Canadian Diamond Anti-Money Laundering Rules In-The-Making
April 20, 06One of the world’s larger diamond producers, Canada, may soon announce anti-money laundering and anti-terrorism financing diamond and jewelry industry rules that may well be more demanding than that of its southern neighbors. The Canadian government seems to hold rather exaggerated fears about the AML/CFT risks associated with its diamond production. In a preamble to a rule-making consultation paper, the government states, “Police investigations indicate that organized crime groups are taking a growing interest in Canada’s expanding diamond industry. Unless preventative measures are taken, law enforcement authorities predict that the incidence of money laundering and terrorist activity financing in the sector will significantly increase in the future with the domestic expansion of the precious metals and jewelry industries.”
With reference to the appropriate FATF recommendations (12 and 16), the Canadian government proposes to subject to the Proceeds of Crime (Money Laundering) and Terrorist Financing Act (PCMLTFA) persons or entities in the business of selling or purchasing gold, diamonds and other precious stones, including jewelry. Similar to the rule-making process that was followed in the United States, the Canadian government sought views from the industry on the following specific elements:
· segments of the industry that would be subject to the requirements (e.g. cutting, polishing, manufacturing, wholesale, retail);
· reporting large cash and suspicious transactions;
· the range of client identification and record-keeping requirements that would be applicable;
· and compliance mechanisms.
The invitation for to the public (meaning the industry participants) to make comments gave a deadline. By the time this deadline expired, only one industry player had clearly enunciated its thoughts – BHP Billiton Diamonds. No other industry comments were submitted – as far as we could discover.
BHP Billiton Diamonds has formulated a detailed position, which is presently under governmental consideration. It “encourages the adoption of provisions that are clearly aligned with those already implemented by Belgium, for both uniformity of coverage and implementation within the industry. However,” it says, “having had more than 18 months of operating experience with the Belgian legislation, we believe that certain improvements can be made when including Dealers in Precious Metals and Stones (DPMSs) in the PCMLTFA that will facilitate more meaningful compliance, reduce paperwork and retention, and enhance both the client monitoring and reporting functions of the legislation.”
BHP Billiton Fears False Reporting of Suspicious Activity
In virtually every country in the world, the filing of a suspicious activity report is done (and kept) in greatest secrecy. In Belgium, we have seen that government has taken action against certain diamond firms based on suspicious activity reports, without allowing the suspect party much room for defending its reputation or pleading its case. BHP Billiton wants to avoid that situation in Canada. “[W]e believe that – save and except in the case where national security is at immediate and direct risk - an expedited appeal process should be established for access by those whose conduct or reputation may have been wrongly impugned by a report that was filed more as a defensive reaction to the legislation (out of fear of being prosecuted "after the fact") or as a vendetta for past wrongs than because of a bona fide belief that the proposed transaction involved "suspicious" circumstances.”
BHP Billiton Diamonds vice president Graham Nichols, who presented the company’s position to the government, wryly (but rightly) implies that he believes the government overstated the “dangers” posed by the industry, when he remarks that “subject to further explanation by the Federal Government as to how the sale or trade in rough or polished diamonds has been used as a mechanism to facilitate money laundering (the financing of terrorist activities having being documented), we believe that all segments of the diamond industry engaged in sale and purchase transactions should be included in the PCMLTFA, from the sale of rough by producers and traders, through the cutting and polishing (manufacturing) processes, to the retail sale of loose stones and jewelry to the consuming public.” [All emphasis added.]
BHP Billiton specifically includes its direct rough clients, the diamond manufacturers “because they often buy and trade in large quantities of rough stones in order to meet specific customer programs for polished diamonds and, if criminal elements wished to inflate value or to introduce or commingle stones of diverse origin, the manufacturing process is one step in the supply chain where such conversions could occur.”
“We do, however, also recognize that the legislation requires the making, and lengthy retention, of copious internal client and transaction records and reports that could prove to be quite costly for compliance by smaller dealers in gemstones and precious metals,” says Nichols. “Accordingly, we support the U.S. approach of placing a monetary minimum on mandatory compliance with the PCMLTFA. We propose that such minimum be set at annual net sales of US$50,000.
Spot compliance audits could be conducted by:
(i) Financial Transactions and Reports Analysis Centre of Canada (FINTRAC) officers under their investigatory powers,
(ii) Review of the filed Compliance Questionnaires (proposed to be made mandatory by Proposal 6.14), or
(iii) Review of business income as reported under applicable tax legislation.”
Transactions to be Covered and Method of Reporting:
“Based on average product unit cost in the industry, we recommend that Cdn.$10,000 (in a single or related transaction) be adopted as the minimum transaction level at which mandatory record-keeping and reporting obligations of suspicious transactions should apply to DPMSs whose net sales exceed the proposed annual minimum, and further that application of the mandatory compliance criteria be expressly extended to capture not only cash transactions or electronic fund transfers but also diamond trades and exchanges made for other untraceable, criminal commodities,” says BHP Billiton.
The company further suggests that, “to ensure the consistency and sufficiency of reports by dealers (not all of which possess the expertise and staffing needed to maneuver between the provisions of the various Acts and Regulations referenced in the PCMLTFA), the Government should consider developing and appending as a Schedule to Regulation SOR/200l-
Registration of Diamond Dealers
Following the Belgian model, where all diamond dealers need to be registered with the Economic Ministry before they can engage in the diamond business, BHP Billiton suggests the “creation of a national registry of precious stones and metals dealers.” The Report Form, which it suggests must be adopted, should all:
(i) Be marked "Confidential"
(ii) State at the top the timeframe within which it must be filed
(iii) Contain the name, telephone contact (not voicemail), and e-mail/mailing address of FINTRAC along with designated fields for the insertion of the relevant following customer information.
It recommends that the rather detailed Report Form emphasize - at the outset - the need for good faith, due diligence and accuracy in its completion and the fact of immunity from civil or criminal repercussions only when proper care has been exercised in filing the report. While reporting timelines [in present law] are sufficiently long to facilitate proper internal due diligence before any report is filed, “we are concerned that, in the absence of such precautionary note, the legislation may initially encourage "defensive" reporting in an effort to avoid possible prosecution whenever the nature of a proposed transaction is in doubt,” states BHP Billiton Diamonds.
“Defensive reporting” has become a major problem in the financial industries in the United States.
Range of Client Identification and Reporting Required
Again, based on its experience in Antwerp, BHP Billiton Diamonds stresses that client identification has proven to be a most arduous and time consuming task for vendors of diamonds in Belgium, as most have dozens of customers, each using different banks, some providing "corporate status" or other personal records in the original language of issuance (without the requirement for accompanying translations), and each being subject to the vagaries of the industry (which can result in smaller customers being financially viable one month and insolvent the next), thereby necessitating frequent customer background checks for proper compliance with the legislation – especially given the emphasis [in the Canadian proposals] on "ongoing due diligence".
Further, the required retention of such records for five years or more – even in electronic form - can be prohibitive when added to the retention obligations imposed by other statutes (such as the Income Tax Act). The result is that the principle of ‘Know Your Own Customer’ is becoming increasingly difficult and expensive for industry participants to achieve on a timely and cost-effective basis, especially in the face of privacy legislation and the attendant reluctance of banks to release customer information.
Proposed Diamond and Metal Dealers National Registry
Seeking ways to ease the burdensome due diligence requirement, BHP Billiton suggest that “in lieu of introducing yet a further level of compliance for FINTRAC to monitor (in the form of the "Agents or Introducers" suggested by the government), we believe that a better means of alleviating the preceding problem, while at the same time earning the Government extra income, would be to create a national electronic data bank or registry of authorized dealers in diamonds or precious metals (DPMSs) to which producers and suppliers of stones could refer prior to concluding any proposed transaction (similar to the registry system outlined in Proposal 3.1 for Money Service Businesses). DPMSs seeking to sell, trade, or acquire rough or polished diamonds could be required to register - for a set annual or bi-annual fee - by providing to the Government copies of basic business data, ownerships, location, banking relationships, etc.
The creation of such a registry would reduce the amount of information required to be collected and entered on the Report Form (thereby encouraging timely reporting) and would also assist FINTRAC in performing its own due diligence following the filing of a report. Dealings with DPMSs not listed in the registry would require full direct compliance with all client identification requirements specified in the legislation,” suggest Graham Nichols.
False or Unjustified Reporting and Ruined Reputations
BHP-Billiton Diamonds’ Graham Nichols raises a number of addition concerns (that are not all covered in this article), but what deserves to be stressed is that the company has certainly placed some new issues on the diamond industry’s AML/CFT compliance agenda, very much based on “lessons learned” from Belgium.
A fascinating feature of the company’s proposal is the suggestion that because compliance with the legislation will be new to most dealers impacted by the anti-money laundering legislation (and publication of companies’ failure to comply is proposed in the Canadian proposals), initial reporting may be unduly prolific until guidelines are established and the industry develops a greater familiarity with the legislation.
This could lead to precautionary reporting, which ultimately could prove to contain unfounded suspicions. At present, the legislation prohibits any disclosure to others by the author of a report and provides for no right of appeal by the reported party. This raises the specter of ruined reputations and damaged business interests without the impugned party having either knowledge or recourse as regards the report, made worse by the proposed disclosure to other local government departments and international law enforcement agencies and "foreign partners."
Given the preceding circumstances, and with the proviso that the report filed does not evidence a direct and imminent threat to national security, Nichols recommends that “FINTRAC be required - as part of its own investigative measures and prior to any disclosure of the report or its contents to other entities – to meet at a senior level (preferably in the presence of an independent, objective arbiter or ombudsman) with the impugned party to review the allegations and determine if they have any merit.”
This may create all kinds of unintended consequences – including tipping off the party who filed the suspicious activity report to begin with – but it deserves to be considered and this and similar suggestions deserve to be part of the public debate well before the enactment of the relevant legislation.
Have a nice weekend.