Nonbank Financial Institutions

Nonbank Financial Institutions Credit Card Industry The credit card industry includes: • Credit card associations, such as American Express, MasterCard, and Visa, which license member banks to issue bank cards, authorize merchants to accept those cards, or both • Issuing banks, which solicit potential customers and issue the credit cards • Acquiring banks, which process transactions for merchants who accept credit cards • Third-party payment processors (TPPP), which contract with issuing and acquiring banks to provide payment-processing services to merchants and other business entities, typically initiating transactions on behalf of merchant clients that do not have a direct relationship with the TPPP’s financial institution Credit card accounts are not typically used in the initial placement stage of money laundering, because the industry generally restricts cash payments. They are more likely to be used in the layering and integration stages. Examples • Money launderer Josh prepays his credit card using illicit funds that he has already introduced into the banking system, creating a credit balance on his account. Josh then requests a credit refund, which enables him to further obscure the origin of the funds. This constitutes layering. Josh then uses the illicit money he placed in his bank account and the credit card refund to pay for a new kitchen. Through these steps, he has integrated his illicit funds into the financial system. • A money launderer places his illegal funds in accounts at offshore banks and then accesses the funds using credit and debit cards associated with the offshore account. Alternatively, he smuggles the cash out of one country into an offshore jurisdiction with lax regulatory oversight, places the cash in offshore banks, and accesses the illicit funds using credit or debit cards. • In a report entitled Extent of Money Laundering through Credit Cards Is Unknown, the US Government Accountability Office, the US Congressional watchdog, offers the following hypothetical money laundering scenario using credit cards: “Money launderers establish a legitimate business in the US as a ‘front’ for their illicit activity. They establish a bank account with a US-based bank and obtain credit cards and ATM cards under the name of the ‘front business.’ Funds from their illicit activities are deposited into the bank account in the United States. While in another country, where their US-based bank has affiliates, they make withdrawals from their US bank account, using credit cards and ATM cards. Money is deposited by one of their cohorts in the US and is transferred to pay off the credit card loan or even prepay the credit card. The bank’s online services make it possible to transfer funds between checking and credit card accounts.” Third-Party Payment Processors TPPPs are generally bank customers that provide payment-processing services to merchants and other business entities. They often use their commercial bank accounts to conduct payment processing for their merchant clients. Often, they are not subject to AML/CFT requirements. TPPPs traditionally contracted with US retailers (i.e., merchants) that had physical locations in the United States in order to help collect monies owed by customers. These merchant transactions primarily included credit card payments, but they also covered ACH debits and creating and depositing remotely created checks (RCCs) and demand drafts. With the expansion of the internet, TPPPs can now service a variety of domestic and international merchants, including conventional retail and internet-based establishments, as well as prepaid travel and internet gaming enterprises. Considering the expansion of services and the fact that a financial organization maintains a relationship with the TPPP and not the underlying merchant, it becomes difficult for the financial organization to know on whose behalf it is processing a transaction. The types of merchants to which a TPPP provides its payment-processing services can increase the TPPP’s vulnerability to money laundering, identity theft, fraud, and other illegal activities. For example, TPPPs that provide services to telemarketing, gambling (e.g., online and physical casinos), and internet merchants, as well as those that process RCCs for these entities, might present a high level of risk to a financial organization, because they carry a high risk for consumer fraud and money laundering. Examples of risks posed by TPPP include the following: • Multiple financial organization relationships: The TPPP might maintain relationships at multiple organizations, which hinders the organizations’ ability to know the entire customer relationship. This arrangement is purposeful by TPPPs engaged in suspicious activity to limit the financial organizations’ ability to recognize suspicious activities and exit the relationships. • Money laundering: TPPPs can be used by criminals to mask transactions and launder the proceeds of crime. One way to engage in money laundering through a TPPP is to send funds directly to a financial organization from a foreign jurisdiction through an international ACH payment. Given the significant number of transactions conducted through a TPPP, this activity might not be identified. • High return rates from unauthorized transactions: TPPPs engaged in suspicious activity, and those being used by criminals might have higher than average return rates related to unauthorized transactions. At the merchant level, the criminal merchant might have acceptable return rates compared to the percentage of the TPPP’s total transaction volume, but when compared with individual originators, the return rate will be significantly higher. It is important to understand that credit card transactions, whether conducted through a TPPP or other financial organization, do not need to be significant in amount to be considered suspicious or unusual. For example, there might be a high number of small dollar transactions, repeat customers or donors with no discernible pattern, and customers who receive international donations or other payments that do not match the information provided by the customer when they described their business or the customer’s historical activity. Therefore, it is important to have strong CDD, EDD, and transaction monitoring controls to detect suspicious activity and customers that fall outside an organization’s risk appetite. Money Services Business A money services business (MSB) or money or value transfer service (MVTS), as defined by FATF, transmits or converts currencies. These businesses typically provide currency exchange, money transmission, check-cashing services, and money order services. MSB laws vary by jurisdiction. For example, in the United States, FinCEN defines MSB as any person doing business, whether or not on a regular basis or as an organized business concern, in one or more of the following capacities: • Dealer in foreign exchange: These MSBs provide currency exchange services (e.g., US dollars converted to euros). They typically operate along international borders, in airports, and near communities with high populations of foreign individuals. • Check casher: Check-cashing services can be offered by retail businesses or as standalone operations. Depending on the model, the MSB might cash checks for consumers and commercial businesses. In addition to check cashing, these MSBs might provide additional financial services so their customers can pay bills, purchase money orders, and transmit funds domestically and internationally. • Issuer of traveler’s checks or money orders: The issuer of a money order or traveler’s check is responsible for the payment of the item and often uses agents to sell the negotiable items. • Money transmitter: Money transmitters accept currency and funds for the purpose of transferring those funds electronically through a financial agency, institution, or EFT network. Money transmitters also include certain business models involving money transmission denominated in value that substitutes for currency, specifically, convertible virtual currencies (CVCs). Examples of well-known money transmitters are Western Union, MoneyGram, PayPal, and Coinbase. • Provider and seller of prepaid access: Providers of prepaid access arrange for access to funds or to the value of funds that have been paid in advance. These funds can be retrieved or transferred at some point in the future through an electronic device or vehicle, such as a card, code, electronic serial number, mobile identification number, or personal identification number. Prepaid access is also referred to as stored value. Prepaid access can be open loop or closed loop. o Open-loop prepaid cards can be used for purchases at any merchant that accepts cards issued for use on the payment network associated with the card. They can also be used to access cash at any ATM that connects to the affiliated ATM network. Open-loop prepaid cards usually are branded with the network logo, such as American Express, Visa, or MasterCard. o • Closed-loop prepaid cards are typically limited to buying goods or services from the merchant issuing the card. US Postal Service: Because the US Postal Service sells its own money orders, it is considered to be an MSB. FinCEN published a Final Rule in 2012 to expand the definition of MSB to detail when an entity qualifies as an MSB based on its activities within the United States, even if none of its agents, agencies, branches, or offices is physically located there. The Final Rule arose in part from the recognition that the internet and other technological advances make it increasingly possible for persons to offer MSB services in the United States from foreign locations. Absent an exception, MSBs are required to register with FinCEN. FinCEN issued additional interpretive guidance consolidating current FinCEN regulations and related administrative rulings. FinCEN applied these rules and interpretations to other common business models involving CVCs engaged in the same underlying patterns of activity. MSBs in Canada are defined as businesses engaged in foreign exchange dealing; money transferring; and cashing and selling money orders, traveler’s checks, and similar monetary instruments to the public. These MSBs are required to register with the Financial Transactions and Reports Analysis Centre of Canada (FINTRAC). MSBs can range from small, independent businesses to large multinational organizations. Organizations can either provide MSB services as their primary business or as an ancillary service to primary retail store operations. Businesses that provide ancillary MSB services typically include grocery stores, drug stores, restaurants, and bars. The services provided by these businesses include, but are not limited to, cashing payroll checks and selling prepaid cards. Although many of these businesses have brick-and-mortar locations, the number of MSBs operating solely on the internet with no physical presence or a network of agents is increasing. Traditional MSBs typically provide services to the underserved or unbanked individuals. The focus on this market leads them to locate their operations in regions with limited or no banking services. Additionally, they typically provide lower cost services compared with financial institutions for certain service offerings. For example, engaging in domestic or international wire transfers through a financial institution can be time consuming and costly for a consumer. Conducting similar transactions through an MSB can occur quickly and at a much lower cost. Additional services could include bill payments, payday lending, and commercial check cashing. MSBs can be categorized into principals or agents. Principals primarily provide MSB services and act as the issuers of money orders and traveler’s checks or the providers of money transmission. In the United States, principal MSBs are required to have written AML policies, procedures, and internal controls; appoint a BSA officer; provide education and training; conduct independent reviews and audits; and monitor transactions for suspicious activity. Agents are entities that seek to provide MSB-type services in addition to their existing products and services. An agent could be a principal MSB because it offers check cashing as its primary service but an agent because it provides money-transmission services through a principal money transmitter MSB. For agents to use money-transmission services, they must enter into an agent service agreement with a principal MSB. An additional byproduct of the principal-agent relationship is that it allows principal MSBs to expand their business and reach a wider customer market without the need for added overhead. Agents of a principal MSB are required to follow the same state and federal regulations as a principal MSB (e.g., AML/CFT procedures and suspicious activity monitoring). Examples of how MSBs can be used by criminals include: • Fraud in the healthcare industry is rising. Healthcare businesses, such as home healthcare companies, might engage in fraudulent practices by presenting checks derived from fraud to check cashers that they know will not ask for proof of the payee’s identity, will either not file or file false currency transaction reports (CTRs), and will not report them to the government for engaging in suspicious activity. The check casher can be compromised by an employee insider or attempt to be business-friendly by avoiding complying with legal or regulatory requirements that are considered to be burdens to its customers. • Criminals obtain low-cost workers’ compensation insurance policies by grossly deflating payroll amounts. After securing certificates of insurance, organizers rent the certificates to other individuals and businesses for a fee. Because the policies are obtained fraudulently, employees are not covered and are therefore left vulnerable to high medical costs when they incur an on-the-job injury. The payroll amounts are then concealed by cashing checks at an MSB that circumvents proper bookkeeping measures. The criminal makes a significant amount of money to the detriment of workers. • Money launderers use money remitters and currency exchanges to make funds available to criminal organizations at a destination country in the local currency. The launderer or broker then sells the criminal dollars to foreign businesspeople wishing to make legitimate purchases of goods for export. It is a common misconception that there is minimal oversight of the MSB industry. In fact, many MSBs are overseen by a variety of national and/or local regulators and often maintain compliant AML/CFT programs. In addition, they are monitored by the banks with which they maintain relationships. However, the scrutiny applied to MSBs can vary significantly, in large part due to the ease with which some MSBs can establish their business. Additionally, many MSBs are small (i.e., one-store operators) and might not have robust AML/CFT programs compared with their larger national counterparts. For this reason, one of the most important aspects of due diligence for a bank that is establishing a relationship with an MSB is to confirm that the MSB has implemented a sufficient AML/CFT program (e.g., procedures, training, and suspicious activity monitoring) and is properly licensed and/or registered in the jurisdictions in which it operates. Use of MSBs (Case example: Methods of money laundering) Nonbank financial services, such as money services businesses (MSBs) provide valuable services to facilitate remittances, conduct money changing and foreign exchange activities, support areas that are underserved by the banking sector, and promote financial inclusion for individuals who have limited access to the formal banking system. However, the cash-intensive nature of MSBs and the transactional nature of their relationships with customers make this service attractive to financial criminals for moving illicit funds. The Anti-Money Laundering Council (AMLC), the Philippines’ financial intelligence unit, cited MSBs as high risk in facilitating criminal proceeds in its 2021 National Risk Assessment, particularly in relation to drug trafficking and child and sexual exploitation. It highlighted that the frequent use of cash poses a threat in concealing the source of funds and its potential associated links to unlawful activities. AMLC’s statement followed the US$81 million Bangladesh Bank Heist in 2016, in which three MSBs, including Philrem Service Corp. (Philrem), facilitated the movement of money from the heist via remittances from fictitious accounts to casinos in the Philippines. This incident drove increased scrutiny from the regulators on the risks posed by such entities and led to a more proactive supervisory stance. In 2016, the financial regulator Bangko Sentral ng Pilipinas (BSP), in its campaign to combat illegal money movement via MSBs, revoked the licenses of three MSB companies, due to "significant violations” in AML compliance. Among them was Philrem; it’s licenses to offer services as a foreign exchange dealer, money changer, and remittance agent were subsequently revoked. AML rules and regulations covering MSBs such as Philrem have been in place since 2011 in the Philippines and require MSBs to comply with the same requirements as banks, such as risk assessments, CDD, and transaction monitoring. The BSP and AMLC have since implemented new measures to combat the risks of facilitating illegal proceeds via MSBs, including a restructure and consolidation of the sector to strengthen its framework for AML/CTF compliance. In the Philippines, the fragmented nature of the MSB industry and its smaller size means that principals and agents often lack appropriate resources and experience and that, as a result, the understanding of the financial crime risks associated with the sector is still developing. Key takeaways • MSBs must comply with the same AML requirements as banks. • Small MSBs might lack resources and experience, leading to compliance issues. • The cash-intensive and transactional nature of MSBs can facilitate money laundering. • MSBs offer valuable services and are important for financial inclusion. Insurance Companies The insurance industry provides risk transfer, savings, and investment products to a variety of consumers worldwide, ranging from individuals to large corporations to governments. An important aspect of the way the insurance industry operates is that most of the business conducted by insurance companies is transacted through intermediaries, such as agents and independent brokers. Insurers, with some exceptions, are subject to AML requirements. The susceptibility of the insurance industry to money laundering is not as high as that for other types of financial organizations. For example, policies for property, casualty, title, and health insurance typically do not offer investment features, cash buildups, the option to transfer funds from one to policy another, or other means of hiding and moving money. However, certain sectors of the insurance industry, such as life insurance and annuities, are a primary target of criminals who engage in money laundering and terrorist financing. In several ways, the sector’s vulnerability to money laundering is similar to that of the securities sector; in some jurisdictions, life insurance policies are even viewed as investment vehicles similar to securities. According to FATF, life insurance is by far the most attractive area of the insurance sector to money launderers. Substantial sums can be invested in widely available life insurance products, and many feature a high degree of flexibility, while at the same time ensuring nonnegligible rates of return. Many life insurance policies are structured to pay a fixed dollar amount upon the death of the insured party. In contrast, other life insurance products, such as whole and permanent life insurance, have an investment value, which can create a cash value above the original investment when the policyholder cancels it. Such characteristics are of considerable value to honest policyholders, but they also offer money launderers opportunities to legitimize their illicit funds. Furthermore, the most frequently observed individual typology relates to international transactions, demonstrating the cross-border reach of insurance-related money laundering operations. For criminals seeking to launder funds, life insurance products with no cash surrender value are the least attractive. Products that feature payments of cash surrender value and the opportunity to nominate beneficiaries from the first day of the policy are the most attractive and therefore higher risk. Annuities are another type of insurance policy with cash value. An annuity is an investment that provides a defined series of payments in the future in exchange for an up-front sum of money. Annuity contracts can allow criminals to exchange illicit funds for an immediate or deferred income stream, which typically takes the form of monthly payments starting on a specified date. In both cases, a policyholder can place a large sum of money into a policy with the expectation that it will grow based on the underlying investment, which can be fixed or variable. Unit-linked policies and insurance wrappers are also high-risk insurance products because of their high value accumulation and flexibility in adding and managing assets. Typical features of high-risk insurance products include: • Offers the ability to fold funds and assets into the policy • Full or partial underlying investments under the control of the customer • Can offer the option of asset transfers • Can have a high upper limit for the amount of funds held Another indicator of possible money laundering in the insurance industry is when a potential policyholder is more interested in a policy’s cancellation terms than its benefits. Vulnerabilities in the insurance sector include the following: • Lack of oversight/controls over intermediaries: Insurance brokers have a great deal of control and freedom regarding policies. • Decentralized oversight over aspects of the sales force: Insurance companies can have employees (i.e., captive agents) who are subject to the full control of the insurance company. Noncaptive agents offer an insurance company’s products, but they are not employed by an insurance company. They often work with several insurance companies to find the best mix of products for their clients and may “fall between the cracks” of multiple insurance companies. Agents who are complicit with money launderers might work to find the company with the weakest AML oversight. • Sales-driven objectives: The focus of brokers is on selling the insurance products; therefore, they might overlook signs of money laundering, such as a lack of explanation for wealth and unusual methods for paying insurance premiums. Examples of how money can be laundered through the insurance industry include: • Certain insurance policies operate in the same manner as unit trusts or mutual funds. The customer can overfund the policy and move funds into and out of the policy while paying early withdrawal penalties. When such funds are reimbursed by the insurance company (e.g., by check), the launderer has successfully obscured the link between the crime and the generated funds. • The purchase and redemption of single premium insurance bonds are key laundering vehicles. The bonds can be purchased from insurance companies and then redeemed prior to their full term at a discount. In such cases, the balance of the bond is paid to a launderer in the form of a sanitized check from the insurance company. • A free-look period is a feature that allows investors—for a short period of time after the policy is signed and the premium paid—to back out of a policy without penalty. This process allows the money launderer to receive an insurance check, which represents cleaned funds. However, as more insurance companies are subject to AML program requirements, this type of money laundering is more readily detected and reported. • One indicator of possible money laundering is when a potential policyholder is more interested in the cancellation terms of a policy than the benefits of the policy. The launderer buys a policy with illicit money and then tells the insurance company that he has changed his mind and does not need the policy. After paying a penalty, the launderer redeems the policy and receives a clean check from a respected insurer. The FATF Money Laundering Typologies report provides some additional typologies related to the insurance industry: • Third parties that fund insurance policies (i.e., not the policyholder) have not been subject to regular identification procedures when the insurance contract was concluded. The source of funds and the relationship between policyholder and the third party might be unclear to the insurance company. • Some customers actually do not seek insurance coverage; rather, it is an investment opportunity. Money laundering is enabled by using large sums of money to make substantial payments into single-premium life insurance policies, which serve as wrapped investment policies. A variation on this method is the use of large premium deposits to fund annual premiums. Such policies, which are comparable to single-premium policies, also enable the customer to invest substantial amounts of money with an insurance company. Because the annual premiums are paid from an account that must be funded with the total amount, a life insurance product with apparently lower money laundering risk will bear the features of the higher risk single-premium policy. In the insurance sector, most of the business is conducted through intermediaries. As a result, often it is the intermediaries’ application of AML regulatory requirements that is unsatisfactory. When an insurance company assesses money laundering and terrorist financing risks, it must consider whether it permits customers to: • Use cash or cash equivalents to purchase insurance products • Purchase an insurance product with a single premium or lump-sum payment • Borrow money against an insurance product’s value Securities Broker-Dealers The securities industry provides opportunities for criminals to engage in money laundering and terrorist financing anonymously, given the varying levels of AML program requirements in different types of businesses and the high volume of transactions. The world’s capital markets are vast in size, dwarfing deposit banking. FATF has strongly recommended money laundering controls for the securities field since 1992, in conjunction with the Madrid-based International Organization of Securities Commissions (IOSCO), a global association of governmental bodies that includes the Commodity Futures Trading Commission (CFTC), which regulates the securities and futures markets. The difficulty in dealing with money laundering in the securities field is that typically little currency is involved. It is an industry that runs by electronic transfers and paper. Its use in the money laundering process is generally after launderers have placed their cash in the financial system through other methods. Aspects of the securities industry that increase its exposure to money laundering include: • International nature • Speed of transactions • Ability to conduct free-of-payment asset transfers, in which securities are transferred without a corresponding transfer of funds • Ease of conversion of holdings to cash without significant loss of principal • Routine use of wire transfers to, from, and through multiple jurisdictions • Competitive, commission-driven environment, which, like private banking, provides ample incentive to disregard the customers’ source of funds • Practice of brokerage firms of maintaining securities accounts as nominees or trustees, thus permitting concealment of the identities of the true beneficiaries • Weak AML programs that do not have effective CDD, suspicious activity monitoring, and other controls The illicit money laundered through the securities sector can be generated by illegal activities, both from outside and within the sector. For illegal funds originating outside the sector, securities transactions for the creation of legal entities can be used to conceal or obscure the source of these funds (i.e., layering). In the case of illegal activities within the securities market itself (e.g., embezzlement, insider trading, securities fraud, and market manipulation), the transactions and manipulations generate illegal funds that must then be laundered. In both cases, the securities sector offers money launderers the potential for a double advantage: allowing them to launder illegal funds and acquire additional profit. Money laundering can occur in the securities industry in customer accounts that are used only to hold funds and not for trading. This allows launderers to avoid banking channels for which the launderer believes there are more stringent money laundering controls. Other indications of money laundering are wash trading and offsetting transactions, which involve the entry of matching buys and sells in particular securities, creating the illusion of trading. Wash trading through multiple accounts generates offsetting profits and losses, as well as transfers of positions between accounts that do not appear to be commonly controlled. The FATF Money Laundering and Terrorist Financing in the Securities Sector typologies report identifies the following areas as presenting the greatest money laundering vulnerabilities in the securities industry: • Wholesale markets • Unregulated funds • Wealth management • Investment funds • Bearer securities • Bills of exchange Several compliance challenges that are unique to the securities sector include: • Variety and complexity of securities: Security offerings are broad, with some products tailored to the needs of a single customer and others designed for sale to the general public. Products range from the simple and almost universally known to the relatively complex and esoteric. Some knowledge of the underlying security is typically required to address risk. • High-risk securities: Although most securities are issued by legitimate companies, securities that are underregulated or established for illegitimate purposes pose risks. In the United States, securities that are not traded on regulated exchanges are typically sold over-the-counter, with tiers such as “pink sheets” that require only minimal reporting. These products make it easier to obscure information such as beneficial ownership and make it difficult to determine associations with sanctioned jurisdictions and companies. Securities firms are required to identify securities that might pose risks and develop processes to restrict trading of those securities, often on dozens of platforms. • Multiple layers and third-party risk: The securities industry involves many participants, including financial organizations and broker-dealers, financial advisors, transfer agents, securities lenders, custodians, introducing brokers, and sales agents. The many layers of intermediaries, who may also cross borders, make standardizing controls difficult and further challenge overall compliance. FATF has identified a number of suspicious indicators within the global securities markets. Those particularly relevant to the securities sector include: • A customer with a significant history with the securities firm who abruptly liquidates all of her assets in order to remove wealth from the jurisdiction • A customer who opens an account or purchases a product without regard to loss, commissions, or other costs associated with that account or product, including early cancellations of long-term securities • A securities account that is used for payments or outgoing wires with little or no securities activity (e.g., account appears to be used as a depository account or a conduit for transfers) • A customer’s transactions that include a pattern of sustained losses, which might indicate the transfer of value from one party to another • Transactions in which one party purchases securities at a high price and then sells them at a considerable loss to another party, which might indicate the transfer of value from one party to another • A customer who is unfamiliar with a financial product’s performance and specifications but wants to invest in it nonetheless • A customer who is known to have friends or family who work for the securities issuer, or a trading pattern that suggests he might have nonpublic information • Two or more unrelated accounts at a securities firm that trade an illiquid or low-priced security, or “penny stock,” suddenly and simultaneously • A customer who deposits physical securities that (1) are in large quantities; (2) are titled differently from the name of the account; (3) do not bear a restrictive legend, even though the history suggests that they should; or (4) lack sense in terms of the method by which they were acquired Retail broker-dealers are the industry’s frontline defense—and its most vulnerable access point. They are under constant management pressure to expand their client base and manage more assets. The more assets in a client’s account, the more commission will be generated. Money launderers can potentially use this situation to their advantage by promising a large or steady commission stream. Therefore, it is important for broker-dealers to understand who they conduct business with and to monitor customers for suspicious activity. In the United States, the Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA), as directed by the BSA’s regulatory rules, implement requirements for broker-dealers at both small and large organizations. These requirements compel organizations to implement AML programs that include an appointed BSA officer, CDD, suspicious activity monitoring, training, and independent audits. They also subject broker-dealers to oversight by the SEC, FINRA, or both to monitor if and how they are complying with the AML program requirements. Weak or nonexistent AML program requirements can result in substantial monetary and criminal penalties. Use of securities (Case example: Methods of money laundering) In 2017, the Financial Conduct Authority (FCA) fined Deutsche Bank AG £163 million for the lack of an adequate anti-money laundering/countering the financing of terrorism (AML/CFT) control framework between 2012 and 2015. During that time, Deutsche Bank failed to obtain sufficient information about its customers to inform the risk assessment process and ensure effective transaction monitoring. The infractions and resulting loopholes allowed the front office of Deutsche Bank’s Russia-based subsidiary, DB Moscow, to execute more than 2,400 pairs of mirror trades between April 2012 and October 2014. The FCA identified significant deficiencies in Deutsche Bank’s AML control framework. Its Corporate Banking and Securities division (CB&S) in the UK had significant deficiencies, which contributed to the successful execution of the trades. The deficiencies included: • Inadequate KYC and customer due diligence (CDD) • Failure to ensure that the CB&S front office took responsibility for its KYC obligations • Flawed customer and country risk-rating methodologies • Deficient AML policies and procedures • Inadequate AML information technology infrastructure • Lack of automated AML systems for detecting suspicious trades • Failure to provide adequate oversight of trades booked in the UK by traders in non-UK jurisdictions The customers of the institutions in the UK and Russia used mirror trades to transfer more than US$6 billion from Russia. The funds went through Deutsche Bank in the UK to bank accounts located in Cyprus, Estonia, and Latvia. The orders for both sides of the mirror trades were received by DB Moscow, which executed both sides, or transactions, at the same time. Investigators determined that the customers from Moscow and London who executed the mirror trades were connected to each other. In addition, the volumes and values of the securities were the same on both sides. The customers were successful in changing rubles into US dollars and transferring those funds out of Russia. Deutsche Bank should have recognized these transactions as red flags for financial crime. The inadequacy of Deutsche Bank’s overall AML/CFT framework and governance made the fictitious mirror trades simple to execute. The importance of a robust AML/CFT framework and testing for reliability and effectiveness cannot be overemphasized. Key takeaways • Inadequate AML/CFT frameworks allow abuse of the financial system by criminals. • Real-time mirror trades involve the rapid transfer of significant sums of money around the world. • It is critical to have adequate KYC and CDD procedures in place to identify suspicious activity. • Organizations need to undertake continuous risk assessment and ensure controls are in place to mitigate against existing, new, and emerging risks. Securities and broker-dealers (Case example: Methods of money laundering) In June 2020, Hong Kong’s Securities and Futures Commission (SFC) fined Guotai Junan Securities (Hong Kong) Limited HK$25.2 million for multiple internal control failures and regulatory breaches of AML regulations, as well as its handling of third-party fund transfers, placing activities, and late reporting of wash trades. Wash trading is the illegal process of buying shares of a company through one broker, while selling shares through a different broker. Specifically, the SFC investigation found that, from 2014 to 2015, Guotai Junan failed to take reasonable steps to mitigate AML/CFT risks in relation to nearly 15,600 third-party deposits and withdrawals, totaling HK$37.5 billion. The investigation determined that Guotai Junan did not respond to several red flags indicating that certain third-party fund transfers it processed were suspicious. This resulted in a failure to monitor clients’ activities, conduct proper scrutiny of the fund transfers, and report unusual and suspicious transactions to the local financial intelligence unit (FIU). More than 5,000 deposits were made by third parties into the dealer’s client accounts without documenting the depositors’ identities, their relationships with the account holders, and the purpose of the deposits. Similarly, when two deposits were made into a client account for the purpose of buying shares, the firm failed to recognize that the funding was coming from a third party. Maintaining a solid understanding of one’s customers and their business operations, scrutinizing their activity for any discrepancies, and performing KYC/CDD on any related and, particularly, unrelated third parties are key elements of an organization’s AML/CFT program. Regulated entities are required to know the beneficial owners of their customers. It is also important to ascertain the source of wealth or funds in transactions. Guotai Junan failed to do so on several occasions, for example when HK$28.8 million used by five clients to purchase shares of a Hong Kong-listed company were deposited by the same third party in amounts that well exceeded their self-declared net worth. Key takeaways • Ongoing transaction monitoring is a key component of an effective AML/CFT compliance program. • Share offerings have associated risks for money laundering, insider trading, and wash trades. • Both potential and confirmed breaches should be promptly disclosed to the relevant regulator.