[Federal Register Volume 67, Number 141 (Tuesday, July 23, 2002)]
[Proposed Rules]
[Pages 48318-48328]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-18194]


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SECURITIES AND EXCHANGE COMMISSION

17 CFR Part 270

[Release No. IC-25657; File No. S7-26-02]

DEPARTMENT OF THE TREASURY

31 CFR Part 103

RIN 1506-AA33


Customer Identification Programs for Mutual Funds

AGENCIES: Financial Crimes Enforcement Network, Treasury; Securities 
and Exchange Commission.

ACTION: Joint notice of proposed rulemaking.

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SUMMARY: The Department of the Treasury, through the Financial Crimes 
Enforcement Network (FinCEN), and the Securities and Exchange 
Commission are jointly issuing a proposed regulation to implement 
Section 326 of the Uniting and Strengthening America by Providing 
Appropriate Tools Required to Intercept and Obstruct Terrorism (USA 
PATRIOT) Act of 2001 (the Act). Section 326 requires the Secretary of 
the Treasury to jointly prescribe with the Securities and Exchange 
Commission a regulation that, at a minimum, requires investment 
companies to adopt and implement reasonable procedures to verify the 
identity of any person seeking to open an account, to the extent 
reasonable and practicable; maintain records of the information used to 
verify the person's identity; and determine whether the person appears 
on any lists of known or suspected terrorists or terrorist 
organizations provided to investment companies by any government 
agency. The proposed rule would apply to investment companies that are 
mutual funds.

DATES: Written comments on the proposed rule should be submitted to the 
Treasury Department and the Securities and Exchange Commission on or 
before September 6, 2002.

ADDRESSES: Because paper mail in the Washington area may be subject to 
delay, commenters are encouraged to e-mail comments. Comments should be 
sent by one method only.
    Treasury: Comments may be mailed to FinCEN, Section 326 Mutual Fund 
Rule Comments, P.O. Box 39, Vienna, VA 22183, or sent to Internet 
address [email protected] with the caption ``Attention: 
Section 326 Mutual Fund Rule Comments'' in the body of the text. 
Comments may be inspected at FinCEN between 10 a.m. and 4 p.m. in the 
FinCEN Reading Room in Washington, DC. Persons wishing to inspect the 
comments submitted must request an appointment by telephoning (202) 
354-6400 (not a toll-free number).
    Securities and Exchange Commission: Comments also should be 
submitted in triplicate to Secretary, Securities and Exchange 
Commission, 450 Fifth Street, NW., Washington, DC 20549-0609. Comments 
also may be submitted electronically at the following E-mail address: 
[email protected]. Comment letters should refer to File No. S7-26-
02; this file number should be included on the subject line if E-mail 
is used. All comments received will be available for public inspection 
and copying at the Commission's Public Reference Room, 450 Fifth 
Street, NW., Washington, DC 20549-0102. Electronically submitted 
comment letters will be posted on the Commission's Internet web site 
(http://www.sec.gov). Personal, identifying information, such as names 
or E-mail addresses, is not deleted from electronic submissions. Submit 
only information you wish to make publicly available.

FOR FURTHER INFORMATION CONTACT: Securities and Exchange Commission: 
Division of Investment Management, Securities and Exchange Commission, 
(202) 942-0720.
    Treasury: Office of the Chief Counsel (FinCEN), (703) 905-3590; 
Office of the Assistant General Counsel for Enforcement (Treasury), 
(202) 622-1927; or the Office of the Assistant General Counsel for 
Banking & Finance (Treasury), (202) 622-0480.

SUPPLEMENTARY INFORMATION:

I. Background

A. Section 326 of the USA PATRIOT Act

    On October 26, 2001, President Bush signed into law the USA PATRIOT 
Act.\1\ Title III of the Act, captioned ``International Money 
Laundering Abatement and Anti-terrorist Financing Act of 2001,'' adds 
several new provisions to the Bank Secrecy Act (``BSA''), 31 U.S.C. 
5311 et seq. These provisions are intended to facilitate the

[[Page 48319]]

prevention, detection, and prosecution of international money 
laundering and the financing of terrorism.
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    \1\ Pub. L. 107-56.
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    Section 326 of the Act adds a new subsection (l) to 31 U.S.C. 5318 
that requires the Secretary of the Treasury (``Secretary'') to 
prescribe regulations setting forth minimum standards for financial 
institutions and their customers that relate to the identification and 
verification of any person who applies to open an account. Section 326 
provides that the regulations must require, at a minimum, financial 
institutions to implement reasonable procedures for: (1) Verifying the 
identity of customers, to the extent reasonable and practicable, when 
accounts are opened; (2) maintaining records of the information used to 
verify the person's identity, including name, address, and other 
identifying information; and (3) determining whether the person appears 
on any lists of known or suspected terrorists or terrorist 
organizations provided to the financial institution by any government 
agency. In prescribing these regulations, the Secretary is directed to 
take into consideration the various types of accounts maintained by 
various types of financial institutions, the various methods of opening 
accounts, and the various types of identifying information available. 
Final regulations implementing Section 326 must be effective by October 
25, 2002.
    Section 326 applies to all ``financial institutions.'' This term is 
defined very broadly in the BSA to encompass a variety of entities 
including investment companies, banks, agencies and branches of foreign 
banks in the United States, thrifts, credit unions, brokers and dealers 
in securities or commodities, insurance companies, travel agents, 
pawnbrokers, dealers in precious metals, check-cashers, casinos, and 
telegraph companies, among many others. See 31 U.S.C. 5312(a)(2).\2\
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    \2\ For any financial institution engaged in financial 
activities described in section 4(k) of the Bank Holding Company Act 
of 1956 (section 4(k) institutions), the Secretary is required to 
prescribe the regulations issued under section 326 jointly with the 
Securities and Exchange Commission (``Commission''), the Commodity 
Futures Trading Commission (``CFTC''), and the banking agencies 
(``banking agencies''), namely, the Office of the Comptroller of the 
Currency, the Board of Governors of the Federal Reserve System, the 
Federal Deposit Insurance Corporation, the Office of Thrift 
Supervision, and the National Credit Union Administration.
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    Although the BSA includes ``an * * * investment company'' among the 
entities defined as financial institutions, Treasury has not previously 
defined the term for purposes of the BSA.\3\ The Investment Company Act 
of 1940 (codified at 15 U.S.C. 80a-1, et seq.) (``1940 Act'') defines 
investment company broadly and subjects those entities to comprehensive 
regulation by the Commission.\4\ However, privately offered entities 
commonly known as hedge funds, private equity funds and venture capital 
funds typically rely on exclusions from the 1940 Act definition of 
investment company.\5\ For purposes of the Section 326 requirement, the 
scope of this proposed rule is limited to those entities that are 
required to register with the Commission as investment companies and 
that fall within the category of ``open-end company'' contained in 
section 5(a)(1) of the 1940 Act.\6\ These entities are commonly 
referred to as ``mutual funds.'' \7\
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    \3\ 31 U.S.C 5312(a)(2)(I).
    \4\ Section 3(a)(1) defines ``investment company'' as any issuer 
which--
    (A) is or holds itself out as being engaged primarily, or 
proposes to engage primarily, in the business of investing, 
reinvesting, or trading in securities;
    (B) is engaged or proposes to engage in the business of issuing 
face-amount certificates of the installment type, or has been 
engaged in such business and has any such certificate outstanding; 
or
    (C) is engaged or proposes to engage in the business of 
investing, reinvesting, owning, holding, or trading in securities, 
and owns or proposes to acquire investment securities having a value 
exceeding 40 per centum of the value of such issuer's total assets 
(exclusive of Government securities and cash items) on an 
unconsolidated basis.
    \5\ E.g., Sections 3(c)(1) and 3(c)(7) of the Investment Company 
Act. Section 356 of the Act requires that the Secretary, the Board 
of Governors of the Federal Reserve System and the Commission 
jointly submit a report to Congress, not later than October 26, 
2002, on recommendations for effective regulations to apply the 
requirements of the BSA to investment companies as defined in 
section 3 of the 1940 Act, including persons that, but for the 
provisions that exclude entities commonly known as hedge funds, 
private equity funds, and venture capital funds, would be investment 
companies.
    \6\ Other types of investment companies regulated by the 
Commission include closed-end companies and unit investment trusts. 
Closed-end companies typically sell a fixed number of shares in 
traditional underwritten offerings. Holders of closed-end company 
shares then trade their shares in secondary market transactions, 
usually on a securities exchange or in the over-the-counter market. 
Unit investment trusts are pooled investment entities without a 
board of directors or investment adviser that offer investors 
redeemable units in an unmanaged, fixed portfolio of securities. The 
Secretary and the Commission will continue to consider whether a CIP 
requirement would be appropriate for the issuers of these products, 
or whether they are effectively covered by the CIP requirements of 
other financial institutions involved in their distribution (e.g., 
broker-dealers).
    \7\ By interim rule published on April 29, 2002, Treasury 
required that mutual funds adopt anti-money laundering programs 
pursuant to Section 352 of the Act. 67 FR 21117 (April 29, 2002). 
Treasury temporarily exempted investment companies other than mutual 
funds from the requirement that they establish anti-money laundering 
programs and temporarily deferred determining the definition of 
``investment company'' for purposes of the BSA. Id. However, it is 
likely that some of the entities excluded from the definition of 
``investment company'' in the 1940 Act will be required to establish 
anti-money laundering programs and customer identification programs 
pursuant to sections 352 and 326 of the Act.
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    Regulations governing the applicability of Section 326 to other 
financial institutions, such as broker-dealers and those institutions 
regulated by the banking agencies, are being issued separately. 
Treasury, the Commission, the CFTC and the banking agencies consulted 
extensively in the development of all rules implementing Section 326 of 
the Act. All of the participating agencies intend the effect of the 
rules to be uniform throughout the financial services industry. \8\
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    \8\ Section 314(c) of the Act provides that: ``Compliance with 
the provisions of this title requiring or allowing financial 
institutions and any association of financial institutions to 
disclose or share information regarding individuals, entities, and 
organizations engaged in or suspected of engaging in terrorist acts 
or money laundering activities shall not constitute a violation of 
the provisions of title V of the Gramm-Leach-Bliley Act (Public Law 
106-102).''
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    The Secretary has determined that the records required to be kept 
by Section 326 of the Act have a high degree of usefulness in criminal, 
tax, or regulatory investigations or proceedings, or in the conduct of 
intelligence or counterintelligence activities, to protect against 
international terrorism.

B. Codification of the Joint Proposed Rule

    The substantive requirements of the joint proposed will be codified 
with other Bank Secrecy Act regulations as part of Treasury's 
regulations in 31 CFR part 103. To minimize potential confusion by 
affected entities regarding the scope of the joint proposed rule, the 
Commission is also proposing to add a provision in its own regulations 
in 17 CFR part 270 that will cross-reference the regulations in 31 CFR 
part 103. Although no specific text is being proposed at this time, the 
cross-reference will be included in a final rule published by the 
Commission concurrently with the joint final rule issued by Treasury 
and the Commission implementing section 326 of the Act.

II. Section-by-Section Analysis

A. Section 103.131(a) Definitions

    (1) Account. The proposed rule's definition of ``account'' is 
intended to include all types of securities accounts maintained by 
mutual funds. This includes each account at a mutual fund.
    (2) Commission means the United States Securities and Exchange 
Commission.
    (3) Customer. The proposed rule defines ``customer'' as any 
shareholder

[[Page 48320]]

of record who opens a new account with a mutual fund and any person 
granted authority to effect transactions in the shareholder of record's 
account with a mutual fund. Under this definition, a shareholder of 
record prior to the effective date of the regulation would not be a 
``customer.'' However, such a person becomes a ``customer'' if the 
person becomes a shareholder of record or is granted trading 
authorization in a different account after the effective date. 
Moreover, a person becomes a ``customer'' each time they open a 
different type of account. For example, after the effective date, if a 
person opens a taxable account and subsequently opens an IRA account, 
the person is a ``customer'' subject to the requirements of this rule 
on both occasions.\9\ However, a shareholder who exchanges shares of 
one fund for shares of another fund within the same account (or 
initiates any other transaction that does not involve the opening of a 
separate account) does not become a ``customer'' for the purpose of 
this rule.
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    \9\ As discussed infra, this does not necessarily mean that a 
customer whose identity has been verified by a mutual fund must 
always have their identity verified every time they subsequently 
becomes a customer with respect to a different account.
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    A person with trading authority prior to the effective date of the 
regulation is not a ``customer.'' However, any person granted trading 
authority after the effective date is a customer. This is true even if 
the person is granted authority with respect to an account that existed 
prior to the effective date or the person had been granted authority 
for another account prior to the effective date.
    The requirements of Section 326 apply to any person who opens a new 
account or is granted trading authority for an account, but do not 
apply to persons seeking information about a mutual fund such as a 
request for a prospectus or profile. In addition, transfers of accounts 
from one mutual fund to another that are not initiated by the customer 
(e.g., as a result of a merger, acquisition, or purchase of assets) 
fall outside of the scope of Section 326, and are not covered by the 
proposed regulation.\10\
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    \10\ However, there may be situations involving the transfer of 
accounts where it would be appropriate for a mutual fund to verify 
the identity of customers associated with the accounts acquired by 
the mutual fund. Therefore, Treasury and the Commission expect 
procedures for transfers of accounts to be part of a mutual fund's 
overall anti-money laundering program required under section 352 of 
the Act.
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    (4) Mutual Fund means an entity that is required to register with 
the Commission as an ``investment company'' (as the term is defined in 
Section 3 of the 1940 Act) and that is an ``open-end company'' (as that 
term is defined in Section 5 of the 1940 Act).
    (5) Person. The proposed regulation defines ``person'' as having 
the same meaning as that term is defined in section 103.11(z). Thus, 
the term includes natural persons, corporations, partnerships, trusts 
or estates, joint stock companies, associations, syndicates, joint 
ventures, any unincorporated organizations or groups, Indian Tribes, 
and all entities cognizable as legal entities.
    (6) Taxpayer identification number. The proposed rule defines 
``taxpayer identification number'' to have the same meaning as 
determined under the provisions of section 6109 of the Internal Revenue 
Code and the regulations of the Internal Revenue Service thereunder.
    (7) U.S. person. The proposed rule defines ``U.S. person'' as a 
U.S. citizen or, for persons other than natural persons, an entity 
established or organized under the laws of a State or the United 
States.\11\ A non-U.S. person is a person who does not satisfy these 
criteria.
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    \11\ The terms ``State'' and ``United States'' are defined at 31 
CFR 103.11.
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B. Section 103.131(b) Customer Identification Program

    Section 326 requires the Secretary and the Commission to prescribe 
regulations requiring mutual funds to adopt and implement ``reasonable 
procedures'' for: verifying the identity of customers ``to the extent 
reasonable and practicable;'' maintaining records associated with such 
verification; and consulting lists of known terrorists.
    Paragraph (b) of the proposed rule sets forth the requirement that 
mutual funds must develop and operate a customer identification program 
(``CIP'') and sets forth relevant factors for the design of CIP 
procedures.\12\ The degree to which a CIP is effective will be a 
function of a mutual fund's assessment of these factors and the nature 
of its response to them (as manifested in the CIP's procedures and 
guidelines). In addition, as Section 326 and the proposed rule provide, 
the reasonableness of the CIP also will be a function of what is 
practicable for the mutual fund.
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    \12\ An interim rule issued by Treasury pursuant to Section 352 
of the Act requires all mutual funds to establish anti-money 
laundering programs that, at a minimum, include (1) The development 
of internal policies, procedures, and controls; (2) the designation 
of a compliance officer; (3) an ongoing employee training program; 
and (4) an independent audit function to test programs. 67 FR 21117 
(April 29, 2002). The proposed rule requires that the CIP be 
incorporated into a mutual fund's program established under Section 
352. At the same time that it issued the interim rule under Section 
352 of the Act, Treasury delegated to the Commission authority to 
examine mutual funds for compliance with Bank Secrecy Act 
regulations.
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    In developing and updating CIPs, mutual funds should consider the 
type of identifying information available for customers and the methods 
available to verify that information. While certain minimum identifying 
information is required in paragraph (c) of this proposed rule and 
certain suitable verification methods are described in paragraph (d), 
mutual funds should consider on an on-going basis whether other 
information or methods are appropriate, particularly as they become 
available in the future.
    Mutual funds must also base their CIPs on the risks associated with 
their business operations. Some relevant risk factors to be considered 
are set forth in paragraph (b) and discussed below in general 
terms.\13\
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    \13\ This discussion of risk factors is not intended to be 
comprehensive or exhaustive.
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    The first risk factor to consider is the mutual fund's size. For 
example, a large mutual fund that opens a substantial number of 
accounts on any given day will have different risks than one that opens 
a much smaller number of new accounts.
    The second risk factor is the method by which customers open 
accounts at the mutual fund. Accounts opened exclusively on-line 
present different, and perhaps greater, risks than those opened in-
person on the firm's premises.
    The third risk factor is the type of accounts offered by the mutual 
fund. Mutual funds should assess whether there are different risks (and 
degrees of risk) associated with the various types of accounts they 
provide to customers (e.g., taxable, IRA, 401(k) and 403(b) accounts).
    The fourth risk factor is the customer base. Mutual funds should 
assess the risks associated with different types of customers. For 
example, a mutual fund should examine whether it is opening accounts 
for customers located in countries the Secretary determines to be of 
``primary money laundering concern'' pursuant to Section 311 of the 
Act. Verification procedures should account for the concerns raised by 
such customers. In addition, certain types of customers may pose 
greater risks (e.g., individuals and certain types of business 
entities, such as closely held corporations, may pose a greater risk 
than institutional shareholders).
    Because mutual funds typically conduct their operations through 
separate entities, which may or may not be affiliated, some elements of 
the CIP

[[Page 48321]]

will best be performed by personnel of these separate entities. It is 
permissible for a mutual fund to contractually delegate the 
implementation and operation of its CIP to another affiliated or 
unaffiliated service provider, such as a transfer agent. However, the 
mutual fund remains responsible for assuring compliance with this rule. 
Accordingly, the mutual fund must actively monitor the operation of its 
CIP program and assess its effectiveness.
    A mutual fund's CIP does not have to include verification of 
individuals' identities whose transactions are conducted through an 
omnibus account. Typically, a fund has little or no identifying 
information for the individual customers represented in an omnibus 
account. For example, when fund shares are sold through a broker-
dealer, the shareholders' accounts are opened at the broker-dealer. The 
broker-dealer obtains the identifying information about the customers. 
This rule does not require that a mutual fund obtain any additional 
information regarding the identities of individual shareholders who 
open their accounts through an omnibus accountholder. Of course, the 
omnibus account holder is itself a customer for purposes of this 
rule.\14\
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    \14\ This treatment of omnibus accounts is consistent with the 
legislative history of the Act which includes the following: [W]here 
a mutual fund sells its shares to the public through a broker-dealer 
and maintains a ``street name'' or omnibus account in the broker-
dealer's name, the individual purchasers of the fund shares are 
customers of the broker-dealer, rather than the mutual fund. The 
mutual fund would not be required to ``look through'' the broker-
dealer to identify and verify the identities of those customers. 
Similarly, where a mutual fund sells its shares to a qualified 
retirement plan, the plan, and not its participants, would be the 
fund's customers. Thus, the fund would not be required to ``look 
through'' the plan to identify its participants. H.R. Rep. 107-250, 
pt. 1, at 62(2001).
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    Finally, paragraph (b) requires that the identity verification 
procedures must enable the mutual fund to form a reasonable belief that 
it knows the true identity of the customer. This provision makes clear 
that, while there is flexibility in establishing these procedures, the 
mutual fund is responsible for exercising reasonable efforts to 
ascertain the identity of each customer.

C. Section 103.131(c) Required Information

    Paragraph (c) of the proposed regulation provides that a mutual 
fund's CIP must require customers to provide, at a minimum, certain 
identifying information before an account is opened for the customer or 
the customer is granted trading authority over an account. 
Specifically, the mutual fund must obtain each customer's: (1) Name, 
(2) date of birth, if applicable, (3) addresses,\15\ and (4) 
identification number.\16\
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    \15\ With respect to addresses, each customer must provide a 
mailing address and, if different, the address of the customer's 
residence (if a natural person) or principal place of business (if 
not a natural person).
    \16\ If the customer is a U.S. person, he must provide a U.S. 
taxpayer identification number (e.g., social security number or 
employer identification number). If the customer is a non-U.S. 
person, he must provide a U.S. taxpayer identification number, an 
alien identification card number, or the number and country of 
issuance of any other government-issued document evidencing 
nationality or residence and bearing a photograph or similar 
safeguard. The term ``similar safeguard'' is included to permit the 
use of any biometric identifiers (e.g., fingerprints) that may be 
used in addition to, or instead of, photographs.
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    The rule only specifies the minimum identifying information that 
must be obtained from each customer. Mutual funds, in assessing the 
risk factors in paragraph (b), should determine whether obtaining other 
identifying information is necessary to form a reasonable belief as to 
the true identity of each customer. There may be circumstances when a 
mutual fund should obtain additional identifying information. The CIP 
should set forth guidelines regarding what those circumstances are and 
what additional information should be obtained in such circumstances.
    Treasury and the Commission recognize that a new business may need 
to open a mutual fund account before it has received an employer 
identification number (``EIN'') from the Internal Revenue Service. For 
this reason, the proposed regulation contains a limited exception to 
the requirement that an EIN be provided prior to establishing an 
account. Accordingly, in the case of person other than an individual 
(such as a corporation, partnership or trust) that has applied for, but 
has not received, an EIN, the EIN may be provided within a reasonable 
period of time after an account is established, provided that a copy of 
the EIN application is submitted to the mutual fund prior to the time 
the account is established. Currently, the IRS indicates that the 
issuance of an EIN can take up to five weeks. This length of time, 
coupled with when the entity applied for the EIN, should be considered 
by the mutual fund in determining the reasonable period of time within 
which the entity should provide its EIN to the mutual fund.

D. Section 103.131(d) Required Verification Procedures

    After obtaining identifying information from a customer, the mutual 
fund must take steps to verify some, or all, of that information in 
order to form a reasonable belief that it knows the true identity of 
the customer. Accordingly, paragraph (d) of the proposed rule requires 
a mutual fund's CIP to have procedures for verifying identifying 
information provided by the customer. The mutual fund need not verify 
each piece of identifying information obtained pursuant to paragraph 
(c), if it is able to form a reasonable belief that it knows the 
customer's identity after verifying only certain of the information.
    Paragraph (d) further requires that the verification procedures 
must be undertaken within a reasonable time before or after a 
customer's account is opened or a customer is granted authority to 
effect transactions with respect to an account. This flexibility must 
be exercised in a reasonable manner, given that verifications too far 
in advance may become stale and verifications too long after the fact 
may provide opportunities to launder money while verification is 
pending. The amount of time it will take a mutual fund to verify the 
identity of a customer may depend on the type of account opened, 
whether the customer opens the account in-person, and on the type of 
identifying information available. In addition, provided that the 
appropriate disclosure is made, a mutual fund may choose to place 
limits on the account, such as temporarily limiting additional 
purchases in an account until the customer's identity is verified. 
Therefore, the proposed rule provides mutual funds with the flexibility 
to use a risk-based approach to determine when the identity of a 
customer must be verified relative to the opening of an account or 
granting of trading authority.
    A person becomes a customer each time they open a new account with 
a mutual fund. Therefore, upon the opening of each account, the 
verification requirements of this rule would apply. However, if a 
customer whose identification has been verified previously opens a new 
account, the mutual fund would not need to verify the customer's 
identity a second time, provided that the mutual fund continued to have 
a reasonable belief that it knew the true identity of the customer 
based on the previous verification.
    The rule provides for two methods of verifying identifying 
information: verification through documents and/or verification through 
non-documentary means. For natural persons, suitable documents for 
verification include unexpired government-issued identification 
documents evidencing nationality or residence and bearing a

[[Page 48322]]

photograph or similar safeguard. For non-natural persons, suitable 
documents must evidence the existence of the entity, such as registered 
articles of incorporation, a government-issued business license, a 
partnership agreement, or a trust instrument.
    The proposed rule requires a mutual fund's CIP to address both 
methods of verification. Depending on the type of customer and the 
method of opening an account, it may be more appropriate to use either 
documents or non-documentary methods. In some cases, it may be 
appropriate to use both methods. The CIP should set forth guidelines 
describing when documents, non-documentary methods, or a combination of 
both will be used. These guidelines should be based on the mutual 
fund's assessment of the factors described in paragraph (b) of the 
proposed rule.
    The risk a mutual fund will not know a customer's true identity 
will be heightened for certain types of accounts, such as accounts 
opened in the name of a corporation, partnership, or trust that is 
created, or conducts substantial business, in jurisdictions designated 
as primary money laundering concerns or designated as non-cooperative 
by an international body. Obtaining sufficient information to verify a 
given customer's identity can reduce the risk a mutual fund will be 
used as a conduit for money laundering and terrorist financing. A 
mutual fund's identity verification procedures must be based on its 
assessments of the factors in paragraph (b). Accordingly, when those 
assessments suggest a heightened risk, the mutual fund should utilize 
additional verification measures.
1. Verification Through Documents
    Paragraph (d)(1) provides that the CIP must describe when a mutual 
fund will verify identity through documents and set forth the documents 
that will be used for this purpose. The rule also lists certain 
documents that are suitable for verification. For example, documentary 
verification could include obtaining a driver's license or passport 
from a natural person or articles of incorporation from a company.
2. Verification Through Non-documentary Methods
    Paragraph (d)(2) provides that the CIP must describe non-
documentary verification methods and when such methods will be employed 
in addition to, or instead of, verification through documents. The rule 
allows for the exclusive use of non-documentary methods because some 
accounts are opened by telephone, mail, or over the Internet. However, 
even if the customer presents identification documents, it may be 
appropriate to use non-documentary methods as well. Ultimately, the 
mutual fund is responsible for employing sufficient verification 
methods to be able to form a reasonable belief that it knows the true 
identity of the customer.
    The proposed rule sets forth certain non-documentary methods that 
would be suitable for verifying identity. These methods include 
contacting a customer after the account is opened; obtaining a 
financial statement; comparing the identifying information provided by 
the customer against fraud and bad check databases to determine whether 
any of the information is associated with known incidents of fraudulent 
behavior; comparing the identifying information with information 
available from a trusted third-party source, such as a credit report 
from a consumer reporting agency; and checking references with other 
financial institutions. The mutual fund also may wish to analyze 
whether there is logical consistency between the identifying 
information provided, such as the customer's name, street address, ZIP 
code, telephone number (if provided), date of birth, and social 
security number.
    Paragraph (d)(2) also provides that the CIP must require the use of 
non-documentary methods in certain cases; specifically, when a natural 
person is unable to present an unexpired government-issued 
identification document that bears a photograph or similar safeguard 
and when the mutual fund is presented with unfamiliar documents to 
verify the identity of a customer, does not obtain documents to verify 
the identity of a customer, does not meet face-to-face a customer who 
is a natural person, or is otherwise presented with circumstances that 
increase the risk the mutual fund will be unable to verify the true 
identity of a customer through documents.
    Treasury and the Commission recognize that identification 
documents, including those issued by a government entity, may be 
obtained illegally and may be fraudulent. In light of the recent 
increase in identity fraud, mutual funds are encouraged to use non-
documentary methods, even when a customer has provided identification 
documents.

E. Section 103.131(e) Government Lists

    The proposed rule requires that a mutual fund's CIP must include 
reasonable procedures for determining whether a customer's name appears 
on any list of known or suspected terrorists or terrorist organizations 
prepared by any federal government agency and made available to the 
mutual fund. This requirement applies only with respect to lists 
circulated, directly provided, or otherwise made available by the 
Federal government. In addition, the proposed rule states that mutual 
funds must follow all Federal directives issued in connection with such 
lists. A mutual fund must have procedures for responding to 
circumstances when a customer is named on such a list.

F. Section 103.131(f) Customer Notice

    Section 326 provides that financial institutions must give their 
customers notice of their identity verification procedures. Therefore, 
a mutual fund's CIP must include procedures for providing customers 
with adequate notice that the mutual fund is requesting information to 
verify their identities. A mutual fund may satisfy the notice 
requirement by generally notifying its customers about the procedures 
the fund must comply with to verify their identities. If an account is 
opened electronically, such as through an Internet website, the mutual 
fund may provide notice electronically. However, notice must be 
provided to the customer before the account is opened or trading 
authority is granted.

G. Section 103.131(g) Lack of Verification

    Paragraph (g) of the proposed rule states that a mutual fund's CIP 
must include procedures for responding to circumstances in which it 
cannot form a reasonable belief that it knows the true identity of a 
customer. A mutual fund's CIP should specify the actions to be taken 
when it cannot form a reasonable belief that it knows the customer's 
true identity, which could include closing the account or placing 
limitations on additional purchases. There also should be guidelines 
for when an account will not be opened (e.g., when the required 
information is not provided). In addition, the CIP should address the 
terms under which a customer may conduct transactions while the 
customer's identity is being verified. Mutual funds are also 
encouraged, but not required at this time, to adopt procedures for 
voluntarily filing Suspicious Activity Reports with FinCEN and for 
reporting suspected terrorist activities to FinCEN using its Financial 
Institutions Hotline (866-566-3974).

H. Section 103.131(h) Recordkeeping

    Section 326 of the Act requires procedures for maintaining records 
of the information used to verify a person's identity, including name, 
address, and other identifying information. Paragraph

[[Page 48323]]

(h) of the proposed rule sets forth recordkeeping procedures that must 
be included in a mutual fund's CIP. These procedures must provide for 
the maintenance of all information obtained pursuant to the CIP. 
Information that must be maintained includes all identifying 
information provided by a customer pursuant to paragraph (c). Thus, the 
mutual fund must make a record of each customer's name, date of birth 
(if applicable), addresses, and identification numbers provided. Mutual 
funds also must maintain copies of any documents that were relied on 
pursuant to paragraph (d)(1) evidencing the type of document and any 
identification number it may contain. For example, if a customer 
produces a driver's license, the mutual fund must make a copy of the 
driver's license that clearly indicates it is a driver's license and 
legibly depicts any identification number on the license.
    Mutual funds also must make and maintain records of the methods and 
results of measures undertaken to verify the identity of a customer 
pursuant to paragraph (d)(2). For example, if a mutual fund obtains a 
report from a credit bureau concerning a customer, the report must be 
maintained. Mutual funds also must make and maintain records of the 
resolution of any discrepancy in the identifying information obtained. 
To continue with the previous example, if the customer provides a 
residence address that is different than the address shown on the 
credit report, the mutual fund must document how it resolves this 
discrepancy or, if the discrepancy is not resolved, how it forms a 
reasonable belief that the mutual fund knows the true identity of the 
customer, notwithstanding the discrepancy.
    The mutual fund must retain all of these records for five years 
after the date the account is closed. Nothing in this proposed 
regulation modifies, limits or supersedes Section 101 of the Electronic 
Records in Global and National Commerce Act, Public Law 106-229, 114 
Stat. 464 (15 U.S.C. 7001) (``E-Sign Act''). Thus, a mutual fund may 
use electronic records to satisfy the requirements of this regulation 
in accordance with previously issued Commission guidance.\17\
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    \17\ See Investment Company Act Release No. 24991 (May 24, 2001) 
[66 FR 29224 (May 30, 2001)].
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    Treasury and the Commission emphasize that the collection and 
retention of information about a customer, as an ancillary part of 
collecting identifying information, do not relieve a mutual fund from 
its obligations to comply with anti-discrimination laws or regulations.

I. Section 103.131(i) Approval of Program

    Paragraph (i) of the proposed rule requires that the mutual fund's 
CIP be approved by its board of directors or trustees. The board should 
periodically assess the effectiveness of its CIP and should receive 
periodic reports regarding the CIP from the person or persons 
responsible for monitoring the fund's anti-money laundering program 
pursuant to 31 CFR 103.130(c)(3).

J. Section 103.131(j) Exemptions

    Section 326 states that the Secretary and the Federal functional 
regulator jointly issuing the rule may by order or regulation exempt 
any financial institution or type of account from this regulation in 
accordance with such standards and procedures as the Secretary may 
prescribe. The proposed rule provides that the Commission, with the 
concurrence of the Secretary, may exempt any mutual fund or type of 
account from the requirements of this section. The Commission and the 
Secretary shall consider whether the exemption is consistent with the 
purposes of the Bank Secrecy Act, and in the public interest, and may 
consider other necessary and appropriate factors.

III. Request for Comments

    Treasury and the Commission invite comment on all aspects of the 
proposed regulation, and specifically seek comment on the following 
issues:
    1. Whether the proposed definition of ``account'' is appropriate 
and whether other examples of accounts should be added to the 
regulatory text.
    2. How mutual funds can comply with the requirement to obtain both 
the address of a person's residence, and, if different, the person's 
mailing address in situations involving natural persons who lack a 
permanent address.
    3. Whether non-U.S. persons that are not natural persons will be 
able to provide a mutual fund with the identifying information required 
in Sec. 103.131(c)(4), or whether other categories of identifying 
information should be added to this section. Commenters on this issue 
should suggest other means of identification that mutual funds 
currently use or could use in this circumstance that would allow a 
mutual fund to form a reasonable belief that it knew the true identity 
of the entity.
    4. The extent to which the verification procedures required by the 
proposed regulation will use information that mutual funds currently 
obtain in the account opening process. We note that the legislative 
history of Section 326 indicates that Congress intended ``the 
verification procedures prescribed by Treasury [to] make use of 
information currently obtained by most financial institutions in the 
account opening process.'' See H.R. Rep. No. 107-250, pt. 1, at 63 
(2001).

IV. The Commission's Analysis of the Costs and Benefits Associated With 
the Proposed Rule

    The Commission is considering the costs and benefits associated 
with the proposal and requesting comment on all aspects of this cost-
benefit analysis, including identification and assessment of any other 
costs and benefits not discussed in the analysis. Commenters are 
encouraged to identify, discuss, analyze, and supply relevant data 
concerning the costs and benefits of the proposed rule's implementation 
of Section 326 requirements.
    Section 326 of the Act requires Treasury and the Commission to 
prescribe regulations setting forth minimum standards for mutual funds 
regarding the identities of customers that shall apply in connection 
with the opening of an account. The statute also provides that the 
regulations issued by Treasury and the Commission must, at a minimum, 
require financial institutions to implement reasonable procedures for: 
(1) Verification of customers' identities; (2) determination of whether 
a customer appears on a government list; and (3) maintenance of records 
related to customer verification. The Commission believes that the 
requirements in the proposed rule are reasonable and practicable. 
Accordingly, the costs to mutual funds to (1) establish a CIP; (2) 
obtain certain identifying information from customers; (3) verify 
identifying information of customers; (4) check customers against lists 
provided by federal agencies, (5) provide notice to customers that 
information may be requested in the process of verifying their 
identities; and (6) make and maintain records related to the CIP are 
attributable to the statute.
    While the Commission believes the costs are attributable to the 
statute, it nonetheless has undertaken an analysis of the costs and 
benefits of the requirements. The Commission seeks comment on whether 
the costs are attributable to the statute. The Commission also seeks 
comment on whether the proposed rule, by setting forth minimum 
requirements, creates a benefit or, conversely, imposes costs because 
mutual funds will not have to establish their own minimum requirements 
as required by the statute.

[[Page 48324]]

A. Benefits Associated With the Proposed Rule

    The anti-money laundering provisions in the Act are intended to 
prevent, detect and prosecute money laundering and the financing of 
terrorism. The proposed rule is an important part of this effort. It 
requires mutual funds to establish a program for verifying the true 
identities of their customers, thereby reducing the risk that mutual 
funds will be unwittingly aiding criminals, including terrorists, in 
accessing U.S. financial markets to launder money or move funds for 
illicit purposes. Additionally, the implementation of such programs 
should make it more difficult for persons to successfully engage in 
fraudulent activities involving identity theft or the placing of 
fictitious orders to buy or sell securities. It is virtually impossible 
to quantify in monetary terms those benefits.

B. Costs Associated With the Proposed Rule

    Section 326 of the Act and the proposed rule allows for great 
flexibility in developing CIPs. Given the considerable differences 
among mutual funds regarding their distribution channels, customers, 
and exposure to other relevant risk factors, it is difficult to 
quantify a cost per mutual fund. Most mutual funds already have some 
procedures in place for detecting fraud in the account opening process 
by looking for inconsistencies in the information provided by customers 
and/or checking customer names against certain databases. In those 
instances, the Section 326 requirements supplement those procedures.
    Section 326 requirements will impose initial, one-time costs and 
ongoing costs on mutual funds. The costs associated with establishment 
of CIPs and modification of account applications (both paper and web-
based applications) to require that customers provide the information 
required by the CIP and to provide the required notice regarding use of 
that information will primarily be initial, one-time costs.
    Ongoing costs for mutual funds will be associated with the need to: 
(1) Collect the information required by the CIPs, (2) verify customers' 
identities, (3) determine whether customers appear on lists provided by 
federal agencies, and (4) make and maintain records related to CIPs. 
These ongoing costs will primarily be a function of the number of new 
accounts opened at a mutual fund. From January 1, 1990 through December 
31, 2001, approximately 16 million mutual fund accounts were added 
annually.\18\
---------------------------------------------------------------------------

    \18\ This estimate is derived from information reported in the 
Investment Company Institute's 2002 Mutual Fund Fact Book. It 
represents the net annual increase in the number of mutual fund 
accounts. The actual number of new accounts that were opened during 
this period is probably higher as this estimate is reduced by the 
number of accounts that were closed during the same period. No data 
are available regarding the number of accounts that were closed.
---------------------------------------------------------------------------

1. Establishment of a CIP
    There are approximately 3,060 mutual fund companies that are 
registered with the Commission (``mutual fund registrants'').\19\ For 
estimating the total costs associated with Section 326 requirements, 
the Commission assumes that each mutual fund registrant will be 
responsible for establishing a CIP.\20\
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    \19\ This estimate is based on figures compiled by the 
Commission staff from Commission filings.
    \20\ Using the number of mutual fund registrants to estimate the 
total costs associated with development of CIPs may result in a high 
estimate of those costs. A mutual fund complex (or mutual fund 
family) often comprises several mutual fund registrants. The 
Commission assumes that, in many instances, a single CIP will be 
developed by a mutual fund complex and utilized by all of the mutual 
fund registrants in that complex.
---------------------------------------------------------------------------

    The Commission staff believes that it will take mutual funds on 
average approximately 50 hours to establish a CIP. The Commission staff 
believes that the hourly personnel cost and overhead associated with 
development of CIPs will be approximately $125. Therefore, the 
estimated total cost per mutual fund to establish a CIP will be 
approximately $6,250. Consequently, the estimated initial cost for the 
3,060 mutual fund registrants will be approximately $19,125,000.
    The actual development costs associated with a single CIP may be 
higher than the $6,250 estimate. For mutual fund registrants that 
delegate implementation of their CIP to unaffiliated service providers, 
the burden per mutual fund registrant may be less because those service 
providers will likely use the same or similar software and systems for 
several different registrants. Similarly, the cost per registrant on 
registrants that utilize a CIP developed by their fund complex may be 
less. Consequently, the Commission believes this is a reasonable 
estimate of the cost per mutual fund registrant of developing and 
implementing the requisite CIPs.
2. Obtaining Identifying Information
    Generally, mutual funds currently only require a name and mailing 
address from a customer in order to open an account. While most mutual 
funds request a social security number, they generally will open an 
account if the customer does not provide one. Most funds currently do 
not require that customers provide a residential address (if different 
from the mailing address) or a date of birth.
    Collecting identifying information for the majority of new accounts 
should create no additional burden on mutual funds. Most of the burden 
associated with this requirement will be associated with those account 
applications where the customer did not provide some of the required 
information, thus requiring follow-up by the mutual fund. Mutual funds 
can minimize this burden with clear disclosure on account applications 
that an account cannot be opened without the requisite information.
    The Commission staff believes that the average time spent 
collecting the requisite information will be one minute per account and 
that the hourly personnel and overhead cost associated with these 
requirements will be $25 per hour. Therefore, the estimated cost to the 
industry from this requirement is: (16 million new accounts per year * 
\1/60\ of an hour * $25). Thus, the estimated annual, industry-wide 
cost will be approximately $6,666,667.
3. Providing Notice to Customers
    A mutual fund may satisfy the notice requirement by generally 
notifying its customers about the procedures the mutual fund must 
comply with to verify their identities. If an account is opened 
electronically, such as through an Internet website, the mutual fund 
may provide notice electronically. The Commission expects that mutual 
funds will provide the required notice to customers by modifying their 
paper and electronic account applications.
    The Commission staff believes that it will take mutual funds on 
average approximately two hours to modify account applications to 
provide the adequate notice. The Commission staff estimates that the 
hourly personnel cost and overhead associated with this modification 
will be approximately $125. Therefore, the estimated total cost per 
mutual fund to modify its account applications will be approximately 
$250. Consequently, the estimated initial cost associated with 
modifying account applications to provide the requisite notice to 
customers for the 3,060 mutual fund registrants will be approximately 
$765,000.
4. Verifying Customers' Identities
    The proposed rule provides mutual funds with substantial 
flexibility in establishing how they will independently verify the 
information provided by customers. For example, customers that open 
accounts on a

[[Page 48325]]

mutual fund's premises can simply provide a driver's license or 
passport, or if the customer is not a natural person, it can provide a 
copy of any documents showing its existence as a legal entity (e.g., 
articles of incorporation, business licenses, partnership agreements or 
trust instruments). There are also a number of options for customers 
that open accounts via the telephone or Internet. In these cases, 
mutual funds may obtain a financial statement from the customer, check 
the customer's name against a credit bureau or database, or check the 
customer's references with other financial institutions.
    The documentary and non-documentary verification methods set forth 
in the rule are not meant to be an exclusive list of the appropriate 
means of verification. Other reasonable methods may be available now or 
in the future. The purpose of making the rule flexible is to allow 
mutual funds to select verification methods that are, as section 326 
requires, reasonable and practicable. The proposed rule allows mutual 
funds to employ such verification methods as would be suitable to a 
given firm to form a reasonable belief that it knows the true 
identities of its customers.
    The Commission believes that verifying the identifying information 
could result in costs for mutual funds because some firms currently may 
not use verification methods. The estimated total annual cost to the 
industry to verify the identifying information will be $49,333,333.\21\
---------------------------------------------------------------------------

    \21\ The Commission staff believes that the processing costs 
associated with verification methods will be approximately $1.00 per 
account. The Commission staff further estimates that the average 
time spent verifying an account will be five minutes. The hourly 
cost of the person who would undertake the verification is estimated 
to be $25 per hour including overhead. Therefore, the estimated 
costs to the industry reported above are: (16 million new accounts 
per year) * ($1.00) + (number of new accounts per year) * (\1/12\ of 
an hour) * ($25).
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5. Determining Whether Customers Appear on Government Lists
    Mutual funds should already have procedures for checking customers 
against government lists. There are substantive legal requirements 
associated with the lists circulated by Treasury's Office of Foreign 
Asset Control of the U.S. Treasury (OFAC). The failure of a firm to 
comply with these requirements could result in criminal and civil 
penalties. The Commission believes that, given the events of September 
11, 2001, most mutual funds that receive lists from the federal 
government have implemented procedures for checking their customers 
against them. The Commission believes that this requirement could 
result in some additional costs for mutual funds because some may not 
already check such lists. The estimated annual cost to the industry to 
check such lists is $3,333,333.\22\
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    \22\ The Commission staff believes that it will take mutual 
funds on average thirty seconds to check whether a customer appears 
on a government list and that the cost (including overhead) of this 
process will be $25 per hour. Therefore, the costs to the industry 
reported above are: (16 million new accounts per year) * (\1/120\ of 
an hour) * ($25).
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6. Recordkeeping
    The Commission believes that the recordkeeping requirement could 
result in additional costs for some mutual funds that currently do not 
maintain certain of the records for the prescribed time period. The 
estimated total annual cost to the industry to make and maintain the 
required records is $13,333,333.\23\
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    \23\ The Commission staff believes that it will take 
approximately two minutes per new account to make and maintain the 
required records. This estimate takes into account the fact that, 
for many new accounts, the recordkeeping will be fairly simple 
(e.g., making a photocopy of a driver's license or financial 
statement, or keeping a record of the results of a public database 
search or credit bureau query. The estimated cost associated with 
the recordkeeping is $25 per hour (including overhead). The 
estimated cost to the industry is: (16 million new accounts per 
year) * (\1/30\ of an hour) * ($25).
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V. Paperwork Reduction Act

    Certain provisions of the proposed rule contain ``collection of 
information'' requirements within the meaning of the Paperwork 
Reduction Act of 1995.\24\ Treasury has submitted the proposed rule to 
the Office of Management and Budget (``OMB'') for review in accordance 
with 44 U.S.C 3507(d). An agency may not conduct or sponsor, and a 
person is not required to respond to, a collection of information 
unless it displays a currently valid control number.
---------------------------------------------------------------------------

    \24\ 44 U.S.C. 3501 et seq.
---------------------------------------------------------------------------

A. Collection of Information Under the Proposed Rule

    The proposed rule contains recordkeeping and disclosure 
requirements that are subject to the Paperwork Reduction Act of 1995. 
In summary, the proposed rule requires mutual funds to (1) maintain 
records of the information used to verify customers' identities and (2) 
provide notice to customers that information they supply may be used to 
verify their identities. These recordkeeping and disclosure 
requirements are required under Section 326 of the Act.

B. Proposed Use of the Information

    Section 326 of the Act requires Treasury and the Commission jointly 
to issue a regulation setting forth minimum standards for mutual funds 
to verify the identities of their customers. Furthermore, Section 326 
provides that the regulations must require, at a minimum, mutual funds 
to implement reasonable procedures for (1) verifying the identity of 
any person seeking to open an account, to the extent reasonable and 
practicable; (2) maintaining records of the information used to verify 
the person's identity, including name, address, and other identifying 
information; and (3) determining whether the person appears on any 
lists of known or suspected terrorists or terrorist organizations 
provided to the financial institution by any government agency.
    The purpose of Section 326, and the proposed rule, is to make it 
easier to prevent, detect and prosecute money laundering and the 
financing of terrorism. In issuing the proposed rule, Treasury and the 
Commission are seeking to fulfill their statutorily mandated 
responsibilities under Section 326 and to achieve its important 
purpose.

C. Respondents

    If adopted, the proposed rule would apply to approximately 3,060 
mutual fund companies that are registered with the Commission.\25\
---------------------------------------------------------------------------

    \25\ This estimate is based on figures compiled by the 
Commission staff from Commission filings.
---------------------------------------------------------------------------

D. Total Annual Reporting and Recordkeeping Burden

1. Recordkeeping
    The requirement to make and maintain records related to the CIP 
will be an ongoing burden. The total burden will depend on the number 
of new accounts added each year. From January 1, 1990 through December 
31, 2001, approximately 16 million mutual fund accounts were added 
annually.\26\ The Commission estimates that mutual funds, on average, 
will spend two minutes per account making and maintaining the required 
records. Therefore, in complying with this requirement, the Commission 
estimates an annual, industry-wide burden of

[[Page 48326]]

533,333 hours will be associated with the record-keeping requirements 
of the proposed rule.
---------------------------------------------------------------------------

    \26\ This estimate is derived from information reported in the 
Investment Company Institue's 2002 Mutual Fund Fact Book. It 
represents the net annual increase in the number of mutual fund 
accounts. The actual number of new accounts that were opened during 
this period is probably higher as this estimate is reduced by the 
number of accounts that were closed during the same period. No data 
available regarding the number of accounts that were closed.
---------------------------------------------------------------------------

2. Notice to Customers
    The requirement for mutual funds to provide the required notice to 
customers regarding use of customers' information will necessitate the 
amendment of mutual funds' account applications, both paper and web-
based applications. The Commission estimates that the approximately 
3,060 mutual fund registrants will each spend approximately two hours 
modifying their account applications to satisfy the notice requirement. 
Thus, the Commission estimates an initial, industry-wide burden of 
6,120 hours to modify fund applications.

E. Collection of Information Is Mandatory

    This collection of information is mandatory.

F. Confidentiality

    The collection of information pursuant to the proposed rule would 
be provided by customers and other sources to mutual funds and 
maintained by mutual funds. In addition, the information may be used by 
federal regulators, self-regulatory organizations, and authorities in 
the course of examinations, investigations, and judicial proceedings. 
No governmental agency regularly would receive any of the information 
described above.

G. Record Retention Period

    The proposed rule will require that the records with respect to a 
given customer be retained until five years after the date the account 
of a customer is closed or the grant of authority to effect 
transactions with respect to an account is revoked.

H. Request for Comment

    Pursuant to 44 U.S.C. 3506(c)(2)(B), Treasury and the Commission 
solicit comments to:
    (1) Evaluate whether the proposed collection of information is 
necessary, and whether it would have practical utility;
    (2) Evaluate the accuracy of the Commission's estimate of the 
burden of the proposed collection of information;
    (3) Enhance the quality, utility, and clarity of the information to 
be collected; and
    (4) Minimize the burden of the collection of information on those 
required to respond, including through the use of automated collection 
techniques or other forms on information technology.
    Comments concerning the recordkeeping and disclosure requirements 
in the proposed rule should be sent (preferably by fax (202-395-6974)) 
to Desk Officer for the Department of the Treasury, Office of 
Information and Regulatory Affairs, Office of Management and Budget, 
Paperwork Reduction Project (1506), Washington, DC 20503 (or by the 
Internet to [email protected]), with a copy to FinCEN by mail or the 
Internet at the addresses previously specified.

VI. Regulatory Flexibility Act

    Treasury and the Commission are sensitive to the impact our rules 
may impose on small entities. Congress enacted the Regulatory 
Flexibility Act, 5 U.S.C. 601 et seq. (RFA), to address concerns 
related to the effects of agency rules on small entities. In this case, 
we believe that the proposed rule likely would not have a ``significant 
economic impact on a substantial number of small entities.'' 5 U.S.C. 
605(b). As discussed in Section IV (The Commission's Analysis of the 
Costs and Benefits of the Section 326 Requirements), we believe that 
the impact on mutual funds, including small entities, is imposed by the 
statute itself, and not by the proposed rule. Moreover, the economic 
impact on small entities should not be significant because we believe 
that most small entities are likely to have a relatively small number 
of accounts, and thus compliance should not impose a significant 
economic impact. Treasury and the Commission seek comment on whether 
the proposed rule would have a significant economic impact on a 
substantial number of small entities and whether the costs are imposed 
by the statute itself, and not the proposed rule.
    While we believe that the proposed rule likely would not have a 
significant economic impact on a substantial number of small entities, 
we do not have complete data at this time to make this determination. 
We have therefore prepared this Initial Regulatory Flexibility Analysis 
in accordance with 5 U.S.C. 603.

A. Reason for the Proposed Action

    Section 326 of the Act requires Treasury and the Commission jointly 
to issue a regulation setting forth minimum standards for mutual funds 
and their customers regarding the identity of the customer that shall 
apply in connection with opening of an account at the mutual fund. 
Furthermore, Section 326 provides that the regulations must require, at 
a minimum, mutual funds to implement reasonable procedures for (1) 
verifying the identity of any person seeking to open an account, to the 
extent reasonable and practicable; (2) maintaining records of the 
information used to verify the person's identity, including name, 
address, and other identifying information; and (3) determining whether 
the person appears on any lists of known or suspected terrorists or 
terrorist organizations provided to the financial institution by any 
government agency.
    The purpose of Section 326, and this proposed rule, is to prevent, 
detect and prosecute money laundering and the financing of terrorism. 
In issuing the proposed rule, Treasury and the Commission are seeking 
to fulfill their statutorily mandated responsibilities under Section 
326 and to achieve its important purpose.

B. Objective

    The objective of the proposed regulation is to make it easier to 
prevent, detect and prosecute money laundering and the financing of 
terrorism. The rule seeks to achieve this goal by requiring mutual 
funds to obtain identifying information from customers that can be used 
to verify the identity of the customers. This will make it more 
difficult for persons to use false identities to establish customer 
relationships with mutual funds for the purposes of laundering money or 
moving funds to effectuate illegal activities, such as financing 
terrorism.

C. Legal Basis

    The proposed rule is being promulgated pursuant to Section 326 of 
the Act, which mandates that Treasury and the Commission issue a 
regulation setting forth minimum standards for financial institutions 
and their customers regarding the identity of the customer that shall 
apply in connection with opening of an account at the financial 
institution.

D. Small Entities Subject to the Rule

    The proposed rule would affect mutual funds that are small 
entities. For purposes of the Regulatory Flexibility Act, the 
Commission has determined that an investment company is a small entity 
if it, together with other investment companies in the same group of 
related investment companies, has net assets of $50 million or less as 
of the end of its most recent fiscal year.\27\ Approximately 156 mutual 
funds meet this definition.\28\
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    \27\ 17 CFR 270.0-10.
    \28\ This estimate is based on figures compiled by the 
Commission staff from outside databases.

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[[Page 48327]]

E. Reporting, Recordkeeping and Other Compliance Requirements

    Section 326 requires mutual funds to adopt reasonable procedures 
to: (1) Verify the identities of their customers; (2) check customers 
against lists provided by federal agencies, (3) provide notice to 
customers that information the customers provide may be used to verify 
customers' identities; and (4) make and maintain records related to the 
CIP.

F. Duplicative, Overlapping or Conflicting Federal Rules

    We have not identified any federal rules that duplicate, overlap or 
conflict with the proposed rule. Congress has mandated that Treasury 
and the Commission issue a regulation that requires mutual funds to 
verify their customers' identities. This congressional directive cannot 
be followed absent the issuance of a new rule.

G. Significant Alternatives

    If an agency does not certify that a rule will not have a 
significant economic impact on a substantial number of small entities, 
the Regulatory Flexibility Act directs Treasury and the Commission to 
consider significant alternatives that would accomplish the stated 
objective, while minimizing any adverse impact on small entities.
    In connection with the proposed amendments, we considered the 
following alternatives: (1) The establishment of differing compliance 
or reporting requirements or timetables that take into account the 
resources of small entities; (2) the clarification, consolidation, or 
simplification of compliance and reporting requirements under the rule 
for small entities; (3) the use of performance rather than design 
standards; and (4) an exemption from coverage of the proposed 
amendments, or any part thereof, for small entities.
    The proposed rule provides for substantial flexibility in how each 
mutual fund may meet its requirements. This flexibility is designed to 
account for differences between mutual funds, including size. 
Nonetheless, Treasury and the Commission did consider alternatives such 
as exempting certain small entities from some or all of the 
requirements of the proposed rule. Treasury and the Commission do not 
believe that such an exemption is appropriate, given the flexibility 
built into the rule to account for, among other things, the differing 
sizes and resources of mutual funds, as well as the importance of the 
statutory goals and mandate of section 326. Money laundering can occur 
in small firms as well as large firms.

H. Solicitation of Comments

    Treasury and the Commission encourage the submission of comments 
with respect to any aspect of this Initial Regulatory Flexibility 
Analysis, including comments regarding the number of small entities 
that may be affected by the proposed rule. Such comments will be 
considered by Treasury and the Commission in determining whether a 
Final Regulatory Flexibility Analysis is required, and will be placed 
in the same public file as comments on the proposed amendment itself. 
Comments should be submitted to Treasury or the Commission at the 
addresses previously indicated.

VII. Executive Order 12866

    The Department of the Treasury has determined that this rule is not 
a significant regulatory action for purposes of Executive Order 12866. 
As noted above, the proposed rule closely parallels the requirements of 
section 326 of the Act. Accordingly, a regulatory impact analysis is 
not required.

Lists of Subjects in 31 CFR Part 103

    Administrative practice and procedure, Authority delegations 
(Government agencies), Banks, banking, Brokers, Currency, Foreign 
banking, Foreign currencies, Gambling, Investigations, Law enforcement, 
Penalties, Reporting and recordkeeping requirements, Securities.

Authority and Issuance

    For the reasons set forth in the preamble, part 103 of title 31 of 
the Code of Federal Regulations is proposed to be amended as follows:

PART 103--FINANCIAL RECORDKEEPING AND REPORTING OF CURRENCY AND 
FOREIGN TRANSACTIONS

    1. The authority citation for part 103 is revised to read as 
follows:

    Authority: 12 U.S.C. 1786(q), 1818, 1829b and 1951-1959; 31 
U.S.C. 5311-5332; title III, secs. 312, 313, 314, 319, 326, 352, Pub 
L. 107-56, 115 Stat. 307.

    2. Subpart I of part 103 is amended by adding Sec. 103.131 to read 
as follows:


Sec. 103.131  Customer identification programs for mutual funds.

    (a) Definitions. For the purposes of this section:
    (1) Account means any contractual or other business relationship 
between a customer and a mutual fund established to effect financial 
transactions in securities, including the purchase or sale of 
securities.
    (2) Commission means the United States Securities and Exchange 
Commission.
    (3) Customer means:
    (i) Any mutual fund shareholder of record who opens a new account 
with a mutual fund; and
    (ii) Any person authorized to effect transactions in the 
shareholder of record's account with a mutual fund.
    (4) Mutual Fund means an entity that is required to register with 
the Commission as an ``investment company'' (as the term is defined in 
Section 3 of the Investment Company Act of 1940 (15 U.S.C. 80a-3) 
(``Investment Company Act'')) and is an ``open-end company'' (as that 
term is defined in Section 5 of the Investment Company Act, 15 U.S.C. 
80a-5).
    (5) Person has the same meaning as that term is defined in 
Sec. 103.11(z).
    (6) Taxpayer identification number. The provisions of Section 6109 
of the Internal Revenue Code of 1986 (26 U.S.C. 6109) and the 
regulations of the Internal Revenue Service promulgated thereunder 
shall determine what constitutes a taxpayer identification number.
    (7) U.S. person means:
    (i) Any U.S. citizen; and
    (ii) Any corporation, partnership, trust, or person (other than a 
natural person) that is established or organized under the laws of a 
State or the United States.
    (8) Non-U.S. person means a person that is not a U.S. person.
    (b) Customer identification program. A mutual fund shall establish, 
document, and maintain a written Customer Identification Program 
(``CIP''). A mutual fund's CIP procedures must enable it to form a 
reasonable belief that it knows the true identity of the customer. A 
mutual fund's CIP must be a part of its anti-money laundering program 
required under 31 U.S.C. 5318(h). A mutual fund's CIP procedures shall 
be based on the type of identifying information available and on an 
assessment of relevant risk factors including:
    (1) The mutual fund's size;
    (2) The manner in which accounts are opened, fund shares are 
distributed, and purchases, sales and exchanges are effected;
    (3) The mutual fund's types of accounts; and
    (4) The mutual fund's customer base.
    (c) Required information. (1) General. Except as permitted by 
paragraph (c)(2) of this section, the CIP shall require the mutual fund 
to obtain specified identifying information about each

[[Page 48328]]

customer before an account is opened or a customer is granted authority 
to effect transactions with respect to an account. The specified 
information must include, at a minimum:
    (i) Name;
    (ii) Date of birth, for a natural person;
    (iii) Addresses:
    (A) Residence and mailing (if different) for a natural person; or
    (B) Principal place of business and mailing (if different) for a 
person other than a natural person; and
    (iv) Identification numbers:
    (A) A taxpayer identification number from each customer that is a 
U.S. person; or
    (B) A taxpayer identification number, passport number and country 
of issuance, alien identification card number, or number and country of 
issuance of any other government-issued document evidencing nationality 
or residence and bearing a photograph or similar safeguard from each 
customer that is not a U.S. person.
    (2) Limited exception. In the case of a person other than a natural 
person that has applied for, but has not received, an employer 
identification number, the CIP may allow such information to be 
provided within a reasonable period of time after the account is 
established, if the mutual fund obtains a copy of the application for 
the employer identification number prior to such time.
    (d) Required verification procedures. The CIP shall include 
procedures for verifying the identity of customers, to the extent 
reasonable and practicable, using information obtained pursuant to 
paragraph (c) of this section. Such verification must occur within a 
reasonable time before or after the customer's account is opened or the 
customer is granted authority to effect transactions with respect to an 
account:
    (1) Verification through documents. The CIP must describe when the 
mutual fund will verify customers' identities through documents and 
describe the documents that the mutual fund will use for this purpose. 
Suitable documents for verification may include:
    (i) For natural persons, unexpired government-issued identification 
evidencing nationality or residence and bearing a photograph or similar 
safeguard; and
    (ii) For persons other than natural persons, documents showing the 
existence of the entity, such as registered articles of incorporation, 
a government-issued business license, partnership agreement, or trust 
instrument.
    (2) Verification through non-documentary methods. The CIP must 
describe non-documentary methods a mutual fund will use to verify 
customers' identities and when these methods will be used in addition 
to, or instead of, relying on documents. Non-documentary verification 
methods may include contacting a customer; independently verifying 
information through credit bureaus, public databases, or other sources; 
and checking references with other financial institutions. Non-
documentary methods shall be used when a customer who is a natural 
person is unable to present an unexpired, government-issued 
identification document that bears a photograph or similar safeguard; 
the mutual fund is presented with unfamiliar documents to verify the 
identity of a customer; or the mutual fund does not obtain documents to 
verify the identity of a customer, does not meet face-to-face a 
customer who is a natural person, or is otherwise presented with 
circumstances that increase the risk the mutual fund will be unable to 
verify the true identity of a customer through documents.
    (e) Government lists. The CIP shall include procedures for 
determining whether a customer's name appears on any list of known or 
suspected terrorists or terrorist organizations prepared by any federal 
government agency and made available to the mutual fund. Mutual funds 
shall follow all federal directives issued in connection with such 
lists.
    (f) Customer notice. The CIP shall include procedures for providing 
customers with adequate notice that the mutual fund is requesting 
information to verify the customer's identity.
    (g) Lack of verification. The CIP shall include procedures for 
responding to circumstances in which the mutual fund cannot form a 
reasonable belief that it knows the true identity of a customer.
    (h) Recordkeeping. The CIP shall include procedures for maintaining 
a record of all information obtained pursuant to the CIP. A mutual fund 
must retain all records made or obtained when verifying the identity of 
a customer pursuant to its CIP until five years after the date the 
account of the customer is closed. Records subject to the requirements 
in this paragraph (h) include:
    (1) All identifying information provided by a customer pursuant to 
paragraph (c) of this section, and copies of any documents that were 
relied on pursuant to paragraph (d)(1) of this section evidencing the 
type of document and any identification number it may contain;
    (2) The methods and results of any measures undertaken to verify 
the identity of a customer pursuant to paragraph (d)(2) of this 
section; and
    (3) The resolution of any discrepancy in the identifying 
information obtained.
    (i) Approval by the board. The CIP shall be approved by the mutual 
fund's board of directors or trustees.
    (j) Exemptions. The Commission, with the concurrence of the 
Secretary, may by order or regulation exempt any mutual fund or type of 
account from the requirements of this section. The Commission and the 
Secretary shall consider whether the exemption is consistent with the 
purposes of the Bank Secrecy Act (31 U.S.C. 5311 et seq.) and in the 
public interest, and may consider other necessary and appropriate 
factors.

    Dated: July 15, 2002.
James F. Sloan,
Director, Financial Crimes Enforcement Network.

    Dated: July 12, 2002.

    By the Securities and Exchange Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-18194 Filed 7-22-02; 8:45 am]
BILLING CODE 4810-02-P