CDD Final Rule: Your Guide to Enhanced Customer Due Diligence

The financial industry is one of the most significant groups in the global economy as it ensures its stability. An important part of this task is the effective measures for the identification of the clients, namely, customer due diligence or CDD measures. The CDD Final Rule, implemented by the United States Financial Crimes Enforcement Network (FinCEN), is a major step in increasing the standards of transactions and fighting financial crimes like money laundering and terrorism financing.

What is the CDD Final Rule?

The Customer Due Diligence Final Rule simply refers to the regulatory framework that has been developed to streamline the requirements for US financial institutions and it was issued by FinCEN.

The Customer Due Diligence Rule was implemented in 2018 in addition to the existing AML and CTF CDD regulations, with the purpose of increasing the stringency of measures in customer identification and verification.

Key Changes in the CDD Final Rule

The guidelines included in the CDD Final Rule have been changed and updated several times after its release and the amendments affect AML solutions and the compliance of the banking and finance institutions. 

Such change may require financial institutions to impose certain penalties such as fines hence the need for such institutions to keep abreast with the change. Here are the major changes to expect in the final Customer Due Diligence rules:

1. Expanded Definition of Beneficial Owners

• In 2021, FinCEN released its plan for the amendments of beneficial ownership which included entities like trusts and shell companies for the first time. This change means that institutions need to obtain extra data for the identification and confirmation of the beneficial owners of such a complex legal structure.
• A new rule with respect to the financial institutions is that they need to upgrade their AML compliance software and mechanism of screening records and looking for UBOs (AKA Ultimate Beneficial Owners) of these newly added entities.
• The FinCEN customer due diligence final rule requires financial institutions to identify and verify the beneficial owners of legal entity customers. So, the CDD beneficial ownership final rule helps ensure that criminals cannot hide behind anonymous entities.

2. Streamlined Certification Process

• The CDD Final Rule requires financial institutions to state and assure that they have gathered and verified all the essential information of their customers’ beneficial owners.
• In 2020, FinCEN issued guidance on how it would simplify this certification process and that will let the financial institutions rely on the third-party service providers. This alteration is designed to help minimize the paperwork in the financial industry while retaining the quality of beneficial ownership identification measures.

3. Enhanced Customer Due Diligence

• Banks and other financial institutions are under obligation to engage in constant monitoring of their clients as a way of preventing fraudulent transactions.
• In 2020, the US FinCEN issued new guidance that elaborated the enhanced due diligence (EDD) by indicating which fields of extra information on the sources of funds of customers and the purpose of their accounts must be filled in by financial institutions. That is why this enhancement can assist financial institutions in the understanding of their customers’ risk profile as well as recognize possible signs of a risk for additional considerations.

Read more: What is Enhanced Due Diligence (EDD): A Comprehensive Guide 2024

4. Risk-Based Approach‍

• The CDD Final Rule emphasizes the use of a risk-based approach (also known as RBA) for assessing the identity of customers and the corresponding beneficial owners. The risk assessment should be comprehensive and should be conducted by the financial institutions themselves, each on their own customers, and the procedure of due diligence should be specific to the risks involved. FinCEN released in 2021 guidelines to help the financial institutions in implementing the risk assessment in the CDD Final Rule.

These core change areas in the CDD Final Rule need the attention of financial institutions, they must review their AML compliance solutions and set up their CDD requirements more aligned with these changes in the regulations. In this manner the agencies can help fight financial crimes like money laundering and terrorist financing, all while preserving the financial system as a whole.

Core Principles of the CDD Final Rule

According to the Financial Crimes Enforcement Network (FinCEN), the CDD Final Rule is based on four significant factors for effective customer due diligence:

1. Get to Know Your Customer (KYC) and Authenticate: Financial institutions must have adequate measures in place to identify their customers and validate data such as legal name, date of birth, and/or address.

2. Determine if your customer has the usufruct right: Before considering customer risk profile, financial institutions should understand the type of relationship it has with those customers. This involves establishing whether the customer has the legal right of usufruct.

3. Identify your customer's risk profile with an accurate customer risk assessment: Financial institutions must determine the risk of their customer based on the geographical location of customers, customers’ industries and products and services consumed. Thus, according to the identified risks, financial institutions are able to apply adequate CDD measures to minimize threats.

4. Comply with a risk-based process to ensure that your risk situations are continuously reported: The CDD Final Rule includes continued checking of customers’ accounts and transactions with the purpose of identifying and reporting suspicious activities. AML CDD procedures help in identifying any activities related to money laundering.

In addition to these four core factors, the CDD Final Rule also places a strong emphasis on Ultimate Beneficial Owner (UBO) Practices:

• Financial institutions must identify and verify the identity of the beneficial owners (the individual(s) who ultimately own or control a legal entity customer) of their legal entity customers.
• Customer due diligence requirements for financial institutions include having information about the beneficial owners of accounts. 

Importance of the CDD Final Rule in Combating Financial Crime

Enhancing customer identification and verification is not the only importance of the rule, the rule aims at:

1. Increasing transparency, especially when it comes to the source of funds.
2. Preventing money laundering, which is the most prominent point.
3. Protecting the financial system & maintaining public trust.

Establishing Beneficial Ownership

A key component of the CDD Final Rule is the identification and verification of beneficial owners. Financial institutions must:

1. Identify and verify the identity of any individual who owns 25% or more of the equity interests of a legal entity customer, as well as the individual who has a significant responsibility to control, manage, or direct the legal entity customer. This information must be obtained through a certification from the legal entity customer.
   
2. Verify the identities of the beneficial owners using reliable, independent source documents, data, or information. This may include reviewing government-issued identification, such as passports or driver's licenses, as well as other publicly available information or third-party data sources.

CDD Rule Red Flags Related to Beneficial Ownership

Financial institutions should be alert to potential red flags and warning signs that may indicate attempts to obscure beneficial ownership, such as:

1. Complex Ownership Structures: Customers, who are legal entities, and have multiple levels of ownership or offshore companies, should be regarded as high-risk customers and should be investigated further.
2. Unwillingness to Provide Beneficial Ownership Information: If the customer is hesitant to provide complete and accurate information about the ownership, this should be considered as a potential risk since such an action is likely to conceal the ownership’s nature.
3. Frequent Changes in Beneficial Ownership: Investigation may be required if a legal entity customer has had any recent or multiple changes in the beneficial owners since it may be an effort to hide the real beneficial owners.

In such cases, financial institutions should raise their level of suspicion, conduct more scrutiny, and possibly file a Suspicious Activity Report (SAR) with the Department of Treasury’s Financial Crimes Enforcement Network (FinCEN) if called for. Hence, while ensuring that they do not compromise on their other responsibilities, financial institutions can help prevent the abuse of the financial system in the execution of unlawful crimes.

Conclusion

The CDD Final Rule is one of the important measures that the financial sector often use to fight financial crimes and protect the financial system around the world. With regard to the sources of customers’ funds, the customer due diligence measures and identification and verification of the beneficial owners are crucial to learn more about the customers’ sources of funds.