Bridging the Week by Gary DeWaal


Bridging the Week by Gary DeWaal: May 2 – 6 and 9, 2016 (AML CIP; Ether; LOPR; Variable Annuities)

AML and Bribery    Bitcoin Ecosystem    Bridging the Week    Position and Trade Reporting    Position Limits    Uncleared Swaps   
Published Date: May 08, 2016

The Financial Crimes Enforcement Network finalized rules that will impose new due diligence requirements on banks, broker-dealers, futures commission merchants, mutual funds and introducing brokers when opening new accounts for legal entity customers (e.g., corporations). In addition, the New York State Department of Financial Services approved the trading of a new digital currency, Ether, on a previously approved cryptocurrency exchange. As a result, the following matters are covered in this week’s edition of Bridging the Week:

  • FinCEN Finalizes Rules Requiring Banks, Broker-Dealers, FCMs, Mutual Funds and IBs to Help Verify Beneficial Owners of Certain Accounts (includes Compliance Weeds);
  • NYS Approves Trading of Ether, a Bitcoin Alternative Cryptocurrency;
  • FINRA Reminds Members of Large Options Positions Reporting Requirements;
  • Broker-Dealer Sanctioned US $25 Million by FINRA for Variable Annuity Sales Offenses; and more.

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Article Version:

FinCEN Finalizes Rules Requiring Banks, Broker-Dealers, FCMs, Mutual Funds and IBs to Help Verify Beneficial Owners of Certain Accounts:

The Financial Crimes Enforcement Network finalized rules requiring banks, broker-dealers, future commission merchants, introducing brokers and mutual funds (collectively, “covered firms”) to identify the beneficial owners of their legal entity customers. Currently such entities are mandatorily required to know the identity of each of their legal entity customers, but not necessarily their beneficial owners.

FinCEN also adopted rules making explicit the obligation of covered firms to understand the nature and purpose of their customer relationships in order to develop customer risk profiles, as well as to conduct ongoing monitoring for reporting suspicious transactions and, on a risk-basis, maintaining and updating customer information.

Under FinCEN’s new rules, covered firms must establish and maintain written procedures reasonably designed to identify and verify the identities of beneficial owners of legal entity customers unless such customers are expressly excluded (e.g., certain US or non-US regulated financial entities).

Beneficial owners include each real person who directly or indirectly has a 25 percent or more equity ownership interest in the legal entity customer, and a single individual with “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.” Legal entity customers include corporations, limited liability companies, partnerships and other similar business entities.

A covered firm must evidence its compliance with FinCEN’s new requirements by obtaining a mandatory certification form from a legal entity customer that identifies its beneficial owners or by receiving the information required by the form (i.e., for each beneficial owner, name, date of birth, address, and social security number, or for non-US persons, passport number) by another means with an appropriate certification. A covered firm must also verify the identity of each enumerated beneficial owners according to risk-based procedures that contain the elements required for verifying the identity of individuals under FinCEN’s existing relevant rules through documents or non-documentary methods (i.e., Customer Identification Program requirements (click here for a background on these requirements)). However, a covered firm may use photocopies or reproductions of original documents in connection with such verification.

FinCEN’s new requirements only apply in connection with the establishment of new accounts and will not ordinarily apply retroactively. However, a covered firm may have an obligation to obtain beneficial ownership information for an older account, if concerns about the account arise during ongoing monitoring.

If an intermediary is a covered firm’s customer and the covered firm currently has no FinCEN obligation today with respect to the underlying clients of the intermediary under CIP, the firm should treat the intermediary (not the intermediary’s underlying clients) as its legal entity customer.

Under FinCEN’s new rules, one covered firm may delegate its responsibilities to another covered firm, but only pursuant to a written contract that includes certain enumerated obligations.

In adopting its new rules, FinCEN expressed its belief that the new formal obligation of covered firms to understand the nature and purpose of their customer relationships and to conduct ongoing monitoring for reporting suspicious transactions are already implicit obligations of covered firms in connection with their suspicious activity reporting requirements.

As part of its new rules, FinCEN formally stated each of the elements of an acceptable anti-money laundering program for covered firms. The provisions are generally the same for each type of covered firm and include the following elements:

  • establishment and maintenance of polices, procedures and internal controls reasonably designed to prevent the firm from being used for money laundering or terrorist financing;
  • independent testing;
  • designation of an individual(s) responsible for implementing and maintaining the firm’s AML program; and
  • adoption of “appropriate” risk-based procedures for ongoing customer due diligence, knowing customers and ongoing monitoring to identify and report suspicious activities and to update customer information.

All covered firms except mutual funds are also expressly required to conduct training of appropriate persons under the new rules.

Covered firms must comply with FinCEN’s new rules beginning May 11, 2018. FinCEN is part of the US Department of Treasury. FinCEN initially proposed adoption of the new rules in March 2012.

Simultaneously with issuance of FinCEN's new rules, the US Department of Treasury announced its proposal for a new federal law that would require companies to report to it information regarding their beneficial ownership at the time of their creation.

Compliance Weeds: As under FinCEN’s existing CIP rules, an account for a futures commission merchant under its new beneficial ownership rules appears to be a clearing account, not an execution account. There are no CIP obligations for execution accounts. For broker-dealers, an account appears to be both a clearing and an execution account, however. That being said, in its commentary in connection with adoption of the its final rule for FCMs, FinCEN noted that “all account relationships, and not only those which are ‘accounts’ within the CIP rule definitions …must be monitored in some form in order to comply with existing [suspicious activity reporting] requirements.”

Briefly:

  • NYS Approves Trading of Ether, a Bitcoin Alternative Cryptocurrency: The New York State Department of Financial Services authorized the Gemini Trust Company, LLC to offer the trading of Ether, a new digital currency, on its virtual currency exchange based in New York City. In October 2015, the NYDFS granted Gemini Trust Company a charter under the New York Banking Law to operate a Bitcoin exchange. Ether is a cryptocurrency like Bitcoin whose transactions are recorded on a blockchain known as Ethereum. As a condition of its charter, the Gemini Trust Company is required to comply fully with NYDFS’ BitLicense regulatory framework. (Click here for details of this framework in the article “NYDFS Issues BitLicense Framework for Regulating Virtual Currency Firms” in the June 7, 2015 edition of Bridging the Week.)
     
  • FINRA Reminds Members of Large Options Positions Reporting Requirements: The Financial Industry Regulatory Authority issued a reminder to members regarding their obligation to timely report large options positions to the Large Options Position Reporting (“LOPR”) system as required by applicable rules. FINRA requires members to report or have reported on their behalf any options position in any account or multiple accounts where the firm or any customer, whether alone or in concert, maintains an aggregate position of 200 or more options contracts (whether long or short) of the put class and the call class on the same side of market for the same underlying security or index. All positions must be reported to LOPR by no later than close of business on the business day following the day the transaction or transactions happened that necessitated the filing. Where aggregate positions meet the 200-contract threshold, the option position of each individual account must be reported. Accounts must be aggregated when they are under common control or acting in concert. Control is presumed for all parties to a joint account who have authority to act on behalf of the account; all general partners of a partnership account; a person or entity that has a 10 percent or more ownership interest in an entity or shares 10 percent or more of an account’s profits and losses; accounts with common directors or management; or an individual or entity who has authority to execute transactions in an account.
     
  • Broker-Dealer Sanctioned US $25 Million by FINRA for Variable Annuity Sales Offenses: MetLife Securities, Inc. agreed to pay fines and restitution totaling US $25 million to resolve allegations by the Financial Industry Regulatory Authority it had made material misrepresentations or omissions to “tens of thousands” of customers from 2009 through 2014 in connection with the replacement of one variable annuity for another. According to FINRA, “[e]ach misrepresentation and omission about the cost or guarantees associated with the existing VA made the replacement appear more beneficial to the customer, even thought the replacement VAs were typically more expensive than the existing VAs.” FINRA also claimed that MetLife failed to adequately train its registered representatives “on how to conduct a comparative analysis of material features of the existing and proposed VAs.” This, said FINRA, constituted a supervisory failure. MetLife’s sanctions include a fine of US $20 million and restitution of US $5 million.

And more briefly:

  • CFTC Issues Final Rules Regarding the Material Terms for Swap Portfolio Reconciliation: The Commodity Futures Trading Commission approved a final rule to make clear that swap dealers and major swap participants must only exchange the “material terms” of swaps in connection with their ongoing obligation to provide swap counterparties with data to reconcile their swap portfolios. Material terms include only minimum primary economic terms as defined in the CFTC’s rules (click here to access Appendix 1 to Part 45). The final rule is generally consistent with prior CFTC staff no action letters. (Click here for information on the CFTC’s proposed rule in the article, “CFTC Proposes to Amend Definition of 'Material Terms' to Reduce Reconciliation Obligations of Swap Counterparties” in the September 20, 2015 edition of Bridging the Week.)
     
  • ESMA Revises Standards on Commodity Derivatives and Other Non-Equity Position Limits: The European Securities and Markets Authority proposed amendments to draft Regulatory Technical Standards under the Markets in Financial Instruments Directive II and Regulation to lower the position limits for liquid derivatives with agricultural products as an underlying to 2.5 percent. ESMA also proposed that where deliverable supply and open interest significantly diverge, other months’ positions limits should also be adjusted. Under MiFID II and MiFIR, national regulators will implement position limits for derivatives subject to general parameters established by ESMA. It is proposed that spot month position limits will be based on deliverable supply while other months (including all months) limits will be a function of total open interest. (Click here for details regarding proposed European position limits in the article, “ESMA Publishes Final Technical Standards for MiFID II” in the October 4, 2015 edition of Bridging the Week.)
     
  • Fed Proposes Restrictions on Counterparties to Biggest Banks From Cancelling Certain Non-Cleared Financial Contracts After a Bank Enters Bankruptcy: The Board of Governors of the Federal Reserve System proposed a rule that would require US global systemically important banking institutions to amend their contracts for certain common financial transactions to preclude the immediate termination of such contracts if a firm enters bankruptcy or a resolution process. Relevant contracts – termed “qualified financial contracts” – that would have to be amended include those used for derivatives, securities lending and short time financing such as repurchase agreements. Relevant institutions could comply with the FRB’s requirements by using qualified financial contracts that are modified by the International Swaps and Derivatives Association 2015 Resolution Stay Protocol.
     
  • NFA Begins Accepting Margin Models for Uncleared Swaps for Review: The National Futures Association began accepting risk-based initial margin models for review from swap dealers for their uncleared swaps. Previously, NFA announced that it would review and approve such margin models. Under recently adopted rules of the Commodity Futures Trading Commission related to uncleared swaps, relevant SDs may use a standardized methodology to calculate margin requirements or use an internal model approved by the CFTC or NFA.
     
  • CFPB Proposes to Prohibit Arbitration Clauses by Banks: The Consumer Financial Protection Board proposed rules that would prohibit certain providers of financial products and services to consumers from including an arbitration clause in any agreement between them that would foreclose a consumer from participating in a class action against the provider in court. Impacted providers would include most banks, other entities that provide financing to consumers, and companies that extend or broker automobile leases. Comments may be submitted to the CFPB for 90 days after publication of the proposed rule in the Federal Register.

For more information, see:

Broker-Dealer Sanctioned US $25 Million by FINRA for Variable Annuity Sales Offenses:
http://www.finra.org/sites/default/files/MSI_AWC_050316.pdf

CFTC Issues Final Rules Regarding the Material Terms for Swap Portfolio Reconciliation:
http://www.cftc.gov/idc/groups/public/@newsroom/documents/file/federalregister050216.pdf

CFPB Proposes to Prohibit Arbitration Clauses by Banks:
http://files.consumerfinance.gov/f/documents/CFPB_Arbitration_Agreements_Notice_of_Proposed_Rulemaking.pdf

ESMA Revises Standards on Commodity Derivatives and Other Non-Equity Position Limits:
https://www.esma.europa.eu/press-news/esma-news/esma-amends-mifid-ii-standards-non-equity-transparency-and-position-limits

Fed Proposes Restrictions on Counterparties to Biggest Banks From Cancelling Certain Non-Cleared Financial Contracts After a Bank Enters Bankruptcy:

http://www.federalreserve.gov/newsevents/press/bcreg/bcreg20160503b1.pdf

FinCEN Finalizes Rules Requiring Banks, Broker-Dealers, FCMs, Mutual Funds and IBs to Help Verify Beneficial Owners of Certain Accounts:
Anticipated final adopting release and rule:
https://s3.amazonaws.com/public-inspection.federalregister.gov/2016-10567.pdf

NFA Begins Accepting Margin Models for Uncleared Swaps for Review:
https://www.nfa.futures.org/news/newsNotice.asp?ArticleID=4719

The information in this article is for informational purposes only and is derived from sources believed to be reliable as of May 7, 2016. No representation or warranty is made regarding the accuracy of any statement or information in this article. Also, the information in this article is not intended as a substitute for legal counsel, and is not intended to create, and receipt of it does not constitute, a lawyer-client relationship. The impact of the law for any particular situation depends on a variety of factors; therefore, readers of this article should not act upon any information in the article without seeking professional legal counsel. Katten Muchin Rosenman LLP may represent one or more entities mentioned in this article. Quotations attributable to speeches are from published remarks and may not reflect statements actually made.


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