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Chasing Dirty Money: We Have Lost Sight of Our Objective

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Over the past 30 years, international financial authorities have made progress in developing a consistent and comprehensive global regime to combat money laundering and the financing of terrorism.1 But they have lost sight of the ultimate objective in developing a robust global anti-money laundering (AML) regime: It is principally a means to the end of reducing the incidence of the underlying crimes by identifying the perpetrators and bringing them to justice.

A case in point is the renewed attention to the beneficial owners of secret offshore accounts following the leaked documents known as the Panama Papers, which hit the news in early April. Such accounts, which need not be offshore, are designed to conceal the beneficiaries. The purpose may be legal or illegal. The owners may pay taxes on the proceeds or may not, but it is impossible to know unless those dealing with the accounts know who the beneficiaries are.

The United States has been particularly lax on this aspect of the global AML regime. In 2006, the United States was found to be noncompliant with the Financial Action Task Force (FATF) recommendation to have rules requiring identification of beneficial owners and obtaining information on their activities, known as due diligence. Before the release of the Panama Papers, the US Financial Crimes Enforcement Network (FinCEN), an agency of the US Treasury charged with the enforcement of US AML laws and regulations and the collection of information on such activities, had put in motion a process to strengthen due diligence requirements that financial institutions must satisfy to identify beneficial owners of certain legal entities. The final regulation was issued on May 11.

But the new US standard for the identification of beneficial owners such as those revealed in the Panama Papers is not up to that of the European Union (EU). For example, FinCEN regulation defines a beneficial owner that must be disclosed as one with a 25 percent direct or indirect equity interest. By contrast, the EU defines such an owner as having a 10 percent interest. I am doubtful that in the next FATF review the United States will have made it to the fully compliant category. In light of the Panama Papers, I also expect that Congress will force FinCEN and other financial regulators to go back to the drawing board with respect to beneficial owners.

In addition, the process that led to the release of this new regulation illustrates the fact that in strengthening the AML regime the authorities have lost sight of the ultimate objective with respect to reducing the underlying crime. Because of the scope of the new regulation, FinCEN was required to assess its costs and benefits. FinCEN estimated the 10-year costs for financial institutions and their customers of compliance with the new regulation of between $380 million and $1.46 billion in 2016 (on present value basis). These costs were compared with an updated estimate of the total amount of money laundered in the United States in 2010 drawn from the US Treasury’s 2015 National Money Laundering Risk Assessment and National Terrorist Financing Risk Assessment. That estimate was “about $300 billion…in illicit proceeds.” FinCEN asserted that the new regulation would easily reduce money laundering by more than 0.16 and 0.6 percent per year over the next 10 years, thus, exceeding the cost of the new regulation.

However, as Peter Reuter and I argued in chapter 2 of Chasing Dirty Money: The Fight Against Money Laundering, published by the Institute in 2004, such estimates of the total amount of money laundered are of no practical value for policy guidance. First, the amounts of money actually laundered are not the same as the gross proceeds of the underlying crimes, and the latter are the data relied on to make the overall estimates. Second, an increase or decrease in those amounts tells nothing about whether there has been an increase or decrease in the underlying crimes. Third, a dollar associated with a terrorist attack has a larger anti-social value than a dollar associated with the sale of a package of marijuana in a state where such sales are not legal.

The most serious flaw in FinCEN’s framework, however, is the lack of any analytical link between the reduction in the amount of money that might be laundered and the impact on the incidence of the crimes that might be uncovered by increased due diligence about beneficial owners. The framework finesses this important issue through the sleight-of-hand that laundering money itself is a crime.

In our study of the global AML regime, Reuter and I were disappointed to have to conclude that useful data to assess the regime are scarce and, more importantly, little work had been done exploiting the data in order to determine what worked and did not work to combat the diverse underlying crimes that give rise to the returns from money laundering.

Unfortunately, in recent years the enforcement focus has been more on identifying “gotcha” mistakes by financial institutions subject to the regime than on using the regime to fight crime. The institutions, in particular financial, that are subject to the regime are constantly on the defensive trying to make sure that they are complying with the regime’s requirements rather than being enlisted to help address the underlying criminal activities. In my view, the senior leaders of those institutions should take greater initiative to encourage senior policymakers to pull back the Stormtrooper examiners and micro-managing supervisors and to give greater attention to the basic objectives of the AML regime.

The Panama Papers provide a unique opportunity to turn the page. The release of the Papers with their near-full disclosure of multiple beneficial owners provides the raw material for law enforcement and financial institutions to cooperate with social science researchers to establish the benefits of the global AML regime in bringing criminals to justice.

Note

1. This post draws from my remarks on June 16 at a symposium on anti-money laundering and financial crimes compliance organized by EY in New York City.

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