CA Magazine
By Paul McLaughlin
October 2001
Recently, the BC Securities Commission accused a Vancouver brokerage firm of ignoring the fact that some of its clients were engaged in mob-related activities. Steve Wilson, executive director of the commission, reportedly alleged that the firm should have known the clients were using US-dollar accounts for manipulating stocks and laundering money. The brokerage firm has denied any improper conduct. In another unrelated case, a major Canadian retailer - unknowingly or otherwise - helped a Colombian drug cartel integrate the illicit proceeds from the street sale of cocaine and heroin into the mainstream economy. Were these Canadian firms innocent victims of mobsters skilled in the latest methods of generating clean money? Or did they wilfully turn a blind eye to what was going on?
Wayne Blackburn, a former superintendent of the RCMP's Ontario Economic Crime Branch and a proceeds-of-crime expert, isn't certain.
But he does know this: The retail company involved - a household name - failed to perform due diligence when it was asked to ship $400,000 worth of electronic equipment to a company located in the heart of Colombia's known drug centres. If it had, he says, alarm bells should have begun to ring at corporate headquarters.
"The criminals that sell narcotics are astute and have figured out that the police, thanks in part to new money-laundering legislation internationally, can now generally follow money from a drug deal and freeze and seize it if it's in a financial institution," says Blackburn, now the president of Signature Integrity Solutions Corporation, an Oakville, Ont., investigative firm. "So they've come up with another way to clean the money up - by using it to purchase commodities."
Known as "the black peso money-laundering system," the scheme works like this: The drug traffickers require pesos to pay for their lavish lifestyles in Colombia. But most of their money is in US dollars, so they sell the dollars - usually at 20% below the official exchange rate - to Colombian-based companies in exchange for local currency. The companies, which are in cahoots with the drug traffickers, use the US currency to purchase commodities such as cigarettes, liquor, TVs and other consumer appliances, abroad. These commodities are either given to the cartel members for their own use or are sold in retail stores in Colombia, often for a profit, which is shared by all the parties involved. That's what happened in the case Blackburn came across.
"The goods from Canada were sold to the public for about $500,000 in Colombia," he says. "So the traffickers not only laundered their money, they made a profit on it too. And if the police ask where they got the money from, they can say they are partners in what seems to be a legitimate business enterprise." As for the Canadian company, it is now aware of its involvement in a money-laundering operation and has taken some measures to reduce the possibility of making the same mistake again.
The emergence of the black peso system is the latest twist in the cat-and-mouse game of money laundering played between criminals and law enforcement agencies. Until recently, the money launderers have by far had the upper hand, exploiting the absence, in most parts of the world - especially Canada - of effective anti-money-laundering legislation and the banking industry's obsessiveness with secrecy. According to the federal solicitor general, between C$5 billion and C$17 billion is laundered in Canada each year (the International Monetary Fund estimates that worldwide laundering ranges from US$590 billion to US$1.5 trillion annually, or between 2% and 5% of the world's GDP).
"In the recent past Canada has been considered one of the best places in the world to launder money," says Chris Walker, a former criminologist with Grant Thornton LLP. "One reason was because it has the largest undefended border in the world, which made it easy for dirty money to pass from the US into Canada and vice versa." He cites as an example a famous case that took place during the height of the tobacco smuggling era in the mid-'90s. Four armoured vehicles loaded with $450 million cash left Masena, New York, which is near the Akwesasne Reserve - a place that was well known at the time to be heavily involved in tobacco smuggling. The trucks drove to Ottawa where the money was deposited into a branch of a major Canadian bank.
Another reason that Canada is a target for laundering, he says, is the stability of its banking system and "the willingness of its major financial institutions to do business with people who just walk through the door." Walker also points to the presence of our major banks in many of the money-laundering havens of the world (see "Hall of shame" at end of article), and the fact that, until recently, all Canadian laws regarding money laundering had been voluntary. "I can tell you," he says, "that not much voluntary reporting ever took place."
However, that's about to change with the recent implementation of Bill C-22, the Proceeds of Crime Act - tough new federal legislation for money laundering that received Royal Assent in June 2000. "It has strict reporting requirements that should make it harder to launder money in Canada," says Walker, who has founded About Business Crime Solutions Inc., an e-based consulting firm (www.moneylaundering.ca) to assist Canadian businesses and professionals, such as accountants and lawyers, in complying with the new legislation.
One result of Bill C-22, according to Lee Lamothe, an investigative researcher and co-author of the recently published Bloodlines: The Rise & Fall of the Mafia's Royal Family, is that the criminals are going to become "more violent and intimidating" when trying to coerce individuals within the business community to help them launder cash. "Before C-22, you had guys taking big bags of money to a friendly, corrupted bank manager, who would get a percentage for facilitating [the transaction]," he says. "But now the risk and penalties are so great that fewer people will be willing to cooperate." In response, says Lamothe, the criminals will either take control of some financial institutions or resort to strong-arm tactics.
"I had a client at a Canadian brokerage who had been asked by the Italian Mafia to invest in a certain company," he says. "When they found out that he then hired us to check them out, he received a very threatening phone call saying that they knew how many children he had, where his house was, where his cottage was, and that he was going to do this deal or else. I knew, from hearing a tape of the call, who it was and that it was a serious threat. But I was able, through some of my contacts, to get them to back off."
If the investment broker had complied - and, more than likely, the squeeze was simply shifted to another victim - the Mafia would have benefited in two ways. First, the money would have been integrated into the economy, and second, the stock would probably have risen in value due to the large sale of shares. "It was a classic pump-and-dump scheme," says Lamothe. "They drive the price up and then sell off their shares, gaining a nice profit along the way."
If intimidation doesn't work, the money launderers have another, perhaps even more persuasive, method of corrupting insiders: money. "It used to be that they offered a few percentage points return [to the insider]," says Christopher Walker, "but that's gone way up recently. On average, they're now willing to lose 20% as a cost of getting the dirty money into the system. But in some cases it's as much as 30%, even 40%, at the very high end."
Not that the criminals aren't still eager to save a buck. Bill C-22's requirement that cash transactions of $10,000 or more be reported to an agency called the Financial Transactions and Reports Analysis Centre (FINTRAC) will likely see the introduction of "smurfing" in Canada. This term, named after the small, blue cartoon characters, originated in the US some years ago when organized crime groups would pay elderly men and women - but especially the latter - a few hundred dollars each to deposit up to $9,999 in cash into bank accounts. (Few banks were suspicious of an elderly person with a large sum of cash.) Because many of the unwitting depositors were small in stature, they became known as smurfs, and the scam came to be called smurfing. A variation on the theme also took place in casinos, where individuals (both criminals and smurfs of all ages and sizes) would buy up to $9,999 in chips with dirty cash, place a few small bets over several hours, then exchange their remaining chips for a casino cheque, negotiable anywhere.
While it's no surprise that more than half of the dirty money being laundered through casinos, banks, insurance companies, money exchange outlets, stock brokerages and other favoured institutions comes from the sale of illegal drugs, the second most common source of dirty money may not be as obvious. "It's from white-collar crime - fraud, that kind of thing," says Garry Nichols, regional director of FINTRAC for Ontario and a retired RCMP inspector with extensive experience in its proceeds of crime unit. "We have an aging population that includes criminals, and they would much rather defraud a bank than try to jump over a counter and rob it."
As organized crime increasingly gets involved in white-collar scams, it will invariably apply its understanding of how Canadian businesses operate to the laundering of its fraudulent profits. One lesson it has already learned is the need to install its own people or bribe existing personnel within banks, airports (to facilitate customs clearances) and other institutions that it plans to exploit. "Financial institutions, for example, are well aware of this problem," says Blackburn, "but it's a hard one to prevent, especially with the kind of privacy and hiring regulations that now exist." A solution, of course, is to conduct effective employee screening, a relatively inexpensive measure that for some reason many companies seem reluctant to adopt.
More important, though, is the need for meaningful due diligence, to a far more intensive degree than ever before. The advent of the commodities scam, and future variations on that theme, make it critical that companies know their clients and customers. Is this a feasible requirement, considering how expensive and time-consuming that could be for a large corporation? "It's the cost of doing business globally," says Blackburn. "They have no choice." Lamothe predicts that the scope of the new due diligence will extend to existing customers and clients. "They're also going to have to do past due diligence," he says. "Examine people they've been in business with, perhaps for years, to make sure they're not involved in money laundering."
While Canadian companies now have to be alert to any suspicious transactions that might smack of money laundering, the most prevalent schemes will have an international scale. The easiest way to hide money is to move it around among business entities and jurisdictions. "Criminals move money between banks, between different financial instruments, and in and out of tangible assets such as businesses or property," writes Nigel Morris-Cotterill, author of "How not to be a money launderer," in the investment publication Foreign Policy. "They try to change the shape and size of the financial holding by using different currencies and by adding to and subtracting from the amount so that it is more difficult to identify."
FINTRAC's Garry Nichols recalls a vivid example of that particular approach from a few years ago. "There was one investigation involving some Canadian hash dealers who moved the money into 110 different corporations they'd set up on five continents. Most were shells [entities that exist for the sole purpose of facilitating illegal activities] in jurisdictions with strong secrecy laws."
Do law enforcers have the resources and expertise to combat such a web of deception? "It's definitely time-consuming and expensive," says Nichols, "but it's a lot easier now because of international cooperation. I think there are 55 other financial institutions in the world doing similar work to what we do [at FINTRAC], so it's easier to follow the money."
If law enforcement does indeed have a new edge to combat money laundering, it doesn't necessarily mean the problem will soon be under control. "There will be just as much money laundering as before," says Lamothe. "It's just going to take a different form." That new form will probably involve fewer bank transactions and more manipulation of businesses, as with the black peso scheme. Although FINTRAC intends to apply "a velvet glove" at least in its first few years of operation, according to Nichols, the new reporting and due diligence rules mean that Canadian companies, and the accountants and lawyers who work with and advise them, had better be as aware of how money laundering works as money launderers are of how business operates.
Advice for CAs
If a wealthy potentate - such as a current or former ruler of a Third World nation or a military or police leader - wants to do business with you or your company, consider that a red flag, says James Hunter, CA, a forensic accountant with KPMG LLP in Toronto. "The FATF has identified potentates and other public servants who don't typically make a lot of money as people who may be involved in corruption," he says. "Be careful and make sure you thoroughly check them out."
The most important action, of course, is the "smell" test, says Hunter. "If it doesn't seem right, it may well not be." He also advises being careful when you have a trust as a client. "If you, as a CA, can't understand the wording of the trust, then I'd say that's pretty suspicious." He also warns against "flying trusts." These have a clause saying that if there's an investigation into the trust, it must be moved to another jurisdiction.
Walker adds that the traditional red flag - lots of cash - is becoming more rare. "Companies have to be alert to the movement of monies back and forth, to classic laundering havens," he says. In addition to reiterating the need to do exhaustive due diligence, he also advises watching out for investors who don't seem to care whether they get a return on their investment. "Remember that, to a money launderer, a significant proportion of his money is expendable."
Will the new requirement for careful scrutiny of clients and customers be a hardship on CAs? Not according to Hunter. "I think it will do them a favour," he says, "in that it will force them to reevaluate some of their clients. They may have to let some go. Since I don't think CAs want bad people as clients, they may end up getting rid of some undesired people."
Hall of Shame
Nauru is a tiny Pacific atoll northeast of Australia. As Reuters reports, it has a population of 10,000, one main road and 400 banks. In 1998 alone, according to the US Treasury department, those financial institutions received US$70billion that originated in Russia - most, if not all, from organized crime.
When it comes to accommodating money launderers, Nauru, along with Russia and the Philippines, are the worst offenders in the world, according to the Financial Action Task Force on Money Laundering (FATF), an international body founded in 1989 by the G-7 countries. In its 2001 report, the FATF blacklist also includes Cook Islands, Dominica, Egypt, Guatemala, Hungary, Indonesia, Israel, Lebanon, Marshall Islands, Myanmar, Nigeria, Niue, St. Kitts and Nevis, and St. Vincent and the Grenadines.
Perhaps the most effective weapon wielded by FATF is to "name them and shame them." That approach seemed to work with the Bahamas, the Cayman Islands, Liechtenstein and Panama, all of which were on last year's list but made sufficient improvements - "addressed the deficiencies," as FATF puts it - and were removed from the 2001 list. The existence of FATF's list is among the pressures that forced Canada, long after the United States, to adopt meaningful money-laundering legislation.
Paul McLaughlin is a communications consultant with Kroll Lindquist Avey, an international forensic accounting, litigation consulting and business valuation firm in Toronto.