Beneficial Ownership and Due Diligence for Commercial Lenders NEW JERSEY BANKERS ASSOCIATION COMMERCIAL REAL ESTATE CONFERENCE JUNE 29, 2017

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1 Beneficial Ownership and Due Diligence for Commercial Lenders NEW JERSEY BANKERS ASSOCIATION COMMERCIAL REAL ESTATE CONFERENCE JUNE 29, 2017

2 Agenda Why does due diligence matter? The Mechanics of due diligence A Few Challenges The significance of due diligence Summary

3 Why Due Diligence Matters

4 Why Due Diligence Matters Financial Action Task Force o Took exception to how easy it is in the U.S. to form a legal business entity A relatively small fee and a few minutes of time o Took exception to how easy it is in the U.S. to form a legal business entity without clearly identifying yourself Registered agents Delaware companies Wyoming companies Nevada companies o Begs the question How can you have a top flight AML regime when businesses and owners have a low barrier to entry and can so easily hide themselves behind the corporate veil?

5 Why Due Diligence Matters Banks, bank holding companies, and their subsidiaries are required by federal regulations to file a SAR with respect to: o Transactions conducted or attempted by, at, or through the bank (or an affiliate) and aggregating $5,000 or more, if the bank or affiliate knows, suspects, or has reason to suspect that the transaction: Has no business or apparent lawful purpose or is not the type of transaction that the particular customer would normally be expected to engage in, and the bank knows of no reasonable explanation for the transaction after examining the available facts, including the background and possible purpose of the transaction

6 The Mechanics of Due Diligence During the underwriting process we are gathering all sorts of customer risk data but we call it credit risk o Financial health o Business strategy details o Banking transactions o Ownership structure(s)

7 The Mechanics of Due Diligence The customer risk is closely tied to credit risk o Financial health Is it too good to be true based on the business? o Business strategy details Who are our customer s customers? o Banking transactions Do bank statements show exotic transactions? o Ownership structures Who owns or benefits from the business?

8 The Mechanics of Due Diligence Beneficial Owner: o A natural person who directly or indirectly owns 25% or more equity in the entity for which the Bank is establishing an account for Indirectly means owned through another business entity LLC 3 is opening an account with the Bank LLC 3 is owner by Asaad and his business partner, but his business partner owns LLC 3 though his subsidiary company LLC 2, which incidentally he owns through his holding company LLC 1

9 The Mechanics of Due Diligence New requirements During the account opening process, banks need to identify any beneficial owners of any entity seeking to open an account with the bank o In the Branch this is accomplished by simply asking: Are you the sole owner of the entity or are there other equity owners? Follow up question Are you the sole person in control of the entity or is that someone else? o In commercial lending this should all be identified during the underwriting process The customer can then sign the certification form used by the Bank including the names and information about the beneficial owners o And of course provide the Name, Address, D.O.B. and SSN of those identified on the certification o Happens at closing if not before closing

10 The Mechanics of Due Diligence The Bank still needs to verify the identity of the Beneficial Owners o Documentary verification Unlike CIP copies of documents are acceptable o Non-documentary verification Exactly the same as CIP The Bank should then have a clear policy for how it will complete the documentary and non-documentary verifications o Including what happens if the identity cannot be verified

11 The Mechanics of Due Diligence The commercial loan question o Many institutions require the customer to also open a deposit account at or before loan closing Won t they handle this requirement through that mechanism instead of through commercial lending? Commercial loan closing will still require this information be documented based on 31 CFR (g): o New account. For the purposes of this section, new account means each account opened at a covered financial institution by a legal entity customer on or after the applicability date.

12 The Challenges of the New Requirements What happens if a $1.5 million community development qualifying commercial loan with impeccable financials and strong underwriting is about to close, but the borrower has a silent partner in London who is unable or unwilling to provide copies of their ID to the Bank? o Do you not close the loan? o Do you make an exception to your BSA policy? o Do we close the loan but notate that the customer risk is different?

13 The Indirect Owner Challenge

14 The Indirect Owner Challenge For most smaller institutions a complex, multitiered indirect ownership structure will be a rarity o Single owners o Local partners o Family owned businesses For New Jersey banks, a complex, multi-tiered indirect ownership structure will be slightly more common o Real estate development and management companies o Science and technology companies o Proximity to international business center (NYC)

15 The Indirect Owner Challenge BSA compliance is driven by events o Event is an unofficial term that can be defined by When the Bank became aware of something In terms of the new rules and deposit account opening the Bank can rely on the customers honesty o Branches don t necessarily have the means to verify information at account opening Unfortunately the amount of information we collect for underwriting means we can t simply rely on customer honesty o In most cases we have the documentation to verify what the customer says

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17 The Indirect Owner Challenge How comfortable should the Bank be with an indirect beneficial owner structure? o Assessing the risk of indirect ownership Is indirect ownership a common structure for the type of business our customer is in? By industry Across our customer base Is there a legitimate business purpose to the indirect ownership of our customer? Tax benefit What is the nature of the business which indirectly owns our customer? Venture capital

18 The Indirect Owner Challenge How comfortable should the Bank be with a double, triple, or quadruple indirect ownership structure? o A function of risk Multiple layers of indirect ownership is quite normal in a real estate development or management deal Less common in a mechanics garage o A matter of policy How comfortable does the Bank want to be? Three or more layers of indirect ownership requires BSA Officer approval? Two or more layers of indirect ownership and we won t open the account?

19 The Significance of Due Diligence The Beneficial Ownership rules are clearly tied to the Customer Due Diligence ( CDD ) process FinCEN used this correlation to expand and codify their expectations for CDD going forward o Establish risk-based procedures for conducting ongoing customer due diligence, including the development of customer risk profiles and implementation of ongoing monitoring to identify and report suspicious activity and, on a risk basis, to update customer information CDD is now a pillar of the BSA/AML compliance program

20 The Significance of Due Diligence Due Diligence will now be a global concept within our BSA/AML program o Customer data and information will need to be decompartmentalized and shared throughout the organization (or at least with the BSA Department) The more complex the financial institution the bigger this challenge will be e.g., commercial lending is a treasure trove of customer risk data not usually obtained or verified by branches when opening an account Financial health Business strategy details Banking transactions Ownership structures

21 Summary The new due diligence expectations are likely not that new to those in commercial lending o However they require more attention to the customer risk instead of simply the credit risk Internal communication is crucial for commercial lenders and the success of the BSA program o Get involved with your BSA officer and the types of data/information you routinely collect for underwriting so they can build an effective compliance process Remember any event that impacts a customer maybe something the BSA officer needs to know o Don t just think due diligence stops when the loan closes, financial updates, new tax returns, etc. will all convey new and important customer risk information

22 Questions and Contact Asaad Faquir, MBA, MBS Director, RSK Compliance Solutions (855)