SEC and FinCEN Propose Enhanced Anti-Money Laundering Rules for Investment Advisers
VerifyInvestor.com
The Securities and Exchange Commission (SEC) has been turning its attention to investment advisers recently. After amending the Investment Advisers Act in March of 2024 to crack down on online investment advisers’ responsibilities, the SEC, along with federal regulators, is now taking the “know your customer” (“KYC”) requirement that applies to banks, wealth management firms, fintechs, insurance companies, broker-dealers, and, indeed, any business that opens and maintains financial accounts for customers — and applying it to investment advisers.
Joint SEC and FinCEN Proposed Rule
In a joint effort to strengthen the anti-money laundering (AML) and countering the financing of terrorism (CFT) legal frameworks currently in place, while at the same time reducing money laundering activities that involve the customers of investment advisers, on May 13, 2024, the Securities and Exchange Commission (SEC) and the U.S. Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN), issued a joint notice of proposed rulemaking (NPRM) proposing a new rule that will apply to specific investment advisers.
In February 2024, FinCEN separately proposed a new rule designating registered investment advisers (RIAs) and exempt reporting advisers (ERAs) as “financial institutions” under the Bank Secrecy Act (BSA). This new rule, which follows on the heels of a similar rule proposed by FinCEN that did not pass, would, if passed, subject RIAs and ERAs to the anti-money laundering/countering financing of terrorism (AML/CFT) program requirements and the suspicious activity report (SAR) filing obligations. (We will refer to this proposed rule as the “FinCEN Proposed Rule.”) The FinCEN Proposed Rule foresees delegating authority for enforcement to the SEC and anticipates further collaboration with the SEC on this issue. Importantly, the FinCEN Proposed Rule does not contain a Customer Identification Program (CIP) requirement.
The SEC’s proposed “Customer Identification Programs for Registered Investment, advisers and Exempt Reporting Advisers” rule (which we will refer to as the “CIP Proposed Rule”), announced by the SEC and FinCEN in the May 13, 2024 NPRM, complements the FinCEN Proposed Rule. If adopted, the CIP Proposed Rule would require investment advisers to establish a Customer Identification Program (CIP).
Although financial institutions are subject to CIP requirements as part of the broader AML/CFT programs, until now, investment advisers have not had similar CIP requirements. The CIP required under the CIP Proposed Rule would not be a separate program, but would be required as part of an investment adviser’s AML/CFT program.
The federal government has determined that the time has come to strengthen the AML/CFT laws and apply them to investment advisers. According to FinCEN, in addition to investment advisers defrauding their own clients, they serve as “an entry point into the U.S. for illicit proceeds associated with foreign corruption, fraud, and tax evasion… .”. FinCEN also reports that the highest illicit finance risk in the investment adviser sector is among ERAs and RIAs.
Together, the two proposed rules are aimed at preventing money laundering, financial terrorism, and the criminal exploitation of the investment adviser sector.
Who the new rule applies to?
The new rule would apply to:
SEC-registered investment advisers (“RIAs”). These are investment advisers who are registered with the SEC or who are required to be registered with the SEC under the Investment Advisers Act of 1940, and
Exempt reporting advisers (“ERAs”). These are investment advisers who are exempt from registration under sections 203(l) or 203(m) of the Investment Advisers Act of 1940.
The CIP Proposed Rule will not apply to state RIAs or ERAs, or non-U.S. advisers that are not RIAs or ERAs. Note, however, that state RIAs and ERAs must comply with all state securities rules. Plus, under the FinCEN Proposed Rule, non-U.S. advisers who are required to register as an RIA or file as an ERA, will be deemed “financial institutions” — even if they do not maintain a branch, office, or staff in the United States.
As will be discussed more fully below, if enacted, the CIP Proposed Rule would require RIAs and ERAs to develop written CIPs as part of their AML/CFT programs and meet certain minimum requirements.
Minimum CIP requirements.
Under the CIP Proposed Rule, both RIAs and ERAs would have to establish a CIP program that:
Is written. The CIP should be appropriate for the RIA’s/ERA’s size and business, but it must be a written program.
Has risk-based procedures that allow the RIA/ERA to verify the identity to the extent “reasonable and practicable” of each customer. This can be done either before or after an account is opened, but each customer must be identified.
Contains procedures that will ultimately culminate in the RIA or ERA being able to form a “reasonable belief” that the RIA/ERA knows the identity of each customer.
Has procedures for maintaining records of the information that was used to verify the customer’s identity — including name, address, and other identifying information like social security numbers, as more fully described in the CIP Proposed Rule, and
Has procedures for providing customers with adequate notice of the CIP’s requirements.
For the most part, the CIP Proposed Rule is consistent with CIP rules that currently apply to other regulated entities in the financial industry, like broker-dealers.
In addition to being consistent with CIP requirements applicable to other regulated entities and individuals, the CIP Proposed Rule is designed to align with the FinCEN Proposed Rule. For example, both rules would have the same definition of “investment adviser.” The CIP Proposed Rule would apply to “…any RIA (those registered or required to register with the SEC) or ERA (those exempt from SEC registration under the listed provisions).” Because the two rules will work together harmoniously, regulators anticipate that enforcement of both rules would be consistent.
The CIP Proposed Rule would require investment advisers to use both documentary and non-documentary methods to collect and verify the identity of customers who directly open and hold accounts with them. The CIP must address when documentary procedures will be used, when non-documentary procedures will be used, or when a combination of the two will be used to verify the identity of each customer. In addition, the procedures must be such that verification will reach a point where the adviser can form a “reasonable belief” as to the identity of the customer. This is especially applicable to current customers. Investment advisers would not be required to re-verify the identity of current account holders if their identity was previously verified — so long as the RIA/ERA has a “reasonable belief” that it knows the true identity of the customer.
RIAs and ERAs would be required to maintain records of the information they obtain and verify the information they receive about the identity of each customer.
As drafted, the CIP Proposed Rule defines the words “account” and “customer” very broadly and has some important exceptions to these definitions. Since these terms are defined far more broadly in the CIP Proposed Rule than the way investment advisers define those terms currently, the SEC is taking comments on the question of what is an “account” for an investment adviser and who is his/her/its “customers.”
Although investment advisers would be required to collect identifying information from private funds as “customers,” the rule does not require the adviser to collect information as to the individuals or entities invested in the private funds. It may, however, require the adviser to collect information regarding the individuals who control the fund.
While some RIAs and ERAs may already employ KYC procedures, investment advisers should not just assume that their current procedures will satisfy the requirements of the CIP Proposed Rule. The KYC procedures may be different from, or not adequate for purposes of the CIP Proposed Rule, so as always, consult with experienced counsel.
If both the FinCEN Proposed Rule and the CIP Proposed Rule are adopted, RIAs and ERAs will need to ensure that their CIP and AML/CFT programs and procedures meet the specific requirements of both rules.
When must investment advisers comply with the CIP requirements rule?
Both the SEC and FinCEN are taking comments on their joint proposal. The comment period will close on July 22, 2024. The effective date for the CIP Proposed Rule is 60 days after publication of the final rule in the Federal register. Investment advisers will need to have a compliant CIP in place on or before 6 months after the effective date of the final rule.
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