Money laundering and AML compliance

From the article:

[D]ue to quirks of the real estate industry, many legitimate transactions are highly effective money laundering in every respect other than being perfectly normal. You can set up a corporation whose only reason to exist is to own one apartment building. That building could be purchased with a wire from a lawyer’s escrow account. The bank receiving the funds into escrow would, if they enquired further, likely accept “I’m an attorney and this is to fund a client’s purchase” as a full and adequate response under their AML policies.

This is not the unique way that e.g. Russian oligarchs purchase apartment buildings. It is simply how one purchases an apartment building. (There exists some desire to bring real estate professionals into the AML fold via new regulation. Real estate professionals are numerous, politically influential, and are less intrinsically creatures of state action than financial institutions are, and so these efforts have made little headway in most jurisdictions despite upwards of a decade of trying.)

Speaking of Russian oligarchs: we ordinarily expect laws to be written down and then relatively impartially enforced. In the specific case of AML, changing political winds have moved particular transactions involving oligarchs from a declared policy goal of Western governments ("economic integration of Russia with the West") to a policy anti-goal ("supporting the Putin regime"). We discussed this previously. This has the effect of making previously supportable transactions now unsupportable, and an interesting function of this compliance regime is communicating that change without acknowledging that it actually happened.

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[E]very financial institution of any size has a Compliance department. One of their functions is having a technological system which will sift through the constant stream of transactions they produce and periodically fire “alerts.” Those alerts go to an analyst for review.

This implies floors upon floors of people who read tweet-length descriptions of financial transactions and, for some very small percentage, click a Big Red Button and begin documenting the heck out of everything. This might sound like a dystopian parody, and it is important to say specifically that this is not merely standard practice but is functionally mandatory.

The right orders of magnitude to think of are “tens of millions of transactions flagged” and less than 5% requiring a report.

Another way to think of it is that private industry employs roughly as many intelligence analysts as the intelligence community does; the rough order of magnitude is "tens of thousands." How do you want to spend your Friday? They are going to spend theirs doing what they always do; actioning transaction reports.

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An example from here in Japan: an immigrant attempted to wire the equivalent of $600 to his cousin in Africa. He was asked the purpose of the wire and said it was for a tuition payment. Bank staff asked for supporting documentation like e.g. a tuition statement or student ID card for the cousin. The customer refused to provide that documentation. The bank refused the wire. The customer accused the bank staff of racially profiling him and raised his voice.

I was not a party to that transaction and, for clarity, it did not involve any employer or business partner of mine. I winced when reading a news report about it, because this is practically ripped from Compliance training. The customer is absolutely right and they are very likely getting a SAR filed on them.

This will likely have zero legal effect, for reasons we’ll get into in a moment. However, SARs are relatively expensive for a bank to process. A client who produces an excessive number of them will be judged as ipso facto a compliance risk. This means that clients who generate SARs will often be forcibly offboarded with the fact of the SAR being filed being the true reason for the offboarding.

At many institutions, one SAR is a non-event. Two, for a retail client, means one gets a letter saying the bank wishes you the best in your future endeavors and will not bank you anymore. That letter will often mention that this is a commercial decision of the bank and will not be reversed. Some clients receiving that letter will, on attempting to open account at a different bank, get refused because the first bank entered them into Chexsytems as “account closed at bank’s discretion” and the second bank, on reviewing that entry, said “yep, we are not touching this hot potato.”

Frustratingly, regulators will say “Well, that is the bank’s decision. We didn’t direct them to do that.”, even though the purpose and effect of AML regulations is causing a lot of behavior not specifically asked for. Banks will, meanwhile, say “Our hands are tied. Look at these enforcement actions. Clearly, this is an unacceptable level of risk.” And meanwhile, there is an actual person who has done nothing wrong and now finds themselves somewhere between greatly inconvenienced and frozen out of the financial system entirely.

Also, this interesting bit about what Alameda Research was up to:

Alameda Research made its initial money in defeating AML controls at Japanese regional banks. They described it as an “arbitrage opportunity” because Bitcoin was more expensive at Japanese exchanges than at U.S. exchanges.

Mechanically, to profit from the arbitrage, you'd buy BTC with dollars, send to Japan, sell for BTC for yen, exchange your yen for dollars, and send those dollars back to the U.S. Then, you repeat this, at high velocity, for high amounts transacted, until the price converges in both locations.

The arbitrage existed because, in the wake of the Mt. Gox implosion, the Financial Services Agency (Japan’s banking regulator) told Japanese banks to be extremely skeptical of cryptocurrency businesses.

Alameda recruited a Japanese national to be the director of a Japanese company (both of these are considered less risky than the alternatives), then found a regional bank with weak compliance controls, and moved tens of millions of dollars daily through them with wires.