Demystifying beneficial ownership

Financial institutions should not wait for a central registry to come online. Banks benefit by becoming proactive right now.

By Henry Balani

The focus on identifying beneficial ownership continues to increase as revelations from the Pandora Papers scandal with prominent government officials with shell companies set up in offshore tax havens. This has prompted public and government outrage with a bipartisan group in Congress proposing legislation to target “enablers” of money laundering.

The Anti-Money Laundering Act of 2020 expands the existing Bank Secrecy Act of 1970, with a new focus on establishing a uniform beneficial ownership reporting regime. Reporting companies, including banks and other obligated financial services entities, are required to submit to the Financial Crimes Enforcement Network specific identification information for each beneficial owner.

UPDATE: On Dec. 16, The Financial Crimes Enforcement Network issued a notice of proposed rulemaking that would implement provisions of the Corporate Transparency Act that govern the access to and protection of beneficial ownership information. FinCEN also proposed amendments to the final reporting rule to specify when reporting companies may report FinCEN identifiers associated with entities. Written comments are due within 60 days. See more details here. See also ABA’s staff analysis.

On Sept. 30, FinCEN issued its final rule establishing a nationwide beneficial ownership reporting requirement per the Corporate Transparency Act. The rule requires most corporations, LLCs and others that do business in the U.S. to register their beneficial owners into a centralized, national database. The effort will provide more transparency and help counter money laundering activity, especially targeting sanctioned individuals. Additional rules around access to the register as well as reconciliation against current Customer Due Diligence rules are also forthcoming.

The AML Act of 2020 also expands enforcement and investigatory powers of enforcement agencies, including the authority of courts to subpoena U.S.-based foreign correspondent banks. Penalties for non-compliance have also increased, with civil penalties of not more than $500 per day plus criminal penalties of $10,000 fine or two years in jail.

Global practices—central registries

The Customer Due Diligence final rule brings the U.S. into alignment with international standards, closely emulating EU and U.K. regulations, by requiring financial institutions to identify and verify the identity of the natural persons, known as beneficial owners, of legal entity customers who own, control and profit from companies when those companies open accounts.

A beneficial owner is defined as an individual who directly or indirectly exercises substantial control over the entity or owns or controls not less than 25 percent of the ownership interest of the reporting company.

Unlike EU countries, the U.S. currently does not have a centralized ultimate beneficial owner registry. (There are registries at the state level.) It should be noted that beneficial ownership registries have been implemented to varying degrees of efficacy in Europe. In the U.K., Companies House offers a publicly available data source where company information, including registered address, date of incorporation, current and resigned officers, are easily accessible. Companies House has been around since 1844 and the British government is introducing reforms to improve corporate transparency.

In the U.S., based on the Corporate Transparency Act of 2020 (included in the AML Act), FinCEN is mandated to develop a federal level BO registry to address anti-money laundering financial crime. However, this centralized registry will not be ready until June 2023. This puts the U.S. behind the U.K. and other EU countries in terms of open, easily available access to beneficial ownership information.

Inconsistent and variable information

There are unique challenges the U.S. faces in developing this centralized database. Currently, company information is collected at the state level and is not a federal initiative, resulting in different company information collected from state to state.

Many states acknowledge a company’s formation without requiring the disclosure of beneficial ownership information. In June 2019, the National Association of Secretaries of State conducted a survey to collate key business entity information collected from articles of incorporation or organization. In this survey, Alaska reported collecting ownership information for newly registered corporations, and Arizona and Florida reported collecting ownership information for newly registered LLCs, meaning only three states require beneficial ownership information to be reported at the time of registration.

Things improve only slightly when reviewing periodic reporting requirements, with Alaska, Arizona and Kansas requiring ownership information for corporations, and Alaska and Kansas requiring ownership information for LLCs.

The disparate and inconsistent ownership information being collected from state to state upon registration of an entity has increased the likelihood of shell companies being created. Although many trust and shell companies are operating within the law, their anonymity is attractive to criminals seeking to launder the proceeds of crime. Examples such as the Panama Papers, Paradise Papers and FinCEN Files have repeatedly highlighted this challenge.

In addition, the registry, as currently proposed, will not be publicly accessible or searchable. Privacy issues limit what data can be collected and shared, as company data can be categorized as personal identifiable information. The Corporate Transparency Act also identifies entities that do not need to be included in the UBO registry. These include:

Public companies; registered investment advisers; broker dealers; money services businesses registered with FinCEN; public accounting firms; banks and credit unions; bank holding companies; public utilities; and mutual funds.

The rationale here is that the beneficial ownership information is already available from other public data sources.

As such, reporting companies can access these data sources across multiple states and, together with these additional data sources, paint a picture of beneficial ownership information while waiting for a federally available registry. Data from state level sources are “closer to the ground” and typically provide a more accurate and recent picture of ownership. However, reporting companies and other financial institutions would need to ensure the data collected is harmonized and standardized with existing CDD processes to ensure accurate identification of beneficial owners.

While we have more information at our fingertips than ever before, finding all the data required to create a full picture of beneficial ownership is a laborious undertaking. Smoother, more accurate and efficient methods can solve the core challenges for all those involved, reducing cost, and improving customer experience.

Harnessing technology to improve ultimate beneficial owner identification

In the absence of complete and consistent ultimate beneficial owner (UBO) information, how can FIs ensure their CDD processes fulfill regulatory requirements?

For most financial institutions, the onboarding process requires a great deal of discovery groundwork around corporate structures and ownership, with information coming from many different databases and lists before being collated by the onboarding team. The volume of checks and research involved in identifying beneficial owners add a huge amount of manual work and cost to the due diligence process.

The need to collect accurate data to comply with new regulations requires the accessing of more sources of data, including central registries, and to dig deeper to identify UBOs. The UBO identification process is traditionally slow as many corporate structures are either accidentally or deliberately complex, and the transparency of jurisdictions in the U.S. and globally varies immensely. Without robust policies and technology in place, your profit and revenue streams suffer. Client onboarding can grind to a halt. Weaker relationships with your customers are inevitable given the culture of “now.”

The impact on targets and internal service level agreements are bound to be significant unless you can develop compliance processes that are accurate, fast and satisfy your good customers. This is where technology comes in. Getting a system in place that elevates accuracy without creating an onboarding bottleneck is crucial.

Globally, financial institutions are already embracing technology to help unwrap corporate structures and uncover beneficial ownership as part of their CDD process with know your customer automation. Although automation is becoming a popular way to manage KYC and the identification of UBOs, few have perfected it.

Intelligent process automation represents an opportunity to meet the increasing challenges of KYC and UBO in banking and other regulated sectors.

To take advantage, companies can redesign KYC processes where people and new technologies collaborate. Codifying policies to program a software robot automates the UBO identification process and ensures that the KYC policy is consistently applied for every new customer. Compliance analysts can then step in when their judgement and problem-solving skills are needed to complete more valuable tasks such as tackling complex UBO investigations or advancing policies.

Future-proofing customer due diligence

Reporting companies and other banks should continue to monitor progress of the AML Act and the implementation of a centralized UBO registry, as mandated by FinCEN.

Given the maturity and availability of similar UBO registries around the world, best practices are already in place to identify beneficial owners. Financial institutions and other organizations should not wait for a central registry to come online. They must be proactive in their strategy. Ongoing revelations from scandals such as the Pandora Papers, plus public pressure, will no doubt result in additional regulations that require beneficial ownership identification as part of a CDD process. The recent sanctions actions against Russia have only compounded the complexity as they have been unprecedented in scope, given the coordinated nature across most Western nations in flagging individuals and corporations assets. Financial institutions have a daunting challenge.

As criminals look for new ways to hide their activity and income, identifying beneficial owners will only become more complex and important. Financial institutions are now at a turning point: Adapt automated processes to fit the new demands of UBO identification and verification or fall behind on margin, speed to market and risk.

The challenge here is to be able to incorporate the complexity of due diligence into a process that is effective and cost efficient. The resources involved in manual compliance processes and managing disparate data sources, along with the risks of errors and fines for regulatory breaches, are key drivers for implementing digital KYC solutions.

Automating KYC offers the chance to significantly reduce the time taken to onboard new customers and conduct event-driven KYC refresh and remediation. Automation can involve the integration of existing CDD workflow processes into sources of information that identify beneficial owners of sanctioned entities.

For example, if a financial institution is looking to onboard a new corporation (say from Eastern Europe) the key is to determine if there is a Russia connection. By interrogating company registers (such as Companies House), regulatory listings and commercial data sources, a picture of the corporate structure (divisions, subsidiaries of the corporation) can emerge, along with the ultimate beneficial owner where available. Automating this process and integrating across multiple sources means comprehensive view can be obtained to assess the risk level.

The key here is consistency. An analyst responsible for identifying these structures can adopt a standardized, automated approach as part of the CDD process. Decisions on onboarding the customer and categorizing the risk can be made quickly, down to minutes instead of days. This means that clients will also benefit from a smoother experience, which, in turn, will boost retention rates and, ultimately, revenue.

Henry Balani is global head of industry and regulatory affairs at Encompass.