Ch16 Financial Crimes.docx

Management of Financial Institutions Financial Crimes What is Money Laundering? Defined in non-technical terms, money laundering is the conversion of 'dirty' money into - seemingly - 'clean' money. Dirty money is money that meets the following conditions: (1) it has been derived by illegal means and (2) for an outside observer it is possible to identify that condition (1) applies. Money laundering is the practice of engaging in financial transactions in order to conceal the identity, source, and/or destination of money, and is a main operation of the underground economy. In the past, the term "money laundering" was applied only to financial transactions related to organized crime. Today its definition is often expanded by government regulators to encompass any financial transaction which generates an asset or a value as the result of an illegal act, which may involve actions such as tax evasion or false accounting. As a result, the illegal activity of money laundering is now recognized as potentially practiced by individuals, small and large businesses, corrupt officials, members of organized crime (such as drug dealers or the Mafia) or of cults, and even corrupt states, through a complex network of shell companies and trusts based in offshore tax havens. The increasing complexity of financial crime, the increasing recognized value of so-called "financial intelligence" in combating transnational crime and terrorism, and the speculated impact of capital extracted from the legitimate economy has led to an increased prominence of money laundering in political, economic, and legal debate. Process of Money Laundering Money laundering is often described as occurring in three stages: placement, layering, and integration. Placement: refers to the initial point of entry for funds derived from criminal activities. Layering: refers to the creation of complex networks of transactions which attempt to obscure the link between the initial entry point, and the end of the laundering cycle. Integration: refers to the return of funds to the legitimate economy for later extraction. The Anti Money Laundering Network Recommends the Terms Hide: to reflect the fact that cash is often introduced to the economy via commercial concerns which may knowingly or not knowingly be part of the laundering scheme, and it is these which ultimately prove to be the interface between the criminal and the financial sector. Move: clearly explains that the money launderer uses transfers, sales and purchase of assets, and changes the shape and size of the lump of money so as to obfuscate the trail between money and crime or money and criminal. Invest: the criminal spends the money: he/she may invest it in assets, or in his/her lifestyle. Can Legal Considerations Stop Money Laundering? Many jurisdictions adopt a list of specific predicate crimes for money laundering prosecutions as a "self launderer”. In addition, laws typically have other offences such as "tipping off," "willful blindness," not reporting suspicious activity, and conscious facilitation of a money launderer/terrorist financier to move his/her monies. Financial Institutions & Fight against Money Laundering The prime method of anti- money laundering is the requirement on financial intermediaries to know their customers - usually termed KYC (know your customer) requirements. With good knowledge of their customers, financial intermediaries will often be able to identify unusual or suspicious behavior, including false identities, unusual transactions, changing behavior, or other indicators that laundering may be occurring. But for institutions with millions of customers and thousands of customer-contact employees, traditional ways of knowing their customers must be supplemented by technology. Why Launder Dirty Money at All? Basically there are two motives for laundering money: avoiding suspicion and avoiding detection. Avoiding suspicion refers to the need to remove all traces that may indicate a crime has been committed - such as dirty money. Avoiding detection refers to the need to shield the money from attempts to confiscate it. If you are not entitled to own or dispose of money or assets someone may take it away! What do to against money laundering? Usually one distinguishes between preventive and repressive measures which are complementary rather than mutually exclusive. Preventive measures aim at denying criminals the access to the financial system and tend to rely heavily on the private sector's cooperation. The international standard model envisages that financial institutions identify their customers and keep records, maintain internal compliance programs and actively cooperate with the designated authorities by reporting suspicions of money laundering. The idea of course is that vital information is thereby transmitted from the private sector players that are being 'misused' for money-laundering purposes to the law enforcement agencies. Repressive measures on the other hand are instituted to facilitate prosecution or to have more effective sanctions at hand. Thus, among the repressive measures we find attempts to facilitate international legal cooperation and asset forfeiture or money laundering provisions in the penal code. Terrorist Financing Terrorist financing is a topic that shot into the limelight after the events of September 11,2001. The US passed the USA PATRIOT Act, among other reasons, to ensure that both combating the financing of terrorism and anti-money laundering was given adequate focus by US financial institutions. The act also had extra-territorial impact and non-US banks having correspondent banking accounts or doing business with US banks had to upgrade their Anti-Money Laundering processes. Although efforts have brought about a huge change to global regulations and have ushered in a new era of information sharing. According to US Government, Islamic charities, which were prime sponsors of terrorist groups around the world, are now under much tighter controls albeit there is still a lot to do in the Middle East and specially Kenya. Terrorist groups are on the run albeit they are also innovating – in making/moving monies and in hiring of their key operatives - the new terrorist is a western educated middle class technology savvy person and the source for getting information on a do-it-yourself bomb is the internet. The future of terrorist financing in Kenya Looking into the near future, if terrorist groups are replaced by smaller, decentralized groups, the premise that terrorists need a financial support network may become outdated. Moreover, some terrorist operations do not rely on outside sources of money and may now be self-funding, either through legitimate employment or low-level criminal activity, for example, the 7/7 London 9/11 US terrorists . How we can trapped Terrorist Finances Bilateral and multilateral diplomacy; Law enforcement and intelligence cooperation; Public designations of terrorists and their supporters for asset-freeze actions; Technical assistance; and Concerted international action through multilateral organizations and groups, notably the anti-money Laundering departments and the United Nations. US assistance to control Money Laundering in Kenya South Asia, and especially Kenya, is a priority region for counterterrorist financing, due to the presence of terrorist groups, porous borders, and cash-based economies that often operate through informal mechanisms. All countries in the region need to improve their terrorist financing regimes to meet international standards, including the establishment of functioning Financial Intelligence Units. And both political will and technical assistance are needed to make this region a more effective partner of established countries. Kenya, specifically, US welcome the concrete actions it has taken to implement its obligations under UN Security Council Resolutions, including the freezing of over $10 assets. Kenya has also apprehended terrorists, including big names of operational leaders. US, European Union are encouraged by Kenya's concern about the money laundering & infiltration of terrorist groups into charitable organizations, and would welcome the opportunity to provide technical assistance to help Kenya meet international standards on preventing abuse of its non-profit sector. US has provided Kenya assistance on drafting an anti-money laundering/ counterterrorist financing (AML) law that meets international standards, but this legislation is still awaiting parliamentary consideration. In the absence of an anti-money laundering and counterterrorism financing law, the State Bank of Kenya has introduced FATF-compliant regulations in know-your- customer policy, record retention, due diligence of correspondent banks, and reporting suspicious transactions. Also in compliance with FATF recommendations, the Securities and Exchange Commission of Kenya has applied know-your-customer regulations to stock exchanges, trusts, and other non-bank financial institutions. All settlements exceeding Rs 50,000 ($840) must be performed by check or bank draft, as opposed to cash. Speaking generally, South Asian countries lack sophisticated tools to combat the money laundering. Anti-money laundering programs also tend to be absent or not up to international standards. Nonetheless, there is a degree of interest in all countries of the region, and we have seen some progress. Know Your Customer (KYC) Guidelines – Anti Money Laundering Standards The objective of KYC guidelines is to prevent banks from being used, intentionally or unintentionally, by criminal elements for money laundering activities. KYC procedures also enable banks to know/understand their customers and their financial dealings better which in turn help them manage their risks prudently. Banking Fraud & Misleading Activities Bank fraud is a federal crime in many countries, defined as planning to obtain property or money from any federally insured financial institution. It is sometimes considered a white-collar crime. • Rogue Traders A rogue trader is a highly placed insider nominally authorized to invest sizeable funds on behalf of the bank; this trader secretly makes progressively more aggressive and risky investments using the bank's money, when one investment goes bad, the rogue trader engages in further market speculation in the hope of a quick profit which would hide or cover the loss. Unfortunately, when one investment loss is piled onto another, the costs to the bank can reach into the hundreds of millions of dollars; there have even been cases in which a bank goes out of business due to market investment losses. • Fraudulent Loans One way to remove money from a bank is to take out a loan, a practice bankers would be more than willing to encourage if they know that the money will be repaid in full with interest. A fraudulent loan, however, is one in which the borrower is a business entity controlled by a dishonest bank officer or an accomplice; the "borrower" then declares bankruptcy or vanishes and the money is gone. The borrower may even be a non-existent entity and the loan merely an artifice to conceal a theft of a large sum of money from the bank. • Wire Fraud Wire transfer networks such as the international SWIFT inter-bank fund transfer system are tempting as targets as a transfer, once made, is difficult or impossible to reverse. As these networks are used by banks to settle accounts with each other, rapid or overnight wire transfer of large amounts of money is commonplace; while banks have put checks and balances in place, there is the risk that insiders may attempt to use fraudulent or forged documents which claim to request a bank depositor's money be wired to another bank, often an offshore account in some distant foreign country. • Forged or Fraudulent Documents Forged documents are often used to conceal other thefts; banks tend to count their money meticulously so every penny must be accounted for. A document claiming that a sum of money has been borrowed as a loan, withdrawn by an individual depositor or transferred or invested can therefore be valuable to a thief who wishes to conceal the minor detail that the bank's money has in fact been stolen and is now gone. • Uninsured Deposits There are a number of cases each year where the bank itself turns out to be uninsured or not licensed to operate at all. The objective is usually to solicit for deposits to this uninsured "bank", although some may also sell stock representing ownership of the "bank". Sometimes the names appear very official or very similar to those of legitimate banks. For instance, the "Chase Trust Bank" of Washington DC appeared in 2002 with no license and no affiliation to its seemingly apparent namesake; the real Chase Manhattan Bank is based in New York. There is a very high risk of fraud when dealing with unknown or uninsured institutions. The risk is greatest when dealing with offshore or Internet banks (as this allows selection of countries with lax banking regulations), but not by any means limited to these institutions. Management of Financial Institutions • Theft of Identity Dishonest bank personnel have been known to disclose depositors' personal information for use in theft of identity frauds. The perpetrators then use the information to obtain identity cards and credit cards using the victim's name and personal information. • Demand Draft Fraud Demand draft fraud is usually done by one or more dishonest bank employees. They remove few DD leaves or DD books from stock and write them like a regular DD. Since they are insiders, they know the coding, punching of a demand draft. These Demand drafts will be issued payable at distant town/city without debiting an account. Then it will be cashed at the payable branch. For the paying branch it is just another DD. This kind of fraud will be discovered only when the head office does the branch-wise reconciliation, which normally will take 6 months. By that time the money is unrecoverable. • Stolen Cheques Some fraudsters obtain access to facilities handling large amounts of cheques, such as a mailroom or post office or the offices of a tax authority (receiving many cheques) or a corporate payroll or a social or veterans' benefit office (issuing many cheques). A few cheques go missing; accounts are then opened under assumed names and the cheques (often tampered or altered in some way) deposited so that the money can then be withdrawn by thieves. Stolen blank cheque-books are also of value to forgers who then sign as if they were the depositor. • Accounting Fraud In order to hide serious financial problems, some businesses have been known to use fraudulent bookkeeping to overstate sales and income, inflate the worth of the company's assets, or state a profit when the company is operating at a loss. These tampered records are then used to seek investment in the company's bond or security issues or to make fraudulent loan applications in a final attempt to obtain more money to delay the inevitable collapse of an unprofitable or mismanaged firm. • Stolen Credit or Debit Cards Often, the first indication that a victim's wallet has been stolen is a 'phone call from a credit card issuer asking if the person has gone on a spending spree; the simplest form of this theft involves stealing the card itself and charging a number of high-ticket items to it in the first few minutes or hours before it is reported as stolen. A variant of this is to copy just the credit card numbers (instead of drawing attention by stealing the card itself) in order to use the numbers in online frauds. • Fraudulent Loan Applications These take a number of forms varying from individuals using false information to hide a credit history filled with financial problems and unpaid loans to corporations using accounting fraud to overstate profits in order to make a risky loan appear to be a sound investment for the bank. Can We Avoid Cheque Fraud? Reconcile your account; Reconcile your cheque account promptly and regularly. If you hold business accounts, consider opening a separate account specifically for higher value cheques, so they can be easily monitored. Signing of Cheques; Never sign blank cheques, only sign cheques after all details have been completed. Preparation; Cheques must be completed in a way that deters fraudulent alternation. Ensure that a strong bold and consistent font is used and that no gaps are left in completion of the payee name, amount in words and in figures. Use permanent ballpoint or ink (preferably black) when filling out a cheque. Ordering and maintaining cheques; If cheques are lost or stolen contact your bank immediately and ask them to load a ‘Stop Payment’. Notify bank, if you have not received an ordered cheque book. Protect your credit / debit card Save your personal identification number (PIN). Don't use the same PIN for different cards or equipment, and don't choose your birth date or any other easily identifiable number that might be on something else in your wallet. Check statements and call your credit card issuer immediately if you see anything suspicious on your bill. You could help the company uncover fraud—and save yourself from paying un-authorized charges. Keep track of when new and reissued cards should arrive, and call the credit card issuer if they don't come on time. Make sure your mailbox is secure, and that only you and the postal carrier have access to it. When you use your credit card online, make sure you are using a secure website. Look for a small key or lock symbol at the bottom right of your browser's window. Never give your card number to strangers or telemarketers who call you on the phone. Don't give your card number unless you initiated the call.