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FinCEN Proposes New Rule Needing Identification of Advantageous Proprietors

 

FinCEN Proposes New Rule Needing Identification of Advantageous Proprietors

This summer time the Financial Crimes Enforcement Network (“FinCEN”) released a notice of suggested rulemaking suggesting a guide that, if adopted, would mandate that banking institutions require their legal entity clients to recognize natural persons meeting certain possession thresholds.

Introduction –

The suggested rule signifies a departure from current FinCEN rules, to which banking institutions exercise their very own judgment for making risk-based checks whether or not to require advantageous owner information for legal entity accounts. The suggested rule would affect all banking institutions presently susceptible to customer identification program (“CIP”) needs: banks, broker-dealers, mutual funds, futures commission retailers, and presenting brokers in goods (“covered financial institutions”).

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2
In 2012, FinCEN issued an advanced notice of proposed rulemaking (the “ANPR”), which
set forth FinCEN’s rationale for an express beneficial owner identification requirement,
and sought comment on particular aspects of the proposed rulemaking.3 The ANPR noted
in particular that though existing CIP rules may implicitly require beneficial owner
identification based on risk-based assessments, in FinCEN’s view there was a lack of
uniformity and consistency across financial institutions in how those obligations were
being carried out, and noted the importance of such information in efforts to combat
terrorism and more traditional money-laundering.
Existing Customer Due Diligence Requirements
Covered financial institutions are already required to have robust policies and procedures
to conduct customer due diligence (“CDD”) and comply with recordkeeping and reporting
requirements, such as the filing of suspicious activity reports (“SARs”).4
Explicit Requirements
Explicit requirements include obtaining, and in some cases verifying, customer
identification information pursuant to the mandatory CIP and filing SARs. Only in limited
circumstances must covered financial institutions obtain beneficial ownership information:
in the contexts of private banking accounts and correspondent accounts.5 Firms that offer
private banking accounts must take reasonable steps to identify the nominal and beneficial
owners of such accounts.6 Those that offer correspondent accounts for certain foreign
financial institutions must take reasonable steps to obtain information about the identity of
persons with authority to direct transactions through an account that is payable-through,
i.e., the sources and beneficial ownership of funds in the account.7
With respect to certain accounts, covered financial institutions must collect sufficient
information to develop a customer risk profile that can be used to identify higher-risk
customers and accounts, investigate unusual and suspicious activity, and make an
informed decision whether to file a SAR. Also, they must monitor suspicious activities,
which is important in assisting criminal investigations and to facilitate tax reporting and

3 See our March 2012 client publication about the ANPR, available at
http://www.shearman.com/en/newsinsights/publications/2012/03/more-diligent-customer-due-diligence-fincen-and-
__.
4 See, e.g., Federal Financial Institution Examination Council Bank Secrecy Act Anti-Money Laundering Examination
Manual; Financial Industry Authority, Updated AML Template for Small Firms (Jan. 2010); and National Association
of Securities Dealers, Notice to Members 02-21 (Apr. 2002).
5 See, e.g., 12 C.F.R. §§ 208.62, 211.5(k), 211.24(f), 225.4(f), and 353.3 (2013); and 31 C.F.R. § 1023.320 (2013).
6 31 C.F.R. § 1010.620(b)(1) (2013).
7 31 C.F.R. § 1010.610(b)(1)(iii)(A) (2013).
Contacts (cont.)
Sylvia Favretto
Washington, DC
+1.202.508.8176
sylvia.favretto@shearman.com
Christina Broch
Washington, DC
+1.202.508.8028
christina.broch@shearman.com
SHEARMAN.COM
3
investigations.8 A CIP must address situations where, prompted by a risk assessment of a new account opened by a
customer that is not an individual, additional information about individuals with authority over the account should be
obtained.9
Implicit Requirements
Implicit requirements are those that FinCEN believes covered financial institutions must follow to achieve compliance
with existing regulations. One example is the obligation to conduct adequate ongoing diligence to ensure that customer
information is accurate and to determine whether filing a SAR is appropriate, which flows from the BSA/AML
requirement to maintain accurate customer risk profiles and risk assessments and to report suspicious activity.10
Because covered financial institutions must consider potentially suspicious activities in the context of the normal or
appropriate activities of a particular customer, it follows that they should understand the nature and purpose of an
account or customer relationship to assess the risk presented by the relationship and effectively monitor for suspicious
activity. In particular cases, this requirement may mean that beneficial ownership information needs to be obtained.11 The
proposed rule would codify these and other similar requirements, requiring banks and securities firms to establish and
maintain policies and procedures for ongoing monitoring of all client relationships.
The Proposed Rule
Four Elements of Customer Due Diligence, but Only One New
The NPR states that CDD consists of at least the following four elements:
1. Identifying and verifying the identity of customers;
2. Identifying and verifying the identity of beneficial owners of legal entity customers;
3. Understanding the nature and purpose of customer relationships; and,
4. Conducting ongoing monitoring to maintain and update customer information and to Identify and report suspicious
transactions
The NPR notes that (1) is already expressly required by existing CIP requirements, and in FinCEN’s view (3) and (4) are
implicit in existing CIP requirements. This note therefore focuses on the proposed rule’s requirements regarding
identification of legal entity customer beneficial owners.

8 For example, suspicious activity monitoring requirements would facilitate the new tax reporting provisions of the Foreign Account Tax Compliance Act,
which requires overseas financial institutions to identify US account holders and to report certain information about their accounts to the Internal Revenue
Service. See generally, Internal Revenue Service, “Regulations Relating to Information Reporting by Foreign Financial Institutions and Withholding on
Certain Payments to Foreign Financial Institutions and Other Foreign Entities,” REG-121647-10 (Feb. 8, 2012), available at
http://www.irs.gov/pub/newsroom/reg-121647-10.pdf.
9 13 C.F.R. §§ 1020.220(a)(2)(ii)(C), 1023.220(a)(2)(ii)(C), 1024.220(a)(2)(ii)(C), and 1026(a)(2)(ii)(C) (2013).
10 See, e.g., 31 C.F.R. §§ 1010.610, 1010.620 (2013); 12 C.F.R. § 208.63 (2013).
11 See FIN-2010-G001.
4
Beneficial Owner Identification
Types of Legal Entities Subject to Beneficial Owner Identification Requirements
The proposed rule requires beneficial ownership identification for “legal entity customers,” defined to include the
following types of entities: corporations, limited liability companies, partnerships, and similar business entities, whether
organized under US or foreign law.
Excluded from the definition of legal entity customer and, accordingly, from beneficial owner identification requirements
are those types of entities that are currently excluded from the customer identification requirements of the CIP rules, as
well as some additional types of entities. Accordingly, the types of entities excluded from the beneficial ownership
identification requirement of the proposed rule include:
 Financial institutions regulated by federal functional regulator (i.e., federally regulated banks, brokers or dealers in
securities, mutual funds, futures commission merchants, and introducing brokers in commodities);
 Publicly held companies traded on certain US stock exchanges, and any majority-owned domestic subsidiary of any
entity whose securities are listed on a US stock exchange;
 Registered investment advisers or an exchange or clearing agency;
 Domestic government agencies and instrumentalities and certain legal entities that exercise governmental authority;
and,
 Charities or non-profit entities meeting certain conditions.
The NPR notes that most trusts would not fall under the definition of “legal entity customer,” and, accordingly, would not
be subject to the beneficial ownership identification requirements of the proposed rule.12
Responding to industry concerns, the NPR notes that with respect to intermediated accounts and pooled investment
vehicles, where the covered financial institution does not have any CIP obligation with respect to the intermediary’s
clients under current CIP rules, the financial institution can treat the intermediary itself as the legal entity customer.
Accordingly, the covered financial institution need only require the identification of the beneficial owners of the
intermediary itself, rather than the intermediary’s clients.
The proposed rule only requires beneficial owner identification for legal entity customers that open new accounts after the
date of implementation of the proposed rule. Covered financial institutions would not be required to identify beneficial
owners of existing legal entity customer accounts.
Beneficial Owner Identification
The proposed rule requires the identification of all individuals that meet either the “ownership test” or “control test”:
 Ownership test: requires identification of any individual who, directly or indirectly, owns 25% or more of the equity
interests of the legal entity customer

12 The NPR notes, however, that this exclusion does not mean that FinCEN necessarily considers trusts to poses a reduced money laundering or
terrorist risk, but rather that the exclusion is due to the impracticality of subjecting the variety of trusts to proposed rule’s beneficial owner
identification requirements, and FinCEN’s level of comfort with financial institutions’ existing CIP for trusts.
5
 Control test: requires identification of one individual with significant responsibility to control, manage, or direct the
legal entity customer, which may be an executive officer or any other person.
The beneficial owners identified must be natural persons. For the ownership test, this means that several layers of legal
entities may need to be “looked through” to determine whether an individual is a 25% owner. The NPR notes that covered
financial institutions need not conduct such analysis themselves, but generally may rely on the representations of the legal
entity customer.
With respect to pooled investment vehicles that are not excluded from the definition of legal entity customer, such as
hedge funds, the NPR notes that FinCEN is aware of the difficulties associated with determining 25% beneficial owners
due to fluctuating ownership percentages. FinCEN is considering, therefore, whether to exempt such vehicles from the
ownership test component of beneficial owner identification.
The NPR includes a standard certification form at Appendix A, which the must be used by covered financial institutions to
obtain beneficial owner information of legal entity customers.
Verification Requirements
The proposed rule requires that covered financial institutions verify the identity of all disclosed beneficial owners in the
same manner as current CIP requirements (for example, by collecting a driver’s license or other similar identification
document). The proposed rule does not require that the covered financial institution verify that a beneficial owner
reported by a legal entity customer in fact beneficially owns the legal entity customer.
Reliance on Other Financial Institutions
When a covered financial institution shares customers with another financial institution, a financial institution may rely
upon the other financial institution to collect the beneficial owner certification form provided that: (i) such reliance is
reasonable; (ii) the other financial institution is subject to an AML program rule and is regulated by a federal functional
regulator; and (iii) the other financial institution enters into a contract and provides annual certifications regarding its
AML program and CIP requirements. This extends existing CIP guidance to beneficial owner identification.
Conclusion
The proposed rule, if adopted, would in many cases represent a departure from current practice with respect to legal
entity account opening requirements, and impose a new compliance obligation on covered financial institutions. The
public comment period will close on October 3, 2014.

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This memorandum is intended only as a general discussion of these issues. It should not be regarded as legal advice. We would be pleased to provide additional details or advice about specific
situations if desired.
599 LEXINGTON AVENUE | NEW YORK | NY | 10022-6069
Copyright © 2014 Shearman & Sterling LLP. Shearman & Sterling LLP is a limited liability partnership organized under the laws of the State of Delaware, with an affiliated limited liability partnership
organized for the practice of law in the United Kingdom and Italy and an affiliated partnership organized for the practice of law in Hong Kong.

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