When do you say “No” to a prospect customer or counterparty? (Part 2 of 2)

A fine local dentist is a good account to have…

In the first part of this article, we reviewed the “tick the box” hurdles that a prospect must overcome in order to meet basic anti-money laundering requirements. In this second part, we will look at the considerations that must be made when taking a Risk Based Approach towards the client or counterparty.

 

Would you rather have the well-to-do local dentist or the billionaire foreign despot as your client?

The final hurdle in a customer or counterparty due diligence (CDD) is often difficult to set since it is a grey area in which the risk must be evaluated and compared against your own tolerance or appetite for risk. There are several factors that are considered in the evaluation of CDD risk.

First, there is the customer or counterparty themselves. The degree of political exposure is also a risk factor, as politically exposed persons (PEPs) are often in a position of power that is conducive to bribery and corruption. The reasons given for the proposed relationship should be scrutinized and validated. The nature of the relationship should be considered as well: how much business and of what kind is expected over the duration of the relationship. Finally, the history of the party is a risk factor with facts such as past criminal or civil investigations, indictments, and convictions playing a role in judging the risk.

Second, there is contextual and geographical risk. If the party is foreign, then this presents more risk than would a well-known local. If the party comes from a country or region where corruption and crime are high this will raise the risk profile. A party from country with significant extractive resource revenue will also present a higher risk. There is some truth in the stereo type of a third word government official from an oil rich country making off with stolen funds, as this happens much more often than it does with first world government officials from diversified service driven economies.

Finally, there is the business proposed. If the proposed transaction involves new and innovative products then it should be carefully reviewed. If the party is action through opaque and complex structures, particularly those located in certain “secrecy jurisdictions” then the risk profile should be increased. Finally, if the proposed business involves transactions that would be conducive to money laundering, i.e. cash or high value asset transactions, then the increase in risk must be considered.

In the Risk Based Approach it is up to your organization, based on a thorough understanding of your business risk tolerance, to decide which clients to accept as “low risk”, which ones to accept as “higher risk”, and which ones to “reject” and the processes used to make and continually evaluate these decisions. You may have several levels of risk and appropriate risk management procedures for each. It is up to you, within the confines of your regulatory regime, to select the right tools and define and implement the processes that are suitable for your business. In order to do this, you must understand the risks you face and press the pedal down hard enough to get your business to the finish line, while turning away any client that presents unreasonable levels of risk for your business.

In short, it is a much lower risk proposition to do business with a well-known community dentist who owns a local practice for the last 25 years and is planning for retirement than it would be to deal with a high-level judge from a foreign country who has been investigated for bribery in the past and wishes to open a “confidential savings account”.

What’s a PEP problem and do you have one?

Is your rich foreign businessman a PEP back home?

In the age of globalized banking it is very important to understand the risk that “Politically Exposed Persons” pose to any business, no matter how small, that deals with international clients involving transactions or asset management of even modest sums.

Politically Exposed Persons or PEPs are those people that due to their own position or that of a close associate exercise functions that are conducive to corruption and related criminal activity.

Being a PEP does not necessarily mean that a person is corrupt, although some may argue this point.  A PEP is simply someone who has the access and the authority to be corrupt. According to FATF guidance on evaluating PEP risk, a PEP may be anyone who is elected or appointed to a political office, anyone who heads a state-owned or state controlled enterprise, any family member of the former two, or a known a close associate of the former types of people.  This includes judges, high ranking military officers, and government officials, especially those in a position where corruption is common, such as procurement or contracting.

A glaring example of such abuse by PEPs is the “Cash for Kids” scandal in which two U.S. judges were found to have been sentencing children to serve time in private juvenile prisons in which the very judges held a commercial interest.  While this scandal may have been difficult for the bank of the judges to detect there are often warning signs that should not be ignored.

The first step is to know that your client is a PEP.  Identifying PEP status and risk should be part of your KYC (Know Your Customer) client on-boarding and risk evaluation process.  You should ask your customer to disclose any political office or other politically exposed position they may hold and you should expect an honest answer.

Following advice that Ronald Regan made famous: a “Trust, but verify” approach is necessary.  Good research tools can be used to screen individuals against a database of known PEPs, as well as provide access to media coverage that will allow you to qualify the extent of the individual’s political exposure.

Take the very recent press example of former Minister Ninu Zammit of Malta.  HSBC Geneva managed accounts of more than 3 million Euros for him.  They took active steps to move the funds from Europe to BVI companies in order to avoid the EU Savings Tax Directive and clearly knew Zammit for several years.  However, a glaring red flag is that Mr. Zammit declared earning only 37,000 Euros per year from his ministerial position.  How is it then that he amassed a fortune of more than 70 years worth of his salary?  This is a typical Red Flag for a PEP: having assets far beyond their logical means.  Zammit claims that these deposits were built up since the 1970s through his savings and property business.  Unless he could document these deposits over that time, the source of the funds through tax returns and business records, and he could explain why he needed to put the funds in a secret offshore account, it would appear that HSBC may have been aiding and abetting corruption and been an active participant in money laundering in this case.  HSBC’s reputation is now suffering from their failure to manage this risk.

According to current statements, HSBC has changed their procedures and cleaned up their bank since this time; however, the example of Zammit is a very good case study of a high-risk PEP that would require a thorough KYC/AML evaluation and monitoring in order to manage the risk of the account.

Lex FIFA means sports officials are now like PEPs in Switzerland

A new law, dubbed “Lex FIFA”, passed in Switzerland means that sports officials, such as those from FIFA, the International Olympic Committee, and Formula 1 will be subject to additional scrutiny in the compliance process, like Politically Exposed Persons are already.

The Swiss law comes after many years of allegations of corruption and bribery within the sports industry and was written specifically to account for FATF and FinCEN anti-money laundering guidelines.

This is an interesting development in that it acknowledges the strong influence between sports and politics and places the sporting organizations in a special “high risk” category.  With this development, it becomes increasingly important to address KYC (Know Your Customer) responsibility within professions required to guard against money laundering.  Adequate procedures and resources must be deployed to mitigate risk.  This can only be done by selecting well trained and knowledgeable staff in sufficient quantity and equipping them with the tools and procedural guidelines to perform effectively.  List checking must not be relied on as the sole mitigation tool for money laundering risk.

FIFA as seen by KYC3.com. Analysis of thousands of documents reveals the people and organizations most linked to FIFA.

Automated “list checking” solutions for identifying money laundering risk are but a first line defense.  As the nature of risk becomes more apparent, it will be increasingly necessary to rely on “open source” research tools, such as KYC3, in order to conduct judgement calls on a case by case basis that take into account contextual information.  The inclusion of general news, not just negative news, and of general business relationship information becomes necessary in order to evaluate the context and potential beneficiaries of proposed customer relationships and transactions.

This Swiss law is the first of its kind and other countries and international organizations, such as FATF-GAFI, can be expected to follow with regulations and guidelines of their own.

For more details on Lex FIFA, please refer to Swissinfo.ch

KYC3 Quick Tour

Take a quick tour of KYC3.com and see what it can do for your compliance process.  Be the first to check out the Know Your Customer AML/CFT/PEP screening reports and the enhanced News and Company research tools.

 

Anti-money laundering officers urged to be vigilant over Ukrainian cash movements

Recently, FATF regime governments have been urging caution with respect to Ukrainian assets.  At this sensitive time, there is a real risk of expropriation and plundering of assets that should remain within the Ukraine.  From Reuters:

Money laundering reporting officers must balance extra vigilance about suspicious Ukrainian cash entering or leaving the UK following the ousting of President Victor Yanukovich but they cannot afford to jump to conclusions, officials said. Serious civil unrest has followed in recent days with scores of people killed.

Campaign group Transparency International (TI) issued a risk alert on Ukraine saying it believed corrupt assets might be laundered through or into the UK following the devastating upheaval in the country. It called on the government, money laundering reporting officers (MLROs), law and accountancy firms plus luxury estate agents to be on the lookout for dirty funds emerging from the country. TI said lessons needed to be learnt from the Arab Spring where, it said, there had been a slow international response to freezing assets.

The article goes on to discuss the potential for capital flight and how Money Laundering Reporting Officers (MLROs) should vigilantly report and suspicious activity to the authorities and that the government must respond to suspicious activity reports (SARs) without any delay.

What is not mentioned in the article is that financial institutions should know their existing customers and now is a good time to review any Ukrainian client accounts already in your institution.  This should be done with a specific focus on their political exposure and the source of funds of any significant accounts, especially in comparison to the means of the account holder.

A quick look in KYC3.com reveals many Ukrainian businesses using corporate structures in western jurisdictions such as the United States and Luxembourg.  These should be of particular interests as these offshore trading companies are often the vehicle of choice for capital flight from troubled regions.

A quick look at Ukrainian company links in Western jurisdictions using kyc3.com

As sanctions are being considered against some Ukrainian and Russian officials, it would not be foolish to get a handle on your current accounts so that compliance can be assured quickly and efficiently in the event that sanctions materialize.

For the full Reuters article, please read here.

Four Essential Reasons to do Relationship Mapping

Understanding the relationships of your client, counter-party or competitor is essential to your understanding of their motivations, resources and future behaviors.

1. Seeing the relationships will reveal if the target is “legitimate”.  If the person claims to be a banker from the United Kingdom, is the person connected to the people that would normally be expected?  Are there past banking relationships and business partnerships that show a track record confirming the person’s history?

2. Through relationships we may better understand the source of funds.  Suppose the person who is opening an account at your institution claims to have a successful flower shop and intends to deposit several hundred thousand dollars per month in a business account, then you should expect to see a well established business in a good location that has been around for some time.  If not, the relationships may reveal something else.  For example, the person may be married to a city council member who actually controls hundreds of millions of dollars in zoning….

3. Relationships can be used to measure political exposure.  If the person or company you are looking at is closely connected to politicians or their close relatives, then you may have a case of Political Exposure.  This isn’t necessarily bad, but politically exposed persons must be treated differently.  This is because politically exposed persons have a higher propensity to accept bribes or be involved in corruption and therefore need a different level of monitoring in your risk management program.

4. Relationships can reveal past mis-deeds or associates. A person may appear to be clean, but a relationship review may reveal that the person is in fact closely related to a problematic person from the past or has been involved in unwanted behavior in the past.  Or perhaps this person is close to someone who has a bad past and is now “fronting” for that person.

We can use social networks on an ad-hoc basis to get some personal relationship information – as we tend to do with friends and family.  But to understand real relationships – those with a legal dimension – we need to look at corporate and civil filings.  Through analysis of these documents, we can see the connections and understand the past and present interests of our clients, counter-parties and competitors.  Doing this in a structured manner with a tool like KYC3 is essential to any professional risk management effort.

Evaluating Politcally Exposed Persons

Sometimes its tough to evaluate the risk associated with PEPs.  In fact, most compliance professionals seem to have a difficult time deciding if someone is a PEP or not.  There are few resources to go on.  The Central Intelligence Agency publishes some information in their World Leaders publication and in the World Fact Book.  But aside from that, there is no real official list of PEPs.  In addition to national regulatory bodies publishing guidance, the Financial Action Task Force has published a useful guideline, which is the international reference on PEP evaluation.  By these guidelines, there are certainly a large number of PEPs out there: Foreign PEPs, Domestic PEPs, International PEPs, and their families and close associates.  Basically anyone who is elected or appointed by an elected official can be considered a PEP.

Once the PEP decision has been made, which can be easily accomplished with KYC3 Instant KYC Reports, the risk needs to be evaluated.  Rather than a simple tick the box exercise, the judgement is subjective and needs to take into account the individual and their associates in order to judge the risk that these people might be involved in an illicit financial transaction.  Likewise, the countries and jurisdictions involved need to be reviewed for the risk they present.  Are they offshore tax-havens?  Where are they on the Transparency International Corruption Perceptions Index? The proposed relationship needs to be considered.  Is the PEP proposing a current account to pay the expenses of their child in university in your country … or are they procuring a yacht?  And finally the risk tolerance of the financial institution and its relationship with the regulator need to be considered.

Conducting a first level screening to determine the degree of political exposure is critical.  Following up on all positive results with a comprehensive risk based assessment is the best way to properly manage PEP risk.