Asset Management

New EU and UK Anti-Money Laundering Rules: The Fifth AML Directive Extends to Cryptocurrencies

and Posted on

The Fifth Anti-Money Laundering Directive (MLD5) entered into force in July 2018. MLD5 updates the legal framework under the Fourth Anti-Money Laundering Directive (MLD4) and must be implemented by the EU member states by January 2020. In response to the growing concerns over terrorist financing and the revelations of the Panama Papers, the amendments in MLD5:

  • increase transparency with respect to the beneficial ownership registers, which EU member states are required to establish under MLD4;
  • clarify and harmonize the enhanced due diligence measures that need to be applied to business relationships or transactions involving “high risk third countries”;
  • require EU member states to create and maintain a list of public functions that qualify as “politically exposed persons” or “PEPs” in their jurisdiction;
  • restrict the anonymous use of prepaid cards in order to mitigate the risk that they may be used for terrorist financing;
  • grant new powers for financial intelligence units, including the power to request, obtain and use information from any obliged entity based on their own analysis and intelligence, rather than just when triggered by a prior suspicious activity report; and
  • require member states to establish centralised registers or data retrieval systems to enable financial intelligence units and national competent authorities to access information about the identities of holders of bank and payment accounts and safe-deposit boxes.

In addition to these broad objectives, MLD5—for the first time—brings certain virtual currency service providers within the scope of EU anti-money laundering and terrorist financing regulations.

Extension of the AML Regime to Virtual Currencies

Virtual currencies, as defined in MLD5, are “a digital representation of value that is not issued or guaranteed by a central bank or a public authority, is not necessarily attached to a legally established currency and does not possess a legal status of currency or money, but is accepted by natural or legal persons as a means of exchange and which can be transferred, stored and traded electronically.”

Under this definition, most of the coins, tokens, and cryptocurrencies known today probably qualify as “virtual currency.” While not all of the tokens are necessarily used as a “means of exchange,” and this may not be their intended purpose, MLD5 adds that its objective is to cover “all the potential uses of virtual currencies,” such as “means of exchange, investment, store-of-value or use in online casinos.”

As for the reason behind the extension of the AML regime to virtual currencies, in its 2016 Communication on an Action Plan for Strengthening the Fight Against Terrorist Financing, the European Commission identified the ability for virtual currencies to be abused to conceal transactions related to terrorist financing, due to the relative anonymity of the virtual currency environment and the lack of an EU-level reporting mechanism for identifying suspicious activity.

To tackle these issues, MLD5 brings the “gatekeepers” of virtual currencies within the scope of EU anti-money laundering and terrorist financing legislation. Providers engaged in exchange services between virtual currencies and fiat currencies (“virtual currency exchange platforms”) and providers of services to hold, store and transfer virtual currencies (“custodian wallet providers”) have been made “obliged entities” for the purposes of the EU anti-money laundering and terrorist-financing framework. This means that providers of those services will be subject to the same obligations to carry out customer due diligence and report suspicious transactions as other firms designated as obliged entities under EU law, including credit institutions, financial institutions and certain professionals such as auditors and accountants.

The EU acknowledges that regulating virtual currency exchange providers and custodian wallet providers will not entirely address the issue of anonymity attached to virtual currency transactions, since users can transact without going through such providers. But to combat the risks related to anonymity, MLD5 states that national financial intelligence units should be able to obtain information allowing them to associate virtual currency addresses to the identity of the owner of virtual currency.

What’s Next for the UK AML Regime?

EU Member States have until January 10, 2020 to implement MLD5 into their national legislation. Since the implementation date falls within the anticipated transitional period of the UK’s exit from the EU, it is widely assumed that the UK will implement MLD5. MLD5 takes the form of a minimum harmonising Directive, which means that it sets minimum EU-wide standards that the UK could, if it chooses, go beyond.

Going forward, the Sanctions and Anti-Money Laundering Act 2018 (“SAMLA 2018”), which received Royal Assent on May 23, 2018, establishes a broad framework allowing the Secretary of State to pass UK anti-money laundering and terrorist financing regulations after the UK leaves the EU. Regulations may be passed to detect, investigate or prevent money laundering and terrorist financing and implement standards published by the Financial Action Task Force. SAMLA 2018 does not affect the substantive UK money laundering and terrorist financing offences under the Proceeds of Crime Act 2002 and Terrorism Act 2000, which can only be amended by Parliament. However, the broad enabling powers created under the legislation give rise to the possibility that the EU and UK anti-money laundering regimes could start to diverge over time.

Federal Reserve Board Provides New Details on Volcker Rule’s Illiquid Funds Requirements

Posted on

On December 12, 2016, the Federal Reserve Board announced additional details regarding how banking entities may seek an extension to conform their investments in a narrow class of funds that qualify as “illiquid funds” to the requirements of Section 619 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, commonly known as the Volcker Rule. An illiquid fund is defined by the statute as a fund that is “principally invested” in illiquid assets and holds itself out as employing a strategy to invest principally in illiquid assets.

The Volcker Rule generally prohibits insured depository institutions and any company affiliated with an insured depository institution from engaging in proprietary trading and from acquiring or retaining ownership interests in, sponsoring or having certain relationships with a hedge fund or private equity fund. These prohibitions are subject to a number of statutory exemptions, restrictions and definitions.

The Dodd-Frank Act permits the Board, upon an application by a banking entity, to provide up to an additional five years to conform investments in certain legacy illiquid funds where the banking entity had a contractual commitment to invest in the fund as of May 1, 2010. The five-year extension for certain legacy illiquid funds is the last conformance period extension that the Board is authorized to provide banking entities under the statute.

According to the guidelines adopted by the Board, firms seeking an extension should submit information, including details about the funds for which an extension is requested, a certification that each fund meets the definition of illiquid fund, a description of the specific efforts made to divest or conform the illiquid funds, and the length of the requested extension and the plan to divest or conform each illiquid fund within the requested extension period.

The Board expects that the illiquid funds of banking entities will generally qualify for extensions, though extensions may not be granted in certain cases – for example, where the banking entity has not demonstrated meaningful progress to conform or divest its illiquid funds, has a deficient compliance program under the Volcker Rule or where the Board has concerns about evasion.

The Board consulted with staffs of the other agencies charged with enforcing the requirements of the Volcker Rule, and the agencies plan to administer their oversight of banking entities under their respective jurisdictions in accordance with the Board’s conformance rule and the attached guidance.

SEC Issues No-Action Letter Regarding Relief from Registration under Advisers Act for Adviser to Affiliated Foundation

Posted on

On December 8, 2016, the Chief Counsel’s Office of the Division of Investment Management of the Securities and Exchange Commission (“Commission“) provided “no‑action letter” assurance to CenturyLink Investment Management Company, an investment adviser registered as such under the Investment Advisers Act of 1940 (“Adviser“), that it would not recommend enforcement action to the Commission if it were to withdraw its registration. Adviser is an indirect wholly owned subsidiary of CenturyLink, Inc., a telecommunications firm (“Parent“), that was established, and has been operated, for the sole purpose of providing investment advisory services to (i) the employee benefit plans sponsored by the Parent (the “Plans“), which were established solely for the benefit of current and previous employees of the Parent, its predecessors and affiliates, and comprise retirement and health and welfare employee benefit plans, including both qualified and nonqualified plans governed by the Employee Retirement Income Security Act of 1974 (“ERISA“); and (ii) the CenturyLink – Clarke M. Williams Foundation (the “Foundation“), a charitable foundation organized as a Colorado nonprofit corporation by a predecessor company of the Parent for charitable and educational purposes.

The response of the staff is consistent with other no-action letters issued to wholly owned subsidiaries of a parent that satisfy comparable conditions, except with respect to the Foundation. The significance of this letter is that it extends the application of these principles to advisory services provided to a charitable foundation under the circumstances presented.

In providing its response, the staff stated that its position is based particularly on representations that:

  • Adviser is an indirect wholly owned subsidiary of the Parent and has been established, and has been operated, for the sole purpose of providing investment advisory services to the Plans and the Foundation;
  • Adviser does not hold itself out to the public as an investment adviser, provides investment advice only to the Plans and the Foundation, and will not in the future provide investment advisory services to any third party;
  • The Plans are established solely for the benefit of current and previous employees of the Parent, its predecessors and affiliates, and comprise employee benefit plans governed by ERISA;
  • The Foundation is a charitable foundation organized as a Colorado nonprofit corporation by the Parent for charitable and educational purposes, and its beneficiaries are charitable and educational organizations; the Parent is the sole voting member of the Foundation, has rights with respect to the management of the Foundation and, since 2012, is its sole contributor;
  • The only amounts received by the Parent in connection with the Plans are reimbursements that are subject to the restrictions imposed by ERISA;
  • The only amounts received in connection with Adviser’s advisory services to the Foundation are reimbursements to the Parent from the Foundation for Adviser’s expenses associated with such advisory services; and
  • Neither the Plans nor the Foundation is required to register as an investment company under the Investment Company Act of 1940.

CFPB Structure Ruled Unconstitutional

Posted on

On October 11, 2016, the U.S. Court of Appeals for the District of Columbia Circuit ruled in PHH Corporation v. Consumer Financial Protection Bureau that the CFPB’s structure is unconstitutional.

In reaching this conclusion, the appellate court found that “No head of either an executive agency [established by the President] or an independent agency [established by Congress] operates unilaterally without any check on his or her authority” and, therefore, the Director of the CFPB “enjoys more unilateral authority than any other officer in any of the three branches of the U.S. Government, other than the President.” The court concluded that the CFPB “lacks that critical check and structural constitutional protection, yet wields vast power over the U.S. economy.” In order to remedy the constitutional flaw, the appellate court ruled that the CFPB can continue to operate but “will do so as an executive agency akin to other executive agencies headed by a single person, such as the Department of Justice and the Department of the Treasury,” and will be removable by the President. Report.

California Enacts Legislation Requiring Public Investment Funds to Make Disclosures Concerning Fees and Expenses Paid to Private Fund Managers

Posted on

 

On September 14, 2016, Governor Jerry Brown approved an amendment to the California Government Code, effective January 1, 2017, that requires a “public investment fund,” defined to mean “any fund of any public pension or retirement system, including that of the University of California,” to make certain disclosures at least annually concerning investments in each “alternative investment” vehicle in which it invests.  An “alternative investment vehicle” is defined to mean “the limited partnership, limited liability company, or similar legal structure through which a public investment fund invests in an alternative investment.”  An “alternative investment,” in turn, means an investment in a private equity fund, venture fund, hedge fund, or absolute return fund.”

Such disclosures include: (i) the fees and expenses that the public investment fund pays directly to the alternative investment vehicle, the fund manager or related parties; (ii) the public investment fund’s pro rata share of fees and expenses not included in (i) that are paid by the alternative investment vehicle; (iii) the public investment fund’s pro rata share of carried interest distributed to the fund manager or related parties; and (iv) the public investment fund’s pro rata share of aggregate fees and expenses paid by all of the portfolio companies held within the alternative investment vehicle to the fund manager or related parties.

These disclosure requirements are in alignment with: (i) enforcement actions brought by the Securities and Exchange Commission over the past several years against private fund managers for failure to adequately disclose conflicts of interest and the fees and expenses borne by investors in their funds; (ii) similar legislative initiatives in other states; and (iii) the publication by the Institutional Limited Partners Association of a proposed reporting template that captures greater detail on fees, expenses and carried interest paid to private fund managers and their affiliates.

SEC Adopts Amendments to Form ADV

Posted on

 

On August 25,  2016, the Securities and Exchange Commission (SEC) adopted amendments to Form ADV that are designed to provide additional information regarding advisers, including information about their separately managed account business, incorporate a method for private fund adviser entities operating a single advisory business to register using a single Form ADV, and make clarifying, technical and other amendments to certain Form ADV items and instructions. The SEC also adopted amendments to the Investment Advisers Act of 1940 books and records rule.

In particular, the amendments to Part 1A of Form ADV are intended to provide a more efficient method for the registration on one Form ADV of multiple private fund adviser entities operating a single advisory business (“umbrella registration”). Although under existing staff guidance a large number of advisers have already been making umbrella registration filings, the method outlined in the staff guidance for filing an umbrella registration was limited by the fact that the form was designed for a single legal entity. These amendments are intended to eliminate confusion for filers and the public. Press release.

New Jersey Appellate Court Clarifies Definition of Compensation under Advisers Act

Posted on

 

On August 12, 2016, the United States Court of Appeals for the Third Circuit affirmed the decision of the District Court of New Jersey and held in United States v. Everett C. Miller that the defendant was an “investment adviser” within the meaning of the Investment Advisers Act of 1940 (the “Advisers Act”), notwithstanding defendant’s arguments that he did receive “compensation” and was not engaged “in the business” of acting as an investment adviser.

The Advisers Act does not explicitly define “compensation” or what constitutes being engaged “in the business.”  Consequently, the Court of Appeals based its decision on a 1987 Release issued by the Staff of the Securities and Exchange Commission (Investment Advisers Release No. 1092) which states, in part: “The Staff considers a person to be ‘in the business’ of providing advice if the person . . . holds himself out as an investment adviser or as one who provides investment advice.” In reaching its decision that the defendant provided advice for “compensation,” the Court recognized that the Advisers Act also does not define “compensation.”  The Court again cited the SEC Release which defines compensation as “any economic benefit, whether in the form of an advisory fee or some other fee relating to the total services, rendered, commissions, or some combination of the foregoing . . .” and concluded that: “It is not necessary that an investor pay a discrete fee specifically earmarked as payment for investment advice.”  Opinion.

FinCEN Issues Customer Due Diligence Rule (CDD) FAQs

Posted on

On July 19, 2016, the Financial Crimes Enforcement Network (“FinCEN”) issued FAQs regarding the customer due diligence requirements (“CDD”) that it published on May 11, 2016, for certain financial institutions, including brokers, dealers, future commission merchants and introducing brokers in commodities.  The FAQs provide interpretive guidance with respect to these requirements, including, in particular, the new regulatory requirement to identify and verify the identity of the “beneficial owners” of virtually all legal entity customers, other than a sole proprietorship and an unincorporated association.  The CDD defines “beneficial owner” as:

  • “each individual, if any, who, directly or indirectly, owns 25% or more of the equity interests of a legal entity customer; and
  • a single individual with significant responsibility to control, manage, or direct a legal entity customer, including an executive officer or senior manager. . .
  • or any other individual who regularly performs similar functions.”

The FAQs states:  “In short, covered financial institutions are now required to obtain, verify, and record the identities of the beneficial owners of legal entity customers.”

SEC Proposes Rule Requiring Investment Advisers to Adopt Business Continuity and Transition Plans

Posted on

On June 28, 2016, the Securities and Exchange Commission proposed a new rule that would require registered investment advisers to adopt and implement written business continuity and transition plans.  In announcing the proposed rule the SEC stated that:  “The proposed rule is designed to ensure that investment advisers have plans in place to address operational and other risks related to a significant disruption in the adviser’s operations in order to minimize client and investor harm.”

The risks identified by the SEC include: business disruptions – whether temporary or permanent – such as a natural disaster, cyber-attack, technology failures, and the departure of key personnel.

The proposed rule also would require an adviser’s plan to include policies and procedures addressing the following specified components: maintenance of systems and protection of data; pre-arranged alternative physical locations; communication plans; review of third-party service providers; and plan of transition in the event the adviser is winding down or is unable to continue providing advisory services.

The proposed rule and rule amendments also would require advisers to review the adequacy and effectiveness of their plans at least annually and to retain certain related records.

In addition to the proposed rule, SEC staff issued related guidance addressing business continuity planning for registered investment companies, including the oversight of the operational capabilities of key fund service providers.

The proposed rule can be found by clicking here. Comments are due on or before September 6, 2016.

Financial Stability Board Issues Asset Management-Related Policy Recommendations

Posted on

On June 22, 2016, the Financial Stability Board (FSB) published for public consultation Proposed Policy Recommendations to Address Structural Vulnerabilities from Asset Management Activities. The document sets out 14 proposed policy recommendations to address the following structural vulnerabilities from asset management activities that could potentially present financial stability risks:

  1. Liquidity mismatch between fund investments and redemption terms and conditions for fund units;
  2. Leverage within investment funds;
  3. Operational risk and challenges in transferring investment mandates in stressed conditions; and
  4. Securities lending activities of asset managers and funds.

The key recommendations for liquidity mismatch and leverage focus on both public and private funds.

The FSB reported that it “intends to finali[z]e the policy recommendations by the end of 2016, some of which will be operationalized by the International Organization of Securities Commissions (IOSCO).”