U.S. Treasury Releases Proposed Rules to Require ?Unregistered Investment Companies? to Adopt an Anti-Money Laundering Program - 10/09/02

On September 18, 2002, the Financial Crimes Enforcement Network (?FinCEN?) of the U.S. Treasury Department (?Treasury Department?) issued proposed rules (the ?Proposed Rules?) requiring inter alia hedge funds and commodity pools to establish an anti-money laundering program pursuant to Section 352 of the USA PATRIOT Act. The Proposed Rules would require hedge funds and commodity pools to undertake the following: (i) adopt a written anti-money laundering program; (ii) conduct audits on a regular basis to test the anti-money laundering program; (iii) appoint a compliance officer; and (iv) provide ongoing employee training on anti-money laundering. Furthermore, the Proposed Rules would require hedge funds and commodity pools to file notice with FinCEN by completing and submitting a proposed form included in the Proposed Rules.

This article addresses the following: (i) who the Proposed Rules affects; (ii) who is exempt from compliance; (iii) the requirements under the Proposed Rules; (iv) other rules and obligations that apply to hedge funds and commodity pools; and (v) the deadline for compliance.   

I. Who Must Comply: the ?Unregistered Investment Company?

A. Onshore Funds

Under the Proposed Rules, hedge funds and commodity pools that fall under the category of ?unregistered investment company? would be required to comply with the Proposed Rules. The test to determine if a fund or pool is an ?unregistered investment company? is if the fund or pool is exempt from the definition of ?investment company? pursuant to Sections 3(c)(1) or 3(c)(7) of the Investment Company Act of 1940, as amended, or is a commodity pool that has:

(i) less than a two-year lock-up;
(ii) total assets of more than $1 million; and
(iii) a U.S. nexus (i.e., organized under the law of a State or the United States, sells an ownership interests to a U.S. person, or organized, operated, or sponsored by a U.S. person).

B. Offshore Funds

Furthermore, an offshore hedge fund or commodity pool that satisfies the above three elements would be considered to be an ?unregistered investment company? and therefore would have to comply with Section 352 of the USA PATRIOT Act.

II. Who is Exempt from Compliance with Section 352 under the Proposed Rules?

The Proposed Rules list three types of entities that are exempt from compliance with Section 352: (i) family companies without regard to the amount of assets owned by such a company; (ii) employees? securities companies which are investment companies established by employers for the benefit of employees; and (iii) employee benefit plans that are not construed to be pools under CFTC Rule 4.5(a)(4).

Also note that a hedge fund or commodity pool that does not satisfy any of the three elements listed above in Section I of this article would fall outside the term ?unregistered investment company? and therefore would not be required to comply with Section 352 of the USA PATRIOT Act.

Finally, financial institutions that are already required to comply with Section 352 (such as broker-dealers and financial commodity merchants) are excluded from the Proposed Rules to prevent duplication.

III. What is Required under the Proposed Rules?

A hedge fund or commodity pool that falls under the category of ?unregistered investment company? would be required to undertake at a minimum the following:

(i) establish and implement policies, procedures, and internal controls reasonably designed to prevent the investment company from being used for money laundering or the financing of terrorist activities and to achieve compliance with the applicable provisions of the Bank Secrecy Act (the ?BSA?);
(ii) provide for independent testing for compliance to be conducted by the investment company?s personnel or by a qualified outside party;
(iii) designate a person or persons responsible for implementing and monitoring the operations and internal controls of the program; and
(iv) provide ongoing training for appropriate persons.

A. The Written Anti-Money Laundering Program

A hedge fund or commodity pool that falls under the definition of ?unregistered investment company? would be required to adopt a written anti-money laundering program. The anti-money laundering program should take into account the size, location, activities, and risks or vulnerabilities to money laundering of the ?unregistered investment company.? In particular, ?unregistered investment companies? should be sensitive of investors from jurisdictions on lists maintained by the Treasury Department?s Office of Foreign Asset Control (?OFAC?) (sanctioned countries), FinCEN (country advisories), and the Financial Action Task Force on Money Laundering (?FATF?) (non-cooperative countries or territories (?NCCTs?)). In the event an ?unregistered investment company? identifies suspicious activity, such ?unregistered investment company? should take reasonable steps to determine if its suspicions are justified and respond accordingly.

Furthermore, the anti-money laundering program would have to be approved in writing by the ?unregistered investment company?s? board of directors or trustees, the general partner, or senior management.

It is permissible to delegate by contract the implementation and operation of an ?unregistered investment company?s? anti-money laundering program to a third-party. However, ultimate responsibility for compliance with Section 352 and the program?s effectiveness would remain with the ?unregistered investment company.? Moreover, an ?unregistered investment company? would have to actively monitor the third-party?s administration of its anti-money laundering program since it is not sufficient ?for an unregistered investment company simply to obtain a certification from its delegate that the company ?has a satisfactory anti-money laundering program.??

B. Conduct an Audit to Test for Compliance

A hedge fund or commodity pool that falls under the category of ?unregistered investment company? would be required to conduct periodic tests of its anti-money laundering program to assure that the program is functioning as designed. The tests are to be conducted by persons knowledgeable about the BSA?s requirements. An independent third-party service provider may conduct such tests. Moreover, these periodic tests may be conducted by an employee of the ?unregistered investment company? or its affiliate so long as this employee is not involved in the operation or oversight of the ?unregistered investment company?s? anti-money laundering program.

C. Appoint a Compliance Officer

A hedge fund or commodity pool that falls under the category of ?unregistered investment company? would be required to designate a person or persons with the responsibility for overseeing and enforcing the anti-money laundering program. In addition, the compliance officer should be an ?unregistered investment company?s? officer, trustee, general partner, organizer, operator, or sponsor. In practical terms, the compliance officer would be responsible for screening investors, conducting internal inquiries on suspicious activity, serving as the contact person with respect to government inquiries, and filing suspicious activity reports (?SARs?) and OFAC blocking reports, if necessary.

D. Employee Training on Anti-Money Laundering

Employees of a hedge fund or commodity pool that falls under the category of ?unregistered investment company? would be required to be trained regarding the BSA requirements that are relevant to their job functions and to recognize the signs of money laundering that could arise in the course of their duties. The employee training program should cover the BSA requirements, a description of money laundering, how money laundering is carried out, what types of activities and transactions should raise concerns, what steps should be followed when suspicious activity arises, and the OFAC obligations.

E. Filing Notice with FinCEN

A proposed obligation specific to hedge funds and commodity pools that fall under the category of ?unregistered investment company? would require such entities to file notice with FinCEN. Under the Proposed Rules, an ?unregistered investment company? would be required to furnish the following information: the name and contact information of the ?unregistered investment company?; the name and contact person of the investment adviser, commodity trading advisor, commodity pool operator, organizer, and/or sponsor of the unregistered investment company; the name and contact information of the compliance officer(s); the total assets under management held by the unregistered investment company as of the end of its most recent fiscal year; and the total number of participants, interest holders or security holders in the unregistered investment company.

Hedge funds and commodity pools that are required to file notice with FinCEN would have to file a notice within 90 days after they become subject to the provisions of the Proposed Rules. Once an ?unregistered investment company? has filed notice with FinCEN, such an ?unregistered investment company? would be required to file an amendment with FinCEN within 30 days after any change in the information submitted. However, an ?unregistered investment company? would not have to file an amendment with respect to changes in the total amount of assets under management or in the number of participants, interest holders or security holders in a fund or pool.

IV. Other Obligations Applicable to Hedge Funds and Commodity Pools

A. Reporting Cash Transactions

Hedge funds and commodity pools are currently required to report on Form 8300 the receipt of cash or certain noncash instruments totaling more than $10,000 in one transaction or two or more related transactions.

B. OFAC Obligations

OFAC regulations prohibit U.S. persons (natural persons and entities) from engaging in certain transactions with persons, entities, or government agencies of certain countries. Compliance with the OFAC regulations currently applies to both onshore hedge funds and commodity pools and offshore funds and pools that are managed by a U.S. investment manager because according to OFAC: ?All investments and transactions in the United States or involving U.S. persons anywhere in the world fall under U.S. jurisdiction and need to comply with OFAC regulations. . . . U.S. companies and their offshore offices are responsible for maintaining identifying information concerning all clients, investors, and beneficiaries as well as for knowing the source of investment funds. . . .? Therefore, both onshore funds and pools and offshore funds and pools managed by U.S. persons must have controls and monitoring programs to screen investors from countries listed on the OFAC Regulations or who appear on the OFAC List of Blocked Persons and Specially Designated Nationals.

C. Reporting Suspicious Activity

Additionally, although hedge funds and commodity pools that fall under the category of ?unregistered investment company? are not obligated to file SARs with FinCEN, the Treasury Department does encourage ?unregistered investment companies? to file SARs in the event an ?unregistered investment company? detects suspicious activity. Also, hedge funds and commodity pools are encouraged to call FinCEN?s Financial Institutions Hotline at 1-866-566-3974 to report suspected terrorist activity.

D. Compliance with Section 314 of the USA PATRIOT Act

On September 18, 2002, FinCEN also released final rules to implement Section 314 of the USA PATRIOT Act. Section 314 is to become operative on hedge funds and commodity pools that fall under the category of ?unregistered investment company? because such funds and pools are required to adopt an anti-money laundering program. Pursuant to Section 314(a), ?unregistered investment companies? would be required to have procedures in place to respond to a government inquiry via FinCEN. In addition, pursuant to Section 314(b), ?unregistered investment companies? may share certain information about suspected money laundering or terrorist activity with other financial institutions provided a filing of notice is made with FinCEN prior to the information sharing.

V. Deadline for Compliance

Since there is a 60 day comment period prior to publication of final rules and then a 90 day transitional period to develop and implement an anti-money laundering program pursuant to Section 352 of the USA PATRIOT Act, it is expected that compliance with Section 352 will become effective by spring 2003.

         _x000D_