In today’s world, procedures relating to anti-money laundering have become part and parcel with correct and careful business practice.
According to a study conducted by the United Nations Office on Drugs and Crime, it is estimated that, in 2009, proceeds generated by drug trafficking and organised crimes amounted to 3.6% of the global GDP, with 2.7%, or about EUR 1.4 trillion, being laundered.
Naturally, it is difficult to procure precise statistics due to the illegal nature of such transactions, however, in the last decade, there has been a shift towards increasing the importance of compliance. Anti-money laundering (“AML”) regulation has been revised and strengthened to challenge the advanced methods used by criminals to legitimise illicit funds.
Globalisation and the rise of the Internet continue to shape daily life, including the way in which business is conducted. The concerns this has brought about are addressed in the 5th Anti-Money Laundering Directive, set to be implemented by EU member states by 2020 to replace the rapidly inadequate 4th Anti-Money Laundering Directive.
The developing legal landscape, while certainly valuable in safeguarding global industries from criminal efforts, present several hurdles in the way of compliance. Non-compliance with AML, Know Your Customer (“KYC”), and sanctions regulations can not only lead to the further propagation of money laundering, but also hefty fines levied against one’s business, as has happened to entities ranging from small companies to globally ranked institutions. A recent case occurred in the United States in May, where the Financial Industry Regulatory Authority imposed a USD 17m against a financial services firm for several points of non-compliance, such as an insufficient customer identification system.
To avoid such penalties and to strengthen one’s business reputation, it is vital to first know what the threat one is dealing with consists of.
The crime of money laundering is the process of making quantities of funds generated through criminal activities, such as drug trafficking or terrorist funding, appear to have originated from a legitimate source. The criminal proceeds are considered “dirty” and the process “launders” it to make it look clean.
The means by which money is laundered vary in appearance and complexity, ranging from business fronts such as restaurants and carwashes to gambling, property investment, shell companies and trusts, and the purchase of virtual currencies. While different money laundering models may have extensive differences, money laundering methods can ordinarily be said to possess three identifiable stages:
Placement – Here, the dirty money is placed into the legitimate financial system, to remove the funds from their original place of acquisition.
Layering – This consists of obscuring the trail of the funds from their source.
Integration – Finally, processes are conducted so that the laundered money may be held and used legitimately for the purposes intended by the criminals.
Understanding each stage is important in preventing one’s business from being a potential target of such illicit activities.
PEPs and Money Laundering
When entering into a business relationship, it is important to examine the potential risk of money laundering. Risks associated with a potential customer can originate from geographical, product-based, interface, and personal characteristics. It is important to screen for these, as each may lead to increased risk of exposure to money laundering.
Some potential customers pose an inherently higher risk, and correct compliance requires that these are always subjected to more rigorous due diligence processes. An example of such are politically exposed persons (“PEPs”). A PEP is generally described as a natural person who is or has been entrusted with prominent public functions. This generally includes politicians, generals, judges, and other persons in public positions. It also includes the immediate family members, or persons known to be close associates of such persons.
The law requires the application of enhanced due diligence to PEPs, meaning that it is important to maintain a robust risk approach to screen such individuals. This is necessary because, while PEPs are generally thought to be under heavy scrutiny by the media and the public eye, it must be borne in mind that PEPs are individuals with significantly higher status, access, and influence than normal.
Corrupt officials use money laundering as a means to siphon public funds and to conceal bribery. When such crimes are committed, they tend to be highly complex and involve multiple individuals and processes. However, in several cases, the means could still be categorised into the three stages.
The Azerbaijani Laundromat
In September 2017, a massive leak by the Organised Crime and Reporting Project (OCCRP) linked the country’s President, Ilham Aliyev, and a number of close associates in the Azerbaijani elite, of running a slush fund and an international money laundering scheme. Numerous European banks and financial institutions were also implicated.
The key component in the case was the usage of legitimate institutions to create the appearance that the funds involved were legally obtained. Bank records, which spanned from 2012 to 2014, showed the laundering of USD 2.9bn from Azerbaijan.
One of the institutions used for this measure was a small branch of Danske Bank, situated in Estonia. Danske admitted it had not performed the necessary steps required for due diligence when the money was deposited into accounts and claimed nothing seemed amiss at the time, despite warnings from the Estonian government from as far back as 2007. Thus, the first stage of money laundering, Placement, was achieved by the transfer of the funds to the institution.
Using Danske as the first stop for transactions, the second stage of laundering the money could commence: Layering, which is the further movement of funds through transactions. The transactions were mainly conducted via four shell companies in the UK, two of which were Scottish limited partnerships, which at the time did not require disclosure of the owners of the company, allowing the individuals who owned the shell companies to remain anonymous. This has been changed with new legislation enacted in June 2017. These offshore companies were reportedly used to pay-off European officials to sway their votes on matters related to Azerbaijan.
Finally, the third stage could be achieved: Integration. The funds were integrated into the financial system through the sending of the money to various countries to be spent as investments. This included jurisdictions like Kazakhstan, Turkey, Iran, the UK, and Germany. The funds were also used to purchase luxury goods and to line the pockets of the perpetrators.
At present, Danske Bank is still under investigation in numerous European countries. However, it has already faced numerous consequences. The bank was ordered by Estonian authorities to close its operations in Estonia and potentially faces billions in fines. In addition, ten local employees were arrested in Estonia. The bank’s operations have also ceased in three other nations, and the CEO, Thomas Borgen, has been removed from his position by the board of the bank.
The Azerbaijani Laundromat raises many AML issues. Firstly, proper due diligence was not conducted when these funds were first transferred to Europe. The second issue is PEPs misappropriating public funds through the means accessible to them because of their position and influence. Their ability to manipulate their local financial institutions for their benefit demonstrates the high risk when conducting business with such persons. Furthermore, several European officials were implicated in the scandal, which highlights the need for greater vigil by regulators and operators in the financial world.
What Steps Should be Taken to Prevent this in Future?
PEPs are viewed as engendering higher risk due to their access to public funds and foreign resources, as well as their influence, as was highlighted in the Azerbaijani Laundromat scandal; which was further linked to the Russian Laundromat scandal.
As advancements are made in an almost cashless society, the tools and methods of money laundering continue to augment in complexity, and a greater number of mediums, jurisdictions, and services are used to make illicit funds appear legitimate. Certain older methods have also experienced a resurgence.
In the case of the Azerbaijani Laundromat, the flaws of the Danske branch were highlighted almost at the offset of the branch opening, especially in the performance of due diligence. Therefore, one of the most important parts of correct compliance is adopting appropriate measures to screen customers for risk assessment. To accomplish such, it is important to make use of the appropriate tools to detect factors, such as the presence of a PEP within the ownership or control structure, during the initial period of onboarding and monitoring. Current AML legislation is assisted in this regard by technology that has been developed to allow businesses to operate at optimal efficiency without compromising compliance.
The information, views, and opinions in this article are being provided solely for educational and informational purposes and should not be construed as advice. StartKYC Ltd has not verified and consequently neither warrants the accuracy nor the veracity of any information, views or opinions included in this article.