FinCEN Proposes Extending Anti-Money Laundering Compliance Requirements to Investment Advisers

By: Eric Mikkelson

Yesterday, the United States Department of Treasury’s Financial Crimes Enforcement Network (FinCEN) proposed a rule that would require SEC-registered investment advisers, including private equity and hedge funds, to comply with certain anti-money laundering (AML) rules. These rules already apply to other types of financial institutions such as banks and securities broker-dealers.

PURPOSE AND BACKGROUND

With these rules, FinCEN expects investment advisers to assist it in protecting the integrity of the overall financial system by making it harder for a client “trying to move or stash dirty money,” including terrorist financers, in this multi-trillion dollar sector. FinCEN perceives that investment advisers currently provide a relatively low-risk way for such illicit money to enter the system. This proposal has been discussed for years (similar rules have previously been proposed and withdrawn), and thus was not unexpected.

AML PROGRAMS AND SUSPICIOUS ACTIVITY REPORTING

The rule would require SEC-registered investment advisers to adopt and comply with tailored AML policies and file suspicious activity reports (SARs) with FinCEN as applicable. Many investment advisers have already implemented AML programs, either voluntarily or in response to an SEC-no action letter that allows broker-dealers to rely on investment advisers to perform their AML-related customer identification program obligations under certain circumstances. However, for other investment advisers, the development and implementation of a required, written AML policy and compliance with the applicable new reporting requirements could be a significant undertaking.

An AML policy should, at a minimum, (a) establish and implement policies, procedures and internal controls; (b) provide for independent testing for compliance; (c) designate a compliance officer; and (d) provide a training program. SARs would be required to be filed for transactions in excess of $5,000 which the adviser knows, or has reason to know, involve illegal or other suspicious activity.

CURRENCY TRANSACTION REPORTING

By expanding the definition of “financial institution” pursuant to the Bank Secrecy Act (which includes the PATRIOT Act) to include SEC-registered investment advisers, FinCEN would require them to file Currency Transaction Reports (CTRs), and keep and share other fund transmittal records that currently apply to other financial firms. Investment advisers are already  generally required to file Form 8300 for the receipt of more than $10,000 in cash or negotiable instruments. The new rule would replace the Form 8300 requirement with the CTR and would apply to transfers of more than $10,000 in actual currency, which may be less burdensome for the investment adviser in the case of transactions using negotiable instruments (not currency) that were previously reportable (although depending on the context those might now need to get picked up on an SAR). Additional records requirements imposed by the new rule apply for other transmissions exceeding $3,000. Such records will be required to be shared with other financial institutions in the payment chain. Some are similar to records already kept by the advisers, but advisers would need to confirm compliance with the nuances of the new rule.

EXAMINATION

FinCEN proposes to delegate its authority to examine advisers for compliance with this new rule to the SEC. FinCEN is expected to propose additional related rules jointly with the SEC, including requirements for a customer identification program for investment advisers.

View the full text of the proposed rule changes, and FinCEN’s explanation of it.

COMMENT PERIOD

Written public comment on the proposal will be accepted by FinCEN for a period of 60 days from the proposed rule’s publication in the Federal Register. If this rule is finalized, FinCEN is proposing that investment advisers have six months from the rule’s effective date to adopt compliant programs.

To discuss the proposed rule changes and the potential effect on your operations, please contact the attorneys listed below or your usal Stinson Leonard Street LLP attorney.

Eric Mikkelson

816.691.2680

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John Granda

816.691.3188

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David Jenson

612.33531464

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Tom Jensen

312.335.1809

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Jack Bowling

816.691.2314

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Vicki Westerhaus

816.691.2427

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Steve Quinlivan

612.335.7076

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August 28, 2015 at 5:30 am Leave a comment

Important Changes to Kansas Banking Law in Electronic Transactions

Written by: George Sand

Kansas electronic transactions no longer have different customer liability limits than those available to consumers under the Federal Electronic Funds Transfer Act as implemented by Regulation E. Effective July 1, 2015, the Kansas Legislature repealed the long-standing (and confusing in implementation) Kansas law, K.S.A. 9-1111d, which established different liability limitations for Kansas compared to other states. Out of state banks that engage in electronic transactions with Kansas customers likewise are effected and need to address Kansas’s change in law.

The former law. Under the former law, depositor liability for unauthorized transaction was limited to $50 dollars unless the customer failed to notify the institution within 4 business days after learning of the loss or theft of the machine readable instrument of which liability was then limited to $300.

Regulation E. Depositor liability for unauthorized transaction is limited to $50 unless the customer fails to notify the institution within 2 business days after learning of the loss or theft of the access device of which liability is then limited to $500.

How repeal of K.S.A. 9-1111d affects banks:

  • Kansas banks should amend agreement disclosures for electronic transactions. Kansas banks should amend their electronic transaction agreement disclosures to provide for the more bank-friendly Regulation E liability limitations and timing. Specifically, Kansas banks should amend their electronic transfer agreement disclosures by decreasing the permissible period for customer notification from 4 to 2 days and increasing a customer’s maximum liability after the 2 days from $300 to $500. To amend, banks must provide a change-in-terms notice to consumer deposit customers at least 21 days prior to implementing the change. The change-in-terms notice has no form requirements.
  • Kansas banks should amend the agreement disclosures addressing limitation of liability for electronic transactions prior to any system update. Processors may be making changes to their systems to accommodate the repealed K.S.A. 9-1111d, and banks should ensure customers have proper notice of the changes prior to the Processor system update. Banks may be exposed to risk if the Processor system change operates in a manner which is inconsistent with the bank’s agreement disclosures.
  • Kansas banks using standard forms should ensure the actual form is consistent with operations. Form providers may not be updating form disclosures at the same time that third-party Processors update the system to accommodate the repealed K.S.A. 9-1111d. Kansas banks should ensure that their form agreements and disclosures are updated in a manner that any changes will coincide with system updates.

August 26, 2015 at 1:16 pm Leave a comment

Dead Hand Proxy Puts: A Cautionary Tale

Written by: Lisa Connolly

The Dead Hand

In the context of credit agreements, a “proxy put” is a provision that can trigger a default which then allows the lender to accelerate debt as a result of changes in control of the borrower. A proxy put containing a “dead hand” feature allows the lender to call the entire debt due to a change in control resulting from the appointment of a director elected as a result of an actual or threatened proxy contest. For purposes of the proxy put, such a director is treated as a non-continuing director, thus triggering a default under the loan.

Although proxy puts are common, dead hand proxy puts have come under scrutiny in recent years. Such provision eliminates the discretion of the board to approve a slate of dissident directors in a proxy contest. Additionally, a dead hand provision raises questions of a board’s fiduciary duty to its shareholders to appoint a dissident slate when such appointment triggers the put.

Healthways

Most recently, in a ruling from the bench, the Delaware Chancery Court refused to dismiss a claim of breach of fiduciary duty against a board for agreeing to a proxy put in the face of a proxy contest, and, significantly, a claim against a lender for aiding and abetting the breach for including the dead hand proxy put in its credit agreement (Pontiac General Employees Retirement System v. Ballantine, C.A. No. 9789-VCL (Del. Ch. Oct. 14, 2014) (transcript ruling). The case stems from Healthways, Inc.’s execution of a fifth amended and restated credit agreement with a dead hand provision just days after its shareholders voted to de-stagger the board, a move that the board opposed. Notably, until the threatened proxy contest, Healthway’s credit agreement historically provided for a proxy put without a dead hand prong.

Although the lender argued that the proxy put arose out of an arms-length negotiation, was market practice and that there were legitimate business purposes served by the put, the court ultimately found issue with the dead hand proxy put adopted in the shadow of a proxy contest and the entrenching effect of such provision. The court found that although a claim of aiding and abetting may be negated by evidence of an arms-length transaction, an arms-length negotiation does not allow lenders “to propose terms, insist on terms, demand terms, contemplate terms, incorporate terms that take advantage of a conflict of interest that the fiduciary counterparts on the other side of the negotiating table face.” The court further noted that that lenders had notice that such proxy puts are “highly suspect” and could result in a breach of duty. See generally, San Antonio Fire & Police Pension Fund v. Amlin Pharms., Inc., 983 A.2d 304 (De. Ch. 2009); Kallik v. SandRidge Energy, 68 A.3d 242 (Del. Ch. 2013).

Although the court never ruled that the board breached its fiduciary duty, the lender aided and abetted the board’s breach, or that dead hand proxy puts were per se illegal, since the court’s initial ruling, in May 2015, the parties reached a settlement agreement which required the parties to eliminate the dead hand proxy put from the credit agreement (Pontiac General Employees Retirement System v. Ballentine, C.A. No. 978-VCL (Del. Ch. May 8, 2015) (Transcript).

Proceed with Caution

In light of the Healthway’s case, lenders should proceed with caution when negotiating proxy put provisions in credit agreements, particularly in the context of a pending or actual proxy contest. Lenders would be wise to consider viable alternatives without an entrenching effect that allow them to gauge their borrower and its business, including financial covenants with coverage and leverage ratios.

Click here to check out our firm’s recent update on proxy put lawsuits.

August 14, 2015 at 8:00 am 1 comment

Are Some Banks Too Small to Comply?

The Commissioner of Florida’s Office of Financial Regulation thinks Dodd Frank’s one-size-fits-all approach to regulation is hurting banks and consumers.  Check out Commissioner Breakspear’s recent article on that very topic at the American Banker’s website by clicking here.

 

 

August 13, 2015 at 1:24 pm Leave a comment

A Momentous Court Decision May Hurt Bank Lending Powers

Written by: Barkley Clark and Mike Lochmann

In a recent decision that has sent shockwaves through the banking industry, a federal appellate court in New York has ruled that, for usury purposes, non-bank buyers of charged-off credit card debt are not allowed to step into the shoes of a national bank that originated and sold the debt. We think the ruling in Madden v. Midland Funding, LLC (May 25, 2015) is flat wrong because it contradicts 182 years of well-settled law, disrupts secondary markets, and interferes with the core powers of a national bank to sell its loans to third parties.

This article was first published at BankDirector.com. Please click here to view the full article. 

July 22, 2015 at 4:26 pm Leave a comment

Commercial Real Estate Portfolio Reminder: New Rules on Increased Risk Weighting for Commercial Real Estate Loans Now in Effect

Written by: Joseph Hipskind

The first quarterly Consolidated Reports of Condition and Income for 2015 have been generated and fresh attention is being paid to the possibility of increased risk weighting for many real estate loans. For most banks, savings and loan holding companies and large bank holding companies, new rules for the risk weighting of “High Volatility Commercial Real Estate” (HVCRE) loans went into effect on January 1, 2015. As a result of these new rules, some loans that might have been classified as being risk-weighted at 100 percent are now being risk-weighted at 150 percent.

Most followers of the actions of the multi-national Basel Committee on Banking Supervision, which includes the United States, and the U.S. banking agencies are well aware of the increased focus on capital adequacy and risk management.  The Basel Committee’s Basel III Accord took aim at the financial crisis of 2007. The framework developed as part of Basel III led to the Federal Reserve Board’s promulgation of rules in 2003 which implement both the Basel III Accord and the Dodd-Frank Wall Street Reform and Consumer Protection Act.  These rules were also approved and promulgated by the OCC and the FDIC.  One small part of these rules focus on lending institution exposure to real estate loans.

The final rules amount to hundreds of pages of text and one such final rule relates to what U.S. banking agencies classify as HVCRE loans.  In what amounts to a material change to past practice, HVCRE loans are required to be risk-weighted at 150 percent.   HVCRE loans include all loans that finance the acquisition, development and construction of commercial real estate, with important exceptions.   One to four family residential properties, certain loans for the purchase or development of agricultural land,  and certain loans for projects that qualify as community development investment are exempt from the HVCRE classification.

Also, as elucidated in the FDIC’s final rule codified in Title 12 of the Code of Federal Regulations in Part 324, a  commercial real estate loan may avoid the HVCRE classification if:

  • the loan-to-value ratio (LTV) is equal to or less than the maximum supervisory LTV (which is 80% for commercial construction loans), and
  • the borrower contributes capital to the project in the form of cash or unencumbered readily marketable assets (or has paid development expenses out of pocket) of at least 15% of the real estate project’s “as completed” appraised value, and
  • the borrower contributed the amount of capital before the advance of funds under the loan and the borrower’s 15% is contractually required to remain in the project until the loan is converted to a permanent loan, sold or paid off.

These rules were finalized in 2013 but the first quarter of 2015 presented the first opportunity for banks to grapple with the new rules.  Naturally, if such work has not already been done, financial institutions should take immediate action on reviewing real estate loan portfolios in light of the new rules. Among other things, “as completed” appraisals for real estate projects must be reviewed for the “as completed” appraised value.  Borrower contribution to the capital of the project must be calculated. Loan documents should be analyzed to determine whether contributed capital is contractually required to remain in the project. And, looking ahead, care should be taken in insuring that future real estate loans include appropriate contractual provisions to address these points.

July 22, 2015 at 8:00 am Leave a comment

“Legalized” Marijuana: A Banking Compliance Conundrum

Written byZane Gilmer

On July 1, 2015, Minnesota will join 23 other states and the District of Columbia as the latest jurisdiction to permit the sale of medical marijuana. Minnesota’s medical marijuana laws are much more restrictive than many of its sister states’ marijuana laws in terms of who may purchase products, the types of products that may be sold or consumed, and the number of facilities permitted to sell the products. Nevertheless, those restrictions do not eliminate the myriad of issues created by permitting the sale of marijuana, including compliance challenges for banks and other financial institutions. This article will address some of the key compliance issues that face Minnesota’s financial industry following the legalization of medical marijuana.

The “Cash-Only” Problem

Most of the major credit card companies prohibit the use of their card networks for marijuana purchases. As a result, “legalized” marijuana sales across the country are conducted largely on a cash basis. Many states that permit either medical or recreational marijuana have seen marijuana revenues soar into the millions of dollars on a weekly basis. The scenario in Minnesota will likely be no different. Financial institutions, however, have to proceed with caution in banking those marijuana proceeds.

The Bank Secrecy Act (“BSA”), for instance, requires banks to monitor money passing through their institutions for potential money-laundering activities.[1] To comply with the BSA, banks are required to a file Suspicious Activity Report (“SAR”) related to certain transactions they suspect involve potential money laundering. Because the cultivation, possession, and distribution of marijuana are illegal under the federal Controlled Substances Act, any proceeds deriving from those transactions would be proceeds of an illegal transaction. Any marijuana-related business (“MRB”) attempting to bank proceeds of marijuana sales would trigger the bank’s obligation to file a SAR. Banks that fail to file a SAR for a reportable activity face criminal and civil fines and other penalties. As a result, many banks in states where marijuana is legal have refused to offer depository services to marijuana businesses.

On February 14, 2014, in response to banks’ reluctance to accept marijuana proceeds, the Department of the Treasury’s Financial Crimes Enforcement Network (“FinCEN”) and the Department of Justice (“DOJ”) issued separate guidance to financial institutions related to providing banking services to the marijuana industry.[2]

DOJ Guidance

The DOJ guidance makes clear that the provisions of the BSA, money-laundering statutes, and the unlicensed money remitter statute remain in effect with regard to marijuana-related conduct, despite efforts at the state level to legalize marijuana.[3] The DOJ guidance advises that its prosecutors, in determining whether to initiate an investigation or to charge an individual or institution for violation of a provision related to marijuana conduct, should focus on whether the conduct violates any of the following eight enforcement priorities:[4]

  1. Preventing the distribution of marijuana to minors;
  2. Preventing revenue from the sale of marijuana from going to criminal enterprises, gangs, and cartels;
  3. Preventing the diversion of marijuana from states where it is legal under state law to other states;
  4. Preventing state-authorized marijuana activity from serving as a pretext for trafficking other illegal drugs or other illegal activity;
  5. Preventing violence and the use of firearms in the cultivation and distribution of marijuana;
  6. Preventing drugged driving and the exacerbation of other adverse public health issues related to marijuana;
  7. Preventing the growing of marijuana on public lands and other public safety hazards associated with marijuana on public lands; and
  8. Preventing marijuana possession or use on federal property.

The guidance explains that a violation of one of these priorities may be ripe for investigation or prosecution, whereas a marijuana-related activity that does not implicate one of these priorities may not be appropriate for prosecution. Notably, however, the DOJ guidance does not guarantee that marijuana-related activities that do not implicate one of these priorities will not be prosecuted.

FinCEN Guidance

FinCEN, for its part, issued much more tangible guidance for the financial industry. Indeed, FinCEN’s stated goals in issuing its guidance were to clarify BSA “expectations for financial institutions seeking to provide services to marijuana-related businesses” and to “enhance the availability of financial services for, and the financial transparency of, marijuana-related businesses.”[5]

Development and Implementation of Thorough Customer Due Diligence Programs Required

FinCEN’s guidance provides that “the decision to open, close, or refuse any particular account or relationship should be made by each financial institution based on a number of factors specific to that institution.” To make these decisions, financial institutions are expected to develop and implement a thorough due diligence program that includes: (1) verifying with state authorities whether the MRB is licensed and registered; (2) reviewing the state application and supporting documentation submitted by the MRB to state authorities in support of its marijuana application; (3) requesting from state authorities information related to the MRB and individuals involved with it; (4) developing an understanding of the MRB’s “normal and expected activity,” including the products it sells and types of customers it serves; (5) ongoing monitoring of adverse public information concerning the MRB; (6) ongoing monitoring for any suspicious activity; and (7) updating the due diligence information on a periodic basis. The financial institution must also consider whether the MRB is in violation of one of the DOJ’s eight priorities or state law.

SARs for MRBs

If, after completing due diligence, the financial institution decides to provide services to the MRB, the financial institution must file one of two SARs: either a “Marijuana Limited” SAR—if the financial institution “reasonably believes” that the MRB is not in violation of any of the DOJ’s eight priorities or state law—or a “Marijuana Priority” SAR—if the financial institution reasonably believes that the MRB is in violation of one of the DOJ’s eight priorities or state law. In addition, the financial institution must file a “Marijuana Termination” SAR if it provides financial services to an MRB and later decides to terminate that relationship due to money-laundering concerns or if the MRB is in violation of one of the DOJ’s priorities.

To assist financial institutions in determining which SAR to file, the FinCEN guidance sets forth the following “red flags” that, if present, could mean that an MRB is violating one of the DOJ priorities or state law:

  1. An MRB appears to be using a state-licensed marijuana business as a pretext to launder money related to other criminal activity;
  2. An MRB cannot produce sufficient documentation and other evidence to demonstrate that it is duly licensed and operating in a manner consistent with state law;
  3. An MRB cannot demonstrate the legitimate source of significant outside investors;
  4. An MRB appears to be disguising its involvement in the marijuana industry;
  5. A review of publicly available information about an MRB and related parties reveals negative information;
  6. An MRB or related parties have been subject to state or local enforcement actions;
  7. An MRB engages in international or interstate activity;
  8. The owners or related parties of an MRB reside outside of the state in which the MRB is located;
  9. An MRB is located on federal property or marijuana that is sold by the business is grown on federal property;
  10. An MRB’s proximity to a school is not in compliance with state law; and
  11. An MRB purporting to be a “nonprofit” is engaged in commercial activity inconsistent with its designation as a nonprofit.

If any of these red flags exist, the financial institution must conduct further due diligence to determine whether the MRB is in compliance with the guidance.

Compliance Challenges Not Limited to Depository Accounts

In addition to the compliance challenges of providing depository services to MRBs, banks are also faced with similar issues related to extending loans to MRBs. Not only could such action be viewed as “aiding and abetting” a federal offense, but any loan proceeds and collateral securing the loan could be subject to federal forfeiture.[6] The same may also be true for loans to third parties. For example, if a bank lends money to a strip mall developer who then rents space to an MRB, the debt service paid by the borrower/landlord is likely going to be paid with at least some proceeds of marijuana sales by the borrower’s tenant, because the tenant likely used those proceeds to pay rent to the borrower. Further, banks risk litigation, including claims related to violations of the federal Racketeer Influenced and Corrupt Organizations Act [7]—for providing knowing assistance to MRBs in violation of federal drug laws—and False Claims Act lawsuits [8]—for using proceeds of federally backed loan programs to fund or assist state MRB operations that are unlawful under federal law.

In short, there are a myriad of compliance challenges facing banks in the wake of marijuana legalization. Those challenges, however, have proven manageable. The key is to develop and implement thorough policies and procedures based on DOJ and FinCEN guidance.

[1] 31 U.S.C. § 5311, et seq.; see also 18 U.S.C. §§ 1956 and 1957 (federal anti-money laundering statutes).

[2] FinCEN Guidance, “BSA Expectations Regarding Marijuana-Related Businesses,” February 14, 2014, available at http://www.fincen.gov/statutes_regs/guidance/pdf/FIN-2014-G001.pdf; James M. Cole, “Guidance Regarding Marijuana Related Financial Crimes,” U.S. Department of Justice, February 14, 2014, available at http://www.justice.gov/usao/co/news/2014/feb/DAG%20Memo%20-%20Guidance%20Regarding%20Marijuana%20Related%20Financial%20Crimes%202%2014%2014.pdf.

[3] DOJ Guidance, p. 2.

[4] Id.; James M. Cole, “Guidance Regarding Marijuana Enforcement,” U.S. Department of Justice, August 29, 2013, available at http://www.justice.gov/iso/opa/resources/3052013829132756857467.pdf.

[5] Press release announcing FinCEN guidance, available at http://www.fincen.gov/news_room/nr/html/20140214.html.

[6] See, e.g., 21 U.S.C. § 853 (forfeiture statute related to controlled substances violations); 18 U.S.C. § 981, et seq. (forfeiture statute related to money laundering).

[7] 18 U.S.C. § 1961, et seq.

[8] 31 U.S.C. § 3729, et seq.

 

July 21, 2015 at 10:59 am 1 comment

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