House of Lords - Money laundering and the financing of terrorism

Money laundering and the financing of terrorism - European Union Committee Contents

CHAPTER 4: THE PRIVATE REGULATED SECTOR

Introduction

96. The fight against money laundering and terrorist financing depends on close cooperation with the authorities by those who may, however unwittingly, handle on behalf of criminals large sums of money or other valuable property. They include, among many others, banks and other financial and credit institutions; lawyers, auditors, insurers and estate agents; dealers in precious metals and precious stones; and casinos. These constitute the private regulated sector. We took oral evidence from the Law Society, the Institute of Chartered Accountants in England and Wales (ICAEW), the British Bankers' Association (BBA),[61] and Lloyd's.[62]

Customer due diligence (CDD)

97. FATF Recommendations 5 to 12 deal with customer due diligence (CDD): the measures which institutions in the regulated sector are required under normal circumstances to take in respect of their customers and their transactions. Chapter II of the Third Directive sets out what is required from such institutions when establishing a business relationship; when carrying out large occasional transactions as one transaction or part of a series; where there are suspicions of money laundering or terrorist financing; or where there are doubts about data previously obtained.

BOX 5
Customer due diligence measures: a summary

98. In 2003 the FATF introduced a significant risk-based approach into its Recommendations for the first time: "The principle is that resources should be directed in accordance with priorities so that the greatest risks received the highest attention".[63] CDD is one of the areas where this approach is manifest. Examples of higher risk situations, requiring enhanced CDD, include dealings with politically exposed persons[64] and correspondent banking relationships. In lower risk situations, such as dealing with listed public companies, financial institutions may reduce or simplify (but not completely avoid) CDD measures.

99. This risk-based approach, with its promise of facilitating the more efficient allocation of resources, has been incorporated into the Third Directive. In the CDD context this approach has been elaborated in considerable detail by a Commission Directive.[65] The approach is supported by the United Kingdom Government[66] and has been broadly welcomed by the regulated private sector. Some, such as ICAEW, suggested its further extension. (Q 37)

Suspicious Activity Reports (SARs)

100. FATF Recommendations 13 to 16, and Chapter III of the Third Directive, impose on the regulated sector the duty to report to the FIU—in the case of the United Kingdom, to SOCA—any transaction or activity which seems to involve funds which are the proceeds of criminal activity, and related aspects of the reporting regime. As Ms Sally Scutt, the Deputy Chief Executive of the BBA, told us, "it is a suspicion based regime … the law requires that if you suspect, you must report". She agreed with the statement: "You smell a rat and you report it". (QQ 40-43) And the figures show that the BBA smell a great many rats: in 2007-08 their members submitted no fewer than 145,000 SARs to SOCA, and 838 SARs specifically on terrorist financing. (p 1)[67]

THE "ALL CRIMES" APPROACH

101. The breadth of the obligation depends on the criminal activities involved. What is described as the predicate offence[68] is the underlying criminal offence that gave rise to criminal proceeds which are the subject of a money laundering charge. Plainly a requirement to report a transaction which may involve even a relatively minor predicate offence will be more onerous than one limited to serious criminal offences. The approach to adopt is left to individual States.

BOX 6
FATF Recommendation 1 (extract)

102. The approach adopted by the United Kingdom is the "all crimes" approach. No matter how trivial the criminal activity, if there is a suspicion that it might involve property which might be laundered, there is an obligation to report it. From the standpoint of the authorities, the advantages are plain. If every criminal offence is potentially a predicate offence, laundering of the proceeds of any such offence constitutes the criminal offence of money laundering. The prosecutor thus has a choice of prosecuting for the predicate offence, or for the money laundering offence to which it gives rise, or both. And, as John Ringguth pointed out, it facilitates prosecution if all that needs to be shown is that the money laundering defendant knew that the proceeds came from some crime, without necessarily knowing which. (Q 490)

103. We put to our witnesses from the regulated sector the question whether the "all crimes" approach was right for them. For the BBA, Ms Scutt believed it was. She thought it important to remember that the reputation of the United Kingdom and the City as an international centre rested upon doing what is necessary. The fact that other European countries did not do so should not influence this. Ms Felicity Banks of the ICAEW entirely agreed. (Q 45)

104. The Law Society's view was different. The Chief Executive, Desmond Hudson, agreed on the importance of reputation for a well regulated market, but was not certain that this was enhanced by the current system. He pointed out that the all-embracing definition of property, and hence of criminal property,[69] resulted in the inclusion of criminal property deriving from a wide number of regulatory offences which could not have been intended to be within the focus of the Government's AML/CFT strategy. Examples were a failure to register as a processor of personal data with the Information Commissioner; failure to obtain a waste disposal licence; or failure to obtain a fire and asbestos report for the sale of commercial premises. There was also a need continually to report old offences.[70]

105. It can be argued that in practice prosecutions would never be brought for a failure to report such matters; but we agree with the Law Society that this is not an adequate answer. If the regulated sector is to be certain that prosecutions will not follow in such cases, this must be because the law does not require them to be reported. It is not enough to say that a law which requires them to be reported can be broken with impunity because a solicitor can be certain—or so he hopes—that a prosecution will not follow.

106. If the "all crimes" approach is to be modified, the most radical of the two alternatives postulated by the FATF is to have a list of serious crimes which would constitute the predicate offences. In the Glossary to their 40 Recommendations the FATF set out a long list of designated categories of offences which should be included as a minimum. There are examples of similar lists in EU legislation, as for example the list of offences for which the European Arrest Warrant disapplies the normal requirement of double criminality.[71] The Third Directive itself has a definition of "serious crimes" which relates to definitions in other instruments, but has in Article 3(5)(f) a wrap-up provision reading: "all offences which are punishable by deprivation of liberty or a detention order for a maximum of more than one year or, as regards those States which have a minimum threshold for offences in their legal system, all offences punishable by deprivation of liberty or a detention order for a minimum of more than six months".

107. Our witnesses differed as to the best course to follow. Professor Alldridge favoured "a more thought-out list" of crimes. (Q 346) Jonathan Leslie, a partner in the solicitors firm Travers Smith, suggested qualifying the definition in the Proceeds of Crime Act by excluding offences listed by the Secretary of State in a statutory instrument. (p 273) Although this would achieve the result they seek, we believe the list would be inordinately long and need constant updating, which would not benefit users.

108. The approach we prefer is that suggested by John Ringguth. He told us, on behalf of the Council of Europe, that he subscribed to the "all crimes" approach, but thought it appropriate to look at the possibility of a de minimis provision. (Q 490) He did not suggest how this might be drafted, and nor do we.

109. Failure to report a suspicious transaction based on a minor criminal offence should not be prosecuted; and this should be achieved, not by a decision that in a particular case prosecution would not be of public benefit, but by amending the law so that such a transaction would not need to be reported.

110. Consideration should therefore be given to amending the Proceeds of Crime Act 2002 to include a de minimis exclusion.

Consultation with the private sector

111. Given the degree of involvement of the private regulated sector, ongoing consultation with it is no more than common sense. At the level of the FATF it seems that significant progress was made during the British Presidency.[72] The Secretariat told us that the FATF undertook a series of consultation meetings with private sector representatives, including a meeting in London in December 2007 which focused on the exchange of information on money laundering and terrorist financing techniques. They told us that this reflected "an enhanced commitment by the FATF to engage with the private sector. The response by the private sector has been overwhelmingly constructive and productive." (p 249) In support of this view, Ms Scutt told us that the BBA and the International Banking Federation had a great deal of interaction with the FATF and that their experience was "very positive indeed". (Q 48)

112. Within the United Kingdom, the Government "views continued cooperation and engagement with the private sector as critical to the success of the anti-money laundering and counter terrorist financing regime."[73] The Government consulted extensively prior to the implementation of the Third Directive and have established various fora through which they seek to maintain an ongoing dialogue. Several of the private sector representatives from whom we heard participate in the work of these bodies. While there was a generally positive attitude towards these efforts at securing better interaction it was felt in some quarters that there remained room for improvement. (QQ 1-6)

113. In the Revised Strategy on Terrorist Financing which he issued on 17 July 2008[74] the EU Counter-terrorism Coordinator recommended that the Commission and Member States should consider steps to increase the effectiveness of public-private cooperation on countering terrorist financing. We agree with this recommendation, and urge the Government and the Commission to take it forward. We believe this applies equally to AML.

Feedback

114. FATF Recommendation 25 requires FIUs to "establish guidelines, and provide feedback which will assist financial institutions and designated non-financial businesses and professions in applying national measures to combat money laundering and terrorist financing, and in particular, in detecting and reporting suspicious transactions." Article 35 of the Third Directive is to the same effect. Paragraph 2 requires that institutions governed by the Directive must have access to up-to-date information on the typologies adopted by launderers and terrorist financiers to facilitate the identification of suspicious transactions, while paragraph 3 provides: "Member States shall ensure that, wherever practicable, timely feedback on the effectiveness of and follow-up to reports of suspected money laundering or terrorist financing is provided."

115. The Treasury told us that there was extensive bilateral engagement with the private sector across the SARs regime. A number of improvements to private sector cooperation and communications had been taken forward. These included structured feedback by the UKFIU to a vetted group of private sector representatives of SARs reporters. Additionally there was direct feedback to firms from security and law enforcement agencies, and ad-hoc bulletins were produced by the UKFIU for reporting entities, describing current terrorist financing techniques drawn from current counter-terrorist investigations.

116. One of the 24 recommendations in Sir Stephen Lander's review of the SARs regime[75] was that SOCA's discharge of its responsibilities should be supervised by a Committee of SOCA's Board which would also include representatives of the reporting sectors and the end users. The SARs Regime Committee was set up in October 2006; it oversees the performance of regime participants and the discharge of their responsibilities. The Committee has produced two annual reports, for 2007 and 2008.[76] They provide a useful overview of the overall working of the regime, with valuable statistics.

117. Notwithstanding these improvements in private sector cooperation since the creation of SOCA, we received evidence that there remains room for improvement in both the guidance and the case-specific feedback addressed in Article 35 of the Third Directive. An important criticism by the BBA was that the information contained in guidance issued by SOCA was often of too general a character to be of much practical utility to private sector participants. (Q 46)

118. We agree with Sir James Sassoon (Q 396): "It also comes back to what is happening to suspicious activity reports. There is only a certain length of time when we can expect the private sector across the world to be generating this vast volume of data without giving them more general feedback and an opportunity to discuss the methodology." We urge SOCA to intensify its dialogue with the private sector in order to improve the practical utility of its guidance, and so to ensure better focus on matters of real importance.

CASE-SPECIFIC FEEDBACK

119. SOCA at present provides only a limited degree of case-specific feedback to those who have filed SARs. (Q 175) Ms Banks for the ICAEW concluded: "… we think SOCA are already working hard with us in that area and so it is not something that necessarily needs political or parliamentary attention at this time". She did say that many accountants would like more feedback on a case by case basis, but she conceded that this was problematic. (Q 24)

120. The Law Society believes there are more significant shortcomings in feedback within the United Kingdom.[77] "In relation to individual SARs, the private sector will only receive feedback on the usefulness of their SAR and what action law enforcement is taking if they have sought consent, or if law enforcement requires further information from the reporter during an investigation. However, the level of feedback will be very limited or non-existent in most cases. Many of the Society's members still report a perception that their SARs are simply going into a black hole and they are not sure that they are actually making any difference in the fight against crime generally or money laundering more specifically." The Society gives only qualified support to the SARs Regime Annual Reports, and would like to see the Government look at how they can provide a more comprehensive review of the effectiveness of the anti-money laundering and asset recovery regimes within the United Kingdom on a regular basis.

121. Sean McGovern, the General Counsel of Lloyd's, also emphasised the need for improvement in this area. As he noted, "feedback would be quite helpful because it would justify the effort that has gone into it, but also may help in preventing further cases in future". (Q 512)

122. We appreciate the problems of providing case-specific feedback; they include the fact that SARs feed into different law enforcement processes, that many SARs can contribute to a single criminal investigation and that some SARs are used more for civil proceedings than criminal proceedings—reports of tax evasion being a particular example.[78] Nevertheless we believe that it is only by being provided with increased levels of case by case feedback that the regulated sector will be persuaded of the value of the efforts it puts into the SARs regime.

123. Where it is clear that particular SARs have contributed to the success of an AML or CFT operation, and that feedback on this can be given to the originator of the SARs without compromising operations, SOCA should make it the practice to do so in selected cases where they believe that this will demonstrate the importance of providing such reports.

Cost/benefit analysis

124. From the evidence we have received it seems that no cost/benefit analysis is carried out by any body at any level: not by the FATF, not by the EU,[79] and not by any department or agency within the United Kingdom. Yet individual institutions are dedicating very large sums of money to fulfilling their statutory obligations—as much as £36 million a year from one bank. (Q 29)

125. Ms Banks told us that the accounting profession believes that the SARs regime is cost-effective as it stands. "The benefits must be measured not only in terms of prosecutions for money laundering but in prosecutions for the underlying criminal offences; they must be measured not only in terms of the recoveries made but also in terms of more cost-effective criminal investigation generally, in the reputation of this country in terms of clean business practices, and in economic benefits in that business can be carried out much more fairly if people are competing on a level playing field, in that economic crime is picked up and dealt with." (Q 26)

126. Only the Law Society attempted to provided us with a cost/benefit analysis.[80]

BOX 7
Law Society estimate of cost/benefit of SARs

127. The Law Society would be the first to admit that this can only be the roughest of estimates, yet in our view it shows that the return per SAR, though low, is high enough to demonstrate the value of the regime.

128. However, we also think that the system will work better if reporters believe the benefit to AML/CFT is worth the effort and cost to them. It is vital that SOCA should make a serious attempt to calculate the cost/benefit of the reporting of suspicious activities by the United Kingdom private regulated sector. The Government must similarly press international bodies to provide a rigorous cost/benefit analysis.

129. On 10 June 2009 the Commission released a review of the cost of compliance with financial services regulation.[81] The study considers the cost of compliance with five Directives forming part of the Financial Service Action Plan (FSAP), together with the Third Money Laundering Directive which (unlike the Second Directive) was not part of the FSAP. We commend the Commission for commissioning this study, recognising the importance of attempting to estimate the burden of compliance. We hope they will take this work forward, in particular to see whether the benefits of compliance justify the burden.

Is the burden on the private sector disproportionate?

130. We have already referred in paragraphs 103-104 to differences of opinion between our witnesses from the regulated sector on the burden imposed on them by the SARs regime. The Law Society also believes that the implementation of the Third Directive in the United Kingdom, which is much more rigorous than in many other Member States, puts the regulated sector at a competitive disadvantage, though again the BBA and the ICAEW differ. (Q 45)

131. Jonathan Fisher QC, a barrister practising in London and advising firms in the regulated sector, agreed that they complained "on occasions bitterly" about the cost and burden of compliance, but thought they took the view that these were outweighed by the advantages of continuing to operate in London. He pointed out that there had not been an exodus of financial institutions from London as a result of the new AML and CFT regime being implemented. On the contrary, he believed that the imposition of robust AML and CFT procedures, far from damaging a country's financial interests, arguably served to enhance a financial centre's reputation and made it a more attractive venue for financial services. (p 253)

132. Later this year the Treasury will be beginning a review of the burden on the private sector. (Q 464) We welcome this. One matter to which we expect them to pay particular attention is whether this burden does, as has been claimed, put the regulated sector at a competitive disadvantage compared to other countries.

Third country equivalence and simplified customer due diligence

133. FATF Recommendation 9 authorises countries to permit financial institutions or intermediaries or other third parties to perform certain elements of the CDD process or to introduce business subject to certain conditions. The Recommendation further stipulates that "it is left to each country to determine in which countries the third party that meets the conditions can be based, having regard to information available on countries that do not or do not adequately apply the FATF Recommendations." This is the system of third country equivalence. The purpose is to help the private sector by allowing simplified due diligence—a lifting of the more rigorous customer due diligence—in relation to transactions with persons in named third countries.

134. The Third Directive embraces the concept of equivalence in Article 11 on simplified CDD, in Article 14 concerning reliance on third parties, and in Article 28 in relation to the operation of exceptions to the prohibition of disclosure. However, the term "equivalent" is not defined in the Directive. In May 2008 the Member States agreed to a list of equivalent countries in the EU Committee on the Prevention of Money Laundering and Terrorist Financing. We were informed that "the equivalence list recognises all EU and EEA Member States as equivalent (because of their obligations to implement the EU's Third Money Laundering Directive)".[82] Surprisingly, even Member States which have failed to transpose the Directive into domestic law are so characterised.

135. The list also includes most (but not all) FATF countries; Gibraltar (because it is directly subject to the requirements of the Directive); and certain French and Netherlands overseas territories (on the basis that they are part of their mother countries which are members of the FATF). The United Kingdom Crown Dependencies (Jersey, Guernsey and the Isle of Man) "may" be considered equivalent by EU Member States, and nine countries (including the United Kingdom) have now availed themselves of this option. (Q 84) None of the United Kingdom Overseas Territories appears on the May 2008 list, which so far has not been amended.

THE EFFECT ON THE PRIVATE REGULATED SECTOR

136. Our witnesses are unanimous in thinking that third country equivalence does not achieve its object of helping the private regulated sector. There is, as we have said, no definition of equivalence, and the Treasury "statement on equivalence" listing equivalent third countries was described by the Law Society as "voluntary, non binding and does not have the force of law … Regulated individuals or entities are required to make the assessment of equivalence themselves." [83] The Fraud Advisory Panel described equivalence as "at best simply another factor in the risk assessment of a customer and, at worst, meaningless." (p 267)

137. We believe that the Government must provide a definition of equivalence, and allow the regulated sector to rely on the list of equivalent countries.

THE POSITION OF THIRD COUNTRIES

138. There are several curious features concerning the way this issue has been treated at the EU level. First, the construction of such a "white list" of equivalent countries is not mandated by or foreseen in the Directive itself. Secondly, it was clear from the evidence of James Robertson that the criteria applied by the Member States in drawing up the list in May 2008 had not been made public. (QQ 74, 76) And thirdly, there is no clear procedure for seeking admission to the list, though we were informed that what would probably happen in practice "is that a third country would have to request via the Commission or a Member State that its candidature, if you like, could be discussed". (Q 75) We do not regard this as satisfactory.

139. Reputable third countries will want to get onto the list since it equates their AML/CFT procedures with those of Member States. The Government should press for tough and clear published EU criteria for States to be granted third country equivalence status, and for a set procedure for them to apply for inclusion in the list, and for handling such requests.

Non-cooperative countries and territories (NCCTs): enhanced CDD

140. The concept of equivalence is intended to provide a form of positive recognition to those countries which have built and implemented AML/CFT systems in accordance with international standards. Conversely, the FATF and MONEYVAL have also introduced compliance enhancing procedures to reinforce the mutual evaluation process when reports identify deficiencies in specific countries. In addition, FATF Recommendation 21 provides the basis upon which further action can be taken in respect of specific jurisdictions which do not apply, or insufficiently apply, FATF recommendations.

141. The current process—one which was improved under the recent United Kingdom Presidency—involves the identification of problematic jurisdictions by the International Cooperation Review Group (ICRG) within the FATF, followed by efforts to engage with the countries concerned. Where this fails to produce the necessary progress the FATF will issue a public statement urging all jurisdictions to advise their financial institutions to take the risks arising from these deficiencies into account for the purposes of enhanced CDD. Several such public statements have been issued in respect of non-FATF member countries in recent years, with inevitable implications for the reputations of those countries.[84] MONEYVAL also issued a public statement of this kind in respect of one of its own members—Azerbaijan—in December 2008, and publicity was given to this initiative by the FATF. (Q 503)

142. Recommendation 21 also envisages that where States identified in this way do not respond positively and improve their AML/CFT systems, countries should be able to apply appropriate counter-measures.

BOX 8
FATF counter-measures against non-cooperative countries

143. In the United Kingdom the Counter-Terrorism Act 2008 has conferred on the Treasury new powers which mean "the United Kingdom is now able to comply fully with FATF Recommendation 21 concerning the requirement to impose counter-measures against jurisdictions of concern".[85] We welcome this development.

144. In February 2009 the FATF issued a public statement in which it called upon its members and all other countries to apply effective counter-measures to protect their financial sectors from AML/CFT risks emanating from Iran. At its plenary meeting in Lyon on 24-26 June 2009 the FATF reaffirmed this statement. However, it did not specify what counter-measures should be resorted to, it being left to each state to determine, in the light of its particular circumstances, what course of action was appropriate. (QQ 65-68)

145. Sir James Sassoon stated that "it would be highly desirable in these circumstances if the FATF, since it has specific ranking of counter-measures of its members—whether it is Iran or for anybody else—was actually able to agree where in the ranking of counter-measures they would expect their members to be." (Q 417) We strongly endorse this view, which seems to be accepted by the FATF.[86] There is a need for greater harmonisation of approach within the FATF when, as with Iran, counter-measures are called for. The Government should press for this in the present FATF review of the ICRG process.

61 Evidence session on 4 March 2009, QQ 1-53. Back

62 Evidence session on 13 May 2009, QQ 506-541. Back

63 "Guidance on the Risk-Based Approach to Combating Money Laundering and Terrorist Financing: High Level Principles and Procedures", FATF, June 2007, p.2. Back

64 The Glossary to the FATF Forty Recommendations contains the following definition: " 'Politically Exposed Persons' (PEPs) are individuals who are or have been entrusted with prominent public functions in a foreign country, for example Heads of State or of government, senior politicians, senior government, judicial or military officials, senior executives of state owned corporations, important political party officials. Business relationships with family members or close associates of PEPs involve reputational risks similar to those with PEPs themselves. The definition is not intended to cover middle ranking or more junior individuals in the foregoing categories." FATF Recommendation 6 sets out some of the enhanced CDD measures appropriate where the customer is a PEP. Back

65 Commission Directive 2006/70/EC of 1 August 2006 laying down implementing measures for Directive 2005/60/EC of the European Parliament and of the Council as regards the definition of politically exposed person and the technical criteria for simplified customer due diligence procedures and for exemption on grounds of a financial activity conducted on an occasional or very limited basis (OJ L214 of 1 August 2006). Back

66 Memorandum by HM Treasury, paragraph 16, p 42. Back

67 The corresponding figures for the Law Society were 6,460 (Q 7), .for the ICAEW 7,300 (Q 7), and for Lloyd's 70 (Q 508). Back

68 A term of US origin now widely used in the FATF and elsewhere. Back

69 Proceeds of Crime Act 2002, section 340. Back

70 Q 45, and Supplementary memorandum by the Law Society, March 2009, paragraphs 2.5 to 2.10, pp 35-36. Back

71 Council Framework Decision 2002/584/JHA of 13 June 2002 on the European arrest warrant and the surrender procedures between Member States, Article 2 (OJ L190 of 18 July 2002). Back

72 Sir James Sassoon, Q 396. Back