Why Enhanced Due Diligence (EDD) Decisions Are Still Causing Headaches for Law Firms

Enhanced Due Diligence (EDD) remains a complex, often subjective, area in law firm compliance. Recent conversations among compliance professionals at the Compliance Collective have revealed ongoing challenges in defining and implementing EDD consistently across firms. In this post, we delve into the nuances of EDD, explore the common obstacles faced by firms, and discuss strategies for building a more structured approach to due diligence.

Understanding EDD: Why the Inconsistencies?

Enhanced Due Diligence is more than just a box-ticking exercise; it requires a nuanced assessment of risks based on various factors, including the client’s profile, the nature of the transaction, and jurisdictional considerations. However, professionals consistently face the difficulty of establishing a uniform understanding of EDD within their firms. Many firms struggle with the following questions:

• When should EDD be conducted? There is often uncertainty around what exactly triggers EDD, with some firms unsure if they have established a clear threshold for taking extra measures.
• What constitutes “enhanced” in EDD? While regulations and guidance indicate the need for additional checks, they often do not provide clear standards for what specific steps should be taken, leaving room for subjective interpretation.

The discussion revealed a mixture of views. While most agreed that their firms somewhat understand when to conduct EDD, there was less confidence that colleagues would make the same decisions or take consistent actions. This lack of uniformity can lead to missed risks and potential compliance issues.

Practical Scenarios: Decision-Making in EDD

Several hypothetical scenarios were explored to understand how different firms might approach EDD. Here’s a breakdown of some key takeaways:

Scenario 1: U.S.-listed Company with Operations in Nigeria

• Decision: Most participants agreed that EDD might be necessary due to the client’s presence in a high-risk jurisdiction. However, opinions varied on the extent of due diligence required.
• Considerations: It was noted that while certain regulations may provide a carve-out for majority-owned subsidiaries of companies in low-risk jurisdictions, firms might still opt for additional checks as a precaution.

Scenario 2: Property Purchase in the UK by a Croatian Seller

• Decision: The responses were split. Some argued that EDD was necessary due to the cross-border element, while others believed that the involvement of an SRA-regulated solicitor on the seller’s side might be sufficient.
• Considerations: Participants debated the necessity of scrutinising the source of funds from the counterpart, highlighting the balance between thoroughness and practicality.

Scenario 3: A Client with Adverse Media Attention

• Decision: The group emphasised the importance of adverse media checks, particularly for clients involved in high-profile sectors like media rights. However, they agreed that not all adverse media relates to financial crime risk, and a firm’s reputational stance also plays a role.
• Considerations: The subjective nature of these assessments underscored the need for firms to clearly define their risk appetite and ensure documentation of decision rationales.

Balancing Risk, Regulatory Requirements, and Practicality

The diversity of opinions on these scenarios reflects the subjective nature of EDD and the challenge of achieving consistency. Some firms adopt a more conservative approach, opting for EDD in borderline cases to mitigate potential risks. Others rely on risk assessments to tailor their approach based on the transaction’s specifics.

Key insights from the conversation included:

• Risk vs. AML Risk: There is a common conflation of general risk with anti-money laundering (AML) risk. Not all high-risk clients pose an AML threat, and firms must distinguish between broader reputational risk and specific regulatory obligations.
• Documenting Decisions: A crucial aspect of EDD is maintaining a clear rationale for decisions, particularly when opting not to conduct EDD in situations where it might otherwise seem warranted. Adequate documentation can help demonstrate compliance in case of future scrutiny.
• Communication and Consistency: The discussion highlighted the need for ongoing dialogue within firms to foster a shared understanding of EDD standards. Examples, role-playing, and real-life scenarios were recommended as tools to align practices and improve decision-making consistency.

Best Practices for Navigating EDD Challenges

Moving Forward: The Path to Consistent EDD

Enhanced Due Diligence is a multifaceted process that requires both clear guidelines and a flexible approach. While the lack of a universal standard can be frustrating, firms can address this challenge by fostering open discussions, building robust risk assessment frameworks, and encouraging consistent documentation practices.

In navigating EDD, the goal is to strike a balance between regulatory compliance and practical risk management, ensuring that firms remain vigilant while not overburdening their processes. With the right approach, firms can mitigate risks, protect their reputation, and ensure they are conducting business ethically and responsibly.