What Are the Three Stages of Money Laundering?

Money laundering has become a very common criminal practice in the world—hiding the source of the income earned through illicit operations. The estimated amount of laundered money is continuously increasing every year at alarming volumes.

These figures are estimated because there is a lack of regulation or process to identify and track the laundered money. The United Nations Office on Drugs and Crime describes it as being between 2% and 5% of worldwide GDP. This comes to a USD 800 billion to USD 2 trillion range.

Money Laundering includes three different States: Placement, Layering, and Integration. In this blog, we will cover the three steps that criminals use to launder dirty money and we will detail various techniques used in each of the steps.

What Is The First Stage Of Money Laundering?

The first stage is known as placement, where the "dirty money," an informal term referring to money gained from illegal deeds, can first enter the legitimate financial system. At this stage, dirty money gained from illegitimate activities, such as drugs or corruption, is transformed into a legitimate capital asset.

Placement of laundered money is very important because at this point there is going to be a transition from traceable cash into some other form that will be easily manipulated and hidden. Success in placement is the foundation for the whole laundering process.

Objective: The main objective during this phase is to transfer the money from its illegal origin to legitimate financial channels, making it less suspicious and more difficult to trace. This involves the removal or diversion of large amounts of cash from the scene or source of the crime and into the financial system without attracting the attention of authorities or raising red flags.

Methods Used in the First Stage of Money Laundeing

1. Breaking Down Bulk Cash

Criminals hardly ever deposit bulk cash in a bank. This would definitely result in suspicion and trigger the anti-money laundering (AML) protocols. A common preliminary step is therefore breaking down the large amount of cash into smaller deposits. This can be done in a number of ways:

• Smurfing: Breaking up a large amount of money into smaller parts, for each of which a person then separately deposits at different banks. Think of a number of people—the "smurfs"—each depositing a few thousand dollars and making it look like any other transaction.

• Structuring Cash Deposits: The structuring of cash deposits represents a situation in which such deposits are arranged slightly below the amount the institutions consider as the reporting threshold. For example, if the reporting threshold happens to be $10,000, a criminal might structure a series of $9,800 deposits to avoid having one $10,000+ deposit reported.

• Co-mingling With Legitimate Business Funds: This refers to mixing illegal money with legal business receipts. Infiltration of cash-intensive business sectors, such as car washes, restaurants, or convenience stores, would allow criminals to mix their dirty money with the legal earnings in order for integration to be hard to detect, since the illegal source is indistinguishable from the legal income.

2. Using Money Service Businesses

Utilizing money service businesses or MSBs, be it check cashing stores, money transmitters, or prepaid card providers, to deposit funds. Criminals may structure cash deposits into these businesses, purchase money orders using small cash amounts, or use prepaid cards preloaded with illegal funds. While MSBs are regulated, some criminals will target those with weaker AML controls.

3. Purchase of High-Value Goods

High-quality and luxurious goods, such as jewelry, cars, or art, can be purchased with cash and then quickly resold for a possibly larger amount, again through legitimate channels, for clean money. By doing so, this establishes a paper trail that proves a legitimate deal, even though originally the money was dirty.

4. Attending Casinos

Because of the huge number of cash transactions, casinos can also be attractive for placement. Criminals play with dirty money, exchange it for chips or tokens, and then cash these, whereby the illegal funds are converted into seemingly legal casino winnings. However, casinos are increasingly implementing AML countermeasures with the specific objective of this form of laundering.

5. Using Currency Exchanges

Money can also be exchanged from dirty money into various currencies to make its source harder to trace and easier to move across borders. Since the source of income is not documented at currency exchanges and no background checks are conducted to verify individual identities, it provides a fitting place for the exchange of laundered money.

Thus, the ultimate goal of placement is to finally get the dirty money through the financial system without an alarm. Careful planning and execution is required to avoid flagging, otherwise the whole operation is can be brought under radar. Understanding these methods will assist law enforcement and financial institutions in identifying and disrupting money laundering activities at the very incipient stage.

What Is The Second Stage Of Money Laundering?

The second phase, called layering, involves separating the money from its illicit source by means of what seems to be a very complicated financial web, all to make tracing hard. As such, it incorporates several transactions and movements of funds across multiple accounts and jurisdictions in order to hide the origin of money.

This stage forms the real backbone of money laundering, since, if succeeded, the process makes connecting the dots by an investigator to identify the origination of ill-gotten money highly complex and complicated.

Objective: The primary purpose is, therefore, to complicate the tracing of money through the introduction of multiple layers of financial transactions. This shadows the origin and path of illegitimate money through the development of a complicated scheme of transactions, which renders it tedious and time-consuming for law enforcers, in addition to regulatory agencies, to trace the money back to the illegal origin.

Methods Used in the Second Stage of Money Laundeing

1. Conducting Multiple Financial Transactions

At the center of this strategy would be the laundering of money through a series of complicated and always frequent financial transactions. This may include:

• Transfering Across Many Bank Accounts: The money can be transferred across several bank accounts, both at national and international levels. All these transfers can fog the transaction history, making it quite hard to trace the source of funds back to the initial point of placement. This works like a network of pipes that are interlinked, where one pipe transfers some of the water to another, making the source hard to trace.

• Using Shell Companies and Investments: The money can be moved or transacted by shell companies, which are bogus businesses specifically created for laundering money. These firms can invest in stocks, bonds, and real estate that can be sold quickly, hence creating an extra layer of transactions between money and its criminal origin.

• Trade-Based Money Laundering: This method is based on the manipulation of invoices or other trade documents involving imports and exports. Inflating the cost for imported goods is one type of overvaluation, whereby criminals can transfer illicit money abroad in the guise of payment for the overvalued products. The foreign company will redirect part of money sent by the criminals as a supposed payment for the overpriced goods. As is apparent, such cross-border money flow looks quite legitimate in appearance but conceals the illegitimate source of funds.

2. Exploiting Jurisdictions with Weak AML Regimes

A laundering route may use countries where the regimes have weaknesses. Customer identification and/or reporting may be weak in these countries, thereby accommodating the hiding of the source of the money. International cooperation among law enforcement agencies has improved, and such loopholes are increasingly becoming difficult to exploit.

3. Creating Fictitious Transactions

The criminal, in some cases, may create entirely fabricated transactions to further distance the money from the source. This may be in terms of processed fake invoices or agreements for services between front companies, in effect laundering the money through nonexistent business activities.

4. Participating in Securities Transactions

These involve the purchase and sale of stocks, bonds, and other securities. This introduces a number of additional layers of potential complexity because such transactions can occur within, as well as across, markets and institutions. Also, securities are such that they don't have an owner listed or named on them, so they are perfectly suited for laundering.

5. Repaying Loans

Illicit funds may be used to pay off loans or mortgages. This then makes the source of the money appear to be from clean earnings or investments. Also, since these loans are under different names and registrations, it is tricky to track and trace their origin.

The overall purpose of layering is to create such a maze in finance that would break the linkage between the dirty money and its criminal source. With more and more layers, it becomes really hard for the investigators to trace back the origin of some money. In this stage, financial institutions and law enforcement can make a big difference by recognizing patterns of dubious activity and breaking up money laundering schemes.

What Is The Third Stage Of Money Laundering?

The third and final stage of money laundering is integration. At this very final stage, laundered money is introduced back into the legitimate financial system. The intention in this step is to render the illegal source of money traceless. Integration involves various complicated ways of concealing the origin of illicit money so that it appears to be generated from a legal means of livelihood.

After dirty money is successfully introduced to the system in the placement stage and its origin obscured in the layering stage, integration finally frees the possibility of criminals using such apparently clean funds for a case at hand.

Objective: The principal objective of this integration stage is to provide a cover for the legitimacy of fund origin so that the launderer can use the money without any suspicion.

Methods Used in the Third Stage of Money Laundeing

1. Reinvestment in Businesses or Assets

This involves reinvesting the laundered money in bona fide businesses or assets. This can be by way of:

• Buying Real Estate: High-value property such as houses, apartments, or commercial buildings could also come in handy for integration. Criminals may use the laundered money to buy such property and, perhaps, inflate the purchase price to compensate for the full amount of dirty money. Apart from the possibility of selling or renting them at a later stage, profits derived from such transactions would then appear to be from legitimate real estate deals. Real estate offers an avenue to park large sums of money and generate rental income or future profits from appreciation.

• Business funding: This laundered money may be used to start up or invest in another business. This creates the pretence of a successful entrepreneur and allows access to and availability of this business income stream, thus investing in shares, buying a share in a startup, or even acquiring existing businesses out rightly; however, due vigil by the financial institutions like banks would track the dubious investors or capital of unknown sources.

• Funding Lavish Lifestyles: Ultimately, the laundered money is used to sustain a lavish lifestyle. Expensive cars, holidays, or other extravagant purchases are possible without attracting suspicion because the money seems to have a legitimate source. At some future date, these high-value assets can be sold to further obscure the origin of the money.

As in the placement phase, criminals would take an interest in those sectors of integration with weaknesses or deficiencies in AML regulation implementation. This can mean investments in industries dealing with cash-based businesses, such as casinos, trading in precious metals, or specific forms of art sales. Such sectors probably have weaker reporting requirements, allowing the integration of laundered money more easily.

2. Repatriation

There will be occasions when the laundered money will be moved back to its country of origin—that is, the place where the crime was carried out. This may be repatriated in various ways, possibly by using shell companies or such other complex financial instruments and mechanisms. The basic concept behind all this is to then disguise this money as some form of earnings or profit for external investments.

3. Creating Fictitious Invoices

Setting up fictitious invoices for goods or services for the launderers' legitimate business can be prepared, recounting large cash inflows. Further, loaning or transfers from shell companies also disguise the source of money received by other real businesses.

Such is the success of integration that the criminal can now use such money fully without fearing any detection from anti-money laundering agencies. They continue relentlessly to look for suspicious patterns of investment activity, unexplained wealth, or people living beyond their apparently legitimate means.

One such way to look for money laundering practices is to run all parties participating in a financial transaction through restricted party screening. This helps flag potential money laundering by identifying entities sanctioned or restricted by various authorities across the globe.