PMLA and KYC compliance for an AIF (Alternative Investment Fund)
INTRODUCTION
KYC as a part of PMLA compliance is a mandatory compliance procedure that regulators in India have specified for Banks and financial intermediaries registered with these regulators. The KYC is one of the most vital compliance process for any institution dealing in the financial sector. Yet due to lack of its importance or intention behind enforcing it, it is mostly overlooked. This article summaries the KYC and PMLA compliance for SEBI registered AIFs. Similar would be the compliance requirement laid out by other regulators such as RBI, IRDA, PFRDA for their registered intermediaries. Before, looking at the requirements, it’s pertinent to note the importance of it and understand some key terms that are used in relation to KYC
Alternative Investment Fund: Alternative Investment Fund or AIF means any fund established or incorporated in India which is a privately pooled investment vehicle which collects funds from sophisticated investors, whether Indian or foreign, for investing it in accordance with a defined investment policy for the benefit of its investors. AIF does not include funds covered under the SEBI (Mutual Funds) Regulations, 1996, SEBI (Collective Investment Schemes) Regulations, 1999 or any other regulations of the Board to regulate fund management activities. Further, certain exemptions from registration are provided under the AIF Regulations to family trusts set up for the benefit of ‘relatives‘ as defined under Companies Act, 1956, employee welfare trusts or gratuity trusts set up for the benefit of employees, ‘holding companies‘ within the meaning of Section 4 of the Companies Act, 1956 etc.
KYC: The process of knowing your investor/client is called KYC. It is to verify the identity of an investor/client based on written details submitted by him/her on a form, supplemented by an in-person verification (IPV) process. Once the verification is carried out successfully, the relevant investor’s data is uploaded to the KRA/CKYCR database.
CKYCR: The Central KYC Registry is a centralized repository of KYC records of customers in the financial sector with uniform KYC norms and inter-usability of the KYC records across the sectors with an objective to reduce the burden of producing KYC documents and getting those verified every time when the customer creates a new relationship with a financial entity.
The Central KYC Record Registry, which started operating from 2016, caters to reporting entities of all four major regulators of financials sector i.e. RBI, SEBI, IRDAI & PFRDA. It allows investors to carry out their KYC only once. CKYC compliance will allow an investor to transact/deal with all entities governed/regulated by the Government of India/different regulators (RBI, SEBI, IRDA and PFRDA) without the need to complete multiple KYC formalities. A 14 digit KYC number issued by CKYCR can be used by all other intermediaries for carrying out KYC and downloading data.
As on 30th June 2020, CKYCRR hosts more than 22 crores KYC records and the growing number of KYC Records downloaded by REs from CKYCRR signify the benefit and ease this repository has provided to the REs and their customers. CERSAI (https://www.cersai.org.in) acts as the CKYCR.
KRA : With a view to eliminate duplication of KYC process to be executed by the investors and to have uniform KYC process across SEBI registered intermediaries, SEBI has introduced the concept of KYC Registration Agency (KRA) in 2011. KRA is an agency registered with SEBI that maintains KYC records of the investors centrally, on behalf intermediaries registered with SEBI. KRA provides for centralization of the KYC records in the securities market. The client who wish to open an account with any intermediary shall provide the KYC details and supporting documents to the Intermediary that shall perform the initial KYC and upload the details on the system of the KRA. This KYC information can be accessed by all the SEBI Registered Intermediaries while dealing with the same client. As a result, once the client has done KYC with a SEBI registered intermediary, he need not undergo the same process again with another intermediary.
There are many KRAs registered with SEBI. It is mandatory and obligatory for each client to get registered with any one out of various KRA before availing services of any intermediary. The KRA generates a unique number to identify the client which can used by used by other intermediaries to check and download KYC documents.
PMLA The Prevention of Money Laundering Act, 2002 (“PMLA”) was brought into force with effect from 1st July 2005 by the Department of Revenue, Ministry of Finance, Government of India. PMLA was introduced to prevent money laundering and seizure of property obtained by way of money laundering. Crimes like white collar crimes, corporate and financial frauds, drug trafficking or smuggling and even cross border crimes (if anyhow connected to India) come under the ambit of PMLA Act, 2002. RBI, SEBI and IRDA have been brought under the PML Act, and therefore it will be applicable to all financial institutions, banks, mutual funds, insurance companies, and their financial intermediaries.
The Enforcement Directorate (ED) is responsible for investigating offences under the PMLA. Also, the Financial Intelligence Unit – India (FIU-IND) is the national agency that receives, processes, analyses and disseminates information related to suspected financial transactions. Punishment prescribed in the Act includes a jail term (rigorous imprisonment) of minimum 3 years to maximum 7 years.
Money Laundering : Money Laundering is the process of cleaning the money received through illegal activities and concealing its illegal source through a series of transaction. The money required for running illegal activities like sale of drugs, human trafficking, terrorist financing etc, are sourced and the income generate from such illegal activities are send back to the legal system in a way that the illegal origin or use of such money can be concealed.
NEED FOR PMLA and KYC COMPLIANCE
Money laundering is a global issue that has challenged all nations of the world. It is not only about hiding money or evading taxes. It promotes illegal activities, threatens security and has far reaching impact on the socio-economic situation of a country. It jeopardises the growth and prosperity of any nation. There have been worldwide efforts to combat money laundering and India has also enacted various statues to counter the same, once of which is PMLA. Under the PMLA, any Person who directly or indirectly attempts to indulge or knowingly assists or knowingly is a party or is actually involved in any process or activity connected with proceeds of crime including its concealment, possession, acquisition or use and projecting or claiming it as untainted property shall be guilty of offence of money-laundering. Mostly, financial intermediaries such as banks, insurance companies, mutual funds and other intermediaries are used as tools to accomplish money laundering. They are used as medium to have transaction or series of transactions to smartly get illegal money back into the system. Whenever a person is accused of offence of money laundering, the burden of proof lies on the accused. Hence it is crucial for financial intermediaries to not be a party to or not assist in such activities knowingly. Therefore it becomes paramount for the financial intermediaries to take due care and know the identity of their clients/investors before allowing them to use their services for any kind of transactions. If proper due diligence is not done, financial intermediaries can be used for money laundering and may be prosecuted against for being involved in or assisting in money laundering for offences committed by their clients, if it can be demonstrated that they were aware of the commission of a scheduled offence, knowingly became recipients of the proceeds of crime and projected the proceeds as untainted property. Thus, the obligation case on reporting entities under the PMLA and its rules, and the guidelines issued by various regulators in this regard, including AML and KYC guidelines, are to exercise due diligence in their dealings with clients and to maintain and supply records of certain prescribed dealings with clients. It may be used as a factor in demonstrating the lack of knowledge of the commission of money laundering by their clients.
SEBI AML and KYC compliance requirements for AIF
SEBI has issued a Master Circular on AML and CFT dated 5th October 2019 based on the PMLA and its rules and the recommendations made by Financial Action Task force (FATF) on anti-money laundering standards. Further, SEBI has issued various circulars guiding the SEBI registered intermediaries on uniform KYC procedure to be followed.
Below is the brief snapshot of the requirements:
KYC
1. A standard KYC form would be used by all SEBI registered intermediaries for doing KYC and the same supporting documents shall also be used by all SEBI registered intermediaries (“RI”). The KYC template finalised by CERSAI shall be used for both individuals and legal entities.
2. Uploading KYC data: All SEBI registered intermediaries shall perform initial KYC on their clients including in person verification and upload the KYC data on KRA as well as CERSAI. This would require the SEBI intermediary to get registered on any one of the KRA as well as CERSAI. Every RI shall within ten days after the commencement of an account-based relationship with a client, file the electronic copy of the client’s KYC records with CERSAI and KRA.
Till April 2021, data related to individuals were uploaded on CERSAI and that of legal entities were uploaded on both KRA and CERSAI. Form April 2021 onwards KYA data for both individuals and legal entities will be uploaded both on KRA and CERSAI. Currently, there isnt any link between the CERSAI’s CKYC system and SEBI-registered KRAs. The data about non-individuals until Apr 2021 still rests with SEBI registered KRAs and as per the recent notification dated 10th March 2021, the same will be uploaded on CERSAI as and when updated KYC records are received from the client as per the client monitoring and due diligence policy of the RI.
AML
3. Written Anti Money Laundering Procedures: Each registered intermediary shall adopt written procedures to implement the anti- money laundering provisions as envisaged under the PMLA. Such procedures shall include inter alia, the following three specific parameters which are related to the overall ‘Client Due Diligence Process’:
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- Policy for acceptance of clients
- Procedure for identifying the clients (KYC)
- Transaction monitoring and reporting especially Suspicious Transactions Reporting (STR).
4. Maintenance of records for a period of 5 years. Records should include Nature, amount, date and parties to the transaction.
5. Registration with FIU-IND and reporting suspicious transactions: Intermediaries shall ensure that appropriate steps are taken to enable suspicious transactions to be recognized and have appropriate procedures for reporting suspicious transactions. While determining suspicious transactions, intermediaries shall be guided by the definition of a suspicious transaction contained in PML Rules as amended from time to time.
6. Appointment of Principal Officer and Designated Director: Registered intermediaries shall appoint senior officers as Principal Officer and Designated Director to ensure compliance with PMLA and its rules. RI to communicate details such as name designation and address the aforesaid to FIU-IND.
7. List of Designated Individuals/ Entities:
An updated list of individuals and entities which are subject to various sanction measures such as freezing of assets/accounts, denial of financial services etc., as approved by the Security Council Committee established pursuant to various United Nations’ Security Council Resolutions (UNSCRs).
Registered intermediaries are directed to ensure that accounts are not opened in the name of anyone whose name appears in said list. Registered intermediaries shall continuously scan all existing accounts to ensure that no account is held by or linked to any of the entities or individuals included in the list. Full details of accounts bearing resemblance with any of the individuals/entities in the list shall immediately be intimated to SEBI and FIU-IND. Full details of accounts bearing resemblance with any of the individuals/entities in the list shall immediately be intimated to SEBI and FIU-IND.
8. Employees’ Hiring/Employee’s Training/ Investor Education
The registered intermediaries shall have adequate screening procedures in place to ensure high standards when hiring employees. There should be ongoing employee training programme so that the members of the staff are adequately trained in AML and CFT procedures. Intermediaries to sensitize their clients about these requirements of the AML and CFT framework. Intermediaries shall prepare specific literature/ pamphlets etc. so as to educate the client of the objectives of the AML/CFT programme.
NON COMPLIANCE:
Fines under PMLA :
Under the PMLA, fines ranging from 10,000 rupees to 100,000 rupees for each failure can be imposed on a reporting entity if it has failed to maintain records or supply information in the manner prescribed under the PMLA and its rules.
Revocation of License:
Section 11B of the SEBI Act 1992, inter alia, empowers the SEBI to regulate the securities market by any measures as it thinks fit and to cancel the licence of an intermediary for non-compliance with the directions issued by the SEBI, including, for instance, the SEBI AML/CFT/KYC Guidelines.
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