The Financial Action Task Force’s (FATF) best practice paper on Trade Based Money Laundering is useful, but it can be educational to look at an actual case study concerning money laundering and fraud to get a better understanding of the techniques perpetrators use and to see them operate in a real-life situation. It is also useful to look at red flag indicators which, if monitored and incorporated into an institution’s anti-money laundering (AML) program, will be effective in combating the illegal movement of monies.

There are three main methods by which criminals, money launderers and terrorist financiers move money through the placement, layering and integration stages:

• The first uses the financial system by means of multiple cash deposits, cheques, credit cards, investment products, insurance and wire transfers.
• The second involves physical movement of cash through agents acting as couriers or through smuggling.
• Trade Finance is one of the areas that fall in the third category, through which money laundering, tax evasion and fraud takes place.

Post 9/11, considerable regulations have been introduced by governments to regulate the first two methods. It is the third, involving trade finance, that presents the greatest challenge to businesses as, let’s face it, how many of us in risk management and compliance know the intricacies of how letters of credit and performance bonds can be used to facilitate nefarious activities? It is therefore worth bankers, customs agencies, financial intelligence units, tax authorities and regulators developing the skills necessary to identify and combat trade-based money laundering.

Case Study: Company X

One of the classic cases of trade-based fraud involved “Company X”. More than 17 national and international banks lost over US$360 million when a UAE-based expatriate businessman, “Mr Doe”, fled the country without paying his debts. It took over two years and concerted action from regulators in over three countries to untangle the web of trade transactions and front companies that were created by Mr Doe. For all external purposes, he was a suave businessman who had built what appeared to be a highly profitable metal trading business over a period of twenty years. Through his Dubai and Sharjah based firms-Company X, Company Y and Company Z-Mr Doe imported and exported metal commodities. These entities regularly opened both export and import letters of credit with Middle Eastern banks. Their frequent turnover generated sufficient funds to recycle back to his firms, which in turn settled the original dues.

Mr Doe’s scheme was simple. He exploited both the import and export sector, through collusion with companies that he is alleged to have controlled. The UK’s Serious Fraud Office (SFO) investigated two of these London-based companies, S Ltd and F Ltd, which were run by two metal suppliers. This particular scheme can be depicted as follows:

Scheme 1: Over-Invoicing For Goods

In the above scheme, S Ltd and F Ltd were purported to have shipped cargoes of high value metal through the European ports to Company X , Company Y and Company Z in the United Arab Emirates. In reality, the consignments were either low value metals or phantom shipments that never existed.

S Ltd and F Ltd falsified trade-based documentation such as purchase orders, certificates of origin, and bills of lading during a 6 month period. They presented these to their bank (exporter’s bank) in the United Kingdom, which in turn presented them to Mr Doe’s banks in the United Arab Emirates (importer’s bank).

S Ltd and F Ltd were reimbursed the higher value on the purchase orders or bills of lading, through banks in the United Arab Emirates that had extended lines of credit for Mr Doe’s Company X. The line of credit was extended based upon the fraudulent balance sheets and company standing of X. The beneficiaries S Ltd and F Ltd retained part of the proceeds (as their share of the “profit”) and transferred the balance to companies controlled by Mr Doe outside the United Arab Emirates. By the time the banks went to recover the extended credit from Mr Doe, he had fled the country.

In the normal course of business where importer and exporter are not distinct, unconnected parties, the importer would have refused payment for receipt of poor quality goods or non-receipt of goods. In this case, because there was collusion between importer and exporter, money was moved illegally to shell companies that traced their ownership directly or indirectly to Mr Doe.

Yet another scheme purportedly used by Mr Doe was the use of the performance bond to claim funds. This is illustrated below.

Scheme 2: Claim Under a Performance Bond

Mr. Doe’s UK-operating Company A signed a contract and agreed to purchase aluminum metal from Indian exporter Company H. Company H, incidentally, was controlled by Mr. Doe’s father. Company A extended a US$5 million advance to Company H that was to be repaid by the receipt of aluminium ingots from the exporter at a future date. Company H’s obligations to supply the metal were backed by a performance bond that was issued by its bankers (Bank H), favouring Company A. This gave Company A the comfort that in the event Company H defaulted on its ability to deliver the ingots, Bank H would compensate Company A to the extent of US$5 million.

Company A in turn borrowed US$5 million from its bankers (Bank Y) and assigned the benefit of the performance bond to that bank. In due course, Company H reneged on its obligations under the original purchase contract. For reasons best known to Mr Doe, Company A repaid the US$5 million to Bank Y and took back the performance bond that was in its favour. Company A then claimed a similar amount from Bank H.

In the normal course of business, obligations under a performance bond are treated as the equivalent of cash, subject to compliance with their documentary requirements. Under English law, the only exception under which the issuer can desist from paying is when it is established prior to the date when payment is claimed that the beneficiary has knowledge that the demand being made under the bond is fraudulent in nature. The courts have adopted a very high standard for establishing fraud; it is quite challenging for bankers to prove that fraud existed prior to the claim. If not proven, the issuing bank (in this case Bank H), is forced to honour the claim thereby leaving it out of pocket if it cannot recover this amount from the exporter.

Bank H was lucky in the sense that investigations into Company H’s transactions had already started. Customs and tax inspectors in India reportedly queried discrepancies that they noticed between the goods described in bills of lading and the underlying nature of those goods in certain shipments. The queries were directed to Company H on the basis that it was suspected of having evaded payment of customs duties. As the scheme unraveled, Mr Doe’s father confessed to defrauding Indian banks and implicated Company A and other associates. Based on these parallel investigations, Bank H was successful in proving the intent of fraud and consequently did not have to pay the claim.

Red Flag Indicators for Trade-Based Money Laundering

Trade finance has its own pitfalls when it comes to identifying potential money laundering because banks deal in documents, not goods. The Trade Based Money Laundering paper published by the FATF has a list of red flag indicators that can be used proactively by bank trade finance departments. These red flags include the following:

• Significant discrepancies between the description of the commodity on a bill of lading and the invoice.
• Significant discrepancies between the value of the commodity or goods reported on the invoice and the fair market value. For example, gold jewelry being exported at US$500 an ounce when the market rate is approximately US$950 per ounce.
• The type of commodity being shipped is not in line with the exporter or importer’s regular business activities, e.g., a manufacturer of toys exporting IT equipment. Cross linking “know your client” data and regular business alerts is an absolute requirement for an effective AML compliance program.
• The size of shipment appears inconsistent with the scale of the exporter or importer’s regular business activities. For example, a small textile exporter shipping a consignment worth US$50 million when its normal turnover is $1.5million.
• The goods are shipped through one or more jurisdictions or unconnected subsidiaries for no apparent economic reason.
• The transaction involves the receipt of cash (or other payments) from third party entities that have no apparent connection with the transaction.
  The transaction involves the use of front or shell companies.
• From a due diligence perspective, high value or unusual transactions over a particular threshold should be reviewed by two experienced trade finance managers who have in-depth knowledge of the potential issues of money laundering.

Wider Actions

Clearly, the trade finance sector is vulnerable to money laundering activities and it is vital that this field is monitored. Suggestions for effective actions to be undertaken by relevant businesses include the following:

• The international sharing of trade data to identify glaring anomalies, such as identifying that the actual volume of trade between Country A and Country B differs drastically between the records.
• Cooperation between financial institutions, regulators, customs agencies, law enforcement agencies, and tax authorities. This involves sharing information between these parties and quickly following-up on suspected cases of money laundering.
• Training trade finance staff to recognise patterns and trends in trade-based money laundering and escalating suspicions to their supervisors.

About Deepa Chandrasekhar

Deepa Chandrasekhar MBA, CAMS, CFE, ACSI is the Senior Vice President, Chief Compliance Officer of United Gulf Bank (BSC), Bahrain.