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Repost: “A Critical Analysis of the Legal and Enforcement Framework Governing Canada’s Anti-Money Laundering and Anti-Terrorist Financing Regime”

Posted By August 20, 2019 No Comments

Presented to Dr. Martin S. Navias by Bartek Zalech
For the Course: Finance and Security: An Analysis of Terrorist Financing, Money Laundering, Corruption, and Sanctions.
January 10, 2019

War Studies Department
King’s College, London

This essay will review the ML and TF threat that Canada faces and will present the make-up of the AML/ATF Regime that has been put in place to defend Canada’s financial system from bad actors. Also a summary of the FATF’s 2016 MER of Canada will be presented and compared with Canada’s own review of its stated goals under the PCMLTFA. And finally a comparison of the two reports will lead to a presentation of which improvements to the AML/ATF Regime would allow for greatest detection and deterrence of ML and TF risks while minimizing the costs and burden to FIs involved in compliance and de-risking.

Canada has a population of roughly 36,5 million inhabitants of which 20.6% are foreign-born, a statistic that is the highest among G7 nation-states. Canada has a 1.8 trillion dollar (USD) economy making it the tenth largest in the world. All these factors along with the Canadian economy’s well-known characteristics of openness, stability, accessibility, and technologically advanced financial systems, which are based on the country’s strong democratic institutions make Canada a target for both domestic and international money launderers as well as individuals or groups that raise and move funds associated with terrorism. A 2015 assessment on the inherent risks of ML and TF showed that the key threat actors for ML were transnational criminal organizations (TCO) and professional money launderers. The TF threat was analyzed according to specific groups or actors that represented the highest level of concern towards Canada depending on factors such as geography, diaspora and ideology. Despite the vulnerabilities of TF within the financial system, the threat of TF in Canada is not as pronounced as in other parts of the world. The FATF assesses the Threat of ML as being higher than that of TF.  

Canada has set in place a rigorous AML and ATF Regime based on the Criminal Code of Canada, which led to the creation of the PCMLTFA. The policies and legislative framework that make up the PCMLTFA are led and coordinated domestically and internationally by the Department of Finance Canada (DFC). The broader AML/ATF Regime is comprised of 13 federal departments and agencies that act under the guidance of the Criminal Code and of the PCMLTFA and operate with an annual budget of roughly $70 million. The FATF published its latest MER of Canada in September 2016 with a strong grade: “Canada has a good understanding of its money laundering and terrorist financing risks and that AML/ATF cooperation and coordination are generally good at the policy and operational levels… Canada was found to have a strong set of AML/ATF legislation and Regulations but with some weaknesses noted.” 

Canada faces important ML risks both from within the country and from abroad, a 2007 report from CSIS estimated that POC generated anywhere from 3-5% of GDP, which represented roughly the equivalent of USD47 billion, whereas in 2011the RCMP estimated this sum to be between USD5 billion and USD15 billion. The greatest ML threat actors to the Canadian financial system are the transnational criminal organizations (TCOs). TCOs are the most capable of generating the highest POC and in exploiting the laundering of those proceeds due to the complex webbing of networks, methods and infrastructure they possess within and outside of Canada. The overall ML threat was rated “very high” for the following activities: corruption and bribery, counterfeiting and piracy, certain types of fraud, illicit drug trafficking, illicit tobacco smuggling and trafficking, and third-party money laundering. What appears to be a more worrying phenomenon; is the growing use or nexus between TCOs and “professional money-launderers.” These are large-scale sophisticated enterprises that usually take place outside of Canada and can have significant repercussions on the Canadian and international financial system. 

Public Safety Canada (PS) maintains that the principal terrorist threat to Canada remains Sunni Islamist extremism through individuals attracted by its ideology and groups like Daesh and al-Qaida (AQ). Other major terrorist threats to Canada are: right-wing, Shia and Sikh extremists. Daesh, AQ and Hezbollah continue to be the main concern since they have expanded financial capabilities around the world and networks that continue to use Canada to help in financing the costs associated with running their organizations.  An example of this is the threat to TF in Canada by Hezbollah, which has internationally ranging operations and a large following of Lebanese diaspora in Canada (roughly 40,000 in 2006) that help in funding the group back home through simple grass roots donations but also through deep pocketed successful businessmen and charities set up for educational and humanitarian aid destined for Lebanon.Another TF threat, are Canadians who simply send funds through formal and informal banking systems (EFTs or hawalas) to areas near conflict zones: in Turkey, Syria or Iraq. The newest trend to come out of ATF is to concentrate on actual cities and not just on broader geographic areas, which would help in freezing funds that are destined for high-risk cities known to harbor terrorists, such as towns in Iraq and Syria bordering with Turkey.  

Canada has established a strong AML/ATF Regime directed by the legislation found under the Criminal Code of Canada that deals with the penalties that an individual or organization may face by engaging in ML or TF, of importance to note is the extraterritoriality that the AML/ATF provisions are privy to. While ML and TF differ widely in their goals they tend to use the same set of vulnerabilities identified in a given financial system. Therefore we must assess the ML threat separately from the TF threat, but we can assess the ML/TF vulnerabilities without a great level of separation since they both tend to exploit the same sets of vulnerabilities within the financial system. 

The Canadian Department of Finance is the lead actor in the legislation that falls under the PCMLTFA, which applies to Canadian Reporting Entities (REs) and forces them to set up a compliance regime that is in line with the FATF and includes: using an RBA, having a policy to “know your customer” (KYC) in place, appropriate record-keeping, flagging STRs, and finally making sure to have risk assessment and mitigation programs. The private sector makes up the first line of defense against ML and TF, there are roughly 31,000 financial institutions (FIs) and designated non-financial business and professions (DNFBPs) that are required to report STRs under the PCMLTFA. The FIs, mostly the six largest banks or D-Sibs, and DNFBPs made up of: financial entities, securities dealers, money service businesses and life insurance companies, together make up what are called the REs, and are coached by the Department of Finance to use a RBA in both AML and ATF measures.

The AML/ATF Regime is built on three interdependent pillars: first, policy and coordination, which is led by the Department of Finance and provides the Finance Minister with all necessary information and emerging developments on combatting ML and TF. It is also responsible for developing AML/ATF policy related to domestic and international commitments. The Minister is also the individual responsible to oversee the FINTRAC. The DOJ drafts and amends statutory provisions dealing with criminal law and procedure it also negotiates and administers mutual legal assistance and extradition treaties. Global Affairs Canada (GAC) is responsible for the designation of entities and individuals in Canada associated with terrorist activities listed by the UN 1267 Sanctions Committee or under UNSCR 1373. Also, under this pillar is PS, which ensures coordination across all federal departments and agencies responsible for national security including TF matters. PS is also responsible for listing of terrorist groups or organizations under the Criminal Code of Canada.

The second pillar of prevention and detection involves the following departments and agencies: FINTRAC Canada’s financial intelligence unit is responsible for supervising and monitoring REs. For example if a RE files a STR or a large cash transaction it goes to FINTRAC for further review. FINTRAC is responsible for the production of the financial intelligence that will support the other investigative and intelligence partners that make up the AML/ATF Regime. The OSFI works closely with FINTRAC in monitoring and supervising Federally Regulated Financial Institutions (FRFIs). Another department involved in prevention and detection is the Innovation, Science and Economic Development Canada (ISED) that collects information about business corporations, including the name, address, and information about the directors.

The final pillar deals with investigations and disruption and is made up of multiple law enforcement agencies (LEAs), intelligence services, and other relevant departments. The RCMP is Canada’s main LEA responsible for investigating predicate offenses, ML, PF and TF. Working in conjunction with the RCMP is the Public Prosecution Service of Canada (PPSC) that is responsible for prosecuting criminal offenses under federal jurisdiction. The Canada Revenue Agency (CRA) has its own Criminal Investigations Directorate (CID) that works closely with the PPSC in cases involving tax fraud or tax evasion. The CRA also plays an important role when it comes to TF, as many charities have been abused by terrorists for funneling funds from one country to another, the CRA must administer the registration system for charities under the Income Tax Act through its Charities Directorate. The Canada Border Service Agency (CBSA) is responsible for enforcing cross-border reporting obligations. CSIS is responsible for gathering, analyzing and preparing daily briefs to the Prime Minister and his National Security team regarding any information or intelligence that could be a threat to the national security of Canada. And the last department under this pillar is Public Services and Procurement Canada (PSPC) that is responsible for managing the assets seized by LEAs in connection with criminal offenses. 

As stated in the introduction the 2016 FATF MER of Canada’s AML/ATF Regime showed that Canada has a good understanding of the risks it faces when it comes to ML and TF threats, as well as having a strong set of AML and ATF legislation and regulations, there are certain areas that remain vulnerable to ML and TF operations. In the first section of the report entitled “Effectiveness and Technical Compliance Ratings” which is made up of eleven Immediate Outcomes, Canada had five scores of “Substantial” for IOs 1, 2, 3, 9, and 10, five scores of “Moderate” for IOs 4, 6, 7, 8, and 11 and a single score of “Low” for IO 5, which pertains to the “Transparency of Legal Persons and Arrangements.” This Immediate Outcome 5 goes along with Recommendation 25 of the “Technical Compliance Ratings” that was deemed “Non-Compliant” by the FATF. Canada must recognize the importance of ensuring corporate ownership transparency to prevent the use of complex corporate vehicles for ML and TF purposes. Presently (since 2014) there are only four REs sectors: financial entities, securities dealers, money service businesses (MSB) and life insurance companies, which are obliged under the PCMLTFA to collect beneficial ownership information on corporations, trusts or other complex legal entities. Because beneficial ownership information is harder to obtain for legal entities, legal arrangements and trusts than it is for legal persons (publicly available) this causes a loophole that is at high risk of being taken advantage of for ML and TF purposes. In the second section of the 2016 FATF report: “Technical Compliance Ratings”, which evaluates Canada on its performance with regards to the 40 Recommendations that the FATF formulated in 2012. In this section Canada was deemed “Non-Compliant” for the following Recommendations: R.12, 15, 22, 23, and 25. Recommendations 12, 22, and 23 are in some ways linked to each other since Politically Exposed Persons (PEPs) under R.12 PEPs are especially vulnerable to corruption and ML. Only four REs that fall under the DNFBP umbrella are presently subject to obligations to identify PEPs in certain situations. Canada must extend the reporting requirements against PEPs to be fully vetted through enhanced customer due diligence methods by a majority of DNFBPs (R. 22 and 23).  The AML/ATF framework could be strengthened to incorporate more DNFBPs to have the same reporting obligations such as other FIs like the D-SIBs. This would allow for DNFBPs like finance and leasing companies, unregulated mortgage lenders, and the real estate sector to be obligated in reporting under the scope of the PCMLTFA. Recommendation 15 has to do with “New Technologies” such as virtual currencies, online casinos and prepaid payment products. Unfortunately the PCMLTFA did not have the proper legislative and other enforceable obligations to deal with the risks caused by the development of new technologies at the time of the FATF evaluation. It is currently working on legislation to deal with this vulnerability. 

The recommendations made in the 2016 FATF report and Canada’s own 2018 review of AML and ATF Regime make for a broad scope of new policies and measures that could be added to the current PCMLTFA and its Regulations in order to improve the effectiveness of Canada’s AML/ATF Regime. An RBA should continue to be applied in all areas where it is deemed appropriate. Most importantly as a first step Canada must aim to comply with the latest MER, especially with IO.5 and Recommendation 25, because Canada does not have a single central registry for the information pertaining to the beneficial ownership of corporations or other types of legal entities. Instead this information is spread out across multitudes of different statutes such as incorporation, tax, and financial authorities. To try and remedy this complex issue the Government of Canada announced that it is working to establish a national strategy to enhance the transparency of legal arrangements and strengthen the availability of beneficial ownership information. In December 2017 the Department of Finance agreed to pursue legislative amendments to corporate statutes at federal, provincial and territorial levels, which are intended to come into force by July 2019 and are designed to improve corporate transparency by providing standardized directions to corporations as to what information they should record and maintain regarding their beneficial ownership. Included in this effort is the passage of Bill C-25 that would eliminate usage of bearer shares. By creating legislation that would force more DNFBPs to gather appropriate beneficial ownership information there would be a much higher percentage of the 31,000 REs that would be contributing in this area. 

Another area that must be improved upon is the number of new entities that present serious ML and TF risks and should be under the obligations of the PCMLTFA. As ML and TF schemes evolve and present new vulnerabilities and risks to the financial system, so must the government by modernizing the framework and its supervision and therefore the following high-risk entities should fall under the jurisdiction of the PCMLTFA: white label or privately-owned automated teller machines (WLATM), Pari-Mutuel Betting and horse racing, expanding the scope on the real estate sector and the non-federally regulated mortgage lenders, non-transactional activities of DNFBPs, company service providers, finance, lease and factoring companies, armored cars, high-value goods dealers, and finally jewellery auction houses. Another way to bypass the PCMLTFA is by setting up a business model in a way that avoids the triggering of STRs to FINTRAC. In Canada this practice of “smurfing” is not illegal and the Department of Finance is looking at ways to eliminate this deficiency by implementing an explicit prohibition on structuring of transactions to avoid reporting requirements.  

Another crucial area in which Canada can make changes to existing legislation in order to better detect and deter ML and TF is in the realm of information sharing. The current laws in Canada have certain restrictions on information sharing between the public and private sector and within the government itself. Not all departments and agencies under the PCMLTFA are listed as disclosure recipients and hence they cannot receive designated information from FINTRAC, only Canadian LEAs, the CBSA, the CRA, and CSIS can receive such information in specific circumstances. The private sector’s information is protected by the Personal Information Protection and Electronic Documents Act (PIPEDA), which sets out measures to protect the personal information of Canadians and also requires the private-sector to obtain consent for collecting personal information as well as disclosing it to other parties. The language of PIPEDA should be re-crafted in a way that puts organizations at ease to be able to rely on the exemptions of the act to pursue effective and appropriate exchange of information not only between private sector organizations and government institutions but also between private sector organizations. Finally once the information relayed to FINTRAC is converted to financial intelligence, and is cleared to be shared, it should be communicated to support both domestic and international partners in AML/ATF related investigations and prosecutions. The collaboration between REs, FINTRAC, national security agencies and LEAs should decrease the threats posed to the Canadian financial system by allowing for relevant information to be exchanged in a timely manner.

The modernization and supervision of the AML/ATF regime in certain key areas can also help in better detecting ML and TF in Canada. MSB de-risking has proven to be a challenge in MSBs maintaining bank accounts with FIs because of the continued perception that MSBs are high-risk institutions and also because some FIs perform their KYC policies in ways that are excessive and burdensome. FINTRAC has also found that there needs to be improvement in the way that MSBs registration applications and procedures are being handled. While the issues around MSBs are known there does not seem to be any solutions that have been brought up to address them as of yet. The AML/ATF regime currently has an existing whistleblowing framework, however the whistleblowing program could be strengthened in several ways. Finally and most importantly administrative monetary penalties or AMP need to be revamped in Canada to have a greater effect on deterrence against individuals who don’t respect their compliance obligations under the PCMLTFA. FINTRAC should develop a transparent formula for determining a penalty amount when there has been a violation to the AML/ATF Regime, and this formula should be employed to calculate monetary penalties.  This would provide increased clarity in the AMP process.

Finally Canada’s AML/ATF Regime can be strengthened in two other areas: strengthening intelligence capacity and enforcement and applying stricter penalties to those found guilty of ML or TF. Under “intelligence capacity strengthening and enforcement” the following steps should be taken by LEAs, intelligence agencies, and the private sector in order to keep up with evolving criminal schemes: Under the PCMLTFA, EFTs over $10,000 are reported to FINTRAC when they are initiated by a client. EFTs are not captured when they pass through a Canadian financial entity which is not the sending nor the recipient destination. This results in a gap in the information that FINTRAC receives and prevents it from identifying potential ML or TF transactions. This gap must be addressed by the proper legislation. Another area where intelligence strengthening should take place is under the PCMLTFA and the introduction of geographic targeting of orders under this Act. Some geographic areas are targeted because they are popular destinations for real estate and luxury goods purchases through bulk cash. Geographic targeting orders assessed through an RBA could improve financial intelligence and cause for the establishment of obligations for individuals and companies at heightened scrutiny that exist within a geographic area where transactions are at a higher risk for ML and TF. Finally, the border is another area where intelligence gathering and enforcement vulnerabilities have been identified. While there is no easy way to stop smuggling of illicit substances or bulk cash there could be tougher legislation on cross-border reporting and also reviewing the penalties associated with failing to declare currency and monetary instruments, as currently they aren’t sufficiently high enough to serve as an effective deterrent. The FATF also indicates that criminal sanctions against ML offences are not sufficiently dissuasive since the majority of convictions, even for professional money launderers, fall in the lower range of sentencing guidelines of one month to two years.

Canada is not a new economy that’s just beginning to put in place a compliance regime, in fact Canada is one of the founders of the FATF and has acquiesced with most of the recommendations it has received from MERs and from its own PCMLTFA reviews. If we look at the Basel Institute’s AML/CFT index for 2017, Canada is ranked 103rd with a score of 5.14, Finland ranks best in 146th place with a score of 3.04 and Iran ranks worst with a score of 8.60. The FATF MERs remain the main influence on a nation-state’s final score and therefore nation-states need to comply with the FATF as it can cause negative repercussions on non-compliant countries, which may hurt their economies. If we look at this 2017 Basel Index report more closely we see that younger economies tend to have a greater swing in their scores, such as Jamaica improving from 6.60 to 4.16 in a year. An economy like Canada’s has very little wiggle room in terms of gaining much advancement in the Basel standings even with continuous implementation of MER recommendations. The question is whether the integration of these changes, diminish ML and TF threats and vulnerabilities to a degree where the benefits outweigh the costs? 
The 31,000 main REs are the first-line of defense against ML and TF. So far the FIs have been patient, tolerant and acquiescent of the compliance demands for fear of being blacklisted by the Department of Finance. Given the ML figures for Canada that range anywhere from $CAD5-43 billion dollars annually there simply is no case to stop any kind of AML/ATF Regime and its innovation through recommended changes by the FATF. By improving the regime it will hopefully lead to deter ML and TF and to some extent even detect some ML/TF schemes such as the Canadian Lebanese Bank that was involved in ML for Hezbollah and was indicted in 2011 for those activities. With that being said PPSC must improve its terrorism conviction record as only three individuals have been convicted of terrorism charges in Canada since 2001, of those two have been for TF even though FINTRAC had credible information on 234 TF operations in 2015 alone. Unfortunately the RCMP and PPSC are not well enough equipped to tackle charging individuals on terrorism charges and instead prefer convicting on other predicate offences: “We know that within the RCMP, they lack the skill set to do complex financial investigations,” said Royal Military College professor Christian Leuprecht, an expert on terrorism. “There’s a serious challenge with regard to building the professional development and skill set capabilities to actually prosecute. Just changing laws won’t do much if we can’t actually change the capacities.” Other experts advocate for new “trip wires” for FINTRAC as they don’t see the current STR triggers as being efficient in the system and in need of an entire revamping of the department operating guidelines. The FATF MER recommendations should be adopted for protecting the international financial system, but Canada should also focus on its own issues identified by the PCMLTFA review and aim to solve those issues within their five year review period.