KYC & Anti Money Laundering CA. Ramesh Shetty FCA, DISA(ICA), CISA(USA)

1. KYC & Anti Money Laundering CA. Ramesh Shetty FCA, DISA(ICA), CISA(USA)

2. Basic Concepts • How it happens • Case Studies – Abroad • International Initiatives • Indian Scenario • Know Your Customer • Case Studies – India • Role of CA’s

3. Sec.3 of PML Act, 2002 defines ‘money laundering’ as: “whosoever directly or indirectly attempts to indulge or knowingly assists or knowingly is a party or is actually involved in any process or activity connected with the proceeds of crime and projecting it as untainted property shall be guilty of the offence of money-laundering”

4. Is to conceal criminal activity associated with it, including crimes it generated such as drug trafficking, tax evasion, corruption, extortion, circumventing regulations etc Process by which criminals attempt to hide and disguise the true origin and ownership of the proceeds of criminal activities, thereby avoiding prosecution, conviction and confiscation of criminal funds(IBA definition) Process by which dirty money appear clean or profits of criminal activities are made to appear legitimate. Concepts of Money laundering

5. Concepts - contd.. • Organized criminal groups use money laundering as a means to reinvest money. • The main objective is to get the illegal funds back to the individual or group of individuals who generated them. • Financial intermediaries (banks, financial institutions) are used to change money gained from illegal businesses into acceptable and transferable units, turning illegal gain into legal tender

6. Concepts - contd.. ML generally refers to ‘washing’ of the proceeds or profits generated from:- • Drug trafficking – South Asian • People smuggling – African Countries • Financial frauds - • Arms, Antique and gold smuggling • Illegal sale of wild life products and others. • Prostitution rings • Corruption

7. Concepts - contd.. • ML every year $600 Billion to $2 Trillion. • Financial powers • Big time criminals • Use professionals to create legal structure/ entities which act as a front

8. Money Laundering Process Money laundering is a diverse and a complicated process that involves three independent steps that often occur simultaneously • Placement • Layering • Integration

9. Stage 1 - Placement • Physically disposing of cash derived from illegal activity. • Funds are placed close to the underlying activity in the country where the funds originate. • One way of accomplishing this is by placing criminal proceeds into traditional financial institutions or non financial institutions such as currency exchanges, casinos.

10. Placement • launderer inserts the dirty money into a legitimate financial institution. • In the form of cash deposits. • to report high value transactions. • This is the riskiest stage of the ML process because large amounts of cash are pretty conspicuous and banks are required

11. Stage 2 - Layering • Separating the proceeds of criminal activity from their source through the use of layers of financial transactions. • These layers are designed to hamper the audit trail, disguise the origin of funds and provide anonymity • They use shell companies, offshore banks or countries with no or less regulation, a large business centre.

12. Layering • involves sending the money through various financial transactions to change its form and make it difficult to follow. • Layering may consist of several bank to bank transfers • wire transfers between different accounts in different names in different countries • making deposit and withdrawals to continually vary the amount of money in the accounts • changing the money’s currency • purchasing high value items (boats, houses cars, diamonds) to change the form of money-making it hard to trace.

13. Stage 3 - Integration • Placing the laundered proceeds back into the economy in such a way that they re-enter the financial system as apparently legitimate funds. • The launderer may choose to invest in other centres. • Eg. False invoices for goods exported, domestic loan against a foreign deposit, purchasing property, etc.

14. Integration • At the integration stage the money re-enters the mainstream economy in legitimate looking form it appears as a legal transaction. this may involves final bank transfer into an account of a local business in which the launderer is investing in exchange for a cut in the profits., a sale of a yacht bought during the layering stage. at this point the criminal can use the money without being caught. It is difficult to catch a launderer during the integration stage if there is no documentation during the previous stages • Overseas banks • Money launderers often send money through various offshore accounts in countries that have bank secrecy laws –these countries allow anonymous transactions. A complex scheme may involve hundreds of bank transfers to and offshore banks .According to the international Monetary fund ,”major offshore centres iclude Bahamas, Bahrain,Cayman islands, hong kong, Antilles, Panama, and Singapore (IMF)

15. Types/Techniques • Debit/Credit Cards • Deposit structuring (or smurfing) • Connected accounts – Connected to each other • Alternative Remittance services –the hawala route • Loan back arrangements • Forex money changers • Investment banking and the securities sectors • Insurance and personal investment products • Correspondent banking • Lawyers, Accountants and other intermediaries • Mis-use of non-profit organizations • Use of “Payable through accounts” by international launderers

16. Types/Techniques – Contd… • Use of legal persons • Corrupt Politicians/Public officials • Underground banking /alternative banking – • Countries in asia - well established legal alternative banking systems that allow undocumented deposits , withdrawals & transfers. • Are trust based systems and often have ancient roots, leave no paper trail and operate outside government control. • Eg. Hawala system in Pakistan and India and Fie Chen system in China. • Shell companies (fake companies) – • Take in dirty money for payment of supposed goods or services but actually provide no goods and services. • Create the appearance of legitimate transactions through fake invoices and balance sheets

17. Deposit Structuring/Smurfing $ 50, 000 Laundered money Below deposit amts Days $ 10,000 1 $ 10,000 2 $ 10,000 3 $ 10,000 4 $ 10,000 5 Balance = $ 50,000

18. Computers/Electronic systems can be used as at tool for perpetrating illegal or criminal activities . Organized criminals can break security in electronic systems more easily and more cheaply by forcing employees who have legitimate access to the system to furnish them with passwords. Easier to corrupt an individual in a country where average salary is low. Money launderers look for countries where there are highly educated well trained banking personnel on a low salary to corrupt them. Money laundering through electronic systems/cross border activities

19. Legal Sources of terrorist financing: • Collection of membership dues • Sale of publications • Cultural of social events • Door to door solicitation within community • Appeal to wealthy members of the community • Donation of a portion of personal savings

20. Illegal Sources • Kidnap and extortion • Smuggling • Fraud including credit card fraud • Misuse of non-profit organisations and charities • Fraud, thefts and robbery and • Drug trafficking

21. Use of shell companies by lawyers • A prominent attorney • Ml network 16 FIs-US and abroad offshore locations • Charged flat fee to money launder funds • Funds of clients were wire transferred to his offshore accounts • Moved to Carribbean destinations and USA • Issued credit cards in false names to help clients withdraw money through ATMs

22. Smaller banks and NBFCs • Private banking assistance provided by the employees-help structure and smurf to recycle funds in the bank accounts-typically by making deposits and withdrawing heavily from the accounts. A few month before audit the activity would stop with a small balance. • Done to avoid suspicion and disclosure • Loan back arrangements a technique- the launderer usually transfers the illegal proceeds to another country- then deposits the proceeds as security or g’tee for a bank loan- then sent back to original country –gives the appearance of a genuine loan.

23. Payable through accounts • They are demand deposits accounts maintained at FIs by foreign banks. The foreign banks channel all deposits and cheques of its customers into one account at a local bank. The foreign customers have a signatory authority for the account as sub account holders and could conduct normal international banking transactions-defeats KYC norms.

24. Case Study-Franklin Jurado • During -1990 Harvad educated economist ran a ML network for Columbian drug lord Jose Santa Cruz –Londono complex scheme. • ML of $ 36 Million • Wiring out from Panam Bank to Merril Lynch and other Institutions • 100 bank accounts in 68 countries • When a Monaco bank collapsed and a subsequent audit revealed numerous accounts that traced back to Jurado. Also a complaint on his money counting machine made all night by his neighbor in Luxembourg. • Found guilty convicted sentenced to prison.

25. Drug Money laundering- Franklin Jurado case Drug (dirty) Money • Placement Panama Banks • Layering 100 Bank accounts in Europe • Shell companies in Europe • Integration Colombian businesses

26. Case Study-Accounting firm • Two Narcotics traffickers • Regular deposit of criminal proceeds from drug sales Receipts issued. • Accounting firm • Stored in the accountant’s office. Accountant structured deposits. Opened trust/coy accounts/personal accounts • Wire transfer • Transferred proceeds overseas. Structured transactions • Purchase of assets • Purchase of truck parts, brought back parts into country sold for a profit. Also purchased real estate. • Services provided by many professionals such as accountants, lawyers, real estate agents also serve as potential mechanisms to launder money.

27. Suspicious transactions Riggs Bank was fined $25 mn for violation of AML under the US Bank Secrecy Act. It pleaded guilty and paid $ 16 mn in fines in February 2005 It also paid $9 mn to Pinochet’s victims Criminal charges against some of the bank’s employees Bank’s operations acquired by PNC Bank in May 2005 Riggs Bank-Money Laundering Scandals

28. Riggs Bank-Money Laundering Scandals • Augusto Pinochet- former Dictator of Chile widely accused of corruption, illegal arms, sales, etc-Riggs invited Pinochet to open an account • US Senate reported that Riggs executives connived with Pinochet to disguise millions of dollars that had been stolen from Chilean people. • Pinochet arrested in 1998 in Britain- extradited to Spain • Accounts were frozen. But by using shell companies and hiding accounts from federal regulations, Riggs allowed Pinochet to retain access to his fortune.

29. Riggs Bank-Money Laundering Scandals • A Saudi Omar Al Bayoumi opened a bank account for 9/11 hijackers • Two weeks later his wife received monthly payments in tens of thousands of dollars from Princess Haifa Bint Faisal (the wife of Saudi Ambassador). • Prince Bandar Bin Sultan (confidante of Bush ) also had an account with Riggs bank. Large transactions between him and other saudis (no background checks done ) • An FBI investigation carried out Was closed with no action.

30. Case Study-Insurance policies and real estate • Two European nationals • Purchase of Life insurance policies (Total value $ 268,000) • Payment of premium (Payment made by cheques drawn on brokerage firm in a major EU financial market and a notary in the country) • Policies put up as collateral (provided by a leasing company) • The offenders were brothers who were involved in the illegal export/import of classic cars • Non banking institutions could also become conduits for money laundering.

31. Rough estimate - 2 to 5% of GDP (1996) $600 bn to $2 trillion every year. Principal sources of illegal proceeds-Drug trafficking –single largest generator of illegal funds Banking sector- smurfing common Shell companies-tool widely used by lawyers and accountants Smaller banks and NBFCs used as channels-Private banking assistance-Help given in restructuring accounts- Reports/Facts on Money Laundering

32. Impact – On Economy • Unpredictable changes in money demand • Risks to banking system - Reputational risk, legal risk, operational risk, concentration risk. • Increased volatility of international capital flows • Increased volatility of exchange rates due to unanticipated cross asset transfers. • Economic and political influence of criminals can change social systems, ethical standards • Crime can infiltrate financial bodies, public officials/ governments • Macro economic situations • Money laundering poses a serious threat to the international community and financial systems in countries the world over

33. FATF (Financial Action Task Force) • Established by the G-7 Summit that was held in Paris in 1989 • An inter-governmental body / Post 09/11 • Purpose - Development and promotion of policies, both at national and international levels, • to combat money laundering and terrorist financing. • 34 countries, India is being one of the observer status • Published 40 + 9 recommendations • Political level commitment to comply with FATF recommendations • FATF focuses on setting standards for AML/TF • Assessing implementation of the programmes • Identifying and studying ML and FT methods and trends

34. Legal Systems-money laundering to be treated as a serious offence Measures to be taken by financial institutions Undertaking customer due diligence(CDD) and record keeping Countries to establish Financial Investigation Unit (FIU) for receiving, analysing of info and enforcement of law. Reporting systems-CTR and STRs/penalties Internal policies for adequate screening procedures for hiring employees. Non financial businesses (lawyers, notaries, dealers, trusts service providers) required to report suspicious transactions Countries should not allow operation of shell companies Robust supervision and regulation of financial institutions Regulation of casinos. FATF Recommendations -Features

35. Under the PMLA 2002, rules were framed in 2005 & 2009 Setting up of the FIU-IND in 2004 Section 12 of the Act casts certain obligations on banking companies/Financial Institutions/Intermediaries in regard to reporting of customer account information and preservation of records Maintenance of record of all cash transactions above Rs 10 lakhs All series of cash transactions of value less than Rs 10 lakhs integrally connected if they have taken place within a month (aggregate value above Rs 10 lakhs) All cash transactions here forged or counterfeit notes have been used. All suspicious transactions made in cash or otherwise. Indian Scenario/InitiativesPrevention of Money Laundering Act, 2002

36. Preservation of records for 10 years Reporting to FIU Manual reporting of cash transactions (CTR) & suspicious transactions (STR) Consolidated reporting of cash transactions FIU-preservation and reporting requirements

37. Appointment of a Principal Officer To assess, monitor and control money laundering risks. Receive information from branches and analyze information The PO will be responsible for timely submission of CTR and STR to FIU-IND Utmost confidentiality to be maintained while filing Reports for all branches are filed in one mode –manual and electronic A summary of cash transaction report for the bank as whole be complied by PO of the bank RBI KYC norms

38. Advantages of KYC norms Sound KYC procedures have particular relevance to the safety and soundness of banks, in that: - They help to protect banks’ reputation and the integrity of banking systems by reducing the likelyhood of banks becoming a vehicle for or victim of financial crime and suffering consequential reputational damage; - They provide an essential part of sound risk management system (basis for identifying, limiting and controlling risk exposures in assets & liabilities)

39. KYC - Meaning Customer? • One who maintains an account, establishes business relationship, on who’s behalf account is maintained, beneficiary of accounts maintained by intermediaries, and one who carries potential risk through one off transaction. Your? Who should know? - Branch manager, audit officer, monitoring officials, PO Know? What you should know? - True identity and beneficial ownership of the accounts - Permanent address, registered & administrative address

40. KYC - Meaning • Making reasonable efforts to determine the true identity and beneficial ownership of accounts; • Sources of funds • Nature of customers’ business • What constitutes reasonable account activity? • Who your customer’s customer are?

41. Elements of KYC • Customer Acceptance Policy • Customer Identification Procedure- Customer Profile • Risk classification of accounts- risk based approach • Risk Management • Ongoing monitoring of account activity • Reporting of cash and suspicious transactions

42. High Risk Customers • Non-bank financial institutions ( money transmitters, cheque cashiers, full fledged money changers, sellers of stored value cards, security brokers & dealers etc. ) • Travel agencies / Property dealers/ builders • Professional and consulting firms • Exporters or importers of goods and services • Cash intensive business e.g. retail stores, restaurants, gambling casinos, second hand car dealerships etc. • Off-shore corporations • Non-profit organizations eg. charities

43. High Risk Products • Wire transfers: • Both domestic and cross border wire transfers carry potential risk of money laundering • Payment gateways facilitate wire transfers for customers of banks located anywhere in the world • Ascertain whether it is regulated at the place of incorporation • Insist on complete originator information with wire • Make payment to beneficiary through account or DD • Keep record of transactions • Electronic banking services which includes services offered through internet, credit cards. • Private banking relationships • Correspondent banking relationships

44. Measures to deter ML • Board and management oversight of AML risks • Appointment a senior executive as principal officer with adequate authority and resources at his command • Systems, controls & Documentation - identify, assess & manage the money laundering risks • Make a report to the Board on the operation and effectiveness of systems and control • Creating customer profiles • Screening of employees before hiring and of those who have access to sensitive information • Appropriate quality training to staff • Quick and timely reporting of suspicious transactions

45. A transaction whether or not made in cash to a person acting in good faith. Gives rise to a reasonable ground of suspicion that it may be proceeds of crime No economic rationale or bonafide purpose Identity of client False identification of documents Identification cannot be verified within a reasonable time Accounts opened with names very close to other established business entities Background of client Links with known criminals Suspicious transactions - FIU-IND

46. Multiple accounts Unexplained transfer between accounts with no rationale Unusual activity compared with past transactions Sudden activity in dormant accounts Activity inconsistent with what would be expected from declared business Frequent purchase of drafts with cash Categories for financial intermediaries –financial brokers. Merchant bankers, portfolio manager Large sums being transferred overseas for payment Dealings at off market rates. Suspicious transactions - FIU-IND

47. FIU Directions • Only banks and other financial institutions are obligated to report on suspicious transactions regularly to the financial intelligence unit set up under the Finance Ministry. • Such transactions are forwarded by the FIU to enforcement agencies for action after scrutiny. • Financial intermediaries like full-fledged money changer, money transfer service providers such as Western Union and International Payment gateways, including VISA and MasterCard are brought under the amended PMLA. • India’s international obligation and empower the enforcement directorate to search the premises immediately after the offences are committed and police have filed a report

48. Customer regularly depositing or withdrawing large amounts by wire transfer to or from or through countries known for narcotics or where ML laws are lax. Sending or receiving frequent large volumes of wire transfers to and from offshore institutions Loan proceeds are wired to offshore bank Receiving wire transfers and immediately purchasing monetary instruments payable to third party. Customer pays for a large wire transfer using multiple instruments drawn on several financial institutions IBA Check list - Caution to be exercised

49. Manipulation of primary market by financers and market players using fictitious names. Sole person authorized to operate all the accounts. The person was also director in all the companies Current accounts opened in multiple companies on the same date at the same bank branch Failure to identify the identity and address of all directors of the companies Identity disguised by using different spellings for the same name in different companies. Proper introductions nor obtained Risk profiling not done Objective for opening large number of accounts in the names of large number of joint account holders not questioned Transfer of huge funds from companies account to individuals account which was used to invest in IPO Poor monitoring and reporting system IPO SCAM - INDIA

50. Operational deficiencies Factors that facilitated the IPO scam are - • Proper introductions not obtained • Photographs not obtained • Failure to independently verify the identity and address of all joint account holders • Signatures not taken in the presence of bank official • Directors identity/ address not verified • Customer Due Diligence done by a subsidiary