Principles of Money Laundering
by Stephan Girard
RMO, Special Forces Underground
Money laundering is simply the act of bringing unreported money into a person's or organization's recorded (or unrecorded) account by diverting it through legitimate business fronts. Financial crimes investigators classify laundered money into four types; black money, grey money, white money, and subterranean money.
Black money is money obtained by criminal means, such as kidnapping, bribery, fraud, tax evasion, theft, smuggling, trafficking in illegal commodities (such as drugs), and armaments dealing.
Gray money is money that the owner does not want known to be in his possession, even though it may not have been illegally obtained. Tax avoidance is legal if obtained through a "loophole" that the government has overlooked. A loophole has value only until it is used to such a degree that attention is focused on it. Then the government usually changes regulations so that the loophole can no longer be used. Thus the person or institution using the tax avoidance scheme may want to prevent having his legal tax avoidance system come to the attention of the government.
As another example of gray money, a person may have a business which is exceedingly profitable, and may want to conceal his prosperity to avoid attracting attention which could cause increased competition. Or a man who may not want his wife, or partners, or relatives to know he has made or obtained a large amount of funds.
The third type of money is clean, ordinary money--the type most of us obtain in small quantities at rare intervals by hard work, investment, or inheritance. However, some people get clean money by laundering black or gray money.
The fourth and last type of money is that obtained through the "subterranean," or underground, economy. It has been estimated that in the United States alone, this economy is worth at least $500 billion per year, in both legal and illegal money, depending on the circumstances. Basically, it is like the ancient bartering system. A barber cuts his dentist's hair free, and the dentist gives him free dental services. But the phenomenal amount of this unreported money indicates a substantial portion may be illegal.
The difficulty of money laundering depends on the amount to be laundered, the place of laundering, and the sophistication of the procedure used. The simplest method in many countries is to take a risk and use the local banking system. However, this is difficult in the United States because of the reporting required. It is generally not difficult to change the respectability of currency.
There are three principle means of laundering money. The bank method, the tax haven method, and the black market method. The last is the simplest in many countries. Every country has a parallel money rate, variously called the free market, inland, or black market rate. The cost of changing currency in most countries is about 10 percent, but in countries with strong currency, it may only be 2 or 3 percent.
In practice, the black market method works this way. Assume a person has "black" money in a given country, say, New Zealand. He can take it to the black market and change it for another currency such as U.S. dollars, at the black market rate of about 5 percent. This money, now in U.S. dollars, can officially be sent back to the country in which the switch was made. The black money has been made white.
In countries with no exchange controls, money need not go through the black market. It can be changed at the official rate at any bank, without records. The system of using the parallel market involves two countries, but it is safe as long as the person is not caught dealing with the black market money changer.
The bank method of legitimizing black or grey money is perhaps the most commonly practiced method in the United States. A drug trafficker, for example, instigates the changing of money through the banking system thus: A bag of soggy bills collected from street sales is taken to the neighborhood bank and changed to reputable financial instruments such as T-Bills, Letters of Credit, large denomination traveler's checks, real estate deeds, or bank drafts, thus becoming "clean." Up until 1980, this was reasonably easy to carry out in the United States.
In 1979, proposed amendments were considered by the Treasury Department, and a new Bank Reporting Ruling went into effect in July 1980. The ruling is too complex to report in full, but its main thrust was to amend the Bank Secrecy Act which requires financial institutions to report uninsured currency transactions in excess of $10,000. Specific forms provided by the Secretary of Treasury must be used for reporting purposes.
In sum, every currency transaction over $10,000 has to be reported, with positive identification of the person making the transaction (including name, address, Social Security number if a U.S. citizen, or passport number if alien, and various other details). The new regulation made it most difficult for any one person to make a currency transaction of more than $10,000 without a complete disclosure to the government.
The tax haven method is probably the most important of all. When World War II ended in 1945, there were approximately 55 countries in the world. Today there are just under 200. Every fragment of a major country seems to want independence. Once they have independence they usually find that their costs of operating greatly increase. However, all of the costs cannot be supported by inward cash flow. The new countries usually give up agriculture, and everyone moves to the city, where there is electricity and television. For a while they "borrow their way to success" from overseas banks. But when their credit lines are exhausted, they eventually scratch at any source of income. One ever-present possibility is to operate as a tax haven--a conduit for tax evasion money, tax avoidance money, or black market derived from crime.
Money goes around the planet earth 24 hours a day in search of vacuums. "Hot money" seeks out the cool areas of survival, including what the Germans call Eine Steveroase (a tax oasis) and the French call un paradis fiscal (a financial paradise). Tax havens are refuges from death duties and high taxes. The oldest and best known tax havens are the Cayman Islands, the Bahamas, Switzerland, Liechtenstein, the Netherlands Antilles, Monaco, Macao, Hong Kong, and Luxembourg. However, so many new havens are being created--e.g., the New Hebrides, Andorra, the Caicos, and Turk Island--that policing them for infractions is all but impossible. The new nations of the Federated States of Micronesia and the Marshalls and numerous other newly spawned nations in Africa, Asia and Europe will undoubtedly play in important role in money laundering.
Take the case of Nauru as an example. It is an independent nation, 8 square miles in size. It is a member of the United Nations and a British Commonwealth. It has no taxes of any kind, no tax treaties, and no exchange controls; commercial transactions may be carried out in any currency. The country prohibits immigration. Government almost never grants tourist visas, and it certainly does not grant tax investigation visas. A visa would be virtually impossible for an IRS or any other tax investigator to obtain. The government is sound and stable. The people of Nauru have a standard of living 50 percent higher than that of the average American citizen. There is no political unrest. English is the official language. Nauru has modern companies and trust laws, and the law draws on British traditions. It is the smallest nation in the world with a president, elected parliament, and a well-developed civil service. It has its own highly efficient airline which flies to 20 or more countries.
A holding company can be set up in Nauru with as few as one and not more than 20 shareholders. The holding company has remarkable powers. It can operate without an annual meeting, and there is extraordinary freedom in relation to its shares. It need not have an auditor. Books can be kept outside Nauru's jurisdiction. A company is effectively established by sending in a form issued by the government. The annual corporation fee is as low as $150.00 (naturally, the cost varies with the number and complexity of services required).
Commercial transactions or money can be routed through Nauru. The structure of Nauru's corporation act makes it easy for U.S. companies to form Nauruan holding corporations and manage them as wholly owned corporate subsidiaries without the necessity of setting up a "board of directors" as is required in many countries. The laws of the country have a statutory bar against any disclosure. An overseas company can easily and cheaply form a holding company which can do almost any conceivable commercial transaction such as being an intermediary in money legitimation, tax avoidance, profit stripping, re-invoicing to skim profits and take them tax-free, or do almost anything that does not represent fraud or a legal breach in Nauru (the transaction can breach laws of other countries, but Nauru does not set itself up as the world's policeman). The government has made positive efforts to welcome offshore investors and offers Nauru as a secretive tax haven, superior to those that suffer political unrest and upheaval.
It is not difficult to see how this serves those who have a need to transform black currency into white currency at a low cost, with complete secrecy. It is nearly impossible to prosecute someone through tracing finances if that person is sophisticated and knows how to use tax havens.
U.S. federal law requires that any transfer of over $5,000 out of the United States must be reported to the treasury. This, however, does not apply to inter-bank transfers. Therefore, anyone moving large amounts of cash have to set up their own banks. These are usually one-room operations in places like St. Vincent, Anguilla, or the Cayman Islands. The cost of a banking charter and license in the Cayman Islands is $6,500 in total. The bank can be "owned" by a Cayman management service company, and the beneficiary owner need never be known to any investigator. In Anguilla, no paid-up capital or reserves are required. Anguillan law states that a bank's license and charter can be sold without government approval.
Some bank haven countries even offer bank charters and licenses for as little as $60.00. The low cost of owning an offshore bank makes it quite easy to transfer huge sums of money, with no reporting to anyone, and the cash filters through the bank as a conduit. It can be returned to the United States, pure as the driven snow, as a loan or any other similar way, or it can be placed in a secret account elsewhere.
Another ruse is the use of bearer bonds. These are not registered in anyone's name--they belong to whoever holds them. A person who wants to hide his money can buy municipal bonds and store them with his broker (unlike T- bills). The broker keeps them separately in a special account for each customer. The only place where a name is registered is at the brokerage house, which keeps the name only of the original buyer and the holder at the time of sale. It does not record intermediate sales. A lot of people use this system to keep their money possessions secret.
Tax-free municipal bonds are also used. The Wall Street Journal lists these and their interest rates. They are usually in bearer form, and interest is paid by redeeming coupons. They are available only through brokerage houses. The broker keeps the name of the original purchaser, but intermediate sellers and buyers are not registered. These bonds may purchased with cash or otherwise, through a third party. Millions of dollars of unreported assets and income can be accumulated this way.
There are numerous other methods of laundering money. For example, insurance agents can accept deposits in any amount, and no bank reports are necessary. Examples laundering money through insurance companies include:
1) The overseas "Umbrella life policy." An overseas insurance company (usually in the United Kingdom, Jersey, Switzerland, Hong Kong, or Australia) sells a life insurance policy in the United States. (They are even sold by direct mail or telephone solicitation.) These overseas companies have devised an "umbrella policy" which includes not only life insurance, but also investments. For example a $300,000 policy may have $100,000 in full life insurance, and $200,000 in currencies, stocks, bonds, T-bills, or other investments. The policy is classified by the United States as insurance, even though it is only partially insurance. It is usually single payment, the total cost for life is paid up at the time the policy is taken out. The cost may be $60,000 or more, depending on the makeup of the policy, for a $300,000 policy.
The advantage of this type of policy to a normal customer is that when the insured dies, his heirs get the full value (investments and all) tax free. If the investment part was separate and not packaged with the insurance, the heirs would have to pay death duties.
If a policy holder wants to cash in the policy before death, say in five years, he pays only capital gains on his earnings.
2) "Borrowing" against a life insurance policy. A money launderer buys a policy from a company. He can pay the agent in any way he wants, perhaps even with bags of soggy bills. Unlike banks, the insurance agent does not have to report cash transactions over $10,000. The money is received by the agent, who finds ways to get it to the parent company. The money launderer then borrows up to 90 percent of the value of his policy, and the money is sent to him wherever he desires. The U.S. government is quite accustomed to loans from insurance companies to policyholders. The borrower pays no tax on a loan. It is all legal, and the $300,000 (or whatever the sum) has been returned to the laundry man with no tax, and only a small service charge, quite proper. The IRS has no objection showing a loan from an insurance company.
Contrary to popular belief, the 1980 reporting regulations (Section 103.22 of part 103 of Title 21, code of Federal Regulations) did not make money laundering impossible. The 1980 Treasury Department Regulations have produced only two results: 1) money laundering was temporarily retarded while people found more sophisticated systems of circumventing the regulations; 2) it is now more difficult, more costly, and more important to launder money. The amount of money laundering may even have increased because laws make it imperative to launder black and gray money.
The 1980 regulations did not stop money laundering for a variety of reasons. Federal regulations do not restrict banks or other financial institutions from accepting or transferring cash. It only requires financial institutions to "report within 15 days all unusual deposits or withdrawals or other transactions, the name and address, the account number, social security or taxpayer number (if any), or in the cases of
aliens a passport or identification document (unless the person or institution is exempt) and only in cases of over $10,000 transactions."
Exempt from this regulation are U.S. residents who operate retail stores which deal in a "substantial amount" of currency. Exempt also are U.S. residents who operate amusement parks, bars, restaurants, sports arenas, racetracks, grocery markets, hotels, licensed check cashing services, or theaters. For example, one could own 3 different bars in 3 different cities, use several banks in each city, and make cash deposits of tens-of-thousands of dollars per day with no reports filed by the banks, and without breaking the regulations.
Exempt also are withdrawals of cash for payroll purposes. Finally, transactions between domestic commercial banks or home loan banks are exempt as are transactions between nonbank financial institutions and commercial banks.
Because currency transactions involving less that $10,000 do not have to be reported, one can deposit or "legalize to other forms of money" any amount as long as it is divided up--for example, he can launder $24,000 by three $8,000 deposits in three banks or branches.