Given the most recent economic crime legislation, the Economic Crime and Corporate Transparency Act (ECCTA) and developing attitudes to regulation by the legal sector the Legal Sector Affinity Group (LSAG) recently issued an addendum to their current guidance.
We will examine the significant contents of this addendum and discuss the remaining challenges for firms around client due diligence and client risk assessments (CRAs).
As a start it is worth reminding ourselves of the Solicitors Regulation Authority (SRA) warning notice in October 2023.
The SRA made a point that despite the latest ML Regulations being in force since 2017 – yes 7 years ago – and the SRA 2019/20 report discovering 51% of client risk assessments were “ineffective” and 29% of files examined had no written matter risk assessment they still “see a persistent level of non-compliant client/matter risk assessments”.
The warning notice explains that it is a firm’s responsibility to comply with the regulations and in doing so “you must consider relevant materials that we publish, including, but not limited to the warning notice, our sectoral risk assessment and any Legal Sector Affinity Group Guidance”
The notice ends in warning firms of the potential for disciplinary action, criminal prosecution, or both for failure to comply with the warning notice. It also will consult on the application of “fixed financial penalties for AML systems and control failing. This will include issues such as not undertaking a client or matter risk assessment”.
This is strong stuff and some, say from the financial sector, may say “About Time”. Of course, the first problem firms have is whether they have a process and capacity to a) receive this regular flow of information/guidance, b) review its contents and c) amend current processes, controls and procedures to comply (on an assumption they have any in the first place!)
Starting with the more absolute aspects of the Addendum which do not require significant discussion
- A) Discrepancy Reporting Companies House and HMRC Trust Register and B) Register of Overseas Companies
- Firms are required to report ”material discrepancies” to Companies House or to HMRC regarding the information it holds about a person with significant control (PSC) or registrable beneficial owner of an overseas entity or information about a trust that is significantly different from the proof of registration given by the trustee or they have not registered the trust with HMRC.
The further, and important ingredient of a “material discrepancy”, is that the firm reasonably believes the discrepancy has occurred from money laundering, terrorist financing or concealing the business of the client/trust.
- Overseas entities who want to buy, sell or transfer property or land in the UK, must register with Companies House (CH) and advise CH who their registrable beneficial owners or managing officers are.
The challenge for firms here is need to insert these requirements into their PCPs. In respect of A) fee-earners need to consider the information already held or gathered on entity/trust clients, whether it differs from what is held at Companies House/HMRC and whether the definition of material deficiency is met. For B) Again fee earners as part of the CDD process should verify such registration.
NB: Whilst the above changes in the ECCTA will increase the detail retained at Companies House and will assist in assessing risk and completing client due diligence it does NOT fully satisfy the requirements to perform client due diligence it merely assists in the wider checks carried out.
Full guidance is for these are provided at:-
https://www.gov.uk/guidance/register-an-overseas-entity
- Supply Chain Risk
The risk to be considered here is the “who is ultimately benefitting” from the service a firm is providing. In the financial sector this is often referred to as KYCC (Know Your Client’s Clients) be that as suppliers or their clients.
Again, clear PCPs relevant to CDD need to address this risk and where firms are only one element of a whole transaction/instruction they should understand what the whole transaction/instruction is about, who is involved in the transaction/instruction (e.g. accountants, formation agents) and be comfortable with their involvement.
- Source of Funds – Third Party Funding
While only 2 paragraphs long in this Addendum herein lies, perhaps, the most challenging areas for firms considering their CMRA. Challenging because of its subjectivity. With words such as “…seek to understand and obtain evidence relating to the third party’s underlying SoF”…BUT the very next sentence says “The extent to which you should obtain, review and evidence third party SoF is dependent upon the risk profile of the client or matter.
So, it seems to suggest you should “obtain evidence” in all circumstances but then states “the extent” of this depends on client or matter risk.
The second paragraph goes on to say that “Without understanding the source of funds of both client and associated third parties to the transaction, you are unlikely to be able to carry out an effective risk assessment…”.
The challenges faced by firms are a) a view forming that for an effective risk assessment to be completed a firm has to virtually apply Enhanced Due Diligence (EDD) in all high risk ‘matter’ circumstances (e.g. conveyancing); and b) to try and define in PCPs, given multiple possible scenarios, what “evidence” consists of and what level of “evidence” is necessary.
Without clear PCPs there is a danger of significant inconsistency between fee-earners. Of course, training will also play a crucial role in meeting this guidance but it would seem fair that an initial CMRA could be determined from information taken from the client ‘up front’ such as type of client, value of transaction (and value of third party funding), who the third party funder is and any jurisdictional risk. This should be sufficient for an initial CRA. The PCPs could then set out how deep i.e. “the extent of evidence to obtain” based on that CRA.
To demonstrate this challenge let us look at some examples:-
While conveyancing is deemed a High Risk “matter” is this at any value e.g. £300k.
Taking the above value and where the clients are 2 x teachers with the vast majority of funding being by mortgage and a portion of deposit from a parent who themselves was a Head Teacher? a) is it really a High Risk transaction? and b) What actual evidence is required of the parent’s “underlying SoF”?
The purchase of the same property but by a manager in a restaurant with a substantial amount of third party funding by the parent, the owner of the restaurant, again what actual evidence is required of the parent’s “underlying SoF”?
In the first example above, it could well be that evidence of third party funding could be merely a letter from the parent detailing that the ‘gift’ was from savings over many years as a head teacher whereas in the second example it may well be essential for detailed evidence of the restaurant profitability and salary/dividends of the parent would be necessary.
Despite these challenges clearer PCPs, a clear CMRA methodology both alongside effective training will assist in dealing with the challenges faced.