Placement, Layering & Integration : Money Laundering
The Panama papers and further leaks revealed that money laundering and tax evasion are an important issue, often underestimated by politicians. The major role of offshore centres is to provide secrecy. With this, offshore centres play an important role for hiding illegal activities, criminal identity and criminal ownership of assets. Money laundering, disguising the proceeds from criminal activity, by bringing them back into the legal financial circuit, is a relatively new topic in politics. It started in the late 1980ies and referred first only to drug money. Later it was extended to proceeds from other predicate crimes like fraud, corruption, bribery, weapon and human trafficking. Today also tax crime is a predicate crime for money laundering. This makes offshore activities double interesting: first they can hide criminal proceeds of drugs, bribery and other crimes, but they can also serve to hide money from evaded taxes from honest business. Offshore centres always had and still have the function of hiding activities. Their legal purpose is for companies who want to hide their activities from their competitors by going offshore. But this ‘hiding’ capacity also always invited illegal activities. Offshore centres were first mentioned in the 1920ies, when criminals like Al Capone brought their illegal proceeds from alcohol during the American prohibition (1920-1933) outside their US state to places like Delaware or New Jersey (van Koningsveld 2015). Al Capone was finally convicted for tax evasion (and though the term laundering is attributed to his launderettes not for money laundering).
Offshore
centres proved useful after World War II so that occupied zones (Germany,
Austria) could do business overseas. Multinational Companies like Shell or
Unilever could continue their business with this ‘remote-access’ instrument
(van Koningsveld 2015). After the oil shock 1975 offshore centres for finance
emerged which circumvented the regulations of (US and European) national
central banks. Proceeds of OPEC countries from the sixteen times higher oil
price, the so called Petro-dollars, were not reinvested in the US or Europe,
but off the mainland in Bahrain etc. (see Scharpf and Schmidt 2000) This is why
central bank lost control over financial flows which was the starting point for
financial liberalization in the early 1980ies. Today the term ‘offshore’ is
used in two different ways. The first includes banking centers as the following
definition reveals: “The term offshore is not necessarily restricted to tiny or
remote islands. It can also be applied to any location (e.g. New Jersey,
Delaware, City of London, Switzerland) that seeks to attract capital from
non-residents by promising low/no taxes, low regulation, secrecy and
confidentiality” (Prem Sikka 2003). The second definition excludes banking
centres like City of London, Switzerland or Germany. Offshore centres are
“jurisdictions that specialize in attracting the registration of investment
vehicles with foreign sponsors.” This definition focuses on shell companies,
trusts, special purpose vehicles, and mutual funds (Meinzer 2016). Depending on
the definition, there are between 20 (IMF 2014 definition), 40 (van
Koningsveld), 69 (IMF 2000 definition) and 92 (see Palan, Murphy and Chavagneux
2013) offshore centres in the world. Estimates on the volume of offshore
finance vary between 1 trillion and 21 trillion USD (van Koningsveld 2015,
p.233).
Source: UNODC
In 2015, University of California, Berkeley professor
Gabriel Zucman, published a widely noticed book ‘The Hidden Wealth of Nations -The Scourge of Tax Havens ‘. He concluded that as of 2014, at least 7.6
trillion of world's total financial wealth of 95.5 trillion USD was 'missing'
Zucman’s Martian men were systematically revealed:
heads of governments, top politicians, football players and football managers,
actresses, film makers; an elite which had apparently stopped paying taxes by
making use of loopholes emerging in an unregulated global world. These elites
used apparently the same offshore channels as drug dealers and human
traffickers.
Laundering techniques in the Placement phase
Smurfing and Structuring
As a first phase, Smurfing and Structuring (breaking
up a large deposit into smaller deposits which helps avoid the currency
transaction reporting requirements) takes place. If the reporting limit is say
10,000 Euros, launderers who do not want to risk reporting will smurf that
means put amounts up to 9,990 Euros on their accounts in order to stay slightly
under the reporting mark
Currency smuggling
This method refers to the physical movement of bulk
currency across borders in order to disguise its source and ownership. A
launderer smuggles ill-gotten cash into a country with lax money laundering
laws. He then places it in a bank there. Very often it is deposited in an
offshore bank account and eventually wired back at a later date. Smuggled cash
has been found in bowling balls, coffins and scuba diving oxygen tanks of
supposed tourists. But cash is heavy. If a drug trafficker sells heroin for one
million dollars, he or she must transport 22 pounds of heroin, but then ends up
with 250 pounds of currency (if there is an equal mix of 5, 10 and 20 dollar
bills) (see Cuellar 2003, p.13). This means that there is great incentive to
place money into the financial system or to use the cover of an existing
cash-intensive business.
Travellers’ cheques
The purchase of travellers’ cheques with ‘dirty money’
is quite a lucrative laundering technique. The FATF has reported cases of
purchase of large quantities of cheques for cash in several of the FATF member
states. (FATF Report on Money Laundering Typologies, February, 2002)
Gambling, casinos
Casinos can be used for the first and third phase of
money laundering. A launderer can clean cash by converting it into chips at a
casino, and then exchanging it back into cash to deposit at a bank and have a
cheque from the casino showing a legitimate transaction. In the third phase of
laundering, the launderer can buy a casino. Casinos are a highly cash intensive
business. The launderer can own a casino and claim that the large amounts of
cash held are profits from the casino.
Laundering techniques in the Layering phase: Correspondent
banking
Correspondent banking amounts to one bank (the
‘correspondent bank’) carrying out financial services for another bank (the
‘respondent bank’). By establishing networks of a multitude of correspondent
relationships at the international level, banks are able to undertake
international financial transactions in jurisdictions where they do not have
offices. The respondent bank can also be at some offshore centre, such as
Cayman Islands; Panama or Seychelles, which are historically known for lax anti-money
laundering regulations. Evidently, these relationships are vulnerable to misuse
for money laundering. The reason for this is the indirect character of this
type of banking where the correspondent bank will carry out services for
clients of another bank, the integrity of which it has not had verified
beforehand by the correspondent bank. For example, Al Qaeda used the
correspondent network of a Sudanese bank for cross border dealings. These cross
border dealings included France’s Credit Lyonnais and Germany’s Commerzbank
(see Busuoic 2006 in Unger 2006 Chapter 5)
Loan at low or no interest rates
A very easy method is to give interest-free loans.
This allows the launderer to transfer large amounts of cash to other people and
so avoid having to deposit the money into a bank or other institution. These
loans will be paid back slowly, which avoids deposits hitting the reporting
threshold. The receiver of the loan is likely to be aware of the dubious nature
of the money, but will be put off from reporting it due to the benefits he
receives from the preferential loan rates. Back-to-back loans Back-to-back
loans are a construction used for currency hedging. They involve an arrangement
in which two companies in different countries borrow each other's currency for a
given period of time, in order to reduce foreign exchange risk for both of
them. This hedging construction can also be used for laundering purposes. In
the Netherlands, it is sometimes used when launderers want to buy real estate,
which needs a Dutch bank guarantee. For example, a person takes cash to
Paraguay and deposits it in a bank account there. This money is then
transferred to Switzerland. The person then purchases real estate in the
Netherlands using the bank deposit in Switzerland as a guarantee. Money
exchange offices Money exchange offices are a legal way of exchanging money
into the currency of choice. Money exchange offices can also be abused
regarding unauthorized money transfers. Most of the Surinamese Cambios, for
example, are only authorized to do money exchange but not international money
transfers. However, many of them do (see Unger and Siegel 2006). The drug
dealer gives money to the Dutch underground banker in cash. The underground
banker calls the Cambio in Suriname, who pays out the money in cash in
Suriname. Since the drug business is running both ways quite well (cocaine
versus ecstasy pills), clearing is not needed too often.
Money transfer offices
Money transfers via money transfer offices such as
Western Union and MoneyGram seem to be important for money laundering, but
small in size. The total amount of money transferred by the existing 30 Dutch
money transfer offices is €325 million per year. According to Kleemans (2012),
these relatively expensive money transfers are mainly used for smuggling
illegal immigrants and women. Insurance market One way for the launderer to use
the insurance market is to arrange insurance policies on assets, either real or
phantom, through a dishonest or ignorant broker. Regular claims on this insurance
can then be made to return the cash to the launderer.
Fictitious sales and purchases
This method entails the use of false sales and
purchase orders. These can be with legitimate organizations that will have no
knowledge that these purchase orders exist. Fictitious sales documents are
created to explain the extra income showing in the accounts, which has come
from illegal activities. Shell companies Shell companies are businesses without
substance or commercial purpose and incorporated to conceal the true beneficial
ownership of business accounts and assets owned (A number of shell companies
are set up in countries known for strong bank secrecy laws or for lax
enforcement of money laundering statutes. They can also be in the form of
Special Purpose Entities (SPE’s) or International Business Companies (IBC’s).
The dirty money is then circulated within these shell companies via two
methods. The first is the loan-back systemand the other is the double invoicing
system. In the case of the loan-back method, the criminal sets up an offshore
company and deposits the ill-gotten gains with the respective company, which
subsequently returns the funds to the offender. Given that the ownership of
offshore companies is very difficult to establish, it will appear as if a company
is lending money to the criminal while in fact he is lending it to himself. The
double invoicing systemamounts to keeping two sets of books or false invoicing.
Funds can be moved across borders through overcharging or undercharging imports
and exports. Trust offices The term ‘trust’ refers to the ability of the
institution's trust department to act as a trustee– someone who administers
financial assets on behalf of another. The assets are typically held in the
form of a trust, a legal instrument that spells out who the beneficiaries are
and what the money can be spent for. Trust offices in the Netherlands are
somewhat different. They provide services in the field of tax and law for
foreign companies. The foreign companies do not run businesses in the
Netherlands; they are only placed in the Netherlands because of tax advantages
on royalties or worldwide dividends. The huge volume of transactions and the
little knowledge on beneficial ownership makes these offices suspect of money
laundering
The role of special purpose entities (vehicles)
Special Purpose Entities (SPEs), also known as Special Purpose Vehicles, (SPVs)
are companies settled in the Netherlands where non-Dutch resident participants
are able to earn foreign income in the Netherlands and then to redistribute it
to third countries For example: Esso collects the receipts from all over the
world in the Netherlands and then redistributes these to its branches or to
financial institutions abroad. This happens in order to reduce global tax
exposure. The volume of these transactions is so huge (eight times the Dutch
GDP) that if only half a percent of the turnover was used for illegal
activities such as money laundering, money laundering would be around 18
billion Euro a year in the Netherlands. Underground banking Underground banking
can be considered as any financial operation outside the conventional or
regulated banking and financial sector. The term ‘hawala’, used for parts of
underground banking, means ‘transfer’ in Arab. Ethnic groups often use currency
exchange offices in food, telephone, and video shops which deliver local
currencies to their relatives. While these systems have been traditionally used
by transnational ethnic networks, lately they are being increasingly used by
those who would like to be undetected when moving money such as drug
traffickers, tax evaders, money launderers and terrorist financiers. Black
market of foreign currency The launderer uses the foreign currency black market
both to remove the risk of transporting large amounts of currency and to avoid
depositing large amounts of foreign currency in domestic banks
Money laundering techniques in the Integration phase
In the third phase, money launderers want to park the
laundered money safely without being detected and with profit. Offshore centres
are only marginally involved in this final phase. Capital market investments
Capital market investments can happen in all phases of laundering. In the first
phase, the launderer uses his ill-gotten cash for buying. The launderer can
invest the money into financial assets so as to avoid having large amounts of
cash. But he can also use capital market investments in the layering phase or
for placing the money in its final spot. These assets, such as shares and
bonds, are generally low risk and so the chances of losing money are small.
Furthermore, the assets are highly liquid, which means they can be converted
back into cash very easily. Laundered funds are co-mingled with lawful
transactions.
Derivatives
Derivatives are financial assets and all have in
common that they can be interpreted as bets on future events. Their value is
intrinsically linked or contingent upon some external item of worth, hence they
‘derive’ their value from something else. This ‘something else’ is conventionally
referred to as the ‘underlying’, which, depending on the type of derivative,
can be bets on stocks, bonds, currencies, interest rates, energy, third party
or instrument credit quality, commodities, the weather, macroeconomic data and
mortality rates, for example.
These are financial assets and so can be purchased by
the launderer in order to invest the cash in reputable enterprises. Again, a
disreputable broker is probably needed. These assets are highly liquid and so
can easily be resold in order to return the cash back to the launderer.
However, derivatives are much more risky than traditional financial
instruments. Biggins (in Unger and van der Linde 2013) calls them dangerous
markets. Credit Default Swaps were mentioned during the Greek financial crisis.
Speculators speculating on Greece’s default bought Greek government bonds with
high interest and parallel bought CDS, a sort of insurance to pay out in case
of Greek default. So they had a perfect win-win situation, no matter what
happened to Greece. Biggins (2013) shows diverse ways in which derivatives can
be used for money laundering. For example ‘mirror trading’ where two trading
accounts are opened, one to receive funds which are laundered and one and the
other to receive the ‘washed’ funds. The broker enters the market and, for
example, simultaneously buys and sells some quantity of futures contracts.
Later in the day, the broker re-enters the market and repeats this process. The
broker has thus, in effect, created four trades. The broker makes it appear as
though the account set up for the funds to be laundered has made a loss while
the account set up to receive the ‘washed’ funds has recorded a profit. Put
simply, ‘framework conditions must be manipulated in such a way that the dirty
money is lost on the bet, while winnings are clean money’. ‘When considering
the potential for money laundering to occur through derivatives, it is
important to highlight not only the derivative related strategies themselves,
but also the existence of, for example, sham companies and other arrangements,
such as the complicity of professionals involved in the derivatives markets.
These factors can be crucial, providing necessary infrastructural support in
the initiation of the strategy and any results flowing from it’ (Biggins 2013).
Real estate acquisition The launderer can invest the illegal cash into
property, which is generally a non- depreciating asset. This would normally
require a facilitator. A real estate agent or notary, who is willing to
overlook the fact that the launderer wants to pay cash for an expensive asset,
or uses a strange mortgage from Switzerland. Real estate is extremely
attractive for launderers. It is difficult to estimate the true value of an
object. One can use it for criminal purpose. One can use it to derive regular
legal income from tenting (see Unger and Ferwerda 2011) Industries with cash
intense business and/or high value The catering industry, the gold market, the
diamond market, buying jewels, the acquisition of luxury goods, cash-intensive
business like restaurants, football bet offices etc. all belong to this
category
Trade base money laundering
The stricter regulations of financial markets might
lead to an increase of trade based money laundering. To overprice imports (for
example a cheap watch which is declared a Dior watch and can explain high
payments of the importing firm to the exporter) or to underprice exports (the
Dior watch is sent as a cheap watch abroad. The importer then sells it
expensive. With this the exporter has brought money outside the country). As
Zdanowicz showed in 2016, the amounts of trade based money laundering rise
significantly. The cost of false invoicing to the US authorities between 2003
and 2014 was more than $2.3 trillion. Abnormally priced goods were used to mask
complex tax avoidance schemes, and that the overall figure had grown by some
30% over the period from $168.3 billion in 2003 to $230.6 billion in 2014,
despite improved understanding of the threat and efforts to combat trade based
money laundering. (see FIU, Zdanowicz 2016). In June 2016, the US Congressional
Research Service published a report highlighting the importance of trade-based
money laundering R. Miller et al 2016). Also the Treasury of the Isle of Man
(Isle of Man Treasury: Customs and Excise Division 2016) warns from this oldest
form of money laundering dating back to ancient Chinese trade, in new disguise.
New money laundering risks
With the advent of the internet, new forms of money
transfers and possibilities for launderers have occurred. On-line banking
On-line banking makes it easier for the launderer to conduct transactions as
they can avoid having to go to banks and being seen or having to complete many
forms. Furthermore, it is much more difficult to trace the operators of these
accounts if they never go to banks
E-cash
E-cash, or electronic cash, is even harder to trace
than real cash as the ease with which it can flow around the world makes it
twice as hard for the authorities to detect. Money becomes not a real commodity,
but simply a line on a piece of paper or a computer screen. The launderer then
does not have to worry about depositing large amounts of cash, as the money
does not physically exist. All payments and receipts are made electronically.
E-gold
One can buy gold on the internet, using addresses such
as http://www.e- gold.com/examiner.html or http://goldmoney.com/. These sales
and buys still need some identification, one has to register, but when used
after having cleaned the money they still guarantee some anonymity. Pre-paid
phone cards Pre-paid phone cards can be bought on the streets. One can pay with
criminal cash for them and use the prepaid phone cards for shopping anonymously
on the internet. The possibilities and variety of products for sale increases
steadily. The Dutch Banking Association calculated that payments over the
Internet valued 2 billion Euros (5-7 million transactions) in 2004. Payments
via mobile phones amounted to about 1 billion Euros in the Netherlands (NVB
2006).
Proprietary systems
Proprietary systems refer to a specific set of payment
and funds transfer rights owned and patented, with intellectual property
protections, to a financial services provider located anywhere in the world.
Proprietary systems enable customers to access electronic banking or funds
transfer routing systems located offshore and hence avoid local reporting
requirements. This does not mean that customers are engaging in money
laundering, but it does mean that customers can make undetectable financial
transactions that may increase the risk of money laundering. These proprietary
systems may include international funds transfers between offshore
accounts/entities, cheque writing, trading facilities, letters of credit and
securities trading. They also involve alternative payment systems with the
conversion of funds into a virtual currency with e-credits, Pay PAL and e-gold.
Funds can then be disbursed offshore without triggering the reporting
requirements (Hackett 2003: 3). The use of electronic offshore access and
payment methods is related to the growth of proprietary systems that
potentially escape reporting requirements and detection strategies. This
involves accessing overseas accounts, trusts and companies. Money is
permanently kept offshore and shifted between offshore jurisdictions that have
a high degree of bank secrecy. These overseas accounts are then accessed at
ATMs using offshore debit/credit cards, which can also be used to make local
purchases. Entities such as trusts, banks and International Business
Corporations, also established offshore, then repay the credit cards and
continue to deposit funds into them on a regular basis. In 2002, the United
States Internal Revenue Service (IRS) found that MasterCard alone processed 1.7
million offshore transactions for 230,000 US resident account holders with
offshore debit/credit cards issued in 30 countries with bank secrecy and
minimal reporting requirements (US Department of Justice 25 March 2002).
Virtual currencies
Lately, virtual currencies such as BITCOINS and
ETHEREUM (the latter can be linked to smart contracts), have shown to be used
for laundering. Viruses installed in order to receive Ransom have to be paid in
bitcoins. Bitcoins can be used for internet shopping, e.g. Amazon accepts them.
Since the owner of bitcoins is almost not traceable, this currency might become
attractive for criminals. The EU Working Group on Virtual Currencies (Burkhard
Mühl and Sebastiano Tine of DG Home) keeps track of these new events.
DESTINATION OF THE LAUNDERED MONEY
Not all types of crime necessitate the same amount of
laundering. Some crimes, such as proceeds from homicide, usually do not require
much laundering, whereas proceeds fromdrugs need substantial laundering. Drug
dealers need laundered money in order to create facades of legal income for
their businesses and thus enjoy the profits from their illegal activities.
Robberies are quite costly to the community but the amount of money gained from
each robbery is usually a small enough amount that it has no need of being
laundered. Ordinary theft is similar to robbery (in fact can be the same in
some jurisdictions) in so far as there is little need for laundering. Offenders
are much more likely to spend any money earned from theft rather than undertake
the often complex transactions required to first ‘clean’ their gains through
laundering. Drugs and fraud offences, however, are usually associated with
money laundering. Large amounts of money are involved (earnings exceed those
amounts that could be reasonably spent without detection) which creates an
incentive for laundering. Walker (2009) revised the percentage that is likely
to be laundered for drug proceeds by lowering it. Before, he assumed that 80
percent or “considerable amounts” of drug proceeds were laundered. In his
latest revision he speaks of “medium laundering intensity” and he assumes
60%-70% (see Walker 2009). Additional income that results from tax evasion can
either be immediately spent (as with ordinary theft) or laundered, depending on
the amount of money involved. Company fraud can be 100 percent laundered.
Social security fraud, wherein social benefits are paid out under false
pretences can either be spent immediately or laundered, depending on the
amounts involved or the techniques used to achieve the fraud.
The threat to attract money for laundering: Which
countries are attractive for launderers?
Launderers prefer countries with solid financial
markets, good financial services, not too high corruption, high Gross Domestic
Product, high exports and imports, with high secrecy and lax anti-money
laundering regulations and low fines. They prefer countries which they know or
with which they share language, culture, social ties and networks. Figure 5
displays how threatened European countries are from laundering. Big countries
are leading. The UK tops the list being threatened by 282 billion Euro of
annual laundering, followed by France, Belgium, Germany, Luxembourg, the
Netherlands and Austria. The picture changes, once one corrects for country size
(see Figure 5a). Compared to their Gross Domestic Product, the Baltic States,
Luxembourg and Cyprus are over proportionally threatened by money laundering.
The Baltic States are the entrance port to the Euro for Russia. Also Cyprus was
a popular target for Russian oligarchs to park their money outside Russia
Happy Reading
Those who read this, also read:
1. Offshore Financial Centres(OFCs) & AML/CFT
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