Money Laundering Regulation Compliance; Risks and Costs

Transcription

1 Money Laundering Regulation Compliance; Risks and Costs Submitted by ID Supervised by Rodrigo Olivares Caminal LLM Program August, 2012

2 ABSTRACT When complying with anti-money laundering (AML) regulation, financial institutions faced some problems reflected in the form of risks and costs. In some cases, those problems have legal solutions but, in other cases, place banks in the position to decide between two risks one being less harmful than the other. The aim of this dissertation is to provide an analysis of such risks and costs handled by financial entities, presenting some solutions provided by courts, but also identifying the gap between regulation and reality. Chapter I includes a general overview of money laundering; it makes reference to Financial Action Task recommendations in this matter and at the end the regulatory context of the crime in United Kingdom (UK). In Chapter II, each subsection refers to the risks banks may have when complying with money laundering regulations; the duality between the risk of being involved in a money laundering offence against the risk of being sued as a constructive trustee, the problem between reporting suspicious transactions against the tipping off offence, the dilemma of whether compliance with AML requirements and breaching contractual duties with customers, and an analysis of how legislation has partially solved the dilemma regarding confidentiality duty. Then, I shall discuss the costs that banks have to assume in implementing the AML system and the perception of the bankers regarding AML regulation. 2

3 TABLE OF CONTENT INTRODUCTION... 5 CHAPTER I: GENERAL ASPECTS OF MONEY LAUNDERING Definition Stages of Money Laundering Placement Layering Integration Financial Action Task Force (FATF) Recommendations Anti- Money Laundering (AML) Regulation in UK Proceeds of Crime Act Money Laundering Offences Failure to Report Offence Tipping off CHAPTER 2: COMPLIANCE COSTS AND RISKS Constructive Trustee Definition The Dilemma Case Law Tipping Off Definition The Dilemma Case Law Breach of Contractual Duties

4 The Dilemma Case Law Confidentiality Definition The Dilemma- (Solved) Costs of compliance (banks perspective) Economic Cost Bankers perceptions CONCLUSION BIBLIOGRAPHY

5 INTRODUCTION Money laundering represents a threat to the financial sector; criminals use the financial system to allocate their sources and make them appear legal. They usually try to find gaps in control within the financial system to channel funds illegally obtained. Thus, the role of the sector is of key importance to prevent crime. Money laundering differs from other crimes, is not easy to detect, it does not have a straight effect on the balance sheet of the entities, given that the illegal funds are registered as a legal source. Regarding the particularities of the crime and the importance of the financial sector in the detection and prevention of money laundering, international and local authorities have focused their efforts on issuing strict regulations to engage financial institutions in the fight against the crime. As a consequence, institutions have developed AML procedures of identification, control, measure and monitoring, as well as procedures to disclose and report suspicious transactions. AML regulation has brought considerable benefits for the financial sector. It has allowed the creation of a corporate culture of prevention of money laundering and enhancing controls and procedures. Considering the complexity of the crime and the different steps followed by criminals to perpetuate the crime, regulation has been a tough work for governments and has been evolving through the years according to the practices frequently updated by the criminals. Despite the efforts made by regulators, the financial sector has been facing a range of dilemmas when applying AML requirements - dilemmas that have no answer in regulation, dilemmas that make institutions become exposed to different risks, dilemmas that make banks take decisions between compliance with AML regulations or non -compliance to avoid being exposed to a different liability. 5

6 Regarding the compliance with money laundering legislation, financial institutions have fallen in the predicament between their duties to their customers and their duties to the State. Banks are required to follow specific procedures (i.e. freeze customer accounts) that may directly affect their customers, though at the same time they have duties to their customers (i.e. honour payments). A State s Order to freeze an account could hold the bank liable for damages suffered for breach of contract with their customers. As a consequence, the dilemmas faced by banks bring risks and costs that could be avoided if the regulations would grant guidelines or tools to protect institutions to be able to avoid claims or liabilities. Current legislation leaves open gaps that makes banks doubt how to apply the law. In addition to analysing the law and how it is described in statutes and documents, it is important to understand the practical application of the law and its effectiveness. Financial institutions are facing problems and dilemmas in applying AML regulations, but apparently each institution must contact the authority to help them solve the dilemmas. However, the role of the authorities is not as effective as banks would expect. The purpose of the dissertation is to discuss and analyse risks and costs banks may have when complying with money laundering regulations; the duality between the risk of being involved in a money laundering offence against the risk of being sued as a constructive trustee, the problem between reporting suspicious transactions against the tipping off offence, the dilemma of whether to comply with AML requirements or to breach contractual duties with customers, and an analysis of how legislation has partially solved the dilemma regarding confidentiality duty. The analysis will be developed mainly under the United Kingdom s Law and considering recommendations issued by the Financial Action Task Force (FATF) and bringing some examples from Colombian practices and legislation. 6

7 CHAPTER I: GENERAL ASPECTS OF MONEY LAUNDERING Money laundering threatens the stability of the financial system and the integrity of the markets. The Financial Sector has been recognized as a key actor at the starting point of the money laundering process that begins with the placement stage in which the money (from an illegitimate source) is deposited in order to, after another stage, be transformed into legal money. Under those conditions, International Organisations, such as the Financial Action Task Force (FATF), have issued international standards to obstruct the use of the financial system for money laundering. Following those standards, some countries have adopted money laundering regimes establishing offences in order to penalise those involved in money laundering. This Chapter will present the definition of money laundering, the stages to conclude the process of laundering, FATF recommendations regarding the prevention of the crime and finally money laundering legislation in United Kingdom (UK) Definition Money laundering has been identified as a crime not easy to be followed or to be identified by the authorities, considering that there is no victim able to provide information to help the authorities find the facts that something has been obtained illegally 1. Regarding this important issue, governments need help from Financial Institutions to prevent the crime. In trying to define money laundering, there are some difficulties. As Professor Bernasconi has established, one problem is that money laundering is poorly understood 1 Guy Stessens, Money Laundering a New International Law Enforcement Model. (Cambridge University Press 2000) 160 7

8 and criminals are all the time changing their modus operandi to be out of any control. To define the crime, each country takes into consideration specific local conditions, the legal system and how in practice measures have been adopted to overcome obstacles to enforcement. 2 After September 11, 2001, measures to fight against money laundering and financing of terrorism have taken importance for international organisations and financial institutions. Money laundering can destabilise the economy and financial systems. 3 The term money laundering comes from mafia practices in United States (US) in Mafia groups acquired launderettes to give a legitimate presence to assets or property obtained from illegal activities. The use of the term money laundering in a legal scenario was initially in the US in 1982 until 1986 when it became a criminal offence for first time in the world through the Money Laundering Control Act The second country was the UK, through the Drug Trafficking Offences Act It is possible to find many definitions of money laundering depending on the perspective; it can be analysed from a legal, economic, and political point of view. As 2 Joanne Greig, Combatting money laundering (1997) Reviewing: Paolo Bernasconi (ed.), Money Laundering and Banking Secrecy:XrVth International Congress of Comparative Law. Criminal Law Forum. Vol. 8 number 1, Raul Hernández-Coss and others, AML/CFT Regulation: Implications for Financial Service Providers that Serve Low-income People (2005) The International Bank for Reconstruction and Development/ The World Bank, 14 < accessed June See the web site of the United Nations Office on Drugs and Crime (UNODC), 4 Roberto Durrieu. Towards a New International Crime of money laundering: a global comparative analysis. Chapter One - Redefining money laundering and Financing of Terrorism. < %20Money%20Laundering_RD.pdf> accessed June

9 was established before, the definition of the term is ambiguous. Below, a range of definitions shall be presented. The Financial Action Task Force (FATF) defines money laundering as the processing of these criminal proceeds to disguise their illegal origin. This process is of critical importance, as it enables the criminal to enjoy these profits without jeopardising their source. 5 Another definition is the one provided by the Joint Money Laundering Steering Group, as the process whereby criminals attempt to hide and disguise the true origin and ownership of the proceeds of their criminal activities. 6 According to the United Nations Office on Drugs and Crime (UNODC) and the International Monetary Fund (IMF), money laundering may be described as the process by which a person conceals or disguises the identity or the origin of illegally obtained proceeds so that they appear to have originated from legitimate sources. 7 The Law Society has defined money laundering as the process by which the proceeds of crime, and the true ownership of those proceeds, are changed so that the proceeds appear to come from a legitimate source 8. 5 Financial Action Task Force, What is money laundering? < org/pages/faq/moneylaundering> accessed June Financial Service Authority, The Money Laundering Theme Tackling our new Responsabilities (2001), < accessed June United Nations Office for Drug Control and Crime Prevention and International Monetary Fund, Model Legislation on money laundering and financing of terrorism (2005), < accessed June Anti-money laundering (29 October 2009) < accessed June

10 In the 19 th Report of Session , the House of Lords of the European Union Committee defined money laundering as the process by which the source and ownership of criminally derived wealth and property is changed to confer on it a perception of legitimacy. From the point of view of the criminal, there seem to be three basic requirements: the need to conceal the true ownership and origin of the proceeds; the need to maintain control of the proceeds; and the need to change the form of the proceeds 9 In the above definitions, it is possible to find common elements that allow the understanding of the meaning of money laundering as the activity to hide or disguise the origin or identity of illegally obtained proceeds, with the purpose to make them appear to be legally obtained Stages of Money Laundering The process of laundering the proceeds of illegal activities is completed in different stages, thus it is possible to have as many as the launderer would have. Even so, international organisations such as the World Bank and the International Monetary Fund (IMF) have made references to three phases or stages; placement, layering and integration. As was mentioned before, one of the instruments used by launderers to perpetrate the crime are financial institutions Placement At this stage, the proceeds of crime are brought into the financial system. The criminal goal is to separate the dirty assets away from its original source. Launderers place the 9 House of Lords European Union Committee, Money Laundering and the financing of terrorism (2009) 7 10 Durrieu (n 4) 16 10

11 illegal funds through a variety of mechanisms, such as deposit in cash into bank accounts or the use of cash to buy different assets at high value, splitting large sums of money into small amounts and to make a series of small payments, pretending to avoid controls or making some reports required by banks Layering After the proceeds of crime are placed in the financial system, criminals will try to disguise the source of the funds through different transactions moving around black money. The idea is to break the relation between the funds and its origin through complex financial transactions erasing the track of the movements. 12 Criminals at this stage will try to move the funds through different financial entities and jurisdictions, obscuring its illegal origin Integration Having hidden or erased the origin of the funds, the last stage of the money laundering process is the recycling, integration or consumption of the assets in the formal economy through financial investments or property. It could be in jurisdictions far away from the place where the offence was committed. 13 One example that could reflect the stages of money laundering process is the Medellin Cartel case study named Santos Caballero, Maria and others. In 1995 the police in 11 Ibid Friedrich Schneider and Ursula Windischbauer, Money laundering: some facts (2008) E.J.L. & E. < cguid=ia41723b2f9aa11deafd4cd525a9169d9&hitguid=ia41723b2f9aa11deafd4cd525a91 69D9&spos=1&epos=1&td=1&crumb-action=append&context=10&resolvein=true> accessed June Ibid 11

12 Argentina found a high quantity of cash in many different currencies. After the investigation, they established that the cash came from a Colombian drug traffic cartel, then it was moved to Argentina through different ways, and finally it was established that the cash was frozen in Argentina to be introduced into the economy. In this case it is possible to identify the three stages, the origin of the illegal money is Colombian from the trafficking activities, then the money was layered out to Argentina through different mechanisms or ways and the last phase were ready to be completed - that was the integration into the formal economy Financial Action Task Force (FATF) Recommendations FATF is recognised as the body that sets international standards regarding the prevention and control of money laundering. In 1990 the original document of Forty Recommendations to fight against money laundering was issued and the document has been revised accordingly with the evolution of the typologies of money laundering. Those standards are related to: knowing your customer (KYC) procedures, due diligence, reporting, risk assessment and record keeping. Basically, it instructs countries on how financial institutions should act to fight against money laundering. The recommendations have been adopted by more than 180 countries and other international organisations. For the purpose of this study, it will mention the main recommendations related to bank secrecy restrictions, reporting, confidentiality and tipping off. Countries should criminalise money laundering on the basis of the Vienna Convention and the Palermo Convention. Countries should apply the crime of money laundering to all serious offences, with a view to including the widest range of predicate offences. 14 Durrieu (n 4) 19 12

13 Countries should ensure that financial institution secrecy laws do not inhibit implementation of the FATF Recommendations. Financial institutions should be prohibited from keeping anonymous accounts or accounts in obviously fictitious names. If a financial institution suspects or has reasonable grounds to suspect that funds are the proceeds of a criminal activity, or are related to terrorist financing, it should be required, by law, to report promptly its suspicions to the financial intelligence unit (FIU). Financial institutions, their directors, officers and employees should be: (a) protected by law from criminal and civil liability for breach of any restriction on disclosure of information imposed by contract or by any legislative, regulatory or administrative provision, if they report their suspicions in good faith to the FIU, even if they did not know precisely what the underlying criminal activity was, and regardless of whether illegal activity actually occurred; and (b) prohibited by law from disclosing ( tipping-off ) the fact that a suspicious transaction report (STR) or related information is being filed with the FIU Anti- Money Laundering (AML) Regulation in UK Proceeds of Crime Act 2002 It is important to mention AML regulation in the UK, considering that the purpose of this study is to analyse risks and costs that financial institutions have to assume in order to comply with money laundering legislation. A presentation of the main offences included in The Proceeds of Crime Act 2002 (POCA) regarding money laundering shall be done below. 15 International Standards on Combating Money Laundering and the Financing of Terrorism & Proliferation the FATF Recommendations. (16 February 2012) < accessed June

14 Money Laundering Offences The Proceeds of Crime Act 2002 (POCA) created three substantive money laundering offences in sections 327, 328 and 329. According to section 327 a person commits an offence if he conceals, disguises, converts, transfers, removes criminal property. Concealing or disguising criminal property is related with concealing or disguising its nature, source, location, disposition, movement or ownership or any rights with respect to it 16. Section 328 establishes that A person commits an offence if he enters into or becomes concerned in an arrangement which he knows or suspects facilitates (by whatever means) the acquisition, retention, use or control of criminal property by or on behalf of another person. 17 According to Section 329, an offence is committed if a person (a)acquires criminal property; (b)uses criminal property; (c)has possession of criminal property 18 The defences contemplated to avoid being involved in the offences mentioned above are; if a person (a) makes an authorised disclosure under section 338 and (if the disclosure is made before he does the act mentioned in subsection (1)) he has the 16 Proceeds of Crime Act 2002, s327 (1) and (3) (1 and 3) 17 Ibid s 328 (1) 18 Ibid s

15 appropriate consent; (b) he intended to make such a disclosure but had a reasonable excuse for not doing so; (c)the act he does is done in carrying out a function he has relating to the enforcement of any provision of this Act or of any other enactment relating to criminal conduct or benefit from criminal conduct. For section 329 there is an additional defence in cases in which the act he does is done in carrying out a function he has relating to the enforcement of any provision of this Act or of any other enactment relating to criminal conduct or benefit from criminal conduct 19. According to section 340 (3), something is criminal property if it constitutes a person s benefit from criminal conduct or if it represents such a benefit (in whole or in part and whether directly or indirectly), and the alleged offender knows or suspects that it constitutes or represents such a benefit. The property which may comprise the benefit from criminal conduct is defined also in section 340 (9) and includes: Money, all forms of property or real estate, things in action and other intangible or incorporeal property. According to these offences, for the purpose of this document financial institutions may be criminally liable for money laundering if they conceal, disguise, convert, transfer, or remove criminal property from a part of the UK, and also if they enter into an arrangement which they know or suspect will facilitate the retention or control of criminal property. Additionally, financial institutions may be liable, if they acquire, use or possess criminal property Failure to Report Offence 19 Ibid s 329 (d) 15

16 Considering that authorised disclosure is a defence of money laundering offences, in order to engage financial institutions to cooperate in the fight against money laundering and to promote the disclosure of information, section 330 creates an offence requiring disclosure. This offence incentivises banks to create a process and mechanism to identify unusual and suspicious transactions and report them to the authorities. Section 330 establishes that an offence is committed when a person does not make the required disclosure as soon as is practicable after the information or other matter comes to him 20. When the information is gained in the course of a business. The offence is committed if the person knows or suspects, or has reasonable grounds, to suspect that another person is engaged in money laundering. 21 The duty to disclose is placed on any person acting in the course of business in the regulated sector. 22 There are also defences; the relevant one for this study is that the financial entity has reasonable excuses for not disclosing. Banks or financial institutions must report to the Serious Organised Crime Agency (SOCA), 23 who after seven (7) days may issue consent to operate; if there is not any answer after that period, the silence will be presumed as a consent to operate. If SOCA instruct the bank to freeze the account, a moratorium period lasts for 31 calendar days. After the moratorium period the bank can continue with the transaction Tipping off 20 Ibid s Ibid s Ellinger, E.P., Modern Banking Law (5th ed., E.P. Ellinger 2011) The Serious Organized Crime Agency tackles serious organised crime that affects the UK and our citizens. For more information see < 24 Roberts Graham, Law Relating to Financial Services (2009 Global Professional Pub)28 16

17 According to section 333, an offence of tipping off is committed if there is a disclosure that someone has made a report (disclosure) under POCA For this offense there are also some defences; basically the most important is that the defendant did not realise that the investigation would be prejudiced. Another defence is that the disclosure was made in connection with a function relating to enforcement, or if the information is passed on in circumstances that amount to legal privilege. 26 This offence has caused some difficulties for banks, given that there are not clear instructions for banks to act, as will be shown in the study in Chapter II of this document. 25 Ibid (n 16) s 333 (2) 17

18 CHAPTER 2: COMPLIANCE COSTS AND RISKS It seems that the far-reaching requirements of the existing money laundering regime conflict with fundamental principles of law and cause serious difficulties for innocent banks and their customers. 27 (Joan Wadsley) Regarding the importance of money laundering regulations, it is important to analyse which costs and risks banks have to assume to comply with the legislation. It has been identified that in practical terms, banks have been having some problems and dilemmas represented in risks and costs when they suspect that funds in a customer`s account are the proceeds of crime. First of all, this chapter will present the risks faced in complying with AML requirements. The first dilemma arises between criminal and civil liability. If the bank does nothing and permits the customer to have access to funds, it could be a criminal liability for a money laundering offence and also in not reporting the suspicions, but additionally the bank could have a civil liability on assisting a breach of trust by the customer. 28 Another dilemma is that, according to Section 330 of POCA, financial institutions are obliged to report their suspicions to SOCA and wait for (an) appropriate consent to continue the transaction; in that period, if the customer needs his funds, the institution has to refuse the payment and, through doing that, it is exposing itself to the risk of tipping off, so the customer could become suspicious that he is under investigation. The third dilemma that banks need to face in complying with AML legislation is being exposed to breaching contractual duties with their customers. 27 Joan Wadsley, Banks in a Bind: The implications of Money Laundering Legislation (2001) JIBL Ellinger (n 22)

19 Having presented risks, another important point to be presented in this chapter is related with the economic costs that are not always equivalent to the benefits or effectiveness in preventing money laundering. Finally, the last dilemma will be presented, which is the one that already has been partly solved by law, and is related to the breach of duty of confidentiality. Such problems, risks and costs have increased litigation cases, since there is no clear course of action for banks; those can be seen as a regulatory gap. As one judge, (with some incredulity) put it: the bank may commit a criminal offence if it pays or if it refuses to pay Constructive Trustee Definition International fraud is a growth business. Electronic transfer of funds; the widespread use of nominee companies and offshore accounts; the increased sophistication of legitimate financial transactions; and the reluctance of bankers and professional men to inquire into their clients` affairs; all contribute to the ease and speed with which fraudsters can transfer substantial sums from one country to another and conceal their source and the identity of those who control them Per Laddie J in Governor Company of the Bank of Scotland v. A ltd (2000) in Ellinger (n 22) Peter Millett Tracing the Proceeds of Fraud (1991) 107 L.Q.R. 71 in Slaughter and May, Civil Liability for money laundering (2009) 5 19

20 Regarding financial frauds, victims will normally desire to recuperate lost money; for them it is not enough to know that fraudsters have been criminalised, they wish to have an action against financial institutions through which defrauded money was laundered to recover the money. In the UK, victims have a varied choice of potential claims against the financial institutions that have assisted in laundering the proceeds of fraud. For the purpose of this study, reference will be made only to the remedy against the financial institutions that have assisted in a breach of fiduciary duty to make them liable as constructive trustees. 31 Constructive trustee liability may arise for dishonest assistance and it is not necessary that the bank receives or holds any property, and it is not necessary to owe any fiduciary duty, since the liability is to help recover the loss that the bank has caused with its assistance. It is only necessary to prove; i) breach of trust or fiduciary duty; ii) assistance in the breach of trust and iii) dishonesty on the part of the firm and a sufficient causal connection. 32 Definitions of dishonesty have caused controversy; in Royal Brunei 33 Lord Nicholls explained that dishonest means not acting as an honest person, is an objective standard and in Barlow Clowes v Eurotrust International Ltd 34 the Privy Council established that a person may be dishonest as a result of making a mistake as to what ordinary people consider as honest, and that which is required in a criminal context to establish dishonesty is not required in civil context. 35 It was also said that it is not necessary that the assister knows all the details about the trust to suspect a breach of trust Slaughter and May, Civil Liability for money laundering (2009) 5 32 Herbert Smith, The effect of the risk base approach on civil liability (2006), < >accessed July Royal Brunei Airlines Sdn v Tan (1995) 2 A.C Barlow Clowes v Eurotrust International Ltd (2004) W.T.L.R Slaugther and May (n 31) Herbert Smith (n 32) 20

21 Constructive trustee liability also is possible for knowing receipt, to be liable is required; i) disposed of assets in breach of fiduciary duty; ii) the beneficial receipt of assets; iii) knowledge that the assets received are noticeable to a breach of fiduciary duty. 37 Regarding the beneficial receipt, in the case of banks, case law has suggested that there are potential liabilities just in those cases in which the money received is paid in overdraft accounts. Being liable as a constructive trustee is only possible in those cases in which the stolen money is laundered; in cases of drugs or terrorist funds and when the money is not stolen, there is no victim, so there is no possibility in making the bank liable as a constructive trustee The Dilemma The dilemma to be presented in this section arises when the financial institution knows or suspects that any of its customers is involved in money laundering activities. There are two hypotheses to be studied; i) if the bank does not report to SOCA, ii) if the bank reports to SOCA and the authority issues an appropriate consent to continue with the transaction. If a financial institution knows or suspects that a customer`s funds are involved in money laundering activities, but refrains to report it to SOCA, it carries the risk of a potential criminal liability for committing money laundering offences. 37 Ibid 38 Roberts Graham (n24) 30 21

22 If the financial institution reports to SOCA and it is granted an appropriate consent to carry on the transaction, but if the bank continues with the transaction, it carries the risk of being sued by the victim of the fraud for assisting in breaching the fiduciary duty as a constructive trustee. As was mentioned in Section 1.4 of this document, making a report usually grants banks with a defence against criminal liability under POCA However, the defence granted by making a report does not protect financial institutions from civil liability as a constructive trustee and, in some cases; the report would be considered as evidence of the knowledge or suspicions about the doubtful precedence of the funds to be liable as a constructive trustee. 39 In those cases, there is no clear guidance of how banks should act, since they have no strong arguments to refuse the transaction; therefore they have to assume the risk of potential civil liability. According to Herbert Smith (July 2006), the observation made by the courts is that, in those cases, the institutions must take a commercial decision to comply with the instruction and assume the risk. 40 The problem may be to what extent banks want to be exposed to a risk to assuming civil liability by commercial decisions. It is not clear what the analysis must be; if they suspend the transaction and have no argument for his customer, they can lose the customer and be sued due to breach of contract; or if they continue with the transaction, they can be sued by the victim of fraud because of the assistance in breaching fiduciary duty. In both scenarios, banks are assuming risks Case Law 39 Ibid 40 Herbert Smith (n 32) 22

23 In order to try to solve the dilemma for banks, from case law it is possible to infer some guidelines that help banks to identify how to act in such cases. In Finers v. Miro 41, a financial institution under the risk of being liable as a constructive trustee, before reporting, it was allowed to apply to the court for directions. The fear of the banks was to be exposed to tipping off in following court instructions. In C.v S 42 the court established a procedure to be followed by the institution that had to make a disclosure under civil jurisdiction about something already reported to criminal authority. The decision was the basis to allow the institution to follow court instructions without the risk of being tipped off. 43 In Bank of Scotland v A ltd. 44 The court established what the bank should do under those conditions. First of all, is it said that the bank should ask the authority what information it is able to reveal. If it is not possible, then, the bank may seek an interim declaration from the court, making the authority a defendant in the case. According to this, if the bank rejects the payment, and the customer sues the bank, the latter has a tool to defend himself using the information as the interim declaration permits. As a conclusion, the court said that, under this kind of behaviour, the bank could not be liable for tipping off 45. In Tayeb v HSBC Bank 46, the banks became suspicious of a deposit made by electronic transfer into the customer`s account and, considering that the customer s explanation 41 Finers v. Miro (1991) W.L.R C.v S (1999) 1 W.L.R Savla Sandeep, Money Laundering and Financial Intermediries (2001 Boston: Kluwer Law International) Bank of Scotland v A Ltd.(2001) The Times, 6th Feb CA 31. January 18, Roberts Graham (n24) Tayeb v HSBC Bank46 (2005) 1 C.L.C

24 about the source of funds was not enough, the bank transferred the money back to the paying bank and then closed the account. The court held that the bank had an obligation to receive the transfer; money laundering does not require banks to refuse transactions, it only asks for a report in such cases. If the bank had suspicions that the money was stolen, then the bank can refuse access for the customer to the funds or inform the authority and discuss what action should be taken if the customer tries to withdraw funds 47. Regarding the potential risk of the banks to be sued by assisting the breach of trust (constructive trustee), in the above mentioned cases, courts have said that it is unthinkable to hold that a bank which had asked for a court`s guidance has acted dishonestly and that the risk of constructive trustee liability is improbable if the bank has followed the court s guidance. 48 According to Herbert Smith, even with the guidance proposed by the courts, it is important to consider some aspects that remain regarding the risk of constructive trust liability. Those cases having been taken into account by the courts are normally focused on liability for dishonest assistance, in which it is required to follow the highest test of dishonesty; the same kind of protection is not clearly possible to be applied in cases of liability for knowing receipt. In United Mizrahi Bank v Doherty 49 the court felt unable to grant protection to a law firm that received fees that had been frozen as a potential trust property. 50 Following Herbert Smith s analysis, despite the court establishing that, in complying with the court guidance there is no space for potential liability for banks, this statement 47Roberts Graham (n24) Herbert Smith (n32) 49 United Mizrahi Bank v Doherty49 [1998] 1 WLR Herbert Smith (n24) 24

25 is under the hypothesis in which the bank has no paid funds where a third party interest is protected. Nonetheless, if the bank has paid the funds away, the bank may face civil liability from the victim. In Amalgamate Metal Trading Ltd v City of London Police FIU and others 51, the court said that the declaration from the court that funds had a legal origin is only possible on a final basis, and not an interim basis; and that the customer and the victim would be parties in the case and that the bank needs to prove the legal origin of the funds, instead of relying on the absence of evidence 52. Finally, Smith emphasises that, in practice, institutions try to find SOCA s consent more than court consent; nonetheless this will not provide defence to a civil liability. According to Barry A.K. Rider 53, the relationship between the civil law and the criminal law regarding the duty to report is not clear. Reporting a suspicions transaction brings automatically civil law relating to knowing receipt in the breach of trust. It would be difficult for a bank that apparently has enough arguments to report to argue that it does not have enough bases for suspicion in civil law. The consent of the authority is not a good defence in civil law. To sum up, money laundering legislation requires financial entities to report in those cases in which they suspect or know about the illegal source of any customer`s transaction. In compliance with the duty to report, banks and financial institution avoid being criminally liable for money laundering - this is a defence to be involved in that kind of liability. 51 Amalgamate Metal Trading Ltd v City of London Police FIU and others (2003) 52 Ibid 53 Barry A. K. Rider, The limits of the law: an analysis of the interrelationship of the criminal and civil law in the control of money laundering (1999) J.M.L.C

26 In spite of this, financial institutions face the risk of being sued as a constructive trustee in civil jurisdiction; in civil law the compliance to report suspicious activities, more than a defence for banks, is an evidence to prove liability. Thus, currently to make a report, banks should balance the possible criminal money laundering risk vs. potential civil liability as a constructive trustee, in order to decide which exposure they prefer to assume or adopt appropriate measures to prevent the risk. Solutions provided by courts do not cover all possible scenarios, and reflect the regulatory gap considering the dilemma that banks have to face in applying AML regulation. Forcing banks to ask for instructions from the authority or the court in every single case reflects the gaps in the law that need to be filled up with clear instructions in such cases. It is not possible to delegate the authority to provide instructions in particular cases when it is evident that the dilemma exists and that banks are facing it in practice. Additionally, if the banks ask for instructions from the authorities or the court, this will not constitute a defence in civil jurisdiction to avoid liability as a constructive trustee. Under those conditions, the institution will need to prove that the knowledge or suspicions of the criminal activity did not have enough elements for civil liability concerns. The statutory defence granted to banks from criminal liability for reporting only refers to liability able to arise from breaching the contract or violation of a duty of confidentiality; breach of trust is not included Tipping Off 54 Barry A.K rider (n53) 26

27 Definition According to section 333 of POCA tipping off offence is described as follows: (1) A person commits an offence if (a) he knows or suspects that a disclosure falling within Section 337 or 338 has been made, and (b) he makes a disclosure which is likely to prejudice any investigation which might be conducted following the disclosure referred to in paragraph (a). (2) But a person does not commit an offence under subsection (1) if (a) he did not know or suspect that the disclosure was likely to be prejudicial as mentioned in subsection (1); (b) the disclosure is made in carrying out a function he has relating to the enforcement of any provision of this Act or of any other enactment relating to criminal conduct or benefit from criminal conduct; (c) he is a professional legal adviser and the disclosure falls within subsection (3). (3) A disclosure falls within this subsection if it is a disclosure (a) to (or to a representative of) a client of the professional legal adviser in connection with the giving by the adviser of legal advice to the client, or (b) to any person in connection with legal proceedings or contemplated legal proceedings. (4) But a disclosure does not fall within subsection (3) if it is made with the intention of furthering a criminal purpose (n 16) s

28 The offence is to disclose to the customer that a report has been made according to POCA. This is to disclose that an investigation is following up or there is an analysis to begin the investigation. The offence has some limits. It is required that the disclosure is likely to prejudice any investigation and that the information disclosure came from the course of business in the regulated sector. Another limit is that there is no tipping off regarding legal advice The Dilemma The offence causes difficulties for banks when they freeze the customer`s account if they know or suspect illegal property is in their accounts after having made a report to SOCA. The freezing of the account may tip off the customer, given that he can suspect that he is under investigation. 56 As a consequence, trying to avoid being involved in money laundering offences, by reporting suspicions activities, banks are exposed to the risk of committing another offence called tipping off. While banks wait for the authority (SOCA) consent, customers may suspect if the banks reject allowing them to have access to their funds. It is possible to say that the law is not completely clear regarding this situation; banks are prone to commit another offence if they comply with the duty to disclose. There is not a clear mandate on what banks should do or say to their customers, while SOCA issue an appropriate consent. In practice, banks have no statutory guidelines on how approach the customer, which explanation should they give to the customer that is asking and demanding for his funds but the bank has to refuse it. 56 Ellinger (n22)

29 Additionally, it is important to mention that regarding individual customers suspicious activities, banks also have problems in deciding whether to report and be exposed to tipping of or avoid the report but be exposed to money laundering offences. One example is when 57 the bank is suspicious about customer transactions and submitted a report to the authority. Considering the facts, the police begin an investigation requiring information from the customer s employer. The customer becomes aware of the situation and asks for information from the bank, who are unable to provide it, trying to avoid tipping off. Finally, the customer explained all of its transactions and the bank decided to compensate the customer before going to court, given that the suspicions would be discarded if they had analysed the customer`s information. This is an example of how difficult it is for banks to take decisions regarding suspicious activities of money laundering. Banks have to develop internal advanced procedures to identify, detect and report. It is not easy for them to choose which risks they prefer to assume. The dilemma is also faced in some countries in South America; Colombia will be taken as an example of this. According to Colombian law 58, financial entities have to report to the authority 59 any unusual or suspicious activity of money laundering. 60 At the same time, financial entities cannot disclose to customers that they have made any report to the authority. 61 The regulatory gap in Colombia is higher than in UK: there is no statutory guidance on what financial entities have to do after reporting any suspicious activities. The UIAF does not have to issue any consent; if they find something relevant they could ask for 57 Example in the Guidance Note on Money Laundering cited in Wadsley (n27) Ley 599 de 2000 article The Financial Intelligence Authority in Colombia is called Unidad de Análisis e Información Financiera 60 Estatuto Orgánico del Sistema Financiero (Decreto 663 of 1993) article Estatuto Orgánico del Sistema Financiero (Decreto 663 of 1993) article

30 additional information, but they do not instruct banks on how to act towards their customers. Banks have to adopt internal procedures 62 to decide how to act in such situations and decide which risk they want to assume. If the institution decided to freeze the account, they have to find ways to give an explanation to the customer in order to avoid tipping off 63. The situation has caused banks to prefer making a report and assuming the risk to be sanctioned by tipping off and lose the customer rather than being exposed to money laundering crime. The problem in Colombia is that there is no immediate answer from the authority (UIAF) to the reports made by banks. The authority analyses the information and if it found elements to be investigated, the information is submitted to the prosecutor who will open a formal criminal investigation. This procedure takes a long time and not all the cases finish in investigation. Thus, banks do not have a clear way to follow in those cases. Instead, they have to manage in a good way the relationship with the customer to explain why his account has been frozen or why his payments have not been posted Case Law In UK, it is possible to say that the dilemma has been managed by case law, through which the court established or recommended what banks can do in such situations. In C. v S 64 a bank was required by a court to disclose some information on litigation between his customer and a defendant that apparently defrauded him. The bank had made a report to the authority regarding his suspicion; then, the dilemma for the bank 62 Circular Básica Jurídica (Circular Externa 007 de 1993) Title I Chapter XI 63 In Colombia tipping off is not a criminal offence, it is an obligation for Banks, it cause administrative sanctions for entities 64 C. v S. (n 42) 30

31 was if he discloses the information he would tip off the investigation. The risk for the bank was being called to court if it did not disclose the information or being criminally liable for tipping off. The Court of Appeal provided some guidance, encouraging the authority to negotiate with the bank as to what information could be disclosed. If it is not possible to get an acceptable solution from there, the court should find the solution balancing between the interests of the individual against the interests of the State in fighting against the crime. Lord Woolf M.R. in C. v S. said: This case demonstrates how statutory provisions designed to achieve the highly commendable objective of combating serious crime can interfere with the individual s rights the investigation created a conflict between the interest of the State in combating crime on behalf of the public and the entitlement of a private body to obtain redress from the courts. It was also in conflict with the principles to which the courts attach the greatest importance. 65 In Governor and Company of the Bank of Scotland v. A Ltd, B&C 66 the dilemma was between being liable as a constructive trustee by paying money apparently involved in fraud or being liable for tipping off by refusing the payment. In a public hearing, Laddie J. 67 established that the assisting offence of money laundering and the tipping off offence could put the bank in a difficult position, so the bank can commit an offence if it pays or if it refuses sums that are apparently proceeds of crime. Finally, Laddie J. said it is unthinkable that our law should put an honest institution in such a position Wadsley (n 27) Governor and Company of the Bank of Scotland v. A Ltd, B&C (2001) All E.R. (D) 81 In 1999 A Ltd. Opened accounts and considerable amount of money were transferred to it. The bank though that some individuals were involve in fraud. The bank notified the authority (Metropolitan Police) and was informed by the police that there was an investigation over a person who appeared to be close to the company. 67 Laddie J. in public hearing (2000)Lloyd`s Rep. Bank. 271 at 287 cited in Wadsley (n27) Ibid 31

32 The Bank of Scotland in this case was looking for instructions from the court, without involving its customer. However, the authority (Metropolitan Police) blocked the bank to provide information even to the court. Though, at the hearing, the judge recommended that the order should be to freeze the account and the bank did it. As a consequence, A. Ltd could not get access either to his account or to an explanation; the customer realised that an investigation was carrying on, so he was tipped off. After many hearings, the customer was found innocent and the bank had to pay the cost of the procedure. From the bank s point of view it was hard to understand, since at the end the day the bank just followed the law, complying with criminal law and trying to avoid any civil liability. The Court of Appeal, Lord Woolf C.J. said that considering that the bank was in a difficult situation, the way used to try to get assistance was the wrong one 69. The bank should try to agree with the authority 70 regarding the information that may be revealed to the customer; if it does not work, the bank should apply for an interim declaration from the court that clarifies what the bank can disclose. If the customer sues the bank for the funds, then the bank could defend itself using the information as the interim declaration permits. The court said that if a bank follows this way, it would not be liable for tipping off. 71 Regarding the solution proposed by the court, it is important to mention the perception of the guidelines issued by SOCA. The role of SOCA has been highly criticised 72 and is considered too general, too hard to be applied in practice. The European Union Committee 73 required SOCA to have a closer relation with the private sector to help them apply the guidelines in their activities. SOCA has limited his role to provide 69 Wadsley (n 27) In this case the authority is the Serious Fraud Office 71 Roberts Graham (n 24) House of Lords European Union Committee (n 9) Ibid 35 32