Tag: FinCEN

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.

Sources:

Egypt, Mubarak and Politically Exposed Persons

Egypt’s top prosecutor requested the freezing of the foreign assets of ousted president Hosni Mubarak and his family. I expect that is one step in trying to figure out how much of Mubarak’s fortune was derived from corruption. I’ve read reports that his assets could be worth $3 billion and upwards of $70 billion.

That highlights a messier part of the investor due diligence process. Everyone is aware of the blocked-persons list from FinCEN. Those are the bad guys that you are prohibited from doing business with.

Mubarak falls into the category of “politically exposed person.” Those are senior foreign political figures.  They have not necessarily done something wrong, but should be subject to a higher level of scrutiny.

31 CFR 103.179

“In the case of a private banking account for which a senior foreign political figure is a nominal or beneficial owner, the due diligence program required by paragraph (a) of this section shall include enhanced scrutiny of such account that is reasonably designed to detect and report transactions that may involve the proceeds of foreign corruption.”

That is the US standard. The standard will differ from country to country. Switzerland enacted a new law giving officials the ability to freeze accounts belonging to any former leader suspected of corruption.

If you are taking money from foreign leaders you need to be careful and figure out where the money is coming from. If it’s cash from bribes you need to refuse it. The hard part is figuring out where the money came from. The leader could be independently wealthy. They could own successful business. They could be siphoning billions of dollars of foreign aid or skimming from an oil for food program.

If Mubarak showed up with wheelbarrows full of cash, theoretically, these accounts should already have been frozen when the money came in. But I suppose that’s a question of the winners making the rules. Bankers didn’t want to take steps while he was in power. Now that the money is sitting in their vaults, they are happy to freeze it. Especially now that Mubarak doesn’t control a half million soldiers.

Just as a reminder, FinCEN send out an advisory that: “Financial institutions should be aware of the possible impact that events in Egypt may have on patterns of financial activity when assessing risks related to particular customers and transactions.”

Sources:

Image of Muhammad Hosni Mubarak, President of Egypt addressing the Opening Plenary session of the World Economic Forum on the Middle East 2008 held in Sharm El Sheikh, Egypt is by the World Economic Forum

New Anti-Money Laundering Guidance

Money Laundering is bad and financial institutions need to have internal controls policies, procedures and processes to identify higher-risk accounts and monitor the activity. At the core of an anti-money laundering program is that an institution must know its customers and the risks presented by its customers.

The program becomes more difficult when the customer is a corporation or legal entity.

An alphabet soup of federal regulators just jointly issued new guidance “to clarify and consolidate existing regulatory expectations for obtaining beneficial ownership information for certain accounts and customer relationships.” The Financial Crimes Enforcement Network, Federal Reserve System, Federal Deposit Insurance Corporation, National Credit Union Administration, Office of the Comptroller of the Currency, Office of Thrift Supervision, Securities and Exchange Commission, and Commodity Futures Trading Commission all joined in the guidance.

Identifying the ownership and control of a legal entity can be difficult. Often, the only way to get the information is from the entity itself, with no third party way to identify the veracity of the information. Most financial institutions struggle with how far to dive into a legal entity to determine the beneficial ownership.

This joint guidance effectively adopts the FinCEN definition of beneficial owner:

“[T]he individual(s) who have a level of control over, or entitlement to, the funds or assets in the account that, as a practical matter, enables the individual(s), directly or indirectly, to control, manage, or direct the account. The ability to fund the account or the entitlement to the funds of the account alone, however, without any corresponding authority to control, manage, or direct the account (such as in the case of a minor child beneficiary), does not cause the individual to be a beneficial owner.” [31 CFR 103.175(b)]

The first step is to obtain enough information about the structure and ownership of the entity so you can determine if the account will pose a heightened risk. With a heightened risk, you should conduct enhanced due diligence.

Accounts for senior foreign political figures always require Enhanced Due Diligence that is reasonably designed to detect and report transactions that may involve the proceeds of foreign corruption. [31 CFR 103.178 (b)(2) and (c)]

The one interesting statement is that financial institutions should consider implementing policies on an enterprise-wide basis to share information about beneficial ownership of their customers. Anti-money laundering staff should be able to cross-check for information with other departments. Avoid silos of information.

The guidance does not offer anything new or insightful. But it is good to see the regulators joining together to try to standardize the expectations across different types of financial institutions.

Sources:

Image is by AlwaysAwake: 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

FinCEN and Address Confidentiality Programs

How do you open a bank account when you are hiding from domestic violence?

The rules implementing the Bank Secrecy Act require a financial institution to implement a Customer Identification Program that includes procedures that enable it to form a reasonable belief that it knows the true identity of its customers. The rules also require that a financial institution obtain a residential or business street address from each customer.

To make it easier for the victims of domestic violence, sexual assault or stalking to stay hidden from their attackers, 31 states have enacted Address Confidentiality Programs to help protect the home address of victims. These programs provide a confidential mail forwarding system. Typically, the Secretary of the State assigns a substitute address to the program participant to be used as their legal mailing address. Staff retrieve the participant’s mail and forward it to the participant’s actual physical location.

That is where the Address Confidentiality Program program runs into the Customer Identification Program.

But the Financial Crimes Enforcement Network issued a letter ruling to help financial institutions get out of this pickle. The FinCEN regulations also allow:

“If the individual customer does not have a residential or business street address, then the rules permit the individual customer to provide a “residential or business street address of next of kin or of another contact individual.”

See 31 C.F.R. §103.121(b)(2)(i)(3)(ii), §103.122(b)(2)(i)(A)(3)(ii), §103.123(b)(2)(i)(A)(3)(ii) and§103.131(b)(2)(i)(A)(3)(ii)

In FIN-2009-R003, FinCEN found:

A customer who participates in a state-created ACP shall be treated as not having a residential or business street address and a secretary of state, or other state entity serving as a designated agent of the customer consistent with the terms of the ACP, will act as another contact individual for the purpose of complying with FinCEN’s rules. Therefore, a financial institution should collect the street address of the ACP sponsoring agency for purposes of meeting its CIP address requirement.

Problem solved. At least it will be once knowledge about the ruling is passed along to front line people enforcing the Customer Identification Programs.

Sources:

Financial Crimes Enforcement Network 2008 Annual Report

The Financial Crimes Enforcement Network 2008 Annual Report (.pdf) has been released.

Outcome Goal 1: Financial systems resistant to abuse by money launderers, terrorists and their financial supporters, and other perpetrators of financial crime

Outcome Goal 2: Detection and deterrence of money laundering, terrorism financing, and other illicit activity.

Outcome Goal 3: Efficient management, safeguarding, and use of BSA information.

Management Goal: FinCEN’s mission is accomplished by high-performing employees and managers operating in a stimulating and responsible work environement.

Opening Securities and Futures Accounts from an OFAC Perspective

The Office of Foreign Assets Control published new guidance specific to the securities industry on 11/06/2008: Opening Securities and Futures Accounts from an OFAC Perspective.

A strong OFAC compliance program consists of procedures that are similar to those found in a brokerage firm’s Customer Identification Program (“CIP”). Firms should use risk-based measures for verifying the identity of each new customer who opens an account. In establishing procedures, firms should identify and consider their size (e.g., total assets under management), their location, their customer base, the types of accounts they maintain, the methods by which accounts can be opened (e.g., in person or non face-to-face), and the types of identifying information available for each customer. Firms should also assess risks posed by each customer and transaction, asking questions such as:

  • Is the customer regulated by a Federal functional regulator, widely known, or listed on an exchange?
  • Has the firm had any previous experience with the customer or does it have prior knowledge about the customer?
  • Is the firm facilitating a U.S. person’s investment in a foreign issuer or other company that conducts business in a sanctioned country?
  • Is the customer located in a high-risk foreign jurisdiction that is considered to be poorly regulated or in a known offshore banking or secrecy haven?
  • Is the customer located or does it maintain accounts in countries where local privacy laws, regulations, or provisions prevent or limit the collection of client identification or beneficial ownership information?

Prior to entering into a business relationship with a client, you should screen the new client’s identification information, as well as the customer’s proposed transaction(s), against OFAC’s Specially Designated Nationals and Blocked Persons list (“SDN list”) [which is available at
http://www.treasury.gov/resource-center/sanctions/SDN-List/Pages/default.aspx], and applicable OFAC sanctions programs.

The paper highlights a few key differences between OFAC compliance and CIP requirements. OFAC requires you to look deeper into the beneficial ownership of a client. CIP is limited to the “person that opens a new account.”

The other key difference is that OFAC does not permit you to reallocate your legal liability to a third party such as an introducing firm. OFAC takes the position that you can still be “held liable for any OFAC violations that occur due to the third parties’ negligence.”

Effects of FinCEN’s Withdrawal of Rule-Making on Anti-Money Laundering

Last week, FinCEN withdrew a proposed rulemaking for anti-moneylaundering procedures for unregistered investment companies. [See: FinCEN Withdraws Proposed Rulemaking for Unregistered Investment Companies]
FinCEN warned that they have not abandoned plans for rule-making. They merely felt that after six years the notice had gone stale. FinCEN may come out with AML program rule proposal, but would only do so after allowing for public comment that could take into account developments since the initial proposal.

Other existing AML obligations may limit the practical effect of this FinCEN action. First, the action does not alter the reach of the U.S. criminal money laundering laws, which still may apply in cases of “knowing” or “willfully blind” participation in money laundering schemes. Second, the FinCEN action does not affect the obligation of the subject entities to comply with the U.S. sanctions programs, which are administered by the U.S. Office of Foreign Assets Control (“OFAC”). Third, many advisers, unregistered investment companies, and commodity trading advisers likely will continue to be required by their investors, banks, prime brokers, and other counterparties to adopt AML programs, regardless of the scope of applicable legal standards. Entities may also be subject to AML regulation in non-U.S. jurisdictions where they conduct business or investment activities.

FinCEN Programs for Mutual Funds

Here are links to the text of some FinCEN program for mutual funds:

31 CFR 103.130 Anti-money laundering programs for mutual funds(.pdf)

each mutual fund shall develop and implement a written anti-money laundering program reasonably designed to prevent the mutual fund from being used for money laundering or the financing of terrorist activities and to achieve and monitor compliance. . .

31 CFR 103.131 Customer identification programs for mutual funds(.pdf)

A mutual fund must implement a written Customer Identification Program (‘‘CIP’’) appropriate for its size and type of business that, at a minimum, includes each of the requirements of
paragraphs (b)(1) through (5) of this section.

FinCEN Withdraws Proposed Rulemaking for Unregistered Investment Companies

On September 26, 2002, Financial Crimes Enforcement Network 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.

Today they gave notice under 31 CFR Part 103 Withdrawal of the Notice of Proposed Rulemaking for Anti-Money Laundering Programs for Unregistered Investment Companies. FinCEN is 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.