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Banking and Finance

Hedge Funds And Money Laundering

 There are indications from Washington that hedge funds, long exempt from anti-money laundering reporting rules, may soon be brought into the fold under new rules proposed by the Treasury Department's Financial Crimes Enforcement Network (FinCEN).

Rule-making issues aside, hedge fund managers want to know the answers to these two questions:

1. How would a hedge fund fit into a money laundering scheme? 

2. Aside from using an administrator's AML services, what else can a hedge fund do to prevent its fund from being used to launder money?

Here are some answers:

1. While public hard data is scant on the amount of money laundering through hedge funds, we believe that hedge funds would easily fit into money laundering schemes. They offer varying degrees of: secrecy, offshore accounts and the ability to place large sums of money. While it is often thought that a "lock up" of the investment for long period would be a deterrent to money laundering, this may no longer be the case with more complex schemes.

Perhaps most importantly, hedge funds have traditionally delegated the anti-money laundering function to admistrators, who will do a very good job performing as much checking and monitoring as required under applicable law and their own internal procedures.  However, the administrators may be at a disadvantage in spotting the launderer because their personal contact with the investor is cursory at best- and the personal contact element in the hedge function scenario may be the most important. That is, spotting the launderer by identifying a potential investor with some of the "softer markers", like a nonsensical investment plan or complete disregard for the fund's risk, may in fact be the best way to spot the launderer in the hedge fund context. The bifurcation of the AML function between the administrator and the fund may actually help the launderer.

2. The answer to the prevention question may lie in training, particularly of marketing staff.  The markers of a hedge fund money launderer may only come through during repeated interactions with a potential investor, which the marketing staff is in a prime position to evaluate.  In addition, many hedge funds have generally had the feeling that they were somehow immune from money laundering.  Even a heightened sense of awareness at a firm could be helpful in this regard.

If a firm believes they may be a target, the firm may undertake heightened screening and analysis of particular accounts either by the administrator or a specialty consulting firm.  For example, it may be necessary to find linkages between accounts or analyze more carefully the origin of the investor's initial deposit.

Most hedge fund compliance manuals address the money laundering topic in at least a cursory manner, and that may be the best place to start to develop a firm's anti-money laundering program.

Read more articles about the hedge fund industry and related legal issues at Hedge Rows, a blog by Judith Gross.

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