Just over two years ago, an anxious group of bankers, broker-dealers, law enforcement agents and trade association representatives packed into a room on 1500 Pennsylvania Avenue in Washington, DC, for a rare public hearing called by the US Financial Crimes Enforcement Network (FinCEN).
The crowd was drawn there by FinCEN’s March 2012 “Advance Notice of Proposed Rulemaking (ANPR),” which laid out standards for customer due diligence at US financial institutions. While some attended to voice their support for the measures, many in the audience came with serious concerns over one unprecedented new obligation contained in the Advance Notice – a requirement to identify the beneficial owners behind legal entity customers.
As FinCEN takes the next step in its gradual rulemaking process, it appears the concerns expressed by the financial services industry two years ago have been heard loud and clear. Last week, the regulatory agency and US financial intelligence unit issued a “Notice of Proposed Rulemaking” on customer due diligence requirements for financial institutions. The latest rules ease compliance burdens on institutions substantially, compared to the obligations originally contemplated in the ANPR. FinCEN’s proposed rules now offer a narrower definition of “beneficial owner,” exclude many types of legal entities, and simplify procedures for identifying and verifying the true owners of legal entities.
Institutions would be allowed to collect beneficial ownership information through a standardized self-certification form, included in the proposed rules. While the ANPR would have forced institutions to verify that the beneficial owners listed by an account holder were actually the entity’s beneficial owners, the new proposed rules do away with this requirement.
Instead, institutions are only required to verify the identity of beneficial owners using existing customer identification processes, though they will still be required to dig through layers of corporate ownership in some cases.
Proposed rules raise questions on how to use beneficial owner data
The proposed rules are likely to come as a relief for the estimated 21,550 banks, securities broker-dealers and other institutions covered by them. The next critical question is how these institutions will be expected to use the new information they will be collecting on beneficial owners, says Robert Rowe, Senior Counsel with the American Bankers Association in Washington, DC.
“Once you have that information [on beneficial owners], what do you do with it?” asks Rowe. He cites several reporting and compliance questions that could arise related to beneficial ownership of customer accounts. How will beneficial ownership information factor into aggregating transactions for the purposes of filing Currency Transaction Reports? Should institutions factor in beneficial owners when monitoring for activity indicative of structuring, or when applying other ongoing monitoring rules on accounts?
Institutions will be seeking further guidance from FinCEN on “how information on beneficial ownership is supposed to feed into compliance and operations,” Rowe says.
The proposed rules indicate that beneficial ownership information should be collected and weighed as part of a customer risk assessment, although they stress that such data is only “one component of a broader profile that is necessary… to develop when assessing risk.”
“Beneficial ownership information is a means of building a more comprehensive risk profile; it is not an end in and of itself,” FinCEN states in the proposed rules.
Customer due diligence will be ‘fifth pillar’ of AML programs
FinCEN is currently accepting responses and feedback on the rules in a 60-day comment period, closing at the end of September.
Only financial institutions with existing customer identification programs would be required to comply with the beneficial ownership requirements, including banks, credit unions, broker-dealers, mutual funds, and futures merchants. However, FinCEN does note that in the future it will consider expanding coverage to other financial institutions, such as money services businesses, casinos and insurance companies.
The rules also narrow the types of legal entity customers that would be required to provide beneficial ownership information, covering only corporations, LLCs, and partnerships, and excluding trusts.
While the beneficial owner standards are the only truly new compliance obligation, the proposed rules also seek to clarify existing regulations on other aspects of customer due diligence. These focus on what FinCEN calls key elements of a CDD program – customer identification and verification, understanding the nature and purpose of customer relationships, and ongoing monitoring and updating of customer information.
By codifying these regulations, FinCEN says it is effectively adding CDD requirements as a “fifth pillar” of AML programs.
New proposed rules streamline and simplify beneficial owner standards
In the dozens of comment letters penned by the financial services industry after the ANPR, a recurring complaint was that the standards used to define a “beneficial owner” were overly complex and inapplicable. The ANPR asked institutions to identify any individual “with greater responsibility than any other individual for managing or directing the regular affairs” of a legal entity.
Many institutions argued they had no access to information that would allow then to determine this type of ownership, and that following such a standard would force employees to make their own uninformed judgment calls.
In the proposed rules, FinCEN acknowledges that commentators found its previous definition “conceptually confusing and unworkable in practice,” and replaces it with a streamlined version. Under the latest iteration of the rules, a beneficial owner would be a natural person who meets one of two standards, or “prongs:”
- “Each individual, if any, who, directly or indirectly… owns 25 percent or more… of a legal entity customer, and
- An individual with significant responsibility to control, manage, or direct a legal entity customer.”
The second of the two prongs would include senior managers or directors of an entity, such as CEOs, presidents, CFOs, general partners, or similar high-level positions.
Institutions would be asked to collect information on any individuals with a 25% or more ownership stake, if any exist. They would only be required to name one person who meets the second prong of “significant responsibility.” In both cases, the persons listed would have to be individuals, or “natural persons,” and cannot be other legal entities.
While the new definition removes much of the ambiguity from who can be considered a beneficial owner, the requirement to identify natural persons will still force institutions to peel back multiple corporate layers in some instances.
“FinCEN acknowledges that identifying the individuals who own… 25 percent or more of… a legal entity may not be straightforward in every circumstance,” the rules state, going to say that “several intermediate analytic steps” may be required for complex ownership structures.
Nevertheless, the rules are unambiguous on the requirement to identify actual individuals, “regardless of how many corporate parents or holding companies removed the natural person is from the legal entity customer. “
Self-certification is primary tool for collecting ownership information
Institutions would use a self-certification form to collect information from an individual opening an account for certain types of legal entities at the time of onboarding. FinCEN provides a relatively straightforward model self-certification form on pages 80 and 81 of the proposed rules.
The form provides the definition of “beneficial owner” set out in the rules, and asks the person opening the account to list the names, dates of birth, addresses, and tax identification numbers of any persons meeting those definitions.
In one of the most significant departures from the ANPRM, FinCEN’s latest proposal would no longer require financial institutions to verify that the individuals listed as beneficial owners on the self-certification were actually the owners of the legal entity. This is referred to as verifying “status” of beneficial owners in the proposed rules.
Instead, institutions will be allowed to simply verify that the persons listed as the beneficial owners exist, using procedures already in place from their customer identification program to confirm their identity. In many cases, institutions will be able to satisfy this requirement by collecting a driver’s license, passport, or similar government-issued documentation for the individuals listed as beneficial owners.
The changes reflect FinCEN’s willingness to listen and respond to the financial services industry, Rowe notes.
“It’s obvious FinCEN did seriously consider the concerns raised,” he says, “[the agency] also considered that in many cases verification of beneficial owner status is just not possible. Banks [and other institutions] in the US have no resources to obtain this information.”
US financial institutions have long argued that their hunt for the true owners of companies is hamstrung by the fact that US state agencies collect little to no information on beneficial owners at the time of incorporation.
Other nations, particularly in the European Union, have moved forward with plans to create publicly accessible corporate registries that include beneficial ownership data. While bills requiring nation-wide collection of beneficial owner information on companies have been introduced in the US Congress every year since 2008, little progress has been made on their adoption.
New CDD obligations will play key role in global tax evasion hunt, says FinCEN
As the US continues its global hunt for offshore tax evaders and financial institutions around the world struggle to implement Foreign Account Tax Compliance Act (FATCA), FinCEN draws a direct connection between tax enforcement and beneficial ownership in the proposed rules.
“Information held by banks and other financial institutions about the ownership of companies can be used to assist law enforcement in identifying the true owners of assets and their true tax liabilities,” the rules state, going on to say that “strengthening CDD is an important part” of the effort to crack down on cross-border tax evasion.
To date, the US Treasury has signed nearly 100 “intergovernmental agreements” with other nations, enlisting them as partners in FATCA implementation. Many of these agreements require US institutions to report information on accounts held by residents of other nations for tax purposes, including accounts held by foreign legal entities. Unlike financial institutions in FATCA partner nations, US institutions are not currently required to identify and report the beneficial owners of foreign entities.
As FinCEN notes, those requirements may very well change soon. As FATCA obligations expand, and new tax information exchange systems develop, US institutions will likely be forced to identify and report on the owners of certain legal entities in the near future. The proposed rules are one way to prepare for that new reality.
“A general requirement for U.S. financial institutions to obtain beneficial ownership information for AML purposes advances this commitment [made in intergovernmental agreements], and puts the United States in a better position to work with foreign governments to combat offshore tax evasion and other financial crimes,” the proposed rules state.
No timeline on final rules
Once the proposed rules become finalized, FinCEN expects institutions will have one year to implement new CDD measures and prepare to comply.
The regulator even provides some detailed estimates of the number of additional hours the new beneficial owner requirements will demand from institutions. Estimating that 21,550 institutions will be covered by the new rules, FinCEN states the new rules will generate approximately 2,715,300 hours of recordkeeping and reporting requirements for US institutions annually.
Currently, FinCEN has not provided any indication of when final rules can be expected, although the wait could be shorter than the two-year period between the ANPR and proposed rules.
“It may go faster now, but the unknown is the comments that FinCEN will get back,” says Rowe. “I think they were surprised at the volume of responses they’ve already received.”