TAX HAVENS : IN A SEA OF TROUBLES / THE FINANCIAL TIMES COMMENTARY & ANALYSIS ( A MUST READ )

Tax havens: In a sea of troubles

By Michael Peel

Published: January 12 2011 22:57

Cash flow: George Town, capital of the Cayman Islands, a British overseas territory that is home to roughly 50,000 people and 70 per cent of hedge fund registrations worldwide

The first time John Evans tried to steal into the office of the newspaper where he worked, he set off the alarm. His second after-hours attempt was more successful; he reached the partition behind which lay the desk of Cayman Net News’s editor. He then looked in vain “in all possible places” for a file of leaked police documents. Later, he would tell Scotland Yard investigators this was not a break-in but an act of investigative reporting. “Newspaper owners have to understand that their journalists look in both directions,” he said enigmatically.

Whatever the truth, it is unlikely he or anyone else anticipated the strange and serious consequences of the nocturnal visits of September 2007. In the three years that followed, the repercussions would embroil judges, senior lawyers, the Metropolitan police and the Foreign Office. It would also add to scrutiny of governance in the British island territories scattered around the world that have transcended their tiny size to become important operators in the world financial system.

Nicholas Shaxson, author of Treasure Islands, a book about offshore finance centres published this month, says these small havens “all tend to be plagued by allegations of corruption and there are often questions about whether they are investigated properly. When it comes to these problems, the buck stops in London.”

The affair has intensified the focus on Cayman – a group of three islands with a population of 50,000 – and the other British colonial-era possessions that have blossomed into significant offshore centres but have never taken full independence. Because of their prominent roles in the world financial system, some have assumed importance far bigger than their size would suggest. Bermuda is a leading insurance centre, while the British Virgin Islands is the global capital for incorporation of offshore companies.

The Cayman case forms part of a tapestry of allegations of corruption and misgovernance in British-controlled jurisdictions. In the Turks and Caicos Islands, Britain took direct control in 2009 over suspected corruption in the government and legislature. Bermuda was gripped in 2007 by a scandal over suspected political graft involving the state housing corporation. In Gibraltar, Derek Schofield, chief justice, was removed from office in 2009 having been found to have “damaged the interests of good governance” in the territory. In a separate case, also involving Mr Evans, Priya Levers, a Cayman judge, was sacked for misconduct last year.

At its heart, the Cayman story is one of how investigators from the metropole were repelled by legal authorities in a quasi-autonomous UK overseas territory. The argument that has exploded since is over whether the British probe unravelled through incompetence and a lack of evidence, or whether a necessary inquiry was unjustifiably blocked.

The behaviour under investigation in Cayman is not as serious as that alleged in the Turks and Caicos. However Cayman because of its much greater economic profile – with a large finance industry attracted by its tax exemptions and privacy – requires a cleaner reputation.

It is home to 70 per cent of hedge fund registrations worldwide and is also a significant banking centre. Britain’s Barclays alone has 181 subsidiaries registered there, claimed Chuka Umunna, a UK Labour MP, during this week’s appearance by Bob Diamond, the bank’s chief executive, before a parliamentary committee.

While the prevalence of English-style common law – and the assumption of a UK guarantee of stability – is an attraction for investors, islanders sometimes resent the British background presence as overbearing and feel unfairly criticised internationally. In a lively blog by Mr Evans, a contributor on the message thread warns: “You had better watch yourself with these disparaging remarks about the mighty Brittania [sic] government or the axe may fall on your head.”

The Cayman imbroglio began with a claim in summer 2007 by one of Mr Evans’ colleagues that a senior police officer was leaking information to the paper.

Scotland Yard was called in to investigate, with the support of Stuart Jack, then the islands’ governor. The probe, Operation Tempura, was led by now retired chief superintendent Martin Bridger, an experienced officer who had been an anti-corruption in­vestigator and also commander in the gritty London borough of Lambeth.

FAR FLUNG FINANCES

● Bermuda Finance employs more than 5 per cent of the population. Told by UK Treasury-commissioned review of offshore centres to increase efforts against financial crime. Set up a Financial Intelligence Agency in 2008.
● British Virgin Islands Investing in legal infrastructure to deal with commercial disputes arising from its status as the leading incorporator of offshore businesses. Treasury review said the BVI should do more to fight financial crime.
● Cayman Islands Base to most of the world’s hedge funds. London lent CI$50m (US$59m) in 2009 to bolster public finances and has been pressing for the introduction of various taxes.
● Turks and Caicos Islands A centre for offshore trusts. UK imposed direct rule in 2009 after a report found “high probability of systemic corruption”.

The Tempura team soon discounted the initial police leak allegations, but Mr Evans’ late-night office search gave the probe new life. In interviews with investigators, he claimed Stuart Kernohan, then Cayman police commissioner, had suggested he try to find the documents in question. Mr Kernohan was later removed from his post, although he has always denied any wrongdoing and was never charged with any offence.

Mr Evans also claimed he had been trying to find information in response to a separate request from Mr Justice Henderson, a Canadian who is a full-time judge on the islands. Mr Evans asserted that the judge had asked him to look for letters published by the paper that criticised members of the judiciary, in particular Anthony Smellie, chief justice, over their stance on legal aid and other matters. Mr Evans added that Mr Justice Henderson was not aware of his clandestine visit.

According to court papers, Mr Justice Henderson acknowledged mentioning “in confidence” to Mr Evans the “collective concern” of the judiciary over the letters, although he said he never asked the journalist to recover them. The Tempura team began to focus more closely on the role of Mr Justice Henderson. In September 2008, they arrested him on suspicion of misconduct in public office.

He was released without charge.
. . .

For the investigators, the arrest proved fateful. Sir Peter Cresswell, a retired English judge brought in to review the case, declared the arrest unlawful and said “failures and misrepresentations” on the Tempura side had resulted in the “gravest abuse of the process”.

Martin Polaine, a UK barrister who advised the investigators, was later expelled from the profession, admitting “fundamental and far-reaching errors” and “demonstrating poor judgement and flawed thinking”. Mr Bridger left Tempura in 2009, amid heavy media criticism in Cayman.

The waters might have closed over the case had Mr Polaine not decided to hit back last summer with a complaint of his own to the Foreign Office over the way the Cayman authorities handled the matter. The counter-attack, which Mr Bridger later joined, was referred to Duncan Taylor, the Cayman governor. Mr Polaine formally withdrew his complaint late last year, citing a lack of confidence in the process, but Mr Bridger pressed on. He declined to comment ahead of the governor’s decision. Mr Taylor has asked Benjamin Aina, a London-based QC, to offer advice on how he should handle the case. The barrister handed the governor his confidential report days before Christmas.

The nub of Mr Polaine’s and Mr Bridger’s argument, seen by the Financial Times, is that Tempura was checkmated by the questionable behaviour of individuals involved in the case. Mr Polaine asks why Chief Justice Smellie, overseeing a crucial earlier Tempura legal hearing, spoke to Mr Justice Henderson outside the courtroom about his relationship with Mr Evans, the journalist. Mr Polaine also claims the chief justice went to see Mr Justice Henderson at the police station after his detention and, without notifying the arresting officers, spoke to him in a private room.

Chief Justice Smellie says his police station chat with Mr Justice Henderson lasted less than 10 minutes, adding that it was appropriate to ensure the arrested judge had access to proper representation. He declines to comment on his conversation with Mr Justice Henderson about Mr Evans, beyond what he has already said in court rulings. In a February 2008 judgment, the chief justice said he did not think he should recuse himself from the case over perceived bias, adding that the Tempura investigators were free to challenge his decision.

Mr Polaine raises further concerns about the role of Sir Peter, the former English judge. Sir Peter, an active member of the Flyfishers’ Club, a Piccadilly-based group dedicated to “the social intercourse of gentlemen interested in the art of flyfishing”, was in late 2009 appointed to the Cayman grand court, the latest in a series of English judges – including Lord Woolf, former lord chief justice – to take up post-retirement appointments in small but ambitious business centres, from the Gulf to the Caribbean.

Mr Polaine claims Sir Peter made findings of bad faith without supporting evidence.

He questions why Sir Peter met Chief Justice Smellie after arriving on the islands.

Sir Peter retorts that “at all material times” he maintained “total independence” in the case and an “appropriate and necessary distance” from those involved. He declines to comment on his judgments and says he spoke to the chief justice only very briefly on arrival in Cayman, without discussing the case.

Mr Polaine also questions the role of Larry Covington, a Foreign Office law enforcement adviser. Mr Polaine highlights an e-mail that suggests Mr Kernohan, the police commissioner, briefed Mr Covington on the Cayman Net News office search on the very night it happened. Mr Covington referred Financial Times questions to the Foreign Office press office, which declined to comment.

A final – and potentially even more significant – strand of Mr Polaine’s dossier is his claim that Tempura heard disturbing allegations from about 70 people of a much wider pattern of graft and misconduct in Cayman. “Many of those who came forward said they had been waiting for years to have sufficient confidence in a team who seemed serious about tackling corruption,” he asserts.
. . .

Whatever the full tale of Tempura, the affair does seem to have raised im­portant questions about the rule of law in Cayman – and the network of close relationships that dominates the elite of this and other small British territories – many of which have been obscured by arguments over the conduct of the investigation.

The case also goes to the heart of the UK’s awkward relationship with the “pink dots on the map” that are both imperial relics and significant operators in world finance.

Mr Umunna, the MP who is also parliamentary private secretary to Ed Miliband, UK opposition Labour party leader, says: “Britain should certainly be using its influence and the leverage that flows from that to encourage better standards of financial probity and governance to be adopted.”

The UK government has promised “further measures for promoting good governance and preventing corruption” in overseas territories. The Foreign Office concedes there “may be individual incidences where governance has been a concern” but denies there is “systematic or widespread” problem across the islands.

Mr Jack, the former governor who backed Tempura, provides a suitably cryptic coda to the case sparked by Mr Evans’ office search. In a blog posted the day he left the islands in December 2009, he admits “some mistakes were made” over the investigation but suggests this bitter dispute in one of Britain’s offshore financial flagships may not be done yet.

“I remain firmly of the view that I did what I had to do,” he says. “I believe that when more of the story can be told more people will understand that.”
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SECRECY UNDER SCRUTINY: Pressure for transparency persists as havens yield billions for G20 treasuries

When leaders of the world’s biggest economies met in London in April 2009 they issued an ultimatum to tax havens, writes Vanessa Houlder. “The era of banking secrecy is over,” they declared.

The Group of 20 summit triggered a scramble by almost all offshore centres to meet their bigger neighbours’ demands. “Tax havens are disappearing,” French president Nicolas Sarkozy – one of their fiercest critics – said last summer, after 500 tax information exchange agreements had been signed.

Critics say the results do not live up to the hype. Tax Justice Network, an international pressure group, describes the agreements as “extremely weak” because they require offshore centres to help track down evaders only if a foreign tax authority can prove it has grounds for suspicion. Its scepticism was reinforced by recently unveiled German and British plans to negotiate a withholding tax for undeclared funds in Switzerland rather than forcing account holders to come clean.

But the official erosion of banking secrecy, coupled with a spate of thefts of confidential bank data, has yielded results. Fear of detection has prompted many evaders to take advantage of official amnesties. Germany has collected €4bn from offshore evaders; France, €1bn; Italy, €5bn. The UK has collected an extra €600m and expects this to rise to at least £6bn by 2015.

An even more powerful weapon will soon be wielded by the US in the form of an act to stop the evasion of an estimated $8.7bn of taxes in the next decade. From January 2013, financial institutions outside the US will have to hand over details of American clients’ accounts or face a withholding tax on income from all their US investments.

Offshore centres continue to face questions about their role in the financial crisis, in what International Financial Centres Forum, a lobby group, says is “a politically expedient distraction from regulatory failures in the major onshore capital markets”. But no one doubts the crisis exposed risks inherent in small countries with big financial sectors. It has also exacerbated hostility to low or zero tax rates, evident in Brussels’ recent scrutiny of the tax systems in Britain’s Crown Dependencies. Charities that believe developing countries lose more to tax havens than they gain in aid are campaigning for more disclosure by multinationals.

Whatever the difficulties of securing a consensus, interest in the role of tax havens at a time of widespread austerity is likely to persist. With Mr Sarkozy at the helm at the November G20 summit in Cannes, they face another turbulent year.

Copyright The Financial Times Limited 2011