On May 1, 2020, the Federal Bureau of Investigation issued an intelligence bulletin warning, reported on in late July by several members of the media, concerning the use by threat actors of the “private placement of funds, including investments offered by hedge funds and private equity firms, to launder money, circumventing traditional anti-money laundering (AML) programs.” The FBI asserts that hedge funds and private equity funds have been used to facilitate transactions in “support of fraud, transnational organized crime, and sanctions evasion.”
What can hedge funds and private equity firms do to lessen their use in this way? The following provides actionable AML program best practices to avoid this growing fraud.
How Threat Actors Use Investment Funds to Circumvent AML Programs
Private investment funds under management have grown over the past 25 years into a several-trillion-dollar industry in the United States, providing ever-increasing opportunities for threat actors to co-opt investment funds without being overly scrutinized.
Specifically, the FBI is concerned that many hedge funds and private equity firms receive funds from entities registered in nations that maintain laws conducive to “masking underlying beneficial owners,” which make it more difficult for U.S. financial institutions and regulators to understand funding sources.
Unlike most industry participants, who are subject to certain AML-related regulations (such as Bank Secrecy Act (BSA) filings) and who must publicly register with the Securities and Exchange Commission, private investment funds historically have not had to disclose information publicly due to the private adviser exemption. These entities are also not subject to many of the public reporting requirements that other investment advisers (such as mutual funds) are subject to.
Of the limited information available about hedge funds, most is not publicly reported. The funds do have to file with the SEC Form PF, “Reporting Form for Investment Advisers to Private Funds and Certain Commodity Pool Operators and Commodity Trading Advisors.” Once completed, however, the results of this form are not available for public consumption as the form is primarily for use by potential investors in evaluating financial risks associated with a fund. The FBI is concerned that this form is not adequate, as it only requires fund advisors to disclose the total amount invested by beneficial owners who are non-U.S. persons (non-USPERs). The disclosure of these names and entities through Know Your Client (KYC) and Know Your Entity (KYE) processes would be invaluable to regulatory and law enforcement, as they could use the form to understand the underlying investors in investment vehicles like private equity and hedge funds and assess a fund’s specific money laundering risk.
The FBI has produced the chart below describing the open issues with the current regulations and why private equity and hedge funds are targeted versus mutual funds and other-broker dealer funds.
Increased AML Vulnerability for Investment Funds
Private Equity Funds
Anti-Money Laundering Program
Bank Secrecy Act Filings
Customer Due Diligence
Customer Due Diligence (aka Know Your Customer) process required
SEC Filings (private)
Subject to examination by the Financial Industry Regulatory Authority (FINRA) and the SEC. Detailed trading data and access to the firm’s books and records must be made available upon request.
SEC Form PF: Reporting Form for Investment Advisers to the Private Funds and Certain Commodity Pool Operators and Commodity Trading Advisors:
Participate in information sharing programs pursuant to the USA PARTRIOT Act
Avoid Becoming a Statistic
How can financial institutions safeguard their organizations and avoid becoming part of 2020’s victim statistics? Applying the following AML best practices ensures an organization is set up for success:
Amidst uncertainty, having a strong AML compliance program can help those in the investment world stay ahead of the curve, and drive further transparency in investing.