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Understanding and Preventing Money Laundering

Elizabeth Vallery Mulig


L. Murphy Smith*

*Corresponding Author

Working Paper

Understanding and Preventing Money Laundering


Abstract
The abilities and skills of internal auditors suit them well for the war against
money laundering. Forensic accounting skills, as well as audit expertise, are needed to
help in combating this crime. The development of internal policies, procedures, and
controls to prevent money laundering fits within the accountant's abilities and expertise.
Money laundering can be defined as a process in which illegally obtained money (e.g.
from drug trafficking, terrorist activity or other serious crimes) is given an appearance of
having originated from a legitimate source. Although the basic goals of money
laundering are no different today than from decades ago, money laundering is now taking
place in a high-tech global environment. This article provides background and recent
developments in efforts to combat money laundering.

Understanding and Preventing Money Laundering


This article addresses how internal auditors can help combat the crime of money
laundering. Money laundering can be defined as a process in which illegally obtained
money, such as from drug trafficking, terrorist activity or other serious crimes, is given
an appearance of having originated from a legitimate source. Although the basic goals of
money laundering are no different today than from decades ago, money laundering is
now taking place in a high-tech global environment.
The most serious aspect of money laundering is not the crime itself. The major
problem is that it provides criminals access to the proceeds of their criminal endeavors,
and facilitates other criminal activities. Recent legislation under the USA Patriot Act
(USAPA), passed in response to the events of September 11, 2001, has increased
accountants responsibilities in the fight against money laundering.
Accountants are increasingly more liable and responsible for assuring that
companies have in place adequate systems of internal control. Such controls should
include procedures to detect and prevent money laundering schemes. The position and
role of accountants in the financial community necessitates that they take a proactive role
in initiating organizational controls to expose such corruption.
Background on Money Laundering
The term "money laundering" is derived from activities carried out by organized
crime, which used laundry cleaning businesses to disguise, "launder," large amounts of
cash actually earned through extortion, prostitution, gambling, and bootlegging. The
money laundering process takes basically three steps. These steps can be achieved in one
combined transaction or in three separate transactions:1

1.

Placement: In this step, large amounts of illegally obtained cash are placed
into the financial system, used to buy high-dollar goods, or smuggled out
of the country. The idea is to transform the cash as quickly as possible
into other types of assets and thus avoid detection.

2.

Layering: This step is performed to hide the source of the illicit funds.
Layering is accomplished by creating complex levels of financial
transactions to obscure audit trails and cloak the true ownership of the
funds. Some of the methods used are Electronic Funds Transfer (EFT),
conversion into monetary instruments, investments in legitimate
businesses, and purchase of real estate. In many cases, EFTs are used to
shuttle funds around between offshore banks and shell companies. Since
so many EFTs are processed each day, determining what is legitimate and
what is not, can be difficult indeed.

3.

Integration: The final step in money laundering integrates the newly


laundered money into legitimate business operations. At that point, any
future use of the money will further hide its original source.

Three popular methods are used to integrate clean money. First, money
launderers establish private corporations in other countries and route the money to these
corporations. These foreign corporations can then provide loans to the money launderers
back in the home country. Second, phony invoices are created in import-export
businesses. The import-export company gives inflated value to the export goods and
when the invoices are paid, the cash is transferred, including the laundered money, from

one company to the other. The invoices make the transfer of the money look legitimate.
Third, the money launderer simply purchases an offshore bank. Illegally acquired funds
are deposited in the new bank, then transferred via EFT to a legitimate bank.
Exhibit 1 provides an overview of the steps in the money laundering process.
[Insert Exhibit 1 here]
The Problem
For most people, money laundering itself is not considered a particularly heinous
crime. However, money laundering provides criminals with access to their proceeds.
These proceeds can be used by money launderers to fund a myriad of other crimes.
Money laundering furthers the ambitions of drug traffickers, organized crime members,
terrorists, and others.
Money laundering undermines the integrity of financial markets. While large
sums of laundered money may arrive at institutions, they may also disappear just as
quickly, causing liquidity problems.
Governments lose revenue as a result of money laundering. Money laundering
diminishes tax revenue and that often means higher tax rates for other, honest citizens.
McDowell and Novis, in Economic Perspectives, state that money laundering
presents the world community with a complex and dynamic challenge.2 They believe that
the nature of the problem calls for global standards and international cooperation to
reduce the ability of criminals to launder their proceeds and carry out their criminal
activities.
Current Nature of the Problem

Linda Davies writes, in Nest of Vipers, The money screamed across the wires, its
provenance fading in a maze of electronic transfers, which shifted it, hid it, broke it up
into manageable wads which would be withdrawn and redeposited elsewhere, obliterating
the trail.3 She captures the essence of the current nature of the money laundering
problem. In todays high tech global environment, the money laundering process is even
harder to trace.
Alvin James, Principal at Ernst and Young, LLP, examined the use of
underground financial systems, such as the Colombian Black Market Peso Exchange
(BMPE), by terrorists.4 He noted that while terrorists may not need to launder their
money, they do need the means to move the funds covertly. The major similarity among
underground financial systems, also called parallel payment systems, James notes, is their
ability to facilitate anonymous international transfers of money. That ability is what
makes these existing systems so attractive to terrorists: they can use them to move the
dollars needed to support their activities.
Experts indicate that there should be more coordinated efforts against the BMPE
and other money laundering operations. The nature of these efforts should include
securities, insurance, and money-changing enterprises. Efforts should be made to force
drug dollars out of the safety of the parallel payment systems and into an area less secure
for them and more susceptible to law enforcement.
The Extent of the Problem
There is difficulty in precisely measuring the extent of money laundering,
including the number of terrorist dollars moving through the same financial channels.
The persons and organizations who engage in these activities obviously are not reporting

them to the government. However, there have been numerous attempts to establish the
magnitude of the problem. Money laundering around the globe has been estimated at
$500 billion a year.
John Walker Consulting Services in Australia created a logical crime-economic
model that draws on public crime statistics and used various socio-economic inputs to
estimate the percentage of the crime proceeds that will be laundered and where it will
take place.5 They aggregate these estimates and assess the likely extent of money
laundering and each countrys contribution. Preliminary numbers from the model
estimate the amount of money laundered globally at $2.85 trillion per year. The model
breaks the total into various components. It ranks the sources of laundering and the
destinations of the money. Unfortunately, the United States ranks at the top of both these
lists, with a 46.3% estimate as to origin of the laundered dollars and an 18.9% estimate as
to the destination. While this model is not exact (or proven), there is no disagreement
over the fact that money laundering is big business.
The Colombian BMPE launders as much as $5 billion dollars, or about half of
U.S. wholesale drug proceeds each year. The BMPE is the primary vehicle used to
counter the Bank Secrecy Act (BSA). The peso brokers smuggle large amounts of
currency to countries who have correspondent relationships with U.S. banks. The foreign
bank then sells a U.S. dollar check drawn on their U.S. correspondent account. The
foreign banks accept the currency deposits and then order a wire transfer from their
correspondent account to whomever the depositor designates. The foreign bank is left
with a large amount of U.S. currency, which they then deposit in their correspondent
bank. Alvin James states: the effect of this transaction is that we are back to suitcase

deposits of U.S. drug currency into our financial system. The only difference is that the
dollar peso broker uses the correspondent back door to the bank rather than the front door
in Miami or New York. Again, this shows that the BSA is working by forcing the dollar
peso brokers to move their money offshore instead of structuring deposits here in the
U.S.6
Recent terrorist acts make it all the more imperative that we stem the flow of
dollars through these channels. The USAPA, passed in response to the events of
September 11, 2001, broadens the powers of government to investigate terrorism and the
manner in which it is funded, including money laundering.
Efforts to Stop Money Laundering
For efforts against money laundering to be effective, there must be an
environment conducive to fair and open reporting. Legal authorities, politicians, and the
general public must be supportive. The International Federation of Accountants (IFAC),
in an effort to create such an environment, encourages its member bodies to form
collaborative relationships with legislative and regulatory authorities, both corporate and
political.
A number of domestic and international groups address the issue of money
laundering. The U.S. has the toughest laws against money laundering. United States
laws dealing with money laundering include:

1988

Anti-Drug Abuse Act or 1988

1990

Crime Control Act of 1990

1992

Annuzio-Wylie Act of 1992

1994

Money Laundering Suppression Act

1995

Terrorism Prevention Act of 1995

1996

New Reporting Requirements for Financial Institutions

2001

USAPA

Foreign efforts to combat money laundering are found in The World Bank,
International Accords, and the Financial Action Task Force (FATF). The World Bank
promotes measures that halt, or slow, the flow of money into emerging markets.
International Accords include The Vienna Convention, the 1990 Council of Europe
Convention, Basle Committee Statement of Principles, European Union Directive, and
the Resolution of the International Organization of Securities Commissions. The FATF
consists of representatives from 26 countries and two international organizations.
The Challenge for Accountants
Accountants can play a key role in combating money laundering. Section 352 of
the PATRIOT Act requires all financial institutions to establish anti-money laundering
programs. These programs must include (at a minimum):7

The development of internal policies, procedures, and controls to prevent money


laundering.

The designation of a money laundering compliance officer,

An ongoing training program for awareness of money laundering, and

An independent audit function to test the programs.


Accountants are well versed in developing internal policies, procedures, and

controls and in performing audits. In fact, their role and position necessitate that they take
a pro-active stance in initiating organizational controls to expose corruption and prevent
money laundering.

Recent legislation has increased accountants obligations to be part of the war


against corruption and money laundering. "Accountants are increasingly responsible for
more effective systems of internal controls as well as periodic evaluations, examinations,
and audits."8
Conclusions
The professional skills and expertise of internal auditors suit them well for the
war against money laundering. Forensic accounting skills, as well as audit expertise, are
needed to help fight this crime. The development of internal policies, procedures, and
controls to prevent money laundering falls within the accounting professions
responsibilities.
Money laundering, due to todays high-tech, global environment, is a worldwide
industry. As many interested parties realize the need for global efforts to combat this
very expensive crime, internal auditors have a unique opportunity, and obligation, to take
a pro-active role in these efforts.

Exhibit 1
Basic Steps in the Money Laundering Process

Placement

Layering

Integration

Cash deposited into bank


(often with complicity of
staff or mixed with proceeds
of legitimate businesses)

Funds are transferred abroad,


often to shell companies or
disguised as proceeds of
legitimate business.

False loan repayment or


forged invoices used as cover
for laundered money

Cash physically transported


out of country.

Deposits made in overseas


banking system or closelyheld bank.

Complex web of transfers


(both domestic and
international) makes tracing
original source of funds
virtually impossible.

Cash used to buy high value


goods, property, or business
assets.

Previously purchased goods


and assets are sold to obtain
cash.

Income from property or


legitimate business assets
appears clean.

Endnotes
1. B. Steel, Billys Money Laundering Information Website. Money Laundering A Brief
History. http://www.laundryman.u-net.com/page1_hist.html, February, 2004.
2. John McDowell and Gary Novis, The Consequences of Money Laundering and
Financial Crime. Economic Perspectives, an IIP Electronic Journal, Website:
http://usinfo.state.gov/topical/econ/group8/summit01/wwwh01050101.html, May, 2001.
3. Linda Davies, Nest of Vipers, Reed Business Information, Inc., 1995.
4. Alvin James, The Avalon Project at Yale Law School. September 11, 2001: Attack on
America Hearing on the Administrations National Money Laundering Strategy for
2001 Prepared Statement. Website:
http://www.yale.edu/lawweb/avalon/sept_11/james_001.htm, September 26, 2001.
5. John Walker Consulting Services. Modelling Global Money Laundering Flows.
Website: http://members.ozemail.com.au/~born1820/mlmethod.htm, November 30,
1998.
6. Op cit., Alvin James, 2001.
7. Fraud Examiners Manual (excerpts from), The USA PATRIOT Act, signed into law
after 9/11, strongly targets suspected money laundering activities and creates new
requirement for financial institutions. The White Paper, July/August, 2003.
8. Robert Larson and Paul Herz, Accountants, Corruption, and Money Laundering. The
CPA Journal, June, 2003 Vol. LXXIII, No. 6.

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