The CPAs Role in Fighting Money Laundering

AUDITING

All practitioners—not just auditors—need to understand
how regulators expect them to help.

The CPA’s Role in Fighting Money Laundering

BY ALAN S. ABEL AND JAMES S. GERSON

EXECUTIVE SUMMARY

MONEY LAUNDERING HELPS ILLICIT ORGANIZATIONS by lowering their cost of capital, giving them a competitive advantage over legitimate businesses.

NEITHER GOVERNMENT OFFICIALS NOR THE BUSINESS community alone has the resources to counter international money laundering by drug cartels and other organized criminal groups.

ACCOUNTANTS ACTING IN A NUMBER OF PROFESSIONAL capacities have contributed their expertise in implementing and monitoring controls that hinder money laundering and in identifying warning signs of possible illegal activity.

THE PROFESSION WILL BE CALLED UPON for continued help in creating controls that are effective in fighting the growth in money laundering.

MANY NON-AUDITING PRACTITIONERS MAY BE SURPRISED to find they have certain responsibilities in the war against money laundering.

FEDERAL LEGISLATION AND RELATED REGULATIONS applying to money laundering have been in effect since 1970 and they have increased in number and scope over the years.

THE INTERNATIONAL COMMUNITY SEEKS to improve controls in laxly regulated jurisdictions where money launderers base their operations.

ALAN S. ABEL is Global Practice Leader of PricewaterhouseCoopers’ Money Laundering Compliance Practice, and chairs the Accounting Issues Sub-Group of Treasury’s Bank Secrecy Act Advisory Group and the Anti-Money Laundering Task Force of the International Federation of Accountants. His e-mail address is alan.abel@us.pwcglobal.com. JAMES S. GERSON is chairman of the Auditing Standards Board, a partner of PricewaterhouseCoopers LLP and leader of its U.S. Assurance Policy and Communications division. His e-mail address is james.s.gerson@us.pwcglobal.com.

ntil approximately 10 years ago, law enforcement officials in the United States and around the world waged the battle against money laundering without support from the business community or other branches of government. At the time, few of the world’s governments had passed laws making money laundering itself a crime. Instead, they focused on activities—such as drug trafficking—that led up to it. Because this strategy didn’t address all aspects of the growing problem, however, it was only partly effective.

How Big Is the Money Laundering Problem?

Global money laundering volume—high estimate	$1.46 trillion
Gross domestic product—United Kingdom	$1.28 trillion
Global money laundering volume—low estimate	$584 billion
Gross domestic product—Spain	$531 billion

Note: Each amount is an annual total, based on 1997 statistics—the latest available.

Sources: United Nations Statistics Division and the Organization for Economic Cooperation and Development’s Financial Action Task Force on Money Laundering, 2001.

CPAs entered the picture in the early 1990s when, in response to government requests for their help, forensic accountants scoured financial institutions’ records for signs of money laundering activity. The evidence they accumulated helped prosecute offenders and contributed to the fight against further offenses.

Now, in recognition of accountants’ expertise in devising controls that make it more difficult to launder illicit proceeds, government and the business community are asking the profession to come up with recommendations on how to deny money launderers and their accomplices in organized crime opportunities to legitimize their illegal gains. Meanwhile, many nations have supported these undertakings by classifying money laundering as a severely punishable felony.

Independent auditors and other accounting practitioners have a role to play in ongoing public- and private-sector efforts to prevent money laundering. The following information on U.S. and international regulatory and legal initiatives to combat money laundering explores the details of that function.

THE LAW OF THE LAND

To fully understand their part in the fight against money laundering, CPAs should familiarize themselves with the provisions of the Bank Secrecy Act (BSA, Titles I and II of Public Law 91-508) and related regulations (31 CFR Part 103), the federal “Money Laundering Laws” (18 U.S.C. 1956–1960) and the rules and regulations issued by the federal bank supervisory agencies, the SEC and securities industry self-regulatory organizations and the U.S. Department of the Treasury. These provisions govern most of the registration, recordkeeping, reporting and control obligations financial institutions and individuals have with respect to money laundering. They also establish civil and criminal penalties for failure to meet related obligations.

The BSA (31 U.S.C. 5312(a)(2)) defines only certain kinds of businesses as “financial institutions” (See “Who Has to Care About the BSA and Why” below) and requires them to report to the Treasury signs of potential money laundering or any other suspicious activity. Since this requirement also applies to financial institutions’ employees, including CPAs, practitioners need to be sure which entities are affected. Under the BSA, an independent insurance company is not a financial institution, but an insurance company owned by a bank holding company is. So, a CPA working for the former would be subject to BSA requirements, but one employed at the latter would not.

Who Has to Care About the BSA and Why

Under the Bank Secrecy Act, a wide range of businesses are defined as “financial institutions,” making them subject to the anti-money laundering regulatory requirements issued by the U.S. Department of the Treasury under 31 CFR Part 103 (the federal “Money Laundering Laws”). But other—sometimes similar—entities do not fall within the definition and the BSA does not apply to them.

The BSA classifies the following businesses as “financial institutions:”

Banks, thrifts and credit unions.
Securities and commodities brokers or dealers.
Currency exchange houses.
Casinos (including tribal casinos) and “card clubs,” in which card players compete with each other.
Issuers, redeemers or cashers of checks, travelers checks, money orders or similar instruments.
Money transmitters.
Postal systems.

The Treasury has not, however, exercised its authority to extend these regulatory requirements to these businesses:

Insurance companies.
Dealers in precious metals, stones or jewels.
Pawnbrokers.
Loan or finance companies.
Travel agencies.
Dealers and sellers of automobiles, airplanes, boats and other vehicles.
People who close and settle real estate transactions.
Federal, state or local government agencies with duties or powers similar to financial institutions.

When financial institutions report suspicious activity to the government, however, a “safe harbor” available under the BSA protects them and their employees against their customers’ civil claims. Moreover, voluntary compliance is on the upswing. A number of major securities firms and insurance companies have been reporting suspicious activity (for example, transactions passed through intermediaries for no apparent business reason) to the Treasury voluntarily for several years, and the courts generally have upheld the civil safe-harbor provisions.

It is likely that new legislation or Treasury rules soon will mandate reporting of suspicious activity by the entire financial services sector. Within the next year, for example, the Treasury expects to issue a rule requiring casinos and certain other gambling establishments to set up programs to detect and report suspicious activity conducted through these businesses. The Treasury also has announced its intention to issue a rule that would subject the securities industry to suspicious activity reporting.

In 1998, the Money Laundering and Financial Crimes Strategy Act chartered a joint Treasury and Justice Department initiative to develop a broad, comprehensive plan to combat money laundering at federal, state and local levels. Among tactics the strategy contemplated are methods accountants and auditors can use to help detect and deter money laundering. (See “U.S. Wants CPAs to Help Fight Money Laundering,” May00, JofA, page 17.) Most states now have some form of anti-money-laundering or related asset seizure and forfeiture statute. These developments point to a time in the near future when CPAs will be expected to contribute more to the fight against money laundering.

Typical Money Laundering Scheme

To disguise the source of their income from illicit activities, criminals first must place the money in legitimate financial institutions. Someone accomplishes this by transferring funds into the account of a confederate who has issued him or her an invoice for products or services never delivered.

Next, the accomplice adds a deceptive layer of complexity to the process by wire-transferring those funds, in relative anonymity, to a bank account in a laxly regulated “offshore” jurisdiction. The account holder then “lends” the money to the person who paid the fake invoice.

In the final step, the first criminal integrates his or her money into the economy by purchasing real estate and other legitimate assets with large amounts of difficult-to-trace—but illegally earned—cash.

Source: United Nations Office for Drug Control and Crime Prevention.

WHAT AUDITORS NEED TO KNOW

Generally, businesses are most useful to money launderers as conduits for tainted funds. So, since money launderers usually don’t expropriate assets, they seldom leave evidence of their activity on financial statements, making it difficult to detect their illegitimate activities during conventional audits.

Nevertheless, independent auditors have a responsibility under SAS no. 54, Illegal Acts by Clients, to be aware of the possibility that illegal acts may have occurred, indirectly affecting amounts recorded in an entity’s financial statements. In addition, if specific information comes to the auditor’s attention indicating possible illegal acts that could have a material indirect effect (for example, the entity’s contingent liability resulting from illegal acts committed as part of the money laundering process) on the entity’s financial statements, the auditor must apply auditing procedures specifically designed to ascertain whether such activity has occurred.

Possible indications of money laundering activity include the following:

Transactions that seem to be inconsistent with a customer’s known legitimate business or personal activities or means; unusual deviations from normal account and transaction patterns.

Situations in which it is difficult to confirm the identity of a person.

Unauthorized or improperly recorded transactions; inadequate audit trails.

Unconventionally large currency transactions, particularly in exchange for negotiable instruments or for the direct purchase of funds transfer services.

Apparent structuring of currency transactions to avoid regulatory recordkeeping and reporting thresholds (such as transactions in amounts less than $10,000).

Businesses seeking investment management services when the source of funds is difficult to pinpoint or appears inconsistent with the customer’s means or expected behavior.

Uncharacteristically premature redemption of investment vehicles, particularly with requests to remit proceeds to apparently unrelated third parties.

The purchase of large cash value investments, soon followed by heavy borrowing against them.

Large lump-sum payments from abroad.

Insurance policies with values that appear to be inconsistent with the buyer’s insurance needs or apparent means.

Purchases of goods and currency at prices significantly below or above market.

Use of many different firms of auditors and advisers for associated entities and businesses.

Forming companies or trusts that appear to have no business purpose.

Silence Is (Not Always) Golden

In March 2000, an insurance company executive embezzled $90 million by faking the purchase of bonds as an investment for his employer. To conceal the funds’ movement, he arranged for them to be passed first through two companies an accounting firm had set up for him in a Caribbean nation and then to his personal account in a third jurisdiction. Six months later, the accounting firm detected the executive’s fraud and its inadvertent role in laundering the proceeds. Nevertheless, the firm’s management committee did not report its findings to the authorities and later both they and the executive were apprehended and charged for their offenses.

Source: FATF Report on Money Laundering Typologies, 2000-2001.

When an auditor becomes aware of information concerning a possible illegal act, SAS no. 54 requires him or her to obtain from management—at a higher level than those employees potentially involved—information on the act’s nature, the circumstances in which it occurred and its possible effect on the client’s financial statements.

If management does not provide conclusive evidence that an illegal act has not occurred, the standard requires the auditor to consult with the client’s legal counsel or other specialists about how relevant laws apply to the situation and the impact it may have on the financial statements.

To better understand the act, the auditor may also have to perform additional auditing procedures, such as comparing invoices, canceled checks and other supporting documents with accounting records.

Operation “Risky Business”

In January, 12 individuals in Florida received jail terms for their involvement in a $60-million money laundering conspiracy, uncovered during the largest nondrug-related investigation in Customs Service history.

The scheme began in 1994 with ads offering venture capital loans in return for “advance fees.” At least 400 entrepreneurs from around the world paid the fees, which ranged from $50,000 to $2 million, in the hopes of obtaining venture capital.

Once the conspirators received the fees, however, they demanded letters of credit—for collateral amounts as high as $20 million—from their victims. Failure to immediately remit the funds led to forfeiture of the advance fees.

To hide these funds, the criminals established a bank in Antigua, in which they set up accounts, bought expensive assets, including real estate, and established lines of credit enabling them to launder their illicit proceeds and use them anywhere.

Alerted by the would-be borrowers, the Customs Service pursued leads, ultimately resulting in the apprehension and conviction of each conspirator.

Source: U.S. Customs Service.

In cases where the auditor concludes the act is illegal and could have a material effect on the entity’s financial statements, he or she must inform management and the audit committee of it immediately. Further, under Section 10A of the Securities Exchange Act of 1934, if management does not take “timely and appropriate remedial action” to address the illegal act, the auditor must report the situation to the board of directors. If the auditor does not receive confirmation that the board reported the act to the SEC within one day of receiving notice of it, the auditor must either resign or, by the following day, give the SEC a copy of his or her report to the board. (See “The [Private Securities Litigation] Reform Act: What CPAs Should Know,” JofA, Sep.96, page 55.)

As noted earlier, independent auditors performing financial statement audits are less likely than other members of the profession to encounter possible signs of money laundering. But accounting professionals acting in the following capacities may find such evidence. Their responsibilities are addressed in both authoritative and non-authoritative guidance. (See “Professional Guidance,” at the end of the article)

Accountants in management positions who record and report entity transactions, such as CEOs, COOs, CFOs, CIOs, controllers, risk managers, compliance officers and related staff.

In-house financial systems consultants.

Internal auditors responsible for operations and compliance auditing.

Practitioners who provide outsourced regulatory examination services.

Forensic accountants.

Public practitioners who perform compliance and operational audits.

Risk management practitioners and compliance specialists.

Tax practitioners, especially in jurisdictions where filings connected with anti-money-laundering laws (currency transaction and suspicious activity reporting) are directed to tax authorities.

Terms of the Money Laundering Trade

While money laundering techniques have become increasingly complex, they tend to consist of three basic steps:

Placement is the transfer of illegal activities’ proceeds into financial systems without attracting the attention of financial institutions and government authorities. Money launderers accomplish this by dividing their tainted cash into small sums and executing transactions that fall beneath banks’ regulatory reporting levels.

Layering is the process of generating a series of transactions in order to distance the proceeds from their illegal source and to obfuscate the audit trail. Common layering techniques include outbound electronic funds transfers, usually directly or subsequently into a “bank secrecy haven,” or a jurisdiction with lax recordkeeping and reporting requirements, and withdrawals of already placed deposits in the form of highly liquid monetary instruments, such as money orders or travelers checks.

Integration, the final money laundering stage, is the unnoticed reinsertion of successfully laundered, untraceable proceeds into an economy. This is accomplished through a variety of spending, investing and lending techniques and cross-border, seemingly legitimate transactions.

THE INTERNATIONAL RESPONSE

Money laundering disrupts financial systems around the world by damaging international financial institutions’ reputations and weakening their relationships with intermediaries, regulators and the general public. To coordinate an international response to this danger, the Group of Seven (G-7) (Canada, France, Germany, Italy, Japan, the United Kingdom and the United States) in 1989 formed a global money-laundering watchdog organization called the Financial Action Task Force (FATF). Since then, FATF membership has grown to nearly 30 countries and jurisdictions.

But as wealthy nations came up with ways to regulate the multiple avenues to concealment their complex economies offer to money launderers, developing nations’ inadequate controls became an attractive alternative for financial criminals. This vulnerability has hampered poorer countries’ growth by discouraging foreign investors wary of organized crime’s influence on government.

The Bank of Commerce and Credit International (BCCI) case involved the first highly publicized money laundering operation of truly global proportions. In 1988, BCCI was the seventh largest private bank in the world, with headquarters in Luxembourg. It had approximately $20 billion in assets and 400 branches in 72 countries. In what has since become a commonly used tactic, perpetrators bought BCCI certificates of deposit (CDs) in six countries with drug money and then used them as collateral for loans. One of the reasons they succeeded was that banking regulators did not adequately oversee the bank’s operations in the many jurisdictions in which it did business.

The BCCI scandal quickly elevated international organized financial crime to the agenda of the 1988 Annual Economic Summit of the G-7. As a result, in 1990 the FATF issued 40 recommendations—related to legal issues, financial services regulation and international cooperation—designed to help governments fight money laundering. The “FATF 40 Recommendations” still are the foremost set of international anti-money-laundering standards and have encouraged governments to launch anti-money-laundering initiatives. They are available on the OECD Web site at www.oecd.org/fatf/40Recs_en.htm.

The “Black Market Peso Exchange” System

Columbian money launderers designed the black market peso exchange system to evade U.S. Bank Secrecy Act (BSA) currency reporting requirements. This is how it works:

A Colombian drug cartel exports drugs to the United States, where they are sold for U.S. currency.

A cartel representative in the U.S. delivers these dollars to a U.S.-based representative of a Colombian black market peso exchanger, who then deposits an amount (calculated according to an agreed-upon exchange rate) in the cartel’s account in Colombia.

The exchanger then introduces the dollars into the U.S. economy by means of transactions falling beneath the $10,000 BSA currency reporting threshold.

Once the exchanger has laundered the drug trade proceeds, he or she can sell them to Colombian importers who use them to buy goods in the United States or anywhere else.

Finally, the imported goods arrive in Colombia, completing the cycle that began with the export of drugs to the United States.

Source: U.S. Department of the Treasury, Financial Crimes Enforcement Network.

WHAT THE FUTURE HOLDS

More than ever, regulators expect the private sector to detect, report and prevent money laundering. This has boosted demand for the profession’s expertise in creating effective controls—a trend not expected to abate anytime soon. In fact, regulators, law enforcement and the business community will likely call on the profession for ongoing help in protecting the international economy from the hazards of money laundering.

Professional Guidance

Authoritative:
Statement on Auditing Standards no. 54, Illegal Acts by Clients.
Statement on Auditing Standards no. 82, Consideration of Fraud in a Financial Statement Audit.

Nonauthoritative:
AICPA Industry Audit Risk Alerts.
Fraud Examiners Manual, Association of Certified Fraud Examiners.

For information on how to obtain these publications, visit the AICPA Web site at www.icpa.org or the ACFE Web site at www.cfenet.com.