“Know Your Client” remains a key focus of regulators – Jon Gerty, Head of Compliance at Shore Capital, considers the implications of an investment firm’s duty to know its client and the consequences of not getting it right.
UK financial services firms and companies such as Shore Capital are subject to a vast array of rules and regulations – not just from the Financial Conduct Authority (“FCA”) – to “know your client” (KYC). At its most basic, the rules focus on:
– The prevention of financial crime; and
– Conduct of business obligations.
This requires firms to request information from prospective clients at the outset of the relationship or else be subject to the wrath of the regulator. At Shore Capital we seek to take into account the needs and requirements of the client when complying with the rules, whilst ensuring that sufficient KYC information is obtained to demonstrate a thorough understanding of the client.
Financial Crime Prevention
Firms need to ensure they obtain the correct amount of “client due diligence” whilst balancing the needs of clients for privacy and confidentiality. With this in mind there are a number of areas of financial crime that are particularly relevant:
Anti-money laundering (“AML”): Most people are broadly familiar with the requirement on firms to obtain AML information. Firms need to obtain the right information to understand their clients, the client’s business and/or investment needs and profile. This includes verifying the identity of “beneficial owners” of any companies, partnerships or trusts. Where a client falls into a higher risk category, firms are under even more extensive KYC obligations, in particular to know the client’s sources of wealth and funds. This can sometimes be difficult, for instance where the client is based offshore or is understandably reluctant to divulge information. A “higher risk category” includes:
– a client is a politically exposed person (“PEP”), for example a government or foreign official;
– where the client has not been met by the firm, face-to-face; and/or
– where there are reasons to be suspicious from an AML perspective.
The FCA continues to impose heavy fines on firms for failing to obtain adequate AML information about their clients, particularly PEPs. In January 2014 Standard Bank was fined £7.6 million and in March 2013 EFG Private Bank was fined £4.2 million. The FCA also visited a number of firms and found that their AML systems and controls were not up to scratch. The FCA reminded firms that it expected all firms to improve their AML crime prevention procedures and systems or they could face heavy enforcement action. There are therefore good reasons why firms request a myriad of AML related information from prospective clients at the outset of the relationship.
Sanctions: UK legislation requires that firms do not “make funds or economic resources” available to any person on a UK sanctions list. As with AML due diligence, this requires the firm to know the client and, in the case of company, trust or partnership, any person who controls the client. And this is just the UK – many firms are also legally or commercially obliged to take account of the sanctions regimes of other countries.
Anti-Bribery and Corruption (“ABC”): It is important that any due diligence programme includes a review of ABC risks. Some clients may be based in jurisdictions which, traditionally, have been viewed as higher risk from an ABC perspective. A firm which deals inadvertently with funds that a client (or its beneficial owners) obtained, even innocently, as a result of corruption could commit a money laundering offence. Firms will therefore want to establish that the risk of corruption by the client is low. Besso Limited was fined £315,000 by the FCA in March 2014 for filing to have proper systems in place to detect and prevent corruption.
Conduct of Business
Firms are not only concerned with collecting information from clients to prevent financial crime. Where a firm is engaged to provide particular services (for example that of giving investment advice), it needs to obtain specific information from clients at the outset of the relationship. The FCA will not hesitate to impose significant fines on a firm for failing to obtain adequate information to comply with its rules. For instance, Santander plc was fined £12.4 million in March 2014 for failing to ensure it gave suitable advice based on the information it obtained from clients. The FCA has stressed that firms need to “treat clients fairly” and in practice this means firms must sensitively probe prospective clients for information about their needs and requirements. Firms may also obtain information for commercial reasons (eg to assess credit risk) or to determine the fitness and propriety of a client, for instance when taking on the role of a Nominated Adviser to an AIM listed company.
What the above demonstrates is that, for a firm to comply with its legal obligations and to avoid getting into trouble with its regulators, the firm needs to have a thorough understanding of who their clients are, who they are controlled by and what they want. This information is critical to the firm demonstrating that it has systems in place to prevent financial crime and to comply with its conduct of business obligations. Whilst clients may find information requests daunting and, for understandable reasons, may be reluctant to divulge detailed information, firms realistically have no choice but to request the information. At Shore Capital we take into account the needs and sensitivities of the client when requesting information whilst at the same time complying with the diverse requirements of the law and the regulator’s expectations.