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 RegisterSep 4, 2024

Ask Donna

What actually matters in this document.

Text

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:

Final rule.

SUMMARY:

FinCEN, a bureau of the U.S. Department of the Treasury (Treasury), is issuing a final rule 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 certain investment advisers, require certain investment advisers to report suspicious activity to FinCEN pursuant to the BSA, and make several other related changes to FinCEN regulations. These regulations will apply to certain investment advisers who 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 and who threaten U.S. national security.

DATES:

This rule is effective January 1, 2026.

FOR FURTHER INFORMATION CONTACT:

The FinCEN Regulatory Support Section at 1-800-767-2825 or email

frc@fincen.gov.

SUPPLEMENTARY INFORMATION:

I. Introduction

In this final rule, FinCEN is adding certain investment advisers to the definition of “financial institution” to regulations issued pursuant to the BSA, prescribing minimum standards for AML/CFT programs to be established by certain investment advisers, requiring certain investment advisers to report suspicious activity to FinCEN pursuant to the BSA, and making several other related changes to FinCEN's regulations that implement the BSA. This final rule follows FinCEN's notice of proposed rulemaking on AML/CFT program and suspicious activity report (SAR) requirements for investment advisers released on February 15, 2024 (referred to as the IA AML NPRM or proposed rule).

FinCEN,

Anti-Money Laundering/Countering the Financing of Terrorism Program and Suspicious Activity Report Filing Requirements for Registered Investment Advisers and Exempt Reporting Advisers,

Notice of Proposed Rulemaking, 89 FR 12108 (Feb. 15, 2024).

This rule aims to address and prevent money laundering, terrorist financing, and other illicit finance activity through the investment adviser industry. As detailed in an investment adviser illicit finance risk assessment (Risk Assessment) published concurrently with the release of the IA AML NPRM, Treasury has identified several illicit finance threats involving investment advisers.

Investment advisers have served as an entry point into the U.S. financial system and economy for illicit proceeds associated with foreign corruption, fraud, and tax evasion, as well as billions of dollars ultimately controlled by sanctioned entities including Russian oligarchs and their associates. Investment advisers—including those exempt from Securities and Exchange Commission (SEC) registration—and their private funds, particularly venture capital funds, 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. Finally, there are numerous examples of investment advisers defrauding their customers and stealing their funds.

See

Treasury,

US Sectoral Illicit Finance Risk Assessment Investment Advisers

(also titled

2024 Investment Adviser Risk Assessment

) (2024), available at

https://home.treasury.gov/about/offices/terrorism-and-financial-intelligence/terrorist-financing-and-financial-crimes/office-of-strategic-policy-osp.

To address these risks, this rule adds “investment adviser” to the definition of “financial institution” at 31 CFR 1010.100(t) and defines investment advisers to be SEC-registered investment advisers (RIAs) and exempt reporting advisers (ERAs). However, FinCEN is narrowing the definition of “investment adviser” from the proposed rule to exclude RIAs that register with the SEC solely because they are (i) mid-sized advisers, (ii) multi-state advisers, or (iii) pension consultants, as well as (iv) RIAs that do not report any assets under management (AUM) on Form ADV. For investment advisers subject to this rule that have their principal office and place of business outside the United States, FinCEN is clarifying that the rule applies only to their activities that (i) take place within the United States, including through the involvement of U.S. personnel of the investment adviser, such as the involvement of an agency, branch, or office within the United States or (ii) provide services to a U.S. person or a foreign-located private fund with an investor that is a U.S. person. Given that the risk of money laundering, terrorist financing, and other illicit finance activity is generally lower for State-registered advisers, FinCEN, as proposed in the IA AML NPRM, is not applying this rule to State-registered advisers at this time. However, FinCEN will continue to monitor activity involving State-registered investment advisers for indicia of money laundering, terrorist financing, or other illicit finance activity, and may take appropriate steps to mitigate any such activity. As in the proposed rule, this final rule also does not cover foreign private advisers or family offices.

With respect to the minimum standards for an investment adviser's AML/CFT program, FinCEN is adopting the minimum requirements largely as proposed in the IA AML NPRM, with several changes. In line with the proposed rule, the final rule maintains the exclusion of mutual funds from the requirements of an investment adviser's AML/CFT program requirements. It includes modified text, however, to permit an investment adviser to categorically exclude any mutual fund from an investment adviser's AML/CFT program requirements without obligating the adviser to verify that such mutual fund has implemented an AML/CFT program. Additionally, FinCEN is expanding the exclusion from the AML/CFT program to also apply to (i) bank- and trust company-sponsored collective investment funds that comply with the requirements of 12 CFR 9.18 or a similar applicable law that incorporates the requirements of 12 CFR 9.18, and (ii) any other investment adviser subject to this rule that is advised by the investment adviser. With respect to the requirement to establish, maintain, and enforce a financial institution's AML/CFT program that is the responsibility of, and must be performed by, persons in the United States who are accessible to, and subject to oversight and supervision by, the Secretary of the Treasury and the appropriate Federal functional regulator (the Duty Provision), as discussed further below, FinCEN has determined to not include this requirement in this final rule.

With respect to this rule's other requirements, FinCEN is adopting the SAR filing provisions largely as proposed. The final rule does not exempt investment advisers from the requirements to file Currency Transaction Reports (CTRs), adhere to

the Recordkeeping and Travel Rules, or other general recordkeeping requirements.

Following the proposed application of the information sharing provisions of sections 314(a) and 314(b) under the USA PATRIOT Act,

the final rule is applying both requirements as proposed, but is clarifying that investment advisers may deem these requirements satisfied for any mutual funds, bank- and trust company-sponsored collective investment fund, or any other investment adviser they advise subject to this rule that is already subject to AML/CFT program requirements. With respect to the proposal to implement special due diligence requirements for correspondent and private banking accounts and special measures under section 311 of the USA PATRIOT Act,

investment advisers may deem these requirements satisfied for any mutual fund, bank- and trust company-sponsored collective investment fund, or any other investment adviser they advise subject to this rule that is already subject to AML/CFT program requirements. FinCEN is also extending the proposed date for compliance to January 1, 2026, meaning that no later than this date, investment advisers must have implemented AML/CFT programs, commenced filing SARs when required, and begun complying with the other reporting and recordkeeping requirements in this final rule.

See

31 CFR 1010.310 through 1010.315 (CTR), 31 CFR 1010.410(e) and (f) (Recordkeeping and Travel Rules), and 31 CFR 1010.415 through 110.440.

See

31 CFR 1010.520, 1010.540.

As discussed further below, in addition to special measures under section 311 of the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (USA PATRIOT Act), investment advisers must also comply with actions taken under section 9714(a) of the Combating Russian Money Laundering Act, codified as a note to 31 U.S.C. 5318A, and section 7213A of the Fentanyl Sanctions Act, codified at 21 U.S.C. 2313a.

See infra

Section III.G.2.

II. Background

A. Statutory Authority

Enacted in 1970, the Currency and Foreign Transactions Reporting Act—which, along with its amendments and the other statutes relating to the subject matter, is generally referred to as the BSA—is designed to combat money laundering, the financing of terrorism and other illicit finance 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,” as well as “to facilitate the tracking of money that has been sourced through criminal activity or is intended to promote criminal or terrorist activity.”

The Secretary of 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 terrorism.”

The Secretary may also “establish appropriate frameworks for information sharing among financial institutions and service providers, their regulatory authorities, associations of financial institutions, the [Treasury], and law enforcement authorities to identify, stop, and apprehend money launderers and those who finance terrorists.”

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. 310, 5311-5314, 5316-5336, and including notes thereto, with implementing regulations at 31 CFR Chapter X.

31 U.S.C. 5311(2), (3).

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

31 U.S.C. 5311(5).

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; see also

31 U.S.C. 310(b)(2)(I) (providing that FinCEN Director “[a]dminister the requirements of subchapter II of chapter 53 of this title, chapter 2 of title I of Public Law 91-508, and section 21 of the Federal Deposit Insurance Act, to the extent delegated such authority by the Secretary.”

Pursuant to this authority, FinCEN may define a business or agency as a “financial institution” if such business or agency 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 establish programs to combat money laundering and the financing of terrorism that include certain minimum standards. The BSA explicitly authorizes the Secretary—and thereby FinCEN—to “prescribe minimum standards” for such AML/CFT programs.

Similarly, under the BSA, Treasury—and thereby FinCEN—“may require any financial institution . . . to report any suspicious transaction 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, terrorist financing, or other illicit finance activity.

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

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

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

See

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.

The Investment Advisers Act of 1940 (Advisers Act) and its implementing rules and regulations form the primary Federal framework governing investment advisory activity, along with other Federal securities laws and their implementing rules and regulations, such as the Investment Company Act of 1940 (15 U.S.C. 80a

et seq.

) (Company Act), the Securities Act of 1933 (15 U.S.C. 77a

et seq.

) (Securities Act), and the Securities Exchange Act of 1934 (15 U.S.C. 78a

et seq.

) (Exchange Act). The Advisers Act also defines an investment adviser as a person or firm that, for compensation, is engaged in the business of providing advice to others or issuing reports or analyses regarding securities.

This final 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.

See

15 U.S.C. 80b-2(a)(11) for this definition of “investment adviser.” The statute excludes some persons and firms: certain banks, certain professionals, certain broker-dealers, news publishers, persons who advise on or analyze only Treasury-designated exempt securities, statistical ratings agencies, and family offices.

See

15 U.S.C. 80b-2(a)(11)(A)-(G).

Since the Advisers Act was amended in 1996 and 2010, generally only investment advisers who have at least $100 million in AUM or advise a

registered investment company

may register with the SEC.

Advisers solely to private funds are only required to register with the SEC if they have least $150 million in AUM in the United States.

Advisers to only venture capital funds are exempt from registration with the SEC regardless of the amount of AUM. Other investment advisers typically register with the State in which the adviser maintains its principal place of business.

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(a) and cannot rely on an exception or an exemption from the definition of investment company, generally it must register with the SEC under the Company Act and must register its public offerings under the Securities Act.

Investment advisers with more than $100 million AUM

may

must

See

17 CFR 275.203A-1.

See

15 U.S.C. 80b-3(m)(1); 17 CFR 275.203(m)-1(a), (b).

SEC-Registered Investment Advisers.

Unless eligible to rely on an exemption, 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.

Besides having AUM above $110 million, additional criteria may require an investment adviser to register with the SEC.

Unless a different exception applies, investment advisers with AUM under $100 million are prohibited from registering with the SEC,

but must register instead with the relevant State securities regulator. The SEC administers and enforces the Federal securities laws applicable to such RIAs. As of July 31, 2023, there were 15,391 RIAs, reporting approximately $125 trillion in AUM for their clients.

See

17 CFR 275.203A-1.; 17 CFR 275.204-1;

see also

15 U.S.C. 80b-3(

) (venture capital fund adviser exemption), 15 U.S.C. 80b-3(m) (private fund adviser exemption). Investment advisers register with the SEC by filing Form ADV and are required to file periodic updates. 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. A detailed description of Form ADV's requirements is available at

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

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” are required to register as investment advisers with the SEC.

See

Form ADV: Instructions for Part IA, Item 2. Advisers with a principal office and place of business in New York and over $25 million AUM are required to register with the SEC.

17 CFR 275.203A-1. Note that if an RIA's AUM falls below $90 million as of the end of such RIA's fiscal year then it must withdraw its registration with the SEC, unless otherwise eligible for an exception to the prohibition on SEC registration.

Id.

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, as described in the IA AML NPRM. 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. FinCEN reviewed investment adviser Form ADV filings through June 4, 2024, to assess whether to update the industry data used in the IA AML NPRM. FinCEN found approximately 10 fewer RIAs and ERAs as of June 4, 2024 compared to July 31, 2023. Out of approximately 19,900 entities subject to the final rule, this is not a substantial change.

Exempt Reporting Advisers.

An ERA is an investment adviser that would be required to register with the SEC but is statutorily exempt from that 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 with the SEC, ERAs must still file an abbreviated Form ADV—they are required to answer fewer client-related questions and provide less information about the services they provide—and the SEC maintains authority to examine ERAs. As of July 31, 2023, there were 5,846 ERAs with total gross assets of $5.2 trillion 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.

See

17 CFR 275.203(

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

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 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

note 25. ERAs do not report assets under management on Form ADV, but instead report gross assets for each private fund they advise.

State-Registered Investment Advisers.

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 reporting approximately $420 billion in AUM.

See

17 CFR 275.203A-2;

See also

17 CFR part 275.206(4)-8 (prohibiting fraudulent practices by an investment adviser to a pooled investment vehicle with respect to any investor or prospective investor in the pooled investment vehicle).

While some of these obligations mitigate illicit finance risks to the investment adviser industry, these obligations are not explicitly designed for that purpose, and the SEC generally does not have existing authority to apply AML/CFT specific requirements to investment advisers. Some investment advisers may nonetheless already apply AML/CFT requirements, for example, if they are also banks (or are bank subsidiaries), are registered as brokers and dealers in securities (broker-dealers), or advise mutual funds, but this is not consistent across the industry.

Further, some investment advisers have voluntarily implemented certain AML/CFT measures. But implementation of such measures is generally not subject to comprehensive enforcement or examination. This means that 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.

Investment advisers that are banks (or bank subsidiaries) subject to the jurisdiction of the Office of the Comptroller of the Currency (OCC), the Board of Governors of the Federal Reserve System (FRB), the Federal Deposit Insurance Corporation (FDIC), and the National Credit Union Administration (collectively, the Federal Banking Agencies, or 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).

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

Overall, there is currently no comprehensive set of obligations directly applicable to most investment advisers that is explicitly designed to address illicit finance risks in this industry.

C. Illicit Finance Risk

As noted above, concurrent with the publication of the IA AML NPRM, Treasury released the Risk Assessment.

The Risk Assessment found that, while the degree of risk is not uniform across the sector, RIAs and ERAs pose a material risk of misuse for illicit finance.

See

Risk Assessment,

supra

note 2.

Id.

at 32.

First, as already noted, the lack of comprehensive AML/CFT regulations directly and categorically applicable to investment advisers means they are not required to understand their customers' ultimate sources of wealth or identify and report potentially illicit activity to law enforcement. The term “investment adviser” is not presently included in the definition of “financial institution” under the BSA or its implementing regulations. This means that, although they have obligations to report cash transactions above $10,000 via the FinCEN/Internal Revenue Service Form 8300, 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. Investment advisers that are not dually registered as a bank or a broker-dealer are not required to maintain an AML/CFT program nor satisfy customer due diligence (CDD) or customer identification program (CIP) obligations.

Investment advisers, because they are not defined as a “financial institution” under the BSA, are also prevented from participating in the USA PATRIOT Act 314(a) and 314(b) information sharing programs, meaning investment advisers cannot provide useful information on suspected illicit finance activity to law enforcement or to other financial institutions participating in 314(b) information sharing associations. As they are not presently included in the BSA definition of “financial institution,” investment advisers are also not afforded the protection from liability (safe harbor) that applies to financial institutions when filing SARs.

Even though investment advisers are currently able to file voluntary SARs, without the safe harbor they could face increased legal risk from customers or other counterparties. The current patchwork of AML/CFT program 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.

See infra

Section II.E (providing a summary of the proposed rule to apply CIP requirements to RIAs and ERAs).

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

Second, where AML/CFT obligations apply to investment adviser activities, the obliged entities (such as custodian banks, broker-dealers, and some 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, the 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). Additionally, an adviser may use multiple custodians or broker-dealers, so that these entities may not have a complete picture of transactional activity facilitated by the investment adviser for their customers. Investment advisers, while not taking possession of financial assets, often have the most direct relationship with the customers they advise and thus may be best positioned to obtain the necessary documentation and information. 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.

FinCEN notes that, in the private fund context, the adviser's customer is typically the private fund itself, and not underlying investors in that private fund. However, in many cases an adviser has a relationship (in some cases contractual) with underlying investors and has access to information about underlying investors. Indeed, the SEC requires RIAs and ERAs to report information regarding underlying investors. For instance, Question 13 on SEC Form ADV asks an investment adviser for the approximate number of the private fund's beneficial owners.

See

SEC Form ADV, Part 1A at 51 (Aug. 2022). In addition, Question 16(m) on SEC Form PF requires SEC-registered private fund advisers to identify, with respect to each private fund it advises, the approximate percentage of the private fund's equity that is beneficially owned by different types of investors, including “Investors that are

United States persons,

” “Investors that are not

United States persons,

” and, acknowledging that an adviser may not have complete beneficial ownership information in certain circumstances, “Investors that are not

United States persons

and about which the foregoing beneficial ownership information is not known and cannot reasonably be obtained because the beneficial interest is held through a chain involving one or more third-party intermediaries.” SEC Form PF, Section 1b, at 7 (Dec. 2023) (emphasis original). In addition, Congress, in the Corporate Transparency Act (enacted into law on January 1, 2021, as part of the Anti-Money Laundering Act of 2020), recognized that advisers to private funds file information related to private fund ownership on Form ADV and accordingly that private fund advisers have such information.

See

31 U.S.C. 5336(a)(10) and (11)(B)(xi), (xviii).

Third, the existing Federal securities laws and regulations 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.

These laws and regulations 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 do not incorporate AML/CFT purposes, do not require an understanding of relevant illicit finance risks and activity, and do not include requirements for processes to report suspicious activity. In turn, existing laws do not provide any Federal regulatory body with comprehensive authority to monitor whether investment advisers are meeting any AML/CFT objectives.

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.

Fourth, RIAs and ERAs routinely rely on third parties, some of whom may be located outside of the United States, for administrative and compliance activities. These entities—particularly offshore entities—are subject to varying levels of AML/CFT regulation. The due diligence and verification practices of these fund administrators are not uniform and may vary based upon the requirements of the local regulatory regime as well as the requirements imposed by the fund's adviser.

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—under existing frameworks—to collect information relevant to understanding illicit finance risks.

For examples of how these private funds are structured,

see

Risk Assessment,

supra

note 2, at 8-10. In its review of law enforcement cases and BSA reporting conducted for the Risk Assessment, FinCEN found several instances where advisers to private funds had ongoing contact or relationships with underlying investors in those funds, to include discussing investment strategies or fund distributions.

Regarding investment adviser-related illicit finance risks and threats, Treasury's analysis showed that 15.4 percent of RIAs and ERAs were associated with or referenced in at least one SAR filed between 2013 and 2021.

The number of SAR filings associated with or referencing an RIA or ERA increased by approximately 400 percent between 2013 and 2021—a far greater increase than was observed in relation to sectors with a SAR filing obligation.

This analysis, along with a review of law enforcement cases and other information available to the U.S. government, identified cases of the investment adviser industry having served as an entry point into the U.S. financial system for illicit proceeds associated with foreign corruption, fraud, and tax evasion. The analysis further showed that certain advisers manage billions of dollars ultimately controlled by sanctioned entities including Russian oligarchs and their associates who help facilitate Russia's illegal and unprovoked war of aggression against Ukraine.

Id.

at 16. SARs are not themselves conclusive evidence of illicit conduct but can generate important information about potential criminal activity that can prompt or assist a law enforcement investigation or support the identification of threats or vulnerabilities in the U.S. financial system.

Id.

Finally, certain RIAs and ERAs and the private funds they advise are also being used by foreign states, most notably the PRC and Russia, to access certain technology and services with long-term national security implications through investments in early-stage companies.

Id.

Foreign state-funded investment vehicles may seek to hide their involvement 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.

See

Risk Assessment,

supra

note 2, at 21. Exploitation of this access can advance foreign-state economic and military capabilities at the expense of the United States.

See Safeguarding Our Innovation,

National Counterintelligence and Security Center 1 (Jul. 24, 2024), available at

https://www.dni.gov/files/NCSC/documents/products/FINALSafeguardingOurInnovationBulletin.pdf.

D. IA AML NPRM

In the IA AML NPRM released on February 15, 2024, FinCEN proposed to designate certain investment advisers as “financial institutions” under the BSA and subject them to AML/CFT program requirements and SAR filing obligations, as well as other BSA requirements.

Specifically, the IA AML NPRM would have added “investment adviser” to the definition of “financial institution” at 31 CFR 1010.100(t), and then would have defined investment advisers to mean RIAs registered or required to register with, or ERAs that report to, the SEC. Accordingly, RIAs and ERAs would have then been required to comply with several AML/CFT requirements.

See

89 FR 12108 (Feb. 15, 2024).

The proposed rule would also have required RIAs and ERAs to keep records relating to the transmittal of funds (Recordkeeping and Travel Rules) and to meet other obligations of financial institutions under the BSA. The proposed rule would also have applied information-sharing provisions between and among FinCEN, law enforcement, government agencies, and certain financial institutions, and would have subjected investment advisers to certain “special measures” imposed by FinCEN

pursuant to section 311 of the USA PATRIOT Act.

See also

section 9714(a) of the Combating Russian Money Laundering Act; 21 U.S.C. 2313a.

In the IA AML NPRM, FinCEN did not propose to include a CIP requirement for investment advisers, nor did it propose to require investment advisers to collect beneficial ownership information for legal entity customers. FinCEN has proposed to apply CIP requirements to investment advisers via a joint rulemaking with the SEC (described below, Section II.E) and intends to address the requirement to collect beneficial ownership information for legal entity customers in a subsequent rulemaking.

The proposed rule would have allowed an investment adviser to exclude any mutual fund that it advised from the investment adviser's AML/CFT program and SAR filing requirements, provided that the mutual fund had developed and implemented an AML/CFT program compliant with the relevant regulations governing mutual funds.

The proposed rule would also have removed the existing requirement that investment advisers file reports for the receipt of more than $10,000 in cash and negotiable instruments using Form 8300. Investment advisers would have instead been required to file a 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 used in this release, “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 Company Act (15 U.S.C. 80a-3)) that is an “open-end company” (as that term is defined in section 5 of the Company Act (15 U.S.C. 80a-5)) that is registered or is required to register with the SEC under section 8 of the 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 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 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 Company Act).

Finally, FinCEN proposed 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 broker-dealers and certain investment companies for AML/CFT compliance.

E. Customer Identification Program NPRM

In the IA AML NPRM, FinCEN noted that it intended to address the application of a CIP requirement for investment advisers through a joint rulemaking with the SEC.

On May 21, 2024, FinCEN and the SEC published a joint NPRM to apply CIP requirements to RIAs and ERAs (IA CIP NPRM).

89 FR at 12129.

See

FinCEN and SEC,

Customer Identification Programs for Registered Investment Advisers and Exempt Reporting Advisers,

Notice of Proposed Rulemaking, 89 FR 44571 (May 21, 2024).

As proposed in the IA CIP NPRM, RIAs and ERAs would be required to establish, document, and maintain written CIPs appropriate for their respective sizes and businesses. The CIPs would include risk-based procedures to identify and verify the identity of their customers

to the extent reasonable and practicable within a reasonable time before or after the customer's account is opened. The procedures would have to enable RIAs and ERAs to form a reasonable belief that the adviser knows the true identity of their customers. RIAs and ERAs would be required to obtain certain identifying information with respect to each customer, such as the customer's name, date of birth or date of formation, address, and identification number. The proposed rule would also require procedures for, among other things, maintaining records of the information used to verify the person's identity, notifying customers that the adviser is requesting information to verify their identifies, and consulting lists of known or suspected terrorists or terrorist organizations provided to the RIA or ERA financial institution by any government agency to determine whether a person seeking to open an account appears on any such list.

CIP requirements are a long-standing, foundational component of a financial institution's AML/CFT requirements and they are required for banks, broker-dealers, futures commission merchants and introducing brokers in commodities, and mutual funds.

The IA CIP NPRM proposed to define a customer as a person who opens a new account with an investment adviser.

Id.

at 44573.

The IA CIP NPRM proposed to define “account” for these purposes as “any contractual or other business relationship between a person and an investment adviser under which the investment adviser provides investment advisory services,” with limited exclusions.

Id.

The comment period for the IA CIP NPRM closed on July 22, 2024, and FinCEN and the SEC received 36 comments. Treasury and the SEC are reviewing comments and are working toward finalizing the CIP rule. As FinCEN and the SEC noted in the IA CIP NPRM, adoption of CIP requirements for RIAs and ERAs would depend on—and not occur unless—investment advisers are first designated as “financial institutions” for purposes of the BSA.

Id.

at 44572, note 11.

F. General Summary of Comments

FinCEN received 49 comments on the IA AML NPRM. Of the 49 comments, 16 were from individual commenters; 16 were from trade associations representing various financial services entities (including seven that were a form letter provided by one association); six were from think-tanks or non-governmental organizations (NGOs); and five were from RIAs. For the remainder, one comment letter was from a law firm, one comment letter was from a self-regulatory organization, one comment letter was from an association of state securities regulators, one comment letter was from a service provider to investment advisers, one comment letter was from an office within another federal government agency, and one comment letter was from seven U.S. Senators.

Several commenters noted support for the proposed rule and the application of comprehensive AML/CFT requirements to RIAs and ERAs, noting that it would address illicit finance risks or other illicit activity involving investment advisers. Several other commenters, including a self-regulatory organization, an association of state securities regulators, seven U.S. Senators, several financial transparency NGOs and a think-tank, and some financial services trade associations, supported adoption of the proposed rule, but had suggested changes. These changes included expanding the scope of coverage to include State-registered investment advisers, family offices, and foreign private advisers, as well as modifying certain exemptions or requirements in the proposed rule. Other commenters who generally supported the rule requested that FinCEN apply CIP requirements and the obligation to collect beneficial ownership information for legal entity customers as soon as possible. These proposed changes are discussed below.

Another group of commenters, including several financial services trade associations and some RIAs, noted that they generally supported the objectives of the proposed rule, but thought that the rule as drafted was overly broad and/or too prescriptive and would impose significant costs on investment advisers without a corresponding benefit to efforts to

combat illicit finance. They suggested several more significant changes that would exempt certain categories of advisers or advisory activities from the proposed rule and instead focus on what they considered higher-risk activities. They also suggested not applying certain requirements that may be duplicative of obligations applied by other financial institutions, such as broker-dealers and banks, which are involved in advisory activities, as well as modifying requirements of the proposed rule in the context of private funds activity. These commenters' proposed changes are discussed below.

Several commenters opposed the rule, primarily highlighting the potential burden on investment advisers and that the requirements in the proposed rule were duplicative of AML/CFT requirements imposed on broker-dealers and custodians that facilitate transactions for investment advisers and their clients. One commenter noted that AML/CFT measures, along with measures related to sanctions issued by Treasury's Office of Foreign Assets Control (OFAC), were implemented by the fund administrator for their hedge fund. Another commenter indicated that foreign-located fully regulated RIAs and ERAs are already subject to extensive AML/CFT and anti-bribery requirements by their home country regulators.

Regarding the burden, one commenter noted that advisers, especially those that advise private funds, were already facing additional costs to implement recently finalized or proposed SEC requirements. Other commenters also highlighted the potential costs for smaller investment advisers.

Two commenters noted their opposition to applying the proposed rule to venture capital advisers. One of those commenters stated that the requirements of the proposed rule would have a significant and adverse effect on venture capital advisers and the innovative start-ups they advise. The other commenter claimed that the identified risks did not justify applying AML/CFT rules to venture capital advisers, would produce less valuable information because of the limited interactions that venture capital advisers have with limited partner investors, and would not lead to a more effective AML/CFT regime.

One commenter reasoned that, given the focus on the risks posed by private funds, the rule should be narrowed to address those higher-risk activities, and not apply to advisers that manage assets for individual investors. Two commenters requested that FinCEN address concerns raised in the comments with respect to private fund advisers and venture capital advisers, respectively, and issue a revised NPRM.

III. Discussion of Final Rule

A. Illicit Finance Risk

Commenters expressed varying views on the illicit finance risks associated with RIAs and ERAs that were discussed in the IA AML NPRM and Risk Assessment. Several commenters agreed that illicit actors, including corrupt officials, have exploited the U.S. investment adviser sector, particularly the private funds sector, to hide or obscure illicit proceeds, and that the lack of AML/CFT requirements for investment advisers presented illicit finance and national security risks. One commenter described how corrupt officials had exploited the U.S. private investment industry and would continue to do so unless effective and robust AML/CFT controls were applied. Another commenter concurred with the findings of the Risk Assessment and wrote that it was consistent with the commenter's own research, which found significant foreign ownership in private funds that are managed by advisers who report to the SEC. This commenter's research suggests that this level of foreign ownership in private funds presents a challenge to the United States' ability to effectively monitor foreign investment. Other commenters agreed with the national security risks identified and provided additional examples of misuse, including narcotics trafficking and laundering proceeds of corruption or funds from authoritarian regimes.

One commenter observed that while broker-dealers may hold or trade assets controlled by an investment adviser, they may have no independent knowledge of the investment adviser's customers, and that investment advisers are often in the best position to obtain information about their customers that is relevant for AML/CFT purposes. Finally, another commenter, a non-profit coalition, agreed that, given the growth of the private funds industry and investment advisers' role in critical sectors of the economy, investment advisers should be held to the same standard as other financial market participants.

However, several other commenters took issue with the findings regarding the level of illicit finance risk facing investment advisers. Several commenters disagreed that the case examples cited provided adequate support for the rulemaking, noting that the examples involved concealment of ownership, complicit actors whose activity would not be addressed by the requirements of the proposed rule (but that were addressed by laws criminalizing money laundering, or anti-fraud provisions of the Federal securities laws), or compliance failures at financial institutions already subject to AML/CFT requirements. They also claimed that the case examples were too few to justify the cost associated with the proposed rule's requirements. One commenter said that the cases also demonstrated that BSA requirements for banks and broker-dealers were already identifying illicit activity. One commenter questioned the accuracy of the analysis of SARs included in the Risk Assessment and felt that they lacked context or that findings tied to SARs were not proof of illicit activity.

Other commenters noted that existing OFAC sanctions requirements addressed the examples and data on illicit finance tied to Russian oligarchs, and that the blocking of assets owned by sanctioned Russian parties demonstrated those sanctions were effective in mitigating this illicit finance risk. Another commenter stated that most investments made by Russian oligarchs occurred prior to their designation, that there was nothing illegal about their investments in U.S. assets, and that the proposed requirements would thus not have addressed the AML/CFT risks arising from Russia's invasion of Ukraine.

Regarding risks associated with private funds, one commenter claimed that private funds generally present a low risk of money laundering and terrorist financing due to several key factors, including the long-term nature of the investments made in such funds and the existing due diligence by funds into potential investors (including sanctions screening). Another commenter disagreed with the money laundering risk associated with hedge funds, noting that, at the hedge fund where they worked, the transfer agent would “perform KYC [know your customer procedures] and check OFAC and sanctions lists before admitting a new investor or paying a redemption” and “are required to report suspicious activities.”

Regarding venture capital funds, in particular, two commenters stated that none of the examples in the preamble of incidents in which illicit finance was uncovered included venture capital funds or advisers and therefore such examples do not illustrate the need for the adoption of AML/CFT programs by venture capital advisers. These commenters claimed that illiquidity and long-term focus are standard features of venture capital funds that make them poor targets for money launderers. One commenter argued that FinCEN

acknowledges this in the release accompanying the proposed rule, but nevertheless proposes AML requirements for venture capital advisers. One commenter alleged that the proposed rule does not focus on the use of venture capital funds by foreign actors (including foreign governments) to facilitate illicit finance activity, but on attempts to access sensitive or dual-use technology by potentially hostile foreign state interests. The commenter claimed that this threat would not be addressed through the application of AML/CFT requirements to venture capital funds, and are more appropriately addressed through other government authorities, such as the Committee on Foreign Investment in the United States (CFIUS). One commenter indicated that FinCEN does not provide evidence or disclose essential facts that might support a decision to extend the AML/CFT program requirement to venture capital advisers and that such inclusion would amount to an arbitrary and capricious application of the rule.

Regarding the vulnerabilities discussed in the IA AML NPRM, some commenters stated that investment advisers were much less likely to serve as channels to the U.S. financial system that can be taken advantage of by criminal actors, as compared to other financial institutions that are already subject to AML/CFT requirements under the BSA.

Several commenters noted that RIAs and ERAs rely heavily on banks, broker-dealers, custodians, and other financial institutions that are already subject to AML/CFT requirements to custody customer and investor monies, process funds transfers, or effect securities transactions on behalf of advisers. Commenters also noted that banks and broker-dealers regularly request AML/CFT and sanctions-related representations and affirmations from RIAs and ERAs as part of their diligence processes. One commenter also noted that RIAs and ERAs and their affiliates already maintain robust records of the types of transactions that would be captured by the proposed rule, such as adviser or broker-dealer requirements applicable to maintaining transaction records related to financial transactions between advisers' customers and those customers' investors. Another commenter opined that “a failure to conduct adequate due diligence or to otherwise fail in complying with applicable AML laws could . . . expose a Covered IA to a fund to accusations that it failed to satisfy its fiduciary duties [to the fund] . . . [and] given the risk that an AML error or oversight could create claims of fiduciary breach, Covered IAs are already strongly incentivized to develop and maintain robust AML policies and procedures.”

FinCEN responds below to these comments. Following consideration of comments, for the reasons discussed below, FinCEN continues to assess that there is a material risk that RIAs and ERAs can be abused for illicit finance activity, although the degree of risk is not uniform across the sector. Regarding the case examples, as FinCEN noted in the IA AML NPRM, some of the examples both in the NPRM and in the Risk Assessment involve complicit individuals at a financial institution.

FinCEN notes that other commenters provided additional research confirming the risks associated with foreign investors in private funds that were identified in the Risk Assessment, as well as additional examples of misuse.

Further, the Financial Industry Regulatory Authority (FINRA), a Self-Regulatory Organization (SRO) responsible for regulating member broker-dealers, conducted a review of referrals that its specialized insider trading, market fraud, and offering review teams made to other regulators and law enforcement between January 1, 2023 and March 14, 2024. This review suggests that at least 14.5 percent of those referrals related to investment advisers or their customers.

See

89 FR at 12114-12115.

Several commenters from think tanks and non-governmental organizations provided additional examples of misuse, while one commenter provided a report titled

Private Investments, Public Harm: How the Opacity of the Massive U.S. Private Investment Industry Fuels Corruption and Harms National Security.

The report is available at

https://thefactcoalition.org/wp-content/uploads/2021/12/TI_Private-Investments-Public-Harm-10.pdf.

These cases are intended to be illustrative, and, as FinCEN noted in the proposed rule, “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.”

In addition, the IA AML NPRM referenced the comprehensive Treasury review contained in the Risk Assessment, which included substantial information beyond the case examples, including a review of BSA reporting, materials derived from civil enforcement actions, analysis provided by U.S. government agencies, and other non-public information that demonstrated investment advisers could be misused to help launder illicit proceeds. What the case examples in the IA AML NPRM and Risk Assessment demonstrate is that a range of illicit actors view investment advisers as potential entry points into the U.S. financial system, and have sought to exploit them.

See

89 FR at 12115.

Further, without an AML/CFT program requirement or an obligation to file SARs, an investment adviser has no obligation to evaluate the risk of money laundering, terrorist financing, or other illicit finance activity associated with its advisory customers and activities. As discussed below, FinCEN understands, as some commenters have explained, that investment advisers often conduct certain due diligence and screen against sanctions lists, that they may provide AML/CFT and sanctions-related representations and affirmations regarding their clients at the request of banks or broker-dealers, and that an adviser's fiduciary duty requires it to act in the best interest of its clients. At the same time, FinCEN notes that investment advisers to private funds are most commonly compensated based on a combination of (i) management fees that are based on total AUM invested in (or committed to be invested in) the private fund and (ii) performance-based compensation based on the private fund's performance. These compensation arrangements incentivize private fund advisers to add new investors and grow their private fund assets.

This incentive may lead to some advisers refraining from voluntarily conducting a robust review of illicit finance risk, as such review could lead to the adviser turning away certain AUM, and thus lead to less compensation for the adviser. As described in the IA AML NPRM, this can lead an investment adviser to unwittingly assist in illicit finance activity.

Other investment advisers, who are often compensated as a percentage of AUM even if they do not also receive performance-based compensation, are similarly incentivized in general to increase their assets under management.

See

89 FR at 12115.

This rule will require investment advisers to adopt a risk-based approach pursuant to which they must ask questions and analyze potential money laundering, terrorist financing, and other illicit finance risks—steps that will make it more likely that an investment adviser will detect illicit finance activity. The reporting and recordkeeping requirements of the BSA, especially SAR filing obligations, are intended, among other things, to assist federal law enforcement in the enforcement of existing money laundering statutes, including by identifying instances of money

laundering activity to help facilitate investigation and prosecution. In addition, AML/CFT requirements can serve as a separate basis for civil or criminal enforcement action.

The Risk Assessment's conclusions were also supported by an analysis of SARs. This analysis included approximately 12,000 SARs filed over seven years where the investment adviser was identified either as a subject of the SAR or in the narrative section of the SAR (with the number of SAR filings in the analysis increasing 400 percent over the review period). FinCEN agrees with the statement made by one commenter that SARs are not by themselves proof of illegal activity, but are intended to assist law enforcement in identifying potential violations of law. FinCEN also notes that the SAR trend and pattern analysis undertaken to support development of the Risk Assessment can be valuable in helping the public and private sectors identify and address illicit finance trends and systemic vulnerabilities. For example, in section 6206 of the Anti-Money Laundering Act of 2020 (AML Act), Congress mandated that FinCEN publish semiannual threat pattern and trend information derived from BSA filings.

Such efforts will only be enhanced by requiring investment advisers to file SARs as well, which will provide additional relevant information for FinCEN to analyze.

See

31 U.S.C. 5318(g)(6).

See also

FinCEN's Financial Trend Analyses, issued pursuant to section 6206 of the AML Act of 2020, available at

https://www.fincen.gov/resources/financial-trend-analyses.

Regarding illicit finance tied to Russian oligarchs, FinCEN recognizes that, as noted by some commenters, many of these investments were made prior to the designation of these individuals and entities by OFAC. Many investment advisers, along with other financial institutions, took action to freeze assets linked to designated Russian individuals and entities. However, even prior to their designation, many of these individuals and entities were publicly known to be linked to corruption, other criminal activity, or Russian malign influence campaigns; yet they were still able to make investments through the U.S. financial system.

By engaging in such activities these individuals and entities may be violating U.S. law and engaging in sanctionable conduct even if they are not yet designated. Additional AML/CFT requirements may have helped identify—or even mitigate the extent of—assets or accounts that were owned, controlled, or otherwise linked to criminal or sanctionable activities

before

the relevant individuals were designated by forcing investment advisers to adopt a risk-based approach to working with these individuals. More broadly, such AML/CFT requirements are likely to help identify additional assets or accounts that are owned, controlled, or otherwise linked to designated persons, in turn supporting effective sanctions enforcement efforts.

See

89 FR at 12115-12116.

See

FIN-2023-Alert002,

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

(Jan. 25, 2023) (noting that investors seeking to evade sanctions may lower their interest in an investment fund to just below the threshold set by a financial institution's CDD standards to avoid detection).

FinCEN agrees with the point raised by some commenters that certain characteristics of private funds, such as longer lock-up periods or limited opportunities to make withdrawals, may make these funds less attractive for certain illicit finance activity that seeks to rapidly enter and exit a financial product. However, as noted in the NPRM, these requirements are unlikely to deter certain illicit actors who have a medium- to long-term investment horizon and do not need immediate access to invested capital, such as corrupt foreign officials, financial facilitators for transnational criminal networks, or those acting on behalf of designated persons, especially because of the potential for high returns in these private funds.

In addition, some illicit actors may see private fund investments, in combination with the use of a trust or other legal arrangement, as an alternative if they are unable to launder or obscure funds directly through a bank or brokerage account.

FinCEN acknowledges that while private fund advisers may perform sanctions or politically exposed person (PEP) screening as part of their investor diligence, such efforts are only one part of effective AML/CFT compliance. In addition, because such advisers are not subject to consistent supervision for AML/CFT compliance measures they may undertake, such measures may not be applied consistently, and any deficiencies in these measures may not be identified or remediated.

For instance, one subset of SARs analyzed for the Risk Assessment found that RIAs that advised private funds were associated with or referenced in SARs at twice the rate of RIAs that did not advise private funds. The higher rate of filing tied to private funds may result from custodians and other entities with SAR filing obligations lacking insight into the identity and source of wealth of underlying investors in the fund, even where those filers may pursue additional diligence.

See

Risk Assessment,

supra

note 2, at 16 & 27.

For venture capital funds in particular, FinCEN notes that the threat of misuse is not only for purposes of illicit technology transfer through investments in portfolio companies of venture capital funds, but also to facilitate the laundering and growth of illicit proceeds. As noted in the IA AML NPRM and Risk Assessment, a Treasury review of select BSA reporting filed between January 2019 and June 2023 identified more than 20 private fund advisers located in the United States where the adviser was identified as having significant ties to Russian oligarch investors or Russian-linked illicit activities. The vast majority of those private fund advisers advised investment funds that held themselves out as pursuing a venture capital strategy. Some of these Russian oligarch-linked investors may have been attracted to investing in venture capital funds because, like other venture capital investors, they had a medium-to-long term investment horizon and were willing to accept higher risk for higher investment returns.

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.

See

Risk Assessment at 21-22.

FinCEN also notes that while the BSA and its reporting and recordkeeping requirements were originally developed to combat money laundering, Congress has added to the purpose of the BSA over time an objective to combat terrorism,

as well as addressing other threats to U.S. national security.

Illicit technology transfer—that is, the transfer of technology in violation of sanctions, export controls, or other applicable laws—is both a threat to national security and may be linked to money laundering and other forms of illicit finance. For instance, in 2022 and 2023 FinCEN issued a series of joint alerts with the Department of Commerce's Bureau of Industry and Security (BIS) to assist financial institutions in detecting transactions linked to Russian attempts

to acquire military or dual-use technology.

These alerts reflect the reality that money laundering and other forms of illicit finance may be part of illicit technology transfer because adversaries must conceal their illegal attempts to obtain technology. FinCEN assesses that applying AML/CFT measures to RIAs and ERAs will assist in combating these and other threats to the U.S. financial system and national security.

See

31 U.S.C. 5311(2) (preventing the financing of terrorism). Section 358 of the USA PATRIOT Act added to the purposes of the BSA to require reporting or recordkeeping highly useful in “intelligence or counterintelligence activities, including analysis, to protect against international terrorism.” Public Law 107-56, sec. 358(a).

See

31 U.S.C. 5311(4) (safeguarding the national security of the United States). Section 6101 of the AML Act amended the purposes of the BSA to include “assess the money laundering, terrorism finance, tax evasion, and fraud risks to financial institutions, products, or services to . . . safeguard the national security of the United States.” Public Law 116-283, Div. F, sec. 6101(a).

See

FIN-2022-Alert003,

FinCEN and the U.S. Department of Commerce's Bureau of Industry and Security Urge Increased Vigilance for Potential Russian and Belarusian Export Control Evasion Attempts

(Jun. 28, 2022);

see also

FIN-2023-Alert004,

Supplemental Alert: FinCEN and the U.S. Department of Commerce's Bureau of Industry and Security Urge Continued Vigilance for Potential Russian Export Control Evasion Attempts

(May 19, 2023).

FinCEN does not believe that the comments regarding the absence thus far of an adviser to a venture capital fund engaging in illicit finance in the IA AML NPRM requires any change to the final rule. The examples cited in the preamble are meant only to be illustrative of the risks and do not lay out the full evidence available to FinCEN, and these comments rely upon a particularly narrow framing of the evidence presented in the IA AML NPRM. The IA AML NPRM states that “according to the 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.”

As one commenter acknowledges, the IA AML NPRM discusses state-guided or -owned venture capital funds acting on behalf of the PRC and Russia.

Furthermore, as noted by other commenters, there are public reports of specific venture capitalists with ties to Russian oligarchs or Russian government-backed institutions.

Indeed, a recent bulletin published by the National Counterintelligence and Security Center highlights how foreign threat actors can exploit venture capital and other private investment to undermine U.S. national security.

For these reasons, FinCEN's assessment that venture capital funds pose illicit finance risk is supported by the available evidence.

89 FR at 12116.

Id.

See, e.g.,

Joseph Menn et al.,

From Russia with money: Silicon Valley distances itself from oligarchs,

Washington Post (Apr. 1, 2022); Giacomo Tognini,

Russian Oligarch Roman Abramovich Invested In Startups That Received U.S. Government Contracts,

Forbes (June 9, 2023).

See Safeguarding Our Innovation

at 1,

supra

note 51. This bulletin highlighted common tools that foreign threat actors use to penetrate the U.S. financial system, including complex ownership structures, investments through intermediaries, and limited partner investments.

Id.

at 2. For example, one firm identified in the bulletin that had been added to the Department of Defense's list of “Chinese military companies” in January 2024 is an ERA that has made investments in more than 1,600 companies, including several U.S. firms.

In response to the suggestion that these threats would be better addressed through other government authorities like CFIUS, FinCEN seeks to clarify fundamental differences between the CFIUS process and the AML/CFT obligations set out in this rule. FinCEN notes that CFIUS reviews are focused on certain transactions involving foreign investment in the United States and certain real estate transactions by foreign persons, in order to determine the effect of such transactions on the national security of the United States.

Whereas CFIUS reviews lawful investments, this rule is aimed at combating illicit activity, whether in the form of money laundering and other illicit finance, or in the form of technology transfer in violation of applicable law. CFIUS jurisdiction has well-established limits, and many common financial transactions, such as certain loans or passive fund investments, are not subject to CFIUS jurisdiction.

By Executive Order, CFIUS mitigation agreements may only address national security risks “not adequately addressed by other provisions of law,” such as the BSA.

Within its jurisdiction, CFIUS has a broad mandate to assess the effect of a covered transaction on national security; it need not find any violation of law in order to recommend the transaction to the President who has the authority to block or unwind a transaction, as appropriate under CFIUS legal authorities.

The connection between CFIUS and the final rule would therefore be limited: SARs identifying potential unlawful activity will assist CFIUS in identifying transactions linked to such activity that may raise national security concerns, and recordkeeping and other requirements may facilitate the collection of additional information on certain participants in CFIUS transactions who may seek to obscure their role through private funds.

See

Executive Order (E.O.) 11,858, as amended, sec. 6(b), 73 FR 4677, 4678 (Jan. 23, 2008) (“The Committee shall undertake an investigation of a transaction in any case . . . in which . . . the transaction threatens to impair the national security of the United States and that the threat has not been mitigated.”).

31 CFR 800.302(b), 800.306(a).

50 U.S.C. 4565(d)(4)(B); E.O. 11858, sec. 7(a) as amended by E.O. 13456.

See, e.g.,

50 U.S.C. 4565(b), (d).

In the IA AML NPRM and Risk Assessment, FinCEN considered the existing requirements under the Advisers Act and its implementing regulations, the extent to which AML/CFT requirements were applied to advisory activities, and how other rules and regulations, such as those issued by OFAC to implement sanctions requirements,

may mitigate the identified illicit finance risks. While AML/CFT obligations for banks, broker-dealers, and other financial institutions can assist in detecting some illicit activity, these entities may not directly interact with an adviser's underlying customers. Moreover, these entities may not be in the best position to obtain the necessary documentation and information about the customers that is relevant for AML/CFT purposes, such as the source of customers' assets, the customers' backgrounds, and the customers' investment objectives. One commenter observed that in connection with oversight of broker-dealers for compliance with AML/CFT requirements, investment advisers often have the sole or most direct relationship with customers and possess knowledge of the full spectrum of transactions effected through broker-dealers and other custodians that may present money laundering or other illicit finance risks. Another commenter noted that investment advisers in some cases already provide other financial institutions with AML/CFT and sanctions-related representations and affirmations regarding customers they advise (including private funds), which underscores the fact that advisers often have more information on their customers than banks or broker-dealers have. Further, requiring RIAs and ERAs to apply AML/CFT measures may lead to earlier notification of illicit finance activity via SAR filings, and reduce the time law enforcement needs to receive relevant information and take action against illicit actors.

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.

While existing requirements under the Advisers Act and its implementing regulations, including recordkeeping, compliance, and reporting requirements, can assist in implementation of AML/CFT measures, they do not require the collection of the same information as do the AML/CFT requirements. The illicit finance risks

documented in the IA AML NPRM and Risk Assessment remain, despite such existing requirements and the assertions in comments about existing fiduciary duty, and thus FinCEN has determined that the final rule is necessary and appropriate to mitigate those risks. Further, while FinCEN recognizes that an adviser involved in facilitating illicit finance activity could face contractual liability on a variety of bases, these violations generally result in civil liability to private parties. This is not an adequate substitute for the comprehensive government civil and criminal enforcement mechanisms available for violations of AML/CFT laws, and the range of effective, proportionate, and dissuasive penalties that can be applied. These measures are necessary to address the public harm resulting from illicit finance activity that may occur through investment advisers.

B. Definition of “Financial Institution” and “Investment Adviser”

1. Defining Investment Advisers as “Financial Institutions”

Proposed Rule:

FinCEN proposed to add “investment adviser” to the definition of “financial institution” under the regulations implementing the BSA because FinCEN has determined 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.

Comments Received:

FinCEN received comments that both supported and did not support including investment advisers within the definition of “financial institution” under the regulations implementing the BSA and including RIAs and ERAs within the definition of “investment adviser.” Three commenters noted that the proposed definition is a proactive step to address gaps in existing AML/CFT framework and called for FinCEN to retain a comprehensive definition in the final rule. One commenter called for FinCEN to also include foreign private advisers, family offices, and advisers to real estate investment funds within this definition.

Nine commenters disagreed with adding “investment adviser” to the definition of “financial institution” in the regulations issued pursuant to the BSA. Several of these commenters asserted that doing so would apply redundant and unnecessary AML/CFT requirements to investment advisers, as the entities that process cash and securities transactions, such as broker-dealers and banks, are already subject to AML/CFT requirements.

One commenter claimed that as investment advisers are not specifically enumerated in the statutory definition of “financial institution” under the BSA, FinCEN may not have the authority to define investment advisers as “financial institutions” under the BSA without additional Congressional action. This commenter also disagreed with FinCEN's determination that investment advisers engaged in activities that were “similar to, related to, or a substitute for” activities in which any of the enumerated financial institutions are authorized to engage. The commenter stated that BSA-defined financial institutions, such as banks and broker-dealers, are required to apply AML/CFT requirements because of their status as banks and broker-dealers, and not because they engage in particular activities.

This commenter also asked whether FinCEN intended to include within the definition of “financial institution” other professions or entities that are authorized to make investment or other financial decisions on behalf of a principal. The commenter argued that the proposed rule could raise questions about whether trustees, attorneys, executors of estates, receivers in bankruptcy proceedings, or others similarly situated are substituting for the activities of BSA-defined financial institutions and are covered by the proposed rule.

Another commenter stated that entities defined as “financial institutions” under the BSA have in common the fact that they have custody over customer's funds. The commenter noted that investment advisers, by contrast, do not take custody of a customer's funds, and must act in conjunction with other financial institutions to transact on behalf of their clients. The commenter suggested that if the proposed rule were to be finalized, the definition of “investment adviser” must be narrowed to capture only advisers who engage in activities that arguably more closely resemble financial institution activities. Another commenter suggested that FinCEN apply AML/CFT requirements to private funds rather than to the investment advisers to those funds, noting that the fund itself has the contractual relationship with the investor and receives customer due diligence information.

Two other commenters raised questions about the impact of including “investment adviser” in the definition of “financial institution” in the regulations that implement the BSA. These two commenters indicated that FinCEN must account for the differences in the roles and functions of investment advisers from banks and broker-dealers in existing and future BSA rulemakings, and should consult with investment advisers before applying general AML/CFT requirements for “financial institutions” to investment advisers.

Final Rule:

For the reasons described in the IA AML NPRM, FinCEN is adding “investment adviser” to the definition of “financial institution” under the regulations implementing the BSA, as proposed, because FinCEN has determined 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.

While the BSA has an enumerated list of entities that are “financial institutions,”

the statute also explicitly provides the Secretary of the Treasury with the authority to add entities to that list upon determining,

“by regulation,”

that any business or agency is engaged in

“an activity similar to, related to, or a substitute for any activity”

in which any of the enumerated financial institutions are authorized to engage.

This language provides Treasury with the statutory authority to define additional entities as financial institutions as business and organizational structures, and risks, in financial services evolve and illicit actors seek to exploit potential gaps in AML/CFT regulation, as FinCEN has observed with respect to investment advisers.

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

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

FinCEN continues to see ample evidence that investment advisers engage in activities “similar to, related to, or a substitute for” activities in which other financial institutions are authorized to engage. As noted in the IA AML NPRM, 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. An RIA must use a qualified custodian—such as a bank or broker-dealer—to take custody of client assets, even when advising private funds.

In addition, investment

advisers are frequently owned by or under common ownership with banks, broker-dealers, and other financial institutions. Broker-dealers may conduct certain similar advisory activities for their customers

and investment advisers must compete with other financial institutions that provide investment opportunities, such as banks and broker-dealers, to attract investor funds.

See

17 CFR 275.206(4)-2;

see also

12 CFR 225.125(a) (FRB determining that investment adviser activities “to be so closely related to banking or managing or controlling banks as to be a proper incident thereto”).

See

15 U.S.C. 80b-2(a)(11)(C).

There is ample evidence that RIAs and ERAs who advise private funds engage in activities “similar to, related to, or a substitute for” activities in which other financial institutions are authorized to engage. The services provided by RIAs and ERAs advising private funds are closely related to the services provided by broker-dealers who buy and sell securities on their behalf. Private fund advisers may be under common ownership with banks, broker-dealers, or other financial institutions. Broker-dealers, like RIAs or ERAs advising private funds pursuant to the Advisers Act, may “advis[e] others . . . as to the value of securities or as to the advisability of investing in, purchasing, or selling securities.”

And an RIA or ERA advising private funds must also compete with other financial institutions that offer investment opportunities for investor assets.

15 U.S.C. 80b-2(a)(11).

See also

SEC,

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

Interpretation, 84 FR 33681 (Jul. 12, 2019).

FinCEN's statutory authority to designate investment advisers as financial institutions is confirmed by clear evidence of Congressional intent. The legislative history during the drafting of the USA PATRIOT Act supports that Congress viewed RIAs as sufficiently similar to certain other financial institutions that Treasury could require them to file SARs.

Congress reaffirmed this view more recently when, in connection with appropriations legislation passed in December 2022, Congress highlighted the illicit finance concerns associated with “investment advisers such as hedge fund managers” and encouraged FinCEN “to update and finalize its 2015 investment adviser rule as soon as possible.”

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, sec. 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)).

See

Consolidated Appropriations Act, 2023, Public Law 117-328, 136 Stat. 4459, Joint Explanatory Statement (Division E), p.1156, available at

https://www.congress.gov/117/cprt/HPRT50347/CPRT-117HPRT50347.pdf.

FinCEN also notes that having custody or directly holding customer funds is not a prerequisite for being included within the definition of “financial institution” in the regulations issued pursuant to the BSA. For example, the BSA defines an “investment company” and an “operator of a credit card system,” as a “financial institution,” and neither of these institutions routinely custody or directly hold customer funds.

In addition, an “investment banker” and “persons involved in real estate closings and settlements” are also defined in the BSA as financial institutions, but may not directly receive, send, or transmit any customer funds. While broker-dealers and banks provide custodial services to their customers, they are also authorized to engage in a range of other financial services—such as extending credit—that do not involve taking custody of client funds, but are nonetheless subject to AML/CFT requirements. In sum, the statutory language authorizes Treasury to define as a financial institution any business that engages in activity similar to any activity in which the enumerated financial institutions are authorized to engage, not just specific activities involving the transfer or custody of customer funds.

31 U.S.C. 5312(a)(2)(L), (M).

In response to the comment asking whether FinCEN intends to regulate other entities or professions that act as agents for a principal and whether this would create ambiguity for those entities and professions, FinCEN notes that the rule would only apply to RIAs and ERAs, categories of entities that are clearly defined under the Advisers Act. If FinCEN were to regulate such other entities or professions in the same manner as in the final rule, this would occur through a new rulemaking on which any affected person could comment. An attorney, trustee, executor, or other person in a principal-agent relationship therefore has no reason to find the scope of the final rule ambiguous as applied to them; they merely need to know if they have registered (or are required to register) or have filed with the SEC as an RIA or ERA.

Regarding whether to apply AML/CFT obligations to private funds rather than the advisers to those funds, FinCEN notes that in many cases the adviser to a private fund will have a relationship (in some cases contractual) with underlying investors and has access to information about underlying investors. Indeed, the SEC requires RIAs and ERAs to report information regarding underlying investors on Form ADV and Form PF.

Further, private funds also typically lack employees, and are reliant upon their service providers, such as their advisers, to satisfy the private fund's legal and compliance obligations. Accordingly, the adviser, rather than the fund, is best positioned to apply the full range of AML/CFT measures beyond customer due diligence. FinCEN also acknowledges the point made by commenters that there are AML/CFT requirements that may be applied to all BSA-defined financial institutions, which if amended, would also change the obligations of investment advisers.

If FinCEN were to amend these AML/CFT requirements, it anticipates considering the specific attributes of investment advisers when deciding whether and how to apply such requirements to investment advisers.

See supra

note 45.

For instance, FinCEN did not include “investment adviser” in the proposed rule to amend the AML/CFT program requirements for other types of BSA-defined financial institutions.

See

FinCEN,

Anti-Money Laundering and Countering the Financing of Terrorism Programs,

Notice of Proposed Rulemaking, 89 FR 55428 (Jul. 3, 2023).

2. Registered Investment Advisers

Proposed Rule:

FinCEN proposed to include SEC-registered investment advisers (RIAs) in its definition of investment adviser with regard to the proposed changes to the definition of financial institution under 31 CFR 1010.100.

Comments Received:

Six commenters commented on the proposed definition of “investment adviser” and the impact it would have on smaller RIAs. One commenter stated that smaller advisers generally pose less illicit finance risk and should be excluded for the same reasons that FinCEN had proposed to exclude State-registered advisers, namely their lower AUM, fewer customers, and that their customers tend to be localized. Another commenter asserted that the reliance on AUM as the sole determinant for regulatory thresholds overlooks the practical considerations of the size and capacity of RIAs, particularly smaller firms, and that AUM may not accurately reflect the complexity or scale of a firm, especially when AUM is primarily derived from a small number of clients. They suggested that regulatory thresholds be evaluated based on a combination of factors, including the number of employees and average AUM per client.

Two commenters suggested advisers with fewer than 20 employees should be exempt from the requirements of the proposed rule, while one commenter suggested that firms with fewer than 100 employees should be exempt from the requirements of the proposed rule. These commenters claimed that smaller advisers would need to divert resources from client-servicing functions and other compliance requirements to invest in building out an AML/CFT program, and would need to outsource the independent testing requirement to a third party, which would create additional burden.

One commenter requested that investment advisers who do not manage client assets be excluded from the proposed rule. That commenter contended that applying AML/CFT requirements to these investment advisers would produce no valuable information for law enforcement or regulators, as these advisers are not involved in the management of client assets or funds transfer activity. Another commenter suggested that RIAs whose client's investments are held by an account custodian should be exempt from the proposed regulation.

Final Rule:

FinCEN is modifying the definition of “investment adviser” from the proposed rule to exempt certain types of RIAs in response to comments.

Accordingly, these types of RIAs will not be subject to the final rule. FinCEN recognizes the concerns raised by commenters regarding the impact of the proposed rule on smaller RIAs, based on AUM or other applicable criteria. As noted in the IA AML NPRM, FinCEN is mindful of the effect of new regulations on small businesses, given their critical role in the U.S. economy and the special consideration that Congress and successive administrations have mandated that Federal agencies should give to small business concerns. FinCEN would like to reiterate that the AML/CFT requirements in this rule are designed to be risk-based and that their cost will vary with the size of the business, along with the risk level of its advisory activities and customers. This means that smaller advisers would be expected to adopt AML/CFT programs that are consistent with their (often) simpler, more centralized organizational structures and so would be more likely to have lower implementation-related costs, absent other high-risk attributes for illicit finance risks.

These changes reflect, in part, comments received in response to the IA AML NPRM.

In reviewing the comments that addressed this issue, FinCEN sought to identify an approach that would balance concerns about the burden on smaller RIAs as well as ensure that such an approach is easily understood by advisers subject to the final rule, systematically addresses illicit finance risk in the investment adviser sector, and is administrable in practice by FinCEN and the SEC (and other relevant regulators). Regarding the proposal to exempt advisers with fewer than either 20 or 100 employees, FinCEN notes that the number of employees that an adviser has is not necessarily aligned with the types of advisory customers, activities, or other factors relevant to the illicit finance risk of an adviser. Some advisers may manage significant assets from a small number of customers, while other advisers may manage small accounts held by a large number of customers, requiring additional employees to service those accounts. To create a threshold for application of AML/CFT requirements based on employee numbers alone would be inconsistent with Treasury's understanding of risk in the sector. For example, an adviser managing significant assets, but with few employees, is of greater risk of being used by malign actors to launder large sums of money than an adviser with more employees but a small amount of assets under management. Further, imposing such a threshold could lead to perverse outcomes where RIAs are incentivized to hirer fewer non-revenue staff, such as those responsible for AML/CFT compliance. A threshold could also raise questions with respect to other BSA-defined financial institutions, which typically do not have such thresholds. FinCEN therefore declines to apply the proposed exemption for RIAs with fewer than either 20 or 100 employees.

However, FinCEN has sought to appropriately tailor the scope of entities covered by the final rule to balance commenters' concerns about the potential burden on smaller advisers with the investment adviser sector-wide identified illicit finance risks. FinCEN also sought to, while considering the diversity of business models in the advisory business, fashion the rule in a way that can be clearly applied and examined by the SEC, and that is transparent to RIAs and ERAs subject to the rule. Therefore, FinCEN is exempting from the definition of “investment adviser” RIAs that register with the SEC because they are (i) Mid-Sized Advisers, (ii) Multi-State Advisers, and (iii) Pension Consultants, as well as (iv) RIAs that do not report any AUM on Form ADV. The final rule's exemptions apply, however, only to investment advisers that are registered with the SEC on only one or more of the above listed bases, and have no other basis for registration.

For example, an investment adviser that registers (or could register) with the SEC both because: (a) it has AUM of more than $110 million (and so registers as a “large advisory firm” on Form ADV) and (b) it would otherwise be required to register with more than 15 states, will not be eligible for the exemption.

See

31 CFR 1010.100(nnn)(ii)(1) (exempting an investment adviser that is registered “only” because it meets the conditions of being is either a mid-sized adviser, a pension consultant, or a multi-state adviser). For the avoidance of doubt, an investment adviser that is registered because it meets the conditions of more than one of these exemptions, but that is not otherwise required to register, is also exempt from the definition of “investment adviser.”

As described below and in the Risk Assessment, FinCEN assessed State-registered advisers as generally lower-risk for money laundering, terrorist financing, or other illicit finance activity. Therefore, FinCEN has chosen not to apply the proposed rule to State-registered advisers at this time. At the same time, FinCEN notes that there are certain types of RIAs that resemble State-registered advisers because they would otherwise be prohibited from registering with the SEC but are required to or choose to do so because they satisfy the conditions of certain exemptions from the prohibition on SEC registration.

First, there are certain RIAs who have AUM between $25 million and $100 million but who either: (i) are not required to be registered as an adviser with the state securities authority in the state where they maintain their principal office and place of business; or (ii) are not subject to examination as an adviser by the state in which they maintain their principal offices and places of business (Mid-Sized Advisers).

These Mid-Sized Advisers are required to register with the SEC.

According to a review of information filed on Form ADV, there are 468 Mid-Sized Advisers who, on average, have $54.6 million in AUM, 6 employees, and 129 customers, 97 percent of which are natural persons.

See

15 U.S.C. 80b-3a(a)(2). On Form ADV, these Mid-Sized Advisers check the box in Item 2.A noting they are a “mid-sized advisory firm.”

See

Form ADV, Instructions for Part 1A, available at

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

See

15 U.S.C. 80b-3a(a)(2); Form ADV, Instructions for Part 1A, available at

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

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

See supra

note 25.

Second, advisers who would otherwise be required to register in more

than 15 states, but have less than $100 million in AUM, can choose instead to register with the SEC (Multi-State Advisers).

According to a review of the information filed on Form ADV, in 2023 there were 90 Multi-State Advisers who, on average, have $27.6 million in AUM, 28 employees, and 1,300 customers.

While the majority of Multi-State Advisers' customers are legal entities, approximately 90 percent of these customers are United States persons. These firms have a larger number of employees and customers than the average State-registered adviser, but relatively small AUM.

100

FinCEN has decided to exempt these two categories of advisers because their advisory activities and customers are generally lower-risk,

101

more closely resembling State-registered advisers than RIAs who satisfy the general requirements for registration, to address some of the concerns regarding possible burden on smaller advisers that were raised by commenters.

See

17 CFR 275.203A-2(d).

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

See supra

note 25.

100

This exemption was designed to allocate regulatory responsibility to the SEC for larger investment advisers, whose activities are likely to affect national markets, and to relieve these advisers of the burdens associated with multiple state regulations.

See

SEC,

Exemption for Investment Advisers Operating in Multiple States; Revisions to Rules Implementing Amendments to the Investment Advisers Act of 1940; Investment Advisers with Principal Offices and Places of Business in Colorado or Iowa,

Final Rule, 63 FR 39708, 39709 (Jul. 24, 1998).

101

This determination is based on the tailored BSA analysis on this subset of RIAs described

infra.

Along with these two categories of RIAs, FinCEN also identified two categories of RIAs that do not directly manage client assets and, as discussed below, pose little or no risk of being used as an entry point into the U.S. financial system for illicit proceeds. First, there are some RIAs who do not manage client assets as part of their advisory activities, and report zero AUM on Form ADV.

102

According to information derived from Form ADV, as of July 2023 there were 655 RIAs who report zero AUM on Form ADV.

103

These RIAs have, on average, 73 employees and 640 customers, and 90 percent of their customers were United States persons.

104

Services provided by these advisers may include non-discretionary financial planning (such as fee-only advice) and publication of securities-related newsletters, “model portfolios,” or research reports.

102

See supra

note 28 (for additional information on how AUM is calculated). The Form ADV instructions provide general criteria for determining whether an investment adviser provides continuous and regular supervisory or management services. For example, the instructions to Item 5.F state that an investment adviser provides such services if it has “discretionary authority over and provide[s] ongoing supervisory or management services,” and the Form ADV Glossary of Terms defines “discretionary authority” for these purposes. The Form ADV instructions are available at

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

103

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

See supra

note 25.

104

Id.

FinCEN agrees with commenters that such advisers are generally unlikely to have sufficient information about a customer's source of funds, background, and investment objectives to detect suspicious financial activity, and, in some instances, may lack even the names of individual customers. While these advisers may have more employees and customers than the average State-registered adviser, as described above, these advisers' activities are unlikely to be used for illicit finance activity, these advisers may not be able to provide useful information to law enforcement or other government authorities, and, to the extent their customers effect financial transactions in the United States on the basis of the services received from the investment adviser (

e.g.,

trading based on reading research reports), they likely do so as direct customers of a BSA-regulated financial institution, such as through a brokerage account.

FinCEN also identified 186 RIAs who register with the SEC because they are “pension consultants” as that term is defined under the Advisers Act regulations.

105

According to a review of information filed on Form ADV, these RIAs have, on average, 334 employees, and over 20,000 customers.

106

Advisers registered as pension consultants advise at least $200 million in assets held by certain employee benefit plans subject to, or described in, the Employee Retirement Income Security Act of 1974 (ERISA).

107

As FinCEN understands, many of these advisers do not exercise investment discretion over assets they advise, but generally assist other investment advisers or ERISA plan fiduciaries in designing investment lineups for employee benefit plans.

108

In addition, as noted by commenters, employee benefit plans are generally subject to strict contribution and withdrawal limits, are usually available to only employees of a participating company, and are subject to other requirements under ERISA (or similar state laws) and/or the Internal Revenue Code (IRC).

109

105

An investment adviser is a “pension consultant” for purposes of rule 203A-2(a)(2) if it provides investment advice to (i) any employee benefit plan described in section 3(3) of ERISA, (ii) any governmental plan described in section 3(32) of ERISA, or (iii) any church plan described in section 3(33) of ERISA (29 U.S.C. 1002(33)). 17 CFR 275.203A-2(a)(2).

106

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

See supra

note 25.

107

17 CFR 275.203A-2(a)(1).

108

See Rules Implementing Amendments to the Investment Advisers Act of 1940,

Final Rule, 76 FR 42950, 42959 (Jul. 19, 2011) (“[P]ension consultants typically do not have “assets under management,” but we have required these advisers to register with [the SEC] because their activities have a direct effect on the management of large amounts of pension plan assets.”);

Rules Implementing Amendments to the Investment Advisers Act of 1940,

Final Rule, 62 FR 28112, 28117 n. 60 (May 22, 1997) (“[A] pension consultant has substantially less control over client assets than an adviser that has assets under management.”).

See also

SEC,

Staff Report Concerning Examinations of Select Pension Consultants,

1 (May 16, 2005), available at

https://www.sec.gov/news/studies/pensionexamstudy.pdf.

109

See, e.g.,

29 CFR 2520 (rules and regulations for reporting and disclosure for ERISA plans).

While these are not, on average, “smaller” advisers, they exclusively engage in certain activities that are less likely to be used for, or to generate useful information for law enforcement about, illicit finance activity. For instance, their advisory activities on behalf of these employee benefit plans are subject to additional disclosures and restrictions on compensation arrangements under ERISA and other relevant statutes that limit their incentive to facilitate the movement of illicit proceeds. While the misuse of employee benefit plans has been linked to certain types of financial crime, such as fraud or account takeover activity,

110

these plans, whether defined benefit plans or defined contribution plans, are less likely to be misused to obscure illicit proceeds generated from a separate criminal scheme. While defined benefit plans may invest plan assets in private funds, there is not the same uncertainty as to beneficial ownership and source of wealth as with other private fund investors.

111

For defined benefit plans, the funds are typically derived from the employer contributions to the defined benefit plan. In addition, these advisers are less

likely to have unique information or knowledge about plan activities or assets to identify and report suspicious activity. As such, FinCEN assesses that these advisers will likely not generate relevant information to assist government authorities in combating illicit finance and subjecting these advisers to the rule's coverage would not meaningfully advance the rule's objectives.

110

See, e.g.,

FBI,

IC3 2023 Elder Fraud Report,

at 14, 19, available at

https://www.ic3.gov/Media/PDF/AnnualReport/2023_IC3ElderFraudReport.pdf.

111

For the avoidance of doubt, the absence of uncertainty as to beneficial ownership and source of wealth is the case only when the investment in a private fund comes from a defined benefit plan. When an investment adviser directs investment into a private fund, the risk of any other investments directed into the private fund must be evaluated separately. An investment adviser who is not a pension consultant and advises a private fund that receives investments from a defined benefit plan may not exclude such private fund from its obligations under this rule, although, as explained below, such an adviser may account for the source of such investment in determining which policies, procedures, and controls to apply to the fund on a risk basis.

FinCEN, in coordination with federal law enforcement, reviewed BSA reporting associated with these four groups of RIAs (

i.e.,

Mid-Sized Advisers, Multi-State Advisers, pension consultants, and advisers who report zero AUM on Form ADV). This analysis found that 5.5 percent of these RIAs 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) between 2013 and 2023. That is substantially less than the 15.4 percent of all RIAs and ERAs that were associated with or referenced in at least one SAR between 2013 and 2021. When considering this information with other information on illicit finance threats available to FinCEN, and the structural factors discussed above that may make these subgroups of RIAs less vulnerable to misuse for illicit finance, FinCEN has determined that exempting these groups of RIAs from the final rule would be consistent with the objective of this rule.

Therefore, for all of the reasons noted above, FinCEN has determined to exempt from the definition of “investment adviser” investment advisers that register with the SEC solely on the basis that they are Mid-Sized Advisers, Multi-State Advisers, pension consultants, and advisers who report zero AUM on Form ADV. FinCEN notes that, should the registration status of an RIA change such that the RIA would no longer be exempt from the definition of “investment adviser,” the adviser will become subject to the AML/CFT requirements in this rule as of its next annual updating amendment to Form ADV.

112

The scope of such advisers exempted from the final rule's definition of “investment adviser” is reflected in the regulatory text added at 1010.100(nnn)(ii).

112

Under the Instructions to Form ADV, Item 2 of Part 1A, which addresses an investment adviser's basis for registration with the SEC, must be updated annually.

3. Exempt Reporting Advisers

Proposed Rule:

FinCEN proposed to include Exempt Reporting Advisers (ERAs) in its definition of “investment adviser” with regard to the proposed changes to the definition of financial institution under 31 CFR 1010.100.

Comments Received:

Four commenters supported FinCEN's proposal to include ERAs in the definition of “investment adviser,” noting the significant illicit finance risks present in this subset of the investment adviser sector and the “loophole” that would be created by subjecting RIAs but not ERAs to the proposed regulations. Some of these commenters noted that the Risk Assessment found that the risks were higher amongst ERAs than RIAs. One commenter stated that ERAs should be subject to the requirements in the proposed rule because they were already subject to rules and prohibitions under the Federal securities laws designed to root out misconduct in financial markets, and that the rationale for applying these requirements supports applying AML/CFT requirements to ERAs.

However, other commenters were generally opposed to the rule's scoping-in of ERAs, with one commenter asserting the outsized regulatory impact of the proposed regulation on ERAs was not merited given the low number of examples provided regarding illicit finance risk amongst ERAs. Another commenter stated that FinCEN lacked statutory authority to include ERAs in the scope of the proposed regulation. One commenter claimed that FinCEN had failed to put forward an adequate reason for the expansion of AML/CFT requirements to ERAs beyond citation to the Risk Assessment and further claimed that the Risk Assessment does not identify ERAs as particularly vulnerable to illicit finance risks. One commenter suggested that ERAs below a certain threshold of U.S. AUM be exempt from the proposed rule, and that this AUM threshold should be measured similar to the private fund adviser exemption in the Advisers Act and its implementing regulations. The commenter claimed that this would be consistent with the goal of the SEC to avoid imposing U.S. regulatory and operational requirements on a foreign-located adviser's foreign-located advisory business.

Final Rule:

FinCEN is implementing this part of the definition of “investment adviser” without change from the proposed rule. Accordingly, each ERA will be subject to the final rule. For the reasons stated above, in Section III.B.1, FinCEN has determined that it has legal authority to determine that ERAs are “financial institutions” for BSA purposes. Including ERAs in scope of the regulation, as proposed, is supported by the findings of the Risk Assessment as well as the responses from several commenters supporting inclusion of ERAs demonstrating the illicit finance and national security risks posed by ERAs. As noted by a commenter, while ERAs are not subject to certain requirements under Federal securities laws, they are subject to many of the requirements designed to prevent misconduct in financial markets, for instance. In addition, FinCEN agrees with the point made by several commenters that exempting ERAs could create a loophole through which illicit actors would be able to access a range of private funds without being directly subject to AML/CFT requirements. The Risk Assessment found that, within the investment adviser sector, ERAs bear the highest risks as they solely advise either private funds or venture capital funds, both of which were found in the Risk Assessment to be involved in illicit finance and other criminal investigations carried out by U.S. law enforcement.

113

In addition, private funds are more likely than other types of customers to be based in jurisdictions with weaker and less effective AML/CFT controls, making it more difficult for the ERA to assess the risk posed by the relationship or prevent abuse.

114

113

See supra

note 47 and accompanying text (discussing the analysis of BSA reporting linked to private fund advisers).

See also

Risk Assessment,

supra

note 2, at 20-22, 26-28 (noting that private funds, including those advised by ERAs, have served as an entry point into the U.S. financial system for sanctioned Russian oligarchs and their associates, and as back door for hostile nation-state actors to acquire assets of interest in the United States, such as equity stakes in companies developing critical or emerging technologies).

114

Only 52 percent of the total net asset value of private funds managed by U.S. investment advisers is held by funds domiciled in the United States. Of the remaining 48 percent held in offshore funds, most is held by funds domiciled in the Cayman Islands (33 percent) and the remainder is held by funds in Luxembourg (5 percent), Ireland (4 percent), Bermuda (1 percent), British Virgin Islands (1 percent), United Kingdom (1 percent), and other jurisdictions (4 percent).

See

SEC, Private Fund Statistics, Third Calendar Quarter 2023, Page 13, Table 11,

https://www.sec.gov/files/investment/2023q3-private-funds-statistics-20240331.pdf.

These figures come from publicly available data provided by the SEC aggregating periodic filings made on Form PF. While this data represents only the subset of RIAs required to file Form PF (RIAs that manage at least $150 million in private fund AUM), this accounts for a substantial amount of overall private fund assets and FinCEN assesses the geographic distribution of fund domiciles is generally consistent for ERAs.

See also

89 FR at 12114 (discussion on the effectiveness of foreign AML/CFT supervision for private funds domiciled in certain jurisdictions).

Through the course of its advisory activities, an ERA may collect information about either the private fund it advises (the customer of the ERA) or the underlying investors in that private fund that may alert the ERA to illicit activity. FinCEN has also assessed

that ERAs, along with RIAs advising private funds, are exposed to higher money laundering, terrorist financing, or other illicit finance risks compared to advisers who do not advise private funds.

115

Adding ERAs to the definition of “investment adviser” is therefore consistent with the categorization of other entities as a financial institution and with FinCEN's authority to make changes to the list of financial institutions under FinCEN's regulations implementing the BSA in order to combat illicit activity.

115

See supra

Section III.A; Risk Assessment,

supra

note 2, at 20-22, 32.

FinCEN also declines to limit the applicability of the proposed rule to only certain ERAs with assets exceeding a specified threshold, such as $100 million AUM, as was proposed by one commenter. FinCEN considered setting such a threshold and understands that many RIAs below this threshold will not be subject to the rule, given the rule's definition of “investment adviser.” However, as noted above, FinCEN has concerns that such a threshold would mean that ERAs advising funds with fewer assets but carrying material illicit finance risks would remain out of scope of AML/CFT controls. The Risk Assessment and some of the underlying examples analyzed for the Risk Assessment show that private funds with relatively small AUM may still bear substantial illicit finance risk.

116

Such a threshold would also be challenging to administer; for example, ERAs do not currently report AUM on Form ADV.

117

In addition, a threshold based on AUM or similar metric would mean that an ERA hovering just above or below the threshold would come in and out of coverage based on market returns, making it more challenging for the SEC and FinCEN to accurately assess systemic money laundering, terrorist financing, or other illicit finance risk among ERAs.

116

See

Risk Assessment,

supra

note 2, at 18, 20, and 31 (noting the highest illicit finance risk in the sector is for ERAs). Several of the 20 private fund advisers identified as having significant ties to Russian oligarch investors or Russian-linked illicit activities managed private funds with less than $100 million in AUM.

117

ERAs do not report AUM on Form ADV, but instead report gross assets for each private fund they advise. However, they only report gross assets for a private fund if that fund is not reported by an RIA or ERA in its own Form ADV; therefore, some ERAs report zero gross assets because all of the funds they advise are also reported by an RIA or ERA.

See

Form ADV, Instructions for Part 1A.

FinCEN also declines to categorically exclude ERAs reporting zero private fund assets on Form ADV. FinCEN notes that ERAs do not report regulatory AUM on Form ADV, and that the information they do report—gross assets of each private fund they advise—does not necessarily distinguish between ERAs that manage client assets from those that do not. ERAs that report zero gross assets for private funds they advise may still have discretion for customer assets and thus present the risk of being misused for illicit finance activities.

118

FinCEN therefore declines to exclude ERAs reporting zero gross assets for private funds they advise from the requirements of the final rule.

118

See

17 CFR 275.203(m)-1(d)(1) (excluding from the calculation of regulatory AUM, for purposes of the private fund adviser exemption, assets associated with certain types of private funds).

See also

Risk Assessment,

supra

note 2, at 18, 20.

Regarding the applicability of the requirements of the final rule to the activities of foreign-located ERAs, those are discussed in the next section. FinCEN notes the concerns raised by some commenters about the specific burden that may apply to ERAs but reiterates that the AML/CFT requirements in this rule are designed to be risk-based and their cost will vary with the size of the business, along with the risk level of its advisory activities and customers. FinCEN will work with the SEC staff so that any examinations of ERAs for compliance with requirements of the final rule take into account the risk-based nature of AML/CFT programs.

4. Foreign-Located Investment Advisers

Proposed Rule:

In the proposed rule, FinCEN noted that the proposed definition of “investment adviser” would include certain foreign-located investment advisers that are physically located abroad (

i.e.,

whose principal office and place of business is outside the United States) but nonetheless are: (i) registered or required to register with the SEC (for RIAs), or (ii) file reports with the SEC on Form ADV (for ERAs). FinCEN therefore proposed that the rule's requirements would “apply on the same basis” to such foreign-located advisers as to domestic advisers.

119

FinCEN requested comment on any challenges for foreign-located advisers in taking this approach, including any potential conflicts with domestic or foreign law.

119

89 FR at 12130.

Comments Received:

FinCEN received eight comments regarding the application of the proposed rule to foreign-located investment advisers. One commenter stated that the proposed scope of application of the proposed rule conflicts with Congress' intent during its original passage of the BSA in 1970. Other commenters raised concerns about the application of the proposed rule deviating from past positions of FinCEN regarding BSA regulation and the SEC regarding Advisers Act regulation. One commenter suggested an AUM threshold for foreign-located ERAs that would draw from the SEC's AUM thresholds for RIAs and its approach to measuring AUM for foreign-located private fund RIAs, specifically suggesting that foreign-located ERAs with less than $100 million of U.S. AUM be exempt from the proposed rule.

Several commenters raised concerns that foreign-located investment advisers will face significant challenges in adhering to the proposed BSA requirements. First, commenters indicated that obligations under the BSA may not be consistent with local privacy rules and other requirements, potentially creating “conflict-of-laws and compliance challenges.” Another commenter suggested that applying this rule to foreign-located advisers would “deprive U.S. clients and investors from [sic] the expertise of foreign-located investment advisers” due to additional compliance burdens and “make it less likely that non-U.S. investment advisers hire U.S.-based employees or engage in other economic activity in the United States.” One commenter noted that the substantive provisions of the Advisers Act do not apply to “a non-U.S. adviser's relationship with its non-U.S. clients and non-U.S. funds (including funds with U.S. investors)” and recommended that for non-U.S. advisers, this rule not apply “with respect to their non-U.S. clients, including non-U.S. private funds, even if such non-U.S. private funds have U.S. investors.”

Commenters called for FinCEN to provide clarification on the reach of the proposed rule to foreign-located advisers. One commenter called on FinCEN to clarify that application of the proposed rule would be confined to investment advisers “organized and operating in the U.S., or to foreign-based or foreign-organized [investment advisers] only to the extent they are operating in the U.S.” One commenter called for foreign-located ERAs from Financial Action Task Force (FATF)-compliant jurisdictions to be excluded from the rule and another raised concerns about the proposal's application to foreign-located subadvisers. Several commenters called for FinCEN to fully exempt foreign-located advisers from the proposed rule.

Final Rule:

FinCEN is applying the requirements of the proposed rule to foreign-located investment advisers, and is clarifying the scope of their advisory activities that are subject to the

requirements in the final rule. Accordingly, the final rule will define “investment adviser” to include foreign-located investment advisers that are registered or required to register with the SEC (RIAs, subject to the exemptions set forth in 1010.100(nnn)(ii) for certain types of RIAs) or that file reports with the SEC on Form ADV (ERAs). Including foreign-located investment advisers in this final rule is consistent with the BSA's express authorization for the Secretary to, by regulation, determine new types of financial institutions

120

as well as the BSA's intelligence, national security, and counter-intelligence purposes, which are inherently international in nature.

121

Moreover, this interpretation of authority granted by the BSA is aligned with FinCEN's existing approach applying BSA obligations to certain types of foreign-located BSA-defined financial institutions that have a nexus to the United States. FinCEN has considered the illicit finance risks arising from foreign-located investment advisers and the funds they advise, as well as the alternatives for mitigating these risks consistent with the purposes of the BSA enumerated at 31 U.S.C. 5311. For these reasons, FinCEN has determined that the requirement of a U.S. nexus provides a lawful basis for this rule to apply to foreign-located investment advisers.

120

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

121

See

31 U.S.C. 5311.

Section 1032.110 of the final rule defines a “foreign-located investment adviser” as an “investment adviser whose principal office and place of business is outside the United States.” Section 1032.111 of the final rule sets forth the scope of a foreign-located investment adviser's obligations, stating that the requirements of part 1032 apply to a foreign-located investment adviser only with respect to its advisory activities that (i) take place within the United States, including through involvement of U.S. personnel of the investment adviser, such as the involvement of an agency, branch, or office within the United States, or (ii) provide advisory services to a U.S. person or a foreign-located private fund with an investor that is a U.S. person.

122

With respect to services provided to a foreign-located private fund with an investor that is a U.S. person, as described below, the rule incorporates SEC definitions and standards for identifying investors that are U.S. persons in foreign-located private funds.

122

In contrast, an adviser with its principal office and place of business in the United States must comply with the final rule with respect to all of its advisory activities.

To determine whether an investment adviser is a foreign-located investment adviser (as defined at section 1032.110), the adviser must look to its “principal office and place of business,” which FinCEN considers to be the executive office of the investment adviser from which the officers, partners, or managers of the investment adviser direct, control, and coordinate the activities of the investment adviser.

123

RIAs and ERAs are required to identify their principal office and place of business on Form ADV, making it clear which investment advisers consider themselves to be “foreign-located investment advisers” for the purposes of this final rule.

123

This definition is consistent with that used by the SEC in regulations applicable to investment advisers.

See

17 CFR 275-222.1(b).

Moreover, all foreign-located advisers subject to the final rule have a U.S. nexus with certain advisory activities such that they are required to or have chosen to register with or file reports with the SEC, and therefore are subject to SEC regulation. The Advisers Act requires registration of investment advisers that have a minimum amount of assets under management

124

and who “make use of the mails or any means or instrumentality of interstate commerce in connection with his or its business as an investment adviser,” unless subject to an exemption, such as ERAs,

125

and the scope of the registration requirement has been further refined in SEC regulations and guidance as discussed above. Moreover, de minimis ties to the United States do not automatically make a foreign-located investment adviser subject to the final rule, particularly because foreign private advisers as defined pursuant to the Advisers Act are not subject to the requirements of the final rule. An adviser may be a foreign private adviser if it: (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.

126

Foreign-located RIAs and ERAs covered by the final rule therefore not only have sufficient nexus to the United States to trigger SEC registration or filing requirements, but also a U.S. nexus too great to qualify as a foreign private adviser (or have voluntarily chosen to be regulated as RIAs or ERAs).

127

124

Certain other investment advisers that make use of the mails or any means or instrumentality of interstate commerce in connection with their business as an investment adviser may also be permitted or required to register with the SEC. See footnote 23,

supra.

125

15 U.S.C. 80b-3(a), (l), (m).

126

See

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

127

Certain RIAs or ERAs may opt to register or report to the SEC despite the fact that they could rely on the foreign private adviser definition; such investment advisers have chosen to subject themselves to the U.S. regulatory requirements and supervision applicable to such advisers, and so will be subject to this final rule.

As noted above, a foreign-located investment adviser's advisory activities must also have a U.S. nexus to be subject to the requirements of the final rule. Under section 1032.111, foreign-located investment adviser's advisory activities are subject to the requirements of the rule if the advisory activities: (i) take place within the United States, including through involvement of U.S. personnel of the investment adviser, such as the involvement of an agency, branch, or office within the United States, or (ii) provide advisory services to a U.S. person or a foreign-located private fund with an investor that is a U.S. person (subject to specified definitions of “foreign-located private fund,” “investor,” and “U.S. person”).

For the purposes of section 1032.111, U.S. personnel means, regardless of citizenship, any director, officer, employee, or agent of the investment adviser conducting advisory activities from a U.S. agency, branch, or office of the investment adviser. U.S. personnel would be involved in advisory activities if, for example, an employee of the investment adviser manages assets of a client from a U.S. office or other U.S. workplace of the investment adviser, or if the employee works remotely from the United States on a regular basis. Conversely, a U.S. citizen employee of the investment adviser managing assets of a client from a non-U.S. office of the foreign-located investment adviser would generally not constitute U.S. personnel involved in advisory activities for this purpose.

128

The term “agency, branch, or office” of the investment adviser is not exclusive, and the rule would apply to any location in the United States from which U.S. personnel of the foreign-located investment adviser perform advisory activity. For the avoidance of doubt, personnel that perform activity that is

clerical or administrative in nature are not involved in advisory activity for purposes of the final rule.

129

128

However, a U.S. employee (of a foreign-located investment adviser) whose advisory activities are undertaken from a non-U.S. office for the purpose of evading the final rule or as part of a course of conduct the employee undertook while based in the United States, would constitute U.S. personnel involved in advisory activities and be covered by the final rule.

129

This discussion of “clerical or administrative” activity is intended to apply to foreign-located investment advisers only and is not intended to apply for any other purpose. This is because it aligns with the reporting of “clerical workers” on Item 5.A of Form ADV with which investment advisers are already familiar and enhances consistency with SEC regulation in a portion of the final rule that references several SEC regulations.

For a foreign-located investment adviser, the final rule also applies to the provision of advisory services to a U.S. person or a foreign-located private fund with an investor that is a U.S. person. This includes, but is not limited to, providing investment advice to a U.S. person, regardless of the location from which such investment advice is provided. A foreign-located investment adviser would be providing advisory services to a U.S. person if, for example, the investment adviser manages assets from an office outside of the United States on behalf of an individual U.S. person.

For purposes of determining a foreign-located investment adviser's activities subject to this rule, the final rule defines “U.S. person” as a person meeting the definition in 17 CFR 230.902(k), which is part of Regulation S under the Securities Act. The SEC relied on this definition for purposes of the foreign private adviser exemption because it provides specific rules when applied to various types of legal structures.

130

FinCEN adopts the Regulation S definition for this reason, consistency with other SEC regulations cross-referenced in section 1032.111, and administrability because this definition is already familiar to investment advisers. This definition also includes an element designed to mitigate potential evasion concerns.

131

130

See

76 FR 39645, 39697-39678 (Jul. 6, 2011).

131

17 CFR 230.902(k)(1)(viii) (encompassing any corporation or partnership formed by a U.S. person principally for the purpose of investing in unregistered securities unless owned or incorporated by accredited investors who are not natural persons, estates or trusts).

With respect to a foreign-located investment adviser's advisory activities to a foreign-located private fund, the final rule requires a foreign-located investment adviser to determine whether any foreign-located private fund that it advises has at least one investor who is a U.S. person.

132

This determination must be made with respect to every investor in that foreign-located private fund in accordance with SEC requirements familiar to private fund advisers. If a foreign-located private fund has at least one U.S. person investor, the foreign-located investment adviser must apply the final rule with respect to that foreign-located private fund. This standard is designed to be both administrable—it incorporates SEC standards for identifying investors that are U.S. persons in private funds—and tailored to address risks to the U.S. financial system through foreign-located private funds, which FinCEN has identified as presenting significant illicit finance risk.

132

A U.S.-located private fund advised by a foreign-located investment adviser is itself a U.S. person under this definition, and so a foreign-located investment adviser will also be required to apply the final rule with respect to any U.S.-located private fund it advises, irrespective of the presence or absence of any U.S. person investors in such U.S.-located private fund.

The final rule defines “foreign-located private fund” by reference to section 202(a)(29) of the Advisers Act, which defines “private fund” to mean “an issuer that would be an investment company, as defined in section 3 of the [Company Act] (15 U.S.C. 80a-3), but for section 3(c)(1) or 3(c)(7) of that Act.” The “foreign-located” aspect of the definition refers to a fund that is a legal entity or arrangement that is incorporated or organized outside the United States and therefore is not a U.S. person for purposes of the final rule. This definition therefore covers the types of foreign-located private funds advised by ERAs and that FinCEN has identified as giving rise to illicit finance risks. It is also commonly used by investment advisers in complying with the federal securities laws, including, for example, in completing multiple portions of Form ADV.

133

See

Form ADV Glossary, defining Private Fund to mean “An issuer that would be an investment company as defined in section 3 of the Investment Company Act of 1940 but for section 3(c)(1) or 3(c)(7) of that Act.”

The final rule defines “investor” by reference to Advisers Act Rule 202(a)(30)-1(c)(2), under which a foreign private adviser can determine whether private funds it advises have more than 14 “investors in the United States.” That rule, in turn, refers to sections 3(c)(1) and 3(c)(7) of the Company Act, which generally exclude certain issuers from the definition of investment company based on the number of beneficial owners or qualifications of their security holders, respectively.

134

Consistent with statements by the SEC and its staff and the SEC's underlying authorities,

135

depending upon the facts and circumstances, persons other than the nominal holder of a security issued by a private fund may be counted as the beneficial owner under section 3(c)(1), or be required to be a qualified purchaser under section 3(c)(7).

136

For purposes of section 3(c)(1), if a company owns 10 percent or more of the outstanding voting securities of the issuer (the prospective private fund), and is, or but for section 3(c)(1) or 3(c)(7) of the Company Act, would be an investment company, the issuer must “look through” that investing company to the holders of the company's securities.

137

In the context of this rule, a foreign-located investment adviser is required to perform the same look through with respect to any private fund it advises that relies on section 3(c)(1) of the Company Act with two modifications: (1) the foreign-located investment adviser must count beneficial owners of a private fund's commercial paper as investors (consistent with Advisers Act Rule 202(a)(30)-1(c)(2)); and (2) a person who is considered a beneficial owner for purposes of section 3(c)(1) will be considered an “investor” in the private fund despite holding its interests indirectly. If this look through results in a U.S. person being considered an investor in the private fund, the foreign-located private adviser must apply the requirements of the final rule to that fund.

134

Section 3(c)(1), 15 U.S.C. 80a-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), 15 U.S.C. 80a-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 investments whose value exceeds a specified threshold).

135

See, e.g.,

76 FR 39645, 39676 (Jul. 6, 2011);

Privately Offered Investment Companies,

Final Rule, 62 FR 17512, 17519, 17524 (Apr. 9, 1997) (“The Commission understands that there are other forms of holding investments that may raise interpretative issues concerning whether a Prospective Qualified Purchaser `owns' an investment. For instance, when an entity that holds investments is the `alter ego' of a Prospective Qualified Purchaser (as in the case of an entity that is wholly owned by a Prospective Qualified Purchaser who makes all the decisions with respect to such investments), it would be appropriate to attribute the investments held by such entity to the Prospective Qualified Purchaser.”);

see also

Cornish & Carey Commercial, Inc., SEC Staff No-Action Letter (June 21, 1996) (staff discussed the application of section 3(c)(1)(A) to an issuer relying on section 3(c)(1)), available at

https://www.sec.gov/divisions/investment/noaction/1996/cornishcarey022696.pdf.

136

Section 3(c)(1)(A) of the Company Act requires a private fund relying on section 3(c)(1) to “look through” any company that owns 10 percent or more of the company's voting securities. “Voting security” is defined in section 2(a)(42) of the Company Act, 15 U.S.C. 80a2(a)(42). In contrast, this 10 percent look-through is not required for purposes of section 3(c)(7).

137

See

15 U.S.C. 80a-3(c)(1)(A).

Similarly, for purposes of both section 3(c)(1) and section 3(c)(7), a foreign-located investment adviser will be required to “look through” any entity

that is formed for the purpose of investing in a foreign-located private fund it advises.

138

For purposes of the final rule, if a foreign-located investment adviser determines that an investing entity has been formed for purposes of investment in the private fund, such an adviser must look through the entity to determine whether it has U.S. person investors. Consistent with statements by the staff of the SEC and the SEC's underlying authorities,

139

a foreign-located investment adviser's determination that an entity is formed for the specific purpose of investing in a foreign-located private fund will depend upon an analysis of all of the surrounding facts and circumstances (including any knowledge that the foreign-located adviser has regarding the identity of its customers). Thus, to the extent that a foreign-located investment adviser determines that there is an underlying U.S. person investor (by conducting a look-through or because of other information available to the foreign-located investment adviser), the foreign-located investment adviser must apply the final rule with respect to the foreign-located private fund in which the U.S. person is indirectly invested.

138

See, e.g.,

17 CFR 270.2a51-3(a) (discussing an entity formed for the purpose of acquiring securities of an issuer relying on section 3(c)(7)); Cornish & Carey Commercial, Inc., SEC Staff No-Action Letter (June 21, 1996) (staff discussing an entity formed for the purpose of acquiring securities of an issuer relying on section 3(c)(1)), available at

https://www.sec.gov/divisions/investment/noaction/1996/cornishcarey022696.pdf.

For purposes of section 3(c)(1), SEC staff guidance states that if a company or fund invests more than 40 percent of its assets in a 3(c)(1) fund, it is potentially formed for the purpose of investing in a 3(c)(1) fund. For purposes of section 3(c)(7), 17 CFR 270.2a51-3(a) requires an investment adviser to determine whether the beneficial owners of the entity formed for purposes of investment in the fund are also qualified purchasers.

139

See, e.g.,

American Bar Association Section of Business Law, SEC Staff No-Action Letter (Apr. 22, 1999) at 19-20 (describing circumstances under which an entity would be deemed to be formed for the specific purpose of acquiring securities in a private fund that relies on section 3(c)(7)), available at

https://www.sec.gov/divisions/investment/noaction/1999/aba042299.pdf.

These tests are incorporated into the final rule in order to address the illicit finance risks posed by foreign-located investment advisers. The greatest risks arise, as discussed above, from private funds advised by foreign-located investment advisers. The requirement of a U.S. nexus in the form of at least one investor that is a U.S. person is consistent with FinCEN's desire to focus on risks to the U.S. financial system. The presence of a U.S. person investor increases the likelihood that illicit finance risk associated with a private fund affects the U.S. financial system and the likelihood that U.S. persons might be involved in the underlying illicit finance activity. Although the presence of one investor that is a U.S. person requires the investment adviser to apply the requirements of the final rule to the entirety of a private fund, FinCEN notes that the fund as a whole is the customer of the foreign-located investment adviser. By their nature, private funds involve the commingling of investor assets in a pooled vehicle. As previously detailed in the Risk Assessment, the pooled nature of such funds may be used to obscure ownership of investments (which may present the possibility of higher returns on capital) by illicit actors who seek stable returns and do not need immediate access to capital.

140

See

Risk Assessment,

supra

note 2, at 16.

While FinCEN considered other thresholds for establishing an appropriate U.S. nexus, including whether or not to apply the rule's obligations with respect to non-U.S. private funds with U.S. investors, FinCEN balanced addressing the relevant illicit finance risks to the U.S. financial system (such as arising from investments by illicit actors in non-U.S. private funds that are commingled with funds from U.S. investors and enter the U.S. financial system),

141

the purposes of the BSA, and administrability. FinCEN also considered, as noted by a commenter, the SEC's approach in applying substantive provisions of the Advisers Act and the purposes underlying that approach. FinCEN further considered other SEC rules and practices, such as the foreign private adviser exemption and Advisers Act Rule 202(a)(30)-1(c)(2). The SEC standards incorporated in section 1032.111 are used to focus on illicit finance risks associated with private funds specifically and are familiar to foreign-located investment advisers from SEC regulations.

142

By setting a clear minimum standard of at least one U.S. private fund investor defined by reference to Advisers Act Rule 202(a)(30)-1(c)(2), this places clear limits on the ability of investment advisers or illicit actors seeking to obscure their ownership or control of certain assets through a private fund to avoid application of the final rule by admitting U.S. persons as indirect investors through intermediate entities. Advisers must “look through” nominee and similar arrangements to the underlying holders of private fund-issued securities to determine whether the private fund has an investor that is a U.S. person.

141

Id.

at 16-20.

142

The standards for determining beneficial ownership of investments in private funds, including by U.S. persons, should be familiar to investment advisers from SEC reporting requirements and determining the status of such funds under the Company Act.

See

Instructions to Form PF, Section 2b Item 16 (requiring reporting of a fund's equity that is beneficially owned by various categories of investors, including individuals who are U.S. persons); Question 16 of Section 7.B.(1) of Schedule D to Form ADV (requiring the reporting of the percentage of a private fund's beneficial owners that are non-U.S. persons); 15 U.S.C. 80b-2(a)(30) and 17 CFR 275.202(a)(30)-1 (foreign private adviser exemption).

See also

76 FR 39645, 39678 (Jul. 6, 2011) (“A non-U.S. adviser would need to count the same U.S. investors [as in connection with Investment Company Act exclusions] (except for holders of short-term paper with respect to a fund relying on section 3(c)(1)) in order to rely on the foreign private adviser exemption. In this respect, therefore, the look-through requirement of the foreign private adviser exemption will generally not impose any new burden on advisers to non-U.S. funds.”).

Moreover, a foreign-located investment adviser retains the option of availing itself of foreign private adviser status if it has limited U.S. ties and does not wish to apply the requirements of the final rule to private funds with lower levels of U.S. investment. Given this option, FinCEN anticipates it is unlikely that a significant number of foreign-located investment advisers will be required to apply the requirements of the rule on the basis of having a small number of investors that are U.S. persons or small amount of U.S. investment. When a foreign-located investment adviser's activities involving a private fund fall within the scope of the final rule, the foreign-located investment adviser will be expected to subject its advisory activities with respect to the fund to internal policies, procedures, and controls reasonably designed to prevent the investment adviser from being used for money laundering, terrorist financing, or other illicit finance activities and to achieve compliance with the applicable provisions of the BSA and implementing regulations. Advisers are often involved in implementing such internal policies, procedures, and controls for their funds for both AML/CFT requirements (if the fund implements such requirements voluntarily or to comply with the AML/CFT laws of a foreign jurisdiction) as well as requirements under securities or other corporate laws. Therefore, foreign-located investment advisers should be able to apply the requirements of this final rule, including applicable internal policies, procedures, and controls, to advisory activities with respect to these private funds, and doing so will help prevent these funds from becoming gateways into the U.S. financial system for illicit finance activity.

Certain of a foreign-located investment adviser's advisory activities are not subject to the final rule. This is similar to the SEC's regulation of investment advisers pursuant to the Advisers Act: non-U.S. advisers are not required to apply the substantive provisions of the Advisers Act when advising non-U.S. clients.

143

While taking into account the distinct purposes of the BSA, FinCEN believes that the final rule's requirements should not apply to a foreign-located adviser when it: (i) provides services exclusively to a foreign-located person,

144

and (ii) the personnel providing such advisory services are all outside of the United States as discussed above.

143

See, e.g.,

76 FR 39645, 39681 (Jul. 6, 2011); SEC No-Action Letter,

Uniao de Bancos Brasileiros S.A. (Unibanco),

1992 WL 183054 at *3 (Jul. 28, 1992), available at

https://www.sec.gov/divisions/investment/noaction/1992/uniaodebancos072892.pdf.

The SEC's approach considers the location of the client. The final rule does not modify the SEC's position on the application of the Advisers Act to non-U.S. investment advisers.

144

Other than a private fund with a U.S. person investor, as described above.

To ensure that activities within the scope of the rule are properly included, a foreign-located investment adviser should (i) determine to the extent reasonable and practicable whether its customers and the investors in its private funds are within the scope of this rule based upon the regulatory text as clarified in this preamble and any relevant future guidance that FinCEN might issue, and (ii) ensure that it does not provide advisory services to its private fund customers in a manner that results in the adviser being unable to identify a potential U.S. customer or investor.

The final rule states that upon request, a foreign-located investment adviser must make available to FinCEN or the SEC (in its capacity as delegated examiner for this rule) records and reports required under this rule and any other records that it has retained regarding the scope of its activities covered by this rule. As discussed below, the records that an investment adviser—including a foreign-located investment adviser—is required to maintain to comply with the requirements of the final rule include those required when developing and implementing an AML/CFT program as required under section 1032.210, including but not limited to a written AML/CFT program that includes internal policies, procedures, and controls, as well as those required by subpart D of the final rule, which are generally records of certain transactions and transfers of funds.

As for any investment adviser subject to this final rule, for a foreign-located investment adviser, properly scoping the advisory activities covered by its AML/CFT program is an important part of ensuring that its AML/CFT program is reasonably designed to prevent the investment adviser from being used for money laundering, terrorist financing, or illicit finance activities, and of achieving and monitoring compliance. As part of establishing a risk-based and reasonably de

This text is long and has been trimmed here. Open the source document for the complete record.

This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.