FinCEN Issues Proposed Rule Expanding AML Requirements to Investment Advisers

After over two decades of examining anti-money laundering (AML) risks in the asset management industry, the Treasury Department appears poised this year to sweep certain investment advisers under the AML umbrella of the Bank Secrecy Act (BSA). On February 15, 2024, Treasury’s Financial Crimes Enforcement Network (FinCEN) issued a notice of proposed rulemaking (NPRM) that would require certain investment advisers to establish anti-money laundering/countering the financing of terrorism (AML/CFT) programs, file reports with FinCEN, and maintain records. FinCEN first proposed rules regulating private funds and investment advisers in 2002 and 2003; it has simultaneously withdrawn its narrower and most recent 2015 NPRM. Concurrent with this NPRM, the Treasury Department released the 2024 Investment Adviser Risk Assessment, which outlined four main categories of illicit finance activity involving the investment adviser sector in the United States, including (i) the potential for investment advisers to serve as an entry point into the United States market for illicit proceeds associated with foreign corruption, fraud, and tax evasion, (ii) management of significant assets ultimately controlled by sanctioned entities, (iii) that registered investment advisers (RIAs), exempt reporting advisers (ERAs), and the private funds they advise are at risk of being used by foreign states to access certain technology and services with long-term national security implications through investments in early-stage companies, and (iv) in certain cases investment advisers have stolen client assets, including through fraud.

The proposed rule would include RIAs and ERAs within the BSA’s definition of a “financial institution” and require them to:¹ 

• Create, implement, and monitor AML/CFT programs.²
• File Suspicious Activity Reports (SARs) and Currency Transaction Reports (CTRs) with FinCEN.
• Comply with the Recordkeeping and Travel Rules for transmittals of funds exceeding US$3,000.³
• Adhere to information-sharing requirements, due-diligence standards, and “special measures” provisions under the USA PATRIOT Act.
• Submit to periodic compliance examinations by the US Securities and Exchange Commission (SEC) and FinCEN.

The public comment period on the proposed rule ends on April 15, 2024. Compliance is required within 12 months of the effective date of the final rule.

AML/CFT Program Requirement

Under the proposed rule, RIAs and ERAs would need to create and implement an AML/CFT program that covers all advisory activities, except for advisory activities in connection with mutual funds. The program would have to be risk-based and reasonably designed to prevent third parties from using the investment advisers for illicit finance activities such as money laundering, fraud, and terrorist financing. The program would have to be approved by the investment adviser’s board of directors/trustees or a comparable authority, and the program would be subject to FinCEN and SEC examination authority. Currently, many investment advisers voluntarily implement programs to prevent money laundering, but such programs are generally not subject to FinCEN and SEC examination. 

Scope of the AML/CFT Program Requirement

• The AML/CFT program requirement would apply to RIAs and ERAs who act as primary advisers or provide sub-advisory services.⁴
• An RIA or ERA could delegate the management of the AML/CFT program to a third party, but the investment adviser would remain liable for the program’s compliance with BSA and FinCEN requirements.
• An RIA that is dually registered with the SEC as a broker-dealer, or is a bank or bank subsidiary, would have the option of creating a separate AML/CFT program or participating in an enterprise-wide AML/CFT program that covers all of the entity’s activities subject to the BSA. The same option similarly applies to RIAs or ERAs that are affiliated with or a subsidiary of another entity.

Required Elements of a Risk-Based AML/CFT Program

Under the proposed AML/CFT program requirement, an RIA or ERA would have to:

• Create and implement policies, procedures, and internal controls reasonably designed to prevent illicit finance activities.
• Provide for independent testing of the program by the investment adviser’s employees or a qualified outside party.
• Designate one or more persons to implement and supervise the program.
• Provide for ongoing training of personnel.
• Implement risk-based procedures for performing ongoing customer due diligence (CDD), in accordance with FinCEN’s CDD Rule.⁵

SAR and CTR Filing Obligations

The proposal would require RIAs and ERAs to:

• File SARs on suspicious transactions conducted or attempted by, at, or through an investment adviser, involving or aggregating to at least US$5,000, and that the adviser knows, suspects, or has reason to suspect involved funds derived from illegal activity, is designed to evade reporting requirements, has no business or apparent lawful purpose, or involves the use of the investment adviser to facilitate criminal activity.
• Collect and maintain documentation regarding each SAR for five years.
• File a CTR for each transaction involving a transfer, during one business day, of more than US$10,000 by, through, or to the adviser. This would replace the current requirement that investment advisers file Form 8300 reports for the receipt of more than US$10,000. 

Recordkeeping Requirements

The proposal would require RIAs and ERAs to:

• Comply with the BSA’s Recordkeeping and Travel Rules, including maintaining records for transmittals of funds of at least US$3,000, and ensure that certain information related to the transmittal “travels” to the next financial institution.
• Create and maintain records for extensions of credit and international transfers of currency, monetary instruments, checks, investment securities, and credit. 

Information Sharing

RIAs and ERAs would be subject to FinCEN rules governing information-sharing processes among FinCEN, law enforcement, regulators, and financial institutions to identify money laundering or terrorist activity. These processes are known as the 314(a) and 314(b) programs, and RIAs and ERAs should expect an increase in contact from FinCEN in support of law enforcement investigations, as well as from other financial institutions, under this proposed expansion. 

Due-Diligence Requirements and Special Measures Under the PATRIOT Act

The proposal would make RIAs and ERAs subject to FinCEN rules under the USA PATRIOT Act that create special due-diligence requirements for private banking accounts and correspondent bank accounts involving foreign persons and adopt “special measures” when the Treasury Secretary determines that a foreign jurisdiction, institution, transaction class, or account type is a “primary money laundering concern.” 

Delegation of Examination Authority to SEC

FinCEN would delegate to the SEC the authority to examine RIAs and ERAs for compliance with the new requirements. The SEC’s Division of Examinations staff has extensive experience reviewing AML programs, and they continue to be a priority area in 2024.⁶

Considerations

While the proposed rules are just that, the enactment of some version of these rules seems highly likely. Investment advisers should give careful thought and consideration, which may prove beneficial in the long and short term, to begin planning for the inevitability of being subject to AML/CFT requirements. Creating and implementing a risk-based AML-CFT program that is reasonably designed to prevent illicit finance will require company resources and strategic planning. Our O’Melveny team—with significant experience at both FinCEN and the SEC and with investment advisers—can help.

¹ RIAs are investment advisers who (1) are required to register with the SEC because they have more than US$110 million in assets under management and are not exempt from registration or (2) voluntarily register with the SEC. ERAs are investment advisers who are exempt from registration with the SEC because they are (1) advisers only to venture capital funds or (2) advisers only to private funds and have less than US$150 million in assets under management in the United States.
² Note that mutual funds are excluded as they are already subject to the BSA. See 31 C.F.R. 1024.
³ Note that mutual funds are excluded as they are already subject to the BSA. See 31 C.F.R. 1024.
⁴ The NPRM does not cover state-registered investment advisers or non-US investment advisers that rely on the foreign private adviser exemption.
⁵ Upon a Final Rule’s effectiveness, FinCEN would not require that advisers comply with the first two elements of the CDD rule—customer identification programs (CIP) and beneficial owner verification. FinCEN expects to address these two elements in separate, future rulemakings, including a joint rulemaking on CIP with the SEC.
⁶ See US Sec. & Exch. Comm’n, Div. of Examinations 2024 Priorities (October 16, 2023), https://www.sec.gov/files/2024-exam-priorities.pdf.

This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Alicja Biskupska-Haas, an O’Melveny partner licensed to practice law in New York; Tracie Ingrasin, an O’Melveny partner licensed to practice law in New York; Michele W. Layne, an O’Melveny of counsel licensed to practice law in California; AnnaLou Tirol, an O'Melveny partner licensed to practice law in California and the District of Columbia; Waqas A. Akmal, an O'Melveny counsel licensed to practice law in California; and Danny Hirsch, an O'Melveny associate licensed to practice law in California, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.

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