CHAPTER 1

Background

Evolution of the Money Laundering Process

In many countries the “unregistered economic values” have been an important issue for the evolution of money-laundering activities. Although clear definition of ‘unregistered economy’ exists, according to Erdilek, unregistered economy could be associated with:

    •  Excessive tax burdens,

    •  Corporate and personal taxes,

    •  Social security contributions,

    •  Inflexible labor markets (Erdilek, 2007).

Erdilek adds that ‘the reluctance of some people to pay their share of taxes’ could be another reason for unregistered economy. He mentions that the reason for the unwillingness of paying the full share of taxes could be that people believe governments are wasting tax revenues.

Economic activities could be defined using the Gross Domestic Product (GDP) index. GDP involves legal and illegal economic activities. For example, according to the Turkish Confederation of Employers’ Associations’ survey in 2003, ‘Turkey’s unregistered economy increased from 36 % of the registered economy in 1985 to 66 % in 2003’ (Erdilek, 2007). The Turkish Central Bank study in 2004 revealed that the unregistered Turkish economy, (including 52 % of total employment and 37 % of private sector employment), was between 16 to 50 % of total economic activity. In 2005, The Trade Union Turkish-Is reports that ‘more than half of the Turkish labor force was engaged in the unregistered economy’ (Erdilek, 2007).

Unregistered economies have negative effects on the country’s economy.

The unwanted effects of the unregistered economy could be listed as follows:

    •  Official statistics are no longer reliable.

    •  Financial policies are difficult to develop and implement.

    •  Companies within the registered economy invest out of the country because of unfair competition.

    •  Governments need to increase the tax load that results from unregistered taxes.

    •  The value for the legal foundations of the society decreases.

Besides the negative effects, unregistered taxes have some positive effects on the society and economy: they maintain an additional employment and income opportunity. However, the negative effects of unregistered economy are much greater than the positive ones to people and the country’s financial system.

Countries’ financial systems may include different methods of illegal fund movement transactions. These fund movements can be considered as a form of unrecorded economy and could include:

    •  Funds accumulated for tax evasion,

    •  Funds generated from illegal activities, and

    •  Funds to be used for terrorist financing.

Even though these three types of fundsare different, at times they partly cover each other’s area according to the type of criminal financial activity.

The source of the funds for criminal activities is called ‘Black Money’.

The cycle process of black money can be shown as:

Crime images Black Money images Money-Laundering1

Criminals launder money to hide the original source of funds that are generated by a criminal activity. The purpose of the activity is to legalize illegal income with an official cover through a variety of methods.

Hiding money laundering activities can be achieved through:

    •  Converting dirty money into acceptable form of funds,

    •  “Washing” the proceeds gained from the drug trade, and

    •  Formalizing the incomes generated from illegal activities.

Illegal sources of money can be listed as follows:

    •  Bribing,

    •  Drug Smuggling,

    •  Illegal weapon or arms trading,

    •  Human trading,

    •  Refugee smuggling, and

    •  Other unofficial trading activities.

Money laundering gives criminals significant financial power.

In the 1970s, the United States of America implemented the Bank Secrecy Act (BSA)2 to prevent money laundering-type activities. According to Internal Revenue Service (IRS)’s report in 2011, ‘The BSA requires businesses to keep records and file reports that are determined to have a high degree of usefulness in criminal, tax, and regulatory matters’. This act helped also other governments limit terrorist financing activities and control financial transactions.

Financial institutions have a variety of policies and regulations to fight illegal money transactions. These policies help prevent criminals from using individual banks for money laundering transactions. These policies are often referred to as anti-money laundering applications.

Anti-money laundering applications could affect financial institutions’ legal positions, and involve compliance costs as well as affect negatively their financial position.

Legal Position

Employees in financial institutions are required to follow their organization’s rules. Besides following organization’s rules, employees are also required to

    •  Maintain proper record-keeping of financial transactions,

    •  Maintain internal reporting, and

    •  Train other employees about legal obligations and report suspicious transactions to management.

Compliance Cost

The compliance costs of financial institutions or services increase when adopting anti-money laundering applications in an organization. These costs consist of administration, training, and storage costs.

Compliance departments within financial institutions are established to monitor the activities of a financial institution and identify possible suspicious transactions within the organization. Financial organizations establish these compliance departments and develop policies required to meet the legal standards and manage clients’ assets.

For that reason, banks implement a continuing compliance program to meet their obligations and responsibilities.

Compliance policies regulations and procedures support the fulfillment of anti-money laundering and anti-terrorist financing measures. Those measures are also supported with strict local laws and regulations. In this respect, the functions of Compliance Officers are vital for financial institutions.

According to the ‘Bank Regulatory Compliance Officer Job Description’ on the website www.advisoryhq.com, the duties of a bank’s Compliance Officer are as follows:

    •  Ensuring that the bank unit operates in compliance with all applicable regulations as well as the internal policies and procedures,

    •  Implementing bank’s Compliance Policies within the unit,

    •  Providing counsel on regulatory issues and potential effect of regulatory changes,

    •  Developing, implementing, and revising compliance policies,

    •  Cooperating daily with local regulatory authorities,

    •  Ensuring senior management and staff are educated and trained with the bank’s compliance policies and procedures,

    •  Monitoring the bank’s compliance unit’s activities to detect and prevent possible faults of the agreement,

    •  Conducting regular internal investigations and providing recommendations to correct some actions,

    •  Dealing with complaints and maintain objection files and records,

    •  Managing clients’ orders and permissions with written guidelines and restrictions,

    •  Interacting with members from internal audit, risk management, and financial reporting, and

    •  Reporting hierarchically to the Management Board and functionally to the Council of Directors.

Financing terrorism and money laundering are related to each other. Money launderers are not always providing funds to terrorist organizations. However, terrorism financing activities need money laundering to legalize their funds and sources.

Money Laundering Stages

Money laundering may look like a simple process that criminals use for hiding the source of the proceeds of their illegal financial criminal activities. However, money laundering has a deep social significance with direct links to corruption in financial organizations.

United Nations Office on Drugs and Crime (UNODC) (See Figure 1.1), states the money laundering process has three stages: Placement, Layering, and Integration.

In the Placement stage, the launderer tries to transform the cash into other assets such as postal orders or checks to remove the link between the cash and its source. In the second stage, Layering, the goal is to conceal the audit trial, source, and ownership of funds. To achieve that purpose, the launderer disguises the source of the funds by creating complex layers and forming different financial transactions. During the third stage, Integration, the launderer assimilates the money with other assets of the financial system.

Under the above scheme, banking systems are at the center of the money laundering processes. Therefore, rules and regulations applied in banking systems are the key factors for fighting money laundering activities.

Money laundering activities, which also can be used as terrorist-financing activities, affect the world’s economy. As a result of an international networking system, countries affect each other’s economy. Illegal money transactions increase the gap between different classes of incomes. Governments cannot collect taxes from these illegal sources of income. Consequently, corruption increases.

Some bank offerings could attract money launderers, notably:

    •  A wide range of services and access to wider financial systems.

    •  International connections and facilities.

    •  Accessibility through networks. (Kumar, 2009)

A wide range of services and access to wider financial systems

A wide range of services and access to wider financial systems refer to the activity of controlling money transactions.

images

Figure 1.1 The money-laundering cycle

Source: UNODC (United Nations Office on Drugs and Crime) https://www.unodc.org/unodc/en/money-laundering/laundrycycle.html

Managing money laundering activities are difficult when financial activities increase and become complex.

International connections and facilities

International connections and facilities refer to the transfer of the funds. In addition, international connections make tracing money transactions difficult after the funds are transferred from one financial institution to another.

Accessibility through networks

International networks make money transfers easier.

Financing Terrorist Activities

The terrorism in the Southeast Asia and the financial sources behind the terrorist groups are mentioned by the authors. The authors also state that Southeast Asia has been a home for terrorist groups for decades. Islamic groups focus on religious and domestic issues such as adoption of Islamic law within Southeast Asia. The militant groups like Al Qaeda in the Southeast Asia are against globalization and America’s increasing power in some countries like Iraq and Afghanistan. The authors argue that the militant groups in Southeast Asia are also trying to collaborate with other Muslim groups within the region to increase their financial power. Governments of Southeast Asia play a significant role in enforcing social discipline. The law and its penal sanctions could decrease terrorist activities if the governments of Southeast Asia apply them. (Vaughn et al., 2008)

Giraldo and Trinkunas explore the relation between terrorist activities and terrorism financing. The authors discuss various ways to finance terrorism by transferring the ‘dirty money’ (a term for illegally acquired funds) from one source to another. The writers also explore terrorist financing activities in different regions such as Arabia, Europe, East Africa, Southeast Asia, and South America. The authors also suggest developing a comparative perspective on the topic, possible solutions, and governments of Arabia, Europe, East Africa, Southeast Asia, and United States of America (USA)’s responses. For instance, after the attack of September 2001, the USA government strengthened the anti-money laundering policies with the implementation of the Patriot Act (Giraldo and Trinkunas, 2007). As a result of the strict money laundering regulations within the Patriot Act in the USA, ‘dirty money’ activities have decreased. However, USA’s strict policy about money laundering affects other regions. Terrorism funds and money-laundering activities increased in Europe as result of USA’s Patriot Act (Giraldo and Trinkunas, 2007).

Financial Action Task Force (FATF) is an international standard setter for combating money laundering and terrorist financing (Borekci and Erol, 2011). The authors mention that Turkey’s current situation has improved as a result of following FATF measures for combating money laundering and terrorist financing.

MASAK, the Turkey’s Financial Crimes Investigation Board, explores preventing money laundering and terrorist financing in its Suspicious Transactions Guideline, published on the IBA Anti-Money Laundering Forum’s website.3 This website provides information about increasing the awareness and the importance of diagnosing money laundering actions and establishing anti-money laundering regulations. The website is a guideline for financial institutions and banks to improve their anti-money laundering action plans by providing information on different suspicious transaction types such as detecting abnormal money increases in a person’s bank account, large cash movements from one bank account to another, or making payments to the same bank account by people without reasonable explanations (MASAK, 2011). MASAK also provides the authorized information and legal regulations for financial organizations to diagnose money-laundering issues. The legislation of terrorist financing and laundering proceeds of crime is analyzed from both national and international points of view (MASAK, 2011). National and international laws and regulations of terrorist financing and money-laundering help employees working in financial institutions be aware of the steps they need to follow to prevent Money-Laundering Activities (MLAs). For instance, national regulations include exchanging customer identifications with other institutions and periodically reporting the activities to presidency or the examiners (MASAK, 2011).

Corruption is a problem that financial institutions are dealing with. Understanding the nature of anti-corruption and the effects of corruption are vital information for the members of financial organizations to prevent it. Corruption has an effect on economic development projects, international business transactions, and government procurement activities (Olsen, 2010). Financial institutions could apply a compliance strategy to prevent the negative effects of corruption within organizations.

An effective compliance program includes corporate code of conduct, training and communication, compliance monitoring, auditing, reporting, and responding. Olsen provides the information about United States of America’s government’s effort to combat global corruption. He explores the subjects of nongovernment and world trade organizations, global forum on fighting corruption, international financial institutions, international chamber of commerce, transparency international, global corporate governance forum, the role of civil society, and the emerging markets to indicate the attempt of USA government’s fight against global fraud.

Tracking the flow of the money in the globalized world is difficult for financial institutions. The international regulations for tracking money traffic are significant (Jojarth, 2009). Jojarth’s book is a guideline that describes different ways of global money trafficking. The author discusses money laundering, narcotic drug trafficking, trading in small arms and light weapons, and diamonds as subjects of illegal money resources. The author mentions the importance of the Vienna Convention regarding money laundering. The Vienna Convention requires that countries provide the mutual legal guidance for international corporations to fight drug trafficking. Jojarth also examines the costs and benefits of the implementation of international drug control policies. The Vienna Convention Commission has policies for other types of crime and anti-money laundering, like the Financial Action Task Force (FATF), which was established for strengthening the efforts tracing the flow of funds of the member countries’. Jojarth argues that FATF and its 40 recommendations are the most important anti-money laundering initiatives available presently to financial institutions.

Money laundering is not always considered as harmful in some countries (Alexander, 2007). Money laundering could benefit some countries. Jojarth mainly focuses on three areas: capital flight, avoidance of financial embargoes, and the investment of the earnings of corruption in a secure financial system. Jojarth discusses the position of the European Union (EU) toward money laundering. He describes ways of dealing with money laundering and its effect on financial institutions. Jojarth’s book is a useful source of information for developing a new model of MLA enforcement to correct some issues that need to be addressed in anti-money laundering legislation.

‘The Organization for Economic Cooperation and Development (OECD), the forum in which the governments of 304 democracies work together, deals with the social, economic, and environmental issues that arise from globalization’ (Aiolfi, Dobovcek, Klemencic, Lebeaux, Ledergerber, Loo, Moehrenshlager, Pontifex, Savran, Uriarte and Zudova, 2008). The representatives of 30 governments also discuss different aspects of countries and regions dealing with money laundering activities. This article contains specific recommendations and policies about anti-corruption processes for each country in Eastern Europe and Central Asia.

Terrorism financing has a close relationship with money laundering. Terrorist groups aim to legalize or launder their ‘dirty money’. To succeed, terrorist groups need to be able to raise funds and access to those funds to operate (Lormel, 2007). Lormel describes terrorist groups ‘operations, purposes, and financial resources. He also discusses the relation between terrorist activities and its funding methods. Developing and applying detective and preventive strategies are vital for financial organizations to prevent money laundering. Lormel’s article provides information about terrorist groups’ funding capacities and mechanisms in their fundraising and operations.

Technology is necessary for financial organizations to work efficiently (Demetis, 2010). Demetis highlights the importance of technology in financial institutions while applying anti-money laundering policies. In addition, he mentions the most important initiatives that affected anti-money laundering (AML). The Vienna Convention, the Financial Action Task Force (FATF), the United Nations (UN) Convention, and the Basel Committee have proposed and developed policies on anti-money laundering.

The ‘Know Your Customer ‘(KYC) procedures play a vital role in protecting the reliability of the banking system and reducing the probability of banks becoming an instrument for money laundering, terrorist financing, and further illegitimate activities.

Terrorist financing causes various problems around the world (Koh, 2006). For that reason, international standards have been accepted and implemented by a number of countries for preventing financing terrorism. Koh examines the evolution and implementation of international standards against the terrorism financing. He includes examining and implementing the international standards of anti-terrorism financing by organizations like the FATF and the Basel Committee.

Risk assessment methods and mobile money services are important for money laundering and terrorist financing (Solin and Zerzan, 2010). Solin and Zerzan indicate that a risk assessment method has three main steps.

    •  Understanding the mobile money service

    •  Identifying Money Laundering and Terrorist Financing (ML/TF) vulnerabilities of the particular service

    •  Identifying how criminals could exploit these vulnerabilities.

Financial institution customers in developing countries can use mobile services to help prevent ML/TF activities. The Financial Action Task Force’s (FATF)guideline suggests a risk assessment method to follow.

Trading activities are one of the oldest ways launderers use to move the money from one country to another. The guideline discusses money laundering and terrorist financing within the perspective of trading, and import-export activities (Zdanowicz, 2004). Zdanowicz examines the relation between transferring funds from the USA to other countries and terrorist activities within the guidance of data published by the Trade Research Institute.

Money laundering and terrorist financing has similarities and differences (Roberge, 2007). Money laundering is about protecting the income without following the law, whereas terrorist financing intends to support terrorist groups. Roberge’s article presents targeted strategies for both illegal activities. Policies and regulations related with preventing money laundering mainly focus on financial services sector. On the other hand, terrorist groups are funding their groups with laundered money. The author indicates how money laundering and terrorist financing activities affect each other.

One of the most important ways financial institutions can fight money laundering is by knowing the customer (Low Kim Cheng, 2010). ‘Knowing the customer’ (KYC) means identifying the customer and the customer’s business. The author indicates that knowing the customer is vital to knowing his or her needs. To prevent money laundering, employees in financial institutions should ask, check, and monitor the transactions of a customer. The author discusses the importance of screening customers.

Tracking and record-keeping are vital to prevent money laundering in financial institutions (Reider-Gordon, 2011). The author discusses worldwide and legal anti-money laundering developments including policies and enforcement actions in 2010. Employees in financial institutions need to be aware of the methods to combat terrorist financing. However, implementing methods to prevent money laundering activities within the financial institutions is difficult. In this research, the author explores implementation strategies of anti-money laundering applications.

Money laundering is an international problem. Implementing traditional methods to prevent money laundering in financial systems require important human resource effort and time (Le-Khac, Markos and Ketchadi, 2009). The author discusses an approach to improve the performance of data mining-based- solution for money laundering.

The effects of fighting against terrorism in financial institutions are different on society and individuals (Vlacek, 2007). A relation between individuals’ liberty and security needs to be considered. Personal privacy and liberty arises from a surveillance of financial transactions to combat terrorist financing. Vlacek describes people banking experiences since 2001. After 2001, the requirement for Know Your Customer (KYC) became vital in the banking sector. KYC caused some problems for some recent immigrants concealing their finances from authorities. The author argues that the solution of the European Union is ‘One-size-fits-All’, means applying the same money laundering policies in the ECC.

Laws and regulations are developed for fighting corruption and fraud. However, some developing countries fail to apply anti-money laundering applications (Sharman and Chaikin, 2009). The authors examine the reasons and benefits of using anti-money laundering (AMLs) systems for anti-corruption purposes. They argue that applying anti-money laundering systems is logical in the standards for each cost of the former. They discuss how AML systems could expand the anti-corruption efforts, and they the importance of ‘ownership’ in applying AML applications in developing countries.

Detecting the action of money laundering is as important as reporting the action and applying anti-money laundering applications in financial organizations (Yang and Wei, 2010). The authors focus on three detection methods:

    •  Deviations in trading volume and frequency

    •  Unusual payments to or receipts from a typical trade partner, and

    •  The number of times a specific digit occurs in a particular position in numbers to detect financial fraud.

The authors also design an approach for detecting possible fraud and money laundering.

Governments have a significant role to stop terrorist financing activities (Lo, 2002). Lo discusses governments’ responsibilities to combat terrorist financing. The mixture of tougher legislation, enforcement, and increased international cooperation of governments can be effective to fight against terrorist financing. The author also mentions Financial Action Task Force’s (FATF) invitations and recommendations to other countries about joining the force to combat terrorist financing.

Terrorist groups are mostly established in the Middle East. The scale of those terrorist groups can be large or small (Rudner, 2010). Rudner focuses on large-scale terrorist groups that include a variety of networks within them. Rudner describes terrorist groups’ resource requirements, and the role of military, media, enterprises, and underground networks for the groups’ operational activities.

The procedures to avoid money laundering and terrorism financing in financial sector are vital in every country. To prevent money laundering and terrorism financing, private and public sector have different roles in implementation of protective procedures (Gordon, 2011). Gordon suggests that instead of private sector, governments of each country should take the responsibility of deciding whether the clients of financial institutions are money launderers or terrorists. Gordon presents information on how to prevent money laundering, the roles of the private sector, government’s role to prevent money laundering, and terrorism financing, effectiveness of the current system, and successes and failures in private sector’s role.

Anti-Money laundering policies and crime rates have a close relationship (Ferwerda, 2009). Ferwerda argues that the crime rates decrease as the anti-money laundering policies become stricter. However, implementing the policies in countries with high corruption levels is difficult. From the author’s point of view, corruption affects money laundering in two different ways. Some degree of corruption attracts money laundering whereas some level of corruption decreases MLAs by increasing the risk of money launderers to lose their funds. According to the article, the development level of a country affects the success of implementing anti-money laundering policies.

Globalization has an effect on money laundering types. Money launderers find an alternative system - the trade-based money laundering that operates outside the financial systems (McSkimming, 2010). McSkimming observes that the policies to prevent trade-base money laundering are not successful because monitoring the activity is difficult. The author also adds that even if monitoring the data is possible, the application of policies would still be unsuccessful when the current system has major flaws. In this article, the writer also discusses the flaws of the system.

Transparency is the key to a successful global financial system (Baker, 2010). Financial institutions need to take several steps to fix the global economy. The first step is to eliminate secrecy of ownership. Determining the beneficial owners of the non-individual accounts, would protect the financial institutions from the unknown owners and money launderers. The second step is to report cross-border financial institutions’ and multinational corporations’ results on a country-by-country basis. The third step is to exchange tax information across the borders automatically. The final step is forbidding businesses to maintain two different sets of accounts. These steps are maintained to protect the financial institutions and businesses from illegal activities.

The use of Internet in business is important. Electronic money transferring is an opportunity for money launderers (Morris-Cotterill, 1999). Money launderers can send a message to hide, invest, or move the money via electronic money transferring systems. Internet banking systems are more efficient than traditional banking systems for financial funds transfer. This author discusses the method that money launderers use within the Internet banking systems.

Canadian anti-terrorism financing regulations have two components (Annand, 2011). The first is an amendment to the Criminal Code of Canada that includes the subjects of terrorist financing and related activities in the criminal code. The second includes the Proceeds of Crime Act that involves the money laundering and terrorist financing act. Annand discusses the success of Canada’s current legal system on preventing terrorist financing by analyzing its negative and positive aspects. The author uses cost and benefit analysis to indicate the efficiency of anti-money laundering regulations of the existing legal system.

International businesses adopt anti-money laundering and combat terrorism financing applications by including reporting suspicious activities and knowing and identifying customers to protect their businesses from money laundering and terrorism financing (Delston and Walls, 2009). The authors describe trade-based money laundering and its requirements, Financial Action Task Force’s (FATF) 40 requirements and implications for financial institutions including exporters, importers, and other traders.

European Union (EU) has some approaches to prevent money laundering and terrorist financing (Tavares and Thomas, 2010). Members of the EU need to apply the regulations imposed by the EU Commission. The authors measure money laundering at the European level. The authors also examine the statistical data between EU member countries and Suspicious Transaction Reports (STRs). The authors also observe and explain the reasons behind the difference in STRs for each country.

Financial Transactions and Reports Analysis Centre of Canada has recent (2016) information and developments about anti- money laundering regulations for financial institutions and the public.5

‘General public and financial institutions should be aware of money laundering methods to chase dirty money’ (Reuter and Truman, 2004). Knowing the methods and results of the crime has a relation with the crime’s effect on macro and micro economy of a country. The authors also examine the prevention and enforcement methods of the crime.

‘Money laundering can have devastating economic consequences’ (Quirk, 1997). Fighting against money laundering is vital for all countries to prevent the negative effects of the crime. The author observes various ways of money laundering and problems that arise from it. Policy implications are significant for anti-money laundering efforts. The author also examines the importance of exchange controls, statistical reporting, and tax collection.

Yen (2005) examines the cost and benefit relation of anti-money laundering regulations. The author observes the efficiency of the regulations when costs of applying them change. He also compares the U. K with the USA, Italy, Germany, and France. The costs of applying AML applications vary in each country. The authors also observe people’s perceptions on how the regulations are effective to prevent money laundering activities.

Rietbroek explores the significance of technology in money laundering methods. Launderers take advantage of the technology to launder dirty money. The main reason for launderers to choose digital system is the weakness in financial systems’ regulations. As digital system improves the governments of countries have difficulties in adapting new technologies because of their limited budgets.

____________

1Money laundering is the process of transforming the proceeds of crime into ostensibly legitimate money or other assets.

2The Bank Secrecy Act (BSA), also known as the Currency and Foreign Transactions Reporting Act, is legislation passed by the United States Congress in 1970 that requires U.S. financial institutions to collaborate with the U.S. government in cases of suspected money laundering and fraud.

3http://www.anti-moneylaundering.org/

4OECD is comprised of 35 countries as of August, 2016. http://www.oecd.org/internet/broadband-statistics-update.htm

5 Please note that you have a transition period of one year (June 30, 2016 to June 30, 2017) to adopt new methods to ascertain the identity of clients. http://www.fintrac.gc.ca/intro-eng.asp

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