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November 2001

Secret money crackdown fuels legal dilemmas


In the wake of recent events, bankers and their lawyers need to be much more aware of the need to balance effective legal compliance with a respect for client confidentiality.




With money-laundering now accounting for between 2% and 5% of the world's GDP (according to the IMF), the pressure on banks and their advisers to prevent criminal misuse of the global financial system has been increasing. Since September 11, however, there has been a substantial escalation in the drive to cut off terrorist funding. The result, for financial institutions worldwide, is an environment where compliance has become an urgent concern. Lax controls can create significant risk to reputation. This was true before September 11 - take, for example, the £350,000 fine imposed on the UK arm of PaineWebber by the Securities&Futures Authority for its sub-standard anti-money-laundering procedures (although the authority noted that no money laundering had taken place and no customers or clients suffered any financial loss). But the new climate of vigilance means that these risks have multiplied. Indeed, it is hard to quantify the fallout for any financial institution of revelations that Osama bin Laden's funds had passed through its systems undetected.
Jon Holland, a partner in Lovells' banking and financial litigation and international commercial arbitration group, points out that there had already been a lot of uncertainty among financial institutions about their legal obligations in this area - a situation that has been exacerbated considerably in light of recent events. "There is," he says, "an increasing amount of overlapping regulation, legislation and private initiatives in this field, ranging from the Wolfsberg Principles and the Basle Committee's guidelines through to the forthcoming changes to the EU money-laundering directive and the recently tightened US legislation aimed at foreign entities deemed to present a major money-laundering threat to the US."
Holland continues: "We're getting a huge number of calls on this issue and it is clear that banks are moving this aspect of compliance to the top of the list." He cautions that banks need to follow all international developments - not just those affecting them in their home jurisdiction. "The US," he says, "is beginning to promulgate legislation that has a significant extra-territorial element. To an extent, they are seeking to become self-appointed policemen of the global financial system and this has the potential to create a wide range of problems."
His advice for banks falls into three main categories:
Compliance: In the UK, banks need to ask themselves whether they are complying with the existing money laundering regulations and FSA rules.
Post-September 11 issues: There have been two lists published - one by the US State Department, and one by the US Treasury, of people believed to be involved in the terrorist attacks, and these have been reflected in initiatives from the UN and EU. The problem this poses for banks goes to the heart of their business - whereas the key focus used to be the origin of funds deposited, it is now increasingly also the intended destination of funds withdrawn - or "reverse money laundering" as the legal counsel of one Swiss private bank recently described it.
Continuing obligations: Since the money-laundering regulations and primary legislation in this area first came into force, banks have been forced to tread a delicate line between balancing their obligations under both the civil law and the money-laundering regulations. This balancing act is getting harder and harder.
For banks subject to English law, the current legal and regulatory environment is complex enough. Since the introduction of the Drug Trafficking Offences Act in 1986, marking the beginning of the UK government's campaign to deprive criminals of the fruits of their crimes, there has been a progression of primary and secondary legislation. The matter of compliance is complicated by the breadth of international initiatives now in place (or forthcoming), as well as by the US's apparent desire to push forward its own extra-territorial agenda. As Holland sums up the situation: "Terrorists need funds and it is self-evident that someone somewhere is banking someone currently involved in international terrorist activities. As far as the authorities are concerned, if they cannot get the terrorist, they will go for the softer target, and in a lot of cases, that's going to be a bank. As things stand, the people responsible for spotting transactions that don't feel right on a day-to-day basis are often not that senior, and those in charge of the compliance function cannot practically oversee everything that is going on. This can create a real risk management issue." As he says, banks need to focus on getting experienced external legal advice in at a much earlier stage: "They need to concentrate on prevention - not damage limitation."
For the immediate future, the most significant changes to the European landscape will stem from the tough new rules on the reporting of money laundering due to be introduced by the EU by the end of the year. The EU's member states are on the verge of passing a new directive, following a compromise obliging lawyers to report privileged information on clients "known" to be seeking legal advice "for money laundering purposes". This requirement is already in place under English law, and although the EU's compromise solution has been hailed as a major breakthrough on the continent, there has been some speculation over exactly how sure lawyers have to be before reporting clients to the authorities.
The text makes clear that reporting is required "of any fact which might be an indication of money laundering", and as Sarah Ludsford, Liberal group spokesperson on justice&home affairs in Brussels, recently pointed out, the specified exemption for lawyers is only under tightly defined criteria of legal privilege, "in essence when giving neutral advice on the state of the law or when representing them in court proceedings". Ludford has called for strict interpretation of the directive across Europe when incorporating it into their national law.
Once in force, the directive will increase significantly the obligation on lawyers, bankers, accountants and others to report dubious financial transactions to law enforcement agencies. If recent UK statistics are correct, lawyers in particular have a lot of ground to catch up in this respect. The UK's national criminal intelligence service (NCIS), which maintains a database of suspicious financial transactions, has already voiced its concerns about the fact that both lawyers and accountants are ignoring the need for heightened vigilance. According to the NCIS, while UK banks registered a 25% increase during 2000 in the number of suspicious transactions reported (over 17,000 in total), lawyers and accountants between them reported just 325 (15 fewer than in 1999).
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