In the third and final blog of our series examining the new anti-money laundering (AML) guidance from the Legal Sector Affinity Group, our Head of AML Graham MacKenzie explores an issue at the heart of effective anti-money laundering control – Source of Funds and Source of Wealth.
In my experience, the legal profession often finds Source of Funds/Source of Wealth checking challenging, complex and difficult to apply in practice. It was on this knowledge that the Legal Sector Affinity Group (LSAG) sought to significantly expand guidance in this crucial area, giving both definitions, the circumstances when such checking must or should apply, and what evidence should be documented.
I have summarised the key points below and these can also be found, along with examples and summary tables, in the AML FAQ section on our website.
Why are Source of Wealth and Source of Funds considerations so important?
A fundamental element of client due diligence is understanding the nature, background and circumstances of the client. This includes their financial position and making an assessment as to whether the legal services provided to the client are in keeping with your understanding of that background and circumstances.
The financial circumstances of a client can broadly be categorised into Source of Funds (SoF), and Source of Wealth (SoW).
As per the LSAG guidance you:
- must take adequate measures to check SoF and SoW, as a part of Enhanced Due Diligence (EDD) when applied to Politically Exposed Persons (PEPs).
- should also consider doing so as a part of ongoing monitoring of any business relationship (whether high risk or otherwise).
- should also apply a source of wealth check in other applications of EDD on a risk-based approach.
What is Source of Funds?
LSAG guidance states:
"Source of Funds refers to the funds that are being used to fund the specific transaction in hand – i.e., the origin of the funds used for the transactions or activities that occur within the business relationship or occasional transaction. The question you are seeking to answer should not simply be, “where did the money for the transaction come from,” but also “how and from where did the client get the money for this transaction or business relationship. It is not enough to know the money came from a UK bank account."
Thus, Source of Funds means establishing the provenance of the particular funds for use in a transaction. This includes the remitting account details, but also an understanding of the activity that generated those specific funds, for example savings from employment or inheritance.
You may already be obtaining bank statements to show the client’s possession of the funds in question, and you should continue to do this on the understanding that these statements are also intended to evidence possession and transit of the funds i.e. what account they are coming from and is that in the name of the client.
Where risks are assessed as higher, actions might also include more investigation to confirm the source of any gifted funds and/or evidence of employment, though there may also be reasons particular to any transaction (low, medium or high risk) where further investigation or evidence should be sought.
Source of Funds: Things to Consider
- Source of Funds should be evidenced in line with risk grading (and may have an effect on your risk grading!)
- It is not just about collecting documents; you should consider what you have been given e.g. is the client’s explanation and evidence sensible/feasible? Do the bank statements show what you’d expect to see? How many months of statements should you collect in line with the risk profile?
- Document your rationale and decision-making. If the Society asked you what you had done to satisfy Source of Funds, would you be comfortable explaining and evidencing the decisions you had made, why you made them, what you had done to satisfy requirements?
What is Source of Wealth?
LSAG Guidance states:
“The source of wealth refers to the origin of a client’s entire body of wealth (i.e., total assets). SoW describes the economic, business and/or commercial activities that generated, or significantly contributed to, the client’s overall net worth/entire body of wealth. You should seek to answer the question: “why and how does the individual have the amount of overall assets they do – and how did they accumulate/generate these?”
When addressing SoW in PEP or higher risk situations, you should consider whether the SoW is commensurate to your client in general i.e. does it make sense that the client in front of you obtained their overall wealth in the way that they have advised you?
SoW information will usually give an indication as to the volume of wealth the client would be expected to have and a picture of how the person acquired such wealth.
It does not, however, require you to account for all of a client’s assets, but to build a rationale and reasoning as to why they have such wealth and to provide assurance that it was obtained through legal means. This will help you to establish whether the transaction makes sense.
Aside from the bank statements you might collect as part of Source of Funds (which remains an obligation even when Source of Wealth checks are engaged), you should collect and assess documents which account for the wider wealth of your client. Depending on the client, this evidence may include audited accounts, share registers, property portfolios or other reliable documents that give you comfort as to the level of wealth of the client, and where it came from.
Source of Wealth: Things to consider
- Does the matter involve high risk or a PEP?
- Along with the specific funds being used in the business relationship/transaction at hand, what is the value of the client’s overall body of wealth and where/what activity is it generated/derived from?
- What types of information, evidence or documentation would help you gain comfort that the client’s wealth is not derived from criminal activities (including the proceeds of corruption), and to what extent do you feel you need to go to satisfy the risk? Is the client’s explanation and evidence sensible/feasible?
- Document your rationale and decision-making. If the Society asked you what you had done to satisfy Source of Wealth, would you be comfortable explaining and evidencing the decisions you had made, why you made them, what you had done to satisfy requirements?
Source of Funds and Source of Wealth: Why do they exist separately?
As the inherent risk increases, so does the need to ensure that the funds in use in a matter are not derived from criminal activities, including the proceeds of corruption. Understanding the funds proffered for use in a particular transaction (SoF) and the client’s funds more generally (SoW) can help in this exercise.
In higher risk situations, it is important to evidence SoF and SoW, in order to ensure that the SoF evidence collated to fund one transaction is not then used again to fund another.
For example, a client is able to demonstrate to your firm that they possess £1m in order to fund a house purchase and those funds have been derived legitimately (source of funds). A criminal client could then go to another department in your firm or to another firm and (in the absence of SoW checks being undertaken) potentially use the same SoF information to then buy another £1m property or use for another investment/business activity.
Evidencing Source of Wealth would help prevent or mitigate the risk of this scenario occurring and may also mitigate the risk of commingling funds from another part of the client’s total wealth, which may include the proceeds of crime particularly in PEP/higher risk scenarios.
The Wolfsberg Group offers further useful reading on Source of Wealth and Source of Funds. Click here to read its FAQ on the topic.