It’s Time for the United States to Mandate Enhanced Scrutiny of Domestic Politically Exposed Persons

In February, former Baltimore mayor Catherine Pugh became the latest in the long line of Maryland politicians sentenced to prison for corruption-related crimes. According to the Department of Justice, Pugh sold copies of a self-published children’s book series to a variety of local organizations that already had or were attempting to win contracts with the city and state governments. Over eight years, Pugh and her longtime aide failed to deliver, re-sold, and double-counted the orders, squirrelling away nearly $800,000 into bank accounts belonging to two shell corporations registered to Pugh’s home address. Pugh, who did not maintain a personal bank account, used the funds to purchase and renovate a private home as well as fund her re-election campaign, among other activities.

These facts are classic red flags in the anti-money laundering (AML) world. Pugh would have had more difficulty executing this corrupt scheme, and might have been brought to justice much earlier, if the banks handling her illicit revenues had conducted the sort of enhanced customer due diligence and monitoring that financial institutions are required to perform on so-called “politically exposed persons” (PEPs), as well as their immediate family and close associates. While there is no uniform definition, PEPs are typically understood to be someone who holds a powerful government position, one that provides greater opportunities for engaging in embezzlement, bribe-taking, and other illicit activity. (Defining a PEP’s “close associates” is more challenging, but the category is generally thought to include someone like Pugh’s aide, who has the requisite status and access to carry out transactions on behalf of the PEP.) But U.S. financial institutions were not required to subject Pugh or her aide to enhanced scrutiny, because under the U.S. AML framework, such scrutiny is only obligatory for foreign PEPs, not domestic PEPs.

For many years, that was the standard approach internationally. But a new consensus is emerging that financial institutions should subject all PEPs, both domestic and foreign, to enhanced scrutiny. This position has been embraced by the Financial Action Task Force (FATF), the international body which sets standards for combating corruption in the international financial system, by the Wolfsberg Group, an association of the world’s largest banks, and by the European Union’s Fourth AML Directive. But far from joining the growing tide of domestic PEP screening, the United States seems to be swimming against it. The United States is one of the few OECD countries that does not require domestic PEP screening, and this past August, the Financial Crimes Enforcement Network (FinCEN), the primary U.S. agency tasked with investigating financial crimes, reiterated that it “do[es] not interpret the term ‘politically exposed persons’ to include U.S. public officials[.]”

This is a mistake. It’s time that the United States joined the international consensus by formally requiring enhanced scrutiny of domestic PEPs as well as foreign PEPs.

Of course, wading into domestic PEP territory would not be without its challenges, but ultimately each of the principal rationales that have been advanced for resisting domestic PEP screening turns out, on closer inspection, to be unpersuasive:

First, some say that domestic PEP screening is unnecessary because the risk of U.S. PEPs engaging in corruption is substantially lower than for their foreign counterparts. This view is short-sighted. Whether or not the incidence of domestic PEP corruption is lower than foreign PEP corruption, U.S. public officials are hardly immune to corruption, as Pugh’s case illustrates. (For other examples, see here, here, and here.) In fact, the perception of corruption in the United States is at an all-time high. There is thus no basis to assert that U.S. PEPs present such a minimal risk that there is no need to scrutinize their transactions more closely.

Second, and relatedly, some argue that U.S. PEP transactions typically involve much smaller sums of money than transactions involving foreign PEPs, making detecting suspicious transactions too difficult to be worth the costs of enhanced scrutiny. But significant technological advances reduce the compliance burden—especially when implemented at scale—and enable more accurate detection of suspicious patterns in account activity, even with small sums. And institutions would calibrate the cost based on their internal risk assessment, as with all other AML requirements. Moreover, cases like Pugh’s highlight that domestic PEPs are often less sophisticated at obscuring shadowy money trails, indicating that detection of domestic PEP illicit activity could even be easier than in the case of foreign PEPs.

Third, some posit that domestic PEP screening is redundant, because suspicious activity reports (SARs), which banks are obligated to file on all customers, together with other reporting requirements that apply to public officials, such as tax and campaign finance regulations, effectively serve the same function. This thinking is misguided. SARs are only generated when a transaction falls outside of an institution’s risk-based parameters. These parameters are necessary because U.S. financial institutions process a staggering number of transactions: in 2019 alone, institutions sent more than 100 million wire transfers, 15.5 billion automated clearing house payments, and $300 billion in peer-to-peer transactions—and these were only some of the types of purely inter-bank transfers. Given this volume, it is unlikely that existing screening procedures would identify domestic movements of potentially small sums as suspicious activity if U.S. PEPs are not considered high risk within the screening parameters. Similarly, existing reporting requirements for public officials are insufficient. Tax and campaign finance reporting occur on a quarterly or annual basis, potentially much less frequently than domestic PEP screening. Furthermore, and perhaps more importantly, the penalties for money laundering far exceed the penalties for false reporting.

There’s no such thing as American exceptionalism when it comes to the need to scrutinize more carefully the financial transactions of public officials. Public corruption is a domestic problem, not just a foreign problem, and there’s no good reason to give U.S. PEPs a special exemption from the due diligence obligations that apply to all other PEPs.

 

6 thoughts on “It’s Time for the United States to Mandate Enhanced Scrutiny of Domestic Politically Exposed Persons

  1. Really enjoyed this post. I’m wondering what the exact source of resistance is to domestic monitoring of PEPs within the US. Is it a purely political issue (and thus potentially liable to change with administrations) or is there a larger systemic reason for pushback? Are the US domestic banks and financial institutions themselves opposed?

    • Great questions. My read is “all of the above.” From the government side, some of the resistance seems to stem from the perennial problem in the PEP discussion: who exactly is a PEP and, more difficult, who are their close associates? Financial institutions consistently seek clearer guidance from regulators and regulators consistently decline to provide a precise definition. There are certainly merits to the flexible PEP definition for casting a wider net of potential bad actors but the expansive approach also creates administrability challenges, especially in the local government context. From the private sector side, some institutions have erred on the side of caution and already conduct their own PEP designations and monitoring, but others do not want to spend the extra compliance costs and/or risk souring the PEP client relationship by asking more information about their activity, especially if the extra due diligence is not required by law.

      • Hey Laurel- a very illuminating post! I wanted to follow up a bit on Zach’s comment. The exclusion of U.S. public officials is certainly a puzzle to me, and I hesitate to entirely contribute this particular policy to the machinations of the Trump administration. It sounds like this is a longstanding interpretation, and several independent agencies endorse this interpretation. At the risk of sounding like a conspiracy theorist, I’m wondering who the actors driving this policy are. Could the reason that the United States has not been able to self-scrutinize PEPs be that those drafting policy and those under scrutiny would be one and the same? Should this be something that a future Biden administration focus on changing?

        • Hi Jaylia – you’re right, it is a puzzle and the aversion to domestic PEP screening originated long before the Trump administration (though the recent announcement was one of the more forceful policy statements on the subject). The natural disincentives for politicians to subject themselves to additional scrutiny, a common challenge for anticorruption reforms in the political arena, could certainly be overcome by a Biden administration focused on this issue. After all, domestic PEP screening is just a rule change away. That said, given the entrenchment of the anti-domestic-PEP position, the administration is likely to face significant opposition, from both inside and outside government.

  2. This is a very informative post thank you Laurel! I would love to pick your brain a bit more on the definition of PEP. Based on the example you provided, we can safely say that a Mayor, and their close aides, counts as someone under PEP. But what about a local councilman, like an alderman from Chicago? I’m just curious as to how “powerful” does a government official have to be to warrant a domestic PEP designation and if you have a definition that you like and recommend the U.S. should adopt? Given how it’s “politically exposed,” should every individual who holds some kind of elected position be subject to this?

    • Hi Vincent–thanks for your comment! You’ve identified the key challenge in the PEP space. There is no one generally accepted definition beyond the idea that a PEP is someone who is “entrusted with a prominent public function.” In the domestic PEP context, I favor an interpretation that includes all elected officials, even at the council level. I’m also open to expanding the net beyond just elected officials–say to civil servants with sufficiently prominent positions–though I am not sure exactly where I would draw the line in that arena. Covering elected officials would be a great start!

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