The Global Community Must Take Further Steps to Combat Trade-Based Money Laundering

Global trade has quadrupled in the last 25 years, and with this growth has come the increased risk of trade-based money laundering. Criminals often use the legitimate flow of goods across borders—and the accompanying movement of funds—to relocate value from one jurisdiction to another without attracting the attention of law enforcement. As an example, imagine a criminal organization that wants to move dirty money from China to Canada, while disguising the illicit origins of that money. The organization colludes with (or sets up) an exporter in Canada and an importer in China. The exporter then contracts to ship $2 million worth of goods to China and bills the importer for the full $2 million, but, crucially, only ships goods worth $1 million. Once the bill is paid, $1 million has been transferred across borders and a paper trail makes the money seem legitimate. The process works in reverse as well: the Canadian exporter might ship $1 million worth of goods to the Chinese importer but only bill the importer $500,000. When those goods are sold on the open market, the additional $500,000 is deposited in an account in China for the benefit of the criminal organization. Besides these classic over- and under-invoicing techniques, there are other forms of trade-based money laundering, including invoicing the same shipment multiple times, shipping goods other than those invoiced, simply shipping nothing at all while issuing a fake invoice, or even more complicated schemes (see here and here for examples).

As governments have cracked down on traditional money-laundering schemes—such as cash smuggling and financial system manipulation—trade-based money laundering has become increasingly common. Indeed, the NGO Global Financial Integrity estimates that trade misinvoicing has become “the primary means for illicitly shifting funds between developing and advanced countries.” Unfortunately, trade-based money laundering is notoriously difficult to detect, in part because of the scale of global trade: it’s easy to hide millions of dollars in global trading flows worth trillions. (Catching trade-based money laundering has been likened to searching for a bad needle in a stack of needles.) Furthermore, the deceptions involved in trade-based money laundering can be quite subtle: shipping paperwork may be consistent with sales contracts and with the actual shipped goods, so the illicit value transfer will remain hidden unless investigators have a good idea of the true market value of the goods. Using hard-to-value goods, such as fashionable clothes or used cars, can make detection nearly impossible. Moreover, sophisticated criminals render these schemes even more slippery by commingling illicit and legitimate business ventures, shipping goods through third countries, routing payments through intermediaries, and taking advantage of lax customs regulations in certain jurisdictions, especially free trade zones (see here and here). In a world where few shipping containers are physically inspected (see here, here, and here), total failure to detect trade-based money laundering is “just a decimal point away.”

The international community can and should be doing more to combat trade-based money laundering, starting with the following steps:

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Guest Post: Are Public UBO Registers a Good or a Bad Proposition? A Further Reply to Professor Stephenson

Today’s guest post, from Martin Kenney, the Managing Partner of Martin Kenney & Co., a law firm based in the British Virgin Islands (BVI), continues an ongoing debate/discussion we’ve been hosting here at GAB on the costs and benefits of public registries of the ultimate beneficial owners (UBOs) of companies and other legal entities. That debate was prompted by the UK’s decision to mandate that the 14 British Overseas Territories create such public registries, and Mr. Kenney’s sharp criticism of that decision in a post he published on the FCPA Blog. That post prompted reactions from Rick Messick and from me. Our pushback against Mr. Kenney’s criticisms stimulated another round of elaboration on the critique of the UK’s decision, with a new post from Mr. Kenney and another from Geoff Cook (the CEO of Jersey Finance). I subsequently replied, explaining why I did not find Mr. Kenney’s or Mr. Cook’s criticisms fully persuasive. Today’s post from Mr. Kenney continues that exchange:

Public [UBO] registers are rather cheap political playing to the gallery, saying “Aren’t we wonderful to have done this?” – ignoring the fact that what we have established in the UK does not work properly….  It seems to me outrageous that the UK Government, who lack a lot in the area of anti-money laundering, should thus seek to impose on their overseas territories measures – often, where they cannot be afforded economically, that go far beyond what the UK has.

Lord Flight (Conservative), Member of the House of Lords, Speech to the House of 21 May, 2018, Debate on the Sanctions and Anti-Money Laundering Bill [HL] 

The fact that Professor Stephenson welcomes a good discussion and has opened the doors to his blog once again, means it would be impolite of me to not provide a response to his latest observations.

From the outset, I will stress that I will not seek to address every point Professor Stephenson makes. However, having addressed those below, if there are others he wishes me to respond to, I will endeavor to do so. Continue reading

Guest Post: Just Because UBO Data Isn’t Available for Everyone to See, It Doesn’t Make It Secret

Today’s guest post comes from Geoff Cook, CEO of Jersey Finance (a non-profit organization established to promote Jersey as an international financial center of excellence). Mr. Cook’s piece continues a debate over the UK’s recent decision to require British Overseas Territories to adopt centralized public registers with information on the ultimate beneficial owners (UBOs) of legal entities registered in those jurisdictions. The discussion of this issue at GAB was prompted by Martin Kenney’s post on the FCPA Blog, which sharply criticized the UK’s decision. GAB published two replies to Mr. Kenney’s criticisms, the first from Senior Contributor Rick Messick, and the second from Editor-in-Chief Matthew Stephenson. Earlier this week, GAB published Mr. Kenney’s response, and today Mr. Cook continues the discussion by explaining why, from the perspective particularly of a jurisdiction like Jersey, public UBO registers are unnecessary and potentially dangerous.

It is claimed that jurisdictions such as the Crown Dependencies that fail to introduce public registers of company ownership are advocating secrecy and encouraging the laundering of “dirty” money through the financial system. But the call for public registers, which serves a political agenda, is proposed in isolation, ignoring other effective measures for exchanging information that have been implemented during the last few years.

The Common Reporting Standard (CRS), for instance, has been largely ignored in the debate.  Through this OECD inspired agreement, the values of all bank accounts and investments in whatever form are exchanged automatically each year to the owner’s home tax authority. Company ownership details are included in that exchange. Jersey was an early adopter of the system in 2017 and has already swapped information with the other 50 countries that participate. More countries are joining, and will be exchanging data again in September – not a measure that fits with a secrecy agenda.

Jersey has been examined by independent standard setters such as the OECD as recently as 2017, and found to be in the top drawer for the quality of its standards and response to transparency. Jersey is one of only two jurisdictions to have the top rating so far, yet the standards attained by global organizations that truly understand the financial system are rarely quoted in the debate. Instead we are accused by detractors of obstruction and secrecy, with no regard for what is actually taking place. Continue reading

The Flawed and Flimsy Basis for the American Bar Association’s Opposition to Anonymous Company Reform

In last week’s post, I raised the question of why the American Bar Association (ABA), which represents the U.S. legal profession, so strenuously opposes even relatively modest measures to crack down on the use of anonymous companies for money laundering and other illicit purposes. In particular, the ABA has staked out a strong, uncompromising opposition to the bills on this topic currently under consideration in the U.S. House (the Counter Terrorism and Illicit Finance Act) and in the Senate (the TITLE Act). As I noted in my last post, the substance of the ABA’s objections (summarized in its letters here and here) appear, at least on their surface, unpersuasive as a matter of logic, unsupported by evidence, or both. This, coupled with the fact that many ABA members strongly disagree with the ABA’s official position on this issue, made me wonder how the ABA’s President and Government Affairs Office had come to take the position that they had.

After doing a bit more digging, and talking to several knowledgeable people, I have a tentative answer: The ABA’s opposition to the currently-pending anonymous company bills is based on an aggressive over-reading of a 15-year-old policy—a policy that many ABA members and ABA committees oppose but have not yet been able to change, due to the ABA’s cumbersome procedures and the resistance of a few influential factions within the organization.

Why does this matter? It matters because the ABA’s letters to Congress deliberately give the impression that the ABA speaks for its 400,000 members when it objects to these bills as against the interests of the legal profession and contrary to important values. But that impression is misleading. There may be people out there—including, perhaps, members of Congress and their aides—who are instinctively sympathetic to the anonymous company reforms in the pending bills, but who might waver, for substantive or political reasons, if they think that the American legal profession has made a considered, collective judgment that these sorts of reforms are undesirable. The ABA’s lobbying documents deliberately try to create that impression. But it’s not really true. The key document setting the policy—the one on which the ABA’s House of Delegates actually voted—was promulgated in 2003, hasn’t been reconsidered or updated by the House of Delegates since then, and doesn’t really apply to the currently-pending bills if one reads the document or the bills carefully.

I realize that’s a strong claim – one could read it as disputing the ABA President’s assertion, in her letters to Congress, that she speaks “on behalf of” the ABA and its membership in opposing these bills. And I could well be wrong, and remain open to correction and criticism. But here’s why I don’t think the ABA’s current lobbying position should be read as reflecting the collective judgment of the American legal profession on the TITLE Act or its House counterpart: Continue reading

Fixing India’s Anti-Money Laundering Regime

In the past year, India has been among the most zealous countries in the world in stepping up the fight against money laundering and related economic and security issues. The effort that probably got the most attention was last year’s surprise “demonetization” policy (discussed by Harmann in last week’s post), which aimed to remove around 85% of the total currency in circulation. But to assess India’s overall anti-money laundering (AML) regime, it’s more important to focus on the basic legal framework in place.

The most important legal instrument in India’s AML regime is the Prevention of Money Laundering Act, which was enacted in 2002, entered into force in 2005, and has been substantially amended since then. The Act defines a set of money laundering offenses, enforced by the Enforcement Directorate (India’s principal AML agency), and also imposes a range of reporting requirements on various institutions. Furthermore, the law gives the Enforcement Directorate the authority to freeze “tainted assets” (those suspected of being the proceeds of listed predicate offenses), and to ultimately seize those assets following the conviction of the defendant for the underlying offense.

How effective has India been in its stepped-up fight against money laundering? On the one hand, over the past year (since the demonetization policy was announced), banks logged an unprecedented increase of 706% in the number of suspicious transaction reports (STRs) filed, and reports from last July indicated that the total value of the assets frozen under the Prevention of Money Laundering Act in the preceding 15 months may have exceeded the cumulative total of all assets frozen in the prior decade-plus of the law’s operation. And the government further reported that its crackdown on shell companies had discovered around $1.1 billion of unreported assets.

Yet these encouraging numbers mask a number of serious problems with India’s AML system, problems that can and should be addressed in order to build on the momentum built up over the past year. Here let me highlight two areas where greater reform is needed: Continue reading

Should There Be a Public Registry of Politically Exposed Persons?

Under the “Know Your Customer”-oriented regulatory regime endorsed by organizations like the Financial Action Task Force (FATF), financial institutions and similar entities must apply heightened scrutiny to so-called “politically-exposed persons” (PEPs), as well as their family members and close associates. FATF defines PEPs as individuals who are or have been entrusted with prominent public positions (such as heads of state or government, senior politicians, senior government, judicial, or military officials, senior executives of state-owned companies, and important political party officials), as well as their family members and close associates. (For simplicity, here I’ll use the term PEP to include both the PEPs themselves, and their family members and close associates, as the FATF recommendations make clear that the latter should be covered by the same heightened due diligence rules.) The rationale behind FATF’s recommendation of more stringent due diligence for PEPs is the idea that PEPs are higher-risk customers, because they have more opportunities than ordinary citizens to acquire assets through unlawful means like embezzlement and bribe-taking. Thus, FATF’s Recommendation 12 (which many countries have adopted) advises that countries should require financial institutions to employ additional due diligence measures for foreign PEPs in order to establish the source of the PEP’s assets, and to conduct enhanced ongoing monitoring of the business relationship with the PEP.

That all seems like a good idea. But how, exactly, is a bank supposed to determine whether a prospective client is a PEP? Here, the FATF recommendations say only that financial institutions should “have appropriate risk-management systems to determine” whether a prospective customer is a foreign PEP. In practice, financial institutions rely on a relatively small number of private providers—like World Check (Thompson Reuters), World Compliance (Lexis-Nexis), and a handful of others—to screen prospective clients to see if they are in a database (generated and maintained by the private service providers) of known PEPs. Presumably (though I haven’t been able to figure out whether this is true) financial regulators in countries that have adopted the FATF recommendations on PEP screening will treat a bank’s use of one of these reputable services as satisfying the bank’s responsibility to take reasonable measures to determine whether a client is a PEP, even if in fact the service failed to accurately identify a given customer as a foreign PEP—though the bank might still be on the hook for other legal violations in connection with the PEP’s account.

So, keeping track of who’s a PEP has been entrusted to the private market. There is no “official” PEP list maintained by any national government or inter-governmental organization like FATF, nor does any government (to the best of my knowledge) directly monitor or regulate the private providers like World Check and World Compliance to ensure their PEP lists are accurate and up to date. Is this a problem? Should we be happy leaving PEP screening entirely to the private market, or should there be greater government and/or civil society involvement in generating, maintaining, and revising PEP lists?

This issue came up last month at the “Tackling Corruption Together” conference held the day before the London Anticorruption Summit. David Lewis, the Executive Secretary of FATF, gave a presentation that emphasized (among other things) the importance of due diligence on PEPs. During the Q&A someone from the G20 Research Group (whose name I didn’t catch) asked Mr. Lewis about whether there was the need (and political will) to create public PEP registries, noting both the importance of accurate PEP lists, as well as the inefficiency of individual banks paying private services for screening individual names one at a time. Mr. Lewis replied, quite forcefully, that the creation of public PEP registries would be a “terrible idea.” He knows far more about this issue than I do, and I don’t know nearly enough to come out in favor of public PEP registries, but I have to say, I didn’t really find Mr. Lewis’s reasoning all that persuasive. Continue reading

Guest Post: After the Media Circus, What (If Anything) Have We Learned from the Panama Papers?

GAB is pleased to welcome back Professor Jason Sharman, Deputy Director of the Centre for Governance and Public Policy at Griffith University, Australia, who contributes the following guest post:

After the initial flurry of media attention to the Panama Papers, Matthew Stephenson rightly asks how much, if anything, we have really learned from this affair beyond the celebrity gossip.

A notable degree of modesty is in order here, as what we have seen so far is a tiny, almost certainly unrepresentative sample of the vast quantity of information leaked to International Consortium of Investigative Journalists (ICIJ). The initial wave of media coverage related to 140 individuals, including 12 heads of state or government. Since the ICIJ database became searchable on May 9th, we have a few more names, mostly small-time crooks, and it is possible to run individual name searches to your heart’s content. Nevertheless, given that Mossack Fonseca had created 214,000 shell companies, what we have seems to be less than 1% of their clientele, and presumably the most sensational and outrageous cases. If you looked at your average big international bank, took the records of 214,000 accounts, and subjected them to a detailed financial audit, you probably would find at least a few hundred people engaged in crime or some other seriously shady business (putting banks’ own criminal conspiracies like rigging the LIBOR and Forex markets and sanctions-busting to one side).

Matthew’s earlier post asked about the structure of the offshore shell company industry–in particular, whether it was dominated by a few major providers, or whether it was a highly fragmented market with many firms, each with small market share. The answer is both: There are a few big wholesalers of shell companies, four or five, plus a couple in the US. The wholesalers sell to thousands of intermediary retailers, who then sell to the end-users, i.e. the beneficial owners. I was surprised by how many retailers Mossack Fonseca dealt with (14,000), given that the other wholesalers of equivalent size engage with 2,000-3,000 intermediaries. The difficulty keeping track of this number of retailers, let alone their customers, might explain Mossack Fonseca’s otherwise-puzzling suicidal indiscretion in transacting with customers who brought a huge amount of risk for a fairly trivial sum of money, e.g. those on US government sanctions lists.

What does the structure of the industry mean for regulatory solutions? The retailers could take up the slack if the wholesalers were put out of business, although the process of forming shell companies would be less efficient and more expensive. More importantly, the more concentrated the industry, the easier it is to regulate, compared to the whack-a-mole situation of thousands of independent retailers. As Rick Messick rightly points out, for this regulation to work, however, it is necessary for the Eligible Introducer system between wholesalers and retailers to work in identifying beneficial owners. Despite a litany of earlier high-profile failures, a Guardian piece actually suggests that the British Virgin Islands authorities had recently got on top of this problem: in 2015, 90 requests from the local Financial Intelligence Unit to Mossack Fonseca turned up the names of 89 beneficial owners. However, because customer identity documents are now almost always scans rather than paper, there seems to be no good reason why they can’t be held in the jurisdiction of incorporation.

More broadly, with the Panama Papers and the earlier April 2013 offshore leak, we (or at least the ICIJ) now have information on just over 320,000 offshore shell companies, which probably represents something like 15-20% of all the offshore shell companies ever created. You can work out the total number in that BVI has about 40-45% of the worldwide market. It currently has 450,000 active companies, and 950,000 formed in total since the creation of its registry. If we could draw a random sample of these companies and the associated documentation, rather than cherry-picking the worst of the worst, then we could form a much more accurate and robust conclusion on what the typical uses of offshore shell companies actually are.

In just looking at the information we do have from the Panama Papers, two things are fairly apparent, yet don’t seem to have attracted much comment so far: Continue reading