Source of wealth: Choose the truth

The article offers some advice on avoiding pitfalls associated with source of wealth checks, including new challenges from outside the traditional finance matrix.

The article was originally published by the ICA organisation. You can access it here for further reading.

One aim of conducting source of wealth (SoW) checks is to uncover illegitimate wealth and avoid engaging with clients involved in criminal activities. However, this represents only a fraction of the true purpose of this undertaking. Financial institutions are not the sole actors in this narrative, as any organisation from any industry may be mandated by law to carry out SoW verification. The practice of implementing a robust SoW programme is inherently ethical, as evidenced by the fact that even firms not subject to formal regulations voluntarily undertake this process. Drawing on my experience in developing effective SoW methodologies, this article offers some insights that may not have been considered as part of your organisation’s strategy.

Behind the scenes of SoW

The essence of SoW lies in identifying what the client does for a living and the origin of the wealth accumulated. A comprehensive SoW demands an assortment of assets, encompassing employment or business ownership history, family inheritances, and investment revenue streams. SoW serves to uncover how the individual has accrued their total wealth, whereas the source of funds (SoF) illuminates the means and motives behind, say, an account’s funding. If SoW is akin to a movie, then SoF is like a scene in that movie.

While both SoW and SoF may be featured in a single reading, I have chosen to focus here primarily on SoW. With that in mind, the following offers some recommendations aimed at enhancing your SoW programme.

Client-provided documents

The first consideration is whether documents that are not publicly accessible are necessary in every circumstance. While private documents like bank statements are crucial for SoF verification, it is possible to create a comprehensive SoW profile using only publicly available information. In some jurisdictions, publicly accessible records can provide a complete history of property ownership, among other things.

Alternatively, the risk-based model permits the use of client-provided documents as the sole basis for SoW data, particularly when the client poses a lower risk or when

the existing information is highly plausible. However, it is important to note that counterfeiting a document is relatively simple, especially with the widespread availability of AI tools. Accordingly, I strongly recommend verifying information whenever possible and practical, such as by confirming business ownership positions through the relevant registry.

Local expertise

Netflix’s highly acclaimed series, Narcos, is a gripping drama that is widely enjoyed by audiences with the exception, perhaps, of Colombians who may take issue with the main character’s inauthentic accent. Similarly, while you may feel confident in your ability to comprehend a foreign client’s SoW documentation, engaging a local expert can provide crucial contextual information that may not be readily apparent to an outsider.

While a client’s business activities may appear on first inspection to be ethical, a local specialist can offer insights into the local landscape that can affect the accuracy of your analysis. Moreover, identifying propagandist context or subjectivity in adverse media articles can be a challenging task, requiring a nuanced understanding of the local context. A local specialist can provide a more comprehensive and accurate interpretation of such materials, strengthening your due diligence processes and mitigating potential risks.

Critical evaluation

Crafting a comprehensive SoW profile for your client is an analytical endeavour, rather than a static one that merely involves checking boxes or filling out forms. Consider the following two examples pertaining to business ownership.

Beginner’s attempt: Examination of a corporate registry, such as the UK Companies House, has revealed that the share capital of an entity that is wholly owned by your client amounts to £10,000. This critical information has been promptly documented in the relevant section of the KYC profile.

Masterful performance: It’s important to note that the share capital provided by corporate registries only reflects the nominal value – also known as the face value – of shares and cannot be recorded in a straightforward manner in every case. To obtain a more accurate representation of the entity’s value, it’s necessary to consider the market value – also known as the real value – which is typically substantially higher. In the case of public companies, determining market value can be accomplished by locating the entity’s most recent stock exchange - provided share price. Private entities, on the other hand, require a more comprehensive approach. The answer may be found in annual reports or media articles, although this is a more challenging task.

While it’s unlikely that every business will achieve the success of well-known private businesses like IKEA, Fidelity, or Huawei, it’s important to recognise the difference between nominal value and market value when evaluating an individual’s net worth. Understanding the true purpose of the entity in question is key, as subsidiaries of larger parent entities may be required to employ local people, or shell companies may be created to hold specific assets such as real estate.

These are just a few examples, and in some cases, client outreach may be necessary to reveal such information. While nominal value may suffice for UBO searches, a thorough evaluation of net worth requires a more comprehensive approach.

Cutting-edge solutions for high-risk clients

The use of reputational intelligence as a service involves conducting professional interviews with unbiased sources, such as industry experts or employees of companies associated with a client. In some cases, it may be necessary to seek more insider input to safeguard a business’s reputation.

Properly conducted intelligence can reveal potential ties to organisations such as Al-Qaeda or the Yakuza, particularly for companies and individuals with a presence in jurisdictions with high levels of media censorship. While this requires additional resources, the benefits of working with ultra-wealthy clients far outweigh the costs. Ultimately, it’s essential to consider the potential cost of losing one’s reputation and take proactive measures to mitigate any potential risks.

Above and beyond illicit income

The primary concern is undoubtedly to avoid any association with clients who have acquired their wealth through illicit means. A robust SoW strategy, however, entails drawing insights from a wide range of information sources. Firstly, the definition of what constitutes illegal behaviour varies by country, as illustrated by the cannabis, brothel, and cryptocurrency mixer industries. Secondly, legal activities are not necessarily ethical by default (take, for example, tax avoidance). Lastly, you should be vigilant of any factors that may initially seem innocuous but may later give rise to uncertainties.

By implementing ongoing screening for negative media and sanctions, you can promptly terminate your relationship with clients and their associates, such as Elizabeth Holmes, Sam Bankman-Fried, or Do Kwon. In conclusion, SoW information plays a pivotal role in assessing a client’s ultimate level of risk and determining the necessary mitigation steps.

SoW pitfalls

Every story has an antagonist, and in the world of financial crime, there are numerous pitfalls that can pose a threat to your company’s reputation. It is essential to be vigilant and pay close attention to any recent concerns that may arise.

Extensive promotional strategies

The client’s net worth may stem from enlisting the services of a company that engages a celebrity to endorse its products or possesses a robust social media following. The 2016 United States presidential election showed how trolls and bots (now further bolstered by AI) can orchestrate media manipulation on a grand scale. Fashioning a credible yet counterfeit persona for a given entity could feasibly be a straightforward feat for such actors.

To avoid incurring a subpoena for one’s high-profile clientele, a rudimentary know your customer (KYC) query should be executed. Additionally, one must exercise judgement in assessing whether the underlying product or business model appears too good to be true. As the adage goes, “if you don’t know where the profit comes from, YOU ARE THE PROFIT”, a maxim that rings true in the context of Ponzi schemes.

It is advisable to conduct a professional interview with impartial local sources to glean insights beyond the scope of media coverage. If certain aspects of the relationship appear dubious, take swift action and promptly terminate said arrangement.

Red pill or blue?

Although remaining within the confines of the “traditional finance matrix” may appear to be a more convenient option, FinCrime experts must opt for “the red pill rather than the blue” and delve into cutting-edge concepts such as initial coin offerings (ICO), non-fungible tokens (NFT), or decentralised finance (DeFi). It may be tempting to believe that your firm’s sole reliance on fiat currency renders any involvement in cryptocurrency obsolete. However, it is important to acknowledge that your clients may operate crypto-based businesses that generate revenue in fiat currency, potentially implicating your organisation.

ICOs

The concept of raising funds through the issuance of tokens or cryptocurrencies is brilliant. In

essence, it operates akin to a venture capital (VC) model, but without the need for intermediaries. This enables anyone to create their own token, representingeven the most innovative and imaginative ideas. However, the abundance of ICOs has led to an increase in fraudulent activities within the industry. These scams can take months or even years to be exposed, potentially implicating your client who is the UBO of the project.

Some red flags relating to ICO scams include:

• the promotion of the project as a quick and highly profitable investment, often utilising celebrities as ambassadors to lure in new investors

• the offer of a commission to individuals who refer new investors to the project

• the absence of any software developed for the given project, or a lack of open-source code that could help to establish trust in the project’s operational methodology

• the poor quality of the white paper (essentially the project’s “business plan”). A comparison with the Bitcoin or Ethereum white papers is helpful

• cryptocurrencies or tokens that lack any market valuation and are not listed on any reputable exchanges, and/or cannot be exchanged for Bitcoin or any other cryptocurrency in a free-market manner, but can only be traded on an internal exchange

• cryptocurrencies or tokens that are only available in the form of a voucher or certificate, trading is frozen for some reason, and free disposal is only possible at some point in the future

• instead of digital coins, the receipt of “settlement cycles”, “priority rights in a queue”, or other dubious quality rights that are not found in digital or traditional financial systems.

Again, exercise caution and avoid anything that seems too good to be true when it comes to investing in virtual assets.

NFTs

Many individuals have successfully generated a substantial income through trading ownership certificates of digital items. Although the capitalization of the NFT market is still measured in billions of dollars, its peak days are over. Consequently, the chances of an NFT's value skyrocketing and generating significant wealth for your client are quite slim. If it does occur, it is often merely the result of circumstance rather than an accurate reflection of the artist’s talent. It is critical to exercise caution regarding excessively inflated values.

It is essential to ascertain which NFT marketplace your client utilises and whether a user verification policy is in place. Additionally, understanding the process of NFT authentication verification can aid in mitigating the possibility of onboarding a client whose NFT performance was founded on fraudulent or deceptive practices. Note that the NFT industry is not immune to the same risks associated with traditional art dealing. Criminals with their dirty money seeking for the allocation can admire modern artists that almost no one from the community believes in.

DeFi

In conclusion, it is important to note that entities such as cryptocurrency exchanges, NFT marketplaces, or ICO crowdfunding firms may exist solely in the digital realm without any physical employees. These entities may rely on the functionality of smart contracts to execute their operations. In the absence of any links to a particular jurisdiction, regulation does not apply to entities such as DeFis. While certain DeFis may choose to voluntarily implement AML and KYC procedures, the effectiveness of such policies is subject to scrutiny in the absence of proper oversight. It is crucial to assess whether the DeFi concept aligns with your organization’s risk tolerance before considering its adoption.

Ensure a happy ending

I began this article with the suggestion that the SoW task is not merely restricted to uncovering the client’s illegitimate wealth. Rather, it involves meticulously documenting factual details that will serve as answers to queries in the future. For instance, is the current activity observed consistent with the financial capacity we had previously established for the client? How should we react to the recent negative media publicity about the company that generates income for our client? Are we equipped to detect biased context?

A robust due diligence programme provides a panacea for future predicaments, revealing an accurate picture of your clients and the associated risk. I'm glad to have shared my vision of SoW with you. Feel free to join the effort, but remember the famous words of Morpheus from The Matrix: “Remember… all I’m offering is the truth. Nothing more.”