The Money Laundry: Regulating Criminal Finance in the Global Economy

By J. C. Sharman

A generation ago not a single country had laws to counter money laundering; now, more countries have standardized anti–money laundering (AML) policies than have armed forces. In The Money Laundry, J. C. Sharman investigates whether AML policy works, and why it has spread so rapidly to so many states with so little in common. Sharman asserts that there are few benefits to such policies but high costs, which fall especially heavily on poor countries. Sharman tests the effectiveness of AML laws by soliciting offers for just the kind of untraceable shell companies that are expressly forbidden by global standards. In practice these are readily available, and the author had no difficulty in buying the services of such companies. After dealing with providers in countries ranging from the Seychelles and Somalia to the United States and Britain, Sharman demonstrates that it is easier to form untraceable companies in large rich states than in small poor ones; the United States is the worst offender.

Despite its ineffectiveness, AML policy has spread via three paths. The Financial Action Task Force, the key standard-setter and enforcer in this area, has successfully implemented a strategy of blacklisting to promote compliance. Publicly identified as noncompliant, targeted states suffered damage to their reputation. Subsequently, officials from poor countries became socialized within transnational policy networks. Finally, international banks began using the presence of AML policy as a proxy for general country risk. Developing states have responded by adopting this policy as a functionally useless but symbolically valuable way of reassuring powerful outsiders. Since the financial crisis of 2008, the G20 has used the successful methods of coercive policy diffusion pioneered in the AML realm as a model for other global governance initiatives.

• Language: English
• Publisher: Cornell University Press
• Release date: Oct 15, 2011
• ISBN: 9780801463204

Book preview

Introduction

Policy Diffusion and Anti-Money Laundering

The world’s sovereign states are characterized by their diversity. From continent-spanning federations to tiny islands, they range from fantastically rich to shockingly impoverished and encompass societies that may be incredibly variegated or relatively homogenous. Yet states increasingly adopt the same institutions and policies, seemingly regardless of their numerous and fundamental differences. This book examines a puzzle that exemplifies this coincidence of sameness and diversity: more than 180 states, large and small, rich and poor, have adopted a standard set of anti-money laundering policies, apparently without reference to local conditions. Why would so many countries that are so different adopt the same policy?

The strangeness of this situation is epitomized by the extreme instance of Nauru. A minute, bankrupt Pacific island republic with a population of 11,000, Nauru has adopted a state-of-the-art policy template designed to keep criminal money out of the financial sector. But Nauru has no financial sector of any kind: no banks, no credit cards, no loans, no currency, no insurance. Nevertheless, a quarter of the legislation passed by the parliament since 2003 has been designed to protect the nonexistent financial sector from money laundering. There are currently officials in Nauru paid to supervise and educate any financial institutions that may in future arise regarding their responsibility to counter money laundering. In the interim, these officials are busily responding to international surveys of their activity by entering long columns of zeros and N/As, as well as attending capacity-building workshops and plenaries abroad. Meanwhile, the country has no shortage of immediate problems, from a debt of more than 1600 percent of gross domestic product (GDP), to 90 percent unemployment, to the world’s highest rate of obesity and type 2 diabetes, to the fact that most of the island’s surface has been rendered uninhabitable by phosphate mining. If local needs and priorities cannot explain why a country like Nauru would adopt such an obviously redundant policy, what can? The answer that this book develops is that a large majority of states have been pressured to adopt a standard policy template by the exercise of new, indirect, but nevertheless very effective forms of global coercion.

The recurrent trend of remarkably similar policies and institutions being found in remarkably different local contexts is too obvious to have escaped attention. In fact, there is a rich commentary on the closely related concepts of convergence, diffusion, and transfer. The argument presented here relies on the idea that institutions and policy can owe more to the need to conform to outside conceptions of legitimacy than the need to solve actual problems at home. As a result, I find a pronounced decoupling or disconnect between the content of the formal models and templates and what actually happens in practice.¹ For poor states in particular, adopting anti-money laundering policies allows them to avoid international censure, spares local officials embarrassment at foreign meetings, and soothes nervous international financial firms. But these policies make little difference to the level of crime. Although profiting from the keen insights of earlier work stressing the symbolic rather than practical logic of many institutions and policies, this book also makes three distinctive contributions. The first is a method based on becoming directly involved with spreading and then breaking anti-money laundering (AML) rules: I posed as a would-be money launderer, soliciting offers for prohibited anonymous shell companies and bank accounts. The second looks at power, which I argue is central to the process of diffusion. Last is the focus on anti-money laundering, a key policy area now seen by the Group of 20 (G20) as a model for how to conduct global financial reform.

Many scholars looking at the global diffusion of particular institutions and policies have taken a big-picture perspective. As can readily be appreciated, there are good reasons for doing so. How can we know that a process is really global unless we take a bird’s-eye view of it? As many accounts of why we are seeing growing similarity in policies and institutions, despite radically different local conditions, rely on deep, epochal causes, an abstract, general approach makes sense. The big-picture view has successfully raised the issue of why we see such commonality amid diversity for a wide variety of policies.² It has also provided some persuasive broad-brush explanations of why this kind of change has come about.³

This book draws on key elements of such explanations, but it also provides a fresh perspective based on direct participation to address objections to earlier diffusion accounts. Scope and scale involve a trade-off. Critics have complained that even if big-picture scholars have established that the trends of convergence and diffusion are worth our attention, they have done much less to specify the particular mechanisms (the how) through which the global trends are realized.⁴ It is precisely in this area, in unearthing the processes and mechanisms that connect cause and effect, that evidence from the direct participant perspective can help to increase our understanding. As well as conducting conventional fieldwork and interviews, I worked with various international organizations in diffusing rules to counter money laundering. To test the effectiveness of rules barring anonymous entry into the international financial system, I purchased shell companies and set up bank accounts without providing proper identification. Much of the argument to come is thus based on seeing firsthand how the gears and cogs of the policy-diffusion machine work.

I stress the role of power in policy diffusion, a role that has commonly been underrated. In part this is because various direct attempts by countries and international organizations to mold states in the developing world to conform with Western templates have proved to be disappointments, and sometimes disasters, thanks to unexpected friction and resistance. Iraq and Afghanistan stand as cautionary tales for those who would seek to remake foreign polities in their own image by military means. Efforts by the World Bank and International Monetary Fund to impose common policy solutions by loan conditions have seldom worked as planned. But the limitation of these hard or direct exercises of power to impose common solutions in diverse contexts does not mean that power as such is unimportant. As much of the book is devoted to showing, indirect mechanisms of power can be, and have been, highly effective in driving policy convergence in countries as diverse as the most vulnerable South Pacific islands and the most xenophobic rogue state. Power in this broader sense is the production, in and through social relations, of effects that shape the capacities of actors to determine their circumstances and fate.⁵ One of the book’s main goals is to establish that exercises of power can be at the heart of diffusion processes and that such exercises are no less effective for being indirect.

Beside the focus on the how of policy diffusion through research by participation and the emphasis on power, the third main innovation is the substantive focus: money laundering, or more specifically, the package of institutions, policies, and practices developed to counter it. Why this specialized focus? How much can anti-money laundering tell us about much bigger developments? More of one thing in a research design is almost always less of something else: a narrow focus puts limits on the ability to offer grand generalizations. But AML policy provides vital insights in a number of ways. First, policy in this area shows in clear, stark form the key features of the general diffusion process. AML policy has come from nowhere in the 1980s to being all but universally adopted two decades later. There are especially deep uncertainties about whether the policy solves the problem it is designed to solve in the rich Western countries for which it was crafted, let alone in the larger number of developing countries to which it has been transferred. The costs involved are substantial and conspicuous. The indirect coercive effects of ranking and rating, enmeshment in international regulatory networks, and the uncoordinated actions of private financial firms are especially apparent. Such soft measures can have hard effects, indeed more so than the traditional levers of influence used by one state over another. Thus if global governance means enforcing rules without recourse to traditional means of military and economic coercion, a process of governance without government,⁶ there is no better policy area in which to study it than AML. This is reflected by the number of scholars from different orientations scrutinizing the subject.⁷

Finally, the response to the financial crisis and resulting recession of 2008–2010 by the G20 and other bodies indicates that the measures pioneered in exporting money laundering policy around the world will increasingly become the norm rather than the exception. The success of the policy, in terms of the run of its writ if not its effectiveness, has provided a seductive example for those looking to strengthen or remake the web of global rules and standards. The techniques of rating, ranking, blacklisting, transnational enmeshment, and socialization, and of shaping private investment decisions, offer the promise of general adherence to tough global standards rather than just the lowest common denominator.

The Argument Summarized

The key issue for this book is the coincidence of a policy of dubious worth that has nevertheless been adopted by almost every state in a short period of time. This runs directly counter to the intuition that policies known to be successful would rationally be copied and thus spread from country to country, whereas policies not known to be successful would not spread. My argument is instead that diffusion has occurred not because it solves the problem of criminals abusing the financial system or related offenses but because AML policy is now a symbol of what all modern, progressive states must have. Especially in countries outside the West, adoption of AML policy has been driven by the indirect exercise of power carried out by international organizations, networks of regulators, and private firms. To show that the policy has indeed diffused is relatively easy; the next two tasks are much harder.

The first of these tasks (part 1) is to substantiate the claim that the standard set of policies and institutions designed to counter money laundering are probably not effective, in either an absolute sense or relative to the cost. To advertise the limits of the argument at the outset, the book cannot prove that AML policies are ineffective. Much of the evidence for such a definitive claim is missing. Because the incidence and magnitude of financial crime is essentially unknown, contradictory claims are made. Does a lack of convictions, for example, indicate a lack of crime or a lack of enforcement? Beyond these inherent difficulties, the national and international agencies responsible for policy in this area have often been curiously uninterested in measuring the results of their labor. But at the very least, there is little evidence to show that AML policy has been effective in the rich, OECD (Organization for Economic Co-operation and Development) states for which it was first designed and even less among the poorer countries that have recently copied it. The point that it is impossible to definitively prove a given policy is not working, however, does little to solve the mystery of why it has been so widely diffused. "Well, you can’t prove it doesn’t work" is not a sales pitch that we would expect to attract many buyers.

With this caveat in mind, the most careful surveys of effectiveness in rich countries have not been able to find evidence that the policy is achieving the results its proponents claimed it would. Even senior officials in the various national and international AML agencies are often startlingly frank about these doubts. Comments such as no one really has any idea if this policy works are not uncommon.⁸ But it is in the developing world that these doubts are most pronounced (there are now more developing countries with AML policies than developed ones). In part this is because of the lack of fit between the rich-world context for which the policy was first designed to operate and the local conditions that obtain. But it also reflects the incredibly urgent competing priorities and demands on governments’ money, time, and attention to meet the basic human needs of their citizens.

Rather than just seek to assess effectiveness in an absolute sense, however, the issue of cost-effectiveness is at least as important to consider. The argument, sometimes heard from sympathetic officials, that this policy is better than nothing because it does put some criminals behind bars, ignores the idea that the general benefits delivered to society by a policy should be greater than the costs this policy imposes on it. These costs can come in the form of the tax that must be raised to pay for the government’s directives and also, and more important in the case of AML, the burden of regulatory compliance imposed on private firms and citizens. These costs are particularly important in poorer countries where so many needs are unmet. Spending money on inappropriate or ineffective policies is thus particularly costly in a technical sense and perhaps is immoral as well. The book argues that on the balance of available evidence, AML policy is neither effective in an absolute sense nor cost-effective, especially in the poor countries that are my main empirical focus. The assessment of effectiveness sets the stage for the power-based explanation. First, it rules out the default, commonsense position that countries have emulated these policies because they are known to effectively solve pressing local problems. Second, the results show that in important instances major OECD countries are less conscientious in applying rules than are small, developing states. This selective enforcement indicates that the pressures are greater for small, vulnerable states than for rich, powerful ones.

So why, then, do countries adopt AML policy? How has an expensive policy with little proven ability to solve problems and deliver benefits spread to almost every country in the world over a relatively short period of time? The argument put forward in part 2 is that the diffusion of AML standards has been a result of power. Most often, however, this power has not been exercised directly by the traditional means of international statecraft. Instruments such as military force, economic sanctions, and conditional lending have generally proved either ineffective or prohibitively expensive in compelling large numbers of target states to adopt given institutions or specific measures. Instead, the mechanisms at work are soft tools of governance—blacklisting, rating, ranking, structuring incentives for uncoordinated private actors, and socialization within regulatory networks.

In the 1990s, AML policy was consensually developed and diffused among the rich states of the OECD, but by and large did not spread beyond this group. By 1998 this core group of rich states, assembled in the Financial Action Task Force (FATF), decided that they needed to actively export AML standards outside their group, coercively if necessary. The first step was to evaluate twenty-nine nonmember jurisdictions and publicly blacklist those countries adjudged to be delinquent in the fight against money laundering. Through stigmatizing these countries, and in some cases precipitating significant capital flight as a result, pressure was exerted to adopt and conform to the standard template of AML measures. Beyond the target group, the blacklisting exercise successfully scared other countries into adopting these policies so that they themselves would not be blacklisted in the future. Although blacklisting was phased out in 2002, it enjoyed a resurgence beginning in 2007 in an effort to target the few holdouts who had not yet adopted the policy template. Partly by accident and partly by design, the blacklist provided the impetus for bandwagon effects in terms of the adoption of AML policy.

The tight network of rich-country AML officials was then spread into the developing world, as personnel from central banks, ministries of justice and finance, financial supervision bodies, and later, dedicated AML agencies in poor countries were drawn into outreach seminars, workshops, and technical assistance and capacity-building programs carried out by international organizations. These contacts moved from an ad hoc to a regular basis, as regional AML bodies were formed in Asia, Latin America, and Africa, and more and more international organizations developed a role in this issue area. The officials from national governments and international organizations drawn into these transnational networks became socialized in line with the lexicon and repertoire of AML practices. This process was greatly aided by the system of regular rating and rankings that countries were subject to in order to assess their compliance with international AML regulations. Both the regulations themselves (the 40+9 Recommendations) and the assessment procedures (the methodology) are standardized, with officials being evaluated by their peers and receiving a public score. Countries whose financial sectors and domestic priorities were vastly different from those states that had first adopted AML policy thus nevertheless came to adopt and entrench the package of similar policies and institutions to counter a problem they did not previously know they had.

Concurrent with this process of socialization within transnational policy networks, the rapid diffusion of AML policy began changing incentives for private firms. The responsibility for fighting money laundering and related financial crime has to a large extent been delegated to the private sector, especially banks. On pain of administrative, civil, and criminal penalties, financial firms must engage in extensive surveillance of those who use their services. These firms are left in a vulnerable position if it turns out that they have hosted the proceeds of crime. Yet in seeking to identify and screen out criminal money, banks and other financial institutions face a difficult task: governments have been clear about the penalties for dereliction of duty in the fight against illicit finance but have provided very little indication as to how to tell clean from dirty money. In dealing with foreign transactions from poor countries in particular, banks have sought to cover their bases by simply adopting the presence or absence of AML policy as a proxy for the underlying risk. According to this proxy of convenience, developing states without an AML policy face higher costs in accessing international financial networks. This approach demonstrates that firms are doing something and provides legal cover if it should turn out that a firm has been used by criminals to launder money. Developing countries have responded by adopting AML policy as a functionally useless but symbolically useful measure to reassure outsiders. Unintentionally, the uncoordinated actions of private actors have in this manner created competitive pressure for developing countries to adopt AML policy as a symbol of propriety, decoupled from underlying practice. Those countries that do not have an AML policy have faced increased difficulty and expense in transacting with the outside world.

These three mechanisms, blacklisting by the Financial Action Task Force, socialization of officials, and the use of AML policy as a talisman to communicate in-group status to private firms, have in combination operated to diffuse the standard template of policies and institutions across the globe. The threat or actuality of being blacklisted gave the initial impetus for exporting AML policy beyond the rich world, brought national officials into transnational networks, and began to reshape the structure of incentives for private firms and hence governments looking to access international financial networks. After this initial impetus, socialization and private actors created a self-reinforcing dynamic of diffusion: the more countries that adopted, the greater the pressure to follow suit, subsequently increasing the pressure on those that did not, isolating them, and stamping them as deviant. As a result, AML systems look likely to expand and deepen in the future, irrespective of their ineffectiveness. Although there have been different degrees of intentionality involved, singly and in combination these mechanisms reflect that diffusion has in this instance been a power-driven process.

Almost every country in the developing world has now been pressured into adopting a policy that is ill-suited to local conditions, does not seem to work, and diverts significant resources that could be used to address a host of more urgent priorities. To make matters worse, the evidence presented indicates that in important instances AML standards are applied more stringently in small developing states than in the United States and United Kingdom. There are already significantly more countries with AML agencies than there are countries with armies.⁹ Within the next decade, there may be no sovereign state that lacks the standard template of AML measures. The unstoppable march of AML policy, the power-driven nature of the diffusion process, and the human and financial costs associated with it mark this as an issue with consequences too large to ignore.

Evidence and Method

As foreshadowed earlier, two basic claims need to be substantiated: that AML policy is on balance ineffective and that this policy has been diffused by an essentially coercive process. This evidence is gathered using not only some conventional methods but also some unconventional ones involving my participation in rule-diffusing and rule-breaking activities. In order to uncover the mechanisms at work through which very broad and nebulous conceptions of appropriateness translate into legislation, regulation, and institutions, it is necessary to get close to the action. Similarly, perhaps the most direct way to test the effectiveness of rules is to attempt to break them and see what happens, in this case those rules that prohibit anonymous participation in the international financial system.

I start with reports from those agencies charged with designing, enforcing, and evaluating policies to counter money laundering. These include not only national institutions, but also, and more important, the international organizations that assess and score countries on the implementation and effectiveness of their AML standards. Among the growing secondary literature on the topic are some careful studies of AML effectiveness and cost-effectiveness, although these tend to be heavily skewed toward rich countries, now an unrepresentative minority in the global AML policy community.

Although growing strongly, the community of those individuals involved in the international AML policy network is still relatively small. I was able to talk with officials from a plethora of international organizations that have been important in the diffusion process. These groups include the Financial Action Task Force, the Eastern and Southern African Anti-Money Laundering Group, the Caribbean Financial Action Task Force, the Asia-Pacific Group on Money Laundering, the Governmental Action Group against Money Laundering in West Africa, the World Bank, the International Monetary Fund, United Nations Office on Drugs and Crime, the Commonwealth, the Egmont Group, the Asian Development Bank, the Pacific Islands Forum, the Caribbean Development Bank, Asia-Pacific Economic Co-operation, the European Union, the Organization for Economic Co-operation and Development, and others. Similarly, I met with relevant national officials involved in AML policy from two dozen countries from Europe, North America, and Australasia as well as Africa, Asia, the South Pacific, and the Caribbean, both in their home countries and at their various international workshops, conferences, and plenary meetings.

In addition, I observed two plenary sessions of the FATF, two of the Asia-Pacific Group on Money Laundering, and one of the Council of Europe’s AML body. These plenary meetings are the venue for each organization to plan its future course, discuss ongoing initiatives, and debate and approve the evaluation reports assessing members’ compliance. The plenaries are closed and hence include no ministers, no media representatives, no diplomats. Instead, they are populated by regulators from member states and international organizations. Unsurprisingly, the formal business is complemented by intense informal networking in the margins, during coffee breaks and lunch and, in the case of the FATF, during the traditional karaoke session (socialization involves a lot of socializing). These plenary meetings were complemented by observing smaller, more specialized APEC and Pacific Island Forum workshops.

Turning from observation to participation, I have been involved in several applied projects to assess and diffuse AML standards in the developing world. This direct participation included leading a cost-benefit analysis of AML policy in three small developing countries (Barbados, Mauritius, and Vanuatu) on behalf of the World Bank and