Specified transaction

Ordinary client due diligence is done once, when the relationship opens. That is enough for most business, but it is exactly the wrong control for a client who behaves normally for a year and then moves a very large sum in one go.

Section 12AA of the Prevention of Money Laundering Act, 2002 adds a second gate that operates transaction by transaction. Certain transactions — defined as specified transactions — cannot be commenced at all until the reporting entity has re-verified who is doing them, where the money came from, and why the transaction is happening.

The important word is prior. This is not a report filed afterwards. It is a condition of being allowed to process the transaction in the first place.

The Explanation to section 12AA defines a specified transaction as:

• (a) any withdrawal or deposit in cash exceeding a specified amount;
• (b) any transaction in foreign exchange exceeding a specified amount;
• (c) any transaction in high value imports or remittances;
• (d) such other transaction or class of transactions, in the interest of revenue or where there is a high risk of money laundering or terrorist financing, as may be prescribed.

Prior to commencing one, the reporting entity must:

1. verify the identity of the client by authentication under the Aadhaar Act, 2016 in the prescribed manner — and where the person is not entitled to obtain an Aadhaar number, by such other prescribed process;
2. take additional prescribed steps to examine the ownership and financial position, including the sources of funds, of the client;
3. take additional prescribed steps to record the purpose behind conducting the transaction and the intended nature of the relationship between the transaction parties.

If the client fails to fulfil these conditions, section 12AA(2) is mandatory: the reporting entity shall not allow the specified transaction to be carried out.

Where a specified transaction, or a series of them, is considered suspicious or likely to involve proceeds of crime, section 12AA(3) requires the entity to increase future monitoring of the business relationship, including greater scrutiny of transactions. The information gathered under the enhanced due diligence is maintained for five years from the date of the transaction.

Meridian Securities, a reporting entity, onboards Bluewater Exports Pvt Ltd in April. In June the client asks to route Rs 3.8 crore of foreign exchange through the relationship in a single transaction — which the firm's AML policy has mapped to the "transaction in foreign exchange exceeding specified amount" limb.

The desk cannot process it and review it later. Before commencement it must authenticate the identity of the person undertaking the transaction under the Aadhaar Act, examine ownership and financial position including the source of the Rs 3.8 crore, and record the purpose of the transaction and the intended nature of the relationship between the parties to it.

Bluewater produces the Aadhaar authentication and its export contracts but will not identify the party funding the remittance. Section 12AA(2) leaves no discretion: the transaction is not allowed to be carried out.

Three months later Bluewater attempts a second, similar transaction of Rs 2.6 crore. Because the earlier one was considered suspicious, section 12AA(3) obliges Meridian to increase future monitoring of the relationship and to apply greater scrutiny to its transactions. Every document generated by the enhanced due diligence is retained for five years from the date of the transaction.

Chapter 9 (Prevention of Money Laundering Act, 2002), in the obligations of reporting entities. Questions ask which section imposes enhanced due diligence (12AA), which transactions fall within the definition, what the entity must do when the client does not cooperate (refuse the transaction, not merely report it), and the five-year retention. The four-limb Explanation is a standard "which of the following is not a specified transaction" item.

• Section 12AA is enhanced due diligence; section 12 is record-keeping and reporting. Different sections, different duties — do not mix the obligations.
• The "specified amount" in limbs (a) and (b) is prescribed, not stated in the section. Do not import the Rs 10 lakh cash transaction figure used for record-keeping and the Cash Transaction Report under section 12 — that is a different threshold for a different purpose.
• When the client fails the conditions, the entity must not allow the transaction. Filing a Suspicious Transaction Report and processing it anyway is wrong.
• Two different five-year clocks: 12AA(4) runs five years from the date of the transaction; section 12(4) runs five years after the business relationship ends or the account is closed, whichever is later.
• Identity verification here is by Aadhaar authentication, with an alternative prescribed process only for a person not entitled to an Aadhaar number — not a free choice of documents.
• A specified transaction is a four-limb list, not a single monetary test; high value imports and remittances in limb (c) carry no stated amount at all.