Identifying ‘Close Associates’ of PEPs

The treatment of Politically Exposed Persons (PEPs) by financial institutions has been high on the regulatory agenda for several years. With the implementation of the Fourth EU Money Laundering Directive, it will remain an issue because the definition extends to both domestic and foreign individuals.

Financial institutions invest significant time and effort in identifying PEPs, and a large range of commercial databases provide useful information in this respect. PEPs seeking to do business with financial institutions therefore can and should expect to be subject to enhanced scrutiny.

For the majority of these PEP customers, who are not involved in financial crime, this scrutiny should not present issues. However, PEPs are set apart as a category of customer specifically because a minority do abuse their positions of authority and trust, often for personal gain, and frequently at a high cost to local communities. They have an interest in distancing their physical assets from their original source of wealth. This being the case, any PEP with a basic understanding of international financial systems will recognise that linking their name to an account risks triggering alerts on those PEP screening tools that are widely used. They may seek to hide their interest behind corporate or trust vehicles, and hope that the prospective financial institution will not probe too deeply in their attempts to identify the ultimate beneficial owner (UBO). However, regulators have also taken steps to tighten up the requirements to properly identify UBOs, and forthcoming registers of beneficial ownership in the European Union will increase levels of transparency.

In our experience, assuming they want to make use of mainstream financial services, sophisticated corrupt PEPs may seek to engage the services of one or more close associates (or possibly more distant family members with dissimilar names), to disguise their own interests. Using trusted close associates, many of whom do not appear on commercial databases, reduces the likelihood that financial institutions will recognise the PEP association, and institute enhanced due diligence.

The Financial Action Task Force (FATF) provides examples of close associates including the following types of relationships:

  • (known) (sexual) partners outside the family unit (e.g. girlfriends, boyfriends, mistresses);
  • prominent members of the same political party, civil organisation, labour or employee union as the PEP;
  • business partners or associates, especially those that share (beneficial) ownership of legal entities with the PEP, or who are otherwise connected (e.g. through joint membership of a company board).

The FATF also adds: “In the case of personal relationships, the social, economic and cultural context may also play a role in determining how close those relationships generally are.”

Given this very broad definition, identifying close associates can become a particularly onerous task, particularly in countries where little reliable public information exists, or press and media is controlled by influential PEPs or their associates.

Many financial institutions automatically conduct enhanced due diligence on customers from higher risk jurisdictions, irrespective of initial PEP screening results. This is an important step, provided the type of enhanced due diligence undertaken addresses the range of potential PEP relationships set out above.

To adequately understand the existence of close associates of a PEP, it is worth considering the following steps:

  • Make adequate up-front requests of the client to confirm the identity of the account holders, controllers and UBOs, taking into account that, whilst the customer can be the best source of information, this does not hold true for those fronting for corrupt officials. It is important to seek independent corroboration and to challenge prospective customer representations as and when it is deemed necessary. Incomplete, superficial or evasive answers may indicate a cause for concern.
  • Establish that the customer’s source of wealth and source of funds matches their overall profile. The aim is to reconcile the value and stated source of the funds deposited with the background and track record of the potential customer. If not, this may indicate the existence of other, hidden individuals.
  • Occasionally, a close associate acting on behalf of a PEP may themselves be a wealthy individual with a profile that stands up to some degree of scrutiny – indeed an element of their earnings may well be legitimate. In these cases, it is particularly important to understand whether their source of wealth could realistically have arisen from legitimate business affairs or whether – as is sometimes the case – that wealth was originally generated because of a PEP association, through which the PEP indirectly benefited as a form of hidden partner. (Note that in our experience, this scenario can also apply to organised crime groups who use ‘legitimate’ high net worth individuals as a front).
  • Corrupt officials may entrust their affairs to an individual or small number of individuals in whom they have a high degree of trust. Such relationships are generally established over many years and the same individuals may be employed repeatedly in trusted positions such as account holders or as company directors. Being a member of the same organisation could be relevant, although a corrupt PEP may avoid links to readily-identifiable corporate entities.
  • A common educational background (e.g. attending the same school or university), or common religious ties – including members of the same tribes, castes or sects – can give rise to strong informal links. It is important to understand the dynamics of informal associations to properly understand why and how individuals can be associated. These informal associations can sometimes explain why a corrupt official is willing to entrust an apparently unconnected individual.

As scrutiny of PEPs increases, we believe that corrupt individuals are more likely to use close associates – and these links can be complex and varied, demanding more than cursory due diligence. The illustration below (Figure 1) provides an example of how close associates may interact with corrupt PEPs.