Offshore Financial Centers in the Pre and Post-September 11th, 2001 International Regulatory Context
Andrew Adler-Herrera Comparative Business-Government Strategies Professor Murphy December 16, 2002
Introduction On September 11, 2001 when al Qaeda terrorist s carried out a well-orchestrated attack against the World Trade Center in New York City, US and international citizens—from the average “Joe” to policy makers in Washington, DC—knew that the world would never quite “be the same”. Indeed, the focus of international
relations today seems to revolve almost entirely around the pursuit of terrorists and the prevention of their ability to carry out further attacks against the US or US interests abroad. Furthermore, the task of ensuring global security has pushed associated issues into the forefront of the international reform table. In particular, the offshore banking industry, one which
for decades has functioned in an environment of lax financial regulation and strict secrecy laws, has received a significant surge of reform pressure in the post 9/11 environment due to the ability of terrorists to launder money through Offshore Financial Centers. While the international community had emphasized the need for reform in OFCs in the years preceding September 11th, the events of that day seemed to have mobilized an unprecedented level of commitment and urgency to stringently follow “know your customer” principles and reform secrecy laws that have sheltered not only terrorists and other international criminals but also high net-worth individuals and corporations for decades.
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Domestic US law enforcement agencies, intelligence organizations, the Bush administration, international financial organizations and other global institutions remain the principle “pressure actors” that have begun to press for change and seek concrete results as opposed to empty promises for reform. Many previously “blacklisted” nations that championed offshore laxity have jumped on board, but the international community is by no means completely rid of offshore avenues to stash illicit funds or other assets to avoid income taxes. Certainly, individuals and corporations around the world that have enjoyed cushy benefits from OFC laxity, as well as OFCs themselves, continue to resist pressure for change. Yet whereas
the pre 9/11 environment may have given justice to such wealthy interests, the commitment of the Bush administration and other international organizations to the “war on terror” nulls these once more influential interests. In the post 9/11 environment,
OFC reform has become a near mandatory trend because it is viewed as an essential means to tackle terrorism today. Money Laundering and Offshore Banking The International Monetary Fund estimates that between 2% 5% of the world’s GDP or as much as 3 trillion dollars, is laundered each year through the global economy and as much as
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one-third of these illicit funds enter the US financial system1. US criminal code research asserts that over 100 crimes predicate money laundering, including kidnapping, fraud, espionage and drug deal. It is for precisely this connection between money
laundering, offshore banking, and crime that has brought OFCs to the forefront of international debate pre and post- September 11, 2001 for, in theory, by combating money laundering through use of OFCs, authorities can prevent terrorists and all high-net worth criminals from using their illicit profits and proliferating their crimes. Proceeds from international crimes often take the form of hard, cold cash that while untraceable is also very bulky and difficult to transport. If a Venezuelan drug supplier where to
sell 44 pounds of cocaine to a North American distributor for one million dollars, the supplier could be stuck with up to 256 pounds of money with which he/she would then need to either hide or invest so as to give the assets the outward appearance of legitimacy, a process know as money laundering2. The first step
in the three-stage process is known as “ placement”, wherein the physical currency enters the international financial system after being deposited at a financial institution. Here,
authorities have the best chance of catching criminals in the
1
Morais, Richard, “Private Banking: R.I.P.” (Forbes. November 12, 2001), p 80. 2 Malander, Roger C., and Wilson, Peter A. eds., “Cyberpayments and Money Laundering”. (Rand Corp. 1998) 5.
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act of stashing away their proceeds, but laxity in offshore banking laws has provided criminals the secrecy they need to successfully make the transactions without being detected. Next, during the “layering” stage, criminals may dilute the original depository source by breaking up the funds and making numerous wire transfers to and from hundreds of banks all around the world, entangling their monies in complicated webs that are highly difficult for authorities to trace3. Again, offshore
baking secrecy privileges and inter-jurisdictional red tape hinder intelligence and law enforcement from tracking the money4. Finally, at “integration” dirty money is withdrawn from various offshore accounts connected to false corporations or trust funds and enters into the international economy through normal, everyday transactions, and unless an audit trail has been placed earlier on in the process, the dirty money has now become permanently “clean”, and authorities have no way to detect its falsity5. A few concrete examples of money laundering cases illustrate the extent to which offshore financial centers (OFC) have offered save havens for criminal proceeds. After being
convicted of bribery in 1999 and having all of his accounts audited,
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Asif Ali Zardari, the husband of Pakistan’s former
Over 500,000 international electronic transfers or $1 trillion occur per day. (www.laundryman.u-net.com) 4 “Cyberpayments and Money Laundering”, p 5. 5 United Nations Commission for Drug and Crimes Prevention: www.undcp.org.
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prime minister was found to have diffused illicit funds through banks in the United Arab Emirates, Switzerland, and the United Kingdom, blindly offering Zardari the havens necessary to mask embezzled funds. In a more publicized case, Nigerian president
Sani Abacha was discovered to have stolen $3.5 billion from the Nigerian government, nearly bankrupting the treasury in a scandal that involved two-dozen private banks from around the globe, including Credit Suisse and M.M. Warburg6. In both cases
the offshore banks involved retained onshore affiliates or “correspondents”, major banks in New York and London, wherein the individuals contained onshore accounts contain increments of cash but no information about the owner of the account. Since
large banking institutions often have hundreds of affiliated correspondent banks, “knowing” their customers can become a tedious, expensive task. Offshore Banking and Terrorism In the post-9/11 international environment, offshore banking institutions have come under increased scrutiny because of their role in providing safe-havens for financial resources of terrorist organizations. Many centers have allowed customers
to open accounts without demanding any information as to the origin of the funds, merely issuing customers identification and account numbers to access their money.
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Secrecy laws have
“Private Banking: R.I.P.”, p 80.
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allowed terrorist organizations to hide funds because secrecy laws prevent releasing what little information they have to a third party without compelling evidence of wrongdoing and it is often difficult for authorities to provide clear proof that an individual is beyond a doubt funding a terrorist cell. It is
important to note that the nature of secrecy laws protects not only the organization itself, but also any individual, organization or state that may be supporting that group, allowing states that sponsor terrorism to obscure their involvement by writing untraceable offshore checks. OFCs often
allow for the opening of accounts via the Internet or by phone, hence allowing for groups to avoid physically walking into a bank and risk being identified to authorities7. The current US
Bush administration has increasingly emphasized the need to crack down on terrorist financing because doing so can deliver substantial financial blows to terrorist organizations that rely on offshore havens to carryout their causes8. While the exact extent to which terrorist organizations like Al Qaeda use offshore financial centers is not known, Washington analysts estimate that Bin Laden retains up to one billion dollars in assets world-wide stored in offshore accounts, and as of November 2001 only $27.7 million of those
7
Murphy, Dale. “Part II: Lower Common Denominator, Chapter III: Offshore Finance”. p 5 (2002 WIP) 8 Floor Statement by Senator Kerry (October 25, 2001).
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funds had been discovered and confiscated9.
Indeed, the
organization has used OFCs not only to remain invisible to the eyes of prying intelligence agencies but also as a means to launder drug proceeds from their multi-billion dollar opium industry that endured to a much greater extent before the US campaign in Afghanistan but has not been completely destroyed. Furthermore, as highlighted by Senator Kerry in an October 2001 testimony, al Qaeda has established false charity organizations to which individuals (unsuspecting or affiliated) donate funds in the name of that cover cause, monies that are then transferred to other al Qaeda accounts and distributed to terrorist cells. In the end the percentage of individuals that
take advantage of laxity in the international banking system to support terrorist actions is probably relatively low. Yet the
psychological, physical, and economical costs of terrorist actions constitute dire costs that make combating financial laxity a priority for Washington policy makers involved in the war against al Qaeda and terrorism. Nevertheless, it is
necessary to highlight that OFCs have long offered benefits to non-criminal, high net-worth individuals and corporations both within the US and internationally that stand to lose significant sums of income with industry regulation. As such, the Bush
administration thus finds itself under pressure from very
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www.whitehouse.gov/response/finacialresponse.html
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opposing interests: the war against terrorism vs. the protection of wealth in corporate America. Individuals and Corporations in the Offshore Banking Industry The principle aspect of attraction for high net-worth individuals investing in offshore financial centers has always been the lack of taxation for foreign investors. So-called
“asset protection” has become the technical term that defines a process essentially of tax evasion wherein high net-worth individuals in the US and other nations have stowed money in OFCs to avoid paying high income taxes at home. By transferring
their assets or a significant portion of their assets offshore, individuals seek to avoid paying up to 65% income tax at home, often arguing that their home nations lack the infrastructure to provide for a secure, worthy organization to hold their money. In third world nations plagued with corruption and other financial/economic risks dealing with exchange rates and economic policies, OFCs offer wealthy individuals the option of holding their cash in a location that will not be subject to the same potential economic mishaps they could suffer at home. Seeking to avoid this financial risk, individuals from volatile nations around the globe place assets offshore. Also, the fact
that the industry has remained highly deregulated has allowed individuals to attain maximum returns on their investments by avoiding national capital gains taxes. A whole host of
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financial products have become available to investors, including low risk , high return funds and high interest rate-generating accounts that make putting assets offshore a lucrative, safe means to maximize earnings on current assets. Indeed, one
instrument OFCs use to compete for business is in the interest rate offered on investment. “icing on the cake”. Finally, secrecy laws are the
The specific level of secrecy has varied
from nation to nation, but information on clients is generally kept within the banking institution, and permission to examine an account has often required a judicial approval. While
government authorities seeking to bring assets back home claim OFC regulatory laxity and secrecy laws encourage criminal activity, OFC representatives continually assert the right of the individual to privacy. The banks simply provide the service It is
that by no means forces individuals to evade taxes.
completely up to the individual to decide whether or not he/she will declare offshore assets to home country governments. Multinational corporations have benefited from offshore banking in similar ways that the high net worth individual benefits from using OFC services. Indeed, with the advent of
globalization and the expansion of business investment in multiple countries outside of firms’ home nations has allowed for the consequent growth of the offshore banking industry as a means for firms to invest increased cash flows from numerous
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sources into safe, secure and lucrative banking localities.
As
firms have expanded operations into nations where political and economic risks increasingly affect their project’s stability, OFCs have offered the needed element of stability. By offering
comfortable regulatory and fiscal policies, low costs, stable and friendly political regimes that cater to their needs, and competitive communications structures, OFCs have provided solutions to the financial risks associated with investment in volatile nations10. Low tax and high interest policies, in addition to political stability, market proximity, and ease of incorporating are among the top motivators for MNCs to invest offshore11. Often firms operating on an international scale will
create headquarters in OFCs, allowing them to sell products in a virtually tax-free environment and reinvest into product development while minimizing external loses they would normally incur if located in the US or Europe. Individual, corporate, and criminal investment in offshore financial centers profoundly affects the economy of host nations who increasingly on their business to support local economic growth and stability. While most offshore environments have
been relatively relaxed in nearly every aspect of regulation, many centers do require a percentage of capital remain within
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www.offshore4business.com/theoffind.htm www.tax-news.com
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the country for domestic lending.
The business and general
economic development that occurs as a result of MNC presence within their territories brings revenues to small governments that otherwise rely on tourism as their principle source of national income. OFCs have benefited for several decades from
foreign investment, and they stand to lose a great deal of income if the regulatory environment where to increase in stringency. Within this basic economic concern lies a basic
competitive dilemma: if OFC A chooses to increase regulation, tax rates, and eliminate secrecy laws, its business will simply withdraw to OFCs B, C, or D and so on who have chosen not to regulate. As such, why should A regulate its growth and
stability-inducing financial system? Multilateral Reform Efforts: Pre vs. Post 9/11 Even before al Qaeda’s attack on the World Trade Center in 2001, as a result of several highly publicized cases illustrating laxity in OFC regulation including that of Nigerian president Sani Abacha, the international financial system came under increased scrutiny in an effort to combat money laundering associated with all levels of international crime and to force the return of lost tax revenues and financial business. tarnishing of private bank reputations has been the chief motivator for banks to instill reforms, due to increased surveillance by international institutions like the Financial The
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Action Task Force (FATF) who blacklist “rogue” institutions. Indeed, pressure to reform has forced banks to sign the Wolsfberg Principles, which establish guidelines for banks to scrutinize their customers and provide standards for dealing with suspicious clients. Pre- 9/11 efforts successfully reduced
the number of locations where money could be easily laundered without risk of exposure12. The FATF, created by the Organization for Economic Development (OECD) in 1989, has been the principle international organization exclusively designated to combat money laundering. The organization actively attempts to persuade international governments to reform policies and offers technical assistance needed to enact the changes13. Perhaps its most effective
“watchdog” technique involves its blacklisting of individual jurisdictions that insufficiently cooperate with efforts to reforms laundering regulations, a tactic that threatens not only to tarnish national and industry reputation but also to inflict economic damage, as OECD member nations threaten economic sanctions against “blacklisted” nations. The FATF has called
for mandatory information on clients opening new accounts and for retaining of records for at least five years after accounts have been opened to allow law enforcement to examine needed
12
Levi, Michael. “Money Laundering: Private Banking becomes Less Private”, Global Corruption Report 2001. p 207. 13 “Fighting the Dirt”, The Economist. June 23, 2001. (accessed at www.economist.com)
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information.
Indeed the increased pressure has produced
results: since June of 2001, the Bahamas enacted eleven new money laundering initiatives, and Liechtenstein created a supervisory accounting firm to educate financiers about money laundering14. Also, the Bank for International Settlements
(BIS), an institution established by the world’s leading central banks, took steps in January of 2001to combat money laundering by proposing a series of more stringent, yet voluntary regulations for bank customer identification, recognizing that banks who chose to ignore the codes of conduct would be subject to increased reputational, operational, and legal risks which would result in financial loses15. Finally, in 2000 a group of
private banks met in Wolfsberg, Switzerland to address reputational concerns and established the necessity of “due diligence” of bank clients in order to determine the identity not only of the individual opening the account (e.g. the lawyer, accountant), but more importantly the individual or organization at the source of the money16. According to the principles, when
opening accounts for international firms, banks should “ understand the structure of the company sufficiently enough to determine the provider of funds, the principal owners(s) of the
14
“Fighting the Dirt”, The Economist. June 23, 2001. (accessed at www.economist.com) 15 Bank of International Settlements, “ Customer Due Diligence for Banks,” Basel Committee Publications, No 85, October 2001. 16 Wolfsberg group. Section 1 of Global Anti-Money Laundering Guidelines for Private Banking. “Client acceptance: general guidelines.”
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shares, and those who a have control over the funds….”17.
These
“know your customer” principles also call for due diligence in purpose and reasons for opening an account; the anticipated account activity; the source of wealth; and, the source of the funds, including their origin and means of transfer for monies that are accepted at the account opening18. Actions carried out by international financial and governmental institutions in the pre-9/11 world started the momentum for reform, but their efforts have accelerated to a higher degree since the terrorist attacks against the US. Indeed, an increased urgency and sense of purpose has been added to the picture as actors within the US and the international community increasingly pressure OFCs to reform. As far as the
US government is concerned, one key reform post 9/11 includes the virtual consolidation of various financial and intelligence agencies into increasingly networked organizations that share information on a more regular basis. The US Treasury department
spearheaded an initiative know as “Operation Green Quest” that seeks to create a multi-faceted financial enforcement web of investigators from existing organizations like the IRS, Naval Criminal Investigations, the Justice Department, the Office of Foreign Assets Control, and the Secret Service19.
17 18 19
The operation
Ibid. Ibid Department of the Treasury Press Release (October 25, 2001)
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has produced results: Green Quest has seized approximately $10.3 million in smuggled U.S. currency and $4.3 million in other assets; implemented 21 search warrants/consent searches, 12 arrests, and 4 indictments; and, the operation is currently investigating more than 300 terrorist finance cases20. Also,
the signing of the US Patriot Act by president Bush on October 26 of 2001 increased the ability of domestic and international intelligence agencies like the FBI and CIA to share information regarding all issues surrounding terrorism, including financial asset laundering. Increased urgency within the post 9/11 context is also
illustrated by the October 2002 meeting of the OECD’s Financial Action Task Force to review the progress of Offshore Financial Center conformation to its 2001 banking reform principles. As a
result of the three-day conference, Russia was removed from the list of non-conforming nations. According to FATF president
Jochen Sanio, Russia’s success in implementing reforms to combat money laundering and terrorist financing associated with lax regulation illustrates its commitment to the anti-terrorist finance campaign and marked an important turning point in the international regulation effort21. The Marshall Islands,
Dominica and Niue were also removed from the list of non-
20 21
Department of the Treasury Press Release (February 26, 2002). Financial Action Task Force on Money Laundering, October 11, 2002.
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cooperative countries and territories.
While the FATF expressed
a positive outlook on international OFC regulation progress, the organization emphasized the existence of several non-conforming nations and urged OECD nations to implement “counter-measures” on Nigeria and the Ukraine for their persistent negligence in conforming to FAFT reform22. Other non-conforming nations
remaining on the “black list” include the Cook Islands, Egypt, Grenada, Guatemala, the Philippines, St. Vincent and the Grenadines, Indonesia, Nauru, and Myanmar23. Just as US agencies
have increased collaboration of information and resources, so has the international community: the FAFT announced its
collaboration with the IMF and World Bank in establishing uniform processes to determine whether or not countries are properly enacting the forty-step FATF recommendations. Conclusion While several publicized money laundering cases fueled an initial crack-down on Offshore Financial Centers and their lax regulatory environments during the late 1990s, the terrorist attacks of September 11th 2001 mobilized a more concentrated and purposeful effort on behalf of the United States government, international banking companies, international financial organizations, and international monetary watchdog organizations
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Ibid. Ibid.
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to reform OFC policies so as to impede terrorist financing.
The
societal actors involved in this reform movement s perhaps begin with law enforcement agencies whose top priority is to bring domestic and international criminals to justice. Implicating
some international criminals for drug trafficking might often be hard to prove, but law enforcement may be more able to imprison that same individual for laundering the illicit proceeds from his/her crimes. As such these organizations exert pressure on Intelligence
US policy makers to enforce OFC regulation.
agencies like the CIA who are increasingly entrusted with the duty to protect the US and its allies from terrorist attacks also retain a vested interest in OFC reform that can restrict terrorists’ abilities to carry out their acts. As such, policy
makers receive pressure from such organizations to instill international reform. Furthermore, and perhaps one of the most
impacting players in the process, international institutions like the OECD’s Financial Action Task Force with the collaboration of financial organizations like the World Bank and IMF have spearheaded the movement, outright blacklisting nonconforming nations and further exerting economic pressure to reform lax regulation and break secrecy laws. These
organizations have been mobilized as a result of increase US pressure to do so as well as other international interests that seek to rid the commercial environment of corruption and
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laundering.
Finally, the past few years have witnessed a
surprising effort by the part of banking institutions themselves to reform, motivated principally by the desire to preserve their reputations as respectable international financial institutions. Offshore banks are “pressure reactors” that have responded to the sum pressures of these US and international institutional reform pressures, and they remain essential players in the success or failure of OFC reform. Although substantial conformation to FATF recommendations has occurred, pressures from within the United States and OFCs conflict with this pursuit of increased regulation and the On the one hand ,
consequent pursuit of terrorist financing.
the prospect of regulating OFCs threatens billions if not trillions of dollars in assets of high net-worth individuals and international corporations around the world that have benefited for years from high interest rates, non-tax environments, and identity protection. or necessary Whether or not such benefits are merited The more important the offshore banking
is only part of the issue.
point remains, rather, that regulating
system involves big money and big interests that can wield significant power within the US political context so as to limit the extent to which reforms are set in stone for the long run. Nevertheless, while these interests may have hindered US pressure for reform pre-9/11, the attacks have concentrated the
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Bush administration’s interests to the protection of US domestic and international interests from further attacks, which in the end means attacking terrorists anywhere possible, even if such action requires the breakdown of a cushy system that has protected powerful domestic interests for years.
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Works Cited
Bank of International Settlements, “ Customer Due Diligence for Banks,” Basel Committee Publications, No 85, October 2001. “Cyberpayments and Money Laundering”, p 5. Department of the Treasury Press Release (October 25, 2001) Department of the Treasury Press Release (February 26, 2002). Financial Action Task Force on Money Laundering, October 11, 2002. “Fighting the Dirt”, The Economist. June 23, 2001. (accessed at www.economist.com) Floor Statement by Senator Kerry (October 25, 2001). Levi, Michael. “Money Laundering: Private Banking becomes Less Private”, Global Corruption Report 2001. p 207. Malander, Roger C., and Wilson, Peter A. eds., “Cyberpayments and Money Laundering”. (Rand Corp. 1998) 5. Morais, Richard, “Private Banking: R.I.P.” (Forbes. November 12, 2001), p 80. Murphy, Dale. “Part II, Chapter 3: Offshore Finance”. (2002 WIP) United Nations Commission for Drug and Crimes Prevention: www.undcp.org. Wolfsberg group. Section 1 of Global Anti-Money Laundering Guidelines for Private Banking. “Client acceptance: general guidelines.” www.offshore4business.com/theoffind.htm www.tax-news.com www.whitehouse.gov/response/finacialresponse.html
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