I have come across two interesting articles on seemingly disparate topics that are nonetheless more related than you think. One word sums them up: globalization. The first concerns offshore tax breaks luring in hedge fund operators to destinations like the Cayman Islands from the New York Times. A fine book on this topic, by the way, is Ronen Palan's The Offshore World: Sovereign Markets, Virtual Places, and Nomad Millionaires which vividly depicts the deracination of global finance. Here, the NYT describes the case of the Cayman Islands seeking more business from hedgies to the growing opposition of politicians Stateside who perceive them as not paying their fair share:Speaking of money laundering, efforts by the worldwide authorities such as the Financial Action Task Force (FATF) to crack down on illicit financial flows--especially in the wake of 9/11--have resulted in, er, "launderers" (Mr. Clean, anyone?) shifting their modus operandi. The Wall street Journal notes that instead of sending funds electronically, would-be terrorists are now using old-fashioned trade as a way of shuttling funds worldwide:William E. Grayson, the president of EGM Capital, a hedge fund firm in San Francisco, has never set foot on the Cayman Islands, but he knows that sun-baked Caribbean haven quite well. That’s because he set up one of his funds in the Caymans, where lucrative tax breaks and fabled financial secrecy have made this British territory a magnet for hedge fund managers.
“All of the offshore jurisdictions are competing against each other to provide the most hospitable regulatory landscape, and the Caymans are really coming on strong,” Mr. Grayson says. “As a hedge fund manager, you just might be deciding whether you want to golf or scuba-dive more.”
In as little as two weeks, and for about $35,000 in fees, hedge funds can set up shop in the Caymans — just a fraction of the time and up to one-tenth the price of incorporating a fund in drearier climes like Delaware.
While speed and bargain prices are big attractions, the real draw, say analysts and Congressional investigators, are perfectly legal Caymans-based corporations and partnerships that allow major investors to avoid taxes of up to 35 percent that the Internal Revenue Service levies on unearned business income. Cayman tax laws also help American fund managers legally defer domestic taxes on their personal profits by channeling them offshore through their funds.
The biggest of the three islands that make up the Caymans, Grand Cayman, is only 22 miles long and, at its widest, 8 miles across. But the territory’s tax advantages have turned it into one of the linchpins of the estimated $1.5 trillion global hedge fund business.
“So many of the best money managers have set up in the Cayman Islands,” says Kurt N. Schacht, managing director of the CFA Centre for Financial Market Integrity, a nonprofit research organization in Charlottesville, Va. “It has become the place to go.”
As recently as a decade ago, regulators and law enforcement officials regarded the Caymans, an outpost 480 miles south of Miami that once served as a shelter for pirates like Blackbeard, as a hotbed for money laundering and other dubious financial schemes. Today, it is the corporate home for what the Cayman Islands Monetary Authority estimates to be three out of every four of the world’s hedge funds — more than anywhere else — thanks to its friendly tax and regulatory regimes, as well as an army of foreign bankers, tax lawyers, accountants and fund administrators who make it all work.
“With some of the other jurisdictions, there’s an island mentality,” says Michelle Kline, a principal at Genesee Investments, a hedge fund based in Bellevue, Wash. “The thing that’s different about Cayman is that the regulators realize that hedge funds are a business, rather than just something to regulate.”
For their part, Cayman officials, regulators and private-sector lawyers, bankers and accountants say that there is nothing illegitimate about how the territory supports offshore finance, and that it is a system that is unfairly tarred and much misunderstood by its critics.
True, “we’re not a widows-and-orphans jurisdiction,” says Ted Bravakis, the director of public relations in the Portfolio of Finance and Economics, a Cayman government agency that helps to oversee financial services there. But, he adds, “the Cayman Islands sees the use of our jurisdiction and service providers by U.S. entities and individuals to avoid their tax responsibilities as abusive — we feel equally abused because our regime is not intended to be used in that way.”
The Caymans’ ascent as a hedge fund haven coincides with recent calls by American legislators for greater oversight and taxation of hedge funds — lightly regulated, secretive investment pools for wealthy individuals and institutions — as well as greater scrutiny of the tax status of private equity firms.
As legislators like Senators Carl M. Levin, Democrat of Michigan, Charles E. Grassley, Republican of Iowa, and Max S. Baucus, Democrat of Montana, also make renewed calls for a broader crackdown on financial abuses in offshore tax havens, the Cayman government has continued spending heavily on high-profile lobbyists, public relations firms and well-connected lawyers to persuade the world’s senior financial officials and regulators that the Caymans has outgrown its past as a center of financial high jinks.
During the spring, Cayman representatives lobbied the Securities and Exchange Commission, aides and members of the Senate Banking Committee, tax policy officials of the Treasury Department, and the office of Vice President Dick Cheney in an effort to foster the impression that the island territory has remade itself into a law-abiding, smoothly run financial supermarket...
The daily nuts-and-bolts investment activities of most hedge funds still occur, of course, in places like Manhattan and Greenwich, Conn. — the manicured enclave that is home to “hedgies” earning up to hundreds of millions, sometimes billions, of dollars a year — or behind glossy black doors in the upscale Belgravia and Mayfair sections of London.
But the legal home of many of the world’s hedge funds, the place where they often choose to incorporate for tax purposes, is the Caymans.
Most American individual investors are not able to play the Cayman tax game. Such investments are taxable to American investors under United States tax laws, so investors typically put their money in a section of hedge funds that are set up as Delaware partnerships or limited liability companies. That means that they will pay taxes of anywhere from 15 percent for capital gains or up to 35 percent for ordinary income taxes when they cash in their investments.
After a long and intense crackdown on cross-border money laundering, authorities say terrorist supporters, narcotics syndicates and sanctions busters have adopted a new method of sneaking funds past the watchful eye of the law: the global commodity trade.The practice, known as "trade-based money laundering," was pioneered by Latin American drug smugglers in the 1990s. Now, it is spreading to Europe and the Middle East.
Here's how the practice works: Instead of wiring money directly from one country to another, a would-be money launderer buys foodstuffs like sugar or vegetable oil or other goods. Those goods are far easier to deliver to restricted destinations like Iran and the Palestinian territories because they often look like legitimate aid. When they arrive, local merchants transfer the goods on, or simply sell them for cash. A portion of the proceeds end up with local terrorist groups or criminals.The illicit trades are often blended in with legitimate ones, which makes them difficult to single out and the source of their funding hard to trace. Authorities say the scope and prevalence of the practice is tough to determine with any precision, but it is clearly on the rise.
One such case recently surfaced in Europe when French authorities discovered that a Paris-based charity the U.S. officially designates as a sponsor of terrorism has been buying large lots of commodities for delivery to the Palestinian territories. While much of the goods constitute legitimate aid, a portion of the shipments ultimately ends up with terror groups, officials allege.
Funds for the original goods purchases by money launderers increasingly come from Iran, Israeli officials say. Some of the funds and goods allegedly end up with Palestinian Islamic Jihad and Hamas. Both groups are seeking to disrupt the Palestinian peace process with Israel and often sponsor terrorist attacks.
For at least two years, Israeli and European counterterrorism officials allege, supporters of the Palestinian groups have been using donations raised in Europe to purchase sugar and other commodities.
U.S. officials have been warning about such swap deals since the State Department's release of its 2004 International Narcotics Control Strategy Report. "As both the formal international financial system and money-service businesses become increasingly regulated, scrutinized, and transparent, criminal money launderers and terrorist financiers are increasingly likely to use fraudulent trade-based practices in international commerce to launder, earn, move, and integrate funds and assets," the report said...
Now, U.S. officials say the trade-based model is being adopted across the Persian Gulf region. U.S. sanctions on Iran and Tehran's own rigid financial controls promote the practice, the State Department said in a recent report. "The trade and smuggling of goods into Iranian commerce leads to a significant amount of trade-based money laundering," according to the department's annual narcotics-control report released in March.
"There is no reliable estimate on trade-based money-laundering because no authorities are looking systematically at their trade activities," says money-laundering expert Nikos Passas of Northeastern University in Boston. "The vulnerability is gigantic though, and undermines all other financial controls we have in place, no matter how well these may be implemented."
Much of the money in question is laundered in the United Arab Emirates, the primary conduit for Iranian imports. Trade-based laundering in the Emirate of Dubai also helps finance the booming Afghan-Iran heroin trade, according to U.S., Italian, and U.A.E. law-enforcement officials.
