Article by Dr Dayanath Jayasuriya published in Amicus Curiae - Journal of the Society for Advanced Legal Studies. The Journal is produced by the Society for Advanced Legal Studies at the Institute of Advanced Legal Studies, University of London

Jayasuriya, Dayanath

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26Amicus Curiae Issue 65 May/June 2006VULNERABILITY OF THE STOCK MARKETThe stock market is vulnerable to money launderingactivities in a number of ways, including thefollowing:1. One or more individual or corporate investors may beassociated with money laundering activities.Occasionally, there may be certain corrupt officialswithin stock broking firms, stock exchanges andregulatory bodies who may knowingly support thosewho engage in money laundering activities. Clearinghouses and depositories and settlement banks may beimplicated if they willingly permit a transaction even ifinformation is available that the funds are generatedfrom an illegal source.2. The nature of the trading instruments and the purposesfor which funds raised through the market are to bedeployed may be linked to money laundering activitiesor to fund the predicate offences such as drugtrafficking or terrorist activities.3. A listed company may be a front for a moneylaundering operation.Whilst this list is not exhaustive, it is necessary torecognize that in each of the situations mentioned above,there are underlying factors that facilitate the participationof individuals and corporate bodies linked to moneylaundering activities. A few examples will suffice tounderline how this occurs.Prescreening processThe registration or licensing of stock brokers and othermarket intermediaries used to be a routine function for thestock market regulator and the stock exchange, and it isonly in more recent times that stricter standards of duediligence have been applied. A company seeking a listing onan exchange goes through a screening process, but theprocess rarely captures the receipt or use of any fundslinked to money laundering activities. Details of holding,associated and subsidiary companies that are provided atthe time of listing may not be adequate to make anyjudgment regarding the operations of the entire group.Individual and corporate clients are required to furnishpersonal details to stockbrokers only in those countrieswhere there is anti-money laundering legislation. Securitiesand Exchange Commissions, stock exchanges and centraldepositories rarely undertake a detailed search with regardto junior level staff being recruited.Share trading transactionsTransactions may be funded from money linked tocrime, but unless the stockbrokers, the stock exchange,listed companies, banks and the regulators exercise a highdegree of vigilance, it will not be possible to track down thesource of income or the purposes for which the proceedswill be used. The large volume of transactions on thetrading floor can eclipse the occasional transfer that oughtto raise a certain degree of suspicion.Listing of IPOs and other instrumentsListing applications set out only in broad terms thepurposes for which the company intends to use the fundsmobilized through the IPO and other instruments. Thisinformation will generally be insufficient to provide any in-depth understanding of the business operations andbusiness plans so as to be able to detect whether there isany possibility of the funds being diverted for illegalpurposes.Good stock market governancein the context of anti-moneylaundering regimesby Dr Dayanath JayasuriyaIt is increasingly recognized that the stock market offers opportunities to launder funds. It is alsorecognized that good governance practices must be the norm in the corporate financial world.Despite increasing recognition on both counts, inadequate attention seems to have beenaccorded to the type of good governance practices that must be followed by stock market playersand stock market regulators to minimize the vulnerability of the stock market being used as amedium to circumvent anti-money laundering controls.Compliance and other reportsCompliance reports by firms of stockbrokers, and otherreports such those by audit committees and investmentcommittees and the annual reports of listed companies,may not necessarily accord much attention to theimplementation of anti money laundering controls.CONCEPTS OF GOOD CORPORATEGOVERNANCEConcepts of good corporate governance are beingfollowed by companies to varying degrees. In the absenceof a law or a mandatory code of conduct, a high degree offlexibility is available for a company to decide on the normsand structures of governance it may wish to adopt. Thepressure to adopt norms of good corporate governance ismounting due to various problems identified in the wake ofmajor corporate scandals and failures.The following are among the many underlying andcontributory causes identified in post-mortems that havebeen undertaken:• accounting deficiencies;• financial reporting deficiencies (“window-dressedaccounts”);• absence of processes for identifying, assessing,managing and minimizing risks;• front for organized crime;• lapses in regulatory oversight• lack of communication;• auditors’ negligence;• failures in acquisition or diversification strategy• in-fighting within board• negligence, misconduct or failures on the part of themanagementCorporate responses to such problems have been manyand varied. Each cause or problem area seems to lend itselfto one or more responses. The jury is still out; what worksis as much uncertain as what does not work. What hasworked for one company in one country has notnecessarily worked elsewhere to the same extent.Experience has, however, shown us that there are someessential building blocks without which one cannotconstruct a solid house of good corporate governance.INTEGRATING GOOD CORPORATEGOVERNANCE PRACTICES INTO ANTI-MONEY LAUNDERING CONTROLS IN THESTOCK MARKET CONTEXTAnti-money laundering activities within the stockmarket can be regulated through a series of measures,rather than through one single measure.Firstly, there needs to be a better understanding ofvulnerable situations; the danger each such situation posesto the economy, to financial institutions and society atlarge; and of the ameliorative measures that can beintroduced. In this connection more attention should begiven to the 1992 resolution on money laundering by theInternational Organization of Securities CommissionsOrganizations (IOSCO). Each Member State wasrequested to consider and strengthen the application of theknow your customer concept and the procedures forreporting suspicious transactions in the context ofsecurities market transactions. Monitoring and complianceprocedures were to be reinforced.An area covered in this 1992 resolution which has notreceived much attention in recommendations of certainother organizations that have also addressed the subject ofmoney laundering is that IOSCO Members must ensurethat there are procedures in place to prevent criminalsfrom obtaining control of securities and futures businesses.This requires, inter alia, working together with foreigncounterparts to share information, a process facilitated bythe IOSCO multilateral agreement.Secondly, compliance officers must be under a legal dutyto address specifically in their reports how they monitoredcompliance with anti-money laundering requirements, andthe problems they encountered. Their terms of referencemust refer to the specific task of monitoring compliance inrelation to these requirements.Thirdly, there must be meetings held periodicallyinvolving all securities market and bank regulators and therepresentatives of stock market players to address thecurrent state of controls and identify emerging trends andissues of concern. Annual state-of-the-art reports mightprovide useful information to guide future actions.Fourthly, audit and investment committees in companiesmust address the issue as to whether the internal controlsystems and other risk assessment methodologies in placeare adequate to prevent or detect money launderingactivities involving such companies, their shareholders orcustomers, and business partners. It is important thatsystems in place do not impose requirements which aredisproportionate to the objectives sought to be achieved,and that there is a healthy balance.Fifthly, a “fit and proper” test must be applied wherefeasible to ensure that institutions such as firms of stockbrokers and stock exchanges are run by persons withintegrity.Sixthly, standard business agreements must contain acommitment to avoid possible situations that might lendthemselves to facilitating money laundering activities withan obligation to report transactions or situations of asuspicious nature.In the context of anti-money laundering controls, thechallenge for those who deal with the stock market is to 27Amicus Curiae Issue 65 May/June 200628Amicus Curiae Issue 65 May/June 2006ensure that bridges are constructed between the twovertical control columns on anti-money laundering on theone hand and good corporate governance norms on theother. These should not be seen as parallel streams thatnever meet; each must reinforce and supplement the otherand the collective synergy that is thus generated shouldyield a bumper crop of good results.A culture of good corporate governance needs to befostered not only for the sake of giving effect to a conceptcurrently in vogue, but also because of our commitment tominimize crime and terror and prevent dirty money beinglaundered through the stock market.Dr Dayanath JayasuriyaVisiting Professor of Mercantile Law, University of the Free State, SouthAfrica; former Chairman, Securities and Exchange Commission and theInsurance Board of Sri Lanka

Good stock market governance in the context of anti-money laundering regimes

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