Understanding Money Laundering Stages, Laws, and Prevention

There are countless laws in place that track money in the financial system to ensure its legitimacy. However, the concept of legitimacy raises important questions: What or who defines the legitimacy of cash? How do we spot the difference between legal and illicit funds?

Most importantly, despite the plethora of existing regulations, how do criminals continue to resort to deceptive methods to hide their illicit financial gains and activities from law enforcement and tax agencies?

In this article, we discuss at length the three money laundering stages that criminals employ to escape scrutiny and checks when it comes to the accumulation of illegal personal or business funds. We also talk about some popular real-life cases and a few different ways to stop these bad actors and make sure they are not able to escape the law.

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What Is Money Laundering?

Money laundering is the criminal act of disguising the origin of any funds obtained unlawfully. It is done to avoid scrutiny of money made through illegal means such as corruption, extortion, drug trafficking, human trafficking, sale of smuggled or counterfeit goods, illegal bookmaking, tax evasion, arms trafficking, and terrorism financing. Money laundering effectively “cleans” dirty money, making it seem like it was earned through a legal business venture or transaction.

Money laundering is not an easy or quick process (you’ll understand what we mean when you get to the next part detailing the stages of money laundering), so why bother with it instead of just using up all that cash?

Suppose a criminal is making a fortune through manufacturing and selling drugs (not a Breaking Bad reference!). What happens if/when they start making elaborate purchases with all the money they’re minting? If they use the illegal cash directly, no matter how tempting it might sound, it will alert the authorities, who’ll come asking how they got that much money in the first place. The investigation would lead to serious legal consequences. So, the illegal money is practically good for nothing if not “washed.”

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The Level of Damage Caused by Money Laundering

Money laundering provides criminals with unchecked financial resources and fuels organized crime, corruption, terrorism, and other illegal activities worldwide. Eurojust (the European Union Agency for Criminal Justice Cooperation) observed an over 100% increase in cases registered between 2016 and 2021, with over 600 cases filed in the latter year alone. Dirty money harms legitimate businesses, disrupts legitimate economic activity, destabilizes financial systems, ruins international relations, and prevents real economic growth and development, among other damages.

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The Three Stages of Money Laundering

There are typically three money laundering stages.

1. Placement
2. Layering
3. Integration, aka extraction

Not every money launderer follows these steps sequentially. Sometimes, the process is cyclical; other times, there might be so much happening that it becomes difficult to separate the process into distinct stages. It can get quite complicated.

Criminals begin the money laundering process with placement, where they must find ways to insert their illicit funds into the legitimate financial system without attracting attention. They might use various clever tactics to dodge reporting mechanisms and law enforcers.

Next is the layering stage, where launderers conceal the money’s origin by running it through an elaborate maze of investments, holding companies, global bank accounts, and/or other intermediaries to throw regulators and investigators off the scent.

In the final step of money laundering, integration, the laundered funds are retrieved from seemingly legitimate sources and used for other legitimate transactions, such as donations, loan repayments, luxury purchases, or funding legitimate businesses.

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1. Placement

Money laundering starts with a sleight of hand: Placement. Here, the criminal discreetly introduces their illicit funds into the legitimate financial system. Large sums of cash are a dead giveaway, so the owner often splits them into smaller portions to deposit into their bank account over multiple transactions. This process, called structuring or smurfing, helps them in avoiding CTRs (Currency Transaction Reports – reports filed by banks to report large cash transactions).

Cash-intensive businesses like laundromats and casinos are a common means of placement where the criminal can easily mix their dirty money with legitimate takings. Financial instruments like bonds and insurance policies offer another disguise, allowing the owner to move the money away from its dubious source.

Where international borders are a hurdle, the criminal could employ “money mules,” people who transport smaller amounts of cash across countries to tackle border control. Other common placement methods include exchanging dirty cash for foreign currency or buying luxury goods and valuable assets like jewelry that can easily be resold.

The key to placement is operating under the radar. Success at this step is critical to reaching subsequent stages of money laundering that will ultimately transform dirty money into seemingly clean funds.

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2. Layering

The placement stage of money laundering introduces dirty money into the financial system, but its illegal origins remain fairly traceable at this stage. The second stage, layering, aims to sever this connection completely.

In layering, the criminal wants to make it difficult to trace the illegal funds by running them through several financial transactions of various natures, such as wire transfers and invoice payments. The goal is to make it virtually impossible for auditors, regulators, and law enforcement agencies to follow the paper trail back to the original criminal activity.

One strategy involves exploiting the obscurity and anonymity offered by digital currencies. Some criminals engage in “chain-hopping,” converting their cash from one cryptocurrency to another multiple times in quick succession. This rapid movement of money through several platforms creates a fragmented digital money trail that’s difficult to trace.

Another tool used in layering is shell corporations. These are fictitious companies that don’t perform any actual business operations but are used by the criminal to perform money laundering transactions in disguise. Shell companies can not only help hide the real owner’s identity but also act as intermediaries when the criminal sets off a series of account transfers through them to mask the true owner of the funds. They’re also often used to launder money through fake invoicing.

Offshore accounts located in regions that are not big on enforcing regulations such as AML and CTF rules and tax laws are another means of layering. A criminal transferring funds to these foreign bank accounts can exploit the secrecy provisions to hide the transacting parties.

Money launderers may also use non-traditional remittance systems like Hawala (Middle East and North Africa) or Hundi (India) to transfer the money without physically moving it.

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3. Integration

The integration stage, also called extraction, is where the criminal gets their “washed” funds back in their accounts or physical possession, this time from a seemingly legit source (after all the layering). The laundered money is now squeaky clean, and they can use it on all sorts of purchases and expenses.

Luxury goods are one tempting option. Fancy cars, expensive jewelry, or rare artwork, too – these not only show off the criminal’s newfound riches but also act as an easy way to store and move the money around without raising eyebrows.

But integration isn’t all about flashy purchases. Criminals can also use this laundered money to invest in legitimate businesses. This is a double win – they get a seemingly honest source of income and potentially expand their financial portfolio. Real estate is another popular choice. Investing in property allows criminals to store wealth, generate rental income, and pass themselves off as any other property investor.

This brings us to the end of the money laundering process.

This illustration by UNODC perfectly captures the complete money laundering flow.

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How Does the Law Keep Money Launderers in Check?

Money laundering isn’t just about stolen cash – it can destabilize and bring down entire financial, economic, and political systems. To fight financial crime, a global effort is underway.

International institutions such as the Financial Action Task Force (FATF) and EU have worked extensively to establish globally recognized AML compliance laws and guidelines to identify risky individuals and businesses, track money trails, and enforce financial sanctions.

These recommendations have shaped countless national laws, like Canada’s Proceeds of Crime Act and the U.S. Code §1956: Laundering of Monetary Instruments. The US Department of Justice (DoJ) states in detail how to process cases against money launderers as well the punishments for guilty parties in the form of up to 20 years of jail time and heavy fines worth tens of thousands of dollars.

Due to the global nature of money laundering and similar offences, international cooperation is key.

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Case Studies: Two Real-Life Examples

Here are two famous money laundering cases that shocked the world and taught us valuable lessons.

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1. The Panama Papers (2016)

This scandal tore through the veil of unbelievable secrecy surrounding an extensive offshore account network.

Wealthy individuals and corporations from all over the world, wanting to hide illegally obtained funds and assets and evade taxes, had long been turning to the law firm Mossack Fonseca. They were all left exposed when over 11 million documents containing their confidential details were leaked. A network of shell companies in Panama – a haven for financial ambiguity – was uncovered, leading to major investigations in many countries and resignations coming in from their top political leaders. The fact that money flowed undetected within this black hole of anonymity for so long highlighted the devastating impact of lax regulations governing offshore havens.

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2. The FTX Money Laundering Scandal (2022)

The FTX scandal rocked the crypto world in 2022, with founder Sam Bankman-Fried accused of misusing billions in customer funds. Allegations point to potential money laundering, where FTX customer money had been funneled to Alameda Research, another company Bankman-Fried founded. The lack of separation between these businesses and the absence of safeguards for customer funds raises serious concerns. This case highlights the need for stricter regulations in cryptocurrency to protect users from potential misuse of their funds.

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Preventative Measures

We need strong defenses to protect the financial system from money-laundering schemes. Here are a few key ways to prevent money laundering.

1. AML Compliance Solutions: Countries and institutions need AML compliance solutions. Tools like KYC (Know Your Customer) and KYB (Know Your Business) platforms offer real-time transaction monitoring, customer due diligence (CDD), sanctions checks, and more to identify suspicious transactions, assess customers’ risk levels, and keep an eye on those likely to be linked to terrorism, corruption, and other serious crimes. Anti-money laundering tools can help spot problems early on and ensure swift action is taken.
2. Enhanced International Collaboration: Countries need to share key information and intel to proactively track currency as it crosses borders. Regular audits and checks must also be carried out on local financial and non-financial institutions to foster transparency and openness on a global scale.
3. Raising Awareness at the Individual Level: It is crucial to educate people about money laundering and ensure they know how to identify suspicious behavior and report it to the relevant authorities. Training programs help workers like bank tellers and real estate agents know of common money laundering signs to look for. There is also a need for proper programs and streamlined helplines where people can report anything questionable they see.

These measures serve as proactive steps in detecting and apprehending criminals before they can cause massive damage.

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Paving the Way to a Legitimate Financial System

Criminals typically conceal their illegally acquired money and make it appear legit by running it through the three-step method of money laundering – placement, layering, and integration.

Money laundering isn't just a financial crime. It plays a major role in the fueling of organized crime, terrorism, drug trafficking, and much worse.

While the impacts of money laundering can be devastating on individuals, businesses, or even entire economic systems, robust Anti-Money Laundering (AML) compliance practices serve as effective counters. With appropriate preventative measures, authorities can be alerted promptly to any suspicious activity so that they can take timely action, ultimately making the financial ecosystem more secure.

Both old and new real-world cases teach us important lessons and reinforce the fact that we must continue to stay vigilant and dedicated in our efforts to combat money laundering and related crimes. By working together, nations, corporations, and individuals globally can give culprits a real challenge in getting away with their financial crimes.

Vespia can help your organization achieve complete AML compliance so that you can play your part in thwarting money laundering efforts globally. To get started, shedule a DEMO call with Vespia today.

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