SEC Investment Management FAQ: Mutual Fund Customer Identification Program Rule

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August 11, 2003

Guidance from the Staffs of the Department of the Treasury and the U.S. Securities and Exchange Commission

Question 1

Q:

If a shareholder of a mutual fund exchanges his or her shares for shares issued by a second mutual fund in the same fund complex, is the shareholder a "customer" of the second fund, and must the second fund perform customer identification procedures with respect to the shareholder?

A:

No. A shareholder of one fund who has exchange privileges with a second fund in the complex would be considered to have accounts with both funds under the mutual fund CIP rule. If the shareholder exchanges into the second fund and the second fund establishes a new account with the shareholder, the shareholder would be a person who already has an "existing account" with the second fund. The shareholder therefore would not be a "customer" of the second fund if it has a reasonable belief that it knows the true identity of the shareholder, and the second fund would not be required to perform its CIP procedures for that shareholder.

Mutual funds are frequently organized into "complexes" or "families" of funds, and a shareholder in one fund commonly is permitted to exchange his or her shares in the fund for shares issued by the other funds in the complex. The CIP rule for mutual funds defines a "customer" of a mutual fund as a person who establishes a "new account" with the fund, and "account" as "any contractual or other business relationship between a person and a mutual fund established to effect transactions in securities issued by the mutual fund, including the purchase or sale of securities" (emphasis added). A shareholder who has exchange privileges with other funds has a "business relationship" with those funds to effect transactions in their securities. Thus, the shareholder has an "account" with the exchanging fund, and the fund may rely on the exclusion from the definition of "customer" in paragraph (a)(2)(ii)(C) for "a person that has an existing account with the mutual fund, provided that the mutual fund has a reasonable belief that it knows the true identity of the person." Similarly, if a mutual fund shareholder purchases shares from a second fund in the same complex with which he or she has exchange privileges, the shareholder would already have an existing account with the second fund and therefore would not be a "customer" of that fund under the rule, if that fund has a reasonable belief it knows the shareholder's true identity.

Of course, if a person initially becomes a shareholder of the first fund on or after October 1, 2003, the exchange privilege with the second fund would create a CIP obligation for the second fund at that time as well. We anticipate that the second fund would normally satisfy this obligation by relying on performance by the first fund or by an affiliated financial institution, or by delegating performance to a common investment adviser or service provider. See 68 FR 25131, 25140-41 at nn.115-122 and accompanying text.

Question 2

Q:

If a broker-dealer or other financial institution ("intermediary") purchases mutual fund shares on behalf of its customers by opening an account for the intermediary through the Fund/SERV system operated by NSCC, are the customers of the intermediary also customers of the mutual fund for purposes of the mutual fund CIP rule?

A:

No. Broker-dealers and other intermediaries typically open accounts with mutual funds through the NSCC Fund/SERV system. These accounts may include sub-accounts for individual customers of the broker-dealer, but only limited information (if any information at all) about the individual customers is provided to the mutual fund. These accounts therefore function in a manner similar to omnibus accounts. Under the mutual fund CIP rule, a "customer" of a mutual fund includes a "person that opens a new account." Therefore, if an intermediary opens an account with a mutual fund through the NSCC Fund/SERV system, the intermediary would be the person that opens the new account, and the intermediary's customers would not be customers of the mutual fund.

Question 3

Q:

May a mutual fund close the account and redeem the shares of an investor whose identity the fund is unable to verify within a reasonable time after the opening of the account? If so, as of what time should the mutual fund value the investor's interest in the fund when it closes the account?

A:

The mutual fund CIP rule states that the CIP "must 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," and that "[t]hese procedures should describe ... [w]hen the mutual fund should close an account, after attempts to verify a customer's identity have failed." 31 CFR 103.131(b)(2)(iii)(D). The SEC staff would not object to a mutual fund's closing of an account and redemption of an investor's shares after reasonable efforts to verify his or her identity have failed, if the shares are valued in accordance with the net asset value next calculated after the mutual fund decides to close the account. A mutual fund may want to consider whether the circumstances surrounding the failure to verify the customer's identity would warrant the filing of a Suspicious Activity Report (SAR).

Question 4

Q:

A mutual fund must implement a written CIP, as part of its anti-money laundering program, by October 1, 2003. Must the board of directors approve the CIP by October 1, 2003?

A:

Yes. The preamble to the final mutual fund CIP rule states that each mutual fund must "fully implement its CIP" by October 1, 2003, and that this transition period was designed to allow time for mutual funds to, among other things, "obtain board approval." Customer Identification Programs for Mutual Funds, 68 FR at 25133. The preamble also states that a fund with a board-approved AML program "must nonetheless obtain approval of a new CIP," and that the addition of the CIP is a "material change [to the AML program] that must be approved by the board." Id. at 25135. In light of the need to implement the CIP by October 1, 2003, however, we would not object if the fund were to obtain approval by a committee of the board by that date, and obtain approval by the full board at the next regularly scheduled board meeting. See Anti-Money Laundering Programs for Mutual Funds, 67 FR 21117, 21119 n.12 (Apr. 29, 2002) (board approval of a mutual fund's AML program "could be given at its first regularly scheduled meeting after the program is adopted").

http://www.sec.gov/divisions/investment/guidance/qamutualfund.htm

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Modified: 08/12/2003