The Shadowy World of Illicit Finance

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The illicit economy involves any activity done in the shadows that is not regulated or reported to law enforcement―hence why these criminals remain enigmatic. All too often illicit finance leaves an indelible impression on society and its impact is vast because of the high-dollar values usually attached to it. This article will examine the effects of illicit finance through the varying means of money laundering, terrorist financing, tax evasion, embezzlement, bribery and corruption.

Background

The terrorist attacks on September 11, 2001, along with some recent revelations (e.g., the Panama Papers and the Paradise Papers) revolutionized the anti-money laundering (AML) and counter-terrorist financing field and brought into stark relief the movement and disguising of funds destined for terrorist attacks, anonymous shell companies and corruption. As a result, banks, nonbank financial institutions and nonfinancial businesses in virtually all countries now face tougher national and international legal requirements and harsher penalties than ever before. The U.S. government was determined to protect the integrity of the American financial system, target illicit activity, and place sanctions on terrorist groups and high-profile actions related to Venezuela, Russia, human rights abusers, drug kingpins and cybercriminals.1 By the same token, the regulators of those businesses, law enforcement and the prosecutors who enforce the criminal laws also faced greater challenges and responsibilities in their work.

Money Laundering

Money laundering has made a huge impact in the illicit finance world, despite the fact that the United Nations (U.N.), national governments and various nonprofits combat money laundering globally. The most high-profile instances of money laundering have involved not just private individuals, but major financial institutions (FIs) and even government officials.2 In 2008, the International Monetary Fund estimated that about $1.8 trillion has been laundered worldwide, about 10% of U.S. gross domestic profit (GDP).

According to the U.N. Office on Drugs and Crimes, annual illicit proceeds totaled more than $2 trillion dollars globally, and the proceeds of crimes in the U.S. were estimated at $300 billion, or about 2% of the overall U.S. economy, in 2010.3 The economic effects of money laundering are felt on a broad scale. Developing countries often bear the brunt of money laundering because their governments are still establishing regulations for their newly privatized financial sectors, making these countries a prime target.

As drug traffickers’ bank of choice for many years, HSBC allowed its services to be used as a conduit for money laundering. HSBC Mexico was one of the banks recommended by drug traffickers and money launderers between 2006 and 2010 due to its lax controls and willingness to turn a blind eye in exchange for constant business. The El Dorado Task Force―made up of federal agents from the U.S. Justice Department, the U.S. Treasury Department and the U.S. Department of Homeland Security―traced the channels used by Mexican and Colombian drug traffickers to launder their money within the country’s financial system. The U.S. and Mexican governments slapped historic fines on the bank for its lax controls and permissiveness. According to InSight Crime, “The discovery of HSBC’s multiple failures to prevent the laundering of illicit funds resulted in the heaviest fines ever imposed on a financial institution in either the United States or Mexico: $1.9 billion and 379 million pesos (about $27.5 million), respectively.”4

Terrorist Financing

The line between criminal networks and terrorist networks has become increasingly blurry in recent years. Terrorists often finance their operations illicitly by selling drugs, counterfeiting goods, and becoming involved in weapons trafficking and human trafficking.

Terrorists and criminal organizations have also become transnational as they take advantage of weak states, lax banking super­vision, corruption and weak financial systems

Criminal organizations represent a major threat for national governments. Terrorists and criminal organizations have also become transnational as they use traditional and contemporary techniques to take advantage of weak states, lax banking supervision, corruption and weak financial systems. The methods being used―including human trafficking, money laundering, drug trafficking, corruption, cybercrime, fraud and other financial crimes―all pose serious threats globally. Thus, criminal organizations use illicit financing to ensure greater financial returns and expand their operations. Even though transnational organized groups could not be farther apart in terms of their goals, the ever-mounting financial scrutiny placed on criminal organizations will continue to be the driving force behind their collaboration and adoption of sophisticated money laundering practices.5,6

Corruption and Tax Evasion

Corruption is a pernicious reality throughout the world in developed and underdeveloped countries alike. It weakens and undermines democratic institutions, distorts national economies, contaminates business practices, fosters government instability, discourages external investments, unjustly enriches public officials and private sector businesspeople, worsens social conditions and public services, and hurts hundreds of millions of people each day.

For all these reasons, corruption and its many deleterious consequences have gained great public and international attention in the past two decades. Official corruption, which refers to the dishonest acts of public officials, can take many forms. It can be bribery, extortion, embezzlement, tax evasion, influence peddling, nepotism and alliances with criminal elements.

Within illicit finance, most offshore corporations have one main purpose―to create anonymity. In 2016, the Panama Papers revealed that some of the shell companies, cloaked in secrecy, provide cover for dictators, politicians and tax evaders. Of note, there were 140 politicians from more than 50 countries who were connected to offshore companies in 21 tax havens. The Panama Papers became the Wikileaks of the financial world: Nearly 12 million unearthed documents from one Panamanian law firm showed how offshore shell companies kept trillions of dollars out of the global economy—with some of it held by drug traffickers, arms dealers and politicians.7

The Devastating Effects of Illicit Finance

According to the 2015 World Economic Forum, “The global illicit trade has grown at an unprecedented pace, in both relative and absolute terms, ushering in immense risks to society, governance and the global economy.”8 The rise of the internet, the dark web and social media have all fundamentally altered criminal activities and enabled criminals to become more efficient.9 Among its destructive effects, illicit finance robs governments of taxes, creates countless threats to national security worldwide, encourages corruption and threatens the rule of law.10



The illicit market can also alter the economy of countries worldwide. By taking away revenue from legitimate businesses, it hinders the free market and GDP. Companies hurt by the illicit market become more vulnerable to participating in it and in countries that are hurting economically, the illicit market tends to rise.

The Effect on Developing Nations

Illicit economies are often larger in developing nations and in such cases it is estimated that the illegal market accounts for approximately 3.6% of total GDP.12 Corruption is another large factor when considering the growth of the illicit economy―the more corruption, the larger the illicit economy. This can be seen in places like Zimbabwe, where the illicit economy is almost the same size as the formal market.13

Illicit finance facilitates many of these risks and seems to have an overall negative impact on poor countries.14 The stability of developing countries’ economies relies on the regular flow of financial funds, so these countries become more vulnerable and unstable as illicit funds are transferred from the country. Without an effective AML effort on a large scale, individual nations remain at risk. According to a policy paper from the Center for Global Development, “Illicit financial flows are a worldwide obstacle to global development.”15 It strips vital resources from underdeveloped countries, such as public services, social services, and health and education services.

According to the book “Convergence: Illicit Networks and National Security in the Age of Globalization,” the scale of illicit finance is proportional to the level of globalization.”16 In 1999, the amount of revenue in the illicit financial world ranged between $100 billion and $25 trillion depending on the source.17 When considering that globalization will likely continue to increase and that technology will likely allow for closer and faster global communications, the opportunities for illicit finance should also continue to thrive.

In a study of 148 developing nations, illicit activities (specifically trade misinvoicing) equaled 18% of total trade with developed nations.18 Thus, developing nations do not benefit as much as they could from foreign investments,19 contradicting any assumption that greater economic investments by the international community will benefit the recipients proportionally.

However, because illicit finance accounts for approximately 3%-5% of world revenue, eliminating it would cripple economies in developing nations.20 Illicit finance keeps developing nations afloat because they have no established economic structure to provide citizens with a means of generating revenue and recycling it back into the local economy.21

Geography plays a critical role in facilitating illicit finance and any related activities within a developing nation. In the world of illicit finance, successfully transferring funds from A to B is a risky enterprise and requires skill to remain undetected. For example, some countries in Asia have well-established, legal alternative banking systems that allow for undocumented deposits, withdrawals and transfers. These are trust-based systems, often with ancient roots, that leave no paper trail and operate outside of government control. This includes the hawala system in Pakistan and India and the fie chen system in China.

Political and economic instability creates vulnerabilities for local and transnational criminal organizations to exploit for profitable gain

Political and economic instability creates vulnerabilities for local and transnational criminal organizations to exploit for profitable gain. Without an effective governance system established within a nation, the balance of power often falls in favor of nefarious organizations.

The Effect on the U.S.

As noted in the 2018 “National Strategy for Combating Terrorist and Other Illicit Finance,” illicit finance also has an enormous impact on the U.S. because it weakens the U.S.’ financial systems and allows illicit proceeds to enter. The report goes on to say, “that a strong and transparent financial system, one that denies criminals and malign actors access to the funds and resources they need to carry out nefarious activities or to profit from their crimes, strengthens U.S. national security and protects Americans.”22

The effects on the U.S. are staggering both culturally and economically. On the sociocultural end of the spectrum, successful illicit financial flows imply that criminal activity does pay off. This success encourages criminals to continue their illicit schemes, which leads to more corruption, more drug trafficking, more weapons trafficking and other crimes. Law enforcement resources become stretched beyond their means and there is a loss of morale throughout society. The economic effects are felt on a broader scale. As previously mentioned, developing countries often bear the brunt of illicit finance, particularly from money laundering because the governments are still in the process of establishing more robust regulations.

Confronting and combating illicit finance seems to be a multipronged issue as illegal monies are being flooded into the U.S. from multiple directions and potentially multiple actors. Some key organizations that contribute to this ever-expanding U.S. concern are transnational organized criminal organizations, such as drug cartels and human trafficking networks. According to the “Worldwide Threat Assessment of the U.S. Intelligence Community,” by Daniel R. Coats, “Global transnational criminal organizations and networks will threaten US interests and allies by trafficking drugs, exerting malign influence in weak states, threatening critical infrastructure, orchestrating human trafficking, and undermining legitimate economic activity.”23

Conclusion

Trade of illicit finance deprives governments of tax revenue, fuels corruption and terrorism, and expands the global illegal economy which in turns hampers competition and gives rise to other forms of illicit trade such as drug trafficking, arms trafficking and human trafficking.24 Furthermore, corruption and illicit trade are at the root of instability in many parts of the world. As international trade expands, so does illicit trade. The impact of illicit trade affects all, undermining the fabric of societies worldwide.25

Criminals seem to adapt and overcome challenges much more frequently and at a faster pace than law enforcement. According to the Organisation for Economic Co-operation and Development, law enforcement must make an effort to stay one step ahead of criminals:

“Criminal activities are dynamic and adapt quickly to take advantage of new opportunities for financial gain, frequently outpacing the legislative changes designed to combat them. Countering these activities requires greater transparency, more effective intelligence gathering and analysis, and improvements in co-operation and information sharing among federal agencies and among countries to prevent, detect and prosecute criminals and recover the proceeds of their illicit activities.”26

The U.N. also stresses the importance of vulnerability assessments, surveillance and focusing law enforcement efforts on the most relevant channels as they pertain to their respective countries.27

Thus, anti-financial crime professionals who strive to protect their organizations from being used for money laundering and terrorist financing have careers that are now much more demanding and the pressure to combat illicit finance is more urgent than ever before.  

Delena D. Spann, U.S. Federal Law Enforcement Agency, Chicago, IL, USA, dspann7594@aol.com

  1. National Strategy for Combating Terrorist and Other Illicit Financing,” U.S. Department of The Treasury, 2020, https://home.treasury.gov/system/files/136/National-Strategy-to-Counter-Illicit-Financev2.pdf
  2. Holly Whitehead, “Top 5 Money Laundering Cases of the Last 30 Years,” International Compliance Association, July 22, 2016, https://www.int-comp.org/insight/2016/july/top-5-money-laundering-cases-of-the-last-30-years/
  3. “Combating Money Laundering and Other Forms of Illicit Finance: Regulator and Law Enforcement Perspectives on Reform” FBI, November 29, 2018, https://www.fbi.gov/news/testimony/combating-money-laundering-and-other-forms-of-illicit-finance
  4. Ignacio Rodriguez Reyna, Zorayda Gallegos and Silber Meza, “HSBC: Dirty Money and White Collars,” Insight Crime, October 9, 2020, https://www.insightcrime.org/news/analysis/hsbc-dirty-money-white-collars/
  5. Delena D. Spann, “A Compilation of Illicit Finance in The 21st Century: Money Laundering and Offshore Banking,” 2015.
  6. David Luna, former U.S. diplomat and national security official, Senior Fellow for National Security (Terrorism, Transnational Crime and Corruption Center), Schar School of Policy and Government, George Mason University.
  7. “The Power Players,” International Consortium of Investigative Journalists, January 2017, https://www.icij.org/investigations/panama-papers/the-power-players/
  8. “State of the Illicit Economy,” World Economic Forum, October 2015, http://www3.weforum.org/docs/WEF_State_of_the_Illicit_Economy_2015_2.pdf
  9. Louise Shelley, “Illicit Trade and Our Global Response,” American Foreign Service, www.afsa.org/illicit-trade-and-our-global-response
  10. Ibid.
  11. “UNODC estimates that criminals may have laundered US$ 1.6 trillion in 2009,” United Nations, October 25, 2011, https://www.unodc.org/unodc/en/press/releases/2011/October/unodc-estimates-that-criminals-may-have-laundered-usdollar-1.6-trillion-in-2009.html
  12. Kathleen Murray, “Underground Economy,” SAGE Business Researcher, April 3, 2017, file:///C:/Users/d40831837/Downloads/underground-economy.pdf
  13. Ibid.
  14. “Illicit Financial Flows from Developing Countries: Measuring OECD Response,” Organisation for Economic Co-operation and Development, https://www.oecd.org/corruption/Illicit_Financial_Flows_from_Developing_Countries.pdf
  15. Petr Janský, “Illicit Financial Flows and the 2013 Commitment to Development Index,” Center for Global Development, December 2013, https://www.cgdev.org/sites/default/files/illicit-financial-flows-2013-commitment-development-index_final_0.pdf
  16. Michael Miklaucic and Jacqueline Brewer, Convergence: Illicit Networks and National Security in the Age of Globalization, (Washington, D.C.: National Defense University Press, 2013).
  17. Joseph Serio, “Fueling global crime: the mechanics of money laundering,” International Review of Law Computers & Technology, January 22, 2007, 435-444.
  18. “Illicit Financial Flows are Significant and Persistent Drag on Developing Country Economies,” Global Financial Integrity, January 28, 2019, https://gfintegrity.org/press-release/2019-iff-update-press-release/
  19. Ibid.
  20. Dev Kar and Joseph Spanjers, “Illicit Financial Flows from Developing Countries: 2004-2013,” Global Financial Integrity, December 8, 2015, https://gfintegrity.org/report/%20illicit-financial-flows-from-developing-countries-2004-2013/
  21. “Illicit Financial Flows (IFFs),” The World Bank, July 7, 2017, https://www.worldbank.org/en/topic/financialsector/brief/illicit-financial-flows-iffs
  22. “National Strategy for Combating Terrorist and Other Illicit Financing,” U.S. Department of The Treasury, 2020, https://home.treasury.gov/system/files/136/National-Strategy-to-Counter-Illicit-Financev2.pdf
  23. Daniel R. Coats, “Worldwide Threat Assessment of the US Intelligence Community,” Senate Select Committee on Intelligence , May 29, 2019, https://www.dni.gov/files/ODNI/documents/2019-ATA-SFR—SSCI.pdf
  24. Mapping the Impact of Illicit Trade on the Sustainable Development Goals,” Transnational Alliance to Combat Illicit Trade, https://unctad.org/system/files/non-official-document/DITC2020_TRACIT_IllicitTradeandSDGs_fullreport_en.pdf
  25. Louise Shelley, “New security challenge: The growth of illicit trade and corruption,” NATO Review, December 8, 2017, https://www.nato.int/docu/review/articles/2017/12/08/new-security-challenge-the-growth-of-illicit-trade-and-corruption/index.html
  26. “About tax and crime,” Organisation for Economic Co-operation and Development, https://www.oecd.org/ctp/crime/about-tax-and-crime.htm
  27. “The Least Developed Countries Report 2019,” United Nations, 2019, https://unctad.org/system/files/official-document/ldcr2019_en.pdf

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