Tranche II is coming: Legal professionals as gatekeepers

The participation of legal professionals in the facilitation of money laundering and terrorist financing is a matter of growing concern. According to an updated recommendation from the Financial Action Task Force (‘FATF’), which sets the global standard in anti-money laundering (‘AML’) and counter-terrorist financing (‘CTF’), countries should require lawyers, notaries and other independent legal professionals – including sole practitioners, partners and employed professionals within firms, but excluding corporate legal officers and professionals working for government agencies – to identify, assess and mitigate their money laundering and terrorist financing risks. Legal professionals, states the recommendation, should document their assessments, keep them up to date, and put in place appropriate mechanisms to provide risk assessment information to competent authorities and self-regulatory bodies. This recommendation is in conflict with legal professional privilege, which plays an important role in the administration of justice. Nonetheless, many countries have introduced new or amended regulatory regimes that cover the legal sector, thus complying with FATF’s non-binding norms.

Australia’s AML/CTF regime is based on the international standards developed by FATF. Various pieces of legislation have been amended to align with the FATF recommendations. In 2006, the Australian government passed tranche I of legislation establishing a new AML/CTF regime covering the financial sector in order to meet Australia’s international obligations as a FATF member. Australia promised to apply the Anti-Money Laundering and Counter-Terrorist Financing Act 2006 (Cth) to legal professionals – tranche II – by 2008. In July 2010 – already well behind schedule – the government deferred discussion of tranche II until mid-2011 to allow time for recovery from the global financial crisis. Australia has still not fulfilled its promise. Australian legal professionals do not have comprehensive AML/CTF obligations – at least not yet.

In June 2021 – 15 years after tranche I – the Senate referred the adequacy and efficacy of Australia’s AML/CTF regime to the Legal and Constitutional Affairs References Committee for inquiry. The Committee received 41 submissions from peak industry bodies, government agencies and academic experts. In November 2021, it held public hearings. The Committee was due to publish its report by 2 December 2021, but on 18 October 2021 the date was extended to the last sitting day in March 2022.

The role of legal professionals in money laundering and terrorist financing

The involvement of legal professionals in money laundering and terrorism financing is a significant and increasing problem. The stringent AML/CTF controls imposed on financial institutions have made it more difficult to launder criminal proceeds, while also heightening the risk of detection. Laundering methods have, as a result, become more complex. For these reasons, criminals have become more reliant on lawyers to launder funds – sometimes because a legal professional is required to complete certain transactions, and sometimes to access specialised legal and notarial skills and services that could assist in laundering the proceeds of crime. Furthermore, there is a perception among money launderers that if they engage the services of lawyers, legal professional privilege or professional secrecy will serve to delay, hamper or effectively prevent criminal investigations or prosecutions against them.

Legal professionals may facilitate money laundering and terrorist financing in several ways. First, criminals may use legal practitioners to open bank accounts, to move cash, and to deposit, transfer or withdraw funds. This can obfuscate the connections between criminals and the proceeds of their crimes. Second, legal professionals may operate trust accounts that are used to deposit, hold and disburse funds on behalf of clients. Criminals may use legal professionals to facilitate the movement of illicit funds through these trust accounts. Third, criminals may use legal professionals to move illicit funds disguised as the proceeds of legitimate debt recovery action. Fourth, legal professionals may assist criminals in money laundering and terrorist financing through real estate transactions activities by establishing and maintaining domestic or foreign legal entity structures and accounts; facilitating or conducting financial transactions; receiving and transferring large amounts of cash; falsifying documents; establishing complex loans and other financial arrangements; and arranging the transfer of ownership of property to nominees or third parties. Fifth, some legal professionals are specialists in the establishment and administration of corporate structures, which allow criminals and terrorists to conceal and legitimise illicit funds and to obscure ownership through complex layers.

The global regime

Law enforcement and regulators have for many years been concerned about legal professionals acting as advisers and facilitators for money laundering and terrorist financing. In 2001, FATF included the legal profession among seven sectors identified as gatekeepers for money laundering and terrorist financing (the other six being casinos and other gambling businesses, dealers in real estate and high value items, company and trust service providers, notaries, accountants and auditors, and investment advisers). FATF issued revised recommendations in 2003, recommending for the first time that they apply to legal professionals when preparing for or carrying out transactions for a client. The recommendations have since been revised many times, most recently in October 2021, to ensure they remain up to date.

Of particular relevance for legal professionals is Recommendation 22, which focuses on customer due diligence (‘CDD’). This includes verifying the identity of clients and beneficial owners where relevant; understanding the nature and purpose of the business relationship, including the source of funds; and maintaining records of CDD material. Also relevant is Recommendation 23, which deals with other measures.

Recommendation 22 provides that FATF CDD and record-keeping requirements apply to legal professionals acting for their clients in specified activities, including buying and selling real estate; managing client money, securities or other assets; managing bank, savings or securities accounts; organising contributions for the creation, operation or management of companies; creating, operating or managing legal persons or arrangements; and buying and selling business entities. Under Recommendation 23, legal professionals must report suspicious transactions when, on behalf of a client, they engage in a financial transaction in relation to the activities described above (legal professionals acting as independent legal professionals are not required to report suspicious transactions – but they do need to perform CDD – if the relevant information was obtained in circumstances where they are subject to professional secrecy or legal professional privilege).

Impediments to Australia regulating legal professionals

To comply with their duty to the court and the administration of justice, legal professionals in Australia must not engage – in the course of practice or otherwise – in conduct which demonstrates they are not a fit and proper person to practise law, or which is likely to a material degree to be prejudicial to, or diminish public confidence in, the administration of justice, or bring the profession into disrepute (Legal Profession Uniform Law Australian Solicitors’ Conduct Rules 2015, r 5.1). A breach of the regulatory rules can constitute unsatisfactory professional conduct or professional misconduct and may give rise to disciplinary action (r 2.3). The duty to the court and to the administration of justice is paramount and prevails to the extent of inconsistency with any other duty (r 3.1), even if the client gives instructions to the contrary (as Mason CJ observed in Giannarelli v Wraith (1988) 165 CLR 543, 556).

Money laundering and terrorism are criminalised under Division 400 of the Commonwealth Criminal Code. Legal professionals who inadvertently allow money laundering to occur by failing to make proper enquiries can be prosecuted. The Anti-Money Laundering and Counter-Terrorism Financing Act 2006 (Cth) (‘AML/CTF Act’) stipulates what a reporting entity must do if it reasonably suspects that a matter falls within the wide circumstances outlined in the Act (AML/CTF Act, s 41). A legal professional is not a ‘reporting entity’.

Australia’s compliance with the global regime

FATF’s first mutual evaluation report (‘MER’) on Australia’s AML/CTF policies was in 2005. The MER found that while Australia had indeed legislated according to the standards, there were deficiencies that amounted to a failure to comply with all accepted standards. Australia was rated non-compliant with Recommendation 22. In a subsequent evaluation, FATF noted that some progress had been made through the adoption, in 2006 and 2007 respectively, of the AML/CTF Act and the AML/CTF Rules. However, Australia deemed that only casinos and bullion dealers were subject to AML/CTF obligations under the standard. The AML/CTF Act also provides exemptions for legal professionals, even though Australia’s national threat assessment identified those two sectors as high money-laundering threats.

The AML/CTF Act applies to a ‘reporting entity’, which is a person who provides a designated service (ss 5, 6) as well as legal professionals when they provide designated services. However, the Act does not affect the law relating to legal professional privilege. Legal professionals are obliged under the Financial Transactions Reports Act 1988 (Cth) to report when they receive more than $10,000 in cash (s 15), but these obligations are not specific to them (it is also important to note the obligations under that Act do not apply to transactions to which the AML/CTF Act applies). As a result, in 2015, Australia was again rated non-compliant with Recommendation 22. And, because it does not subject legal professionals to AML/CTF requirements on suspicious transaction reporting, Australia was also found non-compliant with Recommendation 23.

The experience of other countries with regulating legal professionals

Many countries comply with the international standard for legal professionals. This is noteworthy, considering the tension with legal professional privilege. For example, in Hong Kong, there was no statutory obligation for CDD and record-keeping for legal professionals. Therefore, in 2008, FATF rated Hong Kong non-compliant with the global standard. Hong Kong then took progressive steps to comply. Its Anti-Money Laundering and Counter-Terrorist Financing Ordinance was amended by the Counter-Terrorist Financing (Financial Institutions) (Amendment) Ordinance 2018, including to apply statutory CDD and record-keeping requirements to legal professionals when they conduct specified transactions. Singapore, in its third MER, was rated non-compliant with Recommendation 22. FATF noted that the AML/CTF measures for legal professionals were not consistent with the FATF standards and there were deficiencies in the CDD measures for legal professionals. Singapore took steps to enhance its AML/CTF requirements with regard to the legal profession. In 2016, it was rated partly compliant. In 2007, the United Kingdom was rated partially compliant with the same requirements. By 2018, it has improved to achieve a rating of largely compliant. Israel was rated non-compliant with the recommendations in 2008, as it imposed no reporting obligations on legal professionals. In 2014, Israel amended the Prohibition on Money Laundering Law (5760-2000) and, in 2018, FATF found that Israel met the CDD requirements for legal professionals. In 2009, New Zealand was rated non-compliant due to deficiencies regarding CDD thresholds and insufficient coverage of the legal profession. New Zealand then introduced the Anti-Money Laundering and Countering Financing of Terrorism Act 2009 (NZ), which was substantially amended in 2017 after another FATF review, to expand its coverage in the legal sector. Today, lawyers in New Zealand are required to conduct CDD when establishing a business relationship with a new customer and where a customer seeks to conduct an occasional transaction or activity.

Costs and benefits of extending AML/CTF obligations to the legal profession

Trend of positive compliance

Australia has been a member of FATF since 1990 and has demonstrated an ongoing amenability to implementing the international standard. Where the 2005 MER found the implementation to be insufficient, FATF recommended that Australia enact new legislation or amend existing laws. Australia did so. Many of the deficiencies were addressed by the AML/CTF Act, one of the objects of which is to address matters of international concern, specifically including the FATF recommendations (s 3(3)(a)). The 2015 MER found that, although Australia was not yet fully compliant, it had indeed improved its compliance with many of the deficiencies that had been identified. The same trend of positive compliance was found in the last follow-up report on Australia’s AML/CTF regime.

Risk to financial reputation

FATF has announced various measures to be taken against countries that do not remove detrimental rules and practices. Pending the adoption of appropriate laws and policies, FATF demands that countries scrupulously apply Recommendation 19, which holds that ‘[f]inancial institutions should be required to apply enhanced due diligence measures to business relationships and transactions with natural and legal persons, and financial institutions, from countries for which this is called for by FATF’. These enhanced due diligence measures should be proportionate to the risk. Countries should, for example:

• refuse to allow the establishment of subsidiaries, branches or representative offices of financial institutions from (or in) the country concerned, or otherwise take into account the fact that the relevant financial institution is from a country that does not have adequate AML/CTF systems;
• limit business relationships or financial transactions with the country, or with persons within it;
• prohibit financial institutions from relying on third parties located in the country concerned to conduct elements of the CDD process; and
• require increased supervisory examination and/or external audit requirements for branches and subsidiaries of financial institutions based in the country concerned.

Any country that is subjected to such countermeasures suffers a blow to its international reputation. All banking operations within that country could then be scrutinised for suspicious activity. While this does not, strictly speaking, amount to sanctions, it creates substantial difficulties for the country in question.

It is not suggested that FATF will apply such countermeasures to Australia for failing to comply with Recommendations 22 and 23. There also seems to be a low risk that FATF will find Australia to be among the ‘high-risk jurisdictions’. This would occur only as a result of specific money-laundering, terrorist financing, or proliferation financing risks or threats. Therefore, the main reason for Australia to expand its regime to apply to legal professionals is simply to provide relevant information that can assist with mitigating the risks of money laundering and terrorist financing. This would promote public confidence in the Australian financial system and fulfil Australia’s domestic and international AML/CTF responsibilities.

Conclusion

It is strongly in the interests of Australia to act now and amend the AML/CTF Act to cover legal professionals. If the government waits until pressure from FATF (such as deadlines for compliance and, if necessary, a finding of non-compliance) forces it to comply, this may tarnish Australia’s international reputation and adversely affect the legitimacy and effectiveness of its AML/CTF regime. Given Australia’s record of compliance with the FATF regime, and the need to mitigate AML/CTF risks, it is clearly a question of when – not if – Australian will extend its AML/CTF obligations to legal professionals. It is suggested that sooner is better than later.

Dr Doron Goldbarsht is a Senior Lecturer at Macquarie Law School.