Loopholes for Kleptocrats

On April 3, 2016, journalism colleagues around the world and I broke the story of the Panama Papers, 11.5 million documents leaked from the files of Mossack Fonseca, a Panamanian law firm that specialized in creating anonymous shell companies. The documents exposed how wealthy individuals and corporations, criminals, and corrupt government officials employ a hidden financial circulatory system to evade taxes and launder money.

Two days later, President Obama discussed the leak with reporters. “There is always going to be some illicit movement of funds around the world,” he said. “But we shouldn’t make it easy.”

As Casey Michel’s American Kleptocracy and Chuck Collins’s The Wealth Hoarders demonstrate, the US has made it astonishingly easy to evade taxes and launder money. While the term “tax haven” may conjure images of Caribbean islands and palm trees, Michel and Collins make the case that the world’s leading tax haven is America, which offers not only vehicles to hide ownership—anonymous companies, trusts, foundations—but also ways to invest illicit funds, such as real estate, hedge funds, art, even factories. A new leak, called the Pandora Papers, published in October by the International Consortium of Investigative Journalists (ICIJ), bolsters the case. The Guardian, an ICIJ member, found at least $1 billion held by more than two hundred US-based trusts.

The roots of this permissive system date in part to the 1830s, Michel writes. Under President Andrew Jackson, the federal government declined to assume responsibility for the incorporation of companies, leaving it to the states. (Incorporation allows companies to take collective action, provides them some protection from liability, and offers a legal structure, for which the government can charge fees and taxes.) It didn’t take long for New Jersey to seize the opportunity that the absence of federal oversight created. The state changed its laws to permit companies to exist in perpetuity and to operate entirely outside its boundaries, allowing citizens to sidestep the incorporation laws of the states where they lived, enriching New Jersey in the process. By 1902 income from company taxes and fees allowed New Jersey to abolish its property tax.

When the reform-minded Woodrow Wilson served as governor of New Jersey, he halted many of the state’s shadiest practices, and neighboring Delaware stepped forward. Under its incorporation law, as long as a company does no business in Delaware, it pays no state taxes. The state offers company owners complete anonymity. The combination of secrecy and tax avoidance worked so well that Panama’s lawmakers borrowed from Delaware’s incorporation law, which in turn inspired the laws of the British Virgin Islands. Beggar-thy-neighbor as government policy spread through America and into the rest of the world.

Today, nearly half of all US corporations are registered in Delaware, and nearly 68 percent of the Fortune 500. The state boasts 1.3 million corporations and a population of only 960,000. It’s a great business for Delaware—companies account for $1.3 billion in direct annual revenue, about 28 percent of the state budget—but not so great for the other forty-nine states. By one estimate, they lost approximately $9.5 billion over a decade to Delaware, the second-smallest state in the union.

Delaware’s early start gave it special purchase on corporate tax avoidance. To compete, other states promoted secrecy and ease of use. Wyoming offers low fees, the ability to maintain company records outside the US, and a public database searchable only by the names of companies, not individuals, to ward off the curious. In Nevada, it is easier to form an anonymous company than to get a library card. Anonymity and the ability to hide one’s activities and assets is a powerful draw. The website of one of the state’s top company incorporators promises “Control everything, own nothing.”

In each of these states, the legislature and industry worked together, but in few places were they as synchronized as in South Dakota. When it abolished usury laws in 1981, credit card companies rushed there, eager to soak Americans with higher interest rates. The entrepreneurial governor William “Wild Bill” Janklow searched for another honeypot and landed on trusts. First devised in England in the Middle Ages, trusts were legal instruments by which a guardian—the trustee—could temporarily oversee the assets of a knight on crusade and, if necessary, transfer them to the knight’s next of kin.

Janklow pushed a law to allow South Dakota trusts to exist in perpetuity. As the state’s trust business grew, the governor in 1997 formed a task force with industry representatives and state legislators to seek further improvements. Together they wrote a new law regulating trusts that elevated secrecy, sealed court documents that named trusts, permitted them to operate wholly outside the state, and allowed a trust’s creator to be its beneficiary. As Janklow foresaw, the world’s wealthy, eager to conceal their assets and avoid taxes, flocked to the state. Between 2010 and 2020, the amount held in South Dakota trusts grew from $57 billion to $367 billion.

There is not enough space here to recount the crimes and scandals in which Delaware companies are implicated, let alone those of other states. A World Bank survey from 2011 of more than 150 cases of grand corruption found that 85 percent involved anonymous companies. Most were American. Any tour of Delaware’s lowlights must include 1MDB, a multi-billion-dollar Malaysian fraud that involved at least eight Delaware companies, Goldman Sachs, the art world, and Hollywood, among other highfliers. A department of bribery that operated inside Odebrecht, a Brazilian multinational construction firm, allegedly paid bribe money to a Delaware company to maneuver its way into projects in Ecuador. The Russian arms dealer Viktor Bout, known as “the merchant of death,” owned two Delaware companies; in 2011 he was convicted of various charges in a US federal court. And Michael Cohen, Donald Trump’s attorney, used a Delaware company to pay hush money to the pornographic film actress Stormy Daniels during the 2016 campaign.

In American Kleptocracy, Michel, a freelance journalist, is concerned with the benefits that US secrecy affords a specific kind of malefactor, the foreign kleptocrat who attempts to legitimize tainted money in the United States. Michel defines kleptocrats as political leaders or government officials (and family members of such powerful people) from countries where corruption is endemic and the thieving begins at the top. In larger kleptocracies, such as Russia, the principal kleptocrat is frequently surrounded by oligarchs beholden to him.

Life is good for the kleptocrat. Often his territory is blessed with natural resources. He lives in opulence. Elections are rigged, if held at all. Institutions of the state, including the administration of justice, are suborned. The kleptocrat does face one significant challenge, however.

After extracting as much wealth from the populace as he can, he must get the money out of his country to safeguard it and put it to use. Perhaps this is done through acquiring a vineyard and castle in Tuscany, like the one purchased by a foundation allegedly controlled by former Russian prime minister Dmitry Medvedev, or a mega-yacht, as Isabel dos Santos, the daughter of Angola’s former president José Eduardo dos Santos, did. Or it can be achieved by storing the money in something that will retain or increase in value, like overseas property, art, or, in the case of Teodorin Obiang, the son of Equatorial Guinea’s strongman, Michael Jackson memorabilia. Regardless, these transactions can be tricky, particularly if the kleptocrat is under sanctions or accusations of wrongdoing that impede access to American or European banks and currencies. A Delaware company or a South Dakota trust can help conceal the kleptocrat’s activities and provide access to the international financial system.

Before September 11, this was simple enough to do. Teodoro Obiang Nguema Mbasogo, the president of Equatorial Guinea, and his family had sixty accounts and certificates of deposit with the well-respected Riggs Bank, based in Washington, D.C. Riggs exercised no control over what were personal funds of the Obiang family versus funds from the Equatorial Guinea national treasury. In the early 2000s the bank accepted multiple deposits from President Obiang’s underlings in twenty-pound stacks of plastic-wrapped hundred-dollar bills. Comingling government and personal funds was not the only reason the president and his family should have raised concerns for Riggs; in 1979 Obiang seized control of the small Central African nation from his uncle, Francisco Macías Nguema, who had won the first election after independence from Spain eleven years earlier but then declared himself dictator. Obiang had his uncle executed. When oil was discovered off the country’s coast, Obiang grew rich under the protection of Western oil companies, even as three quarters of Equatorial Guineans lived in poverty.

Obiang gave Teodorin, his eldest son, the vice-presidency and the country’s timber concession. Teodorin used his position to extort and steal from foreign companies to fund a jetsetter lifestyle. He purchased lavish mansions in Malibu and Paris; a Gulfstream jet; ten collectible automobiles, including a $5 million Lamborghini; a yacht that cost $800,000 a month to maintain; and the King of Pop’s famous beaded glove. His time abroad made him vulnerable. Obiang has ruled with a heavy hand for more than forty years with minimal interference from the global community. Teodorin, however, who preferred Malibu over Malabo, was fair game for countries from the United Kingdom to Switzerland to France, which have investigated, sanctioned, or seized his assets. One of the first to examine his activities was the US Senate’s Permanent Subcommittee for Investigations, under the chairmanship of Senator Carl Levin.

Levin, an avuncular Democrat from Michigan, fundamentally changed the fight against money laundering. Beginning in the mid-1990s, his Senate subcommittee exposed how global banks like Citigroup and HSBC abetted graft and other criminality. For instance, the committee showed how HSBC laundered billions of dollars in Mexican drug profits by sending them to its US branch and how Citigroup acted as personal banker to kleptocrats like the crooked older brother of Mexican president Carlos Salinas de Gortari. Levin wanted tougher laws that would force banks to know their customers’ business better, which might prevent abuse. But Texas Republican senator Phil Gramm, chair of the Senate Banking Committee, and his friends in the banking lobby stymied reform.

After September 11, concern about terrorist financing prevailed over the banks’ pecuniary interest. With Democrats controlling the Senate, Maryland Democratic senator Paul Sarbanes managed to include in the Patriot Act provisions that forced banks to establish tougher standards to detect and eliminate money laundering, particularly when dealing with foreign accounts. Levin’s committee continued to investigate, however, exposing more banks profiting off kleptocrats and criminals. At Riggs Bank, they discovered not only the questionable activities of Obiang and his family but those of others, including Augusto Pinochet, Chile’s former dictator. After 169 years in business, Riggs succumbed to the scandals and was acquired by PNC Financial Services.

The passage of ambitious new laws that contain loopholes or suffer from poor enforcement has been a recurring pattern in US efforts to combat money laundering and tax evasion. For instance, banks are required to file Suspicious Activity Reports (SARs) whenever they encounter questionable customers. SARs are sent to FinCEN, the financial intelligence unit of the Treasury Department, which, while not a law enforcement agency, is charged with fighting money laundering. Once banks notify FinCEN of a shady customer, they often continue to do business with that customer. Understaffed and inept, FinCEN has done little with the SARs it receives. In 2020, thanks to a leak from a treasury official, reporters with the ICIJ got hold of years’ worth of SARs and cataloged more than $2 trillion in suspicious transactions that bank compliance officers had flagged between 1999 and 2017.

The Patriot Act allowed the treasury secretary to exempt industries from customer due diligence. Six months after its enactment, the Bush-Cheney Treasury Department issued exemptions for the real estate industry, lawyers holding escrow accounts for clients, private equity, and hedge funds. All were subsequently abused by kleptocrats and other malefactors, but US real estate in particular has been a staggeringly attractive destination for dirty money. Global Financial Integrity, a Washington-based think tank, recently tallied more than one hundred publicly reported real estate money laundering cases in the US over the past five years and arrived at the figure of $2.3 billion worth of transactions.

Ironically, what makes real estate in America alluring to the international criminal set is our rule of law. Property rights are generally protected in the United States. Disputes are adjudicated by an independent judiciary. Under this safety blanket, real estate assets appreciate. There is no limit to the number of appealing places a kleptocrat can buy. Teodorin’s 15,000-square-foot mansion overlooking the Malibu Pier must have offered spectacular sunsets.

In cities like New York and Miami—or London and Vancouver—high-end residential real estate buyers, often cloaked in anonymity, have crowded out locals and compounded inequality, turning metropolises into playgrounds of the global elite. Prior to 2016, absolute secrecy for high-end real estate purchases was common. Then the Obama administration initiated a pilot project through FinCEN that forced title insurance companies to identify the owners of shell companies paying cash for residential real estate costing over $1 million in New York, Miami-Dade County, Los Angeles, San Francisco, San Diego, and San Antonio. The effect was immediate. In Miami-Dade, there was a 95 percent drop in cash real estate purchases by shell companies and anonymous corporations. A subsequent academic study found that all-cash residential real estate purchases nationwide declined by 70 percent.

Still, the pilot project left enormous gaps, for example in commercial real estate. This weakness was exploited by the Ukrainian oligarch Ihor Kolomoisky, one of the resourceful, ruthless men to emerge with a fortune from the collapse of the Soviet Union’s industrial sector. In the 1990s Kolomoisky cofounded PrivatBank, which became one of Ukraine’s largest financial institutions. Its employees allegedly created fake loans, according to an internal audit, Ukraine’s banking regulator, and US prosecutors. They paid the loans off with more loans through dozens of shell companies, creating a pyramid of fake borrowers that siphoned off billions for Kolomoisky—allegations he and his partner deny.

The money then had to be laundered and stashed. Using proxies and more foreign shell companies, Kolomoisky preyed on vulnerable American communities already reeling from a collapsed manufacturing base and so desperate for investors that they didn’t ask many questions. At one point, Kolomoisky was the largest commercial landlord in Cleveland, with assets that included a 484-room luxury hotel and a historic 21-story office tower. By the time the Justice Department started to seize some of the real estate, the damage was done.

It was his purchase and neglect of industrial facilities, including eight steel factories, that caused the most harm in layoffs, workplace accidents, and toxic waste. In Illinois, Kolomoisky bought a former Motorola plant, injecting hope into the hard-pressed town of Harvard, then stopped paying utility bills and property taxes. Frozen pipes did the rest. Suppliers in Kentucky, Indiana, and Illinois were stiffed. The Ohio attorney general filed a case against a Kolomoisky-owned metallurgical plant in Warren for failing to stop toxic waste from poisoning a nearby river. Soon after, the factory suffered a fire. When firefighters arrived, none of the hydrants around the plant worked. The blaze is under investigation by US fire marshals.

Once again a global bank aided the fraud. Kolomoisky’s shell companies banked with Deutsche Bank. The US government has fined the bank billions of dollars for its regulatory failures, yet its behavior scarcely changes. ICIJ discovered that Deutsche Bank had filed SARs about Kolomoisky’s activities and then assisted him as he rampaged through the American heartland.

It’s clear that the banks and the US government, even when they work together, are not equal to the task of preventing the traffic in illicit funds. The profit motive ensures that private industry will always be a reluctant partner. The government’s regulatory structure urgently needs to evolve, and it appears that may be happening, although too recently to have significantly affected the writing of American Kleptocracy.

On New Year’s Day 2021, Congress overrode President Trump’s veto and passed the National Defense Authorization Act. Tucked into the enormous bill was legislation that anticorruption activists had worked for years to enact. It requires most nonpublic corporations and limited liability companies, for the first time, to disclose their owners to the government. FinCEN will collect the information, which it is supposed to make available to law enforcement and financial institutions. Criminal penalties have been added for anyone who hides the ownership and assets of foreign kleptocrats in excess of $1 million or of others involved in significant money laundering.

Dragging US company incorporation out of the shadows required surmounting multiple obstacles. The National Association of Secretaries of State, led by Delaware, had always blocked reform. In the face of ceaseless bad publicity and criminal cases—Brazil even blacklisted companies registered there—Delaware determined it had enough corporate tax avoidance business that would not be affected by the law and withdrew its objections. The legislation leaves lawyers untouched, checking another potential opponent. Any company that reports to a US financial regulator or has twenty or more employees is exempt. Banks, which are supposed to have access to the company ownership database, welcomed the shared accountability in policing money laundering. In the end, an unlikely coalition, from the US Chamber of Commerce to good-government groups, gave its endorsement.

The bill’s drafters, mindful of the legacy of loopholes and weak enforcement, included requirements for validation and clarification checks on the data. The US Government Accountability Office will do an audit. There will also be regular audits by the Treasury Department’s inspector general. However, there remain numerous opportunities for the legislation’s intent to be waylaid.

The law is supposed to go into effect on January 1, 2022, and FinCEN has yet to finalize the rules for how the reporting will occur and who must report. What will the agency determine is covered? Trusts? Foundations? Family wealth management offices? How will FinCEN handle the new responsibilities? Will it actually make the ownership data it collects accessible? Can FinCEN improve its culture, and do so while being woefully underfunded? Last year FinCEN’s budget was around $130 million, not significantly greater than what Australia spends on its financial intelligence unit, although the United States has a vastly larger GDP and the world’s reserve currency. President Biden has asked for a 50 percent increase in the FinCEN budget, a good start if enacted, but probably still insufficient given its mission.

Even if the National Defense Authorization Act succeeds in limiting the United States’ leading position in worldwide criminal money laundering and tax evasion, such activities will continue to be relatively easy. Part of the problem is defining what constitutes “dirty money.” The definition that Michel uses in his book is both expansive and troublingly vague: “Wealth gained by underhanded means.” His determination rests not on a judicial finding of illegality—for much of the offending behavior is legal, particularly in the countries where it takes place—but rather on something less tangible. “You know ‘dirty money’ when you see it,” he writes.

Coming from a nation that eagerly serves as a global tax haven, Americans may not be the best arbiters of what constitutes dirty money. The United States needs to put its own house in order before it can lecture the world. The new company legislation could be an important step in that direction. Reformers like Senator Levin and leak investigations by ICIJ have placed the reality of America’s dirty money habit squarely before the public. As a result, tolerance for money laundering and tax evasion is waning. The focus now must turn to accountability for the enablers—lawyers, accountants, company incorporators, and wealth managers—who facilitate money laundering and tax evasion. The federal government should require that they report wrongdoing among their clients rather than foster it.

Chuck Collins is a senior scholar at the Institute for Policy Studies in Washington, D.C., who comes to this subject through personal experience. In The Wealth Hoarders, he argues that genuine change requires clamping down on what he calls the “Wealth Defense Industry,” its clients, and its self-serving ideology. Collins was an heir to the Oscar Mayer lunchmeat fortune. In the 1980s, while in his early twenties, he attended a weekend conference for millionaires held by a local family office and foundation. When he admitted that he was uncomfortable with the ethics of inherited wealth, attendees expressed alarm. Donate every penny of the interest, if it makes you feel better, but don’t touch the principal, they counseled. Instead, Collins decided that the benefits of his upbringing, skin color, proper nutrition, health care, and good education were privilege enough. Soon after the conference, he donated his entire inheritance to four progressive foundations.

The power of dynastic wealth has only concentrated since then, Collins writes. In 2019 there were more than 20,000 individuals in the US worth at least $100 million. He chronicles how the Wealth Defense Industry works to make taxes low and complex, collectively through campaign contributions and lobbying, and individually through trusts, foundations, and tax havens. The ultrawealthy have successfully bent the political system to their will. Not surprisingly, between 1980 and 2018 the tax burden on America’s billionaires decreased by 79 percent, despite the fact that most Americans believe the wealthy should pay higher taxes.

The issue will only grow in importance. In the coming decade, households with wealth over $5 million will transfer an estimated $15.4 trillion to the next generation. By 2050, this intergenerational transfer of wealth is expected to be as high as $68 trillion. The transfer will occur as humanity faces its greatest collective action challenge—a pandemic, global warming, a chasm of inequality.

It’s not only an American problem. A global elite has formed, unbound by the nation-state and aided by the secrecy of tax havens. Their assets are transnational, mobile, and inaccessible to governments that wish to tax and regulate them. The workforce that serves this elite has itself prospered and grown worldwide. Estimates of the number of family offices that manage concentrated wealth range from 7,000 to 10,000, with over half founded in the last fifteen years. Keeping money out of the hands of the government is big business. While the bulk of the activity consists of legal tax avoidance, criminals employ the same methods.

The system protecting the ultrarich poisons America by increasing inequality. When 640 US billionaires possess more than $3.5 trillion combined—equivalent to the total wealth of all 50 million US Latino residents—economic opportunity and social mobility become constricted. From South Dakota to Washington, D.C., the Wealth Defense Industry and its clientele write the rules in their own interest rather than that of the public, with the Trump tax cut only the most recent example.

At its most virulent, the Wealth Defense Industry adheres to a libertarian ideology that taxation is theft and the common good does not exist. It is they, the wealth creators, who are the oppressed of society. This ideology is not new to America. In 1933, during the Great Depression, Congress called J.P. Morgan Jr. to testify. Morgan, no stranger to underhanded means, had paid no income tax in the previous two years. The master financier argued that it was up to the government to fix the loopholes, and until they did, he would employ them. Nearly eighty-five years later, Gary Cohn, President Trump’s chief economic adviser, told Senate Democrats that “only morons pay the estate tax,” presumably so the senators wouldn’t fret over raising the eligibility for who pays it. Cohn later clarified that the morons in question were “rich people with really bad tax planning.”

Brooke Harrington, a sociologist who spent a decade interviewing wealth managers, has concluded that about 25 percent subscribe to a deep-seated antitax libertarian ideology. Collins optimistically believes that some in the industry, perhaps sensing the direction of public opinion, are beginning to question the ethics of what they do. As for those who were born with a trust fund but believe it’s their duty to keep their inheritance out of the hands of a wasteful government, Collins points to the public amenities they enjoy: the roads, the Internet, the police, the rule of law. Their taxes support these common goods, but only if they pay them.