AML Programmes

Increased demand is driven by new regulatory reforms

Originally published in the February 2013 issue

Anti-money laundering (AML) procedures already in existence were further enhanced by the US Patriot Act enacted by Congress in 2001 to amend the Bank Secrecy Act (BSA), initially adopted in 1970. The US Patriot Act requires financial institutions to establish AML programmes to decrease terrorism funding and money laundering activities.

As the financial global market continues to expand, regulatory monitoring and reform also continue 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 programmes – much like other financial institutions are already required to do. 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 programme
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 programmes 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 programme 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 programme 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 a designated person may make a determination to accept or decline a prospective investor.
  • An employee training programme 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 programme. Results should be reported and include any noted deficiencies and areas requiring further follow-up.
  • Record-keeping and documentation with respect to the AML programme. 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, obtaining their social security number or tax identification number; confirming if the investor is located in a Financial Action Task Force (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; and anyinvestor who causes the investment adviser to believe that the source of its subscription funds may not be legitimate and/or for which a SAR has been filed.

Noting the FinCEN’s proposal for AML requirements, hedge funds and investment advisers will benefit greatly from a robust AML programme. Additional regulatory reform for the hedge fund industry does not equate to additional burden. Much of the AML best practices outlined above could be easily achieved with the assistance of a qualified third-party service provider delegated to:

Prepare a draft of AML policies and procedures, if they do not pre-exist.
Assess AML policies and procedures, if already in place.
Review AML processes employed by other third-party providers for consistency.
Test the fund’s AML programme.
Review investor KYI documents per the investment adviser’s written procedures or service provider requirements.
Perform 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 high risk of money laundering or fraud or at the request of the investment adviser.
Screen select investors against 300+ sanction and AML watch-lists.
Develop a report identifying any potential risks and AML procedures carried out.
Conduct AML programme staff training.
Assist in suspicious activity reporting and filing.
Maintain records of all reported transactions, SARs and AML training.