Institute of International Bankers Anti-Money

Laundering Seminar – Trade Finance Issues

New York - May 23, 2011

Susan J. Galli

HNAH AML Compliance PUBLIC 1

Trade-Based Money Laundering Defined

Criminal enterprises have long misused international trade mechanisms to

avoid taxes, tariffs, and customers duties.

As both the formal and international system and money service businesses

(“MSBs”) are subject to increased regulation, scrutiny and transparency,

criminal money launderers and terrorist financiers are increasingly likely to use

fraudulent trade-based practices in international commerce to launder, earn,

move and integrate funds and assets.

U.S. officials define trade-based money laundering as a type of alternative

remittance system that allows criminal organizations the use of trade to

legitimize, conceal, transfer, and convert large quantities of illicit cash into less

conspicuous assets or commodities.

In turn, the tangible assets or value are transferred globally without being

subject to financial transparency laws and regulations

2

Trade-Based Money Laundering – How it Works

Value can be moved through this process by false-invoicing, over-invoicing

and under-invoicing commodities that are imported or exported around the

world.

Global trade is frequently used by criminal organizations to move value

around the world through the complex and sometimes confusing

documentation that is frequently associated with legitimate trade

transactions.

Colombian drug cartels repatriate drug proceeds commonly referred to as

the Black Market Peso Exchange (“BMPE”), and underground banking,

unlicensed money service businesses and hawalas have all utilized trade

to move value as settlement of a debt arising from remittances overseas.

3

Trade-Based Money Laundering – Red Flags

Criminal enterprises can accomplish settlement by purchasing commodities in

one country and then transferring them to another country where the

commodity is sold, and the proceeds are remitted to the intended recipient.

Red flag indicators of trade-based money laundering include:

o Payments to a vendor made in cash by unrelated third parties

o Payments to vendor made via wire transfers from unrelated third parties

o Payments to vendor made via checks, bank drafts or postal money orders from

unrelated third parties

o False reporting such as commodity misclassification, commodity over-valuation or

under-valuation

o Carousel transactions: the repeated importation and exportation of the same high-

value commodity

o Commodities being traded do not match the business involved

o Unusual shipping routes or tran-shipment points

o Packaging inconsistent with commodity or shipping method

o Double-invoicing

4

Techniques to obscure the illegal movement of funds

Techniques commonly utilized include methods to misrepresent the

price, quality or quantity of goods.

Over invoicing: by misrepresenting the price of the goods in the invoice and

other documentation (stating it at above the true value) the seller gains

excess value as a result of the payment

Under invoicing: by misrepresenting the price of the goods in the invoice

and other documentation (stating it at below the true value) the buyer gains

excess value when the payment is made.

Multiple invoicing: by issuing more than one invoice for the same goods a

seller can justify the receipt of multiple payments. This is harder to detect if

the colluding parties use more than one FI to facilitate payments/transactions.

5

Techniques to obscure the illegal movement of funds

Techniques commonly utilized include methods to misrepresent the price, quality or

quantity of goods (continued)

Short shipping: the seller ships less than the invoiced quantity or quality of goods in the

documents. The effect is similar to over invoicing.

Over shipping: the seller ships more than the invoice quantity or quality of goods thereby

misrepresenting the true value of goods in the documents. The effect is similar to under

invoicing.

Deliberate obfuscation of the type of goods: parties may structure a transaction in a way

to avoid alerting any suspicion to FIs or to other third parties which become involved. This

may simply involve omitting information from the relevant documentation or deliberately

disguising or falsifying it. This activity may or may not involve a degree of collusion between

the parties involved and may be for a variety of reasons or purposes.

Phantom Shipping: no goods are shipped and all documentation is completely falsified.

6

Trade-Based Money Laundering – Over and Under-

invoicing

One of the older methods of transferring value across borders is

accomplished by misrepresenting the price of a good or service in order

to transfer money between colluding importers and exporters

Money may be moved out of the U.S. to a foreign country by undervaluing

U.S. exports or over-valuing U.S. imports

Money may be moved into the U.S. from a foreign country by over-valuing

U.S. exports or under-valuing U.S. imports

7

Trade-Based Money Laundering – Example of

Overvalued U.S. Imports

Assume a criminal enterprise wants to launder $1 million dollars to a foreign

country. The enterprise requires a foreign exporter to collude on the

transaction. The set of transactions used to launder the money would

include:

1) Foreign exporter purchases 10,000 razor blades for $.10 per blade

(cost - $1,000)

2) Foreign exporter exports 10,000 razor blades to the domestic importer for

$100 per razor blade. (Total Invoice $1,000,000)

3) Domestic importer receives 10,000 razor blades worth $1,000 but pays the

foreign exporter $1,000,000.

Outcome: The domestic importer has moved $1 million to the foreign

country less the $1,000 cost of the razor blades and shipping costs.

Source: John S. Zdanowicz – Florida International University

8

Trade-Based Money Laundering – Example of

Undervalued U.S. Imports

Assume a criminal enterprise wants to launder $1 million dollars to a foreign

country. The enterprise requires a foreign importer to collude on the

transaction. The set of transactions used to launder the money would

include:

1) Domestic criminal uses $1 million to purchase 200 gold watches for $5,000 per

watch (value $1 million). The watches would be purchased on open account.

2) The Domestic exporter sells the 200 gold watches to a foreign importer for

$5.00 per watch ($1,000).

3) The foreign importer receives the 200 gold watches and is presented with an

invoice for $1,000, which he pays by wire transfer to the domestic exporter.

4) The foreign importer sells the gold watches at the market price of $5,000 per

watch and converts the 200 gold watches into $1 million.

Outcome: The domestic exporter has moved $1 million to the foreign

country less the $1,000 cost of the invoice payment inclusive of shipping

fees

Source: John S. Zdanowicz – Florida International University

9

Example of Trade-Based Alternate Remittance

System – The Black Market Peso Exchange

The BMPE is an underground financial system used to evade reporting

and record keeping requirements mandated by the BSA, as well as

Colombian foreign exchange and import laws and tariffs. The system

works as follows:

1. The Colombian cartels export narcotics to the US where they are sold for U.S.

dollars

2. In Colombia, the cartels contact a third party – a peso broker – to launder their dirty

money.

3. The peso broker enters into a “contract” with the Colombian cartel, wherein he

agrees to exchange pesos he controls in Colombia for U.S. dollar the cartel controls

in the U.S. Once this exchange occurs, the cartel has effectively laundered its

money and is out of the BMPE process. The pesos broker, on the other hand, must

now launder the U.S. dollars he has accumulated in the U.S.

10

Example of Trade-Based Alternate Remittance

System – The Black Market Peso Exchange

The BMPE is an underground financial system used to evade reporting and record

keeping requirements mandated by the BSA, as well as Colombian foreign exchange

and import laws and tariffs. The system works as follows:

4. The peso broker uses contacts in the U.S. to place the drug dollars he purchased from the cartel

into the U.S. banking system. The peso broker, still operating in Colombia, now has a pool of

narcotics-derived funds in the U.S. to “sell” to legitimate Colombian importers.

5. Colombian importers place orders for items and make payments through the peso broker.

Again, the peso broker uses contacts in the U.S. to purchase the requested items from U.S.

manufacturers and distributors. The peso broker pays for these goods using a variety of

methods, including his U.S. banking accounts.

6. The purchased goods are shipped to Caribbean or South American destinations, sometimes via

Europe or Asia, then smuggled or otherwise fraudulently entered into Colombia. The Colombia

importer takes possession of the goods, having avoided paying extensive Colombian import and

exchange tariffs, and pays the peso broker for the items with Colombia pesos. The peso broker,

who has made his money charging both the cartels and the importers for his services, uses

those new pesos to begin the cycle once again.

11

Trade-Based Money Laundering – Black Market Peso

Exchange

U.S. exports that are purchased with narcotics dollars through the BMPE often

include, but are not limited to, household appliances, consumer electronics,

liquor, cigarettes, used auto parts, precious metals, and foot ware.

Certain types of payment methods often provide red flags indicating that

BMPE activity might be taking place. Example of red flags are as follows:

Payments for outstanding invoices made in cash by third-party entities having no

connection to the underlying transaction for which the payments is being made,

often from a secrecy jurisdiction.

Payments for outstanding invoices made with wire-transfers from third-party entities

having no connection to the underlying transaction for which the payment is being

made; and

Payments for goods through checks, bank drafts, or money orders not drawn on the

account of the entity that purchased the items.

12

Black Market Peso Exchange – Implications for FIs

BMPE schemes may manifest themselves through a number of products and in

multiple business lines in a U.S. bank:

Deposit services may be used to accept payments by check. This could be through

a wholesale lockbox maintained for the U.S. exporter, remote deposit capture or

cash letter or through check deposits to a retail or business account at a branch.

Foreign cash letter or remote deposit capture deposits received from foreign

respondents may contain items drawn on U.S. retail accounts that are under the

control of the peso broker. This may come from the importing country or from other

nearby countries with free trade zones.

Wire transfers may be credited to the exporter’s account that are from third parties

unrelated to the transaction.

13

Know your Customer Challenges

The ability to detect and deter money laundering, terrorist

financing and sanctions violations through trade-based money

laundering will depend to a large degree on the FIs role in the

transaction and the nature of the trade transaction, i.e., open

account trade versus, trade finance involving credit.

For trade finance, involving credit, one of the basic tenets is that

“Banks deal with documents and not with goods, services or

performance to which the documents may relate”

Banks do not get involved with the physical goods nor do they

have the capability to do so.

14

Trade – Know Your Customer

The FI with the best ability to detect possible money laundering is the issuing bank in a letter of credit

transaction or for open account transactions, the FI directly dealing with the importer/exporter customer.

Based on the FIs customer risk assessment, the FI should develop policies and procedures for

conducting site visits to determine that its business customer is an actual business, and that the

facilities are consistent with the stated nature of the business

Based on the FIs risk assessment, customers that are involved in commercial transactions with

jurisdictions posing a heightened risk for money laundering, terrorist finance or sanctions issues, and

customers engaged in high risk businesses, should be subjected to procedures for enhanced due

diligence

This may involve a more thorough understanding of the geographies served, the nature of the

anticipated transaction/product activity, and an understanding of the role that the customers plays in the

trade/commercial transaction.

It may be helpful to collect the names of frequent suppliers and customers of the FIs customer, to assist

with the monitoring of trade transactions that are settled via wire or check for open account

transactions.

15

Other useful information Sources:

The Wolfsberg Group Trade Finance principles at:

www.wolfsberg-principles.com/pdf/WG_Trade_Finance_Principles_Final_(Jan_09).pdf

FATF’s “Best Practices Paper on Trade Based Money Laundering” (June 2008) at:

www.fatf-gafi.org/dataoecd/9/28/40936081.pdf

16