Understanding Money Laundering: Money Laundering Techniques and Detection Methods

Understanding money laundering is crucial to effectively combat financial crime, as it not only involves tracking the illegal proceeds but also scrutinizing the predicate offenses that generate such funds and deploying rigorous detection and compliance measures to disrupt this illicit activity.

The term money laundering describes the activity of concealing or disguising the identity of illegally obtained proceeds. This activity has the goal of making the illegally obtained proceeds appear to have originated from legitimate sources. The precise definition of money laundering varies slightly in each country where it is recognized in criminal law, and it varies according to relevant organizations and standard-setting bodies, which are covered later on.

Money laundering is the processing of criminal proceeds to disguise their illegal origin. The money laundering process enables criminals to enjoy profits and funds without jeopardizing their source. When a criminal activity generates substantial profits, the individual or group involved must find a way to control the funds without attracting attention to the underlying activity or the persons involved. 

Criminals do this by disguising the sources, changing the form, or moving the funds to a place where they are less likely to attract attention.

When criminals derive funds from illegal activities, that money must be disguised before it can be introduced into the legitimate financial system. Money laundering is the illegal process of disguising the profits of financial crime, typically by using the services of banks and businesses. Criminals transfer their illegal funds from one place to another, through the use of a financial system of the country such as banking channels. The transfer of illegal money may be to support other criminals in various other jurisdictions or countries. 

Understanding Money Laundering from Predicate Offenses to Detection Strategies

The Financial Action Task Force describes money laundering “as the processing of […] criminal proceeds to disguise their illegal origin.” 

Common between all definitions of money laundering is that they contain two key elements:

Funds or assets that were obtained through criminal or illegal activities.

Disguising the illegal origin of these funds are assets.

For the first element, it is, therefore, necessary to conduct a crime first and to make money from it. These crimes that build the basis for money laundering are called predicate offenses.

Predicate offenses vary in each country and are usually codified in a country’s criminal code.

Exemplary predicate offenses may include crimes such as narcotrafficking, tax evasion, murder, grievous bodily harm, corruption, fraud, smuggling, human trafficking, illegal wildlife trafficking, and forgery.

If one conducts such a predicate offense, makes money from it, and tries to hide the illegal origin of the funds, this makes for money laundering.

Predicate offenses in ML refer to a crime component of a larger crime. In a financial context, the predicate offense would be any crime that generates monetary proceeds. The larger crime would be money laundering or financing of terrorism. 

A predicate offense is a crime that is a component of a more serious crime. For example, producing unlawful funds is the primary offense, and money laundering is the predicate offense. In money laundering, a predicate offense that generates funds or assets is required as an entry condition. Predicate offenses vary in each country and are usually codified in a country’s criminal code. Since 2004, the FATF has updated the 40 Recommendations to expand the list of predicate offenses. Financial intelligence units in the European Union and the United States have created legislation to mirror or expand these offenses.

In the United States, these offenses were initially created by the Bank Secrecy Act of 1970 and have been expanded by the USA Patriot Act of 2001. With the passage of the 6th EU Money Laundering Directive, the European Union has now adopted a standard set of predicate offenses to mitigate loopholes in member-state AML legislation. 

In the European Union, for example, the so-called sixth European Union AML Directive defines and standardizes 22 such offenses for money laundering in all its member states. Exemplary predicate offenses include narcotrafficking, tax evasion, murder, grievous bodily harm, corruption, human trafficking, illegal wildlife trafficking, and forgery. Money laundering risks and incidents are identified through effective compliance monitoring and regular AML/CFT compliance reviews.

Money Laundering Detection

Institutions detect money laundering risks and incidents, through the implementation of different means and measures, including:

Development and implementation of risk-based AML compliance program, policies, and procedures,

Strong controls in the customer due diligence and know your customer (CDD/KYC) processes to onboard customers and stakeholders,

Defining parameters to identify the high-risk customers, and their relevant verification procedures before and after onboarding,

Planning periodic AML compliance reviews at head-office and branches level,

Setting transaction thresholds and scenarios, to monitor the daily transactions,

Regular onsite and off-site AML compliance reviews, based on a risk-based AML compliance review plan.

A strong AML compliance culture requires performing appropriate planning for the on-site and off-site investigations for transactions identified as suspicious. Usually, planning the off-site investigation requires streamlining and identifying the need and scope to gather relevant data and pieces of evidence that may be available in the system. 

The compliance investigation team plans offsite reviews based on the availability of required evidence or information. During the offsite review of transactions and system-based evidence, the compliance team may assess the need to perform the onsite investigation as well, and visit the particular location or meet with relevant employees, to gather more specific and relevant evidence. This would require the compliance team to perform an on-site investigation, where the compliance team shall discuss, observe and gather more evidence of the transaction under investigation. 

Onsite AML compliance visits would enable the compliance team to gather more relevant and specific transaction evidence, which shall be added to previously gathered system-based evidence. The onsite investigation also requires a review of files and documents, for which the compliance team shall have the necessary authority to obtain and review. Management must ensure that the compliance team is facilitated in the investigation process, and all required information is provided to the team for review.

Planning onsite and offsite investigations should consider applicable AML/CFT and KYC laws, rules, regulations, instructions, and end-to-end compliance program requirements, to determine the resources required to perform compliance investigations.

The AML compliance team for the onsite investigation may contact the customer, through the relationship officers or branch manager. The relationship officers or branch manager must contact the relevant customer, on demand of the AML compliance team, to gather more relevant data, facts, or information, about the transaction or transactions under investigation.

The ML/TF case investigation is a process that involves the review of historical financial transactions and other related information, to identify the root causes of the ML/TF event that occurred in the entity. It involves the analysis of various conditions that highlight the breaches of internal controls and any possible management bias for the actual financial crime incident.

The identification process is also a forward-looking activity to assess the possibilities of the reoccurrence of financial crime incidents. To assess the reoccurrence of ML/TF activities in the future in any particular department or function of the company, the investigators analyze the historical as well as current financial crime trends and incidents, to establish the inter-connections between them. This connection assessment helps in the prediction of possible future fraud incidents

Final Thoughts

Money laundering is a multifaceted issue, encompassing the intricate process of disguising ill-gotten proceeds and making them appear as if they originated from legitimate sources. Understanding the predicate offenses, which serve as the foundation for money laundering activities, is critical. Across the globe, the definitions and the list of these predicate offenses may vary, but their common denominator remains the same, they generate funds for illegal activities.

Both EU and US legislation have taken significant strides to mitigate these offenses and ensure better tracking of money laundering incidents. Detection strategies, involving robust AML compliance programs and efficient onsite and offsite investigations, are vital in identifying and preventing money laundering. By understanding the complex layers of money laundering, we can work towards more effective strategies to combat this global issue.

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