New York regulators’ fining of Mega Bank last year for lax compliance practices was a wake-up call.

In a victory for the nation’s regulators, Taiwan in July was removed from a regional list of countries judged to have insufficient money-laundering controls. Taiwan had spent months revising legislation and pushing its financial institutions to crack down on money laundering as it sought to be eliminated from a list that put it in the same category as Afghanistan, Pakistan, and Papua New Guinea.

“We revised anti-money laundering legislation and enacted a law to prevent terrorism financing, bringing Taiwan into line with international standards,” Hugh Hung, an auditor in the Banking Bureau of the Financial Supervisory Commission (FSC), said by email. The government this March also established an Anti-Money Laundering Office under the Executive Yuan, directed by a minister without portfolio.

Deputy Minister of Justice Tsai Pi-chung lauded Taiwan’s removal from the watchlist of the Asia/Pacific Group on Money Laundering (APG). “All of our revised legal standards have demonstrated our determination to fight money laundering and carry out reforms,” he was quoted as saying by Reuters.

Founded in Thailand in 1997, the APG is an international organization that uses a mutual evaluation or peer review program to evaluate the compliance of its members with the anti-money-laundering standards set by the Financial Action Task Force (FATF). FATF was set up at the G-7 summit in 1989 to combat money laundering.

As much as removal from the list deserves celebration, how did Taiwan end up there in the first place? The island, after all, is hardly a hub for illicit financial flows. In fact, in 1996 Taiwan became the first Asian country to pass a Money Laundering Control Act.

According to a statement on the Executive Yuan website, Taiwan’s efforts to combat money laundering in subsequent years focused more on criminal prosecution than moving into line with global standards. As a result, in 2007 APG deemed Taiwan’s system to prevent money laundering non-compliant with FATF standards. A subsequent audit in 2011 landed Taiwan on a reinforced follow-up list.

“Taiwan is not a place where foreign drug dealers and gun runners would be expected to launder money earned from illicit activities, or terrorists would be expected to seek financing,” says Thomas McGowan, an expert in financial-services law and a foreign legal consultant in the law firm of Russin & Vecchi Taipei. “Actual money-laundering issues as they relate to Taiwan are more likely to arise in the context of wealthy Taiwanese receiving or routing funds offshore for the purpose of avoiding taxes.”

Although in the past Taiwan’s system to combat money laundering and terrorism financing was not as robust as it should have been, Taiwan has also suffered from undeserved perceptions, McGowan observes. For example, pressure from China has kept Taiwan from becoming a member of FATF, which currently has 37 member countries. “The result is that Taiwan’s name appears on a list of non-FATF members alongside rogue states actively involved in global financial crime and creates a pre-conceived notion that Taiwan’s anti-money laundering regime is much more defective than it really is,” he says. “Taiwan is always fighting to prove that it is FATF equivalent.”

After the 2011 audit, “some of the issues in the banking and regulatory system were fixed or partially fixed, but at more of a form rather than substance level,” he says. As a result, Taiwan remained on the APG transitional follow-up list.

A jarring wake-up call

The impetus for Taiwan to overhaul its anti-money laundering controls came in August 2016 when the New York State Department of Financial Services (DFS) slapped a US$180 million fine on government-invested Mega Bank’s New York branch. The DFS found that the branch had breached the United States’ Bank Secrecy Act, which requires financial institutions operating in the United States to cooperate with authorities in cases of suspected money laundering and fraud.

“There had been repeated efforts on the part of the regulator to engage Mega prior to the issuance of the fine,” says Ross Darrell Feingold, a senior advisor at consultancy firm D.C. International Advisory. “Mega provided poor or deficient explanations of the transactions in question, suggesting a lack of situational awareness, and prompting the regulator to take punitive action.”

The incident was a major embarrassment for Taiwan given Mega’s stature in the banking system. Created from the merger of two state-run local banks more than a decade ago, it is one of Taiwan’s largest banks by asset size.

The major red flags that prompted DFS’s investigation were suspicious transactions between Mega Bank’s New York and Panama branches. For instance, Mega New York acted as an intermediary paying bank in connection with questionable “debit authorizations” (or payment reversals) received from its Panama branches that reversed wire payments processed on behalf of remitters. In a statement, DFS noted that the “suspicious nature of this activity is compounded by the fact” that many of the remitters and beneficiaries associated with the payment reversals were identical parties.

The investigation further determined that many “customer entities” were formed with the assistance of the Mossack Fonseca law firm in Panama, known for its frequent engagement in shell-company activity. In February, the firm’s founders Juergen Mossack and Ramon Fonseca were arrested in Panama City as Panama’s attorney general began an investigation into their possible connections with Brazil’s Lava Jato corruption scandal.

In a statement, the DFS censured Mega New York’s compliance deficiencies. “The compliance failures that DFS found at the New York branch of Mega Bank are serious, persistent and affected the entire Mega banking enterprise and they indicate a fundamental lack of understanding of the need for a vigorous compliance infrastructure,” said Financial Services Superintendent Maria T. Vullo.

Indeed, these were mega compliance failures. The New York branch’s Bank Secrecy Act and Anti-Money Laundering officer and its chief compliance officer were unfamiliar with U.S. regulatory requirements; the chief compliance offer had business, operational and compliance responsibilities, creating a conflict of interest; and compliance staff at both headquarters and in New York failed to regularly monitor suspicious transactions.

This was not the first time Mega had fallen afoul of financial regulators abroad. In 2012, Hong Kong’s Securities and Futures Commission (SFC) revoked the license of Mega Capital (Asia) – a subsidiary of Mega Securities – to advise on corporate finance, and fined it US$42 million for its misconduct during the listing application of the chemical-fiber manufacturer Hontex.

In a statement, the SFC panned Mega for performing poor due diligence, failing to act independently and impartially, and filing an untrue declaration with the Stock Exchange of Hong Kong. “Mega Capital’s failure in discharging its sponsor’s duties prejudiced the regulatory assessment of Hontex’s suitability for listing and jeopardized the interests of the investing public,” Mark Steward, the SFC’s Executive Director of Enforcement, said in the statement.

“Mega has suffered two embarrassing incidents outside of their home market in five years,” Feingold says. “It comes down to sloppy management, which hasn’t shown itself to be serious about meeting global compliance standards.”

Still, from a fiscal standpoint, Mega remains in solid condition. “The financial impact of the recent fine is manageable,” says Cherry Huang, a director at Fitch Ratings in Taipei. She notes that Mega’s brush with the New York financial regulator has not hurt its business in Taiwan, where the company’s share of SME lending has risen over the past year.

To be sure, Taiwanese regulators will increase scrutiny of Mega, as it has the largest offshore network of any local bank and is a key part of the Taiwanese financial system. “Mega Bank is too big to fail,” she says.

The FSC did punish Mega after the scandal broke, fining it NT$10 million (about US$315,000), mandating the ouster of six executives and barring the bank from opening new branches overseas.

Regulatory renaissance

In the wake of the Mega Bank scandal, Taiwan moved swiftly to address underlying weaknesses in the nation’s money-laundering controls. The Executive Yuan website notes that the government began working to amend the Money Laundering Control Act in 2013, but it does not say why Taiwan failed to make significant headway in the process over the next three years.

It would seem that the fallout from the Mega debacle shocked the island’s bureaucracy out of its torpor. A statement on the website of the Executive Yuan’s new Anti-Money Laundering Office says that the scandal harmed “our country’s international financing reputation…and also indirectly damaged the whole country’s development potential and opportunities.”

Compared to previous efforts to reform the nation’s money-laundering controls, “the current round of post-Mega revisions are very much substantive and the actual implementation steps are robust and visible,” says Russin & Vecchi’s McGowan.

Sweeping changes to the Money Laundering Control Act were promulgated in December 2016 and became effective this June. Crucially, the Act now stipulates that it is a crime to permit another person to use one’s name in property or shell-company transactions. This change aligns Taiwan’s definition of money-laundering crime with global standards.

To boost transparency in money flows, financial institutions must now perform customer due diligence, keep records, and report suspicious transactions. They also are obligated to “apply a risk-based approach when performing due diligence on politically exposed persons and substantive beneficial owners.”

Border controls over cash and gold have also been tightened through mandatory customs declarations for New Taiwan dollars and gold over a certain value. It is also obligatory to declare items mailed or sent by express delivery.

Taiwan also enacted the Terrorism Financing and Prevention Law last year as part of its efforts to fight money laundering. The new law imposes penalties for the financing of terrorist activities, organizations, and individuals, and emphasizes that those infractions are classified as “serious crimes” under the Money Laundering Prevention and Control Act.

In a January statement, the Executive Yuan stressed the government’s determination to combat money laundering, but pointed out that legislation alone is insufficient. The statement called for heightened public awareness of money laundering and terrorism-financing crimes, and for the public to “join forces with the government.”

By doing so, “Taiwan will showcase the excellence of its financial structure, contribute to anti-money laundering and counter-terrorist financing efforts worldwide, and build its reputation as a global financial hub,” the statement concluded.