The Panama Papers is the name given to the more than 11.5 million confidential financial and legal records detailing information on over 214,000 offshore companies and their directors and shareholders. The documents, compiled by the Panamanian law firm Mossack Fonseca, reveal how many wealthy people around the world hide billions of dollars in assets from public scrutiny.
Mossack Fonseca reportedly worked with more than 14,000 banks, law firms and companies to set up the shell companies and offshore bank accounts in Panama and other well-known tax havens like the Cayman Islands. Although the establishment of shell companies and the use of offshore bank accounts are not against the law, several reports alleged that the law firm set up some of these entities for such illegal purposes as tax evasion, corruption and money laundering.
Those Affected So Far
The individuals caught up in the scandal include prominent public officials, athletes, celebrities and current or former heads of state. Other high-profile people whose names appear in the documents include friends of Russia’s President Vladimir Putin and relatives of the prime ministers of Britain and Pakistan. In the wake of the massive document leak, Iceland’s Prime Minister Sigmundur David Gunnlaugsson, who was named in the Panama Papers but denied any wrongdoing, resigned from office.
Many major global banks were named in the papers as having engaged in dealings with Mossack Fonseca. Altogether, approximately 500 banks and their subsidiaries had requested the creation of more than 15,000 shell companies through the law firm. The banks have not been accused of any wrongdoing, although New York State’s banking regulator has ordered that several banks turn over the records of their transactions with the law firm.
Further Investigations Underway
Investigations by multiple countries are now underway to determine whether or not clients of Mossack Fonseca engaged in illegal activities. If this is determined to be the case, these individuals may face criminal prosecution in their home countries and even foreign jurisdictions. The U.S. Department of Justice, for instance, stated that it is investigating “all credible allegations of high-level, foreign corruption that might have a link to the United States or the U.S. financial system.”
“The leaked data covers nearly 40 years, from 1977 through the end of 2015,” The International Consortium of Investigative Journalists (ICIJ) said in its report. “It allows a never-before-seen view inside the offshore world — providing a day-to-day, decade-by-decade look at how dark money flows through the global financial system, breeding crime and stripping national treasuries of tax revenues.”
Mossack Fonseca insists it has broken no laws and affirms that all its operations are legal, operating “beyond reproach” for more than 40 years. The Panamanian government also denies that the country is a tax haven, although it has launched an investigation into the allegations. In late-April, Panamanian investigators raided a property used by Mossack Fonseca, removing bags of shredded documents that investigators described as evidence.
These startling events are occurring as many nations engage in efforts to clamp down on tax evasion and money laundering by their citizens. As the investigations continue, the unprecedented document leak elevates the critical importance of strict compliance by the private wealth management industry with anti-money laundering (AML) and “Know Your Customer” (KYC) laws, in addition to proper due diligence into the related risks. This report outlines these issues and endeavors to explain how the leak will likely affect the wealth management industry from a legal and regulatory compliance and enforcement standpoint in the near future.
Legal Considerations
It is important to note that setting up a shell company—a company that exists only on paper and has no offices or employees—in an offshore tax haven is not illegal. Such entities are considered illegal only if they are used for criminal purposes like tax evasion or money laundering. Criminals like drug traffickers also are known to use offshore accounts to hide the financial gains from their illegal activities. Shell companies provide greater privacy, limited regulation and taxation, and are easy and inexpensive to develop.
In a nine-page letter to the ICIJ, Mossack Fonseca stated that in its role as an intermediary for its clients, it had established shell companies in multiple jurisdictions “for a variety of legitimate reasons,” such as estate planning. The law firm said it had complied with international protocols like the U.S. Foreign Account Tax Compliance Act (FATCA) and had conducted “thorough due diligence” on all its clients, many of whom have “come from established and reputable law firms and financial institutions” bound by AML and KYC protocols. It further stated that the offshore companies it had incorporated were not being used “for tax evasion, money laundering, terrorist finance or other illicit purposes.”
Clients of U.S. Firms Could Face Charges
If the ongoing investigations determine this not to be the case, clients of the firm residing in the U.S. could face severe charges, including tax evasion, securities fraud, mail or wire fraud, money laundering and additional crimes. More than 200 U.S. citizens were named in the Panama Papers as clients of Mossack Fonseca. Federal prosecutors in the U.S. also are considering the possibility of establishing jurisdiction over foreign individuals if they were engaged in illegal activities with American intermediaries or their transactions were cleared by correspondent accounts in U.S. dollars. Other nations conducting criminal investigations include France, Germany, Austria, Sweden and the Netherlands.
Irrespective of the legal status of shell companies, their secretive nature has long compelled questions about the possible hiding of illegal activities. Such questions will be more pronounced in the wake of the document leak, putting the onus on intermediaries like Mossack Fonseca and the thousands of global banks that are engaged in wealth management activities like the establishment of offshore funds to step up their due diligence.
Wide Impact on Offshore Funds
The release of the Panama Papers is expected to result in the increased scrutiny of offshore funds and the intermediaries, banks and other financial entities engaged in these activities. Given the current political turmoil in many countries over the issue of income inequality, these inquiries are expected to result in possible new laws and heightened enforcement of current regulations.
In a press conference in early April, U.S. President Barack Obama called global tax avoidance a “huge problem,” but pointed out that a “lot of it is legal.” He blamed the problem on “poorly designed” laws that allow wealthy people “to wiggle out of responsibilities that ordinary citizens are having to abide by."
Many countries have expressed concerns over porous legal distinctions on tax avoidance strategies that benefit the wealthy. Denmark’s financial regulator has reached out to the European Banking Authority to determine how best to respond in its supervisory capacity to Danish banks named in the Panama Papers. Germany is said to be enhancing efforts to curb legal but “morally questionable” tax avoidance schemes. Sweden’s financial regulators are investigating possible misdeeds of one of the country’s largest banks, Nordea Bank AB, which was alleged in the Panama Papers to have helped clients avoid taxes. And Panama’s government is under tremendous pressure to shore up its AML legislation and enforcement.
Swiss Precedent
Efforts to create greater banking transparency are expected to accelerate in the post-Panama Papers environment. This momentum was already evident in the decision by Switzerland’s government in 2014 to relax its confidentiality rules protecting the sharing of banking information with other countries. The decision to reverse the country’s long history of banking secrecy was prompted by its desire to be compliant with FATCA regulations.
Prior to the document leak, the Paris-based OECD had announced an ambitious agenda to improve global banking transparency and the open exchange of bank information for tax purposes. OECD members have agreed on a three-year mandate to implement these new standards. The Panama Papers is expected to ensure members stick to this timetable.
More Regulations to Come
Other regulations are underway to further banking transparency. The U.S. Department of Treasury’s proposed customer due diligence (CDD) rule would require banks and other financial institutions to reveal the identities of individuals who have incorporated shell companies. Under current KYC regulations, international banks with American branches in the United States must provide the names of these account owners. But the rules do not require the banks to know the identities of customers that set up accounts in shell companies. The proposed rule would close this loophole, a senior Treasury Department official said.
These existing and proposed regulations underscore the need for the wealth management industry banks to anticipate more thorough examination, monitoring and disclosure of offshore funding arrangements, particularly as the momentum for account transparency picks up steam.
Need to Focus on AML and KYC Diligent Due Diligence
To remain squarely within the boundaries of current and evolving international laws and regulations, banks and other wealth managers must undertake thorough due diligence into the individuals seeking to invest in shell companies and offshore bank accounts.
This due diligence is required to ensure regulatory compliance with both AML and KYC initiatives in many countries. Under KYC, for instance, banks must verify the identity and business history of those they conduct business with to ensure their compliance with anti-money laundering rules. In these efforts, banks must determine whether or not such parties pose an increased risk or are on the fringes of compliance, e.g., on the U.S. government’s watch list or other government watch lists. The due diligence should involve an audit of the public records held by different regulatory agencies to identify potential past abuses.
Reputational due diligence is evident in the growing number of firms that have come to CT requesting negative news searches, combing through thousands of media reports looking for damaging information that could pose a risk to the KYC and AML compliance objectives. These searches often inform whether additional investigation is required to ensure proper due diligence for compliance purposes.
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Learn more about how CT can provide support for every stage of the deal, from due diligence to closing to on-going compliance. Contact a CT representative at 844-701-2064 (toll-free U.S.) or visit ctcorporation.com.
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