Iran renews calls for the deportation of Khavari

By Christine Duhaime | June 19th, 2016

The following are my personal thoughts on the Khavari situation and I offer them merely out a personal fascination, from a financial crime perspective, of this file in case what Iran alleges is accurate. I would have thought that any bank or firm would have declined to onboard him, or to have derisked him, but apparently not.

The requested deportation of Mahmoud Reza Khavari, a former Iranian foreign national, and a Canadian citizen living in Toronto, seems to be at the centre of the arrest of a Canadian professor from Montreal, Homa Hoodfar, also an Iranian foreign national and equally a Canadian citizen, who was visiting Iran.

Professor Hoodfar was arrested by the Revolutionary Guard in Tehran just before Norwuz and is alleged to be incarcerated in Evin prison in Northern Tehran. The Canadian government has sought her release from Iran. The government of Iran has countered with its renewed requests for the deportation of Khavari.

Khavari 

Some background on Mahmoud Reza Khavari. He was prosecuted in Tehran for participating in the embezzlement of US$2.6 billion from the Melli Bank, a state-owned bank in Iran (Washington Post). It is the largest bank theft in Iran and its largest money laundering case, although it was not prosecuted on the basis of money laundering.

Khavari fled Tehran and came to Canada. Prior to that, however, he was granted citizenship of Canada in circumstances that seem unclear since he appears to have been living full-time in Tehran running a state bank; meeting the residency requirements under the Immigration and Refugee Protection Act to earn the right to citizenship would have been quite challenging, to say the least.

Khavari purchased a mansion on the Bridal Path in Toronto, which is like having a mansion in Elahiel in Northern Tehran, only with a yard. The yards are so large and private on the Bridal Path that one family once secretly kept a thoroughbred horse there for many months.


According to court filings, Khavari is alleged to have told a Toronto friend that he has “vast financial resources”. It turns out that Khavari was actively investing in Toronto – he invested $14.2 million in the construction of two Toronto luxury condominium buildings (Financial Post) and he has interests over them (they are at 131 Hazelton Avenue, 195 Davenport Road and part of 145 Davenport Road in Toronto) (2011 ONSC 101)

Also according to those court filings, Khavari assumed the name “Khalili” when he moved to Canada to conceal his true identity.

The US$2.6 billion stolen from Iran was never recovered.

The government of Iran has sought the deportation of Khavari for many years from Canada without success; prosecutors in Tehran omitted to charge Khavari with money laundering in Iran, which would have accelerated his removal. While Iranian agents have visited Canada and physically searched for Khavari in Ontario, also without success, it now turns out that his address has been published in Court documents filed in Ontario in connection with a civil litigation in which he is embroiled (Financial Post). My guess is that he will be in Vancouver.

Iran has called the refusal of Canada to return Khavari to Iran as “one of the biggest hostilities of Canada towards Iran” (Fars News Agency), in part because allegedly Canadian officials misled Iran as to the whereabouts of Khavari, claiming that he was no longer living in Canada when he was in Toronto.

Anti-money laundering law & sanctions law 

Khavari was the Chairman of the Melli Bank, hence he and all his family members are foreign politically exposed persons, subject to anti-money laundering heightened due diligence that requires that the source of all their wealth be ascertained for legitimacy, when he opened bank accounts in Toronto.

Salaries in Iran are about 30% what they are in Canada, even for state officials, and therefore it would likely be very challenging for any bank in Canada to comply with its anti-money laundering compliance requirements for such a high profile politically exposed person such as Khavari, given his state employment income compared to his assets. More interesting, of course, is that Iran was subject to sanctions after 2010 which prohibited any bank or brokerage firm, in fact any person, from doing anything but freezing funds of Khavari that originated from Iran after 2010 unless it was approved by the Canadian government. To avoid sanctions, Iranians have typically moved their money  through Dubai, which Canadian banks know.  Obfuscating the original of money from Iran through banks in Dubai does not make the funds sanctions-free — it does the opposite, it makes them proceeds of crime, the predicate criminal offense being sanctions avoidance.

Dual citizens with dual passports

Back to Professor Hoodfar. The jurisdiction, as a matter of law, of the arrest of Professor Hoodfar is not as straight forward as it may seem to Canadians. All Canadian Iranians are Iranian citizens under the laws of Iran, and both countries allow them to have passports from both countries. However, Iran does not recognize dual residency and as long as an Iranian has not relinquished Iranian citizenship formally, in the eyes of Iran, they are Iranian.

Iranians often have two passports to facilitate their travel and often it is so that they can enter the United States as Canadians, without disclosing to US border agents the existence of their Iranian passports, and enter Iran as Iranians, without disclosing the existence of their Canadian passports to Iran’s border control agents. Professor Hoodfar likely entered Iran under her Iranian passport as an Iranian citizen, otherwise she would have needed to have applied for a visa to enter Iran from Dubai, which is unlikely. Khavari as well, although now a Canadian citizen, is still a citizen of Iran under the laws of Iran. Getting Professor Hoodfra back to Canada will not be as easy as it would be if she were just a Canadian citizen visiting Iran. In the eyes of Iran, she is an Iranian in Iran, not a Canadian in Iran.

The political situation between Canada and Iran became more complicated and tense because of the $13 million judgement against Iran awarded by a Toronto Court last week (National Post) for American plaintiffs.

What will Iran do? 

If I were to take an educated guess, I think Iran will act on this file, as follows:

(1) Iran will start discussing the case of Khavari internationally with other countries, the UN and such. At the end of the day, if the rule of law prevails, Canada has to return Khavari – he was prosecuted in Iran pursuant to their rule of law and is being sought in connection with the most serious financial crime possible involving a US$2.6 billion theft that materially harmed Iran and the integrity of its banking system – these are not minor issues for any country. Likewise, he will have to be removed from Canada pursuant to the rule of law;

(2) Iran will seek the deportation of Khavari to Tehran in exchange for the release of Professor Hoodfra;

(3) Iran will seek from Canada the payment of an amount of money equal to the Ontario court judgment of $13 million, either directly or indirectly;

(4) Iran may go after the assets of the Yorkville condo projects, the home and the bank accounts of Khavari and sue a number of parties to recover its US$2.6 billion. If nothing else, they may succeed on this action; and

(5) The failure to return Khavari to Iran will financially cost Canadian companies billions of dollars – one way or another, likely through lost trading opportunities with Iran – of that I am certain.

What will Canada do? 

On the part of Canada, if I were to take an educated guess, I think it will respond as follows:

But before I get to that, what will weigh on the mind of Canadian politicians in my view is this: (a) Canada does not want to face another situation like it did with China whereby it dragged its feet in deporting a money launderer back to Xiamen who fled to Vancouver, a decision that caused resentment among the people of Xiamen, as well as the Government of China because Canada harbored an international money launderer and which caused strained trade relations between the two countries, and cost Canadian businesses trade opportunities with China; (b) While Iranians love Canada and Canadians in Vancouver especially, the people of Iran, as well as its government, are not happy in respect of the Khavari file, and are unhappy to have been allegedly misled in respect of his whereabouts. If the claims against Khavari are true and if he brought proceeds of crime to Canada, then it means he is living a luxurious lifestyle in Toronto off the proceeds of crime that belong to the people of Iran, since it was a state bank. Iran has almost 4 million refugees that it supports – more than any other country in the world – that money could be used, if it belongs to Iran and was parked in Canada illegally, to support Iran’s growing refugee population and provide food, shelter and education to them – rhetorically, what are we doing holding onto it if its here when it does not belong here?; (c) if this file gets any more international media attention, unless there are salient facts that are known only to the Canadian government in respect of Khavari, there is no possible light under which Canada can look good on the Khavari file if the facts as alleged against him are accurate; (d) Canada does not want to be seen as negotiating Khavari for Hoodfra even though Iran seems to have suggested that is exactly how it will to play out; and (e) entering into negotiation requires that Canada inform Iran that it may be ten years before Khavari is removed if he appeals and therefore they may never get Khavari simply due to the length of time involved for due process unless Canada expedites the process or Iran does through anti-money laundering law. That will not go over so well in Iran because so many years have passed with delays that were unjustified (e.g., not caused by due process of law but rather appear to have been political).

So, what will Canada do?

(1) I suspect it will indeed move on the deportation of Khavari. In order to do that, I suspect it may scour through Khavari’s immigration application to see if it can find a material misrepresentation;

(2) Canada will require that Iran promise not to execute Khavari if he is returned;

(3) Canada will require, before it does anything at all, that Professor Hoodfar be released once the two countries have signed an agreement for an exchange of foreign nationals; and

(4) Canada wants to renew its relationship with Iran for trade purposes and is rebuilding its embassy in Tehran in preparation thereof and it will pay the government of Iran to re-establish relationships so that it can open a trading partnership with Iran.

My guess is that politically, Iran can and will wait this one out; Canada can’t and doesn’t want to wait this one out.

Knowing both how Canadians and Iranians think, my guess is that Professor Hoodfra is caught in the middle of a political situation between Canada and Iran over money – US$2.6 billion to be exact.

Politics is a game, sometimes a messy one, even when law is involved. The stakes are high on this one for both countries. Not only are the stakes high but Iranians are offended by the actions of Canada, which complicates the file and the resolution thereof.

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The CIA on terrorism and tech

By Christine Duhaime | June 18th, 2016

On June 16, 2016, the Director of the CIA testified before the Senate Select Committee on Intelligence in respect of the Islamic State (ISIS), terrorism and technology generally.

Here is an executive summary:

  • The CIA said there there has never been a time when there is such a “dizzying” array of national security issues and threats affecting countries;
  • The so-called “Twitter Terrorist” and terrorist propaganda phenomena poses an international security threat and such propaganda takes place mostly on Twitter, Tumblr and Telegram, working to inspire attacks by sympathizers globally to harm the West (to learn more, you can read our research here);
  • ISIS is still able to raise tens of billions of US$ per month in revenues;
  • Libya is now ISIS’ most developed and dangerous jurisdiction, followed by Egypt. The Libya branch of ISIS is actively planning attacks in the EU;
  • ISIS will be moving with groups of migrants and refugees to access the West;
  • The US financial system (its banks and financial institutions) are under serious threat of cybersecurity threats;
  • The rebuilding of Syria will take billions and billions of dollars;
  • The digital realm, including mobile and online activities, pose the most challenge to the CIA and other intelligence agencies. The CIA called digital challenges a “new frontier”, noting that the law has not kept up with those challenges; and
  • The Internet of Things (IoT),  where every type of electronic and mobile device will be connected to the Internet will create inherent security risks to the US.

With respect to national security solutions, the Director of the CIA said that the agency is (a) embracing diversity and ensuring that it has women in leadership in the intelligence community; (b) working with the EU over threats to terrorism and on the issue of social media propaganda promoting terrorism, and the movement of prospective terrorists to the EU; and (c) working with the tech private sector to advance the national security interests to ensure that the tech companies are aware of their responsibilities in respect of national securities issues and are cooperative.

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FinTechs are being derisked out of bank accounts over terrorist financing and money laundering risks says UK study

By Christine Duhaime | May 29th, 2016

The Financial Conduct Authority released an interesting soft study on the incidents of derisking affecting companies in the UK and pursuant to the study, MSB, charities and FinTechs are the three business client groups whose bank accounts are most frequently closed because they are too risky for the bank (a practice known as derisking). No business, least of all a FinTech, can survive for very long without a bank account.

By way of background, banks are required by complicated anti-money laundering, counter-terrorist financing and sanctions laws to implement robust legal compliance programs that include, inter alia, the appointment of an experienced compliance officer, the undertaking of a geographically tailored risk assessment, regular company wide training, and a reporting regime for suspicious transactions tied to enumerated predicate offenses under national criminal law statutes, tax statutes, terrorism statutes, UN Conventions, sanctions statutes, and anti-corruption statues, and the reporting of certain transactions. The requirements are based on national laws and vary by country.

The costs of compliance for any reporting entity is at least $1 million per year, regardless of the size of the entity. Across the board, reporting entities in most countries agree that that is the baseline cost and it goes up based on the size of the financial institution. Large banks have compliance costs in the tens of millions of dollars per year. The costs is the same, in terms of a baseline amount because all reporting entities regardless of size have similar basis requirements that are costly to implement.

Diving into the minutia of costs, banks in the survey disclosed that it costs them annually between $4,200 to $6,400 (converted to CDN) per account holder to meet its AML / CTF complete compliance obligations. Those costs are not being passed onto the actual bank clients but rather are absorbed by the banks as part of its costs of operations. A FinTech paying $4,200 to $6,400 per month for the actual costs of compliance would have to raise money to match the actual costs of doing business. Based on many financing documents in the FinTech space, a number of FinTechs pay large monthly management fees to their insiders and next to nothing for legal compliance. That makes the FinTech risky for any bank or investor.

The AML / CTF requirements are similar across all reporting sectors, whether the reporting entity is a casino, a bank, a stock broker, a realtor or an MSB or a FinTech that is a reporting entity, and the costs incurred by each group should also be the same to comply with AML / CTF law. But its not. Typically only land based casinos, some investment firms and banks tend to implement the full suite of AML / CTF legal requirements. The rest of the sectors of reporting entities do not.

And so the derisking problem is this; all companies (including charities, MSBs and FinTechs), have to have banking relationships and bank accounts for their business and to complete financial transactions on behalf of their customers. The banks who provide those banking services are on the hook for AML / CTF compliance failures for banking the little players and therefore carry the risk of the banking relationship. The risk is a regulatory risk,  a civil liability risk and a risk of criminal liability for AML / CTF failures, not only of the bank but also of its officers and directors. As noted in the study, banks also have a real concern with the media backlash and reputation damage to them if  it were to emerge that banks participated in banking a FinTech that was involved in a financial crime scandal, or funded a terrorist organization inadvertently by not being familiar with well-known typologies.

FinTechs that onboard customers and conduct financial transactions do not spend $4k – $6k per customer per year, like banks do, in AML / CTF compliance costs. For banks, that means that the bank now has a double compliance burden of being concerned with its own compliance and the compliance of the FinTech and thus its costs escalate.

In the banking relationship, FinTechs are essentially asking banks to trust that the FinTech management will be legally compliant in respect of AML / CTF. Banks are saying: “No, show us on paper that you know what AML / CTF involves so that we have comfort that your FinTech is not a risk to us.” AML / CTF compliance lawyers working at banks are not willing to lose their job, pay a huge fine or be prosecuted for a FinTech’s AML / CTF failures.

Every bank does a risk assessment of a FinTech, which they will never share with you if you’re a FinTech but you can rest assured that if you are derisked, its because your startup, your management team, or your control systems (or lack thereof) were deemed too risky to the bank. Sometimes its not the FinTech that is risky but its the people behind a FinTech financing that are of concern to a bank, such as unlicensed individuals who raise money for startups who have been investigated by securities commissions for taking financing fees off the books. Banks are also adverse to banking FinTechs that have ties to jurisdictions associated with offshore gambling operations that operate in some countries illegally.

FinTechs that do not know AML / CTF law or who know it but fail to comply because they costs are prohibitive for a startup or because they prefer to use their financing funds for other purposes, are too risky for a bank to bank and consequently they are derisked and their bank accounts are terminated.

I’ve heard from a number of chiefs of innovation at the world’s largest banks in the leading FinTech cities that FinTechs often approach them to partner or for investment without having spent time understanding the legal environment in which banks operate, and often they have already developed sophisticated tech that may be amazing but which a bank could never use because it would not mesh with the law. A FinTech that invests in tech but not the legal requirements for applying that tech is risky to a bank and signals that its house is not in order.

Many FinTechs operate with contracts in place with banks whereby, if they are partnering with a bank, the AML / CTF obligations remain with the banks, rather than the FinTechs. Others have no contracts in place and the banks in those partnerships have decided that since FinTechs are not registered as reporting entities, or registrable with the FIU, AML / CTF laws are suspended in respect of those transactions (although that is not the law). Many other FinTechs and banks are struggling to carve out the obligations in respect of AML / CTF to ensure that responsibilities and liabilities are clearly defined and that the risks are borne by one of the parties for AML / CTF failures.

In addition to contractual risk allocations, the solutions may be to pass on the actual costs of compliance to each business customer so that banks quit derisking and the FinTech carries the true costs – a move supported by the UK government in the study; and to have a regulatory sandbox to allow FinTechs to innovate in a controlled bubble where there is no potential harm to the financial system by their failures to comply with AML / CTF law because their financial transactions are limited in volume and transactional number, and subject to different oversight.

You can read the report here.

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The $200 million a year refugee smuggling operation in Libya

By Christine Duhaime | May 27th, 2016

A $200 million a year business and growing 

The EU – Turkey deal to close the borders of the EU to refugees and migrants has shifted the human smuggling routes back to Libya. The focus back to Libya means ISIS’ large source of terrorist financing from this activity is flowing again, which may also facilitate ISIS moving their own people to the EU.

It is a concern for terrorist financing because ISIS is a transnational criminal organization (“TCO“)  operating in a growing number of places in the world with sophisticated unknown networks that move money, people, drugs and weapons. Those activities fill ISIS’ treasury, especially outside of Syria, allowing them to fund more acts of terrorism and expand their sphere of influence and correspondingly, inject vast sums through the financial system as proceeds of crime.

Large profits made by money laundering smugglers

Here are the financial numbers on the amount of terrorist financing and money laundering earned from the Libyan human smuggling operations:

  • 2015 – Revenues conservatively may be as high as $528,000,000 (derived from 330,000  migrants who apparently arrived in the EU from Libya and who paid, at the lowest end, $1,600 each for the trip. It does not include those who died and paid a fee regardless).
  • 2016 – Revenues year-to-date are likely $59,200,000 (derived from the rate of $1,600 with an estimated 37,000 migrants who have arrived from Libya to EU directly so far in 2016, not including the thousands who died or were arrested en route but paid for the journey).
  • May 2016 – Revenues for May alone are $17,600,000 ($1,600 per migrant  with 11,000 migrants who arrived in EU from Libya this month). If the trend continues, the amount may be as high as $210,000,000 for 2016.
  • Two Libyan men, Medhanie Yehdego Mered and Ermias Ghermay, with alleged ties to ISIS, and who are part of a large TCO, are said to be behind much of the early human smuggling operations in Libya and earned a total of $2,000,000,000 from human smuggling of migrants.

Europol estimates that the human smuggling of refugees and migrants to the EU is netted traffickers between $1,000,000,000 to $6,000,000,000 last year from all areas, not just Libya, and the payments surprising, come from relatives in the West, such as the US, who pay even though they know the payments are for terrorists or those affiliated with terrorist organizations and that the payments are for illegal human smuggling. This means, of course, that banks in the West are being used to send funds for the illegal human smuggling of refugees and migrants that may fund terrorism.

According to reports, Eritreans pay $5,400 to be trafficked, not $1,600 applicable to other migrants, an amount that is 8 times the average annual income of an Eritrean, suggesting that funds are indeed coming from the West to move them to the EU with TCOs.

The unfortunate Canadian connection

One of the Libyan smugglers who is said to allegedly have ties to terrorists, Medhanie Yehdego Mered, aka Mered Medhanie, also known as “The General”, may operate in Canada as well. He was recorded on a wire tap saying he would invest $170,000 in Canada – part of the proceeds of crime from trafficking migrants from Libya to the EU. He also is heard on wiretap saying that $7,800 is the price to smuggle a person into Canada illegally using fake passports from the US or Italy (see Globe & Mail article here).

In order to be investing in Canada, he would need a bank account, a lawyer, a securities broker or realtor. The other, Ermias Ghermay, also has a Canadian connection – one of his operatives told Italian police that they arrange for people to be smuggled into Mexico and Canada with fake Italian passports. The operative of Ghermay also claimed to have smuggled himself into Canada. A third Libyan smuggler is recorded as saying that it’s easier to get into Canada illegally than the US.

Mered is believed to be the kingpin smuggler who arranged for the boat that sank near the Italian island of Lampedusa in October 2013 in which 359 migrants died when the boat capsized and laughed about their deaths when he learned of it.

He allegedly parked his wife in Sweden as a fake refugee, with some of his proceeds of crime.

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Google’s office raided in alleged money laundering probe

By Christine Duhaime | May 25th, 2016

The Paris office of Google was raided today, as part of an investigation over allegations that Google was engaged in tax evasion, which because it is a predicate offense, also means that the investigation involves money laundering (that the purported proceeds of crime from the alleged tax evasion and fiscal fraud were then put through the financial system and used for other purposes).

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A banker’s update on terrorist financing and money laundering from the US Committee on Homeland Security

By Christine Duhaime | May 23rd, 2016

Summary of the Updates

The US House Committee on Homeland Security released a number of updates and received testimony on the status of terrorist financing, terrorism and money laundering in the last few weeks with some interesting developments relevant to banks in terms of changes in terrorist financing typologies that should be added to anti-money laundering and counter-terrorist financing risk assessments, wherever banks are situated, since the new information is globally relevant.

The updates and testimony before the Committee, if all accurate, mean that:

  1. Antiquities collectors in New York City are essentially engaged in the financing of terrorism (of ISIS specifically) and money laundering by virtue of the fact that they are buying antiquities stolen from Syria and Iraq that are trafficked by ISIS to New York. The proceeds of crime seem to involve collectors, auction houses, brokers, importers, agents of ISIS and ISIS itself. The plunder and trafficking of antiquities by ISIS is such a highly visible news item that collectors can’t possibly not know that the proceeds of crime from these antiquities purchases are used to finance ISIS.
  2. People in the West are essentially engaged in the financing of terrorism (of Al Nusra specifically) and money laundering by virtue of the fact that they are paying $40,000 to surgeons in Egypt, with a large and increasing portion of the proceeds of crime being paid to Al Nusra, for illegal kidney transplants using kidneys harvested from destitute Syrian refugees, who are paid no more than $2,000 for a kidney, often much less.
  3. Al Qaeda has $100 million chilling in bank accounts in Yemen.
  4. Syrians with terrorist connections, or who are terrorists, have attempted to enter the US through its immigration program, claiming to be Syrian refugees.

1. Terrorists have posed as fake Syrian refugees to attempt to enter US

According to the Committee’s latest assessment:

  • Terrorists have attempted to gain access to the US under its immigration program posing as fake Syrian refugees.
  • US law enforcement and intelligence officials lack the ability to vet and screen whether immigration applicants claiming to be Syrian refugees are real refugees or members, or former members, of a terrorist group in Syria (my note - no country has this capability because the Syrian government is not effectively operational – there is nothing to vet or screen against that is reliable in Syria).
  • Banks continue to onboard terrorist organizations and to provide banking services to them. For example, al Qaeda in Yemen has $100 million deposited in banks in Yemen at its disposal.
  • There are over 1,000 defectors to ISIS from the EU who have returned to the UK, France, Germany and Belgium. It is unclear whether they are incarcerated or have been charged, or are in the EU anonymously.
  • ISIS now has 8 official branches in other countries and there are 24 countries with active ISIS members engaged in terrorist financing including Philiipines, Pakistan, Russia, Yemen, Nigeria, Tunisia, Jordan, Libya, Indonesia, Bangaldesh, Algeria, Egypt, India and the Sudan.
  • ISIS controls 60 miles of the border with Turkey (my note - a concern for money transfers in the border towns of Turkey for terrorist financing) and its numbers in Libya doubled in the last year.

2. Looted antiquities from Syria and Iraq that finance ISIS are sold in New York

The illegal sale of stolen antiquities from Syria and Iraq for terrorist financing continues.

Based on documents obtained from the US Delta Force raid on ISIS’ financiers Abu Sayyaf (now dead) and his wife Umm Sayyaf  (in Iraq awaiting prosecution for, inter alia, her role as a human trafficker for ISIS for her role selling Yazidi children as sex slaves) in March 2015, it was learned that ISIS has a separate ‘Ministry’ to manage the looting and for the sale of antiquities illegally removed from Syria and Iraq. ISIS makes $5 million per year in the sales of antiquities to agents in Lebanon and Turkey, who then sell to individuals, art galleries and auction houses mostly in the US. The US is now the largest importer of stolen antiquities from Syria and Iraq trafficked by ISIS as a method of terrorist financing to western collectors. While regular trade with Syria has diminished with the US, imports of Syrian antiquities have apparently skyrocketed, all of it apparently coming into the US through the Port of New York.

In early May, according to testimony heard by the Committee, over $400 million was sold in antiquities during a New York antiquities festival called “Asia Week” and while there were hundreds of raids by law enforcement, only one person was prosecuted. The Committee noted that it would look at a dialogue with the Department of Justice and the FBI to revisit the issue, presumably, based on the Committee Q&A, with a view to looking at the banking transactions underlying the illegal sales  of stolen antiquities from war-torn Syria and Iraq and seeing whether banks are reporting the requisite suspicious and terrorist financing transactions, and following the money trail.

My note – the sale of looted antiquities from Syria and Iraq is low hanging fruit when it comes to identifying members of ISIS in charge of this aspect of their trade and identifying the foreign bank accounts and beneficial ownership structures used by ISIS. If there is an area where ISIS is financially vulnerable in terms of detection, this is it because this is one area where ISIS has to use bank accounts for international trade and commerce. It is also low hanging fruit for regulators to identify banks that may be non-compliant in the area of counter-terrorist financing in trade-based money laundering and terrorist financing on two fronts –  banks that bank terrorists and bank collectors buying stolen antiquities. These purchases are out-of-pattern, both by merchant code and dollar amount, and should be detectable in a nano-second by an AI system in a bank or charge card company monitored by the bank’s AML / CTF lawyers.

3. People in the West are paying terrorists indirectly to buy human organs harvested from refugees

A new way of terrorist financing involving refugees is by the sale of human organs.

According to testimony before the Committee, agents in Turkey work in refugee settlements to locate refugees willing to sell their kidneys. Once a refugee agrees to sell a kidney, the refugee is transported to Egypt for the operation and is then paid, and subsequently uses the money to pay human smugglers to travel to Europe. The refugee is paid about $2,000, often less. The price paid by the patient is $40,000. According to this news report, over 18,000 Syrian refugees have sold their organs. This practice is not new.

What is new, according to testimony before the Committee, is that Al Nusra uses the organ transplants as a form of terrorist financing. People from the West pay Al Nusra $40,000 to buy a kidney from Syrian refugees through travel agencies by depositing money directly into the bank accounts apparently accessible by Al Nusra in Europe, thereby avoiding the wiring of funds to terrorists which could be detected. Western organ buyers use medical travel agents because the doctors performing the operations in Egypt have the arrangements brokered through those travel agencies. It’s not clear how the doctors and hospitals are paid – presumably by Al Nusra.

My note – some of the testimony on the trafficking of refugee organs was odd. The expert testifying before the Committee did not identify the concerns as being the trafficking of human organs of refugees or terrorist financing but rather the concern was articulated as one that arose because “Al Nusra is intimidating the doctors who have traditionally performed the trade and are taking many of the profits out of this trade”. Honestly, does anyone care if the doctors performing such operations are earning less profit? Would anyone care if the mafia earned less profit from an illegal activity except the mafia? What we care about is that people from the West are financing terrorism by human organ transplants involving destitute refugees and that the practice is morally repugnant, illegal and unethical in those circumstances. We also care about the human rights violations and upholding the rule of law.

I suspect that the testimony in respect of Al Nusra receiving payments directly from organ buyers through travel agents is, with respect, incorrect – it is more likely that the doctors and hospitals are the ones who are paid in the EU from travel agents and that they in turn, pay Al Nusra in Egypt. It is terrorist financing either way, one more direct than the other, but in terms of banking risks, the points of entry to be cognizant of are wires from the EU and Dubai to Egyptian medical facilities in the range of $30,000 to $50,000 since they are high risk for terrorist financing of Al Nusra and involve, in addition to terrorist financing, money laundering, the predicate offense being the illegal trafficking of human organs.

4. Transnational Criminal Organizations & Beneficial Ownership

The Committee heard testimony from a sociologist that in Franco Europe (France, Belgium), law enforcement and intelligence agencies do not appreciate the connection between terrorist financing and transnational criminal organizations and apparently cannot “connect the dots.”

My note – With respect, I doubt the above statement is accurate, but nonetheless the testimony was that although we know that TCOs operate with terrorist groups, in Europe law enforcement and intelligence agencies seem to have missed that point. The reason I doubt this is accurate is because Europol has, for many years, been looking at that exact issue and published material on point. It is indeed well-known in counter-terrorism law that terrorist groups are closely aligned with, and often are, TCOs in their own right. For example, at the end of this article, the head of Frontex talks about this issue.

Much of TCO transactions are conducted through beneficial ownership structures. A large global concern at the moment is in respect of beneficial ownership but that concern is all geared towards identifying tax evaders and none of it directed towards terrorist financing.

Part of the testimony before the Committee, however, was tied to beneficial ownership. The testimony was that illicit trade, including trade conducted by terrorists, is “supported by banks, by law firms and by professional services firms (accountants)” in places such as the US who help mask it through contracts as “high level facilitators”.

Smuggling from Libya

The testimony before the Committee was interesting but was lacking the most critical security threat at the moment — the human smuggling operations from Libya by TCOs affiliated with ISIS, who are engaging in large volumes of terrorist financing and money laundering (more here), who will unfortunately manage to smuggle more terrorists into the West.

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“Responsible Innovation” – What the coming regulation of FinTech will look like

By Christine Duhaime | May 15th, 2016

Financial regulators balance innovation and protection

Financial regulators serve two important functions for the financial system. 1. They support growth and innovation where it could improve access to finance, or the delivery of financial services or grow the economy. 2. At the same time,  they  protect consumers and society at large by supervising the financial services sector actors to ensure that the financial system is sound, risks are identified and mitigated, consumers are protected and financial crime is mitigated. The balancing act requires regulators to take a well-considered approach.

How US, UK and Canada rank in balancing regulation and FinTech

Generally speaking, the US does the best job at balancing these two interests, managing to lead the world both in financial innovation and in the regulation and enforcement of financial crime. The UK is quite strong in both, having recently agreed to adopt the sandbox model invented by Kosta Peric of the Gates Foundation.

The Etherium case

People say that Canada may have a way to go in balancing regulation with innovation but the jury is out. The most prominent example of an unbalanced approach that was likely unintended, is of Etherium, a Canadian Blockchain startup driven by Canadian tech brains which relocated to Switzerland when Canada announced it was implementing the world’s first law to regulate digital currency transactions. Canada was once (in 2013 and 2014), the global leader in Blockchain, now the hottest area of FinTech but no longer, as a result of it being unable to balance the promise of leading in global innovation in FinTech with what it perceived, under a previous government, as an imminent threat to international security from the Blockchain being used to transact with Bitcoin. Canada still has that law on the books but decided not to bring it into force and consequently is viewed as a jurisdiction where there is uncertainty among global investors in respect of FinTech. Sometimes a decision that may seem prudent at the time, tips the scale too much in one direction with unintended and unanticipated consequences.

Bank jobs will be lost with FinTech; different jobs will be gained

We know in the FinTech world that financial services will be delivered almost entirely on a mobile phone in a few short years and while that will substantially drive up the costs for banking in terms of investment in tech, innovation, AI and data centers, it correspondingly will drive down the larger costs of maintaining physical branches, tellers and back office employees. Moreover, banks have hundreds, sometimes thousands of compliance personnel whose jobs will be rendered redundant as banking becomes mobile, saving banks hundreds of millions of dollars per year in compliance personnel. So while innovation will cause mass unemployment  in the financial services sector, it will correspondingly create new employment in FinTech. Wall Street and Bay Street will disappear as we currently know them as financial centers (it will be too expensive to maintain bank towers for tech and AI) but tech centers will pop up all over as banking undergoes fundamental shifts.

Many developed countries have national FinTech strategies (Canada is an anomaly in not having one) to ensure that the tech and AI shifts affecting financial services result in startups being created in, and remaining in, their jurisdictions so that they develop FinTech for export as opposed to being consumers of the tech. With respect to Canada, it is already, for the most part, a consumer of FinTech at the large financial institutional level with banks investing in FinTech expertise in the US, Singapore and UK , and more marginally in Canada. R3CEV, a US based company, is an example of foreign FinTech being invested in by Canadian banks. Ironically, some of R3CEV’s techs are Canadian, despite being in New York.

Some promises and perils

To weigh innovation and regulation, financial regulators look at the promises and the perils of FinTech.

Some of the promises of FinTech are that it will drive down the overall costs of operating a bank and of providing services to consumers, while increasing access to financial services across a broader sector, and potentially solving the growing problem of financial inclusion for small businesses and individuals all around the world. It also promises to make banking more efficient and reduce customer friction.

Some of the perils of FinTech that are of concern to financial regulators will be obvious things like consumer protection and misrepresentations to investors of FinTech startups and of the services they offer and of less obvious things like if analytics and GPS locating are used to exclude people from financial services. For example, an online lender or online bank may make decisions based on demographics or geo-locations to exclude more impoverished sectors of the population.

Another peril is with respect to financial crime mitigation. FinTechs that are front facing, or customer-facing have anti-money laundering and counter-terrorist financing obligations governed by contracts with deposit-taking institutions, rather than imposed as a matter of law. Because they are not directly regulated by prudential regulators or subject to FIU audits, compliance is spotty, non-existent or not uniform. Terrorist financing has occurred through FinTechs, some deliberately and some by accident.

There are also privacy law, consumer protection, securities law and prudential concerns with FinTechs in the sense that most FinTechs plow ahead without considering what is required, legally speaking, to provide financial services in a regulated environment. Global banks in the UK routinely say that they are frequently pitched to by FinTechs who have developed great tech but the tech is completely useless to financial institutions because it does not comport with the law and is built on wrong assumptions on the law, or without considering, legal requirements of financial institutions.

AML & CTF law is rocket science

The anti-money laundering regime is particularly problematic with FinTechs, and often raised by global banks as an area where FinTechs are venturing without background knowledge or legal expertise to understand the regulatory landscape.

While analytics and AI can be used to improve processes for anti-money laundering law and counter-terrorist financing legal compliance, and undoubtedly will in time, we are facing a tech and knowledge gap in the sense that there is no existing technology that can deliver counter-terrorist financing or anti-money laundering legal compliance at any standard or level that is acceptable to a responsible regulator, or that any financial crime lawyer could sign off on.

I enormously respect FinTech startups and the work they do, but the truth is that FinTechs are just not there yet in this space and the jury is out among counter-terrorist financing and anti-money laundering professionals as to whether a FinTech could ever get there. One needs only to ask a FinTech in this space to describe how their systems deal with legal versus beneficial ownership at on-boarding; how their systems detect a politically exposed person from Vietnam, Austria, Russia, Brunei, or any other country; or to identify which terrorists lists they are using for their warning system. Most can’t have that conversation because anti-money laundering and counter-terrorist financing law is rocket science.

A financial institution using a system created without expertise in anti-money laundering and counter-terrorist financing detection, mitigation, reporting or terrorist property asset freezing, poses a security risk to everybody.

Bar associations may move into FinTech & LawTech regulation

It is likely that other regulators will emerge as well to have their say on the debate on innovation versus regulation and I suspect it will be the law societies and bar associations, especially on financial crime and increasingly on LawTech.

By law, only lawyers are permitted by state, federal and provincial legislation, to practice law, give legal advice or provide legal services, including in anti-money laundering and counter-terrorist financing law, even if it involves just the provision of tech for legal solutions.

A law firm owned by a lawyer licensed to provide services to the public (ergo, not one in-house) can create and sell tech that provides legal solutions such as compliance or legal forms, or auto-divorces, let’s say, but not a startup that is not owned by a licensed lawyer. FinTechs need to be cognizant of where they can go, and cannot go, in tech that is legal. The same is true for accounting services. FinTechs need to be careful to not be providing services that are accounting in nature.

LegalZoom, a tech company that sold online legal solutions and was not a licensed law firm, was required to hire lawyers to vet and approve all of its legal solutions in order to avoid protracted litigation over allegations that it was engaged in the unauthorized practice of law. A few months ago, LegalZoom, bought a law firm to acquire a license to sell legal solutions to the public without running into issues of the unauthorized practice of law. In time, we are likely to see more tech companies buying law firms in order to enter into the field of anti-money laundering and counter-terrorist financing legal tech compliance to avoid being sued by bar associations.

The direction financial regulators are likely headed in a few years on the financial crime front is to require that anti-money laundering law and counter-terrorist financing systems be tested and licensed to preserve the integrity of the financial system in the same was as we require gambling systems to be tested and licensed to preserve the integrity of gambling. A financial crime system that is tested and licensed balances innovation with regulation.

New era of  ”responsible innovation”

Generally, we are heading into an interesting phase with FinTech. Financial regulator have taken a fairly hands off approach with FinTechs around the world, allowing them to grow to support innovation but there are signs that that is about to change. The mood seems to be swinging towards light regulation with a sandbox and in some cases, heavy regulation. The SEC is now looking at P2P lending and other FinTechs from the perspective of whether or not the disclosures to consumer are adequate and to investors.

The new buzz word for FinTech from regulators will be “responsible innovation” and that will mean that FinTechs will be regulated on a sliding scale depending upon the services rendered to the public and the risks involved.

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US amends anti-money laundering law for beneficial ownership after Panama Papers, including to detect purchases of expensive real estate with illicit money

By Christine Duhaime | May 8th, 2016

Panama Papers Driven Changes

The US Treasury has announced several amendments, and proposed legislative amendments, to its anti-money laundering (“AML“) legislation in the wake of the Panama Papers scandal to tackle the disclosure of what is called “beneficial ownership.” Beneficial ownership means the beneficial, as opposed to the legal, owner of shares of a private company, foundation, trust or similar organization. A beneficial owner is one who actually owns or controls shares of a private company and who may or may not also be the legal owner. The legal owners of shares is the person who legally holds them.

The US announcement tackles three areas: (a) enhanced customer due diligence (“CDD“) requirements; (b) proposed beneficial ownership laws; and (c) new reporting obligations for expensive real estate purchases to detect money laundering.

1. Customer Due Diligence Laws

Under the CDD requirements, banks, brokers and securities dealers will have to collect and verify the personal information of the beneficial owners of private companies when they open bank or other accounts.  In parallel, the Bank Secrecy Act (“BSA“) regulations will be amended in respect of CDD for beneficial ownership at 25% or above, and for those shareholders who control the company irrespective obviously of the percentage of shareholdings.

With respect to the BSA aspect, financial institutions will be required to: (1) identify and verify the identity of the beneficial shareholders of private companies opening accounts; (2) understand the customer relationships and create risk profiles; and (3) monitor, on an ongoing basis, customer transactions for the purposes of reporting suspicious transactions.  The purpose of the CDD rule is to collect more information on international financial transactions for sharing with law enforcement and ties into the global FATCA regime that requires reporting to the IRA from most countries in the world by over 200,000 banks.

2. Beneficial Ownership Laws

The US will also be adopting new beneficial ownership legislation that is triggered at the time of incorporation of a private entity. The law would require that companies, as opposed to lawyers or corporate registries, retain records of their beneficial owners, file it with the US Treasury and make it available to law enforcement.

Interestingly, the proposed legislation authorizes the government to require every US entity to report beneficial ownership in respect of itself or others and therefore extends way beyond normal reporting entities captured under the BSA. The change is quite sweeping because a US entity is defined to include any company registered in the US and that uses the US postal service, wire services (essentially any Internet) or any facility (a venue, an office, a garage, a home) for interstate or foreign commerce for business.

As a result, every single business that is qualified, registered, organized or created in the US is going to be required to, as a matter of practice, become a reporting entity in the anti-money laundering legal sense for beneficial ownership purposes, including any foreign company, such as a Canadian company.

There may be an exemption for foreign entities that are not created or registered in the US and conduct business there but that is doubtful because they may be caught by being “qualified” even though not registered in the US and also because it would otherwise not do much to capture information in respect of tracking the movement of proceeds of crime using beneficial ownership structures if it just applied to registered corporate entities operating in the US. The sole distinction here is between foreign entities doing business in the US that do so under registered companies in the US versus those that do business in the US without registering companies.

3. Reporting of Expensive Real Estate Purchases (mostly from China) to Detect Money Laundering

The proposed law also contains  amendments to existing orders to clarify the authority of FinCEN to collect information on all cash purchases of mansions and high-value homes. The amendments are designed to allow the US government to  look at vulnerabilities in the real estate sector to detect money laundering.

The US is leading in the crack-down against proceeds of corruption being used for the purchase of mansions as a matter of financial crime by requiring real estate transactions of a high value in New York and Miami be reported to FinCEN. A similar strategy could be adopted in Vancouver by FINTRAC to curb a similarly troubling trend of the purchase of real estate with proceeds of foreign corruption but no action has been taken to adopt such a strategy, and there are no plans to implement such requirements in Canada.

AML Law & Compliance Just Changed Forever

Banks, brokers, service providers and AML personnel should make no mistake about it – the beneficial ownership amendments in the US will change the practice of AML law as we know it. That is because beneficial ownership is complex and requires an understanding of beneficial and legal share structures and ownership, which requires an understanding of corporate law, M&A law, corporate financing and AML law. Beneficial ownership law in the US also includes not just beneficial ownership of shares of private entities but also the disclosure of the control persons behind private company, irrespective of the titles such persons hold, mirroring securities law concepts. The obligations are not simply in respect of collection but of verification. Moreover, the tolerance of the US for breaches in respect of beneficial ownership henceforth will be about nil. By virtue of the correspondent banking regime, that means that every bank wherever situated, even a Canadian one, will be bound by the US beneficial ownership AML laws (and in addition to FATCA requirements) and will have to become knowledgeable in respect of beneficial ownership requirements.

Beneficial Ownership in the Bangladesh Bank Case & Terrorist Financing 

There is growing concern about beneficial ownership and the failures of financial institutions in the past ten years in respect of its compliance under anti-money laundering laws. And not just as a result of the Panama Papers. The Bangladesh Bank fiasco in which $80 million was successfully fraudulently wired from the Bangladesh Bank before anti-money laundering specialists suspended further wires, is another example of beneficial ownership deliberately used by money launderers and transnational criminal organizations to move and receive proceeds of crime anonymously.

Beneficial ownership is known among organized crime as an area in which there is little compliance among financial institutions, regulators or bank supervisors, and thus organized crime tends to use private companies to launder funds to avoid or reduce anti-money laundering requirements internationally. In the Bangladesh Bank case, organized crime set up a foundation as the purported banking client to receive the wired funds. The $80 million was eventually washed through casinos in the Philippines. Terrorist organizations also use beneficial ownership structures for the same purpose, namely to move money without detection of the true senders or receivers of the funds. The anonymous nature of beneficial ownership structures are appealing to terrorist organization and very dangerous for international security.

I sometimes hear financial institutions say they believe they are well-versed in beneficial ownership  by virtue of the fact that they engage third parties to on-board corporate clients or by virtue of enhanced training of their tellers at physical bank branches. None of these actions improve beneficial ownership detection skills. The only way to ascertain and then verify beneficial ownership is to look at a Minute Book of a private company and in some cases, their debt financing records if they are financed. No third party service provider that offers online on-boarding of corporate clients can meet the anti-money laundering legal requirements for beneficial ownership. I sometimes also hear that financial institutions do something called self-disclosure wherein they ask corporate clients to self-disclose beneficial ownership in a form. In terms of the law, this is not a method that is legally compliant because it does not meet the obligation to either ascertain or verify beneficial ownership information.

Beneficial Ownership Transactions that Obfuscate Share Ownership are Anonymous

A transaction involving beneficial ownership that is obfuscated is identical to, and carries precisely the same risks as, an anonymous transaction.

Some large banks help create beneficial ownership structures that obfuscate share ownership as part of their business model. Those banks have set up companies in offshore jurisdictions that act as the directors and officers of private companies that are controlled by people who do not want to be detected. The way it works is that such a bank will have a company that provides just director services for private companies, or just secretarial services for private companies in places like the BVI or Jersey. When law enforcement attempts to determine who is behind offshore companies or trusts, instead of being able to make that determination and elicit the name of the true controller of a private company, they find out that it is a well-known bank subsidiary that is holding two or more directorship positions of the private company and acting as its secretary, all for hefty monthly fees. Usually law firms in offshore jurisdictions have assisted in the creation of these bank owned little companies that provide such services and in the ultimate beneficial ownership structures offshore of the persons who do not wish detection. Neither FIUs, regulators or bank supervisors have made attempts to address this activity to date.

And yes, it is inconsistent with financial crime mitigation that a financial institution is engaged in the creation of beneficial ownership, as a business line, to obfuscate share holders of private entities when they have duties under anti-money laundering law to be seeking out, recording and reporting that very activity.

Artificial Intelligence R& D and Investment in AML Functions May Grind to a Halt

The legislative changes in the US will  impact FinTech and artificial intelligence being experimented with in the AML compliance function. AI R&D may grind to a halt for AML mitigation and detection because the requirement for verification means that human intervention will still be required to look beyond the legal owners in corporate documents to verify beneficial owners of shares.

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The Anti-Money Laundering Lawyer’s Primer on Beneficial Ownership and Numbered, Shelf and Shell Companies

By Christine Duhaime | April 24th, 2016

Beneficial ownership … Shell companies … Shelf companies … What’s the Difference? 

Since the Panama Papers, there seems to be an increasing interest in, and a corresponding mis-understanding of the concepts of beneficial ownership, numbered companies, shell companies and shelf companies.

Most lawyers who have done large M&A deals, including me, have created for clients, shelf, shell and numbered companies and have created beneficial ownership structures. In my case, it was for legal purposes. Here is our primer on what these terms mean.

1. Shelf Companies – one that literally “sits on a shelf”

A shelf company literally means a company sitting “on a shelf.”

This is an area that few people know much about. That is because lawyers are the creators, holders and protectors – in essence the gatekeepers – of shelf companies.

The way it works is this – lawyers incorporate private companies in which the law firm typically is the incorporator (the first shareholder holding one share). The company undertakes no business activity and the Minute Book for that company sits on a shelf for a number of years, sometimes ten years, like a bottle of wine aging and increasing in value. Eventually, the law firm will have a client who needs or desires a pre-existing company and it will sell to the client, one of its shelf companies. Law firms often have many shelf companies. On the rare occasion, a person will create their own shelf company but very rarely. Once a shelf company is sold, it ceases to be a shelf company.

In case you did not know, most law firms that practice business law have a Corporate Records Department, which is like a library with the Minute Books for every company the law firm represents or acts as the Records and Registered Office (the “Library“). The Library has another important collection of books – those are deal books, sometimes called closing books, that have every single piece of paper signed in respect of a financing or M&A transaction involving any of the companies for which the law firm holds a Minute Book. The closing books are material in respect of beneficial ownership, described below, because they often contain the documents evidencing beneficial ownership.

Shelf companies are created solely for the purpose of selling those companies at a later date for large sums of money. While a person could incorporate a new company, often a person will want a pre-existing company to demonstrate corporate longevity. The so-called longevity is a fiction because a shelf company may be 10 years old but in terms of business activity, it has not even been born yet.

Why would a person want corporate longevity? There are negative and positive reasons. The positive reason is that more money can be raised for a shelf than a non-shelf company because of its fictional longevity.

I’ll let you guess what the negative reasons are.

Specifically in respect of financial crime, this is an area of significant concern that is never looked at by the FATF, FIUs, banks or regulators because they tend not to have expertise in respect of corporate financing or M&A law to be familiar with what shelf companies are, how they are used, and why and by whom. Moreover, they often confuse shelf with shell companies.

Unfortunately, transnational criminal organizations, including those from the Middle East that are engaged in terrorist financing, have been known to use shelf companies. I’m sure you can guess why. The good news on this front, is that an AML / CTF lawyer can tell after spending a minute of time on due diligence, if a company was a shelf or not.

Although law firms are the creators and gatekeepers of, shelf companies, once a shelf company transitions from shelf to non-shelf, it becomes a regular company to the outside world and lawyers are no longer the gatekeeper of such a company.

There are two misconceptions about shelf companies that are worth noting:

(a) It is not accurate that nominees are used for shelf companies – that is an example of where NGOs and people confuse shelf companies with shell companies; nominees are used in shell companies but not in shelf companies.

(b) It is not accurate that shelf companies are used when a person needs a company that is “ready to go”. In modern jurisdictions, it takes mere minutes to register a company online with a law firm. Obtaining a company that is “ready to go” is not the purpose shelf companies serve in 2016.

2. Numbered Companies – relax, they’re perfectly fine

Some jurisdictions, such as British Columbia, allow the incorporation of numbered companies, as opposed to a company that has a name. People object to numbered companies without any basis. There is nothing the matter with, or suspect about, a numbered company.

A numbered company in British Columbia, for example, looks like this – BC1568796. But every company in British Columbia, even those that have actual names, such as Ocean View Holdings Inc., also has a corresponding number and is legally also known as BC1568797, and therefore its legal name is Ocean View Holdings Inc., BC1568797. It is no different than the company that is a solely numbered company, BC1568796.

The reason people object to numbered companies is because it’s harder for them to recollect the name of a numbered company than a company without a number. In terms of purpose, structure, shareholders and organization, there is no difference whatsoever between a numbered and a non-numbered company, and there is moreover, nothing nefarious about any numbered company arising solely from the fact that it does not have a corporate name attached to its corporate number. There is also no evidence to suggest that numbered companies are used for financial crime in greater numbers than non-numbered companies.

3. Shell Companies – there are two meanings

A shell company has two meanings.

In the securities law context, it means a company that no longer has business activities, although it once did have business activities, hence it is now a “shell” of its former self, as in “an empty shell.” In the public company context and in the securities law context, a shell company is legitimately used for the listing or re-listing process, or when there is a change of material business activities. There is nothing the matter with this type of, or reference to, a shell company.

In the corporate law context, a shell company has a different meaning. A shell company in this context means a company created to obfuscate ownership of shares (the beneficial ownership issue) and the purpose may be criminal or not.

If a person sets up a company in the Cayman Islands, a well-known tax evasion and money laundering jurisdiction, it is not necessarily a “shell company.” It all depends upon how the company is organized in a structural sense and what it is used for.

The key to determining whether a shell company was established with a criminal intent, or is used criminally or to obfuscate ownership for a criminal intent, is to look at beneficial ownership. Not all companies created to obfuscate ownership are criminal either – many people who run companies purposely use nominees to protect their privacy.

4. Beneficial Ownership

Beneficial ownership refers to the beneficial owner of the shares of a private company, as opposed to the legal owner of shares of a company, namely the de jure versus de facto ownership of shares.

To be technical, beneficial ownership is a common law concept used to distinguish rights held by persons with a beneficial interest in property from those who hold those interests legally (i.e., in name only). In the case of shares, a person can hold shares legally (in their name) or beneficially (as a nominee shareholder – meaning for the benefit of another person).

Canadian corporate law protects both de facto and de jure ownership of shares of private companies because it is not possible to find out the legal or beneficial owner of the shares of a private company. That information is held and maintained by law firms and are in the Library, both in Minute Books (where the legal owners of shares are listed) and deal books (where beneficial owners may be recorded in financing documents, such as in a pledge of shares).

It is not just companies – this is also the case with LLPs, partnerships, funds, charities and trusts.

In addition to the fact that in Canada, the shareholder records are maintained in law firms, they are further protected by privilege which only the client is entitled to waive for access. Canada has the strongest privilege protection laws compared to anywhere else in the world. Coupled with the fact that in Canada, lawyers are exempt from anti-money laundering law compliance, beneficial ownership has another layer of unintended protection.

Beneficial ownership confusion

The term beneficial ownership is widely misused.

Here’s why; groups are calling for legislative changes around the world to solve what is called the “beneficial ownership problem” by eliminating corporate secrecy by requiring the disclosure of the names of the shareholders of private companies on public registries. But if governments do that, all they are doing is requiring the public disclosure of the legal owner (e.g., the person whose name is on the securities register) of the shares of private companies. It does nothing to help determine beneficial ownership. You can only determine beneficial ownership of private companies by accessing the records of law firms where such records are held. And protected.

It would be more clear for NGOs to say they are seeking the establishment of public registries of private companies, which will yield the name of legal shareholders and to refrain from using the term beneficial ownership altogether since the public registries they are seeking will not yield the names of beneficial owners and does not advance financial crime mitigation.

The Offshore Company Problem

The offshore problem is that people set up shell companies with beneficial ownership structures and obfuscate their connections to those companies to stash or move money illicitly, in which nominee directors and nominee shareholders are paid to act as fake directors and shareholders, when in reality, the real owners of the shares and the real control persons behind the companies are usually politically exposed persons chilling in places like Vancouver, Hong Kong or New York buying up expensive real estate.

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Brazil’s former President, his wife and son charged with money laundering

By Christine Duhaime | March 13th, 2016

Brazil’s former president, Luiz Inacio Lula da Silva, and his wife and son were charged with money laundering and identity fraud in connection with real estate purchases. According to Brazil’s prosecutor, the former president used proceeds of crime to acquire real estate in Guaruja for he and his family that was destined for regular families in Brazil.  Prosecutors believe that the real estate was part of a bribery scheme to kick back benefits to, da Silva, a politically exposed person.

A spokesman for Lula da Silva admitted that he and his wife invested in the real estate but said they decided not to exercise an option to buy it entirely.

Brazil continues to undergo a massive corruption and money laundering investigation involving the state-owned oil company, Petrobras, and has implicated the current president, Dilma Rousseff. Brazilians think its a matter of time before she is ousted from power over the financial crime issues circling the government.

According to Brazilian news, the ruling party of Brazil is considering offering Lula da Silva a ministerial position to make him more immune from the charges.

 

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