Working Paper. Effects of Cell phones on Anti-Money Laundering/Combating Financial Terrorism (AML/CFT) Wire Remittance Operations 1

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1 Working Paper ASIAN DEVELOPMENT BANK March 2007 Effects of Cell phones on Anti-Money Laundering/Combating Financial Terrorism (AML/CFT) Wire Remittance Operations 1 John Forbes, AML Specialist 2 Asian Development Bank Staff of the Asian Development Bank (ADB) and the United States Department of Treasury s Office of Technical Assistance have assisted in preparing this paper. The views expressed in this paper are solely those of the author and do not necessarily reflect the views and policies of ADB or its Board of Governors or the governments they represent. ADB does not guarantee the accuracy of the data included in this publication and accepts no responsibility for any consequence of their use. Use of the term country does not imply any judgment by the author or ADB as to the legal or other status of any territorial entity. This report is dedicated to the staff of the Anti-Money Laundering Council (AMLC) of the Philippines, AML/CFT related government agencies, and the private sector partners who are working hard to design a well regulated market place that includes AML/CFT and fraud safeguards. Special thanks to Globe and SMART Telecom, the Philippine regulatory community and the AMLC, all of whom were generous with their time and advice. We hope this paper stimulates our counterparts worldwide to examine the issues arising from these new integrated financial and telecommunications (wireless) systems as they relate to AML/CFT operations and the security of financial systems. 1 This paper is an excerpt from a larger work to be published by John Forbes with the assistance of Valeria J. McNevin, International Legal Advisor. This working paper may be published without permission from the author and Asian Development Bank. 2 John F. Forbes is seconded from the U.S. Department of Treasury Office of Technical Assistance to the ADB as part of a Asia Pacific Economic Cooperation (APEC) security trust fund, cooperation Fund for Regional Trade and Financial Security Initiative (FRTFSI), administered by the ADB. details at can be found at: Appendix 1 1

2 TABLE OF CONTENTS INTRODUCTION 4 I. A SHORT HISTORY OF CURRENCY AND MONEY LAUNDERING CONTROLS IN THE UNITED STATES 5 II. MONEY LAUNDERING IN THE UNITED STATES VIA CASH-BASED REMITTANCES 8 A. Money Laundering by Bulk Cash Movement 9 B. Money Laundering through a Money Broker: The Black Market Peso Exchange Method 9 C. How Money Launderers Game the Wire Transfer Remittance System 11 D. How Law Enforcement Agencies in New York Addressed Money Laundering Through the Wire Remittance System 12 E. Factors that contributed to success 14 F. Strategies that worked 15 III. VALUE TRANSFER INNOVATIONS DIGITAL MONEY 16 A. The Electronic Wallet ( ) 17 B. Problems Posed by the Open System and Digital Value Transfers in General 18 IV. THE CONVERGENCE OF FINANCIAL SERVICES AND TELECOMMUNICATIONS: CASE STUDY OF CELLULAR PHONE VALUE TRANSFER SERVICES IN THE PHILIPPINES 19 A. The wireless situation in the Philippines, November B. Who Benefits? 22 C. A Well-Designed Regulatory System 22 D. Vulnerabilities in the System and Possible Responses 27 V. ANALYSIS 33 A. What does the convergence of telecommunications and financial services mean for law enforcement? 33 B. Anti-money laundering law enforcement operations will need to be more visionary 36 C. Other Things to Think About 37 D. Increasing integration of telecommunications sector and cross-border digital value transactions require sharing lessons learned 37 E. International cooperation: the need to assist and be assisted 37 VI. SPECIFIC RECOMMENDATIONS FOR THE PHILIPPINES 38 A. Public Private Partnership 39 B. Law enforcement 42 C. Legal / Regulatory 42 D. How do we work together regionally 44 Appendix 1 2

3 VII. SUMMARY & CONCLUSION 44 BIBLIOGRAPHY 45 APPENDIXES 1. Brief History of Value and Money Transfer 2. Money Laundering Typologies 3. The Value of Cell Phone Based Remittance Systems 4. Model Initiatives to Protect Telecommunication and Financial Infrastructure 5. 3G Phones and the Threat to the Telecommunications and Financial Infrastructure 6. Evidence and Cybercrimes 7. Offshore Cybercenters and Criminal Jurisdiction 8. Other Mobile Phone Initiatives Appendix 1 3

4 INTRODUCTION 1. Now that wholesale payments have been caught in the full tide of the electronic revolution, traditional commercial banks will face stronger competition from non-banks and from dis-intermediation as lenders and borrowers can deal more easily and directly with each other without needing a financial intermediary. Central Banker s tasks in attempting to define, measure, monitor, control and supervise their own countries changing forms of money and monetary instruments, will become much more complex as the old boundaries between national and regional monetary domains will be broken down by new forms of competitive currencies Fast-moving technology and new business models are bringing about the convergence of telecommunications and financial services. This convergence demands the modification of the cash-based premise of current Anti-Money Laundering (AML) efforts. 3. The goal in compiling this paper is two-fold: (i) provide a common knowledge base about money, money laundering methods and techniques for policy makers, the private sector, regulators and the law enforcement community, and (ii) spur dialogue between these actors so they are better prepared to deal with the regulatory and AML/CFT enforcement issues raised by an increasingly digital financial world. The intention of the larger work is not to create a comprehensive paper, things are moving too fast for that, but a seminal one that will highlight basic issues with wireless value transfer that were raised in the 1990 s that appear once again today. The intention of this shorter version is to focus on the law enforcement issues raise by digital value transferred via mediums such as cellphones. 4. Since the original draft of this paper was provided the AMLC Secretariat in July 2006, the Philippines has taken action to protect its critical telecommunications infrastructure by increasing its funding to law enforcement, has taken strides to address the stolen and secondary market for cellular phones and issued circulars on addressing risk to include those associated by wireless value transfer. This paper hopefully will serve to help others, as well as the Philippines, which has given great thought to the issue of a future with money from thin air. 5. The paper presents the United States (US) current AML regime and cases of successful enforcement to highlight the factors that contribute to the detection, apprehension and conviction of money launderers operating in a cash-based regime. It shows that small value transfers in the form of remittances support large criminal empires such as Colombia s notorious Norte Valle cartel, and effective law enforcement and regulatory action can bring these organizations down. 6. The paper then describes the changes demanded by cellular phone value transfer services. In the Philippines, cellular phone value transfer services are viewed as particularly important. They facilitate remittance flows from Philippine overseas migrant workers, reduce costs to the poor, and are convenient to use. As a leader in developing technology to facilitate cellphone value transfer and in developing regulations that respond to the novel challenges arising from such technology, this paper brings the Philippine experience to bring to light. Presenting both the benefits and challenges that mobile phones value transfers pose to law enforcement and the often nascent AML legal framework recently enacted in many countries around the world it identifies and discusses important public policy concerns and proffers realistic goals for countries to strive to reach in the near-term. How the Philippines regulates cellular phone value transfer services will be analyzed to bring to light both best practices and vulnerabilities in similar value transfer systems that may be developed in the future. Appendix 1 4

5 7. Finally, the paper concludes with a special section on the Philippines admirable antimoney laundering efforts, and a summary of policy and law enforcement issues that it needs to address in order to be able to build on these efforts and effectively combat money laundering in the digital age. The recommendations to the Philippines Anti-Money Laundering Council that are found in this section may well be applicable to other countries that seek to improve their anti-money laundering framework. I. A SHORT HISTORY OF CURRENCY AND MONEY LAUNDERING CONTROLS IN THE UNITED STATES 8. Money laundering has been described as the process by which one conceals the existence, illegal source, or illegal application of income, and disguises that income to make it appear legitimate. 2 The money laundering process often takes place in three stages: (1) placement; (2) layering; and (3) integration. Placement is the unnoticed introduction of funds into the financial system; it is the stage most vulnerable to detection. Layering is the process of distancing funds from illegal sources by conducting a series of financial transactions that resemble legitimate transactions. Integration is the introduction of funds into the economy with a legal paper trail. 9. Although it was the Money Laundering Control Act of 1986 that brought the term money laundering into the vernacular, the earliest precursors of money laundering controls in the US emerged in the 1970s to address public concerns about corruption, drugs, and drug-related crime. Cash proceeds of crime were ruining neighborhoods and driving the cost of real estate beyond the reach of the average citizen. People could see and understand cash, and they wanted it tracked and seized if it was crime-related. 3 The focus then was on addressing the first stage of the money laundering process the placement stage. 10. The year 1970 was a watershed year for financial regulation and crime control. The Bank Secrecy Act (BSA), otherwise known as Currency and Foreign Transactions Reporting Act, 4 was passed in the US that year to provide a reporting scheme for cash transactions in excess of $5,000. (This was changed later on to and remains at $10,000 today) entering the financial system and crossing the borders of the US. The law provided regulators and law enforcement agencies to develop an audit trail to follow criminal cash. The BSA s reporting requirements were not immediately successful, primarily because there was a steep learning curve on the part of financial institutions and law enforcement. Not until the late 1970 s, following several celebrated prosecutions and supportive judicial findings especially a positive ruling on the constitutionality of the BSA in 1974 that the reporting requirements began to have an effect. As a result, account opening procedures were enhanced, and reporting systems to regulators were improved. 11. Passing the Racketeer-Influenced and Corrupt Organizations Act of 1970 (RICO), 5 the centerpiece of the Organized Crime Control Act, Congress laid the cornerstone by which law enforcement would initiate the war against organized crime. Sixteen years later, it would serve as a model for anti-money laundering legislation. Demonstrating its commitment for the new war, Congress authorized stiff fines of $25,000, penalties, and asset forfeitures, backing these monetary repercussions with up to 20 years in prison, and a life sentence for activities involving murder. These provisions made racketeering one of the highest risk activities in the U.S., since at that time, the normal sentencing range for crimes under Federal statutes was 5 years imprisonment and a $10,000 fine. Equally aggressive were the civil remedies; including treble damages and attorney s fees. Not only did Congress make organized crime activities riskier through RICO, it also made them harder. By providing sweeping new powers to law enforcement such as the ability to freeze a defendant s assets at the time of indictment and confiscate them after conviction, along with the ability to tie predicate Appendix 1 5

6 crimes over a ten year period to a criminal organization without the need to prove the mental state of the perpetrator(s), Congress provided law enforcement with much needed weapons to fight the war on organized crime. 12. A body of law and regulatory practice developed soon after to address the second and third stages of money laundering layering and integration. Civil and criminal sanctions for structuring funds below the $10,000 threshold and for failing to file appropriate currency reporting forms were among the measures introduced. Currency task forces formed by U.S. Customs, the Internal Revenue Service, the Department of Justice and other agencies in the mid-1970s played a significant role in the formulation and enforcement of these laws and regulations. During this time, currency task forces relied heavily on currency reporting tools to pursue financial crimes such as foreign bribery, political corruption and currency drug profits. Soon, realizing these were not enough, task forces such as U.S. Treasury s Operation Green Back 6 in South Florida disclosed the need for additional tools to address illegal money movements. In response, the U.S. Congress made violations of the BSA predicate offenses under the RICO. RICO authorized stiff fines, penalties, forfeitures; up to 20 years in prison, a life sentence for activities involving murder; and civil remedies that could include treble damages and counsel s fees. However, it soon became clear that even these efforts did not go far enough. Sixteen years after the initial attempt to control criminally obtained proceeds under RICO and through cash and negotiable instruments reporting under the BSA, congress responded again with a plan to bring all the lessons learned together. 13. The Money Laundering Control Act of 1986 was part of a larger Omnibus Drug Enforcement, Education, and Control Act of containing 31 separate bills. The MCLA of 1986 established even higher civil and criminal penalties, fines and allowed forfeitures up to $500,000 (or twice the value of the property involved), plus 20-year prison sentences. Structuring of transactions below the BSA reporting requirements was added as an offense to counter the practice of smurfing. Smurfing refers to the dividing of large amounts of money in multiple transactions in a way that ensures each transaction comes in below the reporting threshold, at that time $10,000. Converting small denomination bills to larger denominations now was considered a transaction under the law, as money launderers often converted smaller denomination bills to larger ones for easier transport. The law went even further punishing attempts to enter into transactions and movements of funds that facilitated shifting, concealing, or hiding of criminal proceeds, and avoiding federal or state reporting requirements. The law permitted federal agencies to conduct certified undercover operations focused on money laundering with government-provided on-hand cash and operational flexibility. Operations were now able to obtain exceptions from the Federal Accounting Regulations (FAR) and open accounts in undercover names, establish financial identity for undercover firms and permit funds to be laundered. These opportunities did not come without strict operational and financial oversight. Undercover operations units were established in all federal law enforcement agencies. All operations were closely coordinated with the Department of Justice at the local and national level. 14. Commitment to the war on organized crime grew clearer with passage of the Anti-Drug Abuse Act of along with reinstitution of the death penalty. The Act contributed four significant weapons to law enforcement s arsenal against organized crime. First, it made the death penalty applicable to anyone who commits or causes to commit a drug-related intentional killing, not just Drug Kingpins. 9 Second, it created the Office of Drug Control Policy (ONDCP) to coordinate government drug programs including the High Intensity Drug Trafficking Area initiative. Third, it mandated strict identification and record keeping for cash purchases of certain monetary instruments purchased in excess of $3,000. Lastly, it provided the Secretary of the Treasury with the ability to require additional BSA reporting for amounts less than $10,000 for certain geographical areas within the US where significant abuses are documented. 10 Known as the Geographic Targeting Order 11 capability, Appendix 1 6

7 this power would prove invaluable within a short time of its passage in the New York metropolitan area. 15. At the G7 Summit in Paris in 1989, the Financial Action Task Force (FATF) was established to address the threat that money laundering posed to the banking system and financial institutions. The G7 Heads-of-State or Government, along with the President of the European Commission, convened the Task Force from the seven-member States, the European Commission, and eight other countries. A year later, in 1990, FATF published its first set of Forty Recommendations, providing a comprehensive plan of action needed to fight against money laundering. 12 Among the significant recommendations of the FATF was the Know Your Customer (KYC) 13 requirement. Briefly, the KYC best practices focus on identifying the beneficial owners of financial accounts or parties to other financial transactions. These procedures ensure against fraud and other financial abuses as well as money laundering and terror financing. Each country addresses these requirements differently but the FATF has been the international standard-setter in this area. 16. The year 1990 also saw the creation of the Financial Crimes Enforcement Network (FinCEN) in the US. Initially, FinCEN was established with U.S. Customs financial analysts and investigators and included access to information about suspects stored on the Treasury Enforcement Communications System (TECS) and the IRS. Shortly after it became operational, a wide variety of other federal enforcement and regulatory agencies joined. Today FinCEN serves as the Financial Intelligence Unit (FIU) 14 of the US and is an important part of the US Anti-Money Laundering regulatory network. 17. Following the financial scandals and high profile investigations of the late 80 s and 90 s like C- Chase, 15 Bank of Credit and Commerce International (BCCI), 16 and the Kerry 17 and Nunn 18 Committee s congressional investigations on money laundering, regulators and investigators began focusing on wire transfers, resulting in even more legislation to address those issues. 18. Passage of the Annunzio-Wylie Anti-Money Laundering Act of 1992 strengthened sanctions for BSA violations by requiring financial institutions to report suspicious transactions, wire transfers, and to retain specific information on certain wire transfer fields for examination. Adding a conspiracy provision making the penalties for an attempt to launder the same as a substantive offense the Act also required banking agencies to formally consider revoking the charter of any depository institution convicted of money laundering. Further, it outlawed the operation of illegal money transmitting businesses. The legislation also created a BSA Advisory Group to suggest methods of increasing the effectiveness and efficiency of the Treasury s anti-money laundering programs The unlicensed remitter legislation, codified as 18 USC 1960, was of tremendous assistance to drug and terror financing investigations. It provided a means for law enforcement and regulators to pursue hawala and other money services firms. However, the federal government did not license or register money services businesses at the time. Consequently, the law assisted enforcement only in those states where licensing was required. However, 23 states did not have a licensing requirement and the federal law had no power in those states. It was not until the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism (USA PATRIOT ACT) Act of was passed with its implementing regulations that registration was required at the federal level and the use of 18 USC 1960 became nationally effective.] In 1995, the war on organized crime escalated to a point where international economic weapons needed to be called on. In response, Targeted Financial Sanctions 22 were added to the administration s tools against international money laundering, drug trafficking and terror organizations. On 21 October 1995, President Clinton signed Executive Order (EO) 12978, under the authority of Appendix 1 7

8 the International Emergency Economic Powers Act (IEEPA), 23 otherwise known as PDD-42. It finds that the activities of significant foreign narcotics traffickers centered in Colombia coupled with the unparalleled violence, corruption, and harm that they cause constitute an unusual and extraordinary threat to the US' national security and economy. In addition, it bars US individuals and companies from engaging in financial transactions or trade with those identified individuals or enterprises linked to the Colombian Cali Cartel. The next day, the President addressed the United Nations General Assembly on its 50 th anniversary and called for international cooperation to address the threat posed by international money laundering, drug trafficking and terrorism noting it had moved from beyond the ability of any single nation to control alone. Ordering federal agencies to step up and integrate efforts to combat international crime syndicates and money laundering, this EO became the cornerstone for efforts to combat transnational crime. 21. As a follow up, the White House sent The International Crime Control Act of 1996 (ICCA) was presented to the U.S. Congress on 27 September The Act was designed to enhance the ability of the U.S. to pursue violent international criminals by vigorously investigating and prosecuting them, freezing their assets, confiscating their money, and depriving them of their ability to cross America's borders and strike at its domestic institutions. 24 It finally passed in 1998 with few changes. 22. In 1996, U.S. Treasury made the implementing rules and regulations for reporting suspicious activities under the Annunzio-Wylie Act effective. The Suspicious Activity Report (SAR) was circulated to financial institutions. With little delay the SAR would become the primary means of addressing the second and third stages of the money laundering process, layering and integration. It also brought wire transfer activity into the anti-money laundering (AML) regime. This was a significant step in detecting the more difficult parts of the money laundering chain. The SAR proved to be a great benefit to regulators and law enforcers. With it The Terrorism Prevention Act of 1996 added terrorist crimes to the list of specified unlawful acts for money laundering violations The PATRIOT Act of 2001, considered by some to be the most important AML legislation since the BSA, criminalized the financing of terror organizations, strengthened customer identification requirements for banks and financial institutions and improved information sharing between banks, government, prohibited certain activities with foreign shell banks and enhanced due diligence requirements regarding foreign correspondents and private bank accounts It gave the U.S. Secretary of the Treasury new powers to examine institutions and suspend accounts and provided the Secretary the ability to make a determination of a primary money laundering concern ; placed special reporting requirements on financial institutions; and provided substantial penalties for noncompliance. 25. The legacy of money laundering controls in the US was a continuing response to the public s concerns about crime and corruption. The financial services industries accommodated these concerns through enlightened self-interest and a balance of executive and legislative action. This effort is marked by three major trends drug trafficking, organized crime to include drug trafficking, and terrorism. One clear message rings out through these efforts; take the profit out of crime and cut off funding for terror. II. MONEY LAUNDERING IN THE UNITED STATES VIA CASH-BASED REMITTANCES 26. Law enforcers engaged in the detecting and apprehending money launderers are often engaged in drug and terrorism-related investigations. Terror financing and drug models have several Appendix 1 8

9 things in common. The most interesting is that both need to deal with small amounts of cash, often less than $200, which correspond to drug payments or contributions by individuals to the terrorist cause. The money is consolidated by collectors and moved to safer locations, called stash houses or consolidation points. From there, the money moves to a safer location directed by drug cartels, money brokers, or financial support cells of terror organizations. In some cases, both groups use the same methods and often the same support organizations to move their funds Dealing with cash or cash equivalents presents a high risk to criminal organizations. Keeping criminal cash proceeds invites competitors and law enforcers to target the collection and consolidation points. Ultimately, the quick movement of cash becomes necessary. A. Money Laundering by Bulk Cash Movement 28. The most basic money-laundering scheme is the use of bulk cash movements, where cash is flown or moved via cargo or mail out of the collection country, and moved into an off-the-shelf company in a haven country. The off-the-shelf company is only a shell, with merely a bank account opened under a corporate name. Money is then borrowed from the shell corporation in the haven country and wired to a subsidiary company of the drug organization, where it is used to open a front business that is cash-based. A retail store, convenience store, or restaurants are good examples. That gives the drug organization the ability to cover the illegal funds being supplied by the offshore account. The money is reported to tax authorities as revenue, while the resulting net funds are successfully cleaned Smuggling cash out of the country is not without its inherent dangers. Moving cash in bulk is likely to attract attention from competitors and law enforcers. 29 Interdiction efforts by law enforcement agencies and predatory operations by competing drug gangs made such trips particularly risky. B. Money Laundering through a Money Broker: The Black Market Peso Exchange Method 30. The Black Market Peso Exchange Method (BMPE) is a money laundering method that authorities find more difficult to detect because it facilitates movement of cash through wire remittances of small amounts, rather than through bulk cash movement. The usual steps involved in BMPE are illustrated in the following situation: 31. Mr. A is a Colombian drug lord operating out of New York. He makes a million dollars from cocaine sales. The money sits in New York in need of laundering. Mr. B is a legitimate Colombian businessperson who wants to buy a million dollars worth of American computers from XYZ computers in Florida. However, Mr. B s government wants him to pay fees of 21- cents on every American dollar he buys with pesos. As a solution, the two contact a money broker who takes care of their needs for a fee. 32. The broker: (1) arranges for a million dollars in drug cash to be transferred in small amounts (smurfed) into various accounts, picked up and integrated through cash based businesses, placed through remittances, or hauled overland and directed to an account in a Mexican bank; (2) writes a check for $1 million, drawn on a New York correspondent of the Mexican bank, and gives it to XYZ computers; (3) instructs XYZ computers to ship the machines to Mr. B from its Panamanian free-trade zone warehouse; (4) receives a million dollars worth of pesos from Mr. B; and (5) turns over the pesos to Mr. A. Appendix 1 9

10 33. A particularly pernicious effect of the BMPE method of money laundering is that it results in huge losses in government revenue. As an example, it has been reported that the Colombian government lost some $6-8 billion annually because of money laundering The Indispensable Money Broker 34. Money brokers are important actors in BMPE money laundering. In the drug trade, they serve as intermediaries between the drugs, the cash, and the domestic importers. There is great demand for their services and they operate openly where importers shop for U.S. dollars. There is significant incentive because buyers can save as much as 21% on each foreign exchange transaction simply by accessing their services. In addition to the fact that no taxes and tariffs are paid on each transaction, a surplus of cash from the drug trade reduces the exchange rate on the black market Smurfs, the Money Launderer s Army 35. Smurfs are workers in the money launderer s army. They spread small denomination drug payments or contributions to terrorist causes between various remittance centers or multiple bank accounts. With these small amounts of cash, they purchase money orders and traveler s checks upon the direction of money brokers. Smurfing breaks down criminal proceeds into small amounts that can be moved with less risk of attracting the authorities attention. Although more sophisticated detection systems, increased government oversight and heavier penalties, have slowed down smurfing through remittance and banking in recent years, smurfing remains a basic procedure in moving cash and cash equivalents. 3. The Cash-Based Remittance Industry 36. A wire transfer is the most sought after financial instrument for criminals. It allows them to transfer funds at low risk and with speed of movement. They are given the ability to shift value throughout the world using shell accounts and secret banking to avoid law enforcement scrutiny. A wire transfer is the highest valued instrument and criminals constantly look for ways to infiltrate or establish wire remittance outlets to convert cash into the prized wire transfer payment orders. 37. A cash-based wire transfer remittance industry is organized into persons that hold franchises or licenses to operate a wire transfer business ( franchisees or license holders ) and storefront outlets, which serve as cash remittance centers. This is only one model, there are four models 38. Storefronts: i) prepare the remittance payment order from information provided by the sender, ii) inform the sender of the remittance fees and foreign exchange iii) screen for identification as required by law, in the US identification is required to be presented and copied for all transitions more than $3,000, iv) required to report suspicious transactions, and v) complete currency/covered transactions reports. The storefronts have banking relationships in the name of the franchisor or themselves and deposit the cash in these accounts or have an armored car service pick the cash up for safe transport. Besides financial services, they also serve as a meeting place for people in the immigrant communities who use their services. 39. At the storefront, there is a bifurcation of cash into the wire transfer payment order 32 and the value of the cash being transferred. The storefront sends a copy of the payment order to the wire transfer franchisee or licensee for which it works, and the latter then sends the payment Appendix 1 10

11 order to a paying agent in the country where the value is remitted. The paying agent is thus informed of the person entitled to the cash value transferred and ensures that the value is credited to the correct account in that person s name. 40. Meanwhile, the cash collected at the storefront is pooled with other cash at the franchisee s or licensee s remittance bank accounts. Remittance accounts are linked to a correspondent bank, with branches or affiliates in the jurisdiction where the recipient s are located. The paying agent in the foreign country pays the recipient in local currency with cash equivalent to the value indicated in the payment order and is reimbursed through a settlement process usually through the correspondent banks in the sending country. 41. The system s effectiveness is premised on two key concepts: (1) cash value (as opposed to cash) can be transferred, and (2) cash is fungible. Since cash is fungible, one can send a payment order that basically orders a third party to ensure that cash equivalent to the value to which he or she is entitled is deposited into an account or paid directly to a person in a different jurisdiction, even as what is deposited is not necessarily the same bills or notes that had initially been deposited at the storefront. The process based on the ancient bill of exchange is the basis for most value transfer systems including such high profile ones as hawala and hundi. C. How Money Launderers Game the Wire Transfer Remittance System 42. Storefronts can assist money launderers in abusing the front-end of the remittance process. The following five ways are the most frequently observed: i) Providing bank deposit slips to the launderer for their direct use and permitting launderers to make large cash deposits directly to a bank night depository while the storefront structured payment orders in the amount of deposit, ii) enabling launderers to schedule money drops to co-opted conspirators to avoid unnecessary or repeated contact with other storefront workers by providing extended working hours; iii) circumventing reporting requirements and providing smurfs with phony identity documents where transaction thresholds require such documents; iv) creating false payment orders to cover criminal proceeds; v) taking the risk of having large amounts of cash from the launderer by providing armored car service and other similar services to transport the latter s cash. 43. Storefronts are an important network component on the back end of the transaction as well. Since storefronts are usually connected to paying agents domestically or in foreign countries, back-end insider knowledge allows them to set up. Such flexibility makes it particularly difficult for law enforcement to detect money-laundering patterns based solely on surveillance. 33 Some storefronts establish their own codes with the launderers at the receiving end to uniquely identity which laundering group is to receive the particular remittance other than the name on the remittance payment order. They are also privy to a legitimate remittance firms network s codes, protocols as well as other operating information and security methods required to successfully shepherd money through the laundering process. Occasionally sending storefronts will strike an arrangement with the paying agent to bypass the license holder s systems and deal directly saving on the legitimate processing or drug fees they were receiving. 44. Usually, storefronts are involved in marketing other products and services. This makes it easy to provide activity in the storefront when there is a lack of legitimate remittances. For example less than market rates for phone calls made from the storefronts premises, or discount packaging service all to drew people to mask lack of legitimate remittance business. Appendix 1 11

12 45. License and franchise holders, and even regulators and law enforcement officers, find it difficult to regulate the system simply by regulating the license and franchise holders. Storefront outlets usually work for multiple license holders. Since the drug cash can be spread over as many as six to eight license holders, license holders, regulators and law enforcement officer find it hard to detect money laundering patterns in the remittance activities of storefront outlet customers. By structuring huge amounts of cash into transactions less than $3,000 that are spread among multiple license holders, money launderers are able to circumvent requirements to produce identity documents that storefronts need to record, had the total amount been remitted through only one storefront. D. How Law Enforcement Agencies in New York Addressed Money Laundering Through the Wire Remittance System 46. Following is an account of a law enforcement operation that successfully addressed money laundering through the wire remittance system. The operation focused on cash and cash equivalents as these objects provided the evidence of a crime, and could be recognized, handled, processed, seized, forfeited, and shared after forfeiture. Wire transfers allowed value to be transferred to another jurisdiction even as cash remained in the country of origin but such value was directly linked by payment orders and other documents required by the law, to cash deposited in storefronts in the country of origin. 1. The El Dorado Task Force, Operation Wire Drill, and the Use of Geographical Targeting Orders 47. In 1992, the US Customs Service and Internal Revenue Service formed the El Dorado Task Force (EDTF) to dismantle and disrupt money laundering and criminal financing organizations operating in the New York/New Jersey area. 34 In late 1993, EDTF s Customs Group focused on bringing money laundering in the wire remittance industry under control through Operation Wire Drill. Operation Wire Drill s initial successes resulted from covert operations, penetration of criminal networks, and financial investigations. Further success followed after the US Treasury issued, upon EDTF s and the Department of Justice s request, a Geographical Targeting Order (GTO). 48. The Anti-Drug Abuse Act of 1988 permitted the Secretary of Treasury to issue a GTO to require financial institutions in a given area to make additional money laundering reports where reasonable grounds exist to foster a belief that the threat of money laundering was present. Using data from payment orders, together with census data from the New York City Planning Department, and wire remittance flow patterns from New York and Colombia, US Treasury estimated that out of $900,000 remitted, $400,000 was being laundered Issued upon EDTF s request, the GTO targeted initially 12 then 23 license holders and approximately 3,200 retail storefronts in New York City. It required that customers wiring money to Colombia fill out a special remittance form and present identification for transactions in excess of $750 an amount that was significantly higher than the average transaction size of $250-$300, but still below the normal threshold limit to trigger the presentation and copying of proof of identity ($3,000). This simple requirement created an audit trail for transactions in excess of $750 that law enforcement officers could use to detect and apprehend money launderers. 50. As the GTO took effect, EDTF coordinated with DIAN, 36 an investigative agency under the Ministry of Finance of Colombia. They also coordinated with local law enforcement agencies Appendix 1 12

13 in New York. Soon, money laundering patterns in New York shifted. The GTO pressured criminal organizations to undertake other forms of money laundering, primarily bulk cash movements. EDTF anticipated this shift and coordinated with other government agencies such as the US Customs to undertake significant bulk cash seizures. 37 From 1996 to 1997, bulk cash seizures increased by $63 million as compared to those made over the previous year. There was also an increase in bulk cash seizures in Colombia. Moreover, over 100 arrests and convictions for money laundering or other crimes were made, and approximately $13 million in cash were seized in New York immediately up to and during that period. Implementing the GTO and the Wire Drill Operation also resulted in an immediate drop in the cost of remittances from 7% to 3.5% of the value remitted. As criminal proceeds were forced out of the market, wire remitters needed to lower fees and attract legitimate customers. 51. Effects from the GTO and Wire Drill Operation s extended to Colombia, where drug enforcement and revenue collection efforts were enhanced using knowledge about BMPE money laundering obtained during congressional hearings on the GTO and others using Wire Drill confidential sources. 38 Soon, there were crackdowns on unlicensed remitters in Colombia. 52. The Wire Drill group continued spinning off significant cases from the remitter activity. Seven years later, a case originally developed as a Wire Drill investigation led to the arrest of four Colombian Norte Valle Cartel kingpins for smuggling one million pounds of cocaine into the US, laundering $10 billion dollars, and using bribery, murder, and wiretaps on rival drug traffickers. 39 The arrest and conviction of one of these kingpins was a key to unraveling the structure and hierarchy of the Norte Valle Cartel. The kingpin Juan Alberto Monsalve between smuggled roughly 30,000 kilograms of cocaine into the USA and laundered $70 million proceeds through three remittance storefronts named Tele-Austin that were the subject of Wire Drill search warrants. In addition to the drugs and money offences Monsalve was responsible for several homicides one of which he pleaded guilty to. 53. As a follow up, the Wire Drill Group initiated Operation Meltdown, which began an investigation in 1999 into several New York jewelers alleged to be involved in the moneylaundering scheme. In Operation Meltdown, EDTF investigated and shut down a large narcotics money laundering operation in which criminals smuggled gold, disguised as common household goods, to Colombia. Agents in New York made 26 arrests and seized $2.8 million in cash, approximately $1.4 million in gold, and approximately $1 million in diamonds On 7 February 2007, El Dorado Task Force, as part of Operation Pinpoint a Wire Drill operation, announced the arrests 27 money remitter owners or employees and the search of 24 money remitter locations for wire-transferring approximately $2 million in drug money to Colombia from storefronts located in Queens, Long Island and White Plains, New York. During the execution of the search warrants, agents seized approximately $300,000 in currency, some of which were hidden in ceilings or in wall safes. 41 Continued surveillance of the industry indicated that money laundering had increased and the Wire Drill team acted once again. The enforcement action showed that the remittance system was still at risk to money laundering abuse in NYC. 2. The Numerically Integrated Profiling System (NIPS): Creative Modification of Technology to Detect Money Laundering Through Wire Remittances 55. A key tool used in the operation was the Numerically Integrated Profiling System (NIPS), 42 a tool for analyzing trade data to detect fraud, which was modified to analyze financial data for the operation. The creative modification of NIPS technology enabled EDTF to track Appendix 1 13

14 displacements of payment orders and remittances originating in NYC going to Colombia and detect money laundering activities with greater facility. 43 The program, now know as Digital Analysis and Research Tool (DAART) became further refined and is now a critical tool in targeting trade based money laundering and other financial crimes. 3. The AML Monitor: Case Study of the Vigo Remittance Company 56. A significant effect of employing the GTO and cracking down on money launderers was that it affected the behavior of errant firms positively. 57. In 1995, EDTF s efforts resulted in an AML case against VIGO Remittance Company. The company pleaded guilty to money laundering in The VIGO investigation and cooperation served as the basis for the GTO. Because of its cooperation, VIGO was permitted to remain in operation with an AML monitor. The AML monitor approved by the Court and/or regulator, the New York State Banking Department, and Department of Justice, was paid for by the VIGO and reported to all three regarding the company s progress in achieving AML standards. 58. Firms found to be non-compliant in AML by regulators or those the Court finds guilty but whose criminal transgressions are not that egregious are good candidates for a court-appointed outside AML monitor. The VIGO Remittance company is proof that this approach works. Now the company is a market leader and was recently acquired by Western Union. E. Factors that contributed to success 1. Supportive legal framework 59. The tools used by law enforcement to track down these types of remittance based money laundering operations included: i) the ability to record non-consensual conversations from telephonic intercepts for evidentiary purposes; 44 ii) The ability to record single party consensual conversations following DoJ guidelines and USCS policy 45 iii) money service businesses in the state of New York and New Jersey were required to be registered and licensed by the state iv) A mature body of law that addressed willful blindness v) The ability to cross-designate local law enforcement as US Customs Special Agents significantly increased the effectiveness of the operating teams. vi) the Bank Secrecy Act that requires the reporting of cash and negotiable instruments and provides the capability to bring into effect the Geographical Targeting Order; vii) the Money Laundering Control Act of 1986, which identified the crime of money laundering, provided strict criminal and civil sanctions, the sting provisions to enable more sophisticated undercover operations, and which also provided opportunities to conduct a federal certified undercover operation with government provided on-hand cash and operational flexibility; viii) criminal and civil forfeiture laws to assist in interdicting criminal proceeds; ix) an Asset Forfeiture Fund, which permitted law enforcers to share in the forfeited criminal proceeds, and then use a portion of the forfeited criminal funds for operational purposes. This was one of the key elements holding the Appendix 1 14

15 various domestic law enforcement agencies together under the El Dorado Money Laundering Task Force and strengthened cooperation between international partners Colombia in particular. x) Most importantly, the operation focused on legally specified cash and cash equivalents; these objects provided the evidence of a crime, the opportunity to infiltrate criminal organizations. It was something that could be seen recognized, handled, processed, seized, forfeited and shared after forfeiture. Most importantly, value was directly linked to the stacks of $20 s, $50 and $100 s. xi) The digital value future will change this by replacing objects with electronic digits changing the spatial dynamics of evidence and operations as well as the legal definition of what is money. 2. Capability to ensure accurate evidence is collected and presented 60. EDTF s capabilities to identify, search, and seize evidence relevant to the prosecution of money launderers also contribute to its success. EDTF efforts concentrated on seizing evidence that pointed them in the direction of the laundered cash or cash equivalents. Financial intelligence analysts were available to the enforcement teams through the Financial Analysis and Coordination Team (FACT). An asset forfeiture and removal unit was created to trace criminal proceeds in support of operations units. These analysts and staff supported the team in tracing the evidence necessary to detect and apprehend money launders and seize their assets. 3. Collocation of team members from various agencies and disciplines 61. No one agency has all the necessary knowledge or authority to take on all abuses in a major industry or established criminal organization. It requires teamwork, focus and strong coordination between law enforcement, regulatory and intelligence units. Co-location facilitates such teamwork. Co-location of law enforcement, regulatory and intelligence units also permitted transfer of knowledge, skills and eased coordination issues. Close interaction and teaming with the federal, state, and local prosecutors was also helpful A key element that promotes strong coordination among various law enforcement agencies involved in AML efforts is the formation of an Asset Forfeiture Fund. The Asset Forfeiture Fund permits law enforcement agencies to share in forfeited criminal proceeds. A portion of these funds is then used for operational purposes. F. Strategies that worked 1. Focus on systemic money laundering issues. 63. By focusing on the remittance industry in NYC, a team was able to build investigative and prosecutorial expertise in a specific financial sector where abuse was proven to exist. Judicious use and propagation of non-law enforcement data, as well as data derived from operations was essential to understanding the industry, the scope of the money laundering threats and the action that would most likely yield results in reducing the risk of money laundering. Appendix 1 15

16 2. Judicious use and propagation of data 64. Support for the establishment of the Geographical Targeting Order (GTO) came from the New York City Planning Department. The planning department relied on national census data for federal grants. This data were very helpful in establishing that the volume of transferred funds to Colombia could not possibly reflect what was happening on the ground. With other law enforcement and regulator data, a clearer picture of the remittance systems problem emerged, and it was possible to plan and take appropriate action. 65. Information collected from AML operations such as the GTO should be used to inform the public, policy makers, senior management and legislators as to the scope of the problem, and possible responses. Evidence collected by EDTF was used to persuade U.S. Customs, IRS, NYPD, NY State Banking, NY State Police, the Manhattan and Brooklyn District Attorney s Offices and the NY/NJ HIDTA and federal prosecutors to support the use of the GTO. 66. Data derived from the EDTF efforts supported the money services business regulations, the black market peso exchange efforts, the national money laundering strategy, the expansion of the NIPS program, and Colombian efforts to control money laundering in the remittance industry. These efforts also resulted in greater interaction between the U.S. Treasury and Justice Departments, which ultimately led to semi-annual meetings to discuss operational matters and strategies. 3. Support non-enforcement methods to modify aberrant behavior 67. Legitimate remittance agents, after seeing evidence of the competition s abuse, used their influence to improve the remittance industry. By providing training, setting up internal systems to identify potential money laundering and supporting legislative and regulatory changes the industry proactively changed its standing in the community. These and similar efforts need to be supported by law enforcement agencies. 4. Continue until the job is done 68. It took seven years for the Wire Drill team and others to topple the Colombian Norte Valle Drug Cartel. For Wire Drill and El Dorado, constancy and patience was the key to a successful operation. III. VALUE TRANSFER INNOVATIONS DIGITAL MONEY At the GTO briefing at EDTF August 1996 U.S. Treasury Secretary Robert E. Rubin asked, Will the electronic wallet effect your operations. Wire Drill team s response was, until the time comes that at drug dealer and the user can exchange value safely and easily it will be a cash-based world. 69. It should be emphasized that EDTF focused on recognizing, handling, processing, seizing and forfeiting cash being laundered through the wire transfer system. Although wire transfers allowed the transport of value without physical movement of cash, such transfers were directly linked to the cash, and US laws provided ample regulations to ensure the formation of an audit trail that would lead law enforcement officers to identify and seize the laundered cash, Appendix 1 16

17 and prosecute the launders. Vulnerabilities in the wire remittance system were addressed by law enforcement officers through use of the GTO, creative use of available technologies such as the NIPS as well as non-law enforcement data to detect money laundering patterns, and addressing expected modifications in behavior (such as using the bulk cash method of money laundering) brought about by increased law enforcement action. Using these tools and strategies, law enforcement officers were able to seize the laundered cash, which was used to apprehend and prosecute money launders. The seized cash is also relevant in that it constituted a reward to the law enforcement office responsible for the seizure. The Asset Forfeiture Fund was key to building and maintaining close cooperation between law enforcement agencies combating money laundering. 70. By the mid-1990s, however, technologies emerged that allowed the transfer of value between anonymous parties. This time, value was not necessarily tied directly to a bank account opened under the name of an identified person. A. The Electronic Wallet ( ) 71. At this time, cash (coins and paper bills) was being replaced by digital data. Nascent financial applications tied to the Internet were also emerging in the 1990 s: Amazon.com, Priceline.com and retailers of all kinds were scrambling to do business and make their fortune on the World Wide Web. A new form of value such as digital cash/money or digital value tokens were needed for commerce to flourish on the internet. For the new money to take hold, it would have to be accepted by the public and that meant the money had to be as secure as cash or checks or other instruments consumers rely on. Cryptography, the scrambling of data to ensure security and privacy, had long been a cornerstone of the banking industry s various wire transfer systems. 47 A series of walls, visible and invisible, secured by expensive encryption and physical barriers and supported by practices of permissions and authentications, protected the worldwide electronic value transfer network. By the mid-1990s, technology had developed to such a level that encryption became inexpensive and allowed routine transfers of large values. In 1995, large value transfer systems in the US routinely transmitted more than $2 trillion dollars every business day. 48 However, inexpensive encryption, which offered data protection and ensured bank secrecy, also make digital value transfers vulnerable to exploitation by money launders. Do not forget that wire transfers continue to be the number one instrument that criminals go after and succeed at compromising. 72. Digital or electronic money transfer systems involve the transformation of value into digital units that are credited into some form of an electronic wallet. In the 1990s, two emerging models of electronic money transfer systems were beginning to take shape. One would leave an audit trail; the other would be totally anonymous. Both are discussed in a report of the Task Force on Stored Value Cards published in the Business Lawyer on 1 February Closed systems are those where an issuer of value offers a single product with corresponding value that could be used for a specific purpose. It refers to the New York City Metropolitan Transit Authority metro card, prepaid telephone cards and a university provided value card that could be loaded and decremented as value was subtracted. 50 Open systems involve single or multiple issuers of value who offer products that could be used to pay for a wide variety of transactions. In this instance, the issuer of value is not necessarily the entity providing the goods or services. In the case of the single issuer model, one firm could develop the product and issue the Appendix 1 17

18 value used on the cards but would employ other firms as members of its distribution chain. An example of this is Mondex, a consortium of 17 banks led by MasterCard. 51 The Mondex system used a card to load value from ATM s or telephones. The card would then be read from a pocket-sized wallet from which the owner could transfer value to someone else or purchase items at various authorized points of sales terminals. Value could be redeemed directly from the originator. Visa followed introducing its own product in Visa used its existing merchant network and its cards were reloadable at authorized ATM s. In the open system, electronic value needs to be stored on a computer, in some cases on a personal computer but in most instances on the financial service providers server where it can be accessed by any member of the distribution chain where the value is being exchanged for another product. B. Problems Posed by the Open System and Digital Value Transfers in General 73. E-Cash was similar to other products in the open system in the 1990 s with a few key exceptions. Its value is stored on a computer like the others but once disbursed digitally allegedly it became anonymous. Electronic-coins were purchased from a bank. To ensure privacy, E-cash coins were designed so blind verification can occur no bank will be able to ascertain on which hard drive a particular coin is resident or who was the payor in a particular transaction. 52 This application would pose serious questions in making the determination of where the value actually resided or was being stored and who actually possessed it. 74. CyberCash was more the norm as a computer stored value product. It could be loaded from a bank account or credit card. All transactions went though CyberCash's encrypted server systems for processing. CyberCash was used to make international purchases online, and payments were made in foreign currency at transparent exchange rates and all transactions were tracked and an audit trail produced. 75. Recognizing that the new technologies may be vulnerable to abuse by money launderers, FATF recommended that countries pay special attention to money laundering threats from new or developing technologies that may favor anonymity, and take measures, if needed, to prevent their use in money laundering schemes. 53 The FATF Report on Money Laundering Typologies from 1996 included a section on cyberpayments as a potential emerging money laundering threat Meanwhile, Secretary Rubin and G-10 partners established a Working Party on Electronic Money. 55 This group submitted a report in April 1997 that cited cross-border issuance of electronic money could limit the reach of national laws and regulations Thinking of the future of money laundering operations in the fast approaching digital world, the US Treasury Department in 1998 commissioned Rand Corporations 57 Critical Technology Institute 58 to prepare a study entitled Cyberpayments and Money Laundering: Problems and Promise. The study evaluated the used of a cyberpayment network targeting order modeled after the GTO. 78. The study team 59 saw the need for a future legal order involving the use of networkborne cyberpayment system control elements to interrogate [read] stored value type smart cards used at a retail merchant or cyber payment issuer for value transfers. The process Appendix 1 18

19 envisioned a way to trace movement of value within Cyberpayment networks. It was a cyberspace version of the GTO a Cyberpayment Network Targeting Order (CNTO). The application of a CNTO would require the same legal justification as a GTO and would be issued through the Treasury Department. Rand saw such a mechanism as a potential means of more effective detection of suspicious financial activity within cyberspace, and thus a more efficient allocation of limited law enforcement [and regulatory] resources In spite of these discussions, regulation of electronic wallets has not progressed much since the 1990s. Early electronic wallet devices were cumbersome to use and not widely accepted. 80. Nevertheless, using the Internet was another matter. Significant commercial headway in the areas of online payments and the supporting clearing services were ascending to meet the demands of Amazon.com and other online venders. The import was not lost on Glyn Davies, who noted, Now that wholesale payments have been caught in the full tide of the electronic revolution, traditional commercial banks will face stronger competition from non-banks and from dis-intermediation as lenders and borrowers can deal more easily directly with each other without needing a financial intermediary. Central Banker tasks in attempting to define, measure, monitor, control and supervise their own countries changing forms of money and monetary instruments, will become much more complex as the old boundaries between national and regional monetary domains will be broken down by new forms of competitive currencies. 61 IV. THE CONVERGENCE OF FINANCIAL SERVICES AND TELECOMMUNICATIONS: CASE STUDY OF CELLULAR PHONE VALUE TRANSFER SERVICES IN THE PHILIPPINES 81. In November 2004, representatives of Globe Telecom, a Philippine cellular phone operator, explained their G-Cash product and its myriad applications, to an interested audience of ADB staff and other local embassy personnel. These applications included retail sales, loading of prepaid airtime over the air and most importantly peer-to-peer cash transfer in an easy, safe, convenient manner. Secretary Rubin s question to the Wire Drill team was now in fact reality. 82. Would this system replace cash in drug sales or other criminal activity? Would this system cause a paradigm shift in law enforcement operations? Alternatively, would it provide a sea change for the good guys and deny the cover of legitimate remittance to the drug trade and terror financing, helping to close this avenue of abuse? Which of these alternative futures will prevail is not yet clear, but the story in the Philippines is a good one and bodes well for the future. The question is whether continued progress in technology and market forces will eventually overtake that well-designed regulatory system as well. A. The wireless situation in the Philippines, November The Philippine wireless market is unique. It has a very mature market for Short Message Service (SMS) services and has the largest population of SMS text messaging (texting) users in the world. It has come to be known as the SMS texting capital of the world. Ninety five percent (95%) of the market uses prepaid reloadable value cards to access services offered by wireless providers. 62 This is for many reasons lack of credit, convenience for operator and user, extensive infrastructure to support prepaid cards and phones. Thirty five percent (35%) of the population has a cellular phone, while 95% of those remaining have access to a cellular phone Appendix 1 19

20 through friends or family members. 63 Even geographically inaccessible locations normally have cellular phone coverage. 84. In November 2004, there were three wireless providers in the Philippines, two of which had developed a cellular phone value transfer program. The Philippine Long Distance Telephone (PLDT), the largest telecommunications company in the country was the parent company of SMART Telecom, which, in August 2004, started SMART Padala, a bank-based remittance system in conjunction with a local bank - Banco de Oro. Globe Telecom, 64 the second largest wireless provider, was the sole provider of peer-to-peer (P2P) value transfer (or direct value transfers from one person s cellular phone to another s) at the time Recorded international remittances in 2005 rose by 25% to $10.7 billion, though actual remittances could be substantially higher as a considerable amount is sent via informal channels. 66 The figures are vague and amorphous due to challenging statistical collection methods and the variety of transfer methods. 86. Cellphone value transfer services in the Philippines reduces or eliminates first mile remittance issues those relating to the process of getting value into a system in one location, and responds to last mile issues efforts required to deliver the value or money to the recipient at the other end. Near-universal cellular site coverage in the Philippines eliminates the last mile for cellular phone remittances by putting the value in the hands of the recipient shortly after the sender transmits it. The cellular phone transfer eliminates the need for the recipient to have the funds brought to them or having to go pick it up. 87. The system also works because it puts the system in the realm of most people s usual and customary habits and does not give rise to money laundering concerns, if subscribers are properly identified, wallet limits are reasonable and transactions are monitored for fraud and AML activity. The system is also inexpensive for small businesses since they need only a cellular phone, no additional equipment is required. 88. To illustrate how convenient the service is, the box below describes the value transfer process: Once a month, 24-year-old Jane Manarang drops by the McDonald's in her busy Manila neighborhood, but she's not there for a burger and fries. Instead, she is stopping by to cash an electronic check. Her husband, a teller at Forex International in Hong Kong, sends a portion of his salary to Manarang using a new mobile-phone-based cash remittance service called SMART Padala. His Hong Kong remittance company sends a text message to Jane's phone, crediting the money to her cellular phone account. Then she transfers the credit to McDonald's cellular phone account through her phone, and gives her the money, taking a percentage of the amount cashed as a fee. It's a great deal for Manarang and her husband, Glenn, because it costs much less than the $5 Glenn would pay for a wire transfer. For amounts above $180, Manarang gets a free Big Mac meal to boot. "It's so fast," marvels Manarang. "I receive a text message, and I can quickly get cash." 67 Appendix 1 20

21 89. The Gartner Group provides an example of what the cellphone screens look like for Globe s G-Cash. Both the Globe and SMART systems are visually similar. The models should give the reader an idea of how easy it is to send and receive value. 68 Appendix 1 21

22 90. Other features like the SMS direct transfers and the salutations that can accompany the value transfer for example notations can mark an event like Happy Birthday, Happy Anniversary or Study harder or I won t send any more money, make the system more appealing than traditional money transfer programs. B. Who Benefits? 91. Cellphone remittance value transfers benefit the public. The poor subsisting on limited incomes and those remotely located can now conduct limited financial transactions. The overseas foreign workers remittances, from where a major percentage of the country s incoming cash flow is generated, are a major support for the Philippine economy are increasing using this method to send money home The government can potentially benefit in several areas: from more accurate remittance flow statistics; a better view of transfers and overseas connectivity: the elimination of petty corruption in government since citizens can pay for government services directly. The Philippine Bureau of Internal Revenue (BIR) and Globes G-Cash originally teamed up to permit Philippine taxpayers to make payment via cellphone. The pilot was successful launched in January 2005 as PAYBIR. The BIR has since signed up SMARTs - SMART money program and is in discussions with other value transfer providers to expand the system. The wireless payment system permits a convenient and more transparent way to pay taxes. The same concept could be applied to micropayments for other government services including border crossings within the region. This payment system would reduce the possibility of graft and the risk posed to drivers who carry large amounts of cash to pay border fees. 93. Businesses are likely to benefit too, as the technology would allow fast settlement of accounts usually by the end of the business day. As mentioned earlier, there are no requirements for major systems purchases at Points of Sale (POS). C. A Well-Designed Regulatory System 94. Money launderers do not have a significant entry at current Philippine standards that we know of, even as this could, and most likely will, change within the next year as the technology evolves and 3G capable phones bring the Internet to the cellular phone handset. Rampant use of false identification, purchase of wireless value transfer services from others, renting of services to others and the lack of adequate law enforcement authority to examine abuses in the system all make the possibility of undetected abuse by money launderers probable. The Philippine model provides safe guards that the traditional international remittance model does not. The sender transmits direct to an individual in the Philippines eliminating the possibility of a payout agent being able to pool large amounts of digital cash using fictions names, the funds remitted are screened using pattern recognition software to detect abuses and the recipient has to show identification on account opening or cash in or out for any amount. Appendix 1 22

23 95. The following section describes the value transfer services of two wireless providers in the Philippines and the rules that currently regulate each system. 96. Special note has to be made of the importance of the Core Technology Supervision Unit created by the BSP in 2005 to assist in the examination and regulation of new digital products. The Unit was instrumental in providing guidance to the BSP and private sector in risk management for digital financial products. Creation of such a unit should be considered a best practice for all nations engaged in or considering offering digital financial products to the public. 1. SMART Telecommunications 97. In 2000, via a joint venture with Banco de Oro (BDO), SMART Telecommunications Inc. introduced MasterCard SMART Money 70, the world s first electronic cash card linked to a mobile phone. SMART Money allows users to transfer money from a bank account to a mobile phone. Value on the phone can be used like a debit card to pay for goods and services at a number of retailers and merchants. Cash can also be transferred from one SMART Money account to another via short message system (SMS). 98. In May 2003, SMART introduced a new product from its SMART Buddy m-commerce technology platform called SMART Load. Transferring pre-paid airtime from a retail merchant or other reseller to a pre-paid phone customer, allows the consumer to make cash payments to the retailer. Permitting payments as small as P30 (US$.54) and P60 (US$1.07), SMART launched the first pre-paid cellular phone subscriber service created for the base of the pyramid (BOP) market. Advertised as telecom in sachets, it was followed in December of the same year by denomination loads of P2 (US$.03) and P5 (US$.08). 99. Responding to the fact that a large number of Filipinos live on U.S. $2/day 71 and need to purchase in small quantities, SMART designed a product to serve the particular needs of a large portion of this consumer market. By using in-air reloads, SMART minimizes physical product distribution cost, decreases risk to product theft, and makes reloading more accessible and faster, especially in rural areas. In-air reloads coupled with a demand response stocking system for pre-paid airtime and special SIMs for retailers that allow them to open or close the handset [which serves as the retailers cash register] via an SMS, [allows retailers] to carry out business without the need for a specific physical location or regular business hours created anytime, anywhere commerce for the low income market sector. 72 Using sari-saris 73 as well as high-end retailers provided SMART with a ready-made distribution chain 74 known and trusted by the market to sell its services to the consumer In August 2004, SMART introduced the first international text-based remittance system called SMART Padala. 76 Again, SMART relied on existing international bank partners and retail outlets to distribute its product. 77 SMART provides cellphones to the remitting agents, the agents in turn send money through the phones to the recipient s account via an electronic wire transfer. SMART also provides a local revolving fund in a SMART Money ATM account so the recipient can withdraw money immediately, by-passing the normal three-day waiting period. SMART charges a 1% fee on the front and back end of the transfer with a maximum charge of P1 for every P100 encashed. This constitutes a significant cost savings for the remitter and the beneficiary, especially if the remitter pays the full fee on the front end. In addition, some retailers, such as McDonald s offer a meal to customers as an incentive to use it as the service provider. Appendix 1 23

24 2. How SMART s services are regulated 101. SMART value transfer services are tied to Banco de Oro banking support and basically acts as the latter s communication support. Thus, the Bangko Sentral ng Pilipinas (BSP) regulates SMART s services as it would the services of a bank. KYC and clearing/settlement purposes, is viewed as bank-centric. It is viewed as a bank-centric model because all value transfer subscribers need to have accounts/access cards and also have customer due diligence preformed by Banco de Oro or other banking partners. Because of its banking status the limits are higher, a PhP50, 000 ($1,000) a day limit per subscriber with maximum of PhP 20,000 ($400) for ATM withdrawal and merchandise purchases and PhP 10,000 for cash withdrawals at points of sale. Other than the daily wallet size, there are no monthly or annual limits on transactions In addition, SMART is compliant with BSP and AML requirements relative to ID for subscriber at the time of account opening. It uses pattern recognition systems to monitor account/subscriber activity. This practice is a necessary and complementary part of both good anti-fraud and AML procedures. It is required to report any suspicious activity to the Anti-Money Laundering Council of the Philippines (AMLC). It is also subject to AML compliance examinations by regulators. 3. GLOBE Telecom 103. Coming late to the wireless application market, Globe realized it faced significant competition with SMART. However, instead of attacking the small transfer and remittance market head on with a bank-centric model, Globe approached it from a telecommunication centric model. By offering micropayment capability, sachet packaging of airtime and value Appendix 1 24

25 transfer together with low cost cellphones (phones are available to rent for pesos a day or own for a few dollars depending on the type), Globe s creative entrepreneurial spirit resulted in a small payment model designed to meet the critical needs of its consumer base A wholly-owned subsidiary of Globe Telecom, G-Cash/G-Exchange launched its product line in November 2004 with 20,000 subscribers. By January 2006, Globe was boasting 1.2 million subscribers. Globe s premiere product, G-Cash is premised on the patent pending technology platform Share-A-Load. 78 Text messaging is a throwaway technology built into the GSM specifications that no one ever thought would be a moneymaking service. 79 Ironically, sending payment instructions or transferring value via text now is the engine driving adoption of cellular phone mobile commerce Share-A-Load enables peer-to-peer transfer of prepaid airtime. Facilitated by Ask-A- Load where consumers are given one Ask-A-Load message to a potential value transferor if they have no airtime left In 2006, Globe implemented virtual ATMs. A virtual ATM provides users with the ability to download value from their bank account to a user s cellphone. With virtual ATMs now operational, Globe s service footprint increases significantly. By working with known and trusted entities such as the United States Agency for International Development s (USAID)supported program Microenterprise Access to Banking Services (MABS) and the Rural Bankers Association it provides financial services at minimal cost to those who had no access before. One of these programs: Text-a-Deposit is outlined below. Text-a-Deposit It was a monthly errand that Evelyn did not mind making. She walked a few blocks from her employer s Makati condominium to the mall and made her way to the familiar Globe Hub outlet at the Power Plant Mall. Evelyn handed over a thousand pesos to the smiling sales-clerk, filled out a form, showed her ID card and paid the P10 cash-in processing fee. A few minutes later, Evelyn s phone beeped with the familiar message, You have received 1,000 of G-Cash from BC-Rockwell Hub on 9/15/06 at 12:40 PM. It only took Evelyn another five minutes to key in instructions to transfer her G- cash balance directly to her brother s savings account with the New Rural Bank of Victorias (bank Victorias) in Bacolod City. Edwin, Evelyn s brother, does not own a mobile phone but through the new service, Text-A-Deposit, Evelyn can send G-Cash directly to his Bank Victorias deposit account. Evelyn returned to work, happy at the thought that later, during her brother s afternoon break, he would go to Bank Victorias Bacolod City branch, present his ID, and claim the cash. She was sure that upon arriving home tonight, he will be able to give the money to their mother. The amount was Evelyn s monthly allowance to her mother, who saved a fraction of the sum and used the rest for food. Evelyn used to send through a large commercial bank, paying P100 for every transaction, while her mother had to travel for two hours to and from their house to Bacolod City to claim the cash. 80 Appendix 1 25

26 4. How Globe is Regulated 107. Globe worked from the start with the Bangko Sentral ng Pilipinas (BSP) (i.e. Central Bank) and AMLC to overcome any concerns about a telecommunications carrier appearing to provide financial services. The regulators accepted Globe as a Money Service Business (MSB) 81 a non-bank financial institution or money services business. It complied with antimoney laundering laws by setting limits on transfer and loads. Though a wallet can store as little as one peso, the maximum a subscriber can transfer at one time is 10,000 pesos ($200) or a maximum of 40,000 pesos ($800) a day and 100,000 ($2,000) pesos per month. The cost to transfer value is one peso G-Cash is regulated by Bangko Sentral ng Pilipinas (BSP) and AMLC as a money services business. Globe obtained concurrence from the BSP for a maximum per transaction value of PhP10, 000 ($200), a maximum per day of PhP40, 000 ($800) and a maximum per month of PhP100, 000 ($2,000) per subscriber. In addition, G-Cash remains a closed system you must be a Globe subscriber, register with Globe in person, and provide a valid photo identification document to put cash in or take cash out of the system thereby fulfilling the AML Know Your Customer requirements. Appendix 1 26

27 109. Customers can load cash into G-Cash in the form of prepaid cards, through Globe e- Load website, bank accounts or Globe sales stores. They can withdraw cash by filling out a withdrawal form at the point of sale (POS), at G-Cash ATM s (wireless, cardless), Globe outlets and participating banks. All withdrawals require a form be filled out with name address and subscriber number, more information for non-subscribers, and a valid ID which is photo copied which is forwarded to Globe Headquarters for with the signed cash in and cash out form for analysis. The system worked out by Globe and the BSP/AMLC is a good model: it has controls on cash in and cash out, it is a closed system and the amounts transferred are reasonable and small. The monthly spending limits of PhP100, 000 ($2,000) restrict the potential of money laundering abuse D. Vulnerabilities in the System and Possible Responses 1. SIMs as possible digital smurfs 110. The two business models that the various money/value transfer systems are premised on are the 1) bank-centric model (SMART), which requires the obtaining of a debit card from the Banco de Oro with AML due diligence performed by the bank and unique SIM chip set from SMART; and 2) telecom-centric model (Globe), which uses a standard SIM card that is authenticated by an over the air registration routine identifying SIM and user to the system, when cash is placed in or taken out of the system at a Globe authorized establishment, a form is filled out and identification required. The lower value transfer limits agreed to by Globe and the AMLC indicate a risk associated by the lack of initial face-to-face account opening procedures for the recipients of G-Cash that are not yet subscribers. Both models use pattern recognition to test transfer activity for fraud and money laundering patterns A key feature of both models is that each employs wallet and transaction limits that are linked to the SIM that are consistent with the provisions of the Anti-Money Laundering Act of the Philippines. By limiting the amount of each transaction to their customers, for each day, each month and year, SMART and Globe are able to scrutinize transactions for fraud and money laundering. Wallet and transaction limits may not be adequate to address future money laundering threats. SIMs can be easily compromised, duplicated, or simply retrieved from stolen phones. A major Colombian drug cartel, for instance, is known to have had a telecommunications expert modify cellular phones so that multiple identities could be programmed into it. Before each call was made, the identity of the phone would be tumbled to a new number so that any law enforcement agency would have no idea what number to tap all the numbers on the phone would look like a list of legitimate users Taking the example of Colombian cartels tumbling of phone numbers, the question is, why can t the Manila, Cebu or Queens, New York phone books be attached to the tumbled numbers to conduct electronic digital smurfing of funds? Admittedly, the Globe wallet limit of PhP40, 000 ($800) with monthly caps of PhP100, 000 ($2,000), is unlikely to generate the volume necessary to be effective for a larger money laundering operations. The $1,000 SMART wallet limit, however, is very close to those used by Mr. Monsalve of Tele-Austin and the North Valley cartel fame to move his drug proceeds through the wire remittance system in New York City. Appendix 1 27

28 Digital Value Smurfing In the digital age, smurfs have the option of exchanging cash for digital value in the form of stored value cards, the internet or cellular phone digital cash or airtime. This next generation of smurfs could be considered Digital Value Smurfs (DVS). Small street sales of drugs, stolen property or terror financing contributions can be wirelessly transferred via cellphones avoiding the risk of cash movement with the extra benefit of speed dialing the funds out of a given area for further safety. DVSing could be used by either individuals or front firm to purchase digital value on line or with cash under the reporting thresholds. False identification would also be used open accounts much the same as in the paper world. People working for the digital value providers could create accounts for a limited time and then remove them from the system much the same as was done in a recent drug investigation in Australia. Money brokers employing the DVS in turn would be able to develop a digital capital pool for use in laundering. It is possible that computer software programs called bots, which could store value in numerous electronic locations for retrieval later, could automate the process. The advantages of this system over the current one for the money broker is the quick conversion of cash to digital value and the facility of integrating different digital value pools, such as on-line accounts, SMART cards and wireless digital value. Physical evidence at the scene of a police stop is reduced since there may not be any cash or cash equivalents to seize or develop a line of questioning from. If value is transferred electronically, and the SIM is destroyed before the apprehension then there may not be a way to identify what was on the phones. For example, control of 10 subscriber accounts with a maximum daily limit of $800 - $1,000 could provide the launderer with $8,000 to $10,000 in domestic funds to launder each day, on an annual basis it would be $24,000, and $365,000 depending on the branded services used. It may not seem like much but technology can help laundering cells maximize their capacity Generally, in the US, drug cartels structured funds below the $3,000 limit required for photocopies of sender s identification. During the NYC GTO, money-laundering storefronts were willing to structure $100,000 bundles of cash below the temporary USD$750 reporting limit for a higher fee and a longer waiting period through the wire remittance system in NYC. 83 The normal reporting threshold in the USA was $10,000. The structuring was done to avoid detection. It was generally through undercover operations that these drug money-laundering systems were uncovered. Response 114. One area where regional law enforcement and regulators have made a decisive move is in the registration of SIM cards. The extensive use of cellphones and in particular prepaid phones has resulted in a decision by Indonesia, Thailand, and China to register the SIM s cards Appendix 1 28

29 and the user. The goal is to help link a face with a bomb, a criminal gang with its members, or a crash victim with a name. The registration would be a useful activity to consider for the Philippines, given the new, more expensive and capable 3G phones with Internet connectivity. 2. 3G Phones, Open Digital Remittance Systems, and Anti-Money Laundering 115. The advantage of both the SMART bank-centric and Globe telecom-centric model for regulators and law enforcement is that these are closed systems. The registered users stay within their unique systems. This permits basic KYC techniques, transaction monitoring for criminal activity, and a point of contact to which regulators and the public can refer to resolve issues. Japan, a leader in mobile technology, uses a similar system, which is bank-centric. So long as these systems stay in place, governments will have a way to regulate and oversee commerce and financial activity. So long as mobile value transfer system remain in one country and are closed-looped (meaning the service providers digital value stays within their system only) then, service providers, regulators and law enforcement can oversee the service However, third-generation (3G) phones handsets that permit increased data handling rates, make the handset, in effect; a mini computer linked to the Internet through wireless broadband connection will change that paradigm. 84 3G phones can run on the WCDMA (Wireless Code Division Multiple Access) platform. This technology allows for faster data transmission speeds from 114 kbps up to two Mbps, making high-speed data communications and mobile multimedia services such as video conferencing, audio streaming and mobile Internet possible. All these changes will support mobile banking. More importantly, 3G phones may allow open-looped digital transfers that enable digital value to move freely through various providers systems domestically and/or internationally As larger onboard handset memory and advanced SIM s are developed, the opportunity for real web connectivity and security are becoming a reality. "The SIM card will become almost like normal computing memory," says Gary Waite, technology manager for devices and SIMs at UK-based operator O2. "Then it will start interfacing with other servers. I can see it setting up secure channels with the operator to back up data." 85 The industry is at a point similar to the one at which the corporate world had arrived in the 1980 s. System operators could choose where to house the brains of the system on the company server as Globe and Smart currently do, where data can be controlled and protected easier, or to expand functionality to the user by improving the user interface devices by adding capacity to the PC or handset. These enabled handsets could resurrect the earlier issues of anonymity posed by the E-Cash and blind verification. 3G adds the capability for far greater functionality much like the PC did for office system. From a law enforcement point of view, it also poses greater challenges, requiring additional training and forensic capabilities In other words, digital transfers made via an open system through the use of 3G phones are vulnerable to abuse by money launderers, since it makes it difficult to determine where value actually resides or where it is being stored and who actually possesses or owns it. 3G phones can be carted around or hidden, and the SIMs, easily destroyed, by money launderers. Searches and seizures to capture money laundering-related evidence will be more difficult because of the mobile nature of the handset and general lack of law enforcement capacity to conduct proper forensic examinations of the mini-computer handsets While some believe that bankers are the custodian of critical data and are responsible for making it available to authorized parties, 86 some mobile representatives met with researchers, academics, and technology experts affiliated with the World Wide Consortium Appendix 1 29

30 (W3C) to devise a plan for making the mobile Internet more like using the web from a personal computer by establishing best practices for the mobile environment. 87 This focus will certainly lead to a quickened tempo of handset internet convergence, which will bring financial services with it. Responses 120. Basically, 3G mobile phones put the Internet into the hands of the mobile cyber criminal. 3G phones will emphasize both the best and the worst of the Internet. The worst includes fraud, terrorism, electronic banking, and spoofing of bank sites, but the best is convenience, powerful tools for commerce, trade and economic development. New tools however will be needed; from data preservation orders to electronic search warrants (as proposed by the Australian Crime Commission and noted below) to make the new technology and the public less vulnerable to abuse by criminals. Cyber Search Warrants On-line investigation is a not fully developed emerging technology with implications for Law Enforcement. The process includes the ability to legally electronically access an offender s computer remotely, for the purpose of gathering evidence. Ironically, computer hackers have been doing just that illegally since the advent of the internet. Monitoring warrants that allow real time surveillance of computer based activity - under s25a of the ASIO Act 1979 as distinct to conventional search warrants operate so as to allow ongoing searches of computer data for a period up to 6 months subject to the issuing Minister being satisfied that there are reasonable grounds for believing that access to the data in the target computer will substantially assist the collection of intelligence in respect of a matter that is important to national security. Such a monitoring warrant enables law enforcement to use investigative tools such as DCS-1000, an electronic surveillance device used by the FBI with a surgical ability to intercept and collect the communications of the subject of the warrant, while ignoring those communications which the authorization to intercept does not cover. The FBI s technology operates as a network diagnostic tool similar to those used by ISP s except that it provides the FBI with the unique capacity to distinguish between communications that can be intercepted lawfully and those that may not. For example, if a court issues a warrant that provides for the interception of , but excludes other communications such as online shopping the FBI technology can be configured to intercept only those s transmitted from one named subject to another Others are also engaged in trying to address the legal issues of the cyberworld. A European Project on the Admissibility of Electronic Evidence in Courts; Fighting Against High Tech Crime (A.E.E.C.) is underway. This innovative project is financially supported by the European Commission and the Spanish company Cybex. The main objective of the A.E.E.C. project is to develop Electronic Evidence as a useful tool to fight against high tech crimes. 89 Appendix 1 30

31 122. The International Telecommunications Union prepared a paper titled Harmonizing National Legal Approaches on Cybercrime. Citing the rapid growth of the Internet an estimated 6.4 billion people on the Internet in 2005 and the need to harmonize criminal enforcement mechanisms in the newly arrived cyberworld, in order for permit the cyberworld to continue to grow. It is critical to realize that shaping standards and legal norms of conduct on the Internet now will affect millions of people in our immediate future. The standards and laws created must include great flexibility to account for exponential growth in technology and innovations. 90 Cybercrime laws will also ease the evidentiary burden for law enforcement and prosecutors, and the courts will be able to participate in the process of establishing precedents and ethical standards more significantly through these rulings and sentencing. Countries must be able to prosecute cybercrimes committed by national individuals or any person domiciled in that country, whenever the acts are committed abroad. And each country should be able to prosecute a foreigner present in the country, whenever it does not extradite that person after a request is made for extradition for cybercrimes committed abroad These are certainly interesting and valuable goals. The process, however, may take longer than hoped for, since the issues of legal history, culture and sovereignty will play a significant role in the harmonization process The Asia-Pacific region does have its own forum for discussion in the Asia Pacific Economic Cooperation (APEC), in which the Philippines play a significant role, especially as regards counter terrorism. Leaders of member economies at the APEC Ministerial Meeting in Santiago, Chile, on November 17 to 18, 2004, agreed to strengthen the respective economies ability to combat cybercrime by enacting domestic legislation consistent provisions of international legal instruments, including the Convention on Cybercrime (2001) and relevant U.N. General Assembly Resolutions The Global Business Dialogue on Electronic Commerce has produced a series of worthwhile recommendations on cybersecurity, cybercrime, and e-commerce requirements. One of the more interesting is the Culture of Security relative to electronic commerce that addresses the responsibilities of all involved in the electronic world All of these initiatives need to be brought together under a coordinated Asia-Pacific umbrella for the regional security and commercial well-being. Bridging existing initiatives would make good sense. Finding a way to accomplish that coordination objective requires a temporary effort on the part of existing regional organizations, or the efforts of an ad hoc group to tie things together. 3. Near-field Communications (NFC) and the digital trail 127. Matthew Edwards posed the question in the Banker in 2002, For the mobile phone generation that is coming of age, will the natural place to carry their plastic be in their phone rather than their wallet? 94 Edwards referred to silent commerce whereby advanced tagging and sensor technologies, microchips, wireless mobile communications and content services endow everyday objects with intelligence and the ability to interact with their circumstances, their immediate environment and their location. This capability, in Edward s mind, is a forerunner of and emerging object Internet in which objects, not just computers, are networked and can be Appendix 1 31

32 accessed and addressed from anywhere in the world. It means that objects can communicate with each other, and commerce can take place without human intervention According to Erik Michielsen, director of ABI Research's RFID and M2M practice, who claims contactless commerce is on a steep growth curve, "By 2010, more than 50% of cellular handsets some 500 million units will incorporate NFC capabilities that will be used not only for payments at points of sale and remotely, but also to access information from 'Smart objects.' Imagine, for example, seeing a poster advertising a concert you want to attend. Hold your phone near the poster, and it connects you to a website where you buy your tickets, download them to the phone, and tap the phone at the turnstile to enter the show." The question for law enforcement is this can these technologies be used for more sinister things like the transfer of value from cellphone to cellphone after drugs or other contraband has been passed? An NFC transfer may break the telecom audit trail, as will links to the internet via mobile phone. Therefore, these areas need to be examined by technically qualified experts, from industry, law enforcement, regulatory and legal communities, to determine viable options to reduce criminal use. Response 130. In Globe s implementation of its RFID service (G-Pass) which is initially used for MRT (railway system) fares, the RFID chip has to be registered and linked to a mobile phone, consequently, the transfer from SIM to RFID is traceable. Moreover, the RFID is an endpoint, i.e. there can be no RFID-to-RFID transfer, since the mobile phone owner is the registered owner of the RFID. However, recent innovations in peer to-peer, NFC transfer by Nokia and other hand set providers indicate the industry is quickly moving in the direction of Peer to Peer NFC value exchange. Law enforcers and regulators need to prepare for this eventuality. 4. KYC Requirements 131. In June 2004, Japan s Financial Services Agency ordered an online brokerage house, Monex Inc., to correct its common practice of having clients make transactions without confirming identities. Monex accepted transaction orders even though they were aware they were issued to customers using fictitious names. Monex found about 2,750 suspect accounts. 97 The same on-line challenges will be facing the Philippines as the cell phones move beyond remittance to other financial services, which they will certainly do. Consideration needs to be given to the intersection of online services and the cell phone. Regulatory AML, safety, and soundness audit programs for covered institutions may need to be reviewed to identify holes in the electronic safety net. Response 132. Then, what do we really require for customer due diligence? The first and most important thing is positive identification. Whether in person, over an electronic medium or by regular mail, it is imperative that a financial institution, government agency or religious institution know the correct identity of the individual they are dealing with. The 3G phones may provide the answer to the digital dilemma of KYC with the use of biometrics. Current security practices rely on something tangible; say an ATM card, and something requiring knowledge, such as a password. In the new world of 3G capable phones, however, new technological opportunities allow the use of tangible objects such as voice, face or fingerprint recognition and a password. Appendix 1 32

33 133. On February 28, 2006, in Japan, Vodaphone announced its first 3G mobile hand set with face recognition as a security feature 98. This followed Vodaphone s mobile 804SH wallet-phone in Japan on 21 December The market place is driving these cellphone security features because people are storing more and more sensitive data on their handsets. PDA s currently have fingerprint recognition features to lock data. Owners can even lock certain phones that are thought to be stolen or abused using special passwords. Efforts are under way to improve these fingerprint identification systems for 3G phones A cautionary note needs to be added with the findings of the Finnish Ministry of Defense: unencrypted digital fingerprints can be stolen and used by criminals to incriminate or defraud innocent persons. A security loophole in Microsoft s fingerprint reader provided the potential gap for hackers to capture and manipulate data on computers Perhaps now is the time to engage the industry to develop a digital KYC with biometric and password protection standards for value transfer customers, whether originating from a bank or other funding source, with the proper encryption packages installed on the devices. V. ANALYSIS A. What does the convergence of telecommunications and financial services mean for law enforcement? 136. Digital value on a cellular phone, unlike bulk cash in a bag, will change law enforcement operations. A bag of cash is observable, and law enforcement can articulate what they know about the people carrying it. That articulation may lead to grounds for further questioning and eventual seizure of the funds for evidence. Cellular phone value transfers pose a very different scenario. If the value is speed dialed to another location outside the jurisdiction, and the SIM card is destroyed before LEA s can intervene, there is no evidence at the time of the law enforcement stop for LEA s to discuss with the suspect. Nor will there be any assets to seize at that point in time either. Any asset seizures will be a long and protracted exercise that may require assistance from several jurisdictions. Although the information of the transaction will reside on a server somewhere, law enforcement at the scene may not readily know what the handset subscriber number is much less, where the server that the value is stored on is located This does not suggest that law enforcers will be bereft of evidence to prove money laundering using digital cash. However, it does require that law enforcers identify the kind of evidence that would be relevant to detecting and apprehending money launderers. An African office worker s daughter was detained by immigration. The mother bought a prepaid card for mobile phone airtime and sent the card activation numbers via cellphone to the relevant official for the release of her daughter. The wireless bribe process saved the office worker the time and money of taking cash to the airport to pay the bribe directly to the official. 101 Although the use of the cellular phone to transfer value appears to have speeded up the business of bribery as usual, the process leaves clues for anticorruption investigators if they know how to look for them. The cellular phone records for the immigration official provide significant investigative leads. If the records of the immigration official are obtained and analyzed, they could provide significant leads as to other persons who may have been extorted, the size of the conspiracy, if there is one, and potential accomplices. All these pieces of evidence could lead to a conviction for graft. Appendix 1 33

34 138. One of the most important questions will continue to be Where does the value lie? A Question of Value The discussions of the mid 1990s left what is money? for the future to address. The future is now in products like WebMoney and e-gold; they are in fact private currencies. They are brought under the anti-money laundering regimes somewhere. However, there is no guarantee that other web based products will be. As noted in FATF Recommendation 13, these applications should be continually reviewed by regulatory authorities In the case of the New York Remittance anti money laundering operations, there was no problem determining where value lay. It was in the currency or currency equivalent i.e., the money orders, travelers checks, and/or stored value cards found on the suspect. Alternatively, it could be found in a domestic bank account waiting to be transferred by wire or check to a recipient at the direction of the cartel or their money broker. As micropayment systems progress, determining where value lies will become more difficult. Let us look at two examples A drug user loads $300 of value on his cellphone or his Internet value account. In need of socially enhancing party material, he contacts his cocaine or ecstasy supplier. They meet on the corner of 83rd and Roosevelt Avenue in NYC. The drugs are passed in a bag of cookies. Instead of cash, the street supplier and the user text message or swipe their prepaid NFC enabled cellphones and the value is transferred from the buyer to the seller of the drugs The drug supplier speed dials the value direct to a location outside of the country or to a bodega on the same wireless value service, which easily gets lost in the multitude of other small value transfers, much like the convenient cash based storefront. The drug courier is now free of the responsibility of the funds collected. He is off the hook if the police stop him or a rival gang tries to steal the cash since there is none to be had The surveillance team follows the drug user to see where he goes. Other parts of the surveillance team split to follow drug supplier and the moneyman. The team is hoping to find the money consolidation points or stash houses. The surveillance pictures do not really show that much, only a suspected hand off Taking a chance, the team on the drug supplier moves in on the target. The target spots the team approaching, takes the SIM card out of his cellphone, drops it down the sewer, and replaces the original SIM with a clean one. The police stop the trafficker, question him, and ask to see the phone. The police inspect the phone and a blank screen appears, or a picture of the suspect s mother comes up and no speed dial numbers appear in the directory other than mom The questions that law enforcement and prosecutors have to ask are; where is the evidence? Where is the value? How can we connect the pass to this runner? We could always grab the individual with the drugs and check his phone but the trail would lead to the missing SIM, if we were lucky. In the case of a near-field communications exchange via the RFID enabled phone, there may be no number showing on the recipient or transmitting phone. Even if a number were retrieved, not much could be done unless those who have access to the server are willing to assist. However, what server? The fact of the matter is that the server could be anywhere in the country or anywhere outside the country. Now where is the value? Depending Appendix 1 34

35 on the system, it will be where the bank or telecom server resides. It will not be on the mobile phone handset, but on the service providers computer server to be accounted for and decremented. These servers can be placed anywhere from floating platforms in international waters, to pieces of contested terrain held by militant organizations, to NCCT listed countries. In any case, cooperation and quick responses to investigative requests may not be forthcoming Easy peer-to-peer funds transfer makes wireless value transfer through international roaming susceptible to abuse by money launderers, especially if the systems are open ended and reasonable value transfer limits are not established. Technology has now provided the ability to bifurcate the token (i.e. paper money) from its value. 102 Criminals can go direct internationally with crime related value transfer making asset seizure and evidence collection more complicated. These developments will create a need for increased international cooperation and data sharing for analysis on suspect accounts, if in fact, accounts can be located Thought will also have to be given to KYC requirements in this digital age; perhaps a digital KYC needs to be explored on an international level. SIMs can be easily compromised, retrieved from stolen phones, and with the advent of third generation (3G) phone technology, can carry more than one phone number as well as Internet connectivity. This raises the possibility of the handset acting as a digital smurf. The cellphone SIM, if modified to be tumbled or programmed for up to 10 numbers can hold up to USD$10,000 in value based on the bank-centric limit of $1000 per day in the current Philippine configuration. The numbers/subscriber accounts can be rented by individuals to launderers or accounts can be opened specifically for the launderers. Unless service providers use appropriate pattern recognition technology, digital smurfs would be very difficult to detect Globe s Fraud Monitoring Systems are able to trace the origin of transfers from one SIM to multiple SIMs and from multiple SIMs to a single SIM. Hence, Globe s reporting of suspicious and/or significant transactions include not only those transactions that breach thresholds, but also those that show abnormal patterns. It serves as a best practice for others If the SIM cards cannot be retrieved from a suspect s mobile phone(s), there may be no evidence of a potential crime. Criminal and terror organizations continually change numbers to avoid detection. Removing an unregistered SIM card, costing less than $1 in some countries, and destroying it, is a cheap and easy way to avoid jail. Law enforcement officers and regulators must find ways to respond to this issue If the activities take place in a closed loop system, where each carrier will only use its own branded service like the Philippines, then the government will at least have an investigative starting point if they can identify the service provider. If the system, however, becomes open looped, whereby any prepaid phone SIM can be use to move value between various branded services, similar to the wire remittances storefronts in NYC, then wallet limits would be meaningless unless all branded services identified to that SIM could be consolidated for analysis Service providers computer systems are vulnerable to crime and abuse; internally from employees and externally from hacking and organized criminal incursions designed to steal services, compromise systems and to provide anonymous or phony subscriber accounts by bypassing the front-line account opening processes. These internal and external threats bring the anti-fraud and anti-money laundering objectives closely together. Appendix 1 35

36 151. Viruses have recently infected the mobile phone handset / SIM s, which poses another question. If a virus can penetrate the mobile phone handset/sim system, why can t a botnet 103 be run to move value without the owner being aware? This would be difficult in the Philippines since both systems send a confirmation message to the service user, but other emerging markets may not be as well regulated as the Philippines. The arrest of a 20-year-old California man accused of profiting from networks of hijacked computers, among the first cases of its kind, illustrates law enforcement's increased focus on the growing scourge of "bot" viruses. Malicious computer programs known as bots, short for robots, allow hackers to hijack thousands of far-flung computers and control them remotely. Criminals can use the commandeered machines to disseminate spam, hawk fake goods, send "phishing" s to steal bank and other personal information or bombard corporate Web sites with Internet traffic to extract extortion payments The case also highlights the role of electronic-payment services, such as ebay Inc.'s PayPal. According to the indictment, Mr. Ancheta accepted payments through PayPal, directing his customers to describe the transaction as "hosting" or "Web hosting" services in order to conceal its real nature [extortion payments]. 104 B. Anti-money laundering law enforcement operations will need to be more visionary 152. AML law enforcers need to plan to move beyond traditional pick-up and surveillance operations to other more pro-active strategies that will require a high level of technical skills. To support these initiatives, mobile commerce (M-commerce)/M-AML legislation relative to search, arrest and seizure may need to be enacted or existing legislation enhanced. There will need to be more emphasis on cyber-aml capacity building, and tools. If an open system between providers evolves, then AML controls will need to be rethought and a digital KYC method developed There will still be a need for money brokers and criminal organizations to organize their funds collection effort. Now would be a good time for law enforcement to initiate a program to penetrate these or at least debrief suspects who are engaged in criminal value transfer to see the extent of mobile phone abuse. Europe and Japan have extensive experience in mobile phone value transfer and may provide significant insight to others on the topic Law enforcers also have to rethink their strategies in gathering relevant information and evidence to prosecute money laundering. The physical evidence of only a decade ago is being replaced quickly with the digital evidence of today. Law enforcement and regulators are attempting to catch up with the criminals who are out to make their fortunes or wreak their havoc at the public s expense on the digital highway The Convention on Cybercrime of November 23, 2001, contains provisions for data preservation, international cooperation and digital evidence. The CoE effort has caused a number of countries to examine their own laws to see how they need to modernize in order to address the new Digital Silk Road realities. What evidence is needed to prove a crime in a borderless environment? How will crime be detected, investigated and criminals and terrorists be brought to justice? What internal changes to commercial, (e/m-commerce) and criminal (cybercrime) laws and regulations are needed to protect the society and ensure commercial safeguards in the digital highway? The discussions have focused on the crimes of fraud, child pornography, gambling, Internet attacks against service providers or users, but money laundering as such as been left to the FATF to address. As technology has converged with the Appendix 1 36

37 3G phones, money laundering needs to be part of e/m-commerce, cyber-crimes and critical infrastructure protection planning. C. Other Things to Think About 1. Public-Private Partnership 156. There are numerous other instances of the private sector and law enforcement working together. In the area of e and/or m commerce, the need is greatly increased due to the every increasing need on the part of law enforcement for the kind of sophisticated technical skills that will allow them to interdict and apprehend criminals operating in cyber space. Quite often, the regulatory and law enforcement communities lack this constant exposure to various technologies. It is a deprivation that undermines their ability to protect effectively the nation s financial systems. At the same time, the private sector could be victims of internal fraud or criminal manipulation of corporate assets by employees acting on their own or at the direction of an outside group, and in that case, it would have to turn to law enforcement for help The Philippines has a lot to be proud of in the rapid development of its telecommunications and financial services systems. The success of the anti-money laundering challenges of the cellphone value transfer program shows that the government and private sector in the Philippines can work together successfully. Both have a responsibility to protect their partnership and the critical infrastructure it represents. A suggestion on how to do this is to bring together computer security leaders from universities from across the country to build better systems and develop better policies for government and business. 105 Such an effort would build digital security capacity for the Philippines, allowing them to protect their own assets as well as to create a community of practice that would encourage more high skilled employment and international competitiveness. D. Increasing integration of telecommunications sector and cross-border digital value transactions require sharing lessons learned 158. Just as cross-border issuance of electronic money could limit the reach of national laws and regulations. 106 The transmission of digital values via cellular phone will have cross-border effects. It would be prudent for countries to discuss how such cross-border transactions and effects will be regulated The Bridge Mobile Alliance, 107 an alliance of eight of Asia-Pacific s biggest mobile operators is currently laying the groundwork for an estimated $40 million regional mobile infrastructure that will allow for seamless cross-border services. As the Bridge Mobile Alliance begins to implement its system of value transfer/micro-payments system, opportunities exist for public private partnerships to work with APEC and ASEAN, ensuring that appropriate anti-fraud and anti-money laundering protocols are implemented region-wide. The Philippines, South Korea, China, and Japan could pool their commercial, regulatory, and law enforcement experience. This kind of collaboration could serve as a regional opportunity to work out information sharing agreements, exchange lessons learned, and discuss regulatory and law enforcement requirements. E. International cooperation: the need to assist and be assisted 160. The Australian Crime Commission has pointed out the need for international cooperation in criminal investigations. More importantly, they have outlined the appropriate safe guards that Appendix 1 37

38 the private sector must employ to ensure that employees are not providing assistance to criminal organizations. On the international cooperation point, law enforcement must find a way to take on crime no matter where it happens, and either brings criminals to justice in the region where the crime was committed, or assists other countries in their enforcement and prosecutorial efforts. Below is an example of what did not work in one investigation. Earlier we mentioned that the USA had complained about the delays they encountered with Russian assistance in the WebMoney investigations. Australians, however, needed help from USA in their case but for one reason or another, it was not forthcoming. CASE STUDY: Internet s and Cyber cafes An established criminal network was involved in well-planned and methodically executed importation of ecstasy into Australia and its distribution throughout Sydney on the wholesale and retail markets. The network was totally conversant with modern forms of communication. The members of the network communicated via the American-based 'hotmail' system and the SMS text message facility on their mobile telephones. A member of the group used Internet Cafes to send s. Upon identifying this method of communication, attempts were made to establish subscriber details for those addresses. This request proved fruitless, as the offences did not relate to the US (either to or from), where the service provider was based. One member of the group was an employee of a telecommunications service provider and he would facilitate the provision of new mobile telephones and/or SIM cards for group members. He also used work to arrange the supply and distribution of narcotics to other staff members A lot can be said about international cooperation, but in practice the best method is always to bring, concerned people together on either the telephone or the internet with or without a web cam. It is important to be able to add life to the paper request to get better results. Resource constraints can slow things down, but should never terminate a promising case against a criminal/terrorist organization. Getting the matter into the hands of the right individuals or teams that have worked together in the past is critical. In certain circumstances, financial crimes investigators may have a larger problem than international cooperation in pursuing proceeds of a crime or terror funding in the wireless/internet world. VI. SPECIFIC RECOMMENDATIONS FOR THE PHILIPPINES 162. In June 2005, Executive Director Vicente Aquino of the Anti-Money Laundering Council (AMLC) of the Philippines briefed the delegates at the FATF plenary meeting in Singapore on the cellular phone value transfer system, and the regulatory regime used to ensure it would not be co-opted by money laundering and terrorist financing. 109 The FATF established a working group on new technologies shortly after to examine the effects of various new technologies on money laundering. Their comprehensive Report on Money Laundering and Terrorist Financing Vulnerabilities in New Payment Methods is available on the FATF web site. Thereafter, the Philippines, through AMLC, was invited to join the prestigious Egmont Group of Financial Appendix 1 38

39 Intelligence Units. 110 The year and a half effort that saw the FIU grow from non-compliant to a positive force in the worldwide anti-money laundering effort. Although there is more to do, the Philippines has undoubtedly established its worldwide credentials in the anti-money laundering field That the Philippines is showing leadership in this area is an accomplishment particularly when one considers that the Philippines was placed on the FATF Non-Cooperative Country and Territory list in The Philippines had long been considered a money-laundering haven due to the lack of appropriate anti-money laundering legislation and lax enforcement efforts. Years of martial law under President Ferdinand Marcos had left the country weary of property confiscation and the involvement of the military and law enforcement in financial crimes, money laundering in particular. Things began to change with the enactment of the Anti-Money Laundering Act in 2001 and the establishment of the AMLC All money-laundering investigations were to be handled by the AMLC. If police support was needed, it was obtained through the law enforcement liaison desks assigned either to the AMLC, or at the law enforcement agency (LEA). If an LEA then needed assistance, it could request help up the chain of command to the AMLC. 111 The AMLC executive directorate 112 managed everything related to money laundering analysis, investigation, regulation, trial case preparation and, in some cases, actual trials From 2004, Aquino and his team dedicated themselves to removing the country from the list. His teams remarkable progress was noted on February 25, 2005 when the Philippines was, in fact, removed from the list and complimented on its efforts for the preceding year In 2005 and into early 2006, the Philippines showed significant AML improvements. There was a dramatic rise in covered transaction and suspicious transaction reports, and the Supreme Court enacted civil forfeiture procedures. Public and private sector AML training sessions were carried out, and a number of investigations covering a wide variety of predicate offenses were initiated. In short, the AMLC is moving rapidly to meet its goal becoming a world-class institution and protecting the Philippines financial infrastructure At the inception of this project, Director Aquino asked how this study would help the people of the Philippines. The Philippines has set an example to others in the region and the world of how to erect an appropriate regulatory environment that permits business and society to flourish, but which poses challenges to criminals who try to manipulate it. There are, however, things that apply to everyone in the process and some specifically to the Philippines. A few are listed here for consideration: A. Public Private Partnership a) Know Your Employee (KYE) principles need to be adopted. Employees need to be screened and internal controls need to be in place to prevent suborning of internal systems for criminal purposes as identified in the Australian Internet example. b) Strong security of internal data servers and networks from hacking is critical for both the public and private sector. The young hacker that provided himself and his friends with cellphone accounts by hacking into a telecom server exemplified the importance. Additionally, substantial thought needs to be given to new antivirus and malware protections as exemplified by the discovery of the first Appendix 1 39

40 Trojan horse virus found on a Java software platform that will power a great number of 3G devices. c) Critical infrastructure protection of your nations financial and telecommunications infrastructure through teaming of regulators, law enforcement, academics, industry and technologists should be encouraged to determine the best methods to do this. (since the draft report was provided in July 06 the GoP has increased the funding for critical infrastructure protection) d) Focus should be placed on pattern recognition software to detect both fraud and money laundering in wireless value transfer. These are not mutually exclusive objectives; they are the same. Those who would steal your airtime would also use your systems to launder criminal proceeds. The NBI proved they are capable in arresting text scammers. Give them a chance to go after other criminals. e) P2P transfers are a wonderful way to bring a lot of happiness to people, especially children, who can get lunch money from their parents. The same miracle of the age can also pay for gambling numbers, drugs, revolutionary taxes, and blasting caps. Again, pattern recognition and close interaction with law enforcement and AMLC may help to ameliorate this issue, but probably not stop it. You should expect to see the type of criminal activity in your systems as you have seen on the Internet. f) A number of your firms refuse to pay revolutionary taxes and are penalized for it by exposing their systems infrastructure to terrorist attacks. Why not make sure that these criminals are pursued vigorously and do not have access to your systems infrastructure to finance their killing operations? The recent steps by the Philippine government to focus on this form of terrorist financing are encouraging and should be followed by others in the region. g) The account screening process should always be ongoing. With the very large second hand market for prepaid phones in the Philippines, it is likely that one of the cleared SIMS may end up in the hands of someone other than the original subscriber. It would be worthwhile to consider ways to check periodically on the owner of the cellphone or SIMs that are involved in financial activity. Thought should be given to using technology to match photocopied id s with subscriber accounts to ensure they are not being falsified. h) The Philippines has developed a very good model for others to follow. As your firms move into more prominent regional activity, like the Bridge Mobile Alliance, it is in your best interests to ensure that the regulatory model of close interaction and common sense, developed in the Philippines, is replicated in the region through partnership arrangements and technical assistance. i) Point of Sale locations pose a significant vulnerability for money laundering. The current due diligence used to establish account relationships in the Philippines seems to be working. However, time will tell. As in the New York City model, criminals will look to move the most funds into the least risky locations and to cash based business. It may be prudent to consider risk-based models of pattern recognition for high-risk businesses as defined by the AMLC. j) Handsets (i) There is a large market for second hand cellphones. Prepaid phones may have the SIM still active whether the phone is stolen, bartered or sold for Appendix 1 40

41 (ii) k) SIM (i) (ii) cash. It may be worthwhile considering, in cooperation with law enforcement and regulators, better ways to dispose of the old cellphones and their SIM s. (The Philippines should be credited for taking on this issue in August 2006). There are two identifiers on the handset, International Equipment Manufacturers Identity (IEMI) number, which identifies the handset, and the SIM, which identifies the subscriber account number. For security and anti-crime efforts, it may be worthwhile to consider tracking both numbers to determine if and when they are separated in order to determine unusual activity. For value transfer it may be worthwhile to establish a money services business (MSB) chip similar to the TK chip, which is used by the Bank of China, or the patented chip set used by SMART. An MSB chip may be more secure and easier to track from the other standard chips. Protocols could be instituted or developed to secure recovery or to disable unused or expired chips. A number of articles indicated that a SIM could be manipulated to act as a server. If that is the case, it is conceivable that a SIM could be used to hold numerous numbers, serving the role of a digital value smurf. Service providers and technologists in conjunction with the AMLC and law enforcement agencies to develop possible solutions to a SIM acting as a server or digital smurf for criminal purposes should explore these vulnerabilities. l) Digital Know Your Customer (KYC) (i) A wide variety of biometric handset security features already exist that will give customers comfort and trust in their cellphones. Consideration should be given to utilizing these features or a combination of several of them as a digital KYC, as noted in the preceding section. voice recognition facial recognition fingerprint recognition (ii) However, if any or all these features were added, misuse or possible hacking of the SIM must be considered as well, based on the findings of the Finland relative to non-encrypted fingerprint registration. m) There are others in the region making significant inroads in the m-commerce value transfer field. They will soon intersect with the Philippines. It would be worthwhile to convene a meeting with China, Japan, Singapore, and South Korea to share experiences in regulatory and security aspects of mobile phone value transfer. Appendix 1 41

42 B. Law enforcement a) Regulators and private sector partners need your help in evaluating crime in the mobile commerce system. You will see criminal activity before others. You know what you are looking for based on your experience and sources of information. (i) It is suggested that you work with your informants in gambling, drugs, terrorism, and arms trafficking to see if the mobile payment system is being used to move criminal proceeds and inform the AMLC. (ii) Examine what tools that may be needed to counter the potential abuse of m-commerce to launder criminal funds. For example: electronic search warrants; training for cellphone evidence recovery for current cellphones and 3 G Internet capable handsets; tools and/or training to read SIM s or other boards on handsets; In addition, the development of Internet capable teams to assist on investigations. (iii) Consider what tools you need to address money laundering and financial crimes in the era of e/m commerce. sting provisions to develop evidence of crimes; long term undercover operations capability; a forfeiture fund to support law enforcement operations; freeze orders to quickly block funds traveling in m-commerce or e- commerce; quick international responses for international cooperation; and Evaluation of international asset sharing to recover some of the investigative costs associated with these sophisticated investigations. C. Legal / Regulatory a) The major question for law enforcement is: What evidence is required to make an arrest and obtain a conviction? The merging of electronic and mobile commerce may require rethinking law enforcement operations and evidence collection. It may be worthwhile for the legal, regulatory, and law enforcement community to consider what needs to be addressed in the coming years. The Council of Europe Cyber-crimes Convention is a good place to start evaluating what needs to be done. FATF has provided some guidance on the money laundering aspects of m-commerce to date. Why not have the Philippines take the lead along with another Asian partner like Japan, through ASEAN or APEC and the APG to frame the issue for others? b) An evaluation of existing e-commerce rules and regulations should be conducted to ensure that m-commerce is well covered. Consideration should be give to mobile banking, which is surely on the way with the 3G cellphone platform. If a working group has not been established, it would be worthwhile to do so. Members should include regulators, financial, legal, law enforcement, academics, telecom, and public interest groups. Appendix 1 42

43 c) Assistance should be given to regional partners to enable them to establish appropriate regulations. The Philippines has done an exemplary job in balancing the needs of law enforcement, the financial sector, and the public good. It is a model worth sharing with others worldwide. d) As the cross-border movement of funds expands, it is likely that the Philippines may be facing a situation where the value of the money will lie on a server in a foreign country. This may impede regulatory oversight and law enforcement action. This possibility should be examined before the issue arises. e) Existing AML and safety and soundness audit inspections may need to be evaluated to include appropriate tests of electronic systems security, hardware, software, customer ID and point-of-sale samples, anti-virus protection, and internal policies and procedures relative to electronic systems security. This is exemplified in the abuses noted in the security section of the report. f) A critical infrastructure protection-working group for the telecommunications and financial sector should be established as an open forum to discuss new trends and threats to the countries financial and telecommunications infrastructure. The forum should include law enforcement, industry, AMLC, academia, technologists and other appropriate parties. g) Cross industry and regulatory collaboration will be essential in the m-commerce environment. Fast moving criminal and security activity will require imaginative and flexible responses. AMLC Executive Director Vicente Aquino, who stated on August 5, 2005 that the National Telecommunications Commission (NTC) and telecommunications companies have agreed to block the mobile phone numbers used in spreading the text fraud and possible capture those behind it, endorsed this type of collaboration. The agreement, forged by the AMLC and the NTC, offered an opportunity to immediately process requests and put blocks on certain cellular phone numbers, specifically those used in the text fraud, even before receiving a written request. 113 The National Bureau of Investigation (NBI), true to Director Aquino s word, arrested four suspects in Davao City on August 8, 2005 for stealing PhP155, 000 from Philippine OFW s in a texting fraud. At the time of arrest, police seized false identification cards, prepaid SIM cards, and deposit slips that the suspects used to prey on the victims. 114 The precedent set, this same teamwork can be focused on other criminal and terrorist activity. h) Consideration should be given to the development of a Cyberpayments Network Targeting Order as proposed by RAND Corporation to effectively monitor cross platform movement of funds. Consideration should be given to law enforcement access and privacy concerns. i) Revisit regulatory paradigms is now essential. For example, the telecommunications sector has been regulated on the basis of a public utility. What is n the interest of health, safety and public benefit via universal access. Where banking is regulated on the basis of safety and soundness with nondiscriminatory access. The new paradigm may be safe and sound universal access. The question is whether this paradigm is realistic or possible. Appendix 1 43

44 j) Revisiting regulatory concepts is equally required. For example, what is value, what is money, what is a deposit? Basic fundamental questions like this are needed to sort out the premises on which these services are offered and taken. Do today s definitions adequately address the expectations and agreement in the mind of the public as to the financial services the common man now has access to. D. How do we work together regionally 168. As noted in the report there are a number of different initiatives, regionally and internationally, that can help move the process of safe secure and crime controlled digital value transfer along. The question is how to bring it all together in a sustainable way. Perhaps a donor could start the process by bringing regionally concerned countries and organizations together to scan regional wireless value transfer innovations and best practices, from a technology, regulatory, law enforcement and systems security standpoint. That effort could generate regional recommendations for sustainable progress in implementation, safety and security. VII. SUMMARY & CONCLUSION 169. In looking back over the decade of profound change in the telecommunications and financial services arenas, Rubin s simple question posed ten years ago as to whether law enforcement was ready for the electronic wallet was profound. Taking ten years for regulators, law enforcement and government to answer in the negative, people still refuse to acknowledge the depth of change that occurs in a society when value transfer goes digital. The past decade has been used by law enforcement to get educated and armed to fight organized crime, money laundering and terrorist financing. More needs to be done now than ever The explosive growth in cellphones, payment possibilities and remittances puts everyone on notice that a portion and possibly a significant portion of the growth is related, directly or indirectly, to money laundering. There are many important competing policy concerns from financial stability, critical infrastructure, small value payment systems supervision and oversight to bi-lateral agreements providing for consumer protection of migrant workers and more efficient remittance processes Having stepped squarely into the future, the Philippines are leading the way with innovative business models that provide a poorly underserved sector of the economy with access to financial services for the first time. Not only are these business models creative, responsive and responsible, they clearly are what others in the region look to emulate. Improving the security and anti-money laundering will only add to the remarkable achievements the Philippines have already accomplished. Appendix 1 44

45 BRIEF HISTORY OF MONEY AND VALUE TRANSFER A. Where did money come from? 1. Our ancestors most likely began bartering one thing for another. When someone had something of value, and someone else wanted it, a trade naturally ensued. The advent of the wheel in Sumeria, in approximately 3500 BC, allowed commerce to begin to develop in earnest, as it provided an efficient method of movement for surplus products. By 3100 BC in Mesopotamia, the invention of writing made bookkeeping possible. Early lists of livestock and agricultural equipment 115 were discovered on clay tablets. In turn, the increasing organization and regulation of transactions, trade and surplus commodities turned barter, trade and plunder into what we understand today as true commerce. 116 Clay tokens were employed to record counts and to lesser degree commodities. 117 The tokens usually signified a unit of measurement, but they also served as the structural foundation for the practice of accounting, without which there complex commercial growth could not have been sustained. In a relatively sudden leap of about 400 years, Sumerian culture progressed from tokens and moved to script Those who stored commodities in the various temple storehouses received inscribed tablets or tokens as receipts for valuable deposits or trade purposes. 119 These receipts, scripts or tokens, were an acknowledgement of individual rights to property, in these cases, commodities. This progression from tokens to script would pave the way for the notion, invention, and use of money as Hernando de Soto noted, Money presupposes property Given these developments, it was clear that the time had come to codify the rules of the commercial road. Hammurabi, the sixth king of the first Babylonian dynasty, proclaimed a collection of laws to provide just ways for people of the land (to) establish truth and justice as the declaration to the land (and to) enhance the wellbeing of the people. 121 The Code of Hammurabi was a practical guide to life and commerce in his kingdom that took into account the darker aspects of human nature. There are references to examination of facts, and very significantly the first written reference to fraud, civil forfeiture and possibly the first references to money laundering. He wrote: 3. Law 37 if a man should purchase a field, orchard and house of a soldier, fisherman, or a state tenant, his deeds shall be invalidated and he shall forfeit his silver: the field, orchard or house shall revert to its owners It is believed that the king conveyed this property or state to the recipient and only the king or state was permitted to sell or speculate with it. Fraudsters or swindlers beware: the King protects his property and people! As history absorbed Hammurabi s Sumerian lessons regarding a legal property system, societies came to grips with property value, value transfer and predictable rules of commerce and acceptable commercial behavior. Those societies used and still use various objects as a means of exchanging value. Stone money measuring up to 20 feet in diameter was used on the Yap Islands as symbols of wealth. Although it was much too large to be considered pocket change, it certainly attracted attention. While no one would ever think of Appendix 1 45

46 counterfeiting the stone money, the real value of these coins was determined by the difficulty entailed in their production. 5. The dangers of the journey contributed to the value of the stone in trade. Often the pieces of stone were given the names of the men who had brought them back to Yap. The stones began to take on all the characteristics of money: A store of value A medium of exchange A Unit of Account. The stone money came in various sizes from tiny to 9-10 feet high weighing several tons. 123 Image: Yap Stone Money 6. The Romans used salt to pay soldiers, and it is from that practice that the word salary is derived. In Africa, elephant hair became a means of exchange, a tribute to its scarcity, strength and usefulness. In Siberia, black tea money was used Cowrie shells, a small, hard, pretty shell, served as a viable currency from the shores of the Indian and Pacific Oceans where they were found to Oceania, the Middle and Far East, and even as far away as Africa, to which they were exported. The Cowrie played such an important role in ancient China, for example, that its image in the Chinese system of writing came to represent the word for money. 125 In the Warring States period ( BC in China), bronze coins came into circulation and were widely used, together with seashell coinage. 126 As man has tried to find alternatives to moving orchards, cows, or grain silos from one place to another, various mediums of exchange developed. Appendix 1 46