Online Gambling as a Game Changer to Money Laundering?

Transcription

1 Online Gambling as a Game Changer to Money Laundering? Ingo Fiedler Introduction $16 billion criminal proceedings are transferred yearly into the legal system by money laundering (UNODC 2011) Only about 02% are identified and confiscated The manifold negative consequences of money laundering are devastating and threaten the functionality of capital markets (Unger 2007) An important aspect of money laundering is that it is a necessity for organized crime Without money laundering most crime would not pay This paper analyses why the relatively new market of online gambling provides different opportunities to launder money cheaply and its consequences Starting point of this article is the distinction between criminals and money launderers and an analysis of their interaction on the market for money laundering The main part of this paper deals with the analysis of online gambling and its unique opportunities it provides to launder money Eight factors are identified that make online gambling prone to money laundering: (1) the virtuality of the products, (2) the virtuality of the cash flows, (3) the internationality of the cash flows, (4) the complexity of the payment processing, (5) the vast amount of legal and illegal players on the market, (6) unharmonized law and legal uncertainty, (7) very high payout percentages, and (8) tax-free winnings in many jurisdictions These factors lead to a very low risk of detection as well as low costs of money laundering Subsequently an analysis of three scenarios a small, a medium and a large drug dealer laundering their proceedings via online gambling provides insight into the procedure of money laundering Small and medium sums of criminal proceedings can be laundered using current unregulated gambling operators to transfer the funds into the legal system To launder large sums an online casino in a regulatory haven can be founded and fake revenues created which can be paid out to the owners as legal business profits The findings of this qualitative analysis of the online gambling market and its potential for money laundering are then integrated into the broader logic of the market for money laundering Online gambling, it is suggested, reduces the supply costs and leads to a decrease in the price criminals have to pay to launder their proceedings This increases the profitability of organized crime and its prevalence It is thus argued that online gambling is a game changer to money laundering This finding is then discussed from a regulatory perspective in the last section

2 2 The Market for Money Laundering An impressive literature has emerged on the economics of money laundering (see Masciandaro (2005), and Unger (2007), Gnutzmann et al (2010) for an overview) The existing literature, however, tends to treat the criminal, who generates criminal proceeds, and the launderer, who converts the dirty dollars into clean ones, as being one and the same individual This procedure ignores (1) the special role and features of the money launderer in the chain of crime; and (2) the reality, that most real-world investigations seem to suggest that the lions share of the laundering is done by professionals, and established institutions That is, the criminals mostly outsource the business of money laundering to an external service provider (McCarthy et al 2013) Thus, the criminal and the money launderer are often different identities By modeling their interaction with each other it can be shown that the interdependent variable is the price charged (or the share kept) for the service of money laundering This price directly relates to the utility function of the criminal who belonging to organized crime is a businessman rationally reacting to incentives Hence, tackling money laundering to increase the price paid by the criminal is a powerful tool to tackle organized crime indirectly The typical instruments of this strategy are to increase the detection and arrest rate of money launderers and the fine (monetary and in form of jailing) he has to bear once being convicted (McCarthy et al 2012) A similar but more subtle approach is to change the outcome of the bargaining between criminal and money launderer with the intention to raise the share of the criminal proceedings going to the money launderer as this reduces the profitability of crime and thus the overall crime level in society (McCarthy et al 2013) For this paper it is important that criminals need professional launderers to transfer the bulk of their illegal proceedings to the legal system (about 20%-40% are consumed directly, see Unger 2007) The price for the service of money laundering is determined on a market where criminals and money launderers are interacting As both parties are professionals they directly react to changes in their cost functions For the criminal that means that it becomes less attractive to engage in organized crime when the price to clean dirty dollars increases And for the money launderer it means that the higher costs of money laundering, eg in form of effort to disguise their activity or the expected fine of getting caught 1, the higher the price he will charge for his service While legislators and police forces try to tackle traditional ways of money laundering the criminal and launderer are constantly on the lookout for new and potentially cheaper ways to convert criminal into clean proceedings Finding such new ways of cheap laundering thus increases the overall crime level One of these cheap new ways to launder money is online 1 The expected fine of getting caught is the probability of being arrested times the fine to be paid in that scenario 2

3 gambling: it allows criminals to launder funds themselves at least at a small and medium scale by using existing gambling and it allows professional money launderers to launder huge sums by founding gambling operators 3 Money Laundering via Online Gambling Gambling is as a perfect tool for money laundering due to three reasons: (1) Gambling involves a huge volume of transactions and cash flows which are necessary to disguise money laundering (2) Gambling does not involve a physical product making it much more complicated to track the flow of money and proof real vs virtual turnover (3) Gambling wins are tax free in many jurisdictions All three aspects make gambling very attractive for money laundering The first reason reduces the risk of detection which translates to a decrease of the expected fine The second reason also lowers the risk of detection but also allows he operator to scale revenues upwards (to launder money) or downwards (to save taxes) The third reason reduces the costs for anyone using a gambling operator to launder money: while other types of money laundering lead to business profits which are taxed, gambling allows tax free crime proceedings Three different cases of money laundering via gambling can be distinguished (1) Illegal gambling is as an illegal transaction and all its proceedings are thus a money laundering offense per se (2) An illegal transaction occurred ex ante and the proceeds are then laundered by betting them and receiving any payouts as gambling wins (3) Gambling can be used as a payment tool for illegal transactions, for example by paying out gambling wins to the supplier of an illegal good The first case is not relevant to the issue of money laundering of organized crime proceedings; by making gambling legal this form of money laundering would disappear The other two forms of money laundering, especially the case where dirty dollars are used as stakes in games to be converted into gambling wins, are important as they allow drug or weapon dealers to transfer their illegal profits into the legal system The risk of money laundering via gambling is long known and casinos are highly regulated to prevent it at least in a larger scale However, the dawn of the age of computers and the Internet introduced a new way of gambling: online gambling In 2011 the mostly illegal or unregulated markets of online gambling yielded gross gaming revenues of $24 billion for the operators (H2GC 2012) Currently 2,926 websites offer gambling products like casino games, sports betting, poker bingo or so called skill games (casinocity 2012) To deposit, customers can choose between 235 different payment methods (casinocity 2012) These mostly include credit cards but also debit cards, prepaid cards, bank wire, ACH systems, cheques, player-toplayer transfers (P2P) and even (mobile-) telephone bills and cash Figure 1 gives a gross overview over the procedure of money laundering via online gambling relating to the scenario where an illegal transaction occurred ex ante online gambling The first step is to transfer a small amount of money from a legal bank account to a player ac- 3

4 count at an online gambling operator This is necessary for identification and verification purposes and also to later argue that these funds were used as gambling stakes This first step is observable for the financial intelligence Not observable is the second step where the criminal deposits his illegal funds via an anonymous method (eg a prepaid card) to the player account In the third step these funds are withdrawn to the legal bank account as tax free gambling wins (of course, not everywhere gambling wins are tax free but it is here assumed that a jurisdiction is chosen where they are tax free) If ever asked, it can be argued that these gambling wins resulted from the gambling stakes deposited in the first place Figure 1: Money Laundering where an illegal transaction already occurred Bank Illegal $ Deposit via eg prepaidcards Player Deposit for identification (tax free) gambling win Bank Figure 2 gives a gross overview over the scenario where online gambling is used as a payment tool for illegal transactions Again, the first step is a deposit from a legal bank account This time, however, the purchaser of the illegal good also deposits his money from a legal bank account to his account A He then uses a player to player transfer to send these funds from his gambling account to account B the gambling account of the seller of the illegal good The seller can then cash out the sum as tax free gambling wins Figure 2: Online gambling as a payment tool for illegal transactions Deposit Bank A Player Acc A Player Acc B Bank B Player-Transfer (P2P) (tax free) gambling wins A necessary condition for both forms of money laundering is that the gambling operator does not exchange his information with the financial intelligence, eg because he is unregulated and incorporated in an offshore jurisdiction But before both scenarios are discussed in more detail the complexity of the e-payment system in online gambling is described to argue why it is currently nearly impossible for the financial intelligence to detect and proof money laundering via online gambling 4

5 31 The Complexity of e-payment in Online Gambling Payment processing in online gaming takes place when a player deposits or withdraws money from an operator Figure 3 shows a simple general value chain of deposits The player chooses a deposit option, for example a credit card A payment processor then transfers the funds from his credit card to an account of the gambling operator who then issues them to the balance of the player s account The value chain for withdrawals is quite similar to that of deposits (see figure 4) Figure 3: The Value Chain of Deposits Player Deposit Option Payment Processor Gambling Operator Figure 4: The Value Chain of Withdrawals Player Withdraw Option Payment Processor Gambling Operator To show why such a simple transaction can be complex, consider the example where the player chose a payment gateway which is connected with his credit card to deposit funds Payment gateways are an intermediary between the operator and the processing platform Gateways are mostly used by merchants to consolidate activity across multiple points of sale They earn their revenue via licensing, installation, subscription, reporting and transaction fees (and offline, they also do business by selling or leasing hardware) Figure 5 shows a typical payment process involving a credit card payment and a gateway such as authorizenet, Servebase or Shift4 In the first step the player enters his credit card information on the operator s site The author then submits this information on behalf of the player to the payment gateway (step 2) The payment gateway receives this information and passes it on to the payment processor (step 3) In step 4 the payment processor approaches the credit card issuer (or the credit card network), who proofs the credit card information and determines if enough funds are available Next, the transaction is either approved or declined, and if approved the appropriate funds are provided to the payment processor (step 5) The payment processor then informs the payment gateway (step 6) which sends the information to the operator (step 7) Finally, the payment processor passes the funds to the operator s bank With a growing number of currently nearly 3,000 gambling operators in the internet and 235 different available payment options, e-payments in online gambling already seem complex But what makes money laundering really hard to be detected is the branch of payment pro- 5

6 cessors Besides some huge processors who are engaged in all online and offline markets there are thousands of small payment processors specialized in internet payments Little is known about these often very small businesses often because e-payment is a young phenomenon and these companies do not exist for too long But another reason is that at least the dubious ones are often incorporated in offshore jurisdictions This makes it already very hard to track cash flows and detect and proof money laundering The final step in hiding money laundering from financial authorities is that the business of e-payment processing does not involve high sunk costs that is investments which cannot easily be transferred and reused This allows quick and effortless re-incorporation of payment processors Figure 5: The payment process involving a credit card and a payment gateway Player 1 Operators Site 7 2 Operators Bank Credit Card Issuer Payment Gateway 6 3 Payment Processor These characteristics of the current online gambling market can be used for money laundering of small as well as large sums The following subsections discuss three examples of money laundering via online gambling in detail 32 Case I: A Small Drug Dealer Consider a small drug dealer, let s call him Edgar, located in Germany, who directly consumes most of his proceedings from illegal sources but now wants to transfer 10,000 to an official bank account so he can use it for investment and saving Figure 6 shows one example why online gambling is a perfect tool for this objective Edgar opens an account with one of the many casino operators, verifies his identity and deposits a small amount from his bank account He then uses his cash from his drug sales to buy 100 Paysafecards each at a value of 100 With these Paysafecards Edgar deposits the funds to his casino account Because transferring money is costly for an online gambling operator (they have to pay risk premiums 6

7 due to a higher than average risk of fraud and chargeback (CyberSource 2012; Davis 2012), especially in an uncertain legal environment), they restrict payouts so that the player has to gamble a given amount 2 Edgar begins to gamble and loses 5%, or 500, of his stake until he is allowed to withdraw the funds He then wires the money via three bank wires to his legal bank account As gambling wins are tax free in Germany Edgar has to pay only 5% of his proceedings to launder his dirty cash into clean Euros he can freely invest Figure 6: Example of using online gambling to launder 10,000 of illegal proceedings 10,000 Cash 100x100 Paysafecards Deposit 10,000 Play 9,500 3 Wire Transfers as Gambling Wins 9,500 Bank 10,000 Customers Fog: Not observable for financial intelligence 500 Operator Tax free income! Figure 7 shows an example where Edgar uses online gambling as a payment tool for his customers He opens an account with a sports betting operator, verifies his identity and deposits a small amount from his bank account Let s suppose he has ten customers and each buys drugs for 1,000 They use their bank account to deposit this amount to their gambling account and then send the funds via a player transfer to the account of the drug dealer Edgar gambles the necessary amount until the funds are not restricted anymore which comes at an expected cost of 500 Afterwards, he can pay out his proceedings as tax free gambling wins Figure 7: Example of online gambling as a payment tool for illegal transactions 1,000 Bank Customer A Deposit 1,000 Poker Customer A Player Transfer 10,000 Poker 3 Wire Transfers as Gambling Wins 10,000 Bank 1,000 Credit Card Customer J Deposit intelligence 2 How much the player has to gamble depends on the operator but can be estimated to lead to an expected loss of 5% of his deposit amount 1,000 Poker Customer J Fog: Not observable for financial Tax free income! 7

8 33 Case II: A Medium Drug Dealer Figure 8: Example of using online gambling to launder 200,000 of illegal proceedings 200,000 Cash Switch Country 200,000 Foreign Bank Couple of Deposits 200,000 Play 195,000 Wire Transfer + Phone Call Jackpot 195,000 Bank 200,000 Customer Fog: Not observable for financial intelligence 5,000 Operator Tax free income! Now, consider that our small drug dealer Edgar continued his career successfully and became a medium sized drug dealer His objective is to transfer 200,000 cash from illegal drug sales to a legal and official bank account in Germany Figure 8 shows how he can use online gambling to accomplish this task He either receives the money in a foreign country or takes the money abroad to an offshore jurisdiction where he deposits it to a foreign bank account where he can be sure that no information is exchanged with his local financial intelligence He then uses a couple of deposits to transfer these funds to his online casino account He gambles until his funds are not restricted anymore which yields the casino an expected profit (and the drug dealer an expected loss) of 10,000 and wires the remaining 190,000 to his bank account At the same time he calls his bank to announce the good news that he won a jackpot online and expects a wire of 190,000 to arrive soon As long as this does not happen regularly the bank cannot intervene Even if the bank gets suspicious there is no way to prove that these funds stem from illegal sources and not from winning an online gambling jackpot The reason is that Edgar was clever enough to choose an online casino which is incorporated in an offshore jurisdiction which does not share any information with the financial intelligence of other countries Edgar still knows how to use online gambling as a payment option for his customers But this time the amounts are higher than at the time when he was just a small drug dealer He now wants to disguise the flow of money even more Figure 9 shows Edgar s plan He advises his customers to not deposit the money from their bank accounts to a sports betting account where they initiate a player-to-player transfer but to open an E-Wallet account and use it as 8

9 an additional intermediary 3 His customers deposit funds in their E-Wallet and then send them to the E-Wallet account of Edgar to pay for their illegal drugs Edgar then transfers the funds via multiple deposits to his casino account where again he gambles before he pays out his proceedings as tax free gambling wins Figure 9: Example of using online gambling as a payment tool for 200,000 of illegal proceedings 20,000 Customer A 20,000 Customer J 20,000 E-Wallet A 20,000 E-Wallet J 200,000 E-Wallet Drug Dealer Couple of Deposits Fog: Not observable for financial intelligence 200,000 Play 5,000 Operator Wire Transfer + Phone Call Jackpot 195,000 Bank Tax free income! 34 Case III: A Huge Drug Dealer In the third case, our drug dealer Edgar has made a huge deal and is now confronted with the challenge to launder 200,000,000 of drug money Figure 10 shows how he can use the system of online gambling to turn his illegal proceedings into legal business profits Receiving the money abroad (or smuggling it) he deposits it in an offshore bank account where he can be sure that no information is exchanged with his local financial intelligence The next step 4 is to found an online gambling company, for example an online casino, which is officially owned by Edgar (or his in between letterbox companies) People are hired and casino software is bought Real games are offered to real customers The purpose, however, is not to serve the real customers but to launder the drug money Thus, fake accounts are set up and used to generate fake revenue This revenue is fully declared and paid taxes upon But Edgar, of course, searched for a regulatory haven with extremely low tax rates so that he expects to pay about 5% of his profits in form of real expenses and taxes The remaining 190,000,000 are business profits which he can legally pay out and freely invest 3 An E-Wallet is a virtual bank account that can regularly only be funded electronically Two e-wallets play an important role in today s unregulated internet gaming market: Skrill (formerly Moneybookers) and Neteller 4 To further disguise the origin of the money and complicate any investigations the money launderer might set up a couple of letterbox companies in between 9

10 Figure 10: Laundering 200,000,000 of illegal proceedings by founding an online casino Found a Gambling Operator in a tax heaven 200,000,000 Cash Switch Country Foreign Bank Create Fake Revenues (and Expenses) 200,000,000 Business Real Expenses and taxes 190,000,000 Business Profits Dividend payout 190,000,000 Bank 200,000,000 Customer Fog: Not observable for financial intelligence 10,000,000 Tax Heaven 4 The Effect of Online Gambling on the Market for Money Laundering Two different costs can be distinguished in the profit function of the money launderer: (1) the costs to perform the money laundering process and (2) the expected fine The more complex it is to launder money, the more time and resources have to be invested to reduce the risk of detection 5 The expected fine is the product of the fine times the probability of getting caught As money launderers can be expected to be highly rational criminals they react to changes in their cost functions That is, the higher the costs the higher the fee they will charge for their service And, in a competitive market, the lower the costs the lower is the price of money laundering The price of money laundering, in turn, is directly related with the profit function of the (organized) criminal The higher the costs of money laundering the lower are his profits (and vice versa) And as profit motivated criminals are as rational as every business owner they become more active the more crime pays (and vice versa) This logic implies that there is a link between the costs of money laundering and the crime level in society The essence of this relation can be shown in a typical market diagram with the y-axis representing the price of money laundering and the x-axis the quantity of money 5 The risk of detection will not be minimized but, in fact, the money launderer maximizes his payoff by minimizing the total costs of money laundering This maximum is reached when the marginal costs of reducing the risk of detection by a more complex procedure equal the marginal costs of the expected fine 10

11 laundering which equals the crime level (see figure 11) When the supply of money laundering is getting cheaper, the price of money laundering decreases With the demand curve of money laundering being negatively related to the price, this yields a higher quantity of money laundering and thus crime Hence, the higher the costs of money laundering the lower is the crime level and the lower the costs the higher the crime level Figure 11: The effect of decreasing costs of money laundering in a market diagram Price of ML Supply of ML (gets cheaper) Demand of ML Old crime level New crime level Online gambling is a game changer to this market It provides a way to launder money with an extremely low risk of detection Low and medium sums can be laundered directly by the criminal via existent operators of online gambling who transform illegal proceedings into legal gambling wins For huge sums a new online casino has to be set which is used to transform criminal proceedings into fake revenues, that is, business profits The reason for the low detection rates of these procedures is their offshore character The necessary information to detect and proof this kind of money laundering is not shared with local financial intelligence This is true at least for the unregulated part of the market, which can loosely be defined as the revenue generated by operators in countries they do not have a license to operate in Contrary to fully legal operators owning a license the grey operators are not obliged parties according to anti-money laundering directives And this grey market is the significant part of the market Even in countries like France, Spain or Italy in which legal operators play an important role, there still exist illegal offers In most countries, however, the market is not regulated at all which means only grey operators (which may be legal operators in other jurisdictions) serve the market For example, Germany is the largest market for online poker alt- 11

12 hough it is illegal to offer this product in Germany (Fiedler & Wilcke 2012) A loose estimate is that more than 80% of all revenues in the online gambling market are generated without a license The low detection rate of money laundering leads to an increase in crime (see figure 12): A low detection rate means a low expected fine and thus low costs of money laundering These low costs, in turn, lead to a lower price charged for the service of money laundering and translate into a higher profit for the criminal Profit motivated criminals react by expand their businesses which means more organized crime In essence, online gambling offers a low cost opportunity to launder money and thus leads to more organized crime Figure 12: How reduced detection rate of money laundering leading to more crime Reduced detection rate of ML Lower costs of ML Lower price of ML Higher crime profitability More crime 5 Conclusion and Regulatory Advice Organized crime needs to launder their illegal profits to invest it in the legitimate economy This leads to an estimated yearly volume of $16 billion being laundered (UNODC 2011) The higher the cost of money laundering the less crime pays Reduced costs of money laundering thus directly lead to a higher profitability and prevalence of crime This is the effect of the relatively new market of online gambling which comes with the potential to launder money cheaply Gambling per se is already prone to money laundering due to three reasons: (1) gambling involves a huge volume of transactions and cash flows which are necessary to disguise money laundering; (2) gambling does not involve a physical product making it much more complicated to track the flow of money and proof real vs virtual turnover; (3) gambling wins are tax free in many jurisdictions The huge potential for money laundering in online gambling lies in the combination of these reasons with complexity of virtual cash flows and multiple involved jurisdictions which are often regulatory havens, which do not share information with financial intelligence Hence, online gambling can be used to launder money easily Small and medium sums of criminal proceedings can be laundered using current unregulated gambling operators to transfer the funds into the legal system To launder large sums an online casino in a regula- 12

13 tory haven can be founded and fake revenues created which can be paid out to the owners as legal business profits All forms involve very low costs and a detection of virtually zero Online gambling is thus a game changer to money laundering It increases the profitability and thus the prevalence of crime All forms of money laundering in online gambling involve unregulated or illegal operators as they do not have to oblige to anti-money laundering directives but can hide in regulatory havens Legal operators, in contrast, are not prone to money laundering (Brooks 2012), especially because of the much lower payout ratios However, the online gambling market is still dominated by illegal operators; legal ones play only a minor role This leaves plenty of opportunities of money laundering The obvious way to tackle money laundering in unregulated/illegal online gambling is to introduce legal markets But this is far from sufficient Legal operators are far less attractive to customers due to lower payout ratios which result from taxes and fees the operators have to pay Even in regulated markets like France the illegal operators still play an important role The reason is a lack of law enforcement against unregulated/illegal operators For example, Germany is the largest online poker market worldwide although it is illegal (Fiedler and Wilcke 2012) Thus, the first and most important step in tackling money laundering in online gaming and preventing it from increasing the prevalence of organized crime in our society is to enforce the law against illegal/unregulated operators Literature G Brooks, Online gambling and money laundering: "views from the inside", Journal of Money Laundering Control, 15 (3), city, 2012, wwwcasinocitycom CyberSource, 2012, Online Fraud Report R P Davis, 2012, Opinion: Payment Challenges for the Emerging United States Intrastate Poker Market, Gaming Law Review and Economics, 16, H Gnutzmann, K J McCarthy, B Unger, 2010, Dancing with the devil: Country size and the incentive to tolerate money laundering International Review of Law and Economics 30(3), KJ McCarthy, PC van Santen, I Fiedler, 2013, Modeling the Money Launderer: Microtheoretical Arguments on Anti-Money Laundering Policy, working paper I Fiedler, A-C Wilcke, The Market for Online Poker, UNLV Gaming Research & Review Journal, 16(1), 5-17 H2GC, 2012, egaming data bulletin, reports for sale at wwwh2gccom 13

14 D Masciandaro, 2005, False and reluctant friends? National money laundering regulation, international compliance and non-cooperative countries, European Journal of Law and Economics 20, Unger, 2007, The scale and impacts of money laundering, Edward Elgar Publishing UNODC, 2011, Estimating illicit financial flows resulting from drug trafficking and other transnational organized crimes, United Nations 14