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money laundering

Money laundering is the act of disguising the original ownership, identity and destination of the profits of a crime by hiding it within a legitimate financial institution and making it appear to have been acquired from a legal source.

Successful money laundering hides the illegal proceeds of a crime from the public eye, disguising the funds as legitimate profit made in legal ways and allowing the criminal owners to use it without drawing attention to their illegal activities. Money laundering was criminalized in an effort to remove the profit from crime. The focus was that it is wrong for anyone to help a criminal benefit from their illegal activities or ease the exercise of the activity by providing financial assistance.

Not all criminal money relies on financial organizations for assistance, but the services provided by the financial sector, like managing, controlling and possessing the money and property of others, make the industry vulnerable.

The threat of money laundering has increased as new technology allows money to move faster and in automated ways. This automation makes it more likely for law enforcement or financial organizations to miss steps and the smuggling of laundered money to occur. Automation also makes it harder to trace where the money came from and where it's going, allowing dirty money to be exchanged. Therefore, as technology and ways of transferring money continue to change, it becomes increasingly important for a company to trace suspicious activity and the path of money within its system to prevent cybercrime.

Stages of money laundering

Money laundering occurs whenever an outside person or business handles the funds of another person's criminal activities. Tax evasion and false accounting practices are common examples. Drug trafficking also relies on the process to disguise its assets as clean money. Money laundering relies on placement, layering and integration. Placement is the very first stage and involves the introduction of the illegal money into the financial system.

Next is the biggest stage in the process: layering. In this phase, the money is separated (or washed) from its original ownership. Money launderers will do this by passing the money through a complex path of transactions in order to obscure its origin.

Shell companies -- an inactive company used to facilitate financial actions -- are often used in layering to disguise the source of the money. The shell company will usually perform a service that reasonably requires customers to frequently pay with cash. The anonymity of cash transactions is beneficial to the laundering process because it makes it harder for the government to trace the money. The shell company will also create falsified invoices and receipts to further disguise the money. Sometimes, it continues to pass the money on to different shell companies to further remove it from the original source.

Finally, in the integration stage, the successfully laundered money is returned to the initial owner in an indirect way and reintroduced to the economy. For example, the shell company may buy real estate that will then be used by the original criminal.

Criminals will also keep their money in foreign banks. These offshore accounts offer increased privacy, less taxes and reduced regulation. The illegal money holder will be able to hide their money in the account without reporting its existence to the U.S. government and will be able to earn interest on the deposited money without paying U.S. personal income taxes.

Dangers of money laundering

The biggest risk for any individual involved in money laundering is jail time. This risk applies to corrupted bankers, lawyers and accountants that are coerced into participating as well as company leaders who may or may not have been aware of the process. An individual who is pulled in to help the money laundering process may also open themselves to the risk of blackmail or threats against themselves and their families from the criminals they work for.

Financial organizations are at risk of being sued for failing to comply with mandatory standards and inadequately identifying customers and their businesses. This can lead to fines, criminal liabilities and penalties forced upon supervisors. The institution also risks destroying its reputation and losing reliable, trustworthy clients and shareholders due to its association with criminals.

In countries with weak governments who offer offshore financial services, criminals are able to obtain apparently legitimate financial accounts which allow them to move their money anonymously. In these countries, money laundering is often ignored and the criminals are able to increase their profits, gain respect as they climb the social ladder and open the opportunity to commit more crimes. The government is then further weakened when a fraud is eventually discovered.

Money laundering builds organized crime. When the money is successfully laundered, it can be fed back into the crime organization which can use it to create an enterprise which will further prevent detection. This may also create an illegal, underground economy that is unregulated and untaxed. This hidden economy generates a government fiscal deficit and problems with national budgeting, forcing the government to borrow money.

How is it being stopped?

Financial companies have started using anti-money laundering  (AML) software to examine customer data and stop potentially illegal transactions. Banks are also using artificial intelligence (AI) to assist in regulatory compliance which helps them know their customers and prevent laundering attempts. Finally, governance, risk, and compliance (GRC) programs have been adopted by companies and can help monitor day-to-day activities, making it less likely for dirty money to enter the system.

The U.S. government is actively trying to stop the money laundering process. In 1970, Congress passed the Bank Secrecy Act, requiring banks to report any transaction over $10,000. This was followed by the Money Laundering Control Act of 1986 which officially made money laundering a crime. Fifteen years later, the 2001 U.S.A. Patriot Act expanded jurisdiction by increasing the types of financial institutions involved and scope of reporting responsibilities in an effort to fight funding of terrorist activities. Most recently, in 2008, two different cases caused Congress to clarify the definition of money laundering. The decision of Cuellar v. United States declared that the money must be disguised with the purpose of hiding ownership, control or source in order for the action to be called money laundering. The United States v. Santos case decided that the word 'proceeds' -- used in the federal laundering statute -- refers only to criminal profits and not receipts.

Examples of money laundering

HSBC, the British multinational banking and financial services company, was put under investigation by the U.S. Senate in 2012 after violating AML laws. The company was found to have failed to treat their Mexican counterpart as high risk even though there were ties to drug trafficking; offered banking services to known terrorist affiliations in Saudi Arabia; and worked around efforts to prevent transactions to North Korea and Iran. An estimated $8 billion was laundered.

Nauru, a small island off the coast of Australia, became the perfect location for shell companies after the land was depleted of its natural resources. The Russian mafia used the island to pass an estimated $70 billion that was unaccounted for. However, the island reacted by banning all shell banks and has managed to resume conduct in compliance with AML laws.

In 2010, Wachovia, a diversified financial services company, was fined for AML non-compliance. The company laundered an estimated $390 billion for drug cartels in Mexico. Since then, Wachovia has merged with the bigger, multinational financial services company Wells Fargo.

This was last updated in June 2019

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