The United States is the single largest recipient of foreign investment worldwide. This openness reflects the country’s innovative industries, deep capital markets, and ease of doing business – and it also contributes to making them possible. At the same time, a hands-off reporting regime makes it difficult for law enforcement and other government agencies to determine whose money is behind investment flows or where they should focus their investigative resources. While most foreign investment is benign, the current framework presents inviting loopholes through which adversaries can gain non-transparent access to U.S. businesses, technology, and data.
The method of choice for the sophisticated actor to make a targeted investment in the United States – as opposed to taking a passive stake in a publicly traded company – is a private investment fund.1As investment vehicles, they are ideal for gaining access to the most prestigious, highly sought-after opportunities, and they allow investors to be selective in a way that more plain vanilla strategies like index funds do not. Private funds have only limited obligations to disclose their investors or their investments. And unlike banks, broker-dealers, and mutual funds, they have no legal obligation to detect suspicious activity by their clients. This lack of transparency is troubling in any case, but especially in the context of malign influence operations by Russia and other actors. To protect ourselves, we need more transparency into and enhanced vigilance over this $12.5 trillion pool of capital,2in the form of disclosure requirements and anti-money laundering (AML) obligations.
A number of large-scale Russian holdings in the U.S. via private investment funds have already made the press, and many more likely remain unreported. The sanctioned Russian businessman Viktor Vekselberg invested in the U.S. through Columbus Nova, a private investment firm. Vekselberg’s company, Renova, was Columbus Nova’s largest client. LetterOne, the international investment group co-founded by the billionaire owners of Russia’s Alfa Group, maintains a U.S. office and over $2 billion of investments in the United States.
Altpoint Capital, the private equity firm of Russian billionaire Vladimir Potanin – who made his fortune in metals and mining– made the news recently because in 2015 it bought a company that has the contract to store Maryland’s statewide list of eligible voters on its servers. Governor Larry Hogan has stated that Maryland was unaware of Potanin’s ownership until informed by the FBI. The contract still appears to be in effect. The same company has also won data center work for the Department of Defense and the Department of Labor. Another data center company in which Altpoint has invested received an Energy Department contract last year.
The concerns posed by opaque private investment funds extend to allegations of espionage, as described by Zachary Dorfman in Politico Magazine in July. “Because of increasing Russian and Chinese aggressiveness, and the local concentration of world-leading science and technology firms, there’s a full-on epidemic of espionage on the West Coast right now,” Dorfman wrote. “And even more worrisome, many of its targets are unprepared to deal with the growing threat.”
Dorfman’s article cites as an example Rusnano USA, the U.S. affiliate of Rusnano, a Russian state-owned entity focused on nanotechnology. Anonymous former U.S. intelligence officials quoted in the story say Rusnano USA has been used both to facilitate “the acquisition of technology” and “as an intelligence platform, from which [Russia] launched operations.” Rusnano and Rusnano USA have made a broad array of investments in the United States, often in biotech or semiconductors. According to a Russian state-owned media outlet, Rusnano’s U.S. holdings topped $1 billion in 2013.
The vulnerabilities presented by private investment funds are not limited to risk from Russia, China, or geopolitical adversaries. These vehicles have featured prominently in three of the largest public corruption cases in recent years. The Justice Department’s civil forfeiture complaint seeking to recover assets allegedly stolen from Malaysia’s state-owned development company, known as 1Malaysia Development Berhad or 1MDB, claims that hundreds of millions of dollars were layered through private investment funds. According to the complaint, the proceeds of a 1MDB bond offering were “invested” in Curacao-based private investment funds, which immediately transferred the same amount of money to shell companies controlled by the alleged perpetrator of the scheme. A similar technique may have been used in the alleged theft of hundreds of millions of dollars from Venezuela’s state oil company, with the proceeds layered through a Malta-based investment fund, according to a recently filed Justice Department criminal complaint. In the world of private equity, the Angolan government has sued a Swiss-based asset manager in the UK, claiming the Swiss firm (run by a friend and former business partner of the former Angolan president’s son) stole money from the country’s sovereign wealth fund via its Mauritius-based private equity funds. The claims have led to the opening of a criminal money laundering investigation in Switzerland. To be clear, the asset managers involved in the Malaysia, Venezuela, and Angola cases are not U.S.-based, but lax U.S. rules create the risk of similar malfeasance.
There is no evidence that any of the Russia-linked private investments funds described above, or their managers, have engaged in nefarious behavior in the United States. However, their extensive and wide-ranging holdings are often opaque and generally not subject to meaningful reporting requirements, such that the full universe of their positions is unknown. In fact, it is entirely possible that the Russian government and Russian oligarchs hold many billions more in undeclared venture capital, private equity, and hedge fund investments in the United States.
Mind the Gaps
Current rules prevent the U.S. government from understanding the full scope of foreign actors’ private investment fund holdings and assessing the risk that some of them could potentially be used as pathways for malign influence or other illicit activity.
Under the current framework, there are three main gaps related to private investment funds:3
- Fund managers are not required to report or maintain records of the identities of the beneficial owners of the funds they manage. Fund managers are only required to report to the Securities and Exchange Commission (SEC) the percentage of investors who are foreign, without disclosing their names or nationalities.
- Fund managers are not required to disclose their investments in the United States. SEC rules generally mandate that fund managers disclose only positions in publicly traded stock.4 Recently passed reforms to the Committee on Foreign Investment in the United States (CFIUS), which reviews foreign acquisitions for national security risk, will improve the U.S. government’s ability to block high-risk transactions that were previously outside the Committee’s purview, especially transactions in which foreign actors gain influence but not control over a U.S. company. Increased disclosure requirements for private investment funds would be complementary to, rather than duplicative of, the CFIUS process and would help inform the allocation of the Committee’s resources.5
- Fund managers are not required to maintain an AML compliance program or file suspicious activity reports. By contrast, banks, broker-dealers, and mutual funds must do both. Since private investment firms are among financial institutions’ most important clients, this opacity inhibits the effective functioning of banks’ and broker-dealers’ compliance programs. The Treasury Department issued a proposed rule to close this gap in 2015 (after withdrawing its 2002 rulemaking in 2008) but has yet to complete the process. Congress called for such requirements in Section 352 of the USA PATRIOT Act, passed in 2001. Closing this gap would also bring the United States into compliance with global AML standards.6
In order to understand the landscape of strategic investments by the Russian government and Russian oligarchs that may be of national security concern, the U.S. government will need to rely on the help of the private investment fund industry. That means disclosing investors and holdings to the SEC, checking the sources of investors’ money, and reporting suspicious activity to Treasury. Importantly, such confidential reporting would be collected by the government for internal use and not made public. This confidentiality would ensure that fund managers’ proprietary ideas, which give them their competitive edge, are protected. As the United States continues to strengthen the financial system’s defenses against illicit influence, it is prudent to harden the highest-value priority targets first. Private investment firms are the smart place to start.
The views expressed in GMF publications and commentary are the views of the author alone.
- The terms “private investment funds” or “alternative investments” refer to arrangements in which an investment vehicle is open only to “accredited investors,” generally wealthy individuals or institutions such as pension funds. Such structures include private equity firms, venture capital firms, and hedge funds. The typical arrangement would consist of multiple investment funds managed by one “adviser.” The advising management firm typically registers with the Securities and Exchange Commission and reports the names of the funds under its management on Form ADV. The minimum figure of $100 million in assets under management triggers registration. Firms managing less than $100 million are typically registered at the state level.
- To paraphrase the (apocryphal) old Everett Dirksen saw, “$12.5 trillion here, $12.5 trillion there, and pretty soon you’re talking real money.”
- American investments made by foreign firms, including sovereign wealth funds, are even more opaque. Most of the time, the U.S. government knows virtually nothing about them, or even that they exist at all. That is a related but distinct issue that the U.S. will also need to address.
- Positions in publicly traded equities may be covered either by Form 13F or Schedules 13D or G, both of which the SEC includes in its searchable EDGAR database. Certain large trades are also covered by Form 13H. Advisers managing over $150 million in assets report certain aggregate information about the composition of their investments on the non-public Form PF. This information is intended to help assess systemic financial risk and does not require the disclosure of specific investment positions. An exception to these generally limited disclosure requirements is the detailed reporting required of large private liquidity fund advisers on Form N-MFP.
- The Foreign Investment Risk Review Modernization Act of 2018 will, among other things, expand the scope of CFIUS to cover transactions for “investments in certain U.S. businesses that afford a foreign person access to material nonpublic technical information in the possession of the U.S. business, membership on the board of directors, or other decision-making rights, other than through voting of shares.” The extent to which private equity investments will constitute covered transactions will be determined in forthcoming regulations.
- Failure to require private investment fund managers to maintain AML programs and file suspicious activity reports puts the United States in breach of the global standards set by the Financial Action Task Force. This was one of the key shortcomings highlighted by the task force in its 2016 evaluation of the United States.