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IPO ScamLessons for banks

Presentation byLALIT SRIVASTAVAGeneral ManagerReserve Bank of India

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Money LaunderingUnderstanding Process & Objectives

Money Laundering is called what it is because that perfectly describes what takes place – illegal, or dirty money is put through a cycle of transactions or washed, so that it comes out of the other end as legal, or clean, money. In other words, the source of illegally obtained funds is obscured through a succession of transfers and deals in order that those same funds can eventually be made to appear as legitimate income.

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Stages of Money Laundering

Money Laundering consists of a three stage process:

Placement

The first stage involves the Placement of proceeds derived from illegal activities – the movement of proceeds, frequently currency, from the scene of the crime to a place, or into a form, less suspicious and more convenient for the criminal.

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Stages of Money Laundering

Layering

The second stage is called Layering. It involves the separation of proceeds from illegal source through the use of complex transactions designed to obscure the audit trail and hide the proceeds. The criminals frequently use shell corporations, offshore banks or countries with loose regulation and secrecy laws for this purpose.

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Stages of Money Laundering

Integration The third stage is called Integration. It represents the

conversion of illegal proceeds into apparently legitimate business earnings through normal financial or commercial operations. Integration creates the illusion of a legitimate source for criminally derived funds and involves techniques as numerous and creative as those used by legitimate businesses. For example, false invoices for goods exported, domestic loan against a foreign deposit, purchasing of property and co-mingling of money in bank accounts.

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Salient features of IPO scam

Modus operandi Current account opened in the name of multiple

companies on the same date in the same branch of a bank

Sole person authorised to operate all these accounts who was also a Director in all the companies

Identity disguised by using different spelling for the same name in different companies

Multiple accounts opened in different banks by the same group of joint account holders

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Salient features of IPO scam

Huge funds transferred from companies accounts to the individual’s account which was invested in IPO’s

Loans/ overdrafts got sanctioned in multiple names to bypass limit imposed by RBI

Loans sanctioned to brokers violating guidelines Multiple DP accounts opened to facilitate

investment in IPO Large number of cheques for the same value

issued from a single account on the same day

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Salient features of IPO scam

Multiple large value credits received by way of transfer from other banks

Several accounts opened for funding the IPO on the request of brokers, some were in fictitious names

Refunds received got credited in brokers a/cs Margin money provided by brokers through single

cheque Nexus between merchant banker, brokers and

banks suspected

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Operational deficiencies

Factors that facilitated the scam Photographs not obtained Proper introductions not obtained Signatures not taken in the presence of bank

official Failure to independently verify the identity and

address of all joint account holders Directors identity/ address not verified Customer Due Diligence done by a subsidiary

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Operational Deficiencies

Objective of large number of jt. account holders opening account not ascertained

Purpose of relationship not clearly established Customer profiling based on risk classification not

done Poor monitoring and reporting system due to

inadequate appreciation of ML issues Absence of investigation about use and sources of

funds

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Operational Deficiencies

Unsatisfactory training of personnel No system of fixing accountability of bank

officials responsible for opening of accounts and complying with KYC procedures

Ineffective monitoring and control

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Measures to prevent scams

An analysis of IPO scam clearly brings out the laxity on the part of banks to scrupulously implement the KYC/AML guidelines issued from time to time. It also raises serious concerns about the integrity of the systems & systemic risks.

While scams may still happen despite best of preventive measures, it should not undermine the efforts being made to insulate the financial sector from money laundering. It is going to be a long fight with constant need to improve and innovate new strategies.

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Measures to prevent scams

It is important to understand that the risks banks run as a result of non-compliance with regulatory and statutory guidelines can cause severe reputational and financial damage to individual banks and the Indian banking system as a whole

Need for comprehensive operational framework implementing important aspects of KYC instructions e.g.

Documentation procedure for opening of all types of customer accounts;

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Measures to prevent scams

Clarity in understanding of risk classification of accounts and proper customer profiling

Ongoing monitoring of medium and high risk accounts

Enhanced due diligence in respect of accounts with beneficial ownership, non-face to face transactions, group companies, high risk businesses and wire transfers etc.

Prompt reporting of cash and suspicious transactions to Principal Officer by branches

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Measures to prevent scams

An effective audit machinery Good understanding of regulatory and statutory

prescriptions in letter and spirit Clear demarcation of duties and responsibilities Violations to be dealt with sternly

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Are penalties a deterrent

Impact of penalties

(a) Quantum of penalties not important in the initial stages

(b) Signal sent by Regulator is more important

(c) Discussion with top management precedes imposition of penalty

(d) Continued non-compliance may affect other approvals

(e) Banks international business dealings may get affected

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Role of DSA

Of late banks have been increasingly resorting to outsourcing of certain types of banking services. However, the PMLA, 2002 and guidelines on KYC norms clearly put the responsibility of verifying basic customer information at the time of establishing a business relationship on banks. The draft guidelines on outsourcing of services also stipulate that DSA’s cannot be used for complying with KYC procedures. Reporting of unusual and suspicious transactions to Principal Officer/MLRO

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Thank You