Financial institutions may soon need to take a closer look at their customers in the interest of combating money laundering and terrorist financing, under new rules proposed by the Treasury Department.

Earlier this month, the Treasury’s Financial Crimes Enforcement Network (FinCEN) published a proposed rule that clarifies and expands customer due diligence requirements currently mandated under the Bank Secrecy Act. Under the BSA, financial institutions must maintain records that have “a high degree of usefulness in criminal, tax, or regulatory investigations or proceedings, or in the conduct of intelligence or counterintelligence activities.’’

The most significant change would require financial institutions—banks, mutual funds, futures commission merchants, broker-dealers, and commodity brokers—to identify and verify the beneficial owners of their legal entity customers, such as companies and partnerships, that open any new accounts.

“The beneficial ownership requirement is intended to provide us an important new tool to track down the real people behind companies that abuse our financial system to secretly move and launder their illicit gains,” David Cohen, Under Secretary for Terrorism and Financial Intelligence, said in a statement. “This rule would make our financial system more transparent by exposing the activities of illicit actors who will no longer be able to hide behind their anonymity.”

The proposal comes after FinCEN reviewed more than 90 comment letters and held five public hearings. At the meetings, participants offered recommendations on how to minimize the costs and compliance challenges associated with obtaining beneficial ownership information.

“This proposal has been kicking around for a couple of years, so it should not come as a big surprise to the financial community,” Charles Horn, a partner with law firm Morgan Lewis, says.

Beneficial Owner Defined

Among the significant changes, FinCEN modified its definition of “beneficial owner” in the proposed rule, including an ownership threshold and a control threshold. Under the rule a beneficial owner is any individual who holds a 25 percent or greater ownership interest in the legal entity. It also defines a beneficial owner as an individual, who could also be a 25 percent owner, who controls or manages the legal entity customer.

“This rule would make our financial system more transparent by exposing the activities of illicit actors who will no longer be able to hide behind their anonymity.”
David Cohen, Under Secretary for Terrorism and Financial Intelligence, Treasury Dept.

Such a definition does not require a financial institution to comparatively assess individuals to determine who has the greatest equity stake in the legal entity. Rather, the 25 percent threshold “sets a clear standard that can be broadly applied,” the rule states.

The difficulty for financial institutions will be how to obtain this information from the corporate account, particularly from foreign legal entity customers where there is a culture of secrecy, Horn says.

Financial institutions may find themselves in a situation of having to determine “whether or not they want to accept accounts for which they cannot obtain beneficial ownership information,” Horn says.  “Some financial institutions may determine it’s not worth the risk.”

In order to identify the beneficial owner, the proposed rule would require financial institutions to obtain a certification from the individual opening the account on behalf of the legal entity customer. Using a standard certification form, the individual opening the account must state the beneficial owner’s name, address, date of birth, and social security or passport number.

Financial institutions must then verify the identity of the beneficial owner listed on the certification form. They are not required, however, to verify the status of any individual listed as a beneficial owner.  In this regard, “banks view this proposal as much more reasonable than the first one,” Greg Johnson, an associate with law firm Stinson Leonard Street, says.

From a practical standpoint, however, the recordkeeping obligations imposed by the proposed rule creates a “significant compliance burden,” Johnson says. Specifically, financial institutions would be required to verify the identity of owners by documentary or non-documentary methods.

Financial institutions must also maintain in their records for five years:

A description of any document relied on for verification;

Any non-documentary methods and results of measures undertaken; and

The resolution of any substantive discrepancies discovered in verifying the identification information.

Another question that will need to be answered with implementation of the final rule is what financial institutions are supposed to do with the information they collect, Johnson says. “How do they incorporate this information into due diligence programs?”

In response to concerns that some financial institutions already identify beneficial owners using a lower ownership threshold, FinCEN reiterated that the intent of the proposed rule is to set forth minimum due diligence expectations. “Accordingly, a financial institution may determine, based on its own assessment of risk, that a lower percentage threshold, such as 10 percent, is warranted,” FinCEN stated.

IMPORTANCE OF CUSTOMER DUE DILIGENCE

Below the Treasury Department’s notice of proposed rulemaking describes the new rule’s due diligence aims.
Clarifying and strengthening customer due diligence requirements for U.S financial institutions, including an obligation to identify beneficial owners, advances the purposes of the BSA by:

Enhancing the availability to law enforcement, as well as to the federal functional regulators and SROs, of beneficial ownership information of legal entity customers obtained by U.S. financial institutions, which assists law enforcement financial investigations and regulatory examinations and investigations;

Increasing the ability of financial institutions, law enforcement, and the intelligence community to identify the assets and accounts of terrorist organizations, money launderers, drug kingpins, weapons of mass destruction proliferators, and other national security threats, which strengthens compliance with sanctions programs designed to undercut financing and support for such persons;

Helping financial institutions assess and mitigate risk, and comply with all existing legal requirements, including the BSA and related authorities;

Facilitating reporting and investigations in support of tax compliance, and advancing national commitments made to foreign counterparts in connection with the provisions commonly known as the Foreign Account Tax Compliance Act (FATCA); and

Promoting consistency in implementing and enforcing CDD regulatory expectations across and within financial sectors.
Source: Treasury Department.

FinCEN also addressed concerns raised by financial institutions, citing a potential situation in which multiple individuals with independent holdings act in concert with each other to structure their ownership interest to avoid the 25 percent threshold. In this regard, FinCEN responded that the proposed rule is “not intended to preclude a financial institution from identifying them, and verifying their identity, when it deems it appropriate to do so.”

Risk-Based Approach

In response to comments raised, the proposed rule calls for a risk-based approach to take into account the wide variety of financial institutions, account types, products, and customers. A risk-based approach avoids “requiring financial institutions to misallocate scarce compliance resources away from high-risk customers,” the rule stated.

FinCEN acknowledged that the ownership structure of a legal entity may not be obvious in every instance. When other entities own a legal entity, for example, determining ownership “may require several intermediate analytical steps,” the proposed rule states.

The expectation is that financial institutions will “identify the natural person or persons who exercise control of a legal entity customer through a 25 percent or greater ownership interest, regardless of how many corporate parents or holding companies removed the natural person is from the legal entity customer,” according to the proposed rule.

The proposed rule will not apply to certain financial institutions that are not currently subject to customer identification program requirements—such as money services businesses, casinos, and insurance companies. Extending these requirements in the future, however, “may promote a more consistent, reliable, and effective [anti-money laundering] regulatory structure across the financial system,” FinCEN stated.

EU Rules

FinCEN’s proposed rule comes at a time when the European Parliament is mulling updates to its EU Anti-Money Laundering regulations. Under a recent directive, EU companies would be required to know and document the “beneficial owner” of any third party doing business on its behalf. Similar to FinCEN’s proposed rule, the directive defines a beneficial owner as any individual with 25 percent or more ownership of an entity.

Enforcement regulators around the world are pursuing money laundering with more vigor in recent months and targeting companies for deficiencies in their anti-money laundering compliance programs. In response, banks and financial firms are reviewing their AML compliance programs and current anti-money laundering regulations in every part of the world where they operate.

FinCEN is seeking comments on the proposed rule until Oct. 3, 2014.