In May of 2016, the Financial Crimes Enforcement Network (“FinCEN”) published the final version of anti-money laundering (“AML”) regulations designed to enhance financial transparency. Broadly speaking, the so-called “Customer Due Diligence” (CDD) rules mandate that financial institutions implement procedures for the identification and verification of the “beneficial owners” of US financial accounts held by any “legal entity customer”.
The Preamble to the proposed CDD regulations stated:
“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:
• 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); …”
This mandate for information gathering may just be the ‘first’ step before a later law is enacted mandating that US financial institutions send the gathered information to the Internal Revenue Service (IRS) for onward submission to FATCA Intergovernmental Agreement (IGA) partners. One of the stated goals for obtaining the information is to enable the USA to comply with the US government’s obligations to any countries with which it has a “reciprocal” IGA under FATCA.
A “reciprocal” IGA is a Model 1A IGA. (A full list of countries having IGAs and the type of IGA can be accessed here).
With a “reciprocal” IGA, the US is generally required to exchange information about accounts held in US financial institutions by citizens or residents of the IGA partner countries. The reciprocal IGA also incorporates a policy commitment by the US to implement rules and support legislation that would provide for equivalent levels of information exchange (which rules the USA currently lacks, making “reciprocity” a hollow promise).
To date, the US has been very slow in meeting its “reciprocity” commitments. This has not gone unnoticed by prominent commentators or by foreign signatories to the so-called “reciprocal” IGAs. While the issuance of the final CDD regulations may inch the US a bit closer to financial transparency, it still has a very long way to go. For example, there is currently no mandate for US financial institutions to send financial information to foreign IGA partners or to the US government for the forwarding of such information on to an IGA partner. As has been noted before with respect to FATCA, “reciprocal is, as reciprocal does”. And the United States? Well, it doesn’t.
“Customer Due Diligence” Regulations
The final CDD regulations became effective on July 11, 2016. These regulations require “Covered Financial Institutions” (CFI) to identify the “beneficial owners” of each “legal entity customer” and to verify the identities of such owners. CFIs have until May 11, 2018 (the “applicability date”) to implement the required procedures.
Up until the time the new CDD regulations took effect, financial institutions had not been obligated to “look through” a legal entity that was its customer of record in order to determine the identity of the entity’s beneficial owners. Under the new rules, a CFI must implement new procedures, in part, to obtain beneficial owner information from its “legal entity customers” regardless of whether the entity is organized in the United States or in a foreign jurisdiction.
As stated in the preamble to the Regulations, FinCEN intends that the legal entity customer identify its ultimate beneficial owner or owners and not “nominees” or “straw men.”
On July 16, FinCEN issued FAQs providing further guidance on the new regulations. Below follows some of the guidance gleaned from those FAQs and the CDD Regulations.
CDD — Who has to Comply?
The new Customer Due Diligence rules apply to “Covered Financial Institutions.” This term encompasses financial entities that are currently subject to industry-specific AML regulations. That is, the term covers banks and other depository institutions, brokers or dealers in securities, mutual funds, futures commission merchants, and introducing brokers in commodities.
Although the new rules apply to CFIs, there is no legal requirement that a legal entity customer comply with the CFIs information requests. Thus, the customer can simply refuse to provide the requested information, with the likely result that it will be denied an account or have a currently existing account be closed. There is no requirement that a CFI do business with a customer that refuses to provide the requested beneficial owner information. Once the applicability date kicks in on May 11 2018, “legal entity customers” will probably be unable to maintain accounts unless they give the required information.
What is a “Legal Entity Customer”?
A “legal entity customer” is a corporation, limited liability company, or other entity 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. The definition also includes limited partnerships, business trusts that are created by a filing with a state office, and any other entity created in this manner. A legal entity customer does not include sole proprietorships, unincorporated associations, or natural persons opening accounts on their own behalf.
A list of excluded entities is provided in FAQ 21 and includes, for example, a foreign financial institution established in a jurisdiction where the regulator of such institution maintains beneficial ownership information regarding the institution.
Who is a “Beneficial Owner”?
CFIs must identify and verify “beneficial owners” of the “legal entity customer”. The Regulations define a “beneficial” owner as either of the following types of individuals:
- each individual, if any, who, directly or indirectly, owns 25% or more of the equity interests of a legal entity customer (i.e., this is the so-called “ownership prong”); and
- a single individual with significant responsibility to control, manage, or direct a legal entity customer, including an executive officer or senior manager (e.g., a Chief Executive Officer, Chief Financial Officer, Chief Operating Officer, Managing Member, General Partner, President, Vice President, or Treasurer); or any other individual who regularly performs similar functions (this is the so-called “control prong”). The rules recognize that since there is significant diversity in how legal entities are structured, the list of positions is not exclusive.
If no individual satisfies the ownership prong, the covered financial institution must identify and verify the identity only of a control person of that legal entity customer. Under the definition of “beneficial owner”, a legal entity will have a total of between one and five beneficial owners (i.e., one person under the control prong and zero to four persons under the ownership prong).
The FAQ’s make clear that a legal entity customer is not to provide the identification of a nominee owner in response to a financial institution’s request for the identification of a beneficial owner. However, at the same time, the FAQ’s note that the CFI is entitled to rely on the identification of the owner unless it has reason to question its accuracy.
What are the Required CDD Procedures?
Beginning on the applicability date in May 2018, CFIs must establish and maintain written procedures “reasonably designed” to identify and verify the identities of beneficial owners of legal entity customers and to maintain the relevant records. It is important to note that the FAQs clarify that the CFI need not obtain the required information directly from the beneficial owners of the legal entity customer.
This due diligence must be carried out when a new account is opened and also when, in the normal course of customer monitoring, the CFI finds pertinent information. The required information can be obtained through use of a certification form created by FinCEN (see Appendix A of the new regulations) or through another method so long as it complies with the substantive requirements of the CDD regulations. In short, CFIs must now obtain, verify, and record the identities of the beneficial owners of legal entity customers.
What About Trusts? Are They Treated as Legal Entity Customers? Are they Treated as Beneficial Owners?
Trusts are not included in the definition of a “legal entity customer” unless the trust is a statutory trust. A statutory trust is one which is specifically created by a filing with the Secretary of State or similar office. Therefore, generally speaking, a CFI need not obtain beneficial owner information about its customer, the non-statutory trust. However, as made clear by FAQ 22, certain existing obligations and practices regarding trusts are already in place for financial institutions, and are not superseded by the CDD rules.
Trusts can be “beneficial owners” of a “legal entity customer” (e.g., imagine the situation when a trust owns, say, 60% of a corporation and the corporation has an account at the CFI). If 25% or more of the equity interests of a legal entity customer are owned by a trust (other than a statutory trust) CFIs can satisfy the ownership prong of the beneficial ownership requirement by obtaining and verifying the identity of the trustee. FinCEN commented that a CFI would also be required to identify an individual associated with the trust under the “control prong”; it is also possible that a single individual could satisfy both prongs.
And the Future?
Implementation of the CDD regulations will undoubtedly pose some operational challenges to CFIs; but they do have two years to get systems in order. Foreign beneficial owners of legal entity customers with accounts at US financial institutions will become more and more concerned now about FATCA. They may terminate their accounts or seek ways to work around the rules if they have not been tax compliant in their home country or if they have sensitive privacy concerns. It is well known that the “limited liability company” (LLC) created under the laws of a US State is a favored vehicle for the single-owner foreign individual. Up until recently, such single member LLCs were sheltered from any US tax information reporting. Now, with issuance of the CDD rules, identification and verification of the identities of the beneficial owner of the LLC by financial institutions where the LLC has an account, will be required commencing May 2018. We can see that the transparency landscape is changing, albeit rather slowly. Certainly, however, the issuance of the final CDD regulations will heighten the expectations of foreign IGA signatories. Time will tell whether those expectations will be met.
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