Feeling that you haven’t been as familiar with your clients as you could be? Not to worry – you’re about to get to know them a whole lot better.
Client identification and verification requirements based on the Model Rule on Client Identification and Verification Requirements adopted by the Federation of Law Societies of Canada (FLSC) are now in force in nearly every jurisdiction.
Because the rules implemented by the law societies are based on the FLSC Model Rule in an effort to harmonize requirements across the country, this article offers general suggestions based on the text of the Model Rule, with references for ease of reading to generic "Know Your Client Rules" or "KYC Rules." Readers are advised to consult the official version of the KYC Rules adopted by their governing society for specific information about the rules in place in each jurisdiction, and to verify that no material discrepancies exist between the description of the Model Rule used herein and their applicable governing rule. (As of Jan. 1, 2009, all but two Canadian jurisdictions had implemented KYC rules; Quebec and Saskatchewan were expected to follow soon).
The KYC Rules arose partly as a response to federal government efforts to regulate suspicious and fraudulent transactions by means of the Proceeds of Crime (Money Laundering) and Terrorist Financing Act (enacted in 2000) and, in particular, amendments and regulations to the statute promulgated in 2007. From the time the Act was introduced, the profession objected to the applicability of the reporting requirements under the legislation to lawyers, on the basis that they interfered with solicitor-client privilege and self-governance principles. Subsequent litigation led to an interlocutory order of the BC Supreme Court exempting lawyers from the reporting scheme until the matter was finally determined, and in 2005 all parties agreed that any further proposed amendments or regulations under the Act impacting lawyers or law firms would require either consent of all parties, or the court’s confirmation of constitutional validity.
Following the 2007 amendments and regulations concerning client identification, the FLSC elected to codify the steps a prudent lawyer would take in the normal course to verify a client’s identity and initiatives were undertaken to develop the Model Rule. The KYC Rules adopted in each province and territory constitute a professional ethical obligation for lawyers, which will be monitored and enforced by the applicable law society.
There are some important exceptions. For example, in the FLSC Model Rule the requirements to "identify" the client and "verify" the identity of the client do not apply when the client is a financial institution, public body, or "reporting issuer" (i.e. an organization that is a reporting issuer within the meaning of securities law of any province or territory of Canada, or a publicly traded company or its subsidiary). There is also an exception related to the mode of handling where the payment, receipt or transfer of funds is by electronic funds transfer, a defined term in the Model Rule. Different KYC Rules as adopted in the different provinces and territories treat the identification and verification slightly differently - so, for example, in Ontario the "identification" obligation applies regardless of any exceptions, but the "verification" obligation can be overriden by the presence of an applicable exception.
Implementing Your Obligations – The IVRW Structure
The KYC Rules are structured around four primary obligations:
The Identification and Verification obligations form the core concepts of the KYC Rules and, though they can occur temporally quite close together, they involve distinct processes and are triggered by different events, as described below.
The KYC Rules are intended to act as a screening device for potential money-laundering and anti-terrorist financing initiatives and so they, subject to a number of exceptions detailed below, apply to a wide range of activities relating to "funds." "Funds" is defined broadly to mean cash, currency, securities and negotiable instruments or other financial instruments that indicate the person’s title or interest in them. The range of activities includes the receiving, paying or transferring of funds or the giving of instructions in respect thereof (in other words, even if a lawyer does not personally ever hold the funds but merely provides instructions on behalf of the client, the lawyer’s obligations are engaged).
Under the KYC Rules, lawyers are required to "identify" each client at the commencement of a new retainer with respect to a matter and, with respect to organizations, undertake reasonable efforts to "identify" directors and owners of significant interests in the client (i.e., those holding more than 25 per cent of the client) whenever funds are handled on behalf of the client. If a client refuses to provide the required information, lawyers are obliged to decline representation of the client as to do otherwise would involve a breach of their professional obligations.
What constitutes "identification" is stipulated in detail in the KYC Rules and requires a lawyer to obtain a wealth of information, which varies depending on a number of factors: the type of client (individual or organization); whether there has been a simple retainer or whether funds are going to be handled imminently; and, with respect to organizations, the type of organization in question.
There is also a distinction between what information a lawyer is required to obtain and what information the lawyer must only make reasonable efforts to obtain – the lower standard applies to information about directors and significant interest owners that is required to be obtained when handling funds. "Reasonable efforts" may be achieved by asking the client for the information or consulting corporate minute books or online corporate registry databases.
The chart below summarizes the Identification requirements in each scenario.
Information Required When Retained
- full name
- business address and business telephone number (if applicable)
- home address and home telephone number
- full name
- business address and business telephone number
- incorporation number or business ID number and the place of issue of its incorporation or business ID number
- general description of the type of business or activity undertaken*
- name, position and contact information of individual(s) authorized to give instructions with respect to the matter for which lawyer is retained
* not required if client is a "financial institution," "public body" or company that is not a "private company"
NB: if the client is acting for or representing a third party, a lawyer is required to collect information about that third party as set out above (under "Individual" or "Organization," as applicable)
Information To Be Obtained When Engaging In or Giving Instructions in Respect of Receiving, Paying or Transferring Funds
Lawyer must make reasonable efforts to obtain:
- the name and occupation(s) of each director of the organization (unless organization is a securities dealer)
- the name, address and occupation(s) of each person who owns 25 per cent or more of the organization
As noted above, the Identification process must be undertaken at the time of retainer by the client. Where a lawyer has a relationship with a client that precedes the coming into effect of the KYC Rules, the Identification process must be undertaken at the time of being retained on any new matter. In other words, for matters that are "in progress" on the date on which the KYC Rules come into effect, the KYC Rules do not impose an Identification obligation (however, they do impose a Verification obligation, described in the next section, if the handling of funds occurs after the effective date).
Once a lawyer has complied with his or her Identification obligation with respect to a particular client, the Identification process does not need to be repeated for that client on future matters unless (a) the lawyer has reasonable grounds to believe that the information provided by the client has changed or (b) the client is an organization and the person authorized to instruct the lawyer changes, in which case the lawyer must obtain the relevant information about that person (i.e., name, position and contact information). (NB: The Model Rule is curiously silent about "multiple identifications," however the KYC Rules that have been implemented in all provinces and territories to date appear to have addressed this lacuna consistent with the advice contained in this paragraph.)
Two elements distinguish the Verification obligation from the Identification obligation. First, while the Identification obligation relates primarily to the collection of information, the Verification obligation extends to the examination of "independent source documents" to confirm that the information gathered at the Identification stage is accurate. Second, the Verification obligation is triggered only when a lawyer, on behalf of a client, engages in or gives instructions in respect of the receiving, paying or transferring of funds – subject to a host of exceptions (described below). Thus, while every new client retainer will involve an Identification obligation, not every client retainer will involve a Verification obligation.
Timing of Verification
When dealing with individuals (including an individual who is authorized to give instructions on behalf of an organization), the verification process must occur "upon engaging in or giving instructions in respect of" the receiving, paying or transferring of funds. As a practical matter, this means that the verification process must occur prior to the handling of the funds. Once the identity of an individual has been verified, no re-verification is required so long as the lawyer recognizes the individual.
When dealing with an organization, the verification process must occur within 60 days of engaging in or giving instructions in respect of the receiving, paying or transferring of funds. Once verified, a lawyer is not obliged to re-verify the identity of the organization (but re-verification is required when the identity of the organization changes or when the individual(s) giving instructions on behalf of the organization change(s)).
Exceptions to Verification
As the KYC Rules are designed to catch potentially fraudulent or money-laundering activities, exemptions to the Verification obligation are made for situations that relate directly to the provision of professional services and/or involve the handling of funds by bodies that are themselves transparent or otherwise subject to verification and identification obligations. Thus, the Verification obligation is not triggered when the funds in question are:
- paid by or to a "financial institution," "public body" or "reporting issuer";
- received by a lawyer from the trust account of another lawyer;
- received from a peace officer, law enforcement agency or other public official acting in his or her official capacity;
- paid or received pursuant to a court order or to pay a fine or penalty;
- paid or received as a settlement of any legal or administrative proceedings;
- paid or received for professional fees, disbursements, expenses or bail.
Source Documents for Verification
If the Verification obligation has been triggered and none of the exceptions are applicable, a lawyer is obliged to "take reasonable steps to verify the identity of the client and, where appropriate, the third-party beneficiary or principal, using what the lawyer reasonably considers to be reliable independent source documents, data or information."
The KYC Rules do not dictate what "independent source documents" a lawyer must consult. Instead, they provide illustrations of appropriate source documentation.
Examples of Appropriate Independent Source Documentation
- valid original government-issued identification
- driver’s licence
- birth certificate
- health insurance card
- written confirmation from a government registry as to existence/name/address, including names of directors and officers
- a copy from a public body of a record that the organization is required to file annually under applicable legislation
- a copy of a similar record obtained from a public body that confirms the organization’s existence
- if the organization is not registered in a government registry (such as a trust or partnership) a copy of the organization’s constating documents (such as a trust or partnership agreement)
Verifying Non-face-to-face Transactions (Client in Canada)
There are separate rules applicable where a lawyer is dealing with a client in a "non-face-to-face transaction" but the individual is present in Canada (i.e., where the client is an individual who is not physically present before the lawyer but is present elsewhere in Canada). In such circumstances, the lawyer is obliged to verify the client’s identity by obtaining an attestation from a commissioner of oaths in Canada, or a guarantor in Canada, that the commissioner or the guarantor has reviewed one of the suggested "independent source documents."
The KYC Rules stipulate that the attestation must be produced on a legible photocopy of the document and include certain identifying information (i.e., the name, profession and address of the person providing the attestation, the signature of the person providing the attestation and the type and number of the source document). Where a commissioner of oaths is not available, a guarantor must belong to one of 15 prescribed professions (including dentists, medical doctors, accountants and professional engineers).
Verifying Non-face-to-face Transactions (Client Not in Canada)
When dealing with a client who is not physically present in Canada, a lawyer is required to retain an agent to obtain the information necessary to verify the client’s identity. The agent will preferably be a lawyer or notary or, failing that, a member of one of the professions eligible to provide an attestation.
That verification process can include an attestation in the manner described above. When an agent is retained for this purpose, the KYC Rules require that the lawyer and agent enter into a written agreement for the purpose, stipulating the steps to be taken by the agent.
The record-keeping requirements under the KYC Rules are relatively straightforward:
- a copy of all information obtained and each document used for Identification and/or Verification purposes must be retained;
- copies can be in electronic form, so long as a paper copy can be readily produced; and
- the copies must be retained for the longer of:
- the duration of the lawyer/client relationship,
- the period necessary for the purpose of providing service to the client, and
- six years following completion of the work for which the lawyer was retained.
Strictly speaking, the Withdrawal obligation contained in the KYC Rules is not new: existing Rules of Professional Conduct require lawyers to withdraw their services when they suspect they are being asked to participate in dishonest, fraudulent, illegal or criminal activities. The KYC Rules clarify and codify the Withdrawal obligation, but it should be noted that the Withdrawal obligation as contained in the KYC Rules extends beyond the confines of the Identification and Verification processes.
The Withdrawal obligation becomes effective on all lawyers on the date the KYC Rule comes into effect in the relevant jurisdiction. This means that the Withdrawal obligation applies to any matter for which a lawyer is retained, whether that retainer occurred prior to the effectiveness of the KYC Rules or arises thereafter.
The KYC Rules impose two separate Withdrawal obligations: one that relates to the Identification and Verification processes, and one that applies generally to the representation of a client. In both cases, the substance is the same: if a lawyer reasonably suspects that he or she is or would be assisting a client in dishonesty, fraud, crime or illegal conduct, the lawyer must withdraw from representation of the client.
To What Lawyers Do These Rules Not Apply?
It is important to bear in mind that the Withdrawal obligation applies to all lawyers in all circumstances. However, the Identification and Verification obligations do not apply to lawyers who fall into the following categories:
- Employees – Where a lawyer provides legal services and engages in or gives instructions in respect of the receipt, payment or transfer of funds on behalf of his or her employer.
- Acting as agent for another lawyer who has already complied
- – Where a lawyer acts (i.e., provides legal services and/or engages in or gives instructions in respect of the receipt, payment or transfer of funds) as an agent for another lawyer and has undertaken due diligence to confirm that the principal lawyer has already fulfilled the Identification and Verification obligations.
- Acting on referral from another lawyer who has already complied
– Where a lawyer acts (i.e., provides legal services and/or engages in or gives instructions in respect of the receipt, payment or transfer of funds) for a client referred by another lawyer and has undertaken due diligence to confirm that the referring lawyer has already fulfilled the Identification and Verification obligations.
Because the Identification and Verification obligations do not apply in the foregoing three circumstances, the Record-keeping obligations consequently do not apply in those circumstances.
Though the KYC Rules may at first glance appear to impose arduous new obligations on lawyers, a comprehensive review of the structure and exceptions reveals that they present a manageable set of expectations. A variety of materials has been made available by the various law societies, and links are provided below to some of the more pertinent. One item that each practitioner will need to address regards any additional costs incurred as a result of compliance with the rules.
While the Model Rule is silent on the subject, there are no prohibitions on lawyers charging a disbursement to cover the costs – it will thus be left to individual practitioners and firms to assess whether the matter is best treated as an additional overhead item or a separate levy to clients.
On January 15, 2009, Lorraine Lawyer received a call from Jesse asking her to represent him on a new matter. Catherine previously represented Jesse on a large number of matters in a lawyer/client relationship extending back nearly 15 years. What does Lorraine need to do in order to comply with the KYC Rules?
- Lorraine needs to abide by the Identification and Record-keeping requirement (and, if funds are being handled, the Verification requirements), regardless of the duration of her previous relationship with the client.
Larry Lawyer, who carries on the practice of law from his office in Waterloo, Ontario, receives a phone call from Katherine Client, who is resident in Vancouver, British Columbia. Katherine tells Larry she is acting as principal for a corporation located in Japan, and that the corporation would like to retain Larry in order to close a purchase transaction on an expedited basis, which will involve Larry handing over a cheque for the purchase price to the seller. What does Larry need to do in order to comply with the KYC Rules?
- The Identification obligation will apply to both Katherine and the Japanese corporation, which means that Larry will need to inquire about the basic identifying information for Katherine, the Japanese corporation and the individual(s) authorized to give instructions on behalf of the corporation to Katherine (and, because Larry will be handling funds, he will be obliged to inquire into the directors and owners of the Japanese corporation).
- The Verification obligation will apply to both Katherine and the Japanese corporation. Because Larry is not dealing with Katherine face-to-face, but she is physically present in Canada, Larry will need to obtain an attestation or guarantor’s statement that they have reviewed the source documentation. Because Larry is not dealing with the Japanese corporation face-to-face, and they are not present in Canada, he will need to enter into a written agreement with an agent who can provide the required attestation that the agent has reviewed the independent source documentation.
Larry is unable to verify the identity of Katherine. What are Larry’s obligations under the KYC Rules?
- Larry is obliged to cease representation of Katherine and the corporation, as continuing to do so without having complied with the KYC Rules is a breach of his professional obligations.
Larry is unable to obtain information to his satisfaction about the names, addresses and occupations of the directors and shareholders of the Japanese corporation. What are Larry’s obligations under the KYC Rules?
- Provided that Larry has made reasonable efforts to obtain the information, Larry is not obliged to withdraw from his representation of the corporation. Larry should, however, consider whether his inability to obtain the information is indicative of an issue that rises to a level that triggers his Withdrawal obligation (i.e., reasonable suspicion of participation in dishonest, fraudulent, illegal or criminal activities).
Larry is able to verify the identity of Katherine and is able to obtain the required information regarding the directors and shareholders of the Japanese corporation. However, despite his best efforts, he is unable to verify the identity of the Japanese corporation within 60 days of being retained. Because the transaction was moving so quickly, the transaction has now closed and Larry handled the funds in the absence of completed verification of the Japanese corporation’s identity. What is Larry’s position under the KYC Rules?
- Although such a scenario is not expressly contemplated in the Model Rules per se, the FAQs of various law societies indicate that, so long as Larry took all reasonable steps to comply with the Verification obligation within the 60-day period, he will not be in breach of the KYC Rules (see, e.g., Ontario FAQ #31 and Alberta FAQ #9).
Bob Tarantino is a freelance writer and entertainment lawyer in Toronto. He is the author of Under Arrest – Canadian Laws You Won’t Believe (Dundurn 2007), and can be reached at firstname.lastname@example.org.