Category: Anti-Money Laundering

Proposed Anti-Money Laundering Regulations for Investment Advisers and Fund Managers

After years of talking about it, the Financial Crimes Enforcement Network (FinCEN) issued a proposed a rule requiring certain investment advisers to establish anti-money laundering programs and report suspicious activity to FinCEN. The new regulations propose to include investment advisers in the general definition of “financial institution,” which would require them to file Currency Transaction Reports and keep records relating to the transmittal of funds.

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For private funds, engaging in Know-Your-Customer and Anti-Money Laundering has become a standard practice. Now, 12 years after FinCEN first proposed a rule-making, and then withdrew it, FinCEN published a new 86-page proposal.

The proposal would apply to investment advisers that are required to be registered with the U.S. Securities and Exchange Commission, including advisers to hedge funds, private equity funds, and other private funds. FinCEN would delegate its authority to examine investment advisers for compliance with these requirements to the SEC.

Here is the main part of the proposed regulations:

(a)(1) Each investment adviser shall develop and implement a written anti-money laundering program reasonably designed to prevent the investment adviser from being used for money laundering or the financing of terrorist activities and to achieve and monitor compliance with the applicable provisions of the Bank Secrecy Act (31 U.S.C. 5311 et seq.) and the implementing regulations thereunder.

(2) Each investment adviser’s anti-money laundering program must be approved in writing by its board of directors or trustees, or if it does not have one, by its sole proprietor, general partner, trustee, or other persons that have functions similar to a board of directors. An investment adviser shall make its anti-money laundering program available for inspection by FinCEN or the SEC upon request.

(b) Minimum requirements. The anti-money laundering program shall at a minimum:

(1) Establish and implement policies, procedures, and internal controls reasonably designed to prevent the investment adviser from being used for money laundering or the financing of terrorist activities and to achieve and monitor compliance with the applicable provisions of the Bank Secrecy Act and the implementing regulations thereunder;
(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; and
(4) Provide ongoing training for appropriate persons.

You would have 60 days to comment once it is published.

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Upcoming Anti-Money Laundering Rules for Private Funds

The Treasury’s Financial Crimes Enforcement Network has been toying with how to impose anti-money laundering standards on private funds and investment advisers for years. There is rumbling from the White House Office of Management and Budget that it approved proposed new regulation.

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A notice of rulemaking was dropped a few years ago. The thought then was that the underlying custodian has AML standards in place to keep things in line for investment advisers.

The posting at the OMB states that a proposal is moving along. According to the entry, the rule would “prescribe minimum standards for anti-money laundering programs to be established by certain investment advisers and to require such investment advisers to report suspicious activity to FinCEN.”

A few months ago U.S. Treasury Undersecretary for Terrorism and Financial Intelligence David Cohen gave speech to to the ABA/ABA Money Laundering Enforcement Conference and said changes are underway.

It looks like changes are coming.

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Laundering Dollar Bills is by  TaxRebate.org.uk

Lighting Up the Towers of Secrecy Through Anti-Money Laundering Requirements

Money Laundering: Hiding ownership and profits in offshore jurisdictions using myriad mechanisms in Switzeland, money laundering capital of the world, & other islands and nations. Favorite tool of mega-rich arch-criminal banking & corporate investors

A group of nonprofit organizations urged the Treasury Department’s Financial Crimes Enforcement Network to repeal the 2002 temporary exemption from provisions of the Patriot Act that had been granted to the real estate industry. The letter was a reaction to the Towers of Secrecy story in the New York Times.

Behind the dark glass towers of the Time Warner Center looming over Central Park, a majority of owners have taken steps to keep their identities hidden, registering condos in trusts, limited liability companies or other entities that shield their names. By piercing the secrecy of more than 200 shell companies, The New York Times documented a decade of ownership in this iconic Manhattan way station for global money transforming the city’s real estate market.

The issue with imposing anti-money laundering requirements on real estate transactions is deciding who is responsible for doing so. Is it the real estate broker? the buyer? the buyer’s attorney (if there is one)? If there is a mortgage loan, the lender is running a KYC program. But if there is no loan, there is no AML check.

You can also understand privacy concerns of many wealthy buyers. Tom Brady and Giselle Bundchen don’t need crazed fans outside their door. Besides the nuisance, there are legitimate personal safety concerns.

When it comes to anti-money laundering requirements in real estate there are really several different sectors. The Towers of Secrecy story focuses only on ultra-expensive residential real estate. When the purchase price is in the tens or hundreds of millions of dollars it is easier to impose some transaction costs and paperwork associated with anti-money laundering. It’s hard when the scale comes down to regular priced real estate that you and I could afford.

Commercial real estate already operates under the concern of anti-money laundering. There may not be any specific proscribed steps, but its still illegal to conduct business with sanctioned individuals.

These are the groups that signed the letter:

Center for Effective Government
Citizens for Responsibility and Ethics in Washington (CREW)
EG Justice
Financial Accountability and Corporate Transparency (FACT) Coalition
Global Financial Integrity
Global Integrity
Global Witness
Government Accountability Project
(GAP)
Jubilee USA Network
Missionary Oblates USA
New Rules for Global Finance Coalition
Open The Government.org
Oxfam America
Tax Justice Network USA
Transparency International
Transparency International – USA
U.S. Public Interest Research Group (PIRG)

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Anti-Money Laundering Regulations are Coming for Private Funds

Money Laundering: Hiding ownership and profits in offshore jurisdictions using myriad mechanisms in Switzeland, money laundering capital of the world, & other islands and nations. Favorite tool of mega-rich arch-criminal banking & corporate investors

Investment advisers and private funds have largely not been under the strict regulatory requirements under Bank Secrecy Act. The rationale is that the custody requirements impose a custody account and the custodian is subject to those rules.

It looks like things are going to change. U.S. Treasury Undersecretary for Terrorism and Financial Intelligence David Cohen gave  speech to to the ABA/ABA Money Laundering Enforcement Conference and said changes are underway.

FinCEN, in consultation with the SEC, is working to define SEC-registered investment advisers as financial institutions and, because of their unique insight into customer and transaction information, to extend AML program and suspicious activity reporting requirements to them.

In 2012, the Federal Reserve, FDIC, OCC, NCUA, SEC, CFTC, IRS, and DOJ, formed an AML Task Force to review the AML regime.  The Task Force’s mandate was to take a close look at what was working well and what areas might need some improvement, leveraging input from the private sector through the Bank Secrecy Act Advisory Group.

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Kleptocracy Asset Recovery Initiative

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Last week, the son and heir-apparent to the president of Equatorial Guinea agreed to give up $34 million in assets as part of a settlement with the U.S. government over corruption claims. This was the latest attack by the Department of Justice’s Kleptocracy Asset Recovery Initiative.

According to the Wall Street Journal, the Kleptocracy Asset Recovery Initiative has collected about $600 million out of the $1.2 billion pursued from 15 cases against current or former officials and businessmen.

The government accused Second Vice President Teodoro Obiang Nguema Mangue of amassing assets worth $300 million on an annual salary of less than $100,000.

He has agreed to sell a Malibu mansion, a Ferrari and six life-size Michael Jackson statues. He gets to keep a Gulfstream jet, a luxury boat and most of his collection of Michael Jackson memorabilia, including the crystal-encrusted glove from the late singer’s ‘Bad’ tour (At least for now). If you want to see an incredible collection of Michael Jackson memorabilia, you can find it at the Equatoguinean Cultural Center in Malabo.

Mr. Obiang’s father is still in power, so the government of Equatorial Guinea didn’t cooperate with the U.S. government’s investigation. There are obvious signs of corruption, but the US government faced an uphill battle trying to trace Mr. Obiang’s US based assets back to corruption in his native country.

The main link was the anti-Money laundering failures of Riggs Bank. Starting in the mid-1990s, Riggs Bank opened dozens of accounts for the government of Equatorial Guinea, as well as senior government officials. By 2003 those accounts were worth almost $700 million.

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Proposed Regulations on Customer Due Diligence Requirements

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The U.S. Treasury Department’s Financial Crimes Enforcement Network has proposed revisions to its customer due diligence rules. Of course, the proposed rule would affect financial institutions that are currently subject to FinCEN’s customer identification program requirement: banks, brokers-dealers, and mutual funds. However, FinCEN suggested that it may be considering expanding these customer due diligence requirements to other types of financial institutions. FinCEN names money services business, casinos and insurance companies. Investment advisers and private fund managers are not specifically mentioned.

According to FinCEN, an Anti-Money Laundering program should have four elements:

  1. Identify and verify the identity of customers;
  2. Identify and verify the identity of beneficial owners of legal entity customers
  3. Understand the nature and purpose of customer relationships; and
  4. Conduct ongoing monitoring to maintain and update customer information and to identify and report suspicious transactions.

Please notice number 2. The definition of “beneficial owner” is proposed as have two prongs:

  • Ownership Prong: each individual who, directly or indirectly, through any contract, arrangement, understanding, relationship or otherwise, owns 25% or more of the equity interests of a legal entity customer, and
  • Control Prong: An individual with significant responsibility to control, manage, or direct a legal entity customer, including an executive officer or senior manager (e.g., a Chief Executive Officer, Chief Financial Officer, Chief Operating Officer, Managing Member, General Partner, President, Vice President, or Treasurer); or (ii) any other individual who regularly performs similar functions.

For identifying ownership of an entity, FinCEN has proposed a form of certification. I find the certification to be overly simplistic. It only asks for individuals with ownership in the entity. This would clearly miss ownership of the account holder by other entities who could be “bad guys.” The certification also only requires one senior officer.  That makes it too easy to appoint a straw man as executive officer to hide the underlying control by a “bad guy.”

On the other hand, it makes it really easy for the financial institution to check the boxes with requirements and confirm compliance.

The rule does not specifically contemplate investment advisers or private fund managers. For many investment advisers, the underlying broker-dealer or custodian will end up with KYC responsibilities. The investment adviser will have to be a conduit for that information.

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FinCEN Emphasizes a Culture of Compliance

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The US Financial Crimes Enforcement Network has finally come around to realizing that US financial institutions should promote a culture of compliance. FinCEN does not point to any specific problem, but mere notes that “Shortcomings identified in recent Anti-Money Laundering enforcement actions confirm that the culture of an organization is critical to its compliance.”

FinCEN’s mission is to safeguard the financial system from illicit use and combat money laundering and promote national security through the collection, analysis and dissemination of financial intelligence and strategic use of financial authorities.

I don’t think that that anyone believes that these roadblocks in the financial system will prevent terrorism, drug sales or other illegal activities. But it should prevent law-abiding financial institutions from helping illegal activities.

The FinCEN’s advisory (.pdf) comes off as a bit stale since the culture of compliance mantra has been echoing throughout financial institutions for many years.

One piece of the FinCEN guidance did catch my eye:

Compliance should not be compromised by revenue interests

Again, this guidance is not novel, but rarely have I seen it so specific. AML compliance should operate independently and be able to take appropriate actions to mitigate risk and investigate possible inappropriate activity.

When BNP Paribas SA, compliance staff gave warnings but then assisted with misconduct, you understand the need for FinCEN to be more explicit about compliance culture.

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Bank Fraud is Okay, But not Drugs or Terrorism

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I would like to think that many of the bankers involved in illegal money laundering are not actually aware of the full extent of their malfeasance. Maybe they should have done a better job looking at a client when they noticed a red flag. But sometimes you run across a case where the bankers are truly scumbags. The Department of Justice just brought charges in such a case.

A combined Department of Justice and Internal Revenue Service sting lead to the arrests of two Caribbean-based bankers and their lawyer for conspiracy to launder money and hide the identities and assets of U.S. taxpayers. According to the indictment, Joshua Vandyk and Eric St-Cyr lived in the Cayman Islands and worked for an investment firm based there. Patrick Poulin was the firm’s attorney, based in Turks and Caicos. According to the indictment, Vandyk, St-Cyr and Poulin solicited U.S. citizens to use their services to hide assets from the U.S. government.

The case starts off as bread and butter fraud, trying to shield assets and avoid tax. The feds sent in three undercover agents to use the services to catch them red-handed. Vandyk and St-Cyr told the agents to create offshore foundations, with help from Poulin, so the investment firm wouldn’t look like it dealt with U.S. clients. Vandyk and St-Cyr then invested the money outside the United States in the name of the offshore foundation. The investment firm said it wouldn’t disclose its clients or their gains to the U.S. government, or send the clients any investment statements. The firm’s clients could monitor their investments online through the use of anonymous, numeric passcodes and liquidate their accounts on request.

What caught my attention was the defendants knew the money coming in was illegal money. One of undercover agents told all three defendants that the cash was coming from a bank fraud that he committed. Vandyk “indicated that this was acceptable to the co-conspirators so long as the money was not linked to drugs or terrorism.”

Of course, the information in this article comes only from the indictment, so the defendants have not had a chance to tell their side of the story.

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New Lists to Check for Bad Guys

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If you conduct business overseas or have foreign investors in your funds, you are checking the various block persons lists to ensure you’re not working with bad guys. (You are checking, right.) The Office of Foreign Assets Control (“OFAC”), of the U.S. Department of the Treasury, has created two new lists: the Foreign Sanctions Evaders List and the Blocking Property of Additional Persons Contributing to the Situation in Ukraine.

Foreign Sanctions Evaders List

The FSE List implements Executive Order 13608 by identifying non-U.S. persons and entities that have engaged in conduct evading U.S. economic sanctions with respect to Iran or Syria.  The FSE-listed individuals or entities are not necessarily located in Iran or Syria.

You are generally prohibited from all transactions or dealings, direct or indirect, involving persons or entities identified on the FSE List related to any goods, services, or technology (i) in or intended for the United States, or (ii) provided by or to U.S. persons, wherever located.  However, unlike the OFAC Specially Designated Nationals List, the new FSE List does not require blocking of property and reporting of transactions with FSE-listed entities.

OFAC has elected to maintain a separate FSE List rather than include the FSE entries on the Specially Designated Nationals List.  That means you need to screen against both lists. Most likely, you are using software or a third-party service provider, so check to make sure the FSE List was added to the screening protocol.

Blocking Property of Additional Persons Contributing to the Situation in Ukraine

By Executive Order on March 20, 2014, President Obama put in place new restrictions on companies and individuals that operates in sectors of the Russian Economy that would support the Russian Federation’s annexation of Crimea. It’s an expansion of 13660 and 13661.

So far, the orders have brought sixteen Russian government officials, members of the Russian leadership’s inner circle, and a Russian bank into the sanctions regime. Bank Rossiya (ОАО АБ РОССИЯ) is the personal bank for senior officials of the Russian Federation.

OFAC has added the blocked persons to the Specially Designated Nationals List. I received a notice that my vendor has already included the names in its database.

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Image of villain is a caricature by J.J. McCullough
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J.P. Morgan’s Madoff Failure

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Yesterday J.P. Morgan agreed to forfeit $1.7 billion for its failure related to the Bernie Madoff fraud, plus several hundred million in fines. As part its deferred prosecution agreement, the bank agreed that it did not have the proper systems in place to catch Madoff. It’s easy to target the bank for compliance failures but I wanted to dig a little deeper to see what went wrong. The picture is not very clear and I’m not sure why the bank forfeited so much cash.

J.P. Morgan was the main bank for Madoff from 1986 until the fraud collapsed. With money moving in an out of the accounts, J.P. Morgan could presumably have noticed something wrong with the flow of money. But that would likely be difficult. Madoff would have moved money around through several accounts. It would not be a simple task to track the flow of cash and see the fraud. If it were that simple, it would have been spotted much earlier. The agreement notes a few flags on the account and some inadequate diligence by the relationship personnel. None of that data seems to indicate a bigger problem with the flow of cash.

There was a mid 1990s transaction that looked like check kiting between an unnamed private bank client of Chemical Bank (which was eventually consumed by J.P. Morgan), Madoff and a second bank. The second bank ended up terminating the relationship and filing a suspicious activity report. J.P. Morgan did not. The private bank client did not terminate the relationship because Madoff had turned the investment from $183 million to $1.7 billion over 12 years. Madoff’s fake returns bought silence.

In the late 1990s and again in 2007 divisions of J.P. Morgan were considering having its private bank invest in Madoff. But Madoff was unwilling to help with the bank’s diligence efforts and the the bank expressed concerns when it was unable to reverse engineer Madoff’s returns.

In 2006 the London office of the bank had set up an exotic derivative that would provide clients with synthetic exposure to a hedge fund without making a direct investment in the fund itself. To cover the other side, J.P. Morgan invested in a Madoff feeder fund. Apparently, the derivative was wildly successful and hit the bank’s $100 million exposure limit. The traders went to an internal committee to get an exposure increase to $1 billion. The committee tabled approval because the bank couldn’t get the diligence it wanted. Madoff refused to allow the bank to conduct due diligence on his fund directly.

That triggered more diligence efforts and an increasing unease at the bank about having exposure to Madoff. J.P. Morgan began redeeming its interests in the Madoff feeder funds. This was 2008 and Lehman had just collapsed and the Madoff fraud would be exposed in a few months. J.P. Morgan also began unwinding those synthetic exposures. It looks like the bank was able to save $250 million before the Madoff collapse.

The key dagger seems to be when the London office of J.P. Morgan filed a report with the U.K. authorities as a result of its diligence. But J.P. Morgan did not file an equivalent report in the US. Under the Bank Secrecy Act, a bank needs to file Suspicious Activity Reports with FinCEN if the bank notes any suspicious transaction relevant to a possible violation of law or regulation.

The second big failure was that the suspicions were not transmitted from the investment side of the bank to the commercial banking side of the bank. The investment side wanted to limit its exposure and minimize its losses for being invested in a fraud. The banking side would have to take steps to prevent funds from leaving for improper purposes.

From the time the report was filed in London, the Madoff bank account at J.P. Morgan had fallen from $3 billion to $234 million. The $1.7 billion paid by J.P. Morgan is supposed to represent a portion of the money that the bank allowed to leave the Madoff account during that period.

What is boils down to is that in the Fall of 2008, just before the collapse of the Madoff fraud, J.P. Morgan took steps to protect its own business interests but failed to notify FinCEN of the same suspicious, potentially fraudulent, activities.

In the end I suspect J.P. Morgan thought it would not win the case if it went to trial. It has some bad facts on its side. One of the diligence emails joked that they should visit Madoff’s accountant’s office to make sure it wasn’t a car wash. The bank would never find a jury that would offer one iota of sympathy or understanding.

Then it was just a matter of how much cash the bank was willing to pay. It sounds like the initial government ask was about $3 billion: the $2.75 billion that left the Madoff bank account, plus the $250 million that the bank managed to avoid losing by redeeming out of the Madoff feeder funds. I assume the bank is looking to end as much of the regulatory actions from the 2008 financial crisis hanging over its heads as it can. Another one down.

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