Effective May 11, 2018, final rules adopted by the Financial Crimes Enforcement Network, or FinCEN, under the Bank Secrecy Act require "covered financial institutions" (e.g., federal regulated banks, federal insured credit unions, mutual funds, broker dealers, futures commission merchants) to identify and verify the identity of beneficial owners of legal entity customers (other than those that are excluded) at the time a new account is opened (other than accounts that are exempted) (the "rule"). The rule requires risk-based procedures for conducting ongoing customer due diligence, and requires an understanding of the nature and purpose of customer relationships for the purpose of developing a customer risk profile.
LEGAL ENTITY CUSTOMER
A legal entity customer means 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 (including partnerships, business trusts, etc.). The definition does not include natural persons opening accounts on their own behalf.
Exclusions. Certain legal entity customers are not covered by the rule, including:
- Regulated banks.
- A department or agency of the federal or state government.
- Entities established under the laws of the U.S., any state or political subdivision of a state.
- Entities whose stock is listed on the NYSE, the NYSE American or Nasdaq.
- A U.S. entity when at least 51% of its common stock or analogous equity interest is held by a listed entity Issuers of securities registered under Section 12 of the 34 Act or that are required to file reports under Section 15(d).
- Investment companies.
- SEC registered investment advisers.
- Clearing agencies.
- Any other entity registered with the SEC under the 34 Act.
- Bank holding companies or a savings and loan holding companies.
- Insurance companies regulated by a state.
- Pooled investment vehicles operated or advised by a financial institution excluded from the definition of a legal entity customer.
- A financial market utility designated by the Financial Stability Oversight Council under Title VIII of the Dodd-Frank Wall Street Reform and Customer Protection Act of 2010.
- A foreign financial institution established in a jurisdiction where the regulator of such institution maintains beneficial ownership information regarding such institution.
- A non-U.S. governmental department, agency or political subdivision that engages only in governmental rather than commercial activities.
- Any legal entity only to the extent that it opens a private banking account subject to 31 C.F.R. § 1010.620.
New Accounts. While the rule applies to "new accounts" it is important to note that if something like a loan renewal or rollover of a certificate of deposit involves a new aspect, the rule would be triggered. Covered financial institutions are not required to review accounts opened prior to May 11, 2018. Instead, covered financial institutions have an event-driven (and not continuous or periodic) duty to update beneficial ownership. The requirement is triggered when a covered financial institution becomes aware of information, during the course of normal monitoring relevant to assessing or reassessing the risk posed by the customer, and such information indicates a possible change of beneficial ownership.
Exemptions. Section 1010.230(h) exempts covered financial institutions from the rule with respect to opening accounts for legal entity customers for specific activities and within certain limitations. The new rule is intended to assist law enforcement in investigating and prosecuting terrorist financing, money laundering, and other financial crimes that may be perpetrated through the use of legal entities; therefore, certain transactions that do not include any payments to third parties and do not allow parties to receive a cash refund and do not create a risk for money laundering and other financial crimes, are exempted.
Covered financial institutions must focus on the those who control accounts owned by legal entities when determining beneficial ownership. The beneficial ownership definition includes two prongs:
- The "control" prong covers a single individual with significant responsibility to control, manage, or direct a legal entity customer, including an executive officer, a senior manger or any other individual who regularly performs similar functions.
- The "ownership" prong covers each individual, if any, who directly or indirectly, through contract arrangement, understanding, relationship or otherwise, owns 25% or more of the equity interests of a legal entity customer.
Determining a trust's beneficial owner. If a trust owns directly or indirectly, through any contract, arrangement, understanding, relationship or otherwise, 25% or more of the equity interests of a legal entity customer, the beneficial ownership for purposes of the regulation shall mean the trustee, regardless of whether the trustee is a natural person or not (ownership prong) to comply with control. Where there are multiple trustees or co-trustees, financial institutions are expected to collect and verify the identify of, at a minimum, one co-trustee of a multi-trustee trust who owns 25% or more of the equity interests. A covered financial institution may choose to identify additional co-trustees as part of its customer due diligence, based on its risk assessment and the customer-risk profile and in accordance with the institution's account opening procedures.
Determining a pooled investment vehicle's beneficial owner. In general, covered institutions are not required to look through a pooled investment vehicle to identify and verify the identify of any individuals that own 25% or more of its equity interest. Because of the way in which ownership of a pooled investment vehicle fluctuates, it would be impractical for covered financial institutions to collect and verify ownership identity for this type of entity, and, therefore, there is no requirement that the covered financial institution should request the legal entity customer to look through the pooled investment vehicle to determine and report any individual's equity interest. Under the control prong, however, institutions are required to identify those with significant responsibility to control manage or direct the vehicle, such as the portfolio manager, commodity pool operator, commodity trading advisor or general partners.
Covered financial institutions must collect each beneficial owner's (1) name, (2) date of birth, (3) address, and (4) either (a) social security number or (b) other government identification number (for non-U.S. persons). A covered financial institution is free to obtain the required information by obtaining a completed Certification Form from the legal entity customer's representative or by any other means that comply with the substantive requirements of the rule's obligations. The Certification Form sets forth general instructions, asks if any exclusions apply, requests the identification of the beneficial owner (the individual opening the account, the legal customer name, the control prong information, the ownership prong information), and requires a signature. Rather than require a heightened knowledge threshold, a covered financial institution may rely on the information provided by a legal entity customer's representative, as long as it does not have knowledge of facts that would reasonably call into question the reliability of such information.
HOW DOES THE NEWBENEFICIAL OWNERSHIP REQUIREMENT AFFECT TRANSACTIONS BETWEEN DEALERS IN STRUCTURED PRODUCTS?
We have observed that underwriters in underwritten offerings are now performing diligence under the new requirements by obtaining completed questionnaires from issuers and selling securityholders. Those questionnaires require the issuer or selling securityholder to either certify that they are within an exclusion from the definition of a legal entity customer or to provide their beneficial ownership information.
When negotiating new dealer agreements or renegotiating existing agreements, broker-dealers should consider expanding upon the standard "compliance with law" representation that exists in dealer agreements and require the legal entity customer to represent that:
- it has either provided the necessary beneficial ownership information or an exemption applies; and
- it will inform the covered financial institution if the legal entity customer's beneficial ownership changes in the future.
Due to the breadth and easy availability of the exclusions from the definition of legal entity customer, we do not believe that it is necessary to renegotiate selected dealer agreements solely to cover this point. However, if a dealer is regularly doing business with a non-U.S. dealer, the domestic dealer should consider amending or renegotiating their selected dealer agreement to ensure that it obtains the necessary beneficial ownership information from the non-U.S. dealer. Dealers negotiating distribution agreements with an unlisted issuer of structured products, such as a non-U.S. bank, should include the representations listed above in the agreement. An affiliated U.S. broker-dealer of a non-U.S. bank should include the representations above with respect to its affiliated issuer.
Additionally, if the legal entity customer is onselling the securities to other dealers, the dealer agreement should include a representation that the legal entity customer is getting the necessary beneficial ownership information, or confirming that an exemption applies, from its customers to ensure that the initial covered financial institution will not be tainted if, farther down the line, securities are sold to a legal entity customer that is engaged in financial crimes. The types of customers that may cause concern include family offices, non-U.S. broker-dealers and non-U.S. investment advisers, none of which are within the available exemptions. There is much less concern if the legal entity customer only sells securities to natural persons such as high net worth individuals or registered investment advisers, each of whom are excluded from the definition of legal entity customer.
Originally published in REVERSEinquiries: Volume 1, Issue
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