Table of Contents
- 1. Unusual Transaction patterns
- 2. Structuring (Smurfing)
- 3. Usage of Shell companies
- 4. Rapid Movement of Funds
- 5. High-Risk Jurisdictions
- 6. Inconsistent or false documentation
- 7. Reluctant to Provide Information
- 8. Usage of Cryptocurrencies
- 9. Politically Exposed Persons (PEP)
- 10. Unusual Business Relationships
Introduction
Money Laundering and Terrorist Financial are the biggest threats to the global financial system. Criminals and terrorist organizations constantly evolve their methods to exploit vulnerabilities. This makes essential for businesses, financial institutions, and regulators to stay alert. Recognizing red flags is the first step towards preventing illicit activities. We have gathered top 10 red flags to watch out for:
1. Unusual Transaction patterns
This red flag occurs when a customer’s intended behaviour or expected behaviour does not align with the financial transactions. These patterns indicate potential fraudulent or criminal activities.
A few examples of these are:
- A retail business which has an average monthly deposit of US$15,000 suddenly receives US$200,000 in overseas transfer.
- A person makes multiples deposits just below the reporting threshold within a few days or weeks. This might indicate an attempt to avoid detection and reporting requirements.
2. Structuring (Smurfing)
This is the act of breaking large sums of money into smaller transactions to avoid regulatory reporting thresholds.
Example:
- A person deposits amounts below the reporting threshold daily across multiple bank branches.
- Some criminals use many people to make smaller deposits
3. Usage of Shell companies
This is the act of using companies which have no legitimate business operations. These types of companies exist only on paper. It is not illegal to have a shell company, but it depends on the purpose that it is being used.
There are several reasons for shell companies to be legal:
- These companies can be established in countries where there are favourable tax laws to legally reduce a company’s overall tax burden.
- People such as high-net-worth individuals, celebrities, or business leaders may use shell companies to maintain privacy and anonymity when conducting financial transactions or owning assets.
- Private companies may use shell companies to go public through a reverse merger, avoiding the lengthy and expensive process of a traditional IPO.
Examples of the usage of shell companies:
- Criminals often use shell companies to buy expensive properties, frequently changing ownership to conceal the true owner’s identity.
- Terrorists use shell companies to hide their identities while transferring money globally.
- Shell companies are nested within other businesses in different jurisdictions to further obscure ownership
4. Rapid Movement of Funds
Rapid money movement involves the swift transfer of funds across accounts, institutions, or borders, facilitated by digital banking, payment platforms, and global financial networks. While this speed is crucial for legitimate transactions, it also presents opportunities for criminals to exploit the system.
Examples:
- Funds deposited from country A are wired to country B, then it is converted to cryptocurrency in country C.
- Transferring US$50,000 from one account to five different accounts within a short period of time, which is followed by immediate withdrawal of those fund.
5. High-Risk Jurisdictions
These jurisdictions are categorized as having a higher risk of Money Laundering and Terrorist Financing. This makes it look attractive to criminals who want to move illicit funds. There are many reasons on why these jurisdictions are known as high-risk:
- Weak or no regulatory framework: This refers to jurisdictions with weak or no AML/CFT laws. This also refers to jurisdictions with poor enforcement, mechanisms, or limited oversight on being exploited to Money Laundering and Terrorist Financing activities.
- Political Instability: These are regions which have frequent political unrest, turmoil, or weak governance. These regions are more prone to be used as hubs for illicit financial flows.
- High-level of corruption: These jurisdictions often help the movement of illicit funds through bribery, misappropriation, or other fraudulent activities.
- Conflict Zones: These are areas armed conflict or terrorism. These areas often see increased TF activities, as these zones may rely on illicit financing to sustain operations.
- Offshore Financial Centers: Offshore Financial Centers, located in jurisdictions with stringent banking secrecy laws or low tax regimes, often attract illicit funds, posing a high-risk geographical environment.
Examples of high-risk jurisdictions:
- Frequent transfers from and to sanctioned countries such as Iran, North Korea, or Myanmar.
- Usage of financial hubs with lax regulation such as Cayman Island.
6. Inconsistent or false documentation
Inconsistent or false documentation is a critical red flag in the context of Anti-Money Laundering (AML) and Combating the Financing of Terrorism (CFT). It involves the deliberate use of fraudulent, altered, or misleading documents to conceal the true nature of financial transactions, obscure the identities of individuals or entities, or facilitate illicit activities.
Examples:
- Fake Identification Documents: Usage of forged passport, national IDs, create false identities or conceal the identity of individuals involved in illicit activities.
- Fraudulent Business Documents: Creating fake incorporation certificates, ownership records, or documents used to legitimize shell companies or front businesses.
- Altered Financial Records: Manipulation of receipts, invoices, or bank statements to misrepresent the source, destination, or purpose of funds.
- Inconsistent Information: Discrepancies between documents provided by a customer and information obtained through independent verification (e.g., mismatched addresses, names, or dates).
7. Reluctant to Provide Information
This refers to customers avoiding to answers questions regarding fund sources or business activities.
Examples:
- A client refusing to disclose the Ultimate Beneficial Owner (UBO) or nature of their business.
- Inconsistent explanation to transactions, for example at first when asked the client says the transaction is a gift and the next time says it is a loan.
8. Usage of Cryptocurrencies
Cryptocurrencies, like Bitcoin and Ethereum, have garnered substantial attention because of their decentralized nature, anonymity, and global reach. While these features provide advantages such as financial inclusion and innovation, they also pose vulnerabilities that can be exploited for illegal activities, including money laundering and terrorist financing.
Examples:
- Sanctioned country like North Korea has been accused of using cryptocurrencies to fund their nuclear program and bypass international sanctions.
- There have been cases of the usage of cryptocurrency wallets by terrorist groups. In 2020, the US Department of Justice seized cryptocurrency wallets linked to terrorist groups like Al-Qaeda and ISIS.
9. Politically Exposed Persons (PEP)
These persons are high-risk individuals in position of power (e.g., politicians and military leaders). Not only the individuals who hold position are PEPs but also close associates and family members. These individuals are probe to high-risk of Money Laundering and Terrorist Financing as they can misuse their power.
Examples:
- PEPs receiving large amount of funds from state-owned enterprises or foreign governments.
- Family members of PEPs who are setting up offshore accounts.
10. Unusual Business Relationships
This refers to business relationship which have a non-transparent corporate structures or illogical partnership.
Examples:
- A tech startup in Hong Kong receiving millions from a seafood exporter in Germany.
- A non-profit with no staff or website donating large sums to unknown entities.