What Is Know Your Client (KYC)?

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What Is Know Your Client (KYC)?

Let me explain what Know Your Client (KYC) really is—it's a vital standard in investment and financial services that you need to understand if you're dealing with clients or accounts. KYC verifies client identities and assesses their financial profiles, using components like the Customer Identification Program (CIP) and other due diligence measures to ensure compliance and mitigate risks in customer relationships.

Key Principles of Know Your Client (KYC) Guidelines

The KYC rule serves as an ethical standard for anyone in the securities industry who works with customers to open and maintain accounts. It kicks in right when a customer-broker relationship starts, establishing the customer's essential profile before any financial advice is given. You should know that the customer gets informed about complying with all securities industry laws, regulations, and rules.

KYC Requirements

Under the Customer Identification Program (CIP), financial firms must collect four key pieces of client information: name, date of birth, address, and ID number. Then there's Customer Due Diligence (CDD), which involves gathering credentials to confirm identity and assess risk for suspicious activities. For high-risk customers—those potentially involved in infiltration, terrorism financing, or money laundering—Enhanced Due Diligence (EDD) requires collecting extra information.

Regulatory Rules for KYC Compliance

Two main rules govern KYC: FINRA Rule 2090 (Know Your Customer) and FINRA Rule 2111 (Suitability). FINRA Rule 2090 demands that every broker-dealer uses reasonable diligence in opening and maintaining client accounts, knowing and recording each customer's profile, and identifying anyone authorized to act on their behalf. FINRA Rule 2111 requires a broker-dealer to have a reasonable basis for believing a recommendation suits the customer, based on their financial situation and needs—this assumes a review of the customer's facts, profile, and other investments before any transaction.

The Relationship Between Anti-Money Laundering (AML) and KYC

The U.S. Financial Crimes Enforcement Network (FinCEN) mandates that customers and financial institutions follow KYC to prevent illegal activities like money laundering. AML refers to the measures and processes for regulatory compliance, and KYC is a component of that. FinCEN requires institutions to understand the type and purpose of customer relationships, create risk profiles to spot suspicious activities, maintain accurate customer information, monitor accounts, and report any findings promptly.

How KYC Standards Impact Cryptocurrency Markets

Cryptocurrency markets offer decentralized exchanges that promote confidentiality, but this makes preventing money laundering tough—criminals use it as a vehicle for that. Governing bodies are imposing KYC on these markets. Most cryptocurrency platforms count as Money Services Businesses (MSBs) and must follow AML laws, including customer identification and reporting. Fiat-to-crypto exchanges, dealing with official currencies, usually apply KYC, and financial institutions vet customers accordingly. Remember, in 2020, FinCEN proposed rules for cryptocurrency participants to submit, maintain, and verify identities, classifying some cryptocurrencies as monetary instruments under KYC—the final action is set for February 2024. As an example, Bitcoin mixer Larry Dean Harmon faced a $60 million penalty for violating AML laws.

What Is KYC Verification?

KYC verification is a set of standards and requirements in investment and financial services to ensure brokers have enough information about clients, their risk profiles, and financial positions.

What Is KYC in the Banking Sector?

In banking, KYC requires bankers and advisors to identify customers, beneficial owners of businesses, and the nature and purpose of relationships. They must review accounts for suspicious or illegal activity and keep customer information accurate.

What Are KYC Documents?

Account owners typically provide a government-issued ID for proof of identity—some institutions want two forms, like a driver's license, birth certificate, social security card, or passport. Address confirmation comes from the ID or an additional document.

Final Thoughts on KYC Standards

KYC is a crucial standard in financial services for verifying identities and assessing risks in financial profiles, involving CIP, CDD, and EDD. Institutions like banks and investment services must comply with FINRA rules to know clients, provide suitable advice, and prevent illegal activities. As regulations evolve, everyone involved needs to stay vigilant and proactive in KYC compliance to ensure secure transactions and system trust.

What Is Know Your Client (KYC)?

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