PMLA 2002 and Banks: Reporting Entity Obligations under Section 12

Money that has been earned by crime is useless until it can be spent, and it cannot be spent until it has passed through a bank. That is why the law of money laundering is, in practice, a law about banks. The Prevention of Money-Laundering Act, 2002 does not merely punish the launderer. It conscripts the banking system, turning every bank into a reporting entity with statutory duties of record keeping, verification and disclosure, and attaching a penalty to the failure to perform them. For a bank the Act is therefore not a chapter of criminal law. It is a compliance obligation with a criminal statute behind it.

1. The architecture: three layers that must be read in order

The single most common error in this subject is to treat money laundering as a free standing offence. It is not. The Act is built in three layers, and each layer depends on the one below it.

Figure 1: Nothing above exists without the layer below

• A scheduled offence is the predicate. The Schedule to the Act lists offences under a long series of statutes, running from the general criminal law through the corruption, narcotics, customs, securities and company law statutes.
• Proceeds of crime, defined in Section 2(1)(u), means any property derived or obtained, directly or indirectly, as a result of criminal activity relating to a scheduled offence, or the value of such property, or property equivalent in value held within or outside the country.
• Money laundering, defined in Section 3, is committed by whoever directly or indirectly attempts to indulge, knowingly assists or knowingly is a party to, or is actually involved in, any process or activity connected with the proceeds of crime, including its concealment, possession, acquisition or use, and projecting or claiming it as untainted property.

Section 4 punishes money laundering with rigorous imprisonment for a term of not less than three years and which may extend to seven years, and with fine. Where the proceeds of crime involved relate to an offence under the Narcotic Drugs and Psychotropic Substances Act, 1985, the upper limit rises to ten years.

2. The bank as a reporting entity

Section 2(1)(wa) defines a reporting entity to include a banking company, a financial institution, an intermediary and a person carrying on a designated business or profession. A bank is therefore squarely within the Act's compliance chapter, Chapter IV, which runs from Section 11A to Section 15.

Clauses (c) and (d), which required the entity to verify the identity of its clients and to identify their beneficial owners, were omitted in 2019, and the duty now sits in Section 11A. That section requires every reporting entity to verify the identity of its clients and of the beneficial owner. A banking company may do so by authentication under the Aadhaar Act, and every reporting entity may use offline Aadhaar verification, a passport or another officially valid document notified for the purpose. No client may be denied services for not having an Aadhaar number.

The retention periods are set by Section 12(3) and 12(4). Records of transactions are kept for five years from the date of the transaction. Records of identity documents, account files and business correspondence are kept for five years after the business relationship ends or the account is closed, whichever is later. Section 12(2) makes everything maintained, furnished or verified confidential save as otherwise provided under any law.

Figure 2: The six duties of a reporting entity

Access to information and enhanced due diligence

• Section 12A empowers the Director to call for records and any further information he considers necessary, within the time and in the manner he specifies, and makes what is sought confidential.
• Section 12AA requires enhanced due diligence before a specified transaction. The entity must authenticate the client's identity using the Aadhaar number, or by another prescribed process for a person not entitled to one, take additional steps to examine the ownership and financial position and the sources of funds, and record the purpose of the transaction and the intended nature of the relationship. If the client does not comply, the entity must not allow the transaction. The information so obtained is kept for five years.

A specified transaction covers a cash deposit or withdrawal above the prescribed amount, a transaction in foreign exchange above the prescribed amount, a high value import or remittance, and such other transactions as may be prescribed.

3. What a bank actually files, and by when

The reports are prescribed by Rule 3 of the Prevention of Money-Laundering (Maintenance of Records) Rules, 2005 and are filed electronically with the Financial Intelligence Unit, India through its reporting gateway.

Two offices must be named and communicated to the Director. The Principal Officer is designated for the purposes of Section 12 and is the person through whom the reports are filed. The Designated Director is responsible for ensuring overall compliance with the Act and the Rules, and in a company this is ordinarily a managing director or a whole time director.

4. Customer due diligence: where the Act meets the Reserve Bank

Section 12 says that identity must be verified in the prescribed manner. The prescription for banks comes through the Reserve Bank's Master Direction on Know Your Customer, issued under Section 35A of the Banking Regulation Act, 1949 together with the Rules of 2005. The two instruments must be read together, because the Act supplies the obligation and the Master Direction supplies the method.

• Customer due diligence at the opening of an account, and at the time of a specified transaction for a walk in customer, using an officially valid document or the permitted digital routes, including video based customer identification.
• Beneficial ownership must be identified where the client is not a natural person, by tracing the controlling interest through the prescribed ownership thresholds.
• Risk categorisation of every customer as low, medium or high risk, with the intensity of due diligence following the category.
• Periodic updation of records at intervals fixed by risk: two years for high risk, eight years for medium risk and ten years for low risk customers.
• Ongoing monitoring of transactions against the profile, which is what generates the alerts that become suspicious transaction reports.

5. Enforcement: attachment, adjudication and trial

1. Section 5 allows the Director or an authorised officer, on the basis of material in his possession and reasons recorded in writing, to provisionally attach property believed to be proceeds of crime, for a period of one hundred and eighty days.
2. Section 8 requires the Adjudicating Authority to issue a show cause notice, consider the reply and decide whether the property is involved in money laundering. Confirmation restrains dealings with the property; it does not transfer title. The power under Section 8(4) to take possession of the attached property survives, but the Supreme Court has held that it should be exercised only in exceptional circumstances.
3. Sections 17 and 18 provide for search and seizure of property and of persons, on reasons recorded in writing, with the material sent in a sealed cover to the Adjudicating Authority.
4. Section 19 provides the power to arrest, on the basis of material in possession and reasons to believe recorded in writing, with the grounds of arrest to be informed to the person arrested.
5. Section 26 provides an appeal to the Appellate Tribunal, and Section 42 a further appeal to the High Court on a question of law or fact, within sixty days.
6. Section 44 places the trial of the offence before a Special Court, which is a Court of Session designated for the purpose, and the Special Court also tries the scheduled offence.

6. The leading case

7. The bank's own exposure

A bank that fails in its Chapter IV duties is not prosecuted for money laundering. It is penalised administratively.

• Section 13 allows the Director, on his own motion or on an application, to inquire into the obligations of a reporting entity, and to direct an audit by a chartered accountant from a panel at the cost of the Central Government. On a finding of failure he may issue a written warning, direct compliance with specific instructions, require the entity to send reports on the measures taken, or impose a monetary penalty of not less than ten thousand rupees and up to one lakh rupees for each failure, on the entity, its designated director or its employees.
• Section 14 protects the reporting entity, its directors and its employees from any civil or criminal proceeding for furnishing information under Section 12(1)(b). The protection is the reason a bank can file a suspicious transaction report without fear of a suit by the customer, and it is expressly subject to Section 13.
• Section 63 punishes false information or a failure to give information when called upon, and Section 70 fixes liability on a company and on the persons in charge of its affairs.

8. Quick Revision

1. A bank is a reporting entity, not an accused, in the ordinary case. Its exposure is administrative under Section 13.
2. The offence is dependent on a scheduled offence and continuing in nature.
3. Section 12AA requires enhanced due diligence before a specified transaction, and the transaction must be refused if the client does not comply.
4. The Principal Officer files the reports; the Designated Director owns the compliance.
5. The suspicious transaction report has no monetary threshold and covers attempted transactions.
6. Attachment is provisional for one hundred and eighty days and is confirmed or released by the Adjudicating Authority under Section 8.
7. Section 24 raises a presumption that the property is involved in money laundering, and Section 45 imposes twin conditions for bail.
8. The Enforcement Case Information Report is not a first information report, but the grounds of arrest must be communicated.
9. Section 14 immunises the bank for filing the report, and Section 12(2) keeps the filing confidential.

9. Frequently Asked Questions

Must a bank tell a customer that it has filed a suspicious transaction report?

No, and it must not. Section 12(2) makes everything maintained, furnished or verified under the Chapter confidential save as otherwise provided under any law, and tipping off the customer would defeat the purpose of the report. The Rules and the Reserve Bank's directions on the subject expressly forbid disclosure of the fact of reporting to the customer or to any third party. The bank may continue to operate the account unless it is directed otherwise, precisely so that the reporting is not revealed by a sudden freeze.

Can a bank be prosecuted for money laundering if a launderer used its accounts?

Only if the bank, or an officer acting for it, knowingly assisted or was knowingly a party to a process or activity connected with the proceeds of crime. Section 3 requires knowledge or actual involvement. A bank that performed its due diligence, maintained its records and filed its reports has discharged its statutory duty, and a failure in that duty is visited with the administrative penalty under Section 13 rather than a prosecution. Where officers have been complicit, they are prosecuted in their own right, and the liability of the company is dealt with by Section 70.

How does a cash transaction report differ from a suspicious transaction report?

The first is mechanical and the second is judgemental. A cash transaction report is generated by crossing a number, more than ten lakh rupees in a transaction or in a connected series within a month, and is filed monthly whether or not anything about the transaction is odd. A suspicious transaction report is generated by a conclusion, has no threshold, covers attempted as well as executed transactions, and must be filed within seven working days of the bank being satisfied that the transaction is suspicious. A transaction can attract both, or either, or neither.

Does an attachment under Section 5 take away the owner's title?

No. Attachment, and even its confirmation under Section 8, operates as a restraint on dealing with the property. Title passes only on confiscation, which follows a conviction by the Special Court and vests the property in the Central Government free from encumbrances. The Supreme Court in Vijay Madanlal Choudhary specifically observed that the power to take possession of confirmed attached property under Section 8(4) should be used only in exceptional circumstances, so that a person is not dispossessed of a running business or a dwelling before the trial has even begun.

What are the twin conditions in Section 45?

The public prosecutor must first be given an opportunity to oppose the application. Where he opposes it, the court may release the accused only if it is satisfied, first, that there are reasonable grounds for believing that the accused is not guilty of the offence and, second, that he is not likely to commit any offence while on bail. The relaxations in the section for a person under sixteen years of age, a woman, a sick or infirm person, and an accused charged with laundering a sum of less than one crore rupees, operate as exceptions. The conditions were upheld in Vijay Madanlal Choudhary, which also held that they apply to an application for anticipatory bail, since the enquiry at that stage is the same.

Is a bank's suspicious transaction report evidence against the customer?

No. The report is an intelligence input, not proof of anything. It records the bank's suspicion, which may rest on nothing more than a pattern that does not fit the customer's declared profile. The Financial Intelligence Unit analyses it, and may or may not pass it on for investigation. What becomes evidence in a proceeding is the underlying material, the account statements, the identity documents and the transaction records that the bank was required to keep under Section 12, together with the testimony of the officers concerned. This is one reason the retention periods in Section 12(3) and 12(4) matter so much: the report is of no use if the records behind it have been destroyed.

What must a bank do on an Enforcement Directorate notice about a customer's account?

It complies, and it does so without telling the customer. A summons under Section 50 or a requisition under Section 12A obliges the bank to produce the records and the information specified, and Section 12(2) keeps the exchange confidential. Where an attachment order under Section 5 is served, the bank must mark the account so that the balance is not dealt with, and it must do so notwithstanding any mandate from the customer, because the order operates on the property itself. The bank's own lien or right of set-off over the balance is a separate question, and where the bank claims a prior charge it must raise that claim before the Adjudicating Authority rather than act on it unilaterally.

10. Related Topics and Provisions

• Opening of accounts and Know Your Customer requirements
• Banking frauds: classification, reporting and the Master Directions, 2024
• Criminal liability in banking and the Prevention of Corruption Act, 1988
• The banker's duty of secrecy and the exceptions to it
• Inspection, supervision and penalties under the Banking Regulation Act, 1949
• Garnishee and attachment orders, and other claims on a customer's balance