When do we or don’t we obtain information on SoW and verify such information?
Recent supervisory inspections of firms have commented critically on a number of those firms’ inadequacies in obtaining information on SoW and their subsequent lack of verification of said information. Whether this is fair or reasonable criticism given the requirement to adopt a risk-based approach is arguable but, for now at least, a focus on this issue from supervisors will likely remain.
In this piece, I look at what the challenges are and suggest an approach which may assist in meeting those challenges, as well demonstrating to supervisors that a sensible risk-based approach has been applied.
- Regulation and Industry Guidance
It is worth starting with what the actual regulations and industry guidance say in this area. There are, in fact, only 2 circumstances where SoW is a mandatory requirement under UK regulations, being:
- where the client is a PEP; and
- where the business relationship and/or transaction involves a High Risk Third Country (HRTC). (This article is only concerned with the challenges faced in b).
The Legal Sector Guidance (LSAG) appears to suggest SoW should be considered in many more scenarios than b) above. On CDD procedures, they state that firms should have “procedures to facilitate a clear understanding of the clients SoW and Funds in relation to a transaction and the level of evidence required, in line with the risk profile of the client/matter.” In the same section, it references Enhanced Due Diligence (EDD) procedures being required to include “measures to establish SoW where appropriate” (my italics). The LSAG also refers to understanding SoW in the sale and purchase or real property. Additionally, in the guidance on client risk assessments it states, “Fundamental to any assessment of client risk is an assessment of whether the client’s…SoW..aligns with the background and wider profile of the client.”
Accountancy Guidance appears less testing. The CCAB guidance refers to firms having, as part of their EDD procedures, “for clients that are higher risk due to connections to a HRTC “, a requirement to obtain information the SoW…of the customer and the customer’s Beneficial Owner. They make no further reference to SoW being required.
The above suggests there may be a difference in approach from one supervisor to another. This could be based on the perceived degree of risk in these different sectors but it does seem to be a significant variance given that, in a number of cases, the matters on offer can be similar (TCSP for example).
- Challenges
Given the above, I do not think that firms should be unduly challenged in meeting the regulatory requirements. However, the industry guidance on SoW may still seem puzzling and complicated to firms and raise questions such as: –
- when are we expected to obtain information on SoW? (Always? Just in real property transactions? Just as part of EDD?)
- how far are expected to go in verifying such information?
- what about entity clients and SOW? and
- how can we ensure a consistency of approach across all of our fee-earners performing due diligence?
Another challenge I think worth mentioning is the danger of firms developing the belief that supervisors have a ‘gold plated’ expectation in their approach to SoW – an approach where, for example, firms start to believe they are required to perform enhanced due diligence (EDD) before even determining the risk of a client. Surely not?
- Suggested Approach
It is perfectly reasonable for supervisors to expect clear policy procedures and processes related to due diligence. My experience is that whilst it is impossible to cater for every situation (hence a need for exceptions), detailed procedures will assist greatly in achieving a consistency of approach. These procedures should set out how a risk assessment is performed (geography/jurisdiction risk, client type risk, matter risk, transaction values etc.) and, for the purposes of this article, when SoW information should be obtained and verified.
As a general principle, a firm should prioritise a CDD ‘flow’ which captures the ‘big risks,’ over being able to defend their system to regulators in every single, conceivable lower risk scenario – thereby also avoiding unrest amongst low-risk clients for being too intrusive.
As an example, where a UK resident is buying a bungalow for £200k, when they have no foreign or sanctions exposure and when the major source of funds is from a UK bank account, is the expectation that they will be asked to disclose how much they are worth in totality and how they came by that wealth? Surely not, which is why a clear, consistent series of questions to a client designed to obtain sufficient information and reveal any high-risk factors can lead to sensible risk assessment and a risk-based approach to SoW.
An idea for a simple approach, whatever the matter or transaction, to meet regulatory requirements and supervisory expectations, for example, could be as follows: –
Situations where the SoW must be understood and verified:
- If the client is a PEP; or
- If the client and/or the matter involves a HRTC (for entities this will include the UBOs); or
- If the client or matter involves a sanctioned country; or
- If the matter involved is above £X.
Situations where the SoW may need to be understood and verified:
- If the client and the matter does not involve HRTC; and
- If the client or matter does not involve sanctioned countries; and
- If the SoF is not from a HRTC; but
- another High-Risk Factor has been ascertained (e.g., high-risk business); and
- the matter/transaction is between £Y and £X above.
In which case, the fee-earner should respond to the following question in the CDD file: –
“Given the relatively high value of the matter/transaction, are you comfortable that this client’s overall net worth is highly likely to have been accumulated through legitimate activity? Factors you may wish to consider and comment upon are e.g. (i)whether the client is personally known to you; (ii)whether the client has been introduced to the firm by someone who is known and trusted; (iii) whether the client has a public reputation (national or local) which speaks to their legitimacy and good standing; or (iii) that any high risk factor is mitigated with sufficient information. If you are unable to respond positively to such factors or if they are absent – then you must understand and verify the SoW.”
Situations where there is typically no requirement that SoW be understood and verified:
- If the client and the matter does not involve HRTC; and
- the client or matter does not involve sanctioned countries; and
- the SoF is not from a HRTC; and
- there are no other High-Risk factors; and
- matter/transaction is below £Y.
NB: It would be for firms to consider what values £X and £Y should be given their size, current client portfolio and average transaction sizes etc. Firms should also detail what SoW is required when the client is an entity. This should be on specified individuals (e.g. the PEP or the UBO) and as regards the entity itself, having detailed information and documentation surrounding its business model, how it makes its money, where it makes it, who its major customers and suppliers are, how it gets paid and the mode of sale.
This approach (or something like it) would deal with the regulatorily mandated situations where SoW should be understood and verified as well as injecting some operational certainty into the need also to do so “where appropriate.”
Stuart Hammond
Director, Legal & Regulatory
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