Identifying the beneficial owner

October 1st, 2017
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By Nkateko Nkhwashu

Coming to the realisation that the traditional methods of trying to hide or introduce illicit proceeds to the formal financial system(s) were fairly easy to detect and dealt with by the relevant authorities. The corrupt, however, took it a step further and came up with new complex and sophisticated methods to achieve the same ends. Among the methods used, is the misuse of corporate vehicles or legal structures, aimed at hiding the true identities of those who actually own, control and benefit from these structures. This challenge is not jurisdiction specific but cuts across borders.

Aside from this misuse or abuse of corporate vehicles, it is also noted – within the illicit financial flow space – that companies or big corporates were instrumental in being used to transfer ill-gotten gains abroad. On this note the international community through various fora took an interest in this and came up with various ways of curbing the challenge. One such way is the need to identify the ‘beneficial owners’ of legal entities and legal arrangements, including trusts. A ‘beneficial owner’ is defined as ‘the natural person who ultimately owns, controls, or benefits from a company or trust and the income it generates’ (Maíra Martini Combating Illicit Financial Flows:  The role of the international community www.u4.no/publications, accessed 11-9-2017).

International efforts on beneficial ownership transparency

The G20 and the Financial Action Task Force (FATF) are working together in trying to address the misuse of corporate vehicles. The FATF sets standards to counter money laundering and terrorist financing. Both the G20 and the FATF agreed that Recommendation 24 (legal persons) and 25 (legal arrangements) of the FATF Recommendation were broad and good enough to address this issue. Thus the G20 further encourages its member jurisdictions to adopt these recommendations on beneficial ownership transparency. The G20 went on further to come up with principles on the same issue. These are the G20 High-Level Principles on Beneficial Ownership Transparency. All G20 members are committed to implementing these principles and South Africa (SA) is one of them. South Africa was also the only African representative at the previous G20 meetings on beneficial ownership.

Through a cabinet decision, SA established an inter-departmental committee on the same issue. This committee aims to address some of the short-comings noted by among others, Transparency International. One concern noted was the fact that in South African law there is no definition of a ‘beneficial owner’ per se and this is required by principle 1 of the G20. South Africa always received a 0% rating when assessed on this principle. In SA the Financial Intelligence Centre Amendment Bill B33D of 2015 (the Bill) was always viewed as a significant piece of legislation that was going to close this lacuna as it would be aligned with international best practice and standards. The Bill draws from the FATF Recommendation and although these recommendations were initially aimed at addressing money laundering and terrorist funding, there was huge consensus that the definition of beneficial ownership in them can be better used for other purposes as they are broad enough for such.

Financial Intelligence Centre Amendment Act 1 of 2017 (the Act)

On 26 April 2017, the President of SA signed the Bill into law. Although the Act has yet to come into effect (and issues around industry guidance, regulations and possibly exemptions still have to be dealt with) this is a huge win for the country for various reasons. Firstly, SA’s financial system remains resilient to money laundering and terrorist funding risks and will be viewed positively by international counterparts. Secondly, the FATF will not issue an ‘adverse statement’ against SA, which may have dire consequences for the country given the current climate characterised by downgrades. Thirdly, the Act makes provision for a risk-based approach to customer identification and verification, which will ensure flexibility for financial institutions and other business and thus cut costs and possibly promote financial inclusion. Fourthly and most importantly of all for this article is that the Act makes provision for a definition of a ‘beneficial owner’, as well as how one will go about identifying the same (beneficial owner) through what is colloquially termed the ‘cascading regime’ under s 21B (additional due diligence measures relating to legal persons, trusts and partnerships). I submit that this is also a huge win for the purposes of the work undertaken by the G20 inter-departmental committee and the country as a whole, as SA will now be assessed positively by the likes of Transparency International.

The ‘cascading regime’ under s 21B closely resembles the one within the FATF’s recommendations. However, it is much clearer and more progressive than the recommendations as it does not only broadly or generally state that institutions should use a ‘mere’ risk-based approach when identifying ‘beneficial owners’ but also makes provision for a mechanism through which that can be achieved. This is called the ‘Risk Management and Compliance Programme’ in the Act.

In short, s 21B requires institutions to establish the following (as a first step) –

  • the nature of the client’s business;
  • the ownership and control structure of the business;
  • the identity of the beneficial owner of the client and take reasonable steps to verify such client’s identity; and
  • establish the identity of each natural person who, independently or together with another, has a controlling ownership interest in the legal person, among others.

Should there be a failure by an institution to establish the identity of a natural person who is a beneficial owner above, then the institution must –

  • establish the identity of each natural person who exercises control of the legal person through other means and take reasonable steps to verify the same; or
  • establish the identity of each natural person who otherwise exercises control over the management of the legal person and further verify such identity.

Implementation challenges

Though regarded as a milestone for SA – to have a working definition of the concept within its statute books – it is going to be interesting to see how this will be implemented in practice. The FATF, for instance, is also grappling with the same difficulty. The definition is too broad and it is very difficult to ascertain the meaning of (or parts of) certain concepts within it, namely, ‘ownership’, ‘effective control’ and ‘identify each natural person who exercise control through other means’. This results from the fact that the definition does not attach a threshold to the share capital of an entity similar to other regulatory obligations, namely, the Foreign Account Tax Compliance Act (10%), the FATF (25%) etcetera. It will be helpful if this is provided for in the new sets of guidance, which are going to be issued by the regulator.

The FATF places an obligation on countries (not financial institutions) to make beneficial ownership information available to all including relevant authorities. This information should be accurate, up-to-date and accessible in a timely manner. Unfortunately, SA does not have such a registry, which conforms to these standards. Currently this obligation lies with the Companies and Intellectual Property Commission (CIPC). Unfortunately not much reliance can be placed on the CIPC either as their efforts do not conform to what is required by the FATF. Currently there are efforts underway to amend the Companies Act 71 of 2008 (and regulations) to cater for this.

One other important challenge is the fact that SA has not yet done a country risk assessment as it pertains specifically to beneficial ownership transparency. This is required by G20 principle 2 (identifying and mitigating risk).

Conclusion

In a nutshell, the signing of the Bill into law is a significant milestone for SA. Efforts aimed at addressing some of the implementation challenges noted above are very welcome and should not lose momentum. Furthermore, it is imperative to note that most countries fail to meet this obligation and others are in a process of trying to address it, namely, within the Organisation for Economic Cooperation and Development countries only 9% complies with this requirement. In the ‘United States, two pieces of relevant legislation have been introduced in Congress, but have not yet been approved’ (Martini (op cit)). Finally, the signing of the Bill into law should be applauded as a significant first step to addressing issues around the misuse of corporate structures.

Nkateko Nkhwashu LLB (University of Venda) LLM (UJ) Cert in Legislative Drafting (UP) Cert in Compliance Management (UJ) Cert in Money Laundering Controls (UJ) is an advocate at the Banking Association of South Africa. Mr Nkhwashu writes in his personal capacity.

This article was first published in De Rebus in 2017 (Oct) DR 22.

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