Know Your Customer

The Know Your Customer process has three major components: a customer identification program (CIP), customer due diligence (CDD), and enhanced due diligence (EDD). Additional steps include continuous monitoring, reporting, and compliance. Know Your Customer regulations aim to:

Know Your Customer requirements provide the foundation for financial organizations' compliance and risk management programs. The Financial Action Task Force (FATF) was crucial in developing international KYC standards.

Under SEC rules, customers must provide detailed financial information before opening a new investment or bank account. Banks, insurance companies, and many creditors must comply with the Know Your Customer rules.

KYC verification begins with a customer identification program, which is followed by multiple steps to ensure that the customer is who they say they are and their business dealings are legitimate.

The customer identification program requires the investment firm or bank to collect four main pieces of information from the client: name, date of birth, address, and identification number.

Those four criteria are the bare minimum. Most firms take things further and request additional information like financial transaction history, which they evaluate for risk. Banks also check government sanctions, known terrorists, and politically exposed persons (PEP) lists to ensure the customer does not appear on them.

Companies performing KYC obtain this information from public databases, reporting agencies, and other third-party sources.

The next step in Know Your Customer compliance is verifying all the information the firm collected during step one. They do this by examining customer transactions and relationships to ensure consistency and accuracy of the customer-provided data.

The goal of this investigation into the customer's business is to gather as much information as possible to evaluate the customer's risk potential and verify their identity beyond a doubt. Doing so requires knowing what red flags look like, for example, quick spikes in activity or inconsistencies in their business that do not appear to be natural.

Most customers will pass this phase without any issues, but those who do not require an additional step, enhanced due diligence.

Any customer flagged as high-risk must undergo additional examination. The financial institution must determine the customer's motives. Some examples of riskier customers are those who have political affiliations or relationships with individuals on red flag lists or those operating out of high-risk countries. Sometimes, the bank will require verification of the person's source of wealth.

Customers wanting to process many cross-country money transfers will flag a deeper investigation into their legitimacy and business operations. These customers will be viewed as high risk for terrorism or money laundering.

Two main rules dictate the KYC standards: Financial Industry Regulatory Authority (FINRA) Rule 2090 (Know Your Customer) and FINRA Rule 2111 (Suitability).

Rule 2090, Know Your Customer, requires every brokerage firm, insurance company, and financial institution to conduct due diligence before allowing a customer to open a new account and when maintaining existing accounts. Due diligence includes collecting data, keeping a customer profile, and verifying the identity and authenticity of the customer they are doing business with. It applies to individuals with a controlling interest or stake in a company or the authority to act on a customer's behalf.

FINRA Rule 2111, Suitability, requires that a financial company have a "reasonable basis" to accept a customer based on the information gathered about the customer's economic situation and needs. The suitability must depend on the bank completing a customer profile and examining all the facts, other securities and investments, and historical transactions before allowing the customer to invest or open an account. They must also update this customer profile with new information when it changes.

KYC and crypto are intimately linked. Cryptocurrency's decentralized structure provides companies and individuals with unmatched privacy and confidentiality, making it much more difficult to prevent or detect money laundering. Criminals regularly use crypto to launder money and pay other criminals to commit crimes. Terrorists frequent the dark web to facilitate transactions. The government is searching for ways to extend KYC laws to cryptocurrency companies.

The good news is that most cryptocurrency platforms are viewed as money service businesses (MSBs), subject to anti-money laundering laws. These laws require that MSBs verify customer identity, maintain specific recordkeeping procedures, and file regular reports.

Nation-to-nation (otherwise known as Fiat-to-crypto) transfers convert a nation's official currency to cryptocurrency and are subject to many KYC rules and regulations. Therefore, their customers have already been vetted and approved before initiating any exchanges.

Know Your Customer and AML, anti-money laundering regulations, are also intricately linked. AML refers to the processes and methods of preventing money laundering, and KYC is a component of that. The U.S. Financial Crimes Enforcement Network (FinCEN) requires banks and other financial institutions to comply with KYC standards to prevent money laundering and other types of illegal activities. Customers of these financial institutions are also required to comply with KYC laws.

FinCEN laws dictate that financial companies investigate each type and purpose of each customer relationship. Then, they must create a customer risk profile and use that as a backdrop for detecting suspicious activity.

Additionally, these financial institutions must maintain current and accurate customer information and continuously monitor accounts for any suspicious activity. If the bank detects anything illegal, they must report it to the authorities immediately.

To comply with KYC regulations, customers are required to provide government-issued identification (ID) to prove their identity. Many banks require more than one form of ID. Some of the allowable forms of identification include:

Beyond that, the financial institution must also verify the customer's address. They can do that through:

As the financial institution sees fit, additional documentation may be required on a case-by-case basis and will vary by individual or company.

Performing a business background check on every customer before opening accounts or allowing them to initiate transactions is time-consuming and expensive. Many Know Your Customer software solutions exist to streamline the customer onboarding process and improve efficiency in verifying identities, evaluating risk, and complying with the rules.

Many of these solutions employ artificial intelligence (AI), machine learning (ML), and even optical character recognition (OCR) to automate tasks and speed up information collection, identity verification, and analysis of the information gathered. These programs are designed to comply with anti-money laundering laws.

As the customer provides the required documents (driver's license, utility bills, bank statement, etc.), a bank representative can scan them into the computer, where the Know Your Customer automation software takes over and instantly compares the information with publicly available data to verify their identity. The software will leverage advanced data analytics and machine learning algorithms to quickly assess the customer's risk and identify red flags that indicate a problem. Because computers and AI can compare and analyze millions of data points in seconds, the solution can more easily identify unusual or suspicious patterns that may indicate illegal activity much quicker than a manual process could. Some of the benefits of using KYC automation include:

Companies outside the financial industry also need to vet their customers to assess and minimize risk and get the complete picture of who they are doing business with. Some reasons to perform a business background check include:

The partial list above details why it's crucial to do your homework and learn all you can about a potential business partner. Before signing any contracts, ensure they aren't engaging in money laundering or illegal business activities. Lawsuits are another possible red flag. You can make better decisions about moving forward by investigating the company and its owner(s), executives, and even board members.

Before developing any business relationship, you want to avoid companies that engage in illegal activities or have serious financial issues. The most prudent way to assess risk is through data. The more you learn, the better off you will be. EntityCheck's primary goal is to collect business data, providing you with everything you need to know to assess and mitigate risk and take action.

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