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Scott Clayton

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Arabella Saker looks at the extent of the provisions of the US Patriot Act and its
implications for non-US financial institutions
(taken from Issue No 21  – October 2002


`You’re either with us, or against us` was President Bush’s message to the world once the dust had settled on Manhattan. President Bush added in the same speech that `a coalition partner must do more than just express sympathy, a coalition partner must perform` and if not, `it’s going to be important for nations to know they will be held accountable for inactivity`.

President Bush’s ‘action, not words’ tone finds echoes in the Uniting and Strengthening of America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act 2001, known as the USA Patriot Act, particularly Title III (the International Money Laundering Abatement and Anti-Terrorism Act 2001, `IMLAA`). Among other things, IMLAA requires US financial institutions to have enhanced due diligence procedures when providing correspondent or private banking accounts to foreign banks operating under an offshore banking licence or a licence issued by any country designated as non-co-operative with international anti-money-laundering principles (e.g. which has been `blacklisted`) by the Financial Action Task Force (`FATF`). IMLAA prohibits US financial institutions from establishing or maintaining a correspondent account with a shell bank (i.e. one that does not have a physical presence in any country). There are further due diligence requirements aimed at spotting the proceeds of corruption, especially where political figures, or their affiliates, open private banking accounts.

Wide scope of the Act
Whilst much of the Patriot Act is firmly aimed at domestic institutions in the US,IMLAA is clearly designed to have extra-territorial application. If it is enforced as widely as it is drafted, there are obvious implications for banks and trust companies in the UK and other major financial centres. The key aim of IMLAA(apart from closing loopholes that have been exploited by money-launderers in the past) is to promote a higher standard of vigilance, and demand greater due diligence, from all US financial institutions in their dealings with US and non-US financial entities. In particular, IMLAA gives sweeping powers to the US Secretary of the Treasury to impose `special measures` on the dealings of US financial institutions with non-US individuals or entities. This includes powers to require additional record-keeping, reporting and the identification of beneficial owners, and restrictions on the use of certain inter-bank, correspondent or payable-through accounts.

So far, this may perhaps have a familiar ring about it. UK and offshore banks and trust companies have for some years been familiar with the need to train staff to spot potential money-laundering transactions and to report those suspicions. However, the context in which that legislation operates, and the environment in which financial institutions undertake those monitoring duties, were changed entirely by the tragic events of 11th September.

OECD/FATF and money laundering
Over the last few years, organisations such as the OECD and FATF have been putting pressure on financial jurisdictions across the globe to admit weaknesses in their banking and regulatory systems and to take steps to reform any legislation and procedures which permit money-laundering to occur. Many offshore financial centres have introduced advanced all-crimes legislation and sophisticated regulatory framework well ahead of their onshore critics. The result of this is – as a regulatory officer of a European member state acknowledged recently – that some offshore financial centres have a more tightly regulated environment than some onshore jurisdictions.

Not, that is, that the onshore jurisdictions have been sloppy either. The UK, for example, already had a substantial range of money-laundering related legislation in the Criminal Justice Act 1988, the Money Laundering Regulations 1993, theDrug Trafficking Act 1994 and the Terrorism Act 2000. With further legislation introduced since September 2001, the UK has brought yet further aspects of the UK’s financial services industry into account. The Anti-Terrorism Crime and Security Act 2001 extended the range of offences in the Terrorism Act 2000immediately after 11th September. The Money Laundering Regulations 20011extended the application of the existing 1993 Regulations to miscellaneous, formerly unregulated financial businesses such as bureaux de change and cheque-cashing services. The Proceeds of Crime Act 2002 introduces a new offence of failing to disclose knowledge or suspicion of money-laundering, previously a significant lacuna in the UK’s proceeds of crime legislation. Finally, the implementation in 2003 of the Second European Money Laundering Directivewill expressly extend existing EC money-laundering regulations to cover all crimes (and not only drugs-related offences), and will extend its compliance requirements to include legal service providers, accountancy and audit practitioners, and estate agents (to the extent that such professionals have not already regarded themselves as covered).

Ironically, before September 2001, although US banks and other primary financial institutions were subject to tight transaction-monitoring rules, these were mainly domestic in their focus, and as a whole, the US legislation may have been less sophisticated than that of other jurisdictions. The purpose of the main US foreign funds monitoring system was to identify movements of funds involving any person or entity on the Office of Foreign Assets Control (`OFAC`) list, who were mainly linked with the half-a-dozen or so territories (including Iraq, for example) against which the US federal government had extant economic sanctions. ThePatriot Act aims to rectify the limited scope of the previous regulations, and indeed appears to go much further than that.

New approach
IMLAA is centred on the activities of `financial institutions`, now given a new definition which is broad enough to capture not only banks and securities brokers, but also jewellery dealers, travel agents and even second-hand car dealers. It includes foreign financial institutions with a branch or agency in the USA. Crucially, however, the definition includes any

`agency of the United States Government or of a State or local government carrying out a duty or power of a business described [in the remainder of the definition]`.

This, it has been suggested, is wide enough to include the Internal Revenue Service, among others. The legislation can thus be applied to almost any transaction involving transfers of property and/or funds. IMLAA is therefore similar to money-laundering legislation in other financial centres, in that it is designed to recruit every financial institution to the process of inhibiting the movement of criminal funds.

Any non-US professional trustees wishing to continue to do business with US-based financial institutions must be have adequate internal policies (including staff training) to comply with the US requirements, must obtain from their clients the necessary information to satisfy the US rules, and supply that information and supporting documentation to their US counterparts in the proposed transaction. This, again, is unlikely to prove a surprise to trustees in regulated jurisdictions – the `know your client` (`KYC`) rules that (for example) UK banks and trust companies must already have as part of their standard operating procedures are likely to be sufficient to enable them to respond to the enquiries of their US counterparts. Typical KYC procedures are aimed at determining the true beneficial owner of the funds and having people properly trained to identify irregular transactions, whatever the apparent source of their funds, albeit without specific focus on terrorism-related crimes. In this regard, IMLAA is unlikely to impose any additional information-gathering requirements on UK-based institutions (nor, presumably, on those in the principal non-blacklisted offshore jurisdictions).

Information sharing
However, the Patriot Act does go further than some of its equivalents. One of the most difficult concepts for non-US bodies to accept will be the information-sharing provisions of IMLAA. Two particularly important points of the legislation are the following:

1. Some non-US financial institutions (such as banks and brokers) holding US banking accounts must appoint a US agent for service of information-production proceedings. The Secretary of the Treasury or the Attorney-General may issue that agent with a summons or subpoena requiring the production of information (even if those records are kept in the foreign bank’s home jurisdiction and/or relate to funds deposited into the foreign bank abroad).

2. US financial institutions must gather information from their foreign clients, and they must also disclose information regarding suspected terrorist or money-laundering activities, both to the US regulatory authorities, and in some circumstances to other US financial institutions.

Failure to comply with these provisions – which are not found in the equivalent domestic legislation of other jurisdictions, and may in some cases clash with a non-US institution’s obligations to its clients under its own laws – can result in the US government ordering the US financial institution to terminate a relationship. Non-US banks, investment managers and trust companies will undoubtedly haveconcerns about providing confidential information to a US financial institution which can be disclosed to other US financial institutions in a way that it perhaps could not be under the provider’s domestic law. This concern is likely to be increased by the fact that the non-US party must waive the usual requirement for judicial assistance proceedings and/or appropriate forum arguments by appointing a US agent to accept service for proceedings relating to the production of such information. Further, the possibility that the IRS is among the `financial institutions` with which information can be shared is an unsettling thought for trustees.

`Long-arm` jurisdiction
As its acronymic name suggests, the Patriot Act was introduced in the immediate aftermath of 11th September, and some aspects of the legislation perhaps reflect the reason for its introduction, rather than the more general international anti-money-laundering impetus. The penalties for non-compliance with IMLAA are one such aspect of the Act. These provisions give the US courts a so-called `long-arm` jurisdiction whereby the US courts have the power to seize the US located assets of a non-US person. Amounts deposited by a non-US financial institution in an inter-bank account with a US financial institution are treated, for this purpose, as having been deposited in the US, and crucially, the funds seized in the inter-bank account need not have any relation to funds deposited in the non-US bank.

The main impact of the Patriot Act for non-US trustees is quite likely to be that trustees will have to be more active in observing the requirements of their existing money-laundering controls, and to ensure that (where those do not dovetail with the requirements of IMLAA) they are able to demonstrate that they meet the differing or additional requirements of IMLAA as well. This may, for example, mean it is prudent to have a trained senior employee who is conversant with, and responsible for compliance with, the requirements of IMLAA. Otherwise, it is less likely to impose a great administrative burden, since the trustees are unlikely to have to provide information and documentation, as a condition of doing business in the US, which they are not already required to have under their domestic law. However, the availability of that information to other financial institutions (including the IRS) is a risk factor that trustees cannot ignore. The beneficiaries do have a right to have information concerning the trust kept confidential by the trustees. As the recent publicity regarding Bank of Ireland has illustrated, disclosure of confidential information (particularly to taxation authorities) is something which trustees must be able to defend as necessary, rather than voluntary.

Given a range of different institutions with which to do business, and different types of available transaction, non-US trustees (and their investment managers) are likely now to have to weigh up the advantages to the trust of dealing with a US financial institution, as against the possibility that information about the trust and its beneficiaries (who may have no connection whatever with the USA) could thereby become available to the IRS and other authorities.

President Bush’s speech spelled out what the USA requires of its allies. In this legislation, the USA makes it clear that it expects every kind of business providing financial services to participate in the regulation of the global financial market, under the watchword of patriotism. As another great patriot, Elizabeth I, once said, `Good neighbours I have had, and I have met with bad; and in trust I have found treason`. Trustees are among those businesses around the world which are now expected, under the long reach of the US Patriot Act, to comply with the US’s requirements to monitor the activities of their clients so as to restrict the flow of the proceeds of crime.

Arabella Saker,
Allen & Overy

1 SI 2001/3641