Red Flags in AML/CFT
Red flags in Anti-Money Laundering /Combating the Financing of Terrorism(AML/CFT) are
indicators of potential illicit activities and include unusual transactions, secretive clients, Politically exposed Persons(PEP) , High risk Jurisdictions , Complex Ownership Structures and large cash transactions. These warning signs, which do not automatically confirm
wrongdoing, trigger further investigation and may lead to the submission of a Suspicious
Transaction Report to the relevant Financial Intellegence Unit (FIU).
Following FATF guidance and local legislation, AML programs should ensure a risk-based
model that reflects their threat landscape and regulatory environment,
effectively highlighting any AML red flags. This should include suitable CDD
Process, identifying customers for enhanced due diligence (EDD), Transaction Monitoring Solutions and sanctions, PEPs, and adverse media
screening.
FATF
red flags in the capital markets are indicators of potential money laundering
or terrorist financing and include customer secrecy, use of fake
documents, unusual transaction patterns, and geographical risks. Other red
flags involve the source and movement of funds, such as large cash payments, funding from high risk jurisdictions, and transactions with no clear business
purpose. Financial institutions must perform Know your Customer (KYC) and
Enhanced Due Diligence (EDD) to detect and report these activities to combat financial crime.
According to the FATF’s report, some of the most frequently
reported offenses include bribery and corruption, tax crimes, and fraud. That
said, companies should look out for various combinations of money laundering
techniques, being able to recognize the following warning signs:
Misuse of
client accounts. For example, using
seemingly legitimate corporate accounts for personal financial interests.
Purchase of
real property. For instance,
taking laundered funds and cleaning them by buying and selling real estate.
Creation of
trusts and companies. For example, trying
to conceal ownership of the parties involved in the transaction to, once again,
use illegally obtained assets.
Managing
client affairs and making introductions. For instance, opening a bank account on behalf of a client
despite noticing the warning signs of money laundering by a politically exposed
person (PEP).
Undertaking
certain litigation. For instance, if
the dispute’s subject is made up (like having no real debt and just
transferring proceeds of crime between entities) or if the litigation involves
a contract related to criminal activity that a court wouldn’t enforce.
Setting up and
managing charities. For example, legal
professionals help create charities or non-profit groups, serve as trustees,
and offer legal advice on charity-related matters. They might also be
established for fraudulent purposes involving laundered proceeds.
FATF's Red Flag Indicators
Financial institutions and regulatory bodies are constantly on the lookout for red flags that signal potential suspicious activity. These red flags are differentiated according to the client, source of funds, choice of lawyer, and nature of retainer. It helps the Money Laundering Reporting Officers (MLROs) to categorize suspicious activities and help them write Suspicious Transaction Reports (STR) and report to the Financial Intelligence Unit of the country, if necessary.
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The FATF lists 42 red flags,
which consists of 4 categories |
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Client and Red Flags
Red flag 1 | Secrecy/Evasiveness: The client is overly secret or evasive about key
details such as their identity, the source of their money, the Beneficial
Owner, the reason for choosing a
particular payment method. Clients who are reluctant to provide such
information may be trying to conceal their identity or the source of their
funds.
Red flag 2 | Fake Documents: The client actively avoids personal contact or refuses
to provide information, data, or necessary documents. They may also use fake
documents or an email address that cannot be verified. Clients who have a
connection to someone involved in terrorist or terrorist financing activities
or who ask repeated questions about procedures may also raise red flags.
Red flag 3 | Unusual Transactions: Parties involved in the transaction, or
their representatives, are located in a high-risk country. There may be no
apparent commercial reason for the parties to be connected, or the links
between them may raise doubts about their authority. Multiple transactions
between the same parties in a short time may also indicate suspicious activity
regarding anti-money laundering
compliance. If the transaction is
unusual for the parties involved, especially if they are below the legal age,
it may also be a red flag. If the person directing the operation is not an
official party to the transaction or their representative, it could be a cause
for concern. Additionally, if a real person working as a director or
representative is not an appropriate representative, it could also be a red
flag.
Red Flags and Source of Funds
Red Flag 4 | Inconsistent Economic Profile: Suggests that a transaction may be
inconsistent with the individual's economic profile. For instance, if an
individual who has a low-income level suddenly initiates a high-value
transaction, it could raise suspicions.
Red Flag 5 | Unexplained Cash Collateral: Points
out that a client or third party contributes a considerable amount of cash as
collateral provided by the borrower without a logical explanation. This could
be a sign that the transaction is being used to launder money.
Red Flag 6 | Unverified Source of High-Risk
Funds: Highlights the importance of verifying the source
of funds, especially if they come from a high-risk customer or country. This is
because these sources of funds are more likely to be linked to criminal
activities.
Red Flag 7 | Multiple or Foreign Bank
Accounts: Indicates that a client has multiple bank accounts
or foreign accounts, which could be used to hide the source of funds or
move money across borders to evade detection.
Red Flag 8-20 | Various Suspicious
Activities: Suggest various other suspicious activities that
financial institutions should watch out for, including unusual payment methods,
short repayment periods, suspicious asset purchases, and unexplained capital
increases.
Red Flags and Choice of Lawyer
There are certain indicators that clients need to
be aware of to avoid potential risks and ensure anti-money laundering compliance when it comes to choosing a lawyer for legal
matters.
Instructions
from an unrelated or inexperienced legal professional: If a client receives instructions or advice from a
lawyer who has no connection or experience in the relevant area of law, it
raises concerns. This can indicate that the lawyer may not have the necessary
expertise to handle the specific legal matter effectively. Clients should
ensure that the lawyer they choose has relevant experience and specialization
in the area of law pertaining to their case.
Willingness
to pay unusually high fees: If a client is willing to pay significantly higher fees than the
average market rate for legal services without a valid reason, it can be a red
flag. This may indicate potential unethical practices, such as
overcharging or exploitation. Clients should research and compare the fee
structures of different lawyers to ensure they are being charged fairly and
transparently.
Multiple
changes in legal consultants within a short period: If a client switches their legal consultant
frequently or without a valid reason, it can raise suspicions. Constantly
changing legal representation may signal underlying issues, such as
dissatisfaction, lack of trust, or conflicts of interest. Clients should
carefully evaluate their reasons for switching lawyers and consider the
potential implications it may have on their case.
Meeting
with multiple legal counsels: If a client meets with multiple legal counsels without a valid
reason or clear objective, it can be a cause for concern. This behavior may
indicate that the client is attempting to gather information or manipulate the
legal process. Clients should be transparent with their legal representatives
and avoid engaging in activities that could be perceived as seeking undue
advantage or engaging in unethical practices.
Denial
of essential services by a professional: If a lawyer denies providing essential legal services
that are typically expected in a particular situation without a valid reason,
it can be a red flag. This may include refusing to draft necessary legal
documents, providing representation in court, or offering legal advice crucial
to the client's case. Clients should carefully assess the reasons provided by
the lawyer and evaluate whether it aligns with their legal rights and
requirements.
Red Flags and Nature of Retainer
Disinterest or desire for
shortcuts: A client who appears disinterested in the outcome
of a retainer or requests shortcuts or unusually fast completion of a
transaction can be a red flag when considering anti-money laundering compliance risks. This
behavior may suggest that the client is more focused on the process rather than
the legal implications, potentially indicating an attempt to bypass necessary legal
checks and safeguards.
Complex ownership structure
without valid reason or involving multiple countries: A retainer with a complex ownership structure that lacks a valid
business reason or involves multiple countries unrelated to the client or
transaction may be indicative of attempts to obscure beneficial ownership or
engage in international money laundering schemes. This can involve the use
of shell companies or complex corporate structures to hide the true
beneficiaries or origins of funds.
Multiple stock purchases with
common elements: If a client repeatedly purchases
stocks or investments with common elements such as partners, shareholders,
registered office addresses, or corporate purposes, without a legitimate
business rationale, it can raise suspicions of potential fraudulent or
manipulative activities, such as market manipulation or illegal insider
trading.
Lack of supporting documents for
customer's story, previous transactions, or company activities: If a client fails to provide
adequate supporting documents or evidence for their narrative, previous
transactions, or the activities of their company, it may suggest that the
information provided is false or fabricated. This could indicate an intention
to deceive or engage in fraudulent activities.
Transfers of similar transactions in a
short period suggesting potential misconduct: Multiple transactions with similar
characteristics, such as the same parties, amounts, or assets, conducted within
a short period of time can be an indication of potential misconduct, such as
layering or structuring transactions to evade detection or engage in illicit
activities. This is one of the most common red flags for anti-money laundering
compliance.
Property transactions with consecutive
purchase prices or abandoned transactions without concern: Property transactions where the
purchase prices are consecutive or show an unusual pattern or instances where
transactions are abandoned without any apparent concern can signal attempts to
manipulate property values or launder money through real estate transaction..
Unexplained changes in instructions,
especially at the last minute: If a client consistently changes instructions or
provides significant alterations to the terms of a retainer, particularly at
the last minute, it may suggest attempts to manipulate or exploit the legal
process for ulterior motives, potentially involving fraudulent or illegal
activities. Utilizing advanced sanction screening software and conducting
thorough sanction checks is essential in detecting and preventing involvement
with entities or individuals subject to list-based sanctions.
High account balance without provision
of legal services: If a
client maintains a significant amount of money in an account without any
reasonable explanation or provision of corresponding legal services, it can
raise suspicions of potential money laundering or the use of legal services as
a cover for illicit financial activities.
Transactions without a valid reason or
unnecessarily increased complexity resulting in higher taxes and fees: Transactions conducted without a
legitimate business or legal reason or deliberately structured in a complex
manner resulting in higher taxes and fees without a clear purpose may
indicate attempts to obscure the true nature or purpose of the transaction and
potentially evade legal obligations or taxes.
Virtual Assets Red Flag Indicators
In October 2018, the Financial Action Task Force
(FATF) updated its Standards to clarify the application of the FATF Standards
to VA activities and Virtual Asset Service Providers (VASPs) in order to, among
other things, assist jurisdictions in mitigating the money laundering (ML) and
terrorist financing (TF) risks associated with VA activities and in protecting
the integrity of the global financial system. In June 2019, the FATF adopted an
Interpretative Note to Recommendation 15 to further clarify the application of
FATF requirements to VA activities or operations and VASPs, including with
respect to suspicious transaction reporting.
Indian Financial Markets and Red Flags
Capital Market
The capital markets offer immense scope for
laundering money due to factors like:
Large trading volumes make detection difficult
Ability to quickly convert cash into securities
Access to foreign funds and offshore structures
Use of opaque financial instruments
The
Securities and Exchange Board of India (SEBI) vide its circular dated 3
February 2023, has updated its ‘Guidelines on Anti-Money Laundering (AML)
Standards and Combating the Financing of Terrorism (CFT) / Obligations of
Securities Market Intermediaries under the Prevention of Money Laundering Act,
2002 and Rules framed thereunder’ (Guidelines). The Guidelines are applicable
to all intermediaries registered with SEBI and recognized stock exchanges in
India. The updated Guidelines have introduced a few key additions and
explanations to the previous SEBI Circular dated 15 October 2019 (now rescinded
by virtue of this circular) and has incorporated elements from several
notifications issued by the Ministry of Home Affairs (India) in the recent
past, with respect to powers of the Central Government under Section 51A of the
Unlawful Activities (Prevention) Act, 1967 (UAPA).
(i) Scheduled Offences:
(ii) Policy for acceptance of clients by
registered intermediaries and stock exchange:
(a) Enhanced client due diligence has been prescribed for client of special category (CSC), and ‘Non-Face-To-Face clients” have been explained as ‘clients who open accounts without visiting the branch / offices of registered intermediaries or
meeting the officers of the registered intermediaries’. On the other hand, it is clarified, that video based customer identification process will be treated as ‘face-to-face’ onboarding of clients.
(b)
Registered intermediaries are required to ensure that a client’s account is not
opened without the intermediary completing the client due diligence measures.
When the identity of the client or the information furnished by the client is
suspected to be non-genuine, a suspicious activity report is to be filed by the
intermediary. Unfortunately, the guidelines are silent on the authority with
whom such a report has to be filed i.e. FIU-IND or SEBI.
(c)
In relation to the continuing clients, the intermediary is expected to
continually evaluate the identity of its clients. Where there is suspicious
trading, it will evaluate and freeze the account and shall discontinue
its business with the client.
(d) Registered intermediaries may permit a client to act on behalf of another person / entity only under specified circumstances. While these circumstances are not articulated in the Guidelines, one will have to assume that the same principle will apply that the other person / entity’s identity is capable of evaluation.
(iii) Reliance on third party for carrying
out client due diligence
a)
Registered intermediaries have been previously permitted to rely on third
parties for the purpose of identification/ verification of the client. In line
with rule 9(2) of the Prevention of Money Laundering (Maintenance of Records)
Rules 2005 (PMLA Rules), the Guidelines lay down the following safeguards to be
observed by registered intermediaries:
- the third party should immediately send all client due diligence information of the client to the registered intermediary;
- ensure that the third party is regulated, supervised or monitored and has measures in place for compliance with client due diligence and record-keeping; and
- third party is not situated in any country or jurisdiction which is classified as a high risk jurisdiction by the Financial Action Task Force (FATF).
(b)
The registered intermediary will be primarily and ultimately responsible for
the diligence of the client.
(c)
All cash transactions exceeding INR 10 lakhs or its equivalent in foreign
currency, or series of transactions integrally connected or remotely connected
/ related, whose aggregate value exceeds INR 10 lakhs, must be recorded by the
intermediary. Further, credits / debits into or from any non-monetary account
are to be noted and where necessary, suspicious transaction reports are to be
filed.
(iv) List of designated individuals /
entities
(a)
Registered intermediaries are required to take note of the updated lists of
persons designated as ‘terrorists’ by the Ministry of Home Affairs (MHA), under
Section 35(1) of the UAPA.
(b)
Stock exchanges and registered intermediaries are required to file a suspicious
transaction report (STR) with the Financial Intelligence Unit of India
(FIU-IND), covering all transaction, specified under Section 35(1) of UAPA.
(c)
A copy of STR and communication with the FIU-IND shall be parallelly shared
with the UAPA Nodal Officer of the State / Union Territory where the account is
held.
(v) Jurisdictions which do not or
insufficiently apply the FATF Recommendations: Registered intermediaries are
expected to update themselves with the FATF Statements released from time to
time and are also expected to update themselves with publicly available
information relating to countries that do not or insufficiently apply the FATF
Recommendations.
Consequent to PMLA 2002, SEBI, has brought out illustrative list of red flags for capital market
i Clients whose identity verification seems difficult
or clients that appear not to cooperate;
ii Asset management services for clients where the
source of the funds is not clear or not in keeping with clients’ apparent
standing /business activity;
iii Clients based in high risk jurisdictions;
iv Substantial increases in business without apparent
cause;
v Clients transferring large sums of money to or from
overseas locations with instructions for payment in cash;
vi Attempted transfer of investment proceeds to
apparently unrelated third parties;
vii Unusual transactions by CSCs and businesses
undertaken by offshore banks/financial services.
It
is said that life insurance is a subject matter of solicitation. This means
that the concept of insurance needs to be sold on its merits and cannot be sold
through luring people with attractive offers.
In its 'Insurance Fraud Monitoring Framework', Insurance Regulatory and Development Authority (IRDA) has asked insurers to lay down procedures for monitoring and early detection of frauds.
The report dated 22 Jan
2013 made the players in the industry responsible to Lay down procedures to
carry out the due diligence on the personnel (management/staff)/ insurance
agent/ corporate agent/ intermediary/ TPAs before appointment with them.
The IRDA classified frauds in the insurance sector under three heads -- claim fraud or policyholder fraud, intermediary fraud and internal fraud. The insurers have to submit a compliance report with the regulator by June 30, 2013. Apart from the these three, external fraud is also possible in this sector
1. Internal Fraud: This occurs within the organization, involving staff,
management, or board members. Typical examples include fund misappropriation,
unauthorized access to sensitive information, or collusion with external
fraudulent claimants.
2. Distribution Channel Fraud: This type involves distribution partners
and could include misrepresentation of policies, falsification of documents,
premium embezzlement, or identity theft. Addressing fraud within distribution
channels is crucial, as these intermediaries serve as direct points of contact
with customers.
3. Policyholder Fraud and Claims Fraud: This includes activities by
policyholders or others involved in acquiring coverage or during claims
processes. Such fraud might involve falsifying claim information, concealing
relevant details, or presenting false identities.
4. External Fraud: External entities, such as vendors, service
providers, or other third parties, can also target insurers. Fraud here could
involve creating fake support documents for claims, inflating repair costs, or
impersonating customers to access policy benefits fraudulently.
Key aspects of Fraud Management System
The Fraud Monitoring Framework
includes several pivotal elements that collectively strengthen an insurer’s
fraud prevention, detection, and response mechanisms:
1. Fraud Risk
Governance Framework
The IRDAI mandates insurers to establish a Fraud Risk Governance
Framework overseen by senior management and key board committees, such as the
Audit and Risk Management Committees. This ensures accountability at the
highest levels. Insurers must create an Anti-Fraud Policy with a zero-tolerance
stance, establish early-warning systems for fraud detection, and maintain
collaboration with law enforcement agencies to ensure timely legal action
against fraudsters.
2. Fraud
Monitoring Committee (FMC)
Each insurer is required to form a Fraud Monitoring Committee
(FMC) to handle fraud deterrence, detection, investigation, and reporting. The
FMC’s primary responsibilities include making recommendations on fraud
management, investigating suspicious cases, and ensuring compliance with
anti-fraud policies across all operational areas. The FMC must also submit
quarterly and annual reports to the board on fraud-related activities, including
the financial impact on the organization.
3. Fraud
Monitoring Unit (FMU)
An independent Fraud Monitoring Unit (FMU) supports the FMC by
performing regular checks, gathering evidence, and collaborating with other
departments on investigations. The FMU’s tasks include assessing transactions
for signs of fraud, conducting thorough investigations, and working with
regulatory bodies and law enforcement as needed.
4. Risk Identification and
Mitigation
To effectively counter fraud risks, insurers must conduct annual risk
assessments and identify potential vulnerabilities across all business lines.
The framework encourages identifying Red Flag Indicators (RFIs) for suspicious
activities and setting up advanced technological systems for ongoing fraud
detection.
Cybersecurity and New Age Fraud
As digital threats evolve, so
do the IRDAI’s guidelines on Cyber Fraud. Insurers must establish robust
cybersecurity frameworks to counteract these modern risks, safeguarding
customer data, digital transactions, and the organization’s reputation. The
guidelines advocate for a dedicated team specializing in cyber risk management,
ensuring that insurers are prepared to counter these new-age threats
proactively.
The Role of the Insurance
Information Bureau (IIB)
The Insurance Information
Bureau (IIB) plays a critical role by providing an industry-wide platform for
data analytics, enabling insurers to detect patterns and prevent fraudulent
activities more effectively. The IIB’s database allows for information-sharing
on suspicious activities and can help insurers pinpoint fraudsters across the
industry through a shared identification system.
Training and Awareness
A key aspect of the IRDAI’s approach is building awareness and capacity within the insurance ecosystem. Insurers are required to conduct regular fraud-awareness programs, not just for employees but also for customers, to educate them about fraud risks and preventive measures. Additionally, insurers must provide targeted training for board members, management, and frontline staff, ensuring that all stakeholders are equipped to recognize and respond to potential fraud.
he Insurance
Regulatory and Development Authority of India (IRDAI) has introduced a
groundbreaking set of guidelines—the Insurance Fraud Monitoring Framework (IRDAI) Guidelines, 2024.. In a landscape increasingly shaped by digital transactions,
these guidelines are aimed at strengthening the insurance sector’s defenses
against fraud, building resilience, and maintaining public trust. This
framework is not only a response to the growing complexity of insurance fraud
but also a proactive step to empower insurers to protect policyholders and
preserve financial integrity. The IRDAI
is a statutory entity under the Indian government’s Ministry of Finance that
was created to monitor and control the country’s insurance market.
Recognizing Insurance Red
Flags
Given
below are various fraudulent offers which are clear red flags:
Returns – Insurance cannot offer
more than 6% return under any circumstances.
Interest-Free Loan is
offered –
no insurance company offers a loan on the paid premium. They offer loans on
Endowment products, i.e., 90% of surrender value, which is much less than the
paid premium by you. They also charge interest.
Gold Coin – No insurance
company is allowed to make any offer to the customer
Job assurance – once again no such
offer can be made
Recovery of money from
lapsed insurance –
there are no conditions. If your lapsed insurance has surrender value, then it
will be paid to you, you need not buy any policy for recovery
Insurance is sold as an FD
by the bank–
Insurance can never offer a higher return than fixed deposit. Moreover, FD is
one-time payment and Insurance requires premium commitment
A foreign trip – once again, the
Insurance company cannot lure a customer
IRDAI
understands and as a part of consumer protection offers a free look period of
15 days where you can return the product and take the premium back if you feel
that you have been cheated!
Happy Reading
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3. Insurance Sector & AML/CFT- India
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