The Financial Crimes Enforcement Network has issued a reminder to financial institutions and their customers that a final rule, “Customer Due Diligence Requirements for Financial Institutions,” known as the CDD Rule, went into effect on Friday, May 11.

FinCEN, the enforcement arm of the Treasury Department, issued the CDD Rule, which amends Bank Secrecy Act regulations to improve financial transparency and, in its words, “prevent criminals and terrorists from misusing companies to disguise their illicit activities and launder their ill-gotten gains.” 

The CDD rule clarifies and strengthens customer due diligence requirements for U.S. banks, mutual funds brokers or dealers in securities, futures commission merchants, and introducing brokers in commodities. It also adds a new requirement for these covered financial institutions to identify and verify the identity the natural persons (known as beneficial owners) of legal entity customers who own, control, and profit from companies when they open accounts.

The CDD Rule has four core requirements. It requires covered financial institutions to establish and maintain written policies and procedures that are reasonably designed to identify and verify the identity of customers; identify and verify the identity of the beneficial owners of companies opening accounts; understand the nature and purpose of customer relationships to develop customer risk profiles; and conduct ongoing monitoring to identify and report suspicious transactions and, on a risk basis, to maintain and update customer information.

With respect to the new requirement to obtain beneficial ownership information, financial institutions will have to identify and verify the identity of any individual who owns 25 percent or more of a legal entity, and an individual who controls the legal entity.

A series of “frequently asked questions” can be found on FinCen’s website, here and here.

On May 11, FinCEN also made public the details of an administrative ruling. The document details the application of beneficial ownership requirements to finance lending products that allow for cash refunds.

Businesses of all sizes typically obtain commercial, property, casualty, and liability insurance policies to mitigate operational risks. While some businesses purchase these policies outright, others either do not have sufficient funds to cover the premiums or prefer to finance the purchase to manage cash flow. In these circumstances, they may engage the services of premium finance lenders.

Premium finance lenders provide short-term loans to help businesses cover their annual insurance premiums by making an advance payment directly to the insurance carrier. In the normal course of business, premium finance lenders process a considerable number of cash refunds.

“Premium finance lenders typically do not interact directly with the borrower,” FinCEN explained. Instead, they interact directly with insurance agents or brokers, who bring financing opportunities to the borrowers, and with whom they have direct contact. These lenders pay the insurance premium directly to the insurance agent or broker arranging the loan transaction or to the insurance company issuing the policy.

FinCEN exempted, subject to certain limitations, accounts established to finance insurance premiums from its beneficial ownership rule, because of the low risk of money laundering presented by these loans. The structural characteristics of premium finance lending and the purpose for which premium finance accounts are established limit a customer’s ability to use the accounts for any other purpose.

The exemption, however, did not apply if there is a possibility of a cash refund on the account activity, in which case the beneficial owner of the legal entity customer must still be identified and verified for such accounts.

That stance has now changed with a reconsideration of the exempted relief.

“Premium finance lending is an automated high-volume industry, with companies routinely processing a significant number of cash refunds each year in the normal course of business,” FinCEN explained. In the normal course of business, a premium finance company may be required to refund funds when:

Unearned interest has accrued, such as when a borrower repays the loan prior to the loan’s maturity date;

A borrower has made inadvertent overpayments, such as forgetting to terminate prescheduled automated payments and accidentally making an extra payment after the loan has been repaid; and

Policies are cancelled, at which point any unearned premiums exceeding the loan amount, earned interest, or fees must be forwarded to the borrower and/or the borrower’s agent or broker.

State laws may also require premium finance companies to refund promptly, to either a customer, or a customer’s insurance broker or agent, any excess funds that the company has not earned.

To the extent premium financing involving cash refunds carries a minimal risk of money laundering and terrorist financing, that risk will be mitigated by the requirement that covered financial institutions are required to comply with other Bank Secrecy Act/anti-money laundering reporting requirements, FinCEN said in its Friday release. For example, covered premium finance lenders have a responsibility to report suspicious activity when a refund may not have an economic purpose or has other indicators of suspicious activity.

Accordingly, FinCEN said it was granting exceptive relief to premium finance lenders where their activities may have the potential for cash refunds.

 “FinCEN had placed limits on the exemption in its rule based on concerns that products involving cash refunds could be subject to misuse and might be used as instruments for money laundering,” the agency wrote. “Based on its current understanding from industry and law enforcement that the business practices surrounding such cash refunds limit such risks, it is issuing this exceptive relief. However, as with any other exceptive relief, FinCEN may withdraw or modify this exceptive relief under any circumstances, particularly if it receives new or different information.”

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