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A new US President has been elected whose platform on international issues is somewhat unconventional. In this new era, will Middle-Eastern banks face increased risks of US legal and regulatory enforcement, particularly in the areas of tax fraud and money laundering 

In the following article, Stephen Huttler, the Senior Partner at PillsburyWinthrop Shaw Pittman, a leading international law firm headquartered in Washington, DC, describes US plans to pursue financial institutions they suspect of facilitating tax evasion or money laundering overseas.

Stephen Huttler
Stephen Huttler

US citizens, in a tax system that is almost unique among developed nations, are taxed by the US on their world-wide income regardless of where they live.Similarly, US residents are taxed on their world-wide income even if they are not US citizens.  Unsurprisingly, some US citizens and residents have sought to evade their tax obligations by concealing their assets in non-US banks, especially those based in jurisdictions with a reputation for banking secrecy and client confidentiality.   In 2010, as a response to these activities, the United States Congress enacted the Foreign Account Tax Compliance Act (FATCA).

One of the primary jurisdictions that used to be favoured by those seeking to avoid tax was Switzerland.  However, as a result of concerted enforcement actions by the US Department of Justice (DOJ) over the past several years, much of the Swiss banking industry has resolved their issues with the US authorities,provided information to the DOJ about their US customers, and changed their business model going forward to avoid onboarding of customers who are not tax compliant in their home jurisdictions.

Following on from their success in Switzerland, we expect the DOJ to now turn its sights to other locations, many of them in the Middle East. As a result, it is important for Middle-Eastern banks to understand what the DOJ did in Switzerland.

On August 29, 2013, the DOJ and the Swiss Federal Department of Finance announced the ‘Program for Non-Prosecution Agreements or Non-Target Letters for Swiss Banks’ (the ‘Program’). Under the Program, the DOJ held out an offer of anon-prosecution agreement (NPA) concerning potential tax-related offenses under US law to Swiss banks who made broad disclosures about their US banking practices and their related account holders.

Among the disclosures the DOJ required under the Program was information concerning

  1. accounts in which US taxpayers held an interest, that were open as early as August 2008,
  2. potential misconduct by bank employees and executives, including cross-border activities,
  3. names of banks to which money was transferred when US related accounts were closed.

The DOJ required each bank participating in the Program to pay a penalty based upon a percentage of the amount of assets under management for ”US-related accounts,”though such penalties could be reduced if the bank provided mitigating evidence. ‘Mitigating evidence’ could include, for example, evidence that an account had been declared to US authorities via timely reporting by the taxpayer or through the taxpayer’s participation in a voluntary disclosure program encouraged by the bank.

On January 27, 2016, the DOJ announced that it had signed a NPA with the final participating Swiss bank.  In total, almost 80 Swiss banks participated in the Program, paying an aggregate penalty of $1.37 billion (with individual penalties as high as $211 million and $188 million).Through the Program, the DOJ acquired a wealth of information about offshore accounts and their use by US taxpayers as vehicles for tax evasion.This information­– particularly when aggregated with information from approximately 60,000 US taxpayers who participated in a voluntary disclosure program – gives the DOJ clear indications about which banks to pursue for potential tax-related offenses outside Switzerland.

Although the DOJ has remained silent about the next jurisdiction it plans to pursue, or whether it will offer a Program similar to the Swiss bank Program, Acting Assistant Attorney General Caroline Ciraolo indicated on several occasions in 2016 that the DOJ will continue pursuing investigations beyond Switzerland and warned institutions that have facilitated account concealment and tax evasion to anticipate DOJ investigations. She encouraged such institutions to voluntarily disclose criminal activity before the DOJ begins its investigations.

Banks in the Middle East are increasingly viewed as potential targets for such DOJ investigations.Similar to Switzerland, many Middle Eastern countries—including UAE, Qatar, Oman, Kuwait, Bahrain and Saudi Arabia – levy income and other taxes at a low to non-existent rate on foreigners. These tax-convenient locations attract US taxpayers seeking to avoid paying US taxes on their worldwide income.  In addition, banks in two Middle Eastern countries – Lebanon and Bahrain – offer services with a high level of secrecy, with the result that foreign governments are thwarted from scrutinising transactions and identifying account holders.

Moreover, a number of Swiss banks that participated in the Program are linked to affiliate banks in the Middle East. The DOJ may have gained access to relevant information about those affiliates.  The recent disclosures of the ‘Panama Papers’ have similarly delivered to the DOJ a treasure trove of information about possible tax evaders and their affiliates. This includes information identifying shell companies or other entities used to obscure the nature, source, and ownership of funds.

The regulatory enforcement of US tax laws is largely pursued and conducted by non-partisan bureaucrats at the DOJ, with political and policy implications addressed at political levels within the DOJ and by the US State Department working with the particular affected jurisdictions, both to facilitate resolutions and to avoid diplomatic conflicts.  With respect to the incoming Trump administration, while it is difficult to anticipate specific policy positions, it seems clear that industries and banks in “disfavoured nations” can expect to be treated less sympathetically and diplomatically than may have been the case in the outgoing or prior administrations. Should the Arab nations of the Middle East become disfavoured by this administration, rigorous enforcement against Arab banks – including indictments and seizures of correspondent bank accounts within the US – can reasonably be expected.

In addition to Arab banks, Israeli banks appear to be directly in the cross-hairs of the DOJ.  Many individuals are dual citizens of both the US and Israel, given Israeli policy of awarding citizenship to Jews seeking to reside in Israel.  The major Israeli banks, including their Swiss affiliates, have been and continue to be pursued by the DOJ, for facilitating the concealment of accounts and income by US citizens.

In sum, Middle-Eastern banks should anticipate increased scrutiny by US authorities, even if they are currently FATCA compliant, with potentially severe consequences if they are found to have facilitated tax fraud by US persons.  These banks would be prudent to conduct internal reviews in the near future to determine whether there is cause for concern.  It is anticipated that a number of banks will voluntarily approach the DOJ to self-disclose any relevant violations. 

Increased Focus on Money Laundering 

Similarly, Middle-Eastern banks should also expect an increase in anti-money laundering (AML) activity by the US authorities, including the exercise of the DOJ’s international capabilities.

In recent years, many foreign banks with branches in the US have come under investigation by the DOJ for allegedly evadingsanctions requirements, or even for facilitating the laundering of illicit proceeds. Some of these investigations have resulted in astronomical fines and serious reputational damage.

Foreign banks thatdo not have a branch in the USmay still be exposed to US jurisdiction through their correspondent banking relationships. As a result, in the present environment, US financial institutions are likely to require assurances from foreign banks that they have sufficient AML controls to detect potential illicit activity. To the extent that foreign banks cannot give such assurances, many US banks will simply choose to ‘de-risk’ and not transact business in certain jurisdictions.

Importantly, money laundering statutes in the United States expressly provide for extraterritorial applicability over conduct covered by the statute if the conduct is by a US citizen, or in the case of a non-U.S. citizen, if the conduct occurs in part in the US and the value of the funds involved exceed $10,000.

In practice, any evidence that the money originated in, ultimately returned to, or passed through the US is sufficient for jurisdiction in the US. Money laundering necessarily involves financial transactions using funds generated by a ‘specified unlawful activity’, to (i) promote additional specified unlawful activity, (ii) conceal the nature, source, or ownership of the funds, (iii) evade State or federal reporting requirements, or (iv) evade taxes on the income produced by the specified unlawful activity. The term “specified unlawful activity’ includes a very long list of state, federal and foreign crimes, including bribery violations of the Foreign Corrupt Practices Act (FCPA).

It is also worth noting that the FCPA which, among other things, criminalises the bribery of non-US government officials remains a priority of the DOJ. As investigations of potential corruption increase, there will be more focus on ‘following the money’, thus implicating financial institutions with deficient AML controls.

As with tax issues, it is anticipated that the incoming Trump administration will pursue offenders in overseas jurisdictions without the same level of diplomatic sensitivity as may have softened such enforcement activity in prior administrations.  Again, it is possible that Middle-Eastern banks can expect a difficult period ahead.

We therefore counsel banks to ensure that their AML controls meet the highest global standards if they clear dollar transactions, even if they have no presence in the US. We also encourage them to engage with attorneys and policymakers to understand the growing implications of the extra-territorial impact of the DOJ on their business.