Deficiencies in financial oversight enable money laundering
After nearly 25 year of failed efforts, experts still ponder how to implement an anti-money laundering regime that works.
In July 1989, the leaders of the economic powers assembled at the G7 Paris summit decided to establish a Financial Action Task Force (FATF) to counter money laundering as an effective strategy against drug trafficking by criminal ‘cartels’. However, since the inception of the international anti-money laundering (AML) regime there is a growing awareness that the regime is not working as well as intended.
A case in point is the recent HSBC money laundering scandal: from 2006 to 2010, the Sinaloa cartel in Mexico and the Norte del Valle cartel in Colombia moved more than $881 million in drug proceeds through HSBC’s US and Mexican branches. Most observers suspect that this is only the tip of the iceberg. In total, the bank’s US and Mexican branches failed to effectively monitor the origin of more than $670 billion in wire transfers and more than $9.4 billion in purchases of US dollars from HSBC Mexico.
Traffickers would sometimes deposit hundreds of thousands of dollars in cash in a single day into a single account using boxes designed to fit the precise dimension of the tellers’ windows in HSBC’s Mexico branches. In December 2012, US federal and state authorities negotiated a $1.92 billion fine with the London-based HSBC to settle charges rather than seeking a criminal indictment against the bank. The fine is less than 10 per cent of HSBC’s $20.6 billion worldwide profit before taxes for 2012 and is about five weeks of income for the bank.
Too big to jail
HSBC’s US branch offered correspondent banking services to HSBC’s Mexican branch, treating it as a low risk client, despite the obvious money laundering and drug trafficking challenges in Mexico. Services included high risk clients like casas de cambio (currency exchange houses), high risk products like US dollar accounts in the Cayman Islands, a secrecy jurisdiction, with inadequate customer due diligence and weak AML controls.
The evidence in the case suggests that customers barely had to submit a real name and address, much less explain the legitimate origins of their deposits. The Mexican branch transported $7 billion in cash US dollars to the US branch from 2007 to 2008, outstripping other Mexican banks, even one twice its size, raising red flags that the volume of dollars included proceeds from illegal drug sales in the United States.
The investigation began in 2008, when various HSBC accounts in Mexico that were associated with the Black Market Peso Exchange (BMPE) were identified. Originally devised to circumvent currency controls, the BMPE developed into a system to move proceeds from the sale of illegal drugs in the US. Colombian traffickers send the cash to Mexican banks, which allow the money to be transferred to buy goods that are then sold for proceeds that are given to traffickers without the hefty transaction fees imposed on currency conversions in Colombia and the scrutiny on funds wired directly to that country. The use of the BMPE system by Colombian drug traffickers is as old as the AML regime itself and is, obviously, still alive and kicking.
Federal authorities did not to indict HSBC for fear that criminal prosecution would topple the bank and endanger the financial system. Confronted with the raw facts, US Senator Elizabeth Warren grilled officials from the Treasury Department at a Senate Banking Committee hearing. “HSBC paid a fine, but no one individual went to trial, no individual was banned from banking, and there was no hearing to consider shutting down HSBC’s activities here in the United States,” Warren said. “So, what I’d like is, you’re the experts on money laundering. I’d like an opinion: What does it take – how many billions do you have to launder for drug lords and how many economic sanctions do you have to violate – before someone will consider shutting down a financial institution like this?” She got no reply.
Not an isolated case
The HSBC scandal is not an isolated case. In March 2010, Wachovia (today part of the financial giant Wells Fargo) paid federal authorities $110m in penalties for allowing transactions connected to drug trafficking, and incurred a $50m fine for failing to monitor cash used to ship 22 tons of cocaine. Criminal proceedings were brought against Wachovia, though not against any individual, but the case never came to court. The bank was sanctioned for failing to apply the proper AML oversight to the transfer of $378.4 billion into dollar accounts from casas de cambio in Mexico – a sum equivalent to one-third of Mexico's gross national product. “Wachovia's blatant disregard for our banking laws gave international cocaine cartels a virtual carte blanche to finance their operations,” according to the federal prosecutor in the case. The total fine for Wachovia was even less than HSBC’s: 2% of the bank's $12.3 billion profit for 2009.
Like with the HSBC case, no one from Wachovia went to jail, but Martin Woods, an anti-money laundering compliance officer in the London office of the bank and the whistleblower in the case, was disciplined for alerting his superiors. “These are the proceeds of murder and misery in Mexico, and of drugs sold around the world,” Woods said at the time of the settlement between the bank and the prosecution. “What does the settlement do to fight the cartels? Nothing. It encourages the cartels and anyone who wants to make money by laundering their blood dollars.” Eventually Woods did win a settlement for himself after bringing a claim for unfair dismissal.
“Overall, there's great reluctance to go after the big money,” says Daniel Mejía, an economist at the University of the Andes in Bogotá. He is part of the initiative by the Colombian government to evaluate global drugs policy. One of the recommendations would be to focus on money laundering by the big banks in America and Europe. “They don't target those parts of the chain where there's a large value added. In Europe and America the money is dispersed – once it reaches the consuming country it goes into the system, in every city and state. They'd rather go after the petty economy, the small people and coca crops in Colombia, even though the economy is tiny.” According to Mejía, “Prohibition is a transfer of the cost of the drug problem from the consuming to the producing countries.”
“In Colombia they ask questions of banks they'd never ask in the US,” Mejia’s colleague Alejandro Gaviria says. “If they did, it would be against the laws of banking privacy. In the US you have very strong laws on bank secrecy, in Colombia not – though the proportion of laundered money is the other way round. It's kind of hypocrisy, right?” If countries like Colombia benefitted economically from the drug trade, there would be a certain sense in it all, according to Gaviria. “Instead, we have paid the highest price for someone else's profits – Colombia until recently, and now Mexico. I put it to Americans like this – suppose all cocaine consumption in the US disappeared and went to Canada. Would Americans be happy to see the homicide rates in Seattle skyrocket in order to prevent the cocaine and the money going to Canada? That way they start to understand for a moment the cost to Colombia and Mexico.”
Failing to apply AML oversight measures is profitable
When one of the HSBC’s compliance officers raised concerns that she didn't have enough staff to monitor suspicious financial transactions at a board meeting in 2007, she was fired. Eventually, to reduce the enormous backlog of suspicious financial transactions alerts, HSBC employed “hundreds of loud, gum-chewing, mostly uneducated, occasionally rowdy call-centre workers on a new gig, turning them into money-laundering investigators,” according to Rolling Stone magazine. Without really training anyone at all, they were used to whitewash suspicious transactions to comply with the requirements of the Office of the Comptroller of the Currency (OCC). The bank was obviously more concerned with clearing its name than with clearing money launderers from its clientele.
Failing to apply AML oversight measures is profitable and bank officials responsible for the stunning failures don’t have to face criminal charges. The sloppy implementation of controls in the current AML regime is barely monitored and, consequently, the regime does not seem to deter banks from engaging in criminal practices. While offshore financial centres (OFCs) outside the main financial centres London and New York are often identified as facilitating unregulated and illicit money flows, the principal sources of tax evasion, tax secrecy, money laundering, and regulatory arbitrage are located in onshore banking systems in the developed world, according to the Stiglitz Commission, formed in 2008 to advise the United Nations on the consequences of the financial meltdown and its impact on development.
Delaware and Nevada, for instance, are two US states that require no beneficial ownership information from companies and make the establishment of anonymous accounts far easier than almost all off-shore financial centres. Not only do these deficiencies in financial oversight assist money laundering, they also facilitate tax evasion, depriving states from badly needed revenue to finance essential institutions and services to their populations. The United States effectively serves the role of Switzerland for Mexico, which suffers from rampant tax evasion. Much of the estimated US$ 42 billion a year of illicit funds flowing out of Mexico each year ends up in US banks. This sum does not include drug cartel money, although the system in place is believed to facilitate those funds as well. These loopholes in the financial system deprived Mexico from some US$ 7-12 billion in tax revenue each year (tax rates in Mexico vary between 17.5 and 30% - the latter being the highest rate for income and company tax). In this context, the US$ 1.9 billion of US aid to fight the drug-related violence in Mexico (the Merida Initiative) is small change.
Looking for an AML regime that works
These deficiencies were recognised in the report The Buck Stops Here: Improving US Anti-Money Laundering Practices, issued by US Senators Charles Grassley and Dianne Feinstein, co-chairs of the Senate Caucus on International Narcotics Control. Among other things, the report denounced the anonymity in US company formation, calling the possibility to hide beneficial ownership in US-based shell corporations “a perfect mechanism for international money laundering.”
The senators urged the US Congress to swiftly pass a bill called the Incorporation Transparency and Law Enforcement Assistance Act that had been introduced in August 2011, but has died in legislative committees. The bill would make it much more difficult for criminal organizations and tax evaders to hide behind shell corporations by requiring the disclosure of beneficial ownership information during the company formation process. This information would then be available to law enforcement upon receipt of a subpoena or summons. Similar requirements are being introduced in Europe in the 4th Directive against Money Laundering.
These initiatives are welcome, but also highlight the fact that after nearly 25 year of failed efforts, experts still ponder how to implement an AML regime that works. To do so, the Stiglitz Commission proposes “a new Global Financial Authority to co-ordinate financial regulation in general and to establish and/or coordinate global rules in certain areas, such as regarding money laundering and tax secrecy.” Financial regulation regimes need to advance from ensuring ‘soft law’ approach compliance toward ensuring implementation and testing effectiveness. Eliminating the veil of secrecy and increasing transparency is crucial to any progress. The elimination of secrecy jurisdictions, offshore and onshore, is equally a top priority.
A recent inquiry shows that the banking sector on Cyprus is also not combating money laundering. The banks know little about their customers and are ill-equipped to identify suspicious transactions. Financial advisory firm Deloitte analyzed the data from a total of 390 top depositors, with more than €2 billion in six Cypriot banks. They found that the Cypriot banks "were not consistently in a position to understand the purpose of the account, define the customer's business economic profile and evaluate the expected pattern and level of transactions."
See also: Counter-terrorism, ‘policy laundering’ and the FATF - Legalising Surveillance, Regulating Civil Society, by Ben Hayes, TNI, March 2012