Changes to AML Rules For Investment Advisors

Be Prepared for Changes to the Anti-Money Laundering (AML) Rules for Investment Advisers in 2016

A. Executive Summary

In August 2015 the Financial Crimes Enforcement Network of the US Department of the Treasury (FinCEN) published a proposed rule which would rope in certain investment advisers (“IAs”) into the definition of “financial institution”. Being subject to the FinCEN definition of “financial institution”, would subject IAs to certain requirements under the anti-money laundering (AML) laws and the Bank Secrecy Act (BSA).

In the proposed rule, FinCEN would require investment advisers that are registered or are required to be registered with the SEC (typically those with $100 million or more in assets under management, or those not regulated by a state authority) to develop and maintain AML programs and to file suspicious activity reports (SAR). FinCEN also noted that it may also consider expanding the scope to include small and mid-sized advisers because they are at risk for “abuse by money launderers, terrorist financers, and other illicit actors.”

It is necessary that investment advisers have a working knowledge of how money laundering originates, the implications, and inherent risks to their business. Those advisers who currently do not have a formal AML program should serious consider having one, or at the very least, draft policies to specifically address the four pillars of an AML program. Advisers that are already incorporating AML policies should review and routinely test their processes on an annual basis to test their effectiveness. Taking these steps now will allow firms to stay ahead of the curve and prepare for the forthcoming regulations and to meet their ongoing fiduciary obligations to clients.

Landscape of Adviser Category and AML Requirements

Landscape of Adviser Category and AML Requirements

To meet the minimum requirements of a four pillar AML Program, the program must include:

  • the development of written internal policies, procedures, and controls;
  • the designation of a AML compliance officer;
  • ongoing employee training program specifically designed for employees at each level (e.g., employee, management, executive manage, and board) ; and
  • independent audit/testing of the program.

While not required, often broker-dealers will request an investment advisory firm to perform certain AML procedures for which the broker may rely upon for its own AML program. In January of 2015, the SEC, in consultation with FinCEN, released a No-Action Letter which extended a previous line of no-action letters permitting broker-dealers to rely upon registered investment advisers to perform certain customer identification aspects of the broker-dealer’s Customer Identification Program (“CIP”). Delegation of this responsibility is typically captured as part of a reliance agreement, or similar document, whereby the duties of the investment adviser are defined and the adviser must agree to:

  • implement its own AML program consistent with the requirements of 31 U.S.C. 5318(h);
  • perform the specified requirements of the broker-dealer’s CIP Program in accordance with Section 326 the US PATRIOT ACT;
  • promptly disclose to the broker-dealer potentially suspicious or unusual activity detected as part of the CIP Program and either file, or assist the broker-dealer in filing, a Suspicious Activity Report as needed;
  • certify annually to the broker-dealer that the representations in the reliance agreement remain accurate; and
  • maintain required books and records and make such records available upon request.

B. History

As of June 2, 2014, there were 11,235 investment advisers registered with the SEC, reporting approximately $61.9 trillion in assets for their clients. Investment advisers provide advisory services to many different types of clients, including individuals, institutions, pension plans, corporations, trusts, foundations, mutual funds, private funds, and other pooled investment vehicles. Some of the advisory services that investment advisers provide include portfolio management, financial planning, and pension consulting. Advisory services can be provided on a discretionary or non-discretionary basis. Investment advisers often work closely with their clients to formulate and implement their clients’ investment decisions and strategies. Investment advisers may be organized in a variety of legal forms, Including corporations, sole proprietorships, partnerships, or limited liability companies. As long as investment advisers are not subject to AML program and suspicious activity reporting requirements, money launderers may see them as a low-risk way to enter the U.S. financial system.

C. General Statutory Provisions

FinCEN exercises regulatory functions primarily under the Currency and Financial Transactions Reporting Act of 1970, as amended by the USA PATRIOT Act and other legislation. This legislative framework is commonly referred to as the ‘‘Bank Secrecy Act’’ (‘‘BSA’’). The Secretary of the Treasury (‘‘Secretary’’) has delegated to the Director of FinCEN the authority to implement, administer, and enforce compliance with the BSA and associated regulations. FinCEN is authorized to impose AML programs and suspicious activity reporting requirements for Financial institutions. In this rulemaking, FinCEN is not proposing a customer identification program requirement or including within the AML program requirements provisions recently proposed with respect to AML program requirements for other financial institutions. FinCEN anticipates addressing both of these issues with respect to investment advisers, as well as other issues, such as the potential application of regulatory requirements consistent with Sections 311, 312, 313 and 319(b) of the USA PATRIOT Act, in subsequent rulemakings, with the issue of customer identification program requirements anticipated to be addressed via a joint rulemaking effort with the SEC.

D. Analysis

It is true that advisers work with financial institutions that are already subject to BSA requirements, such as when executing trades through broker dealers to purchase or sell client securities, or when directing custodial banks to transfer assets. Nevertheless, such broker-dealers and banks may not have sufficient information to assess suspicious activity or money laundering risks. When an adviser orders a broker dealer to execute a trade on behalf of an adviser’s client, the broker dealer may not know the identity of the client. When a custodial bank holds assets for a private fund managed by an adviser, the custodial bank may not know the identities of the investors in the fund. Such gaps in knowledge make it possible for money launderers to evade the BSA/AML Rules.

Money laundering is defined in part with respect to the proceeds of certain predicate crimes referred to as ‘‘specified unlawful activities.’’ Securities fraud is a specified unlawful activity. Both securities fraud and the act of laundering the proceeds of securities fraud are destructive to investors, individual businesses, and the financial system as a whole. The crime of money laundering also encompasses the movement of funds to finance terrorism, individual terrorists, or terrorist organizations. These funds may be from illegitimate or legitimate sources. In addition to offering services that could provide money launderers, terrorist financers, and other illicit actors the opportunity to access the financial system, investment advisers may be uniquely situated to appreciate a broader understanding of their clients’ movement of funds through the financial system because of the types of advisory activities in which they engage. If a client’s advisory funds include the proceeds of money laundering, terrorist financing, and other illicit activities, or are intended to further such activities, an investment adviser’s AML program and suspicious activity reporting may assist in detecting such activities. Accordingly, investment advisers have an important role to play in safeguarding the financial system against fraud, money laundering, terrorist financing, and other financial crime. The money laundering cycle can be broken down into three distinct stages; however, it is important to remember that money laundering is a single process.

n general, money laundering is the processing of criminal proceeds through the financial system to disguise their illegal origin, ownership, control of the assets, or promoting an illegal activity with illicit or legal source funds. Generally, money laundering involves three stages, known as: 1) placement, 2) layering, and 3) integration and an investment adviser’s operations are particularly vulnerable at each stage.

Under the proposed new rules, an example of a money laundering scheme is where money launderers may approach investment advisers seeking to obtain the adviser’s assistance as an intermediary in the “placing” of funds into custodial accounts.

The ‘‘layering’’ stage involves the distancing of illegal proceeds from their criminal source through a series of financial transactions to obfuscate and complicate their traceability. A money launderer could place assets under management with an investment adviser as one of many transactions in an ongoing layering scheme. Layering may involve establishing an advisory account in the name of a fictitious corporation or an entity designed to break the link between the assets and the true owner. A money launderer also may place assets under management with an adviser and then shortly thereafter arrange for their removal.

The ‘‘Integration’’ stage occurs when illegal proceeds previously placed into the financial system are made to appear to have been derived from a legitimate source. For example, once illicit funds have been invested with an investment advisor, the proceeds from those investments may appear legitimate to any financial institution thereafter receiving such proceeds.

Please contact Scott Kaliko at SRFK at (212) 930-9700,, or visit our website at if you wish to learn more or discuss how our firm can assist you in developing, enhancing, maintaining, or testing your AML program.

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Scott Kaliko
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