In an extensive document leak that has come to be known as the Panama Papers, materials released by the International Consortium of Investigative Journalists (ICIJ) in April has cast a spotlight on the use of offshore companies and their connection to global tax evasion and serious financial crimes. The Panama Papers leak is the largest data leak to date on offshore companies, and consists of 40 years of financial data and over 11.5 million financial and legal records from Panamanian-based law firm Mossack Fonseca. A full, searchable database was made public on May 9, 2016, allowing visitors to search almost 320,000 offshore companies linked to over 200 countries.
The anonymous individual who leaked the documents posted a manifesto in April, outlining their motivation in leaking the documents and advancing the policy reforms they see as necessary in confronting the wrongdoing the Panama Papers purport to reveal, describing it as a “glaring symptom of our society’s progressively diseased and decaying moral fabric.” The manifesto begins with the premise that income inequality is furthered by pervasive corruption, with offshore shell companies carrying out a “wide array of serious crimes that go beyond evading taxes.” The policy reforms demanded include: 1) Stronger whistleblower protections and complete immunity from government retribution for “legitimate whistleblowers who expose unquestionable wrongdoing”; 2) Full disclosure of corporate registers, with detailed data on ultimate beneficial owners and standard setting for disclosure and public access; and 3) Ending the practice of self-regulation in the legal industry.
Eligible Introducer Loophole
The Panama Papers fallout brought to light a loophole whereby suspicious accounts were created while hiding the identity of the true beneficial owner by using an eligible introducer. An eligible introducer is a third party intermediary (e.g. professional service providers such as law firms, accounting firms, or financial institutions) that can incorporate an offshore company in a client’s name and open a bank account in the company’s name. The idea of using eligible introducers is to avoid duplication of due diligence efforts where doing so would be unhelpful or onerous, and instead rely on the verification of a third party. As the premise behind conducting due diligence procedures in the first place is to establish a client’s identity to ensure that they are not a bad actor, the eligible introducer signals to regulators the completion of requisite due diligence checks on the client, essentially vouching for their integrity. The benefit of this approach is that it reduces operational inefficiency by not requiring institutions to start the due diligence process from scratch with each client. However, the use of eligible introducers has also facilitated the avoidance of anti-money laundering (AML) laws in obscuring the identification of beneficial owners. Mossack Fonseca often did not store information on beneficial owners, thus creating an opportunity for bad actors to hide money in offshore shell companies while being protected by the layer of secrecy granted by Mossack Fonseca’s role as an eligible introducer.
Due Diligence Implications
The release of the Panama Papers was instantly followed by overwhelming public outcry, precipitating multiple tax fraud charges, including against soccer star Lionel Messi, and even the resignation of Icelandic Prime Minister Sigmundur David Gunnlaugsson. In the U.S., the Department of Justice has launched a criminal investigation into the tax avoidance schemes exposed by the Panama Papers. The Treasury Department issued proposed regulations in May that aim to increase transparency and strengthen disclosure requirements, including beneficial ownership legislation and regulations on foreign-owned single-member LLCs. The beneficial ownership legislation would require companies formed within the U.S. to file beneficial ownership information with the Treasury Department, while the latter would subject foreign-owned disregarded entities to certain reporting requirements and require them to obtain an employer-identification number with the IRS.
The fallout from the document release has already subject AML compliance to further scrutiny, especially in light of the glaring due diligence gaps exposed through the eligible introducer loophole. While the regulatory response is evolving as more information surfaces, this event underscores the importance of maintaining constant vigilance in compliance procedures, and the necessity of enhanced due diligence when attending to offshore transactions.
Amidst a climate of heightened scrutiny and suspicion of the financial services industry, anti-money laundering (AML) regulations continue to rapidly evolve, leaving companies to scramble as they attempt to ensure their compliance efforts are up to snuff. With continuous enforcement actions being brought against a backdrop of new scandals, rules and regulations, it is more important than ever for firms to keep their eyes on the compliance ball.
Customer Due Diligence (CDD) Rule
The U.S. Treasury Department finalized their Customer Due Diligence (CDD) rule in July, which introduces a new requirement for covered financial institutions to determine beneficial ownership and amends Bank Secrecy Act regulations to clarify and strengthen the obligations of financial institutions. As such, when a legal entity customer such as a corporation or partnership opens an account with a financial institution, the customer would have to provide and the financial institution would have to verify the personal information of the individuals who own or control 25% or more of the legal entity customer. Covered financial institutions include federally regulated banks and federally insured credit unions, mutual funds, brokers or dealers in securities, futures commission merchants, and introducing brokers in commodities. Legal entity customers include corporations, limited liability companies, limited partnerships, general partnerships, business trusts, and other entities created by making a public filing.
The CDD rule aims to combat money laundering and other financial crimes by making legal entities more transparent (and thus less attractive to criminals) and strengthening anti-money laundering program requirements by developing customer risk profiles and conducting ongoing monitoring.
New York’s New Anti-Money Laundering Rule
The Empire State has taken additional measures to maintain constant vigilance against financial crimes in the adoption of AML and anti-terrorism legislation by the New York Department of Financial Services (NY DFS). The final regulation requires institutions regulated by the NY DFS to actively monitor for potential Bank Secrecy Act and AML violations by maintaining transaction monitoring and watch list filtering programs. In addition, regulated institutions must adopt either an annual board resolution or finding by a senior compliance officer to certify that they have adhered to the final regulation, which may open them to individual criminal liability should controls prove inadequate. The final regulation will be effective January 1, 2017, and compliance will be required by April 15, 2018.
Changes to Form ADV
The SEC released a final rule regarding amendments to Form ADV and Investment Adviser Act rules, which will require advisers to provide greater disclosure and report additional information, including that of advisers’ use of social media. The goal of these amendments is to increase the depth and breadth of information provided, and by doing so, increase transparency and facilitate the SEC’s examination programs and enforcement initiatives.
The final amendments relate to the following:
1) Information regarding separately managed accounts — Advisers will be required to provide additional information about their separately managed accounts, including the types of assets held and the use of derivatives and borrowings in those accounts.
2) Additional information regarding investment advisers — Advisers will be required to disclose information about their branch office operations and whether they have one or more social media accounts where the adviser controls the content, including profile information for each account.
3) Umbrella registration — These amendments codify and simplify the umbrella registration procedure for registered fund advisers that operate a single advisory business through multiple legal entities.
4) Clarifying, technical and other amendments to Form ADV — These amendments are intended to make the filing process clearer and more efficient so that advisers are better able to understand and complete the Form.
5) Amendments to the Books and Records Rule of the Investment Advisers Act—Advisers will be required to “maintain additional materials related to the calculation and distribution of performance information.”