Mossack Fonseca leak prompts global compliance crackdown

Nothing greases the squeaky wheels of government quite like a scandal.

More than 370 journalists in 80 countries took part in a year-long effort to parse through a massive trove of leaked files (the “Panama Papers”) from the Panama-headquartered law firm Mossack Fonseca, a firm that for more than four decades was at the center of facilitating shell companies, offshore tax shelters, and secret trusts for wealthy and politically connected individuals around the world.

Even in these initial days of the data leak, a lot has happened—much of it in the category of posterior-covering optics. President Juan Carlos Varela of Panama, after years of turning a deaf ear to complaints about his nation’s reputation as a go-to destination for creating shell companies, now promises to convene an independent committee—one that includes Columbia University’s Nobel Prize-winning economist Joseph Stiglitz—to review his nation’s financial practices and improve transparency. Panamanian authorities also raided the offices of Mossack Fonseca to search for evidence of illegal activities, including money laundering and terrorism financing.

Outrage over his financial machinations appearing in the papers prompted thousands to take to the streets in Iceland, successfully demanding the resignation of Prime Minister Sigmundur David Gunnlaugsson. In Geneva, public prosecutor Olivier Jornot launched a criminal inquiry in response to the Panama Papers disclosures. British Prime Minister David Cameron faces a political firestorm after the data revealed potential tax avoidance strategies he and his late father orchestrated. The scandal has given him the unflattering nickname “Dodgy Dave.”

Eric Lewis, a partner with law firm, Lewis Baach, compares the furor to a famous scene in the film “Casablanca.” “There’s an element of, ‘I’m shocked—shocked!—to find that gambling is going on in here.’ We are ‘shocked’ to learn there are Panamanian companies set up by politically exposed persons, tax avoiders, and money laundering.”

A catalyst for action

Nevertheless, regulatory responses are taking shape. The Treasury Department says it is now moving forward with a beneficial ownership rule proposed by its Financial Crimes Enforcement Network in 2014. Banks and brokerage firms would need to seek out evidence of the true owners at the heart of convoluted financial structures.

Beyond U.S. borders, on April 12 the European Commission proposed country-by-country reporting requirements for multinational companies, a move pushed forward by the Panama Papers reveal and in response to estimates that EU member states lose €50-70 billion each year to corporate tax avoidance. Under the rule, companies would need to disclose taxes paid on business they conduct outside the European Union.

EU officials are also threatening to impose sanctions on countries suspected of being tax havens and hotbeds of money laundering. “Particular opportunities for tax avoidance and tax evasion emerge in tax jurisdictions which do not respect international tax good governance standards,” a fact sheet on the proposed tax reporting rule says. Also, 20 financial firms were given an April 15 deadline to report on any of their accounts connected to Mossack Fonseca. “We will require updates on any significant issues or relationships identified and a full response, detailing your findings, when your investigation is concluded,” a letter demanding the disclosures says.

“There is nothing inherently unlawful about setting up an offshore account or corporation for various purposes…The question to ask is the whether it was done to launder money, conceal criminal activity, hide the proceeds of corruption, or evade economic sanctions.”
Seetha Ramachandran, Litigation Special Counsel, Schulte Roth & Zabel

The Panama Papers have also further empowered ongoing efforts to address global corruption. The agenda is likely to now be a very full one at an anti-corruption summit hosted by the United Kingdom on May 12 in London where world leaders, including representatives of the Obama Administration, will meet to address global corruption.

Predating the data dump, a November report by Transparency International looked at how well G20 countries are living up to policy promises, made at a 214 summit in Brisbane, to tackle corporate ownership secrecy. “Governments, including the U.S. and China, have failed to deliver on their promise to fight corruption by adopting laws to end the secrecy that makes it easy for the corrupt to hide their identity and shift money across international borders,” the report admonishes. “The U.S. is one of the worst countries when it comes to implementation, along with countries such as Canada, Brazil, and China.”

The report found that 15 of the G20 countries have “weak or average beneficial ownership transparency legal frameworks in place.” Only the United Kingdom was found to have a very strong framework in place, largely due to legislation giving immediate access to beneficial ownership information to law enforcement, banks, and businesses with duties to check they are not handling stolen cash, such as real estate agents or luxury goods providers. A central registry containing this information was recently made public. Only India and the United Kingdom require companies to record and keep up-to-date information about the real person who owns or controls it.

State-level roadblocks

U.S. efforts to combat money laundering are hampered by check-the-box incorporation laws in some states, notably Nevada, Wyoming, Utah, and Oklahoma. The Panama Papers has, at the very least, put these states under a spotlight. Wyoming Secretary of State Ed Murray announced that, immediately upon hearing the revelations, his office audited 24 companies registered in his state that had ties to Mossack Fonseca.

Addressing state incorporation laws will be difficult—the legislative equivalent of parallel parking a battleship—but efforts are gaining renewed traction. Representatives Carolyn Maloney (D-N.Y.) and Peter King (R-N.Y.) re-introduced legislation, the Incorporation Transparency and Law Enforcement Assistance Act, to require disclosures of beneficial owners. Senator Sheldon Whitehouse (D-R.I.) introduced companion legislation in the Senate.

The proposed legislation directs the Treasury Department to issue regulations requiring corporations and limited liability companies, formed in a state that does not already require basic disclosure, to file information about their beneficial ownership. Minimum disclosure requirements include identification of beneficial owners by name, current address, and any affiliated legal entity that will exercise control over the incorporated entity. Civil penalties are authorized for submitting false or fraudulent beneficial ownership information. “Anonymously-owned companies act as getaway cars for all sorts of criminals – this legislation will make life much harder for them,” says Stefanie Ostfeld of the advocacy group Global Witness’ U.S. office.

Not necessarily illegal

It is important to note that, with a few exceptions, the shell companies detailed in the Panama Papers were not necessarily illegal.

““There is nothing inherently unlawful about setting up an offshore account or corporation for various purposes. People do that all the time for legitimate and lawful reasons,” says Seetha Ramachandran, litigation special counsel at law firm Schulte Roth & Zabel and a former deputy chief in the Department of Justice’s asset forfeiture and money laundering section. “The question to ask is the whether it was done to launder money, conceal criminal activity, hide the proceeds of corruption, or evade economic sanctions.”

U.S. senators demand action

The following, from an April 7, 2016 letter to Secretary of the Treasury Jacob Lew from Senate Democrats Elizabeth Warren of Massachusetts and Elizabeth Warren Sherrod Brown of Ohio, seeks information on how the government is addressing the Mossack Fonseca revelations.
We write to seek a briefing and an assurance that your agency is investigating any potential involvement of U.S. or U.S.-linked banks, financial services institutions, or other companies or individuals with Mossack Fonseca & Co. (MF), the Panama-based law firm with U.S. offices in Miami and Las Vegas whose leaked internal records appear to reveal that it has helped thousands of clients create shell companies to hide assets, some allegedly to launder money and evade their tax obligations.
While we recognize that some of this information may be decades old, we are particularly concerned about whether companies or individuals involved with or utilizing the services of this firm may have facilitated money laundering or terrorist financing with sanctioned persons or entities on Treasury's Specially Designated Nationals (SDN) list, and if so whether they may still be involved in such activity.
The Justice Department is reportedly reviewing this matter to determine whether there may be "high-level, foreign corruption that might have a link to the United States or the U.S. financial system." But, as the primary agency charged with protecting the integrity of the U.S. financial system and enforcing our laws against money laundering and terrorist financing, we strongly urge the Treasury Department to conduct its own inquiry into Mossack Fonseca's activities and its clients.
These disturbing revelations and others reveal activity that may threaten our national security and our financial system by undermining U.S. and international laws promoting financial transparency and combating money laundering and terrorist financing. The reported involvement of U.S. or U.S.-linked institutions and individuals in what may have been efforts to enable international money laundering and tax evasion raises important questions about the susceptibility of the U.S. financial system to money laundering, terrorist financing, and other illicit enterprises.
The Treasury Department's responsibilities include "safeguarding the financial system against illicit use and combating rogue nations, terrorist facilitators, weapons of mass destruction (WMD) proliferators, money launderers, drug kingpins, and other national security threats." Specifically, the Treasury Department's Office of Terrorism and Financial Intelligence (TFI) "bring[s] together, under one roof, an array of capabilities—intelligence, regulation, enforcement, and policy—to confront our adversaries on the financial battlefield."
It has been almost a year since Adam Szubin was nominated by President Obama to head this office, and he is currently serving as Acting Under Secretary for Terrorism and Financial Intelligence. The leak of these important documents underscores the critical role of Mr. Szubin and TFI in combating money laundering and terrorist financing networks, and we hope the Senate confirms hi m as soon as possible.
Last month we voted to advance his nomination out of the Senate Banking Committee, and we are confident in the ability of Mr. Szubin and the office he heads to conduct the relevant inquiries.
We strongly urge the Treasury Department to exercise its full authority to investigate whether any U.S. or U.S.-linked company or person involved with Mossack Fonseca may have facilitated money laundering, terrorist financing, or other illegal activity, including with any U.S.-designated persons.
Source: Elizabeth Warren, Sherrod Brown

She has no doubt that the Justice Department will follow up on the leaked information, even if it isn’t necessarily admissible as evidence in its raw form. “There are questions about how it was obtained and whether it was obtained through a hack, but that doesn’t prevent them from using the information to develop leads and pursue investigations,” she says. New evidence could raise questions about or contradict testimony given in current or past investigations.

While financial institutions consider whether to incorporate data from the Panama Papers as part of their Know Your Customer and AML due diligence processes and screens, they—like others mentioned in the release—may first need to mend damaged brands.

Lewis, the partner at Lewis Baach, expects the release of the Panama Papers to result in a shakeup of the entire offshore market. Companies and funds can no longer turn a blind eye or rely on third parties for due diligence, he warns. There will likely be an increased cost in compliance measures across the board as well as companies being less inclined to conduct business in various jurisdictions such as Panama, where the very use of such offshore vehicles will raise red flags.

The question many will need to ask: “Who is doing the due diligence and at what standard?” Relying on the screening processes of even large, global banks offer no guarantees.

As for the blind-eye incorporation standards in some U.S. states, Lewis describes it as “a race to the bottom” with “Nevada particularly good at having a regulatory infrastructure that is virtually non-existent.”

“What I’ve seen in a number of cases are Chinese companies that do a reverse merger into a Nevada company because their corruption risk and the due diligence risks are less in Nevada than they are in China,” Lewis says. One mitigating factor is that there are at least judicial remedies in U.S. courts. “You could go into a court in Delaware or Nevada and get more disclosure than you might be able to get in a place like Panama or Lichtenstein,” he explains.

While specific names of U.S. persons and entities in the Panama Papers have not yet been made public, underlying issues the leak exposes will come home to roost. “Virtually every Panamanian company has to do business in U.S. dollars,” Lewis says of the web of correspondent accounts. “All business is done in dollars, and all dollars go through New York. What are the standards of due diligence that are applied, such as they are? What ends up happening is that there is a sovereignty issue and very little intelligence until something goes wrong. Then, regulators say they are shocked to know that you didn’t know your customer’s customer.” One solution: “The U.S. has to say that we need certification and you cannot take a correspondent bank on unless they are applying American AML standards.”

Lewis adds that she hopes the Mossack Fonseca leak makes U.S. officials deal with big problems in important places, using their powers—which are quite strong under the Patriot Act and Bank Secrecy Act—to go after the big hitters however the chips fall, rather than going for cheap, symbolic victories.

A distressingly prevalent due diligence failure, one underscored by the Panama Papers and other recent corruption scandals, is a reliance on forms and “box ticking,”

“Due diligence is a skill,” says Scott Lane, founder and executive chairman of The Red Flag Group, a firm that advises companies on integrity and compliance risk solutions. “It requires great knowledge of the markets, industries, the players, the countries, legal risk areas, and how business is done in certain markets. It is not validating forms, or validating registration documents. It involves analysis, research, interviewing, language skills, and a great understanding of risk and what that means to companies and their risk tolerance.”

Relying on a list of countries that have perceived corruption risks is not necessarily the best way to prioritize due diligence. Look at a country-by-country analysis, such as Transparency International’s Corruption Perceptions Index, to assess how they were created and the relevance to your company. “If your biggest growth area as a company is in Japan, and that is where you are growing and investing and making a large part of your non-USA business, isn’t it important that the compliance person map their support to the business to help operate a strong business in Japan? Rather than be off in a 1 percent business market helping the company in eastern Europe, because a ‘list’ says that country is more risk?” Lane asks.

The Panama Papers leak also, yet again, underscores cyber-security concerns with law firms now in the spotlight. Lane asks: Do most law firms even know what an ISO 27001 certification is?

“There are hundreds of third parties that a company deals with, from distributors to law firms,” he says. “Some of the least ‘risky’ third parties like law firms and accounting forms hold all your sensitive deals, all your privileged information, all your financials, all your tax records. Yet, has any company actually done a review of their law firm’s systems? Ever asked them how they manage physical and IT security? Ever conducted a penetration test on their systems? Ever asked for a copy of their penetration tests? Ever done an audit on who in the firm has access to your data?”

There is, Lane says, a silver lining to the Panama Papers exposé and recent corruption reveals, such as the “bribes-for-contracts” scandal embroiling the Monaco-based oil company Unaoil.

“Compliance, particularly awareness of anti-corruption compliance, is the lead story in every news outlet in the world,” he says. “This focus by the media will certainly lead business people engage their compliance office more to help guide them through managing their risks.”

To learn more about the implications of the Panama Papers, be sure to attend the Compliance Week 2016 conference on May 23-25, 2016, in Washington, D.C. Register today!