KYC and the Documentary Arms Race

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William Hogg

Back in the golden days of working from offices, there was apparently a thing known as “my word is my bond”.

I say this as it was certainly before my time, but it was (and is still) spoken about in mythical terms. Back then a handshake was all it took to derive confidence in a counterparty (and a good lunch, and a mysterious absence on a Friday afternoon). Then came close brokers, who assumed the word/bond mantle and ensured the two parties were keeping each other’s promises, and were eventually supported by credit reports, typewritten and carefully faxed to their recipients.

Then came China, the email and the internet. Counterparties started to be introduced on the back of an emailed page of A4 or, for the advanced ones, a website. This is where things started to get wobbly. Was it really the broker’s job to cross-check all the facts put together in these brochures and websites, compiled by a counterparty on the other side of the world? Not really. With an explosion of offshore-registered, asset light shipping investors, certain less scrupulous shipping participants worked out that you could liberally sprinkle your presentations and websites with half- and un-truths, and would probably get away with it enough times to make a buck or two. Some put up more or less the same website for almost every company they created. Need references on there? No problem – get a couple of mates with mobile numbers. Counterparties probably haven’t got the time or inclination to do more than call the numbers provided, conducting a mental calculation that the trade at hand is too contained to cause significant impact, or they can be contractually protected via terms (neither of which, in our experience, offers much when your counterparty disappears with your cash/causes costly ripples in otherwise straightforward trades).

The advent of KYC and compliance has brought another level of chicanery to the table. Credit and compliance departments nowadays wouldn't take a second look at mere websites. Now you need formal documents, showing identity, ownership, financial position, etc. It's certainly more difficult for the unscrupulous to navigate their way through such requirements, but thankfully you are still assisted by shipping fraud’s age-old allies, low disclosure registries, lack of time, and, in markets such as these, desperation.

Over the last 12 months, we’ve seen a sharp uptick in the use of “formal” documentation that is anything but. We’ve had sight of ownership documentation that didn’t reflect the actual ownership (see our earlier article here), a surge of “nominee” owners,  accounts provided for companies that didn’t exist, “consolidated” accounts on two unrelated companies, merged for the purposes of the audit, and carefully signed off, and, perhaps in a “top marks for trying”, accounts lifted in their entirety from the near-decade-old accounts for a public company AND audited. Unlike websites, “documentation” still maintains that allure of seeing something confidential, and therefore more likely to be “real”, awakening a kind of unconscious bias in favour of paper over bytes and over third party audit in favour of old fashioned research.

This isn’t only the preserve of small/niche companies active in marginal trades (although auditors in certain regions seem to be nothing more than a man with a stamp and a bulging wallet stuffed by thankful traders), as the recent allegations against Hin Leong Trading Pte Ltd and Zenrock Commodities Pte Ltd will show. If even the Mighty Warren Buffett can reportedly be “fooled” by a bit of back-office photoshopping, we should all be concerned about how the desire for a trade to succeed can cloud our thinking. There’s an argument for technological solutions to these problems, and the likes of smart contracts and blockchain transmission may cut down the level of such activity, but such solutions require the consent of all parties, and the validity of the documents provided – clearly not much use if what you’re providing is utter garbage.

Sometimes it just takes time (yes please, we keep saying it, time really is money – having more time can save you a lot of money) and true impartiality. My colleagues who uncovered the aforementioned documentary “examples” had no skin in the game, and they weren’t juggling commercial considerations, trader/manager egos and a hundred other requests at once. They also had the support of 50 other people whose sole task it is to scratch their chins and take a different look at things, bringing their own particular skill to the table (in other professions, these are known as nerds). Sometimes it needs such a combination of skills – local contacts/languages, forensic accounting, commercial acumen, an understanding of the alleged trade to spot the difference between a legitimate document and something that has clearly been put out for the sole purposes of providing confidence when none should exist. The experience we gain during this time of great disruption will only last until the next “new trick” is found, but we’re a nerdy and closely-connected bunch. We’ll be on that new normal as and when it happens too. And then meet for a long Friday lunch, at our offices.

If you are interested in discovering how our expertise can support your organisation with compliance, credit reporting, and risk management, download our KYC Fundamentals booklet now.

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Published on 20 May 2020

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