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Ushering in a new ‘know your client’ era

Nick Block, Associate, Clyde & Co and John Leonida, Consulting Superyacht Industry Advisor, LP Squared Ltd explain what this means in practice…

‘Know your client’ and ‘KYC’ are familiar terms to everyone who deals with lawyers or superyachts, but, what does a KYC check actually mean? It’s essentially carrying out due diligence on your clients and customers to check that they really are who and what they say they are. The who is fairly obvious. Are they really, for example, Vincent van Gogh? The what, is a bit more difficult. If Vincent van Gogh claims to be a multi-billionaire art dealer, you are going to need some unimpeachable proof, that goes beyond “trust me, I inherited a few paintings of sunflowers”.


The KYC process is often maliciously painted as an administrative burden and obstacle to getting a deal done, however companies need to take their obligations seriously as the consequences of not doing so are potential criminal liability that can lead to imprisonment, significant fines as well as considerable reputational damage.
The principal purpose of KYC checks is to prevent money laundering, being the means by which criminals seek to legitimise criminal proceeds by distancing such proceeds from their source. The proceeds of crime can be anything derived from any criminal activity, from fraudulently acquired wealth to drug money to kick backs. Money that has been ‘laundered’ can then be used by criminals for legitimate activities.


The UK’s National Crime Agency estimates that the scale of money laundering impacting the UK annually could be in the hundreds of billions of pounds[1]. Similarly, in the EU, the European Commission estimates that around €160 billion annually is involved in suspect financial activity such as money laundering[2]. One of the most common ways that money is laundered is through the purchase of property, however the purchase of any high-value asset, for instance a superyacht, could also be used by criminals.


In the UK, anti-money laundering (AML) laws are derived from the EU AML directive, which was first adopted in the early 1990s and has been supplemented and widened in scope over the years, most recently in 2018. The primary AML legislation in the UK is The Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (the 2017 Regulations). The 2017 Regulations have been supplemented more recently in 2019 (the 2019 Regulations) and again in 2020 as a result of Brexit. The 2017 Regulations apply to companies in the UK, but given that the regulations are derived from the EU AML directive, similar laws will apply in all EU countries. The UK also has other important relevant legislation including (i) the Terrorism Act 2000 (TA 2000) and (ii) the Proceeds of Crime Act 2002 (POCA 2002).


In the superyacht world, brokers, law firms and financial institutions are increasingly involved whether that is during the negotiation or financing of a new-build project, the sale of a second-hand yacht, the drafting of a design agreement or the provision of escrow account services. These sectors, and others such as accountants and tax advisers have duties under the 2017 Regulations to, amongst other things, carry out KYC checks on their clients and customers. The checks must be thorough and will include, for example, identifying and verifying the identity of individuals, the name, registration number and registered address of corporate clients, the law to which the client is subject, the client’s constitution and the full names of the board of directors and senior persons responsible for the company’s operations. The 2017 Regulations also require the identification and verification of the beneficial ownership structure (including anyone who directly or indirectly owns more than 25% of the company) and source of funds. In other words, a new company set up to buy a €200 million superyacht needs to be legitimately funded. It is not enough to be a high-profile public personality ‘known’ to be rich. They have to prove how this particular wealth was acquired and put into the company that will buy the superyacht. For those carrying out the KYC checks they need to show they have done this. Failure to run the checks, even on a legitimate individual, is a breach of the law. This can also be a point of contention between clients and their advisers, with the advisers needing full transparency to comply with their AML obligations and the clients wishing to maintain a level of anonymity through their ownership structures. Lawyers have a legal duty of confidentiality to keep the affairs of current and former clients confidential, unless disclosure is permitted by law or the client consents, which should give clients some comfort.


There is a misconception that AML legislation only applies to limited sectors including those mentioned above. Under the 2017 Regulations, ‘high value dealers’ which are defined as “a firm or sole trader who by way of business trades in goods…, when the trader makes or receives, in respect of any transaction, a payment or payments in cash of at least €10,000  in total, whether the transaction is executed in a single operation or in several operations which appear to be linked”[3] also fall within the scope. The term ‘cash’ means “…notes, coins or travellers’ cheques, in any currency” and includes where a customer or client deposits cash directly into the dealer’s bank account. High value dealers must be registered with HMRC. The €10,000 threshold seems relatively low in the context of a multi-million-euro superyacht, but participants in the superyacht sector including superyacht builders, brokers and suppliers must be aware of their potential obligations under the 2017 Regulations and it is advisable to have a policy in place whereby you do not accept high value cash payments. In addition, under POCA 2002 all companies in the UK have the obligation to submit a Suspicious Activity Report (SAR) to the National Crime Agency as soon as they know or suspect that a person is engaged in money laundering. The reporting party must not inform the client or customer that it has made an SAR as this may prejudice the investigation and could potentially constitute the criminal offence of ‘tipping off’, the reporting party must therefore consider very carefully how to handle its relationship with the client or customer after submitting an SAR[4]. 


Knowing where the money comes from is hugely important. If you are a broker or superyacht builder and you do not receive money from the corporate vehicle or person whose name is on the contract, that is a red flag event which you absolutely must check. It’s not enough to match the monies expected with the monies received from an account the client says “it’s one of my companies”. To do that puts you at risk. In those circumstances you need to talk to your compliance people on what to do next.


In January 2020, the 2019 Regulations came into force and extended the scope of the 2017 Regulations  to include art traders, specifically those who deal in sales, purchase and storage of works of art with a value, for a single transaction or a series of linked transactions of €10,000 or more. Owners should therefore expect to be asked for KYC documentation from their art dealer if they are purchasing, selling or storing artwork where the value of the transaction is more than €10,000.


The UK takes a tough stance against those who breach the AML regulations and the responsibility for enforcing the regulations is delegated to various supervisory authorities depending on the type of company, for lawyers this is the Solicitors Regulatory Authority, for financial institutions this is the Financial Conduct Authority and for other businesses such as high value dealers this is HM Revenue & Customs (HMRC). There are numerous examples of companies being fined for breaking the rules, with the largest fine issued by HMRC being £23.8 million[5], which was handed out in January 2021. The supervisory bodies also have the power to publicly name and shame the rule breakers.


Conclusion


Practical steps that companies can take to ensure that don’t fall foul of the AML regulations include (i) carrying out thorough due diligence on clients and customers where the transaction is for significant value (whether or not a company is within the scope of the AML regulations this is good practice) and (ii) being wary of the AML legislation as these are updated regularly and the consequences for breaching them can be significant.
Know your client checks, although sometimes painful, are an important tool in the fight against money laundering and it is important that companies that fall within the scope of the AML legislation comply with their obligations.  One more point. You need to refresh your KYC every two or three years for existing clients and just because your client was clean yesterday, it doesn’t mean he will be clean tomorrow.


[1] https://www.nationalcrimeagency.gov.uk/what-we-do/crime-threats/money-laundering-and-illicit-finance
[2] https://www.politico.eu/article/europe-money-laundering-failures-signal-policy-headaches-for-new-commission/
[3] https://www.legislation.gov.uk/uksi/2017/692/made
[4] https://www.nationalcrimeagency.gov.uk/who-we-are/publications/158-introduction-to-suspicious-activity-reports-sars/file
[5] https://www.gov.uk/government/news/hmrc-issues-record-238m-fine-for-money-laundering-breaches

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