IT’S BA-ACK: FinCEN Issues Notice of Proposed Rulemaking for SEC Registered Investment Advisers and SEC Exempt Reporting Advisers

On February 13, 2024, the U.S. Treasury’s Financial Crimes Enforcement Network (FinCEN) withdrew its 2015 notice of proposed rulemaking (NPRM) related to registered investment advisers (RIAs) and released a new notice of proposed rulemaking seeking to impose anti-money-laundering/counter-terrorist financing (AML/CTF) program requirements for the U.S. Securities and Exchange Commission (SEC) RIAs along with SEC exempt reporting advisers (ERAs).¹ The addition of ERA as a covered investment adviser for AML program requirements was not contemplated in prior efforts to apply AML obligations to investment advisers.

The current proposal has substantial nuance in who may be covered, the types of advisory services that may be included, and the impact of the AML program requirements. The expanded scope of the proposed rulemaking heightens the importance of comments to address and seek clarity on unclear/uncertain aspects of the proposed rules.

The comment period runs through April 15, 2024, and covered investment advisers would be required to comply with the rule within 12 months from the final rule’s effective date.

The rules would require RIAs and ERAs to establish an AML program and report suspicious activity. FinCEN would revise the definition of “financial institution” to include investment advisers within the general definition of “financial institution” in rules implementing the Bank Secrecy Act (BSA), which would require RIAs and ERAs, among other things, to file currency transaction reports and maintain records relating to the transmittal of funds. The rules, however, would defer extending to investment advisers the Customer Identification Program (CIP) rule and reporting of beneficial owner information for investor entities to later rulemaking. The rules would delegate to the SEC the authority to examine investment advisers for compliance with these AML requirements.

Significant Components of the Proposed Rulemaking

RIAs and ERAs should look closely at the proposed requirements. While prior proposed rulemaking for covered investment advisers has never resulted in a final rule, it appears this time that an AML/CTF programming requirement for RIAs and ERAs is poised for implementation. Substantial work has been done seeking to justify passage of the proposed rules through a risk assessment by the U.S. Department of the Treasury, the results of which were published along with the NPRM.² Below are some key considerations for RIAs and ERAs to consider in connection with this proposed rule.

RIAs and ERAs should begin to review, among other things, the types of advisory activities they provide and the nature of their clients to identify any vulnerabilities to AML/CTF. The policies, procedures, and internal controls must then be developed based on the results of the review to manage and mitigate the identified risks.

RIAs and ERAs should look closely at what regulators will expect when identifying and reporting suspicious activities (it is not just money laundering that is deemed to trigger a reporting obligation). Among other things, FinCEN points to investment fraud and foreign investor access to sensitive and controlled technology through investment relationships as potential triggers for Suspicious Activity Reports (SARs). Covered investment advisers should review prior regulatory matters that involve failure to report suspicious activity to fully understand regulatory expectations that this new rule is likely to thrust on them.

AML Program Requirement

• RIAs that are dually registered with the SEC as investment advisers and broker-dealers would not be required to establish multiple or separate programs, provided that a comprehensive AML program covers the entity’s advisory and broker-dealer activities.
• Similarly, a covered investment adviser that is affiliated with, or a subsidiary of, an entity already required to establish an AML program may implement a single comprehensive AML program covering all the activities and businesses that are subject to the BSA and its regulations.
• Covered investment advisers would be required to establish a written AML program reasonably designed to prevent the adviser from being used for AML/CFT and to achieve and monitor compliance with applicable provisions of the BSA and its regulations. The AML program must be tailored to address the specific risks of the adviser’s services and clients. The proposed rule, however, does not require an adviser’s AML program to cover advisory activities with respect to mutual funds that have established an AML/CFT program that complies with applicable AML/CFT program requirements under other provisions. FinCEN has asked for public comment on whether to exempt mutual funds from coverage in an adviser’s AML/CFT program.
• Acknowledging that the Investment Advisers Act does not distinguish between advisers and subadvisers, the proposal notably does not directly address how the requirements would apply to subadvisory activities. FinCEN has asked for public comment on how a final rule would address subadvisory and certain other advisory services that do not involve management of client assets.
• Covered investment advisers would be required to designate a person or persons responsible for implementing and monitoring the operations and internal controls of the program. In addition, the rule will require that the covered investment adviser provide training and conduct independent testing.
• The program must be approved in writing by the board of directors or trustees, and if there is no such board, by the sole proprietor, general partner, trustee, or other person(s) with functions similar to a board of directors.
• The program must also be made available to FinCEN or the SEC upon request.

No Customer Identification Program (CIP) or Customer Due Diligence (CDD) Program); However, Client Risk Assessments Will Be Key Component of Programming and Ongoing Customer Due Diligence Will Be Required

• The proposed rule does not include a CIP requirement or the CDD requirements for financial institutions that apply to certain other securities-related financial institutions. FinCEN is anticipated to address these issues, as well as other potential AML requirements, in subsequent rulemakings, with the CIP requirements addressed in a joint rulemaking with the SEC.
• For advisers that advise private funds, the proposed rule does not specify whether the private fund or the underlying investors are the clients. Instead, the proposed rule would require a risk-based assessment of the money laundering risks by investors in such investment vehicles using similar factors used to assess clients with directly managed assets.
• Given the likelihood of further program requirements surrounding CIP and CDD rulemaking, covered investment advisers should begin to think about how to integrate CIP/CDD programming as they engage in building their larger AML programming.
• Although there is not currently a prescriptive CIP/CDD rule requirement, covered investment advisers would be required to assess the AML/CFT risks posed by a client by evaluating the relevant risk factors. Ongoing CDD will be required. For example, if the client is an individual, relevant factors would include the source of funds and jurisdiction in which the client is located. If the client is an entity, relevant factors may include the type of entity, jurisdiction of location, and the statutory and regulatory regime of that jurisdiction. Other relevant factors such as the adviser’s history with the client and references of other financial institutions may also be considered.

Adding RIAs and ERAs to the Definition of “Financial Institution”

• A definition of “investment adviser” would be added to the regulations to include any person registered or required to be registered with the SEC under Section 203 of the Investment Advisers Act of 1940 (Investment Advisers Act) (RIAs) or any person currently exempt from SEC registration under Section 203(l) or 203(m) of the Investment Advisers Act (ERAs).
• Investment advisers should pay close attention to the proposed definition of financial institution to determine whether the rule will apply as not all investment advisers are required to be registered under the Investment Advisers Act. The proposed rule does not cover state-registered investment advisers.
• Notably, ERAs that advise only private funds and have less than $150 million in assets under management in the United States or investment advisers that advise only venture capital funds are considered financial institutions for AML program requirements under the proposed rule.
• The proposed rule would include certain non-U.S. investment advisers that are physically located abroad (i.e., do not have a branch, office, or staff in the United States) but are nonetheless registered or required to register with the SEC (for RIAs) or file Form ADV (for ERAs).

Currency Transaction Reporting/Transmittal of Funds and Other Recordkeeping Requirements

• The proposed rule would require covered investment advisers to file currency transaction reports (CTRs). A CTR would be filed for any transaction involving a payment or transfer of more than $10,000 in currency by, through, or to the covered investment adviser during any one business day.
• The BSA imposes on financial institutions certain recordkeeping and travel rules applicable to transmittals of funds that equal or exceed $3,000 (the Recordkeeping and Travel Rules).
• Under the proposed rule, covered investment advisers must create and retain certain records, including information similar to what would generally be required for CIP, regarding each transmittal of funds of $3,000 or more and ensure that certain information “travel” with the transmittal to the next financial institution in the payment chain.
• Covered investment advisers should consider commenting on these new requirements insofar as FinCEN has asked for more information around various aspects of money transmittal within investment adviser structures.

Suspicious Activity Reporting

Under the proposed rule, covered investment advisers will be required to report a transaction if (1) it is conducted or attempted by, at, or through the investment adviser, (2) it involves or aggregates funds or other assets of at least $5,000, and (3) the investment adviser knows, suspects, or has reason to suspect that the transaction (or a pattern of transactions of which the transaction is a part);

• involves funds derived from illegal activity or is intended or conducted in order to hide or disguise funds or assets derived from illegal activity as part of a plan to violate or evade any federal law or regulation or to avoid any transaction reporting requirement under federal law or regulation;
• is designed, whether through structuring or other means, to evade any requirements of the BSA or its implementing regulations;
• has no business or apparent lawful purpose or is not the sort in which the particular customer would normally be expected to engage, and the investment adviser knows of no reasonable explanation for the transaction after examining the available facts, including the background and possible purpose of the transaction; or
• involves use of the investment adviser to facilitate criminal activity (e.g., fraud or terrorist financing).

Evaluation of Client Activity and Relationships for Suspicious Transaction Monitoring

• Covered investment advisers will need to evaluate client activity and relationships and design a suspicious transaction monitoring program that is appropriate considering its money laundering risks. Some types of suspicious activity could indicate possible structuring, for example, subscription of private fund interests with money orders or travelers checks in structured amounts to avoid currency reporting requirements or a managed account funded by multiple wire transfers from different accounts maintained at different financial institutions.
  
  • Suspicious activity is not limited to money movements, and covered investment advisers should pay close attention to the proposed requirements for monitoring and reporting suspicious activity.

Suspicious Activity Report (SAR) Filing and Notification Procedures

• A suspicious transaction is reported to FinCEN by filing an SAR no later than 30 days after the date of initial detection by the RIA that the transaction is suspicious.
• If no suspect can be identified on the date of initial detection, the SAR may be delayed an additional 30 days to identify a suspect, but in no case may reporting be delayed more than 60 days after initial detection.
• For situations requiring immediate attention, such as suspected terrorist financing or ongoing money laundering schemes, the investment adviser must immediately notify an appropriate law enforcement authority in addition to filing a timely SAR.
• Suspicious transactions that may relate to terrorist activity may be voluntarily reported to FinCEN’s Resource Center in addition to filing a timely SAR.

Record Retention

• The covered investment adviser should retain copies of filed SARs and the original (or business-record equivalent) of any related supporting documentation for five years from the date of filing the SAR. Supporting documentation must be made available on request to FinCEN, or federal, state, or local law enforcement agency, or any federal regulatory authority that examines the investment adviser for compliance with the BSA.

Covered investment advisers will want to look closely at the proposed rule to identify potential opportunities to comment on components of the proposed rule. Indeed, FinCEN seeks comment on a host of areas that are pertinent to investment adviser services ranging from subadvisory relationships to third-party administration and fund transmittal, among others. FinCEN specifically requested comments on whether ERAs should be considered covered investment advisers for purposes of AML programming requirements. With the timeline for comments approaching, it will be important to identify further areas where FinCEN can align with industry practices to lessen the burden of significant compliance obligations without compromising efforts to combat AML/CTF concerns.

¹ The FinCEN news release is available here.

² A copy of the U.S. Department of the Treasury 2024 Investment Adviser Risk Assessment is available here.