Perhaps the most difficult task a financial institution must undertake when onboarding a new customer or counterparty is collecting beneficial ownership information. The regulations vary by jurisdiction, are in some cases unclear, and the client or counterparty is often unwilling to provide the requisite information with alacrity. The client or counterparty may not be completely transparent and it’s often difficult to verify the information provided. Further, while beneficial ownership information can change, the client or counterparty is not obligated to provide its financial institution with updates.

Just when it seems the situation cannot get any more difficult, regulators around the world are in the process of codifying new beneficial ownership regulations that are significantly more onerous than those currently on the books. This post attempts to summarize the proposed beneficial ownership requirements incorporated in the EU Fourth Anti-Money Laundering Directive, FinCen’s ANPR, and FATCA.

EU Fourth Anti-Money Laundering Directive and Beneficial Ownership

In response to recommendations of the Financial Action Task Force (FATF), the European Commission published the Fourth Anti-Money Laundering Directive as a legislative proposal on February 5, 2013. The Fourth Directive, increasing the emphasis on a risk-based approach, would supersede the Third Directive that has been effective since 2005. The European Parliament and the Council of Ministers must adopt the Fourth Directive and then EU member states will likely have two years to implement Fourth Directive provisions through national regulations.

The Fourth Directive generally defines “beneficial owner” as “any natural person(s) who ultimately owns or controls the customer and/or the natural person on whose behalf a transaction or activity is being conducted.” Further the beneficial owner “shall at least” include, for corporate entities, the natural person who “owns or controls a legal entity through direct or indirect ownership or control over a sufficient percentage of the shares or voting rights.” Retaining the Third Directive threshold, a percentage of 25% plus one share constitutes sufficient evidence of ownership or control.

For other legal entities, such as foundations and trusts, the beneficial owner would be (1) the natural person(s) who (1) control 25% or more of the property or entity or (2) who is the beneficiary of 25% or more of the property or entity.

Article 11 of the Fourth Directive mandates the following customer due diligence (CDD) measures: (1) identifying and verifying the customer’s identity based on data from a “reliable and independent source,” (2) identifying the beneficial owner and “taking reasonable measures to verify his identity,” (3) assessing and obtaining information on the “purpose and intended nature of the business relationship” and (4) conducting ongoing monitoring of the business relationship to ensure transactions are consistent with knowledge of the customer’s “business and risk profile” and ensuring that data maintained is kept up-to-date.

The Fourth Directive incorporates a risk-based approach by allowing a “simplified customer due diligence” protocol when it is ascertained that the “customer relationship or transaction presents a lower degree of risk.” However, in practice, the directive opens the door wide to ambiguity and inconsistencies because the directive fails to offer guidance on making a high risk versus low risk determination.

Addressing record keeping, the Fourth Directive requires the retention of CDD data for five years after a business relationship with a customer has ended and requires the destruction of those records at the end of that five years. Recognizing that purging information at the five-year mark could be problematic because institutions must maintain CDD data longer if such data is needed for the “prevention, detection or investigation of money laundering and terrorist financing” there is flexibility to allow the records to be kept for 10 years, and then destroyed.

Beneficial ownership was a topic of discussion at this year’s G8 Summit with member nations agreeing to an Action Plan setting forth core principles. Tracking the mission of the Fourth Directive, the first principle states that companies should know “who owns and controls them and their beneficial ownership and basic information should be adequate, accurate, and current.” Addressing cross-border cooperation, the Action Plan urges countries to be responsive to requests from foreign counterparts by ensuring that “relevant authorities can rapidly, constructively, and effectively provide basic company and beneficial ownership information.”

In conjunction with the Summit, the White House released a United States G-8 Action Plan statement confirming its support for company ownership transparency and encouraging comprehensive legislation requiring identification and verification of beneficial ownership at the time of company formation. (As noted below, such legislation is now pending in the Senate). The White House plan envisions a central registry system at the state level and recognizes that states could choose to make beneficial ownership data publicly available.

Addressing the G8 Action Plan, the UK announced plans to introduce new transparency rules calling for beneficial ownership data to be held in a central registry maintained by Companies House, according to an HM Treasury press release. As a first step, the UK Department for Business, Innovation & Skills (BIS) issued a Transparency and Trust consultation paper.

Key issues contemplated by the Transparency and Trust paper include: (1) whether companies already subject to stringent disclosure rules should be exempt from new transparency rules, (2) what information should be provided to the registry and how frequently it should be updated and (3) whether data collected for the registry should be made public. For discussion purposes, the paper adopted a broad definition of “beneficial ownership” to include individuals who ultimately control company activities, whether or not they hold shares of the company. Comments on the paper, submitted through September 16, 2013, are currently being reviewed by BIS.

FinCEN’s ANPR to Clarify Beneficial Owner Threshold

Following the March 5, 2012 release of an Advance Notice of Proposed Rulemaking (ANPR) regarding CDD requirements, FinCEN received written comments for three months and facilitated three public meetings to accept additional comments on the ANPR. In the spirit of continued outreach, FinCEN hosted a roundtable discussion in October 2012 to address significant CDD issues raised by comment submissions and to invite more input from representatives of financial institutions.

According to the summary of the Roundtable Meeting, Treasury officials addressed the definition of “beneficial owner” and clarified that concepts of ownership and control were both included under the scope of the ANPR definition. The control prong is not limited to an account signatory, such as a CPA or financial administrator, because the definition is designed to cover all individuals who control the customer.

FinCEN has generally defined a beneficial owner as an individual who has enough control over an account to directly or indirectly “control, manage or direct” the account. For legal entities, the ANPR proposes the following beneficial owner definition:

“(1) Either: (a) Each of the individual(s) who, directly or indirectly, through any contract, arrangement, understanding, relationship, intermediary, tiered entity, or otherwise, owns 25 percent of the equity interests in the entity; or (b) If there is no individual who satisfies (a), then the individual who . . . has at least as great an equity interest in the entity as any other individual, and (2) The individual with greater responsibility than any other individual for managing or directing the regular affairs of the entity.”

The adoption of the 25% threshold brings the new definition in line with the EU standard, but requiring a determination of who bears the greatest management responsibility for an entity may often introduce a subjective analysis into the equation.

On the issue of when beneficial ownership information should be obtained, Roundtable participants noted that while some financial institutions acquire such data in all circumstances, others do so only for high-risk customers. For a discussion of identification trends, see Best Practices in Beneficial Ownership Identification.

Requests for a safe harbor provision – or exceptions that would carve out certain categories of low-risk customers from beneficial owner identification – were not directly addressed by Treasury officials at the Roundtable. However, the language of the ANPR itself suggests that FinCen has recognized that a practical framework would include some exceptions as well as an application of risk assessment. Part IV of the ANPR states that an effective CDD program would include the following element: “Except as otherwise provided, identifying the beneficial owner(s) of all customers, and verifying the beneficial owner(s)’ identity pursuant to a risk-based approach…” As an example, the ANPR suggests that legal entity customers that are exempt from customer identification program (CIP) rules may be exempt from beneficial ownership identification.

Should CIP rules serve as a model for verifying the beneficial owner’s identity? Should financial institutions be required to independently verify beneficial ownership or should a practice of customer self-certification be adopted? What happens in the context of relationships with trusts or intermediary customers? These questions portend challenges that have prompted some to ask Treasury to grant a three-year period for implementation of the new rules!

The impending compliance burdens in the U.S. may be significantly reduced if a bill making its way through the Senate is passed. On August 1, 2013, Sen. Carl Levin (D-MI) re-introduced – for the fourth time – the Incorporation Transparency and Law Enforcement Assistance Act (S. 1465) calling for states to add one question to incorporation forms asking applicants to identify the company’s true owners. Even though states would only have to disclose the beneficial ownership data for law enforcement purposes, financial institutions could simply ask a legal entity customer to provide a copy of its incorporation form.

Law enforcement agencies generally support the transparency act, but many influential groups – including the National Association of Secretaries of State, the American Bar Association and the U.S. Chamber of Commerce – oppose the measure and have raised concerns over the federal government reaching into the domain of state law in the area of business formation.

FATCA’s Beneficial Owner Threshold Poses Challenges

With a 10% threshold, the FATCA net captures more beneficial owners than transparency regulations using a 25% test. For FATCA purposes, with respect to a corporation, a “substantial U.S. owner” is any U.S. person that owns, directly or indirectly, more than 10% of the stock of the corporation by vote or value.

The Final Regulations for FATCA, effective January 17, 2013, require withholding agents to identify the FATCA status of customers. When a withholding agent lacks information sufficient to assign an appropriate FATCA status, documentation on pre-existing accounts collected for AML/KYC purposes may be relied upon under certain circumstances. Further, FATCA offers a limited self-certification mechanism for accounts held by entities.

From a practical standpoint, it will be challenging for some institutions to acquire sufficient documentation from every 10% owner. On the other hand, building a more complete database on these customers may prove beneficial in the long run if future EU directives and FinCEN rules move from the 25% test toward the 10% threshold.

Great opportunities exist for financial institutions to integrate datasets and streamline workflows to support compliance with evolving global transparency mandates.