Trusts, Stolen Assets and the Financial System
François Valérian of Transparency International has just posted an excellent article on the blog of the Task Force on Financial Integrity and Economic Development. Describing one of the ways that you might turn your dirty money into clean money via the offshore system, it is an important post, so we will reproduce it in full. It complements our earlier long article about trusts.
Stolen Assets and the Financial System
By François Valérian, head of private sector programmes at Transparency International in Berlin
The issue of stolen assets and their management, or lack of adequate management, by the global financial system is a component of the broader issue of illicit money and how it flows through the financial system to be transformed into licit, “usable” money. This physical process, often referred to as money laundering – a sort of modern alchemy, it is important for anyone to understand who is genuinely concerned with the fight against political or business corruption.
In order to be successful at fighting corrupt practices, we need to know what these practices are and which ones work and which do not for moving one’s illicit income within the current financial system.
Most modern banks now have, or try to have, systems which are known as “Know Your Customers”, “Anti Money Laundering” or “Anti-Terrorist Financing”. They are also supposed to exercise increased scrutiny on “Politically Exposed Persons”. Banks and financial institutions now have to pay attention (“exercise due diligence” is probably too strong a word) to who their clients are, who their partner institutions are, and in what form they receive the money from their clients. I will not delve further into the complexities of those systems; I just want to note that it has become more difficult now for corrupt individuals.
Even if those systems bear the complexity of modern banking, they are simple to understand in principle. A bank most often receives money from another bank, or sends money to another bank, and at both ends you find clients who are, to simplify, the account owners. It is no longer possible to wire money directly from a bank account you own in the British Virgin Islands to a bank account you own in HSBC, for example, without paying taxes and raising red flags. HSBC can also no longer accept large cash deposits without generating extra attention and scrutiny by the bank and by regulatory officials. Having seen what does not work, let us see what is concretely working, in spite of most regulations or banking procedures.
Let us assume that I am a corrupt official and that I receive a $ 10 million bribe for facilitating a government contract. First of all, I won’t see this amount for some time. It will be wired from an account in Bermuda to an account in the British Virgin Islands. Do I own this account? Yes and no. It is owned by a trust in London, this trust having been setup by me, or by an entity I control, with me or this entity as the ultimate beneficiary. In other words the account will not list my name, but I am still what’s called the “beneficial owner”.
Once the money is in this Virgin Islands account, what can I do to get it back and use it for various personal purposes? I have already said that this money could not be simply wired from the Virgin Islands to my HSBC account. However, I have many other options for getting the money to the open, licit economy. One option is to form a high tech company. The advantage of a high tech company, when still in its infancy, is that it has intangible assets, like patents or even only files for patents on scientific products or processes. These assets are extremely difficult to evaluate as long as they do not produce revenue.
There is a growing market for that kind of company, which are called “private placements”. Private placements are sales of part of a company’s equity to financial investors prior to a public offering. The way to do it is to increase capital, so that the money you raise goes into the corporation. I don’t have to disclose as much to regulators as I would for a public offering in a capital market, and I don’t face the same disclosure requirements as if I were selling my company. I simply raise private money for it, send a nice information memorandum to a certain number of investors, one of which is the investment company setup in London by the trust I control. I now have my $10 million in my company; it is not yet in my pocket, but it is now in the official, licit economy.
What I can’t do now is use this sum to purchase a nice house on the Riviera. This would be an abuse of corporate assets. I can however form another company, also filing for patent registration, and sell the second company to the first one. This will be a deal between two licit entities of the legal, transparent economy. The proceeds from the sale belong to you directly as opposed to staying in the company, as they did as the result of the capital increase of the first company. It is an abuse of majority control (you) to the detriment of the minority shareholder of the first company, but this minority shareholder ultimately is your trust. I now own my bribe and can spend the money however I want.
I can do all that a bit quicker – within a day or an afternoon, with only a small irregularity: I get acquainted with a trader in a bank. With the help of the trader I can do an intra-day derivative trading against myself over-the-counter (i.e. transparent). (He or she will also have a trust and an offshore account, which he will use to take a fee, say five percent, of the $10m after the deal is completed.)
What does that mean? It means that I personally will buy and sell the Dow Jones index within one afternoon, and during this period an investment company setup by my trust will place the same orders. I win if I buy the Dow Jones at 11,500 and sell it at 11,800; I lose if I do the opposite. What my friend the trader does for me is that he or she places my order and the order of my trust in a symmetric manner, and he or she does it at the end of the day. The reason for this is that if the Dow Jones has increased, the trader makes sure that I bought and my trust sold at the same opening price, and I sold and my trust bought at the same closing price. The loss made by my trust is my gain, and on an OTC market there is low scrutiny on the investment company set by my trust, and low capital requirements. (In the EU today, 40 per cent of trading is done over the counter to avoid strong regulation.)
The most important lesson we can draw from my examples is that fighting corruption necessitates a requirement for the disclosure of the beneficial owners of trusts. Transparency would undermine the utility of trusts as a nexus between the licit and the illicit financial systems. Those trusts which do not comply cannot be accepted as controlling entities of structures you do business with, which would curb the deals I described.
For this effort to be successful, however, enforcement must be global and must apply equally to all major financial centres. What can be observed today (and is probably an embarrassing testimony to our partial success) is that civil society organizations have become economic players by driving opaque business out of some places or countries. However, as long as enforcement is national instead of global, this business will flourish elsewhere.
We are a global movement, but our challenge is to find a global interlocutor. There is no such thing as a global government, but at least there is a global forum on the issues of financial framework, and that forum convenes at each G20 meeting. The G20 has to ban opacity on beneficial ownership. We all know that the embedded interests are strong and have some links with individual wealth, but if we are not able to curb this ability to disguise identity, we won’t have any significant impact against grand corruption and stolen assets.
Very well said.
Stolen Assets and the Financial System
By François Valérian, head of private sector programmes at Transparency International in Berlin
The issue of stolen assets and their management, or lack of adequate management, by the global financial system is a component of the broader issue of illicit money and how it flows through the financial system to be transformed into licit, “usable” money. This physical process, often referred to as money laundering – a sort of modern alchemy, it is important for anyone to understand who is genuinely concerned with the fight against political or business corruption.
In order to be successful at fighting corrupt practices, we need to know what these practices are and which ones work and which do not for moving one’s illicit income within the current financial system.
Most modern banks now have, or try to have, systems which are known as “Know Your Customers”, “Anti Money Laundering” or “Anti-Terrorist Financing”. They are also supposed to exercise increased scrutiny on “Politically Exposed Persons”. Banks and financial institutions now have to pay attention (“exercise due diligence” is probably too strong a word) to who their clients are, who their partner institutions are, and in what form they receive the money from their clients. I will not delve further into the complexities of those systems; I just want to note that it has become more difficult now for corrupt individuals.
Even if those systems bear the complexity of modern banking, they are simple to understand in principle. A bank most often receives money from another bank, or sends money to another bank, and at both ends you find clients who are, to simplify, the account owners. It is no longer possible to wire money directly from a bank account you own in the British Virgin Islands to a bank account you own in HSBC, for example, without paying taxes and raising red flags. HSBC can also no longer accept large cash deposits without generating extra attention and scrutiny by the bank and by regulatory officials. Having seen what does not work, let us see what is concretely working, in spite of most regulations or banking procedures.
Let us assume that I am a corrupt official and that I receive a $ 10 million bribe for facilitating a government contract. First of all, I won’t see this amount for some time. It will be wired from an account in Bermuda to an account in the British Virgin Islands. Do I own this account? Yes and no. It is owned by a trust in London, this trust having been setup by me, or by an entity I control, with me or this entity as the ultimate beneficiary. In other words the account will not list my name, but I am still what’s called the “beneficial owner”.
Once the money is in this Virgin Islands account, what can I do to get it back and use it for various personal purposes? I have already said that this money could not be simply wired from the Virgin Islands to my HSBC account. However, I have many other options for getting the money to the open, licit economy. One option is to form a high tech company. The advantage of a high tech company, when still in its infancy, is that it has intangible assets, like patents or even only files for patents on scientific products or processes. These assets are extremely difficult to evaluate as long as they do not produce revenue.
There is a growing market for that kind of company, which are called “private placements”. Private placements are sales of part of a company’s equity to financial investors prior to a public offering. The way to do it is to increase capital, so that the money you raise goes into the corporation. I don’t have to disclose as much to regulators as I would for a public offering in a capital market, and I don’t face the same disclosure requirements as if I were selling my company. I simply raise private money for it, send a nice information memorandum to a certain number of investors, one of which is the investment company setup in London by the trust I control. I now have my $10 million in my company; it is not yet in my pocket, but it is now in the official, licit economy.
What I can’t do now is use this sum to purchase a nice house on the Riviera. This would be an abuse of corporate assets. I can however form another company, also filing for patent registration, and sell the second company to the first one. This will be a deal between two licit entities of the legal, transparent economy. The proceeds from the sale belong to you directly as opposed to staying in the company, as they did as the result of the capital increase of the first company. It is an abuse of majority control (you) to the detriment of the minority shareholder of the first company, but this minority shareholder ultimately is your trust. I now own my bribe and can spend the money however I want.
I can do all that a bit quicker – within a day or an afternoon, with only a small irregularity: I get acquainted with a trader in a bank. With the help of the trader I can do an intra-day derivative trading against myself over-the-counter (i.e. transparent). (He or she will also have a trust and an offshore account, which he will use to take a fee, say five percent, of the $10m after the deal is completed.)
What does that mean? It means that I personally will buy and sell the Dow Jones index within one afternoon, and during this period an investment company setup by my trust will place the same orders. I win if I buy the Dow Jones at 11,500 and sell it at 11,800; I lose if I do the opposite. What my friend the trader does for me is that he or she places my order and the order of my trust in a symmetric manner, and he or she does it at the end of the day. The reason for this is that if the Dow Jones has increased, the trader makes sure that I bought and my trust sold at the same opening price, and I sold and my trust bought at the same closing price. The loss made by my trust is my gain, and on an OTC market there is low scrutiny on the investment company set by my trust, and low capital requirements. (In the EU today, 40 per cent of trading is done over the counter to avoid strong regulation.)
The most important lesson we can draw from my examples is that fighting corruption necessitates a requirement for the disclosure of the beneficial owners of trusts. Transparency would undermine the utility of trusts as a nexus between the licit and the illicit financial systems. Those trusts which do not comply cannot be accepted as controlling entities of structures you do business with, which would curb the deals I described.
For this effort to be successful, however, enforcement must be global and must apply equally to all major financial centres. What can be observed today (and is probably an embarrassing testimony to our partial success) is that civil society organizations have become economic players by driving opaque business out of some places or countries. However, as long as enforcement is national instead of global, this business will flourish elsewhere.
We are a global movement, but our challenge is to find a global interlocutor. There is no such thing as a global government, but at least there is a global forum on the issues of financial framework, and that forum convenes at each G20 meeting. The G20 has to ban opacity on beneficial ownership. We all know that the embedded interests are strong and have some links with individual wealth, but if we are not able to curb this ability to disguise identity, we won’t have any significant impact against grand corruption and stolen assets.
Very well said.
posted by TJN at 10:04 am
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