Covering Globalization: A Handbook for Reporters

MONEY LAUNDERING is the method of concealing the proceeds of criminal activity in order to disguise its illegal origin and create the appearance that it was generated through I legitimate business activities so that the perpetrators can spend their booty with the minimum of suspicion. Governments have designated it a criminal offense in its own right, just like the underlying offense(s) that resulted in the proceeds being obtained in the first place, in an attempt to take the profit out of crime.

Different jurisdictions have historically defined money-laundering offenses in different ways. Historically, it included only those crimes that were universally considered to be “serious,” such as narcotics trafficking, weapons dealing, racketeering, and murder. Tax evasion, therefore, sometimes escaped attention, as it did not meet the legal standard of dual criminality, that is, it must be an offense in both countries for judicial cooperation to kick in. For example, the judicial authorities of many offshore centers would refuse requests for assistance from foreign governments seeking information about offshore bank accounts if the requests in any way involved an investigation into tax evasion, which was not recognized as an offense in offshore centers. If the word “tax” was even mentioned in a request, it would be refused, and many were, much to the chagrin of criminal investigators in the world’s major countries.

All of this has changed in recent years, however, largely as a result of an effort by the world’s major countries to create a minimum international standard for the creation and implementation of a comprehensive legal, supervisory, enforcement and professional framework to combat money laundering and terrorist financing.

Spearheading this drive is the Financial Action Task Force on Money Laundering, which was established by the G7 countries in 1989 and subsequently published a number of recommendations that it is pressuring all countries to adopt. These recommendations include broadening the number of predicate offenses for money laundering to include fiscal offenses, eliminating banking secrecy, introducing greater transparency of beneficial ownership of businesses, confiscating the proceeds of crime, a requirement that financial institutions and certain nonfinancial companies report suspicious activities and the passage of legislation allowing for greater international cooperation in criminal investigations.

Offshore financial centers, which have become synonymous with banking secrecy and tax evasion, were highlighted as a particular problem by the FATF. In a report dated 14 February 2000, the FATF stated: “In today’s open and global financial world, characterized by a high mobility of funds and the rapid development of new payment technologies, the tools for laundering the proceeds of serious crimes as well as the means for anonymous protection of illegal assets in certain countries or territories make them even more attractive for money laundering. Existing anti-money laundering laws are undermined by the lack of regulation and essentially by the numerous obstacles on customer identification, in certain countries and territories, notably offshore financial centers.”

Setting out its aims, the FATF stated: “All countries and territories that are part of the global financial system should change the rule and practices that impede the anti-money laundering fight led by other countries. The legitimate use by private citizens and institutional investors of certain facilities offered by many financial centers, including offshore centers, is not put in question. An essential aspect of this issue is to make sure that such centers are not used by transnational criminal organizations to launder criminal proceeds in the international financial system. It is also important that they are not used by criminal organizations to escape investigation in other jurisdictions.”

As of August 2003, more than 130 countries had adopted the FATF’s recommendations. Those countries whose anti-money-laundering systems are reviewed by the FATF and do not come up to scratch are placed on a list of “Non-Cooperative Countries and Territories” in what is essentially a global “name and shame” process. Businesses located in jurisdictions not on the list are encouraged not to do business with those that are on it. The first list was published in June 2000 and contained fifteen countries. Since then, several countries have been added and removed from the list, and, as of 8 August 2003, those that were still on it were the Cook Islands, Egypt, Guatemala, Indonesia, Myanmar, Nauru, Nigeria, the Philippines, and the Ukraine.

The economies of many small and developing countries have been affected by the FATF’s measures. For example, effective 1 August 2002, the Central Bank of Montenegro revoked the licenses of all 432 offshore banks licensed in the jurisdiction, most—if not all—of which were “shell” banks committing a variety of criminal offenses in cyberspace and around the world.

Offshore financial centers have been left with “Hobson’s Choice”: implement the FATF’s recommendations and lose significant business because foreign clients will go somewhere else or do not implement the recommendations and lose business anyway because their names will go on a global blacklist and other types of foreign clients will be pressured into no longer doing business with them. Even those that do want to be good global citizens are faced with the problem of how to pay for the introduction of these new measures.

Some small and emerging countries have felt bullied by the world’s major countries, and there is a lingering suspicion that the FATF’s measures, in conjunction with a global “tax harmonization” drive by the Organisation for Economic Co-operation and Development, are as much designed to help major countries collect more taxes as they are to stamp out major crime that is not tax related.

While they are undoubtedly neck-deep in money laundering, it is nevertheless a common misconception that most money is laundered in offshore financial centers and developing countries, an impression that is cultivated by governments of major countries seeking to put the blame somewhere other than on their own doorsteps and encouraged by Hollywood blockbuster movies such as The Firm, which portrayed the Cayman Islands as a den of tax-dodging iniquity.

The reality is somewhat different. More criminal proceeds are laundered in New York or London than the Bahamas or Panama, and the biggest culprits within those jurisdictions are more likely to be the “elite” of world banking than a little-known “shell” bank licensed in a faraway tropical paradise. And much of the criminal proceeds received by offshore banks are sent there by banks in major countries, where the underlying criminal activity originated.

Having said that, one of the most notorious examples of money laundering did indeed involve a Cayman Islands offshore bank called Guardian Bank & Trust, which was operated in Grand Cayman by U.S. national John Mathewson. After Mathewson was arrested in the U.S. in 1996 following his criminal indictment for money laundering and fraud at the U.S. District Court for the District of New Jersey, he handed over his bank’s entire computer records of clients in return for leniency. At his sentencing hearing in 1999, federal prosecutors said that bank records given to them by Mathewson had resulted in investigations into 1,500 U.S. tax-payers and could eventually recover $300 million in unpaid taxes and penalties.

Guardian Bank’s liquidator, accountant Christopher Johnson, unsuccessfully applied to the court for the return of the computerized records, alleging that Mathewson had stolen them. Johnson argued that the use of the records by U.S. prosecutors would harm Cayman’s offshore banking industry, which at the time included 570 banks with total deposits in excess of $425 billion, but the court ruled that “the interest of the United States in its ongoing criminal investigation” took precedence.

Assistant U.S. Attorney John J. Carney described Mathewson as the “the most singularly important government co-operator in tax haven prosecutions in the history of the Internal Revenue Service.” So helpful to investigators was Mathewson that Judge Alfred J. Lechner Jr. said the number of requests for leniency he had received from prosecutors was “extraordinary and had not been equalled by any other case,” according to a report in the New York Times. The newspaper quoted Mathewson as telling the court: “I have no excuse for what I did in aiding US citizens to evade taxes and the fact that every other bank in the Caymans was doing it is no excuse.”

Mathewson’s unprecedented cooperation paid off during his sentencing. Rather than face the rest of his life in prison, the then seventy-one-year-old offshore banker was let off with probation, 500 hours of community service and a $30,000 fine. Not bad for someone who set up numerous shell corporations, provided false invoices, and performed other acts to launder the proceeds of what prosecutors called “the biggest cable television piracy case in history.”

Developing or transition countries are particularly vulnerable to money laundering because they generally lack the level of legal, enforcement, and professional sophistication required to effectively regulate one of the most complex areas of criminal activity. Many also lack the finances to implement a system that will meet international standards. However, if they do not meet these standards, they are likely to find themselves on the FATF’s list of “Non-Cooperative Countries and Territories,” which, apart from being embarrassing, may lead to a loss of revenue as companies in countries that do meet these standards shy away from doing business with them for fear of attracting the unwelcome attention of their home regulators and law enforcement agencies.

Another negative consequence of failing to control money laundering is that it encourages some of the world’s worst criminals, such as terrorists and narcotics traffickers, to establish a foothold in a country, with all of the underlying problems that brings, such as threats of violence, bribery, corruption, murder, and so on.

FATF has recommended that “countries should apply the crime of money laundering to all serious offenses, with a view to including the widest range of predicate offenses.” FATF has recommended that countries should—as a “minimum” measure—include a range of offenses in their legislation within each of the following “designated categories of offenses” as a basis for money laundering:

Placement. The point at which criminally derived proceeds enter the financial system. This might involve breaking up large amounts of cash into smaller amounts that attract less attention and attempting to deposit it into a bank account. This is the phase when the criminal’s ill-gotten gains are considered to be most susceptible to seizure by the authorities. Due to anti-money-laundering legislation in many countries that typically carry severe criminal and civil penalties, financial institutions are becoming increasingly wary of accepting large amounts of cash and have a legal responsibility to report suspicious transactions.

Layering. Proceeds of crime are moved around in a series of complicated and numerous financial transactions with the ultimate goal of making it difficult, if not impossible, to trace the funds back to their criminal origin. This process typically involves setting up an array of “paper” legal entities in multiple jurisdictions, particularly those known for their bank secrecy laws.

Reporters should look out for the existence of “paper” entities on a balance sheet or in ownership records, that is, companies or other legal entities that do not have any employees and do not have a bona fide office in the jurisdiction in which they are incorporated. These entities will exist only as a piece of paper in the filing cabinet of the office of a company-management firm or law firm in their home jurisdiction. Obvious questions that arise are: Why do these entities exist? What do they do? What do they own? This is an important aspect of a money-laundering investigation since the process often involves criminals’ sending cash to what are, in reality, paper entities on the pretext of paying an invoice for services that the paper company is supposed to have rendered, which is an all but impossible task if it has no employees. Enron, which was headquartered in the United States, incorporated more than 600 subsidiaries in the Cayman Islands yet did not have a single listing in the local telephone directory or a local office. It turned out that Enron used these firms to hide massive losses as part of an elaborate fraud.

How does one identify a paper entity? There are certain jurisdictions that are known for incorporating high volumes of paper entities. Jurisdictions to watch out for include Delaware and Nevada in the United States and the following offshore financial centers: Anguilla, Antigua, Bahamas, Bahrain, Barbados, Belize, Bermuda, British Virgin Islands, Cayman Islands, Cook Islands, Costa Rica, Cyprus, Dominica, Dublin (Ireland), Gibraltar, Grenada, Guernsey, Hong Kong, Isle of Man, Jersey, Labuan, Liechtenstein, Luxembourg, Malta, Mauritius, Monaco, Montenegro, Montserrat, Nauru, Netherlands Antilles, Niue, Panama, Singapore, St. Kitts and Nevis, St. Lucia, St. Vincent and the Grenadines, Switzerland, Turks and Caicos Islands, and Vanuatu. Only a tiny fraction of foreign-owned legal entities incorporated in offshore financial centers have a physical presence there. The British Virgin Islands and the Turks and Caicos Islands collectively have several hundred thousand foreign-owned legal entities registered in their jurisdictions, but probably no more than two dozen of these have a physical presence there. Even in Bermuda, which has one of the most developed infrastructures of all offshore centers, only about 300—or 2.5 percent—of its approximately 12,000 foreign-owned legal entities have a physical presence.

If a reporter suspects a company is a paper entity, its address should be run through a major Internet search engine such as Google at www.google.com. If it is indeed a paper company, it is likely that there will be many hits for other “shell” companies who are also using that address, which is typically a mail box operated by a company-management firm or law firm. Also, its name should be run through the local telephone directory to see if it has a listing. Reporters can access a Global Yellow Pages from http://www.globalyp.com/world.htm. The overwhelming majority of paper entities do not have telephone-directory listings.

Learn to differentiate between the terms “beneficial” and “nominee.” A beneficial owner is the person for whose benefit an asset is held, while a nominee owner is simply a “front” for the beneficial owner. In the offshore world, the nominee is king. Many law firms and company-management firms operate nominee holding companies that show up as shareholders on corporate share registers even though the beneficial shareholder is the client. It is done to hide the identity of the client. If “XYZ Holdings Ltd.” shows up as a shareholder of “ABC Telecommunications Inc.,” and XYZ Holdings Ltd. is a wholly owned subsidiary of a law firm, it does not necessarily mean that the law firm has a beneficial interest in ABC Telecommunications Inc. The law firm might be holding its stake on behalf of a client who wishes to remain anonymous. It is also common for foreign-owned companies to have nominee directors, who are usually local attorneys or employees of company-management firms who have little or no idea about the underlying business of the company of which they are a director. If “Joe Public” or “John Smith” shows up as a director of an offshore company, it certainly does not mean that he plays any meaningful role in the governance of that company, as directors are supposed to. Some attorneys and company-management employees simultaneously serve as directors of dozens or hundreds of “paper” companies. The provision of nominee directors and shareholders is done for a fee and is a highly lucrative area of offshore finance for law firms, company-management agents, and others.

Information about legal entities in offshore financial centers is generally difficult to obtain. In most centers, the only publicly available information about a legal entity consists of its registration number, date of incorporation, and the name and address of its registered agent. Perhaps the most open offshore center is Bermuda, where, for a small fee, you are legally entitled to look at each legal entity’s file at the Registrar of Companies and view its share register and list of officers and directors, which are kept at its registered office.

In securities fraud, it is common for insiders to hide illegal trades in the stock of their companies by buying and selling shares through offshore entities whose ownership is hidden. The existence of offshore-registered entities as significant shareholders in regulatory filings for publicly listed companies outside of their home jurisdiction is a red flag that warrants further investigation.

In the world of money laundering, the underlying objective of those involved is to deceive anyone looking into their activities, and very little is as it appears on the surface. A successful investigation into money laundering requires a tremendous amount of time and effort. Reporters need to be persistent and inquisitive.

It is important to understand that all commercial financial institutions are used by criminals to launder money and, as a rule of thumb, the bigger the financial institution, the bigger its money laundering problem. The acid test is whether they were involved knowingly or unknowingly.

The biggest money-laundering centers in the world are generally considered to be the United States and the United Kingdom.

Never forget the scale of the problem. Best-selling author Jeffrey Robinson has described money laundering as the world’s third-largest industry in monetary terms.

AML. Anti-money-laundering.

BENEFICIAL OWNER. Refers to the person or people who ultimately own or control an asset.

CORRESPONDENT ACCOUNT. An account established by a domestic financial institution for a foreign bank to allow the foreign bank to receive deposits, make payments, and transact other business.

CORRESPONDENT BANK. A banking relationship that covers the financial services and operations that financial institutions offer to one another, both domestically and internationally.

FATF. Financial Action Task Force on Money Laundering.

FRONT COMPANIES. In the context of money laundering, a front company is one that appears to be legitimate and have nothing to do with the person who is laundering the funds but, in reality, is secretly controlled by the criminal.

IBC. International Business Company or International Business Corporation; routinely used to describe a foreign-owned “paper” company that is incorporated in an offshore financial center.

KYC. Know your customer.

NOMINEE. A person who has no beneficial interest in a company but is representing a party who wants to remain anonymous.

OFFSHORE FINANCIAL CENTER/TAX HAVEN. Generally, a small country which has passed business-friendly laws designed to attract large amounts of foreign capital, largely on the basis of offering bank secrecy, protection from creditors, and low or no taxes. Only a tiny fraction of foreign-owned legal entities incorporated in offshore financial centers have a physical presence there.

“PAPER” OR “SHELL” COMPANY. A company incorporated in a jurisdiction in which it has no physical presence.

REINVOICING. The use of a corporate tax haven as an intermediary between an onshore business and its customers outside its home country. For example, if Company A in Russia sells goods worth $1 million to Company B in France, it can evade taxes by selling the goods for $500,000 to Company C—a “paper” offshore company that it secretly controls—which, in turn, sells the goods to Company B for $1 million and retains $500,000 in an offshore account on which it pays no taxes. In essence, this is a sham transaction that is designed to evade taxes.

SHELF COMPANY. A company which has already been incorporated but has not started to trade and is available for sale for a minimal amount of money. This is the quickest way to obtain a company.

SAR. Suspicious activity report.

SHELL BANK. A bank incorporated in a jurisdiction in which it has no physical presence and which is unaffiliated with a regulated financial group.

SMURFING. One of the most commonly used money-laundering methods in the United States and Canada. It involves breaking up criminal proceeds into amounts of less than $10,000 and depositing these tranches into many different accounts at financial institutions in order to avoid the type of regulatory scrutiny that may arise if the entire amount is deposited in a single account in one transaction.