What the Profession Needs to Know about Money Laundering.
By Wm. Dennis Huber and Larry Crumbley
There are difficulties in measuring funds channeled into financing terrorist organizations and activities worldwide. Various sources estimate this funding to be between $590 billion and $1.5 trillion through money laundering. PwC suggests that “money laundering transactions are estimated at 2% to 5% global GDP, or roughly $1-2 trillion annually.”
However, financing terrorist organizations and activities is not necessarily the result of money laundering. Financing terrorist organizations and activities may be accomplished by reverse money laundering, or “money dirtying” which may make financing terrorist organizations and activities even more difficult to estimate.
Just as evidence of fraud cannot be ignored, so too evidence of financing terrorist organizations can no longer be ignored.
The goal of money-launderers is, like that of a corporate enterprise, to maximize profits and reduce risk while the goal of terrorists, on the other hand, is to further a political agenda or ideology, or to destroy or kill with no regard to profits and with little regard for risk.
In advancing the agenda of a terrorist organization, whether by money laundering or reverse money laundering, the services of public accountants and accounting firms are considered to be indispensable. In addition, evidence of financing terrorist organizations and activities may be discovered in the course of providing professional accounting services such as an audit engagement.
Yet little has been written about the ethical or legal obligations of CPAs concerning evidence of financing of terrorist organizations and activities discovered during the course of providing professional services. Therefore, the ethical and legal obligations of CPAs concerning the financing of terrorist organizations and activities is not well defined or understood.
We argue that SEC Audit Requirements, PCAOB auditing standards, the AICPA Code of Professional Conduct, and state licensing statutes should be revised to explicitly recognize and impose ethical obligations and create legal obligations to report to appropriate authorities such as the Department of Justice and Department of Homeland Security evidence of financing terrorist organizations and activities discovered during the course of providing professional services.
Terrorism, Money Laundering, and Reverse Money Laundering.
In order to understand the ethical and legal obligations of CPAs concerning financing terrorist organizations and activities one must first understand the definitions of terrorism and the statutes addressing terrorism and financing terrorist organizations and activities. A terrorist is one who, either in an individual capacity or as a member of an organization, not only engages in an activity to commit or to incite to commit, under circumstances indicating an intention to cause death or serious bodily injury, a terrorist activity, but who either prepares or plans a terrorist activity, gathers information on potential targets for terrorist activity, recruits members of a terrorist organization, or solicits others to engage in terrorist activities.
Domestic acts of terrorism are acts that occur primarily within the territorial jurisdiction of the United States and involve acts dangerous to human life that are a violation of the criminal laws of the United States or of any State, and which appear to be intended to intimidate or coerce a civilian population, influence the policy of a government by intimidation or coercion, or affect the conduct of a government by mass destruction, assassination, or kidnapping. International acts of terrorism are basically the same as domestic acts, but which occur beyond the territorial jurisdiction of the United States.
The United States Code definition of a terrorist includes anyone who solicits funds or other things of value for a terrorist activity or organization, who commits an act that the actor knows, or reasonably should know, affords material support, including a safe house, transportation, communications, funds, transfer of funds or other material financial benefit for the commission of a terrorist activity. The operative term is “material support.” Title 18 U.S. Code § 2339B(a)(1) provides that “Whoever knowingly provides material support or resources to a foreign terrorist organization, or attempts or conspires to do so, shall be fined under this title or imprisoned not more than 15 years, or both, and, if the death of any person results, shall be imprisoned for any term of years or for life.”
Material support is defined as “(1)…any property, tangible or intangible, or service, including currency or monetary instruments or financial securities, financial services, lodging, training, expert advice or assistance, safehouses, false documentation or identification, communications equipment, facilities, weapons, lethal substances, explosives, personnel (1 or more individuals who may be or include oneself), and transportation, except medicine or religious materials.” Thus, according to this definition providing professional services to a terrorist organization (such as those of a public accountant) would be providing material support to the organization.
Congress made specific findings which are incorporated into the PATRIOT Act concerning financing terrorism. “Money laundering, and the defects in financial transparency on which money launderers rely, are critical to the financing of global terrorism and the provision of funds for terrorist attacks.”
Money laundering is “the process by which the proceeds of crime are put through a series of transactions, which disguise their illicit origins, and make them appear to have come from a legitimate source.” Money laundering is often conducted through financial intermediaries such as large international banks.
The money laundering process is divided into stages. Transactions are structured to camouflage the source of funds.
The layering stage involves a series of conversions of the funds to distance them from their source such as channeling the funds through a series of purchases and sales of investment instruments, wiring the funds through a series of accounts at various banks around the globe, or disguising the transfers as payments for non-existent goods or services giving them a legitimate appearance. Layering includes the use of correspondent banking, bank checks and drafts, money exchange and transfer offices, the insurance market, fictitious sales/purchases and fake invoicing, shell or front companies, underground banking, and black market foreign currency.
In the final integration stage the funds re-enter the legitimate economy by such things as investing the funds in real estate, luxury assets, or business ventures. Techniques used in the integration phase also include the use of derivatives markets, real estate acquisitions, the gold and diamond market, and the acquisition and smuggling of arms.
However, while terrorist use money laundering to fund their activities, financing terrorist organizations and activities does not fit well into any stage of the money laundering process, particularly the integration stage, since the goal of terrorists is not to maximize profits. Terrorist, therefore, frequently rely on reverse-money laundering with no attempt to disguise the source.
A tool often used by terrorists in reverse money-laundering not typically used by organized crime and drug cartels is a not-for-profit corporation. One reason for using not-for-profit corporations is to collect money from legitimate sources or receive money from legal activities (“clean money”) and use it for illegal activities, thus turning it into “dirty money.”
Because not-for-profit corporations in the U.S. are subject to much less oversight and monitoring as for-profit corporations, not-for-profit corporations may be particularly prone to financing terrorist organizations and activities, especially if a not-for-profit corporation is created as a shell corporation. “Charities represent a perfect cover for collecting large amounts of money for terrorist activities.”
Legal and Ethical Obligations.
Public accountants are increasingly responsible for assuring that companies have adequate systems of internal control that should include procedures to detect and prevent money laundering. But CPAs have no explicit legal or ethical obligations to report illegal acts that do not impact the financial statements.
SEC Audit Requirements. Section 10A of the Securities Exchange Act of 1934 mandates that each audit of the financial statements of an issuer shall include “procedures designed to provide reasonable assurance of detecting illegal acts that would have a direct and material effect on the determination of financial statement amounts…” If, in the course of conducting an audit the auditor detects or becomes aware of information indicating that an illegal act has or may have occurred, the auditor must consider the possible effect of the illegal act on the financial statements of the issuer, including any contingent monetary effects, such as fines, penalties, and damages.
If the auditor discovers that illegal acts were committed by the client during the course of an audit the auditor must first inform the “appropriate level of the management” and the audit committee. If both the appropriate level of management and the audit committee fail to take remedial action, the auditor must inform the board of directors. If the board of directors fails to act, the auditor must resign and inform the Commission. The auditor is granted immunity from liability from lawsuits when reporting illegal acts to the SEC.
These requirements are to be commended. However, they do not go far enough. Illegal acts are defined as “an act or omission that violates any law” which presumably means anti-money laundering laws and providing material support to terrorist organizations. If the illegal acts discovered during the course of an audit are acts related to the financing of terrorist organizations and activities a client is subject to fines. However, reporting such illegal acts to the SEC does little, if anything, to combat the financing of terrorist organizations and activities.
PCAOB Auditing Standards. Auditors have a responsibility, under certain conditions, to disclose to the Securities and Exchange Commission illegal act that the auditors conclude has a material effect on the financial statements.
Auditing Standards §2401 provides guidance on the auditor's responsibilities when a possible illegal act is detected. Illegal acts are defined as “violations of laws or governmental regulations.” However, consideration of laws or regulations are only from the perspective of financial statements assertions. Examples of laws or regulations to consider include those related to securities trading, occupational safety and health, food and drug administration, environmental protection, equal employment, and price-fixing or other antitrust violations. There is no reference to financing terrorist organizations or activities.
AICPA Code of Professional Conduct. The AICPA Code of Professional Conduct applies to all members of the AICPA, but only to members of the AICPA. The Responsibilities Principle maintains that members of the AICPA “should exercise sensitive professional and moral judgments in all their [professional] activities.” The Public Interest Principle urges members “to act in a way that will serve the public interest and honor the public trust.”
Decisions regarding information of financing terrorist organizations and activities obtained in the course of providing professional services involves moral judgments, the public interest, and the collective well-being of the community. The AICPA Code of Conduct therefore recognizes an implicit ethical duty to report to the proper authorities information of financing terrorist organizations and activities obtained in the course of providing professional services. Yet, fulfilling that ethical duty is blunted by contradictory obligations.
Confidential/privileged information. Members of the AICPA are prohibited from disclosing confidential client information without the specific consent of the client. Confidential client information is defined as “any information obtained from the client that is not available to the public.” While there are exceptions to disclosing confidential client information, none of the exceptions apply to reporting financing terrorist organizations and activities to proper authorities.
SEC auditing requirements and PCAOB auditing standards apply only to publicly traded companies. The AICPA Code of Professional Conduct applies only to members of the AICPA and membership in the AICPA is voluntary. But what of CPAs who neither audit publicly traded companies, or the CPAs who are not members of the AICPA?
State licensing laws. State licensing statutes and regulations place no affirmative duty on CPAs to report illegal activities of their clients, in particular with respect to disclosing or reporting evidence of financing terrorist organizations and activities. In fact, some states prohibit CPAs from disclosing client information even if related to a crime.
For example, Arizona confers a “confidential status” to information obtained by public accountants. Exceptions are granted to disclose information for compliance with ethical investigations or practice monitoring programs conducted by the accountancy board. However, no exception is recognized for disclosing evidence indicative of the commission of a crime, and no safe harbor against lawsuits for disclosing evidence indicative of the commission of a crime.
CPAs have no explicit legal or ethical obligation to inform the appropriate authorities (DHS, DOJ) of evidence of financing terrorist organizations and activities. Yet, even lawyers have an affirmative duty to report ongoing, intended, or future crimes.
Revisions of the Securities Act of 1934, PCAOB Auditing Standards the AICPA Code of Professional Conduct, and state licensing statutes must be revised to reduce the possibility of material support for a terrorist from reaching the organization before an attack occurs.
Financing terrorist organizations and activities is a crime, and the SEC requires CPAs to report evidence of a crime to the SEC. However, reporting evidence of providing material support to a terrorist organization to the SEC is too little, too late.
We therefore call upon:
- Congress to amend the securities laws by imposing an affirmative duty on auditors of publicly traded companies to report to the DHS, DOJ, and other appropriate federal agencies evidence of financing terrorist organizations and activities obtained during the course of an audit and to require auditors to resign from such an engagement.
- The PCAOB to amend auditing standards to impose a duty on auditors to report to the DHS, DOJ, and other appropriate federal agencies evidence of financing terrorist organizations and activities obtained during an audit and to resign from such an engagement.
- The AICPA to revise the AICPA Code of Professional Conduct to recognize and impose an ethical duty to report to the DHS, DOJ, and other appropriate federal agencies evidence of financing terrorist organizations and activities obtained during the course of providing professional services and to resign from such an engagement.
- State legislatures to amend state CPA licensing statutes to create a legal duty to report to the DHS, DOJ, and other appropriate federal agencies evidence of financing terrorist organizations and activities obtained during the course of providing professional services and to resign from such an engagement upon penalty of revoking the license to practice. State statutes and rules of privilege must be amended to provide a safe harbor against lawsuits.
This position does not mean that a duty must be imposed on CPAs to search for evidence of financing terrorist organizations and activities obtained in the course of providing professional services anymore then they now have a duty to search for evidence of fraud. But just as evidence of fraud cannot be ignored, so too evidence of financing terrorist organizations and activities obtained in the course of providing professional services cannot be ignored.
Wm. Dennis Huber, JD, LL.M., DBA, CPA, CFE, is on the faculty of Capella University, School of Business and Technology, in Minneapolis.
Larry Crumbley, Ph.D., CPA, CFF, CRFAC, MAFF, is at Louisiana State University, Dept. of Accounting, Baton Rouge, La.
This article is adapted from one originally published in the Journal of Accounting, Ethics and Public Policy, 18(1), 59-79, available at https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2941218, with complete footnotres and citations