It’s unclear to me who the intended audience is for Global Securities Markets: Navigating the World’s Exchanges and OTC Markets (Wiley, 2011) by George W. Arnett III. The flap describes the book as a complete Global Investing 101 course (in about 150 pages), but this is definitely not the case. The author, a lawyer, is primarily concerned with the legal structures, regulatory environments, and safeguards of financial markets. Contrary to the book’s title, the U.S. financial system receives the most extensive coverage.
Rather than write about market structure (exchanges and their associated depositories), the history of U.S. regulation, or issues surrounding margin, derivatives, short selling, and prime brokerage—all topics covered in Arnett’s book, I decided to share an interesting case study of how money can move around the world despite governmental constraints.
In 2003 Hugo Chavez imposed currency controls to restrict the flow of U.S. dollars into and out of Venezuela. A Venezuelan national or company that wanted U.S. dollars had to apply to a government agency under the jurisdiction of the Ministry of Finance. The process was lengthy and cumbersome and the kinds and sizes of approvable transactions were limited. Naturally, enterprising souls found a way to introduce “a parallel unofficial exchange regime.” (p. 129) Enter the process of permuta (swap). It’s far more expensive (6.5 to 7 bolivars to the U.S. dollar as opposed to the official change rate of 2.15 to 1), but it gets the job done. Here’s how it works.
The Venezuelan national or company takes the first step by depositing bolivars in the bank account of a local broker-dealer and using the deposited funds to buy a bond denominated in bolivars. The broker-dealer transfers this bond to an offshore entity that typically it has set up itself for the purpose of permuta. The favorite sites are Panama, the Netherlands Antilles, the Cayman Islands, and the British Virgin Islands. In the next step of the transaction the bolivar-denominated bond is swapped for a U.S. dollar-denominated bond held at a second offshore company, and this dollar-denominated bond is sent to the original client. The second offshore entity, which usually has an account at a U.S. bank or broker-dealer, then buys the bond from the client at a predetermined price and wires the proceeds to the client’s U.S. account. And, finally, it sells the Bolivar-denominated bond into the U.S. market. (p. 130)
The process is lawful even if not transparent. At least, it is normally lawful. An exception may arise if the second offshore entity conducts its activity in a U.S. account. “If the sale of the U.S. dollar-denominated bonds is to effect a permuta transaction whereby a U.S. dollar-denominated instrument is converted into U.S. dollars for the express purpose of moving funds from one place to another on behalf of a third party without any market risk to the participants, then the offshore company, if not licensed in the U.S. to provide money transfer services, may be acting as an unlicensed money transmitter under U.S. regulations.” (pp. 131-32)
Although financial firms can help foreign nationals and companies convert their money, even if the task sometimes requires activity bordering on skullduggery, many countries, including the United States, draw a line in the sand when it comes to helping foreign clients evade taxes in their home country. Recently, for instance, the Argentine government cracked down on transactions to and from tax havens. It was trying to stop the flow of so-called blue money and black money, neither reported for tax purposes, to offshore accounts. The tax evaders cannot turn to U.S. firms for help in masking their identities as their money wends its way to a proscribed tax haven. As Arnett writes, “A U.S. financial firm could run afoul of U.S. law if it knowingly assists Argentinian nationals to evade taxes through the knowing facilitation of intermediary transfers. In 2005 the U.S. Supreme Court decided a case called United States v. Pasquantino that established that a plot to defraud a foreign government of tax revenues (in this case, Canadian customs duties on alcohol) that has a U.S. nexus (use of the telephone in the United States) is a federal crime. The ruling overturned established law that one country would not look to enforce the tax laws of another country.” (pp. 139-40)