On March 5, 2012, the Treasury Department’s Financial Crimes Enforcement Network (“FinCEN”) published an advanced notice of proposed rulemaking (“ANPR”), requesting comment on Customer Due Diligence (“CDD”) requirements for financial institutions.¹ FinCEN is seeking comment on whether it should propose a rule that would require financial institutions to identify the beneficial owner(s) of all accounts, and to verify the identity of certain beneficial owner(s) in accordance with a risk-based approach. In the context of brokered deposit arrangements, the beneficial ownership requirement would require banks to look through The Depository Trust Company (“DTC”), if applicable, and broker-dealers, and conduct anti-money laundering (“AML”) due diligence upon the broker-dealers’ customers. Such a rule would task brokers with the transmission of hundreds of thousands, if not millions, of customer records, and burden banks with the screening of not only their own customers, but broker-dealers’ customers as well.

Comments on the ANPR must be submitted on or before May 4, 2012.

Background

Pursuant to FinCEN’s existing customer identification program (“CIP”) regulations (“CIP Regulations”) applicable to banks, banks must apply their CIPs to “customers.” CIP Regulations define “customer” as any “person” that opens a new “account” with the bank.² Thus, a bank’s AML due diligence responsibility is limited to accountholders, whether or not each accountholder is also the beneficial owner of the account.

In the context of brokered deposit arrangements, consistent with FinCEN’s definition of “customer,” a bank that offers deposit accounts through a registered broker-dealer is not required to apply its CIP to customers who establish their deposit accounts through their broker. When a broker-dealer establishes deposit accounts offered by a bank for its customer, the broker does so in its own name, as agent and custodian for that customer, or through DTC. The broker or, if applicable, DTC, is the legal owner of the deposit accounts and thus the bank’s “customer” for CIP purposes. CIP Regulations exempt both the broker and the DTC from the bank’s CIP measures because they are financial institutions regulated by the Securities and Exchange Commission (“SEC”) and, therefore, are excluded from the definition of “customer.”³

The Beneficial Owner Requirement

In its ANPR, FinCEN outlined four elements it is considering incorporating into a CDD program rule for financial institutions. One element would require financial institutions covered by the rule to identify the beneficial owners of all accounts, and to verify the identity of certain beneficial owners according to a risk-based approach. In effect, financial institutions would be responsible for acquiring the necessary data to conduct, and actually conducting, AML due diligence procedures on both the legal and beneficial owners of accounts. That broker-dealers or, if applicable, DTC, do not meet the definition of “customers” under existing CIP Regulations would not prevent the beneficial ownership requirement from operating in the context of brokered deposit arrangements.

While FinCEN has requested comment on potential exemptions from the beneficial ownership requirement, the ANPR does not specify what these exemptions might be. If the rule is drafted without a beneficial ownership exemption for accounts held by broker-dealers as agents and custodians for their customers, or, if applicable, by DTC, brokers will have to transmit hundreds of thousands, if not millions, of customer account records to financial institutions. This, despite the fact that the beneficial owners are screened by SEC-regulated brokers that are subject to independent AML obligations.

Proposed Action

There is no reason to believe that FinCEN is familiar with the brokered deposit market, or even aware of its existence. Comment from industry participants describing the brokered deposit market and the consequences of requiring brokers to transmit customer information to banks is important to prevent further action by FinCEN that would affect this market.

Please contact Paul Clark if you would like assistance in preparing a comment letter or would like to participate in an industry letter.

_______________________________________________________________________________________________

¹ The ANPR is a preliminary step to a rulemaking proceeding.

² 31 C.F.R. §1020.100(c). An “account” is 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. 31 C.F.R. §1020.100(a). A “person” is an individual, a corporation, a partnership, a trust or estate, a joint stock company, an association, a syndicate, joint venture, or other unincorporated organization or group, an Indian Tribe, and all entities cognizable as legal personalities. 31 C.F.R. §1010.101(mm).

³ 31 C.F.R. §1020.100(c)(2)(i).