Customer Due Diligence - Issues and Best Practices -

1. Customer Due Diligence- Issues and Best Practices - OSFI Anti-Money Laundering and Anti-Terrorist Financing Information Session � November 9, 2005 Fairmont Royal York Presented by Keith Martin Senior Compliance Specialist Compliance Division OSFI

2. 2 Terminology

3. 3 Themes and Content Products and Services Verification of Identity Mortgages Securitizations Credit and Stored Value Cards White Label Lock Boxes Private banking Trusts PEPS Correspondent Banking Beneficial Ownership Not-for-Profit Organizations

4. 4 Products and Services include Deposits Mortgage Lending Private Banking Funds Transfers Lock Boxes Money Service Business Life Insurance Policies Segregated Funds Annuities Credit Cards Prepaid Cards

5. 5 Products Deposits, including: - Chequing - Savings - GICs - Term Credit, including: - Mortgages � conventional and NIQ - Lines of credit - Auto loans - Credit cards - Financing of luxury vehicles (RVs, boats, etc.) - Financial Leases

6. 6 The Basic Requirements Customer Information - Name, date of birth, address, occupation * Third Party Determination Verification of Identity PLUS For credit facilities Employment address Financial capacity

7. 7 Verification of Identity

8. 8 In person vs. Non Face-to-Face

9. 9 Non Face-to-Face Internet Response to mail campaign Application forms in newspaper, etc. Telephone

10. 10 Non Face-to-Face A �cleared cheque�* is the only method of identification provided by the PCMLTFA OSFI�s view (shared by many industry participants) is this, on its own, is not an ideal method OSFI recommends compensating controls be established where the cleared cheque method is used

11. 11 Verification of Identity One piece of government (federal, provincial or territorial) issued ID It must be valid i.e. must not have expired. At least one government document with photo and signature A second document

12. 12 Verification of IdentitySpecial situations

13. 13 Verification of IdentitySpecial situations (1) Immigrants Foreign passport* with Canada Immigration Landed Immigrant or Student Visa Form (unexpired) Permanent resident card Other * Is foreign document legitimate?

14. 14 Verification of IdentitySpecial situations (2) Individuals not physically present in Canada Consider using a correspondent bank or other third party, subject to AML regulatory supervision If another bank or third party is used, provide specific written instructions setting out requirements The correspondent bank or other third party should provide signed certificate stating that they saw the original of the document(s), that they believe them to be valid and providing a description of the document(s) with issuing agency, reference number and expiry date If using a lawyer, notary public, commissioner of oaths or similar person, consider having that individual�s standing confirmed through the Canadian consulate

15. 15 Verification of identity � Special situations (3)Deposit Brokers The FI must stipulate that the broker see original of ID document Must be written agreement between FI and broker, setting out the FI�s documentation standards and the right to audit the broker�s records and practices Details of document(s) must be transmitted to FI along with application Receipt of information a pre-requisite to accepting deposit

16. 16 Verification of identity � Special situations (3)- Deposit Broker doesn�t provide ID details

17. 17 Verification of identity � Special situations (3)- Deposit Broker doesn�t provide ID details For FIs only offering term deposits, GICs, etc., there are only 2 transactions: - The initial deposit - The maturity cheque or roll-over

18. 18 Verification of identity � Special situations (3) Deposit Broker doesn�t provide ID details (cont�d.)

19. 19

20. 20

21. 21 QUESTIONS?

22. 22 Mortgages

23. 23 Money Laundering through Mortgage Lending � The whole house may be one big washing machine! Down payments from proceeds of crime Monthly payments out of funds derived from criminal activities House may be used for criminal activities Early repayment, then house sold and proceeds of crime successfully integrated back into economy

24. 24 Mortgages - Client Identification Is the borrower �fronting� for an undisclosed party? Reasonableness of source of down payment and income NIQ mortgages particularly vulnerable

25. 25 Identification Inconsistencies between address on ID document and stated residence Address on ID document does not match address on personalized cheque Name on ID document doesn�t match with applicant�s name �Sub-standard� ID

26. 26 Mortgages- Identification where the borrower does not meet directly with the FI

27. 27 Mortgages - Identification where the borrower does not meet directly with the FI(cont�d) The law says that the identity of an individual has to be ascertained �before any transaction other than an initial deposit is carried out� No �initial deposit� Disbursement of the proceeds of the mortgage is the only transaction ��

28. 28 Mortgages - Identification where the borrower does not meet directly with the FI(cont�d) FI must instruct the broker that original of document must be seen (Note: Best practice requires written certification that original of document was seen) Must have written agreement between FI and broker, setting out documentation standards and the right to audit the broker�s records and practices Details of document(s) must be transmitted to FI along with application Receipt of information a pre-requisite to funding the mortgage ��

29. 29 Mortgages - Identification where the borrower does not meet directly with the FI (cont�d.) FI must instruct the lawyer that original of document must be seen FI must provide written instructions to lawyer setting out documentation standards Best practice: require certification that original of document was seen Details of document(s) must be transmitted by the lawyer to FI before funding the mortgage ��

30. 30 The FI must have the details of the ID on its records before funding the mortgage The only way it can demonstrate compliance with the legislation Legislation does not permit information to be recorded at a later time Compliance is assured � the lawyer cannot close the transaction without providing the information FI has some level of assurance that the borrowers are who they claim to be Industry best practice

31. 31

32. 32 QUESTIONS?

33. 33 Non Income Qualifying (NIQ) Mortgages Where the financial institution bases its lending decision almost entirely on the equity cushion in the residence being financed. Often, though not always, business sourced through a mortgage broker and there is no in-person meeting with lending institution

34. 34 NIQ Mortgages and the �3 C�s� Character: How a person has handled past debt obligations; personal background, honesty and reliability of the borrower to pay credit debts is determined.  Capacity: How much debt a borrower can comfortably handle.  Capital: Current available assets of the borrower, such as real estate , savings or investment (or mortgage insurance) that could be used to repay debt if income should be unavailable. � 

35. 35

36. 36 NIQ � Customer Due Diligence Has the borrower been properly identified? Has the borrower�s source of funds to meet the monthly payments been verified? Does the source of the downpayment make sense? Does the combination of income, age,occupation, background and value of the property make sense?

37. 37 NIQ Mortgages- Issues Inadequate identification No verification of employment or income source Self-declared employment letters No assessment of reasonability of net worth and/or source of downpayment Inconsistencies between income, age, occupation and net worth

38. 38 NIQ Mortgages Confirmation of income source Source of downpayment Does the combination of age, occupation, income, home value, value of other assets make sense?

39. 39 NIQ Mortgages - self-employed Employment Income Self-declared employment letters not acceptable If CRA Notice of Assessment not available or inadequate Seek other sources (bank statements, suppliers� invoices, list of customer jobs, addresses of job sites, industry or association directories, news articles) to establish legitimacy of business

40. 40 NIQ Mortgages � Actual Case #1 The Successful Travel Agent Letter of employment backed up by copy of a US Income Tax return. No Notice of Assessment (or US equivalent) on file. Source of down payment from an investment account purporting to be worth $1 million. Fax copy of statement appeared to have been altered. Used Ontario ID even though lived in New York City for some years. Mortgage payments using money transfers/money orders from Western Union. Several missed payments

41. 41 Actual Case #2 �Magic Mushrooms�! Married couple (34 and 25 yrs old) purchased a $470,000 home with a $350,000 mortgage. Occupations are both shown as mushroom pickers with a combined income of $23,000. They also claim offshore income of $48,000 but no details provided. Their application shows assets of $898K and a net worth of $523K. Among their assets is another property valued at $320K with a $160K mortgage that they claim they're renting out. So their earned income plus offshore plus rent winds up at some $115K!! Quite how they accumulated just under a $1 million in assets is rather difficult to understand.

42. 42 Actual Case #3And where did you say the downpayment come from? 9 separate money orders for $999.99 each PLUS Five bank drafts from different banks, issued on different dates, for amounts between $3,000 and $9,000.

43. 43 Securitizations - Inbound The purchase by an FI of a package of mortgages from another entity that may or may not be subject to the PCMLTFA

44. 44 Securitizations - Inbound The Issue � �Cross-contamination�: FRFIs investing in mortgage packages originated by entities who are not subject to AML/ATF requirements may risk contagion by facilitating the migration of potentially higher risk mortgages to the regulated sector Risk of financial loss if the mortgages are on properties that are seized by law enforcement

45. 45 Securitizations - Inbound Representations and warranties should require originator to represent that it has complied with AML/ATF customer due diligence standards or, at a minimum, certify that it has: Identified borrower(s) by seeing an original document and recording details Satisfied itself as to the borrower�s source of income and downpayment

46. 46 Securitizations - Inbound FRFI should have recourse to originator if deficiencies in AML/ATF compliance and customer due diligence, result in actual or potential deficiency in collateral Ultimately, FRFI may want to have right to �put� back AML deficient mortgages to the originator

47. 47 Securitizations - Outbound The sale of a package of mortgages to an institutional investor � may be another FRFI

48. 48 Securitizations - Outbound Reps and warranties covering AML/ATF procedures Potential recourse by investor

49. 49 QUESTIONS?

50. 50 Cards Credit Cards - In person - Non face-to-face Stored Value (Prepaid) Cards - Distribution channels - Structuring

51. 51 Credit cards � In person In branch In store Other locations where applicant meets with another person

52. 52 Credit Cards � Non Face-to-Face Ad-hoc group of credit card bank issuers Non face-to-face identification challenges under discussion BUT, under existing regulations, must still: Comply with third-party determination Collect date of birth, occupation and employment address of primary holder and co-applicants

53. 53 Stored Value (Prepaid) Cards Issued by an FI Transactions settled through a clearing entity Cards sold/distributed through non-regulated entities e.g. Convenience stores, Cell phone retailers, etc. Cards do not have holder�s name embossed Retailer/distributor does not collect any personal information from buyer No application form No record of name or address of buyer May or may not have limitations � e.g. cannot be used in ATM, cannot be reloaded

54. 54

55. 55 Stored Value (Prepaid) Cards � AML Issues -

56. 56 Stored Value (Prepaid) Cards � AML Issues - Can be used in smurfing operations (Placement) Low level neighbourhood drug dealer gets paid in cash. Accumulates $5,000 each week. Pays cash for 10 prepaid cards of $500 each Layering and Integration: Delivers cards to �wholesale� supplier Wholesaler uses to fund various activities � gas for vehicles, cell phones, etc.

57. 57 Stored Value (Prepaid) Cards - Some AML/ATF Compliance Issues - What AML/ATF review was made of the programme? What AML/ATF concerns should you have? How does the issuer monitor activity for suspicious transactions?

58. 58 QUESTIONS?

59. 59 Life Insurance Products Universal Life Annuities Segregated Funds

60. 60 Universal Life - Side Accounts Option on universal life policies for premium prepayment Funds are credited to an interest bearing account on the books of the insurance company Funds designated as prepaid premiums Policyholder can withdraw, or deposit, funds to the side account (possibly without limits) at any time Policyholder can direct payments from side accounts to be paid to third parties For all practical purposes, has many of the attributes of a conventional bank account

61. 61 Side Accounts � AML/ATF What monitoring and management reporting for unusual transactions to CAMLO should be done? Similar criteria as for deposit account with a financial entity Suspicious Transaction Reporting to FINTRAC

62. 62 Correspondent Banking Enhanced due diligence NCCT and recently delisted NCCT countries Countries that are not yet FATF members * Countries/regions that have acknowledged relatively high concern about terrorist or criminal elements Sanctions � Canadian, US and Other * Or members of FATF-style Regional Bodies (FSRBs)

63. 63 White Label Lock Boxes A lock box arrangement set up by a non-Canadian financial institution for its customer Canadian FRFI does not deal with the correspondent bank�s client Canadian FRFI entirely reliant on correspondent bank for AML/ATF due diligence

64. 64 White Label Lock Boxes File should: Document background of correspondent bank�s customer and nature of Canadian business activities Document correspondent bank�s AML/ATF due diligence procedures

65. 65 Private Banking- Enhanced Due Diligence It is not sufficient to rely on the fact that �the customer is well known to another branch� without obtaining copies of that branch�s documentation providing background, and evidence, as to the source of wealth File should contain details on client�s background and how personal financial assets were accumulated File should �stand alone�

66. 66 Private Banking- Enhanced Due Diligence (cont�d.) FI is ultimately accountable. Cannot rely on a lawyer or family advisor to verify identity. Ultimate beneficial owners of privately held corporations must be ascertained

67. 67 Beneficial Ownership Certificate of incorporation or corporate status Nature of business Names of shareholders and directors Need to understand ultimate ownership in multi-layered corporate structures Determine name(s) of natural person(s) who ultimately own or effectively control corporation

68. 68 Politically Exposed Persons (PEPS) Research names to ascertain if they are on any major PEP data base. Various private sector vendors BUT � even though a name is not in a database, that is not proof that individual is NOT a PEP Often FI receives information from application, references, etc., that individual may now (or in the future) be a PEP Certain professions, activities, countries of residence, etc., may be indicators of potential PEP Enhanced due diligence is required If client is a PEP, recommend a more senior manager approve account opening

69. 69 Trusts Identify co-trustee (if applicable) settlor and beneficiaries(as they become known) All beneficiaries names must be checked against terrorist list when they are entitled to distributions Same due diligence as for private banking relationships

70. 70 Not-for-Profit Organizations (NPOs) Registration certificate If a registered charity, obtain copy of CRA registration and number Carry out due diligence on name and activities Verify information independently There have been fraud cases involving organizations with names closely resembling legitimate entities � no reason to assume money launderers and terrorists don�t use similar tactics. If no registration documents available, treat as a personal account

71. 71 Thank You!

72. 72 Questions for discussion at 3:30