June 10, 2024 - Registered Investment Advisers (“RIAs”) are facing a new compliance environment under two related proposals targeting money laundering and suspicious financial activity. Last month, the U.S. Department of the Treasury’s Financial Crimes Enforcement Network (“FinCEN”) and the Securities and Exchange Commission issued a joint Notice of Proposed Rulemaking (“CIP Proposal”) requiring registered investment advisers and exempt reporting advisers (“Covered Advisers”) to implement customer identification programs (“CIP”). We understand that this proposal is not new – the concept has come up several times in recent years – but it is expected to proceed now.
The CIP Proposal supplements FinCEN’s February proposed rulemaking designating Covered Advisers as “financial institutions” under the Bank Secrecy Act (“BSA”) and thereby subjecting these entities to additional Anti-Money Laundering and Countering the Financing of Terrorism (“AML/CFT”) and suspicious activity reporting requirements. It also imposes additional recordkeeping and information-sharing obligations. The impetus for the pair of rulemakings was a February Treasury risk assessment report maintaining that advisers “have served as an entry point into the U.S. market for illicit proceeds associated with foreign corruption, fraud, and tax evasion”.
The May proposal mandates that Covered Advisers implement a risk-based CIP to (i) identify and (ii) verify the identity of each “customer” that opens an “account” with that Adviser. The identification procedure would consist of gathering key customer information (name, date of birth and address) prior to the opening of the account. The Covered Adviser must then verify this information to enable it to form “a reasonable belief that it knows the identity of each customer”. The proposal would also enact recordkeeping and customer notification requirements. The compliance deadline is six months from the effective date of the rule.
In response to the February rulemaking, the Investment Adviser Association (“IAA”) submitted an April 15 comment letter (“IAA Comment Letter”) arguing that the proposal was overly broad and making two overarching recommendations: (1) to exclude certain types of advisory business from the AML proposal and to exempt smaller Covered Advisers with only 100 or fewer employees and (2) to limit the practical and operational burdens on Covered Advisers implementing the rule.
The CIP Proposal presents the same issues highlighted by the IAA, which has taken the lead in advocating for right-sizing of the proposed rules. “Customer” and “account” are broadly defined thereunder to mean “a person, including a natural person or a legal entity, who opens a new account with an investment adviser” and “any contractual or other business relationship between a person and an investment adviser under which the investment adviser provides investment advisory services”, respectively. (Private funds, rather than the investors in the funds, would constitute customers of a Covered Adviser, given that the funds directly open and maintain accounts.) Similarly, the text of the rule applies to a wide range of accounts (including ERISA plans) but excludes any transferred accounts (i.e., those acquired through an acquisition). While the rule permits a Covered Adviser to reasonably rely on another financial institution’s performance of a CIP where the latter is already subject to AML/CTF program requirements, reliance requires a contractual undertaking by the performing financial institution. Fortunately, mutual funds are deemed compliant provided they have implemented a CIP as required under the BSA; however, as highlighted by the IAA, many low-risk relationships are within scope.
Comments to the rulemaking are due July 22, 2024. Given its broad application, the rule would impose sweeping compliance obligations on all RIAs. This can be particularly burdensome for smaller managers. The LSTA will continue to monitor the proposal and continue to engage with the IAA.
If you have further questions, please contact Elizabeth Yazgi.
