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Money laundering prevention in the US

With an increased focus on money laundering in the US the private equity industry now faces new regulations. Congress is now of the opinion that private equity funds could potentially act as financial havens for terrorists and thus the Patriot Act was passed in October 2001. Zini & Associates discuss the overall money laundering regulations in the US and explains the requirements of the Patriot Act for private equity firms in more detail.

Due in part to the size and sophistication of the United States financial system and the country's geographical proximity to the drug producing countries of South America, the US continues to have a very serious money laundering problem. It is estimated that 60 to 80 per cent of federal money laundering cases involve narcotics proceeds. Significant illegal proceeds are also generated by offences connected to organised crime and white collar crime, where criminal groups are often formed along ethnic or national lines. In addition, there is considerable laundering of the proceeds from foreign crimes. In view of that, the United States has always been in the vanguard in terms of anti-money laundering legislation.

The US money laundering laws - overview
In 1986, the United States became the first country to make money laundering a crime. It enacted a law that is the most powerful in the world. It applies to far more than drug trafficking proceeds and to much more than just cash (Title 18, US Code Sec. 1956). This extremely broad law has become a favourite weapon of federal prosecutors because of its heavy penalties and broad reach. In 1989, there were 28 convictions for money laundering in the United States. By 1998, that number had climbed to more than 1,500.

The law has an extraterritorial reach if the offence is committed by a US citizen or by a non-US citizen who conducts at least part of the offence in the United States, and if the transaction involves more than $10,000. In addition to its heavy criminal penalties of up to 20 years in prison and $500,000 in fines, the law permits civil penalty lawsuits by the government for the value of the funds or property involved in the transaction.

In addition to that, the United States have taken a number of major steps to strengthen their anti money laundering regime, including :

• the introduction of a new suspicious activity reporting (SAR) system and more comprehensive civil safe harbour provisions;

• the modification of the currency transaction reporting system so as to reduce regulatory burdens on the US banking industry by the expansion of exemptions, and the use of a simplified currency transaction reporting (CTR) forms;

• extending the list of money laundering predicate offences to cover terrorism, health care and immigration offences;

• improved cooperation between government and financial industry representatives in meeting anti money laundering objectives through the establishment of various coordinatory groups;

• the implementation of Project Gateway, which provides online financial intelligence to state and local government authorities;

• new funds transfer record keeping rules; and

• the efforts to encourage the states to enact laws and coordinate law enforcement and regulatory activity against money laundering.

Offences and forfeiture provisions
Generally the US money laundering offences and forfeiture provisions are sound and actively used in practice. Indeed there has been a large number of money laundering prosecutions in the US over recent years, both in absolute terms and relative to the practice in other countries. The money laundering offence currently applies only to a limited number of foreign predicate offences, but that should be substantially improved by proposed amendments. Substantial amendments are also proposed for the civil and criminal forfeiture provisions, and it is to be hoped that changes, such as requiring the government to prove that the property is forfeitable on the preponderance of the evidence, will not reduce the effectiveness of the current civil forfeiture provisions, which have been a key feature of the US anti-money laundering regime.

Interagency and international cooperation
US law enforcement agencies are increasingly coordinating their activities through the use of task forces and other means. Efforts are being currently made to extend this cooperation and coordination to regulatory and state agencies. International cooperation has also been strongly promoted at all levels, and the US authorities have played a leadership role in the relevant international fora. The only area of weakness relates to assistance regarding the forfeiture of criminal proceeds or instrumentalities, but proposed amendments should strengthen this position.

Extraterritorial reach
The US money laundering law contains several provisions that extend its prohibitions and powerful sanctions into foreign countries. The ‘extraterritorial jurisdiction' of the principal US money laundering law can apply to a financial transaction that occurs ‘in whole or part' in the United States if the funds involved were derived from purely foreign crimes that include drug trafficking, extortion, fraud against a foreign bank, kidnapping, robbery, or destruction of property by explosion or fire.

The crime of foreign extortion creates still-untested opportunities for federal prosecutors who can identify present or former foreign public officials who conduct financial transactions in the US with funds extortionately derived from persons who were subject to their official actions in their countries. The 176 ‘specified unlawful activities' whose proceeds can serve as the underpinning of a US money laundering prosecution also include violations of the Foreign Corrupt Practices Act and the Trading with the Enemy Act.

One of the three prongs of the money laundering law deals purely with the international transportation, transmissions or transfers, from or to the United States, of illicit proceeds if done with the intent to ‘promote the carrying on of specified unlawful activity' or if, with knowledge that the funds are from ‘some form of unlawful activity,' to conceal or disguise the nature, location, source, ownership or control of the funds or avoid a federal or state transaction reporting requirement.
Another law makes it a crime to operate a money transmitting businesses without a state license. The law defines money transmitting as ‘transferring funds ... by any and all means ... within this country or to locations abroad....' Violation carries penalties of up to five years in prison. Money services businesses are examined for BSA compliance by the Examination Division of the Internal Revenue Service (Title 18, USC Section 1960).

Civil money laundering lawsuits by the government
The Department of Justice has the unique power under the money laundering law to pursue civil lawsuits against financial institutions even though they are not charged with the crime of money laundering. The suits are based on allegations that the institutions, through their officers and employees, or individuals laundered money (Title 18, USC Sec. 1956(b)). In the case of an institution, the lawsuits seek recovery of the amount of money laundered through the institution by its employees.

The government has used it to sanction institutions for the acts of their employees without filing criminal charges against the institution. In two well-publicised cases, against Norwest Bank Great Falls in 1992 and American Express Bank International in 1995, the US filed civil actions and collected respective penalties of $327,712 and $10m.

The most famous application of the civil penalty provision of the money laundering law was against American Express Bank International in 1994 when two of its private bankers were convicted of money laundering. The US sued AEBI for $7m, the sum the employees had laundered. AEBI settled for the full amount plus an additional $3m for improved laundering controls.

More recently, in the Enron trial, the Justice Department insisted that Michael J Kopper plead guilty to a money laundering charge as part of his ‘cooperation agreement,' marking the first time a major corporate fraud of the Enron type has seen the criminal charge of money laundering lodged against a corporate officer and setting a dangerous precedent for other corporate criminals who are standing in the wing awaiting prosecution in the other major corporate crimes that have surfaced in the past year. Pleading guilty to money laundering raises the spectre of much longer prison terms than are imposed for other crimes. It also enhances the government's ability to forfeit assets for the benefit of the victims.

New compliance requirements for private equity funds
The US Patriot Act of 2002, passed in the wake of the September 11th terrorist attacks, directly affects the fundraising efforts, operations, and new investment initiatives of private equity firms. The genesis of this act was the realisation by Congress that private equity funds could provide financial havens for terrorists. Accordingly, it charged the Treasury Department, the Securities and Exchange Commission, and the Federal Reserve with devising a method for applying anti-money laundering strictures to registered investment companies and private funds. Some of the new laws are already in effect, with very short time horizons.

The Patriot Act requires financial institutions to establish anti laundering programs, which must include, at minimum:

• internal policies, procedures, and controls;

• a designated compliance officer;

• an ongoing employee training program; and

• an independent audit function to “test” all elements of the program.

Private equity firms generally fall within the Patriot Act's broad definition of  ‘financial institutions.' As a result, they are also likely to be subject to mandatory ‘know your investor' requirements, akin to the ‘know your customer' rules presently imposed on banks. These will significantly affect the fundraising and investment activities of private equity firms.

Under the Patriot Act, a private equity firm would be required to investigate and determine: (i) the source of all monies coming into a fund; (ii) the occupation and any corporate affiliations of each investor; and (iii) all lending relationships of each investor, with an eye towards rejecting those who deal with financial institutions linked to terrorist organisations.

Furthermore, private equity firms will probably be subject to ‘know your customer' rules when they invest in target companies as well. These rules would require a firm to make inquiries into the nature of a company and its officers, directors and shareholders. Private equity firms will have to satisfy ‘know your customer' requirements before they can expect to obtain financing, since banks - already subject to such rules - will require that their private equity borrowers conduct the same kind of customer diligence banks do in order to satisfy their own obligation. Indeed, Fannie Mae now requires borrowers to certify that none of the principals behind an investment are associated with any of the many terrorist organisations that appear on government lists.

Apart from the technical requirements of the Patriot Act, no private equity fund can afford the reputational and legal risks of associating with any fund investor or investment target engaged - either directly or indirectly - in terrorism, money laundering or other opaque or illegal activities. Common sense dictates that private equity funds get ahead of the curve and adopt appropriate ‘know your investor' procedures.

Copyright © 2002 Zini & Associates

Zini & Associates is an international firm providing multi-disciplinary services including legal and tax advice with a focus on highly sophisticated, cutting-edge areas of the law. It is uniquely structured and equipped to deliver coordinated legal services to multinational clients around the world in every major financial market and to assist Italian corporations in establishing their presence internationally and, in particular, in the United States. For more information please visit www.ziniandassociates.com