SUBJECT:

Regulations of Securities Market

GROUP MEMBERS:

Topic

MONEY LAUNDERING: AN INSIGHT INTO THE MODUS OPERANDI WITH CASE STUDIES

Index

ABSTRACT

INTRODUCTION

HISTORICAL EVOLUTION

METHODOLOGICAL PHASES

MONEY-LAUNDERING ACTIVITIES

INFORMAL FUND TRANSFER SYSTEMS

VS. INFORMAL VALUE TRANSFER MECHANISMS

EFFECTS

PREVENTION

MONEY LAUNDERING THROUGH BANKS - A CASE STUDY

CONCLUSION

MONEY LAUNDERING: AN INSIGHT INTO THE MODUS OPERANDI WITH CASE STUDIES

ABSTRACT

This article examines definitions of "money laundering" and the conceptual and actual role

its regulation plays in dealing with various sectors of the economy, as well as the procedural

aspects of the same. It gives an insight into the history of this process. Then it goes on to

discuss the three steps involved into money laundering. If laundering is prevented, incentives

to become major criminals are diminished. It identifies and critiques three aspects of harm

arising from laundering: facilitating crime groups' expansion, corroding financial

institutions, and extent. It gives some infamous instances when this menace was unearthed.

Then it deals with the various legislations in force to curb this process. It concludes that

much detected laundering involves the same out-of-place judgments the police use, but

though the proportion of routine and suspicious activity reports that yield arrests may be low,

they do generate some important enforcement actions. Nevertheless, the impact of anti

laundering efforts on enforcement resources, organized crime markets, or drug consumption

levels remains modestly understood at present. The authors have tried to give an insight into

money laundering with solution to curb this menace.

INTRODUCTION

Money Laundering refers to the conversion or "Laundering" of money which is illegally

obtained, so as to make it appear to originate from a legitimate source. Money Laundering is

being employed by launderers worldwide to conceal criminal activity associated with it such

as drug / arms trafficking, terrorism and extortion. But in simple terms it is the Conversion of

Black money into white money.

Money laundering is the criminal practice of filtering ill-gotten gains or “dirty” money

through a series of transactions, so that the funds are “cleaned” to look like proceeds from

legal activities. Money laundering is driven by criminal activities and conceals the true

source, ownership, or use of funds. The International Monetary Fund has stated that the

aggregate size of money laundering in the world could be somewhere between 2 and 5

percent of the world’s gross domestic product.

Money Laundering has a close nexus with organised crime. Money Launderers amass

enormous profits through drug trafficking, international frauds, arms dealing etc. Cash

transactions are predominantly used for Money Laundering as they facilitate the concealment

of the true ownership and origin of money. Criminal activities such as drug trafficking

acquire an air of anonymity through cash transactions.

The most common types of criminals who need to launder money are drug traffickers,

embezzlers, corrupt politicians and public officials, mobsters, terrorists and con artists. Drug

traffickers are in serious need of good laundering systems because they deal almost

exclusively in cash, which causes all sorts of logistics problems. One important aspect of

money laundering is the tendency and need for perpetrators to operate cross border schemes

for the purpose of concealment and/or to take advantage of the uneven developments in the

national anti money laundering regimes.

Banks and financial institutions are vulnerable from the Money Laundering point of view

since criminal proceeds can enter banks in the form of large cash deposits. Bank officials

therefore need to exercise constant vigilance in opening of accounts with large cash deposits

and in checking suspicious transactions.

HISTORICAL EVOLUTION

Efforts to launder money and finance terrorism have been evolving rapidly in recent years in

response to heightened countermeasures. The international community has witnessed the use

of increasingly sophisticated methods to move illicit funds through financial systems across

the globe and has acknowledged the need for improved multilateral cooperation to fight these

criminal activities.

‘Money laundering’ as an expression is one of fairly recent origin. The original sighting was

in newspapers reporting the Watergate scandal in the United States in 1973. The expression

first appeared in a judicial or legal context in 1982 in America.

Money laundering as a crime only attracted interest in the 1980s, essentially within a drug

trafficking context. It was from an increasing awareness of the huge profits generated from

this criminal activity and a concern at the massive drug abuse problem in western society

which created the impetus for governments to act against the drug dealers by creating

legislation that would deprive them of their illicit gains. The term "money laundering" is said

to originate from Mafia ownership of Laundromats in the United States. Gangsters there were

earning huge sums in cash from extortion, prostitution, gambling and bootleg liquor. They

needed to show a legitimate source for these monies1.

As a 1993 UN Report noted: The basic characteristics of the laundering of the proceeds of

crime, which to a large extent also mark the operations of organised and transnational crime,

are its global nature, the flexibility and adaptability of its operations, the use of the latest

technological means and professional assistance, the ingenuity of its operators and the vast

resources at their disposal.

In India money laundering is popularly known as Hawala transactions. It gained popularity

during early 90’s when many of the politicians were caught in its net. Hawala is an

alternative or parallel remittance system. The Hawala Mechanism facilitated the conversion

of money from black into white. "Hawala" is an Arabic word meaning the transfer of money

or information between two persons using a third person. The system dates to the Arabic

traders as a means of avoiding robbery. It predates western banking by several centuries.

METHODOLOGICAL PHASES:

The basic money laundering process has three steps:

1. Placement - At this stage, the launderer inserts the dirty money into a legitimate

financial institution. This is often in the form of cash bank deposits. This is the

riskiest stage of the laundering process because large amounts of cash are pretty

conspicuous, and banks are required to report high-value transactions.

2. Layering - 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 deposits and withdrawals to continually

vary the amount of money in the accounts, changing the money's currency, and

purchasing high-value items (boats, houses, cars, diamonds etc.) to change the form of

the money. This is the most complex step in any laundering scheme, and it's all about

making the original dirty money as hard to trace as possible.

3. Integration - At the integration stage, the money re-enters the mainstream economy in

legitimate-looking form -- it appears to come from a legal transaction. This may

involve a final bank transfer into the account of a local business in which the

launderer is "investing" in exchange for a cut of the profits. At this point, the criminal

can use the money without getting caught. It's very difficult to catch a launderer

during the integration stage if there is no documentation during the previous stages.

Following are the various measures adopted all over the world for money laundering, even

though it is not exhaustive but it encompasses some of the most widely used methods.

• Structuring deposits

This method is also known as smurfing. In this method large amount of money is

broken into smaller, less-suspicious amount.

• Overseas banks underground/ alternative banking

Money launderers often send money through various "offshore accounts" in countries

that have bank secrecy laws, meaning that for all intents and purposes, these countries

allow anonymous banking. A complex scheme can involve hundreds of bank transfers

to and from offshore banks.

• Shell companiesThese are fake companies that exist for no other reason than to launder money. They

take in dirty money as "payment" for supposed goods or services but actually provide

no goods or services; they simply create the appearance of legitimate transactions

through fake invoices and balance sheets.

• Investing in legitimate business

Launderers sometimes place dirty money in otherwise legitimate businesses to clean

it. They may use large business like brokerage firms or casinos that deal in so much

money it's easy for the dirty stuff to blend in, or they may use small, cash-intensive

businesses like bars, car washes, strip clubs or check-cashing stores.

It gives an overview as to how this menace has developed into transnational business

involving various sophisticated techniques and procedures. The ill-effects of money laundering are

unimaginable and have been discussed in next section.

Money-laundering activities:

Both the formal banking sector and the IFT systems are vulnerable to abuse. The number and variety

of methods used to launder the proceeds of criminal and illegal activities and finance terrorist acts

continue to become more complex with time. The methods are diverse and can employ both banking

and non-banking channels including exchange bureaus, check cashing services, insurers, brokers, and

non-financial traders. The methods through which IFTs and the formal banking sector can contribute

to the placing and layering of funds in the money-laundering process are similar, although, as

discussed below, the informal transfer systems have peculiarities, which make them particularly

vulnerable.

First, neither system necessarily involves the physical transfer of funds from one jurisdiction

to another. Instead, they depend on a series of accounting debits and credits between the

accounts of a network of individuals, companies, accountants, lawyers, and intermediaries.

The major potential relevance of an IFT system to money laundering lies in its use for moving

the proceeds away from the place where the crime was committed to destinations where the

transaction can either appear legitimate or from where it can later be brought back to the

country through a variety of legitimate routes for the integration process.

Second, in the same way that banking secrecy laws may facilitate money laundering, the

potential anonymity of an IFT system can render it susceptible to the processing of criminal

proceeds to disguise their association with criminal activities such as drug trafficking,

prostitution, corruption, and tax evasion.

Informal Fund Transfer Systems vs. Informal Value Transfer Mechanisms

IVTS can be divided into two sub-categories: Informal Fund Transfer Systems (IFTS) and Informal

Value Transfer Mechanisms (IFTM). While IVTS includes two types of ‘value’ (funds and value),

IFTS and IVTM refer to the actual processes of carrying out a transfer.10 IFTS and IVTM should not

be viewed as static divisions; an IVTS operator may use both IFTS and IVTM. The term IFTS was

first used in a joint World Bank-International Monetary Fund (IMF) paper, which defined IFTS as

financial systems existing ‘in the absence of, or parallel to, conventional banking channels’. IFTS

centre on fund transfer, and include ethnic IFTS (hawala, Phoe kuan, etc.), black markets for

currency exchange and the physical transfer of currency or value ‘if cash is used to purchase easily

moveable commodities that can later be sold.IFTS are primarily used by workers abroad to send

earnings back home, and as such, the source of these funds is usually licit. To a lesser degree, IFTS

are also used for payment of imported goods, or to pay for services abroad, such as education or

medical care. Within this flow of mostly licit funds exist illicit proceeds of crime, as well as funds

destined for the use of terrorists. It is largely because of these criminal and terrorist fund transfers

through IFTS that international attention and efforts at regulation have arisen.

IVTM by contrast, refer to methods used by individuals, networks and organisations to transfer ‘both

money and value informally, and for the most part illegally, either through formal financial system

infrastructure without detection, or by other methods and technologies that have come about in the

post-Cold war globalised world

EFFECTS

Ill-effects of money laundering are seen all over the world on almost all the sectors of life.

More noticeable are economic effects which are on a broader scale. Developing countries

often bear the brunt of modern money laundering because the governments are still in the

process of establishing regulations for their newly privatized financial sectors. This makes

them a prime target. In the 1990s, numerous banks in the developing Baltic states ended up

with huge, widely rumoured deposits of dirty money. Bank patrons proceeded to withdraw

their own clean money for fear of losing it if the banks came under investigation and lost

their insurance. The banks collapsed as a result.

Other major issues facing the world's economies include errors in economic policy resulting

from artificially inflated financial sectors. Massive influxes of dirty cash into particular areas

of the economy that are desirable to money launderers create false demand, and officials act

on this new demand by adjusting economic policy. When the laundering process reaches a

certain point or if law enforcement officials start to show interest, all of that money will

suddenly disappear without any predictable economic cause resulting in that financial sector

to fall apart. Laundered money is usually untaxed, meaning the rest of us ultimately have to

make up the loss in tax revenue.

The negative economic effects of money laundering on economic development are difficult to

quantify. It is clear that such activity damages the financial-sector institutions that are critical

to economic growth, reduces productivity in the economy’s real sector by diverting resources

and encouraging crime and corruption, which slow economic growth, and can distort the

economy’s external sector – international trade and capital flows – to the detriment of longterm

economic development. Money laundering also facilitates crime and corruption within

developing economies, which is the antithesis of sustainable economic growth. Money

laundering reduces the cost of doing business for the criminal element, thereby increasing the

level of crime.

Money laundering can also be associated with significant distortions to a country’s imports

and exports. On the import side, criminal elements often use illicit proceeds to purchase

imported luxury goods, either with laundered funds or as part of the process of laundering

such funds. Such imports do not generate domestic economic activity or employment, and in

some cases can artificially depress domestic prices, thus reducing the profitability of

domestic enterprises.

PREVENTION

The combating of money laundering presupposes the existence of capacity and resources at

national level. In India Prevention of Money-Laundering Act, 2002 has been passed which

came into effect since 1st of July, 2005. As per Section 3 of the Act, Offence of money laundering

covers those persons or entities who 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, such person or

entity shall be guilty of offence of money-laundering.

Section 4 of the Act prescribes punishment for money-laundering with rigorous

imprisonment

for a term which shall not be less than three years but which may extend to seven years and

shall also be liable to fine which may extend to five lakh rupees and for the offences

mentioned in paragraph 2 of Part A of the Schedule, the punishment shall be upto ten years.

Section 12 (1) prescribes the obligation on Banking companies, financial institutions and

intermediaries (a) to maintain certain records detailing the nature and value of the transaction

which may be prescribed, whether such transactions comprise of a single transaction or a

series of transactions integrally connected to each other, and where such series of transactions

take place within a month; 12 (b) to furnish information of transactions referred to in clause

(a) to the Director within such time as may be prescribed and to (c) verify and maintain the

records of the identity of all its clients, As per Section 12 (2), the records referred to in sub-

Section (1) as mentioned above, is required to be maintained for a period of ten years from

7 Objectives and Principles of Securities Regulation

The date of cessation of the transactions between the clients and the banking company or

financial institution or intermediary, as the case may be.

An effective anti-money laundering program will help minimize exposure to transaction,

compliance, and reputation risks. Such a program should include account opening controls

and the monitoring and reporting of suspicious activity. The Reserve Bank of India's

extensive Anti-Money Laundering (AML) guidelines has become effective from March 2006.

The AML norms such as "Know Your Customer" emphasize that banks must keep a record

of their customers' backgrounds in order to reduce and control the risk of money laundering.

Money laundering through banks - A Case Study

By B V Kumar, Former Member, CBEC

HUMAN ingenuity, creative imagination and expertise have produced infinite varieties of laundering

schemes. They are as varied as, the modus operandi adopted in smuggling contraband.

Banks and Financial Institutions which have access to international money transfers are a vital link

and facilitate international trade in goods and services. They are used by the governments, multi-

national corporations, tourists and ordinary citizens. Banks and financial institutions, being generally

open to public transactions, are also accessible to organized crime, drug traffickers, terrorists and

white collar criminals.

Normally, the banking sector does not attract attention of the law enforcement agencies for unlawful

activities, unless there is specific intelligence about the persons utilizing the banking system either

for criminal activity, fraud, for transfer of funds generated in crime or the involvement of the banking

personnel in such activities.

In 1995, one of the biggest money laundering operations using the banking system was detected by

the Directorate of Revenue Intelligence (DRI). Subsequently, follow up investigations conducted by

the Foreign Exchange Enforcement Directorate (ED) revealed extensive involvement of a number of

banks and individuals abusing the facilities available through the banking system.

Intelligence received by the DRI indicated that the South Indian Bank Ltd., Nariman Point Branch,

Bombay was involved in a massive money laundering operation. Enquiries conducted revealed that a

number of fictitious accounts were opened in the bank for depositing large amounts of currency

which in turn were being remitted to Hong Kong, against fraudulent documents, ostensibly, covering

legitimate imports.

One of the accounts was in the name of M/s Chinubhai Patel & Co. said to be existing at 27, Vaishali

Shopping Center, JVPD, Bombay - 49, with the South Indian Bank Ltd., Nariman Point Branch,

Bombay. Enquiries conducted revealed that the account was opened in February 1994 and the party

was introduced by the Bank Manager Mr. Kasturi Rangan. The Bank Manager did not follow the

instructions of the Reserve Bank of India (RBI), and the account was opened without obtaining the

photograph of the account holder.

Verification of the address revealed that the firm M/s Chinubhai Patel & Co., did not exist at that

address.

This account was utilized for depositing cash of Rs. 387,379,000/- and from his account remittance

equal to US $ 12,048,650/- was remitted to Hong Kong in favour of M/s R.P. Imports and Exports,

Hong Kong. The remittances were made on the basis of fraudulent documents. Further investigations

conducted by the DRI in India and abroad, revealed that four more firms have been operating their

accounts in a similar manner in the South Indian Bank Ltd., and these firms were identified as M/s

Rakesh International, M/s R.M. International, M/s P.M. International and M/s Deepee International.

These firms were also found to be fictitious and not existing at the given address. They were

operating the account with the said bank from June 1992, onwards. Through this account an amount

equivalent to US $ 80 million, approximately equivalent to Rs 2500 million, was transferred from

India to Hong Kong. The identity of the Hong Kong firm is under investigation.

Investigations conducted so far by the Directorate of Revenue Intelligence have revealed that certain

persons, including Rajesh Mehta and Prakash, had opened bank accounts solely for the purpose of

depositing cash and then transferring the said funds in foreign exchange to countries like Hong Kong,

Singapore and Dubai, in a fraudulent manner through the South Indian Bank Ltd., Nariman Point

Branch, Bombay and for this purpose they were using fictitious addresses and fraudulent documents.

The loss of foreign exchange to the country on this account was to the tune of Rs 2500 million.

Prima facie, the transactions which were put through the South Indian Bank Ltd., Bombay,

constituted offenses under the Foreign Exchange Regulation Act, 1973. The matter was, therefore,

referred to the Foreign Exchange Enforcement Directorate, Bombay. Intelligence gathered by the

Enforcement Directorate (ED), Bombay indicated that these activities were not limited to the South

Indian Bank, but similar remittances were effected through other banks notably the United

Commercial Bank, D.N. Road, Bombay.

In February 1996, Officers of the Enforcement Directorate conducted searches at a number of places

and interrogated a large number of persons, including bank officials, who were arrested under the

provisions of the Foreign Exchange Regulation Act, 1973.

Investigations conducted so far revealed that remittances totaling US $ 160.94 million (equivalent to

Rs. 5467.8 million), were effected through 12 different banks in Bombay, during the period 1991-

1995.

Broadly, the following modus operandi was followed :

Persons involved in this racket, with the help of middlemen, recruited front persons for opening a

number of accounts in the names of fictitious and non-existing firms. Large amounts of cash were

deposited in these accounts and immediately after deposits were made, documents purportedly

relating to goods imported into India by these firms were submitted to the banks concerned. On the

basis of such documents the banks were effecting remittances favouring the "overseas suppliers" of

goods. This modus operandi was used for flight of capital using official banking channels.

Investigations conducted so far revealed that the main persons involved in this racket are Dinesh C.

Bhuva and Hemant Barot, who have been absconding ever since it came to light that they are the real

brains behind the racket. However, a major breakthrough was achieved by the Enforcement

Directorate when they succeeded in apprehending a member of this cartel - Harshad P. Mehta (not

the Big Bull), whose interrogation provided numerous clues and vital information relating to this

case.

The money laundering syndicate headed by Dinesh C. Bhuva and Hemant Barot adopted the

following techniques :

Middlemen were employed to recruit persons :

• Of small means for opening bank accounts in the names of fictitious firms, for depositing cash and

pay orders. These deposits were utilized for making remittances, against (fraudulent) documents

covering imports.

• For depositing cash or pay orders obtained from other banks.

• For maintaining proper liaison with bank officials, to ensure that the transactions were conducted

smoothly.

• Specialised in preparing forged documents, viz., Bills of Entry, Packing lists, Invoices, Customs

duty paying documents and other related documents like Bills of lading, Insurance, etc. to cover

fictitious imports.

• For contacting financiers who could lend money to the racketeers.

• For opening bank accounts in places like Hong Kong for receiving foreign exchange remittances

from India. All the bank papers, including signed cheque books, were taken over in advance from

those persons for withdrawal of foreign exchange remitted from the Indian banks to these accounts.

• To sell foreign exchange so obtained in Hong Kong to gold smugglers, exporters (who need foreign

exchange for meeting their requirements of over-invoiced exports), importers (who need foreign

exchange to meet their requirements of under-invoiced imports), and others who need foreign

currency for various purposes.

One of the precautions that was taken in all these transactions was to conceal the identity of the top

hierarchy of the cartel and for this purpose, only middlemen were used for all transactions and for

locating people who would open bank accounts in India and abroad, for depositing cash and pay

orders, for obtaining fictitious documents to show that imports have been effected into India and for

maintaining liaison with the bank officials.

Nearly 33 persons have been arrested during the period February '96 to June' 96.

Conclusion :

This case study clearly indicates as to how a criminal syndicate can set up within a short span a well

organized apparatus for money laundering without revealing the identity of the top racketeers. It also

indicates as to how the banking system is vulnerable to such operations and how the banking staff

can be subverted. It is therefore necessary to emphasize the importance of implementing the

recommendations of the Financial Action Task Force (FATF), immediately and in particular to take

up reasonable measures to obtain information about the true identity of the persons on whose behalf

an account is being opened or transactions are being conducted. The financial institution should keep

records on customer identification.

It is also necessary to observe due diligence and pay special attention to all complex and unusually

large transactions which have no apparent economic or visible or lawful purpose. Suspicious

transactions must be reported to the Competent Authorities to investigate whether the financial

institutions are being used as conduits for money laundering operations.