Why Beneficial Ownership Verification is so Important

Beneficial ownership verification and ongoing monitoring is now an essential component of the KYC onboarding and anti-financial crime procedures. However, peeling back the complex legal structures designed to conceal Ultimate Beneficial Ownership (UBO) represents a significant challenge. In this blog, we explore the confusion over multiple beneficial ownerships, the complexity of share structures, understanding Trusts and how you can minimise risk exposure when onboarding and monitoring UBOs.

Posted on March 24, 2021
Written by Anton Zdziebczok

Ultimate Beneficial Ownership Verification

Who Are Ultimate Beneficial Owners?

As more and more complex money laundering schemes started to be identified towards the end of the 20th century, the letters UBO started to become more prominent.

You might be forgiven for thinking they originally stood for “unidentified beneficial owner” because in most cases then, and still in many cases now, trying to find the ultimate owners of many corporations can be like searching for Higgs Boson with a magnifying glass. 

However, the law in most countries in the world is quite clear. If you provide financial services to a legal entity then you must first identify the ownership chain behind that entity, all the way to the human beings who ultimately own it (or at least those who own more than 25% if such is the case).

Definition of ‘beneficial owner’ from the Glossary to the FATF Recommendations

Beneficial owner refers to the natural person(s) who ultimately owns or controls a customer and/or the natural person on whose behalf a transaction is being conducted. It also includes those persons who exercise ultimate effective control over a legal person or arrangement.

Reference to “ultimately owns or controls” and “ultimate effective control” refer to situations in which ownership/control is exercised through a chain of ownership or by means of control other than direct control.

This definition should also apply to the beneficial owner or a beneficiary under a life or other investment-linked insurance policy.

Company UBOs

If you are dealing with a large multinational company with highly diverse ownership, or a state-owned industry, for example, there is little likelihood of a human being (or natural person to give them the correct nomenclature) fitting the bill. But for the majority of small corporate entities, there is likely to be one or more natural persons who do. And they need to be identified.

In most circumstances this is a straightforward matter. A joint-stock company, for example, is composed of shares (or equivalent). These shares tend to have “voting rights” (i.e., a say in how the company is run) and normally, each share has one vote. Where the legislation calls for firms to identify those who “own or control” more than 25%, that is what they are talking about. The shares give you ownership and the votes give you control.

The complexities of Ultime Beneficial Ownership verification

All well and good, so far. But this is not the only way that companies can be constituted. And it isn’t just companies that have UBOs. 

Let’s look at some specific examples of what I mean by this.

First of all, different ways of constituting a company. 

There might be more than one class of shares issued by the company which carry different voting rights. For example, there might be 100 shares issued in total, 70 “A” shares which carry one vote each and 30 “B” shares which carry 20 votes each. You could easily have a situation where 2 people own all the “A” shares, and 3 people own the “B” shares.

What would this mean in practice?

Each of the “A” shareholders owns 35 shares and therefore owns 35% of the company, so they are UBOs by virtue of ownership. Each of the “B” share holders controls 10 “B” shares and therefore 200 votes each. Given that the total number of votes available is 670 (70 “A” share votes plus 20 x 30 = 600 “B” share votes”) each “B” shareholder is a UBO by virtue of control (200 votes equates to approx. 30% of the voting rights).

Not quite so straightforward.

What if it appears no direct ownership of the company?

To take this a stage further, what happens if there is no direct ownership of the company you are onboarding? Let’s say there are three shareholders, all corporate entities themselves, and they all have a variety of shareholders, some of whom are common to more than one company.

And what if some of those intermediate companies also have different shares with different voting rights? I’m not going to go through another worked example (you’ll be pleased to know) but you get the point. All of those shareholdings need to be worked out (along with voting right calculations if necessary) in order to establish who, if anyone, is a UBO.

Getting all that information is not always easy which further complicates matters.

At this point, it would be nice to think that we’ve now covered all the requirements relating to legal entities but there is still more.

One of the things that regulated entities are obliged to do is to consider the rationale for any, particularly complex ownership structures. Previous fact sheets emanating from the Financial Action Task Force (FATF) have indicated that more than three layers of ownership should be considered as a possible starting point for complexity.

Compliance questions you need to ask

The question that needs to be answered is this.

“Do I understand the commercial rationale for this level of complexity?”

It may be that the company has been subject to numerous mergers and acquisitions and along the way acquired multiple layers of ownership. Or it might be a joint venture with the accompanying baggage which comes with it. Or yet again one of those “special purpose vehicles” which seem to have complexity baked in. All well and good.

But what if there is no obvious commercial rationale for the nature of the corporate structure? What then?

The firm needs to consider whether the complexity was built in solely to obscure or obfuscate the ability, properly to identify the ownership and control. If it is there solely to mask or otherwise disrupt the onboarding firm’s understanding of the real, underlying UBOs it should be treated with suspicion.

UBO and Trusts

One of the difficulties with Trusts (assuming the Trust itself is your client) is that they are not as well covered in the legislation and supporting guidance as corporates are. Who are the UBOs of Trusts? In essence, everyone is! 

  • The Settlor? A UBO.
  • The Trustees? UBOs.
  • The beneficiaries? UBOs.
  • Protector? UBO.

And, for good measure, anyone else (if there is someone) who exerts some form of control.

Not surprisingly, this brings its own complications. What if the beneficiaries don’t yet know they are beneficiaries? What if there is only a class of beneficiary at onboarding? What if the Trustees are a professional, corporate trustee?

Most of these questions are outside the scope of this article to answer effectively but there is always one thing to bear in mind. Where is my greatest risk?

Source of Wealth and Trusts

Clearly, with Trusts, the biggest risk relates to the funds that have been settled into the Trust. After all, you don’t need to launder clean money. And that means being very clear about both the source of the funds that were settled into the trust and the overall source of wealth of the settlor. Sadly, that means establishing these, even where the trust has existed for some time, and even if the settlor has long since shuffled off his mortal coil.

On the other hand, there is simply no need for source of wealth information for the rest of the actors, as they do not contribute any funds and so do not present any risk in this respect.

However, they are still classified as UBOs so identification and verification, to some degree, will be required. And this, in my experience, is where the approach of some firms is more of a hindrance than a help.

How many times have you heard a conversation begin with something along the lines of “I’m sorry to have to ask you this…” or “I know this is a nuisance but…” prior to requesting the requisite documentation.

In so doing you are already inviting the customer to get annoyed, irritated, or intransigent.

How much better to start a conversation with something like “You’ll be delighted to hear that we take your security very seriously and always strive to make sure we don’t do business with the wrong people. For that reason, we are assiduous in ensuring that everyone goes through proper checks…” It makes a huge difference, psychologically, if you prepare the ground properly.

Most people, when presented the information in the right way, understand the need to go through these checks. Of course, those with criminal intent understand it even better, which is why they go out of their way to find nominees, proxies, call them what you will, to provide a “cover” for their activities. It’s why they tend to open bank accounts in countries different from the registration jurisdiction, it’s why they tend to have diverse geographic ownership and control and that is why all of those things, added together, should be treated as “red flags”.

The Dark Money Files Interview

We sat down with Graham Barrow, Director of The Dark Money files, to discuss the importance of understanding Ultimate Beneficial Ownerships (UBOs) in the fight against Financial Crime and why ongoing monitoring of UBOs is critical.