The U.S. Department of the Treasury’s Financial Crimes Enforcement Network (“FinCEN”) has issued a Notice of Proposed Rulemaking (“Proposed Rule”). If adopted, the rule would subject both (i) registered investment advisers (“RIAs”) and (ii) exempt reporting advisers (“ERAs”) relying on either of the venture capital fund adviser exemption (the “VC Exemption”) or the private fund adviser exemption (the “PF Exemption”) under the US Investment Advisers Act of 1940 (the “Advisers Act”), to certain anti-money laundering (“AML”) and countering of financing of terrorism (“CFT”) requirements. For the first time, RIAs and ERAs would be subject to certain provisions of the Bank Secrecy Act (the “BSA”) that would, among other things, require them to maintain AML/CFT programs, subject them to new recordkeeping obligations and, mandate suspicious activity reports and currency transaction reports.
FinCEN published a fact sheet alongside the Proposed Rule, which covers some of the anticipated impacts and potential questions related to the Proposed Rule. FinCEN had previously proposed applying AML/CFT requirements to certain investment advisers in 2015, but that rule was never finalized. As part of this new proposal, FinCEN is withdrawing its 2015 proposed rule.
Summary
The Proposed Rule seeks to expand the definition of “financial institution” in the BSA to include RIAs and ERAs on the basis that such advisers “may be at risk for misuse by money launderers, terrorist financers, or other actors who seek access to the U.S. financial system for illicit purposes via investment advisers and threaten U.S. national security.” Treasury released its 2024 Investment Adviser Risk Assessment, which recognizes the “absence of uniform AML/CFT requirements across all investment advisers” as problematic. Specifically, Treasury reviewed law enforcement cases and found “several illicit finance threats involving investment advisers.”
These threats include:
- serving as an entry point into the U.S. market for illicit proceeds association with “foreign corruption, fraud, and tax evasion,”
- investment advisers and their advised funds being used by foreign adversaries to access certain technologies and services that have national security implications, and
- certain investment advisers stealing client funds.
Details of the Proposed Rule
Investment Advisers in Scope under the Proposed Rule
In proposing the rule, FinCEN raises concerns over “thousands of investment advisers overseeing the investment of tens of trillions of dollars into the U.S. economy [who] currently operate without legally binding AML/CFT obligations.” To address this concern, FinCEN proposes adding “investment adviser” to the definition of “financial institution” at 31 CFR
§ 1010.100(t). RIAs and ERAs would, if the rule is adopted, join a longer list of financial institutions already subject to certain BSA requirements and oversight, including, among others, mutual funds, registered broker-dealers, banks, money services businesses, and casinos.
FinCEN proposes investment advisers that will be considered “financial institutions” subject to these AML/CFT obligations will be:
- investment advisers registered (or required to be registered) with the U.S. Securities and Exchange Commission (the “SEC”) (also known as RIAs); and
- investment advisers that report to the SEC as ERAs (i.e., exempt advisers relying on either the VC Exemption or the PF Exemption).
Notably, by limiting the definition of “investment adviser” to RIAs and ERAs, several categories of investment advisers would not be subject to the Proposed Rule. Generally, those advisers with under $100 million in assets under management are regulated by state law and therefore would not be subject to the Proposed Rule’s AML/CFT requirements. Other investment advisers that are subject to the Advisers Act and SEC supervision may be excluded from the SEC’s registration requirement under other exemptions, such as the foreign private adviser exemption or the small business investment company (SBIC) exemption. Such fully exempt advisers also would not be subject to the new requirements (SBIC advisers who are also RIAs or ERAs, however, would nonetheless be subject to the Proposed Rule). In its discussion of the new obligations, FinCEN nonetheless states that it may consider the possibility of expanding the definition of “investment adviser” in the future to include such other advisers.
Requirements of the Proposed Rule
Investment advisers covered by the Proposed Rule would need to:
- implement an AML/CFT program that is “reasonably designed to assure and monitor compliance” and “risk-based;”
- file certain reports, such as Suspicious Activity Reports (SARs) and Currency Transaction Reports (CTRs), with FinCEN;
- keep records such as those relating to the transmittal of funds (i.e., comply with the Recordkeeping and Travel Rules); and
- be subject to examination and enforcement by the SEC regarding these and other obligations applicable under FinCEN and SEC regulations.
A customer identification program requirement is not being proposed at this time, but FinCEN anticipates future rulemaking related to this in conjunction with the SEC. Similarly, a requirement to collect beneficial ownership information for legal entity customers (and/or in the case of private fund clients, the fund’s individual investors) is not included in this Proposed Rule, but FinCEN also anticipates addressing that in a future rulemaking. All US investment advisers – RIAs, ERAs and other exempt or state-regulated advisers – are already subject to certain AML obligations and US sanctions rules, administered by Treasury’s Office of Foreign Assets Control (“OFAC”). As such, in order to ensure compliance with laws, regulations and executive orders administered by OFAC, advisers already may have sanctions-related procedures including with respect to their clients, fund investors and their ultimate beneficial owners. Many advisers have adopted even broader AML and “know-your-customer” policies out of prudence or because they are also banks or registered broker/dealers; historically, however, neither the Advisers Act nor the rules promulgated thereunder have formally required RIAs and ERAs to maintain and implement AML/CFT-related policies and procedures. To the extent that investment advisers with AML/CFT policies and procedures have delegated responsibilities to fund administrators, the Proposed Rule mentions that practice as potentially acceptable as long as 1) the Adviser is ultimately liable for compliance failures and 2) the administrator is properly supervised, which the rule seems to doubt possible where the administrator is primarily based overseas.
Notably, the Recordkeeping and Travel Rules require financial institutions to create and maintain records for transmittals of funds (that equal or exceed $3,000) and ensure that certain information pertaining to the transmittal of funds “travels” with the transmittal to the next financial institution in the payment chain. Among other requirements, the Recordkeeping and Travel Rules require the transmittor’s financial institution to obtain and retain the name, address and other information about the transmittor and the transaction. Because the Investment Adviser is the next institution in the chain, it must comply with Travel Rule and Recordkeeping requirements and not merely rely on the custodian of the funds to do so.
RIAs are already required under Rule 204-2 under the Advisers Act (the “Books and Records Rule”) to keep detailed records of cash receipts and disbursements, among other financial information. RIAs and ERAs that formerly used FinCEN/Internal Revenue Service form 8300 to report the receipt of more than $10,000 in cash and negotiable instruments will now use CTRs to report such transactions.
Investment advisers currently have the ability to file voluntary SARs with FinCEN in the event of suspicious activity. But in mandating an obligation to file SARs with FinCEN under certain circumstances, the Proposed Rule would allow RIAs and ERAs, for the first time, to benefit from the safe harbor protections from liability that currently applies to financial institutions.
While FinCEN is proposing this rule by itself (and not in conjunction with the SEC), it is however proposing to delegate its examination authority for purposes of the AML/CFT obligations to the SEC in light of the SEC’s expertise in the regulation of investment advisers.
In addition, since January 1, 2024, certain investment advisers have been obligated, like all US entities, to comply with the provisions of the US Corporate Transparency Act (CTA), which obligates all reporting entities (unless they meet one of 23 enumerated exemptions) to file beneficial ownership reports with FinCEN). Our client alert for fund advisers on CTA compliance is available here.
AML/CFT Program
If the Proposed Rule goes into effect, covered investment advisers would be required to establish and implement policies, procedures, and internal controls reasonably designed to prevent money laundering, terrorist financing, and other illicit finance activities. An investment adviser’s AML/CFT program should include procedures for ongoing monitoring, training, and customer due diligence. The Proposed Rule would require investment advisers to seek approval for their proposed AML/CFT program, in writing, from their boards of directors/trustees (or similar persons). FinCEN states that this would ensure AML/CFT programs receive “the appropriate level of attention.” Once established, investment advisers would be required to allow independent testing of the AML/CFT program by the adviser’s personnel or a qualified outside party.
The AML/CFT program would need to take into account risks beyond money laundering, and FinCEN stressed that investment advisers should also be cautious of “any affiliation or relationship with either persons designated by the United States or other jurisdictions with which the United States regularly coordinates sanctions actions, or foreign state-sponsored investment activity in critical or emerging technologies.”
Timing
Covered investment advisers would be required to comply with the Proposed Rule “on or before 12 months from the final rule’s effective date.” At this time, there is no indication of when the final rule’s effective date will be, if implemented.
Next steps
FinCEN will be accepting comments on the Proposed Rule through April 15, 2024 and is specifically seeking information on the estimated costs of implementing the Proposed Rule, the number of SARs and CTRs it should expect, and other factors that may inform its cost/benefit analysis. The final rule, if implemented, may differ materially from the Proposed Rule based on comments received. Please let us know if you have any questions related to the Proposed Rule and how it may affect you.
