The U.S. Treasury’s Financial Crimes Enforcement Network (FinCEN) on April 3, 2018 issued Frequently Asked Questions Regarding Customer Due Diligence Requirements for Financial Institutions (FAQs).1 The FAQs address various issues raised by financial institutions subject to FinCEN’s new customer due diligence requirements (CDD Rule). The FAQs are timely, given the CDD Rule’s May 11, 2018 compliance date is fast approaching.
The CDD Rule requires that covered financial institutions – including mutual funds and broker-dealers2 – implement “risk-based [anti-money laundering] procedures for conducting ongoing customer due diligence.” This due diligence includes “understanding the nature and purpose of customer relationships for the purpose of developing a customer risk profile” and “conducting ongoing monitoring to identify and report suspicious transactions and, on a risk basis, to maintain and update customer information.”3 The CDD Rule requires that financial institutions collect information from their “legal entity customers” to identify and verify the beneficial owners of such customers. The CDD Rule defines beneficial owners as:
- Individuals who own, directly or indirectly, 25% or more of the equity interests of a legal entity customer (referred to in the FAQs as the “ownership/equity prong”); and
- A single individual “with significant responsibility to control, manage or direct a legal entity customer,” including “[a]n executive officer or senior manager (e.g., a Chief Executive Officer, Chief Financial Officer, Managing Member, General Partner, President, Vice President, or Treasurer)” or “[a]ny other individual who regularly performs similar functions” (referred to in the FAQs as the “control prong”).
Financial institutions must collect certain identifying information about beneficial owners from a legal entity customer at the time an account is established.4 This information is required for accounts held by corporations, limited liability companies, general partnerships, foreign entities, limited partnerships, business/statutory trusts and other similar types of entities. There are a number of entities exempted from the definition of legal entity customer, including (among others): registered investment companies; registered investment advisers; and certain pooled investment vehicles that are operated or advised by a financial institution otherwise excluded from the definition of legal entity customer.
Financial institutions may rely on certifications from the legal entity customer regarding the identity of its beneficial owners, but must verify the identity of the beneficial owners according to risk-based anti-money laundering procedures. Such procedures may be different from a financial institution’s existing customer identification procedures (CIP), including, for example, acceptance of a photocopy of a driver’s license if the beneficial owner is not present.
Investment company industry participants have raised questions regarding the scope of certain aspects of the CDD Rule. FAQs of interest for investment companies may include:
- Retroactive Application. The FAQs confirm that financial institutions need not retroactively review legal entity customers’ accounts established prior to May 11, 2018. However, if a financial institution becomes aware of information after May 11, 2018, that indicates the customer had a change in beneficial ownership, the financial institution must update its records for that customer.
- Complex Ownership Structures. The FAQs confirm that, no matter how complex the corporate structure of a legal entity customer may be, the customer must identify any natural person who directly or indirectly owns 25% or more of the equity interests of the customer. This may include a person whose ownership is held through multiple layers.
- Exclusion for Non-U.S. Governmental Department, Agency or Political Subdivision Engaged Only in Governmental Activities. Under the CDD Rule, non-U.S. governmental departments, agencies and political subdivisions are exempt from the legal entity customer definition to the extent they are not engaged in any commercial activities. The FAQs clarify that these governmental entities must be engaging in “activities involving the direct exercise of legislative, executive, or judicial authority and which do not involve taking profits from the endeavor.” As examples of entities not covered by this exemption, the FAQs list sovereign wealth funds, state-owned airlines and oil companies. The FAQs clarify that, to the extent these governmental entities do not have a natural person as a beneficial owner, a financial institution “would only be required to identify an individual under the control prong.”
- Existing Customers. The FAQs confirm that a financial institution may rely on existing CIP information with respect to identifying and verifying a beneficial owner who is subject to the financial institution’s CIP, provided the legal entity customer confirms (verbally or in writing) that such information is still accurate.
The May 11, 2018 compliance deadline for the CDD Rule is imminent. Investment companies and their advisers and service providers, as well as broker dealers, should consider what updates may be necessary for their anti-money laundering procedures, and implement processes to identify and verify underlying beneficial owners for covered customers.