< Magazine Index > < Index For This Edition > < Subscribe >

Conflicts in offshore jurisdictions can arise between "know your customer" and "code of conduct" rules and the confidentiality laws in place to protect those same clients' financial privacy.  In many offshore centers it is a crime to divulge financial information unless there is suspected criminal activity such as money laundering (for some, tax evasion is not a criminal offense).  International pressure is changing the scope of proactive regulation offshore, and it is likely the onus of suspicious activity reporting will extend well beyond banking to any number of client services.

"There can be no doubt that under the current rules, accountants, attorneys, notaries, company and trust formation agents and other licensed professionals can facilitate serious international economic crime through providing advice and services to their clients," said Jonathon Winer, former deputy assistant secretary for US International Narcotics and Law Enforcement Affairs, in his address to the 17th International Symposium on Economic Crime in Cambridge, England on September 13, 1999.
This comment is not the first of its kind, and should come as no surprise with international bodies and governments calling for increased fiscal transparency in offshore jurisdictions.  Some offshore centers are cautiously heeding these calls, and are now faced with performing a juggling act between clients' desire for privacy and the obligation to help fight international white-collar crime.  Many US politicians and government officials say they still have a lot of work to do.

"These jurisdictions have tended to include micro-states, with small populations, who in effect, have chosen to license their sovereignty to those looking for loopholes in financial regulations," said Winer.  "They have in common no or inadequate regulations and supervision of financial institutions, inadequate licensing and creation rules for financial institutions and inadequate customer identification requirements for financial institutions.  They permit bearer shares or anonymous accounts in fictitious names, ineffective obligations for financial institution record-keeping and reporting, grossly ineffective or no requirements on reporting of suspicious transactions and legal and material obstacles to access by administrative and judicial authorities of other countries seeking information with respect to the identity of the beneficial owners of accounts."

Strong words, yes.  By now they should be very familiar to offshore regulators.

Know your customer rules

Know your customer rules were first introduced for banks in 1988 by recommendations from the Basle Committee on Banking Supervision.  The committee, a group of banking supervisory authorities, was established by central bank governors of the Group of Ten countries in 1975.  It consists of senior representatives of bank supervisory authorities and central banks from Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, the Netherlands, Sweden, Switzerland, the United Kingdom and the United States.  The committee's statement urged banks to properly identify all clients, and both onshore and offshore banks have adopted the recommendations to varying degrees since their release.  For some, it's time for them to be extended to other services.

"To be effective, the 'know your customer' requirements of the original Basle Committee recommendations of a decade ago will need to be updated, broadened to cover those who offer banking-like services, and targeted through partnership with the regulated industries to ensure that 'know your customer' rules are effectively tailored to counter risk and not unduly burdensome," said Winer.  "Countries that lag behind in undertaking this approach, either through self-regulation, government regulation, or a mixture of the two, will find themselves and their financial institutions home to the riskiest transactions, and over time, their economies will pay the price."

Winer acknowledged that today's banks, even those located offshore, face a considerable body of standards applying to their operations, beginning with lengthy recommendations from the Financial Action Task Force (FATF).  "By contrast, there are no international standards governing the incorporation and licensing of exempt companies, shell companies, international business companies (IBCs), offshore trusts, offshore insurance and reinsurance companies, or of offshore fund vehicles, including but not limited to hedge funds," he added.

Domestic reporting requirements

In the United States, politicians and citizens worried about the invasion of their financial privacy have expressed concern over suspicious activity reports being filled out by banks, thrift institutions and credit unions, which are submitted to the Financial Crimes Enforcement Network (FinCEN).  The reports are made by institutions when clients make what is deemed to be an unusual transaction in comparison with their banking history.  Banking customers are not informed that the report is being submitted to FinCEN, and each one filed is made available to every US Attorney's office and the 59 law enforcement agencies across the country.  According to information published by the American Civil Liberties Union, suspicion of a committed crime does not need to be submitted to FinCEN by a law enforcement agency before accessing a particular report.

Outside of the banking industry, domestic reporting requirements vary from profession to profession.  Lawyers are regulated at the state level, and are subject to the rules of state bar associations, of which they must be members.  Solicitor-client privilege is, of course, strongly protected.  Accountants are regulated both federally and at the state level, and through self-regulatory organizations such as the American Institute of Certified Public Accountants.  Self-regulatory organizations are in turn subject to federal regulation by the Securities and Exchange Commission, through the Office of the Chief Accountant.

"Our system is one in which there is regulation on both the state and federal level, and so far it has worked well," says Charles Klingman, a senior analyst with FinCEN.  "We've found it to be effective to have state governments that do regulate certain professionals.  It is somewhat complex though."

Three key items provide regulation in the US: the country's criminal money laundering laws, professional best practices and the Bank Secrecy Act (BSA).  Attorneys are not obligated under the BSA to make suspicious activity reports to FinCEN, unless they work at a bank.  Federal criminal money laundering laws control behavior as well, but do not regulate like the BSA.  Some state laws also mirror its provisions.

Klingman points to best practices as playing an important role.  "We're concerned about results here, to reduce money laundering, and best practices can be just as effective and just as controlling," he says.  "So while it might not fall under the jurisdiction of a particular law, if you're governed by best practices, and are faced with the danger of losing your job, it works quite well."

The Channel Islands

It has been over a year since the Edwards Report was released by the United Kingdom, examining regulation of the financial services industries in Guernsey, Jersey and the Isle of Man.  The current regulatory efforts of the Channel Island centers, stimulated in part by the release of the report, are now some of the most proactive in terms of industry regulation.

"The Guernsey authorities are determined to maintain and enhance the island's position as a reputable cooperative international finance center regulated to the highest standards and to ensure that the island continues to play its part in the fight against crime of all types, including tax evasion," reads a report highlighting recent regulatory efforts published by Guernsey's Advisory and Finance Committee in December 1999.

Guernsey's Criminal Justice Law 1999, commonly referred to as "All Crimes" legislation, came into effect on January 1.  The Police and Criminal Evidence Law, giving authorities additional powers to obtain information for investigations, is being slotted for enactment this year, and the Fiduciary and Administration Businesses Law is also being considered for this year, which would provide for the regulation of trust companies and company formation and administration services for the first time.

"I do not like the underlying principles of this legislation in either the UK or Guernsey, partly because they breach the principles of client confidentiality, particularly for lawyers, and partly because they simply play into the hand of other less principled jurisdictions," said Howard Flight, Guernsey Member of Parliament for Arundel and the South Downs and co-chairman of Investec Guinness Flight, in a speech to parliament on February 25, 1999.  "I believe, however, that this legislation is effectively ipso facto happening and therefore the sensible objective is to make it as workable as possible."

The provisions of the Criminal Justice Law 1999 are equivalent to the provisions of similar legislation already in force in the UK, Jersey and the Isle of Man.

"It is also worthy of note that Guernsey, as long ago as 1995, introduced legislation which gave statutory protection to any informant who disclosed his suspicion of money laundering activities in a case where he was subject to an obligation of confidence, secrecy or other restriction on the disclosure of information," reads the December 1999 report.

Codes of conduct for certain professionals will also continue to be developed.  They will be included under the proposed Fiduciary and Administration Businesses Law.

"Despite all this, however, the bottom line of the proposed law is quite clear; if behavior is suspicious, then report," said Flight.  ". . . What is needed in the UK and Guernsey is a list of suspicious behavior in relation to drug money, which prompts the professional to protect himself by reporting."

Peter Crook, director of Guernsey's Financial Services Commission, spoke at the same Cambridge symposium in September 1999 as Winer, and spoke of the jurisdiction's efforts.  "Irrespective of whether or not a distinction is made between onshore and offshore, finance centers should be divided into those that are committed to compliance with international standards (and importantly can demonstrate compliance) and those that do not," he said.  "Hence, jurisdictions such as Guernsey which do not have bank secrecy, which have a can-do attitude to exchanging information and which are committed to enforcing exchange of information legislation should be placed on one side of the fence while those which are not committed to exchanging information and cooperation would be on the other side of the fence."

Bermuda

Bermuda arguably leads the jurisdictions in the Caribbean region in regulation.  In terms of reporting, the main legislation is the Proceeds of Crime Act 1997, and its associated Proceeds of Crime (Money Laundering) Regulations 1998.  The regulations identify certain institutions, in addition to banks, that are regulated in Bermuda.  They include:  deposit companies, trust companies or any other person carrying on trust business, insurance companies carrying on long-term business such as the writing of single premium annuity products, credit unions, collective investment schemes such as mutual fund companies, trading members of the Bermuda Stock Exchange, trading members of the Bermuda Commodities Exchange, entities authorized by the Bermuda Monetary Authority to offer currency exchange, and most recently, licensed investment businesses.

"We've got a fairly detailed structure in relation to regulated financial institutions," says D. Munro Sutherland, general manager of the Bermuda Monetary Authority.  "We technically have a definition that has been expanded over time and which also provides for non-regulated persons to voluntarily seek regulated status.  The way the act was structured, there is that capacity to broaden it."

The act was also recently amended so that with amendments made to the Taxes Management Act 1976, criminal tax fraud is brought within its scope as a money laundering offense.  It was anticipated that these amendments would come into force in January 2000.
 

Regulated institutions are subject to four main duties:

- due diligence, or know your customer, practices

- accurate record-keeping and retention including account openings and transactions

- internal reporting procedures requiring each entity to appoint a reporting officer

- to have continuous training processes in place to explain to staff their responsibilities under the legislation, 
  including how to identify suspicious transactions, and the duty to report them

The regulated institutions are subject to fines for failure to report suspicious transactions, and if drug-money laundering is involved, staff face possible imprisonment.  While the act does not have direct application to all Bermudian companies, offenses do have general application to anyone in Bermuda, such as concealing or transferring proceeds of criminal conduct; assisting another to retain proceeds of criminal conduct; or the acquisition, possession or use of proceeds of criminal conduct.

"In a jewelry store for example, say someone comes in and says 'I want 100 of those $10,000 watches and will pay cash'," explains John Hill, manager of the Policy, Research and Statistics Division of the Bermuda Monetary Authority.  "The salesman thinks it's a good sale.  At the same time, he or she must realize it's an unusual transaction, and it should occur to him or her that it may not be quite kosher, and that drug money might be involved.  If that person has a suspicion, and fails to report that suspicion, they're actually guilty of a crime for failing to report.  That is quite a serious situation."

The proceeds of crime legislation has a provision that if a person does report suspected criminal activity, they cannot be held liable for it.  "Anyone who blows the whistle cannot be sued civilly for breach of confidence," explains Hill.  There are also anti-tipping-off provisions in the act.  If an employee of a bank or regulated service provider warns a suspected customer that a report has been submitted, that action is in itself a crime, and is punishable by fines and imprisonment.

Guidance notes have also been produced by Bermuda's National Anti-Money Laundering Committee, which provide the industry with direction on know your customer procedures and how to recognize suspicious transactions.  In determining whether a person has committed an offense under the proceeds of crime legislation, a Bermuda court will take into account any relevant guidance issued by the National Anti-Money Laundering Committee.  Compliance with the guidance notes may conceivably offer protection from any charge of failing to comply with the regulations.  "If a regulated institution is charged with failure to comply, the institution can perhaps point to the guidelines," says Hill.  "The point is that the structure of the anti-money laundering regime here is not just the act and regulations."

Reporting officers for regulated institutions report to the Financial Investigation Unit (FIU) of the Bermuda police.  Simply speaking, the FIU is a central office that obtains financial disclosure information, processes it in some way and then provides it to the appropriate government authority to support the national anti-money laundering effort.  For a suspicion to be reportable, it needs to be based on knowledge or suspicion of a crime, or on facts that would relate to a reportable crime, such as tax fraud.

The creation of FIUs over the last five to seven years has occurred in several countries.  Through the recommendations of the FATF, and the Caribbean Financial Action Task Force, suspicious transaction disclosures have become a standard part of money laundering detection efforts in a number of centers.

Where is this headed?

"We need to find mechanisms to facilitate suspicious transaction reporting by company formation agents, accountants, auditors, notaries and lawyers, and consider making the intentional failure to file such reports a punishable offense," said Winer.  "These standards need to create clear guidelines that distinguish between zealous representation of a client and facilitation of criminal activity."

The standards and reporting requirements that Winer envisions are probably quite far off, both onshore and offshore.  The US Senate has recently seen much debate over the suspicious activity reports being submitted to FinCEN by domestic banks, and citizens’ financial privacy concerns will be taken into account.

Offshore, the international pressure to reduce money laundering and criminal tax evasion through more intensive reporting requirements will remain.

"In a globalized financial services environment, it is time for us to move beyond the wink and a nod that too often has come to pass among those in the learned professions for the due diligence our citizens deserve," said Winer.
 

Mark Heard is a reporter and assitant editor of Offshore Finance USA magazine. [Copyright 2000 O.F.C. Publications Inc.  This article was published in the March/April 2000 issue of Offshore Finance U.S.A. magazine]