CHAPTER 3

Money Laundering Detection Methods

Money laundering is a dynamic process. It involves a circulation of money or fund transfers in and out of a country to legalize the source of those funds. Some measures to decrease the circumvention of this form of illegal activity include:

    •  Deviations in trading volume and frequency,

    •  Unusual payments and receipts from an unusual trade partner, and

    •  Financial Fraud which is known as Benford’s Law, based on the numbers of times a specific digit occurs in a particular position in numbers to detect financial fraud (Yang and Wei, 2010).

Many applications and reporting regulations are published by anti- money laundering institutions for financial organizations or public to collaborate with AML procedures. These procedures and models have resulted in stopping some dynamic money laundering activities. However, applying each detection model at the same time is difficult because of the amount of information involved.

Trading volume and frequency could be measured by Transaction Assessment as a result of applying a detection model that observes Normal Behavior Patterns.1 According to that model, the technique is to evaluate the information with the unusual (outlier) behavioral pattern in the same data set. For example,

    •  If monthly trading volume and frequency do not match with the Normal Behavior Pattern (NBP), the targeting company would be suspicious, which means that the targeted business is not stable and could involve money laundering activities.

Every company in a stable business has a certain capacity and content. The Trade Correlation Test conformity requires saving all the receipts and payments received from the buyers and suppliers that the company had relation with. With this method, companies may save themselves from involvement in money laundering activities. To achieve that objective, they need to provide evidence of their receipts and payments matching the scope and subject of their businesses.

The Financial Fraud Detection method is based on Benford’s Law2 used to identify accounting capabilities, fraud, and profit manipulations in corporations. The law is not very functional for individuals because of its structure. The law’s structure is based on evaluating the numbers on an income statement of a company. The account needs to involve money received from falsified entries such as forged financial statements or taxes. Cash flow, total assets, account receivables and payables, and the balance sheet include significant data allowing to examine the financial information of a company.

Some weaknesses of these techniques result when each of them is applied only individually in a corporate organization:

    •  Transaction Assessment would not be successful when the corporate firm’s data is close to the targeted data in a same company.

    •  The Trade Correlation Test is a very effective method to examine if the company’s trading status is matching with its business scope. However, this detection strategy could not verify whether the company is related with money laundering activities or not.

    •  Finally, the Fraud Detection method is related only with some particular accounts where fraud might exist. These accounts require detailed analyses by the authorities to find money laundering activities within.

Applying all these methods together is called the ‘Multiple Detections Approach (MDA)’ (Yang and Wei, 2010). MDA is a method to reduce the weaknesses of these three methods when applied individually. Moreover, a money laundering activity may not be detected with only one of these three detection methods. At this point, MDA is the best approach to detect fraud in financial institutions. If a company fails all three of these detection methods, the organization is suspected of money laundering activities.

In addition to the detection methods above, other techniques are used in trading (export and import) activities of financial organizations to detect money laundering and terrorism financing movements. Some different conditions are listed as follows:

1. Overvalued Import Transactions

The value of an imported product is more than its worth and the exporter abroad pays inflated price for the product. As a result, the possession is transferred from the domestic importer to the foreign exporter. The deal is not profitable for the importer. However, if both sides of the business transaction are partners they both share the profit. These kinds of overpriced import transactions may cause three types of crimes:

    •  Customs Fraud, Income Tax Evasion, and Money Laundering (Zdanowicz, 2004).

In addition, the exporter, who receives the money from the domestic importer, might be a member of a terrorist organization and use the fund to serve that purpose. In that case, the transactions would take the form as presented in the example below:

    •  A criminal desires to launder $1 million through an exporter as a business partner to a foreign country. The steps he would follow would be:

    •  The exporter purchases 10,000 products paying $0.10 for each or $1,000 in total.

    •  The exporter exports 10,000 overpriced products to the domestic importer for $100 each. The invoice of the transaction is worth $1,000,000.

    •  The domestic importer pays $1 million for those 10,000 products (originally worth $1,000)

    •  As a result, the domestic importer launders $1 million to a foreign country through the transaction including the original cost of the products at $1,000

2. Undervalued Export Transactions

Another method that criminals choose to launder money to a foreign country is undervalued export transactions.

The domestic exporter purchases products at its market price. These products are shipped to the foreign importer for undervalued prices (below products’ market prices). The importer receives the products below their market value and sells them at their original market prices to make a profit.

According to the research of Zdanowicz, (a Finance professor at Florida University and previous director of the Center for Banking and Financial Institutions, as well as a consultant to the U. S. Department of Justice on transfer pricing and money laundering), terrorist and launderers prefer this method as the most common technique for laundering money out of the United States. Some of the reasons behind the preference of undervalued export transactions are:

    •  Most governments do not effectively monitor their export transactions, and

    •  Criminals do not use financial institutions for their transactions because government agencies monitor them.

Money Laundering and the Combat with Terrorism Financing (CTF)

After the attack on the Twin Towers on September 11, 2001, the threat of terrorist activities became more important. The unfortunate event increased the awareness of people on terrorism and their financing activities. Terrorist groups achieve their illegal activities with the support of their financial sources. The members of terrorist groups aim to launder their financial source of funds to use them for future illegal and criminal activities. The terrorist organizations require financial support to maintain their growth and profit.

MASAK (The Financial Crimes Investigation Board of Turkey) introduced some measures to curtail terrorism financing by expanding its Suspicious Transactions list and bettert protect financial organizations from theterrorist financing. According to the 2009 Turkish Criminal Law No. 5237, the penalties for crimes of terrorism financing and money laundering are as follows:

    •  A person who conceals the source of an income gained from a crime can be sentenced to prison from 3 to 7 years, and a person who transfer the money gained from an illegal activity could end up 6 months in prison.

    •  A person who was not involved the crime but obtains or uses the proceeds of the crime could be sentenced from 2 to 5 years to prison.

    •  If the crime is committed during on duty by a professional or a public officer, the penalty could increase by one half.

    •  The penalty could be doubled when the crime is performed in an organization created to committing a crime.

    •  A person who directly secures the financial assets by reporting the crime to the related authorities before it actuates will not be punished.

‘Criminal organizations and terrorist groups share some similar traits in their organizational structure and dangers they pose to society’ (Roberge, 2007). Criminal organizations plan their activities for profit when terrorist groups plan their actions for political objectives. However, terrorist groups do not only aim to use their funds for acts of terror. Terrorist organizations may also fund organized and militant groups with political objectives.

Terrorism is a very debatable subject. It can also refer to people fighting for their freedom and independence. For that reason, differentiating the terms ‘guerilla warfare’ from ‘terrorism’ by examining their activities is difficult. Some terrorist organizations offer welfare-type of services and some business branches that include political, social, and terror activities. Some governments decrease money laundering and terrorist financing activities by shutting down the charity organizations which might be involved in illegal activities.

Profit and politically focused organizations are also difficult to distinguish. However, they may be connected in some situations. Politically focused groups need funds to continue their activities when they collaborate with other organizations to gain access to illegal sources of funds. On the other hand, profit based organization are not necessarily collaborating with politically focused groups.

Besides organizations, individuals can also support terrorist groups or politically focused organizations. I Individuals or organizations may provide funds to the terror groups voluntarily or under threat. For instance, Pickert states that the Tamil Tigers of Sri Lanka is one of the most organized, brutal, and effective terrorist groups in the world. The members of the group fight for their freedom to separate from Sri Lanka. The group members continue their activities and receive their funds mostly from drug smuggling and robberies. Members of Tamil Tigers also threats people to fund their activities.

Extortion is a generally preferred method by terrorists, especially in drug smuggling. The Washington Post published in 2012 an article about a Canadian who admitted trying to help the members of, the Tamil Tigers, considered a terror organization in Canada. He admitted that he provided $22,000 worth of material in support of the terrorist organization in February of that year.

Terrorism also can be financed by states such as Libya and Iran. Roberge states that Saudi Arabia and some countries in the Middle Eastern Region transferred many times funds to terrorist groups like Al Qaeda and Osama Bin Laden.

Money laundering and terrorist financing activities also affect international financial system in different ways. Money laundering decreases the financial stability and harms the reputation of legitimate organizations when terrorism activities can harm the financial system.

Money launderers can transfer and receive the dirty-money several times by using the same financial institutions to launder the funds.

The use of offshore centers is another efficient way to launder money. Money launderers prefer offshore services, where financial services are offered to non-residents as well as residents, especially in layering stages where they aim to conceal the source of the money. Terrorist organizations also prefer to operate in places where authority is deficient, like in some offshore centers.

Terrorism financing does not require ‘placement, layering, and integration stages’ as money laundering does. According to Zen, the source of terrorism financing may not be illegal so it does not need to be laundered to integrate into the economy. Only the layering stage could be common in both illegal activities to conceal the source of the money.

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1Typically the anomalous items will translate to some kind of problem such as bank fraud, a structural defect, medical problems or errors in a text. Anomalies are also referred to as outliers, novelties, noise, deviations and exceptions.

2Benford’s Law (in mathematics) is the principle that in any large, randomly produced set of natural numbers, such as tables of logarithms or corporate sales statistics, around 30 percent will begin with the digit 1, 18 percent with 2, and so on, with the smallest percentage beginning with 9. The law is applied in analyzing the validity of statistics and financial records.

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