In Industry Insights

Sham litigation is often cited as a potential avenue for money laundering, where the legal process of dispute resolution is abused to disguise the origins of illicit funds. For years, skepticism has been poured on the volume of Russian-linked cases heard in the English courts. 

But is this a real problem, or is it just a theoretical risk that regulators feel compelled to address? Despite being flagged in money laundering risk assessments, the actual empirical evidence of harm caused by sham litigation remains sparse. With the SRA hinting at forthcoming guidance on the issue, it’s worth considering whether we’re in danger of over-regulating an area where the risk to society might not justify intervention.

What Is Sham Litigation?

At its core, sham litigation involves two parties fabricating a dispute. In a commercial setting, these parties might engineer a legal battle on paper, bringing a case to court and obtaining a legitimate-seeming judgment. The court-approved outcome could then be used to move money, often across borders, disguised as damages, settlements, or other legitimate financial exchanges. This process creates a paper trail that could give criminal funds the appearance of legality, thereby laundering the proceeds of crime through the courts.

Sham litigation could take several forms. A company may intentionally file a lawsuit knowing it will lose, agreeing to pay damages to the other party—damages that are, in fact, laundered money. Alternatively, two parties may collude to inflate a claim amount and use the judgment to transfer funds. The question is, while these scenarios are hypothetically possible, how often do they occur in practice?

Is There Empirical Evidence?

The empirical evidence for sham litigation is hard to come by. Much of the concern surrounding it stems from theoretical risk assessments, and its inclusion in the canon of money laundering methods seems more based on potential than practice. While there have been cases involving abuse of the legal system for financial gain, clear-cut examples of sham litigation for laundering purposes are rare. This raises the question: Is this truly an issue requiring heightened regulation, or are we focusing on a fringe scenario?

Regulatory bodies like the SRA evidently believe the risk is real enough to warrant attention. Their upcoming guidance, signaled at the recent Law Society Anti-Money Laundering and Financial Crime Conference, suggests they see this as an area where preventative measures are necessary. But without a solid track record of cases to back up the concern, is there a danger of over-regulating?

The Cost of Over-Regulation

London’s prominence as a hub for international litigation makes this issue even more pertinent. The city’s legal market thrives on international disputes, and increasing regulations around sham litigation could impact its appeal. A delicate balance needs to be struck between ensuring that London does not become a safe haven for financial criminals and preserving the city’s attractiveness as a forum for legitimate international cases.

Keir Starmer’s commitment to reduce regulation to boost the economy highlights a growing recognition in government that regulation has its costs. In the context of sham litigation, is there a risk that additional layers of anti-money laundering compliance could stifle legitimate legal activity? We are all familiar with the inefficiencies that result from treating every client as though they might be the next Madoff. Do we want to place undue burdens on practitioners in the name of a threat that may be more hypothetical than real?

Moreover, litigation doesn’t always require solicitors. Parties can engage directly in disputes as litigants in person, making it easier for sham litigation to slip under the radar. In these cases, regulation aimed at solicitors and law firms might miss the mark entirely. This leads us to a broader question: Are we addressing the root cause of the problem, or simply adding layers of bureaucracy that divert attention from the actual risks?

Focusing on Real Threats

The ultimate objective of anti-money laundering efforts should be to nullify financial crime and the proceeds of crime, not to overburden practitioners with compliance for compliance’s sake. Over-regulation could drive lawyers to work strictly to the letter of the guidance, rather than thinking critically about the risks they face. We need a regulatory framework that encourages practitioners to assess real risks, rather than simply ticking boxes to satisfy pernickety SRA auditors and avoid a costly fine.

Even if the SRA opts to issue non-mandatory guidance on the topic of sham litigation, it is widely understood within the profession that such guidance often carries the weight of de facto rules. While technically not binding, firms are keenly aware that the SRA regularly relies on its own guidance when assessing the conduct of legal practices. In disciplinary cases, a firm’s failure to follow these “non-mandatory” guidelines could easily be interpreted as a failure to uphold required standards of professionalism and diligence. For this reason, solicitors tend to treat these regulatory missives with the same seriousness as formal rules, knowing full well that divergence from the guidance could expose them to enforcement actions. The result is that even soft guidance can lead to significant changes in practice, which is why it’s critical to ensure that any new recommendations are proportionate to the actual risk posed by sham litigation.

Before moving ahead with regulation on sham litigation, it’s crucial to stop and ask whether this is truly an area that needs heightened scrutiny. Is there a demonstrated risk to society that justifies intervention? Or are we at risk of regulating for the sake of regulation, with the unintended consequence of making London less attractive for international disputes and adding unnecessary pressure on practitioners?

Sham litigation, while theoretically possible, has yet to reveal itself as a widespread money laundering technique. Regulators like the SRA are right to be vigilant, but as they consider introducing guidance on the issue, it’s worth questioning whether the risk justifies the action. By over-regulating this area, we may end up focusing on a hypothetical risk rather than addressing the broader aim of fighting financial crime in a proportionate and effective way. 

The key is striking the right balance: protecting the legal system without stifling its legitimate use.

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