6 Money Laundering Cycle (p1-3) by Jason

6 Money Laundering Cycle (p1-3) by Jason

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  The money launderingcycle Valuation of financial instruments BDO supports the Chamber of Hong Kong Listed Companies (CHKLC) director training series 2014 BDO global network development at a glance New Companies Ordinance (Chapter 622) Recent amendment to listing rules relating to connected transactions Albert Au awarded the BBS BDO Asia Pacific Regional Conference 2014 Fanny Hsiang was appointed as a member of the small and medium- sized entities implementation group BDO new appointments Recent BDO publications BDO Annual Statement APERCU August 2014 www.bdo.COM.HK Contents 01 04 06 07 08 09 10 11 12 The Money LaunderingCycle T he Financial ActionTask Force (FATF) is an inter-government anti money laundering (AML) body comprising 34 member jurisdictions and two regional organisations.The primary objective of the FATF is to combat money laundering activities through the establishment of international AML standards and frameworks. Money launderers are creative, sophisticated and well-networked.They design, evolve and comingle new money laundering techniques in thousands of different forms frequently. Studying and researching these new methods and developing new AML procedures are definitely one of the most difficult tasks of FATF. Typically, a complete money laundering cycle has three stages. Although money laundering methods emerge in different forms, they are always based on these three stages. Nevertheless, “Know Your Enemies” is the underlying principle. Placement stage Crime is big business which generates large amounts of cash. After evading the police, the next question money launderers ask is how to hide away the load of illicit cash.This kicks off the first stage of the money laundering cycle – placement – which is about injecting cash into the financial system in the least suspicious manner. The traditional placement method is direct cash deposit into financial institutions (eg banks and securities firms). In order to get around the algorithm of AML transaction monitoring systems, money launderers usually break down the cash deposits into small amounts, so that they can go under the detection thresholds of AML systems, such as the US$10,000 rule which requires banks to file AML reports of cash transactions over US$10,000 to the authorities under the US Bank Secrecy Act. This technique is simple, but immature. It takes a rather long period of time to process all the small- amount transactions. In addition, the illicit money is scattered among different bank accounts held by different dummies whose number has limit. In the long run, evolving algorithms of AML systems are able to recognise such deposit patterns.
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  2 APERCU -August 2014 “Comingling with clean funds” may be a more effective placement method. Money launderers can place illicit cash into financial systems by assimilating it into their legitimate cash businesses, such as pubs, restaurants and retail stores, and by such means comingle the illicit money with clean funds earned from the business. Operationally, these comingled funds can be injected as sales proceeds during peak business seasons which “apparently” justify the increase of sales and related cash deposits. Strategically, money launderers operate different money- washing businesses, close them down on a rotational basis and re-establish them in another form in order to remove unexplainable patterns and trails. In the course of this, the books of these businesses are closed and audited in the normal way and, on that basis, taxes are paid as a small cost of washing money.This could be one of the reasons why the suspicious transaction reporting duty under AML law in many jurisdictions is now extending beyond financial sectors to professional regimes, such as lawyers and accountants. Layering stage Once illicit funds enters the financial system in the placement stage, money launderers then create a large number of financial transactions in order to disassociate the funds from its illicit sources.This is the second stage – layering – which is usually featured by: 1. Moving funds around the globe in order to stop local authorities from tracing trails at their borders; 2. Engaging in financial instruments trading which hides the unusual trading patterns in transaction pools of extremely high volume; 3. Using different dummies in each transaction to conceal the original illicit sources. Figure 1 demonstrates a simple web of transactions and it can go on and on until money launderers are comfortable about the level of disassociation from the original illicit sources. Step 1: • A listed company director engaged in insider dealing wires his funds from the US to HK. (Let’s say) Step 2: • The proceeds are used to buy some stocks in HK. • The shares are transferred to Dummy X which pays some stamp duty to legitimise the trade. Step 3: • Dummy X sells the shares. • A loan arrangement is entered into with Dummy Y which justifies the related fund transfer in another country. Step 4: • Dummy Y transfers the funds back to Country A as capital injection of a company held by Dummy Z on behalf of the listed company director. • “Dizzy enough? Let’s loop again.” said Money Launderers. Step 4 Step 3 Step 1 Step 2 Country B Country C Country A Figure 1 In layering stages, it is difficult to distinguish a normal transaction from one conducted by money launderers unless the whole chain of transactions is presented. In fact, this is the whole purpose of layering. Integration stage After trails are substantially removed in the layering stage, money launderers need to reunite with the washed money and return it to themselves as if it is from legitimate sources. This is the ultimate objective and final stage of the money laundering cycle – integration. Traditionally, integration is achieved through dealing in high-value items, such as properties and antiques whose subsequent sales would return legitimate proceeds. In less developed areas, such transactions can even be facilitated by corrupt professionals, eg accountants and lawyers as perfect “witnesses” endorsing the legitimacy of the fund source.This kind of integration technique is usually applied locally.
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  APERCU - August2014 3 Trade-based money laundering (TBML) is one of the most complex and increasingly important method of bringing together the illicit funds and legitimising it through the use of international trade, according to a study of the FATF in 2006. It is estimated that hundreds of billions of dollars are laundered throughTBML globally. The key element of a basicTBML model is misrepresentation of trade prices. Over-invoicing Make falsified international trade of “apparently” high-valued products and over-bill the amount; hence claim the proceeds in the seller’s country to be legally earned profit. Under-invoicing Make falsified international trade of “actually” high-valued items and under-bill the amount; hence transfer the profit to the buyers’ country in which the items will be resold at a high margin as legally earned profit. Graph 2 depicts the basic operation ofTBML where the key notes are: 1. The illicit funds originate and are maintained in Country C; 2. Buyer in Country A enters into international trade with seller in Country B in the normal course of business. Shipment is instructed and made to affiliate in Country C; 3. Buyer in Country A enters into another trade contract with affiliate in Country C and re-invoices the goods at an inflated price of $1,000.The funds are legitimised and channelled to Country A through letters of credit. This case demonstrates thatTBML (buyer in Country A and affiliate in Country C) can be processed through paper work only and requires no costs of operation. Some red flags ofTBML are: 1. Significant deficiencies between the description of the traded items on the bill of lading and the invoice; 2. Significant deficiencies between the description of the traded items on the bill of lading (invoice) and the actually shipped goods; 3. Significant deficiencies between the reported value of traded items and the fair market price; 4. The volume of trade is inconsistent with the scale of operation or size of capital of exporters/importers; 5. Settlement by unrelated third parties. It is difficult to tackleTBML because it requires Independent seller in Conutry B Affiliate in Country C Bank in Country C Step 3: Invoice the goods at $1,000 Step 6: Pay $1,000 for settlement through letter of credit Step 5: Issue letter of credit Step 4: Pledge the dirty funds after layering with bankStep 7: Legitimise the funds as “apparently” supported by trade contract and paid up by letter of credit Ship goods Step 1: Invoiced normally at $100 Step 2: Wires $100 for AP settlement Buyer in Country A Enjoy life in Country A meaningful statistical analysis built on a strong international trade database. Internationally, many countries are starting to establish a function generally called “TradeTransparency Unit” for conducting ongoing comparison analysis and exchanging trade data. Yet, it will take a while to see the effectiveness of such programmes. For further enquiries about Anti-money laundering standards and programmes, please contact our Director and Head of Risk Advisory Services, Mr Patrick Rozario on (852) 2218 3118 or [email protected] Jason Wong Risk Advisory Services [email protected] Graph 2