Dismantle the Global Financial Secrecy System
By Daniel Calingaert, June 6, 2024
The global system of financial secrecy is a cancer on democratic institutions and a drain on economic development, yet to date only a handful of experts have called for its elimination. It merits far greater attention and bolder action. U.S., British, and European policy makers should set a clear goal of dismantling the global financial secrecy system. A proposed plan to reach this goal is presented here.
What’s at Stake
The profound harm caused by the global financial secrecy system was clearly explained by Charles Davidson and Ben Judah and thoroughly documented by Raymond Baker. Across more than 70 jurisdictions around the world, millions of hidden accounts, secret trusts, and anonymous corporations allow individuals to hide their wealth and avoid taxes. This global system is estimated to hold more than $50 trillion and, as exposed in the leaked Panama, Paradise, and Pandora Papers, is used by leaders and public officials around the world and prominent multinational corporations.
The global financial secrecy system facilitates tax avoidance on a massive scale, which shrinks the tax base, reduces revenues for public services, and shifts the tax burden onto the middle and working classes. It widens disparities in income and wealth and exacerbates social inequalities: while elites evade their responsibilities to pay their fair share of taxes, even as they benefit from the legal protections that government provides, the middle and working classes are expected to play by the rules and often feel—validly—that the rules are written for the benefit of elites. The inequalities look all the more pronounced when citizens find public officials hiding their wealth in secrecy jurisdictions rather than upholding their own government’s laws.
The political ramifications are pernicious: the global financial secrecy system ruptures the social contract on which democratic societies are built and fuels distrust and resentment at democratic institutions. Dissatisfaction with democracy globally has reach at all-time high, and majorities in the United States, France, Japan, and elsewhere are dissatisfied with the way democracy in working in their country. Across leading democratic countries, just over 4 in 10 people indicate high or moderately high trust in their national government, and a similar share see government as responsive to public feedback. Populist demagogues exploit this distrust and amplify resentments to chip away at democratic norms.
Financial secrecy impedes the ability of U.S., European, and other democratic governments to enforce their laws. For example, sanctioned Russian oligarchs hide their assets in Europe and the United States behind opaque trusts, and Chinese entities rely on shell companies to circumvent U.S. sanctions and mask their theft of intellectual property. Financial secrecy facilitates strategic corruption by Russia, China, and other adversaries who use corruption to influence government decisions in democratic countries and bribe national leaders in Africa and elsewhere to gain market access. Russia and China have spent over $300 million to interfere in democratic process in 33 countries.
Authoritarian kleptocrats rely on financial secrecy to move their ill-gotten wealth to safe jurisdictions, such as the United States, United Kingdom, and European Union, where the wealth will enjoy legal protections. Financial secrecy thus conceals kleptocratic plunder and enables grand corruption around the world.
Corruption is a significant drain on economic and social development globally. It diverts wealth on a massive scale, estimated at more than $3.5 trillion annually, equivalent to more than 5% of global GDP. That wealth might have otherwise gone to improve schools, run hospitals, or expand infrastructure. Capital outflows from Africa significantly surpass aid inflows, as proceeds from natural resource extraction are moved to private accounts in foreign tax havens. Corruption contributes to authoritarianism, as kleptocrats crack down on their critics, and state fragility, as corruption exacerbates inequalities, economic vulnerability, and social grievances, which in turn can degenerate into violent conflict.
A Comprehensive Solution
The cancer of financial secrecy has reached a sufficiently advanced stage to merit aggressive treatment. The time has come to dismantle the four pillars of the global financial secrecy system—to (1) end corporate anonymity, (2) eliminate instruments of financial secrecy, (3) make enablers legally liable for complicity in corruption, and (4) insulate our financial system from secrecy jurisdictions.
Significant steps in this direction were taken in 2021, when the Corporate Transparency Act was passed and the Biden Administration introduced its Strategy on Countering Corruption. The Corporate Transparency Act requires companies registered in the United States to disclose to the U.S. Treasury Department who their actual “beneficial” owners are. The Strategy on Countering Corruption raised the global fight against corruption to a national security priority and mobilized a range of agencies across the U.S. government to join this fight. However, there remains a great deal of work to do in dismantling the global financial secrecy system.
The United States needs to take the lead, because it is the world’s greatest enabler of financial secrecy and is best positioned to persuade fellow democracies to follow suit. In 1977, it outlawed bribery of foreign officials with the Foreign Corrupt Practices Act, and while its democratic allies were slow to enact similar measures, they did in time catch up and, in some cases, introduced stricter anti-bribery laws.[1] Similarly, the United States should get out ahead in dismantling financial secrecy and thereby raise pressure on democratic partners to do the same.
Together, the United States, European Union, United Kingdom, and Japan can dismantle the global financial secrecy system. They wrote the laws that created this system and can repeal these laws. They are home to many of the world’s secrecy jurisdictions and to the leading financial centers. They have the financial and political clout to set the global standard. U.S. Dollars, Euros, Japanese Yen, and Pounds Sterling, make up nearly 90% of central bank reserves worldwide, and the vast majority of foreign trade is denominated in these currencies. The leading democracies thus have the power to make the global financial system transparent and insulate their system from whatever secrecy jurisdictions will remain.
Corporate Anonymity
Progress in dismantling the first pillar of the global financial secrecy system—in ending corporate anonymity—is already underway. As 132 jurisdictions to date have set up or pledged to create registries of beneficial owners, corporate transparency is emerging the aspirational standard around the world, though it is still far from the norm in practice. Substantial limitations and gaps remain.
The U.S. Treasury Department set a deadline of January 1, 2025 for companies to report who their beneficial owners are, and access to its registry will be limited to law enforcement officials and approved foreign partners. Financial institutions may look up the beneficial ownership details of registered companies “in certain circumstances” with those companies’ consent.
Such limited access will do substantially less for financial transparency than a publicly accessible U.S. registry would do. Public access would reduce the costs for financial institutions and potential business partners to conduct due diligence on registered companies and thus make U.S. markets more resistant to money laundering. It would allow the public to better monitor government procurements and provide a crucial tool for media and anti-corruption groups to expose the assets owned by kleptocrats and organized crime bosses in democratic countries. Media exposés typically prompt authorities to investigate.
A publicly accessible registry would provide a much greater deterrent to money laundering. The scale of illicit financial flows appears to dwarf the investigative capacity of law enforcement. While U.S. financial institutions file close to 80,000 suspicious activity reports and currency transaction reports with the U.S. Treasury Department each business day, only about 2,500 of these reports lead to money laundering charges each year.[2]
Transparency in beneficial ownership is quite limited in the European Union as well. Public access to beneficial ownership registries is denied in 12 of the 27 EU countries, including secrecy jurisdictions such as Luxembourg, Netherlands, and Cyprus, and three countries are still putting their registries in place.
The European Court of Justice in November 2022 ruled, due to privacy concerns, that EU member states no longer need to provide public access to beneficial ownership registries, though journalists, civil society groups, and financial institutions with a legitimate interest main gain access. The rules for demonstrating such legitimate interest are still being written and could make the process for accessing beneficial ownership registries quite cumbersome.
The United Kingdom has established registers of beneficial ownership, and the Economic Crime and Corporate Transparency Act introduced in October 2023 will enhance government’s capacity to verify the identities of company directors, but trust registration data is not publicly accessible, and the three Crown Dependencies and 14 British Overseas Territories have yet to establish registries. These include such secrecy jurisdictions as Jersey, Guernsey, Bermuda, the British Virgin Islands, and Cayman Islands. The UK’s offshore tax havens are estimated to facilitate nearly 40% of the tax revenue losses suffered annually by countries around the world.
Japan is far behind. It has only committed to establish a beneficial ownership registry, though it remains a significant secrecy jurisdiction, rated 6th by the Tax Justice Network among the jurisdictions most complicit in helping individuals hide their wealth.
Secrecy Instruments
Corporate transparency would remove a central pillar of the global financial secrecy system but would still leave other financial instruments available to move and hide illicit funds. These financial instruments require transparency as well, since illicit funds, like water seeping into crevices, flow to wherever secrecy remains. They should all be subject to beneficial ownership disclosure and know-your-customer requirements.
Private equity, venture capital, and hedge funds are exempt from anti-money laundering requirements and, predictably, have provided vehicles for laundering money at a large scale, in the U.S. Federal Bureau of Investigation’s estimate. They have concealed the wealth of a cryptocurrency fraudster, sanctions busters, Mexican cartels, and Russian oligarchs. Private investment firms and advisors should be required to conduct due diligence on their customers and report the beneficial ownership of each investor.
Trusts can provide even greater secrecy than companies and private investment funds, because they are created between private individuals, and in many jurisdictions there is no requirement to register them with authorities. Not surprisingly, sanctioned Russian oligarchs, Chinese tycoons, and other nefarious characters have used trusts to move or hide dirty money. The Corporate Transparency Act has loopholes that allow some trusts to avoid registration of beneficial owners. Since a large and growing amount of wealth is concealed in trusts—in South Dakota alone, trusts hold an estimated $367 billion in assets, up from $75 billion in 2011—they should be covered by transparency requirements.
To bring transparency, governments should require that trusts are registered with authorities to have legal validity, all parties to trusts and their beneficial owners are disclosed, registries of trusts are created and made publicly accessible, and trustees are subject to anti-money laundering obligations. France, Germany, and the United Kingdom have set up trust registries, though public access to these registries is restricted.
Digital assets, including cryptocurrencies, pose a significant risk of illicit finance, because they can mask the identity of owners and cross borders almost instantly without regulated financial institutions serving as intermediaries. Crypto is increasingly used to launder money and evade sanctions. For example, fentanyl chemical producers in China have relied on crypto to sell their products to drug cartels. The risk posed by crypto was highlighted by Binance, the world’s largest cryptocurrency exchange, when its founder pleaded guilty to money laundering violations.
Anti-money laundering requirements should be extended to digital assets service providers, as the European Union has done in its Market in Crypto Assets regulation and as a bipartisan group of U.S. Senators has proposed in the Digital Asset Anti-Money Laundering Act. Digital assets service providers should be required to identify the beneficial owners of the accounts they offer and transactions they process and to block suspicious financial flows.
The Digital Asset Anti-Money Laundering Act would require financial institutions to mitigate illicit finance risks associated with digital asset mixers, privacy coins, and other anonymity enhancing technologies. This bill would give the U.S. Treasury Department the mandate to devise regulations to mitigate these risks. The regulations should be stringent: financial institutions operating in the United States should be prohibited from transacting with entities that handle digital assets affected by crypto mixers, privacy coins, or other technologies that obscure their owner’s identity.[3]
Enablers
A range of professionals—bankers, corporate executives, auditors, lawyers, brokers and agents—have enabled access by kleptocrats to the global financial secrecy system, abetted corruption, and engineered tax avoidance on a vast scale. These enablers both contribute to and take advantage of the secrecy in the global financial system, and when they are caught and prosecuted for financial crimes, they often get away with mild punishments. To fully dismantle the global financial secrecy system, transparency should be extended to the enablers, penalties for facilitating corruption should be harsh enough to serve as a deterrent, and enforcement should be rigorous enough to bring about transparency in practice.
Bankers
In just the past decade, a parade of major banks, including NatWest, Danske Bank, UBS, ING, ABN AMRO, Commonwealth Bank of Australia, and Bank Hapoalim,[4] were found complicit in money laundering. The frequency of such money laundering scandals, despite the imposition of fines in amounts equivalent to several hundred million dollars and up to €4.5 billion, indicate that banks treat the fines as just the cost of doing business. At least several banks, including JP Morgan, HSBC, Standard Chartered, Deutsche Bank, and Bank of New York Mellon, continued to profit from corrupt customers even after they were fined by U.S. authorities.
While fines have forced banks to cut their staff’s bonuses, top executives have almost always avoided responsibility for illegal activity on their watch and made few if any changes to their bank’s practices. Goldman Sachs set a precedent in 2020, when its board of directors publicly accepted the firm’s responsibility for involvement in the 1Malaysia Development Berhad (1MDB) scandal and cut compensation to top executives, including the chairman, by a total of $98 million. That was after Goldman Sachs had paid fines of over $4 billion for bribery and money laundering.[5] Similar and even larger fines are needed to change the practices at banks that give rise to complicity in money laundering—to force banks to cut their dividends, so that shareholders will pressure boards of directors to fire top executives and institute serious reforms.[6]
In addition, chief executives should have to personally certify their institution’s know-your-customer compliance report. The Sarbanes-Oxley Act requires CEOs to affirm the accuracy of their institution’s financial statements and thus makes CEOs personally liable. A similar requirement for know-your-customer compliance reports would incentivize high-priority attention to such compliance by top executives.[7]
U.S. authorities have imposed most of the largest fines on banks for money laundering, even though many of the culprits were banks headquartered in Europe. In the judgment of Transparency International co-founder Frank Vogl, EU regulators are “willfully negligent.”[8] European governments need to step up enforcement of anti-money laundering laws and, in addition, strengthen protections for whistleblowers. No European country has enforced meaningful legal approaches to encourage whistleblowers to come forward, and some insiders who blew the whistle on corruption ended up in jail.[9]
The United States could contribute to enforcement of tax and anti-money laundering laws in Europe and elsewhere by requiring U.S. financial institutions to report to foreign governments on their citizens’ assets. The Foreign Account Tax Compliance Act requires foreign financial institutions to report to the U.S. Internal Revenue Service on the foreign assets held by their U.S. account holders. There is no reciprocal obligation on U.S. financial institutions, but there should be. Moreover, information on foreign assets held by U.S. citizens abroad should be made available to law enforcement, not just tax authorities, to facilitate investigations of money laundering or corruption.[10]
In addition to harsher penalties and stricter enforcement, greater transparency is needed to remove secrecy—and dirty money—from the U.S. banking system. Banks should require customers to disclose the beneficial owners of accounts and affirm the disclosure with a signature, and they should freeze accounts suspected of containing illicit funds.[11] The signed disclosures would make it harder for banks to turn a blind eye to suspicious sources of wealth and would deter a substantial amount of illicit funds from entering U.S. banks.
Greater transparency is particularly needed in sovereign bond transactions. Bonds issued by kleptocratic governments raise serious questions about mismanagement and corruption, and in significant cases, such as the 1MDB scandal and Mozambique government-backed bonds, bankers paid bribes to win government contracts. When borrowing governments cannot service their foreign debts, the International Monetary Fund invariably has to bail them out, with funds from U.S., European, and other taxpayers.[12] Rather than wait for funds from sovereign bond issues to get mismanaged or stolen and then provide bailouts, the IMF should warn investors in advance of the risks associated with bonds issued by kleptocratic governments.[13]
Corporate Executives
Multinational corporations engage in massive tax dodging by manipulating internal trade prices, transferring intellectual property across borders, and shifting profits to tax havens. Apple, for example, moved a large share of its profits to the tiny island of Jersey, which charges no tax on most corporate profits. Although almost all of its product design and development takes place in the United States, Apple reports that about two-thirds of its worldwide profits were made in other countries. Apple thus managed in 2022 to pay about $22.5 billion in income taxes worldwide on $394 billion in revenue—a tax rate of 5.7%.
Facebook, Uber, and Nike similarly have transferred trademarks, patent rights, and other intangible assets to offshore companies to avoid taxes. Ownership of Facebook’s user database for many countries and the rights to use Facebook’s platform technology are located in Grand Cayman, while the rights to Uber’s app and to Nike’s Swoosh trademark are held in Bermuda. Profit shifting is estimated to cost governments up to $240 billion annually in lost revenue.
To curb tax avoidance, multinational corporations should be required to file a country-by-country report their income, profits, taxes paid, and economic activity in each jurisdiction where they operate (and the report should consolidate information for all subsidiaries). Governments should then agree on a formula to apportion corporate profits among countries based on sales, employment, and assets. Such a formula would minimize the benefits—and use—of tax havens.
Auditors
Auditing services internationally are dominated by the “big four” firms of Deloitte, EY, KPMG, and PwC, which provide a range of professional services, including tax advice. As they both advise clients on tax avoidance and audit company accounts, they have a built-in conflict of interest.[14] Such a conflict of interests raises questions about the reliability of their audits and has contributed to noteworthy examples of complicity in corruption. PwC has helped Russian oligarchs skirt sanctions, and KPMG assisted then-President of South Africa Jacob Zuma to deflect attention from his and his associates’ tax dodges and schemes for state capture.
Legislation is needed to separate audit from tax and consulting services, specifically to require public companies to get audited by firms that provide only audit services. Audits performed by firms with both audit and advisory services should no longer be allowed.[15]
In addition, anti-money laundering rules should be extended to non-financial businesses and professionals, as the ENABLERS Act proposes. This bill would require accountants, lawyers, and trust and company service providers to follow the same regulations as financial institutions, including to know your customer, perform due diligence, and file suspicious transaction reports.
Lawyers
Lawyers should be subject to anti-money laundering regulations because they are in a position to guide tax avoidance and facilitate illicit financial flows. They engineer the legal and financial structures used in complex tax evasion, with offshore entities set up to mask the identity and income of wealthy clients. When lawyers are involved in creating shell companies, they provide an added layer of secrecy through attorney-client privilege.[16] Yet, in the United States, they have no obligation to ask where clients got their money.[17]
The law firm Baker McKenzie has advised Apple, Facebook, and Nike in finding tax havens, worked for sanctioned Russian arms manufacturer Rostec, and set up companies that laundered money stolen from Malaysia’s public investment fund, 1MDB. The financier at the center of the 1MDB scandal, Jho Low, used a client escrow account of DLA Piper to pay his $202 million contribution in a bid to purchase the Park Lane Hotel in New York. Another prominent law firm, Skadden Arps, produced a report to justify the persecution of the opposition leader to then-President of Ukraine, Viktor Yanukovych, a notorious kleptocrat.
In a more egregious case, a California attorney helped launder money for Teodorin Obiang, son Equatorial Guinea’s president, who has plundered his country’s oil wealth. The attorney set up shell companies for Obiang, opened bank accounts for these shell companies with funds from attorney-client and law firm accounts, listed himself as the owner of the shell companies’ bank accounts, and used the shell companies’ bank accounts to pay Obiang’s lavish personal expenses.[18]
Brokers and Agents
Kleptocrats typically move their wealth, after it is laundered through the global financial secrecy system, into tangible assets, such as high-end real estate, art, private jets, and yachts. The purveyors of luxury assets—real estate agents, auction house directors, art dealers, yacht brokers, jewelers, etc.—should be required to adhere to the same anti-money laundering regulations as other enablers, including to know your customer and file suspicious transaction reports. Any enabler, including any auditor or lawyer, who fails to adhere to anti-money laundering regulations should be subject to hefty fines.[19]
Secrecy Jurisdictions
Once the United States, European Union, United Kingdom, and allied democracies have ended corporate anonymity, eliminated instruments of financial secrecy, and constrained the enablers, they will need to address the final pillar of the global financial secrecy system—to insulate our financial systems from secrecy jurisdictions. Unless we do so, dirty money will seep in from outside and undermine the transparency of our financial systems. While the flow of dirty money to alternative secrecy jurisdictions, such as Dubai and Turkey, is likely to increase, and we cannot stop that, we can take resolute measures to keep the dirty money out.
Financial institutions should require disclosure of beneficial ownership for every account they offer and for all transactions they process and should give added scrutiny to funds coming from or going to secrecy jurisdictions (which have no public registry of beneficial ownership). This requirement should apply to all financial institutions, including private equity, venture capital, and hedge funds. All financial institutions should know who owns the funds they manage and process and should be subject to hefty fines for failing to conduct due diligence on the sources of foreign money, particularly from secrecy jurisdictions.[20]
This disclosure requirement should serve as a “price of admission” for foreign banks to operate in the United States, European Union, and United Kingdom. Foreign banks should conduct due diligence on their customers or face severe penalties for non-compliance; the worst offenders should be barred from U.S. operations.[21] Section 311 of the Patriot Act empowers the U.S. Treasury Department to blacklist foreign financial institutions or even entire countries as a “primary money laundering concern” and impose “special measures” including block their access to the U.S. financial system. The Treasury Department should make more aggressive use of Section 311.[22]
In addition, governments should step up efforts to curb trade-based money laundering, which amounted to over $60 billion globally from 2011 to 2021. Trade-based money laundering is used to disguise the proceeds of crime and move money across borders through trade transactions, for example by falsifying the value reported on invoices of exported or imported products. It calls for increased and more sophisticated law enforcement, such as electronic invoicing systems, to deter trade mis-invoicing, and early detection of value gaps in international trade, of significant differences between the exports reported by one country and the imports its trade partner reports, which are indicative of invoice manipulation and trade-based money laundering.
When the U.S., EU, and U.K. financial systems become transparent and insulated from secrecy jurisdictions, they will lose some capital inflows, mostly tainted by corruption, but will gain substantially: kleptocracies will no longer exploit our financial systems to sustain their corruption, increase their power, and undermine our democracy; our financial systems will no longer abet global corruption and its corrosive effects on under-development, instability, and conflict; and all citizens in democracies will play by the same rules and pay their fair share of taxes, which will reduce social tensions, contribute to political stability, and strengthen democracy. These benefits are well worth the effort of making our financial systems transparent.
Insulation from secrecy jurisdictions may add pressure on kleptocrats, criminals, and tax evaders, as they will need to move their money to places with weaker rule-of-law protections. Secrecy jurisdictions may become less attractive for legitimate investments (as the vast majority of investments are) and lose investments to countries with transparent financial systems.
The Imperative of Reform
The global system of financial secrecy is designed to avoid accountability—to hide money, often dirty money, and dodge taxes. It has no economic benefit and is, in fact, a drag on economic development, driver of social tensions, contributor to conflict, and great threat to democracy. The time has come to dismantle this system.
The vast scale of and massive harm caused by the global financial secrecy systems calls for a big, bold response, beyond what is currently underway and proposed in legislation. Such a response, as outlined here, cannot eliminate flows of illicit funds—there will always be money laundering to uncover, investigate, and prosecute—but will change the nature of democratic countries’ financial systems. It will end secrecy as a common practice in the U.S., EU, and U.K. financial systems and make them transparent.
A comprehensive solution is needed to dismantle the global financial secrecy system. Partial solutions will bring improvements but still leave places within our financial systems for dirty money to go. Only a comprehensive solution can end the scourge of financial secrecy that has weakened our democracies, made us vulnerable to authoritarian adversaries, sustain kleptocracy, fueled instability, and held back development.
The United States should take the lead in making its financial system transparent and insulated from secrecy jurisdictions and persuade the European Union, United Kingdom, and allied democracies such as Japan, Switzerland, Canada, and Australia to follow suit. We need to put in place a broad package of reforms—legislation, regulations, stricter enforcement—which needs to start with a firm political commitment to financial transparency. We begin by setting a clear goal to dismantle the global system of financial secrecy.
*Daniel Calingaert is Dean for Global Programs at Bard College. He is a guest author and the views expressed here are his own.
References:
[1] The United States went further in December 2023 by enacting the Foreign Extortion Prevention Act, which criminalizes bribery demanded by foreign officials.
[2] Raymond Baker, Invisible Trillions, p. 90.
[3] Elise Bean interviewed January 18, 2024.
[4] Raymond Baker, Invisible Trillions, pp. 106-108.
[5] Frank Vogl, The Enablers, pp. 113-114.
[6] Frank Vogl, The Enablers, p. 115.
[7] Frank Vogl, The Enablers, p. 123.
[8] Frank Vogl, The Enablers, p. 47.
[9] Frank Vogl, The Enablers, p. 103.
[10] Elise Bean interviewed January 18, 2024.
[11] Raymond Baker, Invisible Trillions, pp. 232-233.
[12] Frank Vogl, The Enablers, pp. 49-51.
[13] Frank Vogl, The Enablers, pp. 124-125.
[14] Raymond Baker, Invisible Trillions, p. 139.
[15] Raymond Baker, Invisible Trillions, p. 236.
[16] Casey Michel, American Kleptocracy, p. 64.
[17] Casey Michel, American Kleptocracy, pp. 63-64.
[18] Casey Michel, American Kleptocracy, pp. 66-68.
[19] Frank Vogl, The Enablers, p. 121.
[20] Raymond Baker, Invisible Trillions, p. 224.
[21] Raymond Baker, Invisible Trillions, p. 224.
[22] Elise Bean interviewed January 18, 2024.