Politically exposed persons

The concern behind this category is not that people in public life are dishonest. It is that public office creates opportunities — bribery, kickbacks, the misdirection of state contracts — and any proceeds have to be placed somewhere. A brokerage account, a portfolio management mandate or a mutual fund folio is somewhere.

SEBI's anti-money laundering framework therefore lists Politically Exposed Persons among its clients of special category (CSC), the client sets that attract enhanced due diligence as a matter of course.

Notice what the rules do not say. They do not say refuse the business. They say: know that you have one, make sure the decision is taken high enough in the organisation, and be satisfied about where the money came from.

Three obligations sit in the Client Identification Procedure, and all three are worth memorising in their own words.

1. Every registered intermediary must proactively put in place appropriate risk management systems to determine whether the client, potential client or the beneficial owner of such client is a PEP. The procedures named are seeking relevant information from the client, referring to publicly available information, and accessing commercial electronic databases of PEPs.
2. Intermediaries must obtain senior management approval for establishing business relationships with PEPs. Where a client has already been accepted and the client or beneficial owner is subsequently found to be, or becomes, a PEP, senior management approval is required to continue the relationship.
3. Intermediaries should take reasonable measures to verify the sources of funds as well as the wealth of clients and beneficial owners identified as PEPs.

PEPs sit within a wider list of clients of special category: non-resident clients; high net-worth clients; trusts, charities, NGOs and organisations receiving donations; companies having close family shareholdings or beneficial ownership; PEPs; clients in high risk countries; non-face-to-face clients; and clients with a dubious reputation as per available public information. The list is expressly illustrative, and the intermediary must exercise independent judgement about whether any other set of clients belongs in it. Clients of special category require a higher degree of due diligence and a regular update of the KYC profile.

A portfolio manager onboards Mrs Kulkarni, who invests Rs 6 crore. Screening against a commercial PEP database shows that her husband is a serving member of a state legislature and that she is the beneficial owner of a family investment company.

The relationship manager cannot clear the file:

1. She is flagged a client of special category, so enhanced due diligence applies and her KYC profile is updated regularly rather than on the ordinary cycle.
2. Senior management approval is obtained before the relationship is established.
3. Reasonable measures verify the source of the Rs 6 crore — Rs 4.1 crore from the sale of an inherited property, evidenced by the sale deed and the bank credit, and Rs 1.9 crore from redemption of mutual fund units held since 2014 — and, separately, her broader source of wealth.

Eighteen months later a different client, onboarded as an ordinary retail investor with Rs 12 lakh, is elected to a municipal corporation. He is now a PEP. The firm does not have to close the account, but it does have to obtain senior management approval to continue the business relationship, re-rate the file as a client of special category, and verify his source of funds and wealth.

Chapter 9, section 9.3 — the customer acceptance policy, clients of special category, and the Client Identification Procedure. Expect a list question asking which of several client types is a CSC, and a scenario question on what an intermediary must do when an existing client becomes a PEP. The answer to the second is senior management approval to continue, and the wrong-but-tempting options are "close the account" and "file a Suspicious Transaction Report".

• The test reaches the client, the potential client or the beneficial owner. Screening only the named account holder is the classic failure — in most real cases the PEP is the beneficial owner, not the applicant.
• A PEP is not prohibited. The requirement is approval at senior management level, not refusal.
• For an existing client who becomes a PEP, approval is needed to continue. There is no obligation to exit the relationship.
• Source of funds and source of wealth are two different checks. Verifying the incoming remittance says nothing about how the client came to have the money in the first place.
• The clients of special category list is illustrative, not exhaustive, and the intermediary must apply independent judgement to other client sets.
• Detection must be a risk management system — information from the client, publicly available information, commercial PEP databases. A tick-box self-declaration on the account opening form is not one.