As part of the U.S. Treasury Department’s ongoing efforts to prevent possible bad actors from using U.S. companies to conceal money laundering, tax evasion, and other illicit financial activities, FinCEN issued, on May 11, 2016, a final rule to strengthen the customer due diligence (CDD) efforts of “covered financial institutions.” This was one of the most important, if not the most important, AML developments in 2016. Covered institutions have until May 11, 2018, to comply with the new CDD rule, which requires covered financial institutions, including banks, federally insured credit unions, broker-dealers, mutual funds, futures commission merchants, and introducing brokers in commodities, to identify the natural persons that own and control legal entity customers—the entities’ “beneficial owners.”

The CDD rule was almost four years in the making; the process began with an Advanced Notice of Proposed Rulemaking in March 2012. The final release of this long-delayed rule appears to have been motivated in part by the April 2016 disclosure of the Panama Papers. Despite the issuance of this new rule, the Financial Action Task Force (FATF) still stated in its December 2016 Mutual Evaluation Report on the Unites States’ Measures to Combat Money Laundering and Terrorist Financing that a continued lack of timely access to adequate, accurate, and current information on the beneficial owners of entities represented a “fundamental gap” in the U.S. AML regulatory regime.

The new CDD rule imposes several new obligations on covered financial institutions with respect to their “legal entity customers.” These include corporations, limited liability companies, general partnerships, and other entities created by filing a public document or formed under the laws of a foreign jurisdiction.  Certain types of entities are excluded from the definition of “legal entity customer,” including financial institutions, investment advisers and other entities registered with the Securities and Exchange Commission, insurance companies, and foreign governmental entities that engage only in governmental, non-commercial activities.

For each such customer that opens an account, including an existing customer opening a new account, the covered financial institution must identify the customer’s “beneficial owners.” The CDD adopts a two-part definition of “beneficial owner,” with an ownership prong and a control prong. Under this approach, each covered financial institution must identify:

  • each individual who owns 25 percent or more of the equity interests in the legal entity customer; and
  • at least one individual who exercises significant managerial control over the customer.

The same individual(s) may be identified under both prongs. If no single individual owns 25 percent or more, the covered financial institution may identify a beneficial owner under only the control prong. The same approach is used for nonprofit entities, which do not have “owners.”

The covered financial institution must verify the identity of each beneficial owner identified by the customer. Importantly, the covered financial institution is entitled to rely on the customer’s certification regarding each individual’s status as a beneficial owner. However, the covered financial institution must obtain personally identifying information about each beneficial owner. This information must be documented and maintained by the financial institution.

The rule references a sample certified form, a copy of which is attached to the rule; the form is optional and the rule permits the covered financial institution to obtain and record the necessary information “by any other means that satisfy” its verification and identification obligations. Nonetheless, it is likely that many financial institutions will use the proposed certified form, or a variant, particularly because the rule allows a financial institution to rely on the representations made in the form in the absence of information that such reliance would be unreasonable. On the proposed form, the signatory—designated as the person opening the account—purports to identify the beneficial owners of the entity opening the account. Thus, although the CDD rule directly imposes new obligations on financial institutions, it is the certification form that may represent the greatest legal risk for individuals. If the person signing the form, or causing the form to be signed, knows or has reason to believe that the beneficial owners listed on the form are mere nominees intended to disguise the true beneficial owner, that person could be directly responsible for a fraud-related offense.

In response to industry concerns that the beneficial ownership identification obligation would require covered financial institutions to continually monitor the allocation of its customers’ equity interests and the composition of its management team to update its beneficial ownership information, FinCEN made clear that the CDD rule does not require covered financial institutions to continuously update each customer’s beneficial ownership information. Rather, the CDD calls for a “snapshot” of the customer’s beneficial owners at the time of account creation. However, FinCEN does expect covered financial institutions to update beneficial ownership information when it detects relevant information about the customer during regular monitoring.

At the same time that FinCEN issued its final CDD rule, the Treasury Department also issued a related Notice of Proposed Rulemaking (NPR) aimed at identifying the beneficial owners of foreign-owned single-member LLCs. The NPR became a final regulation on December 13, 2016. The rule imposes additional reporting and recordkeeping requirements on foreign-owned single-member LLCs by treating them as domestic corporations separate from their owners “for the limited purposes of the reporting and record maintenance requirements” imposed by the Internal Revenue Code. Now, each foreign-owned single-member LLC is required to:

  • obtain entity identification numbers from the IRS, which requires identification of a responsible party—a natural person;
  • annually file IRS Form 5472, an informational return identifying “reportable transactions” that the LLC engaged in with respect to any related parties, such as the entity’s foreign owner; and
  • maintain supporting books and records.

Again emphasizing the focus on identifying beneficial ownership, former Treasury Secretary Jacob Lew explained in a letter to Congress that the new tax regulations are designed specifically “to close a current loophole in our system” that allows foreign persons to use U.S. LLCs to hide assets both in and outside of the United States. Highlighting the increasingly international aspect of AML and anti-tax evasion efforts, the NPR explained that the information obtained will be shared with other governments.

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