In the realm of anti-money laundering (AML) and countering the financing of terrorism (CFT) compliance, the concepts of "source of wealth" and "source of funds" are frequently used interchangeably. However, they represent distinct ideas that financial institutions and other reporting entities must grasp and verify as part of their customer due diligence responsibilities.
Source of Funds (SoF)
Source of funds pertains to the origin of the money employed in a particular transaction or business relationship. It addresses the question, "Where did the money for this transaction originate?" In essence, it is the activity, event, or circumstance that generated the funds involved in the transaction.
Examples of source of funds include:
- Earnings or wages from employment
- Proceeds from the sale of assets (e.g., real estate, investments)
- Inheritance or gifts
- Loans or credit facilities
- Business revenue
By verifying the source of funds, reporting entities can assess whether the transaction aligns with the customer's profile and whether there are any indications that the funds may be derived from illegal activities.
Source of Wealth (SoW)
Source of wealth, in contrast, refers to the origin of a customer's entire wealth portfolio. 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
- Family wealth or inheritance
- Lottery or gambling winnings
Understanding a customer's source of wealth helps reporting entities evaluate the customer's overall financial profile and determine if their wealth is proportionate to their known sources of income and assets.
The Importance of Source of Funds and Source of Wealth
Verifying the source of funds and source of wealth is a vital component of a risk-based approach to AML 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 program.
3. Meet their transaction monitoring and suspicious activity 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 offense.
Techniques for Verifying 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 necessitate more extensive verification compared to lower-risk customers.
Some common methods for verifying source of funds and source of wealth include:
- Reviewing bank statements, pay stubs, 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 certified public accountant (CPA)
- Conducting site visits to the customer's business premises
- Reviewing publicly available information, such as media reports or court records
- Obtaining references from reliable third parties, such as banks or professional advisors
- Analyzing the customer's financial statements and business records
Real-World Scenarios for Verifying Source of Wealth and Source of Funds
1. High-Value Art Purchase: When a customer purchases a multi-million dollar painting at an auction using funds from the sale of another artwork, 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 auction house confirming the transaction details to verify the source of funds.
2. 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 attorney confirming the transaction details to verify the source of funds.
3. Technology Startup Founder: If a high-net-worth customer's source of wealth is derived from their founding and subsequent sale of a successful technology startup, you may obtain the sale agreement, a share registry confirming the customer's ownership, and a letter from the customer's CPA outlining the customer's proceeds from the sale to verify the source of wealth.
4. Life Insurance Payout: When a customer receives a substantial life insurance payout following the death of a spouse and wishes to invest the funds, you may request a copy of the life insurance policy, a death certificate, and bank statements showing the transfer of the insurance payout to the customer's account to verify the source of funds.
5. 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.
6. Professional Athlete: If a high-risk customer's source of wealth is attributed to their career as a successful professional athlete, you may obtain the customer's contracts with their team or sponsors, tax returns for the past three years, and a copy of their professional awards and achievements to verify the source of wealth.
7. Government Grant: When a customer receives a large government grant to fund a research project, you may request a copy of the grant agreement, bank statements showing the disbursement of the grant funds to the customer's account, and a project proposal outlining the purpose and expected outcomes of the research to verify the source of funds.
8. 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 letters testamentary, along with bank statements showing the transfer of the inherited funds to the customer's account to verify the source of funds.
9. 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 crucial elements of a robust AML 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 essential to ensure ongoing compliance with BSA/AML obligations.
If you're unsure where to begin with your AML 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 compliance.
