Our Take: financial services regulatory update – February 16, 2024

• What happened: On February 13th, the Treasury Department’s Financial Crimes Enforcement Network (FinCEN) proposed a rule to expand AML requirements under the Bank Secrecy Act (BSA) to investment advisers. Alongside the proposal, FinCEN also released a risk assessment detailing how investment advisers can - mostly unintentionally - play a role in sanctions evasion, money laundering, tax evasion, terrorist financing and other forms of illicit finance.
• What the proposal says: It would amend the BSA’s definition of “financial institution” to include Registered Investment Advisers (RIAs) and Exempt Reporting Advisers (ERAs). These firms would be required to:
  • Establish risk-based AML programs, which include designating an AML compliance officer, instituting an employee training program, conducting independent testing, and conducting ongoing customer due diligence;
  • File suspicious activity reports (SARs) and Currency Transaction Reports (CTRs) with FinCEN; and
  • Comply with BSA recordkeeping requirements.
• The proposal would not require that RIAs and ERAs implement a customer identification program or collect beneficial ownership information, but it notes that FinCEN anticipates a future joint rulemaking with the SEC to address these issues.
• What’s next: Written comments must be submitted by April 15, 2024. If the proposed rule is finalized, RIAs and ERAs would have 12 months following the effective date to comply.

Our Take

Third time’s a charm? The proposal is the latest of several attempts by regulators to expand AML requirements to investment advisers, which has long been a subject of debate and controversy. There is significant wind behind this attempt, with Democratic Senators, the FBI and Treasury’s own AML risk assessment all calling out AML risks related to investment advisers. However, considering the historical difficulty of reaching a final rule and expected heavy industry pushback, all bets are off on whether this attempt will succeed. If the Administration changes following the upcoming election, the odds will tilt more toward the proposal stalling once again.

Long road to compliance for many. Investment advisers’ AML programs span a wide spectrum of maturity, with those that are affiliated with banks and mutual fund complexes generally having more advanced programs while many others lag far behind. If the proposal were to be finalized as-is, these less-advanced firms would have significant work ahead of them to develop the governance, controls, expertise and training necessary for a risk-based AML program, especially given the short one-year timeframe to comply. Notably, ERAs were included in the proposal, which typically have limited requirements under the Adviser Act and are located outside of the US. Many will likely look to delegate certain aspects of their programs to third parties, but it is important to remember that the firms will ultimately be held responsible for any deficiencies - and FinCEN has warned that it is not sufficient to rely on contractual provisions or certifications. Having strong third-party due diligence practices will be key for these firms that choose to delegate.

These notable developments hit our radar this week:

• Barr speaks on supervision. On February 16th, Fed Vice Chair for Supervision (VCS) Michael Barr spoke on supervision with speed, force, and agility. He confirmed that the Fed “has issued more supervisory findings and downgraded firms' supervisory ratings at a higher rate in the past year.” He also indicated that the Fed is still considering additional capital or liquidity charges for banks that have persistent issues in addressing supervisory findings.
• HFSC hearing and Barr commentary on the discount window. On February 15th, the House Financial Services Committee discussed the Fed’s function as lender of last resort, touching on use of the discount window including stigma around using it, operational improvements, and collateral policies. Similarly, on February 14th, VCS Barr spoke on monetary policy, market functioning and liquidity risk management. In his remarks, he commented on improving bank readiness in using the Fed’s discount window including pre-positioning collateral and testing discount window usage.
• Gensler speaks on AI. On February 13th, SEC Chair Gary Gensler spoke on AI using a myriad of movie references to drive his points home. He highlighted the benefits of generative AI and large language models but also noted the risk and importance of explainability, bias, the need for human validation, setting up guardrails to prevent fraud, and disclosures about AI use.
• FFIEC issues principles on residential lending appraisal and evaluation practices. On February 12th, the FFIEC issued a statement of principles on compliance and risk management practices related to the valuation and appraisal in residential lending.The principles outline what consumer compliance and safety and soundness examiners should consider when assessing the risks arising from potential valuation discrimination and bias.
• HSU speaks on bias. On February 13th, Acting Comptroller of the Currency Michael Hsu spoke on the importance of eliminating appraisal bias in an effort to expand access to homeownership, including to those in low-and moderate-income communities. He highlighted what the OCC is doing to identify potential discrimination in lending activities and property valuations, and supporting research that may lead to new ways to address the undervaluation of housing in communities of color.
• SEC proposes VC rule. On February 14th, the SEC proposed a rule that would update the dollar threshold for a fund to qualify as a “qualifying venture capital fund” for purposes of the Investment Company Act of 1940 (Act). The rule would update the dollar threshold to $12 million aggregate capital contributions and uncalled committed capital, up from the current standard of $10 million. The comment period will remain open until approximately the end of March.