Spying on Money

Published November 17, 2001

Finance Minister Paul Martin was in good company when he promised to use this weekend’s G20 summit to “strengthen international measures to counter terrorist financing.” Days after Sept. 11, British Prime Minister Tony Blair promised an offensive against terrorist money. So did U.S. Secretary of State Colin Powell. It was a key point of agreement earlier this week when U.S. President George Bush met his Russian counterpart, Vladimir Putin.

The crusade is also on the agendas of all major international organizations, including the United Nations and the Organization for Economic Co-operation and Development (OECD). The same is true of both the International Monetary Fund and the World Bank, both of which will discuss terrorist financing in Ottawa this weekend.

The level of international agreement is remarkable, perhaps even unprecedented: It is all but certain that the world’s machinery for fighting the illicit movement of money will be expanded to go after terrorist cash.

And that has critics horrified.

“Tracking down terrorists is an excellent idea,” says Veronique de Rugy, a policy analyst at the Cato Institute in Washington, D.C. “Going after their assets, freezing them, punishing them is a wonderful idea. However, you don’t want to punish innocents. And you want to do it in an effective way.”

But that’s not what is about to happen, Ms. de Rugy fears. The fight against terrorist cash will not be effective. And it will certainly punish innocents.

Those fears are based on experience. In 1988, the United Nations’ Vienna Convention on illegal drugs called on countries to attack money laundering — the practice of moving money around to disguise its criminal origins. Until then, money laundering was not a crime (except in the United States, where it had been criminalized in 1985). In response to the convention, Canada made the practice illegal in 1989.

The intent was to focus law enforcement on the money; if criminals didn’t profit from crime, the theory went, they wouldn’t do it.

This was revolutionary thinking in law enforcement. Previously, police would twig to a suspect, then examine his finances in hopes of finding evidence of the crime. They would also try to determine whether the suspect’s money included proceeds of his crime, which could be seized, but that was only secondary. What mattered was nailing the bad guy.

The new crime of money laundering reversed that. Instead of investigating financial transactions after identifying a suspect, law enforcement would sift through financial transactions to identify suspects.

The problem with that theory is that there are literally billions of financial transactions every day. And they are private. Not only would it be impossible for law enforcement to monitor them, it would be a profound violation of privacy.

A solution was proposed by a group called the Financial Action Task Force (FATF), a body set up by the G7 and the OECD in 1989. It called on countries to make it mandatory for anyone in a financial service business to monitor their clients for “suspicious activity” and to report any such activity. In effect, every bank officer, lawyer, accountant, casino cashier, real estate agent, stockbroker and money changer in the world would be forced to work for law enforcement.

Earlier this month, Canada’s law establishing this system came into force. The linchpin is “FINTRAC,” a new federal agency whose job is to analyse the tens of millions of reports it is expected to receive every year. The agency’s motto is “taking the profit out of organized crime,” but Alan Gold, a former president of the Criminal Lawyers Association, says that, in creating FINTRAC the government has done something far less noble. “They have created a giant system of snitches that Stalin would be proud of.”

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Over the last decade, money laundering became an obsession within governments and law enforcement. International groups, monitoring agencies and special police units proliferated. Private consultants sprang up to help companies comply with the new regulations. Calendars filled with money laundering conferences — the RCMP hosted one just last month in Montreal — at which the beneficiaries of the new crusade met to swap tactics and promote the idea that this was the future of law enforcement. (An RCMP spokesman said no one was available to comment for this story.)

Money laundering is “the No. 1 buzzword,” says Margaret Beare, director of Nathanson Centre for the Study of Organized Crime and Corruption at Osgoode Hall Law School and a former policy director for the ministry of the solicitor general. In the space of a decade, money laundering went from being something that wasn’t even criminal to dominating the fight against crime. “It’s now become the law enforcement strategy,” Ms. Beare says.

That revolution is particularly striking since there is no solid evidence that it works.

The U.S. largely invented the strategy and has been using it longer than any other country, but it has little to show for the effort. In July, U.S. Treasury Secretary Paul O’Neill told a Senate hearing the U.S. measures had done little or nothing to stop the flow of criminal money. Mr. O’Neill added that little had been accomplished by international efforts to impose sanctions on jurisdictions, such as some Caribbean islands, that attract capital with tight bank secrecy laws and low taxes.

The U.S. government’s 2001 National Money Laundering Strategy, although filled with confident statements about future success, implicitly acknowledges there is no evidence so far that such measures have done much good. “We do not have a system in place that objectively evaluates which strategies have proven to be most effective,” the strategy paper notes, citing a lack of “objective means to measure our enforcement efforts.”

The first step in the U.S. crackdown was to force banks to report all cash transactions of more than $10,000. Economist Lawrence Lindsey noted in a speech to the Competitive Enterprise Institute, a Washington, D.C. think-tank, that between 1987 and 1997, “the government collected 77 million currency-transaction reports, something in the order of 62 tons of paper. Out of that, it was able to prosecute 3,000 money laundering cases. That is roughly one case for every 25,000 forms filed. …

“Of the 3,000 money laundering cases prosecuted, the government managed to produce only 580 guilty verdicts. In other words, in excess of 100,000 reports were filed by innocent citizens in order to get one conviction. That ratio of 99,999 to one is something we would not normally tolerate as a reasonable balance between privacy and the collection of guilty verdicts.”

The U.S. government also collects “Suspicious Activity Reports” from employees of financial institutions. There are guidelines suggesting what activities may be “suspicious,” but no objective rules. That vagueness leaves banks unsure of when they should report, so they tend to err on the side of caution: From 1996 to April, 2001, American banks filed more than half a million reports of suspicious activity. FinCEN, the agency that handles them, estimates that only one in five actually involved serious crime.

Even those numbers overstate the effectiveness of having banks snitch on customers. Margaret Beare notes that in the early 1990s, Canada was pressed hard by the U.S. to adopt the U.S. reporting system. “They had said to us that it would trigger investigations,” she recalls. So Canadian officials asked their U.S. counterparts “for the name of some cases where you would argue that bells rang and cases were triggered. They produced a list of cases.” Canadian justice department lawyers went through the cases one by one, and found that “virtually in every case there was (already) an ongoing investigation or (the investigation) had been triggered by something else.”

One problem is the sheer volume of information. With hundreds of thousands or even millions of reports to wade through, monitoring agencies and law enforcement can easily miss the needle in the haystack. That’s what happened in the case of Aldrich Ames, the CIA agent paid by the Soviet Union to spy on the U.S. For years he made suspicious bank deposits far in excess of his salary. His bank noticed and repeatedly filed Suspicious Activity Reports. No alarms were sounded, no investigation launched.

This problem is only compounded when money laundering laws are toughened by including more financial institutions or calling for more reporting. The haystack gets bigger and the needle that much harder to find.

And no matter how wide or tough the reporting requirements may be, they will still be far from foolproof. Despite the vast effort and expense put into the U.S. system, the nine Florida bank accounts operated by the al-Qaeda terrorists who carried out the World Trade Center attacks were only found long after it was too late.

An even bigger hurdle is the existence of what the FATF calls “alternative remittance systems.” These include hawala, or hundi, the traditional South Asian system in which a network of brokers transfer funds, in exchange for a small fee, without any cash actually moving — one broker simply accepts a sum at one end and asks another to give an equal sum to the recipient at the other end. Often, not a scrap of paper is involved so the transaction is entirely untraceable. This system, in place for centuries, is often used by immigrants to send money home to family members where there are no banks, or where corruption makes it dangerous to send money by formal channels.

To date, there is no clear evidence that hawala was used in carrying out the events of Sept. 11, but there has been a great deal of discussion about banning it, or at least forcing it into the mould of western banks. It is extremely unlikely either could be done. As an FATF report noted, hawala is banned in India, yet “some estimates conclude that up to 50 per cent of the economy uses the hawala system for moving funds.”

The FATF also found that “nearly all” its member countries reported the existence of “alternative remittance activity in their jurisdictions.”

By any reasonable measure, the job of extending official moves against money laundering to all the world’s transactions, and making those mechanisms work effectively, is immensely difficult. It may be utterly impossible.

This is the core reason why many observers are deeply skeptical of the headlong rush to expand the anti-money-laundering apparatus. And despite the apparently unanimous call in official circles to fight terrorism this way, some in high places share the critics’ skepticism.

One is Lawrence Lindsey, now Mr. Bush’s chief economic adviser. Aided by Mr. Lindsey, the White House took a “very responsible approach” to money laundering, says Brad Jansen, a policy analyst for the Free Congress Foundation, a conservative Washington think-tank. “The attitude is that you set goals, you set up objective ways of measuring that you meet those goals, and you stop doing things that don’t work and you focus on the things that do work.”

At least that was the approach until Sept. 11. After the attacks, says R.T. Naylor, a professor of economics at McGill and a leading expert on financial crime, “all the law enforcement types and the follow-the-money zealots jumped on the bandwagon.”

In the emotional turmoil following the tragedies, skepticism was unwelcome and politically dangerous. “There was resistance growing in the Bush administration,” says Mr. Naylor, “but then it got scuttled.”

Soon after Sept. 11, a series of money laundering measures surfaced in Congress as part of the drive against terrorism. Most had been rejected by Congress before. Most had been opposed by the White House under Mr. Bush. And yet, with only the slightest examination and virtually no dissent in Congress or the White House, they sailed through.

How much did this have to do with fighting terrorism and how much with getting a rubber stamp on law enforcement’s wish list? Mr. Naylor suspects it was much more the latter. He points out that a key part of the post-Sept. 11 legislative binge was a push for “tougher laws to deal with funds that arise from international corruption. Now what the hell that’s got to do with terrorist financing is beyond me.”

Still, the rush to make the fight against money laundering a key part of the war on terrorism went ahead with blinding speed. At the end of October, the FATF announced it would expand its core mandate and “crack down on terrorism.”

Canada’s anti-terrorism legislation extended the mandate of FINTRAC in the same way. A finance department spokesperson was unavailable for comment, but ministry staff supported the extension of the FINTRAC mandate, pointing to an FATF report. “Experts provided examples,” the report states, “which appear to indicate the same laundering methods are used by both terrorism and organized crime.”

True or not, that is irrelevant, says R.T. Naylor. Anti-money-laundering systems will be even less effective against terrorism than they have been against organized crime, he argues. “It doesn’t take any money to pull off an operation like this. Sept. 11 probably cost $200,000, spread over 20 people. It’s pocket change.” Even if the authorities did detect and cut off the transfer of terrorist cash, terrorist cells could easily finance themselves. “They could do anything. Petty crime, scams, welfare scams. They could put it on their credit cards. They could do anything like that. So all of this money trail stuff is nonsense.”

Mr. Naylor stresses the lack of evidence supporting the call for a crackdown on money laundering, and considers it folly to try to extend that crackdown to the fight against terrorism. And yet it continues to thrive and expand because, he says, money laundering is big business — not for mobsters but for cops and companies. “You have a huge lobby perpetuating it. Not just the police, but all this private security stuff attached to the institutions, so-called think tanks and all this stuff and they’re going to just keep pushing and pushing and pushing.”

That explains in part why, after Sept. 11, the anti-money-laundering machinery was immediately tapped as a key way to fight terrorism. But many critics feel there’s something else at work. “The exercise is being driven internationally, by groups like the Financial Action Task Force, so I think it’s important to sort of know what’s their motivation,” says Margaret Beare of the Nathanson Centre. “I think increasingly it’s not criminal proceeds as such, it’s not drug cases as such.” A major concern, she says, “may be tax evasion and capital flight.”

For years, the European Union and the OECD, supported by the Clinton administration, have fought against what they call “unfair tax competition.” What is “unfair” competition? According to the OECD, it’s a jurisdiction that has bank secrecy laws and “no or nominal taxes.” Such jurisdictions are tax havens, influencing individuals and companies to make capital decisions that are “purely tax driven.” The high-tax countries of Europe and the OECD feel that is harmful and unacceptable — not least because the capital those havens attract comes from them.

“There is really a hidden agenda,” says Ms. de Rugy of the Cato Institute. “The hidden agenda is the one of the OECD and the EU in fighting against low-tax countries. (They’ve) been willing to get rid of financial privacy for a long time because they’re fed up with having their taxpayers escape from their punitive tax regimes and placing their money in offshore centres.”

Ms. de Rugy points out that tax havens do not protect criminals or their cash. Most have law enforcement agreements with other countries, “which means that when someone is under investigation for a crime, the financial privacy is suspended.” Assets can be examined, frozen and seized. What the tax havens tend not to do — and this is what angers the EU and other nations — is follow the new money laundering strategy: Suspend financial privacy so law enforcement can sift through transactions and find new suspects.

Ms. de Rugy and other critics feel the so-called tax havens’ approach to law enforcement is the proper one. It is the strategy of the major nations — including Canada — that is both useless and harmful.

There is little hope among the critics that governments will be persuaded of this any time soon. The atrocities of Sept. 11 have seen to that. “This is going to give this whole anti-money-laundering hysteria a new energy,” says R.T. Naylor. “People were running out of patience with it. People were saying, ‘Look, we’ve got legislation after legislation,’ and finally they were asking, ‘Give us some proof that it works.’ And now all of that resistance will melt away. And the authorities will scare everyone with the notion that, hey, if we don’t have tougher anti-money-laundering legislation, airplanes are going to fall from the sky on our heads.”

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