In the world of anti-money laundering (AML) and counter-terrorism financing (CTF) compliance, the terms "source of wealth" and "source of funds" are often used interchangeably. However, they refer to distinct concepts that are crucial for financial institutions and other reporting entities to understand and verify as part of their customer due diligence obligations.
What is Source of Funds (SoF)?
Source of funds refers to the origin of the money used in a specific transaction or business relationship. It answers the question, "Where did the money for this transaction come from?" Essentially, it is the activity, event, or circumstance that generated the funds involved in the transaction.
Examples of source of funds include:
- Salary or wages from employment
- Proceeds from the sale of assets (e.g., real estate, investments)
- Inheritance or gifts
- Loans or credit facilities
- Business income
Verifying the source of funds helps reporting entities determine if the transaction is consistent with the customer's profile and whether there are any indicators that the funds may be derived from criminal activities.
What is Source of Wealth (SoW)?
Source of wealth, on the other hand, refers to the origin of a customer's entire body of wealth. It answers the question, "How did the customer acquire their overall assets and net worth?" Source of wealth encompasses the economic, business, or commercial activities that have generated or significantly contributed to the customer's total wealth.
Examples of source of wealth include:
- Accumulated business profits
- Investments and capital appreciation
- Professional earnings (e.g., doctors, lawyers, accountants)
- Family wealth or inheritance
- Lottery or gambling winnings
Understanding a customer's source of wealth helps reporting entities assess the customer's overall financial profile and determine if their wealth is commensurate with their known sources of income and assets.
Why are Source of Funds and Source of Wealth Important?
Verifying the source of funds and source of wealth is a critical component of a risk-based approach to AML/CTF compliance. By collecting and verifying this information, reporting entities can:
1. Identify and assess potential money laundering and terrorist financing risks associated with a customer or transaction.
2. Apply appropriate risk-based systems and controls in accordance with their AML/CTF program.
3. Meet their transaction monitoring and suspicious matter reporting obligations.
4. Determine if there are reasonable grounds to suspect that a customer's funds may be derived from criminal activities or linked to the investigation of a criminal offence.
How to Verify Source of Funds and Source of Wealth
The level of verification required for source of funds and source of wealth depends on the assessed risk level of the customer or transaction. Higher-risk customers, such as politically exposed persons (PEPs) or those involved in complex or unusual transactions, may require more extensive verification compared to lower-risk customers.
Some common methods for verifying source of funds and source of wealth include:
- Reviewing bank statements, payslips, tax returns, or other financial documentation
- Obtaining information from independent, reputable sources (e.g., company registries, commercial databases)
- Requesting a formal declaration from the customer
- Obtaining written confirmation from a legal practitioner or accountant
Examples of Verifying Source of Wealth and Source of Funds
1. Real Estate Sale: When a customer purchases a high-value property using funds from the sale of another property, you, as the reporting entity, may request a copy of the sale contract, bank statements showing the transfer of funds from the sale, and a letter from the customer's lawyer confirming the transaction details to verify the source of funds.
2. Business Ownership: If a high-net-worth customer's source of wealth is derived from their ownership of a successful manufacturing company, you may obtain audited financial statements of the company, a share registry confirming the customer's ownership, and a letter from the customer's accountant outlining the customer's annual income and dividends from the business to verify the source of wealth.
3. Inheritance: When a customer receives a substantial inheritance from a deceased relative and wishes to invest the funds, you may request a copy of the will or a certified copy of the grant of probate, along with bank statements showing the transfer of the inherited funds to the customer's account to verify the source of funds.
4. Professional Earnings: If a high-risk customer's source of wealth is attributed to their career as a successful surgeon, you may obtain the customer's tax returns for the past three years, a letter from their employer confirming their position and annual salary, and a copy of their professional license and qualifications to verify the source of wealth.
5. Loan Funding: When a customer receives a large loan from a bank to finance a business venture, you may request a copy of the loan agreement, bank statements showing the disbursement of the loan funds to the customer's account, and a business plan outlining the purpose and expected returns of the venture to verify the source of funds.
Understanding and verifying the source of funds and source of wealth are essential elements of a robust AML/CTF compliance program. By adopting a risk-based approach and implementing appropriate systems and controls, reporting entities can effectively identify, assess, and manage money laundering and terrorist financing risks associated with their customers and transactions. Regular training and independent review of these processes are crucial to ensure ongoing compliance with AML/CTF obligations.
If you're unsure where to begin with your AML/CTF compliance or you need assistance in enhancing your efforts to prevent financial crime, you may consider booking a free consultation with one of our experienced advisors. Our team of experts can provide valuable insights, guidance, and support tailored to your specific needs and help you navigate the complex landscape of AML/CTF compliance.
