A matter of trust

Before he died earlier this year, Robert Brockman stood accused of multiple charges of wire fraud and money laundering in what was the biggest tax evasion case of its kind in U.S. history. During a 20-year period, he allegedly hid over $2 billion in income from the IRS in secret offshore accounts, using encrypted communications and false documents. 

A trial date to decide the fate of Brockman, the CEO of software company Reynolds and Reynolds, had been set for February 2023 following his 39-count, grand-jury indictment in 2020. According to that indictment, Brockman had woven a web of complex offshore companies and trusts to hide capital gains earned from his investments in private equity fund Vista Equity Partners. Those earnings were then allegedly funneled to secret bank accounts in Switzerland and Bermuda. [See “CEO of Multibillion-dollar Software Company Indicted for Decades-long Tax Evasion and Wire Fraud Schemes,” U.S. Department of Justice (DOJ), press release, Oct. 15, 2020 and “Robert Brockman, billionaire charged in $2 billion tax evasion case, dies at 81,” by Ken Dilanian, NBC News, Aug. 8, 2022.]

According to court documents, Brockman employed and compensated people to act as trustees and directors of the offshore structure to give the appearance that they controlled Reynolds and Reynolds and other organizations that were in fact owned by Brockman. He sent encrypted emails to communicate with the trustees and other accomplices using code names such as “Steelhead” and “Snapper” and referred to the IRS as the “house.” (See “United States of America v. Robert T. Brockman,” U.S. District Court for the Northern District of California, Oct. 1, 2020.)

Brockman also stood accused of using the tangled offshore network to hide his purchase in the secondary markets of Reynolds and Reynolds loans, which had plummeted in value in the wake of the 2007-2008 global financial crisis. A credit agreement that Brockman had signed with banks expressly prohibited such purchases. Nonetheless, he snapped up the cheap debt through Edge Capital Investments, an offshore entity set up via a trust to conceal that it was controlled by Brockman himself. (See “The Manipulative, Little Known Billionaire Who Nearly Ruined The Country’s Richest Black Person,” by Christopher Helman, Forbes, Daily Cover, Feb. 5, 2021.)

Stories of fraud associated with offshore havens and the trust vehicles used there, like the ones above, have become increasingly commonplace, especially as leaks like the Panama Papers have peeled back for public viewing how fraudsters and other criminals use this secretive world to hide wrongdoing. 

Here we examine some of the history of international trust centers (ITCs), the types of fraud perpetrated through these vehicles and the changing regulatory backdrop to make them more transparent. But first let’s look at a basic definition of a trust. 

Trusts: A definition

As defined in the ACFE’s Fraud Examiners Manual, “a trust is fiduciary relationship in which a person (the trustee) manages property for the benefit of another (the beneficiary).” Trusts are typically used to minimize or defer taxes, ensure the smooth transfer of assets from generation to generation and also limit creditors’ ability to access certain assets. They can appeal to people who wish to hide assets or ownership of those assets such as in Brockman’s case above. Foreign trusts, which are often the focus of news reports on fraud, are formed under the laws of a foreign jurisdiction. More recently, a burgeoning U.S. trust industry in states like South Dakota and Wyoming has also come under increased scrutiny for sheltering illicit assets and money laundering. (See “Suspect foreign money flows into booming American tax havens on promise of eternal secrecy,” by Will Fitzgibbon, Debbie Cenziper and Salwan Georges, ICIJ, Oct. 4, 2021.) Long before that, though, places like the Cook Islands, the Channel Islands, Belize and the British Virgin Islands enacted laws to make their jurisdictions attractive to the people who create these trusts, known as settlors. 

The history of international trusts is rightfully filled with the usual cliches about yachts, jets, and almost unbelievable tales of wealth and influence. While jurisdictions that have set themselves up as international trust centers have largely done so to spur economic growth rather than aid and abet fraud, lax regulation and secrecy have ruled the day. After decades of unbridled success, transparency initiatives have forced these jurisdictions to revisit the perception of being used as fraud enablers, and the results are instructive. First, some history.

Origins of modern offshore trusts

In the 1960s and ’70s, jurisdictions with close ties to major economies but not subject to their laws saw opportunities to create tax havens. Not only did the collapse of the Bretton Woods system mean capital could flow more freely around the globe, but people, such as those migrating back to Britain as colonies won independence, were seeking ways to avoid increasingly high marginal tax rates in advanced economies. Offshore trusts were a solution. (See “The Evolution Of Offshore: From Tax Havens To IFCs,” by Andrew Morriss and Charlotte Ku, Texas A&M University School of Law and “Archipelago Capitalism: Tax Havens, Offshore Money, and the State, 1950s-1970s,” by Vanessa Ogle, American Historical Review 122, no. 5, December 2017.)

The standard method in the British dependencies and territories was to grant “bank and trust” licenses to branches of major international banks, which were concerned about losing clients seeking more accommodative financial arrangements and local banks that wanted a piece of the action. (See “Licensing and On-Going Requirements of Banks and Trust Companies in the Cayman Islands,” by Bradley Kruger and James Heinicke, Ogier, Jan. 1, 2022.)

Before long, banks were setting up trust companies in as many jurisdictions as possible to take advantage of the various benefits that differed from island to island. Those shopping for the best trust jurisdiction focused on the following items:

• Degree of professional secrecy.
• Types of assets permitted as part of a trust fund.
• Cost of administration, including that of the almost inevitable underlying company.
• Statute of limitations on creditor protection provisions.

The last item is arguably the most relevant for an analysis of fraud, as trusts are often used to defraud a wide array of creditor types. Contrary to common belief, most of these jurisdictions’ trust laws weren’t written in pencil, and we can always look to the trust jurisprudence emanating from various countries. Offshore trusts are often situated in jurisdictions whose legal systems are based on or partly derive from England and Wales legal principles. These include Bermuda, British Virgin Islands, Cayman Islands, the Isle of Man, Guernsey and Jersey. There is also The Hague Convention on the Law Applicable to Trusts and on their Recognition, which has been ratified by multiple countries such as France, Italy and Switzerland. (See “Offshore trusts—general principles—overview,” Lexis PSL and “30: Convention of 1 July 1985 on the Law Applicable to Trusts and on their Recognition,” Hague Conference on Private International Law.)

In the U.S., courts have also clamped down on debtors and fraudsters who have tried to hoard assets and ill-gotten gains in trusts overseas. (See “Court Cases Defeating Offshore Trusts,” McCullough Law.)

Even so, offshore jurisdictions vary in how they hew to the laws of larger countries. And enforcement of court rulings and the recovery of assets can be a completely different matter. (See “Rogue Americans Stashed Assets Offshore, Eluding Victims and Impeding Investigators,” by Debbie Cenziper and Will Fitzgibbon, The Washington Post, Oct. 4, 2021.)

The Cook Islands, a group of coral atolls in the South Pacific, is an offshore trust center that’s drawn considerable attention over the years because of its ability to keep creditors and other claimants at bay.  Its court system doesn’t recognize foreign court judgments. Creditors seeking to reclaim assets must go through local courts, and the statute of limitations on asset recovery is five years. Belize and Nevis in the Caribbean have adopted similarly styled asset protection trusts. While many people use these jurisdictions for legitimate reasons, they’ve also come under fire for their secrecy and how a number of fraudsters have taken advantage of the system to hide ill-gotten gains. (See “Unlocking the Secrets of the Cook Islands,” by Leslie Wayne, ICIJ, Dec. 16, 2013; “Cook Islands, a Paradise of Untouchable Assets,” by Leslie Wayne, The New York Times, Dec. 14, 2013;  and “Nevis: how the world’s most secretive offshore haven refuses to clean up,” by Oliver Bullough, The Guardian, July 12, 2018.)

Brockman, the Texas billionaire cited in our first case above, used entities based in Nevis to hide funds from the IRS. Navinder Sarao, the London-based day trader accused by U.S. authorities of the fraud that caused the 2010 stock market “flash crash,” also recycled his funds through a Nevis-based company called Milking Markets Limited. Richard Moseley Sr., who was found guilty in 2017 of racketeering, fraud and identity-theft offenses for operating an illegal payday lending scheme, set up his company in Nevis to keep it out of the reach of U.S. law enforcement. (See “CEO of Multibillion-dollar Software Company Indicted for Decades-long Tax Evasion and Wire Fraud Schemes,” DOJ; United States of America v. Navinder Singh Sarao, U.S. District Court, Feb. 11, 2015 and “Owner Of Payday Lending Enterprise Sentenced To 10 Years In Prison For Orchestrating $220 Million Fraudulent Lending Scheme,” DOJ, June 12, 2018.)

Form over substance

Once the commoditized trust structures from the ITCs started proliferating, fraudsters began to see more opportunities. At the time, trustees in the ITCs were primarily concerned that the trusts were properly constituted under the laws of the respective jurisdiction. What that really meant was that they respected all the required formalities and rules, but they were less concerned with following vital recognition of trust issues such as tax avoidance and other fraudulent activity.

[T]he ITCs could do little wrong and, as so often happens during economic booms, they ignored the very real potential threats to this business model, which began emerging during this time.

• Nondeclaration of taxable assets and income, either by reliance on secrecy provisions or convoluted and often inaccurate legal advice.
• Transfer pricing fraud schemes, where the trustee would “own” and often “manage” entities engaged in invoicing irregularities to lower its tax burden. (See “Transfer Pricing Fraud,” Hagens Berman.)

According to the logic of the day, the ITCs weren’t obliged to be concerned about such fraud issues as they were nontax jurisdictions and didn’t have the resources to monitor fraud arising in a foreign country. Indeed, throughout the 1980s and into the ‘90s, the ITCs could do little wrong and, as so often happens during economic booms, they ignored the very real potential threats to this business model, which began emerging during this time. Arguably, the unexpected bonanza resulting from billions in Eastern European inflows following the end of the Cold War, as well as funds received from an increasingly prosperous China, blinded ITCs into believing they could weather any threats from countries belonging to the Organisation for Economic Co-operation and Development (OECD) and its satellite economies, which were starting to pay closer attention to fraud and tax evasion taking place through offshore trusts.

Unfortunately for the ITCs, ignoring fraudsters’ manipulation of the offshore system purely for their own benefit — or, in legal terms, focusing on the “form” of these transactions over their lack of economic “substance” or business purposes — worked to their detriment when defendants began to litigate fraud cases involving international trusts. (See “What is ‘Economic Substance?’” Freeman Law.)

It became inconvenient for trust jurisdictions to claim confidentiality when defrauded persons or entities clearly had recourse against local trustees. Attacking trusts involved in fraud on the basis of substance failures, the creditors either successfully argued the trust was a sham (which left the fraudster with disastrous tax consequences) or made the case that the trustees were personally culpable as co-fraudsters. Neither approach augured well for the ITCs. (See “The Sham Trust Doctrine – When will a Court Disregard a Trust for Federal Tax Purposes?” Freeman Law.)

By the first decade of this century, the OECD had run out of patience with ITCs still adhering to their confidentiality provisions and began formulating “black” and “gray” lists of uncooperative jurisdictions. Jurisdictions had to prove to the OECD (and the money-laundering watchdog Financial Action Task Force, or FATF) that they adhered to globally accepted anti-money laundering standards. The European Union followed OECD’s lead with its own lists in 2017. (See “Four countries on OECD tax haven blacklist,” Reuters, April 2, 2009 and “Cayman Islands and Oman delisted, Barbados and Anguilla added to the EU list of non-cooperative jurisdictions,” by Raluca Enache, KPMG, Oct. 6, 2020.)

Here, the economic powerhouses had the ultimate trump card — any jurisdictions remaining uncooperative would find their ability to clear major currencies curtailed significantly. This may not root out fraud entirely in the ITCs, and critics say such lists fail to address how fraudsters use European tax havens. But the measure established a great deal of confidence that fraud culprits would be identified quickly and dealt with accordingly. (See “EU countries fall short of their promises to stop tax havens,” Oxfam, Feb. 24, 2022.)

It’s not a coincidence that the number of trust companies, especially bank-owned ones, has plummeted since the increase in trust fraud cases and the introduction of OECD/FATF sanctions threats. Many bank-owned trust companies have retreated to a few strategic ITCs where they’re comfortable with the legal environment, or they decided to sell their in-house trust companies to independent trust companies altogether. At the same time, the consolidation of independent trustees based in the ITCs has been nothing short of frenetic, with each purchaser hoping that the book of clients and accounts they’re purchasing is purged of cases dating back to the ITCs’ gilded age. (See “Credit Suisse Unloads its Global Trust Business,” finews, Sept. 6, 2022 and “Rothschild Trust in MBO,” by Katharina Bart, finews, Oct. 24, 2018.)

A new world

Serious ITC practitioners are taking this challenge head-on. In addition to implementing the OECD/FATF anti-money laundering regulations, they’re asking many pointed questions about the trust mandates they’re taking on or currently administering. These questions are no longer about “forms” but go to the substance of the proposed trust:

• Does the settlor have the capacity to settle the trust, based on the legal situation in the settlor’s home country?
• Is the trustee comfortable with taking on the proposed trust assets, especially if the assets are illiquid, operative or prone to fluctuations?
• Is the trustee aware of all the accounting/tax requirements in the home countries of all named and likely beneficiaries?
• Will the trustee be sufficiently remunerated for the expected risks?
• Is the trustee sufficiently insured in case any unexpected event should befall the trust or the beneficiaries?

Shifting landscape for excluded beneficiaries

The ITCs are victims of their own success, but even if a significant part of their legacy trust structures is now “remediated” and pass muster with the questions immediately above, a change in the mentality of ITC clients and promoters must also take place as rules and regulations favoring more transparency take shape. This is particularly true regarding the transparency of trust beneficiaries, which arguably has been the single-most significant fraud risk for ITCs.  

Take the growing popularity of private trust companies (PTCs), a form of trust that’s supposed to provide greater privacy and avoid the prying eyes of the U.S. Securities and Exchange Commission (SEC). There’s not much new about this, as the original PTCs go back to the 19th century throughout the North Atlantic but began to receive renewed attention in the last 20 years as a way to potentially obfuscate beneficial ownership (in addition to the stated benefits of estate planning and running large operating companies). This is a variation on a theme from the so-called “Red Cross” trusts, named for the trusts having only a local Red Cross chapter as the sole named beneficiary and where beneficiaries could be added and excluded as the circumstances called for. (See “When is a trust not a trust?” by Sarah Aughwane, withersworldwide, June 24, 2020.)

The secretive nature of PTCs has come under renewed scrutiny in Wyoming, where these types of trusts have stirred up some controversy. The release last year by the International Consortium of Investigative Journalists (ICIJ) of the so-called Pandora Papers showed how a cast of sketchy characters have used the U.S. state’s PTCs to hide their wealth. One of those people was Russian oligarch Igor Makarov, who the Canadian government recently sanctioned and has been accused of being involved in money laundering and kickbacks. (See “The ‘cowboy cocktail’: How Wyoming became one of the world’s top tax havens,” by Will Fitzgibbon and Debbie Cenziper, ICIJ, Pandora Papers, Dec. 20, 2021.)

When Makarov reportedly established the trust in 2016 no U.S. law required him to reveal his identity. But the rollout of the U.S. Corporate Transparency Act (CTA) is expected to enforce stronger transparency regarding beneficial owners, though questions remain over certain trusts that might be exempt. (See “Targeted Sanctions toward Russian Oligarchs Underscore Urgency of U.S. Anti-Money Laundering Reforms,” by Ryan Gurule, FACT Coalition, Feb. 28, 2022; “Lawmakers forgo action on Wyo’s controversial secret trust laws,” by Maggie Mullen, WyoFile, May 2, 2022; and “An Introduction to the Corporate Transparency Act (CTA),” by Glenn G. Fox and Raj A. Malviya, ACTEC, May 17, 2022.)

Promoters of such structures seem to forget the advent of beneficial ownership registries, even in ITCs, and the fact that beneficial ownership can be traced via protectors, enforcers, payees, powers-of-attorney holders and insured persons. In 2016, the U.K. created a public register of companies’ beneficial owners. That same year, the Swiss Bankers Association (SBA) provided guidance regarding this issue in its Circular No. 7908, requiring banks with trust structures to identify living and non-excluded members of a class of beneficiaries, past recipients of trust distributions and any other persons identified as beneficiaries in the trust documentation. The European Union followed suit in 2018 with a directive requiring member states to establish publicly accessible registers of beneficial ownership. And, as part of the CTA, the U.S. Treasury’s Financial Crimes Enforcement Network (FinCEN) is also requiring the reporting of beneficial ownership. Potential fraudsters can no longer rely on ITCs to cover for them. [See “Out in the Open: How Public Beneficial Ownership Registers Advance Anti-Corruption,” Transparency International, Sept. 10, 2021; “Fact Sheet: Beneficial Ownership Information Reporting Notice of Proposed Rulemaking (NPRM),” FinCEN, Dec. 7, 2021; and “New Swiss Bankers Association (SBA) guidelines on the identification of discretionary beneficiaries of trusts and foundations,” Lenz & Staehelin, December 2016.]

This is an instructive moment, as it leads to questions about the banks’ obligations to report beneficiaries who knew nothing about their interests in the trust. The solution accepted by the Swiss regulators was to exchange beneficiary information on the basis of distributions to beneficiaries occurring each year, as the alternative would’ve opened the Swiss banks to banking secrecy violations lawsuits.

Efficient enforcement of the current information exchange regime is a few years in the future but remains on track to deal with most trust fraud risks. Fraudsters in the past have taken a page from the “Red Cross” trusts concept and have themselves excluded as beneficiaries whenever they find themselves residing in high-tax jurisdictions. They then add themselves as beneficiaries when they relocate (usually temporarily) to a zero-tax jurisdiction, which is often in the ITC jurisdiction administering the trust under consideration (and therefore no obligation to exchange information exists). Having received distributions from the trustee, the fraudster waits out any clawback periods from previous and future tax residences and ensures that they’re “re-excluded” before relocating. The only way this fraud can be detected is if, as in the Swiss example noted above, the trustee and bank mention previous beneficiaries on the due diligence forms or if the fraudster’s name appears as a matter of public record in any trust proceedings. As there are many legitimate reasons to exclude beneficiaries from trusts, we’re still awaiting clear rulings that would place “excluded beneficiary fraud” in the same basket as “Red Cross” trusts. A rare case in the Channel Island of a court that ruled in favor of excluding a trustee’s beneficiary might provide some clues of how fraudsters may now place a veil over their identities. [See sidebar: “Exclusionary powers”.]

The ITCs have enjoyed incredible success and are now coming back to earth in the age of transparency. They’ve become repositories of significant administrative and legal knowledge during their time in the sun, and they still offer many advantages (mainly related to tax and cost). Properly regulated ITCs are positioned to thrive in the age of transparency and serve as a bulwark against fraud.

Leonidas Charitos, CFE, is head of business risk and compliance for BERG Capital Management, an advisor to sovereign and pension funds. Contact him at Leo.Charitos@gmail.com.

Exclusionary powers

Last year, the Royal Court of Jersey made a rare ruling to exclude a beneficiary, raising questions about how fraudsters might use the law to their advantage. The case involved a family dispute over a trust in the Channel Islands, which resulted in a decision to exclude one of the beneficiaries of two Jersey family trusts following “hostile conduct.” The court considered ways a trustee could exclude a beneficiary (whose hostile actions threatened the entire value of the trust fund) from two trusts. The three options were:

• Whole or partial exclusion of the beneficiary from future benefit.
• Declaring (irrevocably) that the beneficiary shall cease to be a beneficiary.
• Declaring the beneficiary to be an excluded person.

As this case dealt with protecting an endangered trust fund and not fraud, the court found the middle option to be the most suitable. As the last option would mean that the beneficiary’s “exclusion would be total and final,” fraudsters will likely attempt to operate within the confines of the first two options. If, however, these trustee decisions are ever adjudicated by court, the fraudster and his trustee will have a difficult time staying off the radar screen for due diligence violations. (See “Momentous trustee decisions: the role of the Jersey courts,” by James Dickinson and William Grassick, Dickinson Gleeson, April 2021 and “ To exclude, or not to exclude, that is the question,” by Richard Laignel and James Campbell, Ogier, July 9, 2021.)