[A Version of this article appeared in the Winter
1999/2000 issue of Russia Business Watch]
The Regulatory Framework and Potential Implications
of the Bank of New York Money-Laundering Scandal for Russia and the United
States
Phillip L. Robinson, Esq., and Ethan S.
Burger, Ludwig & Robinson, P.L.L.C.
(Washington, D.C.)[1]
Introduction
The U.S. government’s indictment of four individuals and two companies
in connection with the alleged laundering of more than US$7 billion through the
Bank of New York (“BONY”) has significant economic and political implications
for both Russia and the United States.
The BONY situation highlights Russia’s immense problems of capital
flight, tax avoidance, and corruption.
It is also likely to stimulate new concern about the effectiveness of
existing U.S. rules aimed at combating money laundering.
This article is organized into two parts. The first part provides an economic, legal, political context for
the analysis of the issue of “money laundering” in Russia. The second part discusses the existing
regulatory framework in the United States for preventing money laundering in
light of the BONY situation and examines possible developments that may be
forthcoming.
I. Capital
Flight and Money Laundering in Russia – the Consequences of the Non-Enforcement
of Existing Rules
A. Background
In recent years, estimates of capital flight from Russia have generally
ranged from US$500 million to US$2 billion per month. The Russian Central Bank (RCB) has made certain limited attempts
to stem this flow through the adoption of various normative acts. Such attempts include imposing restrictions
on foreign exchange trading, controlling the repatriation of export revenues
and tightening bank regulations. Much
of the RCB’s efforts have focused on companies and banks operating in so called
“off-shore zones” and particular types of “suspect” transactions. Unfortunately to date, its efforts have not
been successful, in large part due to a lack of resolve and resources. Furthermore, capital flight is a
manifestation of a lack of confidence in the Russian economy and the Russian
political leadership. As a result, the
current situation is unlikely to change in the near term. Given Russia’s current regulatory framework,
capital flight is only possible by violating applicable requirements governing
the use and repatriation of foreign currency.
Frequently, such violations do not involve the laundering of money in
the traditional sense; rather they reflect a portion of elaborate tax avoidance
schemes.
The most significant problem in this area is the lack of enforcement of
existing legal requirements in Russia.
This will not change unless there is a significant change in the
country’s political culture. The
Kremlin, the Mayor of Moscow and regional leaders routinely ignore applicable
rules and judicial decisions. Another
problem is that the RCB has frequently acted to favor a select group of
politically-connected banks that may facilitate tax evasion. In the investigative departments of Russian
law enforcement and the procuracy, it is well known that there are limits to
how far an investigation can go. If one
attempts to go too far, even the Procurator General, as has been recently
demonstrated by the situation with Mr. Yuri Skuratov, is not immune from
retaliation.
One implication of the BONY scandal is that is likely to undermine
further foreign investors’ willingness to invest in Russian securities, in part
because BONY served as the principal depository for American Depository
Receipts (ADRs) of Russian companies.
Furthermore, other foreign banks active in the Russian market (e.g.
Deutsche Bank, Dresdner and Barclays) are investigating their dealings with
Russian companies and their Russian correspondent banks. This cannot but have long-term impact on
Russia’s integration into the world economy.
B. Distinguishing
between Illegal Activity Per Se and Regulatory Avoidance by Persons Otherwise
Engaged in Legal Activity
The intrusive nature of Russian regulatory activity and high taxes often
has the impact of driving businesses into the gray (or black) economy. This gives rise to an unfortunate
cycle. The Russian government lacks
adequate revenues to function and consequently cannot provide services to the
population. In the absence of the
provision of such services, the population goes to great lengths to hide its
income. Such income falls into two
broad categories – income from criminal activity such as illegal exports of
weapons, commerce in drugs and prostitution, and the bribing of state officials
for various reasons ranging from obtaining a license to fixing the outcome of a
privatization tender or court proceeding.
This first type of activity (which often requires the laundering or
hiding of income) must be distinguished from conduct that may be labeled
regulatory avoidance in connection with otherwise legal activity.
Common examples of this latter type of activity include:
-
understating value of import
contracts (to avoid customs duties and import VAT payments);
-
use of “foreign trade” contracts
to disguise purely domestic transactions;
-
avoiding mandatory conversion
of hard currency receipts; and
-
tax evasion generally.
Russian legislative prohibition on the conduct of purely domestic
Russian transactions in foreign currency in violation of Russian law results in
the need to dispose of excess cash,[2]
particularly when there is little confidence in the stability of the ruble.
C. Current
Russian Currency Regulation
The Russian Law “On Currency Regulation and Currency
Control”, dated October 9, 1992, (hereinafter the “Currency Law”) is the basis
upon which Russian currency regulation is based. It envisions the RCB’s authority to require a special license for
the movement abroad of capital which does not qualifying as a “current currency
operation” (Currency Law, Articles 1 and 6).[3] Article 14 of the Currency Law provides that
currency violators shall be held liable by means of (a) seizure by the state of
all proceeds from transactions which are illegal under the law; and (b) payment
into the state budget of assets illegally gained as a result of illegal actions
and not a transaction. Harsher
sanctions are envisioned for recurrent breaches including fines “five times
such sums or a fine in an amount determined by the Currency Control Inspectorate”
in conjunction with the RCB.
The RCB has sought to establish a system of foreign currency
control by requiring “authorized banks” to maintain “passports for foreign
trade transactions involving the import and export of goods and services
involving payment in).[4] Unfortunately, compliance with the
requirements of this system is far from uniform and enforcement has been
episodic.
Similarly, the RCB has issued rules to prevent money
laundering. For example, RCB No. 479,
“On Methodological Recommendations on Issues of the Organization of the Work of
Preventing Incomes Earned Illegally from Getting into Banks and other Lending
Organizations”, dated July 3, 1997, provides guidance to banks covering topics
such as (i) studying banks clients –
examine foundation documents (see if charter capital has not been paid in for a
long time), relationships between accounts receivable and accounts payable,
profits and after tax use of profits, reliability of audit report, etc., (ii)
suspicious transactions and transactions requiring special attention from the
bank, and (iii) recommendations to a bank for the elaboration of internal rules
for preventing money laundering.
Similarly, RCB Order No. 02-378, dated August 29, 1997, approved a procedure for organizing the internal control of financial organizations that contains provisions aimed at preventing the legalization (laundering) of illegal earnings. It requires banks to prevent incomplete or deliberately false identification of partners, clients, or other participants in transactions prior to the implementation of the transaction, requires employees of financial institutions to inform internal control services of any deviations from the standard implementation transaction practices, and gives various characteristics giving rise to suspicion (lack of economic feasibility, unjustified haste, high commissions, noticeable increase in frequency of transactions, and last minute amendments in transaction plans among other things).
The RCB has issued other documents which followed and
enforced would reduce the scope of the problem of money laundering.[5]
Not to be overlooked is the fact that money laundering is
already a criminal offense in Russia.
The Russian Criminal Code -- Article 174 – Legalization (Laundering) of Money
or Other Property Acquired by Illegal Means provides that:
“1. The accomplishment of
financial operations and other transactions with money or other property
knowingly acquired by illegal means, and, similarly, the use of such money for
the effectuation of entrepreneurial or other economic activity, shall be
punished by a fine in an amount from 500 to 700 minimum monthly wages or in the
amount of the wage or other income of the convicted person for a period from
five to seven months, or by the deprivation of liberty for a period of up to
four years, with a fine in the amount of 100 minimum monthly wages, or in the
amount of the wage or other income of the convicted person for a period up to
one month, or without such [fine].
2. The same act accomplished: a) by a group of persons according to
a prior conspiracy, b) more than once, [or] c) by a person using his official
position, shall be punished by the deprivation of liberty for a period from
four to eight years, with confiscation of property or without such
confiscation.
3. The acts envisioned by the first or second parts of this Article,
and accomplished by an organized group or on a large scale, shall be punished
by deprivation of liberty for a period from seven to ten years, with
confiscation of property or without such confiscation.”
The existence of this provision raises the question whether
a separate law is indeed needed if it were to be enforced. It is not clear that there have been a
significant number of prosecutions for money laundering under the Russian
Criminal Code. In any event, Article
174 is deficient by international standards.
Mandatory reporting by financial institutions (with criminal sanctions or
fines for the failure to do so) give similar laws in developed economies the necessary
teeth to be effective.
Despite President Yeltsin’s veto of the earlier money-laundering
law, a new draft is being advanced by the Russian Government that is being
vetted by international experts. This
draft is based on text prepared by the Presidential Administration. If President Yeltsin’s concern (articulated
or otherwise) are sufficiently addressed, there may be support in the Federal
Assembly (both the State Duma and the Council of the Federation) to pass this
draft law. Whether such a law will
ultimately become law (and be enforced) remains in doubt, most observers agree
that it would be an improvement over the existing provisions of the Criminal
Code.
Unfortunately, the economically (and politically) developed nations have
not been significantly vocal about the failure of Russian officials to abide by
their own laws and judicial decisions.
The United States was not adverse to criticizing the Germans and the
French for allowing bribes to foreign government officials to be deducted from
their taxes – and this eventually lead to the OECD Anti-Bribery
Convention. The U.S., other countries
and legal entities and individuals based in them should no longer turn a blind
eye to the lack of the rule of law in Russia.
They must be willing to point out deficiencies in the area of law
enforcement. This is critical not only
for the development of democracy in Russia, but also for an environment that
would be conducive to investment (foreign and domestic). Although not yet clear, it is possible if
not probable that most of the “money laundering” in the BONY case is actually
either non-criminal or only quasi-criminal “flight capital” leaving the country
as the result of political/economic insecurity and burdensome tax and business
regulations, rather than the proceeds of Russian organized crime activity.
II.
U.S. Regulatory Framework for Combating Money
Laundering and its Response to the BONY Scandal
Rampant and interrelated criminality and corruption
among political, bureaucratic, and business elites have been a prominent staple
of U.S. media coverage of events in Russia for several years. Nevertheless, the coverage of the widening
investigations into alleged money laundering through BONY has been taken up by
U.S. media with rare intensity.
It’s not difficult understand why the story is so
compelling for U.S. readers and reporters.
Although hard facts are still remarkably limited, the scandal, (and the
unsubstantiated allegations of which it primarily consists so far) contains an
extraordinary array of themes and subplots that intersect with American fears
and anxieties over what’s happening in, and our relationship with, Russia. Among these are American’s increasing
anxieties concerning the emerging menace of Russian organized crime, massive
theft of U.S. aid, naivete of U.S. and IMF officials in managing both aid and
larger policies toward Russia, and possible corruption of even the most
venerable U.S. financial institutions.
Indeed, it is not hard to discern an emerging “who lost Russia” debate
in many of the stories. Columns in
Prominent U.S. papers have already appeared making accusations of
responsibility for lax oversight of U.S. aid policies to Russia.
It is not our intention to dismiss the allegations
that have been raised by the BONY investigation or the serious concerns they
underscore with respect to the adequacy and competence of U.S. aid policy and
oversight toward Russia. Some or even
most of these suspicions fears may prove to have at least some merit.
However, to
understand and evaluate the larger as well as immediate concerns of U.S.
policymakers and law enforcement officials over the alleged events at BONY and
the legislative and regulatory changes to the U.S. money laundering regime that
are now being proposed as a response, it is necessary to briefly review the
off-shore money laundering problem in the U.S.
The law that attempts to suppress that problem and its current
limitations will then be described as well as the potentially problematic
amendments that have recently been proposed.
U.S. policy makers face complex and potentially controversial choices in
this area as they attempt to monitor and control global capital flows into the
U.S. The challenge they face is
particularly difficult and because there is no consensus among U.S. political,
administrative and business leaders on precisely how “money laundering” should
be legally defined. Legislation pending
in Congress would answer this question, but in a manner that could massively
expand the international reach of U.S. criminal jurisdiction and the reporting
burdens on foreign financial institutions doing business in the U.S.
A.
The U.S. Off-Shore Money-Laundering Problem
The U.S. has had a serious money-laundering problem
for more than fifteen years[7]
and it is growing very rapidly.
Although the amount of money illegally laundered In the US. is inherently
difficult to estimate, the most commonly cited figure, at least until recently,
was $250 billion annually.[8] U.S. Treasury and FBI officials involved in
money laundering enforcement operations privately concede that the actual
amount could easily considerably larger.
The magnitude of overseas money laundering as a law enforcement problem
in the U.S. is perhaps best captured by the comment of a well known former
federal prosecutor: “[t]he white collar
crime of the 1990’s is here and it is money laundering.”[9]
A large majority of-off-shore money laundering in the
U.S. has historically been driven by the large-scale production and export to
the U.S. of cocoa leaf and cocaine by organized drug cartels located in
Bolivia, Peru, Mexico, and, particularly, Columbia. The effect of this drug trade on the health of U.S. society has
been a source of enormous popular and political concern for many years.
However, it has only been relatively recently that U.S. policy makers began to
realize that money laundering posed a threat to the integrity of U.S.
businesses and financial institutions that equaled the threat posed by the
effects of drug abuse itself on American society.
Three recent events have concentrated the attention
of Congress, Treasury, and law enforcement on the threat to the integrity of
U.S. financial institutions posed by money laundering. The first of these was Operation
Casablanca. Casabanca began lasted for
several years beginning in late 1994 and was an elaborate drug sting operation
in which U.S. DEA and Customs agents infiltrated and exposed major money
laundering operations of the Cali and Jaurez drug cartels and exposed their
links to seven major Mexican and Venzuelan banks. Each of the banks and more than 150 individuals were eventually
indicted.
The second was the U.S. Justice Departments 1996
investigation into Citibank’s alleged money laundering of $100 million of
illegal income by Raul Salinas de Gortari, the brother of the former Mexican
President, Carlos Salinas de Gortari.[10] Although Citibank has not yet been indicted,
related investigations lead to well publicized 1997 Drug Enforcement
Administration sting operations against several major Mexican financial
institutions that were allegedly laundering money through U.S, correspondent.
The third wake-up call for U.S. law enforcement
authorities has been the rapidly widening investigation into alleged money
laundering of as much as $7 billion U.S. and IMF financial assistance through
BONY. [11]
The investigation is far from complete and there is growing doubt among those
close to the investigation that either the fund transfers at issue will not be
actionable as “money Laundering” or that it will prove impossible to gather
sufficient evidence with Russia sufficient to indict.[12] Nevertheless, the magnitude of such sums
being transferred through major U.S. money-center banks, even if merely
“flight” capital not subject to U.S. laws has stunned U.S. authorities.
There are several reasons for this concern. First, the BONY scandal highlights the
increased risks posed by non-drug money laundering to the integrity of major
U.S. financial institutions. Second,
the allegations concerning BONY imply that despite recently tightened federal
bank reporting regulations requiring banks to know who they are doing business
with, where funds they accept come from, and report all large or suspicious
transactions are less than effective.
Finally, and most importantly the investigation in to money laundering
at BONY as well as unrelated investigations of suspected Russian money
laundering at the BankBoston Corp. major and enormously controversial questions
concerning the scope and effectiveness of U.S. money laundering law itself.
B.
Current U.S.
Money Laundering Law and Proposed Changes
The two most important laws governing money
laundering in the U.S. are the Bank Secrecy Act, as amended (“BSA”)[13]
which imposes extensive record keeping and reporting requirements on financial
institutions in order to supply law enforcement with evidence of financial
transactions and the Money Laundering Control Act of 1986 (18 U.S.C. 1956,
1957) precludes circumvention of the BSA requirements by creating criminal
liability for individuals who conduct monetary transactions knowing, or with
reason to know, that the proceeds involved were obtained from unlawful
activity.
The BSA requires financial institutions to file
Currency Transaction Reports (“CTRs”) with the U.S. Treasuring reporting
deposits, withdrawals, and exchanges of more that $10,000 of currency. These reporting requirements as well as the
obligations to implement Know Your Customer (“KYCs”) guidelines on banks have
grown substantially over the last few years and the banking industry has
consistently opposed them as unduly burdensome, expensive, and ineffective. Recent
events at Citibank, BankBoston Corp, and BONY support, at least to some extent,
the last of these criticisms.
The BONY scandal can be expected to encourage bank
regulators to reissue in amended form the proposed regulations imposing
stricter Keycaps on banks. Those
controversial proposed regulations were withdrawn before being approved in
April of this year in the face of opposition by banks. Another major initiative to control money
laundering into the U.S. was underway even before the investigation into BONY
began. As a part of International Crime
Control Strategy issued by the President in May of 1998 (Presidential Decision
Directive 42) U.S. law enforcement, diplomatic and intelligence agencies were
ordered to intensify their efforts against international organized crime
including money laundering. Pursuant to
the initiative permanent interagency working groups have been created to
coordinate operations against international crime by the Departments of State,
Justice, Treasury, and the FBI. In addition,
the Department of Justice and the FBI have substantially increased the number
of law enforcement personnel overseas.
The FBI currently has 35 overseas office and is considering opening new
ones.
However, the
most important new money laundering enforcement initiative under consideration
is the Foreign Money Laundering Deterrence and Anticorruption Act (H.R. 2829)
that was recently introduced in both the House and Senate. This legislation which the Justice
Department supports would massively expand the underlying crimes covered by and
the effective reach of international jurisdiction pursuant to 18 U.S.C. 1956
and 1957, as well as bank’s monitoring and reporting obligations under the BSA.[14]
The proposed legislation attempts to address one of
the largest impediments to prosecuting the BONY case and foreign organized
crime money laundering cases general in U.S. courts. In order to prove a charge of Money laundering under federal law,
one of the elements prosecutors must allege and prove beyond a reasonable doubt
is that at least on of the Specified Unlawful Activities (“SUAs”) listed in the
money laundering statutes, 18 U.S.C. 1956 and 1957, gave rise to illegal
proceeds. The money laundering statute
lists dozens of federal crimes, which can serve as the predicate SUA and it a
powerful tool for prosecuting organized crime activity in the U.S. However, only a very limited number of
foreign offenses committed outside U.S. borders, namely: narcotics trafficking,
murder, kidnapping, robbery, extortion, fraud against a bank, and destruction
of property explosives currently qualify as SUAs under the statute.
Unless prosecutors can prove the funds in question in
BONY resulted from one of this short list of overseas illegal activities then
federal prosecutors cannot bring charges against those who moved the money into
the U.S.
The proposed amendment of the money laundering
statute would solve this problem by adding to the list of applicable SUAs any
crime of violence, fraud (or scheme to defraud) committed against a foreign
government or governmental entity, bribery of a public official, or
misappropriation, theft or embezzlement of public funds by or for the benefit
of a public official, misuse of IMF funds, computer fraud, and a variety of
other offenses. Although H.R. 2829 will
certainly make federal prosecutions of off-shore money laundering in the U.S.
much easier it poses several problems and is likely to engender opposition from
U.S. business and banking groups, international banks, and those concerned
about the amendment’s potential for promoting conflict with foreign
jurisdictions and foreign sovereigns.
Foreign businesses, banks, and governments will
almost certainly express concern over the prospect of having U.S. money
laundering laws being extended extraterritorially to the non-U.S. offices of
international banks and businesses for alleged offenses outside the U.S. that
do not involve their U.S. offices.
American
banks are likely to oppose the legislation for two reasons. First, they will argue that the current law
is more than sufficient to prosecute the limited money laundering that is
likely to be found in the BONY case. If
prosecutions in that case cannot be brought it will be due to Russian authorities
inability or unwillingness to investigate those under suspicion in Russia not
the limited scope of the U.S. statute.
Second, they can be expected to oppose any measure that tends to
increase the risk or cost international banks selection and use of U.S.
financial markets and infrastructure for transactions. Increases in such costs or risks to foreign
capital and banks will divert business from the U.S. For these reasons, the legislative outlook for H.R. 2829 is far
from certain.
* *
* * *
[1] The opinions expressed in this article are solely
those of the authors and not necessarily of their law firm.
[2] See
Russian Civil Code, Article 140, November 30, 1994.
[3] The documents that must be submitted to obtain such
a license are set forth in Letter No 12-524 of the Central Bank of Russia,
dated October 6, 1995.
[4] See Joint
Instructions of the RCB and the State Customs Committee of the Russian
Federation Nos. 19 and 01-20/10283 “On the Procedure for Currency Control Over
Export Foreign Exchange Proceeds Remitted to the Russian Federation”, dated
October 12, 1993, as amended, and Joint Instruction of the RCB and the State
Customs Committee of the Russian Federation Nos. 30 and 01-20/10538 “On the
Procedure for Exercising Currency Control Over the Bases for Payments in
Foreign Currency for Imported Commodities”, dated July 26, 1995, as amended.
[5] For example, RBC Bank Directive No. 500-U, “On
Enhancing Currency Control by Authorized Banks over the Lawfulness of their
Clients’ Currency Operations and on the Procedure for the Application of Sanctions
against Authorized Banks for the Violation of Currency Legislation”, dated
February 12, 1999, requires Russian banks to inform the RCB about its clients’
transactions with companies located in “off shore” zones. Russian Banks were instructed to verify the
conformity of export-import contracts with RCB established rules. Subsequently, the RCB issued its Directive
631-U, “On the Introduction of Changes and Additions to Directive No. 606-U of
July 13, 1999 ‘On the Formation of a Reserve for Operations of Credit
Institutions of the Russian Federation with Residents of Off-Shore Zones”,
dated August 24, 1999, which requires Russian banks to create reserves of at
least 50% of their outstanding financial exposure with respect to transactions
for each non-resident client. Finally,
RCB Directive 634-U, “On the Procedure for Establishing by Authorized Banks
Correspondence Relations with Non-Resident Banks that are Registered in States
and in Territories Presenting a Privileged Tax Regime and/or Not Envisioning
the Disclosure and Presentation of Information During the Conduct of Financial
Operations (Off-Shore Zones)”, dated August 26, 1999, limits Russian banks to
open off-shore bank accounts with financial institutions meeting certain
criteria.
[6] In fact, Article 857 of the Russian Civil Code (Part
II) on bank secrets should not be read as precluding adoption of bank secrecy
legislation.
[7] President’s Commission on Organized Crime,
Interim Report the President and the Attorney General, The Cash Connection: Organized
Crime, Financial Institutions, and Money Laundering 7 1984
[8] Vincent Boland, Earnings
from Organized Crime reach$1,000 billion, Financial Times, Feb. 14,
1997, at 9 (estimating the U.S. accounted for approximately a quarter of the
total figure).
[9] Elkan Abramowitz, Money Laundering: The New RICO?, N.Y.L.J., Sept. 1, 1992, at
3 (commenting on the increase in money laundering prosecutions relative to
those for RICO violations).
[10] See Laurie Hays and Michael Allen, U.S. Probe of Citibank and Raul Salinas
Hinges on the Role of Banks in Policing, Wall St. J., June 6, 1996,
at A4 (describing the Justice Department’s investigation Citibank).
[11] On August 18, 199, the press reported that between
October of 1998 and March 1999 more than $4 billion went through BONY. Later reports raised the level to between $7
billion and $10 billion.
[12] Conversations with those familiar with the
investigation, as well as recent press reports, indicate that prosecutors
believe that relatively little of the funds transferred in BONY may be
actionable money laundering and that in any event early disclosure of the U.S.
investigation and likely impediments to effective investigation in Russia make
money laundering prosecutions in the U.S. difficult. See also Sharon LaFraniere, Bank
Probe Up Russian Investigators: U.S. Experts Fearful Cases Will Be Dropped, Wash.
Post, October 29, 1999 at E1.
[13] 31 U.S.C. 5311-53i4, 5316-5324. (1996).
[14] House Banking Chairman James Leach introduced H.R.
2829 in the House of Representatives on September 21, 1999. Testimony of Assistant Attorney General
before that Committee on September 22, 1999 on the threat posed by Russian
Money Laundering to U.S. financial institutions and the Justice Department’s response
appears to endorse the legislation.