Financial Crimes Enforcement Network: Anti-Money Laundering/Countering the Financing of Terrorism Program and Suspicious Activity Report Filing Requirements for Registered Investment Advisers and Exempt Reporting Advisers

Federal RegisterFeb 15, 2024

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DEPARTMENT OF THE TREASURY

Financial Crimes Enforcement Network

31 CFR Parts 1010 and 1032

RIN 1506-AB58

Financial Crimes Enforcement Network: Anti-Money Laundering/Countering the Financing of Terrorism Program and Suspicious Activity Report Filing Requirements for Registered Investment Advisers and Exempt Reporting Advisers

AGENCY:

Financial Crimes Enforcement Network (FinCEN), Treasury.

ACTION:

Notice of proposed rulemaking.

SUMMARY:

FinCEN, a bureau of the U.S. Department of the Treasury (Treasury), is issuing this notice of proposed rulemaking (NPRM) to include certain investment advisers in the definition of “financial institution” under the Bank Secrecy Act (BSA), prescribe minimum standards for anti-money laundering/countering the financing of terrorism (AML/CFT) programs to be established by covered investment advisers, require covered investment advisers to report suspicious activity to FinCEN pursuant to the BSA, and make several other related changes to FinCEN regulations. FinCEN is proposing this action to address gaps in the existing AML/CFT regulatory framework in this sector. The proposed regulations will apply to investment advisers that may be at risk for misuse by money launderers, terrorist financers, or other actors who seek access to the U.S. financial system for illicit purposes via investment advisers and threaten U.S. national security.

DATES:

Written comments on this notice of proposed rulemaking (NPRM) must be submitted on or before April 15, 2024.

ADDRESSES:

Comments may be submitted by any of the following methods:

•

Federal E-Rulemaking Portal: http://www.regulations.gov.

Follow the instructions for submitting comments. Refer to Docket Number FINCEN-2024-0006 and RIN 1506-AB58.

•

Mail:

Policy Division, Financial Crimes Enforcement Network, P.O. Box 39, Vienna, VA 22183. Refer to Docket Number FINCEN-2024-0006 and RIN 1506-AB58.

Please submit comments by one method only.

FOR FURTHER INFORMATION CONTACT:

The FinCEN Resource Center at (800) 767-2825 or email

frc@fincen.gov.

SUPPLEMENTARY INFORMATION:

I. Executive Summary

To address illicit finance risks in the investment adviser industry, FinCEN is proposing to apply certain AML/CFT requirements to certain investment advisers. Currently, there are no Federal or State regulations requiring investment advisers to maintain AML/CFT programs

or records under the BSA, although some investment advisers may do so, for example, if they are also licensed as banks (or are bank subsidiaries), registered as broker-dealers, or advise mutual funds.

This means that thousands of investment advisers overseeing the investment of tens of trillions of dollars into the U.S. economy currently operate without legally binding AML/CFT obligations.

Section 6101 of the AML Act, codified at 31 U.S.C. 5318(h), amended the BSA's requirement that financial institutions implement AML programs to also combat terrorist financing. This NPRM refers to “AML program” when discussing the obligation prior to the enactment of the AML Act, and to “AML/CFT program” in reference to the current obligation contained in the BSA and the proposed rule.

See infra

section IV.E3 and n. 51.

These proposed regulations aim to close this gap by amending chapter X of title 31 of the Code of Federal Regulations to add “investment adviser” to the definition of “financial institution” at 31 CFR 1010.100(t). FinCEN has statutory authority to define additional types of businesses as financial institutions where it determines that such businesses engage in any activity “similar to, related to, or a substitute for” those in which any of the businesses listed in the statutory definition are authorized to engage.

FinCEN proposes to make such a determination with respect to investment advisers, which would be defined to include two types of advisers: those that are (1) registered or required to register with the U.S. Securities and Exchange Commission (SEC, and, such investment advisers, RIAs) and (2) investment advisers that report to the SEC as Exempt Reporting Advisers (ERAs) pursuant to the Investment Advisers Act of 1940, as amended (Advisers Act),

and the rules thereunder.

31 U.S.C. 5312(a)(2)(Y).

15 U.S.C. 80b-1

et seq.

Accordingly, this proposed rule would establish AML/CFT requirements for RIAs and ERAs. In full, the proposed rule would require RIAs and ERAs to implement an AML/CFT program, file Suspicious Activity Reports (SARs) with FinCEN, keep records relating to the transmittal of funds (Recordkeeping and Travel Rule), and other obligations of financial institutions under the BSA. The proposed rule would also apply information-sharing provisions between and among FinCEN, law enforcement government agencies, and certain financial institutions, and would subject investment advisers to the “special measures” imposed by FinCEN pursuant to section 311 of the USA PATRIOT Act.

Concurrent with this proposal, FinCEN is withdrawing the 2015 proposed rule that would have applied AML program, SAR filing, and other AML/CFT requirements to RIAs.

See

FinCEN,

Anti-Money Laundering Program and Suspicious Activity Report Filing Requirements for Registered Investment Advisers,

80 FR 52680 (Sept. 1, 2015).

In this rulemaking, FinCEN is not proposing to include a customer identification program (CIP) requirement, nor is it proposing to include within the AML/CFT program requirements an obligation to collect beneficial ownership information for legal entity customers at this time. FinCEN anticipates addressing CIP via a future joint rulemaking with the SEC and addressing the requirement to collect beneficial ownership information for legal entity customers in subsequent rulemakings.

Moreover, because mutual funds are already defined as “financial institutions” under the BSA (31 CFR 1010.100(t)(10)), and because of the regulatory and practical relationship between mutual funds and their investment advisers, the proposed regulations would also not require investment advisers to apply AML/CFT program or SAR reporting requirements to mutual funds.

The proposed regulations would also remove the existing requirement that investment advisers file reports for the receipt of more than $10,000 in cash and negotiable instruments using the joint FinCEN/Internal Revenue Service Form 8300 (Form 8300).

Investment advisers would instead be required to file a Currency Transaction Report (CTR) for a transaction involving a transfer of more than $10,000 in currency by, through, or to the investment adviser, unless subject to an applicable exemption.

As described below, FinCEN does not propose to permit investment advisers to exempt mutual funds that they advise from the requirements of 31 CFR part 1010, subparts E and F (31 CFR 1010.520, 540, 600-670) that FinCEN proposes to apply to covered investment advisers in the proposed rule (

e.g.,

certain information sharing, special standards, prohibitions, and other requirements).

31 CFR 1010.330(a)(1)(i), (e)(1); 26 CFR 1.6050I-1(e).

Finally, FinCEN is proposing to delegate its examination authority to the SEC given the SEC's expertise in the regulation of investment advisers and

the existing delegation to the SEC of authority to examine brokers and dealers in securities (broker-dealers) and certain investment companies.

31 CFR 1010.810(b)(6).

This NPRM is divided into six main sections including this executive summary in section I. Section II provides background on the existing AML/CFT regulatory framework; the illicit finance risks that this rulemaking will address; the SEC's regulatory framework for investment advisers; the limited extent to which certain RIAs and ERAs may already implement AML/CFT measures; and a summary of past proposed rules to apply AML/CFT obligations with respect to investment advisers. Section III discusses the scope of the proposed rule. Section IV includes the section-by-section analysis of the elements of the proposed rule. Section V lays out questions on which FinCEN seeks comment, and section VI addresses the severability of the proposed rule's requirements. Section VII includes the Regulatory Analysis required by relevant statutes and executive orders.

II. Background

A. Current BSA Framework

Enacted in 1970, the Currency and Foreign Transactions Reporting Act, generally referred to as the BSA, is designed to combat money laundering, the financing of terrorism, and other illicit financial activity, and to safeguard the national security of the United States.

This includes “through the establishment by financial institutions of reasonably designed risk-based programs to combat money laundering and the financing of terrorism.”

The Treasury Secretary is authorized to administer the BSA and to require financial institutions to keep records and file reports that “are highly useful in . . . criminal, tax, or regulatory investigations, risk assessments, or proceedings” or “intelligence or counterintelligence activities, including analysis, to protect against international terrorism.”

The Secretary delegated the authority to implement, administer, and enforce the BSA and its implementing regulations to the Director of FinCEN.

See

31 U.S.C. 5311. Certain parts of the Currency and Foreign Transactions Reporting Act, its amendments, and the other statutes relating to the subject matter of that Act, have come to be referred to as the BSA. The BSA is codified at 12 U.S.C. 1829b, 12 U.S.C. 1951-1960, and 31 U.S.C. 5311-5314 and 5316-5336, and includes notes thereto.

31 U.S.C. 5311(3).

31 U.S.C. 5311(1).

Treasury Order 180-01, paragraph 3(a) (Jan. 14, 2020), available at

https://home.treasury.gov/about/general-information/orders-and-directives/treasury-order-180-01.

Pursuant to this authority, FinCEN may define a business or agency as a “financial institution” if it engages in any activity determined by regulation “to be an activity which is similar to, related to, or a substitute for any activity” in which a “financial institution” as defined by the BSA is authorized to engage.

Additionally, the BSA requires financial institutions to maintain programs to combat money laundering and the financing of terrorism and authorizes the Secretary—and thereby FinCEN—to issue regulations prescribing “minimum standards” for such AML/CFT programs.

Similarly, under the BSA, FinCEN may require financial institutions to “report any suspicious transactions relevant to a possible violation of law or regulation.” This provision authorizes FinCEN to require the filing of SARs.

FinCEN also has authority under the BSA to authorize the sharing of financial information by financial institutions

in specified circumstances, and to require financial institutions to keep records and maintain procedures to ensure compliance with the BSA and its implementing regulations or to guard against money laundering.

31 U.S.C. 5312(a)(2)(Y).

31 U.S.C. 5318(h)(1), (2).

31 U.S.C. 5318(g)(1).

See

Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (USA PATRIOT Act), Public Law 107-56, sec. 314(a), (b).

See

12 U.S.C. 1953; 31 U.S.C. 5318(a)(2).

B. Investment Adviser Industry and Regulation

1. Investment Adviser Industry

The investment adviser industry in the United States consists of a wide range of business models geared towards providing advisory services to many different types of customers.

Some of the advisory services that investment advisers may provide include portfolio management, financial planning, and pension consulting. Advisory services can be provided on a “discretionary” or “non-discretionary” basis.

Investment advisers provide their expertise to a wide range of customers, including retail investors, high-net-worth individuals, private institutions, and governmental entities (including local, State, and foreign government funds).

Investment advisers often work closely with their customers to formulate and implement their customers' investment decisions and strategies. Investment advisers may be organized in a variety of legal forms, including corporations, sole proprietorships, partnerships, or limited liability companies.

This proposed rule uses the term “customers” for those natural and legal persons who enter into an advisory relationship with an investment adviser. This is consistent with the terminology in the BSA and FinCEN's implementing regulations. FinCEN acknowledges that the Advisers Act and its implementing regulations primarily use the term “clients,” and so that term is used in specific reference to Advisers Act requirements; otherwise, the term “customers” is used.

An adviser has discretionary authority or manages assets on a discretionary basis if it has the authority to decide which securities to purchase and sell for the client. An adviser also has discretionary authority if it has the authority to decide which investment advisers to retain on behalf of the client.

See

Glossary to Form ADV, general Instructions at p. 28, available at

https://www.sec.gov/about/forms/formadv-instructions.pdf.

According to the Investment Advisers Association (IAA), as of 2021, over 90 percent of RIAs manage client assets on a discretionary basis. Investment Adviser Association, Investment Adviser Industry Snapshot 2022, p. 53 (IAA Snapshot), available at

https://investmentadviser.org/wp-content/uploads/2022/06/Snapshot2022.pdf.

See

Part 1A, Item 5 of Form ADV for a list of examples of different types of advisory clients.

See

Part 1A, Item 3.A of Form ADV.

The Advisers Act and its implementing rules and regulations form the primary framework governing advisory activity, along with other Federal securities laws and their implementing rules and regulations, such as the Investment Company Act of 1940, the Securities Act of 1933, and the Securities Exchange Act of 1934.

Since the Advisers Act was amended in 1996 and 2010, generally only investment advisers who have at least $100 million in assets under management (AUM) or advise a registered investment company

may register with the SEC.

Other investment advisers typically register with the State in which the adviser maintains its principal place of business.

See generally

15 U.S.C. 80a-1

et seq.

(Investment Company Act of 1940 (Investment Company Act)); 15 U.S.C. 77a

et seq.

(Securities Act of 1933); 15 U.S.C. 78a

et seq.

(Securities and Exchange Act of 1934).

See

15 U.S.C. 80a-3 (defining investment company). If an investment company meets the definition of an investment company under 15 U.S.C. 80a-3 and cannot rely on an exception or an exemption from registration, generally it must register with the SEC under the Investment Company Act and must register its public offerings under the Securities Act.

Investment advisers with more than $100 million assets under management

may

must

See

17 CFR 275.203A-1.

SEC-Registered Investment Advisers.

Unless eligible to rely on an exception,

investment advisers that manage more than $110 million AUM must register with the SEC, as well as submit a Form ADV and update it at least annually.

The SEC administers and enforces the Federal securities laws applicable to RIAs. As of July 31, 2023, there were 15,391 RIAs, reporting approximately $125 trillion in AUM for their clients.

See id.;

17 CFR 275.204-1. Investment advisers register with the SEC by filing Form ADV and are required to file periodic updates. Form ADV is available at

https://www.sec.gov/files/formadv.pdf.

A detailed description of Form ADV's requirements is available at

https://www.sec.gov/oiea/investor-alerts-bulletins/ib_formadv.html.

The number of RIAs and corresponding AUM, and the number of ERAs, are based on a Treasury review of Form ADV information filed as of July 31, 2023. This Form ADV data is available at Frequently Requested FOIA Document:

Information About Registered Investment Advisers and Exempt Reporting Advisers, http://www.sec.gov/foia/docs/invafoia.htm.

The $125 trillion in AUM includes approximately $22 trillion in assets managed by mutual funds, which are advised by RIAs and are subject to AML/CFT obligations under the BSA and its implementing regulations.

Exempt Reporting Advisers.

An ERA is an investment adviser that would be required to register with the SEC but is statutorily exempt from such requirement

because: (1) it is an adviser solely to one or more venture capital funds; or (2) it is an adviser solely to one or more private funds and has less than $150 million AUM

in the United States.

Private funds are privately offered investment vehicles that pool capital from one or more investors to invest in securities and other investments.

Private funds do not register with the SEC, and advisers to these funds often categorize the fund by the investment strategy they pursue. These include hedge funds, private equity funds, and venture capital funds, among others. Even though they are not required to register, ERAs must still file an abbreviated Form ADV with the SEC, and the SEC maintains authority to examine ERAs. As of July 31, 2023, there were 5,846 ERAs that were exempt from registering with the SEC but had filed an abbreviated Form ADV.

An adviser that is eligible to file reports as an ERA may nonetheless elect to register with the SEC as an RIA so long as it meets the criteria for registration. An investment adviser that relies on one of these exemptions must still evaluate the need for State registration.

Form ADV uses the term “regulatory assets under management” (RAUM) instead of “assets under management.” Form ADV describes how advisers must calculate RAUM and states that in determining the amount of RAUM, an adviser should “include the securities portfolios for which [it] provide[s] continuous and regular supervisory or management services as of the date of filing” the form.

See

Form ADV, Instructions for Part 1A, Instruction 5.b.

See

sections 203(

) and 203(m) of the Advisers Act and 17 CFR 275.203(m)-1, respectively. ERAs are exempt from registration with the SEC, but are required to file reports on Form ADV with the SEC and are subject to certain rules under the Advisers Act.

Section 202(a)(29) of the Advisers Act defines the term “private fund” as an issuer that would be an investment company, as defined in section 3 of the Investment Company Act (15 U.S.C. 80a-3), but for section 3(c)(1) or 3(c)(7) of that Act. Section 3(c)(1) excludes from the definition of investment company a privately-offered issuer having fewer than a certain number of beneficial owners. Section 3(c)(7) excludes from the definition of investment company a privately-offered issuer the securities of which are owned exclusively by “qualified purchasers” (generally, persons and entities owning a specific amount of investments).

The number of ERAs is derived from a Treasury review of Form ADV information filed as of July 31, 2023.

See supra

n. 26.

•

Private Fund Advisers.

Private fund advisers, a type of ERA, are exempt from registering with the SEC if they exclusively advise private funds and have less than $150 million AUM in the United States. As of July 31, 2023, there were approximately 4,400 exempt private fund advisers, approximately 500 of which were also venture capital advisers.

Based on a Treasury review of Form ADV information filed as of July 31, 2023.

See supra

n. 26.

•

Venture Capital Advisers.

Venture capital advisers, another type of ERA, are exempt from registering with the SEC if they provide services only to venture capital funds,

regardless of the amount of AUM.

As of July 31, 2023, there were approximately 2,000 exempt venture capital advisers, approximately 500 of which were also private fund advisers.

See

17 CFR 275.203(

)-1 (defining “venture capital fund”).

Certain venture capital advisers may be registered with the SEC if they no longer satisfy the criteria to be ERAs (

e.g.,

they no longer pursue a venture capital strategy (by seeking to hold securities in companies past the initial public offering stage or pursuing hedge-fund like investment strategies)) or otherwise opt to register with the SEC.

Based on a Treasury review of Form ADV information filed as of July 31, 2023.

See supra

n. 26.

State-Registered Investment Advisers.

State-registered investment advisers generally have less than $100 million in AUM. State-registered investment advisers are generally prohibited from registering with the SEC and instead register with and are supervised by the relevant State authority, unless they meet certain exceptions or their State does not supervise these entities.

State-registered investment advisers also file a Form ADV, which they submit to the relevant State regulator. As of December 31, 2022, there were 17,063 State-registered investment advisers who have approximately $420 billion in AUM.

See

17 CFR 275.203A-2. Other exceptions to the prohibition on SEC registration include: (1) an adviser that would be required to register with 15 or more States (the multi-State exemption); (2) an adviser advising a registered investment company; (3) an adviser affiliated with an RIA; and (4) a pension consultant. Persons satisfying these criteria and the definition of “investment adviser” may register as such with the SEC. Investment advisers with a principal office and place of business in New York and over $25 million AUM are required to register with the SEC.

See

North American Security Administrators Association,

NASAA Investment Adviser Section 2023 Annual Report,

p.3,

https://www.nasaa.org/wp-content/uploads/2023/09/2023-IA-Section-Report-FINAL.pdf.

Non-U.S. Investment Advisers.

Non-U.S. advisers whose principal offices and places of business are outside the United States, but solicit or advise “U.S. persons,” are subject to the Advisers Act and must register with the SEC unless eligible for an exception. One of those exceptions is the “foreign private adviser” exemption, and an adviser relying on this exemption is not required to make any filing with the SEC.

For those non-U.S. advisers registered with the SEC, the Commission states that it does not intend to seek to apply the substantive provisions of the Advisers Act to a non-U.S. adviser that is registered with the SEC with respect to its non-U.S. clients.

Non-U.S. advisers may also report to the SEC as ERAs if they meet the requirements to report as ERAs.

The “foreign private adviser” exemption is available to an adviser that (i) has no place of business in the United States; (ii) has, in total, fewer than 15 clients in the United States and investors in the United States in private funds advised by the adviser; (iii) has aggregate assets under management attributable to these clients and investors of less than $25 million; and (iv) does not hold itself out generally to the public in the United States as an investment adviser.

See

15 U.S.C. 80b-2(a)(30), 80b-3(b)(3).

See

SEC,

Exemptions for Advisers to Venture Capital Funds, Private Fund Advisers With Less Than $150 Million in Assets Under Management, and Foreign Private Advisers,

Final Rule, Investment Advisers Act Release No. 3222 (Jun. 22, 2011), 76 FR 39645, 39667 (Jul. 6, 2011).

2. Existing Regulatory Framework for Investment Advisers

Oversight of the investment adviser industry by Federal and State securities regulators generally is focused on protecting investors and the overall securities market from fraud and manipulation. Most investment advisers are subject to certain reporting requirements and the extent of those requirements depends on whether the investment adviser is an RIA, registered at the State level, exempt from registration as an ERA, or otherwise not required to register with a Federal or State securities regulator.

RIAs are subject to various SEC rules and

regulations governing, among other things, their marketing and disclosures to clients, best execution for client transactions, and disclosures of conflicts of interest and disciplinary information. State-registered investment advisers may have similar requirements under State securities laws and regulations.

Investment advisers, depending on their registration status, are also generally subject to examination by the SEC or State securities regulators. In some circumstances, Federal securities, tax, or other rules and regulations may impose on investment advisers information collection or disclosure obligations similar to some AML/CFT measures.

For instance, an investment adviser may be exempt from both

Federal and State

registration requirements if they had less than $25 million AUM and fewer than six clients in a State. These advisers are not required to register, nor are they ERAs.

See, e.g.,

Cal. Corp. Code, Ch.3, 25230-25238.

However, these requirements are not designed to address money laundering, terrorist financing, and other illicit financial activity risks associated with investment advisers. Further, although some investment advisers implement AML/CFT requirements in certain circumstances or for certain customers, as described below in section II.C, application of AML/CFT measures is not uniform across the industry, and investment advisers' implementation of such measures is not subject to comprehensive enforcement or examination. Providers of the same financial services may be subject to different AML/CFT obligations (if any), and an investor or customer seeking to obscure the origin of its funds or identity can choose an investment adviser that does not apply AML/CFT measures to its customers and activities.

For instance, FinCEN research identified two investment advisers with a focus on Russian customers that advertised investment structures that would allow customers to avoid going through “know your customer” procedures.

Generally, RIAs, State-registered investment advisers, and ERAs are required to file (and annually update) Form ADV with the SEC, the relevant State securities regulator, or both.

Form ADV collects certain information about the adviser, including (depending on the adviser's registration status) its AUM, ownership, number of clients, number of employees, business practices, custodians of client funds, and affiliations, as well as certain disciplinary or material events of the adviser or its employees. ERAs who are not registered with the SEC or a State securities regulator are only required to file an abbreviated version of Form ADV—they are required to answer fewer client-related questions and provide less information about the services they provide. Form ADV does not require investment advisers to disclose the names of individual clients or investors.

See

17 CFR 275.203-1 and 204-4.

Advisers to private funds are, however, required to name their private fund clients on section 7.B.(2) of Schedule D of Form ADV Part 1A. In some cases, those names may be coded.

Some RIAs are also required to file a Form PF, which collects information on private funds advised by the RIA.

Information collected on Form PF includes the approximate percentage of a fund's equity that is beneficially owned by different types of investors, including U.S. and non-U.S. investors. Some private fund advisers, including ERAs, that are required to report on Form ADV are not required to file Form PF.

Unlike Form ADV, Form PF is non-public. It is provided to both the SEC and the Financial Stability Oversight Council (FSOC) and is intended to enhance investor protection and provide the FSOC with data for use in assessing systemic risk.

See

15 U.S.C. 80b-4(b). A Form PF must be submitted by any RIA that manages one or more private funds and collectively (with its related persons) had at least $150 million in private fund AUM as of the last day of its most recently completed fiscal year.

See

17 CFR 275.204(b)-1. “Related person” is defined in Form PF, which is available at

https://www.sec.gov/files/formpf.pdf.

See

17 CFR 275.204(b)-1.

C. Illicit Finance Risk Associated With Investment Advisers

As detailed below, Treasury assesses that RIAs and ERAs pose a material risk of misuse for illicit finance. Including investment advisers as “financial institutions” under the BSA and applying comprehensive AML/CFT measures to these investment advisers are likely to reduce this risk.

1. Illicit Finance Vulnerabilities

RIAs and ERAs are vulnerable to misuse or exploitation by criminals or other illicit actors for several reasons. First, the lack of comprehensive AML/CFT regulations directly and categorically applicable to investment advisers means they, as a whole, are not required to understand their customers' ultimate sources of wealth or identify and report potentially illicit activity to law enforcement. The current patchwork of implementation by some RIAs and ERAs may also create arbitrage opportunities for illicit actors by allowing them to find RIAs and ERAs with weaker or non-existent customer diligence procedures when these actors seek to access the U.S. financial system. Second, where AML/CFT obligations apply to investment adviser activities, the obliged entities (such as custodian banks, broker-dealers, and fund administrators providing services to investment advisers and the private funds that they advise) do not necessarily have a direct relationship with the customer or, in the private fund context, underlying investor in the private fund. Further, these entities may be unable to collect relevant investor information from the RIA or ERA to comply with the entities' existing obligations

(either because the adviser is unwilling to provide, or has not collected, such information). Third, the existing Federal securities laws are not designed to comprehensively detect illicit proceeds or other illicit activity that is “integrating” into the U.S. financial system

through an RIA or ERA. Fourth, RIAs and ERAs routinely rely on third parties for administrative and compliance activities, and these entities are subject to varying levels of AML/CFT regulation. Fifth, particularly for private funds, it is routine for investors to invest through layers of legal entities that may be registered or organized outside of the United States, making it challenging to collect information relevant to understand illicit finance risk under existing frameworks.

See, e.g.,

FinCEN and Federal Functional Regulators (including SEC,), Joint Release, “

Guidance on Obtaining and Retaining Beneficial Ownership Information”

(Mar. 5, 2010) (noting that customer due diligence procedures for legal entity customers may include “obtaining information about the structure or ownership of the entity so as to allow the [financial] institution to determine whether the account poses heightened risk.”)

Generally, money laundering involves three stages, known as placement, layering, and integration. At the “placement” stage, proceeds from illegal activity or funds intended to promote illegal activity are first introduced into the financial system. 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. “Integration” occurs when illegal proceeds previously placed into the financial system are made to appear to have been derived from a legitimate source.

(a) Lack of Comprehensive and Uniform AML/CFT Obligations

“Investment advisers” is not presently included in the definition of “financial institution” under the BSA or its implementing regulations.

This means that, although they have Form 8300 obligations to report cash transactions above $10,000, investment advisers are typically not subject to most of the AML/CFT program, recordkeeping, or reporting obligations that apply to banks, broker-dealers, and certain other financial institutions.

For example, investment advisers are not required to maintain an AML/CFT program

(consisting of internal controls, an AML/CFT officer, independent testing, and employee training), and do not have independent SAR filing, customer due diligence (CDD), or CIP obligations. These are key elements of AML/CFT compliance through which an investment adviser would identify and report to law enforcement and regulators a customer, investor, or transaction that may be associated with illicit finance activity.

See

31 CFR 1010.100(t).

Investment advisers are, like any other “person,” subject to an obligation to file Form 8300. 31 CFR 1010.330(a)(1)(i), (e)(1); 26 CFR 1.6050I-1(e).

As noted above, some RIAs and ERAs may perform certain AML/CFT functions if the entity is also a registered broker-dealer or is a bank (

i.e.,

a dual registrant), or is an operating subsidiary of a bank;

other investment advisers are affiliates of banks or broker-dealers, which may implement an enterprise-wide AML/CFT program that would include that investment adviser. A Treasury analysis of Form ADV data found that approximately three percent of RIAs were dually registered as a broker-dealer or licensed as a bank, and that these entities held about 10 percent of the AUM held by all RIAs. The same analysis found that approximately 20 percent of RIAs, representing approximately 75 percent of the total AUM of RIAs, were affiliated with either a bank or broker-dealer.

Investment advisers that are banks (or bank subsidiaries) subject to the jurisdiction of the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, and the National Credit Union Administration (collectively, the FBAs) are accordingly also subject to applicable FBA regulations imposing AML/CFT requirements on banks.

See, e.g.,

12 CFR 5.34(e)(3) and 5.38(e)(3) (OCC requirements governing operating subsidiaries of national banks and Federal savings associations).

In other circumstances, an investment adviser may perform AML/CFT functions via contract with a broker-dealer (

e.g.,

CIP for joint customers) or other financial institution, such as when the adviser advises an open-end registered investment company (

e.g.,

mutual fund). For instance, some RIAs have already implemented voluntary AML/CFT programs pursuant to the Securities Industry and Financial Markets Association (SIFMA) No-Action Letter under which the staff of the SEC's Division of Trading and Markets stated that it would not recommend enforcement action if a broker-dealer relies on RIAs to perform some or all aspects of the broker-dealer's CIP obligations or the portion of CDD requirements regarding beneficial ownership requirements for legal entity customers, provided that certain conditions are met, including that the RIA implements its own AML/CFT program.

Mutual funds,

which are advised by approximately 10 percent of RIAs

and hold approximately $22.1 trillion in assets,

are also subject to AML/CFT obligations under the BSA and its implementing regulations.

See

SEC, Letter to Mr. Bernard V. Canepa, Associate General Counsel, Securities Industry and Financial Markets Association (SIFMA), Request for No-Action Relief Under Broker-Dealer Customer Identification Program Rule (31 CFR 1023.220) and Beneficial Ownership Requirements for Legal Entity Customers (31 CFR 1010.230) (Dec. 9, 2022),

https://www.sec.gov/files/nal-sifma-120922.pdf

(SIFMA No-Action Letter). This request for No-Action Relief was originally issued in 2004 and has been periodically reissued and remains effective. Any SEC staff statements cited represent the views of the SEC staff. They are not a rule, regulation, or statement of the SEC. Furthermore, the SEC has neither approved nor disapproved their content. These SEC staff statements, like all SEC staff statements, have no legal force or effect: they do not alter or amend applicable law; and they create no new or additional obligations for any person.

As used in this NPRM, “mutual fund” has the same definition as in FinCEN's regulations, and refers to an “investment company” (as the term is defined in section 3 of the Investment Company Act (15 U.S.C. 80a-3)) that is an “open-end company” (as that term is defined in section 5 of the Investment Company Act (15 U.S.C. 80a-5)) that is registered or is required to register with the SEC under section 8 of the Investment Company Act (15 U.S.C. 80a-8).

See

31 CFR 1010.100(gg). Exchange-traded funds (ETFs) are a type of exchange-traded investment product that must register with the SEC under the Investment Company Act and are generally organized as either an open-end company (“open-end fund”) or unit investment trust. The SEC's ETF Rule (rule 6c-11 under the Investment Company Act), issued in 2019, clarified ETFs are issuing “redeemable securit[ies]” and are generally “regulated as open-end funds within the meaning of section 5(a)(1) of the [Investment Company] Act.” FinCEN's definition of a mutual fund under 1010.100(gg) applies to an ETF that is registered as an “open-end company” (as the term is defined in section 5 of the Investment Company Act).”

Information derived from a Treasury review of Form ADV information.

See supra

n. 26.

According to the Investment Company Institute

2023 Investment Company Factbook,

as of December 31, 2022, U.S. mutual funds held approximately $22.1 trillion in AUM, while ETFs held approximately $6.4 trillion in AUM. Investment Company Institute,

2023 Investment Company Factbook,

p.2,

https://www.ici.org/system/files/2023-05/2023-factbook.pdf.

See

31 CFR 1010.100(gg); 31 CFR part 1024.

Outside of these circumstances, some investment advisers have voluntarily implemented certain AML/CFT measures, such as CDD or other CIP requirements. However, because these programs are not required by any regulations under the BSA, advisers have wide discretion in what information to request from their customers and private fund investors. Additionally, RIAs and ERAs are not examined for compliance with voluntary AML/CFT measures not required by law, so the adviser may not be made aware of deficiencies or gaps in their programs via examination, and thereafter make improvements, and there are more limited enforcement mechanisms to pursue against the adviser for failing to implement such measures.

While the programs discussed above provide some AML/CFT coverage for parts of the investment adviser industry, they mean that RIAs and ERAs providing the same financial services have differing AML/CFT obligations. For example, depending on corporate policies and practice, stand-alone RIAs or ERAs are likely subject to different AML/CFT compliance approaches than RIAs or ERAs that are part of a bank or financial holding company; and an investor or customer seeking to obscure the origin of its funds or its identity can choose an RIA or ERA that has limited or no AML/CFT obligations.

The fact that investment advisers are not currently BSA-defined financial institutions also limits the ability of investment advisers to provide highly useful information to law enforcement, regulators, and other relevant authorities. For instance, unless they are BSA-defined financial institutions, RIAs and ERAs would not be afforded the protection from liability (safe harbor) that applies to financial institutions when filing SARs.

Even though investment advisers are able to file voluntary SARs, they could face increased legal risk from customers or other counterparties without the safe harbor. RIAs and ERAs are also currently unable to receive and respond to law enforcement requests for information under section 314(a) of the USA PATRIOT Act as they are not BSA-defined financial institutions.

31 U.S.C. 5318(g)(3)(A).

See

31 CFR 1010.520.

Additionally, investment advisers, or associations of investment advisers, that are not BSA-defined financial institutions cannot voluntarily share information under section 314(b) of the USA PATRIOT Act. Moreover, at present, existing BSA-defined financial institutions are limited in their ability to share with RIAs and ERAs, or receive from investment advisers, information potentially related to money laundering or terrorist financing that are not themselves BSA financial institutions.

Becoming a BSA-defined financial institution would allow RIAs and ERAs to share information potentially related to money laundering or terrorist financing with, and receive requests from, other financial institutions that already utilize section 314(b), such as broker-dealers. This could help financial institutions gain additional insight into their customers' transactions with RIAs and ERAs and,

potentially, a more accurate and holistic understanding of their customers' activities.

See

31 CFR 1010.540.

(b) Existing AML/CFT Obligations Often Apply to Intermediaries, But Not the Customer-Facing Entity

Investment advisers engage in trading or transactional activities on behalf of their customers through relationships with financial institutions that are subject to AML/CFT obligations, such as broker-dealers and banks, among others. For instance, Rule 206(4)-2 (the Custody Rule) under the Advisers Act requires RIAs that have custody of client funds or securities generally to maintain those funds and securities with a qualified custodian, defined primarily to encompass BSA-defined financial institutions.

17 CFR 275.206(4)-2. 17 CFR 275.206(4)-2. The SEC recently proposed amendments to the Custody Rule.

See

SEC,

Safeguarding Advisory Client Assets,

Investment Advisers Act Release No. 6240 (Feb. 15, 2023), 88 FR 14672 (Mar. 9, 2023).

While investment advisers often do not take possession of financial assets, they nonetheless may have the most direct relationship with the customers they advise and thus be best positioned to obtain the necessary documentation and information from and about the customers concerning their assets that the investment adviser is deploying in public or private financial markets.

If some of these assets include the proceeds of illegal activities, or are intended to further such activities, an investment adviser's AML/CFT program could help discover such issues and prevent the customer from further using the U.S. financial system, while reporting such information for law enforcement purposes. For example, in some cases, an investment adviser may be the only person or entity with a complete understanding of the source of a customer's invested assets, background information regarding the customer, or the objectives for which the assets are invested.

See

SIFMA No-Action Letter

supra

n.52 (incoming letter to SEC stating “RIAs often have the most direct relationship with the customers they introduce to broker-dealers and are best able to obtain the necessary documentation and information from and about the customers”).

Other market participants may, for example, hold and trade assets in an account controlled by an adviser, but these parties, as intermediaries, often rely solely on the investment adviser's instructions and lack independent knowledge of the adviser's customers. Further, an investment adviser may use multiple broker-dealers or banks for trading and custody services, making it difficult for one financial institution in the chain to have a complete picture of an investment adviser's activity or to detect suspicious activity involving the investment adviser. Without complete information, such an institution may not have sufficient information to file a SAR, or it may be required to file a SAR that only has partial information concerning the investment adviser's transactions on behalf of a particular customer. This limits the ability of law enforcement to identify illicit activity that may be occurring through investment advisers.

RIAs are subject to various SEC rules and regulations governing, among other things, their marketing and disclosures to clients, best execution for client transactions, and disclosures of conflicts of interest and disciplinary information. In some circumstances, Federal securities, tax, or other rules and regulations may impose obligations similar to some AML/CFT measures by requiring the collection or disclosure of certain information by RIAs and ERAs. However, these regulatory requirements are not designed to explicitly address the risk that an RIA or ERA may be used to move proceeds or funds tied to money laundering, terrorist financing, or other illicit activity; they are instead designed to protect customers against fraud, misappropriation, or other illegal conduct by an investment adviser. Accordingly, even if they require an RIA or ERA to report certain kinds of illegal conduct or collect relevant information, they do not provide a comprehensive framework that incorporates the AML/CFT and national security purposes of the BSA, an understanding of relevant illicit finance risks and activity, and a process to assess and report suspicious activity to law enforcement and other appropriate authorities.

For example, the SEC's Custody Rule

generally requires RIAs with custody of client funds and securities to maintain client assets at a qualified custodian and comply with other safeguards, subject to certain limited exceptions. This rule is intended to protect advisory client assets from loss, misuse, theft, or misappropriation by, and the insolvency or financial reverses of, the adviser. Qualified custodians may be able to detect and report certain suspicious activity involving a RIA's customer, such as a high volume of trading or indications of layering activity, but they often may lack identifying information about the RIA's customer and their source of funds because that customer is not their institution's customer. As a result, qualified custodians can be limited in their ability to detect other types of illicit proceeds associated with that RIA's customer.

See

17 CFR 275.206(4)-2.

Other financial intermediaries providing services to an investment adviser or its customers, such as banks, clearing brokers, executing brokers, and futures commission merchants, may have AML/CFT obligations, but often, they may not be well-positioned to have a complete understanding of the identity, source of funds, and investment objectives of the adviser's underlying customer. For instance, some investment advisers may be reluctant to have a broker-dealer contact their customers because they view the broker-dealer as a competitor.

See

SIFMA No-Action Letter,

supra

n.52

Similarly, the Compliance Rule

under the Advisers Act does not require an RIA to implement AML/CFT-related policies and procedures. Under the Compliance Rule, an RIA must adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act and its implementing rules and regulations and to designate a chief compliance officer to administer the RIA's compliance policies and procedures. These policies and procedures should take into consideration the nature of that firm's operations and should be designed to prevent, detect, and promptly correct any violations of the Advisers Act or the rules thereunder. The Compliance Rule does not address the requirements of the BSA. While the Compliance Rule establishes a procedural and organizational framework that RIAs may be able to build upon to implement AML/CFT measures, the rule does not mandate that an RIA address AML/CFT in its policies and procedures. Some investment advisers may have policies and procedures to comply with Office of Foreign Assets Control (OFAC) sanctions, which similarly may provide a framework for implementing certain AML/CFT measures included in the proposed rule.

See

17 CFR 275.206(4)-7.

While OFAC sanctions requirements are separate from AML/CFT requirements, investment advisers, like other U.S. persons, must comply with OFAC sanctions. AML/CFT requirements and OFAC sanctions also share a common national security goal, apply a risk-based approach, and rely on similar recordkeeping and reporting requirements to ensure compliance. For this reason, many financial institutions view compliance with OFAC sanctions as related to AML/CFT compliance obligations, and may include sanctions compliance and AML/CFT compliance in a single enterprise-wide compliance program.

(d) Investment Advisers to Private Funds Routinely Rely on Third-Party Administrators Located Outside of the United States

Routine reliance on third-party administrators by investment advisers to private funds for a range of administrative tasks, including investor due diligence and identity verification, poses a material illicit finance risk. While some third-party administrators are located in the United States and may be affiliated with larger financial institutions, others are located in offshore financial centers where private funds are routinely domiciled, usually for tax or other commercial reasons unrelated to AML/CFT regulation, such as the Cayman Islands.

The due diligence and verification practices of these offshore fund administrators are not uniform, and may vary based upon the requirements of the local regulatory regime as well as the requirements of the fund's adviser. While some investment advisers may rely on these administrators to manage their perceived risk or to comply with local regulatory requirements, the piecemeal review of investor information is not a substitute for comprehensive AML/CFT compliance measures. These third-party administrators may also face legal and regulatory challenges in receiving and verifying documentation from foreign legal entity investors in funds they service. Further, effective AML/CFT supervision of fund administrators based outside the United States is often still nascent, with foreign regulators taking few enforcement actions to date.

See

Caribbean Financial Action Task Force Mutual Evaluation of the Cayman Islands (Mar. 2019), p. 26, 30-31,

https://www.fatf-gafi.org/media/fatf/documents/reports/mer-fsrb/CFATF-Cayman-Islands-Mutual-Evaluation.pdf.

While a fund may be domiciled or registered in the Cayman Islands, the adviser managing that fund may be located in the United States and/or registered with the SEC.

Id.

at pp. 135-140 (Cayman Islands received the lowest possible rating for supervision). Additionally, fund administrators in the Cayman Islands filed only 37 SARs in 2017.

Id.

at p. 117.

(e) Use of Multiple Legal Entities for Cross-Border Investment Structure

Some investment advisers provide advisory services to customers that structure their investments through several layers of U.S. and foreign legal entities or arrangements, such as limited liability companies (LLCs) and trusts, often referred to colloquially as “shell companies.” Such structures may be used for legitimate tax reasons, but can be used to obfuscate the source of funds for either natural person or legal entity investors and obscure unlawful conduct.

An additional challenge is the use of nominee arrangements, in which an intermediary (often a foreign bank or overseas custodial service provider) agrees to be identified as the nominal investor and essentially acts as a “shield” for individuals who want to make investments without disclosing their identities or source of funds. These nominee arrangements can be used in connection with other intermediaries in the ownership chain (

e.g.,

the nominee may be acting on behalf of a foreign asset manager, who in turn has the relationship with an illicit actor or politically exposed person (PEP)). While these nominee arrangements often can have legitimate purposes, if they are not explicitly identified in required reports or records, they can be abused to obscure potentially illicit funds and make it extremely difficult (if not impossible) for regulators to identify and fully understand the nature and extent of illicit finance risks in this sector. As of Q4 2022, private fund advisers reporting on Form PF noted that they did not know, and could not reasonably obtain information about, the non-U.S. beneficial ownership of approximately $284 billion in private fund AUM.

See

SEC, Private Fund Statistics, Fourth Calendar Quarter 2022,

https://www.sec.gov/files/investment/private-funds-statistics-2022-q4.pdf.

In addition, data privacy or other laws or regulations in effect in offshore jurisdictions, or contractual obligations, may impact how certain customer information is shared with investment advisers, broker-dealers, and other financial institutions (and by extension, U.S. law enforcement and regulators). While some investment advisers are introduced to new foreign investors by foreign entities subject to AML/CFT obligations (such as a broker-dealer), this practice is not consistent, as other introducers or promoters may be individuals with no AML/CFT obligations.

2. Illicit Finance Threats to Investment Advisers

Treasury, in coordination with Federal law enforcement and consultation with the SEC, conducted a comprehensive assessment of illicit finance risk in the investment adviser industry. Treasury's review included an analysis of SARs filed between 2013 and 2021 that were associated with RIAs and ERAs.

That analysis found that 15.4 percent of RIAs and ERAs were associated with or referenced in at least one SAR (

i.e.,

they were identified either as a subject or in the narrative section of the SAR) during this time. Further, the number of SAR filings associated with an RIA or ERA increased by approximately 400 percent between 2013 and 2021—a disproportionately higher increase than the overall increase in SAR filings, which was approximately 140 percent.

Information derived from an analysis of select BSA reporting.

From a FinCEN review of the total number of SARs filed between 2013 and 2021.

This SAR analysis, along with a review of law enforcement cases and other information available to the U.S. government, identified several illicit finance threats involving RIAs and ERAs. First, in some instances, the investment adviser industry has served as an entry point into the U.S. market for illicit proceeds associated with foreign corruption, fraud, and tax evasion. Second, certain advisers manage billions of dollars ultimately controlled by Russian oligarchs and their associates who help facilitate Russia's illegal and unprovoked war of aggression against Ukraine. Third, certain RIAs and ERAs and the private funds they advise are also being used by foreign states, most notably the People's Republic of China (PRC) and Russia, to access certain technology and services with long-term national security implications through investments in early-stage companies.

(a) Laundering of Illicit Proceeds Through Investment Advisers and Private Funds

Private funds can be a particularly attractive entry point for illicit proceeds because they present a possibility of high returns, in contrast to other, more costly forms of money laundering, such as trade-based money laundering or informal value transfer systems. Like other types of pooled accounts or legal entities, they can be used to obscure the names of individual investors or beneficial owners so that the investment fund is identified as the owner of a particular asset. However, there are a wide variety of private funds, and some have characteristics that have traditionally been seen as less attractive to money launderers. For instance, some hedge funds may have lock-up periods of more than a year while venture capital funds and private equity funds may not permit any withdrawals due to the time it takes for the private companies in which those funds invest to go public or otherwise provide an exit strategy for these funds. While these restrictions may deter criminals who need immediate access to illicit

proceeds, they are unlikely to deter wealthy corrupt foreign actors who seek stable returns, and have a medium- to long-term investment horizon, and do not need immediate access to capital.

The mechanisms for laundering illicit proceeds through investment advisers and private funds vary, but generally consist of obscuring the illicit origins of funds and pooling them with legitimate funds to invest in U.S. securities, real estate, or other assets.

In one significant case involving funds stolen from the Malaysian government, an RIA was used to launder illicit proceeds into the U.S. financial system. In December 2012, investment funds affiliated with Low Taek Jho (Low) laundered approximately $150 million diverted from 1Malaysia Development Berhad's (1MDB) 2012 bond issuance into the U.S. financial system. Low was CEO of Jynwel Capital Limited, an investment adviser to a private equity fund in Asia.

Through a subsidiary of Jynwel Capital Limited, Low purchased equity interests in a vehicle managed by the Electrum Group, a private equity firm in the United States “whose offices are located in New York and Colorado, invests in public and private companies involved in the exploration and development of natural resources, precious metals, base metals, and oil and gas.”

Electrum Group, LLC is registered with the SEC as an RIA. To conceal their origin, the funds were moved through multiple accounts owned by different entities on or about the same day in an unnecessarily complex manner with no apparent business purpose. This illustrates the general problem: without an obligation to determine the source of wealth and purpose for a customer, an investment adviser may unwittingly permit illicit funds to enter the U.S. financial system.

Low represented to counterparties and potential business partners that Jynwel Capital Limited was an investment adviser to a private equity fund.

Verified Compl. for Forfeiture (Dkt. 3) ¶ 760,

United States

Real Property Located in London, United Kingdom Titled in the Name of Red Mountain Global Ltd.,

No. 19-cv-1326, (C.D. Cal. Feb. 22, 2019),

https://www.justice.gov/opa/press-release/file/1134376/download.

See id.

¶ 204-12.

In some instances, the investment adviser or other financial professional may form a private fund through which illicit proceeds can be transferred as part of a money laundering scheme. While past examples have featured investment advisers complicit in illegal activity, an investment adviser may be unwittingly complicit in this type of activity if they are not required to understand the origin of funds or nature of their owner. A customer wishing to launder money could ask an investment adviser to establish a private fund to certain specifications without informing the adviser of the customer's broader scheme. Without an obligation to report potential money laundering or other illicit finance activity, the adviser could participate without inquiring further.

In July 2018, U.S. law enforcement arrested two alleged participants, Matthias Krull and Gustavo Adolfo Hernandez Frieri (Hernandez), in a billion-dollar international scheme to launder funds obtained through embezzlement, fraud, and bribery from Venezuelan state-owned oil company Petroleos De Venezuela S.A. (PDVSA).

According to the stipulated factual proffer filed in connection with his plea agreement, Hernandez conspired to launder approximately $12 million in PDVSA bribe proceeds by creating a private fund, domiciled in the Cayman Islands, and with a U.S. bank as custodian.

Specifically, he admitted that he conspired to launder $7 million in bribe payments related to a loan scheme, and $5 million in bribe payments related to a separate currency exchange scheme, through his investment advisory firm located in the United States. Separately, a co-conspirator in the scheme set up fraudulent bond schemes in which fake bonds would be issued, money transferred into the private fund, and then the bonds would “default.”

While in this instance the adviser was complicit in the fraudulent scheme, a client could also direct an unwitting investment adviser to create a private fund to specifications that facilitate money laundering. In the absence of an AML/CFT program requirement for investment advisers, the investment adviser might not have any obligation to evaluate such risks.

Department of Justice, “Former Swiss Bank Executive Pleads Guilty to Role in Billion-Dollar International Money Laundering Scheme Involving Funds Embezzled from Venezuelan State-Owned Oil Company,” (Aug. 22, 2018),

https://www.justice.gov/opa/pr/former-swiss-bank-executive-pleads-guilty-role-billion-dollar-international-money-laundering;

Department of Justice, “Two Members of Billion-Dollar Venezuelan Money Laundering Scheme Arrested” (Jul. 25, 2018),

https://www.justice.gov/opa/pr/two-members-billion-dollar-venezuelan-money-laundering-scheme-arrested.

In August 2018, Krull pleaded guilty to one count of conspiracy to commit money laundering, and in November 2019, Hernandez, a former investment adviser, also pleaded guilty to conspiracy to commit money laundering in connection with his role in the scheme. Plea Agreement (Dkt. 163),

United States

Hernandez,

(S.D. Fl. Nov. 26, 2019),

https://www.justice.gov/criminal-fraud/file/1316826/download.

Factual Proffer (Dkt. 164),

United States

Hernandez,

No. 18-cr-20685 (S.D. Fl. Nov. 26, 2019),

https://www.justice.gov/criminal-fraud/file/1316831/download.

Criminal Compl.,

United States

Guruceaga

( ), 18-mj-3119 (S.D. Fl. Jul. 24, 2018),

https://www.justice.gov/criminal-fraud/file/1119981/download.

(b) Russian Political and Economic Elites' Access to U.S. Investments

Investment advisers and private funds they advise have served as an important entry point into the U.S. financial system for wealthy Russians seeking to obscure their ownership of U.S. assets.

Although many of these Russian individuals were not sanctioned by the U.S. Government prior to Russia's full-scale invasion of Ukraine in February 2022, their wealth was sometimes associated with corruption, theft of state assets, or other illicit activity well before their designation.

See

FinCEN Alert, FIN-2023-Alert002,

FinCEN Alert on Potential U.S. Commercial Real Estate Investments by Sanctioned Russian Elites, Oligarchs, and Their Proxies,

p.4 (Jan. 25, 2023). In addition to Russian investors, investors tied to China and Saudi Arabia have invested in U.S. private funds.

See, e.g.,

The German Marshall Fund of the United States,

Policy Brief: An Effective American Regime to Counter Illicit Finance

(Dec. 2018),

https://securingdemocracy.gmfus.org/wp-content/uploads/2018/12/An-Effective-American-Regime-to-Counter-Illicit-Finance.pdf.

A Treasury review of select BSA reporting filed between January 2019 and June 2023 identified more than 20 investment advisers located in the United States advising private funds where the adviser was identified as having significant ties to Russian oligarch investors or Russian-linked illicit activities. This review also identified 60 additional investment advisers located in the United States who managed private funds in which identified Russian oligarchs have invested, although there was no indication the adviser was engaged in any illicit activity.

According to information available to the U.S. government, often, a member of the Russian elite or their trusted proxy invests in a public or private U.S. company with the assistance of a wealth management firm, which is usually located in an offshore jurisdiction such as Bermuda, the Caymans, or Cyprus, but services primarily Russian customers. The wealth management firm invests that money in dollars through the U.S. financial system, often into U.S. technology companies in fields including biotechnology and artificial intelligence. The scale of these investments is significant and may include billions of dollars invested for a single Russian oligarch. These investments are sometimes made directly by the foreign wealth management firm, and in other instances through a U.S.-based RIA or ERA.

In other instances, funds may be routed through a consulting firm or other entity acting as an investment adviser but not registered with or reporting to the SEC or State regulator. For instance, on September 19, 2023, the SEC announced charges against Concord Management LLC (Concord) and its owner and principal, Michael Matlin, for operating as unregistered investment advisers to their only client—a wealthy former Russian official widely regarded as having political connections to the Russian Federation.

As of January 2022, Concord and Matlin allegedly managed investments for their sole client with an estimated total value of $7.2 billion in 112 different private funds.

In March 2022, the United Kingdom and the European Union sanctioned Matlin and Concord's client and the client's assets were subsequently frozen. The SEC's complaint alleges that, a month prior, in February 2022, Concord and Matlin assisted the client in his attempts to redeem investments and/or sell his securities portfolio.

See

SEC, Press Release 2023-186,

SEC Charges New York Firm Concord Management and Owner with Acting as Unregistered Investment Advisers to Billionaire Former Russian Official

(Sep. 19, 2023).

Some strategic nation-state competitors to the United States, most notably the PRC, may see private funds as a back door to acquire assets of interest in the United States, such as equity stakes in companies developing critical or emerging technologies. While there are certain transactions for which notice must be provided to the interagency Committee on Foreign Investment in the United States (CFIUS),

most transactions reviewed by CFIUS are filed voluntarily.

Where transactions are not voluntarily submitted to CFIUS for review, CFIUS agencies actively work to identify those transactions, including whether such transactions may be a covered transaction under the CFIUS regulations and may raise national security considerations, and assess whether to request that the parties file with CFIUS.

CFIUS is an interagency committee authorized to review certain transactions involving foreign investment in the United States in order to determine the effect of such transactions on the national security of the United States.

See

Treasury, “Remarks by Assistant Secretary for Investment Security Paul Rosen at the Second Annual CFIUS Conference,” (Sept. 14, 2023),

https://home.treasury.gov/news/press-releases/jy1732.

Id.

Foreign state-funded investment vehicles may seek to hide their involvement in foreign investments through offshore legal entities and intermediaries in an effort to gain access to sensitive technology, processes, or knowledge that can enhance their domestic development of microelectronics, artificial intelligence, biotechnology and biomanufacturing, quantum computing, and advanced clean energy, among others. These state-funded investment vehicles could persuade an investment adviser to a private fund to grant them access to granular details about the technology or processes used by a company in which the fund is invested, including information that a limited partner investor seeking only an economic return may not typically request.

PRC.

According to the Federal Bureau of Investigation (FBI), the PRC government routinely conceals its ownership or control of investment funds to disguise efforts to steal technology or knowledge and avoid notice to CFIUS.

According to a report by the Office of the U.S. Trade Representative, State-guided PRC venture capital fund activity in the United States is motivated by the Made in China 2025 plan and the military-civil fusion strategy, directing investments towards developing technology with dual-use capabilities.

In 2016, the PRC government explicitly endorsed the use of overseas venture capital funds to invest in “seed-based and start-up technology,” demonstrating the link between the funds and government priorities.

See

Hearing Before the U.S.-China Economic and Security Review Commission, p.139, “Chinese Investments in the United States: Impacts and Issues for Policymakers” Jan. 26, 2017,

https://www.uscc.gov/sites/default/files/transcripts/Chinese%20Investment%20in%20the%20United%20States%20Transcript.pdf; see also

Remarks by FBI Director Christopher Wray, “Countering Threats Posed by the Chinese Government Inside the U.S.,” Jan. 31, 2022,

https://www.fbi.gov/news/speeches/countering-threats-posed-by-the-chinese-government-inside-the-us-wray-013122.

Office of the United States Trade Representative, “Findings of the Investigation into China's Acts, Policies, and Practices Related to Technology Transfer, Intellectual Property, and Innovation under section 301 of the Trade Act of 1974,” Mar. 22, 2018, 14-15 & 95-96,

https://ustr.gov/sites/default/files/Section%20301%20FINAL.PDF.

PRC State Council, “National 13th Five-Year Plan for the Development of Strategic Emerging Industries,” Nov. 29, 2016,

https://cset.georgetown.edu/publication/national-13th-five-year-plan-for-the-development-of-strategic-emerging-industries/#:~:text=During%20the%2013th%20Five%2DYear,healthy%20economic%20and%20social%20development.

Russia.

According to information available to the U.S. government, Russian elites and government entities are moving hundreds of millions of dollars annually through the U.S. financial system by using U.S. and foreign venture capital firms to invest in U.S. technology companies. A Treasury review of select BSA reporting identified several U.S. venture capital firms with significant ties to Russian oligarch investors that invested in firms developing emerging technologies with national security applications. These include autonomous vehicle technology and artificial intelligence systems, as well as contractors to the U.S. military, intelligence, and other government agencies. Further, according to information available to the U.S. government, the U.S.-designated, state-owned Russian Venture Company, which is funded by the U.S.-designated Russian Direct Investment Fund, endows Russian seed funds to invest in emerging technology. The seed funds create a venture capital company, often of a similar name to the seed fund and registered outside of Russia, to invest in U.S. technology firms. The U.S. government has also identified instances where the leadership of certain investment firms has attempted to remove overt ties to Russia or Russian names. Russian investors have obfuscated their connections to Russia, including by relocating to other jurisdictions and changing their names, to continue investing in U.S. technology companies through venture capital vehicles.

D. Prior Rulemaking and Regulatory Guidance

FinCEN has previously proposed AML regulations for investment advisers. On September 26, 2002, FinCEN published an NPRM proposing to require that unregistered investment companies, to include private funds, establish AML programs (Proposed Unregistered Investment Companies Rule).

This was followed by the May 5, 2003 NPRM proposing to require certain investment advisers to establish AML programs (First Proposed Investment Adviser Rule).

Both of these proposed rules would have defined these entities as “financial institutions” under the BSA and required the implementation of AML programs only; they did not propose suspicious activity reporting requirements.

See

FinCEN,

Anti-Money Laundering Programs for Unregistered Investment Companies,

67 FR 60617 (Sept. 26, 2002).

See

FinCEN,

Anti-Money Laundering Programs for Investment Advisers,

68 FR 23646 (May 5, 2003).

In June 2007, FinCEN announced that it would be taking a fresh look at how its broader AML regulatory framework was being implemented to ensure that it was being applied effectively and efficiently across the industries covered

by the BSA.

In conjunction with this initiative, and given the amount of time that had elapsed since initial publication of the Proposed Unregistered Investment Companies Rule and the First Proposed Investment Adviser Rule, FinCEN determined that it would not proceed to apply AML requirements for these entities without undertaking further public notice and comment, and therefore withdrew the proposed rules on November 4, 2008.

See

FinCEN,

Withdrawal of the Notice of Proposed Rulemaking; Anti-Money Laundering Programs for Unregistered Investment Companies,

73 FR 65569 (Nov. 4, 2008); and FinCEN,

Withdrawal of the Notice of Proposed Rulemaking; Anti-Money Laundering Programs for Investment Advisers,

73 FR 65568 (Nov. 4, 2008).

Id.

On September 1, 2015, FinCEN published an NPRM “to prescribe minimum standards for . . . [AML] programs to be established by certain investment advisers and to require such investment advisers to report suspicious activity to FinCEN pursuant to the . . . BSA” (Second Proposed Investment Adviser Rule).

This proposed rule would have included RIAs within the definition of “financial institution” under the BSA and required them to maintain AML programs, report suspicious activity, and comply with other travel and recordkeeping requirements. The Second Proposed Investment Adviser Rule would not have included ERAs as financial institutions under the BSA.

See

FinCEN,

Anti-Money Laundering Program and Suspicious Activity Report Filing Requirements for Registered Investment Advisers,

80 FR 52680 (Sept. 1, 2015).

Since 2015, the investment adviser industry has seen substantial growth in assets under management and the expansion of new products and services. At the time the Second Proposed Investment Adviser Rule was published, there were approximately 12,000 RIAs reporting approximately $67 trillion in AUM.

As of June 30, 2023, that number had grown to more than 15,000 RIAs with approximately $125 trillion in AUM.

Based on a Treasury review of Form ADV data as of December 31, 2015.

See supra

n. 26.

Private funds play an increasingly important role in the financial system and continue to grow in size, complexity, and number. For example, hedge funds engage in trillions of dollars in listed equity and futures transactions each month. Private equity and other private funds are involved in mergers and acquisitions, non-bank lending, and corporate restructurings through leveraged buyouts and bankruptcies. Venture capital funds provide funding to start-ups and early-stage companies. There are approximately 5,500 RIAs who advise more than $20 trillion in private fund AUM.

Over the past five years alone, the number of private equity funds advised by RIAs increased 60 percent to more than 24,000, while the number of venture capital funds advised by RIAs increased by almost 300 percent, to more than 3,300 funds.

Id.

IAA Snapshot,

supra

n. 19 at Table 5E.

Since 2015, the U.S. Government has also developed a more detailed understanding of the illicit finance risks associated with the U.S. investment adviser industry. As described in section II, investment advisers have been exploited by sophisticated criminals, Russian oligarchs, and U.S. strategic competitors.

Although the Second Proposed Investment Adviser Rule was not formally withdrawn,

Treasury does not intend to issue a final rule based on it and is hereby withdrawing the Second Proposed Investment Adviser Rule. Treasury is issuing this new NPRM to ensure that changes in the risk and factual context relevant to the rulemaking since the Second Proposed Investment Adviser Rule was published are taken into account.

Treasury withdrew the proposal from the Fall 2020 Unified Agenda.

See Anti-Money Laundering Program and Suspicious Activity Reporting Filing Requirements for Investment Advisers,

available at

https://www.regulations.gov/docket/FINCEN-2014-0003/unified-agenda.

III. Scope of Proposed Rule

For all the reasons described above, FinCEN is proposing to cover both RIAs and ERAs as “financial institutions” subject to AML/CFT requirements. FinCEN is not proposing to cover State-registered investment advisers because the Treasury risk assessment found few examples of State-registered investment advisers being misused for money laundering, terrorist financing, or other illicit financial activities.

However, FinCEN will continue to monitor activity involving State-registered investment advisers for indicia of money laundering, terrorist financing, or other illicit finance activities, and may take appropriate steps to mitigate any such activity.

See

Treasury,

Investment Adviser Illicit Finance Risk Assessment, https://home.treasury.gov/system/files/136/US-Sectoral-Illicit-Finance-Risk-Assessment-Investment-Advisers.pdf.

As discussed further below, this proposed rulemaking does not impose a CIP requirement or a general requirement that investment advisers identify and verify the beneficial ownership of legal entity customers. Accordingly, the proposed rule would not subject investment advisers to beneficial ownership information identification and verification requirement under 31 CFR 1010.230.

Under the BSA, any CIP requirement for financial institutions that engage in financial activities described in section 4(k) of the Bank Holding Company Act “shall be prescribed jointly with each Federal functional regulator.”

This list of activities includes, among others, “providing financial, investment, or economic advisory services.”

Pursuant to these provisions, any future application of CIP requirements would be proposed jointly with the SEC in a separate rulemaking. In addition, FinCEN intends to amend the CDD Rule to bring it into conformance with the Corporate Transparency Act.

As described below, the proposed revised § 1010.605(e)(1) would expressly provide that an investment adviser would not be considered a “covered financial institution” for the purposes of § 1010.230.

See infra

section IV.H.1.

31 U.S.C. 5318(

)(4).

12 U.S.C. 1843(k)(4)(C).

FinCEN is required to revise the CDD Rule under the Corporate Transparency Act. Sec. 6403(d)(1), AML Act. (“Not later than 1 year after the effective date of the regulations promulgated under section 5336(b)(4) of title 31, United States Code, as added by subsection (a) of this section, the Secretary of the Treasury shall revise the final rule entitled `Customer Due Diligence Requirements for Financial Institutions' . . . .”).

IV. Section-by-Section Analysis

FinCEN is proposing to: (1) include certain types of investment advisers (both RIAs and ERAs) within the definition of “financial institution” in the regulations implementing the BSA, and add a definition of investment adviser to reflect those covered types; and (2) require such investment advisers to (a) establish AML/CFT programs, to include risk-based procedures for conducting ongoing CDD; (b) report suspicious activity and file CTRs; (c) maintain records of originator and beneficiary information for certain transactions; (d) apply information-sharing provisions between and among FinCEN, law enforcement, agencies, and certain financial institutions; and (e) implement special due diligence requirements for correspondent and private banking accounts and special measures under section 311 of the USA PATRIOT Act. These proposals are discussed in greater detail below.

A. Definitions

FinCEN is proposing two changes to 31 CFR 1010.100, the general definitions section of its regulations. First, this proposed rule would amend 1010.100(t) to add “investment adviser” to the definition of “financial institution.”

Second, it would add a new provision to 1010.100 defining the term “investment adviser.”

1. Adding “Investment Adviser” to the “Financial Institution” Definition

The BSA expressly defines various entities as “financial institutions,”

100

while also providing Treasury with the authority to define additional entities as financial institutions in its regulations at 31 CFR 1010.100(t). Specifically, the BSA authorizes FinCEN to define additional types of businesses as financial institutions if FinCEN determines that such businesses engage in any activity “similar to, related to, or a substitute for” activities in which any of the enumerated financial institutions are authorized to engage.

101

Although “investment adviser” is not one of the specifically enumerated financial institutions in the BSA, FinCEN is proposing to make such a determination with respect to the defined set of investment advisers, and thereby add investment advisers to § 1010.100(t)'s definition of financial institution.

100

31 U.S.C. 5312(a)(2), (c)(1).

101

31 U.S.C. 5312(a)(2)(Y). FinCEN may also designate businesses “whose cash transactions have a high degree of usefulness in criminal, tax, or regulatory matters” as financial institutions.

Id.

5312(a)(2)(Z).

Investment advisers provide services that are similar or related to services authorized to be provided by BSA-defined financial institutions. Many investment advisers provide advice to clients who have granted the adviser the power to manage assets on a discretionary basis, which is similar or related to services provided by other BSA-defined institutions, such as broker-dealers or banks. Indeed, many investment advisers provide asset management services that are similar to, and often substituted for, the asset management services that are provided by banks and other financial institutions, such that advisers may compete directly with asset management services provided by certain banks. Investment advisers also often provide services that can substitute for certain products offered by investment companies or insurance companies. For example, investment advisers can sponsor and provide advisory services to pooled investment vehicles such as private funds. As another example, many investment advisers sponsor and provide advisory services to mutual funds and advise on the purchase or sale of mutual fund shares, similar to banks or broker dealers that provide recommendations on mutual fund shares.

Moreover, investment advisers often work closely with, or are otherwise closely associated with, BSA-defined financial institutions. For example, investment advisers work closely with financial institutions when they direct broker-dealers to purchase or sell client securities, and therefore engage in activities that are closely related to the activities of covered financial institutions. In addition, investment advisers are frequently owned by or under common ownership with banks, broker-dealers, and other financial institutions. For example, approximately 20 percent of RIAs and seven percent of ERAs are dually registered as a broker-dealer, licensed as a bank, or affiliated with a bank or broker dealer.

102

Investment advisers typically rely on broker-dealers, banks, and other financial institutions to perform vital functions for them, such as retaining custody of client funds or executing trades of securities.

103

Broker-dealers may recommend securities transactions to customers as well.

104

Accordingly, even investment advisers that lack direct relationships with banks, broker-dealers, or other types of financial institutions engage in activities that are “similar to” the types of services authorized to be provided by certain financial institutions.

102

See supra

n. 26.

103

See, e.g.,

SEC,

Commission Interpretation Regarding Standard of Conduct for Investment Advisers,

Investment Advisers Act Release No. 5248 (Jun. 5, 2019), 84 FR 33669, 33674-75 (Jul. 12, 2019) (discussing an investment adviser's duty to seek best execution of a client's transactions where the investment adviser has the responsibility to select broker-dealers to execute client trades)

104

See

15 U.S.C. 80b-2(a)(11)(C) (excluding from the definition of “investment adviser” under the Advisers Act any broker or dealer whose performance of advisory services is “solely incidental to the conduct of his business as a broker or dealer and [the broker or dealer] receives no special compensation therefor”);

see also

SEC,

Commission Interpretation Regarding the Solely Incidental Prong of the Broker-Dealer Exclusion from the Definition of Investment Adviser,

Investment Advisers Act Release No. 5249 (Jun. 5, 2019), 84 FR 33681 (Jul. 12, 2019). 17 CFR 240.15

-1.

Further, legislative history during drafting of the USA PATRIOT Act indicates that RIAs are sufficiently similar to certain other financial institutions that Treasury could require them to file SARs: “The Committee [on Financial Services] notes that, under the Bank Secrecy Act, the Secretary currently has the authority to require Suspicious Activity Reports for all entities similar to futures commission merchants, commodity trading advisors, and commodity pool operators, namely registered investment advisers and registered investment companies.”

105

House Report 107-250(I),

Financial Anti-Terrorism Act of 2001,

2001 WL 1249988 at *66 (Oct. 17, 2001);

see also

Public Law 107-31, Title III section 321 (Oct. 26, 2001) (section of USA PATRIOT Act adding futures commission merchants, commodity trading advisors, and commodity pool operators to the definition of “financial institutions” for purposes of 31 U.S.C. 5312(a)).

Accordingly, FinCEN hereby determines that investment advisers engage in activities that are “similar to, related to, or a substitute for” financial services that other BSA-defined financial institutions are authorized to engage in and, therefore, may be properly included as a “financial institution” subject to the requirements of the BSA.

2. Adding a Definition of “Investment Adviser”

FinCEN is also proposing to add a definition of “investment adviser” to 31 CFR 1010.100 to clearly define who qualifies as a covered adviser—and thus as a “financial institution” under these proposed amendments to FinCEN regulations. The proposed definition of “investment adviser” is: “[a]ny person who is registered or required to register with the SEC under section 203 of the Advisers Act (15 U.S.C. 80b-3(a)), or any person that currently is exempt from SEC registration under section 203(

) or 203(m) of the Investment Advisers Act (15 U.S.C. 80b-3(

), (m)).”

106

In other words, under this proposed definition, an investment adviser would be any RIA (those registered or required to register) or ERA (those exempt from SEC registration under the listed provisions).

106

See

15 CFR 275.203(

)-1; 15 CFR 275.203(m)-1.

The proposed definition relies on well-established and understood terms and definitions used in the Advisers Act and its implementing regulations to define who would be an investment adviser under FinCEN regulations. FinCEN believes that incorporating existing and well-understood regulatory definitions into its definition of investment adviser would simplify the investment advisers' determinations as to whether they are subject to the proposed requirements. FinCEN requests comment on whether the proposed definition of “investment adviser” is sufficiently clear, or whether some other definition may be preferable. FinCEN also requests comment on whether the proposed definition includes classes of investment advisers or certain services or activities provided by investment advisers that present a very low risk for money laundering,

terrorist financing, or other illicit finance activity such that they should be excluded from the definition, or whether the proposed definition fails to include a type of adviser that presents a risk.

(a) Registered Investment Advisers

Including RIAs within the proposed definition of investment adviser would align FinCEN's regulatory framework with the existing framework under the Advisers Act and would also allow FinCEN to work with the SEC to develop consistent application and examination of the AML/CFT requirements to such advisers. Generally, an investment adviser's amount of assets under management determine whether it is required to register or is prohibited from registering with the SEC.

107

In implementing the Dodd-Frank Act amendments to the Advisers Act, the SEC amended the instructions to Part 1A of Form ADV to further implement a uniform method for an investment adviser to calculate its assets under management in order to determine whether it is required to register or is prohibited from registering with the SEC.

108

Per the Dodd-Frank Act and SEC rules, a “large” adviser has $110 million or more in regulatory assets under management, and is required to register with the SEC. These are RIAs that would be included in the investment adviser definition in the proposed rule.

109

FinCEN notes that large advisers would comprise a substantial majority of the total number of investment advisers that are included in the definition of investment adviser for purposes of the proposed rule.

110

FinCEN requests comment on whether the definition of investment adviser should apply to non-U.S. advisers registered or required to register with the SEC, or who report to the SEC on Form ADV.

107

See

SEC,

Rules Implementing Amendments to the Investment Advisers Act of 1940,

Investment Advisers Act Release No. 3221 (Jun. 22, 2011), 76 FR 42950, 42955 (Jul. 19, 2011).

108

See id.; see also

Instructions for Part 1A, Item 5.F of Form ADV.

109

An investment adviser that is registered with the SEC on a basis other than its AUM would also be an “investment adviser” under the proposed rule and subject to the proposed requirements.

110

Generally, a mid-sized adviser has $25 million or more but less than $110 million in regulatory assets under management and is registered with the State where it maintains its principal office and place of business. A small adviser has less than $25 million in regulatory assets under management and is regulated or required to be regulated in the State where it maintains its principal office and place of business.

See

15 U.S.C. 80b-3A(a)(1). Mid-sized and small advisers are generally prohibited from registering with the SEC, unless an exemption from the prohibition on SEC registration is available (

see

17 CFR 275.203A-2), and therefore are unlikely to be covered by the proposed definition of “investment adviser” in the proposed rule as RIAs.

(b) Exempt Reporting Advisers

FinCEN is also including ERAs in the definition of investment adviser under the proposed rule for the reasons described in section II.C above. In addition, ERAs have less detailed reporting requirements than RIAs, are not required to file Form PF, and are not examined by the SEC on a regular basis.

111

Further, exempt venture capital advisers are able to rely on a registration exemption that is not limited by the amount of AUM. FinCEN requests comment on whether ERAs should be excluded from the proposed definition of “investment adviser,” and if ERAs are excluded, how could FinCEN otherwise address the money laundering, terrorist financing, and other illicit finance risk associated with ERAs. FinCEN also requests comment on whether there are differences in the risks associated with ERAs who advise private funds versus those that advise venture capital funds.

111

See

76 FR 42950, 42963, n.188.

FinCEN recognizes that different investment advisers included within the proposed definition may have different degrees of money laundering, terrorist financing, or other illicit finance risk. As discussed at greater length below, the AML/CFT program requirement is risk-based, and FinCEN anticipates that the burden of establishing an AML/CFT program, filing SARs, and complying with the other requirements of the proposed rule would be commensurate with an adviser's risk profile. As noted, the proposed definition of “investment adviser” 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). Coverage of these non-U.S. investment advisers is discussed further at section IV.E.7.

While FinCEN is limiting the proposed definition to RIAs and ERAs, FinCEN recognizes that other types of investment advisers or other entities that provide investment advisory services may present risks to the U.S. financial system of money laundering, terrorist financing, and other types of financial crimes, or otherwise pose a threat to U.S. national security. FinCEN, therefore, may consider future rulemakings to expand the application of the BSA to include other investment advisers or similar entities not covered by the proposed definition. FinCEN requests comment on whether other types of investment advisers or entities should also be subject to the proposed rule.

B. Delegation of Examination Authority to the Securities and Exchange Commission

FinCEN has overall authority for enforcement of compliance with the BSA and its implementing regulations.

112

FinCEN, however, may delegate examination authority to appropriate agencies while retaining authority for the coordination and direction of procedures and activities of these agencies.

113

FinCEN has previously delegated examination authority for various financial institutions, as reflected at 31 CFR 1010.810(b).

112

Treasury Order 180-1, para. 3; 31 CFR 1010.810(a).

113

Treasury Order 180-1, paras. 3(b), 4(b); 31 CFR 1010.810(a); 31 U.S.C. 5318(a)(1).

FinCEN is proposing to amend 31 CFR 1010.810(b) to add investment advisers to the list of financial institutions for which the SEC has the authority to examine for compliance with FinCEN's regulations implementing the BSA. Persons and entities meeting the proposed definition of investment adviser thus would fall under this provision and be subject to SEC examination for compliance with FinCEN regulations. The SEC has expertise in the regulation of investment advisers. The SEC is the Federal functional regulator for certain investment advisers and is responsible for examining investment advisers for compliance with the Federal securities laws, including the Advisers Act and the SEC rules promulgated under those laws.

114

Moreover, FinCEN has delegated to the SEC examination authority for broker-dealers in securities and certain investment companies, which are BSA-defined financial institutions subject to FinCEN's regulations and for which the SEC is the Federal functional regulator.

115

114

See

15 U.S.C. 6809(2)(F); 31 CFR 1010.100(r)(6);

see also

15 U.S.C. 80b-1

et seq.

and the rules thereunder, 17 CFR part 275.

115

See

31 CFR 1010.810(b)(6).

Accordingly, the proposed rule would designate the SEC as examiner of investment advisers for compliance with the proposed rule.

C. Investment Advisers' Proposed Obligation To File CTRs Instead of Form 8300

Under FinCEN's regulations that apply to a broad range of persons—not just financial institutions—investment

advisers are currently required to file reports for the receipt of more than $10,000 in currency and certain negotiable instruments using joint FinCEN/Internal Revenue Service Form 8300.

116

By defining investment advisers as “financial institutions” under the BSA, the proposed rule would require investment advisers to file CTRs with FinCEN pursuant to 31 CFR 1010.311 instead of filing reports using Form 8300.

117

116

31 CFR 1010.330; 26 CFR 1.6050I-1. “Currency” includes cashier's checks, bank drafts, traveler's checks, and money orders in face amounts of $10,000 or less, if the instrument is received in a “designated reporting transaction.” 31 CFR 1010.330(c)(1)(ii)(A). A “designated reporting transaction” is defined as the retail sale of a consumer durable, collectible, or travel or entertainment activity. 31 CFR 1010.330(c)(2). In addition, an investment adviser would need to treat the instruments as currency if the adviser knows that a customer is using the instruments to avoid the reporting of a transaction on Form 8300. 31 CFR. 1010.330(c)(1)(ii)(B).

117

See

31 CFR 1010.330(a) (stating that § 1010.330 [the BSA provision requiring the filing of the Form 8300] “does not apply to amounts received in a transaction reported under 31 U.S.C. 5313 and 31 CFR 1010.311.”). To the extent an investment adviser conducts transactions other than in currency (as defined in 31 CFR 1010.100(m) for purposes of the CTR requirement), it would be exempt from reporting such transactions because the Form 8300 requirement does not apply to such transactions.

The BSA authorizes FinCEN to promulgate regulations requiring financial institutions to file reports when they participate in certain types of financial transactions.

118

Pursuant to this authority, 31 CFR 1010.311 requires “financial institutions” (other than casinos) to file CTRs for “each deposit, withdrawal, exchange of currency or other payment or transfer, by, through, or to such financial institution which involves a transaction in currency of more than $10,000,” unless subject to an applicable exemption. FinCEN seeks to extend this requirement to investment advisers under the proposed rule. This proposed rule would also add several provisions, §§ 1032.310 to 1032.315, specifying how investment advisers should fulfill their proposed CTR obligations.

118

See, e.g.,

31 U.S.C. 5313(a); 31 U.S.C. 5326.

The threshold in 31 CFR 1010.311 applies to transactions in currency of more than $10,000 conducted during a single business day.

119

A financial institution must treat multiple transactions conducted in one business day as a single transaction if the financial institution has knowledge that the transactions are conducted by or on behalf of the same person.

120

This same requirement would extend to investment advisers.

119

See

31 CFR 1010.311, 1010.313(b). Multiple transactions must be treated as a single transaction if they are conducted by or on behalf of the same person and result in cash in or cash out of more than $10,000 during any one business day. A Form 8300, meanwhile, must be filed when currency is received in one transaction or two or more related transactions. Transactions conducted between a payer (or its agent) and a recipient in a 24-hour period would be treated as related. Furthermore, a distinction is drawn between transactions and the receipt of payments. Installment payments made within a period of 12 months may need to be aggregated and reported on a Form 8300.

See

31 CFR 1010.330(b)(3).

120

Id.

To avoid duplicative requirements, investment advisers would no longer have to report applicable transactions involving certain negotiable instruments reportable on Form 8300. Moreover, since an investment adviser would be required to report suspicious transactions under the SAR rule proposed in this rulemaking, investment advisers would no longer need to use Form 8300 to voluntarily report suspicious transactions.

121

Finally, imposing CTR and SAR requirements rather than a Form 8300 requirement is consistent with the obligations of certain other financial institutions, such as banks, broker-dealers, and mutual funds.

121

Currently an investment adviser can report a suspicious transaction voluntarily by checking box 1(b) in the Form 8300. In addition to the requirement that an investment adviser report on a CTR, under the proposed rule, an investment adviser would also be required to file a SAR if a suspicious transaction exceeds the threshold amount.

D. Proposed Recordkeeping Requirements for Investment Advisers

FinCEN has broad authority to impose recordkeeping requirements on financial institutions under the BSA.

122

Pursuant to this authority, FinCEN has issued several recordkeeping regulations, codified as 31 CFR part 1010, subpart D (§§ 1010.400 to 1010.440), which apply broadly to financial institutions, subject to specified exceptions. By defining RIAs and ERAs as financial institutions, this proposed rule would apply these recordkeeping regulations to investment advisers. Specifically, 31 CFR 1032.410 (cross-referencing 31 CFR 1010.410) would require investment advisers to comply with the Recordkeeping and Travel Rules, which are codified at 31 CFR 1010.410(e) and 31 CFR 1010.410(f), respectively, for the purposes of this proposed rule.

123

The proposed regulations would not require investment advisers to comply with these recordkeeping requirements with respect to any mutual fund that it advises.

124

122

See

12 U.S.C. 1953; 31 U.S.C. 5311; and 31 U.S.C. 5312(a)(2).

123

The Recordkeeping Rule is codified at 31 CFR 1010.410(e) and 1020.410(a), but only 1010.410(e) is relevant here: 1020.410(a) describes the recordkeeping requirements for banks, while those for nonbank financial institutions are described in 1010.410(e). The Travel Rule, as codified at 31 CFR 1010.410(f), applies to both bank and nonbank financial institutions.

See

FinCEN, Board of Governors of the Federal Reserve System,

Amendment to the Bank Secrecy Act Regulations Relating to Recordkeeping for Funds Transfers and Transmittals of Funds by Financial Institutions,

60 FR 220 (Jan. 3, 1995); FinCEN,

Amendment to the Bank Secrecy Act Regulations Relating to Orders for Transmittals of Funds by Financial Institutions,

60 FR 234 (Jan. 3, 1995).

124

Specifically, proposed 31 CFR 1032.400 would permit an investment adviser to deem requirements in Subpart D to be satisfied for any mutual fund it advises that is subject to these same reporting requirements under another provision of Subpart D.

Under the Recordkeeping and Travel Rules, financial institutions must create and retain records for transmittals of funds and ensure that certain information pertaining to the transmittal of funds “travels” with the transmittal to the next financial institution in the payment chain.

125

The Recordkeeping and Travel Rules apply to transmittals of funds that equal or exceed $3,000. With certain exceptions, “transmittal of funds” includes funds transfers processed by banks, as well as similar payments where one or more of the financial institutions processing the payment (

e.g.,

the transmittor's financial institution, an intermediary financial institution, or the recipient's financial institution) is not a bank.

126

125

See

31 CFR 1010.410(e), (f); 31 CFR 1020.410(a). Financial institutions are also required to retain records for five years.

See

31 CFR 1010.430(d).

126

See

31 CFR 1010.100(ddd) (defining “transmittal of funds”);

see also

31 CFR 1010.100(aa), (qq), (ggg) (defining “intermediary financial institution,” “recipient's financial institution,” and “transmittor's financial institution” to include both bank and nonbank financial institutions).

When a financial institution accepts and processes a payment sent by or to its customer, then the financial institution would be the “transmittor's financial institution” or the “recipient's financial institution,” respectively. The Recordkeeping and Travel Rules require the transmittor's financial institution to obtain and retain the name, address, and other information about the transmittor and the transaction.

127

The Recordkeeping Rule also requires the recipient's financial institution (and in certain instances, the transmittor's financial institution) to obtain or retain identifying information on the recipient.

128

And the Travel Rule requires that certain information obtained or retained “travels” with the

transmittal order through the payment chain.

129

127

See

31 CFR 1010.410(e)(1)(i), (e)(2).

128

See

31 CFR 1010.410(e)(1)(iii), (e)(3) (information that the recipient's financial institution must obtain or retain).

129

See

31 CFR 1010.410(f) (information that must “travel” with the transmittal order); 31 CFR 1010.100(eee) (defining “transmittal order”).

Under the proposed rule, however, some transmittals involving investment advisers would fall within an existing exception to the Recordkeeping and Travel Rules designed to exclude transmittals of funds from these Rules' requirements when certain categories of financial institutions are the transmitter and recipient.

130

The proposed application of this exception to investment advisers is intended to provide investment advisers with treatment similar to that of banks, brokers or dealers in securities, futures commission merchants, introducing brokers in commodities, and mutual funds.

130

See

31 CFR 1010.410(e)(6), (f)(4); 31 CFR 1020.410(a)(6). As relevant here, § 1010.410(e)(6)(i) excludes from the requirements of the Recordkeeping Rule “[t]ransmittals of funds where the transmitter and the recipient” are certain types of listed financial institutions. Section 1010.410(f)(4) excludes these same transmittals from the Travel Rule. The proposed rule would amend § 1010.410(e)(6) to add “investment advisers” to its list of financial institutions.

Additionally, FinCEN recognizes that investment advisers operate varying business models and, that in some circumstances, an adviser would not conduct transactions that meet the definition of “transmittal order.” For example, in some advisory relationships, when an investment adviser receives instructions from a customer, the investment adviser would not “be reimbursed by debiting an account of, or otherwise receiving payment from,” the customer, such that the investment adviser's receipt of instructions from a customer would not meet the definition of transmittal order.

131

See

31 CFR 1010.100(eee)(2).

Because FinCEN is proposing to include investment advisers in the definition of financial institutions, investment advisers would be required to comply with the Recordkeeping and Travel Rules when they engage in transactions that meet the definition of a transmittal order. FinCEN understands that the collection of at least some of this information would be required for accounting or other purposes and seeks comment on the extent to which investment advisers or other BSA-defined financial institutions regularly collect information that would be required under the Recordkeeping and Travel Rules. Similarly, FinCEN seeks comment on understanding the structures that investment advisers use to be credited by customers who seek to wire funds out of their accounts with the investment adviser. FinCEN seeks comment on how investment advisers work with qualified custodians to maintain separate accounts to manage customers' funds, including for wire transfers. FinCEN is also seeking comment on whether investment advisers should be required to comply with the Recordkeeping and Travel Rules as proposed, or if the Recordkeeping and Travel Rules should only apply in certain circumstances.

Finally, the proposed rule would subject investment advisers to requirements to create and retain records for extensions of credit and cross-border transfers of currency, monetary instruments, checks, investment securities, and credit.

132

These requirements currently apply to transactions by other BSA-defined financial institutions in amounts exceeding $10,000.

133

132

See

31 CFR 1010.410(a)-(c). Financial institutions must retain these records for a period of five years. 31 CFR 1010.430(d).

133

See

31 CFR 1010.410(a)-(c).

E. Anti-Money Laundering and Countering the Financing of Terrorism Programs

The BSA requires financial institutions to establish reasonably designed risk-based AML/CFT programs to combat the laundering of money and financing of terrorism through the institution.

134

The Annunzio-Wylie Anti-Money Laundering Act of 1992 amended the BSA by authorizing Treasury to issue regulations requiring financial institutions, as defined in BSA regulations, to maintain “minimum standards” of an anti-money laundering program.

135

These anti-money laundering programs must include, at a minimum, the development of internal policies, procedures, and controls; the designation of a compliance officer; an ongoing employee training program; and an independent audit function to test programs.

136

The USA PATRIOT Act further amended the BSA to expand AML program rules applicable to banks to cover certain other industries.

137

The requirements for an anti-money laundering program were further amended by section 6101(b) of the AML Act of 2020 (AML Act), which among other things, expanded the BSA's program rule requirement to include a reference to CFT in addition to AML.

138

FinCEN intends to implement more specific changes to AML/CFT program requirements as a result of section 6101(b) of the AML Act through a separate rulemaking process.

139

FinCEN does not intend to address those more specific changes as part of this rulemaking.

134

31 U.S.C. 5311(2), 5318(h)(1).

135

Annunzio-Wylie Anti-Money Laundering Act, Title XV of the Housing and Community Development Act of 1992, Public Law 102-550.

136

31 U.S.C. 5318(h)(1)(A)-(D).

137

Section 352(a) of the Act, which became effective on April 24, 2002, amended 31 U.S.C. 5318(h).

138

Public Law 116-283 (Jan. 1, 2021);

see

31 U.S.C. 5318(h)(4)(D) (as amended by AML Act section 6101(b)(2)(C)).

139

See

FinCEN Regulatory Agenda (Spring 2023),

Establishment of National Exam and Supervision Priorities,

available at

https://www.reginfo.gov/public/do/eAgendaViewRule?pubId=202304&RIN=1506-AB52.

The BSA authorizes FinCEN, after consultation with the appropriate Federal functional regulator (for investment advisers, the SEC), to further prescribe minimum standards for such AML/CFT programs.

140

In developing this proposed rule, FinCEN consulted and coordinated with the SEC staff, including regarding the statutorily specified factors set out in 31 U.S.C. 5318(h)(2)(B). These factors are:

140

31 U.S.C. 5318(h)(2)(A).

• financial institutions are spending private compliance funds for a public and private benefit, including protecting the United States financial system from illicit finance risks;

• the extension of financial services to the underbanked and the facilitation of financial transactions, including remittances, coming from the United States and abroad in ways that simultaneously prevent criminal persons from abusing formal or informal financial services networks are key policy goals of the United States;

• effective anti-money laundering and countering the financing of terrorism programs safeguard national security and generate significant public benefits by preventing the flow of illicit funds in the financial system and by assisting law enforcement and national security agencies with the identification and prosecution of persons attempting to launder money and undertake other illicit activity through the financial system;

• anti-money laundering and countering the financing of terrorism programs should be—

○ reasonably designed to assure and monitor compliance with the requirements of the BSA and regulations promulgated under the BSA; and

○ risk-based, including ensuring that more attention and resources of financial institutions should be directed toward higher-risk customers and activities, consistent with the risk profile of a financial institution, rather than toward lower-risk customers and activities.

FinCEN has considered these factors in section 5318(h)(2)(B) in the drafting of this proposed rule. In proposing this rule, FinCEN has considered the fact that comprehensive AML/CFT requirements for investment advisers, which would require investment advisers to have effective AML/CFT programs and subject them to SAR reporting requirements, would aid in preventing the flow of illicit funds in the financial system and in assisting law enforcement and national security agencies with the identification and prosecution of those who attempt to launder money and undertake other illicit financial activity. Additionally, FinCEN recognizes that AML/CFT programs at investment advisers should be reasonably designed and risk-based consistent with investment advisers' respective risk profiles, and therefore is proposing an AML/CFT program rule that requires policies, procedures, and internal controls reasonably designed to prevent the investment adviser from being used for money laundering, terrorist financing, or other illicit finance activities, as well as risk-based procedures that consider an investment adviser's risk profile. Further, as discussed in the Regulatory Analysis at section VII, FinCEN has analyzed the financial costs to investment advisers in imposing AML/CFT obligations, including AML/CFT program requirements and SAR filing requirements, and has determined that the public and private benefit to this proposed rule would outweigh the private compliance costs.

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Further discussion relevant to each factor may be found at: Factor (i): the regulatory impact analysis at section VII and other discussions of the costs and benefits of the proposed rule; Factor (ii): we believe that this factor is not relevant to the proposed rule because investment advisers generally do not provide services to the unbanked, process remittances, or participate in informal financial networks. This may be inferred from the risk discussion at section II.C and accompanying discussions of the structure of the investment advisory industry; and Factor (iii): the risk analysis at section II.C; Factor (iv): the risk analysis at section II.C and the discussion of building upon existing requirements and examination programs in this section and at section IV.B.

This proposed rule, by designating investment advisers as financial institutions, would subject investment advisers to AML/CFT program requirements, as reflected in proposed § 1032.210.

142

Additionally, 31 CFR subpart B contains general provisions applicable generally to financial institutions' AML/CFT programs. Proposed § 1032.200 would subject investment advisers those general provisions in subpart B.

Investment advisers are already subject to other regulations similar in certain ways to the AML/CFT program requirements FinCEN is proposing, and thus should be well-positioned to extend their practices to incorporate proposed AML/CFT requirements. RIAs are currently subject to Federal securities laws, which require the establishment of a variety of policies, procedures, and controls. For example, the Advisers Act requires an RIA to maintain certain books and records, as prescribed by the SEC.

143

Under 17 CFR 275.204-2, an RIA is required to keep certain books and records that relate to its investment advisory business.

144

Under 17 CFR 275.203-1 and 275.204-4, RIAs and ERAs, respectively, are also required to complete and submit Form ADV to the SEC. The Advisers Act also prohibits an investment adviser from engaging in fraudulent, deceptive, and manipulative conduct.

145

SEC rules further require RIAs to adopt and implement written policies and procedures reasonably designed to prevent violations of the Advisers Act and the rules that the SEC has adopted under that Act.

146

RIAs must conduct annual reviews to ensure the adequacy and effectiveness of their policies and procedures and must designate a chief compliance officer responsible for administering the policies and procedures.

147

ERAs are also subject to Federal securities laws governing the securities industry, required to complete and submit some sections of Form ADV, and comply with other select requirements of the Advisers Act.

148

While ERAs may not have the full compliance infrastructure that RIAs have, their existing compliance obligations nonetheless offer a point of reference and relevant experience for implementing the AML/CFT requirements in the proposed rule.

143

See

15 U.S.C. 80b-4(a) (requiring investment advisers to make and retain records as defined in section 3(a)(37) of the Exchange Act and to make and disseminate reports as prescribed by the SEC).

144

See

17 CFR 204-2 (books and records to be maintained by investment advisers).

145

See, e.g.,

15 U.S.C. 80b-6(1)-(2)), (4) (prohibiting any investment advisers from engaging in any activity that would defraud a client or prospective client).

See also

31 CFR 1023.220(a)(6) (CIP rule permitting a financial institution to rely on another financial institution to perform all or part of its obligations to verify the identity of its customers as required by 31 U.S.C. 5318(h)).

150

See

2016 Investment Management Compliance Testing Survey (2016 IMCTS Survey), p.21,

https://www.investmentadviser.org/eweb/docs/Publications_News/Reports_and_Brochures/Investment_Management_Compliance_Testing_Surveys/2016IMCTppt.pdf.

This survey included responses from compliance officers at 730 RIAs and is the most recent IMCTS survey to have asked detailed questions about AML policies and programs.

1. Overview of AML/CFT Program Requirement

Section 1032.210(a)(1) of the proposed rule would require each RIA and ERA to develop and implement a written AML/CFT program that is risk-based and reasonably designed to prevent the investment adviser from being used for money laundering, terrorist financing, or other illicit finance activities. Each RIA and ERA would also be required to make its AML/CFT program available for inspection by FinCEN or the SEC. The minimum requirements for the AML/CFT program are set forth in

§ 1032.210(b) and discussed in greater detail below.

FinCEN reiterates that the proposed AML/CFT program requirement is not a one-size-fits-all requirement but is risk-based and must be reasonably designed. The “risk-based and reasonably designed” approach of the proposed rule is intended to give investment advisers the flexibility to design their programs so that they are commensurate with the specific risks of the advisory services they provide and the customers they advise.

151

For example, large firms may assign responsibilities of the individuals and departments carrying out each aspect of the AML/CFT program, while smaller firms would be expected to adopt procedures that are consistent with their (often) simpler, more centralized organizational structures. This flexibility is designed to ensure that all firms subject to FinCEN's AML/CFT program requirements, from the smallest to the largest, and the simplest to the most complex, have in place policies, procedures, and internal controls appropriate to their advisory business to prevent the investment adviser from being used to facilitate money laundering, terrorist financing, or other illicit finance activities and to achieve and monitor compliance with the applicable provisions of the BSA and FinCEN's implementing regulations. FinCEN requests comment on whether existing requirements under the Advisers Act or existing policies and procedures to implement OFAC sanctions could assist investment advisers in complying with the proposed AML/CFT requirements. FinCEN also requests comment on whether any proposed requirements are duplicative of any existing requirements. Finally, FinCEN requests comment on whether there are certain services or activities provided by investment advisers where applying AML/CFT requirements would result in information of limited value to law enforcement and regulators.

151

The legislative history of the BSA reflects that Congress intended that each financial institution should have some flexibility to tailor its program to fit its business, considering factors such as size, location, activities, and risks or vulnerabilities to money laundering. This flexibility is designed to ensure that all firms, from the largest to the smallest, have in place policies and procedures appropriate to monitor for money laundering.

See

USA PATRIOT Act of 2001: Consideration of H.R. 3162 Before the Senate, 147 Cong. Rec. S10990-02 (Oct. 25, 2001) (statement of Sen. Sarbanes); Financial Anti-Terrorism Act of 2001: Consideration Under Suspension of Rules of H.R. 3004 Before the House of Representatives, 147 Cong. Rec. H6938-39 (Oct. 17, 2001) (statement of Rep. Kelly) (provisions of the Financial Anti-Terrorism Act of 2001 were incorporated as Title III in the Act).

2. Scope

As described above, the proposed rule would require all RIAs and ERAs to develop an AML/CFT program, and that program would be required to cover all advisory activities, with one exception: the program need not cover activities undertaken with respect to mutual funds, which have their own obligations under the BSA.

152

As detailed below, advisory activities with respect to mutual funds would be exempt from the AML/CFT program requirements that would be applied in the proposed rule.

152

See

31 CFR part 1024.

An investment adviser would apply an AML/CFT program to all advisory activities other than with respect to mutual funds. Advisory activities subject to an AML/CFT program would include, for example, the management of customer assets, the provision of financial advice, the execution of transactions for customers, as well as other advisory activities. The requirements of the proposed rule would not apply to non-advisory services. One example of this would be in the context of private equity funds: fund personnel may play certain roles with respect to the portfolio companies in which the fund invests. Activities undertaken in connection with those roles (

e.g.,

making managerial/operational decisions about portfolio companies) would not be “advisory activities” for purposes of the rule. FinCEN requests comment on whether certain advisory activities pose a lower risk in all circumstances and on the challenges for advisers in complying with the proposed role when engaged in such activities.

Certain commenters on the Second Proposed Investment Adviser Rule proposed to exempt some advisory activities, such as advising clients without managing client assets and acting as a subadviser, on the ground that such activities are lower risk. Assessing the risk of an adviser's activities requires appreciation of the full context of the activity. For example, subadvisers and advisers who do not manage assets may nonetheless afford their clients access to the U.S. financial system, inadvertently guide the layering or integration of illicit proceeds or other illicit finance activity, or have relationships that provide insight to the investment adviser's AML/CFT program. FinCEN is therefore proposing to include those activities within the scope of this proposed rule. As discussed in the comment request section below, FinCEN requests comment on whether certain subadvisory activities should be excluded from coverage of this proposed rule.

Under the risk-based approach, an investment adviser would tailor its program according to the specific risks presented by its various activities. Factors that may indicate an activity or a customer is lower risk include the jurisdiction of registration of legal person customers, and whether the customer (where a legal person) is subject to U.S. AML/CFT regulatory requirements.

(a) Mutual Funds

FinCEN is proposing to exempt from the proposed requirements activities of investment advisers in advising mutual funds.

153

FinCEN believes that this exemption is appropriate because of the regulatory and practical relationship between mutual funds and their investment advisers. Specifically, although mutual funds are distinct legal entities with distinct legal obligations, mutual funds typically do not have their own independent operations. Rather, mutual funds are entirely operated, and compliance with their legal obligations is undertaken, by their service provider entities, foremost amongst them their investment advisers. As a practical matter, we believe that any AML/CFT requirement imposed on an RIA to a mutual fund is already addressed by the existing AML/CFT requirements imposed on the mutual fund itself.

154

In particular, we expect that the investment adviser to a mutual fund will have both (1) access to the exact same information concerning the mutual fund or its investors that is available to the mutual fund, in part in connection with its AML/CFT obligations and (2) a significant role generally in the operations of the mutual fund's regulatory responsibilities, including its AML/CFT program. Consequently, we are proposing not to require investment advisers to mutual funds to include those mutual funds within the investment advisers' own AML/CFT programs, as we believe including a mutual fund within its investment

adviser's AML/CFT program would be redundant. This exemption is permissive and not mandatory; an investment adviser could decide to include the mutual funds it advises in complying with any of the investment adviser's proposed requirements.

153

FinCEN's definition of a mutual fund under 1010.100(gg) applies to an ETF as an “open-end company” (as the term is defined in section 5 of the Investment Company Act).”

See supra

n. 53.

154

FinCEN notes as well that the First Proposed Investment Adviser Rule would have permitted mutual funds to be excluded from the programs required of investment advisers covered by that proposed rule. Commenters to the Second Proposed Investment Adviser Rule, which would not have permitted such an exclusion, supported instead the 2003 NPRM approach.

Mutual funds are already subject to comprehensive AML/CFT obligations under the BSA and are required to, among other things, establish AML/CFT and customer identification programs, conduct CDD, and report suspicious activity, among other obligations.

155

FinCEN believes that, currently, these requirements sufficiently mitigate the money laundering, terrorist financing, and other illicit finance risks associated with mutual funds and those funds' investors to justify this exemption. FinCEN is requesting comment on whether to exempt mutual funds from coverage in an adviser's AML/CFT program. FinCEN also requests comment on whether there are other categories of entities that, like mutual funds, could be reasonably exempted from an investment adviser's AML/CFT program.

155

See

31 CFR 1010.100(gg); 31 CFR part 1024.

FinCEN is also proposing to exempt investment advisers from having to comply with the reporting and recordkeeping requirements of part 1032, subparts C and D, for its mutual fund customers. FinCEN believes that the proposed regulatory text is sufficiently clear that these subparagraphs would not apply with respect to mutual fund customers, because the internal policies, procedures, and controls to comply with those requirements are closely linked to the AML/CFT program requirement. FinCEN requests comment on whether additional regulatory text in those subparts is needed to clarify this. FinCEN also requests comment on whether the exemption should be dependent on the nature of the relationship between the investment adviser and its mutual fund customer, and whether the exemption would avoid duplication of existing AML/CFT requirements. Lastly, FinCEN requests comment on whether investment advisers to mutual funds should still be required to monitor for and file SARs.

(b) Provision of Other Advisory Services

FinCEN understands that investment advisers provide a range of services that could affect the nature of their AML/CFT programs. An investment adviser may provide customers with advisory services that do not include the management of customer assets or knowledge of customers' investment decisions, such as pension consulting, securities newsletters, research reports, or financial planning.

In the investment advisory industry, an adviser may also act as the “primary adviser” or “subadviser.”

156

Generally, the primary adviser contracts directly with the client, and a subadviser has contractual privity with the primary adviser, though there is variation across the sector with respect to the relationship and function between primary advisers and subadvisers. Because subadvisory services are a subcategory of advisory services, the proposed rule would apply to investment advisers who provide subadvisory services.

156

The Advisers Act does not distinguish between advisers and subadvisers; all are “investment advisers.”

See

76 FR 39646, 39680 (Jul. 6, 2011) at n. 504 and accompanying text.

FinCEN requests comment on whether specific services provided by investment advisers, such as advisory services that do not involve management of client assets or subadvisory services, should be included or excluded from coverage of this proposed rule. FinCEN also requests comment on any alternative approaches for addressing compliance with the proposed rule when advisers provide particular services, such as allowing subadvisers to rely on the primary adviser or allowing the primary adviser to delegate all AML/CFT obligations to the subadviser. FinCEN further requests comment on whether there is an increased risk for a subadviser when providing advisory services to a customer with a primary adviser that is not an investment adviser as defined in the proposed rule. FinCEN also requests comment on the extent a subadviser's AML/CFT program would overlap with the primary adviser's program and how duplication could be mitigated. Finally, FinCEN requests comment on whether there are similar arrangements where an investment adviser may be sub-contracted to provide services to another investment adviser that should or should not be in the scope of an investment adviser's AML/CFT program.

3. Dually Registered Investment Advisers and Advisers Affiliated With or Subsidiaries of Entities Required To Establish AML/CFT Programs

According to a Treasury review of Form ADV filings, approximately three percent of RIAs were dually registered with the SEC as investment advisers and broker-dealers in securities, and approximately 20 percent of RIAs may be affiliated with, or subsidiaries of, banks or broker-dealers, which are required to establish AML/CFT programs. With respect to an investment adviser that is dually registered as a broker-dealer or is a bank (or is a bank subsidiary), FinCEN is not proposing to require such an adviser to establish multiple or separate AML/CFT programs so long as a comprehensive AML/CFT program covers all of the entity's relevant business and activities that are subject to BSA requirements. The program should be designed to address the different money laundering, terrorist financing, or other illicit finance activity risks posed by the different aspects of the entities' businesses and, accordingly satisfy each of the risk-based AML/CFT program requirements to which it is subject in its capacity as both an investment adviser and broker-dealer or bank.

157

Similarly, an investment adviser affiliated with, or a subsidiary of, another entity required to establish an AML/CFT program in another capacity would not be required to implement multiple or separate programs as one single program can be extended to all affiliated entities that are subject to the BSA, so long as it is designed to identify and mitigate the different money laundering, terrorist financing, and other illicit finance activity risks posed by the different aspects of the entity's business and satisfy each of the risk-based AML/CFT program and other BSA requirements to which the organization is subject in all of its regulated capacities, as for example an investment adviser and a bank or insurance company.

158

157

FinCEN notes that while broker-dealers in securities are subject to the full panoply of FinCEN's regulations implementing the BSA, investment advisers would not immediately be subject to certain of those AML/CFT requirements,

e.g.,

the CIP Rule, because the proposed rule does not include CIP requirements at this time. FinCEN intends to address CIP requirements in a subsequent joint rulemaking with the SEC, after notice-and-comment.

158

FinCEN notes that although certain insurance companies are required to establish and implement AML programs and report suspicious activity, the term “insurance company” is not included within the general definition of financial institution under FinCEN's regulations.

See

31 CFR 1010.100(t). Therefore, such insurance companies are not required to file CTRs with FinCEN or comply with the Recordkeeping and Travel Rules and other related recordkeeping requirements. Accordingly, FinCEN would not expect an insurance company that is affiliated with or owns an investment adviser to design an enterprise-wide AML/CFT compliance program that would subject the insurance company to AML/CFT requirements not required by FinCEN's regulations. Conversely, FinCEN would not expect a bank, which is subject to the full panoply of FinCEN's regulations implementing the BSA, to design an enterprise-wide AML/CFT compliance program that would subject an affiliated or controlled investment adviser to AML/CFT requirements that would not be required by the proposed rule.

FinCEN recognizes the importance of enterprise-wide compliance and, therefore, believes it would be beneficial and cost-effective for these types of entities to implement one comprehensive AML/CFT program that includes all activities covered by FinCEN's regulations. However, these entities would not be required to establish one comprehensive AML/CFT program; they may instead establish multiple programs to satisfy their AML/CFT obligations. What would be required, however, is that the covered investment adviser and its affiliated financial institution(s) identify and mitigate the risks arising across the organization or organizations—for example, as they relate to one customer served by both an affiliated bank and an investment adviser. If each of these affiliates conducts due diligence on the same customer individually, without assessing all of this information between both aspects of its business, these businesses' understanding of their shared customer would be incomplete, which could lead to a less effective understanding of risk and detection of suspicious activity.

FinCEN is requesting comments on how dually registered investment advisers and broker-dealers, or investment advisers affiliated with, or a subsidiary of, a bank, broker-dealer, or other BSA-defined financial institution, should apply their existing AML/CFT program to their investment advisory activities. FinCEN also requests comment on whether RIAs or ERAs that are affiliated with a bank or broker-dealer presently apply enterprise-wide AML/CFT requirements, and whether certain AML/CFT requirements are presently tailored for advisory activities.

4. Delegation of Duties

Investment advisers' services routinely involve other financial institutions that have their own AML/CFT program requirements, such as broker-dealers, banks, mutual funds, as well as other investment advisers. FinCEN also recognizes that an investment adviser may conduct some of its operations through agents or third-party service providers, such as broker-dealers in securities (including prime brokers), custodians, transfer agents, and fund administrators. For instance, many investment advisers that operate private funds delegate the implementation and operation of certain aspects of their AML program to a third party, most often the fund's administrator, which is an independent third-party that provides valuation, administrative, and other services to the fund and its investors.

159

FinCEN understands that some fund administrators are nonbank subsidiaries of U.S. bank holding companies and, as such, are subject to the global AML policies and procedures of these U.S. institutions. FinCEN also understands that some investment advisers delegate AML compliance to administrators located outside the United States. These administrators are generally located in jurisdictions that require regulated entities to have their own AML/CFT policies, procedures, and controls.

See, e.g.,

Managed Funds Association, Letter to Financial Crimes Enforcement Network, Re: AML Program and SAR Filing Requirements for Registered Investment Advisers (RIN: 1506-AB10), Docket Number FinCEN-2014-003 (Nov. 2, 2015).

FinCEN recognizes that it is common in the advisory business to delegate a range of compliance, administrative, and other activities to third-party providers. In the proposed rule, similar to other BSA-defined financial institutions, FinCEN would permit an investment adviser to delegate contractually the implementation and operation of aspects of its AML/CFT program. However, if an investment adviser delegates the implementation and operation of any aspects of its AML/CFT program to another financial institution, agent, fund administrator, third-party service provider, or other entity, the investment adviser would remain fully responsible and legally liable for, and need to demonstrate, the program's compliance with AML/CFT requirements and FinCEN's implementing regulations. The investment adviser also would be required to ensure that FinCEN and the SEC are able to obtain information and records relating to the AML/CFT program.

Because investment advisers operate through a variety of different business models, each investment adviser may decide which aspects (if any) of its AML/CFT program are appropriate to delegate. In certain circumstances, for instance, an investment adviser may deem it appropriate to delegate certain aspects of its suspicious activity monitoring and reporting obligation to a third party, such as a qualified custodian.

In addition to these financial institutions, there are other third-party service providers that play an important role in advisory activities, such as fund administrators. As FinCEN understands it, for advisers who presently implement AML/CFT policies and procedures, it is often current practice for those advisers to delegate the administration of AML/CFT policies and procedures to their fund administrator, along with non-AML/CFT activities such as processing subscriptions, transfers, and redemptions administrators. Some fund administrators are subsidiaries of U.S. financial or bank holding companies that may have enterprise-wide AML/CFT programs, while those in foreign jurisdictions may be subject to AML/CFT requirements under local law.

However, as noted above, liability for noncompliance would remain with the investment adviser. The investment adviser would still be required to identify and document the procedures implemented to address its vulnerability to money laundering, terrorist financing, and other illicit finance activity, and then undertake reasonable steps to assess whether the service provider carries out such procedures effectively. For example, it would not be sufficient to simply obtain a “certification” from a service provider that the service provider has a satisfactory AML/CFT program. Similarly, if an investment adviser delegates the responsibility for suspicious activity reporting to an agent or a third-party service provider, the adviser remains responsible for its compliance with the requirement to report suspicious activity, including the requirement to maintain SAR confidentiality.

FinCEN requests comment on the scope of information fund administrators currently collect that would support implementation of the proposed rule, and on the practical effect of permitting an investment adviser to delegate some or all of the requirements in the proposed rule. FinCEN also requests comment on the quality of AML/CFT programs implemented by fund administrators whose operations are primarily conducted outside of the United States, the extent to which these fund administrators are able to collect and provide information on the natural person and legal entity investors in offshore pooled investment vehicles when that information is requested by a U.S. investment adviser, the ability of the U.S. investment adviser to effectively monitor the implementation of proposed requirements by fund administrators, and the quality of suspicious activity or suspicious transaction reports submitted by those fund administrators.

5. AML/CFT Program Approval

Section 1032.210(a)(2) of the proposed rule would require that each investment adviser's AML/CFT program be approved in writing by its board of directors or trustees, or if it does not have a board, by its sole proprietor, general partner, trustee, or other persons that have functions similar to a board of directors. This provision of the proposed rule would ensure that the

requirement to have an AML/CFT program receives the appropriate level of attention and is intended to be sufficiently flexible to permit an investment adviser to comply with this requirement based on its particular organizational structure. The proposed rule would require an investment adviser's written program to be made available for inspection by FinCEN or the SEC.

6. The Required Elements of an Anti-Money Laundering/Countering the Financing of Terrorism Program

(a) Required Policies, Procedures, and Internal Controls

Section 1032.210(b)(1) would require an investment adviser to establish and implement policies, procedures, and internal controls reasonably designed to prevent money laundering, terrorist financing, and other illicit finance activities. As noted in section II, these risks may include not only activities tied to money laundering, such as fraud or corruption, but also any affiliation or relationship with either persons designated by the United States or other jurisdictions with which the United States regularly coordinates sanctions actions, or foreign state-sponsored investment activity in critical or emerging technologies. FinCEN recognizes that some types of customers or customer activities would pose greater risks for money laundering, terrorist financing, or other illicit finance activity than others.

Generally, under the proposed rule, an investment adviser would be required to review, among other things, the types of advisory services it provides and the nature of the customers it advises to identify the investment adviser's vulnerabilities to money laundering, terrorist financing, and other illicit finance activities. It would also need to review investment products offered, distribution channels, intermediaries that it may operate through, and geographic locations of customers and business activities. Accordingly, an investment adviser's assessment of the risks presented by the different types of advisory services it provides to such customers would need to, among other factors, consider the types of accounts offered (

e.g.,

managed accounts), the types of customers opening such accounts, the geographic location of such customers, and the sources of wealth for customer assets. FinCEN expects that investment advisers would generally be able to adapt existing policies and procedures to meet this requirement.

160

FinCEN requests comment on whether it should require an investment adviser to include all the advisory services it provides in its AML/CFT program.

160

See

discussion in section II.B,

infra,

for a discussion of existing Advisers Act recordkeeping and reporting obligations that may enable investment advisers to adapt existing policies, procedures, and internal controls. In addition, as noted above, according to one industry survey, as of 2016, 40 percent of participants had adopted AML programs similar to the AML program requirements proposed in the Second Proposed Investment Adviser Rule.

The discussion below focuses on how an investment adviser's AML/CFT program may address the money laundering, terrorist financing, or other illicit finance risks that may be presented by certain specific types of advisory customers, as well as how an adviser's program may address the risks presented by certain specific advisory services provided to those customers. In addition, this section describes FinCEN's expectations under a risk-based approach regarding advisory services to wrap fee programs. FinCEN requests comment on whether closed-end registered funds, wrap fee programs, or other types of accounts advised by investment advisers should be, on a risk-basis, reasonably exempted from an investment adviser's AML/CFT program.

Registered Closed-End Funds.

Based on one available estimate, at the end of 2022, there were approximately 440 registered closed-end funds that had approximately $250 billion in AUM.

161

Unlike open-end funds, closed-end funds do not have an existing AML/CFT program or SAR requirement. Registered closed-end funds, however, are subject to comprehensive SEC regulation and oversight and typically trade in the secondary market through broker-dealers who have AML/CFT obligations and where there are additional required disclosures and greater transparency.

161

See 2023 Investment Company Factbook

at p.2,17,

supra

n. 55. Unlike traditional mutual funds (or “open-end funds”), closed-end funds are not required to buy back shares from shareholders. Closed-end funds sell their shares in a public offering. After that, their shares trade on national securities exchanges at market prices. The market price may be greater or less than the market value of the fund's underlying investments.

For these reasons, although FinCEN is not proposing to exempt closed-end funds from the AML/CFT or SAR requirements in the proposed rule, FinCEN would expect, absent other indicators of high-risk activity, investment advisers could treat closed-end funds as lower-risk for purposes of their AML/CFT programs. FinCEN requests comments on the money laundering, terrorist financing, and other illicit finance risks faced by closed-end funds, and how entities with existing AML/CFT requirements, such as banks and broker-dealers, apply those requirements to activity involving closed-end funds.

Private Funds.

As described above, the money laundering, terrorist financing, or illicit finance activity risk for private funds may vary with the individual fund's investment strategy, targeted investors, and other characteristics. Some private funds have traditionally been seen as less attractive to certain illicit actors. For instance, due to their long-term investment focus and illiquid nature, certain private equity funds may be less likely to be used by money launderers, terrorist financiers, and others engaging in illicit finance.

162

Other relevant characteristics of private funds include minimum subscription amounts, restrictions on the type of investors they can accept, and the fact that most funds prohibit the receipt of paper currency. However, those factors may not be a barrier to more sophisticated fraudsters or corrupt officials, among others, that have already placed their funds into a foreign bank and are seeking long-term returns outside of their home country.

162

For instance, in the Proposed Unregistered Investment Companies Rule, FinCEN proposed to exclude from the scope of its proposed AML requirements those funds that did not offer their investors the right to redeem any portion of their ownership interests within two years after those interests were acquired.

See

68 FR at 60619.

An investment adviser that is the primary adviser to a private fund or other unregistered pooled investment vehicle is required to make a risk-based assessment of the money laundering and terrorist financing risks presented by the investors in such investment vehicles by considering the same types of relevant factors, as appropriate, as the adviser would consider for clients for whom the adviser manages assets directly. As noted above, the risk-based approach of the proposed rule is intended to give investment advisers the flexibility to design their programs to meet the specific risks presented by their customers, including any funds they advise. In assessing the potential risk of a private fund under the proposed rule, investment advisers generally should gather pertinent facts about the structure or ownership of the fund, including both the extent to which they are provided with relevant information about the investors in that private fund, who may or may not themselves also be customers of the investment adviser, and the nature of such investor-related information that they receive.

Under the proposed rule, where an investment adviser attempted to and was unable to obtain identifying information about the investors in a private fund, the private fund may pose a higher risk for money laundering, terrorist financing, or other illicit finance activity. When a private fund's potential vulnerability to money laundering, terrorist financing, or other illicit finance activity is high, the adviser's procedures would need to reasonably address these higher risks so that the adviser is able to prevent the investment adviser from being used for money laundering or the financing of terrorist activities, and to achieve and monitor compliance with the BSA (including to obtain sufficient information to monitor and report suspicious activity). FinCEN requests comment on what information is currently available to advisers to private funds regarding their investors that could help advisers comply with the proposed AML/CFT requirements. FinCEN also requests comment on whether a subadviser to a private fund or other unregistered pooled investment vehicle should be required to establish the same policies, procedures, and internal controls as when the primary adviser is the investment adviser, or should be required to mitigate the risks of money laundering, terrorist financing, or other illicit activity to the investing pooled investment vehicle's investors, sponsoring entity, and/or intermediaries.

FinCEN recognizes that certain private funds and other unregistered pooled investment vehicles may present lower risks for money laundering or terrorist financing than others. Consequently, FinCEN would not expect an investment adviser to risk-rate the advisory services it provides to a pooled investment vehicle that presents a lower risk the same as it might rate the advisory services it provides to other types of pooled investment vehicles that may present higher risks for attracting money launderers, terrorist financers, or other illicit actors. FinCEN requests comment on factors related to the activities, investors, or structure of private funds or other unregistered pooled investment vehicles that could be higher- or lower-risk. FinCEN also requests comment on how the proposed rule should apply to advisers who manage private funds that receive investments from in-funds or who have funds-of-funds who are investors.

Wrap Fee Programs.

In a wrap fee program, investment advisory and brokerage services are provided together as a single product.

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For the purposes of this discussion, FinCEN will focus on wrap fee arrangements where an investment adviser is solely acting as a portfolio manager and generally managing the customer account to a selected model. In these programs, even if both advisers or broker-dealers are providing services, there is a single “relationship” entity that is responsible for the relationship with the customer, managing the account overall, and selecting the account strategy. That program sponsor has the primary relationship with the customer, which means that the program sponsor is typically best positioned to recognize illicit financial activity in the program.

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A “wrap fee program” for purposes of the proposed rule is a program under which investment advisory and brokerage execution services (as well as administrative expenses and other fees and expenses) are provided for a single “wrapped” (

i.e.,

bundled) fee.

While FinCEN recognizes the characteristics described above regarding the most common structure of wrap fee programs, it is not proposing to exempt wrap fee programs from coverage of the proposed rule. Depending on the structure of the wrap fee program, the investment adviser may be best positioned to spot illicit finance activity (if, for example, it is the program sponsor). Moreover, even a non-sponsoring investment adviser may have additional insights into the activity of the wrap fee program. FinCEN requests comments on how the requirements of the proposed rule can be applied to advisers participating in a wrap fee program, to include when an adviser acting as portfolio manager is either affiliated or not affiliated with the sponsoring entity of the program.

(b) Provide for Independent Testing for Compliance To Be Conducted by Company Personnel or by a Qualified Outside Party

Section 1032.210(b)(2) would require that an investment adviser provide for independent testing of the AML/CFT program by the adviser's personnel or a qualified outside party. The purpose of this provision is to ensure that an investment adviser's AML/CFT program complies with the requirements of § 1032.210 and that the program functions as designed. Employees of either the investment adviser, its affiliates, or unaffiliated service providers may conduct the independent testing, so long as those same employees are not involved in the operation and oversight of the program.

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The employees would have to be knowledgeable regarding AML/CFT requirements and qualified to conduct independent testing. The frequency of the independent testing would depend upon the money laundering, terrorist financing, and other illicit finance risks of the adviser and the adviser's overall risk management strategy. For instance, an adviser could conduct independent testing

over

periodic intervals (

e.g.,

every 12 to 18 months) or when there are significant changes in the adviser's risk profile (with respect to money laundering, terrorist financing, or other illicit finance risks), systems, compliance staff, or processes. More frequent independent testing may be appropriate when errors or deficiencies in some aspect of the AML/CFT compliance program have been identified or to verify or validate mitigating or remedial actions. Any recommendations resulting from such testing would need to be promptly implemented or submitted to senior management for consideration.

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As noted in this NPRM, some investment advisers may implement enterprise-wide AML/CFT programs that are evaluated at the holding company level. It would not be consistent with the requirements of thi

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