Growing international attention to the misuse of shell companies and other legal vehicles for illicit purposes, such as money laundering, terrorist financing and tax evasion, has highlighted the importance of beneficial ownership transparency.
A number of countries have now introduced corporate transparency laws and the momentum is expected to continue. However, compliance with these measures has presented significant challenges for financial institutions because the regulations and guidance remain inconsistent across jurisdictions.
To assist institutions and others to better comply with the evolving requirements, below is a list of frequently asked questions pertaining to FinCEN’s beneficial ownership obligations in the U.S.
1. What is beneficial ownership and why is it important?
A beneficial owner is the natural person who owns and/or controls a legal entity, such as a shell company. Historically, there has been no categorial requirement to disclose the beneficial owners of such entities, thus enabling them to operate anonymously.
As a result, individuals with bad intent have been able to use shell companies and other corporate vehicles in furtherance of financial crimes while concealing their identities.
Beneficial ownerships is an important concept in the fight against money laundering, terrorist financing, tax evasion, and other financial crimes. The identification and disclosure of beneficial owners prevents criminals from hiding behind corporate entities and assists law enforcement in the investigation and prosecution of crimes.
2. What are shell companies?
Shell companies are legal entities such as non-publicly traded corporations and limited liability companies (LLCs). They typically have no physical presence (other than a mailing address) and generate little to no independent economic value.
Shell companies are legal to form and operate, and because they can hold bank accounts and intangible assets, own real estate, and engage in financial transactions, they are used for a variety of legitimate business purposes.
The fact that shell companies can be formed anonymously enables criminals to engage in illegal transactions while evading detection from law enforcement. In this manner, criminals have used shell companies to hide illicit proceeds, launder funds, and even evade sanctions.
3. What is the CDD Rule?
The Customer Due Diligence Final Rule (“CDD Rule”) was issued by the Financial Crimes Enforcement Network (FinCEN) as an amendment to existing Bank Secrecy Act (BSA) regulations and became effective on May 11, 2018. It clarifies and strengthens customer due diligence requirements, with the aim to improve financial transparency and prevent the misuse of corporate entities for illicit purposes. The CDD Rule formalizes the requirement to conduct customer due diligence and creates what has become known as the fifth pillar of a BSA/AML compliance program.
4. What requirements does the CDD Rule impose?
Under the CDD Rule, financial institutions must establish and maintain written policies and procedures that are reasonably designed to meet the following four core requirements:
- Identify and verify the identity of new customers
- Identify and verify the identity of the beneficial owners of companies opening accounts
- Understand the nature and purpose of customer relationships to develop customer risk profiles
- Conduct ongoing monitoring to identify and report suspicious transactions and, on a risk basis, to maintain and update customer information
5. What is the beneficial ownership requirement?
Contained within the four core requirements of the CDD Rule is the beneficial ownership requirement, which imposes the obligation to identify, verify, and record the identity of beneficial owners of legal entity customers who open accounts at the financial institution.
The CDD Rule uses a two-prong test to identify the beneficial owner(s) of legal entity customers: an ownership prong and a control prong.
- Under the ownership prong, a beneficial owner is any individual (human) person who, directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise, owns or controls 25 percent or more of the equity interests of a legal entity customer.
- Under the control prong, a beneficial owner is a single individual with significant responsibility to control, manage or direct a legal entity customer.
Under the two-prong test, a legal entity will have at least one and up to five beneficial owners (i.e., at least one person must be identified under the control prong, and zero to four persons may be identified under the ownership prong).
One individual must always be identified under the control prong, regardless of whether any beneficial owners are identified under the ownership prong. There could be cases where the same individual will meet the definition of beneficial owner under each prong.
6. What types of financial institutions does the CDD Rule apply to?
The CDD Rule applies to “covered financial institutions,” which include the following:
- Depository institutions (federally regulated banks, commercial banks, savings associations, federally insured credit unions, federally regulated trust companies, U.S. agencies and branches of a foreign bank)
- Securities broker-dealers
- Mutual funds
- Futures commission merchants and introducing brokers in commodities
Institutions to which the CDD Rule does not apply, include the following:
- Money services businesses (MSBs)
- Insurance companies
- Casinos and card clubs
- Dealers in precious metals, precious stones, and jewels
- Providers of prepaid access
7. To what types of accounts does the beneficial ownership requirement apply?
The beneficial ownership requirement applies to new accounts of legal entity customers.
A “new account” is defined as each account opened at a covered financial institution by a legal entity customer on or after the applicability date of May 11, 2018.
8. What is a legal entity customer?
A legal entity customer is defined as any of the following:
- Limited liability company (LLC)
- Other entity that is created by the filing of a public document with a Secretary of State or other similar office
- Business trusts that are created by a filing with a state office
- Partnership (Limited and General)
- Any similar entity formed under the laws of a foreign jurisdiction that opens an account
A legal entity does not include sole proprietorships or unincorporated associations.
9. What minimum identification information must be collected from each beneficial owner?
The following minimum identification information must be collected for each beneficial owner of a covered financial institution’s legal entity customers:
- Date of Birth
- Identification Number (such as a Social Security Number or Tax Identification Number for a U.S. Person, or a Passport Number and Country of Issuance for a Non-U.S. Person)
- Non-Expired and Government-Issued Photo Identification Documentation (such as a Driver’s License, State-Issued Identification Document, Alien Registration Card, or Passport)
10. Can a legal entity customer have multiple beneficial owners?
Yes, a legal entity customer must have at least one beneficial owner and may have up to five beneficial owners (i.e., one under the control prong and up to four under the ownership prong).
Example: Individual A is the Founder and CEO of Company A. Therefore, Individual A has been identified as a beneficial owner under the control prong. Individuals B, C, D, and E each own 25% of Company A. Therefore, Individuals B, C, D, and E each qualify as beneficial owners of Company A under the ownership prong. As a result, Company A has five beneficial owners (i.e., Individuals A, B, C, D, and E).
11. What are some examples of a beneficial owner under the CDD Rule?
Example 1: Owner A owns 80% of ABC, LLC. Owners B and C each own 10% of ABC, LLC. In this example, Owner A is the beneficial owner of ABC, LLC.
Example 2: Person A is the President of XYZ Corporation. Person B owns 90% of XYZ Corporation. Person C owns 10% of XYZ Corporation. Both Person A (control prong) and Person B (ownership prong) are the beneficial owners of XYZ Corporation.
Example 3: Partners A and B decide to start a business and form a general partnership where they agree to share voting rights and profits equally. Partners A and B are both beneficial owners.
12. How soon after obtaining client information must an institution verify the identity of each beneficial owner?
The CDD Rule doesn’t specify a specific time frame during which the identity of beneficial owners must be verified.
Rather, an institution must verify the identity of each beneficial owner of its legal entity customers within a reasonable period of time after the account is opened.
13. How can an institution verify the identities of beneficial owners?
According to FinCEN, an institution may use documentary or non-documentary verification methods, or a combination of both methods, to verify the identitiesidentifies of the beneficial owners of its legal entity customers.
Documentary verification methods include unexpired government-issued identification evidencing nationality or residence and bearing a photograph or similar safeguard, such as a driver’s license or passport.
Non-documentary verification methods may include contacting a beneficial owner, independently verifying the beneficial owner’s identity by comparing the information provided by the legal entity customer with information obtained from other sources, checking references with other institutions, and obtaining a financial statement.
A financial institution’s Customer Identification Program (CIP) must contain procedures for verifying customer identification, including describing when the institution will use documentary, non-documentary, or a combination of both methods for identity verification.
In contrast to the CIP rule, the CDD Rule expressly authorizes covered financial institutions to use photocopies or other reproduction documents for documentary verification.
14. How can an institution know that it has verified the true identity of each beneficial owner?
A bank need not establish the accuracy of every element of identifying information obtained.
However, the CDD Rule requires institutions to verify enough information to form a “reasonable belief” that it knows the true identity of the beneficial owner(s) of the legal entity customer.
Institutions should establish a clear internal definition of what constitutes “reasonable belief,” including what documents and information are acceptable or unacceptable. This process should be documented as part of the institution’s written CIP.
15. How often should beneficial ownership information be updated?
There is no prescribed time frame under the CDD Rule for updating beneficial ownership information.
Covered financial institutions must have procedures to maintain and update beneficial ownership information for legal entity customers on a risk basis.
Furthermore, if changes to beneficial ownership information are discovered during the course of normal monitoring, or if a legal entity customer notifies the institution of a change in their information, the institution would be required to make the appropriate updates in the customer profile.
16. How long must institutions retain records of beneficial ownership information collected for legal entity customers and why?
At a minimum, covered financial institutions must maintain any identifying information obtained, for a period of five years after the date the account is closed.
Information on beneficial ownership not only aids the institution in better understanding and addressing customer risk, it also aids law enforcement with investigations and prosecutions.
The requirement that financial institutions know their customers and the corresponding risks presented by their customers, is fundamental to the development and implementation of an effective BSA/AML compliance program. Specifically, conducting appropriate CDD, including the identification of beneficial owners, assists an institution in identifying, detecting, and evaluating unusual or suspicious activity.
However, performing customer due diligence can be both costly and time consuming, often involving manual processes, numerous alerts, and backlogs of false positives. Moreover, the imposition of new requirements and additional compliance obligations can further expose institutions to increased regulatory risk as well as fines and penalties for violations.
Alessa can help financial institutions meet regulatory expectations as well as reduce the operational costs of ongoing compliance and lessen the administrative burden of labor-intensive customer due diligence. Contact us for a demo of the Alessa AML Solution – and see how we can help make AML compliance the easiest part of your day.