Money Laundering

David Marchant

Money laundering is the method of concealing the proceeds of criminal activity in order to disguise its illegal origin and create the appearance that it was generated through legitimate business activities so that the perpetrators can spend their booty with the minimum of suspicion.

Governments have designated it a criminal offense in its own right, just like the underlying offense(s) which result in the proceeds being obtained in the first place, in an attempt to take the profit out of crime.

Different jurisdictions have historically defined crime predicating the offense of money laundering in different ways and it normally included only those crimes that were universally considered to be 'serious', such as narcotics trafficking, weapons dealing, racketeering and murder. For example, offshore financial centers would refuse all requests for judicial assistance from foreign governments if those requests in any way involved an investigation into tax evasion, which was not recognized as an offense in offshore centers and, therefore, did not meet the legal standard of dual criminality, i.e. it must be an offense in both countries for judicial co-operation to kick in. If the word 'tax' was even mentioned in a request, it would be refused, and many were, much to the chagrin of criminal investigators in the world's major countries.

All of this began to change in or around 2000, however, largely as a result of an effort by the world's major countries to create a minimum international standard for the creation and implementation of a comprehensive legal, supervisory, enforcement and professional framework to combat money laundering and terrorist financing.

Spearheading this drive was the Financial Action Task Force on Money Laundering, which was established by the G7 countries in 1989 and subsequently published a number of recommendations that it is pressuring all countries to adopt. These recommendations include broadening the number of predicate offenses for money laundering to include fiscal offenses, eliminating banking secrecy, introducing greater transparency of beneficial ownership of businesses, confiscating the proceeds of crime, a requirement that financial institutions and certain non-financial companies report suspicious activities and the passage of legislation allowing for greater international co-operation in criminal investigations.

Offshore financial centers, which have become synonymous with banking secrecy and tax evasion, were highlighted as a particular problem by FATF. In a report dated February 14, 2000, FATF stated: "In today's open and global financial world, characterized by a high mobility of funds and the rapid development of new payment technologies, the tools for laundering the proceeds of serious crimes as well as the means for anonymous protection of illegal assets in certain countries or territories make them even more attractive for money laundering. Existing anti-money laundering laws are undermined by the lack of regulation and essentially by the numerous obstacles on customer identification, in certain countries and territories, notably offshore financial centres."

Setting out its aims, FATF stated: "All countries and territories that are part of the global financial system should change the rule and practices that impede the anti-money laundering fight led by other countries. The legitimate use by private citizens and institutional investors of certain facilities offered by many financial centres, including offshore centres, is not put in question. An essential aspect of this issue is to make sure that such centres are not used by transnational criminal organizations to launder criminal proceeds in the international financial system. It is also important that they are not used by criminal organizations to escape investigation in other jurisdictions."

By 2009 more than 182 countries (many of them via regional groups such as the European Union and the Gulf Co-operation Council) had adopted FATF's recommendations. Those countries whose anti-money laundering systems are reviewed by FATF and do not come up to scratch are placed on a list of 'Non Cooperative Countries and Territories' in what is essentially a global 'name and shame' process. Businesses located in jurisdictions not on the list are encouraged not to do business with those that are on it. The first list was published in June, 2000 and contained 15 countries. Since then, several countries have been added and removed from the list, including Egypt, Guatemala, Indonesia, Myanmar, Nigeria, Philippines and Ukraine. According to the latest review in October 2007, there were no countries still listed, though Myanmar, which was de-listed in October 2006, was still being monitored.

The economies of many small and developing countries have been affected by FATF's measures. For example, effective August 1, 2002, the Central Bank of Montenegro revoked the licenses of all 432 offshore banks licensed in the jurisdiction, most – if not all – of which were 'shell' banks committing a variety of criminal offenses in Cyberspace and around the world.

Offshore financial centers were left with 'Hobson's Choice': implement FATF's recommendations and lose significant business as foreign clients move their money elsewhere or do not implement the recommendations and lose business anyway because their name will go on a global black-list and foreign clients will be pressured or embarrassed into no longer doing business with you. Even those that do want to be a good global citizen are faced with the problem of how to pay for the introduction of these new measures.

Some small and emerging countries have felt bullied by the world's major countries and there is a lingering suspicion that FATF's measures, in conjunction with a global "tax harmonization" drive by the Organisation for Economic Co-operation and Development, are as much designed to help major countries collect more taxes as they are to stamp out major crime that is not tax-related.

How big is the problem?

Although it is impossible to know the exact figure, the World Bank Group estimates that at least US$1 trillion is laundered annually around the world and the International Monetary Fund puts the figure at between two and five percent of the world's gross domestic product.

While they are undoubtedly neck-deep in money laundering, it is nevertheless a common misconception that most money is laundered in offshore financial centers and developing countries, an impression that is cultivated by governments of major countries seeking to put the blame somewhere other than on their own doorsteps and encouraged by Hollywood blockbuster movies such as 'The Firm', which portrayed the Cayman Islands as a den of tax-dodging iniquity.

The reality is somewhat different. More criminal proceeds are laundered in New York or London than the Bahamas or Panama and the biggest culprits within those jurisdictions are more likely to be the 'elite' of world banking than a little-known 'shell' bank licensed in a far-away tropical paradise. And much of the criminal proceeds received by an offshore bank were sent there by a bank in a major country, where the underlying criminal activity originated.

It is my experience that the biggest financial institutions have become exactly that in part because of their willingness to do business with – and accept money from – virtually anyone if they think there's a profit in it. It's considered to be good business. As a rule of thumb, the bigger the bank, the bigger its money laundering problem and by no means all of it is done unknowingly.

The global economic crisis of 2008 and beyond has flushed out plenty of fraudulent and other dubious behaviour. Even the hallowed vaults of the most respected Swiss banks have echoed to the sounds of angry legislators and taxpayers around the world who have long believed but seldom dared openly accuse them of illegal activities. In early 2009 UBS, already stricken by its part in the downfall of global investment banking, reached a $780m settlement with the US Department of Justice over allegations that it helped Americans evade tax during the financial bubble years. The bank transferred to Washington the names of up to 300 US clients who prosecutors say used sham companies to get round paying tax.

In 2009, a fresh attempt at closing down perceived money laundering in offshore financial centers was made in the U. S. Congress, where U. S. Senator Carl Levin introduced the 'Stop Tax Haven Abuse Act', which is primarily intended to restrict the use of OFCs in helping U. S. taxpayers evade taxes.

How are developing countries affected?

Developing or transition countries are particularly vulnerable to money laundering because they generally lack the level of legal, enforcement and professional sophistication required to effectively regulate one of the most complex areas of criminal activity.

Many also lack the finances to implement a system that will meet international standards. However, if they do not meet these standards, they are likely to find themselves on FATF's list of 'Non Cooperative Countries and Territories' which, apart from being embarrassing, may lead to a loss of revenue as companies in countries that do meet these standards shy away from doing business with them for fear of attracting the unwelcome attention of their home regulators and law enforcement agencies.

Another negative consequence of failing to control money laundering is that it encourages some of the world's worst criminals, such as terrorists and narcotics traffickers, to establish a foot-hold in a country, with all of the underlying problems that brings, such as threats of violence, bribery, corruption, murder, etc.

What crimes predicate money laundering?

FATF has recommended that: "Countries should apply the crime of money laundering to all serious offenses, with a view to including the widest range of predicate offenses."

FATF has recommended that countries should – as a "minimum" measure – include a range of offenses in their legislation within each of the following "designated categories of offenses" as a basis for money laundering:

  • Participation in an organized criminal group and racketeering
  • Terrorism, including terrorist financing
  • Trafficking in human beings and migrant smuggling
  • Sexual exploitation, including sexual exploitation of children
  • Illicit trafficking in narcotic drugs and psychotropic substances
  • Illicit arms trafficking
  • Illicit trafficking in stolen and other goods
  • Corruption and bribery
  • Fraud
  • Counterfeiting and piracy of products
  • Environmental crime
  • Murder, grievous bodily injury
  • Kidnapping, illegal restraint and hostage-taking
  • Robbery or theft
  • Smuggling
  • Extortion
  • Forgery
  • Piracy; and
  • Insider trading and market manipulation

How is money laundered?

There are three distinct phases of the money laundering process: Placement, Layering, and Integration.

Placement: The point at which criminally-derived proceeds enter the financial system. This might involve breaking up large amounts of cash into smaller amounts that attract less attention and attempting to deposit it into a bank account. This is the phase when the criminal's ill-gotten gains are considered to be most susceptible to seizure by the authorities. Due to anti-money laundering legislation in many countries that typically carry severe criminal and civil penalties, financial institutions are becoming increasingly wary of accepting large amounts of cash and have a legal responsibility to report suspicious transactions.

Layering: Proceeds of crime are moved around in a series of complicated and numerous financial transactions with the ultimate goal of making it difficult, if not impossible, to trace the funds back to their criminal origin. This process typically involves setting up an array of 'paper' legal entities in multiple jurisdictions, particularly those known for their bank secrecy laws.

Integration: Once proceeds of crime have been spun around in a cycle of complexity, they will re-enter the legitimate economy by being invested in bona fide investments, such as stocks, business ventures, property or luxury items.

Tips for Writing About Money Laundering

  • Look out for the existence of 'paper' entities on a balance sheet or in ownership records, i.e. companies or other legal entities that do not have any employees and do not have a bona fide office in the jurisdiction in which they are incorporated. These entities will exist only as a piece of paper in the filing cabinet of the office of a company management firm or law firm in their home jurisdiction. Obvious questions that arise are: Why do these entities exist? What do they do? What do they own? This is an important aspect of a money laundering investigation since the process often involves criminals sending cash to what are, in reality, 'paper' entities on the pretext of paying an invoice for services that the 'paper' company is supposed to have rendered, which is an all but impossible task if it has no employees. Enron, which was headquartered in the United States, incorporated more than 600 subsidiaries in the Cayman Islands yet did not have a single listing in the local telephone directory or a local office. It turned out that Enron used some of these entities to hide massive losses as part of an elaborate fraud.
  • How do you identify a 'paper' entity? There are certain jurisdictions which are known for incorporating high volumes of 'paper' entities. Jurisdictions to watch out for include: Delaware and Nevada, in the United States; and the following offshore financial centers: Anguilla, Antigua, Bahamas, Bahrain, Barbados, Belize, Bermuda, British Virgin Islands, Cayman Islands, Cook Islands, Costa Rica, Cyprus, Dominica, Dublin (Ireland), Gibraltar, Grenada, Guernsey, Hong Kong, Isle of Man, Jersey, Labuan, Liechtenstein, Luxembourg, Malta, Mauritius, Monaco, Montenegro, Montserrat, Nauru, Netherlands Antilles, Niue, Panama, Singapore, St. Kitts & Nevis, St. Lucia, St. Vincent and the Grenadines, Switzerland, Turks & Caicos Islands and Vanuatu. Only a tiny fraction of foreign-owned legal entities incorporated in offshore financial centers have a physical presence there. The British Virgin Islands and the Turks & Caicos Islands collectively have several hundreds of thousands of foreign-owned legal entities registered in their jurisdictions but probably no more than two dozen of these have a physical presence there. Even in Bermuda, which has one of the most developed infrastructures of all offshore centers, only about 300 – or 2.5 per cent – of its approximately 12,000 foreign-owned legal entities have a physical presence.
  • If you suspect a company is a 'paper' entity, run its address through a major Internet search engine such as Google at www.google.com. If it is indeed a 'paper' company, you are likely to receive many hits for other 'shell' companies who are also using that address, which is typically a mail-box operated by a company management firm or law firm. Also, run its name through the local telephone directory to see if it has a listing. You can access a Global Yellow Pages from http://www.globalyp.net/index/international. The overwhelming majority of 'paper' entities do not have a telephone directory listing.
  • Learn to differentiate between the terms 'beneficial' and 'nominee'. A beneficial owner is the person for whose benefit an asset is held, while a nominee owner is simply a 'front' for the beneficial owner. In the offshore world, the nominee is king. Many law firms and company management firms operate nominee holding companies which show up as shareholders on corporate share registers even though the beneficial shareholder is the client. It is done to hide the identity of the client. If 'XYZ Holdings Ltd.' shows up as a shareholder of 'ABC Telecommunications Inc.' and 'XYZ Holdings Ltd.' is a wholly-owned subsidiary of a law firm, it does not necessarily mean that the law firm has a beneficial interest in 'ABC Telecommunications Inc.'. The law firm might be holding its stake on behalf of a client who wishes to remain anonymous. It is also common for foreign-owned companies to have nominee directors, who are usually local attorneys or employees of company management firms who have little or no idea about the underlying business of the company of which they are a director. If 'Joe Public' or 'John Smith' shows up as a director of an offshore company, it certainly does not mean that they play any meaningful role in the governance of that company, as directors are supposed to. Some attorneys and company management employees simultaneously serve as directors of dozens or hundreds of 'paper' companies. The provision of nominee directors and shareholders is done for a fee and is a highly lucrative area of offshore finance for law firms, company management agents and others who provide such services.
  • Information about legal entities in offshore financial centers is generally difficult to obtain. In most centers, the only publicly-available information about a legal entity is its registration number, date of incorporation and the name and address of its registered agent. Perhaps the most open offshore center is Bermuda, where, for a small fee, you are legally entitled to look at each legal entity's file at the Registrar of Companies and view its share register and list of officers and directors which are kept at its registered office.
  • In securities fraud, it is common for insiders to hide illegal trades in the stock of their companies by buying and selling shares through offshore entities whose ownership is hidden. The existence of offshore-registered entities as significant shareholders in regulatory filings for publicly-listed companies outside of their home jurisdiction is a red flag that warrants further investigation.
  • In the world of money laundering, the underlying objective of those involved is to deceive anyone looking into their activities and very little is as it appears on the surface. A successful investigation into money laundering requires a tremendous amount of time and effort. Be persistent and inquisitive.
  • It is important to understand that all commercial financial institutions are used by criminals to launder money and, as a rule of thumb, the bigger the financial institution, the bigger its money laundering problem. The acid test is whether they were involved knowingly or unknowingly.
  • The biggest money laundering centers in the world are generally considered to be the United States and the United Kingdom.
  • Never forget the scale of the problem. Best-selling author Jeffrey Robinson has described money laundering as the world's third-largest industry in monetary terms.

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