Treliant Takeaway…FinCEN Proposes Bringing Investment Advisers into Its Regulatory Umbrella

FinCEN Proposes Rule to Combat Illicit Finance and National Security Threats in Investment Adviser Sector

• Source: FinCEN.gov

Takeaway

The Financial Crimes Enforcement Network (FinCEN) announced on February 13, 2024, that it will impose Bank Secrecy Act / Anti-Money Laundering (BSA/AML) compliance requirements on certain investment advisers, issuing a Notice of Proposed Rule Making (NPRM) to that effect. If adopted, the requirements will impose a significant compliance burden on investment advisers, especially smaller institutions with a narrow investment focus on private and venture funds. The compliance requirements are specific to BSA/AML programs, suspicious activity reporting, and record keeping.   

Treliant, a trusted advisor to financial services clients, provides critical support to institutions as they establish or enhance BSA/AML and sanctions compliance and operational programs. Treliant helps ensure that institutions efficiently establish tailored and risk-based programs with minimal impact on existing compliance, operations, and personnel. Our team include both former regulators and industry veterans, including in the investment management space.  

Highlights

On February 13, 2024, FinCEN issued a notice inviting comments on an NPRM that proposes to impose BSA/AML compliance requirements on certain investment advisers that are registered with the SEC. Investment advisers vary in their business model and size, but generally provide services such as portfolio/asset management, financial planning and pension consulting. The rule would apply to two classes of investment advisers that have over $100mn in assets under management (AUM): 

• Investment advisers who are registered with the SEC, otherwise known as Registered Investment Advisers (RIAs) 
• Exempt Reporting Advisers (ERAs) who advise 1) private funds and have less than $150mn in AUM or 2) advise only venture capital funds. ERAs are exempt from SEC registration but are subject to certain reporting requirements pursuant to the Investment Advisers Act of 1940.  

 If approved, the proposed rule would require RIAs and ERAs to undertake the following:  

• Implement an effective AML/CFT program (internal policies, procedures, and controls, designation of an AML or Compliance Officer, an independent audit function, and an ongoing training program). 
• File Suspicious Activity Reports (SAR) and CTR with FinCEN. 
• Establish record-keeping requirements around the transmittal of funds (Recordkeeping and Travel Rule); FinCEN is seeking feedback on this.  
• Comply with information-sharing provisions between and among FinCEN, law enforcement agencies and other financial institutions under section 314 (b) of the USA Patriot Act. 

Investment Advisers will not be required to establish a customer identification program (CIP) or collect beneficial ownership information for legal entity customers at this time. FinCEN plans to address these requirements in subsequent rulemakings.   

In addition, FinCEN will delegate its BSA/AML compliance examination authority to the SEC given its existing activities in this sector.  

Certain investment advisers are subject to anti- money laundering and counter terrorism (AML/CFT) requirements or perform some specific activities (such as customer due diligence and screening), but the industry in general is not subject to the comprehensive requirements set forth in the Bank Secrecy Act (BSA) (as compared to banks, for example). This is because “investment advisers” are not included in the definition of “financial institutions” under the BSA. Citing this regulatory framework, FinCEN expressed concern about potential illicit activities being conducted in the industry as well as investments in start-ups (via investment funds) by Russia and China that may give them access to sensitive information and technology. 

By addressing this regulatory gap, the proposed rule also aims to prevent clients from shopping for investment advisers that conduct minimal due diligence. Finally, the proposed rule seeks to harmonize BSA/AML compliance activities across the industry and open the industry and its participants up to scrutiny by federal regulators. This NPRM is the third time that FinCEN has attempted to impose BSA/AML requirements on the industry and, in issuing this proposed rule, withdraws the NPRM issued in 2015.   

Upon issuance of the NPRM, FinCEN also cited an extensive Treasury Department report outlining the results of a risk assessment of the investment advisor sector. In short, Treasury views the industry as an “entry point” for illicit proceeds of corruption, fraud and tax evasion.   

Comments are due to FinCEN by April 15, 2024.    

What This Means for Investment Advisers:

The proposed rule and associated costs underscore the seriousness with which the U.S. government is approaching issues of transparency, money laundering, terrorist financing, and other illicit activities. As with the NPRM issued last week regarding non-financial transactions in the real estate sector, the rule would significantly expand the scope of FinCEN’s regulatory umbrella. 

If adopted, the rule will impact a rapidly burgeoning industry that includes many small ERAs advising private and venture capital funds and raise capital from trusts, family offices and high-net worth individuals, as well as institutional investors. In fact, the rapid growth of the sector was another motivating factor cited by FinCEN.   

Exceptions do apply as the proposed rule does not apply to the estimated 17,000 state registered advisers, nor does it apply to mutual funds advised by investment advisers as these funds are already considered “financial institutions” under the BSA. It also does not apply to private funds (i.e., hedge funds, private equity firms, venture capital funds).  

The operational, financial, and administrative impact of this rule will be specific to each institution but will be most impactful in small RIAs and ERAs which do not have AML controls, systems, or staff in place. In these cases, firms will need to build risk-based programs that are tailored to their risk profile, business model, and customer types (and include the components noted above). ERAs and RIAs will need to invest in initial training to, inter alia, understand the national security purposes of the BSA, what types of clients regulators see as higher risk and how to identify what may be suspicious or an illicit activity. As FinCEN plans additional rulemaking, firms should plan for how they will address possible requirements to collect beneficial ownership and establish a CIP.  

For investment advisers that are licensed as banks (or bank subsidiaries), registered as broker-dealers, or advise mutual funds, some of these requirements can be bolted onto existing compliance programs in a risk-based manner.   

It is especially important to note that the proposed rule calls out the use of third-party administrators. As such, firms that leverage these partners, particularly outside the U.S., may need to further assess the scope and effectiveness of the activities delegated (e.g., investor due diligence and identification verification) and make enhancements accordingly. This is particularly the case for administrators in the Cayman Islands, despite significant uplifts to the AML regime by CIMA in 2018.  

Looking forward, FinCEN may consider extending these requirements to non-RIA and ERA investment advisers, so the broader industry should be on alert.   Finally, firms should plan for when and if FinCEN adopts rules regarding CIP and beneficial ownership.  

Additional Information: FinCEN NPRM Fact Sheet