Blog
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Compliance & Ethics
Kezia Farnham
Senior Manager
March 21, 2024
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min read
Every year, criminal activity like drug trafficking, sex trafficking and arms trading generates trillions of dollars. To the proceeds of crime, those involved need to erase any trace that they obtained the money illegally — a process called money laundering.
Though money laundering may seem like a black market tactic, it’s a financial crime many white-collar criminals employ. The challenge for modern corporations and their boards is to create policies that effectively identify and prevent money laundering. To help, this article will explain:
- What money laundering is
- Common ways people launder money
- How money laundering works
- Money laundering examples
- Anti-Money Laundering regulations and compliance
- How to prevent money laundering
What is money laundering?
Money laundering definition: “Cleaning” money obtained illegally to erase its connection to criminal activity.
When people traffick drugs or commit other financially motivated crimes, they gain large sums of money. To deposit that money with a financial institution, they must create the illusion that the money came from a legitimate source — like a business they own or invested in — and not their illegal enterprise. Money laundering is the process that makes this illusion possible.
Electronic money laundering
Though traditional money laundering is synonymous with cash, the proliferation of online banks and payment services has given bad actors a new outlet. Money can be laundered through peer-to-peer payments, online money transfers and more, all while using a proxy server to disguise the identity of the launderers.
Criminals can also hold phony online auctions or convert their dirty money into currency for gaming and gambling before withdrawing newly cleaned money. Money laundering and other cryptocurrency-related crimes are also on the rise.
Common ways criminals launder money
People launder money in many different ways, and the advent of online banking has only added to the list. That said, some approaches are more common than others. Criminals most often launder money through:
- Banks: Many banks must report large transactions. Money launderers get around through a process called smurfing or structuring. They divide their total sum into smaller amounts that they deposit into separate bank accounts.
- Cash-intensive businesses: Criminals can also slip their dirty cash into cash-reliant businesses, like laundromats or car washes. If the car wash earned $10,000 one month, they can report the earnings as $15,000 instead and include $5,000 of dirty money in their deposit.
- Trade-based laundering: Criminals can also misreport the value of legitimate transactions to conceal dirty money, including by over- or under-invoicing for goods or services or falsifying the amount of product in a shipment.
- Real estate: Money launderers can channel their dirty money into real estate, buying property with illegitimate money and then selling it to recoup clean cash.
How money laundering works
Money laundering is a relatively simple process. It works by finding a place to house the dirty money, leveraging performative bookkeeping to make it appear as if the money came from legitimate transactions and then returning the clean money for use in the financial system.
This involves three specific steps:
The 3 stages of money laundering
The three stages of money laundering are placement, layering and integration.
- Placement: This involves finding a place to launder the money, usually a business or other third party.
- Layering: Criminals will then use bookkeeping and other practices to make the transaction appear legitimate.
- Integration: The criminal then withdraws the clean money and deposits it with a financial institution so they can use it as they please.
Examples of money laundering
Money laundering is often a covert enterprise, but many infamous examples of money laundering have made the front page. These also make excellent examples for boards that want to prevent this kind of criminal activity in their organization.
- Tobacco Industry (Multi-billion dollar industry): In the early 1990s, a major European subsidiary of a large tobacco company was investigated for a money laundering scheme with criminal groups from Russia and South America. Drug money was smuggled into Europe, then converted into euros through brokers. These euros were used to purchase large quantities of cigarettes from the tobacco company, effectively laundering the illegal drug profits.
- Global Financial Institution (One of the world's largest banks): In 2012, a major international bank was penalized for failing to implement proper anti-money laundering controls. This lapse allowed a drug cartel from a specific region to move illicit funds through the bank's system. The bank faced a significant financial penalty (nearly $2 billion) for these deficiencies.
- European Bank (Large financial institution): This example highlights a bank that intentionally disregarded anti-money laundering protocols. They misrepresented their safeguards to financial authorities in the United States, allowing high-risk clients from various countries to funnel an estimated hundreds of billions of dollars in suspicious funds into the US financial system through the bank's subsidiary.
Anti-Money Laundering (AML)
AML is anti-money laundering legislation that requires companies to verify the identity of their customers. Schemes like that of the European bank mentioned above gave way to these new requirements, as banks and other companies are also liable if their customers launder money or commit acts of terrorism.
Regulations like these heighten the need to detect and thwart money laundering and other financial crimes. That doesn’t mean compliance is easy.
AML compliance
AML compliance programs are tools financial institutions and other covered entities use to prevent money laundering. Banks, money services companies and insurance companies are among the organizations that need rigorous AML compliance efforts.
The Federal Financial Institutions Examination Council’s (FFIEC) guidance on AML compliance requires regulated businesses to:
- Implement a system of internal controls
- Perform independent audits of compliance activities
- Appoint a dedicated compliance officer to oversee day-to-day compliance efforts
- Provide comprehensive employee training
- Create a risk-based approach for identifying customers
- Establish ongoing customer due diligence
How to prevent money laundering
The FFIEC’s recommendations offer a valuable roadmap for tools that may prevent money laundering. However, an effective anti-money laundering program isn’t just about compliance but understanding and mitigating risks.
To effectively and sustainably prevent money laundering, businesses must take a risk-based approach to identifying and transacting with customers of all backgrounds. That requires:
- Identify your day-to-day business activities: Before you can create an AML program, you must understand the activities that the program will govern. Whether it’s creating bank accounts, making secure payments or issuing insurance policies, that’s what your AML policies should emphasize.
- Analyze your risk exposure: To prevent money laundering, the program you build should mitigate the most extreme risks, whether customers, employees, board members or potential other bad actors.
- Create an internal controls system: Your internal controls are where business activities and risk management meet. Wherever those activities may introduce risk, implement controls that prevent it. For example, completing due diligence before opening a customer’s bank account can ensure they are who they say they are and not a criminal with a fake or stolen identity.
- Implement risk-based due diligence: This is the companion to internal controls. While internal controls govern your organization internally, due diligence is your chance to investigate third parties for any risk they may pose. For money laundering, focus specifically on individuals, whether a potential customer or a target company’s CEO.
- Cultivate a culture of compliance: For your anti-money laundering program to be successful, your employees must buy into its importance. Offer thorough and ongoing training to help employees understand money laundering risks and recruit them to help stop it. Be sure to thoroughly explain all AML policies and procedures.
- Conduct ongoing and independent reviews: Your compliance officer should regularly review your AML program, but you should also recruit an independent auditor to do the same. The auditor will offer an unbiased view of the efficacy of your problem with feedback you can use to improve.
- Integrate technology: The above steps are critical, but they only scratch the surface of what truly effective AML compliance requires. Your program must stay one step ahead of money laundering tactics, a feat difficult to achieve amid the many other risks financial institutions face. Due diligence software can tackle much of this process, freeing you up to focus on emerging risks.
Fight back against money laundering and other financial crime
Criminals launder $300 billion in the United States every year and launder billions and even trillions more around the world. As money launderers get smarter, many businesses feel helpless to stop it. However, tools like AML compliance, due diligence, internal controls, and more can all create a hostile environment for money laundering.
However, creating an effective AML program means understanding the ins and outs of financial regulations and what it means to comply. Download Diligent’s guide to financial crimes and anti-corruption regulations to learn more about how to stop money laundering in its tracks.
Frequently asked questions
What is laundered money?
Laundered money has moved through a legitimate financial institution or other company to remove any trace of its illegal origins. Criminals can then integrate their illegally obtained money into the banking system.
Is money laundering illegal?
Money laundering is illegal. It’s a federal crime to use illegitimate funds in any transaction.
Is money laundering a felony?
Money laundering is both a federal and state penalty and is punishable by 10-20 years in prison and fines that depend on the amount of funds laundered.
What is placement in money laundering?
Placement is the first stage of money laundering when criminals place their money into the banking system. Criminals may deposit cash into a bank account, buy assets for a shell company, purchase real estate or even buy currency from an online gambling website.
What is structuring in money laundering?
Structuring in money laundering is when criminals divide their cash into smaller sums to avoid unwanted attention from financial institutions, law enforcement and regulators.
What is layering in money laundering?
Layering in money laundering is a process that distances the laundered money from its source. A criminal might transfer money to a new bank account, change the currency or buy real estate to make the illegitimate cash untraceable.
What is integration in money laundering?
Integration in money laundering is when the criminal retrieves their laundered money so it appears they obtained the money legally.
