Investment into digital assets facilitates anonymity and has the potential to be used by investors to mask various illegal transactions, including money laundering, funding of terrorist activities, and numerous regulatory violations. In addition to the AML procedures that token issuers and various intermediaries must perform, hedge funds must carefully comply with AML regulations when accepting crypto tokens from investors in lieu of fiat capital as an in-kind contribution.
- AML Compliance in the United States
US fund managers must comply with the USA Patriot Act of 2001 and regulations promulgated by the US Treasury Department’s Office of Foreign Assets Control (OFAC), as well as proposed regulations by the Treasury’s Financial Crimes Enforcement Network (FinCEN).
A hedge fund’s AML obligations include identification of the source of capital and beneficial owner of the contributed assets. Investor identification procedures face additional complexities when investment assets are not made using fiat currency—which can be traced through an investor’s financial institution—but via in-kind contribution of an existing asset, such as stocks and bonds. AML compliance procedures for in-kind contributions of tokens can be particularly challenging, given the inability (in most cases) to directly verify transactional ownership details through the token’s issuer.
Fund managers typically delegate certain aspects of their KYC compliance to third parties, including fund administrators and, where applicable, placement agents, but maintain a degree of liability even when properly relying on third parties. Fund administrators that regularly service digital asset funds crypto assets have made significant strides in due diligence techniques to provide needed AML compliance, but generally are limited in the type of tokens held and the exchanges through which the tokens have passed.
For further discussion on potential liability as a hedge fund manager, please see our blog post, “Potential Liability as a Startup Hedge Fund Manager.”