Unveiling FinCEN's Proposal: Strengthening the Financial System with Expanded AML/CFT Obligations

Introduction and Overview‍

In a move to fortify the U.S. financial system against money laundering, terrorist financing, and other illicit activities, the Financial Crimes Enforcement Network (FinCEN) has proposed significant regulatory enhancements. This initiative seeks to redefine the scope of the Bank Secrecy Act (BSA) to include certain investment advisers within its purview by extending Anti-Money Laundering/Countering the Financing of Terrorism (AML/CFT) obligations to a broader segment of the financial industry. This blog post delves into the consultative paper issued by FinCEN, breaking down the proposed changes, their implications, and the potential impact on various stakeholders within the investment advisory sector.

‍Summary of Key Changes from Existing Regulations‍

The consultative paper presents a pivotal shift in the regulatory landscape for investment advisers in the United States. The key proposals include:‍

1. ‍Inclusion of Investment Advisers as Financial Institutions: For the first time, Registered Investment Advisers (RIAs) and Exempt Reporting Advisers (ERAs) are proposed to be classified as "financial institutions" under the BSA. This classification subjects them to stringent AML/CFT obligations, addressing a significant gap in the current regulatory framework.
2. ‍Mandatory AML/CFT Programs: The proposal mandates RIAs and ERAs to establish comprehensive AML/CFT programs. These programs must adopt a risk based approach and should include mechanisms for reporting suspicious activities to FinCEN, conducting independent testing and fulfilling other BSA obligations.
3. ‍Reporting Adjustments: Unlike the previous requirements, the new rule proposes shifting from the use of Form 8300 for reporting certain cash transactions to a more streamlined Currency Transaction Report (CTR) for transactions involving more than $10,000 in currency conducted during a single business day. In addition, by the definition of financial institutions, investment advisors are obliged to report suspicious activities and transactions under the SAR (Suspicious Activity Reporting) rule.
4. ‍Record keeping requirement: Investment advisors are to follow the standard travel rule and record keeping requirement while they engage in transactions that qualify under the definition of transmittal order.
5. ‍SEC as the Examination Authority: FinCEN proposes to delegate its examination authority for these new regulations to the Securities and Exchange Commission (SEC), leveraging the SEC's deep expertise in regulating investment advisers.‍

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What Is Expected

Under the new regulations, investment advisers are expected to implement robust AML/CFT programs tailored to their specific operations and risks. These programs should enable advisers to identify, assess, and take effective action against potential money laundering, terrorist financing risks and other illicit activities, significantly enhancing the transparency and integrity of financial transactions within their purview. The key elements would entail:

• Strong AML/CFT program comprising of robust policies, procedures, and internal similar to any standard financial institutions/ broker and dealers to ensure adequate controls to detect and combat money laundering and terrorist financing.
• The appointment of a designated AML/CFT compliance officer to oversee the implementation of the above program.
• Conduct independent audit and testing of the said program on a periodic basis by someone with adequate AML knowledge and expertise.
• Set up an employee training program covering general awareness of AML/CFT requirements as well as any additional information required by an employee to discharge their duties properly.
• Risk-based approach for conducting ongoing Customer Due Diligence (CDD) including 4 key elements – customer identity verification, beneficial owner identification and verification, understanding nature of customer relationships, and ongoing customer monitoring.
  • However, the requirement wrt beneficial owner identification and verification will be implemented at a later date through a joint rule-making with the SEC, considering the ongoing implementation of the Corporate Transparency Act (CTA).

Who All Are Impacted

The proposed regulations impact a broad array of stakeholders in the investment advisory sector, including:

• Registered Investment Advisers (RIAs): RIAs will now be required to comply with comprehensive AML/CFT obligations, marking a significant expansion of their regulatory responsibilities.
• Exempt Reporting Advisers (ERAs): Like RIAs, ERAs will also fall under the new AML/CFT regulatory regime, necessitating the establishment of formal AML/CFT programs and compliance frameworks.
• Associated Financial Institutions: Banks, broker-dealers, and other financial institutions that interact with investment advisers may also see changes in their dealings, particularly in terms of information sharing and reporting obligations.

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Who All Are Exempt

While the proposed rule significantly broadens the scope of the BSA, certain exemptions are noteworthy:

• ‍Mutual Funds: Already defined as "financial institutions" under the BSA, mutual funds are not subjected to additional AML/CFT obligations under the proposed rule.‍
• State-Registered Investment Advisers: The proposal does not extend to state-registered investment advisers, based on FinCEN's assessment of the irrelatively lower risk for money laundering and terrorist financing activities.

This consultative paper from FinCEN heralds a new era of regulatory oversight for the investment advisory sector, aiming to close significant loopholes in the U.S. financial system's defenses against illicit finance. As these proposals move through the regulatory process, investment advisers and other stakeholders will need to prepare for a more stringent AML/CFT regulatory environment, enhancing their practices to meet the evolving standards of financial integrity and security.

Note: This is an NPRM (Notice of Proposed Rule-Making),which implies that the rules proposed here are under discussion. FinCEN has currently invited comments and the final rules might change significantly from what is outlined in the document.