Treasury and SEC Request Comment on Proposed Regulation Regarding Broker/Dealer Anti-Money Laundering Customer Identification Requirements

INFORMATIONAL

Comment Period Expires: September 6, 2002

Executive Summary

On October 26, 2001, President Bush signed into law the USA PATRIOT Act (PATRIOT Act). Title III of the PATRIOT Act, referred to as the International Money Laundering Abatement and Anti-Terrorist Financing Act of 2001 (Money Laundering Abatement Act), imposed obligations on broker/dealers under new anti-money laundering (AML) provisions and amendments to the Bank Secrecy Act (BSA) in an effort to make it easier to prevent, detect, and prosecute money laundering and the financing of terrorism.

Among other things, Section 326 of the Act required the Secretary of the Department of Treasury (Treasury) and the Securities and Exchange Commission (SEC or Commission) jointly to issue a regulation setting forth minimum standards for broker/dealers and their customers regarding customer identification in the account opening process.

On July 23, 2002, the Treasury and SEC published for comment the proposed regulation to implement Section 326.¹ The proposed regulation would require broker/dealers to, at a minimum: (1) adopt and implement reasonable procedures to verify the identity of any person seeking to open an account, to the extent reasonable and practicable; (2) maintain records related to the verification of the person's identity; and (3) determine whether the person appears on any lists of known or suspected terrorists or terrorist organizations provided by any government agency. The release was published in the Federal Register;² use this URL to view the text: www.treas.gov/FinCEN/section326brokerdealers.pdf.

Questions/Further Information

Questions regarding this Notice to Members may be directed to Kyra Armstrong, at (202) 728-6962, or Vicky Berberi-Doumar, at (202) 728-8905, both of the Department of Member Regulation; or Nancy Libin, at (202)-728-8835, or Grace Yeh, at (202) 728-6939, both of the Office of General Counsel, NASD Regulatory Policy and Oversight.

Background

Introduction

The PATRIOT Act is designed to deter and punish terrorists in the United States and abroad and to enhance law enforcement investigation tools by prescribing, among other things, new surveillance procedures, new immigration laws, and new and more stringent AML laws. The Money Laundering Abatement Act strengthens the AML provisions put into place by earlier legislation.

Among these obligations, broker/dealers are required to have in place as of April 24, 2002, an AML compliance program. NASD Rule 3011, which was approved by the SEC on April 22, 2002, requires that each member develop and implement, by April 24, 2002, a written AML program reasonably designed to achieve and monitor the member's compliance with the requirements of the BSA and the implementing regulations promulgated thereunder by the Treasury, including the obligation to establish reasonable customer identification and verification procedures. In addition to this Notice, members may also refer to Notice to Members 02-21 (April 2002), which provides guidance to members regarding the development of AML programs and procedures for account holder identification and verification.

Description of Proposed Regulation

The proposed regulation provides several definitions, which are briefly reviewed below.

1. Account. The proposed regulation defines "account" to include all types of securities accounts maintained by brokers or dealers.³ These include accounts to purchase, sell, lend, or otherwise hold securities or other assets, cash accounts, margin accounts, prime brokerage accounts that consolidate trading done at a number of firms, and accounts for repurchase and stock loan transactions.

2. Broker/dealer. "Broker/dealer" is defined to include any person registered, or required to be registered, with the Commission as a broker or dealer under the Securities Exchange Act of 1934 (Exchange Act), except persons who register, or are required to be registered, solely because they effect transactions in security futures products.⁴

3. Customer. "Customer" is defined as any person who opens a new account at a broker/dealer or is granted trading authority with respect to an account at a broker/dealer.⁵ Under this definition, a person who has an account at a broker/dealer prior to the effective date of the regulation would not be a customer. However, such a person becomes a customer if the person opens a new or different type of account. The proposed regulation also states that a person with trading authority prior to the effective date of the regulation is not a customer; however, any person who was granted trading authority after the effective date is a customer.

The proposed regulation does not apply to persons seeking information about an account (such as a schedule of transaction fees) if an account is not opened. Transfers of accounts from one broker/dealer to another that are not initiated by the customer are not covered by the proposed regulation.⁶ Examples of an account transfer not initiated by a customer include a merger, acquisition, or purchase of assets or assumption of liabilities.

4. Person. "Person" is defined to include natural persons, corporations, partnerships, trusts or estates, joint stock companies, associations, syndicates, joint ventures, any unincorporated organizations or groups, Indian tribes, and all entities cognizable as legal entities.⁷

5. U.S. person. "U.S. person" is defined as a U.S. citizen, or for persons other than natural persons, an entity established or organized under the laws of a State or the United States.⁸

6. Non-U.S. person. A "Non-U.S. person" is defined as a person that is not a U.S. person as that term is defined in the regulation.⁹

7. Taxpayer Identification number. "Taxpayer identification number" is defined to have the same meaning as determined under the provisions of Section 6109 of the Internal Revenue Code and the regulations of the Internal Revenue Service thereunder.¹⁰

Customer Identification Program

A key aspect of the proposed regulation is the requirement that broker/dealers establish and operate a customer identification program (CIP).¹¹ A CIP must be part of a firm's overall AML compliance program as required under Section 352 of the PATRIOT Act.¹² It must be approved by the most senior level of the firm, which can be the board of directors, managing partners, board of managers, or other governing body performing similar functions, or by persons authorized to approve such a program.¹³ A CIP's procedures also must enable the firm to form a reasonable belief that it knows the true identity of the customer.

Several factors must be considered in creating and developing CIPs. Firms should consider the types of identifying information available for customers and the methods available to verify that information. The release notes that while the proposed regulation sets forth certain minimum required information and suitable verification methods, firms should consider on an ongoing basis whether additional information and methods are appropriate. In addition, firms should consider the risks associated with their business operations. In considering the risks, firms should consider the following factors:

This last risk factor refers to shared accounts subject to a carrying or clearing agreement governed by NASD Rule 3230 or NYSE Rule 382.¹⁹ The proposed regulation notes that firms sharing accounts may share responsibilities pursuant to their clearing agreements. For example, the correspondent firm may undertake to obtain the identifying information while the clearing firm may undertake the verification. Nonetheless, the proposed regulation makes it clear that both firms are responsible for ensuring that each requirement in the regulation is met with respect to each customer. Therefore, broker/dealers must continually assess whether the other firm can be relied on to perform its responsibilities. A broker/dealer is expected to cease such reliance if it is no longer reasonable.

Required Information

A broker/dealer's CIP must have customers provide, at a minimum, certain identifying information before an account is opened for the customer or the customer is granted trading authority over an account. The firm must obtain from each customer, his or her:

• Name;
• 
   
• Date of birth, for a natural person;
• 
   
• Address(es):
•  
  • Residence and mailing (if different) for a natural person; or
  • 
     
  • Principal place of business and mailing (if different) for a person other than a natural person; and
• Documentary Number:
•  
  • For each customer that is a U.S. person, a taxpayer identification number (such as a Social Security number or employer identification number); or
  • 
     
  • For each customer that is a non-U.S. person,
  •  
    • a U.S. taxpayer identification number;
    • 
       
    • a passport number and country of issuance;
    • 
       
    • an alien identification card number; or
    • 
       
    • the number and country of issuance of any other government-issued document evidencing nationality or residence and bearing a photograph or similar safeguard.²⁰

Firms should determine whether other identifying information is necessary to form a reasonable belief concerning the true identity of each customer during this process. The proposed regulation notes that there may be certain situations or customers that may cause the firm to obtain additional information. CIPs should have guidelines for such situations to assist in making such determinations.

The Treasury and the SEC have proposed a limited exception to the requirement that a taxpayer identification number be provided prior to opening an account or the granting of trading authority. For new businesses that have applied for, but not received, employer identification numbers (EINs) from the Internal Revenue Service, the CIP may allow the EIN to be provided within a reasonable time after the account is opened. However, CIPs must require the broker/dealer to obtain a copy of the EIN application prior to the account opening or to the grant of trading authority.

Verification Procedures

The procedures for verifying the accuracy of the information must be undertaken within a reasonable time before or after an account is opened or a customer is granted trading authority. There is some flexibility in determining what is a reasonable time. The amount of time may depend on the type of account opened, whether the account was opened in person, and on the type of identifying information available. Although an account is opened, a firm may choose to place limits on the account until the customer's identity is verified. Therefore, firms may use a risk-based approach to determine when the identity of a customer must be verified relative to the opening of an account or the granting of trading authority.

The proposed regulation explains that the verification requirements would apply every time a person opens a new account at a firm or is granted trading authority with respect to an account. However, if a customer whose identification has been verified previously opens a new account or is granted new authority, the firm would not need to verify the customer's identity a second time, provided the broker/dealer (1) previously verified the customer's identity in accordance with procedures consistent with the proposed regulation; and (2) continues to have a reasonable belief that it knows the true identity of the customer.

Verification may occur through two methods: through documents and through non-documentary means. The means of verification may vary based on the type of customer and the method of opening an account. A CIP must discuss both methods and provide guidance on when it is appropriate to use either one or a combination of both.

Documents

CIPs must provide guidance concerning when it is appropriate to use documents to verify a customer's identity. The proposed regulation lists some suitable documents.

They include:

• For natural persons, an unexpired government-issued identification evidencing nationality or residence and bearing a photograph or similar safeguard.
• 
   
• For entities, documents showing existence such as registered articles of incorporation, a governmentissued business license, a partnership agreement, or a trust instrument.

Non-Documentary Means

A CIP must describe non-documentary verification methods and when these methods will be used in addition to, or instead of relying on, documents. The regulation provides for the exclusive use of non-documentary means (if necessary) due to the number of accounts opened over the Internet, the telephone, and the mail. Suitable non-documentary methods of verification include:

• contacting a customer after the account is opened (particularly, if the account is opened online or by mail);
• 
   
• obtaining a financial statement;
• 
   
• comparing the identifying information provided by the customer against fraud and bad check databases to determine whether any of the information is associated with known incidents of fraudulent behavior (negative verification);
• 
   
• comparing the identifying information with information available from a trusted third-party source, such as a credit report from a consumer reporting agency (positive verification);²¹ and
• 
   
• checking references with other financial institutions.

Other factors to consider include checking whether there is a logical consistency between the identifying information provided such as the customer's name; street address; zip code; telephone number, if provided; the customer's date of birth; and Social Security number.

Non-documentary methods should be used in certain situations, particularly when a firm cannot examine original documents. The following are examples of situations when non-documentary methods should be used:

• a person is unable to provide an unexpired government-issued identification document with a photograph or similar safeguard;
• 
   
• the firm is presented with unfamiliar documents to verify an identity;
• 
   
• the firm does not meet the customer face-to-face; or
• 
   
• there is a risk that the documents will not enable the firm to verify the customer's identity.

Also, in light of the increase in identity fraud, firms are encouraged to use nondocumentary methods, even when a customer has provided documents.

Use of Government Lists

The proposed regulation also requires reasonable procedures for determining whether a customer appears on any list of known or suspected terrorists or terrorist organizations provided by any government agency. This requirement applies only with respect to lists circulated by the federal government such as the list found on Treasury's Office of Foreign Assets Control (OFAC) Web Site (www.treas.gov/fac) and available on www.nasdr.com/money.asp under "OFAC List." Broker/dealers must have procedures for responding to circumstances when a customer is named on a list.²²

Customer Notice

The proposed regulation states that firms must give their customers notice of their identity verification procedures.²³ The CIP must include procedures for providing customers with adequate notice that the broker/dealer is requesting information to verify their identity. This requirement may be satisfied generally by notifying customers about the procedures a firm must comply with to verify their identities. The release also cites, as an example, posting a sign in a firm's lobby or providing customers with any form of written, electronic, or oral notice. Notice must be given before an account is opened or trading authority is granted.

Lack of Verification

As stated above, a broker/dealer should maintain an account for a customer only when it can form a reasonable belief that it knows the customer's true identity. However, a CIP must have procedures for responding to circumstances when a firm cannot form a reasonable belief.²⁴ There should also be guidelines for when an account will not be opened. Furthermore, a CIP should specify when an account should be closed after attempts have been made to verify a customer's identity. There should also be procedures for determining when a suspicious activity report (SAR) should be filed.²⁵

Recordkeeping

The proposed regulation requires procedures for maintaining records of information used to verify a person's identity, including name, address, and other identifying information.²⁶ Information that must be maintained includes all identifying information provided by a customer. A firm must make a record of each customer's name, date of birth (if applicable), addresses, and tax identification number or other number. Firms also must maintain copies of any documents that were relied on, evidencing the type of document and any identification number it may contain. Firms must make and maintain records of the methods and results of measures undertaken to verify the identity of a customer. These records must be maintained for five years after the date the account is closed or the grant of authority to effect transactions with respect to the account is revoked.

Exemptions

The proposed regulation provides that the Commission, with the concurrence of the Secretary of the Treasury, may exempt any broker/dealer that registers with the Commission from this requirement. Excluded from this exemptive authority are firms that register as broker/dealers solely because they deal in security futures products. In issuing such exemptions, the Commission and the Secretary will consider whether the exemption is consistent with the purposes of the BSA and in the public interest and may consider other necessary and appropriate factors.²⁷

Comments

Treasury and the SEC seek comment on all aspects of the proposed regulation, and specifically seek comment on the following issues:

Written comments may be mailed to FinCEN, Section 326 Broker-Dealer Rule Comments, P.O. Box 39, Vienna, Virginia 22183, or sent to e-mail address [email protected] with the caption "Attention: Section 326 Broker/Dealer Rule Comments" in the body of the text.

Written comments should be submitted in triplicate to the Secretary, Securities and Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549-0609. All submissions should refer to the File No. S7-25-02. Comments may also be submitted electronically at the following e-mail address: [email protected]. The file number should be included on the subject line if e-mail is used.

Written comments must be submitted to Treasury and the SEC on or before September 6, 2002.

Conclusion

NASD will update members when the proposed regulation becomes final. In the interim, NASD reminds members to comply with the provisions of the PATRIOT Act that currently apply to broker/dealers.

Endnotes

¹ 67 Fed. Reg. 48,306 (July 23, 2002).

² Treasury, jointly with other federal financial regulators, also separately issued customer identification requirements for banks and trust companies, savings associations, credit unions, mutual funds, futures commission merchants, and futures introducing brokers.

³ 67 Fed. Reg. 48,306 at 48,307.

⁴Id.

⁵Id.

⁶ The release notes that there may be times when a broker/dealer may need to verify the identity of customers associated with accounts it is acquiring. Procedures for the transfer of accounts are expected to be part of a firm's AML compliance program required under Section 352 of the PATRIOT Act.

⁷ 67 Fed. Red. 48,306 at 48,307. Broker/dealers that register solely because they effect transactions in security futures products will be subject to separate customer identification regulations issued jointly by Treasury and the Commodity Futures Trading Commission.

⁸Id.

⁹Id.

¹⁰Id. See also 26 U.S.C. 6109 (2002), which states that, generally speaking, the identifying number of an individual is his or her Social Security account number or employer identification number.

¹¹ 67 Fed. Reg. 48,306 at 48,307- 48,308.

¹² 31 U.S.C. 5318(h).

¹³ 67 Fed. Reg. 48,306 at 48,311.

¹⁴ Firms located in certain known money laundering areas, for example, may pose a greater risk than firms located in other areas. See 67 Fed. Reg. 48,306 at 48,308.

¹⁵ This refers to whether the account was opened in person or whether it was opened online, for example. See 67 Fed. Reg. 48,306 at 48,308.

¹⁶ A firm must determine if the account is a cash, margin, or prime brokerage account, for example. See 67 Fed. Reg. 48,306 at 48,308.

¹⁷ This could be short sales, block trades, repurchases, and reverse repurchase agreements, for example. See 67 Fed. Reg. 48 306 at 48,308.

¹⁸ 67 Fed. Reg. 48,306 at 48,308.

¹⁹ NASD Rule 3230 governs clearing agreements. It states, among other things, that all clearing or carrying agreements entered into by a member, except where any party to the agreement is also subject to a comparable rule of a national securities exchange, shall specify the respective functions and responsibilities of each party to the agreement. NYSE 382 also addresses carrying agreements and states, in part, that each carrying agreement shall identify and allocate the respective functions and responsibilities of the introducing and carrying organizations.

²⁰ A "similar safeguard" is included in the definition to permit for the use of any biometric identifier that may be used in addition to, or instead of, photographs.

²¹See NASD Notice to Members 02-21 at 6, which discusses the use of databases such as Equifax, Exertion and Lexis/Nexis. Please note that NASD is not endorsing any particular product, but offering the names as references.

²² 67 Fed. Reg. 48,306 at 48,310. See also NASD Notice to Members 02-21 at 6.

²³ 67 Fed. Reg. 48,306 at 48,310.

²⁴Id.

²⁵ 67 Fed. Reg. 40448 (July, 1, 2002).

²⁶Id.

²⁷ 67 Fed. Reg. 48,306 at 48,311.

²⁸See 67 Fed. Reg. 48,306 at 48,308. Section 103.122(c)(4) requires that a broker/dealer obtain from a customer before an account is opened or trading authority is granted a "documentary number."

²⁹ 31 CFR 103.35(a)(3) currently provides that a broker/dealer need not obtain a taxpayer identification number with respect to specified categories of persons opening accounts, such as (i) agencies and instrumentalities of Federal, State, local, or foreign governments; (ii) aliens who are ambassadors; ministers, career diplomatic or consular officers; naval, military or other attaches of foreign embassies and legations; and members of their immediate families; (iii) aliens who are accredited representatives of certain international organizations, and their immediate families; (iv) aliens temporarily residing in the United States for a period not to exceed 180 days; (v) aliens not engaged in a trade or business in the United States who are attending a recognized college or university, or any training program supervised or conducted by an agency of the Federal Government; and (vi) unincorporated subordinate units of a tax exempt central organization that are covered by a group exemption letter. The proposed regulation does not contain any exemptions from the Customer Identification Program requirements.

Attachment A — Federal Register Notice

SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 240

[Release No. 34-46192, File No. S7-25-02]

DEPARTMENT OF THE TREASURY

31 CFR Part 103

RIN 1506-AA32

Customer Identification Programs For Broker-Dealers

AGENCIES: Financial Crimes Enforcement Network, Treasury; Securities and Exchange Commission.

ACTION: Joint notice of proposed rulemaking.

SUMMARY: The Department of the Treasury, through the Financial Crimes Enforcement Network (FinCEN), and the Securities and Exchange Commission are jointly issuing a proposed regulation to implement section 326 of the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism (USA PATRIOT) Act of 2001 (the Act). Section 326 requires the Secretary of the Treasury to jointly prescribe with the Securities and Exchange Commission a regulation that, at a minimum, requires broker-dealers to implement reasonable procedures to verify the identity of any person seeking to open an account, to the extent reasonable and practicable; maintain records of the information used to verify the person's identity; and determine whether the person appears on any lists of known or suspected terrorists or terrorist organizations provided to the broker-dealer by any government agency.

DATES: Written comments on the proposed rule may be submitted to the Treasury Department and the Securities and Exchange Commission on or before September 6, 2002.

ADDRESSES: Because paper mail in the Washington area may be subject to delay, commenters are encouraged to email comments. Comments should be sent by one method only.

Treasury: Comments may be mailed to FinCEN, Section 326 Broker-Dealer Rule Comments, P.O. Box 39, Vienna, VA 22183, or sent to Internet address [email protected] with the caption "Attention: Section 326 Broker-Dealer Rule Comments" in the body of the text. Comments may be inspected at FinCEN between 10 a.m. and 4 p.m. in the FinCEN Reading Room in Washington, DC. Persons wishing to inspect the comments submitted must request an appointment by telephoning (202) 354-6400 (not a toll-free number).

Securities and Exchange Commission: Comments also should be submitted in triplicate to Secretary, Securities and Exchange Commission, 450 Fifth Street, NW, Washington, DC 20549-0609. Comments also may be submitted electronically at the following e-mail address: [email protected]. Comment letters should refer to File No. S7-25-02; this file number should be included on the subject line if e-mail is used. All comments received will be available for public inspection and copying at the Commission's Public Reference Room, 450 Fifth Street, NW, Washington, DC 20549-0102. Electronically submitted comment letters will be posted on the Commission's Internet web site (www.sec.gov). Personal identifying information, such as names or e-mail addresses, will not be edited from electronic submissions. Submit only information you wish to make publicly available.

FOR FURTHER INFORMATION CONTACT:

Treasury: Office of the Chief Counsel (FinCEN), 703/905-3590; Office of the Assistant General Counsel for Enforcement (Treasury), 202/622-1927; or the Office of the Assistant General Counsel for Banking & Finance (Treasury), 202/622-0480.

Securities and Exchange Commission: Division of Market Regulation, 202/942-0177 or [email protected].

SUPPLEMENTARY INFORMATION:

I. Background

A. Section 326 of the USA PATRIOT Act

On October 26, 2001, President Bush signed into law the USA PATRIOT Act.¹ Title III of the Act, captioned "International Money Laundering Abatement and Anti-terrorist Financing Act of 2001," adds several new provisions to the Bank Secrecy Act (BSA). See 31 U.S.C. 5311 et seq. These provisions are intended to facilitate the prevention, detection, and prosecution of international money laundering and the financing of terrorism.

Section 326 of the Act adds a new subsection (l) to 31 U.S.C. 5318 that requires the Secretary of the Treasury (Secretary) to prescribe regulations setting forth minimum standards for financial institutions and their customers regarding the identity of the customer that shall apply in connection with the opening of an account at the financial institution.

Section 326 applies to all "financial institutions." This term is defined very broadly in the BSA to encompass a variety of entities including banks, agencies and branches of foreign banks in the United States, investment companies, thrifts, credit unions, brokers and dealers in securities or commodities, insurance companies, travel agents, pawnbrokers, dealers in precious metals, check-cashers, casinos, and telegraph companies, among many others. See 31 U.S.C. 5312(a)(2).

For any financial institution engaged in financial activities described in section 4(k) of the Bank Holding Company Act of 1956 (section 4(k) institutions), the Secretary is required to prescribe the regulations issued under section 326 jointly with each Federal functional regulator appropriate for such financial institution. The Federal functional regulators include the Securities and Exchange Commission (Commission), the Commodity Futures Trading Commission (CFTC), and the banking agencies (banking agencies), namely, the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the Office of Thrift Supervision, and the National Credit Union Administration. Final regulations implementing section 326 must be effective before October 25, 2002.

Section 326 provides that the regulations, at a minimum, must require financial institutions to implement reasonable procedures for (1) verifying the identity of any person seeking to open an account, to the extent reasonable and practicable; (2) maintaining records of the information used to verify the person's identity, including name, address, and other identifying information; and (3) determining whether the person appears on any lists of known or suspected terrorists or terrorist organizations provided to the financial institution by any government agency.

In prescribing these regulations, the Secretary is directed to take into consideration the various types of accounts maintained by various types of financial institutions, the various methods of opening accounts, and the various types of identifying information available.

The following proposal is being issued jointly by Treasury and the Commission. It applies only to persons registered, or required to be registered, with the Commission as brokers or dealers under the Securities Exchange Act of 1934 (Exchange Act), except persons who register pursuant to paragraph (b)(11) of section 15 of the Exchange Act (15 U.S.C. 78o(b)(11)) solely because they effect transactions in security futures products. This class of brokers and dealers will be subject to regulations issued by Treasury and the CFTC separately. Regulations governing the applicability of section 326 to other financial institutions, such as those regulated by the banking agencies, will be issued separately as well. Treasury, the Commission, the CFTC and the banking agencies consulted extensively in the development of all rules implementing section 326 of the Act. All of the participating agencies intend the effect of the rules to be uniform throughout the financial services industry.

The Secretary has determined that the records required to be kept by section 326 of the Act have a high degree of usefulness in criminal, tax, or regulatory investigations or proceedings, or in the conduct of intelligence or counterintelligence activities, to protect against international terrorism. In addition, Treasury under its own authority is proposing conforming amendments to 31 CFR 103.35, which currently imposes requirements concerning the identification of bank customers.

B. Codification of the Joint Proposed Rule

The substantive requirements of the joint proposed rule will be codified with other BSA regulations as part of Treasury's regulations in 31 CFR part 103. To minimize potential confusion by affected entities regarding the scope of the joint proposed rule, the Commission is also proposing to add a provision in its own regulations in 17 CFR part 240 that will cross-reference the regulations in 31 CFR part 103. Although no specific text is being proposed at this time, the crossreference will be included in a final rule published by the Commission concurrently with the joint final rule issued by Treasury and the Commission implementing section 326 of the Act.

¹ Pub. L. 107-56.

II. Section-by-Section Analysis

A. Section 103.122(a) Definitions

Section 103.122(a)(1) Account. The proposed rule's definition of "account" is intended to include all types of securities accounts maintained by brokers or dealers. These include accounts to purchase, sell, lend or otherwise hold securities or other assets, cash accounts, margin accounts, prime brokerage accounts that consolidate trading done at a number of firms, and accounts for repurchase and stock loan transactions.

Section 103.122(a)(2) Broker-dealer. The proposed rule defines "brokerdealer" to include any person registered, or required to be registered, with the Commission as a broker or dealer under the Exchange Act, except persons who register, or are required to be registered, solely because they effect transactions in security futures products. These latter brokers or dealers, which register with the Commission pursuant to section 15(b)(11) of the Exchange Act, will be subject to a separate regulation issued jointly by Treasury and the CFTC implementing section 326.

Section 103.122(a)(3) Commission. The proposed rule defines "Commission" to mean the United States Securities and Exchange Commission.

Section 103.122(a)(4) Customer. The proposed rule defines "customer" as any person who opens a new account at a broker-dealer or is granted trading authority with respect to an account at a broker-dealer. Under this definition, a person who has an account at a brokerdealer prior to the effective date of the regulation would not be a "customer." However, such a person becomes a "customer" if the person opens a different account. Moreover, a person becomes a "customer" each time the person opens a different type of account at a broker-dealer. Thus, if a person opens a cash account and subsequently opens a margin account, the person would be a "customer" for verification purposes on both occasions.

Similarly, a person with trading authority prior to the effective date of the regulation is not a "customer." However, any person being granted trading authority after the effective date is a customer. This is true even if the person is granted trading authority with respect to an account that existed prior to the effective date or the person had been granted trading authority for another account prior to the effective date.

The requirements of section 326 apply to "customers" (i.e., persons opening new accounts or being granted trading authority), but do not apply to persons seeking information about an account such as a schedule of transaction fees, if an account is not opened. In addition, transfers of accounts from one brokerdealer to another that are not initiated by the customer, for example as a result of a merger, acquisition, or purchase of assets or assumption of liabilities, fall outside of the scope of section 326, and are not covered by the proposed regulation.²

Section 103.122(a)(5) Person. The proposed rule defines "person" as having the same meaning as that term is defined in section 103.11(z). Thus, the term includes natural persons, corporations, partnerships, trusts or estates, joint stock companies, associations, syndicates, joint ventures, any unincorporated organizations or groups, Indian Tribes, and all entities cognizable as legal entities.

Section 103.122(a)(6) U.S. person. The proposed rule defines "U.S. person" because U.S. citizens and persons incorporated under U.S. laws will be required to provide U.S. tax identification numbers whereas other persons, who may not have a U.S. tax identification number, will be required to provide other similar numbers. Thus, the rule defines "U.S. person" to mean a U.S. citizen or, for persons other than natural persons, an entity established or organized under the laws of a State or the United States.³

Section 103.122(a)(7) Non-U.S. person. The proposed rule defines a "Non-U.S. person" as a person that is not a "U.S. person" as that term is defined in the rule.

Section 103.122(a)(8) Taxpayer identification number. The proposed rule defines "taxpayer identification number" to have the same meaning as determined under the provisions of section 6109 of the Internal Revenue Code and the regulations of the Internal Revenue Service thereunder.

B. Section 103.122(b) Customer Identification Program

Section 326 of the Act requires the Secretary and the Commission to prescribe regulations requiring brokerdealers to implement and comply with "reasonable procedures" for: verifying the identity of customers "to the extent reasonable and practicable;" maintaining records associated with such verification; and consulting lists of known terrorists.

Paragraph (b) of the proposed rule sets forth the requirement that a brokerdealer must develop and operate a customer identification program ("CIP") and sets forth relevant factors for the design of CIP procedures. The degree to which a CIP is effective will be a function of a broker-dealer's assessment of these factors and the nature of its response to them (as manifested in the CIP's procedures and guidelines). In addition, as section 326 and the proposed rule provide, the reasonableness of the CIP also will be a function of what is practicable for the broker-dealer.

In developing and updating CIPs, broker-dealers should consider the type of identifying information available for customers and the methods available to verify that information. While certain minimum identifying information is required in paragraph (c) of this proposed rule and certain suitable verification methods are described in paragraph (d), broker-dealers should consider on an ongoing basis whether other information or methods are appropriate, particularly as they become available in the future.

Broker-dealers must also base their CIPs on the risks associated with their business operations. Some relevant risk factors to be considered are set forth in paragraph (b) and discussed below in general terms.⁴

The first risk factor to consider is the broker-dealer's size. For example, a large firm that opens a substantial number of accounts on any given day will have different risks than one that opens a new account no more than once or twice a month. The same is true with respect to a firm that has many branches as compared to a firm with one office.

The second risk factor is the location of the broker-dealer. Firms should assess whether they are located in areas where money laundering activities have been known to exist or that otherwise raise the risk that attempts will be made to open accounts for money laundering purposes.

The third risk factor is the method by which customers open accounts at the broker-dealer. Accounts opened exclusively on-line present different, and perhaps greater, risks than those opened in person on the firm's premises.

The fourth and fifth risk factors are the types of accounts and transactions offered by the broker-dealer. Brokerdealers should assess whether there are different risks (and degrees of risk) associated with the various types of accounts they provide to customers (e.g., cash, margin, prime-brokerage) and transactions they execute in those accounts (e.g., short sales, over-thecounter derivatives, repurchase and reverse repurchase agreements, block trades).

The sixth risk factor is the customer base. Broker-dealers should assess the risks associated with different types of customers. For example, a firm should examine whether it is opening accounts for customers located in countries the Secretary determines to be of "primary money laundering concern" pursuant to section 311 of the Act. Verification procedures should account for the concerns raised by such customers. In addition, certain legal entities may pose greater risks (e.g., a closely held corporation as opposed to one that is publicly traded).

The seventh risk factor requires an assessment of whether the broker-dealer can rely on another broker-dealer, with which it shares an account relationship, to undertake any of the steps required by this proposed rule with respect to the shared account. A shared account means an account subject to a carrying or clearing agreement governed by New York Stock Exchange (NYSE) Rule 382 or National Association of Securities Dealers, Inc. (NASD) Rule 3230 (i.e., a customer account introduced by a correspondent broker-dealer to a clearing and carrying broker-dealer). Rules 382 and 3230 allow correspondents and clearing firms to set forth in written agreements a division of responsibilities with respect to the accounts they share.

We anticipate broker-dealers sharing accounts may realize efficiencies by dividing up the requirements in this proposed rule pursuant to their clearing agreements. For example, the correspondent may undertake to obtain the identifying information from customers as required in paragraph (c), and the clearing firm may undertake the verification procedures as required in paragraph (d). Nonetheless, both firms would still be responsible for ensuring that each requirement in the rule is met with respect to each customer. Accordingly, a broker-dealer must continually assess whether the other firm can be relied on to perform its responsibilities. This would include communicating and coordinating with the other firm on an on-going basis. Moreover, a broker-dealer is expected to cease such reliance if it is no longer reasonable.

Paragraph (b) also requires that the identity verification procedures must enable the broker-dealer to form a reasonable belief that it knows the true identity of the customer. This provision makes clear that, while there is flexibility in establishing these procedures, the broker-dealer is responsible for exercising reasonable efforts to ascertain the identity of each customer.

Finally, paragraph (b) requires that broker-dealers make their CIPs part of their overall anti-money laundering programs required under section 352 of the Act (31 U.S.C. 5318(h)).⁵ This requirement is intended to make it clear that the CIP is not a separate program, but rather should be integrated into a broker-dealer's overall anti-money laundering procedures and policies. However, this should not be read to create any negative inference about a broker-dealer's need to establish and maintain an overall money laundering program that is designed to ensure compliance with all other applicable regulations promulgated under the Act.

C. Section 103.122(c) Required Information

The first step in verifying identity is obtaining identifying information from customers. Paragraph (c) of the proposed rule provides that a brokerdealer's CIP must require customers to provide, at a minimum, certain identifying information before an account is opened for the customer or the customer is granted trading authority over an account. Specifically, the broker-dealer must obtain each customer's: (1) Name; (2) date of birth, if applicable; (3) addresses; ⁶ and (4) documentary number.⁷

The rule requires only that the minimum identifying information be obtained from each customer. Brokerdealers, in assessing the risk factors in paragraph (b), should determine whether other identifying information is necessary to form a reasonable belief as to the true identity of each customer. There may be certain types of customers from whom it is reasonable to obtain other identifying information in addition to the minimum required information. There also may be circumstances that make it appropriate to obtain additional information. If a broker-dealer, in examining the nature of its business and operations, determines that additional information should be obtained in certain cases, it should set forth guidelines in its CIP indicating the types of additional information and the circumstances when it shall be obtained.

Treasury and the Commission recognize that a new business may need to open a brokerage account before it has received an employer identification number (EIN) from the Internal Revenue Service. For this reason, the proposed rule contains a limited exception to the requirement that a taxpayer identification number must be provided prior to the opening of an account or the granting of trading authority. Accordingly, a CIP may permit an account to be opened or trading authority to be granted for a person, other than an individual (such as a corporation, partnership or trust), that has applied for, but has not received, an EIN. However, in such a case, the CIP must require that the broker-dealer obtain a copy of the application for the EIN prior to the time the account is opened or trading authority granted. Currently, the IRS indicates that the issuance of an EIN can take up to five weeks. This length of time, coupled with when the person applied for the EIN, should be considered by the broker-dealer in determining the reasonable period of time within which the person should provide its EIN to the broker-dealer.

D. Section 103.122(d) Required Verification Procedures

After obtaining identifying information from a customer, the broker-dealer must take steps to verify the accuracy of that information in order to reach a point where it can form a reasonable belief that it knows the true identity of the customer. Accordingly, paragraph (d) of the proposed rule requires a broker-dealer's CIP to have procedures for verifying the accuracy of the identifying information provided by the customer. The extent of the verification for each customer will depend on the steps necessary for a broker-dealer to reach a reasonable belief that it knows the true identity of the customer.

Paragraph (d) requires that the verification procedures must be undertaken within a reasonable time before or after a customer's account is opened or a customer is granted authority to effect transactions with respect to an account. This flexibility must be exercised in a reasonable manner, given that verifications too far in advance may become stale and verifications too long after the fact may provide opportunities to launder money while verification is pending. The amount of time it will take a brokerdealer to verify the identity of a customer may depend on the type of account opened, whether the customer opens the account in person, and on the type of identifying information available. In addition, although an account is opened, a broker-dealer may choose to place limits on the account, such as restricting the number of transactions or the dollar value of transactions, until a customer's identity is verified. Therefore, the proposed rule provides broker-dealers with the flexibility to use a risk-based approach to determine when the identity of a customer must be verified relative to the opening of an account or the granting of trading authority.⁸

A person becomes a customer each time the person opens a new account at a broker-dealer or is granted trading authority with respect to an account. Therefore, upon the opening of each account or the granting of new authority, the verification requirements of this rule would apply. However, if a customer whose identification has been verified previously opens a new account or is granted new authority, the brokerdealer would not need to verify the customer's identity a second time, provided the broker-dealer (1) previously verified the customer's identity in accordance with procedures consistent with the proposed rule, and (2) continues to have a reasonable belief that it knows the true identity of the customer.

The rule provides for two methods of verifying identifying information: verification through documents and verification through non-documentary means. For example, using documents would include obtaining a driver's license or passport from a natural person or articles of incorporation from a company. Non-documentary methods would include cross-checking the information provided by a customer against that supplied by a credit bureau.

The proposed rule requires that a broker-dealer's CIP address both methods of verification. Depending on the type of customer and the method of opening an account, it may be more appropriate to use either documentary or non-documentary methods. In some cases, it may be appropriate to use both methods. The CIP should set forth guidelines describing when documents, non-documentary methods, or a combination of both will be used. These guidelines should be based on the broker-dealer's assessment of the factors described in paragraph (b) of the proposed rule.

The risk a broker-dealer will not know a customer's true identity will be heightened for certain types of accounts, such as accounts opened in the name of a corporation, partnership, or trust that is created or conducts substantial business in a jurisdiction the Secretary determines is a primary money laundering concern or an international body, such as the Financial Action Task Force on Money Laundering, designates as non-cooperative. Obtaining sufficient information to verify a given customer's true identity can reduce the risk a broker-dealer will be used as a conduit for money laundering and terrorist financing. A broker-dealer's identity verification procedures must be based on its assessments of the factors in paragraph (b). Accordingly, when those assessments suggest a heightened risk, the broker-dealer should prescribe additional verification measures.

The proposed rule sets forth certain non-documentary methods that would be suitable for verifying identity. These methods include contacting a customer after the account is opened; ⁹ obtaining a financial statement; comparing the identifying information provided by the customer against fraud and bad check databases to determine whether any of the information is associated with known incidents of fraudulent behavior (negative verification); comparing the identifying information with information available from a trusted third party source, such as a credit report from a consumer reporting agency (positive verification); and checking references with other financial institutions. The broker-dealer also may wish to analyze whether there is logical consistency between the identifying information provided, such as the customer's name, street address, ZIP code, telephone number (if provided), date of birth, and social security number (logical verification).

Paragraph (d)(2) also provides that the CIP must require the use of nondocumentary methods in certain cases; specifically, when a natural person is unable to present an unexpired government issued identification document that bears a photograph or similar safeguard and when the brokerdealer is presented with unfamiliar documents to verify the identity of a customer, does not obtain documents to verify the identity of a customer, does not meet face-to-face a customer who is a natural person, or is otherwise presented with circumstances that increase the risk the broker-dealer will be unable to verify the true identity of a customer through documents.

Thus, non-documentary methods should be used when a broker-dealer cannot examine original documents. In addition, Treasury and the Commission recognize that identification documents, including those issued by a government entity, may be obtained illegally and may be fraudulent. In light of the recent increase in identity fraud, brokerdealers are encouraged to use nondocumentary methods, even when a customer has provided identification documents.

E. Section 103.122(e) Government Lists

Section 326 of the Act also requires reasonable procedures for determining whether a customer appears on any list of known or suspected terrorists or terrorist organizations provided by any government agency. The proposed rule implements this requirement and clarifies that the requirement applies only with respect to lists circulated by the Federal government. In addition, the proposed rule states that broker-dealers must follow all Federal directives issued in connection with such lists. This provision makes clear that a brokerdealer must have procedures for responding to circumstances when a customer is named on a list.

F. Section 103.122(f) Customer Notice

Section 326 provides that financial institutions must give their customers notice of their identity verification procedures. Therefore, a broker-dealer's CIP must include procedures for providing customers with adequate notice that the broker-dealer is requesting information to verify their identity. A broker-dealer may satisfy the notice requirement by generally notifying its customers about the procedures the broker-dealer must comply with to verify their identities. For example, the broker-dealer may post a sign in its lobby or provide customers with any other form of written or oral notice. If an account is to be opened electronically, such as through an Internet website, the broker-dealer may provide notice electronically. Notice must be given before an account is opened or trading authority is granted.

G. Section 103.122(g) Lack of Verification

Paragraph (g) of the proposed rule states that a broker-dealer's CIP must include procedures for responding to circumstances in which it cannot form a reasonable belief that it knows the true identity of a customer. Generally, a broker-dealer should maintain an account for a customer only when it can form a reasonable belief that it knows the customer's true identity. ¹⁰ Thus, a broker-dealer's CIP should specify the actions to be taken when it cannot form a reasonable belief. There also should be guidelines for when an account will not be opened. In addition, the CIP should address the terms under which a customer may conduct transactions while a customer's identity is being verified. The CIP should specify at what point, after attempts to verify a customer's identity have failed, an account that has been opened will be closed. Finally, the procedures should include a process for determining whether a Suspicious Activity Report should be filed in accordance with applicable laws and regulations.

H. Section 103.122(h) Recordkeeping

Section 326 of the Act requires procedures for maintaining records of the information used to verify a person's identity, including name, address, and other identifying information. Paragraph (h) of the proposed rule sets forth recordkeeping procedures that must be included in a broker-dealer's CIP. These procedures must provide for the maintenance of all information obtained pursuant to the CIP. Information that must be maintained includes all identifying information provided by a customer pursuant to paragraph (c). Thus, the broker-dealer must make a record of each customer's name, date of birth (if applicable), addresses, and tax identification number or other number. Broker-dealers also must maintain copies of any documents that were relied on pursuant to paragraph (d)(1) evidencing the type of document and any identification number it may contain. For example, if a customer produces a driver's license, the brokerdealer must make a copy of the driver's license that clearly indicates it is a driver's license and legibly depicts any identification number on the license.

Broker-dealers also must make and maintain records of the methods and results of measures undertaken to verify the identity of a customer pursuant to paragraph (d)(2). For example, if a broker-dealer obtains a report from a credit bureau concerning a customer, the report must be maintained. Brokerdealers also must make and maintain records of the resolution of any discrepancy in the identifying information obtained. To continue with the previous example, if the customer provides a residence address that is different than the address shown on the credit report, the broker-dealer must document how it resolves this discrepancy or, if the discrepancy is not resolved, how it forms a reasonable belief notwithstanding the discrepancy. The broker-dealer must retain all of these records for five years after the date the account is closed or the grant of authority to effect transactions with respect to an account is revoked. In all other respects, the records should be maintained in accordance with the requirements of Rule 17a-4. ¹¹

Nothing in this proposed regulation modifies, limits or supersedes section 101 of the Electronic Records in Global and National Commerce Act, Public Law 106-229, 114 Stat. 464 (15 U.S.C. 7001) (E-Sign Act). Thus, a brokerdealer may use electronic records to satisfy the requirements of this regulation, as long as the records are maintained in accordance with Rule 17a-4(f), which the Commission has interpreted as being consistent with the requirements in the E-Sign Act. ¹² Treasury and the Commissionemphasize that the collection and retention of information about a customer, as an ancillary part of collecting identifying information, do not relieve a broker-dealer from its obligations to comply with antidiscrimination laws and regulations.

I. Section 103.122(i) Approval of Program

Paragraph (i) of the proposed rule requires that the broker-dealer's CIP be approved by the most senior level of the firm (e.g., the board of directors, managing partners, board of managers, or other governing body performing similar functions) or by persons specifically authorized by that body to approve such a program.

J. Section 103.122(j) Exemptions

Section 326 states that the Secretary and the Federal functional regulator jointly issuing a rule under that section may by order or regulation exempt any financial institution or type of account from the regulation in accordance with such standards and procedures as the Secretary may prescribe. The proposed rule provides that the Commission, with the concurrence of the Secretary, may exempt any broker-dealer that registers with the Commission pursuant to 15 U.S.C. 78o and 78o-4. However, it excludes from this exemptive authority broker-dealers that register pursuant to 15 U.S.C. 78o(b)(11). These are firms that register as broker-dealers solely because they deal in securities futures products. The exemptive authority with respect to these firms will be in the rule issued jointly by Treasury and the CFTC. The proposed rule provides that the Secretary, with the concurrence of the Commission, may exempt any broker-dealer that registers pursuant to 15 U.S.C 78o-5 (i.e., government securities dealers).

In issuing exemptions under the proposed rule, the Secretary and the Commission shall consider whether the exemption is consistent with the purposes of the BSA, and in the public interest, and may consider other necessary and appropriate factors.

² However, there may be situations involving the transfer of accounts where it would be appropriate for a broker-dealer to verify the identity of customers associated with the accounts it is acquiring. Therefore, Treasury and the Commission expect procedures for transfers of accounts to be part of a broker-dealer's overall anti-money laundering program required under section 352 of the Patriot Act. See Footnote 5 infra for a discussion of the requirements of section 352.

³ The terms "State" and "United States" are defined in section 103.11.

⁴ This discussion of the risk factors is included in the release because it may be helpful in providing some meaning and context with respect to the factors. However, it is not meant to provide comprehensive definitions of these risk factors or an exhaustive description of the considerations involved in assessing them. Instead, it should serve as a starting point for defining and assessing them.

⁵ Section 352 requires brokers and dealers to establish anti-money laundering programs that, at a minimum, include (1) the development of internal policies, procedures, and controls; (2) the designation of a compliance officer; (3) an ongoing employee training program; and (4) an independent audit function to test programs. On April 22, 2002, the Commission approved rule changes submitted by the NASD and the NYSE. Exchange Act Release No. 45798 (April 22, 2002), 67 FR 20854 (April 26, 2002). These rules (NASD Rule 3011 and NYSE Rule 445) set forth minimum requirements for these programs.

⁶ With respect to the address requirement, each customer must provide a mailing address, and, if different, the address of the customer's residence (if a natural person) or principal place of business (if not a natural person).

⁷ Each customer that is a U.S. person must provide a U.S. taxpayer identification number (e.g., social security number or employer identification number). Customers that are Non-U.S. persons must provide either a U.S. taxpayer identification number, an alien identification card number, or the number and country of issuance of any other government-issued document evidencing nationality or residence and bearing a photograph or similar safeguard. The term "similar safeguard" is included to permit the use of any biometric identifiers that may be used in addition to, or instead of, photographs.

⁸ We note that it is possible a broker-dealer could violate other laws by permitting a customer to transact business prior to verifying the customer's identity. See, e.g., 31 CFR part 500, prohibiting transactions involving designated foreign countries or their nationals.

⁹ The purpose of engaging in verification is to check identifying information about a customer against an independent source. Contacting a customer may be a useful part of the verification process when an account is opened on-line or by mail. However, a broker-dealer should not rely solely on this method as a means of verification.

¹⁰ There are some exceptions to this basic rule. For example, a broker-dealer may maintain an account, at the direction of law enforcement, notwithstanding that the broker-dealer does not know the true identity of a customer.

¹¹ 17 CFR 240.17a-4.

¹²See Exchange Act Release No. 44238 (May 1, 2001), 66 FR 22916 (May 7, 2001).

III. Conforming Amendments to 31 CFR 103.35

Current section 103.35(a) sets forth customer identification requirements when certain brokerage accounts are opened. Generally, sections 103.35(a)(1) and (2) require a broker-dealer, within 30 days after an account is opened, to secure and maintain a record of the taxpayer identification number of the customer involved. If the broker-dealer is unable to obtain the taxpayer identification number within 30 days (or a longer time if the person has applied for a taxpayer identification number), it need take no further action under section 103.35 concerning the account if it maintains a list of the names, addresses, and account numbers of the persons for which it was unable to secure taxpayer identification numbers, and provides that information to the Secretary upon request. In the case of a non-resident alien, the brokerdealer is required to record the person's passport number or a description of some other government document used to determine identification.

Section 103.35(a)(3) currently provides that a broker-dealer need not obtain a taxpayer identification number with respect to specified categories of persons 13 opening accounts. The proposed rule does not contain any exemptions from the CIP requirements. Treasury believes that the requirements of section 103.35(a)(1) and (2) are inconsistent with the intent and purpose of section 326 of the Act and incompatible with the proposed rule. For these reasons, Treasury, under its own authority, is proposing to repeal section 103.35(a).

In addition, Treasury and the Commission are requesting comments on whether any of the exemptions in Section 103.35(a)(3) should apply in the context of the proposed CIP requirements in light of the intent and purpose of section 326 of the Act.

¹³ The exemption applies to (i) agencies and instrumentalities of Federal, State, local, or foreign governments; (ii) aliens who are ambassadors; ministers; career diplomatic or consular officers; naval, military, or other attaches of foreign embassies and legations; and members of their immediate families; (iii) aliens who are accredited representatives of certain international organizations, and their immediate families; (iv) aliens temporarily residing in the United States for a period not to exceed 180 days; (v) aliens not engaged in a trade or business in the United States who are attending a recognized college or university, or any training program supervised or conducted by an agency of the Federal Government; and (vi) unincorporated subordinate units of a tax exempt central organization that are covered by a group exemption letter.

IV. Request for Comments

Treasury and the Commission invite comment on all aspects of the proposed regulation, and specifically seek comment on the following issues:

V. Paperwork Reduction Act

Certain provisions of the proposed rule contain "collection of information" requirements within the meaning of the Paperwork Reduction Act of 1995.¹⁴ Treasury has submitted the proposed rule to the Office of Management and Budget (OMB) for review in accordance with 44 U.S.C 3507(d). An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless it displays a currently valid control number.

A. Collection of Information Under the Proposed Rule

The proposed rule contains recordkeeping and disclosure requirements that are subject to the Paperwork Reduction Act of 1995. In summary, the proposed rule requires broker-dealers to implement reasonable procedures to (1) maintain records of the information used to verify the person's identity and (2) provide notice of the CIPs procedures to customers. These recordkeeping and notice requirements are required under section 326 of the Act.

B. Proposed Use of the Information

Section 326 of the Act requires Treasury and the Commission jointly to issue a regulation setting forth minimum standards for broker-dealers and their customers regarding the identity of the customer that shall apply in connection with opening of an account at the broker-dealer. Furthermore, section 326 provides that the regulations, at a minimum, must require broker-dealers to implement reasonable procedures for (1) verifying the identity of any person seeking to open an account, to the extent reasonable and practicable; (2) maintaining records of the information used to verify the person's identity, including name, address, and other identifying information; and (3) determining whether the person appears on any lists of known or suspected terrorists or terrorist organizations provided to the financial institution by any government agency.

The purpose of section 326, and the regulations promulgated thereunder, is to make it easier to prevent, detect and prosecute money laundering and the financing of terrorism. In issuing the proposed rule, Treasury and the Commission are seeking to fulfill their statutorily mandated responsibilities under section 326 and to achieve its important purpose.

The proposed rule requires each broker-dealer to establish a written CIP that must include recordkeeping procedures and procedures for providing customers with notice that the broker-dealer is requesting information to verify their identity. The proposed rule requires a broker-dealer to maintain a record of (1) the identifying information provided by the customer, the type of identification document(s) reviewed, if any, the identification number of the document(s), and a copy of the identification document(s); (2) the means and results of any additional measures undertaken to verify the identity of the customer; and (3) the resolution of any discrepancy in the identifying information obtained.

The proposed rule also requires each broker-dealer to give customers "adequate notice" of the identity verification procedures. A broker-dealer may satisfy this disclosure requirement by posting a sign in the lobby or providing customers with any other form of written or oral notice. If the account is opened electronically, the broker-dealer may provide the notice electronically. Accordingly, a brokerdealer may choose among a variety of methods of providing adequate notice and may select the least burdensome method, given the circumstances under which customers seek to open new accounts.

C. Respondents

The proposed rule would apply to approximately 5,568 broker-dealers, which is the approximate number of firms that conduct business with the general public.

D. Total Annual Reporting and Recordkeeping Burden

E. Collection of Information Is Mandatory

These recordkeeping and disclosure (notice) requirements are mandatory.

F. Confidentiality

The collection of information pursuant to the proposed rule would be provided by customers and other sources to broker-dealers and maintained by broker-dealers. In addition, the information may be used by federal regulators, self-regulatory organizations, and authorities in the course of examinations, investigations, and judicial proceedings. No governmental agency regularly would receive any of the information described above.

G. Record Retention Period

The proposed rule will require that the records with respect to a given customer be retained until five years after the date the account of a customer is closed or the grant of authority to effect transactions with respect to an account is revoked.

H. Request for Comment

Pursuant to 44 U.S.C. 3506(c)(2)(B), Treasury and the Commission solicit comments to:

Comments concerning the recordkeeping and disclosure requirements in the proposed rule should be sent (preferably by fax (202-395-6974)) to Desk Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Office of Management and Budget, Paperwork Reduction Project (1506), Washington, DC 20503 (or by the Internet to [email protected]), with a copy to FinCEN by mail or the Internet at the addresses previously specified.

¹⁴ 44 U.S.C. 3502 et seq.

¹⁵ The Commission estimates that the number of new accounts in the upcoming years will be: 15,400,000 in 2002, 16,900,000 in 2003, and 18,600,000 in 2004. The Commission arrived at this estimate by considering: (1) the total number of accounts at the 2001 year-end (102,700,000) as reported by broker-dealers on Form X-17a-5— Financial and Operational Combined Uniform Single (FOCUS) Reports they file pursuant to section 17 of the Exchange Act and rule 17a-5 (17 CFR 240.17a-5) thereunder; and (2) the annualized growth rate in total accounts for the years 1990 through 2001 (ten percent). The Commission also estimates that the number of accounts that are closed each year equals five percent of the total number of accounts. Accordingly, the Commission estimates that the total annualized growth rate for new accounts each year is fifteen percent. Therefore, starting with the 2001 total of 102,700,000 and using an annualized growth rate of fifteen percent, the Commission estimates that 15,400,000 new accounts will be added in 2002, 16,900,000 in 2003 and 18,600,000 in 2004.

¹⁶ The Commission derived these estimates by taking the number of new accounts projected for each upcoming year and multiplying the number by two minutes and then dividing that number by 60 to convert minute totals into hour totals.

VI. Commission's Analysis of the Costs and Benefits Associated With the Proposed Rule

The Commission is considering the costs and benefits associated with the proposal and requesting comment on all aspects of this cost-benefit analysis, including identification and assessment of any other costs and benefits not discussed in the analysis. Commenters are encouraged to identify, discuss, analyze, and supply relevant data concerning the costs and benefits associated with the proposed rule. Section 326 of the Act requires Treasury and the Commission to prescribe regulations setting forth minimum standards for broker-dealers regarding the identities of customers that shall apply in connection with the opening of an account. The statute also provides that the regulations issued by Treasury and the Commission must, at a minimum, require financial institutions to implement reasonable procedures for: (1) Verification of customers' identities; (2) determination of whether a customer appears on a government list; and (3) maintenance of records related to customer verification. The proposed rule implements this statutory mandate by requiring brokerdealers to (1) establish a CIP; (2) obtain certain identifying information from customers; (3) verify identifying information of customers; (4) check customers against lists provided by federal agencies, (5) provide notice to customers that information may be requested in the process of verifying their identities; and (6) make and maintain records. The Commission believes that these requirements are reasonable and practicable, as required by the section 326 and, therefore, that the costs associated with them are attributable to the statute. Moreover, while the proposed rule specifies certain minimum requirements, brokerdealers will be able to design their CIPs in a manner most appropriate to their business models and customer bases. This flexibility should be beneficial to broker-dealers in helping them to tailor their CIPs appropriately, while still meeting the statutory requirements of section 326.

Even though the Commission believes the costs associated with the proposed rule are attributable to the statute, it nonetheless has undertaken an analysis of the costs and benefits of the requirements. The Commission seeks comment on all aspects of the proposed rule, including whether the proposed rule, by setting forth minimum requirements, creates a benefit or, conversely, imposes costs because broker-dealers will not be able to choose for themselves the minimum procedures they wish to use to meet the requirements of the statute. The Commission also seeks comment on whether the costs are attributable to the statute.

A. Benefits Associated With the Proposed Rule

The anti-money laundering provisions in the Act are intended to make it easier to prevent, detect and prosecute money laundering and the financing of terrorism. The proposed rule is an important part of this effort. It fulfills the statutory mandate of section 326 by specifying how a broker-dealer is to establish a program that will assist it in determining the identities of customers. Verifying identities, in turn, will reduce the risk of broker-dealers unwittingly aiding criminals, including terrorists, in accessing U.S. financial markets to launder money or move funds for illicit purposes. Additionally, the implementation of such programs should make it more difficult for persons to successfully engage in fraudulent activities involving identity theft or the placing of fictitious orders to buy or sell securities.

B. Costs Associated with the Proposed Rule

¹⁷ 17 CFR 240.17a-3(a)(9).

¹⁸See, e.g., NYSE Rule 405, NASD Rule 3110.

¹⁹ The Commission estimates that it will take broker-dealers on average approximately 20 hours to establish a written CIP. This estimate seeks to account for the fact that many firms already have customer identification and verification procedures and that discrepancies in size and complexity will result in differing time burdens. The Commission believes that broker-dealers will have senior compliance personnel draft their CIPs and that this will take an average of 16 hours. The Commission anticipates that in-house counsel will spend on average 4 hours reviewing the CIP. According to the Securities Industry Association ("SIA") Management and Professional Earnings 2000 report ("SIA Earnings Report"), Table 051, the hourly cost of a compliance manager plus 35% overhead is $101.25. The hourly cost for an in-house counsel plus 35% overhead is $156.00 (SIA Earnings Report, Table 107 (Attorney)). Therefore, the Commission estimates that the total cost per brokerdealer to establish a CIP would be $2,244 per broker-dealer [(16 × $101.25) + (4 × $156.00)]. As of the 2000 year-end, there were approximately 5,568 broker-dealers that engaged in some form of a public business. Therefore, the Commission estimates that the total cost to the industry would be $2,244 multiplied by 5,568 or $12,494,592.

²⁰ For example, the Anti-Money Laundering Committee of the SIA recommended in its Preliminary Guidance for Deterring Money Laundering Activity (February 2002) that brokerdealers obtain certain identifying information from customers at the commencement of the business relationship, including, for natural persons: name, address, date of birth, investment experience and objectives, social security number or taxpayer identification number, net worth, annual income, occupation, employer's address, and the names of any persons authorized to effect transactions in the account. For non-resident aliens, the SIA Committee recommended that the broker-dealer obtain, in addition to the information above, a passport number or other valid government identification number. The SIA Committee also made a number of recommendations with respect to customers that are not natural persons.

²¹ 17 CFR 240.17a-3(a)(9).

²² Section 15(b)(8) of the Exchange Act (15 U.S.C. 78o(b)(8)) requires each broker-dealer to become a member of a securities association registered pursuant to section 15A of the Exchange Act (15 U.S.C. 78o-3) unless the broker-dealer effects transactions solely on a national securities exchange of which it is a member. The NASD is the only securities association registered pursuant to section 15A. Exchange Act Rule 15b9-1 (17 CFR 240.15b9-1) exempts broker-dealers from this requirement to register with the NASD if they (1) are an exchange member, (2) carry no customer accounts, and (3) derive gross annual income from purchases and sales of securities other than on a national securities exchange of not greater than $1,000. Generally then, most broker-dealers that carry customer accounts are members of the NASD and subject to Rule 3110.

²³ NASD Rule 3110(c)(1).

²⁴ NASD Rule 3110(c)(2).

²⁵ NASD Rule 3110(c)(1).

²⁶ NASD Rule 3110(c)(3).

²⁷ NYSE Rule 405(1).

²⁸ The Commission estimates that obtaining the required minimum identifying information will take broker-dealers approximately one minute per account. This takes into consideration the fact that approximately 97% of customer accounts are held at the 70 largest broker-dealers. These firms likely already obtain the required identifying information from their customers. Therefore, requiring that each piece of identifying information be obtained should not impose a significant additional burden. The average hourly cost of the person who would be obtaining this information is $22.70 per hour (per the SIA Earnings Report, Table 082 (Retail Sales Assistant, Registered) and including 35% in overhead charges). Therefore, the costs to the industry would be: (number of new accounts per year) × (1/60 of an hour) × ($22.70). As indicated previously, the Commission estimates that the number of new accounts in the upcoming years will be: 15,400,000 in 2002, 16,900,000 in 2003, and 18,600,000 in 2004.

²⁹ The Commission estimates that it will take each broker-dealer, on average, one hour to update account opening applications or electronic account opening systems. The Commission believes that broker-dealers will have a compliance manager implement the necessary changes. The hourly cost for a compliance manager is $101.25 (SIA Earnings Report, Table 051 (Compliance manager)). Accordingly, the total cost to the industry would be: ($101.25) × (the number of broker-dealers doing a public business or 5,568) or $563,760.

³⁰ The Commission estimates that the processing costs associated with verification methods will be approximately $1.00 per account. The Commission further estimates that the average time spent verifying an account will be five minutes. The hourly cost of the person who would undertake the verification is $25.90 per hour (per the SIA Earnings Report, Table 086 (Data Entry Clerk, Senior) and including 35% in overhead charges). Therefore, the costs to the industry reported above are: (number of new accounts per year) × ($1.00) + (number of new accounts per year) × (1/12 of an hour) × ($25.90). The Commission estimates that the number of new accounts in the upcoming years will be: 15,400,000 in 2002, 16,900,000 in 2003, and 18,600,000 in 2004.

³¹ The Commission believes that most of the firms that receive these lists already check their customers against them. Moreover, as indicated previously, 97% of customer accounts are held at the 70 largest firms. The Commission understands that most of these firms have automated processes for complying with many regulatory requirements. Accordingly, the Commission estimates that it will take broker-dealers on average thirty seconds to check whether a person appears on a government list. The hourly cost of the person who would check the list is $25.90 per hour (per the SIA Earnings Report, Table 086 (Data Entry Clerk, Senior) and including 35% in overhead charges). Therefore, the costs to the industry reported above are: (number of new accounts per year) × (1/120 of an hour) × ($25.90). The Commission estimates that the number of new accounts in the upcoming years will be: 15,400,000 in 2002, 16,900,000 in 2003, and 18,600,000 in 2004.

³² The Commission estimates that it will take each broker-dealer, on average, two hours to create and implement the appropriate notice. This estimate takes into consideration the fact that many small firms will be able to provide adequate notice by hanging signs in their premises. Larger firms will be able to provide notice by updating account opening documentation or electronic account opening systems. The Commission believes that broker-dealers will have an attorney draft the appropriate notice, and that this will take approximately one hour. The hourly cost for an inhouse counsel plus 35% overhead is $156.00 (SIA Earnings Report, Table 107, (Attorney)). The Commission believes that broker-dealers will have a compliance manager implement the notice, and that implementation will take approximately one hour. The hourly cost for a compliance manager is $101.25 (SIA Earnings Report, Table 051 (Compliance manager)). Accordingly, the total cost to the industry would be: ($156.00 + 101.25) × (the number of broker-dealers doing a public business or 5,568) or $1,432,368.

³³ The Commission estimates that it will take approximately two minutes per new account to make and maintain the required records. This estimate takes into account the fact that many broker-dealers already make and maintain many of the required records. In addition, for many new accounts, the recordkeeping will be fairly simple (e.g., making a photocopy of a driver's license or financial statement, or keeping a record of the results of a public database search or credit bureau query. The hourly cost of the person who would undertake the verification is $25.90 per hour (per the SIA Earnings Report, Table 086 (Data Entry Clerk, Senior) and including 35% in overhead charges). Therefore, the costs to the industry reported above are: (number of new accounts per year) × (1/30 of an hour) × ($25.90). The Commission estimates that the number of new accounts in the upcoming years will be: 15,400,000 in 2002, 16,900,000 in 2003, and 18,600,000 in 2004.

VII. Regulatory Flexibility Act

Treasury and the Commission are sensitive to the impact our rules may impose on small entities. Congress enacted the Regulatory Flexibility Act, 5 U.S.C. 601 et seq., to address concerns related to the effects of agency rules on small entities. In this case, Treasury and the Commission believe that the proposed rule likely would not have a "significant economic impact on a substantial number of small entities." 5 U.S.C. 605(b). First, the economic impact on small entities should not be significant because most small entities are likely to have a relatively small number of accounts, and thus compliance should not impose a significant economic impact. Second, as discussed in Section VI (the Commission's cost benefit analysis), the economic impact on broker-dealers, including small entities, is imposed by the statute itself, and not by the proposed rule. Treasury and the Commission seek comment on whether the proposed rule would have a significant economic impact on a substantial number of small entities and whether the costs are imposed by the statute itself, and not the proposed rule.

While Treasury and the Commission believe that the proposed rule likely would not have a significant economic impact on a substantial number of small entities, Treasury and the Commission do not have complete data at this time to make this determination. Therefore, an Initial Regulatory Flexibility Analysis has been prepared in accordance with 5 U.S.C. 603.

A. Reason for the Proposed Action

Section 326 of the Act requires Treasury and the Commission jointly to issue a regulation setting forth minimum standards for broker-dealers and their customers regarding the identity of the customer that shall apply in connection with the opening of an account at the broker-dealer. Furthermore, section 326 requires, at a minimum, that broker-dealers implement reasonable procedures for (1) verifying the identity of any person seeking to open an account, to the extent reasonable and practicable; (2) maintaining records of the information used to verify the person's identity, including name, address, and other identifying information; and (3) determining whether the person appears on any lists of known or suspected terrorists or terrorist organizations provided to the financial institution by any government agency.

The purpose of section 326, and the regulations promulgated thereunder, is to make it easier to prevent, detect and prosecute money laundering and the financing of terrorism. In issuing the proposed rule, Treasury and the Commission are seeking to fulfill their statutorily mandated responsibilities under section 326 and to achieve its important purpose.

B. Objective

The objective of the proposed regulation is to make it easier to prevent, detect and prosecute money laundering and the financing of terrorism. The proposed rule seeks to achieve this goal by specifying the information broker-dealers must obtain from or about customers that can be used to verify the identity of the customers. This will make it more difficult for persons to use false identities to establish customer relationships with broker-dealers for the purposes of laundering money or moving funds to effectuate illegal activities, such as financing terrorism.

C. Legal Basis

The proposed rule is being promulgated pursuant to section 326 of the Act, which mandates that Treasury and the Commission issue a regulation setting forth minimum standards for financial institutions and their customers regarding the identity of customers that shall apply in connection with the opening of accounts at financial institutions.

D. Small Entities Subject to the Rule

The proposed rule would affect broker-dealers that are small entities. Rule 0-10 under the Exchange Act ³⁴ defines a broker-dealer to be small if it (1) had total capital (net worth plus subordinated liabilities) of less than $500,000 on the date in the prior fiscal year as of which its audited financial statements were prepared pursuant to § 240.17a-5(d) or, if not required to file such statements, a broker or dealer that had total capital (net worth plus subordinated liabilities) of less than $500,000 on the last business day of the preceding fiscal year (or in the time that it has been in business, if shorter); and (2) is not affiliated with any person (other than a natural person) that is not a small business or small organization as defined in the rule.

As of December 31, 2000, the Commission estimates there were approximately 873 broker-dealers that were "small" for purposes of Rule 0-10 that would be subject to this rule because they conduct business with the general public. The Commission bases its estimate on the information provided in broker-dealer FOCUS Reports.

E. Reporting, Recordkeeping and other Compliance Requirements

The proposed rule would require broker-dealers to (1) establish a CIP; (2) obtain certain identifying information from customers; (3) verify identifying information of customers; (4) check customers against lists provided by federal agencies; (5) provide notice to customers that information may be requested in the process of verifying their identities; and (6) make and maintain records related to the CIP.

F. Duplicative, Overlapping or Conflicting Federal Rules

As discussed throughout this preamble, there are other federal rules that contain requirements for collecting certain information from customers. However, these other requirements do not provide sufficient information for broker-dealers to verify the identity of their customers. Congress has mandated that Treasury and the Commission issue a regulation that requires broker-dealers to undertake such verifications.

G. Significant Alternatives

If an agency does not certify that a rule will not have a significant economic impact on a substantial number of small entities, the Regulatory Flexibility Act directs Treasury and the Commission to consider significant alternatives that would accomplish the stated objective, while minimizing any adverse impact on small entities.

In connection with the proposed amendments, we considered the following alternatives: (1) The establishment of differing compliance or reporting requirements or timetables that take into account the resources of small entities; (2) the clarification, consolidation, or simplification of compliance and reporting requirements under the rule for small entities; (3) the use of performance rather than design standards; and (4) an exemption from coverage of the proposed amendments, or any part thereof, for small entities.

The proposed rule provides for substantial flexibility in how each broker-dealer may meet its requirements. This flexibility is designed to account for differences between broker-dealers, including size. Nonetheless, Treasury and the Commission did consider alternatives such as exempting certain small entities from some or all of the requirements of the proposed rule. Treasury and the Commission do not believe that such an exemption is appropriate, given the flexibility built into the rule to account for, among other things, the differing sizes and resources of broker-dealers, as well as the importance of the statutory goals and mandate of section 326. Money laundering can occur in small firms as well as large firms.

H. Solicitation of Comments

Treasury and the Commission encourage the submission of comments with respect to any aspect of this Initial Regulatory Flexibility Analysis, including comments regarding the number of small entities that may be affected by the proposed rule. Such comments will be considered by Treasury and the Commission in determining whether a Final Regulatory Flexibility Analysis is required, and will be placed in the same public file as comments on the proposed amendment itself. Comments should be submitted to Treasury or the Commission at the addresses previously indicated.

³⁴ 17 CFR 240.0-10(c).

VIII. Executive Order 12866

The Department of the Treasury has determined that this rule is not a significant regulatory action for purposes of Executive Order 12866. As noted above, the proposed rule closely parallels the requirements of section 326 of the Act. Accordingly, a regulatory impact analysis is not required.

Lists of Subjects in 31 CFR Part 103

Administrative practice and procedure, Authority delegations (Government agencies), Banks, banking, Brokers, Currency, Foreign banking, Foreign currencies, Gambling, Investigations, Law enforcement, Penalties, Reporting and recordkeeping requirements, Securities.

Authority and Issuance

For the reasons set forth in the preamble, part 103 of title 31 of the Code of Federal Regulations is proposed to be amended as follows:

PART 103—FINANCIAL RECORDKEEPING AND REPORTING OF CURRENCY AND FOREIGN TRANSACTIONS

§ 103.122 Customer identification programs for broker-dealers.