1

CHAPTER 1: INTRODUCTION TO MONEY LAUNDERING

1.1 Background

The term "money laundering" is said to originate from Mafia ownership of Laundromats
in the United States. Gangsters were earning huge sums in cash from extortion,
prostitution, gambling and bootleg liquor. The major headache that gangsters faced was that
the money was in cash, often in small denomination coins. If the coins were put into the
bank, the questions would be asked. But the storage of large amounts of money in low value
coins is a storage nightmare. They needed to show a legitimate source for these monies.
Ironically, one of the methods of concealing the source of the money was legal gambling. So
they created businesses, one of which was slot machines, and another of which was laundries
- so, it is said, that the term "money laundry" was born.

One of the ways in which they were able to do this was by purchasing outwardly
legitimate businesses and to mix their illicit earnings with the legitimate earnings they
received from these businesses. Laundromats were chosen by these gangsters because
they were cash businesses and this was an undoubted advantage to people like Al Capone
who purchased them.

Al Capone, however, was prosecuted and convicted in October, 1931 for tax evasion. It
was this that he was sent to prison for rather than the predicate crimes which generated
his illicit income. It would seem, however, that the conviction of Al Capone for tax
evasion may have been the trigger for getting the money laundering business off the
ground.

Meyer Lansky (affectionately called the Mobs Accountant) was particularly influenced
by the conviction of Capone for something as obvious as tax evasion. Determined that the
same fate would not befall him he set about searching for ways to hide money. Before the
year was out he had discovered the benefits of numbered Swiss Bank Accounts. This is
2
where money laundering would seem to have started and was one of the most influential
money launderers ever. The use of the Swiss facilities gave Lansky the means to
incorporate one of the first real laundering techniques, the use of the loan-back concept,
which meant that hitherto illegal money could now be disguised by loans provided by
compliant foreign banks, which could be declared to the revenue if necessary, and a tax-
deduction obtained into the bargain.

Money laundering as an expression is one of fairly recent origin. The original sighting
was in newspapers reporting the Watergate scandal in the United States in 1973. The
expression first appeared in a judicial or legal context in 1982 in America in the case US
v $4,255,625.39 (1982) 551 F Supp.314. Since then, the term Money Laundering has
been widely accepted and is in popular usage throughout the world.

But whilst the term "money laundering" was invented in the 20th Century, the principles of
money laundering have been around for far longer. Sterling Seagrave in his book "Lords of
the Rim" conducts a roundup of the history of the Overseas Chinese. He explains how the
abuse of merchants and others by rulers led them to find ways to hide their wealth, including
ways of moving it around without it being identified and confiscated. Money laundering in
this sense was prevalent 4000 years before Christ.

"Money laundering is called what it is because that perfectly describes what takes place -
illegal, or dirty, money is put through a cycle of transactions, or washed, so that it comes
out the other end as legal, or clean, money. In other words, the source of illegally
obtained funds is obscured through a succession of transfers and deals in order that those
same funds can eventually be made to appear as legitimate income".

Money laundering as a crime only attracted interest in the 1980s, essentially within a
drug trafficking context. It was from an increasing awareness of the huge profits
generated from this criminal activity and a concern at the massive drug abuse problem in
western society which created the impetus for governments to act against the drug dealers
by creating legislation that would deprive them of their illicit gains.
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Money laundering today is a truly global phenomenon, helped by the International
financial community which is a 24hrs a day business. When one financial centre closes
business for the day, another one is opening or open for business.

1.2 IMPORTANCE AND RELEVANCE OF THE STUDY

Money laundering has become the buzzword for a developing country like India. India
has been witnessing huge capital inflows in the recent past and such flows are getting
channeled into various investment avenues such as stock markets and other related
investment vehicles. With India witnessing such huge flows it has become very important
that India does not attract such black money to its financial hubs merely as a tool to
convert black money to white.

Further as the countries of the west enforce stringent anti-money laundering controls,
launderers are looking at developing countries as attractive destinations to launder their
funds. The impact of black money entering the developing countries can be severe. Thus
India must adhere to high anti-money laundering standards so as to check such black
money entering its economy.

1.3 LITTERATURE REVIEW

Money laundering involves disguising financial assets so that they can be used without
detection of the illegal activity that produced them. Through money laundering, the
launderer transforms the monetary proceeds derived from criminal activity into funds
with an apparently legal source. Money laundering is regarded as the worlds third largest
industry after international oil trade and foreign exchange (Robinson, 1995). The
International Monetary Fund (IMF) estimated the size of money laundering worldwide to
be between US$600 million and US$1.5 trillion, which is about 2-5 per cent of the
worlds GDP (Camdessus, 1998).

4
With the globalisation of economic activities and of financial markets, money can be now
laundered internationally. Money laundering allocates dirty money around the world not
so much on the basis of expected rates of return but on the basis of ease of avoiding
national controls. Dirty money tends to flow to countries with less stringent controls
(Tanzi, Vito. 1996).

Much of the research studies which have been carried out have focused on the areas on
money laundering through banks and financial institutions, with much attention being
paid to developed countries and offshore financial centres. (Baity 2000 & Hampton
1996)

Money laundering and measures to counter it have become the focus of an intense
international effort. The wide range of activities and financial instruments involved in
money laundering are not directly observable and estimates are difficult to compile.
According to Baker (1999), the combination of criminal money laundering and illegal
flight capital constitutes the biggest loophole in the free-market system.

A number of studies have elaborated the numerous domestic, international and private
measures which have been established to fight money laundering, relevant legislation and
the activity of regulatory and professional bodies both domestically and internationally.
International efforts to combat money laundering have gained momentum in the past
decade. United Nations Convention and another planned convention, along with
numerous multilateral governmental initiatives and bilateral agreements, have contributed
to the development of a broad set of national and international legal standards. However,
this emergent regime has developed unevenly, the most significant advances occurring
in regions dominated by the United States and its allies (Castle and Bruce 1998)

The negative economic effects of money laundering on economic development are
difficult to quantify. Such activity damages the financial-sector institutions that are
critical to economic growth, reduces productivity in the economy's real sector by
5
diverting resources and encouraging crime and corruption, which slow economic growth,
and can distort the economy's external sectorinternational trade and capital flowsto
the detriment of long-term economic development (Bartlett 2002). When the integrity of
the financial institutions is weak, it has a discouraging effect on foreign direct investment
due to lack of investor confidence. This in turn can distort the long-term growth of the
economy. Studies by Quirk (1997), Barrett (1997), Paradise (1998) and also
Masciandaro and Portolano (2003) have argued that money laundering threatens
economic and financial systems in countries.

Jurisdictions which offer high levels of secrecy, and a variety of financial mechanisms
and institutions providing anonymity for the beneficial owners are highly attractive to
criminals for a wide variety of reasons including the potential cover and protection they
offer for money laundering and various exercises in financial fraud (Blum 1998).
Historically, it has been argued that offshore financial centres (OFCs) have facilitated
money laundering by providing a conduit for the proceeds of crime. Popular culture,
international bureaucracies, left-wing interest groups, and politicians from high tax
governments have all joined forces to consistently portray OFCs as havens for dirty
money where the authorities are either unwilling or unable to implement measures in
their islands to assist in the global fight against money laundering (Mitchell, 2002).

Money laundering through banking system is doubly difficult to identify as well as
control, mainly because KYC is difficult to implement, because there is no obvious end
point to the information that would be useful to a bank manager in seeking to prevent
money laundering, and it will be hard to deal with third-party introducers (where the
main beneficiaries wish to remain anonymous), and it can be hard to balance KYC with a
customers right to privacy (Jackson 2000).

No major research study has been carried out on money laundering through capital
markets as a tool. The present study tries to examine the problem of money laundering
through capital markets from the point of view of using capital market intermediaries and
6
instruments as channels to launder money. The present study tries to fill the gap existing
with respect to comparison between development of domestic as well as international
legislation for prevention of money laundering, identifying the socio-economic impact of
money laundering on developing economy such as India, assessing the anti-money
laundering compliances used to deter laundering of money through capital markets in
India.

1.4 OBJECTIVES OF THE STUDY

1. To compare and contrast various money laundering methods/techniques being
practiced in India and abroad

2. To assess and evaluate socio-economic impact of money laundering activities as a
whole to the economy, with special focus on financial markets

3. To compare and contrast legislative measures presently existing for anti-money
laundering in India and abroad.

4. To examine the checks used by stock brokers and intermediaries for ensuring
effective anti-money laundering compliance.

1.5 RESEARCH METHODOLOGY

Sources of Data:
The Methodology for the project is based on Secondary sources of Data. The collection
of primary data was not possible. This is because by its very nature, money laundering is
an illegal activity carried out by people with criminal intent which occurs outside of the
normal range of economic and financial statistics and hence data on such activities is
scant. And also money laundering activities are making full use of newer technologies
and offshore jurisdictions to conceal the proceeds of crime. Public sources of data were
chiefly relied on for the study; primarily the regulatory agencies that are entrusted with
7
the job of curbing money laundering activities and from Organizations that collect data
and publish newsletters and reports from the governmental agencies and multilateral law
enforcement agencies. Other resources that were utilized in the course of project work
were, websites accessed via internet, journals, newspapers and magazines. Further
additional sources of information utilized were circulars issued by SEBI (Securities
Exchange Board of India) and Bombay Stock Exchange on Anti-Money Laundering
compliances by financial intermediaries.

1.6 LIMITATIONS OF THE STUDY

The present study is mainly based on secondary sources of data because money
laundering is a secretive activity and hence primary sources of data could not be
obtained. So the inherent limitations of secondary source of data may be termed as a
limitation of this study.

Money Laundering is an illegal activity and the techniques used to launder money tend to
fluctuate dramatically. Hence exact quantity of money laundered and latest techniques
used to launder money could not be obtained.

Financing of terrorism is a topic which has come to attract serious attention in recent
times. And combating Financing of Terrorism has become an integral part of anti-money
laundering efforts. Since the purpose of terrorist financing is very different from that of
money laundering and the scope of the terrorist financing is a very wide, hence for the
purpose of this project the scope of this study has been restricted to money laundering
only.

1.7 CHAPTERISATION SCHEME

The entire project work is divided into seven parts for the purpose of simplification and
easy understanding. The seven parts as shown in seven chapters are as follows.
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Chapter I: Introduction to Money Laundering
This chapter comprises of background of money laundering, importance and relevance of
the study, literature review, objectives of the study, research methodology, limitations of
the study and chapterisation scheme.

Chapter II: Money Laundering
This chapter comprises of introduction to the chapter, stages in the money laundering
process, techniques used by launderers to launder money and the principal laundering
methods detected or suspected in India.

Chapter III: Money Laundering Through Capital Markets
This chapter comprises of introduction to the laundering through securities market,
money laundering through international financial market, money laundering through
stock exchanges in India and conclusion.

Chapter IV: Impact of Money Laundering
This chapter comprises of introduction to the chapter, problem for emerging markets,
impact of money laundering and conclusion.

Chapter V: International and Domestic Initiatives Against Money Laundering
This chapter comprises of introduction to the chapter, anti-money laundering legislations
and initiatives and conclusion.

Chapter VI: Anti-Money Laundering Measures and Compliances
This chapter comprises of introduction to the chapter, anti-money laundering measures
and compliances to combat against money laundering and conclusion

Chapter VII: Findings, Conclusions and Suggestions
This chapter comprises of introduction to the chapter, summary, findings and conclusion.
9
CHAPTER 2: MONEY LAUNDERING

2.1 INTRODUCTION
This chapter looks to understand the concept of money laundering and its global size. A
typical money laundering exercise goes through a series of stages, each stage in the series
has its own particular distinctive characteristics. Hence it is important to assess the
particular characteristics which distinguish each stage. Money launderers use a variety of
methods and techniques to launder funds, each stage in the money laundering process
utilizes certain methods and techniques. This chapter has sought to delve into these
methods. Further it is also important to understand the methods and techniques used to
launder funds in the Indian context.

2.2 MONEY LAUNDERING?
Illegal arms sales, smuggling, and the activities of organised crime, including for
example drug trafficking and prostitution rings, can generate huge amounts of proceeds.
Embezzlement, insider trading, bribery and computer fraud schemes can also produce
large profits and create the incentive to legitimise the ill-gotten gains through money
laundering.

When a criminal activity generates substantial profits, the individual or group involved
must find a way to control the funds without attracting attention to the underlying activity
or the persons involved. Criminals do this by disguising the sources, changing the form,
or moving the funds to a place where they are less likely to attract attention.

Money laundering is the criminal practice of filtering ill-gotten gains or dirty money
through a series of transactions, so that the funds are cleaned to look like proceeds from
legal activities. Money laundering is driven by criminal activities and conceals the true
source, ownership, or use of funds. Money laundering involves the taking the proceeds of
crime and creating the illusion that the person who uses that wealth has obtained it by
legal and lawful means. Money laundering is the processing of criminal proceeds to
10
disguise their illegal origin. This process is of critical importance, as it enables the
criminal to enjoy these profits without jeopardising their source.

As a 1993 UN Report noted: The basic characteristics of the laundering of the proceeds
of crime, which to a large extent also marks the operations of organised and transnational
crime, are its global nature, the flexibility and adaptability of its operations, the use of the
latest technological means and professional assistance, the ingenuity of its operators and
the vast resources at their disposal.

2.2.1 CHARACTERISTICS OF MONEY LAUNDERING
1. Money laundering is a group activity
2. Money laundering is a criminal activity and once begun, normally there is no end
to it.
3. Money Laundering recognizes no boundaries. It has been internationalized.
4. Money Laundering activities do not end on one transaction. These involve a chain
of transactions and are undertaken at a large scale
5. Money Laundering activities involve very sophisticated and complex process

In most financial transactions, there is a financial trail to link the funds to the person(s)
involved. Criminals avoid using traditional payment systems, such as checks, credit
cards, etc., because of this paper trail. They prefer to use cash because it is anonymous.
Physical cash, however, has disadvantages. It is bulky and difficult to move. For
example, 44 pounds of cocaine worth $1 million equals 256 pounds of street cash worth
$1 million. The street cash is more than six times the weight of the drugs. The existing
payment systems and cash are both problems for criminals. Regulations and banking
controls have increased costs and risks. The physical movement of large quantities of
cash is the money launderers biggest problem. Money laundering is a diverse and often
complex process that need not involve cash transactions. Money laundering basically
involves three independent stages that can occur simultaneously:

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2.3 STAGES IN THE MONEY LAUNDERING PROCESS

2.3.1 PLACEMENT
Placement is the first stage in the money laundering process. It is during the placement
stage that physical currency enters the financial system placing, through deposits or other
means, unlawful proceeds into the financial system and illegal proceeds are most
vulnerable to detection. When illicit monies are deposited at a financial institution,
placement has occurred.

2.3.2 LAYERING
Layering describes an activity intended to obscure the trail which is left by dirty money
this is done by separating proceeds of criminal activity from their origin through the use
of layers of complex financial transactions. During the layering stage, a launderer may
conduct a series of financial transactions in order to build layers between the funds and
their illicit source. For example, a series of bank-to-bank funds transfers would constitute
layering. Activities of this nature, particularly when they involve funds transfers between
tax haven and bank secrecy jurisdictions, can make it very difficult for investigators to
follow the trail of money.

2.3.3 INTEGRATION
During the final stage in the laundering process, using additional transactions to create
the appearance of legality through the purchase of assets illicit funds are integrated with
monies from legitimate commercial activities as they enter the mainstream economy. The
illicit funds thus take on the appearance of legitimacy. The integration of illicit monies
into a legitimate economy is very difficult to detect unless an audit trail had been
established during the placement or layering stages.





12
TABLE 2.1: Stage Wise Classification Of Money Laundering Activity
Money laundering is generally described as a three-stage process intended to make the
profits or proceeds of crime appear legitimate.
1. In the initial or placement stage of
money laundering, the launderer introduces
the criminal proceeds into the financial
system
This might be done by breaking up
large amounts of cash into less
obvious smaller sums that are then
deposited directly into a bank
account. The criminal might put the
money into other forms such as
cheques or money orders that are
then collected and deposited into
accounts at another location.

It is at this stage that potential
money laundering can be most
easily detected.
2. After the funds have entered the
financial system, the secondlayering
stage takes place. In this phase, the
launderer engages in a series of changes, or
moves the funds several times to create
distance from the source.
The funds might be used to buy and
sell investments such as stocks and
bonds. The launderer might wire the
funds through a series of accounts at
various banks around the world.

In some instances, the launderer
might disguise the transfers as
payments for goods or services.
This would give them a legitimate
appearance.
3. Having successfully processed the
criminal proceeds through the first two
phases of the money laundering process,
the launderer then moves them to the third
stageintegrationin which the funds
re-enter the legitimate economy
The launderer might choose to
invest the funds in real estate,
luxury assets, or business ventures.

At this third stage, it is very difficult
to distinguish between legal and
illegal funds.







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FIG 2.1: Stages In Money Laundering Process
Source: How stuff works 2005

TABLE 2.2: Summarises The Procedure Depicted In Fig 2.1
PLACEMENT STAGE LAYERING STAGE INTEGRATION STAGE
Cash paid into bank
(sometimes with staff
complicity or mixed with
proceeds of legitimate
business)
Wire transfers abroad (often
using shell companies or
funds disguised as proceeds
of legitimate business)
False loan repayments or
forged invoices used as cover
for laundered money.
Cash exported. Cash deposited in overseas
banking system
Complex web of transfers
(both domestic and
international) makes tracing
original source of funds
virtually impossible.
Cash used to buy high value
goods, property or business
assets.
Resale of goods/assets. Income from property or
legitimate business assets
appears "clean".

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FIG 2.2: Depicts The Estimates Of Money Laundered In Different Regions Of The
World According To Different Research Agencies And Governmental
Organizations.
42.8
45.5
60
179
231.3
257
325.5
590
856.6
1500
2850
0 500 1000 1500 2000 2500 3000
Billions (USD)
1
E
s
t
i
m
a
t
e
Extent of Money Laundering
Model Estimate Worldwide
(John Walker 1998)
High Estimate Worldwide (IMF
1996)
Worldwide (Private Research
Firm 2002)
Low Estmate Worldwide (IMF
1996)
Americas (Private Research
Firm 2002)
Asia/ Pacific (Private Research
Firm 2002)
Europe (Private Research Firm
2002)
United States (US Government
2003)
Caribbean (CFATF 2000)
United Kingdom (UK
Government 2003)
Middle/East Africa (Private
Research Firm 2002)

Source: Kenneth Bryant

The International Monetary Fund (IMF) has estimated that the aggregate size of the ill-
gotten proceeds has increased from circa 2% of global GDP in the early 1990s to around
3.5% today, which translates to a whopping US$ 1.5trillion to US$ 2.4trillion annual
problem based on a global GDP of US$48.3trillion in 2006. Money laundering now ranks
as the third largest business globally after foreign exchange and oil.

However it must be understood that overall it is absolutely impossible to produce a
reliable estimate of the amount of money laundered.

In response to mounting concern over money laundering, the Financial Action Task
Force on money laundering (FATF) was established by the G-7 Summit in Paris in 1989
to develop a co-ordinated international response. One of the first tasks of the FATF was
15
to develop Recommendations, 40 in all, which set out the measures national governments
should take to implement effective anti-money laundering programmes.

TABLE 2.3: Differences Between Money Laundering And Terrorist Financing
Money Laundering Financing of Terrorism
Definition Processing of proceeds of
crimes to disguise their
illegal origin and use them
in the legal economy
Use of funds from legal or
illicit sources to finance
terrorist activities
Source of funds From illegal activities Can be from legal sources
(donations from charitable
organization or individuals)
Use of funds To legitimize illegal funds Funding of terrorist
activities, may be in small
amounts difficult to detect.

TABLE 2.4: Stage Wise Classification of Techniques/Methods Used by Money Launderers
PLACEMENT LAYERING INTEGRATION
Smurfing Tax Haven and Offshore
Banks
Use of haven bank credit
cards
Shipping Money Abroad Bank Secrecy Receiving as consulting or
director fee
Placement through Banks Corporations and Shell
companies
Arrangement of corporate
loans
Use of Pass through or
Payable through accounts
Use of trusts Proceeds of gambling
Electronic Wire transfer Use of walking accounts Real estate transaction
Insurance Products Establishing self owned
bank accounts
Stock purchase
Investment related
transaction
Use of Intermediaries Use of Business
NBFC International importing and
exporting





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2.4 TECHNIQUES USED BY MONEY LAUNDERERS TO LAUNDER MONEY

2.4.1 Structuring Deposits/ Smurfing
Also known as smurfing, this method entails breaking up large amounts of money into
smaller, less-suspicious amounts. The money is then deposited into one or more bank
accounts either by multiple people (smurfs) or by a single person over an extended period
of time.

2.4.2 Offshore Banks
Offshore banks are banks that allow for the establishment of accounts from non-resident
individuals and corporations. A number of countries have well-developed offshore
banking sectors. Offshore banks are popular with money launderers (for layering funds),
tax evaders and corrupt officials.

In contrast, a shell bank is incorporated in and authorised to carry on banking business in
a foreign country, but does not have a physical place of business or any employees in that
country.

Money launderers often send money through various "offshore accounts" in countries
that have bank secrecy laws, meaning that for all intents and purposes, these countries
allow anonymous banking. A complex scheme can involve hundreds of bank transfers to
and from offshore banks. According to the International Monetary Fund, "major offshore
centers" include the Bahamas, Bahrain, the Cayman Islands, Hong Kong, Antilles,
Panama and Singapore

The financial centres that host offshore banks can be very large and help facilitate many
illegitimate cross-border financings. For example, the Cayman Islands are estimated to be
the fifth largest financial centre in the world. Some offshore centres combine loose anti-
money laundering procedures with strict bank secrecy rules. Criminals can easily
17
maintain and transfer funds from banks in these centres because details of client activities
are generally denied to third parties, including most law enforcement agencies.

2.4.3 Underground/Alternative Banking
This includes the hawala system in Pakistan and India and the fie chen system in China,
the Padala in the Philippines, the Hui Kuan in Hong Kong, and the Phei Kwan in
Thailand. Hawala is an alternative or parallel remittance system. It exists and operates
outside of, or parallel to 'traditional' banking or financial channels. It was developed in
India, before the introduction of western banking practices, and is currently a major
remittance system used around the world. The RBI estimates that remittances to India
sent through legal and formal channels in 2007-2008 amounted to $42.6 billion. It is but
one of several such systems; another well known example is the 'chop', 'chit' or 'flying
money' system indigenous to China, and also, used around the world. These systems are
often referred to as 'underground banking'; this term is not always correct, as they often
operate in the open with complete legitimacy, and these services are often heavily and
effectively advertised. Some countries in Asia have well-established, legal alternative
banking systems that allow for undocumented deposits, withdrawals and transfers. These
are trust-based systems, often with ancient roots, that leave no paper trail and operate
outside of government control.

Hawala channels transmit billions of dollars of funds with impressive speed. As an
alternative remittances system or Informal Value Transfer System (IVTS), hawala has
found support among a variety of sources, including large international companies and
local community-based networks. They offer numerous services, employing couriers to
deliver money and intermediaries to deliver gifts or payments in kind, making quick
transfers across countries that come with no cash deliveries.
The settlement takes place between one hawaladar (the intermediary commander) and
another (the intermediary receiver). Upon hearing from a customer who seeks a
remittance transfer, the commander phones the final recipient with an identification
18
number. The receiver awaits the man with the number, provides cash in local currency,
and takes a premium of about two percent.
Herein lies the main elements of the system: trust, oral communication, and anonymity.
There is complete secrecy in content, form, and procedure. Furthermore, with a coding
system for identification, virtually no physical movement of cash, and a code of honor
that quickly weeds out the disingenuous, it is no surprise that counterterrorism agencies
see hawala as a black box. The very characteristics that account for hawalas success
have made it an impenetrable haven for illicit and criminal transactions.

2.4.4 Shell Companies
These are fake companies that exist for no other reason than to launder money. They take
in dirty money as "payment" for supposed goods or services but actually provide no
goods or services; they simply create the appearance of legitimate transactions through
fake invoices and balance sheets. A shell corporation is a company that is formally
established under applicable corporate laws but does not actually conduct a business.
Instead, it is used to engage in fictitious transactions or hold accounts and assets to
disguise the actual ownership of these accounts and assets.

Sophisticated money launderers use a complex maze of shell corporations in different
countries. Most money transfers take place through these shell corporations. At times,
money is transferred through numbered accounts rather than through named accounts. To
further avoid unwanted attention, money launderers build the transaction history of the
shell corporation so that it looks as if it has been in business for a long time.

In many countries (particularly offshore banking centres), the reporting and record-
keeping requirements for corporations are quite minimal, which makes it easy to disguise
ownership of the corporation. In a number of countries, ownership in corporations can be
represented by 'bearer shares. In these corporations, the holder of the bearer share
certificate is regarded as the owner of the shares. This makes it easy to disguise and
transfer ownership.
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2.4.5 Investing In Legitimate Businesses
Launderers sometimes place dirty money in otherwise legitimate businesses to clean it.
Legitimate businesses that also serve as conduits for money laundering are referred to as
'front businesses. The principal requirement when using businesses as fronts is that they
have high cash sales and/or high turnover. This way it becomes easy for criminals to
merge illegal funds and difficult for the authorities to spot the scheme.
They may use large businesses like brokerage firms or casinos that deal in so much
money it's easy for the dirty stuff to blend in, or they may use small, cash-intensive
businesses like bars, car washes etc. These businesses may be "front companies" that
actually do provide a good or service but whose real purpose is to clean the launderer's
money. This method typically works in one of two ways: The launderer can combine his
dirty money with the company's clean revenues -- in this case, the company reports
higher revenues from its legitimate business than it's really earning; or the launderer can
simply hide his dirty money in the company's legitimate bank accounts in the hopes that
authorities won't compare the bank balance to the company's financial statements.

2.4.6 Electronic Transfer
Electronic transfer is a common placement technique. Also referred to as a telegraphic
transfer or wire transfer, this money laundering method consists of sending funds
electronically from one city or country to another to avoid the need to physically
transport the currency. Typically, layers are created by moving money through electronic
funds transfers into and out of domestic and offshore bank accounts of fictitious
individuals and shell companies.

Electronic transfers can be compared to alternative remittances in that both are person-to
person transfers that do not require sending funds through the formal banking system.
Criminals make use of the electronic financial system because it enables the transfer of
large denominations of money instantly to offshore jurisdictions.


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2.4.7 Asset Conversion
Asset conversion is a common placement technique. Asset conversion simply involves
the purchase of goods. Illegal money is converted into other assets, such as real estate,
diamonds, gold and vehicles, which can then be sold. Generally, money launderers prefer
to purchase high-value items that are small and easy to sell or transport to another
country. Often these assets will be purchased in the name of a friend to avert suspicion.

2.4.8 Insurance Purchase
Illegal money is used to buy insurance policies and instruments, which can be 'cashed in'
at a later date. The end result is that the illegal funds have been legitimised by being
washed through a legitimate insurance business.

Single premium insurance products can be particularly vulnerable. They involve a
single payment 'up-front' and the ability to immediately purchase a fully paid instrument.
To a money launderer, these products are attractive because they:
involve a one-time payment
have a cash surrender value
may be transferable

2.4.9 Trusts
Trusts are legal arrangements for holding funds or assets for a specified purpose. These
funds or assets are managed by a trustee for the benefit of a specified beneficiary or
beneficiaries. Trusts can act as layering tools because they enable the creation of false
paper trails and transactions. Trusts are principally governed by a deed of trust drawn up
by the person who establishes the trust. Trusts are more complex to use than corporations,
but they are less regulated.

The private nature of trusts makes them attractive to money launderers. Secrecy and
anonymity rules help conceal the identity of the true owner or beneficiary of trust assets.
Also, the presence of a corporate trustee provides an appearance of legitimacy.
21
In addition, offshore trusts may contain a 'flee clause. This clause allows the trustee to
shift the controlling jurisdiction of the trust if it is in danger because of war, civil unrest
or, more likely, the activities of law enforcement officers or litigious investors and
consumers. Typically, trusts are used in combination with corporations in money
laundering schemes. Trusts are used less frequently than corporations because of their
complexity and their disuse in business transactions.

2.4.10 Walking Accounts
A walking account is an account for which the account holder has provided standing
instructions that all funds be transferred immediately on receipt to one or more other
accounts. By setting up a series of walking accounts, criminals can automatically create
several layers as soon as any funds transfer occurs.

Money launderers use this layering technique because it is extremely difficult to detect
and money moves very fast through accounts across the world. The term 'walking
account' was coined because the money in these accounts appears to 'walk away.

2.4.11 Intermediaries
Lawyers, accountants and other professionals may be used as intermediaries between the
illegal funds and the criminal. Professionals engage in transactions on behalf of a
criminal client who remains anonymous. These transactions may include the use of shell
corporations, fictitious records and complex paper trails.

Money launderers like to use intermediaries because they lend credibility and decrease
suspicion. In addition, these professionals generally have confidentiality obligations to
their clients so the risk of money launderers getting caught is low.
Many countries have realised that criminals are increasingly using non-financial
professionals as intermediaries. To counter these activities, many countries have included
non-financial professionals in new anti-money laundering legislation.

22
2.4.12 Import/Export Transactions
To bring 'legal' money into the criminal's country of residence, the domestic trading
company will export goods to the foreign trading company on an over-invoiced basis.
The illegal funds are remitted and reported as export earnings. The transaction can work
in the reverse direction as well. In many cases, there is no actual export of goods or only
the export of fake goods. In such cases, the trading companies may also exist only on
paper. Bankers may be able to spot these transactions if the underlying trade
documentation is inadequate or the underlying pricing is incorrect.

2.4.13 Corporate Financing
Corporate financing is typically combined with a number of other techniques, including
the use of offshore banks, consultants, complex financial arrangements, electronic funds
transfers, shell corporations and actual businesses. This allows money launderers to
integrate very large amounts of money into the legitimate financial system. Money
launderers may also take a tax deduction on interest payments made by them in corporate
financing.

From appearances alone, such transactions are identical to legitimate corporate finance
transactions. Financial service professionals serving legitimate businesses need to look
closely to find peculiarities in their dealings, such as:
large loans by unknown entities
financing that appears inconsistent with the underlying business
unexplained write-offs of debts.

2.4.14 Consultants
The use of consultants in money laundering schemes is quite common. The consultant
might not even exist. For example, the criminal could actually be the consultant. In this
case, the criminal is channelling money back to him/herself. This money is declared as
income from services performed and can be used as legitimate funds.

23
In many cases, the criminal will employ an actual consultant (e.g. accountant, lawyer or
investment manager) to do some legitimate work. This could involve purchasing assets.
Often, the criminal transfers funds to the consultant's client account from where the
consultant makes payments on behalf of the criminal.

2.4.15 Credit and Debit Cards
Credit and debit cards are efficient ways for money launderers to integrate illegal money
into the financial system. By maintaining an account in an offshore jurisdiction through
which payments are made, the criminals limit the financial trail that leads to their country
of residence.

2.4.16 Bank Secrecy
Bank secrecy (or bank privacy) is a legal principle under which banks are allowed to
protect personal information about their customers, through the use of numbered bank
accounts or otherwise. Effective bank secrecy is better achieved in certain countries, such
as Switzerland or in tax havens, where offshore banks adhere to voluntary or statutory
levels of privacy.

Created by the Swiss Banking Act of 1934, which led to the famous Swiss bank, the
principle of bank secrecy is sometimes considered one of the main aspects of private
banking. Advances in financial cryptography (e.g. public-key cryptography) could make
it possible to use anonymous electronic money and anonymous digital bearer certificates
to achieve financial privacy and anonymous internet banking, given enabling institutions
(e.g. issuers of such certificates and digital cash) and computer systems that are secure
against attackers. Under the principle of bank secrecy, privacy is statutorily enforced,
with Swiss law strictly limiting any information shared with third parties, including tax
authorities, foreign governments or even Swiss authorities, except when requested by a
Swiss judge's subpoena. However anonymous banking is not strictly true as a term as all
Swiss bank accounts, including numbered bank accounts, are linked to an identified
individual under Swiss banking law. This law only permits a bank to share information
24
with others in cases of severe criminal acts, such as identifying a terrorist's bank account.
Any bank employee violating a client's privacy is punished quite severely by law.
Currently in the news United Bank of Switzerland is under severe international pressure
to declare the names of those who evaded taxes. The case is currently continuing.

2.4.17 Stock Purchase
This point has been discussed at length in chapter 3.

2.5 The Principal Money Laundering methods detected or suspected in INDIA are
as follows:
Transfers through the hawala system hawala is a money remittance system.
Such transfers are quite prevalent in India and Pakistan. These transfers are
outside the normal banking channels and are thus anonymous and secretive.
Under-invoicing of exports and over invoicing of imports By under invoicing
of exports, launderers are able to transfer funds in the form of goods, which when
sold shall realize cash. Hence enabling the launderer to transfer funds. By over
invoicing imports the launder is able to transfer funds as legal transfer towards
purchase of goods.
Loan Back Method In this method launderers loan illegal funds to legimitate
businesses, which can be used to fund expenses of the business or loan to front
companies of the launderer. Further the business is able to gain tax deduction on
the interest paid to the launderer on the loan.
Smuggling of Currency Indian and Foreign currency notes of high
denominations, particularly currency of notes of Rs. 500 denominations are
smuggled through couriers to countries like Dubai, Singapore and Hong Kong
where they are converted into convertible foreign exchange at a discount.
Similiarly, foreign exchange acquired locally from unauthorised sources is
smuggled out of the country through couriers.
25
Import of Worthless Goods Launderers usually import high value goods such
as expensive cars, jewellery etc. which cannot be productively employed. Such
high value foreign goods can be easily sold in the domestic market.
Export of Paintings, Antiquities and Artifacts Paintings and Antiquities are
usually high value items which launderers can easily employ to transfer funds.
They may purchase paintings using criminal funds, as a result they are able to
convert high large amounts of cash into an item such as painting and then export
the paintings, thereby avoiding any suspicion.
Funds transferred out of India by adopting one of the above methods are
deposited initially in tax havens with the help of financial and tax
consultants. Such funds are subsequently transferred to shell corporations. From
these shell corporations, funds are invested in India through Overseas Corporate
Bodies (OCB) set up for the purpose, in places like Mauritius, Singapore, Hong
Kong, Bermuda, Cayman Islands etc.

2.6 Conclusion
The form of money laundering has changed with globalization, introduction of newer
technology and setting up of offshore financial centres. Launderers can now move
funds across the globe in a matter of seconds and that too several times. Money
laundering today has become an international activity and a professional activity, it
involves a complex web of transfers alongwith change in form. Further newer money
laundering techniques have gained importance with globalization of financial centres
and improvement in technology. However inspite of the changes in form, the basic
characteristic of money laundering has not changed. A typical money laundering
transaction still follows a three stage process i.e. Placement, Layering and Integration.
Each stage in the money laundering process employs a set of techniques. These
techniques differ from country to country and from region to region. The techniques
vary depending on the anti-money laundering controls prevalent in the country or
region. In India money laundering techniques which are quite prominent are use of
Hawala System, smuggling of currency and use of Tax Havens.
26
CHAPTER 3: MONEY LAUNDERING THROUGH CAPITAL MARKETS
3.1 INTRODUCTION
The Securities Market is characterised by frequent and numerous transactions, and
several mechanisms can be used to make proceeds appear as legitimate earnings from the
financial markets. Inaddition, securities transactions are often international. The sector
most commonly is used during the layering and integration phases, since most law-
abiding brokers do not accept cash transactions. However, this is not an issue for
criminals operating within the financial sector itself, such as embezzlers, insider traders,
or perpetrators of securities frauds, because their (usually non-cash) funds are already
present in the financial system. During the layering phase, a launderer can simply
purchase securities with illicit funds transferred from one or more accounts, then use the
proceeds from selling these securities as legitimate money. Unlike regular securities,
bearer securities (common in some European countries) do not have registered owners,
and when they change hands the transaction involves physically handing over the
security, thus leaving no paper trail. The securitys owner is simply the person who
possesses it. Many but not all countries and jurisdictions have phased out the use of
bearer shares because of their potential role in money laundering and tax evasion.
FIG 3.1: Money Laundering By Global Industry Sectors
Money Laundering by Industry Sector
Money
Services
4%
Credit Cards
5%
Banks
55%
Insurance
Firms
9%
Brokerage &
Investment
Firms
27%
Insurance Firms Banks Credit Cards Money Services Brokerage & Investment Firms
Source:Celent Finsight Risk and Compliance Summit 2007
27
FIG 3.1 depicts that brokerage and investment sector occupies the second highest
position with a share of 27% in terms of susceptibility to money laundering activities.
The above pie chart clearly brings out the importance of brokers and stock exchanges
being used by money launderers as a vehicle for laundering money. This emphasizes the
need for proper regulatory measures and supervision of brokers and exchanges for
ensuring a healthy and vibrant capital market.

In its annual typologies reports on recent trends in money laundering, the FATF reports
that some countries have seen a significant shift in laundering activities from the
traditional banking sector to the non-bank financial sector.

3.2 MONEY LAUNDERING THROUGH INTERNATIONAL FINANCIAL
MARKETS

3.2.1 Money Laundering Through Secondary Markets Globally
Secondary Markets are used during the layering stage of the money laundering process.
This creates additional problems as criminal money arriving to be invested in the Stock
Exchange is more likely to come from another reputable financial centre than a country
with discernible links to organized criminal activity. The increased globalization of
financial marketplaces also throws up other difficulties: such as criminals establishing a
trading account in the office of a financial institution in one country and then having it
transferred to another country.
Organised criminal mafia, terrorists, and intelligence agencies seek to covertly use the
stock markets for earning funds as well as causing economic instability in a target
country. They generally use two methods for this purpose: stock market operations and
stock market manipulation.
Stock market operations help them to earn money and launder black money, and stock
market manipulation helps them to earn and launder money as well as cause economic
instability.
28
For a stock market operation, they use individual stock traders or companies -- either
floated by them or their surrogates -- for buying and selling shares and making profits --
like any other person interested in the stock market.

Terrorists indulge in stock market manipulation -- that is, artificially pushing stock prices
up or down either to earn money or to cause economic instability. Since the terrorists
know in advance the dates of their planned terrorist strikes, which often have an impact
on the stock market, they can use this advance knowledge to push prices up or down.

In the days before and after the 9/11 terror strikes in the US, there were erratic
movements in not only the New York Stock Exchange, but also in the stock exchanges of
some European countries. (B Raman, Are terrorists manipulating Indian Stock Markets?,
February 16, 2007)

Some of these erratic movements affected the shares of airline companies. This gave rise
to widespread speculation and fears that Al Qaeda, which had advance knowledge of the
date of its terrorist strikes, had used this knowledge in an attempt to make money and in a
futile attempt to cause an economic collapse.

Stock Exchanges can also be utilized as money laundering vehicle through listed
companies which are nothing more than a laundering operation themselves. Eg. The now
infamous YBM Magnex International Inc was delisted by the Toronto Stock Exchange in
December 1998 (Proximal Consulting). A US class action suit claimed that YBMs only
successful business is the laundering of criminal proceeds. Red flags have already been
raised about the money laundering possibilities inherent in the listing of dotcom
companies with no track record and unsustainable market valuations. (B Raman, Are
terrorists manipulating Indian Stock Markets?, February 16, 2007)



29
3.2.2 MONEY LAUNDERING THROUGH DERIVATIVES EXCHANGES
Derivatives can also be used by initiating simultaneous put and call transactions on
behalf of the client. The UK experience showed that the futures market, through Capcom
Commodities, a BCCI (Bank for Credit and Commerce International) related institution
was another area that money launderers were taking advantage of for their money
laundering schemes. Because of the anonymous nature of the trading strategies, all
brokers trading as principals and not in their client's name, the true identity of the
beneficial owner is not known. Derivatives therefore are a zero sum game, which means
you can only buy if someone is willing to sell, and vice versa. Launderers can take
advantage by a strategy of buying and selling the same commodity, thereby taking a
small hit for the commission charged by the broker. They pay the losing contract out of
dirty money and receive a cheque that legitimises their profits and creates a paper trail for
any one who asks where the money came from.

3.3 MONEY LAUNDERING THROUGH STOCK EXCHANGES IN INDIA
Laundering black money through the secondary market is a common practice in India.
Unaccounted wealth that got laundered though the secondary market could well run into
several thousand crores of rupees. Tax officials have estimated about Rs 300 400 crore
could have been laundered via the stock market in Mumbai alone.

3.3.1 CASE 1: USE OF PENNY STOCKS
Given that hundreds of penny stocks have been brazenly manipulated, large-scale
ramping up of penny stocks provided a convenient cover for launderers. A number of
companys shares have been manipulated through this route. The modus operandi is as
follows:

A group prepares the ground by ramping up shares of scores of companies that were
traded at just a few rupees each or sometimes less than a rupee. For instance, if X wants
to launder Rs 1,000, the racketeers would give him 10 physical shares of a company
quoting on the bourses at around Rs 100. This would be accompanied by a back-dated
30
contract note, showing the sale at around Rs one per share for a cash consideration. Since
shares cannot be sold in physical form, the buyer sends the shares to the depository to be
dematerialised and converted into electronic form. He sells the dematerialised shares on
the secondary market at the artificially ramped up price of Rs 100 plus and pockets a
cheque payment, converting his black money into white.

Depending on how far the receipt was back-dated, he walks away by paying either zero
or 10 % capital gains tax. It may be recalled that capital gains dropped to 10% since April
2000 and the fraud has been in operation ever since. In one case the price was ramped up
from a few paise to Rs 4.80 and in another case a one rupee face value stock was ramped
up to Rs 85. (Sucheta Dalal, Depositories used for money laundering, 22
nd
March 2006,
Financial Express)

For instance, the shares of one company, with a paid up capital of Rs 7.3 crore showed Rs
20 crore worth of rematerialisation/dematerialisation in the last two years (this is
conversion from physical share certificates to electronic entries and vice versa).
Considering that floating stock of a company on an average is just around 50% to 60 %
of the capital, the entire capital has been put through the demat-remat process several
times in a single year, without attracting the attention of the depositories.

In a compulsory demat environment, large scale rematerialisation of fairly liquid shares
ought to have triggered a loud alarm. While thousands of persons dematerialised shares
and laundered their illegal income, the applicants for rematerialisation in each case were
only a handful of individuals. In most cases, there is no record of the back-dated bills in
the books of the brokers.

3.3.2 CASE 2: USE OF LISTED COMPANIES
The case comprises many companies some of them were trading companies and
related individuals that were alleged for asking for funds with the assurance of high
returns on investments.
31
Presume there is an existing BSE-listed company, which is closed and is not trading at
all. Today, there are over 8,000 companies listed on the BSE, of which more than 50%
companies are in the B2 and Z category and are hardly traded. It can happen that two or
three people form an alliance and take over such a company changing its name to an
infotech company. It is even probable that the existing promoters of the company simply
change the name of their company to a software company. In actual practice, these
companies do not have the necessary infrastructure or the requisite workforce essential to
run a software company. The next step is to form a subsidiary overseas by renting a place
or just even employing a person to carry out the operations. Most of the exports are made
to duty free ports such as Hong Kong, Singapore or Dubai where the money can be
remitted back.

After that, the promoters conduct Hawala/ alternate remittance transactions by paying
cash over here and getting dollars from abroad through the subsidiary. The same dollars
transferred from abroad are shown as software exports in the company's books. In this
way the company is able to report decent sales figures in its balance sheet by the way of
export income. The next step is to grab a flashy share broker or market operator whose
gossips about the company can be floated in the market. The share broker or the operator
then spreads stories such as the company has got big software development orders or tie-
ups and is going to post superb profit numbers. Obviously, the fake export income
compels the net profit stating strong Earnings per Share for the company.

Since, the P/E of the company appears to be quite low in comparison with the industry
P/E; the stock appears to be an excellent buy. The market operators start providing
liquidity in the counter by creating demand for the stock by them. As a result the volumes
in the counter start increasing. The stock price of the company starts touching upper
circuits in sequence. The promoters start taking advantage of this situation by reducing
their own stake and offering it to the small investors who will be willing to buy. In the
end we have the small investors who are left holding the stock which they have
purchased at the high prices. Thus the promoters are able to take advantage in two ways.
32
Firstly they are able to get a superior price for the dead stocks of their company, which
were not being traded at all and secondly are able to exchange their cash into official
export income at a low premium without paying any income tax.

3.3.3 CASE 3: USE OF PARTICIPATORY NOTES
Offshore derivatives instruments (ODIs) are investment vehicles used by overseas
investors for an exposure in Indian equities or equity derivatives. A participatory note is
the most popular offshore derivative instrument. FIIs issue these instruments to overseas
investors against ownership of underlying shares in an Indian company. Foreign investors
need to register as FIIs or as a sub-account of a registered FII to invest in equities listed in
India. To circumvent this process, they also have the flexibility to route their money
through FIIs or sub-accounts of FIIs. The document used to route money in this manner is
the Participatory Note. The identity of foreign investors gets masked when they earmark
funds for investment in India through PNs. A participatory note is a form of equitylinked
note: basically, a derivative instrument, typically issued by a broker registered with Sebi,
against an underlying Indian security. The broker issuing the P-Note purchases the
underlying security and then passes through the dividends and capital gains and losses
generated by the security to the noteholder, effectively giving the holder indirect
exposure to the investment returns associated with the Indian security. Here, brokers
become the medium through which investors, most of whom wish to remain anonymous,
invest in the exchange. The brokers execute trade and use their internal accounts to settle.
Ever since the India growth story caught on, P-notes have become quite the rage with
overseas investors.

FII Sub-Accounts
Sub-accounts are special purpose vehicles floated by foreign funds in which they manage
money on behalf of their overseas clients. FIIs also form proprietary sub-accounts to
invest their own money.


33
FIG 3.2: Shows the increasing Number of FIIs and Sub-Accounts from 2005 to 2007
0
500
1000
1500
2000
2500
3000
3500
4000
N
o
.

i
n

t
h
o
u
s
a
n
d
s
Years
Increasing Number of FIIs and Sub-Accounts
End year number
of FIIs
823 1044 1219
End year number
of Sub-Accounts
2273 3045 3644
2005 2006 2007

Source: Economic Survey 2007-2008

FIG 3.2 shows that the number of Sub-Accounts has exceeded the number of FIIs. The
number of times the sub-accounts have exceeded the number of FIIs registered with
SEBI is almost three-fold. For the year 2004-2005, the Sub-Accounts exceeded FIIs by
2.76 times. For the year 2005-2006, the Sub-Accounts exceeded registered FIIs by 2.92
times. And for the year 2006-2007, the Sub-Accounts exceeded registered FIIs by 2.99
times. These facts clearly show the popularity of sub-accounts as tools for investments
into India.

P-Notes became very popular with foreign investors seeking exposure to Indian equities
markets due to the registration requirement India imposes for direct investment. These
investors approach a foreign institutional investor (FII), who is already registered with
SEBI. The FII makes purchases on behalf of those investors and the FIIs affiliate issues
to them ODIs. The underlying asset for the ODI could be either stocks or equity
34
derivatives like Nifty futures. These investors are not registered with SEBI, either
because they do not want to, or due to regulatory restrictions.

FIG 3.3: Depicts The Cumulative Net Investments Made By Fiis For The Period
Ranging From 1992 To 2008 In Comparison With The Sensex
Growth of Sensex in comparison with Cumulative Net Investment by FIIs
0
10000
20000
30000
40000
50000
60000
70000
80000
1992-
1993
1993-
1994
1994-
1995
1995-
1996
1996-
1997
1997-
1998
1998-
1999
1999-
2000
2000-
2001
2001-
2002
2002-
2003
2003-
2004
2004-
2005
2005-
2006
2006-
2007
2007-
2008
Year
C
u
m
u
l
a
t
i
v
e

n
e
t

i
n
v
s
t

(
U
S

$

m
n
)
0
2000
4000
6000
8000
10000
12000
14000
16000
18000
S
e
n
s
e
x

V
a
l
u
e
Cumulative net investment (US $ mn.) Sensex
Source: Compiled from Sebi and BSE sources

FIIs are very important source of investment in Indian Capital markets. If we look at FIG
3.3 we can see that the reason behind the market booms is the investments made by FIIs.
They are the major contributors to the stock markets. They are very active while trading
in the Indian Securities market. The past boom in the stock markets in 2001-02, 2003-04,
and 2005-06 have been attributed to the FIIs. But still FIIs are looked with a word of
caution and a sense of worry for market regulators.
Whenever, investment climate in the country is not good, they will indulge in capital
flights and overnight withdraw their money from the markets thus making the conditions
in the market worst. They have a very strong influence in Indian markets and
Governments and regulators cannot take the risk of taking them lightly. Their strong
35
presence in the Indian markets has cautioned the government to address the issue of
participatory notes very carefully because otherwise they may adversely affect the FIIs
inflow into India. FIIs that dont wish to register with SEBI or fails to get registration or
are ineligible to get registration, make entries in the Indian capital markets through the
participatory notes. FIIs also earn huge commission while facilitating investment of
participatory notes holders like unregistered FIIs, hedge fund, university endowments,
etc in the Indian Capital markets. The influence of Participatory Notes in Indian Capital
markets can be gauged from the simple fact that, according to one estimate, 51% of FII
investment till August, 2007 were via Participatory Notes and that is equal to 3, 53,484
crores.

Issues Concerning Participatory Notes
The principal concern is the masking of identity of the foreign investor.
Hedge funds tend to use this route.
There is also the possibility of resident Indians channeling unaccounted money
through this route.
The crux of the problem lies in identifying the "real" and "final" beneficiaries of
transactions using PNs. Company A could be controlled by Company B which, in
turn, could be controlled by Company C in a country over which the Indian
government has no jurisdiction. Technically, Sebi officials can try and establish
an "audit trail" up to three layers of beneficiaries although even this is rather
difficult. Thus, the Indian regulator is unable to ascertain the actual source of
funds or the colour of the money coming in through PNs.

It is apprehended that part of the money that is coming into the country actually
belongs to persons of Indian origin who had kept their money abroad at a time
when the government used to have restrictions on the use of hard currency. Such
"round-tripping" funds are now returning to India through tax havens like
Mauritius. With the rupee having appreciated against the US dollar, it is believed
36
that higher flows of such funds are coming to India to finance election campaigns
of politicians.

There are fears that P-Notes are being used as a vehicle by promoters, market
operators, and politicians to repatriate illegitimate funds parked abroad. Quite a
few promoters are said to be using this route to ramp up their stocks.

The fact that Sebi can lift the "corporate veil" only up to a point to identify the
true beneficiaries of transactions using PNs. As per SEBI rules, the FII issuing
ODIs/P-Notes should know the eventual beneficiary to whom the instruments are
being issued to. But through multiple layering, it is possible to conceal the
identity of the original client. Then there are concerns that too much money
flowing into the derivatives segment through the P-Note route is adding to
volatility, not to mention the pressure on the currency.

The possibility of criminal money getting deployed is also a risk. There is the fear
(justified to a large extent based on experience in other markets) that such flows
can be `hot money that could move out in a jiffy, leaving behind negative
consequences for the broad economy.











37
TABLE 3.1: Recent Initiatives By Sebi To Curb Participatory Notes
DATE ACTION TAKEN BRIEF PARTICULARS
October 2007 Sebi imposed a slew of curbs on the
use of PNs for share transactions**
FIIs had pumped in $18 billion into
the countrys stock markets during
2007, these same institutions had
withdrawn around $13 billion
between January and October 2008
October 2008 Sebi reversed its decision to restrict the
use of PNs ostensibly on the ground
that FIIs needed encouragement to
continue to invest in India.
May 27, 2008 Disclosure norms on offshore
derivatives instruments (ODI), market
regulator Sebi asked FIIs to give an
undertaking that these investment tools
are not issued to non-resident and
resident Indians, who otherwise do not
need the FII route.
Sebi wants to track how much
money is coming from FIIs and from
Indian investors separately.
October 31,
2008
Sebi released historical data on short-
sales by FIIs that indicated that on
October 9 there had been short-selling
in 224 specific stocks worth around Rs
6,500 crore
Among the entities whose shares
were "short-sold" (Lending shares
that did not belong to them and
buying them back by obtaining loans
from third parties.) are HDFC, ICICI
Bank, Axis Bank, Reliance
Industries Ltd, Bharti Airtel, Infosys,
Reliance Capital and Reliance
Communications in other words,
the blue chips of the countrys
corporate world.
October 23,
2008
Sebi disapproves of lending to offshore
entities and asked them to reverse such
transactions

POST
OCTOBER
2008
The lending/borrowing activity of FIIs
is being monitored and, if necessary,
stronger measures will be taken by
Sebi as considered appropriate". But
nothing has happened.

Reasons For
Reluctance On
Part Of
Ministry of
Finance In
Curbing
Participatory
Notes

The finance ministry justifies the use of PNs on the ground that it enables
higher inflows through FIIs, adds to liquidity and trading volumes, leads
to better price discovery and lower transaction costs and overheads
Source: Compiled from newspaper article Asian Age dated Friday 8
th
May 2009

38
** P-Notes with stocks as underlying assets can be issued by an FII, subject to a limit of
40% of the overall assets under the custody of that FII. Simply put, if an FII has $100
million worth of assets under custody (AUC), only $40 million of those assets can be in
the form of equity-based P-Notes. Where P-Notes with equity derivatives are the
underlying assets, SEBI has proposed that these cannot be issued anymore, and the
existing positions have to be unwound over a period of 18 months.

3.3.4 CASE 4: USE OF DEPOSITORIES FOR MONEY LAUNDERING
Market intermediaries are using the stock market to convert black money into white by
using benami entities as fronts. The operation requires a slew of demat accounts and a
network of investors ready to lend their demat accounts. Typically a person who wants to
convert some of his idle money approaches these brokers who offer the facility for a
price. The broker makes the necessary arrangements for the client to participate in the
IPO by using a network of benami demat accounts. Profit from the IPO proceeds can be
taken away as white income by paying 10% short term capital gains (STCG) tax.

Now, market manipulators are taking advantage of the buoyant primary market. In
calendar 2005 till date, around Rs 22,000 crore has been mobilized from the market
through 45 issues, a mix of initial public offerings (IPOs) and follow on public offerings
(FPOs).

This is how it works: An investor with a high risk appetite and idle money say Rs 2 crore,
approaches the broker who provides such services. The broker charges a 5% flat fee (Rs
10 lakh) for the end-to-end solution he provides.

He applies in the IPO on behalf of the investor through his network of benami accounts,
keeping in mind factors like levels of likely oversubscription in particular categories and
the possible basis of allotment.

39
Most of the time, the allotment is in line with the expectation and within days of listing,
the entire lot of allotted shares is disposed of. Since the secondary market was buoyant in
the recent past, the listing of most IPOs in the recent past has happened at a huge
premium to the issue price. Taking advantage of this buoyancy, the allotted shares in the
IPOs are disposed of within a very short period after listing, thus attracting short term
capital gains (STCG) tax of 10%. Even after paying the STCG, the investor walks away
with a hefty profit and an added bonus of converting the idle funds into white income.
(Financial Express, 19/12/2005, Demat scam being used to convert black money)

How the System Works:
Broker-operators keep their network of benami demat accounts ready and offer
the facility to those wishing to invest idle funds in the IPO market
Charge flat fee on amount invested, and then put the network to use by applying
in the new issues
Once the allotments come, they quickly disinvest after listing and the investor
pays short-term capital gains tax (STCG) at 10% and walks away after turning
black into white

The practice of using multiple demat accounts to corner shares in an IPO is well known
and prevalent one. In the cases of Yes Bank IPO and IDFC IPO, benamis and front
entities were used to act as conduits for laundering of ill-gotten funds.

The modus operandi used was to submit many applications for shares in the retail
category of an IPO using fictitious names and multiple demat and bank accounts. An
investor approaches a broker if he knows anyone who has a demat account is not
applying for the particular IPO. The broker helps the investor find such a person after
which the rent is fixed. Once the allotments are made to these various accounts, the
investor and his associates consolidate the holding through off-market transactions before
the shares list.

40
This is possible as the transfer of shares from one demat account to another is allowed
without having to route this through the exchanges. That means even if the investor's
shareholding crosses 1%, the exchanges have no clue. Once listed the shares are then
traded by the investor and his associates who control the consolidated accounts. The case
of Yes Bank and IDFC indicates to the systemic lapses by depository participants,
merchant bankers, banks, and registrars.

3.4 Conclusion
In the Global context, Brokerage and Investment Firms rank second in terms of
susceptibility to money laundering worldwide. Stock Markets are usually employed by
launderers during the layering phase of the money laundering process. Launderers use not
only equity markets but also derivatives market to launder funds. India in the recent past
has generated a lot of interest globally as a fast growing economy and hence funds have
been flowing into India ever since. However even launderers have taken a keen interest in
the Indian growth story as a means to launder funds. In India the key methods used to
launder funds through capital markets have been by using Penny Stocks, Listed
Companies, Participatory Notes and Depositories. In the case of Participatory Notes the
Indian government has shown reluctance in curbing such flows since the volume of flows
coming through this channel is huge and such flows are essential for a developing
country like India.
41
CHAPTER 4: IMPACT OF MONEY LAUNDERING
4.1 INTRODUCTION
Money Laundering is associated with large flows of money. Such large flows are
beneficial for an emerging economy like India in the short term but is detrimental in the
long term. This chapter tries to comprehend the impact that money laundering can have
on the various constituent parts of the economy.

4.2 PROBLEM FOR EMERGING MARKETS
1. Increased vigilance by authorities in the major financial centres to combat
money laundering activity provides an incentive for launderers to shift their
activities to emerging markets.
2. As ill-prepared emerging economies open up their financial markets, they
become increasingly attractive targets for money laundering activity.
3. Countries with loose detecting / recording systems attract inflow of criminal
funds. This is evidenced by rising funds movement to such centres
4. Developing states cant be too selective about the sources of capital they
attract.
5. Postponing action on vigilance steps may allow organized crime to become
entrenched.

4.3 IMPACT OF MONEY LAUNDERING

4.3.1 IMPACT ON THE FINANCIAL SECTOR
First, money laundering erodes financial institutions themselves. Money
laundering impairs the development of important financial institutions and
intermediaries.
Second, particularly in developing countries money laundering impairs customer
trust. A reputation for integrity is the one of the most valuable assets of a financial
institution.

42
Table 4.1: Specific Risks Faced by Financial Institutions and Intermediaries
TYPE OF RISK SYNOPSIS OF RISK
Reputational
Risk
The potential that adverse publicity regarding a intermediaries
business practices, whether accurate or not, will cause a loss of
confidence in the integrity of the institution
Operational
Risk

The risk of direct or indirect loss resulting from inadequate or failed
internal processes, people and systems or from external events
Weaknesses in implementation of AML programmes, ineffective
control procedures and failure to practise due diligence
Legal Risk

The possibility that lawsuits, adverse judgements or contracts that
turn out to be unenforceable can disrupt or adversely affect the
operations or condition of an intermediary
Intermediary may become subject to lawsuits resulting from the
failure to observe mandatory KYC standards or from the failure to
practise due diligence
Intermediaries can suffer fines, criminal liabilities and special
penalties imposed by supervisors

4.3.2 IMPACT ON THE REAL SECTOR
Money laundering has a more direct negative effect on economic growth in the
real sector by diverting resources to less-productive activity, which in turn depress
economic growth.
Money laundering also facilitates crime and corruption within developing
economies, which is antithetical to sustainable economic growth.

As can be seen from the various money-laundering typologies reports, money laundered
through channels other than financial institutions is often placed in what are known as
"sterile" investments, or investments that generate little additional productivity for the
broader economy, such as real estate, art, antiques, jewellery, and luxury automobiles.
For developing countries, the diversion of such scarce resources to less productive
43
domestic assets or luxury imports is a serious detriment to economic growth. Moreover,
criminal organizations can transform productive enterprises into sterile investments by
operating them for the purposes of laundering illicit proceeds rather than as profit-
maximizing enterprises responsive to consumer demand and worthy of legitimate
investment capital.

4.3.3 IMPACT ON EXTERNAL SECTOR
Money laundering can impair a developing country's economy through the
country's trade and international capital flows.
Moreover, the confidence that foreign investors and foreign financial institutions
have in a developing country's financial institutions is important for developing
economies because of the role such confidence plays in investment decisions and
capital flows.
Money laundering can also be associated with significant distortions to a country's
imports and exports alongwith increased volatility of exchange rates.

4.3.4 IMPACT ON BUSINESS
The institution could become part of the criminal network itself. Evidence of such
complicity will have a damaging effect on the attitudes of other financial
intermediaries and of regulatory authorities, as well as ordinary customers.
There is a damping effect on foreign direct investment when a countrys
commercial and financial sectors are perceived to be subject to the control and
influence of organised crime.
Unpredictable changes in money demand.

4.3.5 IMPACT ON SOCIETY
Organised crime can infiltrate financial institutions, acquire control of large
sectors of the economy through investment, or offer bribes to public officials and
governments.
44
The economic and political influence of criminal organisations can weaken the
social fabric, collective ethical standards, and ultimately the democratic
institutions of society.
Most fundamentally, money laundering is inextricably linked to the underlying
criminal activity that generated it. Laundering enables criminal activity to
continue. Ultimately influencing the democratic process.

4.4 Conclusion
Developed countries having stringent Anti-Money Laundering controls offer very little
opportunities to launderers. Hence money laundering activities are seeking countries with
poor Anti-Money Laundering controls. In line with such a trend money laundering has
been shifting focus to developing countries with poor or no Anti-Money Laundering
controls. India being a developing country is an attractive destination for launderers. The
impact of money laundering can be very severe on an economy like India. Not only does
money laundering impact the financial institutions but also other key areas of the
economy. Further money laundering also brings about various negative changes in the
social and economic arena of the economy which hinder development and destroy the
fabric of the economy.
45
CHAPTER 5: INTERNATIONAL AND DOMESTIC INITIATIVES
AGAINST MONEY LAUNDERING

5.1. INTRODUCTION
The world community has been taking money laundering very seriously. Since money
laundering has attained a global reach, every country must not only look to safeguard
their economy but also have systems which facilitate cooperation amongst countries. In
line with this view many legislations and initiatives have been taken by countries and also
international communities. The objective of this chapter is to examine important
outcomes of enactments and initiatives taken by the world community. Inaddition it is
also sought to examine the money laundering efforts being taken in the Indian context.

5.2 ANTI-MONEY LAUNDERING LEGISLATIONS AND INITIATIVES

5.2.1 THE BANK SECRECY ACT (USA, 1970) was designed to fight drug trafficking,
money laundering, and other crimes. Congress enacted the BSA to help prevent banks
and other financial service providers from being used as intermediaries for, or being used
to hide the transfer or deposit of money derived from, criminal activity. Among other
items, the BSA created an investigative paper trail by establishing regulatory
reporting standards and requirements (e.g., the Currency Transaction Report), and,
through a later amendment, established recordkeeping requirements for wire transfers.
Key features of the Act were:
Established requirements for recordkeeping and reporting by private
individuals, banks and other financial institutions
Designed to help identify the source, volume, and movement of currency and
other monetary instruments transported or transmitted into or out of the United
States or deposited in financial institutions
Required banks to (1) report cash transactions over $10,000 using the Currency
Transaction Report; (2) properly identify persons conducting transactions; and
(3) maintain a paper trail by keeping appropriate records of financial transactions
46
The Financial Crimes Enforcement Network (FINCEN) acts as the designated
administrator of the Bank Secrecy Act (BSA).
A summary of various legislations and initiatives taken domestically as well as
internationally is provided in the table below:
TABLE 5.1: Timeline of Domestic as well as International Initiatives for Prevention
of Money Laundering
International Initiatives Indian Initiatives
1970 Bank Secrecy Act (USA) 1985 Narcotics drugs and Psychotropic
Substances Act
1986 The Money Laundering Control Act
(USA)
1988 Benami Transaction (Prohibition) Act
1988

Basle Committee Statement of
Principles
1988 Prevention of Illicit Traffic in Narcotics Drugs
and Psychotropics Substances Act
1988 The Anti-Drug Abuse Act (USA) 1999 Foreign Exchange Management Act
1988 Vienna Convention (UN Convention
Against Illicit Traffic in Narcotic
Drugs and Psychotropic
Substances)
2002 Prevention of Money Laundering Act,

1989 Financial Action Taskforce (FATF) 2004 Unlawful Activities Act (UAPA) as amended
1991 European Union Directive Guidelines for anti-money laundering
measures by Securities and Exchange Board
of India (SEBI)
1992 The Annunzio-Wylie Anti-Money
Laundering Act (USA)

1992 IOSCO
1994 The Money Laundering
Suppression Act (USA)

1995 EGMONT Group
1997 Asia/Pacific Group on money
laundering

1998 The Money Laundering And
Financial Crimes Strategy Act
(USA)

2000 The Palermo Convention (The
International Convention Against
Transnational Organized Crime)

2000 The Financial Services And Markets
Act

2001 USA Patriot Act
2001 EU Second Money Laundering
Directive

2002 UK Proceeds of Crime Act of
(PoCA)

2004 Intelligence Reform & Terrorism
Prevention Act

2007 EU Third Money Laundering
Directive

Source: Compiled from various articles and magazines
47
5.2.2 THE MONEY LAUNDERING CONTROL ACT OF 1986 (USA) amended the
BSA to enhance its effectiveness and to strengthen the governments ability to fight
money laundering by making it a federal crime and by making structuring transactions to
avoid BSA reporting requirements a criminal offense. Key features of the Act were:
1. Established money laundering as a federal crime
2. Prohibited structuring transactions to evade CTR filings
3. Introduced civil and criminal forfeiture for BSA violations
4. Directed banks to establish and maintain procedures to ensure and monitor
compliance with the reporting and recordkeeping requirements of the BSA

5.2.3 THE BASLE COMMITTEE STATEMENT OF PRINCIPLES
The increased international concern about organized crime and the concentration of
power and finance around drug and other criminals was shared by the banking
community. The Basle Committee on Banking Regulations and Supervisory Practices
(the Basle Committee) stated in December of 1988.

The statements basic purpose is to ensure that banks are not used to hide or launder the
profits of crime. Its basic principles are in summary:
Know Your Customer: Banks should make reasonable efforts to determine the
customers true identity, and have effective procedures for verifying the bona
fides of new customers.

Compliance With Laws: Bank management should ensure that business is
conducted in conformity with high ethical standards, that laws and regulations are
adhered to and that a service is not provided where there is good reason to
suppose that transactions are associated with laundering activities.

Co-Operation With Law Enforcement Agencies: Without any constraints
imposed by rules relating to customer confidentiality, banks should cooperate
fully with national law enforcement agencies including, where there are
48
reasonable grounds for suspecting money laundering, taking appropriate measures
which are consistent with the law.

Policies, Procedures And Training: All banks should formally adopt policies
consistent with the principles set out in the Statement and should ensure that all
members of their staff concerned, wherever located, are informed of the banks
policy. To promote adherence to these principles banks should implement specific
procedures for customer identification and retaining internal records of
transactions. Arrangements for internal audit may need to be extended in order
to establish an effective means of testing for general compliance with the
Statement.

5.2.4 THE ANTI-DRUG ABUSE ACT OF 1988 reinforced and supplemented anti-
money laundering efforts by increasing the levels of penalties and sanctions for money
laundering crimes and by requiring strict identification and documentation of cash
purchases of certain monetary instruments. Key features of the Act were:

Expanded the definition of financial institution to include businesses such as
car dealers and real estate personnel and required them to file reports on large
currency transactions
Required the verification of identity of purchasers of monetary instruments over
$3,000

5.2.5 THE VIENNA CONVENTION
The Vienna Convention, adopted in December 1988, lays the groundwork for efforts to
combat money laundering by creating an obligation for signatory states to criminalize
the laundering of money from drug trafficking. It promotes international cooperation
in investigations and makes extradition between signatory states applicable to money
laundering. And it establishes the principle that domestic bank secrecy provisions
should not interfere with international criminal investigations.
49
5.2.6 EUROPEAN UNION DIRECTIVE
In June 1991, the Council of the European Communities adopted a directive on the
Prevention of the Use of the Financial System for the Purpose of Money Laundering.
This directive was issued in response to the new opportunities for money laundering
opened up by the liberalization of capital movements and crossborder financial services
in the European Union. The directive obligates member states to outlaw money
laundering. They must require financial institutions to establish and maintain internal
systems to prevent laundering, to obtain the identification of customers with whom they
enter into transactions of more than ECU 15,000, and to keep proper records for at least
five years. Member states must also require financial institutions to report suspicious
transactions and must ensure that such reporting does not result in liability for the
institution or its employees.

5.2.7 RESOLUTION OF THE INTERNATIONAL ORGANIZATION OF
SECURITIES COMMISSIONS
The International Organization of Securities Commissions (IOSCO) adopted, in October
1992, a report and resolution encouraging its members to take necessary steps to combat
money laundering in securities and futures markets. A working group of IOSCOs
Consultative Committee has been set up to collect information from IOSCO
members self-regulatory organizations and exchanges on their efforts to encourage
their own members to fight money laundering.

5.2.8 THE ANNUNZIO-WYLIE ANTI-MONEY LAUNDERING ACT OF 1992
(USA) increased penalties for depository institutions found guilty of money
laundering. The act added several significant provisions to the BSA, including the
reporting of suspicious transactions. The act also made the operation of an illegal
money transmitting business a crime, and required that banking regulatory agencies
formally consider revoking the charter of any depository institution convicted of money
laundering. Key features of the Act were:
1. Strengthened the sanctions for BSA violations.
50
2. Required Suspicious Activity Reports and eliminated previously used
Criminal Referral Forms.
3. Required verification and recordkeeping for wire transfers.
4. Established the Bank Secrecy Act Advisory Group (BSAAG).

5.2.9 THE MONEY LAUNDERING SUPPRESSION ACT OF 1994 (USA) required
regulators to develop enhanced examination procedures and to increase examiner
training to improve the identification of money laundering schemes in financial
institutions.

5.2.10 THE ASIA/PACIFIC GROUP ON MONEY LAUNDERING
The Asia Pacific Group was established in February 1997 as a voluntary cooperative
organisation committed to combating money laundering in the asia/pacific region. Its
primary objective is to facilitate the adoption of universal standards, as set out by the
FATF, and how the 40 recommendations can be implemented effectively. An APG
Steering Group and a Typologies Working group were also established.

5.2.11 The EGMONT GROUP
The Egmont group is a confederacy /informal exchange of many national Financial
Intelligence Units (FIUs) established to address financial crimes. One of the
recommendations of the FATF is that each country should address financial crime. One
of the recommendations of the FATF is that each country should establish an FIU that
will serve as a database for collation and analysis of STRs. The aim of Egmont Group
therefore is to provide support by expanding and systematising the exchange of
financial intelligence. It is also aimed at improving the capacity of law enforcement
agencies, and fostering better communication between and amongst them in the fight
against money laundering, terrorist financing and other financial crimes.


51
5.2.12 THE MONEY LAUNDERING AND FINANCIAL CRIMES STRATEGY
ACT OF 1998 (USA) required the Secretary of the Treasury, in consultation with the
Attorney General and other relevant agencies, including state and local agencies, to
coordinate and implement a national strategy to address money laundering. Key features
of the Act were:
Required banking agencies to develop anti-money laundering training for
examiners
Required the Department of the Treasury and other agencies to develop a National
Money Laundering Strategy

5.2.13 THE FINANCIAL SERVICES AND MARKETS ACT OF 2000 (UK)
Treasurys enactment of this AML law served as an operational framework the Britains
Financial Services Authority (FSA), which started operating in 2001. Significantly, it
served to facilitate the move from a voluntary compliance culture to a statutory one.

5.2.14 The USA PATRIOT Act, 2001 (Uniting and Strengthening America by
Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of
2001) evolved as a response by the U.S. government to combat international terrorism.
The act contained strong measures to prevent, detect, and prosecute terrorism and
international money laundering. Signed into law on October 26, 2001, the act establishes
new rules and responsibilities affecting U.S. banking organizations, other financial
institutions, and non-financial commercial businesses. The Key features of the Act were:
Provides the Secretary of the Treasury with the authority to impose special
measures on jurisdictions, institutions, or transactions that are of primary money-
laundering concern.
Requires financial institutions to increase their due diligence standards when
dealing with foreign private banking and correspondent accounts.
Prohibits correspondent accounts with foreign shell banks.
Expands the ability of the public and private sectors to share information related
to terrorism and money laundering investigations.
52
Facilitates records access and requires banks to respond to regulatory requests
for information within 120 hours.
Establishes minimum standards for customer identification at account opening
and requires checks against government-provided lists of known or suspected
terrorists.
Requires regulatory agencies to evaluate an institutions anti-money laundering
record when considering bank mergers, acquisitions, and other applications for
business combinations.
Extends an anti-money laundering program requirement to all financial
institutions.
Increases the civil and criminal penalties for money laundering.

5.2.15 PROCEEDS OF CRIME ACT OF (POCA), 2002 (UK)
UK Proceeds of Crime Act (2002) makes the disclosure of income sources mandatory,
and also gives law enforcement agencies such as the Organized Crime Force the legal
muscle to seize undisclosed assets funded by illicitly generated profits.

The Act also makes explicit provisions for the handling of seized goods and assets to
prevent further foul play once financial criminals have been apprended. This piece of
AML legislation broadened the range of entities being regulated, and constituted as
substantial expansion of the breadth of principal and non-disclosure offences.

5.2.16 FOREIGN EXCHANGE MANAGEMENT ACT, 1999 (INDIA)
It permits only authorised person to deal in foreign exchange or foreign security. Such
an authorised person, under the Act, means authorised dealer, money changer, off-shore
banking unit or any other person for the time being authorised by Reserve Bank.

5.2.17 BENAMI TRANSACTIONS (PROHIBITION) ACT, 1988 (INDIA)
When a person owns a property through another person who is only a name lender to
him, he has a benami ownership. This is forbidden under the law. A special enactment,
53
The Benami Transactions (Prohibition) Act, 1988 has been passed and the highlights of
the same are as follows:
The Act does not apply to property held in the benami names of wife or
unmarried daughter, or held under a Trust by a trustee for the benefit of another as
a beneficiary.
The real owner loses all his rights and remedies to recover his property from his
benamidar.
The Government is vested with the power to acquire the property from the
benamidar without paying compensation.
After the passing of the Act, to own a property in the name of a benamidar will
constitute an offence.
It is to be noted that upto the passing of the above enactment, benami transactions
were covered by Section 82 of the Indian Trusts Act, 1882.

5.2.18 PREVENTION OF MONEY LAUNDERING ACT, 2002 (INDIA)
The Prevention of Money Laundering Act, 2002 (PMLA) enacted to prevent money
laundering and provide for confiscation of property derived from, or involved in, money
laundering
Administered by:
Financial Intelligence Unit for verification of identity of clients,
maintenance of records and reporting
Enforcement Directorate for investigation of and prosecution for
money-laundering offences

The Prevention of Money-Laundering Act, 2002 came into effect on 1 July 2005.

Section 3 of the Act makes the offense of money-laundering cover those persons
or entities who directly or indirectly attempt to indulge or knowingly assist or
54
knowingly are party or are actually involved in any process or activity connected
with the proceeds of crime and projecting it as untainted property, such person or
entity shall be guilty of offense of money-laundering.

Section 4 of the Act prescribes punishment for money-laundering with rigorous
imprisonment for a term which shall not be less than three years but which may
extend to seven years and shall also be liable to fine which may extend to five lakh
rupees. However, where the proceeds of crime involved in money laundering relates
to any offence specified under the Narcotic Drugs and Psychotropic Substances
Act, the punishment may extend to rigorous imprisonment for ten years.

Section 12 (1) prescribes the obligations on banks, financial institutions and
intermediaries (a) to maintain records detailing the nature and value of transactions
which may be prescribed, whether such transactions comprise of a single
transaction or a series of transactions integrally connected to each other, and where
such series of transactions take place within a month; (b) to furnish information of
transactions referred to in clause (a) to the Director within such time as may be
prescribed and to (c) verify and maintain the records of the identity of all its clients.

As per Section 12 (2), the records referred to in sub-section (1) as mentioned above,
must be maintained for ten years after the transactions finished.

Intermediary under PMLA includes persons registered under Section 12 of the
Securities and Exchange Board of India (SEBI) Act, 1992:
Stock brokers Registrars to issue
Sub-brokers Merchant bankers
Share transfer agents Underwriters
Bankers to an issue Portfolio Managers
Trustees to trust deed Custodian of securities
Depositories Foreign institutional investors
Credit rating agencies Venture capital funds
Collective investment schemes including
mutual funds

55
5.2.19 FINANCIAL ACTION TASK FORCE (FATF)
The FATF is an inter-governmental body which sets standards, and develops and
promotes policies to combat money laundering and terrorist financing. Founded in 1989
by G7 Group in response to mounting concerns over Money Laundering. It currently has
33 members: 31 countries and governments and two international organisations; and
more than 20 observers. It focuses on:
Spreading the anti-money laundering message to all continents and regions of the
globe.
Monitoring the implementation of its Forty Recommendations.
Reviewing and publishing money laundering trends and countermeasures
(typologies exercise).

The original FATF Forty Recommendations were drawn up in 1990 as an initiative to
combat the misuse of financial systems by persons laundering drug money. In 1996 the
Recommendations were revised for the first time to reflect evolving money laundering
typologies. The 1996 Forty Recommendations have been endorsed by more than 130
countries and are the international anti-money laundering standard. In October 2001 the
FATF expanded its mandate to deal with the issue of the financing of terrorism, and took
the important step of creating the Eight Special Recommendations on Terrorist
Financing.

The FATF reviewed and revised the Forty Recommendations into a new comprehensive
framework for combating money laundering and terrorist financing. The FATF now calls
upon all countries to take the necessary steps to bring their national systems for
combating money laundering and terrorist financing into compliance with the new FATF
Recommendations, and to effectively implement these measures.

The revised Forty Recommendations now apply not only to money laundering but also to
terrorist financing, and when combined with the Eight Special Recommendations on
Terrorist Financing provide an enhanced, comprehensive and consistent framework of
56
measures for combating money laundering and terrorist financing. The Recommendations
therefore set minimum standards for action for countries to implement the detail
according to their particular circumstances and constitutional frameworks.

A key element in the fight against money laundering and the financing of terrorism is the
need for countries systems to be monitored and evaluated, with respect to these
international standards. The key FATF recommendations applicable to financial
intermediaries are as summarised in Table 5.2:























57
TABLE 5.2: Key FATF Recommendations Applicable to Financial Institutions &
Intermediaries
FATF
Recommendations
Brief Particulars Implemented in
India
Recommendation 5 Financial institutions should not keep anonymous accounts or accounts in obviously fictitious
names.
Financial institutions should undertake customer due diligence measures, including identifying and
verifying the identity of their customers, when:
establishing business relations;
carrying out occasional transactions: (i) above the applicable designated threshold; or (ii) that
are wire transfers
there is a suspicion of money laundering or terrorist financing; or
The financial institution has doubts about the veracity or adequacy of previously obtained
customer identification data.

Recommendation 6 Financial institutions should, in relation to politically exposed persons, in addition to performing
normal due diligence measures:
a) Have appropriate risk management systems to determine whether the customer is a politically
exposed person.
b) Obtain senior management approval for establishing business relationships with such customers.
c) Take reasonable measures to establish the source of wealth and source of funds.
d) Conduct enhanced ongoing monitoring of the business relationship.

Recommendation 8 Financial institutions should pay special attention to any money laundering threats that may arise
from new or developing technologies that might favour anonymity. In particular, financial
institutions should have policies and procedures in place to address any specific risks associated
with non-face to face business relationships or transactions.

Recommendation
10
Financial institutions should maintain, for at least five years, all necessary records on transactions,
both domestic and international, to enable them to comply swiftly with information requests from
the competent authorities.

Recommendation
11
Financial institutions should pay special attention to all complex, unusual large transactions, and all
unusual patterns of transactions, which have no apparent economic or visible lawful purpose.

Recommendation
13
If a financial institution suspects or has reasonable grounds to suspect that funds are the
proceeds of a criminal activity, or are related to terrorist financing, it should be required,
directly by law or regulation, to report promptly its suspicions to the financial intelligence
unit (FIU).

Recommendation
15
Financial institutions should develop programmes against money laundering and terrorist financing.
These programmes should include:
a) The development of internal policies, procedures and controls, including appropriate compliance
management arrangements, and adequate screening procedures to ensure high standards when hiring
employees.
b) An ongoing employee training programme.

Recommendation
21
Financial institutions should give special attention to business relationships and transactions with
persons, including companies and financial institutions, from countries which do not or insufficiently
apply the FATF Recommendations.

Recommendation
26
Countries should establish a FIU that serves as a national centre for the receiving (and, as permitted,
requesting), analysis and dissemination of STR and other information regarding potential money
laundering or terrorist financing. The FIU should have access, directly or indirectly, on a timely basis
to the financial, administrative and law enforcement information that it requires to properly undertake
its functions, including the analysis of STR.

Recommendation
29
Supervisors should have adequate powers to monitor and ensure compliance by financial institutions
with requirements to combat money laundering and terrorist financing, including the authority to
conduct inspections.


58
5.2.20 FIU (Financial Intelligence Units)
An important recent development in the international approach to combating money
laundering is the creation of Financial Intelligence Units (FIUs) around the world. An
FIU is a centralized unit for financial intelligence, formed by a nation to protect its
financial services sector, to detect criminal abuse of its financial system, and to ensure
adherence to its laws against financial crime and money laundering. An FIU, quite
simply, is a central office that receives disclosures of financial information, analyzes or
processes them in some way and then provides them to appropriate government
authorities in support of a national anti-money laundering effort. Some FIUs may also
investigate and prosecute money laundering cases; some are actively involved in the
development of their governments anti-money laundering policies and the administration
of their anti-money laundering regulatory controls. FIUs typically have independent and
unique relationships with banks, central banks, and law

Financial Intelligence Units were created to act as an interface between financial sector
and law enforcement agencies for identification of suspicious money laundering activities
requiring investigation. In 1995, some FIUs decided to establish an informal group
known as the Egmont Group for promoting international cooperation amongst FIUs
FIG 5.1: Role Of Financial Intelligence Unit

Source: Egmont Group report 2007.
1-Disclosures transmitted to FIU
59
2-FIU receives additional information from law enforcement
3-Possible exchange with foreign counterpart FIU
4-After analysis, FIU provide case to prosecutor for action

5.2.21 FIU-IND
Is the central national agency of India responsible for receiving, processing, analyzing
and disseminating information relating to suspect financial transactions. FIU-IND is also
responsible for coordinating and strengthening efforts of national and international
intelligence, investigation and enforcement agencies in pursuing the global efforts against
money laundering and related crimes. Its prime responsibility is to gather and share
financial intelligence in close cooperation with the regulatory authorities including RBI,
SEBI and IRDA.

5.3 Conclusion
The fight against money laundering has been mainly taken up by the developed countries
of the world. USA has been the pioneer in this regard. International community has
realized that money laundering is not restricted to a particular region or country, but is
now a global activity and a complicated one. Thus many international and regional
groups such as the Egmont Group, Asia/Pacific group and Financial Action Task Force
have been founded. These groups have been actively engaged in setting standards and
enhancing cooperation among the nations of the world. The Financial Action Task Force
has stated 40 recommendations to be implemented by its member nations. India has
initiated the recommendations in the field of finance and is thus adhering to international
standards. Adhering to international standards is essential for India since otherwise
launderers will view India as country with poor money laundering controls and it will
become an attractive destination for launderers. Further India has been active in framing
new legislations to concretely tackle the problem of money laundering and is currently in
the process of framing a new PMLA Amendment Act, which shall be wider in scope and
shall cover financing of terrorism too. Prevention of Money Laundering Act, 2002 is a
comprehensive legislation covering money laundering. Further India has also set up the
FIU-IND in adherence to the FATF 40 recommendations.
60
CHAPTER 6: ANTI-MONEY LAUNDERING MEASURES AND
COMPLIANCES

6.1 INTRODUCTION
The basic objective of AML Measures is to have in place adequate policy, practice and
procedure that promote professional standards and help prevent intermediaries from
being used, intentionally or unintentionally for money laundering. KYC Standards and
AML Measures would enable the Intermediaries to know/ understand its customers, the
beneficial owners in case of non-individual entities, the principals behind customers who
are acting as agents and their financial dealings better which in turn will help the
intermediary to manage its risks prudently. The approach towards KYC Standards is
based on risk perception and money laundering threats that may be posed by different
types of customers. Alongwith KYC standards the law prescribes record keeping and
submission of Suspicious Transaction Report (STR) to the appropriate regulatory agency.
Intermediaries are largely guided by the KYC standards prescribed by SEBI for
Depository Participants and/or Stock Brokers. This chapter looks to assess the measures
and compliances is necessary to check money laundering activities.













61
TABLE 6.1: Depicts the various measures to be implemented by intermediaries
registered under section 12 of the SEBI Act under various circulars
Points to be
implemented by
Intermediary
SEBI Circular
Guidelines on Anti
Money Laundering
Standards (Dt
18/01/2006)
SEBI Circular on
Obligations of
Intermediaries
(Dt 20/3/2006)
SEBI Master
Circular on
AML (Dt
22/12/2008)
Depositories
Circular on
PMLA (Dt
12/11/2007)
Maintenance of
Records

Written Proper
Policy Framework
to be maintained

Appoint an Offficer
as Principal Officer
and intimate to FIU

Information to be
maintained and
period for which to
be maintained


Implement Client
Identification
Programme



Report CTRs and
STRs to FIU-IND


Incorporate
Financial Status,
Nature of Business
in account opening
form


Incorporate
Consideration and
Reasons in Delivery
Instruction Slip used
for off market trades


Customer Due
Diligence


Monitoring of
Transaction


Employee hiring
and training


Source: Compiled from BSE Exchange Notices
62
6.2. ANTI-MONEY LAUNDERING MEASURES AND COMPLIANCES TO
COMBAT AGAINST MONEY LAUNDERING

As per the provisions of the Prevention of Money Laundering Act, every intermediary
(which includes a stock-broker, sub-broker, share transfer agent, banker to an issue,
trustee to a trust deed, registrar to an issue, merchant banker, underwriter, portfolio
manager, investment adviser and any other intermediary associated with securities market
and registered under section 12 of the Securities and Exchange Board of India Act, 1992)
shall have to maintain a record of all the transactions; the nature and value of which has
been prescribed in the Rules notified under the PMLA. Such transactions include:
All cash transactions of the value of more than Rs 10 lakhs or its equivalent in
foreign currency.
All series of cash transactions integrally connected to each other which have been
valued below Rs 10 lakhs or its equivalent in foreign currency where such series
of transactions take place within one calendar month.
All suspicious transactions whether or not made in cash.

6.2.1 WRITTEN ANTI MONEY LAUNDERING PROCEDURES
Each registered intermediary should adopt written procedures. Such procedures should
include inter alia, the following three specific parameters which are related to the overall
Client Due Diligence Process:

Policy for Acceptance of clients
Procedure for Identifying the clients
Transaction monitoring and reporting especially Suspicious Transactions
Reporting (STR)




63
6.2.2. CUSTOMER DUE DILIGENCE
The customer due diligence (CDD) measures comprise the following:
Obtaining sufficient information in order to identify persons who beneficially own
or control securities account.
Verify the customers identity using reliable, independent source documents, data
or information;
Identify beneficial ownership and control, i.e. determine which individual(s)
ultimately own(s) or control(s) the customer and/or the person on whose behalf a
transaction is being conducted;
Verify the identity of the beneficial owner of the customer and/or the person on
whose behalf a transaction is being conducted.
Conduct ongoing due diligence and scrutiny, i.e. perform ongoing scrutiny of the
transactions and account throughout the course of the business relationship to
ensure that the transactions being conducted are consistent with the registered
intermediarys knowledge of the customer, its business and risk profile, taking
into account, where necessary, the customers source of funds.

6.2.3 POLICY FOR ACCEPTANCE OF CLIENTS
All registered intermediaries should develop customer acceptance policies and
procedures that aim to identify the types of customers that are likely to pose a higher than
the average risk of money laundering. In a nutshell, the following safeguards are to be
followed while accepting the clients:

1. No account is opened in a fictitious / benami name or on an anonymous basis.

2. Factors of risk perception (in terms of monitoring suspicious transactions) of
the client are clearly defined having regard to clients location (registered
office address, correspondence addresses and other addresses if applicable),
nature of business activity, trading turnover etc. and manner of making
payment for transactions undertaken. The parameters should enable
64
classification of clients into low, medium and high risk. Clients of special
category (as given below) may, if necessary, be classified even higher. Such
clients require higher degree of due diligence and regular update of KYC
profile.

3. Documentation requirement and other information to be collected in respect of
different classes of clients depending on perceived risk and having regard to
the requirement to the Prevention of Money Laundering Act 2002, guidelines
issued by RBI and SEBI from time to time. An indicative list of the nature and
type of documents/information that may be relied upon for customer
identification is given in Annexure-I.

4. Ensure that an account is not opened where the intermediary is unable to
apply appropriate clients due diligence measures / KYC policies. This may be
applicable in cases where it is not possible to ascertain the identity of the
client, information provided to the intermediary is suspected to be non
genuine, perceived non co-operation of the client in providing full and
complete information. The market intermediary should not continue to do
business with such a person and file a suspicious activity report.

5. The circumstances under which the client is permitted to act on behalf of
another person / entity should be clearly laid down. It should be specified in
what manner the account should be operated, transaction limits for the
operation, additional authority required for transactions exceeding a specified
quantity / value and other appropriate details.

6. Necessary checks and balance to be put into place before opening an account
so as to ensure that the identity of the client does not match with any person
having known criminal background or is not banned in any other manner,
65
whether in terms of criminal or civil proceedings by any enforcement agency
worldwide.

6.2.4 RISK-BASED APPROACH
It is generally recognized that certain customers may be of a higher or lower risk category
depending on circumstances such as the customers background, type of business
relationship or transaction etc. As such, the registered intermediaries should apply each of
the customer due diligence measures on a risk sensitive basis. The basic principle
enshrined in this approach is that the registered intermediaries should adopt an enhanced
customer due diligence process for higher risk categories of customers. Conversely, a
simplified customer due diligence process may be adopted for lower risk categories of
customers.

Clients of Special Category (CSC)
Such clients include the following-
a. Non resident clients
b. High networth clients,
c. Trust, Charities, NGOs and organizations receiving donations
d. Companies having close family shareholdings or beneficial ownership
e. Politically exposed persons (PEP) of foreign origin
f. Current / Former Head of State, Current or Former Senior High profile politicians
and connected persons (immediate family, Close advisors and companies in
which such individuals have interest or significant influence)
g. Companies offering foreign exchange offerings
h. Clients in high risk countries (where existence / effectiveness of money
laundering controls is suspect, where there is unusual banking secrecy, Countries
active in narcotics production, Countries where corruption (as per Transparency
International Corruption Perception Index) is highly prevalent, Countries against
which government sanctions are applied, Countries reputed to be any of the
66
following Havens / sponsors of international terrorism, offshore financial
centers, tax havens, countries where fraud is highly prevalent.
i. Non face to face clients
j. Clients with dubious reputation as per public information available etc.

6.2.5 CLIENT IDENTIFICATION PROCEDURE
KYC is an acronym for Know your Client or Know your Client, a term commonly
used for Client Identification Process. Pursuant to PMLA, SEBI has prescribed the
certain requirements relating to KYC norms for Financial Institutions and Financial
Intermediaries to 'know' their clients. This could be in the form of personal meetings or
verification of identity and address, financial status, occupation and such other personal
information. Many companies who do not have face-to-face transacting employ the
verification route. The underlying principle is to follow the principles enshrined in the
PMLA as well as the SEBI Act, 1992 so that the intermediary is aware of the clients on
whose behalf it is dealing.The Know your Client (KYC) policy should clearly spell out
the client identification procedure to be carried out at different stages. i.e.
While establishing a business relationship (or)
Carrying out a financial transaction (or)
Where the intermediary has a doubt about the authenticity/veracity (or)
Inadequacy of the previously obtained customer identification data if any.
When the intermediary feels it is necessary to obtain additional information
from the existing customers based on the conduct or behaviour of the
account.

In order to further strengthen the KYC norms and identify every participant in the
securities market with their respective PAN thereby ensuring sound audit trail of all the
transactions, PAN has been made sole identification number for all participants
transacting in the securities market.

67
All registered intermediaries should put in place necessary procedures to determine
whether their existing/potential customer is a politically exposed person (PEP). Such
procedures would include seeking additional information from clients, accessing publicly
available information etc.
All registered intermediaries are required to obtain senior management approval for
establishing business relationships with Politically Exposed Persons. Where a customer
has been accepted and the customer or beneficial owner is subsequently found to be, or
subsequently becomes a PEP, registered intermediaries shall obtain senior management
approval to continue the business relationship.
The information should be adequate enough to satisfy competent authorities (regulatory /
enforcement authorities) in future that due diligence was observed by the intermediary in
compliance with the Guidelines. Each original document should be seen prior to
acceptance of a copy.

Every intermediary shall formulate and implement a client identification programme. A
copy of the client identification programme shall be forwarded to the Director, FIU- IND.

6.2.6 RECORD KEEPING
Registered intermediaries should ensure compliance with the record keeping
requirements contained in the SEBI Act, 1992, Rules and Regulations made there-under,
PML Act, 2002 as well as other relevant legislation, Rules, Regulations, Exchange Bye-
laws and Circulars.

Registered Intermediaries should maintain such records as are sufficient to permit
reconstruction of individual transactions (including the amounts and types of currencies
involved, if any) so as to provide, if necessary, evidence for prosecution of criminal
behavior.



68
6.2.7 INFORMATION TO BE MAINTAINED
Intermediaries are required to maintain and preserve the following information in respect
of transactions referred to in Rule 3 of PMLA Rules:
o The nature of the transactions;
o The amount of the transaction and the currency in which it denominated;
o The date on which the transaction was conducted; and
o The parties to the transaction.

6.2.8 RETENTION OF RECORDS
Intermediaries should take appropriate steps to evolve an internal mechanism for proper
maintenance and preservation of such records and information in a manner that allows
easy and quick retrieval of data as and when requested by the competent authorities.
Further, the records mentioned in Rule 3 of PMLA Rules have to be maintained and
preserved for a period of ten years from the date of cessation of the transactions between
the client and intermediary.

Intermediaries are required to formulate and implement the client identification program
containing the requirements as laid down in Rule 9 and such other additional
requirements that it considers appropriate. The records of the identity of clients have to
be maintained and preserved for a period of ten years from the date of cessation of the
transactions between the client and intermediary.

In situations where the records relate to on-going investigations or transactions which
have been the subject of a suspicious transaction reporting, they should be retained until
it is confirmed that the case has been closed.

6.2.9 MONITORING OF TRANSACTIONS
Regular monitoring of transactions is vital for ensuring effectiveness of the Anti Money
Laundering procedures. This is possible only if the intermediary has an understanding of
69
the normal activity of the client so that they can identify the deviant transactions /
activities.

Intermediary should pay special attention to all complex, unusually large transactions /
patterns which appear to have no economic purpose. The intermediary may specify
internal threshold limits for each class of client accounts and pay special attention to the
transaction which exceeds these limits.

The intermediary should ensure a record of transaction is preserved and maintained in
terms of section 12 of the PMLA 2002 and that transaction of suspicious nature or any
other transaction notified under section 12 of the act is reported to the appropriate law
authority. Suspicious transactions should also be regularly reported to the higher
authorities / head of the department. Further the compliance cell of the intermediary
should randomly examine a selection of transaction undertaken by clients to comment on
their nature i.e. whether they are in the suspicious transactions or not.

6.2.10 DESIGNATION OF AN OFFICER FOR REPORTING OF SUSPICIOUS
TRANSACTIONS
To ensure that the registered intermediaries properly discharge their legal obligations to
report suspicious transactions to the authorities, the Principal Officer would act as a
central reference point in facilitating onward reporting of suspicious transactions and for
playing an active role in the identification and assessment of potentially suspicious
transactions. Names, designation and addresses (including e-mail addresses) of Principal
Officer including any changes therein shall also be intimated to the Office of the
Director-FIU. As a matter of principle, it is advisable that the Principal Officer is of a
sufficiently higher position and is able to discharge his functions with independence and
authority.



70
6.2.11 SUSPICIOUS TRANSACTION MONITORING & REPORTING
Intermediaries should ensure to take appropriate steps to enable suspicious transactions to
be recognised and have appropriate procedures for reporting suspicious transactions. A
list of circumstances which may be in the nature of suspicious transactions is given
below:
Table 6.2: Indicative List of Suspicious Activities
Category Examples of Suspicious Transactions
Identity of
Client
o Identification documents were found to be forged
o Address details given by the account holder were found to be
false
o Doubt over the real beneficiary of the account
Suspicious
Background
o Positive match of name and date of birth with person on
various watch lists
o Account of publicly known criminals
Multiple
Accounts
o Large number of accounts having a common account holder,
introducer or authorized signatory with no rationale or bona
fide purpose
o Unexplained transfers between multiple accounts with no
rationale
Activity in
Accounts
o Unexplained activity in dormant accounts
o Unexplained activity in account inconsistent with what would
be expected from declared business
Nature of
Transactions
o Doubtful source of funds
o Doubtful overseas fund transfer
o Doubtful foreign remittance to non relatives
o Doubtful cash deposits in a bank account at multiple locations
o Suspicious use of ATM/ Credit card
o Doubtful foreclosure of loan account in cash
o Suspicious off-market transactions in demat accounts
Value of
Transactions
o Multiple transactions of value just under the reporting
threshold amount in an attempt to avoid reporting
o Unexplained large value transaction inconsistent with the
clients apparent financial standing






71
6.2.12 REPORTING TO FINANCIAL INTELLIGENCE UNIT-INDIA
In terms of the PMLA rules, intermediaries are required to report information relating to
cash and suspicious transactions to the Director, Financial Intelligence Unit-India (FIU-
IND)
TABLE 6.3:Obligations Of Reporting Entity Under PMLA
OBLIGATION DETAILS WHEN
Communicate details of
Principal Officer
Communicate the name,
designation and address of the
Principal Officer to FIU-IND
At the time of appointment/change
of principal officer
Verify identity of Clients Verify identity, current address
including permanent address,
nature of business and financial
status of the client
At the time of opening an account
as well as executing any
transaction
Implement a Client
Identification Programme
Formulate and implement a client
identification programme to
determine true identity of clients
and forward a copy of the same to
FIU-IND
At the time of formulation
/modification of CIP
Evolve internal mechanism for
maintaining and furnishing
information
Details of the internal mechanism
have been prescribed by the
respective regulators
Ongoing
Furnish Information of cash
transactions
Furnish Cash Transaction (CTR)
to FIU-IND containing details of:
All cash transactions of the value
of more than rupees ten lakhs or
its equivalent in foreign currency

All series of transactions integrally
connected to each other which
have been valued below rupees
ten lakhs or its equivalent in
foreign currency where such
series of transactions have taken
place within a month
Within 15
th
day of the succeeding
month (Monthly Reporting)
Furnishing information of
counterfeit currency
transactions
Furnish Counterfeit Currency
Report (CCR) to FIU-IND
containing details of all cash
transactions where forged or
counterfeit currency notes or bank
notes have been used as genuine
or where any forgery of a valuable
security or a document has taken
facilitating the transactions.
Within 7 days from the date of the
transaction.
Furnishing Information of
Suspicious Transactions
Furnish STR to FIU-IND
containing details of all suspicious
transactions whether or not made
in cash
Within 7 working days on being
satisfied that the transaction is
suspicious
Maintain and Retain records Maintain records of identity of
clients and records of all
transactions reported to FIU-IND
For a period of Ten years after
cessation of relationship with the
client
FINES Director, FIU-IND is empowered to
levy fine on reporting entities of
not less than Rs. Ten thousand
which may extend to Rs. One lakh
for each failure
72
Table 6.4: Suspicion Transaction Report (STR) Submitted by Category to FIU-IND
Category 2006-07 2007-08 Percentage Increase
Banks 437 1183 271%
Financial Institutions 88 288 327%
Intermediaries 292 445 152%
Source: FIU-IND Annual report 2007-08

Prevention of Money Laundering Act, which makes it compulsory for financial sector to
report suspicious transactions to the FIU-IND, came into effect in the year 2005, since
then Financial Institutions have shown the most remarkable growth in terms Suspicious
Transactions Reported (STR) to the FIU-IND, followed by Banks. Intermediaries such as
brokers have recorded the lowest growth in terms of STRs reported. This trend could be
explained by the fact that launderers use mostly use banks and financial institutions
during the placement stage wherein cash enters the financial system as compared to that,
intermediaries are used during the layering and integration phase of the laundering
process, when funds are already present in the system. Hence Intermediaries are not
being able to detect such activities. Thus leading to such low rate of report filings.

FIG 6.1: Type of Suspicion Reported in STRs
Type of Suspicion Reported in STRs
0
500
1000
1500
2000
2500
Years
N
o
.

o
f

S
T
R
s
2006-07 2007-08
2006-07 107 79 164 287 159 176 112 817
2007-08 395 97 129 695 682 488 338 1916
Identity of
Client
Background
of Client
Multiple
Accounts
Activity in the
Account
Nature of the
transactions
Value of the
transactions
Miscellaneou
s
Total

Source: FIU-IND Annual report 2007-08

73
FIG 6.1 graphically displays the type of suspicions which have been reported in STRs
submitted to the FIU-IND during the two years of its operation. It is observed from the
graph that the type of suspicions reported to FIU have been mainly in the nature of:
activity in the account, nature of the transaction and value of the transaction. These 3
heads of suspicion have also seen much of the increase in STRs reported in the year
2007-08 over the year 2006-07. This implies that intermediaries must implement
effective monitoring mechanisms to monitor transactions.

Table 6.5: STR Processing Stage Wise
Category 2006-07 2007-08 Total
STRs Received 817 1916 2733
STRs Brought forward from
Previous Year - 171
STRs Processed 646 2001 2647
STRs Disseminated 391 935 1326
Percentage of STRs Disseminated to
STRs Processed 60.5% 46.7% 50%

Table 6.5 depicts the Suspicious Transaction Reports handled by Financial Intelligence
Unit-IND. Thus FIU work has mainly related to two heads i.e. STR Processing and STR
dissemination to the appropriate law enforcement agency. Only after STR are processed
they are disseminated to the enforcement agency. Over the years 2006-07 to 2007-08, it
can be observed that percentage of STRs Disseminated to STRs Processed has declined.
It can be inferred that eventhough STRs reported have increased significantly over the
year, the quality of STR being reported are poor leading to such low dissemination.

6.2.13. EMPLOYEES HIRING/EMPLOYEES TRAINING/ INVESTOR
EDUCATION

Hiring of Employees
The registered intermediaries should have adequate screening procedures in place to
ensure high standards when hiring employees. They should identify the key positions
within their own organization structures having regard to the risk of money laundering
74
and the size of their business and ensure the employees taking up such key positions are
suitable and competent to perform their duties.

Employees Training
Intermediaries must have an ongoing employee training programme so that the members
of the staff are adequately trained in AML procedures. Training requirements should
have specific focuses for frontline staff, back office staff, compliance staff, risk
management staff and staff dealing with new customers. It is crucial that all those
concerned fully understand the rationale behind these guidelines, obligations and
requirements, implement them consistently and are sensitive to the risks of their systems
being misused by unscrupulous elements.

Investors Education
Implementation of AML measures requires intermediaries to demand certain information
from investors which may be of personal nature or which has hitherto never been called
for. Such information can include documents evidencing source of funds/income tax
returns/bank records etc. This can sometimes lead to raising of questions by the customer
with regard to the motive and purpose of collecting such information. There is, therefore,
a need for intermediaries to sensitize their customers about these requirements as the ones
emanating from AML framework. Intermediaries should prepare specific literature/
pamphlets etc. so as to educate the customer of the objectives of the AML programme.

6.3 Conclusion
SEBI alongwith Self Regulatory Organisations like Stock Exchanges have been actively
involved in ensuring Anti-Money Laundering Measures and Controls. Eventhough much
of the Anti-Money Laundering compliances to be implemented are dictated by
regulations, financial intermediaries are slowly moving to voluntary and wider anti-
money laundering standards than that laid down by the regulatory agencies. In terms of
reporting suspicious transaction to the FIU-IND, the STRs reported have increased
significantly showing that intermediaries and financial institutions are much more pro-
75
active in ensuring money laundering compliance. However Intermediaries have shown
the lowest growth in STRs reported. Much of the Anti-Money Laundering measures
revolve around the 7 key elements i.e. Risk Classification, Customer Acceptance Policy
and Identification procedures, Reporting, On-going Monitoring Processes, Reporting,
Customer and Staff education and awareness.
76
CHAPTER 7: SUMMARY, FINDINGS AND CONCLUSION

7.1 INTRODUCTION
This chapter seeks to present the key findings of the project in a summarized and brief
manner.

7.2 SUMMARY
The basic idea underlying money laundering is to disguise the illegal origin of the
illicit funds so that the illicit funds look like they have arisen from a legal source.
With the evolution of newer technologies and offshore financial centres, money
laundering has attained a global characteristic.
Money Laundering has evolved into a Professional and Complex Activity.
Money laundering is a continuous process and involves a chain of transactions.
A typical money laundering transaction follows a three stage process consisting of
Placement, Layering and Integration.
The biggest problem for a launderer is that cash is bulky. The Second Biggest
problem for a launderer is that most financial transactions leave an audit trail.
Money laundering now ranks as the third largest business globally after foreign
exchange and oil
Globally launderers use a variety of methods and techniques to launder funds.
Every stage in the money laundering process has certain distinctive methods and
techniques which the money launderers employ.
In India, Hawala, Import/Export transactions, smuggling of currency and the use
of tax havens are the most prevalent form of money laundering techniques
Securities Market is mostly used during the layering and integration phases of the
money laundering process.
Launderer through stock purchase method purchases securities with illicit funds
and then uses the proceeds from selling these securities as legitimate money.
Brokerage and investment firm occupy the second highest position in terms of
susceptibility to money laundering activities after Banks.
77
Money laundering activities have been shifting from the banking sector to the
non-bank sector.
Derivatives Exchanges are also being employed by launderers to launder funds.
In India the key methods used to launder funds through capital markets have been
by using Penny Stocks, Listed Companies, Participatory Notes and Depositories.
In the case of participatory notes, the government has been reluctant in curbing
the flows coming from through this route.
Launderers use two methods for the purpose of money laundering i.e. stock
market operations and stock market manipulation.
Increased vigilance by authorities in the major financial centres to combat money
laundering activity provides an incentive for launderers to shift their activities to
emerging markets.
Financial Institutions are very essential for the development of emerging
economies. Financial Institutions are exposed to specific risks such as reputational
risks, operational risks and legal risks.
Money laundering also has a negative effect on the real sector, external sector,
business sector as well as the social aspect.
The international community has taken the issue of money laundering very
seriously. And thus formulated plethora of legislations to tackle the problem.
Pioneer among the countries has been USA which has been actively involved in
fighting the problem.
International community has recognized the fact that money laundering is not
restricted to a certain region only but is a global problem. Hence cooperation
between nations has been emphasized.
It has also been realized that money laundering targets those countries with loose
money laundering controls.
India too has taken legislative steps to actively tackle the problem of money
laundering through enactment of Prevention of Money Laundering Act, 2002.
Currently India is in the process of amending the Prevention of Money
78
Laundering Act, 2002 to include within its fold terrorist financing and inclusion
of non-financial professionals.
India has largely complied with the FATF Recommendations as applicable to the
financial markets.
Anti-Money laundering measures have been laid down by the SEBI Guidelines
as applicable to intermediaries and by the PMLA Act, 2002.
Much of the Anti-Money Laundering measures revolve around the 7 key
elements i.e. Risk Classification, Customer Acceptance Policy and Identification
procedures, On-going Monitoring Processes, Record-Keeping, Reporting,
Customer education and awareness, Staff education and awareness.
Obligations for intermediary reporting and the time frame for reporting have
been set out under the PMLA Rules.
Intermediaries have recorded the lowest growth in terms of STRs reported to
FIU-IND.

7.3 FINDINGS

7.3.1 To compare and contrast various money laundering methods/techniques being
practiced in India and abroad
Laundering from its earlier days of laundering funds through Laundromats has
evolved into a complex and global activity, which makes use of new technologies,
offshore centres and professionals.
Every stage in the laundering process i.e. Placement, Layering and Integration has
a distinctive set of laundering methods or techniques.
In India the most prominent techniques used to launder money are Hawala
system, use of tax havens, import/export transactions and smuggling of currency.
Brokerage and Investment firms occupy the second highest position in terms of
susceptibility to laundering activities.
Launderers are shifting laundering activities from the banking sector to the non-
banking financial sector.
79
Laundering through stock exchanges in India have occurred through use of penny
stocks, use of listed companies, use of participatory notes and use of depositories.
Government has shown reluctance in curbing flows coming from the offshore
derivative instrument route. This is on account of large capital inflows coming
through this route are very important for a developing economy like India.

7.3.2 To assess and evaluate socio-economic impact of money laundering activities
as a whole to the economy, with special focus on financial markets
Launderers seek countries with loose anti-money laundering controls. With
countries of the west enforcing strict anti-money laundering norms, launderers are
shifting to developing countries which have loose anti-money laundering controls.
For developing countries such capital flows are important for economic
development. Hence they tend to postpone action against such flows of capital
thus allowing crime to become entrenched.
Laundering impacts various constituents of the economy, finally impacting the
entire economy as a whole.

7.3.3 To compare and contrast legislative measures presently existing for anti-
money laundering in India and abroad.
The current anti-money laundering measures have evolved from various
legislations.
The beginnings of the fight against money laundering centered around banking
institutions. From the year 1988 onwards the thrust area widened to include drugs.
USA has been highly active in the fight against money laundering. Post 9/11 USA
has furthered its fight against money laundering by covering financing of
terrorism by enacting the PATRIOT Act, 2001.
Financial Action Task Force has laid down universal standards to be applied by
all its member countries. India has applied all the recommendations as applicable
to financial institutions and intermediaries. Thus India is adhering to international
standards in protecting itself from money laundering.
80
7.3.4 To examine the checks used by stock brokers and intermediaries for
ensuring effective anti-money laundering compliance.
Much of the Anti-Money Laundering measures revolve around the 7 key elements
i.e. Risk Classification, Customer Acceptance Policy and Identification
procedures, On-going Monitoring Processes, Record-Keeping, Reporting,
Customer education and awareness, Staff education and awareness.
Intermediaries have recorded the lowest growth in terms of STRs reported. This
trend could be explained by the fact that launderers use mostly use banks and
financial institutions during the placement stage wherein cash enters the financial
system as compared to that, intermediaries are used during the layering and
integration phase of the laundering process, when funds are already present in the
system. Hence Intermediaries are not being able to detect such activities. Thus
leading to such low rate of report filings.
Much of the STRs filed with FIU-IND have related to transactions of the clients.
Thus it is imperative for intermediaries to effectively monitor transactions.
STRs processed have increased significantly however dissemination have
reduced, this could indicate that the quality of STRs filed have been poor or
without sufficient analysis.

7.4 CONCLUSION
Capital market integrity can only be ensured when laundered funds are not allowed to
mix with pure capital. If capital markets consist of healthy funds from legal sources, it
leads to the creation of a healthy and vibrant capital market which in turn boosts
corporate growth and gives the economy a strong foundation. Anti-money laundering
measures and compliances weed out the bad money and allow only pure capital to enter
the capital market. India has in place an effective anti-money laundering control system
which adheres to universal standards. However intermediaries on their part have to be
vigilant to see that anti-money laundering measures are implemented in letter as well as
in spirit.

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ANNEXURE I:
Customer Identification Procedure Features to be verified and documents that may
be obtained from customers
Type of Entity Documents to be verified
Individuals

(i) Passport (ii) PAN card (iii) Voter's
Identity Card (iv) Driving licence (v)
Identity card (vi) Letter from a recognized
public authority or public servant verifying
the identity and residence of the customer
to the satisfaction of bank (i) Telephone
bill (ii) Bank account statement (iii) Letter
from any recognized public authority (iv)
Electricity bill (v) Ration card (vi) Letter
from employer (any one document which
provides customer information)
Companies (i) Certificate of incorporation and
Memorandum & Articles of Association
(ii) Resolution of the Board of Directors to
open an account and identification of those
who have authority to operate the account
(iii) Power of Attorney granted to its
managers, officers or employees to transact
business on its behalf (iv) Copy of PAN
allotment letter (v) Copy of the telephone
bill
Partnership Firms (i) Registration certificate, if registered (ii)
Partnership deed (iii) Power of Attorney
granted to a partner or an employee of the
firm to transact business on its behalf (iv)
Any officially valid document identifying
the Partners and the persons holding the
Power of Attorney and their addresses (v)
Telephone bill in the name of firm/partners
Trusts & Foundations (i) Certificate of registration, if registered
(ii) Power of Attorney granted to transact
Business on its behalf (iii) Any officially
valid document to identify the trustees,
settlers, beneficiaries and those holding
Power of Attorney, founders/managers/
Directors and their addresses (iv)
Resolution of the managing body of the
foundation / association (v) Telephone bill