Privacy, Enforcement and the Operation of an Efficient Commercial System

By Jason Allison, Partner and Tim Buckley, Partner, Walkers, Cayman Islands (01/08/2014)

How much should governmental authorities be permitted to know about our private lives?  Should any member of the public be able to explore our financial affairs, such as ascertaining the amount of our bank balance?  The right to privacy is considered by most people to be fundamentally important in a democratic society, however, like most rights, the right to privacy is not absolute.  If a person is hiding behind privacy to commit criminal acts, mechanisms should be available to draw aside the veil of privacy and reveal the wrongful activities.  Such mechanisms, while necessary, must be proportionate to address the illicit activities concerned and should only intrude upon the right to privacy to the minimum extent required to accomplish the goal of bringing perpetrators to justice.


The current initiative to seek to introduce a global system to record and monitor beneficial interests in assets gained momentum when UK Prime Minister, David Cameron, announced a commitment to pursue such a system in June 2013 when the UK held the G8 presidency (now held by Russia).


The UK action plan states that enhanced transparency ‘is a matter of good governance as well as a means to tackle a wide range of illicit activity.’  There is not much detail on exactly how a register of beneficial ownership would help to address the presumption of illicit activity.  The main assumption underpinning the drive to establish a publicly accessible register of beneficial interests appears to be that there should be no objection to transparency if one has nothing to hide.  This assumption, together with the presumption that private activity is necessarily suspicious, ignores the fact that the vast majority of people are law abiding citizens who, for a range of perfectly legitimate reasons, would rather not disclose their financial information. 


To use a simple example, a house can be used to raise a family or it can be used as a location for dealing drugs.  The latter purpose is criminalised in many countries, but there needs to be some minimum evidential or suspicion threshold that must be established before a person can inspect the property to check for evidence of wrongdoing.  A government may argue it can be trusted to act in the best interests of its country’s citizens, but recent revelations about improper monitoring of private citizens call into question the ethical approach of governments where sensitive information is involved.  And indeed, effective mechanisms already exist for governments to track down and prosecute tax evaders, money launderers and terrorist financiers.


Even if the establishment of a register for beneficial ownership is thought to be a good idea, there are some very serious practical difficulties which would need to be overcome.  It would involve massive costs, which would no doubt have to be borne by the private sector - further increasing the cost of doing business.  The efficacy of a beneficial registry is highly doubtful, given that the persons it would be designed to expose and prosecute will find ways to avoid detection; law abiding citizens will be left to endure the added cost and difficulty of compliance.


Many jurisdictions recognise that the legal and beneficial ownership of an asset may be split.  A person (for example, a nominee) may hold the legal title to an asset, but he may do so on the basis that the benefits of the asset will accrue to another person.  It is quite common for the legal title to be recorded in a central registry, but very unusual for the beneficial title to be recorded and tracked.  There are good reasons for this, including practicality and the importance for a company to be able to look to a specific person to give instructions in the case of a general meeting (a company is usually entitled to look just to the legal holder as recorded in the register). 


Modern commerce makes extensive use of the legal/beneficial ownership split to promote convenience and efficiency.  Assets beneficially held for a group of beneficiaries in underlying pools (such as investors in a pension fund) may circulate, often making the tracking and continual updating of beneficial ownership information extremely difficult.  And the fact remains that regulatory due diligence is already required to be obtained in respect of each of the investors concerned under anti-money laundering and anti-terrorist financing regimes.  Furthermore, the ability to take security over assets is a fundamental factor for lenders in deciding whether to make loans.  Some mechanisms of taking security involve the transfer of beneficial ownership to the lender, which is usually transferred back to the borrower when the loan is repaid; any accurate register of beneficial interests would need to track such arrangements as well as other situations where legal and beneficial title are not held by the same person or entity.


One of the main arguments militating against a central registry of beneficial interests is that such a system would need to be truly global to be effective.  If it is not global (and updated in real time), the system could be easily thwarted by inserting into the ownership structure a vehicle that is registered in a jurisdiction that does not observe the same or similar reporting standards.  Such jurisdictions are also unlikely to have reliable due diligence standards meaning that the investigation trail will go cold as soon as a non-cooperative jurisdiction is encountered.


A system to force the collection of beneficial ownership information would be unworkable, costly and impractical.  In addition, making information publicly available would be an invasion of privacy, to which private citizens and legitimate businesses are entitled. A proposal along the lines of the UK action plan would undermine competition, discourage innovation, erode the efficiency of global capital markets and drive up the already considerable regulatory costs imposed on industry (eg, Dodd Frank, AML due diligence, FATCA and AIFMD).


Within their current exchange of information regimes, the leading IFCs like the Cayman Islands, the BVI and Jersey, already have advanced systems in place to provide beneficial ownership information where it has been lawfully requested by a foreign tax, regulatory or investigative authority.  As members of the OECD White List, these centres fully comply with all the relevant international standards. Furthermore, the corporate service providers in smaller IFCs collecting such information are already regulated by the appropriate local authorities. This is in contrast with the UK and the other G20 countries where information may be currently incomplete or unverified.  As the IFC Forum and others have stated, any system aiming to collect beneficial ownership has to include procedures for verification as well identification (ie, not just identification).


The proposed 'self reporting' system of collecting information in the UK action plan is open to abuse and without a mechanism for verification, the criminal elements surely need no further incentive to conceal beneficial ownership, or more likely would simply not bother to report data.


At the same time, the G20 nations need to recognise the impact such a system would have on international competitiveness. Requirements for beneficial ownership information to be published will simply direct investment into jurisdictions where that is not the case; and given that corporate regulation is done at individual state level rather than federal level, some commentators doubt the likelihood of the US introducing a reliable system. 


If the implementation of a publicly available beneficial ownership information database is implemented by the UK and its overseas territories first, it is highly likely that this will result in clients and business moving to countries and territories where requirements are less onerous. Unless and until a truly global system is introduced, the proposal is unworkable and will simply be a waste of resources.


For all onshore and offshore jurisdictions to cooperate to the same level on this issue is clearly unrealistic. The regulated corporate service providers in UK offshore centres typically collect due diligence ownership information for holdings of 10 per cent or more following anti-money laundering and anti-terrorist financing standards prescribed by the Financial Action Task Force.  As the information is already available to cross-border authorities in specified circumstances, the huge undertaking of creating a central registry of beneficial information would not provide a proportionate improvement in transparency that would justify the cost.


The European Convention of Human Rights and the UK Human Rights Act state that ‘Government shall respect every person's private and family life, his or her home and his or her correspondence.’ Any large scale degradation of the right to privacy should not be taken lightly and there could be legal challenges if a disproportionate disclosure regime is imposed. 


In addition to the matter of privacy being respected as a legal matter, it is important not to lose sight of the more practical consequences of public access to beneficial information, where criminals in the modern age are already perpetrating fraud on a large scale. The widespread release of private financial data would exacerbate identity theft and other forms of cybercrime. The threat of kidnapping and extortion also exists towards company owners targeted by extreme groups such as animal rights activists or other protest groups.  There is no mention within the UK action plan of any steps the UK government would take to protect its citizens who are exposed to such risks. Perhaps ironically it was only some five years ago that the UK government removed the requirement for UK directors to provide residential address details to reduce the threat of violence and intimidation.


To sum up, the proposal to implement a system to record beneficial ownership of assets is ill-conceived because it would represent a disproportionate degradation of the right to privacy, while effective mechanisms to combat tax fraud, money laundering and terrorist financing already exist. As criminals are encouraged to use the system to advance their illicit activities, global commerce will be negatively impacted and it is implausible that a truly global system could be established, with the first mover jurisdictions losing business to later adopters. The huge costs of implementation and additional regulatory burden would significantly harm private enterprise, while being unlikely to lead to achieve the proposed goals of reducing illicit activity.