Customer Due Diligence (CDD): How Bad Actors Exploit the Gaps

If you are working in Anti-Money Laundering (AML) compliance, you are undoubtedly familiar with the term Customer Due Diligence (CDD). CDD is a foundational aspect of AML efforts, ensuring that financial institutions know their customers and understand the risks associated with them.

So, what exactly does CDD entail?

The Four Key Elements of CDD

There are mostly four main elements when conducting CDD:

1. Customer Identification and Verification: Collect and confirm the customer's identity using reliable, independent sources, such as name, date of birth, address, and identification number.

2. Identifying and Verifying Beneficial Ownership: Determine who ultimately own(s) or control(s) the customer - when an entity - and verify their identities to ensure transparency and detect hidden illicit activities.

3. Understanding the Nature of the Customer’s Business: Gather details about the customer's business activities, sources of funds, and expected transaction types to assess the risk level associated with the customer.

4. Ongoing Monitoring and Updating of Customer Information: Regularly monitor transactions and update customer information to detect and address unusual or suspicious activities.

   
   

Deep Dive into Customer Due Diligence (CDD)

Customer Due Diligence (CDD) is a critical process for financial institutions, aimed at mitigating risks associated with money laundering and terrorist financing.

Each of the four key elements involves unique challenges and risks that can be exploited by bad actors.

Let me share some insights:

1. Customer Identification and Verification

Accurate identification and verification of customers involves collecting comprehensive personal information and verifying it through reliable, independent sources.

Financial institutions typically use government-issued identification documents such as passports and driving licenses to confirm identity.

How Bad Actors Abuse Gaps:

• Use of Fake Documents: Bad actors often use high-quality forgeries to circumvent identity checks. This can include counterfeit passports, IDs, or altered utility bills.

• Synthetic Identities: By combining real and fake information, bad actors may create synthetic identities that can pass through standard verification processes unnoticed.

What you can do: 

It’s challenging and sometimes frustrating to deal with sophisticated forgeries and synthetic identities. Fraudsters and money launderers are using the most advanced technologies – so must we to prevent them from abusing our systems. Advanced verification technologies, such as biometrics and digital identity verification, can provide a robust defense against these tactics.

2. Identifying and Verifying Beneficial Ownership

Identifying and verifying the beneficial owners of entities ensures transparency and helps detect potential illicit activities.

How Bad Actors Abuse Gaps:

• Complex Corporate Structures: Bad actprs use layered and opaque ownership structures, shell companies, and trusts to hide their true identities. In some cases, those structures are designed in a way that is difficult, often impossible to identify the beneficial owner(s).

• Jurisdictional Arbitrage: Exploiting jurisdictions with weak transparency laws or beneficial ownership requirements to obscure the real owners.

What you can do: 

Identifying beneficial owners can be a challenging and time-consuming task, and this is exactly what bad actors count on. They hope that institutions will stop trying when they use complex corporate structures to hide ownership. But, don't stop - keep digging deeper and use all available resources to uncover the true owners of companies, even when things go hard.

3. Understanding the Nature of the Customer’s Business

Assessing the risk level associated with a customer requires a thorough understanding of their business activities, sources of funds, and expected transaction types. This involves gathering detailed information about the customer’s operations, industry, and geographical location.

How Bad Actors Abuse Gaps:

• Misrepresentation of Business Activities: Bad actors may misrepresent the nature of their business to avoid detection, such as using legitimate businesses as a front for their illicit activities.

• Changing ownership structures: Bad actors may buy an existing company and change the shareholders without getting noticed by the bank in a timely manner.

What you can do 

Developing comprehensive economic profiles and conducting thorough risk assessments can help you stay ahead. By understanding the full scope of your customers' businesses, you can identify potential risks more effectively. Regularly review businesses that are vulnerable to money laundering and investigate any changes in their ownership structures​​.

4. Ongoing Monitoring and Updating of Customer Information

CDD is not a one-time process. It requires continuous monitoring and updating of customer information. Regularly reviewing transactions and updating customer profiles help detect and address unusual or suspicious activities promptly.

How Bad Actors Abuse Gaps:

• Exploiting Periods of Inattention: Bad actors often exploit times when monitoring may be lax, such as during holidays or after-hours when the compliance departments are understaffed.

• Anomalous Transaction Patterns: Engaging in atypical transaction patterns to avoid detection, such as structuring transactions just below reporting thresholds by many unrelated individuals.

What you can do

It’s hard to manage large amounts of data and stay alert all the time. Automated monitoring systems can help by continuously checking transaction data and highlighting suspicious activities. Regularly reviewing and updating customer information keeps your monitoring efforts accurate. Leverage technology – it can provide the support you need to maintain robust oversight​​.

Conclusion

Customer Due Diligence (CDD) is vital for financial institutions to combat money laundering and other illicit activities. Implementing effective CDD practices is not without its challenges, from managing high volumes of data to dealing with sophisticated criminal tactics. However, staying vigilant and leveraging technology can significantly enhance your efforts.

As we move forward, it's important to embrace a proactive approach. Continuously update your processes, invest in advanced monitoring systems, and collaborate with other institutions and regulatory bodies.