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Customer due diligence rule: the financial industry's new role of law enforcement

In early May, the U.S. Department of the Treasury announced the final publication of a rule which requires the financial industry to identify client companies' "beneficial owners." The rule, known as the Customer Due Diligence (CDD) rule, specifically requires that banks, brokers, and other financial institutions gather and verify the identities of the actual individuals who own and control a company when said company opens an account with the financial institution.

Though the rule has been in progress since 2012, the publication of the so-called "Panama Papers" has created a renewed sense of urgency on the part of regulators to crack down on money-laundering.

The financial industry's new law enforcement responsibility

Although some critics claim the new rule doesn't go far enough to prevent shell company abuse, the CDD rule nevertheless yokes financial institutions to a significant new role: acting as proxies for law enforcement. Banks now must collect information on client companies' beneficial owners and maintain such information in a database such that records may be retrieved and provided to law enforcement agencies such as the Financial Crimes Enforcement Network (FinCEN) upon request.

True, financial institutions have already long been subject to Suspicious Activity Reporting requirements , but such reporting only applies to potentially suspicious activity that meets certain criteria; the CDD rule applies to all of an institution's client companies, regardless of the individual risk.

Furthermore, it seems likely that the industry's new data collection responsibilities are here to stay. Even though the Treasury Department announced new proposed beneficial ownership legislation at the same time as the announcement of the final CDD rule - legislation that would require companies "to file beneficial ownership information with the Treasury Department" at the time of their formation - there's no indication that this legislative attempt is any more likely to succeed than any others in the history of such legislation.

As such, regulators and law enforcement are going to be relying exclusively on banks for this information, putting considerable pressure on banks to comply with the new rule.

Rising compliance costs

This added regulatory pressure compounds an already high-pressure environment. According to a 2014 survey by audit, tax, and advisory firm KPMG, anti-money laundering (AML) compliance costs have seen notable increases since 2001, with costs increasing at an average rate of 53% from 2011 to 2014 - a rate over 10% higher than predicted.

Implementing FinCEN’s final rule will seemingly push costs up further. Most industry experts say that the bulk of the burden will be borne during the two-year implementation period, during which time institutions will need to establish systems for the collection and storage of beneficial owner information. Although these upfront costs likely won't be inconsequential, they at least do have some reasonable measure of quantifiability.

What is less certain are the costs of ongoing compliance with the rule. While past and current regulatory enforcement habits can provide some indication about FinCEN's expectations regarding CDD rule compliance, institutions don't know for sure how heavy-handed the agency will truly be.

Given the abovementioned low chance of success for legislative action on for a national corporate registry and FinCEN's consequently increased reliance on banks for beneficial ownership information, it would behoove financial institutions to assume the worst about the level of impending regulatory oversight.

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