This blog post is written as an update to a Note previously published in the Michigan Business and Entrepreneurial Law Review on anti-money laundering (“AML”) regulation in crowdfunding. ((Zachary Robock, Note, The Risk of Money Laundering Through Crowdfunding: A Funding Portal’s Guide to Compliance and Crime Fighting, 4 Mich. Bus. & Entrepreneurial L. Rev. 113 (2014), available at http://repository.law.umich.edu/mbelr/vol4/iss1/4 [hereinafter “Original Note”].)) The Original Note analyzed proposed crowdfunding rules published on November 5, 2013 by the Securities and Exchange Commission (SEC). ((SEC Crowdfunding Rule, 78 Fed. Reg. 66428, 66461–65 (proposed Nov. 5, 2013).)) This update is based on the final rule, which became final on November 16, 2015, and will go into effect May 16, 2016. ((SEC Crowdfunding Rule, 80 Fed. Reg. 71388, 71412-13 (Nov. 16, 2015) [hereinafter, “Final Rule”].)) The practical differences between the proposed rules and the final rule from an AML standpoint are not major shifts, but still worthy of review. These differences include: (i) some of the requirements on issuers were revised in the final rules – in particular, the financial disclosure requirements; and (ii) regulatory authority for AML oversight is expected to shift from the SEC to the Financial Crimes Enforcement Network (FinCEN), a division of the U.S. Department of Treasury. Neither change will significantly alter the AML landscape outlined in the proposed rules.
First, the financial disclosure requirements for a crowdfunding offering have changed, which affects one of the red flag recommendations in the original Note. ((Original Note, supra note 1, at 124-26.)) Under the final rule, no issuers will be required to disclose tax returns, whereas the proposed rules required disclosure of tax returns for issuers that did not provide independently reviewed financials. Instead, under the final rule, issuers offering $100,000 or less over a twelve-month period must disclose: (a) the amount of total income, taxable income, and total tax as reflected on their tax returns, and the principal executive officer must certify the accuracy of these figures; and (b) financial statements certified by the principal executive officer to be true and complete in all material respects. ((Final Rule, supra note 3, at 71412-13.)) However, if audited financial statements or financial statements reviewed by an independent accountant are available, then those must be disclosed. ((Final Rule, supra note 3, at 71412-13; 17 C.F.R. § 227.201(t)(1).)) For issuers offering more than $100,000 but not more than $500,000 over a twelve-month period, financial statements reviewed by an independent public accountant must be disclosed; if audited financials are available, then those must be disclosed. ((Final Rule, supra note 3, at 71412-13; 17 C.F.R. § 227.201(t)(2).)) For first-time crowdfunding issuers offering more than $500,000 but not more than $1 million over a twelve-month period, the same rules apply – financial statements reviewed by an independent public accountant must be disclosed, and audited financials must be disclosed if available. ((Final Rule, supra note 3, at 71412-13; 17 C.F.R. § 227.201(t)(3).)) For veteran crowdfunding issuers offering more than $500,000 in a twelve-month period, audited financial statements are required. ((Final Rule, supra note 3, at 71412-13; 17 C.F.R. § 227.201(t)(3).))
These changes to the financial disclosure requirements render the Fourth Question in Figure 2 of the Original Note moot since no issuers will be required to provide tax returns. ((Original Note, supra note 1, at 124-25 (“The fourth question asks whether the issuer’s target offering is $100,000 or less and the issuer is unable to provide tax returns for the prior year. Such offerings present a heightened risk because the financial statements of the company have not undergone external review; they are simply “certified” by an executive of the issuer, and there are no tax returns to corroborate this information.”).)) An alternative consideration may be that any crowdfunding offering under $100,000 that lacks an independent review of its financials should undergo additional AML review. This need not be the full-fledged enhanced review conducted when, for example, negative news is identified, but could be a middle-ground “cautionary review” that reviews the issuer’s online presence and runs background checks on a sampling of investors.
Amounts well below $100,000 can enable or disguise serious criminal or terrorist offenses. The SEC’s thresholds for financial disclosure requirements appear to be based on the cost of an independent review relative to the amount being raised; they do not appear to reflect an AML-risk analysis. ((See Crowdfunding, 78 Fed. Reg. 66428, 66444-50 (discussing considerations for financial disclosures under the proposed rules); Final Rule, supra note 3 at 71412-13.)) In other words, the lack of an SEC requirement for review by an independent accountant under $100,000 should not be read as a dismissal of AML risks for amounts below that threshold. The 2002 bombing of a Bali nightclub is estimated to have cost about $50,000, while the 2004 Madrid train bombing cost approximately $10,000-$15,000, and the 2005 attacks on London’s mass transit system cost about $2,000. ((Council on Foreign Rel., Tracking Down Terrorist Financing (Apr. 4, 2006), http://www.cfr.org/terrorist-financing/tracking-down-terrorist-financing/p10356.)) Consider also that the Currency Transaction Reporting threshold is only $10,000. ((31 C.F.R. § 1010.100(xx).))
Second, regulatory responsibility for AML oversight and compliance with the Bank Secrecy Act (BSA) has shifted from the SEC to FinCEN. ((The term “Bank Secrecy Act” refers to a legislative framework that requires United States financial institutions to assist law enforcement agencies in the detection and prevention of money laundering. It encompasses inter alia the Currency and Foreign Transactions Reporting Act of 1970, the PATRIOT Act, and regulations promulgated under 31 C.F.R. Chapter X. See FinCEN’s Mandate from Congress, Fin. Crimes Enforcement Network, http://www.fincen.gov/statutes_regs/bsa/ (last visited Nov. 30, 2015).)) In its final rule, the SEC declined to adopt a provision in the proposed rules that would have required funding portals to comply with the BSA; however, the SEC specifically noted that FinCEN is in the process of amending its rules to include funding portals in its definition of a broker-dealer. ((Final Rule, supra note 3, at 71471-72 (declining to adopt Proposed Rule 403(b) ).)) The new FinCEN rules are expected to “require funding portals to implement policies and procedures reasonably designed to achieve compliance with all of the Bank Secrecy Act requirements that are currently applicable to brokers or dealers in securities.” ((See Final Rule, supra note 3, at 71471 n.1098; Office of Mgmt. & Budget, Exec. Office of the President, Amendments of the Definition of Broker or Dealer in Securities, RIN 1506-AB29, http://www’reginfo.gov/public/do/eAgendaViewRule?pubId=201504&RIN=1506-AB29.))
There is little practical effect to this shift. Funding portals would have been required to comply with the same standard as the FinCEN rules under the SEC proposed rules. Moreover, funding portals would have needed to register with both the SEC and FinCEN under either the proposed rules or the final rule – registration with the SEC is required in order to operate as a funding portal; ((Final Rule, supra note 3, at 71454-58; 17 CFR 227.400.)) and registration with FinCEN is required in order to file Suspicious Activity Reports. ((See, e.g., FinCEN, BSA E-Filing System, http://bsaefiling.fincen.treas.gov/main.html (last visited Nov. 30, 2015).)) If anything, the SEC’s deference to FinCEN on AML will probably streamline oversight by clearly empowering only one federal entity with AML oversight responsibility.
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