India: Prevention of Money Laundering

Last Updated: 7 September 2004
Article by Rajkumar Dubey

Introduction

Money Laundering, has been a great menace to the world economy particularly in this heightened stage of terrorism and cyber crime. A large number of criminal activities are focused to generate money for the perpetrators. Such criminal activities include the activities of organized crime such as drug trafficking, sale of illegal arms, smuggling, embezzlement, tax evasion, corruption, illegal gambling, arson, racketeering, prostitution etc. which can generate huge sums. Once money has been amassed through these illegal activities, the next concern of the persons involved in such activities would obviously be to legalise them and bring them into the mainstream economy. Money Laundering is a process through which these ill-gotten money is made legal and infused into the mainstream economy. This is usually done by disguising the source, changing the form, or moving it to a place where they are less likely to attract attention of the authorities.

The present article tries to discuss in brief, the intricacies of Money Laundering and in particular the ambit of Prevention of Money Laundering Act, 2002.

What is Money Laundering?

Money Laundering is a process to make illegitimate money appear legitimate. It involves cleansing (by engaging a series of transactions) of dirty money from criminal activities with the object of hiding its true source and making it legally usable. It’s the processing of criminal proceeds to disguise their illegal origin. According to the Black’s Law Dictionary, Money Laundering is a term used to describe the activities of transferring illegally obtained money through legitimate persons or accounts so that its original source cannot be traced.1 This process enables criminals to enjoy such money without jeopardizing its source.

Extent of Money Laundering Activities

According to one recent estimate2 worldwide Money Laundering activity amounts to roughly $ 1 trillion a year. According to an estimate International Monetary Fund (IMF), the aggregate size of Money Laundering in the world could be somewhere between 2 to 5 percentage of the world GDP. These illicit funds facilitate a whole range of additional criminal activities. In addition to this, Money Laundering encourages corruption, distorts economic decision making, aggravates social ills and affects the integrity of financial institutions worldwide.

Modus Operandi

The procedure of laundering the proceeds of fiscal crime can be divided into three stages3. These are:

  1. Placement or Conversion
  2. Layering or Concealment
  3. Integration or Creation

In the first or "Placement" stage the money launderer pumps a large sum of money into the financial system. This is done by splitting the large sum of money into smaller denomination and directly depositing them into bank or by purchasing a series of monetary instruments that are then collected and deposited into bank accounts at any other location.

In the second or "Layering" stage the launderer makes complex layers of financial transactions by transferring money among several banks operating in different countries to hamper the audit trial, disguise origin of funds and provide anonymity to the true owner i.e. Concealment. The funds may be channelled through purchase and sale of financial instruments, or the launderer might simply wire at various banks across the globe. In some instances the launderer may disguise the transfers as payments of goods and services, thus giving them a legitimate appearance.

In the third stage, known as "Integration" stage, the launderer, already having successfully routed his criminal proceeds through first two stages, makes the funds re-enter the legitimate economy. This is usually done by investing the funds into real estate or business ventures. Though Money Laundering can occur anywhere in the world but launderers try to find out places where there is low risk of detection due to weak or ineffective anti Money Laundering regulations. Economies with growing or developing financial centers are more vulnerable to the Money Laundering as established financial centers have comprehensive anti Money Laundering regime. Money Launderers also achieve these objectives by setting up Paper Companies (i.e. companies that exist only on paper and name boards) in tax heavens. Tax heavens are the countries like Bahamas, Bermuda, Cayman Islands, Channel Islands, Seychelles, British Virgin Islands, St. Kitts, Luxembourg, Norfolk Island, Monaco etc. where tax evaders can safely use their black money with no question being asked about their sources.

Effects of Money Laundering

Broadly speaking, Money Laundering has a damaging effect on all strata of the society especially on the national as well as national economic system. The following are some of the ill effects of Money Laundering activities on national and international economy, financial institutions and society at large:

  • Inexplicable variation in money demand. Money laundering creates a parallel economy in countries with the governments of such countries having no control over the actual supply and demand in the financial market.
  • Prudential risks to soundness of banks. Banks and financial institutions are most vulnerable to money laundering. Lack of proper surveillance system to weed out money laundering has a potential threat of causing collapse of banking system.
  • Increased cost of surveillance. As a potential risk to the reputation and soundness of banking and financial institutions, control of money laundering needs increased surveillance and compliance by such institutions. This adds to the expenses and procedural hassles of such institutions.
  • Increased volatility in international monetary market. An unregulated flow of capital in the international market leads to volatility and unexpected fluctuations in the exchange rates among countries.
  • Dampening effect on foreign direct investments. When the financial system of a country is of questionable integrity, foreign investments coming into the country become subject to increased surveillance and further instability in the financial market lead to lesser investors confidence.
  • Increase in corruption. Money laundering has a direct contribution towards increased corruptions in entire spheres of life, which leads to the weakening of social fabric, ethical standards and democratic institution of nations.
  • Potential risk to the reputation of the involved banking or other financial institutions thereby increasing their compliance cost as they come under scrutiny of concerned authorities.

In recent past, the increase in drug trafficking and terrorist related activities has made Money Laundering more menacing than ever before. In some countries in Latin America, Africa and South East Asia, the mafias control a huge network of illegal funds and run an economy parallel to the national economy.

Global inititives to combat Money Laudering

The term ‘Money Laundering’ was coined by the law enforcement officials in United States for the first time in 1970. In 1986, Unites States became the first country to make Money Laundering a crime by enacting Money Laundering Control Act, 1986. Since then efforts to control Money Laundering have been a worldwide endeavor. Recently, after the terrorist attack in 2001, the US has passed the Patriot Act in order to keep tab on suspicious financial transactions used terrorist organizations.

The most significant initiatives in combating Money Laundering has been the formation of Financial Action Task Force (FATF). FATF was established by the G-7 submit held in Paris in 1989 to promote the policies to combat Money Laundering. Currently FATF has 33 members attached to it. The FATF has been providing suggestions such as improving national legal systems, enhancing the role of the financial system in reporting and monitoring suspicious activities and strengthening international cooperation.

In 1991, the European Economic Council issued a directive on The Prevention of the use of Financial System for purpose of Money Laundering which became effective on its member states on January 1, 1993 pursuant to which many European Nations passed anti Money Laundering legislations.

In February, 1990 the United Nations General Assembly adopted the Political Declaration and Global Programme of Action and subsequently a political declaration was adopted by the special session of the United Nations General Assembly in June 1998 which called upon the member states to adopt national anti Money Laundering legislation and programme.

Following this, the Government of India also passed The Prevention of Money Laundering Act, 2002.

The Prevention of Money Laundering Act, 2002.

The Prevention of Money Laundering Act, 2002 ("PMLA") was passed in the winter session of Parliament in 2002 and subsequently got the assent of the President and was published in the Official Gazette of India on 20.1.2003. Though the Act has already been published in the official gazette, it is yet to come into force. The PMLA contains 75 sections divided into 10 chapters. Chapters I and II contain the preliminaries of the Act and the offence of Money Laundering. The PMLA recognizes two types of offences described in the schedules attached to the Act. The offences coming under Part B of the Schedule would come under the ambit of Money Laundering if the total monetary value involved in such offences is thirty lakh rupees or more. However, for offences coming under Part A of the Schedule, there is no such limit of monetary value.

Scope of the Act

The PMLA intends to prevent Money Laundering and provides for the confiscation of the property derived from or involved in Money Laundering and the matters connected therewith or incidental thereto. It further, exposes the banks, financial institutions and intermediaries as well as individuals to varying degrees of duties and penalties.

The offence of Money Laundering

Section 3 of the Act provides that 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.

Adjudication

The Act provides a two-layer system for the purpose of adjudication under the Act. Section 6 of the Act provides for the appointment of Adjudicating Authorities for deciding matters relating to search and seizure of properties, records etc. by the appropriate authority under the Act. Section 25 of the Act provides for the establishment of an Appellate Tribunal to hear appeals against the orders of the Adjudicating Authority and the Authorities under the Act. The Jurisdiction of the Appellate Tribunal may be exercised by Benches thereof. No Civil Court shall have jurisdiction in respect of any matter, which the Director, Adjudicating Authority or the Appellate Tribunal is empowered under this Act to determine. Any person aggrieved by any decision or order of the Appellate Tribunal may file an appeal to the High Court.

Adjudication Authorities

Following classes of authorities have been classified under PMLA:

  1. Director or Additional Director or Joint Director
  2. Deputy Director
  3. Assistant Director, and
  4. Such other class of officers as may be appointed from time to time

The above said persons are appointed by the Central Government and they in turn may be authorised to appoint other authorities below the rank of an Assistant Director.

The authorities mentioned as above have the power pf search, seizure and arrest subject to the provisions of the Act. The Director shall, for the purpose of section 13 have the same powers as are vested in a civil court under the Code of Civil Procedure, 1908 while trying a suit.

Filing of Complaint

A complaint could be filed with the Adjudicating Authority under the following provisions of PMLA:

  1. By the Director, or any other person not below the rank of deputy Director, authorised by him, once he provisionally attaches any property under section 5(5) if he has reason to believe on the basis of material in his possession that,
    1. any person is in possession of any proceeds of crime;
    2. such person has been charged of having committed a scheduled offence; and
    3. such proceeds of crime are likely to be concealed, transferred or dealt with in any manner which may result in frustrating any proceedings relating to confiscation of such proceeds of crime.
  2. By the Director once he seizes any record or property under section 17(4) on the basis of information in his possession if he has reason to believe that a person:
    1. has committed any act which constitutes Money Laundering, or
    2. is in possession of any proceeds of crime involved in money in Money Laundering, or
    3. is in possession of any records relating to Money Laundering.
  3. By an authority authorised by the Central Government by a general or special order, once it seizes any record or property under section 18(10) if it has reason to believe that any person has secreted about a person or in anything under his possession, ownership or control, any record or proceeds of crime which may be useful for or relevant to any proceedings under PMLA.

Procedure post filing of a complaint

  1. The Adjudicating Authority on receipt of the Complaint, may serve a notice of not less than 30 days on such person calling upon him to indicate the sources of his income, earning or assets out of which or by means of which he has acquired the property attached under sections 15(1), 17 or 18, the evidence on which he relies and other relevant information and particulars and to show cause why all or any of such properties should not be declared to be the properties involved in Money Laundering and confiscated by the Central Government.
  2. The Adjudicating authority thereafter passes its order as to whether any or all of the properties referred to in the notice are involved in Money Laundering after considering the reply or hearing the aggrieved person and taking into account all relevant materials placed on record before him.
  3. This is followed by the confirmation of the attachment of the property made under section 15(1) or retention of property or record seized under section 17 or 18 by the Adjudicating Authority.

Appeal

Any appeal against the order made by the Adjudicating Authority may be made to the Appellate Tribunal by:

  1. Director or any aggrieved person
  2. Any banking company, financial institution or intermediary aggrieved by any order of the Director.

Appeal to the High Court

An appeal against the order made by the Appellate Tribunal/Special Court could be made to High Court by any aggrieved person on any question of law or fact.

Special Courts

Apart from establishing Adjudicating Authorities and Appellate Tribunal for deciding matters relating to search, seizure etc., section 43 of the Act also provides for establishment of Special Courts for trial of offences relating to Money Laundering punishable under section 4 of the Act. Section 44 of the Act provides that notwithstanding to anything contained in the Code of Criminal Procedure, the scheduled offences and the offences punishable under section 4 shall be triable only by the Special Court constituted for the area in which the offence has been committed.

Punishment

Section 4 of the Act provides for a rigorous imprisonment of 3 to 7 years and also a fine of up to 5upees five lakhs for the offence of committing Money Laundering. However, where the proceeds of crime involved in Money Laundering relates to an offence specified under paragraph 2 of Part A of the Schedule, the terms of imprisonment can be extended up to 10 years.

Obligation on banking and financial institutions

PMLA imposes certain stringent reporting and verification obligations upon banks, financial institutions and intermediaries. Section 12 of the Act provides that every banking company, financial institution and intermediary shall-

  1. maintain a record of all transactions, the nature and value of which may be prescribed, whether such transactions comprise of a single transaction or a series of transactions integrally connected to each other.
  2. furnish information referred to above, to the authorities within such time and manner as may be prescribed.
  3. verify and maintain the records of the identity of all its clients in such manner as may be prescribed.

In case of a failure to comply with the above said provisions, penalty would be imposed which shall not be less than ten thousand rupees but which may extend to one lakh rupees for each such failure. No civil proceedings shall lie against banking companies, financial institutions and intermediaries for providing information under section 12 of the Act.

Provisions regarding reciprocal arrangement

Money Laundering, most of the time involves various cross border transactions to hide the nature and source of the money and hence invariably needs a multilateral mechanism to check its effect. Section 56 of the Act empowers the central government to enter into agreement with other countries for enforcing the provisions of this Act and for exchange of information for the prevention of Money Laundering. If the Special Court, on an application made by a competent authority in this regard, is satisfied that any evidence in connection with any investigation or proceedings under the Act is available in any contracting state, it can issue a letter of request to a court or authority of such contracting state requesting them to provide such evidence or information. Section 59 of the Act also provides for reciprocal arrangements for process and transfer of accused persons.

Conclusion

The Act is a first step towards a comprehensive legislation for preventing Money Laundering and has placed India on equal footing to its international counterparts. Another best part is that it has also included the banks and financial institutions, which channelise Money Laundering activities, within its ambit, by imposing certain obligations upon them.

The genesis of a transaction pertaining to Money Laundering may be India, however, it may spread to other territorial boundaries. Hence international cooperation is necessary to fight against it. Keeping in mind this vital aspect, the provisions relating to the reciprocal arrangements with other countries to enforce the provisions of this Act, exchange of any information or assistance for the transfer of accused person for the prevention of the offence under this Act, have been clearly provided for in the Act itself. All this ensures a regime under which Money Laundering shall construe to be a serious crime and its practice shall lead to serious consequences.

Disclaimer

Actual resolution of legal issues depends upon many factors, including variations of fact and laws of the land. Though the firm has taken utmost care in the preparation of this article, the information contained herein is not intended to constitute any legal advice and the firm cannot accept any responsibility towards those who rely solely on the contents of this article without taking further specialist advice. The reader should always consult with legal counsel before taking action on matters covered by this article.

Footnotes:

1. 7 Edition, West Group Publication, 1999, Pg. 1022

2. www.usinfo.state.gov

3. www.fatf-gafi.org

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