Rule2024-19260
Financial Crimes Enforcement Network: Anti-Money Laundering/Countering the Financing of Terrorism Program and Suspicious Activity Report Filing Requirements for Registered Investment Advisers and Exempt Reporting Advisers
Primary source
Metadata and text below are from the Federal Register, a public-domain U.S. government work. Always verify the official published version before relying on it for any legal matter.
Published
September 4, 2024
Effective
January 1, 2026
Issuing agencies
Treasury DepartmentFinancial Crimes Enforcement Network
Abstract
FinCEN, a bureau of the U.S. Department of the Treasury (Treasury), is issuing a final rule to include certain investment advisers in the definition of "financial institution" under the Bank Secrecy Act (BSA), prescribe minimum standards for anti-money laundering/countering the financing of terrorism (AML/CFT) programs to be established by certain investment advisers, require certain investment advisers to report suspicious activity to FinCEN pursuant to the BSA, and make several other related changes to FinCEN regulations. These regulations will apply to certain investment advisers who may be at risk for misuse by money launderers, terrorist financers, or other actors who seek access to the U.S. financial system for illicit purposes and who threaten U.S. national security.
Full Text
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<title>Federal Register, Volume 89 Issue 171 (Wednesday, September 4, 2024)</title>
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[Federal Register Volume 89, Number 171 (Wednesday, September 4, 2024)]
[Rules and Regulations]
[Pages 72156-72278]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2024-19260]
[[Page 72155]]
Vol. 89
Wednesday,
No. 171
September 4, 2024
Part II
Department of the Treasury
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Financial Crimes Enforcement Network
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31 CFR Parts 1010 and 1032
Financial Crimes Enforcement Network: Anti-Money Laundering/Countering
the Financing of Terrorism Program and Suspicious Activity Report
Filing Requirements for Registered Investment Advisers and Exempt
Reporting Advisers; Final Rule
Federal Register / Vol. 89 , No. 171 / Wednesday, September 4, 2024 /
Rules and Regulations
[[Page 72156]]
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DEPARTMENT OF THE TREASURY
Financial Crimes Enforcement Network
31 CFR Parts 1010 and 1032
RIN 1506-AB58
Financial Crimes Enforcement Network: Anti-Money Laundering/
Countering the Financing of Terrorism Program and Suspicious Activity
Report Filing Requirements for Registered Investment Advisers and
Exempt Reporting Advisers
AGENCY: Financial Crimes Enforcement Network (FinCEN), Treasury.
ACTION: Final rule.
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SUMMARY: FinCEN, a bureau of the U.S. Department of the Treasury
(Treasury), is issuing a final rule to include certain investment
advisers in the definition of ``financial institution'' under the Bank
Secrecy Act (BSA), prescribe minimum standards for anti-money
laundering/countering the financing of terrorism (AML/CFT) programs to
be established by certain investment advisers, require certain
investment advisers to report suspicious activity to FinCEN pursuant to
the BSA, and make several other related changes to FinCEN regulations.
These regulations will apply to certain investment advisers who may be
at risk for misuse by money launderers, terrorist financers, or other
actors who seek access to the U.S. financial system for illicit
purposes and who threaten U.S. national security.
DATES: This rule is effective January 1, 2026.
FOR FURTHER INFORMATION CONTACT: The FinCEN Regulatory Support Section
at 1-800-767-2825 or email <a href="/cdn-cgi/l/email-protection#85e3f7e6c5e3ecebe6e0ebabe2eaf3"><span class="__cf_email__" data-cfemail="284e5a4b684e41464b4d46064f475e">[email protected]</span></a>.
SUPPLEMENTARY INFORMATION:
I. Introduction
In this final rule, FinCEN is adding certain investment advisers to
the definition of ``financial institution'' to regulations issued
pursuant to the BSA, prescribing minimum standards for AML/CFT programs
to be established by certain investment advisers, requiring certain
investment advisers to report suspicious activity to FinCEN pursuant to
the BSA, and making several other related changes to FinCEN's
regulations that implement the BSA. This final rule follows FinCEN's
notice of proposed rulemaking on AML/CFT program and suspicious
activity report (SAR) requirements for investment advisers released on
February 15, 2024 (referred to as the IA AML NPRM or proposed rule).\1\
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\1\ 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).
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This rule aims to address and prevent money laundering, terrorist
financing, and other illicit finance activity through the investment
adviser industry. As detailed in an investment adviser illicit finance
risk assessment (Risk Assessment) published concurrently with the
release of the IA AML NPRM, Treasury has identified several illicit
finance threats involving investment advisers.\2\ Investment advisers
have served as an entry point into the U.S. financial system and
economy for illicit proceeds associated with foreign corruption, fraud,
and tax evasion, as well as billions of dollars ultimately controlled
by sanctioned entities including Russian oligarchs and their
associates. Investment advisers--including those exempt from Securities
and Exchange Commission (SEC) registration--and their private funds,
particularly venture capital funds, are also being used by foreign
states, most notably the People's Republic of China (PRC) and Russia,
to access certain technology and services with long-term national
security implications through investments in early-stage companies.
Finally, there are numerous examples of investment advisers defrauding
their customers and stealing their funds.
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\2\ See Treasury, US Sectoral Illicit Finance Risk Assessment
Investment Advisers (also titled 2024 Investment Adviser Risk
Assessment) (2024), available at <a href="https://home.treasury.gov/about/offices/terrorism-and-financial-intelligence/terrorist-financing-and-financial-crimes/office-of-strategic-policy-osp">https://home.treasury.gov/about/offices/terrorism-and-financial-intelligence/terrorist-financing-and-financial-crimes/office-of-strategic-policy-osp</a>.
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To address these risks, this rule adds ``investment adviser'' to
the definition of ``financial institution'' at 31 CFR 1010.100(t) and
defines investment advisers to be SEC-registered investment advisers
(RIAs) and exempt reporting advisers (ERAs). However, FinCEN is
narrowing the definition of ``investment adviser'' from the proposed
rule to exclude RIAs that register with the SEC solely because they are
(i) mid-sized advisers, (ii) multi-state advisers, or (iii) pension
consultants, as well as (iv) RIAs that do not report any assets under
management (AUM) on Form ADV. For investment advisers subject to this
rule that have their principal office and place of business outside the
United States, FinCEN is clarifying that the rule applies only to their
activities that (i) take place within the United States, including
through the involvement of U.S. personnel of the investment adviser,
such as the involvement of an agency, branch, or office within the
United States or (ii) provide services to a U.S. person or a foreign-
located private fund with an investor that is a U.S. person. Given that
the risk of money laundering, terrorist financing, and other illicit
finance activity is generally lower for State-registered advisers,
FinCEN, as proposed in the IA AML NPRM, is not applying this rule to
State-registered advisers at this time. However, FinCEN will continue
to monitor activity involving State-registered investment advisers for
indicia of money laundering, terrorist financing, or other illicit
finance activity, and may take appropriate steps to mitigate any such
activity. As in the proposed rule, this final rule also does not cover
foreign private advisers or family offices.
With respect to the minimum standards for an investment adviser's
AML/CFT program, FinCEN is adopting the minimum requirements largely as
proposed in the IA AML NPRM, with several changes. In line with the
proposed rule, the final rule maintains the exclusion of mutual funds
from the requirements of an investment adviser's AML/CFT program
requirements. It includes modified text, however, to permit an
investment adviser to categorically exclude any mutual fund from an
investment adviser's AML/CFT program requirements without obligating
the adviser to verify that such mutual fund has implemented an AML/CFT
program. Additionally, FinCEN is expanding the exclusion from the AML/
CFT program to also apply to (i) bank- and trust company-sponsored
collective investment funds that comply with the requirements of 12 CFR
9.18 or a similar applicable law that incorporates the requirements of
12 CFR 9.18, and (ii) any other investment adviser subject to this rule
that is advised by the investment adviser. With respect to the
requirement to establish, maintain, and enforce a financial
institution's AML/CFT program that is the responsibility of, and must
be performed by, persons in the United States who are accessible to,
and subject to oversight and supervision by, the Secretary of the
Treasury and the appropriate Federal functional regulator (the Duty
Provision), as discussed further below, FinCEN has determined to not
include this requirement in this final rule.
With respect to this rule's other requirements, FinCEN is adopting
the SAR filing provisions largely as proposed. The final rule does not
exempt investment advisers from the requirements to file Currency
Transaction Reports (CTRs), adhere to
[[Page 72157]]
the Recordkeeping and Travel Rules, or other general recordkeeping
requirements.\3\ Following the proposed application of the information
sharing provisions of sections 314(a) and 314(b) under the USA PATRIOT
Act,\4\ the final rule is applying both requirements as proposed, but
is clarifying that investment advisers may deem these requirements
satisfied for any mutual funds, bank- and trust company-sponsored
collective investment fund, or any other investment adviser they advise
subject to this rule that is already subject to AML/CFT program
requirements. With respect to the proposal to implement special due
diligence requirements for correspondent and private banking accounts
and special measures under section 311 of the USA PATRIOT Act,\5\
investment advisers may deem these requirements satisfied for any
mutual fund, bank- and trust company-sponsored collective investment
fund, or any other investment adviser they advise subject to this rule
that is already subject to AML/CFT program requirements. FinCEN is also
extending the proposed date for compliance to January 1, 2026, meaning
that no later than this date, investment advisers must have implemented
AML/CFT programs, commenced filing SARs when required, and begun
complying with the other reporting and recordkeeping requirements in
this final rule.
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\3\ See 31 CFR 1010.310 through 1010.315 (CTR), 31 CFR
1010.410(e) and (f) (Recordkeeping and Travel Rules), and 31 CFR
1010.415 through 110.440.
\4\ See 31 CFR 1010.520, 1010.540.
\5\ As discussed further below, in addition to special measures
under section 311 of the Uniting and Strengthening America by
Providing Appropriate Tools Required to Intercept and Obstruct
Terrorism Act of 2001 (USA PATRIOT Act), investment advisers must
also comply with actions taken under section 9714(a) of the
Combating Russian Money Laundering Act, codified as a note to 31
U.S.C. 5318A, and section 7213A of the Fentanyl Sanctions Act,
codified at 21 U.S.C. 2313a. See infra Section III.G.2.
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II. Background
A. Statutory Authority
Enacted in 1970, the Currency and Foreign Transactions Reporting
Act--which, along with its amendments and the other statutes relating
to the subject matter, is generally referred to as the 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.\6\ This includes ``through the establishment by
financial institutions of reasonably designed risk-based programs to
combat money laundering and the financing of terrorism,'' as well as
``to facilitate the tracking of money that has been sourced through
criminal activity or is intended to promote criminal or terrorist
activity.'' \7\ The Secretary of the Treasury (Secretary) is authorized
to administer the BSA and to require financial institutions to keep
records and file reports that ``are highly useful in . . . criminal,
tax, or regulatory investigations, risk assessments, or proceedings''
or ``intelligence or counterintelligence activities, including
analysis, to protect against terrorism.'' \8\ The Secretary may also
``establish appropriate frameworks for information sharing among
financial institutions and service providers, their regulatory
authorities, associations of financial institutions, the [Treasury],
and law enforcement authorities to identify, stop, and apprehend money
launderers and those who finance terrorists.'' \9\ The Secretary
delegated the authority to implement, administer, and enforce the BSA
and its implementing regulations to the Director of FinCEN.\10\
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\6\ See 31 U.S.C. 5311. Certain parts of the Currency and
Foreign Transactions Reporting Act, its amendments, and the other
statutes relating to the subject matter of that Act, have come to be
referred to as the BSA. The BSA is codified at 12 U.S.C. 1829b, 12
U.S.C. 1951-1960, and 31 U.S.C. 310, 5311-5314, 5316-5336, and
including notes thereto, with implementing regulations at 31 CFR
Chapter X.
\7\ 31 U.S.C. 5311(2), (3).
\8\ 31 U.S.C. 5311(1).
\9\ 31 U.S.C. 5311(5).
\10\ 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>; see also 31 U.S.C.
310(b)(2)(I) (providing that FinCEN Director ``[a]dminister the
requirements of subchapter II of chapter 53 of this title, chapter 2
of title I of Public Law 91-508, and section 21 of the Federal
Deposit Insurance Act, to the extent delegated such authority by the
Secretary.''
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Pursuant to this authority, FinCEN may define a business or agency
as a ``financial institution'' if such business or agency engages in
any activity determined by regulation ``to be an activity which is
similar to, related to, or a substitute for any activity'' in which a
``financial institution'' as defined by the BSA is authorized to
engage.\11\ Additionally, the BSA requires financial institutions to
establish programs to combat money laundering and the financing of
terrorism that include certain minimum standards. The BSA explicitly
authorizes the Secretary--and thereby FinCEN--to ``prescribe minimum
standards'' for such AML/CFT programs.\12\ Similarly, under the BSA,
Treasury--and thereby FinCEN--``may require any financial institution .
. . to report any suspicious transaction relevant to a possible
violation of law or regulation.'' \13\ This provision authorizes FinCEN
to require the filing of SARs.\14\ FinCEN also has authority under the
BSA to authorize the sharing of financial information by financial
institutions \15\ in specified circumstances, and to require financial
institutions to keep records and maintain procedures to ensure
compliance with the BSA and its implementing regulations or to guard
against money laundering, terrorist financing, or other illicit finance
activity.\16\
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\11\ 31 U.S.C. 5312(a)(2)(Y).
\12\ 31 U.S.C. 5318(h)(1), (2).
\13\ 31 U.S.C. 5318(g)(1).
\14\ 31 U.S.C. 5318(g)(1).
\15\ See USA PATRIOT Act, Public Law 107-56, sec. 314(a), (b).
\16\ See 12 U.S.C. 1953; 31 U.S.C. 5318(a)(2).
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B. Investment Adviser Industry and Regulation
1. Investment Adviser Industry
The investment adviser industry in the United States consists of a
wide range of business models geared towards providing advisory
services to many different types of customers.\17\ The Investment
Advisers Act of 1940 (Advisers Act) and its implementing rules and
regulations form the primary Federal framework governing investment
advisory activity, along with other Federal securities laws and their
implementing rules and regulations, such as the Investment Company Act
of 1940 (15 U.S.C. 80a et seq.) (Company Act), the Securities Act of
1933 (15 U.S.C. 77a et seq.) (Securities Act), and the Securities
Exchange Act of 1934 (15 U.S.C. 78a et seq.) (Exchange Act). The
Advisers Act also defines an investment adviser as a person or firm
that, for compensation, is engaged in the business of providing advice
to others or issuing reports or analyses regarding securities.\18\
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\17\ This final rule uses the term ``customers'' for those
natural and legal persons who enter into an advisory relationship
with an investment adviser. This is consistent with the terminology
in the BSA and FinCEN's implementing regulations. FinCEN
acknowledges that the Advisers Act and its implementing regulations
primarily use the term ``clients,'' and so that term is used in
specific reference to Advisers Act requirements; otherwise, the term
``customers'' is used.
\18\ See 15 U.S.C. 80b-2(a)(11) for this definition of
``investment adviser.'' The statute excludes some persons and firms:
certain banks, certain professionals, certain broker-dealers, news
publishers, persons who advise on or analyze only Treasury-
designated exempt securities, statistical ratings agencies, and
family offices. See 15 U.S.C. 80b-2(a)(11)(A)-(G).
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Since the Advisers Act was amended in 1996 and 2010, generally only
investment advisers who have at least $100 million in AUM or advise a
[[Page 72158]]
registered investment company \19\ may register with the SEC.\20\
Advisers solely to private funds are only required to register with the
SEC if they have least $150 million in AUM in the United States.\21\
Advisers to only venture capital funds are exempt from registration
with the SEC regardless of the amount of AUM. Other investment advisers
typically register with the State in which the adviser maintains its
principal place of business.
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\19\ See 15 U.S.C. 80a-3 (defining investment company). If an
investment company meets the definition of an investment company
under 15 U.S.C. 80a-3(a) and cannot rely on an exception or an
exemption from the definition of investment company, generally it
must register with the SEC under the Company Act and must register
its public offerings under the Securities Act.
\20\ Investment advisers with more than $100 million AUM may
register with the SEC, and investment advisers with more than $110
million in AUM must register with the SEC, unless eligible for an
exception. See 17 CFR 275.203A-1.
\21\ See 15 U.S.C. 80b-3(m)(1); 17 CFR 275.203(m)-1(a), (b).
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SEC-Registered Investment Advisers. Unless eligible to rely on an
exemption, investment advisers that manage more than $110 million AUM
must register with the SEC, as well as submit a Form ADV and update it
at least annually.\22\ Besides having AUM above $110 million,
additional criteria may require an investment adviser to register with
the SEC.\23\ Unless a different exception applies, investment advisers
with AUM under $100 million are prohibited from registering with the
SEC,\24\ but must register instead with the relevant State securities
regulator. The SEC administers and enforces the Federal securities laws
applicable to such RIAs. As of July 31, 2023, there were 15,391 RIAs,
reporting approximately $125 trillion in AUM for their clients.\25\
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\22\ See 17 CFR 275.203A-1.; 17 CFR 275.204-1; see also 15
U.S.C. 80b-3(1) (venture capital fund adviser exemption), 15 U.S.C.
80b-3(m) (private fund adviser exemption). Investment advisers
register with the SEC by filing Form ADV and are required to file
periodic updates. Form ADV collects certain information about the
adviser, including (depending on the adviser's registration status)
its AUM, ownership, number of clients, number of employees, business
practices, custodians of client funds, and affiliations, as well as
certain disciplinary or material events of the adviser or its
employees. A detailed description of Form ADV's requirements is
available at <a href="https://www.sec.gov/oiea/investor-alerts-bulletins/ib_formadv.html">https://www.sec.gov/oiea/investor-alerts-bulletins/ib_formadv.html</a>.
\23\ Other exceptions to the prohibition on SEC registration
include: (1) an adviser that would be required to register with 15
or more States (the multi-State exemption); (2) an adviser advising
a registered investment company; (3) an adviser affiliated with an
RIA; and (4) a pension consultant. Persons satisfying these criteria
and the definition of ``investment adviser'' are required to
register as investment advisers with the SEC. See Form ADV:
Instructions for Part IA, Item 2. Advisers with a principal office
and place of business in New York and over $25 million AUM are
required to register with the SEC.
\24\ 17 CFR 275.203A-1. Note that if an RIA's AUM falls below
$90 million as of the end of such RIA's fiscal year then it must
withdraw its registration with the SEC, unless otherwise eligible
for an exception to the prohibition on SEC registration. Id.
\25\ The number of RIAs and corresponding AUM, and the number of
ERAs, are based on a Treasury review of Form ADV information filed
as of July 31, 2023, as described in the IA AML NPRM. This Form ADV
data is available at Frequently Requested FOIA Document: Information
About Registered Investment Advisers and Exempt Reporting Advisers,
<a href="http://www.sec.gov/foia/docs/invafoia.htm">http://www.sec.gov/foia/docs/invafoia.htm</a>. The $125 trillion in AUM
includes approximately $22 trillion in assets managed by mutual
funds, which are advised by RIAs and are subject to AML/CFT
obligations under the BSA and its implementing regulations. FinCEN
reviewed investment adviser Form ADV filings through June 4, 2024,
to assess whether to update the industry data used in the IA AML
NPRM. FinCEN found approximately 10 fewer RIAs and ERAs as of June
4, 2024 compared to July 31, 2023. Out of approximately 19,900
entities subject to the final rule, this is not a substantial
change.
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Exempt Reporting Advisers. An ERA is an investment adviser that
would be required to register with the SEC but is statutorily exempt
from that requirement \26\ because: (1) it is an adviser solely to one
or more venture capital funds; \27\ or (2) it is an adviser solely to
one or more private funds and has less than $150 million AUM \28\ in
the United States.\29\ Private funds are privately offered investment
vehicles that pool capital from one or more investors to invest in
securities and other investments.\30\ Private funds do not register
with the SEC, and advisers to these funds often categorize the fund by
the investment strategy they pursue. These include hedge funds, private
equity funds, and venture capital funds, among others. Even though they
are not required to register with the SEC, ERAs must still file an
abbreviated Form ADV--they are required to answer fewer client-related
questions and provide less information about the services they
provide--and the SEC maintains authority to examine ERAs. As of July
31, 2023, there were 5,846 ERAs with total gross assets of $5.2
trillion that were exempt from registering with the SEC but had filed
an abbreviated Form ADV.\31\
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\26\ An adviser that is eligible to file reports as an ERA may
nonetheless elect to register with the SEC as an RIA so long as it
meets the criteria for registration. An investment adviser that
relies on one of these exemptions must still evaluate the need for
State registration.
\27\ See 17 CFR 275.203(l)-1 (defining ``venture capital
fund'').
\28\ Form ADV uses the term ``regulatory assets under
management'' (RAUM) instead of ``assets under management.'' Form ADV
describes how advisers must calculate RAUM and states that in
determining the amount of RAUM, an adviser should ``include the
securities portfolios for which [it] provide[s] continuous and
regular supervisory or management services as of the date of
filing'' the form. See Form ADV, Instructions for Part 1A,
Instruction 5.b.
\29\ See sections 203(l) and 203(m) of the Advisers Act and 17
CFR 275.203(m)-1, respectively. ERAs are exempt from registration
with the SEC, but are required to file reports on Form ADV with the
SEC and are subject to certain rules under the Advisers Act.
\30\ Section 202(a)(29) of the Advisers Act defines the term
``private fund'' as an issuer that would be an investment company,
as defined in section 3 of the Company Act (15 U.S.C. 80a-3), but
for section 3(c)(1) or 3(c)(7) of that Act. Section 3(c)(1) excludes
from the definition of investment company a privately-offered issuer
having fewer than a certain number of beneficial owners. Section
3(c)(7) excludes from the definition of investment company a
privately-offered issuer the securities of which are owned
exclusively by ``qualified purchasers'' (generally, persons and
entities owning a specific amount of investments).
\31\ The number of ERAs is derived from a Treasury review of
Form ADV information filed as of July 31, 2023. See supra note 25.
ERAs do not report assets under management on Form ADV, but instead
report gross assets for each private fund they advise.
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State-Registered Investment Advisers. State-registered investment
advisers are generally prohibited from registering with the SEC and
instead register with and are supervised by the relevant State
authority, unless they meet certain exceptions or their State does not
supervise these entities.\32\ State-registered investment advisers also
file a Form ADV, which they submit to the relevant State regulator. As
of December 31, 2022, there were 17,063 State-registered investment
advisers reporting approximately $420 billion in AUM.\33\
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\32\ See 17 CFR 275.203A-2; see also supra note 23.
\33\ See North American Security Administrators Association,
NASAA Investment Adviser Section 2023 Annual Report 3, available at
<a href="https://www.nasaa.org/wp-content/uploads/2023/09/2023-IA-Section-Report-FINAL.pdf">https://www.nasaa.org/wp-content/uploads/2023/09/2023-IA-Section-Report-FINAL.pdf</a>.
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Foreign-Located Investment Advisers. Foreign-located advisers whose
principal offices and places of business are outside the United States,
but who solicit or advise ``U.S. persons,'' are subject to the Advisers
Act and must register with the SEC unless eligible for an exemption.
One of those exemptions is the ``foreign private adviser'' exemption,
and an adviser relying on this exemption is not required to make any
filings with the SEC.\34\ The SEC does not apply the substantive
provisions of the Advisers Act to a non-U.S. investment adviser that is
registered with the SEC with respect to its non-U.S. clients.\35\ Non-
U.S.
[[Page 72159]]
investment advisers may also file with the SEC as ERAs if they meet the
requirements to report as ERAs.
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\34\ The ``foreign private adviser'' exemption is available to
an adviser that (i) has no place of business in the United States;
(ii) has, in total, fewer than 15 clients in the United States and
investors in the United States in private funds advised by the
adviser; (iii) has aggregate assets under management attributable to
such clients and investors of less than $25 million; and (iv) does
not hold itself out generally to the public in the United States as
an investment adviser. See 15 U.S.C. 80b-2(a)(30), 80b-3(b)(3).
\35\ See SEC, Exemptions for Advisers to Venture Capital Funds,
Private Fund Advisers With Less Than $150 Million in Assets Under
Management, and Foreign Private Advisers, Final Rule, Investment
Advisers Act Release No. 3222 (Jun. 22, 2011); 76 FR 39645, 39667
(Jul. 6, 2011).
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2. Investment Adviser Regulation
Oversight of the investment adviser industry by Federal and State
securities regulators is focused on protecting investors and the
overall securities market from fraud and manipulation. Most investment
advisers are subject to certain reporting requirements and the extent
of those requirements depends on whether the investment adviser is an
RIA, registered at the State level, exempt from registration as an ERA,
or otherwise not required to register with the SEC or State securities
regulator.\36\ RIAs are subject to the Advisers Act and various SEC
rules and regulations thereunder that govern, among other things, their
marketing and disclosures to clients, best execution for client
transactions, reporting of AUM, a code of ethics requirement (including
reporting of securities holdings), and ownership in public securities,
ensuring compliance with SEC rules governing trading, and disclosures
of conflicts of interest and disciplinary information. State-registered
investment advisers may have similar requirements under State
securities laws and regulations.\37\ While ERAs are not required to
register with the SEC, they must still file an abbreviated Form ADV
with the SEC, and the SEC maintains authority to examine ERAs. ERAs are
not subject to some of the Advisers Act provisions that apply to RIAs.
However, ERAs have fiduciary responsibilities to their clients and must
abide by certain other compliance requirements applicable to all
investment advisers, including anti-fraud requirements of the Advisers
Act.\38\ Investment advisers, depending on their registration status,
are also generally subject to examination by the SEC or State
securities regulators. In some circumstances, Federal securities, tax,
or other rules and regulations may impose on investment advisers'
information collection or disclosure obligations similar to some AML/
CFT measures.
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\36\ For instance, an investment adviser may be exempt from both
Federal and State registration requirements if it had less than $25
million AUM and fewer than six clients in a State. Such advisers are
not required to register, nor are they ERAs.
\37\ For example, in California, the California Corporation Code
assigns to the Commissioner of the Department of Financial
Protection and Innovation authority to issue specific rules and
regulations. See Cal. Corp. Code, Ch.3, sec. 25230-25238; Cal. Code
Regs. tit. 10, sec. 260.230-260.238.
\38\ See 15 U.S.C. 80b-6. See also 17 CFR part 275.206(4)-8
(prohibiting fraudulent practices by an investment adviser to a
pooled investment vehicle with respect to any investor or
prospective investor in the pooled investment vehicle).
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While some of these obligations mitigate illicit finance risks to
the investment adviser industry, these obligations are not explicitly
designed for that purpose, and the SEC generally does not have existing
authority to apply AML/CFT specific requirements to investment
advisers. Some investment advisers may nonetheless already apply AML/
CFT requirements, for example, if they are also banks (or are bank
subsidiaries), are registered as brokers and dealers in securities
(broker-dealers), or advise mutual funds, but this is not consistent
across the industry.\39\ Further, some investment advisers have
voluntarily implemented certain AML/CFT measures. But implementation of
such measures is generally not subject to comprehensive enforcement or
examination. This means that providers of the same financial services
may be subject to different AML/CFT obligations (if any), and an
investor or customer seeking to obscure the origin of its funds or
identity can choose an investment adviser that does not apply AML/CFT
measures to its customers and activities.\40\
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\39\ Investment advisers that are banks (or 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
(FRB), the Federal Deposit Insurance Corporation (FDIC), and the
National Credit Union Administration (collectively, the Federal
Banking Agencies, or FBAs) are accordingly also subject to
applicable FBA regulations imposing AML/CFT requirements on banks.
See, e.g., 12 CFR 5.34(e)(3) and 5.38(e)(3) (OCC requirements
governing operating subsidiaries of national banks and Federal
savings associations).
\40\ For instance, FinCEN research identified two investment
advisers with a focus on Russian customers that advertised
investment structures that would allow customers to avoid ``know
your customer'' procedures.
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Overall, there is currently no comprehensive set of obligations
directly applicable to most investment advisers that is explicitly
designed to address illicit finance risks in this industry.
C. Illicit Finance Risk
As noted above, concurrent with the publication of the IA AML NPRM,
Treasury released the Risk Assessment.\41\ The Risk Assessment found
that, while the degree of risk is not uniform across the sector, RIAs
and ERAs pose a material risk of misuse for illicit finance.\42\
---------------------------------------------------------------------------
\41\ See Risk Assessment, supra note 2.
\42\ Id. at 32.
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First, as already noted, the lack of comprehensive AML/CFT
regulations directly and categorically applicable to investment
advisers means they are not required to understand their customers'
ultimate sources of wealth or identify and report potentially illicit
activity to law enforcement. The term ``investment adviser'' is not
presently included in the definition of ``financial institution'' under
the BSA or its implementing regulations. This means that, although they
have obligations to report cash transactions above $10,000 via the
FinCEN/Internal Revenue Service Form 8300, investment advisers are
typically not subject to most of the AML/CFT program, recordkeeping, or
reporting obligations that apply to banks, broker-dealers, and certain
other financial institutions. Investment advisers that are not dually
registered as a bank or a broker-dealer are not required to maintain an
AML/CFT program nor satisfy customer due diligence (CDD) or customer
identification program (CIP) obligations.\43\ Investment advisers,
because they are not defined as a ``financial institution'' under the
BSA, are also prevented from participating in the USA PATRIOT Act
314(a) and 314(b) information sharing programs, meaning investment
advisers cannot provide useful information on suspected illicit finance
activity to law enforcement or to other financial institutions
participating in 314(b) information sharing associations. As they are
not presently included in the BSA definition of ``financial
institution,'' investment advisers are also not afforded the protection
from liability (safe harbor) that applies to financial institutions
when filing SARs.\44\ Even though investment advisers are currently
able to file voluntary SARs, without the safe harbor they could face
increased legal risk from customers or other counterparties. The
current patchwork of AML/CFT program implementation by some RIAs and
ERAs may also create arbitrage opportunities for illicit actors by
allowing them to find RIAs and ERAs with weaker or non-existent
customer diligence procedures when these actors seek to access the U.S.
financial system.
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\43\ See infra Section II.E (providing a summary of the proposed
rule to apply CIP requirements to RIAs and ERAs).
\44\ 31 U.S.C. 5318(g)(3)(A).
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Second, where AML/CFT obligations apply to investment adviser
activities, the obliged entities (such as custodian banks, broker-
dealers, and some fund administrators providing services to investment
advisers and the private funds that they advise) do not necessarily
have a direct relationship with the customer or, in the private fund
context, the underlying investor in
[[Page 72160]]
the private fund.\45\ Further, these entities may be unable to collect
relevant investor information from the RIA or ERA to comply with the
entities' existing obligations (either because the adviser is unwilling
to provide, or has not collected, such information). Additionally, an
adviser may use multiple custodians or broker-dealers, so that these
entities may not have a complete picture of transactional activity
facilitated by the investment adviser for their customers. Investment
advisers, while not taking possession of financial assets, often have
the most direct relationship with the customers they advise and thus
may be best positioned to obtain the necessary documentation and
information. In some cases, an investment adviser may be the only
person or entity with a complete understanding of the source of a
customer's invested assets.
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\45\ FinCEN notes that, in the private fund context, the
adviser's customer is typically the private fund itself, and not
underlying investors in that private fund. However, in many cases an
adviser has a relationship (in some cases contractual) with
underlying investors and has access to information about underlying
investors. Indeed, the SEC requires RIAs and ERAs to report
information regarding underlying investors. For instance, Question
13 on SEC Form ADV asks an investment adviser for the approximate
number of the private fund's beneficial owners. See SEC Form ADV,
Part 1A at 51 (Aug. 2022). In addition, Question 16(m) on SEC Form
PF requires SEC-registered private fund advisers to identify, with
respect to each private fund it advises, the approximate percentage
of the private fund's equity that is beneficially owned by different
types of investors, including ``Investors that are United States
persons,'' ``Investors that are not United States persons,'' and,
acknowledging that an adviser may not have complete beneficial
ownership information in certain circumstances, ``Investors that are
not United States persons and about which the foregoing beneficial
ownership information is not known and cannot reasonably be obtained
because the beneficial interest is held through a chain involving
one or more third-party intermediaries.'' SEC Form PF, Section 1b,
at 7 (Dec. 2023) (emphasis original). In addition, Congress, in the
Corporate Transparency Act (enacted into law on January 1, 2021, as
part of the Anti-Money Laundering Act of 2020), recognized that
advisers to private funds file information related to private fund
ownership on Form ADV and accordingly that private fund advisers
have such information. See 31 U.S.C. 5336(a)(10) and (11)(B)(xi),
(xviii).
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Third, the existing Federal securities laws and regulations are not
designed to comprehensively detect illicit proceeds or other illicit
activity that is ``integrating'' into the U.S. financial system through
an RIA or ERA.\46\ These laws and regulations are not designed to
explicitly address the risk that an RIA or ERA may be used to move
proceeds or funds tied to money laundering, terrorist financing, or
other illicit activity. They do not incorporate AML/CFT purposes, do
not require an understanding of relevant illicit finance risks and
activity, and do not include requirements for processes to report
suspicious activity. In turn, existing laws do not provide any Federal
regulatory body with comprehensive authority to monitor whether
investment advisers are meeting any AML/CFT objectives.
---------------------------------------------------------------------------
\46\ Generally, money laundering involves three stages, known as
placement, layering, and integration. At the ``placement'' stage,
proceeds from illegal activity or funds intended to promote illegal
activity are first introduced into the financial system. The
``layering'' stage involves the distancing of illegal proceeds from
their criminal source through a series of financial transactions to
obfuscate and complicate their traceability. ``Integration'' occurs
when illegal proceeds previously placed into the financial system
are made to appear to have been derived from a legitimate source.
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Fourth, RIAs and ERAs routinely rely on third parties, some of whom
may be located outside of the United States, for administrative and
compliance activities. These entities--particularly offshore entities--
are subject to varying levels of AML/CFT regulation. The due diligence
and verification practices of these fund administrators are not uniform
and may vary based upon the requirements of the local regulatory regime
as well as the requirements imposed by the fund's adviser.
Fifth, particularly for private funds, it is routine for investors
to invest through layers of legal entities that may be registered or
organized outside of the United States, making it challenging--under
existing frameworks--to collect information relevant to understanding
illicit finance risks.\47\
---------------------------------------------------------------------------
\47\ For examples of how these private funds are structured, see
Risk Assessment, supra note 2, at 8-10. In its review of law
enforcement cases and BSA reporting conducted for the Risk
Assessment, FinCEN found several instances where advisers to private
funds had ongoing contact or relationships with underlying investors
in those funds, to include discussing investment strategies or fund
distributions.
---------------------------------------------------------------------------
Regarding investment adviser-related illicit finance risks and
threats, Treasury's analysis showed that 15.4 percent of RIAs and ERAs
were associated with or referenced in at least one SAR filed between
2013 and 2021.\48\ The number of SAR filings associated with or
referencing an RIA or ERA increased by approximately 400 percent
between 2013 and 2021--a far greater increase than was observed in
relation to sectors with a SAR filing obligation.\49\ This analysis,
along with a review of law enforcement cases and other information
available to the U.S. government, identified cases of the investment
adviser industry having served as an entry point into the U.S.
financial system for illicit proceeds associated with foreign
corruption, fraud, and tax evasion. The analysis further showed that
certain advisers manage billions of dollars ultimately controlled by
sanctioned entities including Russian oligarchs and their associates
who help facilitate Russia's illegal and unprovoked war of aggression
against Ukraine.\50\
---------------------------------------------------------------------------
\48\ Id. at 16. SARs are not themselves conclusive evidence of
illicit conduct but can generate important information about
potential criminal activity that can prompt or assist a law
enforcement investigation or support the identification of threats
or vulnerabilities in the U.S. financial system.
\49\ Id
\50\ Id.
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Finally, certain RIAs and ERAs and the private funds they advise
are also being used by foreign states, most notably the PRC and Russia,
to access certain technology and services with long-term national
security implications through investments in early-stage companies.\51\
---------------------------------------------------------------------------
\51\ Id. Foreign state-funded investment vehicles may seek to
hide their involvement in an effort to gain access to sensitive
technology, processes, or knowledge that can enhance their domestic
development of microelectronics, artificial intelligence,
biotechnology and biomanufacturing, quantum computing, and advanced
clean energy, among others. See Risk Assessment, supra note 2, at
21. Exploitation of this access can advance foreign-state economic
and military capabilities at the expense of the United States. See
Safeguarding Our Innovation, National Counterintelligence and
Security Center 1 (Jul. 24, 2024), available at <a href="https://www.dni.gov/files/NCSC/documents/products/FINALSafeguardingOurInnovationBulletin.pdf">https://www.dni.gov/files/NCSC/documents/products/FINALSafeguardingOurInnovationBulletin.pdf</a>.
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D. IA AML NPRM
In the IA AML NPRM released on February 15, 2024, FinCEN proposed
to designate certain investment advisers as ``financial institutions''
under the BSA and subject them to AML/CFT program requirements and SAR
filing obligations, as well as other BSA requirements.\52\
Specifically, the IA AML NPRM would have added ``investment adviser''
to the definition of ``financial institution'' at 31 CFR 1010.100(t),
and then would have defined investment advisers to mean RIAs registered
or required to register with, or ERAs that report to, the SEC.
Accordingly, RIAs and ERAs would have then been required to comply with
several AML/CFT requirements.
---------------------------------------------------------------------------
\52\ See 89 FR 12108 (Feb. 15, 2024).
---------------------------------------------------------------------------
The proposed rule would also have required RIAs and ERAs to keep
records relating to the transmittal of funds (Recordkeeping and Travel
Rules) and to meet other obligations of financial institutions under
the BSA. The proposed rule would also have applied information-sharing
provisions between and among FinCEN, law enforcement, government
agencies, and certain financial institutions, and would have subjected
investment advisers to certain ``special measures'' imposed by FinCEN
[[Page 72161]]
pursuant to section 311 of the USA PATRIOT Act.\53\
---------------------------------------------------------------------------
\53\ See also section 9714(a) of the Combating Russian Money
Laundering Act; 21 U.S.C. 2313a.
---------------------------------------------------------------------------
In the IA AML NPRM, FinCEN did not propose to include a CIP
requirement for investment advisers, nor did it propose to require
investment advisers to collect beneficial ownership information for
legal entity customers. FinCEN has proposed to apply CIP requirements
to investment advisers via a joint rulemaking with the SEC (described
below, Section II.E) and intends to address the requirement to collect
beneficial ownership information for legal entity customers in a
subsequent rulemaking.
The proposed rule would have allowed an investment adviser to
exclude any mutual fund that it advised from the investment adviser's
AML/CFT program and SAR filing requirements, provided that the mutual
fund had developed and implemented an AML/CFT program compliant with
the relevant regulations governing mutual funds.\54\ The proposed rule
would also have removed the existing requirement that investment
advisers file reports for the receipt of more than $10,000 in cash and
negotiable instruments using Form 8300. Investment advisers would have
instead been required to file a CTR for a transaction involving a
transfer of more than $10,000 in currency by, through, or to the
investment adviser, unless subject to an applicable exemption.
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\54\ As used in this release, ``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 Company Act
(15 U.S.C. 80a-3)) that is an ``open-end company'' (as that term is
defined in section 5 of the Company Act (15 U.S.C. 80a-5)) that is
registered or is required to register with the SEC under section 8
of the 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 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 Company Act), issued in 2019, clarified ETFs
are issuing ``redeemable securit[ies]'' and are generally
``regulated as open-end funds within the meaning of section 5(a)(1)
of the [Investment Company] Act.'' FinCEN's definition of a mutual
fund under 1010.100(gg) applies to an ETF that is registered as an
``open-end company'' (as the term is defined in section 5 of the
Company Act).
---------------------------------------------------------------------------
Finally, FinCEN proposed to delegate its examination authority to
the SEC given the SEC's expertise in the regulation of investment
advisers and the existing delegation to the SEC of authority to examine
broker-dealers and certain investment companies for AML/CFT compliance.
E. Customer Identification Program NPRM
In the IA AML NPRM, FinCEN noted that it intended to address the
application of a CIP requirement for investment advisers through a
joint rulemaking with the SEC.\55\ On May 21, 2024, FinCEN and the SEC
published a joint NPRM to apply CIP requirements to RIAs and ERAs (IA
CIP NPRM).\56\
---------------------------------------------------------------------------
\55\ 89 FR at 12129.
\56\ See FinCEN and SEC, Customer Identification Programs for
Registered Investment Advisers and Exempt Reporting Advisers, Notice
of Proposed Rulemaking, 89 FR 44571 (May 21, 2024).
---------------------------------------------------------------------------
As proposed in the IA CIP NPRM, RIAs and ERAs would be required to
establish, document, and maintain written CIPs appropriate for their
respective sizes and businesses. The CIPs would include risk-based
procedures to identify and verify the identity of their customers \57\
to the extent reasonable and practicable within a reasonable time
before or after the customer's account is opened. The procedures would
have to enable RIAs and ERAs to form a reasonable belief that the
adviser knows the true identity of their customers. RIAs and ERAs would
be required to obtain certain identifying information with respect to
each customer, such as the customer's name, date of birth or date of
formation, address, and identification number. The proposed rule would
also require procedures for, among other things, maintaining records of
the information used to verify the person's identity, notifying
customers that the adviser is requesting information to verify their
identifies, and consulting lists of known or suspected terrorists or
terrorist organizations provided to the RIA or ERA financial
institution by any government agency to determine whether a person
seeking to open an account appears on any such list.\58\ CIP
requirements are a long-standing, foundational component of a financial
institution's AML/CFT requirements and they are required for banks,
broker-dealers, futures commission merchants and introducing brokers in
commodities, and mutual funds.
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\57\ The IA CIP NPRM proposed to define a customer as a person
who opens a new account with an investment adviser. Id. at 44573.
\58\ The IA CIP NPRM proposed to define ``account'' for these
purposes as ``any contractual or other business relationship between
a person and an investment adviser under which the investment
adviser provides investment advisory services,'' with limited
exclusions. Id.
---------------------------------------------------------------------------
The comment period for the IA CIP NPRM closed on July 22, 2024, and
FinCEN and the SEC received 36 comments. Treasury and the SEC are
reviewing comments and are working toward finalizing the CIP rule. As
FinCEN and the SEC noted in the IA CIP NPRM, adoption of CIP
requirements for RIAs and ERAs would depend on--and not occur unless--
investment advisers are first designated as ``financial institutions''
for purposes of the BSA.\59\
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\59\ Id. at 44572, note 11.
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F. General Summary of Comments
FinCEN received 49 comments on the IA AML NPRM. Of the 49 comments,
16 were from individual commenters; 16 were from trade associations
representing various financial services entities (including seven that
were a form letter provided by one association); six were from think-
tanks or non-governmental organizations (NGOs); and five were from
RIAs. For the remainder, one comment letter was from a law firm, one
comment letter was from a self-regulatory organization, one comment
letter was from an association of state securities regulators, one
comment letter was from a service provider to investment advisers, one
comment letter was from an office within another federal government
agency, and one comment letter was from seven U.S. Senators.
Several commenters noted support for the proposed rule and the
application of comprehensive AML/CFT requirements to RIAs and ERAs,
noting that it would address illicit finance risks or other illicit
activity involving investment advisers. Several other commenters,
including a self-regulatory organization, an association of state
securities regulators, seven U.S. Senators, several financial
transparency NGOs and a think-tank, and some financial services trade
associations, supported adoption of the proposed rule, but had
suggested changes. These changes included expanding the scope of
coverage to include State-registered investment advisers, family
offices, and foreign private advisers, as well as modifying certain
exemptions or requirements in the proposed rule. Other commenters who
generally supported the rule requested that FinCEN apply CIP
requirements and the obligation to collect beneficial ownership
information for legal entity customers as soon as possible. These
proposed changes are discussed below.
Another group of commenters, including several financial services
trade associations and some RIAs, noted that they generally supported
the objectives of the proposed rule, but thought that the rule as
drafted was overly broad and/or too prescriptive and would impose
significant costs on investment advisers without a corresponding
benefit to efforts to
[[Page 72162]]
combat illicit finance. They suggested several more significant changes
that would exempt certain categories of advisers or advisory activities
from the proposed rule and instead focus on what they considered
higher-risk activities. They also suggested not applying certain
requirements that may be duplicative of obligations applied by other
financial institutions, such as broker-dealers and banks, which are
involved in advisory activities, as well as modifying requirements of
the proposed rule in the context of private funds activity. These
commenters' proposed changes are discussed below.
Several commenters opposed the rule, primarily highlighting the
potential burden on investment advisers and that the requirements in
the proposed rule were duplicative of AML/CFT requirements imposed on
broker-dealers and custodians that facilitate transactions for
investment advisers and their clients. One commenter noted that AML/CFT
measures, along with measures related to sanctions issued by Treasury's
Office of Foreign Assets Control (OFAC), were implemented by the fund
administrator for their hedge fund. Another commenter indicated that
foreign-located fully regulated RIAs and ERAs are already subject to
extensive AML/CFT and anti-bribery requirements by their home country
regulators.
Regarding the burden, one commenter noted that advisers, especially
those that advise private funds, were already facing additional costs
to implement recently finalized or proposed SEC requirements. Other
commenters also highlighted the potential costs for smaller investment
advisers.
Two commenters noted their opposition to applying the proposed rule
to venture capital advisers. One of those commenters stated that the
requirements of the proposed rule would have a significant and adverse
effect on venture capital advisers and the innovative start-ups they
advise. The other commenter claimed that the identified risks did not
justify applying AML/CFT rules to venture capital advisers, would
produce less valuable information because of the limited interactions
that venture capital advisers have with limited partner investors, and
would not lead to a more effective AML/CFT regime.
One commenter reasoned that, given the focus on the risks posed by
private funds, the rule should be narrowed to address those higher-risk
activities, and not apply to advisers that manage assets for individual
investors. Two commenters requested that FinCEN address concerns raised
in the comments with respect to private fund advisers and venture
capital advisers, respectively, and issue a revised NPRM.
III. Discussion of Final Rule
A. Illicit Finance Risk
Commenters expressed varying views on the illicit finance risks
associated with RIAs and ERAs that were discussed in the IA AML NPRM
and Risk Assessment. Several commenters agreed that illicit actors,
including corrupt officials, have exploited the U.S. investment adviser
sector, particularly the private funds sector, to hide or obscure
illicit proceeds, and that the lack of AML/CFT requirements for
investment advisers presented illicit finance and national security
risks. One commenter described how corrupt officials had exploited the
U.S. private investment industry and would continue to do so unless
effective and robust AML/CFT controls were applied. Another commenter
concurred with the findings of the Risk Assessment and wrote that it
was consistent with the commenter's own research, which found
significant foreign ownership in private funds that are managed by
advisers who report to the SEC. This commenter's research suggests that
this level of foreign ownership in private funds presents a challenge
to the United States' ability to effectively monitor foreign
investment. Other commenters agreed with the national security risks
identified and provided additional examples of misuse, including
narcotics trafficking and laundering proceeds of corruption or funds
from authoritarian regimes.
One commenter observed that while broker-dealers may hold or trade
assets controlled by an investment adviser, they may have no
independent knowledge of the investment adviser's customers, and that
investment advisers are often in the best position to obtain
information about their customers that is relevant for AML/CFT
purposes. Finally, another commenter, a non-profit coalition, agreed
that, given the growth of the private funds industry and investment
advisers' role in critical sectors of the economy, investment advisers
should be held to the same standard as other financial market
participants.
However, several other commenters took issue with the findings
regarding the level of illicit finance risk facing investment advisers.
Several commenters disagreed that the case examples cited provided
adequate support for the rulemaking, noting that the examples involved
concealment of ownership, complicit actors whose activity would not be
addressed by the requirements of the proposed rule (but that were
addressed by laws criminalizing money laundering, or anti-fraud
provisions of the Federal securities laws), or compliance failures at
financial institutions already subject to AML/CFT requirements. They
also claimed that the case examples were too few to justify the cost
associated with the proposed rule's requirements. One commenter said
that the cases also demonstrated that BSA requirements for banks and
broker-dealers were already identifying illicit activity. One commenter
questioned the accuracy of the analysis of SARs included in the Risk
Assessment and felt that they lacked context or that findings tied to
SARs were not proof of illicit activity.
Other commenters noted that existing OFAC sanctions requirements
addressed the examples and data on illicit finance tied to Russian
oligarchs, and that the blocking of assets owned by sanctioned Russian
parties demonstrated those sanctions were effective in mitigating this
illicit finance risk. Another commenter stated that most investments
made by Russian oligarchs occurred prior to their designation, that
there was nothing illegal about their investments in U.S. assets, and
that the proposed requirements would thus not have addressed the AML/
CFT risks arising from Russia's invasion of Ukraine.
Regarding risks associated with private funds, one commenter
claimed that private funds generally present a low risk of money
laundering and terrorist financing due to several key factors,
including the long-term nature of the investments made in such funds
and the existing due diligence by funds into potential investors
(including sanctions screening). Another commenter disagreed with the
money laundering risk associated with hedge funds, noting that, at the
hedge fund where they worked, the transfer agent would ``perform KYC
[know your customer procedures] and check OFAC and sanctions lists
before admitting a new investor or paying a redemption'' and ``are
required to report suspicious activities.''
Regarding venture capital funds, in particular, two commenters
stated that none of the examples in the preamble of incidents in which
illicit finance was uncovered included venture capital funds or
advisers and therefore such examples do not illustrate the need for the
adoption of AML/CFT programs by venture capital advisers. These
commenters claimed that illiquidity and long-term focus are standard
features of venture capital funds that make them poor targets for money
launderers. One commenter argued that FinCEN
[[Page 72163]]
acknowledges this in the release accompanying the proposed rule, but
nevertheless proposes AML requirements for venture capital advisers.
One commenter alleged that the proposed rule does not focus on the use
of venture capital funds by foreign actors (including foreign
governments) to facilitate illicit finance activity, but on attempts to
access sensitive or dual-use technology by potentially hostile foreign
state interests. The commenter claimed that this threat would not be
addressed through the application of AML/CFT requirements to venture
capital funds, and are more appropriately addressed through other
government authorities, such as the Committee on Foreign Investment in
the United States (CFIUS). One commenter indicated that FinCEN does not
provide evidence or disclose essential facts that might support a
decision to extend the AML/CFT program requirement to venture capital
advisers and that such inclusion would amount to an arbitrary and
capricious application of the rule.
Regarding the vulnerabilities discussed in the IA AML NPRM, some
commenters stated that investment advisers were much less likely to
serve as channels to the U.S. financial system that can be taken
advantage of by criminal actors, as compared to other financial
institutions that are already subject to AML/CFT requirements under the
BSA.
Several commenters noted that RIAs and ERAs rely heavily on banks,
broker-dealers, custodians, and other financial institutions that are
already subject to AML/CFT requirements to custody customer and
investor monies, process funds transfers, or effect securities
transactions on behalf of advisers. Commenters also noted that banks
and broker-dealers regularly request AML/CFT and sanctions-related
representations and affirmations from RIAs and ERAs as part of their
diligence processes. One commenter also noted that RIAs and ERAs and
their affiliates already maintain robust records of the types of
transactions that would be captured by the proposed rule, such as
adviser or broker-dealer requirements applicable to maintaining
transaction records related to financial transactions between advisers'
customers and those customers' investors. Another commenter opined that
``a failure to conduct adequate due diligence or to otherwise fail in
complying with applicable AML laws could . . . expose a Covered IA to a
fund to accusations that it failed to satisfy its fiduciary duties [to
the fund] . . . [and] given the risk that an AML error or oversight
could create claims of fiduciary breach, Covered IAs are already
strongly incentivized to develop and maintain robust AML policies and
procedures.''
FinCEN responds below to these comments. Following consideration of
comments, for the reasons discussed below, FinCEN continues to assess
that there is a material risk that RIAs and ERAs can be abused for
illicit finance activity, although the degree of risk is not uniform
across the sector. Regarding the case examples, as FinCEN noted in the
IA AML NPRM, some of the examples both in the NPRM and in the Risk
Assessment involve complicit individuals at a financial
institution.\60\ FinCEN notes that other commenters provided additional
research confirming the risks associated with foreign investors in
private funds that were identified in the Risk Assessment, as well as
additional examples of misuse.\61\ Further, the Financial Industry
Regulatory Authority (FINRA), a Self-Regulatory Organization (SRO)
responsible for regulating member broker-dealers, conducted a review of
referrals that its specialized insider trading, market fraud, and
offering review teams made to other regulators and law enforcement
between January 1, 2023 and March 14, 2024. This review suggests that
at least 14.5 percent of those referrals related to investment advisers
or their customers.
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\60\ See 89 FR at 12114-12115.
\61\ Several commenters from think tanks and non-governmental
organizations provided additional examples of misuse, while one
commenter provided a report titled Private Investments, Public Harm:
How the Opacity of the Massive U.S. Private Investment Industry
Fuels Corruption and Harms National Security. The report is
available at <a href="https://thefactcoalition.org/wp-content/uploads/2021/12/TI_Private-Investments-Public-Harm-10.pdf">https://thefactcoalition.org/wp-content/uploads/2021/12/TI_Private-Investments-Public-Harm-10.pdf</a>.
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These cases are intended to be illustrative, and, as FinCEN noted
in the proposed rule, ``an investment adviser may be unwittingly
complicit in this type of activity if they are not required to
understand the origin of funds or nature of their owner. A customer
wishing to launder money could ask an investment adviser to establish a
private fund to certain specifications without informing the adviser of
the customer's broader scheme.'' \62\ In addition, the IA AML NPRM
referenced the comprehensive Treasury review contained in the Risk
Assessment, which included substantial information beyond the case
examples, including a review of BSA reporting, materials derived from
civil enforcement actions, analysis provided by U.S. government
agencies, and other non-public information that demonstrated investment
advisers could be misused to help launder illicit proceeds. What the
case examples in the IA AML NPRM and Risk Assessment demonstrate is
that a range of illicit actors view investment advisers as potential
entry points into the U.S. financial system, and have sought to exploit
them.
---------------------------------------------------------------------------
\62\ See 89 FR at 12115.
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Further, without an AML/CFT program requirement or an obligation to
file SARs, an investment adviser has no obligation to evaluate the risk
of money laundering, terrorist financing, or other illicit finance
activity associated with its advisory customers and activities. As
discussed below, FinCEN understands, as some commenters have explained,
that investment advisers often conduct certain due diligence and screen
against sanctions lists, that they may provide AML/CFT and sanctions-
related representations and affirmations regarding their clients at the
request of banks or broker-dealers, and that an adviser's fiduciary
duty requires it to act in the best interest of its clients. At the
same time, FinCEN notes that investment advisers to private funds are
most commonly compensated based on a combination of (i) management fees
that are based on total AUM invested in (or committed to be invested
in) the private fund and (ii) performance-based compensation based on
the private fund's performance. These compensation arrangements
incentivize private fund advisers to add new investors and grow their
private fund assets.\63\ This incentive may lead to some advisers
refraining from voluntarily conducting a robust review of illicit
finance risk, as such review could lead to the adviser turning away
certain AUM, and thus lead to less compensation for the adviser. As
described in the IA AML NPRM, this can lead an investment adviser to
unwittingly assist in illicit finance activity.\64\
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\63\ Other investment advisers, who are often compensated as a
percentage of AUM even if they do not also receive performance-based
compensation, are similarly incentivized in general to increase
their assets under management.
\64\ See 89 FR at 12115.
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This rule will require investment advisers to adopt a risk-based
approach pursuant to which they must ask questions and analyze
potential money laundering, terrorist financing, and other illicit
finance risks--steps that will make it more likely that an investment
adviser will detect illicit finance activity. The reporting and
recordkeeping requirements of the BSA, especially SAR filing
obligations, are intended, among other things, to assist federal law
enforcement in the enforcement of existing money laundering statutes,
including by identifying instances of money
[[Page 72164]]
laundering activity to help facilitate investigation and prosecution.
In addition, AML/CFT requirements can serve as a separate basis for
civil or criminal enforcement action.
The Risk Assessment's conclusions were also supported by an
analysis of SARs. This analysis included approximately 12,000 SARs
filed over seven years where the investment adviser was identified
either as a subject of the SAR or in the narrative section of the SAR
(with the number of SAR filings in the analysis increasing 400 percent
over the review period). FinCEN agrees with the statement made by one
commenter that SARs are not by themselves proof of illegal activity,
but are intended to assist law enforcement in identifying potential
violations of law. FinCEN also notes that the SAR trend and pattern
analysis undertaken to support development of the Risk Assessment can
be valuable in helping the public and private sectors identify and
address illicit finance trends and systemic vulnerabilities. For
example, in section 6206 of the Anti-Money Laundering Act of 2020 (AML
Act), Congress mandated that FinCEN publish semiannual threat pattern
and trend information derived from BSA filings.\65\ Such efforts will
only be enhanced by requiring investment advisers to file SARs as well,
which will provide additional relevant information for FinCEN to
analyze.
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\65\ See 31 U.S.C. 5318(g)(6). See also FinCEN's Financial Trend
Analyses, issued pursuant to section 6206 of the AML Act of 2020,
available at <a href="https://www.fincen.gov/resources/financial-trend-analyses">https://www.fincen.gov/resources/financial-trend-analyses</a>.
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Regarding illicit finance tied to Russian oligarchs, FinCEN
recognizes that, as noted by some commenters, many of these investments
were made prior to the designation of these individuals and entities by
OFAC. Many investment advisers, along with other financial
institutions, took action to freeze assets linked to designated Russian
individuals and entities. However, even prior to their designation,
many of these individuals and entities were publicly known to be linked
to corruption, other criminal activity, or Russian malign influence
campaigns; yet they were still able to make investments through the
U.S. financial system.\66\ By engaging in such activities these
individuals and entities may be violating U.S. law and engaging in
sanctionable conduct even if they are not yet designated. Additional
AML/CFT requirements may have helped identify--or even mitigate the
extent of--assets or accounts that were owned, controlled, or otherwise
linked to criminal or sanctionable activities before the relevant
individuals were designated by forcing investment advisers to adopt a
risk-based approach to working with these individuals. More broadly,
such AML/CFT requirements are likely to help identify additional assets
or accounts that are owned, controlled, or otherwise linked to
designated persons, in turn supporting effective sanctions enforcement
efforts.\67\
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\66\ See 89 FR at 12115-12116.
\67\ See FIN-2023-Alert002, FinCEN Alert on Potential U.S.
Commercial Real Estate Investments by Sanctioned Russian Elites,
Oligarchs, and Their Proxies (Jan. 25, 2023) (noting that investors
seeking to evade sanctions may lower their interest in an investment
fund to just below the threshold set by a financial institution's
CDD standards to avoid detection).
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FinCEN agrees with the point raised by some commenters that certain
characteristics of private funds, such as longer lock-up periods or
limited opportunities to make withdrawals, may make these funds less
attractive for certain illicit finance activity that seeks to rapidly
enter and exit a financial product. However, as noted in the NPRM,
these requirements are unlikely to deter certain illicit actors who
have a medium- to long-term investment horizon and do not need
immediate access to invested capital, such as corrupt foreign
officials, financial facilitators for transnational criminal networks,
or those acting on behalf of designated persons, especially because of
the potential for high returns in these private funds.\68\ In addition,
some illicit actors may see private fund investments, in combination
with the use of a trust or other legal arrangement, as an alternative
if they are unable to launder or obscure funds directly through a bank
or brokerage account.\69\ FinCEN acknowledges that while private fund
advisers may perform sanctions or politically exposed person (PEP)
screening as part of their investor diligence, such efforts are only
one part of effective AML/CFT compliance. In addition, because such
advisers are not subject to consistent supervision for AML/CFT
compliance measures they may undertake, such measures may not be
applied consistently, and any deficiencies in these measures may not be
identified or remediated.
---------------------------------------------------------------------------
\68\ For instance, one subset of SARs analyzed for the Risk
Assessment found that RIAs that advised private funds were
associated with or referenced in SARs at twice the rate of RIAs that
did not advise private funds. The higher rate of filing tied to
private funds may result from custodians and other entities with SAR
filing obligations lacking insight into the identity and source of
wealth of underlying investors in the fund, even where those filers
may pursue additional diligence.
\69\ See Risk Assessment, supra note 2, at 16 & 27.
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For venture capital funds in particular, FinCEN notes that the
threat of misuse is not only for purposes of illicit technology
transfer through investments in portfolio companies of venture capital
funds, but also to facilitate the laundering and growth of illicit
proceeds. As noted in the IA AML NPRM and Risk Assessment, a Treasury
review of select BSA reporting filed between January 2019 and June 2023
identified more than 20 private fund advisers located in the United
States where the adviser was identified as having significant ties to
Russian oligarch investors or Russian-linked illicit activities. The
vast majority of those private fund advisers advised investment funds
that held themselves out as pursuing a venture capital strategy. Some
of these Russian oligarch-linked investors may have been attracted to
investing in venture capital funds because, like other venture capital
investors, they had a medium-to-long term investment horizon and were
willing to accept higher risk for higher investment returns.\70\
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\70\ A Treasury review of select BSA reporting identified
several U.S. venture capital firms with significant ties to Russian
oligarch investors that invested in firms developing emerging
technologies with national security applications. These include
autonomous vehicle technology and artificial intelligence systems,
as well as contractors to the U.S. military, intelligence, and other
government agencies. See Risk Assessment at 21-22.
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FinCEN also notes that while the BSA and its reporting and
recordkeeping requirements were originally developed to combat money
laundering, Congress has added to the purpose of the BSA over time an
objective to combat terrorism,\71\ as well as addressing other threats
to U.S. national security.\72\ Illicit technology transfer--that is,
the transfer of technology in violation of sanctions, export controls,
or other applicable laws--is both a threat to national security and may
be linked to money laundering and other forms of illicit finance. For
instance, in 2022 and 2023 FinCEN issued a series of joint alerts with
the Department of Commerce's Bureau of Industry and Security (BIS) to
assist financial institutions in detecting transactions linked to
Russian attempts
[[Page 72165]]
to acquire military or dual-use technology.\73\ These alerts reflect
the reality that money laundering and other forms of illicit finance
may be part of illicit technology transfer because adversaries must
conceal their illegal attempts to obtain technology. FinCEN assesses
that applying AML/CFT measures to RIAs and ERAs will assist in
combating these and other threats to the U.S. financial system and
national security.
---------------------------------------------------------------------------
\71\ See 31 U.S.C. 5311(2) (preventing the financing of
terrorism). Section 358 of the USA PATRIOT Act added to the purposes
of the BSA to require reporting or recordkeeping highly useful in
``intelligence or counterintelligence activities, including
analysis, to protect against international terrorism.'' Public Law
107-56, sec. 358(a).
\72\ See 31 U.S.C. 5311(4) (safeguarding the national security
of the United States). Section 6101 of the AML Act amended the
purposes of the BSA to include ``assess the money laundering,
terrorism finance, tax evasion, and fraud risks to financial
institutions, products, or services to . . . safeguard the national
security of the United States.'' Public Law 116-283, Div. F, sec.
6101(a).
\73\ See FIN-2022-Alert003, FinCEN and the U.S. Department of
Commerce's Bureau of Industry and Security Urge Increased Vigilance
for Potential Russian and Belarusian Export Control Evasion Attempts
(Jun. 28, 2022); see also FIN-2023-Alert004, Supplemental Alert:
FinCEN and the U.S. Department of Commerce's Bureau of Industry and
Security Urge Continued Vigilance for Potential Russian Export
Control Evasion Attempts (May 19, 2023).
---------------------------------------------------------------------------
FinCEN does not believe that the comments regarding the absence
thus far of an adviser to a venture capital fund engaging in illicit
finance in the IA AML NPRM requires any change to the final rule. The
examples cited in the preamble are meant only to be illustrative of the
risks and do not lay out the full evidence available to FinCEN, and
these comments rely upon a particularly narrow framing of the evidence
presented in the IA AML NPRM. The IA AML NPRM states that ``according
to the FBI, the PRC government routinely conceals its ownership or
control of investment funds to disguise efforts to steal technology or
knowledge and avoid notice to CFIUS.'' \74\ As one commenter
acknowledges, the IA AML NPRM discusses state-guided or -owned venture
capital funds acting on behalf of the PRC and Russia.\75\ Furthermore,
as noted by other commenters, there are public reports of specific
venture capitalists with ties to Russian oligarchs or Russian
government-backed institutions.\76\ Indeed, a recent bulletin published
by the National Counterintelligence and Security Center highlights how
foreign threat actors can exploit venture capital and other private
investment to undermine U.S. national security.\77\ For these reasons,
FinCEN's assessment that venture capital funds pose illicit finance
risk is supported by the available evidence.
---------------------------------------------------------------------------
\74\ 89 FR at 12116.
\75\ Id.
\76\ See, e.g., Joseph Menn et al., From Russia with money:
Silicon Valley distances itself from oligarchs, Washington Post
(Apr. 1, 2022); Giacomo Tognini, Russian Oligarch Roman Abramovich
Invested In Startups That Received U.S. Government Contracts, Forbes
(June 9, 2023).
\77\ See Safeguarding Our Innovation at 1, supra note 51. This
bulletin highlighted common tools that foreign threat actors use to
penetrate the U.S. financial system, including complex ownership
structures, investments through intermediaries, and limited partner
investments. Id. at 2. For example, one firm identified in the
bulletin that had been added to the Department of Defense's list of
``Chinese military companies'' in January 2024 is an ERA that has
made investments in more than 1,600 companies, including several
U.S. firms.
---------------------------------------------------------------------------
In response to the suggestion that these threats would be better
addressed through other government authorities like CFIUS, FinCEN seeks
to clarify fundamental differences between the CFIUS process and the
AML/CFT obligations set out in this rule. FinCEN notes that CFIUS
reviews are focused on certain transactions involving foreign
investment in the United States and certain real estate transactions by
foreign persons, in order to determine the effect of such transactions
on the national security of the United States.\78\ Whereas CFIUS
reviews lawful investments, this rule is aimed at combating illicit
activity, whether in the form of money laundering and other illicit
finance, or in the form of technology transfer in violation of
applicable law. CFIUS jurisdiction has well-established limits, and
many common financial transactions, such as certain loans or passive
fund investments, are not subject to CFIUS jurisdiction.\79\ By
Executive Order, CFIUS mitigation agreements may only address national
security risks ``not adequately addressed by other provisions of law,''
such as the BSA.\80\ Within its jurisdiction, CFIUS has a broad mandate
to assess the effect of a covered transaction on national security; it
need not find any violation of law in order to recommend the
transaction to the President who has the authority to block or unwind a
transaction, as appropriate under CFIUS legal authorities.\81\ The
connection between CFIUS and the final rule would therefore be limited:
SARs identifying potential unlawful activity will assist CFIUS in
identifying transactions linked to such activity that may raise
national security concerns, and recordkeeping and other requirements
may facilitate the collection of additional information on certain
participants in CFIUS transactions who may seek to obscure their role
through private funds.
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\78\ See Executive Order (E.O.) 11,858, as amended, sec. 6(b),
73 FR 4677, 4678 (Jan. 23, 2008) (``The Committee shall undertake an
investigation of a transaction in any case . . . in which . . . the
transaction threatens to impair the national security of the United
States and that the threat has not been mitigated.'').
\79\ 31 CFR 800.302(b), 800.306(a).
\80\ 50 U.S.C. 4565(d)(4)(B); E.O. 11858, sec. 7(a) as amended
by E.O. 13456.
\81\ See, e.g., 50 U.S.C. 4565(b), (d).
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In the IA AML NPRM and Risk Assessment, FinCEN considered the
existing requirements under the Advisers Act and its implementing
regulations, the extent to which AML/CFT requirements were applied to
advisory activities, and how other rules and regulations, such as those
issued by OFAC to implement sanctions requirements,\82\ may mitigate
the identified illicit finance risks. While AML/CFT obligations for
banks, broker-dealers, and other financial institutions can assist in
detecting some illicit activity, these entities may not directly
interact with an adviser's underlying customers. Moreover, these
entities may not be in the best position to obtain the necessary
documentation and information about the customers that is relevant for
AML/CFT purposes, such as the source of customers' assets, the
customers' backgrounds, and the customers' investment objectives. One
commenter observed that in connection with oversight of broker-dealers
for compliance with AML/CFT requirements, investment advisers often
have the sole or most direct relationship with customers and possess
knowledge of the full spectrum of transactions effected through broker-
dealers and other custodians that may present money laundering or other
illicit finance risks. Another commenter noted that investment advisers
in some cases already provide other financial institutions with AML/CFT
and sanctions-related representations and affirmations regarding
customers they advise (including private funds), which underscores the
fact that advisers often have more information on their customers than
banks or broker-dealers have. Further, requiring RIAs and ERAs to apply
AML/CFT measures may lead to earlier notification of illicit finance
activity via SAR filings, and reduce the time law enforcement needs to
receive relevant information and take action against illicit actors.
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\82\ While OFAC sanctions requirements are separate from AML/CFT
requirements, investment advisers, like other U.S. persons, must
comply with OFAC sanctions. AML/CFT requirements and OFAC sanctions
also share a common national security goal, apply a risk-based
approach, and rely on similar recordkeeping and reporting
requirements to ensure compliance. For this reason, many financial
institutions view compliance with OFAC sanctions as related to AML/
CFT compliance obligations and may include sanctions compliance and
AML/CFT compliance in a single enterprise-wide compliance program.
---------------------------------------------------------------------------
While existing requirements under the Advisers Act and its
implementing regulations, including recordkeeping, compliance, and
reporting requirements, can assist in implementation of AML/CFT
measures, they do not require the collection of the same information as
do the AML/CFT requirements. The illicit finance risks
[[Page 72166]]
documented in the IA AML NPRM and Risk Assessment remain, despite such
existing requirements and the assertions in comments about existing
fiduciary duty, and thus FinCEN has determined that the final rule is
necessary and appropriate to mitigate those risks. Further, while
FinCEN recognizes that an adviser involved in facilitating illicit
finance activity could face contractual liability on a variety of
bases, these violations generally result in civil liability to private
parties. This is not an adequate substitute for the comprehensive
government civil and criminal enforcement mechanisms available for
violations of AML/CFT laws, and the range of effective, proportionate,
and dissuasive penalties that can be applied. These measures are
necessary to address the public harm resulting from illicit finance
activity that may occur through investment advisers.
B. Definition of ``Financial Institution'' and ``Investment Adviser''
1. Defining Investment Advisers as ``Financial Institutions''
Proposed Rule: FinCEN proposed to add ``investment adviser'' to the
definition of ``financial institution'' under the regulations
implementing the BSA because FinCEN has determined that investment
advisers engage in activities that are ``similar to, related to, or a
substitute for'' financial services that other BSA-defined financial
institutions are authorized to engage in.
Comments Received: FinCEN received comments that both supported and
did not support including investment advisers within the definition of
``financial institution'' under the regulations implementing the BSA
and including RIAs and ERAs within the definition of ``investment
adviser.'' Three commenters noted that the proposed definition is a
proactive step to address gaps in existing AML/CFT framework and called
for FinCEN to retain a comprehensive definition in the final rule. One
commenter called for FinCEN to also include foreign private advisers,
family offices, and advisers to real estate investment funds within
this definition.
Nine commenters disagreed with adding ``investment adviser'' to the
definition of ``financial institution'' in the regulations issued
pursuant to the BSA. Several of these commenters asserted that doing so
would apply redundant and unnecessary AML/CFT requirements to
investment advisers, as the entities that process cash and securities
transactions, such as broker-dealers and banks, are already subject to
AML/CFT requirements.
One commenter claimed that as investment advisers are not
specifically enumerated in the statutory definition of ``financial
institution'' under the BSA, FinCEN may not have the authority to
define investment advisers as ``financial institutions'' under the BSA
without additional Congressional action. This commenter also disagreed
with FinCEN's determination that investment advisers engaged in
activities that were ``similar to, related to, or a substitute for''
activities in which any of the enumerated financial institutions are
authorized to engage. The commenter stated that BSA-defined financial
institutions, such as banks and broker-dealers, are required to apply
AML/CFT requirements because of their status as banks and broker-
dealers, and not because they engage in particular activities.
This commenter also asked whether FinCEN intended to include within
the definition of ``financial institution'' other professions or
entities that are authorized to make investment or other financial
decisions on behalf of a principal. The commenter argued that the
proposed rule could raise questions about whether trustees, attorneys,
executors of estates, receivers in bankruptcy proceedings, or others
similarly situated are substituting for the activities of BSA-defined
financial institutions and are covered by the proposed rule.
Another commenter stated that entities defined as ``financial
institutions'' under the BSA have in common the fact that they have
custody over customer's funds. The commenter noted that investment
advisers, by contrast, do not take custody of a customer's funds, and
must act in conjunction with other financial institutions to transact
on behalf of their clients. The commenter suggested that if the
proposed rule were to be finalized, the definition of ``investment
adviser'' must be narrowed to capture only advisers who engage in
activities that arguably more closely resemble financial institution
activities. Another commenter suggested that FinCEN apply AML/CFT
requirements to private funds rather than to the investment advisers to
those funds, noting that the fund itself has the contractual
relationship with the investor and receives customer due diligence
information.
Two other commenters raised questions about the impact of including
``investment adviser'' in the definition of ``financial institution''
in the regulations that implement the BSA. These two commenters
indicated that FinCEN must account for the differences in the roles and
functions of investment advisers from banks and broker-dealers in
existing and future BSA rulemakings, and should consult with investment
advisers before applying general AML/CFT requirements for ``financial
institutions'' to investment advisers.
Final Rule: For the reasons described in the IA AML NPRM, FinCEN is
adding ``investment adviser'' to the definition of ``financial
institution'' under the regulations implementing the BSA, as proposed,
because FinCEN has determined that investment advisers engage in
activities that are ``similar to, related to, or a substitute for''
financial services that other BSA-defined financial institutions are
authorized to engage in.
While the BSA has an enumerated list of entities that are
``financial institutions,'' \83\ the statute also explicitly provides
the Secretary of the Treasury with the authority to add entities to
that list upon determining, ``by regulation,'' that any business or
agency is engaged in ``an activity similar to, related to, or a
substitute for any activity'' in which any of the enumerated financial
institutions are authorized to engage.\84\ This language provides
Treasury with the statutory authority to define additional entities as
financial institutions as business and organizational structures, and
risks, in financial services evolve and illicit actors seek to exploit
potential gaps in AML/CFT regulation, as FinCEN has observed with
respect to investment advisers.
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\83\ 31 U.S.C. 5312(a)(2), (c)(1).
\84\ 31 U.S.C. 5312(a)(2)(Y) (emphasis added). FinCEN may also
designate businesses ``whose cash transactions have a high degree of
usefulness in criminal, tax, or regulatory matters'' as financial
institutions. 31 U.S.C. 5312(a)(2)(Z).
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FinCEN continues to see ample evidence that investment advisers
engage in activities ``similar to, related to, or a substitute for''
activities in which other financial institutions are authorized to
engage. As noted in the IA AML NPRM, investment advisers work closely
with financial institutions when they direct broker-dealers to purchase
or sell client securities, and therefore engage in activities that are
closely related to the activities of covered financial institutions. An
RIA must use a qualified custodian--such as a bank or broker-dealer--to
take custody of client assets, even when advising private funds.\85\ In
addition, investment
[[Page 72167]]
advisers are frequently owned by or under common ownership with banks,
broker-dealers, and other financial institutions. Broker-dealers may
conduct certain similar advisory activities for their customers \86\
and investment advisers must compete with other financial institutions
that provide investment opportunities, such as banks and broker-
dealers, to attract investor funds.
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\85\ See 17 CFR 275.206(4)-2; see also 12 CFR 225.125(a) (FRB
determining that investment adviser activities ``to be so closely
related to banking or managing or controlling banks as to be a
proper incident thereto'').
\86\ See 15 U.S.C. 80b-2(a)(11)(C).
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There is ample evidence that RIAs and ERAs who advise private funds
engage in activities ``similar to, related to, or a substitute for''
activities in which other financial institutions are authorized to
engage. The services provided by RIAs and ERAs advising private funds
are closely related to the services provided by broker-dealers who buy
and sell securities on their behalf. Private fund advisers may be under
common ownership with banks, broker-dealers, or other financial
institutions. Broker-dealers, like RIAs or ERAs advising private funds
pursuant to the Advisers Act, may ``advis[e] others . . . as to the
value of securities or as to the advisability of investing in,
purchasing, or selling securities.'' \87\ And an RIA or ERA advising
private funds must also compete with other financial institutions that
offer investment opportunities for investor assets.
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\87\ 15 U.S.C. 80b-2(a)(11). See also SEC, Commission
Interpretation Regarding the Solely Incidental Prong of the Broker-
Dealer Exclusion From the Definition of Investment Adviser,
Interpretation, 84 FR 33681 (Jul. 12, 2019).
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FinCEN's statutory authority to designate investment advisers as
financial institutions is confirmed by clear evidence of Congressional
intent. The legislative history during the drafting of the USA PATRIOT
Act supports that Congress viewed RIAs as sufficiently similar to
certain other financial institutions that Treasury could require them
to file SARs.\88\ Congress reaffirmed this view more recently when, in
connection with appropriations legislation passed in December 2022,
Congress highlighted the illicit finance concerns associated with
``investment advisers such as hedge fund managers'' and encouraged
FinCEN ``to update and finalize its 2015 investment adviser rule as
soon as possible.'' \89\
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\88\ House Report 107-250(I), Financial Anti-Terrorism Act of
2001, 2001 WL 1249988 at *66 (Oct. 17, 2001); see also Public Law
107-31, Title III, sec. 321 (Oct. 26, 2001) (section of USA PATRIOT
Act adding futures commission merchants, commodity trading advisors,
and commodity pool operators to the definition of ``financial
institutions'' for purposes of 31 U.S.C. 5312(a)).
\89\ See Consolidated Appropriations Act, 2023, Public Law 117-
328, 136 Stat. 4459, Joint Explanatory Statement (Division E),
p.1156, available at <a href="https://www.congress.gov/117/cprt/HPRT50347/CPRT-117HPRT50347.pdf">https://www.congress.gov/117/cprt/HPRT50347/CPRT-117HPRT50347.pdf</a>.
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FinCEN also notes that having custody or directly holding customer
funds is not a prerequisite for being included within the definition of
``financial institution'' in the regulations issued pursuant to the
BSA. For example, the BSA defines an ``investment company'' and an
``operator of a credit card system,'' as a ``financial institution,''
and neither of these institutions routinely custody or directly hold
customer funds.\90\ In addition, an ``investment banker'' and ``persons
involved in real estate closings and settlements'' are also defined in
the BSA as financial institutions, but may not directly receive, send,
or transmit any customer funds. While broker-dealers and banks provide
custodial services to their customers, they are also authorized to
engage in a range of other financial services--such as extending
credit--that do not involve taking custody of client funds, but are
nonetheless subject to AML/CFT requirements. In sum, the statutory
language authorizes Treasury to define as a financial institution any
business that engages in activity similar to any activity in which the
enumerated financial institutions are authorized to engage, not just
specific activities involving the transfer or custody of customer
funds.
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\90\ 31 U.S.C. 5312(a)(2)(L), (M).
---------------------------------------------------------------------------
In response to the comment asking whether FinCEN intends to
regulate other entities or professions that act as agents for a
principal and whether this would create ambiguity for those entities
and professions, FinCEN notes that the rule would only apply to RIAs
and ERAs, categories of entities that are clearly defined under the
Advisers Act. If FinCEN were to regulate such other entities or
professions in the same manner as in the final rule, this would occur
through a new rulemaking on which any affected person could comment. An
attorney, trustee, executor, or other person in a principal-agent
relationship therefore has no reason to find the scope of the final
rule ambiguous as applied to them; they merely need to know if they
have registered (or are required to register) or have filed with the
SEC as an RIA or ERA.
Regarding whether to apply AML/CFT obligations to private funds
rather than the advisers to those funds, FinCEN notes that in many
cases the adviser to a private fund will have a relationship (in some
cases contractual) with underlying investors and has access to
information about underlying investors. Indeed, the SEC requires RIAs
and ERAs to report information regarding underlying investors on Form
ADV and Form PF.\91\ Further, private funds also typically lack
employees, and are reliant upon their service providers, such as their
advisers, to satisfy the private fund's legal and compliance
obligations. Accordingly, the adviser, rather than the fund, is best
positioned to apply the full range of AML/CFT measures beyond customer
due diligence. FinCEN also acknowledges the point made by commenters
that there are AML/CFT requirements that may be applied to all BSA-
defined financial institutions, which if amended, would also change the
obligations of investment advisers.\92\ If FinCEN were to amend these
AML/CFT requirements, it anticipates considering the specific
attributes of investment advisers when deciding whether and how to
apply such requirements to investment advisers.
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\91\ See supra note 45.
\92\ For instance, FinCEN did not include ``investment adviser''
in the proposed rule to amend the AML/CFT program requirements for
other types of BSA-defined financial institutions. See FinCEN, Anti-
Money Laundering and Countering the Financing of Terrorism Programs,
Notice of Proposed Rulemaking, 89 FR 55428 (Jul. 3, 2023).
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2. Registered Investment Advisers
Proposed Rule: FinCEN proposed to include SEC-registered investment
advisers (RIAs) in its definition of investment adviser with regard to
the proposed changes to the definition of financial institution under
31 CFR 1010.100.
Comments Received: Six commenters commented on the proposed
definition of ``investment adviser'' and the impact it would have on
smaller RIAs. One commenter stated that smaller advisers generally pose
less illicit finance risk and should be excluded for the same reasons
that FinCEN had proposed to exclude State-registered advisers, namely
their lower AUM, fewer customers, and that their customers tend to be
localized. Another commenter asserted that the reliance on AUM as the
sole determinant for regulatory thresholds overlooks the practical
considerations of the size and capacity of RIAs, particularly smaller
firms, and that AUM may not accurately reflect the complexity or scale
of a firm, especially when AUM is primarily derived from a small number
of clients. They suggested that regulatory thresholds be evaluated
based on a combination of factors, including the number of employees
and average AUM per client.
[[Page 72168]]
Two commenters suggested advisers with fewer than 20 employees
should be exempt from the requirements of the proposed rule, while one
commenter suggested that firms with fewer than 100 employees should be
exempt from the requirements of the proposed rule. These commenters
claimed that smaller advisers would need to divert resources from
client-servicing functions and other compliance requirements to invest
in building out an AML/CFT program, and would need to outsource the
independent testing requirement to a third party, which would create
additional burden.
One commenter requested that investment advisers who do not manage
client assets be excluded from the proposed rule. That commenter
contended that applying AML/CFT requirements to these investment
advisers would produce no valuable information for law enforcement or
regulators, as these advisers are not involved in the management of
client assets or funds transfer activity. Another commenter suggested
that RIAs whose client's investments are held by an account custodian
should be exempt from the proposed regulation.
Final Rule: FinCEN is modifying the definition of ``investment
adviser'' from the proposed rule to exempt certain types of RIAs in
response to comments.\93\ Accordingly, these types of RIAs will not be
subject to the final rule. FinCEN recognizes the concerns raised by
commenters regarding the impact of the proposed rule on smaller RIAs,
based on AUM or other applicable criteria. As noted in the IA AML NPRM,
FinCEN is mindful of the effect of new regulations on small businesses,
given their critical role in the U.S. economy and the special
consideration that Congress and successive administrations have
mandated that Federal agencies should give to small business concerns.
FinCEN would like to reiterate that the AML/CFT requirements in this
rule are designed to be risk-based and that their cost will vary with
the size of the business, along with the risk level of its advisory
activities and customers. This means that smaller advisers would be
expected to adopt AML/CFT programs that are consistent with their
(often) simpler, more centralized organizational structures and so
would be more likely to have lower implementation-related costs, absent
other high-risk attributes for illicit finance risks.
---------------------------------------------------------------------------
\93\ These changes reflect, in part, comments received in
response to the IA AML NPRM.
---------------------------------------------------------------------------
In reviewing the comments that addressed this issue, FinCEN sought
to identify an approach that would balance concerns about the burden on
smaller RIAs as well as ensure that such an approach is easily
understood by advisers subject to the final rule, systematically
addresses illicit finance risk in the investment adviser sector, and is
administrable in practice by FinCEN and the SEC (and other relevant
regulators). Regarding the proposal to exempt advisers with fewer than
either 20 or 100 employees, FinCEN notes that the number of employees
that an adviser has is not necessarily aligned with the types of
advisory customers, activities, or other factors relevant to the
illicit finance risk of an adviser. Some advisers may manage
significant assets from a small number of customers, while other
advisers may manage small accounts held by a large number of customers,
requiring additional employees to service those accounts. To create a
threshold for application of AML/CFT requirements based on employee
numbers alone would be inconsistent with Treasury's understanding of
risk in the sector. For example, an adviser managing significant
assets, but with few employees, is of greater risk of being used by
malign actors to launder large sums of money than an adviser with more
employees but a small amount of assets under management. Further,
imposing such a threshold could lead to perverse outcomes where RIAs
are incentivized to hirer fewer non-revenue staff, such as those
responsible for AML/CFT compliance. A threshold could also raise
questions with respect to other BSA-defined financial institutions,
which typically do not have such thresholds. FinCEN therefore declines
to apply the proposed exemption for RIAs with fewer than either 20 or
100 employees.
However, FinCEN has sought to appropriately tailor the scope of
entities covered by the final rule to balance commenters' concerns
about the potential burden on smaller advisers with the investment
adviser sector-wide identified illicit finance risks. FinCEN also
sought to, while considering the diversity of business models in the
advisory business, fashion the rule in a way that can be clearly
applied and examined by the SEC, and that is transparent to RIAs and
ERAs subject to the rule. Therefore, FinCEN is exempting from the
definition of ``investment adviser'' RIAs that register with the SEC
because they are (i) Mid-Sized Advisers, (ii) Multi-State Advisers, and
(iii) Pension Consultants, as well as (iv) RIAs that do not report any
AUM on Form ADV. The final rule's exemptions apply, however, only to
investment advisers that are registered with the SEC on only one or
more of the above listed bases, and have no other basis for
registration.\94\ For example, an investment adviser that registers (or
could register) with the SEC both because: (a) it has AUM of more than
$110 million (and so registers as a ``large advisory firm'' on Form
ADV) and (b) it would otherwise be required to register with more than
15 states, will not be eligible for the exemption.
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\94\ See 31 CFR 1010.100(nnn)(ii)(1) (exempting an investment
adviser that is registered ``only'' because it meets the conditions
of being is either a mid-sized adviser, a pension consultant, or a
multi-state adviser). For the avoidance of doubt, an investment
adviser that is registered because it meets the conditions of more
than one of these exemptions, but that is not otherwise required to
register, is also exempt from the definition of ``investment
adviser.''
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As described below and in the Risk Assessment, FinCEN assessed
State-registered advisers as generally lower-risk for money laundering,
terrorist financing, or other illicit finance activity. Therefore,
FinCEN has chosen not to apply the proposed rule to State-registered
advisers at this time. At the same time, FinCEN notes that there are
certain types of RIAs that resemble State-registered advisers because
they would otherwise be prohibited from registering with the SEC but
are required to or choose to do so because they satisfy the conditions
of certain exemptions from the prohibition on SEC registration.
First, there are certain RIAs who have AUM between $25 million and
$100 million but who either: (i) are not required to be registered as
an adviser with the state securities authority in the state where they
maintain their principal office and place of business; or (ii) are not
subject to examination as an adviser by the state in which they
maintain their principal offices and places of business (Mid-Sized
Advisers).\95\ These Mid-Sized Advisers are required to register with
the SEC.\96\ According to a review of information filed on Form ADV,
there are 468 Mid-Sized Advisers who, on average, have $54.6 million in
AUM, 6 employees, and 129 customers, 97 percent of which are natural
persons.\97\
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\95\ See 15 U.S.C. 80b-3a(a)(2). On Form ADV, these Mid-Sized
Advisers check the box in Item 2.A noting they are a ``mid-sized
advisory firm.'' See Form ADV, Instructions for Part 1A, available
at <a href="https://www.sec.gov/about/forms/formadv-instructions.pdf">https://www.sec.gov/about/forms/formadv-instructions.pdf</a>.
\96\ See 15 U.S.C. 80b-3a(a)(2); Form ADV, Instructions for Part
1A, available at <a href="https://www.sec.gov/about/forms/formadv-instructions.pdf">https://www.sec.gov/about/forms/formadv-instructions.pdf</a>.
\97\ This information is derived from a Treasury review of Form
ADV information filed as of July 31, 2023. See supra note 25.
---------------------------------------------------------------------------
Second, advisers who would otherwise be required to register in
more
[[Page 72169]]
than 15 states, but have less than $100 million in AUM, can choose
instead to register with the SEC (Multi-State Advisers).\98\ According
to a review of the information filed on Form ADV, in 2023 there were 90
Multi-State Advisers who, on average, have $27.6 million in AUM, 28
employees, and 1,300 customers.\99\ While the majority of Multi-State
Advisers' customers are legal entities, approximately 90 percent of
these customers are United States persons. These firms have a larger
number of employees and customers than the average State-registered
adviser, but relatively small AUM.\100\ FinCEN has decided to exempt
these two categories of advisers because their advisory activities and
customers are generally lower-risk,\101\ more closely resembling State-
registered advisers than RIAs who satisfy the general requirements for
registration, to address some of the concerns regarding possible burden
on smaller advisers that were raised by commenters.
---------------------------------------------------------------------------
\98\ See 17 CFR 275.203A-2(d).
\99\ This information is derived from a Treasury review of Form
ADV information filed as of July 31, 2023. See supra note 25.
\100\ This exemption was designed to allocate regulatory
responsibility to the SEC for larger investment advisers, whose
activities are likely to affect national markets, and to relieve
these advisers of the burdens associated with multiple state
regulations. See SEC, Exemption for Investment Advisers Operating in
Multiple States; Revisions to Rules Implementing Amendments to the
Investment Advisers Act of 1940; Investment Advisers with Principal
Offices and Places of Business in Colorado or Iowa, Final Rule, 63
FR 39708, 39709 (Jul. 24, 1998).
\101\ This determination is based on the tailored BSA analysis
on this subset of RIAs described infra.
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Along with these two categories of RIAs, FinCEN also identified two
categories of RIAs that do not directly manage client assets and, as
discussed below, pose little or no risk of being used as an entry point
into the U.S. financial system for illicit proceeds. First, there are
some RIAs who do not manage client assets as part of their advisory
activities, and report zero AUM on Form ADV.\102\ According to
information derived from Form ADV, as of July 2023 there were 655 RIAs
who report zero AUM on Form ADV.\103\ These RIAs have, on average, 73
employees and 640 customers, and 90 percent of their customers were
United States persons.\104\ Services provided by these advisers may
include non-discretionary financial planning (such as fee-only advice)
and publication of securities-related newsletters, ``model
portfolios,'' or research reports.
---------------------------------------------------------------------------
\102\ See supra note 28 (for additional information on how AUM
is calculated). The Form ADV instructions provide general criteria
for determining whether an investment adviser provides continuous
and regular supervisory or management services. For example, the
instructions to Item 5.F state that an investment adviser provides
such services if it has ``discretionary authority over and
provide[s] ongoing supervisory or management services,'' and the
Form ADV Glossary of Terms defines ``discretionary authority'' for
these purposes. The Form ADV instructions are available at <a href="https://www.sec.gov/about/forms/formadv-instructions.pdf">https://www.sec.gov/about/forms/formadv-instructions.pdf</a>.
\103\ This information is derived from a Treasury review of Form
ADV information filed as of July 31, 2023. See supra note 25.
\104\ Id.
---------------------------------------------------------------------------
FinCEN agrees with commenters that such advisers are generally
unlikely to have sufficient information about a customer's source of
funds, background, and investment objectives to detect suspicious
financial activity, and, in some instances, may lack even the names of
individual customers. While these advisers may have more employees and
customers than the average State-registered adviser, as described
above, these advisers' activities are unlikely to be used for illicit
finance activity, these advisers may not be able to provide useful
information to law enforcement or other government authorities, and, to
the extent their customers effect financial transactions in the United
States on the basis of the services received from the investment
adviser (e.g., trading based on reading research reports), they likely
do so as direct customers of a BSA-regulated financial institution,
such as through a brokerage account.
FinCEN also identified 186 RIAs who register with the SEC because
they are ``pension consultants'' as that term is defined under the
Advisers Act regulations.\105\ According to a review of information
filed on Form ADV, these RIAs have, on average, 334 employees, and over
20,000 customers.\106\ Advisers registered as pension consultants
advise at least $200 million in assets held by certain employee benefit
plans subject to, or described in, the Employee Retirement Income
Security Act of 1974 (ERISA).\107\ As FinCEN understands, many of these
advisers do not exercise investment discretion over assets they advise,
but generally assist other investment advisers or ERISA plan
fiduciaries in designing investment lineups for employee benefit
plans.\108\ In addition, as noted by commenters, employee benefit plans
are generally subject to strict contribution and withdrawal limits, are
usually available to only employees of a participating company, and are
subject to other requirements under ERISA (or similar state laws) and/
or the Internal Revenue Code (IRC).\109\
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\105\ An investment adviser is a ``pension consultant'' for
purposes of rule 203A-2(a)(2) if it provides investment advice to
(i) any employee benefit plan described in section 3(3) of ERISA,
(ii) any governmental plan described in section 3(32) of ERISA, or
(iii) any church plan described in section 3(33) of ERISA (29 U.S.C.
1002(33)). 17 CFR 275.203A-2(a)(2).
\106\ This information is derived from a Treasury review of Form
ADV information filed as of July 31, 2023. See supra note 25.
\107\ 17 CFR 275.203A-2(a)(1).
\108\ See Rules Implementing Amendments to the Investment
Advisers Act of 1940, Final Rule, 76 FR 42950, 42959 (Jul. 19, 2011)
(``[P]ension consultants typically do not have ``assets under
management,'' but we have required these advisers to register with
[the SEC] because their activities have a direct effect on the
management of large amounts of pension plan assets.''); Rules
Implementing Amendments to the Investment Advisers Act of 1940,
Final Rule, 62 FR 28112, 28117 n. 60 (May 22, 1997) (``[A] pension
consultant has substantially less control over client assets than an
adviser that has assets under management.''). See also SEC, Staff
Report Concerning Examinations of Select Pension Consultants, 1 (May
16, 2005), available at <a href="https://www.sec.gov/news/studies/pensionexamstudy.pdf">https://www.sec.gov/news/studies/pensionexamstudy.pdf</a>.
\109\ See, e.g., 29 CFR 2520 (rules and regulations for
reporting and disclosure for ERISA plans).
---------------------------------------------------------------------------
While these are not, on average, ``smaller'' advisers, they
exclusively engage in certain activities that are less likely to be
used for, or to generate useful information for law enforcement about,
illicit finance activity. For instance, their advisory activities on
behalf of these employee benefit plans are subject to additional
disclosures and restrictions on compensation arrangements under ERISA
and other relevant statutes that limit their incentive to facilitate
the movement of illicit proceeds. While the misuse of employee benefit
plans has been linked to certain types of financial crime, such as
fraud or account takeover activity,\110\ these plans, whether defined
benefit plans or defined contribution plans, are less likely to be
misused to obscure illicit proceeds generated from a separate criminal
scheme. While defined benefit plans may invest plan assets in private
funds, there is not the same uncertainty as to beneficial ownership and
source of wealth as with other private fund investors.\111\ For defined
benefit plans, the funds are typically derived from the employer
contributions to the defined benefit plan. In addition, these advisers
are less
[[Page 72170]]
likely to have unique information or knowledge about plan activities or
assets to identify and report suspicious activity. As such, FinCEN
assesses that these advisers will likely not generate relevant
information to assist government authorities in combating illicit
finance and subjecting these advisers to the rule's coverage would not
meaningfully advance the rule's objectives.
---------------------------------------------------------------------------
\110\ See, e.g., FBI, IC3 2023 Elder Fraud Report, at 14, 19,
available at <a href="https://www.ic3.gov/Media/PDF/AnnualReport/2023_IC3ElderFraudReport.pdf">https://www.ic3.gov/Media/PDF/AnnualReport/2023_IC3ElderFraudReport.pdf</a>.
\111\ For the avoidance of doubt, the absence of uncertainty as
to beneficial ownership and source of wealth is the case only when
the investment in a private fund comes from a defined benefit plan.
When an investment adviser directs investment into a private fund,
the risk of any other investments directed into the private fund
must be evaluated separately. An investment adviser who is not a
pension consultant and advises a private fund that receives
investments from a defined benefit plan may not exclude such private
fund from its obligations under this rule, although, as explained
below, such an adviser may account for the source of such investment
in determining which policies, procedures, and controls to apply to
the fund on a risk basis.
---------------------------------------------------------------------------
FinCEN, in coordination with federal law enforcement, reviewed BSA
reporting associated with these four groups of RIAs (i.e., Mid-Sized
Advisers, Multi-State Advisers, pension consultants, and advisers who
report zero AUM on Form ADV). This analysis found that 5.5 percent of
these RIAs 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) between 2013 and 2023. That is substantially less
than the 15.4 percent of all RIAs and ERAs that were associated with or
referenced in at least one SAR between 2013 and 2021. When considering
this information with other information on illicit finance threats
available to FinCEN, and the structural factors discussed above that
may make these subgroups of RIAs less vulnerable to misuse for illicit
finance, FinCEN has determined that exempting these groups of RIAs from
the final rule would be consistent with the objective of this rule.
Therefore, for all of the reasons noted above, FinCEN has
determined to exempt from the definition of ``investment adviser''
investment advisers that register with the SEC solely on the basis that
they are Mid-Sized Advisers, Multi-State Advisers, pension consultants,
and advisers who report zero AUM on Form ADV. FinCEN notes that, should
the registration status of an RIA change such that the RIA would no
longer be exempt from the definition of ``investment adviser,'' the
adviser will become subject to the AML/CFT requirements in this rule as
of its next annual updating amendment to Form ADV.\112\ The scope of
such advisers exempted from the final rule's definition of ``investment
adviser'' is reflected in the regulatory text added at
1010.100(nnn)(ii).
---------------------------------------------------------------------------
\112\ Under the Instructions to Form ADV, Item 2 of Part 1A,
which addresses an investment adviser's basis for registration with
the SEC, must be updated annually.
---------------------------------------------------------------------------
3. Exempt Reporting Advisers
Proposed Rule: FinCEN proposed to include Exempt Reporting Advisers
(ERAs) in its definition of ``investment adviser'' with regard to the
proposed changes to the definition of financial institution under 31
CFR 1010.100.
Comments Received: Four commenters supported FinCEN's proposal to
include ERAs in the definition of ``investment adviser,'' noting the
significant illicit finance risks present in this subset of the
investment adviser sector and the ``loophole'' that would be created by
subjecting RIAs but not ERAs to the proposed regulations. Some of these
commenters noted that the Risk Assessment found that the risks were
higher amongst ERAs than RIAs. One commenter stated that ERAs should be
subject to the requirements in the proposed rule because they were
already subject to rules and prohibitions under the Federal securities
laws designed to root out misconduct in financial markets, and that the
rationale for applying these requirements supports applying AML/CFT
requirements to ERAs.
However, other commenters were generally opposed to the rule's
scoping-in of ERAs, with one commenter asserting the outsized
regulatory impact of the proposed regulation on ERAs was not merited
given the low number of examples provided regarding illicit finance
risk amongst ERAs. Another commenter stated that FinCEN lacked
statutory authority to include ERAs in the scope of the proposed
regulation. One commenter claimed that FinCEN had failed to put forward
an adequate reason for the expansion of AML/CFT requirements to ERAs
beyond citation to the Risk Assessment and further claimed that the
Risk Assessment does not identify ERAs as particularly vulnerable to
illicit finance risks. One commenter suggested that ERAs below a
certain threshold of U.S. AUM be exempt from the proposed rule, and
that this AUM threshold should be measured similar to the private fund
adviser exemption in the Advisers Act and its implementing regulations.
The commenter claimed that this would be consistent with the goal of
the SEC to avoid imposing U.S. regulatory and operational requirements
on a foreign-located adviser's foreign-located advisory business.
Final Rule: FinCEN is implementing this part of the definition of
``investment adviser'' without change from the proposed rule.
Accordingly, each ERA will be subject to the final rule. For the
reasons stated above, in Section III.B.1, FinCEN has determined that it
has legal authority to determine that ERAs are ``financial
institutions'' for BSA purposes. Including ERAs in scope of the
regulation, as proposed, is supported by the findings of the Risk
Assessment as well as the responses from several commenters supporting
inclusion of ERAs demonstrating the illicit finance and national
security risks posed by ERAs. As noted by a commenter, while ERAs are
not subject to certain requirements under Federal securities laws, they
are subject to many of the requirements designed to prevent misconduct
in financial markets, for instance. In addition, FinCEN agrees with the
point made by several commenters that exempting ERAs could create a
loophole through which illicit actors would be able to access a range
of private funds without being directly subject to AML/CFT
requirements. The Risk Assessment found that, within the investment
adviser sector, ERAs bear the highest risks as they solely advise
either private funds or venture capital funds, both of which were found
in the Risk Assessment to be involved in illicit finance and other
criminal investigations carried out by U.S. law enforcement.\113\ In
addition, private funds are more likely than other types of customers
to be based in jurisdictions with weaker and less effective AML/CFT
controls, making it more difficult for the ERA to assess the risk posed
by the relationship or prevent abuse.\114\
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\113\ See supra note 47 and accompanying text (discussing the
analysis of BSA reporting linked to private fund advisers). See also
Risk Assessment, supra note 2, at 20-22, 26-28 (noting that private
funds, including those advised by ERAs, have served as an entry
point into the U.S. financial system for sanctioned Russian
oligarchs and their associates, and as back door for hostile nation-
state actors to acquire assets of interest in the United States,
such as equity stakes in companies developing critical or emerging
technologies).
\114\ Only 52 percent of the total net asset value of private
funds managed by U.S. investment advisers is held by funds domiciled
in the United States. Of the remaining 48 percent held in offshore
funds, most is held by funds domiciled in the Cayman Islands (33
percent) and the remainder is held by funds in Luxembourg (5
percent), Ireland (4 percent), Bermuda (1 percent), British Virgin
Islands (1 percent), United Kingdom (1 percent), and other
jurisdictions (4 percent). See SEC, Private Fund Statistics, Third
Calendar Quarter 2023, Page 13, Table 11, <a href="https://www.sec.gov/files/investment/2023q3-private-funds-statistics-20240331.pdf">https://www.sec.gov/files/investment/2023q3-private-funds-statistics-20240331.pdf</a>. These
figures come from publicly available data provided by the SEC
aggregating periodic filings made on Form PF. While this data
represents only the subset of RIAs required to file Form PF (RIAs
that manage at least $150 million in private fund AUM), this
accounts for a substantial amount of overall private fund assets and
FinCEN assesses the geographic distribution of fund domiciles is
generally consistent for ERAs. See also 89 FR at 12114 (discussion
on the effectiveness of foreign AML/CFT supervision for private
funds domiciled in certain jurisdictions).
---------------------------------------------------------------------------
Through the course of its advisory activities, an ERA may collect
information about either the private fund it advises (the customer of
the ERA) or the underlying investors in that private fund that may
alert the ERA to illicit activity. FinCEN has also assessed
[[Page 72171]]
that ERAs, along with RIAs advising private funds, are exposed to
higher money laundering, terrorist financing, or other illicit finance
risks compared to advisers who do not advise private funds.\115\ Adding
ERAs to the definition of ``investment adviser'' is therefore
consistent with the categorization of other entities as a financial
institution and with FinCEN's authority to make changes to the list of
financial institutions under FinCEN's regulations implementing the BSA
in order to combat illicit activity.
---------------------------------------------------------------------------
\115\ See supra Section III.A; Risk Assessment, supra note 2, at
20-22, 32.
---------------------------------------------------------------------------
FinCEN also declines to limit the applicability of the proposed
rule to only certain ERAs with assets exceeding a specified threshold,
such as $100 million AUM, as was proposed by one commenter. FinCEN
considered setting such a threshold and understands that many RIAs
below this threshold will not be subject to the rule, given the rule's
definition of ``investment adviser.'' However, as noted above, FinCEN
has concerns that such a threshold would mean that ERAs advising funds
with fewer assets but carrying material illicit finance risks would
remain out of scope of AML/CFT controls. The Risk Assessment and some
of the underlying examples analyzed for the Risk Assessment show that
private funds with relatively small AUM may still bear substantial
illicit finance risk.\116\ Such a threshold would also be challenging
to administer; for example, ERAs do not currently report AUM on Form
ADV.\117\ In addition, a threshold based on AUM or similar metric would
mean that an ERA hovering just above or below the threshold would come
in and out of coverage based on market returns, making it more
challenging for the SEC and FinCEN to accurately assess systemic money
laundering, terrorist financing, or other illicit finance risk among
ERAs.
---------------------------------------------------------------------------
\116\ See Risk Assessment, supra note 2, at 18, 20, and 31
(noting the highest illicit finance risk in the sector is for ERAs).
Several of the 20 private fund advisers identified as having
significant ties to Russian oligarch investors or Russian-linked
illicit activities managed private funds with less than $100 million
in AUM.
\117\ ERAs do not report AUM on Form ADV, but instead report
gross assets for each private fund they advise. However, they only
report gross assets for a private fund if that fund is not reported
by an RIA or ERA in its own Form ADV; therefore, some ERAs report
zero gross assets because all of the funds they advise are also
reported by an RIA or ERA. See Form ADV, Instructions for Part 1A.
---------------------------------------------------------------------------
FinCEN also declines to categorically exclude ERAs reporting zero
private fund assets on Form ADV. FinCEN notes that ERAs do not report
regulatory AUM on Form ADV, and that the information they do report--
gross assets of each private fund they advise--does not necessarily
distinguish between ERAs that manage client assets from those that do
not. ERAs that report zero gross assets for private funds they advise
may still have discretion for customer assets and thus present the risk
of being misused for illicit finance activities.\118\ FinCEN therefore
declines to exclude ERAs reporting zero gross assets for private funds
they advise from the requirements of the final rule.
---------------------------------------------------------------------------
\118\ See 17 CFR 275.203(m)-1(d)(1) (excluding from the
calculation of regulatory AUM, for purposes of the private fund
adviser exemption, assets associated with certain types of private
funds). See also Risk Assessment, supra note 2, at 18, 20.
---------------------------------------------------------------------------
Regarding the applicability of the requirements of the final rule
to the activities of foreign-located ERAs, those are discussed in the
next section. FinCEN notes the concerns raised by some commenters about
the specific burden that may apply to ERAs but reiterates that the AML/
CFT requirements in this rule are designed to be risk-based and their
cost will vary with the size of the business, along with the risk level
of its advisory activities and customers. FinCEN will work with the SEC
staff so that any examinations of ERAs for compliance with requirements
of the final rule take into account the risk-based nature of AML/CFT
programs.
4. Foreign-Located Investment Advisers
Proposed Rule: In the proposed rule, FinCEN noted that the proposed
definition of ``investment adviser'' would include certain foreign-
located investment advisers that are physically located abroad (i.e.,
whose principal office and place of business is outside the United
States) but nonetheless are: (i) registered or required to register
with the SEC (for RIAs), or (ii) file reports with the SEC on Form ADV
(for ERAs). FinCEN therefore proposed that the rule's requirements
would ``apply on the same basis'' to such foreign-located advisers as
to domestic advisers.\119\ FinCEN requested comment on any challenges
for foreign-located advisers in taking this approach, including any
potential conflicts with domestic or foreign law.
---------------------------------------------------------------------------
\119\ 89 FR at 12130.
---------------------------------------------------------------------------
Comments Received: FinCEN received eight comments regarding the
application of the proposed rule to foreign-located investment
advisers. One commenter stated that the proposed scope of application
of the proposed rule conflicts with Congress' intent during its
original passage of the BSA in 1970. Other commenters raised concerns
about the application of the proposed rule deviating from past
positions of FinCEN regarding BSA regulation and the SEC regarding
Advisers Act regulation. One commenter suggested an AUM threshold for
foreign-located ERAs that would draw from the SEC's AUM thresholds for
RIAs and its approach to measuring AUM for foreign-located private fund
RIAs, specifically suggesting that foreign-located ERAs with less than
$100 million of U.S. AUM be exempt from the proposed rule.
Several commenters raised concerns that foreign-located investment
advisers will face significant challenges in adhering to the proposed
BSA requirements. First, commenters indicated that obligations under
the BSA may not be consistent with local privacy rules and other
requirements, potentially creating ``conflict-of-laws and compliance
challenges.'' Another commenter suggested that applying this rule to
foreign-located advisers would ``deprive U.S. clients and investors
from [sic] the expertise of foreign-located investment advisers'' due
to additional compliance burdens and ``make it less likely that non-
U.S. investment advisers hire U.S.-based employees or engage in other
economic activity in the United States.'' One commenter noted that the
substantive provisions of the Advisers Act do not apply to ``a non-U.S.
adviser's relationship with its non-U.S. clients and non-U.S. funds
(including funds with U.S. investors)'' and recommended that for non-
U.S. advisers, this rule not apply ``with respect to their non-U.S.
clients, including non-U.S. private funds, even if such non-U.S.
private funds have U.S. investors.''
Commenters called for FinCEN to provide clarification on the reach
of the proposed rule to foreign-located advisers. One commenter called
on FinCEN to clarify that application of the proposed rule would be
confined to investment advisers ``organized and operating in the U.S.,
or to foreign-based or foreign-organized [investment advisers] only to
the extent they are operating in the U.S.'' One commenter called for
foreign-located ERAs from Financial Action Task Force (FATF)-compliant
jurisdictions to be excluded from the rule and another raised concerns
about the proposal's application to foreign-located subadvisers.
Several commenters called for FinCEN to fully exempt foreign-located
advisers from the proposed rule.
Final Rule: FinCEN is applying the requirements of the proposed
rule to foreign-located investment advisers, and is clarifying the
scope of their advisory activities that are subject to the
[[Page 72172]]
requirements in the final rule. Accordingly, the final rule will define
``investment adviser'' to include foreign-located investment advisers
that are registered or required to register with the SEC (RIAs, subject
to the exemptions set forth in 1010.100(nnn)(ii) for certain types of
RIAs) or that file reports with the SEC on Form ADV (ERAs). Including
foreign-located investment advisers in this final rule is consistent
with the BSA's express authorization for the Secretary to, by
regulation, determine new types of financial institutions \120\ as well
as the BSA's intelligence, national security, and counter-intelligence
purposes, which are inherently international in nature.\121\ Moreover,
this interpretation of authority granted by the BSA is aligned with
FinCEN's existing approach applying BSA obligations to certain types of
foreign-located BSA-defined financial institutions that have a nexus to
the United States. FinCEN has considered the illicit finance risks
arising from foreign-located investment advisers and the funds they
advise, as well as the alternatives for mitigating these risks
consistent with the purposes of the BSA enumerated at 31 U.S.C. 5311.
For these reasons, FinCEN has determined that the requirement of a U.S.
nexus provides a lawful basis for this rule to apply to foreign-located
investment advisers.
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\120\ 31 U.S.C. 5312(a)(2)(Y).
\121\ See 31 U.S.C. 5311.
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Section 1032.110 of the final rule defines a ``foreign-located
investment adviser'' as an ``investment adviser whose principal office
and place of business is outside the United States.'' Section 1032.111
of the final rule sets forth the scope of a foreign-located investment
adviser's obligations, stating that the requirements of part 1032 apply
to a foreign-located investment adviser only with respect to its
advisory activities that (i) take place within the United States,
including through involvement of U.S. personnel of the investment
adviser, such as the involvement of an agency, branch, or office within
the United States, or (ii) provide advisory services to a U.S. person
or a foreign-located private fund with an investor that is a U.S.
person.\122\ With respect to services provided to a foreign-located
private fund with an investor that is a U.S. person, as described
below, the rule incorporates SEC definitions and standards for
identifying investors that are U.S. persons in foreign-located private
funds.
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\122\ In contrast, an adviser with its principal office and
place of business in the United States must comply with the final
rule with respect to all of its advisory activities.
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To determine whether an investment adviser is a foreign-located
investment adviser (as defined at section 1032.110), the adviser must
look to its ``principal office and place of business,'' which FinCEN
considers to be the executive office of the investment adviser from
which the officers, partners, or managers of the investment adviser
direct, control, and coordinate the activities of the investment
adviser.\123\ RIAs and ERAs are required to identify their principal
office and place of business on Form ADV, making it clear which
investment advisers consider themselves to be ``foreign-located
investment advisers'' for the purposes of this final rule.
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\123\ This definition is consistent with that used by the SEC in
regulations applicable to investment advisers. See 17 CFR 275-
222.1(b).
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Moreover, all foreign-located advisers subject to the final rule
have a U.S. nexus with certain advisory activities such that they are
required to or have chosen to register with or file reports with the
SEC, and therefore are subject to SEC regulation. The Advisers Act
requires registration of investment advisers that have a minimum amount
of assets under management \124\ and who ``make use of the mails or any
means or instrumentality of interstate commerce in connection with his
or its business as an investment adviser,'' unless subject to an
exemption, such as ERAs,\125\ and the scope of the registration
requirement has been further refined in SEC regulations and guidance as
discussed above. Moreover, de minimis ties to the United States do not
automatically make a foreign-located investment adviser subject to the
final rule, particularly because foreign private advisers as defined
pursuant to the Advisers Act are not subject to the requirements of the
final rule. An adviser may be a foreign private adviser if it: (i) has
no place of business in the United States; (ii) has, in total, fewer
than 15 clients in the United States and investors in the United States
in private funds advised by the adviser; (iii) has aggregate assets
under management attributable to these clients and investors of less
than $25 million; and (iv) does not hold itself out generally to the
public in the United States as an investment adviser.\126\ Foreign-
located RIAs and ERAs covered by the final rule therefore not only have
sufficient nexus to the United States to trigger SEC registration or
filing requirements, but also a U.S. nexus too great to qualify as a
foreign private adviser (or have voluntarily chosen to be regulated as
RIAs or ERAs).\127\
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\124\ Certain other investment advisers that make use of the
mails or any means or instrumentality of interstate commerce in
connection with their business as an investment adviser may also be
permitted or required to register with the SEC. See footnote 23,
supra.
\125\ 15 U.S.C. 80b-3(a), (l), (m).
\126\ See 15 U.S.C. 80b-2(a)(30), 80b-3(b)(3).
\127\ Certain RIAs or ERAs may opt to register or report to the
SEC despite the fact that they could rely on the foreign private
adviser definition; such investment advisers have chosen to subject
themselves to the U.S. regulatory requirements and supervision
applicable to such advisers, and so will be subject to this final
rule.
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As noted above, a foreign-located investment adviser's advisory
activities must also have a U.S. nexus to be subject to the
requirements of the final rule. Under section 1032.111, foreign-located
investment adviser's advisory activities are subject to the
requirements of the rule if the advisory activities: (i) take place
within the United States, including through involvement of U.S.
personnel of the investment adviser, such as the involvement of an
agency, branch, or office within the United States, or (ii) provide
advisory services to a U.S. person or a foreign-located private fund
with an investor that is a U.S. person (subject to specified
definitions of ``foreign-located private fund,'' ``investor,'' and
``U.S. person'').
For the purposes of section 1032.111, U.S. personnel means,
regardless of citizenship, any director, officer, employee, or agent of
the investment adviser conducting advisory activities from a U.S.
agency, branch, or office of the investment adviser. U.S. personnel
would be involved in advisory activities if, for example, an employee
of the investment adviser manages assets of a client from a U.S. office
or other U.S. workplace of the investment adviser, or if the employee
works remotely from the United States on a regular basis. Conversely, a
U.S. citizen employee of the investment adviser managing assets of a
client from a non-U.S. office of the foreign-located investment adviser
would generally not constitute U.S. personnel involved in advisory
activities for this purpose.\128\ The term ``agency, branch, or
office'' of the investment adviser is not exclusive, and the rule would
apply to any location in the United States from which U.S. personnel of
the foreign-located investment adviser perform advisory activity. For
the avoidance of doubt, personnel that perform activity that is
[[Page 72173]]
clerical or administrative in nature are not involved in advisory
activity for purposes of the final rule.\129\
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\128\ However, a U.S. employee (of a foreign-located investment
adviser) whose advisory activities are undertaken from a non-U.S.
office for the purpose of evading the final rule or as part of a
course of conduct the employee undertook while based in the United
States, would constitute U.S. personnel involved in advisory
activities and be covered by the final rule.
\129\ This discussion of ``clerical or administrative'' activity
is intended to apply to foreign-located investment advisers only and
is not intended to apply for any other purpose. This is because it
aligns with the reporting of ``clerical workers'' on Item 5.A of
Form ADV with which investment advisers are already familiar and
enhances consistency with SEC regulation in a portion of the final
rule that references several SEC regulations.
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For a foreign-located investment adviser, the final rule also
applies to the provision of advisory services to a U.S. person or a
foreign-located private fund with an investor that is a U.S. person.
This includes, but is not limited to, providing investment advice to a
U.S. person, regardless of the location from which such investment
advice is provided. A foreign-located investment adviser would be
providing advisory services to a U.S. person if, for example, the
investment adviser manages assets from an office outside of the United
States on behalf of an individual U.S. person.
For purposes of determining a foreign-located investment adviser's
activities subject to this rule, the final rule defines ``U.S. person''
as a person meeting the definition in 17 CFR 230.902(k), which is part
of Regulation S under the Securities Act. The SEC relied on this
definition for purposes of the foreign private adviser exemption
because it provides specific rules when applied to various types of
legal structures.\130\ FinCEN adopts the Regulation S definition for
this reason, consistency with other SEC regulations cross-referenced in
section 1032.111, and administrability because this definition is
already familiar to investment advisers. This definition also includes
an element designed to mitigate potential evasion concerns.\131\
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\130\ See 76 FR 39645, 39697-39678 (Jul. 6, 2011).
\131\ 17 CFR 230.902(k)(1)(viii) (encompassing any corporation
or partnership formed by a U.S. person principally for the purpose
of investing in unregistered securities unless owned or incorporated
by accredited investors who are not natural persons, estates or
trusts).
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With respect to a foreign-located investment adviser's advisory
activities to a foreign-located private fund, the final rule requires a
foreign-located investment adviser to determine whether any foreign-
located private fund that it advises has at least one investor who is a
U.S. person.\132\ This determination must be made with respect to every
investor in that foreign-located private fund in accordance with SEC
requirements familiar to private fund advisers. If a foreign-located
private fund has at least one U.S. person investor, the foreign-located
investment adviser must apply the final rule with respect to that
foreign-located private fund. This standard is designed to be both
administrable--it incorporates SEC standards for identifying investors
that are U.S. persons in private funds--and tailored to address risks
to the U.S. financial system through foreign-located private funds,
which FinCEN has identified as presenting significant illicit finance
risk.
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\132\ A U.S.-located private fund advised by a foreign-located
investment adviser is itself a U.S. person under this definition,
and so a foreign-located investment adviser will also be required to
apply the final rule with respect to any U.S.-located private fund
it advises, irrespective of the presence or absence of any U.S.
person investors in such U.S.-located private fund.
---------------------------------------------------------------------------
The final rule defines ``foreign-located private fund'' by
reference to section 202(a)(29) of the Advisers Act, which defines
``private fund'' to mean ``an issuer that would be an investment
company, as defined in section 3 of the [Company Act] (15 U.S.C. 80a-
3), but for section 3(c)(1) or 3(c)(7) of that Act.'' The ``foreign-
located'' aspect of the definition refers to a fund that is a legal
entity or arrangement that is incorporated or organized outside the
United States and therefore is not a U.S. person for purposes of the
final rule. This definition therefore covers the types of foreign-
located private funds advised by ERAs and that FinCEN has identified as
giving rise to illicit finance risks. It is also commonly used by
investment advisers in complying with the federal securities laws,
including, for example, in completing multiple portions of Form
ADV.\133\
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\133\ See Form ADV Glossary, defining Private Fund to mean ``An
issuer that would be an investment company as defined in section 3
of the Investment Company Act of 1940 but for section 3(c)(1) or
3(c)(7) of that Act.''
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The final rule defines ``investor'' by reference to Advisers Act
Rule 202(a)(30)-1(c)(2), under which a foreign private adviser can
determine whether private funds it advises have more than 14
``investors in the United States.'' That rule, in turn, refers to
sections 3(c)(1) and 3(c)(7) of the Company Act, which generally
exclude certain issuers from the definition of investment company based
on the number of beneficial owners or qualifications of their security
holders, respectively.\134\ Consistent with statements by the SEC and
its staff and the SEC's underlying authorities,\135\ depending upon the
facts and circumstances, persons other than the nominal holder of a
security issued by a private fund may be counted as the beneficial
owner under section 3(c)(1), or be required to be a qualified purchaser
under section 3(c)(7).\136\ For purposes of section 3(c)(1), if a
company owns 10 percent or more of the outstanding voting securities of
the issuer (the prospective private fund), and is, or but for section
3(c)(1) or 3(c)(7) of the Company Act, would be an investment company,
the issuer must ``look through'' that investing company to the holders
of the company's securities.\137\ In the context of this rule, a
foreign-located investment adviser is required to perform the same look
through with respect to any private fund it advises that relies on
section 3(c)(1) of the Company Act with two modifications: (1) the
foreign-located investment adviser must count beneficial owners of a
private fund's commercial paper as investors (consistent with Advisers
Act Rule 202(a)(30)-1(c)(2)); and (2) a person who is considered a
beneficial owner for purposes of section 3(c)(1) will be considered an
``investor'' in the private fund despite holding its interests
indirectly. If this look through results in a U.S. person being
considered an investor in the private fund, the foreign-located private
adviser must apply the requirements of the final rule to that fund.
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\134\ Section 3(c)(1), 15 U.S.C. 80a-3(c)(1), excludes from the
definition of investment company a privately-offered issuer having
fewer than a certain number of beneficial owners. Section 3(c)(7),
15 U.S.C. 80a-3(c)(7) excludes from the definition of investment
company a privately-offered issuer the securities of which are owned
exclusively by ``qualified purchasers'' (generally, persons and
entities owning investments whose value exceeds a specified
threshold).
\135\ See, e.g., 76 FR 39645, 39676 (Jul. 6, 2011); Privately
Offered Investment Companies, Final Rule, 62 FR 17512, 17519, 17524
(Apr. 9, 1997) (``The Commission understands that there are other
forms of holding investments that may raise interpretative issues
concerning whether a Prospective Qualified Purchaser `owns' an
investment. For instance, when an entity that holds investments is
the `alter ego' of a Prospective Qualified Purchaser (as in the case
of an entity that is wholly owned by a Prospective Qualified
Purchaser who makes all the decisions with respect to such
investments), it would be appropriate to attribute the investments
held by such entity to the Prospective Qualified Purchaser.''); see
also Cornish & Carey Commercial, Inc., SEC Staff No-Action Letter
(June 21, 1996) (staff discussed the application of section
3(c)(1)(A) to an issuer relying on section 3(c)(1)), available at
<a href="https://www.sec.gov/divisions/investment/noaction/1996/cornishcarey022696.pdf">https://www.sec.gov/divisions/investment/noaction/1996/cornishcarey022696.pdf</a>.
\136\ Section 3(c)(1)(A) of the Company Act requires a private
fund relying on section 3(c)(1) to ``look through'' any company that
owns 10 percent or more of the company's voting securities. ``Voting
security'' is defined in section 2(a)(42) of the Company Act, 15
U.S.C. 80a2(a)(42). In contrast, this 10 percent look-through is not
required for purposes of section 3(c)(7).
\137\ See 15 U.S.C. 80a-3(c)(1)(A).
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Similarly, for purposes of both section 3(c)(1) and section
3(c)(7), a foreign-located investment adviser will be required to
``look through'' any entity
[[Page 72174]]
that is formed for the purpose of investing in a foreign-located
private fund it advises.\138\ For purposes of the final rule, if a
foreign-located investment adviser determines that an investing entity
has been formed for purposes of investment in the private fund, such an
adviser must look through the entity to determine whether it has U.S.
person investors. Consistent with statements by the staff of the SEC
and the SEC's underlying authorities,\139\ a foreign-located investment
adviser's determination that an entity is formed for the specific
purpose of investing in a foreign-located private fund will depend upon
an analysis of all of the surrounding facts and circumstances
(including any knowledge that the foreign-located adviser has regarding
the identity of its customers). Thus, to the extent that a foreign-
located investment adviser determines that there is an underlying U.S.
person investor (by conducting a look-through or because of other
information available to the foreign-located investment adviser), the
foreign-located investment adviser must apply the final rule with
respect to the foreign-located private fund in which the U.S. person is
indirectly invested.
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\138\ See, e.g., 17 CFR 270.2a51-3(a) (discussing an entity
formed for the purpose of acquiring securities of an issuer relying
on section 3(c)(7)); Cornish & Carey Commercial, Inc., SEC Staff No-
Action Letter (June 21, 1996) (staff discussing an entity formed for
the purpose of acquiring securities of an issuer relying on section
3(c)(1)), available at <a href="https://www.sec.gov/divisions/investment/noaction/1996/cornishcarey022696.pdf">https://www.sec.gov/divisions/investment/noaction/1996/cornishcarey022696.pdf</a>. For purposes of section
3(c)(1), SEC staff guidance states that if a company or fund invests
more than 40 percent of its assets in a 3(c)(1) fund, it is
potentially formed for the purpose of investing in a 3(c)(1) fund.
For purposes of section 3(c)(7), 17 CFR 270.2a51-3(a) requires an
investment adviser to determine whether the beneficial owners of the
entity formed for purposes of investment in the fund are also
qualified purchasers.
\139\ See, e.g., American Bar Association Section of Business
Law, SEC Staff No-Action Letter (Apr. 22, 1999) at 19-20 (describing
circumstances under which an entity would be deemed to be formed for
the specific purpose of acquiring securities in a private fund that
relies on section 3(c)(7)), available at <a href="https://www.sec.gov/divisions/investment/noaction/1999/aba042299.pdf">https://www.sec.gov/divisions/investment/noaction/1999/aba042299.pdf</a>.
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These tests are incorporated into the final rule in order to
address the illicit finance risks posed by foreign-located investment
advisers. The greatest risks arise, as discussed above, from private
funds advised by foreign-located investment advisers. The requirement
of a U.S. nexus in the form of at least one investor that is a U.S.
person is consistent with FinCEN's desire to focus on risks to the U.S.
financial system. The presence of a U.S. person investor increases the
likelihood that illicit finance risk associated with a private fund
affects the U.S. financial system and the likelihood that U.S. persons
might be involved in the underlying illicit finance activity. Although
the presence of one investor that is a U.S. person requires the
investment adviser to apply the requirements of the final rule to the
entirety of a private fund, FinCEN notes that the fund as a whole is
the customer of the foreign-located investment adviser. By their
nature, private funds involve the commingling of investor assets in a
pooled vehicle. As previously detailed in the Risk Assessment, the
pooled nature of such funds may be used to obscure ownership of
investments (which may present the possibility of higher returns on
capital) by illicit actors who seek stable returns and do not need
immediate access to capital.\140\
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\140\ See Risk Assessment, supra note 2, at 16.
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While FinCEN considered other thresholds for establishing an
appropriate U.S. nexus, including whether or not to apply the rule's
obligations with respect to non-U.S. private funds with U.S. investors,
FinCEN balanced addressing the relevant illicit finance risks to the
U.S. financial system (such as arising from investments by illicit
actors in non-U.S. private funds that are commingled with funds from
U.S. investors and enter the U.S. financial system),\141\ the purposes
of the BSA, and administrability. FinCEN also considered, as noted by a
commenter, the SEC's approach in applying substantive provisions of the
Advisers Act and the purposes underlying that approach. FinCEN further
considered other SEC rules and practices, such as the foreign private
adviser exemption and Advisers Act Rule 202(a)(30)-1(c)(2). The SEC
standards incorporated in section 1032.111 are used to focus on illicit
finance risks associated with private funds specifically and are
familiar to foreign-located investment advisers from SEC
regulations.\142\ By setting a clear minimum standard of at least one
U.S. private fund investor defined by reference to Advisers Act Rule
202(a)(30)-1(c)(2), this places clear limits on the ability of
investment advisers or illicit actors seeking to obscure their
ownership or control of certain assets through a private fund to avoid
application of the final rule by admitting U.S. persons as indirect
investors through intermediate entities. Advisers must ``look through''
nominee and similar arrangements to the underlying holders of private
fund-issued securities to determine whether the private fund has an
investor that is a U.S. person.
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\141\ Id. at 16-20.
\142\ The standards for determining beneficial ownership of
investments in private funds, including by U.S. persons, should be
familiar to investment advisers from SEC reporting requirements and
determining the status of such funds under the Company Act. See
Instructions to Form PF, Section 2b Item 16 (requiring reporting of
a fund's equity that is beneficially owned by various categories of
investors, including individuals who are U.S. persons); Question 16
of Section 7.B.(1) of Schedule D to Form ADV (requiring the
reporting of the percentage of a private fund's beneficial owners
that are non-U.S. persons); 15 U.S.C. 80b-2(a)(30) and 17 CFR
275.202(a)(30)-1 (foreign private adviser exemption). See also 76 FR
39645, 39678 (Jul. 6, 2011) (``A non-U.S. adviser would need to
count the same U.S. investors [as in connection with Investment
Company Act exclusions] (except for holders of short-term paper with
respect to a fund relying on section 3(c)(1)) in order to rely on
the foreign private adviser exemption. In this respect, therefore,
the look-through requirement of the foreign private adviser
exemption will generally not impose any new burden on advisers to
non-U.S. funds.'').
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Moreover, a foreign-located investment adviser retains the option
of availing itself of foreign private adviser status if it has limited
U.S. ties and does not wish to apply the requirements of the final rule
to private funds with lower levels of U.S. investment. Given this
option, FinCEN anticipates it is unlikely that a significant number of
foreign-located investment advisers will be required to apply the
requirements of the rule on the basis of having a small number of
investors that are U.S. persons or small amount of U.S. investment.
When a foreign-located investment adviser's activities involving a
private fund fall within the scope of the final rule, the foreign-
located investment adviser will be expected to subject its advisory
activities with respect to the fund to internal policies, procedures,
and controls reasonably designed to prevent the investment adviser from
being used for money laundering, terrorist financing, or other illicit
finance activities and to achieve compliance with the applicable
provisions of the BSA and implementing regulations. Advisers are often
involved in implementing such internal policies, procedures, and
controls for their funds for both AML/CFT requirements (if the fund
implements such requirements voluntarily or to comply with the AML/CFT
laws of a foreign jurisdiction) as well as requirements under
securities or other corporate laws. Therefore, foreign-located
investment advisers should be able to apply the requirements of this
final rule, including applicable internal policies, procedures, and
controls, to advisory activities with respect to these private funds,
and doing so will help prevent these funds from becoming gateways into
the U.S. financial system for illicit finance activity.
[[Page 72175]]
Certain of a foreign-located investment adviser's advisory
activities are not subject to the final rule. This is similar to the
SEC's regulation of investment advisers pursuant to the Advisers Act:
non-U.S. advisers are not required to apply the substantive provisions
of the Advisers Act when advising non-U.S. clients.\143\ While taking
into account the distinct purposes of the BSA, FinCEN believes that the
final rule's requirements should not apply to a foreign-located adviser
when it: (i) provides services exclusively to a foreign-located
person,\144\ and (ii) the personnel providing such advisory services
are all outside of the United States as discussed above.
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\143\ See, e.g., 76 FR 39645, 39681 (Jul. 6, 2011); SEC No-
Action Letter, Uniao de Bancos Brasileiros S.A. (Unibanco), 1992 WL
183054 at *3 (Jul. 28, 1992), available at <a href="https://www.sec.gov/divisions/investment/noaction/1992/uniaodebancos072892.pdf">https://www.sec.gov/divisions/investment/noaction/1992/uniaodebancos072892.pdf</a>. The
SEC's approach considers the location of the client. The final rule
does not modify the SEC's position on the application of the
Advisers Act to non-U.S. investment advisers.
\144\ Other than a private fund with a U.S. person investor, as
described above.
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To ensure that activities within the scope of the rule are properly
included, a foreign-located investment adviser should (i) determine to
the extent reasonable and practicable whether its customers and the
investors in its private funds are within the scope of this rule based
upon the regulatory text as clarified in this preamble and any relevant
future guidance that FinCEN might issue, and (ii) ensure that it does
not provide advisory services to its private fund customers in a manner
that results in the adviser being unable to identify a potential U.S.
customer or investor.
The final rule states that upon request, a foreign-located
investment adviser must make available to FinCEN or the SEC (in its
capacity as delegated examiner for this rule) records and reports
required under this rule and any other records that it has retained
regarding the scope of its activities covered by this rule. As
discussed below, the records that an investment adviser--including a
foreign-located investment adviser--is required to maintain to comply
with the requirements of the final rule include those required when
developing and implementing an AML/CFT program as required under
section 1032.210, including but not limited to a written AML/CFT
program that includes internal policies, procedures, and controls, as
well as those required by subpart D of the final rule, which are
generally records of certain transactions and transfers of funds.
As for any investment adviser subject to this final rule, for a
foreign-located investment adviser, properly scoping the advisory
activities covered by its AML/CFT program is an important part of
ensuring that its AML/CFT program is reasonably designed to prevent the
investment adviser from being used for money laundering, terrorist
financing, or illicit finance activities, and of achieving and
monitoring compliance. As part of establishing a risk-based and
reasonably designed AML/CFT program, and to comply with other
requirements in this final rule, a foreign-located investment adviser
should generate records to reflect how it properly scoped the advisory
activities covered by the final rule. A foreign-located adviser must
provide such records to FinCEN and the SEC upon request.
The final rule's treatment of foreign-located investment advisers
broadly is consistent with how FinCEN has treated other foreign-located
financial institutions, such as foreign-located money service
businesses (MSBs) and broker-dealers. Specifically, the definition of
MSBs under FinCEN's regulations includes persons engaged in specified
activities ``wherever located, doing business . . . wholly or in
substantial part'' within the United States.\145\ ``This includes but
is not limited to the maintenance of any agent, agency, branch, or
office within the United States.'' \146\ FinCEN's 2011 MSB final rule
explained that whether a person engages in MSB activities is based on
``all of the facts and circumstances,'' including whether U.S. persons
are obtaining services from the foreign-located MSBs.\147\ FinCEN
applies the same principles taking into account all of the facts and
circumstances of a foreign-located investment adviser's activities,
tailored as described above to the investment adviser sector, in this
rule.
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\145\ 31 CFR 1010.100(ff).
\146\ Id.
\147\ FinCEN, Bank Secrecy Act Regulations; Definitions and
Other Regulations Relating to Money Services Businesses, Final Rule,
76 FR 43585, 43588 (Jul. 21, 2011).
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Foreign-located broker-dealers that are registered or required to
be registered with the SEC are similarly subject to BSA requirements.
FinCEN regulations define a ``broker-dealer'' as a ``person registered
or required to be registered with the SEC under the Exchange Act,
except persons who register pursuant to 15 U.S.C. 78o(b)(11).'' \148\
Foreign located broker-dealers may be required to register with the
SEC,\149\ and if they are required to register, such broker-dealers are
required to comply with applicable BSA requirements for broker-dealers,
including the maintenance of an AML/CFT program and compliance with BSA
recordkeeping requirements.\150\ While broker-dealers registered with
the SEC that are located outside the United States are not required to
file SARs,\151\ this is a policy choice that FinCEN made for broker-
dealers based on the relevant considerations for that sector and does
not reflect an interpretation of FinCEN's authority to require such
reporting.\152\
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\148\ See 31 CFR 1023.100(b). The BSA regulations also use the
related term ``broker or dealer in securities,'' which is defined
based on the same provisions of the Securities and Exchange Act. 31
CFR 1010.100(h).
\149\ See SEC, Registration Requirements for Foreign Broker
Dealers, Final Rule, 54 FR 30013, 30016 (Jul. 18, 1989); Guy P.
Lander, Registration requirement and jurisdiction, 3 U.S. Sec. Law
for Financial Trans. Sec. 13:2 (2d ed.).
\150\ 31 CFR 1023.210, 1023.400, 1023.410.
\151\ See 31 CFR 1023.320(a)(1).
\152\ Amendment to the Bank Secrecy Act Regulations--Requirement
that Brokers or Dealers in Securities Report Suspicious
Transactions, Final Rule, 67 FR 44048, 44052 (Jul. 1, 2002).
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Although MSBs and broker-dealers located abroad have been subject
to FinCEN's regulations under the BSA, some commenters suggested that
the final rule's application to foreign-located investment advisers
would contravene longstanding territorial limits on the application of
the BSA. The BSA authorizes the Secretary of the Treasury (since re-
delegated to FinCEN) to define financial institutions and does not
place territorial limitations on that authority. The BSA does not
define the term ``financial institution'' in general and simply lists
the types of businesses that may be financial institutions at 31 U.S.C.
5312(a)(2) without specifying where they may be located.\153\ FinCEN
has interpreted this authority to enable regulation of foreign-located
institutions that operate within the United States or provide services
to persons in the United States. Moreover, as discussed above, the BSA
authorizes the Secretary to determine, by regulation, new types of
financial institutions \154\ and the final rule is an exercise of that
authority. The BSA confers authority to apply significant obligations
of the final rule--notably the AML/CFT program and SAR requirements--to
all ``financial institutions'' as defined by FinCEN.\155\ FinCEN
therefore interprets the statutory authority to determine investment
advisers as a financial
[[Page 72176]]
institution to impose such obligations on certain foreign-located
investment advisers in the final rule.
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\153\ 31 U.S.C. 5312(a)(2).
\154\ See 31 U.S.C. 5312(a)(2)(Y).
\155\ See, e.g., 31 U.S.C. 5318(g)(1) (SARs); 31 U.S.C.
5318(h)(1) (AML/CFT program).
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Certain requirements of the final rule, however--in particular the
recordkeeping obligations of subpart D and the special measures of
subpart F--apply to ``domestic financial institution'' as defined in
the BSA (also sometimes referred to as a ``domestic financial
agency'').\156\ The BSA describes the term ``a domestic financial
institution'' as applying to ``an action in the United States of a
financial agency or institution.'' \157\ Congress thus defined a
domestic financial institution based on where an institution acts
rather than where it is organized or headquartered. FinCEN interprets,
as it has in the past, ``an action in the United States'' to include
actions with a nexus to the United States.
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\156\ See, e.g., 31 U.S.C. 5318(a)(2) (recordkeeping); 31 U.S.C.
5318A(a)(1) (special measures).
\157\ 31 U.S.C. 5312(b)(1).
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While the final rule's AML/CFT program and SAR requirements rest on
FinCEN's broader authority to define ``financial institutions,''
through its focus on a U.S. nexus, the final rule's approach with
respect to foreign-located financial institutions is consistent with
the reach of ``domestic financial institution'' as defined in the BSA.
Requirements for foreign-located investment advisers apply when a
foreign-located investment adviser engages in advisory activities with
a U.S. nexus, whether by having staff in the United States or advising
U.S. persons or advising foreign-located private funds with an investor
who is a U.S. person. FinCEN took a similar approach with regard to
foreign-located MSBs in requiring them to comply with its regulations
for activities with a U.S. nexus even if some portion of the activity
occurs in a foreign jurisdiction (such as transmitting funds to the
United States from abroad). Thus, in accord with existing practice,
FinCEN is regulating foreign-located investment advisers with a U.S.
nexus based upon Congress' authorization of the Secretary to determine
financial institutions by regulation and to regulate foreign-located
institutions acting within the United States.\158\
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\158\ See 31 U.S.C. 5312(a)(2)(Y); 31 U.S.C. 5312(b)(1).
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Nonetheless, one commenter argued that Congress intended to limit
the application of the BSA to financial institutions located in the
United States when it passed the Currency and Foreign Transactions
Reporting Act in 1970 (the ``1970 Act''), which later became part of
the BSA. At the outset, the text of the 1970 Act is not limited in this
manner nor is FinCEN aware that Congress otherwise intended it to be.
Section 203 of the 1970 Act, which defines the term ``financial
institution,'' states that ``the term `domestic', used with reference
to institutions or agencies, limits the applicability of the provision
wherein it appears to the performance by such institutions or agencies
of functions within the United States.'' \159\ Similar to the term
``domestic financial institution'' in the current BSA, this use of the
term ``domestic'' grants jurisdiction based upon where a financial
institution acts--in the 1970 Act, by performing certain functions--
rather than where it is located. Even if Congress intended to limit the
reach of the 1970 Act with regard to foreign located financial
institutions, the 1970 Act was a distinct statute focused on ensuring
that banks and other institutions maintained sufficient records to
assist government investigations.\160\
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\159\ Public Law 91-508, Title II, sec. 203(e), (f).
\160\ Id. at Sec. 202.
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While maintaining certain records to assist in government
investigations remains one of the purposes of the BSA, Congress has
repeatedly amended the BSA to expand its scope, including the Money
Laundering Control Act of 1986; \161\ the Annunzio-Wylie Anti-Money
Laundering Act of 1992; \162\ the USA PATRIOT Act of 2001,\163\ and the
AML Act.\164\ For example, Title III of the USA PATRIOT Act of 2001--
styled the International Money Laundering Abatement and Anti-Terrorist
Financing Act--amended the BSA to address the threat of international
terrorism,\165\ including the BSA's AML program and SAR filing
requirements.\166\ The AML Act amended the purposes of the BSA to
include addressing a number of international phenomena, including the
facilitation of ``intelligence and counterintelligence activities . . .
to protect against terrorism'' and assessments to ``safeguard the
national security of the United States.'' \167\ These amendments to the
BSA since 1970, among others, demonstrate that the BSA is intended to
protect the United States against international threats to the
financial system and national security, among other purposes, which may
involve regulating some conduct occurring only in part within the
United States.
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\161\ Public Law 99-570, Title I, Subtitle H.
\162\ Public Law 102-550, Title XV.
\163\ Public Law 107-56, Title III.
\164\ Public Law 116-283, Div. F.
\165\ Public Law 107-56, Title III, sec. 358(a), (b).
\166\ See, e.g., id. at sec. 351-52.
\167\ See id. at 6101(a) (codified at 31 U.S.C. 5311).
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Commenters further argue that FinCEN has changed its position on
the scope of the BSA. In so doing, they point to a Treasury report from
1987,\168\ the SAR requirements applicable to broker-dealers, and the
2003 investment adviser NPRM. These sources are inapposite to the final
rule. The 1987 report was issued in response to a statutory requirement
to inform Congress regarding BSA regulation of the foreign branches of
U.S. banks at the time.\169\ The concept of a foreign ``branch'' of a
U.S. bank has a specific legal meaning tied to how banks are supervised
and regulated that is not applicable in the context of investment
advisers, which are a different type of financial institution.\170\
Moreover, the 1987 report was written before the Annunzio-Wylie Anti-
Money Laundering Act of 1992,the USA PATRIOT Act of 2001, and the AML
Act expanded the scope and purposes of the BSA as mentioned above.
Similarly, another type of financial institution--broker-dealers--are
not required to file SARs when located abroad. This is a policy choice
that FinCEN made for broker-dealers based on the relevant
considerations for that sector and does not reflect an interpretation
of FinCEN's authority to require such reporting.\171\ Moreover,
foreign-located investment advisers currently represent a significant
proportion of the market and therefore account for significant illicit
finance risks as discussed above.
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\168\ Secretary of the Treasury, Money Laundering and the Bank
Secrecy Act: The Question of Foreign Branches of Domestic Financial
Institutions (Jul. 29, 1987).
\169\ See id. at 30-33.
\170\ The term ``branch'' is used in the final rule for its
plain meaning rather than this specific concept in banking law.
\171\ 67 FR 44048, 44052 (Jul. 1, 2002).
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FinCEN has also determined not to apply the language of its 2003
proposed rule for investment advisers and fully exempt all foreign-
located RIAs and ERAs from the requirements of the proposed rule.\172\
The approach taken in the final rule is consistent with FinCEN's 2015
proposed rule for investment advisers \173\ and results from
[[Page 72177]]
the significant growth of foreign investment into the United States
from offshore financial centers and identified misuse of the investment
adviser sector by transnational illicit finance threats (as identified
in the Risk Assessment) in the two decades since the 2003 proposed rule
was issued.
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\172\ See FinCEN, Anti-Money Laundering Programs for Investment
Advisers, Notice of Proposed Rulemaking, 68 FR 23646, 23652 (May 5,
2003). The 2003 proposed rule would have defined an investment
adviser to be only persons ``whose principal office and place of
business is located in the United States.''
\173\ FinCEN, Anti-Money Laundering Program and Suspicious
Activity Report Filing Requirements for Registered Investment
Advisers, Notice of Proposed Rulemaking, 80 FR 52680, 52684 (Sept.
1, 2015). The 2015 proposed rule would have defined an investment
adviser to be any person ``who is registered or required to register
with the SEC under section 203 of the Investment Advisers Act of
1940'' and, accordingly, would have applied to foreign-located
investment advisers.
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One commenter stated that foreign-located advisers could face
conflict of laws and compliance concerns due to local laws where they
are based, particularly data protection laws that limit the transfer of
personal data. The commenter does not cite any example of a law that
would create such a conflict, and FinCEN has not encountered such a
conflict in the course of regulating other financial institutions
located outside the United States. FinCEN expects investment advisers,
like other BSA-defined financial institutions, to comply with their
obligations under the BSA, and further believes foreign jurisdictions
are unlikely to interpret their laws to conflict with or otherwise
impede the final rule because the rule is consistent with FATF
standards and the global interest in reducing illicit finance.\174\
Nonetheless, while FinCEN expects financial institutions to comply with
obligations under the BSA as a matter of course, financial institutions
seeking guidance on this rule may submit requests for guidance to
FinCEN if they encounter unexpected difficulties in doing so.\175\
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\174\ See, e.g., FATF, International Standards on Combating
Money Laundering and the Financing of Terrorism & Proliferation, the
FATF Recommendations (Updated November 2023), at 10, available at
<a href="http://www.fatf-gafi.org/en/publications/Fatfrecommendations/Fatf-recommendations.html">www.fatf-gafi.org/en/publications/Fatfrecommendations/Fatf-recommendations.html</a>, (FATF Recommendation 2, stating that national
AML/CFT policies and procedures should ``ensure the compatibility of
AML/CFT/CPF requirements with Data Protection and Privacy rules and
other similar provisions'').
\175\ For questions regarding the BSA and FinCEN's implementing
regulations, investment advisers may contact FinCEN's Regulatory
Support Section at 1-800-767-2825 or email <a href="/cdn-cgi/l/email-protection#2e485c4d6e4847404d4b4000494158"><span class="__cf_email__" data-cfemail="5e382c3d1e3837303d3b3070393128">[email protected]</span></a>.
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Although one commenter said that regulating foreign-located
advisers would ``deprive'' investors that are U.S. persons of their
skills through higher costs and incentivize foreign-located advisers to
avoid U.S. ties, FinCEN does not believe that this is the case. The
United States is the world's largest and most competitive financial
market and the requirements of this rule with respect to foreign-
located investment advisers are substantially similar to the BSA
requirements applicable to other non-U.S.-based financial institutions,
which have not unduly impeded access by investors that are U.S. persons
to financial institutions located abroad or inhibited foreign financial
institutions from developing ties to the United States. And even if
there are some effects along these lines, this would be outweighed by
the increased protection of the U.S. financial system and U.S. national
security due to the scope of the final rule.
These benefits also outweigh the remaining concerns raised by
commenters about covering foreign-located advisers. Commenters argued
that foreign-located advisers located in FATF-compliant jurisdictions,
or certain similar AML/CFT regimes such as in the United Kingdom and
the European Union, should be exempt from the requirements of the final
rule. While a jurisdiction's compliance with FATF standards is helpful
to the international effort against illicit finance, it is not a
replacement for U.S. regulation where the institutions have significant
links to the U.S. financial system. For instance, without a SAR filing
obligation, under certain circumstances U.S. law enforcement would have
to rely on information from foreign authorities to detect U.S.-based
illicit activity involving foreign-located investment advisers. Another
commenter raised concerns about foreign-located subadvisers' ability to
comply with the requirements of the final rule. FinCEN addresses the
application of the final rule to subadvisers (both U.S. and foreign-
located) below. If such a foreign-located investment adviser cannot
exclude subadvisory activity from its AML/CFT program, it may work with
the primary adviser and others to address these issues.
FinCEN believes that concerns raised by commenters are not
sufficient to justify reducing the scope of the final rule to exclude
foreign-located investment advisers or to re-issue the rule to seek
further comment on this issue. As described above with respect to RIAs
and ERAs generally, FinCEN has considered potential AUM thresholds,
including a $100 million U.S. AUM threshold for foreign-located ERAs,
and appreciates commenters' concerns about the potential burden on
relatively smaller entities to comply with the rule. Indeed, FinCEN has
excluded from the final rule certain smaller and mid-sized RIAs. FinCEN
similarly has considered comments encouraging FinCEN to focus on U.S.
AUM and U.S. activities and operations, which informed FinCEN's
determination to limit the scope of foreign-located advisers' advisory
activities subject to the rule and to exclude foreign private advisers.
However, as described above with respect to ERAs generally and as
reflected in the Risk Assessment, FinCEN has determined that smaller
ERAs present generally higher illicit finance risks than RIAs that do
not advise private funds, especially those RIAs with lower or zero AUM
excluded from the scope of this rule. Moreover, for ERAs, lower gross
asset value of private funds advised in many cases does not correspond
to lower illicit finance risk. FinCEN is concerned that an AUM
threshold for smaller ERAs, including smaller foreign-located ERAs,
would also be challenging to administer, for similar reasons described
above.\176\
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\176\ See supra Section III.B.3.
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5. State-Registered Investment Advisers
Proposed Rule: FinCEN did not include State-registered investment
advisers in the scope of the proposed rule but requested comment on the
illicit finance risk for State-registered investment advisers and
whether they should be included in the scope of the final rule.
Comments Received: Some commenters questioned FinCEN's exclusion of
State-registered investment advisers from the expanded application of
the rule. Three commenters requested that State-registered investment
advisers be added to the definition of ``investment adviser'' in the
proposed rule. The commenters claimed that excluding State-registered
investment advisers from the requirements of the proposed rule may
permit bad actors to exploit inadequate technology or perceived
weaknesses in the oversight or regulation of State-registered
investment advisers to circumvent AML/CFT controls at financial
institutions. One commenter noted that certain state financial
institutions have already emerged as hotspots for those who wish to
hide their assets and minimize their tax burdens, especially through
trusts. One commenter also recommended that, despite increased costs,
State-registered investment advisers be subject to the proposed rule
and be required to register with the SEC, and asserted that increasing
costs may be ``partly offset by taxes on money that may have been
laundered.'' Two commenters also suggested that FinCEN assess illicit
finance activity involving investment advisers linked to Tribal
activity.
Two commenters agreed with FinCEN's approach to not apply the
proposed rule to State-registered investment advisers, but advised that
FinCEN continue to monitor State-registered investment advisers for
illicit finance risks. One commenter stated
[[Page 72178]]
that money laundering risk posed by State-registered advisers should be
lower than for RIAs and ERAs as State-registered advisers have lower
AUM than RIAs. This commenter also stated that State-registered
advisers are often comprised of a single person and thus know their
customers personally.
Final Rule: In the final rule, FinCEN is not including State-
registered investment advisers in the definition of ``investment
adviser.'' FinCEN notes that while State-registered investment advisers
may be misused to facilitate illicit finance activity, FinCEN continues
to assess they are at lower risk for such activity than RIAs or ERAs.
As noted by one commenter, State-registered advisers are smaller, in
terms of customers, and tend to be localized. In addition, Treasury's
Risk Assessment found few examples of State-registered investment
advisers being used to move illicit proceeds or facilitate other
illicit finance activity. Furthermore, including State-registered
investment advisers within the scope of the definition of ``investment
adviser'' would create significant challenges in monitoring compliance
with AML/CFT requirements, as the SEC currently has no authority to
examine them for compliance with the Advisers Act or the rules
thereunder.
Given State-registered advisers' lower risk and the potentially
disproportionate cost of imposing AML/CFT requirements on such
advisers, FinCEN assesses that the final rule is less likely to achieve
the same degree of benefits as for RIAs and ERAs. However, FinCEN will
continue to monitor activity involving State-registered investment
advisers for indicia of money laundering, terrorist financing, or other
illicit finance activities and may consider regulatory measures if
appropriate.
6. Foreign Private Advisers and Family Offices
Proposed Rule: FinCEN's proposed regulation did not apply to
foreign private advisers or family offices because such entities are
not RIAs or ERAs pursuant to the Advisers Act and its implementing
regulations. FinCEN sought comment on whether any excluded entities, in
particular family offices, should be included in the scope of the
proposed rule.
Comments Received: Five commenters opposed the exclusion of foreign
private advisers and family offices from the scope of the proposed
regulation, arguing that the definitions under the Advisers Act that
exclude foreign private advisers and family offices from SEC regulation
bear little relevance to FinCEN's mandate to reduce illicit finance
risks and the purposes of the proposed regulation. These commenters
expressed concern that excluding foreign private advisers and family
offices would simply lead some entities, including th
[…truncated; see source link]Indexed from Federal Register on September 4, 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.