Anti-Money Laundering Issues for Hedge Managers, Brokers, Distributors, and Buyers. FOA Hedge Funds Seminar - 5th October 2004

Neil Jeans

Money Laundering Prevention Compliance

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The Hedge/Unregulated Funds Industry has unique issues with regard to Anti-Money Laundering Compliance.

Anti-Money Laundering Drivers for Unregulated Funds

The Unregulated Funds Industry has grown significantly over recent years.

The Unregulated Funds Industry perceived as having a “high” money laundering risk.

Funds routinely employ complex and opaque corporate structures, which make identifying the risks difficult and worry regulators.

Need for more sophistication around the identification of potentially higher risk clients driven by regulatory changes, including Section 326 of USA Patriot Act.

The AML regulatory requirements are increasing generally, thereby increasing the risks associated with non-compliance.

GEN0190n.ppt 3

The Unregulated Funds Puzzle

Complex & Multi -

Jurisdictional Structures

Opaque Ownership

Identificationand

Verification of Identity

Issues

Involvement of

unregulated third parties in transactions

Investor and

Beneficial Owner Issues

Involvement of other

regulated firms in

transactions

Involvement of third

parties in the management of the client

Inconsistent and sometimes

inappropriate managementof the AML

risks

Understanding of the actual risks vs the

perceived risks

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Each of the players has unique roles. Although sometimes the roles can be blurred and may vary from fund to fund.

The Players & Their Roles

Investment Managers/Advisers

Professional Fund Administrators

Prime Broker(s)

Clearing Broker(s)

Executing Broker(s)

Ultimate Controller

Investors

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Document the Client Structure.

Different focus for connected persons than Other Unregulated & Private Entities

How to do KYC for Unregulated Funds – Possibly ?

Standard requirements to obtain identity information.

This type of client is usually treated under the guidelines for unregulated & private entities. However, due to certain characteristics this type of client it is appropriate to apply a different verification standard focusing upon the fund itself, its managers/advisors, the funds ultimate controllers and, in special circumstances, its investors.

Investors treated as source of wealth – resulting in different requirements to identify Investors.

Directors of the Fund, Fund Managers, and Ultimate Controllers treated as connected persons.

Standard documentation requirements to verify the identity of the client.

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It is appropriate that a degree of due diligence is undertaken on relevant investors or that assurance is obtained that other parties have undertaken appropriate due diligence on “relevant” investors.

Treatment of Investors

Investors in a fund could be viewed as representing the source of wealth/funds of the client.

Investors funds are managed for them, therefore investors do not have control over the funds.

Relevant Investors can be defined as:

A person (natural or legal) who holds assets in the fund equating to 10% or more of the total assets held by the fund, where that asset is represented as an equity holding in the fund vehicle, a loan to the fund vehicle, or contractual obligation between the investor and the fund vehicle or its managers.

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Treatment of Investors

Investors in a fund could be viewed as representing the source of wealth/funds of the client.

Investors funds are managed for them, therefore investors do not have control over the funds.

The type of investor investing in the fund must be established and will dictate the due diligence required on the investors:

Where there is evidence that the fund is marketed to or has predominately (90%+) investors that are regulated or exchange listed entities or their subsidiaries - no further steps with regard to obtaining the identity information of all relevant investor need be undertaken.

In all other cases the relevant investors identity information must be obtained.

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Treatment of Investors

Investors in a fund could be viewed as representing the source of wealth/funds of the client.

Investors funds are managed for them, therefore investors do not have control over the funds.

Obtain the identity information of the relevant investors.

Where appropriate to do so, place reliance on a third party regarding the due diligence of the relevant investors.

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Unregulated third parties

Appropriately regulated institutions acting as agent to funds.

Reliance on Third Parties

Entities that are part of a group whose primary activity is appropriately regulated.

In certain circumstances it may be appropriate to

place reliance on others to meet the requirements,

particularly the identification and

verification requirements.

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Is it appropriate to factor in that another regulated firm is party to the transaction, when deciding what level of identity information and verification of identity is appropriate for the client placing orders?

 The firm involved and in whose name the client is placing orders or transactions, and who the executing broker will be settling direct with.

Where Prime / Clearing Broker is Involved ?

Where the client has a clearing broker or prime broker relationship with an appropriately regulated firm that undertakes or becomes involved in the part of the transaction, usually to settle the deal.

Q & A