Detecting misuse of the financial system by PEPs: red flags and indicators for suspicion
Many uncertainties and misunderstandings surround politically exposed persons, or PEPs. Classifying a client as a PEP is not an aim in itself; rather, it forms part of the process that enables financial institutions and DNFBPs (Designated Non-Financial Businesses and Professions) to assess the higher risks related to PEPs. Of course, being a PEP does not in itself equate to being a criminal or suggest a link to abuse of the financial system. However, PEPs are higher-risk customers, because they have more opportunities than ordinary citizens to acquire assets through unlawful means like embezzlement and bribe-taking. Therefore financial institutions and DNFBPs must be familiar with the red flags and indicators that can be used to detect such abuse. After determining that a customer is a PEP, financial institutions and DNFBPs are responsible for conducting ongoing due diligence specifically tailored to the client’s PEP status.
The FATF has developed a list of red flags/indicators that can assist in the detection of misuse of the financial system by PEPs during a customer relationship. This list of indicators is useful in detecting those PEPs that abuse the financial system and does not intend to stigmatise all PEPs. How to interpret these indicators depends heavily on context. Often, matching one or two of these indicators simply indicates a statistically-raised risk of doing business with a particular customer, and several indicators may need to be met before serious suspicion is warranted. However, in some cases—again, depending on specific circumstances—matching just one or more of these indicators could lead directly to suspicion of illegal activity, such as money laundering.
PEPs Attempting to Shield Their Identity
PEPs are aware that their status as a PEP may facilitate the detection of any illicit behaviour. This means that PEPs may attempt to shield their identity to prevent detection. Examples of ways in which this is done are:
- Use of corporate vehicles (legal entities and legal arrangements) to obscure the beneficial owner
- Use of corporate vehicles without valid business reason
- Use of intermediaries when this does not match with normal business practices or when this seems to be used to shield identity of a PEP
- Use of family members or close associates as legal owner
PEPs and Their Behavior:
Specific behaviours and characteristics of PEPs may raise risk levels or cause suspicion:
- Use of corporate vehicles (legal entities and legal arrangements) to obscure (i) ownership, (ii) involved industries, or (iii) countries
- The PEP makes inquiries about the institution’s AML policy or PEP policy
- The PEP seems generally uncomfortable to provide information about source of wealth or source of funds
- The information that is provided by the PEP is inconsistent with other (publicly available) information, such as asset declarations and published official salaries
- The PEP is unable or reluctant to explain the reason for doing business in the country of the financial institution or DNFBP (Designated Non-Financial Businesses and Professions).
- The PEP provides inaccurate or incomplete information
- The PEP seeks to make use of the services of a financial institution or DNFBP that would normally not cater to foreign or high value clients
- Funds are repeatedly moved to and from countries to which the PEP does not seem to have ties with.
- The PEP is or has been denied entry to the country (visa denial)
- The PEP is from a country that prohibits or restricts its/certain citizens to hold accounts or own certain property in a foreign country
The PEP’s Position or Involvement in Business
The position that a PEP holds and the manner in which the PEP presents his or her position are important factors to be taken into account.
Possible red flags are:
- The PEP has substantial authority over or access to state assets and funds, policies and operations
- The PEP has control over regulatory approvals, including awarding licences and concessions
- The PEP has the formal or informal ability to control mechanisms established to prevent and detect ML/TF
- The PEP (actively) downplays importance of his/her public function, or the public function s/he is associated with
- The PEP does not reveal all positions (including those that are ex officio)
- The PEP has access to or control or influence over government or corporate accounts
- The PEP (partially) owns or controls financial institutions or DNFBPs, either privately or ex officio
- The PEP (partially) owns or controls the financial institution or DNFBP (either privately or ex officio) that is a counterpart or a correspondent in a transaction
- The PEP is a director or beneficial owner of a legal entity that is a client of a financial institution or a DNFBP
The Industry & Sector with Which the PEP is Involved:
A connection with a high risk industry may raise the risk of doing business with a PEP. Under the FATF’s Recommendation 1, competent authorities, financial institutions and DNFBPs are required for determining which types of clients may be higher risk. For this, financial institutions and DNFBPs will also be guided by national guidance or risk assessments. Which industries are considered at risk depends on the risk assessments and other industry safeguards that are in place and varies from country to country.
Examples of higher risk industries are:
- Arms trade and defence industry
- Banking and finance
- Businesses active in government procurement (i.e., those whose business is selling to government or state agencies)
- Construction and (large) infrastructure
- Development and other types of assistance
- Human health activities
- Mining and extraction
- Provision of public goods and utilities
Business Relationship & Transactions, Purpose of Business Relationship
Red flag and indicators can also relate to the specific business relationship or transaction:
- Multiple STRs have been submitted on a PEP
- (Consistent) use of rounded amounts, where this cannot be explained by the expected business
- Deposit or withdrawal of large amounts of cash from an account, use of bank cheques or other bearer instruments to make large payments; use of large amounts of cash in the business relationship
- Other financial institutions and DNFBPs have terminated the business relationship with the PEP
- Other financial institutions and DNFBPs have been subject to regulatory actions over doing business with the PEP
- Personal and business-related money flows are difficult to distinguish from each other
- Financial activity is inconsistent with legitimate or expected activity; funds are moved to or from an account or between financial institutions without a business rationale
- The account shows substantial activity after a dormant period,over a relatively short time, or shortly after commencing the business relationship
- The account shows substantial flow of cash or wire transfers into or out of the account
- Transactions between non-client corporate vehicles and the PEP’s accounts
- A PEP is unable or reluctant to provide details or credible explanations for establishing a business relationship, opening an account, or conducting transactions
- A PEP receives large international funds transfers to a gaming account; the PEP withdraws a small amount for gaming purposes and withdraws the balance by way of cheque
- A PEP uses third parties to exchange gaming chips for cash and vice versa with little or minimal gaming activity
- A PEP uses multiple bank accounts for no apparent commercial or other reason
Product, Service, Transaction or Delivery Channels
FATF recommendations also contain examples of product, industry, service, and transaction or delivery channel factors that suggest higher risk, irrespective of the type of customer.
These examples are:
- Private banking
- Anonymous transactions (including cash)
- Non-face-to-face business relationships or transactions
- Payments received from unknown or unassociated third parties
If these industries, products, services, or transaction or delivery channels are used by PEPs, then this adds an additional risk factor (depending on the nature of the PEP). In addition to the examples already listed in the FATF recommendations, there are other products, industries, services, and transaction or delivery channels that can become particularly vulnerable when used by PEPs.
Examples of these are:
- Businesses that cater mainly to (high value) foreign clients
- Trust and company service providers
- Wire transfers to and from a PEP account that cannot be economically explained or that lack relevant originator or beneficiary information
- Correspondent and concentration accounts
- Dealers in precious metals, precious stones, and other luxurious goods.
- Dealers in luxurious transport vehicles (such as cars, sports cars, ships, helicopters, and planes).
- High end real estate dealers
Country Specific Red Flags and Indicators
The FATF recommendations contain examples of higher risk countries and other geographic risk factors that are irrespective of the type of customer. Additionally, the following red flags and indicators relating to countries can be taken into account when doing business with a PEP:
- The foreign or domestic PEP is from a higher risk country
- Additional risks occur if a foreign or domestic PEP from a higher risk country would in his/her position have control or influence over decisions that would effectively address identified shortcomings in the AML/CFT system
- Foreign or domestic PEPs from countries identified by credible sources as having a high risk of corruption
- Foreign or domestic PEPs from countries that have not signed or ratified relevant anti-corruption conventions (or otherwise have not or have only insufficiently implemented these conventions), such as the UNCAC and the OECD Anti-Bribery Convention.
- Foreign or domestic PEPs from countries with mono-economies (economic dependency on one or a few export products), especially if export control or licensing measures have been put in place
Source: FATF Guidance on Politically Exposed Persons (2013)