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Lawyers coming under AML/CFT regime

06 October 2016

  • Appropriately protecting and defining legal professional privilege.
  • Who should regulate and supervise lawyers.
  • Clearly defining what and when lawyers need to report.
  • Minimising the impact on lawyers’ ethical duties.

These were just some of the key areas covered in submissions the Law Society has made on Phase Two of the Anti-Money Laundering and Countering Financing of Terrorism regime. Under Phase Two, lawyers will become reporting entities under the Anti-Money Laundering and Countering Financing of Terrorism Act 2009 (AML/CFT Act). Submissions on the Ministry of Justice’s consultation paper on Phase Two of the regime, Improving New Zealand’s ability to tackle money laundering and terrorist financing: Ministry of Justice consultation paper on Phase Two of the AML/CFT Act, closed on 16 September.

Why lawyers should be reporting entities

“The AML/CFT regime introduced in New Zealand by Phase One to be enhanced by Phase Two is generally comparable to regimes that have existed in other jurisdictions (including nearly all of New Zealand’s major trading partners) for several years,” the submission says.

“The Law Society recognises the case for lawyers being reporting entities under the AML/CFT legislation.

“The Law Society accepts that the New Zealand legal profession is not immune from the mischief which the AML/CFT regime is designed to deter and detect and has a responsibility to co-operate in the global response to money laundering and terrorist financing.

“At the same time, it must be recognised that the proposed AML/CFT obligations for lawyers are fundamentally inconsistent with the traditional solicitor/client relationship of trust and confidence.

“That relationship is based on lawyers’ ethical obligations of confidentiality, acting in the client’s best interests and protecting privileged communications, which run counter to the proposed AML/CFT monitoring and reporting obligations.

“There is a significant tension between the role of lawyers as trusted advisers and their role as informants under the regime.

“The new obligations will need to be carefully crafted to ensure the solicitor/client relationship is preserved to the greatest extent possible, while still delivering on New Zealand’s AML/CFT commitments to the international community.”

What’s needed for success

The Law Society said that the following factors would need to be addressed in order for there to be successful uptake of the Phase Two obligations by the legal profession:

  • an appropriately targeted list of the legal services subject to the AML/CFT obligations;
  • the focus remaining on suspicious transactions, rather than a wider (and more uncertain) category of suspicious ‘activities’;
  • clear definitions of key terms;
  • greater clarity as to the thresholds for monitoring and reporting;
  • putting in place measures to ensure privileged information is protected, including a wider statutory definition of privilege;
  • minimisation of the impact of AML/CFT monitoring and reporting on lawyers’ ethical duties so far as possible (in particular, absolute clarity in respect of when lawyers’ ethical obligations may or must be overridden by their AML/CFT obligations);
  • extensive and clear guidance to the profession on the range of scenarios likely to arise in practice (the Law Society intends to prepare Practice Notes and assist in educating the profession on the AML/CFT obligations);
  • an effective and appropriate supervision model; and
  • finally, provision of adequate time for the profession to understand and implement the new obligations in practice.

How it will affect lawyers

The Ministry’s consultation paper proposes that lawyers will be subject to AML/CFT requirements when providing the following services in the ordinary course of business:

  • acting as a formation agent of legal persons or arrangements;
  • arranging for a person to act as a nominee director or nominee shareholder or trustee in relation to legal persons or arrangements;
  • providing a registered office, a business address, a correspondence address, or an administrative address for a company, a partnership, or any other legal person or arrangement;
  • managing client funds, accounts, securities or other assets;
  • preparing for or carrying out real estate transactions on behalf of a customer; and
  • preparing for or carrying out transactions for customers related to creating, operating or managing companies.

The consultation paper notes that lawyers already have obligations under the Financial Transactions Reporting Act 1996 of identity verification, record keeping and reporting suspicious transactions, but that these only apply in limited circumstances and are not as robust as the AML/CFT obligations.

Why the Law Society should be supervisor

“The Law Society considers it has the necessary experience and capabilities to be the supervisor of the legal profession for AML/CFT purposes,” the submission says.

“The supervisor role logically fits within the Law Society’s current regulatory responsibilities for the profession.

“Given its involvement with and understanding of lawyers the Law Society is best placed to perform this role while ensuring the ethical and legal duties of lawyers are respected and protected so far as possible.

“The Law Society is also the most appropriate body to issue guidance to assist lawyers to comply with their obligations. A concern raised by the profession is how the Law Society would be funded to carry out the supervisor role.”

The Law Society’s submission also noted that the nature of work performed by lawyers meant that the legal profession did not “neatly fit under the umbrella of the current supervisors”.

There are a number of potential advantages in the Law Society being the supervisor of the legal profession for AML/CFT purposes, including:

  • The Law Society is an established regulator with deep institutional knowledge of the legal sector. It has comprehensive oversight of all lawyers through its existing regulatory role. The Law Society’s regulatory framework includes the operation of an established market entry process based on a ‘fit and proper’ test, a Financial Assurance Scheme through which the Law Society’s Inspectorate monitors and enforces compliance with the LCA and LCA (Trust Account) Regulations 2008 and applies a comprehensive risk framework. The Law Society also operates a dedicated consumer complaints and disciplinary process (through the Lawyers Complaints Service).
  • Such a model leverages the significant work and investment undertaken by the Law Society in using the Australia/New Zealand Risk assessment framework (AS/NZ ISO 31000 (2009)) as the basis of its trust account inspection work. It also draws on the knowledge that the Law Society is constantly updating from its regulatory work in regard to the risks faced by lawyers in their operating environments.
  • The Law Society has significant expertise in focusing on risk prevention and mitigation, and has a good appreciation of the ML/TF risks facing members of the legal profession. It is currently working closely with the profession to provide education and assistance in respect of similar threats such as emerging cyber-security risks.

National interest

“Money laundering and terrorist financing (ML/TF) are recognised risks in New Zealand and globally.

“New Zealand is a member of the inter-governmental forum that sets global AML/CFT standards, FATF (Financial Action Task Force), and is committed to implementing the FATF recommendations.

“Failure to implement the recommendations could result in reputational damage to New Zealand and market access being denied.

“The consultation paper records that ML/TF are significant problems in New Zealand, allowing criminals to hide criminal proceeds and to fund serious crimes such as drug offending, organised crime and tax evasion, with an estimated $1.5 billion being laundered in New Zealand each year,” the submission says.

New Zealand introduced the AML/CFT Act to cover business activities that pose a high risk of being misused by criminals to conduct financial transactions or purchase assets.

The Phase One obligations on financial institutions and casinos came into effect in 2013. It was signalled at that time that Phase Two, covering lawyers, accountants and various other sectors, would follow later. In June 2016 the Government announced it would accelerate Phase Two, with the legislation intended to be passed by July 2017.

Officials have advised that “current gaps in coverage are undermining Police efforts to detect and deter criminal activity in New Zealand” and that “professional services (lawyers, accountants) and real estate are high risk sectors for money laundering. Recent Police investigations show that the risk of money laundering from these sectors is rising.”

The consultation paper states that “case studies and research here and internationally show that some services provided by legal professionals are attractive to criminals wanting to launder the proceeds of crime and to finance terrorism” and that “while there are some instances of legal professionals being directly involved in money laundering, most lawyers who are exposed to it are not complicit” – namely that their involvement is innocent (no ‘red flag’ indicators are apparent) or unwitting (basic CDD undertaken; some ‘red flags’ but missed or significance misunderstood)”.

“In the Law Society’s view, the aim must be to establish a practical monitoring and reporting regime for lawyers based on proven AML/CFT risks in the New Zealand context.”

Lawyers’ ethical duties

The relationship of lawyer and client is one of “utmost trust and confidence”, the Law Society observes. (See Rule 5.1 of the Lawyers and Conveyancers Act (Lawyers: Conduct and Client Care) Rules 2008 (RCCC).)

A fundamental precept underpinning the relationship is the concept of absolute confidentiality. This duty is both an equitable and ethical duty.

Under the RCCC lawyers are required to hold in confidence all information about the affairs of clients. This is subject to limited exceptions provided for in the RCCC.

“The lawyer’s duty of confidentiality as well as legal professional privilege are necessary and essential conditions of the effective administration of justice as well as aspects of the rule of law,” the Law Society says.

Reporting and disclosure obligations where the thresholds for reporting and disclosure are not consistent with the exceptions that currently apply, “are inherently incompatible with lawyers’ ethical duties and with the underlying principles those duties serve.

“The Law Council of Australia has expressed concern in its jurisdiction that the requirement for suspicious transaction reporting (if extended to lawyers) ‘would impact on the client lawyer relationship, client confidentiality and client legal privilege’. This would require lawyers to act as the agent of law enforcement agencies, a role that is inherently inconsistent with lawyer-client obligations,” the Law Society’s submission says.

“It is therefore important that the impact of the regime on lawyers’ ethical duties be minimised so far as possible and that there is absolute clarity in respect of when a lawyer’s ethical obligations may and/or must be overridden by the AML/CFT regime.

“This is vital not only for the protection of lawyers but also legal consumers relying on their assistance.”

Legal professional privilege

There is an “obvious tension” between lawyers’ obligations to their clients and their obligation to report suspicious transactions, the Law Society says.

“The Law Society will need to provide guidance to the profession on the relationship between the Act’s requirements, ethical obligations of confidentiality and legal professional privilege.

“Lawyers will want to have some certainty that they are obligated to disclose before disclosing.

“As to when the obligation to report exists, the Act combines an objective test (ie, you must report if you have reasonable grounds to suspect that the transaction or proposed transaction is or may be [prohibited]) and a subjective test (and you are protected from [sanction] unless the information was disclosed or supplied in bad faith).

“Add to this the lawyer’s duty to withhold privileged information unless it meets the threshold of involvement in an illegal or wrongful act, and lawyers could find themselves in some very difficult ethical situations.

“For lawyers treading the fine line between their obligations, guidance (including examples) on the meaning in these contexts of reasonable grounds and bad faith will be essential.

“If appointed as AML/CFT supervisor for the profession, the Law Society will be well-placed to exercise powers such as those under ss 132 – 133 in a way that is sensitive to privilege, as well as the other duties owed by lawyers,” the submission says.

The Law Society says it has identified the following issues which arise in the context of legal professional privilege:

  • the wording of the exception related to committing or furthering the commission of some illegal or wrongful act differs from that used in the Evidence Act 2006 and the Search and Surveillance Act 2012;
  • because of the different thresholds that apply to trigger the obligation to report a suspicious transaction and to exempt information from legal professional privilege, lawyers may be presented with difficult situations where they have suspicions which trigger the requirement to report a suspicious transaction but are uncertain as to whether they have sufficient information such that the exception to privilege applies;
  • it is important that legal professional privilege is protected where the power to conduct onsite inspections of lawyers’ offices is exercised; and
  • the AML/CFT Act should be amended to include litigation privilege in the s 44 definition of legal professional privilege.

Inspecting lawyers’ premises

“The concerns about privilege are particularly acute in the context of search powers such as those provided for in ss 132–133 of the AML/CFT legislation.

“The Supreme Court of Canada held that a similar warrantless search power when applied to lawyers, along with the inadequate protection of privilege, were an unjustified infringement on the right to be free from unreasonable search and seizure (see Canada (Attorney-General) v Federation of Law Societies of Canada 2015 SCC 7, [2015] 1 SCR 401).

“In New Zealand the protection of privilege under s 136 and the procedures to protect privilege under s 145 of the Search and Surveillance Act 2012 would apply.

“However, if the definition of privilege in the AML/CFT legislation differs from that in the Search and Surveillance Act then this may give rise to uncertainty.

“The Law Society submits that, if the definition of privilege is not amended to use the same language for the exception that is used in the Search and Surveillance Act, then s 42 or s 133 should be amended either to make it clear that the Search and Surveillance provisions which protect privilege in the context of warrantless searches apply or to provide that no document or information that is subject to legal professional privilege is required to be provided under s 133(2).

“It is important that it be clear that information that is subject to both legal advice and litigation privilege can be withheld,” the Law Society says.

Including suspicious ‘activities’

The Law Society also submitted on proposed changes to suspicious transaction reporting (STR), which would extend them to reporting suspicious “activities”.

Such an extension raised “particular issues for lawyers,” the Law Society points out.

“Lawyers are often involved in only part of a transaction or proposed transaction and will not always have total oversight of all relevant information.

“It is also important to bear in mind that the role of lawyers is as advocates for clients, not as investigators of their actions.

“The focus to date on ‘transactions’ has limited the tension with lawyers’ duties to their clients and the extent to which issues in relation to privileged information arise.

“The proposed extension of STR reporting obligations to ‘activities’ has the potential to result in a greater number of cases of lawyers being placed in difficult situations where they are forced to breach the usual ethical duties of confidentiality as well as deal with difficult issues of when they can and should withhold information on the basis of privilege.

“It raises the prospect of a much more significant erosion of the lawyer’s role as trusted advisor with duties of loyalty and confidentiality to the client.

“The Law Society considers that if the reporting obligation is to be extended it should only be extended to capture the concerns addressed by the Shewan report (about transactions that do not go ahead and transactions that go through an overseas financial institution).”

The Law Society also points out that it was not clear from the consultation paper what “activities” it is envisaged will be covered.

“If the definition of ‘transaction’ is merely clarified to specifically include transactions that do not go ahead or transactions that do not go through a local financial institution (the concerns of the Shewan report) then this change may raise few concerns.

“However, the reference to ‘suspicious activity’ suggests a broader extension is envisaged.

“Issues may arise in practice if the concept of ‘suspicious activity’ is not clearly defined or understood by the market, leading to confusion around when a report should be made and potential underreporting.

“Supervisors would also need to provide clear guidance on this issue, setting out scenarios and circumstances which could indicate suspicious activity, to minimise confusion,” the Law Society says.

Defining legal services subject to AML/CFT

A series of “definitional and threshold” issues would need to be worked through.

For example: “Carrying out real estate transactions” is significantly broader than the FATF’s equivalent formulation “buying and selling of real estate”.

For the most part it is difficult to argue that it is unreasonable for a lawyer to verify the identity of a client to whom the lawyer is providing legal services.

However, the references to “managing client funds, accounts, securities or other assets” (particularly in relation to estate administration matters) and “preparing for or carrying out transactions for customers relating to creating, operating or managing companies” are vague and ambiguous. It is important that it be clear exactly what services are subject to the obligation.

“The profession will need clarity regarding what is intended to be in scope, and clear definitions in the Bill. The Law Society will want to be consulted on an exposure draft of the Bill before it is introduced,” the Law Society says.

Non-lawyer providers

In New Zealand any individual or entity can provide legal services directly to the public. This is subject to a limited scope of activities that only lawyers may provide.

Those activities are the ‘reserved areas’ of work for lawyers which are generally limited to litigation-related activities and matters that by statute only a lawyer may undertake. Only a lawyer or licensed conveyancer (or person acting under their supervision) may provide ‘conveyancing services’ to the public.

There is, therefore, a wide range of services within the legal landscape that individuals outside the legal profession can provide.

“There is a concern that currently unregulated providers of legal services (outside the Lawyers and Conveyancers Act 2006 regime) may not be captured in the implementation of Phase Two,” the submission says.

“If this were the case, unregulated legal service providers may become an attractive option for individuals seeking to avoid the rigours of the AML/CFT compliance regime.

“Leaving these service providers outside the AML/CFT umbrella could then open a significant loophole ripe for criminal exploitation. This is wholly inconsistent with the Ministry’s aim of stopping the ‘displacement effect’ which relates to criminals accessing assistance outside any supervised sector to avoid detection.”

Time to prepare

Some unique challenges exist for the legal sector and getting properly prepared will be a “substantial” undertaking.

“If the process is rushed, it is likely there will be less effective engagement and a consequent increased burden on supervisors.

“Time also needs to be allowed for professional associations – including the Law Society – to develop guidance for members [and] assist with codes of practice.

“There will be a range of complex scenarios in practice that need to be addressed in practice briefings and educational seminars.

“It would likely take law firms two to three years to properly implement systems and processes to allow them to comply.

“Firms would need to develop procedures manuals, run internal training sessions, appoint Money Laundering Reporting Officers, and bed in the new information gathering and filing protocols.

“The Law Society considers that a 12-month implementation period would be too short, particularly for small firms which will need to absorb the cost in resources and time of setting up new systems and processes.

“The Law Society therefore recommends the Phase Two lead-in period should be at least two years, and preferably three.”

Consultation

The Law Society will need to discuss issues relating to Phase Two of the AML/CFT regime further with the Ministry of Justice.

It will also need to engage more closely with its members to ensure the profession understands the detail of the Phase Two reforms.

“In particular, it is essential the profession is given the opportunity, and adequate time, to comment on an exposure draft of the Bill and the proposed implementation timeframe.

“This will be crucial to gaining the profession’s support for efficient and effective implementation of the reforms,” the Law Society says.

The full Law Society submission on Phase Two of the AML/CFT regime is on the Law Society website.

Last updated on the 4th October 2016