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A Basic Introduction to the Complex Topic of Money Laundering

Thomas Manzi

February 24, 1996

The views expressed in this paper are those of the author and

do not reflect the official policy or position of the Department

of Justice, the Department of Defense, the Drug Enforcement

Administration, or the U.S. Government

KEY TERMS AND ABBREVIATIONS

BSA [Bank Secrecy Act; official name: Currency and
Foreign Transaction Reporting Act]: Law enacted in
October 1970; implemented reporting system for
large financial transactions (over $10,000); intent of
legislation was to control the flow of criminally
obtained proceeds out of the US; reports include:
CTR, CMIR, and FBAR; codified in 31 U.S.C. 5313
et. seq.



CMIR [US Customs form 4790, Report of
International Transportation of Currency or
Monetary Instruments]: BSA report required for
physical transport of currency or bearer monetary
instrument over $10,000 into or out of the US.



CTR [IRS form 4789, Currency Transaction Report]:
BSA report required for cash transactions over
$10,000 conducted at financial institutions.



DEA: US Drug Enforcement Administration (US
Department of Justice).



FATF [Economic Summit Financial Action Task
Force]: International convention formed in 1990 to
combat financial crime; issued a 40-point set of
recommendations to combat money laundering.



FBAR [Treasury Dept. form 90-22-1, Report of
Foreign Bank and Financial Accounts]: BSA report
required for foreign bank accounts with aggregate
deposits above $10,000 held by US persons.



FinCEN: Financial Crimes Enforcement Network (US
Treasury Department).



Integration: Third and final stage in the money
laundering process -- the launderer creates a
legitimate appearing justification for the criminally
derived profits.



Layering: Second stage in the money laundering
process -- the launderer attempts to further separate
criminally derived proceeds from their illicit origin by
moving funds through a complex series of financial
transactions.



MLCA [Money Laundering Control Act]: Law
enacted in October 1986; criminalized money
laundering and structuring; codified in 18 U.S.C.
1956-57.



Overnight Float: Large deposit held by a financial
institution for a very short time; when done regularly,
bank makes large profit from interest it earns on
these deposits.



Placement: Initial stage in the money laundering
process -- the launderer places criminally derived
proceeds into the financial system or disposes of them
through currency smuggling.



RICO [Racketeer-Influenced and Corrupt
Organizations] Statute: Statute sometimes used for
prosecuting money laundering, especially before
enactment of the MLCA; codified in 18 U.S.C. 1961
et. seq.



Smurfing [Structuring]: A money laundering
placement technique in which the launderer divides
large cash deposits into smaller amounts and attempts
thereby to avoid reporting requirements.



USCS: US Customs Service (US Treasury
Department).



What does money laundering have to do with intelligence? Why
should a federal intelligence professional and/or military officer
concern himself with this "law enforcement" topic? He should
because there is a strong probability that, at some point in his
career, he will be tasked with a money laundering mission.
Although money laundering is commonly associated with narcotics
trafficking, (an increasingly significant target of U.S. intelligence),
the financial side of illegal arms trading, terrorism (some forms),
counterfeiting, and other unsavory international enterprises might
well prove to be their Clausewitzian "center-of gravity" for
intelligence to exploit. As the mission of most criminal activity is
to generate profits, virtually all criminal elements engage in
money laundering, to some extent. By targeting the money,
therefore, we effectively shut down the operations of international
crime syndicates, all the while minimizing the risk to friendly
intelligence/law enforcement personnel (by dealing more with
financial institutions, and less with the criminals themselves).

After defining the term "money laundering," we will examine the
methods used in the conduct thereof, recount the significant steps
taken to counter such activity, and expose potential improvements
in our counter-laundering efforts. NOTE: The writer will use
cocaine trafficking as the running example in this paper, but most
of the discussion can be applied to money laundering relating to
other crimes. Drug traffickers provide the best model because they
tend to be the most sophisticated money launderers in the world.

Money laundering is "the conversion of the monetary proceeds of
a criminal activity into funds with an apparently legal source."
An illicit enterprise such as cocaine distribution, for example,
generates massive quantities of capital in the form of cash,
predominately in denominations of $50 or less. This mountain of
money is extremely difficult to liquidate without attracting the
attention of law enforcement, so creative methods for cash
disposal have evolved to meet this need. The various schemes
range from the starkly simple to the mind-numbingly complex, but
all ultimately return accessible, ostensibly-legitimate capital to the
organization's leaders. (In our cocaine example, this necessitates
the transport of money from urban American streets to the coffers
of Colombian cartels, most of which will transit several countries
along the way.)

There are three basic steps in the money laundering process,
although multiple steps may be incorporated in one action, or
steps may be omitted altogether, depending on the method used.
The first step is placement, in which the launderer physically
introduces "dirty" money into the commercial financial system, or
transports it out of the U.S. to a nation with looser bank secrecy
laws. (The physical export of cash is inefficient and dangerous, as
cash is bulky [$1 million in $20's weighs about 100 lbs.], and the
U.S. Customs Service employs dogs specifically trained to sniff
out money. Also, it requires the launderer to put too many eggs
into too few baskets, escalating the damage level if one aspect of
the operation is compromised.) The second step is layering,
through which money already in the banking system is
wire-transferred between several banks in several different
countries, transactions which in their frequency, volume, or
complexity resemble legitimate transactions and obfuscate the
true origin of the funds. The third step is integration, wherein the
illicit funds are "integrated into the economy, where they cannot
be distinguished from legitimate, commercial sources of income.
At this stage, the funds are so thoroughly integrated with
legitimate monies that they are impossible to isolate and identify.

The placement step is the most dangerous for the launderer, as it
involves the actual, physical movement of illicit cash proceeds in
small bills, and is the step most closely located to the actual crime.
(In the case of drug trafficking, this cash also tends to be laden
with narcotics residue in sufficient amounts to tip-off drug-sniffing
dogs.) As such, anti-money laundering law enforcement efforts
focus on the placement stage; after this step the funds become
exponentially more difficult to trace to their origin.

CHRONOLOGY OF LEGAL ACTION AND ITS
CONSEQUENCES

Although money laundering has taken place in one form or
another for as long as currency and criminal profit have existed,
its legal countermeasures began with the Currency and Foreign
Transaction Reporting Act of 1970, more commonly known as the
Bank Secrecy Act (BSA). The BSA was originally intended to
detect tax fraud, and did not criminalize money laundering, but it
did provide law enforcement with a tool to facilitate investigations
into the financial side of criminal activity. The BSA required
banks and other financial institutions to file reports for any
currency transactions greater than $10,000. This report is the IRS
form 4789, Currency Transaction Report (CTR). The act also
required that persons transporting currency or other bearer
monetary instruments into or out of the country in amounts
greater than $10,000 file a U.S. Customs form 4790, Report of
International Transaction of Currency or Monetary Instruments,
more commonly called a CMIR. Furthermore, the BSA requires
that U.S. citizens file an IRS form 90-22-1, Foreign Bank Account
Report (FBAR), for any account in a foreign bank with a balance
of $10,000 or more, and tasks the Treasury Department to
maintain a computerized database of information collected from
the above three forms. This allows the Treasury to monitor
domestic and international money flows, and identify potential
launderers. The BSA was recodified in 1982 to include other,
non-traditional financial institutions in its reporting requirements,
such as travel and insurance agencies, money exchanges, wire
services, and vehicle dealerships, among others.

The BSA produced two notable results: Drug money launderers
began a process known as "structuring" or "smurfing," wherein a
cell head in a U.S. city employs an army of runners, or "smurfs,"
who run from bank to bank, making deposits or purchasing
monetary instruments in amounts just under $10,000 to evade
BSA reporting requirements. Often a smurf would visit 10-20
banks per day, thus breaking up narcotics proceeds into small lots
which could more easily elude the U.S. Treasury. Secondly, the
BSA's response from financial institutions was notable because of
its insignificance. Even without smurfing, most banks simply
ignored BSA rules. Some banks challenged the BSA's
constitutionality, citing the Fourth Amendment's protection from
unreasonable search and seizure, but in 1974, the U.S. Supreme
Court upheld the BSA's constitutionality during a prosecution of
the Bank of Boston, which was ultimately fined $500,000 for
violating the BSA. In the years following, BSA reporting
increased, albeit slowly and reluctantly. (Banks make a large
profit from interest they earn on temporary deposits of large sums
of money. These are called "overnight floats," and banks were
not eager to abandon this source of considerable revenue.) BSA
Compliance improved dramatically after 1984, when the BSA was
amended to impose much heavier penalties for reporting
violations. (Most offenses were escalated from misdemeanors to
felonies.) Also in 1984, the Tax Reform Act produced 26 U.S.C.
6050I, which expanded the types of businesses required to report
transactions of $10,000 or more, using IRS form 8300, Report of
Cash Payments over $10,000 Received in a Trade or Business.

In 1986, the Money Laundering Control Act (MLCA) was passed,
the most sweeping legislation to date in combating money
launderers. Most importantly, it criminalized money laundering
itself; it was no longer necessary to prove a nexus to other
criminal activity to prosecute persons laundering money. (Money
laundering had been previously prosecuted under 18 U.S.C.
1961 et seq. [RICO], if at all.) Under the MLCA, it became illegal
to structure transactions to avoid CTR/CMIR reporting
requirements, banks were forced to obtain statements from clients
who were exempted, criminal penalties were escalated, banks
were exempted from penalties under financial privacy laws when
reporting suspicious transactions, and the President could now
terminate banking relationships with banks in a foreign country
which refuses to disclose suspicious financial information. With
the new law, ". . . an institution can even be found at fault if it
carries out a transaction in which it does not know the true
illegal origin of the funds but should have suspected criminal
activity on the basis of the customer's behavior, business
associations, or the transaction itself." Banks were now
compelled to adopt the "know your customer" philosophy, which
replaced "see no evil, hear no evil," and compliance with
reporting statutes became a matter of survival for banks and
other financial institutions.

Passage of the MLCA had other, far-reaching consequences for
the way money launderers conducted business. Money laundering
became so much more difficult that drug traffickers mostly
withdrew from it, relying instead on a service industry comprised
of a loose, ad hoc network of independent financial professionals
who contract with the cartel leadership to cleanse their profits.
(What money the cartels do launder they bulk ship from the U.S.
to nations with easier financial reporting laws, such as Panama,
Venezuela, the Cayman Islands, the Turks, and Colombia. As
mentioned earlier, this is a method fraught with danger for the
launderer, but the MLCA leaves no other option for expatriating
drug profits from the US.)

The effectiveness of the MLCA is evidenced by the fact that
money laundering fees have risen dramatically since 1986. In
traditional money laundering, funds change hands several times,
with each "subcontractor" taking a cut as his fee. These fees
totaled some 6% before 1986, but now hover around 26%, so the
MLCA has essentially deprived drug kingpins of a fourth of their
profits.

Several prestigious financial institutions, such as E. F. Hutton and
Merrill Lynch, received negative publicity for violating the
MLCA, and the Justice Department secured a guilty plea from
the Bank of Credit and Commerce International (BCCI). In 1990,
BCCI was fined $15 million for money laundering, the largest fine
ever imposed on a bank in the US. American banks and large
financial firms have largely withdrawn from the money laundering
business.

In 1987, a Memorandum of Understanding (MOU) between the
Attorney General and Secretary of the Treasury was signed,
granting joint investigative authority for money laundering to four
agencies: IRS, U.S. Customs Service, DEA and FBI (and later the
Postmaster General). The executive branch then created the
Financial Crimes Enforcement Network (FinCEN) in 1990, to
consolidate intelligence information relating to money laundering,
and conduct analysis to assist law enforcement in combating it.

The steps taken between 1986 and 1990 proved so effective that
financial reporting requirements were actually loosened with the
passage of the Money Laundering Suppression Act of 1994. In
recognition that launderers have moved on to more sophisticated
methods, the act eases the reporting and record-keeping burden
on banks, saving them considerable expense in the process.

INTERNATIONAL ANTI-MONEY LAUNDERING EFFORTS

Although several international money laundering initiatives
provide reasons for optimism, such programs are still largely
devoid of teeth, relying on "moral suasion and fear of damaging
publicity" for results. Issues of sovereignty weigh large in such
efforts, and countries have divergent legal philosophies
concerning financial matters. "The first line of defense against
money laundering must be the financial institution, acting in
partnership with law enforcement and supervisory authorities,"
but some foreign cultures firmly believe in absolute financial
privacy, beyond the jurisdiction of law enforcement (especially
foreign law enforcement).

However, much of the world is coming to the realization that an
influx of illicit money inevitably results in unforeseen social and
political costs, one of which is corruption at the highest levels of
government and industry. Switzerland, for example, long known as
a haven for money launderers, adopted tighter financial reporting
laws in 1989, similar to those already enacted by most of the
European Community. In 1993, Spain, Hong Kong, Canada, and
the United Kingdom instituted comparable laws and regulations,
but the Third World is quickly developing as an alternative
conduit for dirty money. Some of the most remarkable growth in
money laundering activity is taking place in the former USSR,
where financial institutions are desperate for hard, Western
currency to build up their reserves. Such developing nations have
come to rely on such funds as a source of revenue.

Another problem facing law enforcement is that many countries
who agree to share financial information will do so only if there is
a clear, direct nexus to narcotics trafficking. As stated earlier,
modern money launderers are independent contractors who mix
proceeds from many different criminal and legitimate enterprises,
so after the placement stage, it is virtually impossible to identify
purely drug money.

The first formal international efforts to combat money laundering
date to 1988, when the UN Convention Against Illicit Traffic in
Narcotic Drugs and Psychotropic Substances took place. In the
years since, over 75 nations have ratified the convention, which
sets an important precedent to urge nations to exchange
information and enforce their individual, domestic money
laundering statutes.

A more significant international initiative is the Economic Summit
Financial Action Task Force (FATF), formed in 1990. It includes
charter members from the G-7 nations, the rest of the European
Community, additional European countries, and seven other
nations, thus far. The FATF has issued a 40-point set of
recommendations to combat money laundering, which exceed
those of the UN convention. Its provisions include regular, outside
monitoring of each member nation's adherence to the 40 points,
but like the UN convention, no viable enforcement mechanism
exists. The FATF is, however, useful as a framework around
which an effective cooperation and enforcement structure can be
erected. (This will be discussed in he next section.)

Finally, the U.S. has many standing and ad hoc bilateral
agreements with other nations. For countries with which the U.S.
maintains Mutual Legal Assistance Treaties, the process is
especially simplified. Levels of cooperation between U.S. officials
and foreign governments/financial institutions vary greatly;
sometimes the U.S. must hire local lawyers to obtain financial
information from banks, sometimes the request must flow from the
U.S. State Department through the host country's foreign
ministry, and often the foreign bank will notify the account holder
about the inquiry.

In summary, international efforts to counter money laundering are
making progress in the industrialized world, but there is still much
left to accomplish in developing countries.

SOLUTIONS

Although anti-laundering attitudes and initiatives are moving in
the right general direction, any serious attempt to shut down
international crime syndicates (especially drug cartels)
necessitates their acceleration. The writer can attest to the
uncanny adaptability and flexibility of such organizations, so
decisive action will net exponentially greater results than the
characteristically lethargic pace of steps presently being taken by
law enforcement/intelligence. Thus, the solutions offered here are
not radical in their fundamental principles; only radical in the
speed with which the writer recommends their implementation.

The most decisive, and most controversial, step toward ending
money laundering is the creation of an international bank
regulatory body, which would force the financial institutions of all
nations to monitor deposits in their individual countries. Although
this body would not routinely oversee the records themselves, it
would ensure that government and private officials are adhering
diligently to anti-laundering precautions, starting with the UN
convention's 40-point set of recommendations. Under the new
regime, cross-national reporting on money flows would be
standardized and streamlined (and not limited to transactions
relating to narcotics), so illicit funds could be tracked worldwide by
any nation through which those funds pass.

Of course, the U.S. and other industrialized states would need to
exert considerable leverage to elicit this perceived ceding of
sovereignty, and nations refusing to join would become pariahs in
the face of a unified world community prepared to use economic
pressure to force their compliance. (Violations of the regime would
be analogous to violations of the nuclear Non-Proliferation Treaty,
for example.) After the implementation of this system, member
states would become increasingly less tolerant of remaining rogue
non-members, who would find themselves "blacklisted" by the
rest of the world. Such status would be perilous for a Third World
country, given its probable reliance on First World economic
largesse. Finally, there would be huge domestic criminal penalties
for banks in member states which conduct business with banks in
non-member states.

Until the establishment of this international regime, the U.S. could
take more immediate action in the domestic realm. The most
obvious step would be to expand the currency-export detection
capabilities of the U.S. Customs Service (USCS). The USCS has
devoted relatively few resources to this mission, although
empirical evidence indicates that such an expansion would actually
return a profit to the U.S. Treasury. Additionally, new legislation
could be adopted to prevent U.S. financial institutions from dealing
with off-shore operations known to launder criminal funds, and a
comprehensive, single agency could be created to deal specifically
with the money laundering problem. (Or, an existing agency could
be expanded and given primary investigative authority in such
matters.)

Lastly and more generally, law enforcement has been slow to
respond to this problem, and has operated in a purely reactionary
mode against launderers' changing methods. Perhaps the
establishment of a single investigative agency will assemble a
body of money laundering experts who can anticipate how
launderers will respond to law enforcement initiatives, and what
their new methods will be.

The volume of money laundered is expanding, and until law
enforcement and intelligence understand that the money is the
heart of any illicit enterprise, all of our other efforts against global
crime will amount to "picking at the edges."





BIBLIOGRAPHY

Andelman, David A. "The Drug Money Maze."
Foreign Affairs, July/August 1994: 94-108.

An Assessment of Narcotic Related Money
Laundering. Financial Crimes Enforcement Network,
1992.

Bradsher, Keith. "U.S. Relaxes Bank Rules on
Reporting." The New York Times, October 16, 1994.

Cowell, Alan. "Laundering of Crime Cash Troubles
U.N." The New York Times, November 25, 1994.

Degeorge, Gail and John Templeman. "Confessions
of a Money Launderer." Business Week, May 30,
1994: 119.

Drugs, Crime and the Justice System. U.S. Bureau of
Justice Statistics, December 1992.

Fialka, John J. "Drug Dealers Export Billions of
Dollars to Evade Laws on Currency Reporting." The
Wall Street Journal, April 7, 1994: A4.

INCSR Money Laundering Annex for Mexico. U.S.
Embassy Mexico City Cable 001715, dated February
3, 1996.

"Money Laundering Fears." The New York Times,
June 12, 1995.

Money Laundering Update. Financial Crimes
Enforcement Network, 1990.

The National Narcotics Intelligence Consumers
Committee (NNICC) Report 1993. The National
Narcotics Intelligence Consumers Committee, August
1994.

Powis, Robert E. The Money Launderers. Probus
Publishing Company: Chicago, 1992.

Rempel, William C. "Taking the Cartels to the
Cleaners." Los Angeles Times, July 4, 1993: A1.

"Swiss Aim at Laundering." The Wall Street Journal,
January 13, 1994: A7.

"Swiss Proposals on Crime." The New York Times,
January 17, 1994: D3.

"Treasury Eases Rules for Banks Regarding Big
Cash Transactions." The Wall Street Journal,
October 17, 1994: A7.

 

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