New York State's governor, Eliot Spitzer, got caught in a prostitution probe largely because of financial reporting rules emphasized in the post 9/11 era.
As described by Larry Dignan:
[W]hat really snared Spitzer was a money laundering investigation that was flagged by suspicious activity reports (SARs) that banks have to file with the Treasury to surface everything from money laundering to terrorist activity.
Let's take a brief look at the somewhat-arcane subject of money laundering and the technology designed to stop it.
How money laundering works. According to Anti-Money Laundering: A Brave New World for Financial Institutions, a research report from Celent, money laundering is typically a three-stage process:
- Stage One: Placement. Moving illicit funds into the financial system by, for example, depositing cash in banks, buying valuables (gold, diamonds, artwork), etc.
- Stage Two: Layering. Moving the funds around in the financial system to cover the audit trail to the origination point of the funds. Examples are multiple cross-border wire transfers, investments in securities, deposits in overseas “shell” banks or secret bank accounts (e.g., numbered accounts).
- Stage Three: Integration. Finally, the disguised funds are reintroduced into the legitimate economy. This may be accomplished by investing the money in real estate or business ventures, or to acquire luxury assets or other goods, sometimes through the use of credit cards. “Front” businesses are sometimes established for this purpose. A front business engages in legitimate business operations, but at the same time generates false invoices or uses other techniques to absorb the laundered funds.
Money laundering schemes can range from simple to sophisticated. Here are a few examples:
Generation and payment of false invoices. This technique involves a front business which creates invoices for goods and services not actually delivered, or delivered at inflated prices, allowing money launderers to collect and bank cash that is effectively disguised as sales for a business operation.
Loan defaulting. In this scheme, the launderer takes out a bank loan, using the illicit funds as collateral. The launderer then deliberately defaults on the loan, causing the bank to lay claim to the collateral. The launderer has thus effectively traded illicit funds (which the bank now holds) for clean money — the loan money originally extended by the bank.
Manipulation of insurance policies. The malefactor purchases a large insurance policy, pays one or more premiums, and then cancels the policy, obtaining a refund of the premiums (usually minus some penalties). An audit trail would show the refunded monies as originating from the insurance company.
Anti-money laundering (AML) software. The US PATRIOT Act has forced financial institutions to implement a variety of programs and solutions to prevent money laundering. According to Celent, these solutions perform three key tasks:
- Monitoring transactions and other account information and analyzing this data to identify potential money laundering activity
- Checking account holders and beneficiaries against terrorist and criminal watch lists published by various government agencies
- Filing suspicious activity and currency transaction reports with the government.
This diagram portrays a simplified, general architecture typical of anti-money laundering software: