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Source of funds: clean or consistent with risk?

14 April 2010

In many ways, client identification and verification is secondary in anti-money laundering compliance to understanding the source of funds and the purpose of a retainer.

Essentially AML compliance is about limiting the opportunities for criminals to use criminal property. If there is no criminal property, then there is no money laundering.

Client identification is included to remove anonymity for criminals and assist in bringing to the firm's attention clients who may pose money laundering risks due to criminal histories or their association with criminals.

Despite the importance of understanding the source of funds, it is an area which is not well understood in practice and about which a number of misconceptions are regularly repeated at money laundering reporting officer (MLRO) networking groups and training events.

Some of the key misconceptions are:

  • I only have to check the client's identity; there is no obligation to ask about the source of funds.
  • If I have a concern about the source of funds, I have to prove that the money is clean.
  • If the money comes from the bank then I don't have to worry about it, as it is clean.

Obligations with respect to source of funds

The Money Laundering Regulations 2007 (the regulations) only mention the source of funds in two places, regulation 8 for ongoing monitoring and regulation 14 with respect to politically exposed persons (PEPs).

In regulation 8 the obligation is to:

Scrutinise transactions undertaken throughout the course of the relationship (including, where necessary, the source of funds) to ensure the transactions are consistent with the relevant person's knowledge of the customer, his business and risk profile.

In regulation 14 the obligation with respect to a PEP is to:

Take adequate measures to establish the source of wealth and source of funds which are involved in the proposed business relationship or occasional transaction.

Under the Proceeds of Crime Act 2002 (POCA), you are required to make a report if you suspect that someone is engaging in money laundering, which requires that you suspect that someone has criminal property.

Clean or consistent with risk?

If you are concerned about a transaction, consider firstly: am I concerned that the person is not who they say they are, or am I concerned about the source of the funds? If it is the later, then further identity information will not assist in mitigating the risk.

As such, for each retainer, it is important to have an understanding of where the funds to finance the transaction are coming from. That information will then help you decide the level of scrutiny, if any, required of that source.

You are not required to question a wealthy private client about their entire financial history just because they may at some point have avoided paying tax, nor are you required to undertake detailed due diligence of a business to see if some point they failed to pay for a required regulatory licence.

You are required to consider whether the source of funds is consistent with the risk profile of the client, the retainer and their business.

When dealing with a PEP, you also need to consider, is there any information about corruption or evidence that government funds are being used inappropriately.

Supporting documents or proof?

There is no obligation to obtain proof of the source of funds at all, let alone beyond a reasonable doubt.

However, it may be prudent to ask for some supporting evidence to confirm the information provided.

Where such supporting evidence is provided, it is important that you look at that evidence to see if it is actually consistent with the client's explanation or whether it throws up more questions.

If an explanation is consistent with the client's risk profile, is consistent with the type of retainer being undertaken, and you do not have other AML concerns about the transaction, you may simply note the explanation on the file and have your accounts staff check that the funds are coming from the bank accounts the client has said they would come from.

If the transaction is higher risk, you may ask for supporting evidence, possibly in the form of:

  • bank statements,
  • recent filed business accounts, or
  • documents confirming the source such as a sale of a house, shale of shares, receipt of a personal injuries award, a bequest under an estate or a win from gambling activities.

Where cash is involved it becomes more challenging, as a bank statement showing a large withdrawal does not mean that the cash the client is now in possession of was actually the money withdrawn.

Equally, a bank statement showing a large cash deposit does not provide you with information about where that cash has come from in the first place.

There can also be situations where a client cannot or will not produce any paperwork to back up the story of where the funds have come from. Does this mean that you automatically suspect money laundering? Not every one is efficient at keeping paperwork and the funds may have arisen some time ago.

Keep asking yourself the following questions:

  • Is this consistent with what I know about the client?
  • Do I have information which makes me suspicious that there is criminal property involved?

If the retainer is consistent and you do not suspect that existing criminal property is involved, you don't have to go further to prove that the funds are clean.

Make sure you document the questions asked, the answers given and any supporting material received, should the retainer later be queried by the SRA or law enforcement.

What if I am still concerned?

If, after the explanations and the supporting documents are received, you are still concerned about the source of funds, you need to look at whether there is criminal property involved. You cannot have money laundering if there is no existing criminal property.

You may suspect that criminal property is involved because you have information about a specific offence, such as tax being avoided, benefits being received which should not have been, or press articles which show a client has been charged with drug offences.

Alternatively you may suspect that criminal property is involved because this is the irresistible conclusion to be drawn due to the handling of the funds in the transaction. So large amounts of private funding which simply do not fit the client profile, and for which there is no legitimate explanation may warrant a suspicion of money laundering.

If you have a suspicion of criminal property, you need to consider whether you need to make a report to the Serious Organised Crime Organisation (SOCA) and whether you will need consent to proceed. The flowcharts in chapter 12 of the anti-money laundering practice note will assist with this process.

Final thoughts

Just because money comes from a client's bank account does not mean it is clean, as the bank may well have put in a report and received consent to send it to you, while law enforcement watches how the funds are being used and gathers more evidence.

You need to make your own decision about the consistency of the funds with the client and whether there is information on which you can form a suspicion of money laundering or not.

Remember that you are not police officers investigating potential crime; you are simply taking steps to protect your firm from being used to launder funds.

It is your client account and you can ask questions about what money is being deposited into it. Equally, you are entitled to take a pragmatic approach and use your knowledge about how retainers proceed and are generally funded when weighing up the answers provided.

At the end of the day, without existing criminal property you do not have money laundering.