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Hedge Funds Risk Biden-Era End to Money-Laundering Loophole


Private-equity and hedge funds face an increased risk that the U.S. will close a longstanding money-laundering loophole for assets they manage. All it would take is the Biden administration to quickly revive a rule that was developed during Barack Obama's term but left unused by Donald Trump.

The U.S. has intensified its crackdown on dirty money in recent years, requiring banks, brokerages and mutual funds to monitor clients and report suspicious activity.

  • But investment advisers overseeing trillions of dollars in private equity and hedge funds are exempt from such rules, and the Federal Bureau of Investigation says that's attracted more cash from Mexican drug lords, countries under U.S. sanctions and companies with suspected Russian mob ties.

Regulators sought to close that loophole in 2015 with a new set of reporting requirements, but

  • The proposal wasn't enacted before Obama left office and it lay dormant while Trump was president.
  • With Democrats back in control of the White House and bipartisan support for more scrutiny of illicit funds, the Treasury Department's Financial Crimes Enforcement Network may seek to revive the anti-money-laundering proposal.

Michael Buffardi, a managing director in the financial services practice at FTI Consulting SAID

  • "We’re advising clients to expect that during the Biden administration, FinCEN will finalize the AML rule for registered investment advisers,”
  • “We can’t anticipate the timing, but think it’ll be sooner rather than later.”

After the November election, the non-partisan Financial Accountability & Corporate Transparency Coalition called on Joe Biden to enact the 2015 rule in his first 100 days in office to help safeguard the financial system and plug a key U.S. vulnerability to money laundering.

  • “The rule has already undergone the comment process and could be quickly finalized,” the coalition said.

Janet Yellen, who was sworn in as Biden’s Treasury Secretary Jan. 26, said in a staff memo that

  • “Fighting illicit finance” would remain part of department’s “usual business” while it confronts the long-term consequences of the global pandemic, climate change, systemic racism and the lingering economic crisis.

Groups representing private equity and hedge funds don’t want for any such rule to move forward. They say

  • their money is already tracked by regulated financial institutions and doesn’t need additional oversight, despite the FBI report suggesting the problem requires urgent attention.

Opponents of anti-money laundering requirements for managers of private funds have argued that

  • They don’t take physical custody of client assets. I
  • Instead, those assets are held by banks, brokerages or other “qualified custodians,” which are already required to monitor for signs of money laundering and report suspicious activity.

The Managed Funds Association, which represents hedge funds, said in its 2015 written response to the FinCEN proposal.

  • “Hedge funds present relatively limited money-laundering risks,” with the vast majority of investment advisers already using internal measures to track dirty money, Private-equity managers’ practice of requiring investors to tie up capital for long periods make their funds “poor vehicles for money laundering and terrorist financing,” and should be excluded from FinCEN’s proposed rule, American Investment Council, which represents the industry,

In a May 2020 Intelligence Bulletin, the FBI said financial criminals are tapping hedge funds and private equity firms

  • “To launder money, circumventing traditional anti-money laundering programs.”

Without stricter oversight, the funds provide

  • “Ever-increasing opportunities for threat actors to co-opt investment funds without being overly scrutinized,” the agency said.

Ali Burney, a partner at Steptoe & Johnson whose practice focuses on cases of financial crime, SAYS.

  • “The risks highlighted in the FBI assessment are quite real,”
  • “Investment vehicles always offer an attractive target, not only to launder funds but also as conduits for bribery and other schemes.”

The FBI expressed a different view in its report last year.

  • “The proliferation of private investment funds has made the industry less rigid as to the structure of the investment in an effort to attract more capital,” it wrote.
  • “Furthermore, the profit motive does not incentivize the private investment fund manager to scrutinize the source of funds or the underlying beneficial owner.”

Mederic Daigneault, a senior director with National Regulatory Services, a compliance consulting firm SAID

  • Self-policing by private equity and hedge funds is “not as robust as it would be if the 2015 proposal was adopted,”
  • That means the industry’s defences could be strengthened through mandatory requirements for monitoring and reporting money laundering red flags,

Jason Mulvihill, the council’s chief operating officer and general counsel, said:

  • That SEC-registered private fund advisers already provide detailed information about their activities, so adding anti-money laundering requirements is unnecessary.
  • “The new legislation is not going after investment advisers and funds that are regulated,”
  • “It’s focus is on things that are less transparent.”