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Securities markets let criminals double dip--vulnerable to fraud and money laundering.

EVERYONE loves a package deal--especially criminals. The fast-paced international financial securities trade offers a complex business prone to fraud with the means to launder ill-gotten gains at the same time. Keith Nuthall reports.

THE RECESSION has given plenty of examples of how, as Warren Buffet eloquently put it, "only when the tide goes out do you discover who's been swimming naked." The Bernie Madoff scam; the Sir Allen Stanford scandal; India's Satyam fraud--2008 and 2009 were the years where the sharks were beached. And this cacophony of commercial crime has tainted the reputation of complex financial trades such as securities.

And for good reason, according to a report from global anti-money laundering watchdog the Financial Action Task Force (FATF): the shifting and opaque trades of international securities markets do not just offer an excellent environment in which to practice fraud, they offer almost tailor-made systems in which to hide the proceeds.

Its comprehensive assessment 'Money laundering and terrorist financing in the securities sector' notes: "Some of the features that have long characterised the industry, including its speed in executing transactions, its global reach, and its adaptability, can make it attractive to those who would abuse it for illicit purposes, including money laundering and terrorist financing. Moreover, the securities sector is perhaps unique among industries in that it can be used both to launder illicit funds obtained elsewhere, and to generate illicit funds within the industry itself through fraudulent activities. Transactions and techniques associated with money laundering and the specific predicate securities offences are often difficult to distinguish ... " The multiple relationships involved in securities trading are especially vulnerable to insider dealing, notes the report. And the same is true of Ponzi schemes. Investors have to trust their money managers--there is little hope they can monitor the movement of their wealth in complex securities trades. So if an investment firm is bent--their duped clients will find it much harder to detect their dishonesty in securities than in simple trades of shares. And then there is market manipulation, controlling or artificially affecting market prices. 'Pump-and-dump' schemes are probably the most notorious of these scams--touting a company's stock with false or misleading statements that increase a company's value, until the truth is revealed and prices collapse, long after the crooked investor has cashed in.

So, securities trades are vulnerable to fraud. And FATF would not be the first organisation to make that claim. However the organisation breaks new ground in highlighting the pernicious fact that securities are simultaneously useful for laundering these fraudsters' illicit funds. One problem, noted FATF is that suspicious transaction reporting in the sector remains relatively low, partly because of a lack of awareness of its vulnerability to launderers and "insufficient securities-specific indicators and case studies," a weakness its report aims to remedy.

A series of particularly acute problems are pointed out by the international organisation. One focuses on 'bearer securities', which consist of both physical equity and debt securities, but which (unlike registered securities), do not require an owner to register with an issuer or a transfer agent. "The transfer of bearer securities can be as simple as handing the security over to a new owner," noted the report, adding that this transaction can in some jurisdictions be carried out "through electronic means that inhibit tracking any change of ownership". Furthermore, some bearer bonds "are almost equivalent to cash because they can be easily redeemed at financial institutions," a gift to money launderers. FATF explained: "Illicit assets can be placed in the securities industry through the purchase of bearer securities. Once a bearer security has been issued, money launderers or terrorist financiers can hold these securities or transfer them to an intended recipient" without using reputable financial facilities that would even record a transaction, let alone conduct know-your-customer checks.

Another vulnerability is created where variable annuity contracts have (as they usually do) a 'free look' or 'cooling off' period of ten or more days. These allow an investor to terminate a contract without paying any penalties, with a full refund paid reflecting the account value on termination or purchase payments. "This ... gives rise to a particular risk: a money launderer can purchase a variable annuity and then seek a refund during the free look period. The cheque received from the insurance company may not draw suspicion when deposited at a bank," noted FATF.

The anti-money laundering organisation also highlighted the risks involved with low priced securities, or 'penny stocks'. These cheap securities "can be acquired by investing illicit assets into a company that is about to become public. Once the company goes public, the money launderer can sell his or her stake, thereby giving funds the appearance of having been derived from a legitimate securities transaction," said the report. Also criminals can invest in a private company they can then use as a front for mixing illicit and legitimate assets. "They can then take this company public through an offering in the public securities markets, thus creating what appear to be legitimate offering revenues." Options contracts also pose a laundering risk where one party agrees to enter into an options contract on poor terms to guarantee that the counterparty receives a net payment. "In this respect, an ... option can be used as a method of transferring funds," explained FATF. Internet-based securities trading "pose particular challenges" to know-your-customer procedures because there are no face-to-face meetings involved. "This can hamper the ability of a firm to establish an adequate customer profile, which in turn can hamper the firm's ability to detect suspicious activity," said FATF.

Also the use of use of securities to pay for other securities can really help clean dirty money, especially where shares of a different type are issued by a company or new shares are issued in a takeover. "The exchange of shares is a potential way of moving value from one company to another," said FATF, which noted if illicit funds buy shares in a company, "these may be harder to trace once the shares are exchanged for those in another company".

And trust and nominee accounts muddy the waters still further. "A particular risk involves jurisdictions where the formation of a trust or nominee account does not require the collection of beneficial ownership information for individuals," said FATF, noting this can clearly "mask an individual's identity" allowing them to use a financial system to which access might "otherwise be restricted or forbidden".
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Author:Nuthall, Keith
Publication:International News
Date:Feb 1, 2010
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