Obama Administration Issues Broad Anti-Money Laundering and Anti-Corruption Reforms, but Questions Still Remain

July 12, 2016

On May 5, 2016, the Obama Administration announced sweeping measures designed “to combat money laundering, corruption, and tax evasion.” The announcement came on the heels of the so-called “Panama Papers,” which revealed connections between several world leaders and offshore shell companies and resulted in global investigations of possible schemes to evade taxes and shield proceeds of illicit activity. The reforms are part of a broader effort by the Obama Administration targeting shell companies, following reports that such companies were often used to funnel illicit funds into the U.S. financial system, most recently through purchases of luxury real estate in New York and Miami.

Central to these reforms are new regulations and proposed amendments to existing laws from the Department of the Treasury and the Department of Justice (DOJ). Although questions remain as to the scope and breadth of these reforms and the timing of their implementation, it seems likely that banks and other financial institutions will face additional compliance requirements and stepped-up enforcement. 

Treasury Measures 

Treasury announced several measures intended to enhance financial transparency and curb the use of shell companies to hide proceeds from illicit activities. These measures include (i) a final rule requiring financial institutions to conduct Customer Due Diligence (CDD), (ii) proposed legislation mandating collection of beneficial ownership information, (iii) proposed rules requiring foreign-owned entities to obtain an employer identification number (EIN) with the IRS, and (iv) calls for Congress to enact legislation approving pending tax treaties and granting reciprocal Foreign Account Tax Compliance Act (FATCA) information sharing. Each of these measures is summarized below. 

Customer Due Diligence

The final CDD rule extends significant due diligence requirements to covered financial institutions. This group includes insured banks, commercial banks, agencies or branches of a foreign bank in the U.S., federally insured credit unions, savings associations, federally regulated trust banks or trust companies subject to an anti-money laundering (AML) program requirement, corporations organized for foreign banking, securities broker-dealers, mutual funds, and futures commission merchants and introducing brokers in commodities, all of which are currently required to implement customer identification programs. The rule does not apply to casinos, money services businesses, or registered investment advisers. While the rule takes effect on July 11, 2016, covered financial institutions will not be required to comply until May 11, 2018. The full text of the rule is available here.

The final rule is the culmination of more than two years of rulemaking, since the rule was proposed in 2014, and represents a compromise between transparency advocates and financial institutions.  Already, the rule has drawn criticism from both sides. Transparency advocates argue that Treasury’s definition of beneficial ownership (discussed below) is vague and easy to evade, while financial institutions argue that the rule will be costly and impose unreasonable diligence requirements.

The rule requires covered financial institutions to establish and maintain written procedures reasonably designed to identify and verify beneficial owners of their legal entity customers. The rule defines a “legal entity customer” as a corporation, limited liability company, or other entity created by the filing of a public document with a Secretary of State or similar office, a general partnership, and any similar entity formed under the laws of a foreign jurisdiction that opens an account. The rule excludes certain legal entities, including but not limited to federal or state-regulated financial institutions, entities whose securities are listed on the New York Stock Exchange or NASDAQ, SEC-registered entities, and CFTC-registered entities.

The rule also exempts certain types of accounts for legal entity customers from identification and verification requirements because these accounts are used for activities that are considered low risk for money laundering. Exempt accounts include private label retail credit accounts, accounts for financing insurance premiums, and accounts financing the purchase or lease of equipment, among others.  Accounts opened to participate in an employee benefit plan under the Employee Retirement Income Security Act of 1974 are also excluded from identification and verification requirements due to their low money laundering risk.

“Beneficial owners” include individuals that either:

  1. Own, directly or indirectly, through any contract, arrangement, understanding, relationship or otherwise, 25% or more of the equity interests of a legal entity customer (Ownership prong); or 
  2. Possess significant responsibility to control, manage, or direct a legal entity customer, including an executive officer or senior manager, or any other individual who regularly performs similar functions (Control prong). 

Treasury noted that the number of beneficial owners identified will vary based on the circumstances, but that all legal entities must identify at least one beneficial owner under the control prong.

CDD procedures must require the financial institution to identify the beneficial owner(s) of each legal entity customer at the time an account is opened, unless the customer qualifies for an exclusion or exemption (discussed above). The identification requirement applies prospectively to “new accounts,” defined as accounts opened at a covered financial institution by a legal entity customer, on or after May 11, 2018. Treasury provided a sample certification in the appendix to the rule that can be used to satisfy the identification requirement. Although some commenters to the proposed rule observed that collecting identifying information—such as name, birth date, and social security number—on beneficial owners could infringe these individuals’ privacy interests and increase risks of identity theft, Treasury concluded that financial institutions already request this information for opening individual accounts. As a result, Treasury expects financial institutions to protect this information in accordance with federal and state privacy laws, including but not limited to the Gramm-Leach-Bliley Act.

In addition, CDD procedures must enable the institution to verify the identity of each beneficial owner, based on risk-based procedures, to the extent reasonable and practicable. However, the rule clarifies that these risk-based procedures must at least comply with the institution’s existing customer identification program requirements. The rule also notes that photocopies may be used in lieu of originals for documentary verification.

Financial institutions must retain records identifying beneficial owners for five years after an account is closed, and records verifying the identity of beneficial owners for five years after the record is made. Financial institutions can rely on other financial institutions to perform recordkeeping, subject to certain conditions.

Finally, the rule expands existing AML program requirements to require “appropriate risk-based procedures for conducting ongoing customer due diligence.” These risk-based procedures must enable the financial institution to understand the nature and purpose of customer relationships to create a customer risk profile. A customer risk profile contains customer information, gathered at account opening and periodically updated, and used to develop a baseline against which to assess customer activity for suspicious activity reporting purposes. Such information may include the type of customer, the type of account opened, the service or product offered to the customer, or other basic information about the customer such as source of wealth, source of funds used to fund the account, purpose of the account, annual income, net worth, domicile, principal occupation or business, or history of activity. The customer risk profile may, but is not required to, include a system of risk ratings or categories of customers. 

Additionally, the risk-based procedures must provide for ongoing monitoring by the financial institution “to identify and report suspicious transactions and, on a risk basis, to maintain and update customer information…[including] information regarding the beneficial owners of legal entity customers.” Treasury observed that the requirement to maintain and update customer information and to identify and report suspicious transactions is consistent with current industry practice to comply with SAR reporting requirements and therefore should not impose additional burden on financial institutions.

Treasury also made clear that financial institutions’ obligation to update customer information does not impose a categorical requirement to update customer information on a continuous or periodic basis. Rather, financial institutions must update customer information once they detect or learn of any changes about the customer or the account during the course of their normal risk-based transaction monitoring. Changes that may trigger updating include a significant and unexplained change in customer activity or information indicating a possible change in beneficial ownership. This updating requirement applies to both customers with new accounts, and customers with accounts existing as of May 11, 2018.

Beneficial Ownership Legislation

Treasury also sent new legislation to Congress that, if enacted, would amend the Bank Secrecy Act to require any “United States Entity” to maintain records and file reports on its beneficial owners with Treasury. The definition of “United States Entity” covers entities created, organized, qualified, or registered in the U.S., as well as any entities using U.S. mail, wire, or interstate or foreign commerce. This definition is broader than the CDD final rule, as it covers entities that are not “covered financial institutions.” Entities that fail to comply with reporting requirements would face fines of $5,000 per violation. The proposed legislation does not make clear whether these reports will be made available to the public.  

In addition, the proposed legislation contains technical amendments designed to enhance Treasury’s authority to issue Geographic Targeting Orders (GTOs). GTOs impose temporary recordkeeping and reporting requirements on domestic financial institutions or businesses located in a select geographic area, and aid Treasury in collecting information on potential illicit activity. Treasury recently issued GTOs in Manhattan and Miami, as part of the Obama Administration’s efforts to combat money laundering in the luxury real estate market through shell companies.

The full text of the proposed legislation is available here.

Proposed Rules

Treasury proposed new regulations to require foreign-owned, single-member limited liability companies to obtain an employer identification number (EIN) from the IRS. These entities currently have no obligations to report to the IRS and, as a result, foreign owners can use such entities to avoid paying taxes. Requiring these entities to obtain an EIN will combat the use of these entities for tax evasion and other illicit activities because these entities will be required to file tax returns with the IRS, which will strengthen the IRS’s ability to monitor these entities. 
The full text of the proposed rule is available here.    

Calls for Additional Legislation

In a letter to Congress, Treasury Secretary Jacob Lew urged Congress to approve eight bilateral tax treaties, some of which have been pending for five years or more. Approving these treaties would aid U.S. law enforcement in investigating offshore tax evasion by providing access to information about offshore accounts located in these countries. Countries with pending tax treaties include Switzerland, Luxembourg, Spain, Poland, Chile, Japan, and Hungary. The OECD Protocol amending the Convention on Mutual Administrative Assistance in Tax Matters is the eighth pending treaty.

Secretary Lew also urged Congress to grant full reciprocity under FATCA, a 2010 statute that requires foreign financial institutions to provide the IRS with information about financial accounts held by U.S. taxpayers, or by foreign entities in which U.S. taxpayers hold a substantial ownership interest. To date, over 100 countries have executed agreements with the U.S. to provide this information. However, U.S. financial institutions currently are not required to provide the same information to partner countries, absent legislation from Congress implementing this part of FATCA.

DOJ Proposals

In parallel to Treasury, DOJ announced a series of legislative proposals intended to facilitate prosecution of corruption and money laundering. These proposals amend existing laws to address (1) illegal proceeds of transnational corruption and (2) substantive corruption offenses. Congress must enact these proposals in order for them to become law. The full text of DOJ’s proposals is available here.

Proposals Regarding the Illegal Proceeds of Transnational Corruption

DOJ released five proposed amendments to laws targeting the illegal proceeds of transnational corruption. The amendments, both substantive and procedural, enhance prosecutors’ ability to investigate and prosecute money laundering and kleptocracy schemes by criminalizing corrupt activities that occur outside the U.S. and streamlining evidence gathering and authentication procedures. Specifically, the proposed amendments include:

  1. Expanding foreign money laundering charges to include any violation of foreign law that would be considered money laundering if committed in the United States.
  2. Allowing administrative subpoenas, rather than grand jury subpoenas, for money laundering investigations. 
  3. Allowing foreign bank or business records obtained through serving subpoenas on branches located in the U.S. to be admitted as evidence at trial. 
  4. Establishing procedures for handling classified information in civil cases that comply with the Classified Information Procedures Act (CIPA), which currently applies only to criminal cases. 
  5. Lengthening the time period in which the U.S. can seize property based on a request from a foreign government from 30 days to 90 days, and extending certification procedures to authenticate foreign business records in criminal cases to civil asset recovery cases.

Perhaps the most significant of these proposals is allowing foreign bank or business records to be admitted as evidence at trial, because it exposes banks  providing such records to additional document production requirements and to possible liabilities. Currently, U.S. law enforcement can, with approval from DOJ, obtain foreign bank or business records by serving a subpoena on the foreign bank’s branch in the U.S. However, these records cannot be admitted as evidence at trial. DOJ’s proposed amendment would require subpoenaed foreign banks to produce and authenticate requested records consistent with Federal Rules of Evidence, enabling these records to be used at trial.

Also significant is the expansion of foreign money laundering charges to include violations of foreign law. In the past, courts have been reluctant to extend U.S. law to activities that occur outside the U.S. absent express legislative intent to do so. The Supreme Court recently confronted this issue in RJR Nabisco, Inc. v. The European Community, 579 U.S. __ (2016). Petitioners challenged the extraterritorial application of the Racketeer Influenced and Corrupt Organizations (RICO) statute, which criminalizes a “pattern of racketeering activity” involving underlying state and federal offenses known as “predicates,” to conduct occurring outside the United States. Petitioners allegedly laundered the proceeds of illegal drug sales in Europe, traveling to and from the U.S. and wiring funds to U.S. accounts. The district court dismissed these claims because it determined that RICO did not apply to racketeering activity that occurred abroad. The Second Circuit reversed, holding that RICO applies to conduct outside the U.S., if that conduct violates a predicate offense that applies extraterritorially. The court concluded that allegations of money laundering supported the RICO charge because the conduct alleged in the complaint satisfied predicates under 18 U.S.C. §1956(f) and 1957(d), which authorize extraterritorial application to conduct by a U.S. person where the transactions exceed $10,000.

The Supreme Court affirmed the Second Circuit in part, concluding that RICO applies to foreign racketeering activity, to the extent such activity violates predicates that themselves apply extraterritorially. Because the alleged money laundering scheme consisted of predicate offenses that expressly provide for extraterritorial application, the Supreme Court concluded that the RICO allegations were permissible. Together, the Supreme Court’s decision in RJR Nabisco and Congressional enactment of the DOJ’s proposed amendment to foreign money laundering charges will allow prosecutors to directly pursue kleptocracy cases and expand the federal government’s ability to combat foreign money laundering activity. 

Proposals Regarding Criminal Offenses for Fraud and Bribery

DOJ also proposed two amendments to 18 U.S.C. §666, which criminalizes fraud and bribery in connection with programs receiving federal funding. Specifically, the statute criminalizes the corrupt giving and receiving of anything of value to a government official, with the “intent to influence or reward” such official, in connection with any business transactions or series of transactions involving anything of value of $5,000 or more.

The first proposed amendment resolves a circuit split over the meaning of “intent to influence or reward” and whether it includes after-the-fact gratuities, where the corrupt payment is made after the official takes action. The majority of circuit courts agree that the plain language of Section 666 criminalizes both the corrupt offer and acceptance of rewards, and therefore covers gratuities. DOJ’s proposed amendment adopts this approach and explicitly defines “intent to influence or reward” to include anything of value given “either before or after the agent takes some action.”

The second proposed amendment makes clear that paying a bona fide salary or bonus to a government official would not constitute the criminal giving or receiving of “anything of value.” This proposed amendment corrects a drafting error that exempted bona fide salary and bonuses from the entire statute, rather than from the statute’s prohibition on giving or receiving “anything of value” as originally intended by Congress. According to DOJ, this drafting error exempted otherwise criminal conduct, where the defendant obtained related contracts or employment at the outset through bribery or fraud, but received legitimate payments or salary going forward.

In addition, the second proposed amendment lowers the dollar threshold from $5,000 to $1,000, noting that even relatively small bribes to government officials threaten the integrity of the government function and violate public trust.

Practical Implications for Financial Institutions

If adopted, the Obama Administration’s proposals will lead to increased information gathering, monitoring, and enforcement of anti-money laundering and anti-corruption laws, and impose additional operational requirements on financial institutions. The precise breadth, scope, and timing of these rules and proposals, however, remains unclear.

The biggest uncertainties surround the timing and ultimate fate of the legislative proposals from Treasury and DOJ. At a hearing before the U.S. House Financial Services Committee Task Force on Terrorism Financing, Treasury urged Congress to act on its proposed beneficial ownership legislation, noting that the legislation “dovetails” on the CDD rule and both “initiatives are critical to aid law enforcement efforts.” Since that hearing, however, Congress has not introduced the proposed legislation, making it unlikely that the measures will pass this term. Nevertheless, financial institutions should continue to be vigilant in compliance and monitoring efforts to minimize enforcement risk, as these proposals make clear that the Obama Administration will remain focused on countering money laundering, corruption, and tax evasion in its remaining months.

Moreover, the United States is not alone in its increased focus on combating money laundering. The European Union, for example, enacted the Fourth Anti-Money Laundering Directive last year and it will be fully implemented by June 2017. Similar to the Obama Administration’s proposals, the EU’s Directive emphasizes beneficial ownership and enhanced customer due diligence for financial institutions. As a result, financial institutions with global operations should review their anti-money laundering policies and procedures to ensure they are in compliance with both the U.S.’s CDD final rule, as well as the EU Directive and other anti-money laundering laws.

This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Ronald Cheng, an O’Melveny partner licensed to practice law in California, Greta Lichtenbaum, an O’Melveny partner licensed to practice law in the District of Columbia, Jeremy Maltby, an O’Melveny partner licensed to practice law in California, the District of Columbia, and New York, Bimal Patel, an O’Melveny partner licensed to practice law in the District of Columbia, Georgia, and New York, and Mcallister Jimbo, an O’Melveny associate licensed to practice law in California and the District of Columbia, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.

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