Anti-Money Laundering Obligations For Private Funds

The Financial Crimes Enforcement Network, Treasury’s financial intelligence unit has been trying to impose anti-money laundering obligations on private funds for years. On September 26, 2002, FinCEN issued a notice of proposed rulemaking, proposing to require unregistered investment companies to establish and implement anti-money laundering programs. (Anti-Money Laundering Programs for Unregistered Investment Companies, 67 FR 60617 (Sep. 26, 2002))

In that notice of proposed rulemaking, FinCEN proposed to define the term “unregistered investment company” as (1) an issuer that, but for certain exclusions, would be an investment company as that term is defined in the Investment Company Act of 1940, (2) a commodity pool, and (3) a company that invests primarily in real estate and/or interests in real estate. FinCEN proposed requiring these companies to file a notice so that FinCEN could readily identify such companies and require them to establish and implement anti-money laundering programs.

I think most real estate fund managers and other private fund managers keep an eye on the parties to see if there is a reason to be wary and to see if they on the Specially Designated Nationals and Blocked Persons List. But I had some concern that FinCEN could extend the “know your customer” rules deep into transactions, imposing lots of administrative overhead for little benefit.

In November of 2008, FinCEN filed a notice of Withdrawal of the Notice of Proposed Rulemaking for Anti-Money Laundering Programs for Unregistered Investment Companies . In that notice, FinCEN stated that they were not abandoning the possibility of pursing the rulemaking. Given the six year span since the notice, they feel it has gone stale. If (or when) they decide to proceed with an anti-money laundering program requirement for unregistered investment companies, they will publish a new notice.

The “when” seems to be coming closer.

Senator Levin introduced the Stop Tax Haven Abuse Act. Section 203 of that bill would require the Department of Treasury to require

unregistered investment companies, including hedge funds or private equity funds, to establish anti-money laundering programs and submit suspicious activity reports under subsections (g) and (h) of section 5318 of title 31, United States Code.

The bill defines an “unregistered investment company” as one that would be an investment company but is exempt under 3(c)(1) or 3(c)(7).

Hedge funds may be an attractive source for money-laundering (I’m not sure), but private equity can’t be very enticing. Cash is called as investments are made over the course of the investment period and then slowly returned as investments are realized. I don’t generally think of terrorists and drug lords as patient capital sources.

Nonetheless, most private equity fund managers I’ve talked to investigate the background of their investors. It’s a long term relationship on both sides and managers don’t want to have the headache of having a bad investor. The repercussions of having a blocked-person would be tremendous, both from the legal fallout as well as the damage to the sponsor’s reputation. Most lenders require the fund to warrant that there are no blocked persons in their funds.

The Levin bill would technically leave out real estate fund companies, assuming they are taking advantage of the 3(c)(5) exemption. I sense more regulatory overhead approaching.

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