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.