March 07, 2013

As the financial global market continues to expand, regulatory monitoring and reform also continues to grow. As a result of the regulatory changes following the Dodd-Frank Act, the Department of the Treasury’s Financial Crimes Enforcement Network (“FinCEN”), is now working on a proposed rule that would call for investment advisers to implement AML programs – much like other financial institutions are already required to do.

Zabrina Barile
Zabrina Barile

FinCEN’s proposal, which should be made public in early 2013, will also require investment advisers, including hedge funds, to file Suspicious Activity Reports (“SARs”); these filings outline details of any suspected illegal activity and suspicious or unusually large transactions. The goal is for investment advisers to assist government agencies in preventing and detecting money laundering activities; these activities could potentially include insider trading and financial schemes.

Developing an AML Program

In line with sound business practices and preempting any mandatory AML requirements likely to take effect later this year, investment advisers should focus their efforts on adopting and implementing AML programs designed to prevent and detect money laundering and any activity that supports money laundering, finances terrorist activities or violates the Office of Foreign Assets Control (“OFAC”) regulations.

The fundamentals of an investment adviser’s AML program should be comprised of the following:

  • Written policies, procedures and controls which address and identify potential risks. These policies should take into consideration the types of investors, jurisdiction and the nature of the business relationship.
  • Description of patterns and types of activities to be further reviewed and flagged as suspicious and mandating the filing of a SAR.
  • A designated Compliance Officer/Senior Manager with the authority to execute and manage the AML program and to monitor Know Your Investor (“KYI”) policies which are designed to safeguard against identity theft fraud, money laundering and terrorist financing. Based on a review of any potential risks identified and any SARs such designated person may make a determination to accept or decline a prospective investor.
  • An employee training program reviewing AML policies and procedures of the fund and relevant AML laws and regulations.
  • Periodic independent audit by an external third party/service provider to review and test the AML program. Results should be reported and include any noted deficiencies and areas requiring further follow-up.
  • Record-keeping and documentation with respect to the AML program. Some main documents to be retained include: a copy of the AML written policies and procedures; documents and checklists reviewed and prepared during the KYI identification process; all reported transactions and SARs and records of AML training sessions and those in attendance.
  • Investor Due Diligence

    In an effort to detect and prevent terrorist financing and money laundering, investment advisers should establish and maintain investor identification procedures and conduct reasonable due diligence prior to accepting an investment in order to verify who their investors are and to ensure that they do not pose a risk to the fund.

    The investment adviser may wish to develop an investor identity due diligence checklist to assist in monitoring any investor identification controls in place. Such checks, at minimum, should consist of:

  • Collecting basic identifying information like the investor’s name and address; if applicable, obtain their social security number or tax identification number; confirming if the investor is located in a FATF jurisdiction.
  • Running a search through the OFAC Sanctions List, conducting Politically Exposed Persons (“PEP”) Screening and restricting business with any groups, countries and individuals that are identified.
  • Reviewing the fund’s subscription documents to ensure all evidence of identity provided is legitimate and all related information furnished is accurate. Subscription agreements include investor representations indicating compliance with various federal, state and international laws and guidelines, as well as other disclosure forms pertinent to AML and OFAC compliance. The representations should also include a statement noting that the source of funds being invested is lawful; if the investor is a prohibited investor, senior foreign political figure, or politically exposed person and a statement of whether the investor is a fund of funds or an entity that is acting as a representative.
  • Enhanced due diligence, in addition to standard investor identification procedures, should be conducted when the investment adviser believes an investor presents high risk factors for money laundering or terrorist financing. Some high risk factors include investors not located in a FATF jurisdiction; private investment companies based in a non-FATF jurisdiction; any investor residing in or organized under the laws of, a country or territory designated by FATF as a non-cooperative jurisdiction; any investor whose subscription funds originally come from, or run through, an account kept at an “offshore bank,” or a bank organized under the laws of a non-cooperative jurisdiction; any investor who causes the investment adviser to believe that the source of its subscription funds may not be legitimate and/or which a SAR has been filed.

    More Regulatory Reform Doesn’t Mean a Bigger Burden

    Noting the FinCEN’s proposal for AML requirements, hedge funds and investment advisers will benefit greatly from a robust AML program. Additional regulatory reform for the hedge fund industry does not equate to additional burden. With the assistance of a qualified third party service provider, many of the AML best practices outlined above could be readily achieved. The main focus of any outsourced third parties delegated with the task of building out or improving upon any current AML programs should be on:

  • Preparing a draft of AML policies and procedures, if they do not pre-exist. Such policies should be based on best practices with the goal of satisfying regulatory requirements and take into consideration any potential changes to such regulations as rules continue to evolve and expand.
  • Reviewing AML policies, procedures and internal controls, if already in place. This should include a review of any duties or a responsibility designated to a Compliance Officer to ensure that a suitable AML program is in place, is properly being executed and adheres to any guidelines or AML requirements.
  • Periodically auditing AML policies and processes employed by any other third party providers (i.e. administrators etc.) for conformity with the hedge funds and investment advisers’ internal AML policies, procedures and controls. The review should extend to the investor identification procedures performed by such third parties and permit access to copies of any documents reviewed.
  • Evaluating investor profiles and documentation for completeness and cross-checking investor KYI documents received and retained against the investment adviser’s written procedures or service provider requirements. A checklist of such documentation should also confirm that independent verifications or authentications and proper proofs of identity have been provided. Requirements for documentation and certification may differ from one jurisdiction to another dependent on the country of residence.
  • Performing enhanced due diligence and public records background research for any criminal activity, news media, regulatory and disciplinary information that might be available on any investor presenting a potential high risk for money laundering, fraud or other suspicious activity.
  • Screening select high-risk investors and entities identified against a number of recognized sanction and AML Watch-lists for any possible name matches. Routine monitoring of investors against such comprehensive sources should be conducted in an effort to catch and promptly address any potential risk.
  • Reporting on any issues that need to be further addressed or corrected after an independent evaluation and testing of the firm’s AML program. Periodically, there should be a re-review of policies, procedures and internal controls in place. Any new updates, issues, changes based on regulatory rules or internal amendments should be highlighted and reported.
  • Conducting AML program staff training so that at minimum employees understand the AML policies and procedures in place, know documentation requirements for verifying and authenticating the identity of any potential and existing investors, can recognize potentially suspicious activity and transactions and are aware of recordkeeping and reporting obligations. Training records should be documented and annual employee AML training reviews should be performed.
  • Assisting in preparing and filing SARs. Such filings should include detailed information on transactions that appear to be suspicious and potentially involve fraud, money laundering, illegal transactions or other criminal activity. A proper internal investigation should formally be conducted in advance by the designated Compliance Officer or overseer of internal controls to confirm the accuracy of any findings prompting the filing of any SARs.
  • Verifying that all relative AML-related records have been properly retained. Some common documents, that should be retained for a period of time include any manuals related to AML policies and procedures, AML training records, investor documentation collected during the onboarding process, records relating to transactions, any SARs filed and investor account and business correspondence.
  • By focusing on these areas, firms will be better positioned to address the increased regulatory demand for AML programs that is being driven by regulatory reform.
  • Zabrina Barile is the principal & VP of HedgeOp Compliance, and Wendy Toribio-Torres is the assistant VP of HedgeOp Compliance, an IMS Group Company.