INTRODUCTION

International fraud surveys conducted by large auditing companies give some indication of the nature and awareness of fraud trends world-wide. Results from respondents of the Ernst and Young International Fraud Group's survey – where 805 replies were received from questionnaires sent to 5 500 senior executives of major organisations in eleven countries – on the effects of fraud on business found the following:2

The total value of attempted fraud was $780 million, of which only $70 million was recovered.



One in four businesses had lost over $1 million through fraud in the last five years.



Two out of five businesses had suffered more that five frauds in the last five years – some respondents had detected more than 50 frauds.



In total, 88 per cent believed that their businesses were more at risk from fraud today than five years ago.



Financial organisations were mostly affected by external fraudsters, while more than three quarters were perpetrated internally by employees.



Some 75 per cent believed that their internal controls could be overridden by senior managers intent on fraud.



More than half of the frauds were discovered by chance.



Two thirds of respondents did not have written fraud prevention policies.



More than half offered no guidelines for reporting a fraud.

KPMG's 1996 International Fraud Report found that over half the respondents were aware of at least one occurrence of fraud in their organisations in the past year. The most common kinds of fraud by employees and company management were conflicts of interest, cheque forgery, credit card fraud, kickbacks, purchase of items for personal use, falsification of financial statements and misappropriation of cash. Common fraud by external persons included false representation, patent infringements, false invoices and secret payments such as bribes and commissions.3

These crimes are all too familiar to institutions regularly victimised by fraudsters. The challenge, however, involves keeping one step ahead of criminals whose techniques are increasingly more organised, sophisticated and unconstrained by international boundaries. This article examines the nature of organised crime and its linkages to money laundering, as well as dealing briefly with the security threats and opportunities for fraud emanating from improved computer technology, in particular the Internet.

ORGANISED CRIME

"International organised crime is a sophisticated, multi-billion dollar transnational business. Profits from drug trafficking alone – some $200-$300 billion – dwarf the GNP of all of the 170 nations in the international system."4

Historically, organised crime has been regarded as a law and order problem confined to single states or cities, for example geographic areas, such as southern Italy and Sicily, and cities, such as Boston or Hong Kong. However, more recently, assisted by developments in technology and the reality of the 'global village', the nature of organised crime has expanded its interest to become a transnational phenomenon. In reality, organised crime is a business which, like any legitimate business, is concerned to reduce risks, maximise profits and diversify by crossing borders.5

While the problem of organised crime is easily sensationalised, there is a widely held perception that South Africa – a society particularly vulnerable because of its state of transition, weak border controls and sophisticated banking networks – is fast becoming the target of overseas crime syndicates. With Western Europe and America tightening the screws on international crime syndicates, notably drug traffickers, they have been forced to divert their attention elsewhere which may explain why South Africa has become a favourable candidate for infiltration.6

Tentative estimates by the South African Police Service (SAPS) suggest that there are currently about 500 "extremely well financed and superbly armed" crime syndicates operating in and from South Africa, with almost half of these operations based in and around Johannesburg.7 These highly sophisticated criminal organisations know how to exploit the freedom of movement of capital, financial services, goods and persons. Operations include a lucrative trade in drugs,8 gold and diamond smuggling, vehicle theft,9 commercial crime and arms smuggling.10 The activities of these various organised crime networks are often closely linked. In Southern Africa, for example, vehicle theft and robbery are linked to the illegal arms trade in Mozambique, while drug trafficking is connected with motor vehicle theft and money laundering in Zambia.11 Economic crime, in particular, is highly attractive to syndicates, that regard it as a high-reward, low-risk activity that is often employed to protect 'core' criminal activities.12 As such, any attempts to combat organised crime syndicates will involve preventing commercial crime.

While varying in form and structure, organised crime operations in South Africa, as elsewhere in the world, share a number of common characteristics:

a hierarchy of control, with clearly designated ranks and systems of promotion and payment;



sophisticated procedures, often via legitimate business interests, to launder money obtained by illegal activities (often drug trafficking); and



the use of weapons to ensure that 'business' routes are protected and potential competitors eliminated.13

Another common denominator of organised crime operations is the ability to penetrate and use the institutions of state. Good state contacts enable operations to run more smoothly, while forewarning crime bosses of any impending government crackdown. In some states, such as Colombia and Russia, it is often difficult to tell where the state ends and organised crime begins. Crime syndicates have the ability to 'buy into' government and bribe officials – including those in law enforcement – who earn comparatively little. While it is well known that bribery occurs in the lower ranks of the SAPS, the degree to which the higher echelons of the service may have been penetrated, is unclear.14

According to comparative research on the growth of organised crime elsewhere in the world, South Africans should be aware of and monitor the following trends:

the changing commodities that organised crime networks trade in and potential new commodities they may seek to obtain;



the dynamic connections between various syndicates, street level operations, and linkages to the state and external criminal operations; and



the changing shape and structure of organised crime syndicates in reaction to some forms of policing and specific targeting of police agencies, either to be corrupted or for violent retribution.15

The increased sophistication and growth of organised crime also partly result from new communications technology which has opened up new areas of criminality in the commercial world, as well as new opportunities for laundering money or investing profits from illicit activities. In the process, the distinction between legal and illegal sectors of any economy become blurred and the most 'respectable' organised crime operations are often a dynamic mix between licit and illicit activities.16

MONEY LAUNDERING

"If we find someone whose 12-year-old daughter has $10m in her bank account, we can be sure she didn't get that from a paper round."17

Money laundering – the process in which illegally obtained money is given the appearance of having originated from a legitimate source – is a crucial element of fraudulent activity and a main tool used by crime syndicates. Most money laundering is done by organised crime groups, indeed such criminals normally engage professional asset secretion advisors to hide their wealth in a labyrinth of nominee companies and trusts.18 It is a vital necessity to organised crime, as it prevents the detection and consequently prosecution of those responsible for managing and financing criminal syndicates and insulates those at the top of the criminal organisation from the sordid reality of their crime.19 By laundering their ill-gotten gains, criminals can enjoy the fruits of their illegal occupations.

There are varying estimates for the amount of money laundered world-wide. What can be said is that the problem of money laundering is enormous and goes far beyond narcotics profits – it is estimated that the world-wide gross drug trafficking proceeds are in the region of $500 billion – encompassing trade fraud, tax evasion, organised crime, smuggling, bank, medical and insurance fraud.20 The vast sums of money which are laundered have an insidious corrupting effect which stimulates the growth of a second 'underground' economy and debilitates the legitimate financial sector.21

The laundering of money is generally categorised into three stages:22

placement: the placing of cash proceeds derived from illegal activities into the financial system (the most vulnerable stage), e.g., bank, currency smuggling, informal banking networks;



layering: the creation of a complex series of financial transactions designed to disguise the source of the cash, e.g., electronic interbank transactions, purchases of physical assets, an intermediate account; and



integration: the conversion of criminal wealth to apparent legitimacy, e.g., the purchase of shares, the 'loan-back' method, providing collateral.

The methods of laundering money are as varied as the imagination of the launderer. There are quite a number of options open to the money launderer, including bank accounts, trust accounts, casinos, shares in quoted companies, unit trusts, privately held businesses, unlisted companies, antiques, fine art, Persian carpets, jewellery, wine, stamps, high value endowment policies, property purchased via limited companies, aircraft, yachts, exotic cars, precious stones, traveller's cheques, smart cards. However, the jackpot is to exchange the proceeds of criminal activity into money and assets which are not traceable and to quickly hide an illegitimate paper trail and create a legal one, even should this entail taking a loss on the capital sum.23

Money that originates in one country is often transferred out of the country, because once outside it is much more difficult to trace and can easily be hidden under the guise of normal business transactions. In addition, it can be deposited into foreign banks with greater secrecy and without the fear of a currency transaction being filed. Once the funds enter the international banking system, the money can be transferred around the world, thereby further complicating the audit trail.24

Sophisticated hiding techniques abound. Examples of the language used by professional asset secretion advisors include:25

The starburst – a single sum of money is moved into a bank, divided into dozens of fragmentary pieces, and credited to multiple pre-existing dummy accounts.



The hopscotch – money is hopscotched from one pre-existing bank account to the next, around the world, occasionally moving from ten to twenty banks in the course of two months, ultimately coming to rest in a holding account in Switzerland or the like.



The ricochet – money ricochets at lightning speed, through electronic funds transfers, bouncing of a singular bank account to an ultimate end deposit point, offshore.



The boomerang – money moves seemingly away by electronic funds transfer, however, by design floats and comes back to rest.

The critical component of a friendly money laundering environment is anonymity and confidentiality, both with respect to the customer and the transaction. The customer is protected if he or she cannot be identified; the transaction is protected if it leaves no paper trail or a trail which is sufficiently complex to be impenetrable. Accordingly, money launderers are looking for financial institutions:

that require minimal identification, or permit identification that is either easy to falsify or difficult to verify;



ask few questions about the nature of the customer's business;



which account intake procedures permit the concealment of the real or 'beneficial' owner; and



that readily permit counter transactions.26

As such, money launderers usually select areas for operation where they are able to exploit their financial skills in an accommodating regulatory environment, often invoking bank secrecy laws and legitimate expectations of privacy from financial institutions. Off-shore financial centres are often used, even by legitimate and highly respected companies, as a convenient means of parking funds and arranging discreet transfers.27 The offshore world consists of approximately 62 havens, each of which attracts capital by maintaining bank and fiduciary relation secrecy legislation – legislation which purports to criminalise the dissemination of information concerning the ownership of wealth reposed or handled by offshore banks, trust companies, lawyers or other confidants.28 The US Treasury has estimated that at least $500 billion of offshore assets represents the proceeds of economic criminal activity or money laundering.

BANK SECRECY

Arguably, bank secrecy legislation has fuelled the expansion of international fraud and money laundering. While there are numerous good reasons why the duty of bank secrecy exists, all these good reasons are now being exploited by criminals who enjoy the protection of confidentiality.29 Because of complications surrounding disclosure of information internationally, investigators cannot obtain crucial information in time to prevent the fraudster from getting away with it. It has been argued that when serious fraud is committed, resulting in enormous losses to an organisation, banking secrecy based upon the relationship between the bank and the client should no longer apply. Rather, it would be in the interest of the bank and the financial institutions to co-operate and assist the regulator and the law enforcement agencies in understanding the systems followed within the bank, internal control mechanisms and the modus operandi followed by the accused to circumvent such control mechanisms.30

A senior South African banker has noted that "while we may be in competition, we cannot afford to compete for the first place when it comes to the protection of fraudulent transactions ... At investigative level we are all colleagues and no corporate competition should exist."31 He voices the opinions of others in advocating that financial institutions formally agree to co-operate in the internal investigative process by sharing salient information.

The suggestion that co-operation between multiple financial institutions in combating economic crime and its principal derivative – money laundering – is said to be precluded absolutely by the common law duty of confidence owed by a banker to its customer. However, it can be convincingly argued that a contract cannot exist where its purpose is to assist in the commission of a crime or a tort. Thus, if a man comes to the formation of a contract of deposit with his bank male fide, the relation that is constructed thereby cannot give rise to a confidence capable of legal protection or even recognition. The right to secrecy ends where a malevolent purpose begins. Effective detection requires co-operation among capital market intermediaries, co-operation which necessarily invokes consideration of bank secrecy and confidentiality law.32

SECURITY, THE INTERNET AND ELECTRONIC MONEY LAUNDERING

The bill for computer break-ins and losses may be as high as $7 billion annually. Since most organisations are not really willing to share that information, it is difficult to get to the economic cost. A survey of 1 320 US information managers found that 75 per cent of respondents were not confident in the security of their internal networks.33

The rate of growth of the Internet has been unprecedented and is expected to continue exponentially. Figures of 33 million users have been cited.34 The commercial sector represents over 50 per cent of the installed Internet computer-base and is outgrowing the academic and research sector. Significant risks and threats associated in connecting to the Internet have been identified as the following:35

masquerade/'spoofing' – a user masquerades as someone else in order to gain additional privileges;



disclosure – messages and data are seen by other machines, including email files and passwords;



unauthorized access;



loss of information integrity – modification of data, e.g. the addition of a few zeros to the end of a figure on an electronic cheque;



denial of service – active attack, when an Internet computer network is inundated with data and/or requests that must be serviced, rendering the computer useless for any other purpose; and



theft of service and resources – theft of specific clientele or service offered over the Internet.

Advancing technology has improved the ability of financial institutions and their users to conduct cybercommerce. All cyberpayment systems, such as smart cards, DigiCash (Ecash)and Cyber Cash, have the following features in common: they permit the electronic transfer of funds through the use of advanced information technology. To provide security for system users, they rely on encryption technology – where 'encryption locks' are used to protect value which is stored electronically from theft, misuse or counterfeiting – and public communication networks, i.e. telephone systems.36 Cybercommerce depends on rapid, anonymous and unsupervised transactions. Such a system is extremely vulnerable to criminals seeking to launder money on the Internet, because individuals can transfer funds in an instantaneous fashion around the world – without the intermediation of financial institutions. In a system where there are millions of transactions unsupervised by financial institutions, comprehensive oversight becomes impractical.37

Thus, while improved technology that enabled the transfer of money through the use of computers or via computer chips has created great commercial promise, it has also provided an opportunity for criminals and fraudsters to use computer software systems to transfer their illicit gains and thereby sustain their criminal enterprises. Since computer software technology, such as the Internet, have made it possible for individuals and entities to transfer large amounts of money outside normal regulatory and institutional channels, government regulators and bank officials must develop new modes of technology to monitor cash flows. In the absence of adequate supervision and oversight, financial crime in the 21st century will utilise computer software technology to transfer its ill-gotten gains in a manner that could pose a serious threat to the international financial system.38

The US Government has determined that maintaining the security of computer networks and information systems has become the major security challenge of the 1990s, posing a threat to currency stability, systems of exchange and the administration of justice.39 In recent years, 'crackers' from Russian crime organisations have successfully infiltrated the electronic transfer systems of US banks, securities firms and corporations. They usually access various branches of international financial institutions, moving digital cash within the system before suddenly transferring the cash into their network. In 1995, computer crime on the Internet in the US was estimated at more than $5 billion. During a two month period in 1995, an estimated $300 million in untraceable computer transfers disappeared from US banks and securities firms.40

In response to this threat, the US Department of Justice created a computer crime unit in 1992 and is now training prosecutors in techniques to combat cybercrime.41 An international computer crime work group, in which South Africa is represented, has been established by Interpol and meets regularly to exchange information on new trends and methods relating to these types of crime.42

Often however, legislation and enforcement measures battle to keep up with technological developments. Today, computer fraud has become an international problem and the primary issue is which legal system has jurisdiction. For example, in a cash transfer which was initiated in the US, but denominated in cybercurrency Deutsch Marks, which are then issued by a French bank, what criteria should a court consider in deciding jurisdiction?43

As cyberpayment technology becomes more widespread, consumers may become more exposed to fraud over the Internet through the misrepresentation of goods and services, pyramid schemes, etc. In the future, if electronic currency is issued by entities other than banks, governments, or entities controlled by banks, there will be the risk that consumers will be exposed to fraudulent insurances of currency which are not backed by funds on deposit in a regulated financial institution.44

While computer technology, more specifically the Internet, has facilitated the laundering of money through bank accounts, computer systems can also be used to detect laundering through monitoring accounts according to certain rules. For instance, the following can be 'asked':

Is this account doing something unexpected?



Are there signs of quick in-out movement – especially if the account is new?



Is there a high percentage of the original amount transferred out within X days?



Is the percentage of amount deposited relative to any internal or statutory reporting limit (e.g., $9 500 when the limit is $10 000)?



In seeking to root out 'front' companies, is the behaviour of the account comparable to baseline behaviours of other accounts in the same business sector? 45

SOUTH AFRICA AT RISK

Factors making South Africa a money laundering paradise and impeding the investigation of such crimes have been identified as:

increasing intervention of sophisticated foreign and local crime syndicates in South Africa;



fraudulent employees/infiltration in the financial sector by criminal syndicates;



rapidly changing economy;



ambivalent moral standards vis-à-vis fraud and criminal activities;



the justice system as it pertains to money launderers: law enforcement is impeded by the sheer size, variety and pace of change in the financial sector, and the law itself may not facilitate the investigation process;



the inability of the police to effectively deal with sophisticated computer-based financial fraud: law enforcement officials have limited knowledge of the financial system and the sophisticated ways in which financial criminals exploit that system; and



acquiring information for evidence from a number of different organisations is time-consuming and may not be forthcoming.46

With regard to computer-based crimes, a specialised unit has been established within the SAPS and assists the commercial crime and organised crime branch with its investigations. This assistance entails extracting information from computers to assist in the investigation and sometimes in larger systems installing audit trails to monitor certain transactions. According to the head of the unit, reporting of computer-related crimes has increased by 300 per cent in the past 18 months, largely because of a greater public awareness. Legislation pertaining to computer crimes has been drafted and will probably be billed in parliament later this year. In the absence of such legislation, such crimes are usually denoted as theft or fraud.47

CONCLUSION

Policing organised crime requires new methods and greater co-operation with international law enforcement agencies. Special methods are needed to tackle complex criminal organisations and forms of criminal activity that rely on sophisticated financial dealings. Threatening profit margins by limiting what syndicate bosses can do with their ill-gotten gains, through criminalising money laundering, is one of the most effective ways.48 South Africa has gone some way down this road with the introduction of new legislation in this regard.

The South African Extradition Amendment Bill and International Co-operation in Criminal Matters Bill recognise the need for international co-operation in criminal matters. In addition, the Proceeds of Crime Bill, Special Investigating Units Bill and the Special Tribunals Bill which focus on recovering the proceeds of crime, prohibiting money laundering and obligations to report certain information, may assist in the fight against such crimes. The effectiveness of these bills, as with all legislation, however, depend on how they are implemented and enforced. Throughout the world, when it comes to money laundering, banks and financial institutions play an important role, as governments lack the personnel to investigate, implement and regulate these highly specialised activities.

The threat of money laundering demands a multidisciplinary approach in order to understand, track, investigate, analyse and ultimately to reduce the phenomenon to a level where it is no longer a threat. A comprehensive approach to the problem must begin with a strong, unambiguous top-down statement of values. From there, legislation, statutory reporting by target organisations in the financial sector, the establishment of a specialised money laundering investigation service, as well as open sharing of cases and detection techniques will do much to curb the problem.49 It appears that South Africa has gone some way down the road of addressing international fraud threats.

ENDNOTES

Edited version of a paper presented at the AIC Conference on Corporate Fraud, Karos Indaba, Johannesburg, 28 January 1997. Published as part of the Crime and Policing Policy Project, a venture sponsored by the United Nations Development Programme (UNDP).



Ernst and Young, International Fraud Group Survey, Johannesburg, May 1996.



KPMG, KPMG Review, 17, 1996; KPMG, KPMG Fraud Survey 1996: Southern Africa, KPMG, Johannesburg, 1996.



Testimony to the Senate Select Committee on World Wide Threats to US National Security, 10 January 1995.



C Landsberg and Z Masiza, The Anarchic Miracle? Global (dis)order and Syndicated Crime in South Africa, Policy: Issues and Actors, 9(6), Centre for Policy Studies, Johannesburg, November 1996.



Ibid.



M Shaw and L Camerer, Policing the Transformation, ISS Monograph Series, 3, Institute for Security Studies, Halfway House, April 1996.



Between April 1994 and February 1995, the SAPS claims to have confiscated or destroyed illegal drugs to the value of R1 billion, which apparently only accounts for less than 20 per cent of an estimated illegal drug trade of R7 billion. See W Grove, The Drug Trade as National and International Security Threat, ISSUP Bulletin, 7/94, 1994; Nedcor, Nedcor Project Final Report, Nedcor, Johannesburg, September 1995.



Vehicle theft has increased by 25 per cent with the bulk of these cars ending up across the border in places as far afield as Portugal, Greece, Cyprus, Australia and New Zealand. Misdaadinligtingontleding en Vertolkingsentrum, Roof van Voertuie, Jaarverslag, SAPS, Johannesburg, 1994, p.2.



Between April and December 1994, police seized more than 12 000 firearms, an increase of 34,8 per cent over the corresponding months of the previous year. CAICI, Firearm-related Crime, March 1995.



Landsberg and Masiza, op. cit.



Ibid.



Shaw and Camerer, op. cit. For a detailed overview of definitions of organised crime, see G E Caiden and H E Alexander (eds.), The Politics and Economies of Organised Crime, Lexington Books, Washington, 1985.



Ibid.



Ibid.



Ibid.



Interclaim, The Financial Times, 12 November 1996.



M Kenney, About Money Laundering – Current Techniques, 2nd Annual International Fraud Convention, London, December 1996.



KPMG, Fighting Fraud: Forensic Accounting, Special Edition 4.



S Banhegyi, Use of Computerised Systems in the Identification and Investigation of Money Laundering, AIC Conference, op. cit.



KPMG, op. cit.



Ibid.



Banhegyi, op. cit.



KPMG, op. cit.



Kenney. op. cit.



Ibid.



The US Treasury has estimated that $500 billion of offshore funds are assets protected from creditors; Interclaim, op. cit.



Kenney, op. cit.



G Breytenbach, The Conflict between Banker's Confidentiality and the Investigation Process, presentation to the 2nd Annual Financial Fraud Convention, op. cit.



B V Kumar, presentation to the 2nd Annual Financial Fraud Convention, op. cit.



Breytenbach, op. cit.



Kenney, op. cit.



Bloomberg Forum, Ernst and Young says Companies Data not Secure, Internet, 1996.



V Fryer, Telephone interview, Senior Superintemdent, SAPS, 24 January 1996.



KPMG Review, op. cit.



K Alexander and R Munro; Internet: Cyberpayments: Internet and Electronic Money Laundering: Countdown to the year 2000, Journal of Financial Crime, 4(2), 1996.



Ibid.



Ibid.



M Castle, The Future of Money, Testimony by Chairman of the House Banking Domestic and International Monetary Policy Committee, US Congress, Washington, 11 October 1995.



D Morrison, Cell-phone Scam: First Court-approved Tap of email Breaks up Ring, Newsday, 30 December 1995.



Ibid.



Fryer, op. cit.



Alexander and Munro, op. cit.



Ibid.



Ibid.



Banhegyi, op. cit.



Fryer, op. cit.



Banhegyi, op. cit.



Ibid.