Law firms are subject to strict and demanding regulatory compliance standards, and few areas exemplify this more clearly than the anti-money laundering (AML) regulations by which law firms must abide.

AML regulations play an essential role in ensuring that financial institutions, including law firms, are not complicit in financial crime and terrorist financing. As such, all law firms that carry out work relating to finance have a requirement to undergo regular AML audits, not only to comply with money-laundering regulations, but also to maintain the integrity and reputation of the firm. By conducting an independent AML audit, law firms can identify potential risks, mitigate financial crime, and enhance their overall compliance framework.

In this guide, we will explore the importance of AML audits, what they consist of, and why your law firm needs them to remain compliant and secure.

What AML regulations are law firms bound by?

In the UK, AML regulations are primarily governed by The Money Laundering, Terrorist Financing and Transfer of Funds (Information on the Payer) Regulations 2017. These regulations require law firms to implement robust AML procedures, including customer due diligence, transaction monitoring and suspicious activity reporting.

The Solicitors Regulation Authority (SRA) plays a central role in enforcing AML compliance among practising solicitors and law firms. Firms are expected to appoint a money laundering reporting officer (MLRO) and a money laundering compliance officer (MLCO) to oversee AML activities, who are responsible for ensuring that the firm's AML policies and procedures are up-to-date and effective in mitigating potential risks.

Key components of AML regulations include:

• Risk assessment: conducting comprehensive risk assessments to identify and evaluate the risks posed by clients, transactions and geographical locations.
• Customer due diligence: implementing procedures to verify the identity of clients and understand the nature of their business relationships.
• Record-keeping: maintaining accurate records of all financial transactions and client interactions to support audit and compliance activities.
• Suspicious activity reports: reporting any suspicious activities or transactions to the appropriate authorities.

Understanding and adhering to AML regulations is essential for law firms to ensure compliance, protect their reputation, and avoid severe penalties. An independent AML audit can help law firms assess their compliance with these regulations and identify areas for improvement.

What is an AML audit?

An AML audit is a thorough examination of a law firm's AML policies, procedures and practices to ensure compliance with relevant regulations, and to identify areas for improvement. Conducted by an independent audit function, an AML audit assesses the effectiveness of a firm’s AML programme, helping to safeguard against financial crime and ensure regulatory compliance.

AML audits should involve the following:

• Risk assessment: evaluating the firm’s risk exposure to money laundering activities.
• Policy review: examining the firm's AML policies and procedures to ensure they align with current regulatory requirements and best practices.
• Due diligence: assessing the firm’s procedures for verifying client identities, understanding client relationships, and conducting ongoing monitoring.
• Records and processes: reviewing the firm's record-keeping practices to ensure all necessary documentation is maintained accurately and is readily available for review.
• Reporting procedures: evaluating the firm’s procedures for identifying and reporting suspicious activities, including reviewing how the firm handles suspicious activity reports and other regulatory filings.

An AML audit should be considered distinct from a standard financial audit of a company's books and records, and should be carried out as a separate process. The scope of an AML audit can vary depending on the size and complexity of the firm. Larger firms may require more comprehensive audits, while smaller firms might focus on specific high-risk areas.

Many firms conduct annual AML audits to ensure ongoing compliance and to address any emerging risks or regulatory changes. Utilising an independent audit function provides an unbiased assessment of the firm's AML compliance, ensuring thorough and objective evaluations.

Why is an independent AML audit required for law firms?

While the law theoretically allows law firms to have internal functions for carrying out their own internal AML audits, this approach is often impractical for all but the largest firms. Here are the key reasons why an independent AML audit is essential for most law firms:

• Resource limitations: smaller and medium-sized law firms typically lack the resources to establish a robust internal audit function. Developing an in-house team with the necessary expertise, tools and time for comprehensive AML audits is costly and resource-intensive.
• Expertise and specialisation: internal staff may not possess the requisite AML expertise or keep up with the latest regulatory developments. Independent auditors bring specialised knowledge and experience, ensuring that your firm’s AML policies and procedures are thoroughly evaluated and compliant with current regulations.
• Objectivity and unbiased assessment: internal audits, even when performed by a designated team, can be influenced by internal biases and conflicts of interest. An independent AML audit offers an objective and unbiased evaluation of your firm’s compliance framework, ensuring that all potential issues are identified and addressed without internal influence.
• Comprehensive risk assessment: independent auditors are adept at conducting thorough risk assessments, considering all of the relevant factors. They provide a comprehensive analysis that internal teams may struggle to achieve due to limited scope or experience.

As such, a truly independent AML audit function can deliver a number of key benefits. Clients, regulators and other stakeholders are more likely to trust a firm that demonstrates its commitment to compliance through independent audits. This is part of why regulatory bodies like the SRA often recommend independent AML audits as a best practice. Adhering to these recommendations helps law firms avoid potential fines, penalties, and reputational damage associated with non-compliance.

For smaller law firms, outsourcing AML audits to independent experts is often the only viable option, providing thoroughness and expertise without the overhead costs of maintaining an in-house auditing team.

What does an independent AML audit consist of?

Conducting an AML audit involves several stages, each crucial for a thorough assessment of a law firm's AML compliance. Here is a detailed overview of how an AML audit is conducted:

Pre-audit preparation

• Gathering documentation: before the audit begins, the firm must gather all relevant documentation, including AML policies, procedures, training records, risk assessments and previous audit reports. This documentation provides the auditors with an overview of the firm's current AML framework.
• Initial meetings: the audit process starts with initial meetings between the auditors and the firm's key personnel, including the MLRO and MLCO. These meetings help establish the scope and objectives of the audit.

On-site audit procedures

• Interviews: auditors conduct interviews with staff members to assess their understanding of AML procedures and their roles in ensuring compliance. This step helps evaluate the effectiveness of AML training and awareness within the firm.
• Policy reviews: the auditors review the firm's AML policies and procedures to ensure they align with regulatory requirements and best practices. This includes assessing the adequacy of customer due diligence processes, risk assessments and transaction monitoring systems.
• System checks: auditors examine the firm's internal controls and systems used for monitoring transactions, maintaining records, and reporting suspicious activities. They test these systems to ensure they are robust and effective in detecting potential money laundering activities.
• Sample testing: to verify compliance, auditors select a sample of client files and transactions for detailed review. They check whether the firm has conducted proper due diligence, maintained accurate records and reported suspicious activities as required.

Post-audit actions

• Reporting findings: after completing the on-site procedures, the auditors compile a comprehensive report detailing their findings. This report includes an assessment of the firm's compliance with AML regulations, identification of any deficiencies, and recommendations for improvement.
• Implementing recommendations: the firm must address the recommendations provided in the audit report. This may involve updating policies, enhancing training programmes, improving internal controls, and rectifying any identified weaknesses.
• Followup audits: depending on the audit findings, follow-up audits may be necessary to ensure that the firm has implemented the recommended changes and continues to comply with AML regulations. Regular follow-up audits help maintain ongoing compliance and address any emerging risks.

By following these steps, an AML audit provides a comprehensive evaluation of a law firm's AML compliance. It helps identify areas for improvement, ensures adherence to regulatory requirements, and strengthens the firm's overall AML framework.

Do all UK law firms need to have an independent AML audit?

In the UK, all law firms are subject to AML regulations, but whether an independent AML audit is mandatory depends on several factors. This applies to:

• Larger firms with extensive client bases and complex transaction structures, due to their higher volumes of transactions and the larger sums of money they deal with
• Firms offering a broad range of services, particularly those involving high-risk activities such as real estate transactions, international dealings, or corporate services
• Firms dealing with high-risk clients, such as politically exposed persons, clients from high-risk jurisdictions, or those involved in industries prone to money laundering
• Firms operating in multiple jurisdictions, especially those with offices in high-risk countries

The SRA will also consider the findings of previous audits when determining the necessity of an independent AML audit, as firms with a history of compliance issues are more likely to be scrutinised.

While the law does not mandate independent AML audits for all firms, they can nevertheless be a valuable tool for establishing best practice in regulatory compliance. Carrying out an annual AML audit alongside your independent financial statement audit can help your compliance team to demonstrate the firm's credibility and commitment to best practices.

What is the SRA’s position?

The Economic Crime and Corporate Transparency Bill includes a measure allowing for unlimited fines. If the provision becomes law, the Solicitors Regulation Authority (SRA) will be able to issue unlimited fines in cases involving economic crime such as fraud, money laundering, and breaches of international sanctions. The bill amends the Solicitors Act 1974 in this regard. The amendment follows the fairly recent extension of the SRA’s fining powers, from a maximum of £2,000 to £25,000 for a range of breaches. 

The bill’s explanatory notes state: “The purpose of the measure is to put beyond doubt that it is the duty and within the remit of the frontline regulators to exercise the appropriate regulatory actions that are necessary to promote and maintain compliance with economic crime legislation and guidance.”

The SRA’s consultation on the proposed powers features two fining bands. For example, the current draft proposes that bands E and F will accommodate serious misconduct involving economic crime. Penalties within band E range from 6-10% of a firm's annual domestic turnover and 113-145% of an individual's annual gross income. Band F starts at 11% for firms and 146% for individuals. The minimum fine for the least serious misconduct is £5,000 for firms and £2,500 for individuals. For the most serious misconduct, the minimum is £500,000 for firms and £100,000 for individuals.

Paul Philip, the SRA’s chief executive said: “The majority of solicitors do a good job. However, when this is not the case, it is important that we have a robust approach in place which enables us to take action in a way that is fair, transparent and consistent to all. The changes we are proposing will help to ensure we can continue to do that, including for the most serious cases, which by their very nature can and will attract the most significant penalties.”

If the threat of enforcement is not enough to prompt a review of internal procedures, professional indemnity insurers are watching developments closely. If the measures are likely to increase the number and size of claims against the PII policies, one can be sure that premiums will go up if firms cannot demonstrate the effective implementation of AML procedures.

How JMW can assist your firm with AML audits

JMW offers expert AML audit services tailored to the unique needs of law firms. Our team of specialists stays abreast of the latest AML regulations and industry best practices, ensuring your firm achieves and maintains compliance.

Our auditors possess in-depth AML knowledge and experience, providing a thorough evaluation of your firm’s compliance framework. From risk assessment and policy review to client due diligence and record-keeping, we cover all aspects of AML compliance, and we will customise our services to meet the specific needs of your firm, regardless of size or complexity.

Beyond the audit, we offer continued support to implement recommendations and provide AML training for your staff. By choosing JMW, your firm benefits from an objective, thorough and credible assessment of your AML practices. Our audits help you identify and mitigate risks, enhance your compliance framework, and maintain the trust of clients and regulators.

Ensure your firm is fully compliant and protected against financial crime by contacting JMW today to schedule an independent AML audit and secure the integrity of your practice. Find out about our legal services for law firms; you can also call us on 0333 060 1928, or fill in our online enquiry form to request a call back.