The Pandora Papers exposé again reveals how financial secrecy in the United States has made the country a favored destination for the world’s elite to hide illicit funds. The U.S. private investment industry, unfortunately, offers a perfect confluence of factors that make it an ideal place to hide and launder the proceeds of corrupt and criminal activity.
- It is large. The U.S. market alone holds more than US$11 trillion dollars in assets.
- It is opaque. Private funds, which target high-net worth investors, do not have the same reporting requirements as public equity and retail funds marketed for ordinary investors.
- It is complex. In the United States, there are nearly 13,000 investment advisers with little to no anti-money laundering due diligence responsibilities.
The U.S. has adopted and implemented a series of rules to detect and prevent illicit funds from entering its financial system. The Bank Secrecy Act (BSA), passed in 1970, established an anti-money laundering (AML) framework. Subsequent legislative updates and regulations built out a risk-based approach to AML reporting in the U.S. across 25 types of financial institutions ranging from banks, broker-dealers, mutual funds, credit unions, casinos, pawn shops, and others. The expansion of the U.S. rules largely follow international standards. Two notable exceptions are 1) the lack of regulation of investment advisers – that is, individuals or firms in the compensated business of providing advice about investing in securities; and 2) unregistered investment companies such as hedge funds, private equity, venture capital funds, and real estate investment trusts, and family offices.
A growing body of evidence suggests that this gap – the absence of requirements that investment funds and investment advisers establish anti-money laundering programs and conduct reviews to understand with whom they are doing business – is a significant vulnerability that negatively impacts U.S. national security and the lives of ordinary Americans.
As detailed in this report, a few examples demonstrate the risks:
- Russian and Chinese interests have sought access to sensitive U.S. technology and innovation through private investment vehicles.
- A cryptocurrency scheme run through private equity was among the largest financial scams in history.
- A lack of disclosure in private equity obscured the majority stake owned by a Russian oligarch in a U.S. voting management firm active in Maryland, calling into question election security.
- A leaked FBI intelligence bulletin included examples of illicit financial schemes using pooled investment vehicles involving Mexican drug cartels, Russian organized crime, and U.S. sanctioned countries.
In 2002, 2003, and 2015, the U.S. Treasury Department proposed rules to close the gap and require the private investment industry to perform due diligence on potential investors. Unfortunately, the proposed rules were never finalized and the vulnerability in our financial system remains. The FACT Coalition, Global Financial Integrity, and the Transparency International U.S. Office recommend that the U.S. Treasury Department update and finalize an AML rule covering both investment advisers and investment companies to address significant threats to America’s financial system, national security, and citizens. The rule should require (1) establishing a risk- based anti-money laundering and counter terrorist financing (AML/ CTF) program; (2) identification of the real, “beneficial” owners of legal entities that open accounts; (3) assessments of those owners and their transactions to identify money laundering risk; (4) the filing of suspicious activity reports with the Financial Crimes Enforcement Network (FinCEN) when sufficient risk is identified; and (5) the ongoing monitoring of accounts with a higher risk profile.
A strong rule that would bolster national security and mitigate threats to America’s financial system should cover the full range of unregistered investment companies and investment advisers, to avoid inadvertently creating loopholes ripe for exploitation. FinCEN should design the rule to institute affirmative anti-money laundering obligations for the following categories of advisers:
- Advisers currently registered with the U.S. Securities and Exchange Commission (SEC);
- Advisers working solely with hedge funds, private equity, venture capital funds, rural business investment companies, family offices, or any other type of private fund; and
- Advisers working as foreign private advisers.
The Biden administration has rightfully designated the fight against corruption as a national security priority and as a core pillar of the forthcoming Summit for Democracy. Committing to finalize a rule on unregistered investment companies and the full range of investment advisers would provide critical safeguards to close money laundering loopholes and protect the integrity of the U.S. and global financial systems.