Time for Investment Advisors to Invest in AML Technology

After two decades of failed attempts to bring Investment Advisors (IAs) under the obligations of the U.S. Bank Secrecy Act (BSA), which requires financial institutions to establish robust anti-money laundering and counter-terrorist Finance (AML/CTF) programs, the United States Treasury recently finalized IA rules for AML Programs released September 4, 2024.

The rule expands the BSA definition of 'financial institution' (FIs) to include certain registered investment advisors (RIAs) and exempt reporting advisors (ERAs). Those RIAs and ERAs subject to the new rules (Covered IAs) will have until January 1, 2026 to come into compliance with the requirements. The Securities and Exchange Commission (SEC) has been granted oversight for the RIA/ERA AML programs implemented under the rules.

Anti-Money Laundering/Countering the Financing of Terrorism Program and Suspicious Activity Report Filing Requirements for Registered Investment Advisers and Exempt Reporting Advisers:

How technology help Covered IAs achieve regulator-ready compliance

The primary area of investment in core AML technology most likely to be tested by the SEC for sufficiency, and the single biggest area of risk for incurring regulatory actions, is the detection and reporting of potentially suspicious activity. Recent history shows that investment-related FIs, such as broker-dealers, have been subject to significant fines and regulatory scrutiny based on a determination of activity that ‘should have detected and reported’ as ‘potentially suspicious’.

While automated transaction monitoring is not required under the new rule, finding risk manually without the advantages of entity resolution (connecting relevant to customers, counterparties, intermediaries) and network analytics (advanced detection of complex risks) is unlikely to be deemed ‘reasonable’ for large, Covered IAs.

What is suspicious?

Upon adoption of the rules in January 2026, Covered IAs are required to report suspicious transactions conducted or attempted by, at, or through an investment adviser. That’s a broad remit, yet one that firms must prove they have an effective program in place to meet.

Specifically in the rule, 31 CFR 1032.320 requires, “the reporting of any suspicious activity transaction that involves or aggregates at least $5,000 in funds or other assets. required to report a transaction if it knows, suspects, or has reason to suspect that the transaction (or a pattern of transactions of which the transaction is a part):

• involves funds derived from illegal activity or is intended or conducted to hide or disguise funds or assets derived from illegal activity as a part of a plan to violate or evade any Federal law or regulation or to avoid any transaction reporting requirement under Federal law or regulation;

• is designed, whether through structuring or other means, to evade the requirements of the BSA;

• has no business or apparent lawful purpose, and the investment adviser knows of no reasonable explanation for the transaction after examining the available facts; or

• involves the use of the investment adviser to facilitate criminal activity.

Three key phrases stand out in this rule that should become guiding mantras of your AML Compliance detection program:

1. Monitor customer activity conducted or attempted “by, at or through” your institution

2. Identify activity intended to hide or disguise funds or assets, violate or evade laws/regulations or facilitate criminal activity

3. Detect activity with no apparent lawful purpose or not expected for the customer

How Advanced Technologies can help

Due to the complexity, volume and speed of transactions in international Global Markets, advanced technologies are essential to be able to detect potential indicators of AML/CTF risks of financial crime, also known as “red flags”. Typically, no one red flag present in activity is sufficient to conclude activity is suspicious. Yet, traditional transaction monitoring systems have taken a simplistic approach using rules-based identification and “one-size fits all” thresholds, regardless of product or client type. This approach has proven grossly ineffective for Markets and such tools are being replaced by new, innovative technologies that leverage advanced approaches to risk detection, finding multiple red-flags and patterns across networks, rather than looking at single transaction events in isolation. Context matters.

When selecting a monitoring system to cover AML risks, Covered IAs will discover that innovation is driving the market and enabling better results through advanced technologies. Rules-based detection was yesterday's approach. Today, firms are leveraging entity resolution and advanced network analytics deployed via Contextual Monitoring to identify risks previously undetected through traditional monitoring. This results in better risk detection and fewer false positive alerts, increasing program efficiency and effectiveness.

What is Contextual Monitoring?

Contextual monitoring finds risk in Capital Markets by leveraging both internal and external data to create a holistic view of a client’s direct and indirect relationships and transactional activity patterns across complex networks. Advanced analytics are used to traverse complex networks and detect multiple red-flags present at once, which collectively help differentiate risk among clients and adds explainability to risk patterns. Additionally, the identification of risk mitigating factors can offset explainable risks, leading to fewer false positives and more meaningful alert generation. Bad actors are sophisticated – your detection analytic tools need to be, too.

Contextual Monitoring works by:

• Combining internal and external data to create a holistic view of the client

• Identifying direct and indirect connections across datasets to understand the 360’ view of each client’s network of transactional and non-transactional relationships

• applying sophisticated, multi-level analytics to identify and score potentially suspicious activity and/or relationships.

Quantexa is actively supporting AML programs at sophisticated financial institutions globally. We help organizations mitigate risk to the organization, meet evolving regulatory expectations, achieve improved operational efficiencies and contribute to the protection and integrity of the global financial markets.

Learn more about Quantexa’s comprehensive AML Solutions.

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