The Butterfly Effect of Financial Crime

03 November 2017

Most of us carry more advanced technology in our phones than was used to run the entire London Stock Exchange in the 1980s – and the environments we work in are unrecognisable from those of 20 years ago.

One of the most obvious consequences of these changes is that the financial world is now far smaller. With each advance and step forward, the global economy becomes more interconnected and the risks more networked.

In chaos theory, scientists popularly call this the “butterfly effect”, the idea that a butterfly’s wings might create tiny changes in the atmosphere that could alter the path of a tornado.

When it comes to financial crime, the economic butterfly effect, if you like, is amplified. For those charged with tackling financial crime, this is an enormously serious issue.

While the fundamental nature of financial crime may not have changed over the years, the impact of the criminal act is now far quicker mutualised than ever before.  Money laundering and corruption on one side of the planet can fuel crime on the other in a finger snap. High-tech Ponzi schemes now cross borders and time zones, collecting millions of victims along the way.

New entrants also affected

Traditionally, managing the risks related to financial crime has been a responsibility that rested squarely on the shoulders of the financial services industry. However, with the entry of non-banking role players – such as fintech companies, medical aids, life insurers and retailers to name a few – the face of financial services as we know it is changing fast. These new entrants now also fall within the scope of anti-money laundering and counter-financing of terrorism legislation in South Africa, and indeed, worldwide.

While South African legislation promulgated to deal with financial crime and spreading the net as far and as wide as possible are already in place, a recent PwC Global Economic Crime Survey raises the concern that these non-banking role players are sometimes oblivious of the impact financial crime potentially could have on their business.

Combatting financial crime is everyone’s responsibility

Financial crime continues to be a major concern for organisations of all sizes and sectors and impacts us all. We have witnessed the recent terrorist attacks and activities and the impact it had on the world as seen recently in France, Belgium, the US and Somalia. Such attacks need to be funded in some way or form, and terrorist funding/financing can be conducted with both illicit and licit funds.

Unfortunately for law abiding citizens, financiers of criminal and terrorist activities use the same financial institutions that everyone else does and they hide behind structures, aliases and complex transactions to try and remain undetectable.

The international community, including South Africa, agrees that the private sector has a pivotal role to play in assisting and supporting governments and law enforcement agencies to identify the proceeds of crime and combat the possible financing of terrorism.

Knowing our customers

South Africa promulgated the Financial Intelligence Centre Act, 38 (2001) in 2003. The FIC Act establishes the regulatory requirements that banks MUST comply with, to help protect the financial system from abuse by criminals to enable our institutions to play an active role in supporting government and law enforcement agencies in the fight against financial crime.

These requirements established in terms of International Standards and legislation requires all South African financial service providers to comply with the FIC Act. One of these compliance requirements is that a bank needs to know each of their customers by identifying certain information of the customer, as well as confirming obtained information against an independent third party, for example the ID number of a customer against the ID book/smartcard issued by the Department of Home Affairs. This is part of the process known as Know Your Customer (KYC).

KYC is an important step developed globally to prevent identity theft, financial fraud, money laundering and terrorist financing. The objective of KYC is to enable banks to know and understand their customers better and help them manage their risks prudently. This does not mean that all customers are criminals, but to assist the bank to identify possible money laundering or terrorist financing, the bank needs to obtain as much information on a customer as possible to identify those trying to abuse the bank, and report these customers to the Financial Intelligence Centre (FIC) and law enforcement agencies where required.

Banks are therefore not allowed to transact with any customer without first having obtained and confirmed the required KYC information at either on-boarding of the customer or at review of the customer.

The consequence for the individual is that every time you open an account, buy something on credit, invest money or take out a life assurance policy, you may be required to confirm your KYC information with a green barcoded identity document and a utility bill in your name that has been received by mail. It is furthermore expected of customers to regularly update their KYC information whenever there is a change like your address, employer or source of income.

Does the FIC Act work?

Figures in the FICs annual report for 2014/15 show the local successes in identifying and apprehending money launderers and fraudsters.

According to the report, suspected criminal activities during the year included tax-related crime (146 reports), fraud (470 reports) and money laundering (746 reports). Suspicious transaction reports (STRs), which have to be submitted to the Centre by accountable and reporting institutions, are markers that may indicate the presence of illegally generated funds. In the 2014/15 year, the FIC received 267 239 STRs, and this shows growing awareness in the private sector and the general public of the importance of measures to prevent money laundering and terror financing.

Cash threshold reports, which are flagged through automatic screening of all transactions of R25 000 and above, grew from 6, 1 million in 2013/14, to 6.7 million reports in 2014/15. The majority were from banks.

During 2014/15, the FIC initiated and referred 870 matters to law enforcement authorities for investigation and responded to 1 799 requests from national and international law enforcement agencies for assistance and support in their investigations.

In addition, the Centre helped to block R181 million as suspected proceeds of crime and assisted the Asset Forfeiture Unit seize more than R2,3 billion in assets (As opposed to R1,1 billion in 2013/14).

Taking the pain out of re-verification

Since the FIC Act came into effect in 2003, some of its guidelines have evolved with updates to the requirements of the Act. As a result, the accounts of certain customers have been flagged for FICA re-verification and they may have been requested to resubmit or supply outstanding information and documentation.

It would be a breach of FICA regulations for banks to allow for transactions in an account that does not have the requisite FICA documents on record. Where financial institutions do not comply, they face fines of around R100 million per incident and they have a big responsibility to prevent possible money laundering and terrorist financing by doing the FICA process properly.

Financial services providers that are therefore able to remove operational hurdles and bottlenecks from their KYC verification processes and who are able to on-board and perform due diligence on clients in a way that provides a good customer experience, will surely benefit from that.

Absa recently introduced an online FICA document upload service whereby customers whose accounts have been flagged for re-verification, can now submit their required documents via Absa Online, the bank’s digital platform.  This secure online process means that customers no longer need to travel to their nearest branch to fulfil this regulatory requirement and this service has been met with great applaud.

The FIC, National Treasury, the Reserve Bank and the banking sector itself have worked hard over the last few years to build and sustain a regulatory framework that maintains the stability of the banking system and of the broader financial sector, and allows the public to have the utmost confidence that our financial systems will not be abused to hide and/or disguise the proceeds of crime.

Disclaimer: The advice contained on this blog is for general purposes only and does not take into account individual circumstances, objectives or financial needs. Accordingly, readers are advised to seek appropriate advice from licensed professionals prior to making any investment, or taking up a financial product or service.