Regulating Criminal Finance in the Global Economy

JC Sharman

Read our article in the Cayman Financial Review Magazine, eversion 

Sharman’s book is a most interesting contribution to the discourse on the current measures to control money laundering and, to a lesser extent, terrorist financing.

It begins by considering the question whether the current anti-money laundering measures actually work, then goes on to examine how and why the measures have been disseminated globally to the extent that they have before drawing its conclusions. 

In relation to the first, Sharman presents his key argument early on: he states clearly and directly that the current AML system is ineffective in preventing money laundering. This in itself is not at all controversial. Even proponents of the measures openly recognise that they do not achieve the aim of choking off criminals’ money supply to anywhere near the extent that we would wish.

Perhaps uniquely, however, Sharman sets out to prove it, by the rather more controversial means of inviting legal and financial professionals to violate the AML rules in order to find out how willing they were to do so. His discoveries are indeed disturbing: all too many institutions were quite happy to assist him to set up shell corporations with few questions asked.

That financial institutions were rather more diligent in seeking evidence of their customers’ identity was a little more reassuring, although the fact that those based in developing countries applied the rules more strictly than their OECD counterparts shows that there is no place for complacency.

The second part of the book is a detailed study in how a range of mechanisms, some more direct than others, have been used to compel the dissemination of, in particular, the Financial Action Task Force recommendations through almost the entire globe. It is an invaluable analysis, well worth reading as much for its setting out of the general principles as for their specific application to anti- money laundering measures.

However, the conclusion that Sharman draws is unfortunate. To be blunt, he argues that the first part shows that the anti-money laundering regime is an expensive waste of time. Worse, it is one whose cost falls disproportionately on those jurisdictions that are least able to afford it, yet which have had it forced upon them.

This argument is supported with case studies of jurisdictions compelled to introduce comprehensive measures to combat money laundering designed for a sophisticated financial centre when they have no financial centre.  As an extreme example, he cites, on a number of occasions, Nauru.

This, he says, demonstrates particularly clearly the insanity of the current AML/CFT system: detailed regulations on financial transactions imposed on a jurisdiction with no financial institutions (with the exception, latterly, of a single branch of Western Union).

Why are these conclusions unfortunate? There are two flaws in the arguments. First, Sharman does not in fact discover that the anti- money laundering measures are ill-conceived. 

Indeed, his recommendation in the conclusions that they can be used effectively to combat grand corruption implicitly recognises this. Rather, he discovers that their enforcement is inadequate – especially, it would seem, in the developed world. It is a truth that bears repeating that no law can ever be as effective if it is poorly enforced. But this does not mean that the law itself is ill-conceived.

Let us take an extreme example. Most of us would agree that to have a law that prohibits robbery is a good thing – and most, if not all, jurisdictions have such laws, including severe prison sentences for those who violate them. Yet it is well recognised that, in some jurisdictions, particularly in certain areas, violent robbery is commonplace – because law enforcement is poor.

There is, however, some law enforcement and it is expensive: officers have to be well-equipped, police stations need to have good security and of course prosecuting those proportionately few robbers who are caught also costs money, as does imprisoning them afterwards. But the fact that law enforcement is expensive, yet relatively ineffective – because the crime rate remains high – does not mean that the law criminalising robbery is a mistake.

What it does perhaps mean is that there needs to be greater investment in law enforcement. And to return to the issue of money laundering, Sharman’s findings clearly show that greater effort needs to be made by government to ensure that institutions comply with their AML obligations.

The resources that are currently spent on mutual evaluation of jurisdictions, which Sharman describes in detail, could be spent, at least in part, on monitoring institutions – quite possibly including the kinds of tests, or even “sting operations”, that Sharman used for his research.

If it is true, as he claims, that awareness that they are being monitored compels jurisdictions to comply with international standards, that same awareness could improve compliance among institutions. It does mean that some of the emphasis on enforcement needs to be transferred from the private sector back to the government/regulatory sector, but this is not unique to the prevention of money laundering.

As to it being inappropriate to impose detailed anti-money laundering rules on small jurisdictions, this is more complex. It is certainly true that different jurisdictions differ and that the financial sector of, say, the United States is somewhat different to that of Benin. A more flexible approach that is tailored to the particular circumstances of a particular jurisdiction may well, therefore, be suitable rather than the “one size fits all” model that we have at present.

However, we are already moving towards that with the risk-based approach now increasingly being promoted by the FATF itself. Perhaps it needs to be developed more, but it is a move in the right direction.

But Sharman goes further: he says that for a jurisdiction such as Nauru, Malawi or Niger to have any kind of anti-money laundering legislation at all is absurd and that its sole purpose is to follow the requirements laid down by the developed world. The reason he gives is that, as their financial sectors are small and their crimes low-level, money laundering is not a problem for them.

This argument overlooks a crucial factor: the cross-border nature of financial crime. Nauru is indeed a minuscule country with a minuscule population. But before the reforms, it had some 400 shell banks. Similarly, Burkina Faso and Côte d’Ivoire are both small countries, but became increasingly important bases for Nigerian “419” scams when addresses in Nigeria itself attracted too much suspicion.

Yet another example is the abuse by Allen Stanford (formerly Sir Allen) of the financial sector of Antigua and Barbuda. If a given jurisdiction gives a low priority to controlling money laundering, on the basis that it is a small country with little local serious crime and/or a small financial sector, it runs the very definite risk of presenting opportunities to criminals from elsewhere in the world.

Malawi and Niger may not be major centres of criminal finance today, but without proper safeguards, they could easily become so tomorrow. It is for this reason that the framework of anti-money laundering measures has to be global. For the developing world, therefore, it is not a question of making the best of a bad situation, as Sharman claims, it is recognising that the laundering of criminal proceeds is a global problem and we all need to work together to address it.

What is clear from the findings, however, is that the methods of compulsion, which Sharman correctly identifies, have not at all adequately been accompanied by genuine education. As is now clear, I am firmly of the view that the international mechanisms against money laundering and terrorist financing are valuable in their own right, for what they seek to achieve, not merely as a now-accepted, for better or worse, condition of membership of the international community.

This applies to the developed and the developing world alike. But if that value is seriously doubted by as wide a range of regulators (let alone institutions) as Sharman’s research suggests, there is serious work to be done.

Training must deal not only with the measures that are required but also, equally important, why they are needed. Some may see them as an impediment to valuable business, whether the senior management of a bank that saw large unexplained funds coming out of Mexico as a life raft in a financial crisis or an official of a small country, but with a significant international financial centre, who commented, “If we implement the international money laundering rules effectively, then we’ll go back to growing oranges.”

Such persons, and those whom they represent, must rightly be the target of enforcement measures. But for the rest, those who are currently saying, “We have to do it but I really don’t see the point of it,” awareness raising must be a key priority.

In conclusion, then, there is much in Sharman’s book to be questioned. But he has made a valuable contribution in highlighting some key issues that will need to be addressed as we move forward.