Interrupting the Wash Cycle
Between February 2008 and June 2011, Pedro Navarro, Jr., 36, of Zapata, Texas, was involved in a drug trafficking conspiracy in which he helped a Mexican cartel arrange for the distribution of its marijuana and methamphetamine loads in the United States. Navarro pleaded guilty to these offenses in December, along with admitting to conspiring with others to launder the proceeds of his drug trafficking, putting the money from the drug sales back into the cartel’s hands. The case, the result of a three-plus-year investigation led by agents from the U.S. Drug Enforcement Administration and the Criminal Investigations Division of the IRS in conjunction with other agencies, is just one example of how money laundering fuels crime. Unfortunately, most such efforts go undetected.
Money laundering is exactly what it sounds like—a way to clean money by transferring it around so that its dirty beginnings become obscure and less traceable. The money can be from any illicit activity, from tax evasion to illegal trading to drug dealing and everything in between, and it can fund anything from legitimate business to terrorism. Law and regulations designed to catch money laundering have become more stringent since 9-11. For example, the Bank Secrecy Act (BSA) anti-money-laundering provisions were strengthened and the U.S.A. Patriot Act included anti-money-laundering sections. Other countries, such as Mexico, and international governance bodies, have also made efforts to crack down on these schemes. But criminals continue to launder money every day using methods both old and new.
Although more criminals are turning to technologically advanced laundering methods, traditional techniques, such as cash transferring and smuggling, are still effective and widely used. In fact, they still constitute a high proportion of the global money laundering efforts, according to the U.S. Financial Action Task Force (FATF), an intergovernmental organization formed to combat money laundering.
Structuring. One proven means of getting large amounts of cash into banks without triggering reporting requirements is called structuring. Structuring is the movement of money in certain patterns, rather than one bulk sum, so as to avoid having to report it to the government under BSA and IRS rules. Transactions of $10,000 must be reported in a Currency Transaction Report. Bank compliance departments are more vigilant about spotting structuring than they used to be, and now there are plenty of software programs that can flag suspicious patterns. But people still do it.
Shell companies. Another tool for money laundering that doesn’t appear to be going away is the use of shell companies. Shell companies do not necessarily have any actual business operations; they are often set up specifically for carrying out complex financial transactions designed to get around laws.
Kenneth Rijock is a former money launderer turned money-laundering expert who now consults with financial institutions. Rijock used to use shell companies in his money-laundering operations. He says he would form the companies and use them for only six months, then dissolve them before he would have been required to disclose more information about the companies.
He says regulators and officials have their “heads in the sand” and are not doing all they should do to clean up shell companies. “Plus we have all these sharp lawyers in the United States who are involved in minimizing taxes for wealthy individuals. So the wealthy individual forms a shell company, and he invests in hedge funds, which are all located in the Caymans, and there are a lot of transparency problems,” says Rijock. This proliferation of shell companies for tax dodges and even legitimate business purposes makes it even easier to have a shell company that’s for money laundering without it being obvious.
Rijock doesn’t think the use of shell companies for illegal purposes will stop in the United States until ownership disclosure is required. Senator Carl Levin (DMI) and Senator Chuck Grassley (R-IA) have proposed legislation that would require states to collect such information, but the bill had not passed at press time. When the companies exist outside of the United States, it is even more difficult to do anything about it.
Hawalas. Hawalas are informal arrangements for transferring or lending money. While it’s illegal in the United States to have an unregistered remittance business, the motivation isn’t always nefarious among those who use hawalas, who are often immigrants. But after 9-11, hawalas were thrust into the spotlight because al-Qaeda moved money through them.
Since hawalas tend to be run in “mom and pop” stores in communities, it’s not easy for law enforcement to discover them. And since hawalas aren’t always a nexus of large-scale criminal activity, they don’t always get priority treatment.
“One of the realities of all white collar crime is it has to look like a bigger priority than the other things that are in front of that law enforcement agency that day, and hawalas fall in the general category that white color crime does sometimes of being victimless. In other words, there’s no bloody victim standing in front of you,” explains Jonathan Turner, who is the managing director at Wilson & Turner Incorporated and author of Money Laundering Prevention.
“Really, the only thing that we’ve done about [hawalas] is force them to register as [money service businesses]. But what happens is you close them down, and they open up again the next day in a different location. They’re very difficult,” says Kevin Sullivan, who is a retired investigator for the New York State Police and director of the Anti-Money Laundering Training Academy.
Business exploits. Using front businesses and small businesses as money laundering vehicles are also still popular tactics. Some businesses are in on the scam, and some are just taken advantage of. “[Someone] might own a small jewelry store. And suddenly [a new customer] starts coming into the store on a frequent basis to buy jewelry, and he keeps buying jewelry at $9,000, $9,500, all under that $10,000 mark,” says Sullivan. A $10,000 cash deposit would have to be reported to the government. “And the business owner has to eventually start to wonder whether these transactions might be suspicious.
Sullivan notes that it is difficult for business owners to turn away that business, but they need “to go out and contact somebody to get some advice” about whether the transactions warrant a report to the authorities.
When a business has a sharp increase in deposits, banks tend to pay attention to that. Sullivan says the banks are often the ones who give the heads up to law enforcement about potential illicit activity in small businesses.
Money launderers, like all criminals, find ways to adapt to legal countermeasures intended to curtail their activities. “You can get out of the criminal business, which they don’t seem to like to do. Or you can get better at it, and that’s what they have done in spades,” says Turner.
Says Rijock: “When it becomes too difficult to work through the banks, they go to the Fortune 500 companies. When the Fortune 500 companies become too overregulated, they will go to the Ma and Pa [type companies]…. It’s like chess. They’re very good chess players.”
As anti-money-laundering reporting requirements have made banks a less attractive avenue, agrees Turner, launderers have moved to other types of businesses. And as large dollar transactions have become red flags, smaller increments have been used, he notes. “Fifteen years ago, you might have seen somebody moving millions of dollars at a time through a bank, now you’re much more likely to see somebody making purchases from a business in amounts of a few thousand dollars at a time,” says Turner.
And those nonbank businesses are more willing to be complicit in money-laundering operations because of tough economic conditions. So if a toy company gets approached by somebody who wants to hand over wads of cash for a large volume of teddy bears, the seller, who might have questioned that transaction in the past, will just go ahead with the sale, says Turner. “So, many businesses become involved in money-laundering activities not because they are criminal enterprises but because the economy has them running so tight that it’s very difficult to turn [those sales] down,” he says.
The other problem with efforts to fight money laundering is that criminals can be more nimble than the legal process. As criminals figure out new ways to exploit technology and businesses, it takes a while to pass legislation that will address those new tactics.
So law enforcement is at a disadvantage. It’s unlikely that companies will opt on their own to spend extra money on compliance, due diligence, and monitoring when they’re not required to do so and are not at risk of a federal fine.
Virtual world. The most pervasive trend, highlighted in the latest FATF money-laundering report, is the movement into digital currency and other noncash technology.
Prepaid debit cards. Prepaid debit cards or payment cards have become a more popular choice for money launderers in recent years. They provide anonymity, and they have been exempt from currency reporting laws. Now when one travels from one country to the next with them, it’s almost like carrying cash but you don’t have to report it.
In an effort to curb the use of prepaid cards for money laundering, the U.S. Financial Crimes Enforcement Network (FinCEN) recently issued new rules that impose suspicious-activity reporting and record-keeping requirements on certain prepaid cards, including high-value ones that are most vulnerable to use by money launderers.
E-currency and digital transfers. The FATF report spotlights e-currency services as a growing concern. E-Gold was a very high profile e-currency service company that was hit with a money-laundering conviction a few years ago. The ability to transfer the money digitally and anonymously without going through a bank proved an attractive service to money launderers. The founder and senior directors at E-Gold pleaded guilty to money-laundering charges, and the case has been held as an example to digital-currency providers that they must comply with federal anti-money-laundering regulations.
There is an upside to the use of these systems when they are detected by law enforcement, says Carol Van Cleef, partner at Patton Boggs LLP, who is counsel to E-Gold, which has not been in operation for about three years. “With these closed online payment systems, law enforcement can glean much more significant information out of them than what they can get out of the banking system, which often cannot follow the flow of value beyond the first transaction and serves as a point of entry for cash, which by its nature is anonymous,” she explains. “For example, if you have E-Gold, and you wanted to give me some E-Gold, it happens within that E-Gold system, and E-Gold will see both sides of the transaction and even where the E-Gold goes after I get it.”
Third-party processors. Third-party payment processors are nonbanks that provide payment processing services to small businesses and merchants. The payments include credit, debit, and wire transactions, among others. While the processors themselves aren’t banks, they tend to use banks to process the payments, according to the Federal Financial Institutions Examination Council (FFIEC).
Because these businesses are not banks, they are not subject to the same money-laundering regulations as banks. Therefore, they offer money launderers a way to cloak themselves from the banks.
The third-party processor may or may not know that it is dealing with a money launderer. If a payment processor does not verify merchant identities, the fraud risks and money-laundering risks increase. The banks can end up on the hook.
In 2010, for example, Wachovia Bank (now a division of Wells Fargo) agreed to pay more than $160 million to settle a case that alleged it had laundered Mexican drug money. Wachovia admitted failure to detect suspicious activity in third-party payment-processor accounts.
“I can’t tell you how many banks in the country use in some way or other a third-party payment processor for some aspect of their business, especially the smaller organizations. But you will also find many banks providing third-party payment processors with bank accounts and other banking services; banks provide that gateway into the payment system for the third-party payment processors,” says Van Cleef.
Bank accounts are potential vehicles for money laundering, terrorist financing, and other crimes, especially if you do not know your customer’s customer, says Van Cleef. Baseline due-diligence protocols have evolved as banks have become more aware of the vulnerabilities inherent in these accounts, she says.
“To the extent that [parties] are identified as third-party payment processors, the banks are urged to possibly do more due diligence and understand better who the third-party payment processor’s customers are; and then also to monitor the account more closely in terms of funds in/funds out, the nature of those products, and services being used,” says Van Cleef.
Near field communications. Another new technology for transferring money that money launderers are adopting is called near field communication (NFC). NFC allows for data exchange on two devices, such as two iPhones, that are in proximity to each other.
“In the modern money-laundering world, what you have is two guys standing on a corner texting each other. And the one guy texts the locker codes for the drugs at the locker around the corner, and the second guy texts the money from one phone to the other. What do the police see? The police see two people standing on a corner texting. They have absolutely no probable cause to arrest anybody,” says Turner.
That’s a sharp contrast to the old days when criminals would have to surreptitiously hand off briefcases full of cash, notes Michael Hearns, an anti-money-laundering consultant.
Countering new tactics as criminals adapt them is never easy. As mentioned earlier, it takes awhile for the legislation to catch up to the new money-laundering practices. It also takes time for law enforcement and others to change their mind-set.
“We’re still chasing cash at the same time as...our money launderers are learning not to use cash,” says Turner, who points out that it can also be difficult to differentiate between legitimate digital transactions and illegitimate ones.
Progress, however, is being made. Compliance departments and detection mechanisms have become more robust in the past decade. There are now many of government databases to help with due diligence, and there are services like International Trade Alert that can help curb money-laundering attempts on trades.
But this progress is always at risk, because compliance officers face internal pressures. They are considered a cost center for the bank, says Dennis Lormel, president of DML Associates LLC and former FBI special agent. Additionally, Rijock points out that due to the bad economy, there may be internal strife in the bank when compliance officers become suspicious of accounts.
Global efforts. The global movement to curb money laundering has led to increased scrutiny on tax havens. At a recent Group of 20 summit meeting, the attending countries approved an agreement which was developed by the Organisation for Economic Co-operation and Development and the Council of Europe that is aimed at making countries be more transparent about who financial institution account holders are.
At the summit, world leaders placed pressure on Switzerland and other tax havens. Switzerland is known for being secretive about its bank account holders and has been refusing to subscribe to an automatic exchange of information that the United States and other nations have been demanding.
It’s not just about money laundering. Tax evasion has been a driving force as well. In one high-profile case, a former UBS AG banker admitted to helping wealthy individuals cheat on U.S. taxes through Swiss bank accounts, and he assisted the U.S. government in cracking down on other such bankers. The recent attention on tax havens like Switzerland has “created a tsunami, because the smaller tax haven countries and the rest of Western Europe are now knuckling under…. It’s showing that the United States is not just going to sit around anymore and watch people hide all their cash,” says Rijock.
Assessing the true level of progress globally or domestically, however, is difficult. The FATF does not provide an estimate of how much money is laundered annually, due to the inability to know how much goes undetected. And it points out that even though more laundering may be detected each year, it may be just that banks and law enforcement and others are getting better at catching it.
The only certainty is that money launderers will persist in seeking ways to beat the system. As Rijock says, “In the world of money laundering, you’re only limited by your imagination.”