Ultimate Beneficial Ownership An AML-CTF Challenge: Approaches, Issues, and Challenges

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1 Ultimate Beneficial Ownership An AML-CTF Challenge: Approaches, Issues, and Challenges Dr Hugh McDermott Barrister at Law 16 th Floor Wardell Chambers, Sydney Senior Lecturer in Law Enforcement, Fraud & Financial Investigation CSU Australian Graduate School of Policing

2 Introduction Overview of Presentation Definitions of beneficial owner & Identification Requests in Australia 2 key jurisdictions which influence trends in AML-CTF United States and the United Kingdom The difficulties in determining the ultimate beneficial owner (UBO) of proprietary companies The lack of transparency of UBOs Industry Practices in Dealing with UBO identification Explore the problems faced by Australian Institutions Questions & Conclusions

3 The AML Challenge Shell corporations and nominees are widely used mechanisms to launder the proceeds from crime, particularly bribery (e.g. to build up slush funds). The ability for competent authorities to obtain and share information regarding the identification of companies and their beneficial owner(s) is therefore essential for all the relevant authorities responsible for preventing and punishing money laundering Misuse of Corporate Vehicles including Trust and Company Service Providers, FATF, October 2006, page 5. Multi-layered corporate structures present real problems for financial institutions, regulators and law enforcement Used pervasively by serious money launderers While transaction monitoring software has improved our ability to spot placement and structuring, pattern recognition depends on identifying the UBO. Revealing the identity of criminals is the ultimate goal in AML. Without being able to determine the UBO of propriety companies we are unlikely to be able to achieve this aim.

4 Definition of beneficial owner Australia AML/CTF Rules, a beneficial owner in respect of a company means any individual who owns through one or more share holdings more than 25 per cent of the issued capital in the company. Individual is not defined in the AML/CTF Rules or AML/CTF Act. AML/CTF Act defines person to include individuals. Acts Interpretation Act 1901 defines an individual as a natural person. Thus a beneficial owner can only be natural person. The definition contemplates one or more shareholdings - it must include shareholdings held directly or indirectly through other persons, whether legal persons or individuals acting as trustees.

5 Definition of beneficial owner United Kingdom UK Money Laundering Regulations 2007, Regulation 6, definition of beneficial owner Body Corporate - any individual who owns or controls (directly or indirectly) more than 25% of the shares or voting rights in the body, or otherwise exercises control over the management of the body. Partnership - any individual who is ultimately entitled to or controls (whether directly or indirectly) more than 25% share of the capital or profits or more than 5% of the voting rights, or otherwise exercises control over the management of the partnership. Trust - any individual who is entitled to a specific interest in at least 25% of the capital of the trust property, or any individual who has control over the trust. Specific interest is further defined to include a vested interest which is in possession or in remainder or reversion. Control means a power under the trust instrument to dispose of, advance, lend, invest, pay or apply trust property; vary the trust, add or remove a person as a beneficiary; appoint or remove trustees; direct, or withhold consent to or veto the exercise of power. Others - beneficial ownership means the individual who ultimately owns or controls the customer or on whose behalf a transaction is being conducted.

6 United Kingdom The requirement to identify and verify beneficial owners applies before or during the course of establishing a business relationship and when conducting transactions for occasional customers. UK Money Laundering Regulations 2007, Regulation 7 Requires a bank to identify and verify beneficial owners when it: 1.Establishes a business relation; 2.Carries out an occasional transaction (which is defined as a transaction outside of a business relationship amounting to EUR or more, whether the transaction is carried out in a single operation or several operations which appear to be linked); 3. Suspects money laundering or terrorist financing; 4. Doubts the veracity or adequacy of documents, data or information previously obtained for the purposes of identification or verification. In practice, the company's identity comprises its constitution, its business and its legal ownership structure. Key identification particulars are the company's name and business address, registration number and names of directors CDD includes understanding the purpose and intended nature of the business relationship as well as the ownership and control structure of the company.

7 Definition of beneficial owner United States Bank Secrecy Act 1970 and Regulation 31 CFR 103 US AML laws do not require a financial institution to identify the UBO Require financial institutions to identify and verify those companies not deemed to be high risk. Establish a company s principal place of business and collecting a government-issued identifier (such as an ABN for an Australian company), Verify by obtaining documents such as certified articles of incorporation or a government issued business license [31 CFR (b)(4)(ii)(A)]. No specific reference in this provision to the concept of beneficial ownership Department of Treasury Final Rule (68 Fed. Reg ) implementing section 326 of the USA Patriot Act 2001 Based on a bank s risk assessment, a bank may need to take additional steps to verify the identity of the customer by seeking information about individuals with ownership or control over the account. Bank may need to look through an account as part of its ongoing customer due diligence procedures under its Bank Secrecy Act compliance program. US laws promote a risk-based approach to identifying UBO at the point of establishing a relationship US banks tend not to identify UBO of domestic corporate customers at this point. Apply a blanket low-risk status for US companies and a higher risk classification for all foreign companies Banks only identify UBO for domestic companies as part of their ongoing CDD.

8 Definition of beneficial owner FATF Guidance on Risk Based Approach UBO defined as: the natural person(s) who ultimately owns or controls a customer and/or the person on whose behalf a transaction is being conducted. It also incorporates those persons who exercise ultimate effective control over a legal person or arrangement.

9 Steps to ID the UBO Australia AML/CTF Rule minimum information requirements that a reporting entity must capture from a company. The words collect from a company are express and mean that the information must be obtained from the company itself. A customer identification procedure that does not capture this information from the company but captures it from an ASIC search does not meet the requirements of AML/CTF Rule AML/CTF Rule Part B must include a procedure for the reporting entity to collect the name and address of each beneficial owner (if any) of a proprietary or private company (other than a proprietary company that is licensed and subject to the regulatory oversight of a Commonwealth, State or Territory statutory regulator in relation to its activities as a company). The information about a beneficial owner can be collected from any source; it is not limited to being collected from the customer as in AML/CTF Rule Mandatory to collect the name and address of all beneficial owners of a proprietary company. Every proprietary company, whether domestic or foreign, is subject to this requirement for collection of the name and address of the beneficial owner

10 Collection of UBO Information - Australia Part B of the AML/CTF Act Must collect the name and address of each individual that owns, through one or more shareholdings, more than 25 percent of the issued capital of a proprietary company that is not subject to oversight by an Australian regulator. In all cases, without exception, a reporting entity should collect details of every shareholder at every level of ownership in order to ensure that at some level an aggregate 25 percent holding is not missed. Information can be collected by asking the customer or by reviewing publicly available information, such as searching company registers.

11 Verification of UBO Information Australia AML/CTF Rule Part B must include appropriate risk-based systems and controls for the reporting entity to determine whether and to what extent any of the information referred to in paragraph should be verified. AML/CTF Rule Reporting entities must consider the ML/TF risk relevant to the provision of the designated service to the proprietary company when considering what verification, if any, is required under AML/CTF Rule There is no mandatory requirement to verify the name and address that is provided for UBOs There is no mandatory requirement to verify the information about beneficial owners, either that they are beneficial owners, or who they are. However, if high risk, expect AML/CTF program would require verification.

12 Steps to ID the UBO FATF FATF Recommendation 5 requires 2 steps to determine beneficial ownership. 1. Identify the beneficial owner. The step of identification must at least involve the beneficial owner s name. Typically, other characteristics are also used to ensure that the person is readily identifiable from any other person with the same name, e.g. date of birth or residential address. 2. Take reasonable measures to verify the identity of the beneficial owner such that the financial institution is reasonably satisfied that it knows who the beneficial owner is. For legal persons and arrangements, FATF recommendation 5 says this should include taking reasonable measures to understand the ownership and control structure of the customer. Furthermore, the FATF Guidance on the Risk Based Approach suggests that institutions ought to adopt reasonable risk-based measures to identify and verify the identity of any beneficial owner

13 Industry Practice 1 Establish the names and addresses of the shareholders which hold more than 25 percent of the shares directly Focus only on any individuals who are direct beneficial owners ie one layer of ownership (DBOs). Reporting entities only seek additional information to document the beneficial ownership structure back to the UBO where the risk profile of the relationship is higher under the reporting entity s program. Typically the information is collected from a current ASIC search for domestic proprietary companies. Presence of corporate shareholders at the first layer is not automatically regarded as a higher risk factor which requires the seeking of additional information to document the beneficial ownership structure back to the UBO.

14 Problems with this Approach? Industry practice does not meet the formal requirements of AML/CTF Rule , as the first layer of shareholdings may not be the beneficial owners for the following reasons: 1. they may not be individuals as required by the definition in the AML/CTF Rules; or 2. they may hold their shares on trust for others as nominees, trustees or under other legal obligations. Use of an ASIC search to find out the name and address of the shareholders is a level of verification which may be more than is required through the application of the risk-based approach A risk-based practice may not actually meet the requirements of AML/CTF Rule , AML/CTF Rule or AML/CTF Rule unless the shareholders are all individuals Nor does it meet the FATF requirements Low cost/expense Simple and cheap customer acceptance process

15 Industry Practice 2 A variation on the first practice based on a view that the beneficial owner does not need to be an individual and therefore the first layer of shareholding is always sufficient. Problems with this Approach? This practice also does not meet the requirements of the AML/CTF Rules unless the shareholders are all individuals. Nor does it meet the FATF requirements. Nor does it follow the narrow interpretation of the definition of beneficial owner. Low cost/expense Simple and cheap customer acceptance process.

16 Industry Practice 3 Tends to be followed by investment banks, in Australia, Europe and the US UBO is always established, using searches of the corporate registers Not restricted to the DBO Use corporate registers where possible Once the UBOs are found, identified and determined then a risk-based decision made regarding further verification of the ownership and/or verifying the UBO. Problems with this Approach? In line with the interpretive notes to FATF recommendation 5, whereby it is necessary to identify the beneficial owners including forming an understanding of their ownership and control structure, and take reasonable measures to verify the identity of such persons Meets the requirements of the AML/CTF Rules following a broad interpretation of beneficial owner Collects the name and address of the UBO and it then uses a risk-based approach regarding verification. High Cost/Expense Tougher identification standards for customers.

17 Conclusions - Systemic Global Failure Opaque structures are the primary tool of criminals and money launderers and the purpose of the FATF Recommendation 5 is to attack that opacity. The third round of FATF mutual evaluations identified systemic non-compliance by jurisdictions with recommendation 5, primarily due to deficiencies in identifying and verifying beneficial owners of non-natural persons. One response has been law reform, with new laws introduced in Australia, the UK, and the US. Another response has been debate about whether recommendation 5 is achievable. Not a single country has been rated compliant with recommendation 5. Could this be because it is simply not realistic to expect a bank to look through its corporate customers to the UBOs?

18 Conclusions Should the UBO be identified by Regulators at the Formation/Registration of the Company? May be time to treat regulators/agencies as reporting entities subject to the same KYC and monitoring obligations as current reporting entities, so that the opacity of corporations can be addressed at source. Corporate regulators take responsibility for identifying beneficial owners of the companies it registers. With market regulatory functions - best placed to work with share registries to identify the UBO/shareholders of listed companies. Shift in responsibility would strip a rich source of KYC information from a bank s ongoing customer due diligence program & increase cost of regulation if had to go back to UBO FIUs - most useful financial intelligence from high quality suspicious activity reports, where those reports are the result of effective OCDD involving transaction monitoring against expected customer behaviour. Dual model of regulators possessing information about beneficial owners and banks possessing information about transactions? Public information could compromise a company s ability to invest in new projects without distorting market pricing?

19 Conclusions and Questions