Article, Wealth Management and AML Compliance

 International Compliance

Development of Wealth Management and AML/Compliance Lectures

By:  Benjamin M Musau 

Wealth Management and AML/Compliance Lectures
This article constructs a course on Wealth Management and AML in New York City.  You have been hired to speak by yourself for three (3) hours in the morning and three (3) hours in the afternoon. Your audience will be wealth advisors, including attorneys, CFPs, accountants, tax attorneys, trust and corporate service providers, tax lawyers, compliance officers, government agents, clients, et.al. Most persons in the audience will be Americans but with many foreign individuals as well.  You will speak on anti-money laundering in general (USA Patriot Act, laws of various nations, how to do due diligence), the array of compliance issues, how it affects wealth advisors (moving money from country to country, opening accounts at various institutions etc.)., the institutions that they will have to deal with (banks, brokerage firms, insurance companies, et.al.) and the regulators et.al.  The foregoing is only a preliminary overview.  Feel free to add to it and be as creative as you can be.  Your posting should include a table of contents, footnotes, questions for discussion, url cites, bibliography and full text in paragraphs. Remember that you have to speak for six (6) hours.
Audience:

• Wealth advisors
• Attorneys
• CFPs
• Accountants
• Tax attorneys
• Trust and corporate service providers
• Tax lawyers
• Compliance officers
• Government agents
• Clients

Table of contents

1. Introduction
2. Money Laundering Methods
3. U.S. Anti-Money Laundering Framework
4. FATF 40 + 9 Recommendations
5. Best Practices in KYC, CDD, EDD and SAR
6. PEPs
7. Conclusion
8. Discussion questions

Course overview
Anti-Money Laundering and Counter-Terrorism Financing (AML and CTF) compliance and global AML regulations is one of the challenges that is faced in wealth management and that compliance officials across the board have to face.  In this course, AML professionals are guided through the key attributes of wealth management in the context of AML and compliance in a program that mitigates exposure to risk across jurisdictions.
The course is designed to help compliance professionals in order to be well positioned with contemporary international AML/CTF compliance standards.

1. Introduction

• Money laundering is the practice of engaging in a series of financial transactions to conceal the ownership, source, control or destination of illegally gained money.  Ultimately, it is a process by which the proceeds of crime are made to appear to have a legitimate origin.  The crime proceeds involved can be generated by any number of criminal acts, including drug dealing, corruption, accounting and other types of fraud, and tax evasion[1].  The methods by which money may be laundered are varied and can range in sophistication from simple to complex.
• FATF, an intergovernmental body set up to combat money laundering, admitted that “overall it is absolutely impossible to produce a reliable estimate of the amount of money laundered and therefore the FATF does not publish any figures in this regard”[2].
• Nevertheless, the amount of money laundered each year is phenomenal and poses a significant policy concern for governments[3].  Consequently, governments and international bodies have undertaken efforts to stop, prevent and apprehend money launderers.  Financial institutions have equally undertaken to prevent and detect transactions involving dirty money, both as a result of government requirements and to avoid the reputational risk involved.

1. Money Laundering Methods

• Money laundering often occurs in three steps:
  • Placement – cash is introduced into the financial system by some means;
  • Layering – carrying out complex financial transactions in order to camouflage the illegal source;
  • Integration – the final step entailing acquisition of wealth generated from the transactions of the illicit funds.
  • Some of these steps may be omitted, depending on the circumstances; for example, non-cash proceeds that are already in the financial system would have no need for placement[4].
  • Money laundering takes many forms.  For example, these forms include:
    • Structuring (or smurfing) which involves placement by breaking cash into smaller deposits of money, used to defeat suspicion of money laundering and to avoid anti-money laundering reporting requirements[5].
    • Bulk cash smuggling which is the physical smuggling of cash to another jurisdiction, where it is deposited in a financial institution, such as an offshore bank, with greater bank secrecy or less rigorous money laundering enforcement[6].
    • Cash-intensive businesses where the business will use its accounts to deposit both legitimate and criminally derived cash, claiming all of it as legitimate earnings.  Often, the business will have no legitimate activity[7].
    • Trade-based laundering in which invoices are under- or over-valued in order to disguise the movement of money[8].
    • Shell companies and trusts are at times used to disguise the true owner of money.
    • Bank capture where money launderers or criminals buy a controlling interest in a bank, preferably in a jurisdiction with weak money laundering controls, and then move money through the bank without scrutiny.
    • Casinos whereby individuals will walk into a casino or horse race track with cash and buy chips, play for a while and then cash in his chips, for which he will be issued a check.  The money launderer will then be able to present the check into his bank, and claim it as gambling winnings.
    • Real estate may be purchased with illegal proceeds, then sold.  The proceeds from the sale appear to outsiders to be legitimate income.  Alternatively, the price of the property is manipulated by under-valuing.
    • Terrorist financing through which the destination of the money is disguised.
    • Black salaries involving the payment of black cash to employees who are unregistered and without a written contract, normally paid cash salaries.

1. U.S. Anti-Money Laundering Framework

• The U.S. has three main pieces of legislation dealing with money laundering:
  • The Money Laundering Control Act.
  • The Bank Secrecy Act; and
  • The USA PATRIOT Act.
  • The Bank Secrecy Act of 1970
    • The Bank Secrecy Act (BSA, or otherwise known as the Currency and Foreign Transactions Reporting Act) was originally passed by Congress of the U.S. in 1970, and amended several times since then, including provisions in Title III of the USA Patriot Act.  The BSA is also at times referred to as an “anti-money laundering” law (“AML”) or jointly as “BSA/AML”.
    • The BSA requires financial institutions in the United States –
    • To assist U.S. government agencies to detect and prevent money laundering.
    • To keep records of cash purchases of negotiable instruments, and file reports of cash purchases of these negotiable instruments of US$10,000 or more (daily aggregate amount).
    • To report suspicious activity that might signify money laundering, tax evasion, or other criminal activities.
    • Many banks will no longer sell negotiable instruments when they are purchased with cash, requiring the purchase to be withdrawn from an account at that institution.
    • Money Laundering Control Act (1986) (MLCA), passed in 1986, is a U.S. Act of Congress consisting of two sections that made money laundering a Federal crime.  The MLCA, for the first time, criminalized money laundering.
      • Made money laundering a Federal crime.
      • Criminalized money laundering.
      • Section 1956 prohibits individuals from engaging in a financial transaction with proceeds that are generated from certain specified crimes, known as “specified unlawful activities” (SUAs).
      • The law require an individual specific intent in making the transaction to conceal the source, ownership or control of the funds.
      • There is no minimum threshold of money, nor is there the requirement that the transaction succeed in actually disguising the money.
      • A “financial transaction” has been broadly defined, and need not involve a financial institution, or even a business.
      • Section 1957 prohibits spending in excess of US$10,000 derived from an SUA, regardless of whether the individual wishes to disguise it.  This carries a lesser penalty than money laundering, and unlike the money laundering statute, requires that the money pass through a financial institution.
      • The U.S. government enacted the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorists Acts of 2001 (commonly known as “the Patriot Act”) to fight international terrorism.  The Patriot Act drastically reduced restrictions on law enforcement agencies’ ability to search telephone, e-mail communications, medical, financial and other records; eased restrictions on foreign intelligence gathering within the U.S.; expanded the Secretary of the Treasury’s authority to regulate financial transactions, particularly those involving foreign individuals and immigration authorities in detaining and deporting immigrants suspected of terrorism-related acts.
        • The Patriot Act also expanded the definition of terrorism to include domestic terrorism, thus enlarging the number of activities to which the USA Patriot Act’s expanded law enforcement powers can be applied.  The Act is currently set to expire May 29, 2011 after a 90-day extension from February 28 by congress.

1. FATF 40 + 9 Recommendations

• The Financial Action Task Force (FATF) against Money Laundering was formed in 1989 by the G7 countries as an intergovernmental body whose purpose is to develop and promote an international response to combat money laundering.  In October, 2001, FATF expanded its mission to include combating the financing of terrorism.
• FATF has developed 40 Recommendations on money laundering and 9 Special Recommendations regarding terrorist financing.  FATF assesses each member country against these recommendations in published reports.  Countries seen as not being sufficiently compliant with such recommendations are subjected to financial sanctions.
• The developing countries find implementation of the FATF Recommendations to be challenging especially due to cost implications and in most cases lack of political will to implement.

1. Best Practices in KYC, CDD, EDD and SAR

• The first important element of enforcing anti-money laundering laws (AML laws) is the requirement on financial intermediaries to know their customers – often termed KYC know your customer requirements.
• Knowing one’s customers, financial intermediaries will often be able to identify unusual or suspicious behavior, including false identities, unusual transactions, changing behavior, or other indicators of laundering.
• For institutions with millions of customers and thousands of customer-contact employees, traditional ways of knowing their customers must be supplemented with technology.  Many companies provide software and databases to help perform these processes.  While information technology can never be a replacement for a well-trained investigator, as money laundering techniques become more sophisticated, so does the technology used to fight money laundering including KYC software.
• Customer due diligence is actually part of KYC.  KYC is the due diligence and bank regulation that financial institutions and other regulated companies must perform to identify their clients and ascertain relevant information pertinent to doing financial business with them.  KYC is typically a policy implemented to conform to a customer identification program (CIP).
• A key aspect of KYC is to monitor transactions of a customer against their recorded profile, history on the customer’s account(s) and with peers.
• Banks doing KYC monitoring for anti-money laundering (AML) and checks relating to combating the financing of terrorism (CTF) increasingly use specialized transaction monitoring software, particularly names analysis software and trend monitoring software.
• The generated alerts identify unusual activity which is then subject to due diligence or enhanced due diligence (EDD) processes that use internal and external sources of information on the subject, including the internet.  This helps to determine whether a transaction or activity is suspicious and requires reporting to the authorities.
• In the U.S., it would require Suspicious Activity Reporting (SAR) filing to Financial Crimes Enforcement Network (FinCEN).  In the UK, it would require a report to Serious Organised Crime Agency (SOCA).  In Canada KYC is monitored and managed by the Financial Transactions and Reports Analysis Centre of Canada also known as FINTRAC.
• Characteristics of EDD include:
  • Rigorous and robust i.e. consistent, thorough and accurate, documented process that is available for inspection by regulators.  The process must be SMART (Specific, Measurable, Achievable, Realistic and Timebound), scalable and proportionate to the risk and resources.
  • Over and above KYC procedures as EDD files rely upon the initial client screening.
  • Reasonable assurance depending on jurisdiction, risk and resources.
  • Relevant adverse information obtained from any source, including the internet, free and subscription databases and the media, which is directly or indirectly indicative of involvement in money laundering, terrorist financing or predicate offenses including fraud, other dishonesty, and drug trafficking, smuggling.

1. PEPs

• The Politically Exposed Person (PEP) designation dates back to the late 1990s in what was known as the “Abacha Affair”.  Sani Abacha was a Nigerian dictator who organized (with his family members and associates) a network of massive theft of assets from the government and people of Nigeria.  He is believed to have stolen in excess of several billion US$ and the funds were transferred to bank accounts in the United Kingdom and Switzerland.
• The Nigerian Government that succeeded the Abacha Regime lodged complaints in 2001 with several European agencies, including the Federal Office of Police (FOP) of Switzerland which, in turn, investigated close to 60 Swiss banks.  It is in the context of this investigation that the concept of PEP emerged, which was later included in the 2003 United Nations Convention against Corruption.
• PEP is a term that describes a person who has been entrusted with a prominent public function, or an individual who is closely related to such a person.  The terms “Politically Exposed Person” and “Senior Foreign Political Figure” are often used interchangeably, particularly in international fora.  The term PEP is not used in FinCEN’s regulations.  It is to a greater extent similar to the definition of Senior Foreign Political Figure, as defined by section 312 of the USA Patriot Act.  The definition contained in the report of the Financial Action Task Force on Money Laundering (FATF) and that contained in the USA Patriot Act are intended to include middle ranking or more junior individuals in the categories.
• The term Foreign Official is used by enforcement agencies relating to persons who have similar characteristics as PEPs.  This term is used in all industries and is not limited in use to financial institutions.  In fact, it is referenced in the Foreign Corrupt Practices Act in the United States.
• A PEP generally presents a higher risk for potential involvement in bribery and corruption because of their position and the influence that they may hold.  PEPs are, therefore, viewed as potential compliance risks and most financial institutions dealing with them performed enhanced monitoring of accounts that fall within this category.
• The process of screening for PEPs is actually part of the Know Your Customer procedures i.e. initial due diligence that a financial institution performs as part of the account opening and in addition there is periodic screening of accounts as part of ongoing due diligence.  The process of due diligence and screening for PEPs is time consuming and requires screening against a reputable database of known PEPs, usually close to 1 million profiles.  The screening is done against the names, dates of birth, national identification numbers and photographs of clients.
• In the case of Riggs Bank heavy fines were imposed on the financial information for conducting business with PEPs without following adequate Know Your Customer procedures and enhanced due diligence processes.  PEP specific compliance legislation underlines the link between corrupt politicians, money laundering and the financing of terrorism.  There is contemporary interest in new legislation to cover this situation since September 11, 2001 because more than 100 countries have changed their laws related to financial services regulation, with the fight against political corruption playing a fundamental role.  This new legislation is expected to play a key role in dealing with suspicion of corruption involving the immediate Presidents of Libya (Muamar Khadafi) and Egypt (Hosni Mubarak).
• There is no global definition of a PEP.  Most countries have based their definition on the FATF definition:
• The Financial Action Task Force (FATF) proposals in recommendation 6 will largely do away with the often-viewed artificial distinction between domestic and non-domestic PEPs n line with the UN Convention Against Corruption.  However, the FATF recommendation is nuanced as follows:
  • foreign PEPs will always be considered to be higher risk;
  • reasonable measures will be required to be taken to determining whether a customer is a domestic PEP; and
  • enhanced Customer Due Diligence if the domestic PEP is considered to be a higher risk.
  • A case of “there are PEPs, and then there are PEPs”.  In reality, there has always been some grading of PEPs within institutions to allocate resources to genuinely high risk PEPs.  These proposals seem to go some way in confirming this.  The family and close associate’s requirement will also be tightened up.

• current or former senior official in the executive, legislative, administrative, military, or judicial branch of a foreign government (elected or not)
• a senior official of a major foreign political party
• a senior executive of a foreign government-owned commercial enterprise, being a corporation, business or other entity formed by or for the benefit of any such individual
• an immediate family member of such individual; meaning spouse, parents, siblings, children, and spouse’s parents or siblings
• any individual publicly known (or actually known by the relevant financial institution) to be a close personal or professional associate.

1. Conclusion

• While there is a lot of regulation on money laundering, there is also growing and emerging trends of money laundering, and legislation needs to be modernized.
• The developing countries have faced challenges in implementing AML legislation and the FATF Recommendations because of lack of political will as well as the cost implications.
• It is necessary to ensure that enforcement officers are thoroughly trained on AML and CTF policies and processes in order to ensure eradication of money laundering and counter terrorism financing.
• PEPs present a great challenge to AML/CTF compliance regulation in the developing countries.

1. Discussion questions

• What are the emerging challenges in AML/CTF?
• What benefits does a Financial Intelligence Unit bring to an institution?
• What is kleptocracy and how do kleptocracies operate, and which countries are targeted?
• How does bribery and corruption impact on AML/CTF?
• What are the attributes of risk ranking?
• What are the best practices in obtaining beneficial ownership information?
• How do you determine the optimum levels of ongoing due diligence to protect your organization?
• Lessons learnt?

Dr. Benjamin Musau

I am a Kenyan Advocate and the Managing Partner of B M Musau & Co., Advocates, a position I have held since 1999. My work encompasses regulatory reforms, reduction of administrative burdens, the structure of business entities, joint ventures, acquisitions, banking, foreign investment and other general corporate areas