United States: Federal Agencies Jointly Issue FAQs Concerning Customer Information Programs
(Financial Services Alert - Developments of Note)

The FRB, FDIC, FinCEN, NCUA, OCC, OTS and the U.S. Department of the Treasury (the "Agencies") jointly issued an updated set of frequently asked questions (the "FAQs") to provide interpretive guidance regarding the customer identification program requirements of Section 326 of the USA PATRIOT Act and the regulations thereunder (collectively, "Section 326"). Certain of the FAQs were originally issued in January 2004. Section 326 generally requires certain "financial institutions," including banks, thrifts, and credit unions (collectively "Banks") to establish and maintain Customer Identification Programs ("CIP") designed to verify the identity of their customers. Some of the key interpretations covered by the FAQs (including certain interpretations originally issued in January 2004) are as follows:

Definition of Account. As a general matter, the Section 326 requirements are triggered when a customer opens an account. Consequently, a key issue has been the definition of "account" under Section 326. On that issue, the FAQs conclude that a loan becomes an "account" that triggers CIP obligations only when the loan is approved (i.e., when the Bank enters into an enforceable agreement to provide a loan to the customer"). In addition, loan participations purchased from third parties are exempt from the definition of "account." If a Bank, however, is extending credit using a car dealer or mortgage broker as the Bank’s agent, then the Bank must ensure that the agent is performing the Bank’s CIP.

Definition of Bank. Section 326 requirements apply, as noted above, to Banks and to other financial institutions, such as broker-dealers. The FAQs clarify that the CIP requirements do not apply to any part of a Bank located outside of the United States. The CIP requirements also are not applicable to bank holding companies and their non-bank affiliates. Subsidiaries of a Bank, however, are subject to the CIP requirements.

Definition of Customer. Banks are required under the CIP rules to identify their "customers." The FAQs provide ten interpretations concerning the definition of "customer." Among the FAQs’ guidance is that a Bank’s customer will be the named owner of an account rather than an individual with a power-of-attorney, unless the named owner lacks legal capacity. In the case of a trust, custodial, or other administrative account established by an employer at a Bank to maintain and administer assets under a non-ERISA employee retirement, benefit, or deferred compensation plan, the Bank’s "customer" will either be the trust established by the employer to maintain the assets or, if the account is not a trust, the "customer" will be the employer that contracts with the Bank.

Person with an Existing Account. The CIP requirements generally apply to persons who open new accounts; and the CIP obligations generally do not apply to a customer who has an existing account if the Bank has a reasonable belief that it knows the true identity of the customer. The FAQs clarify that a person who has an existing account with a Bank affiliate is not an existing customer of the Bank, and thus that person must be identified by the Bank. As the FAQs point out, the Bank may be able to rely on the affiliate to perform elements of its CIP.

Information Required. The FAQs discuss required information that must be obtained by Banks under Section 326 for those customers who live in rural areas, for persons who do not have a tax identification number and for trust accounts that lack taxpayer-identification numbers.

Customer Verification. The FAQs clarify that, under Section 326, a Bank need not confirm every element of customer identifying information; rather, a Bank must verify enough information to form a reasonable belief that it knows the true identity of its customer. The FAQs make clear that Banks may use digital and electronic credentials for verifying a customer’s identity.

Required Records. Section 326 requires Banks to retain records of, among other things, the steps taken to verify a customer’s identity. The FAQs clarify that such recordkeeping requirements may be satisfied with a description of the non-documentary customer verification method used in a general policy or procedure (instead of recording the particular method used on each individual customer’s record), This approach may be taken provided that the record cross-references the specific provisions of the risk-based procedures in the Bank’s CIP used to verify the customer’s identity.

Retention of Records. Section 326 requires Banks to retain for five years, among other information, all of the identity information about a customer that the Bank used to open the account. The FAQs provide that updated information does not satisfy the requirement to retain the information used by the Bank at the time of opening the account. The FAQs also note that, when a Bank sells a loan, the account is "closed" under the record retention provisions even if servicing is retained.

Section 326 List. To date, no list of known or suspected terrorist or terrorist organizations has been designated for purposes of the CIP rule. A Bank, however, must check the OFAC lists to comply with OFAC’s regulations.

Customer Notice. Section 326 requires that Banks provide a CIP notice to their customers. The FAQs make clear that Banks must provide a CIP notice to all owners of a joint account. The FAQs also provide that, when a mortgage broker or car dealer is acting as a Bank’s agent in a loan, the mortgage broker or car dealer may provide the CIP notice on behalf of the Bank.

Reliance. Section 326 contains provisions that allow a Bank, in certain narrowly defined situations, to rely on another financial institution to perform certain CIP functions. The FAQs clarify that a Bank may rely on another financial institution to perform any of the elements required by the CIP rule. Such reliance is permitted only when the relied upon financial institution is: (1) regulated by a Federal functional regulator; (2) subject to a general Bank Secrecy Act compliance program requirement; and (3) shares the customer with the Bank. Moreover, (4) the reliance on the relied upon financial institution must be reasonable under the circumstances; and (5) the two institutions must enter into a reliance contract and the relied upon financial institution must provide an annual certification on compliance with the contract and CIP requirements.

The four U.S. federal banking agencies (the "Banking Agencies") agreed to delay beyond its expected issuance this summer the publication of their notice of proposed rulemaking to implement the Basel II Capital Accord. The Banking Agencies stated that they decided upon the delay so that they could better assess the impact of the most recently completed quantitative impact study ("QIS4"). The QIS4 analysis revealed (1) material reduction in aggregate minimum capital for QIS4 participants, and (2) a significant dispersion of results across the participants. The Banking Agencies reiterated their commitment to retaining the capital ratios required in the Prompt Corrective Action rules (including the leverage requirement), and stated that the QIS4 results caused them to reevaluate whether adjustments to the Basel II framework were appropriate. The Banking Agencies continue to target the existing overall implementation timeline for Basel II (2008), but concede that this delay may force them to revisit the timeline.

The FDIC adopted amendments to its international banking regulations in connection with regulatory burden reduction efforts. The changes, which will affect both state nonmember banks with operations abroad and foreign banks that have insured branches or bank subsidiaries in the United States, are effective July 1, 2005.

The amendments contain three substantive changes to the regulations governing international activity of state nonmember banks. First, the amendments make the FDIC’s regulations governing foreign activities of state nonmember banks more consistent with the Federal Reserve Board’s Regulation K. Second, the FDIC is expanding the circumstances in which banks will be able to use general consent authority to notify the FDIC within 30 days after establishing new branches or making new investments abroad. Under existing regulations, general consent for foreign branching by a nonmember bank is available if the bank either (1) already operates one or more foreign branches or foreign bank subsidiaries in the foreign country, or (2) relocates an existing foreign branch within a foreign country. Under the amended regulations, general consent also will be available if either (1) the bank’s holding company operates a foreign bank subsidiary in the foreign country, or (2) certain affiliates of the bank operate one or more branches or subsidiaries in the foreign country. A state nonmember bank that meets certain eligibility criteria also will be able to use general consent authority for investments in foreign organizations if the investing bank or an affiliated state nonmember bank operates a foreign branch in the relevant foreign country. Finally, the amendments clarify and enhance the FDIC’s power to place conditions on and, if necessary, order termination of affected banks’ foreign activities.

The amendments also make revisions to the FDIC’s rules applicable to insured branches and subsidiaries of foreign banks. First, the amendments extend application of the FDIC’s rules on cross-border examination and information to U.S. subsidiaries of foreign banks. Under the amended rules, both U.S. branches and bank subsidiaries of foreign banks that are seeking FDIC insurance coverage will be required, among other things, to agree to provide certain information to and permit examination by U.S. regulators about affiliates and offices outside the United States. Second, the FDIC clarified the situations under which a grandfathered branch (i.e., a branch permitted to accept retail deposits of less than $100,000 because it was an insured branch on December 19, 1991) can be transferred to a new foreign bank owner without loss of the branch’s grandfathered status. Third, the FDIC adopted a risk-based approach for calculating the assets that must be pledged by insured branches and bank subsidiaries of foreign banks and revised the asset maintenance rule to provide that asset maintenance requirements will be based on a daily calculation of third-party assets and liabilities. Finally, the FDIC adopted new rules to facilitate the cross-border supervision of insured U.S. branches of foreign banks and insured U.S. bank subsidiaries by providing a framework for the sharing of supervisory information between the FDIC and foreign bank supervisory authorities and providing for the confidentiality of such information.

The FDIC, in the preamble to its proposed amendments, had requested comments about whether it should revise its existing views regarding the availability of FDIC insurance for wholesale U.S. branches of foreign banks. After considering the comments it received, the FDIC decided to maintain its previously stated position that, as a practical matter, it does not foresee many circumstances in which it could be appropriate for the FDIC to approve such an application and that the FDIC would address such situations on a case-by-case basis.

The Massachusetts Commissioner of Banks ("Commissioner"), by letter dated April 26, 2005, and in response to an inquiry of the Massachusetts Bankers Association, Inc., has clarified the ability of Massachusetts-chartered ("MA") banks to make adjustable rate mortgage loans ("ARMs") under the recent amendment of Massachusetts General Laws Chapter 167E ("Chapter 167E"), which establishes the mortgage lending and general lending powers of MA banks. The pre-amendment Chapter 167E had contained two separate grants of authority to make ARMs. The first, under former Section 2(B)(10) of Chapter 167E, permitted MA banks to make ARMs subject to conditions and restrictions imposed by the Commissioner with regard to the method for adjusting interest rates, the frequency of such adjustments, the maximum increase in interest rate, the requirement to decrease the interest rate in response to market conditions, required disclosures, etc. The second was a blanket grant of authority to make or acquire any residential real estate mortgage loan, including ARMs, saleable in the secondary market.

The amended Chapter 167E, in Section 8, contains a counterpart provision substantially identical to the first grant of authority to make ARMs in former Section 2(B)(10). The blanket grant of authority to make or acquire mortgages loans saleable in the secondary market, however, which was also carried over from the former statute and appears in the new Section 3(b)(vi), was made subject to the new Section 8 in the case of ARMs. The result, based on a literal reading of the statute, appeared to be the revocation of MA banks’ ability to make ARMs saleable in the secondary market without regard to the various regulations of the Commissioner.

In the April 26 letter, the Commissioner—drawing upon the legislative grant of authority contained in the new Section 3(g) to "carry out the purposes of this section by directive, guideline or regulation"—specifically authorizes MA banks to make or acquire ARMs saleable in the secondary market under the new Section 3(b)(vi) without respect to the conditions and restrictions imposed by the Commissioner under the new Section 8. The authorization set forth in the April 26 letter is designated by the Commissioner as a "guideline" under the new Section 3(g). New Section 8 continues to operate as a separate and distinct enabling power with respect to ARMs.

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