Category: Alerts

Alaric Compliance Alert: New Know-Your-Customer AML Due Diligence Rule Set for May 11

With a May 11 effective date fast approaching, financial firms will soon be required by law to comply with a new United States Treasury Department Financial Crimes Enforcement Network (FinCEN) Beneficial Ownership Rule intended to strengthen customer due diligence.1

Prior to the new Rule, financial institutions were not required to know the identity of beneficial owners. This left a gaping gray area that criminals have exploited and regulators are aiming to eliminate. Indeed, anti-money laundering (AML) programs are one of U.S. regulatory agencies’ top priorities this year.

With heightened awareness of illicit banking and brokerage activity, particularly regarding off-shore accounts, regulators are finding financial institutions are conducting business—knowingly or unwittingly—in unreported beneficial owner accounts through which money may be illegally laundered.

For instance, an administrative proceeding published in late March charges a compliance officer for failing to report low-priced securities transactions and suspicious account activity, as required under the U.S. Bank Secrecy Act. According to the SEC filing, the defendant appears to have been acting as an agent for an undisclosed principal, with transactions and wire transfers involving “no apparent business purpose to or from a country identified as a money laundering risk or a bank secrecy haven.”2

The United Nations (U.N.) has estimated the amount of money laundered every year is between $800 billion and $2 trillion dollars. However, according to a 2011 report by the U.N. Office on Drugs and Crime, less than one percent of this amount is seized by law enforcement.3

For the first time under the new Rule, banks, securities brokers and dealers, mutual funds, futures commission merchants and introducing brokers in commodities will be required to collect and report beneficial ownership information about individuals who own 25 percent or more of legal entities. Legal entities are defined as those created by a filing with a state office or with a Secretary of State, including corporations, limited liability companies, limited and general partnerships as well as business trusts.

The information that must be gathered and maintained includes the name and title of the natural person opening the account, which information must be certified by a designated control person. The designated control person must have significant managerial control, including the following job titles: CEO, CFO, COO, Managing Member, General Partner, President, Vice President, Treasurer.

Registrants must also establish and maintain written policies and procedures reasonably designed to identify and verify beneficial owners of new accounts opened by legal entity customers.

As outlined in its 2018 National Exam Program Examination Priorities, the U.S. Securities Exchange Commission (SEC) is focusing resources to examine whether registrants are meeting their AML obligations, including the customer due diligence requirement to understand the nature and purpose of customer relationships and to properly address associated risks.4 Similarly, the Financial Industry Regulatory Authority (FINRA) is examining the adequacy of firms’ (1) policies and procedures to detect and report suspicious transactions; (2) resources for AML monitoring; and (3) independent testing required under FINRA Rule 3310(c).5

When the Beneficial Ownership Rule was issued last May, some firms got an early start enhancing their information gathering efforts to identify beneficial account owners. A key facet of what’s needed in this effort is the ability to cross-reference individuals with legal entities, a connecting of the dots that entails traversing many hierarchical levels of research, which begs a relational database approach.

Brian Fahey, CEO of compliance software provider MyComplianceOffice says: “Global regulators are putting growing pressure on institutions across segments to mitigate conduct risks, which all firms face, with liability being found not only for intent, but also negligence. Companies need RegTech tools now more than ever to show they are taking steps to identify and thwart risk proactively.”

Fahey says a growing number of firms, particularly in highly regulated sectors like financial services, are implementing conduct risk management systems to track information about companies and associated persons in a configurable relational database format. This enables firms to more easily spot compliance red flags. For instance, technology-enhanced cross-referencing can facilitate compliance with the AML rule, enabling firms to more easily identify the beneficial owners of accounts and flag suspicious activity.

The time, resources and risk-based systems needed to establish written policies and procedures as well as to analyze, associate and take inventory of information to comply with the pending Rule remains out of reach for many institutions. Hence, with the deadline looming just weeks away, many firms have yet to operationalize a compliant methodology as part of their AML program. This includes establishing updated AML policies and procedures, technological capabilities and staff training.

By requiring disclosure of beneficial owners and control persons, regulators aim to better understand the nature and purpose of relationships between companies and associated persons; to more effectively assist law enforcement efforts; to help financial firms better assess and manage customer risk; and to advance industry compliance standards and best practices.

There are exclusions to the Beneficial Ownership Rule with respect to the types of covered institutions. For instance, the definition of “legal entity customer” does not include:

  • Natural persons
  • Sole proprietorships
  • Unincorporated associations, such as a local Girl Scout troop or a neighborhood association
  • Certain legal entities, including the following, are excluded from the Final Rule: federal or state regulated financial institutions (e.g., federally regulated banks, brokers or dealers in securities, mutual funds, futures commission merchants, and introducing brokers in commodities)
  • Bank and savings and loan holding companies
  • State-regulated insurance companies
  • Publicly held companies listed on the New York, American, or NASDAQ Stock Exchanges
  • Registered s and investment companies
  • SEC-registered exchanges or clearing agencies
  • Entities registered with the SEC as an investment adviser

1 https://www.federalregister.gov/documents/2016/05/11/2016-10567/customer-due-diligence-requirements-for-financial-institutions#citation-39-p29406
2 https://www.sec.gov/litigation/admin/2018/34-82957.pdf
3 http://www.unodc.org/documents/data-and-analysis/Studies/Illicit_financial_flows_2011_web.pdf
4 https://www.sec.gov/about/offices/ocie/national-examination-program-priorities-2018.pdf
5 http://www.finra.org/industry/2018-regulatory-and-examination-priorities-letter
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