This loophole has worried authorities for years, because while banks and most stockbrokers are required by law to identify the beneficial owners behind investments and report any red flags, private equity firms , venture capital funds and hedge funds are not.
The result is a confusing hole in regulations designed to keep criminals and corrupt politicians from around the world from gaining access to the US financial system – a situation that the private investment industry has repeatedly downplayed as it successfully fended off. attempts at reform by Treasury officials and anti-corruption groups.
Now, this lack of insight into America’s $11 trillion private investment industry threatens to complicate White House efforts to punish the financial elite close to President Vladimir Putin over the US invasion. Ukraine by Russia.
“They’re hunting in the dark,” said Lakshmi Kumar, policy director of Global Financial Integrity, an anti-corruption think tank in Washington. “The way the rules are set, there’s a black hole of information.”
President Biden, in his State of the Union address earlier this month, warned the oligarchs that his administration was “coming for your ill-gotten gains.” The Justice Department announced the next day that it had created a “Task Force KleptoCapture” to pursue sanctions against what it called “corrupt Russian oligarchs”.
But US authorities lack a clear track record of assets invested in private equity funds, venture capital funds or hedge funds.
Under current law, private equity firms and hedge companies don’t need to verify the identity of their investors or how they made their money – requirements that U.S. banks have followed in under the anti-money laundering Bank Secrecy Act, passed in 1970, and other anti-corruption laws. The rules are known as “Know Your Customer”, a due diligence process to assess and monitor a customer’s risk and verify their identity.
Anti-corruption groups and Treasury officials have pushed private investments to act more like banks to stamp out money laundering.
These private investments are increasingly important players in the financial markets. Each year over the past decade, more money has been raised in private markets than in public markets, such as stock exchanges, according to the Securities and Exchange Commission. Private markets now hold about half the assets of all US commercial banks, which account for about $22.5 trillion in deposits.
But little is known about where the private funds get their money.
While megayachts, private jets and lavish mansions are obvious signs of the potential wealth of the oligarchs, untold fortunes can remain hidden in different private investments.
“Luxury residences are what is visible. People can see that. But if you own property through an entity with a limited partnership in a private equity fund, no one does,” said Joshua Kirschenbaum, a former Treasury official who works on illicit finance as a senior researcher at the Alliance for Securing Democracy.
Sometimes there are hints of the degree of potentially suspicious activity. The 2020 FBI memo – obtained by online hackers and published by the activist group Distributed Denial of Secrets – outlines a plan by a New York and London-based hedge fund official to create a series businesses “to buy and sell contraband”. articles” from sanctioned countries.
Sen. Ron Wyden (D-Ore.), who has proposed a bill to close the disclosure loophole, said in a statement that he sees America’s massive private equity and hedge fund industry as representative “a much bigger problem” to hide the assets of the Russian oligarch. than real estate.
The Treasury Department is concerned about the lack of anti-money laundering regulations for private investments and plans to continue pushing for change, said a senior Treasury official who spoke on condition of anonymity to discuss the deliberations. of the agency. The aim is for these funds to follow the lead of banks and implement programs to verify the identity of customers and the source of funds, as well as to file “suspicious activity reports” if they believe that there are problems.
Leaders in the private equity industry have argued in interviews and commentary letters that these kinds of transparency requirements are unnecessary because their industry has a low risk of money laundering, as funds are often tied up for two to 10 years and often the client’s investment goes through a bank, which is already required to take steps to remove dirty money.
Some private equity firms are also already doing their own due diligence, even if the law doesn’t require it, said Michael Gershberg, a Washington attorney at Fried Frank, where he advises clients on anti-boycott and anti-trust rules. money laundering.
“I’m not sure there would be a huge change if they were subject to (the anti-money laundering rules),” he said.
But anti-corruption advocacy groups have said the lack of oversight is one reason the US remains a popular place to secretly hide money.
“If you’re a person facing US sanctions, then the best place to hide your assets is in the United States,” Kumar said, “and that’s a problem.”
It may not be possible to know whether an investment belongs to a person subject to sanctions due to the anonymity permitted by applicable law.
For example, a U.S. private equity firm can take money from a foreign-based limited liability company without knowing who owns the business or how it got its funding, anti-corruption experts say. .
On the other hand, banks are required to verify the identity of their customers when opening an account. Banks must also report to the Treasury’s Financial Crimes Network if they suspect money laundering or fraud.
Private equity firms in the European Union and the United Kingdom also follow similar guidelines.
US private investments were supposed to be covered by the new “dirty money” laws that followed the terrorist attacks of September 11, 2001 and the sudden interest in stamping out terrorist financing. But Treasury officials have granted a range of businesses, including investment firms and real estate, temporary exemptions so regulators can focus on other industries.
These temporary exemptions are now two decades old.
The Treasury has repeatedly proposed ending exclusions and requiring private equity firms and hedge funds to do due diligence with potential investors.
The agency last tried in 2015, where it faced industry opposition.
The proposed rule would have applied to most registered investment advisers who managed more than $100 million in assets.
Private equity firms and hedge funds should basically start reporting like banks.
While some hedge funds appeared willing to agree to new regulations, the private equity industry resisted, lobbying and filing comment letters against the proposal.
A group of small private equity funds called the Small Business Investor Alliance argued in a comment letter that criminals were not attracted to its funds because they are “long-term and illiquid investments”.
The Association for Corporate Growth, a group that includes more than 1,000 private equity firms, said the rule “would impose significant costs on advisers to private equity funds and other illiquid pooled investment vehicles, but would not significantly prevent or deter money laundering.”
And the Private Equity Growth Capital Council – a trade group that has since changed its name to the American Investment Council – wrote that their products “pose negligible money laundering risks”.
Today, the position of the American Investment Council has not changed.
While supportive of anti-money laundering regulations, “Congress and (Treasury’s Financial Crime Enforcement Network) have consistently chosen not to impose new AML requirements on private equity due to the profile lower risk,” Emily Schillinger, spokeswoman for the group, said in a statement.
Gary Kalman, US director of anti-corruption group Transparency International, is skeptical of such industry claims.
“It seems unlikely to me that the US private equity market is as pure as packed snow,” Kalman said. “I think that’s the dirty little secret: we don’t know how much money is hidden because nobody has to declare anything.”
The loophole for private equity is even bigger since the United States overhauled its corporate transparency laws last year.
Lawmakers have passed a bill that will eventually require any business created or registered in the United States to report the identities of its owners to the Financial Crimes Enforcement Network, ending the anonymity once promised by shell companies – shields often brandished by wealthy investors or others trying to avoid exposure. Although the reports are intended for law enforcement, they are not required to be made public.
Last fall, a small group of US lawmakers proposed a bill to include art dealers, investment advisers and others in anti-money laundering rules. No follow-up was given to them. In December, the Treasury proposed new anti-money laundering rules for the real estate market, which would align this sector with transparency requirements for other financial services. And the White House announced that same month a “anti-corruption strategywhich includes a plan to ask the Treasury Department to reconsider its 2015 proposal for anti-money laundering rules for private investments.
For now, the private equity remains intact.
As the United States and other countries impose sanctions on wealthy Russians, experts said the job is harder without transparency for a huge investment sector.
“We just don’t know what’s out there,” said Kirschenbaum, the former treasury official.