Offshore finance has always been glamorous. The world’s tax dodgers and kleptocrats seem to favor the same jurisdictions as James Bond, places with soring vistas, crystalline waters, and plenty of five-star resorts. Yet as the recent release of the Pandora Papers makes clear, the geography of offshore finance has shifted in recent years. For those seeking to obscure the origins of their wealth, South Dakota now eclipses Grand Cayman. Customer assets in South Dakota trusts have more than quadrupled over the past decade to $360 billion. And while there are of course legitimate reasons to set up a trust, trusts offer an ideal mechanism—even better than shell companies—for concealing ownership and preserving anonymity.
South Dakota is an especially attractive jurisdiction for setting up such trusts because it offers not only low costs and flexibility, but also a combination of privacy and control that those seeking to hide their wealth find attractive. Notably, South Dakota automatically seals trust records, preventing outsiders from identifying settlors and beneficiaries, and does not require publicly filing trust documents. (Although South Dakota’s privacy laws do not shield settlors and beneficiaries from federal law enforcement, they do conceal the trust from journalists and the private parties, making it less likely that those involved in the trust come to the attention of government authorities.) South Dakota also allows the creation of “dynasty trusts,” which exist in perpetuity, as well as “directed trusts,” which give families and their advisors maximum control in managing the trust’s affairs. Unusually, South Dakota also allows trusts whose settlor and beneficiary are the same person.
These rules make South Dakota trusts particularly appealing to business and political elites whose assets may be the target of civil as well as criminal litigation. Indeed, the Pandora Papers identified, among those who used South Dakota trusts to conceal their assets, a Colombian textile baron who had sought to launder international drug proceeds, a Brazilian orange juice mogul who allegedly underpaid local farmers, and the former president of a Dominican sugar producer who was accused of exploiting workers. With banks and even real estate agents wary of taking large sums from officials in corrupt regions, a U.S. domiciled trust offers a veneer of legitimacy.
Allowing states like South Dakota to join the archipelago of secrecy jurisdictions where bankers and trustees ask few questions undermines the United States’ fight against global corruption. Indeed, attacking those who abet foreign corruption while welcoming dirty money as an investment strategy is not just hypocritical but self-defeating. The rise of anonymous domestic trusts in the United States demands and an aggressive response from federal regulators. That response can and should include the following measures:
- First, as Devon Himelman recently argued in a post on this blog, the U.S. Treasury Department’s Financial Crimes Enforcement Network (FinCEN) should extend the beneficial owner reporting requirements of the 2019 Corporate Transparency Act (CTA) to trusts. Requiring public registration of settlors, trustees, and beneficiaries would make trusts in South Dakota and elsewhere far more transparent. Doing so would also align the United States with Europe and make it easier for financial institutions and law enforcement to trace and recover the proceeds of corruption. Even if FinCEN declines to extend the CTA’s reporting requirement to trusts, at the very least it should amend its rules to require that all financial institutions collect settlor and beneficiary information to assess the risks that trusts are associated with corrupt actors and dirty money.
- Second, FinCEN must vigorously enforce its new requirement that state-chartered trust companies implement anti-money laundering (AML) programs, including internal controls and risk-based customer due diligence. While the promulgation of this rule is a step forward, not all AML programs are effective. To work well, companies must invest in technology and expertise to identify beneficial owners and the sources of their wealth, and must be willing to decline potentially lucrative business opportunities. As we’ve seen in the banking industry, trust companies are unlikely to make these sacrifices without the threat of government intervention. That requires both rigorous supervision of trust companies’ AML programs and substantial penalties for non-compliance, as well as prosecution of trust companies that violate AML laws. Only when the trust industry faces an existential threat to its business is it likely to make the hard changes necessary to identify and reject the proceeds of corruption.
- Third, FinCEN should consider requiring that trust companies in states with large numbers of trusts receiving foreign assets disclose the natural person settlors and beneficiaries of trusts purchasing any property worth more than $100,000. This move would build on the Treasury Department’s existing Geographic Targeting Orders (GTOs), which require U.S. title insurance companies to identify the natural persons behind shell companies making cash purchases of residential real estate. If the success of GTOs in discouraging the use of shell companies in the purchase of high-end real estate is any indication, forcing trust companies to report large asset purchases would make U.S. trusts a far less desirable vehicle for the corrupt. An even more ambitious approach in the same vein would be to adopt a mechanism similar to the UK’s unexplained wealth orders (UWOs), which allow the government to seize property worth more than £50,000 if the person is either politically exposed or involved in a serious crime and there are “reasonable grounds” for suspecting that their income would have been insufficient to obtain property. Adopting a similar approach in the U.S. would likely require Congressional intervention and might raise due process concerns, yet legislation might address these issues by limiting UWOs to cases where the target used a trust or shell company to conceal the asset’s beneficial owner.
Resisting the tide of anonymous offshore wealth that has found its way to South Dakota will undoubtedly prove challenging. South Dakota has prospered by transforming itself into a haven for those who wish to avoid taxes and conceal their identities, and it would be unrealistic to expect the Pandora Papers to spur the state’s legislature to act. Fortunately, federal regulators have powerful tools at their disposal to increase transparency and to target the proceeds of corruption and other malfeasance. Using those tools aggressively is crucial if the United States wishes to remain a leader in the global fight against corruption.
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What a fascinating post, Justin! I’m curious if you think that FinCEN should focus its efforts on particularly high-risk states––like South Dakota––when implementing your policy recommendations, spending more resources to investigate reports from higher-risk states, or whether you think these recommendations could be applied uniformly across the United States. I think it’s probably desirable for them to be implemented nationwide, but of course that runs up against resource constraints.
Great post, Justin! I found it really informative and it was a great opportunity to learn more about a prominent topic and your suggestions seem really well thought out. One of my questions is what beyond the transparency-forcing regulations by FinCEN do you think would be required to end the use of these legal entities by kleptocrats (if any)? Do you foresee increased international cooperation in this space (similar to the OECD’s global minimum corporate tax, but in the corruption space), given the United States’ desire to lead in this global fight?
Mayze, I think we should have baseline requirements for trusts and transparency that apply nationwide but I think we might start with requiring additional disclosure of asset purchases in those places where there is a lot of overseas money coming into trusts (e.g. Nevada / SD). The idea behind the GTOs was that they allowed FinCEN to target real estate transactions in places where there was a lot of illicit money and associated real estate purchases and the same could apply to trusts, although we’d be looking at Nevada and South Dakota rather than New York and Miami. Ideally, you’d have nationwide requirements because dirty money tends to find the weakest link (Los Zetas laundered huge amounts of money through an Oklahoma horse farm) but as you say resource constraints are an important consideration.
Josh, I think the tricky thing with trusts is they open a legal and financial space between the settlor and the beneficiary that makes it hard to determine whether a trust is genuine, or whether it’s merely an instrument for obscuring the true beneficiary. Ideally, we’d create an international database of trusts and corporations and require that entities validate the information in the database before receiving access to financial services. It’s probably optimistic that this will happen any time soon as national corporate registry databases are still in their infancy and notoriously inaccurate.
Great post, Justin!
Usually, when we think about offshore finance, we think about places like Switzerland, Cayman Islands and Jersey. South Dakota seems a perfect place for kleptocrats to hide their assets, because of its privacy laws and because it is low profile.
Anticorruption and transparency are priorities of Biden’s administration, as declared by him in many opportunities. On the other hand, South Dakota seems to be more concerned in attracting financial resources. My question is: do you think that a misalignment between the Federal Government and the States can be harmful in the fight against corruption?
Does anyone have data on how South Dakota compares with Delaware in terms of facilitating money laundering through trusts and other concealed company registrations. Certainly both excel in this, but is there any good data comparing them? See https://fpif.org/the-united-states-of-tax-havens/ After all, money laundering is a bipartisan enterprise, isn’t it?
See Pandora Papers and the meeting between Presidents Biden of USA and Uhuru Kenyatta of Kenya.last month. https://www.whitehouse.gov/briefing-room/statements-releases/2021/10/14/readout-of-president-bidens-meeting-with-president-uhuru-kenyatta-of-kenya/
Rafael, I do think there’s a necessary tension in American federalism between the states and the federal government and that there are many instances where states undermine federal laws/rules. Ironically, South Dakota’s status as a financial hub is a product of federal law preempting state law, which allowed South Dakota to export its more lax usury laws across the United States (that’s less a case of states undermining federal law but it is a case of a state law undermining what might be a desirable national policy of–depending on your perspective–reasonable usury rates). I don’t think, however, these tensions are irresolvable. At the end of the day (the Constitution permitting), Congress can pass laws and federal agencies can issue rules that trump state law, it’s more a matter of political will.
Great post, Justin!
While your argument and writing is incredible, I do also want to note that I really enjoyed your James Bond reference in the beginning. Prior to this post, I was unaware that South Dakota is an attractive jurisdiction for trusts and I think all three of your suggestions would be beneficial to help prevent anonymous trusts in this area. In particular, I am intrigued about the idea of requiring state-chartered trust companies to implement anti-money laundering programs. I question how effective this will be and if companies will put these programs in place but not really use them. As you stated, it will result in them having to decline potentially lucrative business opportunities.
Thanks so much for the thoughtful exploration of this issue. It’s been so surprising to see how much attention American media has given to off-shore tax havens while ignoring the problems right at home. I’d be curious to hear your thoughts on why trusts, particularly in the U.S., have flown under the radar as vehicles for money laundering? I also wonder if you think the U.S. federal courts would pose any barriers to geographic targeting. While it doesn’t look like it has been challenged thus far, I could see a state like South Dakota expressing frustration over the federal government ‘targeting’ them (and those who do business in the state) for their more liberalized economic policies, especially given some of the Supreme Court’s recent disclosure cases in the campaign-finance realm.
As a side note, I love this image of South Dakota as a member of an ‘archipelago of secrecy.’ What a powerful illustration of the role domestic institutions play right alongside their counterparts in the tropics. (Also, a great name for a Bondsean supervillain conglomerate a la SPECTRE.)
Justin, youreally raised thoughtful points about the Pandora Papers.
I am particularly interested about the third measure that you haveproposed. Unexplained wealth orders could be a relevant tool to make trustsless attractive for corruptors. I am wondering if you have other thoughts aboutwhich “reasonable grounds” would be sufficient to trigger this mechanism. In myunderstanding, it seems a drastic measure, on the edge of violation of propertyand privacy, which may require more clear boundaries to be enforced.
Really enjoyed reading this thorough analysis of the problems facing the SD trust regime. Terrific post, Justin! I’m also intrigued by the third suggestion, and I’m curious about the scope of this disclosure. Would you envision this information to be shared with only government bodies (and would it include foreign governments), or the general public as well?
Justin – thank you for sharing your thoughts on this topic. Like the others, I really enjoyed your illustrations and James Bond reference. Regarding your second point, I was wondering if you could elaborate a bit more on what exactly you mean by “more effective AML programs”. It is hard to imagine that a trust company nowadays would take on a client without having conducted any due diligence or KYC on the settlor and source of wealth. Can you give an example of a type of advanced technology and/or expertise you think will assist in improving the effectiveness of existing compliance procedures? I’m curious as to what that program would look like and how smaller boutique trust companies could implement them with limited resources. On a different note, I find your third point to be excellent. Using a GTO approach for states like South Dakota is a very intriguing idea, especially given its success in the real estate industries of Miami and New York. I was wondering if you could explain your concern about U.S. Congressional intervention and due processes a bit further as I’m not sure I fully understood this point. Thank you so much.