Know Your Business: No More Smoke and Mirrors
Do you know who you’re doing business with? Sure, you may have Googled the company and name of person you’re dealing with to distinguish the legitimacy of the business. But do you really know who runs the business, pulls the string behind the scenes and profits from your dealings?
Do you know if proceeds from your business is being directed into bank accounts of corrupt business owners/shareholders, money launderers or even terrorism financiers? If you’re a regulated entity (financial institutions, certain types of businesses, or if the value of the transaction warrants it), it’s a legal compliance requirement.
Besides legal considerations, there are also social and ethical responsibilities for knowing the ultimate beneficial owners (UBO) of companies you are doing business with. Consider all the corruption uncovered by the Panama Papers, which revealed over 200,000 shell companies hiding billions of dollars from lawful taxation. These hidden funds go into the hands of people who already have wealth and power and create a larger tax burden for society. Doing business with these people opens your business up to a host of questions about your moral compass and reputation.
Under the rubric of Know Your Business (KYB), laws require investigating the UBO structure is part of the customer due diligence (CDD) process.
KYB in Europe
For example the 4th AML Directive is already in effect in Europe and requires:
identifying the beneficial owner and taking reasonable measures to verify that person’s identity so that the obliged entity is satisfied that it knows who the beneficial owner is, including, as regards legal persons, trusts, companies, foundations and similar legal arrangements, taking reasonable measures to understand the ownership and control structure of the customer;
Note that a beneficial owner in the EU is someone who owns more than 25% of the corporate entity, but there is a proposal to lower that to 10%. Currently the EU customer due diligence requirements are:
(a) identifying the customer and verifying the customer’s identity on the basis of documents, data or information obtained from a reliable and independent source;
(b) identifying the beneficial owner and taking reasonable measures to verify that person’s identity so that the obliged entity is satisfied that it knows who the beneficial owner is, including, as regards legal persons, trusts, companies, foundations and similar legal arrangements, taking reasonable measures to understand the ownership and control structure of the customer;
(c) assessing and, as appropriate, obtaining information on the purpose and intended nature of the business relationship;
(d) conducting ongoing monitoring of the business relationship including scrutiny of transactions undertaken throughout the course of that relationship to ensure that the transactions being conducted are consistent with the obliged entity’s knowledge of the customer, the business and risk profile, including where necessary the source of funds and ensuring that the documents, data or information held are kept up-to-date.
KYB in the US
Other jurisdictions have, or will have, similar requirements. In the US, the Customer Due Diligence (CDD) Final Rule goes into full effect May 11, 2018: “Beginning on the Applicability Date, covered financial institutions must identify and verify the identity of the beneficial owners of all legal entity customers (other than those that are excluded) at the time a new account is opened (other than accounts that are exempted).” Financial institutions (FIs) includes banks; brokers or dealers in securities; mutual funds; and futures commission merchants and introducing brokers in commodities.
Unfortunately, different jurisdictions have different requirements, and even within the same jurisdictions different regulations are applicable. For example, besides the Bank Secrecy Act (BSA), which covers the CDD rules, US FIs also have to consider Dodd-Frank, SEC disclosure rules, OFAC (Office of Foreign Assets Control), and FACTA (Foreign Account Tax Compliance Act).
Problems of KYB
Even more problematic, beneficial ownership information is often difficult to find. Nominee shareholders can hide true ownership. Shell companies or trusts can obscure information within filings and in different jurisdictions. These registrations can, in turn, be registered by other shell companies or trusts in yet other jurisdictions. Percentage of ownership is potentially obfuscated by complex paper trails that makes identifying the true beneficial ownership complex and costly.
There might not even be paper trails. In some jurisdictions there is no documentation requirements for beneficial ownership, so there is no shareholder information to investigate. Note, this goes against Financial Action Task Force (FATF) global Anti-Money Laundering (AML) and Counter-Terrorist Financing (CFT) recommendations.
Some companies are implementing Know Your Business (KYB) processes similar to how they have been handling KYC (Know Your Customer), using time-consuming, slow, and manual-intensive processes. According to a recent Consult Hyperion study in the UK, “inefficient KYC processes cost the average bank £47 million a year.” The report goes on to say “that AMLD4 and AMLD5, due to take effect in 12 months, will increase these costs substantially.”
Compliance needs to look at multiple reports and different data sets. They are working in one location, but the data could be in another office, or another country. Data is often old or inaccurate, in a variety of different formats that is hard to reconcile. Each company structure is different and can change over time, so the data is difficult to gather and difficult to interpret.
As Dun & Bradstreet note in a report, Smoke and Mirrors: The Opaque Nature of Ownership, “What is clearly obvious is that applying a traditional resource-intensive manual approach and reliance on self-certification is no longer sustainable.”
Companies need to, “automate the identification and verification of beneficial ownership, organizations are able to beat the paradox and makes sense of the opaque nature of ownership.”Click to tweet
Just as with KYC, KYB (Business Verification) processes dramatically improve by adding automated verification systems. Electronic identity verification (eIDV) provides proper analysis on any name of a beneficial owner or director that KYB brings up. eIDV also points the way forward for KYB, pointing to the use of API’s to ease integration and smooth out data capture processes. With the power of APIs and data-driven systems, workflows quickly retrieve information, share it to the appropriate parties, coordinate response and flag cases for manual review.
To avoid the costs, headaches and potential non-compliance of KYB, look to KYC; effective KYB solutions will use similar processes to automated KYC solutions. While the complexity for KYB demands more from compliance, technology that determines who is behind a business will allow for greater scrutiny and better compliance.