Wednesday, December 13, 2006

Financial Crime - Staring failure in the face.

December has been a busy month for Financial Crime conferences.

No sooner has one event finished, than another is clamouring for your attention. Events you ‘…have to…’ attend, programmes you ‘…must not miss…’, workshops where you will learn ‘…how to protect yourself…’

And the lists of speakers. Chairman of this august body, President of so and so Corporation, Secretary General of that policy-making institution, Director of yet another Government Agency.

They are all there, with their speeches carefully crafted by their staff; their fulsome platitudes carefully honed to reflect the latest edition of Government policy; their timid, middle-of-the-road, ‘…on the one hand this but on the other hand that…’ response to the present statistics of fraud and financial crime; their smug acceptance that despite their almost universal lack of domain knowledge or expertise in dealing with real crime, and with one eye, carefully on the look-out for the next advisory panel post or Quango appointment, that their words will be taken as gospel;.

Please don’t misunderstand me, I am not an opponent of the conference circuit. On the contrary, I believe that sometimes, just sometimes it is possible to hear a speaker of real experience, and domain knowledge, who truly manages to make a difference and raise the level of the debate. You can usually tell these individuals because they are most often someone, man or woman, not sponsored by any government or quasi-government agency, they don’t work for the Big 4 Consultancies, they most often run their own successful businesses, have excellent websites and they don’t need to advertise. They can clearly be seen to ‘walk the talk’, and they let their experience and their knowledge do the talking.

Others, most often Government ministers or senor civil servants, clearly demonstrate their paucity of knowledge and lack of experience by their incomprehensible statements, and their criminologically-illiterate policy initiatives.

But when it comes to dealing with fraud, financial crime and money laundering, the talk circuit has become the place to be, Vance Packard was right after all, the medium has truly become the message!

Twenty years ago, I published my first book entitled ‘Fraud In The City – Too Good To Be True’.

The book set out to examine the causes of fraud and financial crime within the financial investment environment, and attempted to take a look at what ought to happen, once the UK Government’s policies for regulatory change, then grouped together under the generic title of ‘The Big Bang’, had begun to take effect.

As a fraud detective at New Scotland Yard, I had witnessed at first hand the dramatic changes that had been engineered inside the financial investment network, following the polices of the then Thatcher Government, and the drive towards financial de-regulation.

My colleagues and I had watched, helplessly, as a tidal wave of fraudsters, con-men, financial snake-oil salesmen, and assorted ne’er do wells, all masquerading under the title of ‘financial advisors’, washed up on the shores of the City of London.

They brought with them a wide range of tactics and techniques, some clever, some not so clever, some downright dumb, but all designed to part the unwitting investor from his cash as quickly, and as efficiently as possible.

We monitored them while they routinely trooped in and out of a small group of solicitor’s offices, on their way to a few chosen accounting practices, stopping off on the way to buy a collection of carefully prepared, off the shelf companies, provided by a select team of company formation agents, who could also help them with access to prestige address, fully serviced offices in the City of London or the West End.

Get off the plane at Heathrow at 10.00am and you could be in business at 3.00pm, and many were, complete with letter-heads, invoices, telephone and fax communications and a sweet-voiced girl answering a bank of phones with your own company’s number!

In the 1980’s London became the fraud capital of Europe!

We told our management about them, but most of them were men who had spent their early police careers dealing with an altogether different kind of fraud, (long-firm fraud, carbon-paper fraud, telephone directory fraud, etc, etc, almost entirely unheard of today), and who didn’t really want to understand that the financial and political environment had changed. To do so would have meant getting out of a comfort zone which didn’t really require very much effort to get through the working day, and would have meant learning a whole range of new tricks.

No, far safer to stick to tried and trusted methods of inertia and bad practice, and report the matter to the Department of Trade and Industry, who might, if they could be bothered, get round to investigating the company some day, for the offence of fraudulent trading. So bad did the reputation of the Investigations Branch of the DTI become that they became universally known as the Department of Timidity and Incompetence.

We did have meetings with the DTI, to see if we could engineer change and introduce some motivation within their midst, but we were told that there was really little they could do, and anyway, the new regime of financial regulation would pave the way for a brand new, bright tomorrow, in which such criminal actors would receive their just deserts.

All the time, German, Swiss, Italian, Dutch, American and British con-men, cemented their hold over the OTC share-traded market, and the British investor lost his shirt, along with foreign investors who had been inveigled to put money into Britain’s booming new investment environment.

We begged the Director of Public Prosecutions for help. We urged him to give us the right to arrest and charge for theft and false accounting in carefully selected cases. To one DPP’s perpetual shame, he responded, ‘…Why should the British tax-payer be concerned if a load of Germans are ripping off another load of Germans, is it really our business…’ When we pointed out that these criminals were successfully sending a series of hugely damaging messages about the British market, he shrugged his shoulders, and said it really wasn’t his problem.

So, we went out and arrested them anyway. We didn’t ask for permission from our management, because we knew it wouldn’t be forthcoming. We didn’t ask for permission from the DTI because we knew we would never get a response. We didn’t ask the DPP before charging those we nicked, we just did our job in the same way as if we had chanced upon a gang of bank robbers or lorry hi-jackers.

When we interviewed them, they glibly told us that the reason they came to London to run their rip-off companies was because they knew that the British prosecutors would not go after them. This time the DPP was shamed into charging them, and eventually, after a long trial they were convicted and imprisoned, the trial judge expressing his great concern that such cases could be going unpunished in the London market.

But it was a Phyrric victory, because after that case, we were forbidden to act in the same way again, and instructed that all such cases should be referred to the DTI and the DPP in future before any action was taken.

Later, we watched impotently as the findings of the Roskill Commission on Fraud Trials were re-engineered by the lawyers and civil servants in the Attorney General’s Office and other Government law departments, and emerged as the Serious Fraud Office (SFO), which proceeded successfully to downgrade the role of the detectives and promote the role of the civilians, so that now, fraud investigations and trials were run by people with no knowledge of criminal behaviour whatsoever, while the detectives were kept in a separate part of the building, and not allowed to undertake their traditional roles in the management of fraud investigations.

Perhaps not surprisingly, the conviction figures plummeted and the public rapidly lost confidence in the Government’s ability to manage the problem.

The Financial Services Act introduced a regime of regulatory overkill, which put more and more powers into the hands of a wide range of untried and untested civilians, and loaded the financial sector with rule books and regulatory dictat, but failed to truly provide the atmosphere necessary to enable entrepreneurial financial business to flourish, while really keeping the bad guys out of the business. Scandal followed scandal, and the poor old investor continued to lose money.

So bad did the problem become that when the Government was finally forced to throw in the towel and admit that the private occupational pensions market had become a scandal of overwhelming proportions, they had to find a new phrase to define the problem. Wary of calling it institutionalized fraud, which is what it was, they chose to call it ‘mis-selling’, a phrase which carried no stigma for the government’s inability to protect investors, and introduced a hitherto-unheard of concept to British criminal jurisprudence.

Money laundering became the next big shibboleth, and we were told that by adopting a dubious US concept of ‘following the money’, we would finally strike at the heart of the criminal enterprise. Directives, regulations, and proposals for legislation poured from the inexhaustible source of the EU Commission. More and more rule books were written and introduced.

A small number of advisory practices emerged, desperately trying to bring some judgement and order into the madness, trying to share wisdom and sense in what was rapidly becoming a regulatory free-for-all. To them, we must be eternally grateful, because they stood like small beams of light in a very dark world indeed. But still the regulatory monster grew and grew, and more and more unqualified people emerged from the shadows to hold down posts of significant importance. The conference circuit boomed, the talk shops proliferated. If you needed to find a senior policeman urgently, it was pointless ringing Scotland Yard or Wood Street. They were all busily talking to PowerPoint slides in smart London hotels!

Major new agencies were headed up by those who had never before investigated so much as a shoplifting case, and those who knew better, but who had the temerity to say so, stood by, while others, who talked the arcane language of the New Labour regime, were preferred, in place of men and women of real, hands on, practical experience.

The market for Fraud and Financial crime is alive and well, and making a great deal of money. Every year the problem gets bigger and bigger, and the big consultancies charge bigger and bigger fees to tell inexperienced management what they ought to know, if they were any good at their jobs.

Last week, a senior manager at a major Big 4 firm told me that his firm would not look at any consulting project unless there was a minimum of ₤1 million in fees on the table. They wanted to hire a financial crime expert, but when asked to define his role I was told that all they really wanted was someone who had just been in a financial crime role in a major bank, and could tell them what policy his former employer was intending to undertake to meet the requirements of the risk-based approach to financial crime management. This information, I was told was priceless, because it would enable the consultancy to re-package the product and sell it again and again to the other major banks, who, in the race to the bottom to minimize their outlay on even more regulatory spending, do not want to spend a penny more or a penny less than their competitors.

It could be said that the market which surrounds the financial crime issue has now become too big to permit an answer to the financial crime conundrum, to be advanced. Too many peripheral businesses depend upon the crime figures growing in a nice exponential curve, simply to justify their continued existence.

There are ways in which these problems can be dealt with. There are solutions, and there are some answers. It will need a very brave financial crime manager to address these responses head on, because a lot of the answers are in reality, very mundane, and rather simple, but they work.

Sprinkling pixie dust on the lap-tops is not going to produce a new generation of IT-driven financial crime solutions. Spending millions of pounds on change-management procedures will not provide an answer.

In order to begin to provide answers, you need to provide education and training for staff so that they really do begin to understand the problem. To achieve this, you need to talk to people who understand how the criminals’ minds work, and how they will behave in all the circumstances. You need to talk to men and women who have spent their careers dealing with professional criminals, and who know what motivates them and what does not.

We have to be willing to stand up to ministers and their juvenile advisers, with their promises of a new Jerusalem, and show them that their latest initiatives for tackling crime, while very headline grabbing, are just not going to work. We have to make them see that sometimes, blue-sky thinking, is just that, standing and looking at an empty horizon.

When Sir Charles Rowan and Sir Richard Mayne first developed the Metroplitan police on the instructions of Sir Robert Peel, they defined the concept which became the bedrock of policing policy in any country which subscribes to the theory of policing by consent. They understood that the biggest disincentive to crime is the likelihood of getting caught. That was as true in 1829 as it is today, nothing has changed. We won’t prevent any more crime by taking the proceeds away from criminals, we will just guarantee more crimes being committed. Think about it!





Wednesday, November 01, 2006

Is contemporary money laundering law intended to deal more with tax evasion?

Having looked at those issues which I believe will be the precursors of the conflict which will increasingly be predicated by social and demographic change, the final aspect of this chapter is to examine those financial environments which will increasingly underpin and welcome the ambitions of the increasing number of financial refugees who will seek to escape from the crumbling edifice of the declining social structures of the old post-industrial economies of the North-Western hemisphere.

For the foreseeable future, one of the inspirations for the global movement of capital will continue to be the gaping US budget deficit. For many years the Americans have been able to sit back and ignore the fact that their profligate lifestyle was underpinned by the unique feature that the US dollar was the leading hedge currency in the world. There are more dollars held outside the USA than circulate within it, and whenever the US needed to increase its inward investment of foreign-held dollars, all it needed to do was create another issue of US investment-grade paper, and watch the money roll in as foreign holders of dollars invested in a very secure method of holding their money (whether lawfully or unlawfully acquired).

This money has for many years provided the US with an almost limitless conduit of cheap, anonymous dollars which has underpinned their ability to lend money to their own house purchasers, job seekers and otherwise maintain an affluent lifestyle at a relatively low interest rate. This money has represented a vast tidal wave of foreign capital flight which has traditionally sought a refuge in the US, and it has been traditionally jealously guarded by US investment advisers.

A letter of 3rd December 2002 sent to the US Secretary of the Treasury and signed by 17 US Congressmen said;

“…We want to express our concerns about the IRS proposed bank deposit reporting regulation…this regulation would force banks to tell the IRS the amount of interest paid to non-resident aliens, even though the information is not needed to enforce US tax law…from a policy perspective, we are concerned that the regulation will undermine the competitiveness of US financial institutions and drive capital out of the US economy. This might be a worthwhile price to pay in pursuit of good policy, but this regulation undermines the long-run tax reform goals that we all share…good tax policy must encourage investment in capital markets – particularly American capital markets…This regulation, by contrast…is discouraging foreign investors from investing in the US market…the proposed rule will drive capital to other jurisdictions. American financial institutions have attracted about $1 trillion from overseas and a substantial share of that job-creating capital will leave our economy if the service compels US banks to compromise the interests of their depositors…this means less money available for car loans, home mortgages, and small business expansion…it is particularly foolish to impose this kind of regulation when the economy is sluggish and financial markets are weak. A regulation of this type is particularly damaging to a financial system recovering from an economic downturn…’

The Americans are still engaged in a consumer spending spree, making them the main engine of growth of the world economy. Largely fuelled by easy-to-get credit, their trade deficit with the rest of the world is unsustainable in the long term, and at some stage, their almost insatiable taste for foreign-made goods will have to slow down as the realisation sinks in that they simply cannot afford to maintain this level of unserviceable debt, all the while watching their own dollars continuing to flood out.

The direct beneficiary of this financial relocation will be Asia. An article in The Times of 8th January 2004 written by Anatole Kaletsky sets out a seminal analysis of the region and the way in which it is becoming an increasingly consumer society. He states;

“…An upsurge of economic confidence is now palpable across Asia, driven by a much more powerful force – a tectonic shift in the global economy, whose centre of gravity has moved irrevocably from the Atlantic to the Pacific in the past ten years…In the past few years, Asia’s teeming but impoverished billions have started to turn into potential consumers with increasing aspirations to Western-style standards of living…”

His point is that what was once a very poor region has, through its focus on being the world’s leading supplier of consumer goods in the form of electronics, computer hardware, as well as designer branded sports clothing, transformed its economy. Indeed, there has begun to emerge a new bourgeois class, which realises it too can now enjoy all the benefits of a Western life-style. Kaletsky again;

“…Until recently there was limited appeal for goal-orientated materialistic politics in countries such as India or Pakistan, since most people, even in the educated middle classes, believed that Western-style economic prosperity was unattainable. This fatalism has now largely vanished…”

Kaletsky identifies the importance of the US trade deficit which as he points out is pumping $500 billion each year into the world economy. Interestingly, this is the same figure as that which the US authorities declare is the amount the illicit drug industry generates each year, but I am certain they have no direct connection! He states;

“…Asian governments and the economies they manage are flush with money because of the vast US trade deficit…almost all of it ending up in the coffers of Asian businesses, workers and central banks. Asian central banks now own foreign exchange reserves worth over $1.5 trillion. The tiny monetary authorities of Hong Kong and Singapore, representing 12 million people between them, now have reserves of £220 billion…”

Kaletsky identifies Asia as being the region where growth is now seen as being a reality as opposed to a pipe-dream, and this is leading to a greater rejection of religion as a political principle in both Pakistan’s and India’s growing middle class. While there may still be fundamentalists on both sides of the political divide, the drift generally is away from religious extremism.

“…This was apparent in last year’s Indian state elections, where the successful candidates generally steered away from religion, caste and ethnicity, and ran on their record of delivering results…” Kaletsky

It is of interest to remember that India and many of the other countries in this region are not part of that group of nations whose child-birth rates are falling. They are defined as ‘young’ populations’ and they are not suffering from the same problems as the north-western old post-industrial democracies. They generally do not have advanced welfare states, and the extended family model is the norm. They have a widely-educated class of young, entrepreneurial people, who are computer-literate, and who are willing to work for wage structures which are significantly lower than those paid in the West. World businesses are queuing up to outsource their call-centre operations in Delhi and Mumbai. Bangalore is the second most advanced city in the world, after Seattle, for computer software development.

Kaletsky paints a very positive image of the future of the Asian region, and the emergence of a new, powerful middle-class, led by economic growth, and the emergence of China as a regional leader.

“…The near miraculous success of export-oriented development in China has created an infinitely more attractive economic model than state-controlled central planning, based on markets, entrepreneurship and private ownership, albeit with ‘Asian characteristics’. When they look at China, the people of India and Pakistan, and especially the middle classes, can see that prosperity for their families within a generation is not an impossible dream…”

These are the countries and this is the region where the world’s wealth will migrate and continue to migrate in the foreseeable future. This is where the new economy of the information age will be most understood, and this is where the technology and the means to drive the new thinking behind the new ways of doing business will be developed. The old wealthy from the former post-industrial economies who choose to hide their money in these emerging wealth-generating democracies will find themselves increasingly under threat from their country of origin. They will seek to do everything in their power to prevent this money from escaping to these safe havens, and they will use all the powers at their disposal.

This is why governments in the old post-industrial democracies are busily passing more and more laws and regulations dealing with the flows of money around the world. This is why they are seeking to introduce even more legislation dealing with charities and other not-for-profit organisations, and why they are seeking to engage ever wider groups of players within the regulatory net. They need the information of where the money is going and where it is being held and who is holding it.

This is the area which I predict, will become the leading area of conflict for governments and its citizens in the future as more and more citizens will retreat from their continued willingness to have their own assets confiscated by government, to support a growing number of otherwise unfunded citizens.

This is where the battle lines for control of the remaining wealth possessed by a shrinking number of citizens will be drawn, and where the myriad laws and regulations regarding money laundering and criminal confiscation will come into their own.

How this will happen and how we have arrived at this state of affairs will become the subject of the next chapter.

Is money laundering law intended to deal more with tax evasion?

This is the second instalment of the article which appeared earlier in OCtober 2006.

Much of the early influence on this chapter comes from the writings of two social commentators, James Dale Davidson and William Rees-Mogg, the former editor of ‘The Times’. In their seminal work ‘The Sovereign Individual’, first published in 1997, I came across an analysis of taxation as a primary function of the Nation State, and a very clear explanation why the conditions of the ‘Information Age’ in which we are now living, meant that governments would find it harder and harder to collect the same level of taxation which they needed, simply to maintain the status quo of society. The changes being introduced by such facilities as the world-wide-web, digital technology and information networks, meant that tax-payers would find new and more efficient ways of hiding, disguising and disseminating their wealth from governments, whose needs to acquire such money were becoming more and more acute.

“…In the twentieth century, advanced industrial nations have taken between 30 and 60 per cent of national income to finance the welfare state. Between the disintermediation, jurisdictional and encryption problems of global computer networks, this capacity is now vanishing. The welfare state was already becoming burdensome in the early 1990s. By 2010 or thereabouts it will simply become unfinanceable, as will all kinds of unfunded state pension…” The Sovereign Individual. p7

The authors’ arguments predicated the emergence of a new kind of citizen, who they call ‘the sovereign individual’, a new kind of independent wealth-creator, whose access to technology and the power of their own intellect, would mean that they no longer needed to consider themselves as the property of an individual state or political collective, but would be free to negotiate their own terms with which they proposed to deal with governments in the future.

This new individual was placed by the authors in the context of his relationship with the nation state thus;

“…The new megapolitical conditions of the Information Age will make it increasingly obvious that the nation-state inherited from the industrial era is a predatory institution, one from which the individual will want to escape. It is an escape that desperate governments will be loathe to allow. The stability and even the survival of Western welfare states depends upon their ability to continue extracting a huge fraction of the world’s total output for redistribution to a subset of voters in the OECD countries. This requires that the taxes imposed upon the most productive citizens of the currently rich countries be priced at supermonopoly rates, hundreds or even thousands of times higher than the actual cost of the services that governments provide in return…” The Sovereign Individual. p116

The Americans, concerned as ever with the number of wealthy members of US society whose commercial or financial activities are registered in offshore, low-tax jurisdictions, either in the form of corporate tax shelters, or offshore hedge funds, and whom the US regulators have perceived could be cheating on their Internal Revenue obligations, sought to deter US citizens from taking their money out of the country by a proposal, made by President Bill Clinton in 1995. Clinton wanted to enact an exit tax or a ‘Berlin Wall for capital’ that would require wealthy Americans to pay a substantial ‘ransom’ to be permitted to escape with even part of their money.

The American authorities have always looked upon the offshore sector with mistrust, seeing them as jurisdictions into which money and value can be imported, and held in conditions of absolute secrecy. Their suspicions of the intentions and the activities of the off-shore sector were amplified by the fact that when they investigated those whom they suspected of taking unfair advantage of US markets, as in insider trading cases, they could not get any assistance from financial institutions or law enforcement agencies operating in these areas.

Nothing infuriates an American regulatory or law enforcement agency more than discovering a foreign jurisdiction which does not have to comply with their demands for cooperation. I use the word ‘demand’ advisedly, as in my experience, the USA generally does not ‘ask’ for assistance, it demands it as of right, and becomes very agitated when it finds its demands being denied, or worse, ignored. For years the offshore sector generally had merely ignored US demands for reciprocal assistance, and the Americans, in turn, had for a very long time, been looking for a means of prizing open the books and records of the offshore banks, in order to pursue their own investigations, into both outright criminal allegations, and, more importantly, into American tax evasion.

“…All advanced tax systems depend upon reporting to the tax authorities by people who make payments. A bank pays interest on a deposit account, reports the interest to the revenue authorities and the income is taxed. If the bank is outside the national jurisdiction, then it cannot be obliged to report the interest. When the internet becomes the normal route for transactions used as freely as the telephone, it will erode the reporting of transactions…” The Sovereign Individual, 1997, Pan Books, p.7.

It is this question of the way that technology is changing, and will continue to change the face of the relationship between the citizen and the State that is polarising the arguments about the way in which societies can legitimately raise revenue through taxation, and how, in future, they will seek to guarantee those sources of State income in order to maintain a social status quo which has long since passed its legitimate maintenance date.

The problem is that the increasing facilities offered by the Information Age will mean that those individuals with the skills to do so will seek to earn their living in those jurisdictions which make it easier for them to do so. The nation state’s tradition of imposing high levels of taxation upon its collective citizens will be eroded as more and more competing jurisdictions make it attractive for enterprising foreigners to seek refuge with them.

The struggle between the State and the private individual will become an altogether more vindictive one as the technology to aid private capital flight and financial secretion becomes more available, with the means to move their capital in conditions of almost total secrecy. The conditions for conflict are becoming more and more acute.

“…The flight of the wealthy from advanced welfare states will happen at just the wrong time, demographically. Early in the 21st century, large aging populations in Europe and North America will find themselves with insufficient savings to meet medical expenses and finance their lifestyles in retirement…” The Sovereign Individual - p289

This is possibly the most important aspect of the core problem with which the new social environment being generated in the post industrial democracies will be required to deal. The welfare states which for the last 60 years have provided our social environment with cradle-to-grave protections in terms of health, education and social welfare are now facing insolvency. Putting it at its simplest, they are running out of money, while at the same time, they are having to face up to the likelihood of a future in which fewer individuals will be either willing, or indeed available to provide the necessary degree of funding to continue to maintain those benefits at even contemporary standards.

The reasons are simple but stark!

We live in an age of declining birth rates, while at the same time the numbers of our elderly are living longer. At first sight, such a statement does not seem to hold any great terrors for us after all, does it really matter if grandfather lives a few years longer. Well, I’m afraid it does.
If you can imagine looking at a mathematical model of an ordinary, normal society, it would look roughly like an equilateral triangle, divided into a series of horizontal layers. The young, the new potential contributors to the welfare of society would make up the broadest layer at the base of the triangle, demonstrating a wide sector of non-financially-contributing individuals, but who would be growing to make a financial commitment to their society.
The next layer would contain those in regular work or employment who are making a contribution to the nation’s wealth via both direct and indirect taxation.

Another sector above the second would represent that group of individuals who had ceased to be net contributors to society, but as yet were not dependent upon its reserves for their well-being, the retired class who were still able to look after themselves from their own savings.
At the top of the triangle sits the group of retired, non-contributing individuals who are wholly or in a large part dependent upon the state for their welfare provision, whether it be pensions, social health care, hospitals, meals-on-wheels, or any of the other myriad services which civilised societies now deem it necessary to deliver in order to provide the needs of their elderly. The problem for these people and for their governments is that all of these individuals, almost without exception when they were working, will have been the providers of contributions but via state-deducted funding from their earnings or from their savings, whether in the form of direct taxation, national welfare or social security contributions, and over the years, those savings should have amounted to a significant pot of ‘wealth’, to enable those above them in the pyramid, to be looked after and supplied with their needs.
However, the difficulty comes when they themselves reach the point where they qualify to become the net recipients of such benefit, only to find that there are insufficient numbers of people below them in the model to make the necessary contributions to keep them in a stable condition.

In addition, it is now quite clear that these elderly people at the top of the triangle are tending to live longer, and their needs are costing more as society is required to look after them for extended periods of time, hitherto not foreseen. The mathematical model is now higher, with an extended peak, a thinner set of intervening layers and much narrower at its base, a classic isosceles triangle.

An important article entitled ‘The Great Baby Shortage’ in the Sunday Times magazine of the 15th February 2004, reported;

“…Unless we in the West produce more children, we face a nightmarish scenario in which the elderly outnumber the young, placing an impossible burden on the workers who must support them. Productivity will plummet. Unemployment will soar. Education will become unaffordable. Optimism will leach from the national psyche and we will become constitutionally depressed…”

The article demonstrated how, in order to maintain a stable population, women needed on average to produce 2.1 children each, what is referred to by demographers as the ‘replacement fertility quotient’. All the leading post-industrial democracies of the western hemisphere are suffering, more or less, from the same predicament. In the U.K the birth rate per woman is 1.6 children, the lowest reported number since records began to be kept in 1924.

In 1961, 25% of the UK population was made up of children aged between 0-15 years old, compared to an aging population in excess of 75 years old of 4%. In 2002, the comparisons were 19.9% of population were between 0-15, while 7.5% were over 75. By the year 2022, there will be 17.5% of population between 0-15, while the over 75s will amount to 10.2%. Indeed, if the falling birth rate is compared to the rising death rate, it is estimated that the two axes will bisect in 2027, when effective depopulation of the UK will begin.

I could continue to develop theoretical arguments using statistics, but I think the point is well made. We are no longer in the prediction game, but we are extrapolating from known figures. The Employer’s Forum on Age is quite clear about the issue.

“…By 2025, for every two people employed there is likely to be one person over 50 who is retired or inactive.”

This inactivity may be due to reasons other than incapacity and I will address these next, but I think the point at issue here is what is the probable response of government likely to be, when it is confronted with the realisation that it simply does not have enough money with which to meet its social and its welfare demands? Is it going to face the ultimate nightmare scenario of permitting homeless and indigent people to die in the streets and lie unburied, or consider raising direct taxation, a political feature of our social life which governments of both parties have eschewed in recent years, because of its vote-losing unpopularity. Is it perhaps going to increase an exponentially-growing amount of stealth taxation, a method which is both politically unpopular and hardly likely to accrue the amount of money it will increasingly need. Or is it most likely to begin to adopt other, more insidious methods of seeking to attack the black or grey economy, recovering money which it claims to be owed already, with legislation designed to undermine civil liberties, so as to make it easier to succeed in seizing those assets it demands, while making it easier for governments to portray such a move as a populist policy, particularly when coupled with vociferous public statements about the need to be being seen to take away the profits from criminals, and undermining the ambitions of terrorists.

How will the citizen react to these changes? Well, not without a struggle, I am convinced. Empowered through their access to web-based technologies, and with access to the best legal and accounting advice, those citizens who have been successful in creating and keeping a high level of personal wealth will become increasingly unwilling to allow it to be left in situations where an increasingly desperate government can get its hands on it. As with their Roman counterparts, they will seek every means of hiding and disguising their personal wealth, moving it out of the reach of rapacious tax gatherers and secreting it in jurisdictions whose own ambitions will be more in tune with their individual requirements. If necessary, they will seek to escape to other, more wealth-friendly environments.

As welfare, health, and education services, and all the other shibboleths of the old nation state begin to break up because government cannot pay for them, we shall see the re-emergence of the extended family unit, particularly among the once-prosperous middle class, as the core welfare model. Living together as an extended family for a much longer period of time, as in Asia, with publicly-inactive members whose role will be to maintain the family, while the elderly will take upon themselves the responsibility for educating the young – largely through privately funded, exclusive educational establishments which will rigidly exclude those who cannot pay, and also those whose children do not exhibit a sufficient level of intelligence to meet the intellectual demands of the institution.

These institutions will be driven by the need to attract the brightest and best of each generation, in order to be able to continue to demonstrate intellectual excellence, which will in turn be driven by the increasing competition between educational establishments whose examination results will be rigidly graded and whose function will be to turn out the next generation of ‘super consultants’. Schools will guard their entrance requirements by both increases in intellectual standards and fee structures so that only the truly wealthy and the most intellectually entrepreneurial will be able to qualify for admission.

Universities, in turn, will be graded by fee structures, having the power to charge on a scale which will exclude the majority of individuals who cannot meet either their intellectual or their financial standards. In order to meet the need to deliver the necessary level of financial requirement to achieve these standards, full family property inheritance will become paramount – inheritance taxes will need to be abolished, and we will see increasing pressure on Government to reform these taxes - parents will literally become the trustees of their children’s future, and in turn, their own welfare, as their offspring will be required to guarantee their parent’s longer term care, as they grow older and live longer. Having the ability to pass on their fortune intact to their offspring will therefore become for the wealthy, a significantly important investment for their own well-being in the future, and just like their Roman counterparts at the end of the 5th century AD, they may need to find other jurisdictions to escape to in order to enjoy the fruits of their labours.

Where will they go?

Well the Asian market seems as good a place as any right now.

The Risk-Based Approach - Is It a Poisoned Chalice?

Alain Damais, the head of the FATF, has recently highlighted some of the problems associated with the approach being adopted by many financial institutions towards the problem of ‘best practice’ anti-money laundering compliance.

In an interview widely reported in the European press, his remarks contain a series of important observations. He is reported as saying…;

‘…The main area of AML concern for banks was their obligation to take a "risk-based approach" to the problem.

"The RBA is a fairly new system for many regulated firms; the dangers are that it will increase the owner's responsibility and therefore the fear. On the other hand, it could be safer as it is more flexible. It could allow the bank to target the difficulty. The risk-based approach is how you deal with the normal people, the majority."Although someone's account may have little unusual activity, his business — or identity — could contain other "red flags" that could throw doubt upon his risk classification. Damais said that each bank had to identify and document the risk linked to each account holder and conceded that this could mean more work on the bank's part. He thought, nonetheless, that this would help each bank deal more easily with people on sanctions lists. He stated unequivocally: "Either you have Osama bin Laden as a client or you don't."

In many ways, it is too easy for a regulator, and particularly the FATF to make broad pronouncements of policy, they don’t have to think through the implications of what the policy will mean to the average institution. In some respects, this identifies one of the perennial problems that the financial industry has with the FATF, an organisation with a self-generated policy objective, and with little or no direct accountability – its pronouncements carry significant weight and moral authority, and can expect to be acted upon, while at the same time, its own authority is little more than a self-fulfilling prophecy!

There is nothing at all wrong with the risk-based approach (rba), in theory! In theory, every bank knows all its customers intimately, and the rba is practised as a sine qua non!

In practice, the rba is not attractive to financial practitioners because it places too great a degree of responsibility on the shoulders of the industry itself, to undertake the necessary degree of due diligence and risk mitigation, and it places a very mobile spotlight into the hands of the regulators which can so easily be shone into some dark and murky corners, when necessary.

The rba in fact, is a poisoned chalice for the industry, while being a consummation, devoutly to be wished, for the regulatory agencies. For the banks, it magnifies their need to provide for additional compliance requirements, while it absolves the regulators from having to make difficult decisions about the minutiae of practical issues, and enables them to focus upon the high-level provision of policy pronouncements. which the regulated sector then has to spend time and money seeking to find ways round!

Indeed, when I was both a regulator and later, a legal practitioner, it never ceased to amaze me how little money a financial institution was willing to spend on developing good compliance procedures; while money became no object if their lawyers could suggest ingenious ways to circumnavigate the implications of an inconvenient regulation!

The policy of most financial institutions has been to develop and implement AML best practice compliance procedures on a grudging, and extremely dilatory basis, in some cases, some institutions have had to be dragged, kicking and screaming into a semblance of compliance with the AML regulatory requirements. One only has had to look at the fines which have been levied on some of the most famous names in the average High Street for failure to comply with the most simple of requirements. If a major institution cannot even provide compliance with a requirement to maintain its own client’s records in an accurate and recoverable manner, then how much credence can be placed on its assertions that it is conducting meaningful transaction monitoring activities?

Possibly the biggest problem however for practitioners is that the rb approach means that they must now make all the decisions as how they engage with the entire compliance process, and without any form of proscription from the regulators. Indeed, their very approach to compliance must adopt rb characteristics. In other words, they must decide how much of a risk they can afford to take by either adopting or not adopting elements of the compliance process!

Let us examine the use of IT systems for assisting in the potential identification of suspicious transactions, as an example!

By far the largest percentage of regulated financial institutions have not implemented any form of IT-assisted transaction monitoring (tm) system, despite the significant importance that is placed on tm by international regulators. It is fast becoming realised that tm is really the only way that institutions can bring any form of meaningful enquiry to the question of how their clients are conducting their affairs.

For many practitioners, making use of a broad-based name checking system has, until now, been considered to be sufficient to meet their KYC needs, but any continued adherence to this policy alone and without additional tm applications, would be a great mistake.

Name checking, while no doubt one method of ensuring that Osama bin Laden is not running an account with your bank, is merely part of the compliance function. Let us be pragmatic, what are the chances of any well-known international terrorist or criminal operating an account in his or her reported name, I mean, it isn’t going to happen, is it? At the same time, how many variations are there on the way in which the single name, ’Mohammed, can be spelt?’ How many false positives must get generated every day by a mere name checking system, and how long do these take to verify?

TM tools have to be seen as now becoming a mandatory part of the regulatory process, and financial practitioners must begin to implement such systems, as part of a best practice, rb approach to AML compliance.

Now, there have been some real scare stories generated in this space, and I have no doubt that everyone who practises in this arena could tell an equally horrifying tale of woe of cases where they have heard of thousands of false positives being generated, all of which have to be examined and analysed.

Such events have happened, it’s true, but at the same time, a significant amount of good work has also been identified as the result of good adherence to these systems. I have always maintained that the use of a well-balanced, properly implemented tm system not only provides the front line of defence against allegations of failing to adhere to the regulatory imperative; but at the same time, in practice can be used to identify real examples of purported fraud against the bank, because the tm system picks up all anomalies. It does not seek to differentiate and only examine those activities which might be indicative of money laundering! That is not its function, it looks at every transaction and seeks to identify any one which breaks the parameters of normative behaviour defined by the account conduct over the past year!

The adoption of the rba means, that in so many cases, and for the first time, the institution is required to take a long look at its business profile and determine its risk parameters in a meaningful way. Having conducted that exercise, it is then better placed to decide what kind of tm system it really needs.

The practice has developed for IT managers to require additional functions to be added to any IT response, in the hope that by packaging a portfolio of different tools within one platform, this will make the product easier to sell, internally. Increasingly therefore, IT solution providers are being asked to provide anti-fraud tools, as well as AML requirements. Some of these anti-fraud tools require a wide cross-section of individual fraud scenarios to be included, yet all this is doing is making the problem of determining potentially suspicious transactions which need to be disclosed to the relevant authorities, more and more difficult to identify, and is radically increasing the possibility of the provision of additional false positives.

The answer to a best practice rba is not to seek to build an entire suite of solutions into one operating model because this will merely exacerbate the potential problems which can be generated.

If the rba is properly determined, constructed and documented, the provision of an IT-led, STR support mechanism, can and should be capable of being calibrated in a simple and extremely functional way. By tailoring the operating function as closely to the risk profile of the institution, false positives should be reduced significantly and the system should become really effective at identifying those disclosures that the institution really needs to be making, rather than just submitting a vast batch of alerts, none of which have been properly qualified.

The intelligence agencies are not looking for a vast volume of disclosures, but value in information; disclosures that really do identify potential wrong-doing and upon which they can rely from an early stage. Any financial institution which is regularly submitting hundreds of alerts on a regular basis, is failing in their duty to provide a properly qualified rba, as is the institution which submits none at all. Both will, in future, stick out like a sore thumb!

Saturday, October 14, 2006

Is contemporary money laundering law intended to deal more with tax evasion?

The World in 2025

“…Thus began the fierce endeavour of the State to squeeze the population to the last drop. Since economic resources fell short of what was needed, the strong fought to secure the chief share for themselves with a violence and unscrupulousness well in keeping with the origin of those in power and with a soldiery accustomed to plunder. The full rigour of the law was let loose on the population. Soldiers acted as bailiffs or wandered as secret police through the land. Those who suffered most were, of course, the propertied class. It was relatively easy to lay hands on their property, and in an emergency, they were the class from whom something could be extorted most frequently and quickly…”

Is this too fanciful, do you think, too apocalyptic? Well, this is not a dark prediction, proceeding from the recesses of some futurologist’s ‘heat oppressed brain’, but a direct quotation taken from The Cambridge Ancient History, pp. 263-264, in the section that deals with the decline of the Roman Empire.

It was a time when the ordinary Roman citizen and those who served him, whether as slaves, freemen or attendants, learned that everything that they had once taken for granted, their much vaunted civic independence (‘Civis Romanus Sum – I am a Roman Citizen’) had long since disappeared. As the once-near guaranteed certainty of their invincible Empire collapsed into what we have come to call the ‘Dark Ages’, the citizens found themselves the victims of a State-turned-predator, as the money required to sustain the normal structure of civic control ran out.
Then, as the controllers of an increasingly feral society looked for even more ways to justify the seizure of the property of the citizen to maintain their own status, the citizens themselves looked for ways to get away and escape, taking with them as much of their property as they could most easily carry. In many cases this meant debating with corrupt magistrates and tax collectors, to negotiate the amount of personal property and private goods which their lawful owner had to leave behind, in order to be left with just enough to sustain any form of lifestyle across the border, in another country, and beyond the Empire.

As more citizens found that escape, the ‘ultimum refugium’, was their only hope, so the State increased the pressure upon those who remained. Returning to the Cambridge Ancient History, we are told;

“…If the propertied class buried their money, or sacrificed up to two-thirds of their estates to escape from a magistracy; or went so far as to give up their whole property in order to get free of the domains rent, and while the non-propertied class just ran away, the State replied by increasing the pressure…”

If you have ever wondered why so many Roman buildings, houses, farms, fortified homes and private estates have been discovered, left almost intact, with a wealth of artifacts; and why modern archaeologists have been able to learn so much about the end of the Roman era while excavating them, it is because they were almost certainly just abandoned, agri deserti, by their owners, as they sought to escape from this renegade army of tax collectors and State registered looters, as the dark shadows of Barbarianism gathered over the decline of the Roman Empire. This analysis also helps to explain why such large hoards of gold and silver coins and plate are continually being found by contemporary treasure hunters. Released from the grip of the cold sticky clay of old fields in the near vicinity of ancient Roman homesteads, valuables, whose hiding-place has remained undiscovered for two thousand years, have been dug up in virtually the same state as when their fearful owners buried them to hide their personal wealth from those who posed the greatest threat to their well-being, the last emperors’ tax collectors.

The relevance of these historical anecdotes to a modern paper on money laundering will soon become more apparent in the ensuing pages as I attempt to deconstruct and re-evaluate the reasons why international money laundering legislation has reached its present stage of development, and, of more concern, why there is still more room for it to grow. Make no mistake, both the US and the UK, already have the necessary laws to confiscate and remove personal assets from their citizenry with an equally sparse lack of requirement to justify their actions, as those which their historical counterparts used 2 thousand years ago. Then, the purported justification was no doubt the need to counter the perceived threat from the Barbarians and the Visigoths, today it is the threat from International Organised Crime and Terrorism.

There is legitimacy therefore in seeking to extrapolate from what information we already have and which we possess now, to determine a picture of the future in the year 2025. I am doing this to seek to place in context that which is reported later in the text. In so doing, I am inviting the reader to exercise his or her own skill and judgement to decide whether what I am writing is a realistic analysis of the real reasons which lie behind the introduction of the international laws and regulations which purport to deal with money laundering and the financing of terrorism.
Like so much else about the money laundering story, the facts and the fantasies have become interchangeable, depending on whose agenda is being best served. This is largely due to the fact that governments on a global basis have so far found no substitute for the value possessed by their ability to instil in the mind of the public, the fear of the actions of the ‘international cartels of organised crime gangs and terrorists’, a series of moral panics which they are anxious to emphasise and at pains to amplify. Coupled with this, they have for so long, steadfastly refused to try and calculate any meaningful and realistic statistics of the real size of the money laundering problem, preferring instead to cling to an armoury of figures so fantastical as to be risible. In doing so, they demonstrate that they do not have to face up to the limitations on their core thinking, and are content to continue to operate on the margins of intellectual legitimacy. Under the shadow of this tattered banner they have long sought to justify their actions and support their ambitions to introduce confiscatory legislation of draconian proportions, which, under any ‘ordinary’ or ‘normal’ or non-contentious circumstances, would have no chance of getting on to the statute book.

Hardly a news story breaks in which some government official or politician, seeking to introduce even more legislation designed to further curtail the rights of the citizen, or to share even more private and confidential information among even more law enforcement agencies, can report his intentions without the traditional bromide of the need to combat the actions of criminals or international terrorists being trotted out.

In a story headed ‘Terrorists use stolen blank passports’, reported in the Philippine Star on 29th February 2004, an Interpol conference was reported to have been told that hundreds of thousands of stolen blank passports plus millions of other virgin documents allow terrorists to ‘breeze across borders’

The real purpose behind this no doubt shocking story was an attempt by the secretary-general of Interpol, Ron Noble, to demand the sharing of important and highly contentious criminal information among all the signatories to the Interpol agreement. Presently only 34 countries out of the 181 members of Interpol share such data, and they alone report over 80,000 missing passports. ‘…That’s only what’s on file…’, Noble is reported to have breathlessly told the conference. ‘…You can imagine the rest. If we don’t have a global database with everyone contributing, think of all the terrorists and criminals trading in documents…

But what possible value would a global database of such suspected criminal information be, and to whom, and how much would it cost? More importantly, what damage could be done if this information was unfortunately leaked into the wrong hands? Why does Interpol, which is nothing more than an international police information-exchange mechanism, suddenly need to control a mega-database of all the information about all the criminals in the world, information which is already maintained everywhere else in the world? Is this not more to do with power and relationships between competing law enforcement and intelligence agencies and the struggle for bigger budgets, at the expense of other competing systems. Is this not precisely the appalling state of affairs which existed between the FBI and the CIA on and up to 11th September 2001, where both agencies, jealous and resentful of each other’s remit, budgets and powers, refused to share information and intelligence with each other, on the basis of ‘need to know’!
In the same newspaper on 29th February 2004 another story outlined how a report from Paris showed the Financial Action Task Force (FATF) demanding that Governments consider tighter controls on religious groups and charities to stop them from being used to fund terrorists. The report complained that charities were still being used to fund extremists. Governments, it was reported are unable to monitor religious organisations in countries where they enjoy a special legal or constitutional status. The report concluded by calling for alternative solutions to guarantee transparency and access when necessary to competent authorities.

This last sentence is thinly-disguised language which when interpreted means that the next round of FATF recommendations will include legal requirements for all charities to submit reports on income and expenditure, or some other similarly over-bureaucratic requirement, and to allow their books to be examined and investigated by police and revenue authorities.

Quite how such a facility would have made any difference to preventing the 9-11 attacks, as an example, is hard to see. In that case, the perpetrators opened a perfectly normal bank account in a small bank, having transferred the funding in from another bank by the normal channels. They had credit cards and other modern financial services facilities. Nevertheless, because charitable giving is now perceived by law enforcement and security agencies to be a conduit for a wide variety of illicit funds, charities themselves must become subject for special scrutiny.
Why senior police officials and law enforcement agencies behave in this way, and the purposes to which all this new proposed legislation is intended to be put, is the purpose of this management report. It is designed to permit the financial practitioner to have a clear, and unambiguous alternative interpretation of the reasons for the need for anti-money laundering legislation, the better to make the necessary commercial judgements on such issues as ‘best practice’ compliance; Basle II risk management provision, or what level of spend is necessary to provide IT support for financial transaction monitoring.

As with all alternative interpretations, it is wise to begin by looking for explanations from a completely different perspective.

In the next edition, I shall expand on this concept.

Saturday, October 07, 2006

Saturday 7th October 2006

Having taken the example from my son, Ross, I have now opened my own blog. From time to time I shall publish my own views and thoughts on this site, and welcome comments from interested readers.