KYC & Anti Money Laundering

CA. Ramesh Shetty

FCA, DISA(ICA), CISA(USA)

Basic Concepts
How it happens
Case Studies Abroad
International Initiatives
Indian Scenario
Know Your Customer
Case Studies India
Role of CAs

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 moneylaundering

Concepts of Money laundering

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 - 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

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

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

Money Laundering Process

Money laundering is a diverse and a complicated
process that involves three independent steps
that often occur simultaneously
Placement
Layering
Integration

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.

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

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.

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 moneys currency
purchasing high value items (boats, houses cars,
diamonds) to change the form of money-making
it hard to trace.

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.

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)

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

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

Deposit Structuring/Smurfing
$ 50, 000 Laundered money
Below deposit amts
Days
$ 10,000
$ 10,000
$ 10,000
$ 10,000
$ 10,000
Balance = $ 50,000

1
2
3
4
5

Money laundering through electronic systems/cross

border activities
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.

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

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

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

Smaller banks and NBFCs

Private banking assistance provided by the employeeshelp 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 countrythen deposits the proceeds as security or gtee for a bank
loan- then sent back to original country gives the
appearance of a genuine loan.

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.

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.

Drug Money laundering- Franklin Jurado case

Drug (dirty) Money
Placement

Layering

Integration

Panama Banks

100 Bank accounts in Europe

Shell companies in Europe

Colombian businesses

Case Study-Accounting firm

Two Narcotics traffickers
Regular deposit of criminal proceeds from drug sales Receipts issued.
Accounting firm
Stored in the accountants 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.

Riggs Bank-Money Laundering Scandals

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 Pinochets victims
Criminal charges against some of the banks
employees
Banks operations acquired by PNC Bank in May
2005

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.

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.

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.

Reports/Facts on Money Laundering

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-

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

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

FATF Recommendations -Features

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.

Indian Scenario/Initiatives
Prevention of Money Laundering Act, 2002
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.

FIU-preservation and reporting requirements

Preservation of records for 10 years

Reporting to FIU
Manual reporting of cash transactions
(CTR) & suspicious transactions (STR)
Consolidated reporting of cash
transactions

RBI KYC norms

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

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)

KYC - Meaning
Customer?
- One who maintains an account, establishes business
relationship, on whos 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

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 customers customer are?

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

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

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

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

Suspicious transactions - FIU-IND

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

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.

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.
Indias international obligation and empower the enforcement
directorate to search the premises immediately after the
offences are committed and police have filed a report

IBA Check list - Caution to be exercised

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

IPO SCAM - INDIA

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

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

SATYAM - Issue
The Enforcement Directorate has registered a case against
Satyam Computer and its tainted founder-chairman B
Ramalinga Raju for alleged money laundering.
The ED sources alleged that Raju had diverted funds of
Satyam into purchasing nearly 50 plots in Medchal and
Qutbullahpur near Hyderabad
The ED alleged that several hundred crore rupees had been
diverted from the Satyam Computer accounts and had been
invested in purchasing land and other infrastructure for
Maytas.
The Directorate will go through deals of the IT company and
ascertain their genuineness including payments made to
acquire companies abroad.
The ED will also send a team to a few countries to investigate
and get documents of bank accounts opened in violation of
Indian laws

Hasan Ali Khan - Issues

India's lone banking regulator, Reserve Bank of India,

recently blocked the application of Swiss bank UBS for a

banking license in India on the ground that it was involved in
$8 billion money-laundering racket
RBI said it put the UBS application on hold because the bank
failed to cooperate in a money-laundering case in which
controversial Bombay-based businessman Hasan Ali Khan was
involved.
Khan is charged with large-scale breaching of India's currency
controls.
_ RBI investigators found the link between UBS and Khan, as
the businessman had deposited $8 billion at a Zurich branch of
UBS.
_ They cited it as direct evidence for blocking the license of
the bank.

High risk areas of AML

High risk countries
Drug producing countries
Countries with high levels of corruption
Countries linked to terrorist financing

High risk customers

Private money transmitters
Money changers
Real estate dealers
Casinos, gambling outfits
Non profit organizations charities

High risk services

Wire transfers
Private banking
Correspondent banking
Electronic banking services-internet, debit/credit cards

Risk Factors
Vulnerabilities
Entities may not be regulated
Customer anonymity(Secrecy)
No face to face relationship
Anonymous funding(Promissory notes)
Cross border transfers
access to cash globally through ATMs

Possible risk mitigants

Verification of customer identity
Limit funding options
Limit card value
Monitor transactions
Reporting of suspicious activity
No direct cash via ATM

- Advise to clients
- Audits - Banks - Statutory Audit (LFAR)
- Concurrent Audit
- KYC and AML Audits
- DP Audits as per SEBI guidelines
- Stock Brokers audit as per SEBI
guidelines

Thank you
ca.rshetty@gmail.com