UK: Financial Regulation Update - The Proceeds of Crime Act

Last Updated: 4 September 2002

In our August 2001 briefing we outlined the important changes to the law of money laundering proposed in the Proceeds of Crime Bill ("Bill"). This Bill received Royal Assent on 24 July 2002 and became the Proceeds of Crime Act ("Act"). The Act will have a significant effect on businesses, necessitating stricter reporting policies and more thorough staff training in light of new and extended money laundering offences.

The Act coincides with a number of recent measures aimed at combating terrorism and tightening financial regulation to which businesses will need to have regard, such as the Anti-Terrorism, Crime and Security Act 2001, the Money Laundering Regulations 2001 and the FSA’s Rules on money laundering.

In this briefing we focus on the Act’s money laundering provisions, which are scheduled for early implementation in December 2002. The remaining provisions of the Act will follow early in 2003.

The Act’s main provisions

The Act is substantially similar to the Bill, as described in our previous briefing. It contains provisions to:

  • establish an Assets Recovery Agency to investigate and recover wealth which has been obtained through criminal conduct;
  • create a right of civil recovery which enables the Agency to recover property which was obtained through criminal conduct, including the right to recover property from third parties. The Agency need only prove its case on a civil standard of proof, and can apply to the High Court for an interim order freezing suspect property which will then be managed by an independent receiver;
  • enable the Agency to exercise the functions of the Inland Revenue and tax the suspected proceeds of crime without identifying a source of income;
  • create new investigative powers, including customer information orders (requiring banks and other financial institutions to identify accounts held by persons connected to an investigation), account monitoring orders, compulsory disclosure orders and production orders. A Code of Practice will be drawn up to provide guidance on the exercise of these functions. Civilian staff of law enforcement agencies will be able to exercise some of these powers if they are accredited as financial investigators; and
  • unify and expand existing money laundering offences and create new obligations to report when there are reasonable grounds to know or suspect that a person is engaged in money laundering.

The money laundering offences

The major extension of the scope of the money laundering offences arises because they will apply to the proceeds of any criminal conduct, not just "serious" crime. There is no de minimis limit and there is no need for the conduct to have any connection to this jurisdiction.

It is also worth noting that the offence of acquisition, use and possession of the proceeds of crime (s.333) draws no distinction between the original criminal and a later recipient of the proceeds of a crime. Therefore the commission of the initial crime will simultaneously give rise to a money laundering offence. Effectively this means in practice that an obligation to report money laundering should be read as an obligation to report any criminal activity whatsoever and wheresoever in the world if it would constitute an offence under English law.

Otherwise the "assisting" and "concealing" offences have, subject to the comments set out below, not altered significantly.

Failure to report offences

Traditionally, firms carrying on certain types of financial business committed an offence if they failed to make a suspicious transaction report ("STR") when they had knowledge or suspicion of the laundering of the proceeds of terrorism or drug trafficking. The Anti-Terrorism, Crime and Security Act 2001 created a ‘negligence’ test for failure to make a report in relation to terrorism, ie the offence could be committed without any knowledge or suspicion of money laundering if there were reasonable grounds for such suspicion.

The Bill originally proposed a similar objective test for firms in the regulated sector (essentially, firms subject to the Money Laundering Regulations 1993) which had reasonable grounds for knowing or suspecting that another person was laundering the proceeds of any type of crime.

The Act has extended this even further and created three new offences of failure to disclose:

  • persons in the regulated sector who obtain information in the course of their business which gives reasonable grounds for the suspicion of money laundering will commit an offence if they fail to make a report (s.330);
  • Money Laundering Reporting Officers ("MLROs") in the regulated sector commit an offence if an employee makes a report to them which gives reasonable grounds for suspicion, but the MLRO does not make an onward STR (s.331). It is a defence for the MLRO to have a reasonable excuse for not making a report; and
  • other MLROs (ie those not in the regulated sector) will commit an offence if they do not make an STR when they know or suspect (ie this is not a negligence test) as a result of a disclosure to them that a person is engaged in money laundering (s.332). Again, the MLRO will have a defence if there is a reasonable excuse for not making the report.

Thus persons in the regulated sector and all MLROs are exposed to liability for failing to make reports even where they do not in fact suspect money laundering and even if the sum being laundered is a trivial amount and/or the proceeds of a trivial offence.

The factors which we consider the court will take into account in determining whether an offence has been committed are:

  • the information available to the employee at the time;
  • transaction records and ongoing Know Your Customer information;
  • the employee’s awareness and experience;
  • the employee’s training; and
  • the employee’s actions and inquiries.

In addition, in relation to offences in the regulated sector the Court is obliged to consider whether relevant regulatory guidance has been followed. Now, more than ever, an institution’s decision not to follow the JMLSG Guidance Notes with need to be justified and, ideally, that justification should be recorded on the file. However, literally following the guidance without tailoring it to an institution’s business as a part of a risk based approach will not constitute a safe harbour.

The importance of training

Complying with the relevant training requirements is even more important in light of the new defence to the Section 330 failure to disclose offence.

If an employee does not have knowledge or suspicion of money laundering (ie if he is prosecuted for negligence alone) it is a defence for him to prove that he has not been provided by his employer with relevant training. Section 330(7) provides that such training will be specified by the Secretary of State by Order. At present we understand that it is intended that this Order will be based entirely on existing provisions, and will simply require employees to be trained in accordance with Regulation 5 of the Money Laundering Regulations 1993 ("Regulations").

The defence is problematic for the employee who will in essence have to prove a negative and attack his employer. Nevertheless, the obvious course for an employee charged with negligent failure to disclose will be to accuse his firm of not providing proper training.

The consequences for the firm may be severe. Failure to comply with the training requirements in the Regulations is a criminal offence. In addition, proper training for all staff who handle, or who are managerially responsible for, transactions which may involve money laundering is a requirement of the FSA Handbook. Although breach of the FSA Rules is not a criminal offence, the FSA may still fine a firm and/or remove authorisation for an approved person.

It is therefore likely that this element of the Act could give rise to conflicts between the individual and the firm. Those conflicts need to be anticipated in advance and incorporated into a firm’s risk management procedures.

The ‘cooling off’ period

A further key difference between the Bill and the Act is the introduction of a seven day ‘cooling off’ period once an STR has been made.

If a person suspects that a transaction in which they are involved will constitute a substantive (not reporting) money laundering offence (eg concealing or arranging), they will have a defence if they make a report and then continue the transaction with the "appropriate consent". This is the consent of the person to whom the report has been made.

In the case of a front line employee, that will be the MLRO. However, it is an offence under Section 336 for an MLRO to consent to the transaction if he knows or suspects that continuing the transaction would involve the commission of a substantive money laundering offence. He will first need to have made a disclosure to NCIS and have waited for consent to be given by a constable.

The Act deems consent to have been given by a constable or customs officer if there is no response to the report within seven working days, or if permission to act is refused but nothing further is heard for 31 days.

Potentially the combined effect of these provisions may be to delay the completion of transactions. If a client suffers loss as a result, they may be able to sue for damages. Imagine the situation where the client is about to draw down further funds under a loan agreement where there are suspicions about the client’s motives or the origin of the bank’s security. The criminal and civil risks could be significant. This may also create problems in terms of tipping off. If the transaction has not completed and the customer inquires as to the reason why, what realistically can be said without NCIS’ consent?

It may be possible to argue that, during the cooling off period, it is unlawful to perform the contract since to action the client’s instructions would be a criminal offence. Illegality is a general defence to actions for breach of contract and rests on an underlying public policy rationale; it is arguably against public policy to enforce contracts in such circumstances. However the defence is untested in this type of situation. The difficulty will be that the likely scenario is that by the time the matter comes to court, the client may no longer be under suspicion and the report to NCIS may have been misfounded.

During the Third Reading of the Bill, the Criminal Justice minister Lord Falconer stated that it was "highly unlikely" that a company in dialogue with NCIS would be found to be negligent for failing to comply with the customer’s instructions. Lord Falconer also said that he was looking into setting up a follow-up hotline within NCIS in the case of urgent transactions, but whether and how this will operate in practice remains to be seen.

Even if there is such a defence, it may still be important to minimise the delay between a report being made to the MLRO and the MLRO making a report to NCIS so that the deemed consent is given as quickly as possible. Otherwise, the customer may claim that the institution unreasonably delayed passing on the report which in turn unnecessarily delayed the completion of the transaction with adverse consequences for the customer. The implicit encouragement for MLROs to pass on reports quickly runs counter to the encouragement given to date to MLROs by NCIS and the FSA Rules to, where appropriate, properly consider internal reports by reference to all the available internal information before reporting the matter to NCIS.

Liability of MLROs in the regulated sector

MLROs are also subject to an increased risk of incurring criminal liability and in practice an MLRO who receives an STR will be in a difficult position.

Until this Act, if an MLRO negligently concluded that there were no grounds to be suspicious and did not pass on an internal transaction report, it would be very unlikely that he would be considered to have committed a criminal offence. However, under the new Act (s.331) it will be an offence for an MLRO to fail to make a report where, in the regulated sector, he had reasonable grounds to suspect money laundering, or he consents to a transaction continuing in the circumstances set out above (s.336). In future MLROs will need to be very comfortable before they do not pass on a report.

Liability of MLROs outside the regulated sector

It is worth noting that, outside the regulated sector, the tests which employees and MLROs will apply in deciding whether to make reports are different, save where terrorism is involved. When making an internal report, the employee will need to consider whether they know or suspect that a transaction involves the commission of a money laundering offence (ie whether the transaction in which they are involved means that they are committing one of the assisting/concealing/receiving offences). However, in deciding whether to make an onward report to NCIS, the MLRO will have to consider whether, based on the internal report, he suspects that someone, not necessarily his firm, is engaged in money laundering, ie whether they have committed a criminal offence. This is a wider test.

Constructive trusts

The greater number of STRs which is to be anticipated from the new reporting obligation is likely to increase the number of situations in which the inherent conflict between the criminal and civil regimes arises. An STR based on "reasonable grounds" could still be important evidence for a Claimant in civil proceedings against the institution who alleges that misappropriated funds have been received by the institution and that it is unconscionable for them to be retained even if full consideration has been given.

A prudent climate

As well as increased reporting, MLROs may find that they wish to review past files. Previously, MLROs may have been aware of unusual transactions but decided that money laundering was not involved. The question arises as to whether such old internal transaction reports should now be reviewed in case there are reasonable grounds for suspicion that a money laundering offence has been committed.

A recent case involving a solicitor who failed to go back and report old transactions in light of new information is an analogous example. Simply because the information is "on file" does not mean that it could not be used to suggest that the institution had reasonable grounds to make a report. It is after all very relevant to know about a client!

A prudent approach would therefore be to review these files to see if the information is still relevant to the current client relationship.

Conclusion

This wide-ranging Act is to be welcomed as part of the initiative to combat money laundering. However, firms will need to revise their procedures to ensure that they properly manage the risk of both criminal and civil liability. Proper training will assume a new importance and MLROs will be at greater risk if they make the wrong decision in not passing on a report to the police.

© Herbert Smith 2002

The content of this article does not constitute legal advice and should not be relied on as such. Specific advice should be sought about your specific circumstances.

For more information on this or other Herbert Smith publications, please email us.

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