Over the past four decades, private equity has become a powerful, and malignant, force in our daily lives. In our May+June 2022 issue, Mother Jones investigates the vulture capitalists chewing up and spitting out American businesses, the politicians enabling them, and the everyday people fighting back. Find the full package here.
After Russia invaded Ukraine, Western nations hit back with punishing sanctions against not just Russian leaders, banks, and businesses, but also the fabulously wealthy oligarchs most closely associated with Vladimir Putin. Their yachts have been seized. Their air travel has been restricted. And they’ve been cut off from the American Express Black Cards and international money transfers that allowed them to live lavishly in London, Miami, and Spain.
But it turns out that yachts and Knightsbridge shopping sprees aren’t where the real money is buried. Oligarchs have stashed huge sums throughout the global financial system, and you cannot sanction money you cannot find. Thanks to gaping regulatory loopholes, many Wall Street titans—specifically private equity firms and hedge funds—have little obligation to investigate where the enormous piles of cash they are investing actually came from. The billions they collect from clients and then use to buy real estate, factories, and farmland are largely exempt from the anti-money-laundering rules other US-based financial institutions have to follow.
Under the US government’s strict “know your customer” rules, an oligarch can’t so much as open a checking account at Bank of America without the bank identifying the source of the funds and alerting authorities. Private equity fund managers, however, aren’t subject to the same requirements. Technically, they still have to abide by financial sanctions, but they aren’t obligated to do much to determine who they are actually doing business with. If you can avoid learning that your client is a sanctioned individual, then you can’t obey the sanctions. That’s how oligarchs have managed to deposit millions, and possibly billions, into private equity funds with no questions asked about who the money really came from and how they got it in the first place.
One of the most prominent examples of how this loophole could undermine US efforts to sanction Putin’s allies is the case of Roman Abramovich. Abramovich earned billions in the early years after the collapse of the Soviet Union, gaining control of huge oil and aluminum resources and parlaying the money into western investments, including ownership of the iconic London soccer team Chelsea. While Abramovich has denied being close to Putin, both the European Union and the United Kingdom have placed sanctions on him. The US has, allegedly, considered sanctioning him, but has reportedly held off at the request of Ukrainian President Volodymyr Zelenskyy, who argued Abramovich could be helpful in negotiations with Putin.
If Abramovich is sanctioned, however, the exemptions and loopholes enjoyed by private equity firms and hedge funds would make it much more difficult for the US government to clamp down on his assets. According to the New York Times, for two decades Abramovich has invested in American private equity and hedge funds with the aid of shell corporations that shuttled money through anonymous tax shelters and an investment adviser who helped place money in big-name funds like BlackRock, Carlyle, and D.E. Shaw. It’s not clear how much money has been invested overall, but the Times reported finding evidence of at least 100 transactions.
“The status quo is plainly untenable,” Sens. Sheldon Whitehouse (D-R.I.) and Elizabeth Warren (D-Mass.) wrote in a recent letter to Treasury Secretary Janet Yellen and SEC Chairman Gary Gensler. “If the United States were to sanction Abramovich…neither the U.S. government nor the entities handling his secretive investments would have a full understanding of where Abramovich has invested his billions in the American financial system, let alone the ability to effectively enforce sanctions against him.”
In 2001, following the 9/11 attacks, Congress passed a host of new anti-money-laundering laws and required compliance from all financial institutions that are covered by the 1970 Bank Secrecy Act. Knowing who your customers really are is a key part of any anti-money-laundering effort. But in 2002, in response to industry pleas, the Treasury Department granted “temporary exemptions” to several categories of financial institutions, including investment advisers. The upshot was that banks, mutual funds, credit unions, brokers, and even casinos would have to follow the new law, but investment advisers—which include private equity funds and hedge funds—would be exempt. That “temporary” exemption has lasted for two decades and remains in place.
It’s enough of a problem that in 2019, the FBI produced a confidential memo (that was later leaked) warning that bad actors are exploiting the system to hide their wealth.
“The FBI assesses threat actors likely use the private placement of funds, including investments offered by hedge funds and private equity firms, to launder money, circumventing traditional anti-money laundering programs. This assessment is made with high confidence,” the memo stated.
“The FBI assesses, in the long term, criminally complicit investment fund managers likely will expand their money laundering operations as private placement opportunities increase, resulting in continued infiltration of the licit global financial system,” the memo continued. “If greater regulatory scrutiny compelled private investment funds to identify and disclose to financial institutions the underlying beneficial owners of investments, this would reduce the appeal of these investment firms to threat actors.”
While the Treasury Department’s Financial Crimes Enforcement Network—known as FinCEN—did propose new rules in 2015, the industry protested and the effort petered out. In December, the issue was revived when the Biden administration released a lengthy report (“Strategy on Countering Corruption”) that recommended “prescribing minimum reporting standards for investment advisors and other types of equity funds.” Last month, Whitehouse and Warren wrote their letter urging Treasury and the SEC to take action.
“Closing the private investment [Anti-Money Laundering/Countering the Finance of Terrorism] loophole will help the U.S. government track down the hidden wealth of sanctioned Russian elites and better combat money laundering, terrorism, the proliferation of weapons of mass destruction, and other criminal activity,” they wrote. “Further delay is not an option.”
Even the exact size of the problem is hard to estimate because investments in private equity are so loosely monitored. While who is investing isn’t closely scrutinized, the overall total invested in the industry is monitored, and it’s enormous—the US private investment sector is potentially as big as $11 trillion, and there are as many as 13,000 investment advisers who are exempted from the anti-money-laundering provisions that most other US-based financial institutions follow.
Many private equity firms and hedge funds say they do routinely try to determine who their clients really are. After all, the things that tend to land a person on the list of sanctioned individuals—financial fraud, kleptocratic theft—and the reasons a person might be seeking to hide their money—tax evasion, efforts by governments to seize assets—don’t make for a very good client. And, the industry has pointed out, many private-equity funds don’t allow clients to move money in and out quickly—money is invested and stays invested for years. If you’re looking to launder money in a hurry, that’s not helpful.
In a 2015 comment letter objecting to FinCEN’s proposed expansion of anti-money-laundering requirements to include private equity and hedge funds, the Private Equity Growth Capital Council, the trade association that represents the industry in Washington, noted that earlier FinCEN evaluations had determined that private equity was a poor vehicle for money laundering. (The group has since changed its name to the American Investment Council.)
“The PEGCC knows of no facts or circumstances that would change FinCEN’s prior analysis,” the letter stated.
The trade group also complained that any attempt to institute new anti-money-laundering rules quickly would be burdensome and that complying with the 2015 proposed rules would take far more time when signing up new clients than FinCEN had estimated.
The 2019 FBI memo on the matter rejected the idea that private equity wasn’t a good vehicle for money laundering. While that may be true of some funds that have more stringent requirements for investors, it’s not the case for every fund, the FBI analysts determined. “The FBI discounted this alternative because the proliferation of private investment funds has made the industry less rigid as to the structure of the investment in an effort to attract more capital,” the memo concluded.
The explosive growth of private equity, the FBI added, creates “ever-increasing opportunities for threat actors to co-opt investment funds without being overly scrutinized.” The bureau cited an example that is particularly relevant to the current crises in Europe: a 2017 incident in which “a New York-based private equity firm received more than $100 million in wire transfers from an identified Russia-based company allegedly associated with Russian organized crime.”