28 February 2020 - Post by:
The definition of a Politically Exposed Person (PEP) is an important one to understand for those involved in financial crime compliance. PEPs are considered to be more vulnerable to corruption so those who deal with them are often obliged to exercise a higher degree of caution. Under UK money laundering laws, dealing with a PEP requires higher level (enhanced) due diligence. Sometimes it is obvious whether someone is a PEP, or if a corporate customer is linked to a PEP. But it is not always that clear, particularly in relation to those individuals who work at commercial enterprises which are owned or partially owned by a State. A recent UK Court of Appeal decision has provided guidance on the meaning of ‘State-owned enterprise’ (on which there was a surprising lack of any previous authority) and PEPs
Chasing the proceeds of crime
Mrs H (the appellant) is the wife of an ex-Chairman of the International Bank of Azerbaijan. The Bank was the largest bank in the country; and the Azerbaijan Democratic Republic had a shareholding of “not less than 50.2%”. Mr H has been convicted in Azerbaijan for misappropriation, abuse of office, large-scale fraud and embezzlement. He is now in prison there. Mrs H is in the UK, not in prison but being pursued for proceeds of crime by the UK National Crime Agency (NCA).
Mrs H’s lifestyle was far more lavish than her husband’s salary as a bank chairman justified. The NCA suspected that she was spending the proceeds of her husband’s crimes. In its first use of an ‘Unexplained Wealth Order’ the NCA sought to confiscate two London properties. To succeed, the NCA had to show that Mr H was a PEP. This would mean that, as a close family member, Mrs H would also be considered to be a PEP. Mrs H argued that her husband did not work for a ‘State-owned enterprise’ and, even if he did, he was not a PEP.
Definition of a PEP
The definition of a PEP in the Proceeds of Crime Act 2002 (POCA) is:
“ a person who is – (a) an individual who is, or has been, entrusted with prominent public functions by an international organisation or by a State other than the United Kingdom or another EEA State,” [Emphasis added]
POCA states that whether a person has been entrusted with a prominent public function should be determined in accordance with Directive 2015/849/EU (4MLD) which provides (at Art 3) that:
‘Politically exposed person’ means a natural person who is or who has been entrusted with prominent public functions and includes the following…..:
….(g) members of the administrative, management or supervisory bodies of State-owned enterprises;. [Emphasis added]
Partially owned company can still be a ‘State-owned enterprise”
Mrs H argued that the Bank was not a State-owned enterprise because there is a distinction between an enterprise that is State-owned and a company whose shares are owned in part by a government body. The Bank was simply a commercial bank substantially owned by the government of Azerbaijan. The fact that the State had a large shareholding in the Bank did not make it a State-owned enterprise, she argued. Mrs H relied on expert evidence that under Azerbaijani law the Bank, which is an Open Joint Stock Company, is not a “state organisation” but a “normal commercial entity”.
The Court of Appeal disagreed. On the facts, the State owned over 50% of the Bank and had ‘ultimate control’. It was therefore a State-owned enterprise. Azerbaijani expert evidence on the status of the Bank was irrelevant as the matter was one of English law.
Chairman of State-owned enterprise is a PEP
Mrs H argued that being a chairman of a State owned bank and being entrusted with ‘prominent public functions’ did not necessarily go hand in hand. Although Mr H was chairman of the Bank, there was no evidence that he was entrusted with prominent public functions ‘by an international organisation or by a State’. He was therefore not a PEP, according to Mrs H.
The Court of Appeal again disagreed. The words in POCA, ‘an individual who is, or has been, entrusted with prominent public functions’ match article 3(9) 4MLD. The question is whether the POCA words, ‘by an international organisation or by a State other than the United Kingdom or [another] EEA State’ (not mirrored in 4MLD), added a further qualification: that the individual has to be specifically entrusted either by an international organisation or by a State. The answer is no – the focus of the statutory wording is on the status of the entrusted person and not how that person has come to be entrusted with prominent public functions. The intent is to exclude from the definition of a politically exposed person those who are entrusted with prominent public functions in either the UK or another EEA State. As the Bank is a State-owned enterprise, Mr H was a PEP because he was its Chairman and therefore fell within article 3(9)(g) 4MLD (“members of the administrative, management or supervisory bodies of State-owned enterprises“). In other words, by definition he was to be treated as ‘entrusted with prominent public functions’. This meant that Mrs H was also a politically exposed person because she was a family member of Mr H.
Foreign sovereign wealth funds and PEPs
The court was asked to comment on how its interpretation of ‘State-owned enterprise’ applied to a UK commercial enterprise, for example a hotel largely owned by a foreign sovereign wealth fund. Would a director of the hotel, asked Mrs H, be a PEP? The court found it ‘unnecessary to consider other issues which may arise in relation to commercial investments by foreign sovereign fund bodies in order to assess whether they are ‘State-owned”’.
The finding on the meaning of a ‘State-owned enterprise’ is helpful, as the same term is used in the definition of a PEP both in POCA and the Money Laundering Regulations 2017 (MLR). The Court of Appeal confirms that the test is based on factual questions of ownership and control, not legal status or powers. This is consistent with the FCA’s approach. Its Guidance on PEPs states that State-owned enterprises are “for profit enterprises where the State has ownership of greater than 50% or where information reasonably available points to the State having control over the activities of such enterprises.” The FCA guidance implies that there may be instances where a State has less than 50% ownership but still exercises control. This was also contemplated in the first instance judgment in the Hajikeva case, but not considered by the Court of Appeal. A State could have control of an enterprise in which it holds a minority stake if, for example, legal stipulations or corporate articles of association ensure the State effectively controls the enterprise or its board of directors.
The finding on the meaning of ‘person entrusted with a prominent public function’ is also helpful. Although the finding was restricted to the meaning of this phrase under the UWO provisions in POCA, the court highlighted the close connection between the definition of a PEP in POCA and 4MLD. The MLR definition mirrors 4MLD. The Court of Appeal’s decision suggests that whether an individual has been entrusted with a prominent public function can be taken as a given for certain senior level individuals at a State-owned entity. There is no need to analyse how the prominent public function is conferred. This is pragmatic. It would be onerous in practice to find out exactly how an individual has been conferred with ‘public functions’ and the scope of them.
A ‘relevant person’ (as designated under the MLR) must analyse whether an individual is a PEP to determine whether heightened scrutiny is required (e.g. enhanced due diligence, escalated decision making/approval processes, ongoing monitoring). Other businesses will want to understand who is a PEP, in order to have adequate compliance policies and procedures in place under the Bribery Act 2010. Dealing with a PEP is listed as a higher risk activity in the UK Government’s Guidance on Adequate Procedures under the Bribery Act 2010, although there is no definition of a PEP in the Bribery Act.
PEP status does not of course mean that transactions by that individual are inappropriate. However being a PEP does put a customer into a higher risk category. This ruling helps those who have to decide whether a person working at a part State-owned entity falls in that category.
Hajiyeva v National Crime Agency  EWCA Civ 108.
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