America’s real border problem

Michael D Goldhaber, IBA US Correspondent

‘We’re going to build the wall’ ranked among President Trump’s most recognisable election campaign slogans. But, even the highest wall can’t stem the flow of dirty dollars sustaining the drug cartels. The epic HSBC case shows the limits of the United States’ unique approach to money laundering.

From the moment he descended the gilded escalator at Trump Tower to launch his presidential campaign, Donald Trump declared that Mexico sends the United States drugs, crime and rapists. Asked to apologise, the candidate would only add infectious disease to his list. ‘Bad hombres’ became a central grievance for the Trump campaign. ‘Build the Wall’ became its refrain.

In reality, arrests on the Rio Grande peaked at the turn of the millennium. More Mexicans have left the US than have arrived since 2009, according to fact checkers. Mexican immigrants are more likely to be vaccinated than the average US citizen, and less likely to commit violent crimes.

The seed of truth in President Trump’s narrative is that North America has a drug problem. Multinational gangs cause untold misery on both sides of the border, with Mexico suffering an astonishing 23,000 drug-related murders last year. The serious question for policymakers and legislators is not how to stop the slowing flow of immigration, but how to dam the continuing flood of dirty money that pumps life into the drug cartels. ‘Building a wall will do nothing to solve or even impede the problem of drug money being repatriated back to Mexico where it’s laundered,’ says Richard Elias of Elias Gutzler Spicer.

The only solution to money laundering is anti-money laundering (AML). But, what sort of AML? Five years ago, the US caught HSBC banking billions in suspect Mexican cash. Faced with the greatest scandal of money laundering history, the US deferred prosecution in favour of massive fines and regulation under the gaze of a court monitor.

Now, as the five-year mark approaches, the US must decide whether to extend its supervision, renew its prosecution or declare victory. The expiration of HSBC’s monitorship does more than test compliance at the world’s biggest bank outside of China. More fundamentally, it tests the US’s stark choice to control dirty money through its distinct system of regulation and settlement rather than prosecution.

While establishment lawyers perceive progress on money laundering, civil society is sceptical. ‘Banks are investing tremendous resources into this issue,’ says Carlton Greene, who served as General Counsel at the Financial Crimes Enforcement Network (FinCEN) during the Obama administration. ‘Compliance has really hit a fever pitch of prioritisation.’

But, despite swelling fines and compliance units, ‘it’s just as likely that a scandal as big as the HSBC scandal could still happen,’ counters Global Witness US Director Stefanie Ostfeld. ‘The US continues to roll out the red carpet to dirty money from around the world.’

The good news on AML

As it happens, the US received its once-a-decade combing-over by the Financial Action Task Force (FATF) just before President Trump arrived on the scene. Add that multilateral assessment to a quick survey of President Trump’s start and you get a vivid snapshot of the US’ AML regime. There’s good news aplenty.

Overall, the FATF deemed the US system ‘robust’. It gave the US highest marks on asset forfeiture, which tops $4bn a year, and counter-terrorism, which is ‘highly effective’. Amazingly, the US ‘appears to have kept terrorist funds out of its financial system to a large extent’. Where the bad guys are known, the US blacklist keeps them out. Bank regulations ‘seem to have the desired impact’. Money laundering prosecutions, often complex and global, march at the clip of 1,200 a year. The US’ initiative to recover kleptocrat assets is one-of-a-kind.

Obama’s Department of Justice (DoJ) summed up the mainstream progressive view by concluding that the FATF showed its AML regime to be ‘unmatched’, with ‘room for improvement’.

Despite a general hostility to the administrative state, the Trump administration has actively carried on the fight against money laundering. One too-cynical column predicted that President Trump’s first move would be to deregulate luxury real estate, because he has a history of selling condos to oligarchs and kleptocrats (like Haiti’s ‘Baby Doc’ Duvalier, who bought a Trump Tower unit through a Panamanian shell company). But, in February, President Trump renewed a successful ‘targeting order’ that forces title insurers to report cash buyers of upscale New York properties. Adding to the irony, Trump’s FinCEN has spent much of its time hounding casino operators. Maybe it’s not curtains for corporate transparency after all.

In May, Citigroup and the DoJ struck a $97m deferred prosecution agreement on Mexican money laundering, which looks much like the HSBC settlement on a smaller scale. FinCEN’s staff and budget remain intact. Trump has not tried to roll back FinCEN’s new ‘Customer Due Diligence’ rule, which makes banks report beneficial owners. Nor has Trump tried to wipe out the new Internal Revenue Service rule forcing companies to report financial data ‘country-by-country’.

Greene, now at Crowell & Moring, is hopeful that his successors at Trump’s FinCEN will finally regulate investment advisers and expand the luxury real estate orders, which are limited in time and space, into a rule. It’s true that Trump has hamstrung rulemakers with his ‘2-for-1’ order, erasing two old regulations for every new one issued. But, a strong argument can be made that all money laundering rules fall under the exception for national security.

‘At the very least’, says Greene, ‘I haven’t seen retrenchment on any of what FinCEN does.’         

The bad news from the FATF

Sharper critics of money laundering policy think the FATF is being diplomatic. ‘The US pays for over 25 per cent of the organisation,’ says Cambridge University’s Jason Sharman, ‘and the organisation is very aware of that. There’s a fine line between maintaining the pretense of objectivity and not annoying the US.’ Even so, the FATF gave Uncle Sam low grades for failing to name the beneficial owners of shell companies – and for failing to regulate lawyers. The FATF focused on the same two key policy gaps a decade earlier. Perhaps the best that can be said, to borrow Transparency International’s phrase, is the US has ‘more roof than holes’.

On beneficial ownership, the US made strides last year by adopting a ‘Customer Due Diligence’ rule, which ostensibly forces banks in the US to name the true owners of new accounts. But, to Global Witness, it’s a flawed and limited rule. Bad guys can still hide by lowering their ownership stake below 25 per cent. Worse, the Treasury will let banks satisfy the rule by merely naming managers. Most fundamentally, the rule doesn’t reach the incorporators of shell companies. If you’re a bad guy, ‘you can still set up a shell company in Delaware on Monday, and open a bank account in Panama on Tuesday,’ says Ostfeld. Incorporation transparency remains ‘the Achilles heel of US AML policy’.

When John Cassara was at FinCEN, he led training sessions for money laundering officials in dozens of countries. ‘Invariably,’ he says, ‘in the class or on a break, I would have a student come up to me and say “I’m working a money laundering case where the bad money from my country goes to this place called Delaware. Can you help us?” There’s nothing I can do. There’s nothing we can do. Do you know how embarrassing that is? I’m standing there preaching the gospel of money laundering and what these guys should do to clean up their act and then they throw Delaware in my face.’

US embarrassment deepened in June, when European Union nations had to pass beneficial owner laws under their new Anti-Money Laundering Directive. Ironically, though the idea has yet to bear fruit in Washington, DC, the EU stole it from a 2008 bill sponsored by then-Senators Carl Levin and Barack Obama. On 29 June, Congress tried to catch up by re-introducing the US Incorporation Transparency and Law Enforcement Assistance Act. Incorporation transparency has always had bipartisan appeal because it would super-charge the fight on drugs and terror. Its champions hope the bill will gain momentum from the newfound support of banks (who don’t wish to be the sole US enforcers of beneficial ownership), and the increased clout of Trump-friendly law enforcement groups who have always liked the idea. While Obama’s Treasury Department favoured some form of incorporation transparency, Trump has yet to take a position. Congress is otherwise occupied.

The FATF’s second chief complaint is the US’ refusal to impose AML obligations on attorneys. This too was dramatised in the spring, when the DoJ sought to seize another $0.5bn of assets traced to an alleged slush fund for Malaysian kleptocrats, known as ‘1MDB’, which was linked with the financing of the film Wolf of Wall Street.

US v Wolf of Wall Street, as one of the seizure cases is styled, spotlights a gaping loophole in US law identified by the FATF. When money is funneled through a lawyer-client bank account, the lawyer has no due diligence duty whatever – and the bank needs only to do due diligence on the law firm. ‘There’s no suggestion that these law firms have done anything wrong,’ says Global Witness’  Murray Worthy. ‘What we’re saying is this is a gap in the regulations.’

An episode that illustrates both of the gaps highlighted by the FATF is last year’s ‘Anonymous Inc’ sting of New York lawyers. A Global Witness researcher posed as an agent for an African kleptocrat, while hidden ‘60 Minutes’ cameras rolled. In pre-client interviews, 11 of the 13 lawyers tested spoke of forming a US shell, and some contemplated using their client accounts.

The prevalence of lawyer trust accounts being abused by money launderers may be impossible to quantify, Worthy says – but this handful of examples is ‘evidence enough’ that it’s a problem.

What is the proper response? ‘Require transactional lawyers to do money laundering checks on all their clients,’ says Ostfeld. Elise Bean, of the Levin Center at Wayne Law, says Congress might simply extend Bank Secrecy Act obligations to lawyers, drawing on the content of the bar’s voluntary best practices. Alternatively, the bar itself could make AML due diligence a binding professional duty. ‘I definitely think the ABA has a role to play,’ says Worthy.

Meanwhile, conspiring to launder money is already a crime and an ethical breach. Bean would like to see lawyers prosecuted and disciplined for forming shells and using client accounts to launder funds. ‘In an appropriate case,’ she says, ‘it would be a good deterrent.’

The bad news under President Trump

While President Trump has carried on the fight against money laundering proper, AML cannot be viewed in isolation. The Trump Congress’ first act of deregulation of any kind was to rescind the Securities and Exchange Commission (SEC) rule forcing natural resource companies to disclose payments to foreign nations. ‘The rollback of the extractive disclosure rule shows we are abandoning our position as the anticorruption leader globally,’ says Ostfeld. ‘[This rule was] important for stopping money from going missing in the first place, before the money is laundered. That’s the behaviour we’re trying to stop.’

In AML proper, experts fear that Trump’s rhetoric on the Mexican wall will undermine cross-border cooperation. President Obama offered a timely reminder of its importance by securing extradition of drug kingpin ‘El Chapo’ Guzman on his last day in office. With Trump’s approval rating in Mexico at a world-low of five per cent, we may see less of that. ‘Any US special agent will tell you that collaboration with law enforcement in Mexico is imperative,’ says Elias.

Indeed, former agent Robert Mazur, legendary for his work as an undercover money launderer, is passionate on the subject. ‘I hope that the Trump administration recognises how precious and important the relationship is with the Mexican government and law enforcement community,’ he says. ‘Because, absent that cooperation, the cartels win, absolutely. In my view, that’s more important than a 50-foot wall. The most important thing is a robust, trustful relationship between these two nations and their respective law enforcement communities. Anything we do that might unnecessarily undermine that relationship is shooting ourselves in the foot.

‘We need a secure border but a secure border is not the answer to the problem. The closest thing to a silver bullet you’re ever going to get is having the most positive, truthful, honourable relationship between nations politically, law enforcement-wise and intelligence-wise.

‘I wish that leaders in our country would recognise that, when you look at the dilemma of Mexico (depending on whose numbers you take), more than 100,000 people have lost their lives in connection with the activities of Mexican drug cartels. Let’s say it’s 120,000. Of that 120,000, there’s a big percentage of people who are former prosecutors, reporters, law enforcement officers, military personnel, shop owners, etc, who had the courage to fight the cartels and are now dead. I think the Mexican people would appreciate us more if we recognised the sacrifice that a good segment of their population has made in an effort to try to fight this war. Such recognition would do nothing other than strengthen the relations between governments and law enforcement agencies.

What the FATF forgot: the prosecution gap

The FATF doesn’t carehow a nation achieves its objectives. And that’s sensible for a group that bridges legal cultures. But, it misses the major US debate: does the DoJ need to pursue the prosecution of banks and bankers in cases like HSBC’s, in order to deter money laundering?

Greene thinks that mega-settlements, combined with regulation, are already starting to change banking norms. In particular, he argues, three new threats have instilled in bankers a healthy fear of individual AML liability. First, the DoJ’s 2015 ‘Yates Memo’ expressly makes personal prosecution a top priority, giving companies under investigation an incentive to point the finger at wrongdoers by making it a prerequisite to receiving credit for cooperation. Second, in this May’s Haider settlement, a compliance officer agreed to a $250,000 fine and a three-year ban to settle a FinCEN claim for civil liability. Third, as of this year, the New York State Department of Financial Services requires a senior officer or the board of directors to formally certify that a company is in AML compliance. ‘You’ve got kind of a perfect storm on individual liability,’ Greene says.

While Greene sees this fear as salutary, he warns that going further and pursuing people criminally could have serious side effects. It could chase able people from the compliance field. And, it could drive banks to abandon whole sectors or regions under the cover of derisking. ‘If they were to start prosecuting people for having a bad AML programme,’ he says, ‘it would have to be really egregious for them to be able to do that and not completely spook the industry.’

The sceptics counter that there will be no deterrent until the threats of liability are backed by actual criminal prosecutions of both banks and banking executives (which is not to say compliance officers). And, if HSBC Mexico wasn’t ‘egregious’ enough to prosecute, what is?

‘I cannot connect the dots between the Yates Memo and the performance of the DoJ during that time frame,’ says Mazur. ‘I don’t see any conduct in the DoJ during the Lanny Breuer/Eric Holder era holding individual people responsible [for money laundering], when you look at the Wachovia bank matter, when you look at HSBC.’ By contrast, when it comes to tax evasion, says Mazur, the DoJ is willing to dig deep enough into bank revelations to identify who is culpable and chase them down.

Global Witness alsofinds the US strategy on money laundering lacking. ‘What we’ve seen from HSBC is that fines by themselves don’t work, they don’t hurt the people responsible, [they’re just] the cost of doing business,’ says Ostfeld. ‘What we’ve seen over recent years is a kind of increasing escalation in regulatory action,’ adds Worthy. ‘But, there’s still a tendency to use deferred prosecution agreements.’

To prosecute both banks and executives, Worthy concludes, ‘would build a much more effective AML compliance regime. It’s about both corporate collective and individual responsibility.’

HSBC: a prosecution deferred   

HSBC Mexico presented a case of money laundering as prosecutable as the US is ever likely to see. A drug lord effectively testified that HSBC Mexico was the cartels’ bank of choice in a moment of honesty caught on tape in 2008. And, he could be corroborated by the bank’s own AML director, who helpfully fretted in an email, sent as he resigned in panic, that HSBC had captured up to 70 per cent of the market for dirty money in Mexico.

According to the US indictment, HSBC tellers routinely accepted millions in cash from people with no identifiable income, packed in boxes custom-fit to the dimensions of their bank windows. In one scene, caught on closed-circuit television, the tellers had to get on the floor and count cash all day. Bankers didn’t want to know, so they simply made up know-your-customer data, and opened fictitious ‘offshore’ accounts to get around Mexico’s ban on depositing dollars. At one point, the Mexico AML director fabricated half a year of imaginary meetings. After the US seized a client’s assets for drug laundering, executives refused to drop the client. ‘What is this, the School of Low Expectations Banking?’ emailed an AML officer. Audits frankly concluded that controls were ‘BELOW STANDARD’.

HSBC USA laughably classified Mexico as a low-risk country. It failed to monitor over $670bn in wire transfers and $9.4bn in bulk cash from Mexico between 2006 and 2010. Just for starters, prosecutors could trace nearly $1bn of it to major drug cartels. ‘I could probably go to a lot of elementary schools in the world and give that fact pattern,’ says Mazur, ‘and I think that most would follow the logic that this could not have been a bank tricked into carrying out these transactions.’

We now know this was the DoJ’s first instinct too. In a bombshell 2016 report, Congress revealed that DoJ’s Asset Forfeiture and Money Laundering Section had urged the US to prosecute HSBC, rather than to settle for a deferred prosecution agreement. According to the House Financial Services Committee’s report Too Big to Jail: Inside the Obama Justice Department’s Decision Not to Hold Wall Street Accountable, Attorney General Eric Holder overruled the prosecutors under pressure from the United Kingdom finance minister and Financial Services Authority, for fear that it ‘could result in a global financial disaster’. Holder told the public countless times that he’d bring the prosecutable cases. But, either out of wisdom or caution, he dropped the most prosecutable case of all.

In December 2012, US authorities accepted $1.92bn from HSBC to settle admitted violations of money laundering law and economic sanctions. It was far and away the largest Bank Secrecy Act settlement in history (though it has since been superseded by JP Morgan’s $2.05bn fine for failure to report the Bernard Madoff fraud). Most crucially, the US agreed to defer prosecution in return for a five-year monitorship. If, at the end of five years, the bank is not in compliance, the US promised to either extend the monitorship or renew the prosecution.

That time is nearly upon us, and the decision is not an easy one. HSBC’s monitor is finding that the bank’s ‘compliance program still struggles,’ according to a summary of this year’s report filed by the US Attorney. Though the reports themselves are secret, some embarrassing details leaked last year. In one episode, HSBC took thousands in cash from a 19-year-old self-described shrimp farmer in the state of Sinaloa, notoriously dominated by the Sinaloa cartel. In another, HSBC Mexico lent money to a ‘factory’ after the site visit revealed only a well-staffed mansion. Though this year’s report found continued improvement and commitment, the monitor ‘remains unable to certify that the bank’s compliance program is reasonably designed and implemented to detect and prevent violations of AML and sanctions laws’.

HSBC spokesperson Suman Hughes says: ‘HSBC is committed to implementing the most effective standards to combat financial crime and has made significant progress over the last five years.  We continue to implement reforms in line with our plan.’ Indeed, as Global Insight went to press, HSBC announced that its share price had improved by 55 per cent in one year. Some commentators attribute this to the bank avoiding scandal and implementing a cleanup. HSBC also now operates in 68 countries, rather than 93, as it did at one point – a move that’s likely to have facilitated considerably better oversight by senior management.

The option of private enforcement

Like most great US scandals, HSBC Mexico enjoys a multifaceted legal afterlife. In Zapata v HSBC, plaintiffs’ lawyers last year filed a suit for private civil enforcement on an arresting theory. They argue that US victims of Mexican drug violence can recover treble damages for their personal injuries because, by serving as the drug lords’ banker, HSBC gave material support to ‘terrorists’ under the US Anti-Terrorism Act.

If nothing else, Zapata serves as a grim reminder of dirty money’s human toll. In one incident, a gunman mowed down a pregnant mother in front of her baby daughter on their way home from a birthday party sponsored by the US Consulate. In another, gang members invaded a church wedding, kidnapped the best man and a groomsman, and asphyxiated them with duct tape.

HSBC initially seeks to remove the case from the federal courthouse near the Mexican border where it was filed. Once the venue is decided, the arguments may turn partly on the definition of terror. To be sure, the Sinaloa cartel differs from Al-Qaeda. But, the statutory definition of terrorism may be satisfied by violent criminal acts that merely ‘appear intended to intimidate’ a civilian population. ‘If you hang a disemboweled journalist from a bridge with a sign that says “This is what happened to me for speaking out,” that is clearly an act of terrorism, ’ says Elias.

AML campaigners sympathise with any extra effort to publicise wrongdoing and compensate victims. But, as a matter of policy, private damage suits suffer from the same flaw as public fines. Even huge ones have little deterrent value, because their cost is borne by shareholders.

What happens to a prosecution deferred?

‘Since the HSBC scandal,’ declares Ostfeld, ‘very little has changed’ in US money laundering policy. She sees only a toothless rule on customer due diligence, and an empty-letter memo on individual prosecution. Nor is there any indication of a decline in the underlying transnational crime trends. Certainly, the gangs keep finding ways to launder the funds that fuel their atrocities. Drug violence reached record levels in the first half of 2017, according to the International Institute for Strategic Studies, with one murder committed every 20 minutes.

The more immediate question is how much has changed at HSBC. The share price and pared-back global operation suggests that much has changed. Nevertheless, the monitor reports are not public. Summaries of the latest monitor reports suggest progress has been made, while compliance challenges remain. Both HSBC and US authorities declined to be interviewed for this article. Predictably, the secrecy of the monitor reports is itself the subject of intense litigation.

A disgruntled HSBC mortgage holder, Hubert Dean Moore, petitioned the New York federal district court that is supervising the deferred prosecution to make the monitor’s report public. Early last year, the court ruled that the public has a right of access to the report, subject to reasonable limits, both under common law and the First Amendment to the Constitution. That ruling was recently argued on interlocutory appeal to the Second Circuit. Both the bank and the government wish the report to stay secret. Moore contends that public access would improve the decision-making of the prosecutors, the monitor and, not least, the court. While Moore foresees an active role by the court in the case’s dismissal, HSBC suggests that a court should merely rubber-stamp any recommendation by the prosecutors to end a deferred prosecution.

The bank’s narrow view of a court’s role in supervising a settlement is generally consistent with the US judicial trend, if not public opinion. Last year, the DC Circuit refused to second-guess the amount of an economic sanctions Deferred Prosecution Agreement (DPA) between the Dutch aerospace firm Fokker Technologies and the DoJ. There was a brief moment after the financial crisis when US District Judge Jed Rakoff threw out a derivatives fraud consent decree between Citigroup and the SEC for its paltry factual admissions. In reasoning that retains its potency, Judge Rakoff wrote that ‘the court, and the public, need some knowledge of what the underlying facts are: for otherwise, the court becomes a mere handmaiden to a settlement privately negotiated on the basis of unknown facts, while the public is deprived of ever knowing the truth in a matter of obvious public importance.’ But, while Judge Rakoff was hailed in the opinion pages, he got flipped by the Second Circuit on appeal.

No member of the public has an adequate basis to assess HSBC’s compliance with its deferred prosecution agreement, and the monitor has yet to make his final assessment. But, in principle, if a monitor finds a company to be out of compliance at the end of the deferral term, the proper response is to extend the monitorship, or (in extremis) to resume the prosecution. On paper, that’s the difference between deferred prosecution and non-prosecution.

‘Where DPAs are in place,’ says Worthy, ‘the point is to drive behaviour change. If that behaviour change isn’t happening and the DPAs aren’t being met, the idea is that prosecution is deferred – not that it simply goes away.’

The facts of HSBC Mexico showed the US’ promise to prosecute banks in egregious cases to be hollow. Having chosen the path of deferred prosecution, the US must make it work. HSBC has poured immense resources into compliance, and may well have turned things around. But, without a published monitor report, the public can’t judge.

Michael Goldhaber is the IBA’s US Correspondent. He can be contacted at michael.goldhaber@int-bar.org