Last summer, the Federal Bureau of Investigations (FBI) stated in a leaked intelligence bulletin that they believe that nearly $10 trillion in private investment funds are being used as vehicles for laundering money. Despite these concerns, when the Anti-Money Laundering Act of 2020 was enacted earlier this year, it largely left the private investment world untouched by any formal regulation.
While the private investment industry appears adequately regulated given the focus of laws such as the Sarbanes-Oxley Act of 2002, the Securities Exchange Act of 1934, and the Securities Act of 1933, these statutes focus primarily on fraud and transparency in the marketplace; they focus on protecting the investor. Although these regulations are necessary, they lack any focus on money laundering prevention.
What Money Laundering Risks Are Present in the Private Investment Industry?
Some might argue that the private investment industry is well-protected from money laundering risks since it generally does not deal in cash and most assets are expected to be maintained over a long period of time, which would be detrimental to most money laundering schemes. However, this industry has weaknesses in the layering stage of money laundering, where a bad actor will attempt to make the source of the illegal funds difficult to identify.
In the FBI’s memo, they provided four separate cases highlighting different strategies for laundering money in the private investment industry. Each case identified weaknesses in terms of monitoring pass-through activity, short-term activity, recognizing shell companies, and lack of information pertaining to non-US beneficial owners.
Bad actors have laundered money through private investment companies by depositing funds into their investment accounts and quickly seeking to withdraw the funds (also known as pass-through activity or short term activity). In one case, a bad actor was able to launder approximately $1 million through investment accounts each week. The amount of activity being withdrawn each week, should have been a red flag.
Other bad actors have disguised transactions with sanctioned counterparties by having their funds remitted to and from shell companies. In this instance, there appears to have been insufficient investigation into the shell companies.
Bad actors have also gone unrecognized as beneficial owners on investment accounts. As a result, the risk of conducting business with a bad actor has increased when private investment companies have failed to conduct adequate customer due diligence (CDD) on beneficial owners.
Why Private Investment Companies Should Strengthen These Weaknesses
Although private investment companies may resist bolstering their anti-money laundering compliance and awareness, the industry should consider strengthening their weaknesses in this area because regulation may be coming anyway. The political landscape is always changing, and if regulations are promulgated, an effective way to prepare for that impact is to operate “as if” the regulations apply.
It is no secret that the public scrutiny of being noncompliant in this space can result in both financial and reputational consequences. While banks are currently regulated differently from hedge funds and private equity firms, last year banks were fined close to $14 billion for money laundering compliance violations.
How Private Investment Companies Can Strengthen These Weaknesses
The private investment industry can strengthen these weaknesses by acting “as if.” By considering your firm to be under more stringent money laundering regulations, you may be better prepared for pending regulation. That may include bolstering your compliance department with better training regarding money laundering risks, increasing monitoring for pass-through and short-term activity, and strengthening CDD programs.
If a hedge fund or private equity firm is unsure how to strengthen its money laundering compliance, seeking help from outside experts may be a good decision, helping protect your company from money laundering risks and advising best practices to strengthen overall compliance risks.
 Timothy Lloyd, FBI concerned over laundering risks in private equity, hedge funds – leaked document, Reuters, (last visited Apr 19, 2021).
 The Anti-Money Laundering Act of 2020: Congress Enacts the Most Sweeping AML Legislation Since Passage of the USA Patriot Act, The National Law Review, (Last visited Apr 19, 2021).
 FBI concerned over laundering risks in private equity, hedge funds – leaked document, Reuters, (last visited Apr 19, 2021).
 Neil Weinberg, Hedge Funds Risk Biden-Era End to Money-Laundering Loophole, Bloomberg, (last visited Apr 19, 2021).