Financial Crime

Financial crime is any activity that allows an individual or group to unlawfully gain financial assets (including money, securities, or other property). It typically involves either directly stealing from a person or institution, or else illegally changing or obscuring who owns an asset.

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Financial crime is sometimes referred to as “white-collar crime” because it targets assets rather than people themselves, and so tends to be non-violent (but not always). In any event, it can still be extremely damaging to individuals’ financial situations, and even regional or global markets.

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What is Considered a Financial Crime?

Financial crimes can be divided into one of two categories. The first category is an entity generating financial benefits for themselves or others through deceptive or illicit practices. This can include a business employee using privileged information to misappropriate some of the company’s funds for their own use. Another example would be a criminal taking money or other assets from someone in exchange for a financial instrument (such as a check or money order) that turns out to be fake.

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The second category is an entity committing a crime that sets them up to commit another crime where they illegitimately gain a financial advantage or protect their financial benefits through dishonest or illegal methods. The most recognizable form of the latter is money laundering: putting the proceeds of crime through a series of complex transactions to make them appear as if they came from a legitimate source. Another example is people using shell corporations or shell banks to store their money, obscuring who owns it and therefore helping them avoid paying taxes on it.

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Financial crime has a broad definition that sometimes includes all illegal activity targeting financial institutions, or even any illicit generation or use of money for an advantage. Here are ten common types of financial crime.

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Fraud

Financial fraud crimes encompass any activities intended to gain or protect financial benefits through deceitful and unethical means. Fraud is a wide category that can include many of the other crimes on this list, such as impersonation, counterfeiting, identity theft, and falsifying business records.

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Money Laundering

Money laundering is a financial crime that aims to cover up the source of the proceeds of crime. Its first objective is to sneak money generated through illegal activities into a financial system (placement). Its second objective is to move that money around to build up a transaction history, giving it the appearance of legitimacy and making it difficult to trace back to its original criminal source (layering/structuring). Its final objective is to return the money to criminals for them to spend without attracting attention from authorities (integration).

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Terrorist Financing

Terrorist financing refers to entities providing financial assets to terrorists—both individuals and groups. Their aim is to help terrorists purchase weapons, supplies, and anything else they need to carry out attacks on innocent civilians.

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The penalties for being caught aiding terrorists are very severe, so terrorist financing is somewhat akin to money laundering. That is, criminals wanting to finance terrorists have to use tricks to sneak assets into legitimate financial systems, then conceal where the money is coming from and going to.

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Embezzlement

Embezzlement is when an entity is entrusted with—or given access to—funds to be used towards certain ends, with the entity then illicitly using that money for other purposes. They may transfer it to their own accounts or those of another, creating fake invoices or receipts to try and cover their tracks. Embezzlement often occurs within organizations and can range from petty theft to multi-million dollar schemes.

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Corruption and Bribery

Similar to embezzlement, corruption is when an entity in a position of power acts outside of its mandate in order to unlawfully gain advantages—including financial ones—for themselves or others. Corruption can actually involve embezzlement, and it can also involve bribery. 

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Bribery is the other side of corruption. It’s when an entity illegally gives financial benefits to authorities in exchange for receiving preferential treatment in decisions affecting the public. An example is a company paying officials in a country to get them to allow it to operate there without needing to comply with all necessary regulatory obligations.

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Tax Evasion

An entity intentionally not paying their taxes, or paying less tax than they owe, is a financial crime called tax evasion. There are several ways to commit tax evasion. One is to deliberately fail to report taxable income. Another is to purposely claim more tax deductions than one is entitled to. Refusing to file a tax return at all also counts as tax evasion.

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An entity may also commit tax evasion by storing or investing their assets in banks or companies in other countries, or that are “shells” (i.e. they have no physical location and/or no active operations). This allows them to falsely claim that they have fewer assets than they actually do, in an attempt to illegally pay less tax than they truly owe.

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Insider Trading and Market Abuse

Sometimes, an entity may cheat the stock market by buying or selling securities based on proprietary information regarding a company’s financial situation. This is called insider trading, and it’s a financial crime in many places. This is because the entity either was entrusted with the information for other purposes (similar to corruption and embezzlement) or outright stole it. So they got an unfair advantage by using information the public wasn't supposed to know (yet).

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There are other ways criminals can illegally manipulate stock markets. One example is “wash trading”—purchasing and then immediately re-selling shares in a company. This creates the illusion that the company’s stock is seeing a lot of financial activity, which can inflate its price.

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Another such scheme is called “pump and dump”. This involves an entity purchasing a low-value stock, then spreading rumors or other misinformation suggesting that the stock will soon increase in price. Their goal is to create a flurry of trading activity around the stock, thereby inflating its value. Then they sell off their shares for a profit before others realize the hype surrounding the stock was fake, and trading activity returns to normal.

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Forgery and Counterfeiting

Other financial crimes involve unlawfully manipulating or duplicating financial assets. These are known, respectively, as forgery and counterfeiting.

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Forgery is illicitly altering a genuine financial asset to create an unintended benefit. In check fraud, for example, a criminal may name a different payee on the check, or change the amount the check is for. They may even attempt to fake the signature or other credentials of the check payer or endorser to make it seem like they authorized the check, when in fact, they did not.

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Meanwhile, counterfeiting creates imitations or unauthorized copies of legitimate financial assets. The criminal’s intention is to spend these fakes as if they were genuine, hoping the other transaction party doesn’t notice the difference. However, many financial assets now have security features that allow people to tell the difference between an imitation and a genuine one, or when a genuine one has been illegally copied.

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Identity Theft

While identity theft doesn’t involve directly stealing financial assets, it’s often considered a financial crime anyway. This is because it’s typically used as a means of committing other financial crimes.

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The goal is for a criminal to steal someone’s private identity or account access credentials, then use them to forge the person’s authorization for transactions. This allows the criminal to illegally profit while the victim bears the costs.

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A criminal can use many different methods for identity theft. A common one is phishing, where they trick victims into revealing their credentials with an enticing and/or urgent request—often appearing as if it came from a legitimate and authoritative source. They can also break into online accounts to steal credentials or impersonate victims. Or they may simply purchase credentials exposed by data breaches from the black market.

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Cybercrime

As more financial activity moves online, so too does financial crime. Fraudsters are turning to digital channels for stealing money and authorization credentials, exposing sensitive information, forging and counterfeiting financial assets, manipulating markets, and committing many different types of fraud.

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Virtual currencies are proving to be especially popular tools for financial crime. Reasons for this include a current lack of financial regulations surrounding them, as well as most transactions being semi-anonymous. In addition, many virtual currencies have non-centralized administration on the blockchain, making transactions difficult to undo once recorded. 

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All of this has made virtual currencies ripe for schemes such as market manipulation, money laundering, terrorist financing, tax evasion, and other forms of fraud.

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According to the PriceWaterhouseCoopers 2022 Global Economic Crime and Fraud Survey, about 46% of organizations worldwide encountered some kind of financial crime that year. Financial crime is tending to target larger organizations—52% of those targeted in 2022 had annual revenues over $10 billion US, as opposed to 38% of companies with less than $100 million US annual revenue.

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And financial crime is becoming more costly, more often. Of larger companies experiencing fraud, 18% had their biggest incident of financial crime in 2022, costing them over $50 million US. And 22% of smaller companies experiencing fraud said their most disruptive financial crime experience cost them at least $1 million US.

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Here are some other financial crime trends to watch for in the coming years.

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The rise of financial crime in cyberspace

While global financial crime statistics show an overall downward trend, one notable exception is in cybercrime. The COVID-19 pandemic fueled the demand and adoption of instantaneous remote financial services, including neobanks, virtual currency trading, and embedded finance. 

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However, these services tend to prioritize smooth user onboarding and interface experiences at the expense of more robust security and risk assessment programs. This leaves them more vulnerable to bad actors—especially hackers, online fraudsters, and other external parties.

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A renewed importance for sanctions screening

Incidents such as Russia’s invasion of Ukraine in February of 2022 have put a spotlight back on sanctions list compliance. Organizations are scrambling to avoid being penalized for illegally dealing with dangerous individuals, groups, and countries—both directly and throughout their supply chains. This will be made more difficult by the increasing popularity of decentralized financing, such as through virtual currencies and crowdfunding.

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AI and other changing financial crime prevention procedures

Regulators and compliance teams continue to realize that if they want to keep up with modern financial crime, they need to do things differently. That includes adopting machine learning models to more accurately identify signs of financial crime, as well as prioritize the alerts most likely to be true positives.

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It also includes taking a more holistic, organization-wide approach to fighting financial crime. That involves stronger communication between departments to assess customer risk across both onboarding and ongoing financial activity. It also involves more stringent auditing processes to ensure all parts of an organization are on board with its overall compliance efforts.

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Again, while financial crime is typically non-violent, it can be used to cover up violent crimes that involve criminals taking what doesn’t rightfully belong to them. Beyond that, financial crime can have far-reaching socio-economic impacts that can threaten the administrative stability of entire countries, and even the world.

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Here are some reasons why.

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• Unfairly disadvantages legitimate private businesses: Individuals and groups that engage in financial crime sometimes conceal their activities behind “front” businesses. Since these businesses are backed by substantial amounts of illegal money, they can often offer their products or services at costs that legitimate businesses just can’t match.
• Warps industry supply and demand: Financial criminals invest in crime to profit. So when they do invest in legitimate industries, it’s often as a means of protecting their assets through money laundering and not because they expect returns. This false demand can put industries in danger of collapsing when criminals decide to move their money somewhere else.
• Threatens the stability of financial institutions: Financial institutions that house the proceeds of financial crime tend to see large amounts of money move around quickly. This is usually either to launder the funds or to keep them away from investigating authorities. That can cause liquidity problems for the FI, which in turn can cause customers to panic and go on bank runs.
• Interferes with government revenue: As part of protecting their proceeds, financial criminals will often try to avoid paying tax on them. This gives a country’s government less money to spend on important projects, makes tax collection more difficult, and often results in higher taxation on legitimate citizens.
• Hampers the economic growth of developing countries: Countries emerging as players on the world economic stage tend to be focused on growing their financial systems as opposed to regulating them. This makes them attractive to financial criminals, which makes them less attractive to people and companies looking to legitimately do business.
• Hijacks control of economic policy: Another danger of financial crime being popular in lightly-regulated developing countries is that its proceeds may exceed the budgets of governments in those countries. This effectively means that criminals are in control of the country’s economy instead of the legitimate government.
• ‍Contributes to moral breakdown: If financial crime is left unchecked in a country, it encourages more people to become involved. This results in more victims of criminal activities—such as drug distribution and human trafficking—who may eventually turn to crime themselves out of isolation and desperation. This cycle can subvert a country’s rule of law, and even its democratic principles.

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To illustrate what financial crime looks like in real life, here are a few famous examples of financial crimes that received significant media attention.

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Bernie Madoff’s Ponzi Scheme

Bernie Madoff founded a legitimate investment firm in the 1960s, but it eventually morphed into the biggest Ponzi scheme in history. It took money from investors and used the funds to pay out dividends to clients who had come earlier, instead of to back what customers actually wanted to invest in. The fraud, worth $65 billion, was publicly exposed in 2009. Madoff was sentenced to 150 years in prison, and died in 2021.

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Enron’s Accounting Fraud

At the turn of the 21st century, the American energy company appeared to be one of the most profitable corporations in the world. The reality, however, was that the business was deeply in debt. The company’s executives—along with accounting firm Arthur Andersen—had been hiding Enron’s money woes behind misleading financial reporting, accounting loopholes, and off-books subsidiary shell corporations.

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By late 2001, investors and journalists had exposed Enron’s fraud, putting the business on the verge of bankruptcy. The company’s collapse cost investors upwards of $74 billion US, and several executives from both Enron and Arthur Andersen were sentenced to long prison terms. The scandal led the US government to pass the Sarbanes-Oxley Act in 2002 to impose stricter regulations on corporate financial reporting.

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Martha Stewart’s ImClone Insider Trading Scandal

The famed retail entrepreneur, author, and TV personality was involved in a very public insider trading scandal in the early 2000s. Her former stockbroker, Peter Bacanovic, illegally told her that ImClone—a biotechnology company she had shares in—was about to have an experimental cancer treatment rejected by the Food and Drug Administration. Knowing this would drive down the company’s stock price, Stewart sold her shares a day before the announcement went public.

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The Securities and Exchange Commission launched an investigation, refusing to believe this move was mere coincidence. In mid-2003, both Stewart and Bacanovic were charged with insider trading. Stewart was found guilty and served 5 months in prison.

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Today, many criminals who commit financial fraud, launder money, and engage in terrorist financing are incredibly sophisticated and agile, allowing them to continue their criminal activity without detection.

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For businesses to avoid exposure to these sorts of illegal actions, they must take preemptive actions, including investing in the infrastructure and systems needed to prevent and identify any kind of criminal activity.

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Many of these financial crimes require cross-border transactions. Unfortunately, the current international financial network makes sophisticated criminal activity even more challenging to trace and prosecute. Money launderers leverage differences in regulations to move money between countries, clouding the trail.

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And those financing terrorist activities need to transfer money in and out of countries to execute their attacks. To complicate matters further, in-country connections such as government officials, bank employees, accountants, and others make it easier for these illegal cross-border transactions to go undetected.

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Most countries have deployed comprehensive regulations to enable financial institutions to help detect, investigate, and report suspicious activity.

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Banks and financial institutions must comply with the Bank Secrecy Act (BSA) in the US. In addition, the UK has instituted the Proceeds of Crime Act (POCA), while the EU has put in place the Anti-Money Laundering Directives (AMLD). All of these regulations are consistent with the guidance provided by the intergovernmental organization, the Financial Action Task Force (FATF).

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By complying with these regulations, financial institutions can help prevent financial crimes such as fraud, money laundering, and the financing of terrorist activity. On top of this, teams can optimize operations and reduce false positives. Compliance generally falls into detecting suspicious activity, investigation, and reporting to the appropriate government entity.

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Unit21’s Anti-Fraud and AML Infrastructure is Here to Help You Guard Against Financial Crime

There’s no denying that it takes a lot of work to stop financial crime. Compliance with national and international detection and prevention standards is a good start. However, this is often easier said than done. New types of financial crimes are constantly appearing as policies, procedures, and technologies change. So regulations—and, consequently, organizations’ compliance programs—have to adapt as well.

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Ultimately, countering financial crime is about risk management: knowing how and where an organization is vulnerable, and implementing the proper controls where reasonable—including identity verification, transaction monitoring, and case management. This helps the organization not only limit the chance of being victimized by financial crime but also work quickly to control the damage financial crime causes if it actually happens.

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Of course, using digital tools like Unit21’s is much more efficient than trying to handle everything manually. Contact us for a demo of how our infrastructure can save an organization time, money, and other resources.

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