18.4 AML & Compliance Programs

Investment advisers must maintain robust compliance programs to prevent money laundering, terrorist financing, and other financial crimes. While investment advisers have historically had less stringent AML requirements than broker-dealers, new FinCEN rules are expanding these obligations.

Anti-Money Laundering (AML) Framework

Regulatory Structure

Bank Secrecy Act (BSA): Foundation of U.S. AML law; Administrator - FinCEN

USA PATRIOT Act: Enhanced AML requirements post-9/11; Administrator - FinCEN

FinCEN Rules: Detailed implementing regulations; Administrator - FinCEN

OFAC Sanctions: Prohibited transactions with sanctioned parties; Administrator - OFAC/Treasury

FinCEN Investment Adviser Rule (2024-2026)

FinCEN has issued final rules requiring investment advisers to implement comprehensive AML/CFT programs. Key timeline:

Final Rule Issued: 2024

Original Effective Date: January 1, 2026

Delayed Effective Date: January 1, 2028 (proposed delay)

Who Is Covered

The rule applies to:

- SEC-registered investment advisers (RIAs)

- Exempt Reporting Advisers (ERAs)

- Approximately 20,800 advisers total

Customer Identification Program (CIP)

Required Information

For all new accounts, advisers must collect and verify:

Name: Full legal name

Date of Birth: For individuals

Address: Residential or business address

Identification Number: SSN (U.S. persons) or TIN/passport (non-U.S.)

Verification: Documentary or non-documentary methods

Identity Verification

- Must verify identity within reasonable time

- Documentary: Government ID, passport, driver's license

- Non-documentary: Credit reports, public databases, references

- Must have procedures for unverified customers

Suspicious Activity Reporting (SAR)

When Required

A SAR must be filed when:

Amount: Transaction involves $5,000 or more in funds or assets

Suspicion: Reasonable suspicion of illegal activity

Types: Money laundering, terrorist financing, fraud, other crimes

Timeline: Filed within 30 days of detection (may extend to 60 days)

SAR Confidentiality

Critical Rule: SARs are confidential

- Cannot disclose SAR filing to the subject

- Cannot disclose to anyone outside firm (except regulators, law enforcement)

- "Safe harbor" protection for good-faith filings

- No liability for filing SAR in good faith

Currency Transaction Reports (CTRs)

Threshold: Cash transactions exceeding $10,000

Filing: Must file CTR with FinCEN

Aggregation: Multiple transactions by same person aggregated

Structuring: Breaking up transactions to avoid reporting is illegal

AML Red Flags

Transaction Red Flags

Unusual Transactions: Large cash deposits, frequent wire transfers to high-risk jurisdictions

Structuring: Transactions just under $10,000 to avoid CTR

Rapid Movement: Funds moved quickly through multiple accounts

Inconsistent Activity: Transactions inconsistent with client's business or stated purpose

Third-Party Involvement: Payments from/to unrelated third parties

Customer Red Flags

Reluctance: Unwilling to provide information or provide incomplete information

Complex Structures: Shell companies, multiple layers with no apparent purpose

High-Risk Connections: Ties to sanctioned countries or persons

PEP Status: Politically Exposed Persons (government officials, family members)

Investment Adviser Compliance Programs

SEC Rule 206(4)-7 Requirements

Every SEC-registered investment adviser must:

Written Policies: Adopt written compliance policies and procedures

Chief Compliance Officer: Designate a CCO to administer the compliance program

Annual Review: Conduct annual review of compliance program effectiveness

Compliance Program Elements

Written Policies: Reasonably designed to prevent violations

Risk Assessment: Identify and address specific risks

CCO Designation: Qualified person with authority and resources

Annual Review: Assess effectiveness and remediate deficiencies

Training: Regular training for advisory personnel

Recordkeeping: Maintain required compliance records

Annual Review Requirements

The annual review must assess:

- Adequacy of policies and procedures

- Effectiveness of implementation

- Material compliance issues and responses

- Changes in business or regulations requiring updates

- Training effectiveness

Code of Ethics Requirements

SEC Rule 204A-1

All investment advisers must adopt a code of ethics containing:

Standard of Conduct: Reflect fiduciary obligations

Compliance with Laws: Require compliance with securities laws

Personal Trading: Address personal securities transactions

Reporting Violations: Procedures for reporting violations promptly

Distribution: Provide to all supervised persons; obtain acknowledgments

Personal Trading Rules

Access Persons: Those with access to nonpublic information about clients

Initial Holdings Report: Within 10 days of becoming access person

Annual Holdings Report: Current within 45 days of year-end

Quarterly Transaction Reports: Within 30 days of quarter-end

Pre-Clearance: May be required for certain securities

Access Persons Defined

An "access person" includes:

- Any supervised person with access to nonpublic information regarding client transactions

- Any supervised person with access to nonpublic information regarding portfolio holdings

- Directors, officers, and partners of the adviser (presumed access persons)

Recordkeeping for Compliance

Required Records

Compliance policies and procedures: 5 years

Code of ethics and acknowledgments: 5 years

Annual review documentation: 5 years

Personal trading reports: 5 years

Training records: 5 years

Complaint files: 5 years

AML/CIP records: 5 years after account closes

On the Exam: Know the SAR threshold ($5,000+ with suspicion of illegal activity) and the CTR threshold ($10,000+ cash). Remember that SARs are confidential - you cannot disclose the filing to the client. All advisers must have written compliance policies, a designated CCO, and conduct an annual review.

Key Takeaways

- SAR required for $5,000+ with suspected criminal activity

- CTR required for cash transactions exceeding $10,000

- SARs are confidential - cannot be disclosed to client

- All advisers must have written policies, CCO, and annual review

- Code of ethics with personal trading rules required

- Access persons must report holdings and transactions