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Special Report on Money Laundering

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In this special report on money laundering, Brendan Hewson, gtnews editor of the Financial Crime section, discusses latest developments in anti-money laundering techniques and how organizations can - and must - implement effective prevention methods.

All anti-money laundering (AML) processes and procedures within an organization should start and finish with the same principle: know your customer (KYC). All organizations must understand KYC guidelines and be able to recognize the warning signs of potential money laundering activity. They are required to know their responsibilities for reporting suspicious activity and understand the variety of money laundering regulations. In addition, they must be aware of the penalties to expect if they should fall foul of the regulators or the law.

But is this true in reality? Is every banker or corporate officer au fait with AML regulations and guidelines, and do they fully understand the subject? The May 2006 financial crime survey on gtnews suggests they do not (read Survey Reveals Worrying Lack of Fraud Prevention Training Among Institutions).

The survey revealed that 91 per cent of banks are concerned or very concerned about financial crime, while 78 per cent of corporates admitted the same. Despite this concern, however, the survey also highlighted the fact that banks and corporates do not have the appropriate training or awareness of prevention methods and activities related to fraud, including money laundering. Money laundering is a worldwide problem and this special report outlines the subject and discusses what is required in order to implement effective prevention methods.

What is Money Laundering?

Money laundering is the process of taking the proceeds of criminal activity and making them appear legal; the concealment of the ownership, location and nature of property; and acquiring or using property or money knowing or believing it is derived from criminal activity. It is a process used predominately by professionals with a criminal nature and also by minor criminals, to conceal the true ownership of assets, while at the same time retaining control over illegally obtained income or assets. In some jurisdictions, such as the US, it is also used to evade taxes.

Those who commit the underlying criminal activity or predicate offence may attempt to launder the money themselves, but increasingly a new class of criminals provides laundering services to organized crime. This new class consists of lawyers, bankers, accountants and businessmen.

It is wise to remember that in all money laundering activities, there is a fraud or deception somewhere and that this can take place in the initial approach with the bank or corporate. The launderer will appear completely legitimate with apparently authenticated references. This approach, disguised with a few convenient, easily accepted falsehoods and a document not quite as genuine as it appears, can deceive the inattentive or unwary. If the launderer is any good, this tactic will be professional, which is why checking references and their statements is so important.

The rationale of money laundering is to legitimize illegally-obtained income through acquisition and use of various innocuous products. For example, this would include domestic and international real estate, deposit accounts, investment securities, loans that are paid off much earlier than anticipated by the lender, and other items of personal property, including works of art.

The UK Joint Money Laundering Steering Group (JMLSG) points out that money laundering takes many forms, including:

  • Trying to turn money raised through criminal activity into 'clean' money (this is classic money laundering);
  • Handling the benefit of acquisitive crimes, such as theft, fraud and tax evasion;
  • Handling stolen goods;
  • Being directly involved with any criminal or terrorist property, or entering into arrangements to facilitate the laundering of criminal or terrorist property; and
  • Criminals investing the proceeds of their crimes in a whole range of financial products.

The launderer's objectives are clear: decriminalize the money while at the same time retain control over it and establish or use an already uncontaminated cover for it. It is very important to remember that the launderer is always prepared to make a loss. Money launderers are decriminalizing an original cash or monetary value product that invariably carries very little in the way of overheads and is thus virtually all profit. That gives them a substantial margin to buy into a market knowing there is going to be a drop or reduction in the invested amount's return.

This is an area seldom examined. It is generally accepted, within the financial industry, that everyone wants to make a profit; so little attention is paid to those who lose money in the marketplace. In this way, the professional money launderer can slip neatly into the system drawing little or no attention to themselves.

Does money laundering have its limitations? The only limitation that any professional money laundering operation faces is the risk of detection. The launderer will have given proper consideration to which area they are going to use, or rather misuse, to get the product legitimized and also evaluated the risks involved. Is the company on the lookout for this sort of activity and is it competent in its AML activities? Is there someone that they can 'persuade' in that company or organization to assist them? Is there someone within the company that is already compromised? Read Do You Know Your Employee?.

The money launderers will ask and answer all these questions. Can every company, financial institution or organization that could be the target for money laundering be sure they have all the necessary precautions in place?

Lessons From Enron

For many years, through lectures, training and innumerable articles, bankers have been warned of the dire consequences of breaching codes, rules and regulations. How many times has this been dismissed with 'it can't happen to me' until a major financial scandal in 2002 showed otherwise. In Washington D.C, in July 2002, deputy attorney general, Larry Thompson, announced that three former British bankers were charged with wire fraud in a US$7.3m scheme involving Enron. "The Department of Justice is committed to the vigorous investigation and prosecution of criminals who prey on the liberties of our financial system," Thompson said. "As these charges demonstrate, our investigation into the collapse of Enron Corporation is active and ongoing."

At the time, Leslie R. Caldwell, director of the Enron task force, stated: "This complaint shows that we intend to address the conduct not only of Enron but also of those who capitalized on Enron's willingness to enter into accounting-driven transactions that lacked business purpose and served instead merely to enrich those involved."

All three defendants were employed in the structured finance group of Greenwich NatWest, a division of NatWest with offices in the US and London. According to the criminal complaint, NatWest, a bank with offices in Houston, Texas and London, UK, should have received the benefit of the $7.3m based on its own investment.

This case should give serious pause for thought to any employee who may at minimum be reckless - let alone outright delinquent - in their dealings with customers. The three are now in the US to stand trial, having been given over to the custody of the US authorities at Gatwick Airport, UK on 13 July 2006.

Extradition is a very sensitive subject, especially where there appear to be anomalies or inconsistencies in the mutual legislation. No matter what the outcome of this judicial process, let it be a lesson to all that not being proceeded against in your home country may not protect or preclude you from being dispatched to another jurisdiction where the rules may not be as friendly as home.

Money Laundering Techniques

The techniques used by many money launderers constantly evolve to match the source and amount of funds to be laundered and the legislative/regulatory/law enforcement environment of the market in which the money launderer wishes to operate. There are three broad groups of offences related to money laundering that firms need to avoid committing:

  1. Knowingly assisting (in a number of specified ways) in concealing, or entering into arrangements for the acquisition, use, and/or possession of, criminal property.
  2. Failing to report knowledge, suspicion, or where there are reasonable grounds for knowing or suspecting, that another person is engaged in money laundering.
  3. Tipping off, or prejudicing an investigation.

Significantly, it is also a separate offence under money laundering regulations not to have systems and procedures in place to combat money laundering (regardless of whether or not money laundering actually takes place).

The process of legitimizing or laundering money is conducted in stages. Invariably, there are three stages to this activity:

  1. Placement - this refers to the initial point of entry for funds derived from criminal activities.
  2. Layering - this is the creation of complex networks of transactions which attempt to obscure the link between the initial entry point and the end of the laundering cycle. This usually means transferring funds to other countries, often with less than rigorous banking supervision and regulations. Once deposited in a foreign bank, the funds can be moved through accounts of 'shell' corporations that exist solely for laundering purposes.
  3. Integration - this involves the movement of layered funds, which are no longer traceable to their criminal origin, into the financial world, where they are mixed with funds of legitimate origin.

The sources of dirty money can be many and varied. The most common sources are international organized crime that in itself operates criminal enterprises dealing in narcotics, fraud, extortion, blackmail, theft (including robbery and burglary) and, in some jurisdictions, tax evasion. In reality, any derivative of crime that has a monetary value can be laundered.

Developments in UK Money Laundering Legislation

Money laundering legislation in the UK, under Sections 327 to 340 of the Proceeds of Crime Act 2002 (PoCA), is extremely wide ranging and includes mere possession of criminal or terrorist property as well as its acquisition, transfer, removal, use, conversion, concealment or disguise.

In the UK, money laundering need not involve money (it relates to assets of any kind, both tangible and intangible, and to the avoidance of a liability) and need not involve laundering either (a thief's possession of the assets he himself stole is included).

There is no lower limit to what has to be reported - a suspicious transaction involving a single £5 note may be required to be reported. In addition, all persons (not just financial services employees and firms) are technically required to report, and obtain consent for, their own involvement in crime or suspicious activities involving money or assets of any kind. In the UK, a thief who steals a jacket from a clothes store commits a 'money laundering' offence because he has possession of an asset derived from crime. He is technically required to seek consent from law enforcement for his continued possession of the jacket if he is to avoid risk of prosecution for money laundering.

The UK legislation also creates a money laundering offence where a person enters into, or becomes concerned in, an arrangement that facilitates (by whatever means) the acquisition, retention, use or control of criminal property by another person. This has impacted both lawyers and other professional advisers in the UK who act for a client whom they suspect may possess criminal property of any kind.

Because the UK legislation is so wide ranging, the UK's financial intelligence authority, the Serious Organised Crime Agency, receives a large volume of suspicious activity reports (SARs): in 2005, nearly 200,000 SARs were received and the number of SARs received appears to be growing by almost 50 per cent each year. This new agency is now dealing with the significant undertaking of re-evaluating the broadened scope of suspicious reporting requirements for companies and businesses.

The UK legislation was relaxed slightly in 2005 to allow banks and financial institutions to proceed with low value transactions involving suspected criminal property without requiring specific consent for every transaction (but the reporting of all transactions is still required).

Read also Developments in AML Legislation in the UK.

Identifying Suspicious Transactions

International initiatives against money laundering have been in existence since the 1980s, when a recognized surge in drug and other major crime led to an international initiative for the criminalization of money laundering as a distinct crime, which the US and UK have led since 1986. The 1988 Vienna Convention then required state parties to introduce this crime into their domestic legal systems. In 1989, the Financial Action Task Force (FATF) was created and its first report, issued in 1990, recommended the criminalization of money laundering. In 1991, the EU required its member states to 'prohibit' the laundering of funds derived from drug offences; the original Directive was revised in 2001 and replaced by another in 2005. Read also International Review of Anti-Money Laundering Laws.

KYC has become vital in preventing banks and other corporates and organizations from serving as a money-laundering conduit. Being able to recognize or identify a suspicious transaction before it is too late is the main difficulty of all anti-money laundering legislation and regulations.

The Criminal Code in the US [31 CFR Part 103 Sec 103.21 (a)(2)(iii)] delivers a very apt and succinct definition of a suspicious transaction: '[It] has no business or apparent lawful purpose or is not the sort in which the particular customer would normally be expected to engage, and the bank knows of no reasonable explanation for the transaction after examining the available facts, including the background and the possible purpose of the transaction.'

However, as the UK's JMLSG points out, suspicion is more subjective and falls short of proof based on firm evidence. The courts have defined suspicion as being beyond mere speculation and based on some foundation, for example, the JMLSG states that:
'A degree of satisfaction and not necessarily amounting to belief but at least extending beyond speculation as to whether an event has occurred or not; and although the creation of suspicion requires a lesser factual basis than the creation of a belief, it must nonetheless be built upon some foundation. A transaction that appears unusual is not necessarily suspicious. Even customers with a stable and predictable transactions profile will have periodic transactions that are unusual for them. Many customers will, for perfectly good reasons, have an erratic pattern of transactions or account activity. So the unusual is, in the first instance, only a basis for further enquiry, which may in turn require judgement as to whether it is suspicious. A transaction or activity may not be suspicious at the time, but if suspicions are raised later, an obligation to report then arises.'

A bank or corporate should have no trouble at all distinguishing a suspicious transaction from all others, if they follow the established guidelines and make sure they do know their customers; and choose to recognize that suspicious activity is happening if they have grounds to believe so.

Willful Blindness

Although it is a global issue, in the US, willful blindness is a term used in law to describe a situation in which an individual seeks to avoid civil or criminal liability for a wrongful act by intentionally putting himself in a position where he will be unaware of facts that would render him liable. For example, in a number of cases, persons transporting packages containing illegal drugs have argued that they never asked what the contents of the packages were, and therefore lacked the requisite intent to break the law. These defences have not succeeded, as courts have been quick to determine that the defendant should have known what was in the package, and they were criminally reckless in not finding out what it was before taking possession of it. So, what are some of the most common signs of willful blindness?

The failure, whether deliberate or thoughtless, to investigate 'red flags' or warning signs that are indicators of potential problems. There is, unfortunately, no common or complete criterion for identifying these red flags.

Don't Help the Criminals!

Staff within any organization must realize and understand that they may become implicated in money laundering if they:

  • Participate or take part in the process in any way.
  • Aid or abet, i.e. help commit the crime, give active assistance or help.
  • Counsel, give advice or guidance, especially if it is solicited from you as a knowledgeable person in your position.
  • Facilitate the criminals' operation or actions.
  • Fail to sufficiently 'know your customers'.
  • Have knowledge of suspicious activity or are 'willfully blind' to warning signs.

Failure to perform reasonable due diligence is also a sign of willful blindness (read Fundamentals of Due Diligence: A Critical Business Tool (Part One) and Fundamentals of Due Diligence: A Critical Business Tool (Part Two)). Firms need to carry out customer due diligence for two broad reasons. First, to help the company reasonably satisfy itself that customers are who they say they are, to know whether they are acting on behalf of another, and that there is no legal barrier (e.g. government sanctions) to prevent them from providing the product or service requested. Secondly, to enable the firm to assist law enforcement, by providing available information on customers or activities being investigated.

Consciously avoiding the truth about the illegal source of funds can also make the individual as culpable and as liable as the launderer. Willful blindness also includes:

  • Failure to keep complete current customer information: it is a requirement of all regulators that customer information is kept up to date. This also makes good business sense.
  • Failure to notify the manager, or the appropriately qualified senior member of staff appointed as the money laundering reporting officer, of suspicious activity.
  • Failure to take expert advice regarding next steps with customers: this can cause serious problems and can lead to prosecution if deemed to be deliberate or willful.

Prevention: Know Your Customer

The best way to avoid implication in any of the ways described in the previous section is to keep a well-documented, up-to-date file indicating thorough investigation of customers and their business, and immediately reporting any suspicious activity or information. Above all, the KYC principle is vital (read Protect Your Reputation; Don't Take a Risk with Financial Crime).

KYC is making every reasonable effort to determine the true identity and beneficial ownership of accounts, knowing the source of funds and determining that the information is correct. For example, comments such as 'you don't need to know that' are vivid red flags. If a customer is reluctant to let you know where the funds are coming from, then the future of the relationship should be evaluated. Knowing and understanding the nature of the customer's business is not only a good money laundering preventative measure; it is also sensible business practice and will help in developing customer relations.

With the right information, it will be easier to understand and know what constitutes reasonable account activity for that customer. Often, it is helpful to know who your customer's customers are and their major suppliers as well.

To assist the KYC process, collect financial statements and records, obtain credit history and, where other bank references are required, obtain them direct from those banks.

Verification of a customer is paramount to the protection of the company's reputation and helps to prevent fraud, bad debt and other criminal misuse, i.e. money laundering. For instance, being aware of counterfeit documents enables a fuller understanding of what identity documentation may be required.

While growing the business is the driving economic factor for any organization, circumstances may arise when the business should be rejected and these can be straightforward operational risk issues. A few examples of these are listed below:

  • If identification of the potential customer cannot be verified, do not, under any circumstances, accept anything that is not capable of confirmation.
  • It is also risky to accept the 'word' of a new customer, who is not established or verified, that required information will be forthcoming in the near future. Once those transactions commence and the information never arrives, it is the company who will be in trouble, not the customer who, by now, has probably disappeared. A classic example of this is where accounts or transactions are allowed to commence prior to receipt of acceptable documentation and where the beneficial owner of the account is unidentified. Experience has shown that some criminals repeatedly use the same documents to open accounts at different branches of the same bank. It is important, where possible, to check for similarity of identification documents in suspect accounts.

KYC applies to all staff and it should be policy that all staff must be responsible for the verification of customer identity and follow the relevant procedures. If in doubt: check it out!

Signs and Symptoms of Money Laundering

There are signs and symptoms that could indicate potential money laundering or other suspect activity, and organizations are well advised to be aware of them. Some of these are discussed in the following section.

A client who is difficult to verify or a client who is reluctant to provide details required by the account or business opening procedure should set off an alarm bell - remember KYC.

The formation in any jurisdiction of trusts, companies or corporations with no apparent commercial purpose, or the formation of trusts, companies or corporations in a country or jurisdiction where such an operation does not make sense is also a clear warning sign.

Often, just asking the simple question 'why' can save a lot of time and trouble and pre-empt unnecessary effort in investigations. This could apply in cases where professionals as nominees or trustees are used where they have no commercial involvement; or where a client has a disregard for profit or is prepared to accept uneconomic terms.

Where Can Money Laundering Happen?

Below are some of the areas where money laundering can take place:

  • Laundering by using cash transactions.
  • Bank or savings and loan accounts, using investment related transactions, using onshore/offshore international activity, secured and unsecured lending, abnormal dealing patterns and transactions.
  • There are, and have been, instances where the involvement of financial institution employees or their agents have facilitated money laundering activities. The involvement of sales and dealing staff and also the use of financial intermediaries have helped the criminal enterprises legitimize their illegal gains using the financial services system.

It is also important to take note of unusual transactions for a client's business. For instance, unusually high transactions with overseas parties where such business has not taken place before. Early examination may indicate that this is not a sign of untoward business but just a new business opportunity.

Changes in the lifestyle or behaviour of associates and customers when there is no tangible evidence to support it must also be evaluated. Often there is a simple answer but it is always better to double check that criminal activity is not taking place.

When reporting suspicious activity, follow your intuition and trust your judgement. If you feel it is suspicious, report it but keep your suspicions confidential. It is a suspicion that is being reported so there is no requirement to build a case before reporting it.

Conclusion

The biggest aid to money launderers is the financial services industry itself, which ignores or fails to recognize the warning signs of suspicious activity and does ensure that adequate and effective anti-money laundering procedures and policies are in place.

It is imperative that all staff understand the rules and ramifications of money laundering, the relevant laws and regulations, and also the sanctions for failure to comply. Indeed, anyone involved in the financial services industry should bear in mind the following statement at all times: 'An efficient, effective company inevitably deters efficient, effective money launderers.'

in association with gtnews.com