March 18, 2010

Federal Agencies Target Identification of “Beneficial Owners” – Now a High AML Regulatory Priority

Holland & Knight Alert
David P. Sofge

The Interagency Guidance 

An important interagency “Guidance on Obtaining and Retaining Beneficial Ownership Information” was issued on March 5, 2010, by FinCEN (jointly with the SEC and each bank regulatory agency) as FinCEN Guidance FIN 2010-G001. While the Guidance purports only to “clarify and consolidate” existing regulatory expectations regarding the identification of beneficial owners of accounts, it in fact provides a clear indication that this has now become a priority for the BSA/AML regulators and their compliance auditors.

The Guidance expressly singles out accounts maintained for various types of entities, specifically those that are not publicly traded in the United States, such as unincorporated associations, private investment companies (PICs), trusts and foundations. It specifically points out the heightened risk posed by these accounts because of the ease with which their unidentified beneficial owners can engage in illicit activity anonymously through them. “Beneficial owners” are defined by current regulations (31 C.F.R. 103.175(b)) as “an individual who has a level of control over, or entitlement to, the funds or assets in the account that, as a practical matter, enables the individual, directly or indirectly, to control, manage or direct the account.” While the Guidance acknowledges that identifying beneficial owners may be “challenging,” the clear message is that such identification is of significant importance.

Customer Due Diligence Procedures and Beneficial Ownership 

The Guidance begins with a general but pointed reminder that customer due diligence (CDD) controls are the “cornerstone” of a strong BSA/AML compliance program, and that careful and ongoing risk assessment of customers to identify those who present a high risk of money laundering or terrorist financing is a “basic and fundamental” part of this effort. The CDD process should be developed to identify high risk customers, and should be “enhanced” according to the degree of risk presented by each customer in order to accurately and effectively identify, evaluate and report suspicious activity. Significantly, the Guidance makes it clear that FinCEN and the regulatory agencies consider the types of accounts noted above not only as high risk, but also that they should be the focus of enhanced due diligence (EDD) by BSA institutions. The Guidance says that this EDD should specifically include identification of beneficial owners and a “reasonable understanding” of the sources and uses of account funds as well as the relationship between the nominal customer and the beneficial owner.

The Guidance recommends various policies and procedures for making the identification. These include sharing or obtaining beneficial ownership information across business lines, separate legal entities within an enterprise and affiliated support units. It further recommends that AML staff cross-check for beneficial ownership information in data systems maintained within the institution, such as credit underwriting, marketing, or fraud detection. For the high risk types of entities identified above, the Guidance states that CDD procedures should include:

  • determining whether a customer is acting as an agent on behalf of another
  • obtaining information about the structure or ownership of such an entity
  • for trustee accounts, obtaining information about the trust structure and determining the provider of funds and the identity of those who either control those funds or have the power to remove the trustee

Current Regulations and Beneficial Ownership 

In addition to standard, risk-based CDD for all accounts, the current BSA regulations mandate beneficial ownership identification for Private Banking Accounts and Foreign Correspondent Accounts. The Guidance focuses on these regulations, and seems to signal a zero tolerance policy.

Private Banking Accounts: With regard to Private Banking Accounts, the Guidance reviews the current regulations, but stresses that “covered financial institutions” (as defined in 31 C.F.R. 103.175(f)) must, as part of their CDD, take “reasonable steps” to determine the customer’s source of wealth and to determine the identity of their nominal and beneficial owners. These accounts, the Guidance points out, “may require the application of EDD procedures.”

Of special importance are accounts held by senior foreign political figures (or “PEPs”). The “reasonable steps” required to ascertain the nominal or beneficial ownership of these accounts include obtaining information on employment status and source of income, as well as consulting news sources and checking references. PEP accounts require, “in all instances,” EDD that is reasonably designed to detect and report transactions that may involve the proceeds of foreign corruption.

The Guidance flatly warns that failure to take reasonable steps to identify nominal and beneficial owners “generally would be viewed as a violation of” the Private Banking regulations. In other words, ineffective compliance procedures here will likely result in civil monetary penalties.

Foreign Correspondent Accounts: Similarly, the Guidance reviews the regulations for “covered financial institutions” in managing Foreign Correspondent Accounts, again with stress on identification of nominal and beneficial owners, as well as identifying any person with authority to direct transactions through payable-through accounts. And, as with Private Banking Accounts, the Guidance warns institutions that fail to make the required identifications “could be viewed” as committing violations of the regulations. In other words, ineffective compliance procedures here will likely result in civil monetary penalties.

On a separate note, the regulations on Foreign Correspondent Accounts require EDD if the account holder operates under a banking license issued by a non-cooperative country (31 C.F.R. 103.176(c)). On February 18, 2010, FATF (the intergovernmental body which devises policies for combating terror financing and money laundering), named eight countries with strategic AML deficiencies: Iran, Angola, North Korea, Ethiopia, Ecuador, Pakistan, Sao Tome and Principe, and Turkmenistan. Even though these countries have not been officially designated as “non-cooperating countries,” each covered financial institution in the U.S. would be well advised to consider applying EDD procedures to any correspondent accounts held by a “foreign financial institution” (as defined at 31 C.F.R. 103.175(h)) operating under a license issued by any of these countries.

The U.S. Senate Permanent Subcommittee of Investigations 

It is fair to ask the reason for the sudden stress put on beneficial ownership by FinCEN, the SEC and bank regulatory agencies. The answer could be a recent report issued by the Senate Permanent Subcommittee on Investigations, chaired by Senator Carl Levin, which identified “glaring gaps” (including the failure to identify beneficial ownership) which, it says, have undermined the effectiveness of the U.S. anti-money laundering laws. It seems likely that the Guidance may be a response to this Report, by demonstrating the regulators’ intention to reinforce the BSA regulatory requirements for determinations of beneficial ownership.

The Report, issued on February 4, 2010, is titled “Keeping Foreign Corruption Out of the United States: Four Case Histories.” This 330-page document sets out in extensive and vivid detail how suspect funds related to four African political figures were successfully moved into the United States over a period of several years using private banking accounts at U.S. banks and at domestic branches of foreign banks, U.S. lawyers and law firm trust accounts, offshore private banks and shell companies, trusts, wire transfers, credit card accounts, real estate agents and escrow companies, and even a prestigious university. In one notable example, a “blind trust” regained partial sight when its beneficial owner (an African political figure) used an offshore shell company to obtain control over the trustee of the trust.

By dint of sustained efforts over a number of years, the foreign political figures described in the Report, with the assistance of their U.S. professional service providers, were successful in bringing large sums derived from suspicious sources into the United States. The Subcommittee Report makes the point repeatedly and emphatically that none of the banks described in the Report broke any laws. Instead, the banks’ due diligence efforts, although well-intentioned, were unavailing, and the money came into the United States despite an apparently formidable AML regime.

In addition to the Subcommittee’s own investigation, the Report draws extensively from a 2009 study prepared by the World Bank as part of its Stolen Asset Recovery (StAR) Initiative. That study, titled “Politically Exposed Persons – A Policy Paper on Strengthening Preventive Measures” (World Bank, Washington, DC, 2009), seeks to draw attention to the baneful effects of “gross abuses” by corrupt PEPs, and the burden that their actions inflict on efforts to improve conditions in the developing world. The study suggests (at pages 3 and 4) that corrupt money obtained by public officials may equal 20 to 40 percent of flows of official development assistance to developing countries.

The World Bank study includes among its “Principle [sic] Recommendations” enhanced due diligence, required declarations of beneficial ownership under criminal penalties and other vigorous measures to identify the natural persons who are ultimate beneficial owners of bank accounts. The objective is to relieve developing and transitional economies of this drain on much-needed resources, by “untying the knot of legal entities” and ascertaining the true identity of owners who may be PEPs attempting to conceal and transfer funds obtained through extortion, bribery and other forms of corruption.

The Guidance as Harbinger of Things to Come 

The tales of abuse and (largely successful) evasion of the U.S. anti-money laundering regime by the PEPs depicted in the Subcommittee Report, together with the powerful public policy arguments set out in the World Bank study and elsewhere, have increased the pressure for strengthening AML protocols to achieve more rigorous identification of the true beneficial owners of accounts. This is particularly the case where they are known or suspected PEPs (or in the equivalent U.S. AML regulatory term, “senior foreign political figures”). (See 31 CFR 103.175(r) and 31 CFR 103.178(c).)

While the Guidance breaks no new ground, its primary significance is that beneficial ownership is the new “hot button” for BSA/AML regulators and their compliance audit teams. Financial institutions should take heed and review their AML compliance procedures in this area to ensure that the “recommended” procedures in the Guidance are in place and rigorously enforced.

The following are links to topics discussed in this alert:

The March 5, 2010 Guidance:

The February 4, 2010 PSI Report:

The 2009 World Bank StAR Initiative:

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