Chapter 9: Prevention of Money Laundering Act, 2002

The Prevention of Money Laundering Act, 2002 (PMLA) forms India's statutory bedrock for preventing financial system abuse for money laundering and terrorist financing. Securities market intermediaries are designated as "Reporting Entities" under Section 2(1)(wa) and bear statutory obligations.

The Three Stages of Money Laundering

1. Placement: Introducing illicit funds derived from criminal activities into the formal financial system (e.g., cash deposits, third-party stock market subscriptions).
2. Layering: Distancing illicit capital from its illegal source through complex layers of financial transactions, circular stock trades, overseas corporate shells, and derivative trades.
3. Integration: Channelling laundered funds back into the legitimate economy as untainted capital (e.g., selling clean stock holdings, capital gains, corporate acquisitions).

Statutory Offence & Penalties (Sections 3 & 4)

• Section 3: Whosoever directly or indirectly attempts to indulge, knowingly assists, is a party, or is involved in any process or activity connected with the proceeds of crime (including concealment, possession, acquisition, or use) and projects or claims it as untainted property, is guilty of the offence of money laundering.
• Section 4 Penalties: Rigorous imprisonment for a term of not less than three (3) years, extending up to seven (7) years (extendable to ten (10) years where predicate offences fall under the Narcotic Drugs and Psychotropic Substances Act, 1985), along with an uncapped fine.

Under Section 12 of the PMLA, every intermediary must maintain transaction records, verify customer identities, and identify beneficial owners.

Client Due Diligence (CDD) Protocols

Intermediaries must conduct CDD before establishing an account or executing any transaction:

1. Verify identity using reliable, independently sourced documents, data, or information (Aadhaar offline verification, passport, voter ID).
2. Understand the client's financial status, source of wealth, and investment rationale.
3. Conduct ongoing due diligence throughout the business relationship, updating KYC dossiers annually for high-risk clients and every two to three years for medium and low-risk clients.

Beneficial Ownership (BO) Thresholds

Intermediaries must identify natural persons who ultimately own or control the legal entity client:

+-----------------------------------------------------------------------------------+
|               BENEFICIAL OWNERSHIP (BO) STATUTORY THRESHOLDS                      |
+-----------------------------------------------------------------------------------+
|  * COMPANIES: Natural person holding > 10% of shares, capital, or profits        |
|  * PARTNERSHIP FIRMS: Natural person holding > 10% of capital or profits          |
|  * UNINCORPORATED ASSOCIATIONS / BOI: Natural person holding > 15% of property    |
|  * TRUSTS: Author of trust, trustee, beneficiaries with >= 10% interest          |
|  * SENIOR MANAGING OFFICIAL: Applied if no natural person crosses thresholds      |
+-----------------------------------------------------------------------------------+

For listed companies or majority-owned subsidiaries of listed companies in FATF-compliant jurisdictions, separate BO identification is not required.

Every reporting entity must designate a Principal Officer (PO) and a Designated Director (DD) to interface with the Financial Intelligence Unit - India (FIU-IND).

Statutory Reporting Flows

Strict Prohibition on Tipping-Off

Reporting entities, their directors, officers, and employees are strictly prohibited from disclosing or "tipping off" to the client or any third party that an STR or related inquiry has been filed with FIU-IND.

The SEBI Master Circular on Anti-Money Laundering (AML) and Combating the Financing of Terrorism (CFT) outlines practical compliance mandates for intermediaries.

Politically Exposed Persons (PEPs)

PEPs are individuals who are or have been entrusted with prominent public functions in a foreign country (e.g., Heads of State, senior politicians, senior government/judicial/military officers, senior executives of state-owned corporations).

• Intermediaries must obtain prior approval from senior management before opening accounts for PEPs or their immediate family members.
• Must verify the client's source of funds through documented evidence.
• Must conduct continuous enhanced transaction monitoring.

Sanctions Screening & Asset Freezing

• UNSC Sanction Lists: Intermediaries must maintain automated screening of client databases against the United Nations Security Council (UNSC) Resolution 1267, 1988, and ISIL/Al-Qaida sanctions lists.
• Unlawful Activities (Prevention) Act, 1967 (UAPA): Where a client name matches designated individuals or terror entities, the intermediary must report immediately to the Central Nodal Officer (Ministry of Home Affairs) and freeze accounts within 24 hours.

Record Retention Mandate

All customer identity verification records, KYC dossiers, account opening files, and business correspondence must be retained for at least five (5) years after the business relationship has ceased or the account has been closed.

To maintain operational compliance with PMLA and SEBI's Master Circular, compliance teams must embed automated transaction monitoring rules and suspicious activity detection into their core processing systems.

Red Flag Indicators for Suspicious Transactions

Intermediaries must configure automated surveillance alerts for the following transactional patterns:

1. Unusual Transaction Volume: Substantial trading activity inconsistent with the client's declared income, net worth, or past trading history.
2. Sudden Dormancy Activation: Accounts inactive for extended periods suddenly engaging in massive, high-frequency transactions followed by immediate fund withdrawal requests.
3. Circular or Structured Fund Transfers: High-value funds received from multiple unrelated bank accounts or third-party remitters, followed by immediate transfers out without corresponding trading.
4. Reluctance to Furnish Information: Clients displaying unusual evasiveness or reluctance to provide complete beneficial ownership data, corporate parentage documents, or audited accounts.
5. Transactions Lacking Commercial Logic: Consistent trading in illiquid scrips or out-of-the-money options resulting in repeated, unexplained trading losses paired with symmetrical counterparty gains.

Mandatory Compliance Officer Controls

• Quarterly AML Audits: Internal auditors must specifically review the AML monitoring framework and test the alert generation threshold parameters.
• Annual Staff Training: Mandatory training sessions for all customer onboarding, operations, and trading desk personnel on emerging money laundering topologies and reporting rules.
• Zero Cash Policy: Complete prohibition on accepting cash deposits for equity, derivative, or currency trades.