Since 9/11, the fight against financial crime has been co-opted into the war on terror. Rich countries have stepped up their campaigns to combat money laundering, tax evasion and offshore finance. But critics say they have picked the wrong targets and question the motives. By Nicholas Kochan –

From a plush office in Paris, a small group of civil servants scrutinize the financial face of the globe. Sophisticated products of France’s grandes ecoles, these officials of the Financial Action Task Force (FATF) are determined to be tough and effective.

“Our manner is quite direct,” says FATF executive director Patrick Moullet, “There is only so much time for diplomacy and dialogue. After that you need to be direct. Otherwise we would not have achieved the progress we have made since 2000.”

Their mission: to impose anti-money laundering controls determined by the richest 30 countries on non-conforming offshore regimes. The events of September 11 2001 catapulted FATF from relative obscurity to prominence.

They have been in the vanguard of the fight against terrorist financing. But in the 18 months since the attacks, many have asked whether FATF has picked its targets well, and whether it is competent.

This critique has been partly picked up by the IMF which, in the autumn of 2002, appeared to be unhappy with FATF’s process of blacklisting countries that did not comply with its anti-money-laundering agenda. The IMF is believed to have argued that involvement with the world economy was likely to be more persuasive as a long-term strategy than isolating non-conforming states.

The outcome of this dispute was an agreement by FATF to suspend publication of a blacklist of non-conforming jurisdictions for one year. In the meantime, the IMF and FATF are to run parallel anti-money-laundering campaigns.

FATF was set up in 1989 under the auspices of the OECD and the G7 countries to examine and standardize anti-money-laundering law but it stayed largely dormant for its first 11 years, merely putting out academic consultative papers.

In 2000, though, FATF officials flexed their muscles. They produced a list of countries whose laws they deemed to be in breach of 40 anti-money-laundering procedures. They were scarcely the dynamos of the world economy, and did not possess the most advanced legal systems, financial or otherwise. They made easy targets. Those on the FATF blacklist have included the Cook Islands, Dominica, Grenada, Guatemala, Hungary, Indonesia, Israel, Lebanon, Liechtenstein and the Ukraine.

Opponents of the FATF/OECD regime have also gathered strength. One of these is Marshal J Langer, a member of the Florida bar and an expert on offshore law who comes from the American libertarian right. “The OECD is a cartel of 30 wealthy countries which has given itself the power and authority to tell the rest of the world how to behave,” he says. “Its claim that it will also police its own members lacks credibility. This is a matter that should be handled by the UN, the IMF or the World Trade Organization, not a self-appointed Opec-like cartel.”

He adds: “The OECD’s policies are clearly designed to assist its member countries rather than the world at large. Most OECD countries are high-tax countries that abhor any non-member country that functions as a low-tax country. The people who run the OECD are government bureaucrats who live in high-tax Paris on tax-free salaries paid for by the taxpayers of the OECD member countries.”

FATF’s burst of activity was prompted by a reassessment of the value of offshore havens, and of low-tax jurisdictions more generally. These entities had mushroomed over the previous 20 years, with the removal of economic frontiers in the drive for globalization and the free movement of capital.

Now, say the critics, timid and bloated onshore countries want to make pariahs out of those offering the most flexible tax and privacy regimes, and replicas of their own bureaucracies out of the more pliable and compromised of the rest.

Some territories, such as Bermuda and the Isle of Man, have raced to comply with FATF principles. “We were among the first to accede to the FATF when it came to us with its money-laundering initiative,” says Eugene Cox, Bermuda’s financial minister. “We gave a high level of commitment because we didn’t want to be tarnished by appearing on any blacklist.”

The island agreed to three principles proposed by FATF – transparency, open information exchange and a preparedness to encourage companies bringing substantive activity to the island.

The island of Jersey is equally keen to be seen to be complying, says Richard Pratt, director general of the Financial Services Commission in Jersey. “This is not a case of offshore versus onshore, it is well regulated against under-regulated and non-cooperative,” he says. “We see ourselves firmly in the cooperative and well-regulated camp. We do not see the IMF and OECD as being our opponents but as being part of a process for improving standards, with which we completely agree.”

Yet Jersey still haggles with FATF over the small print of its agreement on information sharing. John Mills, the island’s most senior civil servant, was recently quoted as saying: “Our particular concern has been to get a level playing field which protects us against our businesses moving to Switzerland. Everyone’s compliance is different, there are no commitments in this little game that are the same, they are all different. It is the nature of the beast.”

Switzerland itself has been markedly less enthusiastic in yielding to the pressures exerted on it by the OECD, the British government and others. It has insisted on its right to provide banking secrecy, in the face of public criticism from UK finance minister Gordon Brown, among others.

The country’s authorities have said that they have strong “know your customer” standards to ensure that they exclude undesirable customers and money. Moreover they have publicly cooperated with foreign governments seeking information on Swiss bank accounts when evidence of criminality has been compelling.

Switzerland argues convincingly that it is not required to collect tax for governments that apply more stringent fiscal rules than it does.

One observer put FATF’s role as fiscal policeman pithily: “The wealthy countries want to compel low-tax jurisdictions to help high-tax nations to collect taxes on an extra-territorial basis.”

Eamon Butler, the director of the Adam Smith Institute, says: “One can see why there is a lot of pressure from socialist administrations and politicians to clamp down on low-tax regimes. They know that their own public spending is extremely high, and they fear that in the internet age business will zip out to other countries where tax is lower.”

Switzerland is of course a powerful economy. The many small states targeted by FATF are not. The Caribbean islands in particular are aware that, for all their protestations of independence, they are in fact extremely dependent on US business and markets.

Offshore-based corporations and fund managers are also feeling the heat of the new crusade. Ian Pilgrim, a director of Cayman Islands-based hedge fund management company Citco, admits as much. “Offshore has become a bit of a dirty word, and using an offshore account is regarded as unpatriotic in the US,” he says. “Things are getting tougher and more regulated in the offshore jurisdictions.”

Pilgrim says politicians are gunning for one structure in particular. US corporations have to pay tax on worldwide income, on-non-US sourced income. So they incorporate a company in Bermuda or in the Caymans and then do a sort of reverse merger so that the US company merges into a Bermuda holding company.

Its shareholders are basically the shareholders of the original US listed company. The new company has a New York listing so the company pays tax on its US sourced income but it is no longer required to pay tax on its non-US income. US conglomerate Tyco introduced this structure about five years ago, says Pilgrim, and has saved an estimated $400 million in taxes.

Dre Barton, another Citco director, is more bullish on the offshore response. “Initially people thought that if they make it too difficult then nobody is going to go offshore any more. In fact the opposite has happened: investors seem to be looking for some way of regulating without being so cumbersome,” he says. “The various jurisdictions have reached a very good balance between finding out what you need to know without making the impositions over-burdensome. Nobody’s business in the hedge fund area has been hampered by the anti-money-laundering rules we have had to introduce.”

The campaign to bring tax havens into line gathered speed under the Clinton administration in the US but the arrival of George W Bush and his free-market-minded treasury secretary Paul O’Neill (since departed) suggested that a brake might be applied. But the events of September 11 gave more interventionist western lawmakers the perfect excuse for interfering in low-tax regimes. Offshore jurisdictions were caricatured as hiding places for funds of opponents of the US, although the largest users of such hiding places are Americans. The allegation made against those secreting objectionable funds was not described as tax avoidance, as that is legal, but as “money laundering”.

The term was deliberately emotive. The key component of anti-money-laundering legislation – whose fundamental aim is to unmask drug money and drug dealers – is a demand on banks to “know their customers”.

But after September 11, it became a campaign to link by inference those using secrecy provisions for tax avoidance, or even evasion, with those with more sinister purposes: terrorist funding.

The campaign against offshore havens was joined by a host of law enforcement officials operating in the private sector who saw a promising business opportunity. Raj Bairoliya, the managing director of Forensic Accounting, for example, was quoted as saying: “The fight against money laundering doesn’t have a hope of succeeding as long as tax havens continue to exist. They are the ones that provide the anonymity behind the offshore trusts and accounts.”

Lobby groups have been mobilized in the US to assert an individual’s right to financial privacy. The Centre for Freedom and Prosperity, for example, argues: “Very little of the money deposited in tax havens has criminal origins. It represents legitimate investment by people seeking sound money management, asset protection and lower tax bills.”

Resistance to anti-tax-evasion measures and money-laundering controls is not only a matters of principle. Law enforcers also argue that they are unlikely to trap criminal money. They say it is very difficult to transfer money to a low-tax jurisdiction unless the funds are already in a financial jurisdiction. But if the criminal money is in a bank the laundering has already taken place. So why bother going offshore?

Criminals also avoid tax havens because of the added risk. Shifting money offshore and then back onshore when the funds are needed greatly increases the probability of detection. The UN has even acknowledged that criminals avoid so-called tax havens because they are a red flag for law enforcement.

FATF, for its part, has also accepted that “criminal funds are usually processed relatively close to the underlying activity, often in the country where the funds originate”. It adds: “Since most of the world’s criminal activity takes place in North America and Europe, it should come as no surprise that tax havens are not major money-laundering centres.”

The Patriot Act passed in the US after September 11 imposed draconian requirements on financial institutions to introduce “know-your-customer” routines.

The result is a more fragile business environment, says Marty Brandt, a Caymans-based fund manager. “Life is getting tougher not only for the offshore jurisdictions, it is getting more difficult everywhere and I think there will be some kind of harmonization.”

“The offshore jurisdictions will need to adopt similar legislation to survive and to be able to compete. These initiatives are not going to see the end of the offshore jurisdictions, but those smaller offshore jurisdictions that are unable to adapt to change and introduce applicable legislation will suffer and could fall by the wayside. There will still be a place for the Cayman Islands and Bermuda.”

Bob Harland, an expert in money-laundering law and a partner at PriceWaterhouseCoopers, concurs, believing that large and well-regulated areas such as Switzerland may benefit. “Some of the rest may fade away,” he says.

A burgeoning bureaucracy

While multinational agencies will seek to intrude on non-conforming countries’ internal affairs, banks’ own regulators and new tiers of officials and internal managers will gain powers to regulate banking relations. Counter clerks are the bank’s frontline policemen and must report every suspicion to their money-laundering reporting officer. This official, whose responsibilities are delineated under anti-money-laundering rules now in place throughout the regulated world, reports to the bank’s board.

As one observer says: “The new anti-money-laundering regime is at the expense of privacy and there is little evidence that it has had an impact on crime. This approach has privatized law enforcement, making detectives of banks, financial institutions, and an increasing segment of our society. It has fuelled the creation of a significant bureaucracy.”

All participants in the offshore world are preparing for further harassment from US and European authorities pursuing their new licence to intrude.

Carlyle Rogers, a lawyer from Anguilla, says: “Persecuted low-tax jurisdictions would lose their sovereign right to determine how income is taxed within their borders. Instead they would be forced to emasculate financial privacy laws so that high-tax nations can impose their oppressive tax burdens on income earned in low-tax economies.”

The pressure on offshore tax locations has widened from checking that offshore banks applied the “know your customer” principle, to requiring their authorities to assist onshore governments and police authorities with inquiries relating to tax or criminal issues.

The strained relations between international law enforcers and national governments can be expected to grow as foreign police are given a licence to snoop round other countries’ citizens.

Dan Mitchell of the Heritage Foundation says: “The attack on sovereignty inherent in any proposal for limited information exchange is accompanied by an assault on due process legal protections.”

He adds: “The bureaucrats in Paris want to eliminate the dual criminality provision which states that one country will not help another country enforce a law unless the so-called offence is a crime in both jurisdictions. Does the OECD really intend to deny access to the courts, to do away with probable cause before violating privacy? If the low-tax jurisdictions surrender before these questions are answered, rest assured that the OECD will unilaterally decide how these questions are resolved.”

The resentment created by the intrusion of the US Treasury and the OECD is exacerbated by the awareness in leading tax havens that the OECD applies particularly vicious double standards. Although limp offshore havens have fallen over themselves to comply with the OECD’s wishes, many of its richest members fail to meet its rules. The lax application of the anti-money-laundering statute in Switzerland and Luxembourg particularly upsets smaller jurisdictions. One observer in the government of Bermuda notes that “these two jurisdictions have abstained from the process of information exchange, transparency, and ring-fencing in Europe”.

The Bahamas government is so sceptical of the willingness of Switzerland and Luxembourg to comply with OECD “unfair tax” rules that it has made its own willingness to comply conditional on all OECD countries doing so.

The Guernsey banking regulator, Hugh Bygott-Webb, claims: “Luxembourg does not have all-crimes money-laundering regulation, that is law that makes any tax offence prima facie an offence against money-laundering law.

“But, because Luxembourg is a member of the OECD, it gets less scrutiny. Its tax structures are probably more unfair and its anti-money-laundering statute less comprehensive than those in the Channel Islands. People need to realize that offshore centres are very important for the economy, they are particularly important for the UK economy. If you didn’t have the money coming in from the Channel Islands, UK tax would rise by something like 10%.”

Eugene Cox, Bermuda’s finance minister, also demands a level playing field from members of the OECD before he will accept that it has a moral basis for its demands.

The Patriot Act exploits the immense power of the US to cut off business from those that it argues have failed to comply with OECD money-laundering regulations, or have been found to have dealings with companies linked to terrorists. But the biggest culprit of OECD double standards is the US. Citco’s Pilgrim says: “The US has one of the worst records, along with Mexico, for implementing the recommendations for money laundering. So in the offshore world we find it hard to have these things imposed by the US when their own shop is not really in order.”

The absurdity of the OECD claim to expose the weakness of statutes in member countries was demonstrated in one questionnaire it published about members’ unfair tax practices. In this survey, the US admitted to just one preferential regime, the Foreign Sales Corporation programme; the UK to none; and Ireland to just two.

The Heritage Foundation’s Mitchell says: “Most OECD member states are guilty of egregious unfair tax competition that is much more serious and harmful than that of which the OECD is complaining. The UN defines an offshore institution as ‘any bank anywhere in the world that accepts deposits on behalf of persons legally domiciled elsewhere’.

“But US banks have paid tax-free interest to foreign persons for nearly 80 years. Hundreds of billions of dollars of US bank deposits are held in the US by non-resident aliens and foreign corporations. If the US Congress ever seriously tried to tax the interest paid on these deposits, this money would immediately disappear from US banks, and probably move to other OECD countries.”

Andrew Quinlan, president of the Centre for Freedom and Prosperity, says Patriot Act proposals and other unfair tax initiatives in the US will impose costly regulations on financial services, drive capital away and harm US banks’ competitiveness. “The legislation requires US banks to undertake burdensome new tasks if a foreign bank or its accounts fall into certain categories,” he says. “Combined with Qualified Intermediary regulations, the laws would impair the flow of foreign capital to the US economy.”

Hedge funds under pressure

US-based hedge funds are now under pressure to monitor compliance as never before, says Brandt. “Every day you see something in the Patriot Act that will potentially impact the funds, both in the US and offshore,” he says. “Before the Patriot Act, very few institutions were required to have an anti-money-laundering programme. Our challenge is seeing what we are required to do under the Bermuda and Cayman legislation versus new requirements under the Patriot Act. How do we match those together and make sure we are complying with everybody?”

The case for the tougher regulations would be stronger if they were likely to catch terrorists, felons, massive tax evaders and fraudsters. But it is now well established that the funds for Al Qaeda originated almost entirely in Saudi Arabia (a country that the west could not afford to blacklist) rather than offshore islands.

The administrators, lawyers and accountants might be better off searching their own backyards for black money before taking another jaunt offshore.