KYX : much of a muchness for what should not be very much 0 Comments | By

KYX : much of a muchness for what should not be very much

(1) Regulations and Regulators: Many Regulators play in the AML & KYC and the OFAC & FATCA arena.

  • The Bank Secrecy Act or BSA(formally The Currency and Foreign Transactions Reporting Act of 1970) was originally assumed to apply only to Banks.BSA exclusion to many types of non-Bank Investment Advisors was essentially removed in 2001 with The Patriot Act (USAPA) and specifically Title III which is the “International Money Laundering Abatement and Anti-Terrorist Financing Act”.
  • The Office of Foreign Asset Control (OFAC)operates under the auspices of the “Office of Terrorism and Financial Intelligence”.Specially Designated Nationals and blocked persons are defined, as also Sanctions programs against individuals and Entities. In 2008 OFAC published “Opening Securities and Futures Accounts from an OFAC Perspective” and “Risk Factors for OFAC Compliance” with the target audience being “securities and futures firms”. OFAC regulations do set forth certain requirements for investment advisers to block the accounts of specified countries, entities and individuals. For investment advisers, OFAC recommends establishing and maintaining an effective, risk-based OFAC compliance program……. “Failure to do so could result in an enforcement action, particularly if the adviser has weak internal controls”
  • Per OFAC, compliance programs should focus on the client acceptance process, which includes performing a check of each potential client against the OFAC list of “Specifically Designated Nationals and Blocked Persons (“SDN”) (which may be found at, to ensure the potential client is not on the OFAC SDN list; and regularly checking the Financial Action Task Force (“FATF”) lists and accompanying narrative information to make sure that no client or potential client is located in or transacting business with any country identified by FATF (this information can be found at Note: OFAC does not require other AML program requirements set forth for broker-dealers and other financial institutions.
  • The Financial Crimes Enforcement Network (FinCEN) is a bureau of the United States Department of the Treasury. FinCEN’s mission is to safeguard the financial system from illicit use and combat money laundering and promote national security through the collection, analysis, and dissemination of financial intelligence and strategic use of financial authorities. As a result of the regulatory changes following the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”), FinCEN announced in 2011 that it would be revisiting its 2003 proposals requiring investment advisory firms to establish AML programs.
  • This year, finally (August 25, 2015) FinCEN issued a Notice of Proposed Rulemaking (NPRM) that imposes anti-money laundering (“AML”) requirements on investment advisers.The NPRM
    a) includes investment advisers within the general definition of “financial institution” under the FinCEN regulations
    b) requires investment advisers to establish AML programs and
    c) requires investment advisers to file suspicious activity reports (SARs) with FinCEN.
    d) NOTE: FinCEN delegates examination authority for compliance with the requirements under the NPRM to the Securities Exchange Commission (SEC).
  • So, not by any means the least, and consistent with FinCEN’s initiative, SEC’s Office of Compliance Inspections and Examinations (“OCIE”) has recently signaled that AML compliance is a priority.Specifically, OCIE announced this year that it would focus on “firms that have not filed SARs or have filed incomplete or late SARs.”

(2) Investment Advisers: state of play

  • Many investment advisers already conduct some form of CIP or KYC during their onboarding process. As a practical matter, and overwhelmingly among Advisers, some form of client identification and diligence is considered necessary to effectively screen for and report suspicious transactions, as proposed under the NPRM. FinCEN meanwhile has reserved the possibility that it could propose a CIP requirement applicable to investment advisers in subsequent rulemakings.
  • SEC Expectations : The SEC focus on anti-money-laundering regulations found in the BSA and USAPA. It has the authority to request proof evidencing how securities industry participants, including investment advisers, are complying with federal securities law. Despite there being no specific requirement for an adviser to develop an AML program, SEC officials may inquire about AML practices during exams citing that, as a fiduciary, an investment adviser should always consider ways in which it can further safeguard client assets and protect the integrity of the U.S. financial system. Factors such as the firm’s operations, nature and location of clients, relationships with third parties, and including of any foreign clients may of course be specific flags.
  • In its NPRM,FinCEN proposes including investment advisers within the broader definition of “financial institution,” which would require investment advisers to comply with all Bank Secrecy Act regulatory requirements generally applicable to financial institutions
  • FinCEN recognizes that some elements of RIA compliance programs may be performed by third-parties, such as broker-dealers, custodians and transfer agents, “in which case it is permissible for an investment adviser to delegate contractually the implementation and operation of those aspects of its AML program to such an entity.”However, FinCEN also emphasizes that the investment advisers still remain fully responsible for the effectiveness of the program.
  • Historically, the rationale behind excluding investment advisers from definitions of entities defined for AML & KYC processes had been that investment advisers conduct financial transactions for their clients through other financial institutions that are subject to BSA and AML requirements, and their clients’ assets must be carried at these other financial institutions. Thus, the idea was that since RIAs are already indirectly participating in AML policies and procedures via their relationship with other “financial institutions,” their inclusion in this definition is somewhat repetitive.

(3) What should YOU do

  • We live in times of very high geo-political sensitivity and rampant fear & concern over terrorism and terrorism-funding. Therefore, any interpretation that all of the above essentially continues to “exclude” anybody from responsibility in regard to AML/KYC is aggressive, and not conservative. Issues coming out of any “incident” are potentially at least likely to be quite embarrassing and a big hit to reputation, even if not illegal or ultra vires the laws & regulations.
  • No respectable (or at least self-respecting?) firm today wants the risk that it be found wanting, and either subjected to some regulatory censure or media highlight, all of which would be particularly bad were they to happen as part of news of an actual event. At the minimum (in my opinion) it should be able to say “Yes” to a “Do you have AML, KYC procedures”. (I believe we do some OFAC stuff… What exactly do we do …Specially Designated Nationals (SDN) vetting, Sanctions & Blocks monitoring, SARs reports?
  • I believe every firm needs to do “some” formal and documented KYC on clients, borrowers, lenders, brokers, intermediaries, law firms, suppliers & vendors, Outsourced service providers… indeed why would you make any Exceptions t such diligence (and hence KYX where X = A, B….Z) .
  • It is very likely that these counterparties will actually appreciate the focus. The actual ways to get the information could be informal and part of Sales & Marketing and Onboarding efforts without necessarily shooting out a Questionnaire to the client. But that is just a relationship-management issue.
  • At its most basic, the focus is on:
    • Who are you as a firm;
    • What is your ownership origin and structure;
    • Who are the key Individuals;
    • Where is your Equity capital from;
    • Where are your Investment monies from;
    • What is your risk appetite;
    • Do you have experience with the products, marketsinstruments you want to engage in;
    • Are thye suitable for you
    • Are they appropriate for us to offer to you
    • What portion or percentage of your asset-allocation is going here;
    • If you are a Regulated entity (why not?), what Regulatory website may have your name;
    • How will you shape up on background checks on firms/principals for sanctions, crimes, litigation, regulatory
    • What is your Target Market definition
    • What is your Tax jurisdiction
    • Are you regulated by a “reputable” regulatory entity/jurisdiction
    • If you are an agent/front, who might the ultimate beneficial faces be
    • Who do you Lend to, or arrange lending for
    • Do you have an AML/KYC program
    • Can your client/counterparty/vendor rely on this program to the exclusion of any program it may itself have
  • In the next page, I have tried to put together the “elements” of a KYC process. But it may or may not be complete, professional, and of course it is not as beautiful as a Form you might create nor am I lawyerly enough to be sure of the arrangement!

Focus areas: KYC across Institutions
(1)Basics of the Counter-party: Investor, Originator, Vendor
– Company Name and Parent name
– Country/City of Incorporation
– Date of Incorporation
– Business Activity, and primary business
– Place of quotation, if a public entity
– Tax Residence country
– Names of Principalswith Nationality
– Majority Investors
– Registered Office
– Mailing Address (if different)
– Contact Details

(2)Regulatory paradigm: Investor, Originator, Vendor
– Is the company Regulated?
– IF Yes, name of Regulator
– Is there a Regulatory webpage showing the name of the entity?
– Does Regulator in Parent AND Host Country require AML process
– Does Regulator in Parent AND Host Country require counter-terrorism-financing processes
– Political mandate (PEP)?
– FATCA classification
– Classification under tax regulation such as Non Financial Foreign Entity (Passive/Active) or Non-Profit

(3)Where is the money coming from and going to: Investor, Originator
– Origin of the Investment money / Subscription
– Destination of the proceeds on maturity / Redemption
– Investing on own behalf as BD or other?
– Investing on behalf of a Third-Party or as an RIA?

(4)Risk and Suitability: Investor
– Risk Appetite for Marketplace
– Marketplace as % of Asset Allocation
– Investment Horizon
– Ability to bear Losses
– Ability to bear lack of Liquidity for entire horizon

5)Orchard Documentation Requirements: Investor, Originator
– Meets all documentation requirements
– Is ready and willing to supply requisite documentation

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