The U.S. Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN) on Aug. 28, 2024, issued a final rule to help safeguard the investment adviser sector from illicit finance activity (Final Rule). The Final Rule aims to help address the illicit financial risks in the investment adviser sector, which has been an area of concern as noted in the Treasury Department’s February 2024 Investment Adviser Risk Assessment and as highlighted in the Biden-Harris Administration’s 2021 U.S. Strategy on Countering Corruption.
Which Investment Advisers Are Subject to the Final Rule?
The Final Rule adds “investment adviser” to the definition of “financial institution” under the Bank Secrecy Act of 1970 (BSA) implementing regulations. Notably, the Final Rule does not apply to all investment advisers. Under the Final Rule, an “investment adviser” is any person, wherever located, who is registered or required to register (registered investment advisers or RIAs) with the U.S. Securities and Exchange Commission (SEC) under Section 203 of the Investment Advisers Act of 1940 (Advisers Act), or any person who is exempt from SEC registration under Section 203(1) or 203(m) of the Advisers Act (exempt reporting advisers or ERAs). However, the Final Rule specifically excludes from the definition of “investment adviser” RIAs who
- register with the SEC solely because they are mid-sized advisers,1 multi-state advisers2 or pension consultants3
- are not required to report any assets under management (AUMs) to the SEC.
The Final Rule also does not apply to state-registered advisers, foreign private advisers4 or family offices.5
For RIAs and ERAs who meet the definition of “investment adviser” under the Final Rule that have a principal office and place of business outside of the U.S. (i.e., “foreign-located investment advisers”), the Final Rule only applies to their advisory activities that 1) take place within the U.S. (including through the involvement of U.S. personnel) or 2) provide advisory services to a U.S. person or foreign-located private fund with an investor who is a U.S. person.
What Are the Requirements Under the Final Rule?
The Final Rule subjects covered RIAs and ERAs to traditional anti-money laundering and countering the financing of terrorism (AML/CFT) obligations comparable to those of banks, brokers or dealers in securities, as well as other “financial institutions” under the BSA and its implementing regulations such as:
- implementing a risk-based and reasonably designed AML/CFT program
- filing certain reports such as Suspicious Activity Reports (SARs) and Currency Transaction Reports (CTRs)
- maintaining certain records such as those relating to the transmittal of funds (i.e., the Recordkeeping and Travel Rules)
- fulfilling certain other obligations applicable to “financial institutions” subject to the BSA and the implementing regulations such as complying with special information sharing procedures, special due diligence requirements for correspondent and private banking accounts, and special measures under the USA PATRIOT Act6
What Does an AML/CFT Program for Investment Advisers Include?
Among other traditional program requirements,7 the AML/CFT program for covered RIAs and ERAs must include appropriate risk-based procedures for conducting ongoing customer due diligence that includes two of the four core elements of a customer due diligence (CDD) program: 1) understanding the nature and purpose of customer relationships in order to develop a customer risk profile and 2) conducting ongoing monitoring to identify (and report) suspicious transactions and to maintain (and update) customer information
The remaining two core elements of a CDD program are 1) identifying and verifying the identify of customers and 2) identifying and verifying the identity of the beneficial owners of legal entity customers opening accounts. FinCEN opted to address the customer identification and verification element in a separate joint rulemaking with the SEC. On May 21, 2024, FinCEN and the SEC issued a Notice of Proposed Rulemaking, which proposes a rule to apply such customer identification program (CIP) requirements to investment advisers.8 FinCEN has also taken the first step toward incorporating the final core element by including “investment advisers” in the definition of “covered financial institution” under 31 C.F.R. § 1010.605(e)(1). However, investment advisers would not be categorically required to obtain beneficial ownership information for legal entity customers until the effective date of the revised CDD Rule.9 Nevertheless, as noted in the Final Rule, “an investment adviser should make a risk-based determination as to whether it needs to collect beneficial ownership information based on the customer’s risk profile.”
What Are the Exceptions, Exclusions, Permissible Delegations and Notable Carve-Outs?
The Final Rule includes several exclusions. Namely, the Final Rule permits an investment adviser to exclude from its obligations certain clients it advises: 1) mutual funds (without the obligation to verify that the mutual fund has implemented an AML/CFT program), 2) bank-and-trust-company-sponsored collective investment funds and 3) any other investment adviser subject to the Final Rule advised by the investment adviser (e.g., certain sub-adviser arrangements and wrap-fee programs).
Subject to certain requirements, the Final Rule also authorizes investment advisers to contractually delegate the implementation and operation of certain aspects of its AML/CFT program to third parties such as brokers or dealers in securities, fund administrators and, if appropriate, foreign-located service providers. Nonetheless, delegation will require the investment adviser to remain fully responsible and legally liable for (and need to demonstrate) compliance with AML/CFT requirements. Covered investment advisers would also be required to ensure that FinCEN and the SEC are able to obtain information and records relating to their AML/CFT program. It is also important to note that FinCEN declined to permit covered investment advisers from expressly relying on the diligence or AML/CFT measure by other financial institutions, service providers or intermediaries.
Notably, the Final Rule also does not reflect AML/CFT program amendments and enhancements proposed in the AML/CFT program proposed rule, which FinCEN announced on June 28, 2024, including the requirement that AML/CFT programs must be administered by persons within the U.S. (See Holland & Knight’s previous alert, “FinCEN Issues Proposed Rule Amending Requirements of Financial Institutions’ AML/CFT Programs,” July 12, 2024.)
Takeaways
- The Final Rule is not the first time FinCEN or Congress has attempted to issue an investment adviser AML/CFT rule.10 Given the broad authority granted to the Treasury Department under the BSA, the backdrop of national security concerns and the current administration’s priorities, the Final Rule may likely avoid legal challenge. That said, it is unclear how federal courts would rule on the question, given recent U.S. Supreme Court precedent overruling the so-called Chevron deference.
- Covered investment advisers will likely need to establish new compliance programs in accordance with the requirements of the Final Rule. Even if they had an established AML/CFT program as part of their overall compliance program, covered investment advisers will need to review their programs to ensure compliance with the Final Rule.
- Covered investment advisers should develop controls to help ensure proper implementation considering the staggered deployment of the CDD requirements under the Final Rule, the CIP requirements that will likely be applied under a separate final rule and a potential future obligation to collect the beneficial ownership information of legal entity customers.
- Covered investment advisers must comply with the Final Rule on or before Jan. 1, 2026.
- Consistent with FinCEN’s existing delegation of examination authority relevant to broker-dealers in securities and mutual funds, FinCEN is delegating its examination authority for the requirements of the Final Rule to the SEC.
For guidance on which investment advisers are subject to and the requirements of the Final Rule, please contact the authors.
Notes
1 RIAs who have assets under management (AUM) between $25 million and $100 million but who either 1) 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 2) are not subject to examination as an adviser by the state in which they maintain their principal offices and places of business. See 15 U.S.C. § 80b-3a(a)(2)(B).
2 Investment advisers who would otherwise be required to register in more than 15 states, but have less than $100 million in AUM, and have chosen instead to register with the SEC. See 17 C.F.R. § 275-203A-2(d).
3 Investment advisers that have chosen to register with the SEC that provide investment advice to 1) any employee benefit plan described in Section 3(3) of Employee Retirement Income Security Act of 1974 (ERISA), 2) any governmental plan described in Section 3(32) of ERISA or 3) any church plan described in Section 3(33) of ERISA. See 17 C.F.R. § 275-203A-2(a).
4 15 U.S.C. § 80B-2(a)(30).
5 17 C.F.R. § 275.202(a)(11)(G)-1(b).
6 Pub. L. 107-56, Section 312 (Oct. 26, 2001), codified as 31 U.S.C. 5318(i).
7 The AML/CFT program shall at a minimum 1) establish and implement 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, 2) provide for independent testing for compliance to be conducted by the investment adviser’s personnel or by a qualified outside party, 3) designate a person or persons responsible for implementing and monitoring the operations and internal controls of the program, 4) provide ongoing training for appropriate persons, and 5) implement appropriate risk-based procedures for conducting ongoing customer due diligence. See 31 C.F.R. § 1032.210(b).
8 See Customer Identification Programs for Registered Investment Advisers and Exempt Reporting Advisers, Notice of Proposed Rulemaking, 89 FR 44571 (May 21, 2024).
9 FinCEN is required to revise the 2016 CDD Rule to bring it into conformance with the Corporate Transparency Act of 2019.
10 See FinCEN, Anti-Money Laundering Programs for Investment Advisers, 68 FR 23646 (May 5, 2003); see also FinCEN, Withdrawal of the Notice of Proposed Rulemaking; see also Anti-Money Laundering Programs for Unregistered Investment Companies, 73 FR 65569 (Nov. 4, 2008); see also Establishing New Authorities for Businesses Laundering and Enabling Risks to Security (ENABLERS) Act, H. R. 5525, 117th Congress (2021-2022).
Information contained in this alert is for the general education and knowledge of our readers. It is not designed to be, and should not be used as, the sole source of information when analyzing and resolving a legal problem, and it should not be substituted for legal advice, which relies on a specific factual analysis. Moreover, the laws of each jurisdiction are different and are constantly changing. This information is not intended to create, and receipt of it does not constitute, an attorney-client relationship. If you have specific questions regarding a particular fact situation, we urge you to consult the authors of this publication, your Holland & Knight representative or other competent legal counsel.
