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Understanding and Preventing Money Laundering

Article · February 2008

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Elizabeth Vallery Mulig Murphy Smith

Southeastern Oklahoma State University Texas A&M University - Corpus Christi
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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

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 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

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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

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 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 today’s 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

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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 country’s 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

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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

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  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.

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 Recent legislation has increased accountant’s 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 profession’s

responsibilities.

Money laundering, due to today’s 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.

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 Exhibit 1

Basic Steps in the Money Laundering Process

Placement Layering Integration

Cash deposited into bank Funds are transferred abroad, False loan repayment or
(often with complicity of often to shell companies or forged invoices used as cover
staff or mixed with proceeds disguised as proceeds of for laundered money
of legitimate businesses) legitimate business.

Cash physically transported Deposits made in overseas Complex web of transfers

out of country. banking system or closely- (both domestic and
held bank. international) makes tracing
original source of funds
virtually impossible.

Cash used to buy high value Previously purchased goods Income from property or
goods, property, or business and assets are sold to obtain legitimate business assets
assets. cash. appears “clean.”

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 Endnotes

1. B. Steel, Billy’s 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 Administration’s “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 Examiner’s 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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