You can’t judge a book by its cover. This maxim applies for the “Know Your Client" (KYC) and "Know Your Provider" (KYP) practices.
In order to mitigate threats of fraud, money laundering, terrorist financing, and other crimes, it is necessary to know your customers and suppliers, the nature of their activities, and the potential risks that may derive from them.
No one is free from being blinded by a customer or supplier who comes in with the aim of generating profits. But beware, because behind them there might be people with bad intentions who end up causing serious legal, economic and reputational problems to the organization.
Problems can be Contagious
One thing must always be clear: customer problems and bad practices can directly affect their business partners. If that happens, then it will not be enough to say that they did not know what they were doing, because the law in many countries, including Guatemala, requires “obligated persons”[1]to know their clients and to have a record and control of their activities, documents that must be kept for a period.
In addition, anti-money laundering laws prohibit transactions with customers who do not provide the required information and documentation in a timely manner. And they specify that prevention programs must be adopted to avoid the improper use of services and products in money laundering or other asset laundering activities. This includes ongoing training, audit mechanisms, and specific measures to know and identify clients.
Internationally, there are high-profile experiences, such as what happened in HSBC bank[2] in 2012. The bank was fined US$1.9 billion for allowing Mexican drug cartels to launder money through them. The lack of effective KYC controls allowed them to open accounts in the name of shell companies and people involved in illicit activities.
In this case with suppliers, a similar situation occurred with the Brazilian oil company Petrobras[3] (part of the case known as Operation Lava Jato), where a corruption scheme involving several of its suppliers was uncovered. Here, the lack of a robust KYP process allowed bogus companies to receive millionaire contracts in exchange for bribes, which not only resulted in financial losses, but also generated a scandal of great magnitude that seriously affected the image of Brazil and the company throughout the region.
These and other examples have had far-reaching consequences in recent years and have introduced a new culture, as many organizations –even those not required to do so–, have begun implementing comprehensive controls and periodically review and adjust them to minimize vulnerabilities and better manage their risks.
The Consequences of Lacking Controls
Implementing KYC and KYP processes is not only a recommended practice, but a necessity in the modern business environment. This goes beyond whether general laws or industry-specific regulations require it. Otherwise, you might face several threats and can even jeopardize business continuity and the operation.Some of the consequences include:
- Regulatory sanctions: obligated companies that fail to comply with KYC and KYP regulations may face severe sanctions from regulatory agencies. These sanctions include prohibition or suspension from participating in competitive procurement processes. In some cases, directors and/or managers may face criminal charges.
- Reputational damage: exposure to fraud, negligence, or illegal activities can severely damage a company's reputation, which can result in loss of trust from customers, partners, employees, and other stakeholders, accompanied by a decrease in the value of the company and loss of business opportunities.
- Financial and operational impact: Beyond fines, the financial cost of poorly implemented KYC and KYP procedures includes lost revenue, the cost of internal investigations, legal fees, business interruption, potential asset seizure, and loss of access to financial markets. All of this could push the company over the edge and even into insolvency.
For these reasons, companies today must adopt a culture of compliance and be constantly monitoring to identify and mitigate any potential risks. Investing in KYC and KYP processes today is an investment in the long-term stability and success of any organization.
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[1] In Guatemala, the Anti-Money Laundering Law establishes the obligation to have client registries. Its Regulation establishes the obligated persons, among which are banks, exchange houses, companies that promote real estate, and others that by their nature would carry out systematic and considerable transfers of assets.
[2] https://www.investopedia.com/stock-analysis/2013/investing-news-for-jan-29-hsbcs-money-laundering-scandal-hbc-scbff-ing-cs-rbs0129.aspx
[3] https://www.ft.com/content/a7b43142-6675-11e9-9adc-98bf1d35a056