FinCEN’s Final Rule: New Customer Due Diligence Requirements

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FinCEN’s Final Rule

The Final Rule refers to the new rules issued by Financial Crimes Enforcement Network (“FinCEN”), under the Bank Secrecy Act, regarding customer due diligence (CDD) requirements with the applicability date of May 11, 2018. Under this rule, it has become mandatory for the financial institutions (financial institutions subject to a CIP requirement, such as the banks, broker-dealers in security, future commission merchants and mutual funds) to collect, maintain, and report the information of beneficial ownership.

Purpose of CDD Final Rule

The reason for which the CDD is strengthened and clarified by the US Government includes:

  1. Facilitates financial investigations by law enforcement
  2. Provides enhanced ability in recognizing the accounts and assets of the criminals
  3. Improves the ability of financial institution in assessing and reducing the risks, and following the existing requirements
  4. Ensures tax compliance by aiding related reporting and investigations
  5. Ensures the uniformity of CDD expectations within and across the financial sectors

The broad view is that the US government has been modifying its laws to improve financial transparency and to prevent criminals and terrorists from misusing the companies for financing their illegitimate gains and money laundering.

Four Core Principles of CDD Final Rule

There are four elements considered crucial by FinCEN while performing due diligence for the Anti-Money Laundering (AML), which includes:

  1. Identification and verification of the customers;
  2. Identification and verification of beneficial ownership of the legal entities (with certain exceptions);
  3. Understand the nature and purpose of customer relationships to develop customer risk profiles; and
  4. Conducting ongoing monitoring for reporting of suspicious transactions, maintaining, and updating customer information on a risk basis.

FinCEN has already explained the first element in existing CIP rules (Customer Identification Program) whereas the second element is the new addition. Although, the third and fourth elements were indirectly implied requirements for the reporting of suspicious activities, now have been specifically included as the “fifth pillar” of an effective AML program.

Second Element: Beneficial Ownership Requirements

When a new account is opened, a set of guidelines must be implemented by all the covered financial institutions, to reveal and verify the identity of the beneficial owner of a legal entity customer. The guidelines, which must be followed from the applicability, date of the final CDD rule includes:

Beneficial Owner

According to FinCEN, it is defined in two prongs:

  1. The Ownership Prong: Under this, a beneficial owner is described as each individual, if any, who directly or indirectly owns 25% or more of the equity interests of the legal equity customer.
  2. The Control Prong: Under this, a beneficial owner is described as a single individual with significant responsibility to control, direct and manage the legal entity customer.

The Ownership Prong requires the identification of four individuals, however, there is no need for identification if a 25% requirement is not met by the individual. The Control Prong requires the need of at least one person under it.

Legal Entity Customer

As per Final Rule, a “legal entity customer” is defined as “a corporation, Limited Liability Company or any other entity created through filing of a public document with a Secretary of State or similar office, a general partnership, and any similar entities formed under the laws of foreign jurisdictions that open an account.” There are many business entities and certain type account openings that are excluded from the definition of the legal entity customer under the Beneficial Ownership Rule. Legal Entity Customer excludes sole proprietorship, unincorporated associations, estate-planning trusts or individuals opening accounts on their own name.

Only Control Prong

Some legal entity customers are subjected to control prongs, either due to fluctuating ownership interest or because they do not exist. These include non-profit corporations or pooled investment vehicles advised by financial institutions that are not an excluded legal entity (e.g. hedge funds, private equity funds).

New Account

Any account that is opened at a Covered Financial Institution by the legal entity customer on or after the date of applicability of CDD final rule, is known as New Account according to the rules of Customer Identification Program (CIP). The beneficial ownership requirements apply to these new accounts only with some exemptions.

Identification and Verification Requirements

The identification and verification procedures for beneficial owners are similar to that of the individuals under a financial institution’s CIP. A covered financial institution’s procedure should permit to identify the beneficial owner of the legal entity customer at the time of opening of new account and verification of his identity according to CIP rules within the reasonable time.

Matthew Ledvina, an experienced US financial expert can help to meet the Beneficial Ownership requirements with solutions covering the verification, reporting, validation, and in detail explanation of the new rule.

Amendment to AML Programs

In addition, the Final Rule amends the FinCEN’s existing Anti Money Laundering (AML) program requirements. It covers the third and fourth elements of CDD. It clearly requires them to implement and maintain risk-based procedures for conducting customer due diligence for such CFIs.

Third Element: Understanding Nature and Purpose of Customer Relationships

A customer risk profile is referred to the information collected about the customer at the time of opening of the account considering it as the baseline against the customer’s activity is assessed, as suspicious for reporting. The third element requires all covered financial institutions to come up with the customer’s risk profile by understanding the nature and purpose of customer relationships.

Fourth Element: Ongoing Monitoring

Further, CDD requires all covered financial institutions to possess efficient tools for conduction of ongoing monitoring to reveal and report suspicious transactions and to update and maintain customer information on a risk basis. 

Conclusion

Until now, the ability of individuals to hide their anonymous business activities has been a hindrance in the fight against financial crimes, resulting in an illicit flow of funds supporting various unlawful and terror activities. The CDD Final Rule proved to be a crucial and much-needed step towards the advancement of financial transparency.