (e.g., making
managerial/operational decisions about portfolio companies) would not
be ``advisory activities'' for purposes of the rule. FinCEN requests
comment on whether certain advisory activities pose a lower risk in all
circumstances and on the challenges for advisers in complying with the
proposed role when engaged in such activities.
Certain commenters on the Second Proposed Investment Adviser Rule
proposed to exempt some advisory activities, such as advising clients
without managing client assets and acting as a subadviser, on the
ground that such activities are lower risk. Assessing the risk of an
adviser's activities requires appreciation of the full context of the
activity. For example, subadvisers and advisers who do not manage
assets may nonetheless afford their clients access to the U.S.
financial system, inadvertently guide the layering or integration of
illicit proceeds or other illicit finance activity, or have
relationships that provide insight to the investment adviser's AML/CFT
program. FinCEN is therefore proposing to include those activities
within the scope of this proposed rule. As discussed in the comment
request section below, FinCEN requests comment on whether certain
subadvisory activities should be excluded from coverage of this
proposed rule.
Under the risk-based approach, an investment adviser would tailor
its program according to the specific risks presented by its various
activities. Factors that may indicate an activity or a customer is
lower risk include the jurisdiction of registration of legal person
customers, and whether the customer (where a legal person) is subject
to U.S. AML/CFT regulatory requirements.
(a) Mutual Funds
FinCEN is proposing to exempt from the proposed requirements
activities of investment advisers in advising mutual funds.\153\ FinCEN
believes that this exemption is appropriate because of the regulatory
and practical relationship between mutual funds and their investment
advisers. Specifically, although mutual funds are distinct legal
entities with distinct legal obligations, mutual funds typically do not
have their own independent operations. Rather, mutual funds are
entirely operated, and compliance with their legal obligations is
undertaken, by their service provider entities, foremost amongst them
their investment advisers. As a practical matter, we believe that any
AML/CFT requirement imposed on an RIA to a mutual fund is already
addressed by the existing AML/CFT requirements imposed on the mutual
fund itself.\154\ In particular, we expect that the investment adviser
to a mutual fund will have both (1) access to the exact same
information concerning the mutual fund or its investors that is
available to the mutual fund, in part in connection with its AML/CFT
obligations and (2) a significant role generally in the operations of
the mutual fund's regulatory responsibilities, including its AML/CFT
program. Consequently, we are proposing not to require investment
advisers to mutual funds to include those mutual funds within the
investment advisers' own AML/CFT programs, as we believe including a
mutual fund within its investment
[[Page 12124]]
adviser's AML/CFT program would be redundant. This exemption is
permissive and not mandatory; an investment adviser could decide to
include the mutual funds it advises in complying with any of the
investment adviser's proposed requirements.
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\153\ FinCEN's definition of a mutual fund under 1010.100(gg)
applies to an ETF as an ``open-end company'' (as the term is defined
in section 5 of the Investment Company Act).'' See supra n. 53.
\154\ FinCEN notes as well that the First Proposed Investment
Adviser Rule would have permitted mutual funds to be excluded from
the programs required of investment advisers covered by that
proposed rule. Commenters to the Second Proposed Investment Adviser
Rule, which would not have permitted such an exclusion, supported
instead the 2003 NPRM approach.
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Mutual funds are already subject to comprehensive AML/CFT
obligations under the BSA and are required to, among other things,
establish AML/CFT and customer identification programs, conduct CDD,
and report suspicious activity, among other obligations.\155\ FinCEN
believes that, currently, these requirements sufficiently mitigate the
money laundering, terrorist financing, and other illicit finance risks
associated with mutual funds and those funds' investors to justify this
exemption. FinCEN is requesting comment on whether to exempt mutual
funds from coverage in an adviser's AML/CFT program. FinCEN also
requests comment on whether there are other categories of entities
that, like mutual funds, could be reasonably exempted from an
investment adviser's AML/CFT program.
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\155\ See 31 CFR 1010.100(gg); 31 CFR part 1024.
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FinCEN is also proposing to exempt investment advisers from having
to comply with the reporting and recordkeeping requirements of part
1032, subparts C and D, for its mutual fund customers. FinCEN believes
that the proposed regulatory text is sufficiently clear that these
subparagraphs would not apply with respect to mutual fund customers,
because the internal policies, procedures, and controls to comply with
those requirements are closely linked to the AML/CFT program
requirement. FinCEN requests comment on whether additional regulatory
text in those subparts is needed to clarify this. FinCEN also requests
comment on whether the exemption should be dependent on the nature of
the relationship between the investment adviser and its mutual fund
customer, and whether the exemption would avoid duplication of existing
AML/CFT requirements. Lastly, FinCEN requests comment on whether
investment advisers to mutual funds should still be required to monitor
for and file SARs.
(b) Provision of Other Advisory Services
FinCEN understands that investment advisers provide a range of
services that could affect the nature of their AML/CFT programs. An
investment adviser may provide customers with advisory services that do
not include the management of customer assets or knowledge of
customers' investment decisions, such as pension consulting, securities
newsletters, research reports, or financial planning.
In the investment advisory industry, an adviser may also act as the
``primary adviser'' or ``subadviser.'' \156\ Generally, the primary
adviser contracts directly with the client, and a subadviser has
contractual privity with the primary adviser, though there is variation
across the sector with respect to the relationship and function between
primary advisers and subadvisers. Because subadvisory services are a
subcategory of advisory services, the proposed rule would apply to
investment advisers who provide subadvisory services.
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\156\ The Advisers Act does not distinguish between advisers and
subadvisers; all are ``investment advisers.'' See 76 FR 39646, 39680
(Jul. 6, 2011) at n. 504 and accompanying text.
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FinCEN requests comment on whether specific services provided by
investment advisers, such as advisory services that do not involve
management of client assets or subadvisory services, should be included
or excluded from coverage of this proposed rule. FinCEN also requests
comment on any alternative approaches for addressing compliance with
the proposed rule when advisers provide particular services, such as
allowing subadvisers to rely on the primary adviser or allowing the
primary adviser to delegate all AML/CFT obligations to the subadviser.
FinCEN further requests comment on whether there is an increased risk
for a subadviser when providing advisory services to a customer with a
primary adviser that is not an investment adviser as defined in the
proposed rule. FinCEN also requests comment on the extent a
subadviser's AML/CFT program would overlap with the primary adviser's
program and how duplication could be mitigated. Finally, FinCEN
requests comment on whether there are similar arrangements where an
investment adviser may be sub-contracted to provide services to another
investment adviser that should or should not be in the scope of an
investment adviser's AML/CFT program.
3. Dually Registered Investment Advisers and Advisers Affiliated With
or Subsidiaries of Entities Required To Establish AML/CFT Programs
According to a Treasury review of Form ADV filings, approximately
three percent of RIAs were dually registered with the SEC as investment
advisers and broker-dealers in securities, and approximately 20 percent
of RIAs may be affiliated with, or subsidiaries of, banks or broker-
dealers, which are required to establish AML/CFT programs. With respect
to an investment adviser that is dually registered as a broker-dealer
or is a bank (or is a bank subsidiary), FinCEN is not proposing to
require such an adviser to establish multiple or separate AML/CFT
programs so long as a comprehensive AML/CFT program covers all of the
entity's relevant business and activities that are subject to BSA
requirements. The program should be designed to address the different
money laundering, terrorist financing, or other illicit finance
activity risks posed by the different aspects of the entities'
businesses and, accordingly satisfy each of the risk-based AML/CFT
program requirements to which it is subject in its capacity as both an
investment adviser and broker-dealer or bank.\157\ Similarly, an
investment adviser affiliated with, or a subsidiary of, another entity
required to establish an AML/CFT program in another capacity would not
be required to implement multiple or separate programs as one single
program can be extended to all affiliated entities that are subject to
the BSA, so long as it is designed to identify and mitigate the
different money laundering, terrorist financing, and other illicit
finance activity risks posed by the different aspects of the entity's
business and satisfy each of the risk-based AML/CFT program and other
BSA requirements to which the organization is subject in all of its
regulated capacities, as for example an investment adviser and a bank
or insurance company.\158\
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\157\ FinCEN notes that while broker-dealers in securities are
subject to the full panoply of FinCEN's regulations implementing the
BSA, investment advisers would not immediately be subject to certain
of those AML/CFT requirements, e.g., the CIP Rule, because the
proposed rule does not include CIP requirements at this time. FinCEN
intends to address CIP requirements in a subsequent joint rulemaking
with the SEC, after notice-and-comment.
\158\ FinCEN notes that although certain insurance companies are
required to establish and implement AML programs and report
suspicious activity, the term ``insurance company'' is not included
within the general definition of financial institution under
FinCEN's regulations. See 31 CFR 1010.100(t). Therefore, such
insurance companies are not required to file CTRs with FinCEN or
comply with the Recordkeeping and Travel Rules and other related
recordkeeping requirements. Accordingly, FinCEN would not expect an
insurance company that is affiliated with or owns an investment
adviser to design an enterprise-wide AML/CFT compliance program that
would subject the insurance company to AML/CFT requirements not
required by FinCEN's regulations. Conversely, FinCEN would not
expect a bank, which is subject to the full panoply of FinCEN's
regulations implementing the BSA, to design an enterprise-wide AML/
CFT compliance program that would subject an affiliated or
controlled investment adviser to AML/CFT requirements that would not
be required by the proposed rule.
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[[Page 12125]]
FinCEN recognizes the importance of enterprise-wide compliance and,
therefore, believes it would be beneficial and cost-effective for these
types of entities to implement one comprehensive AML/CFT program that
includes all activities covered by FinCEN's regulations. However, these
entities would not be required to establish one comprehensive AML/CFT
program; they may instead establish multiple programs to satisfy their
AML/CFT obligations. What would be required, however, is that the
covered investment adviser and its affiliated financial institution(s)
identify and mitigate the risks arising across the organization or
organizations--for example, as they relate to one customer served by
both an affiliated bank and an investment adviser. If each of these
affiliates conducts due diligence on the same customer individually,
without assessing all of this information between both aspects of its
business, these businesses' understanding of their shared customer
would be incomplete, which could lead to a less effective understanding
of risk and detection of suspicious activity.
FinCEN is requesting comments on how dually registered investment
advisers and broker-dealers, or investment advisers affiliated with, or
a subsidiary of, a bank, broker-dealer, or other BSA-defined financial
institution, should apply their existing AML/CFT program to their
investment advisory activities. FinCEN also requests comment on whether
RIAs or ERAs that are affiliated with a bank or broker-dealer presently
apply enterprise-wide AML/CFT requirements, and whether certain AML/CFT
requirements are presently tailored for advisory activities.
4. Delegation of Duties
Investment advisers' services routinely involve other financial
institutions that have their own AML/CFT program requirements, such as
broker-dealers, banks, mutual funds, as well as other investment
advisers. FinCEN also recognizes that an investment adviser may conduct
some of its operations through agents or third-party service providers,
such as broker-dealers in securities (including prime brokers),
custodians, transfer agents, and fund administrators. For instance,
many investment advisers that operate private funds delegate the
implementation and operation of certain aspects of their AML program to
a third party, most often the fund's administrator, which is an
independent third-party that provides valuation, administrative, and
other services to the fund and its investors.\159\
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\159\ FinCEN understands that some fund administrators are
nonbank subsidiaries of U.S. bank holding companies and, as such,
are subject to the global AML policies and procedures of these U.S.
institutions. FinCEN also understands that some investment advisers
delegate AML compliance to administrators located outside the United
States. These administrators are generally located in jurisdictions
that require regulated entities to have their own AML/CFT policies,
procedures, and controls. See, e.g., Managed Funds Association,
Letter to Financial Crimes Enforcement Network, Re: AML Program and
SAR Filing Requirements for Registered Investment Advisers (RIN:
1506-AB10), Docket Number FinCEN-2014-003 (Nov. 2, 2015).
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FinCEN recognizes that it is common in the advisory business to
delegate a range of compliance, administrative, and other activities to
third-party providers. In the proposed rule, similar to other BSA-
defined financial institutions, FinCEN would permit an investment
adviser to delegate contractually the implementation and operation of
aspects of its AML/CFT program. However, if an investment adviser
delegates the implementation and operation of any aspects of its AML/
CFT program to another financial institution, agent, fund
administrator, third-party service provider, or other entity, the
investment adviser would remain fully responsible and legally liable
for, and need to demonstrate, the program's compliance with AML/CFT
requirements and FinCEN's implementing regulations. The investment
adviser also would be required to ensure that FinCEN and the SEC are
able to obtain information and records relating to the AML/CFT program.
Because investment advisers operate through a variety of different
business models, each investment adviser may decide which aspects (if
any) of its AML/CFT program are appropriate to delegate. In certain
circumstances, for instance, an investment adviser may deem it
appropriate to delegate certain aspects of its suspicious activity
monitoring and reporting obligation to a third party, such as a
qualified custodian.
In addition to these financial institutions, there are other third-
party service providers that play an important role in advisory
activities, such as fund administrators. As FinCEN understands it, for
advisers who presently implement AML/CFT policies and procedures, it is
often current practice for those advisers to delegate the
administration of AML/CFT policies and procedures to their fund
administrator, along with non-AML/CFT activities such as processing
subscriptions, transfers, and redemptions administrators. Some fund
administrators are subsidiaries of U.S. financial or bank holding
companies that may have enterprise-wide AML/CFT programs, while those
in foreign jurisdictions may be subject to AML/CFT requirements under
local law.
However, as noted above, liability for noncompliance would remain
with the investment adviser. The investment adviser would still be
required to identify and document the procedures implemented to address
its vulnerability to money laundering, terrorist financing, and other
illicit finance activity, and then undertake reasonable steps to assess
whether the service provider carries out such procedures effectively.
For example, it would not be sufficient to simply obtain a
``certification'' from a service provider that the service provider has
a satisfactory AML/CFT program. Similarly, if an investment adviser
delegates the responsibility for suspicious activity reporting to an
agent or a third-party service provider, the adviser remains
responsible for its compliance with the requirement to report
suspicious activity, including the requirement to maintain SAR
confidentiality.
FinCEN requests comment on the scope of information fund
administrators currently collect that would support implementation of
the proposed rule, and on the practical effect of permitting an
investment adviser to delegate some or all of the requirements in the
proposed rule. FinCEN also requests comment on the quality of AML/CFT
programs implemented by fund administrators whose operations are
primarily conducted outside of the United States, the extent to which
these fund administrators are able to collect and provide information
on the natural person and legal entity investors in offshore pooled
investment vehicles when that information is requested by a U.S.
investment adviser, the ability of the U.S. investment adviser to
effectively monitor the implementation of proposed requirements by fund
administrators, and the quality of suspicious activity or suspicious
transaction reports submitted by those fund administrators.
5. AML/CFT Program Approval
Section 1032.210(a)(2) of the proposed rule would require that each
investment adviser's AML/CFT program be approved in writing by its
board of directors or trustees, or if it does not have a board, by its
sole proprietor, general partner, trustee, or other persons that have
functions similar to a board of directors. This provision of the
proposed rule would ensure that the
[[Page 12126]]
requirement to have an AML/CFT program receives the appropriate level
of attention and is intended to be sufficiently flexible to permit an
investment adviser to comply with this requirement based on its
particular organizational structure. The proposed rule would require an
investment adviser's written program to be made available for
inspection by FinCEN or the SEC.
6. The Required Elements of an Anti-Money Laundering/Countering the
Financing of Terrorism Program
(a) Required Policies, Procedures, and Internal Controls
Section 1032.210(b)(1) would require an investment adviser to
establish and implement policies, procedures, and internal controls
reasonably designed to prevent money laundering, terrorist financing,
and other illicit finance activities. As noted in section II, these
risks may include not only activities tied to money laundering, such as
fraud or corruption, but also any affiliation or relationship with
either persons designated by the United States or other jurisdictions
with which the United States regularly coordinates sanctions actions,
or foreign state-sponsored investment activity in critical or emerging
technologies. FinCEN recognizes that some types of customers or
customer activities would pose greater risks for money laundering,
terrorist financing, or other illicit finance activity than others.
Generally, under the proposed rule, an investment adviser would be
required to review, among other things, the types of advisory services
it provides and the nature of the customers it advises to identify the
investment adviser's vulnerabilities to money laundering, terrorist
financing, and other illicit finance activities. It would also need to
review investment products offered, distribution channels,
intermediaries that it may operate through, and geographic locations of
customers and business activities. Accordingly, an investment adviser's
assessment of the risks presented by the different types of advisory
services it provides to such customers would need to, among other
factors, consider the types of accounts offered (e.g., managed
accounts), the types of customers opening such accounts, the geographic
location of such customers, and the sources of wealth for customer
assets. FinCEN expects that investment advisers would generally be able
to adapt existing policies and procedures to meet this
requirement.\160\ FinCEN requests comment on whether it should require
an investment adviser to include all the advisory services it provides
in its AML/CFT program.
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\160\ See discussion in section II.B, infra, for a discussion of
existing Advisers Act recordkeeping and reporting obligations that
may enable investment advisers to adapt existing policies,
procedures, and internal controls. In addition, as noted above,
according to one industry survey, as of 2016, 40 percent of
participants had adopted AML programs similar to the AML program
requirements proposed in the Second Proposed Investment Adviser
Rule.
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The discussion below focuses on how an investment adviser's AML/CFT
program may address the money laundering, terrorist financing, or other
illicit finance risks that may be presented by certain specific types
of advisory customers, as well as how an adviser's program may address
the risks presented by certain specific advisory services provided to
those customers. In addition, this section describes FinCEN's
expectations under a risk-based approach regarding advisory services to
wrap fee programs. FinCEN requests comment on whether closed-end
registered funds, wrap fee programs, or other types of accounts advised
by investment advisers should be, on a risk-basis, reasonably exempted
from an investment adviser's AML/CFT program.
Registered Closed-End Funds. Based on one available estimate, at
the end of 2022, there were approximately 440 registered closed-end
funds that had approximately $250 billion in AUM.\161\ Unlike open-end
funds, closed-end funds do not have an existing AML/CFT program or SAR
requirement. Registered closed-end funds, however, are subject to
comprehensive SEC regulation and oversight and typically trade in the
secondary market through broker-dealers who have AML/CFT obligations
and where there are additional required disclosures and greater
transparency.
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\161\ See 2023 Investment Company Factbook at p.2,17, supra n.
55. Unlike traditional mutual funds (or ``open-end funds''), closed-
end funds are not required to buy back shares from shareholders.
Closed-end funds sell their shares in a public offering. After that,
their shares trade on national securities exchanges at market
prices. The market price may be greater or less than the market
value of the fund's underlying investments.
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For these reasons, although FinCEN is not proposing to exempt
closed-end funds from the AML/CFT or SAR requirements in the proposed
rule, FinCEN would expect, absent other indicators of high-risk
activity, investment advisers could treat closed-end funds as lower-
risk for purposes of their AML/CFT programs. FinCEN requests comments
on the money laundering, terrorist financing, and other illicit finance
risks faced by closed-end funds, and how entities with existing AML/CFT
requirements, such as banks and broker-dealers, apply those
requirements to activity involving closed-end funds.
Private Funds. As described above, the money laundering, terrorist
financing, or illicit finance activity risk for private funds may vary
with the individual fund's investment strategy, targeted investors, and
other characteristics. Some private funds have traditionally been seen
as less attractive to certain illicit actors. For instance, due to
their long-term investment focus and illiquid nature, certain private
equity funds may be less likely to be used by money launderers,
terrorist financiers, and others engaging in illicit finance.\162\
Other relevant characteristics of private funds include minimum
subscription amounts, restrictions on the type of investors they can
accept, and the fact that most funds prohibit the receipt of paper
currency. However, those factors may not be a barrier to more
sophisticated fraudsters or corrupt officials, among others, that have
already placed their funds into a foreign bank and are seeking long-
term returns outside of their home country.
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\162\ For instance, in the Proposed Unregistered Investment
Companies Rule, FinCEN proposed to exclude from the scope of its
proposed AML requirements those funds that did not offer their
investors the right to redeem any portion of their ownership
interests within two years after those interests were acquired. See
68 FR at 60619.
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An investment adviser that is the primary adviser to a private fund
or other unregistered pooled investment vehicle is required to make a
risk-based assessment of the money laundering and terrorist financing
risks presented by the investors in such investment vehicles by
considering the same types of relevant factors, as appropriate, as the
adviser would consider for clients for whom the adviser manages assets
directly. As noted above, the risk-based approach of the proposed rule
is intended to give investment advisers the flexibility to design their
programs to meet the specific risks presented by their customers,
including any funds they advise. In assessing the potential risk of a
private fund under the proposed rule, investment advisers generally
should gather pertinent facts about the structure or ownership of the
fund, including both the extent to which they are provided with
relevant information about the investors in that private fund, who may
or may not themselves also be customers of the investment adviser, and
the nature of such investor-related information that they receive.
[[Page 12127]]
Under the proposed rule, where an investment adviser attempted to
and was unable to obtain identifying information about the investors in
a private fund, the private fund may pose a higher risk for money
laundering, terrorist financing, or other illicit finance activity.
When a private fund's potential vulnerability to money laundering,
terrorist financing, or other illicit finance activity is high, the
adviser's procedures would need to reasonably address these higher
risks so that the adviser is able to prevent the investment adviser
from being used for money laundering or the financing of terrorist
activities, and to achieve and monitor compliance with the BSA
(including to obtain sufficient information to monitor and report
suspicious activity). FinCEN requests comment on what information is
currently available to advisers to private funds regarding their
investors that could help advisers comply with the proposed AML/CFT
requirements. FinCEN also requests comment on whether a subadviser to a
private fund or other unregistered pooled investment vehicle should be
required to establish the same policies, procedures, and internal
controls as when the primary adviser is the investment adviser, or
should be required to mitigate the risks of money laundering, terrorist
financing, or other illicit activity to the investing pooled investment
vehicle's investors, sponsoring entity, and/or intermediaries.
FinCEN recognizes that certain private funds and other unregistered
pooled investment vehicles may present lower risks for money laundering
or terrorist financing than others. Consequently, FinCEN would not
expect an investment adviser to risk-rate the advisory services it
provides to a pooled investment vehicle that presents a lower risk the
same as it might rate the advisory services it provides to other types
of pooled investment vehicles that may present higher risks for
attracting money launderers, terrorist financers, or other illicit
actors. FinCEN requests comment on factors related to the activities,
investors, or structure of private funds or other unregistered pooled
investment vehicles that could be higher- or lower-risk. FinCEN also
requests comment on how the proposed rule should apply to advisers who
manage private funds that receive investments from in-funds or who have
funds-of-funds who are investors.
Wrap Fee Programs. In a wrap fee program, investment advisory and
brokerage services are provided together as a single product.\163\ For
the purposes of this discussion, FinCEN will focus on wrap fee
arrangements where an investment adviser is solely acting as a
portfolio manager and generally managing the customer account to a
selected model. In these programs, even if both advisers or broker-
dealers are providing services, there is a single ``relationship''
entity that is responsible for the relationship with the customer,
managing the account overall, and selecting the account strategy. That
program sponsor has the primary relationship with the customer, which
means that the program sponsor is typically best positioned to
recognize illicit financial activity in the program.
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\163\ A ``wrap fee program'' for purposes of the proposed rule
is a program under which investment advisory and brokerage execution
services (as well as administrative expenses and other fees and
expenses) are provided for a single ``wrapped'' (i.e., bundled) fee.
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While FinCEN recognizes the characteristics described above
regarding the most common structure of wrap fee programs, it is not
proposing to exempt wrap fee programs from coverage of the proposed
rule. Depending on the structure of the wrap fee program, the
investment adviser may be best positioned to spot illicit finance
activity (if, for example, it is the program sponsor). Moreover, even a
non-sponsoring investment adviser may have additional insights into the
activity of the wrap fee program. FinCEN requests comments on how the
requirements of the proposed rule can be applied to advisers
participating in a wrap fee program, to include when an adviser acting
as portfolio manager is either affiliated or not affiliated with the
sponsoring entity of the program.
(b) Provide for Independent Testing for Compliance To Be Conducted by
Company Personnel or by a Qualified Outside Party
Section 1032.210(b)(2) would require that an investment adviser
provide for independent testing of the AML/CFT program by the adviser's
personnel or a qualified outside party. The purpose of this provision
is to ensure that an investment adviser's AML/CFT program complies with
the requirements of Sec. 1032.210 and that the program functions as
designed. Employees of either 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.\164\ The employees would have to be
knowledgeable regarding AML/CFT requirements and qualified to conduct
independent testing. The frequency of the independent testing would
depend upon the money laundering, terrorist financing, and other
illicit finance risks of the adviser and the adviser's overall risk
management strategy. For instance, an adviser could conduct independent
testing over periodic intervals (e.g., every 12 to 18 months) or when
there are significant changes in the adviser's risk profile (with
respect to money laundering, terrorist financing, or other illicit
finance risks), systems, compliance staff, or processes. More frequent
independent testing may be appropriate when errors or deficiencies in
some aspect of the AML/CFT compliance program have been identified or
to verify or validate mitigating or remedial actions. Any
recommendations resulting from such testing would need to be promptly
implemented or submitted to senior management for consideration.
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\164\ As noted in this NPRM, some investment advisers may
implement enterprise-wide AML/CFT programs that are evaluated at the
holding company level. It would not be consistent with the
requirements of this proposed regulation for an employee at an
affiliated financial institution, including the holding company, to
be responsible for testing the adviser's AML/CFT program, or carry
out such testing, if the affiliate's employee is responsible for
administering the adviser's AML/CFT program.
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(c) Designate a Person or Persons Responsible for Implementing and
Monitoring the Operations and Internal Controls of the Program
Section 1032.210(b)(3) would require that an investment adviser
designate a person or persons to be responsible for implementing and
monitoring the operations and internal controls of the AML/CFT program.
Under the proposed rule, an investment adviser may designate a single
person or persons (including in a committee) to be responsible for
compliance. The person or persons should be knowledgeable and competent
regarding AML/CFT requirements, the adviser's relevant policies,
procedures, and controls, as well as the adviser's money laundering,
terrorist financing, and other illicit finance risk. The person or
persons should have full responsibility and authority to develop and
implement appropriate policies, procedures, and internal controls
reasonably designed to prevent the investment adviser from being used
for those risks. Whether the compliance officer is dedicated full time
to AML/CFT compliance would depend on the size and type of advisory
services the adviser provides and the customers it serves. A person
designated as a compliance officer should be an officer
[[Page 12128]]
of the investment adviser (or individual of similar authority within
the particular corporate structure of the investment adviser) and
someone who has established channels of communication with senior
management demonstrating sufficient independence and access to
resources to implement a risk-based and reasonably designed AML/CFT
program.\165\
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\165\ In particular, RIAs who are subject to the SEC's
Compliance Rule (17 CFR 275.206(4)-7), could designate their chief
compliance officer under that rule to be responsible for this
provision of the proposed rule. The proposed rule does not, however,
require that an investment adviser designate the same person.
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(d) Provide Ongoing Training for Appropriate Persons
Section 1032.210(b)(4) would require that an investment adviser
provide for ongoing training of appropriate persons. Employee training
is an integral part of any AML/CFT program. To carry out their
responsibilities effectively, employees of an investment adviser (and
of any agent or third-party service provider that is charged with
administering any portion of the investment adviser's AML/CFT program)
would have to be trained in AML/CFT requirements relevant to their
functions and to recognize possible signs of money laundering,
terrorist financing, and other illicit finance activity that could
arise in the course of their duties. Such training may be conducted
through, among other things, outside or in-house seminars, and may
include computer-based or virtual training. The nature, scope, and
frequency of the investment adviser's training program would be
determined by the responsibilities of the employees and the extent to
which their functions would bring them in contact with AML/CFT
requirements or possible money laundering, terrorist financing, or
other illicit finance activity. Consequently, under the proposed rule,
the training program should provide a general awareness of overall AML/
CFT requirements and money laundering, terrorist financing, and other
illicit finance risks, as well as more job-specific guidance tailored
to particular employees' roles and functions with respect to the
entities' particular AML/CFT program.\166\ For those employees whose
duties bring them in contact with AML/CFT requirements or possible
money laundering, terrorist financing, or other illicit finance risks,
the requisite training would have to occur when the employee assumes
those duties. Moreover, these employees should receive periodic updates
and refreshers regarding the AML/CFT program.\167\
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\166\ See e.g., DWS Investment Management Americas Inc.,
Investment Company Act Rel. No. 6431, ] 28 (Sept. 25, 2023) (noting
DWS' failure to conduct AML training that was specific to the DWS
Mutual Funds or the risks applicable to mutual funds for those
employees with mutual fund responsibilities).
\167\ The frequency of these periodic updates and refreshers
would depend upon the money laundering, terrorist financing, and
other illicit finance risks of the adviser and the adviser's overall
risk management strategy.
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(e) Ongoing Customer Due Diligence (CDD)
Section 1032.210(b)(5) would require that an investment adviser
implement appropriate risk-based procedures for conducting ongoing CDD
that includes (i) understanding the nature and purpose of customer
relationships for the purpose of developing a customer risk profile;
and (ii) conducting ongoing monitoring to identify and report
suspicious transactions and, on a risk basis, to maintain and update
customer information.
These obligations were added to the AML/CFT program requirements
for financial institutions in May 2016, when FinCEN issued the CDD
Rule.\168\ The CDD Rule clarified and strengthened CDD requirements for
covered financial institutions (banks, mutual funds, brokers or dealers
in securities, futures commission merchants, and introducing brokers in
commodities) and added a new requirement for these covered financial
institutions to identify and verify the identity of the natural persons
who own or control (known as beneficial owners of) legal entity
customers when those customers open accounts.
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\168\ FinCEN, Customer Due Diligence Requirements for Financial
Institutions, final rule, 81 FR 29398 (May 11, 2016).
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The CDD Rule identifies the four core elements of CDD: (1)
identifying and verifying the identity of customers; (2) identifying
and verifying the identity of the beneficial owners of legal entity
customers opening accounts; (3) understanding the nature and purpose of
customer relationships; and (4) conducting ongoing monitoring.\169\
FinCEN requests comment on the types of information investment advisers
regularly receive from their customers, and how investment advisors
would exchange information with other financial institutions, that
could be used to understand the nature and purpose of the customer
relationship and identify and monitor suspicious transactions.
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\169\ Id. at 29398.
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Requiring investment advisers to perform effective CDD so that they
understand who their customers are and what type of transactions they
conduct is a critical aspect of combating all forms of illicit finance
activity, from terrorist financing and sanctions evasion to more
traditional financial crimes, including money laundering, fraud, and
tax evasion. These measures would also enable investment advisers to
identify and report suspicious transactions by filing SARs in the
manner that best serves the purposes of the BSA. For investment
advisers covered by the proposed rule, FinCEN expects to address the
first requirement of customer identification and verification in a
future joint rulemaking with the SEC, as noted above, while the third
and fourth elements of the CDD Rule are being incorporated into these
AML/CFT Program requirements through proposed Sec. 1032.210(b)(5).
FinCEN will take the first steps towards incorporating the second
element by including investment advisers in the definition of ``covered
financial institution'' under 31 CFR 1010.605(e)(1), discussed at
further length below. However, the requirement to identify and verify
the beneficial owners of legal entity customer accounts is predicated
on the existence of a CIP requirement, which, as just stated, FinCEN
anticipates addressing in the future joint rulemaking with the SEC.
The CDD Rule is affected by the Corporate Transparency Act (CTA),
passed as part of the AML Act. The CTA requires certain types of
domestic and foreign entities, called ``reporting companies,'' to
submit specified beneficial ownership information (BOI) to FinCEN.\170\
In certain circumstances, FinCEN is authorized to share this BOI with
government agencies, financial institutions, and financial regulators,
subject to appropriate protocols.\171\
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\170\ See generally 31 U.S.C. 5336(b), (c).
\171\ See 31 U.S.C. 5336(c)(2).
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FinCEN is issuing three key rules pursuant to the CTA. The first
rule--the BOI reporting rule--requires certain corporations, limited
liability companies, and other entities created in or registered to do
business in the United States to report information about their
beneficial owners.\172\ This rule was promulgated on September 30,
2022.\173\ The second establishes rules for who may access BOI for what
purposes, and what safeguards will be required to ensure that the
information is secured and protected.\174\ This rule was promulgated on
December 21, 2023
[[Page 12129]]
and goes into effect on February 20, 2024.\175\
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\172\ See 31 CFR 1010.380.
\173\ FinCEN, Beneficial Ownership Information Reporting
Requirements, final rule, 87 FR 59498 (Sep. 30, 2022).
\174\ See 31 CFR 1010.955.
\175\ .FinCEN, Beneficial Ownership Information Access and
Safeguards, final rule, 88 FR 88732 (Dec. 21, 2023).
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The CTA also requires FinCEN to revise the CDD Rule no later than
January 1, 2025.\176\ FinCEN is required to rescind the existing
specific beneficial ownership identification and verification
requirements of 31 CFR 1010.230(b)-(j), while retaining the general
requirement for financial institutions to identify and verify the
beneficial owners of legal entity customers under 31 CFR
1010.230(a).\177\ FinCEN expects to undertake a third rulemaking to
revise the CDD Rule and anticipates that, because of the changes
required by the AML Act, such a rulemaking could have a significant
impact on financial institutions' CDD obligations.
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\176\ See AML Act section 6403(d)(1) (``Not later than 1 year
after the effective date of the regulations promulgated under
section 5336(b)(4) of title 31, United States Code, as added by
subsection (a) of this section, the Secretary of the Treasury shall
revise the final rule entitled `Customer Due Diligence Requirements
for Financial Institutions' . . . .''). The effective date of the
relevant final rule is January 1, 2024.
\177\ See AML Act section 6403(d)(2) (``[T]he Secretary of the
Treasury shall rescind paragraphs (b) through (j) of section
1010.230 of title 31 . . . upon the effective date of the revised
rule promulgated under this subsection. Nothing in this section may
be construed to authorize the Secretary of the Treasury to repeal
the requirement that financial institutions identify and verify
beneficial owners of legal entity customers under section
1010.230(a).'').
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In light of these anticipated forthcoming changes to the CDD Rule
and the statutory deadline of January 1, 2025, to complete them, FinCEN
assessed that investment advisers should not be required to apply the
current CDD requirements to identify and verify the beneficial owners
of legal entity customer accounts during the period between this
proposed rulemaking and the effective date of the revised CDD Rule.
Therefore, FinCEN has not included requirements to identify and verify
the beneficial owners of legal entity customer accounts in this
proposed rule. However, FinCEN invites comment regarding whether it
should apply such requirements once a joint rulemaking addressing CIP
requirements is finalized, notwithstanding the forthcoming CDD Rule.
Requirement to Identify and Verify Customers. Existing requirements
for other BSA-defined financial institutions require that the relevant
financial institution's CIP include risk-based procedures to verify the
identity of each customer, to the extent reasonable and practicable.
The elements of such program must include identifying the customer,
verifying the customer's identity (through documents or non-documentary
methods, or a combination thereof), procedures for circumstances where
the institution cannot form a reasonable belief that it knows the true
identity of the individual, and determining whether the names of
customers appear on any government-provided list of known terrorists or
terrorist organizations. As noted above, Treasury expects to address
CIP requirements through a future joint rulemaking with the SEC, as
required by section 326 of the USA PATRIOT Act.\178\
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\178\ See 31 U.S.C. 5318(l).
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Understand the Nature and Purpose of Customer Relationships to
Develop Customer Risk Profiles. As is the case for banks, broker-
dealers, and mutual funds, the term ``customer risk profile'' for
covered investment advisers refers to information gathered--typically
at the time of account opening or, in the case of a covered investment
adviser, at the onset of an advisory relationship--about a customer to
develop the baseline against which customer activity is assessed for
suspicious activity reporting.
Under the proposed rule, investment advisers are obligated to
report suspicious activity by filing SARs on transactions that, among
other things, have no business or apparent lawful purpose or are not
the sort in which the particular customers would normally be expected
to engage. Fulfilling this proposed requirement would necessitate that
an investment adviser understands the nature and purpose of the
customer relationship, which informs the baseline against which
aberrant, suspicious transactions are identified. In some
circumstances, an understanding of the nature and purpose of a customer
relationship can also be developed by inherent or self-evident
information about the product or customer type, such as the type of
customer or the service or product offered, or other basic information
about the customer, and such information may be sufficient to
understand the nature and purpose of the relationship. This may include
the customer's explanation about its initial decision to seek advisory
services from the adviser and may be reflected in the particular type
of advisory service the customer seeks, as well as information already
collected by the investment adviser, such as net worth, domicile,
citizenship, or principal occupation or business.
For investment advisers, the risk associated with a particular type
of customer may vary significantly. For instance, key risk factors for
natural person customers may include the source of funds, the
jurisdiction in which they reside, their country(ies) of citizenship,
and their status as a PEP,\179\ among other things. For legal entity
customers, an investment adviser may consider the type of entity, the
jurisdiction in which it is domiciled and located, and the statutory
and regulatory regime of that jurisdiction for company formation and
other financial transparency requirements, if relevant. The investment
adviser's historical experience with the individual or entity and the
references of other financial institutions may also be relevant
factors.
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\179\ See generally Joint Statement on Bank Secrecy Act Due
Diligence Requirements for Customers Who May Be Considered
Politically Exposed Persons, (Aug. 21, 2020), <a href="https://www.fincen.gov/sites/default/files/shared/PEP%20Interagency%20Statement_FINAL%20508.pdf">https://www.fincen.gov/sites/default/files/shared/PEP%20Interagency%20Statement_FINAL%20508.pdf</a>.
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Regarding the legal entity customers of an adviser, some may be
financial intermediaries or third parties that are BSA-defined
financial institutions and have their own AML/CFT requirements.
Consequently, the investment adviser may not always have a direct
relationship with the investors in its legal entity customers. Those
investors may be introduced to the adviser by other entities who or may
or may not have their own AML/CFT obligations (such as a broker-dealer,
other investment adviser, or other intermediary). For these
intermediary entities, and even though investment advisers would not be
required to categorically collect beneficial ownership information on
legal entity customers, investment advisers should collect sufficient
information such that they are able to detect and report suspicious
activity associated with intermediated accounts, including activity
related to underlying clients.\180\ FinCEN expects that non-
intermediary legal entity customers that are not BSA-defined financial
institutions with their own AML/CFT requirements would be subject to a
different assessment than intermediary customers that are BSA-defined
financial institutions for understanding the nature and purpose of the
customer relationship. The requirement to assess customer risk laid out
in this proposed rule must be understood in this context.
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\180\ See FinCEN, Customer Due Diligence Requirements for
Financial Institutions, notice of proposed rulemaking, 79 FR 45141,
45161 (Aug. 4, 2014).
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For understanding the nature and purpose of customers who are
private funds, FinCEN notes that investment advisers can (1) create and
administer a private fund or (2) provide advice to a
[[Page 12130]]
private fund that is created and administered by a third party or an
intermediary. While the particular role played by the investment
adviser will affect the type of information the adviser can collect
about the investors in such a fund, the adviser should collect
sufficient information to develop a customer baseline for suspicious
activity reporting regarding the private fund. FinCEN invites comments
on other types of information, other than beneficial ownership
information, that could be collected to understand the nature and
purpose of a customer relationship with a private fund.
Ongoing Monitoring to Identify Suspicious Transactions and Update
Customer Information. This element of CDD would oblige investment
advisers to perform ongoing monitoring drawing on customer information,
as well as to file SARs in a timely manner in accordance with their
reporting obligations.\181\ As proposed, the obligation to update
customer information would generally only be triggered when the
investment adviser became aware of information as part of its normal
monitoring relevant to assessing the potential risk posed by a
customer; it is not intended to impose a categorical requirement to
update customer information on a regularly occurring, pre-determined
basis. Similar to the CDD obligations for mutual funds,\182\ under the
proposed Sec. 1032.210(b)(5)(ii), investment advisers would be
required to implement appropriate risk-based procedures to conduct
ongoing monitoring to identify and report suspicious transactions and,
on a risk basis, to maintain and update customer information.
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\181\ FinCEN's proposed SAR filing obligations for investment
advisers are discussed below.
\182\ 31 CFR 1024.210(b)(5)(ii); see also FinCEN, 81 FR at
29424.
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Ongoing monitoring may be accomplished in several ways. Customer
information may be integrated into the financial institution's
transaction monitoring system and may be used after a potentially
suspicious transaction has been identified, as one means of determining
whether the identified activity is suspicious. An investment adviser
may also utilize the information sharing provisions under section
314(b) of the USA PATRIOT Act to request relevant information from
other financial institutions that may hold relevant information, such
as the qualified custodians of customer funds.
Regarding legal entity customers, FinCEN assesses that in some
circumstances, on a risk-basis, an investment adviser would not need
information relating to investors in those legal entity customers to
comply with the requirements of the ongoing monitoring obligation.
However, in other circumstances, investment advisers may need to
request information regarding investors in their legal entity
customers. As FinCEN noted in the CDD Rule, the ongoing monitoring
obligation is intended to apply to ``all transactions by, at, or
through the financial institution,'' \183\ and not just those that are
direct customers of the financial institution. Given that risks posed
by each customer differ, FinCEN finds that the level of risk posed by a
customer relationship should be a factor influencing the decision to
request information regarding underlying customers, and if the legal
entity customer does not provide such information, how the investment
adviser should adjust the risk profile of that legal entity customer.
FinCEN is requesting comment on several aspects of the proposed
requirement to apply CDD obligations described above.
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\183\ Id.
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[…truncated; see source link]Indexed from Federal Register on February 15, 2024.
This is legal information, not legal advice. Laws vary by jurisdiction and change frequently. Always verify current law with official sources and consult a licensed attorney in your jurisdiction for advice on your specific situation.