Compliance Solutions for Investment Advisers

FAQs — Anti-Money Laundering

 

Important Note

There is currently no federal or state rule that specifically requires investment advisers to develop and implement anti-money laundering policies and procedures. However, both federal and state regulators expect an adviser to implement at least some basic anti-money laundering procedures. These frequently asked questions (and answers) address a wide-range of anti-money laundering issues. Not all of these issues, however, will be applicable to every investment adviser. Accordingly, an adviser will need to pick and choose those elements of an anti-money laundering program that best fits the risk profile of their advisory business and client base.

 

Anti-Money Laundering Basics

What is money laundering?

Money laundering generally involves dealing in the proceeds of criminal activity (e.g., bribery, fraud, drug trafficking, etc.) when you know or should know of the criminal origins of the proceeds, as well as participating in any transaction intended to facilitate criminal activity. In addition, money laundering may include failing to file required anti-money laundering reports or failing to maintain required anti-money laundering records. Money laundering transactions may involve money in forms other than cash.

What is terrorist financing?

Terrorist financing means the direct or indirect provision of financial assistance to those engaged in terrorist activities. The funds used to provide such assistance may derive from criminal activities or from legitimate activities, such as legitimate businesses or charities. Terrorist financing activities often are referred to as “money laundering” even though money laundering activities encompass far more than terrorist financing.

What are the stages of money laundering?

Money laundering generally is thought of as occurring in three stages, known as placement, layering and integration:

  • First is the “placement” stage, where cash proceeds of illegal activity are placed into the legitimate financial system.
  • Second is the “layering” stage, in which the funds are moved from institution to institution to obfuscate and distance them from their source.
  • Third is the “integration” stage, in which the funds are introduced into the financial system in a way that makes them appear legitimate.

What are the penalties for money laundering?

Violation of U.S. money laundering laws may be punishable by both criminal and civil penalties. These sanctions may be imposed on both the advisory firm and individual employees. The potential penalties for money laundering include imprisonment, fines, and forfeiture of assets and include, but are not limited to, the following:

  • An individual convicted of money laundering may be imprisoned for up to twenty (20) years or made to pay a fine of up to $500,000 or twice the value of the funds laundered, whichever is greater.
  • Civil penalties may result in up to a $10,000 fine or the value of the funds involved, whichever is greater.

 

Anti-Money Laundering Requirements

What should be the goals of an anti-money laundering program?

The intent of an anti-money laundering program is to allow an investment adviser to make a reasonable determination that (i) its clients are not money launderers or terrorist financiers and (ii) its clients’ funds are not derived from or intended for use in money laundering, terrorism, or other criminal activities.

What are central elements of an anti-money laundering program?

An advisory firm’s anti-money laundering program should be comprised of the following four central elements:

  1. Policies, procedures, and internal controls that can be reasonably expected to detect suspicious activity and to assure compliance with anti-money laundering laws;
  2. Naming an anti-money laundering compliance officer who is responsible for implementing and monitoring the operation of the advisory firm’s anti-money laundering program;
  3. Ongoing training; and
  4. Testing.

 

Know-Your-Client Procedures

What types of information should an investment adviser obtain from a new client?

Establishing a new client relationship represents the best opportunity to develop knowledge of the client. Prior to establishing a new client relationship, an adviser should obtain and review the following information:

  • The client’s legal name;
  • The client’s date of birth (if the client is an individual);
  • The client’s physical address (not a P.O. Box or email address);
  • The client’s telephone number;
  • The client’s government identification number (e.g., tax identification number, social security number, or passport number with country of issuance);
  • A short description of the client’s primary business, if any;
  • A short description of the client’s primary source of funds (e.g., business listed above, inheritance, pension); and
  • An estimation of the annual amount the client will invest.

What type of a review should an investment adviser conduct on the information obtained from a new client?

Information obtained from a client should be reviewed for logical consistency. Any inconsistencies or oddities in the collected information (e.g., the client provides a phone number with a Texas area code but lists a New York address, or the client indicates that he is a college student and wants to invest millions of dollars) as well as any client inability or unwillingness to provide such information, should be brought to the attention of the adviser’s chief compliance officer or other designated individual.

How should an investment adviser handle inconsistencies in client information?

In cases of inconsistencies, the adviser should determine: (i) whether to try to resolve the problem by contacting the client or otherwise obtaining additional information; (ii) whether the client is a high-risk client (see below); (iii) whether the request to open an account should be refused (or, if the account already has been opened, whether it should be closed); and (iv) whether to file a suspicious activity report (see below).

What would constitute having a “high-risk” client?

High-risk clients include: (i) a client with unresolved issues regarding new account information; (ii) a senior foreign political official, a legal entity formed by or for the benefit of such an official, a member of such an official’s family, or a person otherwise closely associated with such an official; (iii) a client whose business is unfamiliar, e.g., a client from a foreign country with which the investment adviser has had little experience; and (iv) a client who, after the account is opened, exhibits any suspicious or unusual investment behavior.

What is an investment adviser’s responsibility when a client is deemed high risk?

If a client is deemed high risk, the adviser must verify some or all of the new account information, depending on a risk assessment made by the appropriate compliance personnel. In some cases, it may be sufficient to verify (using the techniques described below) just a few pieces of information collected, but higher risk clients (e.g., multiple unresolved issues regarding the new account information, unresolved issues coupled with unusual investment behavior, etc.) require broader verification efforts, such as verification of the client’s source of funds.

What are some methods of verification an investment adviser can use with high risk clients?

Verification methods can consist of one or more of the following, depending on the risks associated with the relationship:

  • Contacting the client;
  • Reviewing unexpired government-issued identification (e.g., driver’s license or passport);
  • Calling references or reviewing written references;
  • Reviewing audited financial statement or tax filing; and/or
  • Cross checking client provided information with information from a trusted database (e.g., Dunn & Bradstreet or Lexis-Nexis).

How can an investment adviser determine whether a client appears on any list of known or suspected terrorists or terrorist organizations?

An adviser can check the Treasury’s Office of Foreign Assets Control “Specifically Designated Nationals and Blocked Persons” List (“SDN List”) on the OFAC Web Site.

Is an investment adviser permitted to rely on a third-party to conduct anti-money laundering verification?

Yes.  An adviser may, under the following circumstances, rely on the performance by another financial institution of some or all of the elements of the adviser’s client identification program with respect to any client that is opening an account or has established an account or similar business relationship with the other financial institution to provide or engage in services, dealings or other financial transactions:

  • When such reliance is reasonable under the circumstances;
  • When the other financial institution is subject to a rule implementing the anti-money laundering compliance program requirements of 31 U.S.C. 5318(h), and is regulated by a Federal functional regulator; and
  • When the other financial institution has entered into a contract with the adviser requiring it to certify annually that it has implemented its anti-money laundering program, and that it will perform (or its agent will perform) specified requirements of the client identification program.

 

Monitoring and Reporting

Is an investment adviser required to monitor investment activity?

An adviser should monitor client accounts for “red flags” that may be indicative of money laundering issues.

What are some red flags that may indicate problematic behavior?

Red flags that signal possible money laundering or terrorist financing include, but are not limited to:

  • The client exhibits unusual concern about providing identification or source of funds information or otherwise indicates concern about the adviser’s anti-money laundering program.
  • The information provided by the client turns out to be false, misleading, or substantially incorrect.
  • Upon request, the client refuses to identify or fails to indicate any legitimate source for their funds and other assets.
  • The client seeks to engage in transactions that lack business sense or apparent investment strategy, or are inconsistent with the client’s stated business or investment strategy.
  • The client (or a person publicly associated with the client) has a questionable background, or the adviser becomes aware that the client is the subject of news reports indicating possible criminal, civil, or regulatory violations.
  • The client exhibits a lack of concern regarding risks, commissions, or other transaction costs.
  • The client appears to be acting as agent for an undisclosed principal, but declines or is reluctant to provide information or is otherwise evasive regarding that person or entity.
  • The client has difficulty describing the nature of his or her business or lacks general knowledge of his or her industry.
  • For no apparent reason, the client has multiple accounts under a single name or multiple names, with a large number of inter-account transactions.
  • The client’s account reflects transfers that have no apparent business purpose to or from a foreign country.
  • The client’s account indicates large or frequent wire transfers immediately withdrawn by check or debit card without any apparent business purpose.
  • The client makes a funds deposit for the purpose of purchasing a long-term investment followed shortly thereafter by a request to liquidate the position and transfer the proceeds out of the account.
  • The client’s account has inflows of funds or other assets well beyond the known income or resources of the client.
  • The client requests that a transaction be processed to avoid adviser’s normal documentation requirements.

What should an investment adviser do if it learns of a red flag?

The adviser will need to determine if it should file a suspicious activity report with law enforcement.

What is the procedure for filing a suspicious activity report?

If the investment adviser determines that filing a suspicious activity report is warranted, the report generally should be filed within thirty (30) days of the discovery of the suspicious activity. The adviser may file a report using the Form SAR-SF.

 

Recordkeeping and Testing

What types of records will the SEC request during or prior to an examination?

The Staff of the SEC may request some or all of the following documents and information pertaining to anti-money laundering:

  • A copy of anti-money laundering policies and procedures adopted to comply with applicable regulations.
  • Any contracts that delegate the day-to-day implementation of your firm’s anti-money laundering program to a service provider.
  • A copy of the procedures and controls used by any service provider to fulfill your firm’s customer identification procedures and to monitor for suspicious activities and make determinations as to whether a suspicious activity report needs to be filed.
  • Any “new account” procedures and any guidance or anti-money laundering risk indicators that are provided to personnel responsible for opening new client accounts.
  • A copy of a new account form, and the policies and procedures related to obtaining proper and valid identification and verifying information from a new client.
  • A list of accounts that have been placed on heightened monitoring due to a suspicious transaction or series of transactions that have been identified and the reason for placing an account on heightened monitoring.
  • A copy of your firm’s most recent annual review of its anti-money laundering program.

What are some compliance tests an investment adviser can conduct to determine whether the adviser’s policies and procedures adequately address anti-money laundering and reflect the firm’s actual practices?

Tests an adviser can conduct include:

  • Conducting a random review of client accounts and determine if the names have been run against the OFAC Specially Designated Nationals list.
  • Confirming that anti-money laundering training was conducted for all appropriate personnel.
  • Monitoring transactional flow in accounts for suspicious activity.
  • Sampling client files to confirm that proper customer verification program procedures were followed.
  • Reviewing new account/investor documents to ensure adequate collection of anti-money laundering documentation.
  • Contacting custodians to ensure that anti-money laundering tests are being conducted and that nothing was found during the prior 12 months.
  • Reviewing account transactions to determine whether your firm is conducting business in a country that is subject to government sanctions.
  • Substantiating that your firm obtains all information related to anti-money laundering in a timely, accurate, and complete manner.
  • Ensuring that information related to anti-money laundering is preserved for the required period of time and protected from unplanned destruction, loss, alteration, compromise or use.

 

Important Information

The information contained in this Frequently Asked Questions is only a summary and is not intended to be a comprehensive analysis of the rules and regulations applicable to registered investment advisers. It is not intended to constitute legal or compliance consulting advice or apply to any one investment adviser’s particular situation. For more information, please see our Terms of Use.

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