The Beneficial
Ownership Rule- A Two Part series
Part One - What is the rule and What Does it mean to
Me?
On May 11, 2016, the Financial Crimes Enforcement Network
(“Fincen”) announced its final rule strengthening the due diligence
requirements for covered financial institutions. This rule is generally known as the
“beneficial ownership rule”. This rule
represents a significant change in the overall administration of Bank Secrecy
Act/Anti-Money laundering (“BSA/AML”) compliance programs. The purpose of the change was made clear in
Fincen’s announcement of the final rule”
“Covered financial institutions are not presently required to
know the identity of the individuals who own or control their legal entity
customers (also known as beneficial owners). This enables criminals,
kleptocrats, and others looking to hide ill-gotten proceeds to access the
financial system anonymously. The beneficial ownership requirement will address
this weakness[1]
Put another way, the purpose of this rule is to address one
of the biggest weaknesses in the current system for identifying suspicious
activity. The fact that that financial
institutions have been required to obtain information about a legal entity
without considering the ownership and /or control of the legal entity has
allowed many a “bad guy” to effectively hide his/her illicit activity. The preamble to the rules lists out several
examples of how legal entities have been taken over by criminals in an effort
to launder money. Some of the more
interesting examples included:
- A series of shell
companies that were used to take over and loot a publicly traded mortgage
company.
- Using a series of small
legal entities to cover a drug smuggling ring
- Using a series of
companies that were ostensibly for movie production to hide large amounts of
cash that was being used for human trafficking
In all of the cases that were cited, the common feature
was the ownership and control of the legal entities was obscured by a complex
holding structure. The beneficial
ownership rule is designed to addresses this practice. The rule requires that a financial
institution doing business with a legal entity should know who owns and
controls the entity. This is the enumerated
requirement. However, it should be the understood that simply knowing this
information is not enough. Once the due
diligence information is obtained, it is critical to ensure that it makes sense
in context. For example, does it really
make sense that a flower shop owner also owns a casino? These business are entirely unrelated except
for the fact that they are both often cash intensive businesses.
The Rule
Itself
The final rule creates a “fifth pillar” in the standard
group of expectations for a comprehensive BSA/AML compliance program. Ongoing and risk based due diligence for
customers will now be considered an essential part of the compliance
program. The rule makes due diligence a
dynamic process rather than the traditional process that essentially ended at
the time the account was opened.
Financial institutions are expected to stay abreast of who the
beneficial owners of a legal entity are and how their ownership might impact
ongoing monitoring of the account. As
the beneficial owners change, then the manner in which the account is viewed
should change accordingly.
Beneficial Ownership is a broad definition that includes
both ownership and control.
Ownership –
is denied as any person who directly or indirectly owns more than 25 percent of
the equity of a legal entity
Control –
The term “beneficial owner” means a single individual with significant
responsibility to control, manage, or direct the legal entity customer (e.g., a
Chief Executive Officer, Vice President, or Treasurer).
These two prongs are critical because there are many times
when a person or persons could actually have a minimal ownership stake in a
firm or even no actual legal ownership, but still have the ability to control
the firm. The rule requires all covered
institutions to obtain information on all people who own or control a legal
entity.
Financial institutions are expected to design policies and
procedures that detail how staff will use their best efforts to establish and
maintain written procedures that are reasonably designed to identify and verify
beneficial owners of a legal entity customer. The procedures must allow the
financial institution to identify all beneficial owners of each legal entity
customer at the time of account opening unless an exclusion or exemption
applies to the customer or account. [2]
Why Wait?
The rule requires all covered institutions to be in
compliance by May of 2018. Covered
institutions in this case means:
“For purposes of the CDD Rule, covered financial institutions
are federally regulated banks and federally insured credit unions, mutual
funds, brokers or dealers in securities, futures commission merchants, and
introducing brokers in commodities” [3]
Though this rule only technically only applies to covered
institutions, it will be prudent for all financial institutions to become
familiar with the requirements of the regulations and to apply the standards
enumerated therein. Financial
institutions will expect that their Money Service Businesses meet the same standards
because the risks for undetected suspicious activity is the same.
There is absolutely no reason to wait to implement the
principals detailed in the rule. By
developing policies and procedures that are able to determine beneficial ownership,
a financial entity can have more effective risk mitigation of its customer
base. At the end of the regulatory day,
knowing your customers and what it is that they do is the heart of any string
AML Compliance program
In Part Two- we will discuss the details of a strong
beneficial ownership program.
[1] www.federalregister.gov/articles/2016/05/11/2016-10567/customer-due-diligence-requirements-for-financial-institutio
[2] These
excluded entities include banking organizations; entities that have their
common stock listed on the New York, American, or NASDAQ stock exchanges;
SEC-registered investment companies and advisers; CFTC-registered entities;
state-regulated insurance companies; foreign financial institutions established
in jurisdictions that have beneficial ownership reporting regimes; and legal
entities with private banking accounts subject to FinCEN rules
[3] FIN-2016-G003 questions
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