Category Archives: Concealment of Assets

Empty Shells

I attended an out of town presentation not too long ago on investment and tax avoidance scams targeting well-to-do retirees. An especially interesting portion of the CFE presenter’s presentation (a recent retiree himself), focused on the use of paper or shell corporations and companies as tools by the perpetrators of such schemes.

Our presenter emphasized that regulators and other law enforcement personnel attempt to identify instances of fraud against retirees and others in order to prosecute the perpetrator and return the fraudulently obtained goods to the victims. However, such frauds tend to be an under-reported crime as victims may be embarrassed that they easily fell prey to the fraudster or may remain connected to the offender because of the engendered trust cultivated. Reluctance to report the crime can stem from a belief that the fraudster will ultimately do the right thing and return any fees or funds. In order to stop such fraud, regulators and law enforcement must be able to detect and identify crime, caution potential investors, and prevent future frauds by taking appropriate legal actions against the perpetrators.

He went on to say that one of the foremost reasons for the existence of the underground economy is to escape taxation, which in some countries can be as high as 51 percent of a person’s nominal income. Swiss bankers have a saying, “There would be no tax havens without tax hells.” As the rate of taxation increases, so does the cost of honesty. The higher the tax burden, the more incentive people have to attempt evading those taxations. Because it is illegal, tax evasion always involves financial secrecy.

Every few years the Internal Revenue Service (IRS) releases its top 12 most blatant tax scams affecting American taxpayers. Over the years the Service has repeatedly warned retirees not to fall for schemes peddled by scammers for the avoidance of taxes featuring the use of dummy corporations (or shells) associated with off-shore accounts in tax havens and emphasizing that there is no secret trick that can eliminate any senior’s tax obligations. Every tax payer should be wary of anyone peddling any of these scams.

The IRS aggressively pursues taxpayers and promoters involved in promoting abusive offshore transactions to wealthy seniors. Such promoters pitch seniors in the use of methods to avoid or evade U.S. income tax by hiding income through shells with accounts in offshore banks, brokerage accounts, or through other entities. Such actively promoted scams feature the use of offshore debit cards, credit cards, wire transfers, foreign trusts, employee-leasing schemes, and private annuities or life insurance plans. The IRS has also identified the use of shells in abusive offshore schemes including those that involve use of electronic funds transfer and payment systems, offshore business merchant accounts and private banking relationships.

But, as our speaker pointed out, shell companies aren’t just for big and medium-sized tax evaders anymore. They have become the financial and deception vehicle of choice for some of the most corrupt, dangerous and ruthless individuals and entities on the planet. Arms dealers, drug cartels, corrupt politicians, scammers, terrorists and cybercriminals are just a few of the most creative and frequent users of shells.

It’s also important to emphasize that not all shell companies are used for nefarious purposes; assurance professionals and investigators need to be aware that there are legitimate uses for these entities, such as using one as a holding company or creating a shell company (in name) to preserve future business rights or opportunities. Not every shell is involved in a criminal conspiracy, so it’s important to understand why someone might use a shell for criminal purposes.

The primary purpose of the use of a shell in a fraud scheme is like that of the fraud itself: to conceal fraudulent activity. This may include the nature, origin, or destination of misappropriated funds and/or concealment of the true owners and decision-makers of a criminal act or conspiracy.

In many instances, one shell company isn’t enough; fraudsters create networks. Dozens of shells, nominee directors, addresses and fake shareholders might be required to fully conceal a scheme or criminal plot. Big-time criminal conspirators will utilize shell incorporators to do the heavy lifting and help create a corporate web of disguise that can perplex and confuse even the best of investigators.

Shells can come in all different shapes and sizes, and the jurisdiction in which they reside can help further the concealment. Some fraudsters create shell companies for single uses and then discard them. Or they may use them repeatedly and have them change hands multiple times. They also may form what our speaker dubbed shelf companies and not use them for a period of time. A shelf company has a better chance of appearing legitimate and fooling a novice investigator or basic due diligence mechanisms because it appears to have existed longer than it really has. An older shelf could have a creation date predating any specific areas of investigative concern, which would allow it to engage in business activities when it otherwise couldn’t without arousing suspicion.

Given the intent, with a small sum of money, time and patience, fraudsters can set up a very elaborate web of shell companies in little time. But establishing the company name is only the first step in creating a shell network of deception. The company needs nominee directors and shareholders, often illegitimate, to further the concealment.

Scammers use nominee directors, and in some instances, other shell companies, to disguise true owners of entities while giving the appearance of legitimacy. Some nominees simply sell their names to fraudsters who use them on company documents. Others actually provide limited services for the shell companies such as processing corporate records, signing for company documents and forwarding mail. These nominee directors are the linchpins to linking and disguising international criminal organizations and operatives. Their use is so widespread that IRS conducted searches among entities frequently disclose nominee directors crossing paths. Some are even listed as directors for the same shell entities.

So what does our speaker recommend that individual CFEs do if we think that one of our clients may be unwittingly doing business with a nefarious shell?

— A shell company can be set up practically anywhere, but successful incorporators have learned to use particular countries and regions. Advantages can include lack of government enforcement or specific laws protecting corporate secrecy. A good source of a high-risk country list is the U.S. State Department’s annual list of major money-laundering countries.
— Use SWIFT codes – a SWIFT code is a unique identifier that’s associated with particular financial and non-financial institutions around the world. If you can identify the SWIFT code for the financial entities the suspected shell is dealing with, you might consider monitoring for any funds originating from or being disbursed to these banks or check to see if any of your client’s customers/vendors have bank accounts associated with these specific institutions.
–Review all available internal data that contains contact, banking, address and ownership information, such as vendor/customer data, wire transfer data, ship to/ship from locations for sales and purchases, purchase orders and invoice support documentation.

Look for :

• Information that doesn’t make sense given the nature of the business relationship with the entity.
• Entity information mismatch: address, phone, fax, ship to, bank, cell contact, etc. in different geographic locations.
• No discernible online presence when compared to the goods/services and the amount of money changing hands.
• The entity “representative” is associated with numerous other companies.
• Payment is made to or received from an unrelated third party. Review incoming/outgoing wire transfer documents.

Our speaker summarized that involvement with shell companies and those associated with them can be very bad news for any of our client companies. Fraudsters within your client organization might make use of them as vehicles of corruption or asset diversion. External perpetrators can passively use them as money-laundering vehicles against your client organization.

All assurance professionals should attempt to stay current with the latest types of abuse associated with the shell company model, trends in international corruption, fraud and asset diversion, and money laundering. ACFE training is, as usual, an excellent resource to do this. To the extent possible, try to screen information on your client’s customers, vendors and employees on an on-going basis. Cross-reference known bad actors and shell companies in the news against the entities with which your clients are doing business. Contact authorities if you and/or your client determine that it has become the victim of a shell company related scheme.

Concealment Strategies & Fraud Scenarios

I remember Joseph Wells mentioning at an ACFE conference years ago that identifying the specific asset concealment strategy selected by a fraudster was often key to the investigator’s subsequent understanding of the entire fraud scenario the fraudster had chosen to implement. What Joe meant was that a fraud scenario is the unique way the inherent fraud scheme has occurred (or can occur) at an examined entity; therefore, a fraud scenario describes how an inherent fraud risk will occur under specific circumstances. Upon identification, a specific fraud scenario, and its associated concealment strategy, become the basis for fraud risk assessment and for the examiner’s subsequent fraud examination program.

Fraud concealment involves the strategies used by the perpetrator of the fraud scenario to conceal the true intent of his or her transaction(s). Common concealment strategies include false documents, false representations, false approvals, avoiding or circumventing control levels, internal control evasion, blocking access to information, enhancing the effects of geographic distance between documents and controls, and the application of both real and perceived pressure. Wells also pointed out that an important aspect of fraud concealment pertains to the level of sophistication demonstrated by the perpetrator; the connection between concealment strategies and fraud scenarios is essential in any discussion of fraud risk structure.

As an example, consider a rights of return fraud scenario related to ordered merchandise. Most industries allow customers to return products for any number of reasons. Rights of return refers to circumstances, whether as a matter of contract or of existing practice, under which a product may be returned after its sale either in exchange for a cash refund, or for a credit applied to amounts owed or to be owed for other products, or in exchange for other products. GAAP allows companies to recognize revenue in certain cases, even though the customer may have a right of return. When customers are given a right of return, revenue may be recognized at the time of sale if the sales price is substantially fixed or determinable at the date of sale, the buyer has paid or is obligated to pay the seller, the obligation to pay is not contingent on resale of the product, the buyer’s obligation to the seller does not change in the event of theft or physical destruction or damage of the product, the buyer acquiring the product for resale is economically separate from the seller, the seller does not have significant obligations for future performance or to bring about resale of the product by the buyer, and the amount of future returns can be reasonably estimated.

Sales revenue not recognizable at the time of sale is recognized either once the return privilege has substantially expired or if the conditions have been subsequently met. Companies sometimes stray by establishing accounting policies or sales agreements that grant customers vague or liberal rights of returns, refunds, or exchanges; that fail to fix the sales price; or that make payment contingent upon resale of the product, receipt of funding from a lender, or some other future event. Payment terms that extend over a substantial portion of the period in which the customer is expected to use or market the purchased products may also create problems. These terms effectively create consignment arrangements, because, no economic risk has been transferred to the purchaser.

Frauds in connection with rights of return typically involve concealment of the existence of the right, either by contract or arising from accepted practice, and/or departure from GAAP specified conditions. Concealment usually takes one or more of the following forms:

• Use of side letters: created and maintained separate and apart from the sales contract, that provide the buyer with a right of return;

• Obligations by oral promise or some other form of understanding between seller and buyer that is honored as a customary practice but arranged covertly and hidden;

• Misrepresentations designed to mischaracterize the nature of arrangements, particularly in respect of:

–Consignment arrangements made to appear to be final sales;

–Concealment of contingencies, under which the buyer can return the products, including failure to resell the products, trial periods, and product performance conditions;

–Failure to disclose the existence, or extent, of stock rotation rights, price protection concessions, or annual returned-goods limitations;

–Arrangement of transactions, with straw counterparties, agents, related parties, or other special purpose entities in which the true nature of the arrangements is concealed or obscured, but, ultimately, the counterparty does not actually have any significant economic risk in the “sale”.

Sometimes the purchaser is complicit in the act of concealment, for example, by negotiating a side letter, and this makes detection of the fraud even more difficult. Further, such frauds often involve collusion among several individuals within an organization, such as salespersons, their supervisors, and possibly both marketing and financial managers.

It’s easy to see that once a CFE has identified one or more of these concealment strategies as operative in a given entity, the process of developing a descriptive fraud scenario, completing a related risk assessment and constructing a fraud examination program will be a relatively straight forward process. As a working example, of a senario and related concealment strategies …

Over two decades ago the SEC charged a major computer equipment manufacturer with overstating revenue in the amount of $500,000 on transactions for which products had been shipped, but for which, at the time of shipment, the company had no reasonable expectation that the customer would accept and pay for the products. The company eventually accepted back most of the product as sales returns during the following quarter.

The SEC noted that the manufacturer’s written distribution agreements generally allowed the distributor wide latitude to return product to the company for credit whenever the product was, in the distributor’s opinion, damaged, obsolete, or otherwise unable to be sold. According to the SEC, in preparing the manufacturer’s financial statements for the target year, company personnel submitted a proposed allowance for future product returns that was unreasonably low in light of the high level of returns the manufacturer had received in the first several months of the year.

The SEC determined that various officers and employees in the accounting and sales departments knew the exact amount of returns the company had received before the year end, when the company’s independent auditors finished their fieldwork on the annual audit. Had the manufacturer revised the allowance for sales returns to reflect the returns information, the SEC concluded it would have had to reduce the net revenue reported for the fiscal year. Instead, the SEC found that several of the manufacturer’s officers and employees devised schemes to prevent the auditors from discovering the true amount of the returns, including 1), keeping the auditors away from the area at the manufacturer’s headquarters where the returned goods were stored, and 2), accounting personnel altering records in the computer system to reduce the level of returns. After all the facts were assembled, the SEC took disciplinary action against several company executives.

As with side agreements, a broad base of inquiry into company practices may be one of the best assessment techniques the CFE has regarding possible concealment strategies supporting fraud scenarios involving returns and exchanges. In addition to inquiries of this kind, the ACFE recommends that CFE’s may consider using analytics like:

• Compare returns in the current period with prior periods and ask about unusual increases.

• Because companies may slow the return process to avoid reducing sales in the current period, determine whether returns are processed in timely fashion. The facts can also be double-checked by confirming with customers.

• Calculate the sales return percentage (sales returns divided by total sales) and ask about any unusual increase.

• Compare returns after a reporting period with both the return reserve and the monthly returns to determine if they appear reasonable.

• Determine whether sales commissions are paid at the time of sale or at the time of collection. Sales commissions paid at the time of sale provide incentives to inflate sales artificially to meet internal and external market pressures.

• Determine whether product returns are adjusted from sales commissions. Sales returns processed through the so-called house account may provide a hidden mechanism to inflate sales to phony customers, collect undue commissions, and return the product to the vendor without being penalized by having commissions adjusted for the returned goods.

Basic Cash Concealment Strategies

One of the topics in which readers of this blog have expressed consistent interest over the years regards the many strategies of cash asset concealment employed by fraudsters; especially by embezzlers of relatively small sums from employers, who seem particularly creative at such manipulations.  Regardless of the method used to hide ill-gotten assets, one fact remains constant; proceeds from illicit activities must be disguised in some way to avoid being discovered. Those the ACFE dubs ‘asset hiders’ have developed many sophisticated techniques for working the system and accomplishing the goal of concealing their gains; in attempting to track down and recover secret stores of cash, the fraud examiner is presented with a true challenge, and the first step in meeting this challenge is to understand how asset hiders work. This post will concentrate on the concealment of raw cash.

There are three primary ways to hide cash assets. They are:

— Currency hoards;
— Cashier’s checks and traveler’s checks;
— Deposits to financial institutions.

The most basic method for hiding cash is the currency hoard, in which a person simply stores cash in a hidden location, usually in his or her home or on her property. This is the proverbial ‘cash under the mattress’ technique. In a typical home, hiding places for currency or other valuables can range from the obvious to the ingenious.

For example, precious metals and jewelry can easily be hidden in a layer of cooking grease at the bottom of a pot. The space beneath the bottom drawer of bureaus, chests, and cabinets is also a commonly used hiding place. Loose bricks in the wall or fireplace can disguise small spaces for hiding things. A more complex scheme is to build a false ceiling below the original ceiling and then use the space between the two as a hiding place.

Another place to hoard currency is in furniture. The hollow spaces of upholstered furniture make these pieces a good hiding place. Many people find false bottoms in drawers or inside stereo speakers useful places for hiding cash.

The basic structure of the home itself provides many opportunities for creating hiding places. One of the most common spots for hiding objects is in the walls. Cunning hiders may construct false walls in closets or pantries, or they may build large cavities into a wall, which is then covered with a mirror or a painting. Installing false light switch plates and electrical outlets provides easy access to spaces between walls and generally appear quite normal, although amateurs often leave tell-tale marks on the plate screws. These marks often provide searchers with signs of tampering and can lead to the discovery of a cache. An even simpler method is to hide currency inside the electrical boxes behind real electrical plates. If a larger space is needed, hiders sometimes remove the box from the wall and build a shelf below it. Significant amounts of currency can be hidden in these spaces. Currency hoards can also be hidden above ceiling light boxes in the space below the attic.

The plumbing system provides other natural hiding places. For example, many bathrooms have access holes under the sink, which are usually covered with a removable chrome disk. These access holes are designed so a cleaning ‘snake’ can be inserted into the main drain when the lines are clogged. This space is easily utilized as a hiding space. Floor drains are also used for hiding currency. Excellent hiding places can be created by installing false pipes that appear to be part of the home’s plumbing. Some individuals hide objects and money in shower curtain rods. Other places frequently used for hiding are air ducts, doors, and stairways. Heating and cooling system ducts are generally easy to access and have plenty of empty space. Hollow core doors are easily rigged for hiding. The top surface of the door can simply be cut away, allowing access to the natural secret compartment inside. Enclosed staircases have dead space underneath that is accessible. If the staircase is not enclosed, there may be usable space for small objects behind each of the risers. Stairs can be hinged, creating a hidden compartment underneath.

Cashier’s and traveler’s checks are another method used to hide assets. These instruments are useful for several reasons:

–They allow asset hiders to easily disguise their financial dealings from asset seekers like law enforcement, CFEs and forensic accountants;
–They help disguise the asset hider’s financial dealings and reduce the amount of currency physically carried;
–Cashier’s checks or traveler’s checks in denominations of less than $10,000 are negotiable financial instruments that can be exchanged almost any place in the world.

Whilst efforts to control the use of wire transfers for money laundering have traditionally been focused on banks, examiners also need to be aware that there are non-bank money transmitters that fraudsters often use to conceal cash assets.  These non-bank transmitters specialize in money transfers for individuals rather than businesses. In addition to other services, most non-bank transmitters sell money orders and traveler’s checks. These companies range from large international enterprises like Western Union to small mom-and-pop neighborhood check cashing businesses.

There are several reasons fraudsters like using non-bank transmitters. First, non-bank transmitters allow individuals to cash personal checks or wire money to family members nationally or in other countries. Check cashing companies and other sellers of money orders, such as convenience stores and grocery stores, provide a much-needed service to people without bank accounts. Second, non-bank transmitters allow individuals to obtain many individual traveler’s checks and money orders in amounts less than $10,000 each. Most states regulate check cashing and the sale of money orders with licensing and bonding requirements. The Money Laundering Suppression Act of 1994 required all money transmitters to register with the U.S. Department of Treasury. Furthermore, like other financial institutions, these businesses are required to file currency transaction reports (CTRs) for transactions of $10,000 or more in currency and coins, and they are required to file Suspicious Activity Reports (SARs) with the Treasury Department for certain classes of suspect transactions.

Check cashing companies have been known to receive illegally earned or stolen currency and use it to cash legitimate checks for their customers, thus avoiding CTRs or to structure transmittals by issuing multiple traveler’s checks and money orders for less than $10,000 each. Third, the transactions of non-bank transmitters will not trigger a mechanism for identifying unreported cash. Although money transmitters are classified as financial institutions, they are not depository institutions but operate through accounts with commercial banks. And, unlike bank accounts, which contain copies of deposits and canceled checks used in locating assets, non-bank money transmitters do not maintain copies of deposits and canceled checks. Unless the money order or traveler’s check appears in the financial records of the asset hider, it will likely go undetected since there is no place for the investigator to begin a search. However, once a money order or traveler’s check has been specifically identified, it can be traced back like any other financial instrument.

Banks and other financial institutions are frequently utilized by secrecy seekers as vehicles for hiding or disguising currency. The methods used may be as simple as renting a safe-deposit box and storing currency or valuables inside.  Searching the safe-deposit box of a suspected embezzler for evidence is not easily accomplished. It requires a court order. But; even if access to the box is denied, the investigator in a hidden asset case can often make educated guesses as to the contents by observing the movements of the hider. For instance, if the subject makes a visit to her safe-deposit box after attending an antique jewelry collector’s exposition, the examiner could surmise a collection of jewelry items is stored therein. Trips made to a safe-deposit box before foreign travel may indicate that the hider is moving money from his or her native country to a foreign location.

The banking system is, without question, the most important vehicle of both lawful and unlawful financial transactions. While most bankers are not active participants in asset hiding, it can be extremely difficult to distinguish between legitimate transactions and those conducted by secrecy seekers. Some bankers even prefer to close their eyes to the sources of their deposits and, in doing so, knowingly accept tainted funds. It’s important to understand how secrecy seekers use bank deposits and funds transfers to hide assets.  For the examiner, it’s important to know that most large banks have computer programs that can retrieve a specific wire transfer record. Many medium-sized banks cannot electronically retrieve specific wire data more than a month old, and some banks would have to search manually for records. However, even small banks usually send their international money transfers through one of the large Money Center banks, thus creating a record. Many large banks have enhanced their record-keeping systems to assure themselves and bank regulators that they are in full compliance with the Bank Secrecy Act. Some institutions have systems that monitor the wire transfer activity of certain accounts and generate periodic reports highlighting the consolidation of incoming wires followed by an outgoing wire transfer. Most of these systems are designed to monitor only customer accounts and do not record funds transfer services provided for non-depositors for which the bank serves only as an intermediary.

To conduct a successful wire transfer search, the examiner should have as much information as possible relating to the transfer in question when contacting the appropriate entity. Having the following information on hand will help make the search much more efficient:

— Date of transfer
— Amount of transfer
— Names of sending and receiving institutions
— Routing numbers of sending and receiving institutions
— Identity of sender and designated receiver
— Input sequence and/or output sequence

While most banks do not actively participate in fraudulent transfers, some signs for the examiner that could indicate collusion between a bank and its customer are:
— Allowing clients whose funds are not of foreign origin to make investments limited to foreigners;
— Acting without power of attorney to allow clients to manage investments or to transmit funds
on behalf of foreign-registered companies or local companies acting as laundries;
— Participating in sequential transactions that fall under the government reporting thresholds;
–Allowing telephone transfers of funds without written authorization and failing to keep a record of such transfers;
— Entering false foreign account number designations with regard to wire transfers.

Living Underground

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The first signs that the tide may be turning in the world-wide battle against corruption appear to be upon us.  Issues surrounding the growing international Panama Red movement and the scandal of secret money have thrown a spotlight on what’s called the underground economy.

The underground economy is a group of clandestine transactions that create financial value, but are conducted with the intention of escaping something — primarily taxes, but also revelation of bribes, government regulations, exchange controls, or criminal prosecution.  The ACFE has been telling us for years that the underground economy exists for four primary reasons:

— to escape taxation;
— to escape regulation;
— to escape prohibition;
— to further corruption.

Because all of these activities are illegal and the individuals involved in them want to escape detection, the underground economy operates on secret money. Economists have attempted to determine the exact size of the international underground economy, but have, thus far, met with limited success because the main premise of the underground economy is that income is not reported. In the early 2000’s, India, the United States, Canada, Russia, Nigeria, and Italy were believed to have the largest underground economies in the world. According to estimates, the underground economy in the United States has grown significantly, totaling as much as $2.25 trillion annually. Today, most observers in the United States estimate that ten percent of the actual Gross Domestic Product can be attributed to criminal activity.

The underground economy in the United States (as it does to the tax collection efforts in other developed economies) is undermining the effectiveness of the Internal Revenue Service, which is highly dependent on employee’s withholding taxes. If the IRS could collect all of the taxes that it says it is owed from the underground economy, then the current budget deficit would decrease overnight. The IRS has estimated that its tax gap, the estimated amount of taxes owed minus the amount collected, is around $600 billion in any given year. The gap number measures only a portion of the underground economy. Because the number is extrapolated from audited returns, it makes no allowance for criminal enterprises that report no income, and it even fails to capture some typical varieties of non-reporting. This gives just some idea how much the underground economy is costing the U.S. economy alone.

In response to these issues, the IRS developed the Criminal Investigative Unit. This unit serves the American public by investigating potential criminal violations of the Internal Revenue Code and related financial crimes in a manner that fosters confidence in the tax system and compliance with the law. The enforcement efforts of this unit include tax violations, money laundering, currency crimes, and asset forfeiture.

The Criminal Investigation Program Strategy falls into three interdependent categories: Legal Source Tax Crimes, Illegal Source Financial Crimes, and Narcotics-Related Financial Crimes. The Legal Source Tax Crimes Program Strategy addresses tax investigations involving taxpayers in legal occupations and legal industries. The Illegal Source Financial Crimes Program Strategy recognizes that illegal source proceeds, which are part of the untaxed underground economy, are a threat to the voluntary tax compliance system, and that failure to investigate these cases would erode public confidence in the tax system. The primary objective of the Narcotics-Related Financial Crimes Program Strategy is to reduce the profit and financial gains of narcotics trafficking and money laundering organizations that compromise a significant portion of the untaxed underground economy.

The foremost reason for the existence of the underground economy is to escape taxation, which in some countries can be more than half of a person’s yearly income. Swiss bankers have a saying, “There would be no tax havens without tax hells.” As the rate of taxation increases, so does the cost of honesty. The higher the tax burden, the more incentive people have to attempt evading those taxations. Because it’s illegal, tax evasion always involves financial secrecy. And tax evasion, as the Panama Paper’s illustrate, transcends national boundaries due to the investigative and jurisdictional limits set by each country for revenue authorities. While there is a great deal of cooperation between international governments in matters of tax evasion, there are many loopholes that make overseas transactions appealing and profitable to the secrecy seeker.

The second factor that motivates the underground economy is the desire to escape regulation. Government-imposed regulations are often perceived as hindrances to the efficient flow of business. Regulations might affect prices, wages, returns on capital, exchange rates, and so forth. As with taxes, each time a new regulation is enacted, an economic incentive is created to find a way to evade it. In many countries, parallel financial markets, also known as curb markets, are the result of stringent financial controls. These controls also give rise to parallel foreign exchange markets involving currency smuggling and transfer pricing. All of this economic activity is conducted in secrecy and is neither taxed nor reported in official statistics.

Prohibition is defined as the forbidding by law of certain activities. Avoidance of prohibitions is the third reason underground economies exist. Prohibition is usually associated with criminal activities such as narcotics smuggling and sales, prostitution, gambling, and usury (i.e., the lending of money at excessive interest rates). Most of these transactions are made with cash and are therefore extremely difficult to detect and trace.

The final reason for the perpetuation of the underground economy is corruption. Corrupt activities include bribes on public procurement contracts, customs clearance, traffic violations, zoning ordinances and building permits, investment licenses, import and foreign exchange permits, allegations of consumption, investment, and infrastructure goods that are in short supply. As the current revolt of the Mexican people against corruption illustrates, bribery is commonplace in many countries and is pervasive among public officials. Despite official laws banning bribery, the practice is sometimes an intrinsic part of a country’s cultural, political, and economic system. In these places, it is tolerated or simply overlooked.

One of the most important services fraud examiners can render to their clients and to the general public is to increase awareness of the pernicious effect on economic freedom and liberty of the underground economy phenomena, not just in the developed countries in which we primarily practice, but world-wide.

It’s Not Just About Tax Avoidance

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The ACFE tells us that countries in virtually all parts of the world, but especially those located in the Caribbean and South Pacific, are commonly regarded as tax havens.  A tax haven is a country whose laws, regulations, traditions, and treaty arrangements make it possible for a person to reduce his or her overall tax burden. Secrecy is basically supplied by such countries in two ways.

1) Domestic bank secrecy laws: Laws which bar insight by outsiders;2) Blocking statutes: Statutes which effectively prevent the disclosure, copying, inspection, or removal of documents located in the host country in compliance with orders issued by foreign authorities.

Moreover, in many countries, legal depositions may not be taken on national territory in connection with judicial proceedings being undertaken abroad. Many countries, such as the United Kingdom, France, South Africa, Germany, Australia, Norway, and Canada have comprehensive statutes to guard their sovereignty from the extraterritorial reach of foreign authorities. Although these countries are not generally thought of as tax havens they have laws which can be used by the asset hider. In addition to asset hiding, some foreign countries have a legal, banking, or economic climate that provides an excellent site for laundering money. Historically, places such as Panama, the Cayman Islands, the Bahamas, Switzerland, and the Netherlands Antilles have been associated with hidden bank accounts, fictitious corporations, and money laundering.

The most popular off-shore jurisdictions in the news recently are:

–Switzerland
–Panama
–Cayman Islands
–Netherlands Antilles

Countries like Panama with relatively small, open economies have often embraced the financial secrecy business as a way of promoting economic development. With some notable exceptions, these countries are geographically isolated with a narrow production concentrated on a few major commodities, usually for export. This tends to make them vulnerable to adverse climatic conditions and international market development. It also limits their ability to produce an adequate domestic market, invest in an infrastructure, attract foreign direct investment, and gain access to a diversified mix of importers and exporters.

It’s important for CFE’s to understand the general concept of a financial center with regard to financial havens.  Financial centers are of two types:

–A functional center is defined as country where transactions are actually undertaken and the value added is created in the design and delivery of financial services. Examples of functional centers include New York, London, Singapore, Bahrain, and Hong Kong.
–A booking center is defined as a country where transactions are recorded but the value added involved is actually created elsewhere. Examples in this category include Panama, the Bahamas, Cayman Islands, Seychelles, and Vanuatu.

Accordingly, the ACFE classifies the tax havens of the world into four broad categories:

No Tax Havens – these countries have no income, capital gains or wealth taxes. It’s legal to incorporate and/or form a trust. The governments of these countries do earn revenue from corporate registration fees, annual fees and a charge on the value of corporate shares. Examples of “no tax” havens are the Bahamas, Bermuda, the Cayman Islands, Nauru, the Turks, Caicos and Vanuatu.

No Tax on Foreign Income Havens – These countries impose income taxes, but only on locally derived income. Any income earned from foreign sources that involves no local business activity (apart from simple housekeeping and bookkeeping matters) is exempt from taxation. There are two types of “no tax on foreign income” havens. Those that:

–allow corporations to conduct both internal and external business, taxing only the income from internal sources;
–require a decision at the time of incorporation as to whether the company will conduct local business or will act only as a foreign corporation. If the company elects the latter option, it will be exempt from taxation. If it chooses to conduct local business, it incurs the appropriate tax liabilities. Examples are Panama, Liberia, Jersey, Guernsey, the Isle of Man, Gibraltar, Costa Rica and Hong Kong.

Low Tax Havens – These are countries that impose some income tax on company income, wherever it is earned. However, most have double taxation agreements with “high tax” countries. This agreement can reduce the withholding tax on the income derived from a high tax country by local corporations. Examples of “low tax” havens are Cypress, the British Virgin Islands and the Netherlands Antilles.

Special Tax Havens – Special tax havens are countries that impose all or most of the usual taxes, but either allow concessions to certain types of companies, or allow specialized types of corporate organizations such as the flexible corporate arrangements offered by Liechtenstein. Tax havens offering special privileges for holding companies are Liechtenstein, Luxembourg, the Netherlands and Austria.

Understanding the role of tax havens, involves distinguishing between two basic sources of income:

–Return on labor
–Return on capital

The return on labor refers to earnings from salary, wages, and professional services – your work. Return on capital describes the return from investments such as dividends from shares of stocks; interest on bank deposits, loans or bonds; rental income; and royalties on patents. Placing “return on capital” income in certain tax havens can benefit the secrecy seeker. By forming a corporation or trust in a tax haven this income may become tax-free or be taxed at such a low rate that the taxation is hardly noticeable.

In the case of Panama, for example, off-shore banking and incorporation are a major source of revenue. It’s also a good country for laundering drug money through its banks. It was reported by the financial trade press some years ago that at one time $200-$300 million a month was laundered through Panamanian banks. Panama is one of the most effective off-shore havens for money-launderers, offering tremendous secrecy. As the Panama papers seem to bear out, its banking haven business has always been regarded as supplemental to its status as a tax haven.

Before asset hiders and money launderers can utilize off-shore secrecy havens, they must first establish secret off-shore bank accounts. The off-shore account provides asset protection because the existence of such an account will not readily be known by someone seeking to collect against assets. Foreign banks, regulated by their own authorities, are under no obligation to inform the fraudster’s home country bank examiners of the ownership of the accounts they hold. Even if the existence of an off-shore account does come to light, judgments from home country courts are generally invalid in foreign countries, so creditors normally have to get a judgment in the country where the account is located. This allows time for the individual to fight the action or, unless the court immediately issues an order prohibiting the transfer of assets, simply move the assets out of the account.

So why do fraudsters and others secretly move money off-shore?  Not just tax avoidance. There are many additional benefits of doing so, extending well beyond simple tax avoidance:

–Off-shore bank accounts allow an individual to invest in foreign stocks and mutual funds that are not registered with home country government agencies;
–In some instances, off-shore bank accounts offer more flexible customer options than home country accounts;
–The account can be used to profit from currency fluctuations, buy stocks from mutual funds, purchase foreign real estate, and earn the high interest rates available in many foreign countries;
–Foreign accounts are used to trade precious metals and other assets through the banking system;
–For U.S. citizens, off-shore banking income is not presently considered “subpart F income” on U.S. tax returns. The profits accumulate in the off-shore bank and are compounded free of U.S. taxes;
–Most off-shore banks allow transactions to be conducted by mail, fax, or telex.

Keeping money in off-shore bank accounts is generally considered to be a safe move. On the rare occasion when a bank fails, in most developed countries the major banks in the country will take over its business to ensure that depositors do not lose any money. Some countries even have stronger capital requirements for banks than the United States.

The off-shore financial safe haven sector constantly evolves and adds more attractive customer services over time, just like every other dynamic market place that wants to retain and grow its customer base.  To effectively investigate the role off-shoring plays in many high profile frauds, CFE’s need to realize that tax avoidance is often just the tip of the concealment iceberg.