Proposed FinCEN Rules Define Beneficial Ownership

The Financial Crimes Enforcement Network recently issued a notice of proposed rule making that clarifies and strengthens existing customer due diligence requirements under the Bank Secrecy Act and establishes a definition for determining beneficial ownership through a two-prong test.

Under the proposed amendments to the BSA, financial institutions would be required to use a two-prong test to identify and verify the identities of the individuals, known as beneficial owners who own, control and profit from the companies that they service. This notice would provide more consistency in how financial institutions and regulators apply existing due diligence rules and would enhance financial transparency. The proposed rules apply to banks and other financial institutions, including broker-dealers, mutual funds, futures commission merchants and introducing brokers.

Customer Due Diligence

There are four key elements that comprise the minimum standard of customer due diligence, which FinCEN believes is fundamental to effective antimoney-laundering program.

1. Identifying and verifying the identity of customers

Financial institutions are required to have a written customer identification program as part of their BSA-AML compliance program. The CIP must be appropriate for the institution’s size and type of business and must include certain minimum requirements.

2. Identifying and verifying the identity of beneficial owners of legal entity customers

FinCEN has proposed a two-part definition of “beneficial owners” with components referred to as “prongs,” which are each intended to be an independent test. The ownership prong is to identify individuals with substantial equity ownership interest. The control prong is to identify individuals with management control.

• 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 or
• Control prong: An individual with significant responsibility to control, manage, or direct a legal entity customer, including (a) an executive officer or senior manager or (b) any other individual who regularly performs similar functions

3. Understanding the nature and purpose of customer relationships

In its notice of proposed rule making, FinCEN says it believes financial institutions should already be satisfying the third element of CDD by complying with existing suspicious activity reporting and AML program requirements. This element is intended to clarify existing expectations for financial institutions to understand the relationship and the purposes of the account.

4. Conducting ongoing monitoring

The fourth element of customer due diligence requires financial institutions to conduct ongoing monitoring to maintain and update customer information and to identify and report suspicious activity. Ongoing monitoring is already necessary under current regulatory requirements, so FinCEN expects that financial institutions should already be in compliance with this element. By including this obligation in its AML program requirements, FinCEN wanted to make clear that the minimum standards of CDD include ongoing monitoring of all transactions.

Enhancing Transparency

The U.S. Department of the Treasury is focused on enhancing financial transparency to make it easier for financial institutions and law enforcement to identify the assets and accounts of criminals and combat national security threats.

Customer due diligence is fundamental to mitigating the risk of illicit financial activities. The proposed rules to clarify and strengthen the CDD requirements for U.S. financial institutions aim to advance the purpose of the BSA by:

• Aiding law enforcement with financial investigations
• Combating terrorism and other national security threats
• Improving a financial institution’s ability to assess and mitigate risk
• Facilitating tax reporting, investigations and compliance
• Promoting clear and consistent expectations and practices

What does this mean for financial institutions?

FinCEN’s recent notice establishes for the first time a 25 percent ownership threshold for identifying beneficial owners and provides a two-prong test for determining ownership or control. Before this guidance, financial institutions were left to use their discretion to decide at what threshold of ownership they applied CDD to legal entity owners, which created an inconsistent application of the CDD rules. This guidance would provide more consistency in how financial institutions and regulators apply the CDD rules.

Covered financial institutions must be prepared to demonstrate that they not only verify the identity of the customer, but also that they identify and document the beneficiary owner and control person. In addition, they must demonstrate their understanding of the nature and purpose of each account and conduct ongoing CDD monitoring to identify and report suspicious activities.

If the rule is passed as proposed, the effective date of the rule will be one year after the date that the final rule is issued.