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May 11, 2018 marked the compliance date for the Customer Due Diligence Requirements for Financial Institutions rule[1] issued by the U.S. Treasury Department’s Financial Crimes Enforcement Network (“FinCEN”) on May 11, 2016 (the “CDD Rule”).[2]
The CDD Rule represents a departure from prior FinCEN rules, under which financial institutions exercised their own judgment, making risk-based assessments as to when and how to identify and verify beneficial owner information for legal entity accounts, except in respect of specific cases.[3]
In anticipation of this compliance date, the Financial Industry Regulatory Authority (“FINRA”) amended its anti-money laundering (“AML”) compliance program rule (“Rule 3310”), effective May 11, 2018, as announced in FINRA Regulatory Notice 18-19 (“Notice 18-19”).[4] This note provides a brief summary of the CDD Rule, discusses recent FINRA guidance on the CDD Rule and the amendments to Rule 3310, provides an overview of the most recent series of FAQs released by FinCEN[5] and highlights recent updates to FINRA’s Anti-Money Laundering Template for Small Firms (the “Small Firm Template”).[6]
On May 11, 2016, FinCEN issued the CDD Rule. The CDD Rule was later amended on September 28, 2017 to make certain technical corrections.[7]
Under the CDD Rule, “covered financial institutions” (a term described below) must establish procedures to:
Identification of those beneficial owners of a “legal entity customer” (a term described below) must be conducted at the time a new “account” (a term described below) is opened. In addition, covered financial institutions are required to obtain a certification from the individual opening an account on behalf of a legal entity customer that identifies any individuals who meet the definitions under the ownership or control prongs.
As noted above, the financial institution is required to verify the identity of such persons using risk-based procedures that include, at minimum, the same documentary and non-documentary elements required under the CIP Rule[9] (although under the CDD Rule, non-original documents may be accepted, subject to conditions). The institution is not, however, required to verify the fact of the identified beneficial owner’s relationship to the legal entity, absent a financial institution’s knowledge to the contrary. Therefore, for example, a financial institution does not need to independently verify whether or not the individual(s) presented as 25% owners are the only individuals who fall within the ownership prong.
FinCEN has stated that financial institutions should use the collected beneficial ownership information as they use other information they gather regarding customers (e.g., through compliance with CIP requirements), including for compliance with Office of Foreign Assets Control (OFAC) regulations and currency transaction reporting (CTR) aggregation requirements.
The CDD Rule only applies to accounts opened on or after May 11, 2018, but FinCEN noted that institutions may, as a prudential matter, decide to collect the same information from accounts opened prior to May 11, 2018. The CDD Rule provides important exclusions and exemptions for pooled investment vehicles, as well as other entity types. For a discussion of the application of the CDD Rule to pooled investment vehicles, see the Section entitled “Select Questions and Answers From the 2018 FAQs” below.
Account. Generally, “account” means a formal relationship established to provide or engage in services, dealings or other financial transactions, but its definition depends on the entity hosting the account.
Covered Financial Institution. The CDD Rule applies to all financial institutions currently subject to CIP requirements, which includes:
Legal Entity Customer. The CDD Rule requires covered financial institutions to obtain beneficial ownership information for a “corporation, limited liability company or other entity that is created by the filing of a public document with a Secretary of State or similar office, a general partnership and any similar entity formed under the laws of a foreign jurisdiction that opens an account.” Entities that are excluded from the definition of legal entity customer include:
On November 21, 2017, FINRA issued Regulatory Notice 17-40 (“Notice 17-40”), which provided guidance with respect to the obligations of member firms under Rule 3310 and the CDD Rule.[10] FINRA noted that prior to the implementation of the CDD Rule, firms were required to develop and implement an AML program that incorporated “four pillars” enumerated in the Bank Secrecy Act (the “BSA”). These four pillars are:
Notice 17-40 posits that the CDD Rule adds a “fifth pillar” to these requirements:
FINRA echoed language in the CDD Rule, highlighting that this fifth pillar does not represent “new law” and merely codifies existing expectations under the BSA for firms to identify and report suspicious transactions and to know and understand their customers. Notice 17-40 provides information and guidance in this respect, including:
With respect to identifying and verifying the identity of beneficial owners of legal entity customers, FINRA noted that a firm may rely on beneficial ownership information supplied by the individual opening an account on behalf of a legal entity customer, provided that the firm does not have knowledge of facts that would reasonably call into question the validity or reliability of that information, and that a firm is allowed to rely on another financial institution for the performance of the requirements under the CDD Rule to the same extent that this reliance is permitted under the CIP Rule.
FINRA also stated in Notice 17-40 that it was considering further rulemaking to better align the language of Rule 3310 with that of the CDD Rule.
As noted above, FINRA announced in Notice 18-19 that it was amending Rule 3310 to better align the rule’s language with that of the CDD Rule. The proposed amendments were subsequently published in the Federal Register as a Notice of Filing and Immediate Effectiveness.[11]
In Notice 18-19, FINRA referenced the guidance that it had previously provided in Notice 17-40, especially with respect to firms’ ongoing customer due diligence requirements enumerated in the CDD Rule. The amendments add a new subsection (f) to Rule 3310, which states that:
Each member shall develop and implement a written anti-money laundering program reasonably designed to achieve and monitor the member’s compliance with the requirements of the Bank Secrecy Act (31 U.S.C. 5311, et seq.), and the implementing regulations promulgated thereunder by the Department of the Treasury. Each member’s anti-money laundering program must be approved, in writing, by a member of senior management. The anti-money laundering programs required by this Rule shall, at a minimum,
. . .
(f) Include appropriate risk-based procedures for conducting ongoing customer due diligence, to include, but not be limited to:
(i) Understanding the nature and purpose of customer relationships for the purpose of developing a customer risk profile; and
(ii) Conducting ongoing monitoring to identify and report suspicious transactions and, on a risk basis, to maintain and update customer information. For purposes of paragraph (f)(ii), customer information shall include information regarding the beneficial owners of legal entity customers (as defined in 31 CFR 1010.230(e)).
FINRA once again reiterated that the amendments to Rule 3310 do not represent “new law,” and in FINRA’s view merely codify existing expectations for firms, and reminded firms to ensure that their AML programs were updated, as necessary, to comply with the May 11, 2018 CDD Rule compliance date and Rule 3310 effective date.
On April 3, 2018, FinCEN released its second series of FAQs with respect to the CDD Rule, which provides answers to an additional 37 questions (the “2018 FAQs”). The first series of FAQs with respect to the CDD Rule was published by FinCEN on July 19, 2016 (the “2016 FAQs”). [12] The 2018 FAQs primarily cover various topics in connection with the requirement that financial institutions obtain beneficial ownership information for their legal entity customers, including:
The 2018 FAQs also provide guidance and answers to questions regarding the beneficial ownership certification requirement, including when a single customer opens multiple accounts and in respect of product or service renewals, obligations to update beneficial ownership information, requirements to understand the nature and purpose of the customer relationship, internal approval of AML program changes and currency transaction reporting.
On April 4, 2018, FINRA published an updated version of its Small Firm Template. The template was updated to reflect the obligations of firms under Rule 3310 and the CDD Rule. These changes have been incorporated into Section 6 of the template (Customer Due Diligence Rule), which provides revised discussion and example text with respect to a firm’s compliance obligations under Rule 3310 and the CDD Rule. Other substantive changes in the Small Firm Template include additions to the example text in the Firm Policy and National Security Letters Sections. In addition, the updated Small Firm Template includes minor clean-up changes, updated rule references and additional resources and guidance that have been published since the prior version.
The CDD Rule and Rule 3310 codify existing expectations under the BSA for firms to identify and report suspicious transactions and to know and understand their customers. This “fifth pillar” requires firms to understand the nature and purpose of customer relationships, conduct ongoing monitoring and identify and verify the identity of beneficial owners of legal entity customers. While the CDD Rule has been largely finalized since 2016, the May 11, 2018 CDD Rule compliance date and Rule 3310 effective date represents a reminder for firms to review their AML programs to ensure compliance with these rules.
[1] For a comprehensive review of the Customer Due Diligence Rule, you may wish to refer to “FinCEN Issues Final Beneficial Owner Identification Rules” (June 14, 2016), available at https://www.shearman.com/~/media/Files/NewsInsights/Publications/2016/06/FinCEN-Issues-Final-Beneficial-Owner-Identification-Rules-FIAFR-061416.pdf.
[2] 81 Fed. Reg. 29398 (May 11, 2016), available at https://www.gpo.gov/fdsys/pkg/FR-2016-05-11/pdf/2016-10567.pdf. See also supra note 1.
[3] For examples, you may wish to refer to, “Anti-money laundering regulations for broker-dealers: Treasury Department publishes final rules implementing Section 312 of the Patriot Act relating to foreign correspondent accounts and private banking accounts” (February 2006), available at http://www.shearman.com/~/media/files/newsinsights/publications/2006/02/antimoney-laundering-regulations-for-brokerdeale__/files/download-pdf-antimoney-laundering-regulations-fo__/fileattachment/cm_022006.pdf.
[4] Anti-Money Laundering Compliance Program, Regulatory Notice 18-19 (May 3, 2018) http://www.finra.org/sites/default/files/notice_doc_file_ref/Regulatory-Notice-18-19.pdf.
[5] Frequently Asked Questions Regarding Customer Due Diligence Requirements for Financial Institutions (Apr. 3, 2018) https://www.fincen.gov/sites/default/files/2018-04/FinCEN_Guidance_CDD_FAQ_FINAL_508_2.pdf.
[6] The Small Firm Template is available at http://www.finra.org/industry/anti-money-laundering-template-small-firms.
[7] 82 Fed. Reg. 45182 (Sept. 28, 2017), available at https://www.gpo.gov/fdsys/pkg/FR-2017-09-28/pdf/2017-20777.pdf.
[8] This list of positions is illustrative, not exclusive, as there is significant diversity in how legal entities are structured.
[9] See supra note 3. You may also wish to refer to “New Customer Identification Procedure Rules for Brokers and Dealers Take Effect” (Oct. 2003), available at https://www.shearman.com/~/media/files/newsinsights/publications/2003/10/new-customer-identification-procedure-rules-for-__/files/download-pdf-new-customer-identification-procedu__/fileattachment/cm_1003.pdf.
[10] FinCEN’s Customer Due Diligence Requirements for Financial Institutions and FINRA Rule 3310, Regulatory Notice 17-40 (Nov. 21, 2017) http://www.finra.org/sites/default/files/notice_doc_file_ref/Regulatory-Notice-17-40.pdf.
[11] 83 Fed. Reg. 20906 (May 8, 2018), available at https://www.gpo.gov/fdsys/pkg/FR-2018-05-08/pdf/2018-09694.pdf. See also Exchange Act Release No. 83154 (May 2, 2018), available at https://www.sec.gov/rules/sro/finra/2018/34-83154.pdf.
[12] Frequently Asked Questions Regarding Customer Due Diligence Requirements for Financial Institutions (July 19, 2016) https://www.fincen.gov/sites/default/files/2016-09/FAQs_for_CDD_Final_Rule_%287_15_16%29.pdf.
[13] For further discussion with respect to the regulation of correspondent accounts, please see supra note 3.
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