KYC & Anti Money Laundering

CA. Ramesh ShettyFCA, DISA(ICA), CISA(USA)

Basic Concepts How it happens Case Studies – Abroad International Initiatives Indian Scenario Know Your Customer Case Studies – India Role of CA’s

Sec.3 of PML Act, 2002 defines ‘money laundering’ as:

“whosoever directly or indirectly attempts to indulge or knowingly assists or knowingly is a party or is actually involved in any process or activity connected with the proceeds of crime and projecting it as untainted property shall be guilty of the offence of money-laundering”

Concepts of Money laundering

Is to conceal criminal activity associated with it, including crimes it generated such as drug trafficking, tax evasion, corruption, extortion, circumventing regulations etc

Process by which criminals attempt to hide and disguise the true origin and ownership of the proceeds of criminal activities, thereby avoiding prosecution, conviction and confiscation of criminal funds(IBA definition)

Process by which dirty money appear clean or profits of criminal activities are made to appear legitimate.

Concepts - contd..

Organized criminal groups use money laundering as a means to reinvest money.

The main objective is to get the illegal funds back to the individual or group of individuals who generated them.

Financial intermediaries (banks, financial institutions) are used to change money gained from illegal businesses into acceptable and transferable units, turning illegal gain into legal tender

Concepts - contd..

ML generally refers to ‘washing’ of the proceeds or profits generated from:-

Drug trafficking – South Asian People smuggling – African Countries Financial frauds - Arms, Antique and gold smuggling Illegal sale of wild life products and

others. Prostitution rings Corruption

Concepts - contd..

ML every year $600 Billion to $2 Trillion.

Financial powers

Big time criminals

Use professionals to create legal structure/ entities which act as a front

Money Laundering Process

Money laundering is a diverse and a complicated process that involves three independent steps that often occur simultaneously

Placement

Layering

Integration

Stage 1 - Placement

Physically disposing of cash derived from illegal activity.

Funds are placed close to the underlying activity in the country where the funds originate.

One way of accomplishing this is by placing criminal proceeds into traditional financial institutions or non financial institutions such as currency exchanges, casinos.

Placement

launderer inserts the dirty money into a legitimate financial institution.

In the form of cash deposits. to report high value transactions.

This is the riskiest stage of the ML process because large amounts of cash are pretty conspicuous and banks are required

Stage 2 - Layering

Separating the proceeds of criminal activity from their source through the use of layers of financial transactions.

These layers are designed to hamper the audit trail, disguise the origin of funds and provide anonymity

They use shell companies, offshore banks or countries with no or less regulation, a large business centre.

Layering involves sending the money through

various financial transactions to change its form and make it difficult to follow.

Layering may consist of several bank to bank transfers

wire transfers between different accounts in different names in different countries

making deposit and withdrawals to continually vary the amount of money in the accounts

changing the money’s currency purchasing high value items (boats, houses

cars, diamonds) to change the form of money-making it hard to trace.

Stage 3 - Integration

Placing the laundered proceeds back into the economy in such a way that they re-enter the financial system as apparently legitimate funds.

The launderer may choose to invest in other centres.

Eg. False invoices for goods exported, domestic loan against a foreign deposit, purchasing property, etc.

Integration At the integration stage the money re-enters the

mainstream economy in legitimate looking form it appears as a legal transaction. this may involves final bank transfer into an account of a local business in which the launderer is investing in exchange for a cut in the profits., a sale of a yacht bought during the layering stage. at this point the criminal can use the money without being caught. It is difficult to catch a launderer during the integration stage if there is no documentation during the previous stages

Overseas banks Money launderers often send money through various offshore

accounts in countries that have bank secrecy laws –these countries allow anonymous transactions. A complex scheme may involve hundreds of bank transfers to and offshore banks .According to the international Monetary fund ,”major offshore centres iclude Bahamas, Bahrain,Cayman islands, hong kong, Antilles, Panama, and Singapore (IMF)

Types/Techniques

Debit/Credit Cards Deposit structuring (or smurfing) Connected accounts – Connected to each other Alternative Remittance services –the hawala route Loan back arrangements Forex money changers Investment banking and the securities sectors Insurance and personal investment products Correspondent banking Lawyers, Accountants and other intermediaries Mis-use of non-profit organizations Use of “Payable through accounts” by international

launderers

Types/Techniques – Contd…

Use of legal persons Corrupt Politicians/Public officials Underground banking /alternative banking –

Countries in asia - well established legal alternative banking systems that allow undocumented deposits , withdrawals & transfers.

Are trust based systems and often have ancient roots, leave no paper trail and operate outside government control.

Eg. Hawala system in Pakistan and India and Fie Chen system in China.

Shell companies (fake companies) – Take in dirty money for payment of supposed goods or services

but actually provide no goods and services. Create the appearance of legitimate transactions through fake

invoices and balance sheets

Deposit Structuring/Smurfing

$ 50, 000 Laundered money

Below deposit amtsDays

$ 10,000 1 $ 10,000 2$ 10,000 3$ 10,000 4$ 10,000 5 Balance = $ 50,000

Money laundering through electronic systems/cross border activities

Computers/Electronic systems can be used as at tool for perpetrating illegal or criminal activities . Organized criminals can break security in electronic

systems more easily and more cheaply by forcing employees who have legitimate access to the system to furnish them with passwords.

Easier to corrupt an individual in a country where average salary is low. Money launderers look for countries where there are

highly educated well trained banking personnel on a low salary to corrupt them.

Legal Sources of terrorist financing:

Collection of membership dues Sale of publications Cultural of social events Door to door solicitation within

community Appeal to wealthy members of the

community Donation of a portion of personal

savings

Illegal Sources

Kidnap and extortion Smuggling Fraud including credit card fraud Misuse of non-profit organisations

and charities Fraud, thefts and robbery and Drug trafficking

Use of shell companies by lawyers

A prominent attorney Ml network 16 FIs-US and abroad offshore

locations Charged flat fee to money launder funds Funds of clients were wire transferred to his

offshore accounts Moved to Carribbean destinations and USA Issued credit cards in false names to help

clients withdraw money through ATMs

Smaller banks and NBFCs

Private banking assistance provided by the employees-help structure and smurf to recycle funds in the bank accounts-typically by making deposits and withdrawing heavily from the accounts. A few month before audit the activity would stop with a small balance.

Done to avoid suspicion and disclosure

Loan back arrangements a technique- the launderer usually transfers the illegal proceeds to another country- then deposits the proceeds as security or g’tee for a bank loan- then sent back to original country –gives the appearance of a genuine loan.

Payable through accounts

• They are demand deposits accounts maintained at FIs by foreign banks. The foreign banks channel all deposits and cheques of its customers into one account at a local bank. The foreign customers have a signatory authority for the account as sub account holders and could conduct normal international banking transactions-defeats KYC norms.

Case Study-Franklin Jurado During -1990 Harvad educated economist ran a

ML network for Columbian drug lord Jose Santa Cruz –Londono complex scheme.

ML of $ 36 Million Wiring out from Panam Bank to Merril Lynch

and other Institutions 100 bank accounts in 68 countries When a Monaco bank collapsed and a

subsequent audit revealed numerous accounts that traced back to Jurado. Also a complaint on his money counting machine made all night by his neighbor in Luxembourg.

Found guilty convicted sentenced to prison.

Drug Money laundering- Franklin Jurado case

Drug (dirty) Money

• Placement Panama Banks

• Layering 100 Bank accounts in Europe

• Shell companies in Europe

• Integration Colombian businesses

Case Study-Accounting firm Two Narcotics traffickers Regular deposit of criminal proceeds from drug sales Receipts

issued.

Accounting firm Stored in the accountant’s office. Accountant structured deposits.

Opened trust/coy accounts/personal accounts

Wire transfer Transferred proceeds overseas. Structured transactions

Purchase of assets Purchase of truck parts, brought back parts into country sold for a

profit. Also purchased real estate.

Services provided by many professionals such as accountants, lawyers, real estate agents also serve as potential mechanisms to launder money.

Riggs Bank-Money Laundering Scandals

Suspicious transactions Riggs Bank was fined $25 mn for violation of

AML under the US Bank Secrecy Act. It pleaded guilty and paid $ 16 mn in fines in February 2005

It also paid $9 mn to Pinochet’s victims Criminal charges against some of the bank’s

employees Bank’s operations acquired by PNC Bank in

May 2005

Riggs Bank-Money Laundering Scandals

Augusto Pinochet- former Dictator of Chile widely accused of corruption, illegal arms, sales, etc-Riggs invited Pinochet to open an account

US Senate reported that Riggs executives connived with Pinochet to disguise millions of dollars that had been stolen from Chilean people.

Pinochet arrested in 1998 in Britain- extradited to Spain

Accounts were frozen. But by using shell companies and hiding accounts from federal regulations, Riggs allowed Pinochet to retain access to his fortune.

Riggs Bank-Money Laundering Scandals

A Saudi Omar Al Bayoumi opened a bank account for 9/11 hijackers

Two weeks later his wife received monthly payments in tens of thousands of dollars from Princess Haifa Bint Faisal (the wife of Saudi Ambassador).

Prince Bandar Bin Sultan (confidante of Bush ) also had an account with Riggs bank. Large transactions between him and other saudis (no background checks done )

An FBI investigation carried out Was closed with no action.

Case Study-Insurance policies and real estate

Two European nationals

Purchase of Life insurance policies (Total value $ 268,000)

Payment of premium (Payment made by cheques drawn on brokerage firm in a major EU financial market and a notary in the country)

Policies put up as collateral (provided by a leasing company)

The offenders were brothers who were involved in the illegal export/import of classic cars

Non banking institutions could also become conduits for money laundering.

Reports/Facts on Money Laundering

Rough estimate - 2 to 5% of GDP (1996) $600 bn to $2 trillion every year.

Principal sources of illegal proceeds-Drug trafficking –single largest generator of illegal funds

Banking sector- smurfing common Shell companies-tool widely used by lawyers

and accountants Smaller banks and NBFCs used as channels-

Private banking assistance-Help given in restructuring accounts-

Impact – On Economy Unpredictable changes in money demand Risks to banking system - Reputational risk, legal risk,

operational risk, concentration risk. Increased volatility of international capital flows Increased volatility of exchange rates due to unanticipated cross

asset transfers. Economic and political influence of criminals can change social

systems, ethical standards Crime can infiltrate financial bodies, public officials/

governments Macro economic situations Money laundering poses a serious threat to the international

community and financial systems in countries the world over

FATF (Financial Action Task Force)

Established by the G-7 Summit that was held in Paris in 1989 An inter-governmental body / Post 09/11 Purpose - Development and promotion of policies, both at

national and international levels, to combat money laundering and terrorist financing. 34 countries, India is being one of the observer status Published 40 + 9 recommendations Political level commitment to comply with FATF

recommendations FATF focuses on setting standards for AML/TF Assessing implementation of the programmes Identifying and studying ML and FT methods and trends

FATF Recommendations -Features Legal Systems-money laundering to be treated as a

serious offence Measures to be taken by financial institutions Undertaking customer due diligence(CDD) and record

keeping Countries to establish Financial Investigation Unit (FIU)

for receiving, analysing of info and enforcement of law. Reporting systems-CTR and STRs/penalties Internal policies for adequate screening procedures for

hiring employees. Non financial businesses (lawyers, notaries, dealers,

trusts service providers) required to report suspicious transactions

Countries should not allow operation of shell companies Robust supervision and regulation of financial

institutions Regulation of casinos.

Indian Scenario/InitiativesPrevention of Money Laundering Act, 2002

Under the PMLA 2002, rules were framed in 2005 & 2009

Setting up of the FIU-IND in 2004 Section 12 of the Act casts certain obligations on

banking companies/Financial Institutions/Intermediaries in regard to reporting of customer account information and preservation of records

Maintenance of record of all cash transactions above Rs 10 lakhs

All series of cash transactions of value less than Rs 10 lakhs integrally connected if they have taken place within a month (aggregate value above Rs 10 lakhs)

All cash transactions here forged or counterfeit notes have been used.

All suspicious transactions made in cash or otherwise.

FIU-preservation and reporting requirements

Preservation of records for 10 years Reporting to FIU Manual reporting of cash

transactions (CTR) & suspicious transactions (STR)

Consolidated reporting of cash transactions

RBI KYC norms

Appointment of a Principal Officer To assess, monitor and control money laundering risks. Receive information from branches and analyze

information The PO will be responsible for timely submission of CTR

and STR to FIU-IND Utmost confidentiality to be maintained while filing Reports for all branches are filed in one mode –manual

and electronic A summary of cash transaction report for the bank as

whole be complied by PO of the bank

Advantages of KYC norms

Sound KYC procedures have particular relevance to the safety and soundness of banks, in that:

- They help to protect banks’ reputation and the integrity of banking systems by reducing the likelyhood of banks becoming a vehicle for or victim of financial crime and suffering consequential reputational damage;

- They provide an essential part of sound risk management system (basis for identifying, limiting and controlling risk exposures in assets & liabilities)

KYC - MeaningCustomer?- One who maintains an account, establishes business

relationship, on who’s behalf account is maintained, beneficiary of accounts maintained by intermediaries, and one who carries potential risk through one off transaction.

Your? Who should know?- Branch manager, audit officer, monitoring officials, PO

Know? What you should know?- True identity and beneficial ownership of the accounts- Permanent address, registered & administrative address

KYC - Meaning

Making reasonable efforts to determine the true identity and beneficial ownership of accounts;

Sources of funds Nature of customers’ business What constitutes reasonable account activity? Who your customer’s customer are?

Elements of KYC

Customer Acceptance PolicyCustomer Identification Procedure-

Customer ProfileRisk classification of accounts- risk

based approachRisk ManagementOngoing monitoring of account activityReporting of cash and suspicious

transactions

High Risk CustomersNon-bank financial institutions ( money

transmitters, cheque cashiers, full fledged money changers, sellers of stored value cards, security brokers & dealers etc. )

Travel agencies / Property dealers/ builders Professional and consulting firms Exporters or importers of goods and services Cash intensive business e.g. retail stores,

restaurants, gambling casinos, second hand car dealerships etc.

Off-shore corporations Non-profit organizations eg. charities

High Risk Products Wire transfers:

– Both domestic and cross border wire transfers carry potential risk of money laundering

– Payment gateways facilitate wire transfers for customers of banks located anywhere in the world

– Ascertain whether it is regulated at the place of incorporation

– Insist on complete originator information with wire– Make payment to beneficiary through account or DD– Keep record of transactions

Electronic banking services which includes services offered through internet, credit cards.

Private banking relationships Correspondent banking relationships

Measures to deter ML

Board and management oversight of AML risks Appointment a senior executive as principal officer with

adequate authority and resources at his command Systems, controls & Documentation - identify, assess &

manage the money laundering risks Make a report to the Board on the operation and

effectiveness of systems and control Creating customer profiles Screening of employees before hiring and of those who

have access to sensitive information Appropriate quality training to staff Quick and timely reporting of suspicious transactions

Suspicious transactions - FIU-IND

A transaction whether or not made in cash to a person acting in good faith.

Gives rise to a reasonable ground of suspicion that it may be proceeds of crime

No economic rationale or bonafide purposeIdentity of client False identification of documents Identification cannot be verified within a reasonable time Accounts opened with names very close to other

established business entities Background of client Links with known criminals

Suspicious transactions - FIU-IND

Multiple accounts Unexplained transfer between accounts with no rationale Unusual activity compared with past transactions Sudden activity in dormant accounts Activity inconsistent with what would be expected from

declared business Frequent purchase of drafts with cash Categories for financial intermediaries –financial brokers.

Merchant bankers, portfolio manager Large sums being transferred overseas for payment Dealings at off market rates.

FIU Directions Only banks and other financial institutions are obligated

to report on suspicious transactions regularly to the financial intelligence unit set up under the Finance Ministry.

Such transactions are forwarded by the FIU to enforcement agencies for action after scrutiny.

Financial intermediaries like full-fledged money changer, money transfer service providers such as Western Union and International Payment gateways, including VISA and MasterCard are brought under the amended PMLA.

India’s international obligation and empower the enforcement directorate to search the premises immediately after the offences are committed and police have filed a report

IBA Check list - Caution to be exercised

Customer regularly depositing or withdrawing large amounts by wire transfer to or from or through countries known for narcotics or where ML laws are lax.

Sending or receiving frequent large volumes of wire transfers to and from offshore institutions

Loan proceeds are wired to offshore bank Receiving wire transfers and immediately purchasing monetary

instruments payable to third party. Customer pays for a large wire transfer using multiple

instruments drawn on several financial institutions

IPO SCAM - INDIA Manipulation of primary market by financers and market

players using fictitious names. Sole person authorized to operate all the accounts. The

person was also director in all the companies Current accounts opened in multiple companies on the

same date at the same bank branch Failure to identify the identity and address of all

directors of the companies Identity disguised by using different spellings for the

same name in different companies. Proper introductions nor obtained Risk profiling not done Objective for opening large number of accounts in the

names of large number of joint account holders not questioned

Transfer of huge funds from companies account to individuals account which was used to invest in IPO

Poor monitoring and reporting system

Operational deficiencies

Factors that facilitated the IPO scam are -Proper introductions not obtainedPhotographs not obtainedFailure to independently verify the identity

and address of all joint account holdersSignatures not taken in the presence of

bank officialDirectors identity/ address not verifiedCustomer Due Diligence done by a

subsidiary

SATYAM - Issue• The Enforcement Directorate has registered a case

against Satyam Computer and its tainted founder-chairman B Ramalinga Raju for alleged money laundering.

• The ED sources alleged that Raju had diverted funds of Satyam into purchasing nearly 50 plots in Medchal and Qutbullahpur near Hyderabad

• The ED alleged that several hundred crore rupees had been diverted from the Satyam Computer accounts and had been invested in purchasing land and other infrastructure for Maytas.

• The Directorate will go through deals of the IT company and ascertain their genuineness including payments made to acquire companies abroad.

• The ED will also send a team to a few countries to investigate and get documents of bank accounts opened in violation of Indian laws

Hasan Ali Khan - Issues

• India's lone banking regulator, Reserve Bank of India, recently blocked the application of Swiss bank UBS for a banking license in India on the ground that it was involved in $8 billion money-laundering racket

• RBI said it put the UBS application on hold because the bank failed to cooperate in a money-laundering case in which controversial Bombay-based businessman Hasan Ali Khan was involved.

• Khan is charged with large-scale breaching of India's currency controls.

• _ RBI investigators found the link between UBS and Khan, as the businessman had deposited $8 billion at a Zurich branch of UBS.

• _ They cited it as direct evidence for blocking the license of the bank.

High risk areas of AML

High risk countriesDrug producing countriesCountries with high levels of corruptionCountries linked to terrorist financing

High risk customersPrivate money transmittersMoney changersReal estate dealersCasinos, gambling outfitsNon profit organizations –charities

High risk servicesWire transfersPrivate banking Correspondent bankingElectronic banking services-internet, debit/credit cards

Risk Factors

VulnerabilitiesEntities may not be regulatedCustomer anonymity(Secrecy)No face to face relationshipAnonymous funding(Promissory notes) Cross border transfersaccess to cash globally through ATMs

Possible risk mitigantsVerification of customer identityLimit funding optionsLimit card valueMonitor transactionsReporting of suspicious activityNo direct cash via ATM

- Advise to clients

- Audits - - Bank’s - Statutory Audit (LFAR)- Concurrent Audit- KYC and AML Audits- DP Audits as per SEBI guidelines- Stock Broker’s audit as per SEBI

guidelines

Thank you

ca.rshetty@gmail.com