Drugs, Cash, Luxury Goods, and Maternity Wear

Drug traffickers used to move money through bank accounts and wire transfers. Now, in part because the U.S. and Mexican governments cracked down on banks that do business with cartels, the criminals have had to get more creative. Their latest cover? The fashion business — using a complex scheme to transfer profits back to Mexico through the export of maternity clothes.

Early in the morning on Sept. 10, about 1,000 law enforcement agents descended on Los Angeles’s garment district as part of an ongoing investigation into clothing import-export companies that allegedly launder money for Mexican drug cartels. They called it "Operation Fashion Police."

By the end of the day, the agents had uncovered a record-setting amount of cash — piled up in a condo, a mansion, and in warehouses. Greenbacks were everywhere. They found $35 million in a house in Bel Air — in shoe boxes, in drawers, and in duffle bags piled in the shower. There was $20,000 in the trunk of a Bentley. An undercover agent passed along cash that even had blood on it. When they counted it all up, the agents had more than $90 million, which they say is the biggest one-day seizure of cash in the United States ever.

Then the agents went after bank accounts, netting approximately another $40 million, including $15 million in an account in Taiwan. They seized two Pasadena, California, mansions — one worth $8 million — and a house in Alhambra, California.

According to federal agents, the clothing companies were part of a "black-market peso exchange." Drug cartels have lots of cash in the United States, but in order to use it, they have to get it back to Mexico in pesos. This is how the alleged scheme works: After selling cocaine or other drugs, a cartel member in the United States stuffs the proceeds into a duffle bag and gives it to a "peso broker." The broker hands it off to an exporter in Los Angeles who then sends a previously arranged, seemingly normal clothing order to an importer in Mexico. Once the clothes are sold for pesos, the importer gives the pesos to the cartel in Mexico as payment for the order.

The main hub of the operation in Los Angeles was a maternity clothes wholesaler called Q.T. Fashion, which allegedly took in the drug profits and used the dollars to pay invoices at dozens of other shops around the garment district for export orders to Mexico.

Money that allegedly passed through the scheme was even used as a ransom payment to the Sinaloa cartel for a kidnapped drug dealer who was being tortured on a ranch in Culiacán, Mexico. Cartel bosses were angry with him, according to the indictment, because U.S. authorities seized 100 kilograms of cocaine he was supposed to distribute. According to the authorities, the wayward dealer was tortured with electricity and waterboarded until his captors received $140,000 through the black-market peso scheme and released him.

For good measure, the clothing exporters allegedly added a little customs fraud into the mix. One of the indicted conspirators individually removed "made in China" labels from thousands of garments before shipping them, so that it would look like the clothes were made in the United States. For this painstaking work, he was paid 50 to 75 cents apiece. The switch saved the conspirators from paying taxes on the imports — because the items were "American-made," they were exempt from duties under NAFTA.

Lawyers for the owner and business manager of Q.T. Fashion did not immediately respond to requests for comment. John Targowski, lawyer for the accused label-switcher, Jose Isabel Gomez Arreola, said his client is not involved in the broader conspiracy to launder drug and ransom proceeds. 

Claude Arnold, the head of homeland security investigations for Immigration and Customs Enforcement (ICE) in Los Angeles, said agents were monitoring for bulk deposits into the bank accounts of clothing companies it suspected of being complicit in the scheme. The ploy’s brilliance is that no dollars have to be smuggled into Mexico, but instead the cash piles up on the American side of the operation.

A couple of months before the raid, ICE agents went into the garment district with officials from the Internal Revenue Service to visit about 160 companies and remind them that they were supposed to file a form with the government if they took in more than $10,000 in cash.

"All of a sudden the bank deposit levels started dropping," Arnold said. The garment companies, he said, were now afraid to deposit the money into their banks for fear of raising red flags, so they just started stashing the cash anywhere they could.

"They were helping the drug organizations move money and then here they were here stuck with the cash," said Arnold.

According to the indictment against the proprietors of Q.T. Fashion, it wasn’t just U.S. officials that the cartels were worried about; they were trying to avoid new Mexican banking rules too.

In 2010, Mexican authorities started cracking down on the tens of billions of dollars in drug money that experts estimate flows into Mexico every year. Regulators limited the amount of U.S. dollars individuals could use to buy merchandise to $7,000 and put additional limits on how much money Mexicans can deposit in the bank every month. Before these new limits, cartels just had to get the dollars across the border.

"They could take a pallet of money and go deposit it into the bank," Arnold explained. After the rules changed, cartels had to find a new method of exchanging the dollars in Mexico. Like any large legitimate corporation with millions of dollars, cartel bosses want to have their money in safe, aboveboard bank accounts so they can use it to invest back into the organization, pay people, buy a house, or make a deal.

"They had to come up with ways that they could still get the money and convert it into pesos," Arnold said.

Since the Kingpin Act was passed in 1999, the United States has aggressively blacklisted suspected traffickers using banks to move drug money in and out of the country. In 2013, the Treasury Department added 83 people and 67 organizations to the list, freezing their U.S. accounts and barring American banks from handling their money. The year before, in 2012, the Justice Department hit HSBC with a record-setting $1.9 billion fine for violating sanctions and laundering $881 million for cartels in Mexico and Colombia.

Officials say the effort to keep criminals from laundering their money through the banking system has pushed them into more complex plots.

Angela Byers, the head of the financial crimes section of the FBI’s criminal investigative division, warned about the uptick at a recent industry conference.

"Trade-based money laundering schemes are not new, but we believe they are becoming more prevalent as it becomes harder to use the banking system to move money," Byers said at an anti-money-laundering conference in Las Vegas on Sept. 29.

"Trade-based" money laundering means legitimately importing and exporting goods to hide the proceeds of drug sales or other criminal activity. Narcotics traffickers aren’t just into fashion, but also toys, jewelry, or any other cash-heavy business that does lots of trade with a cartel’s home country. Two Southern California-based companies, Angel Toy Corp. and Woody Toys Inc., were convicted in 2012 and 2013 of helping launder millions of dollars’ worth of drug proceeds through similar stratagems.

"Cartels are not using banks because they know we’re watching the banks," said Celina Realuyo, a former State Department director of counterterrorism finance who teaches classes on transnational criminal organizations at George Washington University.

And law enforcement officials say there is more to come. Nine arrests were made and three indictments were filed on the same day as the garment district raid, but the investigation is ongoing. Since Thursday, about 2,000 businesses in the garment district must now report cash transactions exceeding $3,000, instead of the standard $10,000, to the Treasury Department’s financial-intelligence arm.

Lower reporting thresholds are not a new tool, but one that the Treasury Department’s Financial Crimes Enforcement Network (FinCEN) has been using more visibly lately. The orders aren’t always made public, but law enforcement officials in L.A. said the garment district order was the broadest application of the requirements.

In August, FinCEN also cracked down on another potential loophole criminals could exploit to get drug money into the banking system. FinCEN started requiring armored cars operating along the border between California and Mexico to report cash transactions exceeding $10,000. Business owners have allegedly tried to launder money for drug cartels by bringing dollars that have been smuggled into Mexico back into the United States and representing them as proceeds from a legitimate business.

Jennifer Shasky Calvery, the new head FinCEN and a former Justice Department prosecutor, said she’s committed to using whatever weapons the agency has at its disposal.

"I would describe it as a full-out assault on every place they have money, using every tool in our arsenal to go after that money," she recently told FP.

Shasky Calvery, with her prosecutorial background, has made FinCEN into a more muscular agency, according to Realuyo and other former officials — though some question whether narcotraffickers are likely to fill out forms.

"If they’re involved in criminal enterprises, they would probably adjust very quickly to the new thresholds and conduct transactions below that amount," said Tom Fleming, a former FinCEN official who worked on the targeting orders at Treasury, which he says the department is now issuing more of.

Although law enforcement officials concede that this latest raid is not going to end the sale of drugs in the United States or the need to launder the proceeds, rebuilding money-laundering networks takes time.

Zachary Goldman, a former Treasury official and the head of the Center on Law and Security at New York University Law School, said criminals may be endlessly resourceful when it comes to getting access to their money, but finding a new export company to risk indictment by helping them launder money isn’t as easy as opening a new bank account.

"Banks are institutionalized methods of transmission; the other methods of transmission are trust-based," Goldman said. "Your ability to do so at scale is limited because they’re based on trust."

It’s not as easy as just moving to a new city. "They may not have those relationships in San Diego or San Antonio," Goldman added.

But the cartels may have a new opening. Some officials are worried that Mexico’s recent backtracking on banking rules will mean that criminal organizations don’t even have to worry about creating a money-laundering scheme. They may be able to go back to their old money-smuggling ways.

Special Agent Arnold in L.A. said he was surprised to see that only two days after the garment district crackdown, Mexican authorities lifted the limits on U.S. dollar deposits. President Enrique Peña Nieto said he did so to spur trade along the border. But Arnold is worried it might spur bulk cash smuggling by cartels instead.

"Now that they can just sneak the money across the border, they don’t need to rely on trade-based money laundering," Arnold said.