What Is Customer Due Diligence (CDD)?

Customer Due Diligence (CDD) is a fundamental process in the financial industry. Its core purpose is to prevent illicit financial activities, such as money laundering and terrorist financing, by ensuring financial institutions understand their customers. CDD is a regulatory requirement, forming a cornerstone of anti-money laundering (AML) programs in the United States. It enhances financial transparency, helping to safeguard the integrity of the financial system.

Understanding Customer Due Diligence Requirements

Financial institutions collect specific information from customers as part of the initial CDD process. This phase establishes a foundational understanding of each customer, forming the basis for risk assessment and regulatory obligations.

Identity verification requires institutions to gather the following for individual customers:

• Full legal name
• Date of birth
• Residential address
• A unique identification number (e.g., Social Security Number or passport details)

This information is necessary for establishing a customer’s true identity and is a core component of the Customer Identification Program (CIP) under the USA PATRIOT Act.

For legal entities, financial institutions must identify and verify beneficial ownership. This involves pinpointing the ultimate natural persons who directly or indirectly own or control the entity, including any individual holding 25% or more of the equity interest, and a single individual with significant responsibility (e.g., an executive officer or senior manager). Identifying these individuals is important to prevent criminals from using complex corporate structures to hide illicit activities and funds.

Financial institutions also need to understand the nature and purpose of the business relationship a customer intends to establish. This involves describing anticipated activities, transaction types, and projected volumes. Gaining this insight helps institutions develop a baseline profile for normal customer activity.

For larger transactions or higher-risk profiles, institutions may inquire about the source of a customer’s funds or wealth. This helps ensure the origin of assets is legitimate and consistent with the customer’s stated profile, contributing to a comprehensive risk assessment.

Implementing Customer Due Diligence

Implementing Customer Due Diligence involves practical steps financial institutions undertake using information collected during the initial phase. This section focuses on how institutions process and utilize the data to manage risk effectively.

The process begins with identification and verification, where institutions confirm the identity provided by the customer. This can involve reviewing government-issued documents (e.g., driver’s license or passport) or utilizing non-documentary methods like public database checks and credit report verification. The aim is to form a reasonable belief that the institution knows the customer’s true identity.

Next, a risk assessment is conducted, using gathered information to assign a risk rating to the customer. This rating categorizes customers (e.g., low, medium, or high risk) based on factors like geographic location, occupation, and anticipated transaction patterns. This risk profile guides the level of ongoing scrutiny applied to the customer’s activities.

Customer Due Diligence involves ongoing monitoring. Financial institutions continuously scrutinize customer transactions and activities to ensure they align with the established customer profile. This continuous oversight helps detect any unusual or suspicious activities that deviate from expected patterns.

Ongoing monitoring also includes periodically updating customer information to ensure accuracy and relevance. If significant changes occur to a customer’s beneficial ownership, business activities, or transaction patterns, the institution reviews and updates its CDD records. This proactive approach helps institutions maintain an up-to-date understanding of their customers and their associated risks.

Variations in Customer Due Diligence

Customer Due Diligence is applied flexibly, adapting to each customer’s assessed risk level. This risk-based approach ensures resources are allocated efficiently, with greater scrutiny applied where the potential for illicit activity is higher. Two main variations in CDD are Simplified Due Diligence and Enhanced Due Diligence.

Simplified Due Diligence (SDD) is permitted for low-risk customers, products, or transactions where money laundering or terrorist financing risk is minimal. Examples include publicly traded companies, government entities, or financial institutions regulated by federal functional regulators. Even with SDD, basic identification and monitoring requirements apply, ensuring a minimum level of oversight.

Conversely, Enhanced Due Diligence (EDD) is required when a customer or transaction presents a higher risk. This more intensive process involves additional measures beyond standard CDD. Factors triggering EDD include Politically Exposed Persons (PEPs), customers from high-risk jurisdictions, or those engaged in complex or unusually large transactions.

Under EDD, financial institutions undertake more extensive background checks, delve deeper into the source of a customer’s wealth or funds, and conduct more frequent and rigorous monitoring. This heightened scrutiny helps mitigate increased risks associated with these customer profiles. The aim is to gain a more comprehensive understanding of the customer and their financial dealings to better detect and prevent potential financial crimes.