The Pandora Papers and the Heightened Importance of “Knowing Your Customer”

Key Takeaways

• On October 3, 2021, the International Consortium of Investigative Journalists released the “Pandora Papers,” which expose the use by political leaders, billionaires, and others of offshore entities in an apparent effort to hide assets and avoid taxes.

• Although the establishment of offshore entities to make purchases and hold assets is not necessarily improper or illegal, their use increasingly invites scrutiny and suspicion.

• Though the United States and other jurisdictions already enforce robust anti-money laundering (“AML”) and Know Your Customer (“KYC”) requirements, these revelations may lead to the imposition of additional regulatory requirements that enhance transparency in the provision of financial services and, in turn, closer examination of clients and transactions by financial services providers.

The Release of the “Pandora Papers”

On October 3, 2021, the International Consortium of Investigative Journalists (“ICIJ”) released its results from a year-plus long investigation into a leak of almost 12 million confidential records.¹ The records came from 14 offshore service providers that assist wealthy individuals and corporations in at least 38 different jurisdictions incorporate entities in countries with minimal financial regulation and tax consequences.² Termed the “Pandora Papers,” the investigation is described as the “world’s largest-ever journalistic collaboration,” with more than 600 journalists from 150 media outlets in 117 countries involved in the investigation.³ Journalists combed through documents, images, emails, spreadsheets and other data and identified more than 330 politicians and 130 Forbes billionaires that use these services to allegedly conceal assets and avoid taxes, according to public reports.⁴ The investigation found that high-profile and wealthy individuals and entities created shell companies, foundations, and trusts to facilitate high-end purchases and hold assets with minimal regulation and publicity.⁵  

Pandora Papers vs. “Panama Papers” and “Paradise Papers”

Though there have been previous leaks of this nature—such as the 2016 Panama Papers⁶ and the 2017 Paradise Papers⁷—the Pandora Papers involve the largest amount of collected data reviewed to date, with results that connected more than twice as much offshore activity to politicians and public officials and identified many jurisdictions of concern not discovered in prior ICIJ projects, such as Belize, Cyprus, and South Dakota.⁸

Scope, Findings, and Impact of the Pandora Papers

There are often legitimate and lawful reasons to establish offshore entities—as many of the politicians, companies, and public figures who have been exposed in the Pandora Papers have correctly contended.⁹ Nonetheless, the investigation demonstrated that KYC requirements often are not honored, in whole or in part, raising the prospect that offshore entities may be utilized to engage in tax evasion and other illicit transactions.¹⁰ Indeed, just hours after the Pandora Papers were released, government authorities in at least eight countries—Pakistan, Mexico, Spain, Brazil, Sri Lanka, Australia, Panama, and the Czech Republic—announced separate follow-on investigations.¹¹   

The Pandora Papers exposed political leaders’ use of offshore entities to purchase and hold foreign properties and other assets.  For example, the Papers show King Abdullah II of Jordan purchased 14 luxury homes valued at around US$106 million between 2003 and 2017 through offshore entities that protected the King’s identity.¹² The Papers also show Czech Prime Minister Andrej Babis purchased a US$22 million estate on the French Riviera in 2009 through offshore entities.¹³ To be sure, there are legitimate reasons for such under-the-radar purchases, including—if nothing else—privacy and security protection. At the same time, purchases of this kind and magnitude arguably merit more rather than less scrutiny to ensure transparency and deter “public corruption.”

In addition, American citizens, companies, law firms, and states similarly were identified in the investigation; indeed, they were among the top 20 nationalities represented in the data.¹⁴ For example, one of the more surprising revelations is that certain states within the United States, such as South Dakota, have become havens for foreigners to settle or create trusts.¹⁵ South Dakota has become a particularly attractive jurisdiction due to its financial secrecy laws and its lack of income, inheritance and capital gains taxes.¹⁶ (This stems back to 1983, when South Dakota became the first state to allow perpetual trusts, which allows money to be stowed for an indefinite amount of time without any inheritance tax payments.¹⁷) The laws of South Dakota also permit the settlor, trustee, and beneficiary of a trust to legally claim that the money in the trust does not belong to them, further distancing the owner of the trust from the assets within it.¹⁸ As such, individuals can benefit from both tax savings and anonymity in setting up trusts in South Dakota.

Despite the United States government’s criticism of the use of offshore entities to conceal identities and its implementation of AML and KYC programs, both U.S. citizens and foreigners—including individuals accused of money laundering, collusion and exploitation—have used the American trust industry to conceal assets.¹⁹ Indeed, of the 206 U.S.-based trusts identified—which are linked to 41 countries and valued at US$1 billion—approximately 30 are connected to people or companies accused of fraud, bribery or human rights abuses.²⁰ When questioned, the Director of the South Dakota Division of Banking said that trust companies are required to confirm the identities of all customers and that additional checks are required for foreigners.²¹ Nevertheless, the United States is the only major country that has not yet signed on to the Common Reporting Standard (“CRS”), which facilitates information sharing among governments about assets held by foreigners.²²

In another revelation, the Papers showed that two high-profile Americans who are enmeshed in criminal cases (including a conviction for murder) and related lawsuits allegedly established trusts in Belize so that their assets could be outside of the reach of victims trying to enforce judgments against them.²³ This reportedly was made possible by a former Belizean Attorney General, Glenn Godfrey, and his influence on Belize’s trust laws.²⁴ According to Wired, in 2000 Godfrey said, “If a man doesn’t want to pay his taxes, that’s not a crime against humanity. That’s between him and his government.”²⁵ Though neither Godfrey nor his company, CILTrust, have been charged with wrongdoing, they have been identified by federal prosecutors in cases charging Americans with violations of U.S. criminal laws.²⁶

Bank Secrecy Act’s KYC Requirements

The Bank Secrecy Act (“BSA”) requires United States financial institutions—which include banks, investment companies, broker-dealers, insurance companies and future commission merchants²⁷—to implement KYC programs to “prevent the laundering of money and the financing of terrorism.”²⁸ Specifically, the BSA requires financial institutions to implement procedures that (i) verify the identity of a person seeking to open an account, (ii) maintain records of the information used to verify the person’s identity, and (iii) consult lists of known or suspected terrorists to determine whether a person seeking to open an account appears on those lists.²⁹ A “person” seeking to open an account may be an individual, corporation, partnership, trust, estate, or any other entity recognized as a legal person.³⁰ At a minimum, a financial institution must obtain the “person’s” (i) name, (ii) date of birth, (iii) address, and (iv) an identification number.³¹ Additionally, under the “Beneficial Ownership Rule” promulgated by the Financial Crimes Enforcement Network (“FinCEN”),³² financial institutions are also required to identify the natural person who is the beneficial owner of the legal entity.³³  

With these requirements in place, it would appear that United States financial institutions have the ability and the obligation to identify and filter out clients engaged in (potential) wrongdoing. The revelations of the Pandora Papers suggest, however, that persons and entities are continuing to evade these rules and requirements.³⁴

Legislative Proposals

The embarrassing diplomatic and potential legal problems that have surfaced from the Pandora Papers could also prove to be a political tool for Washington, D.C. This is especially so since the Biden Administration has a pending legislative proposal as part of its US$3.5 trillion reconciliation bill that would require financial institutions to increase their reporting on customer account data in order to generate increased revenue through federal tax dollars.³⁵ Specifically, the proposal would allow the Internal Revenue Service (“IRS”) to track gross inflows and outflows of financial accounts to increase visibility and encourage voluntary tax compliance.³⁶ The original proposal required banks to account for gross inflows and outflows of more than US$600 to the IRS.³⁷ However, recent criticism by financial institutions that such reporting would be unduly burdensome and inefficient as it would, in essence, cover almost all of their customers, has swayed Democratic leaders to increase the applicable threshold to US$10,000.³⁸

Time will tell whether the exposure of the Pandora Papers might impact pending or future legislation or otherwise lead to increased regulatory scrutiny over an already highly regulated financial industry. For now, the Pandora Papers can be expected to garner national and international attention from government regulators and law enforcement partners of all kinds.

Footnotes

1) See Emilia-Diaz Struck et al., Pandora Papers: An offshore data tsunami, INTERNATIONAL CONSORTIUM OF INVESTIGATIVE JOURNALISTS, (October 3, 2021), https://www.icij.org/investigations/pandora-papers/about-pandora-papers-leak-dataset/

2) See id. 

3) Id. 

4) See id. 

5) See id. 

6) The 2016 Panama Papers involved 2.6 terabytes of data from a single provider, the former Mossack Fonseca law firm. See Struck, supra note 1.

7) The 2017 Paradise papers involved 1.4 terabytes of data, largely from an offshore law firm, Appleby, Asiaciti Trust, a Singapore-based provider, and government corporate registries in 19 secrecy jurisdictions. See Struck, supra note 1. 

8) See Struck, supra note 1. 

9) See Struck, supra note 1; see also Will Fitzgibbon, While foreign aid poured in, Jordan’s King Abdullah fuelled $100m through secret companies to buy luxury homes, INTERNATIONAL CONSORTIUM OF INVESTIGATIVE JOURNALISTS, (October 3, 2021), https://www.icij.org/investigations/pandora-papers/jordan-king-abdullah-luxury-property/; Sean McGoey, 5 ways celebrities in the Pandora Papers use the offshore system, INTERNATIONAL CONSORTIUM OF INVESTIGATIVE JOURNALISTS, (October 4, 2021), https://www.icij.org/investigations/pandora-papers/shakira-sachin-julio-celebrities-use-offshore/ 

10) See Struck, supra note 1.

11) See Spencer Woodman & Brenda Medina, Governments vow investigations within hours of Pandora Papers revelations, INTERNATIONAL CONSORTIUM OF INVESTIGATIVE JOURNALISTS, (October 4, 2021), https://www.icij.org/investigations/pandora-papers/governments-vow-investigations-within-hours-of-pandora-papers-revelations/.   

12) See Fitzgibbon supra note 9. 

13) See Scilla Alecci, Czech Prime Minister secretly bought lavish French Riviera estate using offshore companies, INTERNATIONAL CONSORTIUM OF INVESTIGATIVE JOURNALISTS, (October 3, 2021), https://www.icij.org/investigations/pandora-papers/czech-prime-minister-andrej-babis-french-property/

14) See Struck, supra note 1 

15) See Will Fitzgibbon, Debbie Cenziper & Salwan Georges, Suspect foreign money flows into booming American tax havens on promise of eternal secrecy, INTERNATIONAL CONSORTIUM OF INVESTIGATIVE JOURNALISTS, (October 4, 2021), https://www.icij.org/investigations/pandora-papers/us-trusts-offshore-south-dakota-tax-havens/

16) See Felix Salmon, How South Dakota became a global tax haven, AXIOS, (October 6, 2021), https://www.axios.com/south-dakota-global-tax-haven-5120d206-20ab-4cc1-ba91-d1d59fe22487.html 

17) See id. 

18) See id.  

19) Fitzgibbon, Cenziper & Georges, supra note 15.  

20) Fitzgibbon, Cenziper & Georges, supra note 15.  

21) Fitzgibbon, Cenziper & Georges, supra note 15. 

22) Salmon, supra note 16. 

23) See Will Fitzgibbon & Debbie Cenziper, Rogue Americans shielded money offshore, eluding victims and criminal investigators, INTERNATIONAL CONSORTIUM OF INVESTIGATIVE JOURNALISTS, (October 4, 2021), https://www.icij.org/investigations/pandora-papers/belize-american-offshore-glenn-godfrey-law-firm/ 

24) See id.

25) See id. 

26) See id. 

27) 31 U.S.C. §§ 5312(a)(2) and 5312(c)(1)(A). 

28) 31 U.S.C. § 5311(2).  

29) 31 U.S.C. § 5318(l)(2). 

30) 31 C.F.R. § 1020.100(c)(1).  

31) 31 C.F.R. § 1020.22(a)(2)(i) 

32) Pursuant to the BSA’s mandate, FinCEN promulgated specific regulations to ensure compliance. See 31 CFR Parts 1010, 1020, 1023, 1024, and 1026. 

33) 31 C.F.R. § 1010.230(b). 

34) Fitzgibbon, Cenziper & Georges, supra note 15. 

35) See General Explanations of the Administration’s Fiscal Year 2022 Revenue Proposals, U.S. DEP’T OF TREASURY,  at 86-89 (May 2021), https://home.treasury.gov/system/files/131/General-Explanations-FY2022.pdf. 

36) See id. at 88. 

37) See id. at 88. 

38) Additional exceptions are also being examined. See Laura Davison & Allyson Versprille, Banks Enlist Customers to Kill Biden’s Account Data Reporting, BLOOMBERG LAW NEWS, (September 29, 2021), https://www.bloomberg.com/news/articles/2021-09-29/banks-enlist-customers-to-kill-biden-s-account-data-reporting.