The Last Word: Client due diligence

Client due diligence and take-on procedures are probably the most significant contribution to a risk-management strategy. In this we include, for example:

Client risks;
Geography;
Work type – corporate work will be higher risk than litigation for anti-money-laundering purposes, for instance;
The ability and capacity of the firm and the individuals to do the work.

Client due diligence has increased significantly in the UK since the introduction of anti-money-laundering legislation in 2003. Although it was largely seen as an unwelcome intrusion into professional life, claims overall have gone down since then, even if there has been an increase in the larger claims.
PricewaterhouseCoopers’ law-firm survey of 2006, on the top-100 UK law firms, reported, however, that only 45 per cent of respondent firms did credit checks as part of their client-acceptance procedure (down from 51 per cent the previous year) and only 67 per cent included an assessment of risk (down from 76 per cent the previous year).
Consider who has authority to take on a new client or a new matter for an existing client. Do you require a second partner or a committee to decide? There may be an inherent conflict for the partner concerned to accept when s/he has financial targets to meet. Client risks may include the following:

Those whose structure or nature of the entity or relationship makes it difficult to identify the true owner or controlling interests;
Cash-intensive businesses;
Clients who conduct their business in unusual circumstances;
Frequent and unexplained movement of funds between institutions, perhaps in different geographic locations;
Clients who have no geographic connection with where you practise;
Politically exposed persons.

See the Financial Action Task Force (FATF) ‘Guidance On The Risk-Based Approach To Combating Money Laundering And Terrorist Financing’. Country risk is also an important factor. Consider, for example:

FATF mutual evaluations – www.fatf-gafi.org;
The Transparency International Corruption Perceptions Index. The score relates to perceptions of the degree of corruption as seen by business people and country analysts;
The Joint Money Laundering Steering Group (JMLSG) Appendix D – current FATF and EU members, dates of most recent evaluations, NCCTs (Nairu) and former NCCTs;
Mutual evaluations by other regional organisations – Asia Pacific Group on Money Laundering, Caribbean Action Task Force, Offshore Group of Banking Supervisors, MONEYVAL;
See also the Economist Intelligence Unit report ‘Regulatory risk: Trends and strategies for the CRO’.

The implementation of the Third EU Money Laundering Directive is being seen by many firms as a reason to review their client-engagement process across all their offices. The requirement to implement risk-sensitive systems, building on the risk-based approach, which has been adopted in the UK since the implementation of the Second Directive in 2003, will further enhance the protection that partners in law firms provide for themselves. In particular, the requirement for ongoing monitoring will be important – clients such as Enron, Worldcom and Parmalat, whose much-publicised financial problems triggered massive potential liabilities for professional advisers, were no doubt good clients when they were taken on initially (and in some cases may be again).
For international firms that have not aligned their worldwide client-acceptance procedures, this gives them the opportunity to address the issue, at least across Europe. Doubtless there are challenges to meet, such as the issues surrounding beneficial ownership and data-protection concerns, but overall, the more resilient the client due-diligence process, the better protected will be the partners’ assets.

Frank Maher is a partner in Legal Risk, solicitors. He can be contacted at frank.maher@legalrisk.co.uk. This is an extract from a paper Frank Maher presented at the International Bar Association’s ‘Risk Management for Law Firms’ conference, September 2007.