Part One – What is the rule and What Does it mean to Me?
On May 11, 2016, the Financial Crimes Enforcement Network (“Fincen”) announced its final rule strengthening the due diligence requirements for covered financial institutions. This rule is generally known as the “beneficial ownership rule”. This rule represents a significant change in the overall administration of Bank Secrecy Act/Anti-Money laundering (“BSA/AML”) compliance programs. The purpose of the change was made clear in Fincen’s announcement of the final rule”
“Covered financial institutions are not presently required to know the identity of the individuals who own or control their legal entity customers (also known as beneficial owners). This enables criminals, kleptocrats, and others looking to hide ill-gotten proceeds to access the financial system anonymously. The beneficial ownership requirement will address this weakness[1]
Put another way, the purpose of this rule is to address one of the biggest weaknesses in the current system for identifying suspicious activity. The fact that that financial institutions have been required to obtain information about a legal entity without considering the ownership and /or control of the legal entity has allowed many a “bad guy” to effectively hide his/her illicit activity. The preamble to the rules lists out several examples of how legal entities have been taken over by criminals in an effort to launder money. Some of the more interesting examples included:
- A series of shell companies that were used to take over and loot a publicly traded mortgage company.
- Using a series of small legal entities to cover a drug smuggling ring
- Using a series of companies that were ostensibly for movie production to hide large amounts of cash that was being used for human trafficking
In all of the cases that were cited, the common feature was the ownership and control of the legal entities was obscured by a complex holding structure. The beneficial ownership rule is designed to addresses this practice. The rule requires that a financial institution doing business with a legal entity should know who owns and controls the entity. This is the enumerated requirement. However, it should be the understood that simply knowing this information is not enough. Once the due diligence information is obtained, it is critical to ensure that it makes sense in context. For example, does it really make sense that a flower shop owner also owns a casino? These business are entirely unrelated except for the fact that they are both often cash intensive businesses.
The Rule Itself
The final rule creates a “fifth pillar” in the standard group of expectations for a comprehensive BSA/AML compliance program. Ongoing and risk based due diligence for customers will now be considered an essential part of the compliance program. The rule makes due diligence a dynamic process rather than the traditional process that essentially ended at the time the account was opened. Financial institutions are expected to stay abreast of who the beneficial owners of a legal entity are and how their ownership might impact ongoing monitoring of the account. As the beneficial owners change, then the manner in which the account is viewed should change accordingly.
Beneficial Ownership is a broad definition that includes both ownership and control.
Ownership – is denied as any person who directly or indirectly owns more than 25 percent of the equity of a legal entity
Control – The term “beneficial owner” means a single individual with significant responsibility to control, manage, or direct the legal entity customer (e.g., a Chief Executive Officer, Vice President, or Treasurer).
These two prongs are critical because there are many times when a person or persons could actually have a minimal ownership stake in a firm or even no actual legal ownership, but still have the ability to control the firm. The rule requires all covered institutions to obtain information on all people who own or control a legal entity.
Financial institutions are expected to design policies and procedures that detail how staff will use their best efforts to establish and maintain written procedures that are reasonably designed to identify and verify beneficial owners of a legal entity customer. The procedures must allow the financial institution to identify all beneficial owners of each legal entity customer at the time of account opening unless an exclusion or exemption applies to the customer or account. [2]
Why Wait?
The rule requires all covered institutions to be in compliance by May of 2018. Covered institutions in this case means:
“For purposes of the CDD Rule, covered financial institutions are federally regulated banks and federally insured credit unions, mutual funds, brokers or dealers in securities, futures commission merchants, and introducing brokers in commodities” [3]
Though this rule only technically only applies to covered institutions, it will be prudent for all financial institutions to become familiar with the requirements of the regulations and to apply the standards enumerated therein. Financial institutions will expect that their Money Service Businesses meet the same standards because the risks for undetected suspicious activity is the same.
There is absolutely no reason to wait to implement the principals detailed in the rule. By developing policies and procedures that are able to determine beneficial ownership, a financial entity can have more effective risk mitigation of its customer base. At the end of the regulatory day, knowing your customers and what it is that they do is the heart of any string AML Compliance program
In Part Two- we will discuss the details of a strong beneficial ownership program.
[1] http://www.federalregister.gov/articles/2016/05/11/2016-10567/customer-due-diligence-requirements-for-financial-institutio
[2] These excluded entities include banking organizations; entities that have their common stock listed on the New York, American, or NASDAQ stock exchanges; SEC-registered investment companies and advisers; CFTC-registered entities; state-regulated insurance companies; foreign financial institutions established in jurisdictions that have beneficial ownership reporting regimes; and legal entities with private banking accounts subject to FinCEN rules
[3] FIN-2016-G003 questions
James DeFrantz 