In a letter to the President of the United States, the Secretary of the Treasury listed several schemes to evade payment of U.S. taxes. First among these was the device of setting up foreign personal holding companies in the Bahamas, Panama and “other places where taxes are low and corporation laws lax.” These various devices, the Secretary wrote, showed “a well-defined purpose and practice on the part of some taxpayers to defeat the intent of Congress to tax income in accordance with ability to pay.” He observed that some cases amounted to fraud, while others fell into “the category of legal though highly immoral avoidance of the intent of the law”, and called for legislation to close loopholes in the tax code that permitted “legalized avoidance or evasion.”
The President to whom this letter was addressed, on May 29, 1937, was Franklin D. Roosevelt, and the Treasury Secretary was my father, Henry Morgenthau, Jr.
What Secretary Morgenthau was concerned about seventy years ago remains a concern today—only more so. Efforts at tax evasion have probably always been abundant, but what has changed is that the schemes to evade taxes have become more numerous and complex, the number of offshore jurisdictions with little or no taxes or responsible government supervision has increased, and the amount of taxes now evaded has grown in proportion. About a decade ago studies estimated that the Federal government was losing about $70 billion every year due to offshore tax evasion. That number is undoubtedly much larger now.
Examples abound that illustrate how tax evasion schemes have become more complex. In a series of cases beginning in 2003, my colleagues and I at the New York County District Attorney’s Office learned of a credit card scheme widely used to repatriate U.S. dollars hidden in offshore banks by U.S. taxpayers. By using the cards at ATMs in this country the cardholders could, with little fear of detection, withdraw the money stored in their offshore accounts. We caught up with some cardholders when they used the cards to make purchases through which they could be identified.
In a 2004 tax case, we convicted a doctor from Long Island of evading taxes on $300,000 of income, $126,000 of which he had put into an account at Leadenhall Bank & Trust Company in Nassau, Bahamas. The doctor used a MasterCard issued on the Leadenhall account to withdraw money at New York ATMs and to make purchases in the city. Earlier, we convicted four New York stockbrokers of laundering more than $750,000 in profits from fraudulent stock deals through credit card accounts at the same Nassau bank to avoid New York City, State and Federal taxes. The brokers withdrew $790,000 using MasterCard debit cards at ATM machines in New York City and Atlantic City, New Jersey, among other places.
As it turned out, 115,000 separate offshore MasterCard accounts were used in the New York, New Jersey and Connecticut area in 2001. In that year alone, the cards were used to access more than $100 million deposited in banks located in at least 17 tax haven jurisdictions, including the Bahamas, Barbados, Belize and the Cayman Islands.
These figures relate to just one of the major credit card companies used by Leadenhall. It has, however, been extremely difficult to get the names of other cardholders. This is partly because MasterCard kept a record only of account numbers, not the names of the account holders, and partly because we are unable to compel offshore banks like Leadenhall to disclose the information. We therefore don’t know what the actual numbers are in the Leadenhall case, except to say that they are vastly larger than $100 million.
In another complex tax evasion investigation last July, we announced the guilty pleas of a father and son, the owner-operators of several successful Manhattan restaurants, who evaded $10 million in New York State and City taxes. Over a seven-year period, the U.S. holding company for the restaurants took deductions for more than $30 million in royalty payments ostensibly made to a Liechtenstein company for the right to the name and the signature decor of its restaurants and other trademarked property. Designed to take advantage of loopholes in the tax code, the scheme came undone when we discovered that no payments had ever been made; they were only book entries in the U.S. company’s records. The company is now operating under the watchful eye of a monitor installed under the terms of the pleas.
There has been a long-standing need for new legislation to better combat financial schemers. The Stop Tax Haven Abuse Act (S. 681), sponsored by Senator Carl Levin (D-MI), addresses some of the problems and is certainly a step in the right direction. This bill would put the onus on U.S. taxpayers who do business in tax havens like the Cayman Islands, Liechtenstein and the Bahamas to establish the bona fides of certain financial transactions in these jurisdictions. It would also allow the Treasury Department to impose sanctions on foreign jurisdictions or institutions that are found to be of concern for money laundering or for impeding collection of U.S. taxes. Measures like these are badly needed, because the problems presented by the tax havens—problems that go far beyond lost tax revenue—are huge and growing.
In the world of tax havens, Liechtenstein and the Bahamas are relatively minor players. On its website, Liechtenstein reports having 161 billion in Swiss francs (equal to about U.S. $158 billion at current rates) on deposit in 2006. The Bahamas reportedly has about $200 billion in deposits. By contrast, the Cayman Islands boasted that it had over U.S. $1.9 trillion on deposit as of September 2007, an increase of $500 billion over the previous 18 months. Total deposits in the Caymans now amount to four times the total deposits in all the banks in New York City.
The Caymans, notorious for its bank secrecy laws and lack of supervision over financial markets, has figured in many major financial scandals. The islands were the nominal home of Long Term Capital, the giant hedge fund that collapsed in 1998. Enron Corporation used 441 Caymans affiliates to hide $2.9 billion in losses. Parmalat Finanziaria—which my office investigated preliminarily before turning over our evidence to Italian authorities—used Caymans subsidiaries to falsely claim $4.9 billion in bank deposits that it did not have. Bear Stearns’s serious troubles began last year when two hedge funds incorporated in the Caymans collapsed following the devaluation of its subprime mortgage-backed investments. The cost to investors was then estimated at $1.6 billion.
The economically developed countries clearly need to impose severe sanctions on tax havens and those who use them to unfair advantage. The Levin bill would, among other things, restrict the ability of banks in rogue jurisdictions to maintain correspondent accounts in the United States, and limit the ability of domestic institutions to run credit or debit card operations on behalf of suspect foreign banks. That is a beginning, but it does not address the problem posed by the major financial institutions in the United States and worldwide conducting business in the Caymans. In fact, 277 U.S. and foreign banks, including forty of the world’s top fifty banks, have branches or other offices in the Caymans. According to the Chairman of the Cayman Islands Stock Exchange, more than 90 percent of the $1.9 trillion in the Caymans is deposited there in banks that do business in Manhattan. The U.S. government urgently needs to get a handle on this situation: As recent history confirms, totally unsupervised financial markets will eventually cause serious problems, producing ripple effects for markets worldwide.
Not all global financial problems can be attributed to offshore tax havens. Indeed, we have found some major problems in our own back yard. In a long series of investigations, we have uncovered international money laundering operations on a grand scale done through accounts at a number of bank branches in Manhattan on behalf of illegal money exchangers, corrupt politicians and others in South America.
In criminal prosecution, as in many other enterprises, success tends to breed more success. Our investigation of the offshore credit cards issued by Leadenhall Bank in the Bahamas led us to Beacon Hill Service Corporation in Manhattan. Beacon Hill was an unlicensed money-transmitting business run out of offices on the seventh floor of a midtown office building. It had about a dozen employees. Beacon Hill was open for business from 1994 to February 2003, when we executed a search warrant on the premises and shut it down. In its last six years of operation, this small company moved $6.5 billion by wire transfers alone through the forty accounts it maintained at a major New York bank. This does not include checks, drafts or cash transactions. Beacon Hill was convicted in February 2004 of operating as a money transmitter without a license.
We can reasonably conclude that very little if any of this money was moved through Beacon Hill for legitimate purposes. Legitimate clients moving that amount of money would have dealt directly with a bank rather than pay the extra fees required to deal with Beacon Hill. What Beacon Hill’s clients got for those extra fees was secrecy. Because Beacon Hill did not keep proper records and because of the nature of its client base—which included numerous offshore shell corporations and doleiros, or exchange houses, in Brazil and Uruguay—it is nearly impossible to identify the real parties of interest behind Beacon Hill’s transactions, or to trace the money through these accounts. Some of the money was linked to narcotics traffickers from South America: We identified one such transaction valued at $25 million. Records also show that Beacon Hill transmitted $31.5 million to accounts in Pakistan, Lebanon, Jordan, Dubai, Saudi Arabia and elsewhere in the Middle East.
Among the foreign authorities that contacted the New York County District Attorney’s Office about the Beacon Hill accounts were Brazilian prosecutors, police and representatives of a special commission established to investigate the movement of some $30 billion out of Brazil. At least $200 million of this money moved through Beacon Hill’s accounts. After our meeting my office obtained a court order permitting us to disclose information to the Brazilian authorities, who then intensified their investigation, code-named Farol da Colina (Operation Beacon Hill, in Portuguese). Thus far, the spin-off of our Beacon Hill investigation has resulted in the issuance of 121 arrest warrants and 215 search-and-seizure warrants in Brazil. Among those arrested was Paulo Maluf, the former governor and mayor of the state and city of São Paulo, a city more than twice as populous as New York City.
In March 2007, after a lengthy investigation conducted in cooperation with Brazilian authorities, a New York County grand jury returned an indictment charging the same Paulo Maluf with stealing more than $11.6 million from a public works project and laundering the stolen funds through bank accounts in New York. Maluf and four co-conspirators were charged with receiving kickbacks and other cash payments in connection with the construction of an arterial highway in São Paulo known as the Avenida Agua Espraiada, a project originally budgeted at $200 million that ended up costing the citizens of Brazil $600 million. The illegal payoffs were funneled through black market operations in Brazil to accounts controlled by Maluf and other members of his family at Safra National Bank in Manhattan. Some of the illegal funds were used to buy jewelry and other items in New York. Much of it was sent to accounts in the Isle of Jersey. Some money was repatriated to Brazil and used to pay Maluf’s campaign expenses or paid out to Maluf in cash. In total, $140 million passed through the Maluf’s principal account at the Safra Bank.
In another case in 2006, we indicted 34 individuals and 16 offshore shell companies for money laundering through a branch of Valley National Bank in Manhattan. In cooperation with Federal authorities, we froze $17.7 million that was illegally transmitted from New York by Brazilian money service businesses. To date $1.6 million of the funds have been repatriated to Brazil.
These cases and others like them should help send the message that New York banks cannot be used as a haven or a conduit for criminal proceeds, no matter where they are generated. These cases also assist foreign governments in prosecuting corrupt officials. That is not entirely altruistic on our part: We help them so that they, in turn, will help us when we need information.
We have been particularly interested since 9/11 in tracking the flow of illegal money though New York, because the same mechanisms that are used by corrupt officials like Maluf and by drug traffickers and identity thieves can also be used by international terrorists. Terrorist organizations, like other criminal groups, need funds to operate—for training, travel and living expenses for their operatives and the operatives’ families. While the prosecution of terrorists is the responsibility of the Federal government, local and state authorities can be of considerable help in dismantling these financing mechanisms. In our investigations we have seen millions of dollars transmitted to and from the tri-border area in South America, where Brazil, Argentina and Paraguay meet—an area notorious for harboring financial backers of Hizballah, Hamas and other terrorist groups.
It is apparent from these and other investigations that U.S. financial institutions need to do a better job of complying with anti-money laundering laws that are already on the books. Beacon Hill is a case in point. Beacon Hill conducted its business through accounts maintained for nine years at a branch of J.P. Morgan Chase in Manhattan that ignored numerous red flags for money laundering. First, many of Beacon Hill’s clients were themselves in the business of moving money in South America, and the identities of their customers were unknown and unknowable by the bank. Wire transfer documents often identified the ultimate beneficiaries of transfers only as a “customer”; one transfer of $100 million was attributed only to “valued customer.” Other Beacon Hill clients were offshore shell corporations. A large portion of Beacon Hill’s business was run out of a pooled account that served many customers, making it impossible to link deposits with transfers out of the account. Finally, the London office of Chase had shut down Beacon Hill’s accounts in 1994, and, as the bank knew, Beacon Hill did not have a license to operate in the State of New York. It is fair to say that, in this case, the bank’s compliance department fell down on the job.
Working with state and Federal banking regulators, as well as law enforcement in other countries, we have prosecuted five unlicensed money transmitters besides Beacon Hill and collected $21 million in penalties from three banks operating in Manhattan. A branch of Hudson United Bank at 90 Broad Street in Manhattan transmitted $1.4 billion through suspect accounts over a 16-month period in 2002 and 2003, including $65 million originating or terminating with individuals and companies in the tri-border area of South America. Our investigation showed that the bank’s compliance department had no appreciation for and no effective controls against the risks of money laundering in these accounts. (The bank did complain, with some justification, that it had inherited these problems when it purchased the branch with the accounts in question in June 2002 from a Federal agency, the Federal Deposit Insurance Corporation, following the liquidation of the Connecticut Bank of Commerce.)
We have also investigated similar activities at Israel Discount Bank and at Bank of America. Over a two-year period ending in April 2004, $3 billion flowed through an account of a large Uruguayan money transmitter at a Manhattan office of Bank of America. Most of the money came from offshore shell companies chartered in Panama and the British Virgin Islands. The shell companies were controlled by money service businesses in Brazil that were transmitting money out of the country illegally. As a result of our investigation, all three banks paid substantial monetary penalties, shut down the questionable accounts and committed to reforms of their internal anti-money laundering policies, procedures and controls.
Banks and other financial institutions should be our first line of defense against illegal money entering the banking system. It is deeply troubling that, in our investigations alone, we have traced nearly $19 billion of illegal money through banks in Manhattan. It is even more troubling that we have virtually no way of determining the source of most of this money or the identity of its recipients. This enormous flow of illegal money poses a grave threat to American national security. Much more needs to be done, particularly by banks and other financial institutions, to know whom they are doing business with.
The global economy and the speed and reach of modern communications systems, including the Internet, have created more opportunities: for financial institutions to extend their operations across national borders; for unscrupulous businesses and individuals to avoid taxes and responsible regulations; and for financial criminals to target victims around the globe. Both regulators and law enforcement have been struggling to keep pace with wrongdoers.
For example, the current system for obtaining financial records in international criminal cases is woefully outdated. We are currently investigating a $17.5 million kickback paid in a Manhattan real estate project. The kickback payment was made out to a shell company in the British Virgin Islands, a bank secrecy jurisdiction, but was actually sent to a bank in the Isle of Jersey. From there it passed to a London bank and was ultimately invested in Hong Kong. To prosecute the case we need records from all four jurisdictions, which must be obtained through the use of Mutual Legal Assistance Treaty (MLAT) procedures. This requires us to go through the U.S. Justice and State Departments as well as foreign bureaucracies and courts, a process that can take months or even years, during which time the evidentiary trail grows cold. In the kickback case, for example, we filed our MLAT request for the London bank records 13 months ago and are just now beginning to get some records.
The Levin bill attempts to address this problem by extending the statute of limitations in tax cases with international aspects, but extending the statute does little good if the passage of time makes it impossible to build a case in the first place. International cooperation simply has to be streamlined to keep up with the methods and devices available to international criminals.
For regulators, other problems have been created simply by the growth and size of our financial institutions. After the 1999 repeal of the Glass-Steagall Act, banks entered the securities and insurance businesses, and with consolidation in the industry, the major banks have become extraordinarily large and complex enterprises. They are regulated by a number of different state and Federal agencies, none of which sees the whole picture, and few of which have had budget increases to help them keep pace with the growing scale of the challenges before them. Accordingly, it is becoming nearly impossible to regulate and supervise banks and other financial institutions effectively and to uncover the illegal activities engaged in by some of their clients.
It would be nice to think we are making progress in dealing with the devastating consequences of tax evasion and other “dirty money” activities. In truth, we are probably falling further behind. The Levin bill will help us deal with the problem, but we will not be in a position to say we are getting the upper hand on it unless the next administration makes a major effort to do so. We are not shy in New York City about touting our capabilities, but this is a job that must be led ultimately by the Federal government at the highest levels: the Secretaries of the Treasury, Justice, Commerce and State, as guided by the President.