What are the risks in dealing with "politically exposed persons"? Ian Murphy, associate director and head of risk, governance and compliance at Hawksford, the trust company, examines the issues.

Editor’s note: The UK regulator imposed a £8.75 million fine on Coutts for failing to take reasonable care to establish and maintain effective anti-money laundering systems and controls relating to high-risk customers, including “politically exposed persons”. So what are the risks in dealing with these persons? Ian Murphy, associate director and head of risk, governance and compliance at Hawksford, the trust company, examines the issues. His views are not necessarily shared by this publication but we are grateful for the contribution to debate. As always, reader comments are welcome.

The existence of Politically Exposed Persons presents a serious business risk for the world’s financial service providers.  Managing and monitoring these high-profile clients requires well-trained, vigilant employees, comprehensive policies and procedures aligned to robust systems. The consequences of getting it wrong can have serious ramifications for individuals, organisations and sometimes even governments.

Since the September 11 attacks on the US, the major powers around the globe have attempted to tighten the noose on corruption, terrorism and drug-related activities. Understanding clients and their activities in greater depth (especially high-risk ones), plays a significant part in this universal crusade.

What is a PEP?

There are a variety of definitions relating to PEPs available in domestic legislation, regulations, supranational bodies and industry guidance; three definitions by world authorities are provided below:

Wolfsberg Group – “Individuals who have or have had positions of public trust, such as government officials, senior executives of government corporations, politicians, important political party officials, etc., as well as their families and close associates.”

The Financial Action Task Force – “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, important political party officials.”

EU Third Money Laundering Directive – “Natural persons who are or have been entrusted with prominent public functions and immediate family members, or persons known to be close associates, of such persons.”

While there is not a single universally accepted definition for PEPs, this category often refers to individuals who are or have been entrusted with prominent public functions. However, most official definitions do not tend to cover middle-ranking or more junior individuals. This can present a problem, as in many cases the middlemen can be overlooked.

Origins

The label of PEP dates back to the late 1990s in what was termed as the “Abacha Affair”. Sani Abacha was a Nigerian dictator, who, through a complex network, and assisted by his family members and close associates, stole vast sums of money from his own country. Estimates put the total amount taken at several billion dollars, the majority of which was transferred to bank accounts in the UK and Switzerland. During 2001, an operation was mounted to attempt to recover the plundered monies. It was from this investigation that the concept of the Politically Exposed Person emerged. This term was later included in the 2003 United Nations Convention against Corruption.

The international community has responded with efforts to mitigate the potential risks posed by PEPs, their family members and close associates. Including:

1. The United Nations Convention against Corruption (UNCAC) (Article 52(1) and (2));

2. Recommendation 6 of the Financial Action Task Force on Money Laundering (FATF) 40 Recommendations;

3. The European Union Third Money Laundering Directive.

Big business

Speaking at a Financial Services Authority conference, Ian Mullen, the chief executive of the British Bankers’ Association, said: “Let us start with a controversial statement: money laundering is 'big business' – a slightly twisted concept but nonetheless true. The International Monetary Fund has estimated the scale of global money laundering as the equivalent of between two and five per cent of the world’s gross domestic product. The UK Home Office has estimated the economic cost of serious crime in the UK to be between £19 billion ($30 billion) and £48 billion per year.” 

What does a PEP look like?

There is no standard PEP; they really do come from all classes of society and very different backgrounds. The purpose of this exercise is to demonstrate virtually anyone can become a PEP or potential PEP at any time in his or her lives. Some PEPs are born into it (and can remain so throughout their lives), while others, fall into the category due to circumstances they find themselves in.

What is PEP risk?

From an organisational perspective, the risks associated with a lack of PEP due diligence do not stop at regulatory fines for non-compliance. There is also the risk of severe reputational damage. To compound the PEP risk, a Politically Exposed Person can become compromised at any given point by just one transaction.

The PEP scandals experienced in the past 50 years involving heads of state, senior officials, their family members and close associates, have clearly demonstrated that an institution’s reputation can be damaged.  In addition, public confidence in ethical standards and even the stability of an entire financial system can be undermined.

While implementing procedures and technology to better know your customer can involve significant costs, failure to do so could have even greater consequences.

When considering PEP risk, there are three main factors to consider:-

1.         The risk of the individual - (what they are like as a person, character etc.);

2.         The risk of the position held - (role, job function, status etc); and

3.         The opportunity risk - (the ability or temptation to conduct acts of corruption).

The one that is often overlooked is the "opportunity" for corruption.

But do we just need to look at individuals when considering PEPs? What about companies, corporations and other structures? Are they PEPs? The answer is a categorical “yes”. All institutions need to be doing PEP due diligence on any corporations they have as clients. Finding the hidden relationships and gathering the pieces of this truly global PEP puzzle takes resource, commitment and dedication that borders on addiction.

PEPs as clients – the main concerns

The label of PEP can often spark fear amongst financial service providers and regulators, fuelled by the horror stories of corrupt individuals who have looted millions of dollars of public funds and placed them into perfectly respectable financial institutions that were allegedly unaware of the origins of the monies.

Individuals can be classified as PEPs for numerous reasons - not all are created equally. Some can pose a considerable risk to both the commercial enterprises and jurisdictions that they become associated with. Should a jurisdiction become well-known for dealing with, or allowing such individuals certain freedoms within a jurisdiction, these actions can lead to the risk of serious international sanctions.

It goes without saying then, that all jurisdictions must be very cautious about who is permitted access to their financial markets and the way in which clients conduct their business activities. Some of the real difficulties are the practical application of the requirements, including:

1.         Identification of family members or close associates of PEPs where it is not readily apparent from their name, situation, information disclosed to the financial service provider or publicly available information;

2.         Identification of situations where existing customers may have become a PEP because of a change in their status, or the status of a family member or business associate of theirs; and

3.         Application of PEP standards in countries with uncertain, unstable or non-transparent political structures.

There is nothing wrong with having PEPs as clients, provided that the source of their income is transparent and able to withstand scrutiny. Key to managing any organisation’s PEP risk is the ability to determine between PEPs who warrant enhanced scrutiny and those who do not.

When does someone cease to be a PEP?

There is no agreed method for determining the time period that an individual should be regarded as a PEP after they have left the public function that gave rise to the initial categorisation. The risks associated with a PEP are closely related to the office or function they held and the influence associated with that post.  Some experts consider that people could be removed from being classed as a PEP once they cease to hold the particular office that placed this label on them in the first place. Others take a more comprehensive approach and state that the individual should remain as a PEP until such time as they could see no further evidence that their influence was still current.

This can be a difficult call as determining the extent of someone’s influence once they are off the public radar can require a great deal of research. Corruption, embezzlement and bribery very often only come to the fore once an individual has left office or indeed once they are deceased. Why would we, (if the very purpose for PEP screening is to fight serious, high level corruption), want to let bad PEPs off the hook one year after leaving office?

The third Money Laundering Directive suggests a PEP expiration of one year after leaving office. This is a totally unreasonable and nonsensical expiration term when put into practice. Consider for a moment whether a financial institution should feel comfortable having a PEP policy that considers Helmut Kohl, Nelson Mandela, George H W Bush senior or Baroness Thatcher as ‘normal’ clients and not PEPs.

World-Check is of the view that PEPs in most countries maintain a position of influence long after leaving office and certainly for considerably longer than one year. In regard to this matter, the sensible approach appears to be to carry on assessing using a risk-based approach.

Should domestic PEPs be included in scrutiny?

Discounting domestic PEPs poses a major risk to organisations, as corruption is not something that just occurs in less-well developed parts of the world.

During the coming years we are likely to see the practice of discounting domestic PEPs being phased out as being of no constructive use. It should be remembered that corrupt or dishonest individuals can be found in every country.

Here to stay

The subject of Politically Exposed Persons has generated much debate over recent years. As a result, a number of world-renowned experts on the subject have emerged. The fight against corruption requires a comprehensive, multi-stakeholder approach, which must be led by supranational and national government agencies and law enforcement, assisted by civil society and the wider business community, if it is to succeed.

Financial services providers the world over are continually faced with dealing with, and catering for, high-risk customers. PEPs have been recognised as a particular money laundering risk because of their perceived connection with corrupt (or financially irregular) regimes. The following is a quote from World-Check:

“You may ask, ‘what is the big deal’, why are these customers any different from any other high-risk, high profile clients? The answer is simple – the average high-risk client does not usually pose a considerable reputational risk in the way that PEPs do. During the last couple of decades, PEPs have become a profoundly misunderstood clientele of the broader financial community. Yet in principle, there is nothing wrong with doing business with a Politically Exposed Person, provided that a number of due diligence criteria are met on an on going basis. PEPs are by no means necessarily money launderers or embezzlers, nor automatically involved in corrupt financial practices”.

Planning

Reducing PEP risks within any business requires careful planning. Organisations must also ensure that the relevant staff are trained to identify and deal with PEP risks, that they have adequate systems to identify PEPs, that PEP databases are used appropriately and that internal audit functions consider PEP risk as an area for review.  

One of the main issues with tackling a subject such as this is that much of the material offers only guidance and theory. Only a limited amount of material gives any real hard rules on the subject, the main sources here being the somewhat limited descriptions found in the laws and secondary legislation. There is no right or wrong method of dealing with PEPs, only the best-fit given the circumstances in each case.

There are many sources of information available on the subject that pontificate what a PEP is defined as, how bad they can be for business, and what the consequences of getting it wrong are. Corruption has a devastating effect on development outcomes in some of the world’s poorest countries. A corrupt PEP can have a disproportionate impact on a country or region. Despite this volume of information, very little of this material actually gives any straightforward, simple to use guidance on how to set out a policy to decide who should actually be defined as a PEP and the most effective ways in which to monitor such a relationship.

Institutions such as Riggs Bank, or the Swiss financial houses indicted for their dealings with Augusto Pinochet, serve as a warning against a lack of PEP risk management practices and one that institutions cannot disregard.

The reality here is that this topic can often prove difficult to find any constructive guidance on. Those who have to make the decision as to whether or not someone is a PEP, often find themselves making a judgement call based on what is quoted on external systems such as World-Check or C6. The use of such external sources however should not be relied upon in isolation. While the use of Google cannot be condoned as the most reliable method of investigation, in many cases it provides the gateway to more accurate and credible sources of information, which can be relied upon for identifying the parties to an entity. All the evidence/facts must be taken into consideration when deciding who is classified as a PEP.

The reality is that not enough practical guidance is publicly available to assist institutions with this difficult area.  

One thing is for certain, any institution that thinks it is immune from falling foul of such corrupt clients, need only examine the list above, which shows some of the more high profile PEPs of the last 50 years. Remember, this money found its way into financial institutions somehow.

It is however important to remember that the majority of PEPs do not abuse their position and will not represent any undue additional risk to a financial institution solely by virtue of that categorisation. Managed sensibly and vigilantly, most PEPs should not be any more of a risk than the average high-risk client.