FinCEN’s New Rule on CDD Will Mean Increased Cost and Complexity of Compliance

by Rick Aragon 0

Financial transparency is the ultimate directive for institutions throughout the financial sector, and the May 5th White House briefing on money laundering, tax evasion and corruption—spurred on by the disclosure of the “Panama Papers”—heralded the most recent high-level initiative on these issues. One direct outcome of this program, the final rule of Treasury bureau FinCEN on beneficial ownership, requires financial institutions to know and keep records on who actually owns the companies with whom they do business. The Treasury is also going to introduce legislation to require declaration of beneficial ownership to the Treasury at the time of company formation.

There are two different aspects of the final FinCEN rule: one is a new obligation to identify and verify the beneficial owners of legal entities; the other is a formalization of due diligence requirements that until now were implicit—making them explicit. What will this mean for banks and other covered institutions? While there are some questions about how effective the rule will be in achieving its aims, it’s clear that one impact of the new customer due diligence rule will be an increase in the cost and complexity of compliance.

The policies and procedures financial institutions follow to open business accounts will have to change, and those changes will require modifications and upgrades to existing information systems. Costs of new IT capabilities as well as the human power needed to install, understand and run the upgraded systems will increase.

Complexity is introduced simply by gathering these new names. What data are banks going to gather, and how are they going to evaluate its risk? The gathering of new names at account opening implies that downstream processes will also be impacted. Once the bank gets the names of the beneficial owners, there is a requirement to verify those names, so an identity verification process will have to be implemented. Banks may also want to consider non-documentary verification, given that in many cases the people who are opening business accounts are not the actual people who gain economic benefit from a going concern.

It’s important to make a distinction between verification of status and verification of identity requirements. According to a recent survey conducted by LexisNexis Risk Solutions, currently only about 53 percent of banks are verifying the status of beneficial owners. Status verification shows that you are actually the beneficial owner of a legal entity. This is hard to determine from an authoritative source, because the information isn’t currently gathered at the time companies are formed. So if you’re a bank and want to actually verify that Jennifer Smith is the beneficial owner of Jennifer Smith Advisors, you can’t just go to the Secretary of State website and verify that information—that item of information is not required for company formation. To verify that status, a bank will have to get documentation from their customer, like a share registry or partnership agreement. This introduces a level of friction into the account opening process, as many people are sensitive to being asked for yet more information on top of what they are already supplying.

Meanwhile, according to the same study, about 80 percent of banks say that they are already verifying the identity of beneficial owners. Identity can be verified more easily, because in many cases there are data sources that can be more easily tapped into. However, as mentioned above, there aren’t the same kinds of data sources to verify beneficial ownership status.

With identity verification, the new regulatory changes will still have an effect. Once those names are gathered, other processes—for example, sanctions screening and risk screening, such as for adverse media or other law enforcement or regulatory enforcement actions—have to be performed. Knowing more information might change the risk profile on an account, bringing to light something that was previously not known about that person. Potentially it could change not only the risk profile of a person, but of the bank itself.

The recent global data leak put a spotlight on transnational corruption and offshore accounts. Banks will probably be reevaluating whether they want to take on this kind of business, given the negative connotations and the notoriety it has caused. Offshore accounts have been considered high risk for some time, so many due diligence processes designed to uncover beneficial ownership are already in place for banks that are following best practices. So in that sense, it’s not clear to what extent banks will feel the effects of this offshore issue. There are, however, many jurisdictions in the U.S. that don’t currently require beneficial ownership, so the ruling of instituting a uniform requirement will definitely have an impact Stateside. For example, may incorporations take place in Nevada and Delaware, so more information will need to be collected about who is behind those legal entities.

In summary, the impacts that the new FinCEN ruling will have on banks and transparency are: