For those not familiar with the U.S. Bank Secrecy Act, hearing the term Politically Exposed Person for the first time might conjure up recent headlines of a U.S. Congressman being seduced by a foreign agent or a former U.S. Senator working for a Chinese surveillance company. However, a Politically Exposed Person or PEP does not include U.S. public officials and can include completely ordinary people who happen to work in foreign governments.
What is a PEP?
A PEP can be an individual or an organization and generally includes the following:
Senior official in the executive, legislative, administrative, military, or judicial branches of a foreign government (whether elected or not).
Senior official of a major foreign political party.
Senior executive of a foreign government owned business.
A corporation, business, or other entity that has been formed by, or for the benefit of, any such individual.
An immediate family member of such individual (including spouses, parents, siblings, children, and a spouse’s parents and siblings).
A person who is widely and publicly known (or is actually known by your financial institution) to be a close associate of such individual.
The fact that an individual is no longer a foreign government official does not automatically remove her from the PEP classification.
Why Should I Care If My Client Is a PEP?
There is a link between political corruption and the weakening of democracy and political rights. Those in government wield power that can adversely impact citizens’ lives. The U.S. financial system is attractive for a variety of reasons to foreigners including PEPs. The U.S. financial regulatory authorities do not want the U.S. financial system destabilized by the presence of corrupt funds and clients who engage in illicit acts such as terrorism, human rights abuses, extortion, corruption, human trafficking, narcotics trafficking, bribery, money laundering, and related crimes.
Moreover, you do not want your financial institution associated with the discovery your client has obtained his funds through corruption or other illicit activities. To avoid penalties and reputational damage, it is imperative to implement effective risk management policies and procedures.
While this post is targeted at PEP risk management, U.S. corruption should not be ignored. Transparency International’s most recent Corruption Perceptions Index ranked the U.S. only 23rd out of 198 jurisdictions reviewed. It seems like every month another U.S. publication issues a corruption ranking of the U.S. states. Just this week, the website bestlifeonline.com released its own corruption ranking of the 50 U.S. states highlighting state by state corruption issues. The key is to follow effective Know Your Customer (KYC) processes on all clients.
Risk Management Practices
In August 2020, the Federal Reserve Board, the Federal Deposit Insurance Corporation (FDIC), the Financial Crimes Enforcement Network (FinCEN), the National Credit Union Administration, and the Office of the Comptroller of the Currency (OCC) issued a joint statement clarifying a financial institution’s BSA due diligence requirements for clients who may be considered PEPs should be commensurate with the risks posed by the PEP relationship.
The joint statement explained there is no regulatory requirement in the Customer Due Diligence (CDD) rule or supervisory expectation for financial institutions to have specific due diligence steps for PEPs. The regulatory authorities emphasized the use of a risk-based approach which enables banks to:
Understand the nature and purpose of customer relationships for the purpose of developing a customer risk profile; and
Conduct ongoing monitoring to identify and report suspicious transactions and, on a risk basis, to maintain and update customer information.
Such an approach includes maintaining written policies and procedures “reasonably designed to identify and verify beneficial owners of legal entity customers.”
Many financial institutions have a policy to determine at onboarding whether a client is a PEP. I find this approach useful as part of developing the customer risk profile. The fact the client is a PEP is not a deal breaker. It is one factor in assessing the risk associated with the client. Other relevant factors are:
Type of products and services to be used.
Expected volume and nature of transactions.
Geographies associated with the customer’s domicile and anticipated activity. (Find the rank of these jurisdictions on Transparency International’s Corruption Perception Index).
Length of time since the PEP was in government employment.
Amount of political influence the PEP held/holds.
PEP’s access to significant government assets or funds.
PEP’s official government responsibilities and apparent influence.
If your standard onboarding process results in the conclusion the PEP may pose a higher than accepted risk, it may be useful to engage in Enhanced Due Diligence (EDD) before turning the potential client away.
What Is Enhanced Due Diligence?
As the name suggests, EDD involves a higher level of scrutiny to guard against onboarding a client engaged in illicit activities. Your EDD can include a review of such additional information as:
Detailed written explanation of the role the PEP played with respect to the government, political party, government-controlled entity or other organization that caused him to be classified as a PEP.
Purpose of the account.
Source of funds and wealth.
Individuals with ownership or control over the account, such as beneficial owners, signatories, or guarantors.
Current occupation or type of business (of customer or other individuals with ownership or control over the account).
Financial statements.
Banking references.
The bottom line is the onboarding of a client is a fact-based assessment of the risk associated with your financial institution providing that particular client financial services. To ensure your team is able to exercise effective judgement in analyzing the facts, you must empower them with clearly written policies and procedures, periodic training, and a management contact matrix outlining the appropriate people who can answer the employee’s questions.
For assistance, please contact me via my contact page or at elizabeth@elizabethmcmorrowlaw.com.
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