MONEY LAUNDERING

By Team YS|16th Feb 2009
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Introduction

Money laundering is a practice which engages in specific financial transactions, in order to conceal the identity, source, and/or destination of money. It is the main operation of underground economy. The Interpol General Secretariat Assembly in 1995 defines money laundering as: "Any act or attempted act to conceal or disguise the identity of illegally obtained proceeds, so that they appear to have originated from legitimate sources". The conversion of criminal incomes to forms, that allows the offender unfettered spending and investment has been an ongoing concern to the law enforcement agencies.


After the attack on the twin towers in the U.S., the world has focused its attention on the entire concept of money laundering and has recognized it as a source of funding of terrorist activities.As per an estimate of the International Monetary Fund, the aggregate size of money laundering in the world could be somewhere between two and five percent of the worlds gross domestic product. This could be between $800 billion - $2 trillion each year. Thereby, all over the world, the need has been recognized to control this form of illegal activity, which involves the misuse of financial systems all around the world.


Money Laundering: Basic Concept

Money laundering is the process, by which, large amounts of illegally obtained money is given the facade of having a legitimate source. Earlier the concept of money laundering was associated with organized crime alone.However in recent times, the ambit of money laundering operations has dramatically increased.


The concept of money laundering originated in the U.S.A. It started with the attempt to disguise the ill-gotten wealth, obtained from trading in alcoholic beverages. American mobster Meyer Lansky transferred funds from small casinos to overseas accounts, especially Swiss banks, the term used for such activity is, 'capital flight'. The first reference to the term, 'Money Laundering' itself appeared during the Watergate scandal. Here illegal funds obtained for the president re-election were moved to Mexico and then brought back through a company to Miami. In this context the British newspaper coined the term 'Laundering'. 


The negative economic effects of money laundering on economic development are difficult to quantify, yet it is clear that such activity damages the financial-sector institutions that are critical to economic growth, reduces productivity in the economy's real sector by diverting resources and encouraging crime and corruption, which slow economic growth, and can distort the economy's external sector—international trade and capital flows—to the detriment of long-term economic development. Developing countries' strategies to establish offshore financial centers (OFCs) as vehicles for economic development are also impaired by significant money-laundering activity through OFC channels. Effective anti-money-laundering policies, on the other hand, reinforce a variety of other good governance policies that help sustain economic development, particularly through the strengthening of the financial sector.


The most important objective of Money Laundering activities are covering up of the factual ownership of illegitimately procured money and placement, layering and integration of such funds. Through money laundering, the launderer transforms the monetary proceeds derived from criminal activity into funds with an apparently legal source. 


There are three independent steps or stages in Money Laundering as shown below:

  • Placement: It refers to the physical disposal of bulk cash proceeds derived from illegal activity.
  • Layering: This term refers to the separation of illicit proceeds from their source by creating complex layers of financial transactions. Layering conceals the audit trail and provides anonymity.
  • Integration: It refers to the re-injection of the laundered proceeds back into the economy in such a way that they re-enter the financial system as normal business funds. 

The 'Hawala' mechanism is amongst the original sources of money laundering. 'Hawala' is an Arabic word connoting the transfer of money or information involving two persons using a third person. Hawala is an effective, efficient system of remitting money.It implies more profit to the parties involved. A hawala transaction can be completed within a day or two and is free of bureaucratic control and other hassles. Essentially the system is based on trust, and proper links and connections between people. The third party in this transaction has to be trusted in order to make such transactions a success. The Hawala system offers better opportunities for placement, integration and layering of illegally earned money and hence is usually considered to be a better system of money laundering. It is has been usually found that such a system is impossible to trace.


Money laundering is thus a substantial effort and obscures the illegal source of money. Launderers for starters, find a bank in a foreign country which does not have very strict banking laws. They strike deals with such banks and then obtain some property discreetly. Later on, the funds are re-routed back to the country as legal money. Nowadays wire transfer systems are being used to make risk free transfers of money from one country to the other. Such money is basically used to prop up illegal activities such as smuggling, terrorist activities etc.


Thus it has been seen that banks have become a chief end of Money Laundering operations and monetary crime because they are endowed with a range of services and instruments that can be used to cover up the source of money. With their refined, coherent and beguiling behavior, Money Launderers attempt to make bankers relax their guard so as to accomplish their purpose.


There can be different sources of laundering and hiding the source of money. Most countries require, transactions above a certain limit to be reported by the banks or financial institutions or organizations. If a person earns money in small change, but above the limit that needs to be reported, he can use a person already involved in heavy cash transactions to deposit his amount and not get caught in the process. Another method involves establishing a business whose cash inflow cannot be monitored, and funneling the small change into this business and paying taxes on it.


The different methods which can be termed suspicious and indicative of money laundering operations include:-

  • Crooked / Doubtful Transactions related to Money Laundering - Customers depositing cash through a large number of cash deposit slips into the similar account or customers having plentiful accounts into which large cash deposits are made. Each deposit is such that the quantity thereof is not noteworthy but the collective of all credits is ample. This is known as "smurfing".
  • A considerable boost in earnings in a sleeping account or large cash withdrawals from a formerly sleeping or immobile account, or from an account that has received an unforeseen large credit from abroad
  • Receipt or payment of big sums of cash, which have no clear rationale or connection to the account holder and / or his business
  •  Disinclination to offer standard information when opening an account or providing negligible or untrue information
  • Depositing high value third party cheques authorized in favor of the customer or other transactions on behalf of non-account holders
  • Abrupt amplification in cash deposits of an entity with no explanation
  • Employees leading sumptuous ways of life that do not match their known sources of income

Money Laundering today, poses a major challenge to countries all over the world and thereby there have been international attempts to curb this problem of money laundering. 

 

International Attempts to Curb Money Laundering

Keeping in mind the gravity of the problem, the Committee on Banking Regulations and Supervisory Practices was formulated at a meeting in Basle in Switzerland, in December 1988.It evolved a set of principles to address the dangers posed by Money Launderers. These principles deal with the prevention of criminal use of the banking system for the purpose of Money Laundering. Recommendations for banks and other financial institutions have been set out in the Basle Principles so that these institutions can protect themselves against Money Laundering. The Basle Statement of Principles covers all aspects of laundering through the banking system.


The Basle Principles suggest policies and procedures in four areas to curb Money Laundering as shown below:

  • Customer Identification - This re-emphasizes the wise saying 'Know Your Customer'(KYC). KYC necessitates that banks should make sensible pains to settle on the customers true identity, and must set up successful measures for verifying the bona fides of new customers
  • Compliance with Laws - The rules and regulations pertaining to financial transactions as performed in different Banking related statutes, must be experimented. Banks should not tender services or make available dynamic aid in case of transactions where they have  superior reason to assume that these are linked with Money Laundering activities
  •  Cooperation with Law Enforcement agencies - Banks should combine forces fully with national law enforcement authorities to the degree permitted by precise local regulations regarding Customer privacy
  • Adherence to the Statement- Holding fast to the Statement entails that banks need to adopt policies that are unswerving with the Statement and guarantee that all staff members are well-versed of the bank's policy in this regard. Some chief factors in supporting loyalty to the Statement of Principles are staff training and putting into practice definite procedures for customer identification and keeping hold of in-house records of transactions.

The Basle Principles set out an effective guideline for what banks and financial institutions should do to cope with Money Laundering. 


FATF on Money laundering


The international response to the underground economy has been coordinated by the Financial Action Task Force on Money Laundering ("FATF"), whose original 40 principles form the basis of most international responses to money laundering activity. Compliance with, or a movement towards compliance with, these principles is now seen as a requirement of an internationally active bank or other financial service entity.This intergovernmental body facilitates the development and promotion of policies, both at national and international levels, to combat Money Laundering. While reviewing Money Laundering techniques and counter-measures, the FATF monitors member's progress in implementing anti-money laundering measures. The FATF also collaborates with other international bodies involved in combating money laundering. All countries are also required to conform with the recommendations made by the FATF. The countries are to be monitored and evaluated with respect to international standards. Such monitoring is to be done by the FATF as well as by the World Bank and the IMF. These are vital mechanisms to ensure that countries conform to the recommendations laid down by these bodies.


UN Convention and Security Council Resolution


The UN Convention for the Suppression of the Financing of Terrorism was proposed on December 9, 1999, which was open for signature from January 10, 2000 to December21, 2001. Prior to Sept. 11, only 41 member nations had signed it but soon after 9/11 more have done so. The Convention required ratification by 22 member nations, which was lacking at the time of Sept.11. Only subsequently, the Convention has entered into force on April 10, 2002. The Convention has a major shortcoming, as it does not provide for a monitoring agency to oversee enforcement of the Convention.


EU Directive of 2001 and Paris Declaration of 2002


The European Union too has issued a new Money Laundering Directive in December 2001to amend its earlier Directive of 1991, which already contained strong anti-money laundering measures which required financial institutions to know their customers, maintain appropriate records and establish anti-money laundering programmes. The Directive of 2001 extends coverage to bureaux dechange, money transfer companies and investment firms. Definition of 'criminal activity' is also expanded to cover not only drug trafficking, but also all serious crimes including corruption and fraud against the EU. The Directive significantly brings within its ambit of lawyers, auditors, accountants, tax advisers, real estate agents and notaries when they participate in the movement of money for their clients. They have to now report to the authorities of any transaction that indicates laundering of money.


February2002 saw a meeting of lawmakers at the conference of EU parliament's against money laundering at Paris. The resultant 30-point Paris Declaration called money laundering "a major threat to democracies" and "a perversion of international financial circuits". It also equated the need to combat money laundering with that of fighting terrorism and called both as "equally urgent tasks". The Paris Declaration calls for drastic steps such as banning business dealings with countries on the Financial Action Task Force (FATF)'s list of "non-cooperative countries and territories" (NCCTs). The Paris Declaration also recognises that money laundering and related crimes transcend national borders and therefore suggests steps to plug loopholes and increase legal, police and administrative cooperation between states to cut off money supply to terrorists.


Legislation in U.K.


The 'money laundering' legislation in the U.K. is, Proceeds of Crime Act 2002 (PoCA).This a legislation is wide in its ambit and encompasses mere possession of criminal or terrorist property as well as its acquisition, transfer, removal, use, conversion, concealment, or disguise. In the UK 'money laundering' need not involve money alone, it could include all forms of tangible and intangible property. There is no lower limit to what has to be reported by people, a suspicious transaction involving a single £5 note may be required to be reported. All persons are technically required to report, and obtain consent for, their own involvement in crime or suspicious activities involving money or assets of any kind. So in the UK a thief who steals a vest from a clothes store commits a 'money laundering' offence because he has possession of an asset derived from crime. He is technically required to seek consent from law enforcement for his continued possession of the vest if he is to avoid risk of prosecution for 'money laundering.' The UK legislation also creates a money laundering offence where a person enters into, or becomes concerned in, an arrangement which facilitates  the acquisition, retention, use, or control of criminal property by another person. This has impacted upon lawyers and other professional advisers in the UK who act for a client whom they suspect may possess criminal property of any kind.The UK legislation was relaxed slightly in 2005 to allow banks and financial institutions to proceed with low value transactions involving suspected criminal property without requiring specific consent for every transaction, yet the reporting of these transactions is still required.


U.S. Legislation


The Money Laundering Control Act of 1986, in the U.S. made money laundering a federal crime. In the United States, Federal law provides that," Whoever knowingly conducts or attempts to conduct a financial transaction, which in fact involves the proceeds of specified unlawful activity with the intent to promote the carrying on of specified unlawful activity shall be sentenced to a fine of not more than $500,000 or twice the value of the property involved in the transaction, whichever is greater, or imprisonment for not more than twenty years, or both." . The US Congress passed the USA Patriot Act of 2001 within 43 days of Sept.11, October 26, 2001. This Act made as many as 52 amendments to the existing Bank Secrecy Act of 1970 (BSA). The scope of these new provisions touched every financial institution and business not only in the US, but also in most of the world. One of the changes made in the BSA requires every financial institution to establish anti-money laundering programmes


Money Laundering in India: The Problem and Solutions


In India, money laundering is largely connected with drug trafficking. The alternate remittance systems such as the Hawala transactions are used effectively for this very purpose. Offenders ensure that money doesn't reach the banking systems at all, so that they can escape being caught or discovered. The easy route here is usually the underground banking system which leaves no paper trial. These systems are based on trust and the fear of retribution. Such systems are based on family and gang alliances and have been found to be difficult to penetrate. People here deposit money in one country and are given a 'chit' or a 'seal'. On production of this 'chit' or 'seal' money is remitted to the person concerned.


Moreover now with the liberalization of the Indian economy and the dismantling of various regulations, increasingly the risk of money laundering via banks has increased tremendously. The impact of money laundering in India is substantial, the Union Revenue Department recently unearthed 900 bank accounts, with a pooled deposit of nearly Rs. 1,000 crore being run with fabricated names of companies and persons in two dozen banks of Delhi alone. According to a KPMG study money laundered in India is approximately 2% to 3% of the country's GDP.


While adopting the political declaration and global programme of action of the Resolution S-17.2 of 1990 and political declaration to adopt the national money laundering legislation and programme in 1998 by the General Assembly of United Nation, India enacted Prevention of Money Laundering Act, 2002. The Money Laundering Act defines the offence of money laundering as any activity connected with the 'proceeds of crime' which in turn is defined as any property or value of such property derived as a result of criminal activity relating to a'Scheduled offence'. The schedule to the Act is in two parts. Part A lists waging of war against the government of India (Sections 121 and 121A of Indian Penal Code) and several offences under the Narcotics Drugs and Psychotropic Substances Act, 1985. Offences listed in Part B have now been subjected to a monetary limit of Rs. 3 million or more which was not there in the original Bill. There has been much concern about the terror funds coming into country. In addition to that it is also widely believed that the stock market can also be potential investment destination for terrorist groups. In absence of the adequate laws and enforcement mechanism in place, it is difficult to trace the source of money coming into the country and going outside from the country. Given the above context, anti money laundering laws and regulations assumes utmost significance. Prevention of Money Laundering (amendment) Bill , 2008 (PMLA) is yet another mile stone in the wide spectrum of anti-money laundering initiatives by government of India. Minister of state for finance Pawan Kumar Bansal on Friday (18 October, 2008) tabled a bill to amend the Prevention of Money Laundering Act, 2005 (PMLA) in Rajya Sabha. This Bill introduces new category of offences that have cross-border implications for fighting terrorism. Insider trading and market manipulation will be treated as a laundering offence and invite stricter punishment. Offences related to human trafficking, smuggling of migrants, piracy and environmental crimes, over invoicing and under invoicing under customs are also punishable under PMLA. With the passing of Prevention of Money Laundering (Amendment) Act, all casinos, payment gateways like Mastercard, Visa and Western Union and even Credit Card deals will be monitored by law. These organizations will be required to report details of all suspected transactions to the government.


The substantive law aspect of the act seems less well developed, compared to the US Patriot Actor the EU Directives, the crimes included under the money laundering are fewer. Significant omissions in the Schedule of Money Laundering Act to the new law are lack of any references to offences relating to tax evasion, smuggling, foreign trade law violations and foreign exchange manipulations on account of these offences. Proceeds of crime relating to these offences, therefore, will remain outside the scope of the Money Laundering Act. It will be the case also with Schedule B offences if the amount involved in a case is less than Rs 3 million. It is also somewhat incongruous that large-scale manipulations of foreign exchange, let us say arising out of tax evasion or import/export violations, will be mere civil offences under FEMA and will attract no penalty under the anti-money laundering law, yet the same can lead to preventive detention under COFEPOSA. Though the Money Laundering Act has been passed, but the rules to effect its operations are yet to come.


The RBI too has played an important role in curbing the menace of money laundering The RBI issued the Know-Your-Customers (KYC) Guidelines – Anti Money Laundering Standards on 16th August 2005. The Government has also established a Financial Intelligence Unit-India (FIU-IND), in rank with FATF recommendations. The FIU would be given the Suspicious Activity Reports from all FIs and would study them before passing them to the Enforcement Directorate for investigation and prosecution. The RBI has asked all the banks to put the policy with the sanction of their boards, within the next three months. The RBI has stressed that banks can successfully control and decrease their risks only if they have an understanding of the normal and practical activity of the customer so that they have the means of spotting transactions that fall outside the standard model of activity.


In the context of internet banking, there is always a danger that being extremely mobile, these transactions shall remain undetected. Thereby such banks have been asked to open accounts only after proper physical introduction and substantiation of the customer. The online banking systems are also required to keep a record of all the transactions or series of transactions taking place within a month, the character and worth of which may be set by the Central Government. This will sufficiently guard in opposition to any abuse of the Internet banking services for the intention of money laundering.


The RBI's know your customer standards are important in the context of controlling money laundering. As per these standards Banks must outline their KYC policies slotting in the following four key fundamentals:

  • Customer Acceptance Policy;
  • Customer Identification Procedures;
  • Monitoring of Transactions; and
  • Risk management. 

Despite the various measures that have been undertaken it has to be understood that India's anti-money laundering regime is still in its early stages and banks need to put in place, better systems to ensure they do not fall prey to misuse. Banks can effectively reduce the risks of banking transactions if they identify transactions that fall outside the regular pattern of consumer's activities. Banks need to have an effective anti-money laundering technology system. These have yet to be effectively implemented in the country.


Conclusion 


Money laundering is a serious threat to global financial system and good governance. It is also boosting international crimes and terrorist activities. Governments in various countries today have come up with different legislations to deal with this menace. However more needs to be done in this regard. Black money in India, it is estimated accounts for around 40% of India's GDP. Moreover it is politicians in India, who are high risk customers who indulge in this activity.


In times of globalization, Indian financial institutions and banks would like to become important players in the financial setup. This could be achieved only by ensuring that proper prevention of money laundering norms are in place and have been setup effectively. In the absence of these norms it is likely that the indigenous institutions and banks shall be black listed by the foreign countries. Thereby there is a need to not only effectively implement the anti-money laundering operations, but also to ensure that there is a constant review of the anti-money laundering (AML) programme and timely up gradation as well. Banks need to strictly adhere to the Know Your Customer (KYC) Guidelines, setup by the RBI. 


Syed Burhanur Rahman, Attorney, New Delhi.


Syed Burhanur Rahman is an alumnus of St. Stephen's College and Campus Law Center, Delhi University. A Quiz aficionado, he has featured in premier T.V Quiz shows including Mastermind India(BBC),University Challenge Quiz(BBC) and Nat Geo Genius Quiz (National Geographic Channel).An Attorney working with INDUS G & D Law(Delhi),his practice areas include Corporate Law, IPR and Taxation Law . 

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