Over 20% of lawyers in UK not complying with anti-money laundering law

By Christine Duhaime | November 1st, 2019

According to this article in the Financial Times, 20% of lawyers in the UK are not complying with federal anti-money laundering laws. Unlike the US and Canada, in the UK, lawyers are reporting entities and must conduct bank-level AML to onboard and report suspicious and other threshold financial transactions externally. The findings come amid concerns that professional money launderers (accountants, lawyers, hawalas and bank officials) are facilitating international money laundering wittingly or unwittingly.

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“Take the money and run, and blame someone else” – a digital currency exchange founder’s exit strategy

By Christine Duhaime | October 28th, 2019

The brother

A criminal complaint filed in the Southern District of New York by the FBI against Konstantin Ignatov, an executive who operated a digital currency exchange and launched an initial coin offering (“ICO“) called OneCoin, sheds some light on the sometimes murky world of digital currency exchange founders.

The money

The ICO and its associated programs, raised approximately €4 billion from investors from 175 countries, and was represented to investors as a legitimate digital currency on its own Blockchain that could be mined. In fact, investigators learned that it did not have a Blockchain, was not actually a digital currency and could not be mined.

The proceeds of the ICO were allegedly laundered through 21 countries, including the Cayman Islands, Jersey and Ireland.

The sister

OneCoin was co-founded by Dr. Ruja Ignatov, Konstantin Ignatov’s sister. She is an Oxford graduate and worked at McKinsey. Both are from Bulgaria. The complaint states that Ruja Ignatov acquired intelligence and unauthorized access to law enforcement information in Bulgaria, presumably about an investigation into OneCoin, and went dark. She has since disappeared. And apparently so has much of the money paid by investors for OneCoin.

Sister likes diamonds; brother likes tattoos

The complaint alleges that, at sales events to pitch OneCoin, the Ignatovs represented that the OneCoin Blockchain was “transparent” and had anti-money laundering compliance built-in, none of which was true. Such sales pitches took place in the EU, Colombia, Singapore and Argentina. On Instagram, Konstantin Ignatov has posted photos of himself beside a OneCoin-branded airplane in Paraguay, driving a Porsche, on yachts and in exotic places in the world.

The founders of OneCoin also created a digital currency exchange called Xcoinx to ostensibly list the coin, which later also went dark.

The charges

Konstantin Ignatov has been charged with wire fraud pursuant to a criminal complaint and Ruja Ignatov has been indicted for money laundering. She is known as the “crypto queen.”

Apparently, even though the exchange and the business were insolvent because the funds raised were not left in the business or used to create Blockchain technology, its founders continued to solicit funds from the public and while the founders were pumping out information to raise money for OneCoin, they were sending various emails to each other that some of the coins were “fake”; that they could manipulate trades on Xcoinx; and that they knew that what they were telling the investing public was “shit.”

Let’s “blame someone else”

The complaint describes how the founders discussed an exit strategy and suggested that one exit option could be that they “take the money and run and blame someone else.” Under this exit strategy, they would take the money at that time (18 months ago) and long after, would blame someone else for the crime. It sometimes happens in criminal law that a person points the finger at someone else a year or two later, not contemporaneously with a now-alleged theft, to deflect from them when they become aware of a law enforcement investigation.

Muslim investors targeted

One of the unique strategies of OneCoin was it promoted itself as a digital currency that was compliant with Islamic finance, apparently with a certificate from the Al-Huda Center of Islamic Banking and Economics. In the UK, Muslim investors believed it was legit and invested in it.

Count the crypto, not the money

Normally, when the pubic invests in ICOs or sends funds to a digital currency exchange, the digital currencies bought for customers or investors, are held in trust in the pooled wallet of the exchange, and preserved until such time as investors make requests to exit out their digital currencies. Irrespective of if actual cash is missing, the key determinant for an exchange for investigative and audit purposes, is whether or not it has, in its pooled wallet, all of the digital currencies bought and not redeemed or transferred out, by its customers at any given time. In other words, does the pooled wallet balance have all the crypto it is supposed to have.

This is the determinant because customers do not send money for ICOs or to exchanges for it to be held in cash. They send it on the expectation and the representation that the exchange or ICO, is holding for them, virtual currencies that they can transfer out at some point in the future. Arguably, digital currency exchanges cannot be deposit-taking to hold cash in a wallet on an exchange unless licenced or exempt from licensing under banking legislation. The only thing they hold, and can hold, are digital currencies and those are in the exchange’s wallet.

Another reason why it is the pooled wallet balance that is the determinant is because some exchanges may gamble or leverage pricing, taking a risk on customer funds. Ethics aside, if they make a windfall on such gambles, they may have excess cash. The opposite may happen and the gamble was a bad one but regardless, they must still have all of the customers’ digital currencies in the pooled wallet, irrespective of risky behaviour they may have engaged in.

So in investigations into digital currency exchanges, or for auditing, one first counts the crypto.

But in this case, count the money

However, in this case, investigators could only follow the money because it appears that there was never any crypto and never any pooled wallet. It appears from the criminal complaint and the indictment, that the Ignatovs did not even buy any digital currencies with funds sent by investors, or create a virtual currency (OneCoin) or convert funds they received into the equivalent number of OneCoins, or give the coins liquidity, as promised to investors.

And follow the receipts for exotic cars, private jets and casino gambling

At the end of the day, Ruja Ignatov’s recommendation to “take the money and run, and blame someone else” can only go so far. When they take the money, some digital exchange and ICO founders don’t so much run as spend and they spend wildly, following precisely the same money laundering typologies the world over, namely they: buy or lease exotic expensive racing cars; move into mansions; travel on private jets; buy expensive watches; and gamble with wads of cash at casinos, all of which is traceable back to them from casino records, travel records and car lease receipts.

A branded little jet for Konstantin. He was #happy and having a #goodmorning
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BC residents warned about virtual shares promoted on WhatsApp

By Christine Duhaime | October 23rd, 2019

The British Columbia Securities Commission has issued a warning about the purchase of virtual shares of a company tied to app games that are being marketed to investors who speak Mandarin in the Vancouver area. Virtual shares are not based on any corporate assets and the shares are only capable of being subscribed to on mobile apps. It also appears that no share certificates are issued, all of which is inconsistent with the Business Corporations Act.

Two promoters have been named – FullCarry and International Money Tree. The way the game works is that investors are told that with rising demand (hyping the stock on the app), the price will be driven up and will allegedly split at a certain point, allegedly generating income for subscribers.

The subscription works like a pyramid scheme where subscribers are given bonuses for new investors they find.

FullCarry is a BVI entity based in Dubai and IMT is in Singapore.

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8 questions you may have had about the movie “The Laundromat” and yes, there are British Columbia connections

By Christine Duhaime | October 21st, 2019

Part 1 – Background

Skip this Part 1 if you know about Mossack Fonseca and shell and shelf companies.

The movie “The Laundromat” is about lawyers and big law firms and the system that fuels offshore money movements, often involving the proceeds of crime.

The movie is about a big law firm called Mossack Fonseca that was based in Panama. It didn’t appear to have provided much in the way of legal services; rather it sold the services of, inter alia, hiding wealth in little offshore tax havens through the use of what are called shell and shelf companies.

The way it worked and still works today at some big law firms, is that the law firm flips shelf or shell companies to a client which are incorporated in a jurisdiction known for lax anti-money laundering compliance and tax evasion. These little jurisdictions are countries whose sole resource is providing a place to allow for incorporation where the identity of the directors, officers and shareholders are protected from disclosure, with a bank account. The two must go together (the offshore shell with a bank account) because the shell by itself is not the actual service the client of such services wants – it wants to move money and do it anonymously. The bank account is the critical piece for such persons – the thing of value – the shell merely sits over the bank account and is the figurative key to the often looted treasure.

The money such persons are moving is either illegally acquired or legally acquired, but either way the person wishes to hide it sometimes to defeat the rule of law. But it wasn’t just tax havens involved. British Columbia was a significant corporate host jurisdiction for Mossack Fonseca, where over 1,100 companies were set up.

Mossack Fonseca also had a stable of nominee directors, officers and shareholders like a stable of horses. For a handsome fee they would come out of the stable and appear on the corporate records to fake to be the director, officer or shareholder of a shell. Mossack Fonseca pimped out those services, and if asked, secured bank accounts for the shell and shelf companies they sold.

On occasion, the shells used bearer shares. A bearer share is one where the owner of the share is its possessor, meaning that whomever is in possession of the share is the shareholder of that share. There is nothing illegal or wrong with bearer shares except that only the company knows who the shareholders are. They are like a promissory note in that rights arise upon presentment. British Columbia’s corporate legislation allows for the issuance of bearer shares. In practice, no one ever uses bearer shares. It’s because to use them, one still has to engage with the corporation and they do not give a person any rights to a bank account where the money is parked.

It wasn’t just Mossack Fonseca that drove the creation of shell and shelf companies – 90% of its clients were big law firms and accounting firms in Germany, Canada, Hong Kong, China, the UK and other places, who were asking them to provide such services, and were advising their clients in their offices about the bona fides (or not) of the practice.

In 2014, a reporter named Ken Silverstein wrote an explosive article about Mossack Fonseca which launched inquiries into the law firm for the first time.

Then in 2016, a John Doe acquired 11 million documents from Mossack Fonseca illegally and disclosed them to the media. The law firm did not bring an injunction application to stop the publication of the files on the basis of privilege and confidentiality. Today it would lose such an application because of the criminality now known to be associated with some files, but back then, it may not have. The leak and trove of documents became known as the Panama Papers.

The Panama Papers reverberated around the world because it disclosed more widely, the practice of law firms that flip shelf and shell companies, and how those entities are used to move around the wealth of politically exposed person anonymously, in disregard of PEP laws and anti-money laundering law. Lawyers at big law firms who practice in the area of corporate finance, immigration for wealthy persons and taxation were familiar with shell and shelf companies (they flip them for hundreds of thousands of dollars each) but regular lawyers and the public were not aware of such practices.

Mossack Fonseca did provide some legal services  – among other things, they set up new corporate entities that were not shells for some clients, where the company had a real underlying business and the directors, officers and shareholder were legitimate.

Part 2

8 Questions you Maybe Had About the Movie “The Laundromat”

1. When Gary Oldman and Antonio Banderas, who play Mossack and Fonseca, respectively, say that there are many more law firms all over the world still in business exactly like them (that flip shells and shelfs to hide who is behind companies to allow them to move money anonymously), is that true? 

Yes. Probably not so much in the US but many big law firms assist with the creation of shell companies, flip shelf companies and set up bank accounts for clients to give them anonymity. Many still use little offshore tax havens and help clients park money there.

2. John Doe, played by Meryl Streep, says that the problem is “the massive pervasive corruption of the legal profession” and that the fact that the Panama Papers was the event that shed light on what lawyers do is cause for concern. Has anything changed? 

It’s hard to say. The US government has signalled that it is prepared to prosecute lawyers who flip shell and shelf companies, and those foreign lawyers who worked with Mossack Fonseca to create shells associated with criminality. It is also the big accounting firms with massive offices in little island tax havens that drive a lot of this work. In the US, the American Bar Association has faced criticism for not supporting changes that address the problem and that would help prevent people from breaking the law.

3. John Doe, played by Meryl Streep, says that as a result of the legal profession, global instability could be around the corner. What does she mean?

She means that the law firm (and the lawyers around the world that fed the machine that was Mossack Fonseca), serviced politically exposed persons who removed millions of dollars, sometimes hundreds of millions from their countries and moved those funds out through banks and shell companies to other countries, and that the corruption underlying that activity and the bankrupting of poorer countries, will lead to civil unrest. EURPOL, for example, has said that if wealth disparity grows, there will be disrespect for the law that leads to global instability.

4. Mossack and Forseca say, in the movie, that what they did was make assets safe from scrutiny by supplying shell companies located where the laws are favourable on islands in the middle of the ocean. Is that true?

Yes. Shell companies they set up are in little islands in the middle of the ocean which have favourable laws; usually favourable to defeat the law that is. But they did other things that are problematic such as doctoring corporate documents to change ownership, or remove ties to a person or corporation or back-dating them. They admitted to back-dating corporate documents and have said that it is “a well-founded and accepted practice”. If corporate documents are back-dated, the ability of law enforcement to successfully peel away the onion to ascertain who is behind a shell, becomes harder. Such practices are not consistent with corporate legislation, tax laws, or financial crime laws either. Mossack Forseca charged fees and a per-document price to back-date corporate resolutions, registers, shareholders and such, as a disbursement from a menu of services.

5. Was there a Boncamper in Nevis who worked with Mossack Forseca to front some shells and did they really doctor documents to remove him?

Yes, Malchus Boncamper was an accountant in St. Kitts and Nevis, who acted as a nominee (fake officer or director) for a number of shells for Mossack Forseca. He was arrested for money laundering and pleaded guilty in the US. For ten years, he laundered the proceeds of crime from a fraudulent scheme that sold fake insurance. He banked in Liechtenstein.

After his arrest, Mossack Forseca did a kind of a “cleanse” pursuant to which they cleansed the corporate records of many shells in which Boncamper was a nominee to remove his existence from those shells. Doing that invalidates all previous corporate actions, including consent resolutions which must be unanimous to be effective. When a lawyer goes back and cleanses resolutions to change the name of a nominee, who did not consent to a resolution or to any corporate actions, then there is not consent for the resolution.

St. Kitts and Nevis is a little island where Chinese foreign nationals are, according to legend, told by immigration lawyers that they could buy citizenship for a price commencing at $250,000 where no questions were asked and no expertise existed on the AML side, and where banks and law firms were friendly. Rich politically exposed Chinese foreign nationals were told by immigration lawyers that they could come to Vancouver to park money because they became part of the Commonwealth if they were citizens of St. Kitts and Nevis, and that’s why St. Kitts and Nevis is popular – its an entry point to Vancouver.

6.  In the movie, when Mossack says that with a shell company, the window is in the BVI and the room is in China, what does that mean?

What it means is that for Chinese foreign nationals, for example, they may have a trust set up under the laws of Guernsey which is controlled by a shell in another jurisdiction, such as the BVI, with bank accounts in Vancouver. When law enforcement, or someone doing an investigation for an asset recovery, attempts to determine where assets are and who controls them, they could be looking through many windows that are illusory because the room (the assets) are not what the view in the window is showing. So, for example, the room is China and one window is Guernsey, another window could be BVI and a third window is Vancouver for the exact same family of PEPs from China.

7. Is it true that Bo Xilai and Gu Kailai were clients of Mossack Forseca? 

Yes. This article describes how they moved money from China illegally to France through shells.

8. Obama says in a news clip in the movie that what Mossack Forseca did was legal. Is that true? 

Yes and no. It is legal to set up a company, even in little tax havens. It is legal to flip a shelf company for hundreds of thousands of dollars, although it is not the practice of law. It is legal to flip a shell company, but that is also not the practice of law. This is as opposed to incorporating a company fresh, which is legal and is the practice of law.

If a service is not the practice of law, the advice is neither privileged nor confidential and is similar to advice received from an accounting firm (not protected).

It is not legal to doctor corporate records. It is not legal to switch out officers, directors, shareholders of shell companies without the underlying corporate approvals or to back-date corporate records. It is not legal to knowingly flip shells and shelf entities, and secure bank accounts for clients to commit crimes or to facilitate the commission of crime, such to launder money, evade taxes or commit securities fraud. It is not legal to set up a whole corporate structure to obfuscate ownership and directors on purpose to provide anonymity to move money offshore to defeat or circumvent the laws.

In some countries, it is also not legal to accept or deal with the proceeds of crime or deposit such proceeds into a law firm bank account, so unless the services were provided for free, legal services can’t be provided, with the constitutional exception of providing legal services to defend an accused in a criminal proceeding.

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Vancouver man who tried to smuggle HK$13 million worth of cannabis buds into Hong Kong, sentenced to 52 months jail

By Christine Duhaime | October 19th, 2019

A Vancouver man, Sinara Nou, was sentenced last week to 52 months in jail following a conviction in Hong Kong for attempting to smuggle in HK$13 million worth of cannabis through the Hong Kong International Airport in two suitcases.

In February 2019, Nou was arrested while attempting to smuggle cannabis buds into Hong Kong – he stashed 16 slabs of cannabis buds wrapped in towels in one suitcase and 14 slabs in the another, weighting 29 kgs combined, with a street value of close to HK$13 million (US$3.8 million).

Nou said he was on welfare in Vancouver and smuggled the drugs into Hong Kong for $25,000.

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Canadian money launderer from Vancouver loses another appeal in Hong Kong; ordered deported to India to face drug trafficking charges

By Christine Duhaime | October 19th, 2019

A Canadian man, originally from China, who is a convicted money launderer, lost a second appeal in the Hong Kong Court of Appeal two weeks ago, to prevent his deportation to India to face trial for drug trafficking.

Xie Jing Feng, whom we wrote about here, appealed decisions for his removal on the ground of non-refoulement and risk of death if deported to India, and this appeal was an appeal of those denials. He is seeking to return to Canada.

Xie was born in China and moved to Canada in 1998. He claimed refugee status, which was accepted and he became a Canadian citizen. It appears that he may have been a drug trafficker in Canada but that is unclear – whatever his business, Court decisions state that he later laundered HK$95 million in proceeds of crime through Vancouver banks and other banks in China, Macau and Singapore and used a shell company offshore. He also goes by the name David Chow. His spouse may live in Vancouver.

On a trip to India several years ago, he was arrested for drug trafficking. He was in remand for 3 years awaiting trial, during which time he escaped, made his way to Nepal then Hong Kong, where he was stopped and arrested for attempting to use a forged Malaysian passport to enter Hong Kong.

He was released pending trial for those immigration offences and was then arrested for money laundering (處理已知道或合理相信為代表從可公訴罪行的得益的財產). He had 3 Canadian passports (two that were alleged to be fake), that he used to open bank accounts at HSBC and Standard Chartered in Hong Kong, where he had laundered millions of dollars, at times using his wife’s name. He was convicted of money laundering and sentenced for a term of incarceration of 4 years and 4 months on April 23, 2013.

In this latest appeal, the Court of Appeal in Hong Kong denied his application, calling his appeals “hopeless.”

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Law firms flipping shelf and shell companies – is it the practice of law? Can it go through a bank trust account?

By Christine Duhaime | October 17th, 2019

Shell games

US law enforcement agencies recently signalled that they were stepping up enforcement, inter alia, in two ways: (a) as against professional money launderers; and (b) as against shell and shelf companies that law firms flip to clients.

Professional money launderers under scrutiny the FBI explained recently, are accountants, hawalas, lawyers and individuals, as well as banks, that wittingly or unwittingly launder the proceeds of crime. Shell and shelf companies are companies that law firms create and flip (sell) to clients. Both are often used by transnational criminal organizations and for securities fraud and are high risk for money laundering.

Law firms flip shelf and shell companies to clients for upwards of $200,000 each. They flip them sometimes as part of a financing, and sometimes because in the case of shelf companies, they give the appearance to the unsophisticated person of having longevity, and ergo legitimacy. Such companies appear to be a going concern when in reality they have just sat on a shelf for years, engaged in no real business. Shell companies are not aged like shelf companies and the advantage of paying extravagant sums for shell companies to law firms appears to be because they come ready-made with legal and beneficial owners.

When law firms flip shelf and shell companies to clients, often the payment is taken from a retainer held in a law firm’s trust account from the client or from proceeds of a financing, and may be billed as a disbursement.

It is debatable whether the business of flipping of shelf and shell companies to a client constitutes the practice of law, because its the resale of a law firm asset to a client (no different than the flipping of a condo owned by the firm to the client) except at a significant profit of close to $200,000 a pop, often more. It cost the law firm $500 to incorporate a company that is flipped to a client for upwards of $200,000.

If the business of flipping shelf and shell companies is not the practice of law, then the proceeds of the sale cannot be run through a trust account.

To flip a shelf or shell company to a client, a law firm would need to ensure that it explains to the client what it is, how much profit the firm is making off the flip, that it can obtain the same thing (a new company) without some of its perks for $500, and because there is a conflict (the firm is the vendor of an asset flipped to its own client), those rules would need to be complied with.

There appears to be no guidance for lawyers and law firms in respect of the practice of being in the business of flipping shell and shelf companies – thus far, law regulators have not expressed concern in respect of the practice, issued guidance in respect of it, or prohibited the practice.

Law firms should be alert to allowing the firm and its reputation to be abused for financial crime through the flipping of shell and shelf companies to a client. Shelf companies identify the involvement of the firm and there is no way to remove that legacy information. Criminals and fraudsters can take a shelf corporation with the firm legacy information and represent to banks and investors that the law firm partners were part of its business. Technically, they would be right and one wonders why law firms knowingly put themselves at a reputational risk.

The SEC recently filed charges against a lawyer for selling 8 shell companies to 3 related clients and referred to it as a “shell manufacturing” operation, and it may be the first step in exerting pressure on law firms to stop the practice. Big firms in Canada and the US are typically the ones in the shelf and shell flipping business and they typically flip quite a number more than 8 shells a year for $200,000 each to clients. Small law firms tend not to be flippers because it requires a corporate maintenance department.

Lawyers as car salesmen

A New York Times story entitled Panama Papers Show How Lawyers Can Turn a Blind Eye showed how Ramón Fonseca, one of the founders of the Panama law firm Mossack Fonseca, which set up companies where its lawyers acted as beneficial owners, directors and officers for a fee, and which also was in the shell flipping business to clients, bankers and accounting firms, told a reporter that its lawyers did nothing wrong in flipping shells to clients: “we are like a car factory” the lawyer said. Precisely the point. What US law enforcement is driving home with indictments against lawyers for this activity, is are lawyers car salesmen or are they a profession? If the latter, why are they selling cars?

That firm also set up thousands of bank accounts with global banks for thousands of clients as part of the shell service, which is also not the practice of law.

In 2014, this article first called lawyers who flip shell and shelf companies, car salesmen.

It is probably fair to say that regulators may require that law firms exit the shelf and shell flipping business, and if they don’t fast enough, firms may exit that business by US law enforcement pressure or by the public denouncement of the practice. Panama Papers is three years old, though, and nothing has happened yet. Big law firms can earn significantly more money flipping shells to clients than legal services. The lawyer charged by the SEC for flipping shell companies charged the client $2 million for shells, and $200,000 for legal services.

Jail time for shell games

To learn more about the significant financial crime risks of shell and shelf companies, the FBI explains some troubling cases here where drug cartels, human traffickers, sanctions avoiders and Ponzi schemers used shells for financial crime. You can read here about a company that sold over 2,000 shell and shelf companies as a business, some of which later were traced to financial crime. You can also read here on how Canada is a facilitator of the creation of anonymous shells. And here on how what are called “service companies” act as fronts for trusts, shells and foundations. The shell games involve using an offshore country known for lax anti-money laundering law and known for tax evasion to act as the place of incorporation of shells owed by wealthy PEPs, such as Guernsey.

You can read here about an employee of the law firm Mossack Fonseca (the firm which said it was like a car factory), arrested for money laundering and extradited to Germany to face charges of facilitating clients break the law, and here, where the US charged three other employees of that same law firm in connection with criminality, including money laundering and creating sham shells, and here where the two founding lawyers of that law firm were charged. The partners have also been indicted in Brazil for flipping shells that were used to move the proceeds of crime from government corruption, and they have admitted to back-dating corporate records, a practice that they said was an “industry practice”, meaning all lawyers do it as a standard practice.

That shells are used for serious criminality and money laundering is no longer an unknown. Thus far, $1.2 billion in fines and payments from tax evasion have been collected arising from shells associated with the law firm Mossack Fonseca. That firm, however, was often acting on instructions from other law firms all over the world, including Canada. It has said that 90% of its shell business was from law firms and accounting firms – in other words, what they allege is that it was law firms and accounting firms instructing them on shells, among other things, to service clients that in cases were tied to serious criminality. There are more than 230 client files associated with those shells in Canada says the CRA, and it has already made inroads with criminal investigations in several Vancouver files.

This video here highlights the harm the law firm did playing shell games, with the harm ranging from human trafficking, medical fraud and the Syrian refugee crisis, which displaced 30 million people.

FI concerned about the risk of banking a shelf or shell company that was flipped to a second set of owners, and of the heightened risks for financial and organized crime associated therewith, can adjust due diligence processes to ask clients about the origin of an entity and if they paid money to acquire it (as opposed to normal fees to incorporate a new company). There are 200,000 corporate entities tied to Mossack Forseca still in existence with bank accounts. Mossack is the son of a Nazi SS officer. The SS were responsible for the so-called final solution of the Jewish population and created and operated the Nazi death camps.

There is an argument to be made by legislators that the more lawyers stray from the practice of law and sell goods, like shell and shelf companies to clients, or open bank accounts for them, they undo the argument that lawyers ought to be exempt from anti-money laundering law reporting.

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SEC obtains emergency order against Telegram’s ICO, which raised $1.7 billion from investors

By Christine Duhaime | October 11th, 2019

Ex parte injunction

The Securities and Exchange Commission (“SEC“) announced today that it filed an emergency application ex parte in US Federal District Court in Manhattan, and after a hearing, obtained a temporary order over the initial coin offering (“ICO“) launched by Telegram Group, Inc. (“Telegram“), the messaging application, which raised $1.7 billion from investors around the world thus far.

According to the SEC, Telegram and its subsidiary, TON Issuer Inc., started to solicit money from investors for its ICO commencing in January 2018 to finance its operations, and its fund-raising activities were global and included the solicitation of funds from US investors. In January 2018, Telegram represented it was creating its own Blockchain called the Telegram Open Network. It is alleged to have sold 2.9 billion units to 171 investors, which in the ICO world translates into 2.9 billion digital currency tokens which were called Grams. Over 39 of those investors were resident in the US.

Part of the representation to investors, alleges the SEC, was the delivery of the Gram tokens to investors in a digital currency wallet by October 2019, ergo, the promise of liquidity and control of the investment, similar to a representation that an investor’s funds would be used to purchase shares that were liquid and tradable.

No registration of securities

Telegram allegedly did not register the offering or the sale of its ICO with the SEC. Part of the requirement of selling investments to the public, subject to an exemption, includes disclosing to investors the information they need to make informed decisions such as risk factors, the legality of the offering, the financial condition of the issuer, the expertise and experience of its management and information in respect of insiders, as well as any material information.

The white paper for the TON ICO is here.

It promises investors that with their investment, the issuer will create a multitude of Blockchains, and like EOS, it will approve limited validators to validate transactions on the Blockchain, thus making it, like EOS, not decentralized. It controls the validation participants and process. One of the applications of the TON is payments, and the TON is providing payments services globally using digital currencies. Holders of the Gram ICO would earn commissions (or dividends) from transactions, according to the White Paper. Page 132 of the White Paper confirms that Telegram considered its ICO an “investment.”

The SEC’s co-director of the SEC’s Division of Enforcement, Steven Peikin, said that “issuers cannot avoid federal securities laws by labeling products a token.”

BVI jurisdiction

TON Issuer Inc. is a BVI company whose directors are two relatives, Pavel Valerievich Durov, also the director of Telegram the app, and Nikolai Durov. In an SEC filing, they represent both to be resident in the BVI with a resident address at a law firm in the BVI, the same place the BVI corporate entity resides. It is the same address that appears in the Panama Papers for various entities. The filing for corporate purposes of residence in the BVI in respect of one director of the app, Telegram, is an attornment to the jurisdiction of BVI of that one director.

The SEC is seeking a permanent injunction, disgorgement of the proceeds of the ICO sales and civil penalties against the two corporate defendants.

The SEC’s investigation is being conducted by Daphna A. Waxman, Morgan B. Ward Doran and John O. Enright of the SEC’s Cyber Unit, and supervised by Carolyn Welshhans, Acting Chief of the SEC’s Cyber Unit and Lara Shalov Mehraban, Associate Regional Director of the New York Regional Office. The SEC’s litigation will be led by lawyers Jorge G. Tenreiro and Kevin McGrath.

Joint statement by SEC, CFTC and FinCEN

At the same time, the SEC, CFTC and FinCEN issued a joint statement in respect of the anti-money laundering and counter terrorist financing obligations of entities that engage in the business of money transmission (whether registered or not), including activities of accepting currency, funds or value, or selling securities, or providing exchange services, including ICOs that transmit and accept digital currencies on behalf of others as their business.

The way ICOs work is that no AML, CTF and sanctions vetting takes place at the time of the investment. That’s because investors, let’s say 20,000 of them, each send Ether or Bitcoin from their wallet, an exchange or a Trezor, to the pooled wallet of the ICO. Technology-wise, the ICO does not need to open an account and onboard each person that sends it digital currencies to invest before the financial transaction takes place. Legally they may have to, but as a matter of technology, they don’t and there is no correspondent bank like in banking, in the middle to gate-keep the system.

Most ICOs wouldn’t have the manpower to onboard for AML purposes, 20,000 people in a few days or even a few weeks. And they typically will not invest in being AML compliant. So they accept the investment via digital currencies into their wallet, not knowing from where it comes or who made the financial transaction, whether it is from a prohibited person or country, and even whether it is proceeds of crime and thus ICOs that have the promise of liquidity are high risk for financial crime, money laundering and terrorist financing.

There is no visibility on who the transactors are behind any of the transactions. Later, when an ICO has closed, some ICOs attempt to obtain and verify the ID of the transactors behind the transactions but they are few and far between.

This digital currency exchange, which has a trust charter with New York State and a BitLicence, both with fairly onerous financial crime and integrity compliance requirements, surprisingly agreed to list Telegram’s ICO but it’s unclear how that is possible if the digital currency is an unauthorized issuance of a securities. Trust charters, issued by bank regulators, require that financial institutions uphold the integrity of the financial system, including by not supporting activities under their licences or charters that are not legal and which could negativity impact integrity or the public’s perception of the rule of law. The concern is that digital currency exchanges take in digital currencies into their pooled wallet and keep it there, and on the administrative accounting side, all they do is ledger an individual account with its holdings. That means that when an exchange takes on an ICO that may be tainted, or be the proceeds of crime, it brings those proceeds into its pooled wallet and co-mingles it.

In the case of TON, the combination of the ICO and the offering of a global payments service in the absence of registration of any kind, and in the absence of any AML, CTF, sanctions processes in place, would have been of concern to any government regulator, considering the reach of the Telegram app, the countries in which it operates (such as Iran), and the anonymity with which it operates on the surface. Areas at high risk for terrorism would be of additional concern because of the real potential that the new digital currency payments function within the app could be used in theory for terrorist financing.

This article a few days before the injunction says that the TON ICO was not on the radar of any regulator.

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Supreme Court Judge in Mexico Resigns over Money Laundering Query

By Christine Duhaime | October 6th, 2019

A Judge of the Supreme Court of Mexico has resigned amid questions in connection with a money laundering inquiry involving his finances stemming from the US. Justice Eduardo Medina Mora was appointed in 2015 by the President of Mexico. Previous to that, he was the Ambassador to the US, and Attorney General of Mexico. The Supreme Court is Mexico’s highest court.

As a Judge, Mora is a politically exposed person in anti-money laundering law, which means he is at higher risk for corruption and to launder money compared to the general population according to the FATF. Politically exposed persons including judges, politicians, heads of NGOs, members of the military and business associates of any of the foregoing.

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Reporting suspicious transactions – when do you have reasonable grounds to suspect in law?

By Christine Duhaime | October 6th, 2019


Proceeds of Crime (Money Laundering) and Terrorist Financing Act

Under Part 1 of the Proceeds of Crime (Money Laundering) and Terrorist Financing Act (“PCMLTFA”),[1] each person or entity subject to the PCMLTFA is required to report to the Financial Transactions and Reports Analysis Centre of Canada (“FINTRAC”) every financial transaction that occurs and every financial transaction that is attempted in the course of their activities if there are reasonable grounds to suspect that either: (a) the transaction is related to the commission or the attempted commission of a money laundering offence; or (b) the transaction is related to the commission or the attempted commission of a terrorist activity financing offence.

The requirements for suspicious transaction reporting are addressed in guidance from FINTRAC but such guidance is non-binding. There must, however, be not only reasonable grounds to suspect but also the grounds must be tied to a predicate offence. It is not enough in law to be suspicious, or to have a suspicion about a person or a transaction – to meet the legal threshold, there must be reasonable grounds to suspect in connection to the predicate offence (of which there are ~160 in Canada). If a person does not know the predicate offences, there is nothing to report because the person can make no connection in law between the reasonable grounds being raised in connection to an offence.

The author in A Guide to Canadian Money Laundering Legislation[2] states that the wording of s. 7 of the PCMLTFArequires that the reporting entity have “reasonable grounds” for suspicion before there is a reporting obligation, and provides:

“Reasonable grounds” is a difficult concept to deal with in law and there is no clear objective meaning to the phrase “reasonable grounds”. Canadian jurisprudence has considered the phrase in the context of its particular usage in statutory provisions raised by the litigation at hand. Still, Canadian legal dictionaries indicate that “reasonable grounds” may involve a bona fide belief in a serious possibility based on credible evidence or judgment of a person exercising his or her training and experience. Guideline 2states: ‘“Reasonable grounds to suspect’ is determined by what is reasonable in your circumstances, including normal business practices and systems within your industry.”

While an entity is only required to report if there are reasonable grounds, the law does not clearly define what reasonable grounds are. Does reasonable mean that something is apparent beyond a reasonable doubt, or is something reasonable when there appears to be a basis for concern? The legal definition as to what are reasonable grounds in the context of the PCMLTFA will evolve as the courts decide when a report should or should not have been made. The judgment that will need to be made in the meantime is whether the indicators are sufficient that you reasonably should have identified the relation to money laundering. This is in the drafting of the statute to require that a suspicious transaction be reported when there is something less than certainty that a transaction is related to the offence.

In the academic article, “Canada’s Laws on Money Laundering & Proceeds of Crime”,[3] the author alludes to the difficultly in proving knowledge in the context of proceeds of crime legislation:

[The Criminal Code] deals with any property or any proceeds of any property which is intended to be concealed or converted. There must be knowledge or belief on the part of the person who is doing the concealing or converting that the property was obtained from an offence. It is very difficult (for police) to prove this knowledge and that is why there are not a lot of prosecutions with respect to laundering activities. 

The authors of “Silence is Golden – Or Is It? FINTRAC and the Suspicious Transaction Reporting Requirements for Lawyers”[4] attempt to address the standard of reasonable suspicion to which lawyers were to be required to follow under s. 7 of the PCMLTFA before it was struck, stating:

Whether or not it is left to the subjective opinion of lawyers to determine what constitutes a suspicious transaction, it is nevertheless a debatable standard given the language of section 7. On the one hand, the word “reasonable” seems to suggest that an objective standard rather than a subjective standard applies. However, given that the offences under the Act are hybrid offences, and given the severe punishment that may result from committing such offences, it is questionable whether a purely objective standard should apply, especially since the PCMLTFA makes intent a necessary element for establishing that an offence has been committed.

If, on the other hand, the standard is indeed purely subjective, it would mean that entities are free to exercise their discretion in deciding whether or not transactions raise suspicion. In that case, the Crown could not argue that those entities that did in fact engage in suspicious transactions and failed to report it, ought to have been suspicious.

Criminal Code

In analyzing s. 462.31 (offence of laundering) of the Criminal Code,[5] the author in Proceeds of Crime and Money Laundering[6] commented that:

The laundering offence vastly increases the reach of criminal law to include a broad range of conduct not previously considered criminal. Shortly after it became law, Alan Gold warned of the implications of the laundering offence:

… the provisions … are expressed in language so broad that anyone dealing with any form of property or proceeds thereof, from anywhere in the world, that may be viewed as derived from acts that would arguably be criminal under Canadian law with knowledge or even merely suspicions concerning these suspect origins is a potential accused for violation of the provisions.

. . .

The definition of laundering in s. 462.31(1) is a 107 word sentence, which does not include the word “launder”, or any derivative. The mens rea is complex, compounded by specific intent and specific knowledge requirements, as follows: 

  • an act,
  • property or proceeds,
  • intent to conceal or convert,
  • knowing or believing its illegal origin, and
  • a nexus to a predicate offence, act or omission.

. . .

(d) ”knowing or believing” its illegal origin

The word “believing” was added by the Criminal Law Improvement Act, 1996 to the definition of laundering in the Criminal Code, the Customs Act and the Excise Act. 

The knowledge requirement can be satisfied by an accused person choosing to remain wilfully blind to the source of funds. The leading case on wilful blindness is R v. Sansregret.[7]

In discussing the element of “knowledge” in the context of criminal liability, Assistant Professor Julian Hermida at Algoma University, states:[8]

The concept of knowledge entails an awareness that defendant is committing an act that is considered an offence. It does not require any knowledge of the unlawfulness of such act or omission. A person acts knowingly when the person is aware of the nature of his conduct or that the circumstances then surrounding the conduct exist; or when he is aware that the conduct is reasonably certain to cause the result. The main distinction between intention and knowledge is that the former entails a conscious desire to cause a particular result by one’s conduct and the latter entails an awareness that the result is practically certain to follow from such conduct. 


Suspicion and Reasonable Grounds to Suspect

In Sellathurai v. Canada (Minister of Public Safety and Emergency Preparedness),[9] the Federal Court considered the meaning of “reasonable grounds to suspect” in the context of seized funds that were proceeds of crime under s. 462.3(1) of the Criminal Code or were to be used in the funding of terrorism. The Court in reviewed the Supreme Court of Canada’s interpretation of the phrase “reasonable grounds to believe” in Mugesera v. Canada (Minister of Citizenship and Immigration),[10] where the Supreme Court of Canada stated that:

  • the “reasonable grounds to believe” standard requires something more than mere suspicion, but less than the standard applicable in civil matters of proof on the balance of probabilities”; and
  • reasonable grounds will exist where there is an objective basis for the belief which is based on compelling and credible information.

In attempting to describe this “lesser but included standard”, the Federal Court clarified:

[70]     … In my view, even reasonable grounds to suspect must involve more than a “mere” or subjective suspicion or a hunch. The suspicion must be supported by credible objective evidence…

[71]     If credible objective evidence is required to support a suspicion, the question becomes where does the lesser standard appear. To this point, both reasonable grounds to believe and suspect have been treated identically. In my view, the difference must appear in the characterization of the evidence. In Mugaserasupra, the Court said that “compelling” evidence was needed to support reason to believe. In my view, this is where the distinction is made. Evidence to support a suspicion need not be compelling, it must simply be credible and objective.

[72]     With regard to the burden of proof on an applicant who wishes to dispel a suspicion based on reasonable grounds, it is my view that such an applicant must adduce evidence which proves beyond a reasonable doubt that there are no reasonable grounds for suspicion. Only in such circumstances will the evidence be sufficient to displace a reasonable suspicion.

The Federal Court’s approach to the standard of proof in relation to “reasonable grounds to suspect” was affirmed on appeal and followed in subsequent federal decisions.[11]

In the recent case of R. v. Kang-Brown,[12] the Supreme Court of Canada considered what constitutes “reasonable suspicion”, which essentially equates to “reasonable grounds to suspect” according to the Federal Court of Appeal in Sellathuraisupra. The Supreme Court of Canada stated:

[75]     The “reasonable suspicion” standard is not a new juridical standard called into existence for the purposes of this case. “Suspicion” is an expectation that the targeted individual is possibly engaged in some criminal activity. A “reasonable” suspicion means something more than a mere suspicion and something less than a belief based upon reasonable and probable grounds. As observed by P. Sankoff and S. Perrault, “Suspicious Searches: What’s so Reasonable About Them?” (1999), 24 C.R. (5th) 123:

[T]he fundamental distinction between mere suspicion and reasonable suspicion lies in the fact that in the latter case, a sincerely held subjective belief is insufficient. Instead, to justify such a search, the suspicion must be supported by factual elements which can be adduced in evidence and permit an independent judicial assessment.

[1] PCMLTFA, as amended, S.C. 2006, c. 12.

[2] Terence D. Hall, A Guide to Canadian Money Laundering Legislation, 2009 ed. (Markham: LexisNexis, 2008).

[3] Tim Tapley, “Canada’s Laws on Money Laundering & Proceeds of Crime” (2004) Asper Rev. of Int’l Bus. And Trade Law 35, online: <http://robsonhall.ca/faculty_public_data/asperweb/conferences/2003/papers/003%20Canada%27s%20Laws%20on%20Money%20Launder%20&%20Proceeds%20of%20Crime.pdf>.

[4] Paul Waller and Katrin Roth von Szepesbela, “Silence Is Golden – Or Is It? FINTRAC and The Suspicious Transaction Reporting Requirements For Lawyers” (2004) Asper Rev. of Int’l Bus. and Trade Law 85, online: <http://robsonhall.ca/faculty_public_data/asperweb/conferences/2003/papers/006%20Silence%20is%20Golden%20-%20Or%20is%20It.pdf >.

[5] The provision reads:

462.31 (1) Every one commits an offence who uses, transfers the possession of, sends or delivers to any person or place, transports, transmits, alters, disposes of or otherwise deals with, in any manner and by any means, any property or any proceeds of any property with intent to conceal or convert that property or those proceeds, knowing or believing that all or a part of that property or of those proceeds was obtained or derived directly or indirectly as a result of (a) the commission in Canada of a designated offence; or (b) an act or omission anywhere that, if it had occurred in Canada, would have constituted a designated offence.

[6] Peter German, Proceeds of Crime and Money Laundering (Carswell: Ontario, 2010) at 6-3 and 6-6.

[7] [1997] 2 S.C.R. 462. Discussed below.

[8] “Canadian Criminal Law” at 30, online: <http://julianhermida.com/algoma/canadacrimlawiel.pdf>.

[9] 2007 FC 208, aff’d 2008 FCA 255.

[10] [2005] 2 S.C.R. 100 at para. 114.

[11] Ondre v. Canada (Minister of Public Safety and Emergency Preparedness), 2007 FC 454 (F.C.); Hamam v. Canada (Minister of Public Safety and Emergency Preparedness), 2007 FC 691 (F.C.); Yusufov v. Canada (Minister of Public Safety and Emergency Preparedness), 2007 FC 453 (F.C.); Majeed v. Canada (Minister of Public Safety and Emergency Preparedness), 2007 FC 1082 (F.C.); Tourki v. Canada (Minister of Public Safety and Emergency Preparedness), 2007 FC 746; Dag v. Canada (Minister of Public Safety and Emergency Preparedness), 2007 FC 427; and Yang v. Canada (Minister of Public Safety and Emergency Preparedness), 2008 FC 158 (F.C.).

[12] 2008 SCC 18.

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