Money Laundering: Sectoral Guidance Private Equity Firms

June 2006

This guidance, which is specific to the private equity sector of the financial services industry, is supplemental to the main summary of JMLSG Guidance "Summary of the Revised Guidance for the UK Financial Sector of the Joint Money Laundering Steering Group (JMLSG) in the Prevention of Money Laundering" (the "Main Summary Guidance"). It should be read in conjunction with the Main Summary Guidance at all times.

1. MONEY LAUNDERING RISKS OF PRIVATE EQUITY

   Investors in private equity firms tend to have long established relationships with that firm. In addition extensive due diligence is generally undertaken on the business irrespective of anti-money laundering requirements, together with regular monitoring. This relationship typically results in a very well known customer base.

   As a result of these factors the general risk of money laundering in the sector is low. However, the obligation remains for a firm to carry out further investigative work where circumstances exist that may result in an increased risk of money laundering or terrorist financing.

   In assessing the risks that may be present in the course of a transaction it is necessary to look at the level of risk posed by the each type of product, and the type of customer with whom the firm may deal, in relation to such a product transaction.

2. RISKS REGARDING INVESTORS AS CUSTOMERS

   2.1. Product Risk

   Investment is usually long term and illiquid and by way of limited partnership, which is collectively managed or advised by the private equity firm, with payments out being made to the original investor. As such, the risk inherent in this product is low.

   2.2. Customer Risk

   2.2.1 Institutions and High Net Worth Individuals

   Investors are generally institutions and high net worth individuals in respect of whom a high level of due diligence is usually undertaken in any event and who will often commit to consecutive investments with the firm. Accordingly, such investors are low risk. Reasonable care should, however, be taken in respect of any high net worth individuals. (Please refer also to our separate summary of guidance for wealth management firms for details of the specific considerations applicable to this category of business.)

   Identification checks in respect of investors in a fund should be completed before the fund closes, or where there is an assignment of a fund, before the assignment is completed.

   2.2.2 Fund of Funds

   Where the investor is a fund of funds the following all need to be understood:

   • Source of the funding;
   • Controller of the fund (the manager):
     • where the manager is regulated, and subject to supervision in the UK or comparable EU regulation and supervision, no further investigation will be required.
     • where the manager is not from a comparable jurisdiction, the firm should exercise discretion to properly assess the underlying risk presented, taking into account:
   • the manager's profile;
   • the track record of the investors in the industry; and
   • its willingness to explain its identification procedures and to provide confirmation that all underlying investors have been identified and are known to the manager.
   • Underlying investors - where identification of underlying investors is subject to confidentiality restrictions, a risk-based approach should be adopted.

   2.2.3 Corporate Investors

   Evidence of identity of a corporate investor, that is neither well known nor quoted on a UK or comparable regulated market or exchange, should be sought by establishing the corporate investor's external accountants, lawyers and brokers and their reputation in the market, together with such other information as they may then consider necessary, taking a risk-based approach.

   2.2.4 Company Pension Scheme

   Where investment decisions are made by representatives of the employer, verification of the identity of those individuals should be sought as well as evidence of their authority to make the decisions.

3. RISKS OF INVESTING IN BUSINESSES

   3.2. Product Risk

   The funding is generally long term, to unquoted companies with the company and management being subject to rigorous due diligence, in any event, prior to funding. The company will also be subject to ongoing monitoring, often involving board representation and receipt of regular financial information. As such, the product is considered low risk. However, if any of the usual commercial monitoring or investigation is not undertaken the need for additional verification and/or monitoring will need to be considered on a risk-based approach.

   3.2. Customer Risk

   3.2.1 Parties to the Transaction

   There are frequently many parties to a transaction and each party involved needs to be considered independently as set out below:

   Target Company
   Directors should all be identified and verified as set out in the main part of this guidance.

   In addition, where the firm is acquiring securities direct from a shareholder, whilst such shareholder is not a customer of the firm for the purposes of the Money Laundering regulations, the firm should be aware of who the vendors are and have sufficient information on them to demonstrate that they have no knowledge, or reasonable grounds for suspicion, of Money Laundering.

   The jurisdiction of the target should not cause further verification to be required provided that the choice is understood and reasonable in the circumstances.

   Relevant Co-Investor
   Relevant co-investors to a lead investor must be identified and, if deemed necessary from the potential risk presented by them, verified.

   Purchaser on Exit
   If the sale is to a member of existing management who is known to the private equity firm with regard to the investment in question, the need for verification may be considered in the light of the existing relationship and knowledge.

   For other prospective purchasers, firms should be aware of the potential risk that the pressure to secure a successful exit may create and should thus ensure that its controls, with regard to identification and verification of exit, are sufficiently robust to withstand this.

4. TIMING OF IDENTIFICATION

   Identification checks should be completed on the target company and its directors and potential directors, on the relevant co-investor and, if necessary, on any purchaser on exit when it is reasonably certain that the deal will complete and, in any event, before completion of the investment.

5. USE OF THIRD PARTY VERIFICATION

   The firm may, if considered appropriate, and using a risk-based approach, take account of written information or assurances provided by other professional advisers.