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In an ever-changing business environment and a digital economy, understanding and mitigating risks have become more critical. In order to protect themselves and their consumers, businesses need to implement strong safeguards to combat fraud, money laundering, terrorist financing, and other illegal activities. Confirming a business’s legitimacy and authenticity becomes crucial before engaging in financial transactions or collaborations. Know Your Business (KYB) serves as a collection of processes and procedures that allow organizations to properly understand and verify their business partners’ or customers’ identity, ownership, credibility, and operations.
Importance of KYB for Businesses
Due to the increasing number of anti-money laundering (AML) and counter-terrorism financing (CTF) regulations, businesses must ensure they are not aiding criminal operations or engaging in fraudulent activities. KYB is a proactive procedure to reduce these risks and safeguard organizations from potential reputational damage, financial losses, and legal liabilities.
In the United States (U.S.) KYB is part of the customer due diligence (CDD) final rule, which amended the Bank Secrecy Act (BSA) regulations to improve financial transparency and prevent criminals and terrorists from misusing companies for their illegal activities. Before this amendment, the BSA had provisions for conducting due diligence on individual customers. However, criminals took advantage of the fact that businesses did not undergo the same level of scrutiny, creating a vulnerable spot for them to exploit. Not only did criminals hide under legitimate businesses to commit crimes and launder money, but many shell companies were also created for the same purpose.
In May 2018, the Financial Crimes Enforcement Network(FinCEN) implemented the CDD final rule to address this blind spot. This new regulation requires financial institutions to identify and verify the beneficial owners when opening accounts for legal entities. The beneficial ownership requirement will address this weakness and provide information that will assist law enforcement in financial investigations, help prevent evasion of targeted financial sanctions, improve the ability of financial institutions to assess risk, facilitate tax compliance, and advance U.S. compliance with international standards and commitments. KYB regulations apply to financial institutions, credit institutions, trusts, cryptocurrency service providers, gambling services, etc.
KYC vs. KYB
Know Your Customer (KYC) and Know Your Business are similar procedures focused on making financial transactions safer and preventing financial crimes. However, they cater to different types of customers. While KYC focuses on individual customers, KYB focuses on legal entities, such as businesses or companies.
What are Shell Companies?
Shell companies are high-risk businesses with financial assets but no significant business activity, directors, or publicly known owners. They have no employees or revenue, but money flows in and out regularly. While they have legitimate uses, criminals often use shell companies for tax evasion, money laundering activities, and to conceal the identity of the owners behind the business.
Components of KYB
1. Customer Identification and Verifications
In the first step of the KYB process, financial institutions collect the necessary information for the verification of the business’s legitimacy and legal existence. Examples of data collected for identification and verification include:
- Business name and address
- Business registration documents
- Licensing documentation
- Taxpayer ID number
2. Beneficial Ownership Identification and Verification
Beneficial owners are the true owners, decision-makers, and controllers of the business or legal entity. A beneficial owner is:
- An individual who directly or indirectly owns 25 percent or more of a legal entity, financial institutions are also allowed to establish a lower percentage threshold for beneficial ownership (i.e., one that regards owners of less than 25 percent of equity interests as beneficial owners) based on their assessment of risk.
- A single individual with significant responsibility to control, manage, or direct a legal entity.
Procedures and Obligations:
Financial institutions must have and maintain documented procedures designed to identify and verify the identities of the beneficial owners of the business. This process is similar to those for individual customers under KYC’s customer identification program (CIP).
- Financial institutions have an obligation to collect information about a business’s beneficial owners when opening an account. This can be done using FinCEN’s certification form, their own forms that meet the approved requirements, or any other means that comply with the substantive provisions. According to CIP, the four minimum pieces of information to collect include the Name, Address, Date of birth, and Taxpayer Identification Number (i.e., government-issued ID).
- In verifying, financial intuitions are to use risk-based procedures to verify the existence of the individual, not just his status as a beneficial owner.
- Financial institutions must have sufficient information to reasonably believe the identities of beneficial owners. If they cannot form such a belief, they should have procedures in place to handle the situation.
- Financial institutions must determine if beneficial owners appear on any government or regulatory sanctions or criminal lists. Afterward, they should decide when it is necessary to conduct additional screening.
- In addition, financial institutions must have procedures for maintaining records of all information collected and used for identity verification. They must also retain the records for the stipulated periods.
3. Understanding the Nature and Purpose of Customer Relationships to Develop Risk Profile
To establish a robust framework for reporting suspicious activities, financial institutions need to understand the nature and purpose of their customer relationships. Subsequently, they must assess the behavior of their clients based on this understanding. This is called a customer risk profile.
- At account opening, financial institutions should obtain information sufficient to understand the regular activity of the customer’s occupation or business.
- They are to collect information regarding customer type, account type opened, or service or product offered.
- Other relevant facts could include basic information about the customer, such as annual income, net worth, domicile, principal occupation or business, and, in the case of long-standing customers, the customer’s history of activity.
4. Maintaining and Updating Customer Information on a Risk-Based Basis to Identify and Report Suspicious Transactions
- Financial institutions must apply existing procedures consistent with CTR regulations for currency transaction reporting (CTR) purposes.
- They are to use existing CTR regulations to determine when to file a suspicious activity report (SAR).
Cost of KYB Compliance
Complying with the rules and regulations of Know Your Business (KYB) comes at high costs, including the following:
- Staff training costs
- Expenses incurred from revising compliance policies and procedures.
- Costs from onboarding new accounts
- Costs from Information technology upgrades
- Cost from internal controls and audit functions for financial institutions.
- Clients will spend additional time at account opening.
However, complying with these regulations will have a significant impact on reducing illicit activities in the country. It will also prevent financial institutions from incurring reputational damages and legal issues. Additionally, all citizens benefit from the actions to mitigate these activities regardless of who pays for the prevention.
Benefits of KYB
- Reduces financial crimes and terrorist activity
- Assist financial investigations by law enforcement: Financial institutions’ collection of beneficial ownership information can provide law enforcement with critical details about suspected criminals who use legal structures to conceal their illicit activities, such as fraud and money laundering.
- It protects the integrity of financial systems and reduces how they are used for illicit activities.
- It encourages transparency from legal entities in their dealings.
- Improves the ability of a financial institution to access and mitigate risk and comply with BSA regulations.
- It facilitates tax compliance and sanctions evasion, thereby increasing tax revenue.
Challenges of KYB
- Expensive cost of compliance
- There are concerns about privacy and data protection related to beneficial ownership information. It contains personal data that may be at risk of falling into the wrong hands or being involved in data breaches if not handled appropriately.
- Businesses may decide to take their accounts abroad, leading to foregone profit.
- Beneficial ownership information may be prone to errors or manipulations.
- A legal entity can obscure the true beneficial owner or have complex ownership structures involving multiple legal entities, subsidiaries, and offshore companies. This can make it easy for criminals to evade the law.
Other Global Regulations for KYB
Apart from the US CDD final rule, the European Union’s Anti Money Laundering Directives (AMLD), especially under the 4th, 5th, and 6th AMLD, is another regulation on KYB. These directives specify rules for identifying and verifying beneficial owners and other standard practices, penalties, and punishments for KYB non-compliance. Entities are required to keep up-to-date ownership information in a central registry accessible to authorities and other relevant bodies or persons.
KYB in Cryptocurrency
The increasing adoption of cryptocurrency has brought about new challenges and risks to transactions because of its anonymity. It is easy for criminals to hide their money laundering, terrorist financing, and other fraudulent activities using cryptocurrency payment systems. Many regulations, including KYB regulations for cryptocurrency, are springing up worldwide to solve these challenges. Exchanges, wallets, and payment processors are now required to register with the relevant authorities in their jurisdictions, conduct customer due diligence to obtain and verify their individual customers and legal entities, and prepare suspicious activity reports where necessary.
KYB is a proactive approach to verifying business legitimacy by performing required customer due diligence using risk-based procedures. The nature of business transactions has undergone significant changes in recent times. Regulatory agencies have shifted their focus from merely knowing the customers to comprehending the businesses they represent. This includes a deeper understanding of the beneficial owners and controllers of those businesses. For an effective AML compliance framework, KYB and other processes are necessary.
As a company leading a blockchain technology that will be helpful in the finance industry, we also believe in the ability to reduce fraud and all irregularities in the financial world. More reason Identity.com doesn’t take the back seat in contributing to this future via identity management systems and protocols. We also belong to the World Wide Web Consortium (W3C), the standards body for the World Wide Web.
The work of Identity.com as a future-oriented company is helping many businesses by giving their customers a hassle-free identity verification process. Identity.com is an open-source ecosystem providing access to on-chain and secure identity verification. Our solutions improve the user experience and reduce onboarding friction through reusable and interoperable Gateway Passes. Please get in touch for more info about how we can help you with identity verification and general KYC processes.