Money Laundering

MONEY LAUNDERING RESEARCH WITHIN A

POSITIVIST PARADIGMPROFESSOR JACKIE HARVEY

Newcastle Business School

Money Laundering

The process of transforming, through a series of stages, the proceeds of illegal or criminal activity, into apparently legitimately acquired funds. “The more able launderers are in exploiting legitimate financial transactions, the greater their likely

success”

Money laundering entered into the legislative framework in 1986, gaining momentum in 1991 with the first EU Money Laundering Directive


Source: UNODC - UN Office on Drugs and Crime : The Money Laundering Cycle

http://www.unodc.org/unodc/en/money-laundering/laundrycycle.html

Three Stages of Money Laundering


Institution Estimate Year

OECD $1.1 trillion (drug money) 1995

IBRD $300 - $500 billion 1995

IMF 2% - 5% GDP ($0.62 – 1.55 trillion) 1999

UN Up to $1.5 trillion 1999

FATF 2% global GDP up to $1.5 trillion 2001

Global Scale


Phantom or Fact?

Global estimates are little more than informed guesses, gaining ‘reliability’ through mere repetition but lacking empirical underpinning The bigger and more threatening the estimate, the more

likely it is to be adopted (van Duyne (2003), Reuter and Truman (2005), Levi and Reuter (2006), Harvey (2005, 2008)).

Implicit assumption that amounts involved are huge and pose a significant threat to the integrity of the financial system and to the reputations of domestic financial institutions Tendency to ‘talk up the figures’ as lower figures would

invalidate the logic of AML (van Duyne et al 2005) “Social Panic” (Harvey, 2008); “Moral Panic” (Alldridge 2008)


Countermeasures

Dual pronged approach comprising Criminalisation of money laundering Regulatory enforcement through a reporting

framework KYC and SARs

The imposition of both increases the probability of detection and conviction (costs) and reduces the financial attractiveness of laundering (benefits) However, “most launderers face a low risk of getting

caught” (Reuter and Truman, 2005)


Theoretical Framework

Money laundering can be considered by applying an economic framework to the legal system transferring the notion of the rational actor

The purpose of the legal system can be viewed as maximising ‘social welfare’ with laws used to achieve specified ends Laws are efficient solutions to the problems of organising society

The positive approach to law is concerned with how actors behave in response to changes in the legislative framework Reliance on the presumption that criminal activity is reactive to

external forces


Theoretical Framework

Removing access to the financial benefit of crime will reduce its attractiveness ‘rational’ criminals will apply cost/benefit analysis to

activity

However, “laws may come about because of the rent-seeking activity of politically powerful actors” (Jolls, Sunstein and Thaler,1998)

Thus laws can be introduced to maximise social welfare or to redistribute ‘wealth’ towards interest groups.


Vested Interest and the “Status Quo”

Politicians need to be seen to be doing something “tough on crime” “removing the benefit of crime”

“Rent-seeking” behaviour by government departments and LEAs Goal of budget maximisation supported by “The criminals are

always ahead of us” Those employed within compliance

Specialist organisation Creation of a ‘profession’

The ‘security’ industry AML solutions, profiling and training is a multi-million pound

business Responsibility to balance the call for an ever widening arsenal

of tools against the costs imposed on society and against legal rights (Van Duyne et al 2005)


The Relentless Expansion of Legislation

No real analysis of costs, benefits or effectiveness of existing regime but sheer hope that such a blanket approach will in some way prove effective. “Unfortunately legislators sometimes behave like fishermen

who cannot stand the fact that some fish may escape their nets. This leads to an ever greater widening of the nets of the penal law in order to catch the last remaining fish (van Duyne, 2003)

The UK “the greatest devotee of AML provisions within the EU (Levi 2003) Van Duyne et al. (2005) draw attention to the belief in ever

increasing amounts of crime money as an ‘article of faith’ whereby the righteous believers do not question its existence but look for and repeat the scattered pieces of evidence that reinforces its existence.


Money Laundering Offences

POCA, 2002, Part 7“acquisition, use, possession, disguise,

concealment, conversion, transfer or removal from one country to another of the benefit of any criminal conduct can be money laundering. Even an attempt to do any of these things, or becoming involved in an arrangement which facilitates them can constitute a money laundering offence”.

Crown Prosecution Service, 2008


“Put simply, POCA makes it possible to seize cash from a suspected criminal and places the onus on that individual to prove that the money has been acquired legitimately. Confiscation orders, reflecting the value of criminal proceeds, can be made against those who commit any of a wide range of offences or can be shown to engage in a ‘criminal lifestyle’. The Act also creates an all-encompassing web to catch anyone who moves, hides, converts or otherwise has possession of cash or property that represent the proceeds of crime.”

Source: Payback Time JOINT REVIEW OF ASSET RECOVERY SINCE THE PROCEEDS OF CRIME ACT 2002


Impact Assessment – the Benefits

“there will be benefits to business from reducing their vulnerability to money laundering ” (1993)

“society will be the main beneficiary of the new regime, as a result of the more effective combating of money laundering and the criminal activity that underlies it ” (2001)

“reduction in money laundering activity” (2003)

Simplification measures estimated to result in savings of £10 - £31 m (2007)


Impact Assessment – the Costs

“total costs for the financial services sector - an initial £30m with recurrent compliance costs of between 0.03% and 0.5% of annual running costs” (1993)

“additional costs of the regulatory regime to be relatively small ” projected total sector costs £5 – £7m pa. (2001)

Between £80 and £100m for the legal and accounting professions and £10 to £15m for estate agents. (2003)

“The Government’s preferred options total £25 – 52m in policy costs and £10.5 – 13m in administration costs for implementing the Directive”(2007)


The Regulatory Framework

It remains to be seen whether this increased burden will be justified by a proportionate increase in the amount of money laundering which is detected and prevented” (Fox and Kingsley, 2002) That burden comprises

Operating costs of compliance Costs of enforcement Costs on society


Major significance for business practiceRegulations cover banks, financial institutions,

accountants, legal professions, gaming, estate agents, auctioneers and so on

Total costs of compliance run to hundreds of millions a year

Need to focus on accuracy of risk assessment ensuring cost of prevention on industry and on society is appropriate

Business Practice


Just as communication and technology enabled developments have dramatically altered patterns of business activity they have created potential for associated criminal exploitation of new modus operandi

Criminal infiltration of legitimate business can have a significant impact IF it occurs

Issue – how much to invest in prevention?Challenge is to objectively assess the scale of

the problem o How likely is it to unwittingly facilitate the action of

launderers?o How great would be the negative impact on reputation?

Risk Background


Expenditure on AML Compliance

A profit maximisingA profit maximisingfirm will invest in AMLfirm will invest in AMLto the point where to the point where costs of compliance costs of compliance just offset ‘costs’ just offset ‘costs’ or losses or losses arising from not arising from not undertaking such undertaking such activity (AMLE)activity (AMLE)

Exp

en

dit

ure

Extent of AML Effort

Cost of compliance

‘Cost’ ofnoncompliance

AMLE

Total cost


The Costs of Compliance

“demands of ML are immense and it is harder to cope with the costs of compliance” and “the level of rigour disregards how little is achieved by obtaining the required information” (interviewee 7)

“there is a need to reduce money laundering but...it is difficult for a profit oriented institution to carry these costs” (interviewee 6)

“in the past we were prepared to spend on compliance but it is now like an escalator – constantly going up” (interviewee 1)

Survey of compliance officers June 2009 budgets ranged from millions to a rather worrying zero “done as additional task outside company time” majority of responses £100-£200k per annum


Reputation

Why do profit maximising institutions commit resource to compliance? A culture of ‘sanction avoiding’ rather than reputation enhancing

compliance SARs used as an internal performance measure “much compliance activity is driven by fear rather than by

benefits to the firm” (interviewee 3) 60% of respondents to 2009 survey noted no disclosure in

annual reports and accounts “no mention or statement of money laundering activity is

included in the annual report. We do not wish to draw attention to the amounts being spent on compliance as this would result in a small revolt internally” ...............“the BBA would have to drive any disclosure of costs but..it does not have the appetite to do this as they are too much in the pocket with the statutory authorities” (interviewee 1)


Public Perception

Impact on institutions fined for non-compliance?

Integrity of the financial system is built on trust and it is this that contributes to reputation not where criminals maintain their bank accounts.

money per se is neither clean nor criminal the tag of laundering becomes attached by association

with something perceived to be illegal.

Public awareness remains low It will only become an issue when customers lose money

(Alldridge, 2003)


Rationalisation

Evidence of a legitimacy seeking approach focused on compliance with systems and procedures “most of the people think this is a moral crusade but the end is

seen as a good thing... [it is] hard to describe what you do on a day to day basis and to say it is a complete waste of time” (interviewee 9)

Emergence of a ‘tick-box’ culture where the objective becomes compliance rather than protecting from criminal contamination Being seen to do the right thing

“the level of rigour disregards how little is achieved...identification does not provide a barrier to crime” (interviewee 7)

Evidence of a “sunk cost bias” “the KYC procedures are embedded in mythology of money

laundering compliance and it will take a lot to suggest a different approach” (interviewee 5)


Effectiveness

Perfectly in order for authorities to anticipate and pre-empt criminal action that has a detrimental impact on society but requirement for prudence

Should we not have seen the impact of over a decade of rigorous application of AML? It is impossible to measure the impact of the anti-money

laundering regime on predicate offences. Cannot measure how much would have occurred in its

absence (Levi and Reuter, 2006) “The vast majority of FATF members lack sufficient data

to support any credible estimate” (FATF, 1997. p.3)

Convenient to suggest that criminal activity continues to expand


Effectiveness

AML may lack effectiveness as it targets the wrong area (Chong and Lopez de Silanes, 2007)

Rather than asking how well it works we should ask – does it make a difference?

Focus on ‘second best’ measures SARs

Regulatory ‘back covering’ Is it ‘suspicious’ or merely ‘unusual’ – Survey 2009 40% of

respondents were confident they could distinguish the difference Prosecutions/convictions Asset Recovery

“seizing criminal assets....is a key tool of law enforcement. It reduces crime...and ensures (and shows) that crime does not pay” (Home Office, 2006)


Suspicious Activity Reports


Prosecutions

All Legislation*

2003 2004 2005 2006 2007

prosecutions

300 552 1327 2379 2318

convictions 123 207 595 1273 1348

sentenced 119 205 575 1244 1322

Of which POCA

prosecutions

87 405 1295 2345 2281

convictions 15 123 566 1257 1330

sentenced 12 121 545 1229 1304* All legislation refers to S49-53 Drug Trafficking Act 1994; Criminal Justice Acts93A-93D as amended by CJA 1993 s29-32 and POCA 2002 s327-334


Prosecutions for Money Laundering

Conviction for Money Laundering Offences

Data for 2005 Number %

Total Convicted 595

Of whom ‘sentenced’ 575 100%

Conditional Discharge 54 9.4%

Fined 53 9.2%

Community Sentence 240 41.7%

Suspended Sentence 29 5.0%

Immediate Custody* 194 33.7%

Otherwise Dealt With 5 0.9%

*Average sentence length: 25.7 months


Asset Recovery

Targeted recovery of £250m 2009/10Longer term goal of £1 billionNaive and unsophisticated estimates – HM

Treasury (2007) study of a sizeable sample of the 200,000 SARs – indicated a median value of £10,000 and a mean of £35,000. assumed 40% ‘suspicious’ thus revealing £2-3 billion of laundered funds (35,000*200,000*40%)


Asset Recovery

2006/7 2007/8 2008/9

£ £ £

Cash seizure 3.3m 8m 9.2m

Restraint orders 27.2m 46.8m 128.8m

Confiscation orders 14.5m 11.6m 29.7m

Civil recovery n/a n/a 16.7m

Restraints can be placed for any hypothetical value on assets ‘frozen’ in advance of investigation – key is confiscation orders imposed by courtBut not all of these are recovered


Costs of the FIU

£million 2004/5 2005/6 2006/7

2007/8 2008/9

SOCA 419.4 456.5 465.3

Total for other agencies*

279.5 282.8

*other agencies refers to ARA, NCS, NCIS and part of Customs and Excise. It was not possible to determine which ofthe costs and associated budget for HMRC was also transferred


Is it entering the Financial System?

US DEA seize $207 million, 200,000 Euros and 158,000 pesos in a drugs raid in Mexicohttp://www.washingtonpost.com/wp-dn/content/article/2007/07/24/AR2007072400150.html


What is the scale of the problem and how threatening are criminal money flows?

Extensive data bases obtained from Home Office (JARD) and ARA

Findings – no evidence to underpin size of threat estimates, flaws in data management and unsophisticated criminals

Evidence


Home Office

Home Office data on asset recovery tracked by remitting agency

2003/4 2004/5 2005/6

Largest single payment

£1.01m £1.07m £0.91m

Average payment size

£11,122 £1,050 £7,832

Median payment size

£491 £500 £300


Data Reliability - ARA

Richer data but contains errors of duplication and amounts do not add up - no internal tracking or verification

Database of 162 cases only 32 were for values of greater than £1m.

218 individuals but 11 cases had no ‘client’; majority (118) involve one person although one case had 11 identified people


Major Areas of Criminal Expenditure (ARA Data)

UK Property 471 houses £75.02m

High value goods

Cars, paintings, jewellery

£ 7.05m

cash £ 9.68m

Financial assets

Bank accounts, insurance, pensions shares

£11.02m


Threat that criminal money flows undermine integrity of financial system lacks foundation

Estimates of scale are unsubstantiated Criminals appear to lack sophistication

Vested interest support the status quo Those employed in the industry will seek to justify the costly

existence of a host of AML solutions and the continued importance of their function by repeating the mantra of threat

But significant costs for regulated sector

There is potential in these spheres but ensure risk assessment is realistic and that response is proportionate, based on empirical evidence – on fact not on phantoms or myths

Key findings


Money Laundering

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