The money laundering regulations 2007 are about to come into force. what impact will they have on law firms? Anita Rice reports
After much to-ing and fro-ing between the Treasury and various professional bodies, including the Law Society and the Society of Trust and Estate Practitioners (STEP), the Money Laundering Regulations 2007 come into force on 15 December.
The rules were revised following concerns that they were so vague as to be effectively unworkable. A leading human rights QC, Rabinder Singh of Matrix Chambers, condemned a previous draft as being so poorly worded that it could have been unlawful to prosecute lawyers who may unwittingly fail to comply with them.
The previous draft regulations sought to expand customer due diligence (CDD) requirements, forcing solicitors to identify the correct beneficial owner of trusts or risk committing a criminal offence. However, the original definition of ‘beneficial owner’ was criticised as being so broad that lawyers may not have been able to determine whether they were in breach of the law.
The Treasury rewrote the rules and clarified the definition of ‘beneficial owner’ after finance and legal professionals, led by the Law Society and STEP, successfully campaigned to limit CDD requirements to those with a vested interest in 25% or more of the actual assets or capital of a trust, as opposed to anyone with merely a potential interest.
Martyn Frost, consultant to Manchester-based firm Lane-Smith & Shindler and head of STEP’s EU money laundering task force, explains: ‘“Beneficial owner” in the context of a trust is a meaningless term under English law. It has no acceptable legal definition. Beneficiaries do not own trust assets – they have an interest in the trust.
‘It is now limited to vested interests only. Under English law, we generally talk of two types of interest – vested or contingent. Contingent is where some form of condition remains to be met. For example, one condition could be attaining 25 years of age before their interest becomes vested. Vested interest is where no further conditions need to be met.’
While the profession has welcomed the Treasury’s clarification with regard to ‘beneficial owner’, Mr Frost warns that the rules are still complex and ‘quite technical’, and that solicitors who do not habitually deal with trusts may find it difficult to differentiate between vested and contingent interests in certain cases.
There are several other outstanding issues for practitioners surrounding the wording and application of the new regulations, which were drawn up to implement the third EU money laundering directive, with which the UK and all other EU member states must comply.
From 15 December, solicitors will need to ensure they comply with several main changes to the rules when carrying out regulated activities, such as financial or property transactions, tax advice, trust and company formation, and insolvency practice work.
First, solicitors will be expected to carry out enhanced CDD – in terms of identification and monitoring client activity – if they determine that a particular client or transaction poses a higher risk or if they have never met the client before. One major concern is that while the rules encourage this risk-based approach to CDD, they are, in reality, quite prescriptive and will unnecessarily burden lawyers, both in terms of effort and cost.
Robin Booth, partner at BCL Burton Copeland and chairman of the Law Society’s money laundering task force, was at the centre of negotiations with the government over the new regulations.
‘The cost of compliance with the regulations is substantial and will have been increased by these changes,’ he says. ‘Law firms have come to accept the need and the cost of the money laundering regulations, but there remains some scepticism and concern about whether the benefits of money laundering regulation are in any way proportionate to the substantial costs borne by the private sector.’
Second is the trust issue that caused so many arguments. While the wording is much clearer than before, Mr Frost says there will be issues with identifying deemed controllers of trusts outside England and Wales.
‘We still have problems with deemed controllers of a trust… the exemptions which STEP and the Law Society negotiated are restricted to English trusts,’ he says. ‘This makes it complex when dealing with foreign trusts because there is a much wider range of people who could be deemed to be controllers.’
Third, solicitors must identify ‘politically exposed persons’ (PEPs), who will then be subject to enhanced CDD, such as establishing the source of wealth/funds involved in transactions and conducting ongoing monitoring of the PEP’s activities.
The new regulations define a PEP as anyone who has been appointed to carry out a prominent public function outside the UK by a community or international body. These would include, for example, foreign heads of state, heads of armies and chief executives of overseas state-owned companies. The rules require solicitors to carry out enhanced CDD on relatives of PEPs and ‘known close associates’.
The problem is again one of definition. ‘Practitioners are concerned by the vagueness of phrases like “known close associates” and also about the practicalities,’ says Mr Booth. ‘How do you obtain this information? It is the sort of information you might think the government is better placed to collect than the private sector. It is unsatisfactory that the government should place such ill-defined responsibilities on lawyers and others in the regulated sector.’
Regulation 14(6) says that to determine whether a person is a close known associate of a PEP, you only need to have regard to information in your possession or which is ‘publicly known’.
David McCluskey, partner and money laundering law specialist at London firm Peters & Peters, points out that there is no definition of what ‘publicly known’ actually means.
‘Many people will take it to mean that you will have to do an Internet search or something like that to do a PEP,’ he says. ‘If the name looks familiar, you will be criticised for not doing something as straightforward as an online search. You need to have an internal policy that deals with how to identify whether someone is a PEP, but there is no indication of what exactly you are supposed to do.’
Peter Burrell, partner at City firm Herbert Smith and also a member of the Law Society’s money laundering task force, says there will be problems with PEPs involved in corporate entities.
‘If individuals or ministers have been incorporated into special purpose vehicles to undertake a property transaction, you will have to determine whether the company is a PEP,’ he says. ‘My advice would be to treat the company as a PEP where an individual owns at least a majority stake and possibly where they are just a beneficial owner for the purposes of the regulations.’
Fourth, the regulations oblige all law firms to put in place appropriate risk-sensitive policies and procedures relating to: CDD; making suspicious activity reports (SARs), record-keeping; ongoing monitoring of high-risk clients/transactions; risk assessment; and monitoring compliance with the rules across a firm.
Finally, the rules state that lawyers can rely on CDD checks carried out by certain other regulated bodies, such as a high street bank or a financial institution regulated by the Financial Services Authority, so long as the solicitor obtains consent to do so. Although designed to save time and avoid duplication, lawyers may well be put off from relying on another institution’s CDD because they will remain liable for any failure to apply CDD measures.
Another bone of contention with many in the profession is that the UK rules will apply criminal sanctions for non-compliance, something that is not required by the EU directive. Solicitors in breach of the regulations could face up to two years in jail.
Mr Booth says the regulations suffer from being heavily reliant on criminal sanctions that ‘encourage a tick-box mentality, a defensive attitude to reporting and bare compliance with a process rather than concern for the quality of the outcome. It actively discourages initiative and any sense of shared objectives’.
In addition to the money laundering regulations, the government launched a last-minute consultation back in August seeking views on amending the Proceeds of Crime Act 2002 and the Terrorism Act 2000 to bring domestic legislation in line with the third EU directive.
Following intensive lobbying by the Law Society, the Home Office has stepped back from introducing an ‘absolute’ tipping-off offence by retaining exceptions allowing solicitors, in certain circumstances and if unlikely to prejudice an investigation, to disclose to their client that a SAR has been made about them or another party.
However, lawyers remain concerned that both Acts will no longer cite legal professional privilege as a defence to tipping-off. The amendments will come into force on 26 December this year.
Commenting on the issues surrounding PEPs, a Treasury spokeswoman said: ‘Known close associates are defined, though the definition is not exhaustive. Firms need to think carefully in the first place about the level of checking they need to undertake... The Treasury has made it clear that we do not consider it appropriate to attempt to draw up a definitive list.’
Des Hudson, chief executive of the Law Society, believes that while the regulations are much improved, issues usually emerge once practitioners begin to apply them.
‘We are putting in place a monitoring panel to ensure that we are aware of any practical difficulties experienced by solicitors, particularly around the new obligations relating to PEPs, beneficial owners and enhanced due diligence,’ he says. ‘This will drive our policy work over the next year. In the meantime, solicitors should refer to the full guidance available on our website.’
LINK: www.lawsociety.org.uk
COPING WITH THE NEW REGULATIONS
Peter Rodd, senior conveyancing partner at 13-partner firm Boys & Maughan in Margate
The biggest problem we face is in respect of clients who you do not meet at any stage of the transaction. The initial problem is obtaining satisfactory proof of the client’s identity and we are looking very seriously at third-party electronic identity verification.
We are trying to risk-assess both the client and the transaction. A low-risk client is one who you meet and there is little doubt as to their identity – a high-risk client is one for whom you haven’t acted before, you don’t meet them, they live out of the area and there seems no good reason why they instruct you.
A low-risk transaction might be a local resident buying another property in the area of the type you would expect and with the assistance of a high street mortgage. An example of a high-risk transaction is one where the client is a cash-buyer, there is no clear explanation as to the source of the funds and it is difficult to see how they are in a position to finance the purchase.
There is also a risk that firms obtain satisfactory identification for the client at the outset and then forget that client due diligence means continual monitoring of the transaction. We are encouraging our staff to look out for anything that is out of the ordinary. All conveyancers know what a normal transaction looks like. If something out of the ordinary arises, the conveyancer needs to stop, question it and, if in doubt, seek guidance from a partner.
You should be watching out for changes – transactions that start out being ordinary but then, say, the buyer changes or money comes from an unexpected source. It is about constant vigilance.
COPING WITH THE NEW REGULATIONS
Alison Matthews, money laundering reporting officer (MLRO) for national firm Irwin Mitchell
For me, as an MLRO in a large and diverse firm, the priorities are training my regulated sector staff in an effective and efficient way, undertaking the risk assessment of my firm and revising my policies and procedures. But that is just the start of the new era, with the need for a step-change by conveyancing, trust, corporate and tax staff to move to the new risk-based approach.
I think this brings a number of challenges, including ensuring our procedures are clear and practical, realising that greater awareness means more queries, with the firm being better protected in the end, and providing more practice area-specific training to help fee-earners understand what to look for.
As in the past, one of the key messages is that staff need to document what they do in order to show that they have complied.
The key differences are:
l Verification of beneficiaries/shareowners entitled to 25% or more of the estate/assets and politically exposed persons, such as foreign heads of state, heads of army, chief executives of state-owned companies and their relatives (this applies to foreign clients);
l Greater assessment of identity;
l Greater due diligence at client take-on: identifying the source of funds, purpose and nature of the relationship;
l Risk-based approach to cases: referring cases to the MRLO if suspicions are aroused and gaining consent before acting or continuing to act for the client; and
l Ongoing monitoring – including keeping ID up to date and when to refer ongoing client transactions to the MLRO.
We will be able to focus our resources better on the real risks, but the new regulations require a different approach and my door will stay open for new queries.
COPING WITH NEW REGULATIONS
Sue Ross Carter, Ross Carter solicitors in Hampshire, sole practitioner in trust law
We are now asking all new clients to bring evidence of identity on the first appointment and our terms of business alert them to our duties in relation to money laundering and suspected terrorist financing.
Our management systems will require updating to reflect the changes and staff will need training. Extra care will be required when acting for clients I have not met before.
On formation of a trust, customer due diligence (CDD) will be carried out on the settlors, trustees, and beneficiaries with at least 25% interest in the trust capital, or those in whose main interest the trust operates.
When operating trusts, I shall carry out CDD on all beneficiaries with at least 25% interest in trust capital, those in whose main interest the trust operates, and trustees. In addition, I shall carry out CDD on identifiable beneficiaries in discretionary trusts.
There are difficulties when the beneficiary is not an individual, such as a company, and I will then have to consider whether anyone exercises control over the management structures, in particular the existence and identity of ‘shadow directors’.
If I find the reasons behind creating a trust are suspicious, I must disclose the matter. If instructed in relation to a trust established in a jurisdiction with limited anti-money laundering or counter-terrorist financing measures, I shall conduct CDD on all the individual trustees and, where possible, on the settlor.
I shall establish the identity of donors of powers of attorney, if appropriate, and of the attorney.
All matters must be regularly monitored and comprehensive records of disclosures will be kept in a central file so anyone under suspicion could not be inadvertently alerted to these concerns.
COPING ITH THE NEW REGULATIONS
Peter Burrell, partner with City firm Herbert Smith
As a firm we have been operating under a risk-based approach for some time. However, the new regulations pose a number of challenges to an international firm with a global client base. Overseas-listed clients will be more difficult to identify due to the need to consider the status of the market upon which they are listed.
Similarly, when identifying private companies it will be necessary to consider beneficial ownership, even where the risk of money laundering is very low.
As a firm, we are also introducing new procedures to monitor our clients who are politically exposed persons (PEPs) and the need to consider how to deal with corporate clients where a major shareholder or the beneficial owner is a PEP – these clearly pose a higher risk.
Like other firms, we are also considering how best to ensure we keep the information we hold up-to-date and the frequency with which we will have to formally look again at the evidence we have. In our case, we have opted for every two years, but we will expect fee-earners to consider whether the information we hold is up-to-date when taking on new instructions. This means ensuring that the evidence we hold is converted to a PDF file so that it can be sent electronically as each new file is opened.
This will help us to monitor the transactions we are involved in and to spot suspicious transactions, but we are also looking at how to assist fee-earners more generally to monitor transactions for suspicious circumstances. Unlike a bank, automated transaction monitoring systems will not work and there is no substitute for effective training in this area.
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