Global Policy Forum

The Truth about Tax Havens: Parts 1 and 2

Tax havens play a vital role in the global financial architecture, used by institutional investors and drug kingpins as a way to mask their assets and cheat the system. They also function as conduits to the large financial centers in New York, London, and Hong Kong. Despite the pivotal role they play in terms of managing money for the wealthy, surprisingly little is understood about how these areas function.




By Nicholas Shaxson

The Guardian
January 8-9, 2011


In 2009 I met a former private banker, Beth Krall, to explore a question that had been nagging me: how do bankers who shelter the wealth of gangsters and corrupt politicians justify what they do? We met one Sunday in Washington DC. She had left private banking and joined the non-governmental sector. Dressed in a striking black-and-white coat, she still looked very much the stylish international financier. Aged 47, and with nearly 24 years in the banking business, Krall (not her real name) was still coming to terms with her past life.

Krall's last offshore posting was in the Bahamas, an island archipelago with over 300,000 residents that has been an important offshore centre since the golden age of American organized crime. A few months earlier, a practitioner in the Caymans had warned me to watch out for my personal safety if I went "asking all these questions" in the Bahamas. Krall said she was unsure what might happen to her if she went back, as she was partly breaking the private bankers' code of silence. "I don't want to have concrete shoes put on me," she said without smiling. One reason for her fear was something that had angered her in the first place: so many of the people she dealt with were powerful members of society in their home countries.

Krall took her banking exams straight after school, and then worked for a number of banks before moving to Cititrust in the Bahamas, where she ran evaluations and accounting for their mutual funds business.

From this point, Krall declined to name her employer. She became a client relationship manager with the private banking arm of a well-known international bank in the Bahamas. They worked with what are euphemistically known as managed banks or shell banks, an offshore speciality. These have no real presence where they are incorporated, so they can escape supervision by regulators.

The terrorist attacks on 11 September 2001 prompted the US to legislate against shell banks. A bank in the Bahamas must now employ two senior bankers and keep its books and records there to be judged real enough to do business. "That means a bank maybe with a room or suite in a building, with two people in it - that's a bank now," Krall said. She directed me to the website of a Bahamas-based trust company that will provide you with exactly that: the appearance of being a real bank - including two staff members as directors and a place to keep the books. Such a setup can allow business almost as usual, yet still tick the regulators' boxes.

Krall moved to a big European bank, again as a client relationship manager - in effect, someone who finds wealthy clients and keeps them happy. Trawling for business, she was routinely pointed towards Latin America, where she travelled frequently. "On the immigration form you would write that you were going for pleasure, though your suitcase would be full of business suits and portfolio evaluations, or marketing materials and presentations explaining the advantages of a trust in the Bahamas." The client's name didn't appear on their portfolio evaluation: in fact, the bank would not even record it as the account name. It was nerve-racking, sometimes, going through airports, but she always got through unchallenged.

Despite her growing qualms, Krall ended up working for a boutique Swiss private bank in the Bahamas. This was no ordinary bank, and was the only one where she actually saw a suitcase full of cash. "My bank never once had a client walk through the door," she said. "The bankers and their clients go on big-game hunting trips, or to the ballet in Budapest. That is where it happens."

Her colleagues hailed from old European aristocratic circles. While Krall was perfectly good at her job and had close working relationships with top lawyers, asset managers and so on, a gap remained. "They went to parties with royalty, with ambassadors," she said. "I wasn't in their circle."

At the time, laws in the Bahamas were being tightened a little, following a feeble global crackdown, and she moved sideways in the bank to work as a compliance officer. These days, offshore bankers make a big show of their know-your-customer rules to keep out the bad money. Depositors may have to supply a certified copy of a passport, for example, and divulge where their money came from. Jurisdictions such as the Bahamas and the Cayman Islands put these requirements into their statutes, and banks employ compliance officers such as Krall to enforce this. That, at least, is the theory. But there are many ways around the restrictions.

Krall was supposed to check for suspicious movements through the accounts - of which there were plenty. She raised many red flags. "They [her managers] would say, 'This was a commission'." Were these bribes? Commissions on what? "I went back, and never got an answer." One Swiss-based trust company that had a relationship with her bank displayed almost nothing on its website, bar some photos of a nice fountain in Geneva. "The crap they brought to us was unbelievable. There is no way a responsible trustee should take this on. You would have no idea who the trust settlers were, what the assets were or where they came from. I objected strongly, but the bank took them on."

There is something about island life that stifles dissent. In the island goldfish bowl, you cannot hide. The ability to sustain an establishment consensus and suppress troublemakers makes islands especially hospitable to offshore finance, reassuring international financiers that local establishments can be trusted not to allow democratic politics to interfere in the business of making money.

John Christensen, Jersey's former economic adviser-turned-dissident, describes encountering extremist right-wing offshore attitudes when he returned to his native island in 1986 after working overseas as a development economist. It was the year of the City of London's Big Bang of financial deregulation, and he found the tax haven amid a spectacular boom. Old houses, tourist gift shops and merchant stores in Jersey's beautiful capital St. Helier were being knocked down and replaced by banks, office blocks, car parks and wine bars. He went to an employment agency and they told him he could have any job he wanted. The following day he had three offers. In his work he soon became aware of practices such as reinvoicing, in which trading partners agree on a price for a deal, then record it officially at a different price in order to shift money secretly across borders.

As the river of money flowing into Jersey became a tide, he expressed unease about the origins of some of it, much of it from Africa, but he was brushed aside.

The concentration of extremist attitudes in Jersey was self-reinforcing, as Christensen explains. "Most liberal people like myself left," he said. "My socially liberal friends from school, almost all of them left Jersey to go to university, and almost all of them didn't go back. I can't tell you how dark it felt." He almost left, but was persuaded to stay by academic researcher Mark Hampton, who was putting together a framework for understanding tax havens and convinced him how important it was to understand the system from the inside. "I went undercover," Christensen said, "not to dish the dirt on individuals and companies, but because I couldn't understand it - and none of the academics I spoke to could either. There was no useful literature."

Jersey is riddled with elite, secretive insider networks, typically linked to the financial sector. After being appointed economic adviser in 1987, Christensen found that many people who came to see him wanted him to join their Masonic lodge, and gave him the secret signal. "Their thinking is very much of the old-boy network - you are either one of us or you are against us," he continued. "It means they can trust you to do the right thing without having to be told - an insidious meaning of the word 'trust'."

Unaccountable elites are always irresponsible, and I got my own flavor of Jersey's moldy governance on the first day of a visit in March 2009, when the Jersey Evening Post carried a front-page story headlined "States in shambles", referring to the States Assembly, Jersey's parliament. "The States resembled a school playground yesterday as foul language and personal insults flew across the chamber," it said. Senator Stuart Syvret, a popular but controversial politician, had complained in the assembly that the health minister was whispering in his ear.

Syvret, the newspaper reported, stood up and said: "On a point of order, I am sorry to interrupt the minister. But the minister to my right, Senator Perchard, is saying in my ear: 'You are full of fucking shit, why don't you go and top yourself, you bastard.'" Senator Perchard responded by saying: "I absolutely refute that. I am just fed up with this man making allegations." The BBC, which was broadcasting the sitting live, had to apologize for the language.

Syvret has been a regular victim of efforts to suppress dissent. "Any anti-establishment figure here is bugged," said Syvret. "There is a climate of fear. Anyone who dares disagree is anti-Jersey, an enemy of Jersey. You are a traitor, disloyal. There is all this Stalinist propaganda." A few weeks after my visit eight police officers arrested Syvret and held him for seven hours while they ransacked his home and personal files, including his computer.

In October 2009, having been accused of leaking a police report about the conduct of a nurse, Syvret fled to London and claimed asylum at the House of Commons, saying he could not get a fair trial in Jersey. British Liberal Democrat MP John Hemming put Syvret up in his flat, declaring that "we should not allow him to be extradited, to be prosecuted in a kangaroo court". When Syvret returned in May 2010 to fight an election he was arrested at the airport. "This is a society with no checks and balances, run by an oligarchy," Syvret said. "It is a one-party state, and it has been for centuries."

At the Smugglers' Inn on Jersey's beautiful coast, I sat with John Heys, a tour guide at the world-famous Durrell zoo, and his friend Maurice Merhet, a retired printer and pig farmer. The two had spoken out - in letters to the Jersey Evening Post and in other forums - and have been decried, publicly and regularly, as traitors. Both described the same climate of fear that Syvret had: the dread of being squeezed out of a job, of never getting anywhere, of being blacklisted.

Heys showed me an email from a government minister to a dissident friend who had, in a cheeky Christmas message to the minister, pointed out the large sums stashed away in Jersey amid global poverty. The minister responded - mistakes included: "Hi Traitor, Please refrain from sending me your unsolicited garbage ... I am surprised you still decide to live in this 'tax haven' island ... ifs its so bad why do you not leave to live somewhere else ... good riddance I would say ... but perhaps NOT because you get a damm good living here, no doubt perhaps funded by banks and your mortgage lender ... in fact my family have lived in Jersey for several generations and I am so very proud of it but to listen to traitorous idiots like you makes me furious. I would not have the nerve to wish you a happy christmas in fact I hope you continue to live a miserable existence in your traitorous world."

One night in 1996, towards the end of his time in Jersey, Christensen opened the books for a reporter from the Wall Street Journal, who was investigating an alleged fraud ring involving American investors and a Swiss bank operating out of Jersey. The story, headlined "Offshore hazard: Isle of Jersey proves less than a haven to currency investors", ran on the front page several months later. Jersey's finance industry and politicians went into spasm. This was one of the first times Jersey's supposedly clean and well-regulated finance sector had been challenged in a serious global newspaper. The end of the article quoted a senior civil servant. Everyone in Jersey was sure it was Christensen. He knew that, in talking to the reporter, he had effectively resigned.

Finance can take advantage of insularity, timidity and moral shortsightedness, but the ethos of the Jersey establishment derives ultimately from the offshore industries and their onshore controllers, not from innate island character. Offshore repression can happen in larger jurisdictions, too. Rudolf Elmer, a Swiss banker who had worked for banks in several offshore centres before becoming a whistle-blower on some of the corruption he had seen, felt the pressure in Switzerland, a country of eight million people.

In 2004 Elmer noticed two men following him to work. Later, he saw them outside his daughter's kindergarten, then from his kitchen window. His wife was followed in her car. The men offered his daughter chocolates in the street and late at night drove a car at high speed into the cul-de-sac where he lived. The stalking continued, on and off, for more than two years. The police said there was nothing they could do. In 2005, they searched his house using a prosecutor's warrant, and he was imprisoned for 30 days, accused of violating Swiss bank secrecy, which is, as he put it, "an official violation, like murder".

"I was thinking of suicide at this stage," he said. "I would be looking out of the window at 2am. They intimidated my wife, children and neighbors. I was an outlaw. I was godfather to a child whose father is in finance. He said I have to stop - 'you are a threat to the family'." A relative was pressured at work to avoid contact with Elmer; after one warning he left the office in tears. "I was bloody naive to think that Swiss justice was different," Elmer said. "I can see how they might control a population of 80,000 people in the Isle of Man, but eight million? How can a minority in the banking world manipulate the opinion of an entire country? What is this? The mafia? This is how it works. Jersey, the Cayman Islands, Switzerland: this whole bloody system is corrupt."

Part II

The offshore world is all around us. More than half of world trade passes, at least on paper, through tax havens. More than half of all banking assets and a third of foreign direct investment by multinational corporations are routed offshore. An impression has been created in sections of the world's media, since a series of stirring denunciations of tax havens by world leaders in 2008 and 2009, that the offshore system has been dismantled, or at least tamed. In fact quite the opposite has happened. The offshore system is in very rude health - and growing fast.

It is no coincidence that London, once the capital of the greatest empire the world has known, is the centre of the most important part of the global offshore system. The City's offshore network has three main parts. Two inner rings - Britain's crown dependencies of Jersey, Guernsey and the Isle of Man; and its overseas territories, such as the Cayman Islands - are substantially controlled by Britain, and combine futuristic offshore finance with medieval politics. The outer ring comprises a more diverse array of havens, such as Hong Kong, which are outside Britain's direct control but have strong links.

This network of offshore satellites does several things. First, it gives the City a truly global reach. The British havens scattered all around the world's time zones attract and catch mobile international capital flowing to and from nearby jurisdictions, just as a spider's web catches passing insects. Much of the money attracted to these places, and the business of handling that money, is then funneled through to London.

Second, this British spider's web lets the City get involved in business that might be forbidden in Britain, providing sufficient distance to allow financiers in London plausible deniability of wrongdoing. Much (but not all) of the financial activity hosted in these places breaks laws and avoids regulation elsewhere.

The three crown dependencies in the inner ring are substantially controlled and supported by Britain but have enough independence to allow Britain to say "there is nothing we can do" when other countries complain of abuses run out of these havens. They channel very large amounts of finance up to the City of London: in the second quarter of 2009 the UK received net financing of $332.5bn (£215bn) just from its three crown dependencies. Jersey Finance promotional literature makes the point plainly. "Jersey," it says, "represents an extension of the City of London."

The 14 overseas territories, the next ring in the spider's web, are the last surviving outposts of Britain's formal empire. With just a quarter of a million inhabitants between them they include some of the world's top secrecy jurisdictions: the Cayman Islands, Bermuda, the British Virgin Islands, the Turks and Caicos islands and Gibraltar.

Just like the crown dependencies, the overseas territories have close but ambiguous political relationships with Britain. In the Caymans the most powerful person is the governor, appointed by the Queen. The governor handles defense, internal security and foreign relations; he appoints the police commissioner, the complaints commissioner, the auditor general, the attorney general, the judiciary and other top officials. The final appeal court is the privy council in London.

It is the world's fifth largest financial centre, hosting 80,000 registered companies, more than three-quarters of the world's hedge funds, and $1.9tn (£1.2tn) on deposit - four times as much as in New York City banks.

The third, outer ring of the British spider's web includes Hong Kong, Singapore, the Bahamas, Dubai and Ireland, which are fully independent though deeply connected to the City of London.

In the Caribbean, the modern offshore system traces its origins back to the time when organized crime took an interest in the US tax code.

When Al Capone was convicted of tax evasion in 1931, his associate Meyer Lansky became fascinated with developing schemes to get mob money out of the US in order to bring it back, drycleaned. A slick mafia operator, Lansky would beat every criminal charge against him until the day he died in 1983. Lansky began with Swiss banking in 1932, where he perfected the loan-back technique.

First he moved money out of the US in suitcases, diamonds, airline tickets, cashiers' cheques, untraceable bearer shares or whatever. He would put the money in secret Swiss accounts, perhaps via a Liechtenstein Anstalt (an anonymous company with a single secret shareholder) for extra secrecy. The Swiss bank would then loan the money back to a mobster in the United States and the money would return home, clean.

By 1937 Lansky had started casino operations in Cuba, outside the reach of the US tax authorities, and he and his friends built up gambling, racetrack and drugs businesses there. It was, effectively, an offshore money-laundering centre for the mob.

Lansky then moved to Miami and plotted to find his next Cuba, small enough and corrupt enough to be able to buy the political leadership, and close enough to the United States for the gamblers to come and go at will.

The Bahamas, the old staging post for British gun-running to the southern US slave states of the Confederacy, was perfect. Lansky set about making this British colony, now dominated by an oligarchy of corrupt white merchants known as the Bay Street Boys, the top secrecy jurisdiction for north and south American dirty money.

A quaint memo from a Mr. WG Hulland of the Colonial Office to a Bank of England official in 1961, just as Lansky began major operations there, illustrates the uneasy nature of this encounter between the British upper classes and American organized crime: "We feel that this [lack of provision of an effective regulatory system] might be a grave omission, since it is notorious that this particular territory, in common with Bermuda, attracts all sorts of financial wizards, some of whose activities we can well believe should be controlled in the public interest."

London did nothing, and Lansky built his empire. Yet many locals were unhappy. In 1965 Lynden Pindling, a populist Bahamas politician, threw the ceremonial speaker's mace out of a parliament window in a dramatic power-to-the-people gesture. He was elected prime minister in 1967 on a platform that included hostility to gambling, corruption and the Bay Street Boys' mob connections.

Yet as it happened there was a reassuringly British place just next door, where the locals were far more friendly: the Cayman Islands.

Milton Grundy, an influential Caribbean offshore lawyer and author of several books on offshore finance, remembers first arriving in the Caymans. Cows wandered through the town centre, there was one bank, one paved road and no telephone system. In 1967 the Caymans published its first trust law, which Grundy drafted, and which a British Inland Revenue official subsequently said "blatantly seeks to frustrate our own law for dealing with our own taxpayers". Within just a few months Grand Cayman was connected to the international phone network and the airport was expanded to take jet aircraft.

Some have argued that Britain set up the offshore networks simply out of a short-sighted desire to find a way for its overseas territories to pay their way in the world. After the second world war, an exhausted Britain found that its empire, once a source of great profits, was becoming more expensive and difficult to run, as locals began to agitate for independence. But the evidence points to a different, more troubling explanation for Britain's decision to turn its semi-colonies into secrecy jurisdictions.

The archives tell a consistent story about how the tax havens grew: private sector operators working in a zone of extreme freedom began to call the shots, with little opposition from Britain and its inexperienced emissaries.

In the archives, two schools of opinion emerge within the British civil service. On one side sits the Treasury, and especially its tax collectors in the Inland Revenue, who virulently opposed tax havenry and found the Cayman Islands especially obnoxious. The US authorities were clearly highly vexed too, and the British Foreign Office broadly opposed havenry, though its position was more nuanced.

On the other side sits the Bank of England, the most vociferous cheerleader for the new arrangements, and its far less influential supporter, the British overseas development ministry, which seems unperturbed by the possibility that local tax haven activities might foster massive capital flight from developing countries elsewhere. Battle lines were drawn; the exchanges become vigorous and even acrimonious.

The Inland Revenue was especially alarmed, while their mandarin bosses in the Treasury showed some, but rather less, concern. They put together a working party, whose report in 1971 said Britain should, in effect, stop encouraging tax havenry in its overseas territories, which in the case of the Caymans had become, as one internal memo in London put it, "quite uncivilized".

A letter marked secret from the Bank of England dated 11 April 1969 gives a better sense of the forces driving the changes in the Caribbean.

"We need to be quite sure that the possible proliferation of trust companies, banks, etc, which in most cases would be no more than brass plates manipulating assets outside the islands, does not get out of hand. There is of course no objection to their providing bolt holes for non-residents but we need to be sure that in so doing opportunities are not created for the transfer of UK capital to the non-sterling area outside UK rules."

The Bank of England's main concern at this time was that the new Caribbean centres were weak points: sources of financial leakage outside the sterling area. So in 1972 Britain shrank the area to Britain, Ireland and the crown dependencies, excluding the new havens.

The year the sterling area shrank, the British officials working against tax havens disappeared from the archive files. Their replacements seemed unaware of the 1971 report and only discovered it in 1977, sitting on the shelf, unimplemented. Again they expressed concerns - and again nothing was done. History repeated itself within and between the departments, all in less than 10 years. And, each time, the Bank of England fought the tax haven corner.

"This is no tropical paradise," said Kenneth Crook, the newly arrived British governor of the Cayman Islands in 1972. "I could enlarge, in terms of a magnificent but mosquito-ridden beach; of a fairly new but rather ill-designed and sadly neglected house; of a pleasant but very untidy little town; of swamp clearance schemes which generate smells strong enough to kill a horse; of an office which will one day ere long collapse in a shower of termite-ridden dust."

But on politics, and the strange relationship between Britain and its little quasi-colony, his tone hardens. "Caymanians don't want independence," Crook wrote. "They don't want internal self-government either - they are very unwilling to trust each other with effective power ... they quite well understand that the British connection gives them a status which they would otherwise not command."

Nothing of substance seems to have changed, as a senior Caymanian politician, who asked not to be named, explained to me in 2009. "The UK wants to have a significant degree of control," he said, "but at the same time it does not want to be seen to have that control. Like any boss, it wants influence without responsibility; they can turn around when things go wrong and say 'it's all your fault' - but in the meantime they are pulling all the strings."

This attitude of the locals towards Britain reassures investors, but the political bedrock underpinning the world's fifth biggest financial centre is Britain's role. If Caymanians gained full control, most of the money would flee.

While these changes were happening in the Caribbean, something similar was under way far closer to the City of London, in the crown dependencies. A constituent's letter forwarded and endorsed by Tony Benn, then an MP, to the then chancellor, Denis Healey, about a tax conference in Jersey, gives a flavor: "I am somewhat surprised to see a Mr. Gent from the Bank of England giving advice on how to avoid paying tax. I wonder if this is really part of the Bank of England's duties? Mr. Gent suggests that the Bank of England will not be prepared to pass on information required by the Inland Revenue! Does the UK Treasury have no control over the Bank of England? Surely Bank employees should not be working against government policy? And just what sort of arrangements and deals are made at these events 'behind the scenes'?

"It really is just a bit too sordid to be true."

As in the Caribbean, offshore banking blossomed here from the 1960s, when merchant banks such as Hambros and Hill Samuel opened for deposits.

Foreign travel was getting easier and more British expatriates opened accounts in Jersey, where the banks were reliable and comfortingly British, but where bank interest was untaxed and secret. Many did not declare their income to their countries of residence, often poverty-racked African nations, knowing they would not be caught.

Martyn Scriven, secretary to the Jersey Bankers' Association, described how Jersey's network grew. "The biggest business developer is client recommendation," he said. "The client will say, 'I'm happy, and I'd like to introduce you to my friend' - and you build it up like that. You get some seriously interesting people ... someone who goes abroad as a rigger 20 years ago for Shell may now be in charge of the company's west Africa operations ... We gather deposits from wealthy folk all around the world, and the bulk of those deposits are sent to London. Great dollops of money go into London from here."

As in the Caymans, Jersey has carefully protected the ambiguous relationship with Britain. Jersey's most senior public sector officials are appointed in London; its laws are all approved by the privy council in London, and Britain handles Jersey's foreign relations and defense, and the lieutenant governor represents the Queen.

As in the Caymans, Britain goes to great lengths to hide its control. And, as with the Cayman Islands, the relationship with the mother country reassures the wealthy and the financial services industry that Britain will step in if needs be, to protect the tax haven from external attacks. Their money is safe in Jersey.


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