A just-passed piece of legislation crafted to bolster countercrime defenses and crack open beneficial ownership bastions, a historical haven for criminals of all stripes, has lesser-known tethers for certain segments of the investment sector – a critical pitfall that should not be lost on compliance teams.
In May 2020, a leaked investigation bulletin prepared by the U.S. Federal Bureau of Investigation (the “FBI”) conveyed the FBI’s concern that “threat actors” are likely using private fund structures “… to launder money, circumventing traditional anti-money laundering (AML) programs.”
The FBI states that “threat actors” encompass both “financially motivated criminals and foreign adversaries.” The report further posits that AML compliance programs within the U.S. private funds industry are not sufficient to combat money laundering by global economic criminals.
The International Monetary Fund estimates that money laundering holds between two and five percent of the annual global gross domestic product, and the World Bank reports the world’s gross domestic product as approximately $83.4 trillion.
Hence, money laundering is estimated to be a $2.9 trillion annual industry.
Further, the United Nations Office on Drugs and Crime reports that less than one percent of illicit laundered funds are seized or frozen. In the U.S., the data tracks the same.
The U.S. Department of the Treasury’s National Money Laundering Risk Assessment of 2018 approximated that money laundering within the U.S. was a $300 billion business; yet, according to the Internal Revenue Service (the “IRS”), during this same period, the U.S. government only confiscated approximately $4 billion in assets derived from illicit funds.
Coincidentally, about six months after the FBI memo was leaked, the U.S. Senate overrode President Trump’s veto of the National Defense Authorization Act (the “NDAA”) on January 1, 2021.
In quest to counter criminals, illicit finance, onus on opaque ownership structures
The NDAA includes the Corporate Transparency Act (the “CTA”) and the Anti-Money Laundering Act (AMLA). This legislation represents the first major AML rehabilitation in 20 years and contains new Federal reporting requirements for funds and advisers.
The AMLA is anchored in compliance teams creating richer and more relevant intelligence for law enforcement, providing more weapons and funding for the U.S. Treasury’s Financial Crimes Enforcement Network (FinCEN) to analyze data and divine criminal trends and closing the loop with industry by forging stronger public-private information sharing partnerships.
The AML upgrades in Congress paralleled initiatives at FinCEN, part of a multipronged approach to strengthen fincrime compliance countermeasures, shift the needle toward “effectiveness” and sharpen intelligence sent to federal investigators.
For banks, AML efforts are now shifting more toward creating “effective and reasonably designed” programs that produce filings with a “high degree of usefulness” to law enforcement, according to a September notice.
FinCEN is also engaging stakeholders to glean if they could better manage risks, resources and threat actors if the bureau created national AML priorities – a similar refrain as in the AMLA – which would be informed by other national illicit finance, proliferation and terror risk assessments published in recent years.
Part and parcel of the proposal would also be to more concretely graft a longstanding compliance best practice and federal regulatory exam flashpoint into formal rules: the AML risk assessment, according to the advanced notice of proposed rulemaking (ANPR).
To read the full notice in the Federal Register, click here.
Under the update, FinCEN’s bi-annual “Strategic Anti-Money Laundering Priorities” would inform the now formalized financial institution risk assessments, with the logic being banks would better be able to marshal technology and investigator capabilities to address rising risks, criminal threat tactics and law enforcement intelligence needs.
The updates in the United States are informed by overarching efforts by global watchdog and private sector groups to prioritize “effectiveness” over technical compliance.
This momentum is occurring at the country, law enforcement and financial institution levels, including the Paris-based Financial Action Task Force (FATF), which sets international standards and best practices and reviews member country compliance, the Wolfsberg Group, the Egmont Group of Financial Intelligence Units (FIUs) and others.
How to illumine ownership? Control the controllers
As for the CTA, it requires certain “reporting companies” to report the name, date of birth, current address, and unique identification number (from a passport or driver’s license, for example) of their “beneficial owner(s)” to FinCEN.
This information must be updated every year to reflect any changes.
Subject to certain exceptions, a “beneficial owner” is defined in the CTA as “any individual who, directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise:
(i) exercises substantial control over the entity; or
(ii) owns or controls not less than 25 percent of the ownership interests of the entity.”
Moreover, under the CTA, the term “reporting company” means any corporation, limited liability company, or similar entity that is:
(i) created by the filing of a document with the secretary of state or similar office under the laws of a state or Indian Tribe, or
(ii) formed under the laws of a foreign country and registered to do business in the United States by the filing of a document with the secretary of state or similar office under the laws of a state or Indian Tribe.
While the CTA specifies that corporations and limited liability companies are subject to its requirements, it is expected that other pass-through entities synonymous with fund structures will be included as well, such as limited partnerships.
The CTA excludes [from the definition of “reporting companies”] any company that employs more than 20 full-time employees in the United States, annually reports more than $5 million in gross receipts or sales to the IRS, and has an operating presence at a physical office within the U.S.
The CTA also excludes broad categories of publicly traded, regulated, nonprofit and governmental entities.
More specifically, the CTA excludes funds and advisors already subject to reporting obligations to Federal agencies, including mutual funds, private investment funds, SEC Registered Investment Advisers, and Venture Capital Fund Advisers.
Exempt or not? Some examples of when private needs to get more public
However, private investment funds are not exempt if they are not operated or advised by an SEC-registered investment adviser.
Similarly, investment advisers exempt from SEC registration pursuant to the “Private Funds Advisor” exemption per Section 203(m) of the Investment Advisers Act of 1940 (including state-registered investment advisers not registered with the SEC) will be required to report as well.
The CTA instructs the secretary of the Treasury to promulgate regulations implementing beneficial ownership reporting requirements within one year of the effective date of the NDAA (January 1, 2022), although FinCEN has indicated that the final regulations will give affected entities additional time in which to comply.
On April 5, FinCEN published an Advance Notice of Proposed Rulemaking (“ANPR”) to implement the CTA. The comment period closed May 5, 2021.
The following provides a non-exhaustive list of the measures that investment fund managers and compliance managers should take in preparation of the arrival of the final CTA regulations:
- Identification collection, who watches the watchmen: Commence collecting the CTA required information from investors and managers/general partners and representatives and owners thereof (i.e. full legal name, date of birth, current residential and business street address, and a unique identification number, which can be from a non-expired US passport, non-expired US or state government ID, non-expired driver’s license, or a valid foreign passport);
- The message to subject entities – get with the program: Consult with your legal counsel to establish an AML policy for employees and representatives of the Company (including the designation of an individual to manage the AML program, FinCEN reporting requirements, suspicious activity reporting and related procedures, and ongoing training and education of employees and representatives of the Company);
- More than program creation, a focus on results: Calendar quarterly senior management meetings and reporting events to ensure the effective administration of the Company’s AML program and timely and effective reporting to FinCEN; and
- Refresh program policies, procedures, agree on agreements: Update the Company’s subscription agreements and private placement memorandums to include reference to the CTA and related compliance requirements in order to obtain the necessary information and minimize money laundering exposure.
Even with beneficial ownership law on the books, challenges, vagaries abound
The CTA was enacted following the “Panama Papers” scandal, where documents leaked from the former Panamanian law firm Mossack Fonseca revealed the ease in which bad actors utilized offshore and U.S. “shell companies” for illicit purposes.
Although the Federal government has finally decided to commit to AML compliance and related enforcement, questions remain regarding how the government will use this data to effectively discourage money laundering and other illicit activities.
For example, in 2019, the state of Delaware alone had 226,000 new entity formations, and as of the end of 2019, approximately 1.5 million entities were incorporated with good standing status in Delaware, far surpassing its population of less than one million persons.
Assuming the vast majority of Delaware entities are required to report under the CTA beginning in 2022, not to mention the vast number of entities from the rest of the country, how will the Federal government effectively use this information to further meaningful and much needed AML efforts to justify this additional burden on private business?
While the answer to this and other questions may not have easy solutions, the tacit message to the financial services and corporate worlds are clear: financial crime compliance is now much more tightly bound to corporate transparency.
Moreover, while painful, private investment groups are better served in analyzing, reviewing and updating AML program policies and procedures and querying required ownership details from fund managers, investors and others considered to have controlling interests now.
Rather than when regulators, or worse, investigators are at the door, wondering why this hasn’t been done yet – with the specter of expensive remediation, or potential for reputation-tarnishing penalties, hanging overhead.
The original article, ACFCS Exclusive Contributor Report: The Corporate Transparency Act Introduces Beneficial Ownership Disclosure Requirements for Investment Funds, was published by ACFCS on June 21, 2021.