14.2 Politically Exposed Persons (PEPs) and High-Risk Relationships

14.2 Politically Exposed Persons (PEPs) and High-Risk Relationships

In securities trading and capital markets compliance, business relationships with Politically Exposed Persons (PEPs) represent significant inherent vulnerability to public corruption, bribery, graft, and the laundering of illicit state assets. Because individuals holding prominent public offices control public procurement, regulatory approvals, and national revenues, international standards formulated by the Financial Action Task Force (FATF)—specifically Recommendation 12—and codified in the 2018 AMLA Implementing Rules and Regulations (2018 AMLA IRR) require covered persons to implement rigorous risk-mitigation measures when dealing with PEPs, their families, and their close associates.

PEPs are not legally barred from investing in Philippine capital markets; rather, the regulatory framework imposes specialized Enhanced Due Diligence (EDD) and continuous oversight to ensure that illicit state proceeds are not laundered through equities, debt instruments, or collective investment schemes.

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Statutory Taxonomy of Politically Exposed Persons

Under Section 3 of the 2018 AMLA IRR and SEC guidelines, a Politically Exposed Person (PEP) is defined as an individual who is or has been entrusted with prominent public functions. The statutory taxonomy establishes three distinct categories:

Taxonomy of Politically Exposed Persons (PEPs)
  ├── Domestic PEPs
  │     └── Heads of State/Gov, Senators, Congressmen, SC/CA Justices, Generals, GOCC Execs, Mayors
  ├── Foreign PEPs (Inherently High Risk)
  │     └── Foreign Heads of State, Ministers, Ambassadors, Senior Foreign Military/Judicial Officers
  └── International Organization PEPs
        └── Directors, Deputy Directors, and Board Members of UN, World Bank, ADB, IMF

1. Domestic PEPs

Individuals entrusted with prominent public functions within the Republic of the Philippines. This category includes:

• Executive Branch: The President, the Vice President, Cabinet Secretaries, Undersecretaries, and Assistant Secretaries;
• Legislative Branch: Members of the Senate of the Philippines and the House of Representatives;
• Judiciary: Chief Justice and Associate Justices of the Supreme Court, the Court of Appeals, the Sandiganbayan, and the Court of Tax Appeals;
• Armed Forces and Law Enforcement: Flag officers and Generals of the Armed Forces of the Philippines (AFP) and Generals of the Philippine National Police (PNP);
• State Entities: Senior executives, presidents, and board directors of Government-Owned and Controlled Corporations (GOCCs), state universities, and government financial institutions (such as Land Bank of the Philippines and Development Bank of the Philippines);
• Local Government Units (LGUs): Provincial Governors, Vice Governors, City Mayors, and Municipal Mayors;
• Constitutional Commissions: Chairpersons and Commissioners of the Commission on Elections (COMELEC), Commission on Audit (COA), and Civil Service Commission (CSC);
• Political Parties: High-ranking officers of accredited national political parties.

2. Foreign PEPs

Individuals entrusted with prominent public functions by a foreign government. Examples include foreign heads of state or government, senior foreign cabinet ministers, senior foreign judicial or military officials, foreign ambassadors, and senior executives of foreign state-owned enterprises.

3. International Organization PEPs

Individuals who are or have been entrusted with prominent functions by an international organization. This encompasses directors, deputy directors, executive board members, and senior management officials of multilateral entities such as the United Nations (UN), the World Bank, the Asian Development Bank (ADB), the International Monetary Fund (IMF), and the International Red Cross.

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Extended PEP Perimeter: Family Members and Close Associates

Financial criminals rarely register corrupt proceeds under their own names; instead, they exploit family ties and trusted associates to conceal illicit funds. The 2018 AMLA IRR extends PEP compliance requirements to two adjacent groups:

1. Immediate Family Members

The statutory definition of immediate family members encompasses:

• The legal spouse or recognized common-law / domestic partner;
• Children (biological, adopted, or stepchildren) and their spouses or partners;
• Parents (biological, adoptive, or parents-in-law); and
• Siblings (full-blood, half-blood, or adoptive brothers and sisters).

2. Close Associates

Close associates are natural persons who are closely connected to a PEP, either socially, professionally, or commercially. This includes:

• Natural persons who are widely and publicly known (or known by the covered person) to maintain an intimate personal or professional relationship with a PEP;
• Natural persons who hold joint beneficial ownership of legal entities, partnerships, or trusts alongside a PEP;
• Natural persons who maintain sole beneficial ownership of a legal entity or contractual arrangement that is known to exist de facto for the benefit of a PEP.

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Mandatory Enhanced Due Diligence (EDD) for PEP Relationships

When a customer or beneficial owner is identified as a PEP, immediate family member, or close associate, the covered institution must execute mandatory Enhanced Due Diligence.

Senior Management Approval

Under SEC AML guidelines and the 2018 AMLA IRR, registered broker-dealers must implement automated database screening at the onboarding stage.

• New Accounts: An institution cannot establish a business relationship with a PEP without prior written approval from Senior Management (such as the Chief Executive Officer, President, or a specialized Executive Compliance Committee).
• Existing Accounts: If an existing client is subsequently elected, appointed, or discovered to be a PEP, the institution must immediately notify compliance and obtain Senior Management approval to continue the business relationship.

PEP Account Governance Workflow
  [Applicant Profile]
        │
        ▼
  [Automated PEP / Sanctions Screening]
        │ (PEP Match Detected)
        ▼
  [Enhanced Due Diligence (EDD) Investigation]
        ├── Independent Verification of Source of Wealth (SOW)
        └── Independent Verification of Source of Funds (SOF)
        │
        ▼
  [Formal Submission to Senior Management / CEO]
        ├── Rejected ──> Account Denied / Terminated
        └── Approved ──> Mandatory Ongoing Enhanced Transaction Monitoring (ETM)

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

A foundational distinction frequently tested on Philippine capital market certification examinations is the difference between Source of Wealth and Source of Funds.

Source of Wealth (SOW)

• Definition: The origin of the customer's total net worth and overall accumulated wealth. It explains the lifelong economic activities that generated the client's financial standing.
• Focus: Global asset accumulation over decades (e.g., family inheritance, accumulated profits from a manufacturing empire, executive equity compensation, long-term commercial real estate holdings).
• Verification Requirements: SOW cannot be satisfied by customer self-declarations. Covered persons must verify SOW using independent, authoritative documentation, including:
  • Certified Bureau of Internal Revenue (BIR) Income Tax Returns (BIR Form 1701 or 1702) across multiple preceding tax years;
  • Audited Financial Statements (AFS) of family-owned operating corporations stamped received by the SEC;
  • Official Statements of Assets, Liabilities and Net Worth (SALN) for Philippine public officials mandated under Republic Act No. 6713;
  • Registered deeds of sale, court decrees of probate/inheritance, or verified settlement of estates.

Source of Funds (SOF)

• Definition: The origin of the specific funds, cash, or monetary instruments utilized in a particular transaction or account opening.
• Focus: The immediate payment mechanism for this specific investment (e.g., a ₱15 million subscription to a corporate bond issue).
• Verification Requirements: Evidenced through immediate transactional documents:
  • Bank account statements showing salary accumulation;
  • Commercial bank wire transfer confirmation slips;
  • Manager's checks drawn against a domestic commercial bank;
  • Dividend distribution vouchers or proceeds from the sale of specific listed securities.

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Ongoing Enhanced Transaction Monitoring (ETM) and De-Listing Protocols

Once Senior Management approves onboarding a PEP, the account cannot remain dormant in compliance reviews. The broker-dealer must implement Enhanced Transaction Monitoring (ETM):

• Dynamic Alert Thresholds: Setting lower monetary thresholds for transaction alerts compared to standard retail clients;
• Pattern Scrutiny: Scrutinizing all securities orders, block sales, cross trades, and fund withdrawals to ensure they remain consistent with the customer's known SOW and legitimate public income;
• Periodic Review Cycle: Conducting thorough account and profile re-examinations at least annually (or semi-annually for very high-risk profiles), with the frequency for other customers also determined by their risk profile and trigger events rather than by an automatic universal cycle;
• Adverse Media Screening: Continuous automated screening against local news media, Sandiganbayan dockets, Ombudsman investigations, and international sanctions lists.

De-Listing and the Minimum One-Year Rule

When a public official leaves office, does their PEP status terminate immediately? Under AMLC regulations, the answer is an emphatic no.

Following the expiration of the one-year period, the institution cannot automatically downgrade the client to standard risk. It must conduct a formal, documented risk assessment evaluating:

1. The lingering political influence and informal patronage networks of the individual;
2. The seniority and executive power of the position previously held; and
3. Whether the individual's ongoing business activities remain linked to government contracts, state concessions, or public procurement.

If lingering influence or heightened corruption risks persist, the institution must maintain the high-risk PEP classification indefinitely.

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High-Risk Jurisdictions and Prohibited Structures

In addition to individual PEPs, capital market intermediaries must enforce enhanced measures on institutional relationships connected to high-risk jurisdictions and non-transparent structures:

• FATF High-Risk Jurisdictions (Black List): Jurisdictions subject to a FATF Call for Action. Intermediaries must apply severe countermeasures, including refusing account opening or terminating business relationships.
• Jurisdictions under Increased Monitoring (Grey List): Jurisdictions actively working with the FATF to address strategic deficiencies. Intermediaries must apply enhanced due diligence and adjusted risk-weightings.
• Prohibition of Shell Companies and Bearer Instruments: Under the Revised Corporation Code (RA 11232) and AMLA, bearer shares are prohibited in the Philippines. Furthermore, covered persons are strictly barred from opening accounts for shell banks or entities with no verifiable physical commercial existence.

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Practical Exam Traps and Regulatory Pitfalls

• Trap 1: Confusing SOW with SOF in Scenario Questions. An exam question might describe a government official presenting a ₱20 million cashier's check from a commercial bank and ask if SOW is established. It is not; the cashier's check only verifies the Source of Funds. The Source of Wealth (how the official legally accumulated ₱20 million on a government salary) remains unverified without tax returns or SALNs.
• Trap 2: Assuming Domestic PEPs are Exempt from Senior Management Approval. While Foreign PEPs are automatically high risk by statute, domestic PEPs assessed as high risk strictly require Senior Management approval prior to account onboarding.
• Trap 3: Believing PEP Status Expires on Resignation Day. A public official does not lose their high-risk status the moment they step down. The minimum 1-year rule and subsequent risk-assessment mandate govern de-listing.
• Trap 4: Excluding In-Laws and Siblings from the PEP Perimeter. Candidates frequently assume that only spouses and children fall within the PEP scope. Philippine law explicitly includes parents, siblings, and children's spouses.