Co-designing compliance to the Anti-Money Laundering Act within the small and medium enterprise sector

Author:Ameya Kelkar
Position:School of Mathematical and Geospatial Sciences, RMIT University, Melbourne, Australia

Purpose – Money laundering is a financial crime that does not directly affect a business but poses a serious threat to a nation's stability and security. The Australian Anti-money Laundering and Counter Terrorism Financing Act (AML/CTF Act – the Act) passed into law in 2006, but achieving compliance is proving a daunting task, especially within the small and medium enterprises (SME) sector.... (see full summary)


Money laundering (ML) and terrorism financing (TF) are serious threats to a nation's economic stability. Compliance with the Anti-Money Laundering and Counter-Terrorism Financing Act (AML/CTF Act) 2006, regulated by the Australian Transaction Reports and Analysis Centre (AUSTRAC), can help businesses protect themselves from being exploited by criminals and terrorists.

Small and medium enterprises (SME) comprise a significant part of the Australian economy ( ABS, 2001 ). Their participation against these activities is crucial. While a number of large financial organisations have reported on the high cost of compliance ( Sathye, 2008 ), SME can avoid compliance by ensuring their services are within the exemption criteria. This, unfortunately, makes SME attractive targets for ML, leading to the question:

Q1. How can AUSTRAC enforce compliance among SME

Ensuring compliance among SME is a complex issue, and a solution taking into account SME strengths and motivations is necessary ( Stappers et al., 2009 ). This paper looks at the efforts made by AUSTRAC to achieve compliance within the SME sector and proposes a co-design strategy to improve communication and education about ML and TF, and thus compliance within this sector. The co-design strategy presented in this paper builds on a design challenge undertaken by the authors along with four other team members in 2010 ( Rao et al., 2010 ). This design challenge resulted in an artwork which was exhibited in Melbourne, Australia, in November 2010. (A number of figures from this artwork are included in this paper.)

The crime and the regulation

Crimes like ML and TF seriously undermine a nation's economic stability. They can potentially affect the integrity and stability of financial institutions by reducing foreign investments and international capital flow. These problems evolve as criminals and terrorists try to find different ways to introduce illegal funds into the financial system ( IMF, 2001 ).

The aim of ML is to hide the source so that the money can be injected back into the legitimate financial stream, i.e. to hide the illegal means by which the money was earned ( Johnson, 2000 ). These crimes do not directly affect a business but can still have overwhelming social and economic consequences ( McDowell and Novis, 2001 ). Unpredictable movement of huge amounts of money can result in misleading market figures, thus affecting economic policies ( McDowell and Novis, 2001 ), while at the same time, human capital diverted to such criminal activities has a negative impact on society. Figure 1 provides an example of how pre-paid cards could be used to launder money across borders, using SME as the conduit.

Countries with weaker policies and regulations are more likely to be targeted by criminals ( IMF, 2001 ) with a review by the Financial Action Task Force (FATF) in 2005 highlighting many loop-holes in Australian legislation and indicating that the amount of money laundered in Australia exceeded AU$ 2B in that year ( FATF, 2005 ). In response to the review, the Anti-Money Laundering and Counter-Terrorism Financing Act (henceforth, the Act) came into force in December 2006 ( AUSTRAC, 2006 ) with the express purpose of bringing Australian anti-money laundering regulations in line with international standards.

AUSTRAC, the regulator of the Act, proposes a risk-based approach and has a number of compliance requirements which need to be fulfilled by the “reporting entities”, organisations that provide any service on AUSTRAC's list of “designated services” ( AUSTRAC, 2010c ). The Act requires organisations that provide these “designated” services to have appropriate controls in place to prevent and detect ML and TF, with maximum fines for non-compliance ranging from AU$ 2.2M for individuals to AU$ 11M for corporations ( AUSTRAC, 2010b ). In spite of this, achieving compliance is proving a daunting task especially within the SME sector.

SME and the effectiveness of the Act when applied to them

We start this section with a case study as a means of illustrating the problems with achieving compliance within this sector. The Act takes into consideration the difficulties that SME may face in implementing a risk-based solution and hence has exemption criteria to allow some relief to SME. No study has yet been done on the effect of the exemption criteria or on the feasibility of enforcement of the Act on SME across all designated services, but research done on a particular sector; the pre-paid card sector ( Choo, 2008 ; Gurung et al., 2010 ) has shown that it is possible for money launderers to exploit the loophole presented by the exemption criteria.

We summarise the case study by Gurung et al. (2010) , for illustration purposes.

Case study: the pre-paid card sector

The main challenge in the pre-paid card sector is, strangely enough, the definition of an SME itself. The most common definition of an SME is the number of employees; in Australia, a small business is defined as one that has less than 20 employees, while a business that has more than 20 but less than 200 is considered a medium-sized business. But this definition does not always work, as shown in the case of pre-paid cards ( Gurung et al., 2010 ).

Pre-paid cards, also called stored value cards or “pay-early” cards are classified as “non-cash payment” (NCP) facilities and providers of these cards are required by the Australian Securities and Investments Commission ( ASIC, 2005 ) to have a financial services licence. Certain, “low-risk” NCP facilities are waived from the licensing requirements. Such a waiver is termed unconditional. Examples of such low-risk facilities include gift cards and vouchers. There is also conditional relief available for those NCP facilities that are of “low value”, that is, of value no more than AU$ 1,000 ( ASIC, 2005 ). The vendors of the latter category are required to provide disclosure statements, clear fees and charges and terms and conditions to purchasers, etc. but do not need to obtain a financial services licence.

Based on this, Gurung et al. (2010) found that even businesses that would not normally be classed as SME (under the number of employees criterion) were offering pre-paid cards within these exemption criteria. Thus, Gurung et al. (2010) redefined SME in the context of pre-paid cards to mean those businesses which offered pre-paid cards that fell within the waiver category listed by ASIC (2005) , arguing that since the exemption criteria for NCP is there to provide assistance for SME, therefore all businesses that use these exemption criteria should be classed as SME. Thus, as per Gurung et al. (2010) , SME in the pre-paid card industry include gift card sellers such as large departmental stores (Myer, David Jones, Woolworths, etc.) as well as banks that sell what are called “semi-open-loop” cards of value less than AU$ 1,000. This classification by Gurung et al. (2010) illustrates the fact that the letter of the law may result in unintended consequences.

Gurung et al. (2010) go on to do a feasibility analysis of compliance to the Act by SME, and discover that out of the seven main areas of compliance, only two are fully applicable, while another three are partially applicable and two more are inapplicable. Employee due diligence and employee training are two compliance requirements that would ensure that SME employees are not condoning ML or, even worse, actively facilitating them. Gurung et al. (2010) conclude that while requiring compliance could cause excessive stress to SME, legislative compliance would definitely help them sustain their business.

Why are SME so important

SME comprise over 90 per cent of the Australian economy ( ABS, 2001 ) and provide around 42 per cent of total employment in Australia ( Ergas and Orr, 2007 ). Their involvement in the economy helps maintain healthy market competition ( Fan, 2003 ) preventing monopoly by larger organisations. In addition, they encourage entrepreneurship by providing the necessary funding and skill enhancement plans to make alliance of skills and innovation possible ( Dickinson, 2008 ). According to Liondis (2008) , small businesses are required to comply with the Act more for their own sake as otherwise they may fall victim to criminals. This is supported by the argument that money launderers hunt for unsophisticated financial markets and economies as their intermediaries to hide from the law ( IFAC, 2004 ). Consequently, SME participation in the fight against these activities could be considered crucial.

Larger financial institutions have resources and a history of exposure to anti-money laundering legislation ( Drummond, 2009 ), leading criminals to consider small businesses to be the weakest link by which to exploit legitimate financial systems. Unfortunately AUSTRAC's risk-based solution, which could be seen as flexible enough to fit large and small businesses, presents considerable disadvantages to SME ( Geary, 2009 ). These disadvantages will be expounded upon in the next section.

AUSTRAC has undertaken a number of initiatives to ensure and enforce compliance by all reporting entities, with some specific measures aimed at SME. The AUSTRAC web site forms the main source of information about the Act, presenting guidelines and compliance obligations ( AUSTRAC, 2010a ). There are on-line courses aimed at...

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