1. MONEY LAUNDERING: THE NUMBERS

Money laundering is, and has been for several years now, a subject that is very much in the public eye? Why?

Well, to start with, it is a subject that affects a substantial portion of the world economy. How substantial? Estimates vary considerably, but concur on one point: the sums involved are considerable and, worse, growing. The International Monetary Fund, for example, estimates that the annual "turnover" of money laundering is between 2 and 5% of the world-wide gross domestic product (between 600 billion and 1.5 trillion US dollars) 1. By way of comparison, the gross domestic product of a country like Spain is only roughly 590 billion US dollars2. In France alone, the estimated volume of funds laundered locally per year is 6 billion Euros, for a total of some 130 billion of criminal-origin funds that may already have been injected into the French economy (1/2 of all foreign investments) 3!

As for the growth of the phenomenon, it can be attributed to a number of factors. First, as the French numbers suggest, the principle is that "once dirty, always dirty." Thus, the various estimates take into account not only the fresh proceeds of criminal activities being injected yearly into the legitimate economy, but also the cumulative total of past injections and the profits generated by them. Second, money launderers and the criminals who employ them are increasingly sophisticated. The fortunes at their command give them access to high quality accounting, tax and legal advice (both from unscrupulous[Page15:] professionals and from professionals who simply fail-out of incompetence or inexperience or because they are being deliberately deceived by their clients- to recognize the true nature of the transaction). Third, international movements of funds are increasingly fluid, thanks notably to innovations in the financial and quasi-financial products market, technological advances such as the generalization of secure financial transactions via the Internet and the legislative abolition or reduction of exchange control or direct investment regulations in many countries. And finally, the definition of money laundering has expanded to sweep in a much broader range of activities.

2. A FEW DEFINITIONS

How, exactly, is money laundering defined? The precise legal definition of money laundering varies from one country to another and may, within a single country, have several definitions (for example, the definition provided in the Penal Code or equivalent text and that used in banking or other regulatory texts or in recommendations issued by professional organizations). The common denominator is that money laundering always designates the processing of "criminal proceeds" to disguise their illegal origin.

As to the activities that may give rise to "criminal proceeds," the list is not the same from country to country nor from year to year and depends on what is characterized as a "crime": drug trafficking, certainly, and racketeering or prostitution, but also, today, terrorism, arms sales and also, sometimes, tax fraud.

As for the processing, it may take, as we will see, many forms, but is universally aimed at permitting criminals to enjoy and continue to control the fruits of their illegal activities, without jeopardizing the source. The objective pursued in a money laundering operation is thus very different from that in a fraudulent transaction or one involving corruption. Indeed, the purpose of a fraud is to create a profit, not to disguise one. And the purpose of corruption is to procure a benefit by giving funds to a third party, not to retain the use of the funds.

3. THE MONEY LAUNDERING PROCESS

Money laundering is generally described as a three-step process, using the services of bankers, lawyers, accountants and other professionals and, in many cases, benefiting from the protection offered by legislation in "friendly" countries. [Page16:]

The first of the three steps in money laundering is the phase colorfully called "smurfing" (a term intended to evoke the involvement or a large number of individuals who are relatively lowly members of the criminal organization). During this phase, cash is converted, through a succession of small and, to the extent possible, anonymous transactions, into a bank deposit or other negotiable, redeemable or saleable instrument or object. The archetypal example of "smurfing" would be that of a bank account opened in the name of a corporation, into which a series of individuals make, repeatedly, cash deposits that are, individually, sufficiently small to fall below the declaratory threshold for the bank in question. A slightly more complex example is that of a series of individuals who remit travelers' checks or wire funds, paid for in cash, to a single recipient abroad. In all of these cases, cash of dubious origins is placed in the banking system, from which it can subsequently be withdrawn in a form that does not readily reveal those origins.

The second and third phases are called, more prosaically, layering (that is, converting or moving the funds to distance them from their source) and integration (that is, injecting the funds into the legitimate economy). An example of layering would be using a bank account that is opened and funded by cash deposits to buy, preferably in another country, a luxury car that is then sold in exchange for a check from a legitimate buyer. An example of integration would be to use the proceeds from that check to buy machines for, say, a … laundromat4.

From this brief description of the money laundering process, it is clear that the services of professional advisers are required by money launderers, at a minimum, to create the corporation into which the illicit funds are ultimately "integrated." More commonly, money launderers (and, more to the point, the principals they represent) act like the very rich people they are and seek out competent legal, tax, financial and accounting advice not only in order to cloak their transactions in an air of legitimacy, but also to minimize taxes, limit on-going operating expenses and recurrent overhead and maximize profits or resale value.

Another by-product of the fact that money launderers (and their principals) are very rich is that the legislation in numerous countries has been slow to integrate anti-money laundering provisions. These countries include the home territories of certain drug traffickers (for example, Guatemala) [Page17:] or other criminal organizations (for example, Ukraine). They also include developing countries with little incentive to cooperate in international cross-border policing activities (for example, Nigeria) and, traditionally, countries with few natural resources that have achieved international prominence by offering to domicile, with few formalities and no taxes, local "off-the-shelf " corporations, including in many instances banks.

A "blacklist" of the countries deemed to be friendly to money launderers is published from time to time by the Financial Action Task Force on money laundering ("FATF" or, in French, "GAFI" 5 ), a multi-country6organization set up, in 1989, at the G-7 Summit held in Paris, for the purpose of "examining money laundering techniques and trends, reviewing the action which had already been taken at a national or international level, and setting out the measures that still needed to be taken to combat money laundering. 7 " Surprisingly, perhaps, this so-called "blacklist" does not include, or more precisely no longer includes, a certain number of countries that top the list of countries commonly perceived as tax havens - the Cayman Islands, the Bahamas and Liechtenstein, notably - or that are reputed to be the "home turf " of criminal organizations of international importance - Panama and Russia, for example. These seeming omissions are due to the fact that the countries in question have at long last, often after considerable vacillation, adopted stringent anti-money laundering laws, which they seem to be enforcing.

4. EXAMPLES OF MONEY LAUNDERING SCHEMES

How, exactly, is money laundered? The methods used by money launderers are varied and, often, complex. For the purposes of illustration, however, let us focus briefly on five examples of money laundering transactions.

Given the topic under consideration today - money laundering (and fraud and corruption) and arbitration - the first example, appropriately, is that of using judicial or arbitral proceedings to legitimate a payment.

How does it work? Very simply: a complicit but apparently unrelated party in Country X asserts a spurious or inflated claim against a party in Country Y seeking to move large amounts of cash into Country X. The defendant (or respondent) then contrives to lose the action and makes payment of the judgment or award entered against it using cash or thinly-disguised proceeds of criminal activity (for example, the balance of a bank account created using cash deposits). [Page18:]

And voilà, the plaintiff (or claimant), which in reality is controlled by or acting for the same principals as the defendant (or respondent), acquires a significant amount of cash (which in many countries is considered as a tax-free income) that it can easily explain to its banker and the tax authorities, and the defendant has, potentially, a loss that it can set off against its local tax obligations.

What is undoubtedly a far more common money laundering scheme is that in which a money launderer undertakes to buy an asset (such as real estate or a business) and offers, as security for the payment of the price, a pledge over an off-shore collateral account (that is, a bank deposit containing cash of dubious origin). When, surprise of surprises, the money launderer defaults, the seller is paid using the bank deposit and the money launderer acquires a valuable asset that he can then sell on to a third party for funds that are much easier to account for than was the original cash.

Import-export sales are also easy vectors for money laundering. All you need do is have excess, and illicit-origin, cash in one country that is used to buy overpriced goods in another country, using and abusing, for this purpose, a standard letter of credit structure8. The seller then has income that it can explain without difficulty; the buyer has goods that it can resell for a "legitimate" profit. The two parties need not be related. Indeed, for many sellers, the incentive of being able to sell goods at above the prevailing market price is sufficient incentive to justify turning a blind eye to the probable origin of the funds used to pay their invoices. Moreover, for money laundering buyers, a transaction cost of up to 20% or more (in the form of a difference between the purchase price of the goods and the amount for which they can be resold, plus expenses) may be perfectly acceptable9, if the result is to make the net funds available for reinvestment without attracting unwanted official attention.

A somewhat more colorful example is that of the Parisian "Asian ants." A few years ago, the Paris police uncovered an Asian money laundering gang working in Paris. The gang recruited, from local Asian neighborhoods, individuals who were, daily, given illegal-origin cash in a pre-agreed amount and asked to impersonate Japanese or other oriental tourists and buy, for cash, luxury goods such as Vuitton handbags and Dior scarves, which they handed over the same day to the gang. The gang then boxed the goods and shipped them to buyers in the Middle East and Asia. To be sure, the resale netted less than the cash expended, but the indirect profit - in terms of illegal cash that transformed into easily explainable checks for goods sold - was considerable. [Page19:]

Yet another example is that of sales contracts where the goods (or, for example, products like insurance policies) are purchased by the money launderer either by paying several cash installments, each of which is below any reporting threshold applicable to cash payments, or by paying in kind. Before the final payment is made, the money launderer terminates the contract and obtains reimbursement, by check from the seller, of the sums paid to date.

Of course, now that money laundering is considered in certain countries to include investments made using the gains from tax fraud10, money laundering may take the form, for example, of a merchant endorsing checks received by him from his customers over to an offshore company or, where checks cannot be endorsed11, accepting checks with the identity of the payee left in blank in payment and inserting the name of the offshore company as payee. In such cases, the merchant is presumably under-declaring his income, since the checks remitted to the offshore company do not transit through his bank account. The merchant will ultimately recover the funds paid by him either because he holds an interest in the offshore company (which may be required to pay tax on its "income," but undoubtedly at a far lower rate, due to its location in a low-tax jurisdiction) or because the offshore company uses part or all of the money to purchase assets, also offshore, for the account of the merchant.

5. RISK FACTORS

The underlying principle of most current laws on money laundering is that, notwithstanding the variety of techniques used by money launderers, there are a certain number of factors that should, almost as a matter of course, elicit suspicion in an alert banker or other professional.

First among these is the involvement, particularly if for no apparent purpose, of transfers of funds from or to a "blacklisted" country. Today, only eleven of these "blacklisted" countries remain: the Cook Islands, Egypt, Grenada, Guatemala, Indonesia, Myanmar, Nauru, Nigeria, the Philippines, Saint Vincent and the Grenadines and Ukraine. Many bankers, however, continue to include on their personal watch lists countries removed only recently, or due to intense political pressure, from the FAFT list. Thus, for example, financial transactions with countries such as the Cayman Islands, Israel or Russia continue to be scrutinized closely by many banks. [Page20:]

Countries appearing on the past and present FATF "blacklists" are, of course, not the only countries that, in practice, are treated with a certain suspicion. In particular, a certain number of countries, considered as a likely home for funds and companies belonging to money launderers because they constitute financial havens, are often included by banks, for example, on their internal watch lists. What are the characteristics of financial havens? Generally, they have no tax treaties providing for the sharing of information with other countries or are lax in enforcing information-sharing provisions. Generally, too, they offer inexpensive "off-the-shelf " corporations and enforce strict standards of confidentiality in banking and corporate matters. In many cases, they also have an excellent infrastructure for electronic communications, use a major world currency, and preferably the United States dollar, as local money and benefit from a local government that is relatively invulnerable to outside pressure. They may also have a large tourist trade that can help explain major inflows of cash and a geographic location facilitating business travel to and from rich neighbors. Finally, they frequently have a well-developed, internationally savvy, financial services sector that generates a significant amount of local income.

Other characteristics of a transaction, above and beyond the countries involved in it, are also deemed to warrant, inherently, greater scrutiny. Thus, for example, certain professions are generally considered, with a certain amount of justification, to be particularly susceptible to use as a conduit for money laundering.

Banks, of course, were the first conscripts in the war against money laundering on the very logical basis that the initial step in any money laundering scheme - smurfing - consists of injecting the liquid proceeds of crime into the banking system and the second step - layering - generally consists of moving the funds, for the most part through banking channels, to another location or account. As a result, banks are, in many countries12, required to put in place internal control procedures directly aimed at identifying suspected cases of money laundering and reporting them to the relevant authorities, the bank's duty of confidentiality to its customers being superseded, in such cases, by the bank's reporting obligation.

Other professions have since been added, in many countries, to the initial list of professions that are obligated by law13to report any suspected money laundering of which they may become aware. These professions are those deemed to be particularly susceptible to use by money launderers to transform cash into goods that can be easily resold or returned in exchange for a check. [Page21:]

Antiques dealers and dealers in precious stones or artwork are an obvious example. They frequently accept cash from their customers and their goods are often easy to transport and have an intrinsic value that permits resale locally or in another country without excessive difficulty or risk of loss.

A slightly less obvious, but arguably more significant, vector for money laundering is that of real estate sales. Typically, money laundering in this sector takes the form of a purchase agreement in which part of the price is either undisclosed or disguised as a commission or payment for furnishings, for example, and is paid offshore and, if possible, in cash. For the seller, this arrangement makes it possible to limit capital gains taxes. For the buyer, the part of the price paid in cash will be recovered when the property is resold for what is ostensibly a "profit." In the case of luxury properties, in particular, this type of manipulation may be difficult to identify, since numerous factors - the financial situation of the seller, the attachment of the buyer to the property or work carried out between the first and second transactions14, for example

- may quite legitimately cause the price of a given property to vary from one sale to another, even within a relatively brief lapse of time. Because of the propensity of money launderers to use real estate sales to convert cash into apparently legitimate-source income, real estate brokers were among the professionals specifically subjected by existing international legislation to an obligation of increased vigilence.

Not all sectors that are in fact used by money launderers as conduits for converting cash into goods or investments are included on the various legislative lists of professions subject to a specific reporting obligation. For example, import-export sales may, as noted above, also be used by money launderers to move money from one country to another and laundromats (and restaurants) are also popular investments for money launderers, due to the fact that they generate cash that can be explained when depositing it in the bank. Nonetheless, these professions are in most countries not currently subjected to a specific reporting requirement.

Car, truck and motorcycle dealerships, which are now subject to a reporting requirement in the US15 but for the most part not elsewhere, are another example of a vector favored by money launderers that has, until now, been subjected to only limited regulatory control. For a money launderer, a car, motorcycle or truck, if it can be purchased wholly or in part for cash and resold[Page22:] to a legitimate purchaser for a check, permits more cash to be converted in a single operation than does, for example, the sale of a Vuitton handbag. Moreover, most motor vehicles have a readily ascertainable value (a very useful attribute from the money launderer's perspective) and are, by definition, mobile and can easily be resold at a certain distance from their point of purchase (yet another valuable attribute). As an added bonus, for the money launderer, between purchase and sale a luxury car can be used by the money launderer for his personal purposes.

Although the businesses that are popular with money launderers are far too legion to be listed in a brief discussion of the phenomenon (remember that we are speaking, roughly, of a trillion dollar per year market), one final sector merits special mention: the market for consultancy and other professional services, particularly in transactions with financial havens16. Here, the money launderer's objective is not to acquire goods with a specific resale value, nor to add value to property that can be recovered on disposal of the property, but to structure international investments and movements of funds so as to attract the least official attention, minimize taxes (but not avoid them, since paying taxes lends an air of legitimacy to the transaction) and reduce operating costs. For the professional, these objectives may appear to be, and indeed are, perfectly consistent with those of a legitimate businessman. Moreover, the ostensible purpose of the transaction - facilitating the purchase of a luxury property in France, for example

- may also appear wholly legitimate. Nonethe-less, like bankers, professionalsspecialized in "tax optimization" cross-border transactions are likely to be, wittingly or not, occasionally or more regularly, at the heart of a certain number of money laundering transactions. It is for this reason that, increasingly, professional advisors are among those singled out as having certain reporting obligations under money laundering laws17.

Finally, existing money laundering laws also identify, as flags marking potential money laundering activities, manifestly overpriced or underpriced transactions (because they generate unequal flows of funds or goods not easily explainable by ordinary commercial objectives), transactions of unusual complexity or dubious profitability (because the need to distance cash from its source may, for a money launderer, impose structuring considerations that outweigh the desire to earn a profit on the transactions) and transactions involving unusual or exotic sources of funding (again, due to the need to convert illicit-origin offshore cash or assets previously purchased using illicit-origin cash into what appears to be a legitimate investment). [Page23:]

All of the foregoing risk factors are taken into account in at least some of the existing anti-money laundering laws.

6. WHAT ARE THE PRIMARY APPLICABLE LAWS?

Internationally, several layers of texts may apply. While the United States enacted domestic legislation directed at identifying money laundering activities as early as 1970 (the date of the United States Bank Secrecy Act requiring cash transactions over a certain threshold to be declared by banks), the first international initiatives of significance were taken in Europe. Indeed, in 1980, the Council of Europe issued Recommendations on money laundering. It was almost ten years later, however, before the first concrete measures were adopted and regional conventions were concluded, initially in Europe only, to take concerted action against money launderers.

Thus, in 1989, at a European Summit (held two years after the enactment, in the United States once again, of the Money Laundering Control Act), it was decided to create the FATF. Shortly after its creation, the FATF issued a list of forty recommendations for identifying and attacking suspected money laundering transactions. These recommendations, with modifications, have largely inspired the international conventions and national legislation sub-sequently enacted to address money laundering issues.

The first truly international convention to be adopted was the Council of Europe's Convention on Laundering, Search, Seizure and Confiscation of the Proceeds of Crime, signed in Strasbourg, France, on November 8, 199018. It was followed almost immediately by the first European directive on the subject, EC Directive 91/308[Page24:] of June 10, 1991, on the prevention of the use of the financial system for the purpose of money laundering. In recent years, there has been a flurry of international treaties or conventions on the subject of money laundering: the Model Regulations Concerning the Laundering Offences Connected to Illicit Drug Trafficking and Other Serious Offences enacted by the Organization of the American States in 1998, the International Convention for the Suppression of Terrorism enacted on December 9, 1999, the Model Legislation on Laundering, Confiscation and International Cooperation in Relation to the Proceeds of Crime (for civil law jurisdictions) enacted in Vienna in 1999, the corresponding Vienna convention, enacted in 2000, for common law jurisdictions (the Model Money Laundering and Proceeds of Crime Bill) and the EC Directive 2001/97 of December 4, 2001, amending EC Directive 91/308.

Throughout the world, local money laundering laws have been adopted, particularly in the past decade. Indeed, the FATF, which for many years has issued lengthy lists of those "non-cooperative countries and territories" (the so-called "blacklist") whose anti-money laundering legislation and local enforcement efforts were judged insufficient, has recently reduced its list, as noted above, to a mere eleven countries.

Local legislation varies, of course. Traditionally, money laundering legislation followed one of two models: the United States model or the European model. In the United States, where, as noted above, the first legislative texts are now over thirty years old, the initial approach was to require banks to report automatically all cash transactions in excess of a certain amount, whether or not they appeared suspicious. In Europe, the approach was to require banks (and, for the past ten years, certain other professionals such as real estate brokers) to get to know their customers and identify and declare suspicious transactions only. Today, the two approaches have largely converged. In the USA Patriot Act 2001, numerous professionals, and not just bankers, are now required to take concrete steps to confirm the identity of their customers and to scrutinize and declare transactions that appear suspicious. Under the most recent EC Directive, which is currently being implemented into local law in European countries, the traditional know-your-customer rules continue to apply, but automatic declarations must now be made in certain cases, even in the absence of suspicions.

French legislation is a good illustration of the modern trend in anti-money laundering legislation. The first specific national legislation on the subject of money laundering was enacted in July 1990 and imposed a duty on financial institutions and a limited list of other professionals to declare suspicious activities and created specific, more stringent, obligations for financial institutions alone, which were required to put in place concrete measures to ensure a constant level of vigilance. It was only in May 1996 that money laundering became a specifically identified criminal offense in France and, initially, was tied specifically to the proceeds of drug trafficking and other organized crime. Aiding and abetting money laundering (like revealing the existence of a declaration of suspicious activities to a suspected money launderer) was also made a criminal offence (subject to sanctions even more severe than those applicable to the money launderers themselves). In May 2001, the definition of money laundering was expanded to include the proceeds of any major crime[Page25:] or "organized" criminal activity, a definition that is generally considered to cover tax fraud. Moreover, the obligation to declare suspicious activities was expanded to include automatic declarations in a certain number of cases and to include transactions that "might" involve money laundering (as opposed to the previous standard, that is, transactions that "appear to" involve money laundering). Currently, legislation is being prepared to enact into French domestic law the innovations reflected in the most recent EC Directive, such as the expansion of the list of professions subject to the obligation to declare suspicious activities and the enlargement of the definition of money laundering to include new types of criminal activities.

On top of this legislation, banks and other financial institutions are subject, under the rules issued by the local French banking authorities, to very detailed and comprehensive internal control requirements, including anti-money laun-dering measures. While these regulations have yet to be emulated by other regulatory bodies, such as that responsible for supervising the insurance industry, numerous white papers or guidelines have been issued, both by such bodies and by professional associations. Increasingly, it seems clear, the trend will be to impose on all professionals that are likely to be touched by money laundering activities an active duty of cooperation, inspired at least in part by the obligations already imposed on bankers.

Anti-money laundering legislation is thus evolving rapidly. Most countries are now participating in the fight against money laundering. The definition of what constitutes money laundering has expanded, distancing it from the limited initial arena of organized crime and drug-related offenses to include a broad range of crimes judged, locally at least, "serious." Passive assistance to money launderers is being criminalized. The types of professionals enlisted in the fight against money laundering have been extended from the initial, restrictive, list consisting largely of financial institutions and professionals in the sectors judged to be the most favored among money launderers, such as real estate sales, to include lawyers, accountants and numerous other professionals and, even, in the United States, car salesmen. The duty to obtain proof of customers' identities and to scrutinize transactions has been refined and extended. Automatic declarations in certain cases are becoming obligatory.

The future, clearly, is one of increased regulation. [Page26:]

To form a better idea of the current state of anti-money laundering initiatives, certain web sites can be consulted. In particular:

• Council of Europe: http://conventions.coe.int

• European Union: www.europa.eu.int

• FATF: www.fatf-gafi.org

• Federal Bureau of Investigation: http://www.fbi.gov/hq/cid/fc/ml/ml.htm

• French Finance Ministry: www.finances.gouv.fr

• French Ministry of Interior Affairs:

http://www.interieur.gouv.fr/police/dcpj/sdaef/Missions.htm

• ICC: http://www. icc-ccs.org

• International Monetary Fund: www.imf.org

• International Money Laundering Information Network:

http://www.imolin.org

• Interpol: www.interpol.int

• OECD: www.ocde.org

• UN: http://www.un.org et www.undcp.org

• United Kingdom Financial Services Authority: http://www.fsa.gov.uk

• US Treasury Department: www.ustreas.org[Page27:]

1
The International Monetary Fund (www.imf.org).

2
World Bank (www.worldbank.org).

3
French Assemblée Nationale (www.assemblee-nat.fr).

4
Laundromats are, as it happens, a popular type of investment for would-be money launderers, since they generate, quite legitimately, cash, and banks holding accounts for laundromats naturally expect to receive deposits in the form of cash and may not be in a position to judge whether the amount of the deposits remitted to them is commensurate with the size and activity of their client's official business. Similar types of businesses that are popular with money launderers are restaurants (pizzerias, for example) and car washes, although any business with a high percentage of cash sales will serve the purpose.

5
Groupement d'Action Financière sur le blanchiment des capitaux.

6
Initially, the Task Force was comprised of members from the G-7 Member States, the European Commission and eight other countries. Today, membership has expanded from the initial 16 members to a total of 28.

7
"History of the FATF" section of the FATF web site, at www.fatf-gafi.org.

8
The buyer opens a letter of credit, secured by a cash deposit, with his bank, which notifies it to the seller's bank. On presentation of the letter of credit, the money lanuderer/ buyer's bank transfers funds to the seller's bank, using the cash deposit.

9
Reputedly, however, the transaction cost that is deemed acceptable by today's sophisticated money launderers has declined considerably and is currently significantly below 10%.

10
For example, French money laundering regulations treat tax fraud as being among the illegal activities whose proceeds can be "laundered."

11
Many European countries prohibit the endorsement of checks unless a special form of check is obtained from the bank.

12
All EU countries and the United States, notably.

13
Antiques dealers, insurance companies, currency exchanges and real estate agents, notably.

14
Construction work is another area that offers interesting opportunities for money launderers. Indeed, many small contractors are often quite happy to work for cash. As for the money launderer, the cash outlay is converted into extra value of the property, which will ultimately be resold for an amount taking into the increase in value.

15
Patriot Act 2001, Section 326, and US Code Section 5312 (a) (2).

16
Consultancy in export sales is perhaps not an issue for money laundering purposes,but is often relevant in cases of corruption.

17
Legal and tax advisors, lawyers, accountants, clerks, real estate agent, notably.

18
In the same year, the United States enacted the Depositary Institution Money Laundering Amendment Act.