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January 13, 2003 at 07:00 PM
WASHINGTON–Hedge funds are attractive vehicles to money launderers, according to a report released to Congress by the U.S. Treasury Department, Securities and Exchange Commission and the Board of Governors of the Federal Reserve System at the end of the year.
The report provides information on the various types of investment companies, registered and unregistered alike, and the regulations proposed and existing for each. While much of the document focuses on proposed regulations for mutual funds, hedge fund managers could find a brief glimpse into the Treasury’s reasoning behind its recommended anti-money laundering rules.
The biggest issues for the industry to date are questions concerning which funds should be required to comply and the ramifications of hedge funds becoming registered and regulated entities.
According to the Treasury’s release last fall, designation as an unregistered investment company for compliance purposes applies to hedge funds with more than US$1 million in assets and/or lock-ups of less than two years. The idea behind the lock-up requirement is that funds with longer lock-ups are less likely to be used in the “placement stage” of the money laundering process, according to the Treasury department.
In the report to Congress, regulators say that compared to the lock-up period imposed by other unregistered companies, such as private equity and venture capital funds, the lock-up period imposed by hedge funds is relatively short. Because money laundering has become more expensive (estimated to cost 8% to 10% of the amount of money being laundered), money launderers might be attracted to investing their assets for a limited period in a fund that generates a return rather than a loss.
The structure of hedge funds also means they could be more vulnerable to criminal activity, and this poses problems for U.S. regulators. Currently, in the case of hedge funds with no anti-money laundering compliance responsibilities, the hedge fund has no responsibility to determine the source of an investor’s funds or to analyze whether the source of these funds is questionable, according to the report.
Offshore hedge funds pose even more problems. The report stated, “The potential availability of ‘anonymous’ investment and the inability of law enforcement to obtain information about the beneficial ownership of the corporate entities in certain jurisdictions make this type of hedge fund particularly attractive to money launderers.”
