Rationale - The Cornerstone of Client Relationships

The focus on AML and CFT in recent years, whilst trying to build in concepts such as corporate governance, ongoing monitoring and Client Due Diligence in the broadest sense has unfortunately been frequently dragged back to the very narrow issue of client identification and verification.  The standard questions such as 'Can I rely on X', 'If a passport expires do I need to get an updated one immediately', 'Is a mobile phone bill adequate to verify address' etc, whilst still valid, have lessened the attention on what some might argue are more important topics.  These include fundamental questions such as 'Why is this person using this product?', 'What is the economic substance behind the transactions we are being asked to carry out?'. These latter questions go to the heart of AML/CFT and are commonly fit under the umbrella of 'rationale'.

Unfortunately for the financial services industry, establishing a legitimate, lawful rationale for the use of a product, service or structure, especially in the context of offshore is often not a simple exercise. Coupled with a risk based approach to AML/CFT and the natural instinct is to seek refuge in a tick box approach and focus on client identification and verification issues which can be more easily substantiated with pieces of paper and forms. With more complex products, such as trust and company structures, determining the rationale is often more time consuming, requires more intrusive questions to be asked, a wider range of specialist advisers and requires more skill from the trustee and/or director.  Ultimately, this leads to increased cost and often client dissatisfaction if handled incorrectly, when faced with a barrage of questions and forms before a financial institution will accept a client.  In an environment where trusts are promoted as products rather than the fiduciary relationships which they actually are, this creates heightened AML/CFT risks.  Recognising the fact that rationale is the cornerstone to any relationship between a financial institution and a client is key.

But what is rationale? There is precious little to go on by way of research and even less by way of practical assistance to assist in arriving at a structured approach to the problem.  In an offshore context it appears that there are three core components to any rationale, being:

- Tax drivers;

- Economic drivers; and

- Structure drivers

There are other drivers which are subsets of economic drivers and structure drivers, being, for example, security and estate planning but the three mentioned above appear to be the key.  In broad terms the tax element of rationale should be independently supported by advice which is independent, properly informed, delivered by those with expertise in a proper format, current and which can be monitored. The client self-certifying tax advice, much like self-certifying mortgages should be a thing of the past. Economic drivers speak to the directors or trustees obligations to a structure - 'Can I justify the economic transactions on the basis of the evidence in front of me or are the transactions papered over with documentation which does not relate to economic reality'. The structure driver is often overlooked.  Whilst it is possible to have a legitimate tax and economic driver, the question must be asked 'Is the complexity of the financial structuring over and above the 'normal' structuring one would expect justifiable?'.

These drivers are often interlinked - the drug dealer trying to launder his profits will depend on hoodwinking a service provider to not kick the tyres of the economic and structure drivers through the use of front companies to launder the proceeds and complex trust structures to hide his interests.  The lure of substantial fees and a natural human tendency to want to believe what is being said can often lead the unwary and those without robust due diligence in to relationships which are subsequently costly both in terms of time and expense.

Rationalise the problems away if you want to, but it doesn't seem a rational approach.

Ed Shorrock is the Director of Forensic & Regulatory Services at BakerPlatt, an offshore law firm specialising in litigation, financial crime, regulatory and insolvency matters.  Ed has been heavily involved in a variety of regulatory, criminal and civil actions with a focus on the restraint, custody, realisation and confiscation of assets. Having qualified as a chartered accountant in 1998, Ed has managed a range of projects involving asset seizures under drug trafficking and criminal legislation and been involved in regulatory investigations and complex liquidations. He delivers on training programmes focusing on financial crime and compliance issues and is a regular speaker at conferences on these topics and how they affect offshore financial centres.

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