Anti-Money Laundering and the Importance of Rigid Due Diligence
Good morning ladies and gentlemen.
One of the requirements under most anti-money laundering regulations is the necessity for companies in the financial services industry, such as administrators, to ensure that their staff - and by that I mean all members of their staff complete an anti-money laundering course. This would normally be an in-house course presented by the Money Laundering Reporting Officer or Compliance Officer and is designed so that the staff know the rules and procedures that must be followed, what they must look out for, why they have to do it and what could happen to them (and their company) if they dont.
A further requirement under the regulations is that the same staff should undergo a refresher course every year to ensure that they dont forget, or become casual in their attitude to, the anti-money laundering regulations.
I assume that IBC, the organizers of this conference, have taken this on board, because I have been asked to talk to you today on exactly the same subject as I did a year ago, namely, The Importance of Rigid Due Diligence in the Context of Anti-Money Laundering.
However, I am not going to repeat everything I said last year, other than to briefly very briefly summarise the main reasons why rigid due diligence is absolutely essential. And, in this context, I am going to suggest that due diligence is satisfied once you know your client in the most literal sense of that phrase.
Obviously, the primary reason is to identify money launderers and prevent money laundering and to be able to provide evidence if any case should come to court. But we, or most of us, are really more concerned with avoiding reputational risk, as well as legal and/or regulatory sanctions. We can only do this if we can ensure compliance with the regulations and this can only be achieved by complying with rigid due diligence procedures.
Nevertheless some of what I say is probably going to sound familiar to those of you who attended last years conference.
In fairness to IBC, when we discussed the topic, we agreed that: firstly, anti-money laundering due diligence is still and always will be a very important subject; secondly, that there was likely to be some progress, news or developments with regard to the USA PATRIOT Act we got that wrong; and thirdly, there have been some changes since last February that are worth exploring and discussing.
The main topic has been broken down into four sub-topics if you like:
i) The importance of the USA PATRIOT Act;
ii) Implications of out-sourcing money laundering (I think they meant Anti-Money Laundering);
iii) Anti-money laundering verification requirements; and
iv) A uniform approach.
When I was originally discussing the content of this presentation, it seems sensible to include the impact of the USA PATRIOT Act, because I was reasonably confident that the US Treasury Department would have published regulations for hedge fund managers and hedge funds to comply with the Act by now. For those of you that dont know, the standard procedure when enacting new legislation in the United States, is to pass an Act in this case, the USA PATRIOT Act - and then follow that with regulations that apply to the Act. These regulations will, essentially, determine how the Act in question will work and how those affected by it can comply with the Act.
You will recall that the USA PATRIOT Act, which is an acronym for
Uniting & Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism
was passed on the 26th of October 2001 as a very strong and understandable knee-jerk reaction to the 9/11 disaster. The Act was, as the name implies, a very broad bit of legislation that affects many different walks of life and does not just address the application of anti-money laundering procedures in the financial services industry. Nevertheless, for whatever reason, the regulations, as they apply to the hedge fund industry, that is, funds and managers, have not yet been established and it is now almost two and a half years since the Act was first published.
So, in answer to the first point the full impact to date of the USA PATRIOT Act has not yet been felt in our industry because we dont know for sure how it is going to be applied but we have expectations and we can make some educated guesses. These include the following:
Firstly, in the context of hedge funds, what will be the scope of jurisdiction It is probable that the US authorities will claim some extra territorial jurisdiction that is outside the United States - with regard to any funds that have what is known as a US Nexus. This will certainly include any offshore funds that have a US investor and probably any fund that has a US hedge fund manager. It may also be deemed to include funds that have US brokers or other service providers or funds that invest on the US markets. Thus, depending on how broad the definition of US Nexus is, in this context, it is possible that funds that you and I would deem not to be US i.e. established outside the United States, managed by non-US managers and with no US investors - could nevertheless be drawn into the US regulatory net, whether they like it or not.
How will this affect non-US investors Frankly, it will not have any great affect on them, except the knowledge that US authorities may require and assume the right to be able to review the books and records of the fund, particularly the share register, to determine whether any of the investors are terrorists or money launderers. On the other hand, from the hedge fund manager and the service providers point of the view, of course, the introduction of compliance with the US PATRIOT Act, is likely to bring in a level of duplication of AML due diligence and compliance which would, otherwise, not be necessary.
I think we all accept the fact that, generally, the anti-money laundering regulations outside the US and, particularly, in major financial centres in Europe, are now very strong and certainly comply with anything the US authorities are liable to ask for - indeed in many countries exceed US requirements. The problem here is the inherent belief of the US regulator that, if they dont control it, its not working.
This is demonstrated in another way. Under the USA PATRIOT Act, a US hedge fund manager will be responsible for carrying out the anti-money laundering due diligence on his clients, including investors in any fund that he acts for. The manager is able to outsource and we are now getting into the second topic of this presentation the anti-money laundering due diligence function to a third party and this should relieve him of a lot of duplicate effort. For example, an Irish administrator acting for any fund, whether domestic or offshore, is obliged, under Irish regulations, to maintain full and complete anti-money laundering due diligence files on each investor, in accordance with the Irish regulations, which are quite draconian.
This should, in my opinion, satisfy the US authorities, however, even if a US hedge fund manager was to rely upon a first class well established administrator, that hedge fund manager would still remain ultimately responsible under the US regulations and could be penalized if the administrator, or any other service provider that he may have delegated the function to, fails to do it or doesnt do it up to the standard required. In the UK and Ireland, I think it is fair to say that the manager would have been deemed to have acted responsibly if it had appointed a regulated body, such as an administrator or custodian, to carry out the anti-money laundering due diligence and the manager would not be penalized if that was not carried out, unless he had failed to take reasonable steps to ensure that it was being done, or had some doubts about it, but had not followed up on those doubts.
And this is, in fact, probably the most important fact to remember when outsourcing delegating the anti-money laundering due diligence to a third party you must satisfy yourself that whoever you delegate the job to has the ability to carry it out properly.
But back to the US - you can see that, as I have already mentioned, it is likely that the US authorities will not take into account the appalling waste of resources that can be incurred if the anti-money laundering procedures are duplicated by everybody in the food chain. The ability to delegate the responsibility is recognized in Europe and has resulted in the concept of the Designated Body. This is a financial institution, typically a bank (in the context of hedge funds), with which an investor may have a bank account and through which account that investor may invest in the fund. Thus, we, as administrators, will receive a subscription from XYZ Bank and, for the most part, it is unlikely that subscription is a proprietary investment of the bank, but is being held by the bank as a nominee for one of its clients. Providing that bank, the Designated Body, is in good standing and is a resident within the list of the FATF that is the Financial Action Task Force approved jurisdictions, then we are able to accept a Letter of Comfort.
This would also apply to Funds of Funds, where an investment in one fund is made by another fund. The administrator of the subscribing fund could act as a Designated Body and confirm to the administrator of the target fund that it had carried out anti-money laundering due diligence on the investors within the subscribing fund and that would avoid further duplication by the administrator of the target fund.
Can you imagine the chaos and waste of resources that would occur if the hedge fund managers of all funds into which a large Fund of Funds invested, were to go back and require the administrator of that Fund of Funds to provide copies of anti-money laundering due diligence on each of the investors in the Fund of Funds to each of the managers of the Target Fund. If you had a Fund of Funds with 70 investors, investing into 30 sub-funds, the due diligence files on each of those 70 investors would have to be duplicated 30 times, thus, producing 2,100 due diligence files, where originally 70 would have been sufficient.
Is it any wonder that compliance is becoming one of the major expenses of our industry
I have just mentioned the concept of the FATF list of approved jurisdictions and you will find a copy of that list in your papers. FATF is the organization that has been largely responsible for establishing a fairly uniform anti-money laundering culture throughout the financial world.
And a quick word on the Letter of Comfort that we require from all Designated Bodies this must also confirm that the Designated Body complies with an acceptable anti-money laundering regulatory regime and will provide back-up documentation as required - again, a case of taking reasonable care when outsourcing. This is, in fact, now a requirement under the latest Irish Guidance Notes published last year, of which more later.
The next subject I am going to discuss is the Client Verification procedures that are necessary to compile the anti-money laundering due diligence file on each investor.
In general, the information that is needed is fairly straightforward and obvious full name, residential address, bank details and confirmation that the source of the money is acceptable. In order to verify the identity of the investor, it is necessary to have a certified or notarized copy of some photo ID document, which is usually a passport or driving license. The identity is verified by the notary, who confirms that it is the likeness of the person who is sending it to us.
The second requirement is proof of residence and that used to be verified by way of receipt of a utility bill. Increasingly, two documents are now required, one of which would be a certified or notarized utility bill and, preferably, not a copy and the other would be a letter from the individuals bank confirming the home address of that individual or a notarized copy of the bank statement.
Verifying the acceptability of the source of the money is, in fact, very straightforward, providing the subscriber has made an investment out of an account in the subscribers own name at a regulated bank in a FATF approved jurisdiction. It is generally accepted that, because all those banks are required to comply with strong anti-money laundering due diligence, they will, as a bank, be able to confirm and verify the acceptability of the source of the monies in the clients account. Therefore, it is not usually necessary for the administrator of a fund to carry out that verification procedure.
Further information is also required and I have attached the Client Verification procedures that we, at Custom House, require from investors in funds that we administer. I dont think youll find that these differ in any material respect from the information that all other administrators would require except perhaps in one respect.
You will all have heard of the EU Savings Directive, which was scheduled to come into law on January 1st 2005 although that is by no means certain. What is certain is that enabling legislation has been enacted in Ireland and if it does come into play, then the fund or its administrator or paying agent, if situated in an EU member state, will have to supply information on all EU individual investors to their local (the administrators or paying agents) tax authority.
And, retrospectively, to January 2004.
I am not going into any detail on this subject here, other than to say that the amount of information that will be required is more than is required to comply with anti-money laundering due diligence and you will probably not be able to rely on Designated Bodies at all.
Back to our Client Verification Requirements: What you will also see is that, if the subscriber is a corporate entity, then we need all of the information about the company: Certificate of Incorporation; Memorandum and Articles of Association; Certificate of Good Standing; and accounts; plus the personal information that I have already referred to on all officers, directors and shareholders holding 10% or more of the shares of the company. We also require similar information for partnerships, unincorporated businesses and trusts, except that, in the case of trusts, we will also need copies of the Trust Deed and information on the trustees and the beneficiaries. It should be noted, in the case of trusts, that in certain circumstances, we may not deem them acceptable.
At this point, I feel I should mention that, since 9/11, the concept of a Politically Exposed Person or PEP has been introduced and this adds another layer of responsibility on those carrying out anti-money laundering due diligence checks. The definition of a Politically Exposed Person is extremely broad and probably covers about a quarter of a million people in the world today. The concern is that politicians and all their families and close friends, around the world, are not above fraud, bribery, embezzlement of public funds, etc. Historically, we know that this has been fairly common in some underdeveloped countries Abacha, Marcos and, of course, Saddam Hussein, all spring to mind. However, and I have made this point before, I do find that the anti-money laundering regulations today seem to have eliminated the principle of innocent until proven guilty because anyone who has suspicions about somebody is obliged to report them and will be committing a criminal offence if they dont with potential penal sanctions, that include prison. I am beginning to realize what it must have been like to live in East Germany before the Wall came down.
So how is an administrator supposed to react in the event of getting a subscription from somebody who could be deemed to be politically exposed and, therefore, possibly politically corrupt For example, you must remember Politically Exposed Persons include, not just the individual, but family and friends of that individual.
Let us imagine that we had a fund into which the following four politicians made investments: Teddy Kennedy, Helmut Kohl, Jacques Chirac and Silvio Berlusconi.
According to all the anecdotal evidence that I have read, there seems little doubt that Teddy Kennedys father was a bootlegger during the prohibition in the United States and that his fortune was based on the profits made at that time. Are we supposed to refuse his subscription or report him Probably not.
Second, Helmut Kohl. Although he didnt go to jail, he definitely was involved in nefarious financial dealings as far as his parties funding was concerned. So should we refuse his investment You tell me.
The next two are equally contentious. Firstly, Jacques Chirac: only a few days ago, one of his close colleagues, ex-Prime Minister, Mr. Joupe was found guilty of financial shenanigans with regard to election monies and, effectively, embezzling public money to meet the costs of the party machine and Mr. Chirac was closely involved with that individual. Of course, Chirac hasnt denied that hes done any wrong in a court or been tried, because he was able to change that law, so that he could not be prosecuted while in office. It seems clear that we have fair grounds for suspicion, but is that grounds enough to stop his investment
Similarly, the reports that weve had about Mr. Berlusconi in some press doubtless, the press that has a different political leaning to him would imply that he has also been involved in some nefarious financial operations. But he has not gone to court yet, let alone been found guilty, so do we have grounds for suspicion
We, as the Administrators of the fund are on a hiding to nothing. There are clear grounds for some suspicion even if just on the no smoke without fire principle so should we refuse the applications and upset the manager and the clients. Can you imagine the headlines if, whilst Jacques and Silvio were dining with Bertie and all their other EU colleagues (some of whom would find it difficult to qualify as angels themselves) at Dublin Castle, in the next few weeks we or another Irish based administrator were to refuse their subscriptions into a client fund
Of course, these are all extreme examples, to make the point. Anyway, undoubtedly, each one of those individuals, with the possible exception of Teddy Kennedy, would probably invest through a third party bank as nominee and so we may never know it was them. Be that as it may, I do believe that, in these sort of circumstances, the responsibilities imposed upon service providers in the context of anti-money laundering due diligence and their liabilities under the regulations are getting increasingly draconian and calling for judgments that, frankly, the average administrator is just not qualified to make.
As a result, the prudent choice is to report everything and that, again, strains resources, both in the context of the service provider and, of course, the authorities who will be receiving all of these reports.
The fourth topic that I am supposed to speak about is a uniform approach. This, I think, is very important and, I regret to say, we are no further down the road on this as we were a year ago. I told you then that we were hoping to produce a white paper on anti-money laundering at AIMA the Alternative Investment Management Association of which I am Deputy Chairman. We have a Sound Practices Committee and one of our tasks is to produce a white paper on anti-money laundering, with the aim of producing a comprehensive analysis - a matrix if you like - of the requirements in all of the major jurisdictions and, hopefully, giving a guideline as to what questions everybody should be asking, so that we all ask the same questions and satisfy the same requirements for clients and for regulators. We believe that this will also make it easier for investors. The delay has been caused for two reasons.
Firstly, we were waiting for the USA PATRIOT Act regulations to come through I think we are now going to ignore those and just produce a paper that will be fluid. We are just going to have to accept that we will have to make amendments to the paper on a regular basis.
This has also become apparent because, in the past year, there have been several adjustments to the regulations in various jurisdictions. For example and this is not an exclusive list - since 11th September 2001, we have seen the USA PATRIOT Act and the Basel Committee on Customer Due Diligence for Banks, which came out in October 2001, as did the FATF recommendations on terrorist financing. This was followed in December 2001 by the EU Directive on the Prevention and use of the Financial System for the Purpose of Money Laundering and the Irish Criminal Justice (Theft and Fraud Offences) Act, as well as the UK Proceeds of Crime Act in July 2002 and the Swiss Banking Commission Ordinance on the Prevention of Money Laundering in December 2002. Furthermore, in both Ireland and the UK, revised guidelines have been published and the offence of assisting a money launderer has been made much more draconian.
In the revised Guidance Notes published in Ireland in June last year, there were some notable changes to the due diligence requirements. In addition to the requirement, re Designated Bodies, Letters of Comfort, which I have already mentioned, these changes include:
i) Tax evasion is now specifically included in money laundering crimes together with all criminal offences providing they are offences in the country of residence of the client;
ii) All anti-money laundering reports must now be made to the Revenue Commissioners unless otherwise advised;
iii) Requirement to cross check investors names with lists of terrorists or suspects supplied by the Regulator (this also applies to the USA PATRIOT Act and the US OFAC lists of terrorists);
iv) Any transaction involving a proscribed jurisdiction must be reported automatically, whether suspicious or not (this is not a major problem as Mauru is the only proscribed jurisdiction);
v) Concerns re corporate investors and a requirement to understand why the entity exists, particularly if it doesnt carry out any business or trading activities.
So the whole thing is changing and getting tougher and I think that, if the industry were to have a uniform approach, then life would be very much easier for all of us.
Finally, and for those of you who have heard me talk on this subject before, you will now be bored with this, but I do think that introducing regulations, such as the USA PATRIOT Act, which is intended to stop both money laundering and terrorist financing is a very difficult task, because they are such diametrically opposed functions. Trying to identify money that is going to be used for a nefarious purpose, such as terrorism, is very difficult because, unlike money laundering, which is the action of taking dirty money criminal money and laundering it so that it becomes clean and respectable, is an entirely different operation to taking what is, essentially, clean and respectable money and using it for a nefarious reason, such as subscribing to a terrorist organization. The controls required, certainly in the context of hedge funds, are entirely different.
It is my contention and, again, many of you will know this, that if the main plank of anti-money laundering legislation in the context of hedge funds was the requirement that all redemptions of proceeds of sale of hedge funds should be paid back to the remitting bank that is into the bank account that the original subscription came out of and this is already an existing rule but if it becomes the primary rule, then no money laundering can occur. Why Because the money wont have been laundered, it will merely have come out of one bank and come back into the same bank. This is, of course, passing the buck onto the bank, but they are doing that every day and my suggestion is just going to save wasting resources and unnecessary hassle, which cannot be a bad thing.
Thank you very much.