The Pandora Papers – Lessons in Compliance

“The Panama Papers on steroids” is how the International Consortium of Investigative Journalists have described their latest leak of confidential financial documents. The leak of the “Pandora Papers” includes documents relating to 35 current and former world leaders, more than 330 political and public figures, and covers 91 countries and territories. They provide an insight into the activities of those who seek, for whatever purpose, to hide their assets in offshore companies.

The fallout of the Pandora Papers is only just beginning, and broadly speaking they have not raised the concern of illegal activity at this point. But it is further proof of the risks companies and individuals face for failing to comply with Anti-Money Laundering (AML) and Countering Terrorist Financing (CTF) standards. Even at this early stage, three lessons for financial institutions stand out:

 

  1. Understand PEP risk in the financial system

The definition of a Politically Exposed Person (PEP) has been widely publicised in financial compliance circles. So has the regulatory obligation to screen for these individuals and, once detected, to apply enhanced due diligence (EDD). The Pandora Papers remind us why this is necessary. Funds derived from the proceeds of corruption, embezzlement, and the abuse of those in a prominent position have severe consequences on the countries those PEPs are linked to, and by allowing these funds to be integrated into the global financial system, place the financial system itself at grave risk.

The Pandora Papers has provided numerous examples of the PEPs from countries regarded as having low risk of bribery and corruption engaging in financial activity that could be described as ‘unusual’. Firms should decide whether it is appropriate to apply a risk-based approach to domestic or low-risk PEPs or instead examine the likelihood of whether these individuals would have access to, or the capability of, using offshore havens to funnel and hide assets out of reach.

 

  1. Always review proof of the source of funds

The Pandora Papers have highlighted the importance of reviewing proof of source of funds. Financial institutions, per the EU’s 4th and 5th Money Laundering Directives, must apply EDD to PEPs once they are detected. 5MLD expressly states that EDD must include requests for information on the source of funds and wealth of a customer and/or beneficial owner. Where such information is hidden in an offshore tax haven, this poses a challenge to compliance professionals in evidencing a reasonable explanation for the activity of a customer.

A specific example seen in the Pandora Papers is the practice of buying a company with an underlying asset, typically a property, for the sole purpose of attaining that property then shutting down the company. Evidence of owning a company has been standard fare in terms of source of wealth checks, however it may now be required that the compliance officer examines the exact make-up of the business, its activities, its assets, and provenance to ensure that all activity relating to it is reasonable.

 

  1. Beware privacy havens in the US

A standout feature of the Pandora Papers is the prevalence of American actors. In particular, South Dakota recurs as a base for foundations and trusts. In terms of privacy havens in the United States, Delaware has ruled the roost but it appears  South Dakota could challenge its supremacy. Whilst legislative efforts there are ongoing, financial arrangements concerning trusts can provide total privacy. Such efforts have led to Delaware becoming the largest holder of trusts of any US state.

Again, criminal activity within these trusts is not apparent. However, for the compliance officer, the above typology should now be added to a review of customers to determine whether further information is required in relation to their activity.

 

The Pandora effect and the future of AML/CTF compliance

The Pandora Papers revelations serve to publicise the very real impact poor AML and CTF compliance controls can have on our financial system and the rule-of-law. Regulation is always changing to ensure that the behaviour of bad-faith actors is minimised and controlled. This is required of all those within the financial sector and, in particular, those working in compliance.

Firms must also consider the potential for severe reputational risk in dealing with this kind of activity. The prevalence of leaked financial information is increasing, exposing more individuals to unwanted scrutiny, and so it would be advisable to keep this mind. The Pandora Papers may act as a for impetus for regulators across all eminent financial centres to continue applying more scrutiny to the AML/CTF controls of firms.

The takeaway for financial institutions is that a strong culture of compliance will help to manage the challenges posed by the Pandora Papers and ensure that those who exhibit the kinds of behaviour and typologies outlined within this blog are subject to the appropriate level of scrutiny.

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