Starting May 11, 2018, compliance officers at broker dealers will have one more responsibility to add to their checklists. On that day, a new Financial Crimes Enforcement Network (FinCEN) rule goes into effect that requires broker dealers (and certain other financial institutions) to identify and verify the identity of beneficial owners of legal entity customers at the time of account opening. With the new beneficial ownership rules right around the corner, now is the time for broker dealers to incorporate the new requirements into their existing AML compliance policies and procedures.

FinCEN, part of the U.S. Treasury, along with the Securities and Exchange Commission (SEC) and FINRA, administers the anti-money laundering (AML) rules for broker dealers and other financial institutions under the Bank Secrecy Act (BSA). Among other obligations, the BSA requires broker dealers to implement Customer Identification Programs (CIPs) and perform Customer Due Diligence (CDD) (colloquially, "Know Your Customer" or KYC).

When the new beneficial ownership rule becomes mandatory in May 2018, broker dealers will be required to obtain from their legal entity customers the identity of (1) beneficial owners of 25% or more of the entity; and (2) a single individual with significant control over the entity, taken together to mean "beneficial owners." The legal entity customer is generally responsible for identifying the beneficial owners, and broker dealers may generally rely on the information provided by legal entity customers. FinCEN provides a sample Certification Form that account applicants may complete to provide beneficial ownership information, but broker dealers are not required to use it.

For any legal entity customer there must be between one and five beneficial owners. For example, if no individuals have a 25% or greater equity interest, then the only beneficial owner will be the control person. At most, there will be four individuals with 25% equity interest plus the control person. A "legal entity" is a corporation, LLC, or other entity "created by the filing of a public document with a Secretary of State or similar office, a general partnership, and any similar entity formed under the laws of a foreign jurisdiction that opens an account." There are a number of exclusions for certain types of legal entity customers, such as those listed on major U.S. stock exchanges, investment companies, and other regulated companies.

Note that broker dealers are not required to verify an individual's status as a beneficial owner. Rather, the broker dealer's verification procedures are limited to the individual's or entity's identity and must include the elements required under existing CIP requirements, including collection of customer information and use of documents or non-documentary methods for verification. One exception is that broker dealers will be permitted to rely on photocopies of documents identifying beneficial owners.

In addition, FinCEN recognizes that equity interests and the management team of a company can change over time. While FinCEN is not requiring broker dealers to monitor these developments, they are expected to update such information when they learn, through normal, risk-based monitoring, of ownership or management changes.

The new FinCEN rule is just one part of a larger regulatory focus on the risks presented by shell companies and other techniques used to obfuscate the identity of beneficial owners in financial transactions. These risks are highlighted by the recent scandals involving 1MDB, Malaysia's state development bank, and the fallout from the publishing of the Panama Papers. And, of course, in addition to these risks, all U.S. companies are prohibited from doing business with individuals or entities that appear on the Office of Foreign Assets Control (OFAC) Specially Designed Nationals (SDN) List of sanctioned persons and companies.

Given these challenges, broker dealers should incorporate beneficial ownership checks into their AML programs. While investment advisers are not directly subject to these requirements, it's a good idea for them to be aware of the new rule, too. FinCEN, as you may recall, proposed a rule in 2015 to establish AML program and CDD requirements for investment advisers required to be registered with the SEC (primarily large-sized advisers). Even if investment advisers remain outside the scope of these requirements, monitoring for beneficial ownership risks is a prudent action, given the current regulatory environment.

In addition to updating CIP requirements as noted in this article, there are a number of practical steps broker dealers should consider with respect to the new identification and verification requirements:

  • Updating customer data input screens to capture beneficial ownership information
  • Coordinating with AML software vendors to address collection and transfer of information
  • Updating account opening documents (applications, signature cards, certification forms)
  • Update policies and procedures (CIP and CDD, account opening, OFAC, CTRs, suspicious activity monitoring and reporting)
    • Addressing exclusions from / exceptions to the rule
    • Developing procedures for authenticating identity documents (which may be photocopied)
    • Identifying alternatives to using FCRA credit reports to verify beneficial owner identities
  • Training (employees and customers)
  • Updating risk assessments
  • Ensuring agreements with business partners / vendors regarding flowdown beneficial ownership rules (where appropriate)