Detecting money laundering and terrorist financing via data mining, JS Zdanowicz

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Content: By John S. Zdanowicz Detecting Money Laundering and Terrorist Financing via data mining
Using import-export information to improve financial transaction security. The terrorist attacks of Sept. 11, 2001 confirmed the importance of open source intelligence. The passage of the USA Patriot Act and the creation of the U.S. Department of Homeland Security signaled a new era in applying information technology and data mining techniques to detecting money laundering and terrorist financing. law enforcement agencies have traditionally focused on money laundering activities facilitated through transactions in the financial service sectors. Historically, banks and other financial service institutions were the main focus of law enforcement. Intelligence agencies are generally doing an adequate job curtailing money laundering through the front door (Financial Institutions) but have, to date, largely ignored money laundering through the back door (abnormal international trade pricing.)
Illustration By Peter and Maria Hoey
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The use of international trade to move money, undetected, from one country to another is one of the oldest techniques used to circumvent government scrutiny. Either overvaluing imports or undervaluing exports can achieve this transfer. If an imported product is overvalued, the foreign exporter receives an inflated value for the product, and wealth is shifted from the domestic importer to the foreign exporter. Normally, this would not be a financially profitable transaction for the domestic importer. However, if the domestic importer and the foreign exporter are colluding partners in the transaction, then both share in the transfer of money to the foreign country. Overvalued import transactions may result in three crimes: customs fraud, income tax evasion, and money laundering. The transaction may also facilitate the movement of money to a foreign exporter who may be an operative of a terrorist organization. An example of such a transaction is detailed in Figure 1.
Assume a terrorist or criminal wants to launder $1 million to a foreign country. He would need to have a foreign exporter to collude on the transaction.The set of transactions used to launder the money would include: 1. Foreign exporter purchases 10,000 razor blades for $0.10 per blade. ($1,000.00) 2. Foreign exporter exports 10,000 razor blades to a domestic importer for $100.00 per razor blade. (Total invoice $1,000,000.00) 3. Domestic importer receives 10,000 razor blades worth $1,000.00 but pays the foreign exporter $1,000,000.00. 4. Outcome: The domestic importer has moved $1 million to the foreign country less the $1,000.00 transactions cost of the razor blades.
Figure 1. Example:
An alternative method used to
Overvalued U.S. imports. launder money out of a country
to a foreign country is through the undervaluation of
domestic exports. Research indicates a majority of the
money laundered out of the U.S. is through under-
valued exports, which is preferred by terrorists and
money launderers for two reasons. First, most govern-
ments, including the U.S. Government, do not ade-
quately monitor their export transactions. The
undervaluation of exports is also preferred because it
allows the terrorist or money launderer to avoid the
use of financial institutions, which may be monitored
by government agencies. The money launderer con-
verts his illegal money into products by purchasing
products for cash at the market price of the product.
The products are then exported to a foreign colluding
importer at below market prices. The foreign
importer receives the undervalued exports and resells
them in the market at the real prices that reflect their
true value. An example of such a transaction is
detailed in Figure 2.
Money may be laundered into a country by
importing products at undervalued prices or export-
ing products at overvalued prices. Recently, there has
been concern these pricing schemes may be used to
finance the illegal activities of Al Qaeda Terrorist cells
operating in various countries.
Data Mining Methodology The analysis evaluates the 2001 U.S. import and export transactions data produced by the U.S. Department of Commerce, Bureau of Census, and contained in the U.S. Merchandise trade database. This is the same database used to determine the U.S. balance of trade.1 The estimate of money shifted out of the U.S. is based on pricing norms, (interquartile range), as spec-
Assume a terrorist or criminal wants to launder $1 million to a foreign country. He would need to have a foreign importer to collude on the transaction.The set of transactions used to launder the money would include: 1. Domestic criminal or terrorist uses his $1 million to purchase 200 gold watches for $5,000.00 per watch. ($1,000,000.00) The watches would be purchased for cash. 2. Domestic exporter sells the 200 gold watches to a foreign importer for $5.00 per watch. ($1,000.00) 3. Foreign importer receives the 200 gold watches and is presented with an invoice for $1,000.00, which he pays to the domestic exporter. 4. Foreign importer sells the gold watches at the market price of $5,000.00 per watch and converts the 200 gold watches into $1,000,000.00. 5. Outcome: The domestic exporter has moved $1 million to the foreign country less the $1,000.00 transactions cost of the invoice payment.
ified in the section 482 regulations of the U.S. Internal Revenue Service tax code. The
Figure 2. Example: Undervalued U.S. exports.
IRS defines suspicious prices as those import prices
that exceed the upper quartile import prices and those
export prices that are less than the lower quartile
export prices. They focus on abnormal transfer prices
between corporations that may result in shifting tax-
Toilet/Facial Tissue Threaded Nuts Tweezers ­ Base Metal Lawnmower Blades Razors
China Belgium Japan Australia U.K.
$ 4,121.81/kg $ 2,426.70/kg $ 4,896.00/unit $ 2,326.75/unit $ 113.20/unit
Abnormally high import prices from Al Qaeda watch countries
Cotton Dishtowels Glass Mirror (less than 929 sq. cm.) Razors Air Pumps (hand/foot operated) Camshafts and Crankshafts
Pakistan Indonesia Egypt Malaysia Saudi Arabia
$ 153.72/unit $ 164.54/sq.cm. $ 22.89/unit $ 5,000.00/unit $15,200.00/unit
able income and taxes out of the Table 1. Abnormally
U.S. An observed price deviation
high U.S. import prices.
may be related to income tax
avoidance/evasion, money laundering, or terrorist
financing. The observed price deviation may also be
due to an error in the U.S. trade database.
Calculation procedures and estimates of money
moved out of the U.S. The median price, lower quar-
tile export price, and the upper quartile import price
for every commodity exported and imported to and
from every country were determined. There were
16,390 import commodity codes and 8,568 export
commodity codes in 2001. There were 230 countries
1data source: CDIM (2001­01 to 12) U.S. Imports of Merchandise, and CDEX (2001­01 to 12) U.S. Exports of Merchandise; www.census.gov/foreign-trade/guide/.
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May 2004/Vol. 47, No. 5 COMMUNICATIONS OF THE ACM
The use of international trade to move money, undetected, from one country to another is one of the oldest techniques used to circumvent government scrutiny. Either overvaluing imports or undervaluing exports can achieve this transfer.
that traded with the U.S. in the same year. Every Conclusion
import record was evaluated and compared to the These estimates of money laundering and terrorist
country-specific import upper quartile price to deter- financing are based on the analysis of historical price
mine if it was overvalued. The dollar amount of over- data. This analysis could be conducted in real time to
valuation for every import transaction was determined. determine which transactions should be audited and
Similarly, every export record was evaluated
which cargo ship-
and compared to the country-specific export COUNTRY
DOLLAR AMOUNT MOVED ments should be
lower quartile price to determine if it was under- Malaysia
$ 2,220,978,718
inspected. The
valued. The dollar amount of undervaluation for
Diamonds ­ Not Industrial Forklifts, Self-Propelled Bulldozers ­ Self-Propelled video projectors ­ Color
India Jamaica Colombia Brazil
$ 13.45/carat $ 384.14/unit $1,741.92/unit $ 33.95/unit
Indonesia Saudi Arabia United Arab Emirates Egypt Total­Top 5 Countries Other Countries­20 TOTAL
$ 564,597,632 $ 486,669,248 $ 232,737,819 $ 148,085,489 $ 3,653,068,906 $ 619,142,176 $ 4,272,211,082
U.S. now requires that manifest information be sent to the U.S. Customs Agency
Missile and Rocket Launchers
Israel
$ 52.03/unit
24 hours in
Abnormally low export prices to Al Qaeda watch countries
Table 3. Money advance of the shipment from a for-
Color Video Monitors Color Video Monitors sports footwear (Athletic Shoes) Radioactive Elements, Isotopes
Indonesia Pakistan Jordan Egypt
$ 22.43/unit $ 21.90/unit $ 0.40/pair $ 0.01/mbq
moved from the U.S. to Al Qaeda watch list countries.
eign port. This requirement will help facilitate real-time audits and inspections of abnormally priced imports
and exports.
Table 2. Abnormally every export transaction was The efficient evaluation of data will be crucial to low U.S. export prices. determined. The dollar amounts winning the war on terrorism. Intelligence is an inex-
of all undervalued export transac- act science, but the utilization of information tech-
tions and all overvalued import transactions for every nology and data mining techniques applied to
commodity, for every country were aggregated. The financial transactions can contribute to increasing the
total estimated money moved out of the U.S. for quality of intelligence information. c
2001 was $156.22 billion. The details of this study
are contained in a report published by the Trade
ReSearch Institute (see cba.fiu.edu/finance/zdanowic). John S. Zdanowicz ([email protected]) is a professor of Finance
Tables 1 and 2 contain a variety of examples of abnormally priced transactions from among thousands such transactions identified in the 2001 U.S. Merchandise Trade Database.
at Florida International University, the former director of the Center for Banking and Financial Institutions, and a consultant to the U.S. Department of Justice on issues related to transfer pricing and money laundering and the U.S. Congress Office of Technology Assessment on the analysis of wire transfers.
Estimated amount of money moved to Al Qaeda
watch list countries. The amount of money moved
Permission to make digital or hard copies of all or part of this work for personal or classroom use is granted without fee provided that copies are not made or distributed for
from the U.S. to the 25 countries appearing on the profit or commercial advantage and that copies bear this notice and the full citation on
U.S. State Department's watch list is estimated to be
the first page. To copy otherwise, to republish, to post on servers or to redistribute to lists, requires prior specific permission and/or a fee.
approximately $4.27 billion. Trade with the top five Al
Qaeda countries on the list resulted in $3.65 billion
moved out of the U.S. to these countries (see Table 3). © 2004 ACM 0001-0782/04/0500 $5.00
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