The Department of the Treasury's Financial Crimes
Enforcement Network (FinCEN) yesterday issued proposed regulations
that would formalize certain financial institutions' Customer
Due Diligence (CDD) requirements and expand the degree to which
those institutions must look beyond the nominal account holder to
identify the natural persons who own or control certain legal
entity customers.
Yesterday's long-awaited Notice of Proposed Rulemaking (NPRM) would
include a beneficial ownership requirement as one of four key
elements of CDD, but the proposed requirement may be more narrow
than many feared and appears to be less burdensome to financial
institutions than the earlier proposals advanced in FinCEN's
February 2012 Advance Notice of Proposed Rulemaking (ANPRM).
Following publication of the ANPRM, Treasury engaged in extensive,
nationwide consultation with the industry. The differences between
the ANPRM and yesterday's proposal suggest that FinCEN took
certain industry concerns into account in its drafting process. For
example, the proposed rule would not require institutions to verify
that named individuals are in fact beneficial owners, and it would
not require the institutions to identify an omnibus or other
intermediated account's clients or those clients'
beneficial owners.
Even so, the proposed beneficial ownership requirement would pose
many challenges to covered financial institutions. The proposed
rule also would amend FinCEN's anti-money laundering (AML)
program rules for "covered financial institutions"
(banks, securities broker-dealers, mutual funds, futures commission
merchants, and introducing brokers in commodities) to, in its
words, "ensure alignment between existing AML requirements and
minimum CDD standards." In addition, the proposed rule says it
would add a fifth CDD pillar that would require covered financial
institutions to understand the nature and purpose of their customer
relationships and conduct ongoing monitoring.
Highlights
- Beneficial Ownership Requirement: Covered
financial institutions will be required to identify beneficial
owners of new legal entity customers, subject to certain
exemptions.
-
- Covered financial institutions will not have to identify
beneficial owners of certain types of legal entity customers.
- Covered financial institutions will not have to identify the
beneficial owners of an intermediary's underlying clients if
that financial institution has no Customer Identification Program
(CIP) obligation with respect to those underlying clients.
- Covered financial institutions will be able to rely on a
standard certification form.
- Covered financial institutions will be able to rely on the CDD
of other financial institutions, consistent with the approach in
the existing CIP reliance structure.
- Covered financial institutions will not have to identify
beneficial owners of certain types of legal entity customers.
- Other AML Program Requirements: The proposed rule would add, as an AML program requirement, a new fifth pillar that would require covered financial institutions to understand the nature and purpose of their customer relationships and conduct ongoing monitoring.
Overview and Rationale
From FinCEN's perspective, an effective CDD is composed of four key elements:
- identifying and verifying the identity of customers;
- identifying and verifying the identity of beneficial owners of
legal entity customers (i.e., the natural persons who own or
control legal entities);
- understanding the nature and purpose of customer relationships;
and
- conducting ongoing monitoring to maintain and update customer information and to identify and report suspicious transactions.
FinCEN states that the proposed rule is intended to amend its existing rules so that each of these CDD elements is explicitly referenced in a corresponding requirement within FinCEN's program rules. FinCEN asserts that the beneficial ownership requirement is the only new requirement imposed by the rulemaking, whereas the other CDD aspects of the proposed rule merely clarify existing requirements. However, the proposed rule repeatedly emphasizes that it is intended to establish minimum CDD standards for covered financial institutions, while noting that other guidance, regulations, or supervisory standards may impose additional requirements to mitigate risk.
Requirement to Identify Beneficial Owners of Legal Entity Customers
Definition of Beneficial Owner
FinCEN has proposed a definition of "beneficial owner"
that would include two independent prongs: an ownership prong and a
control prong.
Under the proposed beneficial ownership rule, a covered financial
institution would have to identify each individual who owns 25
percent or more of the equity interests in the covered financial
institution's "legal entity customer" and also one
individual who exercises significant managerial control over the
legal entity customer. If no individual owns 25 percent or more of
the equity interests, the covered financial institution may
identify a beneficial owner under the control prong only. The same
individual(s) may be identified under both prongs.
This definition is narrower than the definition proposed in the
ANPRM, which would have required financial institutions to identify
the single individual "with greater responsibility than any
other individual for managing or directing the regular
affairs" of the legal entity. FinCEN notes, however, that
identifying a natural person beneficial owner may require looking
through multiple corporate entities and complex holding legal
structures—i.e., piercing the corporate veil, potentially
repeatedly.
Definition of Covered Financial Institution
The proposed rule would cover only those financial institutions
that currently are subject to FinCEN's CIP requirement, i.e.,
banks, broker-dealers, mutual funds, futures commission merchants,
and introducing brokers in commodities. However, FinCEN expressed
interest in possibly extending CDD requirements in the future to
other types of financial institutions, such as money services
businesses, casinos, and insurance companies, in order to promote
better AML regulation across the financial system.
Definition of Legal Entity Customer and Exemptions
FinCEN would require covered financial institutions to identify the
natural persons who are beneficial owners of their "legal
entity customers," which would include corporations, limited
liability companies, and partnerships or other similar business
entities (whether formed under the laws of a state or of the United
States or of a foreign jurisdiction). The proposed rule would not
require financial institutions to identify beneficial owners of
legal entities that are exempt under the current CIP rule, nor
would it require the identification of beneficial owners of certain
other entities whose beneficial ownership is generally available
from other credible sources. Customers exempt from the requirement
would include, among others: certain charities and nonprofits;
most, but not all, trusts; investment advisors; and majority-owned
domestic subsidiaries of publicly traded companies.
Intermediated Account Relationships
The proposed rule states that, acknowledging industry concerns
about burden and efficiency, covered financial institutions would
not have to identify the beneficial owners of an intermediary's
underlying clients if the financial institution has no CIP
obligation with respect to those underlying clients. The proposed
rule states that it is not intended to overtake the existing
requirements for foreign correspondent accounts under Section 312
of the USA PATRIOT Act.
Verification of Identity Rather Than Status
FinCEN acknowledged that industry concerns requiring financial
institutions to verify that an individual identified as a
beneficial owner is in fact a beneficial owner would be unduly
burdensome. Accordingly, FinCEN clarified that it is not proposing
to require financial institutions to verify the status of
a beneficial owner, only the identity of the beneficial
owner. Thus, financial institutions may rely on the beneficial
ownership information provided by their customers.
Reliance on Other Financial Institutions
The proposed rule would extend the CIP reliance provisions to the
new beneficial ownership requirements. Under current rules, one
financial institution may rely on another to conduct CIP with
respect to shared customers, provided that: (1) such reliance is
reasonable; (2) the other financial institution is subject to an
AML program rule and is regulated by a federal functional
regulator; and (3) the other financial institution enters into a
contract and provides annual certifications regarding its AML
program and CIP requirements.1 The proposed rule would
permit such reliance for purposes of complying with the beneficial
ownership requirement, if those same three conditions are
met.
Standard Certification Form
The proposed rule includes a standard certification form that
financial institutions would be required to use to document the
beneficial ownership of their legal entity customers. The form
would require the individual opening the account on behalf of the
legal entity customer to certify that the information provided on
the form is true and accurate to the best of his or her knowledge.
Financial institutions would not necessarily be required to update
or refresh information obtained through the certification, though
they should do so when appropriate based on risk.
Amendments to Existing AML Program
Requirements
To clarify what it characterizes as existing regulatory
expectations, FinCEN proposes to amend the AML program rules for
covered financial institutions to require:
[A]ppropriate risk-based procedures for conducting ongoing customer due diligence, to include, but not be limited to:
(i) Understanding the nature and purpose of customer relationships for the purpose of developing a customer risk profile; and
(ii) Conducting ongoing monitoring to maintain and update customer information and to identify and report suspicious transactions.
FinCEN asserts that it does not intend for these amendments to
necessarily require modifications to existing practices or
procedures with respect to customer onboarding procedures or
suspicious activity reporting. Rather, the proposed rule states
that it would merely codify existing supervisory and regulatory
expectations as explicit requirements to clarify the minimum
standards for CDD.
At the same time, the proposed rule expressly states that it is
"adding to these core provisions a fifth pillar" that
includes CDD requirements, which would be the most significant
modification to AML program requirements in over a
decade.2
International Backdrop
The proposed rule is part of a broader US effort to improve
compliance with the Financial Action Task Force (FATF) standards on
anti-money laundering/countering the financing of terrorism
(AML/CFT). In addition to establishing international standards,
FATF is an international body that conducts peer reviews (Mutual
Evaluations) of jurisdictions' AML/CFT legal regimes and
implementation. Although generally quite positive, the 2006 Mutual
Evaluation of the United States deemed US requirements only
"partially compliant" with CDD standards, and sharply
criticized the United States for lacking a beneficial ownership
regime, slapping it with a rating of
"non-compliant."3 As noted above, the four
elements of CDD in the proposed rule parallel the CDD measures set
forth in the FATF standard. The next Mutual Evaluation of the
United States is tentatively scheduled to commence in late
2015/early 2016, and the proposed rule (and final rule if adopted)
will be a key part of the review.
Key Differences from ANPRM
The proposed rule's beneficial ownership requirements are
narrower than those contemplated in the ANPRM. Key differences
include:
- A narrower definition of "beneficial
owner." The earlier definition could have required
identification and possibly verification of the single individual
"with greater responsibility than any other individual for
managing or directing the regular affairs" for the legal
entity. FinCEN acknowledged industry concerns that this provision
would have required them to engage in a comparative analysis of all
owners to determine who, in practice, had the most
control.
- Exceptions for intermediated accounts. The
Proposed Rule clarifies that institutions do not need to identify
or verify the beneficial owners of clients of intermediated
accounts and pooled investment vehicles. Thus, broker-dealers would
not have to identify the ultimate beneficial owners of omnibus
accounts that establish subaccounts (provided these accounts meet
the elements set forth in 2003 guidance),4 and
respondent banks in correspondent banking relationships would not
have to identify the beneficial owners of their own clients. FinCEN
cautioned, however, that institutions may still need to inquire
into these intermediary relationships as part of their broader AML
obligations. Notably, FinCEN stated that it is still considering
whether the beneficial ownership obligations should include owners
of certain pooled investment vehicles such as hedge funds.
- Exemption of certain legal entities. Beneficial ownership obligations extend only to customers who are foreign or domestic corporations, limited liability companies, partnerships or similar business entities. FinCEN stated that beneficial ownership information is not required from entities exempt from the CIP definition of "customer" (such as banks), as well as numerous other entities whose beneficial ownership is generally available from other credible sources. Exempt entities include trusts, certain charities and nonprofits, investment advisors, and majority-owned domestic subsidiaries of publicly traded companies, among others.
Public Comments
FinCEN has invited public comments on all aspects of the NPRM,
but specifically seeks comments on the following issues: the
definitions of "beneficial owner" and "legal entity
customer"; proposed exemptions from the beneficial ownership
rule; and the treatment of existing accounts, intermediated
accounts, pooled investment vehicles, and trusts. The comment
period will close 60 days after the NPRM is published in the
Federal Register. We expect numerous comments from various industry
participants and other observers.
Effective Date
To give financial institutions time to modify existing customer onboarding processes to incorporate the new beneficial ownership requirement, FinCEN has proposed an effective date of one year from the date the final rule is issued.
Footnotes
1 See 31 C.F.R. § 1020.220(a)(6).
2 The other pillars are: (1) a system of internal controls to
ensure ongoing compliance; (2) independent testing; (3) designation
of a Bank Secrecy Act compliance officer; and (4) training for
appropriate personnel.
3 The United States was far from alone in its struggle to meet the
FATF standards on CDD and beneficial ownership, which subsequently
were streamlined and clarified. In the intervening years, several
jurisdictions have made progress in their compliance with CDD and
beneficial ownership standards, and have criticized the United
States for lagging behind.
4 http://www.sec.gov/divisions/marketreg/qa-bdidprogram.htm.
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