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INVESTMENT MANAGEMENT
Recent Investment Management Developments
May 2016
Below is a summary of recent investment
management developments that affect registered
investment companies, private equity funds, hedge
funds, investment advisers, and others in the
investment management industry.
FinCEN Finalizes Beneficial Ownership
Identification Rules
[Please see our related article regarding AML
requirements for investment advisers on page 20.]
As part of the U.S. Treasury Department’s ongoing
efforts to prevent bad actors from using U.S.
companies to conceal money laundering, tax evasion,
and other illicit financial activities, the Financial
Crimes Enforcement Network (FinCEN) has issued a
final rule to strengthen the customer due diligence
(CDD) efforts of “covered financial institutions.” 1
The CDD rule, issued May 11, 2016, requires covered
financial institutions, including banks, federally
insured credit unions, broker-dealers, mutual funds,
futures commission merchants, and introducing
brokers in commodities, to identify the natural
persons that own and control legal entity
customers—the entities’ “beneficial owners.”
Covered financial institutions have until May 11,
2018, to comply with the CDD rule.
The rule imposes several new obligations on covered
financial institutions with respect to their “legal entity
customers.” These include corporations, limited
liability companies (LLCs), general partnerships, and
other entities created by filing a public document or
formed under the laws of a foreign jurisdiction.
Certain types of entities are excluded from the
definition of “legal entity customer,” including
financial institutions, investment advisers, and other
entities registered with the Securities and Exchange
Commission, insurance companies, and foreign
governmental entities that engage only in
governmental, noncommercial activities.
For each such customer that opens an account,
including an existing customer opening a new
account, the covered financial institution must
identify the customer’s “beneficial owners.” The
CDD adopts a two-part definition of “beneficial
owner,” with an ownership prong and a control
prong. Under this approach, each covered financial
institution must identify:
2
• each individual who owns 25 percent or more of
the equity interests in the legal entity customer;
and
• at least one individual who exercises significant
managerial control over the customer.
The covered financial institution must verify the
identity of each beneficial owner identified by the
customer. Importantly, the covered financial
institution is entitled to rely on the customer’s
certification regarding each individual’s status as a
beneficial owner. However, using the same
procedures employed in its Customer Identification
Program, the covered financial institution must obtain
personally identifying information about each
beneficial owner. This information must be
documented and maintained by the covered financial
institution. The CDD Notice of Proposed
Rulemaking contemplated requiring the use of a
standard certification form. However, the final rule
makes use of the form, a copy of which is attached to
the rule, optional and permits the covered financial
institution to obtain and record the necessary
information “by any other means that satisfy” its
verification and identification obligations.
In response to industry concerns that the beneficial
ownership identification obligation would require
covered financial institutions to continually monitor
the allocation of its customers’ equity interests and
the composition of its management team to update its
beneficial ownership information, FinCEN made
clear that the CDD rule does not require covered
financial institutions to continuously update each
customer’s beneficial ownership information. Rather,
the CDD calls for a “snapshot” of the customer’s
beneficial owners at the time of account creation.
However, FinCEN does expect covered financial
institutions to update beneficial ownership
information when it detects relevant information
about the customer during the course of regular
monitoring.
In addition to the CDD rule, the Treasury
Department also issued a Notice of Proposed
Rulemaking (NPR) on May 10, 2016,2 aimed at
identifying the beneficial owners of foreign-owned
single member LLCs. The NPR would impose
additional reporting and recordkeeping requirements
on these entities, by treating them as domestic
corporations separate from their owners “for the
limited purposes of the reporting and record
maintenance requirements” imposed by the Internal
Revenue Code. Under the proposed approach, each
LLC would be required to:
• Obtain entity identification numbers from the
Internal Revenue Service (IRS), which requires
identification of a responsible party—a natural
person;
• Annually file IRS Form 5472, an informational
return identifying “reportable transactions” that
the LLC engaged in with respect to any related
parties, such as the entity’s foreign owner; and
• Maintain supporting books and records.
SEC Issues Guidance Addressing Fund
Disclosure Reflecting Risks Related to Current
Market Conditions
The Division of Investment Management of the U. S.
Securities and Exchange Commission (SEC) issued a
guidance update3 (the Update) in order to “foster
investor protection by reminding mutual funds,
exchange traded funds, and other registered
investment companies of the importance to investors
of full and accurate information about fund risks,
including risks that arise as a result of changing
market conditions.” In the Update, the staff notes
that it believes that funds should review risk
disclosures on an ongoing basis and assess whether
they remain adequate in light of current conditions.
The guidance states that clear and accurate disclosure
of the risks of investing in funds is important to
informed investment decisions and, therefore, to
investor protection, and the staff has provided
guidance on various aspects of risk disclosure on a
number of occasions.4 The Update is intended to
address what the SEC staff views as another
important aspect of fund risk disclosure, namely, the
changes in risks that a fund may be subject to as a
result of changes in market conditions.
