Less drug-money traffic at HSBC may mean more risk for other banks in U.S.

By Guest Contributor
December 13, 2012

By Brett Wolf, Compliance Complete

NEW YORK, Dec. 13 (Thomson Reuters Accelus) – HSBC was a hotspot for Mexican drug traffickers trying to launder the proceeds of their illicit U.S. sales during the 2000s, as suggested by a Senate report released in July and verified by a deferred prosecution agreement announced by the Justice Department on Tuesday. But now that the British banking giant has been forced to take steps to clean up its anti-money laundering act, Mexican cartels are making moves that may mean more risk for other banks, sources said.

Eager to move cash through the teller windows of HSBC’s Mexico unit in the largest amounts possible — sometimes as much as hundreds of thousands of dollars per day — drug traffickers designed specially shaped boxes, a document released by the Justice Department on Tuesday states. Once the cash was in HSBC accounts, brokers wired it to exporters in New York City and elsewhere in the United States as payment for goods destined for Colombian businesses, according to a”statement of facts” that was filed in federal court in Brooklyn along with a deferred prosecution agreement (DPA).

Those Colombian importers would have provided an equal sum of pesos to the Colombian drug traffickers, via so-called Black Market Peso Exchange (BMPE) brokers, completing the money laundering cycle, sources familiar with the process said. The Justice Department said the Sinaloa Cartel in Mexico and the Norte del Valle Cartel in Colombia took full advantage of HSBC’s failures to police its Mexico-linked transactions, pumping more than $881 million through the bank, the statement of facts said.

That money was a drop in the river of currency that flowed through HSBC’s Mexico unit to its U.S. unit, however. As part of HSBC’s U.S. dollar banknotes operation, currency provided by banks, money-changing businesses and other entities in Mexico was transported into the United States and deposited with the Federal Reserve. Between 2004 and 2007, HSBC’s Mexico unit funneled more than $3 billion per year to the bank’s U.S. unit as part of the banknotes business, court documents state. These numbers reportedly prompted Mexico’s Central Bank to express concern because the volume seemed unusually high.

Concerns continued

In February 2008, Mexican authorities told the chief executive of HSBC’s Mexico unit that law enforcement authorities in both Mexico and the United States were “seriously concerned” that the U.S. dollars being deposited at the bank might be drug trafficking proceeds, according to the statement of facts. It adds that the chief executive was also told that Mexican law enforcement authorities had a recording of a Mexican drug lord saying that HSBC Mexico was “the place to launder money”.

HSBC was undeterred, however, the statement of facts suggests. During 2008, the Mexico unit passed more cash than ever to the U.S. unit — more than $4.1 billion. Between July 2006 and July 2009, HSBC’s Mexico unit moved more than $9.4 billion to its U.S. counterpart. The timing suggests that HSBC may not have drawn down its banknotes operation until U.S. regulators and/or the Justice Department began taking a hard look at its anti-money laundering (AML) controls.

HSBC was vulnerable because it failed to take the steps necessary to know its customers, and because monitoring of banknotes transactions was conducted manually by one or two compliance officers, according to the statement of facts, which is the product of a years-long probe by U.S. law enforcement officials. Furthermore, the bank’s U.S. unit did not appropriately gauge the risks associated with its Mexican counterpart.

The DPA states that HSBC’s compliance lapses violated two Bank Secrecy Act provisions — subsections of Title 31, US Code, Section 5318 — which address inadequate anti-money laundering programs and the failure to conduct proper due diligence in correspondent banking relationships.

Mexico-U.S. dirty cash flow

The Mexican drug cartels traditionally preferred to smuggle their cash out of the United States rather than risk trying to make deposits at U.S. banks, which were thought to have sound AML programs. Furthermore, the enactment of the USA PATRIOT Act in 2001 threatened to tighten the U.S. money laundering net, providing the cartels with ample reason to stash their money elsewhere at the time.

The National Drug Intelligence Center (NDIC) in 2010 estimated that drug traffickers smuggled between $18 billion and $39 billion in drug proceeds across the U.S.-Mexico border each year. Once the tainted U.S. currency was south of the border, the cartels had to dispose of it, and their answer was to funnel much of it through Mexican money-changers and banks and into U.S. financial institutions. From there, some of the money was used to pay for goods destined for businesses in Colombia, which in turn yielded clean pesos for cocaine suppliers.

The U.S. Drug Enforcement Administration (DEA) began targeting Mexican money-changing businesses in the mid-2000s after learning that an unusually large number of U.S. dollar-denominated wires were flowing into Panama to pay down trade debt for Colombian importers, Donald Semesky, former chief of the DEA’s Office of Financial Investigations told a small room full of bank compliance officers at an anti-money laundering conference in Washington, DC last month.

These wires were originating from accounts that Mexican money changing businesses held at U.S. banks, said Semesky, who retired in 2008. The DEA then began tracing the money backward to determine its source and discovered links to drug trafficking.

In 2006, a key Mexican money changing business with purported links to drug traffickers — Casa de Cambio Ribadeo — was shuttered by authorities in Mexico and soon thereafter the U.S. Treasury Department warned banks of the money laundering risks associated with similar businesses. A year later another money changer — Casa de Cambio Puebla — was put out of business. In each instance, when the Mexican money changer was shut down, a U.S. bank that had handled its loads of cash for deposit was forced into a deferred prosecution agreement with the Justice Department for AML failures, Semesky said.

The Ribadeo case led to a 2007 DPA involving Union Bank of California, which agreed to pay more than $31 million, while Puebla led authorities to Wachovia Bank, which in 2010 entered into a DPA and agreed to pay $160 million. The government actions against UBOC and Wachovia did not dent the amount of U.S. currency that the money changers and the Mexican banks they sometimes used as middlemen were pumping into accounts at U.S. banks, however, Semesky said, quoting cash flow data maintained by the New York Fed. Semesky said it was not until HSBC shut down its U.S. banknotes business in Mexico that the flow of cash was stanched.

HSBC began exiting the business in November 2008 and completed the process in January 2009. The overall repatriation of U.S. currency from Mexico through the formal banking system fell from more than $12 billion a year in 2008 to less than $5 billion in 2011, Semesky said, displaying the figures on a line graph that fell precipitously down and to the right.

“What’s interesting to me is that the single biggest impact on dollar repatriation from Mexico was not enforcement actions [against UBOC and Wachovia], it was HSBC stopping their banknotes business,” Semesky told the compliance officers.

A true victory or just a shift in risk?

It remains unclear the extent to which a dramatic reduction in the repatriation of U.S. dollars from Mexico is a victory against the drug cartels, anti-money laundering experts with a knowledge of the traffickers’ dynamic money laundering strategies said.

One source, a former law enforcement official who spoke on condition of anonymity, said the Mexican cartels have been emboldened and are using nominees — many of whom are foreign nationals in the country for only a short time — to make large deposits directly into U.S. bank accounts. By doing so, the cartels are challenging the banks to detect the true nature of the transactions before the money is wired out and disappears via a quickly evolving Mexican equivalent to the Colombian BMPE.

While risky if attempted at banks with top-notch anti-money laundering controls, the new strategy is actually more efficient than transporting heaps of cash across the United States — movement that makes the money vulnerable to detection and seizure — to stash houses that can be costly to maintain just so that the money can eventually be smuggled into Mexico for a circuitous trip back to the U.S., the source said.

He said that with the help of U.S. banks that detect illicit behavior and close accounts, law enforcement authorities will manage to seize some of the money. But he added that the amount of money being deposited by Mexican cartel laundrymen is beginning to overshadow the sums traditionally deposited by the Colombians who have long peppered South Florida banks with drug money. In many cases, the Mexicans’ laundrymen often do not even bother to structure transactions in amount under $10,000 to prevent the filing of currency transactions reports (CTRs), he said.

“The Mexicans are killing us with quantity, not quality [of deposits],” the source said. “Some of them just come in and deposit the money wholesale in huge amounts and because they’re all nominees they don’t care if the bank files a CTR, they’re never going to come back in the country. The money is gone and they walk away from the account.”

As part of its deal with the Justice Department, HSBC vowed to take additional steps to address it AML weaknesses, forfeit nearly $1.3 billion, and retain a compliance monitor. It also agreed to pay $665 million in civil penalties.

(This article was produced by the Compliance Complete service of Thomson Reuters Accelus (http://accelus.thomsonreuters.com/). Compliance Complete (http://accelus.thomsonreuters.com/solutions/regulatory-intelligence/compliance-complete/) provides a single source for regulatory news, analysis, rules and developments, with global coverage of more than 230 regulators and exchanges. Follow Accelus compliance news on Twitter at: http://twitter.com/GRC_Accelus)

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