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Oracle Money Laundering Primer

Oracle Money Laundering Primer

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Published by Lawrence A Hunter
Oracle Financial Services Paper on Hedge Funds and Money Laundering
Oracle Financial Services Paper on Hedge Funds and Money Laundering

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Published by: Lawrence A Hunter on Oct 24, 2012
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10/24/2012

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 An Oracle White Paper October 2009
Hedge Funds and Anti-Money Laundering
 
Hedge Funds and Anti-Money Laundering1
Executive Overview
 A combination of secrecy, weak regulation, and rapid proliferation make hedge funds a veryattractive vehicle for money launderers. This white paper describes how hedge funds fit intothe overall lifecycle of money laundering; the history of money laundering regulations and howthis is shaping the face of the hedge funds industry today; and new regulations such as theUSA PATRIOT Act and how hedge funds are affected by these developments. OracleFinancial Services employs several advanced detection algorithms that are well-suited for finding money laundering in the layering and integration stages, including Link analysis,sequence matching, and outlier detection.
Introduction
The financial services industry is striving to close all loopholes potentially available tolaunderers. One investment vehicle that continues to receive close scrutiny is the Hedge Fund.These funds, or “Private Investment Companies,” operate under certain exemptions fromregistration under the Securities Act of 1933 and the Investment Company Act of 1940 as wellas from the U.S. Securities Exchange Act of 1934 and U.S. Investment Advisors Act of 1940.To maintain these exemptions, hedge funds must meet specific guidelines regarding their structure, clientele, and operation. As “non-public offerings,” these funds are exempted fromcompliance with the registration and prospectus delivery requirements. They are alsoprohibited from advertising, so fund managers must rely on word of mouth or existingrelationships to attract investors. Most funds are established as private investmentpartnerships, strict limits regarding the number of investors are imposed on each fund, andeach investor must meet minimum income and net worth standards since funds are open onlyto “qualified purchasers” or “accredited investors.” Even though fund managers or administrators often know their customers through preexisting relationships, they must gather background information on potential investors to determine whether the investors meet
 
Hedge Funds and Anti-Money Laundering2
minimum requirements. Nevertheless, investors often use intermediaries who do not divulgetheir identities to the fund managers.Offshore funds, or funds located outside the United States, are created for investments by non-U.S. investors and certain U.S. tax exempt investors. These funds are frequently managed byU.S. fund managers, execute securities transactions on U.S. exchanges, and apply strategiessimilar to U.S.-based funds.However, all administrative and audit activities must be conducted offshore for the fund and itsinvestors to avoid certain tax and Internal Revenue Service (IRS) reporting obligations. For example, domestic hedge funds have to file returns with the IRS that identifies all investorswhile offshore hedge funds are not subject to this requirement. While it appears that domestichedge funds will be subject to the Uniting and Strengthening America by Providing AppropriateTools Required to Intercept and Obstruct Terrorism (USA PATRIOT) Act, offshore funds aresubject to the securities laws and regulations imposed by the jurisdiction in which they aredomiciled. Many of these jurisdictions have relatively lax anti-money laundering standards,although they are urged to adopt international anti-money laundering policies. Where suchpolicies are lacking, it is difficult to ensure that sufficient information about the client or client’ssource of wealth is obtained.Funds are set up as a limited partnership (LP) with the fund manager acting as the generalpartner and organized as a limited liability corporation (LLC), a LP, or subchapter S corporation(S Corp). The investors are brought in as limited partners whose liability is equivalent only tothe size of their investment. Investor funds are pooled by the manager and returns are paid outin proportional shares. Therefore, it is very difficult to track the source of funds used by thehedge fund. Funds of funds further clouds these issues and increases the opacity inherent insuch investment vehicles.Due to their relative profitability in the current investment environment, hedge funds areexperiencing an increase in popularity, particularly for “nontraditional” investors such ascorporations, pension funds, private banking clients, and insurance companies. Money

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