On May 11, 2016, the Department of Treasury, Financial Crimes Enforcement Network (FinCEN) published its final rule (81 FR 29298) on required “know your customer” due diligence procedures (Rule). The Rule established a compliance deadline of May 11, 2018 for all “covered financial institutions.”
The Rule was adopted to implement and complement existing federal law comprising the Bank Secrecy Act, as amended by the USA Patriot Act and related legislation (BSA). Its stated purpose is to require covered financial institutions to identify and verify “beneficial owners” of “legal entity customers” and to include such procedures in their anti-money laundering compliance programs required under the BSA.
Under the Rule, “covered financial institutions” generally include FDIC insured banks, commercial banks, US domiciled agencies or branches of foreign banks, federally insured credit unions, savings associations, corporations regulated by the Federal Reserve Board operating under Section 25A of the Federal Reserve Act, federally regulated trust banks or trust companies, SEC regulated securities brokers and dealers, CFTC regulated futures merchants or brokers and mutual funds. The Rule requires such covered financial institutions to establish the identity of each beneficial owner of a legal entity customer at the time a new account is opened, by either obtaining a certification in form attached as Appendix A to the Rule or by obtaining the information required in the form by other certification means.
Covered financial institutions must then verify the identities of such beneficial owners according to risk-based procedures, complying at a minimum with the specific elements applicable to each category of covered financial institution set forth in the relevant sections of Chapter X of CFR Title 31. For example, banks may verify customer identities through government-issued ID containing a photograph, such as a driver’s license or passport, for individuals or, for entity borrowers, by obtaining documents showing the existence of the entity, such as articles of incorporation, a government-issued business license, a partnership agreement or trust instrument. The Rule permits financial institutions to rely on the information for each beneficial owner supplied by the customer, provided that it has no knowledge of facts that would reasonably call into question the reliability of such information.
For purposes of the Rule, “legal entity customers” generally include, with certain exceptions, corporations, LLCs and other entities that are created by the filing of a public document with a Secretary of State or equivalent office, general partnerships and similar entities form under the laws of a foreign jurisdiction. “Beneficial owners” generally include individuals directly or indirectly owning 25% or more of the equity interests of a legal entity and individuals with significant responsibility to control, manage or direct a legal entity. Such controlling individuals include executive officers or senior managers, or persons performing similar functions. In the case of trusts owning 25% of more of a legal entity, the trustee will constitute the beneficial owner. For entities that have multiple beneficial owners, the Rule requires only that up to four individuals be identified, depending on factual circumstances based on risk determinations.
Covered “accounts” are simply defined as “each account opened at a covered financial institution by a legal entity customer” after the Rule’s effective date. Accounts do not include point of sale retail credit card transactions up to $50,000, accounts to finance postage where payment is remitted directly to the provider of postage products and no cash refund is involved, accounts to finance insurance premiums where payment is remitted directly to the insurance provider or broker and no cash refund is involved, and accounts to finance the purchase or leasing of equipment where payments are remitted directly to the vendor or lessor of the equipment and no cash refund is involved.
The Rule also provides exceptions or exclusions for certain categories of otherwise covered legal entity customers. Examples include federally or state regulated financial institutions, issuers of a class of securities registered under the Securities Exchange Act of 1934, SEC registered investment companies, SEC registered investment advisers, SEC registered exchanges and clearing agencies, any other SEC registered entity, CFTC registered commodity traders or advisors, registered FOREX dealers, registered swap dealers or major swap participants, public accounting firms registered under the Sarbanes-Oxley Act, state regulated insurance companies and bank or savings and loan holding companies.
Most covered financial institutions no doubt have robust anti-money laundering policies and procedures in place, given that the BSA has been in effect since 1970 and the Rule first became effective on July 11, 2016. However, AML compliance has become a particularly high priority area of focus for regulators over the past few years. Financial institutions will need to review their existing policies and procedures to ensure they are compliant with the specific requirements of the Rule by the final compliance deadline of May 11, 2018.