AML - Shell Companies, Front Companies and The Misuse of Real Estate

The more things change, the more they stay the same

I’ve been monitoring developments in the Malaysian Sovereign Wealth Fund (“1MDB”) case for the last three years.  That case involves a plethora of alleged crimes – money laundering, corruption, bribery, impersonation fraud – just to name a few of them.  The regulatory sanctions imposed have been numerous and attempts continue to recover stolen proceeds of over $1billion following court orders to freeze the assets acquired by the culprits. The tactics used to move the proceeds from 1MDB’s bank accounts involved law firms, intermediaries, bogus joint ventures and use of offshore shell companies.  Most people think these tactics were novel because of their jurisdictional scope and the amount of funds involved.

In this article, I’ll be looking at a different case that took place here in the UK. It has strong similarities to the 1MDB case. It too involved tactics used to defraud financial institutions and conceal the true owners and controllers of the scheme. This case involved the misappropriation of millions of pounds, involving in excess of 100 transactions over a four-year period. And it took place almost 10 years before legal proceedings were initiated in the 1MDB case.

Placing the Case in Context

Now the events that occurred in this case took place before lenders were required to comply with the UK's AML regulations. This was also true for real estate agents, law firms and other intermediaries that were involved.  However, what makes it interesting is that despite the changes we’ve seen in the AML regulation of these sectors, the tactics used in this scheme have also been used in more recent cases like 1MDB, to launder the proceeds of crime.

The Key Parties

The parties involved in this case included:

• “Lucky” –the brains behind the scheme. As his nickname suggests, Lucky was like a cat with nine lives.  He’d previously been convicted not once, but twice, for financial misappropriation for which he spent time in prison.  His nefarious activities involved shady real estate activities. Although never formally recorded as the shareholder for Lucky Limited, he was the key controller of its operations.
• “Tim” – Lucky’s brother, operated Lucky Limited and had signing authorisation for it and other entities controlled by Lucky. Tim essentially acted as a “shadow director” and was never formally appointed as a member of the Board.
• “Vemi” and “Mina”– Lucky’s sisters. Used mainly as shareholders and directors, Lucky would later allege that the shares they held in some of the entities were really for his own personal benefit.
• “Dad” – Lucky’s dad lived in Pakistan. Dad claimed that he acted as intermediary in the scheme, recruiting investors in Pakistan. However, despite representations by Lucky and his sisters that their family was wealthy and ran a successful real estate business in Pakistan, Dad was an undeclared bankrupt and there was no evidence of his so-called wealth.

All members of the family personally benefited from the scheme. These benefits took the form of cash, ownership of luxury UK property and the ability to raise financing by using that same property as security to raise even more funds for their personal use.

Nature of the Business

“Lucky Limited” was incorporated in the UK in 2000 under the name Property Holdings (Europe) Limited (“PHEL”). It was renamed Lucky Limited in 2004. The business provided bridging loans. A bridge loan is a form of short-term financing offered to parties who want to invest in real property. The loans are provided at short notice and on a short-term basis to allow a buyer to pay the necessary deposit, and “bridge” the financing needed to purchase a property, until the buyer can acquire long term financing such as a mortgage or commercial financing. 

Lucky Limited would provide bridge loans within 24 hours of an application being made. The amount provided would be based on an agreed valuation of the property involved. Lucky Limited’s client base was made up of high-net-worth individuals who would obtain bridge financing as part of larger projects designed to help build their property portfolios. These mainly focused on projects that converted offices and hotels into flats. Lucky Limited’s clients included MP's, celebrities, footballers and even a Middle East charity.

Lucky Limited was so successful in its first year of operation that by 2003, it was reported to be making profits of £21.4m on a turnover of £36m. At its peak, Lucky Limited was worth £300m and owned a number of real properties and hotels worth millions of pounds. 

In 2004, Lucky’s personal wealth was estimated at £250m, placing him 238th on the Sunday Times Rich List. In an interview in 2005, Lucky commented: "Overall, we are a billion-pound company. In 10 or 20 years, I want us to be as big as a high street bank." Lucky also received the “Young Entrepreneur of the Year” from one of the big 4 accountancy firms.

How the Bridge Loans were Financed

When Lucky Limited was first formed, it received an initial loan of £2.5 million from a high street bank (“High Bank”), for the set-up of its operations. However, this was not enough to meet the demand of Lucky’s rapidly growing client based. Instead, Lucky Limited entered into a revolving credit facility agreement (“Agreement”) with High Bank to provide it with the necessary financing. This was later expanded to a syndicate of banks, with High Bank acting, in effect, as the lead bank.

The proceeds provided under the Agreement was secured by a Deed of Charge. A Deed of Charge is essentially like a mortgage that High Bank had over Lucky Limited’s assets.  The arrangement provided that 80% of Lucky Limited’s funding requirements would be provided, with the remaining 20% provided by way of further financing to be provided from either a director’s loan or funding from its shareholder and other backers.

The terms of the Agreement were designed to ensure that the proceeds Lucky Limited received from its clients in repayment of a bridging loan, would be used to pay back the proceeds loaned by High Bank. A bank account was set up with High Bank. Financing drawn down from the facility was deposited into this account, along with loan repayments from clients. Lucky Limited could not use the proceeds in the account for any other purpose, without first obtaining the consent of High Bank.

The Scheme

Despite the above arrangements. Lucky managed to misuse the proceeds provided under the Agreement, using several different tactics. In total over £100million was misappropriated from the funding provided under the Agreement. 

Tactic A

Despite the terms of the Agreement, Lucky opened a new bank account with Bank B. The account was held in both his name and Lucky Limited. He described the account as a Director’s Loan Account, so that it would appear to be intended for use in relation to that 20% funding noted earlier.

Lucky would later claim that Lucky Plc was an entirely different business that was incorporated in Gibraltar and that proceeds deposited into the account originated from an investor in Pakistan named Mr Singh. In later course cases, it was shown that no separate Gibraltar entity had been formed and that Mr Singh was merely a “strawman” or possibly even did not ever exist. However, what was real was the fact that Lucky controlled the account.

The account at Bank B was financed with proceeds that were (a) directly transferred or paid by cheque from the High Bank account and (b) received from client bridge loan repayments that Lucky’s staff redirected into the account at Bank B.  It was estimated that these transfers totalled about £75million.

Proceeds of about £24million were then transferred from Bank B to other accounts held in different banks in the UK and other parts of Europe that were controlled by Lucky and his associates.

Several more millions were paid from Bank B to an account held with Bank C in London who then transferred the money onward to its branch in Pakistan, where it held an account in Dad’s name. In total, about £80million was transferred to the Bank C account - £35m comprising customer repayments of bridging loans redirected into Bank B and £25.5 million from the High Bank account that were described as loan “repayments for financing provided by backers”. These proceeds were then transferred onwards to accounts controlled or held for the benefit of Lucky.

TACTIC B

The second tactic used in this scheme was much more complicated, so I’ve provided a simplified example of how it worked, below.

Lucky arranged through his associates and company formation agents located in jurisdictions such as Switzerland, to incorporate more than 9 corporate entities which were then used to misappropriate further funds. These entities were incorporated in a variety of offshore jurisdictions including Panama and the BVI. Few identified Lucky formally as the shareholder or controller. And yes, I’ve checked and some of these were identified in the Panama Papers.

The general idea of this tactic worked as follows:

1. Lucky Limited would issue a bridge loan to a client, drawing down funds from the High Bank account.
2. Lucky Limited would register a charge over the client’s property as security against the bridge loan.
3. In some cases, clients defaulted on the bridge loan. 
4. Lucky Limited would then arrange, through solicitors, to enforce the charge over the property and essentially take control over its ownership.
5. In the meantime, Lucky would arrange through intermediaries to form an offshore company (“Shellco”).  The intermediary would either provide nominee directors or one of Lucky’s associates would act in this capacity. Similarly, the shares were held in trust for Lucky. 
6. Lucky would arrange for the money to be transferred from either Bank B or C into the account held in the name of the Shellco. At the same time, money would also be drawn down from the High Bank account to pay for a bridging loan issued by Lucky Limited to the Shellco, but for an amount well in excess of what would otherwise be given for the property.
7. Lucky Limited would engage solicitors and arrange for the property to be sold to the Shellco, often at a low price that was not supported by any independent valuation. Lucky would then arrange for records to make it appear as if the Shellco had “paid” for the property in the books and records kept and shown to High Bank.  

When the property sale completed, the title to the property was assigned to the Shellco and the proceeds of the bridging loan never repaid to the High Bank account. There was no indication that this was a non-arm’s length transaction.

While the diagram looks complicated, the result is this: Lucky used the financing provided by High Bank to buy a property and misappropriate funds drawn from the High Street account and redirect them into an account that he personally controlled. 

Tactic B2

This second tactic involved the use of a “phoenix” in order misappropriate further proceeds.  Recall that earlier, Lucky Limited was originally named PEHL. In July 2004, an entity named Holdco1090 Ltd was incorporated in the UK. In November 2004 PEHL changed its name to Lucky Limited. That same month Mena and Vemi were appointed Directors of Holdco1090 Ltd.  One month later, Holdco1090 Ltd changed its name to PEHL.  And so the former name of Lucky Limited, like a phoenix, was revived and reused by a new entity that was controlled in the background by Lucky.

The bank account for this entity received several fund transfers during December with the reference: “PEHL”.

What was the tactic intended here?

1. A client applied for a bridging loan and Lucky Limited draws these funds down from the High Bank account.
2. Lucky Limited issued the bridge loan to a client and registers a charge over the client’s property.
3. The client secured financing from another bank and purchases the property.
4. The client’s repayments of the bridge loan were redirected to accounts held at Banks B and C, both of which are controlled by Lucky.
5. Proceeds were transferred from Bank B or C into an account with Bank E, held in the name of “Lucky Property Finance”. This account is held by a partnership between Lucky and an associate.
6. The partnership later secured financing from Bank E by pledging as security several properties held by one of the Shellcos created by Lucky. Proceeds were transferred from Bank E to another account held by Lucky at Bank F, and were then used to finance Lucky’s lavish lifestyle.
7. Monies were also transferred to another account held by a partnership made up of Lucky and a “Mr. Bali”.  Lucky later claimed that money had been transferred to this entity from High Bank (via Bank B) as part of their “backer” recruitment.
8. It was claimed that investors would only invest in Lucky Limited if this account appeared to have funds already invested and deposited in it.  The strategy had failed to attract investors and so the monies had been repaid to Lucky Limited in a series of transfers ranging from £360,000 to £1.28million.

Or at least that was how it was supposed to look.

Remember the “phoenix” mentioned earlier? Well those transfers included references to “PEHL”. But they were not made to the High Bank account. Instead, they were transferred to the new entity’s bank account, formerly known as Holdco1090 Ltd.

Again, the tactics were complicated but with the same results: proceeds were misappropriated from the funding under the Agreement for the personal benefit of Lucky and his associates.

How it all Unravelled

The scheme came undone when Lucky and Tim were disqualified as directors in relation to a previous business they operated. Administrators who were subsequently appointed to Lucky Limited uncovered the scheme.  This included the discovery that Lucky had also been operating bank accounts in Northern Cyprus, Pakistan and Marbella.

“Lucky” was ultimately sentenced to almost 12 years imprisonment for fraud and false accounting.  He was also disqualified from acting as a company director for 15 years and was ordered to pay costs to the SFO of £250,000. Lucky was last heard to be living in Pakistan. Tim fled the jurisdiction but still received a prison sentence in the UK for his part in the scheme.  Dad received a prison sentence, and the sisters were also disqualified as directors. Their assets that had not been transferred out of the UK were frozen. In total, Lucky misappropriated over £53million pounds for his own personal benefit. Sixteen parties received proceed under this scheme.

How Was All of This Possible?

It would be far too simplistic to suggest that Lucky’s scheme would have been prevented had Lucky Limited been regulated for AML purposes. 1MDB has shown us that regulation alone does not prevent financial crime. The court proceedings relating to this case included some interesting observations by the courts about the sort of red flags the various parties – banks, other financiers and law firms –should have spotted:

• No marketing of the properties sold by Lucky Limited to the Shellcos
• No use of agents or brokers for the sales transactions
• Absence of surveys
• Minimal investigation of property title
• Solicitors used by borrowers and the Shellcos that were common to them
• Inconsistency of dates – in some cases the date on which properties were acquired occurred before the bridge loan was issued or took place on the same day as the sale

Some of these have been identified in recent typology material, but this case helps to illustrate how these red flags, if looked for, might have raised the alarm for some of these transactions.

Concluding Thoughts

Here are a few of my own observations when it comes to KYC and what we can learn from this case:

• Source of funds and corporate entities – have a clear understanding about how a business is funded, how it generates its profits, whether clients are in any way related or how they are introduced;
• Assess the directors – those with an unblemished regulatory history or a notable history in a field of expertise should not be presumed to be proactive in their roles as non-executive directors (“NEDs”). Are the NEDs intended to play an active role in the governance of the business or do they appear to have been chosen because they are “tame and lame”; and
• Avoid assuming no or low risk due to the involvement of intermediaries – this case involved law firms, conveyancers and other intermediaries –and they all played a role, directly or indirectly in this scheme. In this case, the law firm involved in advising Lucky Limited on the Agreement admitted they did not understand its terms because it was “too complicated”.

Understanding the expertise of intermediaries relative to the deals and activities of a new customer is vital in understanding how much weight this gives to the overall risk profile of that customer

And my final though is this - not all banks are created equal. In this case, it was discovered that High Bank knew that transactions were going to Bank B for Lucky’s account but did nothing to step in and intervene when transactions were being made in violation of the facility agreement. Why not is not really known.

Therefore, assuming that all financial institutions apply the same standards of KYC and monitoring simply because they are regulated, can be a risky proposition.