– Level II Study Guide

Anti - Money Laundering

 "Money Laundering" is the process by which proceeds from a criminal activity are disguised to
conceal their illicit origin
 Income earned from illegal or prohibited activities is called a black/illegal or dirty money
 The income cannot be spent freely as it can come under the purview of the Income Tax authorities
 Therefore, a person who has earned the money will perform an activity which converts black >white,
illegal >legal and dirty >clean money
 This process is known as Money Laundering (ML)
 Once the money is clean (looks legitimate), then the person can freely spend it
 Analysis done on the various sources and uses of laundered money resulted in another problem –
laundered money was, more often than not, being used for financing terrorist activities
 Therefore a process known as Anti Money Laundering was set-up whose goals were to prevent
money laundering, and indirectly prevent the financing of terrorism (FT)

Sources of Black/Illegal/Dirty money

 Drugs trafficking
 Smuggling
 Human trafficking
 Insider Trading
 Income earned from casinos & gambling
 Piracy
 Tax Evasion
 Criminal Activities

Examples/Methods of Money Laundering

 Using the black market
 Using overseas banks with lesser regulations
 Underground or alternative banking channels hawala)
 Using of Shell companies
 Using a legitimate business to mix dirty money
 Structuring or recurring non reportable transactions
 Using even dollar amount in transactions
 Transactions structured to lose the paper trail (high volumes of transactions)

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Stages of Money Laundering

 Placement
 Layering
 Integration

Placement
 The first stage of money laundering, involves the placement of bulk cash into the financial system
without the appearance of being connected to a criminal activity.
 There are many ways cash can be placed into the system.
 The simplest way is to deposit cash into a financial institution; however, this is also one of the riskier
ways to get caught laundering money
 To avoid notice, banking transactions involving cash are likely to be conducted in amounts under the
CTR reporting thresholds; this activity is referred to as “structuring.”
 Placement poses the greatest risk to our businesses:
o Transactions may be structured to avoid recordkeeping or reporting thresholds
o False identification and/or information may be provided

Layering
 This stage is the process of moving and manipulating funds to confuse their sources as well as
complicating or partially eliminating the paper trail.
 It may involve moving funds in various forms through multiple accounts at numerous financial
institutions, both domestic and international, in a complex series of transactions (Smurfing)

Methods of Layering
 Exchanging cashier’s checks and other monetary instruments for other cashier’s checks, larger or
smaller, possibly adding additional cash or other monetary instruments in the process
 Performing interbank transfers between accounts owned or controlled by common individuals (for
example, telephone transfers)
 Performing wire transfers to accounts under various customer and business names at other financial
institutions
 Transferring funds outside and possibly back into the U.S. by various means such as wire transfers,
particularly through “secrecy haven” countries
 Depositing a refund check from a canceled vacation package or insurance policy.

Integration
 In the discussion of the placement stage, integration can be accomplished simultaneously with the
placement of funds.

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 After the funds have been placed into the financial system and insulated through the layering
process, the integration phase is used to create the appearance of legality through additional
transactions such as loans, or real estate deals.
 These transactions provide the criminal with a plausible explanation as to where the funds came
from to purchase assets and shield the criminal from any type of recorded connection to the funds.

Methods of Integration
 Inflating business receipts
 Creating false invoices and shipping documents
 Establishing a front company or phony charitable organization
 Using gold bullion schemes

In other words, to convert Black/Illegal/Dirty money into White/Legal/Clean money, the above three steps
are generally required.

Case Study 1: Purchase Fraud

 Store associate tip began the investigation on this case
 Broad sweep identified commonalities between occupation, city of permanent address, geographic
region of the people involved in the pickup of cash
 Video feed review confirmed links
 Total no. of transactions included 896 wire transfers for $2.7 million, 787 different names, 130 stores

Case Study 2: Human Trafficking

 A customer was making atypically large (over $10K) cash deposits to her personal checking account.
The funds subsequently were being depleted via cashed checks made payable to a third person.
 At account opening, the customer reported that she worked for a national fast food chain, making the
large cash deposits suspicious.
 As a result of the detailed information that we provided on both our customer and the non‐customer
individual cashing the checks at our branches, the authorities were able to identify and track down a
subject in an extensive alien smuggling ring.

Financial Action Task Force (FATF)

 In response to mounting concern over money laundering and the threat posed to the banking system
and to financial institutions, the Financial Action Task Force on Money Laundering (FATF) was
established by the G-7 Summit that was held in Paris in 1989.
 The Task Force was given the responsibility of
o Examining money laundering techniques and trends,

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o Reviewing the action which had already been taken at a national or international level, and
o Setting out the measures that still needed to be taken to combat money laundering.
o This was expanded to include Combating the Financing of Terrorism (CFT)

Consequences of not complying with AML/CFT

 Legal and regulatory sanctions and penalty: Organizational and individual sanctions are now the
norm for those who fail to comply
 The Penalty could affect the bottom line
 Negative publicity
 Damage to corporate reputation and loss of goodwill

Financial Intelligence Unit (FIU)

 As part of the FATF recommendations, every country should set-up a Financial Intelligence Unit
(FIU)
 It will be focused on processing financial information that may be related to criminal or terrorist
activity
 FIUs are agencies that receive reports of suspicious transactions from financial institutions and other
persons and entities, analyze them, and disseminate the resulting intelligence to local law-
enforcement agencies
 FIUs must retain sufficient independence to accomplish their objectives without undue interference
or influence.
 Various FIU’s of the world are below
o FinCEN for the United States
o National Crime Agency (NCA) for the United Kingdom
o Qatar Financial Information Unit (QFIU) for Qatar
o Anti Money Laundering and Counter Terrorist Financing Unit for Jordan
o Financial Intelligence Unit-India (FIU-IND) for India
o Zentralstelle fü r Verdachtsanzeigen for Germany

Reporting to the FIU

 A financial institution must file a Suspicious Activity Report (SAR) for suspected money laundering
activities that it knows or suspects to the FIU
 Federal laws prohibit notifying a suspect or person involved in the suspicious transaction that forms
the basis of the SAR

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Know Your Customer (KYC)

 KYC enable banks to know/understand their customers and their financial dealings better
 Understanding the way a customer behaves is also a very effective way to prevent potential money
laundering cases
 The Basel Committee states the need to implement effective ‘know-your-customer’(KYC) standards
as an essential part of risk management practices
 Inadequate KYC risk management programs may lead to significant risks, especially legal and
reputational ones
 The following elements are essential for a robust KYC program:
o Customer Identification Policy (Procedure/Program)
o Customer Acceptance Policy (Procedure/Program)
o Due Diligence/Risk Classification
 KYC has to be a core feature of banks’ risk management and control procedures where a bank
should:
o Establish the identity of their customers
o Monitor their account activity
o Determine those transactions that do not conform with the normal or expected transactions.
o Should include regular compliance reviews and internal audit
o The intensity of the program should be tailored to the level of risk in the business

Customer Identification Policy (Procedure/Program)

 Banks should establish a systematic procedure for identifying new customers and should not
establish relationship until the identity of a new customer is satisfactorily verified
 Customer identification procedure should identify:
– the person or entity that maintains an account with the bank or those on whose behalf an
account is maintained (i.e. beneficial owners);
– the beneficiaries of transactions conducted by professional intermediaries;
– any person or entity connected with a financial transaction who can pose a significant
reputational or other risk to the bank
– Understand if the customer is opening an account for themselves or on behalf of others
 Understand the types of account they want to open (Individual/Partnership/Incoroprated
Entities/Trusts/Foreign/Associations etc)
 Hence the goal is to identify the person who has the ultimate control of the funds; aka Beneficial
Owner

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 The best documents for verifying the identity of customers are those most difficult to obtain illicitly
and to counterfeit
 The extent and nature of the information required depends on the type of applicant (personal,
corporate, etc.) and the expected size of the account
 Banks should never agree to open an account or conduct ongoing business with a customer who
insists on anonymity or who gives a fictitious name.
 Nor should confidential numbered accounts function as anonymous accounts but they should be
subject to exactly the same KYC procedures as all other customer accounts, even if the test is carried
out by selected staff
 Whereas a numbered account can offer additional protection for the identity of the accountholder,
the identity must be known to a sufficient number of staff to operate proper due diligence
 Such accounts should in no circumstances be used to hide the customer identity from a bank’s
compliance function or from the supervisors

Customer Acceptance Policy (Procedure/Program)

 Banks should have a customer acceptance policies and procedures (CAP)
 Factors such as customers’ background, country of origin, public or high profile position, linked
accounts, business activities or other risk indicators are considered in the CAP
 Here the type of documents required for each type of account is also specified
 A review of the customer against the present Sanctions list is also done to ensure that an account is
not opened for a customer who has sanctions imposed on them
 Care should be taken to ensure that the customer acceptance policy does not become restrictive that
it results in a denial of access for people who are financially or socially disadvantaged
 Decisions to enter into business relationships with higher risk customers, such as politically exposed
persons, should be taken exclusively at senior management level
 A bank should obtain appropriate identification information and maintain such information in a
readily retrievable format. This may also fulfill any local reporting requirements
 Few of the official documents that can be accepted as a proof are:
o Document from a public register, certificate of incorporation, certificate of good standing
o Law, regulation, decree
o Official identity document with photography (passport, identity card)
o Notarial deed
o Statutes, partnership agreement, deed of trust, memorandum of association valid and certified
o Certified copy of the shareholders’ register
o Document issued by a regulator
o Stock exchange website
o Income Tax documents (PAN)
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o Reports from agencies such as Banker’s Almanach

o Confirmation from a lawyer or notary
o Verification from systems such as WorldCheck, LexisNexis, Factiva Dow Jones
 The documents accepted will change basis the type of customer and the account they are opening

Due Diligence/Risk Classification

 This refers to the continuous review of the customer’s transactions and activity
 The basis of due diligence is the information received from KYC team on the type of the customer and
information provided
 Without such knowledge, they are likely to fail in their duty to report suspicious transactions to the
appropriate authorities in cases where they are required to do so
 For all accounts, banks should have systems in place to detect unusual or suspicious patterns of
activity
 They may include transactions that do not appear to make economic or commercial sense, or that
involve large amounts of cash deposits that are not consistent with the normal and expected
transactions of the customer
 Very high account turnover, inconsistent with the size of the balance, may indicate that funds are
being “washed” through the account

 Due diligence also includes classifying the customer based on the ML/FT risk levels
o Simplified when the AML/CFT risk of the customer is low,
o Standard, when the AML/CFT risk of the customer is medium, and
o Enhanced, when the AML/CFT risk of the customer is high
 A high risk customer, such as a high net worth individual, whose source of funds is unclear, typically
would have a more extensive due diligence procedure
 A bank should establish a risk-based systematic procedure for verifying the identity of new
customers

Low Risk/Simplified due diligence

 Chances of ML/FT risk is very low and hence not a lot of focus is put on such customers
 E.g’s included Individuals, Salary accounts, students

Medium Risk/Standard due diligence

 Includes customers that are likely to pose a higher than average risk to the bank in cases of ML/FT
 Increased documentation and a more often review of their accounts maybe done
 E.g’s Persons in business/industry or trading activity where the area of his residence or place of
business has a scope or history of unlawful trading/business activity
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High Risk/Enhanced due diligence

 Accounts requiring extensive ‘due diligence’ for higher risk customers, especially those for whom the
sources of funds are not clear
 The examples of customers requiring higher due diligence may include
o High Net worth individuals
o Trusts, charities, NGOs and organizations receiving donations,
o Firms with multiple ‘sleeping partners’
o Politically Exposed Persons (PEPs)
o Non-face to face customers
o Those with dubious reputation as per public information available

Sanctions and Watch Lists

 The Office of Foreign Assets Control administers laws that impose economic and trade sanctions
based on foreign policy and national security objectives.
 Sanctions have been established against various entities and individuals such as
o Targeted foreign countries,
o Terrorists,
o International narcotics traffickers, and
o Those engaging in activities relating to the proliferation of weapons of mass destruction
 Sanctions can be specific to the interests of the U.S, however, many sanctions are based on United
Nations and other international mandates. Sanctions can include one or more of the following:
o Blocking of assets,
o Trade embargoes,
o Prohibition on unlicensed trade and/or financial transactions,
o Travel bans, and
o Other financial and commercial prohibitions

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