Proposed Rule2024-10738
Customer Identification Programs for Registered Investment Advisers and Exempt Reporting Advisers
Primary source
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Published
May 21, 2024
Issuing agencies
Treasury DepartmentFinancial Crimes Enforcement NetworkSecurities and Exchange Commission
Abstract
The Department of the Treasury and the SEC are jointly issuing a proposed rulemaking implementing the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 with regard to certain investment advisers. If, as proposed in a separate rulemaking, certain investment advisers are included in the definition of "financial institution" under the Bank Secrecy Act, the Secretary of the Treasury and the SEC will be required to jointly prescribe a regulation that, among other things, requires investment advisers to implement reasonable procedures to verify the identities of their customers.
Full Text
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<title>Federal Register, Volume 89 Issue 99 (Tuesday, May 21, 2024)</title>
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[Federal Register Volume 89, Number 99 (Tuesday, May 21, 2024)]
[Proposed Rules]
[Pages 44571-44597]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2024-10738]
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DEPARTMENT OF THE TREASURY
Financial Crimes Enforcement Network
31 CFR Part 1032
RIN 1506-AB66
SECURITIES AND EXCHANGE COMMISSION
17 CFR Part 275
[Release No. BSA-1; File No. S7-2024-02]
RIN 3235-AN34
Customer Identification Programs for Registered Investment
Advisers and Exempt Reporting Advisers
AGENCY: Financial Crimes Enforcement Network (``FinCEN''), Department
of the Treasury; Securities and Exchange Commission (``SEC'' or
``Commission'').
ACTION: Joint notice of proposed rulemaking.
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SUMMARY: The Department of the Treasury and the SEC are jointly issuing
a proposed rulemaking implementing the Uniting and Strengthening
America by Providing Appropriate Tools Required to Intercept and
Obstruct Terrorism Act of 2001 with regard to certain investment
advisers. If, as proposed in a separate rulemaking, certain investment
advisers are included in the definition of ``financial institution''
under the Bank Secrecy Act, the Secretary of the Treasury and the SEC
will be required to jointly prescribe a regulation that, among other
things, requires investment advisers to implement reasonable procedures
to verify the identities of their customers.
DATES: Written comments on this notice of joint proposed rulemaking
(``NPRM'') must be submitted on or before July 22, 2024.
ADDRESSES:
Treasury: 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-2024-0011.
<bullet> Mail: Policy Division, Financial Crimes Enforcement
Network, P.O. Box 39, Vienna, VA 22183. Refer to Docket Number FINCEN-
2024-0011.
Please submit comments by one method only.
SEC: Comments may be submitted to the SEC by any of the following
methods:
Electronic Comments
<bullet> Use the SEC's internet comment forms (<a href="https://www.sec.gov/rules/2024/05/cip">https://www.sec.gov/rules/2024/05/cip</a>); or
<bullet> Send an email to <a href="/cdn-cgi/l/email-protection#196b6c757c347a7674747c776d6a596a7c7a377e766f"><span class="__cf_email__" data-cfemail="a2d0d7cec78fc1cdcfcfc7ccd6d1e2d1c7c18cc5cdd4">[email protected]</span></a>. Please include
File Number S7-2024-02 on the subject line.
Paper Comments
<bullet> Send paper comments to Secretary, U.S. Securities and
Exchange Commission, 100 F Street NE, Washington, DC 20549-1090.
All submissions should refer to File Number S7-2024-02. This file
number should be included on the subject line if email is used. To help
the SEC process and review your comments more efficiently, please use
only one method of submission. The SEC will post all comments on the
SEC's website (<a href="https://www.sec.gov/rules/2024/05/cip">https://www.sec.gov/rules/2024/05/cip</a>). Comments also
are available for website viewing and printing in the SEC's Public
Reference Room, 100 F Street NE, Washington, DC 20549, on official
business days between the hours of 10 a.m. and 3 p.m. Operating
conditions may limit access to the SEC's Public Reference Room. Do not
include personally identifiable information in submissions; you should
submit only information that you wish to make available publicly. The
SEC may redact in part or withhold entirely from publication submitted
material that is obscene or subject to copyright protection.
Studies, memoranda, or other substantive items may be added by the
SEC or staff to the comment file during this rulemaking. A notification
of the inclusion in the comment file of any such materials will be made
available on the SEC's website. To ensure direct electronic receipt of
such notifications, sign up through the ``Stay Connected'' option at
www.sec.gov to receive notifications by email.
A summary of the proposal of not more than 100 words is posted on
the SEC's website (<a href="https://www.sec.gov/rules/2024/05/cip">https://www.sec.gov/rules/2024/05/cip</a>).
[[Page 44572]]
FOR FURTHER INFORMATION CONTACT:
Treasury: The FinCEN Resource Center at (800) 767-2825 or email
<a href="/cdn-cgi/l/email-protection#a9cfdbcae9cfc0c7caccc787cec6df"><span class="__cf_email__" data-cfemail="bbddc9d8fbddd2d5d8ded595dcd4cd">[email protected]</span></a>.
Securities and Exchange Commission: Daniel Levine, Attorney-
Adviser; Tom Strumpf, Branch Chief; Adele Murray, Private Funds
Attorney Fellow; or Melissa Roverts Harke, Assistant Director,
Investment Adviser Rulemaking Office, at (202) 551-6787 or
<a href="/cdn-cgi/l/email-protection#11585063647d7462516274723f767e67"><span class="__cf_email__" data-cfemail="b6fff7c4c3dad3c5f6c5d3d598d1d9c0">[email protected]</span></a>, Division of Investment Management, Securities and
Exchange Commission, 100 F Street NE, Washington, DC 20549-8549.
SUPPLEMENTARY INFORMATION:
I. Background
A. Statutory Provisions
Enacted in 1970, the Currency and Foreign Transactions Reporting
Act, generally referred to as the Bank Secrecy Act (``BSA''), is
designed to combat money laundering, the financing of terrorism, and
other illicit finance activity, and to safeguard the national security
of the United States.\1\ The Secretary of the Treasury (``the
Secretary'') delegated the authority to implement, administer, and
enforce the BSA and its implementing regulations to the Director of
FinCEN.\2\
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\1\ See 31 U.S.C. 5311. Certain parts of the Currency and
Foreign Transactions Reporting Act, as amended, and 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. 310, 5311-5314, 5316-5336, including notes
thereto, with implementing regulations at 31 CFR chapter X.
\2\ See 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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Section 326 of the Uniting and Strengthening America by Providing
Appropriate Tools Required to Intercept and Obstruct Terrorism (``USA
PATRIOT Act'') of 2001 added a subsection to the BSA, subsection (l) to
31 U.S.C. 5318, in order to facilitate the prevention, detection, and
prosecution of international money laundering and the financing of
terrorism. Subsection 31 U.S.C. 5318(l) requires the Secretary to
``prescribe regulations setting forth the minimum standards for
financial institutions and their customers regarding the identity of
the customer that shall apply in connection with the opening of an
account at a financial institution.'' The regulations implementing
section 326 must, at a minimum, ``require financial institutions to
implement, and customers (after being given adequate notice) to comply
with, reasonable procedures for--(A) verifying the identity of any
person seeking to open an account to the extent reasonable and
practicable; (B) maintaining records of the information used to verify
the person's identity, including name, address, and other identifying
information; and (C) consulting lists of known or suspected terrorists
or terrorist organizations provided to the financial institution by any
government agency to determine whether a person seeking to open an
account appears on any such list.'' \3\ These programs are referred to
as Customer Identification Programs (``CIPs'') and are long-standing,
foundational components of a financial institution's anti-money
laundering program.
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\3\ 31 U.S.C. 5318(l)(2).
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As enacted, section 326 applies to all ``financial institutions.''
This term is defined broadly in the BSA to encompass a variety of
entities, including commercial banks; agencies, and branches of foreign
banks in the United States; thrift institutions, credit unions, and
private bankers; trust companies; securities brokers and dealers
registered with the Commission; investment companies; futures
commission merchants; insurance companies; travel agencies;
pawnbrokers; dealers in precious metals, stones, and jewels; check-
cashers; certain casinos; and telegraph companies, among others.\4\ The
BSA also grants authority to the Secretary to define, by regulation,
additional types of businesses as financial institutions where the
Secretary 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.\5\ As part of the implementation, administration, and
enforcement of the BSA, this authority has been delegated to the
Director of FinCEN.\6\
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\4\ See 31 U.S.C. 5312(a)(2), (c)(1); see also 31 CFR
1010.100(t) (defining ``financial institution'' for the purposes of
the regulations implementing the BSA).
\5\ See 31 U.S.C. 5312(a)(2)(Y).
\6\ See Treasury Order 180-01, para. 3(a), supra n.2.
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On February 15, 2024, the Secretary, through FinCEN, proposed to
designate certain investment advisers as ``financial institutions''
under the BSA and subject them to anti-money laundering/countering the
financing of terrorism (``AML/CFT'') program requirements and
Suspicious Activity Report (``SAR'') filing obligations, as well as
other BSA requirements (``AML/CFT Program and SAR Proposed Rule'').\7\
Although the Investment Advisers Act of 1940 (``Advisers Act'') and the
rules thereunder apply to a wide range of investment advisers,\8\ the
AML/CFT Program and SAR Proposed Rule--and the rule proposed in this
joint NPRM as well--would only apply to a narrower subset of persons
meeting the Advisers Act definition of ``investment adviser'': \9\
advisers registered or required to be registered with the SEC (referred
to as ``registered investment advisers,'' or ``RIAs''), as well as
those exempt from registration under sections 203(l) or 203(m) of the
Advisers Act and applicable rules thereunder (referred to as ``exempt
reporting advisers,'' or ``ERAs'').
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\7\ See FinCEN, Anti-Money Laundering/Countering the Financing
of Terrorism Program and Suspicious Activity Report Filing
Requirements for Registered Investment Advisers and Exempt Reporting
Advisers, Notice of Proposed Rulemaking, 89 FR 12108 (Feb. 15,
2024).
\8\ Unless otherwise noted, when we refer to the Advisers Act,
we are referring to 15 U.S.C. 80b, and when we refer to rules under
the Advisers Act, we are referring to title 17, part 275 of the Code
of Federal Regulations (17 CFR part 275).
\9\ See 15 U.S.C. 80b-2(a)(11). Accordingly, references herein
to ``investment advisers'' or ``advisers'' refer to RIAs and ERAs,
unless stated otherwise.
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In prescribing regulations for financial institutions implementing
section 326, 31 U.S.C. 5318(l)(3) directs the Secretary to ``take into
consideration the various types of accounts maintained by various types
of financial institutions, the various methods of opening accounts, and
the various types of identifying information available.'' \10\ Further,
31 U.S.C. 5318(l)(4) requires that implementing regulations for certain
types of financial institutions--which would include the set of
investment advisers proposed to be added to the definition of
``financial institution'' through the AML/CFT Program and SAR Proposed
Rule--be prescribed jointly with the appropriate Federal functional
regulator (as defined in section 509 of the Gramm-Leach-Bliley
Act).\11\ The appropriate Federal functional regulator for investment
[[Page 44573]]
advisers is the SEC.\12\ Thus, FinCEN and the SEC are issuing this
proposed rule jointly.
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\10\ 31 U.S.C. 5318(l)(3).
\11\ 31 U.S.C. 5318(l)(4) requires that any CIP requirement for
financial institutions that engage in financial activities described
in section 4(k) of the Bank Holding Company Act be prescribed
jointly with each Federal functional regulator. This list of
activities includes, among others, ``providing financial,
investment, or economic advisory services.'' See 12 U.S.C.
1843(k)(4)(C). 15 U.S.C. 6809(2) lists the institutions that may be
a Federal functional regulator. Adoption of this proposed rule
would, therefore, depend on and not occur unless investment advisers
are first designated as ``financial institutions'' for purposes of
the BSA. Proposing CIP requirements while the AML/CFT Program and
SAR Proposed Rule is under consideration gives affected parties an
opportunity to consider the proposed elements of a CIP--as a CIP is
statutorily required if investment advisers become ``financial
institutions'' under the BSA--in the context of the AML/CFT Program
and SAR Proposed Rule.
\12\ See 15 U.S.C. 6809(2).
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While investment advisers have not been previously subject to CIP
requirements, in certain circumstances, some investment advisers
already obtain and conduct verification of customer identity
information.\13\ For example, some investment advisers may implement
CIP requirements if the entity is also a registered broker-dealer \14\
or a bank (i.e., a dual registrant), or is an operating subsidiary of a
bank; \15\ other investment advisers are affiliates of banks or broker-
dealers, which may implement an enterprise-wide AML/CFT program that
includes a CIP. In addition, some investment advisers have already
implemented voluntary AML/CFT programs that may include CIP
measures.\16\
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\13\ 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. We acknowledge
that the Advisers Act and its implementing regulations primarily use
the term ``clients,'' and therefore, we use that term herein when
making specific reference to Advisers Act requirements.
\14\ See 31 CFR 1023.220 (CIP rule for broker-dealers).
\15\ Banks are subject to their own CIP regulation. See 31 CFR
1020.220. Banks and bank subsidiaries subject to the jurisdiction of
the Office of the Comptroller of the Currency (OCC), the Board of
Governors of the Federal Reserve System (Federal Reserve), the
Federal Deposit Insurance Corporation (FDIC), and the National
Credit Union Administration (NCUA) (collectively, the Federal
Financial Institutions Regulatory Agencies (FFIRAs)) are subject to
applicable FFIRA regulations regarding the BSA, which also require
compliance with the CIP regulation at 31 CFR 1020.220, which was
jointly promulgated by FinCEN and the FFIRAs. See, e.g., 12 CFR
21.21(c)(2) (OCC); 12 CFR 208.63(b)(2) (Federal Reserve), 12 CFR
326.8(b)(2) (FDIC), 12 CFR 748.2(b)(2) (NCUA); see also 12 CFR
5.34(e)(3) and 5.38(e)(3) (OCC regulations regarding operating
subsidiaries of national banks and Federal savings associations).
Investment advisers that are banks (or bank subsidiaries) are
therefore already subject to CIP requirements in their capacities as
banks (or bank subsidiaries) pursuant to 31 CFR 1020.220, which
applies to banks. Under the proposed rule, RIAs that are dual
registrants or affiliated advisers would not be legally required to
establish a separate CIP for their advisory activities, provided
that an existing comprehensive CIP-compliant AML/CFT program covers
all the entity's legal and regulatory obligations under the proposed
rule.
\16\ See infra section C.1. of the Economic Analysis for
additional information on when investment advisers may implement CIP
measures; see also 89 FR at 12112 (discussing circumstances where
some investment advisers implement AML/CFT measures).
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This proposed rule is generally consistent with existing rules
requiring other financial institutions, such as brokers or dealers in
securities, open-end investment companies (such as mutual funds),\17\
credit unions, banks, and other financial institutions, to adopt and
implement CIPs.\18\ The similarity between this proposed rule and those
rules reflects the importance that FinCEN and the SEC (``the
Commission'') assign to the harmonization of CIP requirements,
including for the purposes of increasing effectiveness and efficiency
for investment advisers that are affiliated with other financial
institutions, such as banks, broker-dealers, or open-end investment
companies (such as mutual funds) that are already subject to CIP
requirements. CIP requirements also support the application of other
AML/CFT measures by making it more difficult for persons to use false
identities to establish customer relationships with investment advisers
for the purposes of laundering money, financing terrorism, or engaging
in other illicit finance activity.
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\17\ The rule that applies to those investment companies falling
within the category of ``open-end company'' contained in section
5(a)(1) of the Investment Company Act of 1940 (codified at 15 U.S.C.
80a-1 et seq.) that are registered or required to register under
section 8 of that Act defined such investment companies as ``mutual
funds.'' See FinCEN and SEC, Customer Identification Programs for
Mutual Funds, 68 FR 25131, 25147 (May 9, 2003); see also 31 CFR
1010.100(gg).
\18\ See, e.g., 31 CFR 1020.220, 1023.220, 1024.220, 1026.220.
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B. Codification of the Joint Proposed Rule
Under the proposed rule, the substantive requirements of the joint
proposed rule would be codified with other BSA regulations as part of
Treasury's proposed regulations in 31 CFR part 1032.
II. Section-by-Section Analysis
A. Definitions <SUP>19</SUP>
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\19\ This NPRM has definitions included at proposed Sec.
1032.100 that are not included in the AML/CFT Program and SAR
Proposed Rule version of proposed Sec. 1032.100. Cf. 89 FR 12108.
If both of these rules are adopted as proposed, FinCEN and the SEC
anticipate that this NPRM's Sec. 1032.100 would become part of
Sec. 1032.100.
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Section 1032.100(a) Account. The proposed rule would define
``account'' for the purposes of investment advisers' CIP obligations as
any contractual or other business relationship between a person and an
investment adviser under which the investment adviser provides
investment advisory services.\20\ The proposed definition excludes an
account that an investment adviser acquires through an acquisition,
merger, purchase of assets, or assumption of liabilities. Customers do
not ``open'' such transferred accounts, and, therefore, these accounts
do not fall within the scope of section 326.\21\ Such accounts,
however, may still be subject to other AML/CFT requirements applicable
to advisory activities, including activities within the scope of the
AML/CFT Program and SAR Proposed Rule, to the extent it is adopted.\22\
Additionally, the definition of account would include accounts opened
for the purpose of participating in an employee benefit plan
established pursuant to the Employee Retirement Income Security Act of
1974 (``ERISA''). While ERISA accounts are excluded from the definition
of ``account'' in the CIP rules applicable to mutual funds,\23\ they
are not being excluded here to harmonize the applicability of this
proposed rule with the AML/CFT Program and SAR Proposed Rule, which
would require RIAs and ERAs to apply AML/CFT program and SAR reporting
requirements to all of their accounts, including accounts opened for
the purpose of participating in an employee benefit plan established
pursuant to ERISA.
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\20\ See 15 U.S.C. 80b-2(a)(11) (defining ``investment adviser''
as a person engaged in the business of certain activities). FinCEN
regulations define ``person'' as ``an individual, a corporation, a
partnership, a trust or estate, a joint stock company, an
association, a syndicate, joint venture, or other unincorporated
organization or group, an Indian Tribe (as that term is defined in
the Indian Gaming Regulatory Act) and all entities cognizable as
legal personalities.'' 31 CFR 1010.100(mm).
\21\ Section 326 of the USA PATRIOT Act provides that the
regulations prescribed thereunder shall require financial
institutions to implement reasonable procedures for ``verifying the
identity of any person seeking to open an account.'' 31 U.S.C.
5318(l)(2) (emphasis added). If an investment adviser acquires an
account from another financial institution, the customer is not
opening an account with the investment adviser.
\22\ Such accounts are not exempted from applicable AML/CFT
program rules or other laws or regulations that may be applicable.
Investment advisers may need to implement reasonable procedures to
detect money laundering in any account, however acquired, if they
are already subject to an AML/CFT program requirement, such as in
the case of a dual registrant. See infra section IV.C.1. below. As
part of the proposed AML compliance program requirement for
investment advisers, an investment adviser generally should consider
whether it needs to take additional steps to verify the identity of
customers, based on its assessment of the relevant risks, as well as
to comply with other applicable AML/CFT program requirements. See,
e.g., AML/CFT Program and SAR Proposed Rule.
\23\ See 31 CFR 1024.100(a)(2)(ii).
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Section 1032.100(b) Commission. The proposed rule would define
``Commission'' to mean the United States Securities and Exchange
Commission.
Section 1032.100(c) Customer. The proposed rule would define
``customer'' for the purposes of investment advisers' CIP obligations
as a person--including a natural person or a legal entity--who opens a
new account with an investment adviser. This means the
[[Page 44574]]
person identified as the accountholder, except in the case of an
individual who lacks legal capacity, such as a minor, and non-legal
entities, in which case the customer would be the individual who opens
the new account for a minor or non-legal entity. Under this proposed
rule, an investment adviser would not be required to look through a
trust or similar account to its beneficiaries and would only be
required to verify the identity of the named accountholder.\24\
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\24\ However, based on an investment adviser's risk assessment
of a new account opened by a customer that is not an individual, an
investment adviser may need to take additional steps to verify the
identity of the customer by seeking information about individuals
with authority or control over the account in order to identify the
customer pursuant to section 1032.220(a)(2)(ii)(C) of the proposed
rule, or may need to look through the account in connection with the
customer due diligence procedures described in the proposed AML/CFT
Program and SAR Proposed Rule.
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The proposed rule's definition of ``customer'' would not include
individuals with authority or control over the accounts, if such
persons are not the accountholders. In addition, the definition would
not include persons who fill out the account opening paperwork or
provide information necessary to set up an account but are not the
accountholder. Instead, as described below, section
1032.220(a)(2)(ii)(C) of the proposed rule separately would require an
investment adviser's CIP to address situations where, based on the
investment adviser's risk assessment of a new account opened by a
customer that is not an individual, the investment adviser will need to
obtain information about individuals with authority or control over the
account in order to verify the customer's identity.
The proposed definition of ``customer'' would also not include a
financial institution regulated by a Federal functional regulator or a
bank regulated by a State bank regulator; certain government entities;
certain persons (other than banks) that are publicly listed on U.S.
securities exchanges or certain subsidiaries of persons listed on U.S.
securities exchanges; \25\ or persons that have an existing account
with the investment adviser, provided the investment adviser has a
reasonable belief that it knows the true identity of the person. These
exemptions are being included to be consistent with CIP requirements
for other financial institutions.\26\
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\25\ Such a person that is a financial institution, other than a
bank, would be exempt under the proposed definition only to the
extent of its domestic operations. See 31 CFR 1020.315(b)(4).
\26\ See, e.g., 31 CFR 1023.100(d)(2) (broker-dealers) and
1024.100(c)(2) (mutual funds).
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Section 1032.100(d) Financial institution. The proposed rule
includes a definition of ``financial institution'' that cross-
references the BSA's definition of ``financial institution'' in 31
U.S.C. 5312(a)(2) and (c)(1), and its implementing regulations, which
is currently codified at 31 CFR 1010.100(t).\27\ The proposed rule
includes this definition to avoid any ambiguity about the meaning of
``financial institution'' in proposed Sec. 1032.220(a)(6). Proposed
Sec. 1032.220(a)(6) would allow investment advisers to rely on certain
other financial institutions' performance of their CIP procedures under
specific circumstances, as described below. Accordingly, and as
described below, an investment adviser would be able to rely on such
performance by other ``financial institutions'' as defined in 31 U.S.C.
5312(a)(2) and (c)(1) and its implementing regulations to fulfill those
aspects of its CIP obligations.
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\27\ See section I.A, supra, discussing the BSA's definition of
``financial institution.'' While the BSA expressly defines various
entities as ``financial institutions,'' it also provides Treasury
with the authority to designate additional entities as financial
institutions in its regulations. Specifically, the BSA authorizes
Treasury to define additional types of businesses as financial
institutions if Treasury 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. See 31 U.S.C. 5312(a)(2)(Y). In the AML/CFT
Program and SAR Proposed Rule, FinCEN is proposing to make such a
determination with respect to the defined set of investment
advisers, and thereby add these investment advisers to Sec.
1010.100(t)'s definition of financial institution. See 89 FR at
12118.
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Section 1032.100(e) Investment adviser. The proposed rule includes
a definition of ``investment adviser'' that is the same as the proposed
definition of investment adviser in the AML/CFT Program and SAR
Proposed Rule.\28\ In this way, both this proposed rule and the AML/CFT
Program and SAR Proposed Rule would apply to the same group of persons.
The proposed definition in the AML/CFT Program and SAR Proposed Rule--
and thus the definition proposed in this NPRM--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 is exempt
from SEC registration under section 203(l) or 203(m) of the Advisers
Act (15 U.S.C. 80b-3(l), (m)).'' \29\ In other words, under this
proposed definition, an investment adviser would be any RIA (those
registered or required to register with the SEC) or ERA (those exempt
from SEC registration under the listed provisions).\30\ We anticipate
that any change to the scope of the AML/CFT Program and SAR Proposed
Rule, as finalized, would also be reflected in this rule, to ensure
that the scope of both rules remain consistent.
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\28\ See 89 FR at 12118.
\29\ Id. See also 17 CFR 275.203(l)-1; 17 CFR 275.203(m)-1.
\30\ The proposed definition of ``investment adviser'' would
include both primary advisers and sub-advisers. The Advisers Act
does not distinguish between advisers and sub-advisers; all are
investment advisers.
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B. Customer Identification Program: Minimum Requirements
Section 1032.220(a)(1) In general. Section 326 requires the
Secretary and, where relevant, the appropriate Federal functional
regulator (here, the SEC) to prescribe regulations requiring financial
institutions to implement, and customers (after being given adequate
notice) to comply with, ``reasonable procedures'' for verifying the
identity of any person seeking to open an account, ``to the extent
reasonable and practicable''; \31\ for maintaining records associated
with such verification; and for consulting lists of known terrorists
and terrorist organizations.\32\ Proposed Sec. 1032.220(a)(1)
accordingly would require that each investment adviser establish,
document, and maintain a written CIP as part of the AML/CFT program
under 31 U.S.C. 5318(h).\33\ This proposed requirement is intended to
make clear that the CIP is not a separate program, but rather would be
incorporated into an investment adviser's overall AML/CFT program. The
proposed rule would require that the CIP be appropriate for its size
and business that, at a minimum, includes each of the requirements of
paragraphs (a)(1) through (a)(5) of proposed section 1032.220.
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\31\ Treasury and the SEC are mindful of the legislative history
of section 326 for verification procedures. See H.R. Rep. No. 107-
250, pt. 1, at 63 (2001). (``It is the Committee's intent that the
verification procedures prescribed by Treasury make use of
information currently obtained by most financial institutions in the
account opening process. It is not the Committee's intent for the
regulations to require verification procedures that are
prohibitively expensive or impractical.'').
\32\ 31 U.S.C. 5318(l)(2).
\33\ As discussed above, investment advisers are not yet
required to have an AML/CFT program because this requirement has
been proposed in an ongoing rulemaking.
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The investment adviser may deem these requirements satisfied for
any mutual fund it advises if the mutual fund has developed and
implemented a CIP that is compliant with CIP requirements applicable to
mutual funds under the relevant provision of this subpart. FinCEN and
the SEC believe that this exemption is appropriate because of the
regulatory and practical relationship between
[[Page 44575]]
mutual funds and their investment advisers. As a practical matter, we
believe that any CIP requirement imposed on an RIA to a mutual fund is
already addressed by the existing CIP requirements imposed on the
mutual fund itself.\34\ Consequently, we are proposing not to require
investment advisers to mutual funds to include those mutual funds
within the investment advisers' own CIP programs, as doing so 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 the investment adviser's CIP requirements.
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\34\ See 31 CFR 1024.220 (mutual fund CIP requirement); see also
89 FR at 12123-4 (explaining the relationship between mutual funds
and investment advisers for purposes of AML/CFT compliance).
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Section 1032.220(a)(2) Identity verification procedures. Proposed
Sec. 1032.220(a)(2) would require that an investment adviser's CIP
include risk-based procedures for verifying the identity of customers,
to the extent reasonable and practicable, and that such verification
occur within a reasonable time before or after the customer's account
is opened. The inclusion of ``before or after'' account opening is
intended to offer flexibility to an adviser in complying with the
requirements of the proposed rule during the process of creating an
advisory relationship with a customer. The procedures must enable the
investment adviser to form a reasonable belief that it knows the
identity of each customer.
A person becomes a customer each time the person opens a new
account with an investment adviser. Therefore, upon the opening of each
account, the verification requirements of this proposed rule would
apply. However, if a customer whose identification has been verified
previously opens a new account, the investment adviser would generally
not need to verify the customer's identity again, provided the
investment adviser (1) previously verified the customer's identity, to
the extent required, in accordance with procedures consistent with the
proposed rule, and (2) continues to have a reasonable belief that it
knows the true identity of the customer based on the previous
verification.
Under this proposed rule, the procedures must be based on the
investment adviser's assessment of the relevant risks, including those
presented by the various types of accounts maintained by the investment
adviser; the various methods of opening accounts provided by the
investment adviser, the various types of identifying information
available and the investment adviser's size, location, and customer
base. Other relevant risk factors could include, for example, the types
of money laundering and terrorist financing activities present in the
respective jurisdiction; whether account opening occurs in-person or
online; the types of services and transactions offered or performed by
the investment adviser; and the reliance on third-party firms
(including other investment advisers, broker-dealers, or funds) for
identity verification procedures.
Thus, in developing and updating CIPs, investment advisers would be
required to consider the type of identifying information available for
customers and the methods available to verify that information. While
paragraph (a)(2)(i) of this proposed rule would require certain minimum
identifying information to be obtained, and paragraph (a)(2)(ii)
discusses certain suitable verification methods, as described below,
investment advisers should consider on an ongoing basis whether other
identifying information or verification methods are appropriate,
particularly as they become available in the future.
Section 1032.220(a)(2)(i) Customer information required. Pursuant
to the proposed rule, an investment adviser's CIP must require the
investment adviser to obtain, at a minimum, certain identifying
information with respect to each customer before or after an account is
opened for the customer. Specifically, the investment adviser must
obtain with respect to each customer: (1) name; (2) date of birth for
an individual or the date of formation for any person other than an
individual; (3) address; \35\ and (4) identification number.\36\ Under
proposed Sec. 1032.220(a)(2)(i), the term ``name'' would refer to a
customer's full legal name, and the investment adviser should consider
collecting any aliases or assumed names as well (e.g., ``doing business
as'' or ``DBA'' names). For persons other than an individual, the date
of formation may be available on the certificate of formation or
incorporation (or other document used to create a legal person), as
well as any amendments to those documents.
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\35\ For an individual who does not have a residential or
business street address, the proposed rule would require the adviser
to collect an Army Post Office (APO) or Fleet Post Office (FPO) box
number, or the residential or business street address of next of kin
or of another contact individual. See proposed section
1032(a)(2)(i)(A)(3)(ii). For individuals who live in rural areas who
do not have a residential or business address, an APO or FPO, or the
residential or business address of next of kin or another contact
individual, an investment adviser may obtain a rural route number. A
rural route number, unlike a post office box number, is a
description of the approximate area where the customer can be
located. In the absence of such a number, and in the absence of a
residential or business address for next of kin or another contact
individual, an APO, and an FPO, a description of the customer's
physical location would suffice.
\36\ Proposed section 1032(a)(2)(i)(4) would require that the
identification number be, for a U.S. person, a taxpayer
identification number (TIN), which could be a social security number
for an individual. For a non-U.S. person, the identification number
would be one or more of the following: a TIN; passport number and
country of issuance; alien identification card number; or number and
country of issuance of any other government-issued document
evidencing nationality or residence and bearing a photograph or
similar safeguard. For a non-U.S. person that is not an individual
and that does not have an identification number, the investment
adviser must request alternative government-issued documentation
certifying the existence of the person. As proposed, the CIP may
also include procedures for opening an account for a person that has
applied for, but has not received, a TIN.
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Proposed Sec. 1032.220(a)(2)(i)(A) would require only that this
minimum identifying information be obtained. Investment advisers, in
assessing the risk factors in paragraph (a)(2), however, would also be
required to determine whether other identifying information is
necessary to enable the investment adviser to form a reasonable belief
that it knows the true identity of each customer. There also may be
other circumstances that make it appropriate to obtain additional
information.\37\ For example, under proposed section
1032.220(a)(2)(ii)(C), an investment adviser must set forth guidelines
in its CIP for situations where, based upon a risk-based assessment of
a customer that is not an individual, additional information should be
obtained about the individuals with authority or control over the
customer's account. The CIP generally should include guidelines for
collecting additional information in other situations where the
investment adviser determines in the course of examining the nature of
its business and operations that additional information should be
obtained, consistent with a risk-based CIP, in order to enable the
investment adviser to form a reasonable belief that it knows the true
identity of the customer. Such guidelines generally should indicate the
types of additional information needed and the circumstances when it
would be obtained.
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\37\ For example, it may be appropriate for an investment
adviser to seek to obtain additional information about a customer
that is a recently formed entity, given that this type of customer
may pose a higher AML/CFT risk than established entities that may
have longer-standing business dealings and that may be publicly
known.
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Proposed Sec. 1032.220(a)(2)(i)(B) includes an exception from the
requirement to obtain a taxpayer identification number from a customer
[[Page 44576]]
opening a new account. As proposed, this exception would allow an
investment adviser to open an account for a person that has applied
for, but has not received, a TIN. In this case, the CIP would be
required to include procedures to confirm that the application was
filed before the person opened the account and to obtain the TIN within
a reasonable period of time after the account is opened.
Moreover, under proposed Sec. 1032.220(a)(2)(i), when opening an
account for a non-U.S. person that is not an individual and that does
not have an identification number, the investment adviser would be
required to request alternative government-issued documentation
certifying the existence of the customer. In contrast to the CIP
requirements for mutual funds and broker dealers regarding a non-U.S.
person that is not an individual, this specific requirement is being
included here to account for changes in how financial institutions now
routinely verify the identity of non-U.S. persons that are not
individuals.
Section 1032.220(a)(2)(ii) Customer verification. Under proposed
Sec. 1032.220(a)(2)(ii), after obtaining identifying information with
respect to a customer, the investment adviser would be required to
follow risk-based procedures to verify the accuracy of that information
in order to reach a point where it can form a reasonable belief that it
knows the true identity of the customer. The proposed rule would
require that verification procedures be undertaken within a reasonable
time before or after a customer's account is opened. This flexibility
would have to be exercised in a reasonable time, given that
verifications too far in advance may become stale and verifications too
long after the fact may provide opportunities to launder money or
engage in other relevant illicit finance activity while verification is
pending. The amount of time it will take an investment adviser to
verify the identity of a customer may depend on the type of account
opened, whether the customer opens the account in person, and the type
of identifying information available. For example, an investment
adviser may choose to place limits on the account, such as temporarily
limiting advisory-related activities in an account until the customer's
identity is verified in which case the adviser should inform the
accountholder. Therefore, the proposed rule would provide investment
advisers with the flexibility to use a risk-based approach to determine
when the identity of a customer must be verified relative to the
opening of an account.
Proposed Sec. 1032.220(a)(2)(ii) would provide for two methods of
verifying identifying information: verification through documents and
verification through non-documentary means. This proposed provision
would require that an investment adviser's CIP address both methods of
verification. The CIP would have to set forth risk-based procedures
describing when documents, non-documentary methods, or a combination of
both will be used. These procedures should be based on the investment
adviser's assessment of the factors described in paragraph (a)(2) of
the proposed rule.
The risk that an investment adviser will not have a reasonable
belief that it knows a customer's true identity will be heightened for
certain types of accounts, such as accounts opened in the name of a
corporation, partnership, or trust that is created, or conducts
substantial business, in jurisdictions designated as primary money
laundering concerns or designated as non-cooperative by an
international body, or jurisdictions that are otherwise considered
high-risk for money laundering or terrorist financing with respect to
their compliance with relevant international standards.\38\ Obtaining
sufficient information to verify a given customer's identity can reduce
the risk an investment adviser will be used as a conduit for money
laundering and terrorist financing. An investment adviser's identity
verification procedures must be based on its assessments of the factors
in paragraph (a)(2). Accordingly, when those assessments suggest a
heightened risk, the investment adviser should modify its verification
measures accordingly (e.g., by utilizing additional measures).
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\38\ For example, the Financial Action Task Force (FATF), an
intergovernmental body that establishes international standards for
anti-money laundering, countering the financing of terrorism, and
countering the financing of proliferation of weapons of mass
destruction, issues lists of jurisdictions with strategic AML/CFT
deficiencies, including identifying certain jurisdictions as high
risk. FinCEN issues a press release following each FATF update to
the lists and reminds U.S. financial institutions to apply enhanced
due diligence proportionate to the risks for those identified as
high-risk jurisdictions. See, e.g., Financial Action Task Force
Identifies Jurisdictions with Anti-Money Laundering and Combating
the Financing of Terrorism and Counter-Proliferation Deficiencies
(Feb. 29, 2024), available at <a href="https://www.fincen.gov/news/news-releases/financial-action-task-force-identifies-jurisdictions-anti-money-laundering">https://www.fincen.gov/news/news-releases/financial-action-task-force-identifies-jurisdictions-anti-money-laundering</a>.
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Section 1032.220(a)(2)(ii)(A) Customer verification through
documents. Proposed Sec. 1032.220(a)(2)(ii)(A) would require an
investment adviser's CIP to contain procedures that set forth the
documents that the investment adviser will use for verification, based
on a risk-based analysis of the types of documents that it believes
will enable it to verify customer identities. The proposed rule
includes a list of identification documents, though an investment
adviser would be allowed to use other documents, provided they allow
the investment adviser to establish a reasonable belief that it knows
the true identity of the customer. For individuals, these documents may
include unexpired government-issued identification evidencing
nationality or residence and bearing a photograph or similar safeguard.
For other persons, suitable documents would include documents showing
the existence of the entity, such as certified articles of
incorporation, a government-issued business license, a partnership
agreement, or a trust instrument. The investment adviser's procedures
must take into account circumstances in which there may be problems
authenticating documents and the inherent limitations of certain
documents as a means of identity verification.\39\ These limitations
would affect the types of documents that would be necessary to
establish a reasonable belief that the investment adviser knows the
true identity of the customer and would require the use of non-
documentary methods in addition to documents under some circumstances.
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\39\ Proposed 1032.220(a)(2)(ii)(B) notes examples of potential
circumstances in which an investment adviser may encounter problems
or limitations involving customer verification through documents,
including circumstances in which the investment adviser is not
familiar with the documents presented, among other potential
circumstances.
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Under proposed Sec. 1032.220(a)(2)(ii)(A), once an investment
adviser obtains and verifies the identity of a customer through a
suitable document, the investment adviser would not be required to take
steps to determine whether a document has been validly issued. An
investment adviser generally would be allowed to rely on an unexpired
government-issued identification for verification purposes; \40\
however, if a document has indicators of fraud, the investment adviser
would have to consider that
[[Page 44577]]
factor in determining whether it could form a reasonable belief that it
knows the customer's true identity.\41\
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\40\ Proposed 1032.220(a)(2)(ii)(A) notes that, for verification
procedures relying on documents, documents may include: for an
individual, an unexpired government-issued identification evidencing
nationality or residence and bearing a photograph or similar
safeguard, such as a driver's license or passport; and, for a person
other than an individual (such as a corporation, partnership, or
trust), documents and any amendments thereto showing the existence
of the entity, such as certified articles of incorporation, a
government-issued business license, a partnership agreement, or a
trust instrument.
\41\ If the investment adviser has a broader AML/CFT program,
the presentation by a customer of a document showing indications of
fraud should generally also be considered by the investment adviser
as part of its broader AML/CFT program.
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Section 1032.220(a)(2)(ii)(B) Customer verification through non-
documentary methods. Proposed Sec. 1032.220(a)(2)(ii)(B) would require
an investment adviser's CIP to describe non-documentary verification
methods and when such methods will be employed in addition to, or
instead of, verification through documents. The proposed rule would
permit the exclusive use of non-documentary methods because some
accounts may be opened by telephone, mail, or over the internet in ways
that may make sole reliance on documentary verification difficult or
burdensome.\42\ However, even if the customer presents identification
documents, it may be appropriate to use non-documentary methods as
well. Under this provision, the investment adviser would be ultimately
responsible for employing verification methods that enable the adviser
to form a reasonable belief that it knows the true identity of the
customer.
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\42\ FinCEN and the SEC recognize that account opening by solely
telephone, mail, or over the internet is unlikely in the context of
customers that are private funds.
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Proposed Sec. 1032.220(a)(2)(ii)(B) would set forth certain non-
documentary methods that would be suitable for verifying identity.
These methods may include contacting a customer; obtaining a financial
statement; comparing the identifying information obtained with respect
to the customer against relevant fraud, bad check databases to
determine whether any of the information is associated with known
incidents of fraudulent behavior; comparing the identifying information
with information available from a trusted third-party source, such as a
credit report from a consumer reporting agency or an account
verification database; and checking references with other financial
institutions. This list is not intended to exhaust all methods that may
be suitable, however. For example, the investment adviser also may wish
to analyze whether there is logical consistency between the identifying
information provided, such as the customer's name, street address, ZIP
code, telephone number (if provided), date of birth, and social
security number.
Proposed Sec. 1032.220(a)(2)(ii)(B) also would require an
investment adviser's CIP to address situations in which (1) an
individual is unable to present an unexpired government-issued
identification document that bears a photograph or similar safeguard;
(2) the investment adviser is not familiar with the types of documents
presented; (3) the investment adviser does not obtain documents to
verify the identity of the customer; (4) the investment adviser does
not meet face-to-face with a customer who is a natural person; and (5)
the investment adviser is otherwise presented with circumstances that
increase the risk the investment adviser will be unable to form a
reasonable belief that it knows the true identity of a customer through
documents.
FinCEN and the SEC recognize that identification documents,
including those issued by a government entity, may be obtained
illegally and may be fraudulent. In light of the recent increase in
identity theft, investment advisers would be encouraged to use non-
documentary methods as well, even when an investment adviser has
received identification documents from the customer. Additionally,
investment advisers are encouraged to consider using both documentary
and non-documentary verification methods and should consider on a
regular basis whether their procedures for identity verification are
appropriate.
Section 1032.220(a)(2)(ii)(C) Additional verification for certain
customers. Proposed Sec. 1032.220(a)(2)(ii)(C) would require that an
investment adviser's CIP address circumstances in which, based on the
investment adviser's risk assessment of a new account opened by a
customer that is not an individual, the investment adviser will obtain
information about individuals with authority or control over such
accounts in order to verify the customer's identity. This requirement
would apply only when the investment adviser cannot verify the true
identity of a customer that is not an individual using the verification
methods described in paragraphs (a)(2)(ii)(A) and (B) of the proposed
rule.\43\
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\43\ An investment adviser need not undertake any additional
verification methods with respect to a potential customer in this
circumstance if it chooses not to permit the potential customer to
open an account. However, the adviser may decide to collect such
information if it were to file a SAR regarding the potential
customer.
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While investment advisers may be able to verify the majority of
customers adequately through the documentary or non-documentary
verification methods described above, there may be circumstances when
the investment adviser cannot form a reasonable belief that it knows
the true identity of a customer using such methods. The risk that the
investment adviser will not know the customer's true identity may be
heightened for certain types of accounts, such as an account opened in
the name of a corporation, partnership, or trust that is created or
conducts substantial business in a jurisdiction that has been
designated by the United States as a primary money laundering concern
or by an international body as non-cooperative, or jurisdictions that
are otherwise considered high-risk for money laundering or terrorist
financing with respect to their compliance with relevant international
standards. As a result of this, FinCEN and the SEC are proposing to
require (1) that an investment adviser identify customers that are not
individuals that pose a heightened risk of not being properly
identified and (2) that an investment adviser's CIP prescribe
additional measures that may be used to obtain information about
individuals with authority or control over the account to verify the
customer's identity when standard documentary or non-documentary
methods prove to be insufficient.
Section 1032.220(a)(2)(iii) Lack of verification. Proposed Sec.
1032.220(a)(2)(iii) would require that an investment adviser's CIP
include procedures for responding to circumstances in which the
investment adviser cannot form a reasonable belief that it knows the
true identity of a customer. These procedures should describe (1) when
the investment adviser should not open an account, (2) the terms under
which the investment adviser may provide advisory services to the
customer while the investment adviser attempts to verify the customer's
identity, (3) when the investment adviser should close an account after
attempts to verify a customer's identity fail, and (4) when the
investment adviser should file a SAR in accordance with applicable law
and regulation.\44\
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\44\ Although investment advisers are not currently required to
file SARs, they are encouraged to do so voluntarily. As noted at
n.7, supra, on Feb. 15, 2024, Treasury issued the AML/CFT Program
and SAR Proposed Rule, which, if adopted, would require investment
advisers to file SARs in certain circumstances.
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Section 1032.220(a)(3) Recordkeeping. Proposed Sec. 1032.220(a)(3)
would require that an investment adviser's CIP include procedures for
making and maintaining a record of information obtained under
procedures implementing proposed paragraph (a), as discussed in greater
detail in the following paragraphs. This
[[Page 44578]]
proposal is consistent with the requirement of 31 U.S.C. 5318(l)(2)(B)
that CIPs include procedures for maintaining records of the information
used to verify a person's identity, including name, address, and other
identifying information.
Section 1032.220(a)(3)(i) Required records. Proposed Sec.
1032.220(a)(3)(i) would require that an investment adviser's CIP
include procedures for making and maintaining records related to
verifying customer identity, as well as procedures for how to do so.
Records would have to include the identifying information about each
customer under proposed (a)(2)(i) and a description of any document
that the investment adviser relied on to verify the identity of the
customer (noting the document type, any identification number contained
therein, the place of issuance, and the date of issuance and expiration
as applicable and relevant) under proposed (a)(3)(i)(B). Proposed Sec.
1032.220(a)(3)(i)(C) would require records to include a description of
the methods and results of any measures undertaken to verify the
identity of the customer. This description would include any relevant
non-documentary methods and additional verification for certain
customers used to verify identity under proposed Sec.
1032.220(a)(2)(ii)(B) and (C). Finally, proposed Sec.
1032.220(a)(3)(i)(D) would require investment advisers to record a
description of the resolution of each substantive discrepancy
discovered when verifying the identifying information obtained.
An investment adviser would be allowed to use electronic records to
satisfy the requirements of this proposed rule.
Section 1032.220(a)(3)(ii) Record retention. Proposed Sec.
1032.200(a)(3)(ii) would prescribe a bifurcated record retention
schedule that is consistent with a general five-year retention
requirement. Under this proposed provision, an investment adviser would
be required to retain the information obtained about a customer
pursuant to proposed paragraph (a)(3)(i)(A) (i.e., identifying
information about the customer) while the account remains open and for
five years after the date the account is closed.\45\ The remaining
records required under proposed paragraphs (a)(3)(i)(B), (C), and (D)
(i.e., information regarding the verification of a customer's
identity), however, would only have to be retained for five years after
the record is made.
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\45\ The proposed five-year period is generally consistent with
the retention period under the Advisers Act books and records rule,
which generally requires most books and records to be retained for
five years from the last day of the fiscal year in which the last
entry was made on the document or the document was disseminated. See
Advisers Act Rule 204-2 codified at 17 CFR 275.204-2. Advisers may
be required to keep certain records for longer periods under the
books and records rule.
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Section 1032.220(a)(4) Comparison with Government Lists. Under 31
U.S.C. 5318(l)(2)(C), a CIP must include reasonable procedures for
determining whether a customer appears on any list of known or
suspected terrorists or terrorist organizations provided by any
government agency. Proposed Sec. 1032.220(a)(4) accordingly would
require that an investment adviser's CIP include reasonable procedures
for determining whether a customer appears on any such list provided by
any Federal Government agency that is designated as such by Treasury in
consultation with the Federal functional regulators, and that an
investment adviser make such a determination within a reasonable period
of time after the account is opened, or earlier if required by another
Federal law, regulation, or directive issued in connection with the
applicable list. This requirement would apply only with respect to
lists circulated, directly provided, or otherwise made available by the
Federal government and designated as such by Treasury in consultation
with the Federal functional regulators. In addition, proposed Sec.
1032.220(a)(4) would state that the procedures must require investment
advisers to follow all Federal directives issued in connection with
such lists. Because Treasury and the Federal functional regulators have
not yet designated any such lists for the purposes of CIP, the proposed
rule cannot be more specific with respect to the lists that investment
advisers must check. However, investment advisers would not have an
affirmative duty under this rule to seek out all lists of known or
suspected terrorists or terrorist organizations compiled by the Federal
government. Instead, investment advisers would receive separate
notification regarding the lists that they must consult for purposes of
this provision.
Many investment advisers already have procedures for determining
whether customers' names appear on some federal government lists,
including lists that identify known terrorists and terrorist
organizations. For example, under current law, there are substantive
legal requirements associated with the lists circulated by Treasury's
Office of Foreign Assets Control (``OFAC''). Failure to comply with
these requirements may result in criminal or civil penalties.
Section 1032.220(a)(5) Customer Notice. Section 5318(l)(2) also
provides that financial institutions must give their customers adequate
notice of their identity verification procedures. Therefore, proposed
Sec. 1032.220(a)(5) would require that an investment adviser's CIP
include procedures for providing customers with adequate notice that
the firm is requesting information to verify their identities. The
proposed rule would state that this notice is adequate if the
investment adviser generally describes the identification requirements
of the proposed rule and provides such notice in a manner reasonably
designed to ensure that a prospective customer is able to view the
notice, or is otherwise given notice, before opening an account. Under
proposed Sec. 1032.220(a)(5), depending on how an account is opened,
an investment adviser could post a notice on its website, include the
notice in its account applications, or use any other form of written or
oral notice.\46\ The sample notice included in the proposed rule, if
appropriate, would be deemed adequate notice to an investment adviser's
customers when provided in accordance with the other requirements
described in this section.
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\46\ For example, if an account is opened electronically, such
as through an internet website, the investment adviser may provide
notice electronically.
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Section 1032.220(a)(6) Reliance on another financial institution.
There may be circumstances in which an investment adviser could rely on
the performance by another financial institution of some or all of the
elements of the investment adviser's CIP. However, the investment
adviser would remain responsible for ensuring compliance with the
proposed rule 1032.220(a)(6), and therefore would be required to
actively monitor the operation of its CIP and assess its effectiveness.
Proposed Sec. 1032.220(a)(6) would provide that an investment
adviser's CIP may include procedures that specify when the investment
adviser will rely on the performance by another financial institution
(including an affiliate) of any procedures of the investment adviser's
CIP, and thereby satisfy the investment adviser's obligations under the
proposed rule. Under proposed Sec. 1032.220(a)(6), reliance would be
permitted if a customer of the investment adviser is opening an account
or has opened or has established an account or similar business
relationship with the other financial institution to provide or engage
in services, dealings, or other financial transactions, provided that:
(1)
[[Page 44579]]
such reliance is reasonable under the circumstances, (2) the other
financial institution is subject to a rule implementing the AML/CFT
compliance program requirements of 31 U.S.C. 5318(h) and is regulated
by a Federal functional regulator, and (3) the other financial
institution enters into a contract with the investment adviser
requiring it to certify annually to the investment adviser that it has
implemented an AML/CFT program and will perform (or its agent will
perform) the specified requirements of the investment adviser's CIP.
This last element could be satisfied by a reliance letter or other
similar documentation. The investment adviser would not be held
responsible for the failure of the other financial institution to
fulfill adequately the adviser's CIP responsibilities, provided that
the investment adviser can establish that its reliance was reasonable
and that it has obtained the requisite contracts and certifications.
The SEC and FinCEN emphasize that the investment adviser and the other
financial institution upon which it relies would have to satisfy all of
the conditions set forth in this proposed rule. If they do not, then
the investment adviser would remain solely responsible for applying its
own CIP to each customer in accordance with this rule.\47\
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\47\ Pursuant to a Securities Industry and Financial Markets
Association (SIFMA) no-action letter, staff of the SEC's Division of
Trading and Markets stated that it would not recommend enforcement
action if a broker-dealer relies on an RIA to perform some or all
aspects of the broker-dealer's CIP obligations or the portion of
customer due diligence 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. Letter to Mr. Bernard V. Canepa, Associate General
Counsel, 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), available at <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 no-action letter
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.
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Section 1032.220(b) Exemptions. Proposed Sec. 1032.220(b) would
provide that the SEC, with the concurrence of the Secretary, may by
order or regulation exempt any investment adviser or any type of
account from the requirements of this section. Proposed Sec.
1032.220(b) would also provide that the Secretary, with the concurrence
of the Commission, may exempt any investment adviser or any type of
account from the requirements of this section. In issuing such
exemptions, the SEC and the Secretary would have to consider whether
the exemption is consistent with the purposes of the BSA and in the
public interest, and they may consider other necessary and appropriate
factors.
Section 1032.220(c) Effective Date. FinCEN and SEC anticipate that
the effective date of the proposed rule will be 60 days after the date
on which the final rule is published in the Federal Register. In order
to provide time for investment advisers to come into compliance,
section 1032.220(c) states the compliance date by which an investment
adviser would be required to comply with this section. Specifically,
under this proposed rule, an investment adviser would be required to
develop and implement a CIP that complies with the requirements of this
section on or before six months from the effective date of the
regulation, but no sooner than the compliance date of the AML/CFT
Program and SAR Proposed Rule, if adopted. We believe that six months
strikes an appropriate balance between providing advisers with
sufficient time to develop and implement a CIP while not overly
delaying CIP implementation across the investment adviser industry.
Section 1032.220(d) Other requirements unaffected. The proposed
rule would include a provision, proposed Sec. 1032.220(d), parallel to
that in CIP rules previously adopted for other financial institutions,
stating that nothing in the rule shall be construed to relieve an
investment adviser of its obligations to comply with any other
provision of this chapter, including provisions concerning information
that must be obtained, verified, or maintained in connection with any
account or transaction.\48\
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\48\ See, e.g., 31 CFR 1020.220(c), 1023.220, 1024.220,
1026.220.
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III. Request for Comments
FinCEN and the SEC invite comment on all aspects of the proposed
regulation, and specifically seek comment on the following issues:
1. Whether the proposed definition of ``account'' is appropriate
and unambiguous, and whether other examples of accounts should be added
to the rule text.
a. Should an account opened for the purpose of participating in an
employee benefit plan established under ERISA be excluded from the CIP
account definition?
b. Are there types of accounts that should be exempted from CIP
obligations?
2. The proposed definition of ``account'' would exclude an account
that an investment adviser acquires through an acquisition, merger,
purchase of assets, or assumption of liabilities, given that customers
do not ``open'' transferred accounts, and, therefore, the accounts do
not fall within the scope of section 326. As discussed above, advisers
may be required to apply other sanctions and export compliance and AML/
CFT requirements to those accounts. Are there circumstances in which
advisers should be required to fulfill identity verification
requirements for some transfers?
a. Should the rule require advisers to re-verify a customer's
identity after a certain period of time (e.g., every year, every other
year, or every five years)?
3. Should the definition of ``account'' refer to the activities
enumerated in 15 U.S.C. 80b-2(a)(11) for the definition of investment
adviser? Or is the reference to ``investment advisory services''
sufficient?
4. Is the proposed definition of ``customer'' appropriate? Should
other examples of customers be added to the rule text?
5. Should the definition of investment adviser apply to non-U.S.
advisers registered or required to register with the SEC (for RIAs) or
that report to the SEC on Form ADV (for ERAs), as proposed? What would
be the logistical challenges of this approach?
6. Should terms defined elsewhere within 31 CFR chapter X, such as
``U.S. Person'', ``Non-U.S. Person'', and ``Taxpayer Identification
Number'' be defined in the proposed rule as well or are those terms
well-understood for CIP purposes?
7. To what extent do RIAs and ERAs already require customer
identification and verification or otherwise have procedures in the
manner proposed in the course of regular business or under other,
existing regulatory obligations?
a. To what extent do the customer identification and verification
procedures currently implemented by RIAs and ERAs resemble or differ
from those required by the proposed rule?
8. Are there other categories of entities that, like mutual funds,
should be exempted from an investment adviser's CIP program. Why or why
not?
9. Should the exemption for mutual funds be dependent on the nature
of the relationship between the investment adviser and its mutual fund
customer and the ability of the investment adviser to meet CIP
obligations?
[[Page 44580]]
10. Should closed-end registered funds, wrap fee programs, or other
types of accounts advised by investment advisers be, on a risk-basis,
exempted from an investment adviser's CIP program?
11. FinCEN also requests comment on the money laundering, terrorist
financing, and other illicit finance risks faced by closed-end funds,
and how entities with existing CIP requirements, such as banks and
broker-dealers, apply those requirements to activity involving closed-
end funds.
12. How would an investment adviser apply the identification and
verification requirements at proposed Sec. 1032.220(a)(2) to a private
fund customer? What type of information would the adviser use to ask
identification questions? We expect that advisers would likely already
have this information in respect of private funds that they manage. Do
commenters agree?
13. Proposed Sec. 1032.220(a)(2) would require that an investment
adviser verify customer identity within a reasonable time before or
after the customer's account is opened. To what extent would an
investment adviser provide advisory services prior to verifying
customer identity? How much time would an investment adviser reasonably
need to verify customer identity (e.g., 30 days)?
14. How do investment advisers currently collect identity
information for non-U.S. customers that are not individuals, such as
foreign legal entities or other legal persons and legal arrangements?
15. Are the provisions in section 1032.220(a)(6) sufficient to
permit an adviser to rely on another financial institution to perform
its CIP requirements? Would there be any challenges for advisers with
the proposed approach? Do commenters agree that an investment adviser
should be required to actively monitor the operation of its CIP and
assess its effectiveness in order to rely on another financial
institution, or should the adviser not be held responsible by showing
it reasonably relied on another financial institution that satisfied
all of the conditions set forth in this proposed rule?
16. Is the proposed requirement for the other financial institution
to enter into a contract with the investment adviser feasible? Does it
depend on the size of the investment adviser and its negotiating power?
Should we modify this requirement? For example, should we remove or
modify the requirement for the other financial institution to certify
that it will perform specified requirements of the investment adviser's
CIP?
17. Does the proposed compliance date (six months after the final
rule is issued) give advisers sufficient time to comply with the
requirements of the proposed rule? Should the compliance date be
staggered based on adviser size?
18. If an investment adviser cannot form a reasonable belief that
it knows the true identity of a customer, should the investment adviser
be able to engage in advisory activities on behalf of the customer
prior to verifying the customer's identity?
IV. Analysis of the Costs and Benefits Associated With the Proposed
Rule
A. Introduction
FinCEN \49\ and the SEC are sensitive to the economic effects that
could result from the proposed rule and have accordingly considered
certain likely effects and reasonable alternatives. Section 326 of the
USA PATRIOT Act requires Treasury to prescribe regulations setting
forth minimum standards for financial institutions regarding the
identities of customers when they open an account. It also provides
that the regulations issued by Treasury and the SEC must, at a minimum,
require financial institutions to implement reasonable procedures for:
(1) verification of the identity of any person seeking to open an
account, to the extent reasonable and practicable; (2) maintenance of
the information used to verify the person's identity, including name,
address, and other identifying information; and (3) consulting lists of
known or suspected terrorists or terrorist organizations provided to
the financial institution by any government agency to determine whether
a person seeking to open an account appears on any such list.\50\
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\49\ When proposing a rule, FinCEN must conduct a regulatory
impact analysis in accordance with Executive Orders 12866, 13563,
and 14094 (E.O. 12866 and its amendments) comprised of a number of
assessments of the anticipated impacts of the proposed rule in terms
of its expected costs and benefits to affected parties. The
regulatory impact analysis must also include assessments of the
impact on small entities pursuant to the Regulatory Flexibility Act
(RFA) and reporting and recordkeeping burdens under the Paperwork
Reduction Act (PRA), as well as an assessment under the Unfunded
Mandates Reform Act of 1995 (UMRA).
\50\ 31 U.S.C. 5318(l)(2). In addition to the requirements in
proposed 31 CFR 1032.220, FinCEN and the SEC are also proposing to
revise 31 CFR 1032.100 to define several terms used in proposed
1032.220. This aspect of the proposed rule has no independent
substantive requirements or economic impacts.
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Under the BSA, FinCEN recently published the AML/CFT Program and
SAR Proposed Rule, which would include certain investment advisers in
the definition of financial institutions.\51\ If that rule is adopted
and ``investment adviser'' is thereby added to FinCEN's definition of
``financial institution'' at 31 CFR 1010.100(t), covered investment
advisers would be financial institutions for purposes of section 326.
As a consequence, FinCEN and the SEC would be required to jointly
prescribe rules that establish minimum standards for covered investment
advisers regarding the identities of customers when they open an
account, which are proposed in this release.\52\ This proposed rule is
designed to align the requirements for investment advisers with
existing rules for other financial institutions, such as broker-
dealers, mutual funds, credit unions, banks, and others, to adopt and
implement CIPs.
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\51\ 89 FR 12108 (Feb. 15, 2024).
\52\ USA PATRIOT Act, sec. 326(a)(4).
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B. Broad Economic Considerations
Evaluating the effectiveness of AML/CFT regimes is difficult
because there is no precise method to determine either the actual
number or magnitude of money laundering and terrorism financing crimes
that occur, since some of these crimes go undetected. In addition, it
is impossible to infer either the number or magnitude of such crimes
that would have occurred absent the regime or under some alternative
enforcement regime. To our knowledge, there are no academic studies
that specifically assess the efficacy of CIP provisions as a part of
AML/CFT regimes. However, there is some empirical evidence that points
toward the effectiveness of the U.S. AML/CFT regime more broadly.\53\
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\53\ See, e.g., S.D. Jayasekara, How Effective Are The Current
Global Standards In Combating Money Laundering and Terrorist
Financing?, 24 J. Money Laundering Control (2021). The author finds
that countries whose regulations more closely adhere to Financial
Action Task Force standards are less likely to see proxies for
money-laundering related activities such as bribes, corruption, and
crime. See also J. Jiao, Bank Secrecy Act and Casinos' Performances,
19 J. Acct. Fin. (2019). The author finds that the accounting and
market performance of casinos in Nevada converge after the adoption
of the BSA, indicating that casinos engage in less money laundering.
Further, the market performance of these casinos improves, which is
consistent with a positive overall economic impact of the BSA on
that industry. However, casinos and some other financial
institutions with AML/CFT program requirements do not have CIP
requirements. See 31 CFR 1021.210, 1022.210, 1028.210. Some academic
work disputes the theoretical effectiveness of FATF frameworks with
which the U.S. regime largely aligns: See R.F. Pol, Anti-money
laundering effectiveness: assessing outcomes or ticking boxes?, 21
J. Money Laundering Control (2018).
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The scale of money laundering in the United States is large.
Specifically, in fiscal year 2022, offenders in 1,001 money laundering
cases were sentenced
[[Page 44581]]
in the Federal system according to the United States Sentencing
Commission (``USSC'').\54\ These cases involved a median loss of
approximately $300,000 and approximately 17.3 percent of these cases
involved a loss of greater than $1.5 million.\55\ USSC does not provide
data that would allow us to determine what percentage of these offenses
involved investment advisers. However, a Treasury-led review of SARs
filed between 2013 and 2021 found that approximately 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.\56\ Further, the number of SAR
filings where an RIA or ERA was referenced increased by approximately
400 percent between 2013 and 2021--a disproportionately higher increase
than the overall increase in SAR filings during that time, which was
approximately 140 percent.\57\
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\54\ USSC, Quick Facts--Money Laundering Offenses (2022),
available at <a href="https://www.ussc.gov/sites/default/files/pdf/research-and-publications/quick-facts/Money_Laundering_FY22.pdf">https://www.ussc.gov/sites/default/files/pdf/research-and-publications/quick-facts/Money_Laundering_FY22.pdf</a>. The USSC is
a bipartisan, independent agency located in the judicial branch of
the U.S. government; and, as part of its mission, it collects,
analyzes, and distributes a broad array of information on federal
sentencing practices, serving as an information resource for
Congress, the executive branch, the courts, criminal justice
practitioners, the academic community, and the public.
\55\ Id.
\56\ Investment advisers were not (and are not currently)
required to file SARs during the period of analysis, 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. Investment advisers may also be
identified in SARs filed by other entities. SARs may also be related
to suspicious activity unrelated to money laundering.
\57\ See 89 FR at 12114 n.70 and associated text.
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According to Treasury, in its 2024 National Money Laundering Risk
Assessment (``NMLRA''), ``[m]oney laundering enables criminal activity
and is necessary to disguise ill-gotten gains. It facilitates crime,
distorts markets, and has a devastating economic and social impact on
citizens. It also threatens U.S. national security as money laundering
allows drug traffickers, fraudsters, human trafficking organizations,
and corrupt officials, to operate and expand their criminal
enterprises.'' \58\ Money laundering distorts markets because the
incentives for criminals' use of the financial system differ from those
of the broader market. Illicit funds also have a probability of seizure
that could negatively impact the broader market, as it could increase
the rate of return investors demand as compensation for risk and thus
firms' cost of capital.\59\
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\58\ Treasury, 2024 National Money Laundering Risk Assessment
(Feb. 2024) at 1, available at <a href="http://home.treasury.gov/system/files/136/2024-National-Money-Laundering-Risk-Assessment.pdf">home.treasury.gov/system/files/136/2024-National-Money-Laundering-Risk-Assessment.pdf</a>.
\59\ As an investment's risk increases, investors typically
require a higher rate of return to invest in it. See also infra
section E for a detailed description for how money laundering can
affect efficiency in financial markets.
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Money laundering also provides the appearance of legitimacy to
proceeds of international corruption. By requiring that investment
advisers verify the identity of their customers, the proposed rule
would make it more difficult for money launderers to use investment
advisers as an entry point into the U.S. financial system, reducing
money launderers' ability to launder the proceeds of these criminal
enterprises and thereby decreasing incentives to engage in these
crimes. It would also help address the illicit finance risks identified
in NMLRA.\60\ As a result, the proposed rule would reduce both monetary
as well as nonmonetary costs associated with money laundering involving
investment advisers.\61\
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\60\ See infra note 63 and associated text.
\61\ The economic considerations enumerated here have all been
evaluated for investment advisers of different characteristics,
particularly both large and small advisers. Small investment
advisers have just as much exposure as large ones to the risks of
money laundering, financing of terrorism, or movement of funds for
other illicit purposes since criminals may seek to place their funds
at financial institutions with less sophisticated risk management
capabilities.
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Given the overall scale of money laundering in the United States,
preventing cases involving investment advisers could have substantial
benefits. The NMLRA, has identified several vulnerabilities facing
investment advisers and highlights some cases involving investment
advisers.\62\ The NMLRA cites ERAs, RIAs that are not dually registered
as or affiliated with a bank or broker-dealer, and investment advisers
managing private funds as the highest-risk types of investment
advisers.\63\
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\62\ Supra note 58 pp. 85-88.
\63\ Id. at 87.
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AML/CFT regimes can lower the amount of money laundering that
occurs by creating barriers to these transactions. Economic theory
would suggest that as more entities and transactions are subject to an
AML/CFT regime, the deterrent effect of any particular regulation will
increase: Illicit dollars attempting to access U.S. financial markets
will seek entry via methods that are outside of, or at the weakest
point of, an AML/CFT regime. As the number of possible entryways
shrinks, these illicit dollars would be funneled into fewer and fewer
channels. As the difficulty of laundering illicit dollars thus
increases, the marginal cost of using these channels increases at an
accelerated rate, further deterring their use. In targeting money
laundering involving customers of investment advisers, the proposed
rule thus seeks to fill a current gap in the U.S. AML/CFT regime, as
recognized by the Financial Action Task Force (``FATF'').\64\
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\64\ FATF is an intergovernmental agency, of which the United
States is a member, that was established to promote effective
policies to combat money laundering and other financial crimes. See
FATF, Anti-Money Laundering and Counter-Terrorist Financing
Measures--United States, 3rd Enhanced Follow-up Report & Technical
Compliance Re-Rating (Mar. 2020), available at <a href="https://www.fatf-gafi.org/content/dam/fatf-gafi/fur/Follow-Up-Report-United-States-March-2020.pdf">https://www.fatf-gafi.org/content/dam/fatf-gafi/fur/Follow-Up-Report-United-States-March-2020.pdf</a>.
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C. Economic Baseline
The baseline against which the costs, benefits, and the effects on
efficiency, competition, and capital formation of the proposed rule are
measured consists of the current U.S. AML/CFT statutory framework, its
regulatory implementation, and current AML/CFT practices of investment
advisers and their related parties.
1. Regulatory Baseline
The AML statutory framework in the United States is commonly known
as the BSA.\65\ Under this framework, many types of financial
institutions currently are required to enact AML programs that include
a CIP. The SEC has jointly enacted rules with FinCEN that specifically
impose CIP requirements on broker-dealers and mutual funds.\66\
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\65\ 31 U.S.C. 5311 et seq.
\66\ In this section, ``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 section
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).
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While investment advisers are not currently defined as financial
institutions under the BSA and are not subject to CIP requirements,
certain investment advisers already perform AML/CFT functions,
including those associated with a CIP, as a result of existing
requirements.\67\ Specifically,
[[Page 44582]]
some RIAs and ERAs may perform certain AML/CFT functions, including
those associated with a CIP, if the entity is also a registered broker-
dealer or a bank (i.e., a dual registrant), or is an operating
subsidiary of a bank; other investment advisers are affiliates of banks
or broker-dealers, which may implement an enterprise-wide CIP-compliant
AML/CFT program that would include investment advisers. Some investment
advisers perform these functions via contract with a broker-dealer
(e.g., if the investment adviser performs CIP functions for joint
customers) or other financial institutions.
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\67\ See 89 FR at 12112 (circumstances where some investment
advisers implement AML/CFT measures).
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In addition, certain investment advisers already obtain identifying
information with respect to some accounts or customers. For example,
U.S. investment advisers, like all U.S. persons, must comply with OFAC
sanctions and U.S. export controls, so they are prohibited from
engaging in transactions that violate foreign economic and trade
sanctions and export controls imposed by the U.S. government and may
engage in due diligence to ensure that they remain compliant with such
sanctions and export controls.\68\ As another example, advisers may be
subject to non-U.S. AML and CIP laws, such as those applicable to
private funds organized in the Cayman Islands.\69\
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\68\ For instance, OFAC's Framework for Compliance Commitments
note that ``One of the fundamental components of an effective OFAC
risk assessment and [sanctions compliance program] is conducting due
diligence on an organization's customers, supply chain,
intermediaries, and counter-parties.'' OFAC, A Framework for
Compliance Commitments (May 2019), available at <a href="https://ofac.treasury.gov/media/16331/download?inline">https://ofac.treasury.gov/media/16331/download?inline</a>.
\69\ See The Cayman Islands Private Funds Act (2021 Revision)
and associated regulations.
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Since the USA PATRIOT Act was passed, multiple rules have been
proposed that would have required some investment advisers to apply
AML/CFT requirements. While the substantive requirements contained in
these proposals are not part of the baseline for the present
rulemaking, some investment advisers have developed AML/CFT measures
consistent with these prior proposals, as discussed in the next
section. Specifically, on September 26, 2002, FinCEN published an NPRM
proposing to require that unregistered investment companies, to include
private funds, establish AML programs.\70\ This was followed by the May
5, 2003, NPRM proposing to require certain investment advisers to
establish AML programs.\71\ 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'').\72\ 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, but would not have included ERAs in the
scope of the rule nor would it have established minimum CIP
requirements.
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\70\ See FinCEN, Anti-Money Laundering Programs for Unregistered
Investment Companies, 67 FR 60617 (Sept. 26, 2002).
\71\ See FinCEN, Anti-Money Laundering Programs for Investment
Advisers, 68 FR 23646 (May 5, 2003).
\72\ 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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Some financial institutions are required to establish a CIP that
would include procedures for determining whether a customer appears on
lists of known or suspected terrorists or terrorist organizations
issued by any Federal government agency and designated as such by
Treasury in consultation with the Federal functional regulators.\73\
While no such lists have been designated by Treasury for any financial
institution, our understanding is that some financial institutions,
including some investment advisers, already check their customers
against OFAC's Specially Designated Nationals and Blocked Persons List
(``SDN List'').\74\
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\73\ See 31 CFR 1020.220(a)(4), 1023.220(a)(4), 1024.220(a)(4),
1026.200(a)(4).
\74\ See, e.g., Managed Funds Association Sound Practices for
Hedge Fund Manager, at n.15 and accompanying text (2009), available
at <a href="https://www.mfaalts.org/wp-content/uploads/2011/06/Final_2009_complete.pdf">https://www.mfaalts.org/wp-content/uploads/2011/06/Final_2009_complete.pdf</a>.
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2. Market Practice
While not legally required, some investment advisers currently have
voluntary AML/CFT programs, which may be CIP-compliant.\75\ Investment
advisers also collect identifying information to perform operational
tasks such as distinguishing between customer accounts, or contacting
their customers for the purposes of sending administrative, regulatory,
or other notices.
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\75\ See note 68.
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The 2016 Investment Management Compliance Testing Survey (``2016
IMCTS Survey'') collected information from approximately 700 RIAs on
their existing implementation of AML/CFT measures.\76\ According to
this survey, as of 2016, approximately 40 percent of RIAs had already
adopted AML/CFT policies consistent with the Second Proposed Investment
Adviser Rule. An additional 36 percent of RIAs adopted some AML/CFT
policies and procedures, but those were generally not in line with the
Second Proposed Investment Adviser Rule. Therefore, according to the
2016 IMCTS Survey, approximately 76 percent of RIAs have at least some
AML/CFT measures in place. In particular, 49 percent had annual
employee AML/CFT training, 24 percent had a designated AML/CFT
compliance officer, and 40 percent performed independent testing of
their AML/CFT program annually. Similar information was not available
for ERAs. While this survey did not ask a question about CIPs
specifically, it is possible that some advisers did have a CIP as part
of their AML/CFT policies and procedures.
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\76\ See 89 FR 12145 n.239 and associated text. 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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Some investment advisers currently outsource some or all of the
work needed for investment advisers or other parties to comply with
regulatory requirements.\77\ A variety of third-party firms (e.g., fund
administrators) exist that assist investment advisers in complying with
their regulatory responsibilities and contractual obligations.
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\77\ The 2023 Investment Management Compliance Testing Survey,
which surveys RIAs, found that 38% of those surveyed use a third
party to perform compliance functions, available at <a href="https://www.investmentadviser.org/wp-content/uploads/2023/07/IMCT-Final-Report.pdf">https://www.investmentadviser.org/wp-content/uploads/2023/07/IMCT-Final-Report.pdf</a>.
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3. Affected Parties
As of October 5, 2023, there were 14,914 RIAs, with roughly $114
trillion assets under management and 931,000 employees.\78\ There were
also 5,546 ERAs with additional gross assets of $5.2 trillion (ERAs do
not report the number of employees).\79\ RIAs had
[[Page 44583]]
approximately 51.5 million natural person customers and 2.9 million
legal entity customers.\80\
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\78\ This number is an estimate of all registered investment
advisers with at least one client based on responses to Item 5.D of
Form ADV, as of Oct. 5, 2023. We note that this figure is likely an
overestimate because Form ADV does not allow us to separate advisers
to only open-end investment companies, which generally would be
excluded from this proposed rule since an investment adviser may
deem the requirements satisfied for any mutual fund (as defined in
31 CFR 1010.100(gg)) it advises that has developed and implemented a
CIP compliant with the CIP requirements applicable to mutual funds,
from advisers to closed-end investment companies, which would be
included.
\79\ The number of RIAs and ERAs, their assets under management,
and RIA employees are estimated using Form ADV data, as of Oct. 5,
2023. ERAs report gross assets for each fund they advise, but only
if that fund is not reported by another RIA in its own Form ADV;
therefore, some ERAs report zero gross assets because all of the
funds they advise are also reported by another RIA.
\80\ Estimated from Form ADV data, as of Oct. 5, 2023.
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D. Benefits and Costs
1. Benefits
The provisions added to the BSA from section 326 of the USA PATRIOT
Act facilitate the prevention, detection, and prosecution of money
laundering and the financing of terrorism. Section 326 requires
financial institutions to establish CIP programs. If the AML/CFT
Program and SAR Proposed Rule is adopted, investment advisers will be
financial institutions under the BSA and in such event the BSA would
require specifying how an investment adviser is to establish and
execute a CIP program.
Obtaining and verifying the identity of account holders or
responding to circumstances in which the investment adviser cannot form
a reasonable belief that it knows the true identity of a customer would
reduce the risk of terrorists and other criminals accessing U.S.
financial markets to launder money, finance terrorism, or move funds
for other illicit purposes. Comparing customer identities to those on
government lists of known or suspected terrorists or terrorist
organizations would assist investment advisers in identifying and
preventing criminal activity.\81\ Maintaining records would enhance
investment advisers' internal compliance efforts and aid investment
advisers in detecting and taking measures to prevent potential illegal
activity and in identifying customers who have newly been added to such
government lists. For example, in the event that an investment
adviser's customer is flagged by screening software, maintaining
records as required by the proposed rule would assist investment
advisers in determining whether this flag was a false positive or
whether the customer was truly added to a relevant government list.
Establishing a CIP would help investment advisers systematize, and in
some cases automate, practices that would facilitate detection of
attempted financial crimes and would help ensure that investment
advisers have practices that are as effective as possible at deterring
financial crimes.
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\81\ See infra section IV.D.2.c for caveats related to the
likely costs of this provision which also apply to the benefits.
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In circumstances where investment advisers are or could be
performing CIP activities for certain entities that already have CIP
obligations, the obliged entities (such as banks and broker-dealers)
may not necessarily have a direct relationship with the customer. In
such cases, investment advisers may be able to more efficiently perform
CIP obligations such as collecting the required information from these
customers because they have a more direct relationship with these
customers. The proposed rule would aim to harmonize investment adviser
CIP obligations with those of other obliged entities, which could
enhance the benefits to the public and reduce the total costs imposed
on the industry of these CIP obligations since investment advisers and
other obliged financial institutions can decide by contract which party
is most efficiently able to execute the CIP and the current disparity
in CIP requirements may be distorting these negotiations. To the extent
that investment advisers already have practices consistent with the
requirements of the proposed rule either because of these extant
obligations or for operational efficiency,\82\ the benefits of the
proposed rule described above would be mitigated.
---------------------------------------------------------------------------
\82\ See supra section IV.C.1 and 2.
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The proposed rule would only require investment advisers to collect
and verify the identity of customers that directly open and hold
accounts (as defined in the proposed rule) with the adviser. The
proposed rule's benefits would thus only apply in cases of money
laundering activity involving those customers and not other individuals
or entities. For example, an investment adviser may have a private fund
as a customer. In this case, the proposed rule would require that the
investment adviser collect the identifying information of the private
fund and, in some cases, individuals with authority or control over
such private fund,\83\ but not that of those invested in such fund. In
certain contexts, an investment adviser may itself be the individual
with authority or control over the private fund.
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\83\ The adviser would be required to obtain information about
individuals with authority or control over the account only when the
adviser cannot verify the true identity of a customer that is not an
individual using the documentary and non-documentary methods
described in the rule. See proposed rule 1032.220(a)(2)(ii)(C).
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Similarly, the benefits of the proposed rule would also be lessened
to the extent that an investment adviser's customer holds accounts for
purposes other than accessing financial markets (for example, if the
customer holds an account only to receive investment research
services).\84\ In such cases, the benefits associated with protecting
financial markets would not directly apply, although the other benefits
discussed above would apply.\85\
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\84\ However, these services could also be used to facilitate
other aspects of the money laundering process.
\85\ See infra section IV.G.2 for a fuller discussion of these
types of accounts.
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It is difficult to estimate how much economic loss the requirements
would prevent. Neither the SEC nor FinCEN has data that would allow the
quantification of how much money laundering would be reduced as a
result of the proposed rule, or how much other illegal activity would
be curbed by this reduction in money laundering.\86\ Money laundering
and other illicit financing is related to human trafficking, drug
trafficking, terrorism, public corruption, the proliferation of weapons
of mass destruction, fraud, and other crimes and illicit activities
that cause substantial monetary and nonmonetary damages.\87\ By
reducing money laundering, and by extension its associated crimes, the
proposed rule would reduce those harms to the extent that investment
advisers are being used to facilitate such unlawful activity.
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\86\ See infra section IV.F for a request for comment about the
availability of such data.
\87\ For further discussion of the harms and risks associated
with money laundering, see Treasury, National Strategy for Combating
Terrorist and Other Illicit Financing (2018), available at <a href="https://home.treasury.gov/system/files/136/nationalstrategyforcombatingterroristandotherillicitfinancing.pdf">https://home.treasury.gov/system/files/136/nationalstrategyforcombatingterroristandotherillicitfinancing.pdf</a>;
see also Treasury, National Money Laundering Risk Assessment (2024),
available at, <a href="https://home.treasury.gov/system/files/136/2024-National-Money-Laundering-Risk-Assessment.pdf">https://home.treasury.gov/system/files/136/2024-National-Money-Laundering-Risk-Assessment.pdf</a>.
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2. Costs
While certain provisions of the proposed rule specify minimum
requirements, such as the pieces of information required to be obtained
and verified, many aspects of the proposed rule require an investment
adviser to establish and implement its CIP according to its specific
circumstances. For example, under the proposed rule, the CIP must be
based on factors specific to each investment adviser, such as size,
customer base, and location. Thus, the analysis and detail necessary
for a CIP would depend on the complexity of the investment adviser and
its operations. Highly complex firms have more risk factors to
consider, given, for example, their number of offices, variety of
services and products offered, and range of customers. However, many of
these firms already have some AML/CFT
[[Page 44584]]
procedures in place and investment advisers already collect some
identifying information that they would be required to collect under
the proposed rule.\88\
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\88\ See supra section IV.C.
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Generally, these requirements are similar to those for other
financial institutions with which investment advisers engage. Many
advisers may already bear the cost of these similar CIP requirements
for other financial institutions in certain lines of business in ways
that would reduce the costs of complying with the proposed rules, and
in such cases the proposed rules would create minimal additional costs.
Some RIAs and ERAs may have reduced costs because they may already
perform certain AML/CFT functions, including those associated with a
CIP, because they are dual registrants or affiliated with a bank or
broker-dealer.
Under the proposed rule, RIAs that are dual registrants or
affiliated advisers would not be legally required to establish a
separate CIP for their advisory activities, provided that an existing
comprehensive CIP-compliant AML/CFT program covers all the entity's
legal and regulatory obligations under the proposed rule. RIAs would
also be exempt from having to apply most of the proposed requirements
with respect to the mutual funds they advise, as mutual funds have
their own CIP requirements and are otherwise required to comply with
the other reporting and recordkeeping requirements included in the
proposed rule. Certain RIAs and ERAs may also already collect and
verify certain information provided by customers via contract for a
joint customer with another financial institution or through a
voluntary AML/CFT program.\89\
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\89\ See supra id.
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Some investment advisers may have similarly reduced costs even if
they do not currently directly perform CIP-related AML functions. In
particular, investment advisers that use broker-dealers on behalf of
their customers but that do not perform the procedures required by the
broker-dealer's CIP may currently already bear some or all of the
proposed rule's costs indirectly. Specifically, these investment
advisers could bear such costs in the form of higher charges for the
broker-dealer's services, since these broker-dealers are already
required to comply with similar CIP requirements related to their joint
customers. In such cases, investment advisers would face new costs
associated with the proposed rule, but these may be offset at least in
part by reduced costs for broker-dealer services.
The proposed rule would only require investment advisers to collect
and verify the identity of customers that directly open and hold
accounts (as defined in the proposed rule) with the adviser. This scope
of the rule would mitigate the proposed rule's costs just as it would
mitigate the proposed rule's benefits as described above.\90\
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\90\ See supra section IV.D.1.
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In addition, investment advisers may deem the requirements of the
proposed rule for any mutual fund to be satisfied if the customer
(i.e., the mutual fund it advises) has developed and implemented a CIP
that is compliant with the investment company's CIP requirements. This
provision further lowers the aggregate cost of the proposed rule by
negating or minimizing the cost associated with customers that are
mutual funds.
(a) Establishing a CIP
RIAs and ERAs would have to establish or in some instances modify a
CIP to comply with the requirements of the proposed rule unless they
currently have in place a CIP consistent with the proposed rule's
requirements. Creating or modifying the policies and procedures
detailed in the CIP would entail costs for these advisers. However,
investment advisers may already have procedures in place for obtaining
identifying information of customers and some investment advisers may
have already implemented voluntary AML/CFT programs that are CIP-
compliant or that could serve as a framework for a CIP that is
consistent with the minimum requirements of the proposed rule.\91\ Some
investment advisers may have already implemented voluntary AML/CFT
programs that are CIP-compliant. In particular, certain investment
advisers that use broker-dealers or other financial institutions on
behalf of their customers may have these programs in place, as these
programs assist those financial institutions to comply with their CIP
obligations.\92\ Accordingly, such investment advisers may already have
written policies and procedures for conducting these or similar
activities. The existing infrastructure related to extant practices
would reduce the cost of complying with the proposed rule.
---------------------------------------------------------------------------
\91\ See supra sections IV.C.1 and 2.
\92\ See note 68.
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Establishing a written CIP would result in additional costs for
some investment advisers to the extent they do not have policies and
procedures that meet the minimum requirements in the rule. This
includes investment advisers that would need to augment their policies
and procedures to make them compliant, and costs associated with
programming and testing automated systems. FinCEN and the SEC estimate
that the average internal time cost for an investment adviser to
establish, document and maintain a written CIP as described above would
be $1,169.30, with most investment advisers incurring additional
ongoing external costs of $584.\93\ These estimates imply $23,923,878
in aggregate industry internal costs and $8,961,480 in aggregate
industry annual external costs.\94\
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\93\ See the PRA analysis in Table 1, infra section V.B.
Internal costs in this section are annual ongoing costs and include
initial costs annualized over a three-year period. External ongoing
costs are annual.
\94\ Id.
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(b) Obtaining and Verifying Identifying Information
The proposed rule would require an investment adviser's CIP to
contain procedures that specify the identifying information that will
be obtained with respect to each customer. This information must
include, at a minimum, the name, date of birth (or date of formation),
address, and identification number of customers opening new accounts.
Investment advisers already obtain from customers identifying
information, such as their names and addresses, since most investment
advisers need to distinguish their customers operationally and these
particular forms of personally identifiable information are common ways
of doing so.
Despite this, we estimate that there would be some new costs for
investment advisers because some may not be obtaining all the
information required by the proposed rule or doing so consistently.
These investment advisers would face additional costs in collecting
this information and updating their account opening applications or
account opening websites to insert line items requesting that customers
provide the required information.
The proposed rule would further require an investment adviser's CIP
to include procedures to verify the identity of each customer and would
provide investment advisers with multiple possible methods to do so.
For example, depending on the procedures implemented based on the
investment adviser's assessment of the relevant risks, customers that
open accounts with an investment adviser can simply provide an
unexpired government-issued identification evidencing nationality or
residence and bearing a photograph or similar safeguard, such as a
driver's license or passport, or if the
[[Page 44585]]
customer is not an individual, provide a copy of any documents showing
its existence as a legal entity (e.g., certified articles of
incorporation, government-issued business licenses, partnership
agreements, or trust instruments and any amendments to such documents).
Alternatively, investment advisers may, for example, obtain a financial
statement from the customer or compare the information provided by the
customer with information obtained from a consumer reporting agency or
public database.
The documentary and non-documentary verification methods set forth
in the rule to verify the identities of customers are not meant to be
an exclusive list of the appropriate means of verification. Other
reasonable methods may be available now or in the future. The purpose
of making the rule flexible in this regard would be to allow investment
advisers to select verification methods that are, as section 326 would
require, reasonable and practicable. Methods that are appropriate for
an investment adviser with a localized customer base may not be
sufficient for a different firm with customers from many different
countries. The proposed rule recognizes this fact and, therefore, would
allow investment advisers to employ such verification methods as would
be suitable to form a reasonable belief that it knows the true
identities of its customers.
The SEC and FinCEN recognize that obtaining and verifying the
identity of each customer would result in incremental costs for many
investment advisers if these firms currently do not use verification
methods or do not verify identities in a way that is consistent with
the proposed rule's requirements. According to the PRA analysis in
section V, the average cost of an ERA with two customers (the median
number of ERA customers) to obtain and verify the identifying
information as described above would be $212.60 in internal cost
burdens with most ERAs facing an additional $46.72 in annual ongoing
external costs.\95\ Similarly, the average internal cost burden for an
RIA with 100 customers (the median number of RIA customers) would be
$10,630, with most RIAs facing ongoing external annual costs of
$2,336.\96\ These estimates are based on averages and do not reflect
the fact that costs will vary between investment advisers for myriad
reasons. In particular, ERA customers are limited to venture capital
funds and other private funds. These customers would likely have a
smaller per-customer cost than natural person customers.
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\95\ Id. The PRA analysis in Table 1 estimates an average
internal cost of $106.30 per customer, so an ERA with two customers
would face an internal cost of 2 x 106.30 = $212.60. It additionally
estimates that 75% of investment advisers would require an average
annual external burden of $23.36 per customer, so an ERA with two
customers would face an external cost of 2 x $23.36 = $46.72.
\96\ Id. An RIA with 100 customers would face an internal cost
of 100 x 106.30 = $10,630 and would likely face an annual external
burden of 100 x $23.36 = $2,336. For this and other costs, mutual
fund customers are included in our counts of customers and so they
are included in these cost calculations despite the fact that
investment advisers may consider their obligations under the
proposed rule to be satisfied under certain circumstances for mutual
fund customers. This factor will overestimate costs.
---------------------------------------------------------------------------
The proposed rule would also require an investment adviser's CIP to
include procedures for responding to circumstances in which the
investment adviser cannot form a reasonable belief that it knows the
true identity of a customer. While the direct costs of this requirement
are included in the estimate above, this requirement may create an
additional unquantifiable indirect cost. Specifically, to the extent
that any customers who are not intended to be targeted by the proposed
rule may be unable to have their identities verified, and thus be
subjected to the consequences of this failure to identify (for example,
being unable to receive services from the investment adviser), there
would be costs associated with temporarily (or possibly in unusual
unforeseen circumstances, permanently) losing or having diminished
access to financial markets.
(c) Determining Whether Customers Appear on a Federal Government List
The proposed rule would require an investment adviser's CIP to
include reasonable procedures for determining whether a customer
appears on any list of known or suspected terrorists or terrorist
organizations issued by any Federal government agency and designated as
such by Treasury in consultation with the Federal functional
regulators. Treasury and the Federal functional regulators have not yet
designated any such lists. However, for purposes of this economic
analysis, we nonetheless estimate the costs of complying with this
provision if such lists were to be designated. Our understanding is
that some investment advisers and other financial institutions already
check their customers against the SDN List. Since the SDN List is often
checked in practice and since the creation of such lists that could be
provided to investment advisers is a reasonable consideration given
this provision in the proposed rule, we are estimating the costs of
complying from the current screening practices using the SDN List. We
assume, based on staff experience with firms that already check against
government lists, that for most accounts this process would be
automated and conducted on a batch-file basis, though with significant
manual intervention to address false positives. We estimate that the
average cost to an ERA with two customers to check such lists would
consist of $170.08 in internal time costs with no additional ongoing
external costs.\97\ Similarly, for the average cost of an RIA with 100
customers would be $8,504 in internal costs with no additional ongoing
annual external costs.\98\ These estimates are based on averages and do
not reflect the fact that costs will vary between investment advisers
for myriad reasons. In particular, ERA customers are limited to venture
capital funds and other private funds. These customers are exceedingly
unlikely to be placed on government lists, and so the costs of
compliance with this provision will be lower for ERAs or other types of
advisers that solely have funds as customers.
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\97\ Id. The PRA analysis in Table 1 estimates an average
internal cost of $85.04 per customer, so an ERA with two customers
would face an internal cost of 2 x 53.15 = $170.08.
\98\ Id. An RIA with 100 customers would face an internal cost
of 100 x 85.04 = $8,504.
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(d) Providing Notice to Customers
The proposed rule would require an investment adviser's CIP to
include procedures for providing their customers adequate notice that
the investment adviser is requesting information to verify their
identities. Notice would be considered adequate under the proposed rule
if the investment adviser generally describes the identification
requirements in the proposed rule and provides such notice in a manner
reasonably designed to ensure that a customer is able to view the
notice, or is otherwise given notice, before opening an account. For
example, if an account is opened electronically, such as through an
internet website, the investment adviser may provide notice
electronically. We estimate the average internal cost burden of an ERA
with two customers to provide notice to customers to be $17, with most
ERAs facing annual ongoing external costs of $23.36.\99\ Similarly, the
average internal
[[Page 44586]]
cost burden of an RIA with 100 customers would be $850, with most RIAs
facing additional ongoing annual external costs of $1,168.\100\ These
estimates are based on averages and do not reflect the fact that costs
will vary between investment advisers for myriad reasons.
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\99\ Id. The PRA analysis in Table 1 estimates an average
internal cost of $8.50 per customer, so an ERA with two customers
would face an internal cost of 2 x 8.50 = $17. It additionally
estimates that 75% of investment advisers would require an average
annual external burden of $11.68 per customer, so an ERA with two
customers would face an external cost of 2 x $11.68 = $23.36.
\100\ Id. An RIA with 100 customers would face an internal cost
of 100 x 8.50 = $850 and would likely face an annual external burden
of 100 x $11.68 = $1,168.
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(e) Recordkeeping
The proposed rule would require an investment adviser's CIP to
include procedures to make and retain records of customers' identifying
information for five years after the date of closing of the account and
records regarding the verification of a customer's identity for five
years after the record is made. We estimate that many of the records
required by the rule are already made and maintained by investment
advisers. As discussed above, investment advisers already obtain some
of the minimum identifying information specified in the proposed rule,
and this information is retained for use in firms' operations.\101\ We
estimate that the recordkeeping requirement could result in additional
costs for some investment advisers that currently do not maintain
certain of the records for the prescribed time period. We estimate that
the average cost to an ERA with two customers to make and maintain the
required records would be an internal cost burden of $106.30 with no
additional ongoing external costs.\102\ Similarly, the average internal
cost burden to an RIA with 100 customers would be $5,315, with no
additional annual external costs.\103\ These estimates are based on
averages and do not reflect the fact that costs will vary between
investment advisers for myriad reasons.
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\101\ See supra section IV.C.
\102\ The PRA analysis in Table 1, infra section V.B, estimates
an average internal cost of $53.15 per customer, so an ERA with two
customers would face an internal cost of 2 x 53.15 = $170.
\103\ Id. An RIA with 100 customers would face an internal cost
of 100 x 53.15 = $5,315.
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(f) Reliance on Another Financial Institution
The proposed rule allows an investment adviser to, under certain
circumstances, rely on another financial institution to perform any of
the procedures associated with the adviser's CIP. This provision would
generally lessen the direct compliance cost of the rule since it would
allow these procedures to be done by the party most efficiently
positioned to do so and would decrease the likelihood that multiple
parties will perform duplicative tasks to comply with regulations
affecting different entities. While there may be costs associated with
entering or modifying a contract with another financial institution to
ensure that the contract's terms have language required by this
provision, and there may be monitoring costs to ensure compliance,
investment advisers can generally choose to not rely on another
financial institution instead if those costs are greater than the cost
mitigation that comes from relying on said financial institution.
(g) Summary and Overall Costs
We recognize that the actual costs associated with establishing a
CIP will vary from the estimates above depending on the size of the
investment adviser, its lines of businesses, the relevant risks to be
addressed by the investment adviser's CIP, and the extent to which the
investment adviser's current practices would need to be modified to
comply with the requirements. We estimate that the average total cost
to an ERA with two customers to comply with the proposed rules would be
an internal cost burden of $1,675, with most ERAs facing total annual
ongoing external costs of $654.\104\ Similarly, the average total
internal cost for an RIA with 100 customers would be $26,468, with most
RIAs facing total ongoing annual external cost burdens of $4,088.\105\
We further estimate total aggregate industry costs of: $404,045,339 in
internal time costs and $ 48,446,970 in annual external time
costs.\106\
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\104\ This cost is the sum of the analogous costs listed in
sections IV.D.2.a through e.
\105\ See the PRA analysis in Table 1, infra section V.B.
\106\ Id.
---------------------------------------------------------------------------
We also recognize that these costs would not necessarily be borne
solely by investment advisers. Some of these costs could be passed on
to the funds and other customers managed by investment advisers. The
extent to which these costs would be passed on to customers depends on
the interplay of relevant market forces and thus is impossible to
predict with accuracy.
The proposed rule provides that the SEC, with the concurrence of
the Secretary, may by order or regulation exempt any investment adviser
or any type of account from the requirements of this section, or that
the Secretary, with the concurrence of the SEC, may exempt any
investment adviser or type of account. In issuing such exemptions, the
SEC and the Secretary will consider whether the exemption is consistent
with the purposes of the BSA, and in the public interest, and may
consider other necessary and appropriate factors. This could provide
another way to mitigate costs in unforeseen circumstances. For example,
if the SEC and the Secretary determine that it is not in the public
interest for certain types of accounts to be subject to the
requirements of the proposed rule, they may exempt these accounts.
Investment advisers would be required to develop and implement a
CIP that complies with the requirements of the proposed rule on or
before six months from the effective date of the regulation. Because
the overall development burdens are relatively low,\107\ we do not
believe that this timeline would impose additional costs beyond the
direct costs of compliance as quantified in the PRA.
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\107\ The PRA analysis in Table 1, infra section V.B, estimates
the total average cost of developing a CIP to be $1,753.
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E. Effects on Efficiency, Competition, and Capital Formation
We expect that the requirements would have minimal impact on
efficiency, competition, and capital formation. Relative to the size of
investment markets, the magnitude of assets that are intended to be
targeted are relatively small. Nasdaq estimates that $3.1 trillion in
illicit funds entered the global financial system in 2023.\108\ State
Street Global Advisors, by contrast, has estimated the global market
portfolio (the value of all investable capital assets) to be $179
trillion as of December 31, 2021.\109\ These estimates suggest that the
proposed rule could, at a maximum, impact 1.7 percent of global market
funds using an average investment holding period for illicit funds of
one year and making the extreme assumption that all illicit funds that
enter the global financial system do so through investment
advisers.\110\ The
[[Page 44587]]
actual impact is likely to be much lower because investment advisers do
not facilitate all funds in the global financial system, and the
average time of investment for funds used in money laundering is likely
to be shorter than one year.\111\ Further, the costs associated with
compliance are small enough relative to assets managed by investment
advisers so as not to have a significant impact on competition in the
investment adviser market.\112\
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\108\ See 2024 Global Financial Crime Report, Nasdaq (2024),
available at <a href="https://nd.nasdaq.com/rs/303-QKM-463/images/2024-Global-Financial-Crime-Report-Nasdaq-Verafin-20240115.pdf">https://nd.nasdaq.com/rs/303-QKM-463/images/2024-Global-Financial-Crime-Report-Nasdaq-Verafin-20240115.pdf</a>.
\109\ See Frederic Dodard and Amy Le, Global Market Portfolio:
Value of Investible Assets Touches All-Time High, State Street
Global Advisors (Feb. 2022), available at <a href="https://www.ssga.com/library-content/pdfs/global/global-market-portfolio-value-of-investable-assets-touch-all-time-high.pdf">https://www.ssga.com/library-content/pdfs/global/global-market-portfolio-value-of-investable-assets-touch-all-time-high.pdf</a>.
\110\ Since the estimate of $3.1 trillion entering the market is
a flow measure while the $179 trillion estimate of total asset value
is a stock measure, to compare the two, some assumption is needed
about the average duration for which investments remain in the
financial system. For example, if we were to assume an average
holding period of two years, then the estimate of the percentage of
global market funds impacted would double. Conversely, if we were to
assume an average holding period of six months, then that estimate
would halve.
\111\ While some money laundering, such as using private funds,
may be geared towards long time horizons, other illicit financial
activity likely has a shorter duration than one year. However, it is
possible that the rule could, over time, impact a larger percentage
of global financial market assets if these funds remain in the
market for more than one year, on average.
\112\ For example, we estimate (supra section IV.D.2.g) that the
median ERA would face a total burden of $2,327 (equal to the
internal burden of $1,675 plus the external burden of $654) and the
median RIA would face a total burden of $30,572 (equal to the
internal burden of $26,468 plus the external burden of $4,088).
Meanwhile, the average RIA has assets under management of roughly $8
billion and the average ERA has assets under management of roughly
$900 million.
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To the extent that the rule would be effective at preventing
illicit assets from entering financial markets--for example, if it
deters money launderers from attempting to do so or assists investment
advisers and law enforcement in discovering these activities--there may
be impacts on market efficiency. Specifically, those that engage in
money laundering or finance terrorism are likely to have incentives for
investment unrelated to the expected return or risk of the asset that
differ from the broader market. As a result, their investments change
the equilibrium of expected asset risks and returns from what would
exist in a market without these illicit funds. For example, money
launderers could have very different time horizons for investment and
thus could have different liquidity preferences, and so their
investments could drive up the premium for liquidity. They likely also
have a greater desire to keep their identity hidden and so may choose
assets based on this feature. To the extent that money launderers
invest based on preferences different from those of the broader market,
asset values could, as a result, be distorted relative to what would be
efficient for the broader market. Accordingly, it is possible that
removing those funds from financial markets would increase market
efficiency. The extent to which market efficiency would increase
depends on how different money launderers' investment preferences are
from those of other investors and how much capital would be effectively
prohibited from entering financial markets. We would generally expect
these effects to be small, however, given that the magnitude of assets
that are intended to be targeted are relatively small compared to the
size of investment markets, as discussed above.
Competition may decrease because of the additional compliance costs
associated with the proposed rule. However, the relatively small
magnitude of estimated costs of the proposed rule, as compared to total
assets under management of advisers, suggests that this effect is
unlikely to be significant.
The proposed rule is unlikely to have a significant effect on
capital formation. To the extent that investors choose to invest more
in financial markets because they believe that the proposed rule would
reduce the risk of investing by removing illicit funds from the market,
capital formation could increase.
F. Request for Comment
FinCEN and the SEC seek comment on all aspects of the economic
analysis of the proposed rule, including whether the analysis
accurately characterizes the costs and benefits of the minimum
requirements set forth by the proposed rule, and whether the specific
form of the requirements creates costs or benefits that are not
attributable to the statute. To the extent possible, we request that
commenters provide supporting data and analysis. In particular, we ask
commenters to consider the following questions:
(1) In section IV.B, we state that we do not know what percentage
of money laundering crimes sentenced involve investment advisers. Are
there sources of data that estimate this percentage? In what ways would
this figure be useful for assessing the benefits associated with the
proposed rule that is not achieved by the available Treasury analysis
of SAR reports?
(2) In section IV.C.1, we state that some investment advisers may
already check their customers' accounts against the SDN List. To what
extent do investment advisers currently check the SDN List and what
factors lead an investment adviser to do so?
(3) In sections IV.C.2 and IV.D.2., we state that investment
advisers already collect identifying information required under the
proposed rule, either because of contractual obligations or out of
operational considerations. Under what circumstances do investment
advisers not already collect or retain records of some or all of this
information?
(4) In section IV.D.1, we state that we do not have data that would
allow us to assess how much money laundering would be reduced as a
result of the proposed rule, or how much other illegal activity would
be curbed by this reduction in money laundering. What, if any, data
exists regarding this activity
(5) In section IV.D.2, we state that some investment advisers may
already bear some of the costs of this rule as a result of similar
extant requirements on other financial institutions. Is this assumption
correct, and if so, how prevalent is this practice?
(6) In Section IV.D.2, we state that allowing an investment adviser
to, under certain circumstances, rely on another financial institution
to perform any of the procedures associated with the adviser's CIP
would generally lessen the direct compliance cost of the rule. To what
extent is any anticipated reduction of costs likely to occur,
considering the costs of relying on such institutions?
(7) To what extent do investment advisers currently rely on third-
party service providers to perform functions related to AML/CFT
responsibilities, particularly those associated with a CIP? Would the
proposed rule increase or decrease investment advisers' reliance on
third-party service providers to perform these functions? If the
proposed rule increased investment advisers' reliance on third-party
service providers to perform these functions, what additional costs
would result?
(8) In places where the costs of the proposed rule are estimated,
are these estimates reasonable? Are there any data that could inform
the cost estimates of complying with any provisions of the proposed
rule? To what extent are there important determinants of costs that
could vary between investment advisers that we have not considered in
this analysis?
(9) In section IV.G, we discuss the possibility of requiring the
Legal Entity Identifier (``LEI'') as the identifier for non-natural
person customers. Should the final rule require advisers to use the LEI
as the identifier for such customers?
(10) If the adviser knows or has reason to know a customer's assets
are maintained at a financial institution that performs CIP
requirements because the financial institution is subject to BSA
obligations, what would be the benefits and costs of an adviser being
required to comply with the proposed rule?
[[Page 44588]]
G. Reasonable Alternatives
1. Requiring the Use of Legal Entity Identifier (``LEI'') as the
Identifier for Legal Entities Other Than Natural Persons
The proposed rule allows various forms of identification for non-
natural person customers. We considered whether investment advisers
should be required to use the LEI or some other uniform standard as the
identifier for such customers.
The LEI is an identification number based on the International
Organization for Standardization (``ISO'') 17442-1 standard that
uniquely identifies a legal entity.\113\ It can facilitate the
automatic processing of financial transactions and is used in financial
regulatory reporting. For example, the SEC requires an adviser to
provide an LEI, if it has one, on Item 1.P on Form ADV.\114\
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\113\ See ISO 17442: The Global Standard, available at <a href="https://www.gleif.org/en/about-lei/iso-17442-the-lei-code-structure">https://www.gleif.org/en/about-lei/iso-17442-the-lei-code-structure</a>.
\114\ See Rules Implementing Amendments to the Investment
Advisers Act of 1940, 76 FR 42950 (July 19, 2011).
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Using the LEI would assist investment advisers and enforcement
agencies in detecting money laundering more effectively than using a
broad array of identifiers because of its uniformity and relative ease
of analysis (e.g., minimizing any need to map disparate jurisdictional
identifiers), though this may be mitigated by the proposed rule's scope
which is limited to the direct customers of an adviser and not its
beneficial owners. However, this is balanced against the flexibility
provided to investment advisers to comply with the rule's requirements.
Further, since natural persons could not use this identifier, rule
compliance would already necessitate collecting different types of
identifiers for these individuals. Moreover, omitting an LEI
requirement from the proposed rule would be consistent with the
existing rules for broker-dealers and mutual funds, and notwithstanding
the absence of an LEI requirement, customers could still provide their
LEIs to help advisers satisfy their obligations under the proposed
rule. Finally, because legal names and associated LEIs are publicly
available, bad actors could use such information to impersonate
legitimate entities in their submissions to an investment adviser's CIP
and reduce the reliability of the LEI as an identification tool.
2. Exceptions for Customers That Do Not Use Investment Advisers To
Access Financial Markets
The proposed rule would require an investment adviser's CIP to
apply to all types of accounts,\115\ though the adviser may consider
the type of account in determining what procedures are appropriate. We
considered whether accounts of customers that do not use the investment
adviser to access financial markets, such as those that only receive
investment research services, should be excluded from the definition of
account.
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\115\ Under certain circumstances, the requirements can be
deemed satisfied for mutual fund customers.
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The benefits of the rule related to such accounts are lower than
for other accounts because the benefits relating to protecting
financial markets do not directly apply. However, other benefits
discussed above, including those relating to identifying criminal
activity and preventing illicit proceeds from being legitimized still
apply. Further, criminal networks could still use investment adviser
products to inform their investment decisions or use investment
advisers as ways of appearing legitimate to broker-dealers or other
financial institutions. For example, criminals could potentially gain
information on how to place or layer illicit funds, even if the
investment adviser is not actually doing the placing or layering. An
investment adviser's CIP must assess the relevant risks and enact
procedures that take account of these risks.
Excluding or otherwise excepting these accounts would eliminate the
benefits of the rule for these accounts, but could also reduce the
costs of compliance with the rule, if the costs of differentiating
these accounts are not higher than the costs of complying with the rule
for these accounts. However, we do not believe that these cost savings
would be large because: (1) the cost per account of the rule is
relatively low; (2) to the extent that these accounts create less risk
than do other types of accounts, the compliance cost of these accounts
under the proposed rule could be even lower than for other accounts if
investment advisers enact procedures with lower costs than those they
would establish for riskier types of accounts; and (3) differentiating
these accounts may be relatively costly, as investment advisers would
need to create new systems to identify which customers only have
accounts that would fit the exclusion.
V. Paperwork Reduction Act
A. Introduction
Certain provisions of the proposed rule contain ``collection of
information'' requirements within the meaning of the Paperwork
Reduction Act of 1995 (``PRA'').\116\ The proposed rule would include
new information collection burdens. The title of new collection of
information we are proposing is ``Amendment to 31 CFR part 1032 under
the USA PATRIOT Act.'' OMB has not yet assigned a control number for
this title. We are submitting the proposed collections of information
to the Office of Management and Budget (``OMB'') for review in
accordance with the PRA.\117\ An agency may not conduct or sponsor, and
a person is not required to respond to, a collection of information
unless it displays a currently valid OMB control number. We discuss
below the collection of information burdens associated with the
proposal.
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\116\ 44 U.S.C. 3501.
\117\ 44 U.S.C. 3507(d); 5 CFR 1320.11.
\118\ FinCEN, Anti-Money Laundering/Countering the Financing of
Terrorism Program and Suspicious Activity Report Filing Requirements
for Registered Investment Advisers and Exempt Reporting Advisers, 89
FR 12108 (proposed Feb. 15, 2024).
\119\ 31 U.S.C. 5318(l).
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B. Proposed Rule
If FinCEN's proposed AML/CFT Program and SAR Proposed Rule \118\ is
adopted, section 326 of the USA PATRIOT ACT would require Treasury and
the Commission to prescribe regulations setting forth minimum standards
for investment advisers regarding the identities of customers when they
open an account. Section 326 also provides that the regulations issued
by Treasury and the Commission must, at a minimum, require investment
advisers to implement reasonable procedures for: (1) verification of
the identity of any person seeking to open an account, to the extent
reasonable and practicable; (2) maintenance of the information used to
verify the person's identity, including name, address, and other
identifying information; and (3) determination of whether the person
appears on any lists of known or suspected terrorists or terrorist
organizations issued by any government agency.\119\ These requirements
are referred to as Customer Identification Program (``CIP'')
regulations and are long-standing, foundational components of the
United States' AML/CFT regime. Under this proposed rule, the CIP must
be based on the investment adviser's assessment of the relevant risks,
including, at a minimum, those presented by the various types of
[[Page 44589]]
accounts maintained by the investment adviser, the various methods of
opening accounts provided by the investment adviser, the various types
of identifying information available and the investment adviser's size,
location, and customer base.\120\
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\120\ Proposed 31 CFR 1032.220(a)(2).
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Under this proposed rule, an investment adviser would be required
to retain (1) the identifying information obtained from a customer
while the customer's account remains open and for five years after the
date the account is closed and (2) the records pertaining to the
verification of a customer's identity for five years after the record
is made.\121\ Each requirement to disclose information, offer to
provide information, or adopt policies and procedures constitutes a
``collection of information'' requirement under the PRA.\122\ The
respondents to these collection of information requirements would be
RIAs and ERAs. As of October 5, 2023, there were approximately 14,914
RIAs and approximately 5,546 ERAs.\123\ This collection of information
is found at 31 CFR 1032.220 and is mandatory. All RIAs and ERAs would
be subject to the requirements of the proposed rule. Responses provided
to the Commission in the context of its examination and oversight
program concerning the proposed rule would be kept confidential subject
to the provisions of applicable law.
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\121\ Proposed 31 CFR 1032.220(a)(3)(ii).
\122\ See 44 U.S.C. 3502(3).
\123\ The number of RIAs is an estimate of all RIAs with at
least one client based on responses to Item 5.D of Form ADV, as of
Oct. 5, 2023. The number of ERAs is an estimate of all ERAs with at
least one client based on responses to Item 2.B of Form ADV, as of
Oct. 5, 2023.
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Investment adviser implementation of CIPs and reasonable procedures
related thereto under this proposed rule would make it easier to
prevent, detect, and prosecute money laundering and the financing of
terrorism by (i) specifying the information investment advisers must
obtain from or about customers that can be used to verify the identity
of the customers, (ii) requiring investment advisers to maintain and
retain records of the information used to verify the customer's
identity, and (iii) requiring investment advisers to determine whether
the customer appears on any lists of known or suspected terrorists or
terrorist organizations provided by any Federal government agency and
designated as such by Treasury in consultation with the Federal
functional regulators. This would make it more difficult for persons to
use false identities to establish customer relationships with
investment advisers for the purposes of laundering money or moving
funds to effectuate illegal activities, such as financing terrorism.
We have made certain estimates of the burdens associated with the
proposed rule solely for the purpose of this PRA analysis. The table
below summarizes the initial and ongoing annual burden and cost
estimates associated with the proposed rule.
BILLING CODE 4810-02-P
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[GRAPHIC] [TIFF OMITTED] TN21MY24.004
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[GRAPHIC] [TIFF OMITTED] TN21MY24.005
BILLING CODE 4810-02-C
C. Request for Comment
We request comment on whether these estimates are reasonable.
Pursuant to 44 U.S.C. 3506(c)(2)(B), FinCEN and the Commission solicit
comments in order to: (1) evaluate whether the proposed collection of
information is necessary for the proper performance of the functions of
the Commission, including whether the information will have practical
utility; (2) evaluate the accuracy of FinCEN and the Commission's
estimate of the burden of the proposed collection of information,
including whether the estimates are too high or too low; whether the
median number of clients is an appropriate figure to use; whether
certain costs, such as verification costs, should be
[[Page 44592]]
lower for certain customers (such as private funds if the adviser forms
the private fund) and higher for other types of customers (such as in
separately managed account relationships); (3) determine whether there
are ways to enhance the quality, utility, and clarity of the
information to be collected; and (4) determine whether there are ways
to minimize the burden of the collection of information on those who
are to respond, including through the use of automated collection
techniques or other forms of information technology.
Persons wishing to submit comments on the collection of information
requirements of the proposed rule should direct them to the OMB Desk
Officer for the Securities and Exchange Commission,
<a href="/cdn-cgi/l/email-protection#571a150f79181a1579181e051679041214083332243c083831313e34322517383a357932382779303821"><span class="__cf_email__" data-cfemail="400d02186e0f0d026e0f0912016e1305031f2425332b1f2f262629232532002f2d226e252f306e272f36">[email protected]</span></a>, and should send a copy to
Vanessa A. Countryman, Secretary, Securities and Exchange Commission,
100 F Street NE, Washington, DC 20549-1090, with reference to File No.
S7-2024-02. OMB is required to make a decision concerning the
collections of information between 30 and 60 days after publication of
this release; therefore, a comment to OMB is best assured of having its
full effect if OMB receives it within 30 days after publication of this
release. Requests for materials submitted to OMB by the Commission with
regard to these collections of information should be in writing, refer
to File No. S7-2024-02, and be submitted to the Securities and Exchange
Commission, Office of FOIA Services, 100 F Street NE, Washington, DC
20549-2736.
VI. Regulatory Flexibility Act
The SEC and FinCEN have prepared the following Initial Regulatory
Flexibility Analysis (``IRFA'') in accordance with section 3(a) of the
Regulatory Flexibility Act (``RFA'').\124\ It relates to the proposed
rule that would amend 31 CFR part 1032 and be issued pursuant to
section 326 of the USA PATRIOT Act as amended and codified at 31 U.S.C.
5318(l).\125\
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\124\ 5 U.S.C. 603(a).
\125\ 31 U.S.C. 5318 is part of the BSA.
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A. Reason for and Objectives of the Proposed Rule
The reasons for, and objectives of, the proposed rule are discussed
in more detail in sections I and II, above. The burdens of these
requirements on small advisers are discussed below as well as above in
sections IV and V, which discuss the burdens on all advisers subject to
the proposed rule. Sections II through V also discuss the professional
skills that compliance with the proposed rule would require.
If FinCEN's proposed AML/CFT Program and SAR Proposed Rule \126\ is
adopted, section 326 of the USA PATRIOT Act requires Treasury and the
Commission to prescribe regulations setting forth minimum standards for
investment advisers regarding the identities of customers when they
open an account. The statute also would provide that the regulations
issued by Treasury and the Commission must, at a minimum, require
investment advisers to implement reasonable procedures for: (1)
verification of the identity of any person seeking to open an account,
to the extent reasonable and practicable; (2) maintenance of the
information used to verify the person's identity, including name,
address, and other identifying information; and (3) determination of
whether the person appears on any lists of known or suspected
terrorists or terrorist organizations issued by any government
agency.\127\ The objective of the proposed rule is to make it easier to
prevent, detect and prosecute money laundering and the financing of
terrorism. The proposed rule seeks to achieve this goal by requiring
investment advisers to establish a CIP with procedures that include
obtaining identifying information from customers that can be used to
verify the identity of the customers. This will make it more difficult
for persons to use false identities to establish customer relationships
with investment advisers for the purposes of laundering money or moving
funds to effectuate illegal activities, such as financing terrorism.
The proposed rule is designed to align the requirements for investment
advisers with existing rules for other financial institutions, such as
broker-dealers, mutual funds, credit unions, banks, and others, to
adopt and implement CIPs.
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\126\ FinCEN, Anti-Money Laundering/Countering the Financing of
Terrorism Program and Suspicious Activity Report Filing Requirements
for Registered Investment Advisers and Exempt Reporting Advisers, 89
FR 12108 (proposed Feb. 15, 2024).
\127\ 31 U.S.C. 5318(l).
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We are also proposing to revise 31 CFR 1032.100 to provide numerous
definitions for purposes of proposed 31 CFR 1032.220. This aspect of
the proposed rule has no independent substantive requirements or
economic impacts.
B. Legal Basis
The proposed rule is being promulgated pursuant to the BSA, which
mandates that FinCEN and the Commission issue a regulation setting
forth minimum standards for financial institutions and their customers
regarding the identity of the customer that shall apply in connection
with opening of an account at the financial institution.\128\
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\128\ 31 U.S.C. 5318(l)(4).
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C. Small Entities Subject to the Proposed Rule
The proposed rule would affect investment advisers that are small
entities. Under Commission rules, for the purposes of the RFA, an
investment adviser generally is a small entity if it: (1) has, and
reports on Form ADV, assets under management having a total value of
less than $25 million; (2) did not have total assets of $5 million or
more on the last day of the most recent fiscal year; and (3) does not
control, is not controlled by, and is not under common control with
another investment adviser that has assets under management of $25
million or more, or any person (other than a natural person) that had
total assets of $5 million or more on the last day of its most recent
fiscal year (``small adviser'').\129\ The proposed rule would not
affect most small advisers, because generally small advisers are
registered with one or more state securities authorities and not with
the Commission pursuant to section 203A of the Advisers Act. As a
result of section 203A, most small advisers are prohibited from
registering with the Commission because an investment adviser generally
must have more than $25 million of assets under management or be an
adviser to a registered investment company.\130\ Based on data from the
Investment Adviser Registration Depository system (``IARD''), we
estimate that as of October 5, 2023, approximately 276 RIAs and 113
ERAs are small entities under the RFA.\131\ As discussed above in
section
[[Page 44593]]
IV, FinCEN and the Commission estimate that based on IARD data as of
October 5, 2023, approximately 14,914 RIAs and approximately 5,546
ERAs, including all of the approximately 276 RIAs and 113 ERAs that are
small entities under the RFA, would be subject to the proposed rule.
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\129\ Advisers Act rule 0-7(a) (17 CFR 275.0-7).
\130\ 15 U.S.C. 80b-3.
\131\ Based on SEC-registered investment adviser responses to
Items 5.F. and 12 of Form ADV. We do not have direct data that
indicates how many exempt reporting advisers are small entities
under the RFA because exempt reporting advisers are not required to
report regulatory assets under management on Form ADV. We estimate
that, due to SEC registration thresholds, the only small entity
exempt reporting advisers that would be subject to the proposed rule
would be those that maintain their principal office and place of
business outside the United States. We do not have fulsome direct
data indicating which exempt reporting advisers that maintain their
principal office and place of business outside the United States are
small entities, because although exempt reporting advisers are
required to report in Part 1A, Schedule D the gross asset value of
each private fund they manage, advisers with their principal office
and place of business outside the United States may have additional
assets under management other than what they report in Schedule D.
Therefore, to estimate how many of the exempt reporting advisers
that maintain their principal office and place of business outside
the United States could be small entities, we use a calculation from
a comparable data set: SEC-registered investment advisers. According
to Form ADV data as of Oct. 5, 2023, there are 48 small entity SEC-
registered investment advisers with their principal office and place
of business outside the United States and 797 total registered
investment advisers with their principal office and place of
business outside the United States (48 divided by 797 = 6%). There
are approximately 1,868 exempt reporting advisers with their
principal office and place of business outside the U.S. As a result,
we estimate that the same percentage (6%) of those advisers are
small entities, which equals approximately 113 exempt reporting
advisers.
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D. Projected Reporting, Recordkeeping, and Other Compliance
Requirements
The proposed rule would impose certain notification and compliance
requirements on investment advisers, including those that are small
entities. All RIAs and ERAs, including small entity advisers, would be
required to comply with the proposed rule's CIP requirements, which are
summarized in this IRFA. All of these requirements are also discussed
in detail, above, in sections I and II, and these requirements and the
burdens on respondents, including those that are small entities, are
discussed above in sections IV and V and below. The professional skills
required to meet these specific burdens are also discussed in sections
II through V.
There are different factors that would affect whether a smaller
adviser incurs costs relating to these requirements that are higher or
lower than the estimates discussed in section V. For example, we would
expect that smaller advisers may not already have CIP programs, or they
may not already have CIP programs that meet certain of the elements
that would be required under the proposed rule. Also, while we would
expect larger advisers to incur higher costs related to this proposed
rule in absolute terms relative to a smaller adviser, we would expect a
smaller adviser to find it more costly, per dollar managed, to comply
with the requirements because it would not be able to benefit from a
larger adviser's economies of scale.
As discussed above, there are approximately 276 RIAs and 113 ERAs
that are small entities, and we estimate that 100 percent of these are
subject to the proposed rule. As discussed above in section V, the
proposed rule, which would require advisers to, among other things,
adopt and implement procedures to verify the identity of any customer,
would create a new annual burden of approximately 249 hours per RIA and
15.76 hours per ERA, or 70,504.88 hours in aggregate for small advisers
(1,780.88 hours for ERAs and 68,724 hours for RIAs). We therefore would
expect the annual monetized aggregate cost to small advisers associated
with the proposed rule to be approximately $7,494,668.74 ($7,305,361.20
for RIAs and $189,307.54 for ERAs).\132\
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\132\ Internal time costs calculated as follows: 68,724 hours
for RIAs x $106.30 plus 1,780.88 hours for ERAs x $106.30. The
estimated annual external cost burden for small advisers would be:
$1,502,567.76, assuming 75% of these advisers will use outside legal
services for these collections of information.
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E. Duplicative, Overlapping, or Conflicting Federal Rules
Investment advisers generally do not have obligations under the BSA
specifically for customer identification programs.\133\ As a result, we
have not identified any federal rules that would duplicate, overlap, or
conflict with the proposed rule. If FinCEN's proposed AML/CFT Program
and SAR Proposed Rule \134\ is adopted, section 326 of the USA PATRIOT
Act requires Treasury and the Commission to prescribe regulations
setting forth minimum standards for investment advisers regarding the
identities of customers when they open an account. This congressional
directive cannot be followed absent the issuance of a new rule.
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\133\ As mentioned above, investment advisers that are banks (or
bank subsidiaries) subject to the jurisdiction of the FFIRAs are
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).
\134\ FinCEN, Money Laundering/Countering the Financing of
Terrorism Program and Suspicious Activity Report Filing Requirements
for Registered Investment Advisers and Exempt Reporting Advisers, 89
FR 12108 (proposed Feb. 15, 2024).
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F. Significant Alternatives
The RFA directs FinCEN and the Commission to consider significant
alternatives that would accomplish our stated objective, while
minimizing any significant economic effect on small entities. We
considered the following alternatives for small entities in relation to
the proposed rule: (1) exempting advisers that are small entities from
all or part of the proposed rule; (2) establishing different
requirements, to account for resources available to small entities; (3)
clarifying, consolidating, or simplifying the compliance requirements
under the proposed rule for small entities; and (4) using design rather
than performance standards.
Regarding the first and second alternatives, FinCEN and the SEC
currently believe that establishing different requirements for small
advisers, or exempting small advisers from the proposed rule, or any
part thereof, would likely be inappropriate under these circumstances.
Moreover, FinCEN and the Commission do not believe that those
alternatives are appropriate given the flexibility built into the rule
to account for, among other things, the differing sizes and resources
of advisers, as well as the importance of the statutory goals and
mandate of section 326. As discussed above, implementation of CIPs and
reasonable procedures related thereto under this proposed rule is
intended to assist in preventing, detecting, and prosecuting money
laundering and the financing of terrorism by specifying the information
investment advisers must obtain from or about customers that can be
used to verify the identity of the customers. We assess that this
proposed rule would make it more difficult for persons to use false
identities to establish customer relationships with investment advisers
for the purposes of laundering money or moving funds to effectuate
illegal activities, such as financing terrorism. Establishing different
conditions for large and small advisers even though advisers of every
type and size must open accounts for customers would negate these
benefits.
Regarding the third alternative, we believe the rule as proposed is
clear and that further clarification, consolidation, or simplification
of the compliance requirements is not necessary. As discussed above,
the proposed rule would require advisers to, among other things, adopt
and implement procedures to verify the identity of any customer, to the
extent reasonable and practicable; maintain and retain records of the
information used to verify the customer's identity; and determine
whether the customer appears on any lists of known or suspected
terrorists or terrorist organizations provided by any Federal
government agency.\135\ The proposed rule would serve as an explicit
requirement for firms to adopt and implement a comprehensive CIP.
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\135\ See proposed 31 CFR 1032.220. See also supra section II.
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Regarding the fourth alternative, we determined to use performance
standards rather than design standards. Performance standards allow for
increased flexibility in the methods firms can use to achieve the
objectives of the requirements. Design standards
[[Page 44594]]
specify the behavior or manner of compliance that regulated entities
must adopt. Although the proposed rule would require policies and
procedures that are reasonably designed to address a certain number of
elements, we do not place certain conditions or restrictions on how to
adopt and implement such policies and procedures. The general elements
are designed to enumerate core areas that advisers must address when
adopting and implementing a CIP. As discussed above, given the number
and varying characteristics of advisers, firms would need the ability
to design their CIPs in a manner appropriate for their size and
business. The proposed rule therefore would allow advisers to address
the general elements based on the types of accounts they maintain, the
various methods of opening accounts, and the types of identifying
information that are available. The proposed rule would also provide
flexibility for advisers to determine the personnel who would implement
and oversee the effectiveness of their CIPs.
G. Solicitation of Comments
FinCEN and the Commission encourage written comments on the matters
discussed in this IRFA. We solicit comment on the number of small
entities subject to the proposed rule. We also solicit comment on the
potential effects discussed in this analysis; and whether this proposal
could have an effect on small entities that has not been considered. We
request that commenters describe the nature of any effect on small
entities and provide empirical data to support the extent of such
effect.
VII. Considerations of the Impact on the Economy
For purposes of the Small Business Regulatory Enforcement Fairness
Act of 1996, or ``SBREFA,'' \136\ we must advise OMB whether a proposed
regulation constitutes a ``major'' rule. Under SBREFA, a rule is
considered ``major'' where, if adopted, it results in or is likely to
result in (1) an annual effect on the economy of $100 million or more;
(2) a major increase in costs or prices for consumers or individual
industries; or (3) significant adverse effects on competition,
investment, or innovation. We request comment on whether this proposal
would be a ``major rule'' for purposes of the SBREFA. We also request
comment on the potential effect of the proposed rule on the U.S.
economy on an annual basis; any potential increase in costs or prices
for consumers or individual industries; and any potential effect on
competition, investment, or innovation. Commenters are requested to
provide empirical data and other factual support for their views to the
extent possible.
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\136\ Public Law 104-121, tit. II, 110 Stat. 857 (1996)
(codified in various sections of 5 U.S.C., 15 U.S.C. and as a note
to 5 U.S.C. 601).
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VIII. FinCEN's Regulatory Impact Analysis
Executive Orders 12866, 13563, and 14094 (that is, E.O. 12866 and
its amendments) direct agencies to assess the costs and benefits of
available regulatory alternatives and, if regulation is necessary, to
select regulatory approaches that maximize net benefits (including
potential economic, environmental, and public health and safety
effects; distributive impacts; and equity).\137\ E.O. 13563 emphasizes
the importance of quantifying both costs and benefits, reducing costs,
harmonizing rules, and promoting flexibility. E.O. 13563 also
recognizes that some benefits are difficult to quantify and provides
that, where appropriate and permitted by law, agencies may consider and
discuss qualitatively values that are difficult or impossible to
quantify.\138\
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\137\ The SEC was not required to perform a regulatory impact
analysis.
\138\ Executive Order 13563, 76 FR 3821 (Jan. 21, 2011), section
1(c) (``Where appropriate and permitted by law, each agency may
consider (and discuss qualitatively) values that are difficult or
impossible to quantify, including equity human dignity, fairness,
and distributive impacts, and distributive impacts.'').
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FinCEN has designated this proposed rule a ``significant regulatory
action;'' accordingly, it has been reviewed by the Office of Management
and Budget (``OMB'').
FinCEN believes that the primary costs of complying with the
proposed rule are considered in the Analysis of the Costs and Benefits
Associated with the Proposed Rule described in detail in section IV and
the Paperwork Reduction Act (44 U.S.C. 3507(d)) burden estimates
described in detail in section V, which amount to a new annual
aggregate burden (RIAs and ERAs) of 3,800,990 hours with
$404,045,339.05 in internal time costs, and $48,446,969.76 in estimated
total new annual external cost burden.
As discussed above in sections IV and V, benefits of this proposed
rule are expected to include reduced money laundering and terrorist
financing occurring through the U.S. financial system. Overall, the
proposed rule would benefit law enforcement by improving their ability
to investigate, prosecute and disrupt the financing of international
terrorism and other priority transnational security threats, as well as
other types of transnational financial crime. Obtaining and verifying
the identity of account holders or responding to circumstances in which
the investment adviser cannot form a reasonable belief that it knows
the true identity of a customer would reduce the risk of terrorists and
other criminals accessing U.S. financial markets to launder money,
finance terrorism, or move funds for other illicit purposes. The
proposed rule would also help investment advisers to identify and
prevent criminal activity including by allowing investment advisers to
identify high risk customers. While it is difficult to estimate the
economic losses that would be prevented by reducing money laundering
and other financial crimes through this rule, the prevention of such
crimes would reduce the monetary and nonmonetary harms they cause.
As an alternative to the proposed rule, as discussed in section IV,
FinCEN considered requiring investment advisers use the LEI or some
other uniform standard as the identifier for such customers. While
using the LEI would assist investment advisers and law enforcement
agencies to detect money laundering than using a number of identifiers,
the proposed rule's application to direct customers rather than
beneficial owners limits the benefit of using LEIs. Further, natural
persons could not use this identifier, meaning compliance with the
proposed rule would require the collection of different types of
identifiers.
Regarding costs, as noted above in sections IV and V, in accordance
with section 326 of the USA PATRIOT ACT, the proposed rule would
require an investment adviser to establish and implement its CIP
according to its specific circumstances and do not set inflexible
requirements for all advisers. Further, the proposed requirements are
similar to those for other financial institutions with which investment
advisers engage; complying with the proposed rule may therefore create
minimal additional costs in certain lines of business. Some RIAs and
ERAs may have reduced costs because they may already perform certain
AML/CFT functions because they are dual registrants or affiliated with
a bank or broker-dealer. Finally, per the analysis above in sections IV
and V, investment advisers may deem the requirements of the proposed
rule with respect to its business relationship with a mutual fund to be
satisfied if the customer (i.e., the mutual fund that it advises) has
developed and implemented a CIP that is compliant with the investment
company's CIP requirements.
[[Page 44595]]
The costs incurred by the proposed rule would arise through the
following requirements: establishing a CIP; obtaining and verifying
identifying information; determining whether customers appear on a
federal government list; providing notice to customers; recordkeeping;
and reliance on another financial institution. Overall, FinCEN
estimates that the average total cost to an ERA with two customers to
comply with the proposed rules would be an internal cost burden of
$1,675, with most ERAs facing total annual ongoing external costs of
$654, while the average total internal cost for an RIA with 100
customers would be $26,468, with most RIAs facing total ongoing annual
external cost burdens of $4,088.
Given the analysis included in the preceding sections, FinCEN
believes that the benefits of this rule would exceed the costs.
IX. FinCEN's Unfunded Mandates Reform Act Determination
FinCEN has analyzed the rule under the factors set forth in the
Unfunded Mandates Reform Act (``UMRA'') (section 202(a)). Under this
analysis, FinCEN considered whether the proposed rule includes any
Federal mandate that may result in the expenditure by State, local, and
tribal governments, in the aggregate, or by the private sector, of
$100,000,000 or more (adjusted annually for inflation) in any 1 year.''
\139\ The current threshold after adjustment for inflation is $176
million, using the 2022 GDP price deflator. The proposed rule would
result in an expenditure in at least one year that meets or exceeds
this amount.
---------------------------------------------------------------------------
\139\ 2 U.S.C. 1532(a).
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FinCEN further estimates total aggregate industry costs of:
$404,045,339.05 in internal time costs and $48,446,969.76 in annual
external time costs.\140\ The proposed rule does not foreseeably impose
costs or other compliance burden that would impact any State, local, or
Tribal government. FinCEN believes that the cost benefit analysis in
section IV. Analysis of the Costs and Benefits Associated with the
Proposed Rule, provides the analysis required by UMRA.
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\140\ See the PRA analysis in Table 1, infra section V.B.
---------------------------------------------------------------------------
Authority and Issuance
For the reasons set forth in the preamble, FinCEN and the SEC
propose to add part 1032 to chapter X in title 31 of the Code of
Federal Regulations to read as follows:
PART 1032--RULES FOR INVESTMENT ADVISERS
Subpart A--General
Sec.
1032.100 Definitions
1032.101-1032.199 [Reserved]
Subpart B--Programs
1032.220 Customer identification programs for registered investment
advisers and exempt reporting advisers.
Authority: 12 U.S.C. 1829b and 1951-1959; 31 U.S.C. 5311-5314
and 5316-5336; title III, sec. 314, Pub. L. 107-56, 115 Stat. 307.
Subpart A--General
Sec. 1032.100 Definitions.
Refer to Sec. 1010.100 of this chapter for general definitions not
noted herein. To the extent there is a differing definition in Sec.
1010.100, the definition in this section is what applies to part 1032.
Unless otherwise indicated, for purposes of this part:
(a) Account. For purposes of Sec. 1032.220:
(1) Account means any contractual or other business relationship
between a person and an investment adviser under which the investment
adviser provides investment advisory services.
(2) Account does not include:
(i) An account that the investment adviser acquires through any
acquisition, merger, purchase of assets, or assumption of liabilities.
(ii) [Reserved]
(b) Commission means the United States Securities and Exchange
Commission.
(c) Customer. For purposes of Sec. 1032.220:
(1) Customer means:
(i) A person that opens a new account; and
(ii) An individual who opens a new account for:
(A) An individual who lacks legal capacity, such as a minor; or
(B) An entity that is not a legal person, such as a civic club.
(2) Customer does not include:
(i) A financial institution regulated by a Federal functional
regulator or a bank regulated by a State bank regulator;
(ii) A person described in Sec. 1020.315(b)(2) through (4) of this
chapter; or
(iii) A person that has an existing account with the investment
adviser, provided the investment adviser has a reasonable belief that
it knows the true identity of the person.
(d) Financial institution is defined at 31 U.S.C. 5312(a)(2) and
(c)(1) and its implementing regulation in Chapter X of Title 31.
(e) Investment adviser. Any person who is registered or required to
register with the Commission under section 203 of the Investment
Advisers Act of 1940 (15 U.S.C. 80b-3(a)), or any person that is exempt
from Commission registration under sections 203(l) or 203(m) of the
Investment Advisers Act of 1940 (15 U.S.C. 80b-3(l), (m)).
Subpart B--Programs
Sec. 1032.220 Customer identification programs for registered
investment advisers and exempt reporting advisers.
(a) Customer identification program: minimum requirements--(1) In
general. An investment adviser must establish, document, and maintain a
written customer identification program (``CIP'') appropriate for its
size and business that, at a minimum, includes each of the requirements
of paragraphs (a)(1) through (5) of this section. The CIP must be a
part of the investment adviser's anti-money laundering/countering the
financing of terrorism compliance program required under the
regulations implementing 31 U.S.C. 5318(h). The investment adviser may
deem these requirements satisfied for any mutual fund (as defined in 31
CFR 1010.100(gg)) it advises that has developed and implemented a CIP
compliant with the CIP requirements applicable to mutual funds under
another provision of this subpart.
(2) Identity verification procedures. The CIP must include risk-
based procedures for verifying the identity of each customer to the
extent reasonable and practicable. The procedures must enable the
investment adviser to form a reasonable belief that it knows the true
identity of each customer. The procedures must be based on the
investment adviser's assessment of the relevant risks, including those
presented by the various types of accounts maintained by the investment
adviser, the various methods of opening accounts provided by the
investment adviser, the various types of identifying information
available and the investment adviser's size, location, and customer
base. At a minimum, these procedures must contain the elements
described in this paragraph (a)(2).
(i) Customer information required--(A) In general. The CIP must
contain procedures for opening an account that specify the identifying
information that will be obtained with respect to each customer. Except
as permitted by paragraphs (a)(2)(i)(B) and (C) of this section, the
investment adviser must obtain, at a minimum, the following information
prior to opening an account:
[[Page 44596]]
(1) Name;
(2) Date of birth, for an individual; or date of formation, for a
person that is not an individual.
(3) Address, which shall be
(i) For an individual, a residential or business street address;
(ii) For an individual who does not have a residential or business
street address, an Army Post Office (APO) or Fleet Post Office (FPO)
box number, or the residential or business street address of next of
kin or of another contact individual; or
(iii) For a person other than an individual (such as a corporation,
partnership, or trust), a principal place of business, local office, or
other physical location; and
(4) Identification number, which shall be:
(i) For a U.S. person, a taxpayer identification number; or
(ii) For a non-U.S. person, one or more of the following: a
taxpayer identification number; passport number and country of
issuance; alien identification card number; or number and country of
issuance of any other government-issued document evidencing nationality
or residence and bearing a photograph or similar safeguard. For a non-
U.S. person that is not an individual and that does not have an
identification number, the investment adviser must request alternative
government-issued documentation certifying the existence of the person.
(B) Exception for persons applying for a taxpayer identification
number. Instead of obtaining a taxpayer identification number from a
customer prior to opening an account, the CIP may include procedures
for opening an account for a person that has applied for, but has not
received, a taxpayer identification number. In this case, the CIP must
include procedures to confirm that the application was filed before the
person opens the account and to obtain the taxpayer identification
number within a reasonable period of time after the account is opened.
(ii) Customer verification. The CIP must contain procedures for
verifying the identity of each customer, using information obtained in
accordance with paragraph (a)(2)(i) of this section, within a
reasonable time before or after the customer's account is opened. The
procedures must describe when the investment adviser will use
documents, non-documentary methods, or a combination of both methods,
as described in this paragraph (a)(2)(ii).
(A) Verification through documents. For an investment adviser
relying on documents, the CIP must contain procedures that set forth
the documents the investment adviser will use. These documents may
include:
(1) For an individual, an unexpired government-issued
identification evidencing nationality or residence and bearing a
photograph or similar safeguard, such as a driver's license or
passport; and
(2) For a person other than an individual (such as a corporation,
partnership, or trust), documents and any amendments thereto showing
the existence of the entity, such as certified articles of
incorporation, a government-issued business license, a partnership
agreement, or a trust instrument.
(B) Verification through non-documentary methods. For an investment
adviser relying on non-documentary methods, the CIP must contain
procedures that set forth the non-documentary methods the investment
adviser will use.
(1) These methods may include contacting a customer; independently
verifying the customer's identity through the comparison of information
provided with respect to the customer with information obtained from a
consumer reporting agency, public database, or other source; checking
references with other financial institutions; or obtaining a financial
statement.
(2) The investment adviser's non-documentary procedures must
address situations where an individual is unable to present an
unexpired government-issued identification document that bears a
photograph or similar safeguard; the investment adviser is not familiar
with the documents presented; the account is opened without obtaining
documents; the customer opens the account without meeting in person;
and the investment adviser is otherwise presented with circumstances
that increase the risk that the investment adviser will be unable to
verify the true identity of a customer through documents.
(C) Additional verification for certain customers. The CIP must
address situations where, based on the investment adviser's risk
assessment of a new account opened by a customer that is not an
individual, the investment adviser will obtain information about
individuals with authority or control over such account in order to
verify the customer's identity. This verification method applies only
when the investment adviser cannot verify the true identity of a
customer that is not an individual using the verification methods
described in paragraphs (a)(2)(ii)(A) and (B) of this section.
(iii) Lack of verification. The CIP must include procedures for
responding to circumstances in which the investment adviser cannot form
a reasonable belief that it knows the true identity of a customer.
These procedures should describe:
(A) When the investment adviser should not open an account;
(B) The terms under which the investment adviser may provide
advisory services to the customer while the investment adviser attempts
to verify the customer's identity;
(C) When the investment adviser should close an account after
attempts to verify a customer's identity fail; and
(D) When the investment adviser should file a Suspicious Activity
Report in accordance with applicable law and regulation.
(3) Recordkeeping. The CIP must include procedures for making and
maintaining a record of all information obtained under procedures
implementing paragraph (a) of this section.
(i) Required records. At a minimum, the record must include:
(A) All identifying information about a customer obtained under
paragraph (a)(2)(i) of this section,
(B) A description of any document that was relied on under
paragraph (a)(2)(ii)(A) of this section, noting the type of document,
any identification number contained in the document, the place of
issuance, and if any, the date of issuance and expiration date;
(C) A description of the methods and results of any measures
undertaken to verify the identity of a customer under paragraphs
(a)(2)(ii)(B) and (C) of this section; and
(D) A description of the resolution of each substantive discrepancy
discovered when verifying the identifying information obtained.
(ii) Retention of records. The investment adviser must retain the
records made under paragraph (a)(3)(i)(A) of this section for 5 years
after the date the account is closed and the records made under
paragraphs (a)(3)(i)(B), (C), and (D) of this section for 5 years after
the record is made.
(4) Comparison with government lists. The CIP must include
reasonable procedures for determining whether a customer appears on any
list of known or suspected terrorists or terrorist organizations issued
by any Federal Government agency and designated as such by Treasury in
consultation with the Federal functional regulators. The procedures
must require the investment adviser to make such a determination within
a reasonable period of time after the account is opened, or earlier if
[[Page 44597]]
required by another Federal law or regulation or Federal directive
issued in connection with the applicable list. The procedures also must
require the investment adviser to follow all Federal directives issued
in connection with such lists.
(5)(i) Customer notice. The CIP must include procedures for
providing customers with adequate notice that the investment adviser is
requesting information to verify their identities.
(ii) Adequate notice. Notice is adequate if the investment adviser
generally describes the identification requirements of this section and
provides such notice in a manner reasonably designed to ensure that a
prospective customer is able to view the notice, or is otherwise given
notice, before opening an account. For example, depending upon the
manner in which the account is opened, an investment adviser may post a
notice on its website, include the notice in its account applications,
or use any other form of oral or written notice.
(iii) Sample notice. If appropriate, an investment adviser may use
the following sample language to provide notice to its customers:
IMPORTANT INFORMATION ABOUT PROCEDURES FOR OPENING A NEW ACCOUNT
To help the government fight the funding of terrorism and money
laundering activities, Federal law requires all financial
institutions to obtain, verify, and record information that
identifies each natural or legal person who opens an account, which
may be an individual or a person other than an individual (such as a
corporation, partnership, or trust).
What this means for you: When you open an account, we will ask
for the name, address, date of birth or formation, tax
identification number, and other information pertaining to the
accountholder. This information will help us verify the identity of
the accountholder. We may also ask to see identifying documents
pertaining to the accountholder, such as a driver's license (if you
are an individual) or a busines
[…truncated; see source link]Indexed from Federal Register on May 21, 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.