Background and definitions

Key processes in money laundering and terrorist financing

Money laundering

Terrorist financing

Further differences between terrorist financing and classical money laundering

Suspicion recognition

BACKGROUND AND DEFINITIONS

In historical terms, even though banks and other financial institutions have been used by criminals since the dawn of modern commerce for hiding, transferring money and disguising their source of wealth, the emergence of money laundering and terrorist financing as a bank risk in its own right has been relatively recent.

One can distinguish between money laundering and terrorist financing risk on the one hand, and Know Your Customer (KYC) and regulatory risk on the other. The first is the risk that a financial institution will actually be used as a conduit for criminally derived money, or for money that turns out to have been destined for a terrorist purpose. The second is the risk that, without having actually handled criminal or terrorist funds, a financial institution will nevertheless be deemed to have been negligent or in some other way sub-standard in its adoption and enforcement of adequate policies and procedures designed to prevent actual usage of its facilities occurring.

This distinction is important because it impacts upon the reputational risks faced by financial institutions. Money laundering can be difficult to identify, terrorist financing even more so. Accordingly, the mere presence of criminal or terrorist funds within a financial institution will rarely be sufficient to attract censure or punishment. It must usually be accompanied by an individual or corporate failure in expected standards. The counterpoint is that, conversely, a failure in standards is usually sufficient to attract censure or punishment, along with attendant reputational damage, even without the actual presence of criminal/terrorist funds within the organisation, although clearly it will be much worse when both elements are present.

Source: http://www.gpo.gov/fdsys/pkg/CHRG-106shrg61699/html/CHRG-106shrg61699.htm

Compare this example with the situation involving those US banks that opened accounts for some of the 9/11 hijackers after they had arrived in the United States and were planning their attacks. The National Commission on the Terrorist Attacks upon the United States described their involvement as follows:

Source: National Commission on Terrorist Attacks upon the United States: Monograph on Terrorist Financing, Staff Report to the Commission p.140 (www.9-11commission.gov/staff_statements/911_TerrFin_Monograph.pdf)

The effect of this distinction is that financial institutions need to pay very close attention, in advance of any problems, to the issue of how their policies and standards (and just as importantly their adherence to those policies and standards) will stand up to scrutiny if it turns out that there is a problem subsequently.

KEY PROCESSES IN MONEY LAUNDERING AND TERRORIST FINANCING

Money laundering and terrorist financing bear many similarities, but there are some key distinctions.

With non-terrorist criminal money laundering, the funds in question always have a criminal origin. The process has been described as having three distinct phases:

• Placement: the moment at which criminally obtained money is first ‘dematerialised’ and put into the financial system (e.g. as a credit entry on a bank account).
• Layering: the movement of the money through a large series of transactions with no real economic purpose, in order to make it more difficult to prove the criminal origin of the funds and disguise ownership.
• Integration: the eventual use of the money for a genuine economic purpose (e.g. the purchase of a luxury item or a business capable of generating further profits from legitimate business activities).

With money laundering, the basic aim is to hide the criminal origin of the funds. The amounts in question are typically large and hence easier to detect. WWW (Note: a training film of the money laundering process can be previewed at http://www.antimoneylaunderingvideos.com/player/tew.htm.)

With terrorist financing, the key difference is that the funds passing through the financial system need not have a criminal origin, even though quite often they do. They can stem from a variety of different sources, many of them legitimate at the point of acquisition.

A particular feature of terrorist financing (and not just so-called ‘Islamist’ terrorist financing, but extending to other groups as well over the past few decades) is the use of non-profit, charitable, religious or cultural organisations as ‘cover’ for the passage of funds.

With terrorist financing, the basic aim is to hide the criminal purpose of funds. By the time funds have been designated and made available for a specific terrorist attack, the amounts in question are typically quite small and hence harder to detect.

The key differences between money laundering and terrorist financing processes are represented diagrammatically in Figure 1.1.

Perhaps the most important difference between the two is between the people who undertake each activity. Money laundering is done by criminals – particularly those involved in organised crime. Their goal is solely to enrich themselves, essentially the more the better. They are trying to wash as much money as possible through the system. Terrorists are different animals. One either deeply and genuinely committed to a religious, ideological or political cause, or brainwashed into believing they want to use the financial system only insofar as it assists in the funding of their campaign of violence. WWW (Note: a training film of the terrorist financing process can be previewed at http://www.antimoneylaunderingvideos.com/player/ftm.htm.)

MONEY LAUNDERING

Money launderers use various elements of the financial and commercial system for their activities.

Transportation and consolidation

This is basically the conversion of criminal cash into larger denomination notes. Large amounts of small currency (coins or notes) derived from crime are difficult to manage and very difficult to transport from one physical location to another. A smaller amount of large denomination notes is much easier to handle and can be more easily concealed if, for example, the money launderers want to smuggle it across borders to be laundered in other countries.

Customers who appear regularly to be exchanging large amounts of small currency units for much larger denominations and who do not appear to have any logical reason for doing this might well be cause for suspicion.

Placement

Placement involves the various methods used by money launderers to dematerialise their criminal money within the financial system.

One method involves the use of ‘smurfs’. The money launderer gives a sum of cash to an individual known as a ‘smurf’. The ‘smurf’ deposits the cash in small amounts into a number of different bank accounts, probably held at several different banks. The deposit amounts are small enough that they do not attract attention or suspicion. Once the money is deposited, the placement stage is complete. WWW (Note: a training film of this can be previewed at http://www.antimoneylaunderingvideos.com/player/smurfing.htm.)

A second method involves the use of ‘front companies’. The launderer selects company and business bank accounts belonging to apparently respectable, high net worth individuals. The money launderer gives a much larger sum of cash to these people. The cash is then paid into their accounts and, with the support of forged documentation, is explained as a legitimate receipt from the sale of a property or the sale of an interest in a business for example. Once the cash is deposited and the purpose of the transaction successfully explained, the placement stage is complete.

Any business that is cash intensive is useful, since it already handles large amounts of legitimate cash, and the criminal cash can be mingled with this and banked as if it were the legitimate proceeds of the business. Examples of cash intensive businesses include supermarkets, restaurants and jewellery shops. WWW (Note: a training film dealing with a front company account can be previewed at http://www.antimoneylaunderingvideos.com/player/red_flags_aml.htm.)

Yet another method involves the purchase of different types of insurance and investment policies for cash, through independent financial advisers or brokers who have persuaded themselves that the cash is of legal provenance. At a selected moment, the policy is surrendered and a redemption cheque or funds transfer is received from the issuer.

Ultimately, amounts so ‘placed’ in apparently legitimate accounts held by other people may then be transferred to a single account which acts as a conduit for the money as it is moved on elsewhere, as part of the layering process described below.

Layering

This is essentially the technique used by money launderers to process their money in such a way as to disguise its connection with crime. There are a number of possible examples:

• investment in financial products which have good liquidity and which can be bought and sold easily (e.g. unlisted stocks and shares)
• purchase and sale of real estate – apartments, houses, flats, commercial premises
• transfer of the money to a business, ostensibly as a ‘loan’ with documents such as loan agreements and receipts to support the illusion that the loan is real
• transfer of the money overseas or to other accounts under the guise of money destined for a specific purpose (e.g. education overseas of a family member)
• using fictitious business transactions to move money around (e.g. giving money to suppliers against invoices raised for goods that were never issued; or raising invoices to customers in respect of sales that never took place)
• transferring money to companies overseas in payment for non-existent shipments of imported goods
• use of shell companies and shell banks, i.e. entities that have no real function, no real place of business and no real business operations, but which exist in name only as a conduit for the receipt and distribution of money
• use of the international financial markets to buy and sell securities and move money across international borders.

Use of criminally owned or sympathetic investment firms and banks

Investment business and banking gives money launderers an opportunity to move large amounts of money into the international financial markets. The high turnover of such markets (customers might legitimately buy and sell many times in any one day) is useful in helping the money launderers to move their money around as much as possible.

Investment firms will legitimately transact very large volumes of purchase and sale deals in any one day. A criminally owned investment firm can, of course, use its business systems and resources to launder large amounts of criminal money through large-scale transactions.

Use of shell companies and shell banks within the overall laundering process

Shell companies have no purpose other than to act as a conduit for money. Money launderers will use shell companies as a vehicle for their money movements; as somewhere where money can be received and co-mingled with other funds, before it is transferred on to another destination.

Any activity which appears to have no real economic purpose should be an immediate cause for suspicion. Any activity which does not match your understanding of a customer’s likely needs and which does not seem plausible for that particular customer should also give you cause to be suspicious.

Integration of laundered assets into the legitimate economy and repatriation to the home territory

Once the proceeds of criminal activity have been transported, consolidated, placed and layered they will, by the end of the process, have all the appearance of legitimately earned wealth, which can then be integrated into the legal economy. This could be done, say, through an investment in a business that produces a legally earned dividend or in a work of art or other item of intrinsic value which can either be enjoyed for what it is or sold. Investment income or sale proceeds may now be repatriated back into the country where the crimes were committed, so that they are available there to the ultimate criminal beneficial owner.

At a certain point in a person’s life, he or she may decide to give up the criminal life, seek respectability and even political office, whereupon the powers of the state can then be used to legalise or pardon past acts and confer legitimacy on the criminal and those with whom he or she has consorted.

TERRORIST FINANCING

It is possible to discern two strands of terrorist financing, which occur at different ends of the chain shown in Figure 1.1. Type 1 terrorist financing refers to the financing of a terrorist movement over time, whilst Type 2 refers to the funding of specific attacks.

Terrorist groups such as Al-Qaeda, Jemaal Islamiyah, the Liberation Tigers of Tamil Eelam (the LTTE or ‘Tamil Tigers’) and the Provisional IRA have all used the financial and commercial system in similar ways to fund their activities.

Type 1 terrorist financing

The methods used to obtain, collect and/or disguise funds for terrorist movements or causes have included:

• donations from charities sympathetic to the terrorists’ cause (or possibly even set up by the terrorist group itself), or from charities whose administration systems have been infiltrated and ‘hijacked’ by terrorists who then divert legally obtained charitable donations to their own terrorist cause
• criminal activities including drug trafficking, people trafficking, gun running, counterfeiting operations, fraud, identity theft, etc.
• voluntary payments from ethnic diaspora (both legal expatriates and illegal immigrants)
• funds extorted from ethnic diaspora under threat of exposure to the immigration authorities or harm to their families
• legitimate business activities carried out by front companies, or ‘donor’ businesses sympathetic to the terrorists’ cause.

Type 2 terrorist financing

The methods used to fund specific terrorist attacks have included:

• ATM and credit card withdrawals on personal accounts – used to retrieve money from accounts in one country from a point of retrieval in another country
• use of the Hawala banking system, which is largely unregulated and as such allows for anonymous movements of money between jurisdictions
• physical importation of funds in cash or traveller’s cheques either by the terrorists themselves on arrival in a country of operation or via couriers
• use of company structures and commercial banking operations to transfer money across borders
• wiring of funds between accomplices in different parts of the world, either using their own accounts or those of sympathisers.

In a sophisticated financing operation, cash and proceeds from cheques, cash cards, gold, shares, policies, houses, cars, works of art and any number of items representing ‘value’ are collected into the accounts of charities, high street traders, other legitimate businesses, ‘front’ companies, ‘clean’ individuals, mosques, churches, import–export houses, art galleries etc. ready for onward transmission as invoice payments, investments, contributions, loan repayments, expense reimbursements, intra-entity transfers, salaries and dividend payments, all available for use or further onward movement as and when required. The full range of payment methods can be deployed from formal wire transfers, money transmission (e.g. Western Union), unofficial money transfer (‘hawala’ or ‘hundi’) schemes right through to the withdrawal of cash and its physical transportation via cars, boats, planes, rickshaws, pack animals or people.

Well organised groups will exploit synergies in the process. For example, throughout the 1980s the LTTE in Sri Lanka (which used to raise an estimated $50 million per annum from various sources) operated a fleet of tankers. The ships not only made profits on legitimate lading contracts, but were also used for smuggling the weapons once they had been purchased and for carrying illegal immigrants to foreign countries as another method of earning money to finance the campaign. Often, business activity and terrorism feed off each other in a mutually dependent relationship. Despite its periodic public slayings of ‘drug dealers’, the Taliban funded itself from Afghanistan’s poppy trade for many years. The Provisional IRA took over and ran profit-making taxi-cab businesses, and bombed Belfast buses and bus stations, ostensibly as part of its campaign of violence, but also to remove the commercial competition.

FURTHER DIFFERENCES BETWEEN TERRORIST FINANCING AND CLASSICAL MONEY LAUNDERING

As can be seen from the above, in its deployment of disguising activities to create the appearance of transactional legitimacy, Terrorist Financing (TF) has much in common with its elder sibling, Money Laundering (ML), but there are additional differences:

• The volume of funds involved. For serious money launderers handling the proceeds of serious crime, the amounts involved are very large indeed. Current estimates are that there are approximately $1 trillion in criminal assets hiding within the global economy at any given time. That is far more than is likely to be allocated towards the financing of terrorism worldwide. And whilst many terrorist groups are organised enough to collect very substantial sums running into tens of millions each year, not every attack is spawned from those funds. As the UK’s 7/7 bombers showed, a lethal attack on a transport system can be planned and funded well within the confines of an average monthly salary. This poses severe operational difficulties for those organisations (currently primarily banks and other ‘gatekeepers’ involved in financial services) charged with trying to disrupt the flow of terrorist funds through the financial system. In combating ML, systems are constructed to detect ‘suspicious’ transactions, where ‘suspicious’ tends to mean ‘unusual’, and ‘unusual’ tends (though not always) to mean ‘unusually large’. But as far as the funding of individual attacks is concerned, this approach simply doesn’t work. How do you detect an ‘unusual’ retail purchase or a ‘suspicious’ mobile phone bill?
• The status of terrorism (and hence terrorist financing) as a political issue. Subject to continuing arguments about legal details such as categorisation and mutual enforceability, to a large extent the world now recognises what a criminal is, what criminal money laundering is, and agrees that criminals and money launderers deserve to be caught, punished and stripped of their ill-gotten gains. This is not yet true of terrorism, for the basic reason that there is still no full international agreement on what a ‘terrorist’ actually is and on what constitutes ‘terrorism’. Whilst very few will promote or defend the concept of deliberately causing civilian deaths as a legitimate means of pursuing a cause, the old axiom that ‘one man’s terrorist is another man’s freedom fighter’ still applies. Consequently terrorist financing as an issue has a political ‘edge’ to it that money laundering does not. It makes it a much more sensitive and complicated issue for organisations and governments to deal with, especially in light of the invidious ways in which, in free societies, terrorist groups operate within what we may call innocent society.
• The extension of terrorist financing into innocent society. Non-terrorist criminals and terrorists tend to treat innocent society very differently. If you are not actually a criminal, if you do not live a ‘criminal lifestyle’ (basically spending lots of cash whose origins you can’t explain) and if you do not consort with criminals or seek their company, then other than through mistaken identity, you are unlikely to be thought of as a criminal by society at large. Moreover, other than in your designated role as victim, criminals themselves will most likely leave you alone. They are unlikely to try to recruit you to their cause, ask you to drive their getaway car, or request the use of your bank account to collect their cash before wiring it to an offshore haven. Not for nothing is it called ‘the underworld’ – a phrase aptly denoting the parallel yet separate existence of the criminal community.

The same isn’t true of terrorist financing. As has been described, serious terrorist groups committed to long-term operations will finance their activities using any means they can, and the national, ethnic or religious groups from which they are drawn – be they minority communities within specific countries or diaspora spread around the world – will often pay a heavy price for ‘the cause’. Many who detest the terrorists’ methods will still be viewed with suspicion and fear by wider society. Those who try to disassociate themselves and their families from any connection with terrorism often face pressure to support, to assist or to ‘get involved’ in some way, shape or form, with punishment or ‘discipline’, often invisible to the rest of society, being meted out to those who refuse to conform. And even when they seek to give charity for the support of their own community, whether at home or overseas, they risk the conversion of that most humane of acts into murderous purposes.

SUSPICION RECOGNITION

A critical requirement of financial institutions and others charged with responsibilities for the detection and prevention of ML and TF is that they report instances when they suspect that their facilities and services may have been used by their customers and clients for criminal purposes. But when should you be suspicious? We deal with this key question later in more detail, but for now let’s track the process of how suspicion might develop in a fairly typical, potential money laundering scenario using the example of the Pecunia Banking Corporation. In this fictitous example we will consider at each stage, and purely on the information presented, whether or not we are either ‘neutral’, ‘uncomfortable’ or ‘suspicious’ about this client.