As part of the U.S. Treasury Department's ongoing efforts to prevent bad actors from using U.S. companies to conceal money laundering, tax evasion, and other illicit financial activities, the Financial Crimes Enforcement Network (FinCEN) today issued a final rule to strengthen the customer due diligence (CDD) efforts of "covered financial institutions." The CDD rule 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." Covered financial institutions have until May 11, 2018, to comply with the CDD rule.

The rule imposes several new obligations on covered financial institutions with respect to their "legal entity customers." These include corporations, limited liability companies (LLCs), 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, noncommercial 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. This is somewhat similar to the first two prongs of the definition of "control" under the Bank Holding Company Act. 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 individual owns 25 percent or more of the equity interests, 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, using the same procedures employed in its Customer Identification Program, the covered financial institution must obtain personally identifying information about each beneficial owner. This information must be documented and maintained by the covered financial institution. The CDD Notice of Proposed Rulemaking contemplated requiring the use of a standard certification form. However, the final rule makes use of the form, a copy of which is attached to the rule, optional and permits the covered financial institution to obtain and record the necessary information "by any other means that satisfy" its verification and identification obligations.

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 the course of regular monitoring.

The CDD rule has been almost four years in the making; the process has included an Advance Notice of Proposed Rulemaking, issued in February 2012, and a Notice of Proposed Rulemaking, issued in August 2014. The release of this long-delayed rule appears to have been motivated in part by the recent disclosure of the so-called "Panama Papers," which purport to reveal information about wealthy individuals' and public officials' use of shell companies to conceal assets offshore. The Panama Papers have created a growing national and global focus on the anti-money laundering, terrorist financing, tax evasion, and other illicit activity risks associated with the use of U.S. entities whose owners are obscured through the corporate form, and the need to identify the individuals behind these entities.

In addition to the CDD rule, the Treasury Department also issued a Notice of Proposed Rulemaking (NPR) on May 10, 2016, which is aimed at identifying the beneficial owners of foreign-owned single member LLCs. The NPR would impose additional reporting and recordkeeping requirements on these entities, 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. Under the proposed approach, each LLC would be required to:

  • Obtain entity identification numbers from the Internal Revenue Service (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

  • Maintain supporting books and records

In a letter to Congress, Treasury Secretary Jacob Lew stated that the NPR is designed "to close a current loophole in our system" that allows foreign persons to use U.S. LLCs in order to hide assets both in and out of the United States. Although the CDD rule and the NPR represent important steps in the government's efforts to combat financial crime by increasing transparency of entity ownership, Secretary Lew urged Congress to "pass meaningful beneficial ownership legislation" to build on Treasury's actions. Whether Congress will act remains an open question.

On June 2, 2016, Ballard Spahr attorneys will hold a webinar discussing FinCEN's final CDD rule from 12:00 PM to 1:00 PM ET. The webinar registration form is available here.

Ballard Spahr's Consumer Financial Services Group regularly counsels bank and nonbank clients on anti-money laundering compliance, represents them in connection with enforcement actions, and assists them in preparing and submitting comments in pending rulemakings. The Consumer Financial Services and White Collar Defense/Internal Investigations Groups include experienced lawyers who regularly assist clients in corporate investigations, responses to subpoenas, and civil investigative demands.

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