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For the most part, these Irish operations were front companies, with huge assets and almost no employees. Jim Stewart did a detailed study of treasury management firms in Ireland between 1998 and 2005. He was able to work out figures for forty-eight of them. The results were startling. Most had no fixed (as opposed to financial) assets and most paid no fees to directors, implying that those directors actually worked elsewhere. These were virtual entities, existing in a financial version of Second Life.
In the year 2000, for example, the firms in Stewart's study had combined assets of $48 billion. They employed a grand total of 128 people: fewer than four employees each. In 2005, the firms had median gross assets of $643 million each. They had a grand total of seventy-five employees - on average, fewer than two each. (Twenty-eight of the forty-six had no
employees at all.) With assets of $320 million dollars per job, those employees were so productive they made Stakhanov look like a slacker. Statistically, in fact, as Stewart reported, âthe median number employed was zero for each of the years 1999-2005 and just one employee for the year 1998'.
A not untypical example was Eli Lilly's IFSC wing, Kinsale Financial Services. In 2004, it had profits of $96 million, after paying a dividend of $8.6 million to its US parent and $13.6 million taxes to the Irish state. It employed precisely two people. From the Irish government's perspective, these firms were generating tax revenue but providing practically no employment.
They were, however, very useful vehicles for the transnational corporations. Their Dublin-based financial arms were able to shift huge piles of untaxed money out to the shareholders of their parent companies. For example, in 1999 alone, Brangate Limited, an IFSC-based subsidiary of the notorious American corporation Tyco, paid out a dividend of $6.6 billion. A subsidiary of Johnson and Johnson located in Ireland repatriated a dividend of â¬6.7 billion in 2005. Aggregate dividend outflows and distributed profits from Ireland rose from $13.2 billion in 2003 to $25.7 billion in 2006. When, in 2004, the US allowed its firms a ârepatriation holiday' during which they could bring in dividends from abroad at a very low tax rate, Ireland was the fourth largest source of the money that flowed in, after Holland, Switzerland and Bermuda.
For the Irish state, this whole operation seemed straightforward enough. In return for housing these front companies and allowing their parents to avoid taxes in their home countries, Ireland got no jobs, but it did get the tax revenue. Essentially, the deal was that the front companies would
pony up 12.5 per cent of profits in corporation tax and the state would neither look too closely at its activities nor listen to the complaints of the foreign governments whose exchequers were losing out.
The problem, however, was that if there are vast amounts of money flowing around and no one is watching, the results are predictable. Fiction shades into fraud.
Eurofood IFSC Limited was a classic denizen of the Bahamian outpost beyond O'Connell Bridge. Established at the IFSC in 1997, it had no fixed assets, and no employees, but reported pre-tax earnings of $48 million between 1997 and 2002. It had net financial assets of almost $200 million, but its registered office was simply that of a leading firm of solicitors, McCann FitzGerald. One director was a partner in that legal firm. Another was an employee of Bank of America, which acted as Eurofood's agent and effectively did all of its work. The other two directors were senior executives of Eurofood's parent company, the Italian food conglomerate Parmalat, and lived in Italy.
Eurofood, in other words, was a typical IFSC front company. As the Irish Supreme Court put it: âThe Company's policy was decided at Parmalat headquarters in Italy, by Parmalat executives, and the Company exercised no independent decision-making function.' Yet, as the Irish and European courts later ruled, Eurofood was an Irish company, subject to Irish law and, in theory at least, regulated by the Department of Finance, the Central Bank and the Financial Regulator.
According to the same Supreme Court ruling, the Italian directors did not always bother to attend the meetings of Eurofood's board but âsometimes communicated by telephone'. One of the Italian directors was recorded as being
present on six occasions but on the phone for four meetings. The other was physically present on five occasions and participating by phone on four others. Some of the Irish directors were likewise recorded at times as participating âby phone'.
Yet this board took some very important decisions. Specifically, on one day in September 1998, it approved two huge transactions: the issuing of $80 million to Venezuelan companies in the Parmalat group and of $100 million to âfund a loan by the Company to Brazilian companies in the Parmalat group'. These transactions were supposedly governed by Irish regulatory authorities and by Irish tax law.
Parmalat collapsed in late 2003 and went into administration. What emerged, according to the US Securities and Exchange Commission, was âone of the largest and most brazen corporate financial frauds in history'. A $4.9 billion Parmalat account with Bank of America, which the company claimed to have stowed in the Cayman Islands, did not exist. Parmalat turned out to have debts of $14 billion, more than double what it declared on its balance sheet.
To hide the debt, Parmalat simply transferred the liabilities to subsidiaries based in offshore havens. According to Enrico Bondi, the Italian bankruptcy commissioner, âIn an attempt to hide its state of insolvency, Parmalat entangled itself in grandiose financial operations that were ever more costly.' Eurofood, which managed Parmalat's financial operations, was a crucial part of this operation. According to a spokesman for Parmalat's post-collapse administrators, âEurofood was deeply involved in the fraud at Parmalat . . . A large portion of the fraud involving Parmalat was at off-shore vehicles where there was little or no transparency.'
Fausto Tonna, one of Eurofood's directors, was sentenced
to thirty months in jail in Italy in 2005, having pleaded guilty to playing a leading part in the company's spectacular scheme of faking of its accounts. The other director, Luciano Del Soldato, also pleaded guilty to fraud and got a twenty-two-month sentence. The chairman of McCann FitzGerald, the Irish law firm that had provided Eurofood with space for its brass plate and the statutory Irish resident for its board, described the episode as a case of âbeing in the wrong place at the wrong time'.
By itself, the Parmalat case should have been a warning that the lax regime at the IFSC was wide open to abuse. There was, however, another area of concern, and it arose from one of the success stories of the IFSC, its ability to attract a large slice of the global reinsurance market. By 2003, 10 per cent of that worldwide market was underwritten in Dublin. This success was not based on the joys of the Irish weather. It was rooted in the happy absence of regulation.
Ireland, on the one hand, piggybacked on European Union laws and standards, which provided companies setting up in Dublin with a secure protective framework in which to operate. On the other hand, it specialised in allowing those companies to do as they pleased. A remarkably open analysis by one of the leading Dublin business law firms, William Fry, written in 2004 to mark the fifteenth anniversary of the establishment of the IFSC, was upfront about this contradiction:
A look at the insurance and reinsurance sectors reveals that there is a great paradox surrounding the legal and regulatory landscape. On the one hand, it was the existence of a comprehensive legal framework in the form of the three generations of [European Union legislation on
insurance] that fostered the growth of these sectors. On the other hand, the reinsurance sector thrived because the relative absence of legislation meant that reinsurers could establish in the IFSC without having to concern themselves about solvency margins, asset admissibility rules and authorisation delays . . . the reinsurance sector thrived in the IFSC partly because of the absence of regulation, which allows reinsurance operations to establish quickly and without incurring high costs. The absence of any regulation regarding the solvency margins to be maintained by reinsurers or the admissibility of assets provided a fertile environment for the growth of both the captive sector and the establishment of innovative coverage providers . . . a pure reinsurer established in Ireland is free to provide reinsurance to insurers in any other Member States of the EU, notwithstanding that there is no system of prior authorisation or ongoing supervision of such reinsurers. The Insurance Act 2000 continued (albeit on a more formal basis) the âapproval but no supervision' regime. The [Act] also permits the Irish Financial Services Authority to direct a reinsurance operation to cease writing business in certain stated circumstances. We are not aware that this ânuclear option' has ever in fact been exercised, however, these powers represent a necessary safeguard for the regulator, because once established there is virtually no ongoing supervision of reinsurance operations.
When the
New York Times
reported in 2005 that âDublin has become known in the insurance industry as something of the Wild West of European finance', it was not exaggerating. The IFSC was a lawless frontier town in which the spoils of
the reinsurance trade were up for grabs and the sheriff walked only on the sunny side of the street, tipping his hat to the decent folks and avoiding the gaze of the desperados. And the baddest outlaw was John Houldsworth.
Houldsworth worked for Cologne Re, a German reinsurance firm, and helped to establish its Dublin arm in the early 1990s. Cologne Re was then acquired by an American firm, General Re, which in turn was bought by Warren Buffett's Berkshire Hathaway. Houldsworth became the main man at Cologne Re's Alternative Solutions Group in Dublin. Unfortunately what the group was generally offering was an alternative to ethical behaviour.
Houldsworth first came to notice with his contribution to the largest single bankruptcy in Australian history, the collapse in March 2001 of the HIH Insurance Group. HIH had purchased its apparently profitable rival FAI in 1999. It turned out that FAI's profits were fictional. The company had been kept afloat through a series of reinsurance contracts, the most important of which was with General Re. It had been engineered in Dublin by Houldsworth. He and his colleagues worked a bit of fiscal magic to make FAI seem much more solvent than it was. According to the Australian Royal Commission of Inquiry that examined the scandal: âa wide array of practices were employed to achieve these ends, among them the use of side letters setting out arrangements that negated the transfer of risk, the backdating of documents, the inclusions of sections of cover not intended to be called upon and the use of “triggers” for additional cover that were unrealistic. The word audacious comes to mind.' A Royal Commission source explained to Justin O'Brien, professor of corporate governance at Queensland University of Technology, that those who constructed the deal were âskilful
interior designers' papering over, not just cracks, but âgaping holes'.
As a result of the scandal, Houldsworth and another Dublin-based executive of General Re, Tore Ellingson, were barred from the Australian securities and insurance industries for life. Houldsworth was not prosecuted because he refused to travel to Australia for a legal hearing. The Australian authorities did, however, inform the Irish regulator of the outcome of their investigations. This was the equivalent of the Medical Council in one country warning another jurisdiction that it had struck off a doctor for malpractice. The obvious imperative was to stop Houldsworth working in Dublin. The Irish authorities chose to do nothing.
In late 2000 and early 2001, predictably enough, Houldsworth and his Alternative Solutions Group in Dublin were at the centre of another scam. This time, it involved General Re and the largest US insurer, American Insurance Group (AIG). AIG had a problem with the declining level of its loss reserves - the money it stored away in case of a catastrophe. Concerns about the problem led to a sharp fall in its share price after the release of quarterly results in October 2000.
AIG was General Re's biggest customer. When AIG's chief executive Hank Greenberg approached his opposite number at General Re, the outlines of a solution were agreed. General Re would take out $500 million worth of âinsurance' with AIG against future earnings decline. The âinsurance', however, was to be purely fictional. There would be no premiums and no transfer of risk. The point was simply to deceive AIG's investors by making its books look $500 million better.
They knew where to look for the engineering of this scam: to the âaudacious' Houldsworth in Dublin's Dodge City. In any well-regulated environment, the whole transaction
would have raised immediate suspicions. With any scrutiny, the scheme would have revealed itself to be bogus simply because there was no premium being paid. As the then attorney general of New York, Eliot Spitzer, put it in his subsequent indictment: âGenRe did not pay premiums. And in fact AIG did not reinsure genuine risk. To the contrary, AIG paid General Re US$5 million, and the only genuine service performed by either party was that General Re created false and misleading documentation to satisfy Greenberg's illicit goals.' Or as Houldsworth was recorded as saying in a phone call to General Re in the US: âIf there's enough pressure on their end, they'll find ways to cook the books, won't they?'
The US Securities and Exchange Commission was damningly clear in its interpretation of what had happened: âThis case is not about the violation of technical accounting rules. It involves the deliberate or extremely reckless efforts by senior corporate officers of a facilitator company (General Re) to aid and abet senior management of an issuer (AIG) in structuring transactions, having no economic substance, that were designed solely for the unlawful purpose of achieving a specific, and false, accounting effect on the issuer's financial statements.'