Checking your source

Recent estimates suggest that economic crime costs the UK between £290 billion and £350 billion each year, around double the budget of NHS England. With a growing focus on tackling money laundering and economic crime in conveyancing, solicitors, law firms and legal compliance professionals are having to pay ever more attention to their anti-money laundering (AML) compliance. Unfortunately, there’s no ‘one size fits all’ approach when it comes to AML compliance, particularly regarding source of funds (SoF) and source of wealth (SoW) verification. So, what do property lawyers need to know?

SRA developments

The Solicitors Regulation Authority (SRA) released its Anti-Money Laundering (AML) Annual Report for 2022-23 on October 13, 2023. The report provides insights gleaned from the outcomes of 224 inspections and desk-based reviews conducted during the reporting period, revealing that only 20% of firms investigated were fully compliant with AML regulations. 29% were non-compliant, while 51% demonstrated partial compliance. Among the common issues identified were inadequate customer due diligence, insufficient risk assessments, and a lack of comprehensive staff training.

SoF and SoW checks are integral components of AML compliance and the report flagged a number of areas in need of improvement. Common issues in the report included:

• firms obtaining bank statements without conducting in-depth inquiries into fund sources,
• making written notes on transaction funding without supporting documents, and
• providing transaction details only after regulatory requests.

The report also underscores the significance of customer due diligence (CDD) in AML compliance and flagged some common issues faced by legal firms including failures in identifying clients, politically exposed persons (PEPs), and sanctions violations. The report emphasises the importance of understanding the source of funds in assessing transaction risk and mentions updated guidance from the Legal Sector Affinity Group (LSAG) for firms to follow.

Earlier this year, the SRA also raised the matter of its new fining powers, which include being able to fine individual solicitors up to £25,000. It also seeks to penalise partners who have allowed misconduct to happen on their watch. Automatic fixed penalty fines – previously reserved for administrative mistakes – are being considered for AML non-compliance in a bid to crack down firmly on this.

Why source of funds matters

We’ve also seen the introduction of the Economic Crime and Corporate Transparency Act, which received royal assent on 26 October 2023, a comprehensive piece of legislation to fortify the fight against corruption, money laundering and fraud.

The act introduces several wide-ranging reforms including a new offence of failure to prevent fraud for large firms, reforms to Companies House introducing identity verification to requirements for new and existing directors and increased fines for law firms.

SoF and SoW checks are central to the AML regime because they address the crucial question of where the money for a transaction or business relationship originated. The ability to trace and verify the source of funds is vital in preventing money laundering and terrorist financing. By identifying and understanding the source of a client’s funds, legal professionals contribute to the integrity of the financial system.

Legal practitioners often have questions and concerns about SoF checks, including whether SoW checks are always necessary, how far back they should go, and whether they apply to all clients and transactions.

Understanding source of funds

Source of funds checks seek to understand where the money for a transaction or business relationship originated. These checks involve a comprehensive examination of the activity that generated specific funds. Legal practitioners must continually assess whether the client’s financial circumstances align with their stated source of funds.

The responsibility for conducting SoW checks cannot be outsourced. While technology and support staff can assist in the process, the fee earner with conduct remains ultimately responsible for assessing transaction risk and understanding the alignment between the client’s story, the transaction, and the evidence provided. This underscores the importance of individual accountability in AML compliance.

Understanding source of wealth

The LSAG states that: “The source of wealth refers to the origin of a client’s entire body of wealth (ie total assets).”

SoW describes the economic, business and/or commercial activities that generated, or significantly contributed to, the client’s overall net worth/entire body of wealth.

It is important to understand that SoF and SoW are two distinct concepts. Source of funds means the specific funds used for a particular transaction and where they originated from. Source of wealth, on the other hand, means the origin of a client’s total wealth and assets, encompassing more than just one transaction.

The purpose of gathering information about a client’s SoW is not to determine their net worth. Instead, it’s to better understand the activities that have contributed to the accumulation of their wealth and to assess any potential risks associated with these activities.

Common problems

Several common problems can arise in the context of SoW checks. These issues often pose challenges to legal practitioners and require proactive measures to address:

• Inadequate documentation: Firms may fail to adequately document their rationale and decision-making processes when conducting source of funds checks. This can make it challenging to demonstrate compliance in case of regulatory scrutiny.
• Lack of policy clarity: Firms must establish clear policies and procedures for SoF checks. It is crucial that team members understand when and how these checks are necessary to ensure consistency in compliance.
• Inconsistent adherence: Some firms may struggle with consistent implementation of their SoW checks policies. This can lead to gaps in compliance and undermine the effectiveness of AML measures.
• Lack of risk awareness: Legal professionals may fail to recognise red flags indicating potential money laundering or terrorist financing. Awareness of these red flags is essential for effective SoW checks.

Risk assessment

A robust risk assessment is crucial for AML compliance, both at the client and matter levels. Risk assessments ensure that each client and matter is treated appropriately from the outset, allowing for the implementation of adequate CDD measures. A genuine risk-based approach is not only best practice but is also embedded in UK legislation and AML regulations.

While risk assessments are vital, there are common problems and gaps in their implementation within legal firms. These issues can hinder effective AML compliance and include:

• Lack of clear templates: Firms may struggle to establish clear templates for risk assessments, leading to inconsistencies and incomplete assessments.
• Inadequate training and understanding: Legal professionals may not receive adequate training in conducting risk assessments or may not fully understand the criteria for assessing risk.
• One-time approach: Some firms may treat risk assessments as a one-time requirement rather than a dynamic and ongoing process, neglecting the need for continuous monitoring.
• Incomplete assessments: Firms may conduct risk assessments that are incomplete or fail to consider all relevant factors, leaving potential compliance gaps.

Role of technology

Technology plays an important role in the streamlining of SoF checks and the enhancement of AML compliance practices. Open banking, for example, provides a secure and efficient avenue for law firms to gain access to their clients’ digital bank statements.

Primarily, open banking enables instantaneous access to clients’ digital bank statements, removing the inherent delays associated with traditional document collection methods. This can speed up the process significantly. Furthermore, it significantly enhances security by reducing the risks of statement tampering or interception via email or postal services, thus safeguarding the integrity of financial data. The ease of access extends to the generation of straightforward and accessible reports.

Technology can also play an important role in the analysis of financial transactions. Through the utilisation of data analytics, technology has the capability to discern patterns and anomalies, thereby facilitating the identification of potential money laundering or other illicit activities. This augmentation of SoF checks empowers legal professionals to align their practices with a truly risk-based approach to AML compliance.

Likewise, technology and data analysis can support the risk assessment process. For example, by facilitating the streamlining of controls within risk assessment procedures, automating and optimising certain processes, which, in turn, reduce the likelihood of human errors. Secondly, it can support ongoing monitoring through automated systems. These systems are adept at providing continuous surveillance of client and matter data, promptly identifying any changes or triggers that may indicate heightened risk levels. Furthermore, technology significantly contributes to the realm of client identification and verification. By simplifying and speeding up these crucial processes, technology ensures the swift and accurate determination of the authenticity of clients’ identities, thereby strengthening the risk assessment process. This includes automated screening for PEPs and sanctions.

However, while technology offers substantial benefits in supporting SoF checks and AML compliance, there remain several gaps and challenges:

• Integration hurdles: The integration of open banking and data analytics tools into existing systems can pose difficulties for certain law firms, potentially impeding the seamless flow of compliance processes.
• Data privacy concerns: The handling of sensitive financial data necessitates robust data privacy and security measures. Legal professionals must meticulously adhere to data protection regulations when employing technology for SoF checks.
• Ongoing compliance vigilance: It is crucial to recognise that technology alone does not guarantee compliance. Legal professionals must remain abreast of regulatory updates and best practices in leveraging technology for AML compliance to ensure ongoing adherence to evolving standards.

Looking forward

The SRA’s AML Annual Report 2022-23 gives an indication of where things are moving. In short, regulation is tightening, fines are increasing, and firms are under ever growing scrutiny. AML compliance, effective risk assessments, and thorough SoF checks are a strategic imperative. Property lawyers must stay informed about regulatory updates, embrace technology, and continuously improve their AML practices to combat money laundering and terrorist financing effectively.