by David Sewell, Timothy Clark, Stephanie Brown-Cripps, Nathaniel Balk, Nathalie Kupfer, and Rosie Jiang

On February 13, 2024, the U.S Treasury Department’s Financial Crimes Enforcement Network (FinCEN) issued a proposed rule to extend anti-money laundering (AML) and countering the financing of terrorism (CFT) compliance obligations to certain types of investment advisers operating in the United States (Proposed Rule).[1]  The agency simultaneously released a “2024 Investment Adviser Risk Assessment” (Risk Assessment), its first comprehensive effort to describe and measure “illicit finance threats involving investment advisers.”[2]

FinCEN’s release marks the latest development in a decades-old debate about whether investment advisers should be subject to the Bank Secrecy Act (BSA) and the attendant AML/CFT requirements that have long been applied to banks, broker-dealers, and other financial institutions.  If adopted in the current (or a similar) form, the Proposed Rule would bring this long-running debate to a close once and for all.  

Below, we briefly summarize the Proposed Rule, including its scope, requirements and potential implications, and highlight open questions and next steps.  

What Did FinCEN Propose and Why?

The BSA lists various types of entities as “financial institutions” within its scope and, therefore, subject to the AML/CFT program rules implementing it.[3]  Banks, broker-dealers, insurance companies, money services businesses, and investment companies are among those specifically included, but investment advisers are not.  In the Proposed Rule FinCEN explains that it intends to exercise its authority under the statute to designate as a “financial institution” subject to the BSA “any [other] business” conducting activity that is “similar to, related to, or a substitute for” those of listed entities.[4]  

According to FinCEN, investment advisers provide asset management and advisory services similar to those offered by banks and broker-dealers and, in fact, compete directly with them.  The agency also notes that investment advisers offer products similar to those provided by investment and insurance companies, both of which also are identified as “financial institutions” in the BSA. 

Finally, FinCEN explains that applying an AML/CFT program requirement to investment advisers is warranted because, among participants in the investment and asset management industry, the adviser often has the “most direct relationship with . . . customers” and is best placed to have a “complete understanding” regarding the source of their funds and assets, beneficial ownership, and investment objectives.  The agency appears to have concluded that a vulnerability exists under the current system, in which formal AML/CFT compliance obligations apply to financial intermediaries—most notably broker-dealers and custody banks—but not to “customer-facing” investment advisers. 

In taking this view, FinCEN notes in the Proposed Rule—and discusses at length in the Risk Assessment—that the private fund industry has undergone significant growth in the decades since the USA PATRIOT Act gave rise to the modern AML/CFT compliance framework, and that such funds provide an “attractive” and “important entry point” into the US financial system for wealthy foreign nationals, especially from Russia and China.  Accordingly, FinCEN suggests that requiring investment advisers to adopt AML/CFT compliance programs substantially similar to what is required of other financial institutions would add an important safeguard to the US AML/CFT framework.[5]

Who Would be Covered?

Not all investment advisers are in scope for the Proposed Rule.  FinCEN limits the definition of “investment adviser”—and, therefore, “financial institution” under the BSA—to two specific types: (i) SEC-registered investment advisers (RIAs); and (ii) exempt reporting advisers (ERAs) that are not registered with the SEC but nonetheless are subject to periodic reporting requirements, including an abbreviated Form ADV.  However, as a practical matter, by including both RIAs and ERAs, the Proposed Rule captures most investment advisers of size in the US. 

The first category, RIAs, generally includes any investment adviser with more than $110 million in assets under management in the US (AUM) (or, in the case of NY-based managers, $25 million or more of assets under management).[6]  The second, ERAs, includes any investment adviser that would be required to register except for the fact that it either acts as adviser exclusively to one or more venture capital funds or exclusively to one or more private funds and has less than $150 million in AUM.[7]  The Risk Assessment states that “ERAs represent the highest illicit finance risk in the investment adviser sector” and, accordingly, their inclusion in the Proposed Rule is unsurprising.

The Proposed Rule excludes state-registered investment advisers and non-US investment advisers that provide services in the US but are exempt from registration, including under the foreign private adviser exemption.  For these entities, the status quo would remain and formal AML/CFT program requirements would not apply.

What Would the Proposed Rule Require?

If adopted, the Proposed Rule would require RIAs and ERAs to adopt an AML/CFT compliance program containing features that by now are very familiar to, among others, banks and broker-dealers operating in the US.  Specifically, RIAs and ERAs would be obligated to establish a risk-based, compliance program “reasonably designed” to prevent the adviser from being used for “money laundering, terrorist financing, or other illicit activity.”[8] 

Under the Proposed Rule, a covered investment adviser’s AML/CFT program must be approved by the board of directors or equivalent governing body and include the following elements:

• Written policies, procedures, and internal controls to prevent and detect money laundering, terrorist financing, and illicit activity;
• Procedures for customer due diligence (CDD) to understand the nature and purpose of customer relationships, develop customer risk profiles, and enable ongoing monitoring to identify and report suspicious activity;
• A designated person or persons with responsibility for implementing and monitoring the program;
• Ongoing training for appropriate personnel within the organization; and
• Provisions for independent testing of the program’s effectiveness.

Covered advisers also would become subject to many of the reporting, recordkeeping, and related obligations the BSA places on other types of financial institutions.  These include:

• Requirements to file suspicious activity reports (SARs) regarding certain activity “by, at, or through” the adviser that may indicate unlawful activity and currency transaction reports (CTRs) for cash transactions of more than $10,000;
• Protocols for information-sharing in response to regulatory and law enforcement authorities, in accordance with Section 314(a) of the USA PATRIOT Act, as well as for voluntary information-sharing with other financial institutions pursuant to Section 314(b) of that statute;
• Special standards for due diligence of “correspondent accounts for foreign financial institutions” and “private banking accounts;” and
• Recordkeeping obligations, including under the so-called “travel rule.”

The Proposed Rule does not, however, apply the full panoply of AML/CFT requirements applicable to other BSA-covered financial institutions.  Specifically, and notably, it does not include a Customer Information Program (CIP) requirement for RIAs and ERAs.  It also would not require them to establish procedures for identifying and verifying beneficial ownership information for legal entity customers in accordance with FinCEN’s 2018 CDD rule.[9]

Haven’t We Been Here Before?

The Proposed Rule marks the third time FinCEN has proposed AML/CFT rules for investment advisers or the private funds they manage.

The first came during the initial implementation of rules required under the USA PATRIOT Act, on September 26, 2002, and would have required unregistered investment companies, including private funds, to establish an AML compliance program.[10]  On May 5, 2003, FinCEN issued the second proposed AML rule, this time focusing on investment advisers themselves.[11] 

These initial proposals included several exemptions—most notably for private equity funds and their advisers—that FinCEN explains would be inappropriate today.  In any case, neither the 2002 or 2003 proposal was finalized and, after remaining pending for several years, FinCEN formally rescinded both in 2008. 

The third, and until yesterday most recent, proposal came on September 1, 2015.[12]  The 2015 proposal included similar substantive requirements as the earlier proposals as well as the Proposed Rule but would have applied to all RIAs and did not exempt private equity funds or their advisers; in contrast to the Proposed Rule, however, it would have included an exemption for ERAs.  In the Proposed Rule, FinCEN explains that it is formally withdrawing the 2015 proposal and substituting the 2024 version –to ensure that “changes in the risk and factual context” are reflected, most notably substantial growth in the “size, complexity, and number” of private funds that has occurred since 2015.

Many industry trade groups and other stakeholders took the position that it was unnecessary and duplicative to apply AML/CFT obligations to investment advisers, and opposition to the earlier proposals was widespread.  By simultaneously releasing the Risk Assessment, as well as a YouTube briefing by Treasury Under Secretary for Terrorism and Financial Intelligence, Brian Nelson, FinCEN appears to be taking a more active approach than it has to date in explaining why it believes the Proposed Rule to be necessary.[13] 

What Comes Next?  Are There Immediate Implications?

Immediate implications of the Proposed Rule are limited.  A 60-day comment period will follow official publication of the Proposed Rule in the Federal Register and it is too soon to tell what a final rule would look like or when it could take effect.[14]  As occurred with the earlier proposals, we expect a robust debate to occur in the coming weeks and months.

Additionally, FinCEN recognizes that, even after final implementation, an AML/CFT program rule may have limited impacts on covered investment advisers.  Whether because they are dually registered as a broker-dealer or operate within a financial institution complex that includes affiliated banks or broker-dealers, many investment advisers already have implemented AML/CFT programs that are similar to what would be required under the Proposed Rule.[15]  Indeed, FinCEN cites a 2016 analysis that found approximately 20% of RIAs representing approximately 75% of the total AUM of RIAs, were affiliated with either a broker-dealer or bank.  For these entities—as well as other advisers that have voluntarily adopted AML/CFT programs—the application of a formal program rule may require only a modest incremental compliance uplift.

It may nevertheless be advisable for investment advisers that are not affiliated with banks or broker dealers, and otherwise have not adopted an AML/CFT compliance program, to: (i) begin considering their risk profile and how it maps onto the Risk Assessment; and (ii) evaluate how AML/CFT compliance obligations like those included in the Proposed Rule could be incorporated within their existing compliance framework – to identify gaps and priority areas of focus.  Although FinCEN’s prior history of extending AML/CFT compliance requirements to investment advisers suggests that a formal rule could be delayed, perhaps indefinitely, we think the Proposed Rule is more likely than the earlier proposals to result in formal regulations, and perhaps reasonably soon. 

Footnotes

[1]        FinCEN’s news release and an unofficial draft of the proposal can be accessed here: FinCEN Proposes Rule to Combat Illicit Finance and National Security Threats in Investment Adviser Sector | FinCEN.gov.  References herein are to the text of the unofficial draft.

[2]        See FinCEN, 2024 Investment Adviser Risk Assessment (Feb. 13, 2024) (available at: 2024 Treasury Investment Adviser Risk Assessment).

[3]       31 U.S.C. § 5312(a)(2).

[4]       See FinCEN, Anti-Money Laundering/Countering the Financing of Terrorism Program and Suspicious Activity Report Filing Requirements for Registered Investment Advisers and Exempt Reporting Advisers, Unpublished Notice of Proposed Rulemaking (Feb. 13, 2024) (available at: https://public-inspection.federalregister.gov/2024-02854.pdf) (hereinafter “Proposed Rule”).  

[5]        Proposed Rule at 9-10.

[6]        Id. at 36-37.

[7]        Id. at 37.

[8]        Id. at 44.

[9]        See id. at 68.

[10]      See FinCEN, Anti-Money Laundering Programs for Unregistered Investment Companies, 67 FR 60617 (Sept. 26, 2002).

[11]      See FinCEN, Anti-Money Laundering Programs for Investment Advisers, 68 FR 23646 (May 5, 2003).

[12]      See FinCEN, Anti-Money Laundering Program and Suspicious Activity Report Filing Requirements for Registered Investment Advisers, 80 FR 52680 (Sept. 1, 2015).

[13]      See, Briefing on the Investment Adviser Sector – YouTube.

[14]      The Proposed Rule is scheduled to be published officially on February 15, 2024, with comments due April 15^th. 

[15]      See Proposed Rule at 13-15.

David Sewell, Timothy Clark, and Stephanie Brown-Cripps are Partners, Nathaniel Balk, Nathalie Kupfer and Rosie Jiang are Associates at Freshfields Bruckhaus Deringer LLP. The post was first published on the firm’s blog. 

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