Category: Anti-Money Laundering

AML Failures at GTS

This year is the year that registered investment advisers need to get fully on the bandwagon with the Bank Secrecy Act. FinCEN promulgated the Investment Adviser Rule to spread the Bank Secrecy Act requirements. While most investment advisers are doing some form of AML-CFT reviews, the process is now subject to explicit regulatory requirements. The compliance date is January 1, 2026.

I’ve been keeping an eye on AML actions brought by the SEC to use those failures to help understand what investment advisers need to do (and should not do.)

GTS expanding rapidly as a market maker for OTC securities. From 50,000 daily trades in August 2019 to 200,000 in August 202o, becoming the second largest broker-dealer for OTC securities. According to the SEC order, GTS failed to adopt and implement reasonably designed AML policies and procedures to surveil OTC transactions within its OTC unit and failed to file Suspicious Activity Reports when required to do so by the SAR Rule.

GTS had an AML surveillance system that flagged high-volume trading activity and submitted a report to an OTC unit supervisor. However that supervisor’s primary responsibilities were unrelated to the AML program and did not report to the AML CCO. So the flags went largely unaddressed.

The policies and procedures gave the supervisor little guidance on what to do or what to look for. According to the SEC order, the polices should have listed these as suspicious transactions:

a. Trading activity that comprised a significant proportion of the daily trading volume in a thinly traded or low-priced security;

b. Trading activity involving sudden spikes in demand for, coupled with sudden price changes in, a thinly traded or low-priced security, including instances of such trading coupled with suspicious stock promotion activity; and

c. Significant trading in a thinly traded or low-priced security previously subject to a Commission trading suspension.

The AML failures cost GTS a $350,000 fine.

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Corporate Transparency Act is Back from the Dead (Update: No it’s Not)

On Monday afternoon, the Fifth Circuit issued and order to stay the nationwide injunction against the Corporate Transparency Act. Filings are now due by the end of the year.

UPDATE: And another panel at the Fifth Circuit reversed and let the stay remain in place.

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24-40792_lifting stay on CTA BOIDownload

The Death of the Corporate Transparency Act? (or not)

If you’re reading this, you’ve probably put a bunch of time into getting ready for compliance with the Beneficial Ownership Information reporting under the Corporate Transparency Act. You already know that there has been a nationwide injunction put in place to temporarily stop implementation of the requirements.

Texas Top Cop Shop, Inc. v. Garland (E.D. Tex. Dec. 3, 2024) is one of four cases floating through the judicial system attacking the Corporate Transparency Act. It is only one that has caused much of a ripple. The judge didn’t overturn the CTA. He merely issued the injunction based on the likelihood that the the CTA would be found to be unconstitutional.

Back in March in Alabama, the judge in National Small Business United v. Yellen merely applied his ruling to the parties to the case. If you were a member of the National Small Business United group, you’ve been celebrating for a while. That judge found the CTA to be unconstitutional.

On the other side, Courts in the District of Oregon and the Eastern District of Virginia have come down the other way. The judges in Firestone v. Yellen (D. Or. Sept. 20, 2024) and Community Associations Institute v. Yellen (E.D. Va. Oct. 24, 2024) found that the CTA was likely to be found constitutional and denied the request for an injunction.

All four decisions are under appeal. Do we think all four appellate courts are going to deny injunctions? Maybe. If we get splits, that would make it very likely that the US Supreme Court will take up the case to reconcile the dramatically different results.

Then we have to add in whether the Trump administration will continue to support the appellate process. Who knows what will happen after January 20.

I wish FinCEN was offering a better on-ramp. The current position has a hair-trigger.

[R]eporting companies are not currently required to file their beneficial ownership information with FinCEN and will not be subject to liability if they fail to do so while the preliminary injunction remains in effect. 

The way I read this if the injunction is lifted on January 2, then Reporting Companies have to immediately file to be in compliance.

You can currently file voluntarily. My provider has told me that the automated filing process has been disabled while the injunction is in place.

Hopefully, FinCEN will quickly get a better idea of timing and extend the compliance deadline out for several months while the litigation is ongoing.

The latest short term funding bill has a provision moving the compliance date from January 1, 2025 to January 1, 2026. Of course that could change.

The US filed a motion to stay the injunction pending the appeal. That was (no surprise) denied on December 17.

On the appeal, motions had to be filed this week with the Fifth Circuit Court of Appeals. FinCEN is asking for an emergency motion for stay pending appeal. Maybe the Court is looking to make a ruling by the end of the year. If it stays the injunction, that will cause havoc on many people’s year-end as they ramp back up for the filing process.

Based on filing on December 17 and December 18, the Fifth Circuit is allowing amicus filings on the appeal. That makes it seem less likely that a ruling will come out by year end.

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(update this morning from the original post)

Explicit Anti-Money Laundering/Countering the Financing of Terrorism Rules Put in Place for Investment Advisers 

Investments advisers had been excluded the definition of “financial institution” under the Bank Secrecy Act. At least until today. The Financial Crimes Enforcement Network at Treasury issued a final regulation today that changes that exclusion. Most registered investment advisers are now included in the definition and will have to comply with the strict requirements of the Bank Secrecy Act.

The compliance date is January 1, 2026.

“The final investment adviser rule will apply anti-money laundering/countering the financing of terrorism (AML/CFT) requirements—including AML/CFT compliance programs and suspicious activity reporting obligations—to certain investment advisers that are registered with the U.S. Securities and Exchange Commission (SEC), as well as those that report to the SEC as exempt reporting advisers. The rule will help address the uneven application of AML/CFT requirements across this industry.”

Registered investment advisers will need to get up to speed on filing Suspicious Activity Reports and the other requirements of the BSA.

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The One with Insufficient Compliance Resources

The Bank Secrecy Act requires broker-dealers to file suspicious activity reports. Under the SAR Rule (31 C.F.R. § 1023.320(a)(2)), every broker-dealer has to file a report for a transaction of at $5000 that

  1. Involves funds derived from illegal activity or is intended or conducted in order to hide or disguise funds or assets derived from illegal activity
  2. Is designed to evade any requirements under the Bank Secrecy Act
  3. Has no business or apparent lawful purpose or is not the sort in which the particular customer would normally be expected to engage
  4. Involves use of the broker-dealer to facilitate criminal activity

That’s all a bit vague. So FINRA has produced a list of more actionable items, most recently compiled in FINRA Regulatory Notice 19-18 (May 2019).

There are vendors who sell software that will monitor transactions and flag those that meet the criteria in the FINRA Notice.

OTS Link used one of those automatic surveillance systems. For the first six months of 2021 the system raised over 1800 alerts for transactions to be reviewed. For those 300 alerts a month, the compliance team at OTS Link only devoted 5 hours a month. No surprise, they failed to investigate any or file any SARs.

In the Order, the SEC says that if OTS Link had properly surveilled transactions it would have spotted:

(a) a large volume of thinly-traded, low-priced securities;
(b) a sudden spike in investor demand for, coupled with a rising or decreasing price in, thinly-traded, low-priced securities;
(c) suspicious manipulative, pre-arranged or wash trading activity;
(d) subscribers who were publicly known to be the subject of criminal, civil or regulatory actions for crime, corruption, or misuse of public funds.

In response to the SEC exam, OTS Link added two people to its AML compliance team and hired a third-party compliance consultant to review the program.

The SEC order mandates additional reporting and levied a $1.19 million fine. You either pay for compliance or you PAY for compliance failure.

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Customer Identification Programs are coming for private fund managers

The Securities and Exchange Commission and the U.S. Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN) jointly proposed a new rule that would require SEC-registered investment advisers and exempt reporting advisers to have customer identification programs (CIPs). The proposed rule is designed to prevent illicit finance activity involving the customers of investment advisers. The proposal is generally consistent with the CIP requirements for other financial institutions, such as brokers or dealers in securities and mutual funds.

This proposed rule complements the separate FinCEN proposed from February 2024 to designate RIAs and ERAs as “financial institutions” under the Bank Secrecy Act and subject them to AML/CFT program requirements and suspicious activity report filing obligations. 

I think most fund managers are already taking steps to make sure they are not doing business with terrorists, drug-dealers and other sanctioned people. The proposed rule is going to require more paperwork for low-risk customer/clients/investors.

At this point its just a proposed rule. I think it will eventually be put in place and largely unchanged. It’s really just a question of timing. I assume they will try to put this rule in place with the same compliance deadline as the February proposal. There is a 60-day comment period and then time to address the comments. I’d guess fourth quarter of 2024 for publication of the final rule and 2025 year-end for a compliance deadline.

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Corporate Transparency Act Hits a Snag

On March 1, the US District Court in Northern Alabama ruled that the “Corporate Transparency Act is unconstitutional because it exceeds the Constitution’s limits on Congress’ power.” It’s not clear what effect this ruling is going to have on other parties and other jurisdictions.

Congress passed the 2021 National Defense Authorization Act which included a bill called the Corporate Transparency Act (“CTA”). The CTA requires most entities incorporated under State law to disclose personal stakeholder information to the Treasury Department’s criminal enforcement arm.

There are two dozen exemptions, mostly for entities that are otherwise regulated. Many private fund managers have been trying to figure out how the exemptions apply. There is still some uncertainty on these exemptions. For example, registered investment advisers are exempt and private funds listed on Form ADV are exempt. Subsidiaries can be exempt, but FinCEN Seems to want to keep that exemption very narrow.

L. 6. Does a subsidiary whose ownership interests are partially controlled by an exempt entity qualify for the subsidiary exemption?

No. If an exempt entity controls some but not all of the ownership interests of the subsidiary, the subsidiary does not qualify. To qualify, a subsidiary’s ownership interests must be fully, 100 percent owned or controlled by an exempt entity.

A subsidiary whose ownership interests are controlled or wholly owned, directly or indirectly, by certain exempt entities is exempt from the BOI reporting requirements. In this context, control of ownership interests means that the exempt entity entirely controls all of the ownership interests in the reporting company, in the same way that an exempt entity must wholly own all of a subsidiary’s ownership interests for the exemption to apply.

[Issued January 12, 2024] https://www.fincen.gov/boi-faqs#L_6

Back to the case…

The Government argued that it has three sources of constitutional authority for enactment of the CTA. First, the Government argues that Congress has the power to enact the CTA under its foreign affairs powers. The CTA comes from the government’s interest in curbing foreign money laundering and other bad foreign money influences. The second sources is the Commerce Clause authority. Because many entities engage in activities that qualify as or affect “commerce,” the act of corporate formation itself is enough to invoke Congress’ Commerce Clause powers. Third, the Government argued that the CTA is a necessary and proper exercise of Congress’ taxing power, because one purpose of the FinCEN database created by the CTA is to assist in efficient tax administration.

The Court didn’t agree with any of these three arguments.

So now what?

Unless you are Isaac Winkles or the National Small Business Association, the court’s ruling does not apply to you. I suppose if you are in Alabama, you could argue that it might cover you. For the rest of us, who have created a new non-exempt entity in 2024, I think we still have to make that filing it 90 days.

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Anti-Money Laundering Rule for Investment Advisers – Take 3

We’ve been here before. FinCEN proposed anti-money laundering rules for investment advisers in 2003 and 2015. The pushback has been the Custody Rule, which requires a third-party to hold the client assets. That third-party will be doing the AML-KYC review. Those that are doing self-custody fall under existing AML rules.

Since 2015, there has been expansion in the weaponization of the dollar against persons and countries that the United States has issues with. The current hot button being Russian wealth. So, I think the rule is going to end up being promulgated this time.

It’s a lighter version of the rule that would require registered investment advisers and exempt reporting advisers to:

  • implement an AML/CFT program;
  • file certain reports, such as Suspicious Activity Reports, with FinCEN;
  • keep records such as those relating to the transmittal of funds (i.e., comply with the Recordkeeping and Travel Rule); and
  • fulfill other obligations applicable to financial institutions subject to the BSA and FinCEN’s implementing regulations.

It would not require customer identification program requirements. At this time. That requirement is specifically called out for a future joint rulemaking with the SEC.

The rule also proposes to delegate examination authority to the SEC.

The proposal has a 60-day comment period and a 12-month compliance deadline. No need to act currently. I think we’ll need to pencil it in for workplans in the second half of 2024.

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ABA Amends Rule on Client Due Diligence

The American Bar Association House of Delegates adopted a resolution that strengthens a lawyer’s obligation to decide before accepting or maintaining representation whether a client seeks to use the lawyer’s services to further a crime or fraud. This is part of an effort to alleviate concerns about the use of lawyers to facilitate money laundering and other financial crimes.

Kevin Shepherd, the ABA’s Treasurer, said that the U.S. Treasury Department had informed him that a failure to pass the resolution would cause the agency to take immediate regulatory action and to lobby for legislation imposing additional obligations on lawyers.

A few months ago Robert Wise, a New York lawyer, plead guilty to criminal charges stemming from payments he made for Russian oligarch Viktor Vekselberg, to maintain six properties in New York and Florida owned by the Russian billionaire in violation of sanctions.

The resolution adds a new inquiry requirement for lawyers under the ABA Model Rule of Professional Conduct:

(a) A lawyer shall inquire into and assess the facts and circumstances of each representation to determine whether the lawyer may accept or continue the representation. Except as stated in paragraph (c), a lawyer shall not represent a client or, where representation has commenced, shall withdraw from the representation of a client if:

…. (4) the client or prospective client seeks to use or persists in using the lawyer’s services to commit or further a crime or fraud, despite the lawyer’s discussion pursuant to Rules 1.2(d) and 1.4(a)(5) regarding the limitations on the lawyer assisting with the proposed conduct.

The commentary is very direct

[1] Paragraph (a) imposes an obligation on a lawyer to inquire into and assess the facts and circumstances of the representation before accepting it. The obligation imposed by Paragraph (a) continues throughout the representation. A change in the facts and circumstances relating to the representation may trigger a lawyer’s need to make further inquiry and assessment. For example, a client traditionally uses a lawyer to acquire local real estate through the use of domestic limited liability companies, with financing from a local bank. The same client then asks the lawyer to create a multi-tier corporate structure, formed in another state to acquire property in a third jurisdiction, and requests to route the transaction’s funding through the lawyer’s trust account. Another example is when, during the course of a representation, a new party is named or a new entity becomes involved.

We’ve seen the actions FinCEN have taken against title insurance companies under the Real Estate Geographical Targeting Orders.

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The Biden Strategy on Fighting Corruption

Yesterday’s story on FinCEN planning new Real Estate Anti-Money Laundering Regulations is just part of the larger plan of the Biden administration’s plan to fight corruption. For more details check out the recently released United States Strategy on Countering Corruption.

This is full of worthy goals. The stability of the US dollar is big lure for dirty money. I have some concerns about overly weaponizing the dollar internationally for fear that some other currency will take over as the de facto currency of the world. Right now, there are no other good candidates.

As for the details on the White House plan, I focused on how it might directly affect me.

One is the return of the 2015 rulemaking to “prescribe minimum standards for antimoney laundering programs and suspicious activity reporting requirements for certain investment advisor.” This time there is a particular focus on hedge funds, trusts, private equity funds and other vehicles. In particular, it looks like there will some focus on operations of private placements.

The White House is also looking at the gatekeepers to transactions: lawyers, accountants, and registered agents. They may hit with some anti-money laundering requirements, both as recordkeepers and targets for enforcement.

As yesterday’s story on real estate pointed out that it has been a tool for laundering money, the White House strategy includes a focus on digital assets and art. Those are two areas that are believed to be exploited by illicit money.

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