The threat of public beneficial ownership registers

Even for jurisdictions that are used to moving goalposts in terms of international regulatory pressure, the passing on May 1 of a cross-party amendment to the Sanctions and Anti-Money Laundering Bill in the House of Commons, effectively ordering British Overseas Territories to establish public registers of beneficial ownership, was unique.

It stood out not only because the U.K. government had in the past fended off similar attempts to amend various bills in both houses of parliament, but also because the issue simply did not seem important enough to warrant the extreme measure of an order in council, a method that disregards the independent democratic mechanisms of the overseas territories.

This time, however, the U.K. government relented, faced with numerous defectors and a possible defeat, had the amendment gone to a vote.

During the debate, British lawmakers blamed offshore companies in the overseas territories, in a maelstrom of NGO advocacy and Russian paranoia, for anything from poverty in Africa to Russian kleptocracy and money laundering for organized crime.

Feeble attempts by the government had little effect to emphasize that the overseas territories had all signed agreements with the U.K. only two years ago and subsequently set up beneficial ownership registers that provide access to U.K. law enforcement and tax authorities.

Members of parliament on both sides of the argument acknowledged that the measure would have a negative economic effect for the territories, but most simply suggested that in response the territories should diversify their economies.

As a result, the overseas territories have been told that they have until the end of 2020 to set up publicly accessible registers disclosing the owners of companies and other entities in their jurisdictions or the U.K. government will issue an order in council forcing them to do so.

Orders in council, a relic from the colonial days, have been used before but typically only in the promotion of significant human rights issues. In Cayman, for instance, these extraordinary measures, which bypass the Legislative Assembly, were used to abolish the death penalty and decriminalize homosexuality. Suggestions the U.K. government could institute same-sex civil unions in the territories in the same way, however, were recently rebuffed by Foreign Secretary Boris Johnson.

So how could it come to this? The relentless pressure of the British press over the Panama and Paradise Papers was certainly a factor. The poisoning of former Russian spy and double agent Sergei Skripal and his daughter Yulia in Salisbury in March – allegedly at the behest of the Russian state – created, in addition, a fertile ground for new anti-money laundering measures.

The U.K. parliament’s Foreign Affairs Committee issued a report in May on Russian financial influence in Britain under the title “Moscow’s gold: Russian corruption in the U.K.” In it, the Foreign Affairs Committee stated the overseas territories “are important routes through which dirty money enters the U.K.”

The authors of the report appear fully aware that an order in council dictating public registers would disenfranchise elected representatives in the territories in an area of domestic responsibility for their local governments.

But the report claimed, “While the Government should continue to respect the autonomy and constitutional integrity of the Overseas Territories and Crown Dependencies on devolved matters, money laundering is now a matter of national security, and therefore constitutionally under the jurisdiction of the U.K.”

Unsurprisingly, the move provoked ire in the overseas territories, with many territory leaders describing the action as reminiscent of the colonial era.

Cayman Premier Alden McLaughlin said the position of his government is clear: “[T]he attempt by parliament to legislate for this territory … is unlawful and we do not accept it.”

However, challenging the Sanctions and Anti-Money Laundering law itself is difficult and unlikely to succeed. The Cayman government will therefore wait until an order in council is issued.

Legally, Cayman’s constitution grants very wide reserved powers to both the governor and Her Majesty The Queen. While section 81 of the Constitution gives the governor the right to publish a bill in any area of the governor’s constitutional responsibility, if the Cayman government is reluctant to do so, section 125 grants Her Majesty full power “to make laws for the peace, order and good government of the Cayman Islands.” This is the same catch-all wording used in the constitution for the powers of Cayman’s legislature.

“Cayman’s best course of action is to challenge any decision of the U.K. government by order in council to amend local legislation … which will render the issue to our courts here,” McLaughlin said. “That [challenge] will never happen if the U.K. doesn’t make the order in council.”

If an order is made, the premier argued that a legal challenge would be necessary irrespective of the underlying issue, as it could otherwise open the door to other kinds of legislation by the House of Commons in areas of responsibility that are devolved to the territories. Even then, the matter could take years to resolve.

In the meantime, Cayman would not make its beneficial ownership register public, unless it becomes a globally accepted standard – a position the Cayman government has always maintained.

“When this becomes a global standard, Cayman is there,” the premier said.

Aside from the political arguments over constitutional powers, the debate over public registers centers on two key points: the effectiveness of public registers and their conflict with privacy rights.

Unlevel playing field

Simply opening up the registers in the overseas territories alone risks that any illicit money would simply flow to other jurisdictions with less transparency. This would be detrimental for U.K. law enforcement, who would lose access to critical information that under the existing beneficial ownership registries in the territories is available to them.

More importantly, there is a danger than an unlevel playing field with public registers accessible in only a handful of jurisdictions would lead clients with legitimate privacy concerns to choose other jurisdictions, effectively driving business away from the overseas territories.

But Cayman’s government assures that the fallout from the threat of public registers will not be the “death knell” of Cayman’s financial services industry.

The Chamber of Commerce agrees.

“There is no material impact at this stage given there have been no actual changes to our framework. The Government has also made it clear that they do not accept the U.K.’s right to impose the legislation in 2020 so the industry’s clients will be partly comforted in knowing that,” said Chamber President Paul Byles. “We still have some way to go before assessing any direct impact. It’s possible that some clients may be deterred due to the potential loss of their legitimate right to privacy in the future, but I don’t belief there is much fallout there either.”

Tim Ridley, former chairman of the Cayman Islands Monetary Authority, in turn, believes the stakes are high.

“Failure to find a solution that protects legitimate privacy will lead to a great outflow of quality business to jurisdictions that still respect data privacy (and there are many),” he said.

Clients with legitimate privacy concerns may well be willing to switch service providers if necessary.

But it is hard to put numbers on the potential economic impact from the threat of, or the actual implementation of, public registers, said Ridley, a former senior partner at offshore law firm Maples and Calder.

“Cayman is fortunate that its financial services business is of a high quality and very broadly based, much of which is and will not be affected by these moves. Having said that, uncertainty is very unhelpful, even if the outcome is no public registers,” he said.

Ridley expects the first to suffer will be quality business that would otherwise have come to Cayman.

There are indications that Cayman in recent years has already lost trust business to the United States because of the common reporting standard, a global tax information exchange system that Cayman participates in but the U.S. does not.

It is also not inconceivable that even clients who do not expressly seek privacy would select, given the choice between two identical services, a service provider in a jurisdiction that does not mandate that their client information is put on the internet.

“After all, it is simpler for the client not to have the headache of potential public registers if he can find a solution elsewhere. Or the potential client may decide that going ‘offshore’ anywhere is too burdensome and costly,” Ridley said.

Most well-advised existing clients have come to accept, albeit reluctantly, non-public registers open to law enforcement, tax authorities and regulators.

“But the aggregate of public registers, common reporting standards and the push for greater transparency generally may very well lead many clients, who are fully compliant, nevertheless to seek jurisdictions where their affairs are not subject to the same level of unjustified and irresponsible media and other scrutiny as is possible with public registers,” he added. “Many will wait to see the outcome of the issue; but others may decide it makes sense to plan for the worst and relocate during the uncertainty.”

The places that offer the greatest long-term stability for the confidentiality of client information combined with a respect for privacy rights and the rule of law are the likes of Hong Kong, Singapore and the U.S. In the short term, Cyprus and Malta may also be attractive candidates but given that both are EU members, that may well change. And there is always the possibility that other offshore centers that are not subject to the U.K. mandate will be able to maintain an advantage, until public registers become a global standard.

Effectiveness of public registers

Other criticism of public registers aims at the unreliability of the information available in the U.K. register of persons of significant control, which the territories are now ordered to emulate.

Even public register advocates recognize existing weaknesses in what the U.K. government claims is the “gold standard.” In an October 2017 briefing on the lessons learned from the U.K. public register, advocacy groups OpenOwnership and Global Witness noted that the existing threshold of 25 percent for beneficial owners to be identified is too high.

In many cases, companies used for illegal activity can simply name five shareholder companies in different jurisdictions with each owning less than 25 percent of the shares to circumvent the disclosure requirements. Others report looped ownership chains with companies seemingly owning themselves.

“One of the most significant weaknesses of the U.K. register is that the data submitted is not verified, it is solely self-reported data from companies. This means that data can be submitted that does not comply with the requirements of the register or is inaccurate,” the briefing said.

In a particularly egregious case, first reported by investigative journalists from the Organized Crime and Corruption Reporting Project, members of the southern Italian mafia, Camorra, used U.K.-based companies, often providing fictitious information. One address for the directors of such a U.K. company was located in Via Dei 40 Ladroni, Ali Babbà, Italy, a reference to the folk tale “Ali Baba and the Forty Thieves.”

To verify or improve the accuracy of the data, OpenOwnership and Global Witness suggested a different system should be put in place. They concluded that entities that carry out customer due diligence should be required to file reports to the register, regulators or law enforcement if the beneficial ownership data they find does not match the public register.

In addition, they called for a system to submit identity documentation; the cross-checking of data against other government data sets; and systems for members of the public to easily highlight or report suspected inaccurate data in the registry.

“It is important to note,” the advocacy groups stated, “that all but one of these measures are only possible when the information is available as structured data, and that two are only possible when that data is available to members of the public to use and re-use.”

In other words, to make the U.K. public register work effectively, more personal data is required and that data must be more widely shared.

Data privacy

This puts the demands for public registers further at odds with individual privacy rights.

There is a certain incongruity that as the European Union, including the U.K., is tightening rules to protect the data of its citizens with its General Data Protection Regulation, which came into force on May 26, it completely disregards privacy rights when it comes to beneficial ownership data.

It is more than just an academic question whether it is necessary for the general public to know beneficial owners, especially when law enforcement and tax authorities already have access to the information.

The advocates of open registers think so. They believe that there is simply too much information for law enforcement and tax authorities to sift through, a job that could conveniently be supported by journalists and NGOs.

Conservative MP Andrew Mitchell, who brought the amendment of the Sanctions and Anti-Money Laundering Bill that forces overseas territories to have public registers of beneficial ownership, said, “It is only by openness and scrutiny, by allowing charities, NGOs and the media to join up the dots, that we can expose this dirty money and those people standing behind it. Closed registers do not begin to allow us to do it.”

Mitchell explicitly named the Panama Papers coverage as evidence for the effectiveness of this approach.

Another question is if the mandate of open registers is legal. Privacy rights are not absolute but laws or government actions infringing those rights must be proportionate.

When French lawmakers decided in June 2016 to make information on the settlors and beneficiaries of trusts with French connections available to the public, the public register of trusts was provisionally suspended only three weeks later. In October 2016, the Conseil Constitutionnel, the French Supreme Court, decided that the public trust register was unconstitutional because it represented a disproportionate breach of the privacy rights of individuals that are part of trust arrangements.

The court did not decide against trust registers per se but held that making the information public was a step too far, given that relevant authorities already had access to the information.

The register was subsequently revised and now grants access to law enforcement, regulators and certain groups of professionals if their access to the register is regulated under French law.

The European Data Protection Supervisor, the EU’s independent data protection authority, is also critical of efforts in Europe to make beneficial ownership information public. In an opinion on amendments to the 5th Anti-Money Laundering Directive, Wojciech Wiewiórowski, head of EDPS, recommended that access to beneficial ownership information should be designed in compliance with the principle of proportionality, and that access is only granted “to entities who are in charge of enforcing the law.”

Linking access to beneficial ownership information to the purpose of fighting money laundering by stating that beneficial ownership transparency is needed to trace criminals who could otherwise hide behind a corporate structure explains why competent authorities should have access to the information, the EDPS said.

But the data protection supervisor questioned the proportionality of granting wider access to beneficial ownership data to “any person with legitimate interest.”

EU member states will define what legitimate interest means but, the EDPS said, they must balance the public interest of combating money laundering and terrorist financing and the protection of fundamental rights of individuals, in particular the right to privacy and protection of personal data.

In 2014, the European Court of Justice shocked European legislators when it shot down the EU Data Retention Directive. In the Digital Rights Ireland case, the court established that the fight against international terrorism and serious crime constitutes an objective of general interest that allows the interference with fundamental privacy and data protection rights, but it concluded that the measures must be proportionate.

The court adopted a two-pronged proportionality test, by considering whether a measure was appropriate to achieve its objective and if it did not go beyond what was necessary to achieve this goal. The ruling suggested that general and blanket data retention is no longer possible under EU law.

Under the 5th Anti-Money Laundering Directive, the public will be granted full access to information on the beneficial owners of firms operating in the EU. The corresponding information will also have to be collected for trusts, but access to it will be limited to those with a “legitimate interest.”

Member states can also insist on registration and the payment of a small fee, so that the access of such information would be traceable. Restrictions on access will be allowed in certain circumstances, including where there is a risk of fraud, kidnapping, blackmail, violence or intimidation, although the ability to create exceptions is limited.

If the experience with the U.K. beneficial ownership register is anything to go by, there should not be much hope for those in the wealth management industry, who argue that their clients’ details should not be disclosed publicly for security reasons.

Of the more than one million U.K. companies analyzed by OpenOwnership and Global Witness, 270 individuals applied to have their information withheld claiming that it would put them at risk and only five requests were granted.

If a legal challenge of public registers for infringing privacy rights could be successful in a Cayman court is anyone’s guess. The register of shareholders has traditionally been a public document in many jurisdictions, often to enable creditors and business partners to make an informed decision about their dealings with company owners who enjoy limited liability.

In Cayman, the same principle applies to ordinary resident companies but not to exempted companies, the traditional choice for offshore business.

It could be argued that it was always the intention that dealing with offshore companies should be a case of “buyer beware.”

It is pure speculation to anticipate how a court in Cayman, the U.K. or the Court of European Human Rights would apply the constitutional or convention right to privacy, which is not unlimited, to the issue of public registers, said Ridley.

“These are uncharted waters. One would expect a court to conduct a balancing of interest analysis. And one would hope that a court would decide that general and unrestricted public disclosures is too broad, that there should be a public interest test to be met in order, for say, media access to be permitted,” he noted. “One also hopes that the U.K. can be persuaded to accept at minimum a public interest test in the local Cayman legislation and thus not to pursue the order in council, sledgehammer solution, which itself would likely spawn expensive and protracted litigation.”

EU may force the issue earlier

Rather than being resolved through legal challenges of a potential order in council, the issue may come up sooner than anticipated. The EU is already planning to add the existence of public beneficial ownership registers as one of the criteria to avoid its blacklist of uncooperative countries in tax matters.

In 2017, Cayman avoided a blacklisting by committing to remedy, before the end of this year, what the EU called a lack of economic substance of Cayman-based entities. Minister for Financial Services Tara Rivers visited Brussels in May to talk to EU policymakers about the details of how economic substance is going to be defined.

Even if Cayman can meet EU demands on the question of substance, public registers look set to become the next EU hurdle.