Dirty Money

Last year, the release of the Pandora Papers exposed secret offshore accounts belonging to world leaders, billionaires, and celebrities, and when Russia invaded Ukraine, Western nations responded, in part, with economic sanctions on Russian oligarchs. And, of course, in the US, April is known for Tax Day, which this year falls on April 18. In this episode of Big World, SIS professor Dan Schneider joins us to discuss dirty money and illicit finance in the international system.

Professor Schneider first defines the terms “dirty money” and “illicit finance” (1:32). He then shares how widespread this type of corruption is (3:42) and some factors that have led to the rise of illicit finance (5:45). He also describes the current efforts to fight dirty money and illicit finance (7:03) and breaks down how economic sanctions are supposed to impact the individuals on which they’re placed (8:33).  

What are the dangers of kleptocracy, which is a political system organized around oligarchy, self-dealing, and illicit finance (15:50)? How can governments best tackle illicit flows of money and work to restore the rule of law (18:31)? Professor Schneider answers these questions and explains the difference between unethical and illicit finance, using tax preparation as an example (21:54) and explaining that while something may be legal, that doesn’t mean it’s also ethical.

During our “Take Five” segment, Professor Schneider shares the first five things he would do to fight dirty money and corruption, both in the US and the international system (12:30).

0:00      Kay Summers: From the School of International Service at American University in Washington, this is Big World, where we talk about something in the world that truly matters. When Russia invaded Ukraine, Western nations responded, in part, with economic sanctions on Russian oligarchs. In October 2021, the release of the Pandora Papers exposed secret offshore accounts belonging to world leaders, billionaires, and celebrities. Anecdotally, whenever a world leader falls from power, the aftermath seems inevitably to follow a predictable news narrative of exposing the corruption of that leader's rule, uncovering untold amounts of money that had been acquired through dubious means and hidden through a variety of laundering and evasion techniques.

0:49      KS: So today we're talking about dirty money. I'm Kay Summers, and I'm joined by Dan Schneider. Dan is a professor in the School of International Service. Before coming to SIS, he was a trial attorney in the criminal division of the US Department of Justice. He was also the Department of Justice's resident legal advisor to Russia, and he served as a consultant to the World Bank, the American Bar Association, and other NGOs on issues concerning corruption, the rule of law, governance, and civil society. Dan, thanks for joining Big World.

1:20      Dan Schneider: Thank you. Pleased to be here.

1:22      KS: Dan, to get us started, let's level set on some terms. When we talk about dirty money and illicit finance, what do those words actually mean?

1:32      DS: So we're talking about money that's earned, or perhaps it's more accurate to say money that's derived or obtained, from illegal activities. So this is often money that comes from corrupt government officials or people who have gotten rich, and we're talking about very rich, by bribing key government officials, but it also could be money that comes from drug dealers or arms traffickers or who have gotten rich through various forms of fraud. And it's money that's hidden from government authorities. So we're basically talking about, when we talk about illicit finance, how people can hide dirty money. There are some circumstances, in fact, many circumstances, when illicit finance can be technically legal, but most of us would consider it unethical. For example, if you know you were about to get divorced, but your spouse doesn't know it, you might try and hide your assets from him or her.

2:30      DS: Sometimes you try to avoid paying taxes, which is legal, versus evading taxes, which is illegal. Illicit finance often uses as an offshore jurisdiction. These are jurisdictions where there are low taxes, few regulations, there are opaque disclosure laws. We often think of some sunny tropical island, like the Cayman Islands or Panama or the British Virgin Islands, but we can also include places like London and New York, right? Where many very wealthy people, oligarchs, have bought luxury real estate, and they can do so without revealing the true owner of the real estate. So these offshore jurisdictions are not always literally offshore.

3:25      KS: Dan, you mentioned a few different types of what could be considered dirty money, and thinking specifically about the illicit finance and offshore, keeping money offshore, how widespread is this type of corruption? Why do you think we're hearing so much about it now?

3:42      DS: Well, of course, it's very hard to say how widespread it is because by its nature, it's hidden, it's secret. If we knew the extent of it, the illicit financial system would not be performing its function, which is secrecy, very well. But it's fair to say that it's much more widespread than most people realize. In the introduction you mentioned the Pandora Papers, these were documents leaked from 14 corporate service companies located in offshore jurisdictions. The ICIJ, the International Consortium of Investigative Journalists, did a phenomenal job using over 600 journalists from 117 countries, not only reporting on but going into a deep analysis, which is quite difficult, of these literally millions of documents. So the data they obtained was from more than 27,000 companies and 29,000 of what we call beneficial owners, that is finding out who the real owners are of let's say of shell companies.

4:46      DS: The papers exposed a shadow financial system that benefits some of the world's richest and most powerful people. It was more extensive than almost anyone thought possible. Some of the financial records that were obtained and revealed to the rest of the world came from 35 current and former world leaders, including Abdullah II, the King of Jordan; former British prime minister, Tony Blair; Ilham Aliyev, the current president of Azerbaijan; as well as the current prime minister of the Czech Republic.

5:24      DS: We also were made privy to the records of more than 130 billionaires from 45 countries, sports stars, celebrities, international criminals, arms dealers, spy chiefs, political donors, and 46 Russian oligarchs. So why now, why has illicit finance and dark money apparently grown so much? I think there are five reasons for this. One is the fall of the Soviet Union in 1991 and the subsequent creation of phenomenally wealthy Russian oligarchs. Second, other resource rich autocracies/kleptocracies creating phenomenally wealthy people. Third, is the internet, you no longer need to smuggle cash into countries. You can just wire it. Four, there were more countries, especially, but not exclusively small countries, that realize they can create jobs and lots of jobs by attracting illicit money. And finally, there's been an expansion in the number of experts who help all this happen. Combined, this has created what is becoming a significant yet all too often ignored global problem.

6:46      KS: What efforts exist to fight dirty money and illicit finance in the international system, because sort of by definition, it is extending beyond any one country's laws. What efforts are there to fight this?

7:03      DS: Well, you've put your finger on the main problem. Money, whether it's dirty or not, is like water, it flows. So the problem with an international approach can be summed up in one word, sovereignty. Countries are free to create their own laws. If countries want to have opaque banking and allow for the creation of shell companies and other ways in which people can hide their assets, there's really very little the rest of the world can do about it. There are certain tools we can use, but this is a great example of what's often called the balloon effect or what I sometimes call the whackamole problem.

7:44      DS: If you were to let's say, convince one offshore jurisdiction, and remember offshore jurisdictions can sometimes be technically, let's say, in the United States, the money will just flow somewhere else, okay? And if you crack down there, you're just going to move it somewhere else. So essentially you need to have almost everybody on board, if you really want to significantly crack down. I don't think elimination is a feasible goal, but if you want to seriously curtail the flow of illicit money to these offshore jurisdictions.

8:19      KS: Dan, with the Russian invasion of Ukraine and subsequent war, we've seen sanctions placed on Russian oligarchs. What are sanctions placed on individuals intended to do? And how do we measure if they're successful or not?

8:33      DS: Well these sanctions are designed to prevent these oligarchs from using the international banking system. But also what we've seen is that many of their assets have been frozen. And that's the first of a two step process because then, and I would say, hopefully, those assets will actually be forfeited to the government in which they're located. So these kleptocrats and others will actually take a significant financial hit.

9:06      DS: Now the wildest hope is that these oligarchs, now that much of their wealth has been frozen and will perhaps be lost, will somehow, acting together, bring about Putin's removal. I don't expect this to happen. At a minimum, these measures though, prevent kleptocrats from enjoying the fruits of their wealth, and hopefully will deter others who obtain money illegally. But we also have to acknowledge the role of Western institutions here or what I'll call the enablers. Those are the banks, real estate agents, financial institutions, who too often turn a blind eye to illicit finance. And they often do this by violating or ignoring laws that require them to know who their clients are, who their customers are, require them to conduct due diligence, to make sure that their clients acquire their assets legally. As the last part of your question, how do we know if these measures have been successful? It's really hard to say. If the Russian oligarchs help depose Putin, I'd say that's certainly evidence of success.

10:19      KS: That's the part as a kind of regular news consumer, and speaking for myself here, as a person with the regular mortgage or a regular rent bill or utility bills, maybe a car payment, it can be very difficult I think to conceptualize how sanctioning the finances and activities of a few individuals can affect the foreign policy and military actions of an entire country, especially when you're talking about a country as large as Russia. What I hear you saying is that at least one of the main goals of that sanctioning of individuals is that their influence can swing the country away from the leadership that's doing the actions that the international community has deemed inappropriate or criminal. Is that the goal of sanctioning these individuals, the influence over the power in that country? Or is there a real financial piece of that?

11:20      DS: To me, that would be the ultimate goal, perhaps an unlikely one. But remember, many of these wealthy individuals are not just businessmen, but they are the spy chiefs, the head of the intelligence services, et cetera, who have amassed great wealth. So they might be in a position to actually threaten, if not Putin, a leader of other countries that are kleptocracies. Remember these autocrats, they depend on the support of both wealthy individuals, but also they need the heads of the armies, the police chiefs, the intelligence services, et cetera, to keep them in power. And these are often the very wealthy people. So if they're unable to hide their money, it means that they have less incentive to support an autocratic government.

12:16      KS: Dan Schneider, it's time to Take Five. You get to reorder or maybe just put your spin on the world. What are the first five things you would do to fight dirty money and corruption, both in the US and the international system?

12:30      DS: First, end the real estate exemption to the Patriot Act. Remember the Patriot Act was passed in the aftermath of 9/11, and it had strong anti-money laundering requirements. But FinCEN, that's the investigative unit of the Treasury Department, granted real estate professionals an exemption from their reporting requirements. FinCEN should end this exemption. Two, pass the ENABLERS Act. The ENABLERS Act is bipartisan legislation, which is rare these days, that was introduced in October 2021. It will require accountants, public relations firms, art and antiquities dealers, investment advisors, and even some lawyers to conduct basic due diligence on the sources of their client's funds.

13:17      DS: Three, we need to improve US financial investigative capabilities. Under various laws, particularly the Bank Secrecy Act, which goes back to I think 1970, banks and other financial institutions as well as jewelers and dealers in luxury cars and dealers in yachts and even some casinos as well as the whole list of other types of organizations or institutions are required to submit what's called a Suspicious Activity Report to FinCEN whenever they suspect suspicious activity. And what are known as PEPs or politically exposed people are supposed to be subject to enhanced due diligence.

13:59      DS: Here's the problem. In 2019, banks and other financial institutions filed over 5 million suspicious activity reports. Yet FinCEN only has 3000 employees to follow up on these reports. So there's no way with the resources given to FinCEN that we can really follow up on suspicious activity reports. Fourth, the president and others have to make clear that fighting dirty money is a national security issue. The complexities of banking laws and regulations cause many people maybe to lose interest or roll their eyes, but they won't lose interest if they understand dirty money for what it is, a threat to national security and global security.

14:51      DS: Finally, internationally, we need to use our diplomatic tools to pressure countries that are offshore jurisdictions to make their laws more transparent as well as to strengthen their current laws and to better enforce their existing laws. And we have to use both a combination of carrots and sticks here. There are a host of diplomatic tools we can use to reduce the number of offshore jurisdictions where so much of this dirty money is going.

15:20      KS: Wonderful, thank you.

15:24      KS: Dan, kleptocracy is a term that gets thrown around a lot, and we've used it a few times here. It's dictionary defined as a political system organized around oligarchy, self dealing, and illicit finance. So large scale, what are the dangers of kleptocracy as an institution or a form of organizing a government? What are the dangers of kleptocracy and this type of large scale corruption?

15:50      DS: I think there are a number of significant dangers. One, and the most obvious, is when you have money, illicit money, or frankly, even legally obtained money sent offshore, it's no longer taxable so vital public services are not funded. So schools aren't built, healthcare is not provided, roads are not constructed. And the tax burden also then shifts to people who are middle class who don't, or can't hide their money. A second problem is capital flight. In addition to this money not being available, not being taxable now because it's hidden, this extraordinary sum of money is not available for investment at home, investment that creates jobs grows your economy.

16:37      DS: Another problem, is two systems are created. It creates the impression, which is well justified, that there are two systems: one for the rich and one for the poor. In this way, I believe illicit finance and offshore jurisdictions has contributed to the rise of right wing populism and extremism, not only in the United States, but also in countries in Europe, Latin America, and the Middle East. Illicit finance, dirty money, promotes corruption because it makes it easier for corrupt public officials and politicians and kleptocrats to hide their illegally obtained wealth.

17:16      DS: Also, illicit finance promotes organized crime and terrorism. How? Because it makes it easier for terrorist groups or organized crime groups to do some of the things that they need to do. Lastly, illicit finance just undermines confidence in the rule of law and democratic governance and the accountability of institutions, both government institutions but also the banking and the financial institutions we rely on every day without even necessarily realizing it. So the consequences taken whole are devastating, and sometimes we're not even aware of it.

17:54      KS: So we're talking about how this dirty money can affect people other than those who are hiding it. Dirty money can also affect security as it can sometimes be a source of funding for terrorism and criminal enterprises. How can governments best tackle these illicit flows of money and work to restore the rule of law? And I'm curious if that is something that a single government can handle domestically to ensure its security or if it does require more multilateral international action to cut off funds for terrorism.

18:31      DS: Well, we often hear it said in different contexts that global problems require global solutions. That is certainly true here, but of course the problem is there are many countries that have no incentive to try and reduce the flow of illicit money. In fact, they have many incentives to make it easier for money to go offshore. And that's sometimes because the people sending money offshore are corrupt government officials themselves, or they're corrupt people in the private sector who might support an autocratic government and will make sure that government lets them send money or overseas. And third, as I mentioned, some of these smaller countries, one way to grow an economy or create jobs is to create offshore jurisdictions. But before we go too far in just blaming others, we need to understand how, at least in the United States and other Western countries, we have lots of enablers.

19:30      DS: One prime example is the real estate industry. Many of your listeners have perhaps heard of what's in New York City, what's called billionaires row. The sale of these condos runs, if you look at all these buildings, in the billions and billions of dollars.

19:44      KS: Right.

19:45      DS: These buildings are often only half occupied if even less, because most of the owners don't live there. Not all, but many of the owners, this is a way to hide their money in valuable real estate. Why are they able to do this? Well, largely because the real estate industry in the United States is shielded from our transparency laws. The real estate industry does not have to disclose the beneficial owner of the property. But let's think this through a little more, who benefits, let's say by the construction of these buildings in New York, and other places, Miami and Los Angeles, et cetera? Well, you have all the people involved in not just building but furnishing these condos. But you also have the city of New York, let's say, which has an interest. Because New York City is probably deriving hundreds of millions of dollars every year in property taxes. So none of these entities, individuals or entities, have much of a reason to crack down on this.

20:56      KS: Dan, to close out, I want to ask you about something I feel like I've seen a lot of over the last few years, I don't know if it clears the bar for corruption or not, but to me it certainly sits uncomfortably on the fence and you made reference to it earlier when speaking about is something perhaps legal, but also unethical. In the US, we've all seen this, when a wealthy person is exposed to have not paid taxes, the usual response is something like, "I have good tax lawyers. I use all the legal methods at my disposal to pay as few taxes as possible. That makes me smart, not corrupt," but I do want to know where you think the line is between smart tax preparation and corruption and kind of where's the line between smart tax preparation and really breaking our social contract that we all have with each other? Where is that line?

21:54      DS: I mean, that is an excellent and complicated question. From a strictly legal point of view, the line is if the law says you can do it, you can do it. From the broader and more important perspective of what's good for social cohesion, the line is different, but much more ambiguous. I believe actually Donald Trump when he was running for president, in one of the debates that was brought up and he responded, "That makes me smart."

22:22      KS: Right.

22:23      DS: And that resonated with lots of people. But I point out the following, many people use their money to influence and change government policy and government laws. So in other words, they can use their money to game the system, to make sure that their interests are served rather than a broader public interest. So that's where we're not talking about a level playing field. And of course, if you can hide your money, if you can pay less in taxes, you have more wealth, of which some of that wealth you can use to, through lobbying and financing certain candidates, you can further mold the system to serve your interest. So it becomes a self reinforcing process. So that would be my main response to those who say, respond with admiration.

23:18      KS: Dan Schneider, thank you for joining Big World to discuss dirty money and illicit finance and corruption. It's been a pleasure to speak with you, and I learned a lot. Thank you.

23:28      DS: Thank you very much.

23:31      KS: Big World is a production of the School of International Service at American University. Our podcast is available on our website, on iTunes, Spotify, and wherever else you listen to podcasts. If you'll leave us a good rating or a review, it'll be like receiving your legitimate tax refund just in time to pay for that unexpected car repair or vet bill. Our theme music is "It Was Just Cold," by Andrew Codeman. Until next time.

Episode Guest

Dan Schneider,
professor, SISTwitter

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