Know Your Customer (KYC): Regulation vs. Crime

How regulation has evolved in response to financial fraud

Financial fraud is so sophisticated these days that it can almost seem like it’s a new problem. Nothing could be further from the truth—there’s documentation from as far back as 4000 years ago in China about merchants moving funds to remote locations to avoid paying taxes. Some things never change.

In modern times, financial disasters often trigger governments and policy makers to enhance and expand regulation to prevent the fraud from reoccuring. Regulation is seen as the magic cure, but despite constantly expanding legislation, financial criminals always seem to be able to find new workarounds. Let’s take a quick look at some of the history of this escalating global game of cat-and-mouse. 

Legislation protected criminals at first

In the U.S., financial fraud went gangbuster (literally) in the 1940s, when infamous gangsters like Bugsy Siegel and Meyer Lansky started using casinos as a front for organized crime activity. Protected by the 1934 Swiss Banking Act, they funneled profits into Swiss bank accounts to avoid paying taxes. There’s speculation that Lansky left behind an estimated $300 million in secret bank accounts, but the money was never found.

Bank protections after WWII

After the Great Depression, banks became the institutions that everyone loved to hate. Why would you trust a bank after all of your hard-earned money mysteriously disappeared in one? The US government knew they had to do something fast, otherwise, the entire GDP was going to end up stuffed in mattresses and air vents. So, in 1950, Congress passed the Federal Deposit Insurance Act to restore the public’s faith in banks, and give banks tools to protect themselves from fraud by gangsters and other criminals. It also laid the groundwork for future KYC laws that we’re still using today.

Bank secrecy tackles money laundering 

The 1950 law wasn’t enough—organized crime and drug trafficking found workarounds and kept growing and expanding. Looking to prevent money laundering and funding of terrorist acts, the 1970 Bank Secrecy Act (The Currency and Foreign Transactions Reporting Act) was enacted in the US. The legislation imposed restrictions on all financial institutions in the U.S., including foreign banks with U.S. branches.

The internet changes everything 

When the internet hit the world in the 1990s, it made it possible for connections to be created easily between countries, giving a boost to international financial crime. The US and the EU responded with strict legislation that introduced the importance of Customer Due Diligence (CDD) and Know Your Customer (KYC) procedures.

9/11 and the war against terror

The terrorists in the 9/11 attack kept a significant portion of the funds they used for the attack in banks in the US and Europe. As a result, governments realized that financial data was an important component in the war against terror. The US passed the Patriot Act less than two months after the attack and the EU passed the second EU Directive (2AMLD) shortly thereafter. Both acts listed specific Customer Identification and Customer Due Diligence procedures for the KYC requirements for all financial institutions. 

Even the Swiss banks are held accountable  

Bradley Birkenfeld, a banker at the Swiss UBS bank became a whistleblower in 2007 and exposed Americans who had been using the bank to evade taxes. UBS was charged with tax evasion, which led to an amendment to the decades old 1934 Swiss Banking Act that had enabled financial secrecy for criminals.

The Panama Papers expose major fraud

In 2016, an anonymous whistleblower leaked 11.5 million documents to a German journalist. The documents exposed the network tax havens involving people and entities from 200 different nations. In response, the US Financial Crimes Enforcement Network (FinCEN) issued a rule requiring banks to get additional information from individuals who own 25% or more interest in a legal equity. 

Beyond regulation—protecting yourself from financial fraud today

The above review shows that even though the laws keep getting bigger, but the criminals keep getting better. Compliance with regulation hasn’t been enough to protect financial institutions from fraud in the past, and it’s safe to assume that it won’t be in the future. Fraudsters aren’t working off a government checklist, so you shouldn’t settle for compliance alone. The only way to protect yourself against financial fraud is to go above and beyond, and to use every resource available, including open-source data in your KYC procedures. Rest assured, the criminals are doing the same. 

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