AML Due Diligence Standards for U.S. Lawyers
Today we are very pleased to welcome guest blogger Bruce Zagaris, who is a Partner at the Washington, D.C. law firm of Berliner, Corcoran & Rowe. He is the editor of the International Enforcement Law Reporter; the author of International White Collar Crime: Cases and Materials; and an Adjunct Professor at the Texas A & M University School of Law. Mr. Zagaris also is a member of the Task Force on the Gatekeeper and the Profession of the American Bar Association (“ABA”).
As Mr. Zagaris explains immediately below, growing international trends have led the ABA Task Force to consider a new Model Rule of Professional Conduct that would impose basic “client due diligence” requirements on U.S. lawyers to determine whether their clients are engaging in money laundering or terrorist financing. This development relates directly to issues about which we previously have blogged, including European perceptions of lawyers as potential gatekeepers and of the United States as a haven for money laundering and tax evasion. The possible new Model Rule potentially would represent a significant shift in how the U.S. legal profession regards itself and its relationship to its clients. We hope that you enjoy this discussion by Mr. Zagaris of these important issues. -Peter Hardy
Increasingly, international bodies are calling for higher standards for gatekeepers, known in the parlance of the Financial Action Task Force (“FATF”) as “designated non-financial businesses and professions” (“DNFBPs”). DNFBPs include lawyers, accountants, real estate agents, and trust and company service providers (other than trust companies). In particular, in the United States, lawyers play a key role in areas that give rise to potential money laundering: company formation; real estate transactions; business planning; tax planning; wealth management; trust and estate work; and formation and operation of charities, including transnational philanthropy.
In 2006 and again in 2016, the FATF, an intergovernmental body in charge of making and overseeing compliance with international money laundering standards, performed Mutual Evaluation Reports (“MERs”) to assess compliance by the United States with international standards. While the FATF gave the U.S. high marks generally, both MERs found the U.S. “non-compliant” in gatekeepers and entity transparency.
As a result of this international trend, the ABA’s Task Force on the Gatekeeper and the Profession has prepared and discussed a new ABA Model Rule of Professional Conduct that would impose basic “client due diligence” requirement on lawyers. We discuss this potential new model rule, and the developments which have led to its consideration, below. Clearly, due diligence for lawyers will increasingly be on the radars of banks, financial institutions, and law firms.
The Global Witness Sting Investigation
Civil society is so concerned about the adverse impact of non-compliance by U.S. lawyers of international money laundering standards that the Global Witness, an international NGO, conducted a report on a sting operation on lawyers in Manhattan. The Global Witness’s investigator told lawyers that he worked for an African minister of mines who had accumulated millions of dollars from companies that were seeking business in his country. The investigator told the lawyers that the minister wanted to buy a townhouse in New York and possibly a jet or a yacht.
While none of the lawyers are accused in the report of criminal wrongdoing, Global Witness said 12 of the 13 lawyers its investigator had met with discussed ways to move money that, according to Global Witness, “should have raised suspicions of corruption.” The purpose of the exercise, which was aired on CBS’ 60 Minutes, was to show that American lawyers did not meet international standards for on-boarding new clients. Some lawyers appeared eager to help the phantom African minister move the allegedly suspect money.
One of the recommendations of the Global Witness report was that “the U.S. should ensure that it complies with international anti-money laundering standards. This means that the U.S. should pass legislation requiring transactional lawyers, and anyone else who creates companies, to carry out anti-money laundering checks. The ABA should also update its Model Rules of Professional Conduct to require lawyers to carry out anti-money laundering checks.”
The FATF Reports
A related anti-money laundering (“AML”) issue is that in 2006 and 2016 the FATF has found the U.S. non-compliant with the entity transparency standards. When lawyers form and operate companies and trusts, they often take care of the structuring and the details of maintaining information on beneficial ownership. The U.S. Congress for several years has tried to enact legislation, called the Incorporation Transparency and Law Enforcement Assistance Act (“ITLEA”), which would at least require corporate formation agents to keep and update beneficial ownership information.
In 2010, the ABA issued voluntary Good Practices Guidance on detecting and combating money laundering and terrorist financing (“Good Practices Guidance”). In addition, the ABA has undertaken a robust effort to educate the bar.
The 2016 MER by the FATF expressed concern that the Good Practices Guidance is voluntary and lacks remedial action in the event lawyers do not comply with the guidance. The absence of an enforcement mechanism and the lack of empirical data evidencing that most lawyers have read and complied with the Good Practices Guidance resulted in FATF downplaying the importance of the guidance.
In 2013, FATF published a report outlining some AML vulnerabilities of legal professionals. In this report, they outlined 42 risk indicators of potential money laundering. Some indicators include a client’s reluctance to provide information, data, or documents in order to facilitate the transaction.
Other European AML and Anti-Tax Evasion Initiatives
Another external pressure is that on June 26, 2017, the European Union’s Fourth Anti-Money Laundering Directive (“Fourth Directive”) entered into force. The Fourth Directive reinforces the existing rules by introducing the following changes: reinforcing the risk assessment obligation for banks, lawyers, and accountants; setting clear transparency requirements about beneficial ownership for companies (this information will be stored in a central register, such as commercial registers, and will be available to national authorities and obliged entities); facilitating cooperation and exchange of information between Financial Intelligence Units from different Member States to identify and follow suspicious transfers of money to prevent and detect crime or terrorist activities; establishing a coherent policy towards non-EU countries that have deficient anti-money laundering and counter-terrorist financing rules; and reinforcing the sanctioning powers of competent authorities.
On May 5, 2017, the Organisation for Economic Co-operation and Development (“OECD”) announced the establishment of a facility to disclose Common Reporting System (“CRS”) avoidance schemes. The facility is one of the OECD initiatives to combat schemes that intend to avoid reporting under the CRS. The OECD will identify and systematically analyze all actual or perceived loopholes in order to decide on appropriate courses of action. The facility will help increase the effectiveness of the CRS, which by design already limits opportunities for taxpayers to circumvent reporting to the greatest possible extent. The CRS requires Financial Institutions to report and detail the financial information to be reported as well as the scope of Account Holders subject to reporting. The CRS requires that jurisdictions, as part of their effective implementation of the Standard for Automatic Exchange of Financial Information in Tax Matters (“the Standard”), have anti-abuse rules to prevent any practices intended to circumvent the report and due diligence procedures. The CRS Automatic Exchange Portal enables persons to access the disclosure facility.
At present the CRS Implementation Handbook states that implementing the Standard effectively not only requires “the reporting obligations to be translated into domestic law but the introduction of a framework to enforce compliance with those obligations.” Therefore, the Standard requires jurisdictions to ensure that the CRS is “effectively implemented and applied by financial institutions, including the introduction of provisions that: 1. prevent circumvention of the CRS (anti-abuse provisions); 2. require reporting financial institutions to keep records of the steps undertaken to comply with the CRS (record-keeping requirements); and 3. permit the effective enforcement of the obligations in the CRS (including penalties for non-compliance).”
The Handbook instructs jurisdictions, “to assess the compliance framework they have and determine whether it meets the requirements of the Standard and that it is applicable in relation to a failure to meet the obligations of the domestic rules implementing the Standard. Where there are gaps, new provisions will need to be introduced.”
In this regard, on April 27, 2017, the U.K. Parliament enacted the Criminal Finances Act, which provides law enforcement agencies more powers to recover the proceeds of crime, helping to combat tax evasion, money laundering, corruption, and the financing of terrorism. The measures include a new corporate offense: failure to prevent the facilitation of tax evasion. The offense is expected to take effect in September after HM Treasury promulgates regulations.
Once the OECD identifies and analyzes the schemes to circumvent the CRS, it will be interesting to see what recommendations it makes and/or decisions it takes to implement the anti-avoidance initiatives. Many of the structures to avoid the CRS are being put in place in the U.S., especially in jurisdictions such as South Dakota, Wyoming, Nevada and Delaware.
Finally, another factor motivating the development of due diligence standards for lawyers and law firms is that increasingly banks are asking law firms, especially ones that engage in wealth management, to share with the banks their AML due diligence policies as a condition to keeping their accounts with the banks. Banks are increasingly paying attention to international tax transparency issues.
The ABA Model Rule
As a result of the above-mentioned developments, the ABA Task Force on the Gatekeeper and the Profession has prepared and discussed a new ABA Model Rule of Professional Conduct that would impose basic “client due diligence” requirement on lawyers. As explained in an April 6, 2017 Law360 article by Kevin Shepherd, the past President of the Task Force, lawyers would have to perform reasonable, proportional, risk-based due diligence on prospective clients and certain new legal matters brought by existing clients and would have to monitor their clients during the scope of their services in order to determine whether the clients are engaging in money laundering or terrorist financing. If the ABA adopts these rules, a lawyer who does not comply may be subject to potential disciplinary action by the state disciplinary authority. Hence, the state courts and their state bar agencies would be in charge of the compliance and enforcement.
Even without a change in the ABA Model Rule of Professional Conduct, the New York State Bar Association has responded to an inquiry concerning “(a) client who is a citizen and resident of a foreign country” consulting with an attorney “about a proposed transaction (“Transaction”) in which the client would open a bank account in his name at a New York bank, or create a wholly-owned corporation in a zero tax jurisdiction (“Offshore Corporation”) and have the Offshore Corporation open a bank account at a bank in New York.” The attorney in question learns that the client does not want to report the Transaction in the foreign country because reporting would result in tax or other legal liability. In New York State Bar Inquiry No. 14-08 (Oct. 8, 2008), the New York State Bar opined that DR 7-102(A)(7), which requires a lawyer not to counsel or assist the client in conduct that the lawyer knows to be illegal or fraudulent, encompasses conduct that is “illegal or fraudulent” under the laws of jurisdictions other than New York.
One issue unresolved until now is whether state bars would actually engage in compliance and enforcement. Normally this occurs through some type of audit. Regulatory agencies conduct audits through both offsite and onsite examinations. In this regard voluntary self-regulatory organizations, such as the Canadian and Jamaican Bar Associations, have developed procedures to audit law firms with respect to their compliance with the standards.