Research Topics: Money Laundering

Dissertation Chapter 3 on Money Laundering

Chapter 3   United Kingdom Laws on Money Laundering The expansion of the anti-money laundering efforts in the Western Hemisphere to include serious crimes rather than just drug trafficking brings this group current with practice in the rest of the world. The consideration of a multilateral evaluation mechanism, the exchange of information, training, and even a convention are all efforts to strengthen compliance and indicate broader political agreement and acceptance of the purposes of anti-money laundering. The ongoing assessment, (Zagaris, 1997) the establishment of financial intelligence units (FIUs), and the typologies exercise are small steps towards cooperation in hemispheric anti-money laundering enforcement. Meaningful and effective cooperation, harmonization of laws and standards, and effective establishment of an anti-money laundering regime must await the establishment of a proper network. A solid legal infrastructure with funding for professionals is needed for intensive and daily work on compliance with conventions and resolutions, harmonization of laws, collaboration on common approaches to mechanisms and technology, and common approaches to operational problems. At present, the governments and international organizations in the Western Hemisphere are searching for ways to develop ad hoc solutions to individual criminal problems, such as anti-money laundering. On the international front, anti-money laundering provisions multiplied at a comparable pace. Great Britain, for instance, enacted a counterpart to the American Money Laundering Control Act with the 1986 passage of the Drug Trafficking Offences Act. (Barbot, 1995; Weeling and Todd, 1996) The 1986 Act provides immunity from suit for breach of the implied banking secrecy contract if a person discloses to a police officer “a suspicion or belief that any funds or investments are derived from or used in connection with drug trafficking or any matter on which such a suspicion or belief is based.” While the Drug Trafficking Offenses Act, and its successor, the Drug Trafficking Act, contained a defense against disclosure rather than an affirmative duty to disclose, (Helleiner, 1999) this latter obligation was not far behind. In fact, just three years later, Parliament enacted the Prevention of Terrorism Act of 1989, which imposed just such a duty upon any person who is “concerned in an arrangement whereby the retention or control … of terrorist funds is facilitated.” In England, as in the United States, more stringent anti-money laundering statutes and regulations soon followed. (Walker, 1996) Shortly after the United States and Great Britain launched their first targeted strikes specifically against money laundering, the United Nations joined the fight against dirty money. (Quillen, 1991) The Vienna Convention of 1988, ” recognizing the links between illicit traffic and other related organized criminal activities which undermine the legitimate economies and threaten the stability, security and sovereignty of States,” enjoined its signatories to criminalize the act of money laundering and to adopt measures to enable the identification, tracing, freezing, seizing and confiscation of illicitly derived proceeds. The Vienna Convention of 1988 was important not only in that it was the first multi-national recognition of the seriousness of the money laundering problem, but because it marked the first major step in affording to law enforcement officials the same international reach formerly available to drug smugglers and organized crime rings, whose complex laundering schemes regularly involved cross-border funds transfers that made their transactions more difficult to trace.   Crime Prevention: International Level Multilateral organizations have set the framework for anti-money laundering standards, mechanisms, and institutions. The United Nations pioneered the 1988 Vienna Convention Against the Trafficking in Illegal Narcotic and Psychotropic Substances, which contains the requirements to criminalize money laundering and immobilize the assets of persons involved in illegal narcotics trafficking. (Gilmore, 1999) In 1989, the G-7 Economic Summit Group established the Financial Action Task Force (FATF), which operates out of the Office of Economic Cooperation and Development (OECD) headquarters in Paris. (Gilmore, 1999) FATF has issued a set of forty recommendations (Forty Recommendations) that concern legal requirements, financial and banking controls, and external affairs. FATF operates through a Caribbean FATF (CFATF) and is in the process of establishing a similar group in Asia. It issues an annual report that provides an overview of progress and problems in international anti-money laundering. The G-10 Basle Group of Central Banks has actively provided guidelines for central bank supervisors and regulatory controls. As mentioned below, on September 23, 1997, the Basle Group issued guidelines on supervision. Regionally, the Council of Europe’s 1991 Convention on Laundering, Search, Seizure and Confiscation of Assets has become the major international convention that obligates signatory governments to cooperate against anti-money laundering from all serious crimes. The European Union, as a signatory to the 1988 Vienna Drug Convention and due to its own actions to combat financial crimes against the Communities, issued a 1991 Anti-Money Laundering Directive that it is poised to strengthen. As mentioned below, it is now in the process of an initiative against cybercrimes. An important regional organization in the anti-money laundering has been the Inter-American Drug Abuse Control Commission (CICAD). At its meeting on November 4-7, 1997, CICAD anti-money laundering experts recommended an ongoing assessment of compliance with standards and the creation of national financial intelligence units (FIUs). National governments and international organizations are striving to create mechanisms to monitor regularly compliance with international standards. Because the recent FATF annual reports and topologies provide cutting-edge discussions of the status of money laundering trends, they are discussed next. A significant achievement of FATF during 1996-97 was the annual survey of money laundering methods and countermeasures. The survey provides a global overview of trends and techniques, especially the issue of money laundering through new payment technologies, such as smart cards and banking through the Internet. (Schroth, 1996) FATF reviewed the issue of electronic fund transfers and examined ways to improve the appropriate level of feedback that should be provided to reporting financial institutions. (Bauer and Ullman, 2001) While drug trafficking remains the single largest source of illegal proceeds, non-drug related crime is increasingly important. (Scroth, 1996) The most noticeable trend is the continuing increase in the use by money launderers of non-bank financial institutions and of non-financial businesses relative to banking institutions. The trend reflects the increased level of compliance by banks with anti-money laundering measures. The survey noted, “Outside the banking sector, the use of bureaux de change or money remittance businesses remains the most frequently cited threat.” (Gilmore, 1999) FATF members have continued to expand their money laundering laws, covering non-drug related predicate offenses, improving confiscation laws, and expanding the application of their laws in the financial sector in order to apply preventive measures to non-bank financial institutions and non-financial businesses. (Gilmore, 1999) FATF discussed money laundering threats that may be inherent in the new e-money technologies, of which there are three categories: stored value cards, Internet/network based systems, and hybrid systems. Important features of the systems that will affect this threat are the value limits imposed on accounts and transactions; the extent to which stored value cards become inoperable with Internet-based systems; the possibility that stored value cards can transfer value between individuals; the consistency of intermediaries in the new payment systems; and the detail in which account and transaction records are kept. (Hernandez, 1993) Future issues include the need to review regulatory regimes, the availability of adequate records, and “the difficulties in detecting and in tracking or identifying unusual patterns of financial transactions.” (Summers and Reno, 2000) Since the application of new technologies to electronic payment systems is still in its infancy, law enforcement and regulators must continue to cooperate with the private sector. (Levi, 1991) Then authorities may understand the issues that must be considered and addressed as the market and technologies mature. As a result of difficulties in tracing illicit funds routed through the international funds transfer system, the Society for Worldwide Interbank Financial Telecommunications (SWIFT) board “issued a broadcast to its members and participating banks encouraging users to include full identifying information for originators and beneficiaries in SWIFT field tags 50 (Ordering Customer) and 59 (Beneficiary).” (Helleiner, 1999) Many countries have acted to encourage compliance within their financial communities with the SWIFT broadcast message. To strengthen the body of information on identifying the true originating parties in transfers, SWIFT has devised a new optional format (MT103) for implementation after November 1997. (Helleiner, 1999) The message format will have a new optional message field for inputting all data “relating to the identification of the sender and receiver (beneficiary) of the telegraphic transfer.” Additionally, “SWIFT has issued guidance to users of its current system to describe where such information may appear in the MT 100 format.” FATF has helped SWIFT devise the new mechanism and is encouraging the use of the new message format.   FATF recommends that at least the recipient of a suspicious transactions report should acknowledge receipt thereof. If the report is then subject to a fuller investigation, the institution could be advised of either the agency that is going to investigate the report or the name of a contact officer. If a case is closed or completed, the sending institution should receive timely information on the decision or result. Further cooperative exchange of information and ideas is required for the partnership between units that receive suspicious transaction reports, general law enforcement, and the financial sector to work more effectively. Because of insufficient data, FATF has created an ad hoc group that “will consider the available statistical information and other information concerning the proceeds of crime and money laundering.”(OOC, 1993) This ad hoc group will also “define the parameters of a study on the magnitude of money laundering and agree on a methodology and a timetable for the study.”   Money laundering Laws after September 11 While the infamous Al Qaeda terrorists were furtively hatching their schemes of destruction that depended upon filtering money through the international financial system, policy-makers and legislators were publicly hatching schemes to combat the filtering of money derived from or used to support international illegal activity. Although the European Union’s (EU) new Directive on money-laundering was recently adopted in the world-wide surge of counter-terrorism measures, it reflects legislative choices made before the world could imagine the terror that would be executed by Al Qaeda. Nevertheless, trends have occurred due to the terrorists attack on the 11th of September. The slightest central trend is the contraction of financial regulations and the organization or enhancement of obligatory regulatory and enforcement agencies. New laws in the US which sums to broadening the command of the CIA and of the DOJ extra-territorially, was to a certain extent xenophobically described as proposed to make sure the banking system does not become a refuge for overseas fraudulent leaders or other type of foreign structured criminals. Confidentiality and bank privacy laws have been diluted. Similarly, alliance with off shore shell banks has been prohibited. Dealing with patrons of correspondent banks was truncated. Banks were successfully altered into law enforcement agencies, accountable to verify both the characteristics of their clients and the origin of their funds. Cash transactions were to a certain extent proscribed. And the securities and currency trading industry, insurance companies, and money transfer services are introduced to developing inspection as an intermediary for laundered money. Consequently, in excess of 150 countries guaranteed to lend a hand with the US in its struggle opposed to the bankroll of terrorism – 81 of which (including the Bahamas, Argentina, Kuwait, Indonesia, Pakistan, Switzerland, and the EU) in point of fact immobilized assets of distrustful individuals, supposed charities, and leery firms, or approved new anti money laundering laws and more stringent regulations. A listed EU instruction would compel lawyers to divulge incriminating information about their clients’ money laundering actions. Pakistan commenced a “loyalty scheme”, awarding expatriates who have a preference on official bank conduits to the much criticized Hawala, with extra baggage allowance and special treatment in airports. Still, a worldwide system is emerging, established on the work of the OECD’s FATF since 1989 and on the relevant UN conventions. All nations are anticipated by the West, on pain of probable punishments, to approve a homogeneous legal manifesto including reporting on dubious transactions and freezing assets and to apply it to all types of financial mediators, not only to banks. Credit:ivythesis.typepad.com

Dissertation Chapter 3 on Money Laundering

Chapter 3 United Kingdom Laws on Money Laundering The expansion of the anti-money laundering efforts in the Western Hemisphere to in...

Money Laundering and Terrorist Financing

Money Laundering and Terrorist Financing Introduction             Money laundering is now at the fore of policies for the maintenance of the stability of banking and financial systems as well as the detection and thwarting of terrorism. Focusing on money laundering has become important because of the adverse impacts of this crime to economies and governments as well as the established connection between money laundering and terrorism.             From an economic perspective, money laundering influences economies by affecting the 1) integrity and operations of the financial sector, 2) status of the real economy, and 3) dealings with external sectors. Money laundered enters economies in a similar manner as inward investments. However, unlike investments, dirty funds do not permeate into the economy because laundered funds depart swiftly as fast as these have arrived but leaving adverse impacts against on the economy.[1]             In the case of the financial sector, long-term viability depend on the attraction and retention of legal funds that could be used to finance investments and circulated in the economy in the form of loans and mortgaged as well as credit and debit services. This means that the money entering the company should be subject to investment and reinvestment on a long-term basis, which money laundered cannot provide because of the speed with which dirty money enters and exits the economy. It is not so much the sudden entry of loss of funds that causes an adverse effect to the economy but the implications of the introduction of dirty money to the financial sector. Money laundering carries the ability of eroding the integrity of financial systems by providing an impetus for the corruption of bank employees through bribery that in turn affects public perception of the reliability of the financial sector. This means that money laundering has the ability to create crimes within the financial sector through the corruption of bank employees and processes.[2]             With regard to the real economy, dirty money has an adverse effect by corrupting the financial sector, which is an important institution or mechanism for the management and allocation of funds to various economic activities as well as diverting funds to non-productive or counter-productive activities such as support for the continuance or continuation of new crimes. Laundered money usually becomes sterile investments spent for the purchase of luxury items that do not create necessarily support further growth such as when invested in legitimate economic activities. Although money enters the economy, it does not contribute to economic growth but disrupts legitimate investments by affecting the integrity and reliability perceptions of the financial sector.[3]             In relation to the external sector, money laundered can also adversely affect the balance of trade in economies through which dirty money passes. On the part of the economy from which dirty money came from, money laundered may be legitimate money used in crime and brought outside of the country. This means that the economy loses money similar to capital flight. On the part of economies receiving laundered money, the money entering the economy are used in purchasing luxury items usually as imports without benefiting the economy.[4]             From a political perspective, money laundering has the effect of undermining the confidence of the public towards laws and legal processes because of the inability to prevent the entry of dirty money as well as the commission of fraud by government officials and employees of the financial sector. Moreover, the failure governments to prevent the commission of further crimes such as fraud amounts to the placement of power and control to criminal organisations that could also influence the direction of government decisions in thwarting this crime.[5]             Due to the economic and political effects of money laundering that cuts across financial sectors, economies and governments together with its links to terrorism, concerted action against not only money laundering but also the links to other crimes became important policy considerations.   Definition of Money Laundering             Money laundering has a number of definitions. However, most states adhere to the conceptualisation provided by the Vienna Convention in 1988 and the Palermo Convention in 2000. Under the Vienna Convention, predicate offences were only limited to drug-related crimes so that other predicate crimes were not covered as sources of proceeds processed through money laundering. This created a loophole favourable to people engaged in the laundering of money from other sources apart from drug trafficking. With the recognition of this legal gap, the Palermo Convention expanded the predicate offences of money laundering to a wide range of crimes that could give rise to criminal proceeds subjected to laundering mechanisms. Moreover, the Financial Action Task Force (FATF) on Money Laundering, established as the body charged in establishing international standards for policies against money laundering, defines this mechanism as the process of handling proceeds from crimes to conceal its illicit origin to ensure the legitimisation of such criminal gains.[6]             Money laundering developed to refer to the conversion of money and other property, with the knowledge that these emerged from criminal actions and through direct or indirect participations of the perpetrators, in order to conceal the unlawful origin or to assist the perpetrators in disguising the illicit origin of money and other property as a means of evading legal consequences of such actions[7]. Money laundering also refers to the concealment of the actual nature, origin, location, allocation, movement and rights to property, with knowledge that such property came from illegal actions. In addition, money laundering involves the use, possession or receipt of property derived from crime or participation in illegal activities[8]. In this sense, laundering is a crime with a predicate offence, consisting of the criminal actions, such as drug trafficking or smuggling, which brought about the criminal proceeds or gains laundered[9].   Three Steps in Money Laundering Placement             First phase involves the introduction of money derived from crime into banks and financial institutions by opening personal or company accounts through which large amounts of money are transferred and deposited. Since people engaging in money laundering are aware of the illegality of their actions, they devise various tactics in using financial institutions to provide afford dirty money with a semblance of legality. Tactics used include the breaking up of sizable amounts of money for deposit in many inconspicuous bank accounts, converting money by purchasing monetary instruments, changing the location of accounts, and manually shipping money across borders for deposit in foreign banks, and purchase of valuable goods for resale. This stage involves risks because banks and financial institutions have wide experience in various transactions so that large amounts of money are accorded with care and at the same time suspicion. Moreover, law enforcement authorities seek the cooperation of banks and financial institutions in tracking down the monetary proceeds of crime. Since bank standards involve detailed records of accounts and account activities, law enforcement authorities can easily track money from crime. In addition, banks and financial institution are compelled to report all suspicious transactions so that anything considered by experienced banks and financial institutions as suspicious undergo investigation regardless of the result.[10] Layering             Second phase involves the placement of funds already infused into the legitimate financial system via a succession of financial processes intended to divert investigations towards other areas or parties instead of focusing on the source of the large amounts of money or lead investigations to conclude on the legitimacy of the account and monetary transactions. During this phase, common mechanisms in diverting or ensuring the legitimate perception of money involve the establishment of offshore accounts and the transfer of money to offshore accounts resulting to difficulties in tracking money suspected to have come from crime. Fund transfers are supported by the creation of false loans, invoices and other devices to support the withdrawal and deposit of money from one account to another as well as the use of the skills of legitimate accounting or auditing companies to establish legitimate transactions.[11] Without investigative links, local authorities may find it difficult to identify the destination or recipient of money transfers to offshore accounts outside of their jurisdiction. Integration                Third and final phase of money laundering is the reintroduction of funds through legitimate economic activities. After ensuring the legitimate origin of funds, money is then appropriated through legitimate means in a number of ways. One way of reintroducing money from crime is through consumption, especially luxury or high-end items as a means of disposing the money by converting it into legitimately purchased valuables. Consumption allows members or recipients of crime to burn all funds, which are obtained illegally, and remove all semblance of illegitimacy. Another means of reintroducing laundered money is through investments in common assets such as purchasing company shares and engaging in real estate development projects. By converting money into different legitimate forms, proceeds from these activities can be allocated and utilised freely. Still another means of legitimising laundered money is engagement in investments with economic players with a similar high susceptibility to engage in money laundering mechanisms such as hotels, restaurants, cinemas, casinos, and other establishments receiving or paying money in cash making it easier to infuse dirty money. By engaging in fast-cash investments, money laundered can be easily merged with the flow of cash as well as hide the money laundering activity by averting or complicating investigations by hiding suspicious activity with another activity that could also be considered suspicious.[12] Reintroducing laundered money allows the criminals to engage in legitimate activities and freely allocate money, making money laundering realise its purpose. Overlapping of Money Laundering and Terrorist Financing             Based on the nature and characteristics of money laundering, this constitutes a distinct activity from the financing of terrorism[13]. However, there are overlapping processes between money laundering and terrorism financing[14]. The funds arising from crimes apart from terrorism are laundered to achieve legitimacy to support free spending and appropriation while terrorist funding are laundered to hide the legal origins of the funds such as from public coffers and charitable institutions[15]. This means that money laundering is used as a mechanism for different purposes but nonetheless find great utility for money laundering mechanisms. Moreover, perhaps the only characteristic shared by money laundering and terrorism is the fact that both crimes engage in the financial transactions to conceal the actual source and intentions of funds[16]. People engaged in money laundering and terrorism take common interest in the concealing the illegal source and illegal use of funds to achieve a semblance of legitimacy to enable free spending and use of funds.              Apart from the use of terrorist groups of money laundering as a channel for appropriating funds from legitimate sources to finance terrorist activities, laundered funds from crime could also be appropriated to terrorism. Objective alliances could develop between parties involved in crimes and groups engaged in terrorist activities, based on convergent interests. Criminals engaging in money laundering can benefit from the directed or targeted damage that terrorist organisations are capable of executing. Criminals can use the arms and training of terrorists to execute killings or destruction that would eventually serve their interests such as the creation of diversions to allow them freedom to operate. Terrorist groups can benefit from becoming recipients of money laundered by criminals by obtaining the funds necessary in fulfilling planned terrorist activities.[17]             The interest of terrorist activities in money laundering is supported by the parallelisms in the geographies of terrorist movements and money laundering of criminals, especially drug trafficking. Money laundering and terrorist funding in Africa are centred on the areas engaged in mining and smuggling of diamonds and other precious stones. Al-Qaeda’s operation in Afghanistan has strong links to the illegal opium trade in the area. The ideology of some terrorist groups can also become a front for the operation of crimes in the same way that money laundering by criminals can support terrorist activities.[18]               Money laundering emerged to describe the processes that criminals go through to legitimise dirty money. This developed to encompass the means through which terrorist financing sources are hidden or through which links of funds sourced from crime are obscured. Regardless of the purpose or utility and source of the funds of different terrorist groups, it is clear that terrorist financing go through money laundering mechanisms as a means of obtaining funds from crime or obscuring funds from legitimate sources. Methods of Money Laundering Banking             Banks constitute the first venue targeted by people engaging in money laundering. Since the deposit and transfer of large sums of money draws suspicion, alternative ways of exploiting banking institutions have developed such as using nominees, correspondent banks, and private banks. Nominees are people in good standing in the community so that depositing dirty money under their names allays suspicion by law enforcement authorities. Nominees could be relatives, friends, partners or other people that criminals can use as fronts in placing dirty money in banks for easy transfer and use. Correspondent banking constitutes the arrangement or agreement for one bank to provide services to another bank for fund transfers, currency exchange or other transactions. Money launderers exploit correspondent banks with poor regulation or corrupt systems to transfer funds from one bank to another without the receiving bank knowing the nature of the funds to make the funds achieve legitimacy. Private banking involves customised services to wealthy clients of banks encompassing various financial services such as fund transfers and investments. Due to the personalised nature of private banking services, these become vulnerable to money laundering for a number of reasons. Private banking involves the development of fiduciary relations by bank employees with clients to ensure better service but this could also open opportunities for bribery and corruption of bank employees by money launderers. Private banking consumers are mostly wealthy individuals with political power or connections so that banks no longer inquire into the sources of funds or purpose of money transfers in order to serve the convenience of clients. Private banking could also involve transactions requiring the protection of the identity of clients so that it is common practice for banks to establish shell companies or trusts to protect the identity of their clients. However, situations like this could be exploited to provide legitimate fronts for dirty money as well as provide walls for the investigation of accounts using privacy regulations and other legitimate means.             Apart from these banking processes, one mode of banking has also been observed to be vulnerable to money laundering. Credit cards could also be exploited by money launderers because of the difficulty in using large amounts of cash for transactions. Credit cards can be used in laundering money by overpaying credit in order to maintain a high amount of balance. Credit cards can then be used in different countries for various purchases. In jurisdictions having poor banking regulations, money launderers can apply for credit accounts in different banks and under different names to spread dirty money and then use the accounts to make purchases or withdrawals that make it difficult to trace the people actually using the credit cards. Credit cards are also easier to obtain when compared to opening of accounts for international transfers and less susceptible to investigations. Exchange Offices             The nature of exchange offices of providing a wide range of services to different customers could also be exploited as a means of laundering money. Exchange offices provide services such as purchasing and selling foreign currencies or the consolidation of a number of small-denomination bank notes to large-denomination bank notes, encashment of financial instruments such as personal checks, travellers checks and money orders, and offering of wire transfers for cash pick-up or bank deposits. Since exchange offices offer services to a wide range of people for various transactions, this creates impersonal relations between exchange offices and clients with some offices not having organised records for previous clients served. As such, exchange offices can be a means through which money launderers can evade detection. In countries with relaxed regulations, exchange offices have the propensity to be exploited by money launders by using wire service to send cash or converting financial instruments to clean cash.     Securities Market             Securities market deals with the trading of securities, specifically stocks and bonds through brokers. Clients interested in purchasing stocks and bonds engage the services of brokers to represent them in their purchases and watch over the rise and fall of prices during trading periods. As an incentive for brokers to secure the interests of their clients in terms of the right time for purchasing and selling stocks and bonds, the arrangement works through a commission basis so that the bigger earnings accruing to the client also entails a bigger commission for the broker. Competition is also strong and often harsh among broker companies and brokers so that the stringent competition as well as high stakes and returns could motivate brokers to collude with clients and companies in manipulating stock exchange processes to ensure returns for their clients. Expectations of high returns could be exploited by money launderers in infusing dirty money in the securities market, to achieve the purpose of legitimising dirty money while at the same time earning from the activity. Identity of money launderers can also be protected by using nominees and trusts as fronts. Moreover, relaxed regulations of brokerage firms result to the concurrent relaxed investigations of the background of their clients and the source of funds making it easy to infuse dirty money into the stock exchange system. Legitimate Businesses             Money launderers can establish legitimate business firms by using nominees as fronts using dirty money as capital and using dummies to own, manage and infuse dirty money into the legitimate economy. Great pains are taken to conceal ties of the company with criminals or money launderers so that the company operates much like a normal company duly registered, paying taxes, engaged in legal business activities. Another way of acquiring the use of legitimate businesses is through the stock exchange since the buyers of stocks are not usually divulged; any person with money can buy the stocks of corporations and even gain control of decision-making. By using dirty money to purchase stocks in exchange for future dividends dirty money is legitimised since dividends are traceable to legitimate sources so that this can be appropriated legitimately in the market. Moreover, the company can be used to invest and transfer funds to any place around the world using valid business purposes. Another way of using legitimate business firms is through the mergers with and acquisitions of legitimate businesses using dirty money as payment or capital infusion. This provides money launderers with a means of transferring funds through banks or converting dirty money into legitimate company revenue and profit. In addition, money launderers usually engage in cash-based businesses that speedily spread dirty money such as casinos, restaurants, bars and clubs, hotels, and retail chains. Legitimate business firms become fronts for money laundering with launderers mixing dirty with clean money and receiving clean money in exchange to make it difficult for investigators to separate dirty from clean money or trace the appropriation of dirty money. Definition of Terrorist Financing             To facilitate the development of policies and solutions to money laundering by terrorists, terrorist financing has been provided a working definition by the International Convention for the Suppression of the Financing of Terrorism in 1999. Terrorist financing is a criminal action committed by any individual that use various means, whether the participation is direct or indirect or the action has been willingly or forcefully committed, knowingly collects or provides monetary support for use fully or partially to commit the following actions: a) actions falling under the offences identified and described in treaties; and b) actions intended to result to serious physical injuries or death to civilians or other individuals not part of armed hostilities, intimidate populations, or compel governments and international organisations to commit or abstain from committing certain actions.[19] This law also provides that it is not necessary for the intended actions to have actually taken place in order to constitute a crime. It is sufficient that money has been allocated for these purposes.             This constitutes the commonly accepted definition of terrorist financing for purposes of policy determination and legal actions. The more difficult aspect is defining terrorism and terrorist actions. Although many countries have adopted the international convention, not all states agree on a clear and workable definition of terrorism. Some countries consider revolutionary groups as terrorists while others consider political movements as not terrorists. This creates a problem in the implementation of law, especially for offshore accounts when one jurisdiction considers an account as money laundering for terrorist financing while in other jurisdiction this may be considered as money laundering or maybe classified as not constitutive of crime.   Sources of Terrorist Financing             Crime has become a more important aspect of the sub-economy of terrorists. The economic activities of different terrorist groups depend upon the objectives of the terrorist organisation. Drug trafficking constitute the greatest source of financing for terrorist groups. Other important sources of funding for terrorist groups include racketeering or the forceful collection of payments from households or businesses, kidnapping for ransom collection, goods or human trafficking, as well as the distinct activity of arms trafficking that involves not only the purchase and sale of arms and equipment to gain money and for their use.[20] Since criminal activities have become a primary source of funding for criminal activities, this indicates the development of a stronger link between crime funds and terrorist financing through money laundering.                 Previously, terrorist financing used to come from governments. During the cold war, regional conflicts occurred because of bloc alignments so that terrorist groups were bent on destabilising the other bloc in different geographic regions. As such, governments became the source of funds because the conflicts were embedded with political interests. With the ending of the cold war, government financing have been minimised.  A number of isolated states maintain the provision of armed groups with financing, training and weapons but the other terrorist organisations needed to seek alternative sources of financing.[21]             Initial alternative means of funding terrorist actions included maximisation of diasporic ties to have a source of financing. Terrorist groups draw funds from nationals living abroad with a good or excellent source of income. Individuals and business in industrial countries could be a source of funds of terrorist groups. Charitable institutions play a key role in channelling money from the diaspora to terrorist groups due to its key characteristics. Charitable institutions carry the legitimacy to collect funds and send them to different countries around the world in the guise of social welfare programs. In addition, charitable institutions have the ability to mingle funds obtained from legitimate sources, whether these were exacted voluntarily or forcefully and government funds with money from criminal activities through a legitimate façade.[22] When these forms of mergers happen, investigators find it difficult to distinguish between clean and dirty money or the source and recipient of dirty money.   Methods of Laundering Terrorist Funds               It was only in the last decade that terrorism has been considered as an important predicate crime for money laundering. This recognition was spurred by the internationalisation of the operations of terrorist groups such as Al-Qaeda that led to the September 11 attacks on the key facilities in the United States. This scale of operation implied the collection and use of large amounts of money that could only be transferred through money laundering.             Laundering of terrorist funds occur in the same manner as the laundering of money from crime but with differences since the purpose of terrorist groups is both to obscure the legitimate sources of funds as well as to legitimise money derived from crimes. The stage process of money laundering applies, with terrorist groups infusing money into the banking and finance system, which is easily done with legitimate sources, obscuring or legitimising the source of the money by converting or transferring the funds, and reintroducing funds into the legal economic sector through purchases of weapons and equipment in a legitimate manner.             Laundering of terrorist funds can happen in any country but countries with intricate financial systems are preferred since investigations are more difficult to conduct making it more difficult from law enforcement to track funds suspected as dirty money or money intended to support terrorist groups. Moreover, countries with relaxed regulations or easily corruptible systems also constitute preferred venues for money laundering since money can draw the cooperation of bank employees to help in obscuring or legitimising fund sources. The system also makes it easy for terrorist groups or fund sources to use the banking and finance system to transfer funds to dummy individuals or corporations of terrorist groups. In addition, terrorist groups also perform the different phases of money laundering in different countries and banking institutions.[23] Banking             Terrorists also employ different modes of laundering money such as opening many cash deposits named after different people since large amounts raise suspicion. Funds are transferred to unremarkable accounts of individuals and legitimate businesses to prevent detection. The purpose of using banks is to conceal the source of funds whether these came from legitimate or illegitimate sources while at the same time achieving legitimacy for the money laundered. In the case of terrorism, funds or costs of terrorist activities are not necessarily large so that money can pass through banks and other financial institutions inconspicuously. During the 9/11 terrorist attacks in the US, the estimated cost of the operations ranged between 400,000 to 500,000 US dollars[24], an amount, which when divided into small amounts and sent through banking institutions did not warrant close scrutiny. The Madrid bombing in 2004 was estimated to cost only 10,000 US dollars[25], which means that unlike common money laundering, terrorist financing does not necessarily involve large amounts. This results to the greater difficulty in detecting the flow of funds to terrorism and the ease for terrorists and fund sources to exploit the loopholes in the banking system to conceal the source and purpose of funds.   Alternative Remittance and Wire Transfer Systems             Similar to money laundering, the movement of terrorist funding could also happen through alternative fund transfer systems using exchange offices or money transfer services apart from banks. In completing transactions, alternative money transfer systems seek the identification of the sender and details of the recipient without necessarily investigating the sources of funds or the purpose of the transfer. Unless the money transferred constitutes large amounts, alternative money transfer systems usually do not become suspicious of transactions so that terrorists and their financers divide the money using many senders and recipients. However, even if alternative wire transfer services require identification, these usually do not have the database to check whether the identification and the information contained in the identification match. Terrorists can easily use counterfeit identification cards to send highly untraceable money.   Non-Profit Organisations             Since terrorism could have ideological underpinnings, it is probable for terrorist groups to have links with legitimate non-government organisations espousing similar advocacies to the terrorist groups. Alliances of this kind allow terrorist groups another venue of financing its activities in the form of charitable donations and project funding to justify the transfer of funds. In this way, the reverse occurs since the source of the funds is legitimate and what is being concealed is the recipient and actual purpose of the funds by using valid donation recipients such as community groups or other non-government organisations serving as fronts for terrorists. This makes it difficult for law enforcement authorities to trace the flow of funds and this is made more difficult due to the lack of consistency in the black listed non-governments of the US and the UN. This means that non-government organisations blacklisted in the US but not in the UN can engage in laundering of terrorist financing in other jurisdictions[26].   Alliances with Criminal Activities             Terrorist activities have links with criminal activities such as smuggling and narcotics trade since as mentioned earlier there is a similarity in the geographical routes of these crimes and terrorism. Cash couriers used in smuggling are also used in manually carrying funds from one location to another. Terrorists can even obtain the aid of smugglers to move terrorist financing across different countries. Financing of the bombing of the Australian embassy located in Jakarta has been traced to be sent using cash couriers[27]. Narcotics trade could also be used as source of funds and to support the movement of terrorist funding. Terrorists with arms could offer protection to drug traffickers in exchange for funds or to carry terrorist funds from one country to another.             Launderers are increasingly becoming creative since they also have knowledge of developments in anti-money laundering efforts. This means that money launderers are innovating on their methods and developing new means of laundering funds at the same or even faster rate that policy makers develop anti-money laundering guides and law enforcement in applying anti-money laundering laws and policies. Laundering of Terrorism Funds as a Global Policy & Legal Problem             Money laundering of terrorist financing constitutes a global problem because of the value of money laundered, amounting to ,000 to ,500 billion[28], with an unknown amount reaching terrorist groups. Apart from the amount of money laundered, conservative estimates of money going through the informal international sector around 0 to 0 billion[29], which criminals and terrorist likely share. The sheer value of money that could be allocated to terrorism constitutes a huge threat to governments.              Apart from the value of money laundered that could go to terrorist groups, laundering for terrorist financing is directed towards the maintenance of secrecy, making it difficult to collect the data necessary for statistical analysis. People or groups engaged in laundering do not keep written records of their transactions make public the proceeds of their finance generating activities, source or origin of their proceeds, and recipients or allocation of the money laundered. High levels of secrecy makes it easy for terrorist groups to launder or receive laundered money and difficult for law enforcement authorities to track.             Global occurrence of money laundering makes it difficult to solve by single governments alone so that cooperative investigations and actions are necessary to ensure the continuity of the tracking of funds passing through the different financial channels in different jurisdictions. Criminals and terrorist groups exploit inconsistencies in money laundering policies of different jurisdictions to sidetrack investigations.[30]   International Efforts against Terrorist Financing             The international fight against terrorism finds bases on international law together with the adoption and application of states of these laws. Convention for the Suppression of the Financing of Terrorism introduced in 1999 to become effective in 2002, constituted the first international legislations that directly focused on terrorist financing. The convention provided a broad definition of terrorist financing as the provision or collection of funds with the intention of supporting the actualisation of terrorist actions. Due to the broad definition, funds can constitute any form and emanate from any source. Through this definition, terrorist financing extended beyond the act of money laundering since it also covered the source or contributors of the funds, regardless of the legality of the source, and other accomplices that made the laundering of money for terrorist activities possible. Moreover, criminal liability accrues even if the terrorist activity has not actually been implemented so that as long as funds were intended for terrorist groups, people involved are criminally liable. The convention also contributed a definition of terrorist actions, which was an issue in the previous international legislations, as any action intended to cause serious physical harm or death to civilians or parties not involved in an ongoing conflict when the purpose of the act is to intimidate the public or intimidate governments to do or not to do certain actions. This definition allowed terrorism and terrorist financing to achieve a distinction from money laundering by criminals, which is necessary in the development of specific protocols for terrorism and terrorist financing. Other importance feature of this convention is the provision of common strategies that participating states can enforce to foster cooperation. Moreover, the convention also targeted offshore financing, by drawing focus on shell or front companies with suspicious dealings, management groups authorising irregular transactions, and auditing, reporting or publication of annual accounts of companies under suspicion. To ensure implementation, the convention also enjoins bank officials to make the additional effort of verifying information by asking the client or account holder to produce documents or checking company registrations and other public documents to prove the legitimacy of accounts and transactions.[31] This means that even with the recognition of the impact of terrorism, there is still wide room for cooperation.                  In support of these international laws, the Financial Action Task Force (FATF) has introduced forty recommendations on ways of addressing money laundering. The G7 Summit established the FATF in 1989 to provide policies on money laundering. The recommendations revolved around three objectives including: 1) improvements in national systems in combating money laundering through the criminalisation of money laundering and enforcement of confiscation procedures; 2) strengthening the role of banking and finance systems in reporting and supporting investigations on suspect accounts and account holders; and 3) strengthening of multi-level international cooperation for information sharing, investigations, seizures and extraditions. These recommendations underwent successive revisions to consider changes in the global environment. As such, after 2001, eight recommendations were included to make implementation of anti-money laundering and terrorist financing more effective.             First recommendation is action on the part of governments to ratify the Convention for the Suppression of the Financing of Terrorism and comply with the provision of the UN Security Council Resolution 1373 in 2001 that prohibits the financing of terrorist actions. It is only through international cooperation that terrorist financing that occurs across different jurisdictions can be monitored, curtailed and even prevented. Second recommendation is legislative action in criminalising terrorism and judicial action in prosecuting terrorist groups in order to provide more stringent penalties to people found to be engaged in terrorist financing and terrorism. Third recommendation is for governments to seize or take custody of assets and funds of terrorist groups since funding is the greatest weakness of terrorists. Fourth recommendation is mandating banks and financial institutions to report and assist in the investigation of terrorist financing activities by law enforcement developing close partnerships with banks. Fifth recommendation is for governments to provide international cooperation or assistance in investigating and apprehending terrorist groups and financers together with government and bank officials involved in terrorist financing. Sixth recommendation is ensuring that states do not knowing or unknowingly become hosts to terrorist groups by governments enforcing means of monitoring the entry of suspicious individuals or the movement of groups inside their jurisdictions. Seventh recommendation is implementing sound monitoring and regulatory measures for large monetary transactions in order to provide banks with policy support in dealing with money laundering and terrorist financing. Eighth recommendation is the identification and monitoring of non-government and charitable institutions for use as intermediaries or sources of terrorist financing.[32]        Conclusion              There remains a wide room for development in laws against money laundering and terrorist financing, especially since terrorism has adopted the electronic channels that no longer required a face in opening accounts or transferring funds. The electronic or digital age has opened crime opportunities for terrorist groups. Websites can be used not only to indoctrinate viewers to empathise with terrorist groups but these channels can also be used in soliciting funds and other equipment they need in actualising terrorist activities.             In the case of international law, stronger advocacies are needed for more countries to ratify the Convention for the Suppression of the Financing of Terrorism in order to ensure the cooperation of more states that would result in continuous investigations to support arrests and seizures. Finance remains a weakness of terrorist groups and strengthening anti-money laundering and terrorist financing would weaken the capability of terrorist groups to perpetrate another September 11 or subway bombings.             In addition, the differences between and money laundering and terrorist financing involves an understanding of the legal and policy needs to effect activities against these crimes. One difference that merits varied attention is the role of banks and financial institutions in money laundering and terrorist financing since governments cannot rely on the banking sector for the identification of terrorist financing transactions because unlike money laundering the amounts transferred or moved does not necessarily involve large amounts to warrant suspicion. Another difference is the investigation of terrorist financing since unlike money laundering, the source of funds could be entirely legitimate so that there is need to determine the alliances of non-government organisations involved in crimes.             Since the strategies applied in money laundering and terrorist funding continue to evolve as criminals and terrorists find more loopholes in the legal system, the more important it becomes for governments and private institutions to engage in partnerships and concerted actions to support cross-national investigating and monitoring. This is especially so since criminals and terrorists are exploiting legitimate means such as nominees, legitimate businesses, and inconspicuous transactions to conceal the source and purpose of the transfer or movement of funds.                         Credit:ivythesis.typepad.com

Money Laundering and Terrorist Financing

Money Laundering and Terrorist Financing Introduction Money laundering is now at the fore of policies for the maintenance o...

The fight against money laundering_An economic analysis of a cost-benefit paradoxon

The fight against money laundering An economic analysis of a cost-benefit paradoxon Hans Geiger and Oliver Wuensch Abstract Purpose – To provide an economic view on the costs and benefits of anti-money laundering (AML) efforts. Design/methodology/approach – Based on a international, comparative study conducted in Switzerland, Singapore and Germany, the authors outline the impact of AML measures on banks and the financial services industry. The paper discusses possible reasons for the failure of AML to fight the predicated crimes. It also discusses the collateral damage caused by AML. Findings – Compared with the monetary and non-monetary costs of money laundering prevention for the society and the economy, the benefits are small. Instead of broadening and deepening the current AML framework, a thorough review of the current approach should take place. Research limitation/implications – Costs and benefits of AML measures are hardly quantifiable. The authors resort to a qualitative approach, stylising possible outcomes and side effects of money laundering prevention. Practical implications – Useful set of arguments for discussing the benefits and shortcomings of the current and upcoming AML measures. Originality/value – Money laundering measures and their impact are examined using basic laws of economy and financial intermediation. Keywords Money laundering, Economic value analysis, Cost benefit analysis Paper type Conceptual paper Prologue The Swiss Banking Institute of the University of Zurich has, in co-operation with universities in Germany and Singapore, conducted an international survey on the anti-money laundering (AML) measures among banks in Switzerland, Germany and Singapore[1]. The conclusions of the survey are puzzling: . Banks consider the compliance with AML rules as essential and important. . The AML rules’ implementation is highly burdensome and causes significant costs and efforts throughout the banks. . There seems to be a broad consensus amongst practitioners and scientists that the impact of money laundering prevention on the predicate offences is small. It is the objective of this paper to analyze the puzzle of these three findings and formulate some theses for the future development of AML measures. Introduction Banks and other participants in the economy have become used to ever increasing regulation, but constantly complain about the burden they face in fulfilling the requirements. According to the “Banana Skin Report” in 2005[2], “the remorseless rise in regulation has become the greatest risk facing the banking sector”. Regulators have taken up these concerns and consider the balance between costs and benefits of existing and upcoming regulatory requirements today[3]. This is, however, not true for all regulatory aspects. One notable exception is the area of money laundering and terrorism financing. Various provisions have been enacted which engage the financial services industry in the fight against the use of the financial sector by criminals. In contrast to other regulatory areas such as capital adequacy or risk management, benefits and costs of AML ventures are not considered. The AML pipeline is full of upcoming provisions, especially as the relevance of organised crime, drug trafficking and other illegitimate ventures did not decrease in spite of the massive measures taken during the last two decades. When discussing with banks and other financial services providers about AML, they mainly emphasize on the implementation costs, which place a significant burden on the industry, especially on smaller market participants. A recent study[4] showed, that money laundering prevention measures account for 45 per cent of the total regulatory burden and 2 per cent of the total costs in Swiss private banking. The cost of regulation exhibits strong economies of scale. The burden for small banks[5] is more than twice as high than for bigger banks. Small banks are therefore heavily penalised against larger institutions. This applies for the implementation of banking regulation in general, and for money laundering prevention in particular. However, private banks also regard money laundering prevention as the most important regulatory area[6]. According to the official view, the money laundering prevention measures work along the following principle[7]: first, by depriving the criminals of their illicit assets, the expected revenue of a predicate criminal venture declines. Second, by imposing the necessity of laundering the assets, the transaction costs increase. Finally, the money laundering prevention efforts increase the probability of being detected and convicted[8]. Whilst this deterrence mechanism sounds logically reasonable, its effectiveness and efficiency for fighting predicate crime is doubtful. Direct costs and collateral damages are high, the benefits for reducing predicate crimes small. This paper focuses on the “collateral damage”. We show that money laundering prevention measures leads to undesired side effects both for the economy and for the society as a whole. They may even counteract one of the most important objectives of the endeavor, to fight organized crime. The next section introduces basic economic principles and outlines their applicability in the area of money laundering and money laundering prevention. Applying these economic laws, the following section describes the impact AML provisions have on the legitimate and illegitimate sphere of the economy. The strategy of banks and states in implementing current and developing upcoming AML provision is then discussed. The final section gives basic rules the authors deem important for assessing and improving the AML efforts. Economic aspects of the anti-money laundering measures In this paper, we present a stylised view on AML prevention and its positive and negative effects by applying basic laws of economics. We assume that the same economic laws apply both to the legitimate and the criminal spheres of the society. Basic principles of economics In classical economic theory two basic forces determine the behavior of an individual. First, every individual acts rationally and aims to maximise his personal utility. This principle is taken into account for most decisions an individual takes. For criminal ventures which are committed to acquire personal wealth in particular, the decisions are governed by this principle. Second, the personal utility of an economic venture is mainly determined by its expected costs and revenues, which in turn are governed by the fundamental laws of demand and supply. In this classical world of Adam Smith, it is not the individual person or company who looks after the wellbeing of the nation: He [the individual] generally, indeed, neither intends to promote the public interest, nor knows how much he is promoting it. [. . .] he intends only his own security; [. . .] he intends only his own gain, and he is in this, as in other cases, led by an invisible hand to promote an end which was no part of his intention[9]. The state should protect its citizens from “violence” and “injustice”[10]. Adam Smith proposed the “obvious and simple system of natural liberty”[10], where: . . . every man, as long as he does not violate the laws of justice, is left perfectly free to pursue his own interest his own way, and to bring both his industry and capital into competition with those of any other man, or order of men. But these principles only work, if the legal framework, e.g. AML rules, does not lead to distortion of competition. Given the differences in economic law and implementation worldwide, and also the different impact of AML rules and other regulation on the participants of the economy, this assumption is questionable. State regulation often actively sets competitive incentives and therefore promotes certain institutional structures. This is dangerous, as could it retard, “instead of accelerating, the progress of the society towards real wealth and greatness; and diminishes, instead of increasing, the real value of the annual produce of its land and labour”[10]. Supply and demand. In an open and competitive market the invisible hand determines the volume and the price of goods and services through the law of demand and supply. Any good or service is available and traded on the market if there is enough demand, if producers are willing to supply the product or service in principle, and producer as well as customer can agree on a price. For the supplier, the predominant objective is to create value out of his activities. In that case, the price has to cover the production costs (raw materials, salaries, etc.), transaction costs, and a premium for the risk and the profit of the producer. Besides production costs, transaction costs play a decisive role for a market economy. They represent the price for using the market mechanism and thus for the exchange of goods and services between producers and consumers. The lower the transaction costs are, the better the invisible hand can work to raise the wealth of nations. Examples for transaction costs are transportation costs for a good produced, but also fees for using the financial system to arrange the payment for the good or service obtained. Money laundering costs are also transaction costs. Criminals as rational beings. The modern economic theory of crime is based on the essay “Crime and Punishment” published by Gary Becker[11]. The main purpose of the article was “to answer [. . .] [the] questions [. . .], how many resources and how much punishment should be used to enforce different kinds of legislation”[12]. Becker assumes that a person commits an offense if the expected utility to him exceeds the utility he could get by using his time and other resources at other activities: This approach implies that there is a function relating the number of offences by any person to the probability of detection and conviction, to his punishment if convicted, and to other variables, such as the income available to him in legal and other illegal activities [. . .][13]. Fighting the cause by fighting the result. When applying Becker’s model to the AML world, a peculiarity has to be considered: the prevention and punishment measures are not taken against the predicate offence or offender, but against a consequential act of a money launderer, who is not necessarily the same person as the predicate offender[14]. Consequently, a possible conviction of the money launderer does not automatically imply a conviction of the predicate offender. Ceteris paribus, tighter AML provisions lead to higher production and transaction costs of the predicate crime. They should therefore influence predicate offender. He may loose the assets to be laundered due to confiscation. In addition, detecting money laundering raises the possibility of detection and conviction for the predicate offender. Empirical evidence suggests that this relationship is only weak if verifiable at all[15]. As described below, the predicate offender has other alternatives to choose than laundering all the criminal proceeds. He can thereby significantly reduce the money laundering costs and risks of his venture. Economy of money laundering prevention For most parts of the economy, AML rules act as a cost component and influence the profitability of illegitimate and legitimate ventures. Hence, they set incentives against engaging in legitimate and illegitimate activities. Contrary to most other state determined exogenous variables, AML rules are not static, but subject to constant change and development. This section deals with the rules steering the regulation process, i.e. the economy of money laundering prevention. The “market” participants, i.e. states, international organisations, banks and other members economy, are supposed to be rational decision makers. More of everything. The world of money laundering prevention, AML regulation and rules can be depicted along three dimensions. (1) Criminal vs clean. There is a “clean world” (defined by the absence of predicate offences) and a “criminal world”. Money laundering is moving money from the criminal into the clean world or – what is essentially the same – hiding the criminal origin. (2) Sectors of the economy. Seen from the standpoint of the Financial Action Task Force (FATF), there exist four different sectors of the economy: . Financial institutions are subject to special rules and AML supervision as well as to criminal law. . Designated non-financial businesses and professions are subject to the same special rules and supervision, and are also subject to criminal law. . Non-designated businesses and professions are subject only to criminal law. No special rules and no AML supervision apply. . Private individuals, natural persons outside sector (a) and (b) are only subject to criminal law. (3) Country-specific differences. There are different countries with different domestic laws, rules and institutions. They can be broadly categorized into: . Black-listed countries[16]; . Complying countries, which can be rated further by the extent of compliance with the FATF recommendations[17]. Over recent years, the strategy of FATF has been “more of everything”: to move the fences in a way that the clean world shrinks and the criminal world grows (extending the definition of “predicate offence”); to enlarge the “financial” and “designated” sectors which are subject to special AML rules and supervision, and thus to reduce the non-supervised part of the economy; to sharpen the rules to which the supervised sectors are subjected; to sharpen the requirements for the countries in the AML rating process. Incentives for and against regulation. If state intervention into the market, such as AML rules, affects all market participants in the same way, the relative competitive position of a single participant is not influenced. In that case, regulation fosters or hampers the wellbeing of the economy without changing the relative wellbeing of the single members. If intervention affects different market participants in different ways, certain competitors may face an advantage or disadvantage, the relative distribution of wealth between the members of the economy is affected. In the end, the structure of a particular market and industry is changed. The same is valid if regulatory provisions differ between countries or industries. Such differences lead to “regulatory arbitrage” by rational actors, so that activities are performed in the country or by the industry which faces least regulatory constraints and costs. Only in the latter case, market participants have an economic incentive to try to influence the state interventions in order to improve their position. In the area of money laundering prevention, the following situation applies: . Banks and other financial service providers are against stronger regulation for themselves or promote heavier regulation for others, as long as there are competitors which have a better position. They are indifferent if a level-playing-field exists. They intend “only their own security”; [. . .] they intend “only their own gain,” [9] they do not promote the interest of the economy as a whole. In certain cases, banks may even lobby for stronger regulation, if this could lead to a competitive advantage. . Clients of banks have no or low influence on state intervention, even if their own economic position (compliance costs are in the end paid by the client) and their rights (e.g. privacy and other basic rights) are concerned. The client has no better choice[18], is not thoroughly informed[19] or simply not interested[20]. What is criminal – what is not? A pivotal issue in money laundering prevention is the decision, whether an activity, a person or funds are legitimate or not. This is difficult to judge. The criterion of legitimacy divides the whole economic sphere into two parts, the legitimate and illegitimate (or “criminal”). It seems to be feasible to locate a particular good, service or an economic entity within one of the two spheres. In reality, this is not possible. The classification is even more difficult if several jurisdictions are involved, each with most of the time slightly, sometimes even vastly different views on the legitimacy. The same applies to the offences qualifying as predicate crime for money laundering[21]. Therefore, the legitimacy of a good or service cannot be judged upon the subject itself. One has always to know the background. The classification as (il)legitimate gets even more complicated, if not impossible at all, when we introduce money to the model. By definition, money is a medium of exchange and a store of value. It is, by definition, abstract, i.e. the value or function of money, e.g. a bank note, is independent of the current, prospect or former owner and also independent of the transaction due to which the current owner is in possession of the money. By looking at a bank note or a gold coin, it is impossible to judge if it has been acquired by legitimate means or not. The same applies to account entries in a bank. In most countries bank notes and coins are the only legal tender, and they are anonymous and abstract by definition. The distinction between criminal and legitimate world is only feasible if an activity, a deal, a person or a legal entity can clearly be associated with one of the two spheres. What looks like a simple decision, is a complicated venture, which is traditionally performed by state institutions such as prosecutors and courts. In the context of the fight against money laundering, the judgment about the legitimacy is increasingly transferred to private sector institutions such as banks. These, however, are not well equipped and qualified for this task. If they have to take on police and judicial functions, their primary function as financial intermediaries suffers. In addition, different conditions apply to banks and the state, and the two behave differently. Impact of anti-money laundering measures on the economy Money laundering prevention influences both the illegitimate and the legitimate world. Influence on the criminal world Like any businessman, criminals are interested in keeping costs down and earnings up. In view of rising costs for money laundering, the first and simple solution could be backing out of predicate criminal activities which create a need for money laundering. The current anti-money laundering framework seems to be built on this concept. Reality shows that it does not work, though. Since, the beginning of the fight against money laundering about 20 years ago, the targeted predicate crimes (drug trafficking and organized crime) have grown and prospered. Empirical evidence shows that the shadow economy gained importance during the last decades[22]. Even in developed countries, the shadow economy has the size of 10-30 per cent of the countries’ GDP[23]. The decision to undertake a predicate crime is determined by demand and expected gains. In the case of drug trafficking, the demand is still there, even though drug trafficking is illegal. This means that customers exist which are willing to pay for the good, no matter whether it is illegal or not. Consequently, there also are suppliers on the market. While these have to bear the costs for doing illegitimate, covert activities, they are able to cover these burdens by raising the price of the good. Certain aspects enable them to set their prices nearly without constraints. In legitimate markets, there (mostly) is competition, which is carried out over product quality and price. Competition requires transparent markets, where suppliers and demanders can acquaint themselves with the market condition. Monopolies and other market structures hampering competition and market transparency are actively fought against by the state. In the illegitimate world, the invisible hand of competition does not work well. This world is dominated by other forces. Relying on the addictiveness of the clients, suppliers are able to set the price at their discretion. Competitors are forcefully put out of business and cartel-like arrangements are usual, certainly in the world of organized crime. This enables the suppliers to effectively control the revenue variable of the profitability calculation. Even if money laundering contributes significantly to the overall costs, suppliers are able to get significant excess profits, which in turn makes the business financially very attractive. Reaction of the criminal world The AML measures have made moving money from the criminal world into the clean world more costly. However, criminals are not forced to launder all the criminal proceeds on a gross basis. They can choose amongst several alternatives: . Criminals can keep the money in anonymous form: the most important medium where the distinction between criminal and clean is impossible are bank notes (and coins). In most countries cash is the only legal tender, and it is perfectly legal to store and move any amounts of cash. Although cash may have several disadvantages compared with bank deposits, the difference may not be too severe, especially in the case of currencies that are also accepted outside the respective country. In addition, there are alternative and perfectly legitimate systems for anonymous payments, such as the century old and efficient Hawala[24] system. . Criminals could avoid money laundering altogether by keeping the dirty money in the criminal world. The bigger the criminal world relative to the clean world is, the easier and more valuable this alternative becomes. In the extreme case where the whole world is criminal, money laundering becomes unnecessary and even impossible. . Criminals may use one of the oldest and most efficient payment mechanisms: bilateral or multilateral netting, with or without counterparty substitution. The clearing system[25] is the most important institution for diminishing the demand for money in the broader sense. The system was already described and recommended by Adam Smith for the case that “gold and silver should at any time fall short in a country”[26]. “Buying and selling upon credit, and the different dealers compensating their credits with one another once a month or once a year, will supply it [money] with less inconvenience”[26]. To make use of this mechanism, criminals will “buy and sell upon credit” within the criminal world and balance the remaining net amount by transferring it to the clean world. They can thus reduce the amount and the total cost of money laundering substantially. . Criminals may use the international financial system, thus exploiting legal, regulatory and other differences between different countries. . Criminals may use “non-designated institutions” (in the FATF terminology) and private individuals for transferring criminal money into the clean world. Examples are the legendary pizzeria for smaller amounts, international trade[27], real estate or corporate finance for big transactions. From the criminal’s point of view it could be advantageous to not only use the clean institutions for laundering criminal money, but to merge the predicate criminal activity into the non-criminal activity of a non-designated institution. The routes through the non-designated sectors are less liquid and thus more expensive and need substantial resources. All alternatives require professional resources and long-term investments. Such a environment is typically provided by organized crime. It is conceivable that AML measures promote large, sophisticated organized crime structures rather than fight them. Influence on the legitimate world By definition, crime prevention deals with criminal actions which have not been committed[28]. So, from a criminal law point of view, persons and legal entities are not criminal yet, if at all. This raises the bar for acceptable costs and collateral damages. In contrast to prosecution, which affects only alleged criminals, everyone is subject to crime prevention and AML measures. Current money laundering law exactly requires that, as every financial transaction could involve illicit funds. Besides these direct cost of AML measures, there are also indirect costs in the form of collateral damage: (1) Damage for the society: . A loss of civil liberties[29], especially privacy. The AML provisions are a threat to the privacy of the individual; . It is the goal of the official AML policy “to counter the use of the financial system by criminals”. Society seems to accept that criminals use other parts of its systems jointly with non-criminals: examples are the transportation system, the education system, the legal system, or the health care system. (2) Economic damage: . The AML mechanism increases the direct costs of legitimate market transactions in the same way as illegitimate ones. By increasing the transaction costs of the economy, the AML measures hinder the working of the invisible hand and reduce the wealth of the nations. The whole economy faces increased transaction costs for using the financial system and the payment mechanism in particular. The effect is not limited to transactions of the “financial sector” but it impacts also the “designated non-financial businesses and professions” in the same way. It also increases the production costs of most services provided by the “financial sector” and the “designated non-financial businesses and professions”; . Economic sectors, actors and countries with a low sophistication of AML systems and probably a low reputation[30] face heavy discrimination, severely impacting chances of participating in the benefits of international trade and co-operation; . The risk exists of making the “complying institutions” and “complying countries” an exclusive club. This leads to regulation driven promotion of monopolistic or oligopolistic structures and results in high economic costs. Interaction between criminal and legitimate sphere Applying the AML framework described above, the attributes “criminal” and “legitimate” are not only given by law and courts, but actually by the private sector as well. Because the latter applies a risk-based approach, it may judge a person or an action as “doubtful” which is not “criminal” but “not legitimate enough” or “not profitable enough”. Emphasis has to be put on the fact that “doubtful” for a bank does not need to mean “criminal” in any way. The actual “criminality” of clients and their funds is hardly recognizable. Hence, banks and other financial services providers rely on criteria such as nationality, religious affiliation, industry and domicile of a client to create a risk profile. Depending on the risk affinity the bank has and its regulator allows, prospect clients may be refused because they exhibit high-risk criteria, without any hints on the actual doubtfulness of a client. By treating actually legitimate clients and transactions as “doubtful” they are moved from the legitimate world to the grey one, with many consequences: . Many services and provisions of the legitimate world are not available any more to all economic subjects or only available at prohibitively high costs. . The illegitimate world will be happy to offer these services, but to their conditions. . This will firstly lead to an extension of the criminal world, and secondly to the secluding criminalisation of persons originally acting in the legitimate world. . The extension of the criminal world provides new liquidity and members to it, thus enabling the criminal world to acquire more services and products without leaving the criminal sphere. The results of such a shift can be severe. The more services and products can be supplied out of the criminal world, the higher is the relative value of non-laundered money. This reduces the need for money laundering, strengthens the illegitimate economy and removes funds and resources from the legitimate sphere of the economy, which is subsequently weakened. Here, the fence is not shifted by the regulators and supervisors. Instead it moves by itself into the wrong direction. This is especially the case when the list of predicate offences is extended. When the predicate offence was drug dealing only, the chance to meet this criteria was very small. Today, given the extensive list of predicate offences, it is likely that there is at least a chance that a prospect client is engaged in such activities. Therefore, the investigation effort rises as does the risk and cost for all client relationships. Anti-money laundering and effectiveness: a paradoxon? After over 20 years of money laundering prevention, the results are disappointing: organised crime and drug trafficking still prosper. Banks face a high burden because of their active involvement in money laundering prevention. The various prevention schemes have weakened the basic rights of the bank clients, who have to pay for the prevention measures. Of course, there has been some success. Compared to the direct and indirect costs as well as to the estimated volume of organised crime, the victories are minor and the costs are high. However, AML regulation is going to be extended instead of being thought over. Why does a review not take place? Who is in charge? Role of banks and the financial services industry Banks and the financial services industry are applying the laws and regulations they are required to. Complying with the requirements is mandatory, as the market players risk their license or at least the comity of regulators and supervisors. Even complaining about the rules too loudly could be conceived as doubtful conduct. In addition, they sometimes react with even stricter and more detailed rules defined by themselves or industry associations. They do so mainly to foster their reputation, prevent further regulation by state and international entities and to minimise risk. Applying a risk-based approach. The risk aspect is arguable. Regulators, especially in Europe, begin to apply a risk-based approach to their money laundering regulation. The reason is that innovation on the criminal side makes it difficult for regulators and prosecutors to keep pace and to formulate detailed money laundering criteria ex-ante. In addition, the banks are allowed to adapt their money laundering effort along their risk assessment of a particular client. A retail customer with few and standardised transactions such as the salary reception and rent payment requires less caution than a cash-intensive business or a private banking client with assets distributed internationally. The risk-based approach, however, places a high responsibility on the banks, as they have to develop their own assessment framework, take sound decisions and defend their work when problems arise. In that case, they may have to prove the ability of their assessment framework to courts and regulators and cannot just show a filled form with predefined check boxes, which was supplied by the regulator. Avoiding the risk of wrong decisions. Banks are not always willing to take this responsibility. Big banks with an extensive client base and significant assets under management may be able to apply a very low risk affinity and to refuse clients which raise the slightest suspicion[31]. Smaller banks, in a competitive position not so favorable, may be inclined to accept such clients, at least if checks about the background of the clients do not reveal problematic aspects. These checks, however, are expensive and decrease the profitability of such a client relationship. Another strategy of the bank may be to let the supervisor take the decision. They can achieve that by filing suspicious activity reports (SAR), which will result in a supervisor’s decision about the alleged legitimacy or illegitimacy of a client or transaction. If such a decision is available, the bank minimises its risk to perform any wrongdoing ex-post. Differences in the type of business and attitude of banks and countries regarding SAR reports can be seen by looking at the statistics of Financial Intelligence Units (FIUs). In Switzerland, 863 SARs were sent to the Swiss FIU in 2003. About 80 per cent of these cases were forwarded to the prosecutors after a first investigation. In the same year, 100,000 reports were sent to the FIU in the UK. In 2005, 195,000 reports were filed[32]. The resource requirement to deal with this vast volume of reports on the banks’ and the state’s side is enormous. The relationship between reports and crime is questionable. There is a weak correlation in the area of drugs[33], but no significant dependency to other areas of crime[34]. Furthermore, with each report, the privacy of the client is compromised. Compliance as quality criterion. Furthermore, bank specific compliance efforts performed in addition to the required ones can be used to establish a quality criterion (e.g. a certification) which in turn could result in a competitive advantage like preferential treatment by the regulators or positive effects on reputation[35]. This could result in a “closed shop” where some competitors form and promote a “regulatory island”. Market participants not able to join this shop because of low sophistication, size, upfront effort to meet the arbitrary criteria for joining or due to other factors, are in turn penalised, although their services and products may be equally good or better and there may be no tenable evidence that meeting the joining criteria leads to more effective money laundering prevention. A “three-tiered” world arises: (1) the “good” institutions; (2) the “questionable” institutions and countries, which are not able or willing to comply with the rules, but do not necessarily facilitate money laundering; and (3) the “bad” institutions with a bad track record. For a bank, the objective is to fulfil the regulatory requirements, to belong to the “good” world and to take care that all its competitors face the same requirements and therefore the same costs. In that case, they face no competitive disadvantage, because the rules are the same for all of them[36]. They also have access to the global financial market, because they comply with the international rules. Indeed, banks and financial centres are very much preoccupied with the maintenance of “level-playing fields”. In addition, they are able to pass the cost of compliance efforts to the client. In the end, the client pays for the bank’s efforts to maintain its reputation. Other goals of AML are not relevant for a bank’s decision. Banks do not take part in discussions on the feasibility of AML, as this could hamper their reputation and success. Banks therefore have only a weak incentive to engage in fundamental AML discussions, as long as they are in the “good” tier of the world. If they do not, they may put all efforts in joining the first level, rather than questioning the AML strategy. Role of countries as regulators and policy setters The creation, implementation and enforcement of rules in the area of criminal and civil law as well as banking regulation and supervision is in the competence of sovereign states, which therefore also should be the ones to address the issues of upcoming and existing rules. The advancing globalisation of the economy in general and the financial services business in particular lead to a different picture. In order to foster international cooperation and prevent regulatory arbitrage, frameworks are coordinated on an international level. Single member states of the FATF, although constituting and taking part in the organisations, do not seem to have a significant influence on the rules and “mandatory recommendations”. The classification outlined in the previous section applies for states as well, as does the decision and incentive matrix. Therefore, even most states will neither be able nor willing to question or influence the AML strategy in a substantial way. Challenges in the international space Today, when crossing borders with a financial transaction (e.g. a simple payment), no single state authority seems to be relevant anymore. This has been most impressively proved in June 2006, when it became official that the US Government has tapped into the S.W.I.F.T. database[37]. Many central banks, governments and industry members have been informed. Also, the program should be seen as illegal in most of the G10 countries. However, none of the countries affected, except for the USA and Belgium, saw itself as a responsible point of contact for the issue at all. As long as there is no point of contact, there is no means to effectively complain about a state’s or international organisation’s action. This is devastating, as the typical client has no means to oppose the intrusion in his own basic rights [38]. Conclusion The authors have performed a stylized analysis of the laws governing the cost and benefit of anti-money laundering policies. Without recommending specific actions or strategies, they think that the following theses should be considered: . Measures taken to prevent money laundering in the financial system, may it be by state entities or the private sector, have to be judged upon their effectiveness to achieve the stated goal. . Benefits should be defined in terms of predicate crime. To counter the use of the financial system by criminals is not a viable objective. . There is a limit for the acceptable direct costs and collateral damage. Cost-benefit analyses should be performed and alternatives have to be considered. . As a general rule, a measure should be deployed only, if the benefits achieved exceed the costs. It is not feasible to place a high burden on the society and economy without corresponding results. As a common opinion, the current money laundering prevention framework fails to reach its own original goal, which is to reduce predicate offences. It is wrong to conclude that the current framework is not strong enough. The reason is, that the attractiveness of criminal ventures is determined by many factors, and the cost of money laundering is just one of them and can be compensated by others. AML regulation has achieved a life of its own, where the objective to prevent predicate crime has been replaced by other desires. 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(Ed.), Kapitalmaerkte und Politik, Dahlem University Press, Berlin, pp. 20-45. Geiger, H. and Wuensch, O. (2006), “Unerhoert, diese Signale”, Die Weltwoche, Vol. 26, pp. 14-16, available at: www.isb.unizh.ch/publikationen/pdf/publ1176.pdf German Bundesgerichtshof (2000), 5 StR 252/00. Hassemer, W. (1993), “Innere Sicherheit im Rechtsstaat”, Strafverteidiger, Vol. 12, p. 664. Hassemer, W. (2002), “Zum Spannungsverhaeltnis von Freiheit und Sicherheit”, vorgaenge, Vol. 159, available at: www.bpb.de/files/7QWQUY.pdf Hubli, I. and Geiger, H. (2004), “Regulatory Burden: Die Kosten der Regulierung von Vermoegensverwaltungsbanken in der Schweiz”, ISB Working Paper 37, available at: www.isb.unizh.ch/publikationen/pdf/workingpapernr37.pdf Lander, S. (2006), Review of the Suspicious Activity Reporting Regime, Serious Organised Crime Agency, London, available at: www.soca.gov.uk/downloads/ SOCAtheSARsReview-FINAL-Web.pdf Lichtblau, E. and Risen, J. (2006), “Bank data is sifted by US in secret to block terror”, New York Times, 22 June. Schneider, F. and Enste, D.H. (2000), “Shadow economies: size, causes, and consequences”, Journal of Economic Literature, Vol. 38 No. 1, pp. 77-114. Smith, A. (1846), An Inquiry into the Nature and Causes of the Wealth of Nations, Random House, New York, NY. Venturi, R. (2006), “Alternative Geldanweisungssysteme, Hawala und Regulierungsbestrebungen”, ISB Working Paper 45, www.isb.unizh.ch/publikationen/pdf/workingpapernr45.pdf Wuensch, O. and Geiger, H. (2006), “Die Massnahmen zur Geldwaeschereiprvention im internationalen Vergleich”, available at: www.isb.unizh.ch/publikationen/amls/pdf/ Aml2006-SbiVhv-pdf.pdf Corresponding author Oliver Wuensch can be contacted at: wuensch@isb.unizh.ch Credit:ivythesis.typepad.com

The fight against money laundering_An economic analysis of a cost-benefit paradoxon

The fight against money laundering An economic analysis of a cost-benefit paradoxon Hans Geiger and Oliver Wuensch Abstract P...