KYC, What is it, who's responsible for it, and how far should it be taken? Exploring CDD & EDD

KYC, Know Your Customer.  Seems pretty simple doesn't it?  Some of the areas I specialize in are Risk Mitigation and analysis, and in Sales.  In this article and in my book you will see both aspects addressed as part of KYC and the responsibilities and processes necessary to complete it properly.  I explain KYC, the various levels, and give real world examples to help explain some of the complexities of it and examine various scenarios to demonstrate possible outcomes. Kind of like a choose you own adventure book.  I also explore KYC vs. KYV/S  Know your Vendor/Supplier and what they mean to your business.

The reason for this article and the coming book is that KYC has been primarily a "Big Business", "Big Bank" publicly traded, SEC function or at least it's been perceived that way.  KYC has become more and more an every business function post 9/11, and with the inception of the PATRIOT Act, Dodd Frank, Sarbannes Oxley, etc.   The issue at hand is that with these new laws coming into effect, many business not only are unprepared to conduct KYC, but not equipped and unsure of how to handle it.  In my examples I use small average businesses to show that it is not just big businesses and banks that benefit, and are required to perform KYC and KYV/S.

Sceneario 1:
Joe owns a store,  Jane comes in every day and buys a pack of air fresheners and garbage bags, you chat with her a bit and find out she has 2 cats, is married,  no children, lives down the street in a 2 bedroom apartment, and drives a blue early 2000's Buick regal.  She like wine, hates her boss, and doesn't come in on weekends.
It sounds like Joe knows Jane pretty well, for a store knowing it's customer not much more needs to be known, until Joe starts offering check cashing.
Jane comes in and wants to cash a check for a small amount, let's say for  $10.00.  This is where things change drastically. In an instant Joe finds out he doesn't know Jane.  Jane hates her boss and works at Jobco, or does she? How long has she worked there? What's her full name, her exact address, how long has she lived there? Is she really married?  If so is it to a man, a woman?  Is her car paid for, or does she have a loan,  is she a criminal....A KILLER?? what are those plastic bags and air fresheners for?  

How is Joe supposed to ask Jane?  will she be offended, everything Joe thought he knew about her, he now questions.

The above is a basic and simple scenario, but very realistic. I used a corner store to represent a small business simple service example.  It was not to long ago that Joe would have simply said sure Jane just sign the check and I'll give you 9.50 back there's a 50 cent charge for check cashing,  Jane would have thanked him and been on her way, the third party check would have gone to the bank and been accepted.  
Fortunately or unfortunately (depending on how you look at it) things are not like that today.  Whether Joe has a small convenient store, large supermarket, a chain or is a bank, a certain amount of KYC needs to be performed.

The simplest which is name, address, phone number, place of employment, years at the employer.  This is still very simple so far, but now the bigger part comes in.
How do you verify this information?  How much more information do you need,  who is responsible for it?
Depending on what level of KYC is being done typically A drivers license, utility bill, copy of a deed or lease, Social Security number and a pay stub are sufficient.  

Continuing to use the above scenario, when Joe decided to offer the Check cashing service he had to first consult with his banking Relationship Manager and most likely a Cash Management Representative, (both clever names for bank services sales people).  Joe would have found out the type of services offered by the bank for entering into a cash service business, which in the banking world is called a Money Services business and considered  "High Risk".  One of three things would have occurred:
  1. The bank provides Joe with all the necessary documents, explains the service to him, handles the KYC for him simply by him submitting the provided documents, offers expanded service, explains the cost and procedures, may or may not provide him a check scanning or Remote Deposit Capture (RDC) machine, depending on the services he chooses.  Joe needs only to have his customers fill out the bank provided form submit it to the bank and wait for a reply.
  2. The bank opens an account for him specifically for cashing third party checks, and hold him responsible for conducting KYC, which Joe would then need to contact an attorney, CPA, professional compliance analyst, or someone who is a combination of the three examples. (there are other options however in Joe's situation they would not make sense, like hiring a full time compliance, KYC reviewer, obtaining necessary licenses for background checks, etc.)
  3. Joe's bank tells him that they cannot handle MSBs and if he will be offering a check cashing service he will need to find another bank.  If this sounds drastic and ridiculous, it's not.  This happens quite often.  More and more bank are exiting, or refusing to handle MSBs.  The Association of Certified Anti Money Laundering Specialists (ACAMS)  Has held several conferences addressing these concerns and what can be done to mitigate and minimize the risk that MSBs pose to financial institutions and the impact they have on Money Laundering and terrorist financing.
For the purposes of this specific article we will continue with the first scenario, as the other 2 are much to complex to delve into in this short illustration.

Now that Joe has everything in order on his end he now must convey this to his customer, but how?

I will list possible action and corresponding results below, since I do not have the advantage on this Blog to use a "choose your own"

  1. Joe tells Jane that he cannot cash her check today and in order to cash her $10.00 check he needs her to complete the form, submit her identification and personal information, then wait until he is given the OK from the bank.  He doesn't know why, its just what the bank wants and he has no control over it.
  • Jane does what he asks and all is well
  • Jane does what he asks and is denied by the bank, Joe may or may not be provided the reason
  • Jane gets upset, feels offended stating that Joe knows her and she cant believe it's this much trouble to cash a $10.00 check. She is either now an unhappy customer and the relationship changes, and/or Joe has lost a repeat customer.  From a risk perspective it can be viewed as a customer who may have had something to hide.  from a business perspective it can be viewed as a customer who although a repeat, only purchased minimal goods, either way it can be perceived as minimal revenue loss and no risk, However in the second scenario we will see how that may not be correct.
  1. Joe clearly posts the procedures for check cashing via sign or brochure.  He then explains to Jane that he is unable to cash her check today and that due to recent changes in federal statutes and regulations that any business who wishes to offer check cashing services must do so through a bank or other financial institution while very strict stipulations and requirements must be met.  If they aren't met properly it can put his business and the corresponding financial institutions at risk.  Verifications are used to protect Joe, the bank, and Jane, and to help combat Money Laundering, drug and human trafficking, and Terrorist financing.  
  • Jane Gets upset, feels offended stating that Joe knows her and she cant believe it's this much trouble to cash a $10.00 check, she is either now an unhappy customer and the relationship changes, and/or Joe has lost a repeat customer. (same reaction to the first scenario)
  • Jane understands and is glad Joe has explained it, she submits her information and is approved.  Jane continues to be a happy customer and now cashes more checks at Joe's.  Now that Jane has extra cash readily available her spending at Joe's increases and she is now a regular customer for most of her shopping needs.
The benefits can now easily be seen and the scenarios for presenting it to a customer can be compared.  The scenario can be expanded to other business and reasons for KYC.  In the next section I will expand on the scenarios and briefly compare KYC and KYV/S.

For the next scenario Joe owns a Food distribution company.  Nothing extravagant; A small warehouse, a couple trucks, local clients and a few employees.

Scenario 2:
Joe wants to expand his business.  For this expansion he will need more customers, another truck and wants to expand his selection to include organic beef. 

You may be saying to yourself that this sounds easy of course that's what he would do.  So why doesn't he just go to some local stores and/or restaurants, go buy a truck and contact a local organic beef farm?   It's not as if he is doing something as risky as offering check cashing or financial services right? 
At first glance you wouldn't think so, but Joe is now confronted not only with possible financial risk ( offering terms and others that will be explored), but reputational risk as well.  

1st and easiest, Joe sets out to buy a truck.   The dealer at which he will buy the truck will be his vendor.  In this instance, we will assume that Joe bought his other trucks at auction, but now needs a good reliable refrigerated truck that will last him a long time.  KYV/S on this will be simple.  If you have ever bought a car I would hope you conducted KYV/S.  His procurement manager (assuming it's not him in this case) consults the internet for his due diligence and searches Dunn and Bradstreet, Better Business Bureau, the manufacturers website, authorized dealer websites, their commercial equipment suppliers website, Yelp, Glassdoor, etc.  The dealers registration can clearly be seen on the side of the building along with dealer plates on the cars , the registration number and the certified repair shop as well.  That's two pieces completed.  They have now found a suitable truck made by Truckco and equipped with a cooltech refrigeration body. They also know the price is set from a special commercial pricing offered by Truckco and they know the parameters of the financing they need.
Good Deals Truckco dealer and auto center Inc. has a good reputation.  Their commercial supplier does also; and all three meet the criteria set forth by Joe, his compliance department (in this instance, his attorney) and his general manager who also acts as his risk analyst. 

Joe’s procurement manager conducted KYV and due diligence not only on Truckco, but three other manufacturers as well as their suppliers and on several dealerships.  When an individual conducts KYV for a vehicle purchase they do something similar, but what is it for?  

Most likely it is for:
Vehicles of interest, reliability, options, features, use and price range.
Dealers and their reputation

But for Joe and his company it is different.  They need to take the above and additional items into consideration such as; the customers they will be servicing and/or suppliers and the acceptability of the truck and refrigeration units origins  (American, German, Japanese).  Picking a vehicle that may offend or put-off a customer can be detrimental to your business.  If the company deals with multi generational fishers that have lost business due to imported fish from Asia, they may take offense to a business associate buying a Japanese made truck.  A sustainable, organic farmer may take issue with certain components they may feel are environmentally irresponsible.  The dealers need to be screened for potential reputational risk as well.  Negative news searches should be conducted regarding fraud, tax issues, or reports with the better business bureau.  Do they support controversial people or causes which could harm a business' reputation by association?

These are things that are all become a reality from small business and up.  This process becomes even more intensive when concerning customers.  The second question, "who is responsible for KYC?" comes into play now.  Hands down, without question in every situation, the sales person and/or their assistant is always responsible for preliminary KYC prior to meeting with a prospect.  The more a salesperson knows about the customer the better.  
KYC will do the following for sales:

  • Determine the suitability of prospects.
  • Narrow a sales list down to solid, focused, core, prospects. 
  • Help determine customer demographics
  • Provides key information regarding the prospect
  • Provide a basis for a line questioning in order to determine the honesty of a prospect, or a chance for them to clear up possible derogatory information.
The above examples are fairly self explanatory, however I am going to expand on the first point.   
How a determination can be made regarding the suitability of a prospect. 
This process can definitely get off track and be improperly used for personal discriminatory purposes, as many investigatory process can be.  What is much more important than a few bigoted individuals, is what the proper use of the process is and that is to determine if one of those people is a prospect.  As an example, if this process is used improperly to discriminate for religious purposes,  it could easily be revealed in a negative news search, protests against the business, investigations, accusations, and/or complaints that you may look into further.  The key is deciphering the information and separating factual and credible information from isolated rhetoric or even simple jealousy.
Once a prospect is visited and a business relationship is initiated,  I cannot recommend enough that a legal document be drawn up for permission for a background check and KYC to be performed.  
If a business is too small for a compliance person or legal department, a consultant should be called in to guide the business through a brief KYC process, provide resources and provide a process to follow.

By initiating a KYC program, you will accomplish more than just mitigating risk, screening potential prospects, and ensuring you deal with trustworthy and reliable people.  It conveys a sense of values to prospective clients, customers and to your vendors.  It demonstrates that a business is concerned with the quality of its business associations and will make those associations stronger, making those association feel special that they were chosen as suitable associates. This is  accomplished best and easiest by presenting to the prospect or customer in exactly that way.