FinCEN Issues Final Rule on AML/CFT Obligations for Private Fund Managers

The Financial Crimes Enforcement Network (FinCEN) recently issued a final rule aimed at strengthening Anti-Money Laundering (AML) and Countering the Financing of Terrorism (CFT) obligations for private fund managers, specifically targeting investment advisers (IAs). This rule is a key development in enhancing regulatory oversight within the financial sector and builds upon the Biden Administration’s commitment to combating corruption.

In this article, we will examine the implications of FinCEN’s final rule, explore its key elements, and discuss how private fund managers can adapt to these enhanced AML/CFT obligations.

Overview of FinCEN and the Final Rule

FinCEN operates as a bureau within the U.S. Department of the Treasury and is tasked with safeguarding the U.S. financial system by enforcing AML/CFT regulations. In its latest move, FinCEN has broadened the definition of “financial institution” under the Bank Secrecy Act (BSA) to include registered investment advisers (RIAs) and exempt reporting advisers (ERAs). This means private fund managers advising qualified clients must now comply with more stringent AML/CFT requirements. As we highlighted in the February 2024 regulatory roundup on the proposed rule, this started as an initiative following the U.S. Department of the Treasury’s 2024 Investment Adviser Risk Assessment, which uncovered critical gaps in the industry’s defense against illicit financial activities and notably highlighted the role of investment advisers as potential conduits for illicit proceeds association with corruption, fraud, and tax evasion. We also saw both the FinCen and SEC jointly propose new rules this year aimed at enhancing anti-money laundering (AML) and customer identification programs (CIP) specifically for investment advisers and financial institutions.

FinCEN has authorized the SEC to oversee compliance with its new rule concerning AML/CFT, capitalizing on the SEC’s regulatory expertise with investment advisers. This assignment leverages the SEC’s established role in examining brokers, dealers in securities, and mutual funds under the Bank Secrecy Act (BSA) and FinCEN’s regulations, ensuring that the same high standards of oversight extend to investment advisers.

Key Elements of the Rule

FinCEN’s new final AML/CFT rule mandates significant changes to ensure tighter regulatory oversight for investment advisers, specifically RIAs and ERAs. Under the updated regulations, these advisers are required to establish a comprehensive, risk-based AML/CFT program tailored to their operational scale and client profile. This includes devising strong internal controls, performing thorough customer due diligence, and actively reporting suspicious activities through Suspicious Activity Reports (SARs) to FinCEN. Additionally, firms must adhere to stringent record-keeping practices and comply with the Travel Rule, which requires the transmission of specific information alongside the movement of funds. While mutual funds and certain bank-sponsored collective investment funds receive exclusions from some of these requirements, advisers can delegate certain AML tasks to third parties. However, the ultimate responsibility for compliance remains with them. These measures are designed to enhance transparency, prevent illicit activities, and safeguard the integrity of financial markets.

FinCENs Final vs. Proposed AML/CFT Rules

FinCEN’s final AML/CFT rules include some significant revisions from the initial proposals. These modifications expand and clarify the regulatory framework, enhancing the scope and specificity of AML/CTF obligations. Here’s a breakdown of the key differences between the proposed and the final rules.

Scope of Coverage

The final rule narrows the definition of investment adviser further than initially proposed and specifically extends AML/CFT obligations to all investment advisers registered or required to be registered with the SEC, which includes those advising hedge funds, private equity funds, and other private funds. This expansion is more comprehensive than initially proposed, broadening accountability across a wider array of investment advisers. Like the proposal, ERAs are still also covered under the new rule. This move is aimed at tightening the compliance framework across the financial industry to better prevent money laundering and terrorist financing activities. However, as in the proposed rule, the final rule does not apply to state-registered advisers, foreign private advisers, or family offices.

Clarifications and Definitions

The final rule provides more detailed definitions and clarifications regarding terms such as “senior foreign political figures,” which were not as clearly outlined in the proposed rules. This aims to ensure that all entities have a clear understanding of their compliance obligations under the rule.

Exemptions and Inclusions

The final rule clarifies exemptions for certain types of advisers, such as those exclusively managing venture capital funds, which was a point of contention and confusion under the proposed rules. It provides precise criteria under which advisers might not be subject to some or all of the AML/CFT requirements.

Compliance Timelines and Transition Periods

The final rule offers a more structured timeline for compliance, giving firms specific deadlines to meet the new requirements. This structured approach is in response to feedback from the industry, which sought clearer guidance on implementation timelines compared to the proposed rules.

Enhanced Reporting Requirements

Under the final rule, investment advisers are required to file more detailed and frequent reports to FinCEN, including suspicious activity reports (SARs). This is a shift from the proposed rule that suggested less stringent reporting that aligned more closely with existing SEC reporting standards.

Why Now?

FinCEN created this rule because money laundering in investment funds has become a major threat. Research shows that money laundering continues to pose significant risks to the integrity of global markets, with billions of dollars estimated to be laundered each year. In 2022 alone, the annual losses reported to the FBI’s Internet Crime Complaint Center (IC3) totaled approximately $10.3 billion, which is assumed to underrepresent actual loss based upon the voluntary nature of reporting to the IC3. Regulatory agencies are now ramping up efforts to combat these risks in financial institutions that traditionally had less oversight, such as private fund managers.

The introduction of this rule comes at a time when global money laundering threats are on the rise, with criminals increasingly targeting financial sectors like private funds to hide illicit gains. This rule aligns with broader efforts by regulatory bodies to enhance transparency and reduce financial crime, making it harder for illicit actors to exploit gaps in oversight.

Impact on Private Fund Managers

The final rule’s impact on private fund managers is considerable. While many larger firms may already have compliance programs in place that address the requirements outlined in the final rule, smaller advisers may find the rule’s requirements challenging. The rule emphasizes the need for comprehensive customer due diligence, not just at the initial onboarding of clients but throughout the lifecycle of the customer relationship.

One of the core elements that advisers need to focus on is understanding the nature and purpose of their clients’ businesses. This is crucial in developing risk profiles and for ongoing monitoring of customer activity. Additionally, while the final rule stopped short of requiring mandatory beneficial ownership information, firms must still assess on a risk-basis whether to collect this data from legal entity customers.

Takeaways for Investment Managers

Investment managers subject to FinCEN’s new rules must prioritize establishing or updating their AML/CFT programs to meet the specific needs dictated by the nature and size of their operations. This includes enhancing customer due diligence processes to ensure continuous monitoring of all client activities, with a keen focus on high-risk clients. It’s also critical to refine systems for detecting and reporting suspicious activities, leveraging advanced monitoring technologies. While the rule permits the delegation of certain AML/CFT duties to third parties, investment advisers must choose their providers judiciously, remembering that the ultimate responsibility for compliance rests with them. Lastly, firms should adopt comprehensive methods to systematically assess and manage the risk profiles of their clients, incorporating regular reviews of business relationships and transaction patterns for potential money laundering indicators.

The Bottom Line

FinCEN’s final rule brings private fund managers into closer regulatory oversight, aligning them with broader efforts to curb financial crimes. Given the escalating focus on AML/CFT compliance, investment managers must take these rules seriously and ensure their firms are in full compliance before the rule takes effect in 2026. With regulatory expectations becoming more stringent, now is the time for firms to update internal policies and strengthen their compliance frameworks to meet the evolving demands of global financial oversight.

Staying on top of regulatory changes like this will not only prevent legal complications but will also ensure long-term resilience in a highly scrutinized market. Schedule a discovery call to learn more about how our business advisors can help you.