Hedge Funds Still a Money Launderer’s Dream



By Jim Bleyer

A combination of secrecy, weak regulation, and rapid proliferation have made hedge funds a very attractive vehicle for money launderers.

And, although Congress was on the cusp of legislation making hedge funds culpable for abetting criminal activity, that opportunity evaporated following the 2018 midterm elections.

It’s no surprise that retired hedge fund managers wanted to get back into the game citing “fire in their belly.”

The United Nations Office on Drugs and Crime (UNODC) estimates laundered funds to account for 2-5 percent of the global GDP, or $800 billion-$2 trillion annually. The kinds of secret offshore companies that have hidden political corruption and tax evasion around the world are often used by Wall Street’s multi-trillion and largely unregulated hedge fund industry.

The proceeds from money laundering end up in the hands of gangsters, warlords, drug dealers and terror groups. Mainstream financial institutions are prohibited from enabling such transactions. However, many times hedge funds unwittingly—or perhaps not—skirt that restriction because of little or no regulation over their activities.

Hedge funds are very susceptible to money laundering because they combine all the following traits in a single financial institution:

• Secrecy. Anonymity of investors, intermediaries hide identities, pooling of funds, funds of funds.
• Light regulation. Offshore countries with insufficient laws, exemption from registration.
• Rapid proliferation. Many new funds being started, lower minimum investments, increased use by nontraditional investors.

These three traits can combine to allow launderers to move large amounts of money without undergoing rigid scrutiny.

The now-famous Panama Papers leak offered insight into the workings of this exclusive investment club.

Hedge funds accept individual investors with net worths of $1 million or more and worker pension funds with $5 million or more. They and their investors often locate in tax havens such as the Cayman Islands or the British Virgin Islands.

The names found in the leaked files from the Panamanian law firm Mossack Fonseca include two now-imprisoned hedge fund managers, a major “feeder fund” that was part of the largest-ever Ponzi scheme run by Bernard Madoff and several anonymous investors whose offshore companies became tangled in the Madoff web.

According to Pro Publica, hedge funds and private-equity companies have fended off multiple attempts by U.S. regulators to require them to establish anti-money-laundering compliance programs.

“You’ve got several trillion dollars, the management of which nobody is required to ask any questions about where that money is coming from,” said Clark Gascoigne, deputy director of the Financial Accountability and Corporate Transparency Coalition. “This is very problematic.”

The Financial Action Task Force, an intergovernmental organization that seeks to combat money laundering around the world, in a report two years ago, characterized the lack of anti-money laundering rules for investment advisers, such as those who manage hedge funds and private equity funds, as one of the United States’ most significant lapses.

The push to regulate hedge funds and similar investment firms took off after the Sept. 11 attacks, when Congress passed the Patriot Act. Among other things, the law required federal agencies to take new steps to keep illicit money out of the U.S. financial system.

But hedge fund managers have fought regulation every step of the way.

The Treasury Department exempted investment firms at the time, planning to return to them after tackling other sectors. “Eighteen years ago, the Patriot Act required investment companies to install their own AML [anti-money laundering] programs,” said Elise Bean, a former staff director of the U.S. Senate investigations subcommittee who supports the proposed rule. “But Treasury has yet to enforce the law,” she said.

Under present law, hedge funds can easily, if so disposed, turn a blind eye to suspicious sources of investment.  Hedge funds are requested to take a declaration from their clients verifying that the money being invested has not been realized as a result of criminal or illegal activities.  In other words, no due diligence is required.

What Pro Publica doesn’t mention is that hedge funds have fallen out of favor since the mid 90s and that many present-day hedge fund managers could care less about the source of their funding.

What is a hedge fund’s incentive to pry into the finances of its very deep-pocketed investors?  The now-flailing sector is not about to turn down billions, if not trillions, just to be good citizens and not enable worldwide crime and corruption.

Between 1994 and 2011, hedge funds generated an annual return of six per cent rather than nine per cent. They did about the same as the stock market, which produced an annual return of 5.8 per cent, but not as well as bonds, which generated an annual return of 7.2 per cent.

Another study found similar conclusions.  Between 1980 and 1992, when the hedge-fund industry was still very small, it generated an impressive annual (value-weighted) return of 19.8 percent.  But, between 1993 and 2006, the annual rate of return fell to 11.1 percent. These figures are for unadjusted value-weighted returns.  Converted to dollar-weighted numbers, hedge funds produced an annual return of twelve per cent between 1980 and 2006. That’s less than the S&P 500 annual return of 13.5 per cent over the same period.

Hedge fund assets dwarf the casino and fine art industries where laundering is deemed to be widespread and also largely unregulated.  Legislation aimed at tracking financial sources in art and antiquities similarly fell by the wayside at the end of 2018.

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