Earlier this year the UK tightened its anti-money laundering regime with the passage of the Criminal Finances Act 2017 (“the Act”). Businesses have until the end of this month to comply.

The new legislation

Overhauls suspicious activity reporting,

• provides law enforcement with new powers to investigate and seize property and
• creates a new corporate “failure to prevent” offence for tax evasion.

Together, these measures promise to expand public-private cooperation and encourage financial institutions to exercise greater caution when dealing with their customers and third parties.

Many firms in the regulated sector including banks, law firms, accountancy firms, estate agents, trust companies and financial advisors will need to improve their compliance programmes to comply with the Act.

The line between tax mitigation and tax evasion is a fine one and firms may find that they sell products or have relationships that put themselves at risk of prosecution.

Given this tightening regulatory scrutiny, how can firms ensure they fully understand their risk exposure and are compliant with the provisions of the new Act?

Overhauling the SARs Regime

British businesses file hundreds of thousands of suspicious activity reports (“SARs”) each year, most of which advertise compliance rather than preventing financial crime. The government hopes to make SARs more effective by working with banks and other regulated firms to investigate not only transactions but also individuals. To this end, the Act extends the moratorium period for processing suspicious transactions, encourages information sharing among financial institutions and allows the National Crime Agency (“NCA”) to request further information from SAR filers. The Act also makes it easier for law enforcement to compel third parties to disclose information related to money laundering.

Financial institutions are encouraged by the Act to take a more collaborative approach to suspicious activity reporting. This approach builds on the Joint Money Laundering Intelligence Taskforce, which has brought banks and law enforcement together to combat high-end money laundering. Financial institutions send the NCA more than 14,000 requests a year to process suspicious transactions, and law enforcement struggles to adjudicate these SARs within the current 31-day moratorium period, especially as many investigations now require international collaboration. The Act addresses this by giving law enforcement the capability to apply for up to six, 31-day moratorium extensions. It also provides regulated entities that share information with each other immunity from civil liability. This will allow firms to compile detailed financial intelligence in a single joint disclosure report, or “super SAR”.

Financial institutions and other regulated businesses should respond to the new, more collaborative SARs regime by investing in sustainable compliance programmes. Well-designed transaction monitoring systems, thorough customer due diligence and effective financial intelligence can prevent SARs that block innocent customer transactions for months and damage a business’s reputation. Such measures can save businesses money, whilst potentially preventing regulatory fines and customer fraud.

Unexplained Wealth and Freezing Orders

The Act targets both suspicious customers and suspicious wealth. To this end, it allows various agencies[1] to apply to the High Court for Unexplained Wealth Orders (“UWOs”). UWOs require the respondent to explain the nature and extent of their interest in property and to document how they met the costs of obtaining it. Related to this, the High Court can also issue interim freezing orders (“IFOs”) if it believes that the respondent is uncooperative or might frustrate a subsequent recovery order. Although these disclosure requirements are significant, UWOs only apply to non-UK or non-European Economic Area (“EEA”) politically exposed persons (“PEPs”) and to those involved in serious crime who have assets worth more than £100,000.[2]

UWOs and IFOs will pose new challenges for financial institutions’ compliance departments. Although UWOs target individuals and not financial institutions, regulators may act against firms that fail to collect accurate source of wealth information or whose customers are subject to a disproportionate number of UWOs. Financial institutions will therefore want to maintain robust know your customer (“KYC”) programmes. This is not always easy. Many countries lack centrally held property registers and the proliferation of assets held by shell companies, trusts and other anonymising vehicles makes compiling accurate beneficial ownership information difficult. Moreover, cultural stigma often prevents frontline employees from enquiring about their customers’ source of wealth. Businesses wishing to retain foreign clients should make sure that their KYC procedures are robust enough to stand up to the heightened regulatory scrutiny.

In addition to giving law enforcement new ways of targeting suspicious wealth, the Act allows the government to seize money connected to criminal activity and terrorism. More than 30,000 accounts worth £30 million are currently frozen. However, the government lacks the legal means to confiscate these funds because their owners have not been convicted of a crime and their accounts contain less than £10,000. The Act addresses this by allowing senior enforcement officers and the courts to issue forfeiture notice orders. Banks will therefore need to employ teams to respond to the orders and forfeit the suspended accounts.[3]

Corporate Failure to Prevent Tax Evasion

With the publication of the Panama Papers and allegations that certain private banks helped  customers avoid paying taxes, the UK government wants to hold businesses accountable for their role in tax evasion. Yet the Libor Scandal revealed how difficult it is for the government to prosecute businesses for facilitating financial crime. Based on Section 7 of the UK Bribery Act (“UKBA”), the Act frees prosecutors from identifying a business’s “controlling mind”, making it an offence for a corporation or partnership to fail to prevent an associated person—someone acting for or on behalf of the entity—from criminally facilitating either:

1) A UK tax evasion offence; or

2) An equivalent offence under foreign law.

The Act particularly targets businesses that create and market complex structures to circumvent tax reporting requirements. It seeks to hold businesses accountable in cases where management distances itself from illegal activity or looks the other way.

Like the UKBA, the Act’s failure to prevent provisions have an extra-territorial affect, applying to corporates and partnerships that do business in the UK, wherever they do business.

Banks are therefore understandably concerned that the courts will hold them responsible for the actions of their foreign permanent establishments.

For example,

• a French bank with branches in the UK and Singapore, which uses a law firm in Hong Kong to provide tax planning advice, could find itself prosecuted if the Hong Kong firm facilitated tax evasion.
• However, if the Hong Kong-based subsidiary of a British banking group facilitates tax evasion in Hong Kong, it is only covered by the Act if it facilitates UK tax evasion.

So how can organisations respond?

Despite the Act’s wide reach, the failure to prevent offence has a “reasonable procedures” defence, which is likely less demanding than the UKBA’s “adequate procedures”.

What constitutes reasonable procedures will depend on prosecutors and the courts, but the government has said that they will include “compliance with any applicable published guidance, its contractual terms for its staff, the training it provides and any steps taken to monitor and ensure compliance would all be relevant to the assessment of whether it had taken reasonable steps”.

Further guidance will likely resemble that for the UKBA, which stipulates:

1. Proportionate procedures
2. Top-level commitment
3. Risk assessment
4. Due diligence
5. Communication
6. Monitoring and review

The Act poses a new compliance challenge for financial institutions, accountancy firms, law firms, asset or wealth managers, trustees and company formation agents. Yet much of the regulated sector already has procedures to identify customer tax evasion that could address the failure to prevent requirements. In addition to third party due diligence, banks have developed programmes that promote tax transparency.

These programmes include complying with the Foreign Account Tax Compliance Act (“FATCA”), which requires them to report the assets of their American clients to the US Treasury, and the OECD Common Reporting Standard – which shares information about assets and incomes between jurisdictions.

Such procedures would likely form the backbone of any financial institution’s reasonable procedures defence and should go some way to reducing compliance costs.

1.  Agencies include: the National Crime Agency, HM Revenue & Customs, Financial Conduct Authority, Serious Fraud Office and the Crown Prosecution Service
2. This includes family members and “close associates”
3. Parliamentary Impact Report, http://www.parliament.uk/documents/impact-assessments/IA17-001.pdf
4. BBA Response to Failure to Prevent Legislation, July 6, 2016