On 15 December, 2007, independent legal professionals, as defined, will need to comply with the Money Laundering Regulations 2007. The Law Society recently issued a practice note outlining good practice and providing direction on new measures coming into force.

Money laundering has been a major concern for the legal sector for some years following the introduction of the Money Laundering Regulations 2003 and the Proceeds of Crime Act 2002, but 2007 represents a particular milestone in how firms must tackle the issue and the challenges it presents around effective customer due diligence and risk exposure.

The Money Laundering Regulations 2007, designed to further combat money laundering and particularly the financing of terrorism, are the UK's response to the European Union Third Money Laundering Directive that must be implemented into UK law by December 2007.

The Government's financial crime strategy estimates that organised crime costs the UK £20bn in social and economic harm each year. The Government believes the regulations will strengthen the UK's defences against money laundering and terrorist financing, and are designed to ensure that the UK's response to money laundering at home and abroad is effective and proportionate.

The new requirements

The Money Laundering Regulations 2007 require those legal professionals undertaking relevant business to put preventative measures in place. They require firms to ensure they hold a certain level of information not only on their customers, but, where applicable, beneficial owners represented by their customers. The level of background checking required includes conducting initial customer identification and verification and then undertaking ongoing monitoring where applicable.

Firms will also be responsible for keeping records of identity a clear audit of customer due diligence conducted and for training their staff on the requirements of the regulations. At worst, failure to comply could severely damage business reputation and lead to fines, business closure or even prison.

In summary, the new regulations require legal professionals to:

- make changes to how they undertake customer due diligence through the adoption of a risk-based approach for clients who require those services regulated under the regulations;

- for clients deemed a higher risk, including customers not dealt with face-to-face or, where applicable, politically exposed persons, firms will need to consider enhanced customer due diligence measures to gain further information on for example, the client's identity and their source of funds;

- for clients who are deemed a lower risk according to criteria set out in the regulations, firms can apply simplified due diligence measures. However, the clients to whom this relaxation applies are restricted and, on a risk-basis, firms could still decide to undertake their normal or enhanced procedures;

- firms will also need to identify and verify, where applicable, beneficial owners represented by the customer and obtain information on the purpose and intended nature of the business relationship; and

- monitor, on an ongoing basis, their relationship with the client and have evidence of identity in place for all clients, even those which have been on the books for many years.

Key concerns

A recent study by LexisNexis shows that 50% of law firms believe that the new regulations will mitigate the business risk of being exposed to the threat of financial crime and money laundering. However, a large proportion of UK law firms are concerned about the cost of complying with the new Money Laundering Regulations 2007 and the impact on UK competitiveness.

The research reveals that 52% believe the new regulations will require additional financial investment and half believe they will undermine the competitiveness of the UK economy. For those law firms where additional financial investment is required, 50% claim their overall due diligence costs will increase by as much as 10%-29%.

The research shows that the principal concern about the introduction of the new regulatory requirements facing 38% of all law firms is the reputational risk if found to be non-compliant. A quarter of all law firms are also worried about the impact of the regulations on customer service levels. The second most important concern for a third of law firms is the financial risk if fined due to non-compliance.

Despite the UK Government only publishing the final text of the Money Laundering Regulations 2007 in July, law firms have already begun to make significant investment to prepare for the incoming regulations. The LexisNexis study found that nearly half of all law firms have started to invest in personnel to perform due diligence checks and 68% have already started to invest in training resources to bring staff up to speed on the changes.

Tools to help law firms comply

While the consequences of non-compliance could be severe, there exists a number of tools to help law firms comply with the new regulations. While a level of investment will be necessary, provided firms allow sufficient time and resource to plan and implement any changes to their customer due diligence process, they can realise significant benefits from such an investment – for example, in improved business efficiency and customer service.

Our research found the majority of law firms conduct anti-money laundering checks on their customers and prospects through using official, verifiable, customer data such as passports for individuals and Companies House for information on businesses.

However, with more emphasis placed on customer due diligence, streamlined and faster processes could save firms valuable time and money. These include 'Know Your Customer' (KYC) applications that allow law firms to undertake detailed searches on their potential and existing customers.

Like a good detective, KYC matches the sophistication of the criminals' techniques with the thoroughness of its searches. These applications are always evolving in line with regulatory change and the need to derive greater return on investment from compliance resources.

Looking ahead

While many law firms are sceptical about the Money Laundering Regulations 2007, they are pragmatic enough to know that early action to comply is preferable to the high costs of financial crime. What is important is that law firms are fully prepared for the new regulations by the time of their implementation in December 2007.

Regulators are likely to clamp down hard on firms that do not adhere to the new regulations, so firms need to make sure that they do not run the risk of being penalised. At the same time, this provides an opportunity to review existing due diligence processes – and potentially to improve business efficiencies and save money along the way.

Mark Dunn is head of risk and compliance at LexisNexis.