CDD and the Interaction of the Beneficial Ownership threshold with other AML program obligations
10 September 2018
Revised by Bachir El Nakib (CAMS), Senior Consultant, Compliance Alert (LLC).
The Financial Crimes Enforcement Network (FinCEN) grants exceptive relief under the authority set forth in 31 U.S.C. § 5318(a)(7) and 31 CFR § 1010.970(a) to covered financial institutions from the obligations of the Beneficial Ownership Requirements for Legal Entity Customers (Beneficial Ownership Rule)1 1. 31 CFR §1010.230. “Covered financial institutions” are banks, brokers or dealers in securities, mutual funds, futures commission merchants, and introducing brokers in commodities. and its requirement to identify and verify the identity of the beneficial owner(s) when a legal entity customer opens a new account as a result of the following:
• A rollover of a certificate of deposit (CD) (as defined below);
• A renew al, modification, or extension of a loan (e.g., setting a later payoff date) that does not require underwriting review and approval;
• A renew al, modification, or extension of a commercial line of credit or credit card account (e.g., a later payoff date is set) that does not require underwriting review and approval; and
• A renew al of a safe deposit box rental.
The exception only applies to the rollover, renewal, modification or extension of any of the types of accounts listed above occurring on or after May 11, 2018, and does not apply to the initial opening of such accounts.2 2. covered financial institutions are not excepted from the obligation to identify and verify the identity of the beneficial owner(s) of legal entity customers at the initial account opening for such accounts occurring on or after May 11, 2018. Notwithstanding this exception, covered financial institutions must continue to comply with all other applicable anti-money laundering (AML) requirements under the Bank Secrecy Act (BSA) and its implementing regulations, including program, recordkeeping, and reporting requirements.
On August 8, 2018, the Financial Crimes Enforcement Network (FinCEN) extended for an additional 30 days the exceptive relief granted to covered financial institutions from collecting beneficial ownership information on certain accounts that automatically renewed or rolled over.
The extension provides additional time to financial institutions still grappling with how to develop and implement controls for accounts that existed before the beneficial ownership rule's May 11, 2018 effective date and whose renewals or rollover qualify as a "new account" under the beneficial ownership rule, even if the legal entity customer is an existing customer.
Financial institutions' difficulties implementing controls relating to this issue stem from FinCEN's interpretation that a renewal or rollover of certain products is considered the establishment of another formal relationship and, thus, the opening of a new account. Although FinCEN clarified its position on this issue in its April 3, 2018 Frequently Asked Questions Regarding Customer Due Diligence Requirements For Financial Institutions (FAQs) below:
On April 3, the Financial Crimes Enforcement Network (FinCEN) issued 37 frequently asked questions (FAQs) and responses with the aim of providing Covered Financial Institutions with a better understanding of the scope of the agency's new Customer Due Diligence Requirements (CDD Rule), which become applicable to new accounts beginning on May 11, 2018.
In short, the much-publicized new CDD Rule requires Covered Financial Institutions to identify and verify the individual beneficial owners of most legal entity customers at the time a new account is opened. Specifically, the CDD Rule requires the identification and verification of any individual who owns, directly or indirectly, at least 25 percent of the equity interests of a legal entity customer (the ownership prong), and at least one individual with significant management responsibility over such a customer, for example a CEO, managing member, or president (the control prong). The new CDD Rule also requires Covered Financial Institutions to implement procedures for conducting ongoing CDD.
This "fifth pillar" of an AML compliance program formalizes the longstanding expectation for Covered Financial Institutions to have risk-based procedures for (1) understanding the nature and purpose of the customer relationships for the purpose of developing a customer risk profile, and (2) conducting ongoing monitoring to identify and report suspicious activity and, on a risk basis, to maintain and update customer information (including information on the beneficial owners of legal entity customers).
With the applicability date just a month away, many Covered Financial Institutions likely are well on their way to implementing or enhancing procedures to comply with the CDD Rule. As some have come to realize, however, certain aspects of the CDD Rule are not necessarily as straightforward as initially expected, causing many questions and challenges for institutions. FinCEN's publication of so many and wide-ranging FAQs indicates that uncertainty as to the scope of the new rule is indeed widespread.
Personnel charged with compliance with the CDD Rule would be well-served to read all 37 FAQs and responses, as they provide clarity on FinCEN's expectations and may identify some issues that have yet to surface in their own implementation efforts. Prior to May 11, Covered Financial Institutions should review and incorporate this guidance into its onboarding and due diligence procedures to avoid business disruption and lapses in customer service.
To provide a brief overview of the recent guidance, we highlight below a few of the FAQs that likely address issues common to numerous and different types of Covered Financial Institutions.
DISCUSSION OF SELECTED FAQ TOPICS
I. Requirements for Existing Customers
As a general matter, Covered Financial Institutions are not required to seek beneficial ownership information retroactively from existing customers with accounts opened prior to May 11, 2018. (FAQ 13). Of course, as with any general rule, there are exceptions:
- If, through the course of its normal monitoring of an existing customer, a Covered Financial Institution becomes aware of a possible change of beneficial ownership relevant to the assessment of the customer's risk, the institution is obligated to obtain or update such information on accounts opened prior to May 11, 2018. (FAQ 13).
- FAQ 14 reiterates that Covered Financial Institutions are not required to solicit or update existing customer beneficial ownership information as a matter of course during regular reviews. It is only when the new information is learned that indicates a possible change in beneficial ownership that the obligation is triggered. (FAQ 14). Of course, there is nothing in the CDD Rule or the FinCEN guidance that prohibits a Covered Financial Institution from collecting beneficial ownership information from customers as often as they deem appropriate.
- FinCEN also clarified that product renewals are considered new "accounts" for purposes of the CDD rule. Accordingly, after May 11, 2018, the renewal of certain financial products, such as loans or certificate of deposit (CD) rollovers, that were originally issued before May 11, 2018, will trigger the beneficial ownership identification and verification requirements of the CDD Rule. Although a Covered Financial Institution is required to identify and verify the beneficial ownership information upon the first post-May 11, 2018 renewal, for each subsequent renewal the institution may rely on the customer's confirmation that the prior beneficial ownership information is accurate and up-to-date, so long as the institution has no reason to question the reliability of such information and the product or service remains the same. Moreover, because loans and CDs present low risk of money laundering, it is sufficient for a customer to agree at the time of certifying beneficial ownership to notify the institution of any change in such information. (FAQ 12).
The good news for Covered Financial Institutions is that they will not be required to obtain new Certification Forms for each subsequent account opening if the information has not changed. FinCEN FAQ #10 clarifies that financial institutions may rely on previous Certification Forms so long as the customer confirms such information is up-to-date and accurate at the time of each account opening. Importantly, a covered Financial Institution must memorialize the legal entity customer's confirmation in the customer file. (FAQ 10). Covered Financial Institutions should incorporate this concept into their procedures to minimize disruption during the customer onboarding process.
II. Financial Institution and Publicly Traded Company Customers
The CDD rule excludes certain types of entities from the requirement to collect beneficial ownership on the basis that information regarding their beneficial ownership and management is available through other means. For example, FinCEN clarifies that a financial institution regulated by a Federal functional regulator or a bank regulated by a State bank regulator is excluded from the definition of "legal entity customer." The preamble to the adopting release of the CDD rule states that this exception exists because the information is available from the relevant Federal or State agencies. For similar reasons, with respect to foreign financial institutions, only those whose home country regulators maintain beneficial ownership information on such institutions are excluded from the definition of "legal entity customer." If the home country regulator does not maintain beneficial ownership information on such institutions, then beneficial ownership and control information must be collected on any accounts opened by the foreign financial institution. (FAQ 26).
Companies that are publicly traded in the US are excluded from the CDD Rule because they are subject to public disclosure and reporting requirements. As might be expected given the exemption for certain foreign financial institutions, there is no exception for publicly traded companies listed on foreign exchanges. Covered Financial Institutions must obtain beneficial ownership information for all such legal entity customers. (FAQ 24).
III. Pooled Investment Vehicles and Trusts
Covered Financial Institutions are not required to look through a pooled investment vehicle to identify and verify the identity of any individuals who own 25 percent or more of its equity interests. This is due to the fluctuation in ownership in such vehicles. However, Covered Financial Institutions must collect control prong information for pooled investment vehicles whose operators or advisers are not otherwise excluded from the definition of "legal entity customer." The guidance provides that a control person for purposes of a pooled investment vehicle may be "a portfolio manager, commodity pool operator, commodity trading advisor, or general partner of the vehicle." (FAQ 18).
If a trust owns 25 percent or more of the equity interests of a legal entity customer, the beneficial owner under the ownership prong is the trustee, regardless of whether the trustee is a natural person or a legal entity. (FAQ 19, 20). If a natural-person trustee does not exist for purposes of the ownership prong, a natural person would not be identified (though the institution should collect identification information on the legal entity trustee consistent with its customer identification program (CIP) procedures).
That said, Covered Financial Institutions still must satisfy the control prong and therefore must identify and verify a natural person who controls the legal entity customer. (FAQ 20).
IV. Identification and Verification Requirements; Reliance on Customer Representations
FinCEN also provides guidance on methods for determining whether collection of beneficial ownership is necessary. Specifically, FAQ 21 states that, to determine whether a customer is eligible for exclusion from the definition of a "legal entity customer," it may rely on information provided by the legal entity customer, provided that the Covered Financial Institution has no knowledge of facts that would reasonably call into question the reliability of such information. Covered Financial Institutions should incorporate such reliance into their procedures.
In addition, FinCEN's guidance identifies circumstances where requirements are less stringent than the CIP requirements. FAQ 6 clarifies that the CDD Rule expressly authorizes the collection of photocopies of documents for documentary verification, which is not permissible in the CIP rules. (FAQ 4).
In advance of the applicability date, Covered Financial Institutions should review the complete set of FAQs against their new beneficial ownership policies and procedures to assure their operations are aligned with FinCEN's expectations and to minimize disruptions to new account openings. Covered Financial Institutions interested in assistance with implementing measures to comply with the CDD Rule are encouraged to contact any of the authors listed below or your Arnold & Porter contact. The firm's Financial Services team would be pleased to assist with any questions you may have about the CDD Rule or any other aspects of your entity's AML program, or compliance more broadly
FinCEN issued the initial 90-day exceptive relief on May 16, 2018, explaining that it "understands some covered institutions have not treated such rollovers or renewals as new accounts and have established automatic processes to continue the banking relationship with the customer."
WHAT DOES THIS MEAN FOR OUR BANK?
Covered financial institutions should utilize the new 30-day extension as an opportunity to assure their controls and procedures properly classify renewals and rollovers as new accounts and that their automated monitoring systems are configured to automatically generate alerts to collect beneficial ownership information on qualifying account openings. Financial institutions should also consider conducting training on this issue to employees tasked with monitoring and collecting information on these accounts and revising their audit procedures to capture FinCEN's FAQs and any measures taken by the institution during FinCEN's periods of exceptive relief. Finally, financial institutions should consider documenting their efforts and communicating their progress to their board of directors or appropriate subcommittee.
For your convenience, Question 12: Collection of beneficial ownership information: Product or service renewals, from FinCEN's April 3rd FAQs is reproduced below.
Are financial institutions required to have their legal entity customers certify the beneficial owners for existing customers during the course of a financial product renewal (e.g., a loan renewal or certificate of deposit)?
A. Yes. Consistent with the definition of "account" in the CIP rules and subsequent interagency guidance, each time a loan is renewed or a certificate of deposit is rolled over, the bank establishes another formal banking relationship and a new account is established. Covered financial institutions are required to obtain information on the beneficial owners of a legal entity that opens a new account, meaning (in the case of a bank) for each new formal banking relationship established, even if the legal entity is an existing customer. For financial services or products established before May 11, 2018, covered financial institutions must obtain certified beneficial ownership information of the legal entity customers of such products and services at the time of the first renewal following that date. At the time of each subsequent renewal, to the extent that the legal entity customer and the financial service or product (e.g., loan or CD) remains the same, the customer certifies or confirms that the beneficial ownership information previously obtained is accurate and up-to-date, and the institution has no knowledge of facts that would reasonably call into question the reliability of the information, the financial institution would not be required to collect the beneficial ownership information again. In the case of a loan renewal or CD rollover, because we understand that these products are not generally treated as new accounts by the industry and the risk of money laundering is very low, if at the time the customer certifies its beneficial ownership information, it also agrees to notify the financial institution of any change in such information, such agreement can be considered the certification or confirmation from the customer and should be documented and maintained as such, so long as the loan or CD is outstanding.
Author: © Arnold & Porter Kaye Scholer LLP 2018 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice.