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    Nov. 7, 2024

Parsing FinCEN’s Final AML Rules for Investment Advisers (Part One of Two)

The Financial Crimes Enforcement Network (FinCEN) first proposed requiring investment advisers to adopt anti-money laundering programs more than two decades ago. More recently, on February 15, 2024, FinCEN issued a notice of proposed rulemaking (NPRM), which would add certain investment advisers to the definition of “financial institution” subject to the Bank Secrecy Act; require those advisers to establish anti-money laundering/countering the financing of terrorism (collectively, AML) programs and report suspicious activity to FinCEN; and make other related changes to FinCEN regulations. On August 28, 2024, FinCEN adopted final AML rules (Rules) with some refinements to the NPRM. The Rules subject, with limited exceptions, all advisers registered or required to register with the SEC pursuant to Section 203 of the Investment Advisers Act of 1940 and all exempt reporting advisers to the AML regime under the BSA. This article, the first in a two-part series, discusses the applicability of the Rules, their key provisions and how they differ from the NPRM. The second article will examine the key challenges hedge fund managers will face in complying with the Rules and provide the steps they should take to do so. For more on the NPRM, see “Compliance Corner Q2‑2024: Regulatory Filings and Other Considerations Hedge Fund Managers Should Note in the Coming Quarter” (Mar. 28, 2024).

Study Finds Room for Improvement in Hedge Fund DEI Efforts

Efforts to promote diversity, equity and inclusion (DEI) in the hedge fund industry have progressed in fits and starts. To gauge that progress, the Black Hedge Fund Professionals Network (Network) surveyed diverse industry professionals. Although the death of George Floyd in 2020 prompted a flurry of DEI efforts in the hedge fund industry and the broader financial services sector, those efforts have failed to bring about significant change. There has been “a disparity between intention and tangible results,” the Network found. This article discusses the Network’s survey report, with additional insights from Andra Ofosu, founder of the Network and director at Aspect Capital; and survey leader Adebola Osakwe, member of the Network’s board and founder of Osakwe Consulting. See “Advancing Diversity, Equity and Inclusion in the Alternative Investment Industry” (Jul. 18, 2024).

Adviser Ineligible for Registration Exemption Due to Overlapping Operations With Affiliated Adviser

Advisers must take a holistic approach when determining whether they are required to register with the SEC. And if they get that determination wrong, the SEC is likely to notice and take action. In a settled enforcement proceeding, the SEC claimed an investment adviser improperly relied on the private fund adviser exemption from registration under the Investment Advisers Act of 1940 because it had overlapping owners, managers, advisory personnel and operations with another adviser with which it shared office space. The nature and size of the operationally integrated enterprise rendered the adviser ineligible for the claimed exemption. Additionally, because the adviser should have registered, it was subject to Rule 206(4)‑2 under the Advisers Act – commonly known as the “Custody Rule” – but failed to comply with that Rule. This article discusses the basis for the enforcement proceeding, the alleged violations and the terms of the settlement. See our three-part series on steps an exempt reporting adviser must take to transition to SEC registered investment adviser status: “Registration Triggers and Building a Compliance Department” (Oct. 5, 2017); “Adopting Compliance Policies and Procedures” (Oct. 12, 2017); and “Regulatory Filings, Updates to Fund Documents and Preparation for SEC Examination” (Oct. 19, 2017).

Nine More Advisers Fined by SEC in Ongoing Marketing Rule Sweep

Rule 206(4)‑1 (Marketing Rule or Rule) under the Investment Advisers Act of 1940 took effect on November 4, 2022. Since then, the SEC has issued multiple risk alerts and has been conducting an examination sweep on compliance with the Rule. Prior settlements have alleged violations involving policies and procedures; recordkeeping; presentation of hypothetical performance; and material misstatements. The latest round of nine settlements, announced on September 9, 2024, allege violations in two broad areas. Certain respondents allegedly disseminated advertisements containing material misstatements, ranging from what appear to be typographical errors to claims by certain advisers that they do not have any conflicts of interest. Others disseminated advertisements containing ratings, endorsements and/or testimonials without providing all disclosures required by the Marketing Rule. This article synthesizes the SEC’s claims and the terms of the settlements. See “Third Marketing Rule Risk Alert and New Settlements Portend Vigorous Enforcement” (Jun. 6, 2024); and our coverage of the first and second Marketing Rule risk alerts.

CFTC’s Report Calls for Engagement and Development of AI Risk Management Frameworks

The CFTC has sought to position itself on the cutting edge of regulators’ response to the meteoric advances in artificial intelligence (AI) and its use in the financial services industry. In January 2024, it issued a request for comment on the use of AI in CFTC-regulated markets. In May 2024, the Subcommittee on Emerging and Evolving Technologies of the CFTC’s Technology Advisory Committee issued a report on responsible AI in financial markets (Report). The Report assesses the opportunities and risks presented by AI and offers recommendations for the CFTC, including engaging with the industry, developing risk management frameworks, assessing existing regulations, aligning with other agencies and gaining AI expertise. This article parses the Report and includes relevant insights from CFTC Commissioner Kristin N. Johnson’s public statement regarding the Report. See our three-part series on AI rules: “NYC First to Mandate Audit” (Jul. 28, 2022); “States Require Notice and Records, Feds Urge Monitoring and Vetting” (Aug. 4, 2022); and “Five Compliance Takeaways” (Aug. 18, 2022).

Former SEC Enforcement Official Joins Morgan Lewis in D.C.

Morgan Lewis has welcomed Carolyn M. Welshhans, a 17‑year veteran of the SEC, to its office in Washington, D.C., where she will focus on SEC enforcement, investigations and litigation. Welshhans held a number of senior leadership roles at the SEC, including associate director of the SEC’s Division of Enforcement (Division); Acting Chief of the Division’s Crypto Assets and Cyber Unit; Acting Data Officer for the Division; and Assistant Director in the Division’s Cyber and Market Abuse Units. For another recent Morgan Lewis hire, see “Financial Services Litigator Stacie Hartman Joins Morgan Lewis in Chicago” (Sep. 12, 2024).

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