MONEY LAUNDERING AND GLOBAL BUSINESS
Anthony C. Koh, PhD
Department of Marketing and International Business
The University of Toledo
Toledo, Ohio 43606, U.S.A.
(419) 530-2287
Fax: (419) 530-4610
and
Anthony Zaworski, MBA
Department of Marketing and International Business
The University of Toledo
Toledo, Ohio 43606, U.S.A.
ABSTRACT
Money laundering is a serious threat to the stability of financial markets of the civilized world. It has evolved into a multi-layered complex criminal activity that launders anywhere from $600 billion to $2 trillion annually. This paper examines the origin and growth of money laundering, and the efforts undertaken to combat this illegal activity. Money laundering in a highly technologically interconnected world continues to provide serious challenges to governments and businesses throughout the world. The ideal of democratization is now re-defined to include accepting the fact that financial institutions are required by governments to spy on their customers for the sake of world peace and security.
Keywords: Money laundering, Black Market Peso Exchange, Hawala, financial institutions
INTRODUCTION
The popular saying that “the world is growing smaller everyday” appears to ring true as one observes the increasing pace of globalization. Two macro factors seem to underlie this trend toward globalization: declining trade barriers to the flow of goods, services, and capital that occurred at the end of World War II, and the rapid changes in communication, information, and transportation technologies (Hill, 2006). Improvements in technology, particularly in telecommunications and Internet technologies, have allowed business the opportunity to become increasingly impersonal. Faceless transactions are becoming more and more common as Internet orders and B2B interaction increases. In addition, the ease at which business is conducted has been aided by the ease at which money flows from business to business. Funds move more freely to settle accounts due in part to the removal of many of the barriers that previously existed to doing business across geographical and political borders. The use of electronic transfers and intermediate banks to settle accounts has helped to lower some of the risks incurred when operating across borders. Both the speed at which funds may be transferred, as well as payments being guaranteed by financial institutions, have helped in opening markets that were traditionally either closed to global competition or were considered undesirable due to time constraints or limited access. However, these technological advances and this increasingly global nature of business have also provided new opportunities for those involved in money laundering activities around the globe (Sullivan, 1997).
Although the concept of money laundering has existedfor quite some time, the attacks on September 11, 2001 brought renewed attention to the role of financial counter measures in combating crime around the globe, and particularly global terrorism (Gurule, 2002). In practice, regulation (which includes a complex range of treaties, frameworks, recommendations and laws) has had a great deal of influence in combating money laundering. However, the effectiveness of regulation relies heavily on the compliance of business, especially those operating in the financial sectors. This increased regulation increases the burden on businesses due to the required customer due diligence, and compliance. The purpose of this paper is to look at the global practice of money laundering as well as the potential effects of anti-money laundering legislation and regulation on business. The paper begins by detailing the development of money laundering and how it has evolved with the aid of technology. The case of global terrorism is granted particular consideration because it has given much momentum to the case of “Know Your Customer” regulation. No matter what the impetus to the renewed efforts, great strides have been made in combating global money laundering, although significant obstacles still exist. What remains to be seen is how business will be affected by emerging regulations and the increased scrutiny of its customers.
MONEY LAUNDERING
The term money laundering is believed to have earned its name quite literally in the 1920’s and 30’s, when organized crime syndicates in the United States took money, which was gained illegally and included it with general receipts of a chain of Laundromats, which they owned or operated. Through this process, funds that could not be plausibly explained to inquiring authorities were funneled through legitimate enterprises. The illicit nature of the process was extremely difficult to prove due to the nature of the business the illegal funds were passed through. Laundromats had proved to be a perfect pass through since there was no inventory to be depleted by sales, and customers normally paid in numerous small bills. If a case were to be prosecuted, there was little proof that authorities could offer a jury despite a firm belief that a large portion of the money shown as revenue through the laundering entity had come from illicit sources. To demonstrate the magnitude of this activity, take the case of Las Vegas, Nevada, which sprung from the desert as a creative idea to launder money. Las Vegas proved to be a perfect opportunity to launder money due to the large volume of cash associated with casino gambling.
The term has extended beyond the traditional definition of creating a fictional pretext that funds were legitimately and lawfully acquired. Laundering also includes the illegal movement of money from one country to another, the masking of true ownership or beneficiaries of funds, or even the exchange of large amounts of small denomination currencies with larger denominations that are easier to transport and store (Benning, 2002). The international interest in the prevention of money laundering and illegal asset transfers began with the operation of global narcotics trafficking rings, but it has evolved to include a wide range of criminal activities all of which have similar objectives including tax evasion, insider trading, corrupt politicians, terrorists and a variety of other areas in which persons have a variety of reasons to conceal the ownership of various monies, assets, or corporations (Benning, 2002). In 1998 the Organization for Economic Cooperation and Development (OECD) asserted, “Money laundering poses a serious threat to democracy and to the soundness of the financial systems of all countries” (OECD, 2000). There have been a number of multilateral actions taken to further universal enactment of money laundering laws and foster international cooperation in its detection and prosecution. With the increase in legislation throughout the world to stop money laundering, and the OECD’s efforts to put the pressure on offshore financial jurisdictions, the opportunities to move illicit funds in cash has become increasingly limited and challenging. The movement of money is generally limited to the banking system, which in turn creates an accompanying paper trail. It is this paper trail that can be the key to successful asset tracing and recovery (Hampton and Christensen, 2002).
ROLE OF THE INTERNET IN MONEY LAUNDERING
The Internet was originally developed as a means of ensuring the ability to communicate in the event that a nuclear war destroyed conventional telecommunications. It has been suggested that the very openness of the Internet is both its best asset and worst liability. (Granville, 2003) While having the capacity to promote technical innovation, it is also rendered simultaneously open to exploitation by unscrupulous, profit-minded individuals. The more data that becomes available, the more it is monitored, and therefore more susceptible a target to cyber-terrorism, and fraud. Cyber connectivity has been a catalyst for more sophisticated and elusive opportunities for organized crime (Sullivan, 1997). Therefore, the more advanced industrialized countries, including the United States, are much more open to cyber crimes due to the heavy reliance on technology, versus the primitive infrastructures of developing countries. The increasing complexity of information technologies has created opportunities to utilize it in the traditional crimes including money laundering, acts of terrorism, forgery and fraud. However, the Internet also has simultaneously provided the means for law enforcement agencies around the world to develop new methods and opportunities to counteract crime (Armstrong and Ford, 2003).
Both cyber crimes, and cyber security are dependent on the interconnectedness of states, but authorities have been hampered in combating these crimes in part due to the lack of Internet access in some states, especially in the developing world (Granville, 2003). The global threat associated with cyber crimes necessitates a proactive and cooperative international approach in development of policy and laws in order to effectively catch and prosecute offenders. However, it has proven extremely difficult to convince sovereign nations with primitive computer systems to enact sophisticated cyber laws. Less regulation at the national level in any industry, leads to greater obstacles to anti-money laundering international cooperation. (Savona, 2002) The rapid evolution of new technologies including satellite and wireless access to Internet technologies continues to make even the most remote areas of the world potential targets as well as hiding places, and makes it extremely difficult to update and disseminate effective security measures to promote information systems across all sectors.
ROLE OF THE INTERNATIONAL FINANCIAL SYSTEM
It is also important to understand the role of the international financial system and how it creates opportunities for illicit activity. The international financial system includes a wide variety of financial institutions and other commercial enterprises some of which have no legal definition as a financial institution. Those that are legally recognized are not effectively regulated. At the highest level are the licensed financial institutions established in highly industrialized countries (i.e. banks, insurance companies, thrifts, savings and loans, foreign exchange offices, securities brokerages, etc). Generally these entities are established and chartered under well-established corporate laws, and they are required to comply with governmental regulation and industry standards. Compliance is backed by the threat of both civil and criminal penalties. It should be recognized that even within these formal financial organizations, regulatory provision and enforcement might vary greatly across borders.
There are financial institutions that operate at lower levels of formality in offshore havens, or within developing countries where regulation is less stringent, and those that enforce the laws have far fewer resources, training, and political motivation to effectively monitor their financial sector. Anti-money laundering efforts have focused on persuading low regulation jurisdictions to improve their scrutiny of such institutions; however, some states will always be tempted by the relatively rich rewards offered by individuals seeking to avoid governmental oversight. The sanctions imposed by the developed world in order to pressure these states have not been sufficient to deter these practices. A multi-national firm such as Citibank or JP Morgan Chase can not be prohibited from accepting funds from a bank based in the Ukraine, or even the Cayman Islands, but regulators have very little certainty regarding the ownership of these funds which are held in correspondent accounts established by those institutions (Hampton, 2002). One of the more difficult conditions is the in-dealing with “shell banks”. These are banks that are established at extremely low cost in highly regulated jurisdictions and typically have very opaque structures, a stark contrast toward the shift to transparency desired by regulators. The shareholders of these banks are usually designated as private corporations or organized through a trustee. Shell banks transact business in highly regulated on-shore jurisdictions through correspondent accounts maintained with recognized foreign banks. The correspondent bank, whether located in Europe, the United States or Asia, knows only that the account holder, its primary customer, is another bank and has no means of discovery regarding the true ownership of the funds, or the ultimate beneficiary of the funds it holds (Yaniv, 1999).
ALTERNATIVE GLOBAL REMITTANCE SYSTEM
The OECD, Financial Action Task Force (FATF) has also identified what they describe as an “alternative remittance system”. These are informal (underground) systems that provide the means of moving money across international borders without the need to utilize formal financial system, even those second tier systems that are more lightly regulated. These alternative remittance systems developed due in part to the governmental restrictions imposed on flows of legitimate funds. They were also created in response to a need for a low cost provider of international financial services for individuals who for whatever reason do not have accounts with traditional banks. They offer reliable and timely movement of funds often more efficient than banks for the needs of the customers, and have survived in the present day due to the benefits they offer those in need of illicit financial services (OECD, 2000).
The three most widely known global alternative remittance systems are: (1) the Colombia Black Market Peso Exchange (BMPE) in Latin America, Hawala (or Hundi) system in India and the Middle East, and the Chinese Underground Banking or Chit System in Asia and the Pacific Rim. All three systems operate in much the same way throughout the world. The BMPE has existed since the late 1960s as a means for Colombian importers to pay for goods smuggled from the U.S. with dollars in order to avoid paying the high tariffs imposed by the Colombian government (James, 2005). The peso brokers then transfer the funds to the U.S. exporter on behalf of the Colombian importer. In the beginning, peso brokers acquired the dollars from Colombian exporters of cut flowers and coffee, as well as from immigrants in the U.S. who wanted to remit funds back to their families in Colombia. When the Colombian drug traffickers offered the peso brokers a substantial discount (as much as 30%) for the dirty dollars in exchange for pesos, the peso brokers then began to alter the way they did business. It has been estimated that the annual wholesale Colombian drug proceeds amounted to between $8 billion and $12 billion. The BMPE process (James, 2005) is detailed below:
a)Columbian drug dealers export drugs to North America and Europe.
b)Columbian drug dealers then contact a peso broker in Columbia to exchange the dirty dollars and euros for pesos back home.
c)The peso broker advertises to Colombian importers the availability of foreign funds for the purchase of foreign goods.
d)Columbian importers place their orders and the peso brokers through their contacts purchase foreign goods on behalf of the Colombian importers.
e)The peso broker pays for the foreign products with the drug money (in dollars or euros) and the dirty money is now moved into the banking system in North America and Europe.
f)The Colombian importers then pay the peso brokers in pesos back home.
g)The foreign goods are then smuggled into Colombia from a destination in South American or the Caribbean; the Columbian importer takes possession of the goods and thus, avoids paying the Colombian import and exchange tariffs.
h)In this cycle, the peso brokers have their new peso accounts, the drug traffickers have their pesos, and the Columbian importers have their foreign products at a cheaper price. And, through this process, the drug money moves innocently into the banking system.
The Chinese Underground Banking or Chit system is used throughout the world, and is thought to predate the official bank system in parts of Asia. It is used for legitimate business, as well as profits from drug trade. The Hawala system has garnered the most attention as of late because of its known associations. It was developed in India, before the introduction of western banking practices and is a major remittance system also used around the world. It is estimated that 50% of the Indian economy is dependent on the Hawala system, despite the prohibitions prescribed by law. The Hawala system developed in response to the Indian (and Pakistani) laws prohibiting foreign exchange transactions at anything other than the official rate of exchange, the imposition of strict licensing requirements on money remitters and foreign exchange dealers (Jost and Sandhu, 2000). Indians and Pakistanis with money would like to move money to another country due to concerns about stability (capital flight), and to pay for education or medical treatment. The official remittance system is both cumbersome (wrought with red tape) and costly. In step the Hawala dealers who offer a cost effective (a better exchange rate than the official rate) and efficient (faster due to the almost absence of paperwork) remittance alternative. The transfer though this alternative system is much cheaper than using official banks, requires no documentation, and it operates extremely efficiently and reliably (OECD, 2000). However, the legitimate use of Hawala (called white Hawala) is now mixed with the illegal use of Hawala (black Hawala). The Hawala system has been linked to trafficking of both drugs and human beings, as well as smuggling, corporate and government corruption and global terrorism. Though illegal in India and Pakistan, the Hawala system is very much alive. An example of a Hawala system is illustrated below (Jost and Sandhu, 2000):