The Early History of Money Laundering

Money laundering is not the oldest crime in the book but it’s certainly close. Historian Sterling Seagrave has written that more than 2000 years ago, the wealthy Chinese merchants laundered their profits because the regional governments banned many forms of commercial trading. He writes that the government considers merchant activities with a great amount of suspicion as they were considered to be ruthless, greedy and they follow different rules. Besides this a considerable amount of the income of merchants came from black marketing, extortion and bribe. The merchants who remained invisible were able to keep their wealth safe from the continuous extortions by bureaucrats. [1] So they used techniques like converting money into readily movable assets and moving the cash out of the jurisdiction in order to invest the money in the business. This technique is still used by many money launderers. [2]

According to legend, the term money laundering was originated in 1920’s during the period of prohibition in the United States. The organized criminals in the United States got greatly involved in the profitable alcohol smuggling industry and for legalizing their profits they started combining their profits with the profits from legislative business. But according to Robinson, the term was first used in 1973 in relation with the Watergate scandal. He says this case describes the money laundering perfectly despite of its origin, In that case the dirty or illegal money was put through a series of transactions and the money appears clean or legal at the other end. [3]

Money laundering can be broadly defined as the process of disguising the financial earnings of the crime. The U.S Custom Service defines “money laundering is the legitimization of proceeds from the illegal activity”. And the International Monetary Fund (IMF) defines money laundering as a “process in which assets generated or obtained by criminal activities are concealed or moved to create a link between the crime and the assets which is difficult to understand.” [4] With the introduction of term money laundering, the types of money was created, first is the money derived from the illegal activities that is called black money and the money derived from the legal activities that is called white money. The ultimate goal of the money laundering is to serve the financial link between a crime and the persons behind that crime, allowing them unnoticeable enjoyment of funds. [5]

However it’s difficult to visualize the difference between the two. The basic idea behind visualizing the difference is that the black money cannot be spend easily particularly on high value goods as compared to white money as now a day’s merchant cannot sell high valuable goods on cash as he is liable for the clarification and if the criminal displays his wealth without an obvious legal source, it may raise the suspicion about the criminal therefore the criminals have setup the money laundering scheme to convert their illegal gains into legal earned money. [6]

Stages of Money laundering

The highly complex process of money laundering generally consists of three stages which may overlap. The stages are placement, layering and integration. The stages can be well explained with the help of diagram given below:

Source: UNODC (http://www.unodc.org/unodc/en/money-laundering/laundrycycle.html)

The first stage is the placement stage. When the criminal made money with illegal activities for example selling drugs, he tries to get that money into the financial systems by putting that money into bank or financial system. For example a government official received a bribe of €5000 for the favors he provided and that bribe was paid in cash. In order to disguise the source of fund, the government official visits casino and takes €5000 of chips and then he plays at different tables and after few hours he returned the chips to the casino which can be slightly more or less and takes a check from the casino for the amount. The idea behind this was the government official has legitimate a source of the money he received in bribe. [7]

The second stage is the layering stage. The layering of the money starts after the money is deposited into the financial system. That money can be transferred to either small accounts or different company accounts directly or indirectly operated by the criminal in order to make it hard for someone to track the original origin of money. [8]

The money might be smuggled to different countries having less strict anti-money laundering regulations and with the advanced technologies available, money can be transferred within seconds.

The laundering process ends with the integration stage. This is the final phase in which the criminal has legalized the funds. Now the criminal may use the funds in purchasing high value good or investing the earnings.

Money Laundering Techniques and Methods

The money laundering techniques are complex and a salient feature of money laundering is the number of different methods used. Some of the commonly used measures are discussed below and are related with the three stages of money laundering that is placement, layering and integration.

Cash Smuggling

Cash smuggling is one of the oldest methods used for general smuggling of currency. The bulk shipments of cash hidden in cargo are driven across the border, though it is illegal to export a bulk amount of cash. Every country has its limit of carrying cash legally across the border like United States restricts the currency to $10,000 without filing a report under International Transportation of Currency or other Monetary Instruments (CMIR). However the criminals have been known to purchase of shipping business to transfer the cash hidden in the goods. [9]

Offshore Accounts (Shell Banks)

Offshore accounts are often used by criminals to obscure the audit trail as many different countries in the world offers strictly law for bank secrecy to attract money in their countries. In respect of this law, the country can also refuse to assist international authorities in revealing the information of customer. [10]

Many of these countries also attracts clients by selling Shell banks which means a bank which is incorporated in jurisdiction in which the bank has no physical presence and also unaffiliated with the regulated financial institution. [11]

These kinds of banks, Shell banks are generally developed in a financial haven country for providing the appearance of legitimacy. A customer only needs a false name to open an account in these kinds of bank which provides the customer complete secrecy and protects the customer from investigation and possible prosecution and after establishing the shell bank the customer may gain advantage of “payable though” or “pass through” accounts. The domestic bank offers these accounts to foreign institutions and they are used to shift the funds of foreign client’s into the domestic country without giving any information to the domestic institution on the client. [12]

Shell Company

The other method or technique involved is criminal developing a “Shell company”. It means that the criminal will open an account as a corporation rather than opening an offshore account as an individual. (Koker, 2002). Usually it is essential for the company to have participated already in the legal business dealings to develop an arena of legitimacy. And once the shell company developed, it can easily transfer a huge amount of money to the offshore haven and at the same time avoiding the taxes and registration regulations. Koker says that a shell company in South Africa have been known to sell for as less as $9,000.

The criminal owing that shell company may transfer the ownership of the company to a trust in order to difficult the investigation and the actual control of the company still remains with the criminal though it has been transferred in the name of trust and the clients have full access to the assets of the company. Further the company may also issue bearer shares which means that no record of the owner of the company and hence the company is owned by whosoever person who possess the shares of the company physically. [13]

Underground Banking

The Criminals considers this as the safest way of laundering money and also one of the most common method used for the purpose. Basically there are two types of underground banking systems which are known as Hawala/Hundi and Chitti/Chop banking (Trehan 2002). The term Hawala in Indian and Pakistani language means reference and in Arabic it means transfer related to money whereas word ‘Hundi’ means ‘trust’. Chitti means a mark whereas chops are the seals used to ease the money transactions.

The both of these forms of underground banking are ingrained in the ancient tradition and facilitate the practices of western banks by centuries (Gilligan 2001). These methods were introduced in order to avoid risk of carrying large amount of money by traders. The idea behind these concepts was that a trader would show a letter of credit or a symbol to the distant banker and that foreign distant banker would be the representative of the trader’s local banker and then the foreign banker would honor the letter or token ( Trehan, 2002 ). The use of underground banking has been recognized in many countries and the reason behind the success of this technique was that this banking was based on trust and virtually there is no paper trail involved in that. [14]

Classification of Offences under money laundering

The Offences under the money laundering controls has been classified into five categories that is drug distribution, white collar crimes, blue collar crimes, corruption and bribery and terrorism. These categories differ in their dimensions and are more uniformed in relation with the distribution and seriousness of the harm caused by these specific offenses to the society.

Drug Distribution

Most of the drug dealers deal with the common problem of regularly and frequently managing the large amount of cash. Initially the current anti-money laundering regime was developed primarily to put a control on drug trafficking.

White Collar Crime

This category of crime consists of various ranges of activities such as tax evasion. The different feature of these crimes is the laundering of money which is usually an integrated part of the crime itself. The case of Enron presents a more composite scheme in which the Shell corporations in the Cayman Islands served as a laundering tool to vague the trail of fraudulent behavior and also acted as a questionable tax shelter.

Blue Collar Crimes

The other large scale market other than the drugs for generating large amount of money which in turn generates the demand for money laundering consists of gambling and smuggling of people. However the scale of money generated by any individual operation in these areas tends to be much smaller than the drugs trafficking.

Corruption and Bribery

Corruption and Bribery can be considered as a white collar crime but they are different in respect of the place of occurring, in terms of who benefits and the nature of the harm done by them which may lead to affect the quality of government services and also the credibility of the government.

Terrorism

The different characteristic of terrorism is that it involves money from both, legitimately and the money generated from the criminal activities and then it converts the money into criminal use. The amount of money involved in this activities are not involved in millions but hundreds of thousands of dollar therefore the harm in enormous and unique. [15]

Anti money laundering

After identifying the major role played by the money launderers in the illicit drug trade, In 1980, the government around the world started implementing laws particularly outlawing money laundering. These laws were created in large part to assist agencies around the world. The 1986 U.S. Money Laundering Control Act was one of the first such laws and was followed by similar laws in United Kingdom, France and other countries. [16] From the outset it was clearly evident that the only domestic legislations were not enough as money laundering was a global crime. The more connected and integrated the financial system of the world becomes, the easier it is for launderers to transfer the dirty money worldwide. This created the demand of an international response for such an international crime. Therefore in 1988, the United Nation implemented the Vienna Convention against the illicit money from the drugs and that was the first multilateral agreement that particularly notify money laundering. 171 countries signed that convention and 168 countries implemented that. The domestic laws developed by these countries for money laundering acted as backbone to the global regime of money-laundering. [17]

Anti-Money Laundering Policies

The 1988 UN Vienna Convention Against Illicit Traffic in Narcotic Drugs and Psychotropic Substances

There was a need of an international response to deal with the international crime of money laundering. Therefore in 1988, the United Nation adopted the 1988 UN Vienna Convention against Illicit Traffic in Narcotics Drugs and Psychotropic Substances. This was the first multilateral agreement that particularly deal with money laundering and it was signed by 171 countries and was implemented in 168 countries however the Convention dealt mainly with drug

trafficking rather than money laundering and was written in order to combine the two earlier conventions related to drugs, the 1961 UN Convention on Narcotic Drugs and 1971 UN Convention on Psychotropic Substances.

However, the drafters of the conventions wrote in the introduction that they “know that the illicit drugs traffic creates huge financial gains and wealth, which enables the international criminal organization to survive, pollute and corrupt the government structure and society” and they were determined to identify and remove the persons involved in illicit traffic of the earnings of their criminal activities and thus abolishing their main inducement for doing so. [18]

The Article 3, subparagraph 1(a) of the 1988 UN convention usually needs countries to criminalize the manufacture, offering, production, sale, distribution, exportation or importation and a range of psychotropic materials mentioned in the annexes of convention and more significantly, with regard to the offences described in subparagraph (a), the Convention formulates it as a criminal act to transfer, convert or conceal property gained from that offences of subparagraph (a) of Article 3. [19]

But the list of offences that set off the money laundering laws differs in every country and it is very significant as money launders can structure their operations to take advantage of countries with different law regulations. [20]

While, the Convention may have lead to considerable differences between jurisdictions, it did not develop any significant similarity. Each and every jurisdiction that signed and implemented the Convention was prerequisite to develop laws banning the laundering of funds occurring from the offences under Article 3 subparagraph 1(a).

Financial Action Task Force and Functions

The Financial Action Task Force is an inter-governmental body formed to notify the international nervousness for the international money laundering. It was established in 1989 by G-7 Summit in Paris. Currently, the FATF includes thirty countries including US and UK and two international organizations comprising of European Commission and the Gulf Co-operation Council. [21]

The FATF analyzes the money laundering trends and methods and evaluates global government’s combative steps and creates measures to choke the efforts of criminals. Thus in 1990, the forty recommendations were created as a plan of action against money launderers. The forty recommendations were the counter-measures noticing law enforcement and international efforts to combat money laundering, which included development of world-wide anti-money laundering bodies. [22]

The mission of FATF consists of three steps. The first step is the development of a global network for combating money laundering; the second step is implementation and monitoring the forty recommendations involving yearly self-assessment and close evaluation.22. The yearly self assessment comprises of own evaluation of the questionnaires which are administered yearly and this information gives the status to the recommendations implemented and close evaluation involves the on site evaluation by the team of three or four experts from the field of law enforcement and legal matters and the third step includes a review of money laundering trends and counter measures. [23]

Blacklisting

The first and foremost blacklist related to money laundering and tax havens was published in 1999 by International Monetary Fund. The IMF (International monetary fund) showcased a list of territories and countries with OFC’s (Offshore Financial Centers). The countries may develop OFC’s for various reasons comprising of catching the attention of foreign technical skills and expertise, gaining access to international capital markets, and bring in a tool of competition in domestic financial systems and at the same time covering domestic organizations. [24]

The OFC’s can be exploited for doubtful purposes, which is the key point of the blacklisting. One of the key reasons behind the OFC’s attracting funds is due to the likelihood of tax evasion or avoidance and their secrecy policies. The high level of secrecy policies are used to attract funds and these policies are also exploited for the activities related with money laundering. (IMF, 1999) and after the establishment of blacklist by IMF in 1999, the blacklisting money laundering was assigned to the FATF. [25]

The FATF blacklisted countries with regard to terrorist financing and money laundering by naming and shaming them as NCCT’s (Non-Cooperative Countries and Territories). The FATF published its first report of NCCT’s which was based on the criteria for identifying Countries and Territories who was non-cooperative in anti-money laundering and terrorist financing. The report included 25 negative criteria like secrecy of banking, few loopholes of law and financial regulation outlining the policies and practices which help to smother the international efforts to combat money laundering. [26]

European Union’s Anti Money Laundering Strategy

First Anti-Money Laundering Directive (1991)

The first European anti-money laundering directive for the prevention of use of financial systems for money laundering was adopted in June 1991 and implemented in January 1993. The approach behind the Directive was small but an important step in the combat of EU’s against money laundering. The Directive brought in some minimum requirements to be implemented by the Member States by the Directive was not considered as a perfect legal tool. For instance, it was choice of the Member State to select between the use of administrative law or criminal law to be implemented by the Directive. [27]

In 1990’s, when the Directive was introduced, the protection of financial institutes was of utmost importance as they were seen to play a vital role in the wide European economy. The Directive was committed to protect financial institutions with an aim to prevent the use of financial systems for the purpose of money laundering and to assure the correct functioning of financial and economic transactions.

The Directive had three clear objectives. Firstly, the Directive developed the regime by including both criminal law provisions and regulatory law provisions. The Article 2 of the Directive requires all the Member States to introduce legislations which consider money laundering as a criminal offence. But the Directive was seen as lacking particular provision relating to the identification of the customer’s, although it was mandatory for the financial institutions to verify the identity of customer but there were no details given by the Directive on the appropriate procedures. [28]

The second objective of the Directive was to put lot of pressure on financial institutions both morally and economically. The institutions were also required by the Directive to maintain and implement staff training and adequate control to make sure that the staffs are trained and aware of the law to recognize suspicious transactions. However this strategy of mandatory reporting of all transactions involving more than the prescribed minimal amount was not particularly effective as it was easy to be on safe side and make transactions less than the minimal amount which was to be reported. [29]

The Third objective was prevention strategy of the Directive in which the financial institutions were not allowed to hold anonymous back accounts.[22]. This prevention harmonized the banking practices of Member States but the duty imposed on banks to supply customer information were surrounded to be in conflicts with the duty of the bank to confidentiality of customers. The Directive was also criticized as being too flexible and too much a product of compromise. [30]

The Amending Directive (2001)

The second Directive was introduced by EC on prevention of the use of financial systems on money laundering in December 2001. It was introduced to cover the gaps left by the first Directive. The Amending Directive with a reference to 40 recommendations by FATF concentrated mainly on the importance of broader range of predicate offences. This Directive was established with four main objectives.[23] The first aim of this Directive was that the Member States was obliged to criminalize the money laundering of proceeds from the serious crimes like drug trafficking and which were severely punishable by the law of Member States. It was specifically aimed at ensuring the integrity and stability of the financial systems of the Member States. The second aim of the Directive was to broaden the strategy of identification and verification and also reporting to non financial agents and financial businesses that are likely to be involved in the money laundering like dealers of high luxury goods, casinos. [31]

The Third aim of the Amending Directive was to obligate the Member States to make sure that the particular and adequate measures are adopted to deal with the risk of money laundering which arises in face to face transactions like need of providing supplementary measures or additional documentation as an evidence to certify or verify the supplied documents. The fourth aim of the Directive was to make it obligatory for the Member States to develop FIU’s.190. The idea was to centralize the information management system but this FIU’s took various forms in various jurisdictions and these forms created hassle for the exchange of information. [32]

The Amending Directive only concluded that the money laundering should be prevented however it does not provided any justifications for combat against money laundering. Therefore the European Commission in 2004 made a proposal to improve and update the existing anti-money laundering regimes to strengthen the European Union’s fight against money laundering. [33]

Third money laundering directive

The European Union Third Money Laundering Directive 2005/60/EC were adopted in 2005 and were implemented in December 2007. The main aim for the set up of Third Directive is to support the EEA regulatory regime appropriate for dealing with money laundering and terrorist financing with the recommendations of FATF. [34]

The Third Directive considerably widens the scope of persons who are subjected to regulations in a way such that it included trust and company for the first time. Although the Third Directive broadens the definition of the term money laundering, but still this definition lacks in including all offences as inserted by POCA. The Third Directive broadens the scope of EEA anti-money laundering to the activities related with the terrorist financing. [35]

Customer Due Intelligence

The Third Directive puts in more details and a great deal to the customer due-diligence requirements as mentioned in the 2003 Regulation but also gives specific grounds where due diligence can be simply applied.

The Third Directive summarizes four parts to the customer due diligence which includes: [36]

Verifying and identifying the customer on the basis data, documents or information received from an independent and reliable source.

Attaining information on the intended nature and purpose of the business relationship

Recognizing, wherever applicable, the owner beneficial and incurring risk based and appropriate measures in order to verify the identity so that the firm is satisfied and it knows about the owner beneficial.

It also requires the ongoing business relationship with the customers.

The persons falling within the scope of the Directive that is the Designated Persons should apply appropriate procedures to examine the transactions of customers on an ongoing basis based on the fine understanding of the customer business relationship. [37]

Customer due diligence should be undertaken by the firm when:

Developing a business relationship

If there is any doubt or suspicion of terrorist financing or money laundering, irrespective of any exemption or derogation.

At the time of carrying out infrequent transactions amounting to €15000 or more, irrespective of the transactions being carried out at once or in various transactions which materialize to be linked

If there is any doubt about the adequacy or veracity of documentation obtained. [38]

The Directive also needs that the designated persons should apply the customer due diligence needs to the existing customers on the basis of risk sensitive at suitable times.

Simplified Customer due diligence

To deal with the large added burden as a consequence of the requirements of enhanced customer due diligence, the Third Directive broadens the circumstances in which the firms may use the simplified due diligence. The Directive needs that on a risk sensitive basis, full customer due diligence must apply to the main stream of situations which means that low risk customers should also undergo through the identification, verification and ongoing monitoring process on the risk sensitive basis. Although the Directive also gives examples of the some situations that are very low risk and the firm will not have to undergo customer due diligence however they should obtain sufficient information to satisfy it with the examples set out by Directive. [39]

Reliance in third p