More than a year has gone by since passage of the U.S.A. Patriot Act. Money managers still aren’t sure what their country is asking of them.
By Deepak Gopinath
February 2003
Institutional Investor Magazine
Just six weeks after 9/11, Congress passed the U.S.A. Patriot Act, a sweeping expansion of the Bank Secrecy Act that calls for most financial institutions -- not just banks -- to implement tough new anti-money-laundering programs, follow extensive know-your-customer procedures and share information with the government about clients’ identities and assets. The Treasury Department, whose brief is to draft the new rules with input from the Securities and Exchange Commission, hasn’t been able to match Congress’s speed; it’s taken months to hammer out the specifics of a measure that affects trillions of dollars in assets handled by every conceivable sort of financial entity. And it’s still not done.
“The U.S.A. Patriot Act is the most significant revision to the Bank Secrecy Act in years and has called upon Treasury to issue an unprecedented number of regulations in a short period of time,” says a Treasury official working on the rules.
It’s not just a massive task for government bureaucrats. The act represents an enormous regulatory change and compliance challenge for money managers who have never had to cope with money-laundering issues. The prospect of big shifts in the way they do business and the uncertainty caused by regulatory delays have unsettled money management firms. “There’s a lot to do in a very short time, and people are anxious and want clarification,” says Betty Santangelo, a partner at law firm Schulte Roth & Zabel who specializes in advising financial institutions about anti-money-laundering issues and other compliance matters. There’s also a concern, notes the lawyer, “that compliance will be costly at a time when incomes are down across the board.”
How expensive might it be for money managers to comply with the Patriot Act? No one has made any estimates, but consulting firm Celent Communications projects that banks, broker-dealers and insurance companies and their money management arms will spend a total of $10.9 billion on anti-money-laundering initiatives through 2005. Previously, financial institutions spent $340 million a year on anti-money-laundering procedures and reporting.
In April 2002 Treasury issued interim final rules on anti-money-laundering programs for broker-dealers and mutual funds; they went into effect in July. That month Treasury also released proposed customer-identification program rules for broker-dealers and mutual funds. In October, though, the department deferred implementation of these rules for mutual funds pending further consultation and review. Also delayed were information-sharing rules for mutual funds; these had been finalized in September, but Treasury subsequently issued a moratorium on them pending refinement of the system. And Treasury has yet to finalize suspicious-activity-reporting rules for mutual funds.
Banks and broker-dealers have had to contend with money-laundering regulations for years and were able to adopt uniform procedures by working through self-regulatory organizations like NASD. But the regulations were an entirely new ball game for money managers, whose lack of experience has contributed to delays and confusion about the rules for mutual funds. Many money managers are still wondering how they will have to adapt their existing procedures and systems to comply. “The mutual fund industry, perhaps more than any other, has come to us and said, ‘Tell us how to do it.’ They were relieved that Treasury was working with the Securities and Exchange Commission on this,” says a Treasury official.
Treasury had expected that the customer-identification program rules for mutual funds would be in place last month, but the bureaucrats are running behind schedule. Treasury’s guidance on information sharing should appear soon, although that schedule could change.
Regulators insist that the delays were warranted. “Absolutely the most important issue is input from the industry. It is a truly iterative process; the issues are so far-reaching, we don’t want to get this wrong,” says the Treasury official. “To suggest that not having a rule by now is a delay is not really accurate.”
But that iterative process has been far from smooth. The rules on mutual fund information-sharing that Treasury finalized in September required money managers to compare current and past shareholders, as well as any people who had received payment from the firm, with individuals on government lists. Those requirements seemed especially onerous, and fund managers rebelled, deluging Treasury with complaints. They argued in particular that there was no simple or reliable way for their firms to track down people they had made payments to.
Treasury officials soon backed off.
“In November we got an e-mail telling us that there was a moratorium on the rule and that the government would provide guidance,” says Laura Chasney, an associate counsel for compliance at T. Rowe Price Associates. As of early January money managers had heard nothing more about how to implement the information-sharing rule.
“There is a great deal of cooperation, and we don’t want to be the last avenue for money launderers,” says Robert Grohowski, associate counsel at the Investment Company Institute. “But a lot of people question the overall cost [of compliance] given the small number of money launderers being caught.”
Money managers have had relatively few problems complying with the anti-money-laundering rules that went into effect in July. Because most mutual funds use transfer agencies to handle shareholder-information collection and processing, they rely on these agents to enforce antimoney laundering. For example, PFPC, a leading industry transfer agency, set up anti-money-laundering services for all its fund clients in July.
“Mutual funds have delegated the AML functionality to transfer agencies, although the responsibility for compliance remains with the fund,” says Pamela Mudrick, director of regulatory operations for the transfer agency division at PFPC. Although mutual funds, unlike banks, don’t yet have to file suspicious-activity reports as part of AML, Treasury is expected to introduce filing requirements in the future.
Complying with the as yet undetermined rules for customer-identification programs could prove more problematic. To implement CIP, funds will have to alter application forms to collect four key pieces of information -- name, street address, tax identification number and date of birth. Then they must verify that information, and that could be tough. “There’s no way of verifying if a Social Security number belongs to a particular person,” says T. Rowe Price’s Chasney. The Social Security Administration is working on a database that funds could tap into to verify information about clients, but work is going slowly, and funds may have to use third-party vendors to check identifications until the SSA system is up and running.
Money managers are unsure whether they will be able to rely on the broker-dealers and 401(k) plans that send them clients to vet shareholders or whether they will have to perform that task themselves. “The question is whose responsibility customer identification should be,” says the ICI’s Grohowski. Schulte Roth’s Santangelo thinks the answer should be clear: “Money managers will have to rely on broker-dealers; otherwise everyone will be doing the same process several times.”
Whatever the fine print, money managers want to be certain that they have enough time to transition into the CIP program. It will take months to remove old account-opening applications from circulation, for example, and fund managers don’t want to be forced to reject new customers just because they used an old form. In September the ICI sent Treasury and the SEC a letter calling for, among other things, a six-month minimum grace period for funds and transfer agents to come into compliance with the rules. On December 31 Treasury, the Federal Reserve Board and the SEC issued a joint report to Congress outlining how Bank Secrecy Act regulations are being applied to investment companies. In mid-January Treasury proposed suspicious-activity-reporting rules for mutual funds but hadn’t come up with its final CIP rules.
In the meantime, money managers are responding differently to the new regulations. Some are taking a wait-and-see approach, with PFPC’s Mudrick advising clients to hold off before changing their application procedures. But others have decided to start preparing for the inevitable. “We have gone ahead and updated application forms, and we are getting ready to reprint our applications,” says Chasney. She only hopes that Treasury’s final edicts will be reasonable.
