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Chapter 7Money Laundering and Transnational Financial Flows

CHAPTER SUMMARY

Overview

The purpose of this chapter is to learn how money laundering occurs and to determine whether anything canbe done to trace it and prevent it,

Money Laundering: An IntroductionThe traditional money laundering process can be divided into three steps. First, the money is deposited in a bank

or financial institution. Second, a set of complex transfers is made to disguise the original source for the money andto hide the audit trail. This is called layering the transactions. The final step is integrating the money back into thelegitimate money supply. Not all processes would follow this order, depending on the specific situation.

17001 Legal and Illegal LaunderingA definition of money laundering that covers both legal and illegal contexts is to take money that comes from

one source, hide that source, and make the funds available in another setting so that the funds can be used withoutincurring legal restrictions or penalties.

The primary purpose for money laundering is to make the funds spendable in a context that would have beenunavailable otherwise. Consequently, the definition extends money laundering activities beyond the realm of drugdealers and criminals. It is possible to find accounting practices used within legitimate businesses and governmentsthat closely follow the techniques used by international drug dealers to conceal the source of funds.

1)7011 Cybercash Creates New Laundering OpportunitiesIn the very near future, using the Internet, it will be possible for anyone to transfer large sums money from one

location to another without using a bank and with the transfers being totally anonymous. Today, cybercash transactionsare beginning to take place without the need for third parties and the consequential scrutiny that might otherwise exist.Furthermore, cybercash transfers can be structured so that they originate in a jurisdiction where such activities are notconsidered illegal.

117021 Who Uses Money Laundering Practices?No list can contain all the examples of those who would use the techniques of money laundering. It should be

remembered that the reason for money laundering is to convert resources into a format that makes them usable to theirrecipient.

Grant Recipients. In recent years, a number of universities were caught using methods to convert federal grantmonies into discretionary spending.

Criminals. Many crimes, if successful, have the potential to generate large pools of money whose origin cannotbe explained, thus prompting the use of money laundering procedures.

Political Asylum Seekers. People persecuted for religious or ethnic reasons within a specific country may needhelp in escaping from that country as well as help in taking their personal wealth with them.

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82 Forensic and Investigative Accounting

Financial Institutions' Role in Money LaunderingInternational banking plays a role in identifying money laundering activities, but it also plays a role in creating

an environment where money laundering can exist.

17031 Correspondent Banking

International banking is interrelated with a series of correspondent and respondent banks that allow for the 24-hour transfer of cash to and from any point in the world. Correspondent banks have relationships with thousands ofother banks around the world, and large money center banks can process up to $1 trillion in wire transfers per day.

Correspondent banking takes place when one bank provides services to another bank to move funds, exchangecurrencies, and access investment services such as money market accounts, overnight investment accounts, CDs,trading accounts, and computer software for making wire transfers and instant updates on account balances. Anotherservice provided by foreign respondent banks to their clients through these correspondent-banking relationships is apayable-through account. Such an account enables the respondent bank's clients within the country where the bankis registered to write checks that are drawn directly on the respondent bank's correspondent account in the UnitedStates.

1)7041 Tools Banks Use to Identify Money Launderers

Banks do attempt to identify those individuals who might be laundering money at the point where illegal moneyenters the banking system. Banks have purchased software that allows them to monitor account transactions andidentify suspicious activity.

At a minimum, banks are supposed to have a set of policies and controls, a compliance officer, employeetraining, and independent audits to test their programs. Further, the U.S. Department of the Treasury requires banks tofile Currency Transaction Reports (CTRs) about transactions above a specified dollar amount—currently $10,000—and Suspicious Activity Reports (SARs) for transactions as noticed by bank personnel.

1)7051 Due Diligence Laws for Banks

Laws and regulations require that a bank perform due diligence in its relationships with other banks and importantclients as well as continually monitor account transactions. Within banks, due diligence must co-exist with the client'sneed for privacy and the secrecy laws existing in many foreign jurisdictions that prevent access to bank documents.

17061 Shell Banks

Shell banks are generally high-risk banks that exist without any physical presence in any legal jurisdiction.These banks have a banking license in a specific country, but they are not likely to have a staff and may be operated aspart of another business or operated out of an individual's personal residence. Shell banks are usually not subjected toany scrutiny by banking regulators. These banks should not be thought of as branch banks without a physical presencein a country and affiliated with a home-country financial institution.

Offshore banks are slightly different than shell banks, although neither is mutually exclusive from the other.An addition to an offshore banking license prevents the organization from transacting banking activities with anycitizens of the licensing jurisdiction or transacting business with the currency of the licensing jurisdiction. These bankoperations solely exist within international financial transactions.

Both shell and offshore banks provide nested correspondent services where a foreign bank's private clientsuse U.S. correspondent accounts. Today, respondent shell and offshore banking operations can be entirely Internet-based.

Other Businesses' Role in Money LaunderingBusinesses besides banks are affected by money laundering activities as money launderers look for ways to

legitimatize their cash collections. Small businesses also can be used to launder money. Businesses that typicallyreceive large amounts of cash are especially vulnerable to infiltration by money launderers.

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17071 Cash-Oriented Businesses

Businesses with large amounts of cash sales include vending machine companies, taxicab companies, car washes,currency exchanges, nightclubs, bars, restaurants, real estate agencies, travel agencies, casinos, online auctions, andbrokers. All these businesses are attractive operations for money launderers. By acquiring or investing in one or moreof these businesses, a money launderer can identify a legitimate source of cash receipts, and with businesses such asa tavern there are no sales invoices to falsify.

Currency Exchanges, With a currency1 exchange, the large amounts of cash flowing through in wire transfersprovides an easy means to convert criminal proceeds into legitimate money. All documentation can be falsified,making it difficult to prove that these operations are not legitimate business transactions.

Online Auctions. An online auction provides another good way to launder money into legitimate cash whenitems are overpaid for an auction site. Overpaying for the item, listed on the auction site by confederates shuts outother buyers except for the launderer. The seller of the item receives the money, through PayPal, for example, and thetransaction is legitimized at that point through the sham sale.

Casinos. Money launderers use casino gambling as a way to launder money. There are a number of techniquesto launder money through a casino. The simplest method is for the money launderer to take cash into the casino andbuy gambling chips, A few small normal bets are placed and afterward when the launderer leaves the casino, the bulkof the chips are redeemed at the cashier's cage.

Purchasing Departments. Even normal business purchasing activities can be easily converted into a moneylaundenng operation. By setting up a retail computer company in a country outside the United States, the meansare provided for laundering money overseas and back into the United States. Assume that large-scale purchases ofcomputer equipment are made in the United States with money that has been placed in the banking system throughsmurfing. Smurfing is a money laundering technique in which confederates of the money launderer deposit randomamounts of less than $10,000 into variously named accounts at a number of different banks. The equipment is thensent and sold overseas below cost. At the point of sale, the money has been legitimized.

Credit Cards. Credit cards are another means to launder cash. Credit cards are used to legitimatize cash bymaking prepayments on the cards and transferring the cash into a country other than the one the where the illegal cashwas generated.

17081 Audit Trail for Business Money Laundering Schemes

The more transactions through which illegal money can be churned, the more difficulty one has in followingand identifying the audit trail. The more countries through which the money can be transferred (especially targetingthose countries with strong bank secrecy laws), the more difficult the money trail becomes to follow.

Finding Money Laundering Schemes

17091 Likely SourcesUnder most money laundering schemes, the traditional paper trail only exists in a fraudulent form. In other

words, the audit trail exists to convince investigators that the sources of cash are legitimate. Support for the fraudulenttrail can be complete through the warehousing of inventory items, false purchase orders, false sales invoices, ghoststaffers, etc. Once this fact is realized, one must realize that traditional methods of following the paper trail are onlygoing to be successful when the falsified audit trail is weak or not properly maintained. Certain areas that are moredifficult to falsify and may provide a more reliable source of information for forensic investigators who are trying totrace a money laundering scheme are: web logs, wire transfers, and bank reports.

Identification Through Web Logs. Although web logs and wire transfers are not 100 percent reliable, theyare more reliable than the falsified books maintained by a criminal enterprise. Log data of particular interest to theforensic investigator includes the IP address, user name and password (if used), GMT time adjustment, files requested,and the URL where the visitor was. This information potentially can identify and trace the person using the site.

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84 Forensic and Investigative Accounting

Identification Through Wire Transfers. With both wire transfers and EFTs, there is a great deal of informationlogged about these transactions. Depending on the logging system, different information can be retained.

Identification Through Bank Reports. The mandatory information on a Fedwire transfer is• The receiving bank's nine-digit American Bankers Association (ABA) number• Type/subtype classification: regular transfer

• The sending bank's nine-digit ABA number

• The dollar amount of the transfer• Name of the originator of the transfer

Guarding Against Money LaunderingToday every business has to be careful not to become unintentionally involved in money laundering operations.

A number of steps should be taken when a bank establishes a relationship with a new client, especially when privatebanking is involved. But, even though these policies are particularly important for a bank, they also are important fora business that is considering accepting an investment from another company or group of individuals.

1J7101 Individual Due Diligence Using Identity Checks

Becoming familiar with the background of a new client or investment partner is important. The first step in thisprocess is the verification of his or her identity. If third parties are acting for underlying beneficiaries, the identityverification process also applies to the third party and the underlying parties.

1J7111 Company Due Diligence in Verification Procedures

Webs of shell companies can be fronts for money laundering, so investigators must verify the legal existenceof a company and ascertain that the company has a true economic purpose. The forensic accountant verifies that theperson acting on behalf of a company is really authorized to be an agent of the company and, if not, discerns the trueidentity of the parties who have ultimate control over the business. If these parties cannot be identified, a red flagshould be raised. The nature of the business and intercompany relationships should be clearly understood.

1)7121 Trust Due Diligence Using Trust Deeds

A trust is generally a legal relationship that is established by one person when assets have been placed underthe control of another person for the benefit of the beneficiary for a specific purpose. Trusts provide an easy meansfor criminals to remain unidentified while retaining control of the trust's assets. Therefore, the forensic accountantmust be suspicious if the person establishing the trust and the trust beneficiary are not related in any apparent manner.Usually, a trust is used in a money laundering scheme after the money has already been put into the banking system.

17131 Organization-wide Suspicious Activities

Although one factor in itself does not indicate that money laundering is occurring, a combination of factorsshould be considered suspicious. See f 7131 for a list of examples of red flags.

17141 The Accountant's Role as Gateway Keeper

Generally, antimoney laundering laws have focused their attention at the gateway where the illegal money entersthe financial system (i.e., largely banks). The methods used in money laundering transactions to avoid exceeding legalmonetary limits may not be as visible to individual banks receiving those deposits as they would to the companyaccountant or auditor who observes the network of transactions.

Currently, U.S. auditors have two auditing standards that provide some guidance with money launderingactivities. These standards relate to the overall effects on the entity's financial statements. Guidelines are provided inAICPA's Statement on Auditing Standards (SAS) No. 54, Illegal Acts by Clients, and Statement on Auditing Standards(SAS) No. 82, Consideration of Fraud in a Financial Statement Audit (now replaced by SAS No. 99).

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117151 USA Patriot Act of 2001

In October 2001, the USA Patriot Act (the Act) was signed into law. Although many of the working provisionsof the Act are yet to be fully developed by the issuance of Treasury regulations, a number of statutes apply to moneylaundering. These statutes are found in the section of the Act entitled International Money Laundering Abatement andFinancial Anti-Terrorism Act of 2001 (MLAA). The MLAA increases the penalties for money laundering as well asextends the power of the federal government in controlling money laundering activities Within the provisions of theMLAA are guidelines that allow the U.S. Treasury Department to require U.S. financial organizations to file specificinformation about transactions occurring in countries identified as primary money laundering havens. Use of payable-through accounts, correspondent accounts, and concentration accounts are specifically mentioned in the Act. TheMLAA also made several other enhancements and restrictions, including some to reporting requirements.

17161 ConclusionMoney laundering is a transnational crime that can potentially corrupt financial systems around the world

with bribes and payoffs. When money laundering is used to convert illegal proceeds into spendable resources, theseactivities should be considered a serious crime by all jurisdictions. If laundering techniques are adopted within alegal context to remove government restrictions from funds, for example, they should be considered a violation oforganizational ethical codes.

Solutions to Chapter Exercises1. See 1J7141, The Accountant's Role as a Gateway Keeper. There is currently very little in the way of Auditing

Standards to guide the auditor in this situation. The bankers' guide of "know-your-customer" may apply forthe auditor in this situation. If the auditor is familiar with the business and knows the owners, then the auditorshould have confidence regarding the legitimate origin of a large percentage of cash revenues. If the auditor isnot familiar with the owners or there are new owners of the business, the auditor needs to be more cautious.Although there may not be an auditing requirement to report, money laundering, the audit firm's professionalreputation and its license to operate in the State of Texas may be at stake.

2. Banks are part of the solution as well as part of the problem to money laundering activities. Banks can offera solution to the problem of money laundering because they serve as the gateway to the financial systems.If they are particularly guarded about who has access to the system, they can help to seriously deter moneylaunderers. Banks have a tradition of providing privacy and confidentiality to their clients. For that reason,banks are hesitant to disclose all possible "money laundering types of activity" to the government as some ofthese activities are just normal financial transactions. Finally, the banks receive a great deal of revenue fromservicing foreign accounts and foreign banks. They do not want to take any actions, such as the constant andcontinual disclosure of private information, to outrage their clients and reduce these revenues.

3. Answers will vary. This exercise is an opportunity to study a number of actual money laundering cases withthe class.

4. A virtual bank is one that does not have to have a physical presence in any geographical location. Such abank would be exemplified by a bank operating with a set of PCs and one employee in a bedroom. It is notmonitored by any government agency for compliance with banking regulations.

5. Howard Tech should exercise due diligence procedures and not blindly accept the money. In the past,alumni have illegally obtained monies through frauds and contributed large sums to their alma mater. Theseuniversities have been embarrassed and found it necessary to return the fraudulent funds. Minimum duediligence procedures would require Howard Tech to accurately verify the source of the contribution withconfirming details from a collaborating independent institution. Crosschecks against public records shouldbe made to verify the legitimacy of the business, i.e., directors' names, office locations. If none of thisinformation is available from U.S. sources, it should be determined if such information is available from theforeign country in which the contributor lives. Checks should be made on the bank from which the check isdrawn. Is the contributor's bank an offshore or shell bank? If possible, checks should be made with nationallaw enforcement organizations in the United States.

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