Money-laundering reporting officers and compliance officers at private banks and asset management firms find some sources of background information reliable, while others are far from trustworthy. This article looks at three of the more dubious ones.

It was the US Securities and Exchange Act 1934 that introduced the ugly term ‘due diligence’ to the world; since then, it has unaccountably spread overseas and come to mean many things in the process. In the anti-money-laundering (AML) world of private banking it covers background checks, transaction monitoring, the ascertaining of sources of wealth and sources of funds, benchmarking, name-checks against blacklists and whitelists, the search for ‘unusualness’ in account activity and much more besides. Some methods are reasonably reliable; others are not.

Citizenship-by-investment checks

Checks that precede the issuance of passports are not always what they seem. One interesting and common way of remitting sources of wealth to a safe distance is through the citizenship of many nations. Chinese and Russian businessmen and ex-officials, kleptocrats almost to a man, are especially keen on taking the 'golden visa' route. As in many other cases, they have a good cover story here: a 'golden visa' passport might be issued by a small country (the islands of St Kitts/Nevis pioneered the modern 'citizenship by investment' trend, although it is as old as the ages) but it allows the holder to journey through – and do business in – much larger countries with which the issuing jurisdiction has a treaty.

Great powers that have such agreements with small passport-issuing jurisdictions are becoming more aware of abuses. St Kitts itself had trouble in 2013 when an Iranian businessman was stopped at the Canadian border, claiming that had he bought his passport for US$1 million from officials in St Kitts. The long-standing "visa-free access privilege" that the jurisdiction's passports had in Canada vanished and visiting passport-holders were obliged to obtain visas normally. Privileges were only restored after a particularly heavy remediation exercise.

Other jurisdictions – notably Malta and Cyprus – offer 'golden visas' but are members of the European Union and their passports therefore allow the holders to travel throughout the bloc with constitutional rights attached to them that no other countries can remove. Abuses occasionally come to light, but secrecy often reigns; whereas some jurisdictions at least disclose the names of their new citizens-by-investment in their government gazettes, Portugal and Cyprus keep theirs secret. Indeed, in February 2008 the US Government sanctioned Rami Makhluf, a powerful Syrian businessman and 'regime insider' under Executive Order 13460, which targets people who benefit from public corruption; Cyprus made him a citizen in 2010. Nobody knows how many checks it ran on him, if any. For a real estate investment of €2 million, Cyprus offers a full family qualification (children included up to the generously late age of 28) with no requirement to reside and, if all goes well, a second European passport for one's spouse in just six months.

It is not a good idea, then, for a financial institution to rely on any background checks done by the passport-granting authorities of 'golden visa' countries. A recent example is that of Alberto Chang Rajii, who received a visa from Identity Malta in 2015 and was exposed the next year as the "Bernie Madoff of Chile." Identity Malta, during the first phase of its 'due diligence' process which constituted little more than a telephone call to Interpol, failed to spot the falsehood of Chang Rajii's public and easily-discountable boasts that he owned 1% of Google and that he had attended Stanford University in the mid-1990s and met Google founders Larry Page and Sergey Brin there. No employer who received this on a British curriculum vitae or an American résumé from a candidate for a high-ranking position would be fooled; Identity Malta, for a time, was.

Company registries

If a private bank wants to find out about a HNWI's corporate holdings, one might expect it to be able to scan registers of companies; in fact, there is only one publicly available registry in the world that contains intimate details of companies' beneficial ownership and it is fatally flawed. This is Companies House in the United Kingdom, which became host to the first such registry in the world last year.

With a public register, compliance officers need not go through a potentially tedious and wearing process to find out whether applicants for their banks' business are listed. The register is, however, hopelessly compromised by the existence of a 25% limit on ownership reporting, below which nobody's holding is listed. This is a holdover from a European Union AML conference in 2005, at which Italian premier Silvio Berlusconi insisted on a high figure, some would say for self-interested reasons because he himself was a HNWI who owned many corporations. The UK, up until that time, operated on an informal figure of 10%, which the City of London discarded in favour of the new figure as soon as the next Money Laundering Directive took effect. The country whose registry has the lowest threshold in the world is the Philippines, with 2%.

The British register is also compromised by the fact that Companies House does not police it properly; there are many instances of other corporations being listed as ultimate beneficial owners, even though this is against the law. Nobody has been punished so far. The British recently succeeded in convincing the European Union to force all 27 of its other countries to set up registers; not all have so far, despite the deadline having fallen on 26 June.

In the United States things are even worse for compliance and money laundering reporting officers, with the opacity of Delaware companies (which comprise more than half of all corporations in the US) tantamount to a global scandal. The privacy laws of that state’s corporate sector are so tight that the founder of a new company has to provide the authorities with less information that someone who wants to obtain a library card. Anonymous companies own anonymous companies, creating a tangled skein that investigators usually find impenetrable if it goes on for long enough. HNWIs can use these companies to help themselves commit such exciting crimes as arms dealing and drug trafficking, but more often they use them to stow away resources from the prying eyes of their wives' investigators (and the family courts) in case of divorce. In the United States, a debtor can only go to prison for his debts if he owes them to the Internal Revenue Service or to his ex-wife through a court settlement.

South and East Asian compliance functions

The locations of HNW-owned corporations in the world are another factor. Today's criminals are obviously avoiding the use of Niue, the Marshall Islands, Curaçao and other jurisdictions that the Financial Action Task Force persecuted during its first period of issuing blacklists which ended in the early years of the century.

Onshore Asia presents a far more appetising venue for the setting-up of corporations to hide wealth. Asian banks with private client arms – even in Hong Kong and Singapore (the first and, perhaps still, the only Asian jurisdiction to make foreign tax evasion a predicate crime for money laundering) – are very disinclined to ask searching questions of their prospects during the onboarding process and Asian regulators are sympathetic to this attitude, although they do not say so. Asian back-office outsourcers who perform remote KYC services in such places as Bengaluru often employ graduates with no experience in the AML world. Even though these graduates are often gifted and trained to use the software, they have no eye for criminality, are formulaic in the way they do their jobs, and form a thin managerial crust with unskilled workers below them. The AML software that eastern and western banks use is identical, with the same giants dominating the market all over the world; the attitudes of its users, however, are not.

Other factors make the well-developed hubs of south and east Asia a magnet for HNWs who want to hide wealth, ill-gotten or otherwise, in corporate structures. There is a blurred line between viable businesses that are incorporated and wealth-holding vehicles (which, in the US, are often called personal investment companies or PICs). The former are not particularly well-regulated for money laundering; the latter are. The game, then, is to avoid having one's company classified as the latter and have it classified as the former. It is also important to keep one's wealth in scores of such little companies and not concentrate it.

One reason (among many) for this is that at many banks in advanced jurisdictions in east Asia there is a balance-sheet threshold under which no private banking department will accept business – perhaps US$250,000, perhaps higher – and the bank in question will allocate it instead to the department that handles normal corporate business, where scrutiny is far less intrusive. If the company does find itself allocated to the private banking department, there is usually another threshold below which the bank will not bother to allocate a relationship manager – perhaps US$1 million, perhaps higher. This is good news for the money launderer; the RM is likely to ask unpredictable questions, whereas a company with no such inquisitor is likely to be asked routine questions that it can field with no trouble at all. The company is especially safe in the early stages of its relationship with the bank, before the AML systems can detect patterns in its activity and measure future expectations against them. Once ensconced in a respectable Asian jurisdiction, the company can send its money – and obtain banking business – all over the world. ‘Private banking by other means’ is therefore our third example of ‘due diligence’ failing frequently. Of the three, it seems the most likely to continue for decades.