Ferreting Out Kleptocrats’ Buddies: The Ukrainian Solution Part I

Every kleptocrat needs a buddy.  Someone to serve as an intermediary between the corrupt official and the bankers, real estate agents, and others in London, New York, and elsewhere happy to profit from handling dirty money.  A kleptocrat can’t just walk into a bank or real estate office in the United Kingdom, the United States, or other preferred offshore haven with a pile of money to invest.  As a public official, the antimoney laundering (AML) laws would oblige the banker or real estate agent to ask searching questions about how the kleptocrat came into the money and the law would likely also require them to report the transaction or proposed transaction to the authorities.  A buddy, particularly one who has remained out of the public limelight, is the perfect solution.  So long as they don’t know a potential customer is close to a senior public official, the banker or real estate agent meets their obligation to ascertain the source of the would-be customer’s funds by asking a few pro forma questions.

To plug the buddy loophole, the AML laws require banks and real estate agents to determine if anyone wanting to do business with them is a “close associate” of a senior official — a “politically exposed person” in the inelegant term coined by AML specialists.  If a potential customer is a PEP, the bank or real estate agent must ask the same searching questions about the origins of the individual’s funds that they must ask of a senior official.  Recognizing that bankers and real estate agents can’t be expected to know whether a foreign national wanting to do business with them is a close associate of a senior official in 190 plus countries, AML regulators allow them to rely on one of the several PEP lists peddled by commercial firms.  So long as the potential customer doesn’t appear on whatever PEP list they use, the banker or real estate agent need not conduct a detailed inquiry (“enhanced due diligence” in AML-speak) into where their money came from.

So how well do these commercial PEP lists do at identifying kleptocrats’ buddies? 

The short answer: poorly. In its 2010 report Keeping Foreign Corruption Out, the U.S. Senate’s Permanent Subcommittee on Investigations found that several lists failed to include even the wife of Gabon’s president or the spouse of Nigeria’s recent vice president — let alone close associates of these two suspected kleptocrats.  In 2011 the U.K. Financial Services Authority reported that an individual “with close links” to the political and military elite of a highly corrupt oil-rich state was not on any of the PEP lists used by the bank holding his money.  Research presented to a World Bank meeting in 2011 identified notable omissions in two leading PEP lists, finding for example that none of the senior advisers to the leaders of the Philippines armed forces appeared on either list.

It is no secret why the commercial PEP lists come up so short.  As a major list-vendor acknowledged in a 2008 paper, “there are no magical sources or websites that list [all PEPs].”  Instead, each seller pieces together its list of who is whose buddy by scouring national newspapers, web sites, and other widely available public sources using sophisticated computer search engines.  But there are obvious limitations to this method; not every close associate of a senior political leaders is named in a newspaper story or identified in a web post.  As the Financial Action Task Force, the body that sets international AML standards, explained in a 2013 report, the result is that commercial lists are neither “comprehensive” nor “reliable.”

The obvious solution is to supplement the commercial providers’ web searches with the knowledge that local observers of a country’s political scene possess.  But until the work of the Anticorruption Action Center, a Ukrainian NGO, neither the FATF nor national AML regulators nor commercial providers had made any effort to do so. Representatives of the Center will present their solution  to the “kleptocrat-buddy” problem on October 12 at the Civil Society Forum Policy Forum organized in conjunction with the annual meeting of the World Bank and the International Monetary Fund in Washington, D.C.

Those wanting to attend the session or dial-in should contact the organizers on antac.ua@gmail.com by October 8.  For those unable to attend or dial in, the presentation will appear on this space October 18.

10 thoughts on “Ferreting Out Kleptocrats’ Buddies: The Ukrainian Solution Part I

  1. I have a possibly naive question: Is part of the problem here that financial institutions don’t have a particularly strong incentive to use whichever PEP-list service has the best and most comprehensive list, which in turn means that the don’t have a particularly strong incentive to do a great job? Am I correct that right now, so long as a bank can show it hired a reputable service and the kleptocrat’s buddy wasn’t on it, the bank has insulated itself (entirely or partially) from liability?

    If that’s the case, then might a solution be to adopt some form of strict liability (at least civil liability) for handling dirty money, with very large penalties? If that were the case, I would imagine banks would have a much stronger incentive to get the most comprehensive PEP lists they can, which in turn would give the services compiling those lists much stronger incentives (and the associated ability to charge much higher prices).

    But I don’t really know the AML regime very well, so perhaps I’m missing something important?

    • You have it exactly right. When a bank or other entity covered by the AML laws (coverage differing country-to-country) spyies a potential customer walking in the door, the last thing they want to do is ask him or her a bunch of intrusive questions about where the money is coming from. Bad for business. So they have no incentive to check the would-be customer’s name against a lengthy PEP list. Their hope is the name won’t appear on the list they have and they can thus ask their pro forma questions and then take the $$s. My speculation is that regulators don’t want to fight for better PEP lists as they have enough fights on their hands as it is.

      From an enforcement perspective, imposing strict liability is a great idea. From the financial institutions perspective I suspect not. To say the least. I could imagine a PEP constructing a complex story about the origins of the money that smaller institutions in particular would find it next to impossible to verify. To avoid the risk, they might decline to do business with unknown foreign nationals. That would privilege larger insitutions over smaller ones. One drawback. Have to think if there are others. And then of course there is the political feasibility of imposing additional costs on an industry that in many countries enjoys considerable political clout. Perhaps the current Administration could lead the way?

      • I have to say I’ve never really understood, or had much sympathy for, the argument that a regulatory requirement is unfair because small firms will find it more difficult to comply. Obviously, if the regulation doesn’t really have a valid social purpose, or exists mainly to favor large companies, then it’s bad. But if the regulation would prevent substantial social harm, then if you can’t afford to comply, tough. Would we say that we shouldn’t insist that automobile brakes work properly, because small auto manufacturers will go out of business if they can’t make cars with unreliable brakes?

    • I wonder if, rather than strict liability, a duty to conduct enhanced due diligence could arise of certain circumstances are present which are good indicators of corruption in a transaction. Many financial institutions already screen internally for things like geography, negative news coverage, or unusual transaction patterns – perhaps a set of standards mandating a heightened standard of record keeping would be more palatable to financial institutions than strict liability.

  2. Do you think these lists should be reviewed by the central bank of states? I’m just thinking of situations where the ‘buddy’ is a bank official / chief and how to combat that scenario. Maybe having some sort of auditing mechanism for the lists could help deal with those outcomes?

    • Remember that the list is checked by the bank in a country where a non-national is seeking to open an account. So it is unlikely the central bank in the country where the bank is located would have anyone closely associated with a senior political leader of the country where the would-be customer is from.

  3. How do the anti-money laundering laws handle corporations or LLCs buying investment property? Is the bank or real estate agent required to look into the ownership of the entity in the same way it would be required to search the PEP lists? Otherwise, this seems like another potential workaround.

    • Banks are required by the “know your customer ” rule to determine the beneficial owner of a company seeking to open an account. The bank must then conduct “due diligence” on the name or names of the owners. That would (or at least should) include checking to see if any are PEPs.

  4. This blog does a good job of covering corporate corruption. The major aerospace giant Airbus has recently been involved in a massive scandal involving worldwide kickbacks in several countries. The U.K.’s SFO and France’s PNF are currently investigating:


    Run by a group of investigative journalists.

  5. I wonder about the proposed mechanism for supplementing traditional PEP list-based due diligence with the knowledge of locally engaged NGOs. My first question has to do with the Anticorruption Action Center’s resource: how does it differ from a traditional PEP list? Is it only that the source of the information is local?

    Second, while relying on local NGOs to supply information will certainly increase the quantity and granularity of information supplied, financial institutions will have no way (or incentive) to verify quality – in an age when allegations of corruption are a tool of elite politics in many countries, will banks soon find themselves sifting through a crossfire of declarations, counterdeclarations, and competing PEP lists? The Anticorruption Action Center’s resource states that it was developed with assistance from the Ukrainian Justice Ministry and Financial Monitoring Service: less scrupulous governments could easily invent an NGO to report, say, a timber reselling scandal involving an opposition politician. Are you worried that this sort of effort could muddy the waters, rather than add clarity?

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