Tax Haven Abuse: (Wyly case) (Beneficial Ownership under Anti-Money Laundering Laws)

The 8/1/06 Report: United States Senate (Permanent Subcommittee on Investigations/Committee on Homeland Security and Governmental Affairs), Wyly Case, Beneficial Ownership under Anti-Money Laundering Laws (excerpted pages 296 – 300):

Hiding Beneficial Ownership

From 1992 to 2004, the 58 offshore trusts and corporations in the Wyly offshore structure opened numerous accounts at prominent securities firms in the United States, Credit Suisse First Boston (“CSFB”), Lehman Brothers, and Bank of America. They used these accounts to buy and sell securities, make investments, and send multi-million-dollar wire transfers. All three financial institutions knew that the offshore entities were associated with the Wyly family, but in the face of the offshore entities’ refusal to acknowledge who was behind them, none of the institutions ever required the offshore entities to identify their beneficial owners or document their connection to the Wylys.

These offshore corporations and trusts presented a classic case of hiding beneficial ownership. For more than a decade, U.S. banks have been required to “know their customers” to prevent criminals from misusing bank services; part of that obligation has been, when opening accounts for offshore corporations and trusts from secrecy jurisdictions, to identify the beneficial owners behind the offshore entities. Securities firms did not operate under the same legal requirements until enactment of the 2001 Patriot Act which extended anti-money laundering requirements to securities accounts as well. By July 2002, the Patriot Act required securities firms that opened “private banking accounts” with at least $1 million for foreign account holders, to identify both the nominal and beneficial owners of those accounts. By May 2003, SEC regulations required securities firms to identify the beneficial owner of each account they administered.

By the summer of 2003, the Wyly-related offshore entities had moved to Bank of America and opened dozens of securities accounts. Some of their transactions began tripping alarms in the anti-money laundering surveillance system used by the clearing broker, National Financial Services (“NFS”), that administered the Bank of America accounts. NFS insisted that, if Bank of America wanted it to continue to handle the accounts, it needed the information required by law – the names of the beneficial owners behind the offshore corporations and trusts using the accounts. For more than a year, the offshore entities resisted providing the information, and Bank of America tried to convince NFS not to press for it. Finally, in late 2004, after Bank of America received subpoenas issued by the Manhattan District Attorney seeking information about the accounts, Bank of America closed them.

Bank of America knew that the offshore entities were associated with the Wylys. The key broker who handled the accounts, Louis Schaufele, knew that Sam and Charles Wyly were directing the offshore entities’ investment activities. He nevertheless insisted that the offshore entities be treated as independent of the Wylys and fought efforts to identify the Wylys as their beneficial owners. In addition, when, for tax purposes, the offshore entities submitted W-8BEN forms representing that they were independent foreign entities, beneficially owned the accounts assets, and were not subject to IRS requirements for reporting investment income paid to U.S. persons, Bank of America accepted the forms and never filed a 1099 reporting the account income to the IRS.

Had the offshore entities acknowledged that the Wylys were the beneficial owners of the offshore trusts and corporations for anti-money laundering purposes, and allowed their connection to these entities to be documented at Bank of America, it would have been harder for the Wylys to deny their connection to these entities for tax and securities purposes.

(a) Background on Beneficial Ownership

For decades, U.S. banks have had an obligation to “know their customers,” to understand the natural persons behind offshore corporations and trusts, to ensure that bank services would not be misused for illegal purposes. U.S. banks have also operated for years under legal obligations to report suspicious transactions to law enforcement to prevent money laundering.

In contrast, until recently, U.S. securities firms did not operate under the same know-your-customer obligations. For many years, brokers were required to evaluate their customers to ensure that they were selling them suitable investments – for example, selling high risk securities to persons with a high tolerance for risk and not to an elderly person on a fixed income – but this obligation was not equivalent to performing a due diligence review to guard against opening an account for a questionable person. Some securities firms set up voluntary anti-money laundering (“AML”) programs, but it was not until passage of the Patriot Act in 2001 that all U.S. securities firms became legally obligated to establish AML programs and to identify and verify the identity of their customers.

Beneficial Ownership under Anti-Money Laundering Laws. Three key laws set out the obligations of U.S. financial institutions to know their customers and guard against misuse of their accounts, the Bank Secrecy Act of 1970, the Money Laundering Control Act of 1986, and the 2001 Patriot Act, which amended both prior laws. These and other anti-money laundering (“AML”) laws have, over time, tightened requirements for banks and other financial institutions to evaluate clients, monitor transactions, and report suspicious activity.

The 1970 Bank Secrecy Act was the first to require U.S. financial institutions operating in the United States to undertake AML efforts, authorizing the Treasury Secretary to issue regulations requiring financial institutions to establish AML programs meeting certain criteria. In 1986, the Money Laundering Control Act was the first in the world to make money laundering itself a crime, prohibiting persons from knowingly engaging in financial transactions involving criminal proceeds. In 1996, the Treasury Secretary began requiring banks to file Suspicious Activity Reports on client transactions raising red flags of possible misconduct. In 1997, the Federal Reserve issued special guidance warning banks catering to wealthy individuals through “private banking accounts” of the need to install controls to detect and report possible money laundering. In 1998 and 2000, federal bank regulators issued guidance on spotting suspicious transactions and strengthening regulatory reviews of banks’ AML programs.

In 2001, after the terrorist attack of September 11th, President Bush announced an intensified effort to uncover and stop terrorist financing, and Congress enacted the Patriot Act which, in part, greatly strengthened federal AML laws. Among other provisions, the Patriot Act required all U.S. financial institutions, including securities firms, to establish AML programs, verify the identity of their account holders, and exercise due diligence when opening and administering private banking accounts for foreign persons. It also required securities firms to begin filing Suspicious Activity Reports.

The Patriot Act imposed a special set of requirements to prevent misuse of “private banking accounts” by foreign account holders. “Private banking accounts” are accounts opened by banks, securities firms, or certain other financial institutions that require a minimum of $1 million in funds or assets, are opened for individuals with a “direct or beneficial ownership interest” in the account, and use an employee, such as a private banker or account officer, to act as a personal liaison between the financial institution and the “direct or beneficial owner.” 31 USC § 5318(i)(4)(B). The law required all financial institutions that opened such private banking accounts for foreign account holders to “ascertain the identity of the nominal and beneficial owners” of the account. 31 USC § 5318(i)(3)(A). This provision included, for example, the requirement that financial institutions ascertain the beneficial owners of accounts opened in the name of foreign corporations or trusts. This provision became legally binding in July 2002.

The Patriot Act also directed the Treasury Secretary to promulgate regulations further delineating the due diligence obligations of financial institutions, and further defining which account holders have “beneficial ownership of an account.” Section 312(b) of the Patriot Act; 31 USC § 5318A(e)(3). In response, Treasury issued proposed regulations in May 2002, an “interim final rule” in July 2002, and a final rule in January 2006. Each of these rules repeated the legal obligation of financial institutions to ascertain the nominal and beneficial owners of private banking accounts.

The U.S. accounts opened by the Wyly-related offshore entities must be viewed through this history of evolving AML laws. In the United States, the offshore entities opened securities accounts, rather than bank accounts, which prior to the Patriot Act operated under fewer legal requirements and less scrutiny. When they opened accounts at CSFB in 1992, for example, know-your-customer practices at securities firms were voluntary, and the SEC exercised no routine oversight. When the accounts moved to Lehman Brothers in 1995, the regulatory environment was little changed. By the time the accounts moved to the securities divisions of Bank of America in 2002, however, the Patriot Act had been enacted, AML concerns had heightened, due diligence regulations were being drafted, and U.S. securities firms should have been on full alert about their obligation to know their customers.

View complete report: Tax Haven Abuses: The Enablers, The Tools, & Secrecy