Hedge Funds and Money Laundering

Money laundering is a heinous crime. Although it does not directly lead to loss of human lives, it allows money to reach the hands of wrong individuals. The proceeds from money laundering end up in the hands of gangsters, warlords, drug dealers and terror groups. No financial institutions would want to enable such transactions. However, many times hedge funds unwittingly become part of such transactions. In this article, we will understand how hedge funds can identify and avoid dealing with money launderers.

Declaration

Hedge funds are requested to take a declaration from their clients verifying that the money being invested has not been realized as a result of criminal or illegal activities. Also, hedge funds are required to ask their customers to give a declaration that their name does not feature on the list of high risk investors. In case their name appears on such a list, hedge funds are instructed to not accept money from them.

Symptoms of An Investor Being Engaged in Money Laundering

• Not Following The Process: Attempts to avoid the required documentation are a big red flag which the hedge funds need to watch out. People who want to launder their money have dubious sources of income. Therefore, they may not have the required paperwork or may be unwilling to provide details. Hedge funds need to ensure that they do not give leeway to any investor regardless of the amount that they propose to invest. Unethical individuals who indulge in money laundering have a strategy of overwhelming the fund with the scale of their investments and forcing them to avoid following the proper procedure. However, the recent crackdowns by the SEC and FSA have made this strategy redundant as funds are not willing to compromise on process.

• Questionable Backgrounds: Hedge funds are like a private club. The management of the fund has the right to decide who gets inside and who does not. Therefore, it is in the best interest of the hedge funds to stay away from people who either have a questionable background or associate with others who do. The media has already vilified the hedge funds several times. Associating with a questionable person may invite unnecessary scrutiny and media attention which is likely to do more harm than good. Also, in most cases the people who do associate with people like drug lords, mafia and terror groups, do in fact invest money in the hedge fund with an intention to launder it.

• Lying About Personal Business: Sometimes potential investors may have their paperwork in place. However, while talking to them something may seem unusual. They may be projecting themselves as being very successful at a legitimate business. However, they may know very few details or may avoid talking about their business altogether. In such cases, the hedge funds must verify their background since they could be potential money launderers.

• No Questions about Risks and Returns: Each hedge fund investment is worth a million dollars or so. Hedge fund managers therefore expect the investor to ask a wide variety of questions before they decide whether they want to invest or not. Significant sums of money require significant due diligence. However, in some cases, the investors that turn up at the offices of hedge fund seem all too eager to invest their money. They do not appear to be sophisticated enough to understand the investments that are being made and do not make an attempt to truly understand the risks involved. Hedge fund management must understand that the intention of these people is not to earn money by making investments. Instead they may be laundering the money and may be using hedge funds as a tool to do so.

• Wiring Money to Narco Destinations: A huge red flag that most hedge funds should stay away from is when investors ask the money to be wired to narco destinations. Many countries in South America and Central Asia are known for drugs. Often times, they resort to using the hedge funds in order to settle their accounts. For instance, an investor may put down a significant sum in a hedge fund and two months later may decide to make a withdrawal for no apparent reason. However, he/she may ask for the proceeds to be wired to nations where these criminal enterprises have a lot of clout. Therefore instead of using a bank transfer that would spark interest of the authorities, a fake hedge fund investment is used. Hedge funds may therefore become unwilling participants to money laundering schemes.

• Wiring to Unrelated Parties: Regulators have also instructed hedge funds to only wire funds back to the same people from whom they were received. Narco and terror groups had been passing off hedge fund investments to one another creating a complex web of transactions that becomes very difficult to trail.

  For instance A makes an investment in a hedge fund and while withdrawing the amount asks for the money to be deposited in B’s account. B then makes a separate investment and while withdrawing gets the money credited to C’s account. This process is repeated several times until a huge web of transactions is created to obscure the relationship between the sender and the receiver. To counter this problem, hedge funds must ensure that they only transfer money back to the same entity or person who invested with them. When people ask for their interests to br transferred to third parties that should be a definite red flag and must raise an alarm.

Hedge funds must therefore be very careful as to whom they accept money from. Failure to know the background of their customers is likely to get these funds involved in major legal hassles. Although, they are free from most regulations, they still have to be careful to not be part to felonies like money laundering.