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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Passports for Sale: Why We Should Worry about Golden Visa Programs

In 1984, the government of the small Caribbean island state of Saint Kitts and Nevis had a bright idea for attracting foreign capital: the country would grant permanent resident status to any foreign national who invested a sufficient amount in the country. The idea caught on, and now dozens of countries around the world—including not only small island states, but also major developed economies like the United States and the United Kingdom—have so-called “golden visa” programs. Golden visa programs have proven especially attractive during times of economic hardship, as demonstrated by the spread of these programs across Europe in the wake of the 2008 recession. These European programs are especially notable, as getting a visa in one country in the Schengen visa zone provides access to the other 25 as well. Some states—including EU members Austria, Bulgaria, Cyprus, and Malta—even offer investors outright citizenship, rather than simply residency status, in exchange for sufficiently large investments. And due to pre-existing visa waiver agreements, these “golden passports” may allow access to other countries as well. Those with Maltese passports, for example, can travel to the US visa-free.

According to a recent Transparency International-Global Witness report, in the last decade alone, countries with these sorts of programs have “sold” (that is, traded for investment) more than 6,000 passports and nearly 100,000 residency permits. Yet these policies have always been controversial, and are becoming more so. Canada terminated its golden visa program in 2014 (though it continues in Quebec). Last June, the Trump Administration demanded that Congress either terminate or reform the US investor visa program. And the UK abruptly announced it would suspend its program on December 6th, although it reversed course six days later.

Part of the reason for the growing disillusionment with golden visa programs is that their supposed economic benefits haven’t lived up to expectations. Rather than stimulate economic growth and job creation, the investments used to qualify for golden visas are often passive, such as government bonds or real estate. In Portugal, for example, 95% of total investment has been in real estate—6,141 investments compared to just 12 in employment creation. Real estate investments not only offer limited benefits, but may also distort housing markets. In the US, investments have been, in the words of US Senator Chuck Grassley, funneled towards “big moneyed Manhattan interests” rather than “direct investment to rural and high unemployment areas.” Hungary even managed to lose money on its program—$221 million—as it offered investors discounted bonds that were then fully repaid after five years with an additional 2% interest.

But the bigger problem with golden visa programs is their potential to both facilitate and stimulate corruption and money laundering. This problem, which was highlighted both by the TI-Global Witness report mentioned above, as well as another report from the European Commission, takes several forms. Continue reading

Proposed US Legislation Can Solve the Art World’s Money Laundering Problem

The plan was simple: a wealthy client wishing to launder the proceeds of a stock manipulation scheme could do so through a Picasso painting. His accomplice would be Matthew Green, the owner of a prominent London art gallery and son of one of London’s most powerful art dealers. The client would purchase the painting using the illegal proceeds, own the painting for some time to avoid suspicion, and then sell the painting back to Green, who would transfer the original payment back to the client through a US bank—to “clean the money.” It was completely foolproof, except that the client turned out to be an undercover FBI agent.

Why a painting to launder the money? Because the art business is impenetrable by outsiders: it’s a world limited to highbrow art connoisseurs, dealers, and wealthy collectors, where the prices are whatever they want them to be. Here, $9.2 million, although the painting failed to sell at a much lower price estimate years before. And as the defendants in the Green case explained to their client, the art business is “the only market that is unregulated” by the government. It seems that the players in the art world make up their own rules, unchecked by any authority, making this elusive quality of the business the perfect “hotbed” for corrupt activity.

In May 2018—possibly in response to the February 2018 indictment in this case—legislation was introduced in US Congress to tackle the money-laundering problem in the art business (previously described on this blog). The Illicit Art and Antiquities Trafficking Prevention Act (Act) would cover art and antiquities dealers under the Bank Secrecy Act (BSA), which requires financial institutions and other regulated businesses to establish anti-money laundering programs, keep records of cash purchases, and report suspicious activity and transactions exceeding $10,000 to government regulators. This legislation has, perhaps unsurprisingly, been vigorously opposed by the art industry. But the objections to the proposal do not withstand scrutiny:

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The EU Needs a Centralized AML Authority

The European Union had a tough year. As if the refugee crisis, the rise of nationalist and far-right parties, and the Brexit affair weren’t enough, the 2018 headlines of European newspapers were crowded with a seemingly endless parade of money laundering scandals. Perhaps the most egregious was the case of Danske Bank, the largest bank in Denmark and a major retail bank in northern Europe. According to Danske Bank’s own report, between 2007 and 2015 the bank’s Estonian branch processed more than US$230 billion in suspicious transactions. The investigation, which is still ongoing, has already been dubbed the largest money laundering scandal in history. And there are plenty of others. In September 2018, for example, the Dutch bank ING Groep NV admitted that criminals used its accounts to launder money and agreed to pay a record US$900 million in penalties. And then in October 2018, after a string of scandals, Malta became the first EU Member State to receive an official European Commission (EC) order to strengthen enforcement of its anti-money laundering (AML) rules. By the end of 2018, it became apparent that the EU’s entire AML system needed a major overhaul.

The EU’s current AML legal framework is comprised of several components:

  • The first element is the set of so-called AML Directives, the most recent of which (the sixth) was adopted in 2018. These Directives require Member States to achieve certain legal results, but do not specify the particular measures that Member States must adopt.
  • Second, following the AML Directives, all EU Member States have adopted national AML laws and regulations that provide detailed guidance on a variety of topics, including the specification of different entities’ AML responsibilities, the sanctions for AML system breaches, and so forth.
  • The third important component of the EU’s AML framework is the EU Regulation on information accompanying transfers of funds, which is meant to harmonize across Member States the provision of payers’ and payees’ information when persons are transferring and receiving funds. In contrast to the AML Directives, this EU regulation, like other such regulations, has a direct legal effect on all Member States. Therefore, the information accompanying transfers of funds is identical in all Member States.

Taken together, these various instruments comprise one of the most stringent AML systems in the world, at least on paper. Perhaps for that reason, many commentators, including EU and EC officials themselves, attribute the spate of money laundering scandals plaguing EU countries not so much to weaknesses in the substantive regulations but rather to poor implementation—in particular, the fragmentation of AML oversight. Last October, Bruegel, an influential European think tank, presented a report calling for the establishment of a new centralized European AML authority—one that would work closely with national law enforcement agencies and be empowered to impose fines. ECB Chief Supervisor Danièle Nouy, who is intimately familiar with the problem, seems to agree at least to some extent. After one of last year’s many money laundering scandals, she suggested that “we need a European institution that is implementing in a thorough, deep, consistent fashion this legislation in the Euro area.” In fact, the proposal to create a more centralized EU AML architecture has been around for a while. It seems that the EU has finally decided that the time has come to do something like this, as the European Central Bank (ECB) announced last November that it would set up a central AML supervision office.

To understand the justification for creating a new centralized EU AML agency, one must first understand the extent to which, under the current system, supervisory and enforcement responsibility for the EU’s AML system is divided among several institutions, and the problems that this can create: Continue reading

Ownership Transparency Works: Geographic Targeting Orders in the US Real Estate Market

The anticorruption community, along with those concerned about tax evasion, fraud, and other forms of illicit activity, has made anonymous company reform a high priority on the reform agenda. It’s not hard to see why: Kleptocrats and their cronies, as well as other organized criminal groups, need to find ways to hide and launder their assets, and to do so in ways that are difficult for law enforcement authorities to trace. Moreover, those whose legitimate sources of income would be insufficient to obtain luxury assets would like to conceal their ownership of such assets, as the ownership itself could arouse suspicion, and might make the assets more vulnerable to forfeiture.

So-called “know-your-customer” (KYC) laws in the financial sector have made it much more difficult—though, alas, far from impossible—for account owners to conceal their identities from the banks and government overseers, at least in the US and most other OECD countries. But it is still far too easy for criminals to purchase substantial assets in wealthy countries like the United States while keeping their identities hidden. All the bad actor needs to do is, first, form a company in a jurisdiction that does not require the true owner of the company to be disclosed and verified to the government authorities, and, second, have this anonymous shell company purchase assets in a transaction that is not covered by KYC laws. Step one is, alas, still far too easy. Though we often associate the formation of these sorts of anonymous shell companies with “offshore” jurisdictions like the British Virgin Islands, in fact one can easily form an anonymous shell company in the United States. Step two, having the anonymous company purchase substantial assets without having to disclose the company’s owner, is a bit trickier, because you’d need to avoid the banking system. But you can get around this problem by having your anonymous company purchase assets with cash (or cash equivalents, like money orders or wire transfers), so long as no party to the transaction is under obligations, similar to those imposed on banks, to verify the company’s true owner.

One of the sectors where we’ve long had good reason to suspect this sort of abuse is common is real estate, especially high-end real estate. Though money laundering experts had long been aware of the problem, the issue got a boost from some great investigative journalism by the New York Times back in 2015. The NYT reporters managed to trace (with great effort, ingenuity, and patience) the true owners of luxury condos in one Manhattan building (the Time Warner Center), and found that a number of units were owned by shady characters who had attempted to conceal their identities by having shell companies make the purchases.

The US still hasn’t managed to pass legislation requiring verification of a company’s true owners as a condition of incorporation, which would be the most comprehensive solution to the anonymous company problem. Nor has the US taken the logical step of extending KYC laws to real estate agents across the board. But starting back in 2016, the US Treasury Department’s Financial Crimes Enforcement Network (known as FinCEN) took an important step toward cracking down on anonymous purchases of luxury real estate by issuing so-called Geographic Targeting Orders (GTOs). And thanks to some excellent research by the economists C. Sean Hundtofte and Ville Rantala (still unpublished but available in working paper form), we have strong evidence that many purchasers in the luxury real estate market have a strong interest in concealing their true identities, and that requiring verification of a company’s ultimate beneficial owners has a stunningly large negative effect on the frequency and aggregate magnitude of anonymous cash purchases. Continue reading

Uzbekistan’s Own Donald Trump

Donald Trump owes much of his success as a real estate developer to an easy relationship with the anti-money laundering laws, and he continues to profit from his investments while President thanks to an even easier relationship with conflict of interest norms.  Reports out of Uzbekistan suggest Jahongir Artykhodjaev, mayor of the capital city Tashkent, has followed a Trumpian-like path to wealth and power.  Like Trump, Artykhodjaev has looked past how investors in his real estate projects came into their money; like Trump, while in public office he has steered government contracts to companies he owns, and like Trump, when called on his dual role as businessman and government officials, he claims to have distanced himself from his business empire upon taking office.

The main difference (besides hair color) between Trump and Artykhodjaev is that independent prosecutors are examining whether Trump broke rather than simply bent anti-money laundering and conflict of interest laws. By contrast, after accounts in the international press (here and here) exposed Artykhodjaev’s Trumpian proclivities, senior Uzbek officials called a press conference where they leapt to his defense, going so far as to deny there is any Uzbekistan law that Artykhodjaev could have broken. Continue reading

Will 2019 Be the Year the US Finally Passes Anonymous Company Reform? Not If the ABA Gets Its Way

It’s a new year, a new US Congress, and a new opportunity for the United States to take action to close some of the most glaring loopholes in its anticorruption and anti-money laundering (AML) framework. So far, Washington has been consumed with the government shutdown fight, along with early chatter about who might seek the Democratic nomination to challenge Trump for the presidency in 2020, such that there hasn’t yet been much coverage of what new legislation we might see emerging from this new Congress over the next two years. And to the extent there has been such discussion, it has tended to focus on initiatives—such as the Democrat-sponsored “anticorruption” bills that focus on lobbying, voting rights, and conflict-of-interest law reform—that, whatever their usefulness in shaping the debate and setting an agenda for the future, have virtually no chance of passing in the current Congress, given Republican control of the Senate and the White House. Indeed, many commenters assume that on a wide range of issues, political gridlock and polarization means that the new Congress is unlikely to accomplish much in the way of new legislation.

That may be true as a general matter, but there are a few areas—including some of particular interest to the anticorruption community—where the opportunity for genuine legislative reform may be quite high. Perhaps the most promising such opportunity is so-called anonymous company reform. Anonymous companies are corporations and other legal entities whose true “beneficial owners” are unknown and often hard to trace. (The registered owner is often another anonymous legal entity registered in another jurisdiction.) It’s no secret that anonymous companies are used to funnel bribes to public officials, to hide stolen assets, and to facilitate a whole range of other crimes, including tax evasion, fraud, drug trafficking, and human trafficking. And although in the popular imagination shady anonymous shell companies are associated (with some justification) with “offshore” jurisdictions, in fact the United States has one of the most lax regulatory regimes in this area, making it ridiculously easy for kleptocrats and others to use anonymous companies registered in the US to shield their assets and their activities from scrutiny.

Of course it’s possible for law enforcement agencies, armed with subpoena power and with the assistance—one hopes—with cooperative foreign partners and sympathetic courts can eventually figure out who really owns a company involved in illicit activity, doing so is arduous, time-consuming, and sometimes simply impossible. It would be much better if there were a central register of beneficial ownership information, with verification of the information the responsibility of those registering the companies and stiff penalties for filing inaccurate information. Indeed, one of the striking things about the debate over anonymous company reform is how little disagreement there seems to be among experts about the benefits of a centralized company ownership register. There’s still significant controversy over whether these ownership registers should be public (see, for example, the extended exchange on this blog here, here, here, here, and here). But even those who object to public registers of the sort the UK has created acknowledge, indeed emphasize, the importance of creating a confidential register that’s accessible to law enforcement agencies and financial institutions conducting due diligence. But the US doesn’t even have that.

There’s a chance this might finally change. Continue reading