By THE INVESTOPEDIA TEAM Updated January 06, 2022
Reviewed by CHIP STAPLETON
Fact checked by SUZANNE KVILHAUG
Money laundering is the process of illegally making a large amount of money and hiding it to make it look like it was generated from legitimate sources. The money normally comes from activities like drug and sex trafficking, terrorist activities, and other illicit means. It is considered dirty and is laundered to make it look like it came from a legal source(s). Money laundering is a serious crime that carries heavy penalties, including jail time.
There are three steps used to disguise the source of illegally earned money and make it usable:
Now that we've helped you understand the basics of money laundering, we're going to go through how to recognize whether money is legitimately made or if it was generated from illegal sources. We've highlighted laundering methods and how the digital age plays into these schemes.
Money launderers typically use methods to avoid detection and hide the real sources from where their money actually comes. Some of the most common methods are outlined below.
Contrary to what you may believe, this doesn't have anything to do with the classic children's cartoon. Smurf is the term used to describe a money launderer who wants to avoid government scrutiny. They do this by using the placement, layering, and integration steps to hide the money. Large sums of money are deposited in different banks using smaller transactions.
Financial institutions are required to report large deposits that exceed $10,000 or those they deem suspicious to financial regulators and authorities. By depositing smaller amounts of money or smurfing, money launderers are able to go under the radar and make it look like the money they deposit is legitimately sourced.
Mules are individuals who are hired by money launderers to help carry out their laundering schemes. Money mules are just like drug mules, who may be in on the scheme or may be recruited unknowingly. But rather than smuggling drugs, these individuals carry money.
People who are recruited are usually approached by money launderers and often don't have any knowledge of the scheme. They may be enticed by being promised jobs that pay large sums of money in return. Criminals often target people who usually fall under the radar, including those who don't have a criminal record or the financially vulnerable.
One of the mule's responsibilities is to open up bank accounts and deposit the money into them. Money launderers then begin making wire transfers and using currency exchanges to move the money around the financial system to avoid further detection.
Shells or shell corporations are companies that don't have any business activity or operations, physical operations, assets, or employees. Many shells are legitimate business entities that are used to raise money and fund the operations of a startup company or to manage a merger or acquisition.
But other cases involve the creation of shells by fraudsters who want to hide illegal activities and/or avoid paying taxes. Many individuals do this by setting up shell companies in jurisdictions that guarantee anonymity, allowing them to make deposits and transfer money into different accounts. Shells also allow people to avoid reporting income and paying taxes to authorities like the Internal Revenue Service (IRS).
Other than trying to hide the money through deposits and corporations, money launderers also choose to avoid detection by:
The maximum penalty for money laundering is $500,000 or twice the property value involved in the transaction (whichever is greater), or a maximum 20-year prison sentence—or both.1
While the methods listed above are still common, money launderers often find modern ways to operate, putting a new spin on the old crime by making use of the internet to avoid detection.
A key element of money laundering is flying under the radar. The use of the internet allows money launderers to easily avoid detection. The rise of online banking institutions, anonymous online payment services, peer-to-peer transfers using mobile phones, and the use of virtual currencies such as Bitcoin makes detecting the illegal transfer of money ever more difficult.
Here are a few ways that technology is helping further money laundering activities:
Some of the world's largest banks have been implicated in money laundering schemes, including HSBC, Wachovia, and Standard Chartered.2
Financial regulators have anti-money laundering (AML) policies in place. Banks and other financial institutions are required to comply with these procedures to ensure a safe system, where criminal activities are detected and reported to authorities.
For instance, banks must report large deposits over $10,000 and any suspicious activity that takes place within an individual or corporation's account, whether that's multiple deposits, frequent wire transfers, and currency exchanges, among others. Some of these laws are proving to be slower to catch up to these digital crimes.
Cybercrime has become one of the top priorities for the Treasury's Financial Crimes Enforcement Network (FinCEN). In a June 2021 memo, the agency outlined the growing threat of money laundering vis cryptocurrencies and cyberattacks such as ransomware that can illegally funnel digital funds overseas.3
Some of the steps financial institutions, their employees, and others can take to detect digital laundering include:
Some countries have gone even further by banning certain practices, such as the use of cryptocurrencies. Although investors and advisors firmly insist that using digital currencies is very complex, some financial regulators say that they can dismantle the global financial system. But changes have been made to increase the level of transparency related to cryptocurrencies, many of which provide(d) anonymity to users because of the way they are treated and traded.
There are three common stages to money laundering. The first is called placement, where fraudsters first introduce money obtained from illegal activities into the financial system. They do this by breaking up large amounts into smaller deposits in multiple bank accounts. The second stage is layering, which involves moving the money around to distance it from the fraudsters. The final stage is called integration, where the money is brought back to the perpetrators as clean money.
The traditional forms of laundering money, including smurfing, using mules, and opening shell corporations. Other methods include buying and selling commodities, investing in various assets like real estate, gambling, and counterfeiting. The rise of digital technology also makes it easier to launder money electronically.
The wash wash scam is a scheme commonly used by scammers who fleece victims by promising them large sums of money in exchange for literally cleaning dirty money. Victims are given fake banknotes that are passed off as being real by dyed. The fraudster promises their victims a big cut if they pay a certain fee and purchase a special cleanser. Scammers commonly seek out financially vulnerable individuals and the scheme is also called the black money or black dollar scam.
The act of hiding money is thousands of years old, and it is the nature of money launderers to attempt to remain undetected by changing their approach, keeping one step ahead of law enforcement, just as international governmental organizations work together to find new ways to detect them.
Money LaunderingMoney laundering is the process of making large amounts of money generated by a criminal activity appear to have come from a legitimate source. more Anti Money Laundering (AML)Anti-money laundering (AML) refers to laws and regulations intended to stop criminals from disguising illegally obtained funds as legitimate income. more SmurfA smurf is a colloquial term for a money launderer who seeks to evade scrutiny from government agencies by breaking up large transactions. more White-Collar Crime DefinitionA white-collar crime is a non-violent crime committed by an individual, typically for financial gain. more Combating the Financing of Terrorism (CFT)Combating the Financing of Terrorism is a set of policies aimed to deter and prevent funding of activities intended to achieve religious or ideological goals through violence. more USA Patriot ActThe USA Patriot Act is a law passed shortly after September 11, 2001, terrorist attacks increasing U.S. law enforcement agencies' intelligence powers. more
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