Understanding Beneficial Ownership: A Constant Challenge

Marcin Tobola is a Senior Analyst II at AML RightSource. We encourage our team members

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Defining Beneficial Ownership

In today's intricate financial landscape, beneficial ownership is integral to transparency and regulatory compliance. Beneficial ownership points to the individuals or entities who either own, control or are the ultimate beneficiaries of an asset or entity, even if they aren't listed on legal documentation. For instance, while a trust or corporation might be the named holder of an investment, the beneficial owner is the one who enjoys its benefits or has authority over it.

Adopting FATF Recommendations

In alignment with the guidance of the Financial Action Task Force (FATF), numerous countries worldwide, especially within Europe, have taken significant steps to enhance transparency by introducing registers of beneficial owners. These registers are designed to encourage entities to disclose their beneficial owners and to make this information accessible to the general public or individuals with a legitimate legal interest. Introducing such registers is a strategic move to deter illicit activities by making ownership information readily available, thus increasing the accountability of reporting entities and facilitating the due diligence processes for financial institutions and other stakeholders. Although access to these registers is unrestricted in some countries, in others, they are either paywalled or their access is limited to authorized personnel. An additional complication arises from discrepancies in identifying beneficial owners, which can vary between reporting entities and may not align with the perspectives of financial institutions and regulatory authorities.

Anticipated Changes in the United States

While Europe has moved forward with implementing beneficial ownership registers, the United States is poised to follow suit, with plans to introduce its register in 2024. This forthcoming change reflects a growing recognition of the importance of beneficial ownership transparency to combat financial crimes. The delay in establishing such a register in the U.S. highlights the complexities and considerations involved in balancing privacy concerns with the need for transparency. The eventual implementation of this register will mark a significant milestone in the global efforts to provide greater clarity on asset and entity ownership and to strengthen the integrity of financial systems.

Methods to Determine Beneficial Ownership

1. Direct Ownership: At its most transparent, direct ownership means an individual holds an asset or stake in an entity without intermediaries. This clarity is fundamental for financial institutions in their due diligence processes.
2. Indirect Ownership: via Corporate Hierarchies: Complexity arises when control structures span multiple layers. An individual might command a corporation that holds significant sway over another entity. This chain of influence indicates that the top-tier individual, despite the layers, retains beneficial ownership.
3. Ownership through Legal Structures:

• • Trusts: Trusts are incredibly nuanced. While trustees are the legal custodians, the actual beneficiaries or those who stand to gain from the trust's assets are often seen as the beneficial owners. Different jurisdictions and institutions might also consider roles such as settlors or protectors as part of the beneficial ownership framework.
  • Foundations: These entities can vary widely based on jurisdiction. Beneficial ownership within a foundation might be tied to those managing it, its beneficiaries, or its founders.

4. Contractual Arrangements: Contracts can also dictate beneficial ownership beyond direct or indirect ownership. Such arrangements might give an individual rights over an asset's profits or decision-making capabilities without traditional ownership.
5. Hybrid Frameworks: The world of finance is known for its intricate designs. Sometimes, entities blend various methods, leading to convoluted beneficial ownership structures. A trust, for instance, might own a part of a corporation that's simultaneously involved in several contractual agreements, creating a multifaceted web of ownership.

Interpreting Beneficial Ownership Across Institutions

The lens through which beneficial ownership is viewed can differ significantly across the globe. In the U.S., the "25% or more" ownership benchmark is commonly used to define a beneficial owner. Conversely, Europe might consider anyone with "more than 25%" as such. Given the diverse risks they encounter, financial institutions often customize these figures. In situations where the risk is deemed high, some institutions might employ a threshold as low as 10%, casting a wider net to ensure robust scrutiny.

Furthermore, the U.S. faces its own set of challenges in harmonizing its approach with international standards. According to FinCEN's September 2023 guidelines, the U.S. definition of a beneficial owner significantly diverges from that of the EU. FinCEN's interpretation expansively includes all senior managers as beneficial owners due to their control over the entity and individuals who own or control its voting rights. Conversely, the EU's Anti-Money Laundering (AML) directives primarily identify beneficial owners through ownership and control of voting rights, considering senior managers as beneficial owners only when other methods to determine ownership prove ineffective.

The Domination Method in Beneficial Ownership

Another example of one of the nuances in determining beneficial ownership is the "Domination Method.” To elucidate with an example, consider Company A, owned 51% by Company B, which in turn is owned 51% by Company C. If Company C is owned 51% by Mr. Johnson, then by the standard method, Mr. Johnson would have an approximate stake of 13.27% in Company A. However, with the Domination Method, any majority stakeholder is seen as having full control over the entity they possess. This means Mr. Johnson, due to his majority stakes across the chain, would be perceived as having a 51% stake in Company A, thereby classifying him as a UBO.

Intermediate Beneficial Owners (IBOs)

Another essential facet is the concept of Intermediate Beneficial Owners (IBOs). These are entities that, while not being the ultimate end beneficiaries, hold significant stakes (often over 25%) in the ownership chain, lying between the primary client entity and the UBO. While there isn't a legal mandate to identify IBOs, many corporations, driven by internal regulations, opt to recognize and disclose them. This practice allows for a comprehensive risk assessment of the entire ownership hierarchy.

Special Considerations for Certain Entities

For specific entities, like private investment vehicles or civil partnerships, the traditional thresholds for determining beneficial ownership might not apply. Some financial institutions, adhering to their internal guidelines, may treat all owners or partners of such entities as UBOs. This approach aims to ensure a more exhaustive scrutiny, considering the unique nature of these entities.

The Challenge of Nominee Entities

Entities that hold assets on behalf of others, known as nominee entities, introduce an additional layer of complexity. To pinpoint the real beneficial owner behind such entities, one must navigate a maze of control mechanisms, contractual terms, and a deeper understanding of the intended beneficiaries.

Beneficial Ownership in Limited Partnerships (L.P in the US, UK, KG in Germany)

The dynamics of limited partnerships make beneficial ownership determination particularly challenging. Various stakeholders may take different approaches or models to identify beneficial owners in limited partnerships that act either as their customers or are identified in the ownership structures of their customers.

1. Capital-Focused Approach: Here, the emphasis is on capital contributions, directly tying beneficial ownership to the financial input of both general and limited partners
2. Equal Rights Model: Aiming for an equitable approach, each partner, regardless of their contribution size, is granted equal voting rights. So, for example, when there are four limited partners and one general partner, and each has one vote, no one is the beneficial owner, as each has only 20% of the voting rights of the limited partnership.
3. Risk-Averse Model: Some stakeholders might allocate "more than 50%" voting rights to each general partner, ensuring they are captured as beneficial owners in most cases.
4. All-Inclusive Approach: Casting the widest net, this strategy designates all general partners, and sometimes even their primary stakeholders, as beneficial owners of the limited partnership.

This variety results mainly from different understandings of general partners’ functions and roles in limited partnerships, which are subject to national laws and contractual agreements. On the other hand, the approach to limited partners is relatively straightforward, and the state of being a beneficial owner depends on the size of their capital contribution to the partnership.

The Discrepancy Among Stakeholders

A significant challenge in the beneficial ownership landscape is the potential misalignment between regulators, corporations, and financial institutions. How a corporation perceives an Ultimate Beneficial Owner (UBO) might differ significantly from a financial institution's or regulator’s perspective. This discrepancy can lead to confusion and potential regulatory pitfalls. The root of this divergence often lies in the varied criteria and methodologies used to determine beneficial ownership. Regulatory standards might be more stringent or differ in their focus compared to a corporation's internal policies or vary across different jurisdictions and institutions.

For a more harmonized and accurate determination of beneficial ownership, it's crucial to have a collaborative approach among all stakeholders. By fostering open dialogue and sharing methodologies, corporations, financial institutions, and regulators can converge on a unified understanding of UBOs. This collaborative stance ensures compliance and strengthens the overall financial system by identifying and mitigating risks effectively.

In wrapping up, beneficial ownership, with its myriad facets, remains a pivotal concept that entrepreneurs, institutions, and regulators must grapple with daily. As global financial structures evolve and regulatory requirements tighten, the methodologies to ascertain beneficial ownership will need continuous refinement. This dynamic landscape underscores the importance of all stakeholders staying updated and maintaining a flexible yet robust approach.