The United States has developed a reputation as the country with the toughest anti-money laundering regime and the most aggressive policies to combat illicit finance in the world. Large fines against banks act as a deterrent and spur investments in compliance. Strong criminal law enforcement efforts result in investigation and prosecution of money launderers. Americans would need to look back a decade to the exploitation of HSBC’s U.S. and Mexico operations by drug cartels, or even earlier to the infiltration of the Bank of New York by Russian money launderers in the 1990s, to identify a truly massive money laundering scandal. The strict treatment of banks in violation of anti-money laundering policies has established deterrence and keeps everyone invested in a culture of compliance.
But this narrative is incomplete. If the banks are the well-guarded front door to the U.S. financial system, electronic payments companies, private investment funds, and, to a lesser extent, securities firms are the back door left open—and the opening grows wider as these business models grow in importance. Electronic payments companies, while still relatively small, seem likely to dominate e-commerce and potentially all payments one day, as Facebook’s announcement of Libra coin may presage. Hedge funds, private equity, and venture capital have gone from a niche segment to a colossus. And securities firms, while long-established players, continue to be subject to less vigilant oversight than deposit-taking banks. This back door is a tempting entry point for illicit actors such as organized criminals, corrupt officials, or foreign governments attempting to interfere in the American political process.
Electronic payments companies, whether using dollars or virtual currencies, will only continue to grow in importance in coming years. Facebook’s proposed Libra coin may or may not take off, but the trend is unmistakable. As the Treasury Department has made clear, these companies have money laundering obligations. The problem is that such firms are classified as “money transmitters,” and instead of being subjected to oversight by one federal supervisor, they are primarily licensed and overseen by regulators in all 50 states—creating both legal confusion and limitations on the government’s visibility.
Meanwhile, U.S. hedge funds, venture capital, and private equity firms manage a collective $13 trillion but remain exempt from money laundering requirements. The European Union closed this loophole over a decade ago. Congress called for Treasury to establish money laundering requirements for these funds in 2001, and Treasury proposed a rule to do just that in 2015. Yet the rule has yet to be finalized. In the meantime, these private funds have no obligation to check the sources of their clients’ money or even determine who the clients are. And when private funds are customers of a bank, they are carved out of Treasury’s rule requiring banks and securities firms to identify the underlying owners of an entity that opens a new account.
When it comes to securities firms, which are far more established players, take a look at recent enforcement actions against the American operations of three major securities institutions: UBS, Morgan Stanley, and Merrill Lynch. UBS moved $83 billion through non-resident accounts over two years without properly screening the transactions, including $9 billion involving high-risk jurisdictions. Morgan Stanley failed to properly monitor $55 billion in transactions over five years, including $3 billion involving high-risk jurisdictions. And Merrill Lynch for many years did not apply software screening at all to certain types of accounts. In a three-year period, this resulted in over $100 billion in transactions going unmonitored.
For these infractions, UBS, Morgan Stanley, and Merrill Lynch were fined between $10 and $26 million by the Securities and Exchange Commission and the Financial Industry Regulatory Authority (an industry body known as a self-regulatory organization). Compare this with U.S. Bank, a traditional depository institution, which was fined over $600 million by bank regulators and the Justice Department for similar lapses.
Capitol Hill’s illicit finance focus has rightly been on banning anonymous companies. The ability to form a company anonymously, without reporting its owners to the government, is indeed the most glaring problem the U.S. faces—in stark contrast with nearly every other major economy—and one amenable to a straightforward solution, as bipartisan bills in both the House and Senate attest. But policymakers would be mistaken to assume that ending anonymous companies solves America’s illicit finance problem.
While strong supervision and enforcement have set an impressive standard for the banks, leaving the rest of the financial system comparatively unguarded could prove to have grave consequences. We do not want to go through what Europe has been dealing with in recent years, namely an outbreak of multi-billion dollar money laundering scandals across the continent, frequently involving money originating in Russia and the Commonwealth of Independent States. The challenge for the United States is to raise money laundering enforcement and compliance across the financial system to the high bar set by the banks and their regulators.