Not the “Panama Papers” But the “BVI Papers” or Better Still the “EI” Papers

The immense public service performed by the consortia of journalists who exposed the inner-workings of the Panamanian law firm Mossack Fonseca is plain to all.  The thousands of stories in multiple languages revealing how M/F works with law firms and banks around the globe to help individuals hide their wealth has provided law enforcement a cornucopia of leads — as the investigations launched in France, Switzerland, South Africa, Pakistan, the United Kingdom, El Salvador, Argentina, and India attest to.  Far more important than nailing a few tax cheats or crooked politicians, though, are the revelations showing how easily firms like M/F can dodge laws that supposedly bar them from helping individuals keep their wealth a secret and what changes are needed to end this legal dodge ball.

But there is a risk that, because the revelations have been dubbed the “Panama Papers,” reformers will be thrown off the scent.  Panama is a small part of the story at best.  The real problem lies in jurisdictions like the British Virgin Islands where, as an April 4 Guardian story shows, an obscure provision in its antimoney laundering law allows M/F and other firms like it to establish a BVI corporation without having to verify who the true, or beneficial, owner of the corporation will be.  This creates an opportunity to introduce a layer of secrecy between the owner and his or her money and law enforcement authorities.  A name better calculated to lead reformers in the right direction would have been the “BVI Papers” since most of the corporations M/F establishes for clients are created under the law of BVI.

An even better name still might be the “EI Papers” as it is the “EI” provision of BVI law that allows M/F to duck verifying the identity of the beneficial owners of the corporations it creates.  “EI” stands for “eligible introducer,” and the best way to see how the EI provision in BVI law makes hiding money so easy is through an example.  Suppose, just for the sake of illustration, Russian President Vladimir Putin was about to come into a large amount of rubles that he would rather Russian citizens and his critics abroad not know about.  How would the EI provision in BVI law help him keep his wealth secret?

Putin might start the wealth-hiding process by asking someone he trusts, say a childhood friend who is now a renowned cellist, to act as his front man.  The friend, for convenience call him Sergei Roldugin, would then approach a Russian bank or law firm friendly to Mr. Putin for help.  That law firm or bank would then retain Mossack Fonseca to establish a corporation in Roldugin’s name in the BVI that Putin would actually own.

Roldugin could contact M/F directly, but if he did, Mossack Fonseca, which is licensed to create corporations in the BVI, would be required to ask Roldugin a series of probing questions to meet its obligations under BVI’s antimoney laundering laws:  Who is he?  What’s his reason for creating a BVI corporation?  Where will the money he puts through the corporation come from?  M/F would also have to trawl the internet for information about him and that search would almost certainly turn up his relationship with Putin.  Under BVI law that would trigger further, more searching inquiries.  What is his relationship with Putin?  Is he planning to invest any of Putin’s money in the BVI corporation?  Unless Roldugin could provide satisfactory answers to the firm’s questions, M/F would have to refuse to establish a corporation for him, or if it did, it would have to alert BVI authorities.

But BVI law allows M/F to avoid asking such pesky questions by deeming the Russian law firm or bank asking it to create Roldugin’s corporation an “eligible introducer.” If M/F decides the Russian intermediary qualifies as an eligible introducer, then BVI law allows it to assume the intermediary has asked the questions it would have to ask had Rodulgin approached it directly and that the intermediary has received satisfactory replies.  For M/F to treat a law firm or bank as an eligible introducer, three conditions must be met.

First, the firm or bank must be based in a country BVI recognizes as having an effective antimoney laundering regime of its own.  In the case of Russia in 2010 BVI amended its law to put it in this category.  The amendment apparently was in response to a 2008 evaluation of Russia’s antimoney laundering regime by the 13 nation Eurasian Group on Combating Money Laundering (whose members, besides Russia, include Belarus, Kazakhstan, Tajikistan, Turkmenistan, and Uzbekistan).  That evaluation gave Russia high marks for the vigorous enforcement of its antimoney laundering laws.

But BVI law is not wholly naïve, and before M/F can treat a Russian intermediary as an eligible introducer, it must be satisfied that the introducer is in fact obeying Russia’s antimoney laundering laws.  While BVI law is vague on what M/F must do to satisfy itself, a series of tough questions posed to the introducer followed by a visit to its offices seems to be sufficient.  The third condition before M/F can treat an intermediary as an eligible introducer is that it have a written agreement requiring the intermediary to tell M/F who is the beneficial owner of any corporation it asked M/F to establish.

M/F suggests, in a statement issued when the Panama Papers were released, that the vast bulk of its work is done for eligible introducers:  “90% of our clientele is comprised of professional clients, such as international financial institutions as well as prominent law and accounting firms, who act as intermediaries. . . .” Hence, it is critical that when law enforcement or tax authorities ask M/F who the beneficial owner of one of its corporations is, its eligible introducers comply with their obligation to provide M/F with the information.  Yet most agreements appear to be honored in the breach.  The Guardian reports that in less than ten percent of the cases where law enforcement has asked M/F to name a beneficial owner has it been able to do so.  Presumably this is because M/F’s eligible introducers are ignoring its requests for the information.

BVI’s Premier touts a 2015 reform to its antimoney laundering laws that he claims will plug this gap in the law.  From January 1, 2016, M/F and other incorporation agents can no longer rely on introducers for beneficial ownership data.  They must now keep a record themselves of the name, date of birth, residential address and nationality of beneficial owner or owners of companies they incorporate at the request of eligible introducers.  But there is a hitch.  As BVI’s corporate service providers have been quick to reassure clients (here and here for examples), the new law does not require incorporation agents to verify that the information eligible introducers provide them is true.  Thus, in the (again hypothetical) case of the Roldugin corporation, M/F would be free to accept the representations of the Russian law firm or bank that it is Roldugin, rather than Putin, who is in fact the beneficial owner.  That the law was not meant to interfere with BVI’s lucrative offshore business is suggested by the fact that incorporators are not required to review, let alone have, a copy of the beneficial owner’s passport or other identity documents.  Hence in the (again purely hypothetical) case involving Putin, the Russian firm, instead of saying the beneficial owner was Roldugin, could say it is Daffy Duck so long as it provides an address (presumably Disneyland) and the duck’s date of birth  and nationality (U.S.?).

It should be clear by now how eligible introducer laws like the one in the BVI make it so easy for tax cheats, corrupt politicians, drug lords, and other unsavory characters to hide their money and why it is so important they be changed.  BVI and other offshore jurisdictions need to urgently reform these laws to prevent firms like M/F from passing the buck when asked for beneficial ownership data and other information about their corporate creations.  They must be made responsible for verifying and holding beneficial ownership and punished severely if they do not.  Otherwise, the shell games EI laws enable the worlds’ crooks to play at the expense of the common good will continue.

9 thoughts on “Not the “Panama Papers” But the “BVI Papers” or Better Still the “EI” Papers

  1. Dear Rick, your observation that Panama is only a small part of the story is certainly correct. But I would dispute that closing a loophole in the legal framework of taxhavens is going to make a huge difference. The Guardian article you refer to is quite explicit about what it presents as the bigger problem, legal possibilities to crack down on illegal behavior or enforcement: BVI’s continued licensing of M/F, despite knowing it was repeatedly unable to find out who owned the companies on its books, while registered agents such as M/F have a legal obligation to provide company information on request to the authorities on the islands, a British overseas territory. I would argue that the Guardian is correct in pointing out that political unwillingness is at the heart of the matter. I am not arguing against further tightening of legal frameworks, so as to increase opportunities for cracking down on unwanted behavior, but the core question in this case (BVI and M/F) clearly is why existing legislation was not enforced. On top of that, I would dispute that a focus on the BVI’s of this world should be first priority. Again, this is not to argue against pressuring secretive jurisdictions to become more transparent, they play an important role in the multi-layered ownership constructions designed by the legal & financial services providers specialized in finding loopholes and designing structures to facilitate tax evasion and other secretive needs, but the bulk of this industry is not headquartered in such jurisdictions but in OECD (like) countries. Similar to the finance industry not going to stop designing toxic structured vehicles, and implement high-risk trading tactics until and unless they are legally prohibited from doing so, the aforementioned facilitators are going to continue to find ways to hide wealth, whatever specific loophole is being blocked. The focus should therefore be on the facilitators and the question why governments are so loathe to take action. Global Witness’ work describing New York lawyers’ advice on moving suspect funds into the U.S. is a ‘nice’ vignette for all that is wrong with the service providers specialized in designing ways around the law. The gut reaction always is to close loopholes, but investigations like these show quite vivedly that more is going to be needed. The well-resourced services infrastructure is going to stay ahead of the game if that is the only response. I am no expert in this field but even a general news consumer can by now know that legally proving misconduct is often very difficult, and there is lots of room for regulatory improvement to make clamping down on tax evasion etc. easier for governments. But even with current legislation, much more is possible than actually happening. E.g. that BVI’s government, reported by the Guardian as drawing 50% of its revenue from incorporation fees is reluctant to ‘offend’ its cash-cow is less surprising then the limited resources devoted by large developed economies to fighting tax evasion. As I argue in a recent blogpost, the Global Justice Now image visualizing the UK government’s relative efforts in investigating benefit fraud versus tax evasion is very probably in your WAG category (it claims a ratio of 632:1 inspectors/pound), but also much more realistic estimates would still look utterly ridiculous. Even if the UK government would only devote even 10x more staff on pursuing a pound of benefit fraud, as opposed to a pound of tax fraud by large corporations and the ultra-wealthy, what does that tell us about societal priorities? Something’s fundamentally wrong in the application of the law. I’m not a legal scholar and thus unable to explore this any further but do know that others, more knowledgeable, have looked in the same direction for fundamental change. It’s a bit of a tangent but Matt Taibbi’s “Divide: American Injustice in the Age of the Wealth Gap” on how this plays out in the US would be an example I can point to.

    • Thanks for the thoughtful comment on the post. Two points —

      1) On closing legal loopholes, you are quite correct that as a general matter the issue is not what the law says but whether, and how, it is enforced, The BVI “eligible introducer” rules are an example, however, of where the law does matter. A lot. Under BVI law (or at least as this non-BVI lawyer reads it), the only responsibility firms like Mossack Fonseca have to comply with the rules on beneficial ownership that went into effect January 1, 2016, is to have the name, address, birth date, and nationality of the beneficial owner of the corporations it creates on file along with a promise by the introducer to provide more information about the beneficial owner on request. Period.

      Imagine law enforcement comes knocking at M/F’s door wanting information about who actually owns the XYZ company, a company it created at the behest of an introducer. And say the introducer had told M/F that XYZ’ beneficial owner was John Smith, that he was born July 4, 2000, lives at 123 Main Street, Anytown USA, and is American. M/F has met its legal obligation under BVI law when it provides law enforcement with this information.

      If law enforcement wants more information, say the city and state where Mr. Smith lives, a copy of his passport, his social security number, tax identification number, and other information that would actually help it track Smith down, the only thing it can do is ask M/F to ask the entity that introduced it to Smith to supply that information. If the entity does not reply, or provides false information, this is, in technical legal terms, “no sweat off M/F’s brow.” Thus, even if tomorrow the BVI government had all the political will in the universe to crack down on the M/Fs of the world, under current law there is nothing it could do on the beneficial ownership front until it amended the law.

      When the Panama Papers were released, M/F put out a statement saying the papers showed it had done nothing wrong. Given the revelations, I was puzzled how the firm could make such a bold claim and how its PR advisers could let it. Now I understand. Under BVI law M/F can neither be fined nor its employees imprisoned for the failure to provide accurate beneficial ownership information. That’s on the introducer. To me, this is the real scandal the Papers have uncovered.

      2) I agree we shouldn’t just focus on BVI. We should ask what other countries have laws like that in BVI that allow corporate service providers to point the finger elsewhere when asked to provide real, verifiable information on the companies they establish. And then see those laws are changed to impose significant fines and jail terms on firms like M/F when the fail to supply law enforcement with such information.

      • Dear Rick, I must confess to having criticized your post in a questionable manner. You made a perfectly sensible argument, that I agree with (closing legal loopholes is important) and I then basically argued that you should have focused on something else. I’m not a legal scholar and trust your reading of the BVI law. However, my understanding of the Guardian article was different from yours (and possibly wrong): to me it argued that M/F should have lost its license way before 2016, given its non-compliance to previous (and less stringent?) legislation. Loosing a license is not the same as being prosecuted but obviously quite an effective disincentive. My comments on what you did not write about (1. a focus on the BVI’s of this world may be less effective than a focus on cleaning up our own stables first, and closely related 2. that would have to include a focus on the service providers that specialize in exploiting any loophole potential which may be legal but seems to me in blatant contradiction to the spirit of their respective professions) were written assuming that this would make a larger difference than what you argue for. That assumption may very well be wrong. Change is usually incremental and specific and going after specific loopholes in specific jurisdiction may thus be the better strategy. Would love to learn if you have an opinion on this.

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  3. Thanks for a very interesting and informative post! Is the EI feature you describe here common in other jurisdictions as well? I completely agree with the point that the loophole needs to be closed, and perhaps that this loophole is the most provocative uncovering of the (perhaps misleadingly named) Panama Papers. I wonder, though, if the EI feature has some utility for efficiency of transactions, such that the best way to fix the problem might be to tie EI standards to a more reputable comparative corruption index rather than to remove the EI laws altogether.

    • Glad you found the post useful. The EI loophole is in the law of many jurisdictions. It has no utility (somebody has to conduct the due diligence), and as you will see in a forthcoming post (May 18), it makes a mockery of the antimoney laundering laws. Either it should go or the whole AML edifice should be scrapped.

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