THE NEW ECONOMY IN FINANCIAL CRIMES

Understanding the Effects of Under-Invoicing, Double Invoicing

and False Invoicing in Trade-Based Money Laundering and

Terrorist Financing (TBML & TF) Schemes

J. Scott Mauro

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INTRODUCTION

Trade-based money laundering (TBML) has become an increasingly more attractive method by

which criminal organizations and terrorist financiers move money for the purposes of disguising

its origins and integrating proceeds from illegal activities into the worldwide economy. There is

substantial evidence cited recently by various committees worldwide, such as the Australian

Institute of Criminology (AIC), the Financial Action Task Force (FATF) and the Immigration

and Customs Enforcement (ICE), that a primary method of TBML is directly linked to falsely

invoicing goods traded among various countries. There is no commodity that does not have the

potential to be falsely invoiced and the goods range from cotton dish towels imported from

Pakistan, shorts imported from Hungary, toilet bowls exported to Hong Kong and rocket

launchers exported to Israel, to name a few. While TBML such as over-and-under invoicing and

merchandise substitutions are not new, there is a growing awareness of TBML among

governments, experts, business and individualsi. Trade is “a ready-made vehicle” for dirty

money, says Balesh Kumar of the Enforcement Directorate, an Indian agency that fights

economic crime. A 2012 report he helped write for the Asia/Pacific Group on Money

Laundering, a regional crime-fighting body, is packed with examples of criminals combining the

mispricing of goods with the misuse of trade-finance techniques. Using trade data, Global

Financial Integrity (GFI), an NGO, estimates that $950 billion flowed illicitly out of poor

countries in 2011, excluding trade in services and fraudulent transfer pricing. Four-fifths was

trade-based laundering linked to arms smuggling, drug trafficking, terrorism or public

corruptionii.

This white paper details the effects of under-invoicing, double-invoicing and false invoicing in

TBML and discusses the application of four profiling techniques used to recognize TBML that

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focus on country, customs district, and product and transaction price characteristics. Being

aware of, and also being able to recognize these techniques, will be useful in application for

many financial institutions’ financial crimes personnel when monitoring corporate accounts

within the institution.

What is TBML?

The Financial Action Task Force (FATF) defines TBML 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.”iii Financial institutions, particularly within the consumer banking

business, must monitor accounts for money laundering red flags with deposit accounts. Red flags

could include, but are not limited to, minimal information provided on transactions, lack of

references or identification, non-local customer address, evidence of multiple account holders

and frequent deposits or withdrawals with no apparent legitimate business source of where these

funds were derived.iv

Criminal organizations have begun in earnest to use false trade invoicing to finance terrorists

activities, evade taxes and import duties; although such techniques were used, according to some

academic and professional publications (e.g., Bhagwati, 1964, Cuddington, 1987, etc.) dating

back almost 50 years ago.v

In order to gain a better understanding of the basic elements of TBML, the chart below produced

by GFI presents a clear example of a hypothetical incident of trade-based misinvoicing involving

India, Mauritius, and the U.S.vi

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Source: http://www.gfintegrity.org/issue/trade-misinvoicing/

GFI is a non-profit, Washington, D.C.-based research and advocacy organization, which

produces high-caliber analyses of illicit financial flows, advises developing country governments

on effective policy solutions and promotes pragmatic transparency measures in the international

financial system as a means to global development and security. Financial crimes processionals

can reference and add this advocacy group’s website to the list of those reviewed periodically as

it is a very informative and timely reference source to keep abreast of TBML issues and

preventive measures. The website may be found at http://www.gfintegrity.org/issue/trade-

misinvoicing/.

Three Major Events Created a New Focus of TBML

1. Trade Transparency Units (TTUs):

The U.S. State Department and Treasury Department supported the Immigration and

Customs Enforcement Bureau (ICE) of Homeland Security with necessary funding to

establish TTUs with Brazil, Argentina and Paraguay, in order to analyze both sides of

international trade transactions data provided through these partnerships with other

countries.vii One of these investigations was called ‘Operation Deluge’ and revealed $200

million in Brazilian import duty fraud caused by marking imports at undervalued prices.

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This investigation resulted in the parties being convicted of income tax evasion in the

U.S. This money laundering scheme, detected through Operation Deluge, was said to be

the largest in the history of the country as indicated by Brazilian government officials.viii

2. The Financial Action Task Force (FATF):

In 2006 the FATF released the report entitled Trade-Based Money Laundering, in which

it identified the three major methods used by criminal organizations and terrorist

financers to move money for the purpose of disguising its origins and integrating it into

the formal economy.ix Of the three methods, the physical movement of goods through

the trade system and the focus of this paper was the most compelling of the methods. It is

recommended that readers review the 2006 release to gain a better perspective of the risks

and vulnerabilities the international trade system is subject to.

3. The Federal Financial Institutions Examination Council (FFIEC):

The FFIEC released its first BSA/AML Examination Manual in 2005, which includes key

points such as the assessment of a bank’s system of managing risk associated with trade

financing activities, and the management’s ability to implement rules/regulations,

monitor the organization and report discrepancies.

MONEY LAUNDERING AND OTHER RELATED PRACTICES

TBML represents an important channel of criminal activity and, given the growth of world trade,

an increasingly important money laundering and terrorist financing vulnerability. The main

method behind trade-based laundering is trade price manipulation. Financial institutions and

other businesses must be able to detect abnormalities in pricing for physical commodities that are

exchanged, so that they may be observed and then investigated. Financial institutions’ financial

crimes personnel can check for such abnormalities by analyzing the database produced by the

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U.S. Department of Commerce, Census Bureau.x All transactions with a value of more than

$2,500 for exports and $1,250 for imports are recorded, and on average over 10 million records

are analyzed per year. There is a total data set created for all countries that is segmented and

entered into a country/product table. Each cell in this table contains information regarding

transactions of exports and imports pertaining to the U.S. economy. Financial institutions in

particular, can analyze this information in order to gain preliminary insight into import and

export values and determine if their customer account profits and/or losses or revenue can be

supported by making a comparison.

In January 1992, Money Laundering Alert published an article on www.moneylaundering.com,

which used the average country price versus the average world price for every product in

order to detect TBML via abnormal international trade prices. The initial objective of the

research methods used by Zdanowicz was to estimate the amount of money moving out of the

U.S due to over-invoiced imports and under-invoiced exports. In addition, all U.S. export and

import trade databases from January 1, 1993 to December 31, 1993, in which each

commodity/type of good had a 10 digit harmonized code number were gathered.1 This method

was done in order to create, maintain and re-check a database, which had all large dollar amount

of international trade transactions for the entire year.

This methodology had five features:

1. Recognizes each country has different trade characteristics

2. Analyzes each countries trading history (imports, exports, prices etc.) with the U.S.

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3. Analyzes prices that are 50 percent above or below the average price, determined the

amount of over-invoiced imports and under-invoiced exports and the total amount of

money that moved out due to these types of invoices

4. The same procedure repeated for subsequent years, therefore provides data for three years

(93, 94, 95). This methodology was used to set an example for other researchers etc. so

that they inculcate a habit of creating yearly trade databases for their convenience.

5. Shows the amount of money that moved out of U.S. due to abnormal trade prices in: 1993

- $97.35 B, 1994 - $116.18 B, 1995 - $136.76 B.1

INTERQUARTILE RANGE PRICE ANALYSIS

Interquartile range (IQR) is the difference between the upper and lower quartile, which is the 75th

percentile subtracted by the 25th percentile. Hence this analysis checks the IQR between the

prices of the 75th and 25th percentile, in order to find prices way above or way below the standard

range in which they lie.

Features

1. The Interquartile Range Price Analysis criticized 50 percent deviation analysis by saying that

the filter was either too low or high, hence abnormal prices were not easily detected.

2. In 1994, the U.S. IRS issued its 482 transfer pricing regulations and stipulated that the

interquartile price range be put in use.

3. Suspicious prices are: import prices above upper quartile prices and export prices below lower

quartile prices.

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4. The methodology shifted to using the product/country interquartile price ranges as statistical

filters.

5. The total of both undervalued exports and overvalued imports for every country were

determined.

6. Money moved out of U.S. due to prices being above or below their range: 2004 - $167.76 B,

2005 - $191.95 B, 2006 - $189.05 B.1

EVIDENCE FOUND IN OTHER STUDIES

1. Money moving into the U.S. due to over-valued exports and under-valued imports.

2. Analysis indicate that 2004 - $55.5 billion was net capital flow into U.S., $111.7 billion under-

valued exports moved out of U.S. and $56.2 billion over-valued imports moved out of U.S. [7.34

percent of total trade ($167.7 billion)]. 1

3. Total money moving into the U.S. in 2004: $48.1 billion over-valued exports, $175.2 billion

under-valued imports, total $223.3 billion (9.77 percent of the trade). 1

NEW BANKING REGULATIONS IMPACTING MONEY MOVEMENT IN

SWITZERLAND

In 1998, the Swiss Federal Government broadened the reach of its regulations to include not only

banks but the entire financial services sector. They passed a law known as the Federal Act on the

Prevention of Money Laundering in the Financial Sector – Money Laundering Act (MLA),

which requires all financial institutions to report suspicious transactions to Switzerland’s Federal

Reporting Office for Money Laundering.

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The study measured the amount of money moved from Switzerland to the U.S. through false

invoicing, both before and after the date the law was enacted, and conducted a detailed statistical

analysis. The economic indices this study considered were U.S./Swiss interest rates, exchange

rates, consumer price indices and producer price indices. The analysis showed that the new law

was the only factor that could explain increase in capital outflows from Switzerland to the U.S. 1

The research study further showed that the amount of money moved from Switzerland increased

significantly after the law was enacted and the average amount of money moved increased from

$253 million per month to $628 million per month. There was also an increase in average

monthly amount of money moved as a percentage of Swiss/U.S. trade from 29 percent to 58

percent.1 The following table shows how the monthly capital outflows changed due to the

enactment of the law.

Average Monthly Outflows – Before and After New Law

TIME PERIOD $ AMOUNT % OF TRADE VOL.

Before the law 252,863,571 28.93

After the law 628,437, 709 57.76

% Increase 149% 100%

MONEY MOVED TO AL-QAEDA WATCH LIST COUNTRIES

A sample of some suspicious transactions are listed in a table below,which may show why the

amount of $8.4 billion was moved from the U.S. to Al-Qaeda watch list countries (Freer, 2001;

Zdanowicz etc.)1. Before the September attacks, Al-Qaeda to support its operations, and other

terrorist organizations. Post-9/11 the money is mostly being used to support

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operations, operatives and their families.xi

AL QAEDA WATCH LIST COUNTRIES IN TABLE BELOW

OBS COUNTRY UNDER-ALUED

EXPORTS ($)

OVER – VALUED

IMPORTS ($)

TOTAL MOVED OUT

OF US ($)

SHARE OF

TRADE (%)

5,811,961,635 2,537,901,565 8,349,863,196 6.75

1. Malaysia 2,317,172,101 1,201,554,685 3,518,726,786 9.00

2. S. Arabia 690,811,190 316,492,990 1,007,304,181 3.85

3. Iraq 706,095,531 210,325,795 916,421,327 9.78

4. Indonesia 397,962,961 330,162,743 728,125,704 5.40

5. UAE 639,817,694 22,463,911 662,281,605 12.72

6. Algeria 78,935,289 181,162,213 260,097,502 3.10

7. Pakistan 126,213,808 102,956,529 229,170,337 4.89

8. Egypt 200,826,873 27,078,209 227,905,082 5.14

9. Kuwait 159,018,609 56,749,463 215,768,072 4.54

10. Iran 152,952,617 12,628,410 165,581,027 70.03

11. Jordan 64,374,230 24,273,637 88,647,866 5.39

12. Oman 62,421,004 9,353,236 71,774,240 9.60

13. Qatar 51,792,019 1,416,201 53,208,219 6.32

14. Bahrain 39,923,000 6,629,735 46,552,735 6.59

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ABNORMAL WEIGHT

Interquartile analysis brought to light abnormal weights of goods such as razors, coffee,

footwear, sweaters, briefcases, fabric, pillows and towels that were imported to the U.S. from

foreign countries (i.e., Egypt, Indonesia, France, Germany, and Pakistan etc.). 1

FEATURES OF MANUAL PUBLISHED BY FEDERAL FINANCIAL INSTITUTIONS

EXAMINATION COUNCIL (FFIEC)

The Federal Financial Institution Examination Council (FFIEC) is a formal interagency body

empowered to prescribe uniform principles, standards, and report forms for the federal

examination of financial institutions by the board of governors of the Federal Reserve System

(FRB), the Federal Deposit Insurance Corporation (FDIC), the National Credit Union

Administration (NCUA), the Office of the Comptroller of the Currency (OCC), and

the Consumer Financial Protection Bureau (CFPB), and to make recommendations to promote

uniformity in the supervision of financial institutions.xii

The FFIEC adopted a common examination manual to eliminate inconsistency between bank

examinations. It resulted from the collaboration of the Federal Reserve Board, the OCC, the

FDIC, the NCUA and the Office of Thrift and Supervision.1 Financial crimes personnel should

be familiar with this manual and use recommendations, such as those listed below, to incorporate

into their processes and daily supervisory obligations. The Manual states:

1. Financial institutions should give greater scrutiny to; items inconsistent with the clients

business, clients in high risk jurisdiction, shipments moving through these jurisdictions and non-

cooperative countries and proceeds directed to unrelated third parties.

2. Letter of credit and other documentation may be falsified in order to cover up money

laundering schemes, therefore any such abnormalities must prompt the Office of Foreign Assets

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Control (OFAC) to take additional action but according to the manual the firm should not waste

time looking for laundering if no unusual activity is observed. (Zdanowicz 2007; Money

Laundering Alert, 2008)

3. The FFIEC provides guidance to firms on how to assess their customer due diligence policies

etc. and analyze clients based on their characteristics such as; risk of country, risk of product,

clients appearance on politically exposed persons (PEP) lists, results of OFAC filtering and may

also employ “Know Your Customer” policies1.

COUNTRY, PRODUCT AND CUSTOMS DISTRICT RISK PROFILES

Various risk profiles can be determined by evaluation of U.S. trade databases such as; Country

Risk Index (CRI), Product Risk Index (PRI) and U.S. Customs District Risk Index (CDRI) each

of which is based on analysis of every type of transaction for all products, countries and U.S.

customs districts and this analysis assists law enforcement and financial institutions with

mitigating risk.

INTERNATIONAL PRICE PROFILING SYSTEM (IPPS)

The FFIEC manual stipulates that financial institutions engaged in trade financing with customers

conduct both character-based and transaction-based analysis. This analysis is defined as the International

Price Profiling System (IPPS).

IPPS is a new risk-based analysis that evaluates characteristics of prices related to international trade and

the IPPS will assist financial institutions with compliance requirements related to the financing on

international trade and assist in determining a financial institutions ‘value at risk.’ It also has value to

accounting firms, attorneys and insurance companies who need to evaluate international trade pricing. 13

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MEASURES THAT CAN BE USED TO COMBAT TBML AND TF

As a best practice the regulators recommend that financial institutions implement formal

compliance monitoring and review programs consistent with the following:

1. Each company must have a financial crimes expert and compliance officer who

understands the nuances of TBML and how it can be used for TF to be able to easily

identify those customers who are effecting such transactions.

2. Suspicious activity reporting is the cornerstone of BSA reporting system and is critical to

the U.S. to combat TBML, TF and terrorism. Examiners and banks should recognize that

the quality of content for a suspicious activity report (SAR) is critical to the adequacy and

effectiveness of the reporting system.

3. OFAC reporting – Institutions must file reports with OFAC and must strictly avoid

involvement with people on the Specially Designated National List (SDN).xiii

OFAC Structure

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4. All financial institutions should strictly follow AML laws such as: BSA 1970, Money

Laundering Control Act 1986, Anti-Drug Abuse Act 1988, Annuzio-Wylie AML Act

1992, Money Laundering Suppression Act 1994, Money Laundering and Financial

Crimes Strategy Act 1998, Uniting and Strengthening America by providing Appropriate

Tools to Restrict, Intercept and Obstruct Terrorism Act of 2001, Intelligence Reform and

Terrorism Prevention Act of 2004.

5. Organizations should be more innovative and creative while developing methods to

detect TBML and TF. For example Accuity has created Compliance Link, which does all

screening electronically.xiv

6. Regulators should check the black market premiums (BMP), taxes paid on trade or

income as suggested by A. Buehn and S. Eichler. As both found robust evidence that

BMPs and evasion of taxes on trade are incentives for misinvoicing.xv

7. The elements needed to prove a basic charge of Money Laundering under Title 18,

Section 1956, U.S. Code are 1) specified unlawful activities (SUA) 2) knowledge by

the perpetrator that profits resulted from some type of felony and 3) financial

transaction intended to conceal the proceeds or to promote a SUA.xvi

CONCLUSION

Based upon my research it is clear that there are various techniques that can be employed in

order to check for TBML and TF. The only way financial institutions, regulatory agencies and

the law enforcement can prevent TBML is by working together in a timely manner, create

awareness around the world about how such schemes are practiced and discourage those who

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would attempt to facilitate this type of money laundering scheme by employing methods that will

improve detection through a supervisory or compliance monitoring best practice.

This paper has focused on TBML occurring in the course of international trade in goods. The

study does not include in its scope capital flight, tax evasion, trade in services and domestic

trade. The features of the dynamic environment that distinguish TBML from other forms of

money laundering are its occurrence through intermingling of the trade sector with the trade

finance sector in cross-border transactions. The foreign exchange market and the long supply

chain make international trade particularly vulnerable to TBML.xvii

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REFERENCES

i Trade-Based money laundering: Risks and regulatory responses by Clare Sullivan and Evan

Smith (Australian Institute of Criminology (AIC) Reports)

ii http://www.economist.com/news/international/21601537-trade-weakest-link-fight-against-

dirty-money-uncontained

iii . http://www.hstoday.us/blogs/best-practices/blog/countering-trade-based-money-laundering-a-

new-data-mining-frontier/d34dc28bd424c1ded8be935b1c8fcfe0.html

iv www.ffiec.gov/bsa_aml_infobase/documents/red_flags/deposit_acct.pdf

v Zdanowicz, John S. Trade-Based Money Laundering and Terrorist Financing. Rep. Review of

Law & Economics, n.d. Web. June 2014

vi http://www.gfintegrity.org/press-release/the-economist-highlights-the-scourge-of-trade-

misinvoicing/

vii http://www.ice.gov/trade-transparency/

viii Trade-Based money laundering: Risks and regulatory responses by Clare Sullivan and Evan

Smith (Australian Institute of Criminology (AIC) Reports)

ix http://www.fatf-gafi.org/topics/methodsandtrends/documents/trade-

basedmoneylaundering.html

x http://www.esa.doc.gov/economic-indicators/economic-indicators-9

xi . http://govinfo.library.unt.edu/911/staff_statements/911_TerrFin_Ch2.pdf

xii http://www.cuinsight.com/ffiec-requirements-why-are-they-important.html

xiii http://www.treasury.gov/resource-center/sanctions/SDN-List/Pages/default.aspx

xiv www.accuity.com/compliance/dual-use-goods/trade-finance-screening

xv Buehn, Andreas, and Stefan Eichler. "Trade Misinvoicing: The Dark Side of World Trade."

(2011): n. pag. Web.

xvi http://www.fbi.gov/stats-services/publications/law-enforcement-bulletin/april-2012/money-

laundering-and-asset-forfeiture

xvii http://www.fatf-gafi.org/media/fatf/documents/reports/Trade_Based_ML_APGReport.pdf