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Offshore Bank Failure After AML CTF Policy Violations and Public Interest Concerns

The Hazards of Offshore Banking for Creditors When their Bank Fails due to Violations of AML-CTF Policy and Public Interest Concerns
An In-Depth Study into the Risk Factors of Offshore Banking where Regulatory Intervention and Banking Failure Leave Creditors in Despair


The offshore financial industry is seen controversial by the general public. Unfair tax advantages for multinationals, the use of special purpose vehicles, and financial crime risk further this general view. Yet, offshore jurisdictions are an ordinary part of the global financial ecosystem.

This paper examines specific risks of offshore bank failure for creditors and highlights the mismatch between the assumed cognition of stakeholders for fair and honest behavior of financial institutions, and impermissible conduct of banks leading to default. To understand these risk factors a thorough probe into banking in general and the internal organization of financial institutions was needed. The empirical study with a sociological approach discusses public interest doctrines to protect the financial system, financial regulation, AML-CTF and sanctions violations, and ultimately behavior and conduct leading to the ownership of risk. Thus, insights in offshore bank failure are increased to contribute to actions for risk mitigation by creditors and other stakeholders.

Most academic research is focused on either failure of systemically important financial institutions, money laundering and terrorism financing, or the offshore industry. Meanwhile, conduct risk leading to failure is often underexposed. Regarding the offshore financial industry, there is a bias to common law legal systems with little attention for civil law. Therefore, this study combines the indecipherable purpose of global and macro-economic intervention by regulators in two distinct legal systems and the consequential micro economic challenges for creditors in offshore bank failure.

Accordingly, this study seeks to shed light on the (offshore) financial system, the public interest doctrine that protects the financial system, and conduct that leads to offshore bank failure and potential creditor losses. Arguments will be made to support the central theme of conduct and ownership of risk. To demonstrate these arguments a thorough assessment of existing literature and practical events provides a clear conclusion.

Keywords:  Offshore Bank Failure, AML-CTF violations, Offshore banking, Money Laundering.

1.      Introduction

The objective of this study is to understand the financial industry and its hazards, in particular where these hazards directly and indirectly relate to the offshore financial sector. The financial industry is of critical importance for the economy. The economy supports living standards and development of society. On a micro-economic level, the market in the developed world relies on financial institutions to support payment in its supply chain. This includes the workforce receiving remuneration for labor and small businesses being paid for their services. A systemic disruption results in uncertainty and potentially panic, something capitalistic nations wish to avoid for reasons of trust-based fiduciary relationships between financial institutions and their customers. Protection of the financial system is therefore crucial and financial regulation is used as a conduit to safeguard public interest concerns.

Financial institutions accommodate services to the public. These services contain risk that customers may or may not be aware of. One can distinguish risk for the financial system in financial risk impacting the viability of financial institutions, and operational risk factors threatening the stability of and overall confidence in the financial system. To gauge, identify and analyze the hazards of the offshore financial system, this study starts with a general overview of the global financial system to ultimately narrow these findings down to an accurate inquiry into offshore jurisdictions.

Recent cases of corruption, sanctions violations and money laundering initiate the debate on the preference for regulation versus deregulation, or even re-regulation. In line with penalties and fines, and even exclusion to participate in the international value transfer systems, the public interest doctrine[2] justifies regulatory intervention for violations of globally accepted standards. As such, regular bank customers sometimes have to pay the price for illicit conduct by their bank or a handful of its obscure clients. Offshore financial centres see privacy and confidentiality as being of paramount importance. The downside of this strategy is that unlawful activities and high-risk individuals often use offshore jurisdictions for their activities.

Offshore financial centres use the common law legal system. The main difference with codification of conduct in civil law jurisdictions is that interpretation and case law prevail under common law. The complexity of the current global financial system and its cross-border context enable penetration into various jurisdictions with different legal systems, frameworks and regulation. Consequently, the licensing structure of bank holding companies and their branches and subsidiaries create a single point of entry with regulatory competences following a top-down structure for supervision and control[3].

Based on this complexity, this study aims to define the challenges of the offshore financial industry whilst understanding how creditors can protect themselves from the risk of bank failure. The insights provided for, trigger a multisided approach where creditors regain an understanding of the risk involved and regulators clarify the risk of anti-money laundering – counter terrorism financing (AML-CTF) violations. This multi sided approach therewith covers both micro and macro level recommendations allowing individual creditors to estimate their risk, and regulators to clearly manage future expectations of stakeholders in case intervention is required after complex offshore bank failure.

The challenges of bank failure and closure caused by regulatory and anti-money laundering (AML) violations can be considered from the perspective of the regulator, the institution itself, and the creditor. Regulators want to avoid a run on the bank, maintain public confidence and avoid taxpayer input[4]. Financial institutions want to protect their reputation, limit fines and penalties, and restart operations. Creditors just want their money or assets returned, or their outstanding payments honored. These different interests lead to different problems and questions. This results in the following claim as the foundation for this research project:

‘Empirical data of bank failure due to regulatory violations of the institution reveals a difference between systemic financial institutions versus smaller banks and question the ownership of excessive risk taking. Based on actions taken by the regulator indirectly at the expense of creditors, and in an open market economy, stakeholders should be clearly informed about the risk factors involved in banking prior to possible failure’

This study is motivated by empirical events that reveal a gap between creditor knowledge and expectation in bank failure caused by violations of anti-money laundering and counter terrorism financing frameworks, and other infringements by the designated financial institution. The result is that creditors risk losing their money. To limit the impact of such events, this study has a focus on non-systemic banks located in tax friendly environments, with a predominant non-resident customer portfolio. The scope of this study identifies differences between regulation of global systemic financial institutions and offshore banks, to ultimately focus on the challenges of the offshore banking industry and the regulatory frameworks and soft law protecting it.

Theoretical legal frameworks, directives and recommendations aim to prevent future crises and are built on previous events. Relevant research has a focus on financial crises in a global setting, leaving a footprint in society. Most regulation, directives, guidelines, and academic theories are based on liquidity shortages and the protection of the public interest. After offshore bank failure by substantive – rather than financial – violations, it is difficult to predict by financial modelling whether frameworks such as the Financial Action Task Force (FATF) or UN recommendations apply. This research project identifies the hallmarks of risk for offshore banking and aims to find ways to communicate potential hazards with creditors before failure commences.

1.1    Statement of the research problem

There seems to be a gap between theoretical assessment of the failure of international financial institutions and the consequential regulatory measures that mitigate risk and protect the public interest on one side, and the unfamiliarity and lack of understanding of risk, and uncertainty caused by banking failure that is experienced by non-resident creditors on the other side. Especially, where these non-resident creditors use opaque and multi layered international company structures to manipulate and shield beneficial ownership. For those financial institutions where commercial motives prevail and corporate governance[5] is limited, risk for creditors is furthered by regulatory scrutiny that potentially reveals misconduct.

A preliminary overview of academic literature and institutional research papers reveal a focus on the theory of bank failure caused by liquidity shortages. Furthermore, in the wake of the global financial crisis, it was agreed that rescue missions at the expense of taxpayers should be limited. Yet, the role of financial institutions as gatekeepers that maintain public confidence in the financial system, and the consequences of violations of AML regulation for creditors stays underexposed. This research project aims to contribute to the elimination of this gap in academic literature.

1.2    Aims and objectives of this study

When a financial institution fails or is likely to fail, the impact for creditors can be devastating. From a creditor perspective, this project determines first what can be done to limit risk and maximize repayment for those affected by failure of an offshore financial institution. Subsequently, this is followed by the question how creditors can avoid being dragged into unexpected failure of their offshore bank.

This study aims to understand the reasons offshore banks fail while evaluating and assessing the impact of such failures on stakeholders, including creditors. It follows that the research objectives are to explore and study the differences between bank failure of systemically financial institutions and offshore banks from both a regulatory and creditor perspective; to identify flaws in regulation, action, and the impact on uninformed creditors whoconfused about the action; and ultimately, to propose and formulate recommendations to bridge the gap between bank failure, regulatory intervention and understanding to prepare for risk management by creditors.

The subject of this research project tries to examine the gap between theoretical regulation and practical responses by stakeholders after a financial institution fails and creditors are subject to financial losses. Initially, risk limitation and maximization of repayment for creditors prevailed for this study. Yet, progression revealed that mitigation is necessary, but the reciprocal effects of prevention play a pivotal role as well. Therefore the research question is divided into two segments and further expanded into: ‘What can be done to prevent the involvement of uninformed creditors in offshore bank failure, and for those creditors that are still impacted by offshore bank failure, how can risk be limited, and repayment maximized, whilst maintaining confidence in the financial system?’

Even though offshore financial centres and the banks that operate in these jurisdictions are exposed to unconventional risk factors, the standardized capital based regulatory frameworks still allow for a deeper understanding of the objectives of financial regulation. Therefore, a variety of primary and secondary sources is evaluated to contribute to this paper, answer the research question and substantiate the original claim.

The sociological approach for research allows the author to test theories and legal doctrines in a practical setting. It includes in the study the consequences of financial regulation in a specific setting. Although at this point no statistical analysis forms part of this study, the impact of offshore bank failure on stakeholders can be measured in alternative ways by following the creditor and insolvency hierarchy as proposed by local insolvency law. Thus far the sociological approach to research fits this research project best.

2.     Background information

2.1 General introduction on banking and finance

Law serves economic and social objectives. The complexity of economic globalization, where international trade and global value chains prevail, may contribute to conflicts of law[6]. To ensure comprehension and an equilibrium, legal scholarship and law practice justify an interdisciplinary approach towards research[7]. Therefore, this study combines economic and legal theory, and briefly touches on anthropology and empirical outcomes to uphold the final conclusions.

In ‘The Wealth of Nations’[8], the classical economist Adam Smith argues that human behavior is driven by self-interest. Smith continuous that a market is based on supply and demand. This theory asserts that free trade and competition ensure a balanced and harmonized market. The financial industry is characterized by such freedom. Following laissez-faire capitalism[9], regulation and government interference disrupt the true nature of a free market economy. As a consequence there is a constant conflict between autonomy and regulation in the financial industry.

The overall architecture of the financial industry provides for a level playing field used by offshore banks as well. Therefore, before diving deeper into the subject matter of this thesis, a general outline and understanding of banking and banking law is essential. An assessment of the financial industry highlights economic assumptions, the complex and opaque internal culture and organization of financial institutions, financial product management, and ultimately bank risk management and compliance to ensure a necessary holistic view on the potential hazards.

Society adapts different theoretical economic models to prepare for estimated future outcomes[10]. Private ownership, inflation and capital accumulation contribute to an economic multiplier effect with a volatile monetary value. Spending is facilitated by income and the provision of credit by financial institutions[11]. Future expenditure is prepared for by, for example, value creation, return on investment and inflation. As such, society encourages a model for profitability[12].

To support a constant strive for monetary gains, institutional investors, pension funds, and others looking for return on their investment, purchase shares in listed companies. Shareholder value is interconnected with the culture, motivation and the internal organization of listed companies[13]. As indicated by Friedman[14], corporate social responsibility is related to shareholder interest. The result is that financial institutions maximize profits and strategize for this objective.

The internal organization of financial institutions reveals several potential hazards. Employment in the financial sector is driven by commercial output with limited job security[15]. At the same time, the relationship between a bank and its customer is characterized by a liberal and professional interaction where both parties hold responsibility for their own decisions. The common law[16] doctrine of caveat emptor[17], also referred to as buyer beware, emphasizes on the imbalance between the parties and provides the financial institution with a carte blanche for the composition of complex financial products. Excessive risk taking at the expense of relatively unsophisticated counterparties, the complexity of financial institutions making them seem as being too big to fail[18], and the consecutive moral hazard[19] therewith become accountability issues[20].

Even though financial institutions and professional intermediaries[21] are commercial enterprises, they are, among other professional enablers, considered the gatekeepers of the financial system[22]. A gatekeeper is defined by Gadinis and Mangels[23] as an ‘intermediary whose cooperation is essential for many financial transactions’. As such, customer due diligence and ‘know your client’ procedures are paramount to understand individual benchmarks. While on the one hand the front office of a financial institution is responsible for profitability, on the other hand risk mitigation and compliance is a task for the back office. This conflict of interest between the commercial, strategic and internal objectives of a financial institution reveals another crucial vulnerability.

Financial institutions act as a professional contract party for deposit taking and credit creation[24]. Alongside these core activities, financial institutions fulfil an intermediate role between its customers and external professionals. Standard and customized financial products to maximize profitability and hedge risk[25] are created by third parties and offered to its clients. Contract law decides on the agreement between a bank and its customer[26]. As a result, the intangible qualities of confidentiality, integrity and reputation are the crucial safeguards for this relationship. Service provision by financial institutions aim to solve the financial challenges of their clients by creating financial models and risk management tools for effective and efficient use. For example, derivatives, leveraged Exchange Traded Funds, and Collateralized Debt Obligations, were initially developed to mitigate specific risk, but over time they turned into mainstream vehicles for speculation by market traders with no understanding of their potential downsides[27].

Stability contributes to trust and confidence, whilst a financial meltdown disrupts society and may have an adverse, contagious effect[28]. To mediate this, regulators aim to ensure stability of the financial system by enforcing best practices[29]. In an environment embedded by capitalism, economic growth is driven by the creation of debt and the stimulation of inflation[30]. The theories of fractional reserve lending and quantitative easing both allow financial institutions to maintain a reserve ratio as a fraction of the outstanding liabilities[31]. As a result, central banks can funnel liquidity into local economies via asset purchase programs[32] in conjunction with systemically important financial institutions.

The intention of public interest doctrines is to protect and maintain the critical functions of society[33]. This includes bank resolution and the prevention of financial instability[34]. Even though the recent global financial crisis was considered a ‘black swan’[35], regulators around the world try to avoid future rescue missions at taxpayers’ expense[36]. The interconnectedness and thus contagious nature of the financial system substantiates the impact of a crisis in a global setting when value chains experience severe distress[37]. The decision to act with regulatory intervention and choice of resolution strategy, determines regulatory intervention. The choice for resolution strategies[38] is dependent upon whether the situation involves systemic banks, considered too big to fail, or non-financial, or indirect, risk factors[39].

Liquidity shortages are the core driver for failure of financial institutions. Yet, recent years have revealed new risks for financial institutions to fail, including regulatory violations and infringement of anti-money laundering provisions. Small European banks that mainly serve non-resident creditors and deposits from offshore companies, such as ABLV Bank[40] in Latvia, FBME Bank[41] in Cyprus, and Pilatus Bank[42] in Malta, were shut down by international regulators. For outsiders, the closure of smaller banks often comes as a surprise. Considerations for customers to collaborate with a financial institution seldom include the hidden violations of soft law and international principles of anti-money laundering[43]. Thus, stakeholders are confused due to nescience on the true activities of the bank and the potential regulatory intervention that can lead to penalties, failure, closure, and eventually loss of money for creditors.

As the publication of the Panama and Paradise Papers revealed[44], public outrage, indignation and criticism against money laundering has a post-hoc character and fades away over time waiting for the next scandal. Society and especially individuals experience indirect harm[45] whilst coordination to policy response often leaves gaps between regulation and empirical evidence of AML breaches[46]. The OECD provides in its Awareness Handbook for Tax Examiners and Tax Auditors[47] a detailed foundation for the relevance of AML as it is a serious threat to legitimate economies and the integrity of financial institutions, whilst having adverse effects on economic powers and thus corrupting society[48]. The Awareness Handbook also notes[49] that AML measures also have societal importance, identify tax and other financial crimes, and help to locate and confiscate criminal assets.

Public awareness of money laundering is amplified by impactful events. Terrorism and other activities of warfare need financing. An ecosystem is established by illicit actors to facilitate their operations. This includes costs to develop and maintain a terrorist organization and create an environment receptive for the proposed activities[50]. To obscure the origin and flow of funds, and the financing of acts of war, an interface between the source and use of funds conceals the ultimate purpose. The legal and administrative infrastructure of offshore financial centres simplifies the activities of terrorist networks and thus inquires scrutiny of the industry by international regulators[51].

The subjects of offshore banking and international taxation are covered with a layer of secrecy[52]. Public outrage surrounds multinationals using the loopholes of international tax law to drastically lower their corporate tax burden[53]. Small business owners and high net worth individuals may be willing to utilize similar strategies but cannot always qualify as customer with the recognized and well-established systemic financial institutions. These very individuals and companies unable to open a bank account with the large financial institutions rely on smaller banks in (offshore) jurisdictions, where corporate and regulatory infrastructure is often limited[54]. The result is that international organizations and regulators closely monitor the activities of financial institutions and offshore companies in these jurisdictions[55].

To maintain public confidence in the financial system, avoid abuse for terrorist financing and money laundering, and provide participants with appropriate tools, mechanisms and frameworks, international organizations launched several initiatives[56]. These individual initiatives create isolated and global standards and authorize penalties for non-compliance by participants. Additionally, formal embargos against unwilling incumbents and aliens can extend the scope of its mandate. Blacklisting and sanctioning of jurisdictions, organizations and individuals has effects on participants and members by prohibiting them from transacting with the designated party or location[57].

About three decades ago, the collapse of the Bank of Credit and Commerce International (BCCI) revealed the complexity of international banking and cross border transactions[58]. The bank served as a conduit for criminal activities on an epic scale while it was considered one of the most complex deceptions in bank history[59]. A fast forward to the current era indicates a shift from criminal activities to money laundering as a predicate offense[60]. Large financial institutions are fined for sanctions violations[61] and their smaller counterparts can be banned from transacting in US Dollars[62]. This jurisdiction is granted by the status of the USD as global reserve currency and therefore sanctions have severe consequences for the designated institution.

Even though the collapse of BCCI[63] is long gone, the prolonged legal procedures for correction and recovery revealed challenges for creditors. Similar circumstances appeared with FBME Bank in Cyprus and ABLV Bank in Latvia. The motivation of this study comes from the ambiguity surrounding the winding down procedures and the route from closure and administration to recovery. The result is that existing literature is enriched by the combined focus on regulation and the consequences of regulatory intervention. At the same time, such outcomes procure insights to further protect the public interest and the position of stakeholders and creditors.

2.2 Banking law

Globalization, technological development and financial innovation contribute to rapid changes in the financial industry. Independent states tailor regulation to their domestic environment. Economic, social and political differences between states distinguish relevance and importance of its local laws. It makes defining global banking law difficult. Yet, market players expect a uniform cross-border level playing field. The scope and nature of the financial industry involves, among other things, contracts, taxation, consumer protection, cross border transactions, and liquidity provision. Therefore, banking law combines individual codes of conduct, with rules and regulation, frameworks, directives, binding agreements, as well as case law and jurisprudence. To further emphasize on the complexity, there is no single authority that governs the complete territory of global banking. There are initiatives to combat market failure[64] and money laundering and terrorism financing[65], but these only apply to participants and thus leaving gaps and inconsistencies for global coverage.

The global financial ecosystem needs a flexible approach towards market entry. As such, home state control is granted to the jurisdiction of corporate registration and license to operate. Credibility provided by the regulator in the home state, allows for the opening of branches and subsidiaries in host countries. Via mutual recognition[66] market access is simplified[67]. This approach alleges a uniform regulatory framework between home and host states, potentially leading to regulatory arbitrage where individual frameworks differ from each other.

Banking law in common law jurisdictions considers activities[68] by authorized or exempt persons[69] between a ‘bank’ and a customer agreed by contract[70] in a setting of confidentiality[71]. A relationship between a bank and its customer can also be explained by agency law, where the client is the principal and the bank acts as the agent[72]. Accordingly, the bank owes a duty of care and several fiduciary duties towards the customer[73]. From the perspective of company law, the separation between ownership and control of the legal entity[74] designates the organization responsible for acts and omissions of bankers. Piercing the corporate veil, where the company and its workers can be held responsible for losses, is exceptional. However, where assets are placed offshore under sole discretion of the same company director, both entities can be held accountable.[75]

The limited liability of shareholders and company management is connected with the doctrine of caveat emptor, where professional contract parties and legal entities are alleged to understand the risks of a transaction. Thus, bank customers need proper information to make educated decisions. Transparency allows stakeholders to assess risk and accountability protects the system against failure. Yet, corporate criminal law and corporate liability seldom includes the directing mind and will of the company[76] and mostly punishes the legal entity for wrongful acts or omissions. The legal entity is fined or seizes trading, while the controlling persons remain relatively untouched. However, the fit and proper test by the European Central Bank[77] for example, allows board members to be disqualified for future positions in the financial industry.

For stakeholders, the main concern in offshore bank failure is that fraud against the government by a financial institution and its customers can be punished with heavy fines and closure of the bank. Individual creditors are not considered ‘public interest’ and have a claim against the financial institution only after public action against the bank ends. Limited liability of the controlling persons results in winding up and liquidation proceedings of the bank and its assets without further recourse.

2.3 Conclusion

In a trust based, yet complex global setting[78], financial crises come and go and are unlikely to disappear[79]. The ownership of excessive risk taking and thus accountability for financial losses comes at the expense of the client, or in exceptional circumstances for the account of the tax-payer. Depending on the impact of these losses, further action can be justified.  Regulators attempt to respect the principles of a free market, while protecting the public interest. However, the current flexible approach towards regulation and supervision triggers a corporate identity and climate where symptoms are opposed, and the root of the problem remains underexposed.

The global financial crisis that emerged in 2008 revealed shortcomings across the financial ecosystem. Over time, several financial institutions became too big to fail. These systemically important financial institutions were rescued with tax-payer input, while a toxic interplay of excessive risk-taking and perverse incentives allowed the very same bankers that caused the financial crisis to be rewarded. Public outrage triggered socio-political movements, such as the ‘Occupy’ campaign, promoting morality, equality and democracy. Lawmakers revised financial policy and regulation and now seek to minimize rescue missions with public funds. The implementation of a bail-in strategy to replace traditional bailouts[80] became paramount. Simultaneously, financial warfare[81] to combat illicit funds entering the global financial system gained altitude. Subjects as anti-money laundering, counter terrorist financing and sanctions programs are embedded in the fight for the protection of the global financial system.

3.     Literature review

3.1 Introduction

The global financial system, and banking in general, take a central position in society. Hence the reason that lawmakers and regulators aim to protect the financial system by implementing objective standards and codes of conduct. At first, the contract between the bank and the customer is defined. On a separate level, an enforceable framework should prevent misuse that leads to public suspicion and distrust. This second line of defense is often misunderstood when financial institutions are shut down for indirect and non-financial motives that lead to creditor losses[82].

Terrorist financing and money laundering facilitate public insecurity and social disintegration. Furthermore, it undermines government structures and violates community cohesion. As such, systemic violations should be detected, stopped and prosecuted[83]. This chapter outlines the complexity of traditional banking. It addresses issues such as financial crises, globalization and bank risk management, before it examines how the offshore financial system and AML-CTF violations contribute to offshore bank failure.

Banking secrecy is fundamental for the relationship between the bank and its customer. In a global financial landscape, market players are eager to utilize the most appropriate routes for efficiency and affordability. This quest opens the doors to offshore financial centres where bank secrecy and company law provide enhanced privacy, sometimes at the expense of developing markets[84]. Such offshore financial centres can serve a legitimate purpose but can be abused as a conduit for tax evasion[85], offshore fraud and money laundering[86]. Global banks like UBS and Lloyds[87] act to avoid being held responsible for illicit capital inflows into, and abuse of, the financial system. Even the system of correspondent banking[88] that allows smaller financial institutions and developing markets to access the international payment, and global value and money transfer systems limit their exposure to violations and initiate de-risking processes[89].

The failure of a financial institution can have contagious effects that ultimately impact the global economy. Shocks and collapses of the banking system may create panic and a decline in market confidence. Regulators have a strong focus on capital requirements that allow banks to absorb their own losses and prevent collapse. The preferred nexus is to sustain bank failure as an internal matter that only under exceptional circumstances invoke bail out packages funded by taxpayer input. Yet, the European Bank Recovery and Resolution Directive (BRRD) for example, has a focus on systemic institutions that are considered too big to fail[90]. Failure of non-systemic offshore banks as a result of acts that threaten the stability of the financial system remains a matter of regulatory intervention and domestic insolvency law.

In the United States, the Treasury Department aims to isolate rogue financial institutions from the global financial value chain. The Patriot Act[91] gave the Treasury Department far-reaching powers, and the Financial Crimes Enforcement Network (FinCEN) could name a foreign financial institution a ‘primary institute of money laundering concern’ under section 311[92]. The objective is to trigger market players and other financial institutions to isolate wrongdoers[93], whilst terminating its cooperation and collaboration[94]. Thus, it lets the market take care of the clean-up process itself. In Europe, the BRRD aims to maintain market stability and confidence in the financial system. It limits taxpayer input for failing financial institutions and advocates the concept of bail-in where the bank and its creditors all participate in the potential losses of the financial institution.

Financial institutions are considered gatekeepers of the financial system[95]. Failure to comply with this role may result in fines and sanctions. The current regulatory framework is focused on accountability towards the financial institution. This is followed by a strong incentive for stakeholders, and in particular creditors, to force the bank to limit its business in undesired sectors and terminate its dealings with illicit actors whilst promoting good governance[96]. Bank failure and loss of money becomes an internal matter for the bank at the expense of the stakeholders.

In theory, principles of the free market create an environment for supply and demand where expectations and performance determine the viability of a business relationship. When it comes to banking, individual clients, with some exceptions, often downplay the situation when their bank receives bad press for its failure to comply with regulations. This often unreasonable mismatch can trigger a sentiment of distrust in the government and financial system.

Bank failure requires intervention to resolve the challenges of the financial institution in an orderly manner whilst protecting the public interest[97]. Systemically important financial institutions need to be rescued to avoid global financial distress. Offshore banks, or business units that deal with non-resident deposits, are of less importance for the global value transfer systems and the public interest. Therefore, different approaches to dismantle rogue corporate actors seem justified. This study therefore touches on subjects as corporate governance, global codes of conduct, as well as soft law.

3.2 Policy responses to global financial crises and other impactful events

3.2.1 Understanding global financial crises

The great depression[98] started in the United States and saw an exceptional decline in stock market prices. Public confidence diminished and furthered a fall in consumption, spending and investment. Debt deflation and a limited money supply spiraled[99] and contributed to negative forecast in the mathematical expectations hypothesis[100]. As argued by Ghosh and Qureshi, the Great Depression and the Global Financial Crisis that emerged in 2007 have parallels and similarities[101]. Therefore, to understand the potential hazards of offshore banking different financial crises[102], recessions and depressions[103] reveal insights of the vulnerabilities of the financial system in general.

Underlying causes of the global financial crisis[104] were embedded with assumptions and misconceptions. In the United States, the general consensus prior to the subprime mortgage crisis was that input and valuation for a loan application was always genuine and that homeowners would always find a way to pay for their house. Financial innovation enabled market players to create complex products and increase volume and profitability. Packages of home loans were assessed by credit rating agencies that were hired and paid by the financial industry, thus creating a conflict of interest. Buyers of these packages, and their derivative instruments, compared these exclusive and strongly rated investment-grade debt with their domestic risk profile. This mismatch led to a domino effect in depreciation and heavy losses.

Other relevant incidents and financial scandals that influenced public policy were the dot-com, or tech bubble between 1995 and 2000, the bankruptcy of the Enron Corporation[105], the collapse of Parmalat[106], and the Madoff Ponzi Fraud[107]. The Enron, Parmalat and Madoff scandals utilized offshore financial centres and the financial institutions supporting these, to shield the true nature of their operations[108].

3.2.2 Policy responses

From the perspective of financial economics[109], policy makers need to ensure a stable economy, maintain public confidence and provide for sustainability and long term growth[110]. Ad interim tools used in the wake of a financial crisis are monetary easing[111] and fiscal stimulus[112] by the provision of drastic reduction of interest rates and quantitative measures via asset purchase programs. Subsequently, to enforce long term stability, measures and amendments to current policy and recommendations for equivalence were proposed.

Confidence in the financial system depends on a social and reciprocal goodwill or shared values between the stakeholders[113]. In a free market, there is a thin line between protection of the financial system and the liberal approach to supply and demand[114]. Abuse of the global money and value transfer system disrupts its overall integrity. Therefore, there is justification for tighter regulation and legal frameworks when financial crime and money laundering is involved. As discussed by Hopton the steps involved in the laundering of the proceeds of crime are placement, layering and integration[115]. The dependency theory[116] reveals disparities between modern nations. These disparities allow for the placement and layering of obscure transactions in less developed nations and offshore financial centres. This is confirmed by Alldridge[117], Arnone and Padoan[118], and Gnutzmann et al[119] who unanimously link country size, political stability and sovereignty to gaps into the combat against money laundering and terrorism financing.

3.2.3 International policy challenges

Albeit advanced globalization contributes to economic welfare, greater international financial flows and a growth of money-laundering are connected and negatively impact behavior of economic actors[120]. The difficulty of combatting money laundering at a global level finds its origin in the Westphalian philosophy of sovereignty that allows states to define their own laws and protective measures[121]. Other contributing factors include the rise transnational organized crime[122], the loopholes contrived by illicit actors and professional intermediaries[123], and the constantly increasing complexity of global financial system itself[124]. To complement national laws, international organizations seek to limit the differences in AML-CTF policy on a cross-country level. The challenge for organizations as the FATF, United Nations Security Council, World Bank, OECD, Egmont Group, and the Wolfsberg Process is that they can only indirectly pressure members to isolate unwilling jurisdictions[125].

3.3 Financial globalization and the quest for bank risk management and financial security

Financial institutions operate in a global setting where local laws differ and may enable regulatory arbitrage[126]. Traditionally, bank risk management considered credit risk, liquidity risk and market or systemic risk[127] to avoid potential losses and defaults[128]. A growing interest in off-balance sheet exposures[129] and money laundering and terrorism financing expand risk management strategies imposed on financial institutions and its gatekeepers. Some elements of the internal value chain are vulnerable to financial crime, money laundering, and further abuse[130]. Therefore, these components deserve additional attention. The Financial Action Task Force (FATF)[131], an inter-governmental body responsible to combat money laundering and terrorist financing, defines money laundering typologies and develops recommendations that aim to prevent organized crime, corruption and terrorism[132]. To understand and act upon suspicious activity reports (SARs)[133] and currency transaction reports (CTRs)[134], local Financial Intelligence Units (FIUs) work under the umbrella of the Egmont Group to fulfil and comply with the FATF recommendations[135].

As argued by Nasreen et al[136], policy guidelines develop the financial sector, whilst financial sector development is slowed down by financial globalization. This means that furthering international trade requires a framework to facilitate international transactions. As such correspondent banking allows for banking and payment services to respondent banks, often smaller in size and located in remote areas[137] and offshore jurisdictions[138]. To ensure that goods are sent and delivered without delay, and payments are made for orders, trade finance[139] enables risk reduction in international trade. Both correspondent banking and trade finance are vulnerable to money laundering abuse. For example, trade based money laundering[140] where the proceeds of crime are disguised in an attempt to legitimize illicit origin, by movement of value via trade transactions[141], may utilize both the correspondent banking channel and trade finance facilities. Supervisory authorities monitor correspondent banks active in their jurisdiction[142], while the domestic FIU analyses SAR data provided to them by local financial institutions to identify money laundering activity[143].

3.4 The offshore financial industry in a nutshell

Offshore financial centres provide services to non-resident owned and controlled legal entities[144] and utilize a favorable and lax treatment towards administration, taxation, and corporate infrastructure[145]. The scale of the financial industry in offshore jurisdictions is out of proportion[146] to the size of the domestic economy[147]. The International Monetary Fund (IMF) confirms the size of offshore financial centres incommensurate to the financing of its domestic economy[148].

The scope, nature, and legal framework of common law jurisdictions allows for the exploitation of free trade zones and offshore financial industries[149]. Access to such jurisdictions is further promoted by corporate registries and professional intermediaries by means of the provision of client confidentiality and minimal standards for public transparency. At the same time, domestic tax regulation in the country of residence for beneficiaries of offshore assets may allow for exemption of property tax. This is usually justifiable as long as assets accumulate and remain in a shielded legal entity in the offshore jurisdiction. Hiding assets is therefore not always problematic. However, bringing value back into an economy for spending purposes may be considered tax evasion, which is a criminal offense[150].

Even though the offshore financial industry does not provide illegal services per se, abuse is possible. The fundamental principle of company law in common law and offshore jurisdictions is the separation of the legal entity from its owner[151]. Additional services further an environment for advanced privacy by employing local professionals as directors and shareholders. These strategies to conceal true ownership are attractive for Politically Exposed Persons (PEPs)[152], criminal networks and parties willing to hide their illegally obtained assets due to the potential personal repercussions of their illicit actions. As such, beneficial owners of offshore legal entities may hide their corporate holdings[153] and launder the proceeds in the future.

Offshore companies may use banking relationships in offshore financial centres and abroad. Acts and omissions from both the bank and its customer[154] can trigger regulatory intervention[155]. Synergy between banking secrecy and the architecture of offshore financial centres provides for an ecosystem where proceeds of obscure activities and financial crime remains elementary and confiscation of illegally obtained assets is cumbersome[156]. It follows from the activities of financial institutions and their customers that regulators use a top down approach to correction and fine, isolate or close the bank, and subsequently press charges against individual culprits.

Financial crime and money laundering is sometimes considered a victimless crime. Yet, consequential damage to society does not qualify the underlying activities and the process of placement, layering and integration[157] as victimless[158]. Changes in the public perception against money laundering became paramount after the terrorist attacks on the United States on September 11, 2001. This attitude advanced in the wake of the global financial crisis[159], where taxpayers became indirectly responsible[160] for excessive risk taking by bankers and overuse of offshore special purpose vehicles to conceal and hide the true origin of their investments. Subsequently, money laundering became an event that disrupts society by furthering social disintegration, undermining of government structures and violations of community cohesion at the expense of the public[161]. Efforts to protect the integrity of the financial system therewith is a global challenge without extra-territorial[162] powers.

3.5 The importance of anti-money laundering provisions to protect the public interest

Underground activities and illicit distribution networks bring products to the market that conflict with genuine trade and are often illegal. Both the activities itself, as well as the laundering of the proceeds undermine public confidence and community standards. This also applies to offenses like white collar crime, corruption, counterfeiting of merchandise, crony capitalism, smuggling, and terrorism financing, of which the social cost on society are discharged by the taxpayer. It clarifies that money laundering is not just a financial related crime, but its ecosystem causes social, economic, and fiscal imbalance. Ignoring this undesired behavior leads to a stimulus for illicit actors who see their conduct unaffected. The combined elements of money laundering and the underlying activities therewith concern the public.

There is no distinct definition of what public interest entails. Yet, features include the politics of interest[163], welfare of the individual[164], and in the context of the financial industry, the influence banks have on policy making[165] and the fiscal burdens imposed on governments by financial crises[166]. As such, this study perceives public interest as costs to society to be paid for by the public.

Conduct of gatekeepers and financial institutions may incur conflicts of interest between the commercial interest of the bank and the best interest of the customer. Consequently, good governance is warranted via codes of conduct and contributes to board effectiveness[167]. Good governance thus maintains principles of properness, transparency, participation, effectiveness, accountability, and human rights[168]. Self-regulation and good governance alone are not sufficient to protect the public interest and therefore international organizations and lawmakers implement enforceable rules for market players. To promote an equal playing field, protect international law and safeguard stability and security, organizations and states can impose restrictions, embargoes and sanctions against offenders[169].

Economic sanctions are instruments of public policy that impose significant economic and social costs on target states[170]. The mandate for international sanctions was approved by the Paris Peace Conference and the Covenant of the League of Nations[171]. As such, the Security Council of the United Nations attempts to change public behavior by isolating states with smart sanctions[172]. The theory goes that political change in democratic states is driven by voter preference and thus compliance with international standards is a greater good pursued by the population. To emphasize on a uniform level playing field, and to substantiate its position, the United States strengthens this position by forcing states to comply with their standards. The penalty against violation may trigger OFAC[173] enforcement actions or limitation of US Dollar clearing[174].

The essence of sanctions programs is to isolate rogue nations and rogue actors and encourage drastic alterations of undesirable behavior. Effective sanctions disqualify designated individuals, legal entities and nations from trade, travel and the usage of the financial system. Facilitators and other enablers risk being penalized for cooperation and collaboration with the sanctioned counterpart. As such, these professionals terminate relationships with sanctioned parties and prohibit them from further transacting.

International trade and the international financial system predominantly rely on the US Dollar as the global reserve currency. Clearing of US Dollar transactions moves through the US territory. It follows that the US Treasury Department claims jurisdiction over global transactions in US Dollars, so that illicit financial flows can be detected and disrupted. The consequence is that the global financial system acts as an arbitrator and private extension of law enforcement. Since isolation is a joint action by the public sector as initiator and a voluntary response by an anxious private sector, there is no injunction or court order necessary. The result is that responses to sanctions come entirely at the expense of the private sector and sanctions against financial institutions and other enablers of illicit activities can be seen as definitive.

3.6 Failure, resolution, deposit protection and insolvency procedures

Bank failure and capital cushions able to absorb heavy losses, are mostly interconnected[175]. Risk exposure in financial institutions is assessed by credit, market, operational and interest rate risk. Market discipline protects these risks. Due to its importance, the Basel banking supervision accord addresses market discipline[176] as the third pillar, alongside capital requirements and supervisory review[177]. The limitation of this approach towards disclosure is that it assumes a sincere and genuine modus operandi and excludes malfeasance by the bank, its executives or rogue traders.

Resolution decrees focus on the critical functions of financial institutions in distress. Together with domestic insolvency procedures and deposit protection schemes, resolution strategies can be justified in the public interest. Creditors receive protection up to the insured amount for deposits via the deposit protection scheme leaving the surplus of their claim unsecured. The domestic insolvency law decides on the creditor hierarchy and preferential treatment of the outstanding debts of the organization. In general, the costs of the liquidation, fees for the liquidator, prepayments by a deposit protection scheme, and claims by the tax authorities are prioritized. Secured claims by mortgage or fixed and floating charges come second and are followed by unsecured claims from general creditors. These unsecured claims include customer deposits, but do not cover shareholder equity and other subordinated debt.

Market entry for financial institutions established in different jurisdictions is dealt with by home and host state regulation. Resolution strategies for groups and cross-jurisdiction enterprises consider minimum requirements for eligible liabilities. Resolution is executed via a single point or multiple points of entry. Consolidation is needed for a single point of entry resolution where the losses of subsidiaries are absorbed by the holding company. Losses of subsidiaries are then prioritized over intragroup liabilities[178].

Even though deposit protection and other safety net arrangements such as the lender of last resort[179], can trigger moral hazard[180], resolution strategies maintain an orderly solution of the troubled financial institution. As such, panic runs can be limited and public confidence in the financial system maintained. These prudential measures, as defined by Dragomir, as ‘a category of bank regulation and supervision primarily aimed at safeguarding soundness and safety in the banking market ex ante, in order to prevent failures or crises from occurring’[181] contribute to integration of cross-border activity and financial stability of the underlying system.

3.7 Conclusions

Governments seek a balance between an open market economy and vulnerabilities leading to systemic crises. A constant debate among advocates of regulation and supporters of deregulation influences and determines the level playing field. The result is that financial institutions considered too big to fail are rescued with public support and niche players risk economic isolation, followed by closure. It follows that public interest is more an issue of macroeconomics and economic regulation, leaving the microeconomic environment and social regulation for individual creditors aside, with a limited insurance via capped depositor protection and domestic insolvency law for recourse.

Information asymmetry and the lack of effective understanding of the available information make risk assessment by investors and bank customers difficult. Therefore, creditors are often insufficiently protected against their risk profile and appetite. Intensified by excessive risk taking, illicit collaborations and moral hazard by the bank, losses often come at the expense of individual, uninformed creditors.

4.     Methodology

4.1 Introduction

Even though offshore financial centres, and the banks that operate in these jurisdictions, are exposed to unconventional risk factors, the standardized capital based regulatory frameworks allow for a deeper understanding of the objectives of financial regulation. Therefore, a variety of primary and secondary sources are evaluated to contribute to this paper, answer the research question and substantiate the original claim. Since the available literature and case law provides for a detailed insight in the fundamental challenges of the offshore financial industry, the sociological approach[183] towards research prevails.

4.2 Feasibility and scope of the study

The financial services industry provides payment services, profit enhancement and risk management strategies. For those seeking enhanced protection of their personal and corporate privacy, offshore financial centres offer a variety of means to support asset and wealth management strategies. This study seeks to comprehend the industry and its hazards, including the regulatory responses following public interest concerns. Therefore, the extent of the research area is limited to financial institutions who directly and indirectly work with offshore financial centres and thus have a specific risk profile.

Business activities have a cross-border tendency and intersect different legal systems. However, many offshore financial centres identify as common law jurisdictions. This puts emphasis on the United Kingdom and its overseas territories, and the United States. However, the European Union is subject to abundant employment of offshore companies and thus included in this study as well. Alongside individual jurisdictions and regions, international organizations and their codes of conduct deliver considerable input.

4.3 Research philosophy and design, data collection, and thesis structure

Legal scholars may conduct research in a normative or empirical way.[184] The scope and nature of the challenges faced by stakeholders in global banking, invites an empirical research philosophy. Additionally, the exploratory design of this study contributes to a general understanding of the ecosystem the offshore financial industry participates in. Secondary sources of existing research are appropriate since primary research is difficult to obtain. This is mainly due to the confidential nature of the industries involved. As such, a variety of academic papers, peer reviewed journals, working papers and original study books is complemented with case law, legislation, conventions, treaties and directives to find answers for the research question, aim and objectives.

The methodology used seeks to identify and analyze the hazards of the global financial system and in particular where offshore jurisdictions are directly and indirectly involved in these hazards. Consequently, the structure of this thesis underscores background information as a bridge between the introduction and literature review. A top-down approach addresses risk factors in banking and finance, financial globalization, the role of the offshore financial industry, as well as regulatory action to protect the public interest. It funnels a broader context into a narrow setting to ultimately reveal the hazards of offshore banking for the uninformed.

5.     Results and Discussion

5.1 Introduction

Majone[186] differentiates economic regulation to restrict market power from social regulation that deals with behavior and its impact on micro economics. The fear that contagion of opportunistic financial institutions impacts overall financial stability is not always connected with a run on the liquidity of the bank by creditors[187]. This is confirmed by Dragomir[188] who links the existence of depositor protection with a lax attitude of depositors towards massive withdrawals from struggling financial institutions. This strengthens the view that risk of contagion is the exclusive domain of systemically important financial institutions and the public interest is best served with risk mitigation of such firms.

Unique circumstances where financial institutions violate AML-CTF standards and facilitate sanctions evasions differ from the traditional measures imposed by regulators to protect the financial system. Also, capital cushions as mentioned in the Basel Accords mainly refer to operational and market risk. Capital reservations for policy violations give a wrong signal to the market by alleging an offset of monetary fines for conspiracy and other illicit behavior. Consequently, a firm reprimand condemns detrimental conduct and shows society that such acts or omissions are impermissible and will be punished. This ultimately leads to confidence in the financial system and thus serves the public interest.

The offshore financial industry has features and characteristics that allow for legitimate and illicit The result is a variety of gaps, overlaps and conflicts in administration and regulation of the jurisdictions involved. These gaps are used by both legitimate and illicit actors. However, they are widely misunderstood by the general public on the assumption that all frameworks should be identical. Furthermore, it is argued that differences trigger abuse and exploitation of local workers and developing countries[189] while creating a biased competitive position against more traditional onshore jurisdictions[190].

5.2 Analysis of academic findings and empirical data

The global financial industry is complex. It combines economic policy with sovereignty, human behavior and the consequential dynamics. This is based on the inferior assumptions[191] that history predicts future events, economic growth is endless, and behavior is honest and rational. However, neuroscience and psychology, and in particular the debate on nature versus nurture[192], reveals a gap between how people ought to behave and how they act[193]. This chasm applies to both financial institutions and their customers. Financial liberalization triggers freedom for market players but requires an advanced understanding of risk.

History shows that bursting economic bubbles are mitigated by government support. Consequently, moral hazard is common for financial institutions and customers tend to focus on return on investment instead of a reasonable risk assessment. This attitude is furthered by a natural bias to optimism as seen in bull markets where investors want to join an upward trend whilst the pursuit of returns restricts rational decision making[194]. This toxic environment of self-interest works both ways; it supports the complex financial products offered by financial institutions and it allows the customer to visualize prosperity. Simultaneously, downside risk seems irrelevant for financial decision making.

The following paragraph discusses several challenges of the offshore financial industry. These include the ex-ante character of regulation, the fragmentation of ownership, the prosecution of corporations, insolvency proceedings in two distinct legal systems, and the civil remedies available to stakeholders.

5.2.2 The challenges of regulating the offshore financial sector

Regulation has an ex ante character, based on historic events and forecasts. Successive anti-money laundering directives[195] and additions to the FATF recommendations[196] have a similar character and implement periodic changes to the existing frameworks. The result is that bubbles and crises show correlation with human behavior. Yet, policy design is based on fiscal and economic modelling but leaves morality and irrational human behavior untouched. This is demonstrated by excessive risk taking[197] in divisions like investment banking, non-resident customer portfolios, and offshore banking.

Financial institutions can be victims and enablers of crime. Detection of financial crime can lead to public interference by regulators via civil action, and criminal actions by the prosecution[198] against financial institutions and alleged criminal organizations. The choice between civil and criminal proceedings may arise from evidence[199], the size and global importance of the financial institution[200], the ownership structure[201], and the possibility to hold both the legal entity and the controlling actors accountable by piercing the corporate veil.

The corporate structure and citizenship of financial institutions leads to rights that are ‘conventionally granted and protected by governments of states’[202], and allows for public or private ownership. Where shares of public companies are traded on stock exchanges and thus ownership is fragmented by a general pool of investors, privately held companies are often smaller and easier to prosecute. A combination of the separation of ownership and control with the legal entity[203] and thus the limited liability for shareholders[204] restricts damage to the existing monetary value of the legal entity. Company shareholders protect their investment by instructing the board of directors on the strategic direction of the company via company meetings. It follows that the board of directors is responsible for the daily activities of the company. Such responsibilities include duties[205] and liabilities[206] to ultimately promote the success of the company.

Since private individuals run companies, conduct risk and its ownership is paramount. Yet, regulation to combat excessive risk taking does not quantify conduct and individual acts. The result is that bank failure caused by AML-CTF violations follow an alternative path towards correction. Large companies that are publicly traded can be considered Public Interest Entities (PIEs) by nature of their activities, size, or number of employees[207]. Firms that are not considered too big to fail and fall outside the scope of a PIE, whilst largely violating regulatory standards, risk isolation and a forceful winding down.

Governments can invoke criminal or civil proceedings against wrongdoers. Proceedings under criminal law may lead to sanctions, and violations of tort law compensate injuries. Civil action has a reduced burden of proof to the preponderance of evidence instead of the qualification beyond a reasonable doubt in criminal matters. In general, the legal entity is responsible for the actions of its individual employees and rules of attribution determine whether the criminal act applies to both the individuals and the company. Consequently, the company and staff members can be prosecuted for their acts and omissions, even when there is no unlawful intent by corporate officers and directors. This is clarified in the doctrine of the responsible corporate officer[208] which originates in the United States where executives can be held accountable for crimes they are unaware of[209]. Recent investigations into unlawful activities of individual bankers emerged in the Netherlands[210], Hong Kong[211], and Estonia[212].

Criminal convictions may lead to financial penalties, reduced future career prospects, and other limitations, and even imprisonment for individuals. Corporations, on the other hand, can only be fined, sanctioned, or closed. Deferred prosecution agreements[213] have a voluntary structure to enforce internal reform in exchange for a dismissal of charges and prosecution[214] upon completion. As such, publicly traded and systemic financial institutions can depart from public prosecution and potential closure, whilst privately owned and smaller corporations are subject to a stricter application of the regime.

Financial institutions deal with private investments and public funds. Therefore, emergency relief[215] and civil forfeiture can compensate victims of financial crime and fraud. Civil forfeiture is an action in rem, and thus taken against property. When a court decides to pierce the corporate veil[216], civil forfeiture may include all the legal entities belonging to the culprit, including the assets ‘in personam’ of the controlling minds. In the United States, this position is confirmed in US vs Various Items of Personal Property[217], where the court held that the state owns the property from the moment the offense was committed. Once suspicious assets are distributed, the UK for example allows the burden of proof for obtained assets to be reversed to the property owner[218] via the Proceeds of Crime Act and unexplained wealth orders[219].

When the corporation is forced to close, compulsory winding up is justified. Insolvency proceedings for corporations end when the available assets are distributed to creditors. The applicable creditor hierarchy determines the position of uniform groups of creditors, which are paid on a ‘pari passu’[220] basis. This hierarchy starts generally with prioritized and secured claims, followed by senior unsecured liabilities. The third position is for subordinated debt. Corporations that are solvent enough can monetize and distribute shareholder equity to its owners. In an international setting where corporations have activities in different common law jurisdictions, modified universalism[221] identifies the appropriate jurisdiction while respecting domestic sovereignty. As such, different procedures may apply and local distinctions and interpretation in a global setting can delay winding up. This is clarified by challenges with the enforcement and recognition of foreign judgments when assets are placed offshore.

Creditors who feel wronged by a forced liquidation of a financial institution and the consecutive bail-in scenario[222] have limited options for additional recovery. Anti-deprivation rules prevent unfair advantages for creditors uncertain of, and prior to bankruptcy[223]. The objective of a receiver or liquidator is to orderly resolve the winding up of the corporation by collecting and realising assets and distributing those to creditors. Simultaneously, liquidators have duties towards the company and not to creditors[224]. Therefore, dissatisfied creditors should uncover alternatives to protect their individual property rights. Such can be established by civil claims against the controlling minds of the corporation, or by joining the criminal or civil actions of a prosecutor as a civil party. Especially in the United States, an extensive and comprehensive framework of Acts and caselaw supports extra-territorial jurisdiction in the event of fraud against the US government[225].

For example, under the RICO Act[226], civil conspiracy leads to recovery of all damages that result from the conspiracy. To succeed, federal prosecutors must show that the culprit is a willing participant in the conspiracy[227]. FIRREA[228] creates a civil liability for criminal laws such as mail and wire fraud. In US vs The Bank of New York Mellon Corporation[229], it was established that investors should count on professional financial advisors to inform them truthfully about how their investment is managed, and that fraud against the federal government includes risk for federal insured deposits.

5.3 Conclusions

The general public assumes that banks are stable, and their money is protected. This hypothesis is strengthened by widely reported and known historic economic events. Large and systemically important financial institutions are too big to fail and seem to be too big to manage[230]. Their failure leaves bank management untouched while society bails out the institution. Violations of international standards furthers an unequal level playing field. In exceptional circumstances, creditors are compelled to participate in the losses of the bank via a mandatory bail-in. The contrast between offshore financial institutions and non-systemic banks is substantial. Failure of the latter is considered a domestic issue governed by public interest doctrines and a combination of bank regulation, company law, and insolvency law.

It is for uninformed creditors difficult to define public interest, distinguish between offshore financial institutions and their systemic counterparts, and justify the choice of a bail in versus a bail out. They underestimate unconventional risk factors and bear the consequences of irresponsible behaviour by financial institutions. Meanwhile, large financial institutions may admit wrongdoing by acquiescing to consent orders and other settlements with regulators, but stay vulnerable for abuse by financial crime, money laundering and other illicit conduct. This approach to fine systemic institutions but close its smaller competitors is unexpected, confusing and seems arbitrarily to the outside world.

6.     Conclusions, limitations and recommendations

Financial crises give rise to regulatory improvements, intergovernmental initiatives, and increased capital cushions to absorb losses. The main concern with such post hoc action is that the costs of risk taking that led to a crisis comes at the expense of society, while the true cause is not halted.

The issue of symptom relief by regulators emphasizes the importance of notion and risk awareness by creditors and other stakeholders. However, this responsibility is often immaterial due to biased assumptions of the role of the government to protect the public interest, instead of the rights of individual creditors. When it comes to AML-CTF violations or economic sanctions, enhanced misconceptions arise since many stakeholders can be duped by the acts or conspiracy of few illicit actors. In a way, sanctions programs are successful because they create fear and thus let the market manage isolation of wrongdoers. On a micro economic level, this assumes that individual creditors reject obscure and illegal activities in the future after their investment gets lost.

Conduct and ownership of risk appeared the central theme of this study. It drives on moral hazard and caveat emptor, while the consequences for veil piercing and individual responsibility is random. Risk taking is enabled by the organization and culture of financial institutions where the commercial and compliance divisions are in constant conflict. This is characterized by short-termism, individualism and profitability at the expense of risk management and control.

Offshore bank failure has resemblance with compulsory liquidation of a company followed by insolvency and the novel bank bail-in. Assets are realized and distributed to creditors, resulting in mandatory creditor participation in the corporate losses. Alongside the traditional safeguards like fixed and floating charges, mitigation of creditor losses in bank failure starts with participation in the deposit protection scheme. Unsecured deposits, including the surplus after the insured payment is honored, and subordinated debt are considered risk capital and thus must be handled accordingly. In the event of default, as codified in domestic insolvency law, the creditor hierarchy decides on the ultimate recovery percentage.

In the event of criminal activity, sanctions evasions or money laundering and terrorism financing may lead to civil and criminal prosecution and veil piercing. The public prosecutor can fine or settle with wrongdoers. Causality between the illegal activity, the failure, and loss of money allows individual victims to join criminal cases and collection as a civil party. A variety of Acts are available in the United States and the United Kingdom to provide emergency relief and compensation to victims of fraud and financial crime. Even though forum shopping is prohibited, the cross border and global character of the financial system may provide jurisdiction for different countries in these matters.

Globalization allows offshore financial centres to gain access to the rest of the world. This applies to corporations and financial institutions registered in the offshore jurisdiction. As a result, different legal systems and interpretations may apply. Therefore, the first limitation of this study is the bias to the common law legal system. In future research, the inclusion of civil law doctrines can provide further insights. Furthermore, this study was done in a vacuum, whereas future research could study the depth of human behavior and conduct risk that triggers gatekeeper failure by allowing illicit transactions to enter the financial system. Conclusively, regulatory changes have been identified as repair mechanisms that unravel after crises take place. The difficulties between theories of the free market, regulation, and Westphalian sovereignty further complicate the composition of a unified and global mandatory framework.

This study examined widespread misconceptions about the offshore financial system in comparison with systemic financial institutions. More awareness for all stakeholders leads to a better functioning system. Thus, enhanced clarity and a robust counter mechanism to combat critique against the offshore financial industry contributes to understanding. It helps to focus on the true concern, protection of the global financial system and exclusion of illicit actors and other financial criminals whilst legitimate stakeholders can make their own accurate risk assessment.

7. Done With You Services…

This study was submitted in partial fulfilment of the requirements of the University of Liverpool for the degree of LLM in International Business Law. The author of the paper owns Legal Floris LLC, a boutique firm working on the cross-roads of bank failure, investment fraud and other losses of money involving multiple jurisdictions and offshore financial centers. If you are a victim in (offshore) bank failure or investment fraud, and need a solution to recover your assets, feel free to complete the contact form on this page.


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