For more than a decade, the precious metals and gems sectors have been highlighted by law enforcement as being an increasingly alluring conduit for criminals to launder ill-gotten gains, even as industry groups have tried to stress the importance of complying with financial crime laws.
Industry lobbying organizations and international watchdog groups have also, in recent years, tried to give the sector more guidance on how jewellers can more effectively implement anti-money laundering (AML) programs and uncover and report suspect transactions, but getting that message out has been made more challenging as companies have become more fractious and far flung.
Cecilia Gardner, the current President and Chief Executive of the New York-based Jewellers Vigilance Committee, recognizes that the Paris-based Financial Action Task Force (FATF), which issues global AML recommendations, and other watchdog groups have identified money laundering and conflict minerals as the main risks affecting the industry.
“I think our companies are actively engaged in implementing AML programs and monitoring their transactions,” she said. “The dealers in precious metals and jewels are implementing those controls. Other risks are how the products are brought to market. There are risks in other countries in the production and trade of those materials which has to do with conditions at the mines and trading practices amongst the dealers in these countries where the product is found.”
But those attempts at bolstering compliance are met with equally creative and resilient criminals who want to funnel their illicit funds into precious metals because the assets are redeemable all over the world and rising in price, Gardner said. Criminals close to the source of the commodity will want to exploit the opportunity to smuggle the gold into neighbouring countries, evade reporting requirements, launder money and use it as a currency, she said.
Apart from more recent guidance, problems in the gold and metals area was brought to the fore as far back as 2003, when The New York Times focused on a case that clearly spelled out the intersection of the illegal drug trade and the gold industry.
Jewellery dealers in Manhattan’s diamond district were found to be an important step in a Colombian cartel’s international money laundering scheme.
In the scheme, illicit funds from drug sales were used to purchase gold from complicit jewellery dealers in Manhattan’s diamond district. The newly acquired commodity was then shipped to Colombia, sold to refineries for seemingly legitimate cash and then used to buy more drugs, which then ended up sold in New York, coming full circle.
The former United States Attorney in Manhattan, James B. Comey, said that the gold cycle in that case was essential “for drug lords to be able to survive.” Not once did the drug dealers or jewellery dealers who were complicit in the scheme have to touch the banking system, he said
Today, the same vulnerabilities in the precious metals industry are being exploited, especially AML and counter-terrorist financing controls in financial institutions, which are forcing criminals to discover other conduits, currencies and coffers for their ill-gotten gains.
The international precious metals trade also fosters opportunities for cross-border trade-based money laundering. The precious metals industry, with its own complex regulatory system, is based on trust, historical ties and business contacts and an economic monopoly on a unique product. As intricate as this sector is, it has not been immune to the motivations of financial criminals.
Beautiful but dangerous?
Precious metals and stones have been forged into jewellery, artefacts and currency since the dawn of civilization. The modern trade of precious metals and stones has developed for centuries, but certain industry changes of late have caught the attention of those looking to eradicate financial crime. Analysts and law enforcement agencies have honed in on the illegal mining industry, the smuggling of gold and silver over borders and the use of the products as a laundering mechanism.
Last year, the FATF highlighted patterns of illicit activity involving the gemstones in a 146-page report. The report noted that the monopolized industry has opened up to a number of smaller dealers, creating diverse distribution channels, in some cases with little oversight of where the gems have come from, their value or compliance steps taken by those in the supply chain.
Prior to that, in 2008, the FATF published guidance for the broader sector at large, highlighting the risks facing dealers in precious metals and stones, producers, buyers and brokers, stone cutters, polishers, refiners, manufacturers and retailers – from coal to ring.
The FATF warns that characteristics of the diamond trade – confidentiality in transactions, verbal agreements, the transportability of the product, very high value and low weight, ability to go undetected at travel screenings and ability to retain value over long periods of time – make it vulnerable to abuse by criminals.
In both industries, the practice of purchasing in cash is dwindling. Increasingly, diamond and gold dealers are receiving wire transfers or credit as opposed to cash, making it much harder to launder money – at least without having to go through a financial institution.
Still, the risks of money laundering and terrorist financing exist through the nature of the product itself, which can be used as currency to pay for illicit transactions. The advent of Internet-based precious metals trading has also increased vulnerability to bad actors. Online payment platforms like eBay facilitate large-scale purchases of product and raise challenges for Know Your Customer and Customer Due Diligence practices on businesses and private customers.
Furthermore, the industry is still reliant on voluntary compliance. Although various organizations, from the FATF forum on diamonds, to the Responsible Jewellery Council, to the private sector, have issued guidance on money laundering and terrorist financing vulnerabilities, the guidance cannot be imposed as law, and as the FATF 2013 report points out, there are still several countries that have a significant diamond trade that are not yet subject to AML/CFT legislation.
The recommended AML program in the FATF guidance includes a risk-based due diligence strategy, a timely and effective suspicious activity reporting system, monitoring and the supervision and education of employees.
In addition, in 2005, the Organisation for Co-operation and Development (OECD) published an analysis by Douglas Farah, a national security consultant and journalist with expertise in the precious metals money laundering circuit. The characteristics of the product, he said in the report, make it extremely vulnerable to financial crime.
“Gemstones are ideal for several reasons: they hold their value; they are easy to transport; they do not set off metal detectors in airports; and they can be easily converted to cash when necessary.”
Two highly valuable and popular commodities in particular set off alarms at the OECD and FATF – the gold and diamond trade.
The FATF was alerted by reports of certain gold transactions that not just attempted to launder funds, but make illicit gains through tax evasion. Gold purchasers would attempt to dodge the value-added tax on the mineral by making bulk purchases in countries with low consumption taxes and then exporting the product. FATF members also identified the use of gold in the Gulf States’ hawala system to launder money without even transporting the product.
Hawala is a historical way to transfer money used widely in the Middle East without moving the money, typically using multiple agents, called hawaladars, and is heavily based on trust. This can be done with rarely ever touching the formal banking system, except to settle accounts between agents.
Until the 1980s, the cartel of companies owned by De Beers dominated the supply, production, sorting and sale of diamonds in the world. Now, trade centres in Asia and the Middle East are seeing business boom, with transactions flowing in and out of newly-founded business and trading operations and their ancillary financial institutions.
The largest rough diamond sorting and sale site has also moved from London, United Kingdom, to Gaborone, Botswana, taking over the role played by Belgium and Israel as a major transit trading center.The polishing and refining of diamonds is also transitioning to southern Africa, creating business in developing markets that face particularly high risks for corruption and money laundering.
Regulation of the precious metals, stones and jewellery industry
Since 2003, the Kimberly Process Certification Scheme has attempted to hamper money laundering by preventing illicit conflict diamonds from entering the marketplace. The United Nations created the process “to ensure that diamond purchases were not financing violence by rebel movements and their allies seeking to undermine legitimate governments.”
The system, adopted by 81 countries, requires each shipment of rough diamonds to be compliant and to be subject to revision by the World Trade Organization.
In the U.S., the precious metals industry has been highly regulated and enforced under the Internal Revenue Service. The Patriot Act increased reporting obligations to U.S. dealers, aligning requirements with those needed from financial institutions to prevent structured transactions meant to launder illicit proceeds through the creation of the four-pronged AML compliance program.
Before the USA Patriot Act, the only Bank Secrecy Act regulation that applied to a precious metal dealer was the obligation to report cash transactions of more than $10,000, either as a single amount or in two or more related transactions, called aggregation. FinCEN advocated for more extensive dealer obligations that would cover AML risks in the industry, and the U.S.A. Patriot Act was amended.
However, the Patriot Act wasn’t the first legislation passed to control the precious metals industry. In the turn of the century, the U.S. Congress passed the National Gold and Silver Marking Act in 1906 to protect customers from fraudulent pricing. A committee was formed to uphold the law, forming what would later on be called the Jewellers Vigilance Committee (JVC). During the first half of the century, the JVC focused its efforts on battling the practice of international diamond smuggling and unfair methods of competition.
Today, the JVC helps industry members understand the U.S. laws that affect their businesses, applicable to the manufacture, sale and advertisement of jewellery. Some of the members are international because of globalizing business practices that require them to know U.S. regulations.
Industry complexity can be a boon or bane to launderers and terrorist financiers
Gardner says that it is doubtful that the industry is being exploited on a wide scale as a main mechanism for money laundering. Gardner, who previously prosecuted money laundering cases in federal court, said that most law enforcement agencies identify banking and other financial conduits as larger risks.
“Converting illicit proceeds into our product and then trading them and getting value out of them is complicated and not the most easily accessible mechanism,” Gardner said. She said it requires expertise to know how to assess the value of the product and to know the right place to convert it to cash.
More difficult, surprisingly, is finding someone who is willing to skirt the controls placed on any jewellery dealer, Gardner explained.
In the U.S., jewellery businesses are required to ask for government-issued identification documents with full information on the buyer of the precious metal. If the gold seller receives a cash payment in excess of $10,000, they are required to file an 8300 form to report the payment to the IRS. Much like a suspicious activity report, an 8300 form is the main detection tool used by law enforcement tracking down illicit cash-to-gold transactions, as part of the industry’s AML programs. The IRS AML division was assigned as the examination agency for the precious metals, stones and jewellery industry.
“If they could find someone who would convert the cash into gold, then they would have to find someone who would take the gold for value and smuggle it out of the United States,” she said. “And Customs [U.S. Customs and Border Protection] robustly monitors shipments in and out of the United States.”
Gardner’s organization is dedicated to compliance, mostly to AML programs that have been implemented in order to mitigate those risks in the U.S. The source of the product is also a risk that dealers must confront in an ethical way.
“The level of compliance is the biggest challenge in terms of making sure that everyone that is supposed to comply does.”
Scott Carter, the CEO of Lear Capital, Inc., one of the largest gold and silver retailers in the US, stated that the heightened concern may be due to a lack of knowledge about how the industry works.
“There’s probably a bit of ignorance about our industry, quite frankly,” Carter said. His company provides physical metals to affluent investors that want to diversify their portfolio
“This [the industry] used to be small coin operators on the corner that would take cash. They still exist but not as much as the investors who buy large volume precious metals, where there are contracts signed, where the money is kept track of,” Carter explained. “Now, it’s a classical financial transaction.”
Even as a private sector professional affected by these risks, Carter said the modern domestic precious metals industry is not as exposed as it may seem.
“In my view there’s very little potential for money laundering,” he said “In our business, the purchase of physical metal is done 70 percent through wire transfers that come from an account or personal checks from individuals.”
Carter said that it would be difficult to use large quantities of product to launder money because most wholesalers of precious metals are government mints shipping directly to a specific client and have very little contact with the actual financial transaction.
Gold-based securities transactions, however, which can involve high-volume electronic funds, can be vulnerable to being furtively manipulated, he said.
“The lynchpin comes down to [ensuring that] individuals responsible for complying with AML are actually doing it,” he said. “If there are smaller entities and an individual walks in with 15 grand and wants to buy diamonds and this individual doesn’t record it, then it’s a risk,” Carter said.
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