Originally published on 25 July 2002

There are several historic cases whose facts remain in the memories of former law students long after they retire from practice. There was a Mrs Carlill who caught a cold, contrary to the promises made by the Carbolic Smoke Ball Company1, and there was a dead snail in the bottle of Mrs Donohue’s bottle of Ginger beer2.

It was of little consolation, either to the defendant or any other lemonade manufacturers who sold their products in stone bottles, but it was, of course, technically only an alleged snail, no forensic biologist ever having testified to the fact. Ultimately, however, that was to have no bearing on the law.

The facts of the ‘Bank of Scotland3 case are set to become another such memorable case, the bank having a customer who was alleged to be laundering money. The facts of the case are simple, but the legal point at issue is a particularly difficult one, and there is little doubt that the outcome, both in fact and in the decision of the Court of Appeal is very worrying and unsatisfactory.

In the long term, it is more likely that the facts of the case are remembered long after the point of law is forgotten, over-ruled, or superseded by some statutory provision. For the time being, however, the facts of the case stand out as a warning to the banking industry, albeit one whose lesson is in its prevention, not its cure.

In September 1999, a limited company, identified only as "A" Ltd, opened and account at one of the London branches of the Bank of Scotland. Shortly thereafter, a large sum of money, in the region of £1 Million sterling, was deposited into the account. This was out of keeping with the clients profile and therefore attracted the banks attention.

The bank then conducted some discreet enquiries into their client’s background, and as a result of discussions with the Metropolitan Police, the British Bankers Association and the Commercial Crime Bureau of the International Chamber of Commerce; they learned that their customer was under investigation by the Serious Fraud Office. They also concluded that the money in the account might have been have been acquired as the result of a criminal act, specifically an Advance Fee fraud. As they were legally bound4 to do, the Bank made a report to the National Criminal Intelligence Service. (NCIS)

There is no denial that the Bank was acting quite properly, within the law, and fulfilling their responsibilities to detect and report any suspected cases of money laundering; but at this point they realised they faced a serious dilemma.

If they allowed the customer to withdraw the money from the account, they were concerned that they might later be held liable, as a ‘constructive trustee’, should the defrauded party later raise an action against them in a civil court. Should that happen, the Bank was concerned they would have no defence. The fact that they had made a report to NCIS confirmed that they had knowledge of the fraud and hence that they were aware of their duties as a constructive trustee.

If, on the other hand, the bank did not allow the customer to withdraw the money, they ran the risk that that would alert the customer to the fact that they were under investigation. Not only would this compromise the Police investigation, it would constitute "tipping off", an offence under Section 93D, Criminal Justice Act.5

The "tipping off" law had previously been considered in the context of customer suing a bank in a civil action6. In that case, the bank, knowing that full disclosure would tip off the customer that he was being investigated, sought guidance from the NCIS. They were unsympathetic, warning them that if they did anything to alert the customer, they would be guilty of a "tipping off" offence. The judge later described that reply as "neither sensible nor appropriate", but the problem remained largely unresolved, and now it was back again.

The legal process that then unfolded in the Bank of Scotland case is explained at length in the law report. The bank first went before a judge in chambers seeking directions as to what it should do. Two other parties, an individual named Mr "B" and a company identified as "C" Ltd, were also added into the proceedings as they had been responsible for remitting money into A Ltd's accounts. They were, obviously, the victims of "A" Ltd’s fraud, so they might later have claims against the bank in relation to the money.

In an attempt to help, the judge made the suggestion that he should grant an injunction freezing "A" Ltd's accounts, restraining them from releasing the money. In order to deal with the ‘Tipping Off" concern, the judge directed that neither the customer nor the other parties, were permitted to see any of the bank’s supporting evidence, they were not to see the Order, nor even be informed of its existence.

The inevitable happened, "A" Ltd brought an action in the commercial court against bank, seeking an order that the money in the account be released, if not to "A" Ltd directly, then to their solicitors.

The bank’s lawyers, of course, were constrained by the terms of the first order, and said nothing in open court. After "A" Ltd and their legal counsel had withdrawn, however, they made their submissions to the judge in private, and informed him of the freezing order. The judge gave the bank a deadline by which time, if they had not lodged their own application, he would order them to release the money.

The bank was undoubtedly in a difficult position, stuck between the proverbial rock and a hard place; their attempt to avoid the civil liability risk under an action for breach of constructive trust whist avoiding the criminal offence for ‘tipping off’ resulted in their having one court order ordering them not to release the money, and looking at a second one ordering them to do so.

The effect of all of this was that is achieved precisely what the Bank and the Serious Fraud Office were anxious to avoid all along; "A" Ltd learned that they were the subject of a serious criminal investigation. The money was released and although the Bank was ultimately held liable for costs, they never had to face a civil action for breach of a constructive trust.

The interesting point is not so much one of law, but one of fact. In the final analysis, there was no constructive trust claim because the authorities either could not or would not bring a criminal case against "A" Ltd, and neither Mr. B nor "C" Ltd came forward to say that they were the victims of a fraud.

What really happened? In short, we do not know, but there is merit in considering any one of a number of scenarios that might be relevant.

As far as we know, the alleged Advance Fee Fraud in the Bank of Scotland case was a domestic affair. What if a bank makes a Suspicious Activity Report (SAR) that related to a criminal act that took place in a foreign jurisdiction? The legislation7 extends the definition of "indictable offence" to include something that would constitute an indictable offence if it had occurred in Hong Kong and it is possible that if a money launderer is tipped off in one jurisdiction because a bank has filed a SAR, that has the potential to compromise a criminal investigation almost anywhere else in the world.

There has been some criticism of the police and criminal prosecution authorities being allowed to disclose very little to the court, even to a judge in chambers, on the grounds that the subject matter is highly confidential.

The suggestion that this is often a device to conceal ignorance and speculation, which the court could easily expose, is naïve and reveals a fundamental lack of understanding of the realities of criminal investigation.

In its fight against money laundering and the serious predicate offences associated with it, traditionally accepted and fundamental legal rights are undoubtedly being eroded. The Bank of Scotland case illustrates how a suspects right to confidentiality over his banking affairs, his right to be made aware of the case against him, his right to tender a defence, his right to have that case heard in an open court, and then to hear the reasons for the courts' decision have all been adversely affected.

These represent a major assault on the rights of the individual, and considerable power appears be entrusted to the authorities to exercise in good faith. Unfortunately, it is necessary to consider the nature of the threat to society that is posed by serious crimes such as drug trafficking, corruption and terrorism. In a world where the nature of financial crime is increasingly global, the information linking an individual with a serious crime may come from a foreign source, and there may be good tactical reasons why information cannot be disclosed, even to support a criminal prosecution. Doing so could compromise an even greater, more important and more complicated investigation somewhere else in the world.

If courts are not to take cognisance of that fact, much of the international co-operation that has been established under MLATs8, between members of the Egmont Group9, and among other international law enforcement agencies - and the ability to prosecute international crimes - will be seriously undermined. Investigators might be accused of conjuring up illusions of ‘smoke and mirrors,’ and it is undeniably true that many individuals in law enforcement will abuse their position to one degree or another, but to expect serious criminal investigations always to be conducted openly is simply not sensible.

It is also necessary to consider the pressures on differing branches of the law enforcement community, specifically those of the investigation entity as opposed to those interested in the gathering of intelligence.

From an intelligence gathering perspective, it makes more sense to allow the customer to withdraw the money, this allows the authorities to monitor their activities and identify other parties they may be connected with. The alternative, freezing the account, may afford the bank some protection at civil law, but it will tip off the subjects and almost certainly compromise the investigation.

Who can the Bank rely on?

There was a suggestion in the Bank of Scotland decision that the bank was at fault in not recognising that it was pointless to seek relief against "A" Ltd, and that the appropriate defendant to any application for directions should have been the Serious Fraud Office. Be that as it may, the bank’s real concern was their potential liability in a civil action; something which the SFO would be most reluctant to get involved in.

The Bank of Scotland case was unusual in that the subject of a report to the NCIS learned that it had been made.

In many fraud cases, the victim might not know what happened to his money, or that it was ever the subject of a report to the authorities. He may not even know he is a victim, he may still believe he has made a sound investment.

There is therefore the possibility that when the perpetrator of the fraud is ‘tipped off’ about the filing of a report, this opens up a window of opportunity for him to intimidate his victim before the Police have an opportunity to follow up and investigate the alleged crime. If the victim refuses to report a crime; it might become impossible to prove there was a predicate offence, and therefore any money laundering. This is patently a most undesirable outcome, and underscores the importance of the "tipping off" provision.

Where the crime does subsequently result in a criminal prosecution, even if the money has been lost, dispersed or squandered, the fact that it passed through a bank or another financial institution opens up all manner of possibilities for constructive trust actions being brought against them, alleging the who ought reasonably to have known that the money came from a criminal source. These cases might arise long after the criminal case has been settled.

The fact that a bank may have filed an SAR at the time will then come back to bite them; it is prima facie evidence that the bank had reasonable grounds to believe they were in the position of a constructive trustee.

Such a document will be one of the primary objectives of any ‘Anton Pillar’ Order, and if the criminal case has already been settled, it would be difficult to argue that it should not be disclosed. Similarly, although there is an exemption under the s29 Data Privacy Act which states that information need not be divulged if it would be likely to prejudice the prevention or detection of crime or the apprehension of offenders. Can this exemption apply after the criminal case has been disposed of?

Consider what must be the nightmare scenario for a Private bank when one of their high net worth customers, formerly a ‘Politically Exposed Person’, is charged with corruption, and the bank finds itself accused of money laundering.

The customer may have been a Cabinet Minister, a Town Mayor or a Provincial Governor of a Third World Country, most of which are not known for paying generously high salaries. How a career politician acquired enough money to have an account in a private bank is a pointed, if rhetorical question, beloved of investigative journalists.

The problem, however, is compounded because by that time, although many millions of dollars may have passed through the account at one time or another, the credit balance might be almost nil, the money having gone on its way to somewhere where it could not be traced.

In addition to the considerable embarrassment factor, the institution could be vulnerable to a constructive trust action. They would, of course, have a right of relief against their erstwhile customer, which is of little comfort if he has blown it already.

We must assume that if the facts that gave rise to the Bank of Scotland case are not a fairly routine occurrence in the bank compliance circles, the increased anti-money laundering requirements introduced by the USA PATRIOT Act, the EU Second Directive and the Proceeds of Crime Act in the UK, are likely to increase the chances of the same problem resulting in an altogether different outcome.

All that is missing is a defrauded party to step forward, after a bank allowed suspicious funds to be withdrawn, and the best efforts of the financial institution in question to comply with the its responsibilities under the money laundering regulations will be used in evidence against them in a civil court.

It is very likely that the institution in question will have released the funds with the consent of the NCIS, and although they may be protected from criminal prosecution, what relevance is that to their defence?

Money laundering has been identified as a major element in the war against terrorism as well as against organised crime, and the private sector has a role to play, whether they like it or not. It is apparent that much law will have to be written before this area of the law is finalised, and the fate of money that is deemed to be from a suspicious source is something that must be of paramount concern to the financial industry.

Would the Crown ever be held civilly liable if the NCIS do not require an account to be frozen or will the liability ultimately rest with the financial institution? Given the obvious need to investigate crime and the developments, as well as the volume of the anti-Money Laundering regulations being loaded onto the financial industry, it would probably be unwise to bet on the former.

The point was made at the beginning, that although ‘Bank of Scotland -v- A, B & C’ may be a landmark case of simple facts and complex law, the outcome in both was very worrying and unsatisfactory for the financial community. What should they do? What can they do? At the risk of appearing facetious, the most obvious lesson here might be comparable to the medical profession’s advice on the treatment for AIDS; which is not to catch it in the first place.

With increased regulation and increased potential liability, the time has come to address what ‘Due Diligence’ really means. Tears and tantrums aside, the time has come for the financial sector to look very seriously at what they really can do to protect themselves from customers whose criminal activities might rapidly turn into a serious liability.

This involves much more than confirming the identity documents of individuals and the Memorandum and Articles of a limited company. If there is a suspicion that a customer might be involved in something that could later pose a problem or be an embarrassment; it is up the financial institution themselves to investigate the matter. That involves asking such penetrating questions as "What does this customer do?" and "Is there anything about his business to suggest he might be involved in something fraudulent, or criminal?"

There is nothing new and nothing ‘magic’ about doing Due Diligence into a potential customer and conducting enquiries into their background. It is only new and unfamiliar to those who refuse to accept that the world is a changing place, and it is changing at a faster rate since September 11. These may not be the traditional skills required of as banking professional, but neither was computer literacy, until relatively recently in modern history.

1 Carlill v Carbolic Smoke Ball Company [1893] 1 QB 256

2 Donohue -v- Stevenson [1932] AC 562

3 Bank of Scotland -v- A Ltd & Ors [2001] EWCA Civ 52; [2001] 1 W.L.R. 751

4 S93 Criminal Justice Act, which equates to s25A of the Organised & Serious Crimes Ordinance in Hong Kong

5 In Hong Kong, the same offence exists in S25A(5) Organised & Serious Crimes Act.

6 C v S [1999] 2 AER 343

7 S25(4) Organised & Serious Crimes Ordinance

8 Mutual Legal Assistance Treaty

9 The Egmont Group is an international grouping of financial intelligence units; such as the NCIS in the UK or the JFIU in Hong Kong. Its purpose is to facilitate international co-operation and liaison in money laundering cases.

© Peter A Gallo. 25 July 2002

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