[co-author: Walter B. Donaldson II - Managing Director, Freeh Group International Solutions, LLC]
There are a number of issues that FinCEN must still address, but comments to the proposed rule do not raise any material issues that will prevent the agency from issuing a final rule in 2016.
The Financial Crimes Enforcement Network’s (FinCEN’s) proposed anti-money laundering (AML) rule applicable to Securities and Exchange Commission (SEC)-registered investment advisers (RIAs) remains on track to be finalized in 2016. For background and a detailed discussion of the rule proposed on September 1, 2015, please see our previous client alert on the subject.
The comment period closed on November 2. The major financial services trade associations and several companies affected by this proposed rule submitted comment letters. In total, there were 31 comment letters submitted. In this status update, we will examine the major themes from those letters and our sense of their effect, if any, on the timeline for a final rule and implementation.
Below is a summary of the major themes addressed in the comment letters.
Scope of the Rule
Nearly all commenters expressed frustration with the scope of the rule. Generally, the scope of the rule is viewed as too broad, and it is recommended that it should be curtailed to when an RIA is actually conducting a securities trade. This is especially important because, in certain circumstances, the RIA AML requirements appear to be redundant. For example, if a trade is being conducted by a broker-dealer, no additional AML requirements should be required for the RIA in the view of commenters because the broker-dealer already is subject to reporting under the Bank Secrecy Act (BSA).
Investors in Investment Fund Vehicles
Several commenters discussed the “look through” requirements in the proposed rule. The proposed rule would require RIAs to “look through” investment fund vehicles for which they are providing investment advisory services to assess the money laundering or terrorist financing risks associated with investors in those investment fund vehicles. Commenters stated that RIAs generally do not have access to information about the investors in such funds, particularly in the registered fund context. The same is true for many closely held private funds and fund of funds structures.
Many commenters also strongly suggested that the AML requirements should not apply to RIAs that advise mutual funds. Commenters reason that mutual funds are already covered by AML requirements and adding to the existing framework is unnecessary given the low money laundering risk inherent in mutual funds.
Private Equity Funds
In addition, comment letters discussed the unlikelihood of money laundering activities involving private equity funds. Private equity funds are illiquid by nature and therefore are not likely to be used by money launderers. Commenters believe that the proposed rule would impose significant costs on advisers to private equity funds and other illiquid pooled investment vehicles, but would not likely prevent or deter money laundering.
One of the more significant issues raised by commenters is the extraterritorial effect of the proposed rule. Because of its bright-line definition of “investment adviser,” FinCEN’s proposal would extend AML programs to RIAs located outside the United States if such foreign RIAs are required to register, or if they voluntarily register, with the SEC. Many commenters noted that this proposed rule would conflict with the well-recognized jurisdictional limitations of the BSA, which is focused only on U.S.-based institutions. In order to solve this problem, commenters urge FinCEN to reconsider its bright-line definition of “investment adviser” and find a solution that will not extend AML program requirements to RIAs located outside the United States.
Sub-Advisory Services and Wrap Program Advisers
A number of commenters were concerned with the proposed rule’s effect on RIAs that provide sub-advisory and wrap program services. The proposed rule will require RIAs providing sub-advisory and wrap program services to address those services in their AML programs and monitor those services for suspicious activity. As a practical matter, in the context of both sub-advisory and wrap programs, RIAs typically lack access to information regarding the underlying investors, do not directly manage investor assets, and generally will be unable to monitor the relationships for suspicious activity.
Officers in Charge of AML Program
A recurring concern of the commenters was the requirement that an officer of an RIA be in charge of the AML program. RIAs are not usually structured with a number of corporate officers. One trade association suggested that, as long as the person in charge of the AML program has the requisite knowledge, competence, responsibility, and authority to administer the program, the person should not need to be a corporate officer.
Sharing Suspicious Activity Reports (SARs)
A number of commenters discussed the logistical problems with attempting to implement any proposed requirements without the ability to share SARs within their own corporate structures. Commenters believe that RIAs should have more latitude to share SAR-related information. Many commenters stated that they would like FinCEN to authorize investment advisers to share SARs within their corporate organizational structures, either in the final rule or in guidance issued at the time of adoption of the final rule.
In the alternative, some commenters suggested that RIAs should be able to rely on existing guidance that permits banks, broker-dealers, mutual funds, futures commission merchants and introducing brokers in commodities to share SAR-related information within their corporate organizations.
The proposed rule’s effective date is six months after a final rule is published. Commenters described significant cost and logistical impediments that will make implementation by that time burdensome, time-consuming and complex. Given the substantial undertaking that would be required of RIAs to comply with the proposed rule, the commenters recommended that the compliance date should be extended. Many suggested a timetable of 18 months from the issuance of any final rule as an appropriate amount of time.
Of the issues raised by the comment letters, FinCEN is most likely to push back against the request for the employee in charge of the AML program to be a non-officer. The regulators are likely to demand that a senior management official be accountable for AML programs. Although this requirement could frustrate some in the industry, we do not believe that this will hold up the agency’s timeline of finalizing the rule in 2016. A more interesting sideline is the possibility that an industry that has a penchant for minting lofty titles (like MD, SVP, EVP, etc.) for marketing purposes, but which carry little or no corporate power, may need to rethink that practice — not because of anything that FinCEN will do, but rather as a matter of corporate governance best practices now that the issue has been spotlighted by industry commentators.
The extraterritorial effect of the rule is likely an unintended consequence of FinCEN’s attempt to provide a simple, bright-line scope for the rule. However, FinCEN must address this issue as part of the final rule. Additionally, many foreign RIAs are already subject to AML rules in their countries of origin. This also can create conflicts with local privacy rules for non-U.S. RIAs that may restrict the ability of the non-U.S. RIA to report suspicious activity to FinCEN.
In 2002 and 2003, FinCEN published two proposed rules that would have required certain investment advisers and unregistered investment companies to establish AML programs. After more than five years of consideration, the proposed rules were withdrawn in 2008. We do not see the same happening for this proposed rule. Much has changed since 2008, including the advent of artificial intelligence algorithms that use multiple data sources to show trends and networks; redundancy would appear to be a plus, as opposed to a burden, on government resources this time around. There are a number of issues that FinCEN must address and incorporate in any final rule, but, at this time, we do not believe that there are any material issues raised by the comment letters that will prevent FinCEN from finalizing the proposed rule. This would mean that the timeline would likely include FinCEN issuing a final rule in 2016. The proposed rule has a compliance period of six months, and commenters are asking for it to be extended to 18 months. The compliance date is likely to end up somewhere in between. Given that timeline, RIAs should prepare for an effective compliance date as early as the second half of 2016.
RIAs need to start their compliance preparations now. The first step in those preparations should include working with legal counsel who can help incorporate the fundamentals of this proposed rule into the RIA’s corporate structure. The next step is for RIAs to work with their information technology departments to develop automation and possible outsourcing of some of these requirements. Given the accelerated timeline for implementation and any needed corporate governance changes, RIAs should consider the rule’s effect on their budgets for 2016 and beyond. This is especially important in light of the corporate governance requirement that the AML program be approved in writing by the board of directors, trustees or similar functioning body of the RIA.