Category: Anti-Money Laundering

Changes Coming With Anti-Money Laundering Requirements

James H. Freis, Jr., Director of the Financial Crimes Enforcement Network, let us know that his agency is working on anti-money laundering requirements for investment advisers. At a November 15, 2011 speech at the American Bankers Association/American Bar Association’s Money Laundering Enforcement Conference he highlighted many of the issues of money-laundering in the various financial sectors. FinCEN‘s rules currently apply to broker-dealers and to mutual funds, but not to investment advisers.

On May 5, 2003, FinCEN published a notice of proposed rulemaking in the Federal Register proposing that investment advisers establish anti-money laundering programs. But it never went anywhere. On November 4, 2008, FinCEN announced that it was withdrawing the proposed regulations and would not proceed with regulations for these entities without publishing new proposals and allowing for industry comments.

“FinCEN is currently revisiting the topic of investment advisers, building on the changes to that industry pursuant to the Dodd-Frank Act, the SEC rules implementing Dodd-Frank and other changes, and is working on a regulatory proposal that would require investment advisers to establish AML programs and report suspicious activity.”

The investment adviser line of business has lots of business models. Shortly, the ranks of investment advisers will be flooded with private fund managers. Fries cites these statistics:

“According to the Investment Advisers Association, the number of investment advisers registered with the SEC totaled 11,539 in 2011, and the total assets under management reported by all investment advisers increased 13.7% to $43.8 trillion in 2011, from $38.6 trillion in 2010.28 According to the SEC, there are more than 275,000 state-registered investment adviser representatives and more than 15,000 state-registered investment advisers.29 Approximately 5% of SEC-registered investment advisers are also registered as broker-dealers, and 22% have a related person that is a broker-dealer. Additionally, approximately 88% of investment adviser representatives are also registered representatives of broker-dealers.”

Clearly, it’s a big industry. Clearly, working with “bad guys” on any of the blocked persons lists would be a big problem.

However, the private equity fund vehicle is an unlikely choice for someone to launder money. The investment is highly illiquid, the subscription commitment requires you to contribute money infrequently over a long period of time, and the money is distributed back irregularly.

I welcome some clarity from FinCEN, but hope they are realistic about the burdens they will impose in contrast to the risk.

Laundering the Proceeds of Corruption

The FCPA and the Bribery Act focus mostly on the giver of the bribe. On the other hand, the recipients of the bribes need to deal with the cash to also avoid being caught. Like all criminals, they either shove cash into their mattresses or find a way to launder the money to get it back into the financial system. The Financial Action Task Force recently released a study on the links between corruption and money laundering: Laundering the proceeds of corruption (.pdf – 54 pages).

In running an anti-money laundering program you realize that politically-exposed persons are a potential danger to your firm. More people have noticed the potential dangers in light of the regime upheavals in North Africa and the Middle East. Funds associated with the current regime are being frozen and seized across the world. If one is your investor, you’re going to be tied up in legal headaches for years.

I suppose the money is tantalizing. The FATF report cites an estimate of $50 billion of proceeds from corruption. That’s a lot of cash to launder and big mattresses.

There are many different ways to get the cash flowing:

  • In the Green-Bangkok film festival FCPA case, the bribes were paid simply by means of the wire transfer of funds from US-based accounts, where the promoters were located, into offshore accounts in third countries maintained by family members of the PEP. The bribes never passed through Thailand.
  • Joseph Estrada, then the President of the Philippines, often received cash or check payments from gambling operators in exchange for their protection from arrest or law enforcement activities. This money was simply deposited into domestic accounts in the name of a fictional person or in corporate vehicles.
  • In the case of the bribery of US Congressman Randall Cunningham, who was a senior legislator with significant control over military expenditures, a military contractor bribed him both by checks to a corporation controlled by Cunningham, but also by agreeing to purchase real estate owned by Cunningham at a vastly inflated price.
  • Pavel Lazarenko, former Prime Minister of Ukraine, regularly required entities that wished to do business in Ukraine to split equally the profits of the enterprise with him. These businesses would transfer a share of ownership to Lazarenko associates, and money would be wired from the victim companies to offshore accounts controlled by Lazarenko.
  • Vladimiro Montesinos, Peruvian President Fujimori‘s security advisor, used shell corporations to disguise and move money illegally obtained through defense contracts with the Peruvian government, involving several corporate vehicles in a number of jurisdictions with each vehicle holding bank accounts in yet other jurisdictions.

In the United States, the Financial Crimes Enforcement Network, Treasury’s financial intelligence unit has been trying to impose anti-money laundering obligations on private funds for years. I still take the position that private equity funds are not an attractive target for money laundering, given their illiquidity and the long length of time it takes to see cash returned.

Nonetheless, fund managers should be vigilant to find out where their investors’ money comes from.

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Anti-Money Laundering Obligations For Private Funds

The Financial Crimes Enforcement Network, Treasury’s financial intelligence unit has been trying to impose anti-money laundering obligations on private funds for years. On September 26, 2002, FinCEN issued a notice of proposed rulemaking, proposing to require unregistered investment companies to establish and implement anti-money laundering programs. (Anti-Money Laundering Programs for Unregistered Investment Companies, 67 FR 60617 (Sep. 26, 2002))

In that notice of proposed rulemaking, FinCEN proposed to define the term “unregistered investment company” as (1) an issuer that, but for certain exclusions, would be an investment company as that term is defined in the Investment Company Act of 1940, (2) a commodity pool, and (3) a company that invests primarily in real estate and/or interests in real estate. FinCEN proposed requiring these companies to file a notice so that FinCEN could readily identify such companies and require them to establish and implement anti-money laundering programs.

I think most real estate fund managers and other private fund managers keep an eye on the parties to see if there is a reason to be wary and to see if they on the Specially Designated Nationals and Blocked Persons List. But I had some concern that FinCEN could extend the “know your customer” rules deep into transactions, imposing lots of administrative overhead for little benefit.

In November of 2008, FinCEN filed a notice of Withdrawal of the Notice of Proposed Rulemaking for Anti-Money Laundering Programs for Unregistered Investment Companies . In that notice, FinCEN stated that they were not abandoning the possibility of pursing the rulemaking. Given the six year span since the notice, they feel it has gone stale. If (or when) they decide to proceed with an anti-money laundering program requirement for unregistered investment companies, they will publish a new notice.

The “when” seems to be coming closer.

Senator Levin introduced the Stop Tax Haven Abuse Act. Section 203 of that bill would require the Department of Treasury to require

unregistered investment companies, including hedge funds or private equity funds, to establish anti-money laundering programs and submit suspicious activity reports under subsections (g) and (h) of section 5318 of title 31, United States Code.

The bill defines an “unregistered investment company” as one that would be an investment company but is exempt under 3(c)(1) or 3(c)(7).

Hedge funds may be an attractive source for money-laundering (I’m not sure), but private equity can’t be very enticing. Cash is called as investments are made over the course of the investment period and then slowly returned as investments are realized. I don’t generally think of terrorists and drug lords as patient capital sources.

Nonetheless, most private equity fund managers I’ve talked to investigate the background of their investors. It’s a long term relationship on both sides and managers don’t want to have the headache of having a bad investor. The repercussions of having a blocked-person would be tremendous, both from the legal fallout as well as the damage to the sponsor’s reputation. Most lenders require the fund to warrant that there are no blocked persons in their funds.

The Levin bill would technically leave out real estate fund companies, assuming they are taking advantage of the 3(c)(5) exemption. I sense more regulatory overhead approaching.

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God Says No More Money Laundering

I expect that we will see a see standard in anti-money laundering programs.

Pope Benedict XVI committed the Vatican to the fight against money laundering, counterfeiting and the financing of terrorism. The headquarters of the Roman Catholic Church will now meet international standards of financial transparency. He has established a set of internal regulations which will ensure that the Vatican’s bank, the Institute for Religious Works, will adhere to regulations and cooperate with foreign authorities. The decree creates an independent Vatican watchdog – the Financial Information Authority – which will be tasked with ensuring that all financial transactions comply with internationally accepted norms of the Financial Action Task Force.

In September, Italy’s financial police seized 23 million euros from the Institute for Religious Works after the financial intelligence office at the Bank of Italy noticed two operations by the bank that it deemed suspicious. The move followed claims that it failed to disclose either the sender or recipient involved in a huge transfer of funds.

If a little bit of the papal infallibility rubs off on the Vatican’s anti-money laundering, you would expect it to work.

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Money Laundering Using Trust and Company Service Providers

Trusts and Company Service Providers (TCSPs) can provide an important link between financial institutions and some of their customers.  TCSPs have often been used, wittingly or unwittingly, in the conduct of money laundering activities. The majority of TCSPs are established for legitimate purposes, the Financial Action Task Force’s research Shows that some TCSPs are being used, unwittingly or otherwise, to help facilitate the misuse of trust and corporate vehicles.

The FATF’s Money Laundering Using Trust and Company Service Providers report evaluates the effectiveness of the practical applications of the FATF’s 40+9 Recommendations as they relate to TCSPs.  It also considers the role of TCSPs in the detection, prevention and prosecution of money laundering and terrorist financing.

The report is an update f the 2006 report: The Misuse of Corporate Vehicles, Including Trust and Company Service Providers, 2006. presents issues for consideration that should help to reduce the use of TCSPs for money laundering purposes.

There are no simple answers, other than knowing your business partner. Complex arrangement of entities are usually required to make structures tax-efficient across international borders, to isolate risk, to meet regulatory requirements, and to clarify management. On the other hand, bad guys can use these structures to hide the true ownership and that the true source of capital is dirty money.

The Financial Action Task Force (FATF) is an independent inter-governmental body that develops and promotes policies to protect the global financial system against money laundering and terrorist financing.

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Export Control Limitations

I don’t spend much time dealing with export regulations. It’s kind of hard to ship a commercial office building oversees. The Bureau of Industry and Security (BIS) is responsible for implementing and enforcing the Export Administration Regulations (EAR), which regulate the export and reexport of most commercial items. Other agencies regulate more specialized exports.

If you are shipping stuff oversees, you need to determine if you need a license. There four questions you need to ask:

  • What are you exporting?
  • Where are you exporting?
  • Who will receive your item?
  • What will your item be used for?

I’m focused on the “who will receive your item list, because there are long lists of individuals and organizations are prohibited from receiving U.S. exports. These are the general lists:

BIS Entity List – EAR Part 744, Supplement 4 – A list of organizations identified by BIS as engaging in activities related to the proliferation of weapons of mass destruction. http://www.access.gpo.gov/bis/ear/pdf/744spir.pdf

Treasury Department Specially Designated Nationals and Blocked Persons List – EAR Part 764, Supplement 3 – A list maintained by the Department of Treasury’s Office of Foreign Assets Control comprising individuals and organizations deemed to represent restricted countries or known to be involved in terrorism and narcotics trafficking. http://www.treas.gov/offices/enforcement/ofac/sdn/t11sdn.pdf

The Unverified List is composed of firms for which BIS was unable to complete an end-use check. Firms on the unverified list present a “red flag” that exporters have a duty to inquire about before making an export to them. http://www.bis.doc.gov/enforcement/unverifiedlist/unverified_parties.html

Denied Persons – You may not participate in an export or reexport transaction subject to the EAR with a person whose export privileges have been denied by the BIS. http://www.bis.doc.gov/dpl/thedeniallist.asp

If you’re dealing with defense articles and defense services, you will need to look at the Department of State’s Directorate of Defense and Trade Controls.  They have limitations imposed by country: County Policies and Embargoes.

If you’re dealing with nuclear material, then you need to avoid the embargoed countries listed in 10 CFR 110.28 and the restricted destinations in 10 CFR 110.29.

There are a bunch of other programs, but they seem mostly focused on specialized materials and are do not have specific lists of blocked parties.

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New Anti-Money Laundering Guidance

Money Laundering is bad and financial institutions need to have internal controls policies, procedures and processes to identify higher-risk accounts and monitor the activity. At the core of an anti-money laundering program is that an institution must know its customers and the risks presented by its customers.

The program becomes more difficult when the customer is a corporation or legal entity.

An alphabet soup of federal regulators just jointly issued new guidance “to clarify and consolidate existing regulatory expectations for obtaining beneficial ownership information for certain accounts and customer relationships.” The Financial Crimes Enforcement Network, Federal Reserve System, Federal Deposit Insurance Corporation, National Credit Union Administration, Office of the Comptroller of the Currency, Office of Thrift Supervision, Securities and Exchange Commission, and Commodity Futures Trading Commission all joined in the guidance.

Identifying the ownership and control of a legal entity can be difficult. Often, the only way to get the information is from the entity itself, with no third party way to identify the veracity of the information. Most financial institutions struggle with how far to dive into a legal entity to determine the beneficial ownership.

This joint guidance effectively adopts the FinCEN definition of beneficial owner:

“[T]he individual(s) who have a level of control over, or entitlement to, the funds or assets in the account that, as a practical matter, enables the individual(s), directly or indirectly, to control, manage, or direct the account. The ability to fund the account or the entitlement to the funds of the account alone, however, without any corresponding authority to control, manage, or direct the account (such as in the case of a minor child beneficiary), does not cause the individual to be a beneficial owner.” [31 CFR 103.175(b)]

The first step is to obtain enough information about the structure and ownership of the entity so you can determine if the account will pose a heightened risk. With a heightened risk, you should conduct enhanced due diligence.

Accounts for senior foreign political figures always require Enhanced Due Diligence that is reasonably designed to detect and report transactions that may involve the proceeds of foreign corruption. [31 CFR 103.178 (b)(2) and (c)]

The one interesting statement is that financial institutions should consider implementing policies on an enterprise-wide basis to share information about beneficial ownership of their customers. Anti-money laundering staff should be able to cross-check for information with other departments. Avoid silos of information.

The guidance does not offer anything new or insightful. But it is good to see the regulators joining together to try to standardize the expectations across different types of financial institutions.

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Image is by AlwaysAwake: Money Laundering: Hiding ownership and profits in offshore jurisdictions using myriad mechanisms in Switzeland, money laundering capital of the world, & other islands and nations. Favorite tool of mega-rich arch-criminal banking & corporate investors

FinCEN and Address Confidentiality Programs

How do you open a bank account when you are hiding from domestic violence?

The rules implementing the Bank Secrecy Act require a financial institution to implement a Customer Identification Program that includes procedures that enable it to form a reasonable belief that it knows the true identity of its customers. The rules also require that a financial institution obtain a residential or business street address from each customer.

To make it easier for the victims of domestic violence, sexual assault or stalking to stay hidden from their attackers, 31 states have enacted Address Confidentiality Programs to help protect the home address of victims. These programs provide a confidential mail forwarding system. Typically, the Secretary of the State assigns a substitute address to the program participant to be used as their legal mailing address. Staff retrieve the participant’s mail and forward it to the participant’s actual physical location.

That is where the Address Confidentiality Program program runs into the Customer Identification Program.

But the Financial Crimes Enforcement Network issued a letter ruling to help financial institutions get out of this pickle. The FinCEN regulations also allow:

“If the individual customer does not have a residential or business street address, then the rules permit the individual customer to provide a “residential or business street address of next of kin or of another contact individual.”

See 31 C.F.R. §103.121(b)(2)(i)(3)(ii), §103.122(b)(2)(i)(A)(3)(ii), §103.123(b)(2)(i)(A)(3)(ii) and§103.131(b)(2)(i)(A)(3)(ii)

In FIN-2009-R003, FinCEN found:

A customer who participates in a state-created ACP shall be treated as not having a residential or business street address and a secretary of state, or other state entity serving as a designated agent of the customer consistent with the terms of the ACP, will act as another contact individual for the purpose of complying with FinCEN’s rules. Therefore, a financial institution should collect the street address of the ACP sponsoring agency for purposes of meeting its CIP address requirement.

Problem solved. At least it will be once knowledge about the ruling is passed along to front line people enforcing the Customer Identification Programs.

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Credit Suisse Settles OFAC Charges for $536 million

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The Credit Suisse Group has reached a settlement with U.S. authorities related to U.S. dollar payments involving parties subject to U.S. sanctions. The $536 million global settlement with Credit Suisse represents by far the largest sanctions settlement in the history of US Treasury’s Office of Foreign Assets Control.

The settlement arises out of Credit Suisse’s processing of thousands of transactions over a 20 year period that concealed the involvement of sanctioned parties. Credit Suisse approached OFAC in early April 2006 about an internal investigation it was conducting related to U.S. securities transactions executed on behalf of an entity subject to U.S. sanctions. In early 2007, after the New York County District Attorney’s Office began looking into several suspicious wire transfers, Credit Suisse also informed OFAC of a separate internal investigation related to its activities as a U.S. dollar correspondent for payments involving Iran, Sudan, Burma, Cuba, North Korea.

The settlement agreement lays out the decades long history of bad behavior at Credit Suisse.

“Credit Suisse in Zurich had a standard procedure of structuring payments to avoid disclosing the sanctions nexus of transactions passed through the United States, deleting or omitting certain information when transactions were to be processed through the United States, and providing incorrect information in wire transfer instructions executed through the United States on behalf of U.S. sanctioned individuals and entities. This standard procedure was embodied in internal directives, memoranda, and e-mails involving, among others, a Credit Suisse Bank Payments sector head, Credit Suisse’s Treasury and Trade Finance departments, the head of Credit Suisse’s Iran desk, as well as in e-mails between Credit Suisse and its Iranian bank clients.

…

Specifically, from on or about August 19,2003, to on or about November 1,2006, Credit Suisse processed 4,775 electronic funds transfers, in the aggregate amount of USD 480,072,032.00, through financial institutions located in the United States to the benefit of the Government of Iran and/or persons in Iran, including various Iranian financial institutions, in apparent violation of the prohibition against the “exportation, … directly or indirectly, from the United States, … of any … services to Iran or the Government of Iran,” 31 C.F.R. § 560.204.”

Credit Suisse is making the $536 million payment pursuant to a settlement agreement with OFAC and deferred prosecution agreements with the New York Country District Attorney’s Office and the United States Department Justice.

I would expect that a shareholder class action suit will be filed shortly as well. We have seen these shareholder suits result from FCPA settlements.

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Amendment to the Global Terrorism Sanctions Regulations

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The Office of Foreign Assets Control (OFAC) amended the Global Terrorism Sanctions Regulations, 31 C.F.R. part 594 to define the term “financial, material, or technological support,” as used in sanction regulations.

Section 594.201(a)(4)(i) of the regulations implements section 1(d)(i) of Executive Order 13224, as amended, by blocking the U.S. property of persons who assist in, sponsor, or provide financial, material, or technological support for acts of terrorism that threaten the security of U.S. nationals or the national security, foreign policy, or economy of the U.S.

New section 594.317, in subpart C of the GTSR, defines the term “financial, material, or technological support” to mean any property, tangible or intangible, and includes a list of specific examples:

“The term financial, material, or technological support, as used in § 594.201(a)(4)(i) of this part, means any property, tangible or intangible, including but not limited to currency, financial instruments, securities, or any other transmission of value; weapons or related materiel; chemical or biological agents; explosives; false documentation or identification; communications equipment; computers; electronic or other devices or equipment; technologies; lodging; safe houses; facilities; vehicles or other means of transportation; or goods.

‘‘Technologies’’ as used in this definition means specific information necessary for the development, production, or use of a product, including related technical data such as blueprints, plans, diagrams, models, formulae, tables, engineering designs and specifications, manuals, or other recorded instructions.”

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