Mutual fund complexes are beginning to realize that implementing anti-money laundering programs requires more than just flag-waving. In fact, the rules are complicated, expensive and, because they are being set in stages, confusing.

The USA Patriot Act, passed in October 2001, has forced the entire financial community to harvest all its resources to sniff out any suspicious activity that might indicate money is being funneled to terrorist operatives. As a result, fund houses are scrambling to upgrade their compliance teams to prevent being put at a disadvantage once implementation takes place.

Although the compliance officer and anti-money laundering portions have been effective since last April, the Treasury has not yet clarified other provisions. The know-your-customer and SAR, or suspicious activity reporting, portions are still pending. The Treasury Department is expected to finalize the know-your-customer rule some time in the next couple of weeks to a month. The SAR rule will probably come later in the summer.

Many investment companies have already had some procedures in place for due diligence or "know-your-customer" requirements, but given the stark reality of the post-Sept. 11 world, it is a whole new ballgame. "The Patriot Act really ratchet[s] up the bar for the standard and quality of information that mutual funds have to provide," said Sharie Brown, a partner at Washington-based law firm Foley & Lardner. Implementing it is not as easy as fund companies had imagined, Brown said.

Brown, who also represents the National Association of Securities Dealers, believes that some of the larger fund houses have an advantage because they have more rigorous due diligence to ensure that prospective customers entering into their funds are appropriate. She noted that the biggest firms are already using computerized software to cross-reference clients with the Treasury's Office of Foreign Assets Control list, a who's who of suspected terrorists and drug traffickers. Still, a vast majority of companies do not have those capabilities, and they are finding these requirements to be burdensome, particularly small fund complexes.

Compounding the lack of resources is the fact that fund companies are being stretched thin in terms of the amount of time devoted to compliance and the number of staffers working toward that end. And not only is it more time-consuming and costly, Brown said, but also some members of upper management don't fully appreciate the burden now placed on compliance personnel. If a company doesn't have a large compliance staff and people are assuming additional responsibilities, it can be an extremely onerous task, she noted.

The Investment Company Institute has repeatedly stated that it strongly supports effective rules to combat money-laundering activity.

But the ICI has raised questions about the implementation of the law rather than its ideology, particularly with respect to the suspicious activity reports. Another complaint is that mutual funds do not have the same information available to them as other investment companies, which have more direct contact with customers. "We'd like to see more express recognition in the final [SAR] rule that mutual funds don't always have the same types of information at their disposal as, say, a broker/dealer," said Bob Grohowski, associate counsel with the ICI. He said that a retail broker/dealer has suitability type of information to make those determinations.

There are also concerns about the potential for duplicity in the reporting process. If a broker/dealer and a fund both have obligations concerning a particular transaction and the broker/dealer files an SAR, the ICI believes that the fund should be able to rely on that filing, provided it contains all relevant information. The merits of these complaints remain to be seen, but it is unlikely the Treasury will issue exemptions to mutual funds on those requirements in light of their level of risk and global exposure.

"The political climate is such that it's going to be difficult for a particular sector to truly be exempted out if there is even a medium risk of money-laundering vulnerability for their particular product," Brown said.

Despite the industry's grievances, Grohowski said, it is well positioned to meet the challenges set forth by regulators. "I think, by and large, mutual funds are ahead of the game," he said. Indeed, a lot of funds have been gearing up with their customer identification programs and SAR reporting programs ahead of the rulemaking, essentially guessing what will be in the final rules. The biggest frustration has been that the rules aren't coming out fast enough, he said. Initially, the industry was expecting the rules to be finalized back in October.

Ultimately, Treasury's goal is to eradicate terrorist financing. While critics will complain that it is difficult to comply, the Patriot Act affects all industries to some capacity. It is not singling out a few industries arbitrarily. "What they're trying to do is identify, on a priority basis, where the highest money-laundering risk is and work their way through to those with medium and low risk," Brown said. "It's not an irrational approach," she added.

Tamar Frankel, a law professor at Boston University and an expert on mutual fund regulation, thinks fund companies should be eager for regulation. "All [fund complexes] are going to spend some money making sure this money does not flow to terrorists. If you want to fight terrorism, you have to close the spigot of money. And what that means is imposing on the channels of the money some extra cost."

It is important to understand that the Patriot Act is not going to wreak havoc on the mutual fund industry. There is no doubt that it will require additional expenses, longer hours and a glut of paperwork. But the sooner these programs can be put in place, the better. That is best illustrated by the $124 million in financial assets belonging to terrorist groups, including al Qaeda, that have been frozen since the Patriot Act's inception.

Copyright 2003 Thomson Media Inc. All Rights Reserved.,

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