Category: Anti-Money Laundering

Bank Fraud is Okay, But not Drugs or Terrorism

Flag_of_the_Cayman_Islands

I would like to think that many of the bankers involved in illegal money laundering are not actually aware of the full extent of their malfeasance. Maybe they should have done a better job looking at a client when they noticed a red flag. But sometimes you run across a case where the bankers are truly scumbags. The Department of Justice just brought charges in such a case.

A combined Department of Justice and Internal Revenue Service sting lead to the arrests of two Caribbean-based bankers and their lawyer for conspiracy to launder money and hide the identities and assets of U.S. taxpayers. According to the indictment, Joshua Vandyk and Eric St-Cyr lived in the Cayman Islands and worked for an investment firm based there. Patrick Poulin was the firm’s attorney, based in Turks and Caicos. According to the indictment, Vandyk, St-Cyr and Poulin solicited U.S. citizens to use their services to hide assets from the U.S. government.

The case starts off as bread and butter fraud, trying to shield assets and avoid tax. The feds sent in three undercover agents to use the services to catch them red-handed. Vandyk and St-Cyr told the agents to create offshore foundations, with help from Poulin, so the investment firm wouldn’t look like it dealt with U.S. clients. Vandyk and St-Cyr then invested the money outside the United States in the name of the offshore foundation. The investment firm said it wouldn’t disclose its clients or their gains to the U.S. government, or send the clients any investment statements. The firm’s clients could monitor their investments online through the use of anonymous, numeric passcodes and liquidate their accounts on request.

What caught my attention was the defendants knew the money coming in was illegal money. One of undercover agents told all three defendants that the cash was coming from a bank fraud that he committed. Vandyk “indicated that this was acceptable to the co-conspirators so long as the money was not linked to drugs or terrorism.”

Of course, the information in this article comes only from the indictment, so the defendants have not had a chance to tell their side of the story.

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New Lists to Check for Bad Guys

bad guy

If you conduct business overseas or have foreign investors in your funds, you are checking the various block persons lists to ensure you’re not working with bad guys. (You are checking, right.) The Office of Foreign Assets Control (“OFAC”), of the U.S. Department of the Treasury, has created two new lists: the Foreign Sanctions Evaders List and the Blocking Property of Additional Persons Contributing to the Situation in Ukraine.

Foreign Sanctions Evaders List

The FSE List implements Executive Order 13608 by identifying non-U.S. persons and entities that have engaged in conduct evading U.S. economic sanctions with respect to Iran or Syria.  The FSE-listed individuals or entities are not necessarily located in Iran or Syria.

You are generally prohibited from all transactions or dealings, direct or indirect, involving persons or entities identified on the FSE List related to any goods, services, or technology (i) in or intended for the United States, or (ii) provided by or to U.S. persons, wherever located.  However, unlike the OFAC Specially Designated Nationals List, the new FSE List does not require blocking of property and reporting of transactions with FSE-listed entities.

OFAC has elected to maintain a separate FSE List rather than include the FSE entries on the Specially Designated Nationals List.  That means you need to screen against both lists. Most likely, you are using software or a third-party service provider, so check to make sure the FSE List was added to the screening protocol.

Blocking Property of Additional Persons Contributing to the Situation in Ukraine

By Executive Order on March 20, 2014, President Obama put in place new restrictions on companies and individuals that operates in sectors of the Russian Economy that would support the Russian Federation’s annexation of Crimea. It’s an expansion of 13660 and 13661.

So far, the orders have brought sixteen Russian government officials, members of the Russian leadership’s inner circle, and a Russian bank into the sanctions regime. Bank Rossiya (ОАО АБ РОССИЯ) is the personal bank for senior officials of the Russian Federation.

OFAC has added the blocked persons to the Specially Designated Nationals List. I received a notice that my vendor has already included the names in its database.

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Image of villain is a caricature by J.J. McCullough
cc by sa

J.P. Morgan’s Madoff Failure

jp morgan and compliance

Yesterday J.P. Morgan agreed to forfeit $1.7 billion for its failure related to the Bernie Madoff fraud, plus several hundred million in fines. As part its deferred prosecution agreement, the bank agreed that it did not have the proper systems in place to catch Madoff. It’s easy to target the bank for compliance failures but I wanted to dig a little deeper to see what went wrong. The picture is not very clear and I’m not sure why the bank forfeited so much cash.

J.P. Morgan was the main bank for Madoff from 1986 until the fraud collapsed. With money moving in an out of the accounts, J.P. Morgan could presumably have noticed something wrong with the flow of money. But that would likely be difficult. Madoff would have moved money around through several accounts. It would not be a simple task to track the flow of cash and see the fraud. If it were that simple, it would have been spotted much earlier. The agreement notes a few flags on the account and some inadequate diligence by the relationship personnel. None of that data seems to indicate a bigger problem with the flow of cash.

There was a mid 1990s transaction that looked like check kiting between an unnamed private bank client of Chemical Bank (which was eventually consumed by J.P. Morgan), Madoff and a second bank. The second bank ended up terminating the relationship and filing a suspicious activity report. J.P. Morgan did not. The private bank client did not terminate the relationship because Madoff had turned the investment from $183 million to $1.7 billion over 12 years. Madoff’s fake returns bought silence.

In the late 1990s and again in 2007 divisions of J.P. Morgan were considering having its private bank invest in Madoff. But Madoff was unwilling to help with the bank’s diligence efforts and the the bank expressed concerns when it was unable to reverse engineer Madoff’s returns.

In 2006 the London office of the bank had set up an exotic derivative that would provide clients with synthetic exposure to a hedge fund without making a direct investment in the fund itself. To cover the other side, J.P. Morgan invested in a Madoff feeder fund. Apparently, the derivative was wildly successful and hit the bank’s $100 million exposure limit. The traders went to an internal committee to get an exposure increase to $1 billion. The committee tabled approval because the bank couldn’t get the diligence it wanted. Madoff refused to allow the bank to conduct due diligence on his fund directly.

That triggered more diligence efforts and an increasing unease at the bank about having exposure to Madoff. J.P. Morgan began redeeming its interests in the Madoff feeder funds. This was 2008 and Lehman had just collapsed and the Madoff fraud would be exposed in a few months. J.P. Morgan also began unwinding those synthetic exposures. It looks like the bank was able to save $250 million before the Madoff collapse.

The key dagger seems to be when the London office of J.P. Morgan filed a report with the U.K. authorities as a result of its diligence. But J.P. Morgan did not file an equivalent report in the US. Under the Bank Secrecy Act, a bank needs to file Suspicious Activity Reports with FinCEN if the bank notes any suspicious transaction relevant to a possible violation of law or regulation.

The second big failure was that the suspicions were not transmitted from the investment side of the bank to the commercial banking side of the bank. The investment side wanted to limit its exposure and minimize its losses for being invested in a fraud. The banking side would have to take steps to prevent funds from leaving for improper purposes.

From the time the report was filed in London, the Madoff bank account at J.P. Morgan had fallen from $3 billion to $234 million. The $1.7 billion paid by J.P. Morgan is supposed to represent a portion of the money that the bank allowed to leave the Madoff account during that period.

What is boils down to is that in the Fall of 2008, just before the collapse of the Madoff fraud, J.P. Morgan took steps to protect its own business interests but failed to notify FinCEN of the same suspicious, potentially fraudulent, activities.

In the end I suspect J.P. Morgan thought it would not win the case if it went to trial. It has some bad facts on its side. One of the diligence emails joked that they should visit Madoff’s accountant’s office to make sure it wasn’t a car wash. The bank would never find a jury that would offer one iota of sympathy or understanding.

Then it was just a matter of how much cash the bank was willing to pay. It sounds like the initial government ask was about $3 billion: the $2.75 billion that left the Madoff bank account, plus the $250 million that the bank managed to avoid losing by redeeming out of the Madoff feeder funds. I assume the bank is looking to end as much of the regulatory actions from the 2008 financial crisis hanging over its heads as it can. Another one down.

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A Look Inside a Money Laundering Investigation

infiltrator

In The Infiltrator, Robert Mazur provides an encyclopedic account of his undercover work. Mazur spent years undercover infiltrating the criminal hierarchy of Colombia’s drug cartel, and the dirty bankers and businessmen willing to launder drug cash. His work led to the arrest of dozens of drug traffickers and money launders. It also led to the dismantling of BCCI, a large banking operation that seemed focused on dirty money.

The undercover operation concluded with a fake wedding that was attended by BCCI officers and drug dealers from around the world. The bank officers were all too willing to continue the banking relationship even after Mazur explicitly told them he was moving drug money from the United States to Columbia.

I was interested in the book to see if I could get a better sense of how criminals found targets for money laundering operations. Unfortunately, The Infiltrator provided little insight on how money laundering works. I was hoping for more. BCCI was all too willing to take big piles of cash and assist with money laundering.

I didn’t expect the book to be exceptionally well written or to have a strong narrative. It was written by a federal agent from his first hand experience. Most of the book reads like a police report, dictating the story in a very matter-of-fact manner.

Given the time-frame of the book, it pre-dates the current regulatory restrictions on Know-Your-Customer and predates the internet. That makes it feel very dated and very Miami Vice.

Cash Transactions, Money Laundering, and a CCO Going to Jail

check-cashing

When I see a story about a chief compliance officer going to jail it catches my attention. Judge John F. Walter in the Central District of California sentenced Humberto Sanchez, the compliance officer of G&A Check Cashing to 60 months in prison. Private fund managers rarely have to worry about check cashing and bags of cash. The case is a good reminder that cash transactions have specific limitations.

In this case, G&A Check Cashing was sending customers off with cash in excess of $10,000. Under the Bank Secrecy Act, financial institutions, including private funds, are required to file a Currency Transaction Report with the Department of Treasury for any transaction involving more than $10,000 in currency. As part of the Currency Transaction Report, the financial institution is required to verify and accurately record the name and address of the individual who conducted the currency transaction, the individual on whose behalf the transaction was conducted, as well as the amount and date of the transaction.

G&A was very bad and engaged in multiple transactions involving over $8 million, in which the firm did not file the required Currency Transaction Reports.

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OFAC and Private Funds

An SEC-registered investment adviser entered into a settlement agreement with the U.S. Treasury Department’s Office of Foreign Assets Control for allegedly failing to maintain a compliance program. The problem was triggered when the adviser’s foreign affiliate caused one of its clients to invest in a Cayman Islands fund that appeared on OFAC’s list of Specially Designated Nationals. Genesis Asset Managers, LLP agreed to a $112,500 fine for an apparent violation of the Iranian Transactions Regulations (31 C.F.R. part 560) that occurred in 2007.

OFAC claimed that Genesis did not maintain an OFAC compliance program at the time the investment was made. Of course, Genesis was not required to do so.

These were the aggravating factors in this case:

  • Genesis failed to exercise a minimal degree of caution or care in the conduct that led to the apparent violation
  • Officers of Genesis were aware of the conduct giving rise to the apparent violation
  • Substantial economic benefit was conferred to Iran
  • Genesis did not have an OFAC compliance program in place at the time of the apparent violation

These were the mitigating factors:

  • Genesis has not received a penalty notice or Finding of Violation from OFAC for substantially similar violations
  • Genesis substantially cooperated with OFAC’s investigation
  • Genesis voluntarily self-disclosed the apparent violation
  • Genesis took appropriate remedial action
  • Genesis may not have fully understood its OFAC obligations under U.S. law.

I find the last one strange. Every firm needs to comply with the OFAC regulations that prohibit transactions with parties on OFAC’s list of Specially Designated Nationals. Genesis is based on Britain so maybe the firm was bit confused about the extra-territorial reach of US law across the banking and investment systems.

Advisers should adopt risk-based procedures to ensure compliance with OFAC regulations. Most advisers and fund managers are not subject to a formal regulatory requirement to adopt written AML procedures or know-your-customer programs. That does not mean that such programs are bad ideas.

An adviser that can effectively demonstrate a reasonable OFAC/AML compliance program may be able to avoid heightened scrutiny from regulators. And investors are increasingly expecting their fund managers to have AML programs in place. If a violation does occur, the existence of a formal program can help mitigate the damage. In its enforcement guidelines, OFAC has stated that it may consider the “existence, nature and adequacy of a [firm’s] risk-based OFAC compliance program” in determining whether to bring an enforcement action and the amount of any penalty imposed.

It’s fairly easy to license a system and check your investors and business partners against the OFAC list and other sanctions lists.

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Iran, Tuvalu, and Oil

Anyone who works with sanctions monitoring most likely hates ships. Their names are so common that the ships’ names routinely cause false positives. (My software has a button to exclude ships’ names, but I often forget to activate that feature.) Now the Iranian oil sanctions program is highlighting some issues with ships.

The tiny Pacific island nation of Tuvalu is prepared to re-flag a fleet of National Iranian Tanker Co. vessels to operate under Tuvalu’s ship registry.  From a personal perspective, it will likely mean more ship names in the databases. Fortunately, my company doesn’t deal with ships so it will only affect me when I forget to select the right option.

On a global scale, it may be an effective way to hide ownership and get cash to Iran. There is still the problem of moving the cash through the global financial system.

Rep. Howard Berman, the ranking member of the House Foreign Relations Committee wrote a letter to Willy Telavi, prime minister of Tuvalu, to cancel the registry.

It is my understanding that the Government of Tuvalu has permitted the National Iranian Tanker Company (NITC) to reflag as many as 22 vessels under the Tuvalu ship registry, allowing them to remain under NITC ownership and continuing to transport Iran’s crude oil exports. This has the effect of assisting the Iranian regime in evading U.S. and EU sanctions and generating additional revenues for its nuclear weapons program and its support for international terrorism.

It would be profoundly disappointing to me if your government has acted in contravention of the broad international coalition that is working together to use peaceful means, including economic sanctions, to change the threatening behavior of the Iranian regime.

Prior to selling its soul to Iran, Tuvalu was mostly known for its strong position on global warning. The county is small and flat. At just 26 square kilometers Tuvalu is the fourth smallest country in the world, larger only than the Vatican City at 0.44 square kilometers, Monaco at 1.98square kilometers and its neighbor Nauru at 21 square kilometers. At its highest, Tuvalu is only 4.8 meters above sea level. A dramatic rise in sea level could make the country inhabitable.

Why would such an environmentally fragile country help a rogue nation? Tuvalu has been looking for a place to re-settle its inhabitants once sea levels rise. It seems unlikely that they would choose Iran for resettlement. I would assume it comes down to cash. I suspect Iran offered a big pile of cash, with some of it going directly to select Tuvalu officials.

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Image of Iranian and Tuvalu flags courtesy of crossed flag pins.com

Anti-Money Laundering Program and Procedures

The Foreign Corrupt Practices Act has taken center stage in the headlines for international finance problems. But last week the regulators let us know that the PATRIOT Act has not gone away. ING Bank agreed to forfeit $619 million after admitting that it covered up billions of dollars in transfers that violated U.S. sanctions on Iran and Cuba.

That was a record settlement under the OFAC regime. The settlement resolves OFAC’s investigation into ING Bank’s intentional manipulation of information about U.S.-sanctioned parties in more than 20,000 financial and trade transactions routed through third-party banks located in the United States between 2002 and 2007.

From the Settlement Agreement it looks like ING was trying to isolate some banking relationships with Cuba. It tried to isolate money originating from Cuba from the rest of the international banking world, at least so far as that money is banned from the international banking world. According to the Settlement Agreement, the bank and its employees went too far and altered transaction information to hide the evidence that money was coming from Cuba.

ING also deleted origination information for transactions involving Iranian money. The problem was that some of the transactions used US dollars, which meant the transactions were cleared through New York and subject to US jurisdiction.

Private fund managers are subject to OFAC restrictions and are otherwise prohibited from dealing with “bad guys.” FINRA has provided a template for small brokerage firms: Anti-Money Laundering (AML) Template for Small Firms.

The world of private equity is probably not very attractive for money laundering. The investments are long term and require the contribution of cash over many years. The investment is illiquid and will take years to be returned. Most money laundering transactions look for a more liquid transfer of cash. Since their illegal funds are isolated, they are already illiquid.

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Amsterdam Zuidoost ING-Bank is by Pieter Delicaat

Click to access 06122012_ing_agreement.pdf

Proposed FATCA Regulations Released

The Foreign Account Tax Compliance Act of 2009 was part of the Hiring Incentives to Restore Employment Act of 2010 (the HIRE Act) passed in 2010. 

If you have foreign investors or domestic investors making their investments through offshore entities, you need to pay attention to this law. It requires private funds to collect information on their foreign investors to determine if there are any US investors in the ownership that may not be paying their taxes.

An investor’s failure to meet the regulatory disclosure requirements means that the fund manager will need to withhold 30% from distributions. These withholding obligations will go into effect on January 1, 2013.

The key benchmark is to identify a substantial US owner of an entity. Substantial starts at 10%.

I’m still trying to sort through the regulations to figure out how it will work. I think I can get it to tie into an anti-money laundering program. You should check an investors background. As part of that, you want to peek under the hood of an entity to see the ownership. I have seen people set a de minimis level between 5% and 50%. FATCA would seem to set the level at no less than 10%.

I expect many fund managerS are going to need to reach out to their investors and get more information and certifications from their investors to meet the FATCA standards.

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Regulations Relating to Information Reporting by Foreign Financial Institutions and Withholding on Certain Payments to Foreign Financial Institutions and Other Foreign Entities (.pdf)

New Anti-Money Laundering Requirements for Non-Bank Mortgage Lenders and Originators

Private Equity has been siting on the fringes of Anti-money laundering regulation for many years. It’s still illegal to be involved in money laundering and fund managers should be taking some steps to protect themselves and to identify problems. There’s just no set script. FinCEN is supposedly working on a new rule.

In the meantime, FinCEn has issued a new rule setting out the requirements for Non-Bank Mortgage Lenders and Originators.

The rule starts with a simple principle based approach:

Each loan or finance company shall develop and implement a written anti-
money laundering program that is reasonably designed to prevent the loan or finance company from being used to facilitate money laundering or the  financing of terrorist activities.

What do you have to do to meet this standard? The rule goes on to set minimum requirements:

(1) Incorporate policies, procedures, and internal controls based upon the company’s assessment of the money laundering and terrorist financing risks associated with its products and services.
(2) Designate a compliance officer who will be responsible for ensuring that:
(i) The anti-money laundering program is implemented effectively
(ii) The anti-money laundering program is updated as necessary; and
(iii) Appropriate persons are educated and trained

(3) Provide for on-going training of appropriate persons concerning their responsibilities under the program.
(4) Provide for independent testing to monitor and maintain an adequate program, including testing to determine compliance of the company’s agents and brokers with their obligations under the program

 The mortgage company is also now explicitly required to file suspicious activity reports.

Obviously, private equity firms are not subject to this rule. However, I would guess that the proposed rule for private equity will end up having many of these same elements.

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