Second Life: A Concern Under U.S. Money Laundering Laws?

Two different federal statutes establish the elements of federal money laundering.  First, laundering of monetary instruments is set forth in 18 U.S.C. § 1956.  Second, engaging in monetary transactions in property derived from specified unlawful activity is set forth in 18 U.S.C. § 1957. The first couple paragraphs of this blog entry can be skimmed, as they simply explain the crimes of money laundering.

The purely-domestic laundering of monetary instruments (18 U.S.C. § 1956), requires a defendant to “know[] that the property involved in a financial transaction represents the proceeds of some form of unlawful activity, conducts or attempts to conduct such a financial transaction which in fact involves the proceeds of specified unlawful activity” combined with one of four possible intents: (1) intent to promote the carrying on of specified unlawful activity; (2) intent to engage in conduct constituting a violation of section 7201 or 7206 of the Internal Revenue Code of 1986; (3) knowing that the transaction is designed in whole or in part to conceal or disguise the nature, the location, the source, the ownership, or the control of the proceeds of specified unlawful activity; or (4) knowing that the transaction is designed in whole or in part to avoid a transaction reporting requirement under State or Federal law.

Under 18 U.S.C. § 1956, the term transaction includes “a purchase, sale, loan, pledge, gift, transfer, delivery, or other disposition, and with respect to a financial institution includes a deposit, withdrawal, transfer between accounts, exchange of currency, loan, extension of credit, purchase or sale of any stock, bond, certificate of deposit, or other monetary instrument, use of a safe deposit box, or any other payment, transfer, or delivery by, through, or to a financial institution, by whatever means effected.”  Additionally, financial transaction means either (A) a transaction which in any way or degree affects interstate or foreign commerce (i) involving the movement of funds by wire or other means, (ii) involving one or more monetary instruments, or (iii) involving the transfer of title to any real property, vehicle, vessel, or aircraft OR (B) a transaction involving the use of a financial institution which is engaged in, or the activities of which affect, interstate or foreign commerce in any way or degree.  It is important to understand both terms because the “financial transaction” is criminalized, but “transaction” helps define that financial transaction.

Under engaging in monetary transactions in property derived from specified unlawful activity (18 U.S.C. § 1957), a defendant must “knowingly engage[] or attempt[] to engage in a monetary transaction in criminally derived property of a value greater than $10,000 and is derived from specified unlawful activity” under one of these two circumstances: the offense under this section takes place in the United States or in the special maritime and territorial jurisdiction of the United States or the offense under this section takes place outside the United States and such special jurisdiction, but the defendant is a United States person.  A monetary transaction includes the deposit, withdrawal, transfer, or exchange, in or affecting interstate or foreign commerce, of funds or a monetary instrument by, through, or to a financial, including any transaction that would be a financial transaction under 18 U.S.C. § 1956(c)(4)(B).

Notably, the § 1957 variety of money laundering does not require the prosecutor to prove the intent requirements of § 1956.  The intent requirements must be difficult to prove, because the differences in the possible sentences are quite large.  For a violation of § 1956, a defendant faces a fine of not more than $500,000 or twice the value of the property involved in the transaction, whichever is greater, or imprisonment for not more than twenty years, or both.  A violation of § 1957, on the other hand, likely will lead to a fine under title 18 U.S.C., imprisonment for not more than ten years, or both. For either offense, a convicted defendant is liable to the United States for a civil penalty of not more than the greater of the value of the property, funds, or monetary instruments involved in the transaction or $10,000.

The entire time I was looking at the money laundering laws, I kind of felt like the guys from Office Space when they are looking up how to launder money in the dictionary.  I guess I do not feel as bad since I was looking at the actual statutes.  However, although people do not know much about money laundering, it is a very serious international problem.  The International Monetary Fund estimated money laundering to amount to between two and five percent of global gross domestic product, which is at least six-hundred-billion U.S. dollars.  Additionally, money laundering was found by Congress to be “critical” to terrorist financing.

Because of the obvious concerns over money laundering, certain institutions are required to register with the Department of Treasury, report certain suspicious transactions, and to have independent anti-money laundering review programs.  One type of institution required to register to the Department of Treasury is known as a money service business.  Under 31 C.F.R. § 103.15, the definition of a money service business includes each agent, branch or office within the United States of any person doing business, whether or not on a regular basis, as a currency dealer or exchanger.  That definition brings up the question of whether Linden Lab, maker of second life, is a money service business required to register and report suspicious transactions.

It appears to me Second Life’s money exchange does bring Linden Lab within the definition of a money service business.  Linden Lab does not advertise to the consumer the ability to put U.S. Dollars into the world.  In fact, to do so would detract from the simulation.  If one were asked to deposit regular U.S. Dollars into the world, it may not seem like as much of a “second life” to that individual.  Instead, Linden Lab operates and exchange where you can given Linden Lab your U.S. Dollars and have Lindens in your second life/world.  It fits in with the idea that when you enter Second Life, you really are going to a whole new place.

To categorize Linden Lab as a money services business also makes sense within the purpose anti-money laundering laws.  The government presumably wants to keep tabs on businesses that provide a platform for concealing funds earned from criminal activity.  If all other businesses are on the government’s radar through registration and reporting suspicious activity, money launderers are smart enough to find an alternative.  If Second Life does not fall under the definition of a money service business, then the exchange service is a clear alternative to the businesses that have to report.  The government could not have intended to leave out an exchange service simply because the money goes into a virtual world.  There is a market for trading Lindens back in for US Dollars just as there is a market to exchange Euros back into US Dollars.  I fail to see the difference.

The Financial Action Task Force’s (the “FATF”) recommendations also seem to indicate Second Life’s exchange service should be included in money laundering prevention laws.  The FATF is “an inter-governmental body which sets standards, and develops and promotes policies to combat money laundering and terrorist financing.”  In October 2003, the FATF introduced its most recent recommendations for combating money laundering.  A couple of those points in the recommendations indicate to me that the FATF would believe Second Life should be monitored.

First, the FATF includes in its definition of financial institutions any person or entity who conducts as a business for or on behalf of a customer: the transfer of money or value, trading in foreign exchange, and money and currency exchanging (among other things).  Even if the Second Life Exchange does not qualify as any of those operations, it at least fits within the intent of those operations.  In fact, I would guess that the next FATF recommendations will include something more on point with Second Life.

Second, FATF recommendation twenty states that “[c]ountries should consider applying the FATF Recommendations to businesses and professions, other than designated non-financial businesses and professions, that pose a money laundering or terrorist financing risk.”  This means that even if it does not fit within any of the FATF’s definitions, a country should consider applying the FATF’s strict recommendations to the business.  Second Life surely poses a money laundering risk considering how easy it is to deposit and remove money.

Interestingly, I think the FATF would strongly dislike Second Life.  Consider recommendation five: “Financial institutions should not keep anonymous accounts or accounts in obviously fictitious names. Financial institutions should undertake customer due diligence measures, including identifying and verifying the identity of their customers, when: establishing business relations; carrying out occasional transactions: (i) above the applicable designated threshold or (ii) that are wire transfers in the circumstances covered by the Interpretative Note to Special Recommendation VII; there is a suspicion of money laundering or terrorist financing; or the financial institution has doubts about the veracity or adequacy of previously obtained customer identification data.”

Because we were signing up as UF students, of course we put our real information.  However, if we were planning on laundering money through Second Life or even wanted to avoid giving out personal information over the internet, we would have all put fake names, birthdays, and e-mail addresses.  It seems to me Linden Lab probably does not care who you are as long as you are putting money into their world. This could be problematic going forward as the risk of money laundering through Second Life goes up.

Because of the money laundering risks it provides, I believe Second Life would be found to be included in the definition of money services business.  That it even arguably fits within the definition paired with those risks would seemingly lead a court to find the same (and if it did not, I would guess the law would be changed).

As previously stated, the implications of being a money services business are registration, reporting suspicious transactions, and establishment of an independent review program.  Reporting suspicious business transactions requires a report of any suspicious transaction relevant to a possible violation of law or regulation.  Specifically, any transaction over $2,000 where the company has reason to know there are certain suspicious circumstances requires reporting.

Under the independent review requirement, a money services business must establish anti-money laundering programs with written procedures and policies that: “[p]rovide for independent review to monitor and maintain an adequate program. The scope and frequency of the review shall be commensurate with the risk of the financial services provided by the money services business.”  The main purpose of that review is to monitor the adequacy of the anti-money launder program.

It seems to me that it would be a pain for Linden Labs to have Second Life’s exchange considered a money services business.  However, I presume the company makes enough money from having the exchange to far outweigh the frustration of having to register, report, and review their practices regarding money laundering.  In my opinion, though, it is the proper thing to designate Second Life’s exchange a money services business.  Criminals are going to find a way to launder their money and if the government leaves Second Life open as a loophole, then it will be found and utilized.

That, however, leads me to one final thought.  I find it interesting that according to the Justice Department’s February 2010 National Drug Threat Assessment, the Justice Department believes that large-scale utilization of virtual world banks to launder drug money is unlikely.  The Justice Department explains that these banks will be subject to the same monitoring systems as regular banks and since the money has to be placed into the economy of the world, such large transactions or frequent will stand out in the small economies.  The Justice Department pointed out that one virtual world’s economy was $420 million generated from 820,000 players.

For now, this certainly makes sense; however, as virtual worlds grow, one can expect the economies to become much larger.  More people will lead to more transactions, possibly larger transactions, and definitely larger economies.  The Justice Department will certainly need to keep an eye on virtual worlds going forward as the economies grow and become a more viable source for large-scale money laundering.  The Justice Department probably does acknowledge this fact considering it did admit it is very difficult to establish the actual identity of the players.


~ by timothyufl on October 5, 2010.

11 Responses to “Second Life: A Concern Under U.S. Money Laundering Laws?”

  1. Typical Justice Department. Sometimes it seems like they don’t regulate anything until it spins out of control. Money laundering in large amounts may not be a huge problem right now, but the likelihood seems high of either (a) small-scale transactions now or (b) large scale transactions in the future. By passing laws now (which process takes time to accomplish), it will prevent the harm from occurring.

    From Linden Lab’s perspective, I could see this being a very annoying aspect of operating a virtual world. While I agree with you that Linden can afford it, I hesitate to say that they would easily go along with it, mainly because of the fake name factor and the costs. They would have to implement an identity verification system (or would they?) to ensure that users put their correct name, address, etc. so they can be traced later.

    I imagine that the currency exchange program currently in place allows for Linden to trace the to/from of the transaction. I could be dead wrong on that, but provided that was possible, that may be a temporary solution, at least for now. This would allow monitoring and investigation when a red flag goes up. In the alternative, perhaps Linden could sell the operating rights to the Linden bank to an actual bank that already follows the reporting requirements. If they just incorporate Linden’s bank into the already-running program, then this could save costs.

  2. One thing is clear through all these blogs. There are numerous ways to violate the law using virtual platforms. I don’t know if that is representative of society or society’s laws and regulations.

    It is strange that the Justice Department would brush off the threat of money laundering of Second Life when money laundering around the world is such a problem.

    The problem with brushing off the money laundering issue because the money being transferred isn’t that great is two-fold:

    First, if you plan on laundering money through a virtual world, then it is okay to do it at a small scale.

    Clearly, the laws shouldn’t be neglected to be enforced simply because the violation is at a smaller scale. I would imagine that the transfer of 10 million dollars to a terrorist organization would be something the Justice Department would want to stop. However, they seem to be perfectly okay with allowing multiple smaller transfers that end up adding to one big transfer of 10 million dollars.

    Second, the Justice Department thinking seems to be in line with all political organizations actions toward problems. They would rather be reactive than proactive. By not stopping the problem when it is a low scale problem, they are allowing the situation to grow. The problem will be much easier to fix now than in the future but it appears that the Justice Department would rather cross that bridge when they get there.

  3. I question whether Linden Labs is arguably considered a financial institution, as I am concerned that the primary function and goal of Second Life is not to function as a bank or to operate as a financial exchange. Yes, one could “buy and sell” Linden dollars for “real” world money, but that does not mean it is the primary function of Second Life. Rather, the financial aspects of Second Life, are an extension of the role play itself in the sense that you do need money to function in the “second” world like the real world, but the primary objective of the virtual world is to “live” or exist in the virtual world and not o create a banking world.

    However, with that being said, Linden Labs should be responsible for the content in their world as an alternate to reality. In the real world there are statutes and rules governing the financial world, and even if the financial aspects are not the central function of Second Life, there needs to be some form of governance and Linden Labs would be in the best place to provide those rules and regulations for their virtual world.

    The final comment I have is in regards to the DOJ’s opinion that money laundering in virtual worlds will not become a problem… uhhh really?!?

  4. You basically read my mind when you said: “There is a market for trading Lindens back in for US Dollars just as there is a market to exchange Euros back into US Dollars. I fail to see the difference.” The thing that struck me as the most surprising from our reading is the fact that currently virtual money laundering is basically completely unregulated by both law enforcement and, more importantly, the virtual worlds.

    I agree that this regulation responsibility should first fall on the virtual worlds. In one of our articles about the collapse of the SecondLife bank Gingko Financial, the author stated that in response to the collapse, “residents are already responding by creating a variety of oversight institutions of their own, including companies that insure against fraud and homegrown regulatory institutions like the Second Life Exchange Commission, which is modeling itself on the SEC.” This is a perfect example of the virtual community attempting to regulate itself and it is, in my opinion, what programs such as SecondLife are all about. In order to preserve virtual alternate universe essence that is SecondLife, it should be the responsibility of the residents or Linden Labs to regulate what occurs inside SecondLife.

    I also agree that Linden definitely has the money to aid in these regulation efforts. And, while I’m sure it would be difficult, and I doubt they would be thrilled to do it, I believe that if it were mandated, Linden would take these matters more seriously. And I think at the very least, an attempt to self-regulate would be better than getting real life law enforcement involved in SecondLife criminal activity.

  5. I think that part of my frustration is that I don’t have a full grasp on exactly how money is laundered. I understand the concept of placing it in the virtual world, but how does it get there? Doesn’t it have to be transferred from a real life account INTO the virtual world? Or are people able to place this money in SL via wire transfers like Money Gram??? I am confused because if they have to put the money in a real account to be able to pay Linden Lab it seems it is still going through the process. Despite this unclarity, I do have an opinion.

    I think that classifying Second Life as a money service business would be more than just an inconvenience to Linden Lab. In order to classify as such, it would practically have to be reclassified as a bank. It would have to be subject to federal regulation, FDIC insurance, etc. and it would have to shift its business plan from a virtual community with self-regulating processes to a regulatory business with government regulations. This would seem to me to defeat the purpose which many law-abiding persons use Second Life. At the end of the day, SL is a business, and people who have virtual worlds, use it because of the convenience and ease with which they can develop and expand their business models. Creating so many roadblocks may decrease SL usage and may stop growth in this realm. Regulation means it takes longer for transfers to post, more paper trail, people are obligated to put real information that would have to be verified in RL and would also likely create Tax obligations that are not currently in effect. Is SL income taxable???

    I think a better option might be for SL to self-regulate the amount of SL cash that is convertible to RL cash. Maybe only 1/2 of all funds transferred would be convertible? Something that would still allow ease of use while making it slightly more difficult to check out all your cash as easily. Or maybe have people put their real info and send them sort of “bank statements” each month of their monetary transactions. That would create a paper trail but would not create the stringency of actual regulations.

  6. I agree with Daniella, my guess is that Second Life is already being subject to money laundering regulations. I worked at a bank in college, and we we’re required to report any transaction over $10,000, or if we saw a pattern of suspicious activity for transactions just skirting under the money limit. If someone was repeatedly coming in and withdrawing $9,900 in cash, we would report them and they would go on a watch list. Just as all banks have to do this, so do institutions like paypal and credit card companies. Since Linden Labs obviously keeps track of how much money is in the game, and has to have some kind of records of money transfers (even if no one is actively monitoring this, my guess is they keep records in case some kind of dispute arises), any suspicious activity reported by the services used to get money in and out of the game can be verified by Linden, and appropriate action taken.

    Even making up fake names or identities shouldn’t be able to prevent authorities from tracking these people. As we learned last week from stalking, if the average person can track someone down using their ISP, I’m sure government employees can do the same. Given the seriousness of money laundering, the extra resources to peel away the anonymity of the internet would be worthwhile. I’m guessing this is already happening, and that the comment about money laundering not being a problem in virtual worlds was made because some things are already in place to prevent it.

  7. Yes, it’s regrettable that not all laws are enforced. Unfortunately, this is the product of the level of funding we have decided, as a society, is adequate for law enforcement. Law enforcement only has enough resources to go after the “big fish”, and there is no indication that they are or have been operating in virtual worlds on any significant scale. If larger money laundering operations started up in even the largest virtual world, the amount of virtual money exchanged would be immediately noticeable because it would eclipse the existing virtual economy. I think the virtual world operators would be wise to voluntarily report suspicious activity of that sort, but I honestly don’t see a pressing need there to the extent that enforcement officials for financial crimes should be taken off other assignments to handle this. Of course we shouldn’t leave avenues open for criminal activity, but reality is that law enforcement has to prioritize.

    I’m also going to disagree that changing USD to Linden Dollars is the same as changing USD to Euros. The essential difference is that Linden Dollars aren’t backed by a government. I think the more apt comparison is to various “local currencies” introduced to support local economies. See for further discussion of local currencies along with some examples.

  8. I agree that under the current definition, SL would likely be included. In addition to the fact that the government usually (to my knowledge) tries to regulate anything it feasibly can, I think a judge, upon applying the definition to SL, would decide that it is included. Whether or not virtual worlds were actually within the intent of the drafters of the legislation, I think this is an appropriate conclusion given, as you noted, the alignment of the harms sought to be prevented.

    If people are laundering money, it shouldn’t matter what form it takes or what location they took it from. It’s stealing, either way, and it should be criminalized whether it involved taking fake money and converting it to real money, or just directly taking real money. Like Tim, I don’t see the difference.

    This would, however, present yet another obstacle for upstarts looking to enter the virtual world scene. In addition to the increased liability we’ve been talking about recently, they would have to tackle the issues related with establishing themselves as money services, and all the bureaucratic red tape and increased scrutiny that comes with it. Although this makes it even more onerous for new developers entering the scene, I believe that the interests involved in preventing all kinds of money laundering are of such importance that they outweigh the added burden on developers.

  9. While in France two summers ago I had the pleasure of listening to a presentation by a representative from TRACFIN, (Traitement du renseignement et action contre les circuits financiers clandestins) the French governmental organization that fights money laundering throughout France and the European union. The tactics money launderers use are financially very artistic. A very large amount of laundering occurs through international banking. In the face of the money laundering situations this representative described, it does not seem non-banking virtual environments would support the volume of financial movement that serious money laundering requires.

    That is to say, I don’t believe the microtransactions that occur in virtual environments, online gaming, or even consumer portals are of the sort that would encourage true money laundering, in the sense of criminal organizations attempting to deposit millions of dollars of funds in a bank and having no problem when 40% or more gets confiscated while the rest slips by.

    It took national governments years to adapt to and regulate the money transfer that occurred in online poker games. When the US government did end up regulating online gambling, (under anti-terror laws, of course,) it led to all of the gray market, pseudo-legitimate business being driven to other even less savory providers.

    In light of these anecdotes, I suspect that Second Life is best left alone under the present regulations. Of course that will not be the case.

  10. I think that Second Life must already be subject to some form of money laundering regulations. Not only because of the seriousness of potential offenses, but also because of the simple fact that its virtual (and I may be completely wrong here). I don’t know exactly how it works, but in my mind, the fact that it is virtual means that there will pretty much always be a “paper trail.” Even though someone can create a different identity, they can still be tracked down in other ways. Like Kate said in reference to last week’s stalking discussion, “if the average person can track someone down using their ISP, I’m sure government employees can do the same.” Also, I have no clue how it all works, with transferring/exchanging money online, however doesn’t it have to come from some account in the first place? Or when you exchange it, doesn’t it have to go to an account? You can’t just hit print and have money start printing out on your printer. And if it goes into an account, aren’t those regulated? So there would be a record of who’s name the account was under? Am I completely misunderstanding this?

    On a side note, for those that decide to put their real world dollars into a virtual world such as Second Life should expect the possibility that they may not see that money again. Because of all the real world problems that are occurring, it is almost more expected to occur virtually because of the regulation isn’t the same. Before regulation can focus on the virtual world, the real world problems should probably be tackled first.

  11. First off, I was really surprised when Timothey said
    “The Justice Department pointed out that one virtual world’s economy was $420 million generated from 820,000 players.”
    I mean, I get that that’s no six-hundred-billion US dollars, but that seems like a pretty sizable economy as far as the internet world community goes. If we’re trying to be serious and effective in preventing money laundering, then an easy avenue for exchange like Second Life should be at least explored. (What if 100,000 of those players in the above community were responsible for $200 million of the world’s economy?).

    As fmarie noted in her article, having the government monitor online communities would add more expense to an already expensive problem. Linden Labs really is in the best place to regulate its own economy, and, as we saw with the incident where a player was skimming funds off the top of player accounts in the virtual bank, Linden does regulate financial crime in world (by disabling users who don’t play by the rules). Linden might also be in the best place to protect the rights of its users. Complying with federal money laundering regulations would not necessarily open Linden up to a panoply of federal regulations (like taxes) – that kind of scaremongering shouldn’t make Linden immune from doing its part as a money services business. Linden could still preserve the rights of law abiding consumers who are entitled to privacy and a certain level of anonymity through the site by implementing less invasive and far reaching procedures to target a statutorily well defined problem.
    One alternative for Linden would be to require real names and legitimate identification information for especially large transactions (perhaps over the 2,000$ threshold) or patterns of especially frequent small transactions (like at Kate’s bank). If Scott is correct, and the Linden economy isn’t attractive (or capable of attracting) huge money laundering players, then basic measures (like those instituted at the gas station I worked at where we merely kept record of patterns of large money order purchases) would seem sufficient to catch a number of small time launderers without imposing any heinously expensive or onerous duties on Linden.

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