1 IPO Scam Lessons for banks Presentation by LALIT SRIVASTAVA General Manager Reserve Bank of India

2 Money Laundering Understanding Process & Objectives Money Laundering is called what it is because that perfectly describes what takes place – illegal, or dirty money is put through a cycle of transactions or washed, so that it comes out of the other end as legal, or clean, money. In other words, the source of illegally obtained funds is obscured through a succession of transfers and deals in order that those same funds can eventually be made to appear as legitimate income.

3 Stages of Money Laundering Money Laundering consists of a three stage process: Placement The first stage involves the Placement of proceeds derived from illegal activities – the movement of proceeds, frequently currency, from the scene of the crime to a place, or into a form, less suspicious and more convenient for the criminal.

4 Stages of Money Laundering Layering The second stage is called Layering. It involves the separation of proceeds from illegal source through the use of complex transactions designed to obscure the audit trail and hide the proceeds. The criminals frequently use shell corporations, offshore banks or countries with loose regulation and secrecy laws for this purpose.

5 Stages of Money Laundering Integration The third stage is called Integration. It represents the conversion of illegal proceeds into apparently legitimate business earnings through normal financial or commercial operations. Integration creates the illusion of a legitimate source for criminally derived funds and involves techniques as numerous and creative as those used by legitimate businesses. For example, false invoices for goods exported, domestic loan against a foreign deposit, purchasing of property and co-mingling of money in bank accounts.

6 Salient features of IPO scam Modus operandi  Current account opened in the name of multiple companies on the same date in the same branch of a bank  Sole person authorised to operate all these accounts who was also a Director in all the companies  Identity disguised by using different spelling for the same name in different companies  Multiple accounts opened in different banks by the same group of joint account holders

7 Salient features of IPO scam  Huge funds transferred from companies accounts to the individual’s account which was invested in IPO’s  Loans/ overdrafts got sanctioned in multiple names to bypass limit imposed by RBI  Loans sanctioned to brokers violating guidelines  Multiple DP accounts opened to facilitate investment in IPO  Large number of cheques for the same value issued from a single account on the same day

8 Salient features of IPO scam  Multiple large value credits received by way of transfer from other banks  Several accounts opened for funding the IPO on the request of brokers, some were in fictitious names  Refunds received got credited in brokers a/cs  Margin money provided by brokers through single cheque  Nexus between merchant banker, brokers and banks suspected

9 Operational deficiencies Factors that facilitated the scam  Photographs not obtained  Proper introductions not obtained  Signatures not taken in the presence of bank official  Failure to independently verify the identity and address of all joint account holders  Directors identity/ address not verified  Customer Due Diligence done by a subsidiary

10 Operational Deficiencies  Objective of large number of jt. account holders opening account not ascertained  Purpose of relationship not clearly established  Customer profiling based on risk classification not done  Poor monitoring and reporting system due to inadequate appreciation of ML issues  Absence of investigation about use and sources of funds

11 Operational Deficiencies  Unsatisfactory training of personnel  No system of fixing accountability of bank officials responsible for opening of accounts and complying with KYC procedures  Ineffective monitoring and control

12 Measures to prevent scams  An analysis of IPO scam clearly brings out the laxity on the part of banks to scrupulously implement the KYC/AML guidelines issued from time to time. It also raises serious concerns about the integrity of the systems & systemic risks.  While scams may still happen despite best of preventive measures, it should not undermine the efforts being made to insulate the financial sector from money laundering. It is going to be a long fight with constant need to improve and innovate new strategies.

13 Measures to prevent scams  It is important to understand that the risks banks run as a result of non-compliance with regulatory and statutory guidelines can cause severe reputational and financial damage to individual banks and the Indian banking system as a whole  Need for comprehensive operational framework implementing important aspects of KYC instructions e.g.  Documentation procedure for opening of all types of customer accounts;

14 Measures to prevent scams  Clarity in understanding of risk classification of accounts and proper customer profiling  Ongoing monitoring of medium and high risk accounts  Enhanced due diligence in respect of accounts with beneficial ownership, non-face to face transactions, group companies, high risk businesses and wire transfers etc.  Prompt reporting of cash and suspicious transactions to Principal Officer by branches

15 Measures to prevent scams  An effective audit machinery  Good understanding of regulatory and statutory prescriptions in letter and spirit  Clear demarcation of duties and responsibilities  Violations to be dealt with sternly

16 Are penalties a deterrent  Impact of penalties (a) Quantum of penalties not important in the initial stages (b) Signal sent by Regulator is more important (c) Discussion with top management precedes imposition of penalty (d) Continued non-compliance may affect other approvals (e) Banks international business dealings may get affected

17 Role of DSA  Of late banks have been increasingly resorting to outsourcing of certain types of banking services. However, the PMLA, 2002 and guidelines on KYC norms clearly put the responsibility of verifying basic customer information at the time of establishing a business relationship on banks. The draft guidelines on outsourcing of services also stipulate that DSA’s cannot be used for complying with KYC procedures. Reporting of unusual and suspicious transactions to Principal Officer/MLRO

18  Thank You