Hedge funds get more financial crime scrutiny

In this week’s Financial Crime Wave, hedge funds get more financial crime scrutiny, tax evaders who came clean may still face wrath of IRS, new FATF head lays out his AML agenda with a heavy focus on terrorism and transparency, and more.

Hedge funds

The kinds of secret offshore companies that have hidden political corruption and tax evasion around the world are often used by Wall Street’s biggest money makers — the $2 trillion hedge fund industry. The now-famous Panama Papers leak offers rare insight into the workings of this exclusive investment club. Hedge funds accept individual investors with net worths of $1 million or more and worker pension funds with $5 million or more. They and their investors often locate in tax havens such as the Cayman Islands or the British Virgin Islands. The names found in the leaked files from the Panamanian law firm Mossack Fonseca include two now-imprisoned hedge fund managers, a major “feeder fund” that was part of the largest-ever Ponzi scheme run by Bernard Madoff and several anonymous investors whose offshore companies became tangled in the Madoff web. In the aftermath of the Madoff scandal and the 2008 U.S. financial crisis, hedge funds have been forced to register with regulators, and they face severe penalties under a new “bad actor rule” if they take money from criminals or proceeds of corruption. “Most financial institutions do require considerable information on investors” today, said Robert Van Grover, an attorney with Seward & Kissel LLP in New York who thought the abuses found in the Panama Papers “would be very difficult in the United States” now. But the hedge fund managers and their investors identified in the leaked documents by McClatchy and partners underscore what has been a weakness in oversight: They often used secret offshore companies, which hid investor fraud and potentially unsavory investors from U.S. regulators, (via McClatchy DC).

Tax evasion

U.S. taxpayers who entered into an IRS program that made it easier to disclose their hidden offshore bank accounts may have thought they put their legal troubles behind them. Instead, prosecutors may try to put some of them in jail for not telling all. Since 2012, 30,000 Americans avoided stiff tax penalties by declaring they had innocent reasons for failing to disclose offshore holdings. But under the program they received no guarantees that they wouldn’t be prosecuted in the future. And now the Justice Department and the Internal Revenue Service are combing through thousands of secret records obtained from 80 Swiss banks to determine whether the taxpayers were truthful. We’re “taking all of that data and scrubbing it for leads,” Nanette Davis, a trial attorney in the Justice Department’s tax division, said at the New York University Tax Controversy Forum last week. The effort has been fruitful already, she said. With some taxpayers, “we say ‘we could indict this case tomorrow,”’ said Davis, who is overseeing the review. The U.S. government got a trove of data from Swiss banks under settlements in which they disclosed how they helped Americans evade taxes. The banks handed over account information, as permitted by Swiss secrecy law, and recordings of phone calls with U.S. clients. In exchange for the cooperation, the U.S. agreed not to prosecute those banks, which paid penalties totaling $1.37 billion. The risk of being scrutinized falls on those taxpayers who came forward under the government’s so-called streamlined program. Those living in the U.S. paid penalties of 5 percent of their undisclosed offshore assets, while overseas residents paid none, (via Bloomberg).

The bigger picture: This is a surprising move by the IRS, if the agency follows through on the initiative to harshly punish individuals who came clean under the various disclosure programs. Why? Well, if these people stop being so willing to come forward, it would shut off a vital spigot flowing with information that actually lead to the bigger fish, which were the banks actually offering tax evasion as a business service. But, in a way, this is an interesting way to close the loop on individuals who actually took advantage of the IRS disclosure program, but then didn’t tell the truth. The IRS is actually using the information provided to them by foreign banks who settled with the US government — to go after some of the individuals who gave US investigators information on the illicit activities of the foreign banks in the first place. What goes around, as they say.


More than at any time in their history, banks are being asked to work hand-in-hand with the U.S. government, serving as deputized watchmen for suspicious activity. That has been happening to some extent since legislation passed after the Sept. 11, 2001, terrorist attacks, but banks’ responsibilities have steadily increased. For more than a decade, financial institutions have been required to file “suspicious activity reports” and have been fined billions of dollars for allegedly failing to do so adequately. Banks now have to monitor all funds flowing through them, alerting authorities to anything of interest—for instance, a transfer of funds to a high-risk country inconsistent with a customer’s history—to help uncover money laundering, terrorist financing or other crimes. For the first time, banks also are taking on an additional role, that of corporate registry. Regulators and lawmakers have tried, and failed, to get states to collect information about the owners of corporations at the time they are registered. Authorities are turning to banks to help close that information gap. Financial institutions have been “deputized” by law enforcement, said Ellen Zimiles, a former federal prosecutor. “The government can’t do it without them; they don’t have the access to the same information.” Ms. Zimiles is now director of investigations at consulting firm Navigant Consulting Inc., working on corporate-bribery and money-laundering investigations, (via the Wall Street Journal).

 The bigger picture: This is a great story showing the challenging line banks have to walk while creating and implementing AML programs to both please increasingly picky regulators while at the same time attempting to identify all manner of financial crimes and get that information to law enforcement. One on end, banks have paid more money, in some cases millions of dollars a year, to create strong AML programs, buy new, advanced transaction monitoring systems and staff the program, from alert analysts to compliance bigwigs, with experience, intuitive and creative individuals. In this same span of time, however, they have also paid the highest penalties in financial crime and compliance history. But, at times, the seemingly singular effort to create financial crime compliance programs can have a strange duality. In covering this topic for more than a decade now, I have actually had top AML compliance staffers at some of the largest banks in the country tell me they can’t do more with their staffers and advanced systems to help law enforcement because regulators are dinging them on arcane AML minutiae, so they must spend significant resources on smaller, ticky-tack issues. But at least the good news is that some of these law enforcement agencies are applauding the banks for their good work, which could be strong leverage during these institutions’ next regulatory exams.

Securities enforcement

Regulators are cracking down on anti-money laundering violations among broker-dealers, including smaller firms that may not have the compliance resources to stay on top of the rules. The Securities and Exchange Commission stated in a recent action that New York-based Albert Fried & Co. agreed to pay $300,000 to settle charges that it failed to sufficiently monitor customers’ trading for suspicious activity. Another small broker-dealer, E.S. Financial Services, a Miami-based firm now called Brickell Global Markets, agreed earlier this year to a $1 million settlement for charges it violated anti-money laundering rules, according to a statement by the SEC. Small and medium-sized broker-dealers should brace themselves for increased regulatory scrutiny of their compliance practices, as it’s not just the big, high-profile brokerages that regulators are targeting, according to Nick Fera, chief executive officer of Firm58, a provider of trading surveillance services. “They’re getting moreaggressive about things,” he said. “It’s harder to operate a business in this environment.” It’s not just the SEC. The FinancialIndustry Regulatory Authority Inc. last month slapped two units of Raymond James Financial Inc. with a record $17 million in fines for widespread compliance failures in the brokerage firm’s anti-money laundering programs. It can be difficult for small and medium-sized broker-dealers to keep up with compliance, partly because they don’t always have the internal resources to stay on top of the rules that evolve along with the new schemes employed by criminals to move money around undetected, according to Mr. Fera. Many would prefer to focus on expanding their business, but the heightened regulatory scrutiny demands their attention, he said, (via Investment News).


The Securities and Exchange Commission (SEC) issued landmark transparency rules on June 27 requiring oil, gas and mining companies listed on U.S. stock exchanges to disclose all payments they make to the U.S. and foreign governments. Under the new rules, companies and their subsidiaries are required to file annual reports starting in 2018 disclosing how much they pay governments in taxes, royalties, fees, production entitlements, bonuses and dividends for exploration, extraction and other activities. “I am pleased that the Commission has completed these final rules, which will provide enhanced transparency to further the statutory goal,” said SEC Chair Mary Jo White. The SEC rules cover many international oil, gas and mining companies, such as Exxon, Chevron and Shell, as well as some state-owned companies, such as Brazil’s Petrobras, and China’s PetroChina and CNOOC which trade in the U.S. stock market. The decision, which comes after decades of lobbying by transparency advocates, was welcomed by major non-governmental organization as a “historic” step in the fight against corruption. “This is a huge victory for investors and for citizens in resource rich countries around the world who wish to follow the money their governments receive from oil and mining companies,” said Ian Gary, Associate Policy Director at Oxfam America, (via Forbes).


The incoming president of the Paris-based Financial Action Task Force (FATF), which sets the global anti-money laundering agenda, has laid out the group’s priority for his Spanish tenure, focusing on some of the most pressing, dangerous and challenging areas of financial crime and compliance, including thwarting terrorists, bolstering transparency and ensuring current FATF standards are implemented and effective. FATF President Juan Manuel Vega-Serrano stated his goals were to focus on the persistent terrorist threat and the recently highlighted large scale abuse of corporate vehicles. He stated those broad issues demonstrate once again the critical importance of the work of the FATF in protecting the integrity of the international financial system. Under the Spanish presidency, he noted that this work will continue at pace and in closer collaboration with other international bodies, including the UN, IMF, World Bank, Financial Stability Board (FSB), Egmont Group of Financial Intelligence Units, Interpol, G20 and G7. As well, Vega-Serrano said achieving those lofty ambitions will require a more collaborative approach with the private sector and a greater operational focus of the work of the FATF. “It is imperative that the FATF work to combat terrorist financing remains as a top priority, including through: Implementation of its consolidated strategy; updating and reviewing this as necessary and assessing the progress countries are making to combat terrorist financing and the additional measures that need to be taken, including to break down barriers to information and intelligence sharing,” (via FATF).


The government of Slovenia has taken further steps to strengthen its AML laws, adopting a new draft that should improve corporate transparency with a register of beneficial owners. In addition, Office for money laundering prevention will be given inspection powers, and administrative burdens on taxpayers will be reduced. The draft act transposes the Directive (EU) 2015/849 of the European Parliament and of the Council of 20th May 2015 on the prevention of the use of the financialsystem for the purposes of money laundering or terrorist financing into the Slovenian legal system. The first deadline for the implementation of the Directive national legislation was 26th June 2017, but the Member States undertook to implement it by the end of 2016 due to new terrorist threats. The act is also important in terms of control over transfers of assets to morefavourable tax jurisdictions, which pose a potential risk in relation to money laundering and terrorist financing. It will ensure transparency of ownership structures in business entities, especially those owned by foreign companies and established in offshore financial centres or tax havens where owners are concealed or do not have to be revealed, (via InvestinEU.com).


Newly unsealed court documents have revealed that one of the corrupt federal agents investigating Silk Road, the online drug marketplace, is suspected of stealing hundreds of thousands of dollars worth of bitcoin—after he pleaded guilty last year. Shaun Bridges is one of two agents who pled guilty to stealing from the Darknet market. Bridges stole about $800,000 worth of bitcoins from Silk Road drug dealers after he and a partner arrested a Silk Road admin and learned how to reset passwords. That led to Ross Ulbricht, who was convicted of running Silk Road in February 2015, attempting to order the murder of the admin, Curtis Green. Ulbricht was sentenced to life in prison last year. Bridges’ scam was later discovered, though. The former Secret Service agent, who served on a Baltimore-based task force investigating Silk Road, was arrested in March 2015 and pled guilty a few months later. In January, Bridges was arrested again just one day before he was scheduled to turn himself in. The documents unsealed Thursday shed light on why the second arrest took place, (via ARSTechnica).


Authorities on Thursday raided several properties owned by former Argentine President Cristina Fernandez as part of an investigation into possible illegal enrichment during her time in office. Fernandez used her Twitter account to decry the searches of her properties in southern Argentina under a court order, calling the move political persecution by her successor. Separately, a federal court on Thursday ordered that Fernandez be included in an investigation of alleged money laundering by Lazaro Baez, a businessman who was recently arrested. Baez benefited from public works contracts and other projects during the 12 years that Fernandez and her late husband and predecessor as president, Nestor Kirchner, were in power. The raids in southern Argentina came in a case that was begun after an opposition legislator charged that the renting of properties by the Los Sauces real estate company, established by Kirchner and owned by Fernandez, covered up payments to the couple for granting lucrative contracts. Fernandez blamed conservative President Mauricio Macri, who replaced her in December, (via the San Diego Union Tribune).