When the Cold War ended, long-closed doors in Russia swung open to admit Western capital, Western goods, and even Western-style politics. Those same open doors allowed the export of one of Russia's most refined commodities: corruption. The reach of that corruption was driven home recently when the largest money-laundering case in U.S. history made the news.
The effects have been far-reaching. The reputation of one of America's oldest and largest financial institutions, the Bank of New York, has been tarnished. The International Monetary Fund is rethinking the way it lends and tracks money in corruption-plagued countries. Secretary of State Madeleine Albright has publicly warned the Russian government to clean up corruption or risk losing loans, and the House of Representatives is poised to investigate the Clinton administration's lack of oversight.
Above all, the case has underscored the fundamental lesson for both banks and investors: Make sure you know with whom you are dealing.
What Is Money Laundering?
Money laundering is taking money made from criminal activity - usually cash - and moving it through a sequence of bank accounts until its origins are obscured. Often this involves a series of transactions made through shell companies formed in bank secrecy-havens. Once the trail has been blurred, the money is withdrawn and used for further criminal activity.
Until the Russian story broke, the largest money-laundering case in U.S. history was "Operation Casablanca" in 1998. The case involved $150 million in drug money that had been laundered through Mexican banks.
The Russian case represents a sobering advance from Casablanca on a number of fronts - most notably the amounts involved, and the fact that the art of money laundering has migrated from drug traffickers to white-collar criminals. Indeed, while there's no certainty about where the laundered money in this case came from, there is consensus that it probably represents an unholy troika of criminals, politicians, and businesspeople.
As Old as the Czars
Corruption in Russia has been around since before the revolution, and was a hallmark of the Soviet bureaucracy. But with the fall of communism, privatization and Western investment have created lucrative opportunities for the well connected, including criminals.
Russian organized crime, a.k.a. "the mafiya," and its portfolio of frauds, scams, and brutal acts, are relatively new to the United States. With a dizzying array of secretive offshore concerns, subsidiaries, and holding companies, criminals - along with politicians and business people - have siphoned vast sums of money out of the country. Russia's Interior Ministry estimates that anywhere from $50 billion to $250 billion was illegally transferred out between 1994 and 1998.
And as New as Today's Headlines
While details of the latest case are still unclear, the basic story line is now in place. Sometime before March 1998, money began moving through nine accounts at the Bank of New York in the name of Benex Worldwide Ltd.
In June of that year British authorities notified American law enforcement officials of suspicious banking activity involving Benex and the bank's London office. In July, the IMF agreed to $17.1 billion in loans to Russia over two years. The next month, Republic National Bank of New York notified the Federal Bureau of Investigation of unusually large transfers involving it, Russian companies, and Bank of New York. That same month, the ruble again faltered. In September, Bank of New York began working with the Justice Department and the FBI.
All told, between March 1998 and March 1999 at least $4.2 billion was funneled through the Benex accounts at Bank of New York. In August the bank publicly acknowledged the federal investigation.
So Know Your Customers
Would a clear, rigorously enforced "know your customer" policy have prevented all this? Possibly. At the very least it would have brought it to light sooner. And that's why a stringent policy should be part of every bank's operating procedures. If your bank is dealing with or reaching out to clients domiciled in countries without adequate central bank supervision, a strong program and robust due-diligence procedures are crucial.
Always ask the following questions about prospective clients:
Where does their money come from?
Does the nature and size of the business allow for the amount of money moving through its accounts?
Does the customer or the capital originate in countries known for corruption?
Once you've answered these questions, you must balance your program against privacy issues, especially given the potential for lawsuits and the reluctance of the U.S. government to take on this politically charged issue.
And Your Employees
You also need to know who's working for you, and to be certain that a system of checks and balances is in place to prevent employees from breaching the system. In the Benex/Bank of New York case, the bank employee at the center of the investigation was dismissed for gross misconduct, falsification of bank records, and failure to cooperate with investigators. She has since pleaded guilty, along with her husband.
And since the case broke, investigators have seized documents revealing that the $4.2 billion that passed through accounts at Bank of New York was in the name of the company controlled by that employee's husband. Investigators have in turn linked him to the reputed "don" of the Russian mafiya.
Even though money laundering has been an active issue and a U.S. government focus for 20 years now, many banks still adopt a minimalist approach. They react to government regulatory warnings but go no further.
That can be costly.
Financial institutions should track the latest money-laundering techniques, particularly with e-money and cyber- payments having the potential to remove hard cash from the money-laundering equation entirely.
Still, short of not accepting deposits or transferring money, there is no ironclad system for preventing money laundering. But there is a way to exercise damage control: Don't wait until an investigation begins. Implement stringent risk-management reviews to gauge exposure and identify suspect clients. Mr. Zeldin, former chief of the Justice Department's Office of Money Laundering and Asset Forfeiture, is a principal in Washington with PricewaterhouseCoopers Investigations. His responsibilities include participating in international negotiations on money laundering, developing prosecution guidelines, and coordinating multidistrict litigation.