International Consortium of Investigative Journalists

British Virgin Islands firm kept doing business with shady characters even as regulators prodded it to obey anti-money-laundering laws

The tangled trail of the Magnitsky Affair, a case that’s strained U.S.-Russian relations and blocked American adoptions of Russian orphans, snakes through an offshore haven in the Caribbean.

The death of Moscow tax attorney Sergei Magnitsky sparked international outrage. It also fueled a push to unravel secret deals that had prompted him to claim that gangsters and government insiders had stolen $230 million from Russia’s treasury.

Magnitsky and other private attorneys investigating the affair on behalf of a major hedge fund followed a path from Russia to bank accounts in Switzerland and luxury properties in Dubai — ending up at a small firm based in the British Virgin Islands that specializes in setting up offshore companies for clients who want to remain in the shadows.

This is the story of behind-the-scenes players in the Magnitsky affair — and the tale of how an offshore go-between provided shelter to fraudsters, money launderers and other shady characters from Russia, Eastern Europe and the United States.

*****

In early 2008, lawyers working for a London-based hedge fund scrambled to prove that their client had been the victim of a corporate heist.

A gang of mobsters, the lawyers believed, had quietly transferred ownership of three Russian businesses belonging to the hedge fund to a secrecy-cloaked company in the Caribbean.

The offshore company had been established by Commonwealth Trust Limited, a firm in the British Virgin Islands that sets up overseas companies and trusts for clients around the world.

Lawyers for the hedge fund’s owner, Hermitage Capital Management Limited, contacted CTL and demanded answers.
Who, they wanted to know, was behind the mystery company?

But there was a problem: CTL had no idea.

As far as CTL knew, the owners were two unlikely characters from a small Russian city near the Black Sea — a vocational instructor and a 70-year-old pensioner, according to later court filings. Hermitage’s lawyers claimed that the two were fronts for underworld figures who wanted to keep their stake in the company hidden.

It’s a common scenario in the offshore world, which is served by a sprawling industry of accountants, lawyers, middleman and fixers who are paid to guard their clients’ secrets. Often, anti-corruption advocates say, they do this by closing their eyes to the identities and backgrounds of their customers.

Only later, Hermitage’s lawyers claimed, did the true purpose of the alleged corporate hijackings become clear. The companies had been used, they claimed, as part of a complicated scheme that made off with $230 million in bogus tax refunds from Russia’s treasury.

The alleged heist would eventually have other — wider — implications.

It caused a rift between the U.S. and Russia, spawning human-rights legislation in the U.S that in turn led the Kremlin to retaliate by banning Americans from adopting Russian orphans.

Until now, the role played by CTL in the Magnitsky Affair has gone untold.

Secret documents obtained by the International Consortium of Investigative Journalists show that CTL set up at least 23 of the offshore companies that Hermitage claims were used by the alleged fraudsters to move money and cover paper trails.

Internal CTL documents obtained by ICIJ cover the firm’s relationships not only with figures linked to the Magnitsky case but also with thousands of other clients. The secret files show the firm served as a middleman for an extensive list of shady operators — setting up offshore companies for securities swindlers, Ponzi schemers and individuals linked to political corruption, arms trafficking and organized crime.

There’s no evidence CTL engaged in fraud or other crimes. Records obtained by ICIJ indicate, however, that CTL often failed to check who its real clients were and what they were up to — a process that anti-money-laundering experts say is vital to preventing fraud and other illicit activities in the offshore world.

The documents show authorities in the British Virgin Islands failed for years to take aggressive action against CTL, even after they concluded the firm was violating the islands’ anti-money-laundering laws.

CTL co-founder Thomas Ward blames many of the firm’s problems on “the law of large numbers” — anytime you form thousands of companies for thousands of people, he said, a few of them may be up to no good.

In a written response to questions from ICIJ, Ward said CTL chose its clients carefully and that it had no more problems than other offshore services firms of similar size.

“I regard myself as an ethical person. I don’t think I intentionally did anything wrong,” Ward, who has worked as a consultant for the firm since selling it to new owners in 2009, said in a telephone interview. “I certainly didn’t aid and abet anybody doing anything illegal.”

Treasure Island

CTL’s home base is a chain of coral and volcanic islands reputed to have been the inspiration for Robert Louis Stevenson’s Treasure Island.

The British Virgin Islands — known in shorthand as the BVI — are home to roughly 28,000 souls and 500,000 active offshore companies. That represents about 40 percent of the offshore companies that exist around the globe, according to a 2011 World Bank report.

Secrecy is a selling point for outlanders who want to charter a company on the islands, which govern themselves as a British overseas territory.

BVI authorities demand little or no information about who’s behind offshore companies licensed within the territory. They rely instead on CTL and other local “registered agent” firms to vouch for these companies.

Tax Justice Network, an anti-corruption advocacy group, ranked the BVI 11th highest among the most secretive jurisdictions on its global Financial Secrecy Index.

The BVI became a player in the offshore world in 1984, when local authorities passed the International Business Companies Act. The number of companies birthed in the territory grew quickly, swelling in a decade from fewer than 1,000 a year to 36,000 a year.

By 1994, Euromoney magazine was hailing the BVI as “the world’s pre-eminent offshore corporate domicile” and the territorial government had hired a New York public relations firm to market the islands as an offshore haven.

For the founders of Commonwealth Trust Limited, it was a good year to get in on the action. Ward, an MBA and entrepreneur from Canada, laid the groundwork and brought in Scott Wilson, a Texan who’d been working as a radio engineer in the Caribbean, as computer guru and minority partner.

CTL set up offices in the BVI’s capital and largest settlement, Road Town, on the island of Tortola. As a registered agent, it helped start companies and trusts for clients and served as the official public face for many of the companies it helped charter, receiving summonses and other legal documents.

The firm expanded quickly, establishing subsidiaries in the Bahamas, Belize and other places. It showed special interest in Russia and Eastern Europe as markets for customers, with Ward writing one would-be client from the region, “To the best of my knowledge, we are the only BVI registered agent with a Russian speaker on staff.”

CTL did well enough in its wide-ranging ventures that Ward, who split time between the Caribbean and Canada, was able to buy a home in 1999 amid millionaires and billionaires in Toronto’s most exclusive neighborhood — a 20,000-square-foot Georgian mansion that Ward and his wife rented out as a filming location for the Lindsay Lohan hit movie Mean Girls.

Master clients

The secret documents show CTL attracted much of its business with the help of “master clients” — lawyers, accountants and other middlemen in Russia, Cyprus, and elsewhere who brought in the customers who wanted to set up companies. CTL’s standard procedure was to let these professionals be responsible for what’s known in the financial world as “due diligence,” checking clients’ identities and backgrounds.

In a 1999 fact sheet for master clients, the firm said “we will rely on your firm to do all necessary due diligence in order to adequately ‘know your client’ before providing that client with a BVI company. It will not be necessary for you to provide any of this information directly to Commonwealth Trust. (Obviously this will be preferable for your clients.)”

This system operated with few headaches until January 2002, when U.S. authorities accused one of CTL’s master clients of fraud.

Securities regulators charged that Merrill Scott & Associates Inc., a tax planning and investment firm based in Utah, was operating “as a giant Ponzi scheme, using newly invested money to pay returns to earlier investors.”
Merrill Scott had used CTL’s branch office in Mauritius, a tax haven off the east coast of Africa, to set up companies for American investors.

“Well, we actually likely knew this client better than most, I would say!” Ward wrote in an internal email. “We went to visit their premises (which were elaborate) and met many of their staff.”

Ward distanced his company from Merrill Scott’s conduct, however, and minimized the gravity of the frauds. “If anyone is guilty” at Merrill, he said, “it is only one or two top people.”

A judge eventually ordered three Merrill Scott executives to pay a total of nearly $17 million to settle fraud claims against them.

In his written response to questions from ICIJ, Ward said CTL fully vetted Merrill Scott before starting a working relationship, but ended up being “among the people fooled” by the firm. He said due diligence can’t always protect registered agents such as CTL from “being duped by dishonest clients” or signing on “someone who appears, to all historical examination, to be honest” but “later turns to something dishonest.”

More questions about how CTL screened its clients and business partners came in March 2003, when the main regulator of the BVI’s offshore industry, the local Financial Services Commission, conducted an inspection of the firm’s files. The commission determined CTL had breached the BVI’s anti-money laundering laws by failing to verify and record the identity of its clients, court records show.

It ordered CTL to update its due diligence on its customers, but took no other action, putting the case on hold for nearly three years. The company provided regular updates on its progress in complying with the order, even as it continued taking on new clients from Russia, Eastern Europe and other places known for being sources of shadowy money.

In late 2005, CTL’s general manager, Sandy Holburn, wrote the firm’s founders, Ward and Wilson, raising a warning about the number of clients the firm was attracting from former Soviet bloc countries: “There's obviously a lot going on that we don’t really know or understand concerning the users of the companies we form for these clients.”

Ward replied that there wasn’t much that CTL could do about that.

“You are correct of course that the larger we grow the more clients we have and the more clients we have the more likely one of the clients is to cause some difficulty,” Ward said, “but there is little we can do about that unless we wish to stop growing.”

Ward said last month that he doesn’t recall Holburn’s warning or his own reply.

When BVI regulators returned for another inspection in early 2006, they concluded that CTL had done little to improve its client-screening procedures. The regulators also believed, a judge later wrote, that the company had provided “false and misleading” information in its progress reports.

This didn’t prompt immediate action. The Financial Services Commission and company had what the judge later described as an “ongoing dialogue” over another 12 months, while the commission wrote its report and figured out what to do about CTL.

The regulators’ actions came during a time that influential organizations such as the International Monetary Fund were putting pressure on tax havens to improve oversight of their offshore industries.

CTL co-founder Scott Wilson said he and others at the firm believed their procedures were in line with BVI law and with what other firms on the islands were doing. But he said the regulators “may have chosen to make an example out of CTL” as part of a larger push to rein in the industry.

Most Wanted

Problems with the regulators didn’t do much to slow the firm’s growth. One internal company document shows the number of offshore companies it formed in the BVI more than tripled in seven years, going from 2,100 new companies established during 2000 to 6,600 established during 2007.

The clients who signed on with CTL during this period included Dmytro Firtash, a billionaire businessman from Ukraine with a suspect back story. Media reports going back to at least 2003 had raised questions about his links to Semion Mogilevich, a reputed Russian mob boss who’d been indicted in the U.S. in a $150 million investment scam, a case that would land Mogilevich on the F.B.I.’s “Ten Most Wanted” list.

U.S. State Department cables have reported that Firtash acknowledged to a top American diplomat “that he needed, and received, permission from Mogilevich when he established various businesses, but he denied any close relationship to him.”

Firtash set up an offshore company through CTL, Group DF Limited, in 2006, months after he’d publicly acknowledged that he owned a big stake in RosUkrEnergo, a partnership with Gazprom, the Russian natural gas giant. Group DF Limited became the holding company for Firtash’s vast interests in energy, chemicals and real estate.

Firtash could not be reached for comment.

Internal records show CTL also set up 31 companies in 2006 and 2007 for an individual later named in U.K. court claims as a front man for Mukhtar Ablyazov, a Kazakh banking tycoon who has been accused of stealing $5 billion from one of the former Russian republic’s largest banks.

Twenty-five of the 31 companies appear on the list of entities that BTA Bank alleges Ablyazov used to cover his tracks as he looted BTA between 2005 and 2009.

Lawyers for Ablyazov — who maintains that the allegations are the work of political enemies in Kazakhstan — did not reply to requests for comment.

When BVI regulators returned to CTL for a follow-up inspection in July 2007, CTL officials acknowledged they’d done no due diligence since early 2006 on files involving individual clients and that they’d completed due diligence on fewer than half their master clients, according to later testimony by a commission official.

It was not until February 2008 — nearly five years after the commission first found CTL in violation of anti-money-laundering rules — that the regulators took action that threatened to put the company out of business. They banned CTL from taking on new clients until it complied with the regulations.

CTL officials were stunned. Without the ability to sign new clients, Ward wrote in one document, the firm would be left with “no future.”

“The company will be destroyed,” Ward said.

Magnitsky Affair

In April 2008, more trouble arrived in the form of a letter from lawyers in London.

Hermitage Capital Management, which ran a hedge fund focused on Russia, claimed thieves had “misappropriated” ownership of three Hermitage subsidiaries and had used them to successfully apply for $230 million in bogus tax refunds from the Russian government.

Hermitage claimed the alleged thieves had tried to cover their tracks by trumping up criminal charges against Hermitage executives and by reassigning control of the three companies to an entity called Boily Systems — a BVI company CTL set up in 2007 at the request of one of its top master clients in Russia, G.S.L. Law & Consulting.

Hermitage’s investigation was led by a Moscow-based lawyer, Sergei Magnitsky.

In June and October 2008, he gave to testimony to Russian authorities naming government officials and underworld figures that, he claimed, were behind the tax fraud.

A whistleblower leaked bank records to Hermitage showing what appeared to be an impressive gain in wealth for a Russian tax official — Olga Stepanova — who had approved $155 million of the $230 million in refunds.

Her husband, Vladlen Stepanov, used an offshore company set up for him by CTL, Aikate Properties, to open bank accounts in Switzerland, according to a petition Hermitage later submitted to Swiss authorities. Millions of dollars in deposits later turned up in Aikate Properties’ accounts in Credit Suisse and evidence indicated that the husband and wife were laundering cash via real estate deals in Dubai and Montenegro, the petition claims.

In all, Hermitage claims, the tax official and her husband acquired $38 million in cash and assets, even though their combined salaries were less than $50,000 a year.

CTL smoothed the way for the couple by signing a letter in June 2008 —addressed “To whom it may concern” — that affirmed that Aikate Properties “isn’t involved in any money laundering activities.”

Stepanov has said their wealth came from legitimate businesses and the couple have not been charged with a crime in Russia or elsewhere. They could not be reached for comment by ICIJ.

Hermitage officials eventually compiled a list of nearly 40 companies that they claim were used by a criminal gang and their accomplices in government. Internal records obtained by ICIJ show that at least 23 of these companies had been set up through CTL.

Magnitsky, Hermitage’s lawyer in Russia, wasn’t around for many of these discoveries. In November 2008, Russian authorities arrested Magnitsky and accused him of committing tax fraud — part of an effort, Hermitage officials claimed, to silence him and cover up the alleged criminal scheme.

CTL co-founder Ward said his firm “had no role in the ‘Magnitsky affair’ ” other than performing routine duties as a registered agent.

“Any other Registered Agent could equally well have been in the same role as CTL and would have contributed no more or no less to the ‘affair,’ ” he wrote.

Ponzi

As the Magnitsky Affair heated up, other scandals involving CTL’s clients were coming to light.

A Texas A&M University finance professor used two companies set up through CTL to carry out a Ponzi scheme that caused investors tens of millions in losses. A Ponzi scheme run by a Connecticut hedge fund manager used four companies established by CTL as part of a scam that, securities regulators alleged, bilked investors out of hundreds of millions.

CTL also set up a BVI company implicated in a smaller Ponzi scheme that used the Internet to target U.S. investors of modest means, Wisconsin securities regulators claimed. The company, Delten Holdings, Inc., was the domain owner of minvestment.com, which posed as an online investment site that could take initial outlays as small as $15 from investors, according to the regulators.

Who was behind Delten is murky. CTL’s records show Delten’s only director was an individual based in Moscow and its only shareholder was a proxy based in the Seychelles, a tax haven in the Indian Ocean.

Eleven months after setting up Delten, CTL filed a “suspicious activity report” informing BVI authorities that the company might be running a “pyramid scheme.” It also resigned as Delten’s registered agent.

Authorities didn’t accuse CTL of wrongdoing in the case. But that didn’t prevent worried investors from contacting the firm and pleading for help.

A woman in Brooklyn, N.Y., wrote to say she’d made three $1,000 investments with minvestment.com — one for herself, one for her family and one for her church. Her house and her church needed work, she said, and she’d hoped the huge returns promised by the investment plan would help.

Now that she realized all the money was gone, she said, she was too ashamed to tell her pastor she’d gotten the congregation ensnared in a scam.

“What I don't understand,” she wrote, “is how could people do things like that.”

She was praying, she said, that CTL would find some way to help her.

In internal emails, CTL officials agreed that BVI’s secrecy laws meant they could release little about Delten.

Survival plan

CTL’s staff grew worried in 2008 and 2009 because, along with being blocked by regulators from taking on new business, the firm was losing existing clients. The clients were moving their companies to other registered agents or other jurisdictions.

Many were frustrated with the “more onerous regulatory environment” and were refusing to provide the identifying data that BVI regulators were pushing CTL to gather, internal documents said.

If CTL wanted to ensure its survival, it needed a plan.

Rescue came from a Dutch company, Equity Trust.

CTL and Equity Trust made a proposal to BVI regulators: If Equity Trust bought CTL, would the regulators consider withdrawing the order banning CTL from taking on new clients?

The plan worked.

In June 2009, the BVI’s Financial Services Commission approved Equity Trust’s takeover of CTL and lifted the ban on signing new clients.

Ward stayed on with the firm, officially listed as a consultant while serving as the firm’s director of marketing and sales.

In September 2009, he headed to Moscow to meet with old clients and recruit new ones. One of the master clients he called on was G.S.L. Law & Consulting — the Moscow-based firm that had worked with CTL to set up Boily Systems.

Despite the fallout from the Magnitsky case, Ward noted in his trip report that the two firms still maintained an “excellent rapport” and G.S.L. continued to be CTL’s largest client in Russia.

While Ward was visiting G.S.L. and other Russian business partners, Sergei Magnitsky was locked in a prison built in the time of the czars. He grew weak from untreated illnesses.

He died Nov. 16, 2009.

A Russian investigative commission concluded there had been a “criminal failure” by prison authorities to provide him medical aid.

His death drew condemnation inside and outside Russia. In December 2012, U.S. President Barack Obama signed the Sergei Magnitsky Rule of Law Accountability Act. It bans Russian human-rights abusers from entering the United States or using U.S. banks. In retaliation, Russian President Vladimir Putin signed a law barring Americans from adopting Russian babies.

Russian leaders have given little credence to claims of government corruption and human-rights abuses in the Magnitsky Affair. Prime Minister Dmitry Medvedev told CNN in January that Magnitsky was no corruption fighter, but merely a “common corporate accountant or lawyer who served his boss” in committing tax fraud.

Authorities in Moscow are now conducting a trial on the criminal charges against Magnitsky, in what is likely the first time in Russian history that a defendant had been tried posthumously. The defendant’s cage in the courtroom has stood empty throughout the proceedings.

‘No longer authorized’

Last year at an offshore industry conference in Miami, Magnitsky’s former law partner, Jamison Firestone, singled out CTL as an example of the compliance failures that allowed the Magnitsky Affair to unfold.

On a large video screen, Firestone displayed CTL’s June 2008 letter that affirmed Vladlen Stepanov and Aikate Properties weren’t involved in money laundering.

The evidence, Firestone said, indicated that the Stepanov and his wife, the Russian tax official, had indeed been involved in money laundering.

“Somewhere out there in the BVI there’s a regulatory body, and I wish they’d have a little chat with these people for writing stuff like this,” he said.

During the question period after Firestone was done, Brodrick Penn, then the director of the securities division of the BVI’s Financial Services Commission, spoke in defense of his agency.

“I’m happy to say that Commonwealth [CTL] is no longer an … operational entity in the Virgin Islands,” Penn said. “This particular firm had systemic money laundering issues within their organization,” he said, but there was “punishment” as a result. CTL was “no longer authorized” to do business in the BVI.

“Glad to hear that you caught that one,” Firestone said as the meeting hall welled with applause for BVI regulators’ crackdown. “Very glad.”

There was a problem, though, with the narrative of a bad actor put out of business.

CTL still operates — under the change of ownership — in a new set of offices in the BVI’s capital, Road Town.

It is still an approved agent for new clients in BVI. Ward said he continues to work on a part-time basis, helping CTL manage client relationships.

The Financial Services Commission declined to answer questions about CTL’s status or its investigation of the firm. In a written statement, agency officials said they maintain “world-class regulatory and registration regimes and we demand high standards of integrity and sound financial management of ourselves and from all of our licensees.”

Equity Trust, which is now owned by Amsterdam-headquartered TMF Group, said in its own written statement that it has worked with the commission since 2009 to reshape CTL’s operations. The company said it has replaced CTL’s senior management and “continues to make significant progress in making CTL’s portfolio fully compliant” with the BVI’s anti-money laundering rules.

Amid this clean up, Equity Trust said, roughly half of CTL’s client base has left the firm.

Michael Hudson is a senior editor with the International Consortium of Investigative Journalists. Stefan Candea is a free-lance journalist and co-founder of the Romanian Center for Investigative Journalism. Marina Walker Guevara is the deputy director of ICIJ.

Frédéric Zalac and Alex Shprintsen of the Canadian Broadcasting Corporation contributed reporting to this story.

The International Consortium of Investigative Journalists is an independent network of reporters in more than 60 countries who collaborate on cross-border investigations. It is a project of the Washington-based Center for Public Integrity.

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