Know Your Customer!

The need to prevent money laundering and inhibit the passage of funds intended for terrorist purposes has led to the financial services community, and those as diverse as estate agents, casinos and auctioneers, handling large volumes or sums of money being exhorted to ‘Know Your Customer.’ The penalties, in the UK for one, for not being able to prove that you at least tried to know who your customer is are severe: fines proportionate to the size of the corporate entity rather than the severity of the offence and loss of liberty for individuals. Lisa Bushrod reports.

But how relevant is the issue of money laundering to Europe’s venture capitalists? Judging by the inclusion of money laundering as an issue of ongoing regulatory concern for the European Venture Capital Association, and other major associations, such as the British Venture Capital Association, it would seem that the issue of money laundering is a concern.

In fact, for Europe’s venture capitalists, the issue of provenance of capital is relatively easy to distil. Adrian Johnson, chief executive of Legal & General Ventures, says: “Money laundering is relevant to private equity in terms of your investors. You have to go through money laundering procedures when you have a new investor into your fund. But you also have to look out for money laundering when you do an exit.”

Given that even the largest, billion euro, buyout funds tend to rarely reach triple figures in terms of their numbers of limited partner investors, although an additional administrative burden, checking the provenance of institutional funds ought to be relatively straightforward, especially thanks to the interpretation of the legal and regulatory checks required, provided by the likes of the European Venture Capital Association, which specifically examines anti-money laundering legislation in the UK, Ireland, Germany, Italy, Spain, Belgium, The Netherlands, Finland, Sweden, Denmark, Portugal, France, Switzerland and Luxembourg – see boxed item.

Critically, it also outlines the punishment meted out in each jurisdiction, should an individual or entity be found guilty of being involved in money laundering activity, as well as the official bodies in each country that entities and individuals operating in those jurisdictions need to be familiar with, in terms of the remit and workings of those bodies.

Even in the case of venture capital investors that raise money from the retail market, legislation has tended to at least facilitate the requirements of the venture capitalists, if not actually make life easier for them. For example, in the UK, individuals cannot hide behind the Data Protection Act since the introduction of the UK Proceeds of Crime Act. (The UK Proceeds of Crime Act 2002 requires those in the regulated financial sector to report actual or suspected laundering of the proceeds of crime. It is aided by the UK’s Money Laundering Regulations 2003, which expand the regulated financial sector beyond the banking and investment business into areas as diverse as estate agency, casinos and auctioneers.) In fact, the all-pervasive nature of this piece of legislation has led to the perversity of hours of UK court time being consumed by attempts to retrieve sums of less than £100.

The receipt of funds from investors is the first point of investigation. And the second point at which venture capitalists receive funds is, as Johnson points out, at the point of exiting an investment. While a well-known trade buyer might seem an innocuous enough source of funds, it is still imperative to check the provenance of the payment. For example, funds funnelled through a recognised offshore haven present a potential problem. The Financial Action Task Force on Money Laundering publishes an up-to-date list of those it deems to be Non-Cooperative Countries and Territories. The Task Force also effectively black marks countries or regions with the introduction of counter-measures, making it onerous and unattractive to accept payment from these areas.

While there are many software firms in the business of providing regulatory and anti-money laundering software, their nature seems best suited to the high volume transaction-based financial businesses. Ben William of one such software provider STB Systems points to usage in the high volume market such as monitoring trading five days before and five days after broker reports on stocks are issued, thereby enabling the brokerage house to keep tabs on potential insider dealing infringements. Similarly, volume banks can build statistical profiles of the types of transactions they want highlighted, which are then ear marked for further investigation.

To a certain extent the level of due diligence required is inferred from the assessment of the Financial Action Task Force on Money Laundering’s comments on jurisdictions as well as bodies like the United Nations, the Bank of England (UK) and the Office of Foreign Asset Control (US Treasury), all of which can impose sanctions or embargoes to prevent receipt of payments and make institutions aware of those names considered sensitive, where additional measures and notification are required.

Graham Dillon, Deloitte & Touche’s anti-money laundering and counter-terrorist financing special adviser, believes most money laundering happens in the retail banking sector and then, in order of predominance, private banks, investment banks, prime brokerage, insurance & assurance and independent financial advisers (IFAs.) “You must be seen to ask appropriate questions or you can’t be seen to be taking a risk-based approach,” he says. In essence a risk-based approach implies greater due diligence is likely to be required on certain sizes or types of transaction, for example, those emanating from a jurisdiction with questionable anti-money laundering procedures.

For venture capitalists Dillon believes, what he describes as ‘reputational hazard’ is at issue. Even association can be bad news. The Carlyle Group was widely reported to have returned funds to the bin Laden family post September 11, even though the family is said to be estranged from Osama bin Laden. Association aside, given The Carlyle Group’s investment interests in the defence industry, this course of action was certainly expedient.

With so much terrorist funding frozen thanks to legislation like the UK’s Terrorism Act 2000 and UK Anti-terrorism, Crime and Security Act 2001, recent research suggests terrorist groups are moving into the drugs trade as a way to finance their activities. (In the case of the UK, the Terrorism Act 2000 came into force in early 2001 and reflected the need to review terrorism law in light of the international nature of terrorism. Immediately post September 11, the Anti-terrorism, Crime and Security Act was introduced to ensure the legal framework reflected what was regarded by then as the new global terror environment. )

Given the need to launder money earned through the drug trade, and the penalties for those caught up in the money laundering process, even unwittingly, the regulations and legislation are likely to become more stringent, and perhaps more onerous, over time as governments globally attempt to continue inhibiting terrorist activities by limiting their access to funds.

Information sites relating to money laundering and counter terrorism funding issues in Europe

The European Commission’s Third Money Laundering Directive

This is a sort of rough guide, as well as an initial regulatory impact assessment, to the European Commission’s Third Money Laundering Directive (MLD3), which is due to come into force in November 2004, although draft articles for this directive were issued only in March 2004 by the European Commission. The aim of MLD3 is to consolidate and revise the previous EU money laundering directives and to incorporate the 40 recommendations made by the Financial Action Task Force on Money Laundering and eight special recommendations on terrorist financing.

Financial Action Task Force on Money Laundering

This link goes through to the 40 recommendations of the Financial Action Task Force on Money Laundering issued in 2003 and due to be put into practice in November 2004, as part of the European Commission’s Third Money Laundering Directive (see above.)

This link goes through to the eight special recommendations on terrorist financing, issued by the Financial Action Task Force on Money Laundering, also due to be incorporated in the European Commission’s Third Money Laundering Directive. Financial Action Task Force members include; Argentina, Australia, Austria, Belgium, Brazil, Canada, Denmark, European Commission, Finland, France, Germany, Greece, Gulf Co-operation Council, Hong Kong, China, Iceland, Ireland, Italy, Japan, Luxembourg, Mexico, Kingdom of the Netherlands, New Zealand, Norway, Portugal, Russian Federation, Singapore, South Africa, Spain, Sweden, Switzerland, Turkey, United Kingdom and United States. This means these countries are committed to Anti-Money Laundering initiatives.

The above weblink gives an up-to-date view of those countries the Financial Action Task Force on Money Laundering deems Non-Cooperative Countries and Territories.

Observer bodies, which operate on a similar remit to the Financial Action Task Force on Money Laundering, include; Asia / Pacific Group on Money Laundering), Caribbean Financial Action Task Force), Council of Europe Select Committee of Experts on the Evaluation of Anti-Money Laundering Measures), Eastern and Southern Africa Anti-Money Laundering Group), and Financial Action Task Force on Money Laundering in South America).

EVCA Paper on Anti-money laundering

The European Venture Capital & Private Equity Association’s (EVCA) paper titled Anti-Money Laundering Regulation in Europe, and first published in June 2003, is available to order at the above website address.

Wolfsburg Principles

The Wolfsburg Principles include: Wolfsburg Anti-Money Laundering Principles for Private Banking; Wolfsburg Anti-Money Laundering Principles for Correspondent Banking; and Wolfsburg Statement on the Suppression of the Funding of Terrorism. These are best practice principles launched and undertaken by the banking industry.