Skip to content
Compliance & Risk

Firms need to clearly define PEPs to better review banking and criminal activity

Rabihah Butler  Manager for Enterprise content for Risk, Fraud & Government / Thomson Reuters Institute

· 5 minute read

Rabihah Butler  Manager for Enterprise content for Risk, Fraud & Government / Thomson Reuters Institute

· 5 minute read

Financial services firms and others need to ensure that they are conducting proper due diligence on the politically exposed persons (PEPs) with whom they do business

Inevitably, individuals who work in the political sphere are privy to power, money, and access to public resources, among other things. Once a person is entrusted with a position that has a prominent public function, that person can be considered a politically exposed person (PEP).

This designation would then extend beyond the person in office to their close family and associates — it may even extend beyond their time in office. These individuals represent a potential risk because they can be bribed or coerced and are vulnerable to corrupt schemes. Defining a PEP is important to provide a check on financial institutions but also to bring to bear public scrutiny as concerns might arise.

The definition of a PEP is not straightforward and, in a situation in which there might need to be additional scrutiny, it is also important to begin by seeking clarity. Obviously, a current politician or dignitary would be included in this class but how far down the food chain does one go in search of every individual deserving of this title? Part of this determination requires assessing the amount of power given. For instance, a city council member may not always be a PEP, but a U.S. president would.

In today’s political climate, it is important to identify PEPs and what reputational or other risks are associated with doing business with them. Scrutiny is important for financial institutions and can seep into the public sphere.

In the United Kingdom, the Financial Conduct Authority (FCA) clarifies the dangers of PEPs. “A PEP may be in a position to abuse their public office for private gain and a PEP may use the financial system to launder the proceeds of this abuse of office,” the agency stated. The FCA also recently announced a policy review on PEPs that, at its core, offered an excellent opportunity to revisit the regulated sector’s approach to PEPs and re-examine some of the core principles underlying the U.K.’s anti-money laundering (AML) regime.

Regulatory joint statement

A joint statement issued in August 2020 by the Board of Governors of the Federal Reserve, the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the National Credit Union Administration, and the Financial Crimes Enforcement Network (collectively, the agencies) weighs in on PEPs and the treatment they receive in business relationships. “Not all PEPs are high risk solely by virtue of their status,” the agencies say in the statement. “Rather, the risk depends on facts and circumstances specific to the customer relationship.” While acknowledging that PEPs can pose additional risks, the agencies provide no clear standard for when that risk is posed and how to handle it.

Further, the joint statement does not indicate that there is a regulatory requirement in the customer due diligence (CDD) rule, nor is there a supervisory expectation for banks to have unique, additional due diligence steps for PEPs. The CDD rule also does not require a bank to screen for or otherwise determine whether a customer or beneficial owner of a legal entity customer may be considered a PEP. In short, the review of PEPs comes down to the institution’s risk appetite.

One major difference between the U.S. and U.K., is that the U.K. requires enhanced due diligence on individuals who are considered PEPs to allow the institution to properly handle business relationships with PEPs.

Another major concern is that in the joint statement “[t]he agencies do not interpret the term ‘politically exposed persons’ to include U.S. public officials. [Bank Secrecy Act] BSA/AML regulations do not define PEPs, but the term is commonly used in the financial industry to refer to foreign individuals who are or have been entrusted with a prominent public function, as well as their immediate family members and close associates.”

When considering the loose definition of a PEP and the loose regulatory requirements surrounding it, a larger concern opens up. Corrupt PEPs might seem like a problem in underdeveloped countries or countries that are inherently corrupt, yet this is even a concern in the United States. These PEPs have domestic power and cannot be excused from scrutiny.

For example, Sen. Bob Menendez (D-NJ) wields enormous power and influence as a U.S. senator. Allegations that he used that influence to negotiate on behalf of Egypt have led to accusations that Sen. Menendez and his wife accepted “hundreds of thousands of dollars in bribes” for use of the senator’s political influence. The plot spanned over the course of at least four years and has now led to criminal charges of serving as unregistered agents of the Egyptian government. The more concerning part is that this could be just the tip of the iceberg for Sen. Menendez and his wife as the investigation into their finances and contacts is still ongoing. Even as these allegations swirl around him, Sen. Menendez has not been stripped of his political power, although he did step down as chair of the powerful Senate Foreign Relations committee after his indictment.

One thing is clear, financial institutions and other organizations need to properly define PEPs and set the standard locally and internationally. This will allow a clearer understanding to emerge, resulting in a higher level of scrutiny. More than scrutiny, however, clearly defining PEPs will allow for proper media coverage and public review of such concern.

More insights