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a) As the company’s MLRO (see appendix) my assessment of the red flags that are apparent within this scenario prior to the call from the Royal Canadian Mounted Police (RCMP) are as follows:-

Regardless of the further background checks undertaken by myself, the Bank should already have had cause for concern with this client. A major worry being the multi-jurisdictional aspect of the LLC business; registered in St.Luke but not incorporated there, the Head Office in Canada, business based in Belgium, clientele Canadian and U.S. based and using offshore jurisdictions around the world.

There is no clear commercial rationale behind the reason for this which must be a major consideration when assessing client due diligence (CDD) as multi-jurisdictional structures are vulnerable for money laundering and terrorist financing. Concern is heightened further given that “95 per cent of its dealings involved legitimate money management in offshore jurisdictions around the world” and yet the company is registered for securities business in Canada. There is no precise understanding as to why this is and any account administrator picking up the file for the first time (or anytime) wouldn’t have a clear picture as to the exact nature of this business.

The Financial Action Task Force (FATF) issued a paper (1) on the misuse of corporate vehicles which illustrated four typologies; typology one highlighted the problems behind multi-jurisdictional structures. The report supports the findings of the OECD (2) who have stated that “the types of vehicles most frequently misused are those that provide the greatest degree of anonymity, such as international business corporations (IBC)”. It also highlights the point that LLC’s are vulnerable to misuse because they can be managed anonymously as there is no public disclosure of members’ identities.

Such corporate vehicles have been used in the past in a number of major financial scams to attract investments from third parties. Based on the point that Inter American Maritime Services LLC (IAMS) clientele are Canadian and US high net worth persons wishing to invest for rapid profit, the scenario has all the classic elements of a “high yield investment programme (HYIP) scam”.

HYIP’s scams mislead investors into believing their funds can be used to purchase securities (Debentures, Letters of Credit, Prime Bank Guarantees) at vast discount which are then re-sold at enormous profit. The principle behind every scheme is to exploit lapses in judgement using investor naiveté/greed. Often these are called ‘Ponzi Schemes, named after Charles Ponzi who became notorious for using such scams in America in the 1920’s.

An example of a HYIP scam is the case of the John Smith (3) who perpetrated a multi-million dollar prime bank securities fraud throughout the U.S., Canada and the U.K. To facilitate the fraud IBC’s were established in the Turks and Caicos Islands and in the Jersey. Smith then wooed prospective investors by telling them that high rates of return (30% per month) were guaranteed if they invested, through the IBC’s he had established, in “highly sensitive, proprietary and confidential” trading programs; despite these extraordinary returns their capital was secure. Smith then affected money transfers in excess of US$29 million from the IBC’s through various offshore jurisdictions to accounts he controlled with various accomplices.

Following numerous complaints from anxious investors the U.S. Securities and Exchange Commission brought criminal charges against Smith for fraud and unregistered offerings of securities. The correlation between the Smith case and the IAMS scenario is a major cause for concern.

IAMS clientele are stated as being an assortment of Canadian and U.S. high net worth persons which include politicians and some others ‘high up’ within law enforcement; the inclusion of such officials raises concerns in respect of politically exposed persons (PEPs). Although there is no accepted globally single definition of a PEP, the FATF definition is probably the most widely recognised: 'PEPs are individuals who are or have been entrusted with prominent public functions in a foreign country, for example Heads of State or of government, senior politicians, senior government, judicial or military officials, senior executives of state owned corporations [and] important party officials'.
Maintaining business relationships with PEP designated individuals may expose the company to significant reputational/legal risks and therefore should not be taken without the authorisation of senior management as recommended by Basel Committee on Banking Supervision (4). The FATF Recommendation 6 advises that financial institutions should have increased due diligence measures for PEP’s as follows:-

i) Have appropriate risk management procedures to determine whether a customer is a PEP; ii) Obtain senior management approval for establishing the business relationship; iii) Take reasonable measures to establish the source of their wealth and funds; and iv) Conduct enhanced ongoing monitoring of the business relationship.

This approach is endorsed by the UK FSA (5) and has been adopted by the JMLSG Guidance and the Third Money Laundering Directive.

The worry here is that, although senior management have signed off on the case, it has only been assessed as Medium Risk under the company’s Risk Based Assessment (RBA) process despite the involvement of PEP’s and the business line being classified as a “top producer” for the particular section. There may therefore be a need to reassess the Bank’s RBA process as it could be out of alignment with the FATF Recommendation and industry guidelines.

Noting that the principal behind the business is the son of a Christian Fundamentalist, a movement which has an extremist element whose aim is for global Christendom, there is a possibility that the business may be used for terrorist financing. The FATF have recently published a paper (6) highlighting various methodologies used by terrorists to raise and move funds; this included raising funds through legitimate businesses/donations and the movement of funds through wire transfers.

The FATF evaluation in respect of Canada (7) stated that “Canadian law enforcement authorities have identified a number of terrorist organisations operating in Canada. Investigations have shown that terrorist cells have a tendency to remain self sufficient by generating funds locally.”

The use of wire transfers therefore throws up a further red flag; more so when many transactions will be made using the firm’s internet service. Wire transfers are seen as a particular area of vulnerability to the financial services industry and the FATF (8) continue to raise concerns re their misuse by money launderers and terrorists. The FATF Recommendation 6 states:

“Financial institutions should pay special attention to money laundering threats that may arise from new or developing technologies that might favour anonymity and take measures if need to prevent their use in money laundering schemes.”

The use of cyber payment technology now adds more complexity to law enforcements ability to trace criminal activity and recover their proceeds as, through the use of personal computers/laptops, they are able to move funds from remote locations to anywhere in the world; these payments therefore transcend international borders without any risk of identifying individuals.

In an attempt to counter such threats, the FATF SR VII recommended that accurate and meaningful originator information accompanies electronic funds transfers which should remain with the transfer through the payment chain. This approach has been adopted within the EU Payments Regulation 2007, however, a number of countries remain non-compliant with the recommendation, amongst which Canada (7) is one.

The CDD within this scenario leaves a lot to be desired and any on-site risk assessments by the local regulator may pick up on this fact which could lead to a significant financial fine similar to the £2m penalty imposed on the Abbey National in 2003 by the UK FSA £2m for breaches of AML and KYC regulations. External auditors, as part of their year-end audit processes, also review CDD procedures; they are required to report any negative findings to the Board who have a requirement to notify the local regulator, who in turn inform the lead regulator.

The CDD issues are further inflamed as a result of my own findings, the main concern here is that although the information in respect of the principal was readily available in the public domain it was not identified during the account opening process. The additional information regarding the principals past convictions, prior to the RCMP call, just reaffirms the danger signals that this is a HYIP scam.

b) I perceive that the following risks could arise from this situation:-

Given the background of the principal and the nature of the business there is a distinct possibility that the firm could be liable to the IAMS clients as a constructive trustee. There are two main ways that constructive trustee liability can arise:-

i) Liability for knowing receipt i.e. the firm is aware that the assets received relate to a breach of trust/fiduciary duty (9); and ii) Liability for dishonest assistance, whereby the firm knowingly assists in a breach of trust/fiduciary duty (10).

As the Bank is now on notice that there are money laundering concerns with IAMS, not only due to the approach from the RCMP but also following my file review, under the Jersey (JSY) “all crimes” money laundering legislation (11) it has a duty to report its suspicions to the Jersey Financial Crime Unit (FCU); this requirement adheres to the FATF Recommendation 13.

Reporting to the FCU and receiving the relevant consents will protect the Bank from criminal liability; however, this wouldn’t prevent the risk of civil liability. It is argued that by making a disclosure to the appropriate authority could be seen as evidence that the Bank has the necessary knowledge to be liable as a constructive trustee in respect of those funds and hence the risk of civil liability is increased.

The above dilemma is often faced by financial institutions and is one that is fervently debated amongst the legal profession (12). Although financial services regulators recognise it as an area of major concern, they tend to shy away from any authoritative guidance by stressing licenceholders should seek legal advice; an approach presently adopted within the Jersey Financial Supervision Commission’s AML Guidance Notes (AMLGN). However, their revised draft AML Handbook, currently under consultation with the finance industry, has a section entitled “Managing a constructive trust scenario” but in its present format I consider this to offer minimal guidance.

The fear here is that through this legal risk the Bank could become embroiled in a lengthy court case which, may not only be extremely expensive, it could also tie up senior management time and staff resources over a prolonged period. The multi-jurisdictional facets of the scenario would no doubt make this inevitable; particularly as the involvement of U.S. citizens offers the potential forfeiture of assets by the U.S authorities under the U.S Patriot Act (Section 981k Notices).

Associated with legal risk there is also the compliance risk which ultimately bleeds into a regulatory risk. The compliance risk emanates from the failings by the Bank in respect of its customer due diligence. The Jersey’s AMLGN expects licenceholders to conduct detailed due diligence at the outset of the relationship and thereafter on an ongoing basis where PEP’s are involved; this clearly was not the case in this scenario. The regulator has the ability to pick up such failings through on-site risk assessments, themed visits, audit reports and from licenceholders their selves who are duty bound to report any regulatory breaches.

The risk of non-compliance could result in restrictions on licence conditions, loss of licence, removal of individual’s authorisation and fines. The U.K. FSA has been particular punitive in respect of lapses in AML due diligence by financial firms imposing a number of heavy penalties and fines. Philip Robinson, Financial Crime Sector Leader at the FSA has stated (13):

“The FSA will continue to use enforcement powers to address money laundering concerns where there are significant failings in a firm’s defences. Allowing individuals anonymous access to UK banking facilities, without adequately verifying their identity or source of funds, demonstrates significant failings. Senior management are ultimately responsible for managing their firm’s risks. Where a firm fails to mitigate a high money laundering risk, sanctions against senior management may follow.”

It’s recognised that any associated adverse publicity generated by such regulatory failings or legal case could damage the reputation of the Bank, not only in the Jersey but also UK, and regulatory jurisdiction it operates from.

As IAMS is deemed to be a top income producer for the section there is also a danger of concentration risk; the Bank may have over reliance on the assets and profit generated by this business. There is a danger that, having geared up its resources and systems to administer the account, the impact of losing the business could be operationally damaging.

Were the Bank to agree to assist the RCMP there is a danger that the Bank may commit a criminal offence by ‘tipping off’ IAMS that a money laundering investigation is underway or divulging information which may prejudice the case. Under the IOM Criminal Justice Act 1990 “tipping off” or prejudicing an investigation carries a maximum sentence of 5 years and/or a fine; a risk that would exist even if the Bank failed to agree to the RCMP request.

c) On the basis that the RCMP have no authority within Jersey, nor is there any evidence to support that the call did in fact originate from them, my immediate response would be a non-committal one.

Any inquiry to assist other jurisdictions in matters of mutual concern should be co-ordinated by the appropriate financial intelligence units (FIUs) of the countries concerned. The Egmont Group, established in 1995, an informal organisation of FIUs, encourages such co-operation within its Statement of Purpose. As both the Canadian (FINTRAC) and IOM (FCU) FIUs are members of the Group, the request for assistance should be made via these respective organisations.

Hence, as stated, my response would be to advise the RCMP to go through FINTRAC who would then be able to liaise with the FCU. It is also prudent to neither confirm nor deny that the Bank maintains the IAMS account on the basis that this might be purely a ‘fishing expedition’ by the RCMP and also confirming such on the strength of a conversation with a third party constitutes a criminal offence under banking secrecy legislation.

At this juncture it would also be appropriate to seek a formal written request from the RCMP, a copy of which should be sent to the local FIU; the FCU could then make enquiries to establish if the request is genuine. If it transpires the request is indeed genuine, a line of communication can then be established between the three parties; I would act as the central point of liaison for the Bank.

Given the serious nature of the scenario, I would advise the Board that, if not already undertaken, a disclosure report has to be submitted to the authorities on the basis that the Bank now has reasonable grounds for knowing or suspecting that IAMS is engaged in money laundering.

I would also advise the Board to confirm that the company policy of ‘assisting law enforcement at all times’ is still apposite and to seek legal opinion immediately in respect of the Bank’s position, particularly vis-à-vis constructive trustee liability which, in view of the RCMP wishing the relationship to continue as normal, may deteriorate further. The legal advice should also include the Bank’s position in respect of:-

i) obtaining FCU consent to maintain the relationship, particularly in view of the ongoing transactional activity; and

ii) fungibility (14)

Additionally, the Board is required to notify the local regulator that there is an external investigation underway involving the Bank (15). In view of the potential regulatory and reputational risks posed by the situation, I would strongly advise that, as well as giving an overview of the case, the Bank is clearly demonstrating a proactive approach to putting its house in order in respect of the lapses in CDD. This should include the following areas;-

▪ Review of its risk based assessment processes; ▪ Review of all its existing medium/high risk accounts; ▪ Confirming that its customer take on procedures are fully compliant with local regulatory requirements; ▪ Reviewing its PEP due diligence measures to ensure they fully address the FATF Recommendation 6; ▪ Confirming that its staff AML training programme has been reviewed and where necessary updated to take account of any learning’s from case: and ▪ Timetable for completion of the review

Prior to submission the communiqué should be reviewed by the Bank’s legal counsel and approved by the Board.

The Board should also appoint a senior manager to act as the central point of contact with IAMS, this would reduce any potential ‘tipping off’ or prejudicing the investigation. The file papers should be securely ring-fenced and until the conclusion of the RCMP investigation all the related records, including electronic payment message instructions, must be retained, any document destruction must be pre-authorised by the Board.

Finally, the international flavour of the case coupled with the involvement of “Hells Angels” motorcycle gangs intensifies the potential media interest and the Board should appoint a suitably experienced member to act as spokesperson to the press if necessary.

d) The issues which need to be raised with staff in respect of due diligence and relationship management are as follows:-

Emphasis will need to be placed on reminding staff that CDD is not purely a case of obtaining the required account opening documents; it should provide the business with a clear understanding of the risks that a customer may represent. Although, the required checklists had been completed and senior management sign off obtained there is a distinct lack of joined up thinking in evidence; simply ticking boxes does not make the Bank compliant.

Without this clear understanding there can be no successful relationship management as the Bank is unable to derive how IAMS obtains benefit from its services; the account is simply a means to an end, but what end? The Bank had ample opportunity to acquire further knowledge during the face-to-face meeting with the principal but failed to take advantage.

The Jersey FSC Chief Executive, Peter Frampton, has made it clear that he expects all financial firms to establish and maintain strong and effective anti-money laundering procedures (16), stating that:

“Anti-money laundering measures are not compliance for the sake of it” adding “Knowing one’s customer is not just about completing checks, it embraces an understanding of the whole business relationship and the nature of the transactions being undertaken.”

Apart from giving the Bank major concerns from a ‘know your customer’ point it leaves it vulnerable to being able to recognise any unusual and suspicious transactions. It would therefore be necessary to raise this point with staff, at the same time reminding them of their legal obligations (i.e. assisting to retain, concealing and transferring, acquisition, possession or use, failure to disclose and tipping off).

Amongst the points which also need to be raised are:-

▪ 95% of this US$5 billion asset business involves “legitimate money management”, what does the remaining 5% involve? Is this 5% of the business the main transactional activity over the account?

▪ Why did the Bank not request sight of the latest audited accounts? These would give comfort that IAMS has been independently audited and the underlying assets of the business are as stated.

▪ No address verification documents and surprisingly all certified identification documentation have been signed by Notaries.

▪ There is no indication as to what CDD, if any, IAMS undertakes in respect of their clientele; as the Company was supposedly registered for securities business it should be subject to Canadian AML requirements.

▪ The outstanding securities licences, although the 6 month old checklist indicates these would follow shortly, senior management have signed off on the case. Follow up notes must be diarised and progressed until the information is obtained. A copy of the Canadian securities website page should be on file to evidence registration; additional comfort could have been obtained by contacting the Canadian regulators direct.

▪ There is no clear explanation as to how the principal has suddenly swapped from being a salesman with 3M, a company whose products include adhesives and pharmaceuticals, to being head of a company with approximately US$5 billion in assets and whether he is the ultimate beneficial owner.

▪ The failure to pick up the risk of PEPs, this could be done through the development of a specific policy that includes the use of PEP databases (e.g. World-check).

▪ The failure to undertake background checks on the principal especially as a significant amount of crucial adverse information was in the public domain. Had this been picked up at the account opening stage, the Bank would have rejected the application and submitted a disclosure to the local authorities. The importance of additional checks through websites (World-check, Transparency International) needs to be factored into account take-on/ monitoring processes.

▪ CDD is an on-going process, it doesn’t stop once the relationship is up and running.

Through raising these issues the importance of a holistic view of CDD can highlighted to the staff.

The scenario just proves that “the sophisticated money launderer is like water running downhill: both seek the line of least resistance” (17).

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Bibliography

1. FATF – The Misuse of Corporate Vehicles, including Trust and Corporate Service Providers. October 2006 2. OECD – Behind the Corporate Veil. 2001. 3. U.S. Securities and Exchange Commission v. J Smith and MM ACMC Banque De Commerce, Inc. 4. Basel Committee on Banking Supervision – Customer Due Diligence for Banks (2001) 5. FSA – Politically Exposed Persons: Good Practice 6. FATF - Terrorist Financing February 2008 7. FATF – Third Mutual Evaluation on AML and CFT re Canada. February 2008 8. FATF- Money Laundering and Terrorist Financing Typologies 2004/2005. June 2005 9. BCCI v Akindele, 2001. 10. Barlow Clowes v Eurotrust International Ltd, 2006. 11. Jersey Criminal Justice Act 1993. 12. Constructive Trusts and All Crimes Money Legislation: Is there a problem? – Alan Binnington, 1998 13. FSA fine re Investment Services UK Limited 14. Obligations to Report Money Laundering: The Consent Regime. Home Office Consultation Document, 2007 15. Jersey Banking (General Practice) Regulatory Code 2003 16. IMF Report Special Bulletin. Jersey Finance, November 2003. 17. Combating Money Laundering and Terrorist Financing, Commonwealth Secretariat