FinCEN s Proposed Anti-Money Laundering Compliance Requirements for Investment Advisers: How to Prepare Now
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1 FinCEN s Proposed Anti-Money Laundering Compliance Requirements for Investment Advisers: How to Prepare Now I. INTRODUCTION On August 25, 2015, the Financial Crimes Enforcement Network ( FinCEN ) proposed a rule requiring investment advisers registered with the U.S. Securities and Exchange Commission ( SEC ) to establish anti-money laundering ( AML ) programs and file suspicious activity reports ( SARs ). 1 The proposed rule will affect over 11,000 investment advisers controlling over $62 trillion in assets, and will authorize the SEC to conduct compliance examinations on registered investment advisers. 2 The proposed rule is not without precedent. While until recently, investment advisers have not been subject to affirmative AML requirements, 3 FinCEN previously raised the prospect of AML compliance rules for investment advisers. In 2003, FinCEN issued a Notice of Proposed Rulemaking that would have required certain investment advisers to establish AML compliance programs. 4 FinCEN withdrew the proposed rule five years later. 5 Investment advisers often have critical knowledge of the movement of large amounts of financial assets through the U.S. and global financial markets. 6 In some cases, the investment adviser may be the only person with access to the identity of the customer, the source of the invested assets and the customer s investment objectives. 7 As a result, investment advisers play a CONTACTS» Ellen Zimiles Financial Risk & Compliance Segment Leader Head of Global Investigations & Compliance ellen.zimiles@navigant.com Alma Angotti Managing Director alma.angotti@navigant.com Claire O Leary Slagis Senior Consultant claire.slagis@navigant.com navigant.com CFR Chapter X. RIN: 1506-AB10. See: 2. According to the U.S. Securities and Exchange Commission s Fiscal Year 2014 Agency Financial Report. See: secafr2014.pdf. 3. Though they may have been subject to some AML obligations due to counterparty expectation, broker-dealer or custodial bank requirements or customer requirements Federal Register 68, No. 86 (May 5, 2003) at See Withdrawal of Notice of Proposed Rulemaking: Anti-Money Laundering Programs for Unregistered Investment Companies, 73 FR (November 4, 2008) and Withdrawal of the Notice of Proposed Rule Making: Anti-Money Laundering Programs for Investment Advisers, 73 FR (November 5, 2008) Federal Register 68, No. 86 (May 5, 2003) at Id. FRAZIER ILLUSTRATION
2 critical role in preventing the abuse of their services for money and terrorist financing. 8 As FinCEN notes, the proposed requirements will subject investment advisers to regulations comparable to those already imparted on other financial institutions with similar obligations, such as mutual funds, broker-dealers in securities, banks and insurance companies. 9 Though FinCEN s 2015 rule is a proposal only, there is little chance that FinCEN will not finalize the rule. There are steps that investment advisers can take to prepare. II. WHAT THE PROPOSED RULE ENTAILS FinCEN s proposed rule will categorize investment advisers under the general definition of financial institution under the Bank Secrecy Act ( BSA ), with similar AML obligations. 10 According to FinCEN, the following investment advisers will be subject to the proposed rule: [a]ny person who is registered or required to registered with the SEC under section 203 of the Investment Advisers Act of 1940 (15 U.S.C. 80b-3(a). The definition covers both primary advisers and sub-advisers. 11 All investment advisers covered under the proposed definition will be subject to the requirements applicable to financial institutions, including establishing an AML Program, recordkeeping requirements and reporting requirements. 12 The proposed rule does not include a customer identification program ( CIP ) requirement; however, FinCEN plans to address additional AML requirements for investment advisers in subsequent rulemakings. FinCEN noted in particular that the CIP requirement will be addressed via a joint rulemaking effort with the SEC AML Program 14 Investment advisers falling under the proposed definition will be required to establish a risk based AML compliance program reasonably designed to prevent money laundering and terrorist financing and to achieve and monitor compliance with the BSA. 15 The program requirements will include the same Four Pillars of AML compliance that apply to all financial institutions under the BSA: 8. Id CFR Chapter X. RIN: 1506-AB As defined in the BSA, the term financial institution currently includes such institutions as: insured banks; commercial banks; private banks; agencies or branches of foreign banks in the United States; any credit union; thrift institutions; brokers or dealers registered with the SEC; brokers or dealers in securities or commodities; investment bankers or investment companies; currency exchanges; an issuers, redeemers, or cashiers of traveler s checks, checks, money orders, or similar instruments; operators of a credit card systems; insurance companies; dealers in precious metals, stones, or jewels; pawnbrokers; loans or finance companies; travel agencies; licensed sender of money or persons engaged as a business in the transmission of funds; telegraph companies; businesses engaged in vehicle sales; persons involved in real estate closings and settlements; the United States Postal Services; casinos or gambling establishments with annual gaming revenues of more than $1,000,000; and futures commission merchants, commodity trading advisers, or commodity pool operators registered, or required to register, under the Commodity Exchange Act (7 USC 1, et seq.). See: BSA 31 USC 5312(a)(2), 11. FinCEN also notes that the definition is subject to expansion and may include other types of investment advisers, including state-regulated investment advisers or investment advisers exempt from SEC registration in future rulemakings. 31 CFR Chapter X. RIN: 1506-AB Id. 13. Id. 14. Navigant does not purport to cover an exhausted list of all AML Program requirements, but rather a summary of the seminal requirements CFR Chapter X. RIN: 1506-AB10. 2 PERSPECTIVES FinCEN s Proposed Anti-Money Laundering Compliance Requirements for
3 a. Policies, Procedures and Internal Controls 16 To set the appropriate tone at the top the BSA requires each financial institution to adopt written policies, procedures and internal controls that senior management must approve. Even without a formal customer identification requirement, investment advisers will probably need to obtain all relevant customer information necessary for an effective AML compliance program. FinCEN notes the policies, procedures, and internal controls should be risk-based, with large firms adopting policies, procedures and internal controls covering the responsibilities of all of the individual departments responsible for the varying aspects of the AML Program, and with smaller firms adopting procedures corresponding to their simpler organizational structures. 17 b. AML Compliance Officer Under the proposed rules, FinCEN will require the investment adviser to designate an AML compliance officer responsible for ensuring the successful implementation of the program, monitoring compliance with the program and arranging the appropriate training of personnel. The SEC, however, already requires advisers to have a designated compliance officer. FinCEN believes investment advisers have the ability to successfully adapt existing policies, procedures and internal controls to comply with the proposed rulemaking. 18 c. Ongoing Training All financial institutions with AML program requirements must provide on-going training of appropriate persons about their responsibilities CFR (a) CFR Chapter X. RIN: 1506-AB CFR (b) (4). 3 PERSPECTIVES FinCEN s Proposed Anti-Money Laundering Compliance Requirements for
4 d. Independent Testing All AML compliance program rules require the financial institutions to conduct an independent test to monitor and maintain an adequate compliance program. 19 The independent test is an institution s last line of defense against abuse by criminals and money launderers, because a good test will detect weakness in the program before criminals or regulators do. The testing must also be risk-based, and a knowledgeable third party, or any officer or employee of an institution independent from the designated AML compliance officer, may conduct the test. 2. Reporting, Recordkeeping and Other Requirements 20 In addition to establishing an AML program resting on the Four Pillars detailed above, investment advisers will be subject to compliance with recordkeeping, Suspicious Activity Report ( SAR ) and Currency Transaction Report ( CTR ) requirements. Investment advisers will also be subject to information sharing requests pursuant to sections 314(a) and 314 (b) of the USA PATRIOT Act. a. SAR Requirements Under the proposed rule, investment advisers will be obligated to file SAR reports of suspicious transactions. SARs are a critical tool for FinCEN, giving the agency the ability to combat money laundering, terrorism and other criminal activity using financial information. FinCEN will require investment advisers to file SAR reports for transactions over 5,000 that the investment adviser suspects: i. Are derived from illegal activity, or are intended to hide or disguise funds derived from illegal activity as part of a crime; ii. Are designed to evade the BSA or its implementing regulations; iii. Have no apparent lawful or business purpose; or iv. Involve the use of the investment adviser to facilitate a crime Id. 20. Navigant does not purport to cover an exhausted list of all recordkeeping requirements, but rather a summary of the seminal requirements CFR Chapter X. RIN: 1506-AB10. 4 PERSPECTIVES FinCEN s Proposed Anti-Money Laundering Compliance Requirements for
5 e. CTR Requirements The proposed rule will require investment advisers to file CTRs and will eliminate investment advisers obligation to file Form The proposed rules will replace the Form requirement and instead require investment advisers to file CTRs for transactions involving a transfer of more than USD 10,000 by or through the investment advisers in a single business day. 23 f. Record-Keeping and Travel Requirements Under the proposed rule, investment advisers will be obligated to create and retain records for transmittals of funds, as well as to ensure select identifying information connected to the funds transmittal travels to the next institution in the payment chain. 24 The current rules require financial institutions to keep records of identifying information about the transmitter of the transaction and the transaction s recipient such as name and address and are applicable to transmittals of funds equal to or exceeding USD 3, FinCEN, however, intends to apply an existing exception for certain financial institutions, including securities broker dealers, to investment advisers. Under the exception, investment advisers will be required to create and retain records for extensions of credit and cross-border transfers of currency, monetary instruments, checks, investment securities and credit exceeding USD 10, g. 314(a) and 314(b) Requirements Pursuant to sections 314(a) and 314(b) of the USA PATRIOT Act, financial institutions are subject to information sharing designed to identify money laundering and terrorist activity. 27 Section 314(a) requires information sharing between the government and financial institutions. Under 314(a), FinCEN has the power to require financial institutions to search their records to determine whether they have kept accounts or conducted transactions with persons suspected of engaging in terrorist activities or money laundering. 28 Section 314(b) gives financial institution safe harbor protections from liability for information sharing to facilitate the identification and reporting of possible money laundering or terrorist activities. 29 Under the proposed rulemaking, investment advisers would be subject to both 314(a) and 314(b) FinCEN s current regulations require investment advisers to file reports on Form 8300 for the receipt of more than $10,000 in cash and negotiable instruments. 23. Under the current regulations, a financial institution must treat multiple transactions as a single transaction if the transactions are conducted on behalf of the same person. 24. See 31 CFR (f) and 31 CFR (e)(3). 25. See 31 CFR (f) and 31 CFR (e)(3) CFR Chapter X. RIN: 1506-AB See 31 U.S.C and See U.S.C and Ibid CFR Chapter X. RIN: 1506-AB10. 5 PERSPECTIVES FinCEN s Proposed Anti-Money Laundering Compliance Requirements for
6 III. WHAT YOU CAN DO TO PREPARE The guidance Navigant provided in its publication titled Anti-Money Laundering Compliance for Investment Advisers: What You Can Do Right Now (March 2012) remains pertinent. 31 Investment advisers would be wise to take the following measures to prepare for the proposed rulemaking: 1. Conduct a Risk Assessment The necessary foundation of any risk-based AML compliance program is detailed knowledge of the money-laundering, terrorist financing and financial crime risks inherent in your business. Once you identify the particular risks of your business, you can design an appropriate AML program to mitigate that risk. In addition, you can better identify and mitigate gaps in your internal controls. 32 You should identify the specific risk categories applicable to your business: customer risk, products and services risk, transaction risk and geographic risk. Then when you design an AML compliance program, you can focus limited compliance resources on the parts of the business that present the most risk. 2. Due Diligence FinCEN has not yet proposed a CIP requirement or customer due diligence requirement for investment advisers; however, FinCEN will address the issue in subsequent rulemakings. Investment advisors should further be aware that in September 2014, FinCEN published a Notice of Proposed rulemaking that will augment CDD requirements for financial institutions. The Proposed Rule establishes requirements for covered financial institutions to identify and verify the identity of their customer s beneficial owners. 33 FinCEN has stated the cornerstone of a strong compliance program is the adoption and implementation of internal controls, which include comprehensive CDD policies, procedures and processes for all customers, particularly those presenting a high risk for money laundering or terrorist financing. Under the current requirements for financial institutions, the following minimum requirements apply: 31. See: CFR Chapter X. RIN: 1506-AB Fed Reg. 149, (August 4, 2014). See: 6 PERSPECTIVES FinCEN s Proposed Anti-Money Laundering Compliance Requirements for
7 a. Conducting initial due diligence on customers, which includes identifying the customer and verifying his or her identify on a risk basis when the account is opened; b. Understanding the purpose and intended nature of the account and expected activity to assess risk and report suspicious activity; and c. Performing ongoing monitoring of the customer relationship and conducting additional CDD as appropriate. The only element of the proposed rule that is entirely new is the requirement to identify the beneficial owners 34 of all customers using riskbased identification. Now would be a good time to evaluate the customer information you already collect to make sure you are obtaining sufficient information to understand the risk of your investors. If not, you should think about what additional information you would need to collect if FinCEN finalizes the proposed rule. You may also want to consider evaluating your customer base as a whole. You can review your existing customers and determine whether some of them present a heighted risk of money laundering and terrorist financing based on what you already know. If so, consider whether you will want to obtain additional due diligence information for those higher risk customers in the event the rule is finalized. 3. Training Training your staff is an important step to ensure that your company is ready to implement AML compliance rules. The staff will need training on your program and their roles and responsibilities in its implementation. Your staff should have a good understanding of how typical customers behave. You may need to focus their awareness and make sure they know what to do if they see something suspicious. Training staff on the red flags they may see in the course of their duties, as well as your escalation procedure for identifying and reporting potentially suspicious activities, will be critical to the success of your program. Employees that have specific AML responsibilities will require special training. 34. Under the proposed rule, a beneficial owner is any individual who owns 25 percent or more of the equity interests of a customer (directly or indirectly). The proposed rule will also require the identification of one individual with significant responsibility to control, manage, or direct a legal entity, such as an executive officer or individual who performs a similar function. In order to comply with the proposed rule, financial institutions will therefore need to verify the identity of each individual with 25 or more percent ownership and one individual with control of the entity. Id. 7 PERSPECTIVES FinCEN s Proposed Anti-Money Laundering Compliance Requirements for
8 4. Independent Test One important step you could take now is to think about who will conduct your independent test. If your company is large enough to have an internal audit department, that may be a good choice. You may have to provide training to the internal auditors to ensure they have a working knowledge off the BSA so that the test is adequate. If you do not have an internal audit department, or choose not to use them for your test, you will need to determine whether to engage an outside auditor or another independent party in your company to conduct the test. There is no right answer, but it is imperative that the tester has both working knowledge of the BSA and the risk of your business. The opinions expressed in this article are those of the author and do not necessarily represent the views of Navigant Consulting, Inc. Neither Navigant nor the author assume responsibility for legal advice nor make any representations concerning interpretations of either the law or contracts Navigant Consulting, Inc. All rights reserved Navigant Consulting is not a certified public accounting firm and does not provide audit, attest, or public accounting services. See navigant.com/licensing for a complete listing of private investigator licenses. 8 PERSPECTIVES FinCEN s Proposed Anti-Money Laundering Compliance Requirements for
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