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Money Laundering Update for Family Lawyers

Ellie Foster, of Addleshaw Goddard, highights what family lawyers need to know about the new Money Laundering Regulations 2007 which come into force on 15 December 2007

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Ellie Foster, Addleshaw Goddard

For the harried family lawyer, there would appear to have been a continual bombardment in recent years of fresh money laundering law legislation. The Proceeds of Crime Act 2002 (PoCA) caused widespread uncertainty as to the obligations of the family lawyer with regard to potentially criminal activity, although this was mitigated somewhat by the decision in Bowman v Fels [2005] 2 FLR 247 which drew a collective sigh of relief from the profession. The Money Laundering Regulations 2003 then extended anti-money laundering obligations. There is now yet further activity on the anti-money laundering horizon in the form of the Third EC Money Laundering Directive which has prompted further domestic regulations in the form of the Money Laundering Regulations 2007, which are due to be implemented by 15 December 2007.

It is perhaps helpful to outline the legal framework for anti-money laundering legislation.

The First EC Money Laundering Directive came into force in 1991. Applying to financial institutions, it required member states to make money laundering a criminal offence.

The Second EC Money Laundering Directive came into force on 28 December 2001 and was implemented in the UK in March 2004 by way of the Money Laundering Regulations 2003 and PoCA. It extended anti-money laundering obligations to certain activities provided by designated professionals, including the legal profession.

In 2005, a Third Money Laundering Directive, as required under the terms of the Second Directive, came into effect. The intention was to consolidate the first two directives and incorporate a number of further recommendations. The provisions of the Third Directive extend due diligence obligations to beneficial owners and enhanced due diligence must be undertaken in certain circumstances.

The key provisions of the Third Directive may be summarised as follows:

1 Extension of the definition of "criminal activity"
However, this is anticipated to have little effect in the UK, given the wide definition already included within the Money Laundering Regulations 2003, PoCA and the Terrorism Act 2000.

2 The "Regulated Sector" is to be extended
Again, this is anticipated to have little impact in the UK given the scope of existing legislation.

3 Obligations on those in the Regulated Sector and ongoing monitoring.
The "Know Your Client" obligations have been reinvented as "Customer Due Diligence" or "CDD". The requirements have been enhanced to enable practitioners to more easily identify suspicious transactions if they are more fully familiar with their client and are more able to understand the reasoning behind the instructions given. For a discussion of these obligations see below.

4 Politically exposed persons
In the case of such persons, and on a risk-sensitive basis, practitioners will be obliged to apply enhanced CDD measures and additional checks. These may be cases where there is a higher risk of money laundering or terrorist financing.

5 Tipping-off offences
The Third Directive included a provision proposing to prohibit any disclosure of a report to SOCA (in the UK's case) regardless of whether it would or would not prejudice that investigation. This proposed absolute prohibition is at odds with current UK legislation. For further details see below.
Money Laundering Regulations 2007

In January this year, draft Money Laundering Regulations, to repeal and replace the Money Laundering Regulations 2003 and to incorporate the Third Directive into UK law, were published by the Government and they then commenced a three month public consultation exercise. In July 2007, the Treasury published a summary of the responses to the consultation in respect of which the Law Society had given significant input. In September 2007, the Law Society issued a practice note on anti-money laundering and counter terrorist financing which aims to assist solicitors in good practice and compliance with PoCA, the Terrorism Act 2000 and the imminent Money Laundering Regulations 2007. They are seeking Treasury approval of the document.

Customer Due Diligence
CDD procedures will be required when:

(a) establishing a business relationship;
(b) carrying out an occasional transaction, that is, a transaction amounting to €15,000 or more;
(c) there is a suspicion of money laundering; or
(d) the practitioner doubts the veracity or adequacy of documents, data or information previously obtained for the purpose of CDD.

Practitioners are obliged to carry out ongoing monitoring of their clients on a risk-sensitive and appropriate basis. The general rule is that CDD should be on a risk based approach. It will be possible to undertake simplified CDD in certain circumstances when the risk of money laundering is deemed to be low. One example would be in the case of listed companies.

However, the most controversial element of the new CDD requirements is that of identifying beneficial owners that are not the client. This provision of the Directive will have significant impact in the UK, particularly in relation to trust arrangements. The Money Laundering Regulations 2003 currently do not require the identity of the beneficial interest in such a structure to be established.

The Law Society has been particularly exercised by this provision in the draft Regulations as it creates potentially onerous obligations for the profession. For example, when acting for a client who instructs you on behalf of another person, entity or arrangement, you will need to identify the beneficial owner as well. The Law Society explains that the key is to understand the ownership and control structure of the client and the role, if any, that each beneficial owner has in the retainer. This will mean obtaining their name and recording any other identifying details that are readily available. The Law Society practice note deals in some detail with the types of beneficial owners of a trust and provides numerous worked examples to explain how all beneficial owners may be identified and what CDD verification procedures are necessary.

It is probable that the new obligation to identify beneficial owners, particularly for trust practitioners, will involve the verification of potentially large numbers of people. It is suggested that the required procedures are unreasonable both in terms of time and cost and it is inevitable that the additional costs created by the enhanced CDD requirements will be passed on to the client.

For a detailed discussion of the concerns expressed about the identification of beneficial owners see the Law Society letter to the Treasury of 11 January 2007 (available on the Law Society website) and the HM Treasury paper reporting the responses to their consultation.

As regards ongoing monitoring, practitioners are obliged to ensure that CDD material is kept up to date. The Law Society practice note suggests explicitly that practitioners need not conduct the whole CDD process again every few years or conduct random audits of files once the new Regulations come into force. It is however recommended for existing clients that files should be reviewed and CDD material updated, for example, when taking new instructions from a client, particularly if there has been a gap of over three years between instructions, when information is received of a change in identity details, where there is a suspicion of money laundering or where there is a higher risk retainer.

Tipping off
The Law Society has been particularly excited by the proposal in the Third Directive as to an absolute prohibition on disclosing that a report has been made to SOCA. The existing domestic tipping off provisions in sections 333 and 342 of PoCA mean that it is an offence to make a disclosure which is likely to prejudice an investigation if the person knows or suspects that a report has been made to the firm's nominated money laundering officer or SOCA, or if he/she knows or suspects that a money laundering investigation is being, or will be, carried out. The most important defence to these offences is a disclosure made in connection with the giving of legal advice. In effect, the Directive would seek to remove this legal professional privilege exemption from which the profession currently benefits. The Law Society has conveyed its serious concerns to the Home Office about the impact of this provision. The view was expressed that the development of money laundering legislation must avoid eroding even further the professional duties of solicitors and must not compromise the protection for the client as enshrined in the principle of legal professional privilege. The Law Society pointed out that this issue led them to intervene in the case of Bowman v Fels in order to clarify solicitors' reporting obligations and safeguard the principle of legal professional privilege. The Law Society stated that they took very seriously any attempts to constrain the ability of solicitors to give legal advice which could limit access to justice. The Law Society has met with officials from the Home Office in order to discuss these concerns and the latest news from the grapevine indicates that the Home Office are poised to retreat from introducing this new "absolute" tipping off offence within PoCA following the intense lobbying by the Law Society. The practical effect of the Law Society's lobbying appears to be that solicitors will still be able to give legal advice as long as it does not prejudice an investigation.

Administrative obligations
Under the terms of the Regulations, firms in the Regulated Sector will be monitored and supervised by the Solicitors Regulation Authority for compliance with the Regulations. Firms are obliged to develop systems to meet their obligations in a risk-based and proportionate manner. Staff should be trained in order to understand their legal obligations, to recognise money laundering risks and to apply the CDD systems consistently. Firms need to ensure that they have internal controls to ensure compliance with the Regulations and must monitor compliance to ensure that the policies and procedures introduced are effective. An effective CDD system must be in place and there must be adequate arrangements for record keeping and retention of CDD material. Finally, all firms should have systems in place setting out the requirements for making a report under PoCA or the Terrorism Act 2000.

Impact on family lawyers
It is not anticipated that the new Regulations will have significant impact for the average family lawyer on a day to day basis. All family lawyers should already be fully familiar with their obligations under current money laundering legislation and should have in place thorough systems to verify the client's identity, to recognise the risk of money laundering and address potential criminal activity. However, practitioners should be alert to the changes afoot in the new Regulations to ensure that they comply fully with their obligations.

Identifying and verifying the client should be straightforward in the average matrimonial case. However, do ensure that appropriate original identity documentation is viewed and verified. Make certified copies. Ensure that this documentation is filed safely so that it may be located easily if necessary. In some circumstances, for example, perhaps if you are involved in an Inheritance (Provision for Family and Dependants) Act 1975 claim or if you are acting for trustees in respect of a variation of a nuptial settlement, you may need to consider the identification and verification of beneficial owners. If instructed as an agent on a matter, again undertake a CDD risk analysis to assess what verification is required.

It is recommended that practitioners take time to review the comprehensive practice note issued by the Law Society, which contains background information on money laundering legislation, explains in detail the effect of the imminent Regulations and provides guidance as to the practical application of the enhanced obligations. It would also be prudent to keep one eye trained on the outcome of the Law Society's lobbying in respect of the tipping off provisions in the Regulations.