Implementation of Treasury’s New Customer Due Diligence Rule: A Step Toward Beneficial Ownership Transparency?
Updated October 31, 2018
Implementation of Treasury’s New Customer Due Diligence
Rule: A Step Toward Beneficial Ownership Transparency?
Introduction
journalists revealed a massive leak of 11.5 million records
Since May 11, 2018, U.S. financial institutions are required
from the Panamanian law firm Mossack Fonseca, which
to comply with a U.S. Department of the Treasury rule
collectively became known as the “Panama Papers.” The
aimed at cracking down on illicit capital flows through
firm specialized in the creation of offshore shell companies
accounts held by anonymous corporate vehicles—often
and corporate structures behind which the beneficial
called “shell companies.” The Treasury rule, known as the
ownership of such entities could be obscured. In mining the
customer due diligence (CDD) rule, amends existing CDD
leaked data, investigative journalists revealed how
requirements for certain financial institutions, a key element
numerous politicians and public officials, including current
of know-your-customer obligations. Although the new
and former world leaders, benefitted from offshore
CDD rule was finalized two years ago (May 11, 2016), the
holdings; journalists also found documents linking the firm
Financial Crimes Enforcement Network (FinCEN), a
to a range of drug traffickers, potential tax evaders, and
Treasury bureau, delayed implementation until 2018.
other criminals.
The CDD rule’s implementation is the culmination of a
Citing the Panama Papers as having “brought the issues of
multi-year effort by the federal government to address
illicit financial activity and tax evasion into the spotlight,”
money laundering and tax evasion risks posed by shell
the Obama Administration announced in May 2016 steps to
companies whose beneficial ownership is not transparent.
“strengthen financial transparency, and combat money
Although the rule represents a step toward addressing
laundering, corruption, and tax evasion”—including
criticism of current beneficial ownership transparency
issuance of the CDD final rule and several legislative
practices in the United States, some policymakers continue
proposals. A number of leaks to the media, similar to the
to debate whether legislative action may be required to
Panama Papers, have sustained international attention to the
mitigate fully the potential for criminals, terrorists, and
issue of beneficial ownership and corporate financial
corrupt foreign politicians to hide behind shell companies
transparency in recent years, including the Offshore Leaks
and conceal the proceeds of illegal activity or shelter funds
of 2013, Lux Leaks of 2014, Swiss Leaks of 2015, Paradise
illegally from home country taxation. Several bills in the
Papers of 2017, and West Africa Leaks of 2018.
115th Congress have sought to address beneficial ownership
transparency in sectors not covered by the CDD rule.
Multilateral Attention
The international community has also taken steps to
acknowledge and address the issue of beneficial ownership
Beneficial Ownership and Shell Companies. The
transparency through the Group of Eight, Group of 20,
term “beneficial owner” broadly refers to the natural
Organisation for Economic Co-operation and Development
person(s) who own or control a legal entity, such as a
(including through its Global Forum on Transparency and
corporation or limited liability company. When such
Exchange of Information for Tax Purposes), the World
entities are set up without physical operations or
Bank (particularly with respect to its procurement
assets, they are often referred to as “shell companies.”
practices), and the Extractive Industries Transparency
Shell companies can be used to conceal beneficial
Initiative (in November 2017, the United States withdrew
ownership and facilitate anonymous financial
from EITI). At the 2016 London Anti-Corruption Summit,
transactions. Since corporate vehicles are registered
the United States and more than 40 other countries
at the state level, laws and requirements for corporate
committed to anti-corruption and transparency measures,
formation also vary by state.
including measures related to beneficial ownership.
Background
Some countries, including the United Kingdom, have
U.S. policymakers concern regarding potential risks posed
created a public register of beneficial ownership
by shell companies whose beneficial ownership is not
information—and more countries have committed or are
transparent has grown in recent years. Such concern has
planning to do so. In April 2018, the European Parliament
been punctuated by a series of leaks to the media regarding
voted to adopt the European Commission’s proposed Fifth
the use of shell companies, as well as sustained multilateral
Anti-Money Laundering (AML) Directive, which among
attention to the issue, including criticism of current U.S.
other measures, would require European Union member
practices.
states to maintain public national-level registers of
The Leaks
beneficial ownership information.
In April 2016 (one month prior to the promulgation of the
new CDD rule), a consortium of international investigative
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Implementation of Treasury’s New Customer Due Diligence Rule: A Step Toward Beneficial Ownership Transparency?
Financial Action Task Force Criticism
purpose or when customers engage in unusual and
For years, the United States has been under international
unexplainable financial activity. Without establishing a
pressure to tighten its AML regime with respect to its
profile of a customer’s usual business and financial
beneficial ownership disclosure requirements. Since 2003,
transactions and monitoring and updating such a profile, the
the Financial Action Task Force (FATF), an international
bank would be largely unable to spot transactions that may
AML standards-setting body, has recommended global
warrant suspicious activity reporting.
CDD standards for verifying the identity of customers,
including the beneficial owners of legal entities and
FinCEN’s AML Regulatory Authorities.
arrangements.
FinCEN’s regulations are found in 31 C.F.R. Chapter
X, which is generally arranged according to type of
In its most recent review of the U.S. government’s AML
institution. For example, standards for AML programs
regime, published in 2016, FATF noted that the “lack of
for banks are found in 31 C.F.R. 1020.210 and for
timely access to adequate, accurate, and current beneficial
brokers and dealers in 31 C.F.R. 1023.210. Due
ownership (BO) information remains one of the most
diligence requirements for correspondent accounts
fundamental gaps in the U.S. context.” According to FATF,
for foreign institutions and private banking accounts
this gap exacerbates U.S. vulnerability to money
are prescribed in 31 C.F.R. 1010.610 and 31 C.F.R.
laundering; it also prevents U.S. law enforcement from
1010.620, respectively.
efficiently obtaining such information during the course of
investigations and limits law enforcement’s ability to
Sectors Not Covered by Treasury’s Rule
respond to foreign mutual legal assistance requests for
beneficial ownership information.
Even following the CDD rule’s implementation, critics
argue that gaps remain in U.S. financial transparency
What Does Treasury’s Rule Do?
requirements. Critics note that the 25% ownership threshold
FinCEN, pursuant to its regulatory authority under the Bank
means that if five or more people share ownership, a legal
Secrecy Act (BSA), has long had in place regulations
entity may not name or identify any of them (only one
requiring various types of financial institutions to establish
management official). Also, the rule applies to new, but not
AML programs. Such regulations require a financial
existing, accounts. Others, such as FATF, have criticized
institution to set internal policies, procedures, and processes
the United States for lacking beneficial ownership
for a customer identification program (CIP) and CDD,
requirements for corporate formation agents and real estate
along with other requirements. The regulations cover
transactions. Neither sector is directly affected by the
financial institutions that are currently required to develop
FinCEN rule, but legislation to address both areas has been
AML programs, including, for example, banks, securities
introduced in Congress.
brokers or dealers, mutual funds, futures commission
Beneficial Ownership Disclosure at Company
merchants, and commodities brokers. Prior to the current
Formation
CDD rule, U.S. financial institutions were not required to
document the identities of the individuals who owned and
As previously noted, corporate vehicles are created at the
controlled the financial institutions’ legal entity customers.
state level. Certain bills in the 115th Congress would
address requirements for beneficial ownership identification
Beneficial Ownership Disclosure
when states permit corporate entities to be formed, such as
Central to the CDD rule is a requirement for financial
S. 1454, S. 1717, and H.R. 3089. Another approach would
institutions to establish and maintain procedures to identify
seek to create a federal office to charter corporations (S.
3348).
and verify beneficial owners of a legal entity opening a new
account. As with the establishment of a CIP for natural
Beneficial Ownership Disclosure for Real Estate
persons, covered financial institutions must now collect
Purchases
from the legal entity customer the name, date of birth,
address, and Social Security number or other government
Shell companies can also mask beneficial ownership of real
identification number (passport number or other similar
estate purchases and sales. Treasury is authorized under 31
information in the case of foreign persons) for individuals
U.S.C. 5326 to issue geographic targeting orders (GTOs)
who own 25% or more of the legal entity; financial
imposing recordkeeping and reporting requirements on
institutions are required to obtain the same information for
domestic financial institutions and nonfinancial businesses
one individual with significant responsibility to control or
in certain geographic areas to facilitate law enforcement
manage the legal entity at the time a new account is opened.
detection of criminal activity. Treasury has issued GTOs
requiring disclosure of beneficial owners of legal entities
Risk-Based Customer Monitoring
involved in “all cash” purchases of luxury real estate in
The CDD rule also requires financial institutions to develop
select major metropolitan areas including New York City
customer risk profiles and to update customer information
and Miami, apparently discouraging this as a method of
on a risk basis for the purposes of ongoing monitoring and
money laundering. H.R. 2426 would require similar
information for certain federal agency leases.
suspicious transaction reporting. These requirements make
explicit what has been an implicit component of BSA and
AML compliance programs. Under current regulations
Rena S. Miller, Specialist in Financial Economics
governing the filing of suspicious activity reports (SARs),
Liana W. Rosen, Specialist in International Crime and
for example, banks must submit SARs to FinCEN when
Narcotics
transactions appear to have no business or apparent lawful
IF11014
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Implementation of Treasury’s New Customer Due Diligence Rule: A Step Toward Beneficial Ownership Transparency?
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