Background
Customer identification and verification
Account nature and purpose
Obtaining beneficial ownership information

Ongoing customer due diligence
Additional issues for comment



Background

On March 5 2012 the Treasury Department's Financial Crimes Enforcement Network (FinCEN) published in the Federal Register an advance notice of proposed rulemaking pertaining to the development of a customer due diligence regulation applicable to banks, securities brokers and dealers, mutual funds and futures commission merchants which focuses on the collection of beneficial ownership information about account holders.(1)

The customer due diligence proposal arises out of FinCEN's concern that there is a lack of consistency in the way in which financial institutions implement what it terms 'implicit' customer due diligence obligations and they collect beneficial ownership information. For many financial institutions, the proposal may significantly increase their overall anti-money laundering compliance burden.

Comments on the proposal are due before May 4 2012. Generally, the proposal consists of four conceptual elements, the key aspects of which include a proposed new definition of 'beneficial ownership' that focuses on legal entities and a categorical requirement for financial institutions to identify beneficial ownership of their account holders, subject to limited potential exceptions.

FinCEN states that it is considering extending customer due diligence requirements as outlined in the proposal to other financial institutions (subject to FinCEN's regulations), such as money services businesses, including providers of prepaid access, insurance companies, casinos, dealers in precious metals, stones and jewels and non-bank mortgage lenders or originators. The proposal, in many cases, seeks to build on existing regulations that impose customer-identification programme and anti-money laundering programme requirements.

This update presents the basic elements of the proposal and outlines some of the issues regarding those elements on which FinCEN has solicited comment. Financial institutions that are, or could potentially be, covered by the proposal should review their existing customer identification programme and anti-money laundering policies and procedures to assess whether existing business practices and compliance programmes would enable them to meet the elements of the proposal.

Customer identification and verification

The first element of the proposal focuses on conducting initial due diligence on customers at the time of account opening. Specifically, this element would require covered financial institutions to verify the identity of each customer to a reasonable extent (such that the institution can form a reasonable belief that it knows the true identity of each customer). FinCEN states that this element of the proposal is largely consistent with existing customer identification programme obligations and has expressed the view that it would impose no new or additional requirements. However, FinCEN notes that current customers, banks, governmental entities and publicly traded companies are exempt from existing customer identification programme requirements, and has requested comment on whether the beneficial ownership requirement should apply with respect to those exempt customers.

Account nature and purpose

The second element of the proposal addresses the supervisory expectation that arises in connection with suspicious activity reporting. With respect to this element, FinCEN has proposed language that would require covered financial institutions to understand the nature and purpose of the account and expected activity associated with the account, for the purpose of assessing risk and identifying and reporting suspicious activity. FinCEN states that this element of the proposal would impose no new or additional requirements on financial institutions, given existing guidance in this area and the obligation to detect and report suspicious activity; however, no such obligation is express in existing regulations.

Obtaining beneficial ownership information

The third element of the proposal would expand on the two limited situations where covered financial institutions are currently obligated by regulation to obtain beneficial ownership information – in connection with certain correspondent accounts for foreign banks and private banking accounts – by imposing what FinCEN describes as a categorical requirement (subject to potential limited exceptions) to obtain such information for all customers. Thus, under this element of the proposal, financial institutions would be required to identify the beneficial owner(s) of all customers and to verify the beneficial owners' identities pursuant to a risk-based approach. FinCEN states that it anticipates providing additional guidance regarding entities that would be considered both low and high-risk customers, as well as guidance on what covered financial institutions should do in the event that they are unable to identify or verify a beneficial owner.

As part of this element of the proposal, FinCEN is considering a definition of a 'beneficial owner' that would capture either:

  • each of the parties which, directly or indirectly, through any contract, arrangement, understanding, relationship, intermediary, tiered entity or otherwise owns more than 25% of the equity interests in the entity; or
  • if there is no party which satisfies the first prong, then the party which, directly or indirectly, through any contract, arrangement, understanding, relationship, intermediary, tiered entity or otherwise has at least as great an equity interest in the entity as any other party.

In addition, the party with greater responsibility than any other party for managing or directing the regular affairs of the entity would also be considered a beneficial owner. FinCEN anticipates that this definition would generally apply to legal entity customers and would not be used for purposes of current requirements (ie, those imposed in connection with certain correspondent accounts for foreign banks and private banking accounts).

In addition, recognising that covered financial institutions may not have beneficial ownership information on existing customers, FinCEN is also considering whether and how the proposal would apply to existing customers of such institutions and is seeking comment on how a beneficial ownership identification requirement could be phased into ongoing customer due diligence.

Of interest to issuers of prepaid cards and other institutions that hold assets in omnibus or other intermediated accounts, FinCEN has requested comment on the difficulties associated with identifying beneficial owners in connection with such accounts. This aspect of the proposal will also be significant to various investment vehicles that maintain accounts at regulated institutions. FinCEN states that it is considering whether a potential explicit obligation to identify the beneficial owners of assets in those accounts should be based on the financial institution's risk assessment of the customer, or whether a more specific obligation would be appropriate.

With respect to account opening, FinCEN anticipates that, in general, the party opening the account on behalf of a legal entity customer will identify its beneficial owner, and that covered financial institutions will generally be able to rely on the beneficial ownership information presented by the customer. With respect to verification of that information, FinCEN has identified two possible approaches on which comment is sought. The first approach would require the financial institution to verify the identity of the party identified by the customer as the beneficial owner of the account (ie, verifying the existence of the identified beneficial owner). The second approach would require the financial institution to verify that the party identified by the customer as the beneficial owner is indeed the beneficial owner of the customer (ie, verifying the status of the identified party), which is a much more challenging effort. In either case, FinCEN contemplates that the required procedures would need to be reasonable and practicable and sufficient to form a reasonable belief that the financial institution knows the identity or status of the beneficial owner.

Ongoing customer due diligence

The fourth element of the proposal addresses ongoing due diligence with respect to customer relationships. Observing that due diligence is an ongoing obligation and requires financial institutions to have policies and procedures in place to maintain the accuracy of their customer risk profiles, FinCEN is proposing to require covered financial institutions to establish and maintain appropriate policies, procedures and processes for conducting ongoing monitoring of all customer relationships and additional customer due diligence as appropriate based on such monitoring for the purpose of the identification and reporting of suspicious activity. As with the first and second elements, FinCEN asserts that this element of the proposal is consistent with existing regulatory compliance obligations (ie, requirements contained in the anti-money laundering and suspicious activity reporting rules) and would not impose any new or additional requirements.

Additional issues for comment

In addition to the issues identified above on which comment has been requested, FinCEN has posed a variety of additional questions that are designed to assist it in better understanding what types of customer due diligence information are currently collected, specifically in relation to beneficial ownership information, and under what circumstances such information is collected. These questions ask financial institutions to address, among other things, issues that may arise in the context of implementing the proposal, including any impact on consumers and customers, and the processes through which institutions currently obtain beneficial ownership information. As noted above, comments on these and the other issues raised by the proposal must be submitted to FinCEN before May 4 2012.

For further information on this topic please contact Joel D Feinberg, David E Teitelbaum or Ryan H Rogers at Sidley Austin LLP by telephone (+1 202 736 8000), fax (+1 202 736 8711) or email ([email protected], [email protected] or [email protected]).

Endnotes

(1) See 77 Fed Reg 13,046 (March 5 2012), accessible at www.gpo.gov/fdsys/pkg/FR-2012-03-05/pdf/2012-5187.pdf.