Delay of New Rules for Investment Advisers Leaves Industry ‘Open’ to Sanctions Evasion, Treasury Hears

Transparency International, an anti-corruption non-profit, and the Washington-based Foundation for Defense of Democracies opposed the delay, saying it risks further damaging the integrity and credibility of the U.S. financial system. But groups and law firms representing the financial management industry applauded the announcement, saying the rules were set to impose large burdens and legal uncertainty for investment advisers, money managers and others.

In seven pages of public comments, which were due to Treasury late last month, Transparency International said the rule had represented “one of the most important and long-overdue steps” toward “combating illicit finance,” adding that the U.S. has been urged to bring investment advisers and private funds into the scope of its AML CFT rules “for more than a decade.” But the delay would signal to the rest of the world that the U.S. isn’t “willing or able” to meet its own calls to tighten sanctions evasion, including related to Russia.

“This delay would deepen not only the perception, but the reality, that the U.S. financial system remains knowingly open and available for laundering the proceeds of corruption, kleptocracy, and sanctions evasion, and weakening U.S. law enforcement’s ability to identify, trace, and disrupt illicit financial flows that threaten our public safety and national security,” the group said.

If “a high-profile corruption scandal, sanctions evasion network, or terrorist-financing scheme should flow through U.S. channels,” Transparency International said, Treasury would be to blame.

The Foundation for Defense of Democracies made similar points, saying the investment adviser industry faces “well-established illicit finance risks,” including “known instances of money laundering tied to terror financing, drug trafficking, and organized criminal activity.” It added that those advisers have been granted “temporary” exemptions from these rules for too long.

“It is time for investment advisors to follow the same rules as other financial institutions and establish these basic and straightforward anti-money laundering and counter terror financing programs,” it said.

The Investment Company Institute, the Alternative Investment Management Association, Andreessen Horowitz, the Managed Funds Association and others all supported the delay. Venture capital firm Andreessen Horowitz argued that the rule is “entirely inappropriate” and “fundamentally misaligned” with the business model of many investment advisers, specifically closed-end private funds.

The firm also said the rule “primarily” touches on sanctions or national security issues rather than traditional money laundering risks, adding that those national security issues are already addressed through sanctions programs enforced by the Office of Foreign Assets Control and investment restrictions overseen by the Committee on Foreign Investment in the United States.

“Using the [Bank Secrecy Act] framework to pursue those same objectives needlessly duplicates existing national security mechanisms,” Andreessen Horowitz said.

The Managed Funds Association, a Washington-based industry group representing the alternative asset management industry, said Treasury should also clarify and possibly revise the rule to stress that investment advisers won’t be at risk of enforcement for not putting in place “voluntary” due diligence procedures that are out of the scope of the rule, including procedures “designed to comply with non-U.S. legal requirements or the voluntary application of AML/CFT procedures to non-advisory services” -- even if those procedures are included in a covered adviser’s written AML/CFT program.

“For example, if a Covered Adviser’s written AML/CFT program included a section detailing procedures to comply with the AML laws of the Cayman Islands, the inadvertent failure to follow such procedures would not result in a violation of the AML Program Rule for which money penalties would be assessed or other sanctions or remedies would be imposed,” the association said.

Law firm Troutman Pepper, writing on behalf of an investment adviser client that provides retirement plan services, argued that retirement plans present “little risk” for terrorism financing and shouldn’t be captured by the rules. It noted that because many retirement plans are funded through contributions from participants’ salaries and from the sponsoring employer -- and because the participants can’t withdraw money until age 59 without “significant financial penalties” -- those retirement accounts are “particularly ill-suited for use as vehicles for money laundering or terrorist financings.” It added that “little benefit can be expected to be derived from the imposition of significant AML/CFT obligations on their advisers.”

The law firm said it’s expecting compliance efforts to “impose significant financial burdens on our client and other retirement plan advisers similarly situated.” And although Treasury has argued that compliance should be manageable because investment advisers are already subject to securities regulation, Troutman Pepper said those advisers primarily operate under the U.S. Advisers Act, not the Bank Secrecy Act, which is being proposed here.

“Due to the wholly different purpose of the Advisers Act, there is little substantive overlap between existing regulatory obligations and those proposed here,” the firm said. It added that its client believes, if the rule were to take effect as written, it would need to devote 5% of its operating expense budget to implementation and compliance.