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HFs Money-Laundering Risk Measured

Date: Tuesday, November 4, 2008
Author: Peter Whoriskey, Washington Post

Seven years ago the Patriot Act required every financial institution to establish a program to combat money-laundering.

But the roughly $2 trillion hedge-fund industry today remains free of any such government restrictions, and this week the Treasury Department formally withdrew its once proposed rules.

"Hedge funds do represent some risk because their operations and the identity of investors are generally not very transparent," said Steve Hudak, a spokesman for the Financial Crimes Enforcement Network of the Treasury Department. But "that risk needs to be studied and carefully assessed prior to implementing any anti-money-laundering regulations."

Hedge funds, which are largely unregulated investment pools whose investors are often wealthy individuals or sophisticated financial firms, have drawn increased scrutiny during the financial crisis.

Hedge funds need regulation "to make sure the incentives are right for them and others to do the right thing,'' Rep. Henry A. Waxman (D-Calif.), chairman of a House committee investigating the global credit crisis, said last week. "Certainly we need more transparency.''

There are several reasons the Treasury has been delayed in requiring hedge funds to adopt money-laundering measures.

For one thing, because the industry is unregulated there are no government examiners to enforce the measures.

For another, hedge funds are indirectly regulated because they do business through bank and other financial firms that are required to monitor transactions for possible money-laundering.

"We do have a line of sight on these transactions," Hudak said.

One key reason for the delay, moreover, is that the risk that a terrorist group might use a hedge fund to launder money is deemed relatively small.

For many terrorists, hedge funds may be too risky or require too large an initial investment to be useful.

"It's less likely that you'll see terrorists putting money in hedge funds," said Dennis M. Lormel, former chief of the financial crimes section at the FBI, now a consultant at IPSA International, a financial investigative consulting firm.

For example, a typical hedge fund requires an individual investor to have a net worth of $5 million or more, according to Richard Baker, president of the Managed Funds Association, which represents the industry's interests in Washington.

They also place strict limits on how frequently investments can be withdrawn.

Terrorists need to have access to money on an "as-needed basis," Lormel said.

Hedge funds are also deemed to be a fairly risky investment -- too risky to be a reliable means of laundering money.

For similar reasons the Treasury Department last year exempted casinos from a requirement that they report currency transactions on slot machine jackpots and video lottery terminals.

The Treasury "accepts that customers who win more than $10,000 in jackpots will have won those funds because of the workings of the random number generator and . . . are not likely to form part of a scheme to launder funds through casinos," they announced at the time.

The issue has not stirred much passion in Congress, either.

Baker, of the Managed Funds Association, says the group does not oppose requiring hedge funds to adopt anti-money-laundering programs and noted that many already do so, voluntarily.

Rep. Barney Frank (D-Mass.), chairman of the House Financial Services committee, said that while he has not studied the rules that were withdrawn, many financial institutions have been overburdened by anti-money-laundering regulations.

"They are requiring too much routine reporting," Frank said. "We are requiring law enforcement to find needles while we are building these haystacks."