In response to concerns that the September 11th terrorist attacks may have been financed by the proceeds of international money laundering through United States financial institutions, on October 26, 2001, President Bush signed the USA Patriot Act to giv
By Betty Santangelo a partner with the New York City-based law firm of Schulte Roth & Zabel LLP, who has a nationally recognized expertise in money laundering issues.
In response to concerns that the September 11th terrorist attacks may have been financed by the proceeds of international money laundering through United States financial institutions, on October 26, 2001, President Bush signed the USA Patriot Act to give the government new powers to combat the war on terrorism. Title III of the USA Patriot Act imposes significant new anti-money laundering requirements on all financial institutions, including investment companies, and authorizes the U.S. Treasury Department (the "Treasury") to impose potential additional obligations on them as well. Under the USA Patriot Act, investment companies, including private investment funds, will now be subject to enhanced scrutiny, including a study on the potential use of investment companies for laundering money and mandating recommendations as to whether the reporting requirements of the Bank Secrecy Act, (the "BSA"), should be applied to investment companies.
The USA Patriot Act mandates that a report be jointly submitted to Congress by Treasury, the Board of Governors of the Federal Reserve System, and the Securities and Exchange Commission, within one year of the statute's enactment (i.e., by October 26, 2002), on the potential use of investment companies for laundering money and on recommendations for effective regulations to apply the reporting requirements of the BSA to investment companies. For purposes of the study, the term "investment company" has "the same meaning as in section 3 of the Investment Company Act of 1940; and . . . includes any person that, but for the exceptions provided for in paragraph (1) or (7) of section 3(c) of the Investment Company Act of 1940, would be an investment company." The USA Patriot Act's investment company study provision was proposed by Senator Jon Corzine, the former chairman of Goldman Sachs & Co., who emphasized that the government's focus is now turning to hedge funds, which allow large blocks of money "to flow anonymously on a global basis" and "are probably one of those places where you can [launder illicit money] most efficiently and anonymously." Congress has indicated that the joint report may include different recommendations for different types of investment companies. Thus, those who conduct the study will have the discretion to adjust their recommendations for regulations implementing the reporting and record keeping requirements of the BSA to apply to all or just some types of investment companies. Clearly then, hedge funds exempt from regulation under the Company Act are subject to the provisions of the USA Patriot Act mandating a study and are likely to be subject to regulation resulting from this study.
In fact, investment funds (both registered and unregistered) may well be subject to additional regulations to be imposed prior to the conclusion of the study. For example, section 352 of the USA Patriot Act requires all financial institutions, including investment companies, to establish "Anti-Money Laundering Programs" by April 24, 2002. Such programs, at a minimum, must develop internal policies, procedures, and controls; designate a compliance officer; establish an ongoing employee training program; and establish an independent audit function to test programs. Section 352 became effective 180 days after enactment of the Act (i.e., on April 24, 2002). On April 24th, the Secretary issued regulations implementing section 352, which temporarily exempt private investment funds and private equity funds from the requirements of that section. See 67 Fed. Reg. 21110 (Apr. 29, 2002); 67 Fed. Reg. 21114 (Apr. 29, 2002). In the regulations, Treasury indicates that it will continue to study the money laundering risks posed by all exempted financial institutions, including private investment funds and private equity funds, in order to develop and propose appropriate anti-money laundering program requirements for them by October 24, 2002. However, if Treasury does not issue regulations regarding private investment funds and private equity funds within the six-month exemption period, such funds nevertheless will be required to establish anti-money laundering programs that comply with the requirements of section 5318(h)(1) of the BSA by October 24, 2002.
To add to the analysis, section 321(b) of the USA Patriot Act treats commodity pool operators as financial institutions under the USA Patriot Act. Section 356(b) of the USA Patriot Act expressly authorizes the Secretary of the Treasury, in his discretion, to prescribe regulations requiring commodity trading advisors and commodity pool operators to prepare, file and maintain suspicious activity reports ("SARs") of customers' suspicious financial activities. As many private investment funds employ futures as part of their investment programs, thereby requiring the adviser to register with the CFTC as a commodity pool operator, this section of the Act creates additional potential reporting and record keeping obligations. However, because commodity pool operators also are temporarily exempted from section 352's requirement that they implement anti-money laundering programs, private investment funds will not be required to comply with section 352 until they are required by applicable regulations to do so (or until October 24, 2002 in the absence of any applicable regulations). In the interim, however, investment funds would be wise to revise their procedures to be more responsive to the requests of broker-dealers at which they maintain their accounts. Indeed, investment funds already have begun to receive requests from broker-dealers currently subject to anti-money laundering rules under the BSA for specific information relating to the background of investors and details of transactions in order to enable those broker-dealers to satisfy their own record keeping and reporting requirements.
The USA Patriot Act contains other significant provisions applicable to all financial institutions (including broker-dealers), some of which have the potential for being made directly applicable to investment funds and others of which may affect them indirectly. These include provisions for (1) obtaining accountholder verification and identification; (2) conducting due diligence with respect to private banking and correspondent accounts; (3) prohibiting financial institutions from doing business with shell banks; (4) obtaining additional ownership information for foreign banks; and (5) authorizing certain special measures by the Treasury. Again, the applicability of these provisions to investment companies is not yet clear, and will probably not be clear until implementing regulations are adopted. However, prime brokers that clearly will be covered by regulations may require their hedge fund clients to obtain specific customer and transaction information, as well as verbal representations and/or written certifications necessary to satisfy the broker-dealers' obligations under the USA Patriot Act. For example, a prime broker is likely to inquire as to whether a private investment fund takes steps to know its investors and their source of funds, and whether their investors include any senior foreign political figures or prohibited shell banks. Thus, either through the issuance of regulations affecting prime brokers, or a fund's commodity pool operator (generally, the general partner of the private investment fund), or the hedge funds themselves, hedge funds are likely to be affected by the regulations even before the study is complete. Indeed, in its new rules, Treasury indicated that it is likely that these entities will be subject to anti-money laundering program enforcements. Therefore, private investment funds should be aware of those provisions of the USA Patriot Act that either will affect them directly as investment companies or commodity pool operators or indirectly through the prime brokers at which they maintain their accounts. Thus, it is imperative that all investment companies, including private investment funds, take appropriate steps in order to protect themselves from money laundering activities. Consideration should be given to the following suggested actions:
- adopting money laundering prevention and detection programs that include: developing a system of anti-money laundering policies, procedures and controls; designating a compliance officer; training employees in money laundering detection and prevention; and establishing an independent audit function to test programs on a regular basis;
- implementing "know your investor" programs so that, at the time an investor is permitted into a fund, sufficient information is obtained to make an assessment regarding the client's background and the source of subscription amount to be invested;
- obtaining written assurances from investors that the capital contributions to the fund are not directly or indirectly derived from activities that may contravene federal, state and international regulations, including anti-money laundering laws and Office of Foreign Assets Control ("OFAC") regulations;
- checking the names of clients and any third parties involved in wire transfers through OFAC's list of prohibited foreign governments, agents or persons and refusing to accept investments from any listed parties;
- ascertaining whether the investor, any person for which the investor is acting as agent, a beneficial owner of a private investor or a control person of an investor that is a public entity, is a shell bank; refusing to accept investments from prohibited shell banks;
- ascertaining whether the investor, any person for which the investor is acting as agent, a beneficial owner of a private investor or a control person of an investor that is a public entity, is a senior foreign political figure;
- monitoring the activity in the accounts for suspicious financial activities (e.g., frequent subscriptions or redemptions);
- ascertaining the anti-money laundering procedures that the fund's third-party administrator (if one is used) has in place;
- reporting suspicious financial activities when detected (note that section 351 of the USA Patriot Act protects any financial institution or employee that makes a voluntary disclosure of any possible violation of law or regulation to a government authority; this safe harbor extends to claims under federal or state law or regulation, as well as to any contract or other legally enforceable agreement (including any arbitration agreement)); and
- monitoring new rules and regulations issued to implement sections of the USA Patriot Act applicable to all financial institutions (e.g., sections on accountholder verification and identification, private banking and correspondent accounts) for their applicability to investment companies.
With the enactment of the USA Patriot Act, Congress placed a major focus on the use of U.S. financial institutions, including securities firms, by money launderers to finance terrorist organizations. In the near future, new anti-money laundering rules may become a reality for many, if not all, investment funds. Thus, all investment funds should take the steps noted above to protect themselves from becoming vehicles for money launderers and prepare to meet the new anti-money laundering regulations soon to become effective. u
BVI AND THE BAHAMAS REMOVED FROM LIST OF UNCOOPERATIVE TAX HAVENS
BVI AND THE BAHAMAS REMOVED FROM LIST OF UNCOOPERATIVE TAX HAVENS
The Bahamas and the BVI, two major hedge funds jurisdictions, which had been included in a list of 35 "uncooperative" tax havens released by the Financial Action Task Force of the OECD in June 2000 were removed from an updated list of 7 uncooperative countries published on April 18, 2002. Both governments committed to the effective exchange of information for criminal tax matters after December 31, 2003 and for civil tax matters after December 31, 2005. Both governments undertake to ensure that information on beneficial ownership of entities established within their jurisdictions is available to tax and regulatory authorities. Such information will be subject to exchange under bi-lateral tax information exchange agreements such as those the U.S. recently signed with the Caymans, the BVI and The Bahamas, among others. AB