Treasury’s FinCEN and SEC propose rule requiring investment advisers to develop customer identification programs

On May 13, 2024, the Securities and Exchange Commission (SEC) and the US Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN) jointly proposed a new rule that would impose requirements on SEC-registered investment advisers (RIAs) and exempt reporting advisers (ERAs) to establish, record, and maintain customer identification programs (CIPs) under the US Bank Secrecy Act (BSA) and related regulations. 

The SEC and FinCEN designed the proposal to target illicit actors, illicit funds, and illicit financial activity involving customers of investment advisers by increasing the anti-money laundering and countering the financing of terrorism (AML/CFT) requirements for the investment adviser sector. 

Industry will have 60 days, until July 12, 2024, to publicly comment on the proposed rule. Comments can be submitted here. 

Background

In its press release, Treasury highlighted that the May 2024 proposed rulemaking (Proposed Rule) complements the separate February 2024 FinCEN proposal to designate RIAs and ERAs as “financial institutions” under the BSA and subject them to AML/CFT program requirements and suspicious activity report (SAR) filing obligations, covered in our February 2024 client alert. FinCEN and the SEC explain that the aim of these two complementary proposals is “to prevent illicit finance activity in the investment adviser sector and further safeguard the U.S. financial system.” 

The February 2024 FinCEN proposed rule – released in conjunction with the AML/CFT Program and the Treasury’s Investment Advisor Risk Assessment (Treasury Risk Assessment) and which drew more than 50 comments from industry and others – notably expands the definition of financial institutions to include “investment advisers.” If the February rule is adopted, FinCEN and the SEC would be required to jointly promulgate rules that establish minimum standards for verifying the identities of customers when they open an account with these covered investment advisers. Accordingly, the Proposed Rule is designed to “align the requirements for investment advisers with existing rules for other financial institutions, such as broker-dealers, mutual funds, credit unions, banks, and others, to adopt and implement CIPs.” Thus, investment advisers will be subject to the same or similar requirements regarding CIPs as other financial institutions. 

According to SEC Chair Gary Gensler in his statement supporting the Proposed Rule, “[s]uch harmonization would help reduce the risk of terrorists and other criminals accessing U.S. financial markets by using investment advisers to launder money, finance terrorism, or move funds for other illicit purposes.” Similarly, and consistent with the Treasury Risk Assessment findings, FinCEN Director Andrea Gacki stated that the Proposed Rule is designed to help “investment advisers better identify and prevent illicit actors from misusing their services” for money laundering and terrorist financing because “[c]riminal, corrupt, and illicit actors have exploited the investment adviser sector to access the U.S. financial system and launder funds.”

If adopted in its current form, the Proposed Rule would require RIAs and ERAs to implement, and customers (after being given adequate notice) to comply with, reasonable procedures for establishing a customer identification program, including: 

• Verifying the identity of any person seeking to open an account with the investment adviser (which would not generally include investors in private funds managed by the adviser) to the extent reasonable and practicable
  
  
• Maintaining records of the information used to verify the person’s identity, including name, address, and other identifying information, and 
  
  
• Consulting lists of known or suspected terrorists or terrorist organizations provided to the financial institution by any government agency to determine whether a person seeking to open an account appears on any such list.

The Proposed Rule also explains that these procedures “must enable the investment adviser to form a reasonable belief that it knows the identity of each customer.” The reasonableness of such procedures depends on “the investment adviser’s assessment of relevant risks.” Further, the Proposed Rule specifies the customer information and records required to be collected and maintained, the acceptable methods of verification, and the situations in which additional verification is needed. Importantly, the Proposed Rule also provides that, under certain circumstances, investment advisers may rely on another registered financial institution, including an affiliate, when reasonable, and/or continue to use third-party vendors for compliance functions. 

Key takeaways

• The Proposed Rule, along with the February 2024 proposed rule, addresses the perceived gap in the current AML framework highlighted in the Treasury Risk Assessment and comports with this administration’s continued, whole-of-government focus on strengthening AML/CFT enforcement. 
  
  
• In light of the time invested on the Proposed Rule, FinCEN appears poised to adopt the February 2024 rule at least in some form. And, if the February 2024 proposed rule passes with little modification, RIAs and ERAs will be required to create and implement risk-based AML programs not later than 12 months from the passage of the final rule. This is especially relevant to RIAs and ERAs that do not have broker-dealer or already-BSA-regulated financial institution parents or affiliates with existing AML programs.
  
  
• As we advised in February, investment advisers should consider whether they will be subject to the Proposed Rule if it passes in its current, or close to current, form, and what steps they may need to take to ensure they have adequate policies and controls to fulfill the SEC and FinCEN’s expectations for CIPs. This will involve RIAs and ERAs implementing reasonable procedures to identify and verify the identities of their customers and notifying customers that the adviser is requesting information to verify their identities.
  
  
• Importantly, for private fund managers, the Proposed Rule’s definition of “customers” does not expressly include investors in private funds managed by the adviser. The Proposed Rule only requires investment advisers to collect and verify the identity of customers that directly open and hold accounts with the adviser. Where the adviser has a private fund as a customer, however, the investment adviser would be required to collect information about the private fund and, in some cases, those with authority or control over such private fund, which would implicate sub-advisory arrangements. While the Proposed Rule may cover individuals with authority or control over the private fund (such as members of a general partner to a fund), the adviser would need to collect information from investors in a private fund in certain cases where an investor could be deemed to have authority or control over the private fund and only when the adviser cannot verify the true identity of a non-individual investor.
  
  
• The government appears to acknowledge – and a number of the public comments assert – that a one-size-fits-all approach to developing AML programs and CIPs is not required and, in any event, may not effectively combat money laundering and terrorist financing. First, the SEC and FinCEN recognize that some investment advisers already are required to have practices consistent with the requirements of the Proposed Rule to obtain and verify customer identity information, ie, (a) if they are an affiliate, operating subsidiary, or otherwise a dual registrant of a bank or broker-dealer which has an AML program including CIP; (b) for compliance with global sanctions and screening for names on the Office of Foreign Assets Control specially designated nationals list; and/or (c) because of counterparty/third-party contractual requirements. Second, the February 2024 proposed rule would allow smaller advisers to adopt simpler policies and procedures, consistent with their organizational structures and a risk-based approach to compliance.

For more information as to how the Proposed Rule and the earlier February 2024 proposed rule may impact your business or how to assess your AML framework for compliance, please contact any of the authors or a member of DLA Piper’s White Collar or Investment Funds practices.