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Money Laundering in relation to KYC norms

MONEY LAUNDERING IN RELATION TO KYC

 

Money laundering, in a layman’s term means to clean dirty money. Literally it means concealing or disguising illicit income in order to make it appear legitimate. According to Black’s  Lexicon, the term Laundering is referred to describe investment or other transfer of money flowing from racketeering, drug transactions and other illegal sources into legitimate channels so that its original source cannot be traced. Section 3 of the Prevention of Money Laundering Act 2002, defines it 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 offence of money laundering.”                                      

                      The term money laundering is said to originate from the Mafia ownerships of Laundromats in the United States. Gangsters there were earning huge sums of money from prostitution, extortion, gambling and bootlegging. They needed to show a legitimate source of these monies. The original sighting was in newspapers reporting the Watergate scandal in United States in 1973. The expression first appeared in a judicial or legal context in 1982 in America in the case US vs. $4,255,625.39(1982) 551 F Supp. 314. More recently, “Operation Green Ice (1992)” showed the essentially transnational nature of modern money laundering.

                    Money Laundering deprives Governments of tax revenues thereby raising the relative burden of honest citizens. Because of rapid movements of large amounts of money there occurs destabilization of financial institutions which in turn jeopardizes funds of innocent citizens. The estimated magnitude of the Money Laundering menace totals more than an astounding $500 billion to $1.5 trillion billion a year of which the Asia Pacific alone accounts for around 30 percent.

                 The core of money laundering in India is undoubtedly the parallel remittance system of Hawala which operates independent of the traditional banking or financial channels. It has now spread its tentacles around the world. The popularity of Hawala can be attributed to its cost effectiveness, efficiency and reliability. Some ancillary reasons are the lack of bureaucracy, lack of paper trail and tax evasion. Moreover, the minimal use of negotiable instruments further motivates the hawaladars as the possibility of being exposed is reduced considerably. Hawala is discernable from other remittance systems due to the extensive use of family and regional affiliations. Another unique aspect of Hawala is the importance of trust between the parties involved. It is worth noting that one of the meanings attached to the word Hawala is trust! Even though Hawala is illegal from a regulatory standpoint, hawaladars widely advertise their services in ethnic newspapers as well as on the internet. The term ‘white Hawala’ refers to legitimate transactions whereas ‘Black Hawala’ connotes illegitimate transactions. Black Hawala transactions are always associated with some serious offence like narcotics trafficking and fraud which is illegal in most jurisdictions. Another remittance system is ‘chop’, ‘chit’ or ‘flying money’ indigenous to China and also used around the world.

With the passage of time and technological developments, Money laundering has evolved into more complex and advanced forms like

Smurfing- It is another term used for Placement in Money Laundering. .In the US, for instance, launderers had sent troops around the country’s banks to purchase cashier’s checks, drafts and similar instruments for amounts less than $10,000. In India too, smurfing is quite common. Since most bank branches do not issue cashier’s cheques, drafts etc against cash deposit beyond Rs 10,000 to Rs 15,000 launderers use different names and different bank branches for such transactions Currency notes worth Rs. 1.8 crores seized by the Enforcement Directorate from a money-laundering group in Delhi in 1997.

Bank Complicity, Money Services and Currency Exchanges, Asset Purchases with bulk cash, Electronic Funds Transfer, Postal Money Orders, Credit Cards, Casinos, Legitimate business/ Co-mingling of funds, Value tampering.

                 The most perilous repercussion of money laundering has been Terrorist Financing, the reverse procedure of Money Laundering. In Terrorist Financing white money is converted into dirty money. Here the money earned through legitimate sources is used for illegitimate activities.

                  The endemic of money laundering is similar to that of terrorism. As no country is immune from the malady of terrorism, likewise no nation is impervious to the vicious threat of money laundering. This is corroborated by the various legislations enacted by different countries to tackle it. Strategies used by these countries include effective legal framework and tax systems, sound financial institutions, efficient tracking and monitoring systems to identify irregular financial transactions. A few of the key laws relating to money laundering in some major countries are enumerated below:-

USA

Patriot Act 2001; Money Laundering and Financial Crimes Strategy Act 1998; Annunzio-Wylie Anti-Money Laundering Act, 1992; Money Laundering Control Act, 1986; Bank Secrecy Act, 1970.

 

The Acts establish requirements for record keeping by individuals, banks and other financial institutions, establish money laundering as a federal crime; introduce civil and criminal forfeitures for the Bank Secrecy Act violations, criminalize the financing of terrorism, prohibit financial institutions from engaging in business with foreign shell banks, require financial institutions to have due diligence procedures, provide the Secretary of Treasury with the authority to impose “special measures” on jurisdictions or transactions that are of “primary money laundering concern”.

 

UK

Money Laundering Regulations 2007; Proceeds of Crime Act 2002; and Terrorism Act of 2000.

 

The Acts criminalize both actions relating to criminally acquired property and the failure to disclose suspicious transactions that may indicate money laundering. The Regulations create a regime of Due Diligence, record keeping and reporting that the institutions are required to comply with and also establish penalties ((both civil and criminal) for non-compliance.

 

Germany

Section 261 of the Criminal Code, 1998; Money Laundering Act of 25 October 1993.

 

The Acts penalises any person who hides an object derived from a specified unlawful act, makes its obligatory for institutions or casino to report any financial transaction that serves the purpose of money laundering.

 

Australia

The Anti Money Laundering and Counter Terrorism Financing Act, 2006.

 

The Act covers the financial sector, gambling sector and bullion dealing and any other professionals or business that provides particular ‘designated services’. The Act imposes a number of obligations on businesses when they provide these designated services such as customer Due Diligence, reporting and recordkeeping.

 

Malaysia

Anti Money Laundering Act 2001

 

The Act criminalises money laundering stating that any person who engages in a transaction that involves proceeds of any specified unlawful activity commits an offence. It also provides for an investigation, freezing, seizure and forfeiture of the proceeds of money laundering and terrorist financing offences, suspicious transactions reporting, record keeping and the establishment and functions of the Financial Intelligence Unit.

 

India

The Prevention of Money Laundering Act 2002:- Whoever commits the offence of money-laundering shall be punishable with rigorous imprisonment for a term which shall not be less than three years but which may extend to seven years and shall also be liable to fine which may extend to five lakh rupees:

Provided that where the proceeds of crime involved in money-laundering relates to any offence specified under paragraph 2 of Part A of the Schedule, the provisions of this section shall have effect as if for the words “which may extend to seven years”, the words “which may extend to ten years” had been substituted.”

 

It also attracts offences under The Arms Act, 1959; The Wildlife (Protection) Act, 1972; The Immoral Traffic (Prevention) Act 1956; The Prevention of Corruption Act, 1988; Smugglers and Foreign Exchange and Prevention of Smuggling Activities Act 1974; The Benami Transactions (Prohibition) Act, 1988; The Prevention of Illicit Traffic in Narcotics Drugs and Psychotropic Substances Act 1988.

 

The Parliamentary Standing Committee on Finance examined the Prevention of money Laundering Bill 2008 and suggested recommendations of which a few are enlisted below:-

• The Committee believes that enacting the PML bill is an essential step to strengthen the country’s legal framework from preventing money laundering and counter financing of terrorism.
• Apart from plugging other avenues generating illegal funds such as Hawala, etc, international guidelines should be taken into account for effective enforcement of anti money laundering law.
• The government should consider expanding the ambit of law to cover the FATF recommended DNFB’s such as gold or gem dealers, real estate agents etc.
• MoU’s for mutual cooperation should be concluded with other countries.
• Enforcement Agencies should strengthen their machinery to keep abreast of emerging trends of money laundering and terror funding. This includes having proper software especially with regard to suspicious transactions; strong reporting equipments to monitor transactions, quarterly audit to verify know Your Customer information etc.

 

As a consequence of the emerging trends in money laundering, enforcement agencies must keep themselves updated and this is possible with the help of advanced Anti Money Laundering (AML) software. A few AML softwares available in the market are Complinet from Mantas Softwares, Omni Enterprises from Infrasoftech, Searchspace AML, AML2 from ECONWARE, AMLOCK and Bank Alert from 3i InfoTech. All banks, asset management companies and securities agencies are the target markets. The Indian AML software market is pegged at more than Rs.200 crores. It is still in its early stages. AML vendors need to upgrade beyond KYC requirements. Some banks that have adopted the AML Softwares are IndusInd, ING Vysya, Bank of Baroda, UTI, Karnataka Bank etc. Some major companies involved in the production of AML software are TCS, Infosys, 3i InfoTech, Logica CMG, Wipro, Misys and SAS India.

 

                   The Reserve Bank of India introduced KYC i.e., Know Your Customer norms on 16th August, 2002 owing to the recommendations made by the Financial Action Task Force (FATF) on AML standards. The standards provided by FATF have become mandatory for maintaining cordial international financial relationships. In addition to the FATF, a paper on customer due diligence presented by the Basel Committee on Banking Supervision has been cardinal to the formulation of the KYC and AML measures. The main purpose of the KYC was to restrict money laundering and terrorist financing.

                 The KYC guidelines have been issued under section 35A of the Banking Regulation Act, 1949 and attract stringent penal measures for any contravention or non-compliance under the same act. The guidelines issued in 2002 were:

1. Know Your Customer standards:  It puts forth the objective of KYC which is to prevent banks from being misused by criminal elements and also to enable banks to understand the customers and manage their risks efficiently.
2. Customer Acceptance Policy:  Banks are required to lay down explicit criteria for acceptance of customers and are to ensure that:-
   1. No anonymous or fictitious accounts are opened.
   2. Categorisation of customers into three levels according to their monetary requirements.
   3. Documentation information requirements of different categories of customers to be collected keeping in mind the requirements of the Prevention of Money Laundering Act, 2002.
   4. No opening or closing of existing accounts due to customer non-cooperation or unreliability of information furnished.
   5. Guidelines as to the circumstances in which a customer is permitted to act on behalf of another person or entity should be clearly enunciated in conformity with the statutory law.
3. Customer Identification Procedure: Customer Identification procedure means identifying the customer and verifying his/her identity by using reliable, independent source documents, data or information. Banks need to obtain sufficient information necessary to establish to their satisfaction, the identity of each new customer whether regular or occasional and the purpose of the intended nature of banking relationship. For natural persons, banks should obtain sufficient identification data to verify the identity of the customer, his address and also his recent photograph. For legal entities, banks must verify their legal status and understand the ownership and control of the customer. Banks, may however frame their own internal guidelines.
4. Monitoring of Transactions: Banks must understand the normal and reasonable activity of the customer so that they have the means of identifying transactions that fall outside the regular pattern of activity. Banks should also pay attention to all complex and unusually large transactions. Transactions that involve large amounts of cash inconsistent with the normal and expected activity of the customer should particularly attract the attention of the bank. Indications of funds being washed such as the country of origin, sources of funds, the type of transactions involved and other risk factors must be identified by the bank.  Section 12 of the PML Act 2002 requires the bank to maintain records of transactions. Banks should also ensure that its branches continue to maintain proper record of all transactions (deposits and withdrawal) of Rs. 10 lakh and above.
5. Risk Management: Banks may in consultation with their boards, devise procedures for creating Risk Profiles of their existing and new customers. Banks internal audit and compliance functions have an important role in evaluating and ensuring adherence to the KYC procedures and policies. The compliance function should provide an independent evaluation of the bank’s policies and procedures including legal and regulatory requirements.
6. Customer Education: Banks need to prepare specific literature/pamphlets etc. so as to educate the customer of the objectives of the KYC programme.
7. Introduction of New Technologies- Credit cards/debit cards/smart cards/gift cards: Banks should ensure that proper KYC procedures are duly applied before issuing the cards to the customers. It is also desirable that agents are subjected to KYC measures.
8. Appointment of Principal Officers: Banks may appoint a senior management officer to be designated as Principal Officer. He /she shall be located at the head/corporate office of the bank and shall be responsible monitoring and reporting of all transactions and sharing of information as required under the law.

 

On May 17th 2004, US firm Goldman Sachs stock market saga played out bringing forth the lacuna in the KYC norms for foreign institutional investors (FIIs). Capital market watchdog SEBI had proceeded against Goldman Sachs, as it had found evidence that the US firm had conducted some trades which had resulted in the market crash that day. The regulator wanted to give detailed information about the clients, which the latter did not provide. The contention of the firm was that the interpretation of KYC which SEBI had sought to apply would result in FII being required to know to know ultimate client level information and details of reasons for client trades.

                                 Owing to these interpretation barriers, the Reserve Bank of India in 2004 came up with more specific guidelines regarding KYC. These were divided into four parts:-

Customer Acceptance Policy

Customer Identification Procedures

Monitoring of Transactions

Risk Management

The RBI also directed all banks to make a policy for implementing ‘Know Your Customer’ and Anti-Money Laundering measures and remain fully compliant with given guidelines before December 31, 2005. But there have been instances of lapses in the implementation of these guidelines by several banks. The culmination of these failures and the mother of all scams was undoubtedly the IPO scam. Here, one Roopalben Panchal applied for shares in her own name, in a single application, but failed to get an allotment. Undeterred, she ensured herself 9.47 lakh shares by applying through a staggering 6,315 demat accounts! Most of these accounts were with depository participant Karvy and had almost identical addresses. The Securities and Exchange Board of India unearthed this demat racket involving entities that opened these thousands of demat accounts to ensure higher allotments in the retail offering. The Board advised the two depositories in the country, NSDL and CDSL, to step up their surveillance systems and referred Bharat Overseas Bank and Vijaya Bank to the Reserve Bank of India to examine their roles in opening bank accounts of Benami entities and funding their initial public offer applications. Moreover, SEBI instructed NSDL to thoroughly inspect the systems and procedures put in place by the depository participant Karvy as regards “know your client” norms. Thirteen entities were barred from dealing in Yes Bank shares and in ensuing IPO’s.

Moreover, in the infamous Abdul Karim Telgi case, the machines used to print the fake stamps were acquired by way of money laundering by one Manoj Ramesh Sharma, Telgi’s accomplice.

PROBLEMS WITH KYC

• Banks say the biggest problem with KYC is the non existence of a unique identification number for every individual in the country.
• There are also no ways to verify whether documents submitted by customers are not fake. According to KYC norms, banks and financial institutions need to verify a customer’s identity and address by asking for documents at the time of opening an account. The Indian Banks’ Association (IBA) on behalf of banks is seeking help of the I-T department to solve the problem.

    SOME POSITIVES FOR A BETTER FUTURE

The Income Tax department is now working hand in hand with the banks and is sharing its database with them. This has enabled banks to authenticate the identification proof submitted by customers at the time of opening accounts. Moreover, every bank has been given a unique identification with which they can verify the PAN (Permanent Account Number) card details of a customer.

 

CONCLUSION

Although India has not seen any money laundering scams for funding of anti national activities after the introduction of KYC norms, it sure has failed to prevent innocent customers from being fraught unnecessarily. This is because it has failed to curb offences like fraud, cheating etc. involving money laundering. Another huge threat that India still faces is Narcotics. It is mostly owing to this business that money laundering is used. Hence India has a long way to go before it actually sees the success of KYC norms and is able to nip the menace of money laundering in its bud.

 

 

 

 

BIBLIOGRAPHY:-

1)       Prevention of Money Laundering Act 2002.

2)       Financial Intelligence Unit -India, Ministry of Finance.

3)       Reserve Bank of India notifications from 16th August 2002- 18th February 2008.

4)       The Financial Express (June 4 2009).

5)       Indian Banks Association (Briefing on Compliance to ‘KYC Norms and AML Measures’ June 2  

2006).

       5)    The Web page of the Financial Action Task Force.

       6)   The Web page of the BIS.

       7)    Money Laundering: A New International Law Enforcement Model book, by Stessens Guy.

                                      

                

 

                                        

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