Investment Advisers: FinCEN’s Proposed Rule Requiring AML Compliance Programs

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Citing concerns about bad actors using SEC-registered investment advisers (Advisers) to launder money and obtain proprietary U.S. technology information, FinCEN has proposed a rule requiring Advisers to implement an anti-money-laundering (AML) and counterterrorism financing compliance program and to file suspicious activity reports (SARs) with FinCEN. If adopted, the SEC’s examination division would be in charge of assessing Advisers’ AML programs.

Broker dealers and banks have long been subject to such requirements and many Advisers have at least rudimentary AML programs in place. However, Advisers have not been subject to the same level of scrutiny as banks and brokers and, accordingly, may not have fully fleshed out their AML programs. If adopted, Advisers will likely have a grace period in which to implement and enhance their AML programs. Given the speed and pace of innovation by bad actors, Advisers should promptly evaluate their AML programs and look out for additional FinCEN and SEC guidance in these areas.

Prediction: SEC’s Predictive Analytics Rule Will Harm Smaller Advisory Firms

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The SEC has proposed a rule that it says will remove or uncover conflicts of interest in the use of predictive analytics or AI techonology by investment advisers. If adopted, however, the rule will cause unnecessary compliance headaches and deter advisers from using technology — old and new — that could benefit advisory clients.

The rule is engaged when an adviser uses any covered technology, which is broadly defined as an application that “optimizes for, predicts, guides, forecasts, or directs investment-related behaviors or outcomes.” That covers a wide array of technology that advisers use in connection with providing investment advice, including something as tried and true as Excel macros.

While the rule would not prohibit the use of covered techonologies, it would require firms to build compliance programs around them to eliminate or neutralize any conflict of interest that puts the firm’s interests ahead of the clients. And a firm’s compliance department had better have adequate documentation showing that it assessed any conflicts and had written policies and procedures on this topic.

The net effect, particularly for small to mid-sized advisory firms, would be for the firm to pause and think about using such technology in the first place and to be slow to onboard the technology. That is a disadvantage for smaller firms who plan to use technology to gain a competitive edge against larger competitors. In addition, the rule could slow innovation, which can benefit customers by increasing efficiency and lowering costs.

Furthermore, advisers are already fiduciaries under the 1940 Investment Advisers Act and are required to have adequate policies and procedures in place to avoid violations of the securities laws. That surely covers an adviser’s use of a technology to gain an upper hand against its own clients.