Law commission fungibility

Fungibility

Speed read: In this article, Jonathan Fisher QC explores whether the notion of fungibility has been applied too widely in the money laundering legislation. Consideration is given to whether there is scope for a greater role for ring-fencing where there are mixed funds. Some ‘push-back’ against the conventional application of section 340(3) (a) of the Proceeds of Crime Act 2002 would be warmly welcomed by the business community. Increased use of risk-fencing is tempting and consistent with common sense, but the risk of committing a technical criminal offence will remain extant until legislative intervention provides some clarity.

The wording of section 340(3) of the Proceeds of Crime Act 2002 has been problematic since the day of its implementation on 24 February 2003. This sub-section, it will be remembered, provides that “Property is criminal property if (a) it constitutes a person’s benefit from criminal conduct or it represents such a benefit (in whole or part and whether directly or indirectly), and (b) the alleged offender knows or suspects that it constitutes or represents such a benefit”.

Representative criminal property

Almost certainly, section 340(3)(a) was worded widely with its reference to direct or indirect benefit in order to capture a situation where a person’s benefit from criminal conduct has changed form from one type of property to another. If £100,000 is stolen in a bank robbery and used to purchase a rare Ming vase, the latter represents indirectly a person’s benefit from criminal property. But what is the position where the £100,000 is paid into a bank account with a balance of £100,000 which has been legitimately obtained, and the total balance of £200,000 is used to purchase a top-quality Aston Martin DB7 motor car? Conventional wisdom answers that the motor car constitutes criminal property, since it represents a person’s indirect benefit, in whole or in part. The stolen £100,000 has contaminated the legitimately obtained £100,000, and the total balance in the bank account has become criminally tainted. So far, so good.

Fungibility

However, this example slides over the challenges raised by the application of section 340(3)(a), at the point where the illicitly obtained money is pooled with legitimately obtained funds. The issue of fungibility raises its head and is a matter of considerable concern for the banking sector. ‘Fungibility’ is a strange word and has its origin in medieval Latin where the phrase ‘funci vice‘ meant ‘to take the place’.  In contemporary economics, fungibility is defined as the property of a good or a commodity whose individual units are essentially interchangeable, and each of its parts is indistinguishable from another part.

At the first level, without the concept of fungibility, the paying into a bank account of cash amounting to £100,000 would thwart the application of section 340(3)(a) when the money is withdrawn, since a bank would almost certainly not be paying out the same £100,000 in bank notes which the thief had deposited. The £100,000 paid out by the bank, whether in the form of bank notes or by way of electronic transfer, would have been legitimately obtained and not represent the benefit of criminal conduct. But when the principle of fungibility is applied, a different answer is produced. If money is fungible in economic terms, this means that the money is converted into an asset capable of mutual substitution.

Mixed funds

It is at the next level that the application of the principle of fungibility becomes problematic. Suppose the proportion of monies are changed, and instead of stealing £100,000, it is only £5 stolen from the petty cash box which is mixed with £199,995 of legitimately obtained money. Does the total balance of £200,000 held in the bank account fall to be treated as criminal property for the purposes of the principal money laundering offences?[1]

In its review of the money laundering offences, the Law Commission noted there is confusion among legal practitioners as to what happens to legitimate funds when they are mixed with criminal property (Anti-money laundering: the SARs regime, Law Com No 384, HC 2098, June 2019, at paragraph 8.9). The tendency, according to the Law Commission, is for the banks to freeze the total amount of an account where there are mixed funds, especially following the decision of the Court of Appeal (Criminal Division) in R v Causey, unreported 18 October 1999 in which Otton LJ noted in connection with the pre-POCA legislation that,

“if one penny or penny’s worth of the property dealt with is the proceeds of criminal conduct then the section is satisfied”.

On the particular facts of this case, the prosecutor’s application for confiscation of a mixed fund failed because on the evidence no part of the fund, however small, could be shown to constitute the benefit from criminal conduct. Although the prosecution alleged that the defendant benefited from offences of conspiracy to money laundering the proceeds of drug trafficking, the Memorandum of Conviction did not contain any reference to the benefit which had been obtained. Accordingly, Otton LJ’s comment was obiter dicta, even though it was made in the context of a consideration of the wording used in section 340(3)(a) of POCA. The question which arises is whether the obiter dictum is correct or has precipitated an understanding of the meaning of ‘criminal property’ which is unnecessarily wide.

The reach of section 340(3)(a) of POCA becomes especially acute in commercial mixed fund cases, where corporate criminal conduct has, or may have, arisen. A common example is a company which obtained one of four contracts by paying a bribe. Monies obtained from the contract obtained by bribery can be identified, but they become mixed with monies from the remaining three contracts legitimately obtained. Viewing the application of section 340(3)(a) through the prism of fungibility, the totality of the company’s income constitutes criminal property for the purposes of money laundering offences. There is no space for ring-fencing benefit from criminal conduct and keeping it hermetically sealed in a mixed funds case. The Law Commission has highlighted (at paragraph 8.27) the problems faced by financial institutions where mixed funds are involved.

Lawful business conducted unlawfully

Although section 340(3)(a) of POCA falls to be applied where lawful business is conducted unlawfully, the position is different from the situation arising where mixed funds are involved. The issue arises where business activity is conducted in breach of a licensing or permit requirement. The business activity is inherently lawful, but it is unlawful for a particular act to have occurred. An example is a small factory that disposes of waste in the absence of obtaining the requisite permit. Applying section 340(3)(a), is the benefit from criminal conduct the £1200 saved by not applying for the permit or the total income of the business? Instinctively one might think that the total income is not a benefit from criminal conduct because the underlying business is inherently legal. But applying section 340(3) POCA if the answer is £1200, and this is retained by the business in its bank account, have all the monies in the bank account been contaminated by the retained £1200?

A similar question arises in a case involving tax evasion, where a market trader declares his sale of apples to HM Revenue & Customs but secretes his income from the sale of oranges.  The appellate courts have considered this situation on several occasions and concluded that the business’s total income falls to be treated as criminal property within the meaning of section 340(3)(a) of POCA. Most recently, in R v William [2013] EWCA Crim 1262 the Court of Appeal (Criminal Division) held that where turnover is falsely represented the benefit is the tax due on the undeclared turnover. The criminal property is the entirety of the undeclared turnover, and not merely the tax due because the benefit is represented in part by that sum. There is some additional support for the Court of Appeal’s approach in an earlier decision (R v Middleton [2008] EWCA Crim 233) where the Court held that the prosecution of multiple conversions of criminal property in one count was not bad for duplicity, even where some of the conversions involved monies obtained through legitimate activity.

Different situations, and different outcomes

Against this background, it is suggested that two different situations can arise.

  1. Where there are mixed funds, and it is impossible to distinguish between the proportion of legitimate and illegitimately obtained property in the mixed fund.
  2. Where there are mixed funds, and it is possible to separate the proportion of legitimate and illegitimately obtained property in the mixed fund, albeit with assistance from a forensic accountant if necessary.

In the first situation, section 340(3)(a) will be engaged, and the totality of the mixed funds will be classified as criminal property for the purpose of the money laundering offences.

But in the second situation, does the wording of section 340(3)(a), and the application of the principle of fungibility, compel the same outcome? Or can the legitimately obtained monies be separated from the illegitimately obtained monies, which are ring-fenced and hermetically sealed?

I suggest there is a perfectly proper argument to sustain the latter outcome.

First, when properly understood, the principle of fungibility is not engaged, at least in so far as legitimately obtained monies which have been separated are concerned.

Secondly, the previous decisions in the Court of Appeal do not dictate a different outcome. In R v Causey, the prosecution did not lead evidence of criminal property, identifiable or otherwise. Strictly speaking, it was a case where the existence of criminal property had not been established on the evidence. Both R v Middleton and R v Williams involved general deficiencies, where separation of division between tainted and non-tainted monies was not possible.

Thirdly, the true intent of section 340(3)(a) was intended to capture the situation (1) where the benefit from criminal conduct was processed, with its form changed from one type of property to another, and (2) where the illegitimately obtained monies were placed in a mixed fund or jointly owned property which rendered separation between legitimate and illegitimately obtained property difficult if not impossible to achieve. The acquisition of the Aston Martin DB7 motor car is a case in point. Sophisticated money launderers engage in an activity called ‘layering’, which involves moving criminally obtained money into different types of property, to obscure its illegal origin. Mixing criminally obtained funds with lawfully earned income is a money launderer’s favourite pastime, and it thwarts the efforts of law enforcement agencies in an obvious way. Al Capone in the 1920’s was the archetypal example, where, having mixed mafia monies with legitimate cash takings from laundromats, separation was quite impossible.

However, there is no policy reason why the money laundering offences should seek to capture monies which have been legitimately obtained and are capable of separation.  As a matter of policy, the criminal law should not be penalising a person for handling the proceeds of lawful activity which he/she has managed to extricate from a tainted fund. Indeed, there is surely an argument that such an approach would offend a person’s right to enjoy his / her property in accordance with Protocol 1 Article 1 of the European Convention on Human Rights.

Section 340(3)(a) was not intended to apply, it is suggested, to a situation where the component elements of a mixed fund can be readily identified, withdrawn and ring-fenced. If legitimately obtained money can be identified and withdrawn from a mixed fund, or conversely, if illegitimately obtained money is withdrawn and ring-fenced, it must surely follow that the legitimately obtained monies cannot be said to constitute ‘a person’s benefit from criminal conduct or …  represent … such a benefit (in whole or part and whether directly or indirectly)’ within these circumstances.

Further, I suggest there is no objection in principle to the idea that the character of monies can change, depending on the circumstances in which they are held. It is axiomatic that under the definition of criminal property in section 340(3), it is possible for an item of property to be stigmatised as criminal property if the handler knows or suspects that it has derived from criminal conduct, but in the hands of a person who neither knows nor suspects, the property will be legitimately held. Interestingly, the National Crime Agency has recently implicitly acknowledged the changing character of property in its guidance on the return of victims’ monies, noting that a money laundering disclosure is unnecessary if the reporter’s position since he will not be carrying out activity which falls within Sections 327-8 of POCA.[2]

Accordingly, following this line of argument, there should be no impediment to the greater use of ring-fencing in appropriate cases. Six degrees of separation should not be necessary. One degree of separation should be sufficient.

A final, technical but potentially significant, argument

There is, however, a highly technical, but potentially significant, objection. It would be open for a prosecutor to allege that the act of separating a mixed fund is itself conduct prohibited by section 327(1) of POCA since it involves the handling of criminal property with the total amount representing tainted funds immediately before the split. Following this reason, the legitimately obtained funds which were the subject of the separation could be said to represent the account-holder’s benefit from criminal conduct, which would be identified as the act of separation. The risk of criminal prosecution may be small, but it is sufficient to deter and encourage the professional and business community to err on the side of caution.

The Law Commission

Against this background, it is no surprise that the Law Commission had little hesitation in concluding that the law should be amended to include a provision for ring-fencing. A statutory amendment would remove any uncertainty surrounding the legality of ring-fencing and eliminate the risk of prosecution for a technical offence of handling legitimately obtained monies.

The Law Commission has advised in the following terms (at paragraph 8.57) –

We recommend amending sections 327, 328 and 329 of the Proceeds of Crime Act 2002 (‘POCA’) to provide that no criminal offence is committed by an individual where:

    1. they are an employee of a credit or financial institution;
    2. they suspect or know that property in their possession constitutes a person’s benefit from criminal conduct;
    3. the suspicion or knowledge relates to some but not all of the property in their possession;
    4. the property which they suspect constitutes a person’s benefit from criminal conduct is either:
      1. transferred by them into an account within the same credit or financial institution; or
      2. the balance is not allowed to fall below the level equal to the value of the suspected funds;
    5. they conduct any transaction in the course of business in the regulated sector (as defined in Schedule 9 of POCA); and
    6. any transaction is done with the intention of preserving criminal property.

Conclusion

For my part, for the reasons I have set out, I believe this amendment would be welcomed by credit and financial institutions. But why should the application be limited to this class of business enterprise? Surely, if amendment to facilitate ring-fencing is now to be contemplated, it would be sensible for the exemption from criminal liability to apply more widely. The money laundering offences in sections 327 to 329 of POCA apply to all persons located in the United Kingdom. There is no reason why the exemptions should not apply equally widely, and not be the preserve of a chosen few.

If the National Crime Agency is serious about reducing the number of inconsequential disclosures received under the money laundering legislation, it will be lobbying hard for an amendment to be made at the first opportunity, when the next Criminal Justice Bill is presented to Parliament.

This article was originally published in Money Laundering Bulletin, December 2019/January 2020, Issue 269.

 

[1] Sections 327 to 329 of POCA are engaged where criminal property is handled, or its handling is facilitated.

[2] Suspicious Activity Report (SAR) Glossary Codes and Reporting Routes November 2019