September 6, 2002
Ms. Judith R. Starr, Chief Counsel
Mr. Jonathan G. Katz
Dear Ms. Starr and Mr. Katz:
PFPC Inc. ("PFPC") appreciates the opportunity to comment on the recently proposed rule to implement Section 326 of the USA PATRIOT Act (the "Act") regarding customer identification programs for mutual funds (the "Proposed Rule") (67 Fed. Reg. 48,317) (July 23, 2002).
PFPC is an indirect majority-owned subsidiary of The PNC Financial Services Group, Inc. ("PNC"), Pittsburgh, Pennsylvania, which is one of the largest diversified financial services organizations in the United States. PNC's major businesses include regional community banking, corporate banking, real estate finance, asset-based lending, wealth management, asset management, and global fund processing services. As PNC's primary global fund processing services affiliate, PFPC provides a full range of services to investment companies, including transfer agency and shareholder support services. PFPC is the largest full-service mutual fund transfer agent in the United States.
PFPC supports the Proposed Rule's fundamental goals of requiring mutual funds to (1) adopt and implement reasonable procedures to verify the identity of any person seeking to open an account, to the extent reasonable and practicable; (2) maintain records of the information used to verify the person's identity; and (3) determine whether the person appears on official federal government lists of known or suspected terrorists and terrorist organizations.
However, PFPC does have specific suggestions regarding the practical application of certain aspects of the Proposed Rule and its interaction with some of the counterpart rules proposed for customer identification verification by other types of financial institutions (collectively, the "Proposed Rules"). Our comments address the following: (1) certain considerations relating to the definition of "Customer;" (2) identification numbers for non-U.S. Customers who are not natural persons; (3) verification of identity of non-U.S. Customers who are natural persons; (4) Fair Credit Reporting Act exemption for identity verification and criminal activity detection purposes; (5) notice to multiple Customers within a single account; (6) record retention requirements related to customer identification verification records; and (7) the proposed implementation period.
1. Definition of Customer
The Proposed Rule defines a mutual fund's "Customer" as "any shareholder 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." However, we believe that this definition of Customer may have some unintended consequences, particularly in the conduct of transactions by other financial institutions.
Financial institutions routinely conduct transactions with mutual funds and other financial institutions on behalf of their Customers. Generally, a financial institution will be subject to the anti-money laundering and customer identification and verification program requirements of the Act and Proposed Rules (a "Covered Financial Institution"). We suggest clarification of the definition of Customer to result in each Covered Financial Institution having responsibility to perform customer identification verification for its direct Customers, but not for Customers of its Customers.
For example, if a broker/dealer is a Covered Financial Institution and opens an account for its Customer with a mutual fund, the broker/dealer would be responsible for identification verification of that Customer and the mutual fund would be responsible for identification verification of the broker/dealer, but not of the broker/dealer's Customer.
With this thought in mind, we urge the Treasury Department and the Securities and Exchange Commission to consider three points of clarification to the definition of Customer, which we believe would significantly reduce the burden to the industry without compromising the intent of the Act or Proposed Rule.
A. Investors Who Open Accounts or Conduct Transactions with Mutual Funds Through Covered Financial Institutions Should Be Considered Customers of the Covered Financial Institution, and Not Customers of the Mutual Fund.
Under the Proposed Rules, a person who establishes an account or conducts subsequent transactions with a mutual fund through a Covered Financial Institution would be considered a Customer both of the Covered Financial Institution and of the mutual fund. It would be unnecessarily redundant for both the Covered Financial Institution and the mutual fund to perform similar verification procedures, and would ultimately result in unnecessary costs and lower returns for investors. We suggest that either (1) such persons should not be considered a Customer of the mutual fund or (2) the mutual fund should be exempt from the customer identification program ("CIP") requirements when such measures have been undertaken by the Covered Financial Institution.
It is common in the mutual funds industry for accounts to be established through Covered Financial Institutions. In such cases, the Covered Financial Institution transmits account registration information and trade instructions to each mutual fund into which the investor has directed his or her investment. A single investor's account at the Covered Financial Institution may include a portfolio of many different types of investments, including various mutual funds as well as stocks, bonds, and other investments. Moreover, each mutual fund in an investor's portfolio would have its own CIP verification procedures and notice language. The recently proposed CIP rules for mutual funds and other industries, when taken together, would not only require that the Covered Financial Institution provide identification verification procedure notice to and verify the identity of the investor, but would also require that every mutual fund in that investor's portfolio to provide notice to and verify the identity of the investor.
This result would be inefficient, duplicative, and burdensome for mutual funds and other Covered Financial Institutions, and ultimately result in unnecessary costs and lower returns for investors. It would also be confusing to investors who may receive several identification verification procedure notices and, possibly, several requests for additional or clarifying information from the Covered Financial Institution where the Customer established the primary account, and also from every mutual fund into which the Customer directs investments. This confusion would be compounded in situations where a Covered Financial Institution's established Customer, who already has received a notice and been verified under the Covered Financial Institution's CIP program, makes an investment in a new mutual fund, and receives more notices and may need to submit additional information in connection with the mutual fund's CIP program. In addition to being duplicative, burdensome, and confusing, this requirement could result in a competitive disadvantage to mutual funds because the other types of investments available to the investor through the Covered Financial Institution, such as stocks and bonds, might not be required to mail an additional identification verification procedure notice or conduct a separate customer identification process under the Act and Proposed Rule.
Given that (1) the primary Covered Financial Institution is already verifying its Customer's identity in connection with its own CIP program; (2) the investor has a direct relationship with the Covered Financial Institution and only an indirect relationship with the mutual fund; and (3) the investor's portfolio through the Covered Financial Institution may include any number of mutual funds (and, quite possibly, stocks, bonds and other investments), we recommend that the Proposed Rule be clarified to provide that an investor who establishes and trades in mutual fund accounts through a Covered Financial Institution would be considered a Customer only of that Covered Financial Institution and not also considered a Customer of the various mutual funds held in that Customer's portfolio. As an alternative to narrowing the definition of "Customer," the final regulations could exempt mutual funds from the requirement to perform their own CIP activities in connection with a Customer introduced to the mutual fund by a Covered Financial Institution that is subject to the CIP requirements of the Proposed Rules. This approach would be consistent with the risk-based approach of the Proposed Rule and avoid adding unnecessarily costly, duplicate, and confusing identification processes that do not advance the purposes of the Act.
B. Employees/Representatives of Covered Financial Institutions Should Not be Considered Customers of Mutual Funds when Conducting Transactions on behalf of Customers of the Covered Financial Institution.
Often, mutual funds will receive instructions from employees or representatives of Covered Financial Institutions who conduct transactions in mutual funds for Customers of the Covered Financial Institutions ("Administrative Personnel"). The rule as currently proposed would include the Covered Financial Institution in the definition of "Customer," thereby subjecting the Covered Financial Institution to the mutual fund's CIP processes. In addition, the Proposed Rule would require mutual funds to obtain identifying information about, provide notice to, and verify the identity of all of the Administrative Personnel who may provide instructions to mutual funds on behalf of a Covered Financial Institution's Customer. Since such Administrative Personnel are already subject to rules and regulations regarding the conduct of their activities, including the Covered Financial Institution's employee screening and bonding process and verification by the mutual fund of their authority to act on behalf of the Covered Financial Institution, requiring the mutual fund to verify their identity appears to be of little value to the purposes of the Proposed Rule and would be quite burdensome to both mutual funds and Covered Financial Institutions. Moreover, there are frequent changes and substitutions of the specific Administrative Personnel authorized by the Covered Financial Institution to conduct transactions on behalf of Customers. This makes treating such Administrative Personnel as Customers of the mutual fund even more burdensome to both the Covered Financial Institution and the mutual fund. As noted above, burdensome and duplicative processes would ultimately result in unnecessary costs and lower returns for investors, without advancing the purposes of Section 326.
We therefore recommend clarification of the Proposed Rule so that employees or representatives of Covered Financial Institutions are not defined as Customers of mutual funds when conducting mutual fund transactions on behalf of Customers of the Covered Financial Institution. Instead, the Covered Financial Institution itself would be the mutual fund's Customer and subject to the mutual fund's risk-based CIP procedures for such entities.
C. Customers who Open Mutual Fund Retirement Plan Accounts with the Financial Institution Designated by the Mutual Fund as its Retirement Plan Custodian, Should be Considered Customers of the Mutual Fund, and Not Customers of the Retirement Plan Custodian.
It is common in the mutual funds industry for investors to direct retirement plan investments into mutual funds, and for mutual funds to facilitate this investment by arranging with a bank or trust company to act as custodian for retirement plans sponsored by the mutual fund. In such circumstances, despite the existence of a written custodial agreement between the investor and custodian, the custodian relationship is only incidental to the primary relationship between the investor and the mutual fund. The mutual fund, and not the retirement plan custodian, is positioned to receive requisite customer identification information, provide the verification procedure notice, and verify the identity of the investor.
Since most financial institutions eligible to serve as retirement plan custodians would be Covered Financial Institutions, the combined effect of the mutual fund CIP rule and other recently proposed CIP rules would require both the mutual fund and the Covered Financial Institution serving as retirement plan custodian for the mutual fund to provide identification verification procedure notice to and verify the identity of the investor. This result would be inefficient, duplicative, and burdensome for mutual funds and the Covered Financial Institutions, as well as confusing to investors who may receive multiple identification verification procedure notices and, possibly, multiple requests for additional or clarifying information from both the mutual fund and the custodian of their mutual fund retirement account. This would also result in a competitive disadvantage to mutual funds because the other types of investments available to the investor for retirement accounts, such as bank products and stocks and bonds available through a brokerage firm, would generally only necessitate the mailing of a single identification verification procedure notice and performance of a single CIP under the Act and Proposed Rule.
Given that (1) a mutual fund is already verifying a Customer's identity in connection with its own CIP program and (2) the investor has a direct relationship with the mutual fund and only an incidental relationship with the Covered Financial Institution serving as custodian for retirement plan assets invested in the mutual fund, we recommend that the Proposed Rule be clarified so that investors who establish relationships with retirement plan custodians solely for the purpose of facilitating investments in mutual funds would be considered Customers only of the mutual funds, and not also considered Customers of the Covered Financial Institution serving as the mutual funds' retirement plan custodian. This approach would be consistent with the risk-based approach of the Proposed Rule and avoid adding unnecessarily costly and duplicate identification processes. Again, we note that the ultimate result of inefficient and duplicate requirements is increased costs and lower returns for investors.
2. Identification Numbers for Non-U.S. Customers who are Not Natural Persons
The Proposed Rule requires that mutual funds obtain each Customer's identification number. In discussing acceptable identification numbers, the Proposed Rule addresses natural persons (both U.S. and non-U.S.) and U.S. non-natural persons. The rule does not provide guidance as to what identification number, other than a U.S. taxpayer identification number, is required for non-U.S. Customers who are not individuals. However, not all such foreign investors in mutual funds have a U.S. taxpayer identification number and they may not otherwise be required to obtain one. We recommend that the final rule provide for an alternative identification number that may be accepted for foreign Customers who are not natural persons.
3. Verification of Identity of Non-U.S. Customers who are Natural Persons
The rule as proposed would preclude foreign individuals from investing in mutual funds. The Proposed Rule requires mutual funds to use the non-documentary identity verification method when the mutual fund "does not meet face-to-face a customer who is a natural person." In most cases, foreign shareholders do not meet face-to-face with mutual fund representatives when establishing an account. However, the non-documentary methods identified in the Proposed Rule would be ineffective for foreign shareholders.
One possible solution to this issue would be to allow mutual funds to verify the identity of foreign Customers by receiving two forms of documentation that corroborate each other through common data elements.
We recommend revision of the Proposed Rule to allow verification of the identification of foreign Customers through comparison of two documents in accordance with the mutual fund's risk-based procedures for such situations.
4. Fair Credit Reporting Act Exemption for Identity Verification and Criminal Activity
To permit mutual funds to effectively utilize available non-documentary verification resources, we recommend that the Proposed Rule dovetail with the Fair Credit Reporting Act ("FCRA") or otherwise specify that the use of information provided by third parties, such as consumer credit reports or bad check or fraud databases, will not require the mutual fund to take any action required by the FCRA as long as the information obtained from such sources is used solely for the purpose of verifying the identity of the Customer and preventing or detecting potentially criminal activity.
Without such an exception, mutual funds and their agents would be subject to FCRA compliance even though the mutual fund is not using the information in connection with extending credit to a consumer. Of particular concern is the applicability of the FCRA requirements about providing adverse action notices to Customers, which may result in action by a mutual fund that could "tip off" criminals, thereby thwarting law enforcement efforts. Furthermore, if the results of identification verification utilizing a credit reporting agency could be grounds for filing a Suspicious Activity Report ("SAR"), the FCRA adverse action notice might be inconsistent with SAR rules that prohibit direct or indirect disclosure to the SAR subject that a SAR has been filed.
We believe that recognition of the FCRA implications, and support of an appropriate exception, are essential for mutual funds to utilize available non-documentary verification tools to comply with the customer identification and verification requirements.
5. Customer Notice Requirements
A. Notice to Customers Before Account is Opened or Trading Authority Granted
The Proposed Rule requires that mutual funds give notice of their identity verification procedures to Customers before an account is opened or trading authority is granted. Mutual fund accounts are generally opened through the mail, with the investor sending a completed application directly to the mutual fund's transfer agent.
Existing applications without the required notice will continue to be in circulation for some time after the effective date of the regulation, and will continue to be utilized by investors and received by mutual fund transfer agents. Even if the existing applications contain all required identification data elements, the mutual fund transfer agent would be required to contact all investors who submitted such applications to provide oral or written notice before opening the account if the notice language had not yet been added. This additional notification process would result in delayed investments and market price risks to the investor, as well as additional costs to the mutual funds industry.
We recommend that the Proposed Rule be revised to clarify that mutual funds will be deemed to be in compliance with the Customer notification rule if they include the notice (1) on applications created as of or after the effective date of the rule and (2) in any prospectus created on or after the effective date of the rule. In addition, mutual funds could be required to post the notice on any web site maintained by the fund for Customer access as of the effective date of the rule.
B. Notice to Multiple Customers within a Single Account
When there are multiple authorized signers on an account, and thus multiple Customers within a single account, we recommend that the Proposed Rule be revised to clarify that if a single identity verification procedures notice is provided to the Customers at the address of record associated with the account, the notice will be deemed to have been given to all Customers associated with the account. Because much of the industry's business is conducted through the mail and over the Internet, mutual funds cannot determine if all Customers associated with an account have received and read such notice prior to establishing the account, regardless of how many notices are sent. With this clarification, the notice provision would conform more closely with the delivery requirements for other important mutual fund communications, such as privacy notices, prospectuses, annual reports, and other householded shareholder communications.
6. Record Retention - Customer Identification Verification Records
The Proposed Rule currently draws no distinction between records kept about Customers and records kept about verification processes. The interest in the former is primarily in law enforcement, and it may be necessary and appropriate for such records to be retained for a period that is linked to the existence of a Customer relationship. However, the interest in the records relating to the verification process is primarily that of regulatory compliance, to document that verification measures are being conducted in accordance with a mutual fund's CIP.
In most cases, mutual funds will adopt a non-documentary customer identification verification methodology, and will batch together potentially thousands of Customers into their verification process. The rule as currently written would require that reports relating to this process be kept indefinitely, as the mutual fund could not determine at what point any or all of the Customers in a given verification batch had terminated their Customer relationships with the mutual fund. The maintenance of such reports, even in electronic form, for decades or more would create logistical and financial burdens for mutual funds without a corresponding benefit for documentation of CIP compliance, since such compliance could be tested by examining recent verification records.
Accordingly, we recommend modification of the Proposed Rule such that records related to the information verification process be retained for a period of five years following the date the process was performed, rather than five years from the closing of the respective accounts.
7. Implementation Period
October 25, 2002 is the date the Act requires the CIP rule to take effect. Mutual funds will need to undertake significant development and implementation activities to comply with these requirements, including drafting CIP programs and incorporating them into existing AML programs, revising account application forms (including identification procedure notice statements) and modifying transfer agency systems. The systems changes, particularly, will require substantial analysis, development and implementation time and resources. Our experience with the recently enacted AML program requirements indicates that at least 180 days from the date of the final CIP rule will be needed to reasonably complete these compliance efforts. We therefore recommend that compliance with the final rule be required no earlier than July 31, 2003.
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PFPC appreciates the opportunity to express its views regarding the Proposed Rules. Should you have any questions or require additional information, please do not hesitate to contact me.
cc: James S. Keller