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* FinCEN and SEC Propose Affirmative KYC Requirements for Registered Investment
Advisers and Exempt Reporting Advisers
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FINCEN AND SEC PROPOSE AFFIRMATIVE KYC REQUIREMENTS FOR REGISTERED INVESTMENT
ADVISERS AND EXEMPT REPORTING ADVISERS
Alert
May 14, 2024
7 minutes
Printer-friendly Version
Authors:
Ama A. Adams , Brendan C. Hanifin , Kurt Fowler
On May 13, the U.S. Treasury Department’s Financial Crimes Enforcement Network
(“FinCEN”) and the Securities and Exchange Commission (“SEC”) jointly released a
notice of proposed rulemaking (the “CIP Proposed Rule”) that would require
SEC-registered investment advisers (“RIAs”) and exempt reporting advisers
(“ERAs”) to establish, document, and maintain written customer identification
programs (“CIPs”).
FinCEN previewed the CIP Proposed Rule in a separate, February 2024 notice of
proposed rulemaking that would require RIAs and ERAs to (1) develop and
implement anti-money laundering compliance programs (within 12 months after the
effective date of a final rule) and (2) monitor for and report suspicious
activity to FinCEN (the “AML/CFT Program and SAR Proposed Rule”). Our alert on
the February 2024 AML/CFT Program and SAR Proposed Rule is available here.
CIP PROPOSED RULE
The CIP Proposed Rule would require RIAs and ERAs to establish CIPs that closely
track the customer identification requirements that currently apply to banks,
broker-dealers, and mutual funds (among other financial institutions).
Specifically, RIAs and ERAs would be required to establish:
* A written CIP;
* Risk-based procedures for performing identification and verification of
customers that open accounts, which include:
* collection of certain minimum identifying information of customers (e.g.,
name, date of birth or formation, address, and identification number),
prior to opening an account; and
* verification of the identity of each customer, using the foregoing
information, through documentary or non-documentary means, within a
reasonable time before or after the customer’s account is opened;
* Procedures for making and maintaining a record of information collected under
the CIP, as well as verification performed, for at least five years;
* Procedures for determining whether a customer appears on any list of known or
suspected terrorists or terrorist organizations issued by any federal
government agency and designated as such by the Treasury Department in
consultation with federal functional regulators; and
* Procedures for providing customers with adequate notice of the RIA’s or ERA’s
CIP requirements.
The CIP Proposed Rule would take effect six months from the publication of a
final rule but, in any event, no sooner than the compliance date of the AML/CFT
Program and SAR Proposed Rule, if adopted.
INITIAL REACTIONS
CUSTOMERS AND ACCOUNTS
Under the CIP Proposed Rule, CIP obligations would be triggered by a customer’s
opening of an account, defined as follows:
* Account means any contractual or other business relationship between a person
and an investment adviser under which the investment adviser provides
investment advisory services.
* Customer means a person (individual or entity) that opens a new account.
* The definition of customer would not include (1) a financial institution
regulated by a federal functional regulator or bank regulated by a state
bank regulator; (2) certain domestic government entities; (3) certain
entities that are publicly listed on U.S. securities exchanges; or (4)
persons that have an existing account with the RIA or ERA, provided that
the RIA or ERA has a reasonable belief that it knows the true identity of
the person.
While the above definitions resemble the equivalent definitions in the
broker-dealer CIP rule, it is not entirely clear how they would be interpreted
to apply to private fund structures.
For example, in its “Paperwork Reduction Act” discussion, the CIP Proposed Rule
includes the following language in a footnote, which appears to imply that the
customers of RIAs and ERAs are the funds that they advise (as opposed to
investors in those funds):
Estimates herein assume that (i) the median number of customers per exempt
reporting adviser is two and (ii) the median number of customers per registered
investment adviser is 100. For purposes of the number of “customers” with
respect to exempt reporting advisers, we used the number of private funds
reported by exempt reporting advisers on Schedule D, Section 7.B.1 of Form ADV,
as of October 5, 2023. For purposes of the number of “customers” with respect to
registered advisers, we used the number of “clients” reported by advisers on
Item 5.D of Form ADV, as of October 5, 2023. This estimate is based on the
median number of clients per registered investment adviser with at least one
client. “Customers” does not include the investors in a private fund.
However, this interpretation would appear inconsistent with concerns that have
been expressed by FinCEN leadership, such as gaps in anti-money laundering
regulation of RIAs and ERAs permitting entry into the U.S. financial system to
bad actors. In addition, such an interpretation appears at odds with the CIP
Proposed Rule’s contemplated CIP requirements for natural person investors and
screening against lists of known or suspected terrorists or terrorist
organizations.
RELIANCE
Under the CIP Proposed Rule, RIAs and ERAs would be permitted to rely on another
financial institution to perform any of the procedures associated with the
adviser’s CIP, provided:
* Such reliance is reasonable under the circumstances;
* The other financial institution is subject to a rule implementing 31 U.S.C.
5318(h) and regulated by a federal functional regulator; and
* The other financial institution enters into a contract with the investment
adviser requiring it to certify annually to the investment adviser that it
has implemented its anti-money laundering/countering the financing of
terrorism program, and that it will perform (or its agent will perform)
specified requirements of the investment adviser’s CIP.
RIAs and ERAs would remain responsible for ensuring compliance with the CIP
Proposed Rule and would be expected to actively monitor the implementation of
their CIPs. In practice, many RIAs and ERAs effectively outsource elements of
their current, voluntary know-your-customer procedures to third parties that are
unlikely to meet the above criteria, including non-U.S.-based administrators and
external counsel. Therefore, adoption of the CIP Proposed Rule in its current
form—assuming CIP requirements are interpreted to apply to investors in private
funds—may necessitate wide-scale retooling of existing know-your-customer
procedures across a broad swath of the U.S. private funds market.
EXISTING INVESTORS
As noted above, the CIP Proposed Rule would exclude from the definition of
“customer” persons that have an existing account with the RIA or ERA, provided
that the RIA or ERA “has a reasonable belief that it knows the true identity of
the person.” Assuming that FinCEN and the SEC interpret “customer” to include
investors in private funds, depending on the facts, there may be an argument
that investment advisers’ prior due diligence of such investors would satisfy
the adviser’s obligations under the CIP Proposed Rule. In this regard, the
preamble to the CIP Proposed Rule states that a covered adviser generally would
not need to re-verify a customer’s identity if the customer’s identity
previously was verified “in accordance with procedures consistent with the
proposed rule.” A final rule, if adopted, may clarify whether existing
procedures adopted prior to publication of the final rule—e.g., pursuant to
non-U.S. know-your-customer requirements—would satisfy this standard.
HARMONIZATION WITH EXISTING KNOW-YOUR-CUSTOMER PROCEDURES
Many RIAs and ERAs voluntarily have adopted certain know-your-customer
procedures, including to comply with the anti-money laundering requirements of
non-U.S. jurisdictions. While non-U.S. know-your-customer requirements
historically have been more stringent than U.S. requirements applicable to
investment advisers, RIAs and ERAs should not assume—without review—that their
existing know-your-customer procedures will satisfy the minimum requirements
that would be imposed under the CIP Proposed Rule. For example, the CIP Proposed
Rule would require collection of a taxpayer identification number (i.e., Social
Security Number) for natural person customers, whereas collection of passport
information may suffice under the know-your-customer requirements of non-U.S.
jurisdictions.
The AML/CFT Program and SAR Proposed Rule requires RIAs and ERAs to implement
risk-based procedures for conducting ongoing customer due diligence that
includes (1) understanding the nature and purpose of customer relationships for
the purpose of developing a customer risk profile; and (2) conducting ongoing
monitoring to identify and report suspicious transactions and update customer
information. RIAs and ERAs will need to ensure that their anti-money laundering
programs include both procedures for identifying and verifying new customers,
pursuant to the CIP Proposed Rule, and ongoing monitoring, pursuant to the
AML/CFT Program and SAR Proposed Rule (assuming both rules ultimately are
adopted).
Along similar lines, pursuant to the Corporate Transparency Act, FinCEN will
undertake a forthcoming rulemaking process to revise FinCEN’s Customer Due
Diligence (“CDD”) Rule, which currently requires certain financial institutions
(including banks and broker dealers), inter alia, to establish written policies
and procedures for identifying and verifying the beneficial owners of legal
entity customers opening accounts. It is possible that the forthcoming CDD Rule
updates could extend similar requirements to RIAs and ERAs, which covered
advisers would need to account for in updating their anti-money laundering
compliance programs.
RELATED SERVICES
* Anti-Money Laundering
AUTHORS
Ama A. Adams
Partner
Washington, D.C.+1 202 508 4655
Ama.Adams@ropesgray.com
See Bio
Brendan C. Hanifin
Partner
Chicago+1 312 845 1311
Brendan.Hanifin@ropesgray.com
See Bio
Kurt Fowler
Associate
Chicago+1 312 845 1108
Kurt.Fowler@ropesgray.com
See Bio
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