Money laundering – Glenn Chan’s Random Notes on Investing

While money laundering is illegal, it often leaves behind a paper trail behind that investors can uncover.

Also, it has led to interesting scenes from the movie The Wolf of Wall Street.

Why money laundering is necessary

Pump and dumpers launder money for two reasons:

To hide illegal insider selling. Pump and dumpers will give their shares to a trusted party who will sell shares on their behalf. That party will then launder money back to the pump and dumpers (after taking their cut). It doesn’t look like insider selling because there is no obvious connection between that third party and company insiders.
To convert illegal income into seemingly-legal income. Without money laundering, shady people would go to jail on tax evasion charges. For example, authorities wanted to go after Al Capone because he ran a crime organization. However, because it was hard for authorities to find witnesses who were willing to testify against him, they instead went after him on tax evasion charges. Now criminals engage in money laundering so that their spending is consistent with their quasi-legal sources of income.

Money laundering methods

Physical cash

Handing somebody a suitcase full of cash is one way of transferring money without leaving behind a paper trail. However, there are limitations to this method.

Banks follow anti-money laundering regulations and will report suspicious activity. A large influx of cash being deposited into an account will raise red flags. One way to get around this is to own a business that accepts plenty of cash (e.g. a restaurant). It is not that suspicious when a “highly profitable” business is constantly depositing physical cash into its bank account. However, some banks will pay attention to the serial numbers, conditions, and denominations of the bills being deposited.
If the cash does not go through the banking system, it cannot be used to buy everything that a person might want. It cannot be used to buy a house or a car. Red flags will be raised by the bank if a large amount of cash is deposited to make a large purchase.
Cash takes up space and has a weight. Jordan Belfort, the author of The Wolf of Wall Street, points out that it took many international flights for his associates to smuggle millions of dollars to an offshore country. They could only carry so much cash onto the plane when they hid cash underneath their clothing. This can make cash an inconvenient store of value.

Because cash will not solve all of a person’s money laundering needs, other money laundering methods are commonly used.

Cross holding

Pump and dumpers will use other people to hold onto their shares, and vice versa. If they both sell equal dollar amounts of shares, then they can effectively get around insider trading restrictions and launder money at the same time. That money comes in as legitimate income.

Offshore countries

There are certain offshore countries which design their legal system to make money laundering a lot easier. The most popular ones are:

British Virgin Islands
Cayman Islands
Panama
Liechtenstein, Guernsey and Isle of Man are also used but less popular.

One key legal issue is whether or not the legal system allows somebody to hide their identity. If a company insider can hide their identity, they can get around insider selling laws because the broker does not know the identity of its customer. The broker would only know the identity of the lawyer managing the affairs of the offshore entity.

Some offshore entities hold shares in multiple pump and dumps. Simply looking at everything they own is one way to spot multiple pump and dumps. SEC filings will state their ownership across multiple stocks.

One way to sleuth out the connections is to follow the lawyers. They often sign their names on documents that end up in the SEC filings stored on EDGAR. These lawyers connect different pump and dumps together because the pump and dumpers tend to use the same lawyer over and over again (e.g. because they trust their lawyer).

Another way to connect offshore entities is to look at their mailing address. Because the same lawyer is re-used, many offshore entities will have the same mailing address. A document search tool like Sentieo (and Sentieo’s competitors) can let you quickly see how often an address shows up in SEC filings.

You should also pay attention to an offshore entity’s name. If somebody is using the Cayman Islands for a fairly legitimate purpose, they will not try to hide their identity when naming its Cayman Islands entity. Herbalife’s Cayman Islands entity is named “Herbalife Nutrition Ltd”, which is normal and reasonable. On the other hand, the people hiding their identity will use an extremely generic name that does not reveal who the owner is.

The downside to offshore entities is that the owner needs to go through some work to launder the money back into their home country. One way to do this is to put personal expenses on a credit card paid off by the offshore entity. One of the downsides of that method is that many large purchases cannot be made with that credit card. If millions of dollars are involved, more sophisticated money laundering methods are needed to generate legal income for the owner of the offshore entity.

Infighting reveals money laundering schemes

Pump and dump ringleaders constantly park shares with people that they trust. Unfortunately, there is no honour among thieves. Shady people betray each other all of the time. Jordan Belfort describes his experiences in his book The Wolf of Wall Street. In the case of the shoe company Steve Madden, the company’s founder (Steve Madden) betrayed Belfort and sold shares that he wasn’t supposed to sell. Jordan Belfort presumably wanted other entities to sell shares so that the profits would end up in the right place. He did not want pump and dump proceeds to end up in the hands of somebody that can’t be trusted.

Infighting often leads to lawsuits against the betraying party. The hope is that the betraying side comes to a settlement rather than engaging in mutually assured destruction.

In one case of securities fraud infighting, both sides settled their dispute and posted their legal agreement on EDGAR. The legal agreement specifies that the betraying side would be allowed to remove the legend on a certain number of their shares and that the company would not take action against the legend removal. If you search SEC filings for the phrase “British Virgin Islands” and “Cayman Islands”, you may stumble across this stuff every once in a while. Apparently, some people are crazy enough to spell out their money laundering plan in a legal document… and their lawyers didn’t see a problem with that.

Float analysis

For large-cap China stocks, it may be helpful to analyze the shareholder base to spot fraud risk. When shares are registered in an IPO or secondary offering, the registration documents will often state all of the major owners of the stock. If that list contains offshore entities with generic names, watch out. That offshore entity is likely a vehicle for hiding insider selling.

Organized crime connections

A lot of organized crime organizations like the pump and dump industry because it has good synergies with their other illegal activities. If that crime organization is currently involved in bribing politicians, then pump and dumps are a great way to give out bribes. The mafia can simply sell shares to the politician before the pump happens. The expenses of the pump operation are paid for by the mafia. This scheme generates legal income for the politician so they don’t have to spend time and energy on setting up a money laundering front like book deals, Canada’s WE charity, law firms selling legal advice at inflated prices, artwork sold through NFTs, etc. The hit TV show The Sopranos depicts a pump and dump operation in the episode “Guy Walks into a Psychiatrist’s Office”.

Money laundering – Glenn Chan’s Random Notes on Investing

Why money laundering is necessary