Will This AML Rule for Investment Advisors Finally Come to Life? 

This February, the Financial Crimes Enforcement Network (FinCEN) released a Notice of Proposed Rule Making (NPRM) that would create an anti-money laundering (AML) program and suspicious activity reporting requirements for investment advisors (IAs) and exempt reporting advisors (ERAs). IAs and ERAs to date have not been defined as financial institutions (FI) subject to an AML rule, and so this proposed rule would begin to close a yawning regulatory gap.

Proposals for AML oversight for IAs and ERAs may seem familiar: An NPRM was raised in 2015¹ but then mooted. Tailwinds behind this new effort include a charged economic and political environment. The growth of the independent advice business in recent years further supports the need to strengthen regulatory requirements. 

Many across the industry have pondered why IAs and ERAs have been exempted from AML regulation. To some, it appears that IAs and ERAs pose a lower risk due to their relationships with custodians, which often include broker-dealers and banks that are required to maintain robust AML programs. Treasury conducted a risk assessment as part of the U.S. Strategy on Countering Corruption. “The risk assessment found several cases in which sanctioned individuals, corrupt officials, tax evaders, and other criminal actors have used investment advisers as an entry point to invest in U.S. securities, real estate, and other assets. Treasury’s risk assessment also identified cases of foreign adversaries, including China and Russia, investing in early-stage companies through investment advisers to access sensitive information and emerging technology.”² 

Currently, there is piecemeal coverage of the industry often due to reliance on custodians to provide needed AML compliance controls. Risk can vary significantly, in line with each IA’s and ERA’s business model and structure. This new proposed rule will create a comprehensive requirement for certain IAs and ERAs to embed specific AML and suspicious activity reporting controls to mitigate risks that provide illicit finance a path to enter and permeate the U.S. financial markets. 

Not all IAs are included in the proposed rule. Included are IAs registered with the Securities and Exchange Commission (SEC), also known as registered investment advisers (RIAs). This generally includes IAs with more than US$110 million in assets under management (AUM). Also included are ERAs, which are IAs that either only advise private funds and have less than US$150 million AUM in the U.S. or advise only venture capital funds. Despite being exempt from SEC registration, ERAs must file certain information with the SEC and are included in the proposed rule. 

Proposed Rule Requirements 

1. Implement an AML/CFT program. Though not specifically outlined in the NPRM, this will likely mirror other FIs subject to an AML rule and include the following:
   1. Implementation of policies, procedures, and internal controls 
   2. Independent testing 
   3. Designation of an AML compliance officer 
   4. Ongoing training
   5. Development of a risk-based program to detect and deter suspicious activity 
2. File certain reports, such as Suspicious Activity Reports (SARs) with FinCEN. 
3. Keep records, such as those relating to the transmittal of funds (e.g., comply with the Recordkeeping and Travel Rule). 
4. Fulfill other obligations applicable to FIs subject to the Bank Secrecy Act and FinCEN’s implementing regulations. 

This will also include RIAs and ERAs to participate in FinCEN’s mandatory 314(a) process, the option to participate in FinCEN’s voluntary 314(b) process,³ and be subject to “special measures” imposed by FinCEN pursuant to Section 311 of the USA PATRIOT Act. 

Proposed Rule Exemptions 

At this time, the proposed rule does not require RIAs and ERAs to develop and implement a Customer Identification Program. Furthermore, there is no requirement to gather beneficial ownership information of legal entity customers. These requirements will be addressed in a future joint rulemaking with the SEC. 

FinCEN has also called out an exemption to apply an AML/CFT program or SAR filing requirements to any mutual funds advised by the IA. Mutual funds are already defined as FIs. Due to the regulatory and practical relationships between mutual funds and IAs, fulfilling the AML requirements falls to the mutual fund to avoid duplication of efforts when the IA rule is implemented. 

Industry Impact 

Reaction among affected advisors to the proposed FinCEN action to date has been muted. However, as we approach the conclusion of the comments period, concerns are bubbling up—these center on compliance costs and contradictions embedded in the action itself. 

• Combustible regulatory impact: As noted, the proposed action is comprehensive and overdue in that it fills a glaring regulatory gap. It mirrors the USA PATRIOT Act, to which it is linked, in that it seeks to fuse a patchwork of prohibitions, from which IAs and ERAs have largely been spared. At the same time, it is disruptive in that it seeks to extend the supervisory net. It pulls in IAs functioning as subadvisors, for example, as well as those active outside the US. The extraterritoriality that colors the proposed action speaks to its politically combustible nature and points to future expansion of the FinCEN and Treasury remit.  
• Economic disruption: Reverberating effects, meanwhile, extend to the broader economy. The inclusion of the private funds business threatens to throttle the growth of capital-intensive and politically sensitive sectors such as artificial intelligence and aeronautics, e.g., drones. In the past, regulators have focused on shielding investors from taking on too much risk. Now, they appear to want to shield risk from adoption by certain investors, notably those from adversarial nations such as China and Russia. 
• Operational challenges: Upping the ante for IAs and ERAs are not just costs or risks of censure and indemnification, but the operational challenges involved in compliance. These include reporting and recordkeeping requirements that advisors are ill-equipped to fulfill. They can flag suspicious activity such as layering but lack tools to verify sources of funds. Advisor shopping and other fraudster hijinks are unlikely to slow down.  
• Increased customer and transaction friction: The extent to which advisors will wrestle with basic documentation requirements can be seen in the degree to which they struggle to onboard clients today. Many, if not most, IAs still require new clients to come into the office to verify their identity. Such friction (in a digital age) translates into client dissatisfaction and opportunity cost, as advisors squander the honeymoon period during which clients are most receptive to learning about new products and services.  

The compliance burden, of course, presents an upside for custodians, who may be best positioned to serve the needs of under-equipped advisors. The problem is that custodians also lack visibility on the financial lives of the end investor; that investor is not their client. Specialist vendors such as Quantexa, Onfido, and ComplyAdvantage, with expertise in AML, will have an opportunity to pick up the slack. 

The Bottom Line  

The purpose of this proposed rule can be expanded to include AML rules across all FIs—to protect the U.S. financial system from those looking to exploit it for illegal purposes. AML programs are created, and AML officers are charged with detecting and deterring money laundering and terrorist financing. This proposed rule will now include RIAs and ERAs in those requirements. According to FinCEN,⁴ “The proposed rule is designed to improve outcomes for U.S. investors and to help safeguard investments in the United States. It would improve the detection and reporting of suspicious activity to assist regulators and law enforcement in combating illicit finance, including fraud, in the investment adviser industry.” 

Election-year angst and a volatile geopolitical environment suggest that this proposed FinCEN action has a fighting chance in its current form or a slightly diluted version. Its significance for the advice community cannot be overstated. Even a diluted version of the rule will place a burden on the shoulders of the IA and ERA, who bear ultimate responsibility for AML compliance. That said, the pervasiveness of money laundering, the audacity of perpetrators, and the threat it poses to states and FIs mean that it must be addressed.  

So what now? The comment period closes on April 15, 2024. The IA industry needs to provide feedback to FinCEN to ensure that the rule addresses how the industry can best combat financial crime. This rule must not simply become an exercise in ensuring that RIAs and ERAs comply with the rule yet fail to move the needle to thwart bad actors’ use of the IA industry to advance their nefarious ambitions. Those who work in the IA industry every day are in the best position to provide feedback to FinCEN to ensure they can provide intelligence to law enforcement that will help mitigate their illicit finance risks and exposure to criminal activity. 

1. “FinCEN Proposes AML Regulations for Investment Advisors,” accessed March 12, 2024, https://www.fincen.gov/news/news-releases/fincen-proposes-aml-regulations-investment-advisers. ↩︎
2. “Fact Sheet: Anti-Money Laundering Program and Suspicious Activity Report Filing Requirements for Registered Investment Advisers and Exempt Reporting Advisers Notice of Proposed Rule Making (NPRM),” accessed March 12, 2024, https://www.fincen.gov/news/news-releases/fact-sheet-anti-money-laundering-program-and-suspicious-activity-report-filing. ↩︎
3. See Datos Insights’ report The Conundrum of Information Sharing and Section 314 of the USA PATRIOT Act, December 2023. ↩︎
4. “Fact Sheet: Anti-Money Laundering Program and Suspicious Activity Report Filing Requirements for Registered Investment Advisers and Exempt Reporting Advisers Notice of Proposed Rule Making (NPRM)”, accessed March 12, 2024, https://www.fincen.gov/news/news-releases/fact-sheet-anti-money-laundering-program-and-suspicious-activity-report-filing ↩︎