CHAPTER 1
Money Laundering and Anti-Money Laundering
In some facile, legalistic sense, the perfect and complete solution to money laundering is easily available to all governments: legalize it. Or rather, return to the not-too-distant past when no state had criminalized the practice of money laundering. After all, for a criminal offense to be committed, states must have gone to the trouble to specify that certain conduct constitutes an offense in the first place.1 Given that money laundering is a derivative crime, depending on the proceeds of another crime, this point is less trivial than it might at first appear. In this legal sense, the history of money laundering is quite short because it was first instituted as an offense in the mid-1980s. But the history of money laundering is much longer if the term refers to a practice or type of behavior: the process of hiding the illicit provenance of money derived from crime.
This chapter focuses on the legal history of money laundering and the policies used to counter it as they have arisen over the past few decades. The first aim is to present a brief account of the main features of the contemporary practice of money laundering, although for all the policy attention and money lavished on this subject there are surprisingly large gaps in our knowledge. The second goal is to sketch out the origins and main features of policies designed to counter money laundering, which have been exported in remarkably similar form around the globe. In providing background on money laundering and AML policy, this chapter anchors both the assessments of effectiveness, presented in chapters 2 and 3, and explains subsequent diffusion. My goal is to give the reader a working knowledge of the origins and nature of the AML regime sufficient to put these later, more detailed discussions in context.
What Is Money Laundering?
Most crimes, and nearly all organized and cross-border crimes, are driven by the desire for profit. The majority of criminal offenses generate relatively small sums of money. The proceeds can simply be spent on everyday consumption. In these cases, because the sums are small, there is little or no need to disguise the origins of the money. However, for international and organized crime (the latter a highly contested term),2 there is usually more money than can be spent quickly without arousing suspicion. Stockpiling cash is problematic for several reasons. First, cash may be quite bulky, with a million dollars in twenty-dollar bills weighing perhaps 50 kilograms. Particularly in the case of drug trafficking, relatively low-denomination notes may be common, and the resulting cash often weighs more than the drugs themselves. Second, cash may be vulnerable to physical decay. According to his brother, Colombian drug lord Pablo Escobar suffered losses of approximately 10 percent from having stockpiles of notes damaged by water or being eaten by rats.3 Large amounts of ready cash may present a tempting target for rival criminals. Finally, holding or spending too much cash may arouse the suspicions of law enforcement, especially with the surveillance measures introduced as part of AML policy. Thus in order to securely enjoy ill-gotten gains and ensure readily usable capital for further illegal activities, dirty (illicit) money must be made to seem clean (legal): hence, money laundering.
Disguising the origins of criminal money is said to have been going on for centuries, perhaps even in ancient times.4 However, the demand for this practice has increased exponentially over the last century. The rise of relatively complex financial institutions has provided more scope for fraud and white-collar crime. Even more important to money laundering is the illegal drug trade. To the extent that states have criminalized opium, heroin, cocaine, etc. since the early part of the twentieth century, they have both reclassified what had been legal behavior as illegal, thereby creating much more crime by fiat, and boosted the prices of these drugs.5 The combined result was a great deal more criminal money. In this sense, states have created a problem they have then struggled to solve.6
The term âmoney launderingâ itself is apocryphally said to date from the era of Prohibition in the United States and came about as a result of gangster Al Caponeâs need to invent an alibi for the massive profits from bootlegged alcohol. The story goes that Capone bought pool halls and self-service laundries to provide an explanation for his income and assets and hence âlaunderâ his illegal money.7 Although in lexicographical terms there seems to be little truth to this account, the attraction of comingling criminal money with legal revenues from businesses that engage in a large number of individual small cash transactions remains to this day. (Caponeâs eventual conviction on the grounds of tax evasion after investigators âfollowed the moneyâ has since exercised a powerful hold on the imaginations of those looking to defeat crime by attacking its financial underpinnings.) More accurately, however, money laundering was first used to describe President Nixonâs criminal conspiracy to secure reelection, which later became the Watergate scandal. The financial trail of check clearances connected the burglars who broke into the Democratic National Committee headquarters to Nixonâs campaign, and thence deep into the U.S. intelligence and justice hierarchies, before ending with the president himself.8 The first judicial use of the term was in the United States in 1982, and in 1986 the United States passed the Money Laundering Control Act, the first dedicated AML legislation.
How do criminals launder money? The nature of the laundering process is incredibly varied, in keeping with the huge range of crimes that give rise to the funds in the first place. The underlying crime that gives rise to the criminal money to be laundered is referred to as the âpredicate offense.â Because the initial focus on money laundering occurred concomitantly with the drug trade (as discussed in the following section), the trafficking of illegal drugs is one of the most common predicate offenses. But the number of predicate offenses, and hence the scope of AML law, has ballooned since the 1990s. Such offenses now include robbery, fraud, the illegal trade in arms and people, kidnapping, extortion, bribery, smuggling, embezzlement, counterfeiting, price-fixing, insider trading, and other offenses (tax evasion and the financial support of terrorists are special cases discussed separately). The methods and venues of laundering are almost endless. Various bodies have recently expressed the concern over laundering in the football sector, free trade zones, and even multiplayer computer games such as Second Life.9
A simple expedient is to smuggle cash across borders in bulk, first to complicate pursuit and second to take advantage of less rigorous scrutiny in the destination country. Gambling venues may provide another avenue: winning horse race or lottery tickets are bought at a discount from the genuine winner by a criminal, or criminals convert their cash into chips at a casino then reconvert the chips to cash, checks, or wire transfers. A suspiciously large sum of money may be broken down among a number of couriers who individually deposit money in innocuously small amounts into their accounts, later transferring the funds to a central collection point in the same country or overseas (so-called smurfing). Along the lines of Al Caponeâs self-service laundries, criminals may buy legitimate businesses through which to insinuate their illegal money into the banking system. Criminals may corrupt officials in banks or other established financial institutions, as when Russian underworld groups paid senior Bank of New York officials $1.8 million to launder $7 billion over a three-year period.10 Launderers may choose to set up more or less complex corporate structures of interlocking companies and trusts in a series of jurisdictions, usually favoring those locales with tight bank secrecy or that allow the formation of companies without proper identification checks. Of course, criminals can and do use a combination of methods. Despite the range of methods practiced, it is conventional to view the laundering process as having three stages: placement, when funds first enter the legitimate financial system; layering, to distance funds from the original crime; and integration, through which the funds are then returned to the criminal in a useable, ostensibly legitimate, form.
It has become a commonplace belief that the same technological progress and financial deregulation that has given rise to legitimate cross-border flows of trade and capital have also favored the laundering of money.11 Yet, as with almost everything else having to do with money laundering, it is hard to find the evidence that would put this claim on a firm footing. Meyer Lanksy, infamous in popular culture as âthe mobâs accountant,â reputedly used a network of foreign companies and a Swiss bank he owned to launder the proceeds of illegal gambling operations in the United States and Cuba beginning in the early 1930s.12 Guesses concerning the going rate for money laundering range from 4 percent to 12 percent of the principle.13 However, stand-alone money launderers seem the exception rather than the rule. Rather than one set of criminals (e.g., drug dealers) paying for the services of independent launderers, it seems that most laundering is done in-house by the criminals who perpetrated the original predicate crime.14
An even bigger unknown is the scale of money launderingâhow much illegal money is in the system. The most straightforward answer is that no one knows. This ignorance is not just a result of the self-evident secrecy that surrounds criminal activities but also is due to serious methodological problems in the macro- and microeconomic estimates produced.15 Even absent any other changes, to the extent that gambling or prostitution are legalized the money associated with these industries cross from the underworld to the legitimate economy. Conversely, when tax evasion is defined as a predicate crime for money laundering, it massively boosts the total. During the period 1996â2000, the Financial Action Task Force (FATF) labored in vain to come up with a money-laundering total.16 However, as Peter Reuter and Edwin Truman astutely remark, methodological difficulties aside, âThe demand for numbers creates a supply.â17 Officials are often frank in noting that numbers are invaluable to arouse interest in the media, among policymakers, and in the general public (as well as bodies that give grants to academics such as this author, for that matter).18 Of the statements, âvast sums of criminal money are laundered every yearâ and âa trillion dollars of criminal money is laundered every year,â only the second works in political terms. Thus a combined UN Office on Drug and Crimes (UNODC) and World Bank report on laundering the proceeds of corruption successfully garnered widespread media coverage on the basis of the huge numbers quoted; but only in the footnotes was it admitted that there was little basis for these numbers, which nevertheless become entrenched through being repeatedly...