An Auditor’s Guide to Jurisdiction Risk
Jurisdiction risk affects businesses operating in foreign countries with different regulations, legal systems and economic systems. Jurisdiction risk can apply to companies in any industry. However, the concept is often associated with financial firms that borrow, lend, invest or process transactions outside of their home country.
Alongside exposing themselves to unfamiliar tax codes and laws, companies operating in some jurisdictions may unwittingly facilitate illegal activities. They may expose themselves to liabilities and reputational damage by operating in places with weak regulations. These countries often attract money launderers, organized crime syndicates and individuals or groups that fund terrorism.
These risks can also affect government entities and their contractors. These agencies and organizations need to meet the strict rules of the Governmental Accounting Standards Board (GASB). Private companies operating in high-risk countries can consider the GASB’s rigorous focus on transparency as a way to lower jurisdiction risk.
How jurisdiction risk works
Though there are many different complications that could come from doing business in various jurisdictions, the risk gets measured in the cost of doing business in different places.
Price volatility makes it difficult to plan for business operations and investors want to avoid unexpected costs. Increased expenses could come from various issues, including high tax rates, corruption, political instability or conflict or fines levied by a company’s home country regulators for failure to comply with anti-money-laundering (AML) and counter-terrorism financing (CTF) regulations.
Though jurisdiction risk is often associated with politically or economically unstable countries, it can also apply to any nation where there’s a possibility of legal changes that can affect the company’s business and limit its ability to earn profits.
Examples of jurisdiction risk
Take the EU’s General Data Protection Regulation (GDPR), which limits tech companies’ ability to collect user data. GDPR could significantly impact the business model of social media companies relying on data collection to sell ads.
In addition to potentially affecting share prices, the GDPR exposed companies to potential fines. For example, Facebook's parent company, Meta, was hit with a $275 million fine for violating privacy rules in Ireland.
Conflicts can also cause jurisdiction risk. Many multinational companies pulled out of Russia after it invaded Ukraine in early 2022. They sought to avoid public relations problems, sanctions by Western countries and possible retaliation by Russian authorities. These pull-outs resulted in significant short-term losses for firms operating in Russia.
Notable regulatory bodies
Businesses must understand the requirements of financial regulatory bodies, especially when it comes to AML/CTF issues. Here are some of the most influential agencies.
- Financial Action Task Force (FATF) is an international AML/CTF watchdog. It provides regulation frameworks that countries can use to combat money laundering and the financing of crime and terrorism.
- Financial Crimes Enforcement Network (FinCEN) implements the Bank Secrecy Act (BSA), which outlines compliance standards for combating financial crimes.
- Financial Conduct Authority (FCA) is similar to FinCEN, but it also has the authority to enforce laws ensuring competition and market stability in the UK’s industries.
Pertinent laws and regulations
A number of countries have laws related to financial crimes, while others are more strict about regulating business activities. Here are some examples of these regulations.
- The Bank Secrecy Act (BSA) is a series of laws meant to bring transparency to the U.S. financial system and combat money laundering.
- The EU Anti-Money Laundering Directive (AMLD) provides regulations for member states to follow. This legal framework is largely based on FATF guidelines.
- The Anti-Money Laundering and Counter-Terrorism Financing Act 2006 is a set of regulations set up to combat financial misdeeds. It includes the use of remittance services and cryptocurrencies, as well as business transactions.
Many countries have similar laws, which apply to every domestic and multinational company operating within their borders. Since most of these rules focus on financial transparency, it pays for companies to learn accounting standards, such as the frameworks laid out by the GASB and FASB in the U.S., to ensure transparency.
Countries with strict financial laws
Some countries have strict financial laws aimed at stopping financial crimes. These often require legitimate businesses to take extra steps to prove who they’re working with and provide financial transparency.
- The U.S. requires businesses to follow BSA rules and verify customers’ identities before doing business with them.
- Finland is one of the few countries that have successfully countered money laundering activities. Its rules, overseen by the Financial Supervisory Authority (FSA), carry significant fines and criminal penalties for non-compliance.
- The EU has several regulations related to financial crimes, money laundering and reporting. These also include rules for producing financial records for tax purposes.
Individual countries also have VAT and sales tax rules, employee rights laws and other regulations that may pose a jurisdiction risk for companies that do business within their borders.
Tips for navigating jurisdiction risks
The key steps for limiting jurisdiction risk include ensuring financial transparency and keeping up to date on new laws related to employment, the environment and safety.
- Track employment laws: Prepare your human resources department to keep up with requirements for workers and contractors located within each jurisdiction.
- Organize data management: Keep regulation-related data in an accessible place and back it up often. A cloud-based platform and centralized data warehousing can ensure data remains safe and accessible.
- Automate record keeping: The more evidence of financial activity and compliance, the better for companies seeking to limit jurisdiction risks. Automated accounting software and working papers for auditors can ensure important records are on hand to show authorities.
- Use the right tools: Finally, it pays to use a customizable auditing tool that can handle the types of data necessary to prove compliance with the laws of each jurisdiction.
Potential negative consequences associated with jurisdiction risk
Jurisdiction risk covers both legal and financial problems. Here is a closer look at the damage these dangers could do if they materialize.
- Fines: Companies could face fines both in the country where they operate and their home country for failure to abide by AML laws, tax rules and employment requirements.
- Forex risks: Fluctuating exchange rates can limit or eliminate profits for a company operating outside its home country.
- Loss of profits: Companies forced to cease or move operations due to conflict or other problems can lose profits and incur costs limiting their overall profitability.
- Reputational damage: In many jurisdictions, companies are responsible for verifying clients and proving sources of funds. Alongside fines and prosecution, financial firms could suffer reputational damage that could cost them customers and investors.
- Loss of investors: Failure to account for jurisdiction risks can lead to a loss of investors. Public companies, such as Facebook and Instagram parent Meta, suffered share-price drops after fines for not complying with European laws.
- Reduced production: Companies could also be forced to slow or stop operations until they are able to comply with regulations.
What to do if you make a misstep related to jurisdiction
If a company fails to comply with laws, the best course of action to limit damage is to be as transparent as possible.
Regulators typically don’t recognize ignorance of local laws as a defense for non-compliance, especially when it comes to AML/CTF rules. However, transparent records and financial evidence may prove helpful in limiting the damage.