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Lawyers are comfortable with their age-old role as outward risk advisors, giving sage counsel to clients on how to avoid or mitigate risks. But recent developments should give lawyers pause as to whether they are sufficiently inward looking at the reputational risk they face from their own clients—particularly those seeking to misuse legal services to launder illicit funds.
To be sure, although bound by ethical obligations not to counsel or assist clients to engage in criminal activity, U.S. lawyers have no legal duty to affirmatively report a client whose activities with the lawyer raise a suspicion of money laundering. As criticized in a December 2016 report of the Financial Action Task Force (FATF)—focused on the United States’s anti-money laundering (AML) and counter-terrorist financing measures—U.S. lawyers are not subject to an AML reporting requirement, despite frequently playing a key role in handling financial transactions on behalf of clients. Characterizing this as a notable gap in the U.S. AML infrastructure, the report juxtaposed this situation with many western countries that do have such reporting requirements, such as the UK and France.
Putting aside the debate over lawyers’ being subject to AML rules—a debate certain to evoke strong opinions—U.S. lawyers already have every reason to avoid such pitfalls on reputational grounds. A lawyer’s very livelihood, after all, hinges on reputation. The last thing an innocent individual attorney or firm wants is to be linked to something as unsavory as money laundering. That a basic internet search for the name of a particular lawyer or firm yields news hits for money laundering is obviously something to be avoided at all costs.
Attorneys, particularly those who handle transactions for clients or otherwise hold their money, should zealously protect their professional reputations by implementing prescriptive client due diligence measures. To that end, these lawyers should take a page from the playbook of financial institutions’ compliance programs. As detailed below, this begins at the inception of the attorney-client relationship with the collection of more granular information about the client than might be typical today. Such information should both factor into the decision to accept clients and drive occasional reviews of those relationships. Part and parcel of these processes, moreover, is the establishment of thorough and instructive written procedures.
Traditionally, a law firm’s decision to accept a client has turned on a familiar list of factors, from whether the firm has subject matter expertise matching the client’s needs or a potential conflict of interest from a past representation, to an assessment of the client’s ability or willingness to pay any resulting legal fees. But in this day and age, legal practitioners who handle financial transactions for their clients would be remiss not to delve deeper at the client-intake stage and gather more extensive diligence. The ABA, in fact, has stated that it would be “prudent” for lawyers to undertake customer due diligence, and has published guidance, as recently as 2014 (Formal Opinion 463), which provides a good starting point for an attorney considering these issues.
For an individual client, among other things, transactional lawyers should identify and reasonably verify the client’s identity, residence, nationality, and primary occupation. Using compliance parlance, lawyers should also determine a potential client’s “source of wealth”—i.e., how the client acquired his or her wealth—as well as the “source of funds” for any material deposits into a client trust account—i.e., from where such funds are coming. For an entity-client, proper due diligence should include understanding the entity’s business purpose, and some degree of vetting its directors, controllers, and beneficial owners for reputational concerns. Other salient points of research are the client’s litigation history, bankruptcy filings, political connections, and potential economic sanctions exposure. Just as importantly, if effectuating transactions on the client’s behalf, the attorney should establish expectations as to the nature and frequency of the client’s forthcoming transacactions on the client’s behalf, the attorney should establish expectations as to the nature and frequency of the client’s forthcoming transactions—in other words, determine a general baseline for client activity. To identify abnormal transactions, a lawyer or firm must first understand what kind of transactions will be normal. This is the essence of “know your customer” information.
This more rigorous approach should continue throughout the client relationship. Transactional lawyers should regularly check for material changes in a client’s profile, such as adverse media reporting on the client’s financial troubles or regulatory woes. The use of an automated due diligence product can quickly and inexpensively gather necessary intelligence, reducing the cost and administrative burden. Attorneys should also be on guard for any deviations from the anticipated baseline of client activity. Deviations that may serve as red flags will always be unique to the particular client in question, but could include a client engaging in a transaction inconsistent with its prior practices or industry type. Imagine that a regional dry cleaning chain—for which a law firm has done only labor and employment work for years—suddenly seeks help setting up a trust in the British Virgin Islands, or with a precious metals transaction in Eastern Europe. Or, perhaps, the client requests for the first time that the firm wire money out of the client trust account to a casino. Deviations of this magnitude should trigger additional scrutiny by the law firm of both the client and the relationship.
The foundation for these types of compliance-focused reviews are sound written procedures. Such guidance documents should clearly delineate the roles and responsibilities of those attorneys or support staff who handle the collection and updating of customer due diligence information, including periodically reviewing such information and identifying deviations from expected client activity. For larger law firms serving clients in farflung global locations, and thus carrying greater exposure to money laundering, such procedures should encompass a firmwide customer risk assessment to understand the reputational risks posed by its entire universe of customers.
In conclusion, although U.S. lawyers have no AML reporting obligation, as FATF recently highlighted, they have strong reason to proactively identify and avoid becoming associated with money laundering. A lawyer’s reputation is everything; no lawyer wants to be known for time immemorial as having unwittingly facilitated financial crime. The best advice for lawyers or firms seeking to shore up their reputations against potential client risk is to conduct regular due diligence. Only when equipped with timely and relevant due diligence can an attorney, within his or her own sound judgment, decide to narrow or curtail the transactions in which they engage on a client’s behalf. In the end, this is responsible self-regulation at its best.
Martin J. Foncello is an Associate Director based in Exiger’s New York office, where he focuses on the firm’s anti-money laundering and financial crime compliance efforts. Timothy C. Stone is a Director based in Exiger’s New York office, where he focuses on the firm’s anti-money laundering and financial crime compliance efforts. As part of his duties, Mr. Stone oversees the preparation and drafting of reports submitted to the Department of Justice as well as U.S. and international regulatory agencies.
