On May 11, 2018, a new rule—commonly referred to as the Beneficial Ownership Rule—took effect to establish additional customer due diligence requirements for banks and other financial institutions. The Financial Crimes Enforcement Network (FinCEN) issued the rule under the Bank Secrecy Act as part of its anti-money laundering (AML) framework. This article serves as a refresher for banks as they continue to work through the requirements of the Beneficial Ownership Rule.
General Rule; Helpful Resources
Under the Beneficial Ownership Rule, federally insured banks and other covered financial institutions must establish and maintain written procedures that are designed to identify and verify beneficial owners of legal entity customers. Generally speaking, this means that when an entity customer opens a new account at a bank, the bank must identify and verify the identity of each individual who owns 25 percent or more of the entity, and one individual who controls the entity.
As with many rules that apply to banks, the details of the Beneficial Ownership Rule are important. Certain terminology, including the definitions of “beneficial owner,” “legal entity customer,” “new account,” and “account,” provide exceptions to the rule’s general requirements. In addition, in both the rule itself and related publications, FinCEN addresses common scenarios, frequently asked questions, and other considerations related to the rule.
Key points of the Beneficial Ownership Rule are addressed below. For additional information, institutions can access the full rule at 31 C.F.R. § 1010.230 and can find FAQs and other guidance from FinCEN on FinCEN’s website at https://www.fincen.gov/resources/statutes-and-regulations/cdd-final-rule.
Identification and Verification
The Beneficial Ownership Rule requires banks and other covered institutions to have risk-based customer due diligence procedures that enable them to:
(a) Identify the beneficial owner(s) of each legal entity customer at the time a new account is opened. An institution may accomplish this either by obtaining a certification on a FinCEN-developed form, or by obtaining the information required by the form by another means.
(b) Verify the identity of each beneficial owner identified to the institution, according to reasonable and practicable risk-based procedures. For banks, those procedures must contain—at a minimum—the elements required for verifying the identity of customers that are individuals under the Customer Identification Program (CIP) rules. Those elements generally consist of the individual’s name, date of birth, address, and identification number.
An institution may rely on the information supplied by the legal entity customer’s representative regarding the identity of its beneficial owner or owners, provided that the institution has no knowledge of facts that would reasonably call into question the reliability of the information.
Definition of “Beneficial Owner”
The Beneficial Ownership Rule defines the term “beneficial owner” to mean each of the following:
(a) Each individual, if any, who, directly or indirectly, through any contract, arrangement, understanding, relationship or otherwise, owns 25 percent or more of the equity interests of a legal entity customer. This is the “ownership prong” of the rule.
(b) A single individual with significant responsibility to control, manage, or direct a legal entity customer, including (1) an executive officer or senior manager (e.g., a CEO, CFO, COO, managing member, general partner, president, vice president, or treasurer); or (2) any other individual who regularly performs similar functions. This is the “control prong” of the rule.
For any particular legal entity customer, the number of individuals that must be identified as “beneficial owners” under the rule will vary from one to five. Under the ownership prong, up to four individuals—and as few as zero individuals—must be identified, depending on their ownership percentages. Under the control prong, one individual must be identified. It is possible that in some circumstances the same person or persons might be identified pursuant to the ownership prong and the control prong.
Definition of “Legal Entity Customer”
The term “legal entity customer” means (a) 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, (b) a general partnership, and (c) any similar entity formed under the laws of a foreign jurisdiction that opens an account. The definition of “legal entity customer” does not reach sole proprietorships or unincorporated associations, because neither is a separate legal entity from the associated individual(s).
While the definition of “legal entity customer” covers many entities that banks deal with on a day-to-day basis, several types of legal entities are given special exclusions from the definition. Those exempt entities include, among others, many state or federally regulated financial institutions, state or federal departments or agencies, publicly-traded companies, other SEC-reporting companies, registered investment companies and advisers, registered public accounting firms, and state-regulated insurance companies. Institutions should consult the full rule and the FinCEN resources cited above when considering whether an entity is exempt from the Beneficial Ownership Rule.
Notably, if an exempt entity owns 25 percent or more of the equity interests of a legal entity customer, no individual need be identified for purposes of the ownership prong with respect to that exempt entity’s interests. (If an individual related to an exempt entity has significant responsibility to control, manage, or direct a legal entity customer, however, the individual may need to be identified under the control prong.)
Definitions of “New Account” and “Account”
The Beneficial Ownership Rule largely focuses on due diligence that must be conducted at the opening of a “new account,” which means an account opened by a legal entity customer on or after May 11, 2018. As applied to banks, the term “account” means a formal banking relationship established to provide or engage in services, dealings, or other financial transactions, including a deposit account, a transaction or asset account, a credit account, or other extension of credit. The term “account” also includes a relationship established to provide a safe deposit box or other safekeeping services, or cash management, custodian, and trust services.
The term “account” does not include a product or service where a formal banking relationship is not established with a person, such as check-cashing, wire transfer, or sale of a check or money order. The rule and its accompanying guidance also exempt certain other types of accounts from its scope, including certain types of accounts to finance insurance premiums, certain types of accounts to finance the purchase or leasing of equipment, and rollovers of certain CD accounts.
FinCEN views loan renewals, CD rollovers, and similar events as new banking relationships, and therefore as “new accounts” for purposes of the Beneficial Ownership Rule. FinCEN acknowledges, however, that the industry generally does not treat those types of events as new relationships. Accordingly, FinCEN has issued guidance that relieves institutions of collecting beneficial ownership information upon the rollover of most CDs, the renewal of safe deposit box rentals, and the renewal of some loans, commercial lines of credit, and credit card accounts, if the renewal does not require underwriting review and approval (see FIN-2018-R004 for details). For other types of loan renewals, FinCEN requires institutions to either collect beneficial ownership information at each renewal after May 11, 2018, or to have their customers re-confirm beneficial ownership information previously submitted. Notably, though, if a legal entity customer certifies its beneficial ownership information to an institution in connection with a loan, and the customer also agrees to notify the institution of any change in its information, the institution may rely on that agreement as an ongoing certification for subsequent renewals of that loan, absent knowledge to the contrary (see FAQ #12, FIN-2018-G001, for details). Institutions should consider adding this type of customer agreement to their loan and renewal documents.
In an effort to further curb money laundering activities, the Beneficial Ownership Rule imposes new due diligence requirements on banks and other financial institutions. Under the rule, institutions must identify between one (1) and five (5) “beneficial owners” of their “legal entity customers,” and they must verify the identity of those individuals. The rule applies to the opening of “new accounts,” which generally include both newly originated accounts and renewals and rollovers of existing accounts, subject to certain exceptions.
Although this article raises the key points of the Beneficial Ownership Rule, it does not cover many of the subtleties of the rule. Institutions can find significant guidance on the rule in both the rule itself (31 C.F.R. § 1010.230) and on FinCEN’s website (https://www.fincen.gov/resources/statutes-and-regulations/cdd-final-rule).
Charles Moore is a partner with Bradley. He has substantial experience in commercial finance, including mortgage warehouse lending, real estate finance, and bank holding company lending. Moore also commonly handles change in bank control act matters, bank holding company act matters, formation and capital raising activities of banks and bank holding companies, and other bank regulatory matters.