Written evidence submitted by Trilateral Research (IEF0032)

Responding to illicit and emerging finance 

Author - Matthew Hall

Research analyst 

Trilateral Research Ltd 

This submission benefited from comments from the Centre for Financial and Corporate Integrity at Coventry University

Trilateral Research is a British and Irish SME with a long history in providing policy and ethics advice in research projects and to commercial clients. Our response to this call for evidence is based on the evidence developed during the three-year, EC-funded PROTAX project https://protax-project.eu, which investigated the tax crime enforcement eco-system in the EU. While the evidence base is primarily focussed on tax crimes, tax crimes are integrally linked to different kinds of illicit finance, for example, money laundering and terrorist financing, so the evidence base is applicable. As part of this project, Trilateral Research developed a risk assessment methodology to assess the vulnerabilities in the international governance regime of tax crime enforcement, which gives us certain insights to contribute. 

In our submission, we focus on the following points from the call for evidence: 

1.    What are the pressures affecting the global rules-based economic order and how might illicit and emerging forms of finance affect these? 

2.    How effective are existing international governance regimes and other measures to tackle illicit finance, and what gaps remain? 

3.    What other measures beyond sanctions can counter illicit finance, including bilateral and multilateral approaches? 

1. What are the pressures affecting the global rules-based economic order and how might illicit and emerging forms of finance affect these?  

Asymmetrical financial power between corporations, high-net-worth individuals, certain sovereign wealth funds and enabling organisations, on the one hand, and citizens, on the other, creates social and ethical pressures that can undermine a global rules-based order. Such asymmetries can erode the type of solidarity necessary for a rule-based economic order to be democratically supported and maintained. This is because ordinary citizens see the rules applied inconsistently, dependent upon how much wealth or power individuals and organisations have. Examples demonstrating this inconsistency are the ‘sweetheart deals’ offered to high-net-worth individuals by tax authorities, including the HMRC. Sweetheart deals are arrangements that are reached privately between the two sides in atypical and unofficial ways to the benefit of both parties. While some of the motivation for this is the complexity of financial criminal cases (covered below), the impression amongst the public is that there is a two-tier enforcement system, one for the wealthy and one for the rest of the public. Without the perception of a level playing field, a rules-based financial order is undermined. 

2. How effective are existing international governance regimes and other measures to tackle illicit finance, and what gaps remain?  

The PROTAX project identified the following gaps in international governance regimes to tackle illicit finance. These gaps were identified at an EU level, however, they also exist between states on an international level and work to undermine the effectiveness of international measures to tackle illicit finance.  

There are three strands covered in the evidence below: (i) gaps at the level of governance and rule-making; (ii) gaps in enforcement of the rules; and (iii) gaps in cultural or ethical practices pertaining to illicit finance. These three strands are important because, while it may be the case that the UK has the right rules in place, other political, cultural, institutional, ethical and human factors can make those rules ineffective. This is captured in these three strands. 

Gaps in governance and rule-making 

•       Scope and definitions of tax crimes and fraud 

The scope and definitions of tax crimes, as well as the taxonomies of criminalised conduct related to tax, differ across countries and jurisdictions. For example, no uniform definition of tax fraud (or even VAT fraud) can be found across EU Member States. The majority of states criminalise fraud in relation to other types of taxes. France and Hungary, for example, regulate fraud completely independently of taxes. Only by assessing other elements of a criminal offence is it possible to establish criminal liability for VAT fraud in all countries.[1] This creates risks for those working in the financial sector, policymakers and law enforcement authorities as potential vulnerabilities and loopholes in governance regimes are produced by the different categorisations and typologies of tax crime and fraud. By conducting their financial affairs across different jurisdictions, those who are looking to hide or move illicit funds can exploit this situation. This is further exacerbated by the UK’s arrangements with its overseas territories. 

•       Thresholds of tax crimes and financial crimes 

Clear and harmonised thresholds for financial crime are an integral part of effective law enforcement. Those who seek to hide, move or profit from illicit finance can use the discrepancies in thresholds between jurisdictions and move their funds to places where their acts attract lesser administrative offence. Further complications exist in regard to how thresholds for criminality are determined. For example, according to Austrian law, the threshold for criminalisation relates to the overall sum of taxes evaded, whereas Greek law calculates the threshold according to each kind of tax separately for each fiscal year.[2] Consequently, these discrepancies and variations create risks for the financial sector, policymakers and law enforcement as potential vulnerabilities and loopholes are produced that tax criminals can exploit or lower their own risk of criminalisation. 

•       Jurisdictional obligations to report suspicious financial behaviour 

Discrepancies exist internationally in the legal obligations that different jurisdictions place upon people to report suspicious financial behaviour. This is an issue in Britain’s overseas territories. This will be complicated further in the UK by the development of freeports, which provide another layer in which jurisdictional reporting on financial irregularities becomes more opaque. Such discrepancies present potential vulnerabilities in the law enforcement eco-system, providing gaps to hide and move illicit financial gains. 

•       Legal liability for tax crimes 

Liability of legal persons for tax crimes and other financial crimes differs internationally: some is criminal, some administrative and some countries provide no liability for certain crimes. Greece, for example, is the only country in the EU that does not apply liability of legal persons for tax crimes. Two countries (Bulgaria and Germany) provide only for administrative liability. Finland and Malta limit criminal liability to crimes affecting VAT. Liability of legal entities is formally administrative in Italy, even if it is substantially criminal.[3] 

The differences in legal liability between jurisdictions again may create vulnerabilities that undermine a robust law enforcement environment in financial crimes. This can also create an environment in which illicit finance flourishes, the effects of which could be to make one jurisdiction more attractive than others, undermining competition law and giving unfair advantage to certain localities as more money (both dirty and clean) is attracted to it. This undermines any international economic rule-based order based on equity and harmonisation. 

Gaps in enforcement  

•       Information sharing  

Information sharing across borders, agencies and jurisdictions is key to the investigation of the eco-system of financial crimes and illicit money flows. However, there are key failings in many areas. Some LEAs have good working relationships with their counterparts in other jurisdictions, but this is ad hoc and unpredictable. Within Europe, Europol has identified information sharing as a key area for improvement.  

For example, information on convictions and asset recovery from tax crimes is either not recorded at all in some jurisdictions or is not shared with the relevant authorities when it is recorded. Without this information, operational learning is undermined, meaning, for example, that investigations into companies that may have already been subject to asset seizure (but not necessarily criminal sanctions) are conducted without that knowledge to hand.   

Innovations like FIU.net, a platform to share information about tax crime perpetrators without divulging personal details that may identify them in contravention of local laws, could play a part in improving information sharing. Statistical alignment of information to improve financial crime law enforcement across different jurisdictions is also key.  

•       Resource constraints 

Law enforcement authorities investigating financial crime (including those from the UK) repeatedly highlighted to the PROTAX project researchers that resource constraints impacted upon their successful investigation and prosecution of tax crimes. Limits on personnel, technologies and time means that LEAs and financial and tax authorities must discriminate between different crimes and make hard choices about which financial crime investigation to pursue. Resource constraints contribute to another danger that may undermine an international rules-based economic order. Financial crimes are often complex and difficult to prosecute and in combination with resource constraints, this produces the perceived need among some LEAs and tax authorities to pursue ‘sweetheart deals’ and/or non-prosecution agreements with large corporations or high-net-worth individuals.[4] As mentioned above, this differential treatment itself undermines an equitable rules-based economic order, while also undermining trust in such an order by citizens who see powerful and wealthy people getting ‘special treatment’ by authorities whereas they do not. 

Resource constraints also impact upon the choices made by financial criminals. For example, PROTAX found financial criminals more likely to choose urban centres with more pressures on LEAs and tax authorities over quieter jurisdictions where the likelihood of detection would be higher. This is very relevant for London as a large city and global financial centre. 

Cultural / ethical gaps  

•       Whistle-blower treatment 

Robust and clear protections for whistle-blowers are key to tackling illicit finance as these are the people who can reveal arrangements and secretive practices that still pertain in large parts of the international economic order. Whistle-blower treatment straddles the grey area of human, cultural and institutional factors. For example, while various legal instruments to protect whistle-blowers exist, the corporate culture of a country or the cultural approach to whistle-blowers generally can undermine these protections.[5] If corporate culture has a negative attitude and/or actual reprisals against whistle-blowers, then that whistle-blower may not be able to continue working in the industry after disclosing key information on wrong-doing. This may act as a deterrent to potential whistle-blowers. Some countries treat whistle-blowers as public champions, whereas others consider them negatively, in some case as criminals.[6] This is reflected in the language used to describe whistle-blowers. Some countries do not have a direct interpretation of the term ‘whistle-blower’ and the equivalent is close to ‘snitch’ or ‘grass’. The social shame of being labelled negatively in this way is a disincentive to blow the whistle which subsequently undermines a harmonised rules-based economic order based on transparency. The cultural and corporate attitude towards whistle-blowers is something the UK can address at home and its overseas territories.  

•       Corporate & contractual obligations to maintain secrecy of client’s financial transactions (transparency versus secrecy)  

Institutional, corporate, and cultural factors within which secrecy prevails inside financial institutions, corporations and clients’ financial affairs are an issue internationally and an example of the ‘grey area’ of financial law and human factors that interact to undermine the effectiveness of financial law.  

The tension between the secrecy of a client’s financial affairs and legal or even ethical obligations to report suspicious behaviour generates risks that undermine effective decision-making for enablers and other professionals with reporting duties.[7] This ethical tension between privacy and transparency plays out in the daily duties of the staff members of relevant organisations (banks, tax authorities, notaries, tax consultants, etc.). In this context, they represent individual sources of risk related to how they decide to behave. This type of human factor was found by the PROTAX project to be vital in the discovery and investigation of financial wrongdoing.[8] Culturally and politically shifting this balance between secrecy and transparency, specifically for accounts with significant sums of money in them, can bolster a rules-based economic order where the powerful are treated in the same way as the public. This is commented on further below. 

3. What other measures beyond sanctions can counter illicit finance, including bilateral and multilateral approaches? 

1.          Political will to tackle the problem is a key issue if business attractiveness is viewed as more important than tackling illicit finance in the UK and other jurisdictions. Not all businesses attracted to such an environment have nefarious aims. However, those groups and individuals who do understand that ‘light touch’ regimes and environments are not only about the black letter of the law in that jurisdiction (the UK, for example, has quite robust financial laws), but also about whether the political will to tackle such issues exists. This makes such environments, such as the UK, attractive places to hide illicit finances.  

2.          A new approach to balancing the contractual obligations to maintain secrecy of a client’s financial transactions on the one hand with the public interest in transparency of financial affairs on the other. This will be particularly powerful in the UK’s Overseas Territories. This ethical dilemma – transparency versus secrecy – allows powerful people to hide behind cultural attitudes and legal regimes designed to maintain secrecy. This is also supported by cultural attitudes and important legal commitments to privacy. Powerful figures who use laws designed to protect the privacy of ordinary citizens to damage public finances and undermine rules-based systems need addressing. This is connected to the political will and cultural basis that supports illicit finances. A more democratic approach to transparency that compels openness of financial arrangements above a certain sum of money is one answer. Trilateral Research has expertise in this area and is currently developing a paper and policy framework to navigate this dilemma in a way that would better protect the public. 

Wednesday 9th March