How NAICS Codes Streamline Compliance and Risk Management in Due Diligence

Compliance officers and due diligence teams are increasingly utilizing industrial classification systems to understand businesses. One of the key classifications includes NAICS codes used across the U.S, Canada, and Mexico to categorize businesses by their primary activity. 

With the anti-financial crime workflows, knowing NAICS codes assists in answering a fundamental due diligence question: “What does this business do?” Read the blog to understand NAICS codes and their role in due diligence procedures to ensure legitimate partnerships.

What are NAICS Codes and Who Has Them?

NAICS codes are defined as the six-digit numeric codes used to classify businesses by industry. In 1997, the NAICS system replaced the SIC (Standard Industrial Classification) code. 

The standardized NAICS code list covers the complete array of economic activities across North America. Various government bodies and data providers may collect or assign NAICS codes for their programs.

For instance, the U.S. Census Bureau assigns a NAICS code to each business establishment for statistical purposes, often derived from information provided when the company applies for an Employer Identification Number (EIN)​.

By contrast, unregistered businesses, such as sole proprietorships operating without formal registration, may not have official NAICS codes available. These businesses still fall under the NAICS category based on their activity, but a compliance team might have to look for the proper code manually. 

Low Risk Vs. High Risk NAICS Codes 

Not all industries carry the same level of risk when it comes to compliance and regulations. Compliance programs often maintain an internal NAICS risk rating list, categorising certain NAICS codes as “high risk” or “low risk”. These designations help in the due diligence procedure. 

Businesses falling under high-risk NAICS codes may require enhanced due diligence, while those in low-risk might pass the simple due diligence process. However, the question is which are labeled as high-risk NAICS codes? 

NAICS Association on High Risk Codes 

The NAICS association has published guidance on identifying high-risk and cash-intensive industries. Sectors that are dealing heavily in cash or valuable goods, while having historically been linked to money laundering or tax evasion, are categorized as high-risk codes. Conversely, low-risk NAICS codes are those for industries with lower exposure to financial crimes or volatility.

Purpose of an NAICS Code Lookup

NAICS lookup plays a vital role in how businesses identify, assess, and position other companies within the regulatory framework. Listed below are the key roles that the NAICS code lookup serves:

Proper Industry Classification

Businesses use the NAICS lookup to determine the most precise code that matches their principal activities. It aligns a company with its industry domain.

Regulatory and Tax Compliance

The lookup is fundamental when filling out forms for government agencies. Tax return statements, official documents, or economic censuses usually require an accurate NAICS code to classify business activities consistently.

Government Contract Assistance 

Companies that aim to pursue government contracts require accurate NAICS codes used in registration systems. The NACIS lookup assists businesses in verifying their classification and identifying opportunities that best suit their capabilities.

Streamlines KYB and Due Diligence

Multiple companies and industries perform due diligence using NAICS lookups in order to validate a company’s industrial claims. This is crucial during the onboarding or risk assessment process, where NAICS codes ensure that a business’s described activities align with the public registries

Beyond compliance, businesses also rely on NAICS lookup by company name to perform competitive research and market analyses. In the next section, a comprehensive overview of how NACIS codes are selected and used.

Why NAICS Codes Matter for Business Verification and Risk Screening?

Knowing an entity’s industry via NAICS code is a critical component of business profiling. Distinct industries contain distinct inherent risks related to financial crime, regulatory assessment, or reputation. 

NAICS codes offer standardized methods for categorizing the risk while enabling compliance professionals to make informed decisions regarding a company’s operational and reputational risk profiling.

Some of the reasons why NAICS codes are significant for business verification include:

• To flag illegal financial risk associated with companies.
• To assess financial stability risk. 
• To avoid regulatory and compliance risk.

In simpler words, a NAICS lookup in business verification is done for risk assessment while allowing the compliance teams to classify an entity’s line of business at the onboarding phase. 

Moreover, NAICS-based industry knowledge will assist in avoiding blind spots in compliance: it prompts the due diligence team to consider specific regulatory issues associated with that sector.

How Does NAICS Code Lookup Help in Due Diligence

NAICS code lookup plays a crucial role in the due diligence procedure by enabling the business to assess, classify, and verify the activities of potential clients, vendors, and entities. 

Let’s consider a financial institution – a bank that is in the process of onboarding a new partner. The new company claims to provide financial advisory and investment services. However, before proceeding with the partnership, the bank conducts due diligence on the potential partner, H&M Investments.

• NAICS Code Lookup 

H&M Investments claims to operate as a financial advisory firm, offering investment advice and wealth management services. In order to verify their claim, the bank used the NAICS code lookup by company name using the KYB dashboard. 

The lookup confirmed that H&M Investments is indeed classified under the accurate financial services category. 

• Risk Profiling 

Further, the NAICS business codes help in assessing the risk associated with partnering with H&M investments. The company is classified as a moderate risk industry in terms of fraud and regulatory analysis. 

Also, the bank learned that the investment company faced heightened regulatory oversight and compliance obligations due to AML and KYB requirements.

• Compliance Verification

With strict AML and KYB regulations in the financial sector, the bank ensures that H&M investments comply with the requirements. Therefore, all necessary checks are performed. During this step, the bank discovered that H&M investment is registered with the Financial Industry Regulatory Authority(FINRA). It is a key regulatory body for investment advisors. 

This validated the authenticity of the business while confirming its adherence to industrial standards.

• Potential Risk Identification

While H&M investment appears to be operating within the correct industry classification, the bank used the NAICS code to assess the industrial growth and business stability as well.

• Finalize Decision Making

Based on the NAICS business codes, industry risk assessment, and regulatory compliance checks, the bank concluded that H&M Investments is a legitimate business. It has an acceptable risk profile for partnership, and therefore, they can proceed with the onboarding procedure.

Streamline Due Diligence Using NAICS Codes With THE KYB 

NAICS codes are helpful in the due diligence process, providing a standardized method for classifying companies based on their industry or domain. By assigning a unique six-digit code to every business, NAICS allows companies to evaluate the industry-specific risk. 

The KYB also ensures compliance with regulatory requirements while offering sanction screening, adverse media monitoring, and watchlist screening of the entity. 

Businesses operating in high-risk sectors like finance or retail industries can be easily identified, prompting enhanced due diligence measures. Moreover, NAICS codes facilitate the business verification process while streamlining workflow and reducing manual errors.

Frequently Asked Questions

What are NAICS Codes?

NAICS codes are numerical designations assigned under the North American Industry Classification System. They provide a standardized method to classify business establishments based on their primary economic activities, facilitating statistical analysis and comparison across industries.

How many NAICS Codes can a company have?

Typically, a business is assigned one primary NAICS code that reflects its main line of business. However, companies engaging in multiple activities may also list secondary codes to denote additional business lines.

How do I find out my NAICS code?

You can determine your NAICS code by reviewing a detailed description of your business activities and comparing them with the definitions provided in the official NAICS manual or on government websites such as the U.S. Census Bureau’s NAICS search tool.

What is an NAICS Code for Small Business?

There is no special NAICS code designated exclusively for small businesses. NAICS codes are assigned based solely on industry and activity, regardless of the size of the business.

What is the Best NAICS Code for Business?

The most appropriate NAICS code is the one that most accurately represents your business’s primary operations. Selecting the “best” code involves aligning your business activities with the industry definitions provided in the NAICS manual.