Offshore jurisdictions

Periodically, politicians in the UK start to make public announcements about the wickedness of businesspeople who use offshore jurisdictions as a method of legal tax avoidance. This is largely disingenuous. Not all offshore jurisdictions are acutely vulnerable to corruption: Jersey, Singapore and Bermuda, for example, have high standards and are well run. Legitimate offshore business is huge; some 8% of all wealth under management is thought to be held offshore, an estimated $7 trillion. Some 700,000 companies are registered in the British Virgin Islands. Many thousands of hedge funds are registered in the Cayman Islands. Almost all the world’s major banks and corporations have offshore operations. It is ridiculous to pretend, as some onshore politicians do to their domestic audiences, that the offshore financial world is a marginalised, criminal arena that has nothing to do with regular business; in fact, the offshore world is an integral part of international business and finance.

Nevertheless, offshore finance does have a shady side. Figures associated with many political parties are known to avail themselves of offshore facilities. As one retired offshore tax lawyer once commented to me, ‘offshore jurisdictions will be allowed to continue to exist as long as politicians and businesspeople continue to need somewhere offshore to park their funds.’ But offshore jurisdictions are not merely places to park money. So long as the world consists of nation states that compete economically and have conflicting regulatory systems, there will be many legitimate reasons to practise ‘regulations arbitrage’ by locating some operations in a lightly regulated offshore jurisdiction, just as the world’s shipping industry could not function without the existence of ‘flags of convenience’ – flags of convenience are offered by countries such as Panama and Liberia that allow foreign merchant ships to register with them, generally reducing labour costs and regulatory burdens. Nevertheless, both flags of convenience and offshore finance provide scope for criminal and fraudulent activity, and if we are now entering an era of economic protectionism and high regulation, in contrast to the trend of deregulation and globalisation during the last three decades, then such wrongdoing could actually increase along with an increase in the legitimate use of such jurisdictions, as people seek to avoid high regulations in ‘onshore’ countries.

Many of the frauds discussed in this book involved the use of offshore jurisdictions, from Bernie Madoff’s European connections, to Dennis Levine’s use of offshore bank accounts for insider trading, to Crazy Eddie’s transfer of his secret profits abroad. In this chapter Allen Stanford’s operations in the Caribbean, which are a particularly egregious example of how offshore jurisdictions can be exploited by a fraudster, will be examined in detail. First, it is important to note the essential problem in dealing with frauds that have an international dimension: it is often very difficult for any country’s regulator to obtain information about the fraudster from a foreign jurisdiction, in particular from an offshore jurisdiction that has high secrecy laws, or to pursue a fraudster abroad. In practice, most regulatory bodies do not have the clout to pursue such problems, but the SEC and other US agencies have a long record of pressurising foreign authorities, with some degree of success (in the 1980s the SEC, for example, was able to persuade Bank Leu in the Bahamas to divulge that Dennis Levine was the account holder of accounts used for insider trading – see Chapter 2). As we will see in the Allen Stanford story, however, applying pressure and pursuing litigation in other countries is slow, enabling the fraudster to take evasive action.

Good old boys

In Europe we tend to raise our eyebrows at a ‘new’ bank. If it wasn’t around during the Napoleonic Wars, we tend to feel, then, that it can’t really be quite right. But much of this sense of tradition is illusory. Over the last few decades the extraordinary relaxation of financial regulation across the world has engendered a maelstrom of buy-outs, mergers and entries into new financial areas, to the extent that very few banks remain which are as stuffy and cautious as they used to be. In the Americas, on the other hand, newness is not necessarily seen as a bad thing. The fact that Allen Stanford and his senior team projected themselves as good old boys from the deep South, God-fearing Southern Baptists who believed hard work and honesty could take them to the top in the world of financial services, was appealing to the group’s main customer base in the US and Latin America.

The ‘Forbes 400 Richest People in America’ 2008 feature on Stanford presents a classic rags-to-riches story. ‘The muscular, 6-foot-4 Stanford, whose eyes bulge when he’s excited’ was born in Mexia, a backwater in East Texas, made his first money at the age of 13 chopping wood, and then gave it all to a family whose house had burned down. He had studied finance at Baylor University, Texas, where he met his Chief Financial Officer, James D. Davis, and later, after failing in a health club venture, he joined the family business, a small property and insurance concern. The big break allegedly came in the early 1980s when Stanford and his father bought up as much property as they could during a property market crash in Houston and then made several hundred million dollars selling it off over the next decade as prices recovered, according to the Forbes article.

And that’s when our story really begins. Stanford used the profits he had allegedly made to set up a wealth management business, attracting customers in Mexico, Venezuela and Ecuador as well as back home in the US. ‘Stanford’s investment strategy can be described as sure and steady’, the Forbes piece assures us, ‘it sets an internal return on investment targets based on the market environment … uses leverage sparingly, and holdings are diversified across countries and currencies.’ After the dotcom collapse in 2000, Stanford managed to achieve returns of 10% or more annually, we are told. Stanford complains that as a ‘maverick, rich Texan in the Caribbean’ he is an easy target for censure, and he then proceeds to bat away various criticisms, such as the allegation he had falsely claimed to be related to the founder of Stanford University, and his long-running feud with Antigua’s prime minister. It is pointed out that Stanford received a knighthood from Antigua in 2006. The big excitement in 2008, however, was Stanford’s plan to inject big money into the world of cricket, which offered great potential as ‘an international branding tool for his company’.

In 2008, then, Allen Stanford could be seen as a fairly familiar type of tycoon; slightly megalomaniacal, perhaps, but not worryingly so. In fact, since he had avoided the chaos and scandal of the sub-prime crash in 2007, he could be regarded as a welcome change from all those oily investment bankers on Wall Street who seemed to be – and, indeed, were – so deeply mired in allegations of dirty politics and financial corruption at that time. Investment salesman Charles Hazlett’s concerns about the firm had been aired in an arbitration case a few years earlier, but this had not been widely publicised, and in early 2008 two of the firm’s financial advisers, D. Mark Tidwell and Charles W. Rawl, were alleging in a court case that the Stanford group was involved in unethical practices. Indeed, there had also been a number of other cases making similar allegations brought to the US Financial Industry Regulatory Authority (FINRA) by unhappy ex-employees, but average investors might not have learned of these or, if they had, could easily dismiss them as typical of the industry – after all, big financial services firms are always getting sued by disgruntled ex-employees.

But what of the Certificates of Deposit (CDs) that the group promoted so industriously? Why would any ordinary investor put a large sum of money into CDs offered by an offshore bank? There seem to be a number of answers. First, although CDs are not well known in Europe, in the US they are a popular method of saving; you purchase a CD from a conventional bank for a fixed period of time, and receive a fixed rate of interest. In most cases your investment is insured by the US Securities Investor Protection Corporation (SIPC) or the Federal Deposit Insurance Corporation (FDIC). CDs, therefore, are widely perceived as a safe, boring instrument in which to put your money, earning a low rate of interest. Although Stanford’s CDs appear not to have been insured by SIPC or FDIC, they had a very attractive feature: you could cash out at any time without penalties. Furthermore, the interest rate offered was substantially higher than the going rate back in the US – a warning sign to some, but an attractive inducement to others. Many investors also believed, according to the Receiver, that the money they handed over in return for the CD would be held in some kind of individual account. This is not, in fact, how CDs work. CDs are in essence debts owed by a bank to investors, and are not associated with a segregated account in the name of an investor.

According to the testimony of Stan Kauffman, a customer of Stanford’s, Stanford representatives reassured him about the company’s offshore status by stating that the deposits were insured by Lloyd’s of London and the group was heavily regulated in the many jurisdictions in which it was active. Although the bank was in Antigua, the Stanford Financial Group was based in Houston, Texas. The sales literature Kauffman was given had been approved by the US regulator FINRA, and the sales representatives were registered with the US regulator the SEC, and had an obligation to recommend the most suitable investments for the needs of individual customers. According to Kauffman, the facts that part of the group was managed in the US, many of the senior managers were US citizens, and the Advisory Board included many respectable figures, such as a former assistant Secretary of State, also helped to convince him everything was above-board and properly regulated.

For ‘mom and pop’ investors in the US, often approaching retirement, Stanford’s CDs could be seen as a safe, conservative investment offering a welcome higher return. It appears that not all of Stanford’s depositors were middle-aged, middle-class Americans. As we have seen, from the beginning Stanford had targeted Latin American clients as well. Latin American investors often suffer from serious problems in their own countries, in particular from volatile currencies, arbitrary taxation and a changeable political climate. For many Latin American investors, the solution is to get some of their wealth abroad, and offshore banks in the Caribbean seem to be an ideal solution. For example, Venezuela under Hugo Chavez has experienced a series of measures designed to deprive wealthy Venezeluans of their assets, and this group had to get as much of its money out of the country as it could.

Other customer segments that are naturally drawn to offshore jurisdictions include individuals trying to protect their assets in a divorce, tax avoiders, tax evaders, and, notoriously in the Caribbean, drug traffickers and money launderers. However, this kind of activity goes with the territory in many tax havens, and no substantial evidence has appeared to suggest that Stanford knowingly provided banking services to drug lords or other criminals.

What is clear, though, is that Stanford customers received red carpet treatment. Arriving at the offices, investors were sent to a parking spot bearing their own name, and then whisked through acres of marble and mahogany grandeur to a special cinema to watch a film about the firm’s high moral integrity, inherited from Allen Stanford’s grandfather who had founded an insurance company in the 1930s. After this, you were treated to a luxurious meal in the private dining room. Larger investors might be flown to Antigua in one of the group’s jets to visit the bank, staying at the glorious Jumby Bay island resort, and meeting the great man himself, the picture of confidence and integrity.

Back in the 1980s, flushed with the success of his Texas property deals, Allen Stanford had set up the Guardian International Bank on the Caribbean island of Montserrat as part of his wealth management business. He made his old college room-mate, James M. Davis, the Controller of the bank. Soon afterwards, according to Davis, Stanford asked him to make false entries in the general ledger with the aim of giving the regulators a false impression of the bank’s income and investments. The business of the Guardian bank was essentially the same as the later incarnations of the group: to sell CDs to investors who paid a higher-than-normal interest rate. Allen Stanford had begun to siphon some of the depositors’ money out of the bank to fund a number of his own property deals, apparently with the intention of repaying the money when the property deals came good.

In 1990 a British regulatory crackdown on offshore banking in Montserrat (the island is still a British Overseas Territory) prompted Stanford to move the bank to Antigua, where it was renamed the Stanford International Bank. The Montserrat government had told Stanford that it was about to revoke the Guardian International Bank’s licence; Stanford acted quickly, moving the bank to Antigua, surrendering the Montserrat banking licence before it was taken from him, and claiming publicly the move was due to the devastation caused by Hurricane Hugo.

Late in the same year, Davis found that the bank’s true assets were less than half of those reported; Stanford was set on investing depositors’ money in a wide range of businesses, mostly owned by himself, mostly located in the Caribbean, and mostly losing money. To keep these schemes going, Stanford needed the bank’s CD business to grow. He took a hands-on approach to marketing, reviewing sales spreadsheets daily with managers, and instituting elaborate reward schemes for successful salespeople. In the early 1990s Stanford produced a forged insurance policy to assure sales staff and clients that the bank’s assets were insured (they weren’t), and on one occasion ordered James Davis to fly to London to fax a phoney confirmation to a potential depositor the insurance underwriter actually existed (it didn’t). Stanford personally adjusted the group’s financial statements on occasion to give a false picture, as well as pressing Davis and other accountants to do so.

In 1995 Stanford opened the Stanford Group Company in the US to sell the CDs to American customers; the two main bases for this firm were Houston and Miami, but there was also a large number of smaller offices, mainly in the south of the country. As the business grew, the arrangements to conceal what was happening to the money became increasingly elaborate. Davis, who was to start his own church, met a young woman, Laura Pendergest (now Pendergest-Holt) at a Baptist church meeting in Baldwyn Mississippi, and eventually recruited her. As Chief Investment Officer, Pendergest supervised a team of analysts (actually her and Davis’s relatives and fellow church members, who had little financial experience) based in Mississippi, and, purportedly, managed the bank’s entire portfolio. In fact, Pendergest’s team only managed a small fraction of the bank’s investments (an estimated 15%), and were expressly instructed not to reveal this information to anyone, not even financial advisers working for the firm. Individuals within the organisation who gained an inkling of what was really going on were warned to stop asking awkward questions or face the sack. There was a sustained effort by a small core of insiders – Allen Stanford, James Davis and a few others – to create the impression to customers, employees and regulators that the bank’s investment funds were being prudently and professionally managed by the Mississippi team, when in fact the bulk of the money was going into Allen Stanford’s own private schemes.

One might suppose that customers and employees were relatively easy to deceive; customers rely on the regulatory apparatus to protect them from fraudsters, and employees, including the well-paid ‘financial advisers’ (actually CD salespeople), had a strong disincentive to ask too many questions. As we have seen (page 9), when Charles Hazlett, an experienced investment salesman for Stanford, began to sense that investors’ legitimate questions were not being answered satisfactorily, it was not long before he had to leave the firm. But what about the external accountants and the government regulators in the US and Antigua? These people are professionally trained to spot wrongdoing; couldn’t they have spotted problems early on?

Perhaps they did; but Allen Stanford had some rather interesting solutions for coping with them, too. Possibly as a result of his experience of the unwelcome attentions of the British regulators in Montserrat, when Stanford relocated the bank to Antigua in 1990 he seems to have been determined from the start to ensure that none of the locals would cause him any problems. Even before the move to Antigua, the bank’s external auditor was Charlesworth Hewlett, who ran a small accounting firm in Antigua. According to the prosecution, the Montserrat regulators repeatedly asked Stanford to use a larger auditing firm but he refused to do so because Hewlett was willing to give the bank’s phoney accounts a clean bill of health in return for large fees – allegedly a total of $3.4 million was paid to Hewlett, who died in 2009.

Stanford embarked upon a charm offensive to persuade the island’s government to let him operate freely. He purchased the Bank of Antigua, a failing local bank serving the islanders, for $50 million, and lent the government $40 million which he later agreed to write off. Soon, he received his banking licence and residency permit. Antigua, a tiny island paradise, relies largely on tourism to survive, but locals are relatively poor: GDP per capita in 1998 was only $8,500. Allen Stanford spent money liberally on the island, endearing himself to rich and poor alike, buying large tracts of land, setting up restaurants and a cricket stadium, helping to build a hospital, paying $48,000 for Prime Minister Lester Bird’s US medical expenses, making substantial interest-free loans and political contributions to at least ten other senior government officials and later buying the island’s newspaper, the Antigua Sun.

During the 1990s Antigua was trying to diversify into offshore banking, and when it ran into trouble with outfits allegedly linked to the Russian mafia, Allen Stanford stepped in, helping to write new offshore trust laws and becoming, in 1997, the Chairman of the government’s Antiguan Offshore Financial Sector Planning Committee. As Chairman, Stanford appointed a task force to clean up Antiguan banking, and every member of the task force was a close associate of Stanford (there were no locals on the task force). A new regulatory body, the International Financial Sector Authority (IFSA), was set up, and in a stroke worthy of the seventeenth-century pirate Henry Morgan, Stanford managed to have himself made Chairman of this organisation as well. The IFSA proved remarkably resistant to Stanford at first. Althea Crick, the island’s locally born chief banking regulator until 2002, persistently refused to accept bribes and perks, such as upgrades to first class on flights to London. When Stanford ordered the seizure of his banking competitors’ records through the IFSA, Crick refused to allow him to copy them, and he had to send men to break into the IFSA offices at night and take the records away. On another occasion, according to Crick, when she told Allen Stanford to his face that she would not be influenced by him, ‘he held my hand, and looked me straight in the eye and said, “You remind me so much of myself.”’ After Crick resigned in 2002 and a new regulator, the Financial Services Regulatory Commission (FSRC), had been set up to replace the IFSA, Stanford managed again to get some of his own ex-employees into key positions in the organisation, and developed a close relationship with the man who became the FSRC’s head in 2003, locally born Leroy King, a former ambassador to the US who had also been a Bank America executive in New York. According to James Davis, during 2003 Stanford and King participated in a curious voodoo-type ceremony in which they became blood brothers, ensuring that King, and another FSRC official who was present, would help protect Stanford’s businesses from the prying eyes of regulators both in Antigua and abroad in return for bribes. Leroy King was to prove a loyal associate over the years, providing a stream of information to Stanford about the FSRC’s dealing with foreign regulators, and helping to confuse and deflect regulatory investigations into Stanford’s activities. For example, when, in 2005, the SEC, the US stock market regulator, made a number of requests to the FSRC for information about the Stanford group, Leroy King immediately warned Stanford and was provided by Stanford’s people with a draft FSRC reply to the SEC. In 2006 Stanford transferred part of his business to St Croix in the Virgin Islands, and began to spend less time in Antigua.

The ‘noughties’ had been an extraordinary period of growth for the Stanford group, as the sales drive gathered speed; by the end of 2008, it had sold CDs worth a total of more than $7.2 billion. In 2008 the global financial crisis really began to bite. The major stock markets declined rapidly, and although Stanford claimed that the bank’s investments were immune to any downturn, CD sales slowed and the number of customers redeeming their CDs increased alarmingly. During the year, some $2 billion had to be paid back to customers. By October 2008, Stanford had serious liquidity problems; the bank was running out of money to pay back customers, and Stanford’s private businesses could not be sold. Together they were losing over $1 million a day. From a business point of view, this is a familiar problem: in a financial downturn everything tends to go wrong at once, with asset values, income and liquidity evaporating simultaneously, and powerful business associates beginning to turn against you. Frans Vingerhoedt, President of Stanford Caribbean Investments LLC, the man who is alleged to have first introduced Stanford to the idea of starting an offshore bank in the Caribbean in the 1980s, sent an email to Stanford in early 2009 warning of the need to give preference to ‘certain people in certain countries’ – presumably powerful people in Latin America – because ‘there are real bullets out there with my name on’.

Stanford fought hard to save his empire. Towards the end of 2008 he announced that he was injecting $741 million of his own money into the bank. This was based on a deal in which the bank had purchased, for $63.5 million in June, some raw land in Antigua that Stanford wished to develop as a resort. The plan was that the bank would transfer the land to Stanford personally, who would then sell the land back to the bank through a series of companies at the much larger price of $3.2 billion, thereby wiping out the $2 billion he owed the bank and providing the capital injection. During the court cases the US government has presented this deal as an out-and-out sham, which Stanford appears to deny. The land in question, which had been purchased from Malaysian wheeler-dealer Tan Kay Hock, was the beautiful island of Guiana (five miles square), which Stanford had been lobbying for years to develop into an upmarket resort. As Nigel Hamilton-Smith, one of the bank’s receivers in Antigua, commented later, the increased value depended on obtaining final permission to develop – ‘it could be US$50 million, US$250 million, US$1 billion. I just don’t know’ – and thus it appears that Allen Stanford may genuinely have been about to pull off a value-adding master stroke to fend off the bank’s collapse. He continued to live large, allegedly spending $250,000 on a Christmas holiday with his extended family, dropping $515,000 on gambling and jewellery during a manic week in Las Vegas in January 2009 and then flying to Libya in an attempt to obtain funding for the bank from Colonel Gaddafi.

Were Stanford’s continual protestations of innocence merely part of his legal defence or the result of delusional thinking, or was the SEC’s accusation that he was running a Ponzi scheme an oversimplification designed, perhaps, to appeal to a financially illiterate jury? It seems clear that Allen Stanford consistently deceived his customers about how their money was being invested, and it was established in court that the firms had broken numerous financial regulations in the US and elsewhere, and Stanford and his close associates knowingly published false information about the bank’s performance. However, as the SEC’s own definition asserts, ‘a Ponzi scheme is an investment fraud that involves the payment of purported returns to existing investors from funds contributed by new investors … In many Ponzi schemes, the fraudsters focus on attracting new money to make promised payments to earlier-stage investors and to use for personal expenses, instead of engaging in any legitimate investment activity.’ Stanford, and his lawyer, Ali Fazel, have maintained that he did indeed engage in legitimate investment activity: through his network of companies he set up a number of banks in Latin America, for example in Peru, Venezuela, Ecuador and Panama, and also, although largely in secret, he had funnelled large sums of money that had been received from CD purchasers into real estate deals, especially in the Caribbean, that he personally controlled. If these deals had come right, perhaps Stanford would have been able to pay back the vast loans (estimated to be just under $2 billion) that the bank had made to him personally. If he genuinely believed this was going to occur, then one can have some sympathy with Allen Stanford’s passionate declarations that he was not running a Ponzi scheme. This is little comfort to purchasers of Stanford CDs, and does not exonerate Stanford from his clear deception of his customers, but on this reading it is easier to understand how he could have had such confidence in the long-term future of the operation: the Stanford group of companies was going to continue to go from strength to strength, and the Caribbean property deals were going to produce a bonanza in profits beyond the dreams of avarice. In some respects many big time property tycoons operate in this way, especially in tropical paradises – if you can get some influence with a government, you may be able fix it so that you become the main beneficiary of major development projects. In this light, Stanford’s assertion that he was ‘more of a developer at heart than a banker’ rings true, and his behaviour might be seen more as the risk-taking, rule-breaking behaviour of a narcissistic entrepreneur rather than as a deliberate attempt to commit fraud. Stanford may indeed be justified in claiming that the agencies involved in prosecuting him and attempting to wind up his companies have damaged the value of the schemes in which he invested.

Making sense of Stanford

As the Stanford story illustrates, having officials in your pocket in offshore jurisdictions will not protect you forever, especially if you still need to do business with ‘onshore’ customers. However, the fact that Stanford’s bank was based offshore appears to have been a major factor in repeated decisions by the SEC not to act against him during an eight-year period. In 1997, 1998, 2002 and 2004, investigators at the SEC’s district office at Fort Worth, Texas conducted four separate examinations of Stanford’s activities and decided each time that the CDs were probably a Ponzi scheme. Each time, the examination group at Fort Worth asked the enforcement division to open a formal investigation of Stanford’s companies but were turned down (except in 1998, when an investigation came to life briefly, only to be closed down after three months). An SEC inquiry into this failure found that senior managers at Fort Worth had discouraged pursuing Stanford because they were under pressure from head office to increase the number of successful prosecutions, and they believed the Stanford case would be very difficult to pursue. Thus, the fact that Stanford’s bank was based offshore, making it a challenge to obtain documents, was given as a reason for not investigating.

Significantly, the report found that Spencer Barasch, head of enforcement at Fort Worth between 1998 and 2005, ‘had played a significant role in multiple decisions over the years to quash investigations of Stanford’, and had then tried several times to act as Stanford’s legal representative after he left the SEC. Barasch did act for Stanford in 2006 briefly until he was warned by the SEC that this was unethical. In connection with this, Barasch was fined by the SEC in 2012 and banned for a year from appearing and practising as a lawyer before it. This kind of behaviour is perhaps symptomatic of the atmosphere and institutional culture at the SEC in recent years. According to the Project on Government Oversight, a government watchdog, 219 former SEC officials have left the organisation since 2006 to help clients that are being examined or investigated by the SEC.

Even on the most charitable interpretation, this phenomenon cannot be welcome to investors who look to the SEC for protection. It is even more disturbing that some investigators at the SEC had spotted the big clue with Stanford – returns and commissions on his CDs were much too high for them to be safe investments – repeatedly over many years without being able to persuade their bosses to do much about it. The SEC only began a proper investigation in 2005, under Barasch’s successor, and even then it did not occur to anyone to perform due diligence on Stanford’s investments, which would probably have revealed sufficient problems to enable the SEC to ban Stanford Group Company (the onshore sales organisation) from handling sales of CDs issued by Stanford’s bank in Antigua.

In the final analysis, then, it was not so much the fact that Stanford operated offshore that kept him from being shut down for many years, as the inability of a provincial office of the SEC to prosecute any but the ‘quick hit’ cases. This is a staggering, outrageous institutional failure of the world’s most powerful financial regulator; when it is considered along with many other failures, not least the SEC’s long inaction over Madoff (see Chapter 3), it is plain that the SEC is in great need of reform. Until this happens, investors can have little confidence that the SEC can guard them against large-scale fraud.