One would expect that a 4.5 trillion-euro industry would be subject to stringent transparency and accountability requirements to prevent its misuse by the corrupt and money launderers.
That is not the case with Luxembourg’s investment funds industry, a new investigation by Transparency International and the Anti-Corruption Data Collective reveals.
Luxembourg is home to the largest number of investment funds in Europe and the second largest in the world after the United States. Yet, despite recent anti-money laundering reforms, we know very little about who the real end-investors are and whether the funds they invest are of legitimate sources.
Why care about investment funds?
An investment fund is a pool of capital from different investors that is used to purchase a variety of assets, such as stocks, bonds and real estate. Hedge funds, private equity and mutual funds are among the most common types of such pooled investment funds. These funds are usually registered as legal entities and controlled by a fund manager, who decides which assets to buy or sell, when and how. Investors simply own their individual shares and benefit from them.
The industry, with trillions of euros in assets under its management, continues to operate as a black box in Luxembourg and abroad. In the United States, for example, private investment funds not only do not need to disclose the names of their beneficial owners to the authorities, but fund managers are not subject to any anti-money laundering obligations.
Not surprisingly, the masterminds of the Malaysia 1MDB scheme – one of the largest corruption scandals in the world – chose private investment funds to launder part of the money embezzled from the Malaysian fund. The funds in question, which had other customers and held investments unrelated to 1MDB, created segregated portfolios for individuals involved in the 1MDB scheme that invested solely in a shell company created by those same individuals.
The Financial Action Task Force has classified the sector as high-risk for money laundering. More recently, a leaked May 2020 report of the Federal Bureau of Investigation in the United States reportedly stated “with high confidence” that these financial vehicles are being used by bad actors to launder funds and evade sanctions.
With more scrutiny over other types of legal vehicles, such as shell companies, there is a risk investment funds will become even more attractive to criminals going forward. Closing the loopholes allowing investors to remain anonymous should be a priority.
International Anti-Corruption Conference 2020: Private Investment Funds and Corruption – A Peak into the US$14 Trillion Dollar Black Box
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OpenLux: What we found
Using OpenLux – a database created by Le Monde by scraping the data of the newly released Luxembourg Register of Beneficial Owner (RBO) – we found that, despite Luxembourg’s steps to shine a light on corporate ownership, in the case of investment funds, very little is known about who the real end-investors are and whether the sources of their funds are legitimate.
What is OpenLux?
OpenLux is a collaborative international investigation on the hidden side of the Luxembourg offshore industry. Around three million documents and records were obtained by Le Monde from Luxembourg’s online business register platforms. They include corporate documents, financial statements and beneficial ownership declarations from more than 260,000 companies, covering a period from 1955 to December 2020. Le Monde collaborated with the Organized Crime and Corruption Reporting Project, Le Soir, Miami Herald, Woxx and Süddeutsche Zeitung, among others.
Eighty-one per cent of the 16,777 investment funds registered in the RBO did not declare any beneficial owners. In most cases, this is likely because they could not identify any beneficial owner, following the definition laid out by Luxembourg’s legislation.
We then compared data from the RBO registry to reports that a smaller number of Luxembourg funds had to submit with the US government in order to do business there. Our investigation uncovered significant discrepancies between the way firms filed reports in the two government databases.
By construction, if a fund has less than three owners, then there is at least one individual owner that owns more than 25 per cent of the total fund, and hence should be considered the beneficial owner according to Luxembourg's law. However, for instance, we found 112 funds that reported between one and three beneficial owners to the US government. But only 17 of those funds (16 per cent) reported the names of any beneficial owners to the Luxembourg authorities.
This discrepancy suggests that either the funds are misrepresenting their ownership structure to the SEC, or failing to abide by the rules laid out in the Luxembourg RBO. Either scenario carries potential penalties and illustrates the need for stronger verification mechanisms and enforcement of beneficial owner regulations.
In addition, even among those that did declare beneficial owners in the Luxembourg RBO, the information does not always seem to be accurate. We also found that managers and trustees still appear, in some cases, as the ultimate beneficial owner.
The person who benefits from a fund is the person whose assets are under management. It does not make sense for the definition of beneficial owner to only include certain shareholders or the person making investment decisions.
What future reform efforts should focus on
There is no doubt that beneficial ownership information is essential to uncover corruption and money laundering schemes. However, the extent to which easy access to a register can support the detection of potential wrongdoing and further investigation depends on the adequacy of rules and on the quality of the information recorded.
The findings of our investigation reveal two main loopholes in the current Luxembourg – and the EU’s – corporate transparency framework: an inadequate definition of who qualifies as a beneficial owner and a lack of verification mechanisms to ensure the quality and accuracy of the data in the register.
For investment funds, in particular, law enforcement, tax and other competent authorities should be able to identify all individuals who benefit financially from the fund (such as by earning interest or dividends) and not only those taking decisions (in control) or owning more than 25 per cent of shares.
Beneficial ownership registries are a powerful tool for fighting corruption and money laundering. But they only work as intended when the data contained is complete and accurate.
Our new report, and the stories published as part of the OpenLux project, shine a light on some of the issues that should be taken into account by the authorities in Luxembourg and across the EU if the register is to achieve the stated purpose of the EU Anti-Money Laundering Directive.
In particular, we call on the authorities in Luxembourg to:
- Take steps to review the beneficial owner definition to ensure that all beneficiaries of investment funds, the real natural person who are the end-investors, are accurately identified, disclosed and recorded in the RBO;
- Undertake a review of the data currently in RBO to assess if legal entities are complying with the rules. Cases of non-compliance and/or false information should be sanctioned in a timely manner;
- Adopt a mechanism to verify and validate the information provided by legal entities. This can be done, for example, by cross-checking information in the register against other government databases or by making use of advanced analytics. The parameters for verification should be well specified and in accordance with security and confidentiality provisions.
The European Commission, on the other hand, should use the review of the EU’s anti-money laundering framework expected to take place this year as an opportunity to revisit and to amend the current beneficial ownership definition. It should also mandate member states to independently verify the information recorded in their beneficial ownership registers. This is crucial if beneficial ownership registers are to serve their purpose.
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