It has been ten years since FATF published its last Mutual Evaluation Report (MER) of the United States. On December 1st, 2016, as many of us turned our attention to the final month of what has been quite an eventful regulatory year (think Panama and Bahamas Leaks, FinCEN Final Rule, Margin Requirements kick-off etc.), you would be forgiven for thinking that 2016 could bring no more surprises. And then the Financial Action Task Force (FATF) published its 2016 Mutual Evaluation Report (MER) of the United States. If the FATF report was a school report, the final line US beneficial ownership / shell companies would be “In need of serious improvement”!
While the report clearly notes improvements in the US’ “robust regime” to combat money laundering and terrorism financing, it was scathing in describing the serious gaps that remain and impede timely access to beneficial owner information.
The MER acknowledges that the “AML/CFT framework in the U.S. is well developed and robust and notes that domestic co-ordination and co-operation on AML/CFT issues is sophisticated and has matured since the previous evaluation in 2006. Indeed, it pays homage to the variety of ongoing and complementary risk assessment processes (including the 2015 National Money Laundering Risk Assessment (NLMRA) and National Terrorist Financing Risk Assessment (NTFRA) that supports a deeper understanding of money laundering (ML) and terrorist financing (TR) risks. Furthermore, the US was rated as highly effective the pursuit of terrorism financing controls, noting that the country “proactively and aggressively investigates, prosecutes and convicts individuals for terrorist financing and can capture any form of material support”.
However, on the flip side the report highlights some deficiencies relating to beneficial ownership and shell companies. The report notes that the “lack of timely access to adequate, accurate and current beneficial ownership (BO) information remains one of the fundamental gaps in the US context”. Elsewhere, it states that the US does not go far enough to pierce the corporate veil of secrecy, which leaves the US financial system vulnerable to illicit activity and constitutes a significant counter-terrorism financing (CTF) risk. Moreover, criticisms were also levied at the absence of uniformity in State-level anti-money laundering efforts.
Beneficial Ownership and Shell Companies in Focus
2016 has brought beneficial ownership and shell companies firmly into the center of the regulatory spotlight following several high-profile exposés, most notably the Panama Papers and Bahamas leaks. Both scandals resulted in the financial details of hundreds of thousands of accounts spilling into the public realm. Beneficial ownership requirements within the US have traditionally worked on a best practice endeavor basis, an area that FinCEN has been keen to address. In May this year, following a concerted effort spanning several years, the FinCEN ‘Final’ Rule on Customer Due Diligence was finalized, applying to all accounts opened with covered institutions on or after May 11th, 2018 (also known as the ‘applicability date’).
Complying with the 5th Pillar of Anti-Money Laundering
The FinCEN Final Rule creates what is now termed the fifth pillar for anti-money laundering (AML) programs, adding to the original four pillars of an AML program under the USA Patriot Act, the foundation upon which AML enforcement practices are based. To comply with this rule, financial institutions will be required to establish risk-based procedures for conducting ongoing customer due diligence (ODD). This will include the development of customer risk profiles, the implementation of ongoing due diligence monitoring, updating of risk-based customer information and reporting of suspicious activities.
Under the Final Rule, legal entity customers can be split into two distinct types of beneficial owners:
- Those with ownership i.e. an individual who – directly or indirectly – owns 25% or more of the equity interests of the legal entity customer.
- Those with control i.e. a single individual with significant responsibility to control, manage or direct the legal entity customer (e.g. CEO, VP, Treasurer etc.).
Important to note is that a beneficial owner cannot be another company or legal entity – it must be an individual – and each legal entity customer must have between one and five beneficial owners (up to four individuals with 25% equity interest plus the control beneficial owner or at the very least one control beneficial owner with 100% equity).
What does this mean for Trusts?
The Rule doesn’t apply to every legal entity equally, excluding certain legal entity customers from beneficial ownership identification and verification requirements. For example, trusts are an interesting exemption from the Rule as they are typically defined as a contractual rather than legal arrangement and, thus, are exempt from the definition of “legal entity customer”. Furthermore, the formation of a trust does not generally require any action by the State.
Instead, when a trust is a “beneficial owner” of a legal entity customer, the beneficial owner is to be considered the ‘trustee of the trust’. Financial institutions generally also identify and verify the identity of trustees, as trustees are normally signatories on trust accounts (which, in turn, provides a ready source of information for law enforcement in the event of an investigation).
Furthermore, under supervisory guidance for banks, ‘‘in certain circumstances involving revocable trusts, the bank may need to gather information about the settlor, grantor, trustee, or other persons with the authority to direct the trustee, and who thus have authority or control over the account, in order to establish the true identity of the customer.
Beneficial Ownership Beyond AML – Managing Different Levels of Ownership
Of course, financial institutions need to manage UBO obligations across several regulatory frameworks (AML, KYC, CRS and FATCA). Tax compliance regulations such as FATCA, introduces a requirement for a 10% threshold for beneficial ownership (if the person displays US indicia), which is significantly higher than the 25% norm, which most AML/KYC regulations currently demand (for low risk entities).
This is the part of beneficial ownership that will cause most operational headaches. Financial institutions will need to find a way to manage this on an ongoing level across various regulatory frameworks and jurisdictional regulations.
Solving Global & Pan-Regulatory Beneficial Ownership
Financial institutions should look to standardize management of beneficial ownership through a rule-based technology solution that contains a global directory of beneficial ownership thresholds (which may vary across various jurisdictions and regulatory frameworks).