Fighting money laundering - a UK perspective - III

Examples of suspicious transactions: The Regulations require staff to be trained in recognition and reporting of suspicious transactions.36 To identify a suspicious transaction is an almost impossible task within an organisation chained with the responsibility, but the professional guidance notes seek to identity examples of suspicious transactions which may be relevant.
Some of these include: 1) client for whom verification of identity proves unusually difficult and who are reluctant to provide details; 2) clients with no discernible reason for using the firm's services; 3) any apparently unnecessary use of intermediaries; 4) a large number of security transactions taking place across a number of jurisdictions, particularly if these are not in keeping with the investor's normal activity; 5) transactions where the nature, size or frequency appears unusual; 6) large transactions involving settlements by cash; 7) unusual delivery; and 8) payment to third parties without any apparent connection.
Some issues have also caused legal debate. Among them issues relate to the meaning of "reasonable cause to suspect", "related to acts of terrorism" and "concerned offences". The informal guidance which has been given by the NCIS assumes that consent exists where suspicious transaction continue to be processed and relevant body or institution, continue acting in favour of customer who made a report before he received a reply in respect of a disclosure.
In practice, where a transaction in relation to which a disclosure has been made needs to take place almost immediately the authorised person is required to telephone the NCIS or an appropriate "constable" to get immediate official advice.
2. Money Laundering Regulations relating to Financial Services Customer due diligence measures An authorised person is required to apply customer due diligence measures37 in the following circumstances:
--- When he establishes a business relationship;
--- When he carries out an occasional transaction;
--- When he suspects money laundering or terrorist financing;
--- When he doubts the veracity or adequacy of documents, data or information previously obtained for the purposes of identification or verification.
The authorised person must:
--- determine the extent of customer due diligence measures on a risk-sensitive basis depending on the type of customer, business relationship, product or transaction; and
--- be able to demonstrate to his supervisory authority that the extent of the measures is appropriate in view of the risks of money laundering and terrorist financing.
Ongoing monitoring An authorised person is required to monitor a business relationship.38
Simplified due diligence39 The authorised person is not required to apply customer due diligence measures in the circumstances mentioned in regulations40 where he has reasonable grounds for believing that the customer, transaction or product related to such transaction, falls within provisions of sub regulation (2),(3),(4),(5),(6) and (7) of regulation 7.
Enhanced customer due diligence and ongoing monitoring41 An authorised person is required to apply on a risk-sensitive basis enhanced customer due diligence measures and enhanced ongoing monitoring.
Where the customer has not been physically present for identification purposes, a relevant person must take specific and adequate measures to compensate for the higher risk, for example, by applying one or more of the following measures.
--- ensuring that the customer's identity is established by additional documents, data or information;
--- supplementary measures to verify or certify the documents supplied, or requiring confirmatory certification by a credit or financial institution which is subject to the money laundering directive;
--- ensuring that the first payment is carried out through an account opened in the customer's name with a credit institution.
Record-keeping42 The authorised person is required to keep the specified records.
Training Appropriate measures are to be taken in respect of relevant employees-
--- to make his aware of the law relating to money laundering and terrorist financing; and
--- the employees are regularly given training in how to recognise and deal with transactions and other activities which may be related to money laundering or terrorist financing.
Duties of supervisory authorities A supervisory authority must effectively monitor the relevant persons for whom it is the supervisory authority and take necessary measures for the purpose of securing compliance by such persons with the requirements of the Regulations.
A supervisory authority which, in the course of carrying out any of its functions under these Regulations, knows or suspects that a person is or has engaged in money laundering or terrorist financing must promptly inform the Serious Organised Crime Agency.
Civil penalties
(1) Appropriate authority is empowered to impose a penalty of such amount, as it considers appropriate on a relevant person who fails to comply with any of the said requirement.43
Criminal offences A person, who fails to comply with any requirement in regulation44 or a direction made under regulation 18, is guilty of criminal offence.
He is liable to:
--- On summary conviction, to a fine;
--- On conviction on indictment, to imprisonment for a term not exceeding two years, to a fine or to both.
In deciding whether a person has committed an offence, the court must consider whether he followed any relevant guidance, which was at the time:
--- Issued by a supervisory authority or any other appropriate body;
--- Approved by the Treasury; and
--- Published in a manner approved by the Treasury as suitable in their opinion to bring the guidance to the attention of persons likely to be affected by it. A person is not guilty of an offence (under these regulations) if he took all reasonable steps and exercised all due diligence.
3. Electronic trading and mortgages
MiFID: An Introduction
What is MiFID? MiFID is the EU markets in Financial Instruments Directive.45 It seeks to go much further than the EU's first attempt at a single market in financial services directive, and the 1992 Investment Services Directive, which was implemented in 1996. MiFID aims to create a true single market in financial services across the all EU and EEA member states which are collectively referred to as the "EU".46
MiFID implementation requires every EU regulator to make changes in its financial services regulations that apply to investment business within MiFID's scope. This brings direct consequences for entities regulated by those regulators and indirect consequences for US and other Third Country Firms doing business with EU customers and counterparties but not directly subject to EU regulation.
MiFID sets out a framework of key regulations, which are to be implemented by the domestic law of each EU member state. This is intended to harmonise the key regulatory requirements applicable to financial services businesses across the EU for investment business within MiFID's "scope".
MiFID's on non-EU firms? US and other Third Country Firms carrying on MiFID scope business subject to regulation in any EU member state are subject to the same new rules as EU-incorporated entities. This is so even though they do not benefit from the passport and will be required to obtain separate authorisation from each EU member state in which they intend to carry on business.
MiFID implementation is likely to further narrow the scope for carrying on cross-border business into the EU from Third Countries without being regulated in an EU member state - a process which began when the Investment Services Directive was introduced in 1996. MiFID does not require EU jurisdictions to pass regulations, which affect managers, advisers and marketers who do not have offices in any EU jurisdiction.
However, increasingly exemptions, which permitted limited marketing and other activity by entities unlicensed in any EU jurisdiction are being eliminated. The UK's "overseas person" exemption which permits Third Country Firms without a UK place of business to carry on certain transactions and activities with UK institutional customers is not paralleled in many other EU jurisdictions.
Even the UK permits very limited business to be done with retail clients by Third Country Firms, which are not regulated in the EU. Increasingly the use of a locally regulated firm is being required in EU member states in order to do business with local residents - as has long been the case in the US.
US and other Third Country Firms doing business with EU-regulated entities will have the benefits such as: best execution; management of conflicts; new customer categorisation rules; transaction reporting and suitability. For example, EU-based counterparties doing business with US firms may seek enhanced rights and protections to mirror new EU norms.
The Scope of MiFID The following activities below carried out in relation to any of the investments is within MiFID's scope: Activities: (a) Reception and transmission of orders; (b) Execution of orders on behalf of clients: (c) Dealing on own account; (d) Portfolio management; (e) Underwriting; (f) Investment advice; and (g) Placing of financial instruments.
Investments: (a) Transferable securities; (b) Interests in collective investment products (funds); (c) Money market instruments; (d) Financial futures; (e) Interest rate, currency and equity swaps; (f) Commodity derivatives; and (g) Options on the investments listed above.
All investment business within MiFID's scope carried on by entities located in the EU is subject to the newly harmonised rulebooks of regulators across the EU. Entities carrying on "MiFID scope" business are going to benefit from the so-called "passport."
Portfolio management and investment advice are within MiFID's scope and the UK and other EU hedge fund managers will be "investment firms" covered by the new MiFID rules. Marketing and distribution of fund products are only within MiFID's scope if the marketer also accepts and transmits orders.
As a general rule, a MiFID scope firm is subject to the regulatory capital requirements of the EU capital requirements regime set out in the Capital Requirements Directive ("CRD") which came into force on January 1, 2007. This means that advisers and commodity firms coming within MiFID's scope for the first time may face increases in their capital requirements.
The MiFID passport will enable any entity incorporated and regulated in one EU jurisdiction (including EU regulated investment managers and advisers, and marketers which receive and transmit orders) to provide services within MiFID's scope from its "home state" across EU borders to customers located in other EU jurisdictions ("host states") without being subject to regulatory oversight by host state regulators.
Establishing branches in other member states for MiFID business is also streamlined. Business carried on from host state branches will be subject to host state regulations governing conduct of business, but permission to establish a branch is essentially automatic and host state regulators cannot impose additional capital or systems requirements. Conduct of business regulations, which apply to branches, must be the same as those, which apply to firms established in the host state. Host state regulators cannot impose additional requirements on branches.
Investment advice and MiFID regulated activities involving commodity derivatives are pass-portable for the first time. The passport is only available to entities, which are incorporated in EU member states. EU branches of Third Country firms cannot acquire this EU passport.
Implementation MiFID is effectively shorthand for a collection of measures47 which EU member states are required to implement through its own laws, regulations and rules. The Commission has also passed a Level 2. More detailed provisions48 provide a direct application in member states without needing to be implemented into national law.
In the UK, both statutory instruments enacted by the government and rules issued by the investment business regulator, the Financial Services Authority (the "FSA"), are adequate to achieve MiFID implementation. Each member state is required to publish its implementing laws and regulations. The new provisions have become law across the EU.
Significant areas of change Some of the requirements of the new MiFID regime are familiar to UK fund managers. However, in some key areas, including the five addressed below, MiFID goes much further than the current rules:
Conflicts of interest: Many managers currently use disclosure of potential conflicts of interest as a means of managing them. (This has been the traditional approach used in the US by CTAs.) A key MiFID change is that disclosure can only be used as a last resort. Managers must take all reasonable steps to identify conflicts of interests likely to adversely affect clients' interests and to prevent them arising. Additional MiFID requirements include establishing and maintaining a written conflicts of interest policy which must be made available to clients upon request.
Best execution: Under MiFID, firms are required to take all reasonable steps to obtain the best possible result when executing client orders. Best execution requires firms to take into account not just price but also costs, speed, likelihood of execution and settlement and the size and nature of the transaction. As with conflicts of interest, a documented best execution policy is required. Hedge fund managers will both owe a duty of best execution to their clients and be owed best execution by their brokers.
Transaction reporting: Under the current FSA rules, most managers do not have to make transaction reports. All investment firms who execute transactions in any financial instruments listed on an EU regulated exchange (and in related derivatives) are required to make transaction reports to the FSA concerning transactions in such instruments. This applies regardless of the execution venue.
Client categorisation: MiFID has introduced a new system of client categorisation. The FSA had a three-tier client classification system in the past, which determined what conduct of business rules will apply: private, intermediate and market counterparty. The MiFID system also brings in three-tier, uses different terminology and new rules for determining categorisation. The new categories, retail, professional and eligible counterparty, do not map across to the old ones. Clients, which are funds, will almost always be the middle category, professional clients, but care needs to be taken over individual managed accounts.
Suitability: MiFID has introduced new suitability requirements, which apply to investment management and advice provided to professional as well as retail clients. A suitability determination is based on: (1) investment objectives; (2) financial situation; and (3) knowledge and experience is required. Factors 2 and 3 can be assumed for professional clients other than those opted up from retail; for other clients a determination can be based on all three said factors.
Future Directions The impact of the post-MiFID changes is going to be significant for every EU regulated firm. Third Country Firms doing business in the EU are required to assess whether changes to individual country's rules affects them and in particular in relation to those of the 30 countries which have not previously had a sophisticated investment business regulatory regime. Each firm is required to review that impact at a senior management level with its professional advisers and to establish a project plan in order to ensure compliance.
Electronic order routing system Risk recommendations There are a number of principles for managing the risks in direct access to exchanges. This type of arrangement has become increasingly common among derivatives exchanges in many parts of the world. The report recommends that exchanges establish certain risk controls and apply those risk controls across all trading firms.
This will ensure a level playing field in terms of the latency of trading and avoid creating competitive pressures among clearing firms and trading firms to reduce the latency of trading by applying fewer risk controls. The report was drafted by a working group consisting of representatives from derivatives exchanges, clearing firms and trading firms.
IOSCO's report on Direct Electronic Access There are a number of issues, including minimum customer standards, the importance of legally binding agreements, the delegation of access privileges, customer identification, pre- and post-trade information, and risk systems and controls. The FIA highlighted some of the findings in its September 2007 joint study with the Futures and Options Association on risk controls, and emphasised that futures commission merchants rather than regulators are best situated to determine appropriate risk management for their business.
Mortgage conduct of business (MCoB) The Financial Services and Markets Act 2000 (FSMA) imposed upon the Financial Services Authority (FSA) certain statutory and strategic objectives, including an obligation to provide an effective regulatory regime, aimed at maintaining market confidence and promoting public understanding in all aspects of financial services.
Conclusion The Financial Action Task Force (FATF) has completed an assessment of the implementation of anti-money laundering and counter-terrorist financing standards in the United Kingdom of Great Britain and Northern Ireland (UK). Its major findings state that:
--- To combat money laundering and terrorist financing, UK has a comprehensive legal structure. The number of prosecutions is increasing as scope of the money laundering offences is broad. The scope in respect of terrorist financing offence is also comprehensive.
--- To restrain, confiscate, and recover proceeds of crime, there are comprehensive powers and also to freeze and seize terrorist-related assets.
--- Housed within the Serious Organised Crime Agency, UK now has an effective FIU.
--- Certain requirements, such as beneficial ownership, are not laid out in law or regulation, and it is creating the main deficiency for customer due diligence (CDD).
--- Extensive powers have been given to monitor and ensure compliance by the regulated firms to the Financial Services Authority (FSA). The supervisory system is comprehensive though, yet the supervision of large and small firms requires more vigilance.
--- The law covers all designated non-financial business and professions (DNFBPs). There exists a comprehensive monitoring of casinos, lawyers, and most accountants; the deficiencies lie in the lack of monitoring for the real estate and company service provider sectors. Those sectors will be supervised with the implementation of the Third EU Money Laundering Directive.
1. The actual size of the problem is difficult to define with great precision. However, according to Scotland Yard estimates reported in The Guardian, October 21, 1995, an average of £19m in criminal income is laundered through a London bank every year. According to the same estimate, the amount of criminal income laundered through the City of London's banks per year is £4 billion. The amount of money laundered world-wide may be anywhere up to $500 billion although there is no conclusive figure.
2. Anti-terrorism, Crime and Security act 2001, directive 91/308 of June 10, 1991.
3. The Directive applies to the Member States of the European Union and also to members of the in European Economic Areas.
4. The second limb of the Directive's implementation comprised the Money Laundering Regulations 1993.
5. For accounts of the UK law on money laundering before the CJA 1993 and the Money Laundering Regulations, see for example, K.D. Magliveras, The Regulation of Money Laundering in the United Kingdom, J.I.B.L 525-31 (1991); M. Levi, Regulating Money Laundering - The Death of Bank Secrecy in the UK, The British Journal of Criminology 109 (1991); K.D. Magliveras, Defeating the Money Launderer - The International and European Framework, J.I.B.L. 161(1992).
6. That is, an offence which would be triable in a Crown Court.
7. Proceeds of Crime Act, 2002, s.328.
8. Id. section 329.
9. Id. section 327.
10. Id. section 330.
11. Id. section 331.
12. Id. section 332.
13. Id. section 333.
14. See the discussion on internal reporting obligations.
15. See the discussion on internal reporting obligations.
16. These regulations came into force on December 15, 2007.
17. The Money Laundering Regulations 2007, regulation 3.
18. see paragraphs 2 to 23, 25 to 38, and 40 to 49 of the schedule.
18A. As set out in paragraph 1 of Schedule 2 to these Regulations.
19. See, for example, Radmore, Bhattacharyya and Laddie, Money laundering prevention - effect of the new law on solicitors, 16 Company Lawyer 155 (1995); Laddie, The dilemma for construction trustees, The Money Laundering Bulletin 8 (1995).
20. The Money Laundering Regulations 2007, regulation 3.
21. Id. Reg. 3(3)(a).
22. The identification requirements are set out in regulations 7 to 11.
23. Id. regulation 8.
24. Defined as "a person seeking to form a business relationship, or carry out a one-off transaction, with a person who is carrying out relevant financial business in the United Kingdom". See also requirements given in regulation 7.
25. A list of such institutions can be obtained from the Joint Money Laundering Steering Group. "
26. Id. regulation 13(3).
27. Id. Reg. 13(2)(a).
28. Id. Reg. 13(3).
29. Id. Reg. 13(1).
30. Id. Reg. 13(3
31. For example, see the Professional Standards Bulletins published by the Law Society to solicitors as supplements to the Law Society's Guide to Professional Conduct for Solicitors.
32. Id. regulation 19.
33. In the light of requirements provided in section 2 of Chapter V of the money laundering directive
33A. Id. regulation 15.
34. A "subsidiary undertaking" means:
(a) except in relation to an incorporated friendly society, has the meaning given by section 1162 of the Companies Act 2006 (parent and subsidiary undertakings) and, in relation to a body corporate in or formed under the law of an EEA state other than the United Kingdom, includes an undertaking which is a subsidiary undertaking within the meaning of any rule of law in force in that state for purposes connected with implementation of the European Council Seventh Company Law Directive 83/349/EEC of 13th June 1983 on consolidated accounts;
(b) in relation to an incorporated friendly society, means a body corporate of which the society has control within the meaning of section 13(9)(a) or (aa) of the Friendly Societies Act 1992(c) (control of subsidiaries and other bodies corporate).
35. Id. Reg. 21.
36. Id. Reg. 21.
37. Money Laundering Regulations, regulation 7.
38. Id. regulation 8.
39. Id. regulation 13.
40. Id. regulation 7(1)(a), (b) or (d).
41. Id. regulation 14.
42. Id. regulation 19.
43. Id. In regulation 7(1), (2) or (3), 8(1) or (3), 9(2), 10(1), 11(1), 14(1), 15(1) or (2), 16(1), (2), (3) or (4), 19(1), (4), (5) or (6), 20(1), (4) or (5), 21, 26, 27(4) or 33 or a direction made under regulation 18 and, for this purpose.
44. 7(1), (2) or (3), 8(1) or (3), 9(2), 10(1), 11(1)(a), (b) or (c), 14(1), 15(1) or (2), 16(1), (2), (3) or (4), 19(1), (4), (5) or (6), 20(1), (4) or (5), 21, 26, 27(4) or 33,
45. Directive No 2004/39/EC.
46. EU: Austria, Belgium, Bulgaria, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, Netherlands, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden, and United Kingdom. EEA: Iceland, Norway and Liechtenstein.
Note: Switzerland is not included, nor are Guernsey or Jersey (the Channel Islands), Russia and the rest of the former USSR; along with the US and all other countries from Australia to Zambia, they are considered "Third Countries."
47. This begins with the provisions contained in the "Level 1 Directive" (2004/39/EC) detailed provisions are contained in a second "Level 2 Directive" (2006/73/EC) passed by the European Commission. 48. Regulation (EC/1287/2006).
(Concluded)
(The writer is an advocate and is currently working as an associate with Azim-ud-Din Law Associates)