Expanding AML Requirements to Hedge Funds.

[ by Melanie Gretchen ]

If FinCEN, or the Financial Crimes Enforcement Network has its way, U.S. hedge funds will take on a new role: "white collar crime busters."  Strange as it may seem, FinCEN is drafting a rule that would require U.S. hedge funds to file formal reports notifying U.S. authorities of any suspicious trading by employees or outside parties, the regulatory agency said.  And as the Justice Department and SEC have demonstrated, there surely has been plenty of fraud in the $2 trillion hedge fund industry - almost like "low hanging fruit".

Changing Landscape.  It is anticipated that under the new rule, hedge funds would be required to police itself - just as banks, brokerages and mutual funds must do - and, as necessary, file suspicious activity reports (SARs) with the unit. 

A FinCEN spokesman said a proposed rule for the hedge fund industry could be filed for public comment some time in the first half of 2013.  With expanded responsibilities that would include overseeing insider trading and money laundering, there's little doubt taht a financial burden would be placed on the funds to establish and maintain specialized programs and staff members in their compliance and legal departments.

"Anytime there's any regulatory hook into a firm, it's like a domino.  When taken together, all of the rules and regulations, both new and revised, serve to intimidate entrepreneurs." -- Ron Geffner, a partner with NY-based Sadis Goldberg, who expects many in the industry to oppose the new rule as being both intrusive and costly.

An extension of such responsibilities might also require hedge fund firms and their employees to act as snitches on their competitors.

What Prompted the Move?   Dodd-Frank financial reform law once again is pushing the new regulatory reforms.  The law already obligated U.S. hedge funds to register with the SEC as investment advisers.  This series of events led the SEC to believe it can require hedge funds to conduct AML procedures that would include the filing of SARs. 

Hedge funds are faced with a having to decide how to accommodate the new requirements.  The funds would prefer not to expand their currently small compliance and legal staffs.  So, it's likely these financial companies will resort to hiring outside contractors to perform the work.

Long Overdue.   With most financial institutions already operating AML procedures, former FinCEN director James Freis, says the new rule is long overdue.  And he says it's approrpriate to require hedge funds to do conduct higher levels of due diligence on their employees and customers.  And it brings hedge funds in line with other financial institutions.

Mr. Freis, now with Cleary Gottlieb Steen &Hamilton in its Washington office, added: "Suspicious activity reporting would put an affirmative obligation upon investment advisers, including certain hedge funds, to notify the authorities of suspected illegal activity."

For further details, go to [Reuters, 1/4/13].