An Overview of Modern Money Laundering
By Sarosh Khan, Nicholas Kiritz, and Shahar Shlomi
Money laundering is a complex financial crime in which criminals disguise the illicit origins of their wealth by moving funds through a variety of legal channels. The process typically unfolds in three distinct stages: placement, layering, and integration. Each stage provides money launderers a chance to obscure the source and ownership of the funds – but also presents opportunities for financial institutions and law enforcement to detect and prevent these illegal activities. Understanding the mechanics of these stages is critical for combating this type of financial crime.
The Stages of Money Laundering
1. Placement
The first stage of money laundering, placement, involves introducing illegal funds into the financial system. This stage is particularly vulnerable to detection because it involves the physical movement of large sums of cash, which can attract attention from authorities. Criminals employ various techniques to minimize the risk of detection at this stage. One common method is smurfing, or structuring, which involves breaking large sums of money into smaller, less noticeable deposits, often spread across multiple financial institutions or accounts. This method allows criminals to avoid triggering currency transaction reports (CTR), which are required for cash transactions exceeding a certain threshold (typically $10,000 in the U.S.) (Financial Action Task Force, 2020).Other techniques used at the placement stage include bulk cash smuggling, where criminals physically transport large sums of money across borders to deposit in foreign accounts with less regulatory scrutiny (Unger, 2016). Additionally, some criminals may use cash-intensive businesses, such as restaurants or car washes, to integrate illicit funds into their legitimate revenue streams. By co-mingling illegal proceeds with legal earnings, they can make the funds appear legitimate and evade detection by authorities (Unger, 2016).
Financial institutions can detect this activity using strong monitoring systems and anti-money laundering (AML) policies at the point of deposit. These start with screening processes for new customers using PEP (politically exposed persons) screening, and broader Know Your Customer (KYC) processes when customers open new accounts. These processes help such firms to anticipate what patterns of transactions to expect, and thus identify unusual transactions and implement Enhanced Due Diligence (EDD) for high-risk customers. Financial institutions may prevent placement by denying services to high-risk customers or entities altogether, however, such actions incur direct costs and risk opportunity costs, stemming from false positives (wrongly turning away honest potential customers), and so should be reserved for extreme cases. While not strictly preventive, use of CTRs and Suspicious Activity Reports (SARs), as well as algorithms to detect smurfing or structuring intended to circumvent CTRs, likely discourage would-be money launderers’ activity in certain jurisdictions or use of some institutions.
2. Layering
The second stage of money laundering, layering, involves the separation of illicit funds from their source through complex financial transactions. The goal of this stage is to obscure the money’s origin, making it difficult to trace the illicit funds back to the underlying criminal activity. This is typically done through a series of complicated transfers and conversions that make the audit trail harder to follow. Money launderers may use multiple banks, shell companies, or offshore accounts to execute these transactions (FATF, 2020). Certain offshore jurisdictions with strong confidentiality laws and weak regulatory frameworks are chosen to help shield the identities of the individuals behind the transactions. Additionally, trade-based money laundering (TBML) is a common tactic used during the layering stage. Criminals can over- or under-invoice goods and services to transfer value across borders under the guise of legitimate trade. For example, over-invoicing a shipment of goods allows the movement of excess funds from purchaser to the seller, while the under-invoicing technique allows movement of excess value in the form of goods from the seller to the buyer, who then sells the goods to extract the excess funds (Financial Action Task Force, 2021).
Financial institutions detect layering by deploying transaction monitoring systems and processes in concert with EDD and KYC to identify unusual transaction patterns, such as rapid, frequent transfers between accounts, use of offshore entities, or shell companies, especially with cross-border transfers. Data-sharing agreements between jurisdictions can further help overcome the challenges posed by international money laundering, while robust audit trails allow financial institutions and regulators to trace suspicious money movements. Financial institutions can and do prevent layering by freezing or closing accounts to immediately block suspected money laundering activity, in addition to forwarding SARs to the relevant authorities (Paul, 2021).
3. Integration
The final stage of money laundering is integration, where the now "cleaned" money is reintroduced into the legitimate economy. By this stage, the laundered funds have been sufficiently distanced from their criminal origins, making them harder to trace. The integration process allows the launderer to enjoy the proceeds of the crime without raising suspicions. At this point, laundered money is often used to purchase high-value assets such as real estate, luxury goods, or investments in businesses (Levi & Reuter, 2006). Real estate, in particular, is a common vehicle for money laundering due to its high value and the ease with which property can be bought and sold. Criminals may buy properties at inflated prices or pay for them in cash, making it difficult for authorities to determine whether the transaction was legitimate or part of a larger money laundering scheme (FATF, 2020). Once the money is integrated, the launderer can access it without fear of detection, as it now appears to be legitimate income.
Financial institutions and law enforcement alike can detect irregularities by scrutinizing large cash purchases, property acquisitions, or investments that don't match the profile of the individual or business. Rigorous due diligence in sectors such as real estate, high-value goods, corporate finance and investment can flag potential money laundering activities. Financial institutions can monitor unexplained wealth or sudden spikes in financial transactions that may suggest illicit origins. FinCEN, the US Department of the Treasury’s Financial Crimes Enforcement Network, has proposed expanding coverage of current anti-money laundering programs to cover investment advisers registered with the Securities and Exchange Commission (SEC), also known as registered investment advisers (RIAs), as well as investment advisers that report to the SEC as exempt reporting advisers (ERAs) (Cooley, 2024), suggesting that FinCEN views investment advisors as another vehicle for integration of illicit funds. Financial institutions can prevent integration by establishing strict internal controls on large transactions, requiring additional checks or reporting when high-value assets are involved. Rigorous KYC processes for clients involved in real estate, luxury goods, or high-value investments further help prevent the integration of illicit funds. (Paul, 2021)
Conclusion
Money laundering is a sophisticated crime that evolves across three stages: placement, layering, and integration. Each stage plays a crucial role in the overall process, and law enforcement agencies and financial institutions must focus on identifying suspicious activities early, especially during the placement and layering stages, to prevent illicit funds from entering the legitimate financial system. While financial institutions and governments have made significant progress in developing anti-money laundering (AML) tools and frameworks, the constant evolution of laundering techniques requires continuous adaptation and vigilance.
Annotated References
Cooley. FinCEN Proposes Rule Requiring Investment Advisers to Establish AML Programs. Cooley, 2024. Examines proposed FinCEN rules requiring investment advisers to comply with AML regulations, including SAR filing, transaction monitoring, and enhanced due diligence requirements.
Financial Action Task Force. Money Laundering and Terrorist Financing Vulnerabilities of Legal Professionals. FATF, 2020. This FATF document sheds light on how professionals such as lawyers and accountants are sometimes unwittingly involved in money laundering schemes. It offers practical recommendations for reducing the vulnerability of legal professionals to being exploited by criminals.
Financial Action Task Force. Money Laundering and Terrorist Financing Through Trade and Free Trade Zones. FATF, 2021. This FATF report provides an in-depth analysis of how trade-based money laundering is used to obscure illicit funds through international trade. It outlines specific methods, such as over- and under-invoicing, and highlights the challenges of detecting these schemes within free trade zones.
Levi, Michael, and Peter Reuter. “Money Laundering,” in Crime and Justice, Volume 34, 2006. In this article, Levi and Reuter examine the mechanics of money laundering, breaking down each stage of the process. Their focus on the layering and integration stages provides critical insights into how financial criminals exploit legal and financial systems to launder money.
Paul, Weiss, Rifkind, Wharton & Garrison LLP. Economic Sanctions and Anti-Money Laundering Developments: 2021 Year in Review. Paul, 2021. This report provides a comprehensive review of key AML developments, sanctions, and regulatory trends in 2021. It highlights enforcement actions and regulatory changes across different jurisdictions.
Unger, Brigitte. The Scale and Impacts of Money Laundering. Edward Elgar Publishing, 2016. Unger's work provides a comprehensive overview of the global scale of money laundering and its economic impact. The author explores how various sectors, including real estate and cash-based businesses, are exploited for laundering purposes and discusses international efforts to combat these activities.
