Money and matters: A lawyer’s guide to navigating Tranche 2 Part 5 - red flags

In the last article, we took a look at what it will likely mean for creating an AML programme at a law firm after the Tranche 2 reforms come in. In this piece, we highlight some of the red flags that signal potential money laundering and share real life examples.

Part 5: Money laundering red flags in the legal sector -  what to watch out for and how to avoid both reputational damage and fines

The legal profession has long been considered a gateway for money laundering activities due to the services lawyers provide and their roles as gatekeepers to the financial system. From forming trusts and companies to managing client accounts and facilitating real estate transactions, legal practices can unwittingly become involved in schemes designed to conceal the origins of illicit funds. 

Australian law firms are in a fortunate position, we have the ability to learn from the failings of others before Tranche 2 reforms are introduced. In our closest legislative peers we see the severe impact non-compliance has on firms.

In the UK no one is immune. In January 2024 the Solicitors Regulation Authority (SRA) hit a large law firm in London, Clyde & Co with a £500,000 (~$AU 960,000) fine for non-compliance. The next month they went after Fairbrother & Darlow, a tiny law firm in England who was fined £16,000 (~$A30,000) because of AML non-compliance. 

Across the ditch in 2021, New Zealand’s Department of Internal Affairs (DIA) issued the first and, so far, only warning to a law firm, Kidd Legal, that was accompanied by a threat of a civil penalties of up to $NZ 200,000 for an individual and $NZ 2 million for a corporation, and criminal penalties of up to two years imprisonment or a fine of up to $NZ 300,000 for an individual, and a fine of up to $NZ 5 million for a corporation.

These types of fines are likely to come with Tranche 2 reforms. By understanding the red flags and implementing robust AML compliance programmes, legal professionals can mitigate these risks and avoid becoming facilitators – witting or unwitting – of financial crimes. Let's explore these in more detail. 

Red flags in client onboarding and behaviour

One of the first lines of defence against money laundering is maintaining vigilance during client intake and monitoring ongoing client conduct. Certain behaviours and patterns should prompt heightened scrutiny, such as:

• Clients being overly evasive about their identities, background, or sources of funds/wealth.  
• Frequently switching legal representation with no reasonable justification. This could indicate "lawyer shopping" to find willing facilitators of illicit activities.
• Trusts or arrangements with unusually young/old beneficiaries or parties lacking logical familial connections.
• Clients exhibiting unusual secrecy or anxiety, such as refusing to meet in person or lacking online footprints contrary to their stated activities. Money launderers often attempt to minimise contact and visibility to avoid scrutiny.
• Providing falsified identification documents or companies/trusts with obfuscated ownership structures spanning unexpected jurisdictions (such as the Cayman Islands) with no legitimate business rationale.
• Clients who are politically exposed persons (PEPs) or closely related, or high-net-worth individuals with complex asset situations.
• Clients operating cash-intensive businesses like restaurants or salons, which can more easily disguise illicit cash flows.
• Clients whose activities appear inconsistent or continuously evolving from intake through transactions.

Source of funds red flags

Understanding the true source of funds is critical when assessing money laundering risks in legal transactions. Money launderers often attempt to conceal the origin of illicit cash flows. Key red flags related to a transaction's funding sources include:

• Funds being provided by third parties unrelated to the client or transaction.
• Funds sourced from foreign high-risk jurisdictions with no geographic connection.
• Large cash transactions where the client is evasive about legitimate sources and origins.
• Sudden changes of source of funds at the last minute, e.g. bridging finance brought in just before a transaction settlement.

Suspicious transaction patterns

Money launderers often attempt to disguise the audit trail and origins of dirty money through complex legal transactions and financial flows. Key red flags include:

• Abruptly aborting transactions and insisting funds held in trust be disbursed to third parties instead of returned to the original source. This could indicate an attempt to create false paper trails.
• Making deposits that far exceed the client's known legitimate income streams or net worth profile. An influx of large sums with no clear economic purpose should prompt investigation.
• Transactions exhibiting overpayments or surplus funds deposited beyond what is required. This excess could represent illicit money being "parked" temporarily for future laundering stages.
• Rapidly flipping properties at inflated values in a pattern of back-to-back transactions defying market norms. This could enable value distortion to integrate criminal proceeds into the legitimate financial system.
• Significant use of cash or cash equivalents to fund transactions such as high-value luxury properties. This avoids financial transparency while deploying large illicit cash stockpiles.
• Transactions that are uncharacteristically large, complex, or inconsistent with the client's known legitimate activities.
• Dealings involving high-risk jurisdictions (often known as tax havens)with lax anti-money laundering laws and oversight
• Structuring that involves unnecessary shell companies, trusts or vehicles lacking clear economic justification.
• New third parties introduced late in dealings to bypass client vetting protocols

A recent example 

This may all sound overwhelming, but when you put it together in real life, it just seems ‘off’. In a webinar recently, global AML juggernaut Amy Bell from Teal Compliance, told a story that illustrates the numerous red flags lawyers are faced with when confronting money launderers and this was in one small transaction.

“I recently got a call from a client who had acted on behalf of their client in a property settlement transaction. They wanted to know my opinion on a situation that had transpired. The firm was approached by a student who had just shifted to the area and wanted to purchase a £1 million penthouse. His Dad was going to fund the purchase of the property. The law firm performed financial due diligence on the father to ensure he had the funds available. 

Two days before completion, the father called and said he could not access the full amount immediately due to hold-ups in releasing his money from elsewhere and proposed bringing in bridging finance - a short-term loan that he would repay within a week once his funds cleared. He even had the law firm assist in documenting the arrangement, adding legitimacy to the transaction.

The transaction was completed using the £1 million bridging loan. A few weeks later the lawyer who had onboarded the client left the firm and the AMLCO was checking through transactions. It was at this point that the AMLCO discovered the last-minute funding change was never properly reported internally. When they investigated further, it emerged the father was actually involved in ‘fencing’ which is the on-selling of stolen art and other criminal activities. 

A simple Google search would have revealed the father had been arrested for cocaine possession just weeks earlier to the property transaction going through. But the firm's processes did not include adverse media checks or even a simple Google search.

The firm filed a suspicious activity report and cooperated with authorities. While eventually the firm was cleared of facilitating money laundering, the specific lawyer was disciplined for the lapse. 

Key red flags in the above example include:

• An unusually young person conducting the transaction
• Buying a luxury penthouse in an area they’ve only just shifted to
• The Dad (funder) never meets the law firm in person
• Last minute change in funding origination

Had the lawyer involved been aware of the red flags to look out for, the criminal wouldn’t have been able to be onboarded and then clean his money through the property transaction. 

High risk practice areas

While money laundering can permeate many legal services, certain practice areas carry inherently higher risks that necessitate enhanced due diligence.

Trust and company formation  

Forming legal entities such as trusts, foundations, or shell companies can allow money launderers to conceal ownership and create additional money-moving layers. Red flags include:

• clients seeking these services without valid commercial rationale
• excessively complex multi-jurisdictional structures, and 
• engagements centering solely on routine formation without need for substantive legal advice.

Real estate transactions

The real estate sector has long been a vehicle for laundering ill-gotten gains due to the high values involved and multiple stages where funds can be integrated, layered or extracted. Beyond the transaction red flags mentioned earlier, warning signs include: 

• Purchases made through opaque trusts, shell companies, or nominees rather than individuals.
• Rapidly paying off large mortgages or loans using illegal proceeds shortly after property acquisition.

Client account management

The ability to rapidly move funds through law firm trust accounts without raising suspicion makes this area very vulnerable. Red flags consist of:

• Clients seeking to use the account like a personal bank account without clear links to a legal matter.
• Instructions to wire funds to/from high-risk jurisdictions or parties under sanctions.
• Frequent fund transfers with no legitimate explanation for the underlying transactions.

By following a risk-based approach, developing robust policies and internal controls customised to your specific risks, and ongoing reminders of red flags law firms can meet their obligations and defend against criminals. The costs of compliance pale compared to the alternative of facilitating financial crimes that could destroy your firm’s reputation, invite severe enforcement actions, and threaten professional futures.