Anti-Money Laundering in the Legal Sector: Overview, 2023 Reflections and Opportunities for 2024

Disclaimer: This article is written by Luke McLaughlin. Any views and opinions expressed in this article are those of the writers and do not necessarily reflect the views or positions of the team editor nor any entities they represent.

The legal sector has long been a high-risk sector for money laundering. The wide range of professional services provided by law firms make them attractive entities for perpetrators to launder illicitly-obtained funds.

The SRA’s (Solicitors Regulation Authority) 2023 review into anti-money laundering (AML) measures within law firms documents an alarming statistic: less than a third of law firms inspected were fully compliant with existing AML policies. In addition, 51% were found to be partially compliant, with a further 19% being non-compliant.

Combatting money laundering is a global priority, and this has become more urgent as financial crime becomes increasingly sophisticated. Law firms play an active role in safeguarding against financial crime by identifying potential risks early on, which the SRA has emphasised begins with actively implementing robust measures within their operations. Despite this, compliance with AML regulations is an area that has traditionally been overlooked.

As we progress into 2024, it is worth reflecting on the current measures employed by law firms to safeguard against the risks posed by money laundering, and the faults in these measures that result in their ineffective application. As law firms begin to embrace the opportunities presented by AI (artificial intelligence), this has significantly changed the way AML processes are performed – it will be interesting to see how this will develop in the future.

Overview of money laundering  

Money laundering is a practice employed by criminals to conceal large sums of money generated from illicit activities. The process consists of three distinct stages, conducted sequentially:

1. Placement – placing illicit funds into the banking system by way of converting them from physical into digital currency.
2. Layering – the general term that refers to ‘cleaning’, whereby the money crosses a complex series of (often international) transactions, to cover the true monetary origins and confuse investigating authorities.
3. Integration – illicit funds are reintroduced into the economy through seemingly legitimate transactions; thus, the money has essentially been “cleaned”.

For perpetrators, the advantage of this criminal activity is that it thwarts the potential for law enforcement and financial regulatory bodies to trace and seize laundered funds, and the potential for proceedings to be issued against the perpetrators themselves.

‘Cleaning’ poses a significant risk to law firms, who are vulnerable targets to the attempts of criminals to lauder illicitly-obtained funds. When approaching firms, perpetrators will disguise themselves as ordinary clients by employing their legal services, before depositing a specified sum. Consequentially, lawyers or other professionals may inadvertently become accessories to money laundering.

Legislative protections against money laundering

Under UK legislation, law firms, like other businesses, must comply with AML regulations. Failure to do so (intentionally or not) can result in wide-ranging financial penalties, ranging from automatic fixed fines to the revocation of law firms’ practicing certificates.

The money laundering protocols implemented in the UK derive from the Fifth Money Laundering Directive, which made amendments to the provisions of the Fourth Money Laundering Directive. The Fourth directive established a principal legal authority under which money laundering can be prosecuted under the UK: the Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017 (MLR 2017).

Other primary legislation relevant to money laundering include the Terrorism Act 2000, which contains offences relating to terrorist financing. In addition, the Sanctions and Anti-Money Laundering Act 2018 (SALMA) is intended to ensure the UK maintains its existing regulations and that of international requirements created by the Financial Action Task Force – the intergovernmental money laundering and terrorist financing watchdog.

The risk of unintentional involvement in money laundering

Lawyers have a legal and ethical responsibility not to support or facilitate financial crime of any sort. However, lawyers’ association with money laundering is mostly unintentional. A prevalent reason for this is the variety of methods exploited by criminals to launder their funds.

A common medium through which money laundering takes place is through the creation of shell companies. Existing as companies or trusts, these form an essential ingredient in the ‘layering’ stage by allowing for unlimited financial transactions. The advantage of exploiting shell companies to launder illicit funds for the perpetrators is the unrestricted number of subsidiary shell companies that can exist under any one chain. Solicitors may inadvertently fulfil an integral role in this process by setting up shell companies for their clients, in turn adding a degree of legitimacy to perpetrators’ dealings, limiting the risk of exposure to the perpetrators.

The property market has historically been a source of financial crime in the UK. Money laundering in this sector is wide-ranging, spanning from the purchasing, leasing or selling of property. Criminals may purchase property assets using cash generated from crime proceeds, before leasing or selling assets to produce a seemingly legitimate source of funds. At each stage, the services of specialist property solicitors are often required, hence explaining their risk of involvement in money laundering.

Best AML practices for law firms

Law firms are legally required to undertake identity verification checks on their clients to satisfy regulatory requirements. The SRA’s review found that while there was a high level of compliance in this area, identification and verification documents were still absent in 14% of files. The review also found that in some cases, ID checking was conducted on only one out of several individuals involved in a financial transaction, and that appropriate information was not being obtained on the main beneficiaries of transactions.

Identity verification forms part of a wider process known as customer due diligence (CDD). Its purpose is to ensure that the information provided by clients is accurate and genuine. As well as ID checking, CDD encompasses a variety of other measure, including verifying whether a client is a politically exposed person (PEP) or associated with any high-risk third countries. Law firms are also required to investigate clients’ source of wealth (how clients accumulate their wealth) and funds (the source of the money used for the legal service transaction). This risk-based mitigates the exposure of law firms to financial crime.

Despite this, the SRA has specified that insufficient checks on prospective, new or existing clients’ source of funds is a prevalent cause of money laundering, and is largely a result of a lack of robust measures and ineffective internal procedures.

On a more practical level, limited resources possessed by some, particularly smaller law firms, presents an additional challenge for conforming with compliance. This includes human resources, training, IT systems and monetary resources, but the list is not definitive. While compliance rules apply to all firms, irrespective of size and earnings, those that cannot afford the cost of continuous compliance are more prone to money-laundering.

Proper up-to-date employee training on AML regulation is an effective method to identify money laundering risks early on. Regulation 24 of MLR 2017 requires firms to take appropriate measures to ensure that relevant employees (those in an appropriate position) are made aware of money laundering legislation, and regularly provided with training on identifying and reporting transactions potentially linked to financial crime.

Lastly, it must be acknowledged that law firms should employ a strong ethical culture that emphasises best practices to guarantee AML compliance. This is an essential ingredient that underpins that the willingness and commitment of law firms to adopt effective strategies to safeguard against financial crime.

Can AI present an opportunity for 2024?

The processes involved in AML compliance means this can be time-consuming, expensive, and often results in errors. These effects have been attributed to over-reliance on manual checks and procedures.

It goes without saying that firms have been alive to the practical advantage offered by developments in AI, including novel systems transforming manual AML tasks into efficient AI automated processes. This includes conducting client risk assessments and monitoring bank transfers.

Software created using AI mechanisms allows for early money laundering detection via specialised algorithms, which process and analyse large volumes of data, raising cautions early on. An additional advantage is their ability to pre-fill reports with essential data and standardise language and terminology. This in turn reduces time spent by employees in dealing with potentially suspicious activities, instead allowing for immediate action.

Strong predictions from numerous reports highlight that over the next 12 months, we can expect to see an upsurge in the number of law firms integrating AI and machine learning into their AML systems. The role played by these technologies is becoming paramount in improving the overall client onboarding system and ongoing monitoring throughout client relationships.

Conclusion

This year, law firms are likely to find themselves under mounting pressure to meet their AML obligations, due to more intense monitoring and regulation from the SRA.

As professional regulators focus their attention on closing loopholes and legislating for more effective detection and prevention measures, money laundering remains in a constant state of evolutionary flux, further complicating this process.

This illustrates the importance of the role played by law firms in safeguarding their day-to-day operations, which starts with ensuring that proper and effective AML procedures are implemented and given effect.