Regulators around the globe have observed an uptick in financial crime as the Covid-19 pandemic disrupts normal routines and pressures individuals and institutions to act rapidly on imperfect information. Prior to the pandemic, financial crime was estimated at $2.1 trillion on an annual basis. To place this in perspective, this figure is larger than the gross domestic products of all but the top 10 nations in the world.
On April 1, 2020, INTERPOL raised an alarm, noting that “Criminals are taking advantage of the Covid-19 pandemic to carry out financial fraud and exploitation scams, including advertising and trafficking in counterfeit medicines, offering fraudulent investment opportunities, and engaging in phishing schemes that prey on virus-related fears. Malicious or fraudulent cybercrimes, fundraising for fake charities, and various medical scams targeting innocent victims are likely to increase, with criminals attempting to profit from the pandemic by exploiting people in urgent need of care and the goodwill of the general public and spreading misinformation about Covid-19.”
Earlier, in March, the U.S. Commodity Futures Trading Commission (CFTC) Customer Advisory cautioned the public to be on alert for frauds seeking to profit from market volatility related to the Covid-19 pandemic. The European Banking Authority (EBA) has highlighted fraud and other risks related to payment services in connection with purchases from unknown parties. On March 22, 2020, the U.S. Department of Justice (DOJ) announced its first enforcement action against Covid-19 related fraud. The action was directed against a website operator who claimed to offer consumers access to Covid-19 vaccine kits. Since the kits did not exist, this was an example of simple fraud.
Securities laws generally require the disclosure of material relevant facts in connection with the sale of securities. In April, the U.S. Securities and Exchange Commission suspended trading of more than six companies due to “questions raised about the accuracy and adequacy of information in the marketplace” relating to the companies. In each case, the company claimed to have a product that could prevent, detect, or cure Covid-19.
Not a panacea for addressing financial crime
As these examples illustrate, many financial crimes occur because of the scarcity of verifiable information regarding a counterparty or market participant. The pandemic has created a sense of urgency to move more quickly and simultaneously compromised certain existing procedural safeguards related to the movement of money. Technology can provide powerful solutions to this conundrum, but these benefits will only result from a wise understanding of which technological applications are truly effective.
Technology is not a panacea for addressing financial crime, and solutions need to be researched and reviewed by various stakeholders prior to implementation. The problems with ad-hoc hastily devised solutions are myriad, with a recent example by Christopher Woolard, interim chief executive of the U.K.’s Financial Conduct Authority, demonstrating as much. Woolard issued controversial advice to retail financial service firms struggling to continue operations while staff worked from home. On a list of ways to verify identity remotely was the suggestion that firms could “ask clients to submit selfies or videos”. This advice raised a number of eyebrows because of the ease at which technologically savvy people can manipulate digital photos. Fortunately, modern regtech solutions offer capabilities for identity verification that are far more reliable than the digital selfie.
The Financial Action Task Force (FATF) was established in July 1989 by a G7 Summit in Paris and has now expanded to 39 full members. The objectives of the FATF are to “set standards and promote effective implementation of legal, regulatory and operational measures for combating money laundering, terrorist financing and other related threats to the integrity of the international financial system.
In March, the FATF released Guidance on Digital ID, which highlights the “benefits of trustworthy digital identity for improving the security, privacy, and convenience of identifying people remotely for both onboarding and conducting transactions while also mitigating Money Laundering/Terrorism Financing risks.” On April 1, 2020, the FATF President made a statement regarding Covid-19 and measures to combat illicit financing, noting that, “In line with the FATF Standards, the FATF encourages the use of technology, including Fintech, Regtech, and Suptech to the fullest extent possible.”
The impact of real-time transaction monitoring
Blockchain technology is ideally suited to underpin secure financial transactions when coupled with robust digital identity tools. By compiling a permanent, immutable record of every financial transaction, regulators and other compliance professionals are afforded an unprecedented opportunity to monitor market activity.
Combining blockchain with regtech solutions is viewed as best industry practice in addressing financial crime in the future. Modern attribute-based regtech solutions work by assigning a unique identity to digital wallets as well as other relevant characteristics, such as nationality, residence, investor accreditation, and so on. Systems that utilise sophisticated rules-based approaches to automatically “greenlist” compliant transactions--and block non-compliant transactions--offer tremendous capabilities not currently available on the market.
Securities regulators invest considerable resources in detecting insider trading or transactions involving unqualified participants. After wrongdoing is detected, sometimes years after the fact, firms are investigated and punished and sometimes ordered to unwind transactions or disgorge profits. It is often not possible to reassemble the vase once broken, particularly if a company has gone out of business. This reliance on forensic analysis and after-the-fact penalties strips a tremendous amount of value out of the global economy. Effective preventive measures in the form of automated policy-enforcement can restore much of this value.
Modern regtech offers the possibility to have a system in which market participants are automatically screened and qualified, and non-compliant transactions are blocked from occurring in the first instance. The impact of real-time transaction monitoring and customer risk assessment is both positive and substantial. In this regard, companies may strive for near-perfect compliance. These systems are likely to be more effective than traditional methods in disrupting supply chain or mandate fraud. Mandate fraud is a specific type of cyber-enabled fraud that targets businesses with the intention of diverting money to a bank account operated by the fraudster.
Modern AML compliance programs typically focus on a risk-based approach, in which additional scrutiny is applied to transactions reaching a certain score based on certain defined red flags or indicators. There have been spectacular failures, such as the $200 billion Danske Bank scandal involving its Estonia branch. Regtech tools that leverage artificial intelligence (AI) and machine learning to analyse and make sense of large data sets are likely to avoid such calamities.
Regtech solutions are also more adaptable than traditional compliance systems. As illicit financiers shift their tactics, techniques, and procedures, AI and machine learning systems can detect such changes. Investments in the right regtech solutions offer companies a faster path to revenue generation and market opportunity while maintaining regulatory objectives. In fact, when coupled with the permanent transaction record on the blockchain, the likely result is a system far more likely to detect and prevent money laundering and terrorist financing than traditional compliance regimes.
Stresses caused by the Covid-19 are causing firms to re-evaluate virtually every aspect of their business activity. Regtech provides an opportunity to blunt financial crime during the pandemic, while creating a lasting legacy of making compliance easier for companies with better outcomes.
Jeff Truitt, Chief Legal Officer, Securrency