Money laundering: The enemy within

With new money laundering regulations on the horizon, law firms need to update and review their risk-management procedures, and retrain staff to ensure they are on their guard.

By Sue Mawdsley, partner, Legal Risk

A 15-month jail sentence for UK solicitor Phillip Griffiths for failing to report money laundering was a wake up call for many lawyers. The reduction in sentence to six months by the Court of Appeal was small comfort to Mr Griffiths who faced, as the court reminded him, inevitable striking off. And he was the second solicitor jailed in a week for money-laundering related offences.

The Griffiths case was notable because the jury’s findings, in acquitting him of involvement in the money laundering itself, shows that he had failed to suspect what was going on.

A reasonable solicitor would have done, so mere negligence was enough.

Who can say, hand on heart, they have not gone home at the end of a busy day having made a mistake that, without the pressure of work, might have been avoided?

The Court of Appeal emphasised ‘to all professional people involved in the handling of money and with an involvement in financial transactions the absolute obligation to observe scrupulously the terms of this legislation and the inevitable penalty that will follow failure to do so.’

The previous solicitor jailing caught the attention of those in charge of law firms’ accounts departments as Brian Dougan of Northern Ireland pleaded guilty to converting or transferring the proceeds of criminal conduct by allowing £66,000 to pass through his client account while carrying out conveyancing work for a convicted criminal. Sentencing him, The Times report noted that Judge Swift, a former solicitor himself, ‘accepted that Dougan was a naive victim of a sophisticated criminal, but said that solicitors must “take the greatest care” to stop others using their respectability to launder cash.’ Dougan, a pillar of the local church, was sentenced to three months’ imprisonment.

Most law firms focus their effort, rightly, on work in the regulated sector, such as property, corporate and tax. The risk, however, is that they lower their guard in other areas. Following a decision of the Court of Appeal in Bowman v Fels [2005] EWCA Civ 226 on 8 March 2005, many law firms have assumed that litigation, including personal-injury work, is completely out of the woods so far as compliance is concerned. They may have also assumed, wrongly, that client privilege applies to every piece of paper and information in their office.

Reports that police arrested ten people and seized £1m as part of an investigation into a gang that had allegedly been staging bogus road accidents to defraud insurance companies provide a strong message to personal-injury lawyers that the principal money laundering offences apply to them with full force.

The Court of Appeal in Bowman v Fels made it clear that privilege does not apply to clients who use solicitors to pursue sham litigation, such as staged accident claims. These cases will remind law firms of the need to update and review their procedures and retrain staff, including litigation departments, to ensure they are on their guard.

Litigation may be ‘low risk’, but it is not ‘no risk’. Bowman v Fels held that litigation would not normally constitute the offence of making a money-laundering arrangement under the Proceeds of Crime Act 2002 – unless the claim was a sham. One eminent international firm, which the writer has advised on procedures and training, found that two clients were trying to use its litigation services for money laundering by settling what turned out to be sham litigation rather too readily.

Accounts departments are on the front line of the war on money laundering. Training accounts staff may be the insurance policy against fee-earner error or, heaven forbid, even a rogue partner. Rogue partners often crop up when they are least expected – they are often highly regarded and outwardly successful, as the case of Michael Fielding, jailed for stealing over £6.5m of client money, shows. Fielding had been a partner in a leading City law firm and listed in legal directories as a leader in his field.

In one firm where staff were tested with Desktop, Legal Risk’s online risk-management diagnostic tool, accounts staff admitted that if money was credited twice to client account for the same transaction, they would immediately arrange a refund.

Some of the staff were found to be unlikely to check the source of funds against the expected source. This is just what the money launderer wants. One regular payment comes in, and one irregular payment from another source.

The solicitor refunds it, and the money is now clean. Accounts staff need to be astute to spot financial transactions where there is no underlying legal transaction. This often occurs on ‘miscellaneous’ or ‘general’ ledgers for a client who provides a volume of work. If the matter is not perceived as meriting its own ledger, probably because the partner cannot be bothered with the administrative requirements that were put in place by a conscientious finance director or head of accounts for good reason, the chances are that they will not have a properly defined retainer in place, there will be no engagement letter, and any attempts to limit liability contractually will fail too.

You may have tight procedures operating in your head office, but are the same procedures applied as rigorously in other offices? Problems frequently occur in more remote offices, be they branch offices in this country or overseas offices. In one firm, a major international practice with good overall risk-management procedures, the partners were being asked to sign matter-inception forms three weeks after work had started on matters. Putting this into context, the relevant events giving rise to the high profile conflict case of Marks & Spencer v Freshfields Bruckhaus Deringer [2004] EWCA Civ 741 occurred in less than three weeks.

Firms need to assess the risk of money laundering across the various parts of their practice – different work types and different offices carry different risk. Implementing a risk-based approach is very much the order of the day, made clear by the Law Society’s guidance on anti-money laundering and reinforced most strongly in the latest guidance for the financial sector from the Joint Money Laundering Steering Group (JMLSG). More focus on this approach can be expected in the new Law Society guidance, to which the finishing touches are being put as this article goes to press.

But money-laundering compliance is a culture, not an event. The anti-money laundering landscape is constantly changing – there have been over a dozen major developments in the past year, with many more to follow such as the aforementioned new Law Society guidance and the implementation of the Third EU Money Laundering Directive, which will result in new money laundering regulations in 2007.

Also notable is the new emphasis on Counter Financing of Terrorism (CFT) in the new JMLSG guidelines. This will be of particular concern to conveyancing practices. In November 2006, the Assets Recovery Agency obtained freezing orders on assets worth over £1.5m, including nine properties in Manchester, alleging that they are the proceeds of money laundering, fuel smuggling and mortgage fraud.

A useful document in assessing your firm’s procedures is the Financial Services Authority’s (FSA’s) anti-money laundering self-assessment tool, launched in November 2006: see ttp://www.fsa.gov.uk/pages/Doing/small_firms/advisers/pdf/aml_tool.pdf. Although developed for small financial-adviser firms, the fundamentals will not differ greatly.

The tool, which the FSA emphasises is not a checklist, covers ‘management’ responsibilities, ‘reports to the money laundering reporting officer’, ‘customer due diligence’, ‘training’ and ‘suspicious activity reporting’.

But having decided on the appropriate systems, should a firm audit for compliance? Few do in the writer’s experience. Yet, if you do not audit, how can you tell if your firm is complying?

Remember too, if you change your money-laundering systems and procedures, which you must from time to time to keep them up to date, you must keep an audit trail of the changes. The risk otherwise is that people will be judged against standards that were not in force at the relevant time.

Whatever systems and policies are put in place, they should not be viewed as a standalone money-laundering risk-management policy – they must be integral to the firm’s systems.

It is interesting to note that there has been a fall off in claims against law firms in the past couple of years, and one can but ask whether this may be due in some part to the focus on anti-money-laundering compliance.

It is not that solicitors were habitually acting for money launderers previously but that they now understand that they have to ‘know your client’ and understand the business purpose behind clients’ transactions.

The lesson for law firm FDs is simple – the accounts team will often be the front line resistance to potential money-laundering activities, so the need to train and test them on their understanding of the requirements is absolutely critical.

Sue Mawdsley is a partner at Legal Risk. She can be contacted at sue.mawdsley@legalrisk.co.uk