Bringing Business Back Ashore

Buenos Aires issues world's first ban on offshore shell companies


In December of 2004, there was a horrific fire in a Buenos Aires disco called the Cromagnon Republic. Three rock fans shot off flares that set fire to the ceiling and engulfed the overcrowded discotheque in flames and smoke. In the rush to get out, 200 people were killed and 700 injured, most from trampling and smoke inhalation. The main entrance had been wired shut, and some of the emergency exits were locked, blocking escape.

In the days that followed, thousands of the victims' parents and friends marched in the streets and demanded justice. A judge started proceedings for manslaughter and froze $20 million belonging to the "owner," Omar Chaban. However, investigators soon discovered that Chaban appeared in no official disco documents; he was just the "administrator." The legal owners of the property and the disco company were offshore shell corporations registered in the tax haven of Uruguay, the neighboring country. The listed "owner" of the enterprise was a Uruguayan "straw man" in his 70s who had no money.

The tragedy gave political space to a deceptively unassuming lawyer named Ricardo Nissen, Inspector General of Justice for Buenos Aires, who is committed to fighting the system of tax haven shell companies that is the underbelly of illegal global finance. He told CorpWatch, "We think the owner of the discotheque is a single owner who divided it into offshore companies." In response, Nissen has taken a step that is the first of its kind, anywhere in the world. Six weeks after the deadly fire, he banned offshore shell companies from doing business in the capital district of Buenos Aires.

The Inspector General's directives, issued in February and March, build on two resolutions he issued in 2003 and ban offshore companies that cannot prove they have real business activity in their places of registration. The new rules apply only to the capital district of Buenos Aires, the sphere of Nissen's authority.

"After the tragedy of Cromagnon," Nissen says, "It seemed that the legislation had to become stronger."

There are around three million shell companies in the world. The term "shell" is used to mean front or "mailbox" companies. They are also sometimes called International Business Corporations (IBCs) or Personal Investment Companies (PICs). They are set up with secret beneficiaries to own bank accounts or property, to effect phony transactions, to hide or launder funds, and to evade legal responsibility.

Nissen's directive is a shot across the bow of the world financial system, which relies on offshore shell companies and bank accounts to move money seamlessly around the globe. But it is not an isolated act. Rather, it is one in a series of indications of the confidence of the new Argentine government, following their success in defying international financial institutions such as the International Monetary Fund (IMF).

The New Argentina

The current government of President Néstor Kirchner came to power in late 2001, after street protests against the IMF caused the previous government to collapse. It has since brought about a series of a small economic miracles -- including the reduction of unemployment from 20 percent to around 13 percent and lowering the poverty level nearly 10 points in the last three years by encouraging cooperatives and worker-owned factories.

With the backing of the protestors, who blamed the high rates of poverty and unemployment on the strict debt repayment program imposed by the IMF and other major bank creditors, Kirchner refused to repay the country's crushing $81.8 billion debt owed to bond holders. When the lenders were forced to negotiate (with the added bonus of a rebounding economy that repudiated the IMF's policies) Kirchner struck an agreement that forced creditors holding $62.2 billion of the debt to write off about 70 percent of the value.

Much of the debt that Argentina has been saddled with (around $155 billion in all) is the direct result of the offshore banking system. It began under the dictator General Videla, who came to power in 1978. A judicial inquiry by the Argentine Federal Court in 2000 showed that many of the loans granted to the nation at the time -- by banks like Citibank, Chase Manhattan Bank, Deutsche Bank and Hannover Bank -- were diverted directly to front-companies set up in offshore tax havens. Some of the money was simply stolen and some was spent on weapons. None could be paid back.

Profiting Offshore

There are offshore shell companies registered in as many as 70
jurisdictions around the world -- places such as Grand Cayman, the
British Virgin Islands, Jersey (the Channel Islands), Liechtenstein,
Luxembourg and Switzerland. They are used by corporate fraudsters and
tax cheaters, dictators and corrupt officials, drug traffickers and
other criminals.

Enron's use of offshore shells was
essential to its fraud. It had almost 3,000 corporate subsidiaries and
partnerships, a fourth of them registered offshore, including 692 in
the Cayman Islands, 119 in the Turks and Caicos Islands, 43 in
Mauritius, eight in Bermuda, six in Barbados, four in Puerto Rico, two
in Hong Kong, two in Panama, and one each in Aruba, the British Virgin
Islands, Guam, Guernsey, and Singapore. Regulatory authorities,
investment analysts and stockholders couldn't readily know who the
owners were, and couldn't see that partnerships were secretly owned by
Enron managers or associates. They couldn't check the books to see if
the offshore company was dealing with another insider-owned company
which was siphoning off its wealth. Significant offshore deals involved
Enron's biggest bankers, Citigroup and JP Morgan Chase, which set up
offshore companies which they controlled, to serve as sham trading
partners in order to allow Enron to disguise multi-million dollar loans
as trades, thereby shifting billions of dollars of debt off its balance

Tyco International CEO L. Dennis Kozlowski
moved the company's registration to Bermuda, then went on to set up 115
subsidiaries in tax haven countries, including eight in the Bahamas, 17
in Barbados, 55 in Bermuda, and five in the Cayman Islands. Most of
these companies had nothing to do with real business, but were shells
used in accounting games to shield Tyco interest, dividends, royalties,
and other income from U.S. taxes and to allow it to issue phony
accounting reports that hid bad debts and misreported assets. Stock
prices shot up, investors bought, Tyco executive made a bundle, and
investors lost their shirts when the truth came out. Tyco's former top
executives were charged with looting the company of $600 million.

the global insurance conglomerate, used offshore jurisdictions such as
Barbados, Bermuda and Luxembourg to help the company move debt off its
books, launder profits to evade U.S. taxes and hide insider connections
in supposedly "arms-length" deals. Goldman Sachs helped it set up Coral
Re, an offshore Barbados reinsurance company, which AIG secretly owned,
and when state insurance departments found out about it, AIG
stonewalled and bullied the agencies into declining to take action
against the company. AIG's luck changed when New York Attorney General
Eliot Spitzer discovered some similar current cases.

had ten tax haven subsidiaries, including four in Panama, three in
Bermuda, and one in the Cayman Islands. It used these subsidiaries to
manipulate financial results to hide expenses and inflate revenues in a
$11 billion accounting fraud, the largest in US history, all aimed at
protecting the company's share price and CEO Bernie Ebber's personal
wealth. They consisted of $3.8 billion of operating expenses being
incorrectly reflected as capital expenditure, which hugely inflated
profits to deceive investors and the markets. These expenses were
deliberately distributed across a host of accounts for capital expenses
to escape detection. The scam also cheated the Internal Revenue Service
of hundreds of millions of dollars, and the collapse of the company
cost shareholders about $180 billion; this includes state pension funds
--New York State lost $300 million, Michigan lost $116 million, and
Florida $85-90 million. And 20,000 workers lost their jobs.

Another large chunk of debt was acquired by the Carlos Menem government in the 1990s, which privatized government industries such as telecommunications and the airline industry, and sold them to companies who bought them with discounted debt bonds from the banks, paying fire-sale prices. At the same time, companies that borrowed money did not pay their own debts, and the corporate-friendly Menem government "nationalized" the private debt. And, like the regime before it, the Menem government also stole billions, which it shipped to offshore secret accounts.

Kirchner's refusal to play by the rules of creditors, who for years had turned a blind eye to the wholesale robbery of the government coffers, is a challenge to the international financial system. Ricardo Nissen's ban on offshore companies is a second, more direct challenge to the system.

Nissen's Rules

Nissen is a soft-spoken man who wears oval, rimless glasses and a mild expression. His demeanor is belied by his passion to end the offshore system. He explains that he arrived at this position after 25 years as a business lawyer.

"It always appeared that ghost companies bought a majority of the stocks in companies," Nissen says, noting that many companies privatized during the Menem era of the 90s moved their registrations offshore. He started asking himself, "Isn't it strange that a Barbados or Cayman Island company is the owner of a furniture store, a restaurant, or a kiosk that sells newspapers?"

One of the most creative loopholes, Nissen explains, was the acto aislado ("isolated act"). In Buenos Aires, 15,000 properties in the name of offshore companies have taken advantage of a clause in the national law that allows foreign companies to come to Argentina without registering, if they are doing so in a single incidence.

This loophole led to a proliferation of tiny, fake businesses. Even ex-President Menem once admitted to avoiding the potential taxes on his home because it was the official property of a company in a tax haven. "I don't have anything; a company lends it to me," he says. (Incidentally, Menem is also currently under investigation for illegally selling arms to Croatia and Ecuador in the early 1990s and stashing tens of millions of dollars in "commissions" in offshore Swiss accounts.)

Nissen has issued four regulations over the last two years in an effort to create a watertight system to prevent such offshore scams. First, he ordered that all foreign companies had to prove activities in their original country or in another part of the world (resolution 2/03), then he created another one that closed the "acto aislado" loophole (resolution 8/03). Then, this February, he strengthened the first resolution with another (general resolution 2/05) by banning offshore companies that are not authorized to carry out economic activities in their countries of origin. Finally, in March of 2005, Nissen required that anonymous and limited-responsibility companies, whose stocks are not traded in the local stock market, must identify their shareholders.

The last resolution is the most stringent - all companies seeking to do business in Buenos Aires must provide a name, address, and passport or identification number. They must also disclose the amount of their stocks. If intermediaries hold the stocks, companies must name the ultimate owners. If the company is registered in a territory deemed non-cooperative in dealing with money-laundering investigations by foreign law enforcement, then Argentine authorities are allowed to require even more information.

As a result of the first two orders, Nissen says, the number of foreign companies registered in 2004 was a third of that of previous years. Meanwhile, enforcing the resolutions will be the most difficult aspect of his job to come.

He describes one aspect of the process: "We send inspectors into the street. They ring the bell and ask the porter, 'Who lives here?' He says 'family so-and-so.' We know this family sold property to an offshore company, but continues living there. It's a fraud. When you sell a property, you don't stay there. There were three properties in this house. In each one it was the same: 'We sold property to a Virgin Island company, but for a year the company lent it to me, my mother and my daughter-in-law.' What a generous company!"

Today, Nissen has some other targets, such as the offshore subsidiaries of international banks, that come to Argentina. Then, he wants to end a tax-evasion scheme under which people create foundations that carry out commercial activities, but don't pay taxes because of their status as foundations.

Others have taken up Nissen's example. Mario Cafiero, a deputy in the Argentine Congress and longtime critic of the way the offshore system has been used to facilitate tax evasion and balloon the national debt, is developing legislation to extend Nissen's orders to the entire country.

Important Precedent or Bad for Business?

David Spencer, a lawyer who writes about international tax regulation for "The Journal of International Taxation," says that legislature that takes on these issues, normally does so on an information-gathering level. Therefore, it's significant that Nissen attempts to actually regulate the activities of a company.

Jack Blum, a lawyer and international expert on money-laundering, calls the efforts "fabulous." He says he's been "making the same arguments for years." Blum, who ran the Senate investigations on the BCCI Affair and Iran Contra, also hopes the U.S. will refuse recognize corporate shells. "We don't owe anything to the countries that charter them," he adds.

Dean Baker, co-director of the Center for Economic and Policy Research, a liberal Washington think tank also agrees with the move, as it will pose a barrier to dishonest accounting. The use of shell companies, he says, "disrupts capital markets; it makes it easier to have more dishonest practices across the board. I don't see why any country shouldn't adopt comparable legislation." Even the most conservative economists, he feels, should advocate for a system that is "simple and transparent."

Ted Truman of the Institute for International Economics and coauthor of "Chasing Dirty Money," says, "In the context of Argentina, it is noteworthy because there is a huge history of tax evasion." He adds that, "In principle, it's a good idea. You should be able to track the owners of assets; that would help in the context of taxation and money laundering. It would be easier if it was common practice throughout the world."

"In the U.S. context, it would be a little extreme," says Dan Shaviro, a visiting scholar at the conservative American Enterprise Institute who sees the fact that the US economy is larger that Argentina's as an important factor. "There are a lot of major companies incorporated in the Caymans," he adds. "I suspect, in the U.S., it would be politically unwise for people who want to restrict tax shelters to restrict it in this form. But it would be sensible to have a proposal to say 'if they fit the definition of a tax haven where we don't do business, they are treated as U.S. companies for federal income tax purposes."

Dan Mitchell of Washington's Heritage Foundation sees such restrictions as bad for big business. "The Argentinians who don't want to pay confiscatory taxes are going to invest out of the country," he says. He believes this is only natural, when a country has an economic system that's so "oppressive."

In cases where there's criminal negligence, such as the Cromagnon fire case, Mitchell says, "I assume somewhere there must be some sort of documentation of who the real owner is. That's the solution where there's criminal liability... [countries like] Uruguay would agree to share information." But tax havens do not generally share information, so such getting documentation would be virtually impossible under the current system.

The new rules don't appear to have roiled Argentine big business, at least not publicly. Andrea Canónica, spokesperson for the Argentine Management Association (Asociacion Empresaria Argentina), the nation's chief businessmen's organization, declined to make an official comment, saying, "It's not a theme the association gives opinions about. We speak about things that affect the Argentine entrepreneur."

The news has forced some public figures to come out in support of offshore business. In the daily La Nación, one lawyer, from the firm owned by Martinez De Hoz Jr., son of the economic czar of the 1976-1983 Argentine dictatorship, described offshore companies as "efficient" for investment.

Nissen's resolutions have also elicited disapproval from the real estate agency, Cushman & Wakefield Semco, which specializes in dealing with foreign investment. The company manager told the newspaper that Nissen's orders were a symptom of "legal insecurity."

Indeed, making tax evaders and money-launderers "legally insecure" is just what Ricardo Nissen had in mind.

Lucy Komisar is writing a book about offshore banks and corporate secrecy.

AMP Section Name:Corruption
  • 186 Financial Services, Insurance and Banking
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