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New Case has Huge Potential Ramifications for the US Private Banking and Wealth Management Industry

Philip Marcovici, Baker & MacKenzie, Partner, 12 May 2005

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On April 26, 2005, the United States Supreme Court held in Pasquantino v United States, that a “plot to defraud a foreign government of tax ...

On April 26, 2005, the United States Supreme Court held in Pasquantino v United States, that a “plot to defraud a foreign government of tax revenues” can, where the requisite nexus to the US exists, constitute a wire fraud violation under the US Criminal Code, which is a federal crime. Wire fraud is a predicate offence under the US criminal money laundering laws, and also under the Racketeer Influenced and Corrupt Organizations Act (“RICO”), meaning that wire fraud charges can also expose defendants to concomitant charges under money laundering and RICO crimes, including where appropriate, forfeiture, treble damages, liability for adverse parties’ costs and attorneys’ fees, and severe criminal penalties and imprisonment. Pasquantino may, potentially, have significant consequences for the private banking industry. Just how significant those ramifications are however, is debatable. At least there is the possibility that bankers who directly or indirectly assist clients to “hide” funds from non-US tax authorities using the facilities of US interstate or foreign commerce (something that can be as simple as a US dollar denominated wire transfer) may well be committing a US federal crime subject to substantial penalties, including imprisonment. Private banks, insurance companies, and anyone else involved in the wealth management industry should be reviewing their activities in the United States, reviewing and revising (where appropriate) their due diligence compliance policies, and ensuring that training of staff results in an understanding and management of the risks associated with activities in or out of the US that could have US wire fraud implications. The Facts of the Pasquantino Case The defendants in Pasquantino ordered liquor over the telephone in calls made from New York to Maryland. After picking up the liquor in Maryland, they hid it in vehicles and drove it into Canada. They failed to declare their contraband to the Canadian authorities at the border and, as a result, failed to pay the required Canadian excise taxes. This was not a benign or even negligent activity but, rather, was a deliberate plan to move alcohol into Canada and to sell it at a higher profit by not paying the requisite Canadian excise taxes. In a 5-4 decision, the Supreme Court held that these actions constituted wire fraud under the plain language of the federal wire fraud statute. That statute prohibits “any scheme or artifice to defraud or for obtaining money or property by means of false or fraudulent pretenses, representations, or promises transmitted by means of wire, radio, or television communication in interstate or foreign commerce.”Had the defendants used the US mail, the provisions of the mail fraud statute would have applied.The Court noted that the defendants had used US interstate wires (i.e., telephone lines) to execute a scheme to defraud the Canadian government of tax revenue. The fraud on the Canadian government occurred when the drivers intentionally failed to declare the liquor on Canadian customs forms—although for purposes of the US wire fraud statute, the majority opinion of the Court focused on the defendants’ actions within the territory of the United States. In addition, the Court ruled that Canada’s right to uncollected taxes is “property” as that term is used in the wire fraud statute. Thus, the defendants’ actions satisfied all of the elements of federal wire fraud. In its analysis, the Pasquantino Court (over the objection of the dissenting Supreme Court justices) rejected the defendants’ argument that criminalizing their conduct violated the common law “revenue rule.” The revenue rule is a doctrine under which courts in the United States (and in other common law countries) generally do not enforce the tax laws of other nations. The Court emphasized that the case before it was not a suit to recover a foreign tax liability, but a US criminal prosecution to punish US domestic criminal conduct that occurred in the territory of the United States using the facilities of US commerce. The Court also rejected the argument that the decision espoused by part of the dissenting opinion that gave the wire fraud statute “extraterritorial effect.” As the majority of the Court saw it, the defendants were being punished for their actions within the United States. In any event, as the Court noted, the federal wire fraud statute punishes fraud executed in “interstate or foreign commerce”: and so, the Court reasoned, “this is surely not a statute in which Congress had only domestic concerns in mind.” How Does This Relate to the Private Banking and Wealth Management Industry? Pasquantino’s ramifications for the private banking industry are potentially far-reaching. First, it is now clear that the mere fact that a foreign, non-US, government is being defrauded of tax revenues is not a bar to criminal prosecution in the United States. Second, any scheme to hide undeclared funds will inevitably involve some use of telephones, faxes or other “wires” at some point in the process. Accordingly, this element of wire fraud will usually be easily satisfied. The more debatable issues in the private banking context, however, are (i) the extent to which Pasquantino might be applied to the US wealth management industry (the banking, insurance and securities sector); (ii) whether a banker who has no affirmative duty to make any tax filings in connection with a client’s undeclared funds can be said to have participated in a scheme to defraud for purposes of the wire fraud statute and (iii) whether Pasquantino might extend to actions taken by clients and bankers who are physically located outside the United States. The wire fraud statute, as paraphrased in Pasquantino and earlier cases, requires a “scheme or artifice to defraud” using the facilities of interstate or foreign commerce. This element, in turn, is satisfied if the scheme is designed to “defraud by representations.” Pasquantino held that the intentional failure by the drivers working for the Pasquantinos to declare goods that were subject to Canadian excise taxes, and their failure to pay the required tax on those goods, satisfied this element of wire fraud. The elements of the crime are therefore fairly easily met. It is sufficient that the US “wires” are used as part of a scheme to “defraud by representation” a foreign government of the taxes that it would otherwise be owed. There is no requirement that any particular false statement or declaration be made. The United States has actively encouraged non-US investors through its regulatory and tax laws to invest in the United States. Pasquantino is concerned with smuggling taking place from the United States, an activity hardly to be encouraged by or worthy of the protection of the US Government. Even the majority in Pasquantino acknowledged that “[i]t may seem an odd use of the Federal Government’s resources to prosecute a US citizen for smuggling cheap liquor into Canada.” In this context, it would seem even more odd if the US Government’s power were used to prosecute a banker and his or her client for wire fraud simply for carrying out customary banking, investment, or estate planning activities in the United States. There will, of course, be a line when activities of a private bank or insurance company fall into the category of intentional (or even willfully blind) conduct so that US federal prosecutors will deem the conduct to be worthy of prosecution. The difficulty faced by the industry in identifying what constitutes acceptable behavior and what will be deemed criminal conduct by US prosecutors may be far from easy. ·What of a relationship manager in the United States whose correspondence and discussions with a client relate to the objective of the client to structure a US investment in a manner that legally minimizes US taxation, and that addresses other needs, such as succession planning and asset protection, but where the objectives expressed by the client extend to limiting the flow of information to his home country given that the client has not declared the assets and income involved to his home country tax authorities? The client may well explain to the relationship manager that the monies are undeclared because of safety concerns of the client in view of the leakage of information from home country authorities to criminal organizations active in kidnappings. Can the ongoing activity of the relationship manager be considered to have the requisite criminal intent, with the accordant risks under the US bank fraud and wire fraud statutes, with money laundering and potential RICO action implications? Could the non-US government whose tax revenues are allegedly jeopardized begin to make claims against private banks on the basis of US money laundering or RICO laws? ·What of an insurance company selling an insurance “wrapper” designed to meet the requirements of the client’s home country tax laws, but where the discussions and correspondence between the insurance company and the client reflect an understanding that the monies involved have not been declared for home country tax purposes, and that, as a result, the policy will be designed to not make any payments until home country limitations periods have passed? The sort of activities that were involved in Pasquantino (transporting liquor across an international border and defrauding a government of liquor taxes) are those that are often associated with organized crime. Establishing offshore trusts and companies to accomplish legitimate tax and estate planning might historically be considered as being far less likely to arouse the interest of the US Justice Department, but in today’s more aggressive prosecutorial environment, and with this new weapon in the government’s arsenal, it is impossible to say that such facts may not draw attention of prosecutors. If such activities are also related to (or even appear to be connected to) potential money laundering or terrorist related offences, the likelihood of US government review is significant. We note, however, that many of the very same tools used to accomplish legitimate tax and estate planning, offshore trusts and companies, are often times used by money launderers, making the issue even more murky. Indeed, it is likely that Pasquantino will embolden prosecutors. They now know that the wire fraud theory works, and there is a substantial risk that certain prosecutors will use this new prosecutorial weapon to excess. Pasquantino affirms that as a matter of law, banks (or anyone else) can be prosecuted on the basis of any scheme or artifice to defraud a nation of taxes that has the appropriate nexus with the United States. Banks with relationship managers that have specific knowledge of a client’s tax evasion are therefore at risk of being pursued for conspiracy to commit wire fraud, aiding and abetting wire fraud, not to mention wire fraud itself, money laundering and RICO. There is no such thing as “merely” aiding and abetting, since it leads to the same result as if one were prosecuted for wire fraud. Recognizing the long-held practices of many of private banks and the difficulties inherent in altering such practices, the Pasquantino decision suggests, at a minimum, that practices be reviewed, and that other steps be taken to ensure that client problems do not become the problems of the bank—or the bank’s legal or other advisors. 1 The Existence of a Scheme to “Defraud by Representation” In the private banking context, where a banker takes specific actions to assist a client to defraud the client’s home tax authorities, there is little question that the client’s actions (and inactions) would amount to a scheme to “defraud” as that phrase is interpreted in Pasquantino. A distinction should be made between the provision of customary banking, investment, and estate and tax planning services, on the one hand, and the intentional creation of erroneous documentation intended to mislead local tax authorities, on the other. Where bankers or other advisors assist their clients in establishing structures knowing that the client will use the structure to illegally evade taxes in his home country, a US crime is committed. The filing of a tax return that does not report the undeclared funds, and the consequent failure to pay the tax on those funds, is analogous to the failure to declare the contraband liquor and to pay the tax on that liquor in Pasquantino. But what about the banker’s actions (and inactions)? In the typical case, the banker has no affirmative duty to report the clients’ funds to the foreign tax authorities. Indeed, in many jurisdictions, the banker would be prohibited from doing so. However, it is noteworthy that a false statement is not required for a violation of the wire fraud statute. The model criminal jury instructions in the Ninth Circuit (which are similar to those of other circuits) make clear the government need not prove a defendant made a specific false statementHaving said the above, let’s look at the following example: Mr. V, a Venezuelan, wants to open a bank account with Old American Brokerage (OAB) to purchase US investments, particularly US shares. The relationship manager tells Mr. V that in order to avoid US estate tax, he should put the assets into a Cayman company. Relationship manager is providing legitimate US tax counsel, but also knows that the use of a Cayman Islands company probably means the assets are not declared in Venezuela because the Cayman Islands is on the Venezuelan “black list.” Has the relationship manager potentially crossed the line? 2 How Far, If At All, Does Pasquantino Reach To Cover Wealth Management Professionals and Clients Located Outside the U.S? Any use of the US financial or banking system (e.g., transactions involving US shares or US currency), will normally involve some form of “wire” transmission into the US. Thus, in theory, non-US bankers assisting non-US clients outside the United States to hide funds from non-US tax authorities run at least some risk of violating US law. However, the Court in Pasquantino did emphasize that the defendants in that case were being punished for their actions “inside the United States.” Even though there does appear to be some level of risk of prosecution even when all transactions and events occur outside the United States, that risk is probably relatively slight. Thus, unless the facts of a particular case are egregious enough or the potential defendants are deemed unsavory enough, it seems unlikely that transactions of the sort described would be prosecuted within the United States. Moreover, even if they were, there is significant doubt that they would be successful even after Pasquantino given the Supreme Court’s emphasis on the actions that occurred within the United States. It should be noted, however, that under the USA PATRIOT Act, any financial institution having a correspondent account in the United States has submitted itself to US jurisdiction for money laundering purposes. Conclusion The Pasquantino majority opinion confirms that the wire fraud statute may be used to prosecute activities that result in defrauding foreign governments of taxes that would otherwise be due. As a result, the case adds a powerful weapon to the arsenal of the US Government, and represents yet another global development suggesting that undeclared funds are a danger area for private banks. Private banks and their advisors should not engage in fraudulent activities aimed at defrauding or aiding their customers to defraud their home tax authorities. Could what has been viewed as legitimate and customary banking, investment and planning activities now attract problems of wire fraud and, as a result, money laundering and dramatic exposures under RICO statutes? While the decision gives prosecutors another violation with which to threaten an otherwise bad player, we do not anticipate an immediate flurry of pure “foreign tax” prosecutions (i.e., cases where someone in the United States structures transactions primarily with an eye towards evading foreign tax laws). A prosecutor attempting to prosecute an abusive tax scheme in the United States is almost always desperate to find clear ‘badges of fraud’ the cases are inherently complex, and defense counsel have too easy a time, absent some clear fraud or underlying lie, to argue the government’s failure to prove willfulness beyond a reasonable doubt. Transactions in the United States for foreigners undertaken by lawyers and bankers, and absent blatant evidence of fraud, are unlikely to attract prosecution. Federal prosecutors routinely shy away from cases involving foreign proof, as they are too difficult and time consuming to mount, and are perilous in that a deficiency in pre-indictment (foreign proof) leg work is often impossible to overcome before or at trial. And a federal prosecutor would be clearly loathe to prosecute a complex case where foreign law experts might be called to dispute the government’s contention that a fraud occurred at all, or to opine that the transaction was more in the nature of avoidance than evasion. In the short term, we do not see many prosecutions involving wealthy individuals who structure transactions with the aid of counsel and bankers even when those transactions are done with an eye towards minimizing disclosures to the home country. However, where the private banker or his advisor involved knows that a transaction is being done, at least in part, for the express purpose of illegally evading the reporting of taxable income in another jurisdiction, problems can certainly arise. Banks should take steps to ensure that such circumstances do not arise. Action, should be taken by many private banks given their current activities in the United States and the way in which relationship managers and others deal with the day-to-day realities of many of their non-US clients. There may be circumstances where certain clients may be better served from financial centres other than the United States, and increasingly circumstances when the bank involved should withdraw entirely from working with the family unless the family is ready to address, in a legal way, their home country tax obligations. Training of staff, and the education of clients, will both be keys to both risk minimization and a move towards addressing the real needs of today’s high net worth families. [This article first appeared as a Baker & McKenzie Private Banking Alert. For further information call Philip Marcovici on (41-1) 384-1221.]

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