What is financial crime?

Financial crime is a significant ongoing challenge for banks, institutions, and individuals. As regulators and financial authorities introduce new strategies to detect and prevent financial crime, criminals develop more sophisticated methodologies to evade legal scrutiny and commit offences, including fraud, money laundering, and the financing of terrorism. Financial institutions are also expected to participate in the fight against financial crime, by ensuring compliance with the regulations that authorities put in place – at the risk of potentially severe penalties. Financial compliance is a significant international concern: the global cost of compliance in the financial sector alone is estimated to be around $180.9 billion per year.

Accordingly, every business in the financial sector (and beyond) should understand the criminal threats they face – and the measures they need to put in place to both protect themselves and achieve regulatory compliance.  

What is financial crime?

Financial crime is generally defined as any activity that involves fraudulent or dishonest behavior for the purposes of personal financial gain, although it may also include the illegal conversion of property ownership. Financial crime may be committed by individuals or groups and involve the following activities: 

• Money laundering
• Terrorism financing
• Fraud
• Tax evasion
• Embezzlement
• Forgery
• Counterfeiting
• Identity theft

Financial crime, and the spectrum of criminal activity that it entails, is a law enforcement priority in jurisdictions around the world. The two most significant types of financial crime are money laundering and the financing of terrorism:

• Money laundering: When criminals derive funds from illegal activities, that money must be disguised before it can be introduced into the legitimate financial system. Money laundering is the illegal process of disguising the profits of financial crime, typically by using the services of banks and businesses.

• Terrorism financing: The financing of terrorism involves the provision of funds to individuals and groups for the purposes of committing terrorist acts. Terrorism financing resembles money laundering in the sense that it often requires criminals to conceal the transfer of funds within the legitimate financial system. 

Most jurisdictions have established organizations and agencies dedicated to preventing money laundering and the financing of terrorism. These organizations include the Financial Crimes Enforcement Network (FINCEN) in the US, the Financial Conduct Authority (FCA) in the UK, the Federal Financial Supervisory Authority (BaFin) in Germany, and the Financial Markets Regulator (AMF) in France. 

Financial crime and money laundering

The act of money laundering is typically predicated on other illegal activities – which are known as ‘predicate offenses’. In this context, predicate offenses refer to any illegal activity that generates financial proceeds which must subsequently be laundered before they can be introduced into the financial system. 

For example, when an individual moves drugs illegally across borders they must launder the funds they receive as payment. In this case, the offense of drug trafficking predicates the subsequent financial crime of money laundering. Examples of crimes that may be considered money laundering predicate offenses include:

• Drug trafficking
• Human trafficking/migrant smuggling
• Weapons trafficking
• Sexual exploitation/prostitution
• Fraud
• Robbery
• Insider trading
• Blackmail/bribery

The EU’s Sixth Anti-Money Laundering Directive (6AMLD) set out a codified list of 22 money laundering predicate offenses which all member states must recognize in domestic legislation. The list included two new money laundering predicate offenses: cybercrime and environmental crime. 

While a range of defined offenses underpin the crime of money laundering, many governments are strengthening their AML regulations by adjusting their treatment of predicate offenses. In Germany, for example, an updated version of the Act to Improve Criminal Law Combating Money Laundering removes the need to connect money laundering to a predefined criminal offense. Under the new rules, which came into effect in March 2021, the crime of money laundering may be applied as a criminal charge if the laundering activity is predicated on any ‘unlawful act’ – rather than a list of defined predicate offenses. 

In practice, this means that German prosecutors may now apply the charge of money laundering to an expanded range of offenses, including petty crimes such as shoplifting. 

How do criminals launder money?

The techniques that criminals use to disguise the proceeds of financial crime have matched the pace and sophistication of advances in financial technology. In response to those risks, authorities have intensified their efforts to detect and prevent money laundering activities, introducing new anti-money laundering (AML) and counter-financing of terrorism (CFT) legislation and increased compliance penalties. 

Given the regulatory scrutiny they face, money launderers often seek to evade or out-pace AML/CFT measures by employing the following criminal methodologies:

• Regulatory disparity: Criminals may use the disparity between regulations in different jurisdictions to evade AML scrutiny. In some cases, criminals may seek to move money physically or electronically across international borders to take advantage of weaker AML regulations. 
• Identity fraud: Criminals may seek to conceal their identities when using financial services in order to evade AML measures. Identity fraud is a particularly significant threat in online transactions in which criminals may exploit a higher degree of anonymity to access and misuse legitimate financial services. 
• Structuring: Criminals may transact in amounts or patterns that are designed to evade the scrutiny of AML controls. Similarly, criminals may structure their transactions across multiple institutions in order to avoid triggering certain AML reporting thresholds. 
• Political corruption: Individuals with political influence, such as government officials, may be able to use their status and influence to launder the proceeds of corrupt activities while avoiding AML controls. The relatives and close associates of these politically exposed persons (PEP) may also have increased opportunities to avoid AML scrutiny. 
• Leverage: Through the leveraging of financial institution employees, criminals can commit financial crime by avoiding AML controls. Criminal leverage may be obtained through financial incentives or threats of violence or reprisal. 
• Money-muling: Criminals may seek to coerce or incentivize third-parties – so-called money mules – to conduct illegal transactions on their behalf. Money mules are often vulnerable or financially disadvantaged people. 

How can firms prevent money laundering?

Criminals who launder money and provide financing to terrorists may use very sophisticated techniques, making them difficult to detect and catch. Both of types of financial crime often involve an international element, since money launderers and terrorist financiers need to smuggle cash over borders to facilitate their plans. It is not uncommon for criminals in high risk jurisdictions to have corrupt connections in government and business; these connections could include financial institution employees, accountants, government officials, and other service providers.

Accordingly, banks, financial institutions, and other obligated entities must carefully comply with jurisdictional AML/CFT regulations such as the US’ Bank Secrecy Act (BSA), the UK’s Proceeds of Crime Act (POCA) and the EU’s anti-money laundering directives (AMLD). Most jurisdictions develop AML/CFT legislation in alignment with guidance set out by the Financial Action Task Force (FATF): an intergovernmental organization established to set global AML/CFT standards.

AML regulations are designed to prevent financial institutions knowingly or unknowingly facilitating financial crimes such as money laundering and the financing of terrorism. While regulations vary by jurisdiction, they generally impose reporting and record-keeping obligations, and require firms to develop and implement internal AML/CFT compliance solutions under the risk-based approach recommended by FATF.  

In practice, this means that firms must develop and implement their internal AML/CFT compliance solution following an assessment of the specific risks that they face. Risk-based AML relies on the effective implementation of Know Your Customer (KYC) measures which require firms to collect and analyze a range of data in order to accurately identify their customers, understand their behavior, and assess the legality of their transactions. When potential criminal activity is detected, firms must inform the relevant authorities in a timely manner by completing and submitting a suspicious activity report (SAR). 

An effective AML/CFT program should feature the following measures and controls: 

• Customer due diligence: Firms must be able to establish and verify the identities of their customers and the beneficial ownership of customer entities. Higher risk customers should be subject to enhanced due diligence (EDD) measures. 
• Transaction monitoring: Firms should monitor their customers’ transactions for indications that they are attempting to launder money. Unusual transaction patterns and amounts, or transactions that do not match a customer’s risk profile, represent money laundering red flags. 
• Sanctions screening: Firms must ensure they do not facilitate the criminal activities of customers that are subject to international sanctions and other restrictions. Accordingly, firms should screen against relevant international sanctions and watchlists.
• PEP screening: Firms must screen their customers to establish their politically exposed person status and determine whether they present a higher AML risk. PEP screening should include customers’ relatives and close associates.
• Adverse media monitoring: Adverse or negative media stories often indicate that customers are involved in criminal activities and present a higher AML/CFT risk. Firms should monitor for adverse information from both traditional screen and print news media and online sources. 

AML compliance software: In order to manage the extensive data collection and analysis requirements mandated by AML regulations within their jurisdiction, firms should integrate suitable compliance software within their solution, including a range of smart technology tools. Automated AML technology adds speed, efficiency, and accuracy benefits to the compliance process, and reduces the potential for costly human error. Smart technology also allows firms to adapt to emergent financial crime methodologies, and to changes in the regulatory landscape when new AML legislation is introduced.