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PRIVATE INVESTMENTS, PUBLIC HARMIn recent years, significantattention has been generatedon the use of anonymouscompanies, art, antiquities, andtrade-based money launderingto facilitate illicit money in andout of the United States. Theattention and advocacy aroundthese issues culminated inthe passage of the CorporateTransparency Act (CTA) in 2021.This landmark law requiresthe creation of a beneficialownership directory and an AML/CFT rule for antiquities dealersalongside a requirement that theTreasury Department undertakestudies into the risks of moneylaundering through art andtrade-based money laundering.One area of risk that has beenconspicuously absent in all ofthese efforts to strengthen theU.S. financial system againstabuse are measures to createaccountability within the U.S.private investment industryincluding hedge funds, privateequity, venture capital firms, andfamily offices.These vulnerabilities in the U.S.financial system from the privateinvestment sector are far fromhypothetical and encompassmore than one-off examples. InJuly 2020, a leaked FBI intelligencebulletin revealed that the FBIbelieved with ‘’high-confidence”that the US 11 trillion privateinvestment fund industry wasbeing used to launder money.2The assessment concluded thathedge funds, private equityfunds, and other types of privateplacements of funds were beingutilized to move illicit proceeds,3and referred back to a 2019FBI report where it likewiseconcluded criminal actors were“very likely” to launder proceedsfrom fraud schemes through“fraudulent hedge funds andprivate equity firms.”4So why are criminal and corruptactors turning to privateinvestment vehicles to legitimizetheir illicit funds? Choosing howto obscure one’s illicit fundsinvolves a number of factors,including, but not limited to, theopacity of transactions and thesize of the market. The privateinvestment sector in the UnitedStates, unfortunately, offers aperfect confluence of favorablefactors that make it an ideal placeto hide and launder the proceedsof corrupt and criminal activity.One area of risk thathas been conspicuouslyabsent in all of theseefforts to strengthenthe U.S. financialsystem against abuseare measures to createaccountability within theU.S. private investmentindustry including hedgefunds, private equity,venture capital firms, andfamily offices.9

First, the U.S. privateinvestment market isopaque. While retail tradingplatforms have several publicreporting requirements, privateinvestments have almost none.U.S. securities laws requireprivate equity firms to ensurethat the clients they acceptare “qualified purchasers” or“accredited investors,”but do not require them todisclose – to the public or thegovernment – the identity ofthose clients. While investmentfirms must ensure their clientshave an ability to weather a lossand assume investment risk, theycurrently do not have to screenthe clients’ funds or businessactivities to avoid investing illicitfunds. In addition, accreditedWhat does an investment advisor do?An investment adviser is a firm or individual that offersguidance on, or otherwise manages, the investmentdecisions of their clients.While an investment adviser may direct decision’s aboutclients’ portfolio with their consent, the adviser may ormay not personally execute the purchase, sale, or tradeon behalf of their client. They sometimes work through athird-party broker-dealer to get the job done.It is other instances, in which the investment adviseroperates independently outside the scope of anti-moneylaundering safeguards, that pose the most risk.10investors can be either naturalpersons or legal entities5 whichcan further add to the opacity ofan investor’s identity.Furthermore, public investmentfunds almost always employregistered investment brokersto identify clients and executetrades on the clients’ behalf.These brokers are required bylaw to know with whom theyare doing business, as theyhave what is called “know yourcustomer” (KYC) due diligenceresponsibilities.6 That means thatU.S. brokers have an obligationto check that any prospectiveclient, either an individual or anentity, is not attempting to movedirty money into the U.S. financialsystem. In contrast, privateinvestment vehicles do not alwaysuse registered brokers withAML obligations. While no U.S.business is allowed to directlyengage with anyone on an officialU.S. sanctions list, unlike someother financial service providers– banks for instance – private

PRIVATE INVESTMENTS, PUBLIC HARMGDPS FOR 2020U.S. PRIVATEINVESTMENT 2.7 T 11.0 TCHINA 3.8 T 14.7 TUNITEDSTATES 5.0 T 20.9 TU.S. private investment market would be 3rd largest economyin the world.JAPANGERMANYU.K.21Trillions (USD)Private equity, hedgefunds, and venture capitalhad approximately US 11trillion in assets in 2020,and the private investmentmarket is growing rapidly.0*Source: D?most recent value desc trueinvestment vehicles are notrequired to perform even a basiccheck to determine if an agentor entity requesting servicesis actually a front for a corruptor criminal actor. Nor are theyrequired to report suspiciousactivity to authorities, limiting lawenforcement’s ability to detect orprevent illicit transactions.Second, the U.S. privateinvestment sector is verylarge. Overall, the total equitymarket – public and privateinvestments – in the United Statesis larger than the economy itself.With more than US 59 trillionin assets under management,the U.S. market is at leastfour times the size of the nextlargest market.7 While privateinvestment makes up only aportion of the total market, it isstill a very large market by anymetric. Private equity, hedgefunds, and venture capital hadapproximately US 11 trillion inassets in 2020, and the privateinvestment market is growingrapidly.8 Investments in privateequity have “grown more thansevenfold since 2002, twice asfast as global public equity.”9Venture capital firms, a formof private equity, grew by 13percent per year in that sameperiod including in 2018, whichranked as the third biggest yearfor raising capital on record.10Experts project private equity willdouble its current portfolios toUS 9 trillion by 2025, and hedgefunds will grow to a little morethan US 4 trillion.11 The U.S.commercial banks, which do haveKYC responsibilities, now holdapproximately US 22.5 trillion indeposits.12 The private investmentmarket is quickly growing to anequivalent size.Finally, while there are almost5,000 commercial banks inthe United States, all with KYCobligations, almost 13,000 hedgefunds, private equity, venturecapital firms, and family officesare operational without similarrequirements.1311

MONEY LAUNDERING IN A PRIVATE INVESTMENT TRANSACTIONMr. Bad is a corrupt official who stole millions and is sanctioned bythe U.S. government.SCENARIO 1: U.S. BANKMr. Bad takes his stolen money to a U.S. bank. The bank does a “knowyour customer” check and turns him down.SCENARIO 2: ANONYMOUS COMPANYMr. Bad creates an anonymous company and moves his stolen moneyinto the company. The company goes to a U.S. bank. The bank does a“know your customer” check and turns him down.SCENARIO 3: OFFSHOREMr. Bad registers his anonymous company offshore and tries to investthe money through a U.S. investment broker in public funds. The brokerdoes a “know you customer” check and turns him down.PRIVATE INVESTMENT TRANSACTIONMr. Bad’s anonymous company uses the offshore account to invest withan investment adviser in private funds, who may only check to see if thereare enough funds in the account. Then, they can legally say yes, let’s dobusiness!12

PRIVATE INVESTMENTS, PUBLIC HARMThe Biden administration’sexpansive anti-corruptionplatform has created anenvironment ripe for actionto close gaps in the U.S.AML framework. In its June2021 national security studymemorandum, the White Houseelevated anti-corruption as a corenational security interest, callingcorruption a threat to “UnitedStates national security, economicequity, global anti-povertyand development efforts, anddemocracy itself” and proposing,as a solution, U.S. policiesaround “effectively preventingand countering corruption anddemonstrating the advantagesof transparent and accountablegovernance.”14 A senior WhiteHouse official explained, “we’relooking to make significantsystemic changes to theregulatory structure that governsillicit finance.”15 Safeguardingthe U.S. investment market fromabuse by corrupt regimes, U.S.adversaries, and criminals helpsprotect Americans and Americannational security interests whileaiding U.S. partners in low- andmiddle-income countries tocombat illicit financial flows thatundermine good governanceand rob them of much-neededresources.Safeguarding the U.S.investment market fromabuse by corrupt regimes,U.S. adversaries, andcriminals helps protectAmericans and Americannational security interestswhile aiding U.S. partnersin low- and middle-incomecountries to combatillicit financial flowsthat undermine goodgovernance and rob themof much-needed resources.13

MAPPINGTHE PROBLEM14

PRIVATE INVESTMENTS, PUBLIC HARMAssessing Demandfor Financial SecrecyInstruments with LongTerm HorizonsThe first mention of a moneylaundering operation oftenconjures up the mental image ofa seedy, all-cash business on theedge of town. Yet methodologiesto launder illicit financial flowsare plentiful, and many have keptpace with a modern, globalizedeconomy. The benefits to thecriminal and corrupt are twofold: they discover increasinglysophisticated ways to evadelaw enforcement by diversifyingtheir holdings, while theysimultaneously maximize returnson ill-gotten gains.Established criminal networkslike Italy’s ‘Ndrangheta mafiahave shown the necessarypatience to leverage financialmarkets for their fraudulentschemes. For instance, between2015 and 2019, the powerfulmafia organization reportedlyattracted approximately US 1.6billion in legitimate internationalinvestment – from hedge funds,family offices, pension funds,and other market participants,including one of Europe’slargest private banks – by sellingprivate bonds backed by frontcompanies embedded in Italy’shealth sector.16 The assets werereportedly sold through aninstrument created by CFE, aSwiss investment bank, whichclaimed no knowledge of thecriminal nature of the assets.17The benefits to thecriminal and corruptare two-fold: theydiscover increasinglysophisticated ways toevade law enforcementby diversifying theirholdings, while theysimultaneously maximizereturns on ill-gotten gains.Likewise, foreign corruptionpresents a threat to the integrityof U.S. investment channels.Many authoritarians haveinvestment horizons that matchtheir decades-long rule. As such,they engage in the equivalentof illicit estate planning: toconsolidate power in-country, tokeep their wealth out of reach ofpolitical opponents by moving itto rule-of-law jurisdictions, andultimately, to pass on their wealthto their children.15

For both the criminaland the corrupt, moneylaundering is not justabout short-term gains.16The dictatorial demand for longterm investments moves moneythrough a multitude of financialvehicles. For instance, look toreal estate. Teodoro Obiang –president of oil-rich EquatorialGuinea and one of the world’slongest serving dictators – hasdepleted the country’s coffers andmade Equatorial Guinea one ofAfrica’s lowest per-capita incomecountries.18 He has reportedlyused the stolen wealth tocement his financial and politicaldominance, make extravagantpurchases abroad (including aUS 2.6 million mansion a fewmiles from the U.S. Capitol),and tee up rule for his sons.19According to a settlement withthe Department of Justice,Teodorin Obiang, one of two sonsand the current vice president,reportedly used shell companiesas conduits for embezzled moneyto buy real estate in Malibu,California, Michael Jacksonmemorabilia, and a US 35 millionGulfstream jet. 20,21Trusts offer another investmentvehicle. Ferdinand Marcos ruledthe Philippines as president for21 years, and during that time,was believed to have stolenUS 10 billion while in office.22 Yet,during this 20-year period, hisofficial annual salary never roseabove US 13,500.23 Though manyof the Marcos family accountswere frozen after his governmentfinally fell in the 1980s, hundredsof millions of dollars remainedunrecovered. Two decades later,a whistleblower stated that“lawyers for KPMG (then knownas Fides, a subsidiary of CreditSuisse) moved the 400 million inMarcos funds to a Liechtensteintrust, Limag Management undVerwaltungs AG” where, left toaccrue interest in the interveningyears, its value was estimated tohave doubled.24 KPMG has deniedthe whistleblower’s accusations.The availability, secrecy, and longinvestment horizon of a trustprovide parallels to the operationof many U.S. private investmentfunds.

PRIVATE INVESTMENTS, PUBLIC HARMOther powerful figures injurisdictions plagued bycorruption likewise turn to longterm investments, includingby recruiting family offices andother gatekeepers to managetheir wealth. Jahangir Hajiyev,former chair of the biggest bankin Azerbaijan, earned a salaryof US 70,650 in 2008. 25 YetJahangir and his wife Zamira –who, according to Bloomberg,“earned no significant incomeherself” – spent millions of dollarsin the UK purchasing a US 14.3million townhouse in Londonand a Gulfstream jet for US 42.5million.26 Zamira, in a weekalone, reportedly spent nearlya million dollars at the Harrodsdepartment store in London.27According to a National CrimeAgency investigation, the couplewas allegedly able to hide andspend all this money throughthe assistance of a network ofgatekeepers including the globaltrust administration firm TridentTrust, which has operations inthe U.S., and a multi-family officeWerner Capital, based in London,that helped set up entities to holdthe couple’s various assets.28 It’sunclear what questions eitherfirm asked the couple aboutthe source of their wealth whentaking them on as clients.29Perhaps surprisingly, even thesetraditionally long-term horizoninvestments are not safe fromshort-term exploitation for thepurposes of financial secrecy.There is no better example thanthe 1MDB scandal, a global caseof corruption in which privateequity played a prominent rolein the theft of billions fromthe country’s developmentfund by the former PrimeMinister of Malaysia.30 A 2016U.S. Department of Justice civilforfeiture complaint regardingthe 1MDB scandal claimedthat hundreds of millions ofdollars from the developmentfund meant for a bond offeringwere layered through privateinvestment funds and thenpocketed by the perpetrators ofthe fraud. In one such example,over the course of one weekin May 2013, an arm of thedevelopment bank, 1MDBGlobal, purportedly transferreda total of US 1.59 billion from itsSwiss bank account to accountsbelonging to three differentoverseas investment funds inthe British Virgin Islands and inCuraçao.31 The funds were passedback and forth through multipleaccounts held in the names ofdifferent legal entities but all withthe same beneficial owner. In arelated case, it was determinedthat the crisscross movementof funds had no legitimatecommercial purpose and wasdesigned to “obscure the nature,source, location, ownership and/or control of the funds.”32 Clearly,private investment funds areripe for exploitation, includingas short-term and long-terminvestment vehicles used todisguise and conceal the origin ofillicit funds.The 1MDB case, in particular,illustrates an additional point:the lack of AML programs anddisclosure requirements in theU.S. private investment industryheighten risks among advisersand companies located in theUnited States as well as amongadvisers located outside the U.S.seeking to access U.S. markets.Non-U.S. advisers are boundto view the U.S. financial sectoras an attractive avenue to hideillicit funds, given the lack of AMLcontrols and opacity of the U.S.private investment industry.Increasing the risk to the U.S.financial system is the low level ofAML enforcement activity outsideof the United States, whetherdue to limited resources, a weakregulatory climate, or a lack ofpolitical will to tackle moneylaundering. These non-U.S.deficiencies can be exploited tocreate added opacity around theidentity of non-U.S. individualsand entities seeking to exploit theU.S. financial system.For both the criminal and thecorrupt, money laundering is notjust about short-term gains. Asthe above examples from acrossthe globe illustrate, criminals andkleptocrats are, in fact, interestedin financial instruments with alonger horizon, an acceptablereturn on investment, and theability to diversify their holdingsand conceal their moneylaundering tactics. For those withthe means, the long horizon, highyield, and opacity of multi-yearinvestments like those offered byhedge funds, private equity, andventure capital firms make themattractive conduits for moneylaundering.17

UNDERSTANDINGTHE CURRENTFRAMEWORKThe U.S. anti-money laundering regime – enshrined in BankSecrecy Act (BSA) regulations – has built out a risk-based approachto AML reporting across 25 types of financial institutions includingbanks, mutual funds, credit unions, casinos, pawn shops, andothers.33 The list includes broker-dealers who, like investmentadvisers, can execute trades in securities on behalf of clients.FinCEN’s CDD rule was animportant step towardmeeting internationalstandards, but it failedto include a strongdefinition of beneficialowner, and it failed toencompass all of theentities specified in FATF’sdefinition of “financialinstitution,” such asprivate investment funds.Unlike broker-dealers, however,investment advisers are notcurrently required to maintainanti-money laundering/combatting the financing ofterrorism (AML/CFT) programsunder the BSA. Nor are severaltypes of “investment companies,”which are explicitly exemptedfrom that requirement.34 WhileFinCEN has made multipleattempts to create anti-moneylaundering obligations forinvestment advisers and certaininvestment companies, the U.S.has failed to finish the workand so remains an outlier asthe United Kingdom and othercountries with similar financialsystems in the European Unionhave applied their anti-moneylaundering requirements to theprivate investment sector.This section examines U.S. effortsat strengthening customer duediligence (CDD) requirements forfinancial institutions, previous18attempts at creating AML/CFTrequirements for investmentadvisers and investmentcompanies, and current regulatorypractice among U.S. allies.Current U.S. CustomerDue DiligenceObligations for FinancialInstitutions ExcludePrivate InvestmentCompanies andInvestment AdvisersThe BSA has been regularlyamended over the course ofits 50-year history to meetmodern challenges. The FinancialAction Task Force (FATF), theinternational standard-settingorganization for anti-moneylaundering and combatingterrorist financing, describedthe U.S. framework in its mostrecent evaluation in 2016 as “welldeveloped,” coordinated acrossgovernment agencies, and rooted

PRIVATE INVESTMENTS, PUBLIC HARMin a sophisticated understandingof money laundering and terrorfinancing risks.35Yet the same 2016 FATFevaluation highlighted a majorU.S. deficit. The deficit wasthat, in the United States, lawenforcement and other essentialparties had no way of learning theidentity of the true, “beneficial”owner of legal entities formedin the 50 U.S. states. In January2021, Congress took an importantstep towards curing that deficitby enacting the CorporateTransparency Act, which will,when implemented, requirecorporations, limited liabilitycompanies, and other similarentities to report their beneficialowners to a secure database atFinCEN.A related problem was that,although as of 2001 the BSArequired financial institutionsto establish AML programs,BSA

GFI aims to address the harms inflicted by trade misinvoicing, transnational crime, tax evasion and kleptocracy. By working with partners to increase transparency in the global financial system and promote Trade Integrity, GFI seeks to create a safer and more equitable world. Transparency International U.S. Office Transparency International is a