Know Your Client (KYC): Definition & Overview

KEY TAKEAWAYS

• Know Your Client (KYC) standards are used in the financial services and investment sectors. This is to identify clients and understand their customer risk and financial profiles.
• Customer identification program (CIP), customer due diligence checks (CDD), and enhanced due diligence (EDD) are the three parts of KYC.
• Each new customer must provide comprehensive financial information to the SEC. This is before opening an investment or banking account.

What Is Know Your Client (KYC)?

Know Your Client (KYC) is a guideline that is used within the investment business. It is a moral requirement for people working in the securities business. Especially those who interact with clients when opening and maintaining accounts. It guarantees that advisors can confirm a client’s identity. And that they are aware of their client’s financial situation and investment understanding.

KYC can also stand for Know Your Customer. These terms are used interchangeably.

Who Needs KYC?

Financial institutions that deal with clients must comply with KYC requirements when opening and managing accounts. Standard KYC procedures often apply when a company onboards a new client or when a current client purchases a regulated product.

The following financial organizations must adhere to KYC protocols:

• Credit unions
• Banks
• Private lenders
• Lending platforms
• Wealth management firms
• Broker-dealers
• Finance tech applications – although this depends on which activities they engage in

Essentially, the importance of KYC laws has increased for nearly any entity that deals with money. Banks are obligated to comply with KYC in order to reduce fraud. They also carry this requirement forward to the businesses that they work with.

KYC Compliance

Financial Industry Regulatory Authority (FINRA) Rule 2090 (Know Your Customer) and FINRA Rule 2111 (Suitability) are two regulations. These all govern KYC.

Every broker-dealer is obligated to use reasonable diligence. This is while opening and managing client accounts, according to FINRA Rule 2090. They also have to be aware of each customer’s profile and keep records of it. As well as identify any individuals who are authorized to act on their behalf.

A broker-dealer must have a reasonable opinion that a recommendation is appropriate for a customer. This is based on the client’s financial status and needs, according to FINRA Rule 2111. This regulation presupposes that the broker-dealer has reviewed the client’s facts and profile. This is before buying, selling, or exchanging a security on behalf of a client. This includes the client’s other securities and investments.

What Is a Know Your Client (KYC) Certificate?

A KYC certificate is given out to people who have undergone KYC and CDD training. Knowing how to reduce the risk level connected with customer base acquisition and retention efforts can be easier. This is with the help of training in Know Your Customer (KYC) and customer due diligence (CDD).

You can also receive a KYC certificate. You can get this if you have completed the KYC process and been deemed KYC verified. However, that is not typically the case. 

What Are the Components of Know Your Client (KYC)?

The three components that make up KYC are:

The USA Patriot Act of 2001’s Customer Identification Program (CIP)

Financial institutions are required to collect four pieces of identifying data from clients under CIP. Including name, date of birth, address, and customer identity number.

Customer Due Diligence (CDD)

All of a customer’s credentials are gathered as part of the CDD process. This aims to confirm their identity and assess their risk profile. This is in the search for questionable account activity.

Ongoing Monitoring or Enhanced Due Diligence (EDD)

EDD is put in place once a customer’s account has been established. It is mainly utilized for clients who are more likely to be involved in questionable activities. This includes money laundering, terrorism financing, or infiltration. In these cases, more data collecting is frequently required.

Know Your Client Process

The KYC procedure is essential to all kinds of due diligence investigations. The process is relatively straightforward and tends to be roughly the same from country to country. 

Here are the general steps of the KYC process – though these are not necessarily in order:

1. Submission of Documents

A potential customer or applicant for financial services must provide certain documentation. This is to prove their identity and place of residence. The submission may be made physically or electronically.

2. Verification of Identity

The authorized agency or organization verifies the applicant’s identity. This is based on the given document. For instance, the Department of Motor Vehicles (DMV) could conduct the verification. This is in the event the applicant produces a driver’s license as their form of identification.

3. Verification of Residency

Determine the resident status (domestic or foreign). As well as the current residential address, alternate residential address, and citizenship status. This is all part of the residency verification process.

4. Verification of Financial Condition

Documents, conversations with the issuer, and physical verification are used to confirm the reported assets and obligations. This makes the chance of any form of misrepresentation become lower as a result.

5. Transactions Monitoring

A financial institution will monitor a customer’s or client’s transactions. Any unusual, expensive, or frequent transactions are automatically flagged. They are then subjected to meticulous manual scrutiny.

Once these five steps have been successfully completed, the potential customer would be deemed KYC verified. 

Importance of Know Your Client

According to the law, financial institutions must use KYC to verify a customer’s identification. As well as pinpoint risk concerns. KYC procedures aid in preventing financial crimes such as identity theft, money laundering, financial fraud, terrorism funding, and others. Penalties for non-compliance may be severe.

Within the investing sector, KYC is an industry-standard. It’s a procedure put in place by industry regulatory authorities to safeguard all parties involved in the sector. And any investment firm or investor should follow it if there is a lot of money on the line.

In addition to the KYC procedure for new investors, repeat investors must also go through it. Or the KYC profile currently on file with the firm must be renewed. It is crucial to keep up-to-date, correct records for the entire company.

Benefits of Know Your Client

There are many benefits that are associated with Know Your Client. 

Both sides in a business transaction and the customer relationship are protected. This is by obtaining comprehensive customer information. KYC is crucial for delivering top-notch service and limiting liability as well as avoiding connections to fraud and money laundering.

What Are the Documents Required for Know Your Client?

Account holders often have to present a government-issued ID as identification. Some establishments demand two kinds of identification, they can be any of the following forms of identification:

• Passport
• Birth certificate
• Social security card
• Driver’s license
• Documents that are issued by the federal or state government

Identity verification and address verification are both required. This can be accomplished via identification documentation or a supporting document that verifies the client’s address.

For proof of residence, you can use the following documents:

• Utility bills
• Employment documentation
• Bank statements
• Housing contracts
• Rental agreements

Summary

Investment and financial services firms employ a set of guidelines and regulations known as “Know Your Client” (KYC) to confirm the identification of their clients and any potential dangers in the client-company relationship. Customers must complete a personal identification profile as part of KYC. 

KYC is important both for the identification, and the security of customers within the financial services. By having clear identification, there is a guarantee that investment advisors are aware of their client’s financial situation and risk tolerance.