Money Laundering

Money laundering is the process by which a large amount of illegally obtained money, from drug trafficking, terrorist activity, or other serious crimes, is given the appearance of having originated from a legitimate source. Money laundering has an adverse impact on the economy and political stability of a country and hence such an activity must be curbed with an iron hand. Therefore, nations of the world must join hands and adopt measures to dismantle syndicates engaged in money laundering by resorting to aggressive enforcement of the law. An attempt has been made in this article to explain the concept, significance, and its impact.

“Capital as such is not evil, it is its wrong use that is Evil, Capital in some form or other will always be needed” – Mohandas K. Gandhi

Introduction: If one conducts a survey asking what is money laundering? The general guesses from most people would be that it must be something related to drying, washing, or maybe dry cleaning of the currency notes. To some extent correct but laymen don’t know much of this world’s third largest industry. As per IMF reports the turnover of this industry could be somewhere around $1.5 trillion.

Money laundering is the process by which a large amount of illegally obtained money (from drug trafficking, terrorist activity, or other serious crimes) is given the appearance of having originated from a legitimate source. But in simple terms, it is the conversion of black money into white money. This takes one back to cleaning the huge piles of cash. If done successfully, it allows the criminals to maintain control over their proceeds and ultimately to provide a legitimate cover for their source of income. Money laundering plays a fundamental role in facilitating the ambitions of the drug trafficker, the terrorist, the organized criminal, the insider dealer, the tax evader as well as the many others who need to avoid the kind of attention from the authorities that sudden wealth brings from illegal activities. These criminal enterprises seek to obtain money and power through criminal conduct and then attempt to infiltrate the legitimate society, thereby distorting the terms of the compact. They generate millions upon millions of dollars for the members of the enterprise and allow their associates to live lavish lifestyles that have been forged from the misery and despair that their criminal activity produces.

First, cash is introduced into the financial system by some means (“placement”);

The second step involves carrying out complex financial transactions in order to camouflage the illegal source (“layering”);

The final step entails acquiring wealth generated from the transactions of the illicit funds (“integration”). Some of these steps may be omitted, depending on the circumstances; for example, non-cash proceeds that are already in the financial system would have no need for placement.

Money laundering takes several different forms, although most methods can be categorized into one of a few types. These include “bank methods, smurfing [also known as structuring], currency exchanges, and double-invoicing”.

  • Structuring: Often known as “smurfing”, is a method of placement by which cash is broken into smaller deposits of money, used to defeat suspicion of money laundering and to avoid anti-money laundering reporting requirements. A sub-component of this is to use smaller amounts of cash to purchase bearer instruments, such as money orders, and then ultimately deposit those, again in small amounts.
  • Bulk cash smuggling: Physically smuggling cash to another jurisdiction, where it will be deposited in a financial institution, such as an offshore bank, with greater bank secrecy or less rigorous money laundering enforcement.
  • Cash-intensive businesses: A business typically involved in receiving cash will use its accounts to deposit both legitimate and criminally derived cash, claiming all of it as legitimate earnings. The best suited is a service business. As such a business has no variable costs, it is hard to detect revenue-cost discrepancies. Examples are parking buildings, strip clubs, tanning beds, or a casino.
  • Trade-based laundering: Under- or over-valuing invoices in order to disguise the movement of money.
  • Shell companies and trusts: Trusts and shell companies disguise the true owner of the money. Trusts and corporate vehicles, depending on the jurisdiction, need not disclose their true, beneficial, owner.
  • Round-tripping: Money is deposited in a controlled foreign corporation offshore, preferably in a tax haven where minimal records are kept, and then shipped back as a Foreign Direct Investment, exempt from taxation. A variant on this is to transfer money to a law firm or similar organization as funds on account of fees, then cancel the retainer and when the money is remitted represent the sums received from the lawyers as a legacy under a will or proceeds of litigation.
  • Bank capture: Money launderers or criminals buy a controlling interest in a bank, preferably in a jurisdiction with weak money laundering controls, and then move money through the bank without scrutiny.
  • Casinos: An individual will walk into a casino with cash and buy chips, play for a while and then cash in his or her chips, for which he or she will be issued a check. The money launderer will then be able to deposit the check into his or her bank account and claim it as gambling winnings.
  • Real estate: Real estate may be purchased with illegal proceeds, then sold. The proceeds from the sale appear to outsiders to be legitimate income. Alternatively, the price of the property is manipulated; the seller will agree to a contract that under-represents the value of the property, and will receive criminal proceeds to make up the difference.
  • Black salaries: Companies might have unregistered employees without a written contract who are given cash salaries. Black cash might be used to pay them.
  • Tax amnesties: For example, those which legalize unreported assets in tax havens and cash.
  • Fictional loans.

Concept of Money Laundering

Money Laundering as an expression is one of fairly recent origin. Money laundering is a sophisticated crime not to be taken very seriously at the first glance by anyone in society. As compared to street crimes, it is a modern crime. At times people also refer to it as a victimless crime but the reality is that it is not a crime against a particular individual, but it is a crime against nations, economies governments, rule of law, and the world at large. Money laundering has become a worldwide menace.

The goal of a large number of criminal acts is to generate profit for the individual or group that carries out the act and then hide either the source or the destination of money. 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 jeopardizing their source.

Some of the crimes like-illegal arms sales, smuggling, corruption, drug trafficking, and the activities of organized crime including tax evasion generate huge sums. Insider trading, bribery, and computer fraud schemes also produce large profits and create the incentive to legitimize 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. Otherwise, they can’t use the money because it would connect them to criminal activity, and law enforcement officials would seize it.

If done successfully, it allows the criminals to maintain control over their proceeds and ultimately to provide a legitimate cover for their source of income. Where criminals are allowed to use the proceeds of crime, the ability to launder such proceeds makes crime more attractive.

Significance of Money Laundering

Money laundering is an issue that has gained increasing significance following the events of 9/11 (the attack on the twin towers in the U.S). Since then the world has focused its attention on the entire concept of money laundering and has recognized it as a source of funding for terrorist activities. The globalization process and the communications revolution have made crime increasingly international in scope, and the financial aspects of crime have become more complex due to rapid advances in technology. The spread of international banks all over the world has facilitated the transmission and the disguising of the origin of funds. This may have devastating social consequences and poses a threat to the security of any country, large or small. It provides fuel for drug dealers, terrorists, illegal arms dealers, corrupt public officials, and all types of criminals to operate and expand their criminal activities. Laundering enables criminal activity to continue.

Money laundering causes a diversion of resources to less productive areas of the economy which in turn depresses economic growth. The possible social and political costs of money laundering, if left unchecked or dealt with ineffectively, are serious. The economic and political influence of criminal organizations can weaken the social fabric, collective ethical standards, and ultimately the democratic institutions of society.

Impact of money laundering on the economy of the country

Money laundering has negative effects on economic development. Money laundering constitutes a serious threat to national economies and respective governments. The infiltration and sometimes saturation of dirty money into legitimate financial sectors and nations’ accounts can threaten economic and political stability. Economic crimes have a devastating effect on a national economy since potential victims of such crimes are far more numerous than those in other forms of crime. Economic crimes also have the potential of adversely affecting people who do not prima-facie, seem to be the victims of the crime. For example, tax evasion results in loss of government revenue, thus affecting the potential of the government to spend on development schemes thereby affecting a large section of the population who could have benefited from such government expenditure.

A company fraud not only results in cheating of the people who have invested in that company but may also adversely affects investors’ confidence and eventually the growth of the economy. The negative economic effects of money laundering on economic development are difficult to quantify, yet it is clear that such activity damages the financial-sector institutions that are critical to economic growth, reduces productivity in the economy’s real sector by diverting resources and encouraging crime and corruption, which slow economic growth, and can distort the economy’s external sector international trade and capital flows to the detriment of long-term economic development.

Developing countries’ strategies to establish offshore financial centers (hereinafter OFCS) as vehicles for economic development are also impaired by significant money laundering activity through OFC channels. The negative effects of money laundering activities may be on the financial sector, real sector of formal agents such as the state, financial institutions, and the banking sector.

The Financial Sector

The financial sector may get negative effects of money laundering especially financial institutions including banking and non–banking financial institutions (NBFIs), and equity markets- may directly or indirectly be affected. Basically, these institutions facilitate the concentration of capital resources from domestic savings and funds from abroad. These institutions provide impetus to the furtherance of investment prospects by providing a conducive environment and efficient allocation of these resources to investment projects which contributes substantially to long-run economic growth.

Money Laundering impairs the sustainability and development of financial institutions in two ways:

  1. Firstly the financial institutions are weakened directly through money laundering as there seems to be a correlation between money laundering and fraudulent activities undertaken by employees of the institutions.
  2. Similarly, with the increase in money laundering activities, major parts of the financial institutions of a state are vulnerable to crime by criminal elements. This strengthens the criminals and other parallel systems of money laundering channels. This may lead to the eviction of less equipped competitors & giving rise to monopoly.
  3. Customer trust is fundamental to the growth of sound financial institutions, and the perceived risk to the growth of sound financial institutions, and the perceived risk to depositors and investors from institutional fraud and corruption is an obstacle to such trust.

Money laundering carried out through channels other than financial institutions includes more “sterile” investments such as real estate, art, antiques, jewelry, and luxury automobiles, or investments of the type that gives lower marginal productivity in an economy. These sub-optimal allocations of resources give a lower level of economic growth which is a serious detriment to economic growth for developing countries. Criminals reinvest their proceeds in companies and real estate with the purpose to make further profits, legal or illegal. Most of these investments are in sectors that are familiar to the criminal, such as bars, restaurants, and prostitution. The real estate sector is the largest and most vulnerable sector for money laundering. Real estate is important for money laundering because it is a non-transparent market where the values of the objects are often difficult to estimate and where big value increases can happen and is an efficient method to place large amounts of money. The price increase in real estate is profitable and the annual profits on real business create a legal basis for income. The real estate has the following features, which make it attractive for criminal money:

  • a safe investment
  • the objective value is difficult to assess
  • it allows realizing “white” returns.

The External Sector

Money laundering activities may impair any country’s economy through trade and international capital flows. Excessive illicit capital flight from a state may be facilitated by either domestic financial institutions or by foreign financial institutions. That illicit capital flight drains scarce resources especially from developing economies; so in that way, the economic growth of the respective economy is adversely affected58. Money laundering negatively affects the trust of local citizens in their own domestic financial institutions as well as the trust of foreign investors and financial institutions in a state’s financial institution which ultimately contributes to economic growth. Money laundering channels may also be associated with distortions of a country’s imports and exports. As with the involvement of criminal elements on the import side they may use illicit proceeds to purchase imported luxury goods, either with laundered funds or as part of the process of laundering such funds.

Such imports do not generate domestic economic activity or employment, and in some cases can artificially depress domestic prices, thus reducing the profitability of domestic enterprises. The integrity of the banking and financial services marketplace depends heavily on the perception that it functions within a framework of high legal, professional, and ethical standards. A reputation for integrity is one of the most valuable assets of a financial institution. Dangers to reputation can occur when a country deliberately declares to want to attract ‘criminal money’.

If funds from criminal activity can be easily processed through a particular institution-either because its employees or directors have been bribed or because the institution turns a blind eye to the criminal nature of such funds-the institution could be drawn into active complicity with criminals and become part of the criminal network itself. Evidence of such complicity will have a damaging effect on the attitudes of other financial intermediaries and of regulatory authorities as well as ordinary customers. Money laundering not only threatens the financial system of a country by taking away command of the economic policy from the government but also deteriorates the moral and social standing of the society by exposing it to activities such as drug trafficking, smuggling, corruption, and other criminal activities.

The Global Sector

Money Laundering has become a global problem. Criminals target foreign jurisdictions with liberal bank secrecy laws and weak anti-money laundering regulatory regimes as they transfer illicit funds through domestic and international financial institutions often with the speed and ease of faceless internet transactions. This easy and vast infiltration of criminal proceeds into the world market can stabilize them and can have a corrupting effect on those who work within the market system. The penetration of criminals into the legitimate markets can also shift the balance of economic power from responsible and responsive entities to rogue agents who have no political or social accountability. In short, when criminal enterprises are able to enjoy the fruits of the criminal ventures, the world market can be destabilized, leaving some countries vulnerable to persuasion and interference by corrupt organizations.

Conclusion: Thus one can safely conclude that Money Laundering is a global problem and must attract global concerns. Without international cooperation, money laundering cannot be controlled. The criminals outsmart the enforcing agencies and deploy a team of experts like chartered accountants, attorneys, bankers the mafia, to disguise their illicit money and masquerade it as legitimate income. These experts charge fees between 10 to 15% of the sum involved. The nexus between white-collared criminals, politicians, enforcing agencies, and mafias cannot be ruled out. Bankers play the most prominent role and without their connivance, the operation cannot be carried out. The development of new high-tech coupled with a wire transfer of funds has further aggravated the difficulties to detect the movement of slush funds. The international nature of money laundering requires international law enforcement cooperation to successfully investigate and prosecute those that instigate these complex criminal schemes. Money laundering must be combated mainly by penal means and within the frameworks of international cooperation among judicial and law enforcement authorities. Last but not least it is vitally important to keep in mind that simple enactment of Anti-Money Laundering Laws is not enough, the Law enforcement Community must keep pace with the ever-changing dynamics of money Launderers who constantly evolve innovative methods which help them to stay beyond the reach of the law.

Prevention of Money Laundering – National Level

India has criminalized money laundering under both the Prevention of Money Laundering Act, 2002 (PMLA), as amended in 2005 and 2009, and the Narcotic Drugs and Psychotropic Substances Act, 1985 (NDPS Act), as amended in 2001.

In India, before the enactment of the Prevention of Money Laundering Act 2002, a number of statutes addressed scantily the issue in question. These statutes were The Conservation of Foreign Exchange and Prevention of Smuggling Activities Act, 1974, The Income Tax Act, 1961, The Benami Transactions (Prohibition) Act, 1988, The Indian Penal Code and Code of Criminal Procedure, 1973, The Narcotic Drugs and Psychotropic Substances Act, 1985, The Prevention of Illicit Traffic in Narcotic Drugs and Psychotropic Substances Act, 1988.

The Prevention of Money Laundering Act 2002 is sought to be further amended by The Prevention of Money Laundering (Amendment) Bill, 2011 hereinafter referred to as the ‘Bill’, which has been introduced by the Minister of Finance, Mr. Pranab Mukherjee in the Lok Sabha on December 27, 2011.

The Bill proposes to introduce the concept of ‘corresponding law’ to link the provisions of Indian law with the laws of foreign countries. It also adds the concept of ‘reporting entity which would include a banking company, financial institution, intermediary, or a person carrying on a designated business or profession. The Bill expands the definition of an offense under money laundering to include activities like concealment, acquisition, possession, and use of proceeds of crime.

The Prevention of Money Laundering Act, 2002 levies a fine of up to Rupees five lakhs. The Bill proposes to remove this upper limit of fine.

The Bill seeks to provide for provisional attachment and confiscation of property of any person for a period not exceeding 180 days if the authority has reason to believe that the offense of money laundering has taken place. The Bill proposes to confer powers upon the Director to call for records of transactions or any additional information that may be required for the purposes of investigation. The Director may also make inquiries about non-compliance with the obligations of the reporting entities. The Bill seeks to make the reporting entity, its designated directors on the Board, and employees responsible for omissions or commissions in relation to the reporting obligations. The Bill states that in the proceedings relating to money laundering, the funds shall be presumed to be involved in the offense unless proven otherwise. The Bill proposes to provide for an appeal against the orders of the Appellate Tribunal directly to the Supreme Court within 60 days from the communication of the decision or order of the Appellate Tribunal. The Bill seeks to provide for the process of transfer of cases of the Scheduled offenses pending in a court that had taken cognizance of the offense to the Special Court for trial. In addition, on receiving such cases, the Special Court shall proceed to deal with them from the stage at which it was committed. The Bill also proposes to bring all the offenses mentioned under Part A of its Schedule to ensure that the monetary thresholds do not apply to the offense of money laundering.

Prevention of Money Laundering Act is Indian law passed in 2002 to prevent money laundering and to provide for the confiscation of property derived from money laundering.

Objectives: The main objectives of this act are to prevent money laundering as well as to provide for confiscation of property either derived from or involved in, money-laundering.

Attachment: Prohibition of transfer, conversion, disposition, or movement of property by an appropriate legal order.

Proceeds of crime: Any property derived or obtained, directly or indirectly, by any person as a result of criminal activity relating to a scheduled offense.

Money-laundering: Attempting to indulge or assist another person or actually involved in any activity connected with the proceeds of crime and projecting it as untainted property.

Salient features:

Punishment for money laundering: The Act prescribes that any person found guilty of money laundering shall be punishable with rigorous imprisonment from three years to seven years. He could also be liable to a fine of up to 5 lakh

Powers of attachment of tainted property: Appropriate authorities, appointed by the Govt of India, can provisionally attach property believed to be “proceeds of crime” for 90 days. Such an order is required to be confirmed by an independent Adjudicating Authority.

Adjudicating Authority: The Adjudicating Authority is the authority appointed by the central government. It decides whether any of the property attached or seized is involved in money laundering.

Appellate Tribunal: An Appellate Tribunal is the body appointed by Govt of India. It is given the power to hear appeals against the orders of the Adjudicating Authority and any other authority under the Act. Orders of the tribunal can be appealed in an appropriate High Court (for that jurisdiction) and finally to the Supreme Court.

Special Courts: The trial for the offenses mentioned in the act are conducted by a special court, also called “PMLA Court”. The Central Government (in consultation with the Chief Justice of the High Court), designates a Sessions Court as Special Court. Any appeal against the order passed by the PMLA court can directly be filed in the High Court (for that jurisdiction).

Prevention of Money Laundering – International Level

The Financial Action Task Force on Money Laundering (FATF) an intergovernmental body established by the G-7 Summit in Paris in 1989 and responsible for setting global standards on anti-money laundering and combating the financing of terrorism defines money laundering as the processing of criminal proceeds to disguise their illegal origin in order to “legitimize” the ill-gotten gains of crime.”

India became the 34th country member of the Financial Action Task Force in 2010. India is also a signatory to various United Nations Conventions which deal with anti-money laundering and countering the financing of terrorism.

Money Laundering is a global menace that cannot be contained by any nation alone. The Prevention of Money Laundering (Amendment) Bill 2011 was necessitated in view of India being an important member of the Financial Action Task Force and to bring prevention of money laundering legislation on par with global norms.

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