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Kirkpatrick & Lockhart LLP HEDGE FUNDS/ANTI-MONEY LAUNDERING JULY 2003 Panel Discussion Summary: A Guide to USA Patriot Act Requirements and Compliance for Unregistered Funds On June 24, 2003, Diane Ambler (Partner, DC Office) moderated a panel discussion at the MAR/Hedge Mid-Year Conference on Alternative Investment Strategies. The panel, on the timely topic of The USA Patriot Act: A Guide on Requirements and Compliance, included William Langford, Senior Advisor to the General Counsel, US Department of the Treasury, and was well attended by conference participants. The discussion began with a recognition that the US banking industry and many offshore financial institutions have been living with anti-money laundering (AML) rules and regulations for years, but that the USA Patriot Act has now expanded the definition of financial institutions to be covered by the AML requirements. The panel discussed AML program requirements as relevant to unregistered funds, particularly as reflected in rule proposals under the USA Patriot Act that would cover hedge funds, as defined in the proposals, and certain investment advisers that may manage unregistered funds. [For more details on the proposed AML rules for hedge funds and investment advisers, please see our previous K&L Alerts at http://www.kl.com/files/tbl_s48News/PDFUpload 307/ 8642 AMLeBulletin_0503_FinCEN_Expands.pdf and http://www.kl.com/files/tbl_s48News/PDFUpload 307/8012/ebulletin91802[1].pdf]. The discussion centered on several key industry issues, focusing on the extent of authority to delegate AML responsibilities and the application of customer lookthrough obligations, and included a lively and informative update by Mr. Langford. DELEGATION OF AML COMPLIANCE TO THIRD PARTIES The panelists discussed the proposed rules handling of delegation of AML program compliance to third parties. A fund manager would generally be responsible for adopting an AML program, conducting independent testing of its AML procedures, designating an AML compliance officer, and implementing an active AML training program. The panelists reminded the attendees that fund managers could delegate certain elements of their AML programs to third party service providers, such as fund administrators, but that the managers would remain responsible for monitoring those third parties and ensuring the effectiveness of the implementation of the programs. The panelists also discussed other aspects of third party AML program implementation, such as giving administrators the authority to freeze investor assets or expel individual investors. Consideration was given to revising fund offering documents for this purpose. One of the panelists mentioned that administrators in Bermuda, the British Virgin Islands and the Cayman Islands are reluctant to agree to be fully responsible for carrying out the provisions of a funds US AML program because the administrators are principally charged with ensuring compliance with the AML rules of their particular jurisdiction. ADOPTING A RISK-BASED APPROACH The panelists also emphasized that the USA Patriot Act and related rules stress a risk-based approach to AML programs. In that vein, the panelists stated that subscription agreements may include appropriate investor identification questions and that identity verification documentation may be required. The panelists discussed some of the range of practices adopted by fund managers in this area, which may include requiring copies of photo identification, licenses, passports or utility bills, as well as requiring that subscription/redemption amounts come from, and are sent to, the same account in the investors name. The panelists noted that these practices would likely continue to develop over time as the rules become finalized. In addition, some managers are implementing procedures Kirkpatrick & Lockhart LLP HEDGE FUNDS/ANTI-MONEY LAUNDERING delegating to administrators, under the terms of their administration agreement, the obligation to compare the names of investors to certain watch lists, such as the list posted on the website of the Office of Foreign Asset Control, prior to accepting an investors subscription in the fund. The panelists stressed the importance of having the administrators pay close attention to screening investors that come from higher risk jurisdictions. UPDATE FROM THE DEPARTMENT OF THE TREASURY William Langford, the Senior Advisor to the General Counsel of the Treasury Department, indicated that the agency is working diligently to regulate unregistered funds in a manner consistent with other already-regulated financial institutions, such as mutual funds, without inadvertently creating regulatory arbitrage and thereby causing assets to move out of unregistered US funds. He began his discussion by cautioning the attendees that it would only take one fund implicated in an AML scandal to focus the spotlight on the entire fund industry, and that therefore Treasury is expecting an institutional commitment by fund managers to AML compliance. Mr. Langford stated that fund managers should take a top-down approach to AML compliance to ensure that nothing slips through the cracks. He stressed that, although no institution can guarantee 100% compliance, having an appropriate AML compliance program is critical to avoiding criminal liability in the event a firm is deemed to have financed terrorist activities. Mr. Langford also focused on the importance of taking a risk-based approach to a fund managers AML programe.g., having a Swiss intermediary acting on behalf of an unnamed investor poses a significantly higher risk than having a direct investor from Iowa, and, therefore, the level of due diligence on the Swiss investor must be increased appropriately. He mentioned that there are numerous fund-related activities that take place offshore that the Treasury Department cannot lawfully regulate, and that the purpose of the notice and comment period on the proposed rules is to invite the industry to raise issues such as the extraterritorial reach of the AML rules. In this regard, he mentioned that it is insufficient in Treasurys eyes for a fund manager to solely rely upon a third party to ensure the manager is meeting the AML program requirements. The manager must take steps to ensure these third parties are appropriately carrying out their tasks. For example, Mr. Langford discussed that managers should have their AML programs independently tested on a regular basis and make sure that their programs are updated and appropriately tailored to their particular organization. Furthermore, he also noted that, while the Treasury Department does not intend to knock on doors to ensure that managers are compliant, good faith attempts at AML compliance will ultimately be an important factor in determining whether Treasury brings an enforcement action against a particular firm. Lastly, Mr. Langford mentioned that the proposed rules are likely to be finalized at some point this summer. Currently, the Treasury Department is reviewing the comments they have received to ensure that there is no conflict between the rules that will apply to investment advisers and to unregistered funds. Once the final rules are adopted, there will be a 90-day implementation period by which all entities covered by the rules will be required to maintain and implement an AML compliance program. DIANE E. AMBLER 202.778.9886 dambler@kl.com BETH R. KRAMER 212.536.4024 bkramer@kl.com LARRY COWEN 415.249.1053 lcowen@kl.com Kirkpatrick & Lockhart LLP 2 HEDGE FUNDS/ANTI-MONEY LAUNDERING Kirkpatrick & Lockhart LLP has over 700 lawyers in 10 offices around the United States. The firm maintains one of the largest investment management practices in the United States. The firm represents private funds, offshore funds, mutual funds, insurance companies, broker-dealers, investment advisers, retirement plans, banks and trust companies, and other financial institutions. The firm works with these clients in connection with the full range of investment management products and activities, including all types of private and offshore investment funds, variable insurance products, funds of hedge funds, open-end and closedend investment companies, and unit investment trusts. The firm also offers diverse experience in issues relating to money laundering. We can help banking and diversified financial services clients assess their risk, establish and review compliance practices, investigate potential weaknesses, perform internal investigations, and respond to regulatory inquiries and enforcement actions while being sensitive to the privacy of each client and their customers through an effective attorneyclient privilege relationship. For more information, we invite you to contact any of the following members of Kirkpatrick & Lockharts Hedge, Private and Offshore Funds Practice: BOSTON Joel D. Almquist Michael S. Caccese Philip J. Fina Mark P. Goshko Thomas Hickey III Nicholas Hodge 617.261.3104 617.261.3133 617.261.3156 617.261.3163 617.261.3208 617.261.3210 jalmquist@kl.com mcaccese@kl.com pfina@kl.com mgoshko@kl.com thickey@kl.com nhodge@kl.com LOS ANGELES William P. Wade 310.552.5071 wwade@kl.com NEW YORK Jeffrey M. Cole Beth R. Kramer Richard D. Marshall Robert M. McLaughlin Scott Newman Loren Schechter 212.536.4823 212.536.4024 212.536.3941 212.536.3924 212.536.4054 212.536.4008 jcole@kl.com bkramer@kl.com rmarshall@kl.com rmclaughlin@kl.com snewman@kl.com lschechter@kl.com SAN FRANCISCO Eilleen M. Clavere Jonathan D. Joseph David Mishel Mark D. Perlow Richard M. Phillips 415.249.1047 415.249.1012 415.249.1015 415.249.1070 415.249.1010 eclavere@kl.com jjoseph@kl.com dmishel@kl.com mperlow@kl.com rphillips@kl.com WASHINGTON Clifford J. Alexander Diane E. Ambler Catherine S. Bardsley Arthur J. Brown Arthur C. Delibert Robert C. Hacker Benjamin J. Haskin Kathy Kresch Ingber Rebecca H. Laird Thomas M. Leahey Cary J. Meer R. Charles Miller Dean E. Miller Charles R. Mills R. Darrell Mounts C. Dirk Peterson Alan C. Porter Theodore L. Press Robert H. Rosenblum William A. Schmidt Lynn A. Schweinfurth Donald W. Smith Robert A. Wittie Robert J. Zutz 202.778.9068 202.778.9886 202.778.9289 202.778.9046 202.778.9042 202.778.9016 202.778.9369 202.778.9015 202.778.9038 202.778.9082 202.778.9107 202.778.9372 202.778.9371 202.778.9096 202.778.9298 202.778.9324 202.778.9186 202.778.9025 202.778.9464 202.778.9373 202.778.9876 202.778.9079 202.778.9066 202.778.9059 calexander@kl.com dambler@kl.com cbardsley@kl.com abrown@kl.com adelibert@kl.com rhacker@kl.com bhaskin@kl.com kingber@kl.com rlaird@kl.com tleahey@kl.com cmeer@kl.com cmiller@kl.com dmiller@kl.com cmills@kl.com dmounts@kl.com dpeterson@kl.com aporter@kl.com tpress@kl.com rrosenblum@kl.com william.schmidt@kl.com lschweinfurth@kl.com dsmith@kl.com rwittie@kl.com rzutz@kl.com ® Kirkpatrick & Lockhart LLP Challenge us.® www.kl.com BOSTON n DALLAS n HARRISBURG n LOS ANGELES n MIAMI n NEWARK n NEW YORK n PITTSBURGH n SAN FRANCISCO n WASHINGTON ......................................................................................................................................................... This publication/newsletter is for informational purposes and does not contain or convey legal advice. The information herein should not be used or relied upon in regard to any particular facts or circumstances without first consulting a lawyer. © 2003 KIRKPATRICK & LOCKHART LLP. ALL RIGHTS RESERVED.
