Exotic Financial Instruments Should be Tested for Laundering Risks says PMK Advisory's Principal Consultant Paul M. Kay

1. Moneylaundering.com News
Exotic Financial Instruments Should be Tested for Laundering Risks: Consultant
Like pharmaceuticals, new financial instruments should be thoroughly tested for risks before
allowed on the market, according to Paul Kay, founder and president of PMK Advisory, a
Convent Station, New Jersey-based money laundering and fraud detection consultancy.
Products that are not completely understood by regulators can be exploited by organized
crime groups much in the way that prepaid cards are abused today, he said. In some cases,
mobsters have pressured knowledgeable investors to help them use complex financial
products to hide their illicit proceeds, said Kay, formerly a detective at the Office of the New
Jersey Attorney General.
Kay, who also previously worked as the National Director of Organized Retail Crime and Cyber
Crime at Limited Brands, Inc., spoke with reporter Larissa Bernardes about how the mafia
moves its money and what the economic crisis has meant for the anti-money laundering
(AML) compliance industry. What follows is an edited transcript of that conversation.
You have extensive background investigating organized crime groups. How do
mobsters hide their dirty money from AML officers?
There are several different ways: front businesses, smurfing, sports betting, prepaid cards and
also brokerage accounts and real estate deals. Brokerage and real estate were a lot more
lucrative before the crash last year. These days, they are not a good investment. So common
sense says that they are probably moving back to traditional methods that are tried and true.
One example of how organized groups typically wash money is by opening a pizza shop, or
any other cash-intensive business. Let’s say that the typical income for the place is $1,000
dollars a week. What they do is pad the income with illicit cash and wash the money through
the store. It will then get introduced into the banking system as profits from the store.
AML officers are on the front line to identify these cash-intensive businesses. They need to
make sure to do their due diligence so that the fraud examiners can investigate what’s going
on. One thing a compliance officer can look at is how the store’s expenditures match up to the
income that’s being pulled in. If they are selling 1,000 pizzas a week, are their expenditures
for making the pizzas an appropriate amount of money? A lot of times, these [kinds of details]
slip by until an AML officer files a SAR about it.
What is one of the more sophisticated ways you’ve seen criminals disguise money?
One new trend I’ve been seeing is the use of prepaid cards. As you know, when you leave the
country you have to declare any assets you have that are over $10,000. But there’s currently
no regulation to limit how much money you can be put on a prepaid card. It can be in the
hundred thousands or even in the millions.
As I mentioned before, I’ve also seen laundering done through securities instruments and
brokerage accounts. Typically, for securities laundering, organized crime groups will target a
person in the financial industry who may or may not be participating in some type of illicit
activity, like gambling or narcotics use, and convert them into a conduit to launder money.
Sometimes, the person may have a family member who is doing drugs or partaking in
prostitution and that’s the angle they use.
Your home state, New Jersey, has a reputation for corruption. Are there any AML
lessons to be gleaned from the recent money laundering and corruption bust that
netted New Jersey politicians and rabbis?

2. Sure. First, no matter how reputable they may seem to be, cash-intensive businesses like
churches, temples and charities are great vehicles to launder money. If you see a quick
increase in cash deposits, that should be something to be looked at. They might be a good
church or charity, but keep your eyes open. Second, make sure you are maintaining a robust
KYC [know your customer] and CDD [customer due diligence] program. Of course, politicians
are high-profile figures so make sure to have your list of PEPs as up-to-date as possible.
You mentioned a PEP list. Technically, to be defined as a PEP you must be a foreign
national. Do you think domestic politicians should be classified as PEPs?
They have a higher status than most folks and add more visibility to the bank so I don’t see a
reason why a bank wouldn’t keep a list of PEPs that are local, just for their own protection.
This is one [thing] state laws might demand [in the future].
What should be done now, either by U.S. officials or financial institutions, to improve
on efforts to expose money laundering?
I think the laws are good but things can always be better. There have been talks about
regulating hedge funds and I see that as a good thing.
I also think there needs to be a system to regulate new financial instruments that get
introduced into the system. I’ll use narcotics as an example. When an [illicit] organization
creates a new drug, it’s not considered illegal yet until a law says it is. It’s the same with the
financial system. Many financial products are not regulated because they are brand new.
There should be vetting process like the FDA has for new prescription drugs. Each new exotic
financial instrument should be approved in the same manner.
Why do think this isn’t being done?
Politics. Plus, no matter how much the financial industry says they want controls, who really
wants to be regulated? Who really wants someone always looking over their shoulder?
How has the recession impacted AML efforts?
I’ve seen a decrease in AML engagement by financial institutions. There’s a lot of recruitment
still but, on the flip side, a lot of folks have been downsized. There’s a lot of talent out there,
in relation to consulting work. [As a result], many financial institutions are demanding lower
fees for consulting services. But there’s a high risk involved there. I’ve seen a pattern where
the larger consulting firms bring in the experienced guys at first and then replace them with
less qualified people to finish the deal. If I was a financial institution, I would have an issue
with that.
Are examiners pressing compliance officers as much?
I think they are and then some.
Massachusetts is talking about adopting a state AML law. Are state laws helpful? If
so, how?
Yes and no. The reason: if it adds value and strengthens the existing federal role then yes. As
an example, they can demand that banks create a local PEP list, as we’ve talked about. They
can request that the local cash reporting threshold be decreased.
If you look at New York and all the things going on in Wall Street, a state AML law might be
another weapon for the attorney general to use to take control of Wall Street. Maybe the law
could be used for things that slip through the loophole. Having said that, if extra legislation is
redundant and slows business down, it won’t be effective. State legislation has to be really
thoughtfully planned.

3. What changes do you see on the horizon for AML enforcement and compliance?
After about eight years of deregulation of the industry, I now think the pendulum is swinging
the other way. We’re seeing more regulation and enhancement of existing legislation. On the
front end, we can expect more regulation of exotic financial instruments, such as credit default
swaps and more mortgage-related regulation, for obvious reasons. A lot of financial
institutions are strengthening their systems to prevent mortgage fraud. Hopefully, more
financial products will be brought under AML supervision.
*This article originally appeared on moneylaundering.com and Fortent Inform on August 7, 2009*