Know Your Client (KYC)

What Is Know Your Client (KYC)?

Know Your Client (KYC) is a standard in the investment industry that ensures advisors can verify a client's identity and know their client's investment knowledge and financial profile.

Three components of KYC include the customer identification program (CIP), imposed under the USA Patriot Act in 2001, customer due diligence (CDD), and ongoing monitoring or enhanced due diligence (EDD) of a customer's account once it is established.

Key Takeaways

  • Know Your Client (KYC) are standards used in the investment and financial services industry to verify customers and know their risk and financial profiles.
  • Three components of KYC include the customer identification program (CIP), customer due diligence (CDD), and enhanced due diligence (EDD).
  • The SEC requires that each new customer provide detailed financial information before opening an investment or banking account.


Understanding Know Your Client (KYC)

The Know Your Client (KYC) rule is an ethical requirement for those in the securities industry dealing with customers during the opening and ongoing maintenance of accounts.

It is implemented at the onset of the customer-broker relationship to establish the essential personal profile of each customer before any financial recommendations are made. The customer is also made aware of the need to comply with all the laws, regulations, and rules of the securities industry.

KYC Requirements

Customer Identification Program

CIP requires that financial firms must obtain four pieces of identifying information about a client, including name, date of birth, address, and identification number.

Customer Due Diligence

CDD is a process in which all of a customer’s credentials are collected to verify their identity and evaluate their risk profile for suspicious account activity.

Enhanced Due Diligence

EDD is used for customers that are at a higher risk of infiltration, terrorism financing, or money laundering and additional information collection is often necessary. 

KYC Compliance

Two rules governing KYC include Financial Industry Regulatory Authority (FINRA) Rule 2090 (Know Your Customer) and FINRA Rule 2111 (Suitability).

FINRA Rule 2090 states that every broker-dealer uses reasonable effort when opening and maintaining client accounts and are required to know and keep records on the profile of each customer, as well as identify each person who has authority to act on the customer’s behalf.

FINRA Rule 2111 notes that a broker-dealer must have a reasonable belief that a recommendation is suitable for a customer based on the client’s financial situation and needs. This rule assumes that the broker-dealer has completed a review of the current facts and profile of the customer, including the customer’s other securities and investments before making any purchase, sale, or exchange of a security on the client's behalf.

AML and KYC

The U.S. Financial Crimes Enforcement Network (FinCEN) requires both customers and financial institutions to comply with KYC standards to prevent illegal activity, specifically money laundering. AML, anti-money laundering, is a term for the range of measures and processes used to achieve regulatory compliance. KYC is a component of AML.

FinCEN requires financial institutions to understand the type and purpose of the customer relationship and develop a customer risk profile, used as a baseline for detecting suspicious customer activities.

Financial institutions must also maintain current and accurate customer information and continue to monitor accounts for suspicious and illegal activities. When detected, they are required to promptly report their findings.

KYC and Cryptocurrency

The cryptocurrency market is praised for providing a decentralized medium of exchange that promotes confidentiality. However, these benefits also present challenges in preventing money laundering. Criminals see cryptocurrency as a vehicle to launder money and as a result, governing bodies are looking for ways to impose KYC on cryptocurrency markets.

Requiring cryptocurrency platforms to verify their customers would aline with financial institutions, and although not yet required, many crypto platforms have implemented KYC practices.

Fiat-to-crypto exchanges facilitate transactions involving fiat currencies and cryptocurrencies. Since fiat currency is the official currency of a nation, most of these exchanges employ a measure of KYC and financial institutions would have vetted their customers according to KYC requirements.

$60 million

The penalty assessed against Bitcoin mixer Larry Dean Harmon for violating anti-money laundering laws.

In early 2021, FinCEN proposed that cryptocurrency and digital asset market participants submit, maintain, and verify customers' identities. This proposal would classify certain cryptocurrencies as monetary instruments, subjecting them to KYC requirements.

What Is KYC Verification?

The Know Your Client (KYC) verification is a set of standards and requirements used in the investment and financial services industries to ensure brokers have sufficient information about their clients, their risk profiles, and their financial position.

What Is KYC in the Banking Sector?

KYC in the banking sector requires bankers and advisors to identify their customers, beneficial owners of businesses, and the nature and purpose of customer relationships. Banks must also review customer accounts for suspicious and illegal activity and maintain and ensure the accuracy of the customer accounts.

What Are KYC Documents?

Account owners generally must provide a government-issued ID as proof of identity. Some institutions require two forms of ID, such as a driver's license, birth certificate, social security card, or passport. In addition to confirming identity, the address must be confirmed. This can be done with proof of ID or with an accompanying document confirming the address of the client.

The Bottom Line

Know Your Client (KYC) are a set of standards and requirements investment and financial services companies use to verify the identity of their customers and any associated risks with the customer relationship. KYC requires customers to provide a personal identification profile and KYC ensures investment advisors are aware of their client's risk tolerance and financial position.

Article Sources
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  1. U.S. Securities and Exchange Commission. “Books and Records Requirements for Brokers and Dealers Under the Securities Exchange Act of 1934.”

  2. Financial Industry Regulatory Authority. “Obligations to Your Customers.”

  3. Financial Industry Regulatory Authority. “FINRA Rule 2111 (Suitability) FAQ.”

  4. Financial Industry Regulatory Authority. “2090. Know Your Customer.”

  5. Financial Industry Regulatory Authority. “2090. Know Your Customer.”

  6. Financial Industry Regulatory Authority. “FINRA Rule 2111 (Suitability) FAQ.”

  7. Financial Crimes Enforcement Network. “Information on Complying with the Customer Due Diligence (CDD) Final Rule.”

  8. Financial Crimes Enforcement Network. “FinCEN Guidance,” Pages 1-3.

  9. Federal Deposit Insurance Corporation. “Bank Secrecy Act, Anti-Money Laundering, and Office of Foreign Assets Control,” Page 5.

  10. Organisation for Economic Co-operation and Development. “Public Consultation Document: Crypto-Asset Reporting Framework and Amendments to the Common Reporting Standard,” Page 4.

  11. Organisation for Economic Co-operation and Development. “Public Consultation Document: Crypto-Asset Reporting Framework and Amendments to the Common Reporting Standard,” Pages 6-7.

  12. U.S. Treasury Financial Crimes Enforcement Network. "First Bitcoin 'Mixer' Penalized by FinCEN or Violating Anti-Money Laundering Laws."

  13. Financial Crimes Enforcement Network. “FinCEN Extends Reopened Comment Period for Proposed Rulemaking on Certain Convertible Virtual Currency and Digital Asset Transactions.”

  14. Federal Deposit Insurance Corporation. “FDIC Law, Regulations, Related Acts.”

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