The Panama Papers: What Banks Need to Do

The recently leaked 11 million documents from the database of Panamanian law firm Mossack Fonseca shows the immense size of the problem the world is still facing in relation to money laundering and tax avoidance. Despite national and international efforts to prevent money laundering, the released information leaked from Mossack Fonseca shows that international companies and global leaders are involved in, or at least linked to, money laundering and tax avoidance.

Content of the Leaked Information

The 11 million leaked documents show that 72 former heads of state used the Panamanian law firm to assist in tax avoidance by setting up off-shore companies and schemes for the purpose of tax avoidance and even money laundering. According to reports, Mossack Fonseca also assisted its client in dodging international sanctions.

Whilst the leaked documents will leave many leaders red-faced, it more importantly shows that international financial institutions are still involved in the practice of setting up off-shore companies for their wealthy clients despite many banks having recently been fined for Anti-Money Laundering deficiencies. In fact, 500 banks, along with their subsidiaries and affiliates, created 15,600 shell companies with the help of Mossack Fonseca – 2,300 alone were created on behalf of HSBC and its clients.

What Mossack Fonseca Did

Whilst the setting up of an off-shore bank account and shell company is not necessarily illegal (so long as the rational for the account is above-board and its use is for legitimate purposes) it can be complicated for an individual to set up alone and so law firms are often commissioned to assist in the process.

Mossack Fonseca set up companies for its clients in countries with low or non-existent tax on financial transactions. These countries also have tight banking secrecy laws. Countries such as the British Virgin Islands (BVI), Bahamas and Cayman Islands, as well as Panama itself, have weak financial regulations and therefore, together with their attractive tax and banking secrecy legislation, these countries are often open to abuse from criminal activity.

• Shell Companies

Mossack Fonseca setup shell companies for its clients. A shell company serves as a vehicle for business transactions without itself having any active business operations or significant assets. Shell companies can be used to hide assets and for money laundering and tax evasion purposes. Shell companies are set up as a normal company and have the initial appearance of being legitimate but are often nothing more than a registered post box.

Shell companies typically do not document or disclose the true activity or ownership of the company and are often controlled by law firms such as Mossack Fonseca who do little more than sign legal documents and approve financial transactions on behalf of the true beneficial owner.

Whilst most banks have a policy not to deal with shell banks, it is far more difficult to identify a shell company.

• Recorded Benefical Ownership

Mossack Fonseca allegedly arranged for people, with no link to the underlying client, to be used and recorded as the beneficial owner of the company that was being setup. Whilst this is a breach of money laundering regulations it is not difficult to do with reports of cleaners working for law firms being recorded as owners of shell companies.

This process would enable the true Ultimate Beneficial Owner (UBO) of the company to remain anonymous. Even if the true UBO were a sanctioned person the company would probably still be accepted as a client by financial institutions as the registered UBO would not be well known and would not appear on any international sanctions lists. This would result in the true purpose and owner of the company slipping under the radar of even the most rigorous (Know Your Customer) KYC & Customer Due Diligence (CDD) checks.

The Panama Paper: How Banks Should React

The leak from Mossack Fonseca shows that huge numbers of illegitimate off-shore companies are being set up by financial institutions resulting in potentially criminal companies finding their way onto the client list of even the more discrete and compliant financial institutions.

Whilst the controls and process financial institutions need to adopt in order to protect themselves from money laundering and other criminal activity are well known, the Panama Leak highlights the way illegally acquired or laundered money is still finding its way into the global financial system.

There are a number of red flags that financial institutions should consider in order to protect from the illegal or at least “questionable” activity that firms such as Mossack Fonseca and their customers are involved in.

• Shell Companies

Financial institutions need to ensure processes and controls are in place to identify shell companies. Whilst there is no easy way do to this, the location, address and any complex ownership structure of a company should be a “red flag” which would raise possible concerns. Financial institutions should also make a greater effort to identify law firms and other agents who establish shell companies for their clients and make sure their KYC staff are aware of the locations and addresses of such firms.

• Off-Shore Financial Centres

Dealing with companies domiciled in off-shore financial locations is not in itself illegal, however, the fact that an entity is domiciled in an off-shore jurisdiction should raise the need to ask further questions and invoke the requirement to perform further due diligence on the company in question to ensure that the purpose and activity of the company, as well as the rational for an account to be opened, is legitimate and legal.

• False Ownership

Financial institutions need to carry out enhanced due diligence on companies domiciled in off-shore financial centres to ensure the true beneficial owner has been identified. Like the identification of shell companies, identification of the true beneficial owner of a company is not a straight forward or prescriptive process.

A suitably trained and experience AML professional should have the knowledge to identify red flags relating to fraudulent ownership. Legitimate law firms could also be engaged to verify the information that has been provided with regards to the ownership of a company.

• Bearer Shares

The identification of bearer shares within a corporate structure should raise alarm bells in regards to the legitimacy of the ownership of the company. Bearer shares provide total anonymity of ownership and transfer of assets without the need for any record of transfer.

Many financial institutions have a policy to not deal with companies that have a share structure that includes bearer shares, but the existence of bearer shares in a corporate structure is often difficult to identify.

• Complex & Unusal Transactions

Mossack Fonseca allegedly assisted its clients to break international sanctions by structuring complex webs of transactions and deals in order to get assets from a sanctioned country, entity or person into the legitimate financial system.

Financial institutions should have a robust and effective transactions monitoring process which would identify any suspicious, complex and unusual transactions. Any such transactions could be part of a wider method to launder illegal money through the banking system and should be identified and escalated with further due diligence carried out when required.

The Panama Papers: What Next?

The impact of the Panama Papers will no doubt be long term. Transparency International has already called for an international register of UBOs for all companies. However, the likelihood of this happening in the foreseeable future is slim as too many governments are opposed or dragging their feet.

In the UK the public register of beneficial interest comes into force on the 6^th of April, resulting in all UK registered companies having to confirm ownership on all annual returns complete from the 30^th of June 2016. Whilst this is a step forward, and applied internationally could protect the activities carried out by firms such as Mossack Fonseca, the UK government will not verify the information contained in the return leaving the register open to abuse. In addition the implementation in several UK off-shore centres is delayed or being disputed by the off-shore government.

Equally, as the information being recorded on the UK public register of beneficial interest is not being verified, financial institutions are should not place sole reliance on this information and should additionally carry out their own due diligence.

Conclusion

Off-shore tax havens and shell companies have been used for years to launder money. The content of the documents leaked from Mossack Fonseca shows not only the scale of the problem, but how international leaders use these methods to transfer and manage their assets. That said, analysis of the 11m leaked documents has already led to a number of firms and transaction routes being identified that will help law enforcement agencies and the financial system to more effectively investigate suspicions over firms with a Panama link. Financial institutions should ensure that they gain maximum leverage from this information.

Protecting the global financial system from abuse is not going to happen overnight but investing in robust and efficient processes and controls to identify suspicious activity should be at the forefront of the industry’s war on money laundering.

FATF Recommendation 40 states “Financial institutions should refuse to enter into, or continue, a correspondent banking relationship with shell banks”.