Its History and How It Works

Efforts to police illicit gains have a history stretching back centuries. Anti-money laundering (AML) refers to the contemporary web of laws, regulations, and procedures aimed at uncovering efforts to disguise illicit funds as legitimate income.

Money laundering, a term arising from this regulatory regime, consists of actions taken to conceal financial movements underlying crimes ranging from small-time tax evasion and drug trafficking to public corruption and the financing of groups designated as terrorist organizations.

AML legislation was a response to the growth of the financial industry, the lifting of international capital controls, and the growing ease of conducting complex chains of financial transactions. A high-level United Nations panel has estimated annual money laundering flows total at least $1.6 trillion, accounting for 2.7% of global GDP in 2020.

Anti Money Laundering in the U.S.

AML regulations in the U.S. expanded after the Bank Secrecy Act was passed in 1970 and constitutionally upheld by the U.S. Supreme Court in 1974. Financial institutions were required to report cash deposits of more than $10,000, collect the identities of financial account owners, and maintain records of transactions.

Additional legislation was passed in the 1980s amid increased efforts to fight drug trafficking, in the 1990s to enhance financial monitoring, and in the 2000s to cut off funding for terrorist organizations.

Banks and brokers now follow a complex regulatory framework of conducting due diligence on customers and tracking and reporting suspicious transactions. A written AML compliance policy must be implemented and approved in writing by a member of senior management and overseen by a designated AML compliance officer.

Effective early 2021, the Anti-Money Laundering Act of 2020, the most sweeping overhaul of U.S. AML regulations since the Patriot Act of 2001, subjected cryptocurrency exchanges, arts and antiquities dealers, and private companies to the same customer due diligence requirements as financial institutions.

The Corporate Transparency Act, a clause of the Anti-Money Laundering Act, eliminated loopholes for shell companies to evade anti-money laundering measures and economic sanctions.

International Anti Money Laundering

The European Union and other jurisdictions have adopted similar anti-money laundering measures. Anti-money laundering legislation and enforcement assumed greater global prominence in 1989, when a group of countries and nongovernmental organizations formed the Financial Action Task Force (FATF).

The FATF devises and promotes adopting international standards to prevent money laundering. In October 2001, following the 9/11 terrorist attacks, FATF’s mandate grew to combat terrorist financing.

Other important international organizations in the fight against money laundering include the International Monetary Fund (IMF) and the United Nations (UN).

The IMF has pressed member countries to comply with international norms thwarting terrorist financing. The UN added AML provisions to the 1998 Vienna Convention, the 2001 Palermo Convention, and the 2005 Meridian Convention to address money laundering associated with drug trafficking, international organized crime, and political corruption, respectively.

Know Your Customer (KYC)

Regulatory compliance at financial institutions starts with a process sometimes called Know Your Customer (KYC). KYC determines the identity of new clients and whether their funds originated from a legitimate source.

Money laundering can be divided into three steps. The KYC process aims to stop money laundering at the first step when customers attempt to store funds in accounts.

• Depositing illicit funds into a financial system
• Placing a series of transactions, usually repetitive and voluminous, to obfuscate the illicit origin of the funds, known as “layering”
• “Cleaning” and “washing” the funds by converting them into real estate, financial instruments, commercial investments, and other acceptable assets

During the KYC process, financial institutions will screen new customers against lists of parties that pose a higher than average risk of money laundering: criminal suspects and convicts, individuals and companies under economic sanctions, and politically exposed persons, which encompasses foreign public officials and their family members and close associates.

Customer Due Diligence

KYC extends beyond vetting a customer in the initial stages of opening an account. Throughout the account’s lifetime, financial institutions must conduct customer due diligence, a constant process of checking and specifying the compliance risks of customers, old and new, and their transactions on an ongoing basis. Certain customers may be added over time to sanctions and other AML watchlists.

According to the U.S. Treasury’s Financial Crimes Enforcement Network (FinCEN), the four core requirements of customer due diligence in the U.S. are:

• Identifying and verifying the customer’s identity
• Identifying and verifying the identity of beneficial owners with a stake of 25% or more in a company opening an account
• Understanding the nature and purpose and compiling risk profiles of customer relationships
• Monitoring suspicious transactions and updating customer information 

Customer due diligence may try to uncover and counter money laundering patterns such as layering and structuring, also known as “smurfing”—the breaking up of large money laundering transactions into smaller ones to dodge reporting limits. Financial institutions have instituted AML holding periods, forcing deposits to remain in an account for a minimum of days before they can be transferred elsewhere.

Anti Money Laundering and Cryptocurrency

Cryptocurrency has drawn increasing attention among anti-money laundering professionals. Virtual coins provide more anonymity to users, presenting criminals with a convenient solution to move funds that is on the rise. According to cryptocurrency tracing firm Chainalysis, addresses connected to illicit activity sent nearly $23.8 billion worth of cryptocurrency in 2022, up 68% from 2021.

In the U.S., under the Anti-Money Laundering Act of 2020, virtual currencies are legally required to comply with financial screening regulations that apply to fiat currencies and tangible assets. Businesses that exchange or transmit virtual currencies qualify as regulated entities and must register with FinCEN, adhere to AML and combating the financing of terrorism (CFT) laws, and report suspicious customer information to regulators.

More stringent rules around virtual currency transmission are expected to be introduced, including those that would ask companies to intervene in money laundering facilitated by cryptocurrency products. Recent steps include an IRS proposal and European bills for brokers, platforms, and processors to report digital asset transactions and trades to law enforcement and tax authorities.

Crypto services will employ forensic tools like Chainalysis, Elliptic, and TRM Labs to flag transfers to notable and blacklisted wallets in real-time. Addresses subject to earmarking are tied to designated terrorist organizations, sanctions lists, political groups, government actors, and organized crime such as hacking, scams, and contraband trafficking.

The Bottom Line

Governments have evolved their approach to money laundering deterrence by establishing and revising regulatory controls that elicit proactive participation from financial institutions.