What Is AML/KYC?
AML/KYC stands for anti-money laundering and know your customer, the twin frameworks that require financial institutions to verify the identity of their clients and ensure that funds entering the financial system are not derived from criminal activity, terrorism financing, or sanctioned sources. For private fund managers, AML/KYC is the process you run on every limited partner before accepting their capital commitment.
The Regulatory Landscape
AML regulations in the United States stem from the Bank Secrecy Act (BSA) of 1970, as amended by the USA PATRIOT Act of 2001. Banks, broker-dealers, and other financial institutions have long been required to maintain AML compliance programs. Private fund managers occupied a grey area for years, with FinCEN proposing but not finalizing rules to bring them under the BSA framework until 2024.
Regardless of the US regulatory timeline, the practical reality is that AML/KYC compliance is non-negotiable for fund managers. Institutional LPs will not invest with a manager that lacks AML procedures. Fund administrators require them as a condition of service. And accepting capital from a sanctioned entity or a money laundering operation exposes the general partner to criminal liability, asset freezing, and reputational destruction.
The KYC Process
KYC for private fund investors operates at two levels:
Individual investors. For natural persons investing directly, the process includes collecting government-issued photo identification, proof of residential address, and documentation establishing source of funds or wealth. The fund screens the individual against the Office of Foreign Assets Control (OFAC) sanctions list, other relevant sanctions databases (UN, EU, UK), and politically exposed persons (PEP) databases.
Entity investors. For institutional LPs, family offices, and funds of funds, the process is more involved. The fund collects formation documents, evidence of good standing, board resolutions authorizing the investment, and identification of beneficial owners. The beneficial ownership requirement means looking through the entity structure to identify any natural person who directly or indirectly owns 25% or more of the entity, or who exercises control over it.
Sanctions Screening
Sanctions screening is the non-negotiable core of AML compliance. The fund must verify that no investor (or beneficial owner of an investor) appears on:
- OFAC Specially Designated Nationals (SDN) list. Maintained by the US Treasury. Transactions with SDN-listed persons are prohibited.
- OFAC sectoral and geographic sanctions. Restrictions on transactions involving specific countries (currently including North Korea, Iran, Syria, and others) or sectors within sanctioned jurisdictions.
- UN, EU, and UK sanctions lists. Relevant for funds with non-US investors or investments.
Screening must occur at onboarding and should be refreshed periodically (typically quarterly or when sanctions lists are updated). Automated screening tools cross-reference investor data against updated sanctions databases.
Source of Funds and Enhanced Due Diligence
Beyond identity verification and sanctions screening, AML best practices include assessing the source of funds for each LP. For institutional investors (pension funds, endowments, sovereign wealth funds), the source is generally self-evident. For high-net-worth individuals, family offices, and entities from higher-risk jurisdictions, enhanced due diligence may be warranted.
Enhanced due diligence involves deeper investigation into the investor’s background, the origin of their wealth, and the purpose of the investment. This applies particularly to PEPs (current or former government officials and their close associates), investors from jurisdictions identified by the Financial Action Task Force (FATF) as having strategic AML deficiencies, and complex multi-layered structures where beneficial ownership is difficult to determine.
Operational Integration
The AML/KYC process is integrated into the subscription workflow. Before a capital commitment is accepted and the investor is admitted at first close or a subsequent close, the KYC package must be complete, sanctions screening must be clear, and the compliance team (or fund administrator) must sign off. Incomplete KYC is a legitimate reason to delay or reject an investor, and GPs should build this timeline into their closing schedule.
Frequently Asked Questions
Are private fund managers required to have AML/KYC programs?
Historically, private fund managers were not explicitly subject to the Bank Secrecy Act's AML program requirements, though FinCEN proposed rules in 2015 and finalized rules in 2024 to bring investment advisers under the framework. Regardless of the regulatory status, most fund managers implement AML/KYC procedures voluntarily because institutional LPs and fund administrators require them, and because accepting illicit funds creates significant legal and reputational risk.
What does a standard KYC process involve for an LP?
The LP provides government-issued identification (for individuals) or formation documents and beneficial ownership information (for entities), proof of address, and source of funds or wealth documentation. The fund or its administrator screens the LP against sanctions lists (OFAC, UN, EU) and politically exposed persons databases. For complex structures, the process includes identifying ultimate beneficial owners through the ownership chain.
Who typically handles AML/KYC for a private fund?
Most fund managers delegate AML/KYC to their fund administrator, who collects documentation, runs sanctions screening, and maintains records. Some managers use third-party compliance vendors or handle the process in-house. Regardless of who performs the checks, the GP retains ultimate responsibility for ensuring the fund does not accept capital from prohibited sources.
