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Customer Due Diligence and Beneficial Ownership

fincen2Compliance officers face lots of challenges when conducting third-party due diligence. One issue that frequently arises is determining who exactly owns a potential agent or distributor. In many circumstance compliance officers have a difficult time peeling back the layers of legal ownership, examining related party ownership stakes and other complexities designed to obfuscate the true ownership of the third-party.

In the financial industry, the inquiry becomes even more challenging given the sheer number of customers whom they are required to conduct due diligence. Unlike the corporate anti-corruption compliance context, anti-money laundering and sanctions compliance requires financial institutions to conduct customer due diligence (CDD).

This process may become even more complicated because of the US Treasury Department’s Financial Crimes Enforcement Network’s (“FinCEN’s”) recent proposal to require financial institutions (banks, broker-dealers, mutual funds, commodities brokers) to identify and verify the beneficial owners of legal entity customers, which is commonly referred to as the “look-through requirement.” A beneficial owner includes any natural person who owns 25 percent or more of a company or who has significant control over a legal entity.fincen

FinCEN started this rulemaking proceeding in 2012 but delayed it in response to significant criticism and controversy. To develop more support for the proposal, FinCEN held a series of public hearings on the issue and incorporated many suggestions to reduce the regulatory burden surrounding the definitions and application of the policy.

FinCEN defined CDD as consisting of four basic requirements: (1) identifying and verifying the identity of customers; (2) identifying and verifying the identity of beneficial owners of “legal entity customers”; (3) understanding the nature and purpose of customer relationships; and (4) conducting ongoing monitoring to maintain and update customer information to identify and report suspicious transactions.

Under the proposed regulations, a financial institution can satisfy the look-through requirement by obtaining a certification from an individual opening a account on behalf of the legal entity that would require the individual to: (a) identify and provide basic information for any beneficial owners of the legal entity customer and (b) certify the veracity of the information provided. The certification requirement also could be satisfied, in some situations, by representations from another financial institution.

In response to criticisms, FinCEN clarified that the rules would require financial institutions to verify only the identity of the individual beneficial owner but not the individual’s status as a beneficial owner.

A beneficial owner is defined to include any individual who directly or indirectly owns 25 percent or more of the equity interests of a legal entity customer or a person who exercises significant control over the legal entity customer. Publicly-traded companies and government entities are exempt from the requirements.

The issue gets even more complex when a legal entity account owner is owned by multiple legal entities. In that case, the look through requirement extends to each of these legal entities.

fincen3In the end, FinCEN believes that requiring only a certification by the account owner as to the identity of the beneficial owners in a legal entity will alleviate the burden of this new beneficial ownership requirement.

FinCEN has proposed to make these rules effective within one year. In addition, the new requirement will only apply to the opening of new accounts and not extend to existing accounts.

Financial institutions will have to monitor and update beneficial ownership information as part of a financial institution’s CDD risk assessment process.

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  1. September 18, 2014

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