Money laundering, 21st century-style, part 1 of 2

Companies are realizing that good anti-money laundering programs can do more than satisfy regulators — they can boost the bottom line by reducing major business risks. Transnational organized crime is more profitable than ever, and money launderers are devising new methods to hide the true source of illicit gains. Here are the U.S. federal government's latest anti-money laundering efforts plus ways CFEs can help businesses cope with schemes and payment technology risks.

Even when a crime is innovative and unfamiliar, investigators often can associate it with similar cases they've solved. New needle — old haystack.

On Jan. 24, in McAllen, Texas, a federal district court judge sentenced 12 people to prison after they pleaded guilty to violating the U.S. statutory requirement (31 CFR 103.23) to declare cash sums greater than US$10,000 when entering or leaving the country. The defendants had concealed US$3.1 million in air mattresses aboard a Mexico-bound commercial passenger bus inspected at the Hidalgo, Texas, border crossing. New cache — old method. U.S. Customs and Border Patrol, which astutely detected the stash, and U.S. Immigration and Customs Enforcement's Homeland Security Investigations (ICE/HSI) worked the case jointly.

Sometimes, however, money launderers create an entirely new haystack, making detection and prevention harder. To counter such criminal innovations, HSI has redoubled its efforts, particularly with respect to an emerging technique known as trade-based money laundering (TBML). One week after the Texas trial, the corrupt leaders of a California toy wholesaler were convicted of TBML. Here's how investigators gathered the evidence that made the case.

ICE TURNS UP THE HEAT

On Jan. 30, 2009, two women — co-owners of the Angel Toy Company (ATC) — made a US$7,000 cash deposit into the firm's local bank account. There are nicer parts of Los Angeles than the gritty south side, where ATC, a wholesaler employing 29 people, was located. But business was good, especially when a certain few ATC customers would drop off bags of cash — sometimes containing more than $100,000 — as payment for teddy bears and other toys.

Meichun Cheng Huang, ATC's vice president in charge of sales, and Ling Yu, the president of ATC, would divide the money into amounts less than US$10,000 before bringing them to the bank. Then they would wire the money to a factory in China, which would ship the merchandise to Colombia where another ATC store would sell the toys for pesos and deliver the converted cash to associates of the Los Angeles customers. Through this arrangement, Huang and Yu earned considerable income for ATC, and they kept the assembly line busy in China. Plus, the special Los Angeles customers were happy to have their U.S. dollars converted into Colombian pesos and delivered to their accomplices in Bogota.

Huang and Yu, though, were in for a surprise. A few months earlier, multiple informants had reported the large cash drop-offs to HSI's Los Angeles office. HSI leads all TBML investigations. Cash payments to a wholesaler didn't make business sense, so HSI quickly began surveilling ATC in cooperation with the California Attorney General's Bureau of Narcotics Enforcement. The investigation revealed that the women's US$7,000 deposit was their 76th structuring transaction, totaling US$8 million.

Soon thereafter, the U.S. Department of Justice (DOJ) charged Huang, Yu, ATC itself and Jose Leonardo Cuevas Otalora, the owner of Angel Toys Colombia in Bogota, with structuring, laundering and participation in the Black Market Peso Exchange, which DOJ described as "a method of trade-based money laundering that exchanges drug money in the United States for ‘clean' Colombian pesos through the international purchase and shipment of goods."

In October 2009, a grand jury in U.S. District Court in the Central District of California indicted all four defendants on those charges. Other owners of ATC in Los Angeles apparently were unaware of the fraud, and the grand jury didn't indict them. Huang and Yu pleaded guilty on all counts, and they were sentenced on Jan. 31 to 37 months in prison, and each was fined US$20,000. ATC was ordered to forfeit $1 million to the U.S. government. Cuevas is in custody in Colombia, pending his extradition to the U.S.

"Our efforts against the Angel Toy Company and other TBML operations support the national strategy against transnational organized crime," says Rex Setzer, section chief of HSI's Illicit Finance and Proceeds of Crime Unit in Washington, D.C. "To reduce the fraud risk associated with international trade, we set up Trade Transparency Units (TTUs) that analyze trade-related data we exchange with countries that partner with us on this issue." [In July 2011 President Barack Obama introduced the National Security Council's plan to mitigate global money laundering and other persistent criminal threats to U.S. security.] 

Those countries include Argentina, Brazil, Colombia, Paraguay, Mexico, Panama and Ecuador. A specialized HSI computer resource, the Data Analysis & Research for Trade Transparency System (DARTTS), enables investigators to examine information from both sides of an international transaction, looking for red flags indicative of TBML and other trade- and finance-related crimes.

"DARTTS was one of the many tools we used to detect the ATC scheme," Setzer says. "We have a TTU agreement with Colombia, but not with China, so that left a blind spot on one leg of the ATC trades. But we jumped on those informant tips and on information from financial institutions. If CFEs see similar practices that don't make business sense, we ask that they contact their local HSI office to fill us in," Setzer says. "We welcome their help."

LEAVE THE TOMMY GUN; HIDE THE BOOKS 

"The feds got Al Capone for tax evasion not racketeering," says Jonathan E. Turner, CFE, CII, principal of Wilson & Turner Incorporated, an investigative consultancy headquartered in Memphis, Tenn. "His financial crimes — more than his violent felonies — brought him down. After that success, the federal government began to enact laws that prohibit the financial practices criminal organizations typically employ, such as setting up shell companies to facilitate illegal operations and launder their profits."

Since the 1970s, he says, the federal government has increasingly required the private sector to screen, analyze and report any signs of financial crime.

"Over the past 40 years, most companies have viewed their AML programs as a compliance obligation, but not as a way to manage business risk," Turner says. "That's unwise. Financial criminals used to focus on banks, but now that banks have sharpened their AML programs to satisfy regulators, fraudsters are going after easier targets. That means your clients if you're a CFE who serves small- and medium-sized businesses."

(Turner, an ACFE regent emeritus, specializes in prevention and detection of financial fraud and employee crime, and he's a member of the ACFE faculty. His recent book, "Money Laundering Prevention: Deterring, Detecting, and Resolving Financial Fraud," published by John Wiley and Sons, is available from the ACFE Bookstore.)

RIGHT-SIZE YOUR AML PROGRAM

"It's important that CFEs help their clients and employers understand that money laundering is far from being a crime committed only by drug cartels and terrorists. In fact, it plays an important role in nearly every fraud scheme," Turner said. "In a classic embezzlement, a bookkeeper creates a fictitious company and pays it. Then, through that company, the bookkeeper hires her husband and pays him a salary. That's money laundering."

To guard against such risks, smaller firms don't need the same level of AML protection as a large business, he explained. Simply being aware of the risks they face is key. CFEs, armed with insights gleaned from fraud risk assessments, often can identify and propose relatively minor changes that will significantly reduce their smaller clients' greatest risk exposures.

TOO GOOD TO BE TRUE

"For example, business owners invited to participate in potentially profitable but unusual ventures should be wary," Turner said.

Customers who want to pay cash for commercial transactions or entities that offer generous "commissions" for facilitating in-country payments might not seem risky. But money launderers often use these techniques to obtain the unwitting cooperation of lawful businesses. All known terrorists, narcotics traffickers and slave traders are banned from the U.S. financial system. So CFEs should advise their clients to be on the lookout for tempting but dubious propositions from front companies or apparently legitimate banks and financial firms.

Turner cited a recent case that illustrates the risks money laundering poses to businesses. In December 2011, the U.S. Department of Justice (DOJ) filed a civil complaint against the Lebanese-Canadian Bank (LCB) and others, alleging they had conspired, by means of multinational money laundering, to combine legitimate funds with criminal proceeds and divert both to Hezbollah.

According to the still-pending complaint, the scheme involved transferring approximately US$230 million from Lebanon to the U.S. to purchase used cars from more than 30 dealers, shipping them to West Africa, selling them for cash and transferring the proceeds, along with those from narcotics trafficking and illegal diamond trading, to Lebanon. Thus the scheme allegedly involves a deceptive combination of disparate activities: trafficking in illegal drugs is prohibited everywhere, commerce in diamonds from war zones is banned in some jurisdictions and used car sales are legitimate throughout the world.

By virtue of its name, LCB might appear to be Canadian. But it's headquartered in Beirut and has more than 30 branches in Lebanon. Its Canadian presence consists of a single office in Montreal.

"This scheme and its activities originated in Lebanon," Turner said. "In this way the conspirators allegedly masked the true purpose of their venture — funneling money to a terrorist organization. This case illustrates many modern money-laundering techniques, including the use of numerous intermediaries and straw participants, exploitation of gaps between various countries' legal systems and unrelated criminal activities. As money launderers conceive ever more creative ways to evade government attention, legitimate businesses and CFEs advising them must be more alert than ever to these kinds of fraud."

FINCEN: LEADERSHIP AND SUPPORT

For the U.S. Financial Crimes Enforcement Network (FinCEN), money laundering is a top priority. "Criminals' primary motive is profit," says the FinCEN's director, James H. Freis Jr. "This bureau's role is to follow the money." (Freis is an ACFE Cressey Award recipient.)

FinCEN has two anti-money laundering (AML) goals, he explains. The first is to make it more difficult for criminals to introduce their illicit gains into the financial system so they can use that income as if it were legitimate. The second goal is to use criminals' financial accounts and transactions as sources of intelligence and evidence that law enforcement and the judiciary can use to track the criminals down and hold them accountable.

These long-standing objectives guide FinCEN's support of law enforcement and private industry's AML activities and coincide with the federal strategy to fight transnational organized crime.

As the U.S.'s financial intelligence unit (FIU), FinCEN is the national agency responsible for receiving and requesting — where permitted by law — financial information concerning suspected crimes and disseminating it to law enforcement and other authorities. FinCEN is one of more than 100 FIUs making up the Egmont Group, an international entity whose members share information and analytics to better detect and prevent money laundering and many other cross-border financial crimes.

FinCEN also supports the U.S. Department of the Treasury's efforts to promote adoption of global AML standards through the nation's membership in the Financial Action Task Force (FATF), which the Group of Seven (G-7) nations established in 1989 to fight international money laundering. FATF members include 32 nations and territories and two regional organizations. The FATF has issued 40 "Recommendations" that more than 180 governments use to guide their efforts against money laundering, terrorist financing and corruption.

"Similarly, when we work with our partners in private industry, the keys to success are mutually supportive teamwork and recognition of natural incentives," Freis says. "For example, the bottom line suffers when fraud undermines business. So, we want banks to actively protect their own and their customers' financial interests by being alert to the various ways criminals might move money through their systems."

To illustrate, he says, a bank itself could be the victim of the false representation a criminal makes when applying for a loan he intends never to repay. Or the bank might be the unwitting intermediary a fraudster uses to victimize a bank customer. In that instance, the bank wouldn't experience a financial loss, but its reputation would suffer as a result of its inadvertent enablement of the fraud.

In addition to its statutory role discussed above, FinCEN issues and interprets AML and counterterrorism financing regulations, and it supports and enforces compliance with them.

In 2011, FinCEN issued a rule intended to mitigate the high money-laundering risk presented by prepaid access devices such as plastic cards, mobile phones, electronic serial numbers, key fobs and/or other mechanisms that provide portals to funds that have been paid for in advance and are retrievable and transferable.

"Organized criminal networks are quite sophisticated," Freis says. "So we and law enforcement strive to anticipate and address the risks inherent in new technologies and financial services such as these."

In March 2012, all the rule's provisions had become effective. (See answers to frequent questions.) Because of the anonymity of these products and services, the rule imposes an advance identification and record-keeping requirement that makes them more resistant to criminal abuses and better enables FinCEN to work with law enforcement in following the money during individual investigations.

"We also worked closely with the financial services industry to ensure that, as much as possible, the rule would avoid putting particular products or business models at a competitive disadvantage and would adapt to evolving technology and consumer demand," Freis says. "Public reaction has been favorable, indicating we found a balance between regulatory effectiveness and marketplace feasibility."

FinCEN also has enhanced its data collection in the real estate finance sector. In November 2011, the agency proposed a rule that would require Fannie Mae, Freddie Mac and the Federal Home Loan Banks to develop AML programs and file Suspicious Activity Reports (SAR) with FinCEN. And in February 2012, it finalized a rule that imposes the same compliance obligations on non-residential mortgage lenders and originators. Together these rules will increase mortgage-related SAR filings and provide a more complete perspective on nationwide fraud trends in this sector.

"FinCEN has long warned of rising trends in residential mortgage fraud," Freis says. "Even now, with the economic downturn, there are millions of housing transactions each year. That makes this market a tempting target for opportunistic fraudsters and has created an urgent need for these new regulations."

NO TURNKEY AML

Financial institutions (FI) around the world need AML software that mitigates risk and satisfies regulators. But there are no simple solutions.

"Even the best systems require continual fine tuning to counter money launderers' ever-changing tactics," says Julie Conroy McNelley, a research director with Aite Group, a business, technology and regulatory consultancy serving the financial sector and headquartered in Boston, Mass.

According to her 2011 white paper, "Global Anti-Money Laundering Vendor Evaluation: A Reinvigorated Market," high-profile enforcement actions in the U.S. — totaling US$800 million in 2010 — have caused FIs to take a fresh look at their existing AML programs, many of which are home-grown, and ask whether they'll stand up to regulators' scrutiny.

"For many FIs the answer is no, and a lot is at stake," McNelley says. "In 2011, FinCEN and the Office of the Comptroller of the Currency fined Pacific National Bank US$7 million for failing to implement an effective AML program. To some institutions, that might not seem like much, but it was 1.9 percent of Pacific National's total assets."

Big banks also feel the pain. In 2010 the DOJ fined the Royal Bank of Scotland an amount equal to only .014 percent of its total assets for wire transfers to and from blacklisted countries. Still, the half-billion dollar hit was big enough to make giant RBS more vigilant about prohibited practices. McNelley advises all FIs to follow suit.

"When regulators audit an FI's AML system, they check how well its alerts are tuned to the current risk environment," McNelley says. "For example, some FIs scrutinize currency transactions for US$9,000 or more. So the bad guys just lower their placements to US$5,000. CFEs should advise clients not to let their alert settings remain unchanged for two years. That's one clear sign of an ineffective AML system."

In the July/August issue: CFEs from around the world report on anti-money laundering efforts.

Robert Tie, CFE, CFA, is a contributing editor with Fraud Magazine.

Sidebar: Things to do Monday morning 

In late 2011, KPMG International released the latest edition of its annual Global Anti-Money Laundering Survey. Respondents included institutions from among the world's top 1,000 banks and represented the industry's major sectors — retail, corporate and business, private, investment and wholesale banking.

Following are some of the survey's findings: