Understanding Source of Funds (SOF) vs. Source of Wealth (SOW)

The Source of Funds (SOF) and Source of Wealth (SOW) are essential components in improving AML compliance measures. Institutions combat financial crimes such as money laundering by incorporating SOF and SOW checks in their Anti Money Laundering (AML) procedures.

The implementation of Source of Wealth (SOW) and Source of Funds (SOF) checks verify the legitimacy of funds and thus ensure a robust AML framework by detecting the association of funds with illicit activities.

Are you aware of the concept of  Source of Funds (SOF) and Source of Wealth (SOW), the key examples, AML obligations for SOF & SOW, and the regulatory requirements for conducting SOF/SOW checks in your financial organization?

Give a quick read to this article to get all the knowledge based on these points.

What is Source of Funds (SOF)?

Source of Funds is defined as “The origin of specific funds or other assets that are involved in a business relationship or occasional transaction.”

Source of Funds Meaning

Banks verify the source of funds to determine how money is generated or where it originates, ensuring legitimate funds enter the financial system and reducing the risks of associated financial crimes.

What are examples of SOF?

Common Source of Funds Examples include:

• Personal savings
• Inheritance
• Pension release
• Selling assets
• Business profits
• Winning lotteries
• Investments and dividends

When an individual deposits a large sum of money, the bank authorities verify the source of funds (SOF) to determine whether the money is legitimate and not linked to illicit activities, such as “money laundering (ML) or terrorism financing (TF).”

What is Source of Wealth?

Source of wealth (SOW) refers to the “complete set of wealth and assets owned by a person” instead of merely focusing on one transactional fund.

Source Of Wealth Meaning

The goal of conducting SOW checks is to accurately evaluate the total net worth while pinpointing the specific economic and commercial activities that drive its generation.

What are examples of SOW?

Examples of Sources of Wealth include:

• Family inheritance, including the transfer of assets
• Profits and returns from investments.
• Income generated by employment.
• Business Ownership Interests.

The main questions that need to be addressed in fulfilling the obligations for the Source of Wealth (SOW) are;

• How has the client accumulated this wealth?
• What actual methods did they use to acquire these assets?
• How does the client possess such a significant amount of wealth?

SOW must be monitored as part of ongoing customer due diligence as the source of wealth of a client changes with time.

AML Regulatory Importance of SOF and SOW

SOF/SOW checks are mandated by FATF globally and FinCEN in the U.S. as part of Customer Due Diligence (CDD) and Enhanced Due Diligence (EDD) procedures.

These regulatory checks help financial institutions detect financial crimes such as money laundering and terrorist financing by ensuring that the “funds used in transactions are legitimate.”

U.S. banks are required to detect and report suspicious transactions, especially when the source of funds checks are not established per the Bank Secrecy Act (BSA) and the USA PATRIOT Act.

‍Failure to do SOF/SOW checks can damage the reputation of the organization, result in significant AML fines, and increase“regulatory scrutiny.”

Not all questionable transactions and financial activity require a source of funds investigation, and financial regulators do not encourage such inquiries for every suspicious incident.

According to the Australian Transaction Reports and Analysis Centre (AUSTRAC), rather than conducting an SOF investigation, enhanced due diligence methods (EDD) may be more effective in resolving customer identity issues and other concerns.

AML Obligations Under Isle of Man Financial Services Authority

AML Obligations for Source Of Funds (SOF)

The Isle of Man Financial Services Authority published AML/CFT Guidance notes on “Source of Funds & Source of Wealth” in October 2019, explaining the obligations of relative individuals and authorities to check SOF.

Industry experts, such as legal professionals and real estate agents, must conduct SOF Checks even if they are not receiving the funds directly. For example:

• Legal professionals are mandated to perform Source of Funds (SOF) checks, even when money is transferred through their clients’ accounts.
• Real estate agents are required to verify the source of funds in property transactions, regardless of whether the money is moving between clients’ lawyers’ accounts. This is essential to ensure compliance with Anti-Money Laundering (AML) laws.

Take the necessary steps to fulfill AML’s requirements by establishing the funding source.

Risks Severity

According to the “Anti-Money Laundering and Countering the Financing of Terrorism Code 2019,” the severity of risk will determine whether strict measures should be taken.

Monitoring will be applied to answer these questions;

• How money is generated (through donations, property sales, business sales, employment, etc.).
• And how money is transferred through banks, digital methods, or third parties.

According to paragraph 33(c) of the AML/CFT Code 2019, keep records of transactions covering both aspects mentioned above for later review.

Decision-Making and Documentation

• Relevant professionals must evaluate each case carefully to determine the appropriate measures to resolve it.
• Must record all inquiries and provide justifications for your measures and decisions.
• Preserve the evidence of investigations conducted to identify the source of funds.

Non-Satisfaction of SoF

• If the source of funds is not correctly identified or established, the transaction will not be processed further, and the business relationship will be terminated immediately.
•  Internal disclosure is required. Requirements mentioned in part 7 of the AML/CFT guidance should be followed.
• Legal professionals listed in “Proceeds of Crime Act 2008” and their activities must follow the requirements of the source of funds (SoF)

Measures for Third-Party Funding

Third-party funding is defined as receiving funds from a financial account that doesn’t belong to intended customers.

• Relevant authorities must take appropriate measures to fully understand and check the source of funds when experiencing third-party funding situations.
• Authorities should be aware of the reasons and logic behind using third-party funding.
• It is mandated to apply a risk-based approach same as other assessments  of the source of funds (SOF)
• Assess the connection between the client and the third-party account owner that is a provider of funds. Identify if the third party is a beneficial owner.

AML Obligations for Source of Wealth (SOW)

Reasonable measures to conduct Source of Wealth (SOF) include:

• Comprehensive understanding of the client’s “overall sources of wealth.”
• These measures are customized according to the particular requirements of the clients.
• The requirements of the Source of Wealth are mentioned in the “Paragraphs 14 & 15 of the Code”.
• According to “Paragraph 4(2) of the Code”, a risk-based approach is conducted for the SOW checks.
• The reason for establishing a Source of Wealth Checks is to let the organization “manage and mitigate” risks related to money laundering and terrorist financing.
• In dealing with higher-risk clients, certain reasonable measures should be considered for SOW, such as “verification through reliable and independent data, documents, or information.”
• If SOW is not established and results are unsatisfactory, the client’s business relationship or transaction should not proceed, and the relationship should be terminated.
• Make an Internal disclosure.

What Risks Should Be Considered When Developing A Robust AML/KYC Compliance Program?

Risk Factors Associated with Customers

Risk levels associated with different clients vary based on their “ownership, industry, and other factors.”

High-risk domestic or International PEPs

• While business relationships with Domestic PEPs and Foreign PEPs, Source of Funds (SOF) and Source of Wealth (SOF) checks must apply.
• PEPs that are identified as high-risk clients due to having links with “corruption or misuse of public funds”

• As per the AUSTARC guidance, high-net-worth individuals (HNWIs) must be monitored. As transfer of funds “in or out of Australia for gambling or other cash-intensive services” poses a higher risk of ML/TF.

Identify the “origin of funds and the ultimate destination” for ensuing AML/KYC Compliance.

Complex Corporate or Trust Organisations

• If a legitimate economic purpose is not found  it may raise “red flags”
• Complex corporate or trust organizations usually misuse to “conceal beneficial ownership and mask the illicit financial activities”

Intermediary Customers

• It is possible to conceal the identity and actions of the real client by using intermediaries working on behalf of another party.
• More supervision is required to ensure AML compliance and transparency.

Understand the Risks Associated with Client Profiles

• Thoroughly understand the profiles of clients and based on it, tailor your program accordingly.
• Low-risk clients need less strict SOF and SOW checks.
• Wealth sources require proof of “Family home, Savings, and Ordinary investments or inheritance.”
• High-risk clients need intensive verification for “Source of funds and Source of wealth.”
• Clients with high wealth may be involved in high-risk activities thus showing less transparent sources.
• Your risk-based procedures and controls related to establishing the source of wealth and funds should take this into account if you deal with higher-risk countries.
• Examples of Risk factors in Geographic risks are “corruption risks, organized crime, known tax havens, terrorism financing, proliferation financing, or sanctions risks.”
• If failure to establish these checks with High-risk customers then evaluate whether to continue providing service or terminate the business relationship
• Services may be continued if risks are mitigated under the AML/CFT program of the relevant country.
• Monitor any unusual or suspicious activities while verifying the Source of Funds (SoF) and Source of Wealth (SoW) of the client.
• As per AUSTRAC guidance on AML/CFT, if suspicious activity is flagged with solid evidence linked to financial crimes, submit a Suspicious Matter Report (SMR) to AUSTRAC.
• AML Compliance must report any unusual activities to support investigations related to financial crimes.

Requirements Of AML Compliance Program for Source of Funds

Mandatory steps are required under the risk-based approach to AML compliance, as recommended by FATF.

The customer onboarding & dealing process, which is essential for robust AML compliance includes the following measures:

Customer due diligence (CDD)

• Financial organizations should screen their clients to make authentic decisions after verifying their SOF/SOW in their customer due diligence measures.

Transaction monitoring

• Organizations need to monitor customers’ transactions to detect any unusual activity that deviates from their defined SOF/SOW.

Sanctions screening

• Therefore financial organizations should check the client names against watch lists and sanction lists which are relevant according to their AML/KYC compliance. A list such as “OFAC SDN list, or the UNSC consolidated list.”

Politically Exposed Persons (PEPs)

• Firms should screen domestic and foreign PEPs, as they pose higher risks. PEP screening solutions must also include screening for “Relatives and Close Associates (RCAs)” of PEPs.

Adverse Media Screening

• Organizations should monitor updated stories related to clients as they can deliver information on the sources of their funds and wealth.

How AML Watcher Simplifies AML Screening For Maintaining Source of Funds & Source of Wealth Compliance

AML Watcher helps institutions screen clients using data from “over 100,000 sources, including 1,300+ watchlists 5,000+ news outlets, and 250+ sanction regimes across 235+ countries, in 80+ languages,” ensuring effective Source of Wealth (SOW) and Source of Funds (SOF) compliance.

How?

Through Real-time Data Updates

AML Watcher provides regular updates to ensure that screening algorithms are always using the most recent data.

This lowers the possibility of using obsolete or partial information during essential AML compliance assessments as clients’ source of wealth and financial activity may change over time.

Via PEP and Sanction Screening

AML Watcher provides rigorous screening for elected and government officials with its global PEP databases containing updated PEP status for these high-risk persons and their associates.

It also checks individuals against global sanction lists, including OFAC, UN, SDN, and EU, to ensure SOF/SOW compliance with international and national legislation.

With Adverse Media Screening

AML Watcher incorporates negative media information into its screening procedure and searches reliable local and international sources for unfavorable coverages of financial crime, corruption, or terrorism.

It enables organizations to identify possible threats that aren’t always picked up by routine sanctions or PEP checks.

Our Media watcher also helps institutions determine whether a client’s funds may be derived from illegal sources, thus contributing to SOF and SOW compliance.

With Comprehensive Due Diligence

Conduct thorough background checks using various data sources, including fugitive lists, warning lists, and law enforcement lists to ensure a clear understanding of the client’s background.

Through Cross-Border Screening

AML Watcher ensures that institutions can screen data across borders, giving them access to global data sources to detect risks associated with clients, assets, and transactions from various lesser-known jurisdictions and high-risk areas.

With Customizable Screening Criteria

AML Watcher enables institutions to adapt customizable risk thresholds based on their clients’ risk profiles.

This ensures a tailored approach to AML compliance based on region, client type, and business processes to maintain robust SOF and SOW controls.

Continuous Compliance with Regulatory Standards

AML Watcher minimizes the risks of money laundering may linked with illegal SOF and SOW

while ensuring that institutions maintain continuous compliance with international requirements, such as FATF, OFAC, and local AML laws, by providing a wide range of up-to-date screening data sources.

Through Efficient Risk Assessment

The purpose of this is to help institutions set predetermined risks associated with each client and its source of funds and wealth to draw attention to possible threats.

This risk assessment includes a variety of international data points, the system makes sure that organizations can take the appropriate response.