On August 4, 2014, the U.S. Treasury Department’s Financial Crimes Enforcement Network (“FinCEN”) issued proposed rules to clarify and strengthen customer due diligence (“CDD”) requirements under the Bank Secrecy Act for banks, brokers, or dealers in securities, mutual funds, and futures commission merchants and introducing brokers in commodities transactions (collectively, “covered financial institutions”). Under the proposed rules, covered financial institutions would be required to identify and verify the natural persons behind legal entity customers (beneficial owners), subject to certain exemptions. The new CDD requirements may present significant compliance challenges for covered financial institutions. The proposed rules can be found here.
Four Elements of Customer Due Diligence
FinCEN considers CDD as consisting of the following four elements: (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 to identify and report suspicious transactions. Under FinCEN’s existing rules, the first element of CDD is already satisfied by the existing customer identification programs (“CIPs”) of covered financial institutions. Further, according to FinCEN, the third and fourth elements do not impose new requirements, and instead, codify existing supervisory and regulatory expectations for covered financial institutions. According to FinCEN, the only new requirement in the proposed rules is the obligation to take explicit steps to identify and verify the identity of the natural persons who are the beneficial owners of legal entity customers.
Definition of Beneficial Owner
For the purpose of the proposed rules, FinCEN has proposed a two-pronged definition of “beneficial owner.” Under the first prong, the ownership prong, each individual who, directly or indirectly, owns 25% or more of the equity interests, e.g., shares of stock in a corporation or membership interests in a limited liability company, of a legal entity customer is considered a beneficial owner. Under the second prong, the control prong, each individual 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) is considered a beneficial owner. Covered financial institutions would be required to identify any individuals satisfying the criteria for either prong. A maximum of four people may be identified under the ownership prong, and if no natural person reaches the 25% threshold, the covered financial institution may not have to identify any individuals under the ownership prong. Under the control prong, however, covered financial institutions are required to identify one individual regardless of how many individuals are named under the ownership prong. If one individual is both a 25% owner and meets the definition of control, he or she may be identified as a beneficial owner under both prongs.
Identifying and Verifying the Identity Of Beneficial Owners
At the time a new account is opened, covered financial institutions would be required to identify and verify the beneficial owners of legal entity customers by obtaining a standard certification form from the individual opening the account on behalf of the legal entity customer. This standard certification form would require the individual to (1) identify and provide basic information for any beneficial owners of the legal entity customer; and (2) certify the genuineness of the information provided. Under the proposed rules, covered financial institutions could rely on the representations of this individual for purposes of complying with the beneficial ownership requirement. FinCEN has made clear that the proposed rules would require covered financial institutions to verify the identity of any individual named as beneficial owner (by collecting a driver’s license, passport, or similar document), but not the individual’s status as beneficial owner.
The proposed rules exempt two categories of entities by excluding them from the “legal entity customer” definition. The first category includes entities that are currently exempt under FinCEN’s existing CIP rules, e.g., certain federally registered financial institutions (including banks and broker-dealers), publicly held companies traded on certain U.S. stock exchanges, and certain U.S. government agencies and related bodies. Second, FinCEN proposes to expressly exclude entities for which beneficial ownership information is generally available from other credible sources. Accordingly, under the proposed rules, covered financial institutions would not be required to identify and verify the beneficial ownership for the following types of entities:
- investment companies registered with the U.S. Securities and Exchange Commission (the “SEC”);
- investment advisors that are registered with the SEC;
- certain U.S. publicly listed companies and their majority-owned domestic subsidiaries;
- certain U.S. government agencies;
- certain issuers of securities registered with the SEC under the Securities Exchange Act of 1934 (the “Exchange Act”);
- exchanges or clearing agencies registered under Section 6 or 7A of the Exchange Act;
- any other entity registered with the SEC or under the Exchange Act;
- registered entities, commodity pool operators, commodity trading advisors, retail foreign exchange dealers, or major swap participants registered with the U.S. Commodity Futures Trading Commission;
- public accounting firms registered under Section 102 of the Sarbanes-Oxley Act; and
- certain charities or nonprofit entities as described in the Internal Revenue Code of 1986.
Additionally, because of the potential difficulty of identifying potential owners of nonexempt pooled investment vehicles, such as hedge funds, FinCEN is also considering whether such vehicles should be exempt from the new requirements.
Effective Date, New Accounts Only and No Duty to Update
FinCEN proposed an effective date for the proposed rules of one year from the date the final rules are issued in order to provide covered financial institutions with adequate time to implement the new CDD requirements. Although covered financial institutions would not be required to update the beneficial ownership information obtained under the proposed rules, covered financial institutions should update CDD information, including beneficial information, as appropriate, when updating a customer’s risk profile.