Cryptocurrency, Crowdfunding and Pooled Client Funds – What Should Firms Consider

Due to the variety and complexity of legal services law firms provide, the risk of abuse for money laundering purposes remains high overall. The services most vulnerable to criminal exploitation for money laundering purposes typically include conveyancing, trust and company services and client accounts.

In an updated risk assessment published last year, several emerging issues were also identified, including:

• Sham litigation (i.e. fake lawsuits between collaborating parties to launder money as payment of damages through the courts).
• Use of crypto assets for payments, which while not always automatically suspicious, inherently make it harder to identify the beneficial owner, and as a result, should be treated as high risk.
• Use of crowdfunding, which can make the source of funds extremely difficult to establish.

In a separate guidance, note The Solicitors Regulation Authority (SRA) warned of the risks associated with Pooled Client Funds, which refer to transactions where a large number of participants, often strangers, contribute to fund the purchase of a property or asset.

As highlighted above, cryptocurrency and crowdfunding, or pooled client funds, are key areas of concern. While it is accepted that these emerging forms of financing offer new innovative opportunities and can prove to be a legitimate source of funds, the fact that they do not fall under a traditional financial system heightens the appeal to cyber criminals and other money launderers.

Additionally, there is still some confusion regarding anti-money laundering (AML) obligations and risk management and how these apply to cryptocurrency, or crowdfunding and pooled client funds. Law firms and legal service providers often seek clarification on whether these sources can be considered legitimate funds. Furthermore, how can firms protect themselves from breaching AML regulations when dealing with these transactions?

Below, we provide an overview of the current recommendations regarding managing these risks effectively while staying compliant with the regulations.

What Does the SRA Say About ‘Source of Funds’ Risks?

Law firms must establish the legitimacy of the source of funds, not just where the money comes from, but also why the client has the money. When dealing with crowdfunding, pooled client funds, or cryptocurrency as a source of funds for either a legal service or a property purchase, solicitors must conduct thorough risk assessments and enhanced client due diligence (EDD) to ensure the funds are legitimate and not derived from criminal activity. However, financing derived from these sources can prove particularly challenging.

• The Risks with Cryptocurrency - Cryptocurrencies are seen as cash transactions, so there is an increased risk of money laundering. Unlike traditional, government-issued currency, cryptocurrencies often lack certain safeguards and can be more challenging to trace. Additionally, emerging tools such as crypto ‘tumblers’, can help to make crypto ownership/transfers even more opaque, further obscuring ownership and transfer histories, making it even harder to trace the origins of these assets.
• The Risks of Crowdfunding or Pooled Client Funds - The Solicitors Regulation Authority (SRA) identifies crowdfunding or pooled client funds as an emerging risk due to the challenges in establishing the source of funds, especially where there are numerous separate sums. Without knowing the source of funds, the SRA says it is “impossible” to assess the level of risk involved or to determine whether the funds have been laundered or are subject to sanctions.

How can Law Firms Ensure They Are Meeting Their AML Obligations?

The Solicitors Regulation Authority has identified these areas as high-risk due to their relative anonymity, rapid evolution, and elevated risk of misuse by criminals. Law firms must approach these transactions with caution and implement strict risk assessment procedures before proceeding. Firms must carefully consider and apply the following:

• KYC - Ensure it is possible to perform Know Your Customer (KYC) checks to verify all contributors’ identities and the source of funds
• Perform Practice-Wide and Matter-Level Risk Assessments - Cryptocurrency, crowdfunding or pooled client funds should be considered high-risk indicators. Regardless of the size, type and complexity of your client’s matter and their transactions, a practice-wide and matter-level risk assessment, must be performed. Implement rigorous risk assessments to identify and mitigate potential vulnerabilities and record your findings.
• Enhanced Due Diligence (EDD) - Firms must apply enhanced due diligence (EDD) measures dictated by the level of risk and obligations on source of wealth and source of funds.
• Ensure understanding of policies and procedures - Cryptocurrency or another unusual source of funds should be an immediate high-risk indicator, and firms should report any client seeking to use cryptocurrency as part of their funds to the Money Laundering Reporting Officer (MLRO) for further guidance. Ensure all case handlers fully understand their obligations and the procedures that must be followed.
• Third Party Technology Providers - Consider whether the crypto wallet or pooled client account provider is reputable and regulated by the Financial Conduct Authority (FCA). Where these crypto-asset wallet or pooled account providers are supervised for anti-money laundering to a comparable standard, this may be seen as presenting a reduced risk.

Ultimately, firms are advised to exercise caution regarding transactions involving cryptocurrency or pooled funds. If full and enhanced due diligence checks cannot be conducted, they should avoid proceeding with the transaction.

By establishing strong risk management policies, controls, and procedures that align with regulatory expectations, law firms can ensure that high-risk matters and related issues do not adversely impact the firm. This approach also shows regulators that the firm is fulfilling its regulatory obligations.

Useful Resources

For further guidance, explore the following sources and links:

• The Solicitors Regulation Authority - Compliance with the regulations and preventing money laundering
• The Law Society - SRA identifies emerging money laundering risks
• The Law Society - Can my client use bitcoin to purchase property?