The Anti-Fraud Network


	News China Joins FATF China has upped its status from observer to member of the Financial Action Task Force on Anti-Money Laundering. The People’s Bank of China stated that this will “further enhance the applicability and authority of FATF's standards”. In a future edition of the Newsletter, AFN member Cedric Lam will be examining the implications of China’s membership of the FATF. Cost of Compliance Increases A KPMG survey has highlighted the increasing cost to banks of complying with anti-money laundering laws. Worldwide, the increase has been an average of 58 per cent over the last three years. North America has faced the highest increase with compliance costs having risen 71 per cent in three years. Africa and the Middle East have seen a similar rise of 70 per cent. Russia has faced a 60 per cent increase, Central and South America 59 per cent, Europe 58 per cent and Asia 37 per cent. The KPMG survey explains that the majority of these costs were for technology and the additional personnel needed to monitor transactions. Unfortunately, despite this outlay, only 93 per cent of North American banks that responded to the survey said they had a formal anti-money laundering system in place. Although a seemingly high figure, the bottom line is that seven per cent of banks are not complying with the 1970 Bank Secrecy Act, amended by the 2001 Patriot Act to stop the financing of terrorist activities through money laundering or fraud. It looks like the increase in costs will continue—world wide, they are expected to rise by another 34 per cent over the next three years. Balkan Banks Reach Agreement on Money Laundering Measures The central banks of Greece, Bulgaria, Romania, Serbia, Albania, Macedonia and Cyprus have reached an agreement that will help to fight money laundering and prevent the movement of terrorist funding. The agreement will facilitate the exchange of date and information, improve communication between the banks and pave the way for working groups to look into the prevention of money laundering and terrorist financing. The central banks of Turkey, Bosnia and Montenegro have also been invited to join. Bank of Greece Governor, Nicholas Garganas explained, “Against the background of a constantly rising number of cross-border banking institutions in Southeastern Europe, the governors discussed and agreed on a multilateral memorandum of understanding.”
	Additional Resources The AFN site includes additional articles and items of interested from our worldwide members and readers. Channel islands firm Carey Olsen has added an article examining the implications of Macdoel & others v Federal Republic of Brazil & others (2007) JCA 069. This is Jersey's first substantive Court of Appeal judgment on disclosure orders against third parties applying the Jersey approach to the legal principle which arose in the English case of Norwich Pharmacal v Customs & Excise (1974). Read the article.
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SPECIAL ALERT
SEC Adopts Anti-Fraud Rule Applicable to Hedge Fund Advisors
by Mike Piazza

On 11 July 2007, the United States Securities and Exchange Commission (SEC) held an Open Meeting and approved a new anti-fraud rule specifically targeted at regulating hedge fund advisors. The rule as adopted is little-changed from that proposed by the SEC in December 2006. Under US law, the new rule will go into effect 30 days after the final text of the provision is published in the Federal Register. Generally, after the SEC votes to approve a new rule, it takes about a week before publication occurs, so it is likely that the new regulation will become effective by late August 2007.

The new rule is promulgated under the authority of Section 206 of the 1940 Investment Advisors Act and SEC Rule 206(4). The SEC chose this course because, according to the Staff, the District of Columbia Circuit Court of Appeals indicated in its 2006 Goldstein opinion that this was an appropriate manner for the SEC to undertake hedge fund advisor regulation. Goldstein v Securities and Exchange Commission, 451 F.3d 873 (D.C. Cir. 2006). However, this is not as clear from a close reading of the decision as the SEC would suggest, and one can anticipate that the new rule may well face a legal challenge. The predecessor hedge fund advisor regulation was invalidated by the Goldstein court as arbitrary and thus improper.

As I indicated in the July edition of the AFN Newsletter, Goldstein may ultimately be viewed as a pyrrhic victory for the hedge fund industry. This is because the new anti-fraud rule as adopted is substantially broader in its scope and effect than the simple registration requirement that Goldstein invalidated. Under the new Rule 206(4)-8, the SEC now has the ability to bring enforcement actions against advisors to pooled investment funds who defraud investors or potential investors. The fraudulent activity can also include providing false account statements or issuing misleading reports to existing or prospective investors. Moreover, to find that a violation has occurred, there is no specific requirement to prove fraudulent intent, or prior knowledge of the illegality of the action, baked into the rule. While not a strict liability rule, it is conceivable that the SEC will pursue enforcement actions against hedge fund advisors for conduct that may be construed as simply negligent, as opposed to being seen as reckless or intentional conduct.

Importantly, and as pointed out by Chairman Cox at the Open Meeting on 11 July, the new rule will not apply in situations involving foreign advisors dealings with non-US investors, even if the foreign advisor is registered with the SEC. The Staff explained that this is the result of applying the SEC’s traditional test to determine regulatory jurisdiction—by analyzing where the conduct at issue took place and where the effects of that conduct occur. Here, because the conduct of the foreign advisor and the effects of its actions both occur outside the United States, the SEC has no regulatory authority.
Also significant is the fact that the new anti-fraud rule does not create a private right of action. As the Chairman and Staff confirmed at the Open Meeting, only the SEC has the authority to enforce the Rules promulgated under Section 206 of the Advisors Act.

The SEC voted unanimously to adopt the new rule, although two of the Republican commissioners, Paul Atkins and Kathleen Casey, lamented the broad-brush approach of the new rule and stated that they both would have preferred a more targeted regulation. The two Democratic commissioners, Annette Nazareth and Roel Campos, were predictably pleased with the broad reach of the new rule. Commissioner Nazareth noted that, as adopted, the new rule will remove any questions about the SEC’s authority to oversee potential fraudulent activity in pooled investments including hedge funds. Commissioner Campos commented that he felt that the timing for the rule “could not be more appropriate” (indeed, on the same day that the SEC adopted the rule, Congress was holding two separate hearings on private equity and hedge funds).

SEC Chairman and Republican Christopher Cox summed up the new anti-fraud rule as providing “an important tool to help police this market.” That tool is now in the hands of an already burdened Enforcement Staff. Given the politically charged atmosphere surrounding the impact of hedge funds on US industry and capital markets, we can expect the SEC to move quickly to test this important new enforcement tool.

Mike Piazza is a Partner in Dorsey & Whitney’s Trial, Regulatory and Technology practice group. He is also a member of the firm’s Securities and Financial Institutions Litigation practice group. Prior to joining Dorsey, he was the Regional Trial Counsel for the Los Angeles office of the United States Securities and Exchange Commission. Mike’s practice focuses on securities, intellectual property, and complex commercial litigation.

Contact Details:
Tel: +1 949 932 3614
Email: piazza.mike@dorsey.com