Money laundering and terrorist financing in the securities
industry
By Duruthu Edirimuni
A top financial market regulator said that illegal
activities within the securities markets such as insider trading,
securities fraud, securities transactions and manipulation generate
illegal funds that should be laundered.
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| South Asian regulators at work during the
Colombo meeting |
In both these cases, the industry offers launderers
and terrorists a double advantage by allowing illegal funds to be
laundered and make profits from the investments.
“Proceeds of crime laundered through the
capital markets can be generated by illegal activities both from
outside and from within the securities industry. For illegal funds
generated outside of the industry, securities transactions are used
or concealing the source of these funds and obscuring an audit trail,”
George Fernando, CEO, Financial Intelligence Unit (FIU) of Sri Lanka,
told a gathering of top officials in the securities industry last
week at a Technical Session of the first Annual South Asian Securities
Regulators’ Forum.
He said that when viewed on a global scale, the
securities industry can be characterised by its diversity, the ease
with which trading can take place and the ability to perform transactions
in markets with little regard to national borders.
“Besides making securities markets attractive
to ordinary investors, these same characteristics also make the
industry a potentially inciting mechanism for the laundering of
funds from terrorists and other criminal sources,” Fernando,
whose unit is attached to the Central Bank, said.
“Illicit funds are often laundered through
the purchase and sale of liquid securities,” he said, adding
that the audit trail of the proceeds of crime can be blurred through
several buy and sell transactions involving numerous entities, account
and types of securities.
He said a money laundering method utilising the
securities industry involves establishing a publicly traded company
to serve as a front for a money laundering operation. “Here
a criminal organization creates a company for an apparently legitimate
commercial purpose and then commingles (mingles together) illegal
funds with funds generated by the legal commercial activity,”
he said, adding that this usually requires the use of fraudulent
accounting practices.
He said that another variation of this scheme
would be to invest in a private company first, and then ‘go
public’ with a share purchase offer on the equities market.
“The earnings from the sale of shares create the illusion
that the funds are legitimate earnings on securities investments,”
said Fernando, who has worked in internal control and derivative
markets in several banks overseas for more than 20 years.
He said that the entire arena of online brokerage
accounts is raising some major concerns for law enforcement agencies
such as stopping money launderers who trade securities through shell
companies that may actually be nothing more than a brass plate on
an office door in an offshore secrecy haven.
“These investment accounts also offer an
unprecedented level of anonymity because there is no requirement
for a “face-to-face” meeting between the beneficial
owner of the account and the entity executing the transactions,”
he added.
He said for terrorist funds that are derived from
legitimate sources, such as charities, there are very few indicators
that would make individual, or multiple, financial transactions
stand out as being linked to terrorists.
“Terrorist financing is also more difficult
to detect because the size and the nature of the transactions needed
to mount a terrorist attack do not always require large sums of
money and the associated transactions are usually not complex,”
he said, adding that it is almost like trying to “find a needle
in a haystack”.
Three stages of money laundering
The three basic stages of money laundering
are the placement, layering and integration which can also
be thought of as the ‘wash cycle’, the ‘spin
cycle’ and the ‘dry cycle’.
Placement involves the physical disposal
or deposit of cash proceeds derived from an illegal activity
within the legitimate financial system. There are several
methods of placing the proceeds of crime into the financial
system, including:
* Structured deposits, also called “smurfing”,
involves breaking up large amounts of cash into smaller, less
conspicuous sums that are subsequently deposited directly
into bank accounts, always in amounts lower than cash deposit
reporting levels;
* Bribery of bank or other financial institution
personnel to accept deposits without reporting them
* Smuggling of cash to countries lacking
anti-money laundering requirements for deposit in their financial
institutions
* Purchasing of a series of monetary instruments
that are then collected and deposited into accounts at another
location
Layering involves separating illicit proceeds
from their source by creating complex layers of financial
transactions designed to obscure an audit trail and the original
source thereby providing anonymity. This frequently involves
moving funds across borders to make tracing the source more
difficult for law enforcement. The securities industry is
more at risk at this stage as funds can easily change into
entirely different assets and launderers can engage in a series
of conversions and movements of the funds to distance them
from their source.
The origin of the funds may be concealed
by executing numerous buy and sell transactions of various
investment instruments or the launderer may simply wire the
funds through a series of accounts at various banks across
the globe. Securities transactions are very attractive, because
funds are easily converted into highly liquid assets and investment
portfolios containing both lawful and illicit proceeds that
can be quickly sold. Certified securities can also be moved
easily across borders.
Integration involves the provision of apparent
legitimacy to criminally derived wealth. If the layering process
has succeeded, integration schemes place the laundered proceeds
back into the economy in such a way that they re-enter the
financial system with the appearance of normal business funds.
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India regulator call for more investment
products
India’s top stock market regulator
called out for more products in South Asia for the investing
public, in order to enhance the depth and the liquidity of
the stock markets.
“For our markets to become truly international
markets they need to have enough depth and liquidity. More
investment products, along with more and more issues will
ensure this,” M. Damodaran, Chairman, Security and Exchange
Board of India (SEBI) told The Sunday Times FT.
In Sri Lanka for the inaugural South Asian
Securities Regulators’ Forum last week, Damodaran said
that more products would accelerate the growth of the industry.
Ajith Nivard Cabraal, Governor-Central Bank
who was the Chief Guest at the inaugural session, said that
the biggest challenge the region faces at present is how to
develop more investment products and get more companies to
enter into the stock market. “The number of firms listed
and traded is not enough and the free float is less,”
he said, adding that to emerge as a truly vibrant market both
these elements have to be increased.
He said that capital markets are no longer
national or regional, but truly global. “No one will
have too much interest in emerging markets, because they will
not be emerging always. Once ‘emerged’ it will
be a mature market,” he said.
Damodaram, stressing the importance of mutual
funds, told the meeting that for the first time investor,
mutual funds provide the benefit of research, diversification
and experienced fund management. Therefore mutual funds are
a real need especially in an emerging market, he explained.
He said safety, liquidity and more returns
are the only three elements an investor looks for in an investment.
“For an example he would want a capital protection product
or a product that will give him tax advantages. Therefore
introducing such products to the market is extremely important.”
It is very essential to encourage institutional
shareholder activity in the share market, he said, adding
that regional institutional investor activities have not shown
considerable growth during the last few years.
Highlighting the importance of listed company
disclosures and transparency, Damodaran said that there has
been a paradigm shift from the old merit based regime to a
disclosure based regime. “A primary characteristic of
a healthy market is information.
More information or disclosures will result
in less malpractice,” he said. George Fernando, CEO
of Financial Intelligence Unit (FIU) also stressed the importance
of mutual funds and said that it will give a huge boost to
the capital market. “The real estate market in the country
is a very lucrative option in this regard,” he added.
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