On new AML rules, breathe easy

Last week, it finally happened: US Treasury floated proposals requiring registered investment advisers, like private equity and real estate shops, to officially join the fight against money laundering.

Now most of the private funds community has already adopted AML policies and procedures on a voluntary basis, but practices have been based on guidance from the Office of Foreign Assets Control, which limits its focus to trade sanctions and fighting terrorism. What the proposals do is define registered advisers as “financial institutions,” and therefore subject to heightened AML requirements under the Bank Secrecy Act, like filing Suspicious Activity Reports (SAR).

So it would be fair to say the proposals – anticipated since 2002 when Treasury first pitched the idea – were cause for concern in the industry. The story skyrocketed up our readership charts and compliance consultants were busy last week fielding calls from GP clients worried about what the new proposals would mean in practice.

But here’s the thing: the private funds industry already seems prepared for most of it all. Many firms have adopted SAR procedures and filing protocols following the Patriot Act as a good-faith effort. The requirement to appoint an AML officer can easily be met by pointing to the CCO (which registered advisers are required to have). And the obligation to file “Currency Transaction Reports” will only apply if an LP dumps a pile of cash on a fund manager’s desk, which obviously never happens.

In fact, private equity has a case to make that it deserves exemption from certain requirements. The private funds model – in which cash is locked up for five years or more – is a poor mechanism for criminals to launder money. And unlike hedge funds – which allow new investors in on a quarterly basis – managers running infrastructure, debt, real estate and private equity funds work with a limited number of investors, most of which are long-standing relationships. In other words, these managers exhibit less risk of running into a bad actor. For that reason alone, expect industry trade bodies to make the case that private fund managers do not need to engage in unnecessary due diligence during the proposals’ 60-day comment period.

Treasury may lend a sympathetic ear to the request. Similar proposals in 2003 exempted private equity funds on the same rationale that illiquid investments are of little use to money launderers. And the new proposals stress that financial institutions should take a risk-based approach to AML compliance, which private equity should benefit from.

To be sure, managers will need to review their AML programs for robustness, or implement one if they haven’t done so already. With respect to filing an SAR, GPs will have to use their best judgment when an LP is acting fishy. As the AML officers, CCOs will have to familiarize themselves with Section 314(a) of the Patriot Act – which requires them to scan a government list of suspected criminals every two weeks and see if any LPs are matches. It’s also worth stressing that SEC inspectors are likely to scrutinize firms’ AML programs more closely now that they are a requirement, highlighting the need to record AML policies in the compliance manual and regularly train staff on their meaning.

Still, AML compliance is not exactly a new field of compliance for the industry. The proposal was a long-time coming, and for many, will simply mean formalizing already existing practices. Unlike other new regulations, AML compliance shouldn’t result in any sleepless nights for the CCO.