Financial Crimes Enforcement Network Seeks Comments on Customer Due Diligence Requirements for Financial Institutions

Targeted News Service

WASHINGTON, Aug. 4 -- The U.S. Financial Crimes Enforcement Network published the following proposed rule in the Federal Register:

Customer Due Diligence Requirements for Financial Institutions

A Proposed Rule by the Financial Crimes Enforcement Network on 08/04/2014

Publication Date: Monday, August 04, 2014

Agencies: Department of the Treasury

Financial Crimes Enforcement Network

Dates: Written comments on the Notice of Proposed Rulemaking (NPRM) must be received on or before October 3, 2014.

Comments Close: 10/03/2014

Entry Type: Proposed Rule

Action: Notice of proposed rulemaking.

Document Citation: 79 FR 45151

Page: 45151 -45174 (24 pages)

CFR: 31 CFR 1010

31 CFR 1020

31 CFR 1023

31 CFR 1024

31 CFR 1026

RIN: 1506-AB25

Document Number: 2014-18036

Shorter URL: https://federalregister.gov/a/2014-18036

Action

Notice Of Proposed Rulemaking.

Summary

The Financial Crimes Enforcement Network (FinCEN), after consulting with staff from various federal supervisory authorities, is proposing rules under the Bank Secrecy Act to clarify and strengthen customer due diligence requirements for: Banks; brokers or dealers in securities; mutual funds; and futures commission merchants and introducing brokers in commodities. The proposed rules would contain explicit customer due diligence requirements and would include a new regulatory requirement to identify beneficial owners of legal entity customers, subject to certain exemptions.

DATES:

Written comments on the Notice of Proposed Rulemaking (NPRM) must be received on or before October 3, 2014.

ADDRESSES:

Comments may be submitted, identified by Regulatory Identification Number (RIN) 1506-AB25, by any of the following methods:

Federal E-rulemaking Portal: http://www.regulations.gov. Follow the instructions for submitting comments. Include RIN 1506-AB25 in the submission. Refer to Docket Number FINCEN-2014-0001.

Mail: Policy Division, Financial Crimes Enforcement Network, P.O. Box 39, Vienna, VA 22183. Include 1506-AB25 in the body of the text. Please submit comments by one method only. All comments submitted in response to this NPRM will become a matter of public record. Therefore, you should submit only information that you wish to make publicly available.

Inspection of comments: Comments may be inspected, between 10 a.m. and 4 p.m., in the FinCEN reading room in Vienna, VA. Persons wishing to inspect the comments submitted must request an appointment with the Disclosure Officer by telephoning (703) 905-5034 (not a toll free call). In general, FinCEN will make all comments publicly available by posting them on http://www.regulations.gov.

FOR FURTHER INFORMATION CONTACT:

FinCEN Resource Center at 1-800-767-2825 or 1-703-905-3591 (not a toll free number) and select option 3 for regulatory questions. Email inquiries can be sent to [email protected].

SUPPLEMENTARY INFORMATION:

I. Background

FinCEN exercises regulatory functions primarily under the Currency and Foreign Transactions Reporting Act of 1970, as amended by the USA PATRIOT Act of 2001 (PATRIOT Act) and other legislation, which legislative framework is commonly referred to as the "Bank Secrecy Act" (BSA). [1] The BSA authorizes the Secretary of the Treasury (Secretary) to require financial institutions to keep records and file reports that "have a high degree of usefulness in criminal, tax, or regulatory investigations or proceedings, or in the conduct of intelligence or counterintelligence activities, including analysis, to protect against international terrorism." [2]

The Secretary has delegated to the Director of FinCEN the authority to implement, administer and enforce compliance with the BSA and associated regulations. [3] FinCEN is authorized to impose anti-money laundering (AML) program requirements on financial institutions, [4] as well as to require financial institutions to maintain procedures to ensure compliance with the BSA and the regulations promulgated thereunder or to guard against money laundering. [5]

FinCEN, in consultation with the staffs of the federal functional regulators and the Department of Justice, has determined that more explicit rules for covered financial institutions [6] with respect to customer due diligence (CDD) are necessary to clarify and strengthen CDD within the BSA regime. As demonstrated further below, such changes will enhance financial transparency and safeguard the financial system against illicit use. Requiring financial institutions to perform effective CDD so that they know their customers--both who they are and what transactions they conduct--is a critical aspect of combating all forms of illicit financial activity, from terrorist financing and sanctions evasion to more traditional financial crimes, including money laundering, fraud, and tax evasion. For FinCEN, the key elements of CDD include: (i) Identifying and verifying the identity of customers; (ii) identifying and verifying the identity of beneficial owners of legal entity customers (i.e., the natural persons who own or control legal entities); (iii) understanding the nature and purpose of customer relationships; and (iv) conducting ongoing monitoring to maintain and update customer information and to identify and report suspicious transactions. Collectively, these elements comprise the minimum standard of CDD, which FinCEN believes is fundamental to an effective AML program.

Accordingly, this Notice of Proposed Rulemaking (NPRM) proposes to amend FinCEN's existing rules so that each of these pillars is explicitly referenced in a corresponding requirement within FinCEN's program rules. The first element, identifying and verifying the identity of customers, is already included in the existing regulatory requirement to have a customer identification program (CIP). Given this fact, FinCEN is addressing the need to have explicit requirements with respect to the three remaining elements via two rule changes. First, FinCEN is addressing the need to collect beneficial owner information on the natural persons behind legal entities by proposing a new separate requirement to identify and verify the beneficial owners of legal entity customers, subject to certain exemptions. Second, FinCEN is proposing to add explicit CDD requirements with respect to understanding the nature and purpose of customer relationships and conducting ongoing monitoring as components in each covered financial institution's core AML program requirements. Within this context, FinCEN is also updating its regulations to include explicit reference to all four of the pre-existing core requirements of an AML program, sometimes referred to as "pillars," so that all of these requirements are visible within FinCEN's rules. As discussed in more detail below, these existing core requirements are already laid out in the BSA as minimum requirements and are substantively the same as those already included within regulations or rules issued by federal functional regulatory agencies and self-regulatory organizations (SROs), and therefore we believe they do not add to or otherwise change the covered financial institutions' existing obligations under these regulations or rules.

FinCEN wishes to emphasize at the outset that nothing in this proposal is intended to lower, reduce, or limit the due diligence expectations of the federal functional regulators or in any way limit their existing regulatory discretion. To clarify this point, this proposal incorporates the CDD elements on nature and purpose and ongoing monitoring into FinCEN's existing AML program requirements, which generally provide that an AML program is adequate if, among other things, the program complies with the regulation of its federal functional regulator (or, where applicable, self-regulatory organization) governing such programs. [7] In addition, the Treasury Department intends for the requirements contained in this customer due diligence and beneficial ownership proposal to be consistent with, and not to supersede, any regulations, guidance or authority of any federal banking agency, the Securities and Exchange Commission (SEC), the Commodity Futures Trading Commission (CFTC), or of any self-regulatory organization (SRO) relating to customer identification, including with respect to the verification of the identities of legal entity customers.

The remainder of this background section provides: (a) An overview of the importance of CDD; (b) a description of the Advance Notice of Proposed Rulemaking (ANPRM), [8] which initiated this rulemaking process and Treasury's subsequent outreach to the private sector; and (c) an overview of Treasury's efforts to enhance financial transparency more broadly.

A. Importance of Customer Due Diligence

Clarifying and strengthening CDD requirements for U.S. financial institutions, including an obligation to identify beneficial owners, advances the purposes of the BSA by:

Enhancing the availability to law enforcement, as well as to the federal functional regulators and SROs, of beneficial ownership information of legal entity customers obtained by U.S. financial institutions, which assists law enforcement financial investigations and regulatory examinations and investigations;

Increasing the ability of financial institutions, law enforcement, and the intelligence community to identify the assets and accounts of terrorist organizations, money launderers, drug kingpins, weapons of mass destruction proliferators, and other national security threats, which strengthens compliance with sanctions programs designed to undercut financing and support for such persons;

Helping financial institutions assess and mitigate risk, and comply with all existing legal requirements, including the BSA and related authorities;

Facilitating reporting and investigations in support of tax compliance, and advancing national commitments made to foreign counterparts in connection with the provisions commonly known as the Foreign Account Tax Compliance Act (FATCA); [9] and

Promoting consistency in implementing and enforcing CDD regulatory expectations across and within financial sectors.

i. Assisting Financial Investigations by Law Enforcement

The abuse of legal entities to disguise involvement in illicit financial activity remains a longstanding vulnerability that facilitates crime, threatens national security, and jeopardizes the integrity of the financial system. Criminals have exploited the anonymity that can be provided by legal entities to engage in a variety of financial crimes, including money laundering, corruption, fraud, terrorist financing, and sanctions evasion.

There are numerous examples. Law enforcement officials have found that major drug trafficking organizations use shell companies to launder drug proceeds. [10] In 2011, a World Bank report highlighted how corrupt actors consistently abuse legal entities to conceal the proceeds of corruption, which the report estimates to aggregate to at least $40 billion per year in illicit activity. [11] Other criminals also make aggressive use of front companies, which may also conduct legitimate business activity, to disguise the deposit, withdrawal, or transfer of illicit proceeds that are intermingled with legitimate funds.

Strong CDD practices that include identifying the natural persons behind a legal entity--i.e., the beneficial owners--help defend against these abuses in a variety of ways. Armed with beneficial ownership information, financial institutions can provide law enforcement with key details about the legal structures used by suspected criminals to conceal their illicit activity and assets. Moreover, requiring legal entities seeking access to financial institutions to disclose identifying information, such as the name, date of birth, and social security number of a natural person, will make such entities more transparent, and thus less attractive to criminals and those who assist them. Even if an illicit actor tries to thwart such transparency by providing false beneficial ownership information to a financial institution, law enforcement has advised FinCEN that such information can still be useful in demonstrating unlawful intent and in generating leads to identify additional evidence or co-conspirators.

ii. Advancing Counterterrorism and Broader National Security Interests

As noted, criminals often abuse legal entities to evade sanctions or other targeted financial measures designed to combat terrorism and other national security threats. The success of such targeted financial measures depends, in part, on the ability of financial institutions, law enforcement, and intelligence agencies to identify a target's assets and accounts. These measures are thwarted when legal entities are abused to obfuscate ownership interests. Effective CDD helps prevent such abuses by requiring the collection of critical information, including beneficial ownership information, which may be helpful in implementing sanctions or other similar measures.

iii. Improving a Financial Institution's Ability To Assess and Mitigate Risk

Express CDD requirements would also enable financial institutions to more effectively assess and mitigate risk. It is through CDD that financial institutions are able to develop risk profiles of their customers. Comprehensive risk profiles enable a financial institution to monitor accounts more effectively, and evaluate activity to determine whether it is unusual or suspicious, as required under suspicious activity reporting obligations. [12] Further, in the event that a financial institution files a suspicious activity report (SAR), information gathered through CDD enhances SARs, which in turn helps law enforcement, intelligence, national security and tax authorities investigate and pursue illicit financing activity.

iv. Facilitating Tax Compliance

Customer due diligence also facilitates tax reporting, investigations and compliance. For example, information held by banks and other financial institutions about the ownership of companies can be used to assist law enforcement in identifying the true owners of assets and their true tax liabilities. The United States has long been a global leader in establishing and promoting the adoption of international standards for transparency and information exchange to combat cross-border tax evasion and other financial crimes. Strengthening CDD is an important part of that effort, and it will dovetail with other efforts to create greater transparency, such as the new tax reporting provisions under the Foreign Account Tax Compliance Act (FATCA). [13] FATCA requires foreign financial institutions to identify U.S. account holders, including legal entities with substantial U.S. ownership, and to report certain information about those accounts to the Internal Revenue Service (IRS). [14] The United States has collaborated with foreign governments to enter into intergovernmental agreements that facilitate the effective and efficient implementation of these requirements. These agreements and, to a lesser extent, the applicable FATCA regulations, allow foreign financial institutions to rely on existing AML practices in a number of circumstances, including, in the case of the agreements, for purposes of determining whether certain legal entity customers have substantial owners. Pursuant to many of these agreements, the United States has committed to pursuing reciprocity with respect to collecting and reporting to the authorities of the FATCA partner information on the U.S. accounts of residents of the FATCA partner. A general requirement for U.S. financial institutions to obtain beneficial ownership information for AML purposes advances this commitment, and puts the United States in a better position to work with foreign governments to combat offshore tax evasion and other financial crimes.

v. Promoting Clear and Consistent Expectations and Practices

Customer due diligence is universally recognized as fundamental to mitigating illicit finance risk, even though not all covered financial institutions use the specific term "customer due diligence" to describe their practices. While Treasury understands from its outreach to the private sector that financial institutions broadly accept this principle and implement CDD practices in some form under a risk-based approach, covered financial institutions have expressed disparate views about what precise activity CDD entails. At public hearings held after the comment period to the ANPRM, discussed below, financial institutions described widely divergent CDD practices, especially with respect to identifying beneficial owners outside of limited circumstances prescribed by statute. [15]

FinCEN believes that this disparity adversely affects efforts to mitigate risk and can promote an uneven playing field across and within financial sectors. Covered financial institutions have noted that unclear CDD expectations can result in inconsistent regulatory examinations, potentially causing them to devote their limited resources to managing derivative legal risk rather than fundamental illicit finance risk. Private sector representatives have also noted that inconsistent expectations can effectively discourage best practices, because covered financial institutions with robust compliance procedures may believe that they risk losing customers to other, more lax institutions. Greater consistency across the financial system could also facilitate reliance on the CDD efforts of other financial institutions.

Providing a consolidated and clear CDD framework would help address these issues. As part of this framework, expressly stating CDD requirements in rule or regulation with respect to (i) understanding the nature and purpose of customer relationships and (ii) conducting ongoing monitoring to maintain and update customer information and to identify and report suspicious transactions, will facilitate more consistent implementation, supervision and enforcement of these expectations. With respect to the beneficial ownership proposal, requiring all covered financial institutions to identify beneficial owners in the same manner and pursuant to the same definition also promotes consistency across the industry. Requiring covered financial institutions to operate under one clear CDD framework will promote a more level playing field across and within financial sectors.

B. Issuance of the Advance Notice of Proposed Rulemaking and Subsequent Outreach

FinCEN formally commenced this rulemaking process in March 2012 by issuing an ANPRM that described FinCEN's potential proposal for codifying explicit CDD requirements, including customer identification, understanding the nature and purpose of accounts, ongoing monitoring, and obtaining beneficial ownership information. [16]

FinCEN received approximately 90 comments, mostly from banks, credit unions, securities and derivatives firms, mutual funds, casinos, and money services businesses. In general, and as described in greater detail below, these commenters primarily raised concerns about the potential costs and practical challenges associated with a categorical requirement to obtain beneficial ownership information. They also reflected some confusion with respect to FinCEN's articulation of the other components of CDD, suggesting that FinCEN was imposing new requirements rather than explicitly codifying pre-existing obligations.

To better understand and address these concerns, Treasury held five public hearings in Washington, DC, Chicago, New York, Los Angeles and Miami. [17] At these meetings, participants expressed their views on the ANPRM and offered specific recommendations about how best to minimize the burden associated with obtaining beneficial ownership information. These discussions were critical in the development of this proposal.

C. Treasury's Broad Strategy To Enhance Financial Transparency

Clarifying and strengthening CDD is an important component of Treasury's broader three-part strategy to enhance financial transparency. Other key elements of this strategy include: (i) Increasing the transparency of U.S. legal entities through the collection of beneficial ownership information at the time of the legal entity's formation and (ii) facilitating global implementation of international standards regarding CDD and beneficial ownership of legal entities and trusts.

This proposal thus complements the Administration's ongoing work with Congress to facilitate adoption of legislation that would require the collection of beneficial ownership information at the time that legal entities are formed in the United States. This proposal also advances Treasury's ongoing work with the Group of Twenty Finance Ministers and Central Bank Governors (G-20), the Financial Action Task Force (FATF), and other global partners, who have emphasized the importance of improving CDD practices and requiring the disclosure of beneficial ownership information at the time of company formation or transfer. Moreover, this proposal furthers the United States' Group of Eight (G-8) commitment as set forth in the United States G-8 Action Plan for Transparency of Company Ownership and Control, published on June 18, 2013. [18] This Action Plan is in line with principles agreed to by the G-8, which the White House noted "are crucial to preventing the misuse of companies by illicit actors." [19] While these elements are all proceeding independently, together they establish a comprehensive approach to promoting financial transparency.

II. Scope of and Rationale for the Proposed Rule

This section describes: (i) The range of financial institutions covered by this proposal; (ii) FinCEN's continued interest in potentially extending the proposed rule to additional financial institutions in the future, and (iii) the basis for proposing explicit requirements that, in conjunction with the existing customer identification program (CIP) requirement, will create a clearer CDD framework.

As an initial matter, this proposal covers only those financial institutions subject to a CIP requirement under FinCEN regulations. At this time, such financial institutions are: (i) Banks; (ii) brokers or dealers in securities; (iii) mutual funds; and (iv) futures commission merchants and introducing brokers in commodities. [20] FinCEN believes that initially covering only these sectors is an appropriate exercise of its discretion to engage in incremental rulemaking. These sectors represent a primary means by which individuals and businesses maintain accounts with access to the financial system. In addition, because these covered financial institutions have been subject to CIP rules, FinCEN believes that it is logical to commence implementation with those financial institutions already equipped to leverage CIP practices to the extent possible, as the proposal contemplates.

In addition to input from covered financial institutions, FinCEN sought and received comments on the ANPRM from financial institutions not subject to CIP requirements, such as money services businesses, casinos, insurance companies, and other entities subject to FinCEN regulations. Based on these comments and discussions with the private sector, FinCEN believes that extending CDD requirements in the future to these, and potentially other types of financial institutions, may ultimately promote a more consistent, reliable, and effective AML regulatory structure across the financial system.

Several comments questioned the need for proposing a CDD rule that contained all four elements, when three of the four elements are already consistent with existing requirements or supervisory expectations. FinCEN believes that proposing clear CDD requirements is the most effective way of clarifying, consolidating, and harmonizing expectations and practices across all covered financial institutions. Expressly stating the requirements facilitates the goal that financial institutions, regulators, and law enforcement all operate under the same set of clearly articulated principles. The proposed CDD requirements are intended to set forth a clear framework of minimum expectations that can be broadly applied to varying risk scenarios across multiple financial sectors and can be tailored by financial institutions to account for the risks unique to them. For this reason, and as part of a broader global agenda supported by Treasury, many other jurisdictions have already imposed requirements similar to those proposed herein. [21] These global developments promote a level playing field internationally and mitigate the threat of illicit finance presented by an increasingly interconnected financial system.

Furthermore, additional discussions with the private sector reaffirmed FinCEN's view that a beneficial ownership requirement is best understood in the context of broader due diligence conducted on customers. Beneficial ownership information is only one component of a broader profile that is necessary for financial institutions to develop when assessing a particular customer's risk. Beneficial ownership information is a means of building a more comprehensive risk profile; it is not an end in and of itself. Thus, in addition to proposing a specific requirement for the collection of the beneficial ownership information, FinCEN is also proposing amendments to its AML program rules to specifically reference the two components of CDD that were not elsewhere explicitly included in its regulations, i.e., understanding the nature and purpose of an account and conducting ongoing monitoring.

[*Federal RegisterVJ 2014-08-04]

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