Authors: Paul Kolovos & Brian Atherton
As of May 11, 2018 all member firms of the Financial Industry Regulatory Authority, Inc. (FINRA) were required to be in compliance with the provisions of the Customer Due Diligence Requirements for Financial Institutions (CDD Requirements). FINRA issued Regulatory Notice 17-40 on November 21, 2017 to provide guidance to its member firms’ obligations under FINRA Rule 3310 (Anti-Money Laundering Compliance Program) in light of the Financial Crimes Enforcement Network’s (FinCEN) adoption of a final rule on CDD Requirements.
FinCEN states in the CDD Requirements that firms must have an understanding of the nature and purpose of the customer relationship in order to determine whether a transaction is potentially suspicious and, in turn, to fulfill their suspicious activity reporting obligations. In its CDD Requirements, FinCEN identifies four components of customer due diligence: (1) customer identification and verification; (2) beneficial ownership identification and verification; (3) understanding the nature and purpose of customer relationships; and (4) ongoing monitoring for reporting suspicious transactions and, on a risk basis, maintaining and updating customer information. The CDD Requirements focus particularly on the second component by adding a new requirement that covered financial institutions identify and verify the identity of the beneficial owners of all legal entity customers at the time a new account is opened, subject to certain exclusions and exemptions (including public companies and regulated entities). The second, third and fourth elements constitute the ongoing customer due diligence obligation that is referred to as the “fifth pillar.”
In addition to requiring that member firms incorporate the fifth pillar into their Anti-Money Laundering programs, the CDD Requirements mandate that member firms identify and verify the identities of beneficial owners of legal entity customers. A “beneficial owner” is (1) each individual (if any) who directly or indirectly owns 25 percent of the equity interests of a legal entity customer; and (2) a single individual with significant responsibility to control, manage, or direct a legal entity customer, including an executive officer or senior manager. However, FinCEN’s guidance suggests that financial institutions may find it appropriate to identify and verify beneficial owners at a lower ownership threshold than 25% if circumstances warrant. A legal entity customer is a “corporation, limited liability company, or other entity that is created by the filing of a public document with a Secretary of State or similar office, a general partnership, and any similar entity formed under the laws of a foreign jurisdiction, that opens an account.” Member firms also must obtain from the natural person opening the account on behalf of the legal entity customer, the identity of the beneficial owners of the entity. That individual must certify, to the best of his or her knowledge, as to the accuracy of the information. FinCEN intends that the legal entity customer identify its ultimate beneficial owner(s) and not “nominees” or “straw men.”
Each FINRA member firm may collect the required information, which includes the name, date of birth, address and Social Security number or other government identification number of beneficial owners, by using FinCEN’s standard certification form or by another means, provided that the chosen method satisfies the identification requirements in the CDD Requirements. Although the CDD Requirements with respect to beneficial owners of legal entity customers that open new accounts from the date of the CDD Requirements’ implementation, FINRA has advised member firms to obtain beneficial ownership information for an existing legal entity customer if, during the course of normal monitoring, it receives information that is needed to assess or reevaluate the risk of the customer.
For non-exempt borrowers of funds from financial institutions subject to the new CDD Requirements (which includes banks, broker-dealers in securities, mutual funds, futures commission merchants and introducing brokers in commodities), the result of the new CDD Requirements will have consequences throughout the life of the loan. At origination, the new rules will result in a more robust look into the borrower’s organizational structure, and lenders may need to look through several layers of a borrower entity to determine whether an actual person is a 25% owner. Perhaps more importantly, lenders may tighten restrictions on transfers in interests of the borrower during the course of the loan. Before agreeing to such restrictions, borrowers should consider the impact of such restrictions and consult with a Saul Ewing Arnstein & Lehr attorney to determine if the restrictions are designed to comply with the new CDD Requirements or if they are an attempt by the lender to leverage more control over the borrower.
For more information, please contact the authors or the attorney at the firm with whom you are regularly in contact.
This Alert was written by Brian Atherton and Paul Kolovos. Brian can be reached at (617) 912-0968 or firstname.lastname@example.org. Paul can be reached at (617) 912-0908 or email@example.com. This publication has been prepared by the Consumer Financial Services Practice for information purposes only.
The provision and receipt of the information in this publication (a) should not be considered legal advice, (b) does not create a lawyer-client relationship, and (c) should not be acted on without seeking professional counsel who have been informed of the specific facts. Under the rules of certain jurisdictions, this communication may constitute “Attorney Advertising.”