FinCen Updates Customer Due Diligence Requirements

Modern entertainment, whether it be books or movies,  oftentimes grapple with the issues of “who are you?” As a story line develops the audience is kept guessing as characters turn out to have different motivations or identities than what they were first perceived to have. Political thrillers oftentimes involve agents of shadowy groups behind which the true masterminds operate. How much effort will it take to reach the truth? FinCEN has recently come out with some proposed guidance that addresses this issue in the context of the legal entities that financial institutions do business with.

In a proposed rulemaking published in late July, FinCEN proposed a new regulatory requirement to identify beneficial owners of legal entity customers. Going forward, the essential elements of customer due diligence will include: (i) identifying and verifying the identity of customers; (ii) identifying and verifying the identity of beneficial owners of legal entity customers (i.e., the natural persons who own or control legal entities); (iii) understanding the nature and purpose of customer relationships; and (iv) conducting ongoing monitoring to maintain and update customer information and to identify and report suspicious transactions.

The first element is already something which financial institutions address as part of their customer identification program (“CIP”). The second element is the subject of the proposed rulemaking. In order to identify the beneficial owner, a covered financial institution must obtain a certification from the individual opening the account on behalf of the legal entity customer (at the time of account opening). The certification form  requires the individual opening the account on behalf of a legal entity customer to identify the beneficial owner(s) of the legal entity customer by providing the beneficial owner’s name, date of birth, address and social security number (for U.S. persons). Significantly, the rule also requires financial institutions to verify the identity of the individuals identified as beneficial owners on the certification form. The procedures for verification are to be identical to the procedures applicable to an individual opening an account under the existing CIP rules.

The proposed definition of “beneficial owner” includes two independent prongs: an ownership prong (clause (1)) and a control prong (clause (2)). A covered financial institution must identify each individual under the ownership prong (i.e., each individual who owns 25 percent or more of the equity interests), in addition to one individual for the control prong (i.e., any individual with significant managerial control). If no individual owns 25 percent or more of the equity interests, then the financial institution may identify a beneficial owner under the control prong only. If appropriate, the same individual(s) may be identified under both criteria.

As a practical matter the control prong will sweep up everyone in the senior management of a company including the Chief Executive Officer, Chief Financial Officer, Chief Operating Officer, Managing Member, General Partner, President, Vice President, or Treasurer). It will also cover anyone who regularly performs similar functions. Thus, the test is not solely measured by one’s actual title but includes individuals who may be functioning in the capacity of a senior officer. This could implicate consultants that boards sometimes reach out to when a company is seeking assistance on strategic planning or restructuring depending on the consultant’s level of involvement with management decisions. Assuming that the rule is adopted “as is” financial institutions will need to be sensitive to this point and make sure that they understand if there are in fact any “shadow” officers.

The proposed rule contains a number of exemptions including publicly traded companies, swap dealers, banks, investments companies and certain charities, among others.

The enhanced customer due diligence is expected to assist to government in its enforcement of the Bank Secrecy Act in several ways. (i) assisting financial investigations by law enforcement generally: (ii) advancing counterterrorism efforts; (iii) assisting banks to better assess and manage risk; and (iv) facilitating tax compliance, particularly as it applies to foreign account tax compliance.

The proposed rulemaking will be open for comment until late September, 2014