Using Anti-Money Laundering Measures in the Financial World to Combat Organized Crime

The Concept of Money Laundering

The foremost reason why individuals and groups engage in an illegitimate activity is to make money. Nowadays, due to significant developments in financial information systems and on-line communication, money may be instantaneously transferred anywhere in the world with speed, anonymity, and ease. This makes the task of preventing, detecting, and prosecuting money laundering more critical than ever. According to the United Nations Office on Drugs and Crime (UNODC) Introduction to Money-Laundering, “Money laundering is the method by which criminals disguise the illegal origins of their wealth and protect their asset bases, so as to avoid the suspicion of law enforcement agencies and prevent leaving a trail of incriminating evidence.”

As noted by the former Special Adviser to the U.S. Secretary of the Treasury, William F. Wechsler (2001), for decades money laundering and tax avoidance have relatively frequently been perceived by the international community as intricate issues “hinging on the minutiae of tax codes and regulatory laws” and yet that perception masks “a destructive, often bloody reality.”

Proceeds derived from financial fraud, illegal arms sales, illegal drugs trade, subornment, or human sex trafficking sustain the existence and expand the power of organized crime and terrorist groups on the transnational, national, and local scales. The likely social, economic and political consequences of money laundering, if left unconstrained or tackled inefficiently, are grave and include the derailment of financial institutions, the collapse of emerging economies, and enhanced volatility of the financial markets, all of which can cause and have caused widespread social and political destabilization (FATF, F.A.Q.).

This chaos in turn fuels the formation of a thriving criminal underworld, where the respect for individual human rights and the rule of law is virtually non-existent. As noted by Lousie Frechette (UN, 2000), Deputy Secretary General United Nations,

[V]iolence, corruption and money laundering are the inevitable accessories to large-scale, organized criminal activities. They threaten the fundamental rights of individuals, the interests of legitimate market operators, and the development and stability of entire countries.

In his 1998 Paris address to the Financial Action Task Force (FATF) community, the then IMF Managing Director, Michel Camdessus, stated that money laundering was one of the gravest issues facing the global financial community (IMF, 1998). Launderers ceaselessly look for new routes to hide and legalize their funds. National economies with expanding or developing financial hubs, but with insufficient controls, are predominantly vulnerable, whereas financially established economies implement comprehensive anti-money laundering systems.

In today’s financial marketplace, criminal organizations are capable of penetrating government agencies and financial establishments by engaging in bribery and corruption in public and private sectors (e.g.: the 2000 Bank of New York case, (BBC, 2000)) or even sponsoring political incumbents with their illicit funds, potentially obtaining direct control over multiple sectors of the economy and government. The economic and political influence of criminal organizations can undermine ethical and legal standards and ultimately weaken democratic political institutions.

Essentially, the money laundering apparatus sustains, and thus facilitates, the expansion of criminal activity worldwide (FATF, F.A.Q). Therefore, anti-money laundering investigation seems to be the only available and successful measure in the detection, interception, and restoration of criminal funds derived from unofficial and illegal sources.

Money laundering has three distinguishable phases – placement, layering and integration. The initial stage of money laundering comprises the placement of illegally obtained funds or assets into the financial system. Layering constitutes the second stage of money laundering and involves the conversion and movement of the illicitly derived funds to other legal institutions. This process aims at distancing the placed funds from their criminal source, such as by concealing or disguising their true source, ownership, and audit trail through complicated layers of financial transactions.

The final stage in the process involves the integration of funds into the legitimate economy and financial system. Here the laundered money becomes available to criminals who use it for both legitimate and illegitimate investments, such as purchasing financial assets, real estate, and luxury goods (Levi & Reuter, 2006). By this stage, it is exceptionally difficult to differentiate between legal and illegal wealth.

In discussing financial crimes such as money laundering, it is absolutely critical to comprehend the predicate offenses behind it. These include drug dealing, other illegal market crimes (e.g.: human trafficking inclusive of forced labor and sexual slavery, gambling, extortion) white-collar crimes (e.g.: embezzlement, fraud, tax evasion), bribery, corruption, and terrorism.

This classification, as pointed out by Professor Michael Levi and Professor Peter Reuter (2006), enhances the homogeneity of the results “of interventions and the seriousness and distribution of the harm caused by particular offenses to society.” Whereas narcotics trafficking exclusively deals in cash transactions, white-collar crimes and terrorism constitute a mix of cash transactions and electronic fund transfers.

The former’s scale of operations is often wide, and its severity of harm is high. On the other hand, terrorism’s scope is small, and white-collar crime combines both small and large dimension. Finally, the harmfulness of the two predicate offenses, i.e. terrorism and white-collar crime, runs along a continuum from very severe to low respectively (Levi & Reuter, 2006).

Assessing the Scale of Money Laundering

When it comes to measuring the extent of money laundering, there is no universal method available that researchers believe delivers unequivocal and accurate figures. Contrary to other criminal deeds, from which individuals who suffer wrong inform law enforcement, money laundering is a relatively concealed activity, and only a limited number of offenses are reported. Likewise, the classification and description of money laundering’s predicate offences might vary depending on the jurisdictional authority, hence, it is challenging to compare cross-national activities considering that “like with like” comparisons might not be available (UNODC, 2011).

The traditional methods applied to measure the scale of money laundering vary and range from field and case studies through surveys and interviews or suspicious or unusual transactions to statistical discrepancies. Nevertheless, all of the methods mentioned above have significant flaws that impact the accuracy of measuring the money laundering phenomenon. In the instance of field and case studies, according to Professor Brigitte Unger (2009), it is challenging to determine the representativeness of the data, and if the analysis of the cases is performed, it often does not take into account “the full range of money laundering practices, networks, and behavioral assumptions.”

The surveys and interviews method poses yet another challenge as it includes miscellaneous prejudices – a lack of adequate sample representativeness or the bias of the respondents. The third method, suspicious or unusual transactions, offers an analysis of suspicious transaction reports or unusual transaction reports delivered to the financial intelligence unit (FIU) of a given country. However, it is hardly feasible to take into consideration all discrepancies between individual countries and their reporting requirements or thresholds. Additionally, the private sector might apply the so-called “strategic dilution of information” by not providing the full data to protect its business interests (Unger, 2009).

Finally, statistical discrepancies inhibit the assessment of money laundering through the availability of various fluctuating statistical indicators, such as the ones presented by Unger as “errors and omissions in the balance of payments [hot money method], differences in capital inflows and outflows [residual approach], and differences in money supply and money demand [currency demand approach].” None of these approaches is immune from error either (Unger, 2009).

Essentially, there is no one particular method that could be deemed the ‘gold standard’ for an effective assessment of the money laundering phenomenon. In the face of this limitation, the UNODC proposed a method that simultaneously incorporates criminal activities and the resulting financial flows. The discrete ways of measuring money laundering, according to UNODC (2011), are the following:

“1. Calculating the financial gains arising from the transnational crime activities considered at the various subregional levels; 2. Estimating the amounts - arising from transnational crime activities in the various subregions - that enter the financial system; 3. Estimating the amounts that cross borders for money laundering purposes, reflecting the actual ‘transnational illicit financial flows’ from the proceeds of transnational crime.”

One of the most well-known assessments of the extent of money laundering was offered in 1998 by the International Monetary Fund, which introduced the estimate of the ‘consensus range’ of between 2-5 percent of global GDP. According to the UNODC estimates, earnings derived from all criminal activities could have risen to 3.6 percent of GDP (2.3 - 5.5 percent) or about US$2.1 trillion in 2009, of which money laundering equaled 2.7 percent of global GDP (2.1 – 4 percent) or US$1.6 trillion in 2009.

Out of that last number, the movement of funds associated with international organized crime could constitute as much as 1.5 percent of global GDP, of which approximately three-fourths could have been utilized for laundering through the financial system. Transnational criminal income derived from trafficking in drugs constitute approximately 20 percent of all crime proceeds, circa 50 percent of transnational organized crime, and about 0.6% to 0.9% of global GDP (UNODC, 2011).

Costs of Financial Crime to Government and Society

The prevalence of transnational organized criminal activities, and thus the sheer existence of money laundering, can significantly encumber governance, financial and social stability, and economic development on the local, national and international scales (UNODC, 2011). The implications of financial crime enumerated below constitute just the core consequences endured by society at large.

Illegitimate Money Flows Leading to the Spread of Transnational Organized Criminal Activities

The risks and vulnerabilities for governments, financial institutions and society stemming from illegitimate money flows are predominantly rooted in elementary criminal activities that finance those flows. Trafficking in drugs, in persons, or in counterfeit medicines have significant influence on the public and private sectors. For example, according to a 1999 study conducted in the Netherlands, 89 percent of all the funds amassed by drug dealers are then utilized for conventional investment, licit and illicit business activities, and fund collection for illegal reinvestment.

Drug consumption-related activities stimulate acquisitive crime, particularly domestic burglary, fraudulent activities, or theft, and they comprise the majority of drug-connected economic costs. Further, trafficking activities mentioned above generate the growth of transnational or national criminal organizations that threaten the established social order. Additionally, some research indicates that there is an interrelationship between drug trading, governmental corruption, and a feeble rule of law (UNODC, 2011). With respect to human trafficking, the UNODC stated that it has a detrimental effect on social structures due to enhanced corruption and ubiquitous violence and extortion. In fact, there could be, according to UNODC (2011), “a 10:1 ratio in terms of the importance of drug trafficking (more than US$320 bn) versus trafficking in human beings (some US$32 bn).”

Finally, as estimated by the World Health Organization, the smuggling of counterfeit medicines could equal to US$75 bn in 2010 which, in economic terms, surpasses twice the proceeds derived from human trafficking and constitutes a quarter of worldwide illegitimate drug sales. Dealing in counterfeit medicines inhibits the conducting of scientific research, since the profitability of substantial investment by pharmaceutical companies decreases, and therefore such firms are less inclined to invest, thus hindering medical innovations. Moreover, inferior drugs on the market threaten the well-being of patients, especially in the developing markets, and might contribute to the emergence of antibiotics-resistant bacteria endangering millions of lives (UNODC, 2011).

Investment of Illicit Money Flows in the Legal Sector

Considering the fact that funds derived from diverse criminal activities could amount to US$2 trillion, the bearing of illicit financial flows on the economy is considerable, especially when said funds are then moved into legitimate economic sectors. The following are examples of direct socio-economic consequences of the negative impact of criminal financial flows (UNODC, 2011):

• Alterations in resource allocation from highly profitable investments to ones that run a low risk of detection. The distortion caused by the investment of illicit funds is quite grave since investors’ decisions are not dictated by the highest-yielding ventures. Their objective is rather to ensure the lowest risk of detection feasible. Hence, such decision-making parameters favor concealment at the cost of lower proceeds and contribute to hindering of the economic development by allocating assets to less return-yielding activities and the financing of unprofitable segments (e.g.: real estate, bars, prostitution, transport companies) (UNODC, 2011).

• Alterations of prices, particularly in the property sector. Illegitimate capital flows may significantly disrupt market operations, especially in the real estate sector, which is particularly attractive to criminal organizations due to its opaque and safe nature of investment (UNODC, 2011).

• Alterations of consumption and bearing on imports. Modern-day criminals have a propensity to lead openly lavish lives by purchasing luxurious items such as cars, yachts, or electronic equipment, which are actions that contribute to an imbalance in consumption rates and import numbers (UNODC, 2011).

• Alterations of exports and possible issues with investment and economic development. Investments stemming from the transnational nature of organized crime, where funds flow into a country, thus enhancing economic growth and employment rates, could have a positive impact in the short-term. However, in the long run, the country’s economy will be exposed to the disruptive forces of unstable economic growth, where illicit exports might crowd out licit ones. The market will experience so-called Dutch Disease, where the country’s legitimately manufactured goods and licit services become less competitive and lose their selling edge (UNODC, 2011).

• Unfair competition, risks of forcing out legitimate activities and damaging bearing on direct foreign investment. Legitimate businesses might find it particularly difficult to compete with enterprises sponsored by organized crime, which frequently have unlimited funding and thus can offer lower prices to their customers. Illicit firms can run at barely financially viable levels, since their main objective is to launder the illicitly obtained funds rather than make sustainable profits (UNODC, 2011).

• Corruption and undermining the credibility of legal institutions. Yet another distressing aspect of incoming illicit funds is the criminal organization’s ability to corrupt government and law enforcement officials, as well as private sector businesses, to obtain leverage for their illegitimate or even legitimate investments. Such political influence will result in the overt or covert proliferation of unfair and anti-competitive business practices, leading to the disadvantaging of licit enterprises (UNODC, 2011).

• Risks of business volatility. It is extremely challenging to maintain business continuity if the market is fuelled by illicit funds that are volatile and may vanish as quickly as they appear because of law enforcement actions and prosecution. As a result, regions or countries that rely on illicit source of funding stemming from narcotics trafficking or human and resource exploitation are subject to severe and unpredictable increases and declines in market value (UNODC, 2011).

• Alterations of economic statistics and consequently possible miscalculations in economic policy decision-making. If economic data are skewed due to sizeable illegitimate investment into the economy, the erroneous results may contribute to bad and inaccurate macroeconomic and policy decision-making (UNODC, 2011).

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