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Corporate Transparency Act: Shell Companies are covered … but what about Shelf Companies?

Bad actors and nation states, such as China and Russia, are becoming more proficient in using our financial system to support illicit activity. As bad actors become more sophisticated, so to [sic] must our tools to deter and catch them. One such tool is identifying the beneficial owners of shell companies, which are used as fronts to launder money and finance terrorism or other illicit activity.

Congressman Patrick McHenry (D. NC) made that statement on the House floor on December 8, 2020 as he was speaking in support of the Corporate Transparency Act, which became Title LXIV of the Anti-Money Laundering Act of 2020.[2]

The Congressman’s statement that shell companies are used as front companies may be accurate, but it seems to equate shell companies with front companies. But he is not alone: many people confuse shell companies with front companies, and shell companies with shelf companies. And many of the headlines in the media after the Corporate Transparency Act was passed touted “the end of shell companies” in the United States. Even the 2020 National Strategy referred to “shell and front companies” as if they were interchangeable. They’re not.

What is a “shell company”? After all, one of the six purposes of the AML Act is to establish uniform beneficial ownership in formation reporting requirements in order to “discourage the use of shell corporations as a tool to disguise and move illicit funds” (subsection 6002(5)(B) of the AML Act).

Shell companies are featured in the AML Act but not defined. What is a “shell company”?  And how is it different from a “shelf company” or a “front company”?

Shell Companies, Front Companies, and Shelf Companies[1]

Although these terms are often used interchangeably, they are not the same. A Joint Report published by the FATF and the Egmont Group in July 2018 provides a great description or definition of each:

Shell company – incorporated company with no independent operations, significant assets, ongoing business activities, or employees.
Front company – fully functioning company with the characteristics of a legitimate business, serving to disguise and obscure illicit financial activity.
Shelf company – incorporated company with inactive shareholders, directors, and secretary and is left dormant for a longer period even if a customer relationship has already been established.

Shell companies are legal entities that exist “on paper” – more likely electronically on a state or Tribal company registry database – but have no physical presence, no activity, and no purpose. There is nothing illegal about shell companies.

A shell company that serves as a vehicle or legal entity for business transactions to pass through, without itself having any significant assets or operations, is acting as a front company.  A front company, on the other hand, may be more than a shell, and as FATF and Egmont note, be a fully functioning company with a physical presence which may be conducting some legitimate business, but its main purpose is to disguise illegal activity. So a shell company can be a front company, but a front company isn’t always a shell company (think of a pizza parlor as a front for drug trafficking, or Madoff Securities was a front company for Bernie Madoff’s Ponzi scheme).

Shell companies that have been incorporated but have been sitting inactive “on the shelf” for months or years are known as “shelf companies”. Like new shell companies, aged shelf companies are perfectly legal. Having a shell company that was created three, four, or more years before provides the appearance of a business history and thus legitimacy. As FATF/Egmont note in their paper, “as shelf companies can also be considered a type of shell company, particularly following their sale or transfer of ownership, it is possible that jurisdictions referred to former shelf companies as shell companies when providing case studies.”

Wyoming is known for its shelf corporations: where a new “shell” company might cost $250 – $500 to set up, an aged “shelf” company can cost thousands of dollars. See Dusting off the Congressional Version of an “Aged Shelf Company” – RegTech Consulting, LLC.

Speaking of Shelf Companies – Were They Missed Altogether?

The Corporate Transparency Act (CTA) creates a new section in title 31 – 31 USC section 5336 – that requires a “reporting company” to submit its beneficial ownership information to the to-be-constructed FinCEN central registry or database of beneficial ownership information.  A reporting company is defined in section 5336(a)(11)(A) as “a corporation, limited liability company, or other similar entity that is (i) created by the filing of a document with a secretary of state or a similar office under the law of a State or Indian Tribe; or (ii) formed under the law of a foreign country and registered to do business in the United States by the filing of a document with a secretary of state or a similar office under the laws of a State or Indian Tribe.”

Subsection 5336(a)(11)(B) provides that a reporting company “does not include” twenty-four types of entities. Included in that list is what appears to be a classic shelf company: a company created by a corporate formation agent that does no business, has no employees, etc., and simply sits “on the shelf” of the corporate formation agent, waiting for someone to buy it and use it. Subsection (xxiii) provides that a reporting company does not include:

(xxiii) any corporation, limited liability company, or other similar entity

(I) in existence for over 1 year;

(II) that is not engaged in active business;

(III) that is not owned, directly or indirectly, by a foreign person;

(IV) that has not, in the preceding 12-month period, experienced a change in ownership or sent or received funds in an amount greater than $1,000 (including all funds sent to or received from any source through a financial account or accounts in which the entity, or an affiliate of the entity, maintains an interest); and

(V) that does not otherwise hold any kind or type of assets, including an ownership interest in any corporation, limited liability company, or other similar entity

Although the intent of Congress was likely to exempt companies that had been in business at one point but had been dormant for at least a year, what they came up with is literally the definition of a US shelf company. But what happens when that shelf company is taken off the shelf and purchased by someone? It appears from the definition in (xxiii)(IV) that it is no longer a shelf company: it has “experienced a change in ownership” and no longer qualifies as a dormant company that is exempt from providing beneficial ownership information.

The Act contemplates that a change in beneficial ownership will trigger a reporting requirement. Subsection 5336(b), “Beneficial Ownership Information Reporting”, provides in part:

(D) UPDATED REPORTING FOR CHANGES IN BENEFICIAL OWNERSHIP.—In accordance with regulations prescribed by the Secretary of the Treasury, a reporting company shall, in a timely manner, and not later than 1 year after the date on which there is a change with respect to any information described in paragraph (2), submit to FinCEN a report that updates the information relating to the change.

Based on the explicit wording of section 5336(b)(D), only reporting companies need to submit a report to FinCEN when there is a change in beneficial ownership. A shelf company (a subsection xxiii dormant company) is not a reporting company, but a shelf company that is taken off the shelf and purchased that, because of that change in ownership, becomes a reporting company and could be a front company to disguise nefarious activity. It is no longer excluded from the definition of “reporting company” and would have register its beneficial owners. But updated reporting for changes in beneficial ownership only apply to reporting companies that have a change in ownership, not to non-reporting companies that become reporting companies because of a change in ownership.

Phew. It’s complicated. Can shelf companies that become front companies avoid the beneficial ownership information disclosure laws? Perhaps the regulations that will soon be written can address what could be a loophole.  Better language might be:

(D) UPDATED REPORTING FOR CHANGES IN BENEFICIAL OWNERSHIP.—In accordance with regulations prescribed by the Secretary of the Treasury, a reporting company or any entity created by or registered to do business in a State or Indian Tribe that becomes a reporting company, shall, in a timely manner, and not later than 1 year after the date on which there is a change with respect to any information described in paragraph (2), submit to FinCEN a report that updates the information relating to the change.

For more on the AML Act of 2020 and the Corporate Transparency Act, see https://regtechconsulting.net/beneficial-ownership-customer-due-diligence/the-corporate-transparency-act-of-2020-the-good-the-bad-and-the-ugly/

[1] This is a play on a heading “Shell, Front, and Shelf” in an article “Follow the Proliferation Money” by Professor Moyara Ruehsen and Leonard Spector, published in the Bulletin of the Atomic Scientists 2015, Vol. 71(5) 51–58 (September 2, 2015). The article provides an excellent description of the differences between shell companies, shelf companies, and front companies. As referenced in the body, the joint FATF/Egmont paper, “Concealment of Beneficial Ownership”, offers perhaps the best descriptions and examples of shell, shelf, and front companies and how they are used to conceal true beneficial ownership and to disguise illicit activity. I highly recommend it.

[2] House Congressional Record from December 8, 2020 CREC-2020-12-08-pt1-PgH6919-3.pdf (congress.gov) at pages H6932-6933. See Appendix A for the full transcript.

The Corporate Transparency Act of 2020 … The Good, The Bad, and the Ugly

Corporate Transparency Act – There’s much that is Good, but there’s also some things that are Bad and other things that are downright Ugly

Many people are touting the proposed Anti-Money Laundering Act of 2020 (“AMLA2020”) and one of the titles of that Act, the Corporate Transparency Act, as the biggest change to American efforts to fight crime and corruption since the USA PATRIOT Act of 2001.

And they’re right. As a whole, the AMLA2020 will ultimately have the effect of shifting the US AML/CFT regime from a domestic-focused, regulator-versus-regulated, compliance inputs-based regime to an international, collaborative public/private sector, threat-focused, outputs-driven regime.

Just like Clint Eastwood in the classic Western “The Good, the Bad, and the Ugly”, that is all Good.

But like Lee Van Cleef, there is also some Bad, and unfortunately for the AMLA2020 (but fortunately for Eli Wallach) there is also some Ugly things that will reduce the impact and effectiveness of this new AML law. In fairness, regulations have yet to be issued, and regulations often address some of the bad and even ugly things in statutes.

This article looks at all aspects of the Corporate Transparency Act of 2020: the concept of “ultimate beneficial owner” and the so-called “Matryoshka doll” problem; the definitions of beneficial owner, applicant, and reporting company, and how those definitions differ from the current beneficial ownership rule; the new FinCEN identifier; the time that reporting companies have to report to FinCEN’s new database; the required information for beneficial owners and applicants; and who has access to the database.

The Good – the US gets a centralized, national registry of beneficial ownership information

Advocates celebrate major US anti-money laundering victory

This headline from a December 11, 2020 International Consortium of Investigative Journalists (ICIJ) Article is a good example of the Good of the Corporate Transparency Act. That article describes it well:

The long-sought reforms, effectively ending anonymous shell companies, were included in an annual defense spending bill approved by both houses of Congress with veto-proof margins. Landmark laws to thwart the use of U.S. shell companies by terrorists, human traffickers, arms dealers and kleptocrats are set to be enacted after more than a decade of lobbying and politicking with rare bipartisan support. The sweeping anti-money laundering reforms hitched a lift in the annual defense spending bill that passed the Senate 84-13 today, and was approved by the House 355-78 earlier this week. The Corporate Transparency Act requires U.S. companies to report their true owners to the Treasury Department’s Financial Crimes Enforcement Network, known as FinCEN — largely ending anonymous shell companies in the country.

Welcoming the clampdown, Transparency International’s U.S. director Gary Kalman said, “It is rare for such a simple measure to promise such an enormous impact.” Kalman added that the long sought anti-corruption reforms would “move us into a new era of enforcement.” The new legislation will allow law enforcement agencies and financial institutions to request company ownership information from FinCEN. The data will not be publicly available.

The Bad – Why exclude Money Transmitters and “Tall, Dark, and Handsome” Companies?

Under this new law, money transmitters have been added to the list of exempt entities (up to twenty-four from the current sixteen) that do not have to report their beneficial owner(s) or applicant. The rationale seems to be that they have to register with FinCEN already, so why register again? I discuss below why this doesn’t make sense and may create a loophole a money launderer can drive a truck through.

“Tall, Dark, and Handsome” is a reference to another new exception created by this law: a corporation or LLC that has 20 or more employees and more than $5 million in revenues and a physical office in the United States. These (very few, as it turns out) companies are the legal entity equivalent of (very rare!) men who are tall, dark, and handsome. Why they are not required to disclose their ultimate beneficial owners isn’t obvious to me: it’s discussed below.

(This is the second article I’ve written that includes the phrase “Tall, Dark, and Handsome” (see https://regtechconsulting.net/uncategorized/tall-dark-or-handsome-the-new-special-inspector-general-for-pandemic-recovery/). And this phrase, with its two commas, is an example of the use of the “Oxford comma”: the comma used after the penultimate item in a list of three or more items, before ‘and’ or ‘or’, to clearly indicate three items rather than two. I’ve also written an article on Oxford commas, see https://regtechconsulting.net/uncategorized/grave-danger-and-oxford-commas-words-and-punctuation-matter/).

The Ugly – There is very limited, and difficult, access to the central registry

Even if money transmitters and the “Tall, Dark, and Handsome” companies had to report their beneficial owners and applicant, there would still be very little transparency into those owners, or any other beneficial owners in the proposed FinCEN database. Financial institutions’ access to the database is severely restricted, and the punishing requirements imposed on federal, State, and Tribal government agencies to gain access to the information in the database may dissuade many of them from using it at all. Also ugly is the creation of the FinCEN identifier as a replacement for a Social Security Number, Drivers License number, or Passport number. I’m hedging on how ugly this actually is, though: regulations may turn what appears to be ugly into something pretty attractive.

Caution – the AMLA2020 Hasn’t Been Enacted Yet

The Corporate Transparency Act is one title (of five) within the AMLA2020, the AMLA2020 is one division (of seven) of the National Defense Authorization Act for Fiscal Year 2021 (the “NDAA”). The NDAA has been passed by the House and Senate with veto-proof majorities, and was sent to the President for his consideration on December 11th. As of this writing (December 20th) the President has not signed the NDAA and continues to indicate he will veto it. If he does veto it, it’s not known whether the House and Senate will have the votes or the time to override the veto.

Note: This article focuses only on the beneficial ownership or corporate transparency title of the AMLA2020. I have written an article describing all other aspects of the AMLA2020 (with a short section on beneficial ownership: see https://regtechconsulting.net/aml-regulations-and-enforcement-actions/aml-act-of-2020-renewing-americas-aml-cft-regime/).

Introduction to the Corporate Transparency Act – Title LXIV of the AMLA2020 adding 31 USC s. 5336

Section 6401 simply states “this title may be cited as the ‘Corporate Transparency Act’.” The comments to the conference report provide that “Division F is substantially similar to H.R. 2513, the Corporate Transparency Act of 2019, introduced by Representative [Carolyn] Maloney [Democrat] of New York.” In fact, Rep. Maloney has introduced a corporate transparency bill in every Congress since 2009: HR 6098 (111th Congress), HR 3416 (112th Congress), HR 3331 (113th Congress), HR 4450 (114th Congress), HR 2089 (115th Congress), and HR 2513 (116th Congress). Our collective thanks to Representative Maloney and her staff for their courage and perseverance.

Why has Rep. Maloney, and so many others, been pushing for corporate transparency? Among other reasons, Recommendation 24 of the Financial Action Task Force (FATF) requires legal entity transparency, including the disclosure of beneficial ownership. Since its first FATF Mutual Evaluation in 1996, and in every subsequent evaluation (2006 and 2016), the United States has been criticized for failing to meet this recommendation. Since at least 2008, with Senator Carl Levin’s (D. MI) Incorporation Transparency and Law Enforcement Assistance Act (S. 2956), corporate transparency bills have been introduced in Congress seeking to satisfy the FATF recommendations. They have all failed – until now. A good summary of why they’ve failed, and why this version of the Corporate Transparency Act is still quite limited in its scope and will be quite limited in its impact, is included in the comments of Congressman Patrick McHenry in Appendix A, below.

Section 6402 is the “Sense of Congress” section. This section provides, in part, that “most or all” of the 50 states that create about 2 million corporations and LLCs each year “do not require information about the beneficial owners”, that “malign actors seek to conceal their ownership” and that money launderers layer corporate structures across various secretive jurisdictions “much like Russian nesting ‘Matryoshka’ dolls.” With that ominous beginning, the section then continues with a statement that the beneficial ownership information “will be directly available only to authorized government authorities” and the database is intended to be “highly useful to national security, intelligence, and law enforcement agencies and Federal functional regulators”. There is no mention of making the information directly available to financial institutions or even having it benefit financial institutions.

The result is a national, centralized registry that is not accessible to the public and has limited value to financial institutions. The table to the right summarizes a review done by Transparency International on the types of national registries, as of October 2020: those with a central registry that is publicly accessible with no restrictions (green); central registry that is publicly accessible but is behind a paywall or with other restrictions (yellow); central registry that is not publicly accessible (yellow); no central registry but concrete steps are being taken to develop one (orange); and no central registry (red). I did not include all the countries listed in the “nothing” category as there are more than 150 that do not have such a registry. Currently, the United States is one of those lagging countries. With the AMLA2020 it will move form the lowest (red) tier up to the category of having a central registry that is not publicly accessible (yellow).

Ultimate Beneficial Owner – The Matryoshka Doll Problem

As Congress noted in section 6402 (above), most or all of the 50 states do not require information about the beneficial owners of the corporations and LLCs they create and register. So it currently isn’t difficult to mask the beneficial owner of a US-created or US-registered legal entity. But skilled and experienced money launderers and other criminal actors will create many layers that cross multiple jurisdictions in a bid to mask the true owners as much as possible. This is the “Matryoshka” doll visual – as seen by the (actual) Russian Matryoshka doll I have on my office bookshelf. In this visual, the “reporting company” is the largest doll on the left; the legal owner is the doll immediately to its right; and the ultimate beneficial owner, or UBO, is the smallest doll on the far right:

Figure 1 is taken from a March 2019 OECD “Beneficial Ownership Toolkit”. That toolkit provides “beneficial owners are always natural persons who ultimately own or control a legal entity or arrangement, such as a company, a trust, a foundation, etc. Figure 1 demonstrates how the use of a legal entity or arrangement can obscure the identity of a beneficial owner.” Figure 2 of the OECD toolkit show a more complex, nested series of arrangements that further distance the ultimate beneficial owner from the legal entity.

As Congress did in the Corporate Transparency Act, the OECD has identified these “nested” layers of entities that make it very difficult to identify the ultimate beneficial owner of a legal entity.[1] As explained below, however, Congress may have missed addressing this problem, or even made it worse by allowing ultimate beneficial owners of certain companies and money transmitters to be masked by intervening corporate entities. 

Beneficial Owner

The FATF has established the following definition of beneficial ownership:

“Beneficial owner refers to the natural person(s) who ultimately owns or controls a customer and/or the natural person on whose behalf a transaction is being conducted. It also includes those persons who exercise ultimate effective control over a legal person or arrangement.”

The proposed definition of Beneficial Owner is in 31 USC s. 5336(a)(3). It defines Beneficial Owner as an individual who “directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise, (i) exercises substantial control or (ii) owns or controls not less than 25 percent of the ownership interests”. This is slightly different than the definition of beneficial owner in 31 CFR 1010.540(d), which begins with the so-called ownership prong, which is “25 percent or more of the equity interests of a legal entity customer” and then follows with the control prong: “a single individual with significant responsibility to control, manage, or direct a legal entity customer” including a CEO, CFO, or similar position. In addition, the current regulation includes the trustee of a trust that is a legal owner: the AMLA2020 does not include a trustee. Regulations to be promulgated within one year will need to reconcile these different definitions.

And both the existing regulation – 31 CFR section 1010.230(d)(3) – and the new law – 31 USC section 5336(b)(2)(B) – exempt certain types of legal entities from having to provide beneficial ownership information (these are discussed below). If any of these exempt entities directly or indirectly own 25 percent or more of the equity interests of a legal entity customer or reporting company, respectively, they are not required to identify their owners. The current regulation exempts sixteen categories of entities from providing any beneficial ownership information, and two categories of entities only need to provide the name of one “control” person. The proposed law exempts twenty-four categories of entities from providing any beneficial ownership information. As mentioned above and described in more detail below, the addition of money transmitters and the “Tall, Dark, and Handsome” companies to the list of exempt entities will mask the beneficial owners of some potentially high risk entities. 

Applicant

The current beneficial ownership regulation does not include an “applicant”; rather, it includes the individual providing the beneficial ownership information to the financial institution and certifying that the information is complete and accurate. And that individual is only required to provide their name and position with the legal entity customer.

Subsection 5336(a)(2) defines an applicant as an individual who files an application to form a corporation, LLC, or similar entity with a State or Indian Tribe, or to register a foreign corporation, LLC, or similar entity with a State or Indian Tribe. Most states allow a “registered agent” to file the formation/registration documents, and most registered agents are companies. The individual is often a clerk working for that registered agent. Like the beneficial owner(s), the individual applicant must provide their full legal name, date of birth, current residential or street address, and either an identifying number like a SSN or a FinCEN identifier.

These differences must be reconciled in the new regulations.

Reporting Company

The definition of Reporting Company in 31 USC s. 5336(a)(11) is the same as the definition of “legal entity customer” in the current regulation. However, the exceptions (and, in the case of legal entity customers, the exemptions) are different, and, in some cases, materially different. A side-by-side comparison is set out in an Appendix B to this article, but the notable differences are the AMLA2020’s exceptions for (1) the Tall, Dark, and Handsome companies and LLCs – those with more than 20 FTE, more than $5 million in gross revenues (as reported to the IRS in the previous year), and with an operating presence in the United States (section 5336(a)(II)(B)(xxi))[2]; and (2) money transmitters registered with FinCEN (section 5336(a)(II)(B)(vi)), which include virtual currency exchanges.

Why did Congress carve out larger companies and money transmitters? Congressional staffers have told me that their primary focus was on the types of privately-held companies that can be used as shell companies: new companies without employees, with little or no revenue, and without a physical presence or office. That makes sense – if legal vehicles used to launder money were only shell companies. But larger companies with actual employees, revenue, and physical locations are also perfectly suited to generate, hide, and move illicit proceeds. And now with these companies being exempt from providing beneficial ownership information, they will be used to layer and hide the ownership of otherwise transparent shell companies. It would have been simpler and more effective to include all privately-held, non-financial institution companies and LLCs in the definition of “reporting company”. 

A similar reason was given for money transmitters (a form of Money Services Business, or MSB, and which include virtual currency exchanges): they are required to register with FinCEN (using Form 107) and as part of that registration, disclose their owner. Some of those who have commented on this, such as the pre-eminent law firm Sullivan & Cromwell, have noted that money transmitters “are already required to disclose beneficial ownership information publicly or to federal regulators … and exempting them from the reporting requirement does not appear to represent a gap in coverage.” See https://www.sullcrom.com/files/upload/sc-publication-anti-money-laundering-act-2020.pdf at page 7.

I disagree. First, there is nothing in the AMLA2020 that ties the ownership information contained in the Form 107 (MSB registration form) to the new beneficial ownership information. Second, MSBs do not have to disclose up to four legal owners and one control person – they only need to disclose one owner or controlling person – so FinCEN will not have complete beneficial ownership information on one of the highest risk business types. The instructions to the MSB registration form require that an “Owner or Controlling Person” submit the form, and that person is described in the instructions to the form as:

Any person who owns or controls a money services business is responsible for registering the MSB. Only one registration form is required for any business in any registration period. If more than one person owns or controls the business, they may enter into an agreement designating one of them to register the business. The designated owner or controlling person must complete Part III and provide the requested information [full name, date of birth, address, and identifying number]. In addition, that person must sign and date the form as indicated in Part VII … An “Owner or Controlling Person” includes the following: Sole Proprietorship – the individual who owns the business; Partnership – a general partner; Trust – a trustee; Corporation – the largest single shareholder. If two or more persons own equal numbers of shares of a corporation, those persons may enter into an agreement as explained above that one of those persons may register the business. If the owner or controlling person is a corporation, a duly authorized officer of the owner-corporation may execute the form on behalf of the owner-corporation.[3]

The Act includes a provision that this list of exemptions is subject to ongoing review by Treasury and, if a determination is made that an exempted category is being used to facilitate financial crime, Treasury may remove it from the list or impose other administrative actions. I hope that both money transmitters and “Tall, Dark, and Handsome” companies and LLCs are eventually remoted from the list of exempt entities. The loopholes they create are too tempting for professional money launderers and the gatekeepers (lawyers and accountants) who facilitate so much financial crime.

Time to Report

There are three time frames for reporting companies to report to FinCEN. All three begin when the regulations for this section are promulgated, which must be within one year of the passage of the Act. Companies in existence at the time of the regulations have (a very generous) two years to report. New companies created or registered after the regulations shall report at the time of formation (that is aggressive: money services businesses have 180 days from formation to register with FinCEN under 31 USC s. 5330(a)(1)). Changes in beneficial ownership must be reported within a year of the change.

How Many Companies Will Need to Report?

How many reporting companies will need to register their beneficial ownership information, and when? The most recent US Census Bureau data (2017) suggests there are 6 million businesses in the United States.[4] When adding in sole proprietorships and other single-persons doing business, other data suggests ~30 million businesses. This Act indicates that 2 million new companies and LLCs are being formed every year. There are ~3,000 publicly-traded companies, and ~100,000 regulated financial institutions, public accounting firms, etc., that are excluded from the definition of reporting company.

This leaves the “Tall, Dark, and Handsome” companies that will be excluded: those with more than 20 FTE, more than $5 million in gross revenues (as reported to the IRS in the previous year), and with an operating presence in the United States. Using Census Bureau information that suggests the average small business generates $100,000 in revenue per employee, the ~650,000 businesses the Census Bureau’s SUSB has identified, and analyzing the 5.2 million PPP loan recipients, it appears that approximately 2% of privately-owned small businesses have more than 20 employees, more than $5 million in annual revenue, and have a physical office in the United States (leaving 98% as “reporting companies”). The result is likely:

  • At least 5 million and as many as 20-30 million existing companies and LLCs will need to report their beneficial ownership information to FinCEN from January 2021 to January 2023; and
  • 2 million companies and LLCs per year will need to report their beneficial ownership information to FinCEN when they are created, beginning in January 2021.

The regulations for the FinCEN database of beneficial ownership information that will need to be issued, and the systems and procedures that will need to be designed, need to take into account the initial surge in reporting, as well as the 2 million or more new reports filed each year, and the revisions to existing reporting company records.

Required Information for Beneficial Owners and Applicants

Section 6403 is the main section for the new beneficial ownership information reporting requirements. It creates a new section in title 31 – section 5336. Subsection 5336(2) sets out the required information. There are some interesting, and perhaps some confusing, aspects about this subsection.

First is subsection 5336(2)(A). It provides:

(A) IN GENERAL.—In accordance with regulations prescribed by the Secretary of the Treasury, a report delivered under paragraph (1) shall, except as provided in subparagraph (B), identify each beneficial owner of the applicable reporting company and each applicant with respect to that reporting company by – (i) full legal name; (ii) date of birth; (iii) current, as of the date on which the report is delivered, residential or business street address; and (iv)(I) unique identifying number from an acceptable identification document; or (II) FinCEN identifier in accordance with requirements in paragraph (3).

With this, the report submitted to FinCEN shall identify from one to five beneficial owners and each applicant (defined as the individual who filed the application to create or register the reporting company with the state or Indian Tribe) by their full name, date of birth, address, and either their SSN or driver’s license number or Passport number or a FinCEN identifier. Allowing beneficial owners and applicants to be identified by the FinCEN identifier, and not by the commonly used SSN, drivers license, or passport number, could make the registry effectively unusable and/or ineffective (as explained below).

Subparagraph 5336(b)(2)(B) is the exception set out in (A), above, to providing a report that identifies the beneficial owner(s) and applicants of a reporting company. It provides:

(B) REPORTING REQUIREMENT FOR EXEMPT ENTITIES HAVING AN OWNERSHIP INTEREST. If an exempt entity described in subsection (a)(11)(B) has or will have a direct or indirect ownership interest in a reporting company, the reporting company or the applicant – (i) shall, with respect to the exempt entity, only list the name of the exempt entity; and (ii) shall not be required to report the information with respect to the exempt entity otherwise required under subparagraph (A).

This section mirrors the current regulation at 31 CFR s. 1010.230(d)(3). But the addition of money transmitters and “Tall, Dark, and Handsome” companies and LLCs to the list of exempt entities creates an interesting result. The box to the right shows an example of two of the listed exempt entity types: the so-called “Tall, Dark, and Handsome” companies, and money transmitters that are registered with FinCEN. The effect of this subsection, and subsection 5336(b)(3)(C), described below, may be that the Reporting Company must still disclose the Applicant (the person who filed the registration papers with the State or Indian Tribe that created the entity or registered it, if a foreign company, to do business in the State or Indian Tribe), but need not disclose the individuals that own or control the exempt company that owns the Reporting Company. In the example above, a reporting company owned by a money transmitting business only needs to list the name of the Applicant and the name of the money transmitting company as its beneficial owner: there is no “drill down” requirement as there is in the current beneficial ownership regulation. And because of the Form 107 limitation of listing only one person who own or controls the money transmitter, FinCEN has little information on one of the riskiest business types. One of the stated purposes of this new section was to address layered corporate structures “much like Russian nesting ‘Matryoshka’ dolls …” (section 6402(4)). This appears to be exactly that – a layered corporate structure involving money transmitters and privately-owned companies – which the law should have included.[5]

FinCEN Identifier

Section 5336(b)(3) is the FinCEN Identifier subsection. It provides:

(3) FINCEN IDENTIFIER. (A) ISSUANCE OF FINCEN IDENTIFIER. –

(i) IN GENERAL. – Upon request by an individual who has provided FinCEN with the information described in paragraph (2)(A) pertaining to the individual, or by an entity that has reported its beneficial ownership information to FinCEN in accordance with this section, FinCEN shall issue a FinCEN identifier to such individual or entity.

(ii) UPDATING OF INFORMATION. – An individual or entity with a FinCEN identifier shall submit filings with FinCEN pursuant to paragraph (1) updating any information described in paragraph (2) in a timely manner consistent with paragraph (1)(D).

(iii) EXCLUSIVE IDENTIFIER. – FinCEN shall not issue more than 1 FinCEN identifier to the same individual or to the same entity (including any successor entity).

From this, it appears that once an individual or reporting entity is named in a Beneficial Owner Information Report, they/it can request to have issued to them/it a unique FinCEN Identifier. The required information from subsection (2) – for individuals, that is their full legal name, DOB, current residential or business street address – will remain, but their identifying number, such as SSN, will be replaced by the FinCEN Identifier. This either/or approach is clear from the “required information” section[6] as well as subsection 5336(b)(3)(B): “USE OF FINCEN IDENTIFIER FOR INDIVIDUALS. – Any person required to report the information described in paragraph (2) with respect to an individual may instead report the FinCEN identifier of the individual.”

Like the money transmitter example above (the exception in 5336(b)(2)(B)) and subsection 5336(b)(3)(C)), this appears to allow an opaque “Matryoshka doll” of layered corporate entities. It provides:

(C) USE OF FINCEN IDENTIFIER FOR ENTITIES. – If an individual is or may be a beneficial owner of a reporting company by an interest held by the individual in an entity that, directly or indirectly, holds an interest in the reporting company, the reporting company may report the FinCEN identifier of the entity in lieu of providing the information required by paragraph (2)(A) with respect to the individual.

Once a beneficial owner and/or a reporting company obtains a FinCEN identifier, they/it can update any existing report or submit any new report using that FinCEN Identifier instead of the beneficial owner’s SSN or drivers license number or passport number and not even identify the actual beneficial owners going forward. Are those individuals thereafter “masked” from law enforcement unless FinCEN also maintains the SSN or other identifying number that would be known to law enforcement, and can cross-reference the law enforcement request? In the example above, as long as Reporting Company C has a FinCEN identifier, Reporting Company A may report that FinCEN identifier in lieu of providing the names and information of the beneficial owners (in this example, Messrs. Mossack and Fonseca).

Also, it is unclear how law enforcement will query, and how FinCEN will search, the beneficial ownership information database using FinCEN identifiers. For example, assume Al Capone is named as a beneficial owner of Reporting Company A. He provides his full name, SSN, etc. He then requests a FinCEN Identifier, and updates that report with his Identifier. Later, Reporting Company B submits a report and lists Al Capone with Al’s Identifier, but not his SSN. Law enforcement is later interested in Al Capone and queries FinCEN with “do you have Al Capone, SSN 010-56-1234?” and FinCEN replies “nope, nobody with that name matching that SSN. We’ve got 7 other ‘Al Capones’ with different SSNs or FinCEN identifiers.”

Access to the Database – None for the Public, Limited for Financial Institutions, Difficult for Law Enforcement

Subsection 5336(c) provides for the retention and disclosure of beneficial ownership information. The key is the disclosure provisions. The new FinCEN central registry of beneficial ownership information is not publicly accessible. Financial institutions can only query the database “with the consent of the reporting company to facilitate compliance … with CDD requirements”. And the procedures for law enforcement and other federal agencies are daunting enough that they may be discouraged from accessing the database.

Subsection 5336(c)(2)(B) lists five situations where FinCEN may disclose beneficial ownership information:

(i)(I) upon receipt of a request from “a federal agency engaged in national security, intelligence, or law enforcement activity, for use in furtherance of such activity”;

(i)(II) upon receipt of a request from a State, Tribal, or local law enforcement agency with a court order;

(ii) a request from a federal agency on behalf of a foreign government pursuant to a treaty, mutual legal assistance treaty, etc.;

(iii) upon receipt of “a request made by a financial institution subject to customer due diligence requirements, with the consent of the reporting company, to facilitate the compliance of the financial institution with customer due diligence requirements under applicable law”; and

(iv) upon receipt of a request from a Federal functional regulator.

And the “appropriate protocols” for requesting and releasing beneficial ownership information, set out in subsection 5336(c)(2)(C) are daunting: each request by a federal agency must include “the specific reason or reasons why the beneficial ownership information is relevant” to the investigation; the agency must have procedures and training in place to handle and restrict the information, the agency must keep auditable records, and be audited by the agency and annually by Treasury.

The biggest issue with the central registry of beneficial ownership information may be the limitations placed on financial institutions’ access and use. Examples of these limitations are:

  1. By limiting requests to those made with the consent of the reporting company, financial institutions cannot query the database without “tipping off” the reporting company, so financial institutions may only be able to use the database for onboarding due diligence or updating general due diligence, and not for investigations of unusual or possible suspicious activity;
  2. It is not clear whether financial institutions can perform due diligence on individuals by querying the database to determine if an individual customer is a beneficial owner of the institution’s new or proposed customer (a legal entity customer under the current rules, or a reporting company under the AMLA2020). In the example of Al Capone, above, it does not appear that a financial institution can submit a request to FinCEN to search the database for “Al Capone”;
  3. It is not clear what information FinCEN will return in response to a request for beneficial ownership information: will it release the PII of the applicant and beneficial owner(s), or just the name(s) and address(es)? What utility, if any, will FinCEN identifiers be to financial institutions?
  4. The database won’t be fully populated with the ~5-30 million existing reporting companies until 2023: what will financial institutions do if they get a “null return” from FinCEN for a company the financial institution knows should be registered? What will financial institutions be expected to do when the information they have in their files is different than what is returned by FinCEN?

Why was access to the beneficial ownership registry limited to the extent it was? The answer to that question could be found in comments made by Congressman Patrick McHenry, (R. NC 10). His floor comments from December 8, 2020, as captured in the House Congressional Record, are included in Appendix A, below. His comments bear particular weight, as Congressman McHenry is the Ranking Member on the House Financial Services Committee.

Only Part of the Current Beneficial Ownership Rule Remains

Congressman McHenry commented that this new reporting rule “rescinds the current beneficial ownership reporting regime set out in 31 CFR 1010.230 (b)–(j), which is costly and burdensome to small businesses.” However, it may not be as cut-and-dried as he states. The section that Rep. McHenry is referring to is 6403(d). That section provides:

Section 6403(d) REVISED DUE DILIGENCE RULEMAKING.

(1) IN GENERAL. – Not later than 1 year after the effective date of the regulations promulgated under section 5336(b)(4) of title 31, United States Code, as added by subsection (a) of this section, the Secretary of the Treasury shall revise the final rule entitled “Customer Due Diligence Requirements for Financial Institutions” (81 Fed. Reg. 29397 (May 11, 2016)) to –

(A) bring the rule into conformance with this division and the amendments made by this division;

(B) account for the access of financial institutions to beneficial ownership information filed by reporting companies under section 5336, and provided in the form and manner prescribed by the Secretary, in order to confirm the beneficial ownership information provided directly to the financial institutions to facilitate the compliance of those financial institutions with anti-money laundering, countering the financing of terrorism, and customer due diligence requirements under applicable law; and

(C) reduce any burdens on financial institutions and legal entity customers that are, in light of the enactment of this division and the amendments made by this division, unnecessary or duplicative.

(2) CONFORMANCE.

(A) IN GENERAL. – In carrying out paragraph (1), the Secretary of the Treasury shall rescind paragraphs (b) through (j) of section 1010.230 of title 31, Code of Federal Regulations upon the effective date of the revised rule promulgated under this subsection.

(B) RULE OF CONSTRUCTION. – Nothing in this section may be construed to authorize the Secretary of the Treasury to repeal the requirement that financial institutions identify and verify beneficial owners of legal entity customers under section 1010.230(a) of title 31, Code of Federal Regulations.

(3) CONSIDERATIONS. – In fulfilling the requirements under this subsection, the Secretary of the Treasury shall consider—

(A) the use of risk-based principles for requiring reports of beneficial ownership information;

(B) the degree of reliance by financial institutions on information provided by FinCEN for purposes of obtaining and updating beneficial ownership information;

(C) strategies to improve the accuracy, completeness, and timeliness of the beneficial ownership information reported to the Secretary; and

(D) any other matter that the Secretary determines is appropriate.

Some, But Not All, of the Current Beneficial Ownership Rule Will Change

The current Beneficial Ownership rule is set out in 31 CFR section 1010.540(a) – (j):

(a) “Covered financial institutions are required to establish and maintain written procedures that are reasonably designed to identify and verify beneficial owners of legal entity customers” and to include those procedures in their overall 31 USC s. 5318(h) programs

(b) Identification and verification of beneficial owners when a new account is opened unless excluded pursuant to (e) or exempt pursuant to (h)

(c) Definition of “account”

(d) Definition of “beneficial owner” to be (1) each individual, if any, who, directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise, owns 25 percent or more of the equity interest of a legal entity customer [the so-called “ownership prong”]; and (2) a single individual with significant responsibility to control, manage, or direct a legal entity customer (including CEO, CFO, etc.) [the so-called “control prong”]; and (3) if a trust is the legal owner, the trustee.

(e) Definition of Legal Entity Customer – includes a list of exceptions and entities subject to only the control prong

(f) Definition of “Covered Financial Institution”

(g) Definition of “New Account”

(h) Exemptions

(i) Recordkeeping requirements

(j) Reliance on other financial institutions

The AML Act provides that “the Secretary of the Treasury shall rescind paragraphs (b) through (j) of section 1010.230 of title 31, Code of Federal Regulations upon the effective date of the revised rule promulgated under this subsection”. The result is that financial institutions will still be required to have procedures to identify and verify beneficial owners, but how that is done will be determined by new rules and regulations. So the new rules will be similar to the current beneficial ownership rule.

The current beneficial ownership rule provides financial institutions with more information on more legal entities sooner and requires them to use that information for not only onboarding due diligence, including customer risk rating, but ongoing due diligence (investigations of potential suspicious activity). It also gives financial institutions immediate access to existing legal entities’ beneficial ownership information where those entities open new accounts.

The new beneficial ownership information registration requirement only includes the smallest legal entities, existing legal entities have two years to provide their owners’ information, and, most importantly, financial institutions have limited access to the registry as they need their customer’s approval to access the customer’s information. The differences between the existing rule and new law are recognized in subsection (B), which directs the Secretary to “account for the access of financial institutions to beneficial ownership information filed by reporting companies under section 5336 … in order to confirm the beneficial ownership information provided directly to the financial institutions to facilitate the compliance of those financial institutions with” AML, CFT, and CDD requirements.

Conclusion

There is so much that is good about the Corporate Transparency Act. I’m hoping that by raising what appear to be, but may not be, bad and even ugly things about the Act, we will have more transparency into those aspects of the Act and we will be able to address them in regulations or even amendments to the Act itself.

 

Appendix A – Corporate Transparency Act – Congressional Comments

House Congressional Record from December 8, 2020 CREC-2020-12-08-pt1-PgH6919-3.pdf (congress.gov) at pages H6932-6933 (bold red font has been added for emphasis, and the footnote has been added from the original text):

Mr. MCHENRY. Mr. Speaker, I rise in support of the conference report to the National Defense Authorization Act for fiscal year 2021. Combating illicit finance and targeting bad actors is a nonpartisan issue. However, Congress’ actions must be thoughtful and data driven. An example of this is H.R. 2514, the COUNTER Act, which is included in this conference report. Division G is a compilation of bipartisan policies that will modernize and reform the Bank Secrecy Act and anti-money laundering regimes. These policies will strengthen the Department of Treasury’s financial intelligence, anti-money laundering, and counter terrorism programs.

I would like to thank Chairman CLEAVER and Ranking Member STIVERS for their work on this bill and the language included in Division G. In addition to Division G, the conference report contains an amendment replacing the text of H.R. 2513, the Corporate Transparency Act, with new legislation. H.R. 2513, which passed the House on October 22, 2019, and again as an amendment to H.R. 6395 on July 21, 2020, attempted to establish a new beneficial ownership information reporting regime to assist law enforcement in tracking down terrorists and other bad actors who finance terrorism and illicit activities. But, it did so to the detriment of America’s small businesses.

Beneficial ownership information is the personally identifiable information (PII) on a company’s beneficial owners. This information is currently collected and held by financial institutions prior to a company gaining access to our financial system.

However, bad actors and nation states, such as China and Russia, are becoming more proficient in using our financial system to support illicit activity. As bad actors become more sophisticated, so to must our tools to deter and catch them. One such tool is identifying the beneficial owners of shell companies, which are used as fronts to launder money and finance terrorism or other illicit activity. Beneficial ownership information assists law enforcement to better target these bad actors.

Although well-intentioned, H.R. 2513 had numerous deficiencies in its reporting regime. First, H.R. 2513 placed numerous reporting and costly reporting requirements on small businesses. It lacked protections to properly protect small businesses’ personal information stored with a little-known government office within the Department of Treasury—known as FinCEN. The bill authorized access to this sensitive information without any limitation on who could access the information and when it could be accessed. Finally, it failed to hold FinCEN accountable for its actions.

The text of H.R. 2513 is replaced with new language that I negotiated, along with Senate Banking Committee Chairman CRAPO. This substitute, which is reflected in Division F of the conference report, is a significant improvement over the House-passed bill in three key areas.

First, Division F limits the burdens on small businesses. Unlike H.R. 2513, the language included in the conference report protects our nation’s small businesses. It prevents duplicative, burdensome, and costly reporting requirements for beneficial ownership data from being imposed in two ways. It rescinds the current beneficial ownership reporting regime set out in 31 CFR 1010.230 (b)–(j), which is costly and burdensome to small businesses. Rescinding these provisions ensures that it cannot be used in a future rule to impose another duplicative, reporting regime on America’s small businesses. In addition, Division F requires the Department of Treasury to minimize the burdens the new reporting regime will have on small businesses, including eliminating any duplicative requirements.

House Republicans ensured the directive to minimize burdens on small businesses is fulfilled. Division F directs the Secretary of the Treasury to report to the House Committee on Financial Services and the Senate Committee on Banking annually for the first three years after the new rule is promulgated. The report must assess: the effectiveness of the new rule; the steps the Department of Treasury took to minimize the reporting burdens on reporting entities, including eliminating duplicative reporting requirements, and the accuracy of the new rule in targeting bad actors. The Department of Treasury is also required to identify the alternate procedures and standards that were considered and rejected in developing its new reporting regime. This report will help the Committees understand the effectiveness of the new rule in identifying and prosecuting bad actors. Moreover, it will give the Committees the data needed to understand whether the reporting threshold is sufficient or should be revised.

Second, Division F includes the strongest privacy and disclosure protections for America’s small businesses as it relates to the collection, maintenance, and disclosure of beneficial ownership information. The new protections set out in Division F ensure that small business beneficial ownership information will be protected just like an individual’s tax return information. The protections in Division F mirror or exceed the protections set out in 26 U.S.C. 6103, including:

  1. Agency Head Certification. Division F requires an agency head or designee to certify that an investigation or law enforcement, national security or intelligence activity is authorized and necessitates access to the database. Designees may only be identified through a process that mirrors the process followed by the Department of Treasury for those designations set out in 26 U.S.C. 6103.
  2. Semi-annual Certification of Protocols. Division F requires an Agency head to make a semi-annual certification to the Secretary of the Treasury that the protocols for accessing small business ownership data ensure maximum protection of this critically important information. This requirement is non-delegable.
  3. Court authorization of State, Local and Tribal law enforcement requests. Division F requires state, local and tribal law enforcement officials to obtain a court authorization from the court system in the local jurisdiction. Obtaining a court authorization is the first of two steps state, local and tribal governments must take prior to accessing the database. Separately, state, local and tribal law enforcement agencies must comply with the protocols and safeguards established by the Department of Treasury.
  4. Limited Disclosure of Beneficial Ownership Information. Division F prohibits the Secretary of Treasury from disclosing the requested beneficial ownership information to anyone other than a law enforcement or national security official who is directly engaged in the investigation.
  5. System of Records. Division F requires any requesting agency to establish and maintain a system of records to store beneficial ownership information provided directly by the Secretary of the Treasury.
  6. Penalties for Unauthorized Disclosure. Division F prohibits unauthorized disclosures. Specifically, the agreement reiterates that a violation of appropriate protocols, including unauthorized disclosure or use, is subject to criminal and civil penalties (up to five years in prison and $250,000 fine).

Third, Division F contains the necessary transparency, accountability and oversight provisions to ensure that the Department of Treasury promulgates and implements the new beneficial ownership reporting regime as intended by Congress. Specifically, Division F requires each requesting agency to establish and maintain a permanent, auditable system of records describing: each request, how the information is used, and how the beneficial ownership information is secured. It requires requesting agencies to furnish a report to the Department of Treasury describing the procedures in place to ensure the confidentiality of the beneficial ownership information provided directly by the Secretary of the Treasury.

Separately, Division F requires two additional audits. First, it directs the Secretary of Treasury to conduct an annual audit to determine whether beneficial ownership information is being collected, stored and used as intended by Congress. Separately, Division F directs the Government Accountability Office to conduct an audit for five years to ensure that the Department of Treasury and requesting agencies are using the beneficial ownership information as set out in Division F. This is the same audit that GAO conducts as it relates to the Department of Treasury’s collection, maintenance and protection of tax return information. This information will ensure that Congress has independent data on the efficacy of the reporting regime and whether confidentiality is being maintained.

Division F also requires the Department of Treasury to issue an annual report on the total number of court authorized requests received by the Secretary to access the database. The report must detail the total number of court authorized requests approved and rejected and a summary justifying the action. This report to Congress will ensure the Department of Treasury does not misuse its authority to either approve or reject court authorized requests.

Finally, Division F requires the Director of FinCEN, who is responsible for implementing this reporting regime, to testify annually for five years. This testimony is critical. For far too long FinCEN has evaded any type of congressional check on its activities. Yet, it has amassed a great deal of authority. Now, Congress will shine a light on its operations. It is my expectation that FinCEN will provide Congress with hard data on its effectiveness in targeting bad actors, including the effectiveness of this new authority to collect, maintain, and use beneficial ownership information.

One final comment about the importance of FinCEN’s annual testimony. In the months leading up to the House’s consideration of H.R. 2513 last October, I sought data from FinCEN and from the Treasury Department, along with the Department of Justice, to better understand the need for this legislation. No such data was forthcoming. Rather, FinCEN gave anecdotes of very scary stories to justify the need for a new reporting regime. It is my expectation that FinCEN will provide Congress with the necessary data to justify this new reporting regime and the burdens it is placing on legitimate companies. I will conclude by thanking Chairwoman MALONEY for her work over the last twelve years on this issue and her willingness to work with me to strengthen this bill. I believe we have a better product. I urge my colleagues to support the conference agreement.

[1] Beneficial Ownership Toolkit (oecd.org)

[2] With the Oxford comma separating the three attributes, it is clear that these companies must have all three attributes. And there are very few companies or LLCs in the United States that have all three. They are in fact the corporate equivalent of a man who is tall, dark, and handsome – very rare.

[3] FinCEN FORM 107 (Rev. 8-2008) (irs.gov)

[4] The US Census Bureau’s Statistics of US Businesses, or SUSB, data available at 2017 SUSB Annual Data Tables by Establishment Industry (census.gov). This shows ~5.35 million businesses with 20 or fewer employees; ~550,000 with 20-99 employees; ~100,000 with 100-499 employees (these ~5,990,000 businesses are all “small businesses”. Note that the Paycheck Protection Program, limited to small businesses with 500 or fewer employees, resulted in ~5.2 million loans); and ~10,000 businesses with more than 500 employees.

[5] All money transmitters must register with FinCEN: it is a federal criminal offense for a licensed money transmitter not to be registered with FinCEN. See 31 USC s. 5330 and 18 USC s. 1960.

[6] This is clear from subsection 5336(b)(2)(A) which provides that each beneficial owner and applicant shall be identified by their full legal name, date of birth, current residential or business street address, and either an identifying number from an acceptable form of identification such as a SSN or drivers license or passport, or a FinCEN identifier.

Appendix B – Comparison of Legal Entities Subject to Beneficial Ownership

31 CFR s. 1010.230(e)(2) and (3) Legal Entity Customer ExceptionsProposed 31 USC s. 5336(a)(II)(B) Reporting Company Exceptions
(2)(i) financial institution with a federal functional regulator, or a state-regulated bank(iii) financial institution with a federal functional regulator
 (iv) federal or state credit union
(2) (ii) entity described in 31 CFR 1020.315(b)(2)-(5):     (2) department or agency of the US, state, or           subdivision thereof     (3) entity with governmental authority     (4) entity listed on the NYSE, NASDAQ, ASE     (5) subsidiary owned 51% or more of (4)(ii) same, but also includes Indian Tribe
(2) (iii) issuer of securities under sections 12 and 15(d) of the Securities Exchange Act(i) same
(2) (iv) SEC-registered investment company(x) same
(2) (v) SEC-registered investment advisor(x) same and (xi) same
(2) (vi) SEC-registered exchange or clearing agency(viii) same
(2) (vii) any other SEC-registered entity(vii) for broker dealers, and (ix) same
(2) (viii) CFTC-registered entity(xiv) same
(2) (ix) Sarbanes-Oxley registered Public Accounting Firm(xv) same
(2) (x) Bank or Savings & Loan Holding Company(v) same
(2) (xi) pooled investment vehicle operated by a financial institution(xviii) same
(2) (xii) insurance company(xii) same
(2) (xiii) Dodd-Frank financial market company(xvii) same
(2) (xiv) foreign financial institution (FFI) with a regulator that has a beneficial ownership information requirement for that FFI 
(2) (xv) Noon-US government agency that does only government-related work and no commercial activity 
(2) (xvi) any private banking legal entity customer that has an existing requirement to identify beneficial owners under 31 CFR 1010.620 
(3)(i) control prong only for a pooled investment vehicle other than (e)(xi) 
(3)(ii) control prong only for non-profit entities(xix) similar but also includes political organizations and non-profit trusts
 (vi) money transmitting businesses that are registered under 31 USC s. 5330
 (xiii) US-owned insurance producers
 (xvi) public utilities
 (xxi) any entity that (I) employs more than 20 employees on a full-time basis in the United States; (II) filed in the previous year Federal income tax returns in the United States demonstrating more than $5,000,000 in gross receipts or sales in the aggregate, including the receipts or sales of (aa) other entities owned by the entity; and (bb) other entities through which the entity operates; and (III) has an operating presence at a physical office within the United States
 (xxii) any subsidiary of (i) to (xxi) except (xvi) money transmitters
 (xxiii) any dormant (defined) entity not owned directly or indirectly by a foreign person
 (xxiv) any other entity determined by the Secretary

AML Act of 2020: Renewing America’s AML/CFT Regime

Executive Summary of the AML Act of 2020

On December 3, 2020 the Senate and House jointly issued a Conference Report on the National Defense Authorization Act for Fiscal Year 2021 (the “NDAA”). The Conference Report is 4,517 pages long.[1] The NDAA contains eight divisions – Division F is the Anti-Money Laundering Act of 2020 (the “AML Act of 2020”). The House passed the NDAA on December 8th with a vote of 335-78 (out of 435 Members): the Senate passed the NDAA on December 11th with a vote of 84-13 (out of 100 Senators). The NDAA will be headed to the President’s desk, where he can sign it into law or veto it. If vetoed, both chambers have veto-proof majorities (two-thirds) and can over-ride the veto, if they choose to exercise those powers.

If signed by the President, or Congress over-rides a Presidential veto, the AML Act of 2020 will usher in the most profound changes to the U.S. anti-money laundering regime since the USA PATRIOT Act of 2001.[2] As described in more detail below, the AML Act of 2020 broadens the mission or purpose of the Bank Secrecy Act (“BSA”) to include national security; formalizes the risk-based approach for financial institutions’ compliance programs; greatly expands the duties, powers, and functions of FinCEN; aligns the regulatory agencies’ supervision and examination priorities with the expanded purposes of the BSA; increases civil and criminal penalties for violations of the BSA; calls for multiple studies and reports; and establishes a beneficial ownership information reporting regime. The result is that the US is moving from a US-focused, regulator-versus-regulated, compliance-focused regime to a global, public/private partnership focused on fighting all financial crimes.

Of note is what is not in the AML Act that should be there. What is not in the AML Act are any references to, or changes to, the laws that give duties and powers to the Federal functional regulators. What we call the Bank Secrecy Act is actually three different laws, or parts of the US Code: 12 USC s. 1829b (“retention of records by insured depository institutions”), 12 USC Part 21 (“financial recordkeeping”, sections 1951-1959), and 31 USC subchapter II (“ records and reports on monetary instruments and transactions”, sections 5311-5314, 5316-5322). As explained in the following section, title 12 is “Banks & Banking” and includes the laws relating to the Federal functional regulators, and title 31 is “Money & Finance” and includes the laws relating to Treasury and FinCEN. The AML Act changes the title 31 laws (and regulations) but not the title 12 laws (and regulations) that collectively make up the BSA.[3] It remains to be seen how the title 12 regulators will be impacted, and how willing they will be to being impacted, by the title 31 changes.

Finally, whatever the impacts of the AML Act will be may not be fully realized for years. For example, the USA PATRIOT Act, which included Title III, the International Counter-Money Laundering and Anti-Terrorist Financing Act of 2001, was passed in October 2001; regulations implementing the Act were issued in 2002 and 2003; and regulatory guidance, in the form of the first FFIEC BSA/AML Exam Manual, wasn’t published until April 2005 (and that Manual was revised in 2006, 2007, 2010, and 2014 to reflect changing regulatory guidance). We can expect something similar with the AML Act of 2020: it calls for multiple studies and reports to Congress over the next two years; regulations will need to be issued over the next year to three years; the Exam Manual will need to be revised; regulators will need to be trained; and regulatory guidance will evolve.

I was pleased to see that many of the things I’ve been calling for over the years have been included in the AML Act. Most notably are the provisions relating to – even requiring – the public sector consumers of BSA reports to provide feedback to the private sector producers of BSA reports. My most recent article on what I’ve called “TSV SARs” or Tactical or Strategic Value SARs, is from October 1, 2020: Reforming the AML Regime Through TSV SARs

Background on the US Code, Code of Federal Regulations, and Regulatory Guidance

For those not familiar with how US laws and regulations work, a short primer is in order.

The Conference Report and AML Act of 2020 contain references to the United States Code (“USC”), the Code of Federal Regulations (“CFR”), and regulatory guidance such as the FFIEC BSA/AML Examination Manual.

Legislation, or laws, are set out in the United States Code, the codification by subject matter of the general and permanent laws of the United States. The U.S. Code is divided by broad subjects into 53 titles and published by the Office of the Law Revision Counsel of the U.S. House of Representatives.[4] The first six titles set out the laws relating to the functioning of the government generally. Titles 7 through 50 are alphabetical: title 7 is Agriculture, title 50 is War & National Defense. The main titles relating to anti-money laundering (AML) and countering the financing of terrorism (CFT) are:

  • Title 12 Banks & Banking – laws relating to the Federal financial regulatory agencies such as the Federal Reserve, FDIC, OCC
  • Title 18 Crimes & Criminal Procedure – criminal laws such as structuring and operating an unlicensed money transmitter
  • Title 26 – Internal Revenue Code – tax-related crimes and some BSA-related forms such as the Form 8300 (reporting cash received by a trade or business)
  • Title 31 Money & Finance – the Bank Secrecy Act is part of title 31: subchapter II, sections 5311 – 5322. The AML Act of 2020 adds sections 5333-5336 to subchapter II
  • Title 50 War & National Defense – U.S. sanctions laws administered by OFAC are in this title.[5]

Laws are described by the title and the section: 31 USC s. 5311, for example, is the “purpose” section of the laws known as the BSA that are codified in title 31.

Where laws generally describe “what” Congress has enacted, how those laws are implemented and enforced are set out in regulations issued by the appropriate executive branch agency or department, such as the Treasury Department and the Federal financial regulators. Regulations are set out in the Code of Federal Regulations. The OCC’s regulations are set out in Part 21 of title 12 of the Code ofFederal Regulations – 12 CFR Part 21 – while FinCEN’s regulations are set out in Part X of title 31 of the Code of Federal Regulations – 31 CFR Part X.[6]

Regulations provide the “how” and follow the “what of the law: an example of laws and corresponding regulations is 31 USC s. 5318(h), the law that requires all financial institutions to have AML/CFT programs, and its implementing regulation at 31 CFR s. 1020.200, the general program requirements for banks.

All of the Federal functional regulators and FinCEN issue what is called “supervisory guidance” to set out their expectations or priorities. For AML and CFT purposes, this supervisory guidance has been collected and compiled by the Federal Financial Institutions Examination Council, or FFIEC, into an examination manual that includes their collective guidance to their examiners on AML and CFT laws, regulations, and expectations. It is available at https://bsaaml.ffiec.gov. Although this guidance does not create enforceable requirements – those requirements are in the laws and regulations – the guidance does shape how financial institutions design, build, maintain, and update their programs, and how auditors and examiners test and examine those programs.

Explanation of this Summary of the AML Act of 2020

As set out above, the Conference Report for the NDAA is over 4,500 pages long. The AML Act of 2020, Division F of the NDAA, is at pages 2,843 – 3,078 (it is 235 pages long). The AML Act of 2020 is made up of 56 sections in five titles.[7] Sections 6001-6003 set out the title of the act, its purposes, and definitions of key terms. Following those three introductory sections are the five titles:

  • Title LXI – Strengthening Treasury Financial Intelligence, Anti-Money Laundering, and Countering the Financing of Terrorism Programs (sections 6101-6112)
  • Title LXII – Modernizing the Anti-Money Laundering and Countering the Financing of Terrorism System (sections 6201-6216)
  • Title LXIII – Improving Anti-Money Laundering and Countering the Financing of Terrorism Communication, Oversight, and Processes (sections 6301-6314)
  • Title LXIV – Establishing Beneficial Ownership Information Reporting Requirements (sections 6401-6403)
  • Title LXV – Miscellaneous (sections 6501-6511)

Scattered throughout many of the titles and sections are changes to particular aspects of, or themes of, the current AML/CFT regime. This summary, therefore, is arranged by those aspects or themes rather than going through the fifty-six sections and five titles in order. Text appearing in red font indicates a change or addition to language in laws or regulations: the intent is for the reader to see what has been added (or, in one case, taken away) from existing laws or regulations.

This is by no means a complete review, assessment, analysis, and commentary on the AML Act of 2020. However, I trust it is a good primer for those interested in contributing to the discussion around, and efforts to promote, a more effective, efficient, courageous, compassionate, and inclusive public and private sector effort at mitigating and, to the extent possible, eliminating money laundering ,terrorist financing, and other financial crimes.

Purposes of the Anti-Money Laundering Act of 2020

Section 6202 of the AML Act describes the purposes of the Act.  The full text of this section is set out below:

  • to improve coordination and information sharing among the agencies tasked with administering anti-money laundering and countering the financing of terrorism requirements, the agencies that examine financial institutions for compliance with those requirements, Federal law enforcement agencies, national security agencies, the intelligence community, and financial institutions;
  • to modernize anti-money laundering and countering the financing of terrorism laws to adapt the government and private sector response to new and emerging threats;
  • to encourage technological innovation and the adoption of new technology by financial institutions to more effectively counter money laundering and the financing of terrorism;
  • to reinforce that the anti-money laundering and countering the financing of terrorism policies, procedures, and controls of financial institutions shall be risk-based;
  • to establish uniform beneficial ownership in formation reporting requirements to (A) improve transparency for national security, intelligence, and law enforcement agencies and financial institutions concerning corporate structures and insight into the flow of illicit funds through those structures; (B) discourage the use of shell corporations as a tool to disguise and move illicit funds; (C) assist national security, intelligence, and law enforcement agencies with the pursuit of crimes; and (D) protect the national security of the United States; and
  • to establish a secure, nonpublic database at FinCEN for beneficial ownership information.

The Conference Report (at page 4,456 of the 4,517-page report) included some interesting language on the purposes of the Act:

“One overarching improvement now included in the conference agreement is to broaden the mission of the BSA to specifically safeguard national security as well as the more traditional investigatory pursuits of law enforcement … Currently, there is no clear statutory mandate for BSA stakeholders – law enforcement, financial regulators, and financial institutions – to provide routine, standardized feedback to one another for the purpose of improving the effectiveness of BSA AML programs … [and there is a] clear mandate for innovation.”

Changes to the Purpose of the Bank Secrecy Act – 31 USC s. 5311

The additions to the “purpose” section of the BSA may be the single biggest change to the current AML/CFT regime. As set out below, section 5311 of title 31 is the declaration of purpose. From 1970 through 2001, that purpose was simply “to require certain reports or records where they have a high degree of usefulness in criminal, tax, or regulatory investigations, or proceedings.” The USA PATRIOT Act of 2001 added a clause relating to international terrorism: the amended section provided that the purpose was “to require certain reports or records where they have a high degree of usefulness in criminal, tax, or regulatory investigations, or proceedings, or intelligence or counterintelligence activities, including analysis, to protect against international terrorism.”

As can be seen below, the original (post-2001) purpose has been changed in three ways. First, changing reports “where they have a high degree of usefulness” to reports “that are highly useful”. [8] Second, those reports are now to be used in regulatory risk assessments. And third, it appears that BSA reports are intended for all terrorism purposes, not just international terrorism (domestic and international). The new section 5311 declaration adds four new purposes: strong private sector programs, tracking dirty money, conduct national risk assessments to protect the financial system and national security generally, and to encourage public private sector information sharing. And note the language in subsection (5) where “service providers” has been added, a recognition of the growing regtech/fintech industry. The Declaration of Purpose now provides that:

It is the purpose of this subchapter (except section 5315) to –

  1. require certain reports or records where they have a high degree of usefulness that are highly useful in – (A) criminal, tax, or regulatory investigations, risk assessments, or proceedings; or (B) intelligence or counterintelligence activities, including analysis, to protect against international terrorism;
  2. prevent the laundering of money and the financing of terrorism through the establishment by financial institutions of reasonably designed risk based programs to combat money laundering and the financing of terrorism;
  3. facilitate the tracking of money that has been sourced through criminal activity or is intended to promote criminal or terrorist activity;
  4. assess the money laundering, terrorism finance, tax evasion, and fraud risks to financial institutions, products, or services to – (A) protect the financial system of the United States from criminal abuse; and (B) safeguard the national security of the United States; and
  5. establish appropriate frameworks for information sharing among financial institutions, their agents and service providers, their regulatory authorities, associations of financial institutions, the Department of the Treasury, and law enforcement authorities to identify, stop, and apprehend money launderers and those who finance terrorists.

Changes to the AML/CFT Program Requirements – 31 USC s. 5318(h)

Section 5318 of title 31 is the catch-all “compliance” section of the BSA. In addition to the SAR reporting requirements in subsection 5318(g), and the Customer Identification Program requirements in subsection 5318(l), this section has the requirements for financial institutions’ AML/CFT programs in subsection 5318(h).

Subsection (h)(1) is the so-called “four pillars” or minimum requirements of a program: “In order to guard against money laundering through financial institutions, each financial institution shall establish anti-money laundering programs, including, at a minimum –

(A) the development of internal policies, procedures, and controls;

(B) the designation of a compliance officer;

(C) an ongoing employee training program; and

(D) an independent audit function to test programs.

Subsection (h)(1) is changed to reflect the CFT aspects of the regime. It now requires financial institutions to “establish AML and countering the financing of terrorism programs in order to guard against money laundering and the financing of terrorism”. The minimum standards, or “four pillars”, did not change.

Perhaps this was a lost opportunity to reconcile the four pillar program requirements in 31 USC s. 5318(h) with the five pillar program requirements in 31 CFR s. 1010.210 and with the four pillar program requirements in 12 CFR s. 21.21.[9]

Subsection (h)(2) gives the Treasury Secretary the power to prescribe rules (regulations) for the AML program standards. This subsection is dramatically altered with the addition of factors that the Secretary shall take into consideration. And a new subsection, (h)(4), is added that sets out a new requirement that the Government shall establish national priorities, updated every four years, that need to be incorporated into institutions’ AML/CFT programs and, notably, how those national priorities are incorporated will be examined by the regulatory agencies:

(h)(2)(B) – Factors that the Secretary shall take into account when prescribing minimum standards and regulators shall take into account in supervising and examining: (i) financial institutions are spending private funds for public and private benefit; (ii) key policy goals of the US are extending financial services to the underbanked and facilitating global remittances while preventing criminals from abusing the system; (iii) effective AML and CFT programs safeguard national security and generate public benefit; (iv) AML and CFT programs should be (I) “reasonably designed to assure and monitor compliance with the requirements of this subchapter and regulations promulgated under this subchapter; and (II) risk-based, including that more attention and resources of financial institutions should be directed toward higher-risk customers and activities, consistent with the risk profile of a financial institution, rather than toward lower-risk customers and activities.”

(h)(4) – Priorities: (A) within 180 days the Government shall establish AML And CFT priorities; (B) those priorities will be renewed every 4 years; (C) these priorities will be aligned with national security priorities; (D) FinCEN will promulgate regulations within 180 days of (A); (E) financial institutions shall incorporate those priorities into their AML/CFT programs and will be supervised and examined thereon.

Changes to FinCEN’s Duties, Powers, and Scope – 31 USC s. 310

Part 3 of title 31 sets out the organization, function, powers, and duties of the Treasury Department generally, and each of the bureaus or divisions within the Treasury Department. Section 310 of Part 3 is the section for the Financial Crimes Enforcement Network, or FinCEN.

As can be seen below, the duties and powers of the FinCEN director set out in section 310(b) have been greatly expanded. The current subsection has nine duties – (A) through (I) – and a catch-all (J). That catch-all has been moved down to (O) as five new duties and powers have been added – (J) through (N):

(A) Provide advice and make recommendations to the Under Secretary for Enforcement

(B) Maintain a government-wide database of BSA reports

(C) Analyze and disseminate intel from that database

(D) Maintain a communications center for law enforcement

(E) Furnish research, analytical, and informational services to the private and public sectors

(F) Assist law enforcement and regulators in combatting informal value transfer systems

(G) Support the tracking of foreign assets

(H) Coordinate with foreign FIUs

(I) Administer the requirements of the BSA

(J) Promulgate regulations to implement the exam and supervision priorities of BSA/AML programs

(K) Communicate regularly with the private sector, regulators, and law enforcement to explain the Government’s AML/CFT exam and supervision priorities

(L) Give and receive feedback to and from the private sector and State bank and credit union supervisors

(M) Maintain money laundering and terrorist financing experts to support federal civil and criminal investigations

(N) Maintain emerging technology experts

(O) Such other duties and powers as the Secretary may delegate

Subsection 310(c) on FinCEN’s requirements relating to maintenance and use of its data banks, did not change. However, the AML Act added seven new subsections that greatly expand FinCEN’s purpose, reach, authority, and staffing/budget:

  • 310(d) – FinCEN Exchange (added by s. 6103, which (i) codifies in the statute the Exchange that FinCEN established two years ago; and (ii) requires FinCEN to report to Congress on the effectiveness of the Exchange within one year then once every two years for five years)
  • 310(e) – Special hiring authority for terrorism and intel (added by s. 6105, this gives both FinCEN and its parent agency, the Office of Terrorism and Financial Intelligence, or OTFI, the ability to makes certain hires without going through the usual federal government steps. Like section 6305, FinCEN and OTFI must report to Congress within a year)
  • 310(f) – adds at least 6 FinCEN Domestic Liaisons (added by s. 6107)
  • 310(g) – adds Chief of Domestic Liaison (added by s. 6107, which creates a Deputy Director of Domestic Liaison reporting to the FinCEN Director, with an Office of Domestic Liaison located in Washington DC. The six Domestic Liaisons will report regionally, and can be co-located with Federal Reserve offices, as needed. Same requirements to report to Congress.)
  • 310(h) – adds at least 6 Foreign FIU Liaisons (added by s. 6108, these positions will be similar to Treasury attaches and will work with Egmont and FATF)
  • 310(i) – FOIA protection of information shared with international FIUs (added by s. 6109)
  • 310(j) – requires analytical experts for FinCEN’s “Analytical Hub” (added by s. 6304)
  • 310(l) – Appropriation for FY2021 of $136 million, adding $10 million by s. 6509

In addition to the changes set out in 31 USC s. 310, the AML Act added some general provisions. Section 6203(a) of the AML Act provides that FinCEN shall solicit feedback from a cross section of BSA Officers on their financial institution’s SARs and trends observed by FinCEN, and FinCEN will provide that information to the institution’s regulator. Section 6203(b) of the AML Act requires that FinCEN shall periodically disclose to each financial institution, in summary form, information on SARs filed that proved useful to law enforcement and to DOJ. And section 6208 creates a new position of BSA Innovation Officer reporting directly to Director of FinCEN (similar positions for the Federal functional regulators).

Other Changes to the Bank Secrecy Act – 31 USC Subchapter II, ss. 5311 – 5322

31 USC s. 5321 Civil Penalties – section 6309 adds new subsection 31 USC 5321(f) and provides for enhanced or additional penalties for repeat offenders of 3x the profit gained or loss avoided as a result of the violation or 2x the maximum penalty. Section 6310 adds new subsection 31 USC 5321(g) and bans those who have committed “egregious violations”, defined as criminal convictions where the maximum sentence is more than one year and civil violations where the individual willfully committed the violation and the violation facilitated money laundering or terrorist financing, from serving on a financial institution board for ten years.

Section 6312 adds subsection 31 USC s. 5322(e) to the criminal penalties section. It requires the return of any profit gained by reason of the criminal violation and, if the offender was a partner, director, officer, or employee, they must repay the institution any bonus paid during the calendar year in which the violation occurred or the year thereafter. I expect there to be some questions raised about this subsection around why the offending institution is re-paid bonuses, and situations where directors are not paid bonuses (they rarely are).

Expanded Whistleblower Awards and Protections – 31 USC s. 5323

Section 6314 extensively altered and expanded the whistleblower section of title 31. The current section only allows for “informants” to receive rewards of between $12,500 and $150,000, and there is nothing in the section about protecting informants (whistleblowers) from retaliation. This new section increases the rewards to up to 30% of the penalty, and includes detailed provisions on protecting whistleblowers.

Modernizing the AML/CFT System Generally

Title LXII (sections 6201 – 6216) and title LXV (sections 6502 – 6508) collectively are intended to, and do, modernize the AML/CFT system.

  • 6201 – The Attorney General shall report annually on the use of BSA reports, including whether the reports contain “actionable information” that leads to further proceedings by law enforcement, intelligence community, or national security; and extent to which arrests, indictments, convictions result. Note the term “actional information”: is it different from information that provides a “high degree of usefulness” (the current language of section 5311) or is “highly useful” (the new language of section 5311)?
  • Sections 6204, 6205 call for a review of the contents, forms, and thresholds of CTRs and SARs. I have argued against raising the SAR or CTR thresholds[10]
  • Section 6209 adds 31 USC 5318(o) – a review of whether and how Model Validation applies to AML/CFT. Following that review, the new standards would be put into a regulation and incorporated in the FFIEC BSA/AML Examination Manual. This could be an impactful change: the current pedantic application of strict model validation requirements is a drain and distraction on effective financial crime programs. As I recently wrote:

Revising existing model-risk-management guidance to AML systems assumes there is existing model-risk-management guidance to AML systems. But there isn’t any such guidance. The model risk management guidance – from 2000 and revised in 2011 – was never intended to be applied against AML systems. None of the five editions of the FFIEC Exam Manual, the four after the original 2000 guidance and the one following the 2011 revision of the guidance, make any reference to the model risk management guidance. If AML systems are to be subject to strict model governance, then that governance must be set out in binding regulation subject to public review and comment. And AML systems should not be subject to the same strict model governance requirements as Value-At-Risk models, liquidity models, or even consumer lending models. Nothing has more adversely impacted the ability of large financial institutions to fight financial crime, human trafficking, kleptocracy, nuclear proliferation, etc., as the strict, pedantic, dogmatic application of model risk governance. [11]

  • Section 6213 adds 31 USC s. 5318(p), thereby codifying the October 2018 interagency statement on sharing BSA resources
  • Section 6214 encourages information sharing and Public/Private Partnerships, and requires the Secretary to convene a supervisory team of agencies, private sector experts, etc., to examine strategies to increase such cooperation.
  • Section 6215 requires the GAO to publish a de-risking analysis within one year, followed by a strategy from the Secretary one year thereafter. This section includes a definition of de-risking: “actions taken by a financial institution to terminate, fail to initiate, or restrict a business relationship with a customer, or a category of customers, rather than manage the risk associated with that relationship consistent with risk-based supervisory or regulatory requirements, due to drivers such as profitability, reputational risk, lower risk appetites of banks, regulatory burdens or unclear expectations, and sanctions regimes.”
  • Section 6216 requires a review of regulations and guidance within one year.
  • Title LXV calls for multiple GAO and Treasury studies:
    • Study on beneficial ownership information reporting requirements (section 6502 and both GAO and Treasury shall report separately within two years),
    • Study on feedback loops (section 6503 and GAO to report within eighteen months),
    • Study on CTRs (section 6504 and GAO to report no later than December 31, 2025)[12],
    • Study on trafficking networks (section 6505 and GAO to report within one year),
    • Study on trade-based money laundering (TBML) (section 6506 and Treasury to report within one year)[13],
    • Study on money laundering by China (section 6507 and Treasury to report within one year), and
    • Study on the efforts of authoritarian regimes to exploit the financial system of the US (Treasury and Justice to conduct the study within one year and report within two years).
  • Section 6305 is an assessment of (actually, it contemplates the creation of) BSA No-Action Letters. Within 180 days of the passage of the Act, the Director must report to the House Financial Services Committee and the Senate Banking Committee on (i) whether to establish a process to issue no-action letters in response to inquiries on the application of the BSA or any AML/CFT law or regulation to specific conduct, including a request for a statement as to whether FinCEN or any relevant Federal functional regulator intends to take an enforcement action against the person with respect to such conduct. This would be a major change. Since 1987 FinCEN has an “Administrative Ruling” regime, whereby a financial institution may submit an Administrative Ruling request seeking FinCEN’s interpretation of a particular BSA regulation to the facts set out in the request. FinCEN’s response, the Administrative Ruling itself, has precedential value and may be relied upon by others similarly situated only if the ruling is published on FinCEN’s website. According to a notice published in the Federal Register on December 11, 2020, FinCEN received 98 Administrative Ruling requests from 2018-2020. According to FinCEN’s website, it only published 5 of those 98 requests (so 93 of the 98 are not of value to other institutions). And it takes months, sometimes years, for FinCEN to issue these rulings. For all of these reasons, a “No Action Letter” regime may be more effective than the current Administrative Ruling regime.

Changes to the Reporting of Suspicious Transactions – 31 USC s. 5318(g)

Reporting of suspicious transactions, or Suspicious Activity Reports (SARs), is set out in subsection (g) of section 5318. The AML Act changes the SAR regime in a number of ways, including .

5318(g)(1) – gives the Secretary the ability to issue regulations to require financial institutions to report suspicious transactions.

(g)(2) – Notification Prohibited – A filing financial institution and any officer, director, or employee of a filing financial institution cannot notify or disclose to any person involved in a reported suspicious transaction that the transaction has been reported or otherwise reveal any information that would reveal that the transaction has been reported (this language was added by section 6212 and codifies what was in the regulation and regulatory guidance).

(g)(3) – Liability for disclosure of SAR

(g)(4) – Single designee for SARs (FinCEN)

(g)(5) – Establish streamlined, including automated, processes to, as appropriate, permit the filing of noncomplex categories of SARs (added by section 6202, this is similar to provisions that were in FinCEN’s September 16, 2020 Advance Notice of Proposed Rulemaking)

(g)(6) – FinCEN shall share threat pattern and trend information at least semiannually to provide meaningful information about the preparation, use, and value of BSA reports. It shall include typologies, including data that can be adapted in algorithms, if appropriate on emerging money laundering and terrorist financing threat patterns and trends (added by s. 6206, this appears to compel FinCEN to go back to its semi-annual SAR Activity Reports, which were discontinued in 2013)

(g)(7) – Rules of construction (added by s. 6206)

(g)(8) – Pilot program within one year to allow a US financial institution to share SAR-related information with its foreign branches and affiliates (added by s. 6212, this would close an anomaly in the law and regulation, where foreign banks operating in the United States could share SAR information with their home-country head office, but US banks could not share SAR information with their foreign branches and affiliates. There was an exception: prohibited jurisdictions are China and Russia, any state sponsor of terrorism, any jurisdiction subject to sanctions, and any jurisdiction determined by the Secretary that cannot reasonably protect the security and confidentiality of such information).

New Sections Have Been Added to the BSA (subchapter II of Title 31)

  1. 5333 – Safe harbor for “Keep Open Directives” (added by s. 6306, this section would require law enforcement to notify FinCEN of any “keep open request” made of a financial institution to keep an account “or transaction” open. Financial institutions are not required to comply)
  2. 5334 – Required annual training for Federal financial regulators’ examiners (added by s. 6307, one would have assumed that examiners would be required to be trained on the regulatory requirements they are examining. This new section requires annual training, and the training is to be done in consultation with FinCEN and all levels of law enforcement – federal, state, tribal, and local.)
  3. 5335 – Penalties for concealing PEPs’ source of funds (added by s. 6313, this new section applies to PEPs or Senior Foreign Political Figures where the aggregate value of monetary transactions is not less than $1 million and the transaction(s) affect(s) interstate or foreign commerce. It provides that no person shall knowingly conceal, falsify, or misrepresent, ot attempt to do so, a material fact concerning the ownership or control of assets involved in a monetary transactions. And, if the transaction(s) involve(s) an entity found to be of primary money laundering concern under section 5318A, the same person cannot conceal the source of funds. This section will be complex to administer.)
  4. 5336 – Beneficial Ownership Information Reporting requirements (added by s. 6403 – see below)

Two New BSAAG Subcommittees

Section 1564 of the Annunzio-Wylie AML Act of 1992 created the BSA Advisory Group (BSAAG). The AML Act of 2020 adds two subcommittees: the Subcommittee on Innovation and Technology added by s. 6207 (adding subsection 1564(d)) and the Subcommittee on Information Security & Confidentiality added by s. 6302 (adding subsection 1564(e)). Both subcommittees have a five-year “sunset” clause, or terminate in five years, unless the Secretary renews them for as many one-year terms as the Secretary chooses. The mandate of the Subcommittee on Innovation and Technology is to study and make recommendations on how to “most effectively encourage and support technological innovation [and reduce] obstacles to innovation that may arise from existing regulations, guidance, and examination practices.” This subcommittee will also include the BSA Innovation Officers authorized by section 6208.

New Beneficial Ownership Information Reporting Requirements

The New Requirements

Title LXIV – sections 6401-6403 adds 31 USC s. 5336

Section 6402 is the “Sense of Congress” section. That section provides, in part, that the beneficial ownership information “will be directly available only to authorized government authorities” and the database is intended to be “highly useful to national security, intelligence, and law enforcement agencies and Federal functional regulators”. There is no mention of making the information directly available to financial information or even having it benefit financial institutions. As seen from Congressman McHenry’s comments (see Appendix A), that was the intent: the registry is quite limited.

Under the AML Act:

  • Beneficial Owner is defined as an individual who directly or indirectly exercises substantial control or owns or controls not less than 25%.
  • Reporting Company is defined as not including companies with more than 20 FTE, more than $5 million in gross revenues, and with an operating presence in the United States.
  • Existing companies have two years to report. New companies shall report at the time of formation. Changes in beneficial ownership must be reported within a year.
  • Financial institutions can only query the database about a company with the consent of that company. The existing beneficial ownership rule of May 11, 2016 will be brought into conformance with this section within a year.

Why were the beneficial ownership registry provisions watered down so much? The answer to that question could be found in comments made by Congressman Patrick McHenry, (R. NC 10). His floor comments from December 8, 2020, as captured in the House Congressional Record, are included in Appendix A. His comments bear particular weight, as Congressman McHenry is the Ranking Member on the House Financial Services Committee.

The Impact on the Current Beneficial Ownership Rule

Congressman McHenry commented that this new reporting rule “rescinds the current beneficial ownership reporting regime set out in 31 CFR 1010.230 (b)–(j), which is costly and burdensome to small businesses.” However, it may not be as cut-and-dried as he states. The section that Rep. McHenry is referring to is 6403(d). That section provides:

Section 6403(d) REVISED DUE DILIGENCE RULEMAKING.

(1) IN GENERAL. – Not later than 1 year after the effective date of the regulations promulgated under section 5336(b)(4) of title 31, United States Code, as added by subsection (a) of this section, the Secretary of the Treasury shall revise the final rule entitled “Customer Due Diligence Requirements for Financial Institutions” (81 Fed. Reg. 29397 (May 11, 2016)) to –

(A) bring the rule into conformance with this division and the amendments made by this division;

(B) account for the access of financial institutions to beneficial ownership information filed by reporting companies under section 5336, and provided in the form and manner prescribed by the Secretary, in order to confirm the beneficial ownership information provided directly to the financial institutions to facilitate the compliance of those financial institutions with anti-money laundering, countering the financing of terrorism, and customer due diligence requirements under applicable law; and

(C) reduce any burdens on financial institutions and legal entity customers that are, in light of the enactment of this division and the amendments made by this division, unnecessary or duplicative.

(2) CONFORMANCE.

(A) IN GENERAL. – In carrying out paragraph (1), the Secretary of the Treasury shall rescind paragraphs (b) through (j) of section 1010.230 of title 31, Code of Federal Regulations upon the effective date of the revised rule promulgated under this subsection.

(B) RULE OF CONSTRUCTION. – Nothing in this section may be construed to authorize the Secretary of the Treasury to repeal the requirement that financial institutions identify and verify beneficial owners of legal entity customers under section 1010.230(a) of title 31, Code of Federal Regulations.

(3) CONSIDERATIONS. – In fulfilling the requirements under this subsection, the Secretary of the Treasury shall consider—

(A) the use of risk-based principles for requiring reports of beneficial ownership information;

(B) the degree of reliance by financial institutions on information provided by FinCEN for purposes of obtaining and updating beneficial ownership information;

(C) strategies to improve the accuracy, completeness, and timeliness of the beneficial ownership information reported to the Secretary; and

(D) any other matter that the Secretary determines is appropriate.

The result of this is that the Secretary shall rescind the current beneficial ownership rule but can replace it with a rule that is similar, if not identical to the current beneficial ownership rule. The current beneficial ownership rule provides financial institutions with more information on more legal entities sooner and requires them to use that information for not only onboarding due diligence, including customer risk rating, but ongoing due diligence (investigations of potential suspicious activity). It also gives financial institutions immediate access to existing legal entities’ beneficial ownership information where those entities open new accounts. This new beneficial ownership information registration requirement only includes the smallest legal entities, existing legal entities have two years to provide their owners’ information, and, most importantly, financial institutions have limited access to the registry as they need their customer’s approval to access the customer’s information. The differences between the existing rule and new law are recognized in subsection (B), which directs the Secretary to “account for the access of financial institutions to beneficial ownership information filed by reporting companies under section 5336 … in order to confirm the beneficial ownership information provided directly to the financial institutions to facilitate the compliance of those financial institutions with” AML, CFT, and CDD requirements.

Division H – Other Matters, Title XCVII, Subtitles A, B

  • Subtitle A – Kleptocracy Asset Recovery Rewards Act
  • Subtitle B – Combating Russian Money Laundering Act

Appendix A – Corporate Transparency Act – Congressional Comments

House Congressional Record from December 8, 2020 CREC-2020-12-08-pt1-PgH6919-3.pdf (congress.gov) at pages H6932-6933 (bold red font has been added for emphasis, and the footnote has been added from the original text):

Mr. MCHENRY. Mr. Speaker, I rise in support of the conference report to the National Defense Authorization Act for fiscal year 2021. Combating illicit finance and targeting bad actors is a nonpartisan issue. However, Congress’ actions must be thoughtful and data driven. An example of this is H.R. 2514, the COUNTER Act, which is included in this conference report. Division G is a compilation of bipartisan policies that will modernize and reform the Bank Secrecy Act and anti-money laundering regimes. These policies will strengthen the Department of Treasury’s financial intelligence, anti-money laundering, and counter terrorism programs.

I would like to thank Chairman CLEAVER and Ranking Member STIVERS for their work on this bill and the language included in Division G. In addition to Division G, the conference report contains an amendment replacing the text of H.R. 2513, the Corporate Transparency Act, with new legislation. H.R. 2513, which passed the House on October 22, 2019, and again as an amendment to H.R. 6395 on July 21, 2020, attempted to establish a new beneficial ownership information reporting regime to assist law enforcement in tracking down terrorists and other bad actors who finance terrorism and illicit activities. But, it did so to the detriment of America’s small businesses.

Beneficial ownership information is the personally identifiable information (PII) on a company’s beneficial owners. This information is currently collected and held by financial institutions prior to a company gaining access to our financial system.

However, bad actors and nation states, such as China and Russia, are becoming more proficient in using our financial system to support illicit activity. As bad actors become more sophisticated, so to must our tools to deter and catch them. One such tool is identifying the beneficial owners of shell companies, which are used as fronts to launder money and finance terrorism or other illicit activity. Beneficial ownership information assists law enforcement to better target these bad actors.

Although well-intentioned, H.R. 2513 had numerous deficiencies in its reporting regime. First, H.R. 2513 placed numerous reporting and costly reporting requirements on small businesses. It lacked protections to properly protect small businesses’ personal information stored with a little-known government office within the Department of Treasury—known as FinCEN. The bill authorized access to this sensitive information without any limitation on who could access the information and when it could be accessed. Finally, it failed to hold FinCEN accountable for its actions.

The text of H.R. 2513 is replaced with new language that I negotiated, along with Senate Banking Committee Chairman CRAPO. This substitute, which is reflected in Division F of the conference report, is a significant improvement over the House-passed bill in three key areas.

First, Division F limits the burdens on small businesses. Unlike H.R. 2513, the language included in the conference report protects our nation’s small businesses. It prevents duplicative, burdensome, and costly reporting requirements for beneficial ownership data from being imposed in two ways. It rescinds the current beneficial ownership reporting regime set out in 31 CFR 1010.230 (b)–(j), which is costly and burdensome to small businesses. Rescinding these provisions ensures that it cannot be used in a future rule to impose another duplicative, reporting regime on America’s small businesses. In addition, Division F requires the Department of Treasury to minimize the burdens the new reporting regime will have on small businesses, including eliminating any duplicative requirements.

House Republicans ensured the directive to minimize burdens on small businesses is fulfilled. Division F directs the Secretary of the Treasury to report to the House Committee on Financial Services and the Senate Committee on Banking annually for the first three years after the new rule is promulgated. The report must assess: the effectiveness of the new rule; the steps the Department of Treasury took to minimize the reporting burdens on reporting entities, including eliminating duplicative reporting requirements, and the accuracy of the new rule in targeting bad actors. The Department of Treasury is also required to identify the alternate procedures and standards that were considered and rejected in developing its new reporting regime. This report will help the Committees understand the effectiveness of the new rule in identifying and prosecuting bad actors. Moreover, it will give the Committees the data needed to understand whether the reporting threshold is sufficient or should be revised.

Second, Division F includes the strongest privacy and disclosure protections for America’s small businesses as it relates to the collection, maintenance, and disclosure of beneficial ownership information. The new protections set out in Division F ensure that small business beneficial ownership information will be protected just like an individual’s tax return information. The protections in Division F mirror or exceed the protections set out in 26 U.S.C. 6103, including:

  1. Agency Head Certification. Division F requires an agency head or designee to certify that an investigation or law enforcement, national security or intelligence activity is authorized and necessitates access to the database. Designees may only be identified through a process that mirrors the process followed by the Department of Treasury for those designations set out in 26 U.S.C. 6103.
  2. Semi-annual Certification of Protocols. Division F requires an Agency head to make a semi-annual certification to the Secretary of the Treasury that the protocols for accessing small business ownership data ensure maximum protection of this critically important information. This requirement is non-delegable.
  3. Court authorization of State, Local and Tribal law enforcement requests. Division F requires state, local and tribal law enforcement officials to obtain a court authorization from the court system in the local jurisdiction. Obtaining a court authorization is the first of two steps state, local and tribal governments must take prior to accessing the database. Separately, state, local and tribal law enforcement agencies must comply with the protocols and safeguards established by the Department of Treasury.
  4. Limited Disclosure of Beneficial Ownership Information. Division F prohibits the Secretary of Treasury from disclosing the requested beneficial ownership information to anyone other than a law enforcement or national security official who is directly engaged in the investigation.
  5. System of Records. Division F requires any requesting agency to establish and maintain a system of records to store beneficial ownership information provided directly by the Secretary of the Treasury.
  6. Penalties for Unauthorized Disclosure. Division F prohibits unauthorized disclosures. Specifically, the agreement reiterates that a violation of appropriate protocols, including unauthorized disclosure or use, is subject to criminal and civil penalties (up to five years in prison and $250,000 fine).

Third, Division F contains the necessary transparency, accountability and oversight provisions to ensure that the Department of Treasury promulgates and implements the new beneficial ownership reporting regime as intended by Congress. Specifically, Division F requires each requesting agency to establish and maintain a permanent, auditable system of records describing: each request, how the information is used, and how the beneficial ownership information is secured. It requires requesting agencies to furnish a report to the Department of Treasury describing the procedures in place to ensure the confidentiality of the beneficial ownership information provided directly by the Secretary of the Treasury.

Separately, Division F requires two additional audits. First, it directs the Secretary of Treasury to conduct an annual audit to determine whether beneficial ownership information is being collected, stored and used as intended by Congress. Separately, Division F directs the Government Accountability Office to conduct an audit for five years to ensure that the Department of Treasury and requesting agencies are using the beneficial ownership information as set out in Division F. This is the same audit that GAO conducts as it relates to the Department of Treasury’s collection, maintenance and protection of tax return information. This information will ensure that Congress has independent data on the efficacy of the reporting regime and whether confidentiality is being maintained.

Division F also requires the Department of Treasury to issue an annual report on the total number of court authorized requests received by the Secretary to access the database. The report must detail the total number of court authorized requests approved and rejected and a summary justifying the action. This report to Congress will ensure the Department of Treasury does not misuse its authority to either approve or reject court authorized requests.

Finally, Division F requires the Director of FinCEN, who is responsible for implementing this reporting regime, to testify annually for five years. This testimony is critical. For far too long FinCEN has evaded any type of congressional check on its activities. Yet, it has amassed a great deal of authority. Now, Congress will shine a light on its operations. It is my expectation that FinCEN will provide Congress with hard data on its effectiveness in targeting bad actors, including the effectiveness of this new authority to collect, maintain, and use beneficial ownership information.

One final comment about the importance of FinCEN’s annual testimony. In the months leading up to the House’s consideration of H.R. 2513 last October, I sought data from FinCEN and from the Treasury Department, along with the Department of Justice, to better understand the need for this legislation. No such data was forthcoming. Rather, FinCEN gave anecdotes of very scary stories to justify the need for a new reporting regime. It is my expectation that FinCEN will provide Congress with the necessary data to justify this new reporting regime and the burdens it is placing on legitimate companies. I will conclude by thanking Chairwoman MALONEY for her work over the last twelve years on this issue and her willingness to work with me to strengthen this bill. I believe we have a better product. I urge my colleagues to support the conference agreement.

Endnotes

[1] https://docs.house.gov/billsthisweek/20201207/CRPT-116hrpt617.pdf

[2] The NDAA has broad, bipartisan support in both the House and the Senate. If the President vetoes the bill, as he has threatened to do, Congress can override the veto with a two-thirds super-majority vote in both chambers. More than two-thirds of the members of each chamber voted in favor of that chamber’s version of the bill. The Conference Report is the agreed-upon reconciliation of the two versions.

[3] See footnote 7 for an example of this anomaly of changing the title 31 laws and regulations but not the corresponding title 12 laws and regulations.

[4] US laws are available at https://uscode.house.gov

[5] In an article I published on October 28, 2019, I referred to the sometimes conflicting nature of these titles as “the clash of the titles”. See The Current BSA/AML Regime is a Classic Fixer-Upper … and Here’s Seven Things to Fix – RegTech Consulting, LLC

[6] Regulations are available at https://www.govinfo.gov/app/collection/cfr/2020

[7] There are also two titles in Division H (“Other Matters”) that also impact financial crimes, specifically kleptocracy and Russian money laundering. Those are described below.

[8] Records and reports that have a “high degree of usefulness” were also referenced in the two parts of title 12 – 12 USC s. 1829b and 12 USC Part 21, sections 1951-1959 – that, with 31 USC sections 5311-5314, 5316-5332, make up the Bank Secrecy Act. The AML Act is changing “high degree of usefulness” to “highly useful” in title 31, but not in title 12. That may be an oversight.

[9] In addition, Congress could have, but chose not to treat the Customer Identification Program, or CIP requirements, as a new fifth (or sixth) pillar or minimum standard. Subsection 5318(i) is the “customer identification program” section. It requires financial institutions to identify and verify accountholders, and for the Secretary to implement regulations for the minimum standards in doing so. The regulations set out whether and to what extent the eleven different types of financial institutions are to implement a formal customer identification program (for banks, broker dealers, mutual funds, and futures commission merchants in 31 CFR 1020, 1023, 1024, and 1026, respectively), or to implement some form of customer verification as part of their overall AML program (for casinos, MSBs, insurance companies, loan or finance companies, and government supervised entities in 31 CFR 1021, 1022, 1025, 1029, and 1030, respectively). Two of the eleven types of financial institutions, dealers in precious metals and credit card system operators, do not have to identify or verify the identity of customers. The result is that most financial institutions must have both an AML program and a Customer Identification Program: Congress had the opportunity to consolidate these two programs into one overall program but chose not to. It was a lost opportunity to further streamline the regulatory regime.

[10] See FinCEN Files – Reforming AML Regimes Through TSV SARs (Tactical or Strategic Value Suspicious Activity Reports) – RegTech Consulting, LLC

[11] FinCEN’s Proposed AML Program Effectiveness Rule – Comments of RegTech Consulting LLC – RegTech Consulting, LLC

[12] This was an interesting timeline: a GAO study on the effectiveness of the CTR regime, the utility of CTRs, and an analysis of the effects of raising the reporting threshold must begin no later than January 1, 2025 – four years from the passage of the AML Act! – and must be reported no later than December 31, 2025.

[13] Section 6506 is the only “study and report” section that specifically provides that (in this case) the GAO can contract out the study.

Anti-Money Laundering Act of 2020 – “Pay to Play” Arrives and Perhaps We Have An Answer to the Whereabouts of Section 314(d)

The Senate Banking Committee’s top Republican (Senator Crapo from Idaho) and top Democrat (Senator Brown from Ohio) have joined forces to draft the Anti-Money Laundering Act of 2020 as an amendment to the National Defense Authorization Act. It takes some of what the House passed in HR2513, the Corporate Transparency Act, and replicates most of what the Senate has been horse-trading on with the ILLICIT CASH Act (S2563), and adds a few other provisions: 214 pages of provisions.

If enacted, it would be the biggest revision to the U.S. AML/CFT regime since the USA PATRIOT Act of 2001. The main legislation for the AML/CFT regime is found in Title 31 of the US Code. 31 USC 5311 (the purpose of the BSA) and 5318 (the program and reporting requirements) will materially change, four new sections (5333-5336) will be added, two new BSAAG subcommittees will be created, and of course a FinCEN database of beneficial ownership information will be created to house some legal entity beneficial ownership information (more on that in another article).

Anti-Money Laundering Act of 2020

The proposed AML Act of 2020 would be tacked on to the back end – Division E – of the 2021 Defense Appropriations bill. So the titles for the Act begin at title 51 – actually the Roman numeral LI. There are five titles:

  • Title LI – Strengthening Treasury Financial Intelligence, Anti-Money Laundering [AML], and Countering the Financing of Terrorism [CFT] Programs
  • Title LII – Modernizing the AML and CFT Systems
  • Title LIII – Improving AML and CFT Communication, Oversight, and Processes
  • Title LIV – Establishing Beneficial Ownership Reporting Requirements
  • Title LV – Miscellaneous

Section 5201 – Annual Reporting Requirements

This article focuses solely on section 5201 of Title LII. Why? It includes my long-sought-after SAR feedback from law enforcement, while at the same time resurrects the long-forgotten section 314(d) of the USA PATRIOT Act.

In a nutshell, section 5201 is a “pay to play” requirement imposed on law enforcement and the intelligence community. At requires the Attorney General, on behalf of federal and state prosecutors and law enforcement agencies, to deliver an annual report and, once every five years a broader long-term trending report, to the Secretary of the Treasury, setting out statistics, metrics, and other information on the use of BSA reports. The annual report must include:

  1. The frequency with which the BSA reports contains actionable information that leads to, among other things, actions by law enforcement agencies such as grand jury subpoenas, and actions by intelligence, national security, and homeland security agencies;
  2. Calculations on the time between the BSA reporting and the use of the data by law enforcement or intelligence agencies;
  3. An analysis of the transactions associations with the BSA reports, including whether the accounts were held by legal entities or persons, and any trends or patterns in cross-border activity;
  4. The number of legal entities and persons identified by the BSA reports;
  5. The extent to which arrests, indictments, convictions, etc., were related to the reports; and
  6. Data on state and federal investigations that resulted from the reports.

The five-year report would focus on longer-term trends, patterns and threats: retrospective trends and emerging patterns and threats.

And what would the Secretary of the Treasury do with these reports? That is covered by subsection (d) of section 5201, which provides that the Secretary shall use these reports

  1. To help assess the usefulness of BSA reports;
  2. “to enhance feedback and communications with financial institutions and other entities subject to the requirements under the BSA, including by providing more detail in the reports published and distributed under section 314(d) of the USA PATRIOT Act (31 USC s. 5311 note);
  3. to assist FinCEN in considering revisions to the reporting requirements promulgated under section 314(d) of the USA PATRIOT Act (31 USC s. 5311 note).

The result? This July 2020 proposed AML legislation would require the public sector consumers of BSA reports to provide feedback to the private sector producers of those reports – essentially a “pay to play” requirement, and that feedback would be through the almost 20-year old provision of the USA PATRIOT Act, section 314(d).

I’ve written about both of these things.

On July 30, 2019 I published an article titled “SAR Feedback? What Ever Happened to Section 314(d)?” See https://regtechconsulting.net/aml-regulations-and-enforcement-actions/sar-feedback-what-ever-happened-to-section-314d/ I wrote:

Wouldn’t it be great if Treasury published a report, perhaps semi-annually, that contained a detailed analysis identifying patterns of suspicious activity and other investigative insights derived from suspicious activity reports (SARs) and investigations conducted by federal, state, and local law enforcement agencies (to the extent appropriate) and distributed that report to financial institutions that filed those SARs?

To get Treasury to do that, though, would probably require Congress to pass a law compelling it to do so.

Hold it. Congress did pass that law.  Almost 18 years ago. And, by all accounts, it’s still on the books. What happened to those semi-annual reports? When did they begin? If they began, when did they end?

Section 314(d) – Its Origins

What became 314(d) was introduced in the House version of what became the USA PATRIOT Act. The House version, the Financial Anti-Terrorism Act, was introduced on October 3, 2001. It was marked up by the House Financial Services Committee on October 11. The Senate version, originally titled the Uniting and Strengthening America Act, or USA Act, was introduced on October 4th and had sections 314(a) (public to private sector information sharing), 314(b) (cooperation among financial institutions, or private-to-private sector information sharing), and 314(c) (“rule of construction”). There was no 314(d) in that early version.

On October 17th, HR 3004, the Financial Anti-Terrorism Act, was passed by the House 412-1. Title II was “public-private cooperation”. Section 203 was:

“Reports to the Financial Services Industry on Suspicious Financial Activities – at least once each calendar quarter, the Secretary shall (1) publish a report containing a detailed analysis identifying patterns of suspicious activity and other investigative insights derived from suspicious activity reports and investigations conducted by federal, state, and local law enforcement agencies to the extent appropriate; and (2) distribute such report to financial institutions as defined in section 5312 of title 31, US code.”

The Senate and House versions were reconciled, and on October 23rd the House Congressional Record shows a consideration of what was then the USA PATRIOT Act. That version of the bill then included what had been section 203 and was now 314(d). It was the same, except instead of a quarterly report it was a semi-annual report (“at least once each calendar quarter” was changed to “at least semiannually”).

SAR Activity Review – Was That The Answer to 314(d)?

The ABA has written, and at least one former FinCEN employee has stated that the “SAR Activity Review – Trends, Tips, and Issues” was the response to 314(d). The SAR Activity Reviews were excellent resources. They contained sections on SAR statistics, national trends and analysis, law enforcement cases, tips on SAR form preparation and filing, issues and guidance, and an industry forum. The first SAR Activity Review noted that it was published under the auspices of the BSAAG, was to be published semi-annually in October and April, and was “the product of a continuing collaboration among the nation’s financial institutions, federal law enforcement, and regulatory agencies to provide meaningful information about the preparation, use, and utility of SARs.”  Although that certainly sounds like it is responsive to section 314(d), there is no reference to 314(d).

And the first SAR Activity Review was published more than a year before 314(d) was passed. Even the first SAR Activity Review published after the enactment of the USA PATRIOT Act and section 314(d) – the 4th issue published on July 31, 2002 – didn’t make any reference to 314(d). Beginning with the 6th issue of the SAR Activity Review, published in October 2003, the authors broke out the statistics from the “Trends, Tips & Issues” document and published a separate, and more detailed, “SAR Activity Review – By The Numbers”. The last SAR Activity Review (the 23rd) and the last “By The Numbers” (the 18th) were published on April 30, 2013. None of those forty-one publications referenced 314(d). After the SAR Activity Reviews stopped, FinCEN continued to publish “SAR Statistics”, and did so three times from June 2014 through March 2017.  For the last few years, FinCEN has maintained SAR Stats on its website – https://www.fincen.gov/reports/sar-stats  – that is updated on a monthly basis. Those statistics are useful, but cannot be thought of as “containing a detailed analysis identifying patterns of suspicious activity and other investigative insights derived from suspicious activity reports and investigations conducted by federal, state, and local law enforcement agencies to the extent appropriate”, quoting the 314(d) language.

Does Anyone Know What Happened to 314(d)?

I don’t have the answer to that question. Perhaps 314(d) is seen as satisfied by the accumulation of advisories, guidance, bulletins, etc., published by FinCEN and other Treasury bureaus and agencies and departments from time to time. Perhaps there is a Treasury Memorandum out there that I’m not aware of that provides a simple explanation. Perhaps not: most BSA/AML experts I speak with are not even aware of 314(d), and if the SAR Activity Review did satisfy the spirit and intent of 314(d), the last one was published more than six years ago. But everyone in the private sector BSA/AML risk management space has been clamoring for more feedback from law enforcement and FinCEN on the effectiveness and usefulness of their SAR filings. Perhaps a renewed (or any) focus on 314(d) is the answer.  The revival of 314(d) could give FinCEN the mandate they’ve been looking for to provide more valuable information to the private sector producers of Suspicious Activity Reports. We would all benefit.

Public Sector is Going to Have to Pay in Order to Play With the Private Sector’s BSA Reports

On November 21, 2019 I wrote an article titled “Like Sam Loves Free Fried Chicken, Law Enforcement Loves ‘Free’ Suspicious Activity Reports … But What If Law Enforcement Had to Earn the Right to Use the Private Sector’s ‘Free’ SARs?” See https://regtechconsulting.net/fintech-financial-crimes-and-risk-management/like-sam-loves-free-fried-chicken-law-enforcement-loves-free-suspicious-activity-reports-but-what-if-law-enforcement-had-to-earn-the-right-to-use-the-private-sector/. That article provided:

Eleven year-old Sam Caruana of Buffalo, New York waited outside a Chick-fil-A restaurant in the freezing cold in order to be one of the 100 people given free fried chicken for one year (actually, one chicken sandwich a week for fifty-two weeks). In a video that went viral (Sam Caruana YouTube – Free Chicken), young Sam explained that he simply loved fried chicken, and he’d stand in the cold for free fried chicken.

Just as Sam loves free fried chicken, law enforcement loves free Suspicious Activity Reports, or SARs. In the United States, over 30,000 private sector financial institutions – from banks to credit unions, to money transmitters and check cashers, to casinos and insurance companies, to broker dealers and investment advisers – file more than 2,000,000 SARs every year. And it costs those financial institutions billions of dollars to have the programs, policies, procedures, processes, technology, and people to onboard and risk-rate customers, to monitor for and identify unusual activity, to investigate that unusual activity to determine if it is suspicious, and, if it is, to file a SAR with the Treasury Department’s Financial Crimes Enforcement Network, or FinCEN. From there, hundreds of law enforcement agencies across the country, at every level of government, can access those SARs and use them in their investigations into possible tax, criminal, or other investigations or proceedings. To law enforcement, those SARs are, essentially, free. And like Sam loves free fried chicken, law enforcement loves free SARs. Who wouldn’t?

But should those private sector SARs, that cost billions of dollars to produce, be “free” to public sector law enforcement agencies? Put another way, should the public sector law enforcement agency consumers of SARs need to provide something in return to the private sector producers of SARs?

I say they should. And here’s what I propose: that in return for the privilege of accessing and using private sector SARs, law enforcement shouldn’t have to pay for that privilege with money, but with effort. The public sector consumers of SARs should let the private sector producers know which of those SARs provide tactical or strategic value.

A recent Mid-Size Bank Coalition of America (MBCA) survey found the average MBCA bank had: 9,648,000 transactions/month being monitored, resulting in 3,908 alerts/month (0.04% of transactions alerted), resulting in 348 cases being opened (8.9% of alerts became a case), resulting in 108 SARs being filed (31% of cases or 2.8% of alerts). Note that the survey didn’t ask whether any of those SARs were of interest or useful to law enforcement. Some of the mega banks indicate that law enforcement shows interest in (through requests for supporting documentation or grand jury subpoenas) 6% – 8% of SARs.

I argue that the Alert/SAR and even Case/SAR ratios are all of interest, but tracking to SARs filed is a little bit like a car manufacturer tracking how many cars it builds but not how many cars it sells, or how well those cars perform, how long they last, and how popular they are. And just like the automobile industry measuring how many cars are purchased, the better measure for AML programs is “SARs purchased”, or SARs that provide value to law enforcement.

Also, there is much being written about how machine learning and artificial intelligence will transform anti-money laundering programs. Indeed, ML and AI proponents are convinced – and spend a lot of time trying to convince others – that they will disrupt and revolutionize the current “broken” AML regime. Among other targets within this broken regime is AML alert generation and disposition and reducing the false positive rate. The result, if we believe the ML/AI community, is a massive reduction in the number of AML analysts that are churning through the hundreds and thousands of alerts, looking for the very few that are “true positives” worthy of being labelled “suspicious” and reported to the government. But the fundamental problem that every one of those ML/AI systems has is that they are using the wrong data to train their algorithms and “teach” their machines: they are looking at the SARs that are filed, not the SARs that have tactical or strategic value to law enforcement.

Tactical or Strategic Value Suspicious Activity Reports – TSV SARs

The best measure of an effective and efficient financial crimes program is how well it is providing timely, effective intelligence to law enforcement. And the best measure of that is whether the SARs that are being filed are providing tactical or strategic value to law enforcement. How do you determine whether a SAR provides value to law enforcement? One way would be to ask law enforcement, and hope you get an answer. That could prove to be difficult.  Can you somehow measure law enforcement interest in a SAR?  Many banks do that by tracking grand jury subpoenas received to prior SAR suspects, law enforcement requests for supporting documentation, and other formal and informal requests for SARs and SAR-related information. As I write above, an Alert-to-SAR rate may not be a good measure of whether an alert is, in fact, “positive”. What may be relevant is an Alert-to-TSV SAR rate.

A TSV SAR is one that has either tactical value – it was used in a particular case – or strategic value – it contributed to understanding a typology or trend. And some SARs can have both tactical and strategic value. That value is determined by law enforcement indicating, within seven years of the filing of the SAR (more on that later), that the SAR provided tactical (it led to or supported a particular case) or strategic (it contributed to or confirmed a typology) value.  That law enforcement response or feedback is provided to FinCEN through the same BSA Database interfaces that exist today – obviously, some coding and training will need to be done (for how FinCEN does it, see below). If the filing financial institution does not receive a TSV SAR response or feedback from law enforcement or FinCEN within seven years of filing a SAR, it can conclude that the SAR had no tactical or strategic value to law enforcement or FinCEN, and may factor that into decisions whether to change or maintain the underlying alerting methodology. Over time, the financial institution could eliminate those alerts that were not providing timely, actionable intelligence to law enforcement. And when FinCEN shares that information across the industry, others could also reduce their false positive rates.

FinCEN’s TSV SAR Feedback Loop

FinCEN is working to provide more feedback to the private sector producers of BSA reports. As FinCEN Director Ken Blanco recently stated:[1]

“Earlier this year, FinCEN began the BSA Value Project, a study and analysis of the value of the BSA information we receive. We are working to provide comprehensive and quantitative understanding of the broad value of BSA reporting and other BSA information in order to make it more effective and its collection more efficient. We already know that BSA data plays a critical role in keeping our country strong, our financial system secure, and our families safe from harm — that is clear. But FinCEN is using the BSA Value Project to improve how we communicate the way BSA information is valued and used, and to develop metrics to track and measure the value of its use on an ongoing basis.”

FinCEN receives every SAR. Indeed, FinCEN receives a number of different BSA-related reporting: SARs, CTRs, CMIRs, and Form 8300s. It’s a daunting amount of information. As FinCEN Director Ken Blanco noted in the same speech:

FinCEN’s BSA database includes nearly 300 million records — 55,000 new documents are added each day. The reporting contributes critical information that is routinely analyzed, resulting in the identification of suspected criminal and terrorist activity and the initiation of investigations.

“FinCEN grants more than 12,000 agents, analysts, and investigative personnel from over 350 unique federal, state, and local agencies across the United States with direct access to this critical reporting by financial institutions. There are approximately 30,000 searches of the BSA data taking place each day. Further, there are more than 100 Suspicious Activity Report (SAR) review teams and financial crimes task forces across the country, which bring together prosecutors and investigators from different agencies to review BSA reports. Collectively, these teams reviewed approximately 60% of all SARs filed.

Each day, law enforcement, FinCEN, regulators, and others are querying this data:  7.4 million queries per year on average. Those queries identify an average of 18.2 million filings that are responsive or useful to ongoing investigations, examinations, victim identification, analysis and network development, sanctions development, and U.S. national security activities, among many, many other uses that protect our nation from harm, help deter crime, and save lives.”

This doesn’t tell us how many of those 55,000 daily reports are SARs, but we do know that in 2018 there were 2,171,173 SARs filed, or about 8,700 every (business) day. And it appears that FinCEN knows which law enforcement agencies access which SARs, and when. And we now know that there are “18.2 million filings that are responsive or useful to ongoing investigations, examinations, victim identification, analysis and network development, sanctions development, and U.S. national security activities” every year. But which filings?

The law enforcement agencies know which SARs provide tactical or strategic value, or both. So if law enforcement finds value in a SAR, it should acknowledge that, and provide that information back to FinCEN. FinCEN, in turn, could provide an annual report to every financial institution that filed, say, more than 250 SARs a year (that’s one every business day, and is more than three times the number filed by the average bank or credit union). That report would be a simple relational database indicating which SARs had either or both tactical or strategic value. SAR filers would then be able to use that information to actually train or tune their monitoring and surveillance systems, and even eliminate those alerting systems that weren’t providing any value to law enforcement.

Why give law enforcement seven years to respond? Criminal cases take years to develop. And sometimes a case may not even be opened for years, and a SAR filing may trigger an investigation. And sometimes a case is developed and the law enforcement agency searches the SAR database and finds SARs that were filed five, six, seven or more years earlier. Between record retention rules and practical value, seven years seems reasonable.

Law enforcement agencies have tremendous responsibilities and obligations, and their resources and budgets are stretched to the breaking point. Adding another obligation – to provide feedback to the banks, credit unions, and other private sector institutions that provide them with reports of suspicious activity – may not be feasible. But the upside of that feedback – that law enforcement may get fewer, but better, reports, and the private sector institutions can focus more on human trafficking, human smuggling, and terrorist financing and less on identifying and reporting activity that isn’t of interest to law enforcement – may far exceed the downside.

Free Suspicious Activity Reports are great. But like Sam being prepared to stand in the freezing cold for his fried chicken, perhaps law enforcement is prepared to let us know whether the reports we’re filing have value.

Conclusion

As of this writing – July 3, 2020 – it remains to be seen whether the Anti-Money Laundering Act of 2020 will become law, or what parts of the Act will become law. But section 5201, which requires the public sector consumers of the BSA reports produced by the private sector to provide feedback to the private sector on the usefulness of those reports. This is a critically important, long-awaited development in the US AML/CFT regime.

For more on alert-to-SAR rates, the TSV feedback loop, machine learning and artificial intelligence, see other articles I’ve written:

The TSV SAR Feedback Loop – June 4 2019

AML and Machine Learning – December 14 2018

Rules Based Monitoring – December 20 2018

FinCEN FY2020 Report – June 4 2019

FinCEN BSA Value Project – August 19 2019

BSA Regime – A Classic Fixer-Upper – October 29 2019

[1] November 15, 2019, prepared remarks for the Chainalysis Blockchain Symposium, available at https://www.fincen.gov/news/speeches/prepared-remarks-fincen-director-kenneth-blanco-chainalysis-blockchain-symposium

5 + 4 = 6 … Treasury’s New PPP Math Is Creating Unnecessary Confusion, & Here’s a Proposed Solution

I’ve written two articles on the CARES Act’s Paycheck Protection Program (PPP) – the $350 billion, or $350,000,000,000, pot of federal money available for the lucky few hundred thousand or so of the roughly thirty million American small businesses that can navigate the labyrinth of regulatory requirements to apply for and be approved to get a loan that is intended to cover their payroll for 8 weeks or so. See The CARES Act and the PPP – We Know A Surge of Fraud is Coming

On April 13th the Treasury Department issued some guidance intended to clarify how the PPP lenders – mostly banks and credit unions – can satisfy some of their regulatory requirements around identifying the beneficial owners of the small businesses they’ll be lending to. In some of the more creative math I’ve seen in a while, they were somehow able to take the 5 things required under one set of regulations, combine them with the 4 things required under another set of regulations, and come up with 6 things. Instead of speeding up the delivery of the much-needed assistance to small businesses across America, their math may have the opposite effect.

Title 15 Small Business Administration (SBA) requirements

On April 2nd the SBA rolled out its requirements. Among other things, the two-page Borrower Form requires the “authorized representative” of the small business to certify a number of things, notably (for purposes of this labyrinth) five pieces of information – name, SSN/TIN, Address, Title, and Ownership Percentage – of up to five people that own 20 percent or more of the small business. And, according to the Interim Final Rule published on April 2nd, the lender (bank or credit union) can rely on that certification. And the authorized representative has to provide their name, title, and a signature.

So to summarize – for Title 15 SBA purposes, the borrower’s authorized representative needs to certify five pieces of information on as many as five legal owners of the borrower, and the bank lender can rely on that certification.

Title 31 Bank Secrecy Act (BSA) requirements

In May 2018 the federal anti-money laundering regulations were changed to add a requirement that financial institutions collect and verify “beneficial ownership” information of legal entity customers. Beneficial ownership was made up of what is called the “ownership prong” – a natural person owning twenty-five percent or more of the legal entity – and the “control prong” – one person who controlled the legal entity. The regulation also provided a Beneficial Ownership Certification form. The result was that the person opening the account had to certify a number of things, notably (for purposes of this labyrinth) four pieces of information – name, SSN/TIN, address, and Date of Birth (DOB) – of up to five people: up to four that own twenty-five percent or more of the legal entity and the single “control” person. According to the regulation, the bank can rely on that certification ““provided that it has no knowledge of facts that would reasonably call into question the reliability of such information.” And the account opener has to provide their name, title, and a signature. And the bank is required to verify that beneficial ownership information: not that the persons are the beneficial owners, because that can’t reasonably be done, but that the persons are … persons. And that verification needs to be done within a reasonable time after the account is opened.

And there are some complications in the BSA rule around existing customers opening new accounts, and whether the bank can rely on existing beneficial ownership information or not. Essentially, a bank needs to document whether and when and how it will it can rely on existing information, and that documentation is part of what is known as its “risk-based BSA compliance program”.

So to summarize – for Title 31 BSA purposes, the legal entity’s account opener needs to certify four pieces of information on as many as four legal owners and one control person, and the bank can rely on that certification unless it knows of something that calls into question the reliability of the information, and the bank needs to verify that the persons are, in fact, persons.

Title 31 BSA requirements for Title 15 SBA PPP Loans

On April 13 Treasury and the SBA revised previously published FAQs to add a question and answer relating to how the Title 31 BSA requirements relating to collection (and verification) of beneficial ownership information would be applied to the Title 15 SBA PPP loans. And FinCEN issued, for the first time, the same question and answer. These are summarized below:

Treasury FAQ:  Does the information lenders are required to collect from PPP applicants regarding every owner who has a 20% or greater ownership stake in the applicant business (i.e., owner name, title, ownership %, TIN, and address) satisfy a lender’s obligation to collect beneficial ownership information (which has a 25% ownership threshold) under the BSA?

Existing customers:  if the PPP loan is being made to an existing customer and the lender previously verified the necessary information, the lender does not need to re-verify the information.  Furthermore, if federally insured banks and credit unions have not yet collected such beneficial ownership information on existing customers, such institutions do not need to collect and verify beneficial ownership information for those customers applying for new PPP loans, unless otherwise indicated by the lender’s risk-based approach to BSA compliance.

New customers: the lender’s collection of SIX THINGS – owner name, title, ownership %, TIN, address, and date of birth – from as many as 5 natural persons with a 20% or greater ownership stake in the applicant business will be deemed to satisfy applicable BSA requirements and FinCEN regulations governing the collection of beneficial ownership information. Decisions regarding further verification of beneficial ownership information collected from new customers should be made pursuant to the lender’s risk-based approach to BSA compliance.

Leaving aside (for the moment) the vexing issue of what a bank’s risk-based BSA compliance program requires it to do for existing high risk customers applying for PPP loans, the most elaborate labyrinth the government has created is for new customers. For these new-to-the-lender customers, there appears to be a trade-off. Purely for SBA purposes, PPP lenders need to collect but perhaps not verify SIX things – the name, TIN, DOB, address, title, and ownership percentage – one of which (DOB) isn’t on the PPP Form, for up to 5 natural persons as legal owners. The April 13th guidance doesn’t say anything about the BSA “control” person – nor does it say whether the SBA Authorized Representative can be that control person. And because a lender’s risk-based BSA compliance program requires it to verify beneficial owners, the PPP lender still needs to verify that the Beneficial Owners are, in fact, human beings … not that they are, in fact, the Beneficial Owners of the Applicant Borrower. Also, for both the BSA’s “person opening the account” and the SBA’s “Authorized Representative”, the financial institution must collect the person’s name, title, and signature.

A Possible Solution to Treasury’s Math Problem

The likelihood of rampant money laundering through PPP loans is pretty slim. The likelihood of fraud, though, is 100%. How much fraud is dependent on a lot of factors, but banks are adept at lending money and keeping fraud rates down. In normal times. These are not normal times. But everyone involved in this effort wants to get the $350,000,000,000 into the hands of deserving American small businesses as soon as possible, knowing that there will be some abuses, frauds, mistakes, corruption, laziness, willful blindness, etc., etc. in the process.

But making the lenders collect six pieces of information on the owners of small businesses when neither of the applicable regulatory regimes require them to collect more than five seems to add a layer of unnecessary complexity and can only slow down the lending process.

Having to collect 5 pieces of information (but not DOB) from as many as five legal owners for SBA purposes, and to collect four pieces of information (including DOB) from as many as four legal owners AND one control person for BSA purposes, and now to have to collect SIX pieces of information (including DOB) from five persons for SBA/BSA purposes creates confusion. Treasury needs to take its own risk-based approach: satisfy SBA requirements today, BSA requirements before you forgive the loan.

So here’s my suggestion to Treasury (and the regulatory agencies): PPP lenders can rely on the certifications in the Form 2483 PPP Borrower form. Those lenders can satisfy their BSA-related beneficial ownership requirements by the earlier of (i) September 30, 2020, or (ii) before the PPP loan is forgiven. In other words, focus on the PPP borrowers and requirements today, and worry about the BSA requirements later this summer. Full stop.

The CARES Act and the Paycheck Protection Program – We Know A Surge of Fraud is Coming, Let’s Prevent it Now

SBA’s disaster loan programs suffer increased vulnerability to fraud and unnecessary losses when loan transactions are expedited to provide quick relief and sufficient controls are not in place. The expected increase in loan volume and amounts, and expedited processing timeframes will place additional stress on existing controls. – SBA Inspector General White Paper, “Risk Awareness and Lessons Learned from Audits and Inspections of Economic Injury Disaster Loans and Other Disaster Lending”. April 3, 2020

This article has been updated from its original publication date of April 6, 2020.

The Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was signed into law by the President on March 27, 2020. It is a stunning piece of legislation meant to support our first responders and medical personnel treating those that are stricken, and to provide emergency economic relief to individuals, small businesses, and even large corporations that have been so adversely impacted by the pandemic.

The ink was barely dry on the CARES Act (enacted March 27th), which created the $349 billion Small Business Administration’s Paycheck Protection Program loan program, when the Interim Final Rules were published on various government websites (April 3rd, with publication in the Federal Register scheduled for April 15th). Those PPP loans will be doled out by qualified lenders to qualified Applicants, in increments of up to $10 million per Applicant based on the Applicant’s monthly payroll (essentially 2.5 times the monthly payroll, with some exceptions and limitations), with a limit of one PPP loan per Applicant. Those loans will bear interest at 1% per year, with interest and principle payments deferred for six months and – here’s the best part – the Government will forgive “qualifying” loans.

As soon as the program launched, two things happened. First, thousands of new lenders applied to be PPP lenders – from a pre-PPP of about 1,800 qualified lenders to over 4,000 qualified lenders in a matter of days. Second, many of the qualified lenders were inundated with applications. One of the lenders, Wells Fargo, publicly stated that it had max’ed out its funding capacity ($10 billion) to lend under this new PPP loan program: Wells Fargo was only able to extend its participation after the Federal Reserve relaxed some terms of an asset cap order it had imposed back in February 2020. Bank of America reported that it received 177,000 applications in the first two days seeking $32.6 billion in PPP loans. One week into the program, the SBA apparently had “approved” (more on that later) over 660,000 applications from 4,300 qualified lenders for loans of more than $168 billion. And yet the rules are not yet fully understood, and new guidance is coming out daily.

In 2006 I wrote about the dilemma facing BSA/AML programs:

We’ll be judged tomorrow on what we’re doing today, under standards and expectations that haven’t yet been set, based on best practices that haven’t been shared.

This lament has never been more applicable than it is today with these SBA PPP loans and the BSA obligations that follow.

As I read the Interim Final Rules – the 13 CFR Part 120 IFRs around eligibility generally as well as the 13 CFR Part 121 IFRs around affiliates and the common management standard – it LOOKS like lenders can rely on the documents submitted and certifications given by the borrower and its authorized representative in order to determine eligibility of the borrower, use of the loan proceeds, loan amount, and eligibility for forgiveness … but lenders “must comply with the applicable lender obligations set forth in this interim final rule”.

Here is some of the guidance set out in the Interim Final Rule:

At page 5: “SBA will allow lenders to rely on certifications of the borrower in order to determine eligibility of the borrower and use of loan proceeds and to rely on specified documents provided by the borrower to determine qualifying loan amount and eligibility for loan forgiveness. Lenders must comply with the applicable lender obligations set forth in this interim final rule, but will be held harmless for borrowers’ failure to comply with program criteria; remedies for borrower violations or fraud are separately addressed in this interim final rule.”

That is positive. The Interim Final Rule then poses a question, “What do lenders need to know and do?” then answers it in three sections, each posing a question:

a. Who is eligible to make PPP loans?

b. What do lenders have to do in terms of loan underwriting?

c. Can lenders rely on borrower’s documentation for loan forgiveness?

In response to the second question – what do lender have to do in terms of loan underwriting – the SBA provides the following answer (at pages 21-23 of the Interim Final Rule):

“Each lender shall:

i. Confirm receipt of borrower certifications contained in Paycheck Protection Program Application form issued by the Administration;

ii. Confirm receipt of information demonstrating that a borrower had employees for whom the borrower paid salaries and payroll taxes on or around February 15, 2020;

iii. Confirm the dollar amount of average monthly payroll costs for the preceding calendar year by reviewing the payroll documentation submitted with the borrower’s application; and

iv. Follow applicable BSA requirements:

I. Federally insured depository institutions and federally insured credit unions should continue to follow their existing BSA protocols when making PPP loans to either new or existing customers who are eligible borrowers under the PPP. PPP loans for existing customers will not require reverification under applicable BSA requirements, unless otherwise indicated by the institution’s risk-based approach to BSA compliance.

II. Entities that are not presently subject to the requirements of the BSA, should, prior to engaging in PPP lending activities, including making PPP loans to either new or existing customers who are eligible borrowers under the PPP, establish an anti-money laundering (AML) compliance program equivalent to that of a comparable federally regulated institution. Depending upon the comparable federally regulated institution, such a program may include a customer identification program (CIP), which includes identifying and verifying their PPP borrowers’ identities (including e.g., date of birth, address, and taxpayer identification number), and, if that PPP borrower is a company, following any applicable beneficial ownership information collection requirements. Alternatively, if available, entities may rely on the CIP of a federally insured depository institution or federally insured credit union with an established CIP as part of its AML program. In either instance, entities should also understand the nature and purpose of their PPP customer relationships to develop customer risk profiles. Such entities will also generally have to identify and report certain suspicious activity to the U.S. Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN). If such entities have questions with regard to meeting these requirements, they should contact the FinCEN Regulatory Support Section at FRC@fincen.gov. In addition, FinCEN has created a COVID-19-specific contact channel, via a specific drop-down category, for entities to communicate to FinCEN COVID-19-related concerns while adhering to their BSA obligations. Entities that wish to communicate such COVID-19-related concerns to FinCEN should go to www.FinCEN.gov, click on “Need Assistance,” and select “COVID19” in the subject drop-down list.

Each lender’s underwriting obligation under the PPP is limited to the items above and reviewing the “Paycheck Protection Application Form.” Borrowers must submit such documentation as is necessary to establish eligibility such as payroll processor records, payroll tax filings, or Form 1099-MISC, or income and expenses from a sole proprietorship. For borrowers that do not have any such documentation, the borrower must provide other supporting documentation, such as bank records, sufficient to demonstrate the qualifying payroll amount.

So it looks like the obligations include some detailed BSA-related customer due diligence requirements, citing an April 3rd FinCEN press release on risk-based approaches to BSA.

The new (as of April 2nd) Form 2483 PPP Borrower Application has a lot of detail on 20% or more owners as well as whether entities are “Affiliates” based on the Common Management Standard … so can lenders rely on the borrowers’ certifications contained in these forms absolutely, no matter how patently false or incomplete? Probably not. There must be an implied level of due diligence, as there is with beneficial ownership information.

So it looks like risk-based BSA/AML customer due diligence will trump otherwise willfully blind reliance on patently false certifications, and when the PPP lending storm is over and the tide is out two years from now, the SBA will be holding lenders to account for fraudulent applications, dubious certifications, and sloppy underwriting.

The opportunities for PPP-related fraud are off-the-charts.

Every fraudster on the planet knows that the US Government just created a $350 billion pot of money that needs to be lent out in the next 90 days based on eligibility determined by the “certifications” the borrowers will submit. Even if deliberate fraud (fraudulent or fake borrowers created by professional fraudsters) and opportunity fraud (legitimate small businesses that deliberately “fudge” a few facts in order to qualify for a loan or even inadvertently misstate a few facts) amounts to only 1% of this pot of money, that is $3.5 billion, or enough to pay the promised $1,200 to 3 million Americans.[1]

Even if banks can process hundreds of thousands of PPP loans, can the SBA approve them?

This is a trick question, written to make a point. And that point is that it doesn’t look like the SBA will be “approving” these PPP loans like they did (and continue to do) for “regular” 7(a) loans. In 2019 the Small Business Administration approved a total of just under 59,000 loans totaling about $30 billion. In 2020, through March 20th, the SBA approved 24,745 loans for ~$12.5 billion. According to the SBA’s last congressional report (Fiscal 2021 Congressional Justification & Fiscal 2019 Performance Report), it noted that “The time to process a 7(a) non-delegated loan greater than $350,000 decreased from 15 days to 9 days (40 percent efficiency gain) [from FY 2017] and for loans under $350,000, from 6 to 2 days (67 percent efficiency gain).” So in fiscal 2019, the SBA approved about 46,100 7(a) loans totaling $23.2 billion. Each of those took between 2 and 9 days.

There will be hundreds of thousands of SBA PPP loans written in the next 90 days for as much as $349 billion – over 660,000 loans in the first week for almost $170 billion. But the SBA isn’t approving these; it is simply acknowledging that it received the necessary borrower and lender forms and sending the lender back a Loan Number. With that, the lender then processes, underwrites, and disburses the loan proceeds.

SBA’s E-Tran System Has Been Glitchy … and according to the SBA’s most recent report to Congress, it had 4,191 employees in 2019 but only 3,274 in 2020.

The SBA’s E-Tran system is its electronic loan processing system that allows approved lenders to submit loan information and documentation. Lenders upload the information and documentation and provide a certification (more on that later) and the SBA returns a loan number. With that, the lender has the delegated authority to fund the loan.

And my guess is that the first PPP loans to go to the SBA will be from existing (experienced) lenders lending to their current (experienced) borrowers … to be followed by experienced lenders lending to new (inexperienced) borrowers … to be followed by those new (inexperienced) lenders the SBA is currently approving who will likely lend to new (inexperienced) borrowers. Inexperience + Inexperience = Opportunities for Fraud. So expect the fraudsters to migrate to the inexperienced borrowers.

What will the bank lenders need to do to meet their BSA obligations?

It’s too early to know. The SBA requirements for beneficial owners seem to require 20% or more legal ownership (so up to five persons with legal ownership) and a stunningly complex “control” disclosure requirement set out in 13 CFR Part 121. But, it looks like the SBA is going to allow lenders to rely on the certifications of their borrowers. For SBA purposes. Those lenders still must comply with their BSA requirements.

So the SBA lenders will have information on up to five owners and, perhaps, on some affiliated persons under the SBA’s “common management standard”. The BSA requirements for beneficial owners seem simple in comparison: 25% or more legal ownership (so up to four persons with legal ownership) and a simple “control prong” of one person set out in 31 CFR Part X.

And where SBA expectations or guidance is still to be provided, BSA regulatory expectations have been set with FinCEN’s Ruling (in FIN-2018-R004). That Ruling carves out an exemption from the beneficial ownership rule so that banks – in this case lenders – do not need to re-verify beneficial ownership information for extensions of loans that do not require underwriting review and approval. Based on that Ruling, the exemption does not appear to apply to these PPP loans, as they are, by definition, underwritten. So even though FinCEN’s unofficial press release from April 2nd – it wasn’t formal Guidance or a Ruling – says that PPP loans for existing customers will not require re-verification under applicable BSA requirements, that is qualified by “unless otherwise indicated by the institution’s risk-based approach to BSA compliance.” That risk-based approach should have followed the FIN-2008-R004 Ruling that exempted renewals of loans that didn’t require underwriting.

So where does that leave us? Nobody knows. As Yogi Berra once said,

It’s tough to make predictions, especially about the future.

Three things I will predict with certainty, though. First, we will get new guidance, advisories, press releases, and rulings to come from the SBA and from multiple agencies that oversee the BSA, probably on a daily basis (as I was writing this, the Federal Reserve issued a press release that it will establish a facility to facilitate lending to small businesses via the Small Business Administration’s Paycheck Protection Program (PPP) by providing term financing backed by PPP loans). Second, fraudsters are going to exploit the Paycheck Protection Program. And third, we’ll manage through this and come out stronger and better for it.

Back in January and early February, we failed to recognize that the then-nascent COVID-19 epidemic raging through Asia would, by mid-February, become a full-blown pandemic that would ravage the planet. Comparing the inevitable fraud that will emerge from the Paycheck Protection Program to the coronavirus pandemic is ridiculous, but we can learn from our pandemic planning and take the steps now to prevent, detect, and mitigate the fraud that will accompany the PPP.

Late Tuesday evening, April 6, the Treasury Department published FAQs on the PPP program. Treasury PPP FAQs April 6, 2020. The 18th and last Q/A was the following:

18. Question: Are PPP loans for existing customers considered new accounts for FinCEN Rule CDD purposes? Are lenders required to collect, certify, or verify beneficial ownership information in accordance with the rule requirements for existing customers?

Answer: If the PPP loan is being made to an existing customer and the necessary information was previously verified, you do not need to re-verify the information. Furthermore, if federally insured depository institutions and federally insured credit unions eligible to participate in the PPP program have not yet collected beneficial ownership information on  existing customers, such institutions do not need to collect and verify beneficial ownership information for those customers applying for new PPP loans, unless otherwise indicated by the lender’s risk-based approach to BSA compliance.

Parsing this answer out, Treasury is giving guidance only on PPP loans for existing customers: existing customers with verified beneficial ownership information, and existing customers without verified beneficial ownership information … unless otherwise indicated by the lender’s BSA policies and procedures. There is nothing about PPP loans for new customers.

What has FinCEN said about the PPP loans? In an April 3rd press release  FinCEN wrote:

Compliance with BSA Obligations – Compliance with the Bank Secrecy Act (BSA) remains crucial to protecting our national security by combating money laundering and related crimes, including terrorism and its financing.  FinCEN expects financial institutions to continue following a risk-based approach, and to diligently adhere to their BSA obligations.  FinCEN also appreciates that financial institutions are taking actions to protect employees, their families, and others in response to the COVID-19 pandemic, which has created challenges in meeting certain BSA obligations, including the timing requirements for certain BSA report filings.  FinCEN will continue outreach to regulatory partners and financial institutions to ensure risk-based compliance with the BSA, and FinCEN will issue additional new information as appropriate.

Beneficial Ownership Information Collection Requirements for Existing Customers – One of the primary components of the CARES Act is the Paycheck Protection Program (PPP).  For eligible federally insured depository institutions and federally insured credit unions, PPP loans for existing customers will not require re-verification under applicable BSA requirements, unless otherwise indicated by the institution’s risk-based approach to BSA compliance.

For non-PPP loans, FinCEN reminds financial institutions of FinCEN’s September 7, 2018 ruling (FIN-2018-R004) offering certain exceptive relief to beneficial ownership requirements.  To the extent that renewal, modification, restructuring, or extension for existing legal entity customers falls outside of the scope of that ruling, FinCEN recognizes that a risk-based approach taken by financial institutions may result in reasonable delays in compliance.

FinCEN will continue to assess reasonable risk-based approaches to BSA obligations and will issue further information, as appropriate, particularly as the CARES Act is implemented.

April 13 FAQs Provide More Guidance

The 25th and last question in the April 13 FAQs provides some clearer guidance on the beneficial ownership issue:

25. Question: Does the information lenders are required to collect from PPP applicants regarding every owner who has a 20% or greater ownership stake in the applicant business (i.e., owner name, title, ownership %, TIN, and address) satisfy a lender’s obligation to collect beneficial ownership information (which has a 25% ownership threshold) under the Bank Secrecy Act?

Answer: For lenders with existing customers: With respect to collecting beneficial ownership information for owners holding a 20% or greater ownership interest, if the PPP loan is being made to an existing customer and the lender previously verified the necessary information, the lender does not need to re-verify the information. Furthermore, if federally insured depository institutions and federally insured credit unions eligible to participate in the PPP program have not yet collected such beneficial ownership information on existing customers, such institutions do not need to collect and verify beneficial ownership information for those customers applying for new PPP loans, unless otherwise indicated by the lender’s risk-based approach to Bank Secrecy Act (BSA) compliance.

For lenders with new customers: For new customers, the lender’s collection of the following information from all natural persons with a 20% or greater ownership stake in the applicant business will be deemed to satisfy applicable BSA requirements and FinCEN regulations governing the collection of beneficial ownership information: owner name, title, ownership %, TIN, address, and date of birth. If any ownership interest of 20% or greater in the applicant business belongs to a business or other legal entity, lenders will need to collect appropriate beneficial ownership information for that entity. If you have questions about requirements related to beneficial ownership, go to FinCEN Resources Link . Decisions regarding further verification of beneficial ownership information collected from new customers should be made pursuant to the lender’s risk-based approach to BSA compliance.

So where does that leave us?

According to the SBA’s March 20th weekly update, roughly 13% of the 21,106 7(a) loans it has approved in 2020 are categorized as “change of ownership”. So beneficial ownership is a dynamic attribute that needs to be managed. Below are my thoughts on where we are at 8:20 a.m. PST on April 7, 2020:

  1. Compliance with the Bank Secrecy Act (BSA) remains crucial. FinCEN expects financial institutions to diligently adhere to their BSA obligations. Not to adhere to BSA obligations, to diligently adhere.
  2. PPP loans for existing customers will not require re-verification (if you’ve already verified them) or verification (if you haven’t previously verified beneficial ownership), unless otherwise indicated by your risk-based approach to BSA compliance. So for your higher- and high-risk customers applying for PPP loans, whether previously verified or not, re-verify beneficial ownership. Be diligent about those “cash intensive” businesses that you likely have characterized as higher- or high-risk.
  3. As to new customers, there appears to be a trade-off of sorts. For Title 31 BSA purposes, non-PPP lenders need to collect and verify the name, TIN, address, and DOB of up to four legal owners and one control person. For Title 13 SBA purposes, PPP lenders need to collect but perhaps not verify the name, TIN, address, DOB, title, and ownership percentage of up to four legal owners. The April 13th guidance doesn’t say anything about the BSA control person and whether the SBA Authorized Representative would or could be that control person.
  4. In answering the question “can lenders rely on borrower’s documentation for loan forgiveness?” the Interim Final Rule – again, published by the SBA and Treasury – provides, “Yes. The lender does not need to conduct any verification … the Administrator [of the SBA] will hold harmless any lender that relies on such borrower’s documents and attestation … section 1106(h) [of the CARES Act] prohibits the Administrator from taking any enforcement action …”. So in two places the rule provides that the SBA Administrator will not and cannot take any action against a lender. That is pretty specific. It doesn’t provide that the Federal Government will not and cannot take any action against a lender … does that mean that the lender’s functional regulator (e.g., the OCC) can bring a “safety and soundness” action against a sloppy PPP lender under Title 12? Can FinCEN bring a Title 31 action? Can the Department of Justice bring a Title 18 action? The answer to those three questions is “probably, maybe, perhaps.”

My advice? As FinCEN reminded us, compliance with the BSA remains crucial. Be diligent and confirm – in writing – whatever you decide to do in your policies and procedures and with your regulators. Remember, you will be judged tomorrow on what you’re doing today, under standards and expectations that haven’t yet been set, based on best practices that haven’t been shared.

[1] This paper deals only with the PPP. There are other COVID-19 related disaster loan programs, such as the emergency Economic Injury Disaster Loan (EIDL) program. The SBA Inspector General issued a White Paper on April 3, 2020 titled “Risk Awareness and Lessons Learned from Audits and Inspections of Economic Injury Disaster Loans and Other Disaster Lending”. In that paper, the IG noted that “SBA’s disaster loan programs suffer increased vulnerability to fraud and unnecessary losses when loan transactions are expedited to provide quick relief and sufficient controls are not in place. The expected increase in loan volume and amounts, and expedited processing timeframes will place additional stress on existing controls.” See https://www.sba.gov/sites/default/files/2020-04/SBA_OIG_WhitePaper_20-12_508_0.pdf

Lack of Beneficial Ownership Information: a “Glaring Hole in our System” Says Treasury Secretary

On February 12, 2020, Treasury Secretary Mnuchin testified before the Senate Finance Committee on the President’s Fiscal Year 2021 budget. At the 75:22 mark of the hearing, Senator Mark Warner (D. VA) began a series of statements and questions about the lack of beneficial ownership information. Senator Warner observed that the just-submitted (February 6th) 2020 National Strategy for Combating Terrorist and Other Illicit Financing – National Strategy  – indicated that the number one vulnerability facing the U.S. efforts to combat terrorism, money laundering, and proliferation financing was the lack of beneficial ownership requirements at the time of company formation.

Senator Warren noted that “one of the key vulnerabilities identified in the report is the lack of a legally binding requirement to collect beneficial ownership at the time of company formation.” At the 76:50 mark, the Senator posed the following question:

Mr. Secretary, do you agree that one of our most urgent national security and regulatory problems is that the US Government still has no idea who really controls shell companies?

At the 77:25 mark Secretary Mnuchin replied:

“This is a glaring hole in our own system.”

What did the National Strategy have to say about lack of beneficial ownership information?

2020 National Strategy for Combating Terrorist and Other Illicit Financing – Key Vulnerability is Lack of Beneficial Ownership Information

The National Strategy listed 10 vulnerabilities. In the “Vulnerabilities Overview” section (page 12), the first of the “most significant vulnerabilities in the United States exploited by illicit actors” was “the lack of a requirement to collect beneficial ownership information at the time of company formation and after changes in ownership.” The Strategy goes on:

“Misuse of legal entities to hide a criminal beneficial owner or illegal source of funds continues to be a common, if not the dominant, feature of illicit finance schemes, especially those involving money laundering, predicate offences, tax evasion, and proliferation financing.

*****

More than two million corporations and limited liability companies (LLCs) are formed in the United States every year. Domestic shell companies continue to present criminals with the opportunity to conceal assets and activities through the establishment of a seemingly legitimate U.S. businesses. The administrative ease and low-cost of company formation in the United States provide important advantages and should be preserved for legitimate investors and businesses. However, the current lack of disclosure requirements gives both U.S. and foreign criminals a method of obfuscation that they can and have repeatedly used, here and abroad, to carry out financial crimes. There are numerous challenges for federal law enforcement when the true beneficiaries of illicit proceeds are concealed through shell or front companies. Money launderers and others involved in commercial activity intentionally conduct transactions through corporate structures in order to evade detection, and may layer such structures, much like Matryoshka dolls, across various secretive jurisdictions. In many instances, each time an investigator obtains ownership records for a domestic or foreign entity, the newly identified entity is yet another corporate entity, necessitating a repeat of the same process. While some federal law enforcement agencies may have the resources required to undertake complex (and costly) investigations, the same is often not true for state, local, and tribal law enforcement.

*****

To address a major aspect of this recognized vulnerability, FinCEN issued a Customer Due Diligence (CDD) Rule, which became fully enforceable for covered financial institutions on May 11, 2018. This rule requires, among other things, more than 23,000 covered financial institutions to identify and verify the identities of beneficial owners of legal entity customers at the time of account opening and defined points thereafter.

*****

While the CDD Rule addressed the gap of collecting beneficial ownership information at the time of account opening, there remains no categorical obligation at either the state or federal level that requires the disclosure of beneficial ownership information at the time of company formation. Treasury currently does not have the authority to require the disclosure of beneficial ownership information at the time of company formation without legislative action. The CDD
Rule is an important risk-mitigating measure for financial institutions and an equally important resource for law enforcement, but it is not a comprehensive solution to the problem and a crucial gap remains.

The United Sates is traditionally the global leader on AML/CFT. But the lack of a legally-binding requirement to collect beneficial ownership information at the time of company formation hinders the ability of all regulated sectors to mitigate risks and law enforcement’s ability to swiftly investigate those entities created to hide ownership. Crucially, this deficiency drives significant costs and delays for both the public and private sectors. The 2016 Financial Action Task Force (FATF) Mutual Evaluation Report (MER) underscored the seriousness of this deficiency. Indeed, this gap is one of the principal reasons for the United States’ failing grade regarding the efficacy of its mechanisms for beneficial ownership transparency.” (citations omitted)

Key Priorities of the US Government in Combating Terrorism, Money Laundering, and Proliferation Financing

After setting out the threats and vulnerabilities, the 2020 National Strategy turned to the US Government’s three key priorities in fighting terrorist and other illicit financial activity:

“To make this 21st century AML/CFT regime a practical reality, the U.S. government will continue to review and pursue the following key priorities: (1) modernize our legal framework to increase transparency and close regulatory gaps; (2) continue to improve the efficiency and effectiveness of our regulatory framework for financial institutions; and (3) enhance our current AML/CFT operational framework. This will include the supporting actions discussed below.” (page 39)

Priority 1: Increase Transparency and Close Legal Framework Gaps

This first priority has four supporting actions: (i) require collection of beneficial ownership information by the government at time of company formation and after ownership changes; (ii) minimize the risks of the laundering of illicit proceeds through real estate purchases; (iii) extend AML program obligations to certain financial institutions and intermediaries currently outside the scope of the BSA; and (iv) clarify or update our regulatory framework to expand coverage of digital assets.

Supporting Action: Require the Collection of Beneficial Ownership Information by the Government at Time of Company Formation and After Ownership Changes

Currently, there is no categorical obligation at the state or federal level that requires the disclosure of beneficial ownership information at the time of company formation. Also, Treasury does not have the authority to require the disclosure of beneficial ownership information at the time of company formation without legislative action. Having immediate access to accurate information about the natural person behind a company or legal entity is essential for law enforcement and other authorities to disrupt complex money laundering and proliferation financing networks. However, this must be balanced with individual privacy concerns and not be unduly burdensome for small businesses.

The Administration believes that congressional proposals to require the collection of beneficial ownership information of legal entities by FinCEN, including the Corporate Transparency Act represents important progress in strengthening national security, supporting law enforcement, and clarifying regulatory requirements. The Administration is working with Congress. The aim—pass beneficial ownership legislation in 2020. It is important that any law enacted should closely align the definition of “beneficial owner” to that in FinCEN’s CDD Rule, protect small businesses from unduly burdensome disclosure requirements, and provide for adequate access controls with respect to the information gathered under this bill’s new disclosure regime.

The ILLICIT CASH Act – A Solution to the Beneficial Ownership Vulnerability

The 2020 National Strategy refers to congressional proposals. One of those was mentioned by Senator Warren, who referred to the bipartisan support that exists in Congress for addressing this vulnerability through a Senate bill, the ILLICIT CASH Act, S.2563 before the Senate Banking Committee. Senator Warren noted that the ILLICIT CASH Act, or Improving Laundering Laws & Increasing Comprehensive Information Tracking of Criminal Activity in Shell Holdings Act (clearly one of the great “backronyms” of all time!) had the support of 4 Democrats and 4 Republicans. Title IV of that bill set out “Beneficial Ownership Disclosure Requirements”, and included provisions to establish beneficial ownership reporting requirements. Although there is bipartisan and Administration support for the bill, not everyone is as supportive: the American Bar Association, for one, opposes the bill.

The American Bar Association – Supportive of Reasonable Measures to Combat Money Laundering, But Not the ILLICIT CASH Act

The American Bar Association – ABA Position on Combating Financial Crime  – “supports reasonable and necessary domestic and international measures designed to combat money laundering and terrorist financing. However, the Association opposes legislation and regulations that would impose burdensome and intrusive gatekeeper requirements on small businesses or their attorneys or undermine the attorney-client privilege, the confidential attorney-client relationship, or the right to effective counsel.” With respect to the ILLICIT CASH Act, the ABA opposes key provisions, and expressed that opposition in a June 19, 2019 letter to the Chairman and Ranking Member of the Senate Banking Committee. ABA Letter Opposing the ILLICIT CASH Act. And on their webpage:

“The ILLICIT CASH Act would require anyone involved in a real estate purchase or sale to file a detailed report with the Treasury Department containing the name of the natural person purchasing the real estate, the amount and source of the funds received, the date and nature of the transaction, and other data. Because attorneys often represent clients in real estate transactions, the ILLICIT CASH Act would compel many attorneys to disclose confidential client information to the government, a result plainly inconsistent with state court ethics rules.”

Conclusion – Courage to Compromise Is Needed if We Are to Make Inroads in the Fight Against Terrorism, Money Laundering, and Proliferation Financing

The ABA’s concerns about burdensome and intrusive requirements and undermining the attorney-client privilege are understandable. The Treasury Department’s concerns about the vulnerabilities of, and need to amend, the broken beneficial ownership regime are understandable. Democrats and Republicans in the House and Senate, and Republicans in the White House, will need to come together to draft, pass, and enact laws to fix the broken beneficial ownership regime. All of these groups, and more, will need the courage to compromise if we are to fill the most glaring hole in our AML system.

REAL ID Act of 2005 … REAL Beneficial Owners Act of 2019?

Can something like the REAL ID Act of 2005 be used to solve the beneficial ownership issue?

Without a national registry of beneficial ownership (BO) information, banks can collect BO information, but have no way to verify it

The REAL ID Act of 2005 compelled the 50 states to have their citizens’ state-issued identification documents meet certain minimum requirements and issuance standards … could a similar thing be done to compel the 50 states to have their state-created legal entities meet certain minimum requirements for beneficial ownership information?

The REAL ID Act of 2005 established minimum security standards for state-issued driver’s licenses and identification cards by prohibiting Federal agencies from accepting non-compliant state-issued driver’s licenses and identification cards that do not meet the Act’s minimum standards. The REAL ID Act was a way for the Federal Government to compel (sort of) the fifty states to meet certain standards for their drivers’ licenses. The Federal Government essentially told the fifty states “you have the power to issue state drivers’ licenses, and you can do what you’d like, but if you want those licenses to be used for any federal purposes, such as accessing Federal facilities, entering nuclear power plants, and, notably, boarding federally regulated commercial aircraft, then they have to meet our standards.”

The REAL ID Act’s genesis was the attacks of 9/11. It enacted recommendations from the July 2002 National Strategy for Homeland Security and the July 2004 9/11 Commission Report that the Federal Government “set standards for the issuance of sources of identification, such as driver’s licenses.” The REAL ID Act was included in the Emergency Supplemental Appropriation for Defense, the Global War on Terror, and Tsunami Relief Act of 2005 (PL 109-13, 119 Stat. 231 at 302), and the actual ID provisions are in Title II, Improved Security for Drivers’ Licenses and Personal Identification Cards, section 202, “minimum document requirements and issuance standards for federal recognition.” (Section 204 provides for grants to states to implement the document requirements and issuance standards).

The main part of section 202 provides:

REAL ID Act regulations weren’t finalized until January 2008, at which time it was clear that it would take billions of dollars and many years to get states into compliance. States were originally required to be compliant by May 2008 (the regulations weren’t published until January 2008). That deadline was extended multiple times to 2009, then 2011, then 2013, then 2015, and extended again to January 22, 2018. As of April 2018, only thirty states were compliant and the remaining twenty had obtained extensions. For those with non-compliant driver’s licenses issued by compliant states, they have until October 1, 2020 to get a compliant driver’s license.

To find out more about the REAL ID Act requirements, California’s DMV site has a good section: CA DMV on REAL ID Act

Can’t Board an Airplane … Can’t Bid on Federal Contracts

How could something like the REAL ID Act help banks with the beneficial ownership issue? Like driver’s licenses, creation of legal entities is left to each state, and (anecdotally) only three states currently require the collection and verification of beneficial ownership information.

Like they did to effectively compel the fifty states to issue individuals’ driver’s licenses that met federal standards, the federal government could pass a law that would prevent entities created in states that do not meet certain Beneficial Ownership standards from bidding on and winning federal government contracts. In other words, those states would not be compelled to collect, verify, and maintain accurate beneficial ownership information on state-incorporated legal entities, but would need to have an incorporation regime that did so if it wanted those legal entities to be able to bid on federal government contracts.

This might be a radical idea, full of legal and regulatory pitfalls. There might be dozens of reasons why it can’t work. But it might work. Or something similar could work (it doesn’t have to be about bidding on federal contracts).  But there must be something that could work. As Arthur C. Clarke wrote, “new ideas pass through three phases: it can’t be done; it probably can be done, but it’s not worth doing; I knew it was a good idea all along!”

One word of further caution. It will have taken fifteen years for all states to comply with the REAL ID Act of 2005 requirements. Hopefully it wouldn’t take states fifteen years to comply with the REAL Beneficial Owners Act of 2019.

FinCEN Director Ken Blanco testifies on the new CDD/Beneficial Ownership Rule

House Financial Services Committee – FinCEN Director Blanco Written Testimony 5-16-18

What is interesting is what Director Blanco did not have to testify about the enforcement of the new rule. He wrote, in part:

“Although we expect covered institutions to be ready on May 11, 2018, to begin timely and effective implementation of the policies, procedures, and controls required under the CDD Rule—and we are pleased to have heard from many in industry that they were ready—we also understand that institutions, regulators and other stakeholders may need a little extra time to smooth out any wrinkles. This is the case whenever we issue a new rule, the purpose of which is always to enhance our AML regime and not to serve as a vehicle for punishing financial institutions. There is always an understandable expectation that industry’s fine-tuning of its implementation, and the government’s fine-tuning of the examination process itself, takes time and that new questions often emerge after implementation begins. We have spoken with our counterparts, including the Federal Banking Agencies, the U.S. Securities and Exchange Commission, and the Commodity Futures Trading Commission, to discuss these issues. We are all committed to ensuring that covered financial institutions are able to implement the rule effectively, and in a way that makes practical sense.

Our goal in this rule is to gain the transparency needed to protect the U.S. financial system and to prevent, deter, detect and disrupt money laundering, terrorist financing, and other serious crimes. It is important for us to continue to work with our regulatory partners, their examiners and financial institutions to achieve these objectives through compliance with the rule. It is equally important, however, to understand that seamless implementation does not happen
overnight and, for some areas, we all will need time to benefit from cumulative practical experiences with the new rule as part of the process. In the meantime, we would encourage financial institutions to alert their examiners to any issues early on, and to share such concerns with FinCEN. We will continue to work with industry and regulators to understand and help address any concerns.”

This passage needs to be read carefully. Essentially, there is an expectation that financial institutions’ programs are ready on May 11th, but those institutions and their regulators “may need a little extra time to smooth out any wrinkles.” And that “new questions often emerge after implementation begins” and “we will all need time to benefit from cumulative practical experiences with the new rule”.  But what does not appear? Any statement that there will be a period of forbearance. Based on a strict reading of this testimony, covered financial institutions should expect that their programs will be judged as of May 11, and like with everything in BSA/AML, that judgment will be impacted by the environment the financial institution finds itself in at the time of judgment, not the environment it was in at the time of implementation. So beware! When being audited or examined in 2019 or 2020 for your compliance with the CDD Rule, look to the environment at that time – not as it was in May 2018 – for how your program will be judged as it was in May 2018.

Beneficial Ownership – a Centralized Registry is the Key!

Requiring financial institutions to collect the (one to five) names and PII of what may or may not be the beneficial owners of a legal entity customer, as well as the name and “certification” of the representative of the legal entity that those are, indeed, the beneficial owner(s) of the legal entity, is a positive step. But without a centralized registry of beneficial ownership, it is an incomplete exercise.

A great blueprint for a centralized registry can be found in a December 2017 paper written by Mora Johnson of Publish What You Pay Canada. In “Building a Transparent, Effective Beneficial Ownership Registry: Lessons Learned and Emerging Best Practices From Other Jurisdictions”, Ms. Johnson provides a succinct list of the eight features a beneficial ownership registry must have. Her focus is on Canada, which has 14 provincial and territorial company registries, so much can be learned from this in applying it to the 50 state registries in the United States. Those eight features are:

  1. All legal entities
  2. Centralized registry
  3. Open to the public
  4. Verified information
  5. Skilled, empowered registrar(s)
  6. Prompt information updates
  7. Adequate data standards
  8. Intelligent design considerations (e.g., drop-downs and legal entity identifiers)

The report is available at http://www.pwyp.ca/images/documents/PWYP-Canada-CRBO-Policy-English-INTERACTIVE.pdf