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Money Laundering

The illegal process of converting money earned from illegal activities into "clean" money

What is Money Laundering?

Money laundering is a process that criminals use in an attempt to hide the illegal source of their income. By passing money through complex transfers and transactions, or through a series of businesses, the money is “cleaned” of its illegitimate origin and made to appear as legitimate business profits.

 

Money Laundering

 

Summary

  • Money laundering is the illegal process of converting money earned from illegal activities into “clean” money – that is, money that can be freely used in legitimate business operations and does not have to be concealed from the authorities.
  • Money laundering operations deal with trillions of dollars worldwide each year; therefore, money laundering activities exert a substantial impact on major national economies.
  • Some banks have been complicit in aiding money laundering operations.

 

The Need to Launder Money

A major business problem of large, organized criminal enterprises – such as drug smuggling operations – is that they end up with huge amounts of cash that they need to conceal in order to avoid attracting investigations by legal authorities. The recipients of such large amounts of cash also do not want to have to acknowledge it as income, thereby incurring massive income tax liabilities.

To deal with the problem of having millions of dollars in cash obtained from illegal activities, criminal enterprises create ways of “laundering” the money to obscure the illegal nature of how it is obtained. In short, money laundering aims to disguise money made illegally by working it into a legitimate financial system, such as a bank or business.

 

How Money Laundering Works

Money laundering typically occurs in three phases:

  1. Initial entry or placement is the initial movement of an amount of money earned from criminal activity into some legitimate financial network or institution.
  2. Layering is the continuing transfer of the money through multiple transactions, forms, investments, or enterprises, to make it virtually impossible to trace the money back to its illegal origin.
  3. Final integration is when the money is freely used legally without the necessity to conceal it any further.

 

Money Laundering – Example

One of the most commonly used and simpler methods of “washing” money is by funneling it through a restaurant or other business where there are a lot of cash transactions. In fact, the origin of the term “money laundering” comes from infamous gangster Al Capone’s practice of using a chain of laundromats he owned to launder huge amounts of cash.

The money laundering process usually goes something like the following:

1. Initial placement

A criminal or criminal organization owns a legitimate restaurant business. Money obtained from illegal activities is gradually deposited into a bank through the restaurant. The restaurant reports daily cash sales much higher than what it actually takes in.

Say, for example, that the restaurant takes in $2,000 in cash in one day. An additional $2,000 – which is money coming from illegal activities – will be added to that amount, and the restaurant will falsely report that it took in $4,000 in cash sales for the day. The money has now been deposited in the restaurant’s legitimate bank account and appears as an ordinary deposit of restaurant business proceeds.

2. Layering the money

To deal with tax issues – that is, to avoid having the restaurant incur too large a tax bill as a result of recording more revenue than it generates – and to further disguise the criminal source of the extra deposited funds, the restaurant may invest the money in another legitimate business, such as real estate. Things are further obscured from the authorities by using shell companies or holding companies that control several business enterprises that the laundered money may be funneled through.

The “layering” often involves passing the money through multiple transactions, accounts, and companies – it may pass through a casino to be disguised as gambling winnings, go through one or more foreign currency exchanges, be invested in the financial markets, and ultimately be transferred to accounts in offshore tax havens where banking transactions are subject to much less scrutiny and regulation. The multiple pass-throughs from one account, or one enterprise, to another make it increasingly difficult for the money to be traced and tied back to its original illegal source.

3. Final integration

In the final phase of money laundering – integration – the money is placed into legitimate business or personal investments. It may be used to purchase high-end luxury goods, such as jewelry or automobiles. It may even be used to create yet another business entity through which future amounts of illegal cash will be laundered.

At this stage, the money has, ideally, been sufficiently laundered so that the criminal or criminal enterprise can use it freely without resorting to any criminal tactics. The money is typically then either legitimately invested or exchanged for expensive assets such as property.

 

The Involvement of Banks in Money Laundering

Major financial institutions, such as banks, are frequently used for money laundering. All that is necessary is for the bank to be a little lax in its reporting procedures. The lack of regulation enforcement enables criminals to deposit large sums of cash without triggering the deposits being reported to central bank authorities or government regulatory agencies.

In the recent past, prestigious financial institutions, such as Danske Bank and HSBC, have been found guilty of assisting or enabling money laundering by failing to properly report large deposits of cash. HSBC was found to have facilitated the laundering of almost $1 billion in 2012, and Danske Bank branches were accused of having taken in a whopping $200 billion in Russian mob money from 2007 to 2015.

 

Money Laundering - "Washing" Money through Investments

 

“Washing” Money through Investments

The financial markets offer criminals a variety of avenues for converting “dirty” money to “clean” money. One of the most basic and widely used schemes is to utilize a foreign investor to get illegally-obtained cash into the legitimate financial system.

For example, assume that a criminal organization has a million dollars in cash that it needs to launder. An investor in a foreign country is contacted, and the criminal organization makes a deal with them. Using an investor from another country is just another way to help obscure the origin of the money.

The criminals give their million dollars in cash to the investor. After taking a portion of the money as his fee for services, the foreign investor invests the rest of the money into a legitimate domestic business owned by the criminal organization, which is often a shell company.

Shell companies are businesses that have large amounts of financing but are not directly involved in any specific business enterprise selling goods or services. The finances are used to invest in other businesses – typically, other legitimate businesses owned by the criminal organization.

The influx of cash from the foreign investor appears as an ordinary foreign investment, as the criminals are careful to avoid exposure to the fact that they have any connection with the foreign investor. Once the money has been deposited with the shell company, the criminals can access it by having the shell company invest in another business the criminals own, perhaps by making a loan of the money to the other company.

That company can then – after passing the cash back to the criminals – default on the loan, creating a loss for the shell company that can be used to reduce taxes owed. Having defaulted on its loan, the receiving company may declare bankruptcy and go out of business. The loan default may also cause the shell company to fold up.

The criminals now have their cash, received from an apparently “clean” source – the foreign investor – and the two companies used to wash the cash through now no longer exist. All of that makes it very difficult for investigating authorities to have any hope of tracing the money back to its original source – the illegal activities of the criminal organization.

 

Authorities that Investigate Money Laundering

Many different legal authorities regularly investigate suspected money laundering activities. In the United States, the FBI and the IRS are the two primary agencies that handle money laundering investigations.

Money laundering’s become such a huge problem that international agencies are specifically created to combat it. The International Money-Laundering Information Network (IMoLIN) is a United Nations-sponsored research center that was created to assist law enforcement agencies throughout the world in the identification and pursuit of money laundering operations.

The Financial Action Task Force on Money Laundering (FATF) was created as a G-7 initiative to develop more effective financial standards and anti-laundering legislation. Because money laundering is a key part of terrorist organizations that are usually funded through illegal enterprises, the FATF was also charged with directly fighting to cut off illegal cash flows to terrorists and terrorist groups.

Both the IMoLIN and the FATF work in concert with Interpol, as well as with domestic police agencies in the G-7 nations – the US, Canada, the UK, France, Germany, Italy, and Japan.

 

More Resources

CFI is the official provider of the global Certified Banking & Credit Analyst (CBCA)™ certification program, designed to help anyone become a world-class financial analyst. To keep advancing your career, the additional resources below will be useful:

  • Cash Larceny
  • Embezzlement
  • Forensic Accounting
  • Top Accounting Scandals

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