In a move to enhance the integrity of the U.S. financial system, the Financial Crimes Enforcement Network (FinCEN) has proposed a new rule that would require certain investment advisers to implement comprehensive anti-money laundering and countering the financing of terrorism (AML/CFT) measures. The rule, detailed in a Notice of Proposed Rulemaking (NPRM), aims to address the vulnerability of investment advisers to illicit finance activities.

The proposed rule would apply to two types of investment advisers: registered investment advisers (RIAs) and exempt reporting advisers (ERAs) that report to the Securities and Exchange Commission (SEC). RIAs are investment advisers registered with the SEC, while ERAs are exempt from registration but are still required to submit certain information. These advisers would be considered "financial institutions" under the Bank Secrecy Act (BSA) once the rule is implemented.

Under the proposed rule, investment advisers would be required to establish and implement risk-based AML/CFT programs, report suspicious activities to FinCEN, fulfill recordkeeping requirements, and comply with other obligations specified by the BSA and FinCEN's regulations. Additionally, the rule would facilitate information sharing between FinCEN, law enforcement agencies, and other financial institutions, and subject investment advisers to special measures imposed by FinCEN under Section 311 of the USA PATRIOT Act.

Treasury's risk assessment of the investment adviser sector revealed cases of illicit finance activities, including sanctioned individuals, corrupt officials, tax evaders, and criminal actors using investment advisers to gain access to U.S. assets. The assessment also found instances of foreign adversaries, such as China and Russia, utilizing investment advisers to invest in early-stage companies in order to obtain sensitive information and emerging technologies.

The proposed rule comes as the investment adviser sector has witnessed significant growth, with assets under management (AUM) nearly doubling since the previous NPRM was issued in 2015. The expanding size and rapid development of the sector highlight the need to recalibrate the regulatory environment and strengthen AML/CFT measures.

FinCEN has carefully tailored the proposed requirements to minimize business burden while ensuring transparency and protecting the financial system. Notably, the proposed rule does not impose AML/CFT program or suspicious activity reporting requirements on mutual funds advised by investment advisers, as these funds are already defined as "financial institutions" under the BSA.

The proposed rule aligns the U.S. with international standards and addresses a deficiency identified by the Financial Action Task Force (FATF) in its 2016 Mutual Evaluation of the United States. It aims to improve outcomes for U.S. investors, enhance detection and reporting of suspicious activities, level the regulatory playing field, and mitigate illicit finance risks associated with potential regulatory arbitrage.

The public will have the opportunity to review and provide comments on the proposed rule outlined in the NPRM. FinCEN is also withdrawing the 2015 NPRM, indicating a focused effort to modernize and strengthen AML/CFT measures in the investment adviser industry.

If the proposed rule is implemented, covered investment advisers would be required to comply within 12 months from the effective date of the final rule. The rule holds the potential to significantly enhance the protection of the U.S. financial system, contribute to national security efforts, and safeguard investments in the United States.