Anti-Money Laundering Programs for Unregistered Investment Companies
November 19, 2002
On September 18, 2002, the U.S. Department of the Treasury's Financial Crimes Enforcement Network (FinCEN) proposed rules requiring certain unregistered investment companies to adopt and implement anti-money laundering programs. FinCEN is accepting written comments on the rules through November 25, 2002. FinCEN proposed the rules pursuant to the provisions of the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (USA PATRIOT Act), The act requires all "financial institutions" to implement anti-money laundering programs including, at a minimum, the following: the development of internal policies, procedures and controls; the designation of a compliance officer; an ongoing employee training program; and an independent audit function to test programs.
The term "financial institution" includes an "investment company," a term that, until FinCEN issued the proposed rules, had not been defined for purposes of the USA PATRIOT Act, although "investment company" is defined in section three of the Investment Company Act of 1940 ('40 Act).
Unregistered Investment Companies
Subject to three limitations and three exceptions, the proposed rules would define an "unregistered investment company" as any one of the following:
- an issuer that, but for the exclusions provided in '40 Act sections 3(c)(1), for issuers not engaged in or proposing to engage in a public offering ("private issuers") and with 100 or fewer beneficial owners of the issuer's securities, and 3(c)(7), for private issuers whose investors are all "qualified purchasers,"would be an investment company under the '40 Act;
- a commodity pool; and
- a company that invests primarily in real estate and/or interests therein.
FinCEN stated in the proposing release that hedge funds, private equity funds, venture capital funds, commodity pools and real estate investment trusts (i.e., REITS), among others, would be covered by that general definition. The proposed "unregistered investment company" definition, however, includes only three types of unregistered investment companies: those whose investors have a right to redeem any or all of the investors' ownership interest within two years after the interest was purchased; those with total assets of $1,000,000 or more (as of the most recent calendar quarter); and those that are organized in the United States, sell ownership interests to a U.S. person or are organized, operated or sponsored by a U.S. person.
Furthermore, the following companies are excepted from the "unregistered investment company" definition:
- companies owned by one family without regard to the amount of assets owned by the company;
- employees' securities companies, which are investment companies established by employers for the benefit of employees; and
- employee benefit plans that are excluded by CFTC Rule 4.5(a)(4) from the commodity pool definition.
To avoid subjecting unregistered investment companies to more than one set of anti-money laundering rules, the proposed rules would not apply to unregistered investment companies that also fall within another category of "financial institution" (e.g., a securities broker).
Required Elements of Anti-Money Laundering Programs
Unregistered investment companies subject to the rules would have to develop anti-money laundering programs within 90 days after publication of a final rule. The proposed rules do not mandate the complete structure of an anti-money laundering program because "the requirement to have an anti-money laundering program is not a one-size-fits-all requirement" and "each financial institution should have the flexibility to tailor its program to fit its business, taking into account factors such as size, location, activities and risks or vulnerabilities to money laundering." The proposed rules would require anti-money laundering programs to address each of four elements.
Establish and implement policies, procedures and internal controls reasonably designed to prevent unregistered investment companies from being used to launder money or finance terrorist activities, including, but not limited to, achieving compliance with applicable Bank Secrecy Act (BSA) provisions and regulations.
This provision of the proposed rules would require that each unregistered investment company identify its potential vulnerability to money laundering and terrorist financing activity, understand applicable BSA requirements, identify the risk factors related to those requirements, design procedures and controls reasonably required to assure compliance with those requirements, and assess periodically the effectiveness of those procedures and controls. An unregistered investment company that identifies suspicious activity should take reasonable steps to determine if its suspicions are justified and respond accordingly. If a transaction appears designed to further illegal activity, the company should refuse to enter into the transaction. Sections 18 U.S.C. §§ 1956 and 1957 provide that it is a crime for any person, including an individual or company, to engage knowingly in a financial transaction with the proceeds from any of the listed crimes or "specified unlawful activity." Although the standard of knowledge required is "actual knowledge," actual knowledge may include "willful blindness." Consequently, a person could be deemed to have actual knowledge that proceeds were derived from illegal activity if he or she ignores "red flags" indicating illegal activity.
Provide for independent compliance testing by company personnel or a qualified outside party.
Unregistered investment companies would be required to conduct periodic testing of their programs, or delegate that responsibility to a third party, to assure that the programs are functioning as designed. Those conducting the testing cannot be involved in the operation or oversight of the program.
Designate a person or persons responsible for implementing and monitoring the operations and internal controls of the program.
Unregistered investment companies would be required to delegate a specific individual or committee the responsibility for overseeing the anti-money laundering program.
Provide ongoing training for appropriate persons.
Unregistered investment companies would be required to train their employees (and/or those of any third-party service providers responsible for carrying out an element of the company's anti-money laundering program) regarding the anti-money laundering requirements relevant to the employees' job functions and the signs of money laundering that could arise in performing their duties.
Use of Third-Party Service Providers
Unregistered investment companies, like mutual funds, typically engage a variety of third-party service providers (e.g., fund administrators and investment advisers) to conduct their business. In recognition of that structure, the proposed rules permit an unregistered investment company to delegate the implementation and operation of its anti-money laundering program to third parties. The unregistered investment company would remain fully responsible for the anti-money program and for ensuring that regulators are able to obtain program-related information and records and to inspect the third party for purposes of the program.
Notices
Because unregistered investment companies are not necessarily registered with or identifiable by any U.S. government agency, the proposed rules would require that each unregistered investment company file a short notice with FinCEN identifying itself and providing the following basic information about the company: the name, address, e-mail address and telephone number of the unregistered investment company; the name, address, e-mail address, telephone number and registration number of any investment adviser, commodity trading advisor, commodity pool operator, organizer or sponsor of the unregistered investment company; the name, e-mail address and telephone number of the designated anti-money laundering program compliance officer of the unregistered investment company; the dollar amount of assets under management held by the unregistered investment company; and the number of participants, interest holders or security holders in the unregistered investment company.
An unregistered investment company would have to file an initial notice within 90 days after first becoming subject to the provisions of the proposed rules, amend its notice within 30 days after any change to the information in the notice (other than the amount of assets under management or the number of participants) and withdraw its notice within 90 days after ceasing to be subject to the provisions of the proposed rule.
