What is Ultimate Beneficial Ownership (UBO)?
B2C companies must perform a series of verification operations to verify the identities of their individual customers known as Know Your Customer (KYC). Similarly, companies with B2B clientele must do the same process for businesses; in AML taxonomy this is referred to as Business Risk Assessment or Know Your Business (KYB).
The regulatory requirements for KYB have significantly evolved over the last few years; this includes the FATF (Financial Action Task Force) enhancing its AML recommendations for dealing with businesses. These recommendations work in lockstep with the most important regulatory bodies worldwide, and the regulatory framework has become more specific and stringent with regards to KYB. In particular, this applies to how businesses can uncover and track the ultimate beneficiaries of a business or Ultimate Beneficial Ownership.
It is common for nefarious actors to hide behind corporate structures (think of shell company and Ponzi schemes) to avoid regulatory frameworks, including AML. One such example was Bernie Madoff, who used his brokerage firm to run a Ponzi scheme that resulted in losses worth more than $60 billion, the largest financial fraud in history (he was arrested in 2008 and then died in federal prison April 2021). Another example is Barry Minkow, who created what appeared to be a very successful company (even leading the company through an IPO) that was in fact extremely fraudulent and resulted in losses of over $100 million. Minkow’s scheme is considered to be one of the largest investment and accounting fraud schemes in history, and as a result, and in part due to additional crimes he has committed since, Minkow is expected to pay over $600 million in restitution. These structures can be complex and difficult for financial crime analysts to untangle. As such, the regulatory framework for KYB is currently largely focused on providing visibility into these structures to ensure businesses understand who they are truly doing business with.
What is Ultimate Beneficial Ownership (UBO)?
Each transaction has a person or entity behind it. An Ultimate Beneficial Owner (also known as Ultimate Beneficial Ownership and UBO) is the legal entity or beneficiary (the person who profits) behind a transaction and verifying that identity is a critical component of complying with Know Your Business and Know Your Customer measures. UBO falls under customer due diligence (CDD), the process of assessing the risk associated with customers and verifying that customers are who they say they are to determine whether you should be doing business with them.
While regulations regarding UBOs vary globally across jurisdictions, they tend to remain comparable to the United States’ FinCEN (Financial Crime Enforcement Network) CDD Rule and the European Union’s 4th and 5th Anti-Money Laundering Directives (4AMLD and 5AMLD, respectively), all of which are intended to guarantee a more robust approach to assessing risk and strengthening anti-money laundering measures, specifically when it comes to tackling UBOs.
The Customer Due Diligence Rule
Having gone into effect in 2018, the FinCEN CDD Rule has four primary requirements to ensure financial institutions are being financially transparent while also deterring bad actors’ nefarious behavior.
The four requirements are:
- 01. That the identities of customers are identified and verified.
- 02. That the identities of the beneficial owners behind companies opening accounts are identified and verified. This includes “the identity of any individual who owns 25% or more of a legal entity, and an individual who controls the legal entity.”
- 03. That FIs develop customer risk profiles by better understanding “the nature and purpose of customer relationships.”
- 04. That ongoing monitoring is used to “identify and report suspicious transactions and, on a risk basis, to maintain and update customer information.”
4AMLD & 5AMLD
In Europe, 4AMLD laid the groundwork for CDD requirements, including defining UBOs as “any natural person(s) who ultimately owns or controls the customer and/or the natural person(s) on whose behalf a transaction or activity is being conducted” and expanding the definition of politically exposed persons (PEPs) to include domestic or local-based rather than only foreign-based PEPs. Understanding and validating an identity against global PEP lists is an important factor when determining if a customer (and thus the UBO) is trustworthy. 5AMLD built upon 4AMLD by introducing stricter guidelines for UBOs and determining who can be considered an owner as well as the recordkeeping required when keeping track of said individuals. In Europe this includes any person(s) that has a 25% share or holds significant ownership or control (including shareholders).
The importance of KYB
Know Your Business is the process by which a business assesses and characterizes the risk associated with a business entity that is a client. For financial institutions and other regulated entities, the AML program, which includes KYB, is required for staying compliant with industry regulations.
Having a business as a customer rather than a sole individual typically requires more due diligence because there is more to verify. In this case, there are likely multiple UBOs that need to be checked as well, highlighting why the use of KYB is critical for protecting one’s business and deterring fraud.
The state of the technology currently used to uncover the UBOs behind a business is still largely in development, and while there are databases that connect businesses with directors, executives and those that register the companies as customers, there is no robust existent magical map (i.e., database) between businesses and UBOs. Even so, regulators expect companies to use and leverage the currently available databases as part of KYB.
Tracking the true UBOs behind a business still requires close interaction with the client; this also includes the extensive evaluation of documents such as the articles of incorporation, source of wealth and bank records. Today, the best KYB platforms will allow companies to access these databases, create records between a business and its potential UBOs, perform KYC on these UBOs (as individuals) and support all investigative and operational workflows that are necessary for tracking the data, so that the accessed information is readily available for proper analysis and reporting by regulators and relevant parties.
Utilizing the right risk mitigation strategies and maintaining a robust compliance program that includes KYB, particularly with the proper due diligence for UBOs, is both a regulatory requirement and key for protecting your business from those that would hide behind corporate structures with nefarious intent.
Learn why KYB is key for compliance by reading our guide: Know Your Business: what you need to know.