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FinCEN’s Beneficial Ownership FAQs Miss the Boat on Private Investment Vehicles

On July 19, the Financial Crimes Enforcement Network (FinCEN), a bureau within the US Department of the Treasury responsible for the Bank Secrecy Act, issued guidance in the form of frequently asked questions (FAQs) regarding its recently adopted customer due diligence requirements (CDD Rule). The FAQs offer a condensed summary of the CDD Rule’s requirements, but FinCEN has missed an opportunity to address an ambiguity in the CDD Rule regarding its application to private investment vehicles.

As explained in our White Paper on this subject (FinCEN Requires Financial Institutions to Obtain Beneficial Ownership Information), the CDD Rule requires “covered financial institutions” (federally regulated banks and federally insured credit unions, mutual funds, brokers or dealers in securities, futures commission merchants, and introducing brokers in commodities) to obtain beneficial ownership information for a “Legal Entity Customer.” Although the term Legal Entity Customer is broad, it does exclude, among other entities,

  1. an investment adviser registered (RIA) with the US Securities and Exchange Commission (SEC);

  2. a registered entity, commodity pool operator (CPO), commodity trading adviser (CTA), retail foreign exchange dealer, swap dealer, or major swap participant—each as defined in Section 1a of the Commodities Exchange Act—that is registered with the CFTC; and

  3. a pooled investment vehicle that is operated or advised by a financial institution that is excluded from the definition of Legal Entity Customer (Investment Vehicle Exclusion). In addition, the CDD Rule contains limited beneficial ownership collection requirements for pooled investment vehicles that are operated or advised by a financial institution that is not excluded from the definition of a Legal Entity Customer (Limited Collection Provision).

As explained in our White Paper, the CDD Rule is ambiguous about whether a pooled investment vehicle operated or advised by an RIA or CTA would be excluded from the definition of a Legal Entity Customer. Although RIAs and CTAs are excluded from the definition of a Legal Entity Customer, it is unclear whether they would be deemed “financial institutions” for purposes of the CDD Rule’s Investment Vehicle Exclusion and the Limited Collection Provision. This is because the beneficial ownership requirements of the CDD Rule are codified at 31 CFR part 1010, which indicates that, with respect to terms used in 31 CFR chapter X, “where not otherwise distinctly expressed or manifestly incompatible with the intent thereof, terms shall have the meanings ascribed in this subpart.” FinCEN did not separately define a “financial institution” for the purposes of the CDD Rule, and the definition of a financial institution in 31 CFR §1010.100(t), which does not include RIAs or CTAs, therefore would control for purposes of the CDD Rule’s applicability. In turn, pooled investment vehicles advised by them would be subject to the CDD Rule’s Legal Entity Customer beneficial ownership reporting requirements.

Takeaways

The context in which the discussion regarding pooled investment vehicles occurs in the preamble to the CDD Rule suggests that this ambiguity may have resulted from a drafting oversight. The effect of this oversight, however, is particularly significant when one considers that pooled investment vehicles are most frequently operated or advised by RIAs and CTAs, and not by federally or state-regulated regulated banks or broker-dealers that come within the definition of a financial institution in 31 CFR §1010.100(t). A reading of “financial institution” that excludes RIAs and CTAs, and therefore results in pooled funds advised by a RIA or CTA being caught up in the beneficial ownership reporting requirements, appears “manifestly incompatible with the intent” of the CDD Rule, given FinCEN’s statements in the preamble that non-US-managed mutual funds, hedge funds, and private equity funds would only be subject to limited information collection requirements. Regrettably, FinCEN’s FAQs missed an opportunity to clarify an important aspect of the rule’s requirements.

Copyright © 2022 by Morgan, Lewis & Bockius LLP. All Rights Reserved.National Law Review, Volume VI, Number 202
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About this Author

Ignacio Sandoval, Morgan Lewis, Securities lawyer
Associate

A member of the firm’s securities industry practice, Ignacio A. Sandoval advises broker-dealers on matters relating to their obligations under federal securities laws and self-regulatory organization rules. Prior to joining Morgan Lewis, he was a special counsel in the Office of Chief Counsel in the SEC’s Division of Trading and Markets. Ignacio’s SEC experience includes matters involving domestic and foreign broker-dealer registration matters, anti-money laundering obligations, alternative trading systems, and high-frequency traders.

202-739-5201
Charles Horn, financial services attorney, Morgan Lewis
Partner

Charles M. Horn is a partner in Morgan Lewis's Investment Management and Securities Industry Practice. Mr. Horn focuses his practice on regulatory and transactional matters, primarily in the areas of banking and financial services. He works on behalf of domestic and global financial institutions of all sizes on regulatory, supervisory, enforcement and compliance matters before all major federal financial institutions regulatory agencies, and leading state financial regulatory agencies.

202-739-5951
Melissa R.H Hall, Financial services attorney, Morgan Lewis
Of counsel

Melissa R. H. Hall represents US and overseas banks, nonbank financial services companies, investors in financial services, and technology companies in regulatory and corporate matters. She advises them on a wide range of state and federal financial regulatory laws and regulations. She provides counsel on financial regulatory compliance and enforcement, including state and federal licensing requirements, consumer financial products and compliance, payment systems, corporate and transactional matters, financial institution investment and acquisition, and the development...

202-739-5883
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