AML: Source of funds – have we moved forward?

Under the UK Money Laundering Regulations, firms are required during the ordinary course of business to undertake “scrutiny of transactions… throughout the course of the relationship (including, where necessary, the source of funds) to ensure that the transactions are consistent with the relevant person’s knowledge of the customer, the customer’s business and risk profile” (reg 28(11)).

Source of funds (“SoF”) is not defined in the regulations, so supervisors have been left to opine on what exactly that check means. The legal sector AML guidance tells us that SoF refers to the specific funds that are being used to fund a transaction in hand. It is not enough to know the money came from a UK bank account – instead, we are rightly tasked with having a reasonable understanding of the background of the funds, such that we are comfortable with their legitimacy.

Risk-based approach

It is perhaps interesting to first pick at what the regulations mean by “where necessary”. The Solicitors Regulation Authority notes that this is not defined in regulations, but its view is that, outside of certain mandated higher risk instances not covered in this article, it requires a risk-based approach. This means that your firm, client and matter risk assessments need to be considered when deciding whether it is necessary. As an aside, the SRA further details that the requirement to do SoF checks might apply even if no money is coming through your client account, but that’s a completely different circle of Dante’s inferno which we won’t cover here.

Another area worth thinking about is how the risk-based approach applies. Obviously, for the most part, it would be fair to consider that in order to meet the regulatory requirements noted in the first paragraph above, we actually have to know something about the client in the first place, in order to assess whether the transaction and funds are consistent with that client. Asking the client for their SoF narrative may therefore often be a key piece of the puzzle, but it is interesting to consider the extent to which repeated questioning is required for recurring clients across new matters, and to what level we must collect evidence to account for every penny.

Law Societies’ guidance

The Law Society of England & Wales SoF page notes that: “If an explanation is consistent with the client’s risk profile, is consistent with the type of retainer being undertaken, and you do not have other AML concerns about the transaction, you may simply note the explanation on the file and have your accounts staff check that the funds are coming from the bank accounts the client has said they would come from.”

It goes on to state that “If the transaction is higher risk, you may ask for supporting evidence, possibly in the form of” bank statements, accounts, gambling wins, injury awards etc. This suggests that extensive supporting evidence may be the domain of enhanced risk SoF checks. That all seems to tie in with the regulatory wording.

Compare this to the Law Society of Scotland FAQ, which gives this example: “A client is purchasing a flat for £400,000. The client, a teacher at a local high school, has obtained a mortgage but has a deposit of £25,000 to put down. The client explains that the deposit is a mix of employment savings and a gift from parents. The risk assessment is Medium (Standard CDD). 

“Source of Funds may be assessed and evidenced by, for example, obtaining bank statements to check for sufficient and regular credits from the expected employer and obtaining bank statements to check for gifted funds matching the amount detailed by client. Should remitter details be available, it may also be possible to check any connection/related names to the client’s details.”

That’s as may be

Of course, much of the guidance exhibits characteristic use of the word “may” everywhere, no doubt intended to be helpfully broad enough so that everyone can take part in the way that is right for them. That’s no bad thing, as long as supervisory bodies are sticking to principles and pragmatism, rather than narrow rules around documentation.

The extent to which SoF checks involve being bogged down in endless reams of statements and forensic accounting was never clear to me, and, despite legal sector guidance coming a long way in the last five years, I wonder whether the increased focus on this has made the confusion more, less… or just different.