Emerging money laundering and terrorist financing risks facing the legal sector

The relationship between legal professionals and money laundering is one that is extremely complex and challenging. The National Risk Assessment published in December 2020 (NRA) identified the legal sector as vulnerable to the threat of money laundering because the services provided can afford criminals with a veneer of legitimacy to their transactions. The NRA pinpoints the services most vulnerable to being exploited by criminals as conveyancing, trust and company services and client accounts.

We have witnessed a global expansion of criminal activity as the world has become more technologically, socially, and economically advanced. The exact amount of criminal money flowing through the UK annually is not known but the stark reality is that it is in the hundreds of billions of pounds^[1].

The SRA’s Sectoral Risk Assessment

As a regulator of the legal sector, the SRA is duty bound by the money laundering regulations to produce an annual risk assessment of their supervised sector^[2]. The aim of the Risk Assessment ^[3] is to help the SRA focus resources on areas most vulnerable to the threat of money laundering, at the same time as assisting law firms that fall within the scope of the regulations understand their potential exposure to money laundering risks ^[4].

The Risk Assessment can assist law firms assess emerging risks to the legal sector from money laundering ^[5]when preparing their own firm wide risk assessments. However, the SRA has warned that the Risk Assessment must not be used as a substitute for a law firm’s own firm wide risk assessment. The regulator can request sight of a law firm’s written firm wide risk assessment, together with any anti money laundering policies, controls, and procedures, as part of their supervisory role.

Emerging Sectoral Risks

The Risk Assessment identified the following areas as emerging risks facing the profession:

• Vendor fraud
• Pooled client funds
• Third-party managed accounts
• Irregular methods of transferring funds
• Technological advancements

Such risks identify the importance of knowing your client, satisfying internal client diligence procedures, and understanding the source of the monies being used to fund a client’s transaction.

• There has been an increase in vendor fraud, probably not seen since the 2008 economic downturn. Conveyancing services related to both residential and commercial properties are considered as high risk of the threat of money laundering due to the high value and large volume of transactions involved.^[6]

  Vendor fraud involves criminals targeting mainly residential properties and fraudulently selling them, impersonating the genuine owners. The purchase monies are transferred through the purchaser’s solicitors and upon completion the monies are sent to the vendor’s solicitors. Transactions of this nature are attractive to criminals as they provide both the means to commit fraud and clean illicit funds through two law firms.

  Law firms are reminded to exercise caution when acting for clients they do not meet face to face and be alive to warning signs such as:

  • Properties for sale valued over or below market value
  • Back-to-back/sub sale transactions
  • Cash purchases
  • Reluctance by the client to provide requisite documentation and/or instructions
  • Pressure to expedite the transaction
  • Complex or unusual circumstances around the transaction
  • Funds coming from or going to unconnected third parties
  • Being instructed to act for all parties
• 

  Pooled client funds

  Care is needed if handling transactions involving pooled client funds as this can prove difficult when determining the source of funds, particularly when the parties do not know each other and there are numerous sums involved. Examples of pooled client funds can involve transactions where numerous participants are contributing to fund the purchase of a property, or provide the deposit, such as cash gifts at a wedding or via crowdfunding. These transactions are acceptable as long as the risks have been assessed appropriately, requisite documentation requested and verified, and any decisions made documented.

• 

  Third party managed accounts

  It is common for payments to be made in a transaction by third parties, for example parents or grandparents gifting the deposit to purchase a home for their family member. However, payments being made to or by a third party can be cause for concern if the payment is unexpected or made by unconnected parties. Criminals will seek to conceal the true origins of their funds by making payments via third parties. The warning signs to be alive to include payments being made without notice, requests for monies to be repaid immediately as ‘made in error’ to either the same account or a different account.

  The importance of fully understanding the nature of the transaction and assessing the risk and conducting the appropriate checks on those providing the funds and verifying the source of the monies is crucial in minimising the risk of breaching the money laundering regulations.

• 

  Irregular methods of transferring funds

  Requests for irregular payments may be acceptable provided law firms have asked the right questions of their clients in order to understand the reasons why – are clients trying to evade money laundering checks being imposed by their banks?

  Or are they merely trying to pay over their deposit monies saved and complying with their bank’s limits for transferring/withdrawing funds?

  It is important that questions are asked of clients to enable law firms to carry out the appropriate checks, adequately assess the risk and apply the correct level of due diligence to minimise their exposure to money laundering risks.

• 

  Technological advancements

  As a society we are benefitting from emerging technological advances. Criminals are nothing if not opportunistic and are too taking full advantage of the new opportunities the same technologies are offering. There has been increased legislation closing loopholes that were being exploited by money launderers, but criminals will adapt and find ways to exploit the new measures, using technological advancements.

  The SRA has identified the use of technology in the provision of legal services as an emerging risk area in the Risk Assessment. The regulator recognises that as law firms include technology as a new discipline and/or a new delivery channel for the provision of legal services they may come across new or previously unidentified risks. Clients are using new methods to fund transactions such as cryptocurrencies or fund transfer systems and crowdfunding platforms. The SRA’s advice is that law firms should risk assess any such new products, delivery mechanisms or technologies before they are implemented to determine whether there is any suspicious behaviour.

  In addition, we cannot talk about technological advancement without mentioning cyber risk. Law firms are attractive to cyber criminals as they retain highly sensitive and valuable client information and handle financial transactions with an estimated revenue in the sum of £43.9billion ^[7]. The increased use and reliance on technology heightens cyber security risk, and without adequate security measures vulnerabilities in law firms’ information technology systems may be exploited by criminals.

In summary

The standards expected by the SRA are becoming higher following the increased pressure being imposed on the regulator by the UK Government to crack down on those law firms with inadequate systems in place. We are seeing substantial financial penalties being imposed as well as any reputational fall out that goes beyond any fine.

The UK is still experiencing economic pressures, and often when economic conditions contract, businesses will look to reduce costs. It is often those departments that do not directly generate income, such as risk and compliance departments, that may be at risk from budget cuts.

Regardless of the economic climate the need to ensure compliance with money laundering regulations is still a mandatory requirement, if anything it is more important as money launderers may look to exploit any areas of weakness as a result of any streamlining of resources.

It is essential that law firms fully understand and mitigate against the risks from the emerging threat of money laundering. This includes implementing and reviewing the requisite anti money laundering policies, controls and procedures as well as having measures in place to provide appropriate supervision and training. Such measures are no longer a ‘nice to have’, but a necessity.

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Footnotes

1. Money laundering and illicit finance Return to article
2. The Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 Return to article
3. Sectoral Risk Assessment - Anti-money laundering and terrorist financing Return to article
4. The Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 Return to article
5. NB: We focus on money laundering for the purposes of this article rather than terrorist financing and proliferation financing on the basis that the legal profession is low risk to such threats Return to article
6. National risk assessment of money laundering and terrorist financing 2020 Return to article
7. National Cyber Security Centre. (n.d) Cyber Threat Report: UK Legal Sector. Retrieved Return to article