New Zealand Law Society - The AML/CFT regime - some further queries and comments

The AML/CFT regime - some further queries and comments

Auckland lawyer Steve Dukeson has prepared a fourth article on the AML/CFT regime and some of the issues which are besetting lawyers.

His earlier articles were AML/CFT and the Looking Glass - Retainers, etc and The AML/CFT regime - More on retainers, etc. and The AML/CFT Regime and Some Miscellaneous Issues. The New Zealand Law Society does not necessarily endorse Mr Dukeson's views, but believes his comments are a valuable input into the matters which lawyers are confronting.

I received a lot of emails and calls from lawyers in relation to my first three articles.  Most would’ve been from small firms.  Many lawyers seem to be overawed and intimidated by the regime.  

For anyone who hasn’t read any of my previous articles, I’m no expert on the AML/CFT regime and nothing in the articles constitutes advice. However, the queries and comments that I make in the articles may nevertheless be helpful to lawyers in small firms and sole practitioners who, like me, feel pressured by the regime, both in terms of what’s clearly required of us and what isn’t clear.

I’ve suggested to the New Zealand Law Society that it consider running some seminars, to be presented by lawyers expert on the AML/CFT regime, to deal specifically with the kinds of issues that I’ve raised.  The experts mightn’t be able to give clear or categorical views on every issue.  Where they can’t, it would be helpful to the rest of us to know what issues the experts consider to be unclear and what they would suggest in those cases. There are too many issues of importance that are uncertain or unclear and as a profession, we should be working together to try to resolve those issues as best we can.  

Once again, I have to thank a couple of legal experts in the field who’ve spent time discussing with me some of the issues that I deal with in this article.  

Monitoring – Continued CDD

One matter where there seems to be confusion amongst some lawyers is in relation to continued monitoring/CDD.  Consider this example:

I’ve acted for a client for some time.  I’ve drafted employment agreements for them and given them employment law advice.  I’ve drafted or reviewed a number of commercial contracts for them (none caught by the regime). They now want me to act for them in relation to a lease of commercial premises.  I undertake CDD and the transaction is completed.  I then continue to provide the same kind of services as before.

I don’t have any obligation to monitor or to carry out continued CDD.  The Act only applies to me when I’m engaged in captured activity.

SARs and prospective clients

The FIU SAR Guidelines refer to s39A of the AML/CFT Act and state that you must file a SAR in relation to prospective clients where you have the appropriate level of suspicion that the inquiry may involve or lead to suspicious activity. From a DIA seminar some time ago, I understand that this is the DIA’s view.  There are problems with that view.

Section 6(4) provides that the Act doesn’t apply to lawyers unless they would be engaged in a captured activity.  On the other hand, s39A seems to indicate that a lawyer who receives an enquiry from a prospective client, which would involve the lawyer engaging in a captured activity if the lawyer agrees to provide the service, would have to file a SAR if the lawyer has reasonable grounds to suspect suspicious activity.  

Can this be right?  Section 39A may be yet another section that isn’t easy to interpret but rather than get into all sorts of knots in that regard, let’s cut to the chase.  

First, if the FIU/DIA view is accepted, a lawyer who has no relationship with a person who is requested by them to provide assistance in relation to a captured activity isn’t only required to file a SAR but, it would seem, is also required to carry out EDD (if that’s what s22A requires - I still find s22A difficult to interpret).  Such an obligation would be unreasonable.  Lawyers aren’t financial institutions like banks with large resources (financially and staff-wise).  Most law firms are small to tiny.  Why should an onerous obligation be cast on them to engage in further unpaid police work for the Government, at the risk of prosecution if they fail?  In my view, such an obligation would be another instance under the Act of imposing financial institution type obligations on law firms inappropriately.

Secondly, and tellingly, if s39A were to apply in those circumstances, it would apply to a lawyer who never engages in captured activities (and therefore, who doesn’t even need to have a Risk Assessment or Compliance Programme) but who simply receives an inquiry which, if accepted by some lawyer, would lead to that lawyer engaging in a captured activity.  (I can’t claim any plaudits for this thought, which is an excellent point to raise – one of the experts shared it with me.)  In other words, if s39A would apply to a prospective captured activity in relation to an inquiry from a prospective client, this would capture both a lawyer who engages in captured activities and one who doesn’t and one who might accept the instructions and one who never would. This would violate s6(4) and in any event, would be totally inappropriate.  Such a drastic imposition of responsibility and potential liability can’t have been intended.  (If it was, then it needs to be reconsidered.)

For that reason in particular, I understand that some lawyers, including some who are expert on the regime, will take the approach that an SAR doesn’t have to be filed in relation to inquiries from prospective clients.  I presume that they would word their AML/CFT documentation accordingly.

It’s an extremely important issue.  One saving grace may be that it could be rare that a lawyer would, simply on the basis of an inquiry, have reasonable grounds to suspect suspicious activity and/or may not have enough information to file a SAR (taking into account also the issue of privilege).

Advising vs Engaging

I referred to this issue in my third article. Having discussed it with several expert AML/CFT lawyers, I would like to share further comments.  

I think that it’s true to say that the lawyers to whom I spoke consider that advising and even drafting documentation wouldn’t be engaging in a transaction and so wouldn’t involve the lawyer in a captured activity, provided that in relation to a business sale or share sale (etc), the funds don’t pass through the lawyer’s trust account.  So, for example, being involved in drafting a S&P, and ancillary documents, wouldn’t be a captured activity.

There’s some sense in that point of view.  Contrast the definition of “transaction” in the legislation with that of “conveyancing” – the latter specifically refers to legal work and documentation to effect the matter in question whereas the former doesn’t.

I’ve previously questioned where the line between advising and engaging might be but it hadn’t occurred to me that (for example) drafting a S&P may not be captured.  It’s often difficult to see the wood for the trees in relation to the regime.

Having made these comments, my understanding is that nevertheless, the expert lawyers with whom I discussed this would, as part of risk management, recommend that lawyers within their firms treat these matters as being captured, simply because they don’t want needlessly to antagonise the DIA in relation to an issue of this kind.  Perhaps a bridge too far?

Where lawyers disagree with the DIA’s views, they may draw a line in the sand in some cases and act upon the basis that the DIA’s views are wrong and in other cases, may decide to act in accordance with the DIA’s views even though considered to be wrong.  What decision is made in that regard will presumably depend on appetite for risk, appetite for argument (with the DIA, if audited – two of the lawyers who contacted me after one or other of my articles clearly felt that they had been well and truly put through the mill by the DIA), size of the firm, amount of captured activities engaged in, etc.

Beneficial Owners and the person for whose benefit a transaction is conducted

I referred to this issue in my third article, in relation to the question of what CDD is required when a law firm requests your assistance (the law firm is your customer), where it’s acting for the benefit of its client.  I’m dealing with this issue again particularly because of a case that’s been brought to my attention and because it’s an important issue. It’s complicated.  (I’ve re-written this part several times – whether or not my comments/queries make sense, I hope that it’s clear what they are.)

In informal discussions with some expert AML/CFT lawyers, I referred to the DIA Guide on Beneficial Owners where the DIA interprets the definition as requiring CDD on persons who have control or a certain level of ownership of the customer and on the persons on whose behalf a transaction is conducted (“Powbatics”).  This didn’t seem to me to follow from a natural interpretation of the definition.

To recap, the definition reads:

"Beneficial owner means the individual who
a) has effective control of a customer or person on whose behalf a transaction is conducted; or
b) owns a prescribed threshold of the customer or person on whose behalf a transaction is conducted."

The natural interpretation of that wording is that a beneficial owner controls or owns the customer or the person for whose benefit the matter is conducted.  

A simple way to draft the provision, if it were intended to mean what the DIA contends would be:

"Beneficial owner means the individual who
a) has effective control of a customer or who owns a prescribed threshold of the customer; or
b is the person on whose behalf a transaction is conducted."

One of the lawyers referred me to Qian v Duoduo Limited, where the High Court has previously referred to the ambiguous wording of the definition of beneficial owner.  The Court pointed out that the DIA interpretation is just one of several possible interpretations.  (I haven’t read the case in full or in detail because much of it concerns matters beyond the daily life of even a commercial lawyer.)

But there’s an issue with reading the definition according to its natural meaning. According to its natural meaning, in addition to CDD on the customer, the definition would require CDD on a person who controls or owns the customer who controls or owns the person for whose benefit the matter is conducted when there wouldn’t be any obligation to undertake CDD on the person for whose benefit the matter is conducted (because they aren’t the customer and they wouldn’t be a beneficial owner).  

Perhaps the definition should be along these lines:

"Beneficial owner means the individual who
a) has effective control of a customer or who owns a prescribed threshold of the customer; or
b) is the person on whose behalf a transaction is conducted and where that person is not an individual, includes the individuals who have effective control of or who own a prescribed threshold of the person"

That wording probably isn’t perfect, but you get the idea.  

One point that I would make is that if CDD were to be required on a Powbatic for any reason, how could a lawyer ever be sure that they have found the ultimate Powbatic?  In fact, this could be said in relation to the obligation to due CDD on any person that controls the customer – could a lawyer ever be certain in every circumstance that the controller has been identified?

As practising lawyers, we have to deal with enough in relation to the AMLCFT without having to guess what key provisions mean or should be deemed to mean. Frankly, I’m not sure what I should provide for in my AMLCFT documents in relation to this matter to ensure that I comply with the law.

At this point, let’s return to the question of what CDD is required when a law firm (whether in NZ or overseas) requests your assistance in relation to a matter that is for the benefit of its client, where the law firm is your client (customer) i.e. you are advising or assisting the law firm, directly.  Given that the law firm is your client (customer), there seems to be no doubt that you need to do CDD on it.  

Just what this entails may depend on whether it’s a partnership or corporation and whether there are any beneficial owners.  (There may be no beneficial owners if the shareholders are all individuals and none hold 25% (or more?) of the voting shares.)  

If you’ve already done CDD on the law firm, you could presumably just do simplified CDD on the lawyer giving the instructions on behalf of the law firm (assuming that there’s no reason to suspect that your prior CDD needs updating).

It still isn’t clear to me that CDD is required on the law firm’s client but my guess is that lawyers who receive instructions to act for a law firm (where the law firm is the lawyer’s client) will do CDD on the law firm’s client as well as on the law firm, whether this be in reliance on CDD by the law firm already undertaken on its client or on CDD being undertaken by the law firm as the lawyer’s agent or on CDD being undertaken by the lawyer directly or through some other agent.

Barristers' Fees and Disbursements

I had suggested in a previous article that the DIA may have viewed monies paid on account of barristers’ fees in the same way as a normal retainer but that isn’t the case.  The DIA takes view that receiving a retainer on account of the fees payable to a barrister, as well as receiving payment in advance of disbursements to be incurred by the lawyer, is managing client money.  I’ve expressed the view that the DIA’s view is misguided.  I’ll make some more comments in that regard.

Payment of an amount as fees for professional services isn’t caught by the Act. A retainer paid “on account of barristers’ fees” is payment of an amount for fees for professional services.  

Traditionally, the barrister would invoice the solicitor, who because of the intervention rule, would be the barrister’s client.  The solicitor would invoice their client for that amount (possibly as part of larger fee to cover fees properly chargeable by an instructing solicitor).  In reality, the payment by the solicitor’s client is or is mostly to cover the barristers’ fee.  Whatever, he payment is on account of fees for professional services.  

These days, despite the intervention rule, many barristers are prepared to invoice the solicitor’s client directly but sometimes, the barrister will require the instructing solicitor to have their client pay a retainer to the solicitor on account of the barrister’s fees, to be receipted into the solicitor’s trust account.  It’s even clearer in that case (because the nexus between the payment and the barrister is more direct, with the barrister eventually invoicing the solicitor’s client) that the retainer is paid on account of fees for professional services.

Secondly, whether the payment is to be regarded as a retainer on account of fees for professional services or payment of a disbursement in advance, it’s obvious that there is no management of client funds.  Why is the money being paid in advance? Because a lawyer (whether the barrister or the instructing solicitor) requires it as a condition of their agreeing to provide their services – it wouldn’t otherwise be paid. The client isn’t requesting to pay the money so that it can be managed in some way on their behalf or to their benefit.  The payment is required as a necessary adjunct of the lawyer agreeing to provide their services, to ensure that the lawyer isn’t out of pocket.  

The DIA view, if correct, would force me to become a banker, to advance money to clients and hope that they will repay (a risk that I shouldn’t have to run), or do CDD in relation to a matter that isn’t a captured activity to avoid becoming a banker.  

My understanding is that the NZLS agrees with this point of view.  AMLCFT lawyers who are expert on the regime also agree.  Remember that the focus isn’t on whether the lawyer might be engaging in ML or TF on their own behalf – the regime is about the customer being engaged in ML or TF and whether their lawyer may be assisting them (albeit, unknowingly).  

I consider that it would be appropriate for my Risk Assessment and Compliance Programme to state that the DIA view is wrong and that it shouldn’t be followed.  

If the DIA can’t be persuaded to change its view, a Ministerial Exemption needs to be provided in the legislation to ensure that common sense prevails.

Practical Examples

I want to share two situations that I experienced, to illustrate some difficulties that can arise, including when some of our professional cousins may be involved.

Discretionary Family Trust Selling Some Shares in a Closely Held Company owned by the Trust

This example that I will set out for you involved a sale of some of the shares in a company.  

First, note that it’s clear that the Act doesn’t apply to sale of only some shares in a company – that isn’t the sale of a legal person.  It may be possible to argue that the sale of a controlling interest is the sale of a legal person, but I think that this is still stretching things.  It would have been very easy to include a provisions that a captured activity includes the sale of a share in a company.  

I advised that it’s possible that the DIA may consider the transaction would be caught but that if so, this would seem to be obviously wrong.  Nevertheless, I advised what would be required if the regime were to apply. (If it makes more sense, consider the example on the basis that a party wanted to sell of the shares in the company.)

  • Trustees held all shares in a closely held company.  They wanted to sell some to third parties, less than a controlling interest.
  • I didn’t know the trustees and hadn’t acted for the trust. I knew nothing about the trust.
  • An accountant who I did know, who was referring the matter to me, did know about the trust.  (I had known this lawyer for many years, and his firm, and had worked with that firm on various client matters  over the years. I have no doubt as to the honesty of the accountant and the firm.  The accountant is very smart and practical.) The accountant was able to give me general information as to how and when the trust was created, how it operated, and how it had obtained its assets.
  • I advised that I would need to:
  • Sight originals of or obtain appropriately certified copies of the signed and dated Trust Deed and any other Trust docs e.g. variations, Deeds of Appointment/Retirement of Trustees, Deeds of Appointment/Removal of Beneficiaries etc
  • Sight originals of or appropriately certified copies of ID documents for the Trustees as beneficial owners (Trust was a discretionary trust so no need for CDD on beneficiaries)
  • I said that it might be possible for me to rely on what the accountant had said bu but that technically, I would need to receive information that would reasonably satisfy me as to the trust’s SOW (not so much SOF – the trust was selling).  For example, copy of IRD number, copy of last financial accounts and tax return to the IRD.
  • Despite my excellent relationship with the accountant (and perhaps because of it), he castigated me and said that some of my colleagues were taking a much more superficial approach to things and that I would lose business if I followed this approach.  He didn’t disclose who the colleagues of mine were who were taking a more superficial approach.  He said it was just a question of making sure that the client knew of the risks and having the client sign an acknowledgement to this effect. I broke the news to the accountant that the client wasn’t at any risk at all – all risk is on the poor sod who erred in choosing law as a profession.  (Yes, he should’ve known better given that accountants are now subject to the regime.)
  • I made the point to the accountant that the law deems trusts to be of high risk under the AMLCFT regime and that EDD is required (according to the level of risk in the circumstances).
  • Asa result of having been severely castigated and in case I was overreaching, I sent an email to 5-6 small law firms and to two expert AML/CFT lawyers in two large law firms. I asked if they would follow the same approach.  All but one of the small law firms replied and one of the large law firms replied.  All of those law firms said yes.  I conveyed this to the accountant, who remained unconvinced.
  • One of the expert AML/CFT lawyers who I had emailed then called me and we had a chat about the matter.  His view was that:
  • A simple copy of the signed and dated Trust documents would suffice. A certified copy adds little or no comfort.  Who’s to say that the trust documents are the actual trust documents or that there haven’t been changes since they were signed, etc?
  • I could rely on what the accountant said take a risk based approach e.g. the trust was a family discretionary trust, the sale was of shares that the trust had owned for some time, the transaction didn’t call for any explanation, and importantly, I had known the accountant for many years, he was from a reputable firm and clearly, had detailed knowledge of the Trust’s affairs.
  • I advised my accountant friend of those comments – he was at least moderately appeased. I made the point to him though that had he not been able to provide detailed information that I could rely on, I would have needed to obtain significant information about the trust’s SOW.

I’ve had two separate prospective matters based on the same fact scenario except that  in relation to second, I knew of the trust but hadn’t acted for it and didn’t have knowledge of its affairs and there was no detailed information from the trust’s lawyer or accountant.

One comment that I want to make in relation to the kind of EDD required in relation to SOW and SOF is that despite having practised as a business lawyer for most of my lawyer life, I’m no expert on reading accounts or tax or detecting fraud. There’s a limit as to how much information I could glean from the extensive information required by EDD as to SOW and SOF. It’s a concern from a compliance perspective (financial institutions caught by the regime, and accountants, could be expected to have much more acumen in relation to those matters) and from a time cost and energy perspective.

Barrister and Court fees Example

  • I had acted for a company client for some time in relation to litigation between it and a former employee.  There were employment and IP issues.
  • One set of proceedings had gone through the employment courts.
  • A second set of proceedings had been going through the High Court.  They had commenced long before the AML/CFT regime captured lawyers.  (I don’t have it clear in my mind yet when legal proceedings are captured by the regime – it may be that these proceedings wouldn’t have been captured.)
  • My client lost in the High Court.  I hadn’t received a copy of the judgement but received an email from the barrister that he has asked my client to deposit into my trust account the filing fee payable for an appeal. It transpired that my client had done this.  The filing fee had to be paid out fairly promptly.  It would appear the barrister didn’t know that the according to the DIA, payment of the disbursement triggers the regime (manging client funds).
  • Needless to say, my client didn’t understand this at all.  My choices were to ignore the DIA view and pay out, rely on the existing client “exception” to carrying out CDD (which in the melee, didn’t occur to me), or carry out CDD (not quite so simple because the principal directors/shareholders of the company reside in AUS).

Going forward, it’s likely that I will take the view that the DIA’s view is wrong in relation to retainers paid “for” barristers’ fees and payments of disbursements in advance and act accordingly.

Concluding Comments

I think that anyone who has put serious time in trying to come to grips with the regime will find that their thinking has developed over time.  Sometimes, this will have resulted in greater understanding and clarity, sometimes in confusion, and sometimes, in a change of view.  

The powers that be are increasingly shifting the cost of ensuring compliance with law is shifted to the private sector, with the imposition of liability as part of the package.  In my view, it’s unacceptable that confusion or lack of clarity (however one wants to put it) is as prevalent as it is relation to some key issues under the regime.  

Part of the problem is the application in some instances of financial institution obligations to law firms when this isn’t appropriate.  

As unpaid workers for the Government, I wonder if we should strike – everyone seems to be doing it.

Steven Dukeson is the principal of Dukesons Business Law, an Auckland commercial law firm.