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BRING BACK THE ADEQUATE CONSIDERATION DEFENCE

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In this briefing, Tom Maher (Dougherty Quinn Advocates, Isle of Man) makes a strong case for the re-instatement of the “adequate consideration” defence in anti-money laundering legislation.

SPEED READ

In a surprising move, the Isle of Man abolished the “adequate consideration” defence in its anti-money laundering legislation after the IMF identified the defence as a weakness in the Island’s legislation. The abandonment of the defence has caused enormous problems and undermines access to justice. Other jurisdictions should resist attempts to follow suit. Meanwhile, it is high time the defence is re-instated in the Isle of Man. Apart from anything else, the present situation prevents lawyers from representing clients when they are suspected of committing financial crimes such as tax offences.

COMMENTARY

The primary purpose of the Isle of Man’s Organised and International Crime Act 2010 was to introduce new criminal offences regarding membership of a criminal organisation, people smuggling and human trafficking. However, it also included the quiet repeal of the adequate consideration defence in the Isle of Man Proceeds of Crime Act 2008 (“PoCA”), a repeal which passed under the radar, largely due to insufficient government consultation with relevant sectors in the Isle of Man.

This Act has a direct bearing on all businesses within the finance sector, and also on plumbers, hairdressers and ordinary citizens, each of whom are now directly and adversely impacted by the “back door” repeal of the adequate consideration defence.

These strong words are intentionally provocative, but they are necessary to stimulate an important debate. It is time to stand up for what is right and demand that the Isle of Man Government reinstates the adequate consideration defence into PoCA.

So what is the adequate consideration defence? It is a clear defence to the primary money laundering offence of acquisition, use and possession of criminal property set out in section 141 of PoCA. Section 141 outlines the defence in the following terms:-

“(2)      But a person does not commit such an offence if – …

(c)                that person acquired or used or had possession of the property for adequate consideration

(6)        For the purposes of this section –

(a)        a person acquires property for inadequate consideration if the value of the consideration is significantly less that the value of the property;

(b)        a person uses or has possession of property for inadequate consideration if the value of the consideration is significantly less than the value of the use or possession;

(c)        the provision by a person of goods or services which the person knows or suspects may help another to carry out criminal conduct is not adequate consideration.” (emphasis added)

Interestingly, only the defence itself - section 141(2) - was repealed; section 141(6) was not repealed and remains in force, despite the fact that it relates solely to the defence and cannot stand alone without it. This bad drafting is an unsurprising symptom of the lack of adequate and sufficient consultation. 

The Isle of Man Government repealed the adequate consideration defence, quite simply, because the International Monetary Fund (“IMF”) identified the defence as a “shortcoming” in its report on the Isle of Man dated 5 August 2009. The IMF did not believe that the adequate consideration defence was consistent with international conventions on anti money laundering. I disagree wholeheartedly with this analysis.

In addition to raising misconceived objections to the Isle of Man’s consideration defence (Jersey was also asked to repeal the defence at the IMF’s request but declined to do so), the IMF ignored the concepts of consistency and level playing fields. It did not recommend the abolition or repeal of the defence in Guernsey or Gibraltar, despite their legislation being drafted in substantively the same way as the Isle of Man’s section 141.

Moreover, the United Kingdom still maintains its adequate consideration defence in similar terms to that which was repealed in the Isle of Man and there are no plans to repeal it. Indeed, the Law Society of England and Wales is even lobbying for it to be extended.

The IMF was of the view (see its report on the Isle of Man dated 5 August 2009) that the defence was not provided for in the Vienna and Palermo Conventions and “should be eliminated as it may allow money launderers to abuse the provision to avoid criminal liability for the acquisition, possession, or use of criminal proceeds”.

Frankly, this assessment misunderstands the position completely. Let me give some examples.

Example 1

If a money launderer (A) seeks to use the proceeds of his crimes (for example drug dealing) to purchase a property from an innocent third party seller (B) for a true market value, then A is committing a primary money laundering offence under section 141 of PoCA, as he is using criminal property. He does not have an adequate consideration defence because it simply does not apply. He has not acquired criminal property for adequate consideration. On the contrary, he is using criminal property to purchase a property, thereby laundering his money. In that case, he should, and quite rightly will, be prosecuted.

Now let’s consider the position of B, who is a young single mother selling her first time buyers’ house in order to move up the property ladder. She has no idea, nor does she suspect in any way, that A is a drug dealer and that the money he is using to buy her house at true market value is criminal property or the proceeds of crime. She would, and quite rightly should, be protected by the adequate consideration defence in the sale of her property in these circumstances. She sold her property and has now acquired criminal property (namely A’s proceeds of crime); but she sold her property for adequate consideration. The purchase price for the property was the true market value and she neither knew nor suspected that she was helping A to carry out criminal conduct. This is a perfect example of why the adequate consideration defence is reasonable and proportionate, why it is retained in England, Gibraltar, Guernsey and Jersey and why it must be reinstated in the Isle of Man.

Example 2

Another example is the hairdresser or the plumber who provides services to A, a known drug dealer. The act of the hairdresser cutting his hair and receiving normal payment for it could amount to a primary money laundering offence of using criminal property and there is now no defence for the hairdresser should a prosecution be instituted. The plumber who fixes the drug dealer’s leaking sink in the middle of the night to prevent a flood has to think twice before he asks for payment. These are all ludicrous situations and can be easily avoided by reinstating the adequate consideration defence.

Example 3

My main message, though, in this article is to highlight another example of where the repeal is now causing trouble. How many commentators who object to the adequate consideration defence being reinstated genuinely want to see a deterioration in the quality of the global cooperation being shown by the Isle of Man? None, I suspect.

It is quite clear that the Isle of Man is at the forefront of international cooperation. On a governmental level, we are signing tax information exchange agreements (TIEAs) and double tax agreements at a rate of knots but more importantly we are implementing these agreements with other authorities in a fully effective manner: see the OECD’s top “compliant” rating awarded to the Isle of Man in November 2013.[i] On a judicial level, our Deemsters (judges) have been providing effective international cooperation for many years. To quote our Chief Justice, His Honour Deemster Doyle in Wine v Wine (2007):-

Those endeavouring to make use of the equivalent of Harry Potter’s invisibility cloak to prevent sight of information or documents regarding the proceeds of wrong doing will find, to their disappointment, that it does not work in this jurisdiction.

Increasingly, our firm is acting for fiduciaries and other clients in matters where they wish to provide voluntary cooperation to foreign authorities when, for example, criminal tax investigations into the underlying client or beneficial owner are under way in another jurisdiction. However, the repeal of the adequate consideration defence creates a serious impediment to this voluntary cooperation.

Let us take the following example which I have seen time and time again. Mr X is a US resident who in 1995 acquires an international trading business outside the United States via a newly formed Isle of Man company (“Holdco”) following professional tax advice from his international and US tax advisors.

Mr X engages a large and reputable Isle of Man licensed corporate service provider (“CSP”) to administer Holdco. CSP provides professional directors to Holdco. They are the only directors and they carry out their duties diligently and professionally, always acting in the best interests of Holdco.

Holdco sees the value of its assets (namely the international trading business) increase steadily from 1995 to 2013. In 2013, CSP and Holdco receive requests for disclosure of all company documents for Holdco, in particular, all correspondence with Mr X and documents showing any payments or loans to Mr X. The disclosure request is received from the Isle of Man Income Tax Division (“ITD”) following a request by the United States Internal Revenue Service (“IRS”) under its Tax Information Exchange Agreement (“TIEA”) with the Isle of Man.

CSP and Holdco comply fully with the disclosure request and provide the relevant documents to ITD for onward transmission to the IRS.

In the following months, the IRS wishes to raise more queries and have access to further documents. The documents they request are outside the scope of the TIEA. CSP and Holdco appoint Isle of Man advocates and US attorneys to advise. The joint legal advice is that it would be in the best interests of Holdco and CSP to engage and cooperate constructively with the IRS. The US attorneys ascertain from telephone calls with Mr X’s US attorneys and the United States Department of Justice (“DoJ”) that there is a criminal investigation ongoing into Mr X and his tax affairs. Furthermore, the US attorneys for CSP/Holdco obtain confirmation from the IRS that neither CSP nor Holdco are targets or subjects of their investigation. The IRS invites the senior management of CSP and the directors of Holdco to attend voluntary interviews (which are neither taped nor under caution) in the US. They also ask for a significant amount of further documentation and information. This has now become a major project and the costs being incurred are escalating. The US attorneys’ fees are significant and are now in the hundreds of thousands of pounds. The Isle of Man advocates’ fees are a fraction of that, but are nonetheless not insignificant. Finally, CSP’s own fees for this extra administration work are escalating.

Under the terms of its letter of engagement and contract with Holdco and Mr X, CSP is entitled to be indemnified for any costs incurred in this project. Holdco is sitting on a cash balance of several million pounds and therefore payment of such an indemnity is readily available.

CSP and Holdco decide to ask Mr X whether or not he has any objection to them engaging voluntarily with the IRS, meeting them and providing documentation to them. Mr X does not respond but his US attorneys confirm that Mr X’s position is that CSP/Holdco should do what they think is best. This neither amounts to consent nor an objection. The reason for this is that his attorneys advised him that he cannot object because to do so would be seen as obstructing an IRS interview under US law and this could expose him to further criminal investigation and proceedings.

CSP and Holdco believe that by cooperating voluntarily with the IRS, they may be able to bring the investigation in the US to a close earlier, may well convince the IRS that nothing untoward has happened and, most importantly, will likely protect the assets of Holdco from any attack by the IRS. The directors of Holdco and senior management of CSP travel to the US, carry out their voluntary interviews, provide further disclosure and all goes well. The total fees incurred to lawyers and CSP administration time is now £400,000. Understandably, CSP wants to be paid both its administration fees and the legal fees which it is incurring. Whilst it is a large, successful and reputable CSP, it will not take long for this level of escalating expense to create a significant financial problem for its business, if it cannot avail of its contractual indemnity from Holdco.

The Isle of Man advocates advise that as a matter of contract law, CSP is perfectly entitled to debit its administration fees and the legal fees to the bank account of Holdco. However, there now arises a significant problem.

At this stage, neither CSP nor Holdco knows if there are the proceeds of crime within Holdco. Everything points to the position that the entire assets and cash within Holdco all stem from legitimate trading activity. However, CSP and Holdco are aware that there is a criminal tax investigation into Mr X, the beneficial owner of Holdco. In the event that this criminal tax investigation leads to a conviction for tax fraud, cheating the revenue or similar tax offences in the US, it is possible that any tax saving made by Mr X (for example by failing to declare income from Holdco) will create a benefit (or a “pecuniary advantage” to use the term in POCA) from criminal conduct.  This can therefore have the effect of tainting the otherwise legitimate trading income of Holdco with any tax saving made by Mr X in failing to declare certain income.

Therefore, as a result of this legal (not factual) analysis, CSP and Holdco now have a suspicion that Mr X may have committed tax offences and if convicted, this could result in Confiscation Orders and a determination that there is a tax saving within Holdco and thereby Holdco’s bank accounts contain criminal property.

So now we have this invidious position for CSP, Holdco and its lawyers. If it was not for the voluntary cooperation and assistance of CSP and Holdco, the IRS might never be able to gain a conviction against Mr X. Bear in mind of course that the motivation in cooperating with the IRS was to minimise the impact of this tax investigation on Holdco/CSP and, hopefully exonerate Mr X. But let’s just say that despite the best endeavours of Holdco/CSP, Mr X had pulled the wool over their eyes and was guilty of an offence. It is largely thanks to the cooperation of CSP and Holdco that the conviction was secured.

However, the reality is that this conviction could take several more years for the DoJ/IRS to secure. In the meantime, and to stop itself becoming insolvent, CSP quite properly wants to obtain payment of its fees and legal costs out of Holdco’s account. The payment of CSP’s own administration fees now from Holdco’s account could (if a conviction was ultimately secured against Mr X in the US) amount to the acquisition and use of criminal property by CSP. The payment of legal fees by Holdco to its lawyers could also amount to primary money laundering offences by both the Isle of Man and US lawyers under section 141 of PoCA (acquiring and using criminal property).

In 2014, when CSP is arranging payment of these fees from Holdco’s account, there is no proof that Mr X has committed a criminal tax crime or that there is, on a POCA legal analysis, any criminal property in Holdco’s bank account (the source of funds for which are clearly legitimate trading income). If CSP proceeds to make these payments now and Mr X is not ultimately convicted of a tax crime, then there is no risk to CSP (or indeed the lawyers in getting paid). However, if in 2016, the DoJ secures a criminal conviction against Mr X for tax crimes related to Holdco, the knock on effect of this could be that any tax saving he made taints the otherwise legitimate funds in Holdco’s bank account and all parties who received payment from that account back in 2014 are guilty of a primary money laundering offence under section 141 of POCA.

One option for removing this risk of committing an offence is for CSP, Holdco and the lawyers to make disclosures to the Isle of Man Financial Intelligence Unit (FIU) and receive consent to pay and receive their fees from Holdco’s bank account. However, as there is no proof in 2014 (when consent is requested) that Mr X has committed a tax crime or, more importantly, that there is criminal property in Holdco’s account, the FIU will reply to say that this is not an appropriate case for consent.  This reply does not provide any of the parties with a legal defence to a section 141 prosecution.

However, the adequate consideration defence would provide a legal defence to a section 141 prosecution and this scenario is a perfect example of why and how it is reasonable and proportionate to have the adequate consideration defence.

By having such a defence, Holdco, CSP and their lawyers can properly assist in this global cooperation exercise and can do so safe in the knowledge that their fees, to which they are contractually entitled, will be paid and that they are not exposing themselves to a primary money laundering offence prosecution sometime in the coming years.

Of course some commentators will say that there is no public interest in prosecuting in such a case and therefore CSP, Holdco and their lawyers should take comfort from this. Frankly, the fact that you may take a judicial review challenge against the decision to prosecute in these circumstances on the grounds that there is no public interest, does not give any comfort given the costs and risks involved of such a challenge. Indeed, even getting confirmation from the police and/or prosecuting authorities that they would not prosecute in such circumstances, does not guarantee that this position will not be reversed in the future.

None of this provides an absolute defence to the primary money laundering offence of acquiring or using criminal property. The adequate consideration defence provided a complete and clear defence and was entirely appropriate, proportionate and reasonable.

In summary, there can be no legitimate justification for repealing the adequate consideration defence and I call upon the Isle of Man Government to restore it immediately. It is time to stand up. So let the plumbers, hairdressers, fiduciaries and bankers among you join with me in this crusade.

The views expressed above are the author’s personal views.

FINANCIAL DISCLOSURES – THEIR USE IN CRIMINAL AND ...
Financial disclosures – their use in criminal and ...
The views expressed in this article represent those of the author and not Bright Line Law.

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