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Financial Havens, Banking Secrecy and Money Laundering Issued as: Double issue 34 and 35 of the Crime Prevention and Criminal Justice Newsletter, Issue 8 of the UNDCP Technical Series This study was prepared on behalf of the United Nations under the auspices of the Global Programme against Money-Laundering, Office for Drug Control and Crime Prevention, by: Jack A. Blum, Esq., Prof. Michael Levi, Prof. R. Thomas Naylor and Prof. Phil Williams. The views expressed herein are those of the authors and do not necessarily reflect the views of the Secretariat of the United Nations. The presentation of material and the designations employed herein do not imply the expression of any opinion whatsoever on the part of the Secretariat of the United Nations concerning the legal status of any country, territory, city or area, or of its authorities, or the delimitation of any frontiers or boundaries. Mention of firm names and commercial products does not imply the endorsement of the United Nations. The material published herein is the property of the United Nations and enjoys copyright protection, in accordance with the provisions of the Universal Copyright Convention Protocol 2, concerning the application of that Convention to the works of certain international organizations. Requests for permission to reprint signed material should be addressed to the Secretary of the Publications Board, United Nations, New York, N.Y. 10017, United States of America. © Copyright United Nations, 1998—All rights reserved.
Ten years ago the United Nations Convention Against Illicit Traffic in Narcotic Drugs and Psychotropic Substances placed the issue of the proceeds of crime on the world agenda. Among the Convention’s most important and innovative provisions were those that sought to overcome banking and financial secrecy laws where they presented impediments to criminal investigations. Over the past decade, many Member States have made great efforts to increase the transparency of financial dealings and to make financial and commercial records more accessible for bona fide investigations, with a view to giving effect to the anti-money-laundering provisions of the Convention. Today we may look back at the progress made and the challenges that lie ahead. While there has been a general trend towards enacting money-laundering laws that provide for the lifting of financial secrecy in appropriate cases, such secrecy remains a barrier in many jurisdictions, including some of those that have come to be known as "financial havens". In addition, new laundering techniques have been identified, such as the increased use of professionals, corporate registration secrecy and certain types of trusts. To give a picture of the problem today, at a time when the United Nations General Assembly, at its twentieth Special Session devoted to countering the world drug problem together, has renewed its commitment to take the profit out of crime, I called upon four eminent experts to examine the issues of banking secrecy and financial havens in the context of the fight against money-laundering worldwide. The present study aims to stimulate discussion on bank secrecy and financial havens but is not necessarily intended to reflect the views of the United Nations on the issue. In my view, it will serve as an important contribution to the debate on these issues. I hope that it will also enhance the international community’s commitment to finding solutions to the problems that continue to hamper the progress of financial investigations worldwide.
Vienna
Today, enterprise criminals of every sort, from drug traffickers to stock fraudsters to corporate embezzlers and commodity smugglers, must launder the money flowing from their crimes for two reasons. The first is that the money trail itself can become evidence against the perpetrators of the offence; the second is that the money per se can be the target of investigation and seizure. Regardless of who actually puts the apparatus of money-laundering to use, the operational principles are essentially the same. Money-laundering should be construed as a dynamic three-stage process that requires: firstly, moving the funds from direct association with the crime; secondly, disguising the trail to foil pursuit; and, thirdly, making the money available to the criminal once again with its occupational and geographic origins hidden from view. Criminal money is frequently moved abroad and then cycled through the international payments system to obscure the audit trail. Despite a myriad of complications, there is a simple structure that underlies almost all international money-laundering activities during this stage of the process. The launderer often calls on one of the many jurisdictions that offer an instant-corporation manufacturing business. Many sell "offshore" corporations, which are licensed to conduct business only outside the country of incorporation, are free of tax or regulation and are protected by corporate secrecy laws. Once the corporation is set up in the offshore jurisdiction, a bank deposit is made in the haven country in the name of that offshore company, particularly one whose owner’s identity is protected by corporate secrecy laws. Thus, between the law enforcement authorities and the launderer, there is one level of bank secrecy, one level of corporate secrecy and possibly the additional protection of lawyer-client privilege if counsel in the corporate secrecy haven has been designated to establish and run the company. In addition, many laundering schemes involve a third layer of cover, that of the offshore trust, which is usually protected by secrecy laws and may have an additional level of insulation in the form of a "flee clause" that permits, indeed compels, the trustee to shift the domicile of the trust whenever the trust is threatened. In essence, the rule in successful money-laundering is always to approximate, as closely as possible, legal transactions. As a result, the actual devices used are themselves minor variations on methods employed routinely by legitimate businesses. In the hands of criminals, transfer-pricing between affiliates of transnational corporations turns into phony invoicing; inter-affiliate real estate transactions become reverse-flip property deals; back-to-back loans turn into loan-back scams; hedge or insurance trading in stocks or options becomes matched- or cross-trading; and compensating balances develop into the so-called underground banking schemes. On the surface it may be impossible to differentiate between the legal and illegal variants; the distinction becomes clear only once a particular criminal act has been targeted and the authorities subsequently begin to unravel the money trail. There have been a number of developments in the international financial system during recent decades that have made the three F’s—finding, freezing and forfeiting of criminally derived income and assets—all the more difficult. These are the "dollarization" (i.e. the use of the United States dollar in transactions) of black markets, the general trend towards financial deregulation, the progress of the Euromarket and the proliferation of financial secrecy havens. Fuelled by advances in technology and communications, the financial infrastructure has developed into a perpetually operating global system in which "megabyte money" (i.e. money in the form of symbols on computer screens) can move anywhere in the world with speed and ease. The world of offshore financial centres and bank secrecy jurisdictions is a key part of this but can also be understood as a system with distinct but complementary and reinforcing components, many of which are readily amenable to manipulation by criminals. These components are examined in detail in the present study. The characteristics of offshore financial centres and bank secrecy jurisdictions can be understood as a tool kit that can be used not only to launder the proceeds of drug trafficking and other crimes but also to commit certain kinds of financial crime. Not all jurisdictions are equally lax, however, and the study provides a brief overview of the geography of the world of these financial and bank-secrecy havens. This world is in a constant flux that reflects differential responses to the complex balancing act between competitiveness, on the one hand, and high ethical business standards, on the other. The optimum competitive position is one in which the centre is neither too stringent in vetting customers nor too obviously indiscriminate in accepting all custom. Serious efforts have been, and continue to be, made to create greater transparency in financial matters, but the offshore financial world remains for a large part a "Bermuda triangle" for financial investigations. Law enforcement success stories presented in this study convey a sense of the imaginative, and sometimes rather crude, ways in which financial havens are used to hide, move and clean the proceeds of crime, in an area usually characterized by criminal successes and law enforcement failures. The cases highlight the advantages, from the point of view of criminals, of collusion with bank employees and the use of professional launderers. They also reveal how criminals are able to exploit what for them has, in effect, become a borderless world. It is this combination of rapid and largely anonymous transfers and protective destinations that anti-money-laundering efforts need to pierce. In this context, some issues meriting further consideration include:
The common denominator in money-laundering and a variety of financial crimes is the enabling machinery that has been created in the financial havens and offshore centres. The effectiveness of these centres in helping people and companies to hide assets is not the result of any single device. Changing bank secrecy rules alone will not help. Rather, the centres have created a tool kit composed of new corporate instruments, foundations, trusts, trust companies, banks and bank accounts. The tools are mixed and matched with jurisdictions that have made a point of non-cooperation with the rest of the international community in criminal and tax investigations. What started as a business to service the needs of a privileged few has become an enormous hole in the international legal and fiscal system. If the international community is to develop a rule of law to match the globalization of trade and the global movement of people, the questions raised by this hole in the system will have to be addressed. The world community will have to face the issue of the use of sovereignty by some countries to give the citizens of other countries a way around the laws of their own societies.
References to dollars ($) are to United States dollars, unless otherwise stated. Abbreviations
Foreword I. The money-laundering cycle in action II. The global financial system, offshore financial centres and bank secrecy jurisdictions III. Cases involving financial havens and bank secrecy jurisdictions IV. Offshore finance, banking secrecy and the organization of crime V. Issues for consideration Figures
The major money-laundering cases coming to light in recent years share a common feature: criminal organizations are making wide use of the opportunities offered by financial havens and offshore centres to launder criminal assets, thereby creating roadblocks to criminal investigations. Financial havens offer an extensive array of facilities to foreign investors who are unwilling to disclose the origin of their assets, from the registration of international business corporations (IBCs) or shell companies to the services of a number of offshore banks, which are not subject to control by regulatory authorities. The difficulties for law enforcement agents are amplified by the fact that, in many cases, financial havens enforce very strict financial secrecy, effectively shielding foreign investors from investigations and prosecutions from their home countries. While bank secrecy and financial havens are distinct issues, they have in common both a legitimate purpose and a commercial justification. At the same time, they can offer unlimited protection to criminals when they are abused for the purpose of doing business at any cost. These two issues are analysed in the present study because the recent history of international money-laundering control makes it clear that the indiscriminate enforcement of bank secrecy laws, as well as the rapid development of financial havens, constitute serious obstacles to criminal investigations and jeopardize efforts undertaken by the international community since the adoption of the United Nations Convention against Illicit Traffic in Narcotic Drugs and Psychotropic Substances, 1988 (the 1988 Convention), which first established money-laundering as a criminal offence. The best example of the opportunities, and immunities, offered to money launderers was the Bank for Credit and Commerce International (BCCI), which collapsed in 1991, uncovering the widest money-laundering scheme ever and leading to the seizure of more than $12 billion. The BCCI case, which is described in more detail in chapter III, generated a shock wave in financial markets and among the supervisory authorities of all countries affected by the scandal, forcing them to tighten up regulations to prevent the use of financial markets for money-laundering purposes. However, six years later, another prominent case was revealed following the bankruptcy of the Antigua-based European Union Bank, demonstrating that the problem had gained a new dimension with the application of modern technologies. The European Union Bank was founded by two Russians and is alleged to have been used to launder the illicit proceeds of Russian organized crime. This bank, which was operating on the Internet, offered its clients (according to its advertisements on the net) "the strictest standards of banking privacy in offshore business" and the "financial rewards of offshore banking". Chapter III further analyses the case of the European Union Bank. There are important and sobering lessons to be learned from the experience with the European Union Bank. Among the more important are the following:
In short, bank secrecy and offshore banking offer multiple opportunities for money-laundering and various other criminal activities. In the early and mid-1980s the Permanent Investigations Subcommittee of the Committee on Governmental Affairs in the United States Senate held a series of hearings on offshore banking and bank secrecy. The chairman, Senator William Roth, noted that "we have repeatedly heard testimony about major narcotics traffickers and other criminals who use offshore institutions to launder their ill gotten profits or to hide them from the Internal Revenue Service. Haven secrecy laws in an ever increasing number of cases prevent U.S. law enforcement officials from obtaining the evidence they need to convict U.S. criminals and recover illegal funds. It would appear that the use of offshore haven secrecy laws is the glue that holds many U.S. criminal operations together".2 If the immediate reaction to this is that little or nothing has changed in the last decade and a half, a more considered assessment might suggest that, in fact, the situation has deteriorated with a much larger cast of characters now using offshore financial centres for criminal purposes. This study examines the world of offshore financial centres and bank secrecy jurisdictions in the context of the control of money-laundering and financial crime. It looks at offshore financial centres and bank secrecy jurisdictions as facilitators of money-laundering and other forms of crime, elucidates the ways in which they are used by criminals and identifies a series of remedies or counter-measures that would block or at the very least diminish the attractions of these havens. Chapter I outlines the various stages of money-laundering, warns against using the term in a loose or promiscuous manner and identifies various kinds of secrecy that facilitate money-laundering and other crimes. Chapter II looks at the legitimate as well as the criminal uses of offshore financial and bank secrecy jurisdictions and explains briefly how bank secrecy and offshore banking evolved. It locates offshore banking and bank secrecy jurisdictions within the global financial system, suggesting that the system is a highly congenial one for both licit entrepreneurs and for those trying to launder and hide the proceeds of crime as well as for those who typically exploit loopholes and variations in tax and other laws. Jurisdictions that offer high levels of secrecy, and a variety of financial mechanisms and institutions providing anonymity for the beneficial owners are highly attractive to criminals for a wide variety of reasons including the potential cover and protection they offer for money-laundering and various exercises in financial fraud. Not all offshore financial centres and bank secrecy jurisdictions provide the same services, however, and there are important differences in the schemes they offer to ensure anonymity, the extent of the secrecy they provide and their willingness to cooperate with international law enforcement investigations. Consequently, chapter II also provides an overview of what might be termed the geography of offshore banking and bank secrecy. Chapter III looks at the way in which offshore financial centres and bank secrecy jurisdictions are used by criminals. It highlights not only the way in which money is often moved to and through offshore banks or bank secrecy jurisdictions as part of money-laundering efforts, but also other ways in which offshore jurisdictions are used by criminals. Chapter IV looks at offshore banking and bank secrecy as inhibitors and facilitators for law enforcement investigations, with attention to both de jure and de facto limits to cooperation. Chapter V looks at issues for consideration in relation to preventive and control measures that might be taken to enhance compliance with the 1988 Convention and to make it more difficult for money launderers and other criminals to exploit particular banking jurisdictions with the ease and benefits they do at the moment.
Efforts to curb the laundering of criminally derived incomes have only recently assumed a prominent position on the priority list of law enforcement agencies; the very term "money-laundering" is of quite recent origin. Yet it is safe to say that as long as there has been a need, whether for political, commercial or legal reasons, to hide the nature or the existence of financial transfers, some sort of money-laundering has occurred. In medieval times when the Catholic Church banned usury as not only a crime (rather like the status achieved by drug trafficking today) but also a mortal sin, merchants and moneylenders intent on collecting interest on loans engaged in a wide variety of practices that anticipated modern techniques for hiding, moving and washing criminal money. The central objective was to make interest charges either disappear altogether (hiding their existence) or appear to be something other than what they were (disguising their nature). This deception could be accomplished in several ways. When merchants negotiated payments over long distances, they would artificially inflate the exchange rates sufficiently to cover interest payments as well. They would claim that interest payments were a special premium to compensate for risk. They would make interest appear to be a penalty for late payment, with lender and borrower agreeing in advance that such a delay would take place. They would pretend that interest payments were really profits by using something similar to today’s "shell companies" (companies that have no real operational role). Capital would be lent to the company and then taken back again, supposedly in the form of profits rather than of interest on the loan, even though no profits had really been made. All of these tricks to deceive the Church authorities have their rough equivalents today in the techniques used to launder criminal money flows. If money-laundering can be said to have a long history, so too can the financial havens that are so often a necessary part of it. Among the early users of such havens were the pirates who preyed on European commerce in the Atlantic during the early seventeenth century. There were places that openly welcomed the pirates for the money they would spend. And when the time came to retire from the business, pirates often sought safe havens abroad. Mediterranean city states, much like some of today’s financial haven jurisdictions, competed to have pirates (and their money) take up residence. On the other hand, sometimes their loot was used to buy pardons to permit them to return home. In fact, the year 1612 may have witnessed the first modern amnesty to criminal money: England offered pirates who abandoned their profession both a full pardon and the right to keep their proceeds, anticipating by more than three and a half centuries similar deals requested by prominent drug barons from some modern states.3 Asset seizure in criminal cases is also not new. Many of the antecedents of modern laws facilitating the freezing and confiscating of criminally derived income and wealth have their roots in the medieval European notion of deodand (gift to God) and have come down into modern law in many countries through the English common law tradition. Originally, most forfeitures were a penalty for political rather than economic offences. Later, under common law, any felony conviction could lead to forfeiture of wealth and estates. While forfeitures are no longer used in such a sweeping way, in one respect there is basic continuity. Early forfeitures were justified in public in much the same terms as modern asset-seizure laws, namely by their deterrent effects; in fact, again like some modern forfeiture laws, it was often more because of their usefulness in raising revenues for the Crown. Even after the practice of automatically stripping all felons of their wealth died out, forfeitures continued to be applied in peacetime to enforce customs regulations and in wartime against enemies or enemy sympathizers. It is from those traditions—seizures in contraband cases and the notion of societies at war (drug wars or crime wars now replacing military ones)—that most of the rationalization for modern asset forfeiture derives.4 While acts of money-laundering, use of financial havens and applications of asset-seizure laws (and even "black money" amnesties5 ) all have historical precedents, not until very recently has the act of attempting to launder criminally derived income and wealth been made a crime per se. Traditionally the focus was on the underlying offence generating the money. Asset seizures, to the extent they were used in economically motivated crimes, were punishment for that underlying offence. Today there has been a radical change. Starting in the United States in 1986 and progressing rapidly around the world, the trend is now to criminalize the very act of laundering money and to make the act of laundering, completely independent of the underlying offence, grounds for asset forfeiture. In fact, in some jurisdictions that have taken this path, laundering the proceeds of crime can lead to far more severe penalties than the underlying offences. This has not occurred without considerable controversy. The problem has been that there is something quite unique about the crime of money-laundering. Unlike the underlying offences, be they drug trafficking or armed robbery, illegal toxic-waste dumping or extortion, money-laundering consists of a set of actions; each is innocent by itself but in total they add up to an attempt to hide the proceeds of a criminal act. It is not always immediately obvious to persons outside law enforcement what harm has been done by money-laundering, who (leaving aside fiscal considerations) has been injured and therefore why it should be an offence at all. Thus, the difficulty of convincingly demonstrating the harmful effects of money-laundering is one reason for the delays and hesitations in making money-laundering a crime. In many jurisdictions it still is not. There is no doubt, however, that the current trend is towards criminalizing money-laundering all over the world. There are several reasons for this. One is acceptance of the theory that it does little good to attack criminals while leaving the proceeds untouched: the net profits constitute both the motive, namely personal enrichment, for the underlying offence and the means, namely working capital, for further crime. There is also a presumption that, in the past, those who committed offences might have been punished, but those, like the willing money managers who facilitated it, went unscathed, and that this situation requires rectification. There have also been more immediately practical reasons. Money-laundering statutes are seen as a handy tool, not just for widening the enforcement net to include previously exempt categories of participants in criminal acts but also for creating a means for imposing potentially heavier sentences on those charged with the underlying offence and for therefore using the threat of such heavier charges to secure cooperation. Not least, there is a trend to use asset-forfeiture laws that are so often a part of the anti-money-laundering drive as a device for financing police activities. Definition and purpose of money-laundering Today money-laundering attracts the most attention when associated with trafficking in illicit narcotics. However enterprising, criminals of every sort, from stock fraudsters to corporate embezzlers to commodity smugglers, must launder the money flow for two reasons. The first is that the money trail itself can become evidence against the perpetrators of the offence; the second is that the money per se can be the target of investigation and action. Legitimate business corporations, too, might have recourse to the techniques of laundering whenever they need to disguise the payment of a bribe or kickback. In the current climate, where there has been a highly publicized backlash against corporate and public-sector corruption, laundering in bribery cases is likely to attract an increasing amount of attention. In fact even Governments make occasional use of the same apparatus—to dodge reparations, evade the impact of sanctions or covertly fund political interference in some rival state. Regardless of who actually puts the apparatus of money-laundering to use, or what strange twists and turns it takes, the operational principles are essentially the same. Strictly speaking, money-laundering should be construed as a dynamic three-stage process that requires: firstly, moving the funds from direct association with the crime; secondly, disguising the trail to foil pursuit; and, thirdly, making the money available to the criminal once again with its occupational and geographic origins hidden from view.6 In this respect money-laundering is more than merely smuggling or hiding tainted funds, although those acts may constitute essential constituents of the process. Perhaps the most logical way to keep the nature of the process of laundering distinct from some of its constituent parts is to stress the difference between hiding the existence of criminal money and disguising its nature. If criminal money is hidden from the view of the law, for example if it is spent in the form of anonymous cash or moved to a jurisdiction where there are no sanctions against the use of money of illegal origin, it can scarcely be described as "laundered". All that has happened is that criminally derived money has had its existence hidden from the law enforcement authorities of the place where the underlying offence has been perpetrated. However, if the money is given the appearance of legitimate provenance in a place where sanctions against its illegal origins do exist, then and only then can it be said to be truly laundered—it has had its nature disguised. Money-laundering and tax evasion The nature of the laundering process raises important issues of tax enforcement. While illicit money is being earned, criminals will attempt to ensure that it escapes the scrutiny of the authorities, including fiscal ones. Once the money has been laundered, this is no longer necessary. Although tax evasion and money-laundering share several techniques and can be mutually supporting, it is important to understand that operationally they are quite distinct processes. In general, tax evasion involves taking legally earned income and either hiding its very existence (if, for example, it is skimmed in cash) or disguising its nature (by making it appear to fall into a non-taxable category). In either event, it turns legal into illegal income. Money-laundering does the opposite. It takes illegally earned income and gives it the appearance of being legally earned. In terms of their impact on the fiscal position of a country, evasion and laundering also have quite opposite effects. Earnings of a legal enterprise can be thought of as falling roughly into two categories. Part of the gross proceeds is used to cover expenses, including wages, material costs and interest payments due to those who lent operating funds. Part is left over as profit, which in turn can be either reinvested or distributed to owners who may consume it or save it. However, when illegal goods and services are sold, the results are different. As before, part of the gross proceeds of illegal activity is used to cover expenses of operation and part represents profit, some of which may be reinvested and some distributed to owners. But there is a further division. Regardless of whether earnings are used to cover expenses or to reward owners, some remain in the illegal sector and some may be recycled into the legal one. Of that which surfaces in the legal economy, part may be used to meet expenses owed to illegal suppliers; part may be used to meet expenses owed to legal suppliers; and part may become the apparently legitimate property of the owners of the business, who, in turn, may reinvest it in illegal business, reinvest it in legal business, consume it or save it (by acquiring legitimate assets). The actual form the laundering process takes will depend at least to some degree on the intended disposition of the funds. However, one thing remains true. All of the portion of the criminal earnings that appears in the legal economy potentially attracts the attention of the fiscal authorities. Undoubtedly criminals are as eager as any other entrepreneurs to reduce their fiscal burden, but some such burden is almost inevitable. Tax evaders under-report the earnings of their legal enterprises, thereby paying less tax than they legally should. Criminals, by contrast, over-report the earnings of any legal enterprises they use for cover, therefore paying more tax than their legitimate front companies would normally be required. This is not to suggest that the State would be fiscally better off if legitimate businesses that evade taxes on their legally earned income shifted to explicitly criminal activity on which some taxes were paid. Clearly, even though criminals will pay some taxes on the portion of their illegal earnings that is laundered, overall they will evade taxes on as much of their overall earnings as possible. The point is that, contrary to the stereotype that sees criminal activity as an off-the-books, unrecorded and untaxed activity (with its existence hidden from the authorities), once the money is laundered it becomes at least in part on-the-books, recorded and taxed, albeit with its precise nature disguised. Perhaps the easiest way to understand the distinction is to consider the example of the market for illicit sexual services. A prostitute working the streets might accept cash—the transaction is anonymous, it does not enter the national income accounts of the country and it escapes both formal regulation and taxation. But a prostitute working through the front of a legally registered escort agency or massage parlor might well be paid through checks or credit cards—the transaction is recorded, but it enters the national economic statistics in a misreported way, and it is subject to at least some degree of taxation. In the second example, the earnings are laundered—their nature is disguised but their existence is not hidden. The apparatus in action At home The term money-laundering seems to have been coined in the United States in the 1920s when street gangs sought a seemingly legitimate explanation for the origins of the money their rackets were generating. Their reasons for so doing were varied: to hide their material success from corrupt police intent on collecting protection payments; to avoid attracting the (often brutal) attention of envious competitors; or, a little later, to evade the possibility of tax evasion charges, something discovered in the early 1930s to be a powerful weapon against otherwise impregnable criminals. To accomplish these goals, the street gang might take over cash-based, retail service businesses. The most popular choices were clothes laundries and car washes, hence, it seems, the origin of the term. However, other businesses, such as vending-machine service companies, could function almost as well. The point was to mix illegal and legal cash and report the total as the earnings of the cover business. In so doing, all three stages of a classic money-laundering cycle were combined in essentially one step—the money was distanced (physically or metaphysically) from the crime, hidden in the accounts of a legitimate business and then resurfaced as the earnings of a firm with a plausible reason for generating that much cash. Simple though that process appears to be, it has remained the core of most money-laundering strategies, no matter how apparently complex. There are a wide variety of techniques available today by which money can be laundered. The choice depends partly upon the following criteria:
The simplest forms of laundering take place strictly within the jurisdiction in which the underlying offence has been committed. If the sums involved are relatively small and/or episodic in nature, there are a number of techniques in which all three stages of the laundering cycle can be neatly combined. Race tracks are classic examples—the launderer simply uses his/her illegal cash to purchase winning tickets, probably paying the true winner a premium, and then presents the ticket for payment. The funds can therefore be accounted for as legitimate earnings from gambling. This is a technique with a long history, and it continues to be used today. Much the same can occur with state lotteries—there have even been brokerage rings buying winning tickets and reselling them to persons with money to launder. An additional advantage of lottery schemes is that winnings are often tax-free. More sophisticated techniques using the same general principle can be run with the aid of stock or commodity brokers. The person seeking to launder money buys spot and sells forward, or the reverse. One transaction records a capital gain, the other a capital loss. The broker destroys the record of the losing transaction and the launderer exits with the money now appearing as capital gains. The cost is the double commission plus any hush money demanded by the broker. Property deals are also similar. Someone seeking to wash money purchases a piece of property, paying with formal bank instruments and legitimately earned money for a publicly recorded price that is much below the real market value. The rest of the purchase price is paid in cash under-the-table. The property is then resold for the full market value and the money recouped, with the illegal component now appearing to be capital gains on a real estate transaction. Such techniques, while seemingly popular, are usually employed only episodically and for relatively small sums. No one can convincingly appear lucky at the track too often. To handle on-going flows of criminal money, recourse is usually had to a cash-based retail service business—car-washes and laundries, video-game arcades and video-cassette rental stores, bars and restaurants have long been favourites. The principle is simple: the illegal money is mixed with the legal and the entire sum reported as the earnings of the legitimate business. When the sums become larger and law enforcement in the immediate jurisdiction is seen as particularly dangerous, the laundering process will more likely involve an international dimension. At this point the three stages in the cycle become both logically and chronologically distinct. Moving the money abroad The first task is to move the funds from the country of origin. This can be done by either sidestepping or working through the formal banking system. If the decision is made to sidestep the system, the most popular method appears to be shipping money abroad in bulk cash. Sometimes items like diamonds or gold or even precious stamps and other collectibles are also used; the criterion is that they be of high value in relation to bulk, making them physically easy to smuggle as well as relatively easy to reconvert into cash at the point of destination. However, cash is clearly far more important than valuable commodities. Although an increasing number of countries demand the reporting of the export of all monetary instruments, the record of success is not very encouraging. Bulk cash, particularly in large denomination bills, can still be easily carried out of a country in hand-luggage. While the United States $100 bill is the favourite, others exist that could be useful provided the currency is well-known and universally accepted. The largest denomination deutsche mark and the Swiss franc notes would qualify whereas the Singapore dollar, available in $10,000 denominations, would probably be used only rarely and within a limited geographic area. Even if controls on hand luggage are tightened, bulk cash can be easily moved through checked personal luggage, particularly if the passenger travels by ship. And of course the money can be stuffed into bulk commercial containers whose sheer volume defeats any systematic efforts to monitor them. To the extent detection does occur, it is the result of either blind luck or informants’ tips. Clearly the problem of currency smuggling will increase as world trade grows, borders become more open to both people and goods and currencies become more convertible. The person whose funds are to be moved does not have to assume the risk personally. There are professional courier networks that will handle the job and guarantee delivery. Unfortunately, sometimes couriers possess diplomatic passports, so they and their effects are at least partially immune from search and, in any event, such couriers may be subject to little more than deportation if caught. There is open traffic in diplomatic credentials that should be curbed. Various lateral transfer schemes are also used to export money. These work through compensating balances, a simple principle that has long been used in legitimate trade, particularly when dealing with countries that have exchange controls and/or legally inconvertible currencies. Consider the example: Assume Business I in country A owes $X to Business II in country B. Assume Business II in country B owes $X to Business III in country A. To settle the debts without compensating balancing: Business I would ship $X to Business II Business II would ship $X to Business III This requires two international transfers and four distinct withdrawal and deposit transactions. To settle the debts with a compensating balance all that happens is that Business I in country A settles the debt owed by Business II to Business III in country A. There are only two banking transactions, from the account of Business I to the account of Business II and no international transfers. Obviously in reality the mechanics are much more complex, the sums do not exactly balance and the exchanges are usually multilateral. Still, the principle remains intact. The practice is commonplace, and there are even financial brokers who specialize in arranging such transfers. However, the compensating balance principle is also the basis of operation of the so-called underground banking systems that are becoming more and more popular today as ethnic diasporas grow. Someone in country A seeking to move funds abroad contacts the underground banker and deposits a certain sum. The underground banker sends a coded message to his/her correspondent abroad to credit the equivalent of the deposited sum (less the fee) to a foreign bank account held in the name of the person seeking to move the money out of country A. No actual funds have to move. And the offsetting transaction occurs when someone else abroad attempts to move money back into country A. It is neat and untraceable, particularly when cemented by bonds of extended family trust typical of some ethnic communities living and conducting business abroad. Nonetheless, it cannot be stressed too often that, like so much "informal finance", techniques of underground banking really have benign origins. They were evolved for perfectly legitimate purposes, reflect institutional underdevelopment and/or unfamiliarity with or lack of confidence in the formal banking systems and have been, in some cases, unfairly targeted by law enforcement officials for criticism. It is impossible to avoid the conclusion that ethnic and cultural misunderstandings, even on occasion prejudice, have played a role in some of the adverse attention focused on these so-called underground banking systems. They can indeed be used for criminal purposes, but so too can life insurance companies and nursing homes.7 When the decision is made to send criminal money abroad using the formal banking system, additional precautions are required. Any large cash deposit potentially attracts attention. There are also jurisdictions that subject large cash deposits to some form of additional mandatory scrutiny. This can vary from the United States model of automatic reporting of sums above a certain threshold to others that rely instead on suspicious transaction reports. Enormous backlogs of information are generated by cash transaction reporting systems, a problem that will be only partially solved by electronic filings on the Australian model. Ultimately cash deposit reports, whether in paper or in electronic form, are of little use unless there are not only the resources to process them but also personnel who know what they are looking for. Yet, to date knowledge about the nature, structure and operation of illegal markets remains so rudimentary that there is little logic to piling up raw information until some of those gaps in understanding are addressed. Equally notorious, in response to the cash transaction reporting systems, are the multiple schemes launderers have devised to get around the reporting rules: prior conversion of cash to checks through formal or informal check-cashing services; breaking cash deposits down to sums below the reporting threshold; securing an exemption from reporting; and even bribing bank staff. However, whichever system of formalized scrutiny, if any, is in operation, one rule remains. Large deposits (whether in cash or in checks) with no apparent justification potentially attract attention. Unlike the situation even a decade ago, so much public attention has been focused on instances when banks accepted a huge bundle of cash from unknown parties and either wired it abroad or converted it into bearer instruments, this avenue is likely going to be used less often. Successful money-laundering today probably requires working through a front business, one that has a credible explanation for its level of deposits and—something vital when the next stage begins—an equally credible explanation for moving the funds abroad.8 Such a company would be one that engages regularly in international trade in goods and/or services. A clever laundering operation would assure that any "payments" it makes to supposed suppliers abroad are in odd rather than round sums and that those sums are not repeated. It might also divide the payments between "suppliers" in several countries, alternate between wire and written forms of remittance and ensure that the nominal recipients appear to have sound business reputations. Although services are the best, for there are no clear rules against which to check the prices being charged to the domestic company, there is some evidence that trade in physical goods can be used as cover for criminal money transfers too. Recent investigations by two university professors in Florida revealed huge discrepancies in the prices at which commodities enter and leave the United States when compared to international norms and even from country to country. Although it is likely that most such price discrepancies are due to tax evasion or capital flight, there is likely to be an element of money-laundering as well.9 The above actually points to a potentially fatal weakness in money-laundering schemes that may not have been sufficiently exploited. The usual presumption of law enforcement is that, once the money is inside the banking system, most of the battle is lost. Accordingly, much of the regulatory effort is put into building, if not barriers, then at least screening mechanisms against that happening. However, money inside the domestic banking system is not yet money inside the international banking system. And there is an asymmetry in the types of front companies needed for these two distinct transactions. If the best cover for placing deposits inside the domestic financial system is a cash-based retail service business, the best cover for sending money abroad is a company that engages in international trade in goods and services. There are serious grounds for questioning why a company engaged in domestic retail services should be sending significant sums abroad, especially if done on a regular basis. And there are serious grounds for wondering why a company engaged in international trade in goods and services (which is, by definition, a wholesale operation) should have large sums of cash deposited in its domestic accounts. Such anomalies can serve as a red flag to alert bank staff that something requires further explanation. Seeing the world Once the money is abroad, it is time for stage two of the laundering cycle, moving it through the international payments system to obscure the trail. Despite a myriad of complications, there is a simple structure that underlies almost all international money-laundering activities during this stage of the process. Contrary to popular stereotypes, only the rankest of amateurs would arrive at the front door of a Swiss bank with a suitcase of high-denomination United States bank notes and demand to open a "numbered" account.10 That would undoubtedly both begin and end the would-be launderer’s life of crime. To be sure, Switzerland has not lost all of its appeal as a financial haven. It is stable politically; the Swiss franc is strong and well-respected; the country plays a major role in the world gold market; and it has a variety of banking institutions. The latter range from powerful multi-functional institutions that are well-represented all over the world and that combine commercial and investment banking with fund management and stock brokerage services to small, discrete private banks that specialize in handling the affairs of the "high net-worth individual". Over the last two decades, however, the Swiss authorities have progressively reduced the protection afforded by the country’s famed secrecy laws, signed treaties of cooperation in criminal investigation with other countries and moved actively and rigorously to freeze suspect accounts in everything from embezzlement to insider trading to drug trafficking cases. Switzerland also made money-laundering a crime per se. Undoubtedly, given the size and historical reputation of the Swiss financial system, much criminal money still finds refuge there, but it cannot be said that Switzerland rolls out the welcome mat for drug money (that deriving from tax and exchange control evasion is quite another matter), and most such money that does arrive in Switzerland probably now is subject to a pre-washing elsewhere. Well before a reasonably sophisticated money launderer will attempt to establish a bank account in any haven jurisdiction, there are preliminary steps to be taken. Bank secrecy can often be waived in the event of a criminal investigation. It is for that reason criminal money is normally held not by an individual (even with a "numbered" account) but by a corporation. Prior to the money being sent to Austria, Luxembourg, Switzerland or any other financial haven, the launderer will probably call on one of the many jurisdictions that offer an instant-corporation manufacturing business. The Cayman Islands, the British Virgin Islands, Liberia and Panama are among the favourites, although there are many others that sell "offshore" corporations that are licensed to conduct business only outside the country of incorporation, are free of tax or regulation and are protected by corporate secrecy laws. Preferably for the launderer, such a company will already have a history of actual activity to increase the appearance of legitimacy. Once the corporation is set up in the offshore jurisdiction, a bank deposit is then made in the haven country in the name of that offshore company, particularly one whose owner’s identity is protected by corporate secrecy laws. Thus, between the law enforcement authorities and the launderer, there is one level of bank secrecy, one level of corporate secrecy and possibly the additional protection of client-attorney privilege if a lawyer in the corporate secrecy haven has been designated to establish and run the company. In addition, many laundering schemes devise yet a third layer of cover, that of the offshore trust. There are many perfectly legal reasons for the establishment of offshore trusts, some rather dubious ones (dodging decisions of tax or divorce courts being the most common) and a few clearly illegal ones. The advantage of a trust is that the owner of assets conveys that ownership irrevocably to the trust and therefore prevents those assets from being seized by creditors. Offshore trusts are usually protected by secrecy laws and may have an additional level of insulation in the form of a "flee clause" that permits, indeed compels, the trustee to shift the domicile of the trust whenever the trust is threatened—by war, civil unrest or even by probes from law enforcement officers. The obvious disadvantage is the nominal loss of control by the owner: in theory a deed of trust is irrevocable, and the former owner can influence, but can not control, the actions of the trustee.11 In the past Liechtenstein was a favourite place in which to set up such a trust. In fact, it was probably the only jurisdiction that is not part of the English common law tradition to have such facilities. The Liechtenstein anstalt, unlike most trusts, is a commercial entity capable of doing business; it can make the transferor of the assets the ultimate beneficiary, thereby undermining the notion that the conveyance is irrevocable. Today, however, the very term anstalt in a company name can serve as yet another red flag for revenue authorities and law enforcement officers. "Asset-protection trusts" offered by many former and current British dependencies are an equally serious problem. If suitably set up, they have all of the advantages of the Liechtenstein model. Typically, assets are first conveyed to an offshore company; control of the company is transferred to the offshore asset-protection trust; the person transferring the assets arranges to be appointed manager of the company; and the trust deed may stipulate that the transferor of the assets has the right to buy them back again for a nominal sum, thereby respecting the letter of the law of trusts while undermining its spirit. Whatever the exact form it takes, the offshore asset-protection trust creates yet another layer of secrecy and security in a money-laundering scheme, and it can be complemented by yet more tricks and devices. Companies can be capitalized with bearer shares so there is no owner on record anywhere—the person who physically possesses the share certificates owns the company. There can be multiple systems of interlocking companies, all incorporated in different places, forcing law enforcement officers to proceed from jurisdiction to jurisdiction peeling them away like layers of an onion. There can be multiple bank transfers, again from country to country, where each transfer is protected by secrecy laws that must be breached one at a time. The funds transfer trail can be broken on occasion with the launderer picking up the money in cash from a bank in one place, redepositing it in a bank somewhere else and then wiring it to yet a third location. The trail can be further complicated if the launderer purchases his/her own "instant bank" in one of several jurisdictions that offer such facilities and makes sure that his/her bank is one of those through which the money passes, then closes the bank and/or destroys the records.12 Once the funds have been moved through the international financial system sufficiently to make their origins extremely difficult, if not impossible, to trace, it is time to move them home again, to be enjoyed as consumption or employed as capital. Heading home Many techniques can be used for this stage. Ten (among many) possibilities are listed below:13
The changing frontier of money-laundering The 10 fundamental "laws" of money-laundering are summarized in figure 2. In essence, the rule in successful money-laundering is always to approximate, as closely as possible, legal transactions. As a result the actual devices used are themselves minor variations on methods employed routinely by legitimate businesses. In the hands of criminals, transfer-pricing between affiliates of transnational corporations grades into phony invoicing, inter-affiliate real estate transactions become reverse-flip property deals, back-to-back loans turn into loan-back scams, hedge or insurance trading in stocks or options become matched- or cross-trading, and compensating balances develop into so-called underground banking schemes. On the surface it may be impossible to differentiate legal and illegal variants—the distinction becomes clear only once a particular criminal act has been targeted and the authorities subsequently begin to unravel the money trail. The trend towards institutional commingling is enhanced by three other developments. One, which became evident first with drugs and now is increasingly apparent in other forms of illegal economic activity, is that criminal entrepreneurs have shifted from serving a set of essentially unrelated regional markets to catering to an increasingly integrated world-wide market.15 There appears to have been a parallel change in money-laundering. There is also some evidence to suggest that, in place of the old pattern of the occasional money-laundering institution that was usually linked directly to one or a few criminal entrepreneurs or groups, there has emerged what is virtually an integrated underground global financial system whose relations to criminal entrepreneurs employing its services tend to occur through a series of arms-length commercial transactions.16 Based on the (admittedly spotty) evidence surfacing in actual cases, money launderers are now more often independent contractors who are as comfortable handling drug money as washing payments for a shipment of embargo-busting arms, as skilled in assisting insider trading schemes as in moving corporate bribes. Another aspect is that, whereas in the past the apprehension of a criminal group might well have uncovered the money-laundering apparatus along with it, now there are really two quite distinct targets of investigation and enforcement, which might require two quite separate methodologies. Pursuing transnational crime requires better exchanges of information on particular offenders and improved facilities for transnational investigation and prosecution of particular cases. It remains therefore fundamentally a matter of criminal law. Combating money-laundering, however, may require initiatives that might threaten not a particular institution but rather well-established systems of banking and financial practices that have a long historical pedigree and that are protected by strong vested-interest groups. It might require actions that particular jurisdictions could well interpret as a direct threat to their very sovereignty. As such, demands for action must occur in a context of full awareness of the uniqueness of the economic history and practices of each country affected. A second complication comes from the fact that, while once it was relatively easy to separate the legal and illegal aspects of economic activity because the two existed in a different social and economic space, this is not the case today. Underground activities—either explicitly criminal or merely "informal"—interact with legal ones at many levels. Sweatshops in big cities in the industrialized countries hire illegal aliens who are brought in by smuggling groups that may also deal in banned or restricted commodities, are financed by loan sharks who may be recycling drug money and make cartel agreements with trucking companies run by organized crime families, all in order to sell their goods cheaply to prestigious and eminently respectable retail outlets that serve the general public. The masses of street peddlers in the big urban centres of developing countries17 sell goods that might be smuggled, produced in underground factories using fake brand-name labels or stolen from legitimate enterprises, thereby violating customs, intellectual property and larceny laws. They pay no sales or income taxes but make protection payments to drug gangs that control the streets where they operate. The drug gangs might then use the protection money as operating capital to finance wholesale purchases of drugs or arms. The result of these and many similar sorts of interfaces is an economic complex that can no longer be divided neatly into black and white; rather, it forms a continuum of differing shades of grey. This blurring of traditional frontiers raises new problems of money-laundering control. If economic activity is no longer divisible simply into legal or illegal and if the entire economy is riddled with entrepreneurs who bend this or that rule to and sometimes beyond the breaking point, then the more accepted it becomes for people to violate "small" laws and the greater the probability that others will decide it is permissible to break slightly larger ones, and so on up the scale.18 Moreover, the greater the degree to which legal and illegal, formal and informal, underground and over ground activities are mixed, the deeper the confusion over the origins of funds, the more difficult the job of exercising due diligence with respect to crimes deemed especially serious and the greater the problems of effective use of suspicious transaction reporting.19 The third development, which reinforces the problem, appears at first glance to be a minor statistical technicality but goes to the heart of modern economic development processes and impacts directly on the problem of policing criminal money flows. Although exceptions exist, economic progress is generally associated with a rise in the percentage of economic activity accounted for by the production of services as opposed to physical goods. As countries increase in wealth and degree of development, the shift in the composition of gross national product (GNP) from tangible goods to intangible services opens up new possibilities for the laundering of criminal money. The best cover for laundering is a business engaged in legitimate retail trade, especially one that generates large amounts of cash on a regular basis. The higher the service content of the products sold, the greater the potential to use the legitimate retail business to hide the proceeds of crime. It is much easier in services to cloud the audit trail, since there is seldom as clear a relationship between physical inputs and the market value of outputs in a service firm as there is in one supplying physical goods. Tax authorities have long been aware that it is simpler in the services than in the physical goods industries to skim off income and under-report earnings. It is equally easy to do the opposite, to mix illegally earned with legally earned income and report it all as if it were legal. A simple rule is: other things being equal, the higher the ratio of services to physical goods’ production in a country’s GNP, the greater the facility with which its legitimate business firms can be used for laundering money. This, in turn, has yet another implication that is potentially dangerous from the point of view of money-laundering controls. There is a widely held view that the criminal sector operates overwhelmingly with cash while the legal one uses a mixture of cash and other financial instruments. Indeed, it is common to use changes in the ratio of cash to bank instruments as a tool to estimate the size and growth rate of the underground economy. However, this simple dichotomy may be in the process of becoming obsolete. If the objective is to hide the existence of a criminal money flow or to criminalize legal income after it has been earned (by skimming and hiding) there may be few alternatives to working in cash. But if the objective is to hide the nature of a criminal money flow, an on-going alibi provided by a suitable front company, especially in the retail services field, becomes more important than anonymity. In this case there is nothing that logically precludes the use of cheques or credit cards in conducting retail deals in contraband goods and services. Although there is a lack of data on such transactions, it would seem that while cash still dominates, the use of cheques and credit cards is rising. One of the most brilliant laundering schemes in the United States, a cocaine franchise in Boston that was dismantled in the early 1980s, worked exclusively by retail customers paying in cheques nominally on behalf of a contracting company, which deposited the money in its bank accounts to amortize a revolving line of credit that kept the supply of cocaine replenished. In some major cities today drugs can be purchased over the counter in bars if the customer gives the bartender a credit card to "run a tab". The value of the drugs is simply added to the total bill and settled with the credit card, and the books are balanced by the bartender, who "skims" the appropriate amount of cash from bona fide liquor sales. Such activities can be expected to accelerate as "smart-cards" and other forms of electronic money become more popular. The blending of legal and illegal actions and the mixing of various degrees and sorts of criminality, along with the attendant difficulty of differentiating between ordinary financial transactions and laundering and between petty and serious crime, has two important consequences with respect to anti-money-laundering measures. The first is that it calls into question much of the enthusiasm about the potential use of artificial intelligence (AI) models and similar devices that are supposed to facilitate the task of sorting through great amounts of financial data. Such models can hardly anticipate all the subtle criminal variations on techniques and methods that appear to be completely innocent in themselves but that are intended to hide illegally obtained money. Artificial intelligence is no substitute for human intelligence. Indeed, it calls into question the very efficacy of imposing ever more severe general reporting requirements. It may well be that all such gross reporting requirements can offer is somewhat better reactive efficiency in following money flows once crimes have already been detected using traditional investigatory techniques, and even this will depend on the particular institutional conditions of the country concerned. Therefore, it may be unwise to shift significant amounts of limited resources from old-fashioned and less glamorous policing methods to AI models that rely on collecting large amounts of raw information and/or depend on high-tech solutions. The second consequence is that not only does the blurring of the frontiers between legal and illegal economic activities, along with the process by which illegal acts become institutionally embedded in legal business firms, make the tracing and unveiling of criminal money much more difficult, but it also raises the cost of doing so. The potential regulatory burden imposed on legitimate business and the degree of disruption of normal transactions flows probably increase more than proportionately. This is especially the case given the rule that the lower the percentage of illegal money running through a particular front, the more respectable that front appears and the more successful that front will be in the long term for laundering. This implies that at some point Governments must balance the costs of further regulatory complications against the gains measured in terms of crime control. This is, to be blunt, quite messy. The costs of the extra regulatory burden are, in some cases, relatively easy to approximate in simple quantitative terms, but assessing the gains in terms of crime control is so complex and so mired in definitional and operational complications that it represents a logical and methodological swamp. Yet it is, alas, one into which everyone concerned with the issue of money-laundering will eventually be forced to step. The changing financial context Although the essence of money-laundering has not changed over the centuries, the context in which it occurs has been subject to considerable evolution. In particular there have been a number of developments in the international financial system during recent decades that have made the three Fs—finding, freezing and forfeiting of criminally derived income and assets—all the more difficult. These are dollarization of black markets, the general trend towards financial deregulation, the progress of the Euromarket and the proliferation of financial secrecy havens. Dollarization of black markets Along with the apparent spread of world black markets over the last few decades has come their progressive dollarization. Although most illegal transactions at the retail level are conducted in the currency of the country where they occur, around the world there has been a steadily growing appetite for United States high-denomination bank notes as a vehicle for conducting covert wholesale transactions, for hiding international financial transfers and for holding underground savings. This applies to the full spectrum of illicit and underground activity, but it also has direct implications for the proceeds of serious crimes, including drug trafficking. A foreign currency black market exchanging local currency for United States $100 bills is going to be equally accommodating to cigarette smugglers and tax evaders, dealers in banned wildlife or traffickers in heroin. The more popular the use of the United States dollar, the more easily someone can bring United States currency to parallel money markets, convert it to local currency, deposit the local currency in a financial institution and wire it anywhere else, while attracting considerably less attention than the direct deposit of the United States currency would attract. Even better, a person can convert the United States currency into valuable goods, resell the goods and deposit the money as the proceeds of legitimate commerce, thereby further obscuring the trail. The steadily expanding popularity of the United States dollar as a physical medium of exchange, means of payment and store of value is therefore a serious and direct challenge to international crime control. Trend towards financial deregulation The general trend towards financial deregulation is both internal and external. Internally, the trend manifests itself in the emergence of the "financial services supermarket", the integrated, multi-functional financial institution that offers clients at one and the same time deposit, transfer, security and commodity brokerage, investment management and fiduciary services along with departments skilled in creating foreign shell corporations and offshore trusts. Almost all major institutions today also offer private banking services, intruding on a field in which formerly a handful of Geneva banks had the leading reputation. Although such competition usually brings benefits to consumers in the form of lower prices, it can also lead to reduced standards of diligence on the part of the institutions. The breakdown of the traditional barrier between financial institutions also means the elimination of many of the preliminary checks and balances on the nature, provenance and destination of financial assets that a system of distinct and specialized institutions should have automatically ensured. Once money passes the first barrier to gain entry into the supermarket (which is itself competing vociferously for new business), there are no more layers of scrutiny to pass while the capacity to shift funds from asset to asset and from place to place is greatly enhanced. Simultaneously, international capital markets are also being progressively deregulated. Countries are lowering their barriers to the domestic operation of international affiliates of foreign institutions. The numbers of intra-company transfers between branches and subsidiaries of transnational corporations are increasing, as are international money movements. In addition, many countries that used to impose some form of border control on inflows and outflows of funds have joined the general trend towards liberalization by making formerly inconvertible currencies legally tradable and by dismantling exchange controls. While many arguments have been advanced against the use of exchange controls and denouncing the distorting effects of currency inconvertibility, their existence gave some States at least one potential tool for monitoring and controlling capital movements. The impact of deregulation shows up on many levels. Although in reality all currencies, even those formerly deemed legally inconvertible by their countries of issue, could be exchanged on parallel currency markets both at home and in big international financial centres, the rate was usually sufficiently poor as to discourage the practice. That simultaneously restricted the number of jurisdictions through which criminal money was likely to flow. Furthermore, where capital controls existed, in theory all inflows of foreign currency had to be deposited with, or at a minimum reported to, central exchange authorities, and all outflows of any serious magnitude had to be duly licensed. Thus, there were limits on the capacity of launderers to use most countries’ financial infrastructure. Today, fewer and fewer countries maintain inconvertible currencies, and all over the world exchange controls have been at least severely limited if not completely abolished. When capital movements are free, that freedom applies equally to funds of illegal and of legal origin. The more jurisdictions through which funds can flow and the more currencies into which they can be converted, the harder the job of tracing. Furthermore, exchange controls had at least one useful purpose. They limited or at least delayed and smoothed speculative outflows of capital. Without them it is conceivable that more countries will be subject to destabilizing waves of capital flight. Drained of foreign exchange, they must offset the impact by attracting compensating inflows. This is one of the reasons some countries have adopted bank secrecy laws protecting foreign currency deposits in their banking system. It is also why some Governments have had to resort to issuing foreign exchange-denominated bearer securities. These have been rightfully criticized as presenting a golden opportunity for criminals to hide their money and obtain handsome interest in the process. However, it would seem reasonable to expect the international community, while pressing through the major international lending institutions for measures of financial liberalization, to also come up with a more positive response to countries that attempt to offset some of the short-term consequences of liberalization than merely to criticize them for aiding and abetting international criminal money flows. It can be safely said that for some countries the flight of capital poses a greater danger to their social and economic stability than the laundering of criminal money, which they may be inclined to accommodate precisely in order to offset that flight. Presumably there is the basis here for a quid pro quo. Certain countries most afflicted by drug trafficking are precisely those to which most of the flight capital is attracted. They could pledge their support for efforts by some developing countries to stop the fiscal and financial damage caused by capital flight in exchange for those developing countries ceasing to issue bearer bonds or attempting to attract "black money" through foreign currency accounts protected by bank secrecy laws. Progress of the Euromarket Reinforcing the trend towards liberalization and deregulation, indeed long preceding it, has been the evolution of the Euro-currency market and the general development of an offshore sector of world finance.20 This, incidentally, is a concept widely employed but little understood. The offshore banking centres through which the Euro-currency market operates are not the same thing as financial secrecy havens. Both may exist in one and the same place, but legally and functionally they are quite distinct. Panama, for example, introduced bank secrecy in 1917, buttressed it with Swiss-style "numbered" accounts in 1959, and only introduced offshore banking legislation in 1971. The biggest "offshore" centre is actually the City of London, where bank secrecy laws are no serious impediment to criminal investigations. On the other hand Switzerland, a place which is synonymous with bank secrecy in the public mind, has no offshore banks. In popular parlance, "offshore bank" is taken to mean any bank anywhere in the world that accepts deposits and/or manages assets denominated in foreign currency on behalf of persons legally domiciled elsewhere. In reality, "offshore" should refer to an institution that, while legally domiciled in one jurisdiction, conducts its business solely with non-residents. What offshore banks are really supposed to do is handle wholesale transactions, usually denominated in dollars, on a bank-to-bank basis. They do not deal with the general public; nor do they accept cash in suitcases. Their role is to reduce taxes, avoid regulations with respect to capital adequacy and sidestep interest-rate restrictions imposed by national authorities, not to hide drug money. It is possible for some banks that have both offshore and on-shore licences in a particular jurisdiction to breach the firewall that is supposed to exist between their two types of business. However, this is a violation of their operating principles, not a condemnation of offshore banking per se. Still, the spread of offshore banking does have implications for money-laundering. It means more jurisdictions through which funds can be wired, thereby complicating the chase; and it does so by creating a sector largely or sometimes entirely exempt from the scrutiny of national regulators. While the initiation came from the large international banks, once offshore centres were up and running, all manner of smaller, more dubious institutions took advantage of the laws to set up shop, protected by the fact that the large institutions had a strong profit incentive to keep the offshore sector insulated from regulation. Nonetheless, it is not clear that the existence of an offshore sector per se requires any particular form of anti-money-laundering initiative since law enforcement has long before concurred that the main point of vulnerability for money-laundering occurs when funds enter the banking system on a retail level; the main point of interest for forfeiture is when the funds come to rest inside or outside the financial system as assets whose beneficial ownership can be fixed. It might suffice to request that countries hosting offshore facilities be diligent in maintaining the firewall and in assuring that banks licensed to do offshore business are truly legitimate. The problems relating to the fourth recent development, one that is often confused with "offshore" banking, are much more serious. Proliferation of financial secrecy havens Over the last few decades there has been a remarkable proliferation of jurisdictions offering the protection of bank secrecy. The traditional form of protection assured clients of confidentiality and, in the event a banker breached that confidentiality, clients had recourse to civil remediation. By contrast, bank secrecy laws impose criminal sanctions on those who release information regarding clients’ transactions. There is no doubt that bank secrecy can be a useful tool for hiding criminal money. However, before issuing any blanket condemnations or recommendations, it is important to note several complicating factors. For a start, it is imperative to understand that bank secrecy can take many different forms, with different origins, functions and degrees of defensibility, as follows:
Bank secrecy, then, is a serious concern. In particular the status quo, where one country stiffens its secrecy laws to take advantage of another country that has been successfully pressured by an economically and politically more powerful neighbour to weaken its laws, is the worst of all possible worlds. At the same time it is important not to exaggerate the significance of bank secrecy or to lose sight of other barriers to finding, freezing and forfeiting criminal money. Money-laundering can proceed very easily without bank secrecy; in fact, it may well be that launderers avoid it precisely because it acts as a red flag. Professional launderers advise their clients that the only really effective form of secrecy is keeping their mouths shut. In addition, even if actions are taken to lower or knock down completely the barrier to investigation posed by bank secrecy laws, the most important obstacle may well turn out to be corporate secrecy laws, which are more difficult to defend. It does little good to discover that the owner of a certain bank account is the "Get High Trading Corporation" of Panama if it is impossible to determine just who really runs Get High Trading. Moreover, bank secrecy is only an obstacle once the trail has already been traced to a particular institution. No jurisdiction will ever approve the unrestricted access by law enforcement officers to lists of depositors and their transactions, but many jurisdictions, even those with bank secrecy laws, will permit law enforcement officers to penetrate bank secrecy if they are engaged in investigating something that is a crime in the particular jurisdiction that hosts the bank. The danger then is not that bank secrecy blocks information flows but that it gives those affected by the search time to move their funds to other jurisdictions. It is the potential delay between targeting the account and getting permission to investigate that is the problem, not bank secrecy per se. This could be obviated if all States that have bank secrecy laws would adhere to a common set of principles that spell out precisely the conditions under which they will cooperate in the search for criminal money and engage in peremptory freezes. The discussion about what to do about bank secrecy, of course, raises the fundamental question of why bank secrecy laws are widespread and growing in number. Most modern financial havens are countries with growing populations, limited resources and a crisis in their traditional sources of livelihood. Their agricultural sectors are cramped by lack of fertile land or the dumping of products on world markets by highly subsidized farming in larger and better located producing areas. Some, particularly in the Caribbean, formerly had large numbers of the economically active population employed in sectors like salt harvesting or merchant shipping; when those sectors went into decline, they struggled to find others that were independent of their always limited, often non-existent natural resource endowments. Financial services were an obvious potential growth sector.21 This has many implications. It means that the more competitive the business becomes, the lower the standards of diligence any one haven can introduce without losing customers en masse to others. That may be partly because the money that is fleeing has something to hide. It may well be that, since diligence has its costs, the service charges in a more diligent haven may become uncompetitive. It also means that havens are being driven to diversify their services to attract and hold business. An ideal financial secrecy haven today offers a significant portfolio of services, which are discussed more fully in chapter II. The characteristics of an ideal haven are summarized in figure 3. They include secrecy, the availability of services for rapid incorporation, currency exchange freedoms etc. With a complex and interdependent system of financial services, the havens will defend all the more strongly any one component for fear that if that one is compromised the overall competitive position of the haven will be adversely affected. It is not that most haven countries seek drug money or any other type of assets derived from serious crimes. Rather they literally cannot afford to cooperate too closely. While, particularly given the growing amount of competition, fees for such services are often low and falling, they may constitute a very large percentage of government revenues and private incomes as well, representing the single fastest growing sector of the haven’s job market. It is popular to decry the operation of such financial havens, and it is certainly true that they can have a harmful effect, particularly in terms of facilitating tax evasion and secondarily as places that foster money-laundering. It is however necessary to show some understanding of their positions, their economic vulnerability and their lack of alternative resources. In the field of drug control, the major consuming countries are willing to research and finance alternative development programmes for producing countries. Therefore, it should be possible to imagine alternative economic development solutions for such financial havens, developed in conjunction with the world business community.
In chapter I, money-laundering was seen as a circular process and financial havens and bank secrecy jurisdictions were identified as being an important part of the circle. Yet both bank secrecy and offshore financial centres have legitimate purposes and are integral components of a global financial system with multiple points of access and rapid capital movements, whether in settlement of business and commercial contracts or in search of higher interest rates. Consequently, when identifying ways in which offshore financial centres and bank secrecy jurisdictions facilitate criminal activities, it is also important to acknowledge that such centres continue to have respectable functions within the global financial system. Accordingly, the first part of this chapter identifies important characteristics of the global system. The analysis then focuses on the emergence of the offshore world and the legitimate purposes it serves. Picking up some of the themes identified in chapter I, the interlocking components of offshore banking centres and bank secrecy jurisdictions that are conducive to money-laundering and other financial crimes are delineated. Finally, this chapter offers a brief overview of the geography of these financial havens. The global financial system The move to what is sometimes characterized as a speculative global economy has been facilitated by new technologies that allow unprecedented speed in the movement of money. Flight capital, the proceeds of crime, money seeking preferential interest rates or foreign exchange arbitrage combine with contract payments and debt settlements in a vast melange of movements and transactions that is bewilderingly fast and complex. Indeed, the global financial system provides a crucial underpinning for international commerce and investment in a world characterized by global trade, the prevalence of transnational and multinational corporations and the rapid movement of investment capital. The globalization of financial services has become one of the most important dimensions of the overall globalization process. Fueled by developments in technology and communication, the financial infrastructure has developed into "a system that links countries, banks and other financial institutions such as brokerage houses and stock markets, currencies and investment portfolios in a global exchange mechanism that engages in operation 24 hours a day".22 At the same time, the development of "megabyte money" i.e. money in the form of symbols on computer screens, makes it possible to move funds almost anywhere in the world with speed and ease.22 Not surprisingly, an increasing proportion of the world’s money moves around through electronic rather than cash transactions. Although many economies in the developing world and countries in transition are still cash economies, in advanced industrialized and post-industrialized states, the most important financial transactions (in value as opposed to volume) are no longer cash-based. This is certainly the case in the United States, as illustrated in figure 4, which highlights the inverse relationship between the number of transactions that take place in cash, cheque and electronically, and the value of these transactions.23 The massive growth of electronic payments has been made possible by the development of the electronic transfer mechanisms operated by the Society for Worldwide Interbank Financial Telecommunications System (SWIFT), the Federal Reserve (Fedwire) and the Clearing House Interbank Payments System (CHIPS). The volume and value of the transactions that move through these mechanisms are staggering. "Each day, more than 465,000 wire transfers, valued at more than two trillion dollars, are moved by Fedwire and CHIPS, and an estimated 220,000 transfer messages are sent by SWIFT (dollar volume unknown)".24 In many respects this system is a money launderer’s dream, offering considerable scope to imitate the patterns and behaviour of legitimate transactions, thereby following one of the most fundamental laws of money-laundering identified in chapter I. In addition, there is no obvious institutional and functional separation between the transfer of licit monies and the transfer of the proceeds of drug trafficking or other forms of crime. Differentiation is virtually impossible, thereby meeting another requirement of effective money-laundering—the ability to embed illicit transactions and proceeds within a large volume of legitimate business transfers. Another requirement of effective money-laundering is that the ratio of illegal to legal financial flows be relatively low. Once again, the electronic transfer system is ideal. According to a report by the now defunct United States Office of Technology Assessment, a reasonable guess is that 0.05 per cent to 0.1 per cent of the approximately 700,000 wire transfers a day contain laundered funds up to a value of $300 million.25 This is dwarfed by the more than $2,000 billion that is transferred by wire on an average day, greatly complicating efforts to identify the laundered funds. Furthermore, although bank-to-bank transfers of aggregate funds for settlement or loans constitute about half of the total volume of wire transfers; with the complicity of corrupted bank employees, these can also contain laundered money.25 Although there are hopes that artificial intelligence systems can offer enhanced discrimination techniques that lead to the identification of laundered money, the sheer dynamism of the financial world, "the number of financial institutions, the constantly changing relationships and varying levels of activity make it difficult to identify suspicious activity".25 The problem is compounded by the lack of a "centralized database of wire transfers and limited details about senders and recipients".26 These difficulties are exacerbated by the inclusion in the global financial system of stock exchanges and other financial institutions that allow anonymous trading and thereby make it possible to obscure both origin and ownership of funds. Indeed, an important characteristic of the financial sector in recent years has been the proliferation of new financial institutions and financial centres, an overlapping in the services that are offered by banks and non-bank financial institutions and the development of new banking practices and mechanisms. The result has been the emergence of a more complex system offering multiple opportunities to evade regulation, monitoring and control, even though efforts have been made to strengthen oversight. "New banking practices, such as direct access banking which permits customers to process transactions directly through their accounts by computer operating on software provided by the bank" undermine "the ability of the bank to monitor account activity, such as transactions involving joint accounts and pass-through banking schemes which have been a traditional method of layering. Beneficial owners of funds can now manipulate the identity of the ultimate recipient of the funds without a review by bank officers."27 Moreover, it is possible "to create accounts within accounts, or even to provide quasi-banking services to off-line customers in a kind of bank within a bank".27 Such services "limit the utility of systems in place which allow information about both the originator and the recipient to travel with the electronic funds transfer".27 Correspondent banking relationships that are global in character place "ever more emphasis on vetoing transactions at the bank of origin".28 Yet, many of the banks of origin are in countries where little attention is given to the prevention or control of money-laundering and where "know your customer policies" are totally lacking at worst and grossly inadequate at best. Even when efforts are made in this direction, it is relatively easy to provide a legitimate front that satisfies efforts to check the legitimacy of the customer. Unless banks know not only their customers but also whom their customers are connected to, directly or indirectly, then due diligence will be far from complete. In many cases, banks and other financial institutions have no inclination to know their customers, especially if it puts them at a competitive disadvantage. Since overly vigorous investigation of potential customers, even those who are legitimate, could make them go elsewhere, some bankers will be reluctant to engage in such activities. Although, this is understandable in a highly competitive business environment, it can all too easily result in tacit connivance between some banks and institutions and individuals or groups who are interested in moving, hiding or laundering the proceeds of crime. Efforts to impose new laws or regulations against money-laundering will be resisted strenuously if, directly or indirectly, they also inhibit licit activities and impinge on commercial interests whether at the level of individual firms, a particular industry or economic sector, or a particular nation or group of nations. In extreme cases, of course, connivance can become collusion as the rewards of criminal enterprise are extended to those members of the licit economy who facilitate laundering activities. Money-laundering has become so lucrative that bank officials and others with access to the financial system are sometimes corrupted, as will be seen in chapter III. Even where this does not occur, however, some financial centres in some countries are willing to op | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
