Chapter 1
The Next Frontier

The Financial Action Task Force (FATF) has declared that there are three broad categories for the purpose of hiding illicit funds and introducing them into the formal economy. The first is via the use of financial institutions; the second is to physically smuggle bulk cash from one country or jurisdiction to another; and the third is the transfer of goods via trade.1 The United States and the international community have devoted attention, countermeasures, and resources to the first two categories. Money laundering via trade has, for the most part, been ignored.

The United States' current anti–money laundering efforts began in 1971, when President Nixon declared the “war on drugs.” About the same time, Congress started passing a series of laws, rules, and enabling regulations collectively known as the Bank Secrecy Act (BSA). The BSA is a misnomer. The goal is financial transparency by mandating financial intelligence or a paper trail to help criminal investigators “follow the money.” Today, primarily as a result of the BSA, approximately 17 million pieces of financial intelligence are filed with the U.S. Treasury Department's Financial Crimes Enforcement Network (FinCEN) every year. The financial intelligence is warehoused, analyzed, and disseminated to law enforcement agencies at the federal, state, local, and increasingly the international levels.

The worldwide community slowly followed the U.S. lead. In 1989, the G-7 created the FATF. The international anti–money laundering policy-making body championed 40 recommendations for countries and jurisdictions around the world aimed at the establishment of anti–money laundering (AML), and after September 11, counterterrorist financing (CFT) countermeasures. These included the passage of AML/CFT laws, the creation of financial intelligence, know your customer (KYC) compliance programs for financial institutions and money services businesses, the creation of financial intelligence units (FIUs), procedures to combat bulk cash smuggling, and other safeguards.

The FATF's initial recommendations were purposefully imprecise in order to accommodate different legal systems and institutional environments. In its infancy, the FATF was also Western centric, focusing on money laundering primarily through the prism of the West's “war on drugs,” where large amounts of dirty money were found sloshing around Western-style financial institutions. The FATF and its members almost completely ignored other forms of non-Western money laundering. Unfortunately, the FATF's early myopia had serious repercussions. Terrorist groups and criminal organizations continue to take advantage of what Osama bin Laden once called “cracks” in the Western financial system.2

As FATF evolved and the international community responded to growing financial threats, including the finance of terror, its nonbinding recommendations became increasingly precise. Its recommendations and interpretive notes have undergone periodic updates. In 1996, 2003, and 2012, its standards were significantly revised. The FATF's membership expanded, and today FATF-style regional bodies are found around the world.

Yet outside of FATF's 2006 trade-based money laundering “typology” report and similar studies conducted by FATF-style regional bodies (a study of particular note was conducted by the Asia Pacific Group in 2012), trade-based money laundering and value transfer have, for the most part, been ignored by the international community. This despite the FATF's above declaration that trade is one of the three principal categories of laundering money found around the world. For a variety of reasons, it has not been possible to achieve consensus on the extent of the problem and what should be done to confront it. And there continues to be an ongoing debate about whether financial institutions have the means and should assume the responsibility to help monitor international trade and trade finance as it relates to money laundering.

In 2014, The Economist called trade “the weakest link” in the fight against dirty money.3 I agree with the assessment but believe it will change. Governments around the world—simultaneously pressed for new revenue streams and threatened by organized crime's use of money laundering, corruption, massive trade fraud, transfer pricing, and the associated threat of terror finance—are slowly moving to recognize the threat posed by trade-based money laundering and value transfer. (Note: TBML will be used in this book as the accepted acronym.)

So what is TBML? The FATF defines the term as the “process of disguising the proceeds of crime and moving value through the use of trade transactions in an attempt to legitimize their illicit origins.”

The key word in the above definition is value.4 To understand TBML, we must put aside our linear Western thought process. Illicit money is not always represented by cash, checks, or electronic data in a wire transfer, or new payment methods such as stored-value cards, cell phones, or cyber-currency. The value represented by trade goods—and the accompanying documentation both genuine and fictitious—can also represent the transfer of illicit funds and value. This book will provide many examples of the how and why.

The Magnitude of the Problem

To estimate the amount of TBML in the United States and around the world, we must first examine the magnitude of international money laundering in general. Those estimates are all over the map. In fact, the FATF has stated, “Due to the illegal nature of the transactions, precise statistics are not available, and it is therefore impossible to produce a definitive estimate of the amount of money that is globally laundered every year.”5

However, the International Monetary Fund has estimated that money laundering comprises approximately 2 to 5 percent of the world's gross domestic product (GDP)6 or approximately $3 trillion to $5 trillion per year. In very rough numbers, that is about the size of the U.S. federal budget! The United Nations Office on Drugs and Crime (UNODC) conducted a study to determine the magnitude of illicit funds and estimates that in 2009, criminal proceeds amounted to 3.6 percent of global GDP, or approximately $1.6 trillion being laundered.7 So how much of that involves TBML? The issue has never been systematically examined. However, I will use a few metrics to put things in context.

What is the magnitude of money laundering in general and TBML in particular? The short answer is that nobody knows with precision, but both are enormous!

According to the U.S. Department of State's 2009 International Narcotics Control Strategy Report (INCSR), it is estimated that the annual dollar amount laundered through trade ranges into the hundreds of billions.8 In fact, the State Department has concluded that TBML has reached “staggering” proportions in recent years.9

Global Financial Integrity (GFI), a Washington, D.C.–based nonprofit, has done considerable work in examining trade-misinvoicing. It is a method for moving money illicitly across borders, which involves deliberately misreporting the value of a commercial transaction on an invoice and other documents submitted to customs (see Chapter 7). A form of trade-based money laundering, trade-misinvoicing is the largest component of illicit financial outflows measured by GFI. After examining trade data covering developing countries, GFI concluded that a record $991.2 billion was siphoned from those countries in 2012 via trade misinvoicing!10 In its 2014 study, GFI finds that the developing world lost $6.6 trillion in illicit financial flows from 2003 to 2012, with illicit outflows alarmingly increasing at an average rate of more than approximately 9.4 percent per year.11 See the illustration in Figure 1.1 for the 2002–2012 trade-misinvoicing outflows. Of course, much of this hemorrhage of capital originates from crime, corruption, fraud, and tax evasion.

Figure 1.1 Trade-misinvoicing outflows from developing countries 2003–201212 (in millions of dollars, nominal)

Source: Global Financial Integrity, http://www.gfintegrity.org/issue/trade-misinvoicing/ (2015).

In the United States, the UNODC estimated proceeds from all forms of financial crime, excluding tax evasion, was $300 billion in 2010, or about 2 percent of the U.S. economy.13 This number is comparable to U.S. estimates.14

There are no reliable official estimates on the magnitude of TBML as a whole. Since the issue affects national security, law enforcement, and the collection of national revenue, it is remarkable that the U.S. government has never adequately examined TBML.

Dr. John Zdanowicz, an academic and early pioneer in the field of TBML, examined 2013 U.S. trade data obtained from the U.S. Census Bureau. Using methodologies explained further in Chapters 2 and 9, by examining undervalued exports ($124,116,420,714) and overvalued imports ($94,796,135,280), Dr. Zdanowicz found that $218,912,555,994 was moved out of the United States in the form of value transfer! That figure represents 5.69 percent of U.S....