The Money Laundry: Regulating Criminal Finance in the Global Economy 9780801463198

Table of contents :
Contents
Acknowledgments
Introduction: Policy Diffusion and Anti-Money Laundering
1. Money Laundering and Anti-Money Laundering
Part One. Does Anti–Money Laundering Policy Work?
2. An Indirect Test of Effectiveness
3. A Direct Test of Effectiveness
Part Two. Why Has Anti–Money Laundering Policy Diffused?
4. Blacklisting
5. Socialization and Competition
Conclusions: Implications for Scholarship and Policy
Bibliography
Index

Citation preview

THE MONEY LAUNDRY

A volume in the series Cornell Studies in Political Economy edited by Peter J. Katzenstein A list of titles in this series is available at www.cornellpress.cornell.edu.

THE MONEY LAUNDRY

R EGU LAT I N G C R I M I N A L FINANCE IN THE GLOBAL ECO N O MY

J. C. Sharman

CORNELL UNIVERSITY PRESS Ithaca and London

Copyright © 2011 by Cornell University All rights reserved. Except for brief quotations in a review, this book, or parts thereof, must not be reproduced in any form without permission in writing from the publisher. For information, address Cornell University Press, Sage House, 512 East State Street, Ithaca, New York 14850. First published 2011 by Cornell University Press Printed in the United States of America Library of Congress Cataloging-in-Publication Data Sharman, J. C. (Jason Campbell), 1973– The money laundry : regulating criminal finance in the global economy / J.C. Sharman. p. cm. — (Cornell studies in political economy) Includes bibliographical references and index. ISBN 978-0-8014-5018-1 (alk. paper) 1. Money laundering—Prevention. 2. Banks and banking, International—Law and legislation. I. Title. II. Series: Cornell studies in political economy. HV6768.S53 2011 364.16'8—dc22

2011013087

Cornell University Press strives to use environmentally responsible suppliers and materials to the fullest extent possible in the publishing of its books. Such materials include vegetable-based, low-VOC inks and acid-free papers that are recycled, totally chlorine-free, or partly composed of nonwood fibers. For further information, visit our website at www.cornellpress.cornell.edu. Cloth printing

10 9 8 7 6 5 4 3 2 1

To my family and Bilyana

Contents

Acknowledgments

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Introduction: Policy Diffusion and Anti-Money Laundering 1 1. Money Laundering and Anti-Money Laundering 14 Part One: Does Anti –Money Laundering Policy Work?

2. An Indirect Test of Effectiveness 3. A Direct Test of Effectiveness

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Part Two: Why Has Anti–Money Laundering Policy Diffused?

4. Blacklisting

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5. Socialization and Competition

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Conclusions: Implications for Scholarship and Policy 165 Bibliography Index

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Ack nowledgments

This book grew out of an earlier interest in tax havens. I traveled from island to island conducting interviews about a campaign led by the Organization for Economic Co-operation and Development (OECD) to impose global tax regulations. While those I met with were concerned about this campaign, they stressed that the institution that really scared them was an obscure body called the Financial Action Task Force, which is in charge of enforcing anti-money laundering standards. My curiosity on this subject was further piqued in performing policy work with the Commonwealth. It became clear that introducing regulations to counter money laundering imposed serious costs on developing countries, while the benefits were elusive. Strangely, although regulators and those in the financial sector would accept this conclusion about prominent costs and nebulous benefits, they nevertheless argued that these regulations were a good thing, or at least an inevitable fact of life. Many of those I spoke with in powerful Western governments and international organizations were either bemused or annoyed when asked if the regulations really worked or what costs they imposed. These questions were regarded as a waste of time, as they suggested that countries and firms had a choice about adopting the standard set of regulations on money laundering. In fact, they did not. Given the novelty of money laundering as a policy concern, how had this sense of inevitability come about? The final element that provoked my interest was the extent to which institutions and policies in disparate countries faithfully, perhaps even slavishly, followed foreign models, based on a willing suspension of disbelief about these models’ fit with local circumstances. Whether I was stuck in Nauru after the only plane broke down, or listened to Tanzanian or Malawian policymakers, or observed the destroyed capital and airport of Montserrat, I thought it was plain to see that these countries have incredibly pressing problems aside from financial crime. Yet addressing these problems often gives way to the perceived imperative to keep up appearances for outside audiences concerned about anti-money laundering policy. ix

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In investigating these puzzles, I have accumulated extensive debts to a great number of people, many of whom would vigorously disagree with the book’s conclusions. I am grateful to Cheryl Bruce and Andreas Antoniou for generously establishing several invaluable linkages at the beginning of the project. Percy Mistry was a huge source of support to me at several difficult points. His robust willingness to take the fight to those who tried to massage or suppress inconvenient evidence is particularly important for material in chapter 2. Emile van der Does de Willebois, Stuart Yikona, Arun Kendall, Peter Ritchie, and Rita O’Sullivan were similarly very generous in allowing me to look inside the policy machine at different points. I am fortunate to have had access to extremely knowledgeable sources in the private sector with the patience to deal with questions from the ivory tower, and here I particularly thank Richard Hay, Bruce Zagaris, and David Spencer. I am also grateful to the many other individuals who agreed to be interviewed for this book. The growing community of scholars researching money laundering has been uniformly welcoming in sharing both their insights and their doubts. I particularly acknowledge the help and feedback received from David Chaikin, Michael Levi, and William Gilmore. Richard Gordon straddles the worlds of policy and academia with enviable ease, and I am in his debt for insights from both domains, as well as the support of his students at Case Western Reserve University (Alexis Parker, Parinya Kaewmanee, Nicole Raimo, Aimara Martinez, Pratibha Gupta, Iris Colmenares, and especially Avinash Chak) for half the solicitations in chapter 3. In academia more generally, Kate Weaver and Jacqui Best helped to firm up the argument, and Len Seabrooke also hosted two exceptionally useful workshops at the Copenhagen Business School. Stefano Guzzini and Iver Neumann put together a highly stimulating workshop on the diffusion of authority in global governance, which again advanced my thinking. Additional thanks go to those organizing and participating in seminars at the University of Miami, College of William and Mary, American Bar Association, Society of Trust and Estate Practitioners, Australian National University, and University of Queensland. My colleagues at Griffith University have provided me with the ideal environment in which to pursue the research that has gone into this book, offering a wealth of constructive feedback in seminars and over coffee. Particular thanks are due to Pat Weller at the Centre for Governance and Public Policy and Michael Wesley, formerly director of the Griffith Asia Institute. Also at Griffith I have had excellent research support from Vanessa Newby and Stephen Martin, and especially Jo-Anne Gilbert and Lee Morgenbesser, whose efficiency and diligence have been a huge help at every stage.

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Speaking of following the money, I gratefully acknowledge the financial support of Australian Research Council Discovery Grants DP0771521 and DP0986608. Without this money, the primary research informing this book would have been impossible. I also acknowledge supplementary financial support from the Faroe Islands Research Council. Roger Haydon has again proved to be the ideal editor; he is gracious, straightforward, and efficient. Two anonymous reviewers took a great deal of time to carefully engage with the manuscript, identify shortcomings, and suggest numerous improvements. Finally, as ever, my biggest thanks go to Bilyana, for putting things in perspective.

THE MONEY LAUNDRY

Introduction Policy Diffusion and Anti-Money Laundering

The world’s sovereign states are characterized by their diversity. From continent-spanning federations to tiny islands, they range from fantastically rich to shockingly impoverished and encompass societies that may be incredibly variegated or relatively homogenous. Yet states increasingly adopt the same institutions and policies, seemingly regardless of their numerous and fundamental differences. This book examines a puzzle that exemplifies this coincidence of sameness and diversity: more than 180 states, large and small, rich and poor, have adopted a standard set of antimoney laundering policies, apparently without reference to local conditions. Why would so many countries that are so different adopt the same policy? The strangeness of this situation is epitomized by the extreme instance of Nauru. A minute, bankrupt Pacific island republic with a population of 11,000, Nauru has adopted a state-of-the-art policy template designed to keep criminal money out of the financial sector. But Nauru has no financial sector of any kind: no banks, no credit cards, no loans, no currency, no insurance. Nevertheless, a quarter of the legislation passed by the parliament since 2003 has been designed to protect the nonexistent financial sector from money laundering. There are currently officials in Nauru paid to supervise and educate any financial institutions that may in future arise regarding their responsibility to counter money laundering. In the interim, these officials are busily responding to international surveys of their activity by entering 1

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long columns of zeros and “N/As,” as well as attending capacity-building workshops and plenaries abroad. Meanwhile, the country has no shortage of immediate problems, from a debt of more than 1600 percent of gross domestic product (GDP), to 90 percent unemployment, to the world’s highest rate of obesity and type 2 diabetes, to the fact that most of the island’s surface has been rendered uninhabitable by phosphate mining. If local needs and priorities cannot explain why a country like Nauru would adopt such an obviously redundant policy, what can? The answer that this book develops is that a large majority of states have been pressured to adopt a standard policy template by the exercise of new, indirect, but nevertheless very effective forms of global coercion. The recurrent trend of remarkably similar policies and institutions being found in remarkably different local contexts is too obvious to have escaped attention. In fact, there is a rich commentary on the closely related concepts of convergence, diffusion, and transfer. The argument presented here relies on the idea that institutions and policy can owe more to the need to conform to outside conceptions of legitimacy than the need to solve actual problems at home. As a result, I find a pronounced decoupling or disconnect between the content of the formal models and templates and what actually happens in practice.1 For poor states in particular, adopting anti-money laundering policies allows them to avoid international censure, spares local officials embarrassment at foreign meetings, and soothes nervous international financial firms. But these policies make little difference to the level of crime. Although profiting from the keen insights of earlier work stressing the symbolic rather than practical logic of many institutions and policies, this book also makes three distinctive contributions. The first is a method based on becoming directly involved with spreading and then breaking anti-money laundering (AML) rules: I posed as a would-be money launderer, soliciting offers for prohibited anonymous shell companies and bank accounts. The second looks at power, which I argue is central to the process of diffusion. Last is the focus on anti-money laundering, a key policy area now seen by the Group of 20 (G20) as a model for how to conduct global financial reform. Many scholars looking at the global diffusion of particular institutions and policies have taken a big-picture perspective. As can readily be appreciated, there are good reasons for doing so. How can we know that a process is really global unless we take a bird’s-eye view of it? As many accounts of why we are seeing growing similarity in policies and institutions, despite radically 1. John W. Meyer et al., “World Society and the Nation-State,” American Journal of Sociology 103 (1997): 144–81.

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different local conditions, rely on deep, epochal causes, an abstract, general approach makes sense. The big-picture view has successfully raised the issue of why we see such “commonality amid diversity” for a wide variety of policies.2 It has also provided some persuasive broad-brush explanations of why this kind of change has come about.3 This book draws on key elements of such explanations, but it also provides a fresh perspective based on direct participation to address objections to earlier diffusion accounts. Scope and scale involve a trade-off. Critics have complained that even if big-picture scholars have established that the trends of convergence and diffusion are worth our attention, they have done much less to specify the particular mechanisms (the “how”) through which the global trends are realized.4 It is precisely in this area, in unearthing the processes and mechanisms that connect cause and effect, that evidence from the direct participant perspective can help to increase our understanding. As well as conducting conventional fieldwork and interviews, I worked with various international organizations in diffusing rules to counter money laundering. To test the effectiveness of rules barring anonymous entry into the international financial system, I purchased shell companies and set up bank accounts without providing proper identification. Much of the argument to come is thus based on seeing firsthand how the gears and cogs of the policy-diffusion machine work. I stress the role of power in policy diffusion, a role that has commonly been underrated. In part this is because various direct attempts by countries and international organizations to mold states in the developing world to conform with Western templates have proved to be disappointments, and sometimes disasters, thanks to unexpected friction and resistance. Iraq and Afghanistan stand as cautionary tales for those who would seek to remake foreign polities in their own image by military means. Efforts by the World Bank and International Monetary Fund to impose common policy solutions 2. Kurt Weyland, “Theories of Policy Diffusion: Lessons from Latin American Pension Reform,” World Politics 57 (2005): 264. 3. John W. Meyer et al., “World Society and the Nation-State”; Gili S. Drori, John W. Meyer, and Hokyu Hwang, eds., Globalization and Organization: World Society and Organizational Change (Oxford: Oxford University Press, 2006); Georg Krucken and Gili S. Drori, eds., World Society: The Writings of John W. Meyer (Oxford: Oxford University Press, 2009). 4. For a sympathetic critique of the need for these scholars to pay more attention to mechanisms rather than just broad correlations, see Martha Finnemore, “Norms Culture and World Politics: Insight from Sociology’s Institutionalism,” International Organization 50 (1996): 339 –41. For a less sympathetic argument along the same lines see Daniel W. Drezner, All Politics is Global: Explaining International Regulatory Regimes (Princeton: Princeton University Press, 2007), 17–19. For a partial admission of guilt, see Georg Krucken and Gili S. Drori, “World Society: A Theory and a Research Program in Context,” in World Society, ed. Krucken and Drori, 20 –21.

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by loan conditions have seldom worked as planned. But the limitation of these hard or direct exercises of power to impose common solutions in diverse contexts does not mean that power as such is unimportant. As much of the book is devoted to showing, indirect mechanisms of power can be, and have been, highly effective in driving policy convergence in countries as diverse as the most vulnerable South Pacific islands and the most xenophobic rogue state. Power in this broader sense is “the production, in and through social relations, of effects that shape the capacities of actors to determine their circumstances and fate.”5 One of the book’s main goals is to establish that exercises of power can be at the heart of diffusion processes and that such exercises are no less effective for being indirect. Beside the focus on the “how” of policy diffusion through research by participation and the emphasis on power, the third main innovation is the substantive focus: money laundering, or more specifically, the package of institutions, policies, and practices developed to counter it. Why this specialized focus? How much can anti-money laundering tell us about much bigger developments? More of one thing in a research design is almost always less of something else: a narrow focus puts limits on the ability to offer grand generalizations. But AML policy provides vital insights in a number of ways. First, policy in this area shows in clear, stark form the key features of the general diffusion process. AML policy has come from nowhere in the 1980s to being all but universally adopted two decades later. There are especially deep uncertainties about whether the policy solves the problem it is designed to solve in the rich Western countries for which it was crafted, let alone in the larger number of developing countries to which it has been transferred. The costs involved are substantial and conspicuous. The indirect coercive effects of ranking and rating, enmeshment in international regulatory networks, and the uncoordinated actions of private financial firms are especially apparent. Such soft measures can have hard effects, indeed more so than the traditional levers of influence used by one state over another. Thus if global governance means enforcing rules without recourse to traditional means of military and economic coercion, a process of “governance without government,”6 there is no better policy area in which to study it than AML. This is reflected by the number of scholars from different orientations scrutinizing the subject.7 5. Michael Barnett and Raymond Duvall, “Power in International Politics,” International Organization 59 (2005): 39. 6. James N. Rosenau and Ernst-Otto Czempiel, eds., Governance without Government: Order and Change in World Politics (Cambridge: Cambridge University Press, 1992). 7. For example, for neo-liberal accounts see Beth A. Simmons, “International Efforts against Money Laundering,” in Commitment and Compliance: The Role of Non-binding Norms in the International

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Finally, the response to the financial crisis and resulting recession of 2008– 2010 by the G20 and other bodies indicates that the measures pioneered in exporting money laundering policy around the world will increasingly become the norm rather than the exception. The “success” of the policy, in terms of the run of its writ if not its effectiveness, has provided a seductive example for those looking to strengthen or remake the web of global rules and standards. The techniques of rating, ranking, blacklisting, transnational enmeshment, and socialization, and of shaping private investment decisions, offer the promise of general adherence to tough global standards rather than just the lowest common denominator.

The Argument Summarized The key issue for this book is the coincidence of a policy of dubious worth that has nevertheless been adopted by almost every state in a short period of time. This runs directly counter to the intuition that policies known to be successful would rationally be copied and thus spread from country to country, whereas policies not known to be successful would not spread. My argument is instead that diffusion has occurred not because it solves the problem of criminals abusing the financial system or related offenses but because AML policy is now a symbol of what all modern, progressive states must have. Especially in countries outside the West, adoption of AML policy has been driven by the indirect exercise of power carried out by international organizations, networks of regulators, and private firms. To show that the policy has indeed diffused is relatively easy; the next two tasks are much harder. The first of these tasks ( part 1) is to substantiate the claim that the standard set of policies and institutions designed to counter money laundering are probably not effective, in either an absolute sense or relative to the cost. To advertise the limits of the argument at the outset, the book cannot prove that AML policies are ineffective. Much of the evidence for such a definitive

Legal System, ed. Dinah Shelton (Oxford: Oxford University Press, 2000), 244–63; Anne-Marie Slaughter, A New World Order (Princeton: Princeton University Press, 2004). For a realist version see Daniel W. Drezner, “Globalization, Harmonization, and Competition: The Different Pathways to Policy Convergence,” Journal of European Public Policy 12 (2005): 841–59; Drezner, All Politics Is Global. For a constructivist commentary, see Rainer Hulsse, “Creating Demand for Global Governance: The Making of a Global Money-Laundering Problem,” Global Society 21 (2007): 155–78. For a Foucauldian treatment see Yee-Kuang Heng and Ken McDonagh, “The Other War on Terror Revealed: Global Governmentality and the Financial Action Task Force’s Campaign against Terrorist Financing,” Review of International Studies 34 (2008): 553–73.

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claim is missing. Because the incidence and magnitude of financial crime is essentially unknown, contradictory claims are made. Does a lack of convictions, for example, indicate a lack of crime or a lack of enforcement? Beyond these inherent difficulties, the national and international agencies responsible for policy in this area have often been curiously uninterested in measuring the results of their labor. But at the very least, there is little evidence to show that AML policy has been effective in the rich, OECD (Organization for Economic Co-operation and Development) states for which it was first designed and even less among the poorer countries that have recently copied it. The point that it is impossible to definitively prove a given policy is not working, however, does little to solve the mystery of why it has been so widely diffused. “Well, you can’t prove it doesn’t work” is not a sales pitch that we would expect to attract many buyers. With this caveat in mind, the most careful surveys of effectiveness in rich countries have not been able to find evidence that the policy is achieving the results its proponents claimed it would. Even senior officials in the various national and international AML agencies are often startlingly frank about these doubts. Comments such as “no one really has any idea if this policy works” are not uncommon.8 But it is in the developing world that these doubts are most pronounced (there are now more developing countries with AML policies than developed ones). In part this is because of the lack of fit between the rich-world context for which the policy was first designed to operate and the local conditions that obtain. But it also reflects the incredibly urgent competing priorities and demands on governments’ money, time, and attention to meet the basic human needs of their citizens. Rather than just seek to assess effectiveness in an absolute sense, however, the issue of cost-effectiveness is at least as important to consider. The argument, sometimes heard from sympathetic officials, that this policy is “better than nothing” because it does put some criminals behind bars, ignores the idea that the general benefits delivered to society by a policy should be greater than the costs this policy imposes on it. These costs can come in the form of the tax that must be raised to pay for the government’s directives and also, and more important in the case of AML, the burden of regulatory compliance imposed on private firms and citizens. These costs are particularly important in poorer countries where so many needs are unmet. Spending money on inappropriate or ineffective policies is thus particularly costly in a technical sense and perhaps is immoral as well. The book argues that on the

8. Author’s interview, FATF Plenary, Strasbourg, February 2007.

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balance of available evidence, AML policy is neither effective in an absolute sense nor cost-effective, especially in the poor countries that are my main empirical focus. The assessment of effectiveness sets the stage for the powerbased explanation. First, it rules out the default, commonsense position that countries have emulated these policies because they are known to effectively solve pressing local problems. Second, the results show that in important instances major OECD countries are less conscientious in applying rules than are small, developing states. This selective enforcement indicates that the pressures are greater for small, vulnerable states than for rich, powerful ones. So why, then, do countries adopt AML policy? How has an expensive policy with little proven ability to solve problems and deliver benefits spread to almost every country in the world over a relatively short period of time? The argument put forward in part 2 is that the diffusion of AML standards has been a result of power. Most often, however, this power has not been exercised directly by the traditional means of international statecraft. Instruments such as military force, economic sanctions, and conditional lending have generally proved either ineffective or prohibitively expensive in compelling large numbers of target states to adopt given institutions or specific measures. Instead, the mechanisms at work are soft tools of governance —blacklisting, rating, ranking, structuring incentives for uncoordinated private actors, and socialization within regulatory networks. In the 1990s, AML policy was consensually developed and diffused among the rich states of the OECD, but by and large did not spread beyond this group. By 1998 this core group of rich states, assembled in the Financial Action Task Force (FATF ), decided that they needed to actively export AML standards outside their group, coercively if necessary. The first step was to evaluate twenty-nine nonmember jurisdictions and publicly blacklist those countries adjudged to be delinquent in the fight against money laundering. Through stigmatizing these countries, and in some cases precipitating significant capital flight as a result, pressure was exerted to adopt and conform to the standard template of AML measures. Beyond the target group, the blacklisting exercise successfully scared other countries into adopting these policies so that they themselves would not be blacklisted in the future. Although blacklisting was phased out in 2002, it enjoyed a resurgence beginning in 2007 in an effort to target the few holdouts who had not yet adopted the policy template. Partly by accident and partly by design, the blacklist provided the impetus for bandwagon effects in terms of the adoption of AML policy. The tight network of rich-country AML officials was then spread into the developing world, as personnel from central banks, ministries of justice and finance, financial supervision bodies, and later, dedicated AML agencies in

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poor countries were drawn into outreach seminars, workshops, and technical assistance and capacity-building programs carried out by international organizations. These contacts moved from an ad hoc to a regular basis, as regional AML bodies were formed in Asia, Latin America, and Africa, and more and more international organizations developed a role in this issue area. The officials from national governments and international organizations drawn into these transnational networks became socialized in line with the lexicon and repertoire of AML practices. This process was greatly aided by the system of regular rating and rankings that countries were subject to in order to assess their compliance with international AML regulations. Both the regulations themselves (the 40+9 Recommendations) and the assessment procedures (the methodology) are standardized, with officials being evaluated by their peers and receiving a public score. Countries whose financial sectors and domestic priorities were vastly different from those states that had first adopted AML policy thus nevertheless came to adopt and entrench the package of similar policies and institutions to counter a problem they did not previously know they had. Concurrent with this process of socialization within transnational policy networks, the rapid diffusion of AML policy began changing incentives for private firms. The responsibility for fighting money laundering and related financial crime has to a large extent been delegated to the private sector, especially banks. On pain of administrative, civil, and criminal penalties, financial firms must engage in extensive surveillance of those who use their services. These firms are left in a vulnerable position if it turns out that they have hosted the proceeds of crime. Yet in seeking to identify and screen out criminal money, banks and other financial institutions face a difficult task: governments have been clear about the penalties for dereliction of duty in the fight against illicit finance but have provided very little indication as to how to tell clean from dirty money. In dealing with foreign transactions from poor countries in particular, banks have sought to cover their bases by simply adopting the presence or absence of AML policy as a proxy for the underlying risk. According to this proxy of convenience, developing states without an AML policy face higher costs in accessing international financial networks. This approach demonstrates that firms are “doing something” and provides legal cover if it should turn out that a firm has been used by criminals to launder money. Developing countries have responded by adopting AML policy as a functionally useless but symbolically useful measure to reassure outsiders. Unintentionally, the uncoordinated actions of private actors have in this manner created competitive pressure for developing countries to adopt AML policy as a symbol of propriety, decoupled from underlying

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practice. Those countries that do not have an AML policy have faced increased difficulty and expense in transacting with the outside world. These three mechanisms, blacklisting by the Financial Action Task Force, socialization of officials, and the use of AML policy as a talisman to communicate in-group status to private firms, have in combination operated to diffuse the standard template of policies and institutions across the globe. The threat or actuality of being blacklisted gave the initial impetus for exporting AML policy beyond the rich world, brought national officials into transnational networks, and began to reshape the structure of incentives for private firms and hence governments looking to access international financial networks. After this initial impetus, socialization and private actors created a self-reinforcing dynamic of diffusion: the more countries that adopted, the greater the pressure to follow suit, subsequently increasing the pressure on those that did not, isolating them, and stamping them as deviant. As a result, AML systems look likely to expand and deepen in the future, irrespective of their ineffectiveness. Although there have been different degrees of intentionality involved, singly and in combination these mechanisms reflect that diffusion has in this instance been a power-driven process. Almost every country in the developing world has now been pressured into adopting a policy that is ill-suited to local conditions, does not seem to work, and diverts significant resources that could be used to address a host of more urgent priorities. To make matters worse, the evidence presented indicates that in important instances AML standards are applied more stringently in small developing states than in the United States and United Kingdom. There are already significantly more countries with AML agencies than there are countries with armies.9 Within the next decade, there may be no sovereign state that lacks the standard template of AML measures. The unstoppable march of AML policy, the power-driven nature of the diffusion process, and the human and financial costs associated with it mark this as an issue with consequences too large to ignore.

Evidence and Method As foreshadowed earlier, two basic claims need to be substantiated: that AML policy is on balance ineffective and that this policy has been diffused by an essentially coercive process. This evidence is gathered using not only some conventional methods but also some unconventional ones involving 9. At least thirty-three sovereign states have no armed forces; see Theo Farrell, “World Culture and Military Power,” Security Studies 14 (2005): 462.

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my participation in rule-diffusing and rule-breaking activities. In order to uncover the mechanisms at work through which very broad and nebulous conceptions of appropriateness translate into legislation, regulation, and institutions, it is necessary to get close to the action. Similarly, perhaps the most direct way to test the effectiveness of rules is to attempt to break them and see what happens, in this case those rules that prohibit anonymous participation in the international financial system. I start with reports from those agencies charged with designing, enforcing, and evaluating policies to counter money laundering. These include not only national institutions, but also, and more important, the international organizations that assess and score countries on the implementation and effectiveness of their AML standards. Among the growing secondary literature on the topic are some careful studies of AML effectiveness and cost-effectiveness, although these tend to be heavily skewed toward rich countries, now an unrepresentative minority in the global AML policy community. Although growing strongly, the community of those individuals involved in the international AML policy network is still relatively small. I was able to talk with officials from a plethora of international organizations that have been important in the diffusion process. These groups include the Financial Action Task Force, the Eastern and Southern African Anti-Money Laundering Group, the Caribbean Financial Action Task Force, the Asia-Pacific Group on Money Laundering, the Governmental Action Group against Money Laundering in West Africa, the World Bank, the International Monetary Fund, United Nations Office on Drugs and Crime, the Commonwealth, the Egmont Group, the Asian Development Bank, the Pacific Islands Forum, the Caribbean Development Bank, Asia-Pacific Economic Co-operation, the European Union, the Organization for Economic Co-operation and Development, and others. Similarly, I met with relevant national officials involved in AML policy from two dozen countries from Europe, North America, and Australasia as well as Africa, Asia, the South Pacific, and the Caribbean, both in their home countries and at their various international workshops, conferences, and plenary meetings. In addition, I observed two plenary sessions of the FATF, two of the AsiaPacific Group on Money Laundering, and one of the Council of Europe’s AML body. These plenary meetings are the venue for each organization to plan its future course, discuss ongoing initiatives, and debate and approve the evaluation reports assessing members’ compliance. The plenaries are closed and hence include no ministers, no media representatives, no diplomats. Instead, they are populated by regulators from member states and international organizations. Unsurprisingly, the formal business is complemented

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by intense informal networking in the margins, during coffee breaks and lunch and, in the case of the FATF, during the traditional karaoke session (socialization involves a lot of socializing). These plenary meetings were complemented by observing smaller, more specialized APEC and Pacific Island Forum workshops. Turning from observation to participation, I have been involved in several applied projects to assess and diffuse AML standards in the developing world. This direct participation included leading a cost-benefit analysis of AML policy in three small developing countries ( Barbados, Mauritius, and Vanuatu) on behalf of the World Bank and the Commonwealth in 2005– 2006. For the next three years I conducted policy reviews on various aspects of money-laundering policy for the FATF, Asia-Pacific Group on Money Laundering, and Asian Development Bank, again with a predominant focus on developing states. These projects involved liaising between different international organizations, national government officials, and private sector representatives and thus provided direct involvement in the diffusion process. Even though confidentiality agreements in some cases limit disclosure, my work as an agent of diffusion gave some invaluable clues about the overall process. The final strand of evidence gathering involved being on the other side of the process and relates to the question of effectiveness. This involved a direct test of whether the rules that apply in theory actually apply in practice by soliciting offers for anonymous shell companies with associated bank accounts and buying a subset of these. This approach relies on the simple logic that if international rules ban a certain kind of product, and yet that product is easily available in practice, then the rules are not working. It is by using such a direct test that the authors of Half the Sky graphically demonstrate the shortcomings of antislavery standards by buying slaves.10 Here the forbidden product is anonymous shell companies. For reasons explained in the next chapter, to the extent that it is possible to enter the international financial system hidden behind a company whose ownership is unknown, money laundering is relatively simple. This technique is the most common means of laundering the proceeds of major corruption and the profits of many other kinds of crime. Because AML policy is above all an effort to make the financial system transparent, the “Know Your Customer” rule mandates that banks and other financial institutions establish and record the true identity of their clients. But of course it is a commonplace that rules may be ineffectual, 10. Nicolas D. Kristof and Sheryl WuDunn, Half the Sky: Turning Oppression into Opportunity for Women Worldwide (New York: Vintage, 2010).

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having little or no influence on actors’ behavior. How can we know whether the rules work, whether they make a difference? The rationale behind such a direct test is that if it is relatively easy to enter the financial system anonymously, then the effectiveness of the whole AML apparatus is severely compromised, while to the extent that such attempts are difficult or impossible, the rules work well. In combination with the review of primary and secondary sources and interviews, the observation, participation, and rule-breaking approaches provide a novel view of both the mechanisms by which diffusion occurs and the extent to which key aspects of AML policy are (in)effective. Gathering evidence using these methods also helps to ground and elaborate much larger quantitative studies of diffusion. It further provides important testimony as to just how soft techniques of global governance can be powerful drivers of worldwide policy convergence.

The Shape of Things to Come In setting out to answer the questions concerning effectiveness and diffusion, the first tasks are to establish just what money laundering is, to settle on a working definition, and to provide examples. In doing so, chapter 1 briefly traces the history and nature of money laundering as well as its comparatively recent emergence as a distinct policy problem in the United States during the 1980s and internationally in the 1990s. This section also explains the standard AML policy template and how it is supposed to work. Part 1 tackles the first major issue: Does AML policy work, is it effective? Although most of the available evidence relates to rich countries, this section argues that assessing effectiveness is a more vital question for poor countries. As noted above, “effectiveness” is assessed in a broad sense: both in absolute terms and relative to the cost. Evidence gathered from secondary and primary sources as well as the direct participation test suggest that the answer to the question “Does AML policy work?” is “Probably not.” Following from this conclusion, the question asked in part 2 is, in light of its lackluster results, how has this policy diffused so rapidly to so many countries with so little in common? Their very diversity makes it unlikely that domestic factors are determinative. Nauru has almost nothing in common with the United States, but both have a similar AML policy structure. Part 2 is devoted to explaining the three mechanisms at work ( blacklisting, socialization, and private incentives) and testing them against available evidence. The book has a twofold conclusion, relating to policy and theory. The policy section shows how the developing world can make the best of a bad

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situation. Effective or not, poor countries are now stuck with AML policies. However, they can get greatest value for their money from their AML systems by using them to attack corruption. For although money laundering per se is a second-order problem for developing states, corruption is not. The powerful monitoring, investigative, and punitive features of the AML regime may be able to deliver significant benefits in this area. The main scholarly contributions relate to method and theory. In relation to method, scholars should be more open to fleshing out grand theories by direct involvement in the relevant political processes. For example, the best way to test the effect of different appeals to potential voters may be to go out and pitch them to actual voters.11 Turning to theory, I argue that global governance is a lot less about pitching in to help solve common problems and a lot more about weak states being pushed around than many theories allow for. But it is crucial to note that the exercises of power are not the traditional means of military force, economic sanctions, or even conditional lending. They are less direct and less state-centered notions of power, which are nevertheless highly effective and which are becoming much more common. Nor is the book’s thesis a conventional hegemony account about how the rich few profit from the misery of the poor masses; with some essentially minor unintended and accidental exceptions, no one really gains from the policy apparatus designed to counter money laundering. This fact underlines the need to go beyond conventional explanations to explain the puzzle of why an ineffective, expensive policy such as anti-money laundering has spread so far so fast.

11. Alan S. Gerber, Donald P. Green, and Christopher W. Larimer, “Social Pressure and Voter Turnout: Evidence from a Large-Scale Field Experiment,” American Political Science Review 102 (2008): 33– 48.

Ch a p ter 1

Money Laundering and Anti-Money Laundering

In some facile, legalistic sense, the perfect and complete solution to money laundering is easily available to all governments: legalize it. Or rather, return to the not-too-distant past when no state had criminalized the practice of money laundering. After all, for a criminal offense to be committed, states must have gone to the trouble to specify that certain conduct constitutes an offense in the first place.1 Given that money laundering is a derivative crime, depending on the proceeds of another crime, this point is less trivial than it might at first appear. In this legal sense, the history of money laundering is quite short because it was first instituted as an offense in the mid-1980s. But the history of money laundering is much longer if the term refers to a practice or type of behavior: the process of hiding the illicit provenance of money derived from crime. This chapter focuses on the legal history of money laundering and the policies used to counter it as they have arisen over the past few decades. The first aim is to present a brief account of the main features of the contemporary practice of money laundering, although for all the policy attention and money lavished on this subject there are surprisingly large gaps in our knowledge. The second goal is to sketch out the origins and main features of 1. Peter Andreas and Ethan Nadelmann, Policing the Globe: Criminalization and Crime Control in International Relations (Oxford: Oxford University Press, 2006).

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policies designed to counter money laundering, which have been exported in remarkably similar form around the globe. In providing background on money laundering and AML policy, this chapter anchors both the assessments of effectiveness, presented in chapters 2 and 3, and explains subsequent diffusion. My goal is to give the reader a working knowledge of the origins and nature of the AML regime sufficient to put these later, more detailed discussions in context.

What Is Money Laundering? Most crimes, and nearly all organized and cross-border crimes, are driven by the desire for profit. The majority of criminal offenses generate relatively small sums of money. The proceeds can simply be spent on everyday consumption. In these cases, because the sums are small, there is little or no need to disguise the origins of the money. However, for international and organized crime (the latter a highly contested term),2 there is usually more money than can be spent quickly without arousing suspicion. Stockpiling cash is problematic for several reasons. First, cash may be quite bulky, with a million dollars in twenty-dollar bills weighing perhaps 50 kilograms. Particularly in the case of drug trafficking, relatively low-denomination notes may be common, and the resulting cash often weighs more than the drugs themselves. Second, cash may be vulnerable to physical decay. According to his brother, Colombian drug lord Pablo Escobar suffered losses of approximately 10 percent from having stockpiles of notes damaged by water or being eaten by rats.3 Large amounts of ready cash may present a tempting target for rival criminals. Finally, holding or spending too much cash may arouse the suspicions of law enforcement, especially with the surveillance measures introduced as part of AML policy. Thus in order to securely enjoy ill-gotten gains and ensure readily usable capital for further illegal activities, dirty (illicit) money must be made to seem clean (legal): hence, money laundering.

2. See Petrus C. van Duyne, “The Creation of a Threat Image: Media, Policy Making and Organized Crime,” in Threats and Phantoms of Organized Crime, Corruption and Terrorism, ed. Petrus C. van Duyne et al. (Nijmegen: Wolf Legal Publishers, 2004), 21–51; Petrus C. van Duyne, “Introduction: Counting Clouds and Measuring Organized Crime,” in The Organization of Crime Profit. Conduct, Law and Measurement, ed. Petrus C. van Duyne et al. (Nijmegen: Wolf Legal Publishers, 2006), 1–16; Petrus C. van Duyne, “Serving the Integrity of the Mammon and the Compulsive Excessive Regulatory Disorder,” Crime Law and Social Change 52 (2009): 1–8; R. T. Naylor, Wages of Crime: Black Markets, Illegal Finance, and the Underworld Economy (Ithaca: Cornell University Press, 2004). 3. Roberto Escobar with David Fisher, The Accountant’s Story: Inside the Violent World of the Medellin Cartel (New York: Grand Central, 2009).

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Disguising the origins of criminal money is said to have been going on for centuries, perhaps even in ancient times.4 However, the demand for this practice has increased exponentially over the last century. The rise of relatively complex financial institutions has provided more scope for fraud and white-collar crime. Even more important to money laundering is the illegal drug trade. To the extent that states have criminalized opium, heroin, cocaine, etc. since the early part of the twentieth century, they have both reclassified what had been legal behavior as illegal, thereby creating much more crime by fiat, and boosted the prices of these drugs.5 The combined result was a great deal more criminal money. In this sense, states have created a problem they have then struggled to solve.6 The term “money laundering” itself is apocryphally said to date from the era of Prohibition in the United States and came about as a result of gangster Al Capone’s need to invent an alibi for the massive profits from bootlegged alcohol. The story goes that Capone bought pool halls and self-service laundries to provide an explanation for his income and assets and hence “launder” his illegal money.7 Although in lexicographical terms there seems to be little truth to this account, the attraction of comingling criminal money with legal revenues from businesses that engage in a large number of individual small cash transactions remains to this day. (Capone’s eventual conviction on the grounds of tax evasion after investigators “followed the money” has since exercised a powerful hold on the imaginations of those looking to defeat crime by attacking its financial underpinnings.) More accurately, however, money laundering was first used to describe President Nixon’s criminal conspiracy to secure reelection, which later became the Watergate scandal. The financial trail of check clearances connected the burglars who broke into the Democratic National Committee headquarters to Nixon’s campaign, and thence deep into the U.S. intelligence and justice hierarchies, before ending with the president himself.8 The first judicial use of the term was in the United States in 1982, and in 1986 the United States passed the Money Laundering Control Act, the first dedicated AML legislation.

4. Liliya Gelemerova, “On the Frontline against Money Laundering: The Regulatory Minefield,” Crime, Law and Social Change 52 (2009): 34. 5. Naylor, Wages of Crime, 249. 6. Andreas and Nadelmann, Policing the Globe. 7. Petrus C. Van Duyne, “Money Laundering, Fears and Facts,” in Criminal Finances and Organizing Crime in Europe, ed. Petrus C. van Duyne, Klaus von Lampe, and James L. Newell (Nijmegen: Wolf Legal Publishers, 2003), 73. 8. Carl Bernstein and Bob Woodward, All the President’s Men (New York: Pocket, 2005).

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How do criminals launder money? The nature of the laundering process is incredibly varied, in keeping with the huge range of crimes that give rise to the funds in the first place. The underlying crime that gives rise to the criminal money to be laundered is referred to as the “predicate offense.” Because the initial focus on money laundering occurred concomitantly with the drug trade (as discussed in the following section), the trafficking of illegal drugs is one of the most common predicate offenses. But the number of predicate offenses, and hence the scope of AML law, has ballooned since the 1990s. Such offenses now include robbery, fraud, the illegal trade in arms and people, kidnapping, extortion, bribery, smuggling, embezzlement, counterfeiting, price-fixing, insider trading, and other offenses (tax evasion and the financial support of terrorists are special cases discussed separately). The methods and venues of laundering are almost endless. Various bodies have recently expressed the concern over laundering in the football sector, free trade zones, and even multiplayer computer games such as Second Life.9 A simple expedient is to smuggle cash across borders in bulk, first to complicate pursuit and second to take advantage of less rigorous scrutiny in the destination country. Gambling venues may provide another avenue: winning horse race or lottery tickets are bought at a discount from the genuine winner by a criminal, or criminals convert their cash into chips at a casino then reconvert the chips to cash, checks, or wire transfers. A suspiciously large sum of money may be broken down among a number of couriers who individually deposit money in innocuously small amounts into their accounts, later transferring the funds to a central collection point in the same country or overseas (so-called smurfing). Along the lines of Al Capone’s self-service laundries, criminals may buy legitimate businesses through which to insinuate their illegal money into the banking system. Criminals may corrupt officials in banks or other established financial institutions, as when Russian underworld groups paid senior Bank of New York officials $1.8 million to launder $7 billion over a three-year period.10 Launderers may choose to set up more or less complex corporate structures of interlocking companies and trusts in a series of jurisdictions, usually favoring those locales with tight bank secrecy or that allow the formation of companies without proper identification checks. Of course, criminals can and do use a combination of 9. See, respectively, FATF, Money Laundering through the Football Sector (Paris, 2009); FATF, Money Laundering Vulnerabilities of Free Trade Zones (Paris, 2010); Kevin Sullivan, “Virtual Money Laundering and Fraud: Second Life and other Online Site Targeted by Criminals” April 3, 2008, Bank Info Security, http://www.bankinfosecurity.com/articles.php?art_id=809 (accessed December 2009). 10. David Chaikin and J. C. Sharman, Corruption and Money Laundering: A Symbiotic Relationship (New York: Palgrave, 2009), 75–77.

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methods. Despite the range of methods practiced, it is conventional to view the laundering process as having three stages: placement, when funds first enter the legitimate financial system; layering, to distance funds from the original crime; and integration, through which the funds are then returned to the criminal in a useable, ostensibly legitimate, form. It has become a commonplace belief that the same technological progress and financial deregulation that has given rise to legitimate cross-border flows of trade and capital have also favored the laundering of money.11 Yet, as with almost everything else having to do with money laundering, it is hard to find the evidence that would put this claim on a firm footing. Meyer Lanksy, infamous in popular culture as “the mob’s accountant,” reputedly used a network of foreign companies and a Swiss bank he owned to launder the proceeds of illegal gambling operations in the United States and Cuba beginning in the early 1930s.12 Guesses concerning the going rate for money laundering range from 4 percent to 12 percent of the principle.13 However, stand-alone money launderers seem the exception rather than the rule. Rather than one set of criminals (e.g., drug dealers) paying for the services of independent launderers, it seems that most laundering is done in-house by the criminals who perpetrated the original predicate crime.14 An even bigger unknown is the scale of money laundering—how much illegal money is in the system. The most straightforward answer is that no one knows. This ignorance is not just a result of the self-evident secrecy that surrounds criminal activities but also is due to serious methodological problems in the macro- and microeconomic estimates produced.15 Even absent any other changes, to the extent that gambling or prostitution are legalized 11. John Kerry, The New War: The Web of Crime That Threatens America’s Security (New York: Simon and Schuster, 1997); William C. Gilmore, Dirty Money: The Evolution of Money Laundering Counter-Measures (Strasbourg: Council of Europe, 1995); H. Richard Friman, ed., Crime and the Global Political Economy ( Boulder: Lynne Reiner, 2009). 12. Robert Lacey, Little Man: Meyer Lansky and the Gangster Life (New York: Random House, 1993). 13. Michael Levi and Peter Reuter, “Money Laundering,” in Crime and Justice: A Review of Research, Vol. 34, ed. M. Tony (Chicago: University of Chicago Press, 2006), 289–375. 14. Mariano-Florentino Cuellar, “The Tenuous Relationship between the Fight against Money Laundering and the Disruption of Criminal Finance,” Research Paper 64 (Stanford: Stanford Law School, 2003). 15. See in particular Peter Reuter and Edwin M. Truman, Chasing Dirty Money: The Fight against Money Laundering ( Washington, D.C.: International Institute of Economics, 2004); Reuter and Levi, “Money Laundering”; Jackie Harvey, “An Evaluation of Anti-Money Laundering Policies,” Journal of Money Laundering Control 8 (2005): 339–345; Peter Reuter, “Are Estimates on the Volume of Money Laundering Either Feasible or Useful? Comments on the Presentation by John Walker,” paper presented at the Tackling Money Laundering Conference, Utrecht University, November 2, 2007; John Walker and Brigitte Unger, “Measuring Global Money Laundering: The ‘Walker Gravity Model,’ ”

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the money associated with these industries cross from the underworld to the legitimate economy. Conversely, when tax evasion is defined as a predicate crime for money laundering, it massively boosts the total. During the period 1996–2000, the Financial Action Task Force (FATF ) labored in vain to come up with a money-laundering total.16 However, as Peter Reuter and Edwin Truman astutely remark, methodological difficulties aside, “The demand for numbers creates a supply.”17 Officials are often frank in noting that numbers are invaluable to arouse interest in the media, among policymakers, and in the general public (as well as bodies that give grants to academics such as this author, for that matter).18 Of the statements, “vast sums of criminal money are laundered every year” and “a trillion dollars of criminal money is laundered every year,” only the second works in political terms. Thus a combined UN Office on Drug and Crimes (UNODC) and World Bank report on laundering the proceeds of corruption successfully garnered widespread media coverage on the basis of the huge numbers quoted; but only in the footnotes was it admitted that there was little basis for these numbers, which nevertheless become entrenched through being repeatedly cited.19 Speaking of such estimates, critics such as R.T. Naylor are scathing: “The objective was not to illuminate the shadowy world of crime so much as enlighten politicians about the need for larger law enforcement budgets and more arbitrary police powers. Therefore, these magic numbers assumed the status of religious cant and were rarely revised, except heavenward.”20 Writing about organized crime in general, Peter Andreas and Kelly Greenhill similarly note, “the public announcement of an impressively large sounding number, regardless of its origins or validity, can generate prominent press coverage, which in turn legitimates and perpetuates the use of the number.”21 Numbers are thus often at least as much about advancing an agenda as advancing knowledge as such. Review of Law and Economics 5 (2009): 821–53; Brigitte Unger, “Money Laundering: A Newly Emerging Issue on the International Agenda,” Review of Law and Economics 5 (2009): 807–19. 16. John Walker, “How Big Is Money Laundering?” Journal of Money Laundering Control 3 (1999): 25–37. 17. Reuter and Truman, Chasing Dirty Money, 22; see also van Duyne “Counting Clouds.” 18. Author’s interview, United Nations Office on Drugs and Crime, Vienna, Austria, May 18, 2007; Author’s interview, World Bank, Washington, D.C., June 28, 2004; Naylor, Wages of Crime, 33; Peter Andreas and Kelly M. Greenhill, eds., Sex, Drugs, and Body Counts: The Politics of Numbers in Global Crime and Punishment (Ithaca: Cornell University Press, 2010). 19. UNODC/World Bank, Stolen Assets Recovery (StAR) Initiative: Challenges, Opportunities, and Action Plan (New York, 2007), 9. 20. Naylor, Wages of Crime, 250; see also 32–33. 21. Peter Andreas and Kelly M. Greenhill, “Introduction: The Politics of Numbers,” in Andreas and Greenhill, Sex, Drugs, and Body Counts, 3.

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With the above caveat in mind, in 1998 then-International Monetary Fund (IMF ) chief Michael Camdessus reported that the global flows of illegal money made up 2–5 percent of the world economy (a later report noted “a documentary basis for it [this estimate] could not be found”),22 or between $1.4 and $3.5 trillion in 2009 terms at purchasing power parity rates. John Walker suggested the global total for money laundering in 1995 was $2.85 trillion.23 While strongly declaiming the possibility of coming up with anything like a definitive figure, Reuter and Truman suggest that the total might be anywhere from the low hundreds of billions of dollars to something over a trillion.24 Raymond Baker suggests figures of $500 billion in tax evasion and avoidance, $20–$40 billion in proceeds of corruption, and $500 billion in all other criminal activities.25 Such vast, and vastly differing, estimates, as well as the skepticism evinced by the FATF and many experts toward the possibility of any estimate at all, underline the limited extent of our knowledge about money laundering. Whether one accepts these figures comes down to a question of taste: are bad numbers based on heroic assumptions better than no numbers at all? In their study Sex, Drugs, and Body Counts, Peter Andreas and Kelly Greenhill argue that policy pressures will consistently favor the former position over the latter.26 This uncertainty is a stark reminder of the challenges faced by those designing, implementing, and assessing the policy to counter this phenomenon. Nevertheless, it is not a challenge that has slowed the development and growth of the AML regime, whose origins and development are the subject of the next section.

The Origins of Anti–Money Laundering Policy The fundamental logic of AML policy is that if most crime is profit driven, then lowering the profits will lower the incidence of crime. Not only will attacking the financial underpinnings of crime lessen the incentive to commit offenses, it also will reduce the sums available to fund ongoing criminal activity. In this sense, just as money laundering is a derivative crime, by definition linked to a predicate offense, so too the ultimate object of AML

22. UNODC/World Bank, Stolen Assets Recovery Initiative, 9. 23. Walker, “How Big Is Money Laundering?”; Walker and Unger, “Measuring Global Money Laundering.” For a critique of this method, see Reuter, “Estimates on the Volume of Money Laundering.” 24. Reuter and Truman, Chasing Dirty Money, chap. 2 25. Raymond W. Baker, Capitalism’s Achilles Heel: Dirty Money and how to Renew the Free-Market System (Hoboken, NJ: Wiley, 2005). 26. Andreas and Greenhill, “The Politics of Numbers,” 19.

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policy is not to reduce money laundering as such but rather to reduce the predicate crimes. This section of the chapter briefly summarizes the historical development of the AML regime, and the next section describes the main features of the package of AML measures that have so successfully been diffused across the world. The United States has done more to develop and diffuse AML policy than any other country, and thus this section concentrates heavily on the United States. But it is important to remember that several other Western countries initially developed their AML policies independently at around the same time as did the United States and were strongly supportive of American efforts to spread these policy provisions worldwide. Bodies such as the Council of Europe and what became the European Union, as well as the United Nations, diffused at least the precursors of the AML regime among their members beginning in the late 1980s. Thus although this book argues that the diffusion of the AML regime has in a majority of cases been premised first and foremost on exercises of power, this cannot be reduced to an instance of “American hegemony.” Efforts to counter money laundering in the United States are commonly dated to the introduction of the (misnamed) Bank Secrecy Act of 1970. Although this legislation did not use the term “money laundering,” it did impose the duty on banks to lodge a transaction report with the U.S. Treasury Department for any client depositing more than $10,000. This legislation was motivated by the desire to crack down on tax evasion.27 Even at this very early stage, the tendency to devolve policing functions to the private sector was already pronounced. The first dedicated AML legislation in the United States, and indeed the world, was the 1986 Money Laundering Control Act. Above all else, the rationale behind creating the offense of money laundering and the specialized apparatus to combat it was part of the larger effort to control the drug trade. The latter half of the 1980s marked the crescendo of U.S. political concern with fighting the “war on drugs.” In response to the beginning of a crack cocaine epidemic, in April 1986 President Reagan issued National Security Decision Directive 221, which proclaimed that drug production and trafficking constituted a threat to the security of the United States. The 1986 Anti-Drug Abuse Act (which also contained important AML provisions) created the controversial certification process by which Latin American countries were judged on their efforts to help the

27. Levi and Reuter, “Money Laundering,” 290.

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United States stamp out the drug trade. In 1988 the position of “drug czar” was created, and in 1989 the United States invaded Panama, in part to apprehend its leader Manuel Noriega for his role in the drug trade. The drug trade was seen as an existential threat to the United States. Aside from the immediate damage caused among users, the massive damage done to the political systems and societies of countries such as Colombia, where pervasive corruption, spectacular assassinations, and endemic violence sponsored by drug gangs seemed ready to topple the state, was seen as a cautionary tale. The first impetus for the International Criminal Court in 1988 was not to pursue those guilty of genocide or crimes against humanity, but to prosecute drug kingpins. Aside from intervening in Panama, the United States took increasingly assertive action in a range of other countries to disrupt the flow of drugs. This pressure extended to producer countries, most notably Colombia, home to the Medellin and Cali groups; transshipment points in the Caribbean; and financial centers with strict secrecy rules such as the Cayman Islands and Switzerland. At the same time, there was a deepening of the AML regime domestically as more stringent AML requirements were applied to a wider range of private firms, and the coverage was also broadened to include an international aspect. In part this extension was based on the extraterritorial use of U.S. power and in part by bi- and multilateral agreements. Despite devoting huge resources to this effort and a willingness to bend or even break international law in pursuit of the drug trade, results were uncertain. Many of the disappointments were attributed to the passivity or even complicity of foreign countries. Writing in 1984, one U.S. official held: Quite naturally our interest in drug control led us to investigate what happens to the proceeds of drug trafficking. One might have thought that this would be the Achilles heel of the illegal drug trade and that by following the money . . . we might be able to damage badly the whole illegal marketing system. Unfortunately [we] came up against the reality of the offshore havens—and, up and until now, the havens have been the clear winners.28 In criticizing this picture of weak and dilatory cooperation by foreign parties, Bruce Zagaris, one of the most incisive analysts of international financial law enforcement, noted at the time that “no large country produces as few 28. Richard H. Blum, Offshore Haven Banks, Trusts and Companies: The Business of Crime and the Euromarket (New York: Praeger, 1984), vii.

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treaties and as much rhetoric about international co-operation as does the United States,” and that “foreign banks and governments remain convenient scapegoats for US problems.”29 But the perceived need for the United States to stiffen the resolve of other countries in this arena remained, as seen in the 1988 Anti-Drug Abuse Act. The act called for a multilateral “International Currency Control Agency” to “analyze currency transaction reports filled by the ICCA’s member countries, and encourage the enactment of uniform cash transaction and money laundering statutes by member countries.”30 Although no international currency control agency was ever created, the suggestion provides important background for the creation of the Financial Action Task Force the following year. In many ways, Europe found its own way to this policy problem. As early as 1980, the Council of Europe discussed issues of money laundering.31 It is interesting, in light of developments after 2001, that rather than drugs, at this stage terrorism was the main concern. Italy and West Germany were seeking to suppress the financing of groups such as the Red Brigades and the Baader-Meinhof Gang that funded themselves through kidnapping and bank robberies. Britain and Spain had their own issues with the Irish Republican Army and Euskadi Ta Askatasuna (ETA).32 Switzerland introduced some of the precursors of an AML system after the Chiasso banking scandal in 1977.33 Further afield, in 1988 Australia introduced a transaction-monitoring scheme that was in some ways analogous to that in place in the United States, but in this case tax evasion, rather than drugs or terrorism, was the main motivation. Although the level of political concern about drugs in Western Europe and Australia did not match the extreme levels in the United States, clearly these countries were not immune to the problems of illegal drugs and the accompanying violence and corruption. In the mid- to late 1980s, Western European countries began introducing AML provisions, at first under antidrug legislation and later in dedicated AML laws. These provisions were

29. Bruce Zagaris, “Dollar Diplomacy: International Enforcement of Money Movement and Related Matters,” George Washington Journal of International Law and Economics 22 (1989): 548 and 550. 30. Zagaris, “Dollar Diplomacy,” 475. 31. Mark Pieth, “Financing of Terrorism: Following the Money,” European Journal of Law Reform 4 (2002): 365; Gilmore, Dirty Money, 137. 32. Barry A. K. Rider, “Law: The War on Terror and Crime and the Offshore Centres: The ‘New’ Perspective?” in Global Financial Crime: Terrorism, Money Laundering, and Offshore Centres, ed. Donato Masciandaro (Aldershot: Ashgate, 2004), 61–95. 33. Mark Pieth and Gemma Aiolfi, eds., A Comparative Guide to Anti-Money Laundering: A Critical Analysis of Systems in Singapore, Switzerland, the UK and the USA (Cheltenham: Edward Elgar, 2003).

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standardized and extended by agreements among the Council of Europe in 1990 and the European Economic Community in 1991.34

The Beginning of International AML Coordination As in the United States, the other OECD countries believed that any effective response to the drug trade (and terrorism) depended on international cooperation. Writing from a European perspective, William Gilmore notes “the drugs trade is now universally recognized as a global problem requiring a global solution.”35 Not only were the criminal trades in question essentially cross-border phenomena, but there was also a potential problem of displacement. The dominant analogy quickly came to be that the chain was only as strong as its weakest link, and tough standards to counter money laundering in a majority of countries would be for naught as long as criminals could simply reroute their finances to other jurisdictions with lax (or no) regulations in place.36 This rendering was increasingly matched with concerns about the adverse side effects of globalization for law enforcement agencies and states’ capacities more generally.37 Thus John Kerry, the Democratic senator who was one of the main architects of American antidrug laws, claimed in his book, The New War: The Web of Crime That Threatens America’s Security, that “Crime has been globalized like everything else.”38 He goes on to discuss “a global criminal axis” bent on destroying the American way of life. Although some critics strongly contest the accuracy of this portrayal,39 few dispute its political power. Following on from these concerns, the late 1980s saw the birth of the international AML regime. The United Nations Vienna Convention was concluded 1988, and the Basel Committee on Banking Supervision issued a statement on money laundering later that year; but most important of all was the creation of the FATF after the July 1989 Group of 7 (G7) heads of state summit. In keeping with the initial focus of AML as an auxiliary in the “war on drugs,” the first international provisions to counter money laundering 34. Council of Europe, Convention on the Laundering, Tracing, Seizure and Confiscation of Proceeds of Crime, Paris, 1990; European Commission, First Anti-Money Laundering Directive, Brussels, 1991. 35. Gilmore, Dirty Money, 17. 36. Blum, Offshore Haven Banks, 225; Gilmore, Dirty Money, 36. 37. See, for example, William Wechsler, “Follow the Money,” Foreign Affairs 80 (2001) 40–57; Jonathan M. Winer, “Illicit Finance and Global Conflict,” FAFO Institute for Applied Social Science Research Paper 380, Oslo, 2002. 38. Kerry, The New War, 20. 39. Naylor, Wages of Crime; van Duyne, “Counting Clouds.”

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were in the 1988 UN Convention against Illicit Traffic in Narcotic Drugs and Psychotropic Substances (the Vienna Convention). This agreement included the critical provision that signatories must criminalize the process of obscuring the illegal origins of money derived from drugs ( but no other predicate crimes). The convention sought to ensure that signatories had in place mechanisms to trace, freeze, and confiscate drug profits, as well as to enhance mutual legal assistance. Although later seen as excessively narrow in its focus on money laundering only as it related to drugs, at the time the convention was seen as marking a major breakthrough in international collaboration that provided powerful new tools to law enforcement bodies.40 The U.S. 1986 Anti-Drug Abuse Act had mandated that the Federal Reserve approach the Bank of International Settlements according to the logic that “money laundering is a global phenomenon and that if one country’s banks and financial institutions are required to implement AML measures— increasing their costs and turning away their customers—then the same standards should be applied globally to reduce regulatory arbitrage and level the playing field.”41 The central bankers’ first reaction to the prospect of being involved in crime fighting was “horror,” but the Basel Committee later issued a statement in 1988 establishing the “Know Your Customer” requirement for banks, as well as the need for suspicious transaction reporting and cooperation with law enforcement.42 By far the most significant development for the global diffusion of AML policy, however, was the formation of the FATF, which from its inception to the current day has defined and enforced the reigning standards. The FATF was created on the instruction of the G7 countries at their July 1989 summit in Paris, with the United States and France driving the process. The summit stated that “the drug problem has reached devastating proportions. We stress the urgent need for decisive action, both on a national and international basis to counter drug production, consumption and trafficking as well as the laundering of its proceeds.” In response there was a commitment to: Convene a financial action task force from Summit participants and other countries interested in these problems. Its mandate is to assess the

40. Gilmore, Dirty Money, 74. 41. Reuter and Truman, Chasing Dirty Money, 79. 42. Ibid., 80; Financial Action Task Force, “Prevention of Criminal Use of the Banking System for the Purpose of Money-Laundering,” http://www.fatf-gafi.org/dataoecd/45/23/34343707. pdf.

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results of cooperation already undertaken in order to prevent the utilization of the banking system and financial institutions for the purpose of money laundering, and to consider additional preventive efforts in this field, including the adaptation of the legal and regulatory systems so as to enhance multilateral judicial assistance.43 A group of 130 experts from the G7 countries (Canada, France, West Germany, Italy, Japan, the United Kingdom, and United States), as well as from Australia, Austria, Belgium, Luxembourg, the Netherlands, Spain, Sweden, and Switzerland, working under a French chairman, released a report in February 1990. The report included the first version of the 40 Recommendations, which have thereafter defined the state of the art in AML policy. The report was endorsed by all members, and they decided to extend the FATF’s mandate as well as to include Denmark, Finland, Greece, Ireland, New Zealand, Norway, Portugal, and Turkey in the FATF. A three-person secretariat was co-located at the OECD’s headquarters in Paris. As a task force, the group had no international legal standing, and thus the resulting standards were soft law rather than legally binding rules. The global scale of their ambitions was apparent from these early stages. A 1991 press release notes: “The ministers underscored that a worldwide mobilization effort, on the basis of the recommendations of the FATF, was necessary to ensure the success of the fight against money laundering.”44 Although the recommendations “encouraged” the criminalization of money laundering beyond drug offenses (Recommendation 5), the strict requirement applied only to drug money laundering (Recommendation 6). The FATF revised the 40 Recommendations in 1996 to expand the coverage beyond drug crimes, and in 2001 the Special Recommendations on countering the financing of terrorism were added. Although further revisions continued (especially with the 2003 revisions and the 2004 methodology), by this point a standard package of AML measures had emerged and was increasingly being diffused far beyond FATF members. The next section illustrates the main contours of this policy.

43. G7 Heads of State Summit Communiqué, 16 July 1989, http://www.g7.utoronto.ca/ summit/1989paris/communique/drug.html. 44. FATF Press Communiqué, 4 June 1991, http://www.fatf-gafi.org/dataoecd/63/37/35752 748.pdf.

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The Structure and Nature of AML Policy Reuter and Truman summarize the AML regime of the 40+9 Recommendations as comprising two pillars—prevention and enforcement.45 Prevention is further subdivided into four areas: customer due diligence (also referred to as “Know Your Customer,” or KYC), reporting, regulation and supervision, and sanctions. Know Your Customer is the component that most directly affects the general public. Here, financial institutions must ensure that their customers are really who they say they are by requiring identity documentation. So, for example, when opening a bank account, individuals must present a passport, driver’s license, and/or utility bills to prove their name and address. This requirement may unintentionally exclude those without such identification from the banking system. At first limited to banks, this KYC requirement has now been extended to a variety of other financial institutions such as insurance companies, and in some countries to casinos, real estate agents, those forming companies or trusts, and luxury goods dealers, as well. For corporate customers, banks must identify the individual or individuals in control of a company or trust, a crucial issue covered at length in chapter 3. Knowing the customer may also involve building up a profile of normal financial activity for that customer and forming a benchmark against which suspicious deviations can be identified. Any such suspicions must then be passed on to the authorities. Special scrutiny must be applied to senior government officials, referred to as “Politically Exposed Persons.” Banks must also eschew any dealings with shell banks, that is, those banks without any physical presence. Suspicious transaction reports and other equivalent measures require private firms to identify financial behavior that may indicate ill deeds afoot (transactions that are unusually large, complex, and without apparent business purpose) and report these to an official Financial Intelligence Unit (FIU). The FIU is responsible for receiving, collating, and analyzing these reports and passing them on as needed to law enforcement (in some countries this unit can conduct its own investigations). When must a report be submitted? According to the U.S. 1970 Bank Secrecy Act, a report was required for any deposit over $10,000, a figure that has since become talismanic for other countries, irrespective of currency and subsequent inflation differences. In response to smurfing, that is, structuring transactions to slip just under the reporting threshold, banks and others are now required to report suspicious transactions of any amount. Payments for large items (e.g., a car) in cash also 45. Reuter and Truman, Chasing Dirty Money, 46–48.

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prompt the need for the merchant to submit a report. In some countries, such as the United Kingdom, lawyers are included in the reporting regime, although efforts to impose this requirement in the United States and Canada were defeated. Wire transfers are monitored, and travelers entering and leaving a country must declare cash above a certain value at the border. Firms are forbidden from letting the customer know that a report has been lodged and are indemnified for any breach of duty to their customer created by the reporting requirement. Countries like the United States and Australia aim to maximize the number of reports, which run into the hundreds of thousands or even millions annually, to get an encompassing view. This may create problems of finding the proverbial needle in the haystack. Others, such as Switzerland, however, concentrate on a generating a much smaller number of reports ( perhaps in the hundreds) on activity where strong suspicions of criminal activity exist.46 These KYC and reporting requirements impose a substantial burden on the private sector and, indirectly, the public at large. The FIU is responsible for ensuring that these duties are carried out faithfully. To this end the FIU audits firms’ AML procedures, conducts training and awareness-raising exercises, and also imposes requirements for firms to set up their own internal compliance mechanisms to ensure that regulations are being followed. The FIU has a variety of punishments for those firms that fail to comply. It may publicly reprimand institutions, impose administrative penalties, take civil action, or criminally prosecute either the firm as a corporate entity or its officeholders as natural individuals. Prosecution may occur when firms reasonably ought to have reported a transaction as suspicious but failed to. Another crucial role of FIUs is to advise institutions to pay special attention to firms or countries that are not implementing the 40+9 Recommendations. Again following Reuter and Truman’s schema, the enforcement pillar comprises the designation of predicate crimes, investigation, prosecution and punishment, and confiscation. The issue of predicate crimes has been explained earlier, in the sense of money laundering being a derivative crime. At first limited to the profits of drug crimes, the definition of a predicate crime has been steadily expanded according to one of two routes. The first and most common is to adopt an “all crimes” approach, which is to say any economic crime carrying more than some given minimum penalty (usually a year’s imprisonment) becomes a predicate offense for money laundering. The second approach, taken by the United States, is to maintain a list specifying

46. Pieth and Aiolfi, Comparative Guide to Anti-Money Laundering.

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predicate crimes. Predicate crimes must be defined in such a way that these offenses committed in a foreign jurisdiction must be able to form the basis of a money-laundering charge domestically. As part of their investigative powers, the FIU and law enforcement bodies have the power to compel financial institutions to hand over records and other information, regardless of any local bank secrecy laws. The FATF further encourages countries to allow the use of “special investigative techniques,” such as undercover operations. The United States is particularly aggressive in the use of such techniques, such as sting operations, whereas in many European countries constitutional provisions prevent a similar approach. Countries are further enjoined to ensure effective cooperation between the FIU, law enforcement, and financial regulators. In light of the discussion earlier about cross-border crime and globalization, facilitating international cooperation in investigations is another central plank of the AML regime. This extends to the fullest measure of mutual legal assistance regarding extradition and the exchange of evidence as well as being able to execute freeze orders on funds in another country. To this end, countries must sign on to the relevant international instruments, the Vienna Convention, and later conventions against the financing of terrorism (in 1999) and transnational crime (the Palermo Convention of 2000). According to the FATF standards, punishment for money laundering should be “effective, proportionate, and dissuasive.” It should include not only imprisonment but also the confiscation of the proceeds of crime, and if necessary, the return of the proceeds to the crime’s original jurisdiction. Again stemming from the era of the war on drugs, confiscation was seen as a major weapon against those for whom the loss of their assets might be a greater deterrent and punishment than the loss of their freedom. Pioneered by the United States, countries have sought to strengthen this measure by reversing the onus of proof either via civil legal action or criminal action, which proceeds in rem, that is, against the asset rather than the person. In this way, instead of the authorities having to prove that a given sum of money or asset was directly a proceed of crime, individuals must provide sufficient evidence to establish that this money or asset was not the proceed of crime. Further strengthening the confiscation regime, law enforcement agencies may keep a share of the funds recovered (or as previously in Thailand, the individual officer effecting the confiscation keeps a share of the funds).47 The last two areas to be considered are the questions of terrorism and tax. In some ways, the reaction of the FATF to the September 11 attacks in passing

47. Author’s interview, Bangkok, Thailand, August 20, 2007.

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eight, then later nine, Special Recommendations to Counter the Financing of Terrorism marked a radical departure from its previous concerns (or perhaps for Europeans a return to the concerns of 20 years earlier). Anti-money laundering became AML/CFT, an unwieldy acronym eschewed in this book. But in many other ways, the brief to combat terrorist financing required only minor modifications of the existing AML framework. The KYC requirement now meant checking clients against lists of terrorists. Suspicions of terrorist finance now had to be reported using the existing suspicious transaction report machinery. In addition to their other assessments, FIUs’ inspections now have to include an evaluation of firms’ abilities to detect terrorist financiers, once again with penalties for private sector dereliction of duty. The financing of terrorism was added as a predicate crime, and investigators have gained more powers and an increased ability to share information between agencies and across borders due to measures such as the USA PATRIOT Act. Penalties were made more draconian, and necessary legal adjustments were made to ensure that the confiscation procedures could now be directed to the financial underpinnings of violent extremist groups. Perhaps the only really new provision was that relating to nonprofit organizations (Special Recommendation 8) such as charities, which came under the AML regulatory umbrella so as to prevent them from being used as fronts for terrorist financiers. Although welding terrorist financing concerns onto the existing AML framework caused relatively little substantive regulatory redesign, politically and rhetorically it made an important difference. Whereas the war on drugs had certainly been a central focus of policymakers’ attention in the United States and elsewhere, there was no single, sudden catastrophic event to galvanize rapid political action akin to September 11. Those opposing the expansion of the powers of intelligence and law enforcement agencies, including AML bodies, came to be seen as implicitly dishonoring the memories of those three thousand people who perished in the attacks, or at the very least exhibiting a reckless disregard in the face of a threat that put thousands of other lives at risk. Measures that had been politically impossible, perhaps even unthinkable, became possible almost overnight, even when the link with terrorism was tenuous. In the United States, the USA PATRIOT Act greatly expanded the AML regime. The hitherto successful efforts of the World Bank and International Monetary Fund to exclude AML from their purview were upended.48 International AML pariahs such as Nauru could be linked with al-Qaeda, 48. Richard K. Gordon, “International Organizations and the Regulation of Offshore Financial Centers: The IMF and the Imposition of Standards,” in Offshore Financial Centers and Regulatory Competition, ed. Andrew P. Morriss ( Washington D.C.: American Enterprise Institute, 2010).

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rhetorically at least.49 Developing countries rushed to adopt anti-terrorist measures, and to the extent these included measures to counter the financing of terrorism, such measures required an AML system to be in place first. Despite the unstoppable political momentum, the tendency to see the financing of terrorism as another species of money laundering did raise doubts, however.50 The sums needed for even spectacular terrorist attacks are quite small: under $500,000 for the September 11 attacks51 and less than a tenth of this for the kind of bombings that occurred in Bali, London, Madrid, and with tragic regularity in Iraq after 2003 (although maintaining a terrorist network from month to month requires greater funds). These small sums are much harder to spot than are the millions of dollars that need to be laundered by drug gangs. Also, whereas money laundering must by definition be linked to a prior crime, much of the money used to fund terrorists is from otherwise legal activities. These uncertainties make assessing the results of the financial struggle against terrorism even more difficult than assessing the impact of AML on other kinds of crime.52 The final matter considered in this chapter is the ambivalent relationship between AML and taxes, or more properly, tax evasion. Although the policy apparatus to combat money laundering is new, the struggle of rulers to extract taxes and other resources from the ruled is ancient. If a basic goal of the AML system is to make individuals’ and firms’ financial affairs more transparent to government scrutiny, its success would seem to have major revenue payoffs. As mentioned above, tax concerns put Al Capone in jail and were the rationale for the Bank Secrecy Act in 1970. On some occasions, the fiscal potential of AML policy has been realized. Tax evasion is a predicate crime in most FATF members, and post-2001 FIUs such as the U.S. Financial Crimes Enforcement Network have greater freedom to exchange financial intelligence with the tax authorities. This linkage has gone furthest in Australia, where the FIU largely functions as an annex to the tax agency and claims to more than pay for itself with

49. “Tiny Pacific State of Nauru Could be Laundering Terrorists’ Money, International Agency Says,” Associated Press Worldstream, June 6, 2002. 50. Rider, “The War on Terror and Crime.” 51. Steven Strasser, ed., The 9/11 Investigations: Staff Reports from the 9/11 Commission (New York: Public Affairs, 2004), 390–91. 52. Sue E. Eckert and Thomas J. Biersteker, “(Mis)Measuring Success in Countering the Finance of Terrorism,” in Andreas and Greenhill, Sex, Drugs, and Body Counts, 247–63; Thomas J. Biersteker and Sue E. Eckert, eds., Countering the Finance of Terrorism (London: Routledge, 2007); Michael Levi, “Combating the Finance of Terrorism: A History and Assessment of the Control of ‘Threat Finance,’ ” British Journal of Criminology 50 (2010): 650–69. For an early, upbeat assessment, see Strasser, The 9/11 Investigations, 505–6.

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the extra tax revenue raised (although the derivation of the figures in this claim are not as clear as they might be).53 Relating to intersections in the tax and AML policy agendas at the international level, it was not just tax havens blacklisted by the FATF ( beginning in 2000; see chapter 4) who thought their being targeted owed at least as much to tax matters as money laundering.54 But more generally, there has been a continuing reluctance to link the tax and AML agendas. Human rights and privacy concerns, so often absent in the expansion of the AML regime, have been adduced to limit the flow of information between tax agencies and FIUs. National laws are often characterized by important exceptions for fiscal crimes. For example, although the United States will prosecute laundering cases in its territory that are the result of predicate crimes committed abroad, tax evasion is specifically excepted, much to the frustration of Latin American governments.55 Whereas France does have both domestic and foreign tax evasion as predicate crimes, it in practice exempts financial institutions from having to lodge suspicious transaction reports when this is the suspected predicate crime.56 In Switzerland, tax evasion (as distinct from tax fraud) is not a crime at all, merely an administrative matter.57 The fact that the fiscal potential of the AML system has not been exploited seems to owe as much to political and cultural factors as to any technical obstacles. To put it bluntly, fighting crime and terrorism is popular; collecting taxes is not. AML officials seem to be reluctant to damage their simple, compelling story of good versus evil and descend into the much more complicated questions of who should pay how much to fund public goods.58 Increased surveillance powers for law enforcement targets only criminals, so the logic goes, whereas increased surveillance powers for tax authorities target everyone. AML bureaucracies were first created to fight drugs, then general crime, and more recently terrorism as well, but taxes have rarely featured in their self-image regarding what they do. In the developing world in particular, AML officials regard collecting taxes as someone else’s job. The potential of the system to strengthen these countries’ anemic revenue-raising powers is largely ignored.

53. AUSTRAC, AUSTRAC Annual Report 2009–2010, Canberra, 2010. 54. Gordon, “The IMF and the Imposition of Standards.” 55. Reuter and Truman, Chasing Dirty Money, 181. 56. Ibid., 91. 57. David Chaikin, “Policy and Fiscal Effects of Swiss Bank Secrecy,” Revenue Law Journal 15 (2005): 90–110. 58. Author’s interview FATF, Paris, France, July 8, 2004.

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Despite the complexity and reach of the rules designed to counter it, there are fundamental gaps in our knowledge concerning money laundering. The inherent challenges of quantifying any illicit activity are compounded by the fact that money laundering is a derivative offense, stemming from a wide range of other illegal behaviors whose incidence is also hotly contested. Rather than being just a technical problem, the numbers involved often reflect political gambits and a culture that generates a demand for figures. The United States has had more influence in developing current AML rules than any other country. In their initial form, AML rules were seen primarily as a way to counter the illicit drug trade that was the major U.S. law enforcement priority of the 1980s. However, several countries in Western Europe, as well as the Council of Europe, were already feeling their way toward similar laws, with terrorists as much the target as drug kingpins. The United States found many genuinely like-minded countries inside and beyond the G7 when it sought to coordinate national approaches to money laundering. Beginning in 1989 the FATF took the lead in successively broadening the coverage of the AML regime, expanding it to cover a wide range of nondrug predicate crimes, and after 2001 to the financing of terrorism as well. Although there were subsequent modifications, the main structures of the prevention and enforcement pillars of AML policy were set down in the 40 Recommendations. Having provided this background material, it is now time to begin answering the two interrelated questions at the heart of this book in earnest. The next two chapters try to answer the question, “Does AML policy work?”, which sets up the next question, “Why has AML policy spread?”

Pa rt O n e

Does Anti–Money Laundering Policy Work?

Ch a p ter 2

An Indirect Test of Effectiveness

In 2003 Mark Pieth and Gemma Aiolfi asked: “Are AML rules really effective? After 15–20 years of setting standards it seems very hard to pose such a simple—and yet ‘subversive’—question. How could it become such a taboo?”1 These authors declined to provide answers. But why is such a seemingly straightforward question “subversive”? Why the “taboo”? This chapter is the first of two devoted to breaking this taboo by asking whether AML policy works. Given the empirical problems discussed previously, this is a difficult question to answer. Beyond the problem of evidence, there is the previous question of what effectiveness means in this context. Here I test two alternative views. The first is whether AML policy has produced a major reduction in predicate crime, in line with the logic first used to justify a “follow the money” approach (effectiveness in absolute terms). The second is whether the AML system has delivered benefits to society greater than the costs the system itself has imposed (cost-effectiveness). There has been much less analysis of the effectiveness of the AML system

1. Mark Pieth and Gemma Aiolfi, “Synthesis: Comparing International Standards and their Implementation,” in A Comparative Guide to Anti-Money Laundering: A Critical Analysis of Systems in Singapore, Switzerland, the UK and the USA, ed. Mark Pieth and Gemma Aiolfi (Cheltenham: Edward Elgar, 2004), 415.

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than its reach and depth might suggest.2 AML bodies themselves are peculiarly uninterested in finding out whether the system they administer achieves its fundamental goals. What has been written on the topic has almost always concentrated on rich Western countries. Such material is helpful, but because a growing majority of the countries with AML policies in place are poorer countries, it is more important now to examine their previously neglected experiences. Looking at developing countries may seem only to compound the difficulty of evaluating AML policy. If the evidence is too patchy to permit conclusive answers to even basic questions about money laundering in countries such as the United States and Britain, what can be gained from looking at a country such as Niger or Nauru? The lack of official statistics, the rudimentary financial sector (nonexistent in Nauru’s case), and the size of the informal and subsistence sectors of the economy preclude any sort of precise quantitative conclusions. Instead, detailed evidence is taken from a range of alternative sources. These sources include surveys conducted among the public and private sector in Barbados, Mauritius, and Vanuatu; fieldwork in other South Pacific and Caribbean countries, as well as in Africa; participant work as an AML consultant; and interviews with other officials from developed and developing countries at various AML plenary meetings and workshops. More broadly, if there is little evidence to suggest that AML policy is effective in significantly reducing crime in the countries for which it was originally designed, it seems probable that it will be even less effective when applied in the radically different context of developing countries, where the fit is much poorer. Similarly, given that large, complex financial centers are said to benefit most from AML systems, and the costs accrue to small institutions and marginalized populations, this again makes it likely that the cost-benefit calculus is less favorable in developing countries compared with developed. Finally, the glaringly obvious competing priorities for extremely scarce public money and skilled staff in poor countries make the opportunity costs of AML policy much more apparent in poor countries than in rich ones. Despite the depth and variety of evidence presented below, it is true that conclusions about the effectiveness of AML policy in developing countries

2. Peter Reuter and Edwin M. Truman, Chasing Dirty Money: The Fight against Money Laundering ( Washington, D.C.: International Institute of Economics, 2004); Petrus C. van Duyne, “Serving the Integrity of the Mammon and the Compulsive Excessive Regulatory Disorder,” Crime Law and Social Change 52 (2009): 1–8; John Walker and Brigitte Unger, “Measuring Global Money Laundering: The ‘Walker Gravity Model,’ ” Review of Law and Economics 5 (2009): 821–53; Brigitte Unger, “Money Laundering: A Newly Emerging Issue on the International Agenda,” Review of Law and Economics 5 (2009): 807–19.

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cannot be definitive. But for developing countries to continue to adopt an expensive policy package without any knowledge of whether it increases or decreases general well-being is contrary to common sense as well as to the recommendations of bodies such as the OECD and the World Bank. The presumption that policy is effective unless proven otherwise is intuitively unsatisfying and runs counter to the logic of contemporary policymaking.3 Ascertaining the effectiveness of AML systems in poor countries is partly an end in itself, but it is also closely related to the book’s second fundamental question: why has AML policy diffused so rapidly to so many countries with so little in common? The commonsense baseline is that countries will copy effective policies that deliver benefits and shun those that are ineffective. But at the very least, a compelling case for the effectiveness of AML policy in reducing money laundering and associated crimes has not been made. Because there are no apparent functional technical reasons to adopt this policy package, we must look elsewhere to explain the diffusion of AML policy. Specifically, we must look to the mechanisms of blacklisting, socialization, and symbolic competition. The second half of the book addresses these concerns. The chapter is primarily focused on poor countries’ experiences with AML systems, but as mentioned earlier, the vast majority of the scholarship and policy analysis in this area relates to rich countries. The first section of this chapter reviews this work, both to summarize existing knowledge and to provide a framework for investigating AML effectiveness in the developing world. Academics’ assessments of efforts to counter money laundering most often range from cautious observers that damn with faint praise to those that see the whole effort as worthless. The FATF has adopted benchmarks of effectiveness that tend to foster goal displacement: means to an end become ends in themselves. The fragmentary data available suggest that the costs imposed on developed governments and financial firms are fairly modest, although they are growing fast, but they weigh more heavily on small firms and marginalized populations. On the other side of the ledger, beyond its narrow criminal justice focus, AML policy is said to provide benefits in safeguarding the stability of the financial system in general as well as the reputation of individual financial institutions. There is not much evidence, however, for either claim. The larger portion of the chapter moves to uncharted territory by assessing the effectiveness of AML policies among poorer countries. The starting point

3. OECD, Regulatory Impact Analysis: Best Practices in OECD Countries (Paris, 1997).

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is that current AML standards were designed in and for developed countries’ economies, whereas the circumstances in developing countries are often radically different. This tension can generate “decoupling,” whereby ostensibly goal-oriented, rational behavior can instead be a ritual. An example is entering data no one is able to access or use. No single country’s experience communicates this disconnect more clearly than the case of Nauru, which has state-of-the-art legislation to prevent money laundering in its financial sector; the only problem is that Nauru has no financial sector of any kind. A survey project on the impact of the AML system in Barbados, Mauritius, and Vanuatu provides some evidence that the costs in small developing states are an order of magnitude higher than those in large rich ones. Potentially, the greatest benefit the global AML system could render developing states would be to reduce corruption by preventing the laundering of looted funds and kickbacks by corrupt senior public officials. Yet the evidence suggests that even the most blatant third-world kleptocrats can easily place and enjoy their stolen wealth in rich countries such as the United States and, especially, France. The chapter thus ends as it begins with an investigation of the effectiveness of AML policies in such developed countries.

Assessing AML Effectiveness in Rich Countries The most systematic attempts to assess the effectiveness of AML policy are Peter Reuter and Edwin Truman’s book and the article by Michael Levi and Reuter, relating mainly to the United States and secondarily to Britain.4 Their main conclusion is that a lack of data precludes anything resembling a definitive answer, and Reuter and Truman provide at best faint praise in terms of effectiveness. The little available evidence suggests to these scholars “that the global AML regime has made progress in the general area of prevention, but without much effect on the incidence of underlying crimes.” They continue: “Critics argue . . . there is little change in the extent and character of either laundering or crime. Critics may well be right.”5 Levi and Reuter allow themselves the slightly firmer conclusions that “available data weakly suggest that the . . . AML regime has not had major effects in suppressing crimes,” that the volume of money confiscated is slight relative to criminal flows, that these methods are unlikely to disrupt terrorism, and

4. Reuter and Truman, Chasing Dirty Money; Michael Levi and Peter Reuter, “Money Laundering,” in Crime and Justice: A Review of Research, Vol. 34, ed. M. Tony (Chicago: University of Chicago Press, 2006), 289–375. 5. Reuter and Truman, Chasing Dirty Money, 192.

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that AML rules impose “costly obligations on business and society.”6 Reuter’s views had not changed in 2008.7 Barry Rider, one of the pioneers of research on money laundering and other related crimes, is also downbeat in his assessment: “the success that law enforcement agencies have had around the world in ‘taking the profits out of crime’ is very limited and does not commend itself as a particularly efficient strategy.”8 Although noting “the system is not an unmitigated disaster,” Cuellar argues that in the United States AML policy largely works to impose heavier penalties on petty criminals who are caught with traditional law enforcement methods.9 Other commentators are more sweeping, arguing that AML policy “is being driven by ill-guided activism responding to the need to be ‘seen to be doing something’ rather than by an objective understanding of its impact on predicate crime.”10 Petrus van Duyne even speaks of a syndrome of “Compulsive Excessive Regulatory Disorder” when it comes to countering money laundering.11 Many such quotes could be provided, but the flavor of the academic literature is fairly clear. Answers on effectiveness range from the cautious view that it is unlikely AML rules have had a significant impact on crime to conclusions that the whole system is an expensive, and possibly even dangerous, waste of everybody’s time. Either way, these academics are not so much taking issue with any established policy literature arguing the contrary position—that AML policy is effective—as bemoaning the lack of such analysis. One recent exception argues that AML policy is effective in lowering total crime rates in some FATF members.12 The article uncovers a correlation between countries’ mutual evaluation scores relating to the Recommendations on international cooperation and lower overall crime rates. The conclusion is that “the hypothesis that anti-money laundering policy can

6. Levi and Reuter, “Money Laundering,” 289. 7. Personal communication, Peter Reuter, September 10, 2008. 8. Barry A. K. Rider, “Law: The War on Terror and Crime and the Offshore Centres: The ‘New’ Perspective?”, in Global Financial Crime: Terrorism, Money Laundering, and Offshore Centres, ed. Donato Masciandaro (Aldershot: Ashgate, 2004), 61. 9. Mariano-Florentino Cuellar, “The Tenuous Relationship between the Fight against Money Laundering and the Disruption of Criminal Finance,” Research Paper 64 (Stanford: Stanford Law School, 2003), 461. 10. Jackie Harvey and Siu Fung Fau, “Crime-money, Reputation and Reporting,” Crime Law and Social Change 52 (2009): 58. 11. van Duyne, “Compulsive Excessive Regulatory Disorder.” 12. Joras Ferwerda, “The Economics of Crime and Money Laundering: Does Anti-Money Laundering Reduce Crime?” Review of Law and Economics 5 (2009): 903–929.

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be used to reduce the crime level can be accepted.”13 However, the idea that international AML cooperation would by itself have a significant impact in reducing the total incidence of all types of crime, financial and nonfinancial, even though most crimes have no international aspect, seems implausible. What is the mechanism that connects supposed cause and effect? The claim in the article that more stringent AML policy lowers the incidence of money laundering is simply assumed,14 rather in the manner of the old joke about the economist and the can opener.15 Moving away from the ivory tower, the FATF guidance on the matter of evaluating effectiveness is instructive in terms of the “taboo” mentioned by Pieth and Aiolfi. From the outset in 1990, one of the major tasks mandated for the FATF was to monitor money laundering threats and ensure that its members and others complied with AML standards. There is a strong impression of goal displacement, of the means becoming the ends,16 in the FATF’s approach to assessing implementation. The yardstick of evaluation is compliance with the 40+9 Recommendations. There is no effort to assess the effect the resulting standards have on money laundering or predicate crimes, the fundamental policy problem that justified the introduction of the rules in the first place. In assessing compliance, the FATF has to some extent followed the example of the OECD’s peer-review monitoring of the Convention on Combating Bribery of Foreign Public Officials in Inter national Business Transactions. Whereas phase 1 evaluations of OECD members’ compliance with the convention concentrated on checking that the right laws were in place, phase 2 assessments focused on whether these laws were being implemented.17 Following this example, the FATF has also 13. Ibid., 922. 14. Ibid., 910. 15. A physicist, a chemist, and an economist are shipwrecked on a desert island. Starving, they find a case of canned pork and beans on the beach, but they have no can opener. So, they hold a symposium on how to open the cans. The physicist goes first: “I’ve devised a physical solution. We find a pointed rock and propel it at the lid of the can at, say, 25 meters per second—” The chemist breaks in: “No, I have a chemical solution: we heat the molecules of the contents to over 100 degrees Centigrade until the pressure builds to —” The economist, condescension dripping from his voice, interrupts: “Gentlemen, gentlemen, I have a much more elegant solution. Assume we have a can opener. . . . ” 16. Michael N. Barnett and Martha Finnemore, “Politics, Power, and Pathologies in International Organizations,” International Organization 53 (1999): 699–732; Peter Andreas, “The Politics of Measuring Illicit Flows and Policy Effectiveness,” in Sex, Drugs, and Body Counts: The Politics of Numbers in Global Crime and Punishment, ed. Peter Andreas and Kelly M. Greenhill (Ithaca: Cornell University Press, 2010), 23–45. 17. See “Steps Taken by Parties to Implement the OECD Anti-Bribery Convention,” and various country reports available at http://www.oecd.org/document/24/0,3343,en_2649_34859_1933 144_1_1_1_37447,00.html (accessed September 2009).

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committed to evaluating not only whether the correct legislation has been passed but also whether it is being enforced. The Hand Book for Assessors provides indicators regarding which judgments should be made.18 First, as befits an organization mainly populated by lawyers and despite the ostensible focus on practical effectiveness, there is a strong emphasis on legislation and formal rules. Second, there is a long list of quantitative indicators: the number of suspicious transaction reports, the proportions of such passed on to law enforcement, the amounts of money frozen and confiscated, how many mutual legal assistance requests have been granted or refused, and the number of convictions. Each FIU is assessed in terms of its budget, institutional prerogatives, number of staff and their expertise, the number of audits and awareness-raising seminars performed by the FIU, and the number of reporting entities sanctioned for noncompliance. The potential of many of these indicators to lead to ritualistic “checking the box” behavior is apparent. Indicators (e.g., the number of seminars) become goals in and of themselves, regardless of their effects (e.g., whether anyone learns anything, or puts the knowledge to use, or whether this knowledge contributes to deterring or detecting more criminal activities as a result). This is a close fit with the sort of disconnect scholars speak of whereby bureaucratic procedures become valued as rituals rather than as a functional means by which to achieve a desired outcome.19 Such a method works in making sure that AML laws do not just remain on paper, but says little or nothing about effectiveness per se. There is no mention of trying to assess what impact the AML system has made on the level or incidence of money laundering or predicate crimes. As Pieth and Aiolfi put it, there are none of the basic, “subversive” questions that might be expected (the former is the chair of the OECD anti-bribery working group and thus no stranger to policing international criminal standards). Is there any less money laundering as a result of the AML system? Is there any less predicate crime? The UNODC and IMF are critical of the Mutual Evaluation Reviews as a measure of effectiveness.20 Both organizations emphasize the need to measure how financial intelligence feeds into the investigation of predicate crimes. The economists of the IMF deplore the “militant innumeracy” of the lawyer-dominated FATF. In general, though, there is no 18. FATF, Hand Book for Assessors (Paris: FATF, 2009). 19. John W. Meyer and Brian Rowan, “Institutionalized Organizations: Formal Structure as Myth and Ceremony,” American Journal of Sociology 83 (1977): 340–63; James G. March and Johan P. Olsen, Rediscovering Institutions: The Organizational Basis of Politics (New York: Free Press, 1989). 20. Author’s interview, UNODC, Vienna Austria, May 18, 2007; Author’s interview, IMF, Washington D.C., February 24, 2010.

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debate between policymakers and academics over whether AML policy works in deterring and detecting criminals. Outsiders generally doubt that it does, whereas those within the system regard these first-order effectiveness questions as unhelpful and impractical. In private conversation, officials may acknowledge how little anyone really knows regarding whether the AML system has made a difference to crime in the aggregate, but such questions are far removed from day-to-day administrative concerns. Belief in effectiveness among the policy community is underpinned by two heuristics. The first is the assumption, usually implicit, of an “input model”: if there is more AML regulation, then there must be less money laundering as a result.21 Closely related is the market model. This idea is drawn from the campaign against the drug trade. Here the logic is that greater law enforcement efforts will constrict the supply of drugs, raise the price, and therefore reduce the number of drug users and related crime.22 For the analogy to work for AML policy, however, there must be a market for money laundering services in the same way there is a market for heroin, cocaine, marijuana, and so forth; but it seems that most laundering is done by the same criminals committing the predicate crimes, rather than “professional” launderers who charge a fee for their services.23 In most cases, there is no market and therefore no price signals. Relying on a market model for money laundering thus may be highly misleading.

Costs and Benefits of the AML System in Rich Countries If there is so little evidence for AML effectiveness in absolute terms in rich countries, how does the picture look in terms of costs and benefits? Normally, criminal justice is not expected to turn a profit. Yet even when it comes to life-and-death issues such as road safety or antiterrorist policy, governments engage in deliberate or implicit trade-offs. Grounding all civil aviation may be an effective “solution” to the problem of airline hijacking, but the massive costs this would impose on society rightly rule this measure out of contention. Government interventions may provide benefits to society, but they

21. Jackie Harvey, “Compliance and Reporting Issues Arising for Financial Institutions from Money Laundering Regulations: A Preliminary Cost Benefit Study,” Journal of Money Laundering Control 7 (2004): 335. For an explicit example of such, see Ferwerda, “Does Anti-Money Laundering Reduce Crime?”, 910. 22. For example, Michele Bagella, Francesco Busato, and Amedeo Argentiero, “Money Laundering in a Microfounded Dynamic Model: Simulations for the US and EU-15 Economies,” Review of Law and Economics 5 (2010): 882–902. 23. Reuter and Truman, Chasing Dirty Money; Levi and Reuter, “Money Laundering.”

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often impose costs on firms and private citizens far beyond the tax dollars spent. Most governments have explicitly committed to the notion that laws and regulations should provide greater benefits to society than costs.24 In practice, when it comes to money laundering, governments duck the issue by simply assuming that the purported decrease in money laundering will outweigh whatever the regulatory costs might be.25 A concern for the regulatory burden on firms and individuals is particularly important for AML policy, given the high level of delegation to the private sector. The expense of Know Your Customer rules and submitting suspicious transaction reports is borne by the private sector, whereas these requirements often cause only inconvenience for the public. Depending on the structure of the financial service industry, it seems probable that firms will pass a good deal of this extra expense on to consumers. How much does the AML system cost in developed countries? In calculating a figure for the United States, Reuter and Truman divide the costs into three categories: those borne by the public purse (federal and state government bodies), those borne by private firms (everything from banks to gem merchants), and those borne by private citizens. The respective estimated figures in 2003 for the government sector is $3 billion, private firms $3 billion, and individuals an additional $1 billion, for a total of $7 billion or 0.06 percent of U.S. GDP.26 A guess for costs in the UK in 2003 is £600 million, although no evidence is provided for this figure.27 In 2005 the British Bankers’ Association estimated the costs of AML regulation to its member banks at $400 million, and a report by the accounting firm KPMG estimated the cost to all reporting entities of the suspicious transaction reporting requirement to be £90 million.28 The most detailed global surveys of AML costs have been carried out by KPMG in 2004 and repeated in 2007. Unfortunately, however, these surveys reveal only the percentage cost increase of AML regulations rather than absolute amounts. When the survey was first conducted in 2004, banks were usually unable to provide absolute figures, and those that did tended to underestimate costs

24. OECD, Regulatory Impact Analysis; Claudio Radaelli, “Diffusion without Convergence: How Political Context Shapes the Adoption of Regulatory Impact Assessment,” Journal of European Public Policy 12 (2005): 924–943; Claudio Radaelli, “Desperately Seeking Regulatory Impact Assessment: Diary of a Reflective Researcher,” Evaluation 15 (2009): 31–48. 25. Harvey, “Compliance and Reporting Issues,” 339–40. 26. Reuter and Truman, Chasing Dirty Money, 103. 27. Rider, “The War on Terror and Crime,” 88. 28. Levi and Truman, “Money Laundering,” 262.

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of compliance.29 For the period 2004–2007, the increase in costs is estimated to be 58 percent worldwide, with North America and the Middle East/ Africa seeing even bigger rises.30 The main drivers behind these figures are said to be increased transaction monitoring and staff training.31 By and large, banks regarded the costs of regulation in this area as proportionate and acceptable. It seems in general that the large international banks surveyed by KPMG have felt the least burdened by AML requirements. Confirming this point of view about the differential impact of costs, Reuter and Truman found that, on average, smaller firms in the United States pay proportionately more to meet AML rules than large ones, especially large banks.32 Martin Gill and Geoff Taylor confirm the same situation for the UK.33 These authors suggest that this difference is a product of the upfront fixed costs in setting up a transaction-monitoring system. Banks have always tended to collect more information on their clients, maintain stricter internal controls, and be more regulated than other financial firms, and thus AML requirements are less of a deviation from standard practice. The finding that smaller firms bear a disproportionate load of the regulatory cost is significant for the developing world, where most firms tend to be very small operations by Western standards, as discussed later on. Similarly, for individuals the costs of AML seem to fall disproportionately on the poor and marginalized, such as recent migrants, low-income earners, ethnic minorities, and the homeless.34 One-fifth of the adult population of developed countries (200 million people) do not have bank accounts,35 often because they cannot provide enough identification to satisfy banks’ due diligence requirements.36 These individuals are thus forced to use expensive fringe or underground bank equivalents.

29. KPMG, Global Anti-Money Laundering Survey 2007: How Banks Are Facing up to the Challenge, 16. 30. Ibid., 15. 31. Ibid.,16. 32. Reuter and Truman, Chasing Dirty Money, 100. 33. Martin Gill and Geoff Taylor, “Preventing Money Laundering or Obstructing Business? Financial Companies’ Perspectives on ‘Know Your Customer’ Procedures,” British Journal of Criminology (44) 2004: 590. 34. Reuter and Truman, Chasing Dirty Money, 102. 35. Consultative Group to Assist the Poor, Financial Access 2009: Measuring Access to Financial Services Around the World ( Washington, D.C., 2009); see also Financial Access Initiative, “Half the World Is Unbanked,” http://financialaccess.org/sites/default/files/110109%20HalfUnbanked_0. pdf (accessed April 2010). 36. Elaine Kempson, “Policy Level Response for Financial Exclusion in Developed Countries: Lessons for Developing Countries,” Paper for Access to Finance: Building Inclusive Financial Systems, World Bank, May 30–31, 2006, 6.

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Turning from costs to benefits, aside from cutting crime, AML policy is also said to have the major economic benefit of protecting the integrity of the financial sector. This argument has been made with increasing force and regularity after the G20 summits of 2009. Outside observers are strongly skeptical of this claim. Richard Gordon writes that the IMF staff found the arguments about the negative systemic effects of money laundering thin, owing much more to political imperatives than economic analysis.37 Until September 11, the IMF clearly saw AML as separate from and unrelated to its mandate of ensuring the stability of the global financial system.38 The current tendency in the IMF to attribute macroeconomic problems to money laundering in countries such as Afghanistan and Colombia seems to mistake a symptom of underlying problems (civil war, corruption, and huge illicit drug industry) for a cause.39 Relating to individual firms, the Basel Committee on Banking Supervision has argued that, even aside from the penalties levied for noncompliance, enforcing AML rules is actually in banks’ best interest. The first statement on this matter by this committee in 1988 reasoned, “Public confidence in banks, and hence their stability, can be undermined by adverse publicity as a result of inadvertent association by banks with criminals,”40 a claim subsequently repeated in 2001.41 If a scandal erupts whereby a corrupt head of state or major criminal figure is found to be a client of a major bank, it is suggested, the unfavorable attention will not only come as a major embarrassment to that institution but also may well undermine its share price. Survey evidence from banks and other firms in the financial sector shows that many agree

37. Richard K. Gordon, “International Organizations and the Regulation of Offshore Financial Centers: The IMF and the Imposition of Standards,” in Offshore Financial Centers and Regulatory Competition, ed. Andrew P. Morriss ( Washington, D.C.: American Enterprise Institute, 2010). For similar views, see Petrus C. van Duyne, “The Creation of a Threat Image: Media, Policy Making and Organized Crime,” in Threats and Phantoms of Organized Crime, Corruption and Terrorism, ed. Petrus C. van Duyne et al. (Nijmegen: Wolf Legal Publishers, 2004): 21–51; Peter Reuter, “Are Estimates on the Volume of Money Laundering Either Feasible or Useful? Comments on the Presentation by John Walker,” paper presented at the Tackling Money Laundering conference, Utrecht University, November 2, 2007; Antoinette Verhage, “Between the Hammer and the Anvil? The Anti-Money Laundering Laundering-Complex and Its Interactions with the Compliance Industry,” Crime, Law and Social Change 52 (2009): 9–32; Harvey and Fau, “Crime-money, Reputation and Reporting.” 38. See for example IMF Executive Board Meeting 01/38, April 13, 2001 BUFF01/54. 39. Author’s interview, IMF, Washington, D.C., February 24, 2010. 40. Basel Committee, Prevention of Criminal Use of the Banking System for the Purpose of Money-Laundering, December 1988, http://www.bis.org/publ/bcbsc137.pdf (accessed November 2009). 41. Basel Working Group for Cross-Border Supervision, Customer Due Diligence for Banks (October 2001), 10, http://www.bis.org/publ/bcbs85.pdf (accessed November 2009).

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with this reputational risk argument for AML compliance,42 but a closer look raises some doubts. Scrutiny of the private sector responses indicates that the threat to reputation is not money laundering as such, but rather the reputational damage that might arise from being sanctioned by regulators.43 Thus Jackie Harvey and Siu Fung Fau report “measures are put in place to avoid censure (deficit model of compliance), rather than as an enhancement to reputation (enhancement model of reputation).”44 (As discussed in chapter 4, this “deficit model”—AML compliance to avoid a loss rather than gain a benefit—also applies to states seeking to avoid being blacklisted.) The limiting case for the claims about reputation, money laundering, and AML compliance is Riggs Bank in the United States. Riggs Bank is the cautionary tale deployed by AML officials to exemplify the dreadful fate faced by those financial institutions that fail to do their duty to fight money laundering.45 It is certainly true that this bank’s repeated AML failures were spectacular and that U.S. regulators take a much more aggressive approach to punishing noncompliance than those of most other countries. If any institution should have suffered from reputation damage, it was Riggs. Riggs Bank was intimately involved in not one but three lurid scandals in 2004–2005, any one of which should have been sufficient to wreck the bank’s reputation.46 It also made a habit of openly defying U.S. regulatory authorities for years at a stretch. The first scandal involved soliciting business from former Chilean dictator Augusto Pinochet and assisting in the falsification of records beginning in 2002 to protect these funds after he was charged with genocide and terrorism. Bank officials opened accounts in false names for Pinochet and set up companies and trusts to further obscure his control of particular assets.47 The second scandal involved accepting “gifts” from major oil companies to the notoriously corrupt ruler of Equatorial Guinea, Teodoro Obiang (of whom more below). Here Riggs would accept deposits of up to $3 million

42. Harvey, “Compliance and Reporting Issues,” 341; Reuter and Truman, Chasing Dirty Money, 95; Verhage, “Between the Hammer and the Anvil,” 27. 43. Verhage, “Between the Hammer and the Anvil,” 12. 44. Harvey and Fau, “Crime-money, Reputation and Reporting,” 61. See also Harvey, “Compliance and Reporting Issues,” 343. 45. Author’s observation, Asia-Pacific Group on Money Laundering Plenary, Perth, Australia, July 23–27, 2007. 46. Zoe Lester, “Anti-Money Laundering: A Risk Perspective,” Ph.D. thesis, University of Sydney, 2009. 47. U.S. Senate Permanent Subcommittee on Investigations, “Money Laundering and Foreign Corruption: Enforcement and Effectiveness of the PATRIOT Act: A Supplemental Staff Report on US Accounts used by Augusto Pinochet” ( Washington, D.C., 2005).

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in cash (shrink-wrapped in a suitcase weighing 60 pounds) passed over the counter.48 Bank officials felt there was no need to report such transactions as suspicious. Finally, there was a failure to properly monitor 150 accounts for Saudi customers in the wake of allegations of these individuals’ complicity in the September 11 terrorist attacks. Significantly, in each of these three cases, irregularities were brought to light by the media or Senate investigations and not those responsible for ensuring that banks diligently performed their AML responsibilities, despite their PATRIOT Act–enhanced powers. In fact, the investigations into these scandals also uncovered an embarrassing string of regulatory failures.49 Riggs Bank eventually received separate fines of $25 million and $16 million and was referred to by one presiding judge as “a greedy corporate henchman of dictators and their corrupt regimes.”50 In July 2004, before these fines and the worst of the press coverage, Riggs’s share price was $22.44. In May 2005, after numerous civil and criminal lawsuits, a criminal conviction, hugely negative press coverage, and unanimous political hostility, it had fallen to $19.63,51 a 13 percent decline: not trivial, but hardly financial Armageddon either. Despite the fact that Riggs Bank actively assisted those accused of genocide, terrorism, and grand corruption to launder funds; lied about this to regulators; and defied several compliance orders over a period of years, no official from Riggs was ever convicted, nor was its bank license ever threatened. Although not quite as outrageous as the transgressions of Riggs Bank, many if not most other banks have been found guilty of major AML failures with little evidence of serious reputational damage. The Bank of New York helped launder $7 billion of Russian mafia money. ABN AMRO Bank accepted $3.2 billion of suspicious money from Russia while also assisting clients to break sanctions in sending money to Libya and Iran. Bank of America allowed over $3 billion of illegal money from Brazil to flow through its accounts from 2002 to 2004. Citigroup was banned from operating in Japan after failing to enforce AML standards and then seeking to block an investigation into this lapse. UBS and KPMG have been found guilty of major tax-related money laundering schemes on behalf of their clients. In 2008 and

48. U.S. Senate Permanent Subcommittee on Investigations, “Money Laundering and Foreign Corruption: Enforcement and Effectiveness of the PATRIOT Act: Case Study Involving Riggs Bank” ( Washington, D.C., 2004). 49. Senate, “Riggs Bank”; Senate, “Augusto Pinochet”; Lester, “A Risk Perspective.” 50. “Riggs Bank Fined $16 million for Helping Chile’s Pinochet,” Bloomberg, March 29, 2005, http://www.bloomberg.com/apps/news?pid=newsarchive&sid=aDX6Lhj3.j3I (accessed March 2011). 51. Lester, “A Risk Perspective.”

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2009, Lloyds, Credit Suisse, and Barclays admitted to assisting their clients to remove wire transfer details so they could make illegal transactions. There are many more examples. It would seem that there are few major financial institutions that have not been hit with a serious money-laundering scandal. Yet, in nearly every case, there seems to be little, if any, evidence of reputational damage beyond some transitory embarrassment (in direct contrast to the cases explored in chapters 4 and 5). Two reasons seem to explain why this is so. First, regulators, with a mandate to stabilize and safeguard the financial system, are unwilling to take action that would lead to a crisis of confidence in a bank, and thus they tend to pull their punches. Second, when banks receive reprimands regarding AML deficiencies, these apparently do not feed into private third-party assessments of the bank in question. In sum, there is little evidence to support claims about the benefits of AML compliance for the financial system or for individual firms within it.

AML in Poor Countries The AML regime was developed for the advanced, complex financial system of rich Western countries. Now, however, the majority of the nations with AML policies are poor countries with a markedly different economic structure. These differences are important because there are doubts that a policy designed for one context will work in a radically different setting. One former president of the Eastern and Southern African Anti-Money Laundering Group and IMF consultant listed some of these most important differences.52 In this region, most people do not have addresses, a basic problem for completing the forms necessary to establish a bank account or enter the financial system.53 In answer to the question “Where do you live?,” people might answer “The white house under the big tree by the ocean.” In many parts of the developing world there are few named streets with numbered residences, which is also a problem in the South Pacific.54 Perversely, poor countries generally demand more documentation to prove identity and residence for opening an account than do rich ones, even though their citizens are much less able to produce such documentation.55 Countries such as South Africa, 52. Author’s interview, Port Louis, Mauritius, June 2, 2005. 53. Ibid. 54. Author’s interviews, public and private sectors, Apia, Samoa, July 31–August 1, 2008, and June 29–July 1, 2009; public and private sector, Port Vila, Vanuatu, March 9–10, 2006, and August 4–5, 2008. 55. Consultative Group Assisting the Poor, Financial Access 2009, 18.

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Uganda, Kenya, Tanzania, Samoa, and Vanuatu have sought to introduce alternative forms of identification for banks, such as testimony from the local priest or village head, even though this may cause problems in terms of compatibility with international standards.56 Because the financial institutions involved are generally quite small, these record-keeping requirements may also represent a significant expense. A report from the Consultative Group Assisting the Poor notes that for the average bank account in poor countries “the costs of collecting ‘know your customer’ data, and reporting it and other transaction data, are large in relation to the small size of the account, making such accounts and transactions unprofitable.”57 AML requirements thus tend to exclude the poor and vulnerable from the formal financial sector, forcing them to rely on more expensive and unreliable informal solutions. The large informal economy, the fact that the majority of transactions use cash, and the importance of barter and subsistence farming mean that the economy is opaque to FIUs. Over 70 percent of adults in the developing world (2.7 billion people) do not have access to the formal financial system. In Mauritania there are only thirty-seven bank accounts for every one thousand adults, in Congo only six.58 There are few electronic transactions, and even when there should be paper forms (tax records, property records), these are commonly missing. These features pose basic problems for the AML regime, premised as it is on gathering, storing, and analyzing financial records. Except in a tiny minority of transactions, there simply are no records. The African official in question noted it was an open question whether, given competing priorities such as AIDS, these countries should be trying to implement AML rules at all. But it is not just the economic circumstances in least-developed African countries and tiny Pacific islands that pose obstacles to the workings of the standard AML policy. It is easy for the original members of the FATF to forget how atypical their financial systems are. Even in some of the EU-15 countries, 30–40 percent of houses are still bought with cash,59 and up to 17 percent of the population is entirely excluded from the formal banking system.60 Once again, it is unclear how a policy developed for highly advanced, information-intensive (and therefore

56. Author’s interviews, Port Louis, Mauritius, June 2, 2005; Dar es Salaam, Tanzania, March 5, 2009; Apia, Samoa, July 31–August 1, 2008, and June 29–July 1, 2009; Port Vila, Vanuatu, March 4–5, 2004; March 9–10, 2006; and August 4–5, 2008. 57. Consultative Group Assisting the Poor, Financial Access 2009, 18. 58. Ibid., 54–55. See also Financial Access Initiative, “Half the World Is Unbanked.” 59. Author’s observation, FATF plenary, Paris, France, October 8–12. 60. Kempson, “Financial Exclusion in Developed Countries.”

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highly unrepresentative) financial systems can work in circumstances in which the vast majority of transactions leave no trace for outsiders to see. It may be difficult for FIUs in developing countries to handle and process even the records they do have. Clearly, it does little good if FIUs just receive and archive transaction reports. To be effective they need to analyze information. According to the UN model, each individual transaction report has over 150 fields to be completed. Fiji, for example, receives 150,000 such reports annually, a combination of suspicious transaction reports, reports on all cash and electronic transactions above FJ$10,000 (US$6,000), and cross-border currency movements.61 However, even a primitive AML system without a cash transaction requirement might generate 500 reports a year. Once a report is received, it is necessary to look over all the inbound and outbound transactions to and from that account for the previous year and other accounts held by the same person, as well as the accounts of those transacting with the person in question. The UN suggests that this scrutiny should be extended four levels out to search for patterns of suspicious activity. Unless authorities can look at patterns of transactions between groups of individuals over time, they are unlikely to generate meaningful intelligence. As can be imagined, this quickly begins to require extensive data storage and analysis skills (one presenter spoke of millions of pieces of data per year for FIUs in small developing states). In rich countries, FIUs have specialized information technology departments whose budgets run into the millions of dollars annually. However, in developing countries the situation can be completely different. Assuming that the FIU has electricity and at least one functioning computer (which is not always the case; a report on Bangladesh notes that the FIU is usually without power for two hours a day),62 most handle their dataprocessing needs by entering reports on a standard Microsoft spreadsheet. These spreadsheets become unstable with more than about sixty thousand pieces of data (or four hundred transaction reports, according to the UN standard). It is more important, however, that in a spreadsheet it is impossible to really analyze the data for relationships, and it is difficult to match different data points, which means that the information has limited value. According to those doing technical assistance for FIUs in the developing world, it is reasonably typical for these bodies to spend a great deal of time inputting

61. Author’s observation, Asia-Pacific Group on Money Laundering plenary, Brisbane, Australia, July 6–10, 2009. 62. Asia-Pacific Group on Money Laundering, Mutual Evaluation Report: Bangladesh (Sydney, 2009), 59.

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data that can then never be used by anyone because it is in the wrong format.63 There is no clear solution to this problem. Specialized commercial databases are prohibitively expensive. The UN provides a subsidized version of its own AML software package, but even in this case it may be too expensive. For example, when offered to Papua New Guinea, it cost $350,000 up front plus $50,000 annually thereafter for maintenance and upgrades.64 These figures represent several times more than the total annual budget of the country’s FIU. It may be possible to get donor assistance for the up-front costs, but donors are reluctant to contribute to the regular running costs of the FIU. Ironically, the rationale is that developing countries’ “ownership” of AML systems would be compromised if they were paid for by outsiders.65 The spectacle of data entry for its own sake, rather than to generate usable intelligence to fight crime, is a stark example of decoupling, the tendency whereby the means become ends in themselves. But the ultimate example of this kind of disconnect is the nation of Nauru.

Nauru I draw out the disconnect between standard policy prescription and local circumstances by examining the experience of a single, tiny country. In looking at the decoupling between institutional form and function, sociologists such as John Meyer enjoin scholars to look to “the furthest peripheries of the world.”66 Among all sovereign states in existence, Nauru is that furthest periphery. It is germane to give some details on the country and its precarious position to illustrate the huge contrast between the obligations it has had to shoulder as a “normal state,” and the physical realities that show Nauru to be in practice anything but. Nauru is a single island in the middle of the central Pacific measuring two miles by three miles (it takes three hours to walk around the circumference of the island). Its nearest neighbors are Kiribati and the Federated States of Micronesia. It has no port, but thanks to a runway that stretches from one side of the country to the other (intersecting the only road), there are two flights a week. Nauru became a sovereign state

63. Author’s interview, Asia-Pacific Group on Money Laundering, Brisbane, Australia, July 6, 2009. 64. Ibid. 65. Author’s interview, UNODC, Vienna, Austria, September 17, 2007. 66. John W. Meyer, “Reflections: Institutional Theory and World Society,” in World Society: The Writings of John W. Meyer, ed. Georg Krucken and Gili S. Drori (Oxford: Oxford University Press, 2009), 49.

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after gaining independence from Australia in 1968, though it had previously been incorporated in the German Empire in the late nineteenth century. One day in 1899, an Australian prospector happened to test a rock from Nauru he had been using as a doorstop, only to find it was solid phosphate. Following from this discovery, Nauru became a prize because of its phosphate resources, despite its minute size and physical remoteness. The phosphate core was extensively mined before and after independence. Although almost all of the pre-1968 wealth benefited foreigners, after independence and until the beginning of the 1990s Nauru’s population of eight thousand was per capita the among richest in the world (second only the United Arab Emirates in the early 1980s).67 Most amenities were provided free of charge, there were generous payments to the population, and no tax.68 Almost all Nauruans were employed in the public sector, but the work often consisted of little more than collecting the salary, with jobs in the mines contracted out to workers from Kiribati or Tuvalu. Although over $1 billion of the mining proceeds was put into a trust fund, these funds, as well as the regular revenues, were plundered by the government in an extraordinary display of graft and mismanagement. In the strange case of the airline that ate the country, Air Nauru had a budget more than ten times larger than the combined health and education budgets ($46 million versus $2 million and $1 million, respectively).69 Its fleet of up to ten planes specialized in long, fully catered flights around the Asia-Pacific with few or no passengers. Meanwhile, the country’s politicians spent up to 360 days a year outside the country, enjoying the generous per diems granted to those on “official business” overseas. All this was funded by phosphate rather than normal government revenue. As the optimistic verdict of the day had it: “The government of Nauru imposes no taxes of any kind, and, since the phosphate deposits are far from exhausted, sees no prospect of needing to do so.”70 Unfortunately, only a few years later Nauru’s phosphate production began to drop, and the government began to embark on ever more harebrained schemes for economic diversification. One of these schemes involved selling offshore shell companies, and then offshore banks, later putting the

67. Carl N. McDaniel and John Gowdy, Paradise for Sale: A Parable of Nature ( Berkeley: University of California Press). 68. Helen Hughes, “From Riches to Rags: What are Nauru’s Options and What Can Australia Do to Help?” Issue Analysis Paper, Centre for Independent Studies, Sydney, 2004. 69. Author’s interviews, local and Australian officials, Nauru, August 18–24, 2008. 70. Milton Grundy, Grundy’s Tax Havens: A World Survey, 5th ed. (London: Sweet and Maxwell, 1987), 71.

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government on a collision course with the FATF. Under heavy pressure, the offshore center was abandoned in 2003. After being the victim of a series of con-men and sponsoring a failed West End musical (Leonardo the Musical: A Portrait of Love, based on a supposed romance between Leonardo and Mona Lisa), in the late 1990s the country began to fall apart. The government was unable to pay salaries, national debt stood in excess of 1600 percent of GDP, and the country’s only bank went broke.71 Disgruntled locals burned down the presidential mansion, as well as the only police station and jail. Basic amenities such as diesel fuel (for the generator and water desalination plant) were paid for by Australian and Taiwanese aid.72 Nauruans by this stage had largely lost the habit of working, which had been left to expatriates, and had developed the world’s worst rate of obesity and type 2 diabetes. In short, Nauru has no lack of major problems. But with no financial sector, money laundering would not seem to be one of them. Nauru has had to import a complex and demanding regulatory regime for a financial system, despite the fact that the country has no financial system of any kind. To be specific, since 1999 Nauru has had no banks, no insurance companies, no savings institutions of any kind, no mortgages, no loans, no ATMs, no facilities for using credit cards, no checks, no stock market, and no national currency. The government pays a minimum stipend in cash, which is physically carried in from Brisbane, Australia (the Australian dollar being local currency) $400,000 at a time. The country’s only supermarket carries cash out or gives cash to the government in return for an electronic deposit from the government’s Australian account to its own account in Australia.73 Nauru was blacklisted by the FATF in 2000 because of its offshore shell banks. These bank licenses had all been revoked by 2003.74 In an attempt to placate the FATF, the government passed its first AML legislation in August 2001. Aside from criminalizing money laundering, the legislation specified the standard Know Your Customer requirements for financial institutions. Except, of course, there were no financial institutions and hence no customers. The legislation then went on to describe how the country’s nonexistent financial firms could be penalized for withholding cooperation and how to freeze and block accounts, although all accounts had been indefinitely frozen in any case due to the insolvency of the Bank of Nauru. The charade

71. 72. 73. 74. 2005).

Asian Development Bank, Country Economic Report: Nauru (Manila, 2007). Author’s interviews, local and Australian officials, Nauru, August 18–24, 2008. Ibid. FATF, Annual and Overall Review of Non-Co-operative Countries or Territories 2005 (Paris,

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continued with requirements for financial institutions to lodge suspicious transaction reports and for the Bank of Nauru to institute a training program for these firms.75 Nauru then passed another Anti-Money Laundering Act in March 2003 with even more stringent provisions for scrutiny, regulation, and training in the absent financial sector. A further Anti-Money Laundering Act followed in 2004, and the Corporation and Banking Acts were amended twice to include AML provisions. In 2004 the country passed the Mutual Assistance in Criminal Matters Act, the Proceeds of Crime Act, the Illicit Drug Control Act, and the Counter-Terrorism and Transnational Crime Act.76 To put this in perspective, in the period 2000–2004, the Nauruan parliament passed an average of seven bills per year in total, including the budget.77 After this flurry of legislative activity, Nauru sought out technical assistance in further strengthening its financial sector regulation beginning in 2005 and building an FIU,78 even though there was still nothing to be regulated. In 2006 the government began work on further revising its AML legislation.79 In 2008 Nauru gained the barest hint of a financial sector in the form of a single Western Union office operated by expatriate Paul Finch and one local employee.80 The Australian government paid for a $25,000 AML software package ( World-Check) for the FIU to screen those seeking to open a bank account, although as of 2010 there was still no bank. The FIU was also given a computer and in 2008, after a year’s lobbying, a 56K modem link.81 The sole staff member (Kelson Temakin) is also the only public trustee for the country. Other duties notwithstanding, he entered the world of AML training seminars and plenaries once Nauru joined the Asia-Pacific Group on money laundering, sometimes joined by colleagues from other departments. Lest it be thought that Nauru’s preoccupation with AML is solely because of its association with shell banks (which, to repeat, had been abolished in 2003) and the Russian mafia, it is worth pointing out that all of the other Pacific island states have also adopted the standard suite of AML laws. For example, Palau ( population 20,700) and Tuvalu ( population 12,700) also 75. Trifin J. Roule and Michael Salak, “The Anti-Money Laundering Regime in the Republic of Nauru,” Journal of Money Laundering Control 7 (2003): 75–83. 76. FATF, Non-Co-operative Countries or Territories 2005 (Paris, 2005), 10. 77. Pacific Islands Legal Information Institute: Nauru Acts by Year, http://www.paclii.org/nr/ indices/legis/Nauru_Acts_by_Year.htm (accessed February 2010). 78. FATF, Non-Co-operative Countries or Territories 2006, 5. 79. FATF, Non-Co-operative Countries or Territories 2007, 6. 80. Author’s interviews, local and Australian officials, Nauru, August 18–24, 2008. 81. Author’s observation, Asia-Pacific Group on Money Laundering plenary, Brisbane, Australia, July 6–10, 2009.

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adopted AML policy in 2001 and 2004, respectively, and established FIUs (the Palauan Financial Intelligence Unit and the Tuvaluan Transaction Tracking Unit). In their legal form, this legislation mirrors the structure in the United States that was described in chapter 1, despite the massive differences in the scale of the countries.82 Neither Tuvalu nor Palau has ever hosted an offshore financial center. Even more microscopic Niue, with a population of 1,200, once more adopted a standard AML system, including no fewer than twelve separate pieces of legislation on this issue and a one-person Financial Intelligence Unit.83 Niue, however, had earlier maintained an offshore center.

Barbados, Mauritius, and Vanuatu If Nauru is deliberately provided as an extreme example of the application of AML standards in defiance of local conditions, there is a need for more representative evidence. Especially useful would be figures on the cost of the AML system for developing countries along the lines of those compiled by Reuter and Truman for the United States. The closest equivalent is a survey project conducted in Barbados, Mauritius, and Vanuatu, commissioned by the Commonwealth Secretariat and funded by the World Bank FIRST initiative.84 This project involved interviews and quantitative and qualitative surveys of the public and private sector to capture the local costs and benefits of new global standards governing international financial services. By far the most important of these were AML regulations. After the survey results had been collated and a draft summary prepared, workshops were held in Vanuatu (March 10, 2006), Mauritius (April 10–11, 2006), and Barbados (April 21, 2006) to discuss the results with respondents and refine the findings. A final report distilling and comparing this material was presented at a symposium hosted by the Commonwealth Secretariat in London in June 2006. There are definite limitations to the results, however. Aside from their incomplete coverage, the final figures for the three countries are not comparable due to variations in the survey questions and response rates. It proved easier to measure the costs of new regulations associated with multilateral

82. Pacific Islands Legal Information Institute: Tuvalu Acts by Year, http://www.paclii.org// cgi-bin/disp.pl/tv/legis/num_act/poca2004160/poca2004160.html?query=money%20laundering (accessed February 2010). 83. Author’s observation, Pacific Islands Forum Anti-Money Laundering Workshop, Brisbane, June 17, 2008. 84. Unless noted otherwise, all figures in this section are from J. C. Sharman and Percy S. Mistry, Considering the Consequences: The Development Implications of Initiatives on Taxation, Anti-Money Laundering and Combating the Financing of Terrorism (London: Commonwealth, 2008).

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initiatives than to quantify benefits. The primary benefit to both jurisdictions and firms was preserving, but not enhancing, their reputation. This is akin to the deficit model, discussed earlier in connection with banks in rich countries. The study focused on the international segment of each country’s financial sector rather than that catering to the domestic market. In fact, the impact of AML regulations went much wider. In Mauritius for example, it became the responsibility of insurance companies to ensure that all holders of any kind of insurance policy appeared in person to confirm their identity.85 In Vanuatu, a cash transaction report had to be lodged every time a supermarket deposited its daily takings.86 In Barbados, parents complained of the difficulty of sending money to children studying in the United States and Britain, thanks to AML regulations on international banking transfers.87 For Barbados, the new AML requirements ensured offshore banks had “mind and management” in Barbados, that is a permanent office, the bank’s records, and at least one full-time employee. The banking supervision section of the Central Bank of Barbados instituted a new program of on-site inspections, necessitating a staff increase. A new Anti-Money Laundering Authority and Financial Intelligence Unit were set up, and banks, insurance companies, company formation agents, and other firms became subject to new Know Your Customer requirements. In both the public and private sector, these new, tighter regulations necessitated either hiring more staff or diverting existing staff away from other tasks as well as spending more on items such as software and office space. Extrapolating from partial survey data, it is estimated that the direct net costs of the new regulatory requirements to the private sector totaled $45 million for the four-year period 2002–2005. Once more it must be stressed that this should be taken as an order of magnitude rather than communicating a precise figure. In Mauritius, a regulatory reorganization meant that responsibilities were concentrated in a Financial Services Commission and the Bank of Mauritius. A new twenty-four-person Financial Intelligence Unit was set up. Greater requirements for information collection and exchange were introduced. In particular, small corporate service providers struggled to cope with the demanding and expensive new due diligence and other regulatory requirements. Direct costs of the new regulatory regime to these providers 85. Author’s interviews, public and private sector, Port Louis, Mauritius, May 25–June 2, 2005. 86. Author’s interview, government official, Port Vila, Vanuatu November 14–15, 2005; also true in the Cook Islands and Fiji, Author’s interviews public and private sectors, Avarua, Cook Islands, July 28–29, 2008 and December 2–4, 2009, and Pacific Island Forum, Suva, Fiji, November 22, 2004. 87. Author’s interview, Bridgetown, Barbados, September 25, 2005.

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were estimated at US$27.3 million 2002–2005, whereas the costs to banks over the same period were $7.9 million. Turning to the public sector, the net direct costs in the period 2002–2005 are estimated to be $4.8 million, for a total public and private figure of $40 million. Vanuatu instituted a sweeping program of legislative reforms to conform with the new AML standards. Both the Reserve Bank of Vanuatu and the Vanuatu Financial Services Commission had to take on new staff and incur substantial costs. A new Financial Intelligence Unit was established. Corporate service providers were included in a licensing system, obliging them to exercise enhanced due diligence in vetting prospective and existing customers. Coinciding with this increase in regulatory requirements was a sharp decline in the number of offshore banks, from thirty-seven to seven in a twelve-month period 2002–2003. Representatives in both the private and public sector unanimously attributed this sudden loss of business to new regulatory requirements for offshore banks to maintain a permanent office, all records, and at least one full-time employee in the country (the mind and management rule).88 Taking into account direct costs to the public and private sector, as well as revenue lost to both the government and corporate service providers from the decline in offshore banking, it is estimated that the net cost to Vanuatu in 2002–2005 from the regulatory reforms was $6.25 million. Although there are inherent limits to generalization, the pattern of costs and benefits revealed for Barbados, Mauritius, and Vanuatu is broadly suggestive of the experiences of other similarly situated small states. The greatest direct cost to the public sector in all three countries was hiring extra staff for newly created or expanded regulatory agencies and the associated costs of office space, training, and computer hardware and software. In addition, there were substantial opportunity costs. Qualified personnel, in chronically short supply, were reassigned from vital regulatory tasks such as prudential supervision to AML roles. The greatest cost to the private sector was setting up Know Your Customer mechanisms, costs generally experienced through having to hire new staff, divert existing staff from core business activities, participate in training activities and seminars, and invest in new computer hardware and software. In Barbados and Mauritius, these costs had a much more severe impact on company and trust formation agents compared with offshore banks, whereas in Vanuatu this distribution of costs was reversed. General concerns were expressed in Mauritius and Vanuatu that more 88. Author’s interviews, public and private sector, Port Vila, Vanuatu, March 4–5, 2004, November 14–15, 2005, and March 9–10, 2006.

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onerous KYC due diligence requirements had produced indirect costs, as clients leaned toward other, less-regulated OECD investment destinations. Confirming Reuter and Truman’s finding, large firms in each country generally found it easier to bear the costs of new regulatory requirements than did small ones, leading to increased pressure on small firms to exit the market. International firms had often had to meet higher standards earlier to fit in with group-wide practices or were able to pass on compliance costs to the head office. Smaller local firms had to make a more rapid and wrenching adjustment. In line with the KPMG study, private firms found it difficult to quantify their costs in meeting AML requirements.89 It is counterintuitive, but firms tended to understate rather than overstate costs. For example, if staff were required to go to regular training seminars at the FIU, this was not seen as a cost because the firm didn’t have to pay anything. Firms were surprisingly resistant to the idea that staff time was itself a finite valuable resource and that time spent attending AML seminars was time not spent generating revenue. Although total costs were calculated in relation to the international financial service industry (rather than all financial firms) and public regulatory agencies, some comparison with Reuter and Truman’s figures are suggestive. Their estimate is that the AML regime costs 0.06 percent of U.S. GDP annually (the £600 million guess for the UK would be 0.05 percent of GDP). Using 2004 GDP levels and the partial figures for each country (which, once again, are not measuring the same scope of costs), the figures are 0.4 percent annually for Barbados, 0.16 percent for Mauritius, and 0.47 percent for Vanuatu. These figures support the idea that AML costs in middle-income and poor countries are an order of magnitude greater than those in rich ones.

The Missing Benefit: AML and the Proceeds of Kleptocracy In keeping with the earlier coverage of rich countries, I now turn from a consideration of costs to that of benefits. In principle, what benefits could developing countries expect from introducing an AML policy? For developed countries, AML policy is said to be valuable in combating drugs, crime, and fraud and in protecting the financial system at large. Most developing countries, however, are small drug markets. Although they may be important sites for production or transshipment, most are unlikely to be the source or host of large amounts of drug money vulnerable to tracking, interdiction, and

89. KPMG, Global Anti-Money Laundering Survey 2004.

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confiscation. Developing countries typically have very small financial sectors, meaning there is very little financial system to protect and limited scope for fraud. Many developing countries do, however, have at least one kind of financial crime in abundance: corruption, which is estimated to be the greatest single source of illicit funds laundered in these countries.90 Much of this corruption is small-scale, and thus the proceeds can be spent on everyday consumption without having to be laundered. But there is also a good deal of “grand corruption,” involving large amounts of money embezzled or received as bribes by senior public officials, perhaps even heads of state. The seriousness of this problem is indicated by the World Bank and IMF claim that corruption and other governance problems are the single greatest obstacle to economic development among poor countries.91 One headline-grabbing figure asserted that African countries may lose up to 25 percent of their GDP to corruption.92 Transparency International issued a list of kleptocrats in 2004, which was headed by Suharto of Indonesia (alleged to have stolen between $15 and 35 billion during his time in power), Ferdinand Marcos of the Philippines ($5–10 billion), and Sani Abacha of Nigeria ($2–5 billion).93 Once again, a degree of skepticism is in order about the extent to which public relations concerns trumped methodological rigor in compiling these figures. But there is little doubt that the figures are large and that there is a significant impact on development, not just in terms of the money stolen, but also the indirect economic damage inflicted. Nigeria and Equatorial Guinea provide stark examples. Despite being Africa’s largest oil producer, as of 2006 the average Nigerian was poorer than in 1980, with 71 percent of the population living on less than a dollar a day and estimates of total losses to corruption since independence put at $400 billion.94 Thanks again to oil, Equatorial Guinea enjoys an annual per capita income of $37,200, yet in large part because of corruption 77 percent of its population lives in poverty, more than half lack access to clean water, and less than 1 percent of the state budget is spent on health.95 If AML policy could reduce the damage done by corruption by even a small proportion, it could make a major development contribution. Unfortunately, 90. World Bank, Governance and Anti-Corruption Strategy ( Washington, D.C., 2007), 68. 91. World Bank/IMF Joint Development Committee, “Strengthening Bank Group Engagement on Governance and Corruption” ( Washington, D.C., 2006). 92. UNODC/World Bank, Stolen Assets Recovery (STAR) Initiative: Challenges, Opportunities, and Action Plan ( Washington, D.C., 2007), 9. 93. Transparency International, Global Corruption Report 2004 ( Berlin, 2004). 94. “Capping the Well-heads of Corruption,” Economist, October 19, 2006. 95. Global Witness, Undue Diligence: How Banks do Business with Corrupt Regimes (London, 2009), 4; U.S. Senate, “Riggs Bank,” 40.

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however, there is little evidence that AML policy is making any meaningful difference in this area. Furthermore, the FATF in particular has little interest in improving the performance of AML policy in combating corruption.96 Most of the illicit funds accruing to corrupt senior officials seem to be stashed in Western financial centers, with most conspicuous consumption also taking place in the West rather than at home. If bribes or payment for resources are passed from a foreign company to a corrupt official’s foreign bank account, these funds will never enter the developing world. As such, grand corruption in poor countries should potentially be countered most effectively by AML systems in major Western countries rather than in developing countries.97 Aside from the extensive and intrusive surveillance mechanisms explained in the previous chapter, the FATF requires that corruption offenses be included as a predicate for money laundering and that foreign senior public officials be subject to enhanced scrutiny when opening bank accounts. Despite these requirements, several prominent examples indicate how massive failures of the AML system in Western countries have facilitated the plunder of several developing countries by their rulers. These examples involve heads of state or ministers from countries known to have corruption problems opening and maintaining accounts at major Western institutions, with little attempt to disguise either their identity or the illegal provenance of the money in question. They are exactly the sort of simple, obvious cases that the AML system should be expected to prevent. To their great credit, nongovernmental organizations (NGOs) such as Global Witness and Transparency International, as well as the U.S. Senate Permanent Subcommittee on Investigations, have been fearless and persistent in unearthing and exposing cases of grand corruption. In contrast, various intergovernmental organizations such as the United Nations, the Bretton Woods Institutions, and FATF have been notable for their endlessly repeated lofty platitudes on corruption and their timid refusal to name names. The U.S. and, even more so, French governments have also been prominent in terms of their complicity in allowing the laundering of funds looted from poor countries, sometimes inadvertently, but often deliberately.

96. Although David Chaikin and I prepared a report on money laundering and corruption for the FATF and Asia-Pacific Group on Money Laundering in 2007, it attracted little interest in the former; see David Chaikin and J. C. Sharman, “APG/FATF Anti-Corruption/AML/CFT Research Paper,” presented at the FATF Paris plenary, October 12, 2007. 97. UNODC/World Bank, Stolen Assets Recovery; UNODC/World Bank, Stolen Assets Recovery: Politically Exposed Persons: A Policy Report on Strengthening Preventative Measures ( Washington, D.C., 2009).

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The first case relates to Riggs Bank, in particular with reference to the ruling Obiang family of Equatorial Guinea. Riggs opened around sixty personal accounts for President Obiang’s family, a corporate account for a Bahamian shell company (Otong) set up by Riggs for Obiang, and other accounts under the name of the country or the embassy, with Obiang and his family members as signatories. These accounts held balances of up to $500 million. Riggs knew about the corruption problems in Equatorial Guinea but did not subject any of the accounts to scrutiny. Bank documentation predicted that Equatorial Guinea’s rapidly increasing oil wealth and related political importance would insulate it from criticism on its human rights and corruption records (in this regard, at least, Riggs was right; Condoleeza Rice referred to Obiang as a “good friend” of the United States in 2006, and the Obama administration has been almost as solicitous).98 Riggs accepted six cash transactions of $1–3 million in suitcases for the Otong account without reporting these as suspicious. Additional wire transfers totaling $35 million were sent to HSBC Bank accounts in Luxembourg and Cyprus and to Banco Santander accounts in Spain in the name of other shell companies, again with no suspicious transaction reports being filed. As noted earlier, Riggs was exposed by the press and the Senate (not the AML apparatus), but the Obiang story did not end there. One would have thought that the excoriating verdict of the Senate report and the associated media coverage would have led other Western banks to give the Obiang family a wide berth. In fact, until at least November 2007, Teodorin Obiang, President Obiang’s son, maintained accounts in Paris with Barclays, BNP Paribas, and a private bank owned by HSBC. Obiang junior was also Minister for Forests and Agriculture ( parodied as the “Minister for Chopping Down Trees”), earning an official salary of $4,000 a month. He had been one of the cosignatories in some of the most important Riggs Bank accounts and had himself admitted in a South African court in 2006 that in receiving bids from foreign companies “a cabinet minister ends up with a sizeable part of the contract price in his bank account.”99 From his French bank accounts, Teodorin Obiang bought a number of luxury cars from Rolls Royce, Ferrari, Maserati, and Bugatti for a total of €4.5 million. One of the checks for these transactions reproduced in the Global Witness report clearly shows Obiang’s address listed as the presidential palace, Equatorial Guinea. The French FIU concluded that these funds

98. U.S. Senate, “Riggs Bank,” 46–47. 99. Global Witness, Undue Diligence, 40.

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probably represented misappropriated public money, but neither the FIU nor the banks took any action.100 Meanwhile, Obiang transferred over $73 million to the United States in the twelve-month period beginning in April 2005. This money was moved from Société Géneral Equatorial Guinea to Banque de France and then through a combination of accounts with Bank of America, Citibank, Wachovia, and UBS (some U.S. banks did at least lodge suspicious activity reports).101 Much of the money was spent on a $35 million mansion in Malibu (owned through a U.S. shell corporation) and a $33 million private jet (again held through a shell corporation, this time registered in the British Virgin Islands). Like their French counterparts, U.S. Department of Justice officials were confident this money represented the proceeds of crime, maintaining that “most if not all” of his wealth is “derived from extortion, bribery and the misappropriation of public funds.”102 Aside from a “revolutionary tax” levied on logging concerns but paid to Obiang’s account, the same document says the bribes may come from companies exploiting the country’s oil and gas reserves.103 The most important foreign firms in Equatorial Guinea are American, specifically Exxon, Marathon, and Hess. Why so much attention to just one corrupt family, and how much can be drawn from this isolated instance? Once again, the logic here is that the Obiangs and Equatorial Guinea represent an extreme instance of kleptocracy and a “most-likely case” suitable for the AML system. The corruption was especially blatant and large scale, and although some assets were held in the names of shell companies, the Obiangs also maintained personal accounts in their own names with major Western banks until at least late 2007. According to AML rules in the United States since 2001, knowingly accepting the proceeds of overseas corruption is a money-laundering offense. Even absent the threat of criminal prosecution, the logic put forward by the Wolfsberg Group (the AML think tank of the major international banks) indicates that no bank should accept these kinds of suspect funds purely due to the risk to reputation. Yet the majority of the group’s member banks, the most prominent in the industry, in practice seem to have no problem hosting funds from

100. Ibid., 42. 101. Global Witness, The Secret Life of a Shopaholic: How an African Dictator’s Playboy Son went on a Multi-million Dollar Shopping Spree in the U.S. (London, 2009), 13; U.S. Senate Permanent Subcommittee on Investigations, “Keeping Foreign Corruption out of the United States: Four Case Histories” ( Washington, D.C., 2010). 102. Global Witness, Secret Life of a Shopaholic, 13; “U.S. Door Stays Open Despite Swirl of Corruption,” New York Times, November 16, 2009. 103. “U.S. Door Stays Open.”

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the most obviously corrupt politicians (who have an unenviable record of brutality and repression to boot). Yet as the following list shows, the Obiangs are not an isolated example of kleptocrats laundering their funds through major Western financial centers. The British Financial Services Authority found that twenty-three banks in London had handled over $1.3 billion of Sani Abacha’s corrupt monies stolen while he ruled Nigeria.104 A 1999 U.S. Senate report identifies the ease with which the ruling Bongo family of Gabon accessed the U.S. banking system and were able to launder funds through it.105 In February 2003, HSBC conducted a search for members of this family on its database. The senior compliance officer answered that there were no matches for Bongo. Later that month in Manhattan, Bongo’s daughter, Yamilee Bongo-Astier, made a cash deposit of $107,000 into her HSBC account, which was not flagged as suspicious even though her profession was listed as “full-time student.”106 When HSBC later closed the account, Astier-Bongo simply opened another account with J.P. Morgan Chase, another bank that once more failed to spot the connection with President Bongo. As with the Riggs scandal, this error was identified not by internal bank controls, nor by AML agencies, but by the Senate inquiry. This was a repeat of the situation in 1999 whereby Citibank had handled President Bongo’s accounts, despite being aware of its illegitimate origins, until the Senate hearings on the topic.107 Similarly, the 2010 report details further complicity by U.S. banks in relation to illicit funds from Angola and from the former vice president of Nigeria Atiku Abubakar, who together with his wife brought $40 million into the United States via wire transfers between 2000 and 2008, including bribe money paid by the German firm Siemens. Between 1999 and 2003, Charles Taylor of Liberia used Citibank New York to transfer logging revenue into his own personal account.108 If the effectiveness of the U.S. system has been patchy at best, the French government and private sector seems to have been actively and deliberately complicit in accepting the proceeds of corruption from the developing world, particularly francophone Africa.109 As of late 2007, Omar Bongo had six accounts with BNP Paribas and four with Crédit Lyonnaise in France, despite the well-publicized 1999 U.S. Senate report detailing the illicit origins of

104. Global Witness, Undue Diligence, 21. 105. U.S. Senate Permanent Subcommittee on Investigations, “Private Banking and Money Laundering: A Case Study of Opportunities and Vulnerabilities,” ( Washington, D.C., 1999). 106. U.S. Senate, “Keeping Foreign Corruption Out,” 172. 107. U.S. Senate, “Private Banking and Money Laundering.” 108. Global Witness, Undue Diligence, 69–74. 109. Ibid.

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Bongo’s money.110 The French NGOs responsible for bringing this documentation to light also claimed that leaders and their families from Angola, Burkina Faso, Congo, and Congo-Brazzaville had millions of euros of assets in France that represented the proceeds of corruption.111 In sum, both the U.S. Senate report of 2010 and the Global Witness documents of 2009 unequivocally indicate that the extensive AML regulations in place in the United States, France, and other Western countries are relatively ineffective in preventing even the most obvious and straightforward cases of laundering the proceeds of corruption offenses committed in the developing world. There have been cases whereby funds stolen from developing countries and stashed in the West have been returned, but they tend to be the partial exceptions and have had little to do with AML policy. Thus after an thirteenyear legal battle, the Philippine government succeeded in recovering $356 million plus interest from Marcos family bank accounts, yet this sum probably represents less than a tenth of the money stolen.112 A more promising case that does involve AML law is that relating to the corrupt monies received by Benazir Bhutto and Ali Asif Zadari, once more held in Switzerland. Although the case was suspended when Zadari became president of Pakistan, at time of this writing it looks likely to be revived. As a general comment, however, the verdict of Joseph Stiglitz seems accurate: [We] discovered that bank secrecy was not only for money laundering, tax evasion, drugs and corruption, but also for terrorism; we have since circumscribed the use of bank secrecy for terrorism— and thus we have shown that it can be done. But we have chosen not to deal with the problems of corruption and tax evasion which are so enervating to the developing countries and deprive them of so much needed money.113

This chapter has considered a broad range of evidence in an attempt to find out whether AML policy works. The question is deceptively simple; gaping holes in our knowledge about money laundering and the associated predicate crimes preclude any final answer. At the very least, however, the most knowledgeable independent commentators on this issue see little evidence that AML 110. Ibid., 46. 111. Ibid., 40. 112. David Chaikin and J. C. Sharman, Corruption and Money Laundering: A Symbiotic Relationship (New York: Palgrave, 2009), Chapter 6. 113. Joseph Stiglitz’s testimony to the House Financial Services Committee, May 22, 2007, in Global Witness, Undue Diligence, 41.

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policy is living up to its promise in rich countries, primarily the United States. This goes for reducing either the amount of money laundered or the level of crimes that generate this money in the first place. Others are more comfortable in pronouncing AML policy a failure. Rather than contesting these unflattering assessments of fundamental effectiveness, the FATF and most government AML bodies have concentrated on assessing the second-order technicalities of complying with the 40+9 Recommendations. Claims that AML policy safeguards the stability of the financial system or the reputations of individual firms cannot be substantiated. The evidence suggests that application of AML policy in developing countries is often a question of going through the motions rather than reducing crime. The logic originally used to justify the imposition of AML policy in rich countries is a poor fit in the developing world. There are good reasons to think that the direct and indirect costs of AML policy are proportionately higher in poor countries, especially considering the opportunity cost of addressing the unmet demand for basic human needs such as clean water, primary health care, and education, as well as the scarcity of professionally trained government personnel. Even when AML policy could potentially deliver benefits to poor countries, primarily in an anticorruption context, these benefits have not been realized. To summarize, there is little evidence to show that AML policy does work and a good deal to indicate that it does not. The next chapter seeks further evidence on this score from a more focused, direct test of the effectiveness of AML policy by way of soliciting offers for and establishing the kind of anonymous shell companies prohibited by key AML rules. Yet even based on the material presented so far, the mystery deepens as to why so many countries with so little in common, from Nauru to Niger, the United States and the United Kingdom, would adopt the same standards within a relatively short period of time. Despite all the caveats and riders, it is possible to say unequivocally that there is no clear, compelling evidence of effectiveness that corresponds with and explains the explosive diffusion of AML policy.

Ch a p ter 3

A Direct Test of Effectiveness

On November 5, 2009, U.S. Senator Carl Levin issued an impassioned plea on behalf of proposed legislation mandating that all corporations in the United States be able to be traced back to the real person or persons in control. Levin argued that until this measure was passed, drug traffickers, money launderers, and even terrorists could set up and use U.S. companies to pursue their criminal ends. He noted that “the corporate form is being corrupted into serving those who use the corporate veil to hide their identities while committing crimes.”1 Why would such a dry-sounding, technical matter of corporate accounting elicit such emotion or threaten such dire consequences? One of the goals of this chapter is to show why the kind of anonymous corporations Levin’s legislation sought to target is a major, indeed possibly lethal, threat to the success of the AML regime, both at the national and global level. More than this, however, the central purpose of the chapter is to present the results of a direct test of the effectiveness of the AML regime in this regard, results derived from a process of rule-testing by rule-breaking. Specifically, the direct test was to solicit offers to buy exactly those anonymous corporations and associated bank accounts that are expressly prohibited by FATF standards and, indeed, 1. Statement by Senator Carl Levin, November 5, 2009. http://www.allbusiness.com/crimelaw/criminal-offenses-crimes-against/13401898–1.html (accessed February 2010).

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that are banned in rules mandated by many other international organizations as well. The logic of the test is simple: to the extent that it is easy to break such a crucial AML rule in practice by buying anonymous companies, the regime will tend to be ineffective. On the other hand, if it is difficult to break such rules, then this would suggest that the AML regime is effective. Although the evidence derived from this test does not point in only one direction, the overall pattern of results supports the conclusion of the preceding chapter: AML policy is ineffective. Because it is ineffective and expensive, this sharpens the need for an explanation for why AML policy has diffused so far so fast, which is supplied in part 2. Establishing the logic and significance of this direct test of AML policy, the rule-testing by rule-breaking strategy, requires a number of steps. The first of these returns to the issue identified above: why is it important to be able to link companies with their real owners? Why is the availability of companies that enable their owners to hide behind a “corporate veil” so important for policymakers, and why does it constitute a critical test of the effectiveness of AML policy? In answering these questions, the first section of this chapter explains the nature of anonymous shell companies. It illustrates how they have consistently been used by a wide variety of actors as the mainstay of various money-laundering schemes and related financial crimes, including tax evasion, alleged corporate bribery, drug trafficking, and arms trafficking. The centrality of this issue is further supported by a number of policy reports on money laundering. These reports converge on the importance of being able to pierce the corporate veil, that is, to find out who is really behind a company or other kind of corporate vehicle (trust, partnership, foundation, etc.). The next task is to establish the logic of the direct test employed. This test was premised on emulating the profile of a would-be money launderer by electronically soliciting offers for anonymous shell companies and purchasing a subset of those on offer. The test took place in two rounds. In the first I made all the solicitations, and the second involved students from Case Western Reserve University making the approaches. The importance of this kind of direct test of compliance goes far beyond the issue of money laundering. Even the most casual observation reveals that both domestically and at the international level there is a vast range of laws and regulation that can be completely ineffectual in practice, from speed limits to human rights conventions. What we care about is not so much the laws on the books, but rather whether such laws make any difference to actual behavior. The third and final portion of the chapter presents the results of the test and explains their significance.

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What Are Anonymous Shell Companies? In the rhetoric of the struggle against money laundering, as well as the plot lines of dozens of movie thrillers, banking secrecy or anonymous bank accounts is often central. In the popular imagination “numbered bank accounts” provide the end point for ill-gotten gains. With few exceptions, however, banking secrecy in the form of individuals holding anonymous accounts is a problem that disappeared ten years ago. Truly anonymous personal accounts, where no one in the bank knew the identity of an account holder who was referred to only by a number, were always quite rare. As a legacy of the Austro-Hungarian empire, Austria, Hungary, Slovakia, and the Czech Republic had such anonymous passbook accounts until pressure from the FATF forced their abolition in 2000–2001 (see chapter 4 for details on Austria).2 The anonymity provided by such accounts was perfect, but the downside was that in losing the physical passbook the account holder might also lose the only means of accessing the account. In any case, these accounts had strict limits on their balances (e.g., a ceiling of $7,000 in Hungary).3 A more common variant of banking secrecy was laws that made it a criminal offense for bank employees to reveal information pertaining to their clients to any party, including the local government. Such a law was passed in Switzerland in 1934 and was widely copied thereafter.4 Here, only one or two employees of the bank would know the actual identity of the account holder, which otherwise would be linked only to the account number. As part of the direct-testing logic, I purchased such a personal numbered account in Somalia. Perhaps not surprisingly, things did not go according to plan, as discussed below. While these bank secrecy laws remain in place, in every country they have been amended to include clauses specifying that secrecy is suspended in cases in which there is credible evidence of money laundering. Such amendments, and the abolition of anonymous personal accounts, have largely solved the problem of bank secrecy as such. The problem of corporate anonymity, however, has always been a much bigger problem, and it is far from being solved. It is customary, but incorrect, to assume that companies must have employees, buildings, and the means necessary to produce some good or service.

2. FATF, Review to Identify Non-Co-operative Countries or Territories: Increasing the Worldwide Effectiveness of Anti-Money Laundering Measures (Paris, 2001), 14–16. 3. Ibid., 15. 4. Ronen Palan, The Offshore World: Sovereign Markets, Virtual Places, and Nomad Millionaires (Ithaca: Cornell University Press, 2003); Ronen Palan, Richard Murphy, and Christian Chavagneux, Tax Havens: How Globalization Really Works (Ithaca: Cornell University Press, 2010).

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In fact, legally a company is nothing more than an alternative identity, a legal person as opposed to a biological person. There is no need for companies to have buildings, employees, etc., and those that have only this legal personality are referred to as “shell companies.” Although all companies must have a name to be registered and thus to exist, in the case of anonymous shell companies it is impossible to establish the identity of the real individual who owns and/or controls the company, and thus any associated bank account ( perhaps strictly speaking the shell companies are “anonymizing” rather than anonymous). Therefore, by establishing such a company, criminals can simultaneously enter and use the international financial system and prevent efforts to follow the money trail back to themselves. Because the company is anonymous, in that it cannot be linked with the real owner, all the transactions in which it engages are effectively untraceable and anonymous also. For this same reason, the opacity conferred by anonymous shell companies stands in direct opposition to the injunction to render the financial system transparent by “knowing your customer,” the foundation of all AML rules. As is demonstrated, shell companies can be incorporated online in a huge variety of jurisdictions for a few thousand dollars or less, often within twenty-four hours. One example of such a service available after a simple web search reads as follows: Guatemala Trust Agreement Banking—This is where the law firm forms an anonymous corporation for you. The law firm signs on the bank account. The bank does not know who you are and has no ID documents on you. You can access the online banking and obtain an anonymous no name Visa card from the Mexican bank. The startup fee is $6,000 and the law firm deducts 3% of all the incoming funds, nothing on outgoing funds. . . . We also have corporations with bank accounts open where the law firm is listed as the signatory on the account ready to go.5 Something upward of two hundred thousand shell companies are formed in offshore financial centers each year.6 By comparison, two million companies are incorporated in the United States annually, few of which can be traced back to their real owners, according to Levin.7

5. Guatemala Corporate Trust Agreement Banking, http://www.panamalaw.org/guatemala_ banking.html (accessed November 2009). 6. Offshore Investment, Company Formation Survey 2009. 7. Levin statement.

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The material below aims to establish the central importance of corporate anonymity for the effectiveness of AML rules, taking evidence from two sources. First are a series of reports released by international organizations and governments, all which emphasize the critical importance of being able to establish the real owner of companies and other corporate vehicles. The second considers examples of how anonymous companies have been used in various instances of money laundering and alleged money laundering relating to tax evasion, bribery, and the illegal trade in drugs and arms.

The Importance of Anonymous Shell Companies Anonymous shell companies and the policy problems associated with them are nothing new. In a 1937 letter to President Roosevelt, the secretary of the treasury complained of U.S. citizens setting up shell corporations to hide funds in jurisdictions such as Newfoundland, the Bahamas, and Panama: Their corporation laws make it more difficult to ascertain who the actual stockholders are. Moreover, the stockholders have resorted to all manner of devices to prevent the acquisition of information regarding their companies. The companies are frequently organized through foreign lawyers, with dummy incorporators and dummy directors, so that the names of the real parties in interest do not appear.8 The letter then went on to complain about the use of foreign insurance companies, domestic companies, trusts, and pension trusts as legal devices to obscure the connection between individuals and particular assets or income, once more all problems that have endured to the present day. More than seventy years later, nothing has changed. Thus in 1981, the IRS report Tax Havens and Their Use by United States Tax-Payers noted that probably the most common form of abuse was “companies that are structured to appear to deal with only unrelated parties when they are dealing with related parties . . . hiding the fact of ownership of tax haven corporations.”9 To further parallel the importance of anonymous shell companies, a 1998 UN report explained that “despite a myriad of complications, there is a simple structure that underlies almost all international money-laundering activities. . . . The launderer often calls on one of the many jurisdictions that offer an instant 8. Franklin D. Roosevelt, Message to Congress on Tax Evasion Prevention, http://www.presidency. ucsb.edu/ws/index.php?pid=15413 (accessed November, 2009). 9. IRS, Tax Havens and Their Use by United States Tax-Payers ( Washington, D.C., 1981), 7.

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corporation manufacturing business. . . . Once the corporation is set up in the offshore jurisdiction, a bank deposit is made in the haven country in the name of that offshore company.”10 The authors underline that secrecy regarding the ownership of a corporation is a much more serious obstacle to countering money laundering than banking secrecy as such.11 In 2000 the European Commission published a study on the financing of organized crime. Receiving the most emphasis in the report is the centrality of establishing the beneficial ownership of companies: “company law is the most essential factor in the transparency of a financial system”12 Encapsulating the rationale for the focus of this chapter, the report goes on to say: If [company] regulation seeks to maximize anonymity in financial transactions, enabling the creation of shell or shelf companies whose owners remain largely unknown . . . such anonymity will be transferred to other sectors of the law. Thus the names of ultimate beneficial owners or the beneficiaries of financial transactions will remain obscure, which thwarts criminal investigation and prosecution . . . if company law maximizes anonymity, then the ineffectiveness of criminal law and police and judicial co-operation is inevitable. The same effect arises in banking law, where bank secrecy becomes a marginal issue owning to the anonymity enjoyed by the companies operating the bank accounts under surveillance.13 A 2006 report by the FATF on the misuse of corporate vehicles is unequivocal in stating at the outset: “Faced with the vast scope of a general study of corporate vehicle misuse the study focuses on what is considered to be the most significant feature of their misuse—the hiding of the true beneficial owner.”14 It quotes earlier FATF work noting “the ability for competent authorities to obtain and share information regarding the identification of companies and their beneficial owner(s) is thus essential for all the relevant authorities responsible for preventing and punishing money laundering,” as

10. Jack Blum et al., Financial Havens, Banking Secrecy, and Money Laundering ( Vienna: United Nations Office for Drug Control and Crime Prevention, 1998), 2. 11. Ibid., 31. 12. European Commission, Euroshore: Protecting the EU Financial System from the Exploitation of Financial Centers and Offshore Facilities by Organized Crime (Trento: European Commission, 2000), 14. 13. Ibid., 16. 14. FATF, The Misuse of Corporate Vehicles, Including Trust and Corporate Service Providers (Paris, 2006), i.

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well as those countering tax crimes, corruption, and fraud.15 A 2009 World Bank study authored by Richard Gordon identified the use of anonymous shell companies as the most common mechanism by which corrupt political leaders launder funds embezzled and received as bribes.16 Finally, the Tax Justice Network’s Financial Secrecy Index shares the same logic: “For decades it has been believed that bank secrecy . . . is the touchstone of offshore financial secrecy. This is a myth. . . . Trusts, for example, or certain kinds of anonymous companies offered by places like Delaware in the United States, are used to disguise true identities and ownerships in far more devious and effective ways.”17 There are many more such expressions of official concern, but the basic point is clear: the use of companies that obscure the real owners are the single greatest obstacle to fighting money laundering and other financial crimes. Following from this, to the extent that such anonymous vehicles are easily available, AML standards are unlikely to work. Before discussing the testing for the availability of such vehicles, I briefly present some examples that show how anonymous shell companies can be used in practice to disguise the proceeds of crime. Despite their differences, all of these criminal and allegedly criminal activities share a reliance on interposing a corporate structure to hide the real beneficiaries and controllers of the transactions in question.

Anonymous Shell Companies in Action To address the issue of tax evasion first, consider Sam Congdon, a Texasbased corporate service provider, who set up and sold offshore companies and trusts for roughly nine hundred individual clients.18 In 2005 a potential client e-mailed: “I am interested in opening an offshore account to protect my assets from my ex-wife and Uncle Sam. . . . What does the offshore

15. Ibid., 1–2; see also OECD, Behind the Corporate Veil: Using Corporate Entities for Illicit Purposes (Paris, 2001). 16. Richard Gordon, Laundering the Proceeds of Public Sector Corruption: A Preliminary Report ( Washington, D.C.: World Bank, 2009), 15 and 22; see also Global Witness, Undue Diligence: How Banks do Business with Corrupt Regimes (London, 2009). 17. Tax Justice Network, “Financial Secrecy Index,” 2009, 2; see also U.S. Treasury, Money Laundering Threat Assessment ( Washington, D.C., 2005); Government Accountability Office, Company Formations: Minimal Ownership Information Is Collected and Available ( Washington, D.C., 2006); Financial Crimes Enforcement Network, The Role of Domestic Shell Companies in Financial Crime and Money Laundering: Limited Liability Companies ( Washington, D.C., 2006). 18. U.S. Senate Permanent Subcommittee on Investigations, Tax Haven Abuses: The Enablers, The Tools, and Secrecy ( Washington, D.C., 2006).

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corporation that you offer provide above the protection offered by Swiss banks?” Congdon replied “Having an offshore account won’t really protect your assets because everything is still in your personal name. What will protect you from lawsuits and such is an offshore structure.”19 In an e-mail to another client, Congdon stressed “As long as everything is done in the name of the offshore company, then it is private and no one (including Inland Revenue) can get any information about it.”20 A second corporate service provider, Lawrence Turpen, based in Nevada, premised his advice to clients on the same principle as Congdon: “the key to a successful offshore structure was to separate the client from the paper ownership of the client’s assets, while retaining the ability to benefit from them.”21 Legal separation between the client and the funds was achieved using companies and trusts formed in Nevada and the Isle of Man, and practical control of the flows of money was retained through fictitious consultancy arrangements between the company and the individual. As Turpen related, “I sent $60,000 a year to my offshore corporation for advice. The advice was never worth a damn, but at the end of the year I had $60,000 in my offshore [company’s] account.”22 Money was then repatriated from the company to the owner through further “consultancy work” or fake loans. Besides smuggling clients’ wealth in the form of diamonds hidden in tubes of toothpaste, the Swiss bank UBS also enabled thousands of U.S. clients to evade income tax by helping them hold what were effectively personal accounts in the name of foreign shell companies.23 The EU also has identified anonymous shell companies as the central obstacle to enforcing its measures to tax interest earned on its citizens’ foreign savings.24 Showing the same principle at work at a different order of magnitude is the British Aerospace Systems ( BAE) case. In December 2006, the UK government cancelled a corruption probe into an $86 billion arms deal between BAE Systems and Saudi Arabia. The decision followed threats from the Saudi government that it would suspend all intelligence cooperation with the UK and cancel the deal if the investigation were continued. The

19. Ibid., 27. 20. Ibid., 26. 21. Ibid., 30. 22. Ibid., 33. 23. U.S. Senate Permanent Subcommittee on Investigations, Tax Haven Banks and U.S. Tax Compliance ( Washington, D.C., 2008). 24. European Commission, Report from the Commission to the Council in Accordance with Article 18 of Council Directive 2003/48/EC on Taxation of Savings in the form of Interest Payments ( Brussels, 2008).

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OECD Anti-Bribery Working Group strongly condemned this decision.25 Details of BAE’s allegedly corrupt activity had come to light due to information from a former employee, followed up by two investigative reporters, David Leigh and Rob Evans. The scheme is described by Leigh and Evans as follows.26 BAE allegedly paid bribes to officials from Saudi Arabia and elsewhere in return for arms contracts using agents, the latter being separated from both BAE and bribe recipients by shell companies. The first intermediary company was Novelmight, until 1999 incorporated in the UK, then reincorporated in the British Virgin Islands. A second company, Red Diamond, was set up to channel payments to agents via accounts in New York (Chase Manhattan), London (Lloyds TSB), and Switzerland (UBS) and thence to officials from the governments purchasing BAE’s wares. These payments were excluded from mention in the public contracts but were included in parallel covert contracts for the same deals. Once more, maintaining the corporate veil was key: the British Serious Fraud Office had just obtained crucial documentation elaborating on beneficial ownership of corporate bank accounts when the Blair government cancelled the investigation, citing “a lack of evidence” as well as national security concerns. However, in 2007 the U.S. Department of Justice began its own investigation into the Saudi sales and other BAE deals with the Czech Republic and Hungary 2000–2002. Meanwhile, the UK Serious Fraud Office continued its investigation of how BAE had won a contract to sell a £28 million radar system to Tanzania (a deal that received cabinet approval only after Tony Blair’s personal intervention).27 On February 5, 2010, BAE pleaded guilty to false accounting in the UK as well as conspiracy to make deliberately false statements regarding its compliance with the U.S. Foreign Corrupt Practices Act. Although the company was not convicted of bribery as such, its admission to the U.S. charges corroborated the substance of the allegations consistently made by the Guardian and others and just as consistently denied by BAE. In particular, it admitted knowingly using shell companies in each case to conceal payments (“commissions”) to its “marketing advisors” and encouraging the advisors to set up other shell companies to conceal the origins and

25. OECD, United Kingdom: Phase 2bis: Report on the Application of the Convention on Combating Bribery of Foreign Public Officials in International Business Transactions and the 1997 Recommendations on Combating Bribery in International Business Transactions (Paris, 2008). 26. “BAE’s Secret Money Machine,” Guardian, July 9, 2007. 27. “BAE Deal with Tanzania: Military Air-Traffic Control–For a Country with No Airforce,” Guardian, February 6, 2010.

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destinations of these payments.28 BAE paid a $400 million fine to the U.S. government and £30 million to the UK, but no individuals were prosecuted. The company’s shares rose on the day the guilty plea was announced; analysts had been expecting heavier penalties. Although much of the discussion above has generally presented a simplified structure of a one-layered corporate veil, it is more typical for miscreants, such as BAE, to use a chain of corporate entities to distance themselves from the underlying crime. An example is a Dutch drug trafficker selling ecstasy in Britain. Sales generated a million pounds in cash that was smuggled back into Eastern Europe. Here the pounds were converted into U.S. dollars and deposited into the account of a local bearer shares company (i.e., where there is no central share registry and whoever holds the physical share certificates owns the company) that had been bought from its creator. This money was then wired to a Netherlands Antilles company under a falsified invoice for “management fees.” The Netherlands Antilles company was also formed with bearer shares. These bearer shares were held by another bearer shares shell company, this time formed in Panama, with the shares for this latter company held by a local lawyer. The criminal then arranged for the Antillean company to “loan” the original money to a Dutch company, Real Estate Investment, of which he was the manager and sole shareholder. The money was used to buy a commercial and residential building, with the rent paying the criminal’s salary as manager and paying “interest” on the “loan” from the Antillean company, interest that was tax deductible.29 The final examples relate to illegal arms trafficking. In Levin’s 2009 statement, he recounts the activities of Viktor Bout, the subject of the biography Merchant of Death, and accused by the United States of conspiracy to kill U.S. citizens, illegally acquiring anti-aircraft missiles, and providing support to a terrorist organization (the Revolutionary Armed Forces of Colombia, FARC), in addition to flouting a variety of other international arms embargoes. Bout was arrested in Thailand on the basis of a U.S. extradition request in March 2008 and transferred to New York in November 2010. One of the major obstacles to investigating and prosecuting Bout was again the issue of penetrating the corporate veil. According to the indictment, his arms operations not only depended on shell companies in Liberia and Moldova, but also on hundreds of millions of dollars reportedly transferred through various shell companies formed in Texas, Florida, and Delaware. 28. District of Columbia Court, United States of America v. BAE Systems plc. Violation, Title 18 United States Code, Section 371 (Conspiracy), 2010. 29. Euroshore, 90.

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As Levin glumly concluded: “The end result is that a U.S. company may be associated with an alleged arms trafficker and supporter of terrorism, but we are stymied in finding out, in part because our States allow corporations with hidden owners.”30 Finally, the North Korean Workers’ Party Bureau 39, responsible for producing and distributing heroine, amphetamines, counterfeit U.S. currency, and other illegal products, also uses shell companies to market its wares internationally while hiding their origin.31 In December 2009 a planeload of suspected North Korean weapons en route to Iran were seized in Thailand. The plane was registered to a New Zealand company formed by a New Zealand corporate service provider. The latter had no idea of the real owner “because he only did ‘the incorporation of the company.’ ”32 Despite the differences in the nature of the underlying crime and the scale of the operations sketched out above, the same principle applies: to the extent that the corporate veil between the legal owner and the party exercising practical control remains intact, the underlying conduct cannot be scrutinized. The regulatory reviews conducted by a variety of governments, NGOs, and international organizations, including the FATF, identify anonymous shell companies and other corporate vehicles such as trusts as the central obstacle to combating major international money laundering and related financial crimes. And as a result, a slew of international standards specify the need to establish the identity of the real individual(s) ultimately in control of any such vehicle.33 Thus FATF Recommendation 33 clearly states: “Countries should ensure that there is adequate, accurate and timely information on the beneficial ownership and control of legal persons that can be obtained or accessed in a timely fashion by competent authorities.” (Recommendation 34 imposes the equivalent requirements for trusts.) More generally, G20 pronouncements from 2009 onward are replete with calls for greater financial transparency in general and the need to establish beneficial ownership in particular.34 But all these laws and ringing declarations leave the real questions unanswered: Do the rules actually work? Are the prohibitions on anonymous shell 30. Levin statement. 31. Sheena Chestnut, “Illicit Activity and Proliferation: North Korean Smuggling Networks,” International Security 32 (2007): 90, 98, 105. 32. “New Zealand Businessman Unaware of North Korean Weapons,” Wall Street Journal, December 18, 2009. 33. See OECD, Behind the Corporate Veil; FATF, Report Non-Co-operative Countries and Territories (Paris, 2000), 10–11. 34. For example, Pittsburgh Progress Report, 25 September 2009, point 46, http://www.g20. org/Documents/pittsburgh_progress_report_250909.pdf (accessed November 2009).

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companies, a central plank of any AML policy, actually effective in practice? To return to the point made earlier, it is common place that laws and regulations are often, perhaps in many countries routinely, completely irrelevant for what really goes on. And if enforcing rules within the bounds of sovereign states is difficult, how much more uncertain is the enforcement and effectiveness of international rules operating in a system that by definition lacks a central authority or enforcer? The previous chapter has suggested that in the case of AML policy, enforcement is poor and levels of effectiveness are very low. Testing this crucial element of AML policy directly by trying to purchase the type of anonymous shell companies that are prohibited provides independent confirmation of this claim. The level of difficulty in trying to purchase such an entity points to the effectiveness, or lack of effectiveness, of the AML regime. The next section describes the procedure used to shop for shell companies, and the section that follows presents the results in terms of overall international compliance and the pattern of those countries that are strict or lax in their enforcement.

Soliciting Offers The first step of the direct test was to draw up a list of service providers to approach. Corporate service providers are those firms whose business it is to set up and administer shell companies, trusts, etc. Often law firms, the service providers lodge the necessary paperwork and incorporation fee and generally act as a clearinghouse between the authority in the jurisdiction of registration and the actual client in control of the structure. Commonly, service providers also liaise to help set up a bank account for the shell company. Finally, service providers often have a continuing role by acting as directors, secretaries, shareholders, trustees, or other officers in the structure under the instruction of the real owner to preclude discovery of the link between the real owner and the structure. Service providers are not restricted to selling companies from only the jurisdiction in which they happen to be based. So, for example, some service providers in London offer shell companies from thirty jurisdictions or more all over the globe. It is routine to buy British Virgin Islands shell companies from a provider in Hong Kong rather than one in the Caribbean. Often there is a division of labor between bulk company formation agents who set up companies en masse, such as Offshore Incorporations Limited or Mossack Fonseca, and retailers who buy from wholesalers and then sell single companies to individual clients. It is important that in many jurisdictions service providers are also responsible for gathering the identity documents that prove the individuals forming shell companies really

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are who they say they are. If service providers do not collect this information, in most cases it is simply not available. The next step in performing the direct test of rule effectiveness was to choose the mix of service providers to approach and corporate vehicles to solicit. As noted earlier, it is not necessary that the location of the service provider and the company purchased correspond. The first priority was to use a mix of large, rich OECD countries and small offshore financial centers, largely middle-income or developing countries, to test the conventional wisdom that enforcement was much laxer in the latter than the former. For the same reason, it was important to include jurisdictions perceived to have very good AML standards (the United States, according to its FATF Mutual Evaluation Review) as well as those seen as particularly problematic (island tax havens) to test the conventional wisdom. There was also an effort to test service providers from a wide variety of geographic regions, sovereign and nonsovereign jurisdictions, civil and common law systems. Within the constraints of the sample size, there was a rough attempt to test the more common corporate service provider locales several times (the United States, Britain, Panama, and Hong Kong). Within these broad parameters, the contact details of individual service providers were gleaned from a number of sources in two rounds of testing in 2008–2009 and 2009–2010. Sources included the back pages of the Economist, the directory of Offshore Investment, and Google searches using the search term “offshore company” with the jurisdiction name. This approach tended to bring up more established, larger scale service providers, in the sense that they advertised more prominently and came closer to the top of the list of results from Google searches. If larger providers are more likely to follow the rules than sole operators, it is possible that this result biased the result in overstating the degree of rule effectiveness. In each case the service providers maintained web pages listing services, contact details, and even special discounts (one romantically inclined provider offered a Valentine’s Day special of a Vanuatu shell corporation for only $999). The logic of depending so heavily on the web and e-mail was that it is this easy, cheap, and universal access that these media provide that most worry policymakers. Having identified a sample of service providers, the next step was to draft an approach e-mail. The e-mail from the first round of communication is reproduced below. Here the priority was to adopt the profile most worrying to the guardians of AML policy and global financial regulation in general. The three elements to bring out were secrecy (anonymity or a lack of transparency), tax minimization (often a euphemism for tax evasion), and asset protection (apart from its legitimate uses, it is also helpful in frustrating the decisions of courts).

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These three elements, which tend to be mutually reinforcing, jointly explain much of the rationale for shell companies.35 Aside from these general features, there was also a need to give at least a vague idea of what the company would be used for. Here consultancy provided the best answer. Gordon notes that the most common alibi for funds transferred to and from such shell companies is “consultancy fees.”36 Because there is a large volume of legitimate money being moved around for this purpose, such transactions do not stand out as being unusual. Consulting fees may be relatively large, providing an alibi for large sums of criminal proceeds (Turpen’s fictitious consultancy arrangements and BAE’s “marketing advisors” come to mind). Because consultancy work does not require the buyer and seller to be in the same location, it is hard to prove that a consultancy arrangement was not in place. Indeed, in some cases criminals apparently trawl the web to plagiarize available reports to strengthen the semblance of real work having been done.37 A further issue in conducting the test was whether to use my own name and place of residence. Signing financial and legal documents in a false name may be a criminal offense, but using my real name posed the problem of being linked back through the easiest web search to earlier work that would expose, and thus invalidate, the nature of the exercise. A compromise solution was to use my first initial, full middle name, and surname, which resolved the problem of possibly committing a criminal offense while complicating efforts to link the approach e-mail with my earlier work. Giving my true country of residence (Australia) was important because it allowed the major financial centers to be tested as a nonresident. Because residents of a country are often subject to different requirements in forming companies than nonresidents, this guarded against a bias that would have been introduced by soliciting offers for companies from within the United States or United Kingdom, for example. Because the policy problem has generally been presented as an international one, the separation between the location of the real owner and the service provider and vehicle was key. These requirements gave rise to the following standard approach e-mail: Dear Sir, I am writing to enquire about the possibility of setting up an international company or other corporate vehicle as part of my freelance consultancy work. 35. Caroline Doggart, Tax Havens and their Uses (London: Economist Intelligence Unit, 2002). 36. Gordon, “Laundering the Proceeds of Public Sector Corruption,” 18. 37. Author’s interview, Australian Federal Police, Sydney, Australia, November 7, 2008.

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I am a resident of Australia doing consultancy work for foreign governments and international organizations. Thus far I have done this work as a private individual, in the future I think I may need to incorporate for the reasons given below, and I would be grateful for any advice you might be able to provide me with concerning your products. 1. In the initial stages of my work the relatively small sums under consideration meant that Australia’s very high personal income taxes seemed less of a problem than the cost and trouble of looking at international incorporation options. Now with more and more business this balance is shifting, particularly as I gather that one should take the necessary steps before rather than after particular deals are in train. 2. Although I have only been in the business for 5 years, the contracts I now sign are increasingly large and complex. With these larger sums and my need to subcontract I am keen to limit my liability if things go wrong. 3. I have a strong desire for business confidentiality which I understand is more easily accomplished through incorporation rather than as a natural person. Having not had much experience in these matters before, perhaps you might be able to suggest a range of options that may be appropriate. Thank you for your help, I should be grateful for any advice you might be able to offer. Yours faithfully, J. Campbell Sharman The second round of the test involved solicitations only; there was no attempt to buy any of the companies offered. Students used their real names and identified their country of citizenship (the United States, India, Thailand, Venezuela, and Colombia). The e-mail approach was much shorter, simply asking for a quote on a shell company and particularly asking what identity documents, if any, were required for the transaction to go ahead.38 In both

38. To Whom It May Concern I am writing to you to inquire about the creation of a company to hold my personal assets, including real estate and shares. The confidentiality of my personal information and assets is critical. I am a citizen and resident of the U.S. I’m not concerned about tax considerations, my tax lawyer can take care of that here. I would like to move forward with setting up a company as soon as possible. Could you please recommend a suitable option, and also specify the likely cost and very importantly the documentation I would need to provide in order to establish a company for this purpose? Many thanks for your assistance.

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rounds, all subsequent communication with providers was conducted via e-mail (specially created gmail accounts) to ensure a record, even though many service providers were keen to speak via phone or Skype. In the first round, of 54 approaches made, 45 valid responses were received. In the second round, 163 service providers were contacted with 57 valid responses.39 Invalid responses were those for which either there was no reply at all or a reply simply stating that the party in question could not provide the service requested. The 102 valid replies offered one or more recommendations for products that could meet the requirements and specified whether or not identity documents were required.

Judging Anonymity The most important coding decision was classifying the resulting companies on offer as either anonymous (and thus violation of international standards) or traceable to the beneficial owner (and thus compliant). Here the rule is relatively clear: to be effectively linked to the real owner, the service provider must have a notarized copy or scan of the picture page of a passport, usually complemented by utility bills to establish proof of residence and sometimes a banker’s reference as well. Those responses requiring a notarized passport copy (and almost always utility bills as well) to proceed were thus in accord with international standards. On the other hand, noncompliant service providers allowed incorporation via a web dialogue form. Here the procedure was much like buying a plane ticket online or making a purchase from Amazon.com. The form was made up of a series of dialogue boxes (e.g., preferred name of company, credit card details for billings) and tick boxes with various options (e.g., nominee director or not, stationery accessories or not). Although such forms did call for the owner’s name and mailing address, because there was no supporting documentation required there was no way for the service provider to really know who was forming and controlling the company. Of course it was necessary to provide credit card details or make a wire transfer to complete the transaction, but these would not necessarily leave the service provider with much more information. Having set up one shell company, it is entirely possible to use the credit card issued in the name of this company to pay for the creation of subsequent shell companies. International wire transfers often do

39. It is not possible to say conclusively why the second round obtained a lower rate of valid replies. Some service providers point-blank refuse to deal with U.S. customers, given the extraterritorial reach of U.S. law. Because students could not buy companies, they also had less scope to press service providers for definite answers as the identity documentation required.

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not contain much information on the sender. For example, in an extreme instance, until 2003 hundreds of wire transfers to the value of $6.5 billion were sent through J.P. Morgan in Manhattan, with parties simply identified as “customer,” except for one transfer of $100 million for which the party was specified as “valued customer.”40 Where service providers have no documentation concerning the real owner, the shell company is anonymous. This basic point tends to be overlooked by countries such as the United States that rely on strong investigative powers to obtain information on companies that come under suspicion.41 No amount of pressure from the authorities will summon information when none has been collected, as the quotes from U.S. providers in the results section below attest. Many service providers prominently advertised “anonymous” companies and bank accounts but then undermined this claim by asking for the standard identity documentation of notarized passport copies, etc. For example, one initially replied: An IBC [International Business Company] would suit you fine. There you would get total confidentiality and a tax holiday for the first twenty years of its operation. No one would know you owned the IBC. Your name would appear nowhere else but with us your agent and we cannot by law disclose the information to anyone. But it turned out that the standard suite of identity documentation was in fact required. Certainly by combining chains of such vehicles (company A being the director of company B, which is in turn owned by trust C, etc.), it could be difficult and time-consuming for regulators and those in law enforcement to follow the structure back to its real owner. Yet no matter how complex, where the service provider has proof of the individual’s identity, the veil of secrecy is vulnerable to being pierced. First, a point of vulnerability occurs because the hosting jurisdictions are vulnerable to pressure from outsiders to hand over client identity documentation. For example, after repeated public assurances that the Cayman Islands would not join the EU’s tax information exchange program, Britain successfully obtained a reversal by threatening to suspend the Caymans’

40. Robert M. Morgenthau, “Tax Evasion Nation,” American Interest (2008): 63. 41. OECD, Behind the Corporate Veil, 10, 83–88; FATF, Mutual Evaluation Review: United States (Paris, 2006), 226–239.

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self-government and pass the legislation from London.42 Second, financial intermediaries can also be vulnerable to outside pressure. The United States government successfully took VISA and MasterCard to court to obtain details on 230,000 offshore credit and debit cards held by U.S. residents. Later, the United Kingdom and Australia followed suit, picking up details on another 110,000 and 12,000 accounts, respectively.43 Despite constant reassurance from UBS bank that it would never reveal its American clients’ details to the tax authorities, UBS later completely reversed itself in a letter to clients, satirized in the Tax Notes International piece “Dear Former Tax Evasion Services Customer”: UBS gently suggested that holders might discuss tax liabilities and disclosure obligations for prior years with a tax professional, and noted the IRS voluntary disclosure program. Oh, and by the way, the Justice Department has a continuing investigation of tax evasion by U.S. residents, the bank warned, noting that it was cooperating with that investigation. Oh, and if you by chance don’t enter voluntary disclosure and you get picked up, the consequences may not be pretty.44 Third, service providers can be careless or distracted: after leaving sensitive documents behind in a hotel room, a traveling Swiss-based representative of a Jersey firm had his laptop containing all the details of hundreds of tax-shy clients seized by police in Australia.45 In the Castle Bank case in the 1970s, the IRS actually paid a private detective to steal the provider’s briefcase and Rolodex while he was being entertained by a prostitute, although here the case was dropped after the CIA indicated it was banking with the Caymansregistered bank, as was Playboy owner Hugh Hefner and several prominent underworld identities.46 Service providers can also disregard their own advice about confidential documents. U.S.-based corporate service provider Lawrence Turpen advised his client Robert Holliday, “You should read these documents and destroy 42. J. C. Sharman, “Regional Deals and the Global Imperative: The External Dimension of the European Union Savings Tax Directive,” Journal of Common Market Studies 46 (2008): 1049–1069. 43. J. C. Sharman, “Privacy as Roguery: Personal Financial Information in an Age of Transparency,” Public Administration 87 (2009), 717–731. 44. Lee A. Sheppard, “Dear Former Tax Evasion Services Customer,” Tax Notes International 56 (2009): 92. 45. “Jet Lag Snares a Tax Haven Tout,” Sydney Morning Herald, 2 August 2005. 46. Howard S. Fisher, “The Death of Offshore Secrecy–and It’s Not Resting in Peace,” Offshore Investment 187 (2008): 11–15. Fisher notes that “this story has everything—surf and sun, the CIA, a legendary tax lawyer, a prostitute, mobsters, a billionaire, and the ultimate playboys.”

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them. It would not serve your best interests for them to be found in your possession.” But Turpen himself left numerous documents naming Holliday in his Nevada office to be found when the IRS executed a search warrant. According to the Senate report, after being informed of the situation by Turpen, “Mr Holiday told the Subcommittee that he responded to the effect of, ‘You idiot! That is exactly what you told me never to do.’ ”47 Finally, rogue employees of the service provider such as Heinrich Kieber of Liechtenstein’s LGT bank may steal and sell sensitive material. In 2006 Kieber sold the details of over one thousand customers in exchange for €4.2 million from the German intelligence service, which then sold the information to the tax authorities of many other countries. Kieber himself is now in the U.S. witness protection program, with various websites of dubious provenance offering large rewards for his whereabouts, presumably from former LGT account holders with scores to settle.48 Clearly, however, if the service provider has no information to disclose, these threats to the integrity of the corporate veil are obviated.

Results The detailed results of the tests are presented in Table 1, but the broad patterns are readily apparent. The first conclusion is that the overall effectiveness of the rule prohibiting anonymous shell companies is relatively modest. Contrary to one of the central aims of the global AML regime, buying a shell company while obscuring the real owner is easy and cheap. The second general conclusion is that opening a corporate bank account while maintaining the shell company’s anonymity is more difficult. This is some consolation for AML proponents, but as explained below, is only a partial success. The third, and perhaps most interesting finding is that, in the main, small-state offshore financial centers do a much better job of enforcing the prohibition on anonymous companies and bank accounts than do large OECD countries. In particular, the United States is the main offender in failing to enforce the international standards prohibiting anonymous companies. This failure is despite the fact that the United States had a large say in stipulating the regulation of beneficial ownership and has been most in favor of aggressively imposing it on others. This suggests that core states have tended to follow a “do as I say,

47. U.S. Senate, Tax Haven Abuses, 40. 48. Fisher, “Death of Offshore Secrecy.”

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not do as I do” approach to global AML policy diffusion. Having established the most general conclusions, I now review the detailed results. Of the 102 valid responses, 61 required notarized identification before establishing companies (28 of 45 valid replies from the first round, 33 from 57 in the second). Forty-one were content to form the company without any independent confirmation of identity (17 from the first round plus 24 from the second), requiring only a credit card and a shipping address using the sort of web dialogue form described above. Although the cost varied, establishing an anonymous shell corporation is a cheap proposition, ranging from $800 to $3,000 as an up-front cost followed by a slightly smaller amount on an annual basis. The cost variation is generally explained by the optional extras, in particular, the extra layers of secrecy (e.g., nominee directors, nominee shareholders) as well as various corporate accessories and accoutrements (mail- and phone forwarding, brass plates, rubber stamps, letterhead, embossed seals, etc.). In many cases, service providers recommended holding the ownership of the shell company in an overarching common law trust or civil law foundation. This would present investigating authorities with one more obstacle when seeking to find the beneficial owner: tracking the bank account to the company, the company to the trust or foundation, and then control of the trust or foundation to the beneficial owner via the service provider, with each link in a different jurisdiction. These more complex structures retailed at between $4,000 and $7,000, again depending on the options. Service providers in major OECD economies are much more likely to offer anonymous shell companies than those in classic tax haven jurisdictions. Only 2 of 36 service providers in tax haven jurisdictions offered to form a company without proper identification documentation. Thus attempts to incorporate anonymously with providers in the Bahamas, the British Virgin Islands, the Cayman Islands, Nauru, Panama, and the Seychelles all met with failure in that these agents refused to proceed without proof of identity. In nearly all cases, these agents explicitly noted that anti-money laundering regulations necessitated their keeping this information on file. Thus one response from the second round said: We would be happy to help you establish a trust or company to hold personal assets. Both Cook Islands companies and trusts offer a high degree of confidentiality, in fact it is a crime for anyone to disclose client details. There are exceptions relating to money laundering where funds are derived from serious criminal offences.

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This applied even when providers indicated they promised total confidentiality. One e-mail response I received said: The anonymous structure we offer is totally secure since we manage the bank account on behalf of the owner. The owner’s name appears nowhere. Using this structure, no investigator could determine the true ownership of the structure. . . . We offer additional security by the fact that we could change the nature of the structure and relocate it to other jurisdictions literally within minutes if required. . . . Having said that, we should make it clear that we will not engage in any illegal practices on behalf clients. However, what is illegal in one country may not be illegal in another. In this case the service provider required notarized passport copies and other identity documentation. Even the Liechtenstein-based agent of the Somali International Financial Center required notarized passport copies (although they were much less stringent about bank accounts; see below). Yet of the 47 providers in OECD countries approached, no fewer than 35 agreed to form shell companies without requiring identification documents. By far the worst offender in this group was the United States, with only 3 of 27 providers requiring identification before establishing a company (the score for Britain was 4 from 12).49 In nearly every case, whether or not identity documentation was required was a function of the location of the provider, not the domicile of the legal entity created. For example, whereas obtaining a Nevis company from offshore providers required full identity documents, this was not the case from U.S. providers. The following e-mail exchange is taken from the second round of solicitations: “Could you please provide guidance as to what documentation is needed to set up the company or trust . . . in Nevis or any other appropriate jurisdiction?” “There is no documentation needed to form an offshore company or trust.” Other typical responses from U.S. providers in the second round underline how this lack of diligence extended to domestic companies also:

49. The OECD figure breaks down to 2 from 15 providers requiring identity documents in the first round of the test and 10 from 32 in the second. The U.S. figure includes 0 from 4 providers asking for identity documents in the first round, and 3 from 24 in the second.

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Table 1.

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Results of the Direct Test VALID RESPONSES

COMPLIANT

NON-COMPLIANT

OECD countries

47

12

35

United States

27

3

24

Other OECD

20

9

11

55

49

6

36

3

2

19

15

4

102

61

41

Non-OECD countries Tax havens* Non-tax havens Total

Note: The OECD group comprises Canada (1), Czech Republic (1), New Zealand (4), Spain (1), Switzerland (1), the United Kingdom (12), and United States (27). The non-OECD group comprises first tax havens: Bahamas (3), Barbados (1), Belize (3), Bermuda (1), British Virgin Islands (1), Cayman Islands (2), Cyprus (2), Dominica (4), Gibraltar (2), Jersey (1), Liechtenstein (2), Mauritius (3), Nauru (1), Netherlands Antilles (1), Panama (5), and Seychelles (4); and the non-tax haven non-OECD: Costa Rica (1), Hong Kong (6), Malaysia (2), Philippines (1), São Tomé e Principe (1), Singapore (6), Thailand (1), and Uruguay (1). *Those jurisdictions identified as tax havens by the OECD in 2000.

All we need to get started is to have you fill out our Order Form and provide payment. You may fax your Order Form to us if paying by credit card. . . . We do not require information, nor does the state, regarding assets owned by the entity. So the only information we have is your Order Form, our correspondence and state documents. This information is only available to someone by way of a subpoena. . . . For additional confidentiality, you may use someone else as the Officers/Director who is not an owner (Contract Officer). You just have to make sure that person doesn’t have access and knowledge of the assets. We do allow you to use our address on the state forms and we can also provide you with a package that includes a Contract Officer. . . . If you’re working with an attorney, you may also consider placing your order with us through him/her. This way you also have attorney-client privacy. It’s just one more option for additional privacy. And similarly: “We don’t need any identification. You can place the order right on the website. It will ask you for the State you want to set up in and the type of entity you are looking for— contact information and credit card information. It’s really quite simple.” Finally, the most direct statement of the problem with U.S. companies: “Regarding confidentiality, no information is taken so none can be given—it is that simple!” In combination, these findings suggest that the problem of financial opacity is one for which the G7 countries, particularly the United States, are

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responsible, not island tax havens. Although not an unprecedented finding,50 the result directly contradicts the initial premises of important global regulatory campaigns, including the latest G20-sponsored initiatives. Although nearly all offshore centers regulate corporate service providers, the United States and Britain have chosen to leave them unregulated. The consequences are clear. The example of one shell company set up for this exercise illustrates the problem. The company was an England and Wales Private Company Limited by Shares set up by a UK provider. Upon payment and submission of the order, the provider electronically lodged the application with UK Companies House. The provider became the initial shareholder of the company and subscriber to the Memorandum and Articles of Association for the purposes of the government records. Upon receipt of signed documents from me (once again, without the need for supporting identification), the provider issued bearer share warrants, erasing the provider’s name from the share registry without substituting any other. André Pascal Enterprises had a nominee director and nominee secretary (once more courtesy of the provider), again providing separation from the beneficial owner. The incorporation process took less than a day, with filling out the online forms taking 45 minutes: the total cost was £515.95. The new legal person is the kind of classic anonymous shell corporation that is so important for perpetrating a wide range of financial crimes and that is almost impossible to obtain from offshore providers. The bonus is that as a corporate citizen of the UK, André Pascal avoids the taint associated with offshore companies while securing much tighter secrecy, an advantageous combination remarked upon by a number of other providers (see below). Until 2006 the same UK provider offered corporate accounts at a Latvian bank without the need for any supporting identity documentation. Working from the results of the first round, the next stage of the test was targeting the subset of the 17 providers offering anonymous corporations in an attempt to establish a bank account while keeping my identity as the company owner secret. In seeking to purchase a bank account associated with an anonymous company, I soon ran into requirements for proper (notarized) identity documentation from all but five providers. Thus the general effectiveness of the prohibition on anonymous accounts is substantially higher for bank accounts than it is for anonymous shell companies. But the pattern of ineffective rules for onshore providers compared with those in tax havens

50. See Euroshore, 15; IMF 2005: 3.

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largely remains. At first glance, this high level of overall effectiveness (40 from 45 from the first round results) may seem to rehabilitate global standards on financial transparency; if a shell company is redundant without access to a banking system, and if anonymous companies are barred from the banking system, then the failure to prohibit corporate secrecy is much less serious, particularly for delinquent countries such as the United States and United Kingdom. The difficulty of obtaining anonymous corporate accounts does mark an important change from the situation a decade or more ago.51 But even without direct access to the banking system, anonymous vehicles can be useful in financial crime. Companies can be used to own or lease buildings, ships, or aircraft, as with the New Zealand shell company and the plane carrying North Korean arms noted earlier. One of the most common forms of international tax evasion is holding share portfolios in the name of a foreign shell company to avoid capital gains tax that would be due at home. In a chain of corporate entities, even one anonymous vehicle (e.g., a company acting as the sole shareholder or director of another company) can disrupt the effort to establish the true owner at the end of the chain, rendering the whole structure opaque. Companies can be redomiciled or transferred to reestablish anonymity broken in the process of setting up an account. Finally, however, the fact that it is difficult to retain corporate anonymity while opening a bank account is not to say it is impossible. And because of the “weakest link in the chain” structure of the problem, the laxity of the few can negate the diligence of the many. Only a small number of providers responding to my request for a corporate bank account were deficient in requesting proper identification documentation. The first provider most flagrantly in breach of international standards offered Wyoming Limited Liability Corporation a U.S. bank account. The provider offered to use their employees’ own Social Security numbers in applying for an Employer Identification Number (EIN; other U.S. providers also offered this service), the tax identification number for the corporate vehicle. As the provider reported in an e-mail: “You can open a bank account in any state in the nation. It does not have to be in Wyoming. You will need an EIN number for the LLC, which we may be able to get for you, if you elect the nominee tax ID service. There are no supporting documents required at this time, outside of your contact information.” Unfortunately for would-be criminals, in the months between receiving this e-mail and attempting to buy this structure, the laws in Wyoming changed to prevent this 51. IRS, Tax Havens and United States Tax Payers; Blum et al., Financial Havens and Money Laundering.

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particular service being offered. Yet of all the countries examined, the United States remains in last place in terms of corporate and banking due diligence. A revealing comparison chart from a service provider specifies the documentation necessary to open a bank account in various countries, along with an overall difficulty rating. This ranges from “very high” (Seychelles, Jersey), to “high” (Hong Kong, Singapore), to “medium” (Cyprus, Dominica); the United States is the only country ranked as “low,” allowing accounts to be opened with an unnotarized copy of a driver’s license.52 To test this ranking directly, I established two companies with accounts in 2009, a classic offshore structure and an onshore equivalent. The first example involved approaching a service provider in Singapore and buying the most secret vehicle and bank account available. This was a Seychelles company (Gruppo 20 Enterprises) formed with a nominee director, authorized share capital of $1 million, and bearer shares, meaning that whoever holds the physical share certificate owns the company. The Singaporean offshore service provider acted as retailer, buying the Seychelles company from another wholesale service provider and reselling it to me. The accompanying bank account was in Cyprus (and thus within the European Union), picked on the advice of the first service provider because of this bank’s willingness to accept bearer share companies. The process illustrates the complexity of even one of the simplest such foreign company formations: a beneficial owner in Australia made a euro-denominated wire transfer from a United States account into the Hong Kong account of a Singaporean service provider, who in turn purchased a Seychelles company that had been formed by another Hong Kong service provider, which was linked by the Singaporean provider to a Cypriot bank with signing authority over the resulting account held by the Australian beneficial owner. Despite being the most laissez faire offshore bank available, the Cypriot bank still required a notarized physical passport copy, original bank reference, an original utility bill, and a tediously long questionnaire as to the likely use to which the bank account would be put before opening the corporate account. The questionnaire insisted on specifying, among other issues, the likely amounts of future incoming and outgoing wire transfers, both individually and on an annual basis, as well as the parties likely to be involved in the transactions ( presumably to build up a profile against which any suspicious deviations could later be judged). The bank also insisted on its taking physical possession of the sole bearer share issued. Establishing the company 52. Offshore Bank Comparison, http://www.offshoreinc.net/new_bankcomparison.shtml (accessed May 2009).

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and opening the account cost €1,754, paid into the Hong Kong account of the Singaporean service provider. In contrast, the second, onshore vehicle, BCP Consolidated Enterprises, was a Nevada corporation set up by a Nevada service provider with a nominee director and nominee shareholders. As such, the author’s name appears nowhere on the incorporation documents (which instead show a director in Panama City); but in any case, Nevada refuses to share tax information with tax authorities either at the federal level or in relation to foreign inquiries.53 BCP Consolidated then opened an online bank account with one of the five biggest banks in the United States. The cost of establishing the company and the bank account was $3,695. Neither the original service provider nor the bank required more than an unnotarized scan of my drivers license (showing a outdated address). There was no need for the kind of long questionnaire or profile of likely transactions that the Cypriot bank required. Thus even the laxest offshore bank has due diligence standards far higher than those applied by major U.S. institutions. The final case, the Liechtenstein-Somali joint venture, is unusual in having stricter requirements for establishing a company than for opening an account. Whereas setting up a Somali shell company explicitly requires a notarized passport copy, both the provider’s website and e-mail communications repeatedly note that, although they require a scanned copy of some piece of photo identification, there is definitely no need to get this notarized or certified as a true copy when opening a corporate bank account. The repeated emphasis on this last point suggests that the providers are broadly hinting at the possibility of a de facto anonymous account. I tested this by establishing first a personal account (€300) and then a second, U.S. dollar corporate account for BCP Consolidated Enterprises (Nevada) in Somalia via wire transfers hosted by two Italian banks ( BIPOP Carire SPA and BNL Bank) for another €300. Despite the local authorities’ commitment “to protect the good name of the Somalia International Financial Center,”54 this required only a scan of my unnotarized driver’s license (again, showing an old address) and the company’s Articles of Association (which, to repeat, includes only the nominees’ names rather than mine). The resulting accounts, however, have a curiously one-way quality to them: my attempts to transfer money into them via the Italian banks always succeeded, whereas all efforts to transfer money out have failed. This illustrates another reason as to why both licit and illicit 53. U.S. Senate, Tax Haven Abuses, 37, 48; Nevadan service providers vigorously dispute Wyoming’s claim to offer the most secret companies. 54. See http://kplcyprus.com/item.php?id=208#1 (accessed April 2010).

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customers may prefer established, onshore jurisdictions to those on the margins. A service provider seemingly aiming at the least scrupulous end of the market, and legally (if not physically) based in a jurisdiction where consumers have zero chance of redress through the courts, could simply be a scam. The service provider may take money for services that are then never provided. Outright fraud aside, probably the more important general advantage enjoyed by onshore over offshore jurisdictions is that having to do with reputation raised in connection with André Pascal Enterprises. In their correspondence, it was common for service providers to offer advice on the reputational pros and cons of the various jurisdictions. For example, one provider suggested that because “folks might look askance if you formed your company in Labuan, Vanuatu, Panama, or a similar jurisdiction of ill repute,” Delaware was a better option. The provider then applied the same logic applied to the bank account: “We believe that the bank account we can help you open in Hong Kong would be the direction to go. Again, we are talking about a jurisdiction with a high level of legitimacy.” The contradiction whereby companies formed onshore require less information about the owner but are nevertheless perceived as being more strictly regulated and thus more reputable has been noted by the world’s biggest provider of anti-money laundering software: There is a false sense of security when carrying out due diligence on or dealing with an onshore company, trust, foundation or charity, in comparison to the equivalent offshore vehicles. The registration of a company in most onshore jurisdictions carries little or no KYC [Know Your Customer] requirements on the beneficiaries, owners or company directors. The knowledge that a company is registered in the United Kingdom, the United States or in the EU, as opposed to some small tax haven island nation, for some reason would appear to make us think it must be above board.55 The reason why it is commonly assumed that onshore companies are aboveboard is not at all hard to discern given the constant presumption of onshore diligence and virtue versus offshore laxity and vice that underpins statements by the G20, as well as the FATF’s blacklisting processes, continuously rebroadcast in the media. This chapter broadly confirms the previous doubts raised about the effectiveness of AML policies. Where the last chapter considered a broad range 55. World-Check, “Politically Exposed Person: Refining the PEP Definition” (2008), 9.

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of evidence, this one looked at one narrow, but crucially important, area. Anonymous companies are probably the greatest single potential threat to the effectiveness of AML policy. Shell companies are generally the easiest and cheapest way of obtaining just the sort of secrecy needed to obscure illicit financial flows and frustrate investigations. The potential dangers of anonymous shell companies have been widely recognized by international organizations and governments. Nevertheless, although the FATF and others have passed rules clearly mandating that shell companies and other similar corporate vehicles should always be able to be traced back to their real controllers, the effectiveness of these rules has been in doubt. Given that much of the argument presented in this text is about decoupling, the idea that formal rules may have little or nothing to do with what goes on in practice, it was crucial to go beyond just looking at laws and regulations. It is not the rules themselves that are important, but rather whether they have any impact on actual behavior. The test has been based on the simple logic that if anonymous companies are readily available, the rules are shown to be ineffective; thus there is good reason to doubt the success of AML policy more generally. The results presented above tend to confirm the earlier verdict that AML policy is ineffective. Exactly the kind of anonymous corporate vehicles that are so useful for money launderers and so threatening to various international standards are widely available for a few thousand dollars or less. Indeed, according to Senator Levin, two million companies are formed each year in the United States alone, the vast majority of which cannot be linked with their real owners. There has been some meaningful progress in tightening standards, especially in the area of corporate bank accounts, but this does not obviate the more general problem. Of particular interest is not just the overall level of effectiveness but also the types of countries that do well and do poorly in implementing these policies. Contrary to the conventional wisdom, those countries that have been stigmatized as havens for dirty money are much more rigorous in their AML policies than those such as the United States, who has been most self-righteous in the fight against money laundering. This pattern of selective enforcement again underlines the two central themes of this book: first the ineffectiveness of AML policy in general and second the importance of power in explaining its spread. And, to reiterate, these themes are crucially linked. In the absence of much evidence of success, the diffusion of AML policy has instead been a product of power. It is the task of the second half of the book to explain just how this power has been exercised.

Pa rt Two

Why Has Anti–Money Laundering Policy Diffused?

Ch a p ter 4

Blacklisting

As we have seen, AML policy has had at best uncertain effectiveness but definite cost, particularly in the developing world. The goal of this chapter is to provide a detailed explanation and evidence that shows how blacklisting, and the threat of being blacklisted, helped diffuse the AML regime. It is important to stress that in practice blacklisting has interacted with socialization and the actions of private firms in driving the spread of AML policy, but to keep the discussion manageable, I discuss these latter two processes in the next chapter. Of the three mechanisms, blacklisting has been the most straightforward exercise of power. As the director of one developing country’s Financial Intelligence Unit put it, the prospect of being blacklisted concentrated policymakers’ minds like “a gun to the head.” Blacklisting sees a centralized, unitary actor (the FATF ) deliberately trying to impose its demands on countries that know full well they are being subject to coercion. This tactic was first employed in the form of the Non-Cooperative Countries and Territories (NCCT) list beginning in 2000. In 2007 it was resuscitated in a similar campaign by one of the FATF’s working parties, the International Co-operation Review Group (ICRG). Blacklisting creates pressure to comply primarily by damaging the reputation of those countries listed among the international finance industry and secondarily through creating fears of capital flight. It has also scared countries that are not listed into 99

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preemptively adopting AML policy so they would not appear on a blacklist in the future. The first portion of this chapter gives a brief historical background of the rise, decline, and rise of blacklisting by the FATF. The discussion then considers evidence for the effectiveness of blacklisting by looking at the experiences of different kinds of states. These states are divided into four types, represented by the following : the Cayman Islands and Liechtenstein, small states hosting large offshore financial centers; Nauru, a small state with no financial sector; Austria, a medium-sized developed country, highly integrated in financial and social terms; and two isolated and xenophobic “rogue states,” Burma and North Korea. The states vary not only in size and power but also in the density of their international connections and in the extent to which they define themselves in accord with or in opposition to the rest of the international community. The largest single group to run afoul of the NCCT list since June 2000 were tax havens, generally microstates. This focus in part reflected the desire of countries such as France to neutralize perceived fiscal threats as well as those arising from money laundering.1 Epitomizing this group are the Cayman Islands and Liechtenstein. Tax havens were vulnerable in that they directly depend on their reputation to underpin their offshore financial centers. Barring North Korea, the microstate of Nauru put up the fiercest resistance to blacklisting. Nauru is in a different category from the other small states because of its lack of financial sector. Several orders of magnitude larger is Austria, a developed country within the fold of the FATF, but nevertheless also subject to similar blacklisting threats in early 2000. Most recent are the cases of two rogue states: Burma and North Korea. The latter is particularly significant, being the only case to frustrate the blacklisting process (so far). The penultimate section of this chapter explores the effect of the blacklists on third-party states, those that were not listed but nevertheless were spurred into action for fear of being listed in the future. The blacklists have been deliberately employed as much for their demonstration effect on third parties as for their impact on those directly targeted. Finally, I address a possible objection to the argument by explaining how blacklists constitute a novel form of international coercion in that they are distinct from traditional economic sanctions or threats thereof. This chapter demonstrates that rather than just

1. J. C. Sharman, Havens in a Storm: The Struggle for Global Tax Regulation (Ithaca: Cornell University Press, 2006).

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being cheap talk, blacklisting is the kind of speech that changes the world merely by having been uttered.2 Specifically, the act of blacklisting has damaged the reputation, status, or standing of countries on the list in the eyes of third parties, including both states and private firms. In contrast to the examples of the banks considered in chapter 2, the public naming of particular countries by the FATF as “non-cooperative in the fight against money laundering” or as posing a money-laundering risk has been picked up and rebroadcast by member and nonmember states as well as other international organizations and private financial intermediaries. This label has often made banks and other firms reluctant to maintain links or transact business with listed countries, in some cases to the extent of causing significant disinvestment. Many of those governments on the receiving end are extremely concerned about the way they are perceived in international financial circles and among foreign investors, and thus they have rushed to comply to minimize their loss of standing, even before seeing any economic loss. These governments, and even more so banks and other financial firms, put an almost mystical faith in the value of a good reputation. Other governments, less sensitive in this regard, have been moved to comply only after the reputational damage caused by blacklisting has translated into visible material damage. But it is vital to note that any financial loss is a symptom of a reputational problem. Material loss is a secondary, derivative effect of a fundamentally social issue. Blacklisting has not produced its effects because it indicates a signal for impending “real” actions, such as economic sanctions. Rather than being the signal for real action, blacklisting is the real action.

Historical Background: The Rise, Decline, and Rise of Blacklisting Where did the strategy of blacklisting come from? The perceived need for international collaboration to counter money laundering has been closely linked to stories about the way globalization is said to be transforming the world. Because the defining metaphor has been that the global AML system is only as strong as its weakest link, through the 1990s there was a growing

2. John L. Austin, How to Do Things with Words (Cambridge: Harvard, 1962); John Searle, The Construction of Social Reality (New York: Free Press, 1995); Ian Hacking, The Social Construction of What? (Cambridge: Harvard University Press, 1999).

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anxiety among FATF members that their efforts in this domain were somewhat wasted as long as others failed to follow suit, or they were perhaps even counterproductive if higher standards led to capital being moved to noncompliant states.3 In resolving this problem there was a desire for more robust measures than the conventional approaches of outreach, awareness raising, issuing codes of best practice, and so on.4 Publicly branding nonmembers as derelict in their money-laundering standards marked a break both with the FATF’s previous conduct and general norms of international practice in its confrontational character. In its favor, however, blacklisting initially promised a more direct and, it was hoped, effective approach, without the need for the additional authorization (for the FATF ) or expense (for member states) that would be associated with applying economic sanctions. Because coordinated blacklisting was untested, the FATF did not know quite what to expect.5 Discussions of how to pressure nonmembers to improve their anti-money laundering laws had begun almost from the founding of the FATF in 1990.6 By the end of the decade, these had born fruit as the process of compiling the Non-Cooperative Countries or Territories list began in late 1998. In the first round of the process four regional review groupings (Americas, Asia-Pacific, Europe, and Africa and the Middle East) evaluated twenty-nine nonmember jurisdictions against FATF standards, releasing a list of fifteen jurisdictions that failed to measure up in June 2000. A further eight jurisdictions were added in 2001 and 2002. Delisting was conditional on the introduction and implementation of the standard package of AML regulations (summarized in chapter 1) to the satisfaction of an FATF assessment group. The decision was formalized in a plenary meeting. Delisted countries remained under special monitoring by the FATF for at least a year afterward to ensure there was no backsliding. The successive iterations of the NCCT were instantiated in a series of annual reports released beginning in 2000 after the FATF’s June plenaries. The formal consequences were contained in the activation of Recommendation 21 for member states. In concrete terms, Recommendation 21 specified “the FATF recommends that financial institutions should give

3. Author’s interview, FATF, Paris, France, July 8, 2004. 4. William Wechsler, “Follow the Money,” Foreign Affairs 80 (2001): 40–57. 5. Author’s interview, FATF, Paris, France, July 8, 2004; Author’s interview, former U.S. Treasury official, by phone, September 26, 2002. 6. Eric Helleiner, “The Politics of Global Financial Reregulation: Lessons from the Fight against Money Laundering,” Center for Economic Policy Analysis, Working Paper 15. New School, New York, April 2000.

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special attention to business transactions and relations with persons, including companies and financial institutions” from listed jurisdictions.7 Blacklisting brought about rapid results in most cases as targeted jurisdictions rushed to meet the FATF’s demands by introducing the correct legislation and establishing the appropriate institutions. Coverage of those blacklisted expanded in 2001–2002 from the initial microstates to include major developing and post-Communist countries such as Nigeria, Indonesia, Russia, and Ukraine. The selection process gave FATF members a chance to settle old scores: One of the interesting things about the way the NCCT process began was that the original countries were selected. I have spoken to many individuals involved in the process of the FATF for country selection— what it really was—I am from a country, say the US, and I have been having trouble getting cooperation from the Cayman Islands. I am with the FIU, I am with the Department of Justice, I have been trying to get bank records, those people are irritating the hell out of me, I am going to put them on the NCCT list.8 Putting countries on the list got results. The change in the size of the targets made no difference to the successes achieved; by 2006 the list had ensured 100 percent compliance. Despite this success, however, opposition to the NCCT exercise quickly began to build. Predictably, the countries running afoul of the list protested loudly and, where they could, mobilized support in regional and global international organizations such as the Caribbean Community and the United Nations. Other observers that were less directly involved became troubled both about the inherently coercive nature of the process and the strong suspicion that small countries outside the FATF were being held to a significantly higher standard than the countries inside the club (the findings presented in chapter 3 substantiate this suspicion).9 The regional AML bodies conspicuously failed to endorse the NCCT initiative. From my observations after the

7. FATF, Review to Identify Non-Co-operative Countries or Territories: Increasing the Worldwide Effectiveness of Anti-Money Laundering Measures (Paris, 2001), 18. 8. Richard Gordon, “International Financial Centers, Tax Havens and Money Laundering Havens,” in Money Laundering, Tax Evasion and Tax Havens, ed. David Chaikin (Sydney: Australian Scholarly Publishing, 2009), 81–82. 9. George Peter Gilligan, “Overview: Markets, Offshore Sovereignty and Onshore Legitimacy,” in Global Financial Crime: Terrorism, Money Laundering, and Offshore Centres, ed. Donato Masciandaro (Aldershot: Ashgate, 2004), 7–60.

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fact, many FATF members were also uncomfortable with the aggressive and confrontational character of this strategy. It is important to note that the executive boards of both the IMF and the World Bank, as well as many staff members, signaled a definite preference for measures based on voluntary cooperation rather than arm-twisting. This stance was very much in line with such general notions as “ownership,” “stakeholders,” and inclusive participation within the development policy community. Perhaps this view also reflected these bodies’ own bad experiences as being popularly cast as neo-imperialist oppressors of the poor and vulnerable. The upshot was a deal between the Bretton Woods Institutions and the FATF in November 2002. The FATF agreed to suspend further rounds of blacklisting, although those jurisdictions on the list at that time remained on it until they complied. At the same time, the World Bank and IMF agreed to incorporate the FATF Recommendations as standard in all their reviews of members countries’ financial sectors (as discussed in the next chapter). Given the vast disparity in the size of the secretariats of the FATF, on the one hand, and the IMF and World Bank on the other (10 –12 versus 2,500 and 10,000, respectively), this considerably lightened the load on the former. It also meant that the Recommendations became part of the common benchmarks against which all states were measured, providing a powerful fillip to their further diffusion. After the fact, members of the FATF Secretariat were keen to claim that by the time this deal was struck the list had largely achieved its purpose anyway.10 There is a good deal of truth to this. The worst offenders had been pressured into compliance, and more generally, any sense of complacency about global AML standards among developing countries and the private financial sector had been dispelled. In a highly prescient comment, this same official indicated that the listing process had only been suspended rather than abolished and could conceivably be restarted if the need arose. By the end of 2006, the last state on the NCCT list, Burma, had been removed after implementing the specified reforms.

Blacklisting Déjà Vu: International Cooperation Review Group Just as the NCCT initiative came to a close in late 2006, the FATF established a new working group: the International Co-operation Review Group.

10. Author’s interview, FATF, Paris, France, July 8, 2004.

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Despite the suspension of the blacklisting process, internal discussions in the FATF and among the G7 states had revealed the continued desire to apply direct pressure on countries that did not toe the line on AML policy. The process of building a new list began from what was deliberately termed a “nonlist” of thirty-three jurisdictions compiled in January 2007 in a Tour de Table of FATF delegates. Individual members nominated jurisdictions of concern, just as they had for the earlier NCCT list. This process was unflatteringly described by one participant to me as an ad hoc “mind dump.” By the plenary meeting a month later, thirty-three countries had been whittled down to eleven (among those included on the longer list but not the shorter was the Vatican City, excluded after the intervention of Italy, Spain, Portugal, and France). The criteria for listing included such matters as the failure to criminalize money laundering, failure to extend international cooperation in the fight against money laundering, posing a substantial money-laundering threat, failure to join a regional AML body, and the refusal to publish IMF financial sector reports (despite the IMF’s insistence that publication was entirely voluntary and depended on the consent of the government assessed). In a significant choice of words, the process was described as one of identifying countries with a “prima facie” case to answer. Listed jurisdictions were on trial; the FATF was the judge and jury. After further refinement, in 2007 the review group publicly identified six jurisdictions as deficient in their AML standards: Iran, Uzbekistan, Turkmenistan, Pakistan, São Tomé e Principe, and the “the Northern part of Cyprus.”11 North Korea was also on the list of eleven, but not publicly named, an intriguing issue discussed in more detail in a dedicated section below. The content of the letters sent to the various targeted states is revealing.12 The letters were addressed to the finance minister or equivalent. They announced that the ICRG would be reviewing the country’s AML policies and asked that the government provide relevant legislation and statistics, as well as nominate a contact person. Returning to the trope discussed previously, the letter stated that “in this era of globalization, it is paramount that the fight against money laundering and terrorist financing is also global.” If no reply was received, a follow-up was sent from the head of the FATF. This second

11. Report by the ICRG Co-Chairs, June 27–29, 2007, FATF Plenary, http://210.68.77.78/ files/04/040103096003533200.pdf (accessed November 2009). See also the public statement at http://www.fatf-gafi.org/dataoecd/16/26/40181037.pdf (accessed December 2009). 12. Author’s observations, FATF plenary meetings, Strasbourg, France, February 19–23, 2007 and Paris, France, October 8–12, 2007.

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letter informed the country that the preliminary review had taken place in the last FATF plenary, that the country’s AML standards had been found wanting, and again invited the government to provide relevant information and nominate a contact. The letter stated that the FATF was the authoritative body for setting international standards to counter money laundering and the financing of terrorism, as recognized by the UN Security Council, the World Bank, IMF, and many other international organizations. The conclusion of the text stated: “If a response is not received, then the FATF will consider appropriate next steps to protect the international financial system.” Given the rhetorical parallels with Recommendation 21, any government familiar with the earlier blacklisting process would not have to think too hard to guess what these next steps might entail. In many ways, the unstated presumptions in the correspondence are as significant as what is actually said. First is the idea that the FATF was entitled to assess targeted countries, all of which were nonmembers of the organization, against the FATF’s standards, whether or not these countries consented to or participated in the process. This approach is quite different from that adopted by the Bretton Woods Institutions. Here, reviews are either conducted at the invitation of governments or at least as a condition of membership. Reviews allow for input of the party being assessed. Furthermore, given the near-universal membership of these bodies, unlike the FATF 40+9 Recommendations, the parties being assessed would have had some opportunity to comment on the standards against which they are measured. Also noteworthy is the way authority is derived by a process of mutual recognition among international organizations, echoing the process of mutual recognition among states that forms the foundation of sovereignty. Finally, there is the idea that the FATF’s self-appointed duty to protect the international financial system trumps the sovereign right of states to set their own policies, in this case the choice of whether or not to have an AML policy. In some cases, these letters were sufficient. The targeted government responded that they were keen to work with the FATF, and /or were already in contact with the IMF, a regional AML body, or a bilateral donor in adopting policies to counter money laundering. However, for those recalcitrants that still did not heed the call by June 2007 (Iran and São Tomé e Principe),13 there were further steps. The most obvious action was to use Recommendation 21 in the same way as it had during the earlier blacklisting exercise: all members would encourage their private financial institutions to apply extra scrutiny to

13. Report by the ICRG Co-Chairs, June 27–29, 2007.

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transactions to, from, and through listed jurisdictions. Here, however, proponents of a tough approach ( particularly the United States, Britain, France, and Canada) ran up against the reluctance of most other European countries to go through the same sort of confrontations that had characterized the NCCT process. Furthermore, the Bretton Woods delegations reminded the FATF about their November 2002 deal to stop blacklisting. The compromise solution adopted was to avoid invoking Recommendation 21 for the moment. Instead, the FATF agreed to issue a public warning that, because a given jurisdiction had failed to meet FATF standards, it posed a potential money-laundering threat to the international financial system, and thus private firms should apply extra scrutiny to transactions to, from, or through these jurisdictions. Formalities aside, it is not at all clear how such a public statement differs from the earlier public singling out of those on the NCCT list. Even many delegates at the plenary argued they could not see any difference and that it was even less likely that private financial firms would do so.14 The progress of the review group’s “nonlist” was overtaken in 2008 by the financial crisis. AML deficiencies in developing countries would seem to have little to do with the private sector recklessness and regulatory failures in large developed countries, particularly the United States, that had given rise to the crisis. But whereas the G20 could not bring themselves to name the main culprit (referring vaguely to shortcomings in “some advanced countries” in the November 2008 G20 Washington Communiqué ), they did place considerable emphasis on identifying noncooperative jurisdictions that failed to adhere to the principles of financial transparency, integrity, information exchange, and sound supervision. Because of the crisis atmosphere and the obvious determination of G20 leaders to shift the blame for the unfolding disaster, international organizations were given unusually clear and direct marching orders after the London summit in April 2009. In the context of a discussion on “Non-Cooperative Jurisdictions” and “countermeasures,” the September Pittsburgh summit stated: “We . . . call upon the FATF to issue a public list of high risk jurisdictions by February 2010.”15 In line with this overarching agenda, the FATF was instructed to accelerate, expand, and toughen the scrutiny being exercised by the International Cooperation Review Group. In response, the group met at short notice May 2009

14. Author’s observation, FATF plenary, Paris, France, October 8–12, 2007. 15. G20 Heads of State Summit, Progress Report, http://www.g20.org/Documents/pittsburgh_ progress_report_250909.pdf (accessed November 2009).

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to come up with a “prima facie pool” of thirty-nine jurisdictions. Indicative of the sensitivity attached to the language of blacklisting, the secretariat was extremely careful to repeatedly specify that it was a pool of thirty-nine jurisdictions, definitely not to be confused with a list of thirty-nine jurisdictions. This rather fine distinction did little to placate many of those in the pool, who simply referred to the exercise as “a new blacklist.”16 These jurisdictions had been selected thanks to poor performance on important Recommendations and for having an economy big enough to make them purportedly a systemic money-laundering risk. The make-up of the pool was not to be public. However, those in the pool adjudged to pose a significant money-laundering risk and exhibit an uncooperative attitude would be publicly named in 2010 and could be subject to “countermeasures.” A FATF statement released February 18, 2010, listed Angola, Ecuador, Ethiopia, Iran, North Korea, Pakistan, Turkmenistan, and São Tomé e Principe as posing money-laundering risks.17 Thus, despite significant misgivings about the confrontational nature of the earlier blacklisting exercise among the World Bank and the IMF, many member countries of the FATF, and outside observers, the organization had come full circle. The financial crisis had reenergized the blacklisting process, but because of the effectiveness of this mechanism for scaring states into compliance, it had never really been abandoned.

How Does Blacklisting Work? As the crisis of 2007–2008 so powerfully demonstrated, finance depends fundamentally on confidence and mutual trust. Blacklisting by the FATF has been effective because it deliberately undermines confidence and fosters distrust in relation to those countries singled out. In concept, reputation plays a key role in the explanation presented, acting as an intermediary between blacklisting and compliance. Blacklisting by the FATF damaged reputations as it reverberated and was rebroadcast by states, other international organizations, and firms. Being placed on the NCCT list did not create any obligations under international law. In practice, however, the blacklists were rapidly reproduced among member and nonmember states. Thus when St. Kitts and Nevis, the Cayman Islands, the Cook Islands, and Liechtenstein were blacklisted by the FATF in June 2000, the United States Financial

16. Author’s interviews, Asia-Pacific Group on Money Laundering plenary delegates, Brisbane, Australia, July 6–10, 2009. 17. FATF Public Statement, February 18, 2010, http://www.fatf-gafi.org/dataoecd/34/29/ 44636171.pdf (accessed March 2010).

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Crimes Enforcement Network (FinCEN) issued advisories against all four states the following month, each of which was withdrawn only after FATF delisting. Other countries, both members and nonmembers, have often issued similar advisories in line with FATF listings. The lists have subsequently been incorporated in the national legislation of many countries in and beyond the FATF. For example, in 2003 Argentina amended section 124 of its Company Act to impose special restrictions on firms from the countries then on the FATF blacklist.18 Section 311 of the US PATRIOT Act reserves stringent penalties for jurisdictions “characterized as an offshore banking or secrecy haven by credible international organizations or multilateral expert groups” such as the FATF. The damage caused to reputations by blacklisting often lingers long afterward. In a metaphor used independently by individuals in St. Kitts and Nevis and the Cayman Islands, people who serve their time in jail do not leave with the same reputation they entered with. Aside from government measures, the reputational effects of blacklisting have also reverberated by way of financial intermediaries such as accountancy, insurance, banking, and legal firms. These private actors may have been taking their cue directly from international organizations or indirectly from national governments rebroadcasting these listings. Large multinational financial services firms maintain their own informal blacklists and methodologies for practicing due diligence. Some foreign financial service firms have withdrawn from particular blacklisted jurisdictions rather than be tainted by association. Once particular jurisdictions are listed, they may be placed as key terms on privately produced anti-money laundering software designed to raise red flags and trigger enhanced scrutiny. Particularly with regard to wire transfers and correspondent banking, this means that transactions are slowed, and banks and other financial intermediaries have to spend resources applying extra screening. Many large international banks cut correspondent banking links with counterparts in the region rather than be tainted by association with “deviant” jurisdictions.19 Those that did not tended to impose much higher fees, on the grounds that these banks needed to recoup the costs of the enhanced scrutiny applied. These developments also posed a threat to nonfinancial industries, as domestic merchants and foreign investors worried about their ability to use international financial networks and repatriate profits. In

18. J. C. Sharman and Gregory Rawlings, Deconstructing National Blacklists: Removing Obstacles to Cross-Border Trade in Financial Services, Report prepared for the Society of Trust and Estate Practitioners (London, 2005), 13. 19. Sharman, Havens in a Storm; William Vlcek, Offshore Finance and Small States: Sovereignty, Size and Money (Houndmills: Palgrave, 2006).

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this manner, blacklisting threatened to wreck every internationally connected sector, from tourism to remittances from citizens working abroad. Thus as the blacklists reverberated, at each level they threatened to constrict the flow of new investment and precipitate capital flight, in turn causing a decline in government revenue and general economic activity. In many cases it is difficult to conclusively link material decline to the effects of blacklisting, but the general opinion among government officials and those in the financial services industry was that the lists caused the damage. The next sections match this stylized explanation of blacklisting with evidence from the Cayman Islands, Liechtenstein, Nauru, Austria, and Burma and North Korea.

Offshore Financial Centers The majority of the jurisdictions in the firing line due to the June 2000 release of the first iteration of the NCCT list were small island offshore financial centers or tax havens, places that had designed their tax, banking, and financial regulations with the aim of attracting nonresident clients.20 They were all rapidly forced into shouldering the heavy costs associated with introducing AML standards, costs all the more serious for jurisdictions that had often previously sought to attract investment through minimal regulation and strict confidentiality.21 It might be objected that tiny jurisdictions such as the Cayman Islands and Liechtenstein were easy victories, so weak as to be incapable of any resistance, and thus surveying their experiences tells us nothing about the exercise of power in the international system. This view ignores the fact that the NCCT initiative was proposed as a new approach precisely because tax havens had put up such successful resistance over the preceding decades (remembering Gordon’s comment about small jurisdictions “irritating the hell out of ” the United States). Other U.S. officials maintain that before 2000, when they phoned certain Caribbean havens looking for financial information in connection with an investigation, those on the other end of the line would simply laugh.22 By the late 1990s, not only had American efforts to bring havens into line failed but there were also many more havens offering

20. J. C. Sharman, “The Bark Is the Bite: International Organizations and Blacklisting,” Review of International Political Economy 16 (2009): 573–96. 21. Ronen Palan, Richard Murphy, and Christian Chavagneux, Tax Havens: How Globalization Really Works (Ithaca: Cornell University Press, 2010). 22. Author’s interview, former U.S. Treasury official, Paris, France, July 9, 2004.

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tighter secrecy than at any previous time.23 The on-rush of globalization was assumed to make the problem even less tractable. The Cayman Islands and Liechtenstein are typical of the small states that made up the majority of the NCCT list, especially in their sensitivity to attacks on their reputation. An IMF report on offshore centers such as the Caymans and Liechtenstein concludes: “it is most likely that the major competitive factor in the current international environment is a country’s established reputation.”24 The Cayman Islands have marketed themselves with the slogan “Reputation is our most important asset.”25 After dozens of interviews, Hudson reports that “reputation” was the word most often used by his informants in the Caymans (and the Bahamas, also blacklisted in June 2000) in discussing selling points for a particular location. The head of the major offshore bank in Barbados described his role as “chief reputational officer.”26 The head of the British Virgin Islands Financial Services Commission defined his “mantra” as “reputation, reputation, reputation.”27 A private sector representative in Mauritius stated that in the market for international financial services “your reputation is all you’ve got.”28 In June 2000 the Cayman Islands were classified by the FATF as uncooperative in the fight against money laundering and thus subject to the terms of Recommendation 21. The United States had followed the FATF’s lead in issuing an advisory to apply enhanced scrutiny to all transactions with the Caymans. In particular, worries in the Caymans about potential damage centered on the possibility that banks in New York might terminate their correspondent relationships with the Islands. What was the effect of the NCCT list? There was no noticeable decline in the volume of investment in or business through the Caymans in the year it remained on the list. More importantly, interview material from the public and private sector indicates that the listing had no effect on existing business and little or no effect on new business. To the contrary, the Caymans recorded steady or better growth in bank deposits, the number of captive insurance firms, mutual funds, and

23. Ronen Palan, The Offshore World: Sovereign Markets, Virtual Places, and Nomad Millionaires (Ithaca: Cornell University Press, 2003); Sharman, Havens in a Storm; Palan et al., Tax Havens. 24. International Monetary Fund (2001). Financial Sector Regulation and Supervision: The Case of Small Pacific Islands Countries. Policy Discussion Paper, Asia and Pacific Department (PDP/01/06), 18. 25. Alan C. Hudson, “Placing Trust, Trusting Place: On the Social Construction of Offshore Financial Centers,” Political Geography 17 (1998): 928. 26. Author’s interview, Bridgetown, Barbados, September 25, 2005. 27. Author’s interview, Tortola, British Virgin Islands, May 22, 2007. 28. Author’s interview, Port Louis, Mauritius, May 26, 2005.

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trust service providers, despite the U.S. recession at the time.29 With this lack of economic pain, it might be assumed that the response to inclusion on the NCCT list was one of defiance or indifference. In fact, both the government and the private sector responded with alacrity. Beginning in July 2000, amended legislation allowed for more international information exchange and made suspicious transaction reporting mandatory, and in August the government introduced new recordkeeping requirements. Shortly thereafter, the Cayman Islands Monetary Authority (CIMA) was expanded and made independent, and the new Cayman Islands Anti-Money Laundering Group and Anti-Money Laundering Oversight Group were set up. Rather than just tightening the identification requirements for those opening new bank accounts, it was decided to go back and reverify the identity of all existing account holders. The Cayman Islands Monetary Authority expanded from forty-eight staff at the beginning of 2000 to ninety at the end of 2001.30 Because of fierce price competition, rather than being able to pass these increased costs on to customers, the government and financial intermediaries have had to take on the extra cost, said in press accounts to range up to $30 million.31 Given the lack of material damage caused by the FATF listing, why did the Caymans act so quickly and spare almost no expense, not only to comply with FATF standards but also to exceed them, especially once worries about correspondent banking relations had receded? Government officials point out that even if the listing had not done any damage by the time delisting occurred in June 2001, this would have changed in the future if the Caymans had remained on the list. Those in the private sector also believed that in the medium- to long-term, continued blacklisting was not compatible with continued growth. The Caymans’ success depends on its image as one of the world’s leading financial centers.32 Like the Caymans, the Principality of Liechtenstein was included in the first round of the NCCT process. The government worked strenuously to effect the reforms demanded by the FATF. After the listing, regulatory responsibilities were passed from the Bankers’ Association to the new Financial

29. Cayman Islands Monetary Authority Annual Report 2001. 30. Cayman Islands Monetary Authority Annual Report 2000 (Georgetown), 5; Cayman Islands Monetary Authority Annual Report 2001 (Georgetown), 5; Author’s interview Georgetown, Cayman Islands, January 19, 2004. 31. Author’s interview Georgetown, Cayman Islands, January 19, 2004; Cayman News Net, June 2001. 32. Author’s interview Georgetown, Cayman Islands, January 19, 2004; Author’s interview, Tortola, British Virgin Islands, May 22, 2007.

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Services Authority, Austrian and Swiss officials were hired to staff the new six-person Financial Intelligence Unit, the Due Diligence Unit was set up, and the independent Financial Market Services Authority was established in 2005. Prince Philipp von und zu Liechtenstein became the founding director of the $4 million Institute for Compliance and Quality Management, specializing in anti-money laundering, along with ten KPMG officials.33 Former top Swiss and U.S. anti-money laundering officials were taken on, as was the honorary secretary of Interpol. Ten new judges and six new prosecutors were hired.34 Unlike in the Cayman Islands, however, the damage done to Liechtenstein’s reputation by the list created secondary financial damage. The number of new “establishments” (Anstalten, a cross between a company and a trust) being formed dropped off sharply and, as of early 2004, was still below its 2000 level.35 From 2000 to 2002, the net income of Liechtenstein banks fell from 549 million Swiss Francs to 251 million, taxes paid from 64 million to 27 million, and assets managed from 112 billion to 96 billion.36 More important, in interviews Prince Philipp and others attributed the majority of this decline to the blacklists. Prince Philipp noted, “The danger of being on the blacklist is the risk of being put aside. You might find yourself with few partners to work with or with only a certain type of client, which could drive away the few remaining good clients.”37 Another official remembered: “It was a real disaster. Our foundations trembled.”38 This sentiment was shared among the other offshore centers on the list (according to my interviews regarding the Cook Islands, Panama, and St. Kitts and Nevis), all of which had experienced reputational and sometimes financial damage before complying with the FATF’s demands.

Nauru Blacklisting was successfully used to pressure small countries with disproportionately large, internationally oriented financial sectors into adopting AML policies. But for most developing countries, the international financial services industry is not a major concern. Why might blacklisting work in these circumstances? Nauru is once again an important and extreme case for two 33. 34. 35. 36. 37. 38.

Financial Times, June 8, 2001. Private Banker International, June 11, 2001. Author’s interview, Vaduz, Liechtenstein, January 29, 2004. Liechtenstein Bankers’ Association, Annual Report 2003 ( Vaduz), 4. International Tax Review, July 1, 2001. “The Future’s Bright, the Future’s Aubergine,” Guardian, July 3, 2004.

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reasons. First, despite its small size, it put up the fiercest resistance against the NCCT list.39 Second, because by 2000 Nauru had no domestic financial sector and gained little or no revenue from its few offshore companies, it might be presumed to be invulnerable to blacklisting. The unlikely case of Nauru has already been discussed in relation to the lack of fit between global policy prescriptions and local conditions. Nauru had originally gained notoriety for selling no-questions-asked shell banks to all comers, particularly those from Russia and other former Soviet republics.40 Although these banks had no physical existence, consisting of just a license and number, they could be used to link into the international electronic banking network. The last straw for the FATF was extensive media coverage of a scandal whereby Russian criminals had used a Nauruan shell bank, Sinex, as part of a chain of many other companies and banks to launder $7 billion through the Bank of New York in 160,000 individual transactions.41 Although no one knows for sure, it seems that by the late 1990s there were up to 288 Nauruan shell banks.42 Among others, these were sold by notorious con artist Jerome Schneider for around $80,000 each. To Schneider’s chagrin, he was later undercut when his assistants defected to set up their own rival business selling the licenses for $30,000.43 Very little of this revenue found its way back to Nauru, not more than a couple of million dollars, and most of this money seems to have been stolen by individual government employees.44 From the late 1990s, the infrastructure for the offshore sector was maintained from Australia, with payments routed into and out of Australian banks. By 1998 the country’s only bank, the state-owned Bank of Nauru, was broke. The national debt had reached 1600 percent of GDP, and unemployment topped 90 percent.45 The country’s air links with the outside world were cut when Air Nauru’s sole remaining plane was repossessed by creditors.

39. Daniel W. Drezner, All Politics Is Global: Explaining International Regulatory Regimes (Princeton: Princeton University Press, 2007), 143; Gilligan “Offshore Sovereignty, Onshore Legitimacy,” 52; FATF, Annual Review of Non-Co-operative Countries or Territories 2003 (Paris). 40. Anthony B. van Fossen, “Money Laundering, Global Financial Instability and Tax Havens in the Pacific Islands,” Contemporary Pacific 15 (2003): 239–42. 41. David Chaikin and J. C. Sharman, Corruption and Money Laundering: A Symbiotic Relationship (New York: Palgrave, 2009), 75–77; For a full treatment, see Alan A. Block and Constance A. Weaver, All Is Clouded by Desire: Global Banking, Money Laundering, and International Organized Crime (New York: Praeger, 2004). 42. van Fossen, “Tax Havens in the Pacific Islands,” 241. 43. Author’s interview, former lawyer for Nauruan government, Washington, D.C., September 10, 2008. 44. Anthony van Fossen, “Offshore Financial Centres and Internal Developments in the Pacific Islands,” Pacific Economic Bulletin 17 (2002): 38–62. 45. Asian Development Bank, Country Economic Report: Nauru (Manila, 2007).

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By the early 2000s, the “financial system” comprised one supermarket and the remaining shell of the government. The government would provide some salaries and pensions in cash (flown in from Australia on a Taiwanesefunded plane), thanks to residual income from tuna licensing rights and foreign aid from Australia and Taiwan. People would then spend the money in the country’s only supermarket, Capelle’s. Capelle’s thus had a cash surplus, whereas the government had a cash deficit, leading to a system of IOUs between the two. The government would take the supermarket’s cash and settle the difference by making transfers from its Australian account to Capelle’s Australian account.46 Such was the state of affairs when the FATF began to intrude. Beginning in June 2000, the Cayman Islands and Liechtenstein immediately set about implementing the FATF’s demands, but Nauru was defiant. At a meeting with international regulators in Tokyo on February 14, 2001 (recalled by one of the participants as “the worst Valentine’s Day I’ve ever had”),47 other participants could hear the yelling of the Nauruan delegation in the next room through the walls. Similarly high-volume and undiplomatic exchanges occurred between Nauruan and British officials after a Pacific Islands Forum meeting in Nauru in 2001 and when a Nauruan minister was ambushed during what he thought was a courtesy call on U.S. Treasury officials in Washington.48 The president of the country (correctly) pointed out that most of the illegal money from the scandals affecting Nauru derived from crimes committed in the United States and Europe and that most of the actual laundering had been carried out in the United States and Russia (in the Bank of New York case the perpetrators received light penalties in the United States and none at all in Russia).49 Furthermore, the finance minister, who was also the foreign minister, remarked that Nauru had far more pressing problems than money laundering.50 The Nauruan government made some financial reforms but made acquiescence with the FATF’s demands conditional on a $10 million compensation payment to defray the costs.51 In response, in addition to the FATF blacklisting, at least eighteen other countries’ financial regulators issued advisories calling upon banks and other

46. Author’s interviews, Nauru, August 18–24, 2008. 47. Author’s interview, British Virgin Islands, January 20, 2005. 48. Author’s interviews, Nauru, August 18–24, 2008. 49. Chaikin and Sharman, Corruption and Money Laundering, 77; Block and Weaver, Clouded by Desire. 50. van Fossen, “Tax Havens in the Pacific Islands,” 247–48. 51. Ibid., 248.

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financial firms to apply extra scrutiny in transactions involving Nauru.52 Pressure was ratcheted up further when on December 5, 2001, the FATF called for “countermeasures” to be applied against Nauru. Apart from calling for even more scrutiny to be applied to transactions to, from, and through Nauru, there was a further clause suggesting that Nauruan banks should not be allowed to establish branches in FATF countries. Such a threat betrayed a profound ignorance of Nauru’s real situation: then, as now, there were no banks on the island. In October 2002 the U.S. government claimed that several members of a terrorist group had been found with Nauruan passports, which Nauruan officials were in the habit of selling, both legally and illegally.53 In response, the United States applied section 311 of the PATRIOT Act, a draconian measure that forbade any transaction with any entity connected with Nauru through U.S. dollar-denominated financial networks. This cut off the salary of Nauru’s ambassador to the UN, who was also the ambassador to the United States and the rest of the Americas. The number of offshore companies had by this time slumped from about five hundred to one hundred, yet because most of these funds were being stolen anyway, this made little difference to the government. Once again, there are inherent difficulties applying financial sanctions against a country in which the financial sector had completely self-destructed several years earlier. To the extent it had any money, Nauru’s government continued to transact with the outside world by using money from asset sales in Australia and through Australian bank accounts and financial networks. Domestically it used cash. But in March 2003, Nauru capitulated to the demands to bring its AML regime into line with FATF standards. After several attempts by Nauruan officials to write legislation in such a way as to satisfy the FATF, both sides decided it would be easier if the FATF officials simply wrote the legislation for the country’s parliament to later ratify.54 Why the change of heart? Despite the lack of a financial sector to defend, reputation was again the key. A former minister noted that because of the FATF’s blacklist “there was always a cloud” over any sort of outside financial or commercial relationship, whether to do with phosphate or aid. Third parties were wary of being associated with Nauru, and Nauruans judged that their dealings were much slower

52. Trifin J. Roule and Michael Salak, “The Anti-Money Laundering Regime in the Republic of Nauru,” Journal of Money Laundering Control 7 (2003): 75. 53. Anthony van Fossen, “Citizenship for Sale: Passports of Convenience from Pacific Island Tax Havens,” Commonwealth and Comparative Politics 45 (2007): 138–63. 54. Author’s interview, Nauru, August 18, 2008.

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and more complicated than they would be without the blacklist. In one example, a deal for secondary phosphate mining was tentatively agreed to, with all the numbers in place. Yet as soon as it was revealed that the phosphate came from Nauru, the foreign firm walked away. Although there could be a number of reasons why the deal failed, locals attribute it to the effects of the blacklist. Negotiations to end the island’s complete financial isolation by opening a Western Union money transfer office were greatly complicated and prolonged by the country’s bad name. The reputational consequences of the blacklist are so severe that they still linger today. Although a KPMG report suggested that Nauru would be a profitable venue for the branch of a foreign bank, banks were reluctant to have their names associated with such a stigmatized jurisdiction, even years after Nauru had been delisted.55 Thus even a country with no financial sector proved vulnerable to the reputational effects of the FATF’s blacklist.

Austria The case of Austria is clearly in a different league from those considered so far.56 It has an advanced economy that by size is in the top one-fifth of sovereign states. Politically, Austria is highly integrated, being a member of many of the most important organizations, including the FATF. The conflict with Austria hinged on anonymous passbook (sparbuch) bank accounts. These accounts allowed whoever possessed the physical passbook to access the account, as the issuing bank recorded only the number of the passbook, not the identity of the person opening the account. The passbooks had a long tradition dating back to the Austro-Hungarian Empire. These passbook accounts were regarded as a major money-laundering threat because banks were unable to link any such account with any particular person, providing perfect anonymity. Between twenty-four and twenty-seven million such passbook accounts had been opened and were said to contain an estimated $100 billion.57 Furthermore, by the late 1990s a brisk Internet trade in such passbooks had developed.

55. Author’s interview, former IMF official, Brisbane, Australia, June 20, 2008. 56. This section draws from J. C. Sharman, “The Bark Is the Bite: International Organizations and Blacklisting,” Review of International Political Economy 16 (2009): 573–96. 57. “Austria Defuses Flap over Secret Bank Accounts,” Washington Post, June 16, 2000. The Austrians asked how anyone could come up with such an estimate if the accounts were indeed so secret.

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The FATF, of which Austria is a founding member, had signaled its disapproval of these accounts as far back as its initial meeting 1990. A FATF evaluation in 1992 noted positive developments but further observed: Nonetheless, on current proposals, identification would still not be required for passbook and security deposit Schilling accounts held by Austrian residents–a very sensitive issue in Austria. . . . The retention of the two classes of anonymous accounts is a matter of concern, running directly counter to a very important FATF Recommendation.58 Six years later, the FATF president visited Vienna only to be told again that passbook accounts remained “a very sensitive issue.” The Austrian Council of Ministers wrote to the FATF in mid-January 2000 acknowledging the need for reform but failed to provide any specific assurances. After this long campaign, the FATF lost patience, and on February 3, 2000, issued a public ultimatum that unless the government both made a public commitment to abolish the accounts and introduced a bill to prohibit the opening of new anonymous accounts by May 20, Austria’s FATF membership would be suspended effective June 15 of that year.59 Once again, despite the lack of any formal legal consequences, by suspending Austria’s membership the FATF could make an official declaration sufficient to change the status or reputation of the country. Fearful of the reputational and material consequences should this threat be carried out, Vienna quickly backed down. The Austrian government rapidly complied with FATF demands to the letter. It issued a public commitment on February 22 to eliminate the accounts and introduced the legislation to parliament on March 20. After a short transition period, all anonymous accounts for which ownership had not been established were frozen. Consistent with other countries’ experience, however, the taint lingered. In November 2000, the UK Treasury instructed its financial institutions that “the need to be cautious about bank cheques involving Austrian banks and denominated in Austrian schillings continues.”60 Why this sudden about-face given the large legal, financial, and emotional stake the Austrians had in the continuation of anonymous accounts? The 58. FATF, Financial Action Task Force Annual Report 1992–93, 13. 59. Jackie Johnson, “Blacklisting: Initial Reactions, Responses and Repercussions,” Journal of Money Laundering Control 4 (2001): 212. 60. JMLSG Money Laundering Guidance Notes for the Financial Sector. Equivalence Status of Other Countries, UK Treasury, 21 November 2000, http://www.hm-treasury.gov.uk/press_ 131_00guid.htm (accessed February 2010).

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Austrian banking industry believed that suspension from the FATF would be a disaster for the reputation of Austria in the international financial system and, consequently, for their profitability.61 Specifically, the bankers believed the public threats from the head of the FATF that suspension would damage Austria’s sovereign debt rating as well as the ratings of individual banks, with agencies such as Standard and Poor’s and Moody’s.62 But because of the popularity of the accounts, the banks were unwilling to be seen to side with the FATF and against public sentiment. Instead, bankers lobbied hard behind the scenes in early 2000 for the government to abolish anonymous accounts. Up until 2000, sovereign and bank credit ratings and the fortunes of the bank and financial sector had not been affected by the slow-burning dispute with the FATF. But the private sector believed this would change with continued escalation, and the government was persuaded by these fears.63 Thus despite the huge power differentials between the Cayman Islands, Nauru, and Liechtenstein, Austria preempted the reputational and resulting economic damage that local sources believe would have resulted from continued defiance in much the same way as did the microstates.

Rogue States and Blacklisting: Burma and North Korea North Korea and Burma are different again from the countries considered so far, not just in terms of size and power but also in the way their ruling regimes often liked to portray themselves as besieged by a hostile and ideologically alien international community. Rather than being troubled by the label of a deviant, North Korea in particular largely defines itself by being out of step with the rest of the world. Thanks in part to the military junta’s brutal suppression of popular protests in 1988, the defiance of a landslide election loss in 1990, and routine and massive human rights violations since that time, Burma was also a pariah state. Both countries had a record of flouting demands from far more prominent bodies than the FATF, not to mention defying strict and prolonged economic sanctions. North Korea had even faced down thinly veiled military threats from the United States concerning its nuclear program. It is necessary to understand the FATF’s success vis-à-vis Burma in order to understand why it took on North Korea. More generally, this section shows the effectiveness of FATF pressure against

61. Author’s interview, Vienna, Austria, July 5, 2005. 62. “Austria Risks Suspension over Anonymous Savings Accounts,” International Money Marketing, March 7, 2000. 63. Author’s interview, Vienna, Austria, July 5, 2005.

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even the hardest targets. Despite their ideological and economic autarchy, the rogue states were still vulnerable to reputational damage and the resulting financial dislocation. Although North Korea provisionally bested the FATF in 2007, this did not reflect the ineffectiveness of blacklisting but rather the reverse. Shocked by the damage the United States had inflicted through its money-laundering advisory in 2005, Kim Jong-Il’s government threatened to walk out of the six-party nuclear disarmament talks, which led to FATF overlooking North Korea’s lack of AML law. Yet by 2010, North Korea was once again blacklisted. The campaign against money laundering was initially seen as an additional front in the war on drugs. Because Burma had long been home to some of the world’s biggest drug producers, it had also consistently been the target of public U.S. complaints about money laundering.64 Burma escaped the initial round of blacklisting in 2000 but was included as one of the six countries added to the list in June 2001, as the coverage of the campaign expanded beyond small island tax havens (the other additions being Egypt, Guatemala, Hungary, Indonesia, and Nigeria). It was criticized for failing to criminalize money laundering beyond drug-trafficking offenses, the absence of record keeping and suspicious transaction requirements, and restricted international cooperation.65 In June 2002, just a few days before the next FATF plenary, Burma promulgated the Control of Money Laundering Law. This eleventhhour move made no impression on the plenary. The law did, however, make an impression domestically. Rumors began to circulate concerning certain large depositors surreptitiously withdrawing their money rather than face increased scrutiny.66 At this time Burma had also fallen prey to a series of pyramid schemes, which began to go sour. By February 2003, the collapse of the pyramid schemes, worries about the impact the new national law was having on deposits, and continuing FATF pressure on international financial connections interacted to produce a crisis of confidence in the banking system. To make matters worse, the ham-fisted public statements offered by the central bank in an effort to reassure depositors in fact only further panicked a skeptical populace used to reading between the lines of official propaganda. Through 2003 bank runs ensued, with deposits plunging nationally by 70 percent.67 Accounts were frozen, electronic transactions and check payments ceased, cash 64. See the State Departments’ International Narcotics Control Strategy Reports, http://www. state.gov/p/inl/rls/nrcrpt/index.htm (accessed July 2009). 65. FATF, Non-Co-operative Countries or Territories 2001, 15. 66. This section draws from Sean Turnell, Fiery Dragons: Banks, Moneylenders and Microfinance in Burma (Copenhagen: Nordic Institute of Asian Studies, 2009), Chapter 10. 67. Ibid., 309.

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became scarce as wages went unpaid, and Burmese increasingly fell back on barter. Frustrated by Burma’s lack of progress, in November 2003 the FATF imposed countermeasures,68 followed a couple of weeks later by the United States applying the AML provisions of the PATRIOT Act against two Burmese banks in particular, Asian Wealth Bank and Mayflower Bank. Although significant in some ways, in practice the United States already had stringent economic sanctions in place against Burma on human rights grounds. In December 2003, the regime finally introduced the law it had promulgated the previous year, followed in April 2004 by a new law to meet the FATF’s demands on mutual legal assistance. The FATF was again unmoved in its next review of the blacklist in June 2004, demanding yet more reforms. By the time Burma was finally delisted in October 2006, it had state of the art AML legislation, largely written by the FATF, that exceeded those of many FATF members (e.g., the inclusion of precious metal and gem dealers in the suspicious transaction reporting system).69 Giving a definitive answer for why the Burmese regime complied is limited by the opaque and idiosyncratic nature of the regime. The regime issued 45- and 90-kyat bank notes to reflect the ruler’s lucky number (nine), and after being told he was “too far left” by his astrologer, the ruler had earlier changed Burma’s road traffic from left- to right-hand drive. (Not be outdone, in 2007 Burma’s opposition launched “panties for peace,” sending the regime women’s underwear to weaken their spiritual power).70 These uncertainties notwithstanding, it seems that pressure from the blacklisting interacted with and exacerbated existing domestic problems to produce a major banking and then a general economic crisis. To resolve this situation the regime was convinced that it had to adopt the standard AML policy template and thereby hand control of important elements of its criminal justice and financial regulation systems to an outside body. The situation with North Korea presents some close parallels: a xenophobic dictatorship, an appalling human rights record, international isolation, and long-standing involvement in cross-border crime. In February 2007 North Korea was included as a priority case for the International Co-operation Review Group. Delegates clearly regarded it as one of the worst, if not the worst, offenders, thanks to a complete lack of AML policy as well as credible evidence of intimate involvement in money laundering.71 Four months later, 68. FATF, Non-Co-operative Countries or Territories 2003, 2, 11–12. 69. Author’s observation, FATF plenary, Strasbourg, France, February 19–23, 2007. 70. Andrew Selth, “Burma’s ‘Superstitious’ Leaders,” Lowy Institute Interpreter blog, October 22, 2009, http://www.lowyinterpreter.org/post/2009/10/22/Burmas-superstitious-leaders.aspx (accessed March 2010). 71. Author’s observation, FATF plenary, Strasbourg, France, February 19–23, 2007.

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however, while the other less egregious cases were receiving close attention after being sent the kind of “please explain” letters reviewed earlier, there was no discussion of North Korea. The accompanying document simply noted: “A letter from the FATF President was ultimately not sent to North Korea. The ICRG agreed that the situation could be reassessed again at the next ICRG meeting.”72 But at the next plenary meeting North Korea was absent from the agenda, with the secretariat being evasive and obviously uncomfortable when faced with questions about the subject.73 Clearly, something had happened between February and June 2007 to derail the hitherto irresistible FATF blacklisting process. Two years earlier, on September 15, 2005, the U.S. Treasury issued a press release accusing a small private bank in Macau, Banco Delta Asia, of being a conduit for North Korean entities involved in the state-sponsored counterfeiting of $45 million of U.S. currency as well as laundering the profits of drug trafficking. Funds laundered through Macau were said to be used to finance North Korea’s nuclear program. Using its powers under section 311 of the PATRIOT Act, the United States labeled Banco Delta Asia as an institution of “primary money laundering concern,” the same designation that had been earlier been applied to Mayflower Bank and the Asian Wealth Bank in Burma. The designation authorized the U.S. Treasury to apply a series of measures against the bank, ranging from calling for enhanced scrutiny of any transactions made with the institution to the extreme measure of cutting it off from all U.S. dollar-denominated banking networks. The U.S. Financial Crimes Enforcement Network began an investigation to determine what measures were appropriate, an investigation finalized in March 2007. Although there were no formal or legal obstacles to transacting with Banco Delta Asia while the investigation was in progress, the reputational damage had been done by the initial press release. Within six days, the bank had lost over a third of its deposits.74 It seems the bank would have failed had the government of Macau not extended a loan to shore up the balance sheet. Although it made a significant profit in 2004, the bank (and its parent company, Delta Asia Financial Group) reported major losses by the end of 2005.75 Although protesting its innocence, the bank nevertheless fired several senior officials, pledged to have no dealings with any North Korean entity in the future, and subjected itself to an independent investigation by 72. Report by the ICRG Co-Chairs, June 27–29, 2007. 73. Author’s interview, FATF Secretariat, Paris, France, October 11, 2007. 74. “Squeeze on Banco Delta Asia Hit North Korea where it Hurt,” International Herald Tribune, January 18, 2007. 75. Zoe Lester, “Anti-Money Laundering: A Risk Perspective,” Ph.D. thesis, University of Sydney, 2009.

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the Macanese government. Significantly, the government of Macau also imposed a freeze on $25 million in accounts held by North Korean companies and individuals. Like Banco Delta Asia depositors, U.S. banks did not wait for the results of the FinCEN investigation but immediately cut their ties with the bank, as did major Korean and Japanese institutions. The reverberation effect of blacklisting discussed earlier again came into play. The Hong Kong Financial Intelligence Unit requested that all Hong Kong banks report any relationship with Banco Delta Asia. AML agencies in many other countries circulated the U.S. Treasury Department’s charges among their own financial institutions in the unlikely event that these firms had missed the extensive media coverage of the accusations. Macau’s financial sector in general came under suspicion thanks to unflattering comments by U.S. Treasury, and despite U.S. State Department reports lauding the jurisdiction’s AML systems (the Caymans had similarly been praised by the State Department for its AML policies shortly before being placed on the FATF blacklist). Again the impact of the label on third-party onlookers was regarded as key. In testimony before Congress, senior Treasury official Daniel Glaser noted that the designation was a “shot heard round the world for national bankers who cut off relations with North Korea, fearing that something like what happened to [Banco Delta Asia] could happen to them.”76 It is critical to note that Glaser was also the United States’ most senior representative to the FATF and cochair of the International Co-operation Review Group, and he had earlier been head of the Americas review group in the NCCT process. Glaser had previously come in for personal criticism from Kim Jong-Il, and it was apparently a matter of some satisfaction to Glaser that he had managed to arouse the ire of the “Dear Leader.”77 Speaking more generally on the intended impact of the U.S. advisory on third parties, John McGlynn noted: “Banks . . . are conservative, risk-averse bodies. Washington turned these qualities to its advantage to meet the political objective of isolating the DPRK [North Korea] from the international financial community.”78 The impact of the advisory was in the reputational change it effected, not the evidence it contained or the facts it communicated. The U.S. government’s case relied on extensive classified sources that were not made available to foreign governments, Congress, U.S. courts, or any other outside scrutiny. An independent

76. Ibid., 220. 77. Author’s interview, FATF plenary delegate, Strasbourg, France, February 19, 2007. 78. John McGlynn, “Banco Delta Asia, North Korea’s Frozen Funds and US Undermining of the Six-Party Talks: Obstacles to a Solution. Part III,” The Asia-Pacific Journal: Japan Focus, http://www.japanfocus.org/-John-McGlynn/2446 (accessed April 2010).

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review by accounting firm Ernst and Young found no evidence of money laundering at Banco Delta Asia. As noted earlier, during the FATF’s February 2007 plenary North Korea was squarely in the International Co-operation Review Group’s sights and was seemingly destined to end up on the emerging blacklist. In March 2007, the Treasury concluded its investigation and instituted the most severe measure allowed under section 311: cutting off Banco Delta Asia from all U.S. dollar banking networks. But by this time, most of these links had been preemptively severed by U.S. and foreign banks anyway, once again demonstrating how the reputational effect had been much more significant than any formal legal sanctions. Although, as in the case of Burma, any judgments about such a secretive regime must remain tentative, the financial squeeze and the freeze on the $25 million in Banco Delta Asia seemed to be causing increased discomfiture in Pyongyang through 2006. Yet the North Korean reaction placed the U.S. government in an increasingly awkward position. Treasury had concluded that the $25 million was indeed the proceeds of crime and could not revoke the section 311 measures without a formal explanation of why their initial judgment was incorrect. But in February the North Korean party at the six-party nuclear disarmament talks was adamant that there would be no deal until the money was returned.79 Russia and China both supported this demand, the latter being especially important as Macau Special Autonomous Region is part of its sovereign territory. The United States ultimately bowed to the North Korean demand. Notwithstanding Treasury’s judgment about the illegal provenance of the money, it was released to North Korea. The campaign to stigmatize North Korea in the international financial community had been so effective, however, that it proved difficult to find any bank willing to handle the transaction. Processing the transaction directly contradicted the legal prohibition on banks knowingly transferring criminal funds. The money was eventually transferred via the Bank of China. Banco Delta Asia’s owner, Stanley Au, who had consistently enjoyed the backing of both the Macanese and Chinese governments, recovered control of the bank. Although it is impossible to say definitively, it seems that after being overruled in March 2007, the Treasury, and probably Glaser in his dual capacity as U.S. government representative and International Co-operation Review Group cochair, ensured that North Korea was quietly dropped from the FATF’s agenda (in perhaps a Freudian

79. Sheena Chestnut, “Illicit Activity and Proliferation: North Korean Smuggling Networks,” International Security 32 (2007): 107–109.

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slip, Glaser spoke “in the name of the United Nations” at one plenary).80 Given the flagrant failure of North Korea to meet minimum AML standards, and even more so its direct involvement in money laundering and other crimes,81 it is not surprising that the FATF was extremely uncomfortable discussing its first defeat. Whether this result is final, however, remains to be seen. North Korea unilaterally withdrew from the six-party talks April 14, 2009, and tested a nuclear weapon the following month. The United States thus had little to lose in allowing the FATF to once again blacklist North Korea in 2010.

Onlookers and Blacklisting In the three rounds of the NCCT list, twenty-three countries were successfully pressured to introduce AML systems that met international standards as adjudged by the FATF. But the impact of the initiative spread much farther than just those countries that ended up on the list. In many other countries, policymakers rushed to introduce legislation so as to avoid being blacklisted. The demonstration effect (referred to among some regulators as the “heads on sticks” effect) of the FATF listing meant that this tactic was not only successful in pushing blacklisted countries into reform but also served as a powerful warning to others. The FATF was well aware of the benefits of making an example of some countries and sending a message to the rest.82 Rich country regulators within and beyond the FATF were far more prepared to threaten the reputation, and by implication stability, of foreign financial systems by critical public statements than their own (in contrast to the situation discussed in chapter 2). Commenting on the fourteen countries that were assessed but ultimately not included in the first blacklist, the FATF observed that the review had “revealed—and stimulated—many ongoing efforts by governments to improve their system.”83 Another seven countries were reviewed but not listed in 2001 (the Czech Republic, Poland, Seychelles, Slovakia, the Turks and Caicos Islands, Uruguay, and Vanuatu), and a further three were reviewed in the last round in 2002 (Costa Rica, Palau, and the United Arab Emirates). This dynamic of preemptive action in introducing AML standards is harder to trace, but interviews and workshop discussions among regulators and

80. 81. 82. 83.

Author’s observation, FATF plenary, Paris, France, October 8–12, 2007. Chestnut, “North Korean Smuggling Networks.” Author’s interview, FATF, Paris, France, July 8, 2004. FATF, Review to Identify Non-Co-operative Countries or Territories, 11.

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private sector representatives in Barbados, Mauritius, Samoa, and Vanuatu provide strong evidence. These four countries raced to introduce new policies in 2000 so as to avoid being negatively labeled by the FATF, especially after being told about the damage blacklisting had done to the reputations of neighboring countries.84 The cautionary tale of those on the NCCT list was passed on via the personal ties, professional associations, and specialist journals that linked the financial services industry in the region and beyond, as well as the general media. Speaking at a regional AML seminar with senior Barbadian officials in the audience, one Caribbean representative began his presentation on the effects of being blacklisted: “God forbid that you should share this experience.”85 All the Caribbean countries argued they had suffered heavily from being blacklisted. In the Indian Ocean, Mauritius drew a similar conclusion from one of its own neighbors. In what proved to be a trial run for the NCCT list, in 1996 the FATF had publicly condemned the Seychelles for its proposed Economic Development Act. This ill-considered legislation offered a range of incentives for foreigners willing to put $10 million or more in approved government investments. One of these incentives was absolute immunity from extradition for foreigners guilty of any crime, with the sole exceptions of murder or drug-trafficking offenses committed in the Seychelles. Furthermore, to establish the credibility of its commitment, the legislation was able to be repealed only by a national referendum in which 60 percent of the population voted against it. After a chorus of FATF-led international disapproval, an embarrassed Seychellois government was forced to engineer a court challenge that found the act to be unconstitutional. Yet the reputational effects lingered. Well after the act was withdrawn, a relatively junior HSBC Bank official placed a bar on all transactions with the Seychelles because he vaguely recalled the earlier unfavorable media coverage of the country’s money-laundering credentials.86 Turning to the Pacific, Nauru’s experience has already been described at length, but the Cook Islands and Niue had their own blacklist traumas. These were conveyed to other leaders in the region as special sessions of the Pacific Islands Forum heads of states summits and economic and finance ministers’ meetings were held to discuss the FATF campaign. Samoa’s experience is reasonably typical. Samoa sent a delegate to the Asia-Pacific Group

84. Author’s interview, Bridgetown, Barbados, September 25, 2005; Port Louis, Mauritius, May 25, 2005; Port Vila, Vanuatu, March 4, 2004; Apia, Samoa, June 30, 2009. 85. Wrenford Ferrance, “Case Study: Antigua and Barbuda,” paper presented at the Caribbean Financial Action Task Force conference, Trinidad, December 5, 2000. 86. Author’s interviews, Victoria, Seychelles, May 30, 2005.

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on Money Laundering annual plenary for the first time in September 1999. Here the delegate heard something about the impending blacklist and was forcefully told Samoa should quickly introduce an AML law. The official communicated this to his superior, the deputy head of the Central Bank of Samoa, who soon afterward learned more about the initiative at an unconnected regional IMF meeting. In early 2000, a group of four officials from the FATF, United Nations, and the Asia-Pacific Group traveled through the Pacific island countries warning these countries that they needed to immediately pass AML legislation to escape the blacklist.87 Samoa was able to push through the specified measures just before the June 2000 deadline. More generally, in private interviews and regional workshops in Barbados, Mauritius, and Vanuatu in March–April 2006, those from the public and private sector were unanimous in acknowledging the incredibly powerful threat posed by the FATF blacklist, perhaps the most talked-about issue in the workshops. The majority of participants felt that the presence of blacklists meant that developing countries simply had no choice but to reform. Regulators and banking representatives expressed a willingness to pay any price to stay off the blacklist.88

What’s New about Blacklisting? One of the key claims of this book is that the exercises of power through which AML policy has been diffused are different from the traditional direct tools of military threats and economic sanctions. But this claim may appear to overlook an obvious objection: does blacklisting achieve its impact only to the extent it constitutes economic sanctions or at least represents the threat of future economic sanctions? If this were true, there would be nothing especially new about the FATF’s campaign. Indeed, in his otherwise-persuasive coverage of the FATF, Daniel Drezner explicitly argues this point.89 In fact, blacklists were nothing of the sort. Going back to the first principles, it is worth looking at the detail of the statements issued under Recommendation 21 in line with the NCCT exercise. The U.S. advisory against Nauru is indicative. It reads in part: Banks and other financial institutions operating in the United States should give enhanced scrutiny to any transaction originating in or

87. Author’s interview, government officials, Apia, Samoa, June 30, 2009. 88. J. C. Sharman and Percy S. Mistry, Considering the Consequences: The Development Implications of Initiatives on Taxation, Anti-Money Laundering and Combating the Financing of Terrorism (London: Commonwealth, 2008). 89. Drezner, All Politics Is Global, 143.

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routed through Nauru, or involving entities organized or domiciled, or persons maintaining accounts, in Nauru. A financial institution subject to the suspicious transaction reporting rules . . . should carefully examine the available facts relating to any such transaction to determine if such a transaction . . . requires reporting in accordance with those rules. . . . It should be emphasized that the issuance of this Advisory and the need for enhanced scrutiny does not mean that US financial institutions should curtail legitimate business with Nauru.90 The last sentence clearly indicates the difference between the U.S. action against Nauru and, for example, sanctions against Cuba. Even the countermeasures mainly repeated the call for countries to caution their institutions about the possible dangers of transacting with Nauru.91 A variety of evidence has already been discussed to support the claim that blacklisting was damaging in and of itself through damage to targeted countries’ reputations, which in some cases then gave rise to economic losses. Two final examples show countries’ sensitivity to maintaining their reputation, even where there were absolutely no prospects of words being supported by economic sanctions. The first is what came to be known as the “Grisham effect” with reference to the Cayman Islands. The Caymans government felt moved to issue an official refutation of John Grisham’s popular novel The Firm, which tells a story of a nefarious law practice with dealings in the Caymans, for fear that this fictional account would endanger the jurisdiction’s image among the business community. In a second instance, I had direct experience of this kind of extreme sensitivity. The director general of the International Financial Services Commission of one offshore center (the “body responsible for promoting, protecting. and enhancing the reputation of [the jurisdiction] as an international (‘offshore’) financial center”) was moved to e-mail a complaint about my bracketing of this offshore center with several others in a mildly unfavorable comparison in a trade journal. Despite my having no official capacity beyond that of a university employee, the e-mail noted, “The inclusion of [our jurisdiction] in this ‘blacklist’ is a matter of great concern to us as it seriously damages [our] reputation . . . as an offshore jurisdiction. You may wish to know that the offshore industry . . . is well regulated and all service

90. FinCEN Advisory on Nauru, July 21, 2000. 91. FATF Advisory on Nauru, http://www.fatf-gafi.org/document/47/0,3343,en_32250379_ 32236992_33916527_1_1_1_1,00.html (accessed April 2007).

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providers must be licensed by the IFSC.”92 The e-mail went on to threaten legal action for any financial damage caused by my remarks. In both these instances, as with the FATF blacklists but unlike economic sanctions, countries clearly care about how they are regarded by other countries and firms. They believe that a loss of standing or status may produce material loss entirely independent of material threats. By the end of the NCCT process in 2006, all of the twenty-three jurisdictions blacklisted had legislated and implemented similar AML frameworks, often dictated word-for-word by the FATF. In addition, perhaps a roughly similar number of countries had rushed to avoid inclusion on the blacklist by introducing the same policy. The FATF’s basic aim of extending the coverage of the international AML regime beyond its thirty-odd rich country members had been achieved. Although the initiative had at first focused disproportionately on small tax havens, it had also successfully coerced large developing and transitional states, close U.S. allies such as Israel, and even the pariah state of Burma. Many outside the organization, and even a few countries within the FATF, had been uncomfortable with the aggressive and confrontational nature of the exercise. There were also persistent worries about whether nonmembers were being held to a higher standard than powerful member states. But the tempting prospect of obtaining quick results through this kind of direct action meant that even though blacklisting was suspended for a time, it was never renounced. In 2007 it resurfaced, and any qualms were swept away by the crisis atmosphere that developed later that year as the financial system looked increasingly endangered. As discussed in the concluding chapter, the success of the FATF blacklists led to the G20 copying this tactic from 2009. Roughly, something between a quarter and a third of the world’s sovereign states had been successfully pressured to adopt the standard AML policy via the NCCT list, including both those directly targeted and those complying preemptively. This total is, of course, in addition to the thirty FATF member countries. At this point, rather than being the exception or the sole preserve of a minority of rich countries, AML policy increasingly came to be seen as the norm for all states. Something of a tipping point or critical mass had been reached. Especially in the developing world, the question was no longer “Why would this country have an AML policy?” but rather “Why does this country not have an AML policy?” Representing this shift, two other

92. E-mail to the author, August 27, 2009.

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mechanisms increasingly came into play. The first was a process of socialization that took hold among international financial regulators newly entered into the AML community. The second concerned new incentives to adopt AML policies as a symbol valued by international financial interests. The next chapter is devoted to explaining both.

Ch a p ter 5

Socialization and Competition

Of those consulted, a large majority of the public officials and representatives from the financial sectors in the developing world maintain that adopting global AML standards is in their country’s best interest. This is just as well, as they also say adopting AML rules is unavoidable. But given the costs and benefits explored in chapter 2, what justifies such reasoning? One might expect that the answer would be couched in terms of some reduction in crime, or perhaps a more secure or competitive financial sector, or the utility of recovered criminal assets. But evidence from interviews, focus groups, observation at workshops and plenary meetings, primary documents, and surveys shows that these sorts of answers very rarely come up. Instead, the most common justifications for introducing AML rules are staying off blacklists and protecting the country’s international standing. Status or standing is important for preserving access to the international financial system, but it is also interpreted to mean regulators avoiding the public disapproval of their peers. The “benefits” of not being blacklisted have been covered in the previous chapter. This chapter is devoted to explaining how the related mechanisms of socialization and symbolic competition have pushed forward the diffusion of AML policy. These mechanisms represent a much more structural exercise of power than does blacklisting. Thanks to these mechanisms, AML policies are increasingly seen as inevitable. 131

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To repeat a caveat given earlier, the strict separation in the coverage of the mechanisms is an artifact of the organization of the book rather than a reflection of any strict separation in reality. Blacklisting was successful in pushing states to adopt AML policy precisely because it negatively affected their status and standing and created fears about their ability to access private sector financial networks. Similarly, the Mutual Evaluation Reviews that are so important for socialization involve a process of public judgments that in some instances seem akin to blacklisting. Yet, however blurred the operation of the different mechanisms may become in practice, in analytical terms there are also clear differences between them. The efforts of those directing the Non-Cooperative Countries and Territories list and the International Cooperation Review Group were deliberately targeted exercises of coercion designed to bend targeted states to the will of the FATF. Both sides, and third parties, understood them as such. In contrast, socialization, or mimicry, is a much less centralized process by which regulators and other government officials become drawn into transnational networks and come to accept the standards of the policy community in which they find themselves. This process is coercive in that there is more and more pressure on those within the charmed circle to conform and on those outside to join in. But it is much less an exercise of calculated domination. It does not elicit calculated submission as does blacklisting. Adopting and entrenching AML policy comes to be seen as the natural, normal thing to do. The question becomes not “why do we need an AML policy?” but “why would we not have an AML policy?” Because socialization operates in a much more gradual and indirect manner, it does not bring the rapid and obvious results that blacklisting did. However, its effects in promoting diffusion are, if anything, more widespread, durable, and self-sustaining. The competition mechanism is different again, perhaps halfway between blacklisting and socialization. Here, rather than the driving force being the FATF or the transnational policy networks that constitute the AML policy community, it is the activities of private firms that are most important. Public authorities have delegated much of the AML surveillance function to private firms. Lacking adequate guidance to distinguish clean from dirty money, firms adopt proxy measures that penalize those in jurisdictions without AML policies. In this manner, through their uncoordinated and largely unintended actions in response to a structure of common incentives, international financial firms collectively exert further pressure on states to adopt AML policy. Even when senior government officials in developing states are skeptical of the appropriateness of AML policy for their country and are aware of the kind of costs discussed earlier, they reluctantly agree to pass the

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usual legislation and establish all the standard institutions and procedures. Rather than protesting this regulatory imposition, the local financial sector is usually in favor of it so as to safeguard their links with the international financial system. Here there is a deliberate, calculated decision on the part of policymakers (though not the firms that create the context that determines this decision), but it is of a special kind. Policymakers decide to use AML policy as a symbol or talisman to impress powerful outsiders. These outsiders know little and care less about actual local circumstances. But they do care about certain boxes being checked, and pandering to their prejudices determines important material outcomes, such as attracting foreign investment and gaining and maintaining access to international banking networks. Along these lines, introducing an AML policy is one such important ritual to be performed. Unlike blacklisting, but like socialization, the collective effects of uncoordinated, individual decisions by private firms do not bring about obvious, rapid policy change. But, as with socialization, the very fact that this mechanism is indirect and does not require a deliberate, centralized concentration of effort means it exerts a more constant pressure across a wider front and in a self-reinforcing manner. Again, this is a coercive exercise because policymakers in poor countries feel themselves pushed into adopting policy that they know will do little to fix the array of serious local problems they face. Socialization and competition interact to produce a sense that there is no alternative but to conform to international standards in this domain. They represent a more structural view of power than is common among those studying international politics. Once catalyzed by blacklisting, both socialization and competition tend to exert more pressure the more countries adopt AML policy.1 In this chapter, I begin by looking at developing countries’ initial contact with the AML regime (excluding those blacklisted in 2000–2001) in the form of their encounters with outreach programs conducted by international organizations. In introducing the idea of socialization, the next section notes that, rather than producing culturally determined automatons, socialization equips individuals to play an appropriate role given dominant cues. In the context of the global AML regime, the most important drivers of socialization are argued to be the evaluation process and participation in the plenary meetings of the FATF and the other regional AML bodies. The section on 1. For a more general treatment of this dynamic, see Oded Lowenheim, “Examining the State: A Foucauldian Perspective on International ‘Governance Indicators,’ ” Third World Quarterly 29 (2008): 255–74.

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competition effects begins by distinguishing the conception of this mechanism from that used by other scholars: competition is a manifestation of structural power that prompts symbolic responses. Facing the impossibility of screening out dirty money, private firms adapt and refract global AML standards, thereby unintentionally creating an incentive structure that drives developing countries to introduce these standards.

First Contact In their comparative guide to AML regulation, Mark Pieth and Gemma Aiolfi describe efforts to diffuse this policy as “spreading the gospel,”2 and there is something of a missionary bent to this work. Excepting those who fell afoul of the 2000 blacklist, most developing countries first learned of AML policy through the outreach missions of various international organizations. This section summarizes the sorts of initial conversations that took place. It draws heavily on a long, confidential interview with a developing country national entrusted with spreading AML policy in Africa as well as a controversial plenary presentation given by a developed country national with a similar responsibility for diffusing AML standards in Asia. This material is supplemented with other interview evidence. There is substantial overlap in the accounts, which are at times merged to better preserve confidentiality. Both individuals acknowledged that on first contact with officials in developing countries, usually a minister, AML policy was a hard sell, especially compared with priorities such as clean water and basic health and schooling. The most common first response from the local officials was to say that the country didn’t have a problem with money laundering and thus had no need for an AML policy (interviews among developing country officials confirmed this reaction). Also common was the view that the dirty money was in places such as Switzerland and the United States, rather than in developing countries, and that, in any case, there were no funds available to create an AML system. Finally, there were often delicate allusions to the fact that ministers might have some very personal reservations about exposing financial information to the scrutiny of law enforcement. Given this reluctance, the task of those from the various international organizations was to engage in what was termed “awareness raising”: explaining

2. Mark Pieth and Gemma Aiolfi, “Synthesis: Comparing International Standards and their Implementation,” in A Comparative Guide to Anti-Money Laundering: A Critical Analysis of Systems in Singapore, Switzerland, the UK and the USA, ed. Mark Pieth and Gemma Aiolfi (Cheltenham: Edward Elgar, 2004), 12.

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to (or teaching, as Martha Finnemore would put it)3 these officials that their country did in fact have a money-laundering problem. This confirms Rainer Hulsse’s verdict that the FATF puts “considerable effort into producing problems by creating, defining and persuading others of the very problems which they then offer to solve.”4 Persuading countries that had been on, or that were worried about being on, a blacklist that they had an AML problem was easier. Their “problem” was what the FATF would do if the country didn’t adopt a policy based on FATF’s standards. More positively, to the extent that countries had a problem with illegal logging or fishing, smuggling, large-scale theft, fraud, or kidnapping, AML was advertised as a solution. Meeting international AML standards was said to help in attracting foreign investment and aid, with the associated flow of economic benefits. Continuing this rather optimistic chain of reasoning, it was said that these economic benefits would be popular and thus could lead to more votes. Ministers were assured that foreign technical assistance would pay for the cost of setting up the system. Finally, the legislation need only be introduced after the next election ( by implication, incumbents would not have to worry about transparency concerning the sources of funding for their own reelection campaigns). This rationale was usually effective in assuaging doubts sufficiently for the process of policy adoption to begin, although the representatives from both donor bodies admitted that actual implementation in these environments was often pro forma, with correspondingly low policy effectiveness. The area in which this book argues AML can make the most positive contribution—fighting corruption—was generally not mentioned. One presenter at a regional AML plenary summarized the reservations about AML policy commonly heard among developing countries and argued that there was some truth to them. The delegates’ response was revealing. The presentation was delivered on the first day, garnering a generally hostile response. Upon speaking to the presenter two days later, I found that most other delegates had subsequently refused to speak with her, and some had complained about the negative tone of the presentation to her superior. The perils, perhaps, of not sticking to the script.

3. Martha Finnemore, National Interests in International Society (Ithaca: Cornell University Press, 1996). 4. Rainer Hulsse, “Creating Demand for Global Governance: The Making of a Global MoneyLaundering Problem,” Global Society 21 (2007): 156; see also Michael Barnett and Martha Finnemore, Rules for the World (Ithaca: Cornell University Press, 2004), 7; Tony Porter and Michael Webb, “The Role of the OECD in the Orchestration of Global Knowledge Networks,” paper presented at the International Studies Association conference, Montreal, March 17–20, 2004, 8–9.

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Socialization and Role-Playing Socialization rests on the idea that, although much of our behavior is the result of deliberate decisions, perhaps even more influential are widely shared beliefs or norms that present certain ways of acting as the normal, natural, or appropriate ways of doing things. Within a community, individuals tend to pick up on and be shaped by these shared beliefs. Socialization, or similar concepts under a different name, has enjoyed a long pedigree in social science and is probably a good fit with many commonsense understandings of how people make their way in a society. Despite this intellectual support and intuitive appeal, however, there are problems with explanations premised on socialization. One of the most serious is the tendency to portray individuals as unthinking automatons, “cultural dupes,” spending their lives uniformly acting out the regimen prescribed to them by society. Although this book does rely on a notion of socialization, particularly in shaping the behavior of individuals within the AML policy community, these officials are anything but unthinking drones. As well as often being highly intelligent, reflective individuals, these officials sometimes privately make critical remarks concerning many of the central tenets of the AML regime within which they work. Nor should this be too surprising. Those in academia and many other professions can voice fundamental doubts about basic norms in their field while also drifting along with shared expectations of appropriate behavior, without giving the contradictions too much thought. Likewise, in a fascinating study, Steven Kull explores how those planning for nuclear war in the 1980s could simultaneously believe in the importance of their detailed preparations and admit the futility of their efforts.5 Thus in presenting the explanation below, there is a difficult but very necessary balancing act in reconciling the largely unseen influence of social norms on the transnational AML policy community while also acknowledging the fact that this community is made up of critically reflective individuals. Managing this tension is best achieved by a close empirical focus. One treatment of socialization that aims to be sensitive to this tension is that defined by Jeffrey Checkel et al.6 Checkel defines socialization as “a process of inducting actors into the norms and rules of a given community”7 but sees two types of socialization. Type I is “role playing”: “agents may 5. Steven Kull, Minds at War: Nuclear Reality and the Inner Conflicts of Defense Policymakers (New York: Basic Books, 1988). 6. Jeffrey T. Checkel, “International Institutions and Socialization in Europe: Introduction and Framework,” International Organization 59 (2005): 801–26. 7. Ibid., 804.

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behave appropriately by learning a role–acquiring the knowledge that enables them to act in accordance with expectations–irrespective of whether they like the role or agree with it. The key is the agents knowing what is socially accepted in a given setting or community.” Over time, playing a role tends to become habitual, and individuals give it less and less thought.8 Such role-playing is most likely to develop when a relatively small group of individuals interact regularly over a sustained period in formal and /or informal settings.9 At a deeper level is type II socialization, when actors are genuinely persuaded that a given course of action is the right thing to do in moral and functional terms. In the context of being socialized in the AML community, role-playing (type I) is the more important of the two. Such role-playing helps to explain how officials in FIUs and related institutions in developing countries can privately be very critical of having to implement AML standards so obviously unsuited for local conditions while nevertheless working hard to implement these standards. This idea of playing to a script is a close fit with the notions put forward by the sociologists referred to earlier.10 The cues for both individual and institutional performance are provided by global standards transmitted through international organizations, transnational networks, and private actors. Actors learn a language and a way of conducting themselves according to the demands of legitimacy, not efficiency, which then become routine.11 As to the locus of this process, “occupational socialization is carried out in trade association workshops, in-service education programs, consultant arrangements, employer-professional school networks, and the pages of trade magazines, [where] socialization acts as an isomorphic force.”12 According to these authors, the strength of this pressure for uniformity in following a script is likely 8. Martin Marcussen, “The OECD in Search of a Role: Playing the Ideas Game,” paper presented at ECPR Joint Session of Workshops, Grenoble, France, April 6–11, 2001, 21; Barnett and Finnemore, Rules for the World, 19. 9. Checkel, “Socialization in Europe,” 811; Alastair Iain Johnston, “Conclusions and Extensions: Toward Mid-Range Theorizing and Beyond Europe,” International Organization 59 (2005): 1015. 10. For example, John W. Meyer, “Reflections: Institutional Theory and World Society,” in World Society: The Writings of John W. Meyer, ed. Georg Krucken and Gili S. Drori (Oxford: Oxford University Press, 2009), 38–42; Gili S. Drori and Georg Krucken, “World Society: A Theory and a Research Program in Context,” in World Society, 22. 11. Gili S. Drori, John W. Meyer, and Hokyu Hwang, “World Society and the Proliferation of Formal Organization,” in Globalization and Organization: World Society and Organizational Change, ed., Gili S. Drori, John W. Meyer, and Hokyu Hwang (Oxford: Oxford University Press, 2006), 48; Paul J. DiMaggio and Walter W. Powell, “Introduction,” in The New Institutionalism in Organizational Analysis, ed. Walter W. Powell and Paul J. DiMaggio (Chicago: University of Chicago Press, 1991), 31. 12. Paul J. DiMaggio and Walter W. Powell, “The Iron Cage Revisited: Institutional Isomorphism and Collective Rationality,” in The New Institutionalism, 72.

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to increase in line with the degree of uncertainty in measuring the outputs or success of institutions (a perennial problem for AML policy).13 Finnemore also argues that international organizations lead actors to become “socialized to accept . . . values, rules and roles. They internalize the roles and rules as scripts to which they conform, not because of conscious choice but because they understand these behaviors to be appropriate.”14 Finally, again stressing the importance of socialization for roles and rules in institutions, James March and Johan Olsen are at pains to distinguish this view from a caricature of culture dupes: To say that behavior is governed by rules is not to say that it is either trivial or unreasoned. Rule-bound behavior is, or can be, carefully considered. Rules can reflect subtle lessons of cumulative experience, and the process by which appropriate rules are determined and applied is a process involving high levels of human intelligence, discourse, and deliberation. Intelligent, thoughtful political behavior, like other behavior, can be described in terms of duties, obligations, roles and rules.15 The difficulty of playing the appropriate role is readily apparent in the nervous and overawed countenances of many officials from developing states when first thrown into the thick of AML plenary meetings and mutual evaluations, the sites of socialization.16

Sites of Socialization 1: Evaluations The first main channel of socialization discussed is the Mutual Evaluation Review procedure, under which all countries that have adopted AML policies are assessed against the same standards (the FATF’s 40+9 Recommendations) and according to the same guidelines (the FATF methodology). The

13. See Michael Levi and William Gilmore, “Terrorist Finance, Money Laundering and the Rise and Rise of Mutual Evaluation: A New Paradigm for Crime Control,” European Journal of Law Reform 4 (2002): 361; Peter Reuter and Edwin M. Truman, Chasing Dirty Money: The Fight Against Money Laundering ( Washington, D.C.: International Institute of Economics, 2004); Michael Levi and Peter Reuter, “Money Laundering,” in Crime and Justice: A Review of Research, Vol. 34, ed. M. Tony (Chicago: University of Chicago Press, 2006), 289–375. 14. Finnemore, National Interests in International Society, 29. 15. James G. March and Johan P. Olsen, Rediscovering Institutions: The Organizational Basis of Politics (New York: Basic Books, 1989), 22. 16. Author’s observation, Asia-Pacific Group on Money Laundering plenary, Perth, Australia July 23–27, 2007; Asia-Pacific Group on Money Laundering plenary, Brisbane, Australia, July 6 –10, 2009; Pacific Islands Forum Money Laundering Workshop, Brisbane, Australia, June 18–20, 2008.

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evaluation process is mainly carried out by dedicated AML bodies, the FATF and its regional offshoots. But because AML standards have now become part of the World Bank and International Monetary Fund’s general reviews of their members’ financial sectors, these bodies play an important supplementary role. The second main site of socialization comprises the plenaries of the FATF and the regional AML bodies, supplemented by the seminars and training missions of these and other institutions. Once more, in practice these sites tend to bleed into each other. For example, one of the main tasks of plenaries is to discuss reviews of members. Evidence used here is taken from my participation in various AML plenaries, workshops, and projects in developing countries, as well as more conventional interviews of those in international organizations and AML institutions. Although the linkage between them is increasingly seen as normal and unremarkable, there is not an obvious fit between AML policy and the World Bank and the International Monetary Fund. Indeed, the IMF and the World Bank were highly resistant to the notion of becoming involved in the business of AML assessment, still less countering the financing of terrorism.17 The first is a law enforcement matter and the second, national security; the Bretton Woods Institutions are specifically excluded from both areas. Yet for those intent on spreading AML policy throughout the world, the huge resources of these institutions (10,000 people working for the World Bank and 2,500 at the IMF, versus 10 –15 in the FATF secretariat and 3 –8 in the regional AML bodies) and their long-established review process made them extremely valuable potential allies. From 2000 until September 2001, IMF and World Bank staff had successfully resisted efforts to involve them in this area. Richard Gordon is a particularly valuable insider source in this regard. He recounts: After 9/11 when financing terrorism special recommendations were added to money laundering, the major FATF members, particularly the United States and France, came to the International Monetary Fund (IMF) and said: “You need to adopt these recommendations as the world standard against money laundering, and then go out and assess compliance by jurisdictions with this standard.”. . . [T]hey were pushing money laundering on us and we said no, we do not do money laundering at the

17. Author’s interview, World Bank, Washington, D.C., September 7, 2004; IMF Executive Board Meeting 01/38, April 13, 2001, BUFF01/54.

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Fund because it has to do with criminal law enforcement. They kept pushing it and finally they succeeded.18 As noted previously, the quid quo pro extracted from the FATF by the IMF (and World Bank) was a commitment in November 2002 to refrain from adding any new countries to its blacklist. Nevertheless, for a small, informal body such as the FATF to enlist the World Bank and the IMF to the cause of spreading AML policy was a signal triumph, especially because beginning in 2007 the FATF was allowed to renege on its commitment to not engage in blacklisting. AML policy thus became one of the twelve areas assessed in the Reports on Observance of Standards and Codes and the Financial Sector Assessment Programs as well as the more tailored Offshore Assessment Program. Aside from the logistical fillip provided to the FATF, this again strengthened the legitimacy of the 40+9 Recommendations as something to which all modern, progressive states should adhere. It is important to realize that the assessment teams do not visit a country and ask the locals “do you have a problem with money laundering and therefore need an AML policy?” Nor do those conducting the review ask themselves the question “does this country need an AML policy?” (or perhaps more appropriately “of all the problems this country has, is money laundering one of the most severe?”). Instead, the assessment structure presumes that all countries are vulnerable to money laundering and thus that all should have AML policies in place to combat it. Those that do not receive poor assessments. The unquestioned assumption that all countries must have an AML policy in line with FATF standards tends to rub off on local government officials. The World Bank and IMF were at pains to stress that, as with all of their surveys, the assessments were voluntary and at the behest of those assessed, with the reports released only with the permission of the countries in question. But the mere fact that many developing countries depended on conditional loans from these institutions sometimes created the perception that bad marks on the assessments, including the AML component, might endanger future access to loans. This suspicion proved prescient; since April 2009 the G20 has explicitly instructed all multilateral development banks to make loans conditional on meeting “international standards,” particularly

18. Richard Gordon, “International Financial Centers, Tax Havens and Money Laundering Havens,” in Money Laundering, Tax Evasion and Tax Havens, ed. David Chaikin (Sydney: Australian Scholarly Publishing, 2009), 79–80.

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in relation to AML.19 Further bolstering the legitimacy of the standards, a plethora of other international organizations have also endorsed the Recommendations, from the Black Sea Cooperation Council to the UN Security Council to the Financial Stability Board. For dedicated AML bodies, the process of conducting the Mutual Evaluation Reviews has become something of an industry. Ideally, every member of the FATF or the regional bodies should undergo such a review every three to five years. With the diffusion of AML policies, this equates to something like forty reviews in every given year. The reviews assess compliance with the 40+9 Recommendations according to a uniform methodology, a handbook for assessors, and a questionnaire template developed by the FATF, IMF, and World Bank in 2004 to make sure that, as far as possible, every review is conducted to the same standards (all available at the FATF home page). As well as narrative comments, each country gets a score on each Recommendation that ranges through Compliant, Largely Compliant, Partially Compliant, and Non-Compliant. The FATF itself explains the rationale as follows: FATF member countries are strongly committed to the discipline of multilateral monitoring and peer review. . . . The mutual evaluation reports not only provide an accurate technical assessment of the extent to which the evaluated country has implemented an effective AML/ CFT system, but are also published, and are enforced through the peer pressure mechanism. . . . The FATF has worked to extend and foster this peer review process through the FATF-Style Regional Body (FSRB) network, which is a very important mechanism for promoting timely and effective implementation of FATF Recommendations globally, and for contributing to the creation of a level playing field throughout the membership and beyond.20 The process begins with a long questionnaire sent to the country to be reviewed (many interviewees made a gesture indicating a stack of paper an inch or two thick; the FATF questionnaire template is 55 pages, and the IMF assessment of Bermuda was 188 pages of questions).21 It asks about legislation, regulation, and statistics. The questionnaire is to be completed 19. Financial Stability Board, “Promoting Adherence to International Co-operation and Exchange Standards,” Basel, 2010. 20. “Inquiry into EU and International Co-operation to Counter Money Laundering and the Financing of Terrorism: Submission of the FATF Secretariat,” http://www.dspp.gov.mk/files/FATF/ %28F099%29FATFwrittenevidence.pdf (accessed October 2009). 21. Author’s interview, Tortola, British Virgin Islands, May 22, 2007.

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and returned to the assessment team, who then makes an onsite visit. The assessment team usually comprises three to six people (roughly depending on the size of the financial sector) having expertise in finance, law, and law enforcement. Reviewers may be members of the FATF secretariat or that of a regional AML body, but they are more commonly seconded foreign government officials and staff from the Bretton Woods bodies or private consultants (many individuals move between these categories over time). To the extent that private consultants are interested in repeat business, they may seek to demonstrate their value for money by writing a lot, which generally means finding as many faults to be corrected as possible during the review process.22 The team stays on-site for one or two weeks, conducting interviews with a wide variety of public sector officials and private sector representatives during the day and writing up preliminary results at night, with a little tourism thrown in as well. The impending arrival of the review team is often the cue for the host country to rush to pass and update AML legislation and regulation. The officials responsible for hosting the review team may be occupied with the questionnaire and coaching those to be interviewed in the “correct” answers to be given to the review team for two or three months beforehand. In small, developing states, the evaluation process can be a major distraction from their regular duties, which are put on hold during this time. The visit itself can be a stressful time for the hosts, who sometimes throw an impromptu party once their guests have left. Arriving at scores for the various recommendations is not only a question of having policies in place that guard against money laundering but also of meeting the FATF’s strictures as to the form of the policy. One assessor gave a candid ( private) account of the perverse results this could produce, referring to reviews of two African countries. The first was a police state with government overt and covert intelligence and security agents distributed throughout society, including in the small number of financial institutions. Needless to say, these agents possessed untrammeled law enforcement powers. As a result, the government was superbly well-equipped to know about money laundering and other kinds of crime within its small financial sector (at considerable cost to human rights). Yet the country did not have the apparatus of a Financial Intelligence Unit, suspicious transaction reporting regime, etc. and thus according to FATF standards did not have an AML system. The second example was a small, desperately poor developing country with a tiny financial sector, where not even one in twenty people had any engagement

22. Author’s interview, AML consultant, Brisbane, Australia, July 8, 2009.

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with the formal financial sector. Because they had so few customers, bank officials not only knew them well, they also knew their extended families and lineages. But once again, because they did not adhere to the procedures in the methodology, the verdict in the assessment was that these banks failed the requirement to “Know Your Customer.” In both cases it was not the effectiveness of the system actually used to fight money laundering that was in question, or even relevant, but rather the degree to which institutions and policies fit the outlines of the abstract template or model. In a controversial public remark at a regional plenary that again speaks of “decoupling,” one delegate noted that developing countries are pulled in two directions: trying to satisfy the requirements of the 40+9 Recommendations, while also actually trying to fight financial crime.23 Such instances give powerful support to the primacy of legitimacy concerns over functionality, in that policies that don’t solve a given problem are often valorized and policies that are effective in their technical function are nevertheless discredited on largely aesthetic grounds. The evaluation process of interviewing and quizzing officials also necessitates overcoming cultural obstacles, particularly in nondemocratic contexts. For example, one interviewee related the instance in which some AML functions (such as countering the financing of terrorism) are the province of the intelligence agency. In many such countries, it is not done to even mention the name of that agency; for an outsider to walk in and ask them to detail and justify their activities is unheard of. More generally, other officials may need constant reassurance that their superiors have approved the assessment, that the questions reflect general international standards, and that any criticisms should not be taken personally. Toward the end of an evaluation visit the host government is presented with a draft report and scorecard to respond to, usually giving rise to some haggling over the ratings. The draft report is usually in English, more rarely in French or Spanish, which may create translation problems for the country reviewed if these are not the local languages. In some areas agreement about scoring is reached between the hosts and on-site assessors, but it is common for reviewers and reviewed to be left unreconciled in others. Interviewees recounted a number of tactics that could be used in the event that governments are completely outraged by a long string of bad grades and criticisms in the report. One tactic is to suggest that, although the evaluation team could change the grades to whatever the host government wanted, it would 23. Author’s observation, Asia-Pacific Group on Money Laundering plenary, Brisbane, Australia, July 6 –10, 2009.

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not be in the government’s own best interest to do so. This is purportedly because the more bad grades there were, the more foreign technical assistance the government would receive to fix the problems identified (although arguing that a bad score has no real negative effects is highly misleading, as discussed in the section on competition). Whether the evaluation teams can or do allow governments to write their own report cards seems unlikely; if so it would certainly be a gross violation of the evaluation process. More rarely, and in direct contravention of the formal rules, an assertive and determined government can veto an unflattering evaluation, which is then simply listed for years on end as “under consideration” or some other euphemism. Except in these rare instances, draft reports are then taken to the next plenary meeting to be discussed in general session after having been circulated to all delegates in advance. After the plenary discussion, countries are expected to provide regular postevaluation reports explaining what they are doing to fix the deficiencies identified. Given that more and more countries fall within the Mutual Evaluation Process, and others undergo their second or third review, the number of those people accustomed to the evaluation process (from either or both sides of the process) becomes steadily larger. The AML policy community becomes correspondingly larger and more culturally entrenched.

Sites of Socialization 2: At the Plenary The uniformity of the process by which these evaluations are discussed was quickly apparent when I observed a dozen of these reports being discussed in five plenary meetings of the FATF, the Asia-Pacific Group, and the European regional body (MONEYVAL). This impression is confirmed by interview accounts. Usually two hours are allocated for the discussion of each report. This standardization is striking because it seems to apply almost regardless of the severity of the money-laundering problems in the country, in keeping with the idea of standardization regardless of particular national circumstances. For instance, in a plenary in 2009, the session on the Cook Islands ( population 13,000) took one hour and forty-five minutes, whereas the session on Pakistan was only twenty-five minutes longer (and much of this difference stemmed from tactical errors by the Pakistani delegation). The report on the Cook Islands was 220 pages long and that for Pakistan 248 pages. The Cook Islands’ described its most common predicate crime as the occasional theft of small electrical goods, such as mobile phones and DVD players. The Cook Islands received a very strong assessment, better than most OECD countries, after separate AML assessments by the Asia-Pacific Group

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on Money Laundering (twice), FATF, and IMF, as well as receiving technical assistance in this area from the Australian and New Zealand aid agencies, the Australian Attorney-General’s Department and FIU, the IMF, and the United Nations Office on Drugs and Crime (UNODC). The equivalent problems for Pakistan include being one of the world’s major drug transhipment locales, hosting several of the world’s deadliest terrorist groups and their associated financial infrastructure, having massive and endemic corruption (extending to the head of state), dealing with several active insurgencies, which meant that significant portions of the country are off-limits to law enforcement, and having a high level of serious general crime (kidnapping, extortion, smuggling, etc.). Aside from these problems, Pakistan had also aroused the particular ire of the FATF by its foot-dragging in criminalizing the financing of terrorism. As a result, the country had been privately threatened with suspension from the Asia-Pacific Group and publicly criticized by the FATF in 2009 and 2010. The report went on to find a whole series of other serious problems with the country’s AML system. Thus by any commonsense yardstick, the money-laundering threats in Pakistan are orders of magnitude greater than those in the Cook Islands. One might have thought that a body wedded to the doctrine of “risk-based assessment” might have spent its time concentrating on the manifestly greater risk. Yet in keeping with the idea of conforming to the same policy template regardless of even the most obvious and massive differences between countries’ circumstances, both were “processed” according to the same standard operating procedure. The standard format is for the review team to begin by introducing themselves and thanking the government reviewed for its hospitality and cooperation during the on-site visit before moving on to briefly summarize the main conclusions of the report. Although most countries send only a few delegates to the plenary, those reviewed usually send a larger delegation led by a very senior official from the ministry of finance or equivalent, who may not have much specific experience in money-laundering policy. The country delegation introduces itself, responds to the review team’s opening assessment, thanks them for their hard work, but then asks for upgrades on a number of scores (from Non-Compliant to Partially Compliant, Partially Compliant to Largely Compliant, etc.). Despite the pleasantries at the beginning, the country respondents may become obviously frustrated at what they see as unfair assessments resulting from foreigners’ misunderstandings of their native law and language. This can lead to the spectacle of those from the floor trying to instruct, for example, Finnish justice ministry officials on the finer points of Finnish law or Turkish officials on the particular nuances of

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a specific Turkish word or phrase. Although the language of the report and the review team’s opening statement is quite technical, it can also be direct and bluntly critical. The remainder of the session is taken up with questions from the floor to the assessment team and the country delegation, either in response to the particular appeals or other matters. Before the conclusion, the chair asks if there is support for each of the upgrades requested. The most usual response is silence, with perhaps a quarter of the requests being granted. The process of public criticism and implied rebuke (when upgrades are not granted) from one or two hundred of one’s peers is clearly an experience many officials do not enjoy, especially those from authoritarian countries. Often, the country delegation can be seen bitterly disputing the results (which are nevertheless final) in the break immediately after the session. But the assessment team is also implicitly up for public evaluation by their peers, and it can provoke some nervousness. More generally, although discussing the evaluation reports takes up a major portion of the time for each plenary, there are also other significant tasks. The FATF holds its plenaries in February, June, and October, alternating between Paris and whichever country holds the presidency for that year. Regional bodies generally hold annual plenary meetings. Plenaries may attract up to three hundred delegates and one or two representatives from around two-dozen observer organizations. These include the regional AML bodies, the multilateral development banks, the UN Office on Drugs and Crime (UNODC), the Commonwealth, the International Association of Insurance Supervisors, the Offshore Group of Banking Supervisors, etc. A FATF plenary usually takes four to five days, with the first couple of days taken up with the meetings of the various working groups, such as the International Cooperation Review Group discussed in the last chapter. The remainder of the time is spent in plenary session. The opening of the latter sees the only involvement of politicians and the media as a local minister gives a brief welcome to the delegates, wishes them a successful meeting, and then leaves with journalists in tow. Although there is certainly blunt talk, the atmosphere particularly at the FATF meetings is notably collegial. Even during the formal sessions it is common for many delegates, who have apparently known each other for years, to refer to each other by first names. As one new member of the secretariat put it to me on the opening day of the plenary, “It feels like you’re crashing someone else’s party.” At the welcoming social events, it is clear that many delegates are well acquainted, sometimes even friends. There is an informal FATF tradition of karaoke on Thursday (the last evening when the plenary is in session), perhaps in part explaining the fall off in numbers

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often observed on Friday. Aside from the national delegates regularly representing their countries at the FATF, many attendees know each other from previous jobs. One official remarked on the “musical chairs” that took place among international civil servants in this field after September 2001, and the massive expansion of the AML industry since that time has provided many more opportunities. Other delegates hold different responsibilities concurrently. Thus one senior representative was simultaneously cochair of an FATF working group, chair of a committee of the International Organization of Security Commissions, and senior representative to the Financial Stability Forum, in addition to his “day job” in the national financial regulatory agency. Much of the formal proceedings, and even more of the informal interaction, is taken up with coordinating the activities of different organizations in attendance. All of the working groups, and most of the plenary session, are conducted in English, although with a blizzard of acronyms and technical references to subsections of the 40+9 Recommendations methodology. The FATF in particular prides itself on being a business-like “apolitical” institution dedicated to getting the job done,24 in implicit contrast to other bodies more concerned with what is regarded as time-wasting political grandstanding and pointless diplomatic formalities (delegates at the FATF plenaries speaking more than once on the same issue routinely apologized for taking the floor again). Eric Helleiner notes of AML community: Consensus among financial policy makers in the leading financial powers has been easier to reach than “realist” political scientists predict with their models of governments being driven only by political perceptions of national self-interest. What the realists neglect is the extent to which policy makers in these countries find themselves working in increasingly tight transnational networks of officials who share similar worldviews.25 Even those from other organizations acknowledge that the FATF has an impressive record of results, especially given its very small staff and budget.26

24. Barnett and Finnemore, Rules for the World, 24–27. 25. Eric Helleiner, “The Politics of Global Financial Reregulation: Lessons from the Fight Against Money Laundering,” Center for Economic Policy Analysis, Working Paper 15, New School, New York, April 2000, 10. 26. Author’s interviews, UNODC, Vienna, Austria, September 17, 2004; World Bank, Washington D.C., September 7, 2004.

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Something of the exception that proves the rule occurred when there was a break in this technical, “apolitical” tradition during the discussion of blacklisting “Northern Cyprus” in an International Cooperation Review Group meeting. Supporting the Cypriots, the Greeks ironically regarded blacklisting under this name as a diplomatic compliment, given that it implicitly recognized the statehood of the Turkish Republic of Northern Cyprus. The Greeks passionately insisted that this area be referred to, if at all, by the term “Area of the Republic of Cyprus over Which the Government of the Republic of Cyprus Does Not Have Effective Control.” For their part, the Turkish plenary delegation baited their neighbors by repeatedly using the term “Turkish Republic of Northern Cyprus” until being ruled out of order by the chair. They then switched to “TRNC.” The other delegations’ exasperation with both sides was reflected by the chair when he stated that the FATF was “not a political organization,” that the delegates were “not diplomats,” but rather were merely there to do a technical job (“Northern Cyprus” stayed on the list).27 With this sole exception at the five plenaries observed, the delegates did indeed seem to maintain a technical, apolitical persona, even when deciding deeply political issues. In discussing a proposal for greater ministerial involvement, some delegates explicitly stated that this technical identity and informality (as a task force rather than formal institution) was at the heart of the FATF’s effectiveness. It was decided that there was no need for ministers to be involved. The technical and collegial atmosphere at the plenary meetings did not mean that power differentials were absent, or even invisible, however. The FATF does not use a formal voting system. When differences arise in discussion, either the minority group acknowledges and defers to “the sense of the meeting” or the chair seeks to craft a compromise solution. But whereas most states were quick to concede when the discussion ran against them, France, Britain, and especially the United States were much keener to hold out for a compromise that gave them at least a good portion of what they wanted. These three countries also tended to combine (often with Canada and Australia) to push for more aggressive solutions and a more expansive mandate. Germany, Italy, Russia, and the Latin American and the smaller European states, on the other hand, were usually keener on softer measures and a narrow focus on money laundering. U.S. delegates were also prominent as chairs of the most important working groups (e.g., Daniel Glaser as cochair of the International Cooperation Review Group and previously

27. Author’s observation, FATF plenary, Strasbourg, France, February 19–23, 2007.

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the NCCT process) and as energetically engaging in informal diplomacy during recesses. One senior delegate from a small country joked (or halfjoked), “Everyone knows Danny Glaser runs the FATF.”28 This is not to say the United States can get anything it wants from the FATF, however. Its effort to include Venezuela on the new blacklist in 2007 received no support and was dropped. Experienced individual delegates such as those from the Netherlands, New Zealand, Austria, and Portugal can have disproportionate influence on discussions compared with the Russian or Chinese delegations, thanks to their long familiarity with the procedures. Aside from the relationship between members, there is the relationship with the FATF secretariat, as of 2010 expanded to eighteen people (from ten in 2004 and three in the early 1990s). International relations scholars of late have been impressed by the ability of international institutions to maintain a good measure of autonomy vis-à-vis their erstwhile member-state masters.29 Clearly, the United States delegation was alive to this possibility and made it quite clear that the FATF was a organization steered by members and not the secretariat. In this context, a U.S. delegate at the Asia-Pacific Group plenary noted that the United States pays for a third of the FATF’s budget (of $3.5 million), 20 percent of the Asia-Pacific Group’s budget ($1.3 million), and half of the UNODC Global Program on Money Laundering. Aside from handling logistics, the secretariat plays an important role in setting up subgroup intersessional meetings of countries working on specific issues to report back to the next forum. One delegate estimated that on average these intersessional meetings took up a couple of weeks a year in face-to-face meetings plus extensive e-mail contact. The Asia-Pacific Group plenary shared many similarities with the FATF meeting but also some important differences. Having only one meeting a year, and with a larger membership, many of whom were new to the organization, there was less camaraderie among the delegates (although just as much among the representatives of the twenty-odd observer international organizations). The secretariat took a more obvious role, and the white ( predominantly Australian) color of the secretariat contrasted with the Asian-dominated

28. Ibid. 29. Barnett and Finnemore, Rules for the World; Daniel Nielson and Michael J. Tierney, “Delegation to International Organizations: Agency Theory and World Bank Environmental Reform,” International Organization 57 (2003): 241–76; Bertjan Verbeek and Bob Reinalda, eds., Decision Making within International Organizations ( London: Routledge, 2004); Catherine E. Weaver, Hypocrisy Trap: The World Bank and the Poverty of Reform (Princeton: Princeton University Press, 2008); Patrick Weller and Yi-chong Xu, “To Be but Not To Be Seen: Exploring the Impact of International Civil Servants,” Public Administration 86 (2008): 35–52.

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membership. The “AML literacy” of the delegates was clearly much more varied than at the FATF meetings. Some developing country delegates were embarrassed by not having answers to fairly elementary questions. Nevertheless, the process of working groups and evaluation reviews took place along lines similar to those described above for the FATF. Indeed, the FATF representative did not hesitate to intervene in the discussions when procedures deviated from the FATF model and methodology. From interview accounts, meetings of the African bodies are much more overtly political, with a prominent role for ministers and a weakness for grand declarations often left as a dead letter. A final note is the importance of training and technical assistance for socialization. Aside from the evaluation visits and seminars, often officials in the AML system of a developing country are taken to a developed country for training for a period of weeks or months. Immersing an individual from a very different context in the culture of a Western FIU is a particularly powerful means by which to inculcate appropriate role-playing. Alternatively, an expert from the World Bank, IMF, Commonwealth, UNODC, or national agency may be seconded to the FIU in a developing country. Taking officials from developing countries seems to be particularly popular among bodies granting technical assistance, so much so that the number of staff absent being trained overseas sometimes poses a threat to the functioning of the institution they belong to. The number of capacitybuilding workshops, training opportunities, seminars, and plenary meetings sometimes meant that performing basic AML tasks was impossible. In the limiting case, one-person FIUs simply stop functioning when that person is out of the country attending plenaries, seminars, or being trained. The private sector has also gotten into the act, with the Association of Certified Anti-Money Laundering Specialists offering training and a professional qualification.30 Here it is worth reiterating how important sociologists consider professional education and accreditation for inculcating institutional routines.31

Is Socialization Really Power? It is easy to assert the influence of mimicry or socialization but difficult to prove it. The sections above have provided detailed, first-hand evidence of these processes at work, especially in its most intensive phases during the 30. See http://www.acams.org (accessed March 2010). 31. DiMaggio and Powell, The New Institutionalism; Drori and Krucken, World Society.

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mutual evaluations and plenary meetings. There is a close fit between the general characteristics that the literature suggests are conducive to socialization and the particular circumstances that prevail in the transnational AML community. Sociologists suggest that mimicry will be most common when the relationship between policy means and ends is unclear and when it is difficult to measure success and effectiveness. AML policy has these problems to an extreme degree. Political scientists aver that socialization will take place most readily where there is intensive and repeated face-to-face interaction, as there is during mutual evaluations and plenaries (and even more so during secondment), which serve to reproduce and consolidate the AML policy community as well as induct new members. The last tranche of evidence, presented below, is used to show the durable routines and role-playing that result in action on a day-to-day basis. Even more importantly, however, this material bolsters the proposition, central to the overall argument of the book, that socialization represents an expression of power. Support for this claim is taken from interviews and observation in dedicated AML seminars, but most importantly it is taken from workshops I arranged that were akin to focus group meetings.32 However, it is necessary to explain why mimicry or socialization reflects power at work. In contrast to the ideas of states or individual officials seeking to receive public praise and enhanced self-esteem,33 mimicry as seen in AML policy diffusion is driven by fear of losing social acceptance. As Kurt Weyland puts it: “Governments dread the stigma of backwardness and therefore eagerly adopt policy innovations, regardless of functional needs.”34 Michael Levi and William Gilmore (the latter with a great deal of personal experience as an AML evaluator) state, “The term ‘mutual evaluation’. . . serves the purpose of making international relations look voluntary.”35 Those in technical assistance meetings for developing countries note the reluctance to admit to problems in front of officials from neighboring countries and the general desire to keep up appearances.36 One Caribbean regulator described the mutual evaluation process as “a beauty pageant.”37 Even in the very early days of the mutual evaluation process, before reports were made public, the FATF president 32. For the use of focus groups, see Ted Hopf, “Making the Future Inevitable: Legitimatizing, Naturalizating, and Stabilizing the Transition in Estonia, Ukraine, and Uzbekistan,” European Journal of International Relations 8 (2002): 403–436. 33. DiMaggio and Powell, The New Institutionalism. 34. Kurt Weyland, “Theories of Policy Diffusion: Lessons from Latin American Pension Reform,” World Politics 57 (2005): 270. 35. Levi and Gilmore, “Rise and Rise of Mutual Evaluation,” 360. 36. Author’s interview, Commonwealth, London, UK, May 15, 2007. 37. Author’s interview, Tortola, British Virgin Islands, May 22, 2007.

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noted, “Countries are concerned to have a good story to tell their examiners and thus there is an impetus to get things done that would otherwise be lacking.”38 More generally, Marieke de Goede argues that the FATF achieves its aims as it “deploys technical standards and scorecards in order to induce self-government by states and financial institutions. Above all, the FATF’s is a normalizing power: it does not fix or prescribe the precise set of laws to be implemented but offers evolving standards of normality, best practice, and narratives of reliability that ‘good’ states and financial institutions will wish to adhere to.”39 As noted above, the FATF, IMF, and others simply take for granted that all countries require an AML system. As such, countries do not get plaudits for meeting this minimum international standard and prerequisite for responsible statehood any more than they get plaudits for having a flag or claiming a monopoly on the use of force within their borders. Thus rather than experiencing approbation and enhanced status for their hard work in adopting AML policy, developing states at best avoid condemnation and ostracism (the “deficit model” from chapter 2 again). If power is regarded as actors’ capacity to determine their circumstances and fate,40 it can be seen that this kind of stigma-avoiding socialization represents an exercise of power. By understating the power-based character of socialization or mimicry, scholars have also understated to a significant degree the proposition that, especially for the developing world, policy diffusion in this way is often a coercive process. The policy community’s power, conferring or withholding sought after social acceptance rather than material goods, stems from its control over a body of technical knowledge and language, in this case the arcana of AML policy discourse. In the surveys and focus groups from Barbados, Mauritius, and Vanuatu, the major puzzle was the disconnect whereby a large majority of regulators identified the AML policy changes as being good for the financial services industry, but these same respondents could not identify any significant material benefits stemming from these changes.41 It became apparent that the audience regulators were playing to was not domestic but rather the

38. Levi and Gilmore, “Rise and Rise of Mutual Evaluation,” 349. 39. Marieke de Goede, “Governing Finance in the War on Terror,” in Crime and the Global Political Economy, ed. H. Richard Friman ( Boulder: Lynne Rienner, 2009), 114. 40. Michael Barnett and Raymond Duvall, “Power in International Politics,” International Organization 59 (2005): 39–75. 41. J. C. Sharman and Percy S. Mistry, Considering the Consequences: The Development Implications of Initiatives on Taxation, Anti-Money Laundering and Combating the Financing of Terrorism (London: Commonwealth, 2008).

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transnational networks of regulators in and around formal international organizations. At a later interview in Samoa, when asked what domestic benefits the AML regime produced for the country, the regulator replied, “Our image and standing in the international community.”42 Regulators from these countries and most others are engaged in assessments, meetings, conferences, and exchanges conducted with a huge number of international organizations. Prominent among these are the FATF-Style Regional Bodies, but also the FATF, World Bank, IMF, OECD, Financial Stability Forum (from 2009 the Financial Stability Board), International Organization of Securities Commissions, International Association of Insurance Supervisors, Offshore Group of Banking Supervisors, and many others. Regulators reported spending more and more time and effort participating in and responding to the demands of these bodies, time and effort that could be freed up only at the expense of purely domestic duties. It is symptomatic that in planning the regional workshops in Barbados, Mauritius, and Vanuatu and scheduling interviews, it was difficult to pick a date on which the local regulators were not already booked dealing with visiting international delegations or themselves overseas at conferences. Going to plenaries and conferences turned out to be a more reliable strategy for interviewing developing country regulators than trying to catch them in their home countries. As regulators have become more enmeshed in these transnational networks, both at a regional and global level, the reference group that determines social standing is that of regulators’ foreign counterparts and assessors rather than fellow officials at home or private foreign investors. National policies are measured and declared to be either meeting minimum international standards or failing to meet these standards. AML standards are an extreme example because regulators see their country (and by implication, themselves) publicly graded in front of their peers in a document they have no unilateral prerogative to amend or suppress. The only consolation is the knowledge that their peers go through the same process, building fellow feeling. Although those writing about regulators commonly worry about their being “captured” by the industry they are meant to be supervising, in this case the regulators have been captured by their foreign counterparts. Like most professionals, regulators are troubled if they know their peers regard them as doing a bad job. In speaking of such regulatory networks, Anne-Marie Slaughter notes: “Having and caring about a reputation among one’s peers is a very powerful tool of professional socialization—in the

42. Author’s interview, Apia, Samoa, June 30, 2009.

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profession of governance no less than in the private or nonprofit sector.”43 There can be particular pressure on officials from developing countries in facing a much larger number of their more educated and more confident Western counterparts.44 One Nauruan official painfully recollected what he thought was a brief courtesy visit to Washington but that instead turned into an ordeal as he faced a three-hour grilling from a phalanx of U.S. Treasury and Justice Department lawyers about Nauru’s deficient AML standards.45 Others talked of the reluctance to walk into a room full of counterparts from other countries and know that these others are disapprovingly talking about failures in one’s own country.46 Organizations thus shape policy through the desire of national regulators to avoid being seen as derelict in their duties, backward, or substandard by their peers.47

Competition Effects Competition effects are one of the most commonly adduced mechanisms in explaining diffusion. This is especially so for scholars working with the assumption, taken from economics, that states and other actors act rationally in maximizing net utility when presented with alternative courses of action.48 This logic suggests that policies will diffuse when they help countries solve concrete problems and secure material benefits. More broadly, other commentators have seen the competition-induced convergence of policies across nations as constituting the most important dynamic of globalization.49 In this rendering, the bidding war between states for mobile capital supposedly forces them to adopt increasingly homogenous investor-friendly measures in hewing to the dictates of the “Washington consensus.”50 Rather than operating at such a rarified level, the ambitions of this book are much more

43. Anne-Marie Slaughter, A New World Order (Princeton: Princeton University Press, 2004), 54. 44. Author’s interview, Pacific Island Forum, phone interview, September 27, 2002. 45. Author’s interview, Nauru, August 18, 2008. 46. Author’s interview, Port Vila, Vanuatu, March 5, 2004. 47. Fabrizio Pagani, “Peer Review: A Tool for Co-operation and Change: An Analysis of the OECD Working Method,” paper prepared by Directorate for Legal Affairs for General Secretariat, 2002. 48. For example, Beth A. Simmons and Zachary Elkins, “The Globalization of Liberalization: Policy Diffusion in the International Political Economy,” American Political Science Review 98 (2004): 171–89; Beth Simmons, Frank Dobbins, and Geoffrey Garrett, eds., The Global Diffusion of Markets and Democracy (Cambridge: Cambridge University Press, 2007). 49. Thomas L. Friedman, The Lexus and the Olive Tree (New York: Anchor, 1999). 50. For example, David C. Korten, When Corporations Rule the World ( Bloomfield, CT: Kumarian Press, 1995).

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modest and focus on just one policy area. The argument relies on the effects of competition, but adopts a different understanding of how this mechanism produces diffusion. Competition is another manifestation of structural power and one in which the rationality at work is the effect of the symbolic and normative context that valorizes the standard model of AML policy. If competition effects are about governments exercising their discretion to pick the option that leaves their countries best off, this would seem to be a poor fit with most notions of power and coercion. But, in fact, for developing governments in particular, the choice is between a bad option, adopting the standard template of AML regulations, and a worse one, not adopting the standard template. Adoption encumbers them with an expensive apparatus that does little or nothing to address local priorities. Failure to adopt, however, serves to endanger the country’s place in the international financial system, already marginal for the majority of developing countries. It is not the choice that matters so much as the structure of incentives that serves to determine the choice. Lloyd Gruber’s work on a similar kind of structural power explains how governments can “voluntarily” choose options that leave them worse off as a result.51 According to Gruber’s logic, a core group of states may join together in a common enterprise, say a customs union, in such a way that leaves this core group better off, but presents third-party states with two unequally unattractive choices. Ideally, the third parties would prefer the status quo prior to the customs union. But because, for example, trade shifts in line with the new opportunities presented, the status quo option vanishes. Instead, third parties can either join the customs union, which leaves them worse off, or stay isolated, which entails an even bigger price. Matching this logic to the case at hand, the core group is the FATF countries, whose adoption of AML standards shifts incentives for private firms. This means the pre-AML world is gone, never to return, and those outside the circle are left with the bad option of joining up or the worse one of staying out. To what degree have competitive forces coercively influenced the diffusion of AML policies among developing states in this manner? It would seem that the prevailing tide of liberalization and deregulation would militate against the spread of AML requirements given the costs imposed on firms discussed in chapter 2. In fact, the mechanism of competition has produced the opposite effect; the decision of country A to refuse to introduce AML regulations puts it at a competitive disadvantage relative to its peers.52 At first,

51. Lloyd Gruber, Ruling the World: Power Politics and the Rise of Supranational Institutions (Princeton: Princeton University Press, 2000). 52. Helleiner, “The Politics of Global Financial Reregulation”; Lowenheim, “Examining the State.”

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investors’ logic may seem to reflect a simple calculation: if the return on investment adjusted for risk is higher in country A than country B, investment will flow to the former and away from the latter. If country B is perceived to have a problem with money laundering whereas country A does not, the same investment flow will result. But matters are more complicated. There is a sort of public-private-public progression at work. Intergovernmental organizations set standards, which are interpreted and utilized by private firms, which in turn create a structure of incentives that pushes governments to adopt AML policies. Unlike decisions taken on the basis of differential corporate tax rates, inflation, or histories of sovereign debt defaults, there is no way to measure money-laundering risk.53 The head of the U.S. Financial Crimes Enforcement Network suggested firms may often apply AML safeguards on a “hunch.”54 The Wolfsberg Group, the AML think tank for the major international banks, notes in its guidelines that “it is difficult (at times impossible) for an institution to distinguish between legal and illegal transactions, notwithstanding the development and implementation of a reasonably designed risk based approach in an institution’s anti-money laundering program.”55 What proxies there are can send conflicting signals. For example, despite receiving relatively good FATF evaluations, all G7 countries are classified by the U.S. government as high-risk for money laundering.56 But the lack of objective measures does not change the imperative whereby private firms and public regulators feel the need to “do something” to protect the company or country from international money laundering.

Private Actors and Structural Power AML policy is exceptional in the degree to which governments and regulators have delegated policing and implementation functions to private firms.57

53. Zoe Lester, “Anti-Money Laundering: A Risk Perspective,” Ph.D. thesis, University of Sydney, 2009. 54. R. T. Naylor, Wages of Crime: Black Markets, Illegal Finance, and the Underworld Economy (Ithaca: Cornell University Press, 2004), 330. 55. Wolfsberg Group, “Wolfsberg Statement on Guidance on a Risk Based Approach for Managing Money Laundering Risks,” March 2006, 1. 56. U.S. State Department, International Narcotics Control Strategy Report 2007 ( Washington, D.C., 2008). 57. PricewaterhouseCoopers, “Anti-Money Laundering: A Global Financial Services Issue” (PricewaterhouseCoopers International, 2005); Lester, “Anti-Money Laundering Risk”; KPMG, Global Anti-Money Laundering Survey 2007: How Banks Are Facing up to the Challenge; de Goede, “Governing Finance in the War on Terror.”

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Firms are responsible for assigning risk, and those that get it wrong may incur commercial loss and even criminal prosecution. Transactions seen as high risk necessitate extra scrutiny and safeguards, which means extra expense. Firms may simply decide that investing in and transacting with countries they categorize as high risk is simply not worth the trouble. In this environment of fundamental and pervasive uncertainty, firms fall back on casual impressions and shared stereotypes in making their judgments about which countries are high- and low-risk when it comes to money laundering. Adopting international AML standards makes a country less likely to be rated as high-risk relative to competitors, according to the Wolfsberg Group: “A customer that is a financial institution, for example, regulated in a jurisdiction recognized as having adequate . . . AML standards . . . poses less risk from a money laundering perspective than a customer that is unregulated or subject only to minimal AML regulation.”58 The sensitivity to country risk is demonstrated in a worldwide survey that found that 84 percent of banks assess a customer’s riskiness based on their country of residence, the most common measure excepting only the nature of the business.59 Although some sort of AML policy is better than none at all, banks may also further distinguish risk by looking at Mutual Evaluation Reviews. They may also scan the FATF website for expressions of concern about particular jurisdictions as well as refer to various other World Bank governance indices and the Transparency International Corruption Perceptions Index.60 Rather than construct measures of a country’s AML risk in-house, banks and other firms can also purchase from specialist firms such as Know Your Country risk analyses designed for the compliance departments of international financial firms.61 These analyses construct a measure of country risk by including such factors as the percentage of Compliant and Largely Compliant ratings on the last mutual evaluation, whether the country has ever been on an FATF blacklist, its placement on the Transparency International Corruption Perceptions Index, its rating as a money-laundering risk by the U.S. State Department, whether it is subject to sanctions, its credit rating, and whether it is listed as a tax haven by the OECD. A more sophisticated product along the same lines is Country-Check, sold by World-Check, perhaps the largest commercial AML software producer.62 This is a composite index 58. Wolfsberg, “Wolfsberg Statement,” 3. 59. KPMG, Global Anti-Money Laundering Survey 2007, 25. 60. UNODC/World Bank, Stolen Assets Recovery: Politically Exposed Persons: A Policy Report on Strengthening Preventative Measures ( Washington, D.C., 2009), 40–41. 61. See http://www.knowyourcountry.com (accessed March 2010). 62. See http://www.country-check.com (accessed March 2010).

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of general country risk rather than AML risk per se, but AML variables such as mutual evaluation results are part of the index. The product is marketed primarily to private firms, but to FIUs and intelligence agencies as well. Thus despite the optimistic view noted earlier that bad evaluation grades bring only more technical assistance, the private sector takes a different view. The regional bodies Inter-Governmental Action Group against Money Laundering in West Africa (GIABA) and The Eastern and South African Anti-Money Laundering Group (ESAAMLG) both admit that their members commonly receive “horrific” evaluations, with members rarely having more than three out of forty-nine Compliant grades.63 They further concede that, although certainly better than having no AML policy at all, these bad grades can make foreign firms wary in their dealings with these countries. The tendency of the private sector to reproduce and disseminate the outputs of various AML assessments, albeit in refracted form, tends to act as a something akin to a nontariff barrier for developing countries. Because of AML ratings, large private firms have one more reason to limit their business to FATF members.64 Because the FATF is explicitly limited to “strategically important” developing states, this condemns the majority of poor countries to struggle to retain their already tenuous links with the international financial system. When it comes to AML, then, the developing world is thus locked into the sort of “bad or worse” proposition that Gruber puts forward. The issue of equivalent standards is one of the best indicators of how the private sector responds to the prompts of international organizations and powerful states by creating incentive structures for others to adopt AML policies. As discussed in chapter 2, the Know Your Customer requirement is not only one of the most important elements of the AML regime but also the most expensive from private firms’ point of view. Under the European Union Third Money Laundering Directive (2007), however, EU firms are able to accept the KYC procedures performed by other firms within the European Economic Area as equivalent, rather than repeating the whole exercise of establishing the client’s true identity from scratch. For financial firms this represents a major saving of staff time and, hence, money, while also making life easier for the client. Furthermore, the directive gives a

63. Abdullahi Shehu, “Challenges Facing FIUs/ARAs in Developing Countries,” presentation at the Cambridge Symposium on Economic Crime, Cambridge, UK, September 3, 2008; Author’s observation, FATF plenary, Paris, France, October 8–11, 2007. 64. Sharman and Mistry, Considering the Consequences, 176.

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suggested list of additional countries that are presumed to have equivalent AML measures in place and thus who may also qualify for reduced due diligence requirements. The list comprises the non-EU FATF membership, barring Turkey, China, India, and South Korea but including Russia. But beyond this presumption, the directive specifies that individual firms, not governments, are responsible for determining what counts as an equivalent jurisdiction and thus which business is eligible for reduced KYC provisions. A British Bankers’ Association guide to this issue is highly instructive in providing the logic of determining which countries qualify as having equivalent measures in place and thus how countries get sorted into an “in-group” and “out-group.”65 It lists a series of measures, none individually determinative, that serve to indicate whether or not a jurisdiction should be considered to have equivalent standards in place. It notes “particular attention should be paid to any FATF-style or IMF/ World Bank evaluations that have been undertaken.”66 Other factors include membership of a regional AML group, the level of corruption in that country according to Transparency International, whether it is now or has ever been blacklisted by the FATF, and whether the country is included in commercially produced “lists of jurisdictions [like Know Your Country] . . . that are involved, or that are alleged to be involved, in activities that cast doubt on their integrity in the AML /CTF area.” Also noted are the jurisdictions in the FATF’s 2008 statement (Uzbekistan, Turkmenistan, Northern Cyprus, Iran, São Tomé e Principe, and Pakistan). The document frankly acknowledges the logic of decoupling right from the start: “It should be noted that the basis for the exemption in the directive and the Regulations is focused on the provisions of the legislation in a particular jurisdiction, rather than what actually happens in practice.”67 The attention private financial institutions, particularly banks, give to AML is not so much because these standards are actually effective in lowering the risk that a given transaction will involve criminal money, but rather it serves as an indicator of membership of an “in-group.” Hulsse alludes to this logic: “Money-laundering in itself does not make for a bad reputation, only FATF constructing money-laundering as a problem does that.”68

65. See http://www.bba.org.uk/ content/1/c6/01/43/99/JMLSG_-_PAPER_ON_EQUIVA LENCE.pdf (accessed March 2010). 66. Ibid., 5. 67. Ibid., 1. 68. Hulsse, “Making a Global Money Laundering Problem,” 174.

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In this sense, the spread of AML standards via competition effects constitutes what Kathleen McNamara, writing on delegating monetary policy to independent central banks, refers to as a “rational fiction”: Governments choose to delegate not because of narrow functional benefits but rather because delegation has important legitimizing and symbolic properties. . . . This dynamic is rational and instrumental, as suggested by theories of delegation within the principal-agent framework, but only when placed within a very specific cultural and historical context that legitimizes delegation.69 So, too, adopting AML policies as a symbol with which to impress foreign firms is rational, not because the policy reduces risk or fits with local circumstances, but because it communicates that a country is within the fold.70 As with the standing or social acceptance of regulators, developing countries adopting AML policy in this fashion are not doing so to make a gain so much as avoid a loss. Given that the vast majority of such countries have already put some sort of system in place, despite daunting obstacles to effectiveness, they must in effect run faster and faster just to avoid falling behind. YeeKuang Heng and Ken McDonagh capture this logic in arguing that by its “benchmarking, establishing best practices, periodic monitoring, evaluation, and learning processes” the FATF set up a narrative of “competitive selfimprovement.”71 To fully appreciate the coercive cast of this mechanism, consider the case of Malawi. A poor sub-Saharan country, Malawi is not and does not aspire to be an international financial center, nor has it been associated with money laundering or the financing of terrorism. Speaking at an international financial summit in September 2006, the Minister of Economics and Planning recounted how his country had come to adopt the standard package of AML regulations. The minister was told that Malawi needed an AML policy. The minister replied that Malawi did not have a problem with money laundering but was informed that this didn’t matter. When the minister asked if the package of laws and standards could be adapted for local conditions he was told no, because then Malawi would not meet international standards in this 69. Kathleen McNamara, “Rational Fictions: Central Bank Independence and the Social Logic of Delegation,” West European Politics 25 (2002): 53. 70. See also Powell and DiMaggio, “Introduction,” 33. 71. Yee-Kuang Heng and Ken McDonagh, “The Other War on Terror Revealed: Global Governmentality and the Financial Action Task Force’s Campaign against Terrorist Financing,” Review of International Studies 34 (2008): 562–63.

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area. The minister was further informed that a failure to meet international AML standards would make it harder for individuals and firms in Malawi to transact with the outside world relative to its neighbors and thus less likely to attract foreign investment. The minister concluded, “We did as we were told”; the country adopted the standard package of AML policies.72 A similar logic was in evidence when discussing the cost of AML policy for Niger, one of the poorest countries in the world, where the FIU got its first computer two years after it was established. In response to my question “Do you think Niger can afford to have an AML policy?”, an official from an international organization pointedly answered, “Do you think Niger can afford not to have an AML policy?” Those involved in AML technical assistance in west Africa, southern Africa, Southeast Asia, and the South Pacific from several international organizations agreed that local countries felt they had no ownership of “their” AML policies and had only adopted these policies as a result of pressure from outsiders, investors, and international organizations. In keeping with the ritualistic or symbolic nature of compliance, this generally involved verbatim copying of international standards into national legislation and regulation, including where this was obviously inappropriate (e.g., rules regulating the stock market where no stock market existed). Rather than some hopelessly optimistic belief that these standards would solve local problems, cut-and-paste copying was the cheapest and easiest way of giving outside audiences what they wanted. Unlike those who regularly spent time providing technical assistance in the developing world, Western delegates to the FATF (which does not provide technical assistance) rarely showed much sympathy for the plight of developing countries in this regard, with exceptions such as the Netherlands, Austria, and especially South Africa. The attitude of the UK Treasury that all countries must adopt the same rules and be held to the same standards was more typical. Their rationale for the adoption of AML policy in the developing world comprised a series of fall-back positions. The first was that AML policy provided important benefits for developing countries. Upon being pressed for evidence, the more nuanced position was that, although there might not currently be evidence that AML policy is providing benefits for developing countries, it would in the future. Their final, nonnegotiable position was that regardless of any local benefits now or later, AML standards were an essential prerequisite for membership in the global economy, and

72. Author’s observation, Commonwealth Finance Ministers’ Meeting, Colombo, Sri Lanka, September 13, 2006.

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thus every country must have them.73 For this reason the British government saw any attempt to measure the costs and benefits of AML policy in developing countries as at best pointless and at worse dangerous because of falsely giving the impression that developing countries somehow had a choice of whether or not to conform to international standards in this area. The belief that AML policy was a natural and unavoidable concomitant of maintaining inward investment flows and access to international financial networks was thus common to both the standard-setting (the FATF ) and technical assistance organizations (Commonwealth, the UNODC, the World Bank, Western government aid agencies), as well as developing country governments. But this belief also extended to the private sector in developing countries. A regulator from Samoa noted that private firms in the country were initially dismayed by the high costs AML regulations imposed but had become “resigned” to them as the cost of maintaining international links.74 A private sector representative from Belize concurred that everyone in the financial sector recognized that AML procedures were essential, despite being very time-consuming.75 In the interviews and focus groups in Barbados, Mauritius, and Vanuatu (2005–2006), the overwhelming consensus from the banking, securities, insurance, and legal representatives in attendance was that no price was too high to pay for an AML system. This conclusion was despite the view that AML regulations had imposed high costs with few benefits and had not improved competitiveness.76 The equation was simply seen as being no AML system, no international financial services industry. For these firms, one did not look to an AML policy for benefits so much as for survival.77 Once again, Nauru is a limiting case. From 2001 until May 2008, the only way to move money in and out of Nauru was in a suitcase. What brought this situation to an end was the opening of a single Western Union branch that, for a 10 percent fee, enabled people to send and receive wire transfers. Western Union, however, required a great deal of convincing to allow the office to be opened, and in particular it requested a copy of Nauru’s AML legislation, which it painstakingly compared to international standards.78 A simple “dollars and cents” account that does not take into account the “rational fiction” angle, the ritualistic nature of AML policy adoption, provides a misleading explanation of the competition mechanism at work. There 73. 74. 75. 76. 77. 78.

Author’s argument, UK Treasury, London, UK June 19, 2006. Author’s interview, Apia, Samoa, June 29, 2009. Author’s interview, law firm, Panama City, Panama, April 4, 2008. Sharman and Mistry, Considering the Consequences. Ibid., 175. Author’s interview, Nauru, August 18, 2008.

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is no evidence that the presence of AML policies either decreases moneylaundering risk in the developing countries or even acts as an indicator of such risk. The best guess of many money-laundering experts is that the country with the best FATF evaluation, the United States, is also home to more money laundering than any other.79 In this sense it is not rational for firms to assign risk on this basis or for developing countries to adopt such policies. Absent the context that valorizes AML policy, making it a potent symbol for the benefit of international investors despite its lack of functional effectiveness, these decisions are mystifying. It bears stressing that although symbolic actions (and inaction) may have material effects, they cannot be reduced to such effects.80 Regulators have delegated responsibility for assessing a country’s AML risk to international banks and other financial firms. These risk ratings determine the competitive position of developing countries in terms of their attractiveness as investment destinations and the ease with which they can use financial networks. Because of the lack of objective measures for AML risk, private firms unintentionally create material incentives for developing countries to adopt AML policy as “rational fictions.” Unlike blacklisting, the exercise of power is decentralized (many firms acting in an uncoordinated manner) and noninstrumental (firms do not aim to promote compliance with AML regulations). The competition mechanism generates compliance that tends to be more instrumental and deliberate than the habitualized roleplaying engendered by socialization, but it is a similar instance of structural power. Representatives from both public and private institutions in developing countries simply regarded AML policy as a prerequisite of dealing with the outside world, the regulatory burden repeatedly being referred to as “a cost of doing business” (even if there was also grumbling about regulators being the “business prevention team” or similar comments). As with socialization, competition effects depend on the initial impetus of blacklisting. For the competitive dynamic and the “rational fictions” of AML policy to diffuse, a certain critical mass of states must have already adopted AML standards. After this point, there is a self-reinforcing dynamic whereby as the policy diffuses more widely, the pressure to join increases. Holdouts are seen as ever more out of step and face more numerous compliant (and 79. William C. Gilmore, Dirty Money: The Evolution of Money Laundering Counter-Measures (Strasbourg: Council of Europe, 1995), 232; Reuter and Truman, Chasing Dirty Money, 180; John Walker and Brigitte Unger, “Measuring Global Money Laundering: The ‘Walker Gravity Model,’ ” Review of Law and Economics 5 (2009): 821–53. 80. DiMaggio and Powell, The New Institutionalism; Barnett and Finnemore, Rules for the World; Weaver, Hypocrisy Trap.

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thus more attractive) rivals for investment. The FATF Revised Mandate 2008–2012 bluntly states: “full and effective roll out of the 40+9 Recs in all countries is one of the fundamental goals of the FATF.” Sounding rather utopian, the FATF has set in train self-reinforcing processes of socialization and competition that have now made AML policy a near-universal token of responsible statehood. The chapter began with the puzzle of why both public officials and those in the private sector in the developing world agree that AML policy is in their country’s best interest when there is a good deal of evidence that this policy delivers meager benefits and imposes substantial costs. The coverage of blacklisting, socialization, and symbolic competition mechanisms has aimed to show how, through these related exercises of power, countries are pushed to adopt AML standards. The detailed evidence presented demonstrates how the superficial impression of willing, voluntary compliance obscures both direct, calculated coercion and more indirect structural power. The significance of this finding, examined in the book’s conclusion, is to illustrate how policy diffusion in general can in fact be a much more coercive process than most scholars allow. The failure to appreciate how little control weak states may have over “their” domestic policies is a product of a lack of appreciation of the mechanisms by which this occurs and the relative scarcity of direct methods. But the question posed by many in the developing world, as well as the UK Treasury, remains. What is the value in pointing out that AML policy is in fact an expensive failure given that in practice all countries now have to adopt the FATF’s standards anyway? Scholars aside, how does this finding actually help anyone? Although the book certainly does not seek to present policy blueprints, the conclusion offers some suggestions as to how developing countries in particular can make the best of a bad situation. Thus, as well as arguing that scholars need to broaden their conception of power in diffusion, the concluding chapter is also devoted to making suggestions as to how the worst effects of AML policy can be mitigated.

Conclusions Implications for Scholarship and Policy

Those studying the spread of uncannily similar policies and institutions in radically different contexts generally work from one of two complementary perspectives. First, looking from the top down (e.g., in global statistical studies), there is a suspicious amount of similarity between policies and institutions regardless of very different contexts. Second, despite much rhetoric about efficiency and rational design, looking from the bottom up (e.g., in local ethnographic studies), the design and operation of policies and institutions seems to have very little to do with a technical, functional logic. It is important to note that these insights are complementary. For, “if bureaucracies do not act according to their rationalized formal structures, then the efficiency of rational formal structure cannot be the reason for their proliferation. . . . Organizations exist, proliferate and have the form they do not because they are efficient but because they are externally legitimated.”1 The gap or decoupling between the functional rationale for anti-money laundering systems and the way they work in practice is a close fit with the ideas of those who explain institutions as symbols or ceremony: “Administrators and politicians champion programs that are established but not 1. Martha Finnemore, “Norms, Culture and World Politics: Insight from Sociology’s Institutionalism,” International Organization 50 (1996): 329.

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implemented; managers gather information assiduously, but fail to analyze it; experts are hired not for advice but to signal legitimacy.”2 There is a great stock of wisdom in this literature as it relates to diffusion, but there are also some important shortcomings. In particular, I have argued this kind of work underrates the importance of power in diffusion and the different ways coercion produces effects. Global governance is less a process of consensually addressing common problems and more one of the strong regulating as they will and the weak suffering as they must.3 The other main point is that those studying big international issues, such as the growing sameness of formal institutions and policies, have ignored the potential of direct methods, such as rule-testing by rule-breaking. This concluding chapter briefly suggests why we should pay more attention to power in diffusion and the utility of direct methods. There are also important policy implications. Since AML policy is now entrenched, despite its expense and lack of effectiveness, I offer some brief policy suggestions on how poorer countries can make the best of a bad situation. These suggestions center on using existing AML systems to fight corruption. Aside from its inherent importance, the introduction suggested that the diffusion of the regime to counter money laundering has become a model for the G20’s regulatory campaigns in response to the 2007–2009 crisis. Thus the last section shows how the new techniques of coercive global governance, such as blacklisting, socialization, and symbolic competition, are themselves diffusing to other policy domains.

Power If policies and institutions are emulated for reasons of legitimacy rather than because of their technical problem-solving ability, the spread of AML policy, despite its low effectiveness, is understandable. A basic insight from the work at the heart of this book is that in most countries AML policies and associated formal organizations such as Financial Intelligence Units are not there primarily to fight money laundering: “rather, they are mainly display windows

2. Paul J. DiMaggio and Walter W. Powell, “Introduction,” in The New Institutionalism in Organizational Analysis, ed. Walter W. Powell and Paul J. DiMaggio (Chicago: University of Chicago Press, 1991), 3. For other classics in this vein, see John W. Meyer and Brian Rowan, “Institutionalized Organizations: Formal Structure as Myth and Ceremony,” American Journal of Sociology 83 (1977): 340 –63; James G. March and Johan P. Olsen Rediscovering Institutions: The Organizational Basis of Politics (New York: Free Press, 1989). 3. Michael Barnett and Raymond Duvall, “Power in International Politics,” International Organization 59 (2005): 39–75.

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toward the environment.”4 As a result, their poor technical performance and expense are beside the point. But whereas the insight that policies are often adopted as symbols is fundamental, it is also incomplete. The main flaw is a blind spot regarding power and coercion, which is central to explaining the diffusion of AML policy. Those drawing on this vein of sociology, and especially John Meyer as its leading exponent, have been clear that power is not important in their accounts. Thus Meyer is unequivocal, stating: Realist models (stressing the power of dominant states and economic organizations) have the greatest difficulty explaining why there are universities in New Guinea, thousands of formal organizations in Uganda, scientific establishments in the Congo, efforts at accounting transparency in Honduras, and symbolically-recognised empowered individuals (e.g., gay and lesbian rights) everywhere.5 In their analysis of his work, disciples Georg Krucken and Gili Drori state that “the main emphasis of Meyer and his colleagues to date has been rebuttal of the realist discussions of diffusion as either coercive imposition or strategic compliance.”6 As well as dismissing the role of direct coercion in diffusion, those working from this perspective are also skeptical of more structural or indirect forms of power.7 This reluctance to look at power attracts criticism even from those sympathetic to their overall argument.8 The lack of attention to coercion is often linked to an excessive concentration on diffusion among rich countries at the expense of poor ones, where power is more likely to be a key explanatory factor.9 To the extent 4. Gili S. Drori and Georg Krucken, “World Society: A Theory and a Research Program in Context,” in World Society: The Writings of John W. Meyer, ed. Georg Krucken and Gili S. Drori (Oxford: Oxford University Press, 2009), 8. 5. John W. Meyer, “Reflections: Institutional Theory and World Society,” in World Society, 46–47. 6. Drori and Krucken, “World Society,” 18. 7. Such as those advanced by Michel Foucault, see ibid., 24. 8. Finnemore, “Norms, Culture and World Politics.” 9. Diane Stone, “Learning Lessons, Policy Transfer and the International Diffusion of Policy Ideas,” Centre for the Study of Globalization and Regionalization Working Paper, No. 69/01, April 2001, University of Warwick, Coventry, UK, 18; Chang Kil Lee and David Strang, “The International Diffusion of Public Sector Downsizing: Network Emulation and Theory-Driven Learning,” International Organization 60 (2006): 907; Stephan Heichel, Jessica Pape, and Thomas Sommer, “Is there Convergence in Convergence Research? An Overview of Empirical Studies on Policy Convergence,” Journal of European Public Policy 12 (2005): 819; Daniel W. Drezner, “Globalization and Policy Convergence,” International Studies Review 3 (2001): 61; Colin J. Bennett, “Review Article: What Is Policy Convergence and What Causes It?” British Journal of Political Science 21 (1991): 217.

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that coercion does get attention, there is an unhealthy fixation on conditional lending from the World Bank and IMF. The regularity with which this example crops up in comments on coercion as a mechanism of diffusion clearly indicates that this is what most of the field regards as the exemplar.10 The particular problem of equating power with conditional lending is that most observers now believe that conditional lending does not work and that the World Bank and IMF generally cannot enforce loan conditions even on poor and weak counties. There are persuasive studies of how countries such as Equatorial Guinea, Papua New Guinea, and tiny Pacific island states have managed to resist or evade the conditions attached to loans while still keeping the funds flowing.11 From here it is an easy progression to a false syllogism: because power in diffusion equals conditional lending, and because conditional lending does not work, therefore trying to diffuse policy via the exercise of power does not work. Although Daniel Drezner’s work on global regulatory regimes is certainly centered on power, it is a relatively narrow.12 For Drezner and other realists, coercion is a deliberate and direct exercise of influence by strong states against weak ones using material means for the economic advantage of the former. An exceptionally clear example of the results of coercion is the intellectual property rights regime. In their masterful and exhaustive study of global regulation, John Braithwaite and Peter Drahos refer to the Trade-Related

Even Meyer agrees the periphery has been slighted in this regard, “Institutional Theory and World Society,” 53. 10. For example, David P. Dolowitz and David Marsh, “Learning from Abroad: The Role of Policy Transfer in Contemporary Policy-Making,” Governance 13 (2000): 16; Kurt Weyland, “Theories of Policy Diffusion: Lessons from Latin American Pension Reform,” World Politics 57 (2005): 269; Dietmar Braun and Fabrizio Gilardi, “Taking ‘Galton’s Problem’ Seriously: Towards a Theory of Policy Diffusion,” Journal of Theoretical Politics 18 (2006): 309–10; Kathleen McNamara, “Rational Fictions: Central Bank Independence and the Social Logic of Delegation,” West European Politics 25 (2002): 64; Per-Olof Busch and Helge Jorgens, “The International Sources of Policy Convergence: Explaining the Spread of Environmental Policy Innovations,” Journal of European Public Policy 12 (2005): 64; Beth A. Simmons, Frank Dobbin, and Geoffrey Garrett, “Introduction: The International Diffusion of Liberalism,” International Organization 60 (2006): 791; Lee and Strang, “Public Sector Downsizing,” 890. 11. Robert Klitgaard, Tropical Gangsters: One Man’s Experience with Development and Decadence in Deepest Africa (New York: Basic Books, 1990); Colin Filer with N. K. Dubash and K. Kalit, The Thin Green Line: World Bank Leverage and Forest Policy Reform in Papua New Guinea ( Boroko: National Research Institute, 2000); Peter Larmour, “Conditionality, Coercion and Other Forms of ‘Power’: International Financial Institutions in the Pacific,” Public Administration and Development 22 (2002): 249–60; Weyland, “Latin American Pension Reform,” 273. 12. Drezner, “Globalization and Policy Convergence”; Daniel W. Drezner, “Globalization, Harmonization, and Competition: The Different Pathways to Policy Convergence,” Journal of European Public Policy 12 (2005): 841–59; Daniel W. Drezner, All Politics is Global: Explaining International Regulatory Regimes (Princeton: Princeton University Press, 2007).

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Aspects of Intellectual Property Rights (TRIPS) agreement as “our most spectacular example of economic coercion.”13 Here U.S. business groups lobbied the government in a calculated strategy to advance their commercial interests. TRIPS was the result of a combination of unilateral U.S. economic power and coalition building with business groups and governments in other rich countries. In general, rich countries, especially the United States, gained from the new regime and poor countries lost. Firms and governments deliberately and successfully employed material power at the expense of others in pursuit of reasonably well-understood monetary gains. In contrast, I argue no country gains from the global AML policy, although poor countries lose more than rich ones. Some commercial interests may have gained (e.g., AML consultants), but rather than driving the introduction or expansion of AML policy, they have been incidental beneficiaries after the fact. The consequences of the AML regime are poorly understood, the results often unintended, and the means of coercion employed are primarily (though not exclusively) reflected in speech and symbolism. Power may shape outcomes intentionally through a centralized agent using nonmaterial means ( blacklisting) or unintentionally in a decentralized manner within social peer groups (socialization) or markets (symbolic competition). It may generate effects through calculated compliance ( blacklisting and competition) or through role-playing (socialization). The demonstration effect of the FATF blacklisting meant that this tactic was not only successful in pushing blacklisted countries into reform but also served as a powerful warning to others to adopt AML policies. The conception of socialization is similarly centered on power. Specifically, it is driven by fear of losing social acceptance. Instead of experiencing approbation for their hard work, developing states at best avoid condemnation and ostracism (the “deficit model”). Logically, acting to receive a benefit (status enhancement) or avoid a penalty ( losing social acceptance) may seem to be equivalent, but politically, shaping the behavior of states or individuals through rewards or penalties is a different proposition. If power is understood as the capacity of actors to determine their circumstances and fate,14 then socialization represents an exercise of power by the community over the individual. The power of the policy community to confer or withhold sought-after social

13. John Braithwaite and Peter Drahos, Global Business Regulation (Cambridge: Cambridge University Press, 2000), 79; see also Susan K. Sell and Aseem Prakash, “Using Ideas Strategically: The Contest between Business and NGO Networks in International Property Rights,” International Studies Quarterly 48 (2008): 159–60. 14. Barnett and Duvall, “Power in International Politics.”

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acceptance stems from its control over the technical knowledge and lexicon of AML. National policies are measured and declared to either meet minimum international standards or fail to meet these standards. Organizations shape policy through the desire of national regulators to avoid being seen as derelict in their duties, backward, or substandard by their peers.15 Unlike blacklisting, socialization is a noninstrumental and decentralized exercise of power. Patterns of social acceptance or shunning among regulators are not deliberately created tools. Those complying with these norms are engaged in role-playing rather than utility maximization. How does competition relate to power? Regulators have delegated responsibility for assessing country AML risk to international banks and other financial firms. These risk ratings determine the competitive position of developing countries in terms of their attractiveness as investment destinations and the ease with which they can use financial networks. Because of the lack of objective measures for AML risk, private firms unintentionally create material incentives for developing countries to adopt AML policy as symbols or talismans. Unlike blacklisting, the exercise of power is decentralized (many firms acting in an uncoordinated manner) and noninstrumental (firms do not aim to promote compliance with AML regulations). But unlike socialization, compliance by developing countries’ governments reflects deliberate calculations to avoid economic loss. Just as with socialization, there is a selfreinforcing dynamic. As the policy diffuses more widely, the pressure to join increases. Holdouts are seen as ever more out of step and face an increasing number of compliant (and thus more attractive) rivals for investment. To say that power has been relatively neglected in the study of diffusion is not to say the approach taken in this book is the only one offering a broad view of power in diffusion.16 There are alternatives that provide some useful concepts for the further study of diffusion. First of all, there is the fruitful notion of “coercion isomorphism,” coined by Walter Powell and Paul DiMaggio, but unfortunately it does not seem to have caught on. They define this idea as follows: Coercive isomorphism results from both formal and informal pressures exerted on organizations by other organizations upon which they are dependent and by cultural expectations in the society within which the 15. Fabrizio Pagani, “Peer Review: A Tool for Co-operation and Change: An Analysis of the OECD Working Method,” paper prepared by Directorate for Legal Affairs for General Secretariat, Paris, France, 2002; Anne-Marie Slaughter, A New World Order (Princeton: Princeton University Press, 2004). 16. For power and global governance more generally, see Michael Barnett and Raymond Duvall, eds., Power in Global Governance (Cambridge: Cambridge University Press, 2005).

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organizations function. Such pressures may be felt as force, as persuasion, or as invitations to join in collusion.17 Examples they give include direct legislative and regulatory interventions by the state but more commonly the way that the state shapes the cultural environment in which organizations make their way. Large firms or even charitable bodies may shape cues and incentives that induce conformity among their smaller peers.18 Much like Robert Michel’s “iron law of oligarchy” concerning the inevitable bureaucratization of emancipatory political parties, even those bodies founded on explicitly anti-hierarchical and participatory principles may be remolded around top-down authority relations as interaction with other bodies organized along hierarchical lines promotes mimesis.19 In general, Powell and DiMaggio are at pains to emphasize the subtle and indirect means by which coercion promotes sameness. Another complementary strand of work, specifically focused on the AML regime, is based on the idea of “governmentality.”20 Governmentality suggests that rather than power being intentionally directed by the state, individuals can instead be induced to discipline themselves in a manner that does not involve deliberate calculation or even recognition.21 Power is fragmented and dispersed, working in and through practices and processes.22 In the context of global AML policy diffusion, this work makes much of the reliance on soft law, ranking and rating exercises, and the devolution of policy implementation to private entities such as banks. Setting up a common metric against which states’ performance in a given policy area can be publicly scored and compared helps to inculcate the expectation that the given policy template is normal and necessary. States and other actors will aspire to improve their compliance and shun those who fail to do likewise. According to this view, the most important exercises of power are not spectacular instances like

17. Paul J. DiMaggio and Walter W. Powell, “The Iron Cage Revisited: Institutional Isomorphism and Collective Rationality in Organizational Fields,” in The New Institutionalism in Organizational Analysis, ed. Powell and DiMaggio (Chicago: University of Chicago Press, 1991), 67. 18. Ibid., 68. 19. Robert Michels, Political Parties: A Sociological Study of the Oligarchical Tendencies of Modern Democracy (New Brunswick, NJ: Transaction Publishers, 1999 [1912]). 20. Mitchell Dean, Governmentality: Power and Rule in Modern Society ( Thousand Oaks, CA: Sage, 1999); Marieke de Goede, “Governing Finance in the War on Terror,” in Crime and the Global Political Economy, ed. H. Richard Friman ( Boulder: Lynne Rienner, 2009), 103–17; Rainer Hulsse, “Creating Demand for Global Governance: The Making of a Global Money-Laundering Problem,” Global Society 21 (2007): 155–78; Yee-Kuang Heng and Ken McDonagh, “The Other War on Terror Revealed: Global Governmentality and the Financial Action Task Force’s Campaign against Terrorist Financing,” Review of International Studies 34 (2008): 562–63. 21. Dean, Governmentality. 22. Heng and McDonagh, “The Other War on Terror,” 561.

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military interventions or UN Security Council resolutions, but rather the boring, everyday grind of committee meetings, directives, assessments, and evaluations. The significance of these perspectives, and this book, is that they reject a conventional dichotomy. This is the split whereby some in the field see global governance as the process of coming together to solve common problems, and others (realists) see this process as being power driven, but only in the sense of direct, material coercion deliberately employed by states. A much broader view of the nature of power and its effects should be at the center of the study of global governance.

Method Aside from emphasizing the role of power in diffusion, the other main point for scholars relates to method, in particular the idea of researching political and social processes by becoming directly involved in them. Those studying international politics have seen very little scope for direct approaches such as participant-observation ethnography, audit studies, or field experiments. Scholars interested in big questions of war and peace, power and inequality, have regarded direct methods as applicable only to trivial and parochial matters. In fact, however, several of the most stimulating and insightful treatments of some of the biggest issues in the field have arisen from scholars’ direct experience and participation. The inspiration for Michael Barnett and Martha Finnemore’s hugely influential writings on how international organizations share the pathologies of classic bureaucracies came from their experiences working in the U.S. mission to the United Nations and the World Bank.23 Daniel Drezner credits the importance of the year he spent working with the U.S. Treasury Department on international regulatory affairs (which, significantly, included work on the Non-Cooperative Countries and Territories blacklist) for his argument about the importance of great powers in global regulation.24 The potential for inspiration extends to the study of security questions also. Here, a further fascinating example is that of Carol Cohn.25 By working alongside and becoming acculturated to nuclear weapons 23. Michael N. Barnett and Martha Finnemore, “Politics Power and Pathologies in International Organizations,” International Organization 53 (1999): 699–732; Michael Barnett and Martha Finnemore, Rules for the World (Ithaca: Cornell University Press, 2004). 24. Drezner, All Politics is Global, xiii. 25. Carol Cohn, “Sex and Death in the Rational World of Defense Intellectuals,” Signs 12 (1987): 687–718.

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scientists, Cohn gained rather chilling insights on how their habits of speech and thought influenced nuclear weapon development and war-fighting doctrine. Cohn and Barnett found these experiences so powerful that in the end they struggled to separate their mindset from that of their peers.26 Moving a little further from international relations, James Scott’s ethnographic work has also produced important general findings on political domination and resistance.27 A related approach is the use of audit studies, akin to the approach of soliciting offers for anonymous shell companies seen in chapter 3.28 Peruvian economist Hernando de Soto’s work on the difficulty of entering the formal economy in the third world is a prominent example.29 De Soto and a team of collaborators applied for a sole trader license to produce textiles in Peru, Egypt, Haiti, and the Philippines, following all the requirements of the law and bureaucratic procedure. The researchers carefully recorded all the time spent filling out forms, waiting for official permission, and dealing with bribe requests, mimicking as closely as possible the approach of a genuine applicant. All too often, the process took hundreds of days of waiting, multiple bribes, and a daunting amount of paperwork. The findings give significant support to the proposition that it is extremely hard for those stuck in the underground economy in developing countries to enjoy formal property and other legal rights. In turn, the lack of formal property rights greatly raises the barriers to overall national economic development. As well as inspiring new hypotheses, getting close to the action in this manner allows scholars to explore and detail how big processes and mechanisms actually work in practice. This focus is important because there have been many calls to remedy the lack of attention to the mechanisms that connect presumed cause and effect in diffusion.30 Because of this near-consensus

26. Michael N. Barnett, “The UN Security Council, Indifference, and Genocide in Rwanda,” Cultural Anthropology 12 (1997): 551–78; Cohn, “Sex and Death”; see also Iver B. Neumman, “To Be a Diplomat,” International Studies Perspective 6 (2005): 72–93; Iver B. Neumann, An Ethnography of Diplomacy (Ithaca, Cornell University Press, 2011). 27. James C. Scott, Weapons of the Weak: Everyday Forms of Peasant Resistance (New Haven: Yale University Press, 1985). 28. David Neumark, “Detecting Discrimination in Audit and Correspondence Studies,” National Bureau of Economic Research 16448, Cambridge, MA, October 2010. 29. Hernando de Soto, The Other Path: The Invisible Revolution in the Third World (New York: Harper Collins, 1989); Hernando de Soto, The Mystery of Capital: Why Capitalism Triumphs in the West and Fails Everywhere Else (New York: Basic Books, 2000). 30. Weyland, “Latin American Pension Reform,” 264; David P. Dolowitz, “Introduction,” Governance 13 (2000): 1–4. David Levi-Faur, “Regulatory Capitalism, The Dynamics of Change beyond Telecoms and Electricity,” Governance 19 (2006): 514; Busch and Jorgens, “Sources of Policy Convergence,” 860; David Strang and Sarah A. Soule, “Diffusion in Organizations and Social

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about the importance of mechanisms, chapters 4 and 5 gave a deliberately detailed account of blacklisting, socialization, and competition to explain how causes are linked with the spread of given institutions and policies. The final method considered, field experiments, provides a powerful means of testing explanations and establishing causation. These experiments are based on the principle of random allocation into control and treatment groups, much in the same way as new drugs are tested in clinical trials. For example, in attempting to find out the effectiveness of mosquito nets in reducing malaria, researchers distributed the nets to a random sample of some villagers (the treatment group) but not others (the control).31 Any subsequent difference in malaria rates between the two groups could then be attributed to the effect of the nets. Unlike conventional statistical treatments using observational data (e.g., comparing people who already have mosquito nets with those who don’t), random allocation neutralizes the danger that other, extraneous differences between groups may cause researchers to overlook or mistake the real impact of the nets. Recent research into collective action and the political economy of development has shown that these methods can explain important political outcomes.32 The scale, ambition, and significance of these studies disprove the notion that participatory and field experiment designs must be limited to small questions and minor concerns. There are practical and ethical limits to the use of ethnography, audit studies, and field experiments in international relations. But the relative scarcity of these techniques in the discipline seems to owe more to a lack of imagination. Movements: from Hybrid Corn to Poison Pills,” American Review of Sociology 24 (1998): 280; Benjamin O. Fordham and Victor Asal, “Billiard Balls or Snowflakes? Major Power Prestige and the International Diffusion of Institutions and Practices,” International Studies Quarterly 51 (2007): 36; Braun and Gilardi, “Taking Galton’s Problem Seriously,” 298; Jeffrey T. Checkel, “International Institutions and Socialization in Europe: Introduction and Framework,” International Organization 59 (2005): 801, 805–6; Alister Iain Johnston, “Conclusions and Extensions: Toward Mid-Range Theorizing and Beyond Europe,” International Organization 59 (2005): 1035; Kai Alderson, “Making Sense of State Socialization,” Review of International Studies 27 (2001): 432; Covadonga Meseguer and Fabrizio Gilardi, “What’s New in the Study of Policy Diffusion?” Review of International Political Economy 16 (2009): 528; Benjamin A. Most and Harvey Starr, “Theoretical and Logical Issues in the Study of International Diffusion,” Journal of Theoretical Politics 2 (1990): 396; Finnemore, “Norms, Culture and World Politics,” 340. 31. Jessica Cohen and Pascaline Dupas, “Free Distribution or Cost-Sharing? Evidence from a Randomized Malaria Prevention Experiment,” Global Economy and Development Working Paper 11, The Brookings Institution, Washington, D.C., December 2007. 32. Donald P. Green and Alan S. Gerber, “Reclaiming the Experimental Tradition in Political Science,” in Political Science: State of the Discipline, ed. Ira Katznelson and Helen V. Milner (New York: W. W. Norton, 2002), 805–32; Elaine A. de Rooij, Donald P. Green, and Alan S. Gerber, “Field Experiments on Political Behavior and Collective Action,” Annual Review of Political Science 12 (2009): 389–95; Macartan Humphreys and Jeremy M. Weinstein, “Field Experiments and the Political Economy of Development,” Annual Review of Political Science 12 (2009): 367–78.

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Anthropologists, sociologists, economists, and even journalists have employed such methods to much better effect, even when studying illegal behavior, for example, successfully buying slaves despite the formal prohibition against this practice.33 Properly designed, one could imagine direct tests of compliance with the global intellectual property rights regime, anti-corruption guidelines, or rules controlling the sale of conflict diamonds.34 In sum, whether it is generating new hypotheses, achieving a deeper understanding of processes and mechanisms, or systematically testing alternative explanations, direct approaches can provide unique strengths. So far those interested in explaining big political trends and outcomes have failed to exploit these techniques to full advantage. My hope is that, in at least in a small way, this book may cause scholars to reconsider the value of direct methods.

Policy: Making the Best of Things A few policymakers I spoke with in researching this book were prepared to grant that poorer countries had little choice but to adopt AML policies, even when they delivered few benefits.35 Their blunt view was that time spent reflecting on this situation was essentially wasted because life is often not fair and AML policy is here to stay. Up to a point, it is hard to disagree with this verdict. Most of those consulted in small and developing states also held the attitude that AML policy is now a fact of life, regardless of its performance.36 Accordingly, the clear expectation of this book is that the global AML system will continue to broaden and deepen, irrespective of the costs and its lack of effectiveness. As much as the ideal, ivory tower solution might be for a root-and-branch reevaluation of AML policy, or even repealing the whole apparatus, neither is realistically in the cards. The challenge is to make the best of a bad situation. The book does not provide any policy blueprints,37 but it is possible to venture some suggestions as to how poorer countries in particular can get the

33. Nicholas D. Kristof and Sheryl WuDunn, Half the Sky: Turning Oppression into Opportunity Worldwide (New York: Vintage, 2010). 34. Ben Olken, “Monitoring Corruption: Evidence from a Field Experiment in Indonesia,” Journal of Political Economy 115 (2007): 200–49. 35. Author’s interview, UK Treasury, London, UK, June 19, 2006; Author’s interview, IMF, Port Vila, Vanuatu, March 4, 2004. 36. Author’s interviews, Manila, Philippines, September 10, 2009; Dar es Salaam, Tanzania, March 5, 2009; Bangkok, Thailand, August 21, 2007; Panama City, Panama, April 4, 2008; Bridgetown, Barbados, September 25, 2005, Port Louis, Mauritius, June 2, 2005. 37. See instead David Chaikin and J. C. Sharman, “APG/FATF Anti-Corruption/AML/CFT Research Paper,” presented at the FATF Paris plenary, October 12, 2007; J. C. Sharman and Percy S.

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best (or least-bad ) value out of their AML policies. Above all, this involves reorienting AML policy to concentrate on corruption. According to the World Bank and IMF, problems of governance and corruption are the single greatest obstacle to economic development in poor countries.38 In some African countries, losses attributable to corruption are said to run as high as 25 percent of GDP.39 Given the tendency for such claims to reflect political imperatives and a numbers fetish, it would be overly credulous to take these statements at face value.40 But it does seem hard to dispute that corruption among high-level officials is a major problem for many poor countries. The World Bank’s best guess is that for most of these countries corruption is the single biggest source of laundered money.41 If there is some relationship between corruption and stunted economic development, then to the extent that AML policy could make even a modest contribution to reducing corruption, it could deliver significant benefits. At the very least, AML policy would go some way toward paying for itself. Yet for most countries in the developing world, this potential has not been realized. Rather like low-level drug dealing, petty corruption generates small amounts that are easily fed into everyday corruption, and so there is little need to launder the proceeds. But more serious corruption, whether in the form of embezzlement, giving or receiving bribes, or self-dealing, will often generate enough money to require laundering. This is where AML policy can come into play. AML policy can be used to fight corruption through the ability to access a large volume of financial intelligence, strengthened international cooperation, provisions to recover the proceeds of crime, and opportunities to press rich countries for greater consistency. Each is briefly explained below. Corruption is a crime premised on secrecy. The central goal of AML systems is to make the financial system transparent through Know Your Customer requirements and transaction reporting. In many developing countries, a majority of transactions will be opaque even once AML systems are Mistry, Considering the Consequences: The Development Implications of Initiatives on Taxation, Anti-Money Laundering and Combating the Financing of Terrorism (London: Commonwealth, 2008); UNODC/ World Bank, Stolen Assets Recovery: Politically Exposed Persons: A Policy Report on Strengthening Preventative Measures ( Washington, D.C., 2009); World Bank, Misuse of Corporate Vehicles ( Washington, D.C., 2011). 38. World Bank/IMF Joint Development Committee, Strengthening Bank Group Engagement on Governance and Corruption ( Washington, D.C., 2006). 39. UNODC/World Bank, Stolen Assets Recovery (StAR) Initiative: Challenges, Opportunities, and Action Plan ( Washington, D.C., 2007), 9. 40. Mlada Bukovansky, “The Hollowness of Anti-Corruption Discourse,” Review of International Political Economy 13 (2006): 181–209. 41. World Bank. Strengthening World Bank Group Engagement on Governance and Anticorruption ( Washington, D.C., 2007), 68.

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in place due to the prominence of small cash and barter transactions. But the economic life of politicians, senior government officials, prominent business people, and their families takes place within the formal economy. These individuals’ financial dealings should, in principle, be relatively transparent. These are also precisely the minority of people most likely to be involved in significant corruption. A specific example of how the financial intelligence collected for AML purposes could be used to shore up public integrity is in relation to asset registers. In over a hundred countries, politicians and other senior government officials, and in some cases their families, have to declare all their assets, debts, and sources of income upon taking office.42 These registries are touted as one of the most effective tools for ensuring integrity in government.43 Taken together, the declarations make up an asset registry. The declarations form a baseline against which any suspicious enrichment while in office can be judged. Thus the case to recover $356 million from the Swiss bank accounts of former President of the Philippines Ferdinand Marcos hinged on his initial declaration in 1965 that his net worth was $7,000. Allowing for legitimate income in the period after 1965, the former president’s worth was only $2.4 million. To retain the money, the Marcos family had to put forward a plausible, legitimate source for the remaining $353.6 million. They could not, and the money was forfeited to the government of the Philippines.44 This success, however, is very much the exception rather than the rule. Asset registries are only effective to the extent that declarations can be checked against officials’ actual financial situation, both at the time they make the declaration and subsequently. Too often this is not done because those in charge of administering the registry do not have access to the necessary financial data.45 Those in FIUs do have such access, but checking the accuracy of asset declarations is seen as someone else’s problem.46 It would be a relatively simple matter 42. UNODC/World Bank, Politically Exposed Persons. 43. Author’s interview, UNODC, Vienna, Austria, May 18, 2007; Commonwealth, London, UK, May 15, 2007. 44. David Chaikin and J. C. Sharman, Corruption and Money Laundering: A Symbiotic Relationship (New York: Palgrave, 2009), Chapter 6. 45. George A. Larbi, “Between Spin and Reality: Examining Disclosure Practices in Three African Countries,” Public Administration and Development 27 (2007): 205–14; Charles Goredema and Jackson Madzima, “An Assessment of the Links between Corruption and the Implementation of Anti-Money Laundering Strategies and Measures in the ESAAMLG Region,” report prepared for the Eastern and Southern African Anti-Money Laundering Group, 2009; Michaela Wrong, It’s Our Turn to Eat: The Story of a Kenyan Whistle-Blower (New York: Harper Collins, 2009). 46. Author’s interview, Commonwealth, London, UK, May 15, 2007; UNODC, Vienna, Austria, May 18, 2007; World Bank, Washington D.C., May 19, 2010; International Centre for Asset Recovery, Basel, Switzerland, September 15, 2010.

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to allow FIUs to share the information they already have (or at least could obtain) to give registries real bite. One of the major obstacles for developing countries seeking to follow the money occurs when the trail of corrupt dealings leads beyond their borders. Even when there are formal provisions for international legal assistance in place, using them is often slow, difficult, expensive, and requires considerable legal expertise.47 Links between FIUs may provide a much more expeditious and user-friendly alternative for those looking to investigate cross-border corruption offenses. FATF Recommendations 35–40 are all explicitly directed at improving international cooperation in combating money laundering, including provisions such as mutual legal assistance and extradition. Although this language often replicates that in existing international legal conventions, the international organizations responsible for the conventions cannot apply pressure to live up to these commitments in the way the FATF can and does. Beyond the FATF, the Egmont Group (another node in the transnational AML community) links 115 countries’ FIUs via a secure website and e-mail system for exchanging financial intelligence. Even those countries that cannot afford to join the Egmont Group may conclude bilateral agreements for exchanging information. Inter-FIU exchanges tend to be quick and informal, in part due to the common identification of officials as belonging to the same transnational community.48 Acting through AML networks can thus provide a less cumbersome route for governments looking to track down proceeds of corruption held abroad. In extreme instances, kleptocrats may manage to steal hundreds of millions of dollars from the countries they rule.49 How can successor governments recover these much-needed assets? Here the powerful provisions on asset freezing and confiscation contained in AML systems can be useful. Under the 40+9 Recommendations, officials must have the power to freeze funds (Recommendation 38). There are also a variety of options for confiscating the proceeds of corruption using measures designed with an AML rationale in mind. The first measures are powers that allow those convicted of a predicate offense such as corruption to be stripped of wealth they acquired from the crime. Second, criminal proceedings may be brought against the property itself rather than the person (a case in rem rather than in personam), particularly

47. UNODC/World Bank, Stolen Assets Recovery Initiative; Author’s interviews, Asian Development Bank, Manila, Philippines, September 10, 2009; World Bank, Washington, D.C., May 19, 2010; Commonwealth, London, UK, May 15, 2007; UNODC, Vienna, Austria May 18, 2007. 48. Author’s interview, World Bank, Strasbourg, France, February 20, 2007. 49. Transparency International, Global Corruption Report 2004 ( Berlin, 2004).

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useful when the accused is dead or a fugitive. Furthermore, prosecutors have to establish only a reasonable probability for their case to succeed rather than reach the standard of proof beyond a reasonable doubt.50 Prosecution in rem was used to recover and return bribe money held by Peruvian spymaster Vladimir Montesiños in the United States.51 Officials involved insist that without the option of an in rem prosecution, the assets could not have been confiscated and returned to Peru.52 Third, the government or other private parties may initiate civil proceedings at home or in foreign courts to recover stolen assets, again working to a lower standard of proof than that required for normal criminal cases. The final opportunity AML policy provides for strengthening the campaign against corruption in the developing world is not so much on legal or technical grounds as political ones. Developing countries, in combination with NGOs such as Global Witness, can practice “accountability politics”: attempting to hold rich countries to promises they have made but not honored.53 This applies to rich countries’ failure to implement AML policies where they would most assist poorer countries. These failings relate to issues such as the deliberate inaction of the U.S. government that allows the Obiang family to launder the proceeds of their spectacular corruption in the United States and the even more blatant, long-standing, and repugnant complicity of the French government in hosting funds looted from francophone Africa. A further point at which pressure can be exerted is the poor performance of OECD countries in requiring proper identification of those in control of shell companies. The political priority that the United States and the G20 have placed upon countering money laundering provides a point of entry for those arguing that efforts in this domain should favor poor countries. If there is good potential for AML measures to be used in an anticorruption role, why hasn’t this happened already? There are two primary reasons, both arising from the circumstances in which AML policy has been diffused to poorer countries. The first is that the apparatus to counter money laundering has retained its focus on rich-country problems even when transplanted to poor-country contexts. The predicate crimes of most interest are issues such as drugs and the financing of terrorism rather than corruption. The

50. Anthony Kennedy, “Putting Robin Hood Out of Business: A Proceeds of Crime Case Study,” Journal of Money Laundering Control 9 (2006): 19–26; Asian Development Bank /OECD, Mutual Legal Assistance, Extradition, and Recovery of Proceeds of Corruption in Asia and the Pacific (Manila, 2007). 51. Chaikin and Sharman, Corruption and Money Laundering, 141–45. 52. Author’s interview, U.S. Department of Justice, Perth, Australia, July 26, 2007. 53. Margaret Keck and Kathryn Sikkink, Activists Beyond Borders: Advocacy Networks in International Politics (Ithaca: Cornell University Press, 1998).

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second is that, in keeping with the “window display” nature of the policy, local officials too seldom think of Financial Intelligence Units, suspicious transaction reporting regimes, and the rest as something that can actually deliver practical benefits at home, as opposed to merely assuaging powerful outsiders. To use the cliché, the underutilization of the AML system reflects a lack of “ownership” on the part of poorer countries. The upshot more often than not is tunnel vision or compartmentalization. Judging from interviews with those providing technical assistance in Africa, Asia, the Pacific, and the Caribbean, those tasked with fighting money laundering rarely communicate or cooperate with those fighting money laundering, and vice versa.54 Each agency defines its task in a narrow sense that excludes the potential benefits from the other. The very fact that this potential has not been exploited further suggests how alienated developing countries are from “their” AML policies, thanks to the coercive way in which these policies have been diffused. Even if implemented in full, however, none of these suggestions on fighting corruption would change the verdict that AML policy is ill-suited for developing countries and serves as a distraction from much more pressing problems, such as poverty, education, and health issues.

Beyond AML: The G20 At the start of this book, one of the justifications given for devoting so much attention to money laundering was that the campaign to diffuse AML standards has come to be seen as something of a model for other international regulatory efforts. The techniques of rating, ranking, blacklisting, and manipulating incentives for private actors have themselves diffused. The global standards that powerful states now seek to enforce relate to a much broader range of economic activity. The fact that a small number of rich, powerful countries, most especially the United States, were responsible for the economic crisis has not stopped the rush to coercively diffuse these new standards to the rest of the world. As noted earlier, many observers have regarded international standard setting as prone to settle on lowest common denominator solutions. Sovereign states have diverse interests, so the argument goes, and there are few if any measures to pressure states to adhere to robust standards. Thus these commentators regard global governance as a process of painstaking consensus 54. Author’s interviews, Australian Agency for International Development, by phone, May 20, 2009; UNODC, Vienna, Austria, September 17, 2004; World Bank, Washington D.C., September 7, 2004; Asian Development Bank, Strasbourg, France, February 22, 2007.

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building. But as the diffusion of AML policy demonstrates, this need not be the case, a lesson that the G20 seems to have learned full well. The push provided by the G20 for the FATF’s return to blacklisting has already been discussed, but the same coercive approach is now being employed in bank, insurance, and stock market regulation, as well as by the OECD in relation to tax. These are considered in turn. The April 2009 G20 heads of state summit called upon the Financial Stability Board (FSB, until then the Financial Stability Forum) to compile a list of noncooperative jurisdictions. Reminiscent of the rationale for spreading AML policy, deficiencies in the supervision of banks, insurance companies, and stock exchanges anywhere are said to pose a risk to financial systems everywhere.55 In response, the FSB is to assess a “prioritized pool of jurisdictions” by considering the various ratings and scores these jurisdictions have received when assessed against international standards.56 Very much like the FATF International Co-operation Review Group process beginning in 2007, those that do not measure up receive a confidential letter to their finance minister inviting them to mend their ways and enter into dialogue and the FSB peer review process.57 Those that fail to adopt a constructive approach, however, will be publicly blacklisted as noncooperative jurisdictions, and “additional negative incentives could be applied to promote compliance.”58 These include other attempts to shape private actors’ calculations as to whether to invest in or transact business with particular countries. Thus all the same mechanisms used to diffuse AML policy are in play. Blacklisting is used, most obviously, but also applied are the coercive effects of uncoordinated decisions by market actors in creating incentives for states to sign on to the common standards (competition). Increased emphasis on peer review, ratings, rankings, committee meetings, working groups, plenaries, etc. brings regulators into closer contact and facilitates socialization. But the FSB threatens penalties even more severe than anything employed by the FATF: In extreme cases of continued non-adherence to international standards, governments or supervisory authorities, as appropriate and according to the legal framework of each country and in a manner consistent with 55. Financial Stability Board, Promoting Adherence to International Co-operation and Information Exchange Standards ( Basel, 2010), http://www.financialstabilityboard.org/publications/r_100310.pdf (accessed May 2010). 56. Ibid., 2. 57. Author’s interview, Financial Stability Board, Basel, Switzerland, September 15, 2010. 58. Financial Stability Board, “Promoting Adherence,” 7.

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international law and international obligations, including those under the Articles of Agreement of the IMF, could restrict or even prohibit financial transactions with counterparties located in non-cooperative jurisdictions. Measures could include restrictions on home financial institutions from entering into correspondent banking relationships with counterparties located in non-cooperative jurisdictions.59 Here the FSB has created a multilateral equivalent of the most draconian sections of the PATRIOT Act, aiming to enforce a complete blockade that would destroy the financial sector of a targeted country. On the same day as the London summit, the G20 instructed the OECD to release a three-tiered list (white, gray, black) of countries rating their adherence to purportedly universal standards on the international exchange of tax information. Rumors of the impending list precipitated a scramble among those labeled as tax havens to reverse their previously adamant opposition to exchanging such information. In September 2009, the Pittsburgh G20 heads of state summit noted that they stood “ready to use countermeasures against tax havens,” which were bracketed with terrorist financiers and money launderers.60 As a result, by early 2010 the OECD was able to announce that it had made more progress on enforcing its international standards on tax information exchange in the previous year than in the whole of the preceding decade.61 To reinforce the momentum generated by the listing, the OECD established a regular process of peer review that goes well beyond its rich-country member states. Those reviewed are benchmarked against international standards, with results being presented in public. In a further parallel, private firms are busy recalibrating their risk rating to reflect the 2009 OECD listing and in anticipation of the peer review results to come. One country publicly singled out as particularly deficient in its performance is Nauru (along with its South Pacific neighbor Niue, population 1,200). Why has Nauru failed to meet global standards, agreed to by a rapidly growing majority of states, to collect and exchange tax information with its peers in the international community? According to the G20’s logic, Nauru’s one supermarket, one-plane airline, Western Union branch, two hotels, one bar, few gas stations, and twenty-one restaurants (all Chinese) represent a dangerous anomaly in the global fiscal transparency regime. Because of this external pressure, Nauru will

59. Ibid., 21. 60. G20 Leaders’ Statement, Pittsburg, September 25, 2009, 10. 61. G20 Progress Report, St Andrew’s, July 2009, http://www.g20.org/Documents/20091107_ progress_report_standrews.pdf (accessed September 2009), p. 31.

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in all probability get the standard model of tax information exchange mechanisms devoted to the provision of information to outsiders. The only problem is that Nauru does not levy any tax. Thus the country with financial regulation but no financial sector will also be the country with a tax administration but no tax. Meanwhile, thanks to such coercive exercises in diffusion, the chances of Nauru and other developing countries being able to reconcile standard global templates and local realities recede ever further.

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Index

40+9 Recommendations, 26 –28, 30, 33, 41, 42, 67, 68, 78, 102, 103, 111, 138 – 41, 143, 147, 164, 178. See also Financial Action Task Force Abacha, Sani, 61, 65 ABN AMRO, 49 Abubakar, Atiku, 65 Afghanistan, 3, 47 al-Qaeda, 31 Angola, 65, 66, 108 Anti-Money Laundering (AML), 1, 2, 4, 7, 9, 12, 14, 15, 17, 20, 27–29, 112; and corruption, 13, 40, 61– 66, 74, 135, 166, 176 –80; costs and benefits of, 4, 11, 13, 39, 40, 41, 44, 45, 46, 47, 57– 61, 99, 110, 130, 162, 169, 175; effectiveness of, 4 –7, 12, 13, 37– 44, 47, 66 – 67, 68 – 69, 74, 78 –79, 86, 94 – 95, 99, 143, 151, 162– 63; historical development of, 16, 21–26; in poor countries, 6 – 9, 32–33, 38 – 40, 46, 50 – 60, 61, 67, 99, 129, 130, 134 –35, 138, 140, 142– 44, 150, 152, 154, 158, 160 – 62, 164, 175, 180; and private firms, 8, 9, 11, 27–29, 43, 45, 47, 55, 58 – 60, 108 – 9, 123, 127, 130, 156 –59, 162– 63; in rich countries, 4, 6, 7, 9, 12, 23 –26, 38, 40 – 42, 44 – 45, 50, 51, 61, 87–88, 144, 179; and tax, 31–33, 66, 74; and terrorism, 30 –31, 44, 66, 139 – 40, 143, 145 Argentina, 109 Asian Development Bank, 10, 11 Asian Wealth Bank, 121 Asia-Pacific Economic Co-operation (APEC), 10, 11 Asia-Pacific Group on Money Laundering, 10, 11, 126 –27, 144 – 45, 149 –50 Astier-Bongo, Yamiliee, 65. See also Bongo family Au, Stanley, 124. See also Banco Delta Asia

Australia, 23, 31–32, 55, 56, 85, 92, 114, 116, 145, 149 Austria, 70, 100, 117–19, 149, 161 Baader-Meinhof Gang, 23 BAE Systems, 75 –77, 81 Bahamas, 63, 72, 87, 111 Banco Delta Asia, 122–24 Banco Santander, 63 Bangladesh, 52 Bank of America, 49, 64 Bank of China, 124 Bank of Nauru, 114 Bank of New York, 17, 49, 114, 115 banks, 17, 18, 25, 27, 45 –51, 55, 58, 59, 60, 62– 65, 70, 71, 86, 90 – 93, 95, 101, 111, 117–19, 121, 123, 157, 159 Banque de France, 64 Barbados, 11, 38, 40, 57–58, 111, 126, 127, 152, 153, 162 Barclays Bank, 50, 63 Basel Committee on Banking Supervision, 24, 25, 47 Bermuda, 141 Bhutto, Benazir, 66 blacklisting, 7, 9, 32, 55, 94, 99 –129, 131, 132, 133, 135, 140, 157, 163, 169, 181. See also Financial Action Task Force: International Cooperation Review Group, Non-Cooperative Countries and Territories Blair, Tony, 76 BNP Paribas, 63, 65 Bongo, Omar, 65 Bongo family, 65 Bout, Viktor, 77 Brazil, 49 British Virgin Islands, 64, 76, 79, 87, 111 Burkina Faso, 66 Burma, 100, 104, 119 –21

197

198

INDEX

Canada, 28, 107 Capone, Al, 16, 17, 31 Caribbean Community, 103 Caribbean Development Bank, 10 Caribbean Financial Action Task Force (CFATF), 10 Castle Bank, 85 Cayman Islands, 22, 84 –85, 100, 103, 108, 109, 111–12, 122, 128 Central Intelligence Agency (CIA), 85 Chase Manhattan, 76 China, People’s Republic of, 124, 149 Citibank, 66 Citigroup, 49, 64 Colombia, 22, 47, 82 Commonwealth, 10, 11, 57, 146, 150, 162 competition, symbolic, 8, 9, 99, 101, 108 – 9, 131–34, 154 – 63, 169 –70, 182 conditional lending, 4, 7, 140 – 41, 168 Congdon, Sam, 74 –75 Congo, 51, 66 Congo-Brazzaville, 66 Cook Islands, 87, 108, 113, 126, 144 – 45 Corporate Service Providers, 74 –75, 79 –80, 82–83, 85 – 91 corruption, 12, 19, 42, 47, 61– 66, 134, 135, 173, 176 Costa Rica, 125 Council of Europe/MONEYVAL, 10, 22, 33, 144 Credit Lyonnaise, 65 Credit Suisse, 50 Cuba, 18, 128 Cyprus, 63, 92, 148 Cyprus, Turkish Republic of Northern, 105, 148 Czech Republic, 70, 76, 125 decoupling, 2, 8, 40, 43, 143, 159, 165 – 66 Delaware, 74, 77, 94 Dominica, 92 Eastern and Southern African Anti-Money Laundering Group (ESAAMLG), 10, 50, 158 Ecuador, 108 Egmont Group, 10, 178 Equatorial Guinea, 48, 49, 61, 63, 64, 66, 168. See also Obiang entries Ernst and Young, 124 Escobar, Pablo, 15 ETA (Euskadi Ta Askatasuna), 23 Ethiopia, 108

European Union, 10, 73, 84, 94, 158 –59 Exxon, 64 FARC (Fuerzas Armadas Revolucionarias de Colombia), 77 Fiji, 52 Financial Action Task Force (FATF), 7, 9, 10, 11, 19, 29, 32, 33, 39, 42, 55, 61, 73, 94, 95, 99, 119, 135, 139 – 40, 155, 162; creation of, 23 –26; evaluations performed by, 42– 43, 67, 80, 118, 132, 133, 138 – 46, 151–52, 155, 157, 159, 162; International Cooperation Review Group, 99, 104 –8, 121–24, 132, 140, 146, 148, 149, 181; Non-Cooperative Countries and Territories list, 99 –100, 102– 4, 107, 108 –16, 120 –21, 125 –29, 132, 149, 172; plenaries of, 105, 133, 138, 144 –50 financial exclusion, 46, 50, 51 financial crisis, 2007–2008, 5, 107, 180 Financial Intelligence Units (FIUs), 27, 29, 31, 43, 51, 52, 53, 56, 57, 58, 59, 60, 63, 99, 111, 113, 122, 123, 137, 142, 150, 166, 177–78, 180 Financial Stability Forum/Board, 141, 147, 153, 181–82 Finland, 145 Florida, 77 France, 25, 26, 32, 105, 107, 139 – 40, 148; hosting of stolen assets by, 40, 62– 66, 179 G7, 24, 25, 26 G20, 2, 5, 47, 78, 94, 107, 129, 140 – 41, 166, 179, 180 –82 Gabon, 65 Germany, 23, 86, 148 GIABA. See Inter-Governmental Action Group against Money Laundering in West Africa Glaser, Daniel, 123, 124, 125, 148 – 49 global governance, 4, 5, 12, 13, 172, 180 –83 Global Witness, 62, 179 governmentality, 171–72 Greece, 148 Guatemala, 71 Hefner, Hugh, 85 hegemony, 13, 21 Hess oil company, 64 Hong Kong, 79, 80, 92, 93, 94, 123 HSBC, 63, 65, 126 Hungary, 70, 76

INDEX India, 82 Indonesia, 31, 61, 103 Inter-Governmental Action Group against Money Laundering in West Africa (GIABA), 10, 158 International Monetary Fund (IMF), 3 – 4, 10, 20, 30, 43, 47, 50, 61, 62, 104, 105, 106, 107, 108, 127, 139 – 42, 145, 150, 152, 153, 159, 168, 176 Iran, 49, 78, 105, 108 Iraq, 3, 31 Irish Republic Army (IRA), 23 Isle of Man, 75 Italy, 23, 93, 105, 148 Japan, 49, 123 Jersey, 92 J.P. Morgan, 65, 84 Kerry, John, 24 Kieber, Heinrich, 86 Kim Jong-Il, 123 Know Your Customer (KYC), 11–12, 25, 27, 30, 45, 51, 55, 58, 59, 60, 70 –71, 83, 92, 94, 143, 157, 158, 176 –77 Korea. See North Korea KPMG, 49, 113 Labuan, 94 Lanksy, Meyer, 18 Latvia, 90 Levin, Carl, 68, 71, 95 LGT Bank, 86 Liberia, 65, 77 Libya, 49 Liechtenstein, 86, 88, 93, 100, 108, 111, 112–13 Liechtenstein, Prince Philipp von und zu, 113 Lloyds Bank, 50, 76 Luxembourg, 63 Macau, 122–24 Malawi, 160 – 61 Marathon oil company, 64 Marcos, Ferdinand, 61, 66, 176 Mauritania, 51, 111 Mauritius, 11, 38, 40, 57, 58–59, 60, 126, 127, 152, 153, 162 Mayflower Bank, 121 mechanisms, 3 – 4, 10, 12, 131–33, 163 – 64, 169 –70 methods, 9 –12, 13, 69, 166, 172–75

199

Mexico, 71 Moldova, 77 money laundering, 14 –18, 44, 121, 144, 155, 162; and cash, 15, 17, 27–28, 48, 49, 63; and corruption, 19, 48, 49, 61– 66, 69, 75 –77; and drug trafficking, 15, 16, 17, 21–25, 32, 33, 44, 60, 68, 77, 120, 122, 145; scale of, 6, 18 –20, 33, 38; and terrorism, 23, 26, 29 –31, 48, 49, 68, 77–78, 145. See also Anti-Money Laundering Montesiños, Vladimir, 179 Nauru, 1–2, 31, 38, 54, 87, 100, 113 –17, 127–28, 182–83; Anti-Money Laundering system in, 1–2, 12, 40, 53, 55, 56, 154, 162 Netherlands, 77, 149, 161 Netherlands Antilles, 77 Nevada, 75, 86, 93 Newfoundland, 72 New Zealand, 78, 145, 149 Niger, 38, 161 Nigeria, 61, 65, 103 Niue, 57, 126, 182 Nixon, Richard, 16 Noriega, Manuel, 22 North Korea, 78, 100, 105, 108, 119, 121–25 Obiang, Teodorin, 63 – 64 Obiang, Teodoro, 48, 49, 63 Obiang family, 63, 66, 179 Offshore Financial Centers. See tax havens Organization for Economic Cooperation and Development (OECD), 10, 26, 39, 42, 43, 76, 153, 182–83 Pacific Islands Forum, 10, 11, 115, 126 Pakistan, 66, 105, 108, 144 – 45 Palau, 56 –57, 125 Panama, 22, 72, 77, 80, 87, 94, 113 panties for peace, 121 Papua New Guinea, 53, 168 PATRIOT Act, 30, 49, 108, 116, 121, 124, 182 Peru, 179 Philippines, 61, 66, 176 Pinochet, Augusto, 48 Poland, 125 policy diffusion, 1–7, 12, 95, 132, 154, 165 – 67 Politically Exposed Persons (PEPs), 27, 48, 49, 61– 66, 177

200

INDEX

Portugal, 105, 149 power, 2–5, 7, 9, 12, 13, 131, 133, 134, 151–52, 155, 164, 166 –71 Reagan, Ronald, 21 Red Brigades, 23 reputation, 47, 48, 93, 101, 108, 109, 111, 112, 116–17, 119, 122–24, 132, 151–54, 159 Rice, Condoleeza, 63 Riggs Bank, 48, 49, 63, 65 Roosevelt, Franklin D., 72 Russia, 49, 56, 103, 113, 115, 124, 148, 149 Samoa, 51, 126, 153 sanctions, economic, 7, 100, 127–28 São Tomé e Principe, 105, 108 Saudi Arabia, 49, 75 Senate Permanent Subcommittee on Investigations, 49, 62, 63, 65, 66 Seychelles, 87, 92, 125, 126 shell companies, 3, 11, 17, 27, 48, 54, 63, 64, 68 – 91, 94 – 95, 179 Sinex Bank, 114 Singapore, 92, 93 Slovakia, 70, 125 socialization, 7, 8, 9, 11, 99, 131–53, 163 – 64, 169 –70 Société Générale, 64 Somalia, 70, 88, 93 South Africa, 50, 63, 161 Spain, 31, 63, 105 St. Kitts and Nevis, 108, 109, 113 Suharto, 61 suspicious transaction reporting, 21, 27, 30, 43, 45, 51, 52, 53, 142, 176, 180 Switzerland, 18, 22, 23, 28, 32, 66, 70, 76, 134, 176 Taiwan, Republic of China on, 55, 115 Tanzania, 51, 76 tax havens, 22, 32, 54, 55, 56, 57, 71, 80, 87, 90 – 95, 100, 110 –11, 182 Taylor, Charles, 65 Texas, 74, 77 Thailand, 77, 78, 82 Trade-Related Aspects of Intellectual Property Rights (TRIPS), 168 – 69

Transparency International, 61, 62, 157 Turkey, 145, 146 Turkmenistan, 105, 108 Turks and Caicos Islands, 125 Turpen, Lawrence, 75, 81, 85 –86 Tuvalu, 56 –57 UBS bank, 49, 64, 75, 85 Uganda, 51 Ukraine, 103 United Arab Emirates, 125 United Kingdom, 9, 28, 31, 38, 40, 45, 46, 65, 75–77, 80, 84–85, 90, 94, 107, 114, 118, 148, 159, 161–62 United Nations, 62, 103, 106, 116, 125, 141, 172 United Nations Office on Drugs and Crime (UNODC), 10, 19, 43, 52, 53, 127, 145, 149, 150, 162 United States of America, 9, 16, 21–23, 28, 38, 40, 62– 65, 71, 74, 76, 82, 88 – 93, 103, 107, 110, 115, 119, 121–25, 127–28, 134, 139 – 40, 148 – 49, 153, 155, 162, 169, 172, 179, 180; AML system in, 9, 12, 16, 21–25, 28 –30, 32, 33, 41, 45, 46, 48, 49, 60, 64, 67, 68, 80, 84, 86, 88, 94 – 95, 108 – 9 Uruguay, 123 Uzbekistan, 105 Vanuatu, 11, 38, 40, 51, 57, 59 – 60, 80, 94, 125, 126, 127, 152, 153, 162 Vatican City, 105 Venezuela, 82, 149 Vienna Convention, 24, 25 Wachovia Bank, 64 Watergate scandal, 16 Western Union, 56, 162, 182 Wolfsberg Group, 64, 156, 157 World Bank, 3 – 4, 10, 11, 19, 30, 39, 57, 61, 62, 104, 106, 107, 108, 139 – 42, 150, 153, 159, 162, 168, 176 world society, 2–3, 5, 137–38, 165 – 67 Wyoming, 91– 92 Zadari, Ali Asif, 66