Can Federal Legislation Rein in South Dakota Trusts?
A still image of Sioux Falls, South Dakota — a state where money held in trusts has quadrupled over the past decade — as seen in the November 2021 FRONTLINE and ICIJ short documentary "Pandora Papers."
Update: As part of an ongoing federal effort to introduce greater transparency into the U.S. financial system, the Biden administration on Dec. 6 announced a plan, the United States Strategy on Countering Corruption, that follows a June 2021 memo identifying money laundering as a national security priority. The administration released the strategy two days before a House Ways and Means Subcommittee on Oversight hearing on the Pandora Papers revelations scheduled for Dec. 8.
Just days after the Pandora Papers broke in early October, highlighting how U.S. trusts are sheltering millions in controversial assets, a bipartisan group of House members responded with proposed legislation, requiring the U.S. Treasury to expand due diligence rules for financial-services professionals.
“There’s a whole … industry set up in the U.S., consisting of trusts, law firms, accounting firms, et cetera, that does not have to do any due diligence when someone shows up with a suitcase full of cash and asks for help in hiding it,” said U.S. Representative Tom Malinowski (D-N.J.), who co-sponsored the bill. “The ENABLERS Act tries to close that loophole.”
But some are already asking: Is it enough?
The Establishing New Authorities for Businesses Laundering and Enabling Risks to Security — or ENABLERS — Act came hot on the heels of the Pandora Papers, an examination led by the International Center for Investigative Journalists involving more than 150 media organizations, including FRONTLINE, into a trove of nearly 12 million financial documents.
In addition to revealing the hidden assets of some of the world’s wealthiest and most powerful people, the leaked files illustrate how the long-term deregulation of the trust industry in some U.S. states, such as South Dakota, has encouraged secretive finance, as examined in the November 2021 FRONTLINE and ICIJ documentary Pandora Papers.
The investigation came during a year of sustained federal action for increased financial transparency in the United States. Prior to the introduction of the ENABLERS Act, Congress passed the landmark Corporate Transparency Act in January 2021, and the Biden administration declared money laundering a national security priority in June.
Will the sudden flurry of legislation impact South Dakota and other states that have spent years passing laws designed to attract wealth?
“There are states that are creating protections for trusts that make it incredibly difficult to pierce the veil of secrecy. We need the ENABLERS Act, but then we also need some reforms of the trust industry,” said Gary Kalman, the U.S. director for Transparency International, an anticorruption nonprofit.
What’s in the water in South Dakota?
Under current South Dakota law, trusts can be held secretly. Critics say that’s a problem, because some trusts could be at risk of sheltering the profits of criminal activities, which trusts are barred from knowingly accepting. While there’s no evidence the U.S. trusts identified in the Pandora Papers contain illicit funds, reporters found that nearly 30 South Dakota-based trusts held assets connected to people or companies accused of fraud, bribery or human rights abuses.
“We’re talking about people who have been in all kinds of trouble, accused of some very bad things, who are using this system to hide their wealth,” The Washington Post’s Debbie Cenziper told FRONTLINE in Pandora Papers.
South Dakota wasn’t always the wild west of trusts. The state’s journey to becoming a global tax haven dates back to the 1980s, when then-governor William Janklow loosened regulations on maximum interest rates.
“Until the last generation or so, South Dakota was inconsequential as a location for a trust,” said Professor John Langbein, an expert on trusts at Yale Law School.
At its most basic, a trust is a legal device that splits the ownership and enjoyment of property, according to Langbein. An individual may place property — money, real estate — in the care of a trustee for a beneficiary, such as a minor relative, with directions for how that property should be managed.
But the use of trusts has evolved over time. In South Dakota today, individuals can establish “self-settled spendthrift trusts,” which Langbein called “a 180-degree change in trust law.” These trusts are never made public and are protected from creditors and spouses. The state has also repealed the rule against perpetuities, permitting “dynasty” trusts that do not expire. In addition, there are no state income or capital gains taxes on trusts in South Dakota.
“Gradually, I think, the state kind of caught on that being competitive with the trust laws themselves would further help incubate that industry,” said Professor Tom Simmons, an expert on trust law at the University of South Dakota School of Law.
“What South Dakota did was to combine two radical innovations in the law, defeating well-established common law principles,” Langbein said.
“It encourages people who are trying to hide their money,” said Elise Bean, who investigated money laundering and misconduct for then-Senator Carl Levin (D-Mich.).
South Dakota is not alone. After the Pandora Papers broke, members of the European Parliament submitted a resolution declaring South Dakota, Alaska, Wyoming, Delaware and Nevada all hubs “for financial and corporate secrecy.” To maintain its competitive edge, critics say, South Dakota has the Governor’s Task Force on Trust Administration Review and Reform, which proposes legislation relating to trust administration in the state.
“The role of the task force is to generate proposed legislation for the government first to look at and then, ultimately, for the South Dakota legislature to consider relative to trust administration matters,” said Simmons, who has been on the task force for eight years.
Susan Wismer (D), a former member of the South Dakota House and Senate who has been critical of the trust industry, said the state legislature understands little about the trust laws it has been enacting, relying instead on the task force to explain the benefits of keeping trusts in business.
“If we had somebody that could help us point out the differences between our trust laws and others, there may very well be some things that we ought to address,” she said. “Maybe some of those secrecy provisions aren’t too good. Maybe we’re helping bad actors launder money.”
What Could New Federal Laws Mean for South Dakota’s Trusts?
Federal legislation is critically important, according to Kalman from Transparency International. The U.S. is “a money-laundering center,” he said. “When you put together our gaps in our anti-money-laundering laws, and the fact that we’re a vast economy, it makes us a very attractive site.”
While Kalman said the U.S. has strong money-laundering protections in place for traditional banks and the stock market, other sectors — including private investment and real estate — remain vulnerable.
That could be changing.
The Corporate Transparency Act, passed by Congress in January, banned anonymous shell companies in the U.S. Shell companies — which exist only on paper, as a means of holding money or assets — must now declare a beneficial owner when they register with the U.S. Treasury.
“It was the biggest update to U.S. anti-money-laundering law in the past 20 years,” said Erica Hanichak, the government affairs director at the FACT Coalition, an anticorruption advocacy group. She called the new law a start but added, “There are a myriad of other avenues that kleptocrats, criminals, drug traffickers and terrorists have used to exploit the U.S. financial system and its secrecy to move illicit money around.”
Kalman likewise called the act a “foundational reform” but said it should go further, covering trusts in addition to shell companies. And even if the U.S. Treasury, which is currently writing the rules for the Corporate Transparency Act, broadens the terms, there are other weak links in the system, he said.
Watch the 2021 FRONTLINE and ICIJ short documentary Pandora Papers in its entirety.
“We have now laid the foundation so that you can’t do the most basic, easiest thing, which is to set up an anonymous company,” he said. “We now need to take the next steps … to go and take a look at the enablers, or gatekeepers, depending on how you want to refer to them, to the U.S. financial system.”
Kalman continued: “What we saw in South Dakota, these [trusts] are contracts that are drafted by a lawyer or a financial advisor or what have you, and then they just keep it on file. … They’re completely unknown, and yet they’re able to house money, move money, invest money and help people avoid — or worse, evade — taxes.”
Enter the ENABLERS Act, introduced in the U.S. House by Tom Malinowski (D-N.J.), Maria Salazar (R-Fla.), Steve Cohen (D-Tenn.) and Joe Wilson (R-S.C.) in October. The proposed legislation would amend the 1970 Bank Secrecy Act, making the kinds of disclosures required for banks apply to gatekeepers of the financial-services industry, as well: accountants, attorneys, real estate agents, public relations professionals, art dealers and investment advisors.
The ENABLERS Act could supplement the Corporate Transparency Act, Malinowski said, requiring trust companies to ask “a few basic questions of their customers,” such as: “Where does this money come from? What’s your address? What’s the intended use? And to report anything that’s suspicious.”
He continued: “Most trusts and law firms and accounting firms, I think, would be happy to get the dirty money out of the system, because otherwise they face competitive pressure to accept it too.”
Simmons agreed, saying he believed financial professionals would welcome this legislation.
“I think, to the extent that that’s all kept at the same level, that actually benefits everybody and helps preserve the integrity of the industry,” he said. “Everybody’s harmed when one person has allegedly taken a trust beneficiary that maybe they shouldn’t have.”
Neither the Banking Division of the South Dakota Department of Labor, nor the South Dakota Trust Task Force, nor the South Dakota Trust Association responded to interview requests for this story, although the Banking Division told FRONTLINE in a statement that it routinely audits trust companies and that the firms are required to do intensive vetting, with extra attention to foreign clients.
The Banking Division did not respond when asked to describe the vetting process.
But as with the Corporate Transparency Act before it, not everyone is convinced the ENABLERS Act does enough to address the vulnerabilities of the trust industry.
“I’m not at all sure that disclosure legislation, which is basically what [the act] is, will have much effect on the domestic market,” Langbein said.
The ENABLERS Act isn’t solely focused on trusts but on the broader financial-services industry, of which trust companies are a part — which is fine, Kalman said. It just means more legislation may be needed to address gaps in the system.
Meanwhile, the ENABLERS Act is with the House Committee on Financial Services. It is not yet scheduled for a vote, and Kalman said he does not expect it to pass this year.
“I think that there’s an education process. I think there’s a lot of interest, and there’s bipartisan support for the first time. I think we will pass it, but I think we need to have hearings, we need to get people educated before a markup and a vote in the House and the Senate,” he said.
Hanichak, of the FACT Coalition, said both the Corporate Transparency Act and the ENABLERS Act signal federal steps in the right direction. “At the same time that these states are under scrutiny for their financial secrecy, the U.S. trend is for transparency,” she said.
“I think there could be opportunities to try to bring the states along on that and reform the system.”
This story was updated Dec. 8, 2021.