[PDF]The Secret Money Market Ingo Walter

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LAE SECRET
MONEY MARKET


Inside the Dark World of
Tax Evasion, Financial Fraud,


Insider Trading,


Money Laundering, and
Capital Flight


Ingo Walter





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‘vision of HarperCollinsPublisher





Copyright © 1990 by Ballinger Publishing Company. All rights reserved. No part of this
publication may be reproduced, stored in a retrieval system, or transmitted in any form
or by any means, electronic, mechanical, photocopy, recording, or otherwise, without
the prior written consent of the publishers. Editions are not for sale in countries other
than the USA, its dependencies, the Philippine Islands and Canada.


International Standard Book Number: 0-88730-392-7 (cloth)
0-88730-489-3 (paper)


Library of Congress Catalog Card Number: 89-45776

Printed in the United States of America

First published in Great Britain by Allen & Unwin 1985.

First published in Counterpoint by Unwin® Paperbacks 1986.
second edition published by Unwin® Paperbacks, an imprint


of Unwin Hyman Limited, in 1989. © Ingo Walter, 1985, 1986, 1989


20). Ol eG Oa 7 Oso 64 eal


Contents


List of Tables, Figures and Exhibits
Preface


1 The World of Secret Money


The demand for financial secrecy
The supply of financial secrecy
The cost of secrecy

The price of secrecy

Market structure

Plan of attack


What is Secret Money?


The underground economy
Measurement
Causes
Levels of underground activity
Internationalization of underground financial flows
Secret money vehicles
The direct approach
The indirect approach
The problem of death
Summary


Demand for Secret Money: Capital Flight,
Bribery and Corruption


Confidentiality
Capital flight
Defining capital flight
Measuring capital flight
Capital flight vehicles
Capital flight - consequences
The unhappy case of Antonio Gebauer
Bribery and corruption
Bofors
Tongsun Park
Dictators and others


Demand for Secret Money: Tax Evasion,
Smuggling and Insider Trading


Tax evasion
Avoidance vs evasion


79


79
79


CONTENTS


The Marc Rich case
omuggling

The Mueller case
Violations of securities laws

Pros and cons of insider trading

Catching insider traders

The Levine case

Piggy-backers

The Boesky case

The Vaskevitch case

The Lee case

The Guinness case


Demand for Secret Money: Fraud


The]. David & Co. case

The Chase-Colombia case

Insurance fraud

The Blay-Miezah case

The Ballestero case

The Heiwa Sogo case

The Galanis case

The Pedley case

The DeLorean case

The Mao case

The Mediobanca case

The Polo case

Euroscam

Bank fraud — Central National Bank of New York
Precious stones and jewelry-related fraud
The E. F. Hutton case

ZZZLZ Best

Banco Ambrosiano


Demand for Secret Money: Money Laundering
and Undercover Activities


Money laundering
Secret money and the drug trade
Colombia
Asia
Problems of concealment
International undercover activities
The FLN case
The Nugan Hand case
The IRA case
The PLO case


V1


135


150


150
15]
152
156


171
171
173
173
174


CONTENTS


Trangate
Summary


Supply of Secret Money


Elements of supply
Patterns of secrecy supply
Switzerland
The Liechtenstein link
Costs
Economic significance of banking
Competitive shift
The French connection
Other issues
The defense


Global Secrecy Havens


Caribbean and South Atlantic
Antigua
Bahamas
Bermuda
Cayman Islands
Montserrat
Netherlands Antilles
Channel Islands
Gibraltar
Luxembourg
Panama
Other havens
Austria
Hong Kong
British Virgin Islands
Lebanon
United States
Deak & Co.
The bearer securities problem
Summary


Combating International Financial Secrecy:


Unilateral Initiatives


self-control

National government initiatives
The US Bank Secrecy Act
Operation Greenback
The Bank of Boston case
The E. F. Hutton case


Vil


238


239
241
242


245
248


CONTENTS
New initiatives
The long arm of the tax man
Patterns of national action


10 Combating International Financial Secrecy: Patterns
of Cooperation and External Pressure


Mutual assistance
Pressure tactics
Combating insider trading
St Joe Minerals Corporation
Santa Fe International Corporation
and Ellis AG
IU International Corporation
Watver by conduct
Combating insider trading in Europe, Astaand Latin America
Multilateral approaches
The OECD tnttiative
The UN inttiative
Summary


11 Consequences


Economic effects
Political effects
Social effects
Personal effects
Summary


12 The Outlook


Annex 1 Theory of International Financial Secrecy


Secrecy versus expected returns
Secrecy versus risk

Risk versus returns with secrecy
An overall view

Marginal costs and benefits
Value of secret assets

The principal—-agent problem
Demand and supply

The externality problem
International trade in financial secrecy
Summary


Annex 2 Catalog of US Cases Involving Bank or
Commercial Secrecy

References

Index


About the Author


Vill


250
259
261


344
354
367
377


4.2


4.3
6.1


A.1
A.2


Tables, Figures and Exhibits


Tables
The size of the black economy as a percentage of GDP 14
Summary of global payments balances on current account
(recorded and adjusted), 1979-86 25
Estimated net capital flight cumulative flows during 1976-85
and 1986 36
Identifiable non-bank residents’ deposits in foreign banks,
September 1985 57
Impact of capital flight on debt 38
External debt, capital flight, and capital formation (1974-82) 60
List of countries or territories regarded as tax havens 187
Withholding tax on bond interest 233
Figures
Price distortions and economic growth in the 1970s 15
Self-employment in selected countries (as a percentage of
non-agricultural employment) 17
Opportunities for substituting household spending in the
official economy with work at home, 1986 24
Discrepancy in world current-account statistics 26
General government budget balances in selected countries,
1981 and 1986 80
Net public debt as a percentage of GNP in selected countries,
1973 and 1986 81
Market price of securities with alternative information 103
US bank liabilities to Latin America and the Caribbean, 1970,
1975, 1980-5 160
secrecy versus expected real returns 322
Secrecy versus risk 324


2.1


4.1


TABLES, FIGURES AND EXHIBITS


secrecy and the efficient portfolio 326
Balancing risks, returns, and secrecy 328
Cost-benefit analysis applied to financial secrecy 38)
supply, demand and market equilibrium 337
Price discrimination among secrecy seekers 339
International trade in financial secrecy 34]
Exhibits

sample of US legal cases involving international financial

secrecy 33
Examples of international financial secrecy in cases of insider

trading 102


Preface


This book is about global financial flows that nobody is supposed to
know about — their size, their nature, their causes, and their effects. It is
about the behavior of people who want to keep financial information
from others and are willing to pay for it. It is about people, institutions
and countries that are happy to handle secret assets and keep the
information to themselves, usually for a price. There is demand and
there is supply, there are buyers and there are sellers.

Financial secrecy can be considered a business, one that can be
analyzed in terms of the economics that underlie any business. It forms
an industry that produces services people want and are willing to pay
for, one that has its own players in a global marketplace. It is a
somewhat curious industry, however, in that services are produced that
contribute great value to some, yet are perceived as positively bad by
others —- so that the players are caught in a never-ending series of
cat-and-mouse chases.

This book attempts to describe that industry, in all of its economic,
political, social and personal dimensions. Consequently, economics
forms the basic frame of reference for this book. Concepts of market
analysis, macroeconomics, international trade, economic growth and
international finance all find application here.

So do war stories and anecdotes. Nobody is anxious to talk about
international financial secrecy, and there is little hard evidence avail-
able. Almost all first-hand information is confidential. What second-
hand information exists depends for its accuracy on those who tell it.
Like a jigsaw puzzle with many missing pieces, isolated facts and
observations have to be assembled in an effort to discern the structure of
the whole.

The first edition of Secret Money was published in 1985. In the
intervening years, an amazing array of new cases have arisen, ranging
from the Marcos story case in the Philippines to the Iran-Contra scandal
in the United States, from capital flight and the international debt crisis
to the insider trading and money laundering of the mid-1980s. This
second edition of Secret Money tries to capture these developments and
incorporates them into the framework developed in the first edition of
the book. Not surprisingly, the ‘fit’ is quite good.

Iam grateful to a number of individuals with whom I have discussed
problems of financial secrecy over the years, most of whom don’t want
to be identified. In addition, I am particularly grateful to Ms Amanda
Tealby Lomas, who pulled together the updates for the various chapters
and made a very significant contribution to the completion of this


XI


SECRET MONEY


edition. Ms Ann Rusolo capably and efficiently handled the often
complex word processing. a eee te
INSEAD International Financial Services Pro in Fontainebleau,
France. a _ =e
— INGO WALTER


New York City
september 1988


Xil


The Secret Money Market


1


The World of Secret Money


Few aspects of international finance are more fascinating than secrecy.
Images flash through the mind of suitcases crammed with currency
crossing national boundaries, of close-mouthed couriers slipping easily
into and out of airports, hotels and banking offices, of expatriates living
handsomely along palm-shaded beaches with no visible means of
support, of churning money laundries and quiet slush funds. All find
their parallels in the real world. But there are many other, less dramatic
but much more important images as well: the tax evader skimming
unreported income into an offshore account; the briber shuffling funds
to the bribee; the violator of securities laws squirreling away illegal
profits; the insecure politician or government official building a
retirement fund abroad; the businessman fleeing his creditors; the
husband fleeing his wife; the law-abiding citizen fleeing exposure to
political or economic risk. All are players in the global financial secrecy
game.

International financial secrecy is a subject of enduring and perhaps
growing importance for the international economy, one that is well
worth exploring. With a little imagination, the conventional tools of
economic analysis can yield some useful insights into an otherwise
rather murky subject. As we shall see, it is largely a matter of supply and
demand.


The demand for financial secrecy


Who needs or desires financial secrecy? Practically everybody. The
demand for financial secrecy — meaning non-disclosure of financial
information that people are willing to pay for — arises from at least five
more or less distinct sets of motivations: personal, business, political
fiscal and criminal. Each has a unique pattern of demand that helps
define the overall structure of the global ‘market’ for financial secrecy
A personal desire to keep financial affairs confidential may be a purely


1





SECRET MONEY


domestic matter. Surveys reveal an amazing amount of financial secrecy
between husbands and wives, perhaps to prevent ‘irresponsible’ house-
hold spending behavior or to avoid unfavorable property settlements in
the event of divorce. Parents often keep financial secrets from their
children, in the hope of inducing proper motivation and greater effort.
Moneyed people withhold financial information from their prospective
heirs in the hopes of keeping the vultures at bay. In an employee’s
dealings with his employer over salary matters, or a shopper’s haggling
with salesmen over purchases of goods or services, it is usually worth-
while not showing too many financial cards. And there is the matter of
personal preference. Individuals feel more or less strongly that personal
finances are nobody else’s business, that they have a basic ‘right’ to
financial privacy. Nor is it wise to attract thieves, kidnappers, con-artists
and other social parasites by unnecessary financial disclosure. Personal
financial secrecy usually remains in substantial compliance with the law,
and in many countries has been well served by long-standing traditions
of banking confidentiality. Indeed, it is often regarded as a cornerstone
of personal liberty.

Confidentiality is no less important as an aspect of business affairs.
Withholding financial information from competitors, suppliers, credi-
tors and customers is a right that business people assume from the
outset. Release of such information is made only in a tightly controlled
manner and, where possible, only in a way that benefits that enterprise.
As such, financial information is proprietary. It is capitalized in the
value of a business to its shareholders. Leakage of financial information
could easily erode this value, and so confidentiality and the judicious
use of information is generally assumed in business as a critical com-
ponent of the rules of the game in market-oriented economies. Beyond
this, however, people in business may wish to keep financial infor-
mation from employees, partners, potential acquirers and filers of
lawsuits, not to mention the tax man, all the while remaining fully in
compliance with the law. Again, standard confidentiality arrangements
in national banking and financial systems are usually well suited to meet
the need for ‘normal’ business secrecy.

The kinds of effects the desire for business secrecy can have is
illustrated by events on the Tokyo currency exchange. During the
mid-1980s, foreign institutions’ share of foreign exchange business rose
by 50 per cent, to 45 per cent of total trades. This is in part thought to be
due to good service and aggressive pricing. But there is undoubtedly
another factor, namely a loophole in Japanese foreign exchange regula-
tions. In 1987, the Finance Ministry, worried about the soaring yen,
suggested that Japanese bankers cease their speculative sales of dollars.
As a result, secrecy-prone corporate traders gravitated to foreign-owned
banks. Unlike Japanese institutions, they are not required to report their
foreign exchange activities to the Bank of Japan.!


ie


THE WORLD OF SECRET MONEY


There are times when people worry about their exposure to poli-
tical risk. The owner of a company or a farm worries that a new
regime may confiscate his assets. The government official worries
about being overthrown, possibly necessitating a hasty exit to save
his own life. Ordinary citizens have been wiped out time after time as
governments come and go with exciting but often misguided new
policies. As the years go by, they develop a deep personal distrust of
‘visible’ domestic financial and real assets as a reliable store of value.
Meanwhile, foreign investors in a country worry about the risks of
being aliens, and often seek to submerge themselves as far as possible
in the host environment, possibly through the services of local inter-
mediaries or beneficial owners. Because political risk usually extends
only to a nation’s borders, extraordinary value is placed on ‘outside’
assets kept under wraps in other, less troublesome political jurisdic-
tions. Yet the ownership of ‘outside’ assets may itself be viewed at
home as evidence of a lack of commitment, a telegraphing of options,
and possibly as a crime, thus placing a great premium on secrecy as
long as the principal — or people he or she cares about — remains
behind.

Then there are the tax evaders. Death and taxes are said to be the
only great certainties that face human beings. Around the world
people feel that they are unfairly taxed. Some are exposed to high
levels of income taxation. Others are hit by confiscatory wealth taxes or
death taxes. Still others feel forced by high indirect taxes or wage and
price controls to escape into the underground economy, or are encour-
aged by stiff import duties and other market distortions to enter the
contraband business. And there are always those who are simply
greedy, for whom the only ‘fair’ tax is zero.

There are usually ways to avoid taxes legally, for a price. There are
also ways to evade taxes - illegally to escape government claims on
income or assets. None is entirely risk-free, and all require varying
degrees of financial secrecy to work. Once again, ‘outside’ assets,
beyond the reach of the national fiscal authorities, can take on a high
value to the tax evader.

Lastly, there are the crooks (we can leave aside for the moment tax
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