By Amy G Rudnick and Linda Noonan

Originally published October 2, 2002

On September 26, 2002, the U.S. Department of the Treasury ("Treasury") published in the Federal Register final rules implementing sections 313 and 319(b) of the USA PATRIOT Act. Those provisions prohibit covered financial institutions (i.e., U.S. banks, savings associations, other depository institutions and securities broker-dealers) from providing correspondent accounts to foreign shell banks and require foreign banks that maintain correspondent accounts with covered financial institutions to identify their owners and their U.S. agents for service of process. 67 Fed. Reg. 60562. The final rules supersede interim guidance issued to banks by Treasury on November 20, 2001, and proposed rules published by Treasury on December 28, 2001. The proposed rules were similar to the interim guidance for banks with some modifications and proposed to apply the requirements to the foreign branches of U.S. insured banks and to securities broker-dealers. The final rules become effective on October 28, 2002.

The final rules are substantially similar to Treasury's proposed rules. Consistent with the USA PATRIOT Act, the final regulations prohibit covered financial institutions from establishing, maintaining, administering or managing correspondent accounts for foreign shell banks and require covered financial institutions to take reasonable steps to ensure that any correspondent account for a foreign bank is not used to provide banking services indirectly to foreign shell banks. The final regulations also require covered financial institutions to maintain records in the United States that identify the owners of each foreign bank whose shares are not publicly traded and the foreign bank's U.S. agent for service of legal process for records pertaining to the account. In addition, the final rules continue to authorize the use of modified certification and recertification forms to comply with both the shell bank prohibition and the requirements to identify the foreign bank's owners and U.S. agent for service of process.

There are some notable differences between the proposal and the final rules, however. These differences are highlighted here and discussed in more detail below.

Highlights

  • The final rules exclude from the definition of a covered financial institution the foreign branches of U.S. insured banks. Consequently, foreign branches of U.S. insured banks will not be required to comply with the new rules.
  • While the final rules retain the requirement to identify whether a person owns a 25 percent or greater direct or indirect interest in a foreign bank, the final rules eliminate the complicated rules for determining whether a person is a direct or indirect owner.
  • The final rules limit the definition of "regulated affiliate" to a foreign shell bank that is 50 percent (not 25 percent as proposed) owned or controlled by a U.S. bank or a foreign bank that has a physical presence and that is subject to the supervision of the banking authority that regulates the affiliate.
  • The final rules exempt from the requirements to identify the owners of foreign banks, the owners of any foreign bank that is required to file its ownership information with the Federal Reserve on Form FR Y-7 and foreign banks whose shares are publicly traded.
  • Covered financial institutions are permitted to exercise "commercially reasonable" discretion in determining the time frame for closing accounts where required information has not been obtained.
  • The final rules extend from two years to three years the time generally required to obtain a new certification or a recertification for an existing correspondent account.

Covered financial institutions will have 30 days to obtain an initial certification for accounts opened after October 28, 2002, and until December 26, 2002, for accounts opened on or before October 28, 2002. For accounts opened on or before October 28, 2002, covered financial institutions may continue to use the certification forms attached to the interim guidance if the request is made to the foreign bank by November 27, 2002, and the certification is received by the covered financial institution by December 26, 2002.

Covered Financial Institutions

The final rules include in the definition of covered financial institution:

  • an insured bank (but not a foreign branch of an insured bank)
  • a commercial bank or trust company
  • a private banker
  • an agency or branch of a foreign bank located in the United States (including U.S. territories and possessions)
  • a credit union
  • a thrift institution
  • a corporation acting under Section 25A of the Federal Reserve Act, i.e., Edge Corporations (collectively, "banks")
  • a broker or dealer in securities registered or required to be registered with the Securities and Exchange Commission under the Securities Exchange Act of 1934

Consistent with the current definition of financial institution contained in the Bank Secrecy Act ("BSA") regulations and the plain language of the USA PATRIOT Act, the definition does not include foreign branches, agencies or offices of covered financial institutions located outside the United States. As a result, a foreign branch of a U.S. insured bank will be treated as a foreign bank, and covered financial institutions will be required to obtain certifications from the foreign branches of U.S. banks (other than from their own foreign branches) and take reasonable steps to ensure that the foreign branches' correspondent accounts in the United States are not being used to provide banking services indirectly to foreign shell banks. Treasury cautions, however, that if the correspondent account of a foreign bank actually is established, maintained, administered or managed in the United States, it will be subject to the final rules.

Correspondent Account

With some minor modifications, the final rules continue to track the statutory definition which broadly defines a correspondent account as "an account established by a covered financial institution for a foreign bank to receive deposits from, to make payments or other disbursements on behalf of a foreign bank, or to handle other financial transactions related to the account." According to Treasury, this broad definition is appropriate for purposes of sections 313 and 319(b), but no inference should be drawn concerning whether the definition would be appropriate for purposes of section 312 which requires financial institutions to establish due diligence policies, procedures and internal controls to detect and prevent money laundering through correspondent accounts.

For banks, correspondent accounts include any transaction account, savings account, asset account or extension of credit for a foreign bank and any other relationship with a foreign bank to provide "regular" services, dealings and other financial transactions. For broker-dealers, the term includes any account for a foreign bank that permits the bank to engage in securities transactions, funds transfers or other financial transactions through the account, including accounts to purchase, sell, lend or otherwise hold securities, prime brokerage accounts, accounts for trading foreign currency, custody accounts, over-the-counter derivatives accounts and accounts for trading futures or commodity options. The use of the term "regular" in the bank definition is intended to include arrangements to provide ongoing services and to exclude infrequent or occasional transactions.

Foreign Bank

In the proposed rules, Treasury proposed to provide a new definition of foreign bank. In the final rule, Treasury has replaced the definition with the existing definition of foreign bank included in the BSA regulations.

The BSA regulations define foreign bank as a bank organized under foreign law, or an agency, branch or office of a U.S. bank located outside the United States. 31 C.F.R. 103.11(o). A bank is defined to include the U.S. agencies, branches or offices of commercial banks or trust companies, national banks, private banks, thrift institutions, credit unions, other organizations (other than money services businesses) chartered under state banking laws and supervised by state banking supervisors, and banks organized under foreign law. 31 C.F.R. 103.11(c). Thus, for purposes of Sections 313 and 319(b), agencies, branches and offices of a U.S. bank that are located outside the United States will be treated as foreign banks. Foreign central banks and monetary authorities that function as a central bank or any international financial institution or regional development bank formed by treaty or international agreement will be excluded from the definition.

Foreign Shell Bank

Consistent with the USA PATRIOT Act, the final rule adopts the definition of foreign shell bank contained in the proposed rule without change. A foreign shell bank is defined as a foreign bank that does not have a physical presence in any country (i.e., a foreign bank that is not located at a fixed address in the country where it is authorized to conduct banking activities, that does not employ one or more full-time employees and maintain operating records to its banking activities, and that is not subject to inspection by the banking authority that granted it the license).

Owner

In response to numerous comments that the rules for determining whether an owner was a "large direct owner," an "indirect owner" or a "small direct owner" were overly complicated, Treasury has simplified the definition of owner in the final rule. Under the new definition, covered financial institutions will have to identify any person who directly or indirectly owns, controls or has power to vote 25 percent or more of any class of voting securities or other voting interests of a foreign bank, or any person who directly or indirectly controls the election of a majority of the directors of a foreign bank. Because the definition of person includes members of the same family, the interests of all family members must be combined and each family member identified if their total interests aggregate to 25 percent or more.

The final rule also provides an exemption from the requirement to identify the owners of a foreign bank that is publicly traded and of a foreign bank that is required to file a Form FR Y-7 with the Federal Reserve that identifies the current owners of the bank. A list of banks that have filed a Form FR Y-7 is available on the Federal Reserve's website (www.federalreserve.gov/releases/ibn/).

Regulated Affiliate

Section 313 permits covered financial institutions to open and maintain correspondent accounts with a foreign shell bank that is affiliated with a depository institution, credit union or foreign bank that maintains a physical presence in the United States or a foreign country and that is subject to supervision by a banking authority in the country regulating the affiliate (i.e., a regulated affiliated"). As proposed, the rules would have defined a regulated affiliate as an affiliate that is 25% or more owned or controlled by a U.S. or foreign bank. In response to Congressional criticism, the final rule has been modified to make it more difficult for a foreign bank to qualify for this exemption. Under the final rule, the ownership or control threshold has been increased from 25 to 50 percent. Because the final rule is more stringent than the proposed rule, there may be a question under the Administrative Procedures Act whether Treasury has provided an adequate opportunity for comment on the new definition.

Certifications

To reduce significantly the burden of having to obtain numerous certifications from the same foreign bank, Treasury has modified the final rule to permit covered financial institutions to rely on a single certification form so long as each covered financial institution is named in the certification. Treasury also is permitting foreign banks to execute a global certification applicable to all U.S. correspondent accounts and to complete one certification that covers all of its branches and offices so long as information is included for each branch and office. In addition, the final rule permits covered financial institutions to obtain a copy of a foreign bank's certification either directly from the foreign bank or indirectly through a central database or from another financial institution. In each case, however, covered financial institutions are expected to review the form to determine whether all required information is included or any information is inconsistent and to seek to obtain any missing information.

Closure of Accounts

The final rule provides covered financial institutions with thirty days to obtain an initial certification for new accounts opened after October 28, 2002, and until December 26, 2002, for accounts opened on or before October 28, 2002. If a certification that includes the information required by the final rule is not obtained within the appropriate time period, the covered financial institution must terminate all correspondent accounts with the foreign bank within a commercially reasonable time, during which the covered financial institution may not establish any new position or execute any transactions through the account or establish any new accounts for the foreign bank. This flexibility is intended to provide financial institutions with a reasonable time to close accounts with open securities or futures positions and transaction accounts with outstanding checks.

The final rule further provides that if a correspondent account is closed for failure to obtain a certification or complete information, a covered financial institution may not re-establish the account or open a new correspondent account for the foreign bank unless it obtains the required information.

Recertification and Verification

The proposed rule would have required covered financial institutions to recertify information every two years or whenever it had "reason to believe" that the information in a certificate was inaccurate. The final rule extends the time for obtaining a new certification or a recertification form from two to three years and modifies the other circumstances when a covered financial institution must take appropriate steps to verify information to include those circumstances where the covered financial institution "knows, suspects or has reason to suspect" that any information in a certification may be inaccurate. If a covered financial institution cannot obtain satisfactory verification within 90 days of undertaking the verification process, the covered financial institution must close the account within a commercially reasonable time and take reasonable steps to ensure that new positions are not established or transactions executed through the account.

Summons or Subpoenas of Foreign Bank Records

No changes have been made to 31 U.S.C. 5318(k). That section authorizes the Secretary of the Treasury (the "Secretary") or the Attorney General to issue a summons or subpoena to any foreign bank that maintains a correspondent account in the United States for records related to that account, including records maintained outside the United States. It also requires covered financial institutions that receive a written request from a federal law enforcement officer for records required by the final rule to provide the records no later than 7 days from receipt of the request. If a foreign bank fails to comply with a summons or subpoena, a covered financial institution must terminate its correspondent relationship with the foreign bank not later than 10 business days after receiving a written notice from the Secretary or the Attorney General, unless the foreign bank commences proceedings in a U.S. court to contest the summons or subpoena. A civil penalty of $10,000 per day may be imposed against any covered financial institution that fails to terminate an account within 10 business days of receiving notice from the Secretary or Attorney General.

Safe Harbors and Limitations of Liability

The final rules provide safe harbors for covered financial institutions that use Treasury's certification and recertification forms and limitations of liability for covered financial institutions that terminate correspondent accounts with foreign banks that do not comply with a summons or subpoena and foreign banks that do not provide fully completed and accurate certifications or recertifications. While section 319 specifically provides a limitation of liability for covered financial institutions that terminate correspondent accounts with foreign banks that do not comply with a summons or subpoena, no similar protection is provided in the BSA statute, as amended by the USA PATRIOT Act, for covered financial institutions that terminate the accounts of a foreign bank that fails to provide a certificate or recertification. Consequently, there appears to be a question about a covered financial institution's liability if it were to close an account for the failure of a foreign bank to provide a certification or recertification.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

©Gibson, Dunn & Crutcher LLP, October 1, 2002