The gulf between the rule of law and money laundering in Sri Lanka

Although financial institutions are at the forefront of being vulnerable to money laundering activities, non-financial professions and businesses are also used by criminals as vehicles to conceal the illicit origins of their money

Recent media reports regarding the alleged involvement of some officers of Police Narcotic Bureau (PNB) in drug deals suggest that drug trafficking can be a major source of money laundering activities in Sri Lanka. It is an ill-fated situation when the Police Department, being the main law enforcement authority, is required to undertake investigations to detect assets reported to be illegally acquired by some of their own officers attached to PNB. 

Stories revealed by the media regarding the financial transactions and luxury properties owned by the alleged criminals, who were taken into the legal custody, suggest that there are serious gaps in the legal framework applicable to money laundering activities and the compliance therewith by relevant stakeholders. 

Undetected money laundering creates more room for bribery and corruption at the level of critical gatekeepers in the legal system and thereby weakens action against unlawful activities. It can also undermine the socio-political fabric of society. This article focuses on lacunas observed in the implementation phase of anti-money laundering laws in Sri Lanka.

The process of concealing the illicit nature of ill-gotten money

Money laundering is the process used by criminals to filter ill-gotten gains or “dirty” money through a series of transactions, so that the funds are “cleaned” to look like proceeds from legal activities (World Bank). The process of money laundering has three main stages, i.e. placement, layering and integration. 

Under the “placement” stage money derived from illegal activities are introduced to financial institutions as well as the retail economy to make it less suspicious to the law enforcement authorities. Criminal proceeds are introduced in small amounts at casinos, currency exchange centres, car wash stations and other small shops. Currency smuggling by criminals from one jurisdiction to another and depositing amounts below the reporting thresholds have also been identified as measures under the “placement” stage.

Reports by international agencies reveal that criminals use “front companies” to pretend their criminal proceeds are income derived from legitimate businesses. When criminals can use illegal funds as legal income, they are able to offer rates below the market prices. Over the time, genuine commercial enterprises get crowded out by this criminal element. 

Layering is considered the most complex stage of the process. Criminals try to conceal the money trail by transferring the proceeds to several bank accounts locally or abroad and thereby go under the radars of legal authorities. Deposits or withdrawals, exchange into other currencies and wire transfers can also take place under the “layering” stage. 

Once the proceeds of unlawful activities are introduced to legitimate financial systems and assets are purchased using such money, criminals can enjoy the benefits without drawing the attention of the authorities. This happens under the “integration” stage where criminals try to give plausible explanations for their illegal proceeds. 

As long as the criminals can enjoy luxury lifestyles using ill-gotten money, they have the incentive to violate laws. Therefore, the path to reap benefits from ill-gotten money needs to be made very difficult for criminals by implementing anti-money laundering laws in an efficient and effective manner. 

Negative effects on the economy and social well-being 

Financial, real and external sectors of an economy get affected by money laundering activities. When international monitoring agencies, such as the Financial Action Task Force (FATF), categorise the country as a high-risk jurisdiction for money laundering, it leads to serious reputational damage. Literature shows that sudden withdrawals of large deposits when stringent legal actions are implemented against criminals can cause a run on financial institutions.

The integrity of the financial system gets eroded, if criminals can transact with financial service providers under a “no questioned asked” policy. Deteriorated public trust in the financial system can have contagious effects. Sri Lanka experienced the drawbacks of being classified as a “grey list” country by the FATF. Financial inflows related to tourism, the export sector and worker remittances were adversely affected due to constraints imposed by foreign counterparts. International rating agencies also look at Sri Lanka’s compliance with FATF recommendations on anti-money laundering and financing of terrorism in assigning sovereign ratings which are very vital for external financing purposes.

According to the US Department of State, money laundering distorts money demand and creates volatility in global capital flows as well as interest and exchange rates. Loss of government revenue due to the inability to impose tax on hidden criminal proceeds and concealing ill-gotten proceeds in unviable investment projects are other adverse economic impacts of money laundering. Allowing criminals to enjoy the profits of their crimes will drag the entire society to a hazardous situation.

Legal framework for combating money laundering in Sri Lanka

The Financial Intelligence Unit (FIU), established under the Financial Transaction Reporting Act (FTRA) No.6 of 2006 Sri Lanka, is vested with the power to administer the laws applicable to anti-money laundering and countering financing of terrorism (AML/CFT). The FIU has accordingly taken measures to ensure that Sri Lanka has AML/CFT legal frameworks, which have been introduced in accordance with global standards. However, without the efficient assistance and co-operation of all stakeholders in adhering to relevant rules and regulations the FIU alone cannot curb the money laundering menace.

Section 3 of the Prevention of Money Laundering Act No 5 of 2006 (PMLA) of Sri Lanka defines the offence of money laundering. Accordingly, any person who engages directly or indirectly in any transaction in relation to any property which is derived or realised, directly or indirectly, from any unlawful activity or from the proceeds of any unlawful activity; a person who receives, possesses, conceals, disposes of, or brings into Sri Lanka, transfers out of Sri Lanka, or invests in Sri Lanka, any of such property described above shall be guilty of the offence of money laundering. Persons, who attempt or conspire to commit the offence of money laundering or aid or abet such commissions, shall also be guilty of offences under the said Act.

Another salient feature of PMLA is the “presumption” provided for under section 4 of the Act. It allows authorities to assume the illicit origin of a property or money unless the contrary is proved. In such event, suspects will have to prove the source of funds of the questioned transaction. This shows the stringent nature of the laws applicable to combat money laundering in Sri Lanka. However, the effective use of the said provisions in framing charges against money launderers cannot be observed from the available reports.  

What is the punishment against the offence of money laundering? 

Section 4 of the PMLA states that a person, who is guilty of the offence of money laundering, shall be liable to a fine not less than the value of the property in respect of which the offence is committed and not more than three times the value of such property or to rigorous imprisonment for a period of not less than five years and not exceeding 20 years, or to both such fine and imprisonment. Mere prevalence of a punishment clause in the enactment cannot create a deterrent effect on money laundering activities. Perpetrators need to be brought to book by invoking these rules in bridging that void. 

The assets of any person found guilty of the offence of money laundering shall be liable to forfeiture in terms of Part II of the PMLA. Investigation officers should, therefore, have the experience and expertise in following the money trail to detect the properties acquired using criminal proceeds. An efficient confiscation policy should also be introduced.

Who are at the frontline for detecting criminal proceeds? 

In terms of section 5 of the PMLA, any person, who has knowledge about any property that has been derived or realised from any unlawful activity, shall disclose his knowledge or belief as soon as is practicable to the FIU. Drug trafficking is a key item in the list of predicate offences stipulated under FTRA. Provisions of section 6 of the FTRA require reporting of cash transactions that exceed Rs.1milion (including electronic fund transfers) and section 7 of the Act specifies the requirement to report suspicious transactions by financial and non-financial reporting entities.

If the information pertaining to money laundering activities are brought to the attention of the legal authorities as expected by the legislature, investigations would have been triggered into such cases successfully. In the absence of such active information flows, the lack of effectiveness of enforcement measures against money laundering is inevitable.

The crucial role of designated non-finance businesses and professions

Although financial institutions are at the forefront of being vulnerable to money laundering activities, non-financial professions and businesses are also used by criminals as vehicles to conceal the illicit origins of their money. Casinos, real estate agents and gem and jewellery dealers come under the designated non-bank financial businesses in terms of the FTRA. 

Casinos, where large amounts of cash changes hands, have been identified as locations susceptible to money laundering activities. In addition, real estate transactions have been identified as an easy avenue to camouflage the illicit origin of criminal proceeds. A study by the European Parliament says that the real estate sector provides a veneer of respectability, legitimacy and normality. The Gem and Jewellery sector is also enticing to criminals as it provides a stable anonymous, transformable and easily exchangeable asset to realise their proceeds. 

Accountants, lawyers, notaries and company secretaries are the professions at risk of being misused by criminals in concealing their identities. Therefore, the FIU has imposed regulations requiring these segments to comply with the AML/CFT laws in managing client money and providing other professional services. 

The current economic fallout in the context of COVID-19 outbreak has made the compliance task even more difficult for designated non-finance businesses. In a context which all businesses are struggling to find new customers and sales, there may be a lenient approach towards compliance with the rules and regulations issued by the FIU pertaining to combating money laundering. 

However, it is imperative to emphasise the fact that preventing legal risks always outweighs any short-term business gains. Once the integrity of the economy is compromised due to making it a breeding ground for money launderers, non-financial as well as financial sector businesses will have to bear the consequences. Tarnishing the country’s brand image will make attracting new investments to local businesses extremely difficult.  Businesses cannot thrive when criminals are ruling the social order.

The FATF has also alerted relevant entities about the possibility of criminals finding ways to bypass customer due diligence measures when arrangements to contain COVID-19 pandemic are in place. Designated non-finance businesses and professions should, therefore, take prudent measures to bridge the gaps in their internal controls and systems to comply with AML/CFT requirements. Customer due diligence can play a pivotal role in addressing the gap between effective application of the rule of law and money laundering.

Identifying suspects through customer due diligence

Customer due diligence is considered the task at the heart of combating money laundering. It is the verification process carried out by banks under know-your- customer principles to ensure that their customers are properly risk assessed before being onboarded. 

Financial institutions are required to examine the identification details and sources of funds of their customers under the “Know your Customer” (KYC) principles. However, given the complex nature of money laundering activities, it is necessary to exercise enhanced due diligence in handling transactions. Under the normal due diligence methods, usually the customer’s identity, address and details of the occupation or trade are obtained. 

However, enhanced due diligence requires financial and non-financial institutions and professions to undertake a greater level of scrutiny of the details of a customer. International best practice suggests that potential business engagements of a customer and risk scenarios associated with him need to be detected under this approach. In the current context in which digital KYC/onboarding and online transactions are promoted, all stakeholders will need to follow extremely cautious strategies to ensure such virtual platforms are not abused by criminals.

Collecting basic and in-depth information and undertaking subsequent reviews of existing customers’ profiles make it possible for financial institutions to detect high risk customers and their suspicious transactions. When there are gaps between the applicable rules and regulations and the practical systems in place, criminals can escape from the grip of the law. 

Red flags need due attention

Although a suspicious transaction cannot be given a specific definition, financial and non-financial institutions can be guided by red flag situations in identifying money laundering efforts.  According to the FATF standards, politically exposed persons are considered a category of customers who need to be subject to a strict verification process. 

Structuring transactions into small portions called “smurfing” to circumvent reporting thresholds and frequent third-party deposits also raise suspicious concerns. If an account is used as a temporary repository for funds, a period of significantly increased activity amid relatively dormant periods, “U-turn” transactions and transfers to jurisdictions considered as tax havens too give red indicators. Early payment of loans, unexplained connection with the geographical area, willingness to pay high fees for professional services and having an unusual knowledge about money laundering processes also raise alarms. 

Money launderers can be detected if the reporting entities are vigilant over transactions which are not commensurate with the usual circumstances of a customer. Recent incidents related to PNB showed that there have been transactions unusual for the profile of police officers. When a criminal is allowed to operate despite persistent red flags, anti-money laundering regulations will be ineffective. 

Staff of financial and non-financial institutions need to be trained to ask appropriate questions from their customers. A hesitance to comply with such regulations due to the fear of losing business may cause greater losses from reputational and legal risks in the event of punishment by regulators. Appointing a “compliance officer”, as required by section 14 of FTRA, can be helpful in striking a right balance between adherence with AML/CFT laws while preserving business opportunities. 

Strengthening enforcement of law against money laundering 

Countering money laundering and other financial crimes effectively requires not only knowledge of laws and regulations, investigations, analysis and intelligence. Knowledge on banking, finance, accounting and other economic and business-related activities is also important (World Bank). Capacity building is of essence, therefore, to improve specialised financial investigative skills of investigators in addition to the standard criminal investigative skills. Priority should also be attached to efficient and effective coordination among local and international regulatory and legal authorities. Hon. Attorney General can take the lead in ensuring efficient coordination among the Police Narcotic Bureau, CID, Defence Ministry and FIU.  

Attention of the authorities should not be limited only to money laundering activities taking place within the country.  Flow of illicit funds from foreign countries should also be curbed in this exercise. According to the IMF, inward flows of dirty funds in large volumes can create a “hot money “problem and the existence of a black market dominated by criminals will compromise the accuracy of macroeconomic variables such as monetary levels and the exchange rate. Outflow of funds via illegal remittance channels and smuggling large amounts allow criminals to clean dirty money. Controls under Custom laws need to be implemented effectively to detect such smugglers. The non-profit organisations sector too needs to be prevented from being a money laundering vehicle.

When the country’s brand image as a law-abiding economy is eroded, the prospects of benefiting from global opportunities would become more remote.  Hence, law enforcement authorities, supervisors, financial institutions as well as other stakeholders have a responsibility to prevent Sri Lanka being labelled as a money laundering hub. Zero tolerance should be shown against AML/CFT lawbreaking by these gatekeepers. 

Combating money laundering is not about ticking boxes

Money laundering is happening in Sri Lanka not due to the absence of relevant laws and standards. The FIU has introduced a legal framework in accordance with global standards. The deficiency relates to the compliance therewith and implementation of relevant laws. 

When Sri Lanka is trying to weather the economic storm triggered by the COVID-19 pandemic and other chronic ailments prevailing in the economy, law and order in the country and the overall governance structure attracts heightened attention of the international community. When the loopholes in legal enforcement mechanisms lead to the country being branded as a money laundering haven, actual victims would be legitimate businesses. Restricted access to international markets and higher transaction costs in mobilising funds due to poor compliance with AML/CFT laws are negative effects which cannot be afforded by the economy. 

Taking measures to close the gaps which allow criminals to profit from their crimes by strengthening the rule of law is an overriding priority.  There is ample room for improvement of the compliance level of the designated non- finance and professions sector. Robust risk management systems need to be put in place by financial and non-financial operators to provide actionable intelligence to the FIU and other legal authorities. 

Strengthening risk-based supervision is also vital in keeping track of rapidly evolving crimes. Efficiency of the judicial system is vital to ensure unlawful activities are banned and punished proactively. Efficient policies are also required to confiscate assets of criminals. If luxury facilities are available in prisons, criminals will not mind breaking the law. 

Lax enforcement of laws allows lawbreakers to leave corrosive effects on the country’s economy and social wellbeing. Unwavering political support is a must to ensure weak links in implementation of AML/CFT laws are addressed efficiently to preserve a peaceful society for future generations.

“Money and corruption are ruining the land, crooked politicians betray the working man, pocketing the profits and treating us like sheep, and we are tired of hearing promises that we know that they will never keep” – Ray Davies

(The writer is Deputy Director, CBSL, Attorney-at-Law and can be reached via [email protected]. The views and opinions expressed in this article are those of the writer and do not necessarily reflect the official policy or position of any institution.)