Venture capital (VC) firms are higher risk enterprises that can present unique challenges for attorneys. From speculative investments to the misuse of investor funds, counsel for VC firms or their investors must be ever vigilant in protecting their clients. Because of the high risks involved, it's important to ensure that your clients aren't running afoul of the law. Nowhere is this more true than with money laundering, an ever-growing concern in an age of global finance and free-flowing capital.
In 2015, for example, a risk assessment from the Treasury Department estimated that around $300 billion is generated each year from illicit proceeds which can then be funneled through laundering operations to finance organized crime or terrorist networks. Although VC investments tend to be long-term and illiquid, they can still be used to shelter illicit funds or as part of a broader scheme to fund illicit ventures. Given the risks associated with venture capital funds and money laundering, it's important to ensure that your clients understand their potential obligations under anti-money laundering (AML) laws.
Anti-Money Laundering Laws
In 1970, Congress passed the Bank Secrecy Act (BSA) which created the basic framework for federal AML laws. It required financial institutions to maintain records and reports on suspected money laundering transactions. The BSA was further strengthened by the Patriot Act passed shortly after the September 11, 2001 attacks. Among other provisions of the Act, Section 326 required financial institutions to establish programs to identify and verify customers. In addition, Section 352 of the Act required every financial institution to develop and implement AML programs which, at a minimum, would include the:
- Development of internal AML policies, procedures and controls
- Designation of a compliance officer
- Implementation of ongoing training related to money laundering
- Use of independent audits to test programs
At the time Section 352 was passed, the definition of "financial institution" did not include mutual funds, venture capital funds, private equity funds or hedge funds. However, the definition was expanded by regulation in 2010 to include mutual funds. In 2015 the federal Financial Crimes Enforcement Network (FinCEN) proposed expanding the definition to include all investment advisers required to be registered with the Securities and Exchange Commission. If enacted, this regulation could eventually incorporate VC firms requiring them to establish AML programs.
Establishing AML Programs
If VC firms are required to establish their own AML programs, they should keep in mind that the key element to any AML program is that it be reasonably designed to detect and prevent money laundering. The program must be in writing and approved by senior management. The Federal Financial Institutions Examination Council provides a manual to assist in creating AML compliance programs, but some additional guidance is provided below.
- Your VC clients should know the identity of their investors and the sources of their funding. They should therefore seek to verify investor identities and take affirmative steps to check investors against known lists of suspect entities by referencing the SEC and Commerce Department’s control list, the Foreign Assets Control sanctions lists and the FBI’s Most Wanted List. FinCEN also generates regular advisories regarding illicit financial activities and investors. For nominees, intermediaries or fund-of-funds investors, VCs may need additional procedures to obtain information about ultimate beneficial ownership or to safeguard against investments by suspect entities.
- A designated compliance officer needs to make sure that the AML program is implemented effectively; that appropriate checks are completed on existing and potential investors; that the program is updated as necessary as the AML rules and regulations evolve; and that appropriate personnel are trained in accordance with the rules.
- An employee-training program must be developed to educate employees with AML responsibilities. The nature, scope and frequency of the training will depend on the functions performed, but there should be periodic updates and refreshers addressing legal updates.
- Periodic independent audits must be conducted to ensure the program complies with Treasury requirements and that the program functions as designed. The Association of Certified Anti-Money Laundering Specialists provides helpful information on AML audits and certifications.
Further Resources
Beyond venture capital funds and money laundering, the National Venture Capital Association provides additional information and resources, including model legal documents, which can help you advise your VC clients. For more information on representing corporate clients generally, see FindLaw's Corporate Counsel section.