For most people May 11, 2018 will just be another Friday, but for those in the banking industry, law enforcement or investigations, it could turn out to be a watershed day in the fight against money-laundering.

It’s the day a groundbreaking new customer due diligence rule, written by the Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN) and affecting thousands of financial institutions, goes into effect.

Lifting the Veil of Secrecy

Until now, U.S. financial institutions have not been required to ask their clients that are legal entities – e.g. corporations, partnerships, LLCs, holding companies, trusts, etc. – for information regarding beneficial ownership. That means those wishing to keep their ownership of a company secret could easily do so by hiding behind the names of others that were used on corporate records, which is sometimes called a “straw man” approach. A criminal or terrorist looking to launder money through a U.S. bank could simply establish an account for a shell company under the name of a strawman to make it appear as though the money was legitimately obtained.

The new rule is designed to reduce or eliminate this possibility by requiring that banks and other financial institutions identify and verify the beneficial owners of newly established corporate accounts as part of their anti-money laundering (AML) obligations under the Bank Secrecy Act. Under this rule, beneficial ownership is defined in two ways:

  • As any and all individuals owning at least a 25 percent equity stake in a legal entity
  • At least one individual who has “significant responsibility to control, manage or direct” the legal entity

Therefore, each legal entity will have from one to five beneficial owners – one under the “significant responsibility” part of the definition, and from zero to four under the equity stake part.

The rule covers only newly opened accounts, even if they are opened by existing clients of the financial institution. However, if the financial institution already has information on file for the client that satisfies the new rule, it is not necessary for the institution to ask for it again. Even with these guidelines, it remains to be seen how banks and other covered financial institutions implement the rule, and with any new rule of this kind, there will likely be a great deal of questions and some gray areas that will need to be addressed. For more on guidance related to the rule, see this FinCEN FAQ.

This change in the client due diligence rule effectively forces banks to hold their corporate clients accountable for transparency. No longer will those seeking to launder money through bank accounts held in the titles of shell companies be able to keep their names hidden.

U.S. Trails in Financial Transparency

The new customer due diligence rule was first announced in May 2016, around the release of the Panama Papers report that revealed the extensive use of shell corporations held in offshore accounts for money laundering and tax-evasion purposes by wealthy individuals all over the world. The report also drew attention to lax U.S. financial transparency rules as compared to many other countries. In fact, it might surprise you to learn that the U.S. ranks second among nations with the greatest financial secrecy, behind only Switzerland and just ahead of the Cayman Islands, according to the Tax Justice Network.

Though related, the new FinCEN customer due diligence rule is not to be confused with another effort to increase financial transparency in corporate records, the so-called TITLE (True Incorporation Transparency for Law Enforcement) Act, which is aimed at the state corporate registration process and remains stuck in committee in Congress.

A Welcome and Overdue New Tool in Financial Due Diligence

The new FinCEN rule should make it more difficult for criminals and others with nefarious intentions to hide financial transactions behind shell companies. That means that law enforcement and investigators should have an easier time (although a subpoena may be needed) determining who is really behind a specific company, or tracking down ill-gotten gains.

For private investigators and attorneys, this information may also prove useful in asset searches, for example as part of a divorce case. Previously a party might have been able to hide assets under a shell company officially listed under someone else’s name, but the new FinCEN rule should make this much more difficult.

This isn’t to say that those seeking to hide assets won’t find loopholes or new ways to throw investigators and law enforcement off their financial trail. For example, a money launderer could conceivably own 24 percent of a company’s equity and not be required to divulge his or her name on bank documents. The point is not that this rule is fool-proof. Among criminals, where there’s a will there is often a way. But starting Friday, it will become far more challenging for them to use banks and other financial institutions in the U.S. to hide money.