Money Laundering Prevention: Obligations for Financial Institutions
Money laundering risks are among the most significant risks in the financial markets. In a recent study, Transparency International estimated the volume of money laundering in Germany at up to €100 billion annually. In 2021, the police in Germany recorded 14,785 cases of money laundering, according to Statista. This was an increase of more than 5,000 from the previous year. The number of reports received by the Financial Intelligence Unit (FIU), the central office for financial transaction investigations, regarding suspected money laundering also doubled last year compared to 2020. Financial institutions are particularly affected by these trends. Effective money laundering prevention is the only way for them to protect against the risks of these criminal enterprises.
Money laundering is a clear criminal offence
The term money laundering goes back to the American Mafia boss Al Capone. When asked about his profession, he answered in a trial in 1931: "I'm in the laundry business." He used laundrettes, among other places, to "launder" the proceeds from the drug business.
Money laundering smuggles illegally generated funds into the legal financial and economic circuit, also called black money. Section 261 of the Criminal Code deals with the legal aspects of money laundering and the penalties:
"Whoever 1. conceals an object resulting from an unlawful act, 2. exchanges, transfers or transfers it with the intention of frustrating its discovery, its confiscation or the tracing of its origin, 3. procures it for himself or a third party or 4. keeps it or uses it for himself or a third party if he knew its origin at the time he obtained it, is liable to a custodial sentence not exceeding five years or to a monetary penalty."
Closely related to this definition is terrorist financing.
The "objects" mentioned in the law include, first and foremost, cash, earned primarily through drugs, bribes, extortion and fraud of all kinds and deposited in bank accounts disguised as income from laundromats, restaurants, kiosks or other transhipment points. In line with the market growth in #cryptocurrency, digital assets may also be used in these activities. The number of SARs received by the FIU regarding money laundering with cryptocurrencies more than doubled in 2021 compared to 2020. Solid money laundering prevention is therefore becoming increasingly important.
Closing the loopholes
While the Criminal Code sets out the relevant penalties for money laundering, the Act on the Tracing of Profits from Serious Crimes (Money Laundering Act - AMLA) is preventive. It sets out responsibilities regarding money laundering prevention.
Thus, it obliges certain groups of persons from the financial and banking sectors to exercise special care and supervision. Money laundering prevention aims to create an environment that makes it impossible or at least more difficult for criminals to smuggle the money they have earned through criminal activities into banks.
Similar to how GDPR governs data protection, the Money Laundering Act obliges economic actors operating in Germany to actively cooperate to prevent money laundering. The persons and companies obliged to cooperate are "obligated persons."
The Money Laundering Act specifies very precisely, for example,
- To which companies, traders, associations or institutions the law applies;
- In which companies a money laundering officer is to be appointed for money laundering prevention and for what they are responsible;
- Who is considered a beneficial owner within the meaning of the Act;
- Which retention periods apply to which documents; and
- What an effective risk management system should look like overall.
Failures or breaches of duty in money laundering prevention can have severe consequences for obligated parties. Fines of up to €5 million or up to 10% of the previous year's turnover can be imposed.
Knowing the criminals' modus operandi
Before preventing criminal acts, organisations must understand how the perpetrators carry out their crimes. Numerous institutions provide information on this, including the Federal Criminal Police Office. On its website, the BKA explains that money laundering is a process that can be divided into three crime phases.
The first phase is the placement phase. Here, the incriminated money is introduced into the legal economic cycle for the first time. This can be done by depositing large sums of cash at credit institutions and acquiring real estate, company shares, etc., using money. The risk of being discovered is exceptionally high in this phase.
The second phase is the concealment phase. It is complex and often involves international financial transactions. The main goal of this phase is to separate the illegally acquired funds from their source, thereby obscuring the paper trail and severing any connection to the original offence. During primarily cross-border transactions, the funds remain in motion to avoid detection. For example, loopholes in the legislation of the respective countries are used for this purpose.
The third and last phase is the integration phase. Here, the money is returned to the criminal from a legal source. The aim is to reunite the money with the offender without attracting attention and to give the funds the appearance of a legal origin. Subsequently, the money can be reinvested in the legal economy, for example, by purchasing luxury goods, real estate and company shares.
Obligations of financial institutions in the prevention of money laundering
The list of obligations of financial institutions to prevent this practice is long. The most crucial point is establishing appropriate risk management for money laundering prevention. Whether it is a matter of cash deposits, cryptocurrencies, international transfers to tax havens or company shareholdings, it is relevant to know the legal requirements and to view what is happening with great care.
Those responsible should ask themselves simple questions:
- Is the transaction non-transparent, that is, are the parties involved and the business purpose concealed?
- Are the deposits large amounts of cash?
- In which country is the customer located? Is it a country with a high risk of money laundering?
- Does the customer have good knowledge of the transaction?
- Are third parties involved as intermediaries in a transaction for no reason?
- Does the client have an opaque network of accounts and companies?
Responsibilities for money laundering prevention stateside
With the Act to Improve the Criminal Law on Money Laundering of 9 March 2021, the criminal offence of money laundering under Section 261 of the Criminal Code was adapted to the requirements of the EU Directive on the Criminal Law on Money Laundering. The Federal Financial Supervisory Authority (BaFin) is responsible for compliance with the Money Laundering Act in Germany. There is a separate "Money Laundering Prevention" (GW) department for this purpose.
If the obligated parties show gaps in their risk management regarding money laundering prevention, the authority orders the establishment of appropriate measures.
This Money Laundering Prevention Department also represents Bafin in various international and European bodies. These include, in particular, the Financial Action Task Force on Money Laundering (FATF) or the Sub-Committee on Anti-Money Laundering (AMLC), a sub-committee of the Joint Committee of European (Financial) Supervisory Authorities (ESAs).
The Financial Intelligence Unit (FIU)is the central reporting point for the prevention, detection and assistance in the fight against money laundering and terrorist financing by Article 32(1) of Directive (EU) 2015/849. This abbreviation stands for authorities worldwide that detect money laundering and terrorist financing. The FIU is technically independent. Its powers are derived exclusively from the Money Laundering Act (GwG).
Its central task is to receive and analyse so-called suspicious money laundering reports. A reporting obligation arises whenever there are indications that an asset (e.g., cash) originates from a criminal offence or is intended to be used for terrorist financing. If an office does not comply with these obligations, there is a risk of legal consequences.
In its latest report on the evaluation of money laundering prevention in Germany, the FATF certifies that Germany has made good progress in the prevention of money laundering. However, it also drew attention to deficits such as:
- The monitoring of the private sector (especially the non-financial sector);
- The availability of and access to information on beneficial owners;
- The increased development and use of financial flow tracking technologies by competent authorities; and
- The prioritisation of money laundering investigations and prosecutions.
To improve money laundering prevention in Germany as a whole, the federal government is now looking to bundle the most important competencies under the umbrella of a new authority at the federal level. In the future, the FIU will be joined by the Federal Financial Criminal Police Office and the Central Office for the Supervision of Money Laundering. The three will form the Federal Financial Crime Authority (Bundesbehörde Zur Bekämpfung von Finanzkriminalität, BBF).
Without a doubt, the bundling and expansion of competencies and the use of technological innovations will increase the efficiency of investigations. However, companies will be faced with an increased effort to prevent money laundering. Therefore, it is critical that companies establish practice, money laundering-specific risk management systems and continuously analyse business partners and transactions. It is better to send one too many than too few suspicious money laundering reports to the competent authority.
The views expressed herein are those of the author(s) and not necessarily the views of FTI Consulting, its management, its subsidiaries, its affiliates, or its other professionals.