Treasury's Proposed Rule Setting Forth Anti-Money Laundering Requirements for Certain Unregistered Investment Companies

The Financial Crimes Enforcement Network ("FinCEN") of the Department of the Treasury ("Treasury") has proposed to amend the Bank Secrecy Act (the "BSA") regulations to prescribe minimum standards applicable to certain unregistered investment companies, such as hedge funds, commodity pools and similar investment vehicles, pursuant to the revised provision in the BSA that requires financial institutions to establish anti-money laundering programs.

The proposed rule would define an "unregistered investment company" as (i) an issuer that, but for the exclusions provided in sections 3(c)(1)¹ and 3(c)(7)² of the Investment Company Act of 1940, as amended (the "1940 Act"), would be an investment company under the 1940 Act, (ii) a commodity pool and (iii) a company that invests primarily in real estate and/or interests therein. Several types of investment companies that are not registered within the 1940 Act would be covered by this definition, including hedge funds, private equity funds, venture capital funds, commodity pools and real estate investment trusts, unless one of the limitations or exceptions set forth in the following paragraphs applies.

Because of the broad scope of the type and nature of businesses that may fall under the definition of unregistered investment companies, the proposed rule outlines the following three limitations and three exceptions in order to narrow the definition.

1. Limitations:

(a) Redemption Rights. Under the proposed definition, an "unregistered investment company" would include only those companies that give an investor a right to redeem any portion of his or her ownership within two years after that interest was purchased.

(b) Minimum Assets. The proposed rule would be limited to companies that, as of the most recently completed calendar quarter, have total assets³ of $1,000,000 or more.

(c) Offshore Funds. The definition of an "unregistered investment company" in the proposed rule would only include an entity that is organized in the United States, sells ownership interests to a "U.S. person" (as defined in 17 CFR 230.902(k)⁴), or is organized, operated or sponsored⁵ by a U.S. person.

2. Exceptions:

The proposed rule excepts: (a) companies that are owned by one family (as defined in section 2(a)(51)(A)(ii) of the 1940 Act⁶); (b) employees' securities companies (investment companies established by employers for the benefit of employees) and employee benefit plans that are not construed to be pools; and (c) companies that are also another type of "financial institution" under the BSA (such as a broker-dealer) (in order to prevent duplicative application of the BSA anti-money laundering rules).

By 90 days following the publication of a final rule, unregistered investment companies would be required to develop and implement anti-money laundering programs reasonably designed to prevent them from being used to launder money or finance terrorist activities and achieve and monitor compliance with the applicable requirements of the BSA and Treasury's implementing regulations.

While emphasizing that each unregistered investment company should have the flexibility to tailor its program to fit its business, given its size, location, activities and risks or vulnerabilities to money laundering, the proposed rule also sets forth minimum requirements for an anti-money laundering program for unregistered investment companies. Such requirements are: (a) establishing and implementing policies, procedures and internal controls reasonably designed to prevent the investment company from being used for money laundering or the financing of terrorist activities and to achieve compliance with the applicable provisions of the BSA and the proposed rule; (b) providing independent testing for compliance to be conducted by the unregistered investment company's personnel or by a qualified outside party; (c) designating a person or persons for implementing and monitoring the operations and internal controls of the investment company's anti-money laundering program; and (d) providing ongoing training for appropriate persons.

The anti-money laundering program must be approved in writing by the unregistered investment company's board of directors or trustees, or, if it does not have one, by its general partner, sponsor, organizer, operator or other person who has a similar function. Furthermore, the unregistered investment company must make its anti-money laundering program available for inspection by Treasury or its designee upon request.

Due to the difficulty of identifying entities subject to the new rule, the proposed rule requires unregistered investment companies to file a notice with FinCEN by 90 days following the publication of a final rule. Such notice would have to include: (a) the name, address, e-mail address and telephone number of the unregistered investment company; (b) the name, address, e-mail address, telephone number and registration number of any investment adviser, commodity trading advisor, commodity pool operator, organizer or sponsor of the unregistered investment company; (c) the name, e-mail address and telephone number of the designated anti-money laundering program compliance officer; (d) the dollar amount of assets under management held by the unregistered investment company; and (e) the number of participants, interest holders or security holders in the unregistered investment company.

An unregistered investment company would have to file an amendment to its notice not later than 30 days after any change to the information in the notice. An unregistered investment company would also have to withdraw its notice within 90 days of ceasing to be subject to the provisions of the proposed rule.

It is possible that the final rule will vary from the proposed rule as a result of comments received during the comment period. However, we anticipate that unregistered investment companies will need to implement a compliance program in the near future. We will let you know when the final rule is approved and becomes effective, and will be happy to assist you in developing compliance programs suitable for yo ur unregistered investment companies. 

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1. Section 3(c)(1) of the 1940 Act generally excludes from the definition of an "investment company" any issuer that is not engaged in or proposing to engage in a public offering and whose outstanding securities (other than short-term paper) are beneficially owned by not more than 100 persons.

2. Section 3(c)(7) of the 1940 Act excludes from the definition of an "investment company" an issuer in which all the investors are "qualified purchasers," as defined in the 1940 Act, and that has not engaged in a public offering. A "qualified purchaser" is a natural person who possesses at least $ 5 million in investments; a non- natural person that possesses at least $ 25 million in investments or is owned exclusively by qualified purchasers; and a qualified institutional buyer.

3. Note that the proposed rule does not define "total assets."

4. 17 CFR 230.920(k) defines a "U.S. person" to mean (i) any natural person resident in the United States; (ii) any partnership or corporation organized or incorporated under the laws of the United States; (iii) any estate of which any executor or administers is a U.S. person; (iv) any trust of which any trustee is a U.S. person; (v) any agency or branch of a foreign entity located in the United States; and (vi) any partnership or corporation if (A) organized or incorporated under the laws of any foreign jurisdiction; and (B) formed by a U.S. person principally for the purpose of investing in securities not registered under the Securities Act of 1933, unless it is organized or incorporated, and owned, by accredited investors, who are not natural persons, estates or trusts.

5. Note that the proposed rule does not define "organized, operated or sponsored."

6. Section 2(a)(51)(A)(ii) of the 1940 Act defines a "family company" as any company that owns not less than $5,000,000 in investments and that is owned directly or indirectly by or for 2 or more natural persons who are related as siblings or spouse (including former spouses), or direct lineal descendants by birth or adoption, spouses of such persons, the estates of such persons, or foundations, charitable organizations or trusts established by or for the benefit of such persons. The exception for family companies would be available without regard to the amount of assets owned by the company.

October 23, 2000