On July 30, 2014, the U.S. Treasury Department’s Financial Crimes Enforcement Network (“FinCEN”) issued proposed rules (the “Proposed Rules”) to clarify and strengthen customer due diligence requirements for banks, securities broker-dealers, mutual funds, and futures commission merchants and introducing brokers in commodities (collectively, “covered financial institutions”).1
The Currency and Foreign Transactions Reporting Act of 1970, as amended by the USA PATRIOT Act of 2001 (and otherwise known as the “Bank Secrecy Act”), empowered FinCEN with the authority to impose anti-money laundering (“AML”) program requirements on financial institutions.2 Under this authority, FinCEN issued an advance notice of proposed rulemaking (“ANPR”) regarding customer due diligence requirements for covered financial institutions on February 29, 2012.3 Most notably, the ANPR had required a comparative analysis of ownership interests and management responsibilities. In developing the Proposed Rules, FinCEN took into account comments on the ANPR that were focused on the financial sector’s apprehensions about the proposed scope and potential burdens of the ANPR. As a result of these comments and the ensuing dialogue with the financial industry, FinCEN issued the Proposed Rules to clarify and narrow certain aspects of the ANPR.
FinCEN’s Proposed Rules
The Proposed Rules codify FinCEN’s four “pillars” of customer due diligence: (1) identifying and verifying the identity of customers; (2) identifying and verifying the identity of beneficial owners of legal entity customers; (3) understanding the nature and purpose of customer relationships; and (4) conducting ongoing monitoring to maintain and update customer information and to identify and report suspicious transactions. As FinCEN noted, since the first “pillar” – identifying and verifying the identity of customers – is already explicitly covered under existing regulatory requirements to have a customer identification program (“CIP”),4 the Proposed Rules provide explicit requirements for only the three remaining “pillars” of customer due diligence.
A. Identifying and verifying the identity of beneficial owners of legal entity customers
The most significant new requirement in the Proposed Rules is the obligation to take explicit steps to identify and verify the identity of beneficial owners of legal entity customers (i.e., the natural persons who own or control legal entities). In order to effectively implement this requirement, the Proposed Rules offer specific definitions for both “legal entity customers” and “beneficial owners.”
1. Legal Entity Customers
Under the Proposed Rules, a “legal entity customer” means a “corporation, limited liability company, partnership or other similar business entity,” whether formed under U.S. state or federal law or the law of a foreign jurisdiction.5 FinCEN clarified that a “legal entity customer” would not include trusts, except for trusts that are created through a filing with a state (e.g., statutory business trusts).
The Proposed Rules offer several exemptions from the definition of a “legal entity customer,” including certain federally registered financial institutions such as banks or broker-dealers. In addition, FinCEN exempted the following entities:
• Investment companies registered with the U.S. Securities and Exchange Commission (“SEC”);
• Investment advisers registered with the SEC;
• Certain issuers of securities registered with the SEC under the Securities Exchange Act of 1934 (“Exchange Act”);
• Certain U.S. publicly listed companies and their majority owned subsidiaries;
• Certain U.S. government agencies;
• Exchanges, clearing agencies, or any other entity registered with the SEC under the Exchange Act;
• Registered entities (e.g., derivatives clearing organizations or swap execution facilities), commodity pool operators, commodity trading advisors, retail foreign exchange dealers, swap dealers, and major swap participants registered with the Commodity Futures Trading Commission;
• Public accounting firms registered under the Sarbanes-Oxley Act; and
• Certain charities and nonprofit entities described in the Internal Revenue Code of 1986.6
2. Beneficial Ownership
The Proposed Rules establish two prongs to the definition of a “beneficial owner”: an ownership prong, and a control prong. Under the ownership prong, a “beneficial owner” is each individual (i.e., a natural person) “who, directly or indirectly . . . owns 25% or more of the equity interests of a legal entity customer.” Under the control prong, a “beneficial owner” is a single individual (i.e., a natural person) with “significant responsibility to control, manage, or direct a legal entity customer,” including an executive officer or senior manager, or any other individual who regularly performs similar functions.7
Each prong is intended to be an independent test, so that a covered financial institution must identify and verify up to four individuals under the ownership prong and one individual under the control prong. So, for instance, if a legal entity is owned equally by four persons (e.g., four 25% owners), and then managed by a separate natural person, a covered financial institution would need to identify and verify all five persons.
The same person may satisfy both the ownership and the control prongs, and it is also possible for a legal entity to have no 25% owners. For instance, if a legal entity is owned by one person (e.g., one 100% owner), and then also managed by that same person, then a covered financial institution would need to identify and verify only that one person to satisfy this requirement of the Proposed Rules. On the other end of the spectrum, if a legal entity does not have any 25% owners, then a covered financial institution would need to identify and verify only a single person that satisfies the control prong of the Proposed Rules.
3. Identify and Verify Beneficial Owners
Covered financial institutions would be required to identify the beneficial owners of legal entity customers by completing a standardized form, attached to the Proposed Rules as Appendix A, which requests identifying information about the beneficial owners such as name, date of birth, and social security number. The obligation to identify the beneficial owners would apply only to new accounts opened on behalf of a legal entity after the Proposed Rules are effected, and would not apply retrospectively.8
After identifying the beneficial owners of new legal entity accounts, the covered financial institution must then verify the identity of the beneficial owners. Importantly, covered financial institutions would not be responsible for verifying the status of beneficial owners, but rather only the identity of the beneficial owners.9 FinCEN also clarified that covered financial institutions could verify the identity of beneficial owners using the same risk-based procedures currently used to verify customers under existing CIP practices. For instance, a covered financial institution could verify the identity of the beneficial owner by requesting a copy of the beneficial owner’s driver’s license. But the covered financial institution would not be required to undergo an exhaustive investigation through corporate records to verify the status of the beneficial owner (e.g., verifying that the beneficial owner is, in fact, the beneficial owner of the legal entity).
B. Understanding the nature and purpose of customer relationships
The Proposed Rules would explicitly require a covered financial institution to understand the nature and purpose of customer relationships in order to develop a customer risk profile. According to FinCEN, covered financial institutions should already satisfy this requirement in order to comply with the existing requirement to identify and report suspicious activity under the Bank Secrecy Act.10 Consequently, FinCEN does not anticipate that this requirement would force covered financial institutions to modify existing AML practices and procedures.11
C. Conducting ongoing monitoring to maintain and update customer information and to identify and report suspicious transactions
As the final “pillar” of customer due diligence codified by the Proposed Rules, covered financial institutions would be required to conduct ongoing monitoring for the purpose of maintaining and updating customer information and identifying and reporting suspicious activity. Like the requirement to understand customer relationships, FinCEN believes that covered financial institutions must already satisfy this requirement in order to comply with other provisions of the Bank Secrecy Act, and that no modification of existing AML practices and procedures would be expected.12
Scope of Proposed Rules
FinCEN clarified that the Proposed Rules would initially apply only to covered financial institutions (e.g., banks, securities broker-dealers, mutual funds, and futures commission merchants and introducing brokers in commodities), the same entities subject to CIP requirements. However, FinCEN raised the prospect of eventually extending the Proposed Rules to other financial institutions, including insurance companies, because it would “promote a more consistent, reliable, and effective AML regulatory structure across the financial system.”13
Impact of Proposed Rules
The most significant impact of the Proposed Rules is the requirement to identify and verify the beneficial owners of legal entity customers, as this represents a new requirement for the AML programs of covered financial institutions. Indeed, even FinCEN acknowledged that the “beneficial owner” requirement will likely require modification of existing customer onboarding processes, as well as incorporation of the standardized form (Appendix A) into existing AML programs.14 By contrast, FinCEN asserted that understanding customer relationships and the ongoing monitoring requirements should not require modification of existing AML programs, since it believes that covered financial institutions must already comply with these obligations given the suspicious activity reporting requirements under the Bank Secrecy Act.
The Proposed Rules would also require covered financial institutions to amend their written procedures to explicitly incorporate the new requirements into their existing AML procedures. The financial industry should watch FinCEN’s next move carefully, as FinCEN may extend the scope of the Proposed Rules to other financial institutions in the future. Insurance companies, for instance, are not covered by the Proposed Rules, but may be required to comply with them in the future.
Effective Date of Proposed Rules
FinCEN proposed an effective date of one year from the date that the final rules are issued, which FinCEN believes will afford covered financial institutions sufficient time to implement any new customer due diligence requirements in response to the final rules.
Request for Public Comment
FinCEN invited comments on all aspects of the Proposed Rules, and specifically seeks comments on the proposed definitions of “beneficial owner” and “legal entity customer,” as well as the proposed effective date of the Proposed Rules. Public comments must be received on or before October 3, 2014.
1 The notice of the Proposed Rules (“Notice of Proposed Rules”) is available at http://www.gpo.gov/fdsys/pkg/FR-2014-08-04/pdf/2014-18036.pdf.
2 See also Treasury Order 180-01 (March 24, 2003), delegating authority from the U.S. Treasury Department to FinCEN to implement, administer, and enforce compliance with the Bank Secrecy Act and associated regulations, available at http://www.treasury.gov/about/role-of-treasury/orders-directives/Pages/to180-01.aspx.
3 The ANPR is available at http://www.gpo.gov/fdsys/pkg/FR-2012-03-05/pdf/2012-5187.pdf.
4 Section 326 of the Bank Secrecy Act.
5 Section 1010.230(d)(1) of the Proposed Rules.
6 Section 1010.230(d)(2) of the Proposed Rules.
7 Section 1010.230(c) of the Proposed Rules.
8 Notice of Proposed Rules, at 54.
9 Notice of Proposed Rules, at 43.
10 Section 1020.320 of the Bank Secrecy Act.
11 Notice of Proposed Rules, at 46.
12 Notice of Proposed Rules, at 50.
13 Notice of Proposed Rules, at 15.
14 Notice of Proposed Rules, at 51.