SOUTH DAKOTA
The last 15 years or so have witnessed a gradual migration of money out of traditional tax havens — Switzerland, the Bahamas, etc. — and into the United States, thanks to the difficulty of opening anonymous bank accounts these days. The short explanation for this is that the U.S. imposed rules on other countries, then refused to impose the same rules on itself (which is all part of a general, low-level hypocrisy in anti-money laundering policy from bigger countries, which smaller countries are furious about). The long version you can read in this article I wrote a while ago.
People who campaign against tax dodging, kleptocracy and financial crime have been concerned about this for a while, and it is notable that the Tax Justice Network now puts the U.S. in first place in its Financial Secrecy Index — way, way, way ahead of Switzerland and Singapore, which are tied in second.
Much of the attraction of the United States as a wealth haven for rich foreigners has been the trusts on offer in states like South Dakota, which can now provide a level of protection and secrecy unrivaled in any of the places we traditionally think of as tax havens. Since there are no state taxes on wealth, and no statute of perpetuities, money placed in trust in South Dakota can stay there forever, compounding indefinitely, without anyone else knowing who benefits from it. As of the end of last year, assets worth $607.5 billion had been placed with the state’s trust companies, up from $500.6 billion a year earlier and from just $57.5 billion in 2009.
South Dakota itself has a population of less than 900,000 people and little ability to monitor or regulate the wealth pouring into its trust companies’ coffers. Its division of banking only checks its trust companies every three years and — anti-corruption activists warn — that’s not good enough.
But other people respond that you shouldn’t judge the U.S. by the same standards as traditional tax havens because of its rigorous enforcement mechanisms. Yes, a lot of money has flowed into South Dakota, Nevada, Alaska, Delaware, Wyoming and the others, but that money is overseen by experienced professionals and regulated by the Department of Justice. So, don’t worry, it’s all good. We’re not talking 1980s Florida here.
So, about that.
- “Kingdom Trust had virtually no process to identify and report suspicious transactions, resulting in it processing over $4 billion in international wires with essentially no controls,” said FinCEN’s Acting Director Himamauli Das, shortly after fining South Dakota-headquartered Kingdom Trust $1.5 million. “This enforcement action is an important statement that we will not tolerate trust companies with weak compliance programs that fail to identify and report suspicious activities, particularly with respect to high-risk customers whose businesses pose an elevated risk of money laundering.”
The details of this case are extraordinary and worth reading in full. From 2014, thanks to advice from an unnamed consulting group, Kingdom Trust began relationships with “foreign securities and investment firms” that were struggling to open bank accounts in the U.S., which should have been reason enough to be suspicious before the real suspicions began.
Among these firms were a “Uruguayan money services business,” which moved cash around for its customers, a Nevis-registered “tourism services” company, a British Virgin Islands-registered company directed by two Argentinians, which sent large payments to Miami-based companies purporting to be in the mobile phone business, and a Panamanian holding company with a U.K.-based subsidiary registered at a service address, which specialized in “logistics in general.” Those four examples are not so much waving red flags as they are entirely dressed in red flags while sitting in a red flag factory, based in a town called Red Flag. And that was just the start of it.
After a financial institution closed some of Kingdom Trust’s accounts over fears of money laundering, it hired auditors to check its processes. The auditors raised concerns over these “high-risk customers,” but Kingdom Trust made no meaningful changes as a result.
All financial institutions are obliged to report suspicious transactions to the Financial Intelligence Unit in their country (in the case of the U.S., that is FinCEN), but Kingdom Trust failed to do this on hundreds of occasions. Which was hardly surprising, since it only had one employee overseeing thousands of transactions who had other tasks to do as well and who was in any case not provided with the information necessary to raise the kind of red flags that might have provoked a Suspicious Transaction Report.
- “The red flags included: customer requests for anonymity, customer attempts to open an account without identification, and an account opened with a nominal balance that subsequently increased rapidly and significantly. It would not be reasonably possible for a Kingdom Trust employee to identify those red flags given the quantity of information contained in the daily transaction reports.”
Two things struck me about this case. Firstly, it was remarkably reminiscent of examples I heard about last week when chatting to a detective who worked on Operation Greenback, the first major money laundering investigation brought in the United States, all the way back in 1980. Financial institutions — in those days, banks — were simply ignoring the Bank Secrecy Act provisions designed to monitor suspicious transactions and moving huge sums, which is just what Kingdom Trust was doing. Money laundering investigators were then, and are now, totally reliant on compliance from financial institutions for the information they need. It is worrying how little has changed.
Secondly, it was very instructive about the nature of South Dakota’s trust industry. This is an industry that deprives other jurisdictions, both in the United States and elsewhere, of the ability to tax financial assets by shielding them behind its legislation. It also hides illicit transactions behind a shield of almost-complete anonymity. The justification for this — in South Dakota — is that it creates jobs and prosperity.
So, about that.
Kingdom Trust may well be headquartered in Sioux Falls, but the majority of its 80 employees are in Kentucky. In fact, although there are 116 trust companies in South Dakota, they only employ 482 people in the state, which means each employee — on average — is the steward of more than a billion dollars. Obviously, those are high-paying jobs and mean a lot to the people who have them. However, I wonder if — at a federal level — it might not be time to ask whether this particular game is or is not worth the candle.
- “The world’s wealthy already operate by a different set of rules and laws. But allowing the full scale carveout and manipulation of U.S. state trust law to serve their interests should not be one of them,” says this forceful op-ed from January.
In South Dakota, they argue that the Kingdom Trust case shows that state regulators are doing their jobs.
- “It’s kind of like, if you’re following the speed limit and seeing someone else who was violating the speed limit get pulled over. It’s reinforcing for you that you’re doing the right thing,” said Tom Simmons, a member of the state governor’s trust fund task force. “I think it shows that those who are not doing what they’re required to do — in terms of complying with all the expectations that are imposed on them — are going to get in trouble… That’s exactly what everyone in the trust industry wants to see.”
I would counter that, however, by pointing out that this was brought by federal regulators, under federal regulations. I would have more faith in the ability of South Dakota to police its swollen trust industry if it were to bring a case of its own.
MORE MONEY NEEDED
FinCEN’s acting director, Das, gave evidence last week to the House Financial Services Committee on progress toward implementing the Corporate Transparency Act, as did Brian Nelson, the under-secretary of the Treasury Department.
There was much interest in their presentations, including details about how sanctions have degraded the Russian war machine, how laborious it is to discover who owns a shell company, how criminals are using crypto to launder wealth and more.
But I was most struck by Das’ comments on how limited FinCEN’s resources are, compared to the scale of the task that Congress has set for it. FinCEN regulates 290,000 different entities within the financial industry but has just 300 full-time employees, of whom only a small number work in the enforcement department.
- “This results in FinCEN having by far the smallest ratio of employees to regulated entities compared to all the Federal Banking Agencies and Federal Functional Regulators. Additionally, all of FinCEN’s enforcement and compliance professionals are based at FinCEN’s offices in the Washington, D.C. area, despite their nationwide scope of responsibility, whereas the Office of the Comptroller of the Currency, for example, has more than 30 regional offices and the Federal Reserve system has 12 regional banks,” Das said.
If we want FinCEN to keep regulating the dollar-denominated financial system, to backstop trust regulation in places like South Dakota and to implement the rules of the new beneficial ownership registry, it needs more people.
- “Guarding the U.S. financial system against abuse by transnational and domestic criminals should not be a political issue. FinCEN needs the funding necessary to achieve its critical national security goals, and to end the era of U.S. complicity in global financial crime,” said Ian Gary, the director general of the FACT coalition.
RIGA
Last week, I went to Riga to attend a conference organized to mark Latvia’s compliance with international anti-money laundering standards. This is a big thing, in that — not too long ago — Latvia’s financial system was basically a sewer pumping dirty money into the West. According to one estimate quoted in 2016, fully 1% of all dollar transactions were going through Riga, which meant Latvian regulators’ failure to check where the money came from was a problem for all of us. How times change. This conference was opened by Prime Minister Krisjanis Karins urging banks to be “more proactive in lending to our economy,” and I heard multiple complaints during coffee breaks about banks being excessively risk averse. Being too scrupulous is not something Latvian bankers would previously have been accused of.
A discussion I found particularly interesting was one about how to ensure that refugees have full access to the financial system (something of particular relevance to Latvia, which has welcomed 50,000 Ukrainians, having previously had no refugee population to speak of). Refugees are uniquely ill suited to providing the kinds of documents required for passing anti-money laundering compliance. They often lack a permanent address, not to mention the multiple documents required to prove their source of funds, and they often automatically raise concerns, thanks to arriving from a high-risk country.
One banker told me about writing to a Ukrainian to request information on the source of her funds, only to be told that her husband was on the frontline, hard to contact and — not surprisingly — unwilling to use his rare periods of rest to gather documentation for what must have seemed an insane and officious process. In March, the European Banking Association attempted to bring order to the situation by publishing some new guidelines, including in relation to not-for-profit organizations.
My main conclusion from reading them, however, is how incredibly complex they are. It’s easy to make a sweeping statement — “refugees must have banking services” — but when you try to distill that into guidelines applicable to any compliance officer in any bank faced by any displaced person anywhere, you end up with a stew of acronyms comprehensible only to people with the highest-possible boredom threshold and which are of — I would suggest — very limited actual utility.
That means individual banks still have a high degree of leeway when it comes to choosing their own risk appetite, which is what got Latvia into all that trouble in the first place.
Incidentally: what do the EU and South Dakota have in common? Just like with Kingdom Trust, no one in Europe was willing to get serious with Latvian banks like ABLV until FinCEN told them to. Just imagine what it could do if it had more than 300 employees. And just imagine how great things would be if more than one country had a regulator willing to, you know, regulate.
WHAT I’VE BEEN READING
My computer broke on my way to Latvia, which was annoying and which forced me to delve into my Kindle for things I hadn’t read yet. So imagine my delight when I realized that, by some strange oversight, I had never read “Neverwhere” by Neil Gaiman. It was great and — if only for a little while — consoled me for the fact that I couldn’t get any work done.
