New Proposed AML Customer Due Diligence Requirements

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The Financial Crimes Enforcement Network (FinCEN) is proposing new rules under the Bank Secrecy Act (BSA) to clarify and strengthen customer due diligence (CDD) requirements for banks, broker-dealers, mutual funds, and futures commission merchants and introducing brokers in commodities. The proposed rules would address CDD elements related to identifying and verifying the identity of beneficial owners of legal entity customers (i.e., the natural persons who own or control legal entities), understanding the nature and purpose of customer relationships, and conducting ongoing monitoring to maintain and update customer information and to identify and report suspicious transactions.

FinCEN is addressing those three elements via two rule changes. First, FinCEN is addressing the need to collect beneficial owner information on the natural persons behind legal entities by proposing a new separate requirement to identify and verify the beneficial owners of legal entity customers, subject to certain exemptions. Second, FinCEN is proposing to add explicit CDD requirements with respect to understanding the nature and purpose of customer relationships and conducting ongoing monitoring as components in each covered financial institution’s core AML program requirements.

In the Notice of Proposed Rulemaking (NPRM) issued by FinCEN, it was noted that the proposed rules would clarify and strengthen CDD requirements for U.S. financial institutions, 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;
  •  Increasingthe 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 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 the implementation and enforcement of CDD regulatory expectations across and within financial sectors.

Identification of Beneficial Owners

In the NPRM, FinCEN proposes a new requirement that financial institutions identify the natural persons who are beneficial owners of legal entity customers, subject to certain exemptions. The definition of ‘‘beneficial owner’’ proposed herein requires that the person identified as a beneficial owner be a natural person and the financial institution would satisfy this requirement by obtaining at the time a new account is opened a Certification Regarding Beneficial Owners of Legal Entity Customers Form (Entity Customer Certification Form) directly from the individual opening the new account on behalf of the legal entity customer.

Proposed Definition of “Beneficial Owner”

FinCEN proposes the following definition of ‘‘beneficial owner’’ of a legal entity customer, which includes an ownership prong and a control prong:

  • Ownership Prong: Each individual, if any, who, directly or indirectly, through any contract, arrangement, understanding, relationship or otherwise, owns 25 percent or more of the equity interests of a legal entity customer; and
  • Control Prong: (i) An individual with significant responsibility to control, manage, or direct a legal entity customer, including an executive officer or senior manager (e.g., a Chief Executive Officer, Chief Financial Officer, Chief Operating Officer, Managing Member, General Partner, President, Vice President, or Treasurer); or (ii) Any other individual who regularly performs similar functions.

Each prong of the definition is intended to be an independent test. Under the ownership prong of the definition, a financial institution must identify each individual who owns 25 percent or more of the equity interests. Thus, a financial institution would be required to identify no more than four direct individuals under this prong, and, if no one individual owns 25 percent or more of the equity interests, then the financial institution would identify no individuals under the ownership prong. However, FinCEN’s expectation is that a financial institution will identify the natural person or persons who exercise control of a legal entity customer through a 25% or greater ownership interest, regardless of how many corporate parents or holding companies removed the natural person from the legal entity customer.

Customers Exempt from Customer Identification Procedures (CIP)

FinCEN proposes to exempt from the beneficial ownership requirement those types of entities that are currently exempt from the customer identification requirements under the CIP rules. Those types of entities include, but are not limited to, financial institutions regulated by a federal functional regulator (i.e., federally regulated banks, brokers or dealers in securities, mutual funds, futures commission merchants and introducing brokers in commodities), publicly held companies traded on certain U.S. stock exchanges, domestic government agencies and instrumentalities and certain legal entities that exercise governmental authority.

Additionally, it was noted that the following entities also be exempt from the beneficial ownership requirement when opening a new account because their beneficial ownership information is generally available from other credible sources:

  • An issuer of a class of securities registered under Section 12 of the Securities Exchange Act of 1934 or that is required to file reports under Section 15(d) of that Act;
  • Any majority-owned domestic subsidiary of any entity whose securities are listed on a U.S. stock exchange;
  • An investment company, as defined in Section 3 of the Investment Company Act of 1940, that is registered with the SEC under that Act;
  • An investment adviser, as defined in Section 202(a)(11) of the Investment Advisers Act of 1940, that is registered with the SEC under that Act;
  • An exchange or clearing agency, as defined in Section 3 of the Securities Exchange Act of 1934, that is registered under Section 6 or 17A of that Act;
  • Any other entity registered with the Securities and Exchange Commission under the Securities and Exchange Act of 1934.
  • A registered entity, commodity pool operator, commodity trading advisor, retail foreign exchange dealer, swap dealer, or major swap participant, each as defined in section 1a of the Commodity Exchange Act, that is registered with the CFTC;
  • A public accounting firm registered under section 102 of the Sarbanes-Oxley Act; and
  • A charity or nonprofit entity that is described in Sections 501(c), 527, or 4947(a)(1) of the Internal Revenue Code of 1986, that has not been denied tax exempt status, and that is required to and has filed the most recently required annual information return with the Internal Revenue Service.

Existing and New Customers

The beneficial ownership requirements, including the obligation to obtain an executed Entity Customer Certification Form will apply only with respect to legal entity customers that open new accounts going forward from the date of implementation. Thus, the rules proposed by FinCEN do not require financial institutions to look back and obtain beneficial ownership information for pre-existing accounts; however, to the extent an existing client opens a new account after the implementation date, that customer would be subject to the new beneficial ownership rules.

Nature and Purpose of Customer Relationships and Monitoring for Suspicious Activity

The proposed rule amendments to the AML program that address the nature and purpose of customer relationships and the monitoring of suspicious activity are intended to harmonize these elements of CDD with existing AML obligations.

Understanding the Nature and Purpose of Customer Relationships

This element of CDD requires financial institutions to understand the nature and purpose of customer relationships in order to develop a customer risk profile. FinCEN noted that the proposed rule amendments would not necessarily require modifications to existing practice or customer onboarding procedures, and did not expect financial institutions to ask each customer for a statement as to the nature and purpose of the relationship or to collect information not already collected pursuant to existing requirements. Rather, the amendment to the AML program rule that incorporates this element is intended to clarify existing expectations for financial institutions to understand the relationship for purposes of identifying transactions in which the customer would not normally be expected to engage. FinCEN believes that identifying such transactions is a critical and necessary aspect of complying with the existing requirement to report suspicious activity and maintain an effective AML program.

Ongoing Monitoring

This element of CDD requires financial institutions to conduct ongoing monitoring for the purpose of maintaining and updating customer information and identifying and reporting suspicious activity. As with the proposed rule regarding the prior element of CDD, FinCEN believes that this proposed rule amendment is necessary to clarify the minimum standards of CDD, include ongoing monitoring of all transactions by or through a financial institution. Because financial institutions are already implicitly required to engage in ongoing monitoring, FinCEN expects that financial institutions would satisfy this element of CDD by continuing their current monitoring practices, consistent with existing guidance and regulatory expectations.

Rule Timing and Effective Date

Other than revisions to written policies and procedures that would be necessitated by the proposed rules, FinCEN believes that the two CDD requirements will not require covered financial institutions to perform any additional activities or operations. However, as a result of the modifications that will be required to customer onboarding processes to incorporate the beneficial ownership requirement, FinCEN proposed an effective date of one year from the date the final rule is issued. As the proposed rule is still in the comment period, it is not likely at this time that the effective date will be before 2016.

We hope that this information has been helpful to you. Should you have any additional questions or concerns, please feel free to contact Daniel E. LeGaye or Michael Schaps by e-mail or phone, at 281-367-2454, or consult with your legal counsel or compliance consultant. This legal update has been provided to you courtesy of The LeGaye Law Firm, P.C., 2002 Timberloch Drive, Suite 200, The Woodlands, Texas 77380. Visit our web site at www.legayelaw.com.

The information contained herein is not, nor is it intended to be legal advice or establish or further an attorney-client relationship. All facts and matters reflected in this information should be independently verified and should not be taken as a substitute for individualized legal advice. You should consult an attorney for individual advice regarding your own situation. Not Board Certified by Texas Board of Legal Specialization. Michael Schaps is not an attorney.