The FBI, in a leaked intelligence bulletin, has made a high-confidence assessment on the likely use of Private Investment Funds (PIFs) by “threat actors” for money laundering. Threat actors are defined in the FBI report as financially motivated criminals and foreign adversaries, and PIFs are defined to include hedge funds and private equity funds.
Of note, the FBI “assumes AML programs are not adequately designed to monitor and detect threat actors’ use of private investment funds to launder money.” The FBI’s assumption is based on open source reporting from DOJ, as well as intelligence from corroborated human and financial sources. The FBI also lists examples which highlight threat actors’ use of shell companies to launder money, and the failure of the PIFs’ standardized due diligence, if any, in establishing the source of funds. In one case, the FBI noted the involvement of a “former partner of a major US law firm” who “assisted others in laundering more than $400 million . . . through a series of purported private equity funds holding accounts at financial institutions . . . to conceal and disguise the nature, location, source, ownership, and control of the proceeds.”
While traditional US broker-dealer funds are required to have an anti-money laundering (AML) program, make Bank Secrecy Act filings, and perform customer due diligence, the FBI noted that these requirements are not mandated for PIFs, which are largely exempt from regulatory oversight by the Securities Exchange Commission and other federal financial regulatory authorities. As a result, even where PIFs had in place AML measures, the FBI assessed that money launderers could circumvent traditional AML programs.
The FBI also considered, but ultimately discounted, the argument that PIFs are unattractive targets for money launderers due to illiquidity and standard due diligence procedures. Instead, it assessed that because of the proliferation of PIFs in the past 25 years, the competitive PIF industry has become more flexible in structuring investments, which may include offering shorter lock-in periods, in a bid to attract capital. Coupled with their historically slender due diligence procedures and regulatory reporting requirements, PIFs are now compelling avenues for money launderers to integrate illicit proceeds into the global financial system.
Ultimately, the FBI bulletin highlights that standard due diligence procedures and questionnaires, without sufficiently robust scrutiny into the source of funds or the underlying beneficial owner, are ineffective, especially against experienced money launderers. In addition, our experience shows that if PIFs attempt to streamline due diligence processes by, for example, decentralizing due diligence responsibilities, the risks of overlooking indicators of financial crime such as unduly complex structures and shell companies, significantly increases. Although there is no clear-cut solution, compliance with AML laws requires a more than cursory understanding of the identity of the investors and their source of funds.
Financial regulations regarding PIFs in the AML customer due diligence and beneficial ownership sphere are obviously lagging developments in contrast to other categories of financial institutions, a fact the FBI is clearly and painfully aware of. Beginning in May 2018, the Financial Crimes Enforcement Network (FinCEN), responsible for the development and enforcement of AML regulations, required banks and certain other “covered financial institutions” to, among other measures, identify the beneficial owners of their legal entity customers and enhance their risk-based customer due diligence by requiring these financial institutions to identify and verify the identity of the natural persons behind their legal entity customers.
From the FBI’s assessment, it appears likely that, until there is greater regulatory scrutiny over PIFs to identify and disclose to financial institutions the underlying beneficial owners of investments, both the FBI and DOJ will pay increased attention to PIFs, which they have determined are high risk targets for money laundering facilitators and sanctions evaders.