MP3: Side 1 | Side 2
The title of the program refers to Lucy’s In These Times article about Sodexo, one of the largest food facility contractors in the world. Lucy’s research begins with analysis of Sodexo’s cost to school lunch programs, made much more expensive by Sodexo’s kickback or “rebate” structure.
When “friendly persuasion” fails, Sodexo has allegedly resorted to professional arm-twisting, including (allegedly) diminishing the reputations of dissidents. It is fortunate that the government, many of whose agencies have contracted with Sodexo, is aware of the problem. It remains to be seen if Uncle Sam is willing to pursue the issue.
Returning to a primary focus of Ms. Komisar’s work over the years–offshore financial havens–Lucy details the operations of Swiss-based Julius Baer Investment Bank, the author of an intricate arrangement whereby much of its profit wound up in the Cayman Islands (one of the primary financial havens). Worth noting is the fact that these types of gambits typify the “now you see it, now you don’t” finance that precipitated the global collapse.
Revisiting another of the subjects Lucy’s covered, we note that the U.S. taxpayers now own (in effect) AIG. This is a situation that should result in an investigation of the massive “offshoring” gambits through which AIG was able to disguise the precarious nature lf its operations. As with Sodexo, it remains to be seen if Uncle Sam decides to investigate “offshore” in its queries concerning AIG.
The prospects for a serious inquiry into, and bringing to heel of, AIG appear to be clouded by the track record of Timothy Geithner. While serving with the Federal Reserve Bank of New York, Geithner remained apparently indifferent to a “naked” short-selling scheme involving U.S. Treasury bonds. This gambit cost the United States a lot of money.
Concluding the interview on a highly ironic note, Lucy chronicles the fact that the Vatican publicly denounced “offshore.” This from an institution deeply involved with “offshore” financial machinations, many of which ultimately resulted in loss of life. (Pope Benedict is shown as a Hitler Youth and a young priest in the accompanying pictures.)
Program Highlights Include: Lucy’s review of terms and concepts from the world of finance such short-selling, naked short-selling, hedge funds, etc.; review of the Vatican banking scandals; review of AIG’s offshore gambits.
1. The title of the program refers to Lucy’s In These Times article about Sodexo. Lucy’s research begins with analysis of Sodexo’s cost to school lunch programs, made much more expensive by Sodexo’s kickback or “rebate” structure. In addition to driving small vendors and competitors out of business, Sodexo’s operations add to the cost of providing cafeteria food and diminish the quality.
At the end of the 2006 school year, children’s nutrition advocate Dorothy Brayley had a disturbing conversation with a local dairy representative. He had come to her office to discuss participation in the summer trade show of food providers she runs as director of Kids First Rhode Island.
At the time, the state’s schools were buying 100,000 containers of milk each week. The salesman for Garelick Farms, New England’s largest dairy, told Brayley that Sodexo-a food and facility management corporation that managed most of the state’s school lunch programs-was paying Garelick more than competitors in order to get a bigger rebate.
State Education Department records, which are required to chart milk prices, showed that Sodexo passed on the price hike, billing schools 24 cents to 27 cents a half-pint, while milk was available from Aramark, a competing company, for 18 cents to 21 cents a half-pint – a loss to schools and families of more than $100,000 a year.
That’s just a taste of the hundreds of millions of dollars of “rebates”-or kickbacks from suppliers-that Sodexo, a $20 billion-a-year global leader in the food and facility management industry, has taken while operating cafeterias and other facilities for schools, hospitals, universities, government agencies, the military and private companies across the country, according to evidence provided by whistleblowers and internal company documents.
In some cases, such rebates violate the contracting policies of federal agencies. In others, undisclosed rebates may constitute fraud.
Sodexo’s deputy counsel Tom Morse declined to reveal the size of Sodexo’s rebate from Garelick Farms, and he rejected the notion that rebates are abusive. Dean Foods, which owns the dairy, declined to comment. . . .
2. Lucy details the precise mechanisms involved in the Sodexo scam:
Sodexo, founded in France in the ’60s to do maritime catering, now has more than 30,500 operating sites and 355,000 employees in 80 countries. It reported revenues last year of $20.4 billion, and profits of more than $1 billion. It ranks second in food services worldwide, after U.K.-based Compass Group.
The rebate system, endemic to the industry, works like this: A food management company like Sodexo signs contracts to run a client’s cafeteria. The company buys supplies from vendors such as Coke, Kellogg’s or Tyson. Then, chosen vendors send the management company rebates based on a percentage of sales.
Tom MacDermott, a New Hampshire industry consultant who negotiates for clients with Sodexo and others, says kickbacks date back half a century.
“In the ’50s, it was cash in an envelope slipped to the chef,” says MacDermott. “As companies grew, they were getting back 5 percent from the produce vendor, 2 percent from the meat guy, 2 or 3 percent from dry goods and dairy.”
In the United States, MacDermott estimates that management companies such as Sodexo, Compass and Aramark provide meals, catering and vending machines to virtually every federal agency, 95 percent of corporations with food service, 90 percent of universities, 40 percent of healthcare facilities, and 30 percent of schools. If you’ve eaten at a public cafeteria, you’ve probably eaten food sourced by one of these companies.
As major corporations and government institutions increasingly outsourced purchasing, kickbacks to megacorporations like Sodexo became rife – making up at least 10 percent of sales.
Contracts are typically cost-plus, meaning clients pay the cost set by the supplier, plus a percentage of that as a fee set by the food-service firm. There are generally no cost caps, so rebates-which are not deducted from what the food-service company charges clients-mean higher meal prices. They also limit food choice and quality: food-service companies buy products from vendors that pay bigger rebates rather than those that offer cheaper, locally grown, or higher quality food.
Several managers at small companies described the impact of Sodexo’s demand for rebates, but declined to speak for attribution out of fear that Sodexo would lock them out of future buys.
A manager for a small New England produce supplier describes the system this way: “Say you’re selling a case of apples at $20 and you have to pay 15 percent sheltered income (or rebate) to Sodexo. So now you have a $23 case that should be going at $20,” he says. The price increase pushes the item off the menu. “Now the food-service directors in the schools will use a frozen item to substitute the fresh produce.”
According to the manager, “They (Sodexo) squeezed hundreds of thousands of dollars away from us.” But he adds that his company had no choice but to pay Sodexo rebates: “They own a lion’s share of the market place. If we were to give up the business, someone would be dying to jump in and take it.”
In another case, an East Coast ice cream manufacturer says he stopped working with Sodexo because the 10 percent kickbacks the company demanded cut profits so much that it wasn’t worth the business.
“The school business in winter keeps us going,” he says. “Initially any school in the system that wanted ice cream products would just call us up, so we could supply them. Then Sodexo comes in. You want to deal with Sodexo facilities, you have to sign a contract. (And Sodexo) off the record says you have to send us a rebate check.
“They try to intimidate you,” he adds. “They have such a grasp on the market. They force you to work on low margin, 20 percent. If you give them a 10 percent kickback, you’re pretty much working for nothing. We lost about $30-to-$40,000 a year, which is a lot for a small businessman.”
He continues, “We had been in business since 1930, so we were entrenched in most of the schools. The PTAs would run it. They used the money to buy school equipment. When Sodexo got involved, there was no money for the PTAs, the kids, they took it all.”
3. Those who do not willingly go along with Sodexo are ultimately coerced.
. . . Jay Carciero, 35, a stocky, intense man, lives with his wife and three children in a small American-flag-flying blue clapboard home in Woburn, Mass. His soft-spoken brother John, 37, divorced with one child, lives a few miles away in Reading, in a white clapboard A-frame.
The brothers worked for Sodexo for years: Jay as Sodexo’s manager of food and facilities for the Lahey Clinic hospital, Peabody, Mass., and John at Massachusetts’ Melrose-Wakefield Hospital, and then at Lowell General Hospital.
In 2005, they sounded alarms about Sodexo demanding kickbacks. Both were eventually fired.
In April 2005, John filed a complaint with a business abuse hotline Sodexo set up to comply with the Sarbanes-Oxley Act. He said the company was using “strong-arm techniques” to get rebates from vendors.
Sodexo attorney Tom Morse claims that John Carciero is a disgruntled employee who filed his complaint only after Sodexo began an investigation of Jay for expense-account irregularities (about which Morse declined to supply details).
The explanation lacks credibility because, months later, in January 2006, Jay was proposed by a supervisor for manager of the year. More importantly, the Carcieros supplied In These Times with stacks of internal Sodexo documents that bolster their claims.
According to the Sodexo contract, the company’s rebate system at Lahey Clinic worked like this: Sodexo got a management fee from the clinic that amounted to 0.9 percent of invoices from regional and national suppliers. The contract with Lahey limited purchases to Sodexo-approved vendors, which in practice, eliminated most local merchants, so Sodexo’s fees were effectively calculated to include all rebates. The rebates were not reported to the hospital.
“We weren’t aware of Sodexo getting rebates that just went to Sodexo when they should have been coming in part to us,” says Phillips Axten, the hospital’s attorney.
Jay Carciero claims that the hospital should have been aware; he said he tried to show evidence of rebates to Lahey CEO Dr. David Barrett, but he “did not want to look at documents I was giving to him.”
Sodexo, as the hospital’s agent, had a fiduciary duty to get the best product at the best price. Instead, Jay Carciero says the company directed managers to buy food that supplied the highest rebates. He says he felt “betrayed by a company” and “felt anger at their ripping off the most vulnerable citizens of our society — children, the elderly, the sick and dying.”
In These Times sent Sodexo counsel Morse copies of key internal Sodexo e-mails and documents that back up the Carcieros’ charges, asking Morse if any appeared not genuine. He raised no challenge. In the documents, Sodexo uses a euphemism for rebates, calling them “volume discount allowances” (VDAs). It asks for bills “off invoice,” meaning one invoice it can give clients and keep another for itself—a system that can disguise rebates. “Compliant” refers to vendors who supply rebates.
Documents show that demanding rebates is at the heart of Sodexo’s business plan. Tony Alibrio, then Sodexo USA Healthcare Services president, wrote in a July 21, 2000 memo addressed to “Health Care Food Service Accounts” that “manufacturer and distributor rebates support our entire Purchasing & Procurement Department and network.”
Managers were told to avoid cheaper products in favor of those that produced rebates. Director of Procurement Bob Sulick, in a Sodexho’s Bulletin dated March 22, 2004, wrote, “A manager told me today how he saves money by buying cans of tomato products from his fruit and produce vendor. Please don’t let this happen. People should buy the compliant products through their prime vendors. That is where the highest return is.” (Sodexo dropped the “h” from its name last year.)
Another document shows top company leadership enforcing the rule that only vendors offering rebates should get Sodexo business. According to the document, Richard Macedonia, then CEO of Sodexo USA, told employees at a Feb. 19, 2004 meeting at City of Hope National Medical Center in Los Angeles, “We want to have a compliant program, because it is better for the company as a whole. So, we intend to make it harder to buy outside of the program unless our client wants a specific brand.”
In addition to pressure from the top, the company set up bureaucratic roadblocks to ordering from non-preferred vendors, according to Jay Carciero. “When you go into a unit, you are given a computer,” he says. “When you need to order food or supplies, you order it through a portal controlled by the company. If you want to use the farm down the street selling green beans, you couldn’t do it without special approvals and lots of headaches.”
According to another document, Sodexo USA President Michel Landel was asked at a 2004 managers’ meeting in Vermont, “Will units (clients) ever see rebate money for being product compliant?” Landel responded instead by saying, “We have set up goals for both product and vendor compliance for each of our accounts and our success relies heavily on this.”
Sodexo attorney Morse argues that working only with “compliant” vendors is necessary to assure health and safety and to guarantee supplies in case of shortages.
“When we buy from a vendor, we make a commitment to that vendor that they will be a preferred vendor or we will buy a specific quantity from them or will buy over a period of time,” he says. He adds that “the first thing we vet our vendors for is safety” against food-borne illnesses and the second consideration is “if there’s a food shortage, we want to be at top of their list to make sure we get it.”
However, Morse could offer no evidence that either problem had occurred. . . .
4. The scale of Sodexo’s government contracting (and consequent kickbacks) is considerable:
Sodexo’s U.S. government procurement program amounts to more than hundreds of millions a year. A 2005 Sodexo spreadsheet tracked rebate increases from sales to 13 regional Federal Reserve banks, the FBI Academy, the IRS, the Treasury Department, the Library of Congress, the Center for Medicare/Medicaid Services, NASA and the General Services Administration (GSA), which handles contracts for itself and for most other federal agencies. The spreadsheet showed rebate points from sales to CBS, CNN and CNBC.
The GSA declined to detail how its contracts address rebates. But little evidence exists that the agency is watch-dogging the problem. In May 2008, an investigation outsourced to the Post Office Inspector General concluded that the GSA’s “Federal Acquisition Service was dysfunctional…that GSA leadership appeared to be signaling its employees to favor the commercial interests of certain large vendors.”
When asked about rebates received from government agencies, Morse says they would be passed on to the federal government, but he did not provide evidence that this had occurred.
A 1997 directive from the federal Office of Management and Budget (OMB), Circular A-87, requires that rebates to contractors that reduce costs have to be credited to federal awards. However, Washington has been lax in enforcing it.
The Bush administration’s OMB Deputy Comptroller Daniel Werfel told In These Times by e-mail, “We are not aware of any other agencies who took the step of clarifying their program rules with respect to rebates, as USDA did.” Nevertheless, he added, “At this time, we do not believe it necessary that all agencies initiate a rulemaking similar to the USDA rule.”
The Defense Department may have issued new, more demanding contracting guidelines, but individual services operate under their own rules, which have allowed rebates, sometimes by ignoring them. The Marine Corps has a fixed price-per-meal contract with Sodexo, so rebates are not at issue. The Air Force says it has no policy on rebates, while the Navy says its policy is under review. The Army declined to respond to queries.
The USDA 2002 schools audit shows that even when procurement documents required return of rebates earned through purchases, food-service management companies disregarded the rule and routinely kept them.
Morse says rebates were passed on to schools and cited the example of Rhode Island. However, business managers from the Newport and Coventry school districts explain that while Sodexo said it used rebates to cancel out fees the schools might have to pay, accounting was inadequate.
“It’s difficult to police,” says Anthony Ferrucci, business manager of the Coventry District. “We don’t get invoices per item.”
East Greenwich School District business manager Marianne Crawford says she, too, was aware of rebates but never got dollar figures.
A Sodexo representative told Karen Works, who manages food-service contracts for the Kansas Education Department, that accounting difficulties made it too hard for the company to return rebates to Kansas schools.
“His example was if we buy $1 million worth of chicken from Tyson, we get $10,000 back, spread out among all the Sodexo contracts,” she says. “How will they identify it?”
However, as the Sodexo spreadsheet shows, and as Morse acknowledges, Sodexo has a sophisticated computer system for tracking rebates. It knows exactly what percentage of Tyson’s rebate to Sodexo pertains to each client.
5. As to whether Sodexo’s sheer size and commercial volume helps it escape judicial retribution for its machinations remains to be seen. Is is “too big to fail?”
. . . The rebate system raises issues that could end up in court. For example, Sodexo serves some 1,800 hospitals, many of which fill out cost reports for federal Medicare and Medicaid reimbursements.
“Their cost is what Sodexo charges them,” Morse says. “So they can fill out their reports based on the amounts Sodexo charges them. It’s disclosed to the clients that we get allowances. There really isn’t an issue here.”
However, Jim Sheehan, New York State’s Medicaid Inspector General, points out that this may violate the Medicare-Medicaid Anti-Kickback Act that mandates, as Sheehan explains, that no vendor can give “anything of value in whole or part in cash or kind in return for referral of service paid for by government.” A company like Sodexo “can get a discount,” says Sheehan, “so long as it’s accurately reported on the cost report.” But “a secret rebate would not meet that standard.”
Robert Vogel, a Washington attorney who represents whistleblowers, says that if a contract calls for reimbursement of actual costs and the company is hiding a rebate, then that could constitute fraud.
‘If the purchasing agent’—for example, the Sodexo staffer in a hospital or school—’is getting rebates from the seller of the product and not disclosing the rebates, it may be affecting the purchasing agent’s decision on what product to buy,’ Vogel says. ‘That would be a kickback.’
Law enforcers, take note.
6. Dealing with a primary focus of Ms. Komisar’s work over the years–offshore financial havens–Lucy details the operations of Julius Baer Investment Bank. The complex machinations of this institution and its subsidiary institutions are not easy to follow–they were meant to be opaque! Worth noting also is the fact that these types of gambits typify the “now you see it, now you don’t” finance that precipitated the global collapse.
President Barack Obama said he would crack down on firms that use offshore centres to evade taxes. He could begin with a New York subsidiary of one of the world’s largest private banks, which used a Cayman Islands company to shift its profits.
Why would a New York fund manager run operations through an office in the Caymans? “This type of structure is for optimising taxes,” explained Max Obrist, a Cayman Islands official of the global Julius Baer Group (Zurich).
He told IPS that “generating” the income where a company was actually based, “you would pay much more taxes”. Obrist was describing a company shifting claimed earnings to tax havens to evade home taxes. He allegedly helped Julius Baer Investment Management (JBIM) New York do just that.
Obrist is a director of Baer Select Management (BSM), a Cayman Islands company. According to a whistleblower who used to work with him in the Caymans, BSM is a fake firm created by Julius Baer to sign agreements with JBIM and other subsidiaries so they could evade taxes.
The whistleblower, Rudolf Elmer, 53, a German, was chief operating officer of Julius Baer Bank & Trust Company (JBBT), Caymans, at 212,000 dollars a year and served on the BSM board from 1999 to November 2002. JBIM paid fees to BSM to “manage” its investments. Elmer told IPS that JBIM moved to BSM profits it should have reported to the U.S. Internal Revenue Service.
JBIM is now called Artio Global Investors. It manages 72 billion dollars in assets. It has some 900 institutional clients, including corporations, pension funds, endowments and foundations and major financial institutions as well as more than 700,000 mutual fund shareholders.
Its chief executive and chief investment officer Richard Pell and head of international equity Rudolph-Riad Younes were paid 120 million dollars during the first nine months of 2007, leaving the company with income of 48.6 million dollars.
Artio is a subsidiary of Julius Baer Group, Switzerland’s largest private banking group with over 300 billion dollars in assets invested on behalf of institutions and very wealthy individuals. Julius Baer’s reported profits in 2007 were more than 1.1 billion dollars. It has 30 offices in world financial centres, from New York and London to Dubai and Tokyo. BSM is a Julius Baer subsidiary.
Elmer said, “There was a strategic plan adopted in 1996 to utilise Baer Select Management, JBIM New York and JBIM London to benefit from the offshore system.” He said that JBIM assigned management functions to BSM in order to award it a performance fee. He provided backup documentation to IPS, including financial spreadsheets.
He said that Obrist in the name of BSM ratified a few decisions, but really worked for JBBT. He said that control was exercised and decisions taken by JBIM New York or Julius Baer Investment Funds Services Ltd, Zürich, which were part of Bank Julius Baer & Co, Zürich.
According to Elmer, JBIM made a proposal to Julius Baer Investment Management, Zürich, to launch a fund, and Zürich approved. JBIM did the paperwork and other organisational tasks with the help of JB Zürich and Caymans lawyers.
The offering memorandum said that Baer Select Management was appointed investment manager, Elmer said, and BSM appointed JBIM investment advisor.
JBIM was generally listed as a fund “advisor”, though some public documents said that JBIM managed funds. Elizabeth Nesvold, founder of the New York investment-banking boutique Silver Lane Advisors LLC, noted that though investment managers make most of their money from performance fees, most of the JBIM’s revenue was claimed from advisory fees.
A call to the Grand Caymans phone number for BSM was picked up by a receptionist for Julius Baer Bank and Trust Co Ltd (JBBT). “Is this the number for Baer Select Management?” she was asked. “Yes,” she replied, and passed the call to Max Obrist. He identified himself as BSM’s director. He had a few other jobs. The Jan. 13, 2000 minutes of the JBBT management committee said, “Direct Money Market dealing has started. Max Obrist has assumed responsibility for this activity.”
He was also listed as a director of Directorate Inc., British Virgin Islands, the corporate director of some Julius Baer funds.
Describing BSM’s tasks, Obrist explained, “We have to follow stocks, monitor their investment policies, we monitor the risk reports we receive from the investment advisor and check if there are performance fee calculations involved if they are executed properly, all monitoring duties. We are in contact with the external auditors and the regulatory authorities and Cayman Islands monitoring authority.”
He said BSM’s fee was “a percentage of profits, and it depends on what type of duties we have to do here from Cayman.”
Why was BSM needed? He replied, “That’s an interesting question. I don’t always know when they start something. They decided on a much higher level. I wasn’t involved. We were told: ‘You act as investment manager for these new funds’.” But he didn’t manage, he “monitored”.
Fees paid to BSM resulted in lower company profits and taxes for JBIM. Fund managers generally take profits of 1 or 2 percent of assets plus 10 to 20 percent of investment gains. As the funds had high values, that involved substantial amounts. According to Elmer, BSM, acting through a board whose members worked for JBBT, transferred profits via several offshore companies to Julius Baer Holding Ltd, Zürich.
Obrist denied that BSM is a shell company. He said, “We are physically here in the Cayman Islands, not just a post office box like some companies trying to save taxes without doing anything physically.”
He insisted, “BSM is to give service from an offshore place and at the same time we can within Julius Baer optimise taxes, yes. But we are physically here. We do our job as investment manager. If Baer Select would be here just as a post office box company and generate the millions in Cayman as income instead of in the U.S. or the U.K. or Switzerland, then that would not be a very smart thing.”
Obrist said BSM stopped working for JBIM New York four or five years ago after it closed some hedge funds. However, JBIM/Artio would still be potentially liable for unpaid taxes, as the U.S. has no statute of limitations for tax fraud.
Artio CEO Richard Pell did not reply to numerous phone messages and emails describing this story and requesting an interview. Martin Somogyi, spokesperson for Julius Baer, Zurich, emailed that the company always adhered to applicable regulations and was regularly audited, but that it would not agree to an interview. (Its global auditor is KPMG.)
Julius Baer Americas Inc. (now Artio Global Investors) which owns JBIM/Artio, in February 2008 filed with the SEC that it would go public with an initial public offering (IPO) to sell up to 1 billion dollars of common stock on the New York Stock Exchange. The offering would be handled by Goldman, Sachs and Merrill Lynch. The IPO has been postponed.
7. Returning to a subject Lucy dealt with in FTR #’s 531and 650, Lucy sets forth AIG’s offshore problems and their impact on the U.S. taxpayer, now a major shareholder in AIG. It remains to be seen if the fact that AIG has now become “a ward of the state” will impact its seeming immunity to real investigation. Mr. Emory is not optimistic.
The U.S. will invest 40 billion dollars in American International Group (AIG), and will provide credit lines that could bring federal funding up to 144 billion dollars. It’s the largest subsidy that a U.S. corporation has ever received. In exchange, the U.S. gets nearly 80 percent of AIG stock.
This puts the U.S. in a unique position to investigate the internal operations of a giant corporation with a reputation for using the offshore system for tax evasion.
What accountants could learn would help U.S. President-elect Barack Obama – who has denounced offshore tax evasion – stop scams run by AIG and draft laws to prevent other insurance companies from doing the same.
U.S. authorities could begin their investigations with a look into a very curious practice that was revealed 15 years ago in a case that was never exposed by the mainstream press and which insurance insiders say is endemic.
In 1993, Terry Mills, who worked for a large insurance agency in Wilmington, Delaware, was tasked to get to the bottom of a messy insurance problem. The NVF Corporation, a Delaware holding company which owned a vulcanised fibre factory, was being reorganised after a federal court order stripped control of the company from its owner Victor Posner, a notorious crook.
Posner was a U.S. “corporate raider,” famed for engineering hostile takeovers of companies, looting them and firing workers.
He had been charged by the U.S. Securities and Exchange Commission (SEC) in 1988 for participating in a fraudulent takeover scheme concocted with Wall Street crooks Michael Milken and Ivan Boesky. The SEC banned him from serving as officer or director of any publicly-held company.
It wasn’t the first time he’d broken the law. In 1977, the SEC had filed a complaint against Posner and his companies for overstating earnings and treating assets of public corporations as private property, charging the companies for houses, servants, vacations and even groceries.
In 1987, he had been fined 7 million dollars for evading more than 1.2 million dollars in taxes. A year later, he was a defendant in an SEC complaint about a “stock parking” scheme to gain control of a corporation, that cheated investors of about 4 million dollars.
So Posner was notorious. Even so, Mills was astonished when he examined the insurance books. He discovered that NVF had been paying National Union Fire of Pittsburgh, a subsidiary of the insurance giant AIG, substantially over market for workmen’s compensation insurance.
Mills told the director of the Delaware Insurance Department’s bureau of examination that when he went to buy a policy for NVG from another insurance firm, he found the price was only half what the company had paid the year before.
Mills told IPS, “The fronting company was AIG. And the broker on the deal was Alexander and Alexander… one of the biggest brokers in the world.” He said, “The senior management really didn’t have a handle on what the costs were.” Posner, who died in 2002, had ordered the deal, and the managers went along.
This is how the scam worked. Insurance companies normally insure themselves by laying off part of their risk to reinsurance companies, so if a claim comes in above a certain amount, the reinsurance company will pay it.
AIG had reinsured the NVF policy through Chesapeake Insurance, a reinsurance company Posner owned in Bermuda – an offshore tax and secrecy haven whose books were safe from the eyes of U.S. regulators and tax authorities.
AIG would keep a portion of the inflated NVF premium and send the rest to Chesapeake. AIG would have a higher commission. Posner would write off the entire amount as a business expense and enjoy the extra cash in Bermuda, tax free.
A former insurance regulator told IPS, “Say the normal premium was 1 million dollars.(If I ran the company,) AIG could charge me 2 million dollars and then send a premium of 900,000 dollars over to a reinsurance company that it has set up for me in Bermuda. I never have to pay any claims, so I get to keep the 900,000 dollars tax-free offshore.”
The company and bank records are private, so there is no way for outsiders to know how much tax money was actually diverted.
8. Treasury Secretary Timothy Geithner’s past conduct while serving with the Federal Reserve Bank of New York is not encouraging. Fueling Mr. Emory’s pessimism–expressed in the above discussion of AIG–is the fact that Geithner tolerated short-selling on U.S. Treasurys.
U.S. senators at Timothy Geithner’s confirmation hearing for Treasury Secretary Wednesday may want to ask him about a failure to act that is costing the U.S. a lot more than the amount he evaded on taxes.
The Federal Reserve Bank of New York, which he has led since 2003, conducts the operations on Wall Street of the Federal Reserve Bank in Washington, the country’s central bank. The New York Fed under Geithner’s presidency has failed to stop massive naked short selling of U.S. Treasury bonds that threatens the stability of the market and sale of the bonds.
Ironically, the scam, enabled by a lack of regulation at the behest of Wall Street brokerage houses, makes it more expensive for the U.S. to bail out those same financial institutions.
It happens this way: an individual or fund is allowed to sell bonds without owning them. This is called short selling. The seller, whose broker has generally “borrowed” bonds from another broker, is supposed to subsequently buy them on the market, and return them to the lender. The seller does this because he believes that the bond is going down, and he will buy them at a cheaper price than he sold them for.
Naked short selling occurs when a seller does not borrow the bonds for delivery at settlement, and therefore never has to buy them. This is called a failure to deliver, or FTD.
Meanwhile, the buyer thinks he or she has the bonds but has just an IOU. The result is a distortion of the market. Sellers sell bonds they never own or borrow, so there are more securities sold than issued by the government. These phantom bonds don’t represent money paid to the U.S. Treasury or genuine securities for buyers.
The major broker-dealers who handle bond trades like the system. They profit from fails by using clients’ money for other purposes.
The economist who has done the key work on this issue is Dr. Susanne Trimbath, who heads STP Advisory Services in Omaha, Nebraska. She previously worked for the Depository Trust Co, a subsidiary of Depository Trust and Clearing Corp, the U.S. clearing house for stocks and bonds.
Dr. Trimbath said, “In fall of 2008, about two trillion dollars in Treasury bonds were sold but undelivered for six weeks, more than 20 percent of the daily trading volume, up from 8.6 percent in the first five months of 2008.” It was a spike from 1.2 percent in the first five months of 2007.
“There was excess demand for the Treasuries,” she said. “Rather than allow this to push the price up, the Federal Reserve Bank of New York and the DTCC allowed failures to deliver to depress the price.” This affects the value of bonds held by individuals, funds and major investors such as China.
The latest figures on failures to deliver are 600-800 billion dollars. Dr. Trimbath said, “The numbers look better now because the Fed threw two trillion at the market, which was used to cover these fails.”
She said that Geithner failed to heed the warnings of economists at the New York Fed who in 2002 and again in 2005 analysed failures to deliver of Treasuries and recommended fines for the brokers responsible. A New York Fed white paper in April 2006 called for stricter enforcement of delivery and penalties for violations. The Bond Market Association opposed reforms, and again Geithner failed to act.
Even the current financial crisis has provoked only a faint reaction from the New York Fed. On Jan. 5, it acknowledged that, “Since November, short-term interest rates have declined to unprecedented levels.” It proposes a regulation to allow the buyer and seller to agree that if the buyer doesn’t receive the securities by five days after sale, the buyer could submit a claim against the seller for payment. But this can be done now and could have been done in 2002.
This is how the bond system works. The U.S. Congress authorises the federal government to issue bonds to cover the national debt. Individuals and institutions, even countries, can buy the bonds directly or through brokers. If a purchaser buys through a broker, the bonds remain in the broker’s name or the name of a central depository such as DTCC. The Treasury pays the bond’s interest to the broker, who credits the client’s account.
Since regulators don’t require the bonds to be delivered to the buyer, the broker gives clients an electronic IOU for the bond and for the interest payments as well. But if the bonds aren’t delivered by the seller, the electronic IOUs represent phantoms. Dr. Trimbath points out that, “The significant result of the IOU system is that brokers are able to sell many more bonds than the Congress has authorised. The transactions are called ’settlement failures’ or ‘failed to deliver’ events, since the broker reported bond purchases beyond what the sellers delivered.” She said, “There is no limit on the number of IOUs the broker can hand out…and there are usually more IOUs in circulation than there are bonds.”
This artificially inflates the supply and forces bond prices down. Investors who want to buy Treasuries – to lend money to the U.S. – may instead be lending money to their brokers. Brokers get not only the commission charges for the trade, but the use of the client’s cash for the bond that was never delivered and therefore never paid for. Dr. Trimbath calculates this “loss of use of funds to investors at seven billion dollars per year, conservatively.”
If the broker goes out of business, clients don’t have the Treasuries, only the broker’s electronic IOUs. Dr. Trimbath, said, “Who is going to get the chair when the music stops? It’s not the individual investor. I’ve seen positions just deleted from people’s statements without investors even knowing as the security they supposedly owned turns out to not exist.”
This insecurity could discourage buyers of Treasuries, heralded as ultra-safe investments. “And for the bond buyers, brokerage houses, and banks, it’s yet another crash-and-burn to come,” said Dr. Trimbath.
Her solution: “If regulators and the central clearing corporation would only enforce delivery of Treasury bonds for trade settlement – payment – at something approaching the promised, stated, contracted and agreed upon T+1 (one day after the trade), there would be an immediate surge in the price of U.S. Treasury securities.”
“As the prices of bonds rise, the yield falls. This falling yield then translates into a lower interest rate that the U.S. government has to pay in order to borrow the money it needs to fund the budget deficit and to refinance the existing national debt.”
Brokers would have to buy real bonds to deliver to buyers. She said, “That’s when the music stops.”
Geithner might explain to senators why he has not stopped the billion-dollar phantom Treasury bonds scam.
9. Lucy concludes the interview by discussing the highly ironic situation of the Vatican publicly denouncing “offshore.” The Vatican and its banking scandals are discussed in numerous For The Record programs, as well as various Archive Shows, especially AFA #’s 17-21.
The financial crisis has the U.S. swirling with charges about the immoral greed of some corporate executives who recklessly bet their companies’ futures to line their own pockets. The popular fix for this international calamity stops at the nation’s borders: decouple top-line salaries and bonuses from stock prices and institute more transparency and regulation.
However, last month, the Vatican, in a groundbreaking statement, linked the financial crisis to a much deeper problem largely ignored in discussions of the crisis here. It underlined the need to consider carefully “the hidden but crucial role of the offshore financial system in light of the emergence of the global financial crisis”.
The Nov. 18 statement, drafted by the Papal Council for Justice and Peace and endorsed by the Vatican Secretariat of State which speaks for the Pope on foreign affairs, called offshore markets “an important link, both in the transmission of the present financial crisis, as well as in maintaining a host of mad economic and financial practices.”
Among them it said were the movement of money to evade taxes and recycle profits from illegal activities and also gigantic capital flight.
The Holy See issued its “note” on the causes and consequences of the world financial crisis on the eve of the United Nations General Assembly Conference on finance and development in Doha. Its prescription: “a drastic reduction of offshore financial practices”.
Dr. Flaminia Giovanelli of the Papal Council in Rome told IPS that this is the first time it has made such a statement.
She explained that the Council had been studying the problem of financing for development at the moment that the financial crisis occurred. She said the statement talked about tax havens because the Council’s study connected the fact “that many companies don’t pay taxes” to both financing for development and the financial crisis.
The Papal statement was published in Observatore Romano, the Vatican newspaper. Dr. Giovanelli said there have been “positive reactions from Catholic development organisations” around the world.
The statement asked, “How have we arrived at this disastrous situation, after a decade in which speeches have multiplied on the ethics of business and finance, and in which the adoption of ethical codes has spread?”
A few weeks later, on Dec. 8, in ironic counterpoint, 17 major U.S. corporations signed on to a list of ethical practices. Their statement, which appeared aimed at assuaging public displeasure at corporate misbehaviour, was built on non-controversial hot-button issues – in essence, “we won’t bribe, we won’t despoil the environment”. The issue of offshore money flows and tax evasion was nowhere to be seen.
The Vatican came to its knowledge of offshore painfully. Italy’s Banco Ambrosiano, of which the Vatican was the main shareholder, collapsed in 1982. Its CEO Roberto Calvi, in collaboration with Bishop Paul Marcinkus, the U.S. national who headed IOR, the Vatican Bank, had siphoned off multi-millions of dollars to offshore accounts.
Ambrosiano lost 3.5 billion dollars of customers’ deposits. Calvi, who fled Italy, was murdered and found hanging from Blackfriars Bridge in London. Marcinkus was protected from Italian indictment by the Church and later returned to the U.S. where he lived until his death in 2006.
A few years later, in a 1985 essay on morality and economics, Cardinal Ratzinger – the future Pope Benedict XVI – warned that the decline of ethics “can actually cause the laws of the market to collapse”.
Ethics and offshore. The Vatican now gets it, but U.S. corporations don’t. The U.S.-based multinationals that signed on to yet another ethics pledge included General Electric, The Hartford, Pepsi, Wal-Mart, Accenture, Dell, and United Airlines. Their prescription: comply with laws against fraud, corruption, and bribery; practice transparency; avoid conflicts of interest; be accountable to customers and protect the environment.
Ethics, according to the 17, does not include rejecting the use of the offshore system to evade regulation as well as taxes. Like the Vatican, U.S. corporations have experience with offshore. It’s understandably a sensitive issue.
General Electric cuts its taxes drastically by selling its exports to offshore subsidiaries which then sell them to the real customers. That’s called “transfer pricing”. The corporation transfers profits offshore. GE spokesperson Gary Sheffer declined to comment on ethics and taxes or on the ethics of GE transfer pricing.
Dell, the computer company, has moved patents on intellectual property developed in the U.S. to subsidiaries in Ireland where no taxes are charged on royalties. Regarding Dell’s view of ethics and taxes or the ethics of avoiding taxes on patents, Michele Glaze, spokesperson for Dell on corporate social responsibility, said, “I don’t know the answer.” She didn’t obtain it.
PepsiCo, the global soft drink company, has 10 subsidiaries in Luxembourg, a notorious tax haven. However much soda Luxembourgers drink, that market would not seem to require ten Pepsi companies to serve it. Such companies are routinely used for financial transactions that launder profits. PepsiCo declined to discuss the purpose of its Luxembourg subsidiaries or the degree to which using offshore companies to reduce taxes is consistent with an ethics pledge. Public relations spokesperson Dave DeCecco provided a written statement: “PepsiCo manages its tax affairs in a prudent and lawful manner.”
The ethics pledge was organised by Alex Brigham, founder and head of the Business Ethics Leadership Alliance of the Ethisphere Institute. He said that paying fair taxes “wasn’t an issue that we brought up with these companies in large part because we’re focusing on a lot of non-financial items.”
He explained, “We’re looking at the conflicts of interest; that’s a huge problem for companies.” He added, “I agree that off balance sheets assets are a major problem in the financial services sector. I know Citigroup moved massive amounts of assets off their balance sheet, but I don’t know if it was offshore.”
He said that the business ethics project did not anticipate taking on tax issues “either now or in the foreseeable future”. The Ethisphere approach to offshore tax evasion is typical of U.S. corporate-financed “corporate social accountability”: they ignore it.
However, the issue may get some attention when U.S. President-elect Barack Obama takes office. The amounts at play are huge. The Vatican cited estimates of the taxes evaded from wealth held in offshore centers as close to 255 billion dollars. U.S. tax losses from corporations are said by Senator Carl Levin, co-sponsor with Obama of the Stop Tax Haven Abuse Act, to be 50 billion dollars a year.
In his campaign, Obama spoke out frequently against corporations who don’t pay their fair share of taxes. He said he would deny tax benefits to former U.S. companies that reincorporate offshore to avoid paying taxes. He said he would crack down on companies that use operations in offshore jurisdictions to evade taxes.