Leaked FBI Report Reveals Private Equity Under Enhanced Money Laundering Scrutiny

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FBI Highlights Feared AML Deficiencies in Combating Private Equity Money Laundering

Courtesy of a leaked internal Federal Bureau of Investigation (“FBI”) document, it’s now no secret that the FBI suspects that many investment vehicles, such as private equity firms and hedge funds, are widely utilized for money laundering. The FBI apparently compiled a January 2019 report titled “Financial Crime Threat Actors Very Likely Laundering Illicit Proceeds Through Fraudulent Hedge Funds and Private Equity Firms to Obfuscate Illicit Proceeds.” Now, a recently leaked May 1, 2020 internal FBI report similarly titled “Threat Actors Likely Use Private Investment Funds to Launder Money, Circumventing Regulatory Tripwires” (the “Report”) purports to supplement the January 2019 report “by providing recent reporting of hedge funds and private equity firms used to launder illicit proceeds, and expands the threat context beyond financial threat actors to include foreign adversaries.”

The Report does more than simply identify the financial threat posed by this type of money laundering; it uses some real-world examples to explain the process by which criminals are perceived to be infiltrating the global financial system using hedge funds and private equity firms, and how the current anti-money laundering (“AML”) regulatory regime is ill-equipped to stop them. It’s safe to say the FBI certainly did not intend for this play-by-play money laundering “how to” guide to go public. Investment advisors and firms should consider whether this leaked Report might add at least some momentum to the otherwise moribund (and controversial) effort by FinCEN in 2015 to propose regulations that would have made investment advisors subject to the requirement to create and maintain full AML programs under the Bank Secrecy Act (“BSA”).

The Report

The Report focuses on hedge funds and private investment funds, identifying them as privately managed investment vehicles prone to involving high net worth individuals in both management and investment. With “high confidence,” the FBI posits it’s simple for criminals and foreign adversaries to launder money through such investment vehicles. To demonstrate, the FBI writes:

Hedge funds and private equity firms receive funds from entities registered in nations that maintain laws conducive to masking underlying beneficial owners, thereby making it harder for US financial institutions and regulators to determine the source of funding. Additionally, hedge funds and private equity firms have been used to facilitate transactions in support of fraud, transnational crime, and sanctions evasion.

Many private investment funds also have advisers that are exempt from SEC registration requirements under the private advisor exemption, meaning that these advisers do not have to publicly-disclose information and are not subject to public reporting requirements. Nor are the forms these advisers use to evaluate financial risk publicly available and those funds they work for only provide information to commercially available databases on a voluntary basis. To ice the cake, these funds are also normally unregistered, which limits the SEC’s oversight.

The FBI concludes “with high confidence” that launderers using hedge funds and private equity funds are able to effectively evade detection by AML programs. The FBI thinks this practice will only continue in the long term, as threat actors “likely will expand their money laundering operations as private placement opportunities increase, resulting in continued infiltration of the licit global financial system.”

The Report sets forth this chart of how the BSA currently does and does not apply to players in the securities industry – the point being that hedge and private equity funds are lightly regulated:

FBI-Sourced Real World Examples

The FBI cites four cases where alleged criminals and foreign adversaries avoided AML guardrails by laundering through hedge funds and private equity firms:

  • As of April 2019, an identified former partner of a major US law firm assisted others in laundering more than $400 million from a fraudulent cryptocurrency investment scheme through a series of purported private equity funds holding accounts at financial institutions, including those in the Cayman Islands and the Republic of Ireland, to conceal and disguise the nature, location, source, ownership, and control of the proceeds. The underlying source of funds, the perpetrator of the cryptocurrency scheme, was not disclosed to the bank during the initial due diligence review.
  • As of July 2019, a representative of a New York, New York and London, United Kingdom-based hedge fund proposed investing in private placement funds and using a series of shell corporations to purchase and sell prohibited items from sanctioned countries to the United States. The proposed hedge fund was to have operated entities registered in Luxembourg and Guemsey to evade regulatory requirements when transacting with sanctioned companies.
  • As of January 2019, an unidentified Mexican cartel operating in the Los Angeles, California and Orange County, California, areas recruited and paid individuals to open hedge fund accounts at private banking institutions. The cartel laundered approximately $1 million through the accounts each week and then withdrew the money to purchase gold, according to a human source with direct access whose reporting has not been corroborated.
  • As of August 2017, a New York-based private equity firm received more than $100 million in wire transfers from an identified Russia-based company allegedly associated with Russian organized crime.

These schemes follow the same pattern, says the FBI. Hedge funds and equity firms accept funds from entities that are not required to disclose beneficial owners due to the nation they are registered in, which prevents the United States enforcement systems from determining the true source of the funding. The FBI asserts that, “[r]ight now, if you are a corrupt dictator in a sketchy country and you want to hide money in the United States, you can go through legitimate channels to do so.” To address the use of such private placement opportunities for illicit gains, the FBI suggests “greater regulatory scrutiny,” including beneficial ownership disclosure obligations.

However, not everyone is impressed with the FBI’s logic. As reported in Reuters:

Robert Mazur, a former U.S. Customs and Drug Enforcement Administration agent, who infiltrated both the Medellin and Cali cartels as an undercover money launderer [and now, colorful consultant], disagrees with the FBI’s solution.

“There is absolutely no way on earth that investment funds should, or would, disclose to a bank the identity of every beneficial owner that invests in a fund. To disclose all investors in a fund to an institution would be an outrageous violation of the fund manager’s fiduciary responsibility to its investors,” Mazur said.

“Not only that, can you imagine the many millions of data points that would need to be disclosed by massive funds if all investors’ identities needed to be disclosed? Sorry, but whoever is making this proposal appears to lack insight about the complexity and breadth of the investment world,” he said.

Of course, broker-dealers are already subject to AML program requirements under the BSA. And as we have blogged, AML programs are at the top of the SEC’s Office of Compliance Inspections and Examinations priority list. Although investment advisors are not currently required to maintain AML programs under the BSA, this Report may add some momentum to such future regulations, which FinCEN has described as “remain[ing] on FinCEN’s long-term regulatory agenda. It will be revisited as resources permit.”

DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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