September 6, 2002
Judith R. Starr, Chief Counsel
Re: Section 326 Mutual Fund Rule Comments
Dear Ms. Starr and Mr. Katz:
The Investment Company Institute1 appreciates the opportunity to comment on the recently proposed rule relating to customer identification programs ("CIPs") for mutual funds (the "Proposed Rule").2 The Proposed Rule would implement Section 326 of the USA PATRIOT Act (the "Act")3 by requiring that all mutual funds adopt and implement reasonable procedures to verify the identity of any person seeking to open an account, maintain records of information used to verify the person's identity, and determine whether the person appears on any lists of known or suspected terrorists or terrorist organizations.
The Institute strongly supports effective rules to combat potential money laundering activity in the investment company industry and, in general, supports the Proposed Rule as drafted. However, we have a number of specific comments, set forth below, that address: the definition of customer; intermediated accounts; the recordkeeping requirements; the role of mutual fund boards; and the requirement to search government lists of known or suspected terrorists. In addition to these specific comments, we urge Treasury to consider appropriate implementation and transition periods for this rule, in order to accommodate the significant systems and other changes that will have to be made to comply with its requirements.
I. Specific Comments and Recommendations
1. Definition of "Customer"
a. Individuals with Authority to Effect Transactions
The proposed rule defines "customer" as any shareholder of record who opens a new account with a mutual fund and any person granted authority to effect transactions in the shareholder of record's account with a mutual fund.4 We believe that the inclusion of all persons with the authority to effect transactions makes the definition unintentionally broad. Moreover, we are concerned that it would adversely affect fund investors and impose substantial burdens on funds in a variety of circumstances, many of which do not raise money laundering concerns. Therefore, as discussed further below, we strongly recommend that the definition of customer be limited to shareholders of record who open new accounts and individuals who open new accounts on behalf of or for the benefit of shareholders of record.
The following examples illustrate the breadth of the definition of customer as proposed and the effects on shareholders and funds that we believe are unintentional. First, a mutual fund shareholder's broker often will have the authority to effect transactions in the shareholder's account. Under a strict reading of the Proposed Rule, the individual broker would be a customer of the fund. This would require the individual broker to divulge his or her personal information (i.e., name, address, date of birth and social security number) to every mutual fund in which any of his or her customers invest, and would require the fund take reasonable steps to verify his or her identity. We believe that this would be an unwarranted intrusion on the broker's privacy and is unnecessary to prevent money laundering.
Second, it is common for 401(k) plans and other defined contribution plans to allow participants to direct their account investments among a number of investment options, including mutual funds, offered by the plan. In such cases, plan sponsors often will direct financial institutions providing plan services to accept instructions from participants. Congress clearly expressed its intent regarding this and other situations involving retirement plan investments in mutual funds: "Where a mutual fund sells its shares to a qualified retirement plan, the plan, and not its participants, would be the fund's customers. Thus, the fund should not be required to `look through' the plan to identify its participants."5 Nevertheless, under a strict reading of the Proposed Rule, it is unclear whether these retirement plan participants could be deemed customers of the fund, and thus subject to identification and verification requirements.
Third, the proposed definition appears to capture a number of other persons who pose little or no money laundering risk, such as court-appointed executors and guardians and individuals who are granted authority to effect transactions in an account upon the death of a shareholder, such as Individual Retirement Account (IRA) beneficiaries.
Fourth, the proposed definition of "customer" would include any individual acting on behalf of an entity, such as a corporation or retirement plan, to effect transactions in the entity's account. Given that a substantial number of individuals often are granted authority to effect transactions in these types of accounts, and that these individuals often change over time, we believe that treating all of these individuals as customers under the CIP rule would lead to a significant number of delays in effecting transactions in these accounts. Moreover, we question whether the treatment of these individuals as customers is necessary to address money laundering concerns. Administrative personnel and other individuals acting on behalf of publicly traded corporations or retirement plans, for example, pose a minimal risk of money laundering. Moreover, mutual funds have procedures to authenticate an individual's authority to act on behalf of an entity before permitting that individual to redeem shares owned by the entity. Obtaining additional pieces of information, such as the individual's date of birth, would not seem to further anti-money laundering purposes.
Limiting the definition of "customer" to shareholders of record and other individuals who open new accounts would alleviate many of our concerns about the breadth of the definition as proposed.6 At the same time, it would address customer identification and verification in a way that is consistent with both the express language of Section 326 and sound anti-money laundering policies. Section 326 states that "the Secretary of the Treasury shall prescribe regulations setting forth the minimum standards for financial institutions and their customers regarding the identity of the customer that shall apply in connection with the opening of an account at a financial institution."7 By focusing on the identification and verification of individuals and entities involved in the opening of an account, Section 326 recognizes and seeks to address concerns with illegitimate investors and persons who might seek to use legitimate investors as a front for their own illegitimate purposes. Our proposed definition would subject both types of persons to identification and verification requirements.
To the extent that Treasury and the SEC do not implement our recommendation and instead retain the "authority to effect transactions" language in the definition, we strongly recommend that the definition of customer in the final rule exclude the five categories of individuals described above: (1) broker-dealer representatives; (2) defined contribution retirement plan participants; (3) court-appointed guardians and trustees; (4) individuals granted trading authority as a result of the death of a shareholder; and (5) individuals acting on behalf of entities (i.e., non-natural persons), other than those opening an account on behalf of the entity.8 In our view, the burdens associated with subjecting these individuals to identification and verification procedures are unnecessary to achieve the goals of Section 326.
b. Exchanges of Fund Shares
The Release states that "a shareholder who exchanges shares of one fund for shares of another fund within the same account (or initiates any other transaction that does not involve the opening of a separate account) does not become a `customer' for the purpose of this rule."9 The Institute supports this position. We believe it correctly recognizes that a mutual fund shareholder's exchange transaction does not result in a new customer relationship and, more importantly, does not present any potential for money laundering since no assets are returned to the shareholder.10
As a technical matter, however, exchanges do not necessarily occur within a single mutual fund account. Instead, a shareholder may have an account (with a separate account number) for each fund in a fund family in which he or she invests. Thus, an exchange may be between two existing accounts, or may cause a new account to be opened. As proposed, if a new account is opened, the shareholder would become a customer under the rule.
Given the statement in the Release about exchanges, we do not believe that this result was intentional. We therefore request that Treasury and the SEC clarify in the release adopting the final rule that exchanges of fund shares would not cause an existing fund shareholder to become a customer for purposes of the rule.
2. Intermediated Accounts
Many mutual fund accounts are opened by a broker-dealer or other intermediary that has identification and verification responsibilities under the Act. Where the intermediary holds an omnibus position in these accounts, the Release is clear that a mutual fund's CIP does not have to cover the intermediary's customers whose transactions are conducted through the omnibus account.11 The Institute fully supports this treatment of omnibus accounts and account holders.
As the Institute noted in an earlier comment letter, there are other arrangements similar to omnibus accounts that we believe warrant similar treatment under fund AML programs.12 These arrangements, which we referred to in our earlier letter as "intermediated accounts," include all accounts for which an intermediary required to have an AML program under Section 352 of the Act is involved in opening the account and maintains an ongoing client relationship with the shareholder. In some intermediated accounts, a mutual fund shareholder may be a "customer" (as defined in the Proposed Rule) of both the mutual fund and the intermediary. Consequently, the CIP rule as proposed could require both the fund and the intermediary to perform identification and verification on those shareholders.
The identification and verification of these customers by the mutual fund is unwarranted for several reasons. First, it would be duplicative. If the customer has been appropriately identified and verified once, there is no reason to have another financial institution repeat the same procedures.
Second, the identification and verification required by the rule may be difficult for the fund to complete in many of these cases. The intermediary will have all of the required customer identification information; the mutual fund (or its transfer agent) often will not. Obtaining the missing information likely would lead to a delay in opening the customer's account, since this information must be collected before an account is opened.13 Customers would be exposed to market risk (i.e., the risk of being out of the market) during this delay. We believe that this exposure to market risk is an unnecessary burden on these shareholders. Moreover, requiring funds to collect this information does not seem to be consistent with the legislative intent behind Section 326. As quoted in the Release, the legislative history of Section 326 clearly indicates that Congress intended "the verification procedures prescribed by Treasury [to] make use of information currently obtained by most financial institutions in the account opening process."14
Third, reliance on an intermediary to perform the identification and verification would be entirely consistent with the risk-based approach generally taken in both the interim AML program rule15 and the Proposed Rule.16 Where an intermediary has an independent obligation to have a CIP that covers a mutual fund's shareholders, the fund should be able to reasonably rely on that intermediary to perform the identification and verification of those shareholders and focus its efforts on other, higher-risk customers.
For all of these reasons, we request that Treasury and the SEC confirm that in instances where another entity, such as a broker-dealer, has the obligation to perform identification and verification, funds are not required to perform duplicative identification and verification on those customers. This could be accomplished either through an amendment to the Proposed Rule or a statement in the release accompanying the final rule.
3. Recordkeeping Requirements
The Proposed Rule would require mutual funds to retain three categories of CIP-related information: (1) all identifying information provided by a customer ("identification records"); (2) all records of the methods and results of measures undertaken to verify the identity of a customer ("verification records"); and (3) the resolution of any discrepancy in the identifying information obtained pursuant to the CIP.17 The Proposed Rule would require that all three categories of information be retained for five years after the date the customer's account is closed. We support the retention of identification records for five years after an account is closed, as proposed. However, we recommend changes to the rule with respect to the other two categories of information.
a. Verification Records
We believe that linking the retention of verification records to the date an account is closed will prove to be problematic. It is likely that verification procedures will be done through batch processing (i.e., the processing of all of the accounts opened during a particular time period) and exception reports. The rule as proposed would require each exception report to be retained for five years after the close of every account to which it relates. In practice, we believe that this would be highly impractical, if not impossible, to administer and would lead to the indefinite retention of these records. This would be burdensome and expensive, even if the records were maintained in electronic form.
More importantly, the indefinite retention of verification records does not seem necessary to achieve the legitimate policy goal of providing appropriate records to test for compliance with the CIP rule.18 Verification procedures could be tested by examining recent verification records; a complete history of exception reports does not seem necessary for this purpose.
Thus, we urge Treasury and the SEC to revise Section 103.131(h)(2) of the Proposed Rule to provide that verification records must be retained for five years from the date the verification is performed, rather than five years from the closing of the accounts to which those records relate. Such a requirement would be far easier to administer than the requirement in the Proposed Rule and entirely consistent with the purposes for which these records should be kept.
b. Resolution of Discrepancies
Section 103.131(h)(3) of the Proposed Rule would require that the resolution of any discrepancy in the identifying information obtained pursuant to the CIP be retained for five years after the account associated with the information is closed. Minor discrepancies, such as typographical errors, often arise and are resolved during the account opening process. These discrepancies would not seem to be of interest or value for anti-money laundering compliance purposes. We therefore recommend that the final rule incorporate a materiality standard into Section 103.131(h)(3), such that the records retained pursuant to the rule need only reflect the resolution of material discrepancies in the information obtained pursuant to a CIP.
4. Role of the Mutual Fund Board
The Proposed Rule would require that a mutual fund's board of directors or trustees approve the fund's CIP.19 While the Institute questions the need for this requirement, we are even more concerned by the discussion of the board approval provision in the Release. After noting the approval requirement, the Release states that "[t]he board should periodically assess the effectiveness of its CIP and should receive periodic reports regarding the CIP from the person or persons responsible for monitoring the fund's anti-money laundering program pursuant to 31 CFR 103.30(c)(3)."20 This statement is troublesome for the following reasons.
First and foremost, it appears to impose specific, ongoing responsibilities on fund boards with respect to mutual fund CIPs. In doing so, it fails to appreciate the appropriate role of fund boards. It is well-recognized that the intended role of fund directors is to serve as "watchdogs," protecting fund shareholders by policing potential conflicts between the interests of shareholders and those of fund management.21 Having an effective CIP, while unquestionably important, does not raise any conflict of interest concerns. As such, the board's role in this context should be one of general oversight - the same as it is with respect to other compliance matters not involving potential conflicts of interest. Imposing more specific obligations on the board would contravene the SEC's efforts to allow fund directors "to focus to a greater extent on what they do best - exercising business judgment in their review of interested party transactions and in their oversight of operational matters where the interests of an investment company and its adviser may diverge."22
Second, none of the other releases proposing regulations to implement Section 326 includes a similar statement.23 The Release does not provide a rationale for imposing specific, ongoing responsibilities on fund boards that do not appear to apply to the boards or similar bodies governing the other types of financial institutions as to which CIP implementing rules have been proposed to date.24
For both of these reasons, we recommend that the release accompanying the final CIP rule for mutual funds clarify that the rule does not impose specific, ongoing review and/or monitoring responsibilities on fund boards.
5. Requirement to Search Lists of Known or Suspected Terrorists
The Proposed Rule would require CIPs to include procedures for determining whether a customer's name appears on any list of known or suspected terrorists or terrorist organizations prepared by any federal government agency and made available to the mutual fund. We agree with the Release insofar as it notes that mutual funds should already have procedures for checking customers against government lists, such as the Office of Foreign Assets Control (OFAC) lists. However, we are concerned that the breadth of the Proposed Rule - to check any list prepared by any federal government agency - could result in inadvertent violations of the rule.
We would encourage either Treasury or the SEC to act as a clearinghouse in this regard by formally (e.g., by rule or order) or informally (e.g., by posting on its web site) providing a catalog of the specific lists that mutual funds and other financial institutions are required to check, at least with respect to compliance with the CIP rule.25 In our view, this would provide a level of certainty that would improve compliance and reduce associated costs.
II. Implementation and Transition Periods
Section 326 of the Act requires the CIP rule to take effect by October 25, 2002. However, implementation of the rule will involve several tasks that will take some time to accomplish. We therefore urge Treasury and the SEC to (1) allow funds a reasonable period of time to come into full compliance with the rule and (2) provide a reasonable transition period during which the identification of certain customers can be completed as soon as practicable after an account is opened.
1. Implementation Period
Implementation of the CIP rule will involve a number of steps. CIPs will have to be drafted, incorporated into AML programs and approved by fund boards. To open accounts, certain information will have to be obtained that may not currently be required, such as an identification number, residential address and date of birth. This will require account application forms to be revised and transfer agency systems to be reprogrammed for purposes of capturing the required information. Other systems changes will be necessary to facilitate and maintain records of verification procedures. Also, notice will have to be provided to customers, which will involve a further revision to the account application form or a revision to some other disclosure document.
Clearly, CIPs should be drafted and the changes to application forms and transfer agency systems should be made as soon as possible to help combat money laundering and terrorist financing. However, these tasks cannot effectively begin until after the rule is adopted. For example, until the required fields of information and the scope of the definition of customer (as discussed above) are known with certainty, application forms and transfer agency systems cannot be changed.
Once begun, it is our understanding that these systems and disclosure changes are likely to take at least six months to complete, and more likely nine months for many larger firms. We therefore urge Treasury and the SEC to set a compliance date at least six months after the rule is adopted in its final form. We view six months as the absolute minimum amount of time needed to come into compliance with the rule, and we strongly encourage Treasury and the SEC to consider a nine-month grace period to allow larger mutual fund complexes and transfer agents to make the necessary systems changes.
We note that in similar circumstances when rules have been issued near a statutory deadline, Treasury has been willing to extend the compliance date beyond the effective date in the statute.26 We urge Treasury and the SEC to take a similar approach here.
2. Transition Period
Even after CIPs have been drafted and approved, application forms have been changed, and transfer agency systems have been modified, a number of investors are likely to attempt to open accounts using old application forms. Mutual funds and their intermediaries certainly should be encouraged to use their best efforts to circulate new account application forms to all of their distribution channels. However, past experience with changes to application forms indicates that, despite these best efforts, investors are likely to attempt to open accounts using old application forms for more than a year.
To deal with the residual flow of old application forms, personnel involved in processing account applications will have to be trained to recognize and react to situations where a new investor or existing shareholder attempts to open an account using an old application form. The investor will have to be contacted and provided with the required notice, any missing information will have to be collected, and verification will have to be performed. In the meantime, the transaction would likely be deemed not in good order and not processed. During this period, the investors would be exposed to market risk (i.e., the risk of being out of the market). We see this imposition of market risk as an unnecessary burden on investors who attempt to open legitimate accounts mistakenly using old application forms.
In order to better accommodate these investors, we recommend that the final rule provide a transition period during which the identification of certain customers can be done as soon as practicable after an account is opened. We recommend that this exception be limited to new accounts attempted to be opened using old application forms, and that it be further limited to those situations that do not raise heightened money laundering concerns. Thus, we would recommend that funds be encouraged to take a risk-based approach to the identification of these customers in these accounts during the transition period.
We believe that the residual flow of old application forms will largely dissipate within six months after new application forms are distributed. We therefore urge Treasury and the SEC to consider a transition period of six months after the date set for mandatory compliance, as discussed above.
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Thank you for considering our comments on the Proposed Rule. If you have any questions or need additional information, please contact me at (202) 326-5815, Frances Stadler at (202) 326-5822 or Bob Grohowski at (202) 371-5430.
Craig S. Tyle
cc: Paul F. Roye
May 29, 2002
Judith R. Starr, Chief Counsel
Re: Section 352 Mutual Fund Regulations
Dear Ms. Starr:
The Investment Company Institute1 appreciates the opportunity to comment on the FinCEN's interim final rule relating to anti-money laundering programs for mutual funds (the "Interim Rule").2 The Interim Rule prescribes minimum standards for anti-money laundering compliance programs to be established by mutual funds pursuant to Section 352 of the USA PATRIOT Act (the "Act").3
The Institute strongly supports effective rules to combat potential money laundering activity in the investment company industry and, in general, supports the Interim Rule as drafted. However, several statements in the Release raise issues that we would urge FinCEN to address. These include statements regarding omnibus accounts, AML compliance officers, delegation of compliance functions, reports on Form 8300, and the delegation of compliance examination authority to the Securities and Exchange Commission. The issues raised by each of these statements are described more fully below.
1. Treatment of Omnibus and Similar Accounts
a. Omnibus Accounts
The Release notes that investors may purchase mutual fund shares either directly or through a variety of other distribution channels, including broker-dealers.4 It further indicates that where intermediaries such as broker-dealers sell fund shares, those intermediaries usually hold an omnibus account with the fund. The Institute is pleased that the Release specifically recognizes that it is appropriate for fund AML programs to distinguish between omnibus accounts and other accounts by stating that:
This rule does not require that a mutual fund obtain any additional information regarding individual transactions that are processed through another entity's omnibus account. Consequently, given Treasury's risk based approach to anti-money laundering programs for financial institutions generally, including mutual funds, it is not expected that mutual funds will scrutinize activity in omnibus accounts to the same extent as individual accounts.5
We are concerned, however, about the assertion in the Release that, while mutual funds will not be required to scrutinize the individual transactions within an omnibus account, they will need to "analyze the money laundering risks posed by particular omnibus accounts based upon a risk-based evaluation of relevant factors regarding the entity holding the omnibus account, including such factors as the type of entity, its location, type of regulation, and of course, the viability of its anti-money laundering program."6 The highlighted language is extremely problematic, particularly insofar as it might suggest that a mutual fund would have to assess the viability of the AML programs of each of the intermediaries that sell its shares. Such an obligation would present very serious practical issues and, moreover, is unnecessary to achieve the purposes of the Act.
Funds that are sold primarily through unaffiliated retail broker-dealers, for example, often have literally thousands of selling agreements. It may be possible for a fund to obtain certifications of AML compliance from each retail broker-dealer that sells its shares, but doing so clearly would be a time-consuming and expensive process, and would do no more to assure the fund that the broker-dealer has an effective AML program than a standard contractual clause to the effect that the broker-dealer is in compliance with all applicable laws. To require funds to go beyond certifications and undertake an actual assessment of retail broker-dealers' AML programs would be significantly more burdensome. For example, a mid-sized fund complex indicated to us that it has approximately 2,500 selling agreements in place. Assuming that it would take someone trained in this area an hour to assess the viability of an AML program, which could be a conservative estimate, it would take that person more than a year, doing nothing else, to assess the viability of each of that fund's 2,500 retail broker-dealers' AML programs.
Perhaps more importantly, an AML viability assessment for an intermediary that is itself required to have an AML program under Section 352 of the Act would not seem to strengthen AML compliance or further the policies underlying the Act in any meaningful way. Presumably, a failure by such an intermediary to have a viable program would be a violation of Section 352 of the Act and one or more related rules. Funds should be entitled to rely upon this fact and assume that these intermediaries have viable AML programs in place. We urge FinCEN to clarify that mutual funds therefore are not required to assess the viability of such intermediaries' AML programs.
b. Intermediated Accounts
In addition to the omnibus accounts discussed above and described in the Release, there are other, similar arrangements that the Institute believes warrant similar treatment under fund AML programs. These arrangements, which we refer to as "intermediated accounts," include all accounts for which an intermediary required to have an AML program under Section 352 of the Act is involved in opening the account and maintains an ongoing client relationship with the shareholder. As with the omnibus accounts described in the Release, the intermediary in these arrangements will have "all of the relevant information about the customer." Unlike omnibus accounts, however, the mutual fund (or its transfer agent) also may have limited information about the customer (e.g., a name, address, social security number and/or account number), and may have transaction information relating to the account.
We believe it would be entirely consistent with the overarching goal of ensuring that there are no gaps in AML responsibilities for mutual funds to take a risk-based approach to intermediated accounts that is similar to the approach for omnibus accounts discussed above. In these circumstances, as with the omnibus accounts described above, the intermediary has an independent obligation to have an effective AML compliance program with respect to its customers. The fund, in developing its AML program, should be able to take that fact into consideration. For example, a fund's AML program could recognize that the intermediary is required to satisfy Section 326 of the Act (and any applicable rules adopted thereunder) with respect to the identification and verification of the shareholder, and thus that any identifying information provided to the fund already would have been verified for those purposes.7 In addition, it could take into account the intermediary's obligation to monitor for and report suspicious activity.8 We request that FinCEN indicate its concurrence with these views in the release adopting the Interim Rule in its final form.
c. Other Accounts
In recognizing a distinction between omnibus and individual accounts, the Release implies that the type of account can be a relevant consideration in determining what level of scrutiny is appropriate as part of a risk-based AML program. The Institute agrees with this premise. In fact, in some circumstances, the type of account may be a more important consideration than any of the factors FinCEN describes in the Release with respect to omnibus account holders (i.e., the type of entity, its location, its type of regulation, and the viability of its AML program). For example, a mutual fund might reasonably conclude that an account for a Fortune 500 company's retirement plan would not have to be scrutinized to the same extent as an individual account, since that retirement plan account presents little, if any, money laundering risk. That conclusion might be warranted regardless of whether the company is a financial institution that is required to have a viable AML program in place, or an operating company that has no AML responsibilities. We suggest that FinCEN confirm that a variety of factors could impact the money laundering risk that a particular mutual fund account presents, and that it is consistent with Treasury's risk-based approach to AML compliance for mutual fund AML programs to take all of these factors into account.
2. AML Compliance Officers
The Interim Rule requires each mutual fund to designate an individual (or committee) with the responsibility for overseeing its AML program.9 In discussing this provision, the Release states that "[a]lthough in many cases the implementation and operation of the compliance program will be conducted by entities (and their employees) other than the mutual fund, the person responsible for the supervision of the overall program should be a fund officer."10
Compliance officers in mutual fund complexes often are not fund officers, but instead are officers of the funds' investment adviser, transfer agent, or principal underwriter. The Institute believes that it should not matter whether the AML compliance officer is a fund officer, as long as that person is "competent and knowledgeable regarding BSA requirements and money laundering issues and risks, and empowered with full responsibility and authority to develop and enforce appropriate policies and procedures throughout the fund complex."11 It is the substance of this standard, not the individual's title, that will determine whether he or she would be an effective AML compliance officer. We therefore recommend that FinCEN clarify that the AML compliance officer designated by a mutual fund is not required to be a fund officer, as long as the above-cited standard is met.
3. Delegation of AML Compliance Functions
The Release states that mutual funds are permitted to delegate AML compliance functions to service providers, such as transfer agents. It further indicates that, in order to do so, funds must obtain written consent from the delegate ensuring the ability of federal examiners to obtain information and records relating to the AML program and to inspect the delegate for purposes of the AML program.12
In many instances, a third party to which a mutual fund delegates AML compliance functions will already be required by law or regulation to allow federal authorities to examine its books and records and inspect it for AML compliance purposes. We recommend that FinCEN clarify that it is not necessary to obtain written consent from such a delegate. For example, if a mutual fund delegates its AML compliance to its transfer agent, and the transfer agent is a bank, that bank is itself a financial institution under the Act required to have an AML program in place. Federal authorities have, by law, the right to inspect the bank's books and records and examine its AML program. Requiring the fund to obtain written consent to such inspection and examination in these circumstances would therefore be unnecessary. We request that FinCEN concur with this view.
4. Reporting on Form 8300
The Release indicates that "the only BSA regulatory requirement currently applicable to mutual funds is the obligation to report on Form 8300 the receipt of cash or certain non-cash instruments totaling more than $10,000 in one transaction or two or more related transactions."13 This statement creates ambiguity as to the precise application of the Form 8300 reporting requirement in the mutual fund context. Mutual funds typically have no employees; their operations are conducted by various affiliated and/or unaffiliated service providers. Payments for purchases of fund shares generally are received and processed by the fund's transfer agent. We recommend that FinCEN confirm our understanding that, where a fund's transfer agent receives payments for fund shares, and the transfer agent either (1) is a bank, broker-dealer, or other financial institution subject to the BSA regulations, or (2) is acting as an agent of a bank, broker-dealer (e.g., the fund's principal underwriter), or other financial institution subject to the BSA regulations, there is no requirement for the transfer agent (or the fund or its principal underwriter) to file reports on Form 8300. Rather, in these circumstances, the transfer agent would be required to comply with the reporting requirements applicable to banks, broker-dealers, or other financial institutions under the BSA regulations, including, as appropriate, requirements to file currency transaction reports ("CTRs") and suspicious activity reports ("SARs"). Indeed, Section 6050I(c)(1)(B) of the Internal Revenue Code ("IRC") and the regulations promulgated under Section 6050I provide an express exception from the Form 8300 reporting requirements for certain financial institutions, including banks and broker-dealers, because they are subject to the currency reporting requirements for financial institutions under the BSA regulations.
In addition, as noted above, we understand that Treasury intends to propose a suspicious activity reporting requirement for funds in the near future. We fully expect that any transactions in fund shares involving cash equivalents (i.e., money orders, traveler's checks, cashier's checks, and bank drafts with a face amount of $10,000 or less), that otherwise would be reportable on Form 8300, also would be reportable suspicious transactions.14 Requiring duplicative reporting to FinCEN and the Internal Revenue Service on two different forms would be burdensome and would serve no valid law enforcement or public policy purpose.15 Thus, to the extent that Treasury adopts SAR requirements for funds, it may make sense also to subject funds (and/or their transfer agents) to the CTR requirements for financial institutions under the BSA regulations, instead of the reporting requirements for nonfinancial trades or businesses under the regulations implementing IRC Section 6050I and BSA Section 5331, thereby completely obviating the need to file Form 8300 to report transactions in fund shares. Alternatively, Treasury should take action to provide that, if and when any fund SAR requirement is implemented, there will no longer be a need to file Form 8300 to report fund share transactions involving cash equivalents.16 In this regard, IRC Section 6050I(c)(1)(A) specifically recognizes the potential for duplicative reporting, and authorizes the Treasury Secretary to make exceptions from the Section 6050I reporting requirements "if the Secretary determines that reporting under [Section 6050I] would duplicate the reporting to the Treasury under title 31, United States Code."17
5. Compliance Enforcement
The Release notes that as part of this rulemaking, FinCEN has delegated examination authority to the Securities and Exchange Commission ("SEC"). The Institute supports this delegation of authority, since the SEC is the functional regulator for mutual funds. We note that the SEC's Office of Compliance Inspections and Examinations has general examination authority over not only mutual funds but also their relevant service providers (such as principal underwriters and transfer agents), and thus is well positioned to perform this role in an effective and efficient manner.
With this in mind, we proposed a narrowly crafted carveout from the National Association of Securities Dealers ("NASD") AML program rule, NASD Rule 3011, when that rule was proposed.18 The carveout would have provided a conditional exemption to any NASD member with respect to its activities as a principal underwriter of mutual fund securities, based on the likelihood that the funds' required AML program would cover any relevant activities of the principal underwriter.19 The exemption would apply where the NASD member underwrites funds that have established an anti-money laundering program meeting the requirements of Section 352 of the Act (and any rule applicable to funds adopted thereunder).20 The NASD chose not to incorporate such an exemption in the final rule, but indicated that once Treasury's mutual fund AML program rule is in effect and the study relating to the application of the BSA to investment companies called for under Section 356 of the Act is concluded, the NASD may address whether any adjustment to NASD Rule 3011 would be appropriate.21
We continue to believe that such an exemption would avoid unnecessary regulatory duplication and eliminate the illogical, bifurcated AML compliance examination regime that Rule 3011 otherwise creates for fund complexes. We urge FinCEN to consider whether the same result could be accomplished by amending the Interim Rule to cover a broker-dealer's mutual fund underwriting activities or through some other means. At a minimum, Treasury should address this and other issues related to fund principal underwriters in its report under Section 356 of the Act. In the meantime, we are hopeful that the SEC and the NASD will coordinate their AML compliance examination efforts, keeping in mind the unique circumstances of fund underwriters.
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Thank you for considering our comments on the Interim Rule. If you have any questions or need additional information, please contact me at (202) 326-5815, Frances Stadler at (202) 326-5822 or Bob Grohowski at (202) 371-5430.
Craig S. Tyle
cc: Paul F. Roye
March 18, 2002
Jonathan G. Katz
Re: File No. SR-NASD-2002-24
Dear Mr. Katz:
The Investment Company Institute1 appreciates the opportunity to comment on NASD Proposed Rule 3011 (Anti-Money Laundering Compliance Program).2 The proposed rule would prescribe minimum standards for anti-money laundering compliance programs established by NASD members pursuant to Section 352 of the "USA PATRIOT Act" ("Act").3 Our comments address the rule's application to NASD members that underwrite securities issued by registered investment companies ("funds").
The Institute strongly supports effective rules to combat potential money laundering activity in the investment company industry. With this in mind, we propose a narrowly crafted carveout from Rule 3011 that would create no gaps in anti-money laundering compliance. Specifically, the Institute recommends that the rule provide a conditional exemption to any NASD member with respect to its activities as a principal underwriter of mutual fund securities. The exception would apply where the funds such NASD member underwrites have established an anti-money laundering program meeting the requirements of Section 352 of the Act (and any rule applicable to funds adopted thereunder). 4
We propose this exemption for two reasons. First, it would avoid unnecessary regulatory duplication. In this regard, we note that the Act's requirement to establish an anti-money laundering compliance program by April 24, 20025 applies to funds as well as to broker-dealers, and it is our understanding that proposed regulations setting minimum standards for fund compliance programs are imminent. Where an underwriter is part of a fund complex, it would be logical for the funds' anti-money laundering program to cover any relevant activities of the underwriter. (Indeed, the underwriter and other entities in a fund complex frequently share common personnel.) In these circumstances, there is no need for the underwriter to comply with a separate, duplicative requirement imposed by the NASD on its members.6 This is particularly true where, as is frequently the case, the underwriter does not open or hold shareholder accounts or process transactions in fund shares. 7
Second, our proposed exemption would eliminate the illogical, bifurcated anti-money laundering compliance examination regime that Rule 3011 otherwise would create for fund complexes. Compliance with the anti-money laundering program requirement for funds likely will be examined by the Commission's Office of Compliance, Inspections and Examinations ("OCIE"). As we indicated in our recent Broker-Dealer SAR Comment Letter, due to the scope of the Commission's regulatory authority, we believe OCIE is in the best position to examine funds and their relevant service providers (e.g., underwriters and transfer agents) in a comprehensive and integrated fashion for compliance with applicable anti-money laundering requirements.8 Subjecting fund underwriters to NASD examination authority for this purpose would create a piecemeal regulatory scheme that would be both duplicative and inefficient.
As noted in the Proposing Release, the legislative history of the Act makes clear that the compliance program provision "is not a `one-size-fits-all' requirement."9 Rather, the provision's requirements are general in nature because of Congressional intent "that each financial institution should have the flexibility to tailor the anti-money laundering programs to fit its business, taking into account factors such as . . . activities of the firm's business. . . ."10 Our recommendation reflects the fact that the activities of broker-dealers in acting as underwriters of mutual fund shares are inextricably tied to the activities of the funds themselves. Allowing such broker-dealers to be covered under fund compliance programs with respect to these activities would be consistent with Congress's intent to allow appropriate tailoring of these programs to fit different business models.
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Thank you for considering our comments on proposed NASD Rule 3011. If you have any questions or need additional information, please contact me at (202) 326-5815, Frances Stadler at (202) 326-5822 or Bob Grohowski at (202) 371-5430.
Craig S. Tyle
cc: Paul F. Roye
Patrice M. Gliniecki