Comment: Is FinCEN your next watchdog?

A proposal in the works would have US-based GPs report any suspicious trading to financial regulators – that is unless the industry could convince them the rule would be superfluous in the private equity and real estate spheres.

Recently, it was revealed that the Financial Crimes Enforcement Network (FinCEN) was working on a proposal that requires hedge funds to file formal reports notifying the agency of any suspicious trading by employees or outside parties. A call put into FinCEN by sister publication PE Manager confirmed that a proposal was being written and to expect its release sometime in the next six months. 

The rule also is not being limited to the hedge fund universe, according to a government spokesperson, who clarified its scope would extend to all investment advisers registered with the US Securities & Exchange Commission (SEC). Private equity and real estate firms managing more than $150 million in assets entered the SEC’s remit last March. 

Compliance officers are unlikely to welcome the proposal with open arms. Its arrival would come at a time when regulators are already placing a magnifying glass on GPs’ activity. Critics of the proposal argue it would do little in the way of uprooting insider trading and money laundering in the private equity and real estate sectors.

“In large part, that’s because a fund’s custodial accounts are already subject to self-policing since the account is with a broker subject to the FinCEN requirements,” Doug Cornelius, chief compliance officer at Beacon Capital Partners, wrote in a post on his blog covering compliance and business ethics for private equity real estate. 

Cornelius went on to argue that closed-ended funds were a poor avenue for “drug kingpins and other bad guys” to hide their money, joking that they were “not typically patient investors looking for long-term returns”.

The good news is that FinCEN will not issue rules without first consulting stakeholders on its proposal. According to the spokesperson, a 90-day comment period will provide GPs the opportunity to make the case why not all investment advisers should be obligated to file a suspicious activity report (SAR) at the first sign of trouble. Stakeholders keen to gain a handle on the issue before then can look to similar proposals made by FinCEN in 2003 that were later abandoned due in part to difficulties in defining hedge and private equity funds (a challenge removed by using SEC registration as a litmus test). 

Even better news is that, if passed, sources say the rule is unlikely to be a significant compliance burden. Paul Hastings banking partner Kevin Petrasic says private equity and hedge firms have already essentially constructed compliance programs capable of detecting suspicious trading activity. GPs for instance must file currency transaction reports for any trade north of $10,000, and all US persons, including fund managers, are beholden by trading rules enforced by the Office of Foreign Assets Control. Petrasic says a less pronounced risk may be a GP filing too many SAR reports, which could lead to questions of why a firm was encountering so much shady dealing.

At any rate, it’s safe to say compliance officers would prefer not having to add another regulator to their growing list of supervisors. The solution of course is the same as it has always been whenever an ill-fitting proposal on the industry arises: engage, educate and explain the private equity model to regulators, who may not always be familiar with what compliance with their rules means in practice. Fingers crossed they get it right.