Know your customer.
This is a basic rule of banking in the United States. Without it, the US financial system risks unwitting involvement in crimes ranging from money laundering to terrorist financing.
But the imposition of economic sanctions on Russian oligarchs following the invasion of Ukraine has exposed a loophole that prevents regulators from tracking the flow of offshore money to the United States: hedge funds, private equity firms. investment, family offices and venture capitalists don’t always do it. know who they are taking the money from.
Now, some Capitol Hill lawmakers are joining calls for the Securities and Exchange Commission and the Treasury Department to demand that companies in the $11 trillion private equity market perform the same type of checks as those performed by institutions. financial institutions, including banks, brokerage houses, mutual funds and even casinos.
In a joint letter Tuesday to Treasury Secretary Janet Yellen and SEC Chairman Gary Gensler, Senators Elizabeth Warren and Sheldon Whitehouse said closing the loophole “would help the U.S. government regain the hidden wealth of sanctioned Russian elites and better combat money laundering, terrorism, the proliferation of weapons of mass destruction and other criminal activities throughout our financial system.
Both Democrats cited a New York Times report last week on the deeply complex financial holdings of an oligarch, Roman Abramovich, who invested billions of dollars through private funds. (Mr. Abramovich has been subject to sanctions by British authorities but not those of the United States.)
“The status quo is clearly untenable,” the senators wrote.
A Treasury Department spokesperson declined to comment on the lawmakers’ letter. The SEC did not immediately comment.
Calls for tighter scrutiny of foreign money in hedge funds and private equity firms date back about two decades, when the private equity industry was much smaller than it is today. But some argue that the rationale for exempting these industries no longer takes into account the impact of hedge funds and private equity on markets.
“Right now, brokers, mutual funds and banks are legally required to understand who their customers are and assess the source of their customers’ funds before investing them,” said Elise Bean, a former Director of Staff and Chief Counsel to the Senate Standing Subcommittee. on Investigations, which specializes in money laundering investigations. “But hedge funds, private equity and venture capital funds don’t – which doesn’t make sense.”
Ms Bean is advising a coalition of more than 100 organizations that filed a comment letter with the SEC last week, saying regulators should require private funds to provide regulators with a list of all “beneficial owners” of the money they accept from investors. and to identify the countries in which these investors reside.
The groups, calling themselves the Financial Accountability and Corporate Transparency Coalition, said private funds must be required to make these disclosures to help regulators track the potential “presence of illicit financial flows in private markets”. Russia’s invasion of Ukraine, they said, demonstrated the challenges of keeping tabs on the money of political insiders who made investments shrouded in secrecy at a time when they were not subject to government sanctions.
An SEC spokeswoman said the commission “enjoys strong public engagement” but does not generally respond publicly to comment letters.
There are a number of competing ideas for bringing private funds and unregulated investment advisers to the same know-your-customer standards as banks.
Ms Warren and Mr Whitehouse suggested in their letter that the Treasury could interpret the additional powers given to financial regulators following the 9/11 terrorist attacks as covering private funds.
Some proponents of increased oversight say the Investment Advisors Act gives the SEC the power to require private funds to conduct know-your-client checks.
Another option is to expand the 50-year-old Bank Secrecy Act, which requires banks and other regulated financial institutions to carefully screen their customers and stop potential money laundering.
The Facilitators Act, introduced in the House of Representatives last fall, would extend those rules to private fund investment advisers and others.
“It’s not a bad thing to figure out who you’re taking money from,” said Daniel Tannebaum, a financial crimes expert at consultancy Oliver Wyman.
But the fate of the Enablers Act is uncertain. A comparable bill has not yet been introduced in the Senate and no committee has agreed to consider it in the House. The scope of the legislation could also be a problem: lawyers, PR firms and art dealers would also be required to do the same checks, and the inclusion of so many professions increases the likelihood of opposition.
The assets of wealthy and powerful Russians have come under scrutiny after the United States and other Western countries targeted their ability to do business following the invasion of Ukraine. Private funds in the United States are required to notify the Treasury if they hold assets owned by Russians on the sanctions list, but they are not required to provide this information to other investors.
And the finances of the oligarchs are deeply complex, which can obscure their role as the source of the money: The Times reported that Mr. Abramovich has invested several billion dollars in US hedge funds and private equity through various front companies. In some cases, participants did not even know who owned the money they were helping to manage.
Much of Mr. Abramovich’s investment activity has been facilitated by a small firm, Concord Management, based in suburban Tarrytown, NY Concord Management has previously said it recommends investments but does not directly manage investments. ‘money. Representatives for Mr. Abramovich in London did not immediately respond to messages seeking comment.
The Russian-Ukrainian War and the World Economy
In another example, Fort Ross Ventures, a California venture capital firm, received investment dollars from Sberbank, a Russian state bank. Both the US and UK governments have imposed sanctions on Sberbank.
Ross Ventures said in a statement that it is “analyzing all announced international sanctions against Russia and Sberbank and will act in accordance with applicable law.”
The proposals by Ms Warren and Mr Whitehouse and the FACT coalition involve revisions to a private fund disclosure requirement called Form PF – enacted in the wake of the financial crisis more than a decade ago – that the SEC is already considering revising. .
The SEC has proposed requiring hedge funds, private equity firms and other investment advisers who must file a Form PF to provide regulators with updates on “extraordinary investment losses” or large exposures to other investors who could have an impact on the markets.
The FACT coalition said the existence of money from dubious sources in private funds is also potentially destabilizing to the financial system, which is why regulators must have access to real-time information about these investors.
Representatives of trade associations that represent the hedge fund and private equity industry have said that imposing additional reporting and know-your-client requirements on private funds is largely unnecessary because none of these industries has always been a magnet for money laundering.
The associations note that while a private fund manager in the United States may not do their own background checks, many funds employ independent companies to administer their offshore investment vehicles to perform know-your-client checks. and combating money laundering on foreign investors.
Bryan Corbett, chief executive of the Managed Funds Association, which represents more than 140 hedge funds and other investment funds, said private funds “already work with banks and specialist administrators and conduct standardized and rigorous due diligence on those who invest in funds”.
In the case of offshore funds, many outside administrators are based in the Cayman Islands, which abide by sanction orders from the United States and Britain. When the UK government imposed sanctions on Mr. Abramovich, many administrators decided to freeze funds in entities that could be linked to him.
Shortly before the imposition of the sanctions orders, representatives of Mr. Abramovich had sought to restructure some of the entities that had invested in those funds, according to three people briefed on the matter. But those maneuvers failed to avoid sanction orders, according to the people, who spoke on condition of anonymity because they were not authorized to comment publicly on the case.
But critics said the checks are not foolproof, as many wealthy offshore investors like Mr Abramovich have relied on shell companies to mask their ownership, and private fund managers often don’t know who the beneficial owner is. of a front company.
“It is clear that a significant amount of Russian money has infiltrated the US private investment markets, but we don’t know exactly how much, where it is invested or who could be affected by sanctions due to a lack of transparency,” Ms Bean said.