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Is the UK complying with its International Anti-Money Laundering obligations?

The World Bank has criticised the compliance practices of UK company secretarial service providers as failing to meet the rules on paper. The rules on paper though are far from clear and may not be what the World Bank thinks they are.

The Puppet Master Report

The World Bank has recently released ‘The Puppet Masters’, a new report on the corrupt use of company registrations. They investigated over 150 cases they call ‘grand corruption’ and found the common use of shell companies set up to hide the true identity of the beneficial owners.

As the report notes, many countries have endorsed international standards in the fight against such shell companies. The two key agreements being, the United Nations Convention against Corruption and the 2003 Recommendations of the Financial Action Task Force (FATF).

To test the practical implementation of these standards, the World Bank carried out an extensive exercise whereby researchers posed as would-be customers soliciting shell companies and trusts to hide their financial affairs. The findings were not good.

The United States was singled out as ‘by far the worst performer’ but the UK didn’t come out smelling of roses either. The report found that plenty of UK incorporation agents would happily incorporate a company without photo id (sometimes it was a UK company that was being incorporated and sometimes a non-UK company using a UK agent).

The World Bank is clearly of the view that this practice is facilitating corruption in the modern world and says that “The evidence collected for the present study provides –for the first time – direct insight into the substantial gap between the rules on paper and the rules as applied in practice when it comes to corporate vehicles”.

The UK Money Laundering Regulations 2007

This is a damning finding and one that should be taken seriously. It does however pose the question of whether this is justified.

The Money Laundering Regulations 2007 (MLR 2007) apply to Trust or Company Service Providers (TCSPs) and state that Customer Due Diligence (CDD) needs to be carried out when:

-          establishing a business relationship;
–          carrying out an occasional transaction worth €15,000 or more;
–          suspecting money laundering or terrorist financing; or
–          doubting the veracity or adequacy of documents, data or information previously obtained for the purposes of identification or verification.

Business relationship is defined in the MLR 2007 as a business, professional or commercial relationship between [the TCSP] and a customer, which is expected by the [TCSP], at the time when contact is established, to have an element of duration.

Therefore, simply incorporating a company (without anything more) would seem to fall outside the definition of business relationship and, assuming the value of the services is below €15,000, there would be no requirement to carry out CDD. This chimes with HMRC’s guidance on the applicability of the money laundering regulations to TCSPs which draws on the distinction between an occasional transaction and a business relationship.

The situation is different if the TCSP is doing more than just incorporating a company. If they are providing compliance services, company secretarial services, a registered office or nominee services then this would fall under the definition of a business relationship and CDD would be required. The World Bank’s research project though did not (as far as can be determined from the report) ask for any of these services. So, the TCSPs were arguably not required to carry out CDD or ask for photo id.

To be fair, the solicitation made on behalf of the World Bank stressed the need for confidentiality and tax minimization as part of an international consultancy project which was intended by the World Bank to set off ‘red flags’. I will leave it to the reader to determine whether confidentiality and a desire to reduce ones tax burden is so unusual in the modern world that it should flag criminal behaviour but this was the view of the World Bank.

Compliance with International Agreements

It is interesting to note that if you go back to the FATF recommendations (which formed the basis for the UK Money Laundering Regulations) the wording changes slightly, though perhaps significantly. The FATF recommendations state that CDD should be carried out when ‘establishing business relations’ not a ‘business relationship’. To me, the word relations implies something of a shorter duration although, unfortunately the term is not defined.

I also consulted Tom Arrowsmith, a partner at the consulting firm, Kindleworth and a compliance expert who is of the view that “the core activities targeted by the 3rd EU Money Laundering Directive and the MLR 2007 include ‘the creation, operation or management of trusts, companies or similar structures’. If CDD can be circumvented by limiting these activities to one-off transactions, then the risk is that individuals could instruct numerous TCSPs to create companies without ever having to prove their identity and that part of the spirit of the agreements is being defeated.

I am not familiar with the compliance requirements in other jurisdictions that have implemented the FATF recommendations so I can’t comment on whether the UK has taken a different approach but it certainly appears that the authors of the Puppet Masters report feel that the CDD should be required when using an incorporation agent to set up a company and yet UK law and practice does not seem to fit with this.

I could now write about the effectiveness of the Money Laundering Regulations and whether the cost of complying with them in the UK (even in their current form) is worth the benefits gained. That though is a much longer article and one that I will leave to another day. Instead I will limit myself to two small observations drawn from the World Bank itself.

Firstly, in the Puppet Masters report, the World Bank notes that “in the majority of cases in which a corporate vehicle is misused, the intermediary is negligent, wilfully blind, or actively complicit”. I suspect that these intermediaries will continue to trade their business (probably from off shore hidden by a network of shell companies) regardless of any rule changes.

Secondly, the World Bank thinks slightly better of the UK incorporation process in another report. They carry out an annual review of various regulatory processes across the globe to see how easy it is to carry out business in different jurisdictions. In the latest report (Doing Business 2012) the UK ranks 13th for ease of incorporating a company. In this report, the less processes the better as far as the World Bank is concerned.

Nick Lindsay is a corporate lawyer and a director of Element CoSec. Please see Elemental’s website for details of the company secretarial services they provide.

  1. OdessaBloggerOdessaBlogger11-17-2011

    Many thanks for dropping by my blog and commenting upon my entry on this very theme. Neither you nor I mention the UK Bribery Act that is now in force when commenting upon the WB report. I have though mentioned it on my blog previously:

    http://odessablog.wordpress.com/2010/08/09/the-new-uk-bribery-law-extends-to-ukraine/

    You being a lawyer, will I assume, identify quite well with the final paragraph of that blog entry. The answer as always when it comes to circumvention, lays within the “wiggle room” in any law!

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