Money Laundering
Money Laundering A0250-2
Contents
What is money laundering? 5
Where does money laundering come from? 6
What is the scale of the problem? 7
How does money laundering work? 7
Where does money laundering occur? 12
Why should money laundering be stopped? 15
How can money laundering be stopped? 20
Money laundering trends in South Africa 22
Purchase of goods and properties 22
Abuse of businesses and business entities 23
Cash and currency 24
Abuse of financial institutions 25
The informal sector of the economy 26
Money laundering legislation in South Africa 27
The relevant laws 27
Important definitions 27
The Prevention of Organised Crime Act 29
Negligence and intent (section 1) 29
Laundering offences linked to racketeering (sections 2 – 3) 29
Laundering offences linked to proceeds of unlawful activities (sections 4 – 8) 30
Offences relating to criminal gang activities (sections 9 – 11) 31
Dealing with proceeds of unlawful activities (sections 12 – 36) 31
The Financial Intelligence Centre Act 33
The Financial Intelligence Centre (sections 2 – 16) 34
The Money Laundering Advisory Council (sections 17 – 20) 34
Money laundering control measures (sections 21 to 45) 35
Offences and penalties (sections 46 – 68) 41
Search, seizure and forfeiture (section 70) 42
List of accountable institutions (schedule 1) 43
List of supervisory bodies (schedule 2) 44
List of reporting institutions (schedule 3) 44
Regulations 45
What can I do to combat money laundering? 50
Government 50
Accountants and consultants 51
Independent auditors 52
Internal auditors 53
What is money laundering?
The goal of a large number of criminal acts is to generate a profit for the individual or group that carries out the act. Money laundering is the processing of these criminal proceeds to disguise their illegal origin. This process is of critical importance, as it enables the criminal to enjoy these profits without jeopardising their source.
Illegal arms sales, smuggling, and the activities of organised crime, including for example drug trafficking and prostitution rings, can generate huge sums. Embezzlement, insider trading, bribery and computer fraud schemes can also produce large profits and create the incentive to “legitimise” the ill-gotten gains through money laundering.
When a criminal activity generates substantial profits, the individual or group involved must find a way to control the funds without attracting attention to the underlying activity or the persons involved. Criminals do this by disguising the sources, changing the form, or moving the funds to a place where they are less likely to attract attention.
Governments are now realising that the pursuit and confiscation of illegal monies from crime is as effective a way of attacking crime as arresting the felons, perhaps even more so given that many drug barons are able to continue to conduct business from their prison cells. So by seizing the rewards from crime it is hoped that such activity is discouraged. The extent to which money laundering enables criminals to engage in activities harmful to the economy validates its study so as to prevent such activity.
A second reason for studying the economics of money laundering is that most financial institutions are unaware of the extent to which the world financial markets and banking system are being used to process illegal monies. Banks and financial institutions are at risk from being used for such activities as failure to observe their new legal responsibilities in combating money laundering leaves many of them open to criminal prosecution and the subsequent adverse publicity.
Therefore the study of money laundering as a means to countering crime, which imposes huge economic resource costs on society and threatens the proper functioning of the economy, as well as threatening the stability of the banking system, is a fully justified area of research.
Where does money laundering come from?
The term "money laundering" is said to originate from Mafia ownership of laundromats in the United States. Gangsters there were earning huge sums in cash from extortion, prostitution, gambling and bootleg liquor. They needed to show a legitimate source for these monies.
One of the ways in which they were able to do this was by purchasing outwardly legitimate businesses and to mix their illicit earnings with the legitimate earnings they received from these businesses. Laundromats were chosen by these gangsters because they were cash businesses and this was an undoubted advantage to people like Al Capone who purchased them.
Money laundering is called what it is because that perfectly describes what takes place - illegal, or dirty, money is put through a cycle of transactions, or washed, so that it comes out the other end as legal, or clean, money. In other words, the source of illegally obtained funds is obscured through a succession of transfers and deals in order that those same funds can eventually be made to appear as legitimate income.
Meyer Lansky (affectionately called “the Mob’s Accountant”) was particularly affected by the conviction of Al Capone for something as obvious as tax evasion. Determined that the same fate would not befall him he set about searching for ways to hide money. Before the year was out he had discovered the benefits of numbered Swiss Bank Accounts. This is where money laundering would seem to have started and according to some authors Lansky was one of the most influential money launderers ever. The use of the Swiss facilities gave Lansky the means to incorporate one of the first real laundering techniques, the use of the “loan-back” concept, which meant that hitherto illegal money could now be disguised by “loans” provided by compliant foreign banks, which could be declared to the “revenue” if necessary, and a tax-deduction obtained into the bargain.
“Money laundering” as an expression is one of fairly recent origin. The original sighting was in newspapers reporting the Watergate scandal in the United States in 1973. Since then, the term has been widely accepted and is in popular usage throughout the world.
Money laundering as a crime only attracted interest in the 1980s, essentially within a drug trafficking context. It was from an increasing awareness of the huge profits generated from this criminal activity and a concern at the massive drug abuse problem in western society that created the impetus for governments to act against the drug dealers by creating legislation that would deprive them of their illicit gains.
Governments also recognised that criminal organisations, through the huge profits they earned from drugs, could contaminate and corrupt the structures of the state at all levels.
Money laundering is a truly global phenomenon, helped by the international financial community which is a 24hrs a day business: When one financial centre closes business for the day, another one is opening or open for business.
As a 1993 UN Report noted: The basic characteristics of the laundering of the proceeds of crime, which to a large extent also mark the operations of organised and transnational crime, are its global nature, the flexibility and adaptability of its operations, the use of the latest technological means and professional assistance, the ingenuity of its operators and the vast resources at their disposal.
The international dimension of money laundering was evident in a study of Canadian money laundering police files. They revealed that over 80 per cent of all laundering schemes had an international dimension.
What is the scale of the problem?
By its very nature, money laundering occurs outside of the normal range of economic statistics. Nevertheless, as with other aspects of underground economic activity, rough estimates have been put forward to give some sense of scale to the problem.
The International Monetary Fund, for example, has stated that the aggregate size of money laundering in the world could be somewhere between two and five percent of the world’s gross domestic product. That is more than the total economic output of the United Kingdom, or about ten times the size of South Africa’s economy.
How does money laundering work?
There is no one method of laundering money and those methods that are the most successful are of course unknown to the authorities. Methods of money laundering range from the purchase and resale of yachts and antiques to the transference of money through a purposefully complex system of legitimate international businesses: shell companies and banks, which may be held by a holding company, usually registered in a jurisdiction where no annual accounts need be filed, foreign or domestic nominee directors may be appointed and bearer shares are permitted, (e.g. the islands of St. Kitts and Nevis in the Caribbean[1]). As most money being laundered comes from street level drug deals, a cash intensive business by nature, this source will be the main area of focus.
Money laundering has both macro and micro levels. The macro level has three distinct stages: that of placement, layering and integration, and innumerable micro phases depending on the size of the operation and the degree of deception required.
Placement
The first stage in the washing cycle is the placement of the monies into the financial system or retail economy or smuggling them out of the country. The aims of this stage are to remove the cash from the location of acquisition so as to avoid detection from the authorities and the attention of other criminals and then to transform it into other asset forms.
This is perhaps the most difficult stage of the cycle, for the launderer is faced with converting small denominations of cash into more manageable monetary instruments or assets. If one imagines a weekly drug revenue of R1 million in R50 notes as a 19 kg package[2] launderers must deposit, some appreciation of the launderer’s problem can be gained. One could not simply deposit such money into a bank account weekly without raising some suspicions or, as in South Africa and many other countries, being required to file reports with the authorities. To overcome these problems, launderers:
Engage in smurfing - structuring their deposits to avoid having to file reports.
Have an accomplice in the bank or securities/commodities brokers to help them dispose of the funds.
Eighty to eighty-five per cent of drug sales monies will find their way into the legitimate economy through these channels, the remaining fifteen to twenty per cent will be smuggled out to be deposited with offshore banks which have bank secrecy laws, (i.e. making it a criminal offence for the banks to reveal any information about their client) e.g. Switzerland. It is estimated that one and a half tons of foreign currency arrives at Zurich airport daily, destined for Swiss banks.
Layering
Once the cash is transformed into another asset the second stage can begin: the layering or “the heavy soaping”. The purpose of layering is to disassociate the illegal monies from the source of the crime by purposefully creating a complex web of financial transactions aimed at concealing any audit trail as well as the source and ownership of funds.
Typically layers are created by moving monies in and out of the offshore bank accounts of bearer share shell companies through electronic funds transfer (EFT). Given that there are over 500,000 world-wide transfers a day representing over one trillion US dollars most of which are legitimate, and that not enough information is disclosed on a transfer to reveal the source of the money (and hence whether it is clean or dirty), these provide an excellent way of moving dirty monies. An alternative form is by engaging in a complex set of transactions with stock, commodity and futures brokers. Here, the unnatural degree of anonymity provides ample room for layering as the likelihood of the transactions being traced is negligible given the sheer volume of daily transactions.
Integration
The final stage in the process is integration or the “spin dry” of the illegal funds. Integration of the “cleaned” money into the economy is achieved by making it appear to be legally earned and so safe from probing officials as to its source. One method of integration is by companies falsely overvaluing exports and undervaluing imports so as to move money from one company and country to another. Another simpler method is to transfer the money (via EFT) to a legitimate bank from a bank owned by launderers, as “off the shelf banks” can be purchased in many tax havens.
Techniques and tools
Smuggling
Since 1986 smuggling has been the most common method of beginning the laundering cycle. Smuggling gets cash out of its country of origin and into countries with strict bank-secrecy laws. From these offshore banking havens, the proceeds are layered and repatriated, or smuggled back in the form of non-cash financial instruments.
One example of such a smuggling technique involves a manipulation of the cash-reporting regulations at the border. A launderer smuggles cash out of a country without declaring the money. He then turns around and comes back, declaring the funds as legitimate revenue, backed up with false invoices, receipts, etc. Customs then issues the proper form, allowing the smuggler to deposit that cash anywhere without raising suspicion.
Smuggling cash is generally done in one of three ways:
By shipping bulk cash through the same channels used to bring in the drugs (by container, ship, truck or airplane)
By hand-carrying cash (by courier)
By changing the cash into negotiable instruments (such as traveller’s cheques), then mailing these to foreign banks or other foreign destinations.
Structuring / smurfing
Smurfing is the term used to avoid reporting requirements by dividing large deposits of cash into smaller transactions. The most notorious case of smurfing was the Grandma Mafia Case where a 60-year old grandmother led a group of middle-aged women in making structured deposits of over US$25million in Florida drug money at various California banks.
The use of front companies
Front companies are used by launderers to place and layer illicit proceeds. Any cash-rich business can be an effective front company – see “Industries that are prone to money laundering” on page 13. Front companies are effective tools for money laundering for two reasons. First, they do not necessarily require the complicity of their financial institution or any non-bank financial institution to operate. Second, they are difficult to detect if they are also conducting legitimate business.