PENETRATION OF THE FINANCIAL MARKETS BY ORGANISED CRIMINAL GROUPS

1. PENETRATION OF THE FINANCIAL MARKETS BY ORGANISED CRIMINAL GROUPS by Jonathan Fisher QC 23 Essex Street, London

2. NATURE AND SCALE OF THE PROBLEM “It is estimated that in the UK there are around 400 crime barons with assets of £440 million – the top 39 alone are worth £220 million. The criminal actions of these individuals and their associates affect us all. They run the local drug dealers on our streets and are often linked to the muggings and burglaries that plague innocent people’s lives” Source: Seizing Criminals’ Wealth, Home Office, 2002

3. ORGANIZED CRIME IS OUT OF CONTROL “Organized crime is a step ahead of Europe’s police forces … The criminals have a distinct advantage …We have got to do more because the criminals are running rings around us …” Source: John Abbott, former director-general of NCIS, reported in the Financial Times, 19/11/03, speaking at an international crime congress organized by the EU

4. ORGANISED CRIMINALS ARE HIGHLY SOPHISTICATED BUSINESS OPERATORS “Organized crime gangs are paying to put students through university and law school so that they can employ them as crooked lawyers and accountants … The Mafia-style gangs desire to court respectability has led to them being run increasingly like corporate businesses with turnovers of millions of pounds” Source: Daily Telegraph, 20th August 2001

5. COHESIVE CRIMINAL UNITS FBI definition of organised criminal group: “any group having some manner of a formalized structure and whose primary objective is to obtain money through illegal activities. Such groups maintain their position through the use of actual or threatened violence, corrupt public officials, graft, or extortion, and generally have a significant impact on the people in their locales, region, or the country as a whole”

6. SOCA CORE OBJECTIVE – TO TACKLE ORGANISED CRIME “[SOCA] will have as its core objective reducing the harm caused to the UK and its citizens by organized crime including the trafficking of drugs and people. It will work very closely with the revenue departments which will continue to be responsible for tackling revenue and tax fraud” – www.crimereduction.gov.uk

7. THE USE BY ORGANISED CRIMINAL GROUPS OF THE FINANCIAL MARKET PLACE • The investment markets • The primary markets • The secondary markets • Hedge funds and derivatives • The banking sector • Use of the international foreign currency exchange • Infiltration of the banking system by corrupt employees • The insurance sector

8. CLASSIC ABUSE OF THE FINANCIAL MARKETS Laundering the proceeds in the primary investment markets • Two methods (buying & selling securities): • Purchase of stocks and bonds with criminal proceeds (part of the placement process) using nominees or offshore companies • Sell stocks in companies funded with criminal proceeds (part of the layering process)

9. THE LONDON STOCK EXCHANGE (LSE) • The London Stock Exchange is a preferred marketplace to route money for laundering purposes • It is large (more brokerage firms to take partially washed funds and there are more avenues available for asset conversion) • It is busy (more transactions to scrutinise generally). This begs questions about the ability of the regulators to adequately scrutinize. • The attraction of criminal property from abroad. Illicit proceeds infiltrate the London Stock Exchange notwithstanding that the crimes which generated them are completely foreign. This results in greater regulatory burdens

10. FLOTATIONS & SHARE PLACEMENTS Canadian example:YBM Magnex, whose shares were floated thereby allowing the initial shareholders to realise their assets, to the value of $890 million. It subsequently emerged that Magnex was a vehicle for fraud and money laundering (1999).

11. THE SECONDARY MARKETS • The secondary markets are more vulnerable to the malign activities of organised criminal groups primarily because they are less regulated than the primary markets. Yet it is the reduction in the level of regulation which attracts market participants looking to take bigger risks for greater rewards. • US example: Orlando Supercard (2004) • Dealing in the over-the-counter secondary market (OTCBB) in the USA, • Alleged members of both the Italian and Russian mob had set up boiler rooms to promote stocks marketed using false and misleading financial statements.

12. HEDGE FUNDS & DERIVATIVES • Highly flexible nature of derivatives is an highly attractive quality for launderers. • Both ‘futures’ and ‘options’ gain their flexibility from the avoidance of the restraints of ‘value now’. • Advantages of derivatives: • ‘gearing’ (only small deposits relative to the value of the contract value will be required leaving room for high profit or loss with very little movement of the asset or contract) and • ‘liquidity’ (low bid/offer spreads in a highly liquid market reduce transaction costs to the launderer) as the second and third most attractive characteristics of derivatives respectively • Level of due diligence into the source of monies is very low

13. INFILTRATION OF THE BANKING SECTOR BY ORGANISED CRIMINAL GROUPS • Banking services associated with money laundering activity, in order of popularity Making an term deposit - 79.8% Purchasing monetary instrument – 41.2% Making a wire transfer – 35.1% Obtaining a mortgage – 35.1% Transfer between accounts – 23.7% Using a safety deposit box – 20.2% Obtaining a loan or line of credit – 18.4% Cheque cashing – 18.4% Investing in mutual fund – 17.5% Using credit cards – 14.9% Currency exchange – 13.2% • Source: Schneider, Stephen ‘Money Laundering in Canada’ The Nathanson Centre for the study of Organised Crime and Corruption (2004) p.53

14. EXAMPLE OF A CURRENCY EXCHANGE CASE The Bank of New York (BONY) Case • billions of dollars moved out of Russia and with the help of two BONY employee accomplices (Edwards and Berlin) laundered around the world causing significant loss of tax and duty revenues.

15. EMPLOYEE INFILTRATION IN THE BANKING SECTOR BY ORGANISED CRIMINAL GROUPS • Tony Neate, e-crime liaison for the Serious Organised Crime Agency (SOCA), stated that ‘one of the big threats still comes from the trusted insiders. That is, people inside the company who are attacking the systems’ (2006)

16. THREE FORMS OF INFILTRATION (1) Insider Looking Out. An employee with knowledge looking to exploit or sell their information. Alternatively, the opportunistic employee – not corrupt but if the opportunity arises they may be compromised. (2) Outsider Coming In. A criminal who seeks employment to gain insider information in order to compromise security and perpetrate frauds. (3) Outsiders Trying to Get In. A person outside of the company looking to either compromise security (hacking) or recruit/compromise an employee inside (spear fishing).

17. THE INSURANCE SECTOR Typically, a launderer purchases a single premium policy and then redeems it prematurely at a penalty. Variants on a theme: policy to support a loan on a commercial deal which falls through, insurance on non-existent assets or assets that are sold very quickly Insurance and the financial markets - Lloyds

18. THE CONVENTIONAL MARKET PERCEPTION • AML is necessary and participants in regulated sectors are aware and willing to invest the necessary capital expenditure to conform • But there is concern that stricter regulation in one country results in an unlevel playing field if not evenly implemented • (Example: EC 3rd Directive on AML)

19. MAKING FINANCIAL MARKET PARTICIPANTS MORE EFFECTIVE AT IDENTIFYING ORGANISED CRIME ACTIVITIES • Market participants require tailored, higher quality feedback from SOCA on organized crime trends • Desire for greater efficacy in response to the reporting system. Market perception that SOCA only acts when there is a local ‘collar’ to hang a conviction on • UKFIU sector based seminars could be more helpful. It would be better if the seminars were more product based.

20. SOCA’s PERCEPTION OF ITS ROLE • When asked about fiscal fraud in the UK Sir Stephen recently made two comments that appear to coincide with the same ‘perceptions’ as the market participants: • First, that UK criminal law is somewhat ineffective in prosecuting those who commit fraud outside of the jurisdiction (this supports SOCA’s interest in having a local ‘collar’ or defendant to pursue). • Second, much emphasis is being placed on working with City and financial institutions in response to the need to provide them with information regarding ‘the nature of threats and identities being used’. • Source: uncorrected transcript of evidence given before the Home Affairs Committee on 29, January 2008

21. SARS ANNUAL REVIEW 2007 • SOCA acknowledges in its SARs Annual Review 2007 that there is a communications gap with market participants. • The responsibility of identifying and circulating new typologies has been assigned to the UK Financial Intelligence Unit (UKFIU) • Shortcomings in SOCA’s relationships with regime participants is attributed to lack of resources. It is acknowledged that there is potential for further enhancements.

22. FLAG UP ISSUES FOR DISCUSSION * To what extent have organised criminal groups penetrated the UK’s financial markets? * Whether organised criminal groups have penetrated the UK’s financial markets to the extent that they can influence market movements? * How the UK’s regulators are responding to the threats posed by penetration of the financial markets by organised criminal groups: • The role of SOCA • The role of the FSA • Whether there is any danger of overlap on the one hand, or a regulatory gap on the other.

23. PERCEPTION AND EXPECTATION GAPS? Is there a gap between: (i) the UK market’s perception of the extent of the penetration and the reality (ii) the UK regulators perception of the extent of the penetration and the reality (iii) the expectations made by market participants of the regulators (iv) the expectations made by the regulators of market participants?

24. Contact details Jonathan Fisher QC 23 Essex Street London WC2R 3AA 020 7413 4706 jonathanfisher@23es.com www.jonathan-fisher.co.uk