Cayman Islands: Money Laundering - Some Practical Considerations

Last Updated: 2 July 1999

WHAT IS MONEY LAUNDERING?

Although money laundering is currently a popular topic with financial circles, misconceptions abound when people are asked to describe the problem. Many people still consider it to be drug money deposited as cash in offshore tax havens. In fact the definition is far broader and has been defined as "the disguise of the source of illicit funds" or "the transformation of illegally obtained funds to that which appears legitimate." The broader definition demonstrates why the problem is a world wide problem not solely a tax haven issue.

WHAT ARE THE VOLUMES OF MONEY LAUNDERING?

In attempts to ascertain the current levels of money being laundered world wide one encounters enormous variations ranging from billions to trillions of dollars on an annual basis. In a recent KPMG publication it stated that there are more than 1 million International Business Corporations world wide holding more than US$5 trillion in assets. Law enforcement agencies estimate that as much as 90% of all criminal proceeds are laundered through IBC’s.

There are huge unexplained variations in the estimates. It is obvious that we do not know all the methods being employed to launder funds. As in the drug industry itself the greater rewards from the illicit actions make it hard for the authorities to effectively contain the industry.

Part of the substantial variation may be due to the repeated counting of a single transaction. For example, if a million dollars generated from the drug industry in Colombia is placed (introduced) through Mexico into the banking system, then (layered - disguising its origins) sent by wire transfer to an account in the Turks and Caicos for onward investment to a company in Switzerland for final investment in a real estate company (integration - legitimate operations) in New York the transaction could be seen as either a sole million dollar transaction or four separate transactions of a million dollars each.

As techniques for layering, the process by which money is "cleaned", become more sophisticated the problem is exacerbated and larger estimates are made of the potential volumes.

WHY IS IT IMPORTANT TO QUANTIFY THE VOLUMES?

Given the difficulty of accurately estimating the volumes of money laundering, why do the authorities invest so much of their scarce resources in attempting to quantify their understanding of the volumes?

The main rationale is that the authorities need to have a clearer understanding of the problem they are attempting to redress. Being able to state that over a trillion dollars a year is laundered focuses the attention of the budget makers and is a tremendously powerful political tool.

Although I do not seek to quantify the problem in this article I strongly believe that people involved in the financial services industry and certainly those in the offshore arena consider the problem as one of the most significant issues facing the financial services industry today.

WHAT IS BEING DONE?

In this article I discuss what is being done in the offshore jurisdictions, in particular, in the Cayman Islands. Money laundering is not an offshore problem; it is a world wide problem and whatever the volumes are one can see that there are sufficient sums of illegal proceeds to infiltrate virtually all areas of economic activity.

In my experience the offshore centres are far more aware of money laundering and therefore have taken greater steps to take action against such criminal activity than the larger nations. Admittedly most developed nations have introduced anti-money laundering legislation but to many people such activities are so far removed from their day to day work that they are barely aware of the laws.

On the other hand financial services professionals in the Cayman Islands and other offshore financial centres are frequently exposed to new enquiries and business relationships and are therefore more alert to the identification and prevention of money laundering.

In the offshore centres there is less overt regulation than onshore. By overt regulation I mean extensive compliance rules and substantial, complex and sometimes onerous financial reporting. The regulators objective is to ensure that only respectable and qualified service providers are operating from the jurisdiction. The regulators require quarterly reports containing mainstream financial information of considerably less detail than would be required to effectively manage a business. Recently some of the regulators have introduced onsite visits but, as yet, these visits are rare and not particularly detailed.

As a result the burden of day to day regulation is placed in the hands of the service providers. They are highly effective in the battle against money laundering. They are motivated by a number of measures:

1. Country Reputation

To an extent the service providers are the correct people to bear the burden since they benefit directly from the good name and effective business practices of the jurisdiction. All service providers are well aware of the number of offshore jurisdictions all competing for very mobile and transitory business. They know that any clear evidence of money laundering could lead to substantial outflows of assets from the jurisdiction.

2. Firm Reputation

Many practitioners work for substantial organisations who have built up their reputations over many years. Many of these firms have internal ethical guidelines which determine the business practices of the organisation. The experience of American Express in Mexico clearly demonstrates the costs incurred by a firm when illegal activities are discovered involving the participation of employees.

The argument that excessive inquiries of potential customers reduces an institutions competitiveness is no longer valid. Bona fide clients do not resent valid enquiries if their rationale is explained. Unusual resistance can be a good indication of problems to come.

3. Personal Liability

Many of the offshore centres have introduced legislation which render the service provider personally liable, on a criminal level, for servicing funds generated from criminal activities. Under the Proceeds of Criminal Conduct Law in the Cayman Islands the service provider needs to ensure that they have carried out sufficient due diligence on any prospective client to alert them to any suspicious activity.

HOW DO THE SERVICE PROVIDERS DO THIS?

It is all well and good for the authorities to legislate that the service providers should police the system but in reality how do they do it?

It is a complex area and the issues of client acceptance and ongoing monitoring should be carried out by experienced and knowledgeable personnel. There should be effective mechanisms to review and enhance the measures being employed. Effective knowledge sharing will continue to be a crucial tool in this area.

It is vital for any firm to have sound policies, clear practical instructions and, as importantly, to ensure they are being enforced. Preventive and detective systems of internal controls are required.

However, as a practical measure in my view the primary rule is that of professional scepticism. The professional should not accept everything they are told at face value. They should challenge the statements being made. They should enquire further into aspects of their clients’ business. If possible they should visit the physical premises. From the information available they should ensure that the size of the operation justifies the cash flows being generated. If they have inadequate information to form this view consideration should be given as to whether they need to complete additional procedures.

WHAT PRACTICAL RECOMMENDATIONS ARE THERE?

1. Avoid high risk jurisdictions - current examples are Nigeria, Russia, Eastern Europe. Certainly with Eastern Europe it is exceedingly difficult to obtain valid meaningful references. Amazingly offers of assisting a senior ranking Nigerian official remove millions of dollars from that country still appears to be doing the rounds.

2. Avoid rushed transactions. Where people are trying to complete a substantial transaction at very short notice they may be trying to get you to shortcut your usual due diligence procedures. Remember it is much harder to extricate yourself from a client relationship than anticipated.

3. Avoid transactions that appear to be unusually lucrative without economic risks to justify them. At risk of being banal if it seems too good to be true - it probably is. A few years ago we were approached to set up a company to receive a billion dollars of commission involving the movement of gold equivalent to the total annual gold traded on all the exchanges world wide. The size of the scheme was so ridiculous that it was easy to identify and turn down.

It is important to note that you do not always understand or need to understand the whole transaction but you do need to ensure that there are good indications that there is a valid commercial reason for the transaction. There are several cases of service providers not fully understanding a tax transaction that later turned out to be a fraud. As a service provider in today’s world I believe you need to satisfy yourself of the commercial rationale of the transaction you are assisting.

4. Bank references are useful to get but can say very little - a reference that states that an individual has maintained a bank balance at the institution for two years provides you with very little information about the client. Additional professional references backed up by common sense understanding of your clients business is essential.

5. Do some research into the firms providing professional references. If you have a sole practitioner law firm giving a glowing reference on a client, you need to ensure that there is not an unusual relationship between the two. For example, if the client gives the professional 95% of his business, they may have lost some independent perspective.

6. Avoid transactions that insist that no one else be informed of the transaction otherwise the transaction will become void.

7. Be very wary of accepting substantial gifts or lavish entertaining - these can obligate you or impair your judgement.

8. If you have reservations - turn it down - it is just not worth the risk.

9. If you feel there is some concern that the transaction may have crossed over the line between tax avoidance to evasion be exceedingly careful. This is a particularly thorny area at this time. The defence that it is not a crime in your jurisdiction may not be a valid defence for much longer.

10. Bear in mind that services to military or political figures are higher risk.

11. Be sceptical

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

This article also appears in the 'International Offshore and Financial Centres Handbook 1999/2000'. For further information about this highly informative guide to offshore centres, or to order your copy, please phone +44 (0) 207 820 7733 or send an email to iofch@mondaq.com

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