The role and effect of indirect demand for proceeds of corruption*

  • February 13, 2017
  • Noemi Gal-Or, Ph.D., LL.B.

Note: This article was originally published on Convivialism Transnational. It is being republished with permission from the author. It has been lightly edited for style and spelling. Please see original article for citations.


Governments, international organizations and non-governmental organizations derive a considerable part of their understanding of corruption and how to counter it from independent research. So far, the supply side of corruption – consisting of those who are requested to provide the funds (and goods, services) in order to have their interests satisfied – has been studied extensively, particularly in the context of international development assistance,1 while the demand aspect has remained comparatively understudied.2 A welcome development is Transparency International’s3 recent attention to the “beneficiary” – the natural person gaining from the corrupt transaction concealed behind the legal person’s veil.4 In this paper, I deepen the analysis by examining the outer circle of beneficiaries, those indirectly profiting from, but necessary to, and one step removed from, the primary corrupt transaction.5 This paper thus tackles the indirect demand side-effect of the corrupt transaction. It focuses on the beneficiary in the residential real estate sector in metropolitan cities who facilitates – deliberately or not, knowingly or not, the laundering hence integration of proceeds of corruption into the housing economy.

Although developed societies have ranked the lowest on corruption indicators,6 their governments having committed to institutionalized cooperation at international and transnational fora, the past decade gives rise to concern. Among the affected areas is the residential real estate sector, especially luxury residences7 attributed to massive foreign direct investment in real estate commercial activity and development. Compared with increasing media reporting, there has been scant scholarly study addressing the demand aspect of corruption which is fuelling this growth. There isn’t any study addressing the indirect benefits accruing to the housing sector satellite industries and to governing institutions inadvertently servicing real estate transactions propelled by proceeds of corruption, and in turn, the demand created for thusly financed real estate transactions. There is no study of the impact exerted on developed societies by indirect demand, nor on efforts to curb it – unilaterally, or collaboratively with like-minded states.

This paper thus queries into uncharted territory. The massive infusion of funds feeding the residential real-estate sector in urban metropolitan centres – Sydney and Melbourne, London (United Kingdom), Vancouver and Toronto, New York and San Francisco – has been attributed to the leading emerging economies – in the Pacific Rim – especially to China.8 An indirect demand for the imported funds has been emerging in the host jurisdictions, which although “invisible” has been responsible for the gradual erosion of the relatively equal distribution of material prosperity in local societies.

Unleashing a ripple effect, in Vancouver, the stormy activity in the real estate market has been upsetting the sense of community in affected neighbourhoods, sowing distrust in the solidity of the rule of law underpinning the political governing institutions.9 In the face of unprecedented material temptation, the resilience of some economic sectors has exhibited signs of attrition; the executive branches of the political governing institutions (municipality, federal and sub-federal levels) have been remiss, first in acknowledging, and then, in withstanding the economic pressure created by money laundered into the country.10 Only recently, as the staggering adverse effects could no longer be ignored, and as elections at the provincial and municipal levels in British Columbia have been drawing closer, governments were forced (by the media) to introduce some mitigating legislation and regulation. Obviously, British Columbia’s receptive economic environment has proven a concern also to the governments suffering tax evasion of funds safely deposited under the false guise of real estate investment. At least since 2015, China has been seeking “under an operation called ‘Sky Net’” 11 to repatriate Chinese nationals it had suspected of corruption.

I use the following analysis to emphasise that anti-corruption policies must look beyond countering the immediate elements of corruption. Unless gate-keeping mechanisms are set up to target also indirect demand for proceeds of corruption, the corruptive contagious spillover into the larger society will not be stemmed.

Unveiling the indirect demand aspect of corruption

Even in the absence of data to ascertain the alleged illegality of funds used to purchase and build residential real estate (including luxury real property and other luxury goods), certain hard facts are nevertheless in the public domain. For one, China’s law imposes a currency control of a personal annual limit of $50,000 US to transfer out of China; the regulation provides for exemption requests, an option very infrequently used. This begs the question as to how many of its nationals manage to purchase homes priced at a rate of 50 to over 100 times higher than the limit; carry out expensive residential real estate transactions in an expedited manner; and demolish the pricey homes only to re-build much pricier ones.12

Another well-established fact is that since the events of 9/11, Canada has instituted a regulation requiring the reporting of any money transfer equal to, and exceeding, $10,000.13 Banks and other financial institutions are legally required to report successive transfers of smaller amounts that within twenty-four hours total $10,000.14 This requirement is aimed at intercepting a common yet illegal technique for laundering proceeds of crime (as well as detecting funds that do not constitute proceeds of crime) and is known as “structuring.” The method consists of splitting large sums of money into smaller amounts to be deposited in multiple and frequent wire transfers by many individuals (“nominees” – family members and other individuals) who do not have an account with that bank, into the bank client’s (another “nominee”) accounts under the guise of legitimate transactions. Such activity is considered suspicious by, and may be in contravention of, Canadian (and other countries’) law;15 it is a form of money laundering when a connected to proceeds of crime,16 which unleashes the adverse effects associated with corrupt practices (social, political, economic, cultural).17

It is important to note that “corruption” is not a legal term and as such does not figure in Canadian criminal law. Corruption is a political, social, economic, and conspicuously cultural, term representing perceptions according to the moral standards of any given society. Elements of corruption, however, are detailed in criminal law, e.g. money laundering, bribery, etc.

The following discussing distinguishes the most obvious economic sectors susceptible to developing indirect demand.

A. Banks

There exists no extradition treaty between China and Canada, and although the two countries have concluded a Canada-China Foreign Investment Promotion and Protection Agreement in 2012,18 it does not include a chapter on corruption (and refers only very generally to mutual transparency commitments). Notably, the treaty exempts taxation measures, tax conventions, and certain information on taxation. Consequently, it is not surprising that Chinese capital flight seeks a Canadian abode and that some Canadian banks have been sought out by wealthy Chinese investors for the purpose of transferring large sums of money to Canada. Since 2012, when China embarked on its anti-corruption campaign, more than 8,200 suspicious transactions have been identified by financial institutions in the Vancouver area, of which 96, mostly suspected for money-laundering, were facilitated by the banks.19 While the banks are legally required to report to FINTRAC any transaction they deem suspicious, they are required neither to stop these actions nor to close the accounts. Although FINTRAC collects and analyzes the information, most of the cases were not reported to police,20 and in any event, Canadian law enforcement bodies lack the resources to deal with structuring scheme cases.21 As mentioned below, recently exposed real estate bad practices bordering on illegality22 have drawn public attention to FINTRAC and doubts as to its effectiveness.23

More often than not, evidence of corrupt practices emerges by accident, notably in unrelated court cases such as those among the 200 British Columbia divorces and other disputes,24 rather than resulting from suspicion of structuring, money laundering or other forms of corruption, and unlawful or unethical actions. Thus, in Ogden25 the issue at trial was whether the employer, the bank, had cause to terminate Ms. Ogden’s employment at a time when the value of her clients’ portfolio, which exceeded $233 million CDN, obviously exhibited success in her work performance. When she was found to have breached the Code of Conduct of the bank’s conflict of interest policy, her employment was terminated. Triggering the infraction was Ms. Ogden’s acceptance of two wire transfers from third parties in China, which she had first deposited into her personal account, then immediately thereafter transferred into a portfolio account of a client of hers. During court proceedings, the bank admitted to facilitating transfers of funds made in contravention of China’s laws, 26 yet correctly maintained that it was not bound by the foreign country’s laws.

In another case – a divorce of Chinese nationals – court proceedings exposed abuse of Canadian legal loopholes for tax-evasion purposes. A six million dollar home and two luxury cars were registered in the wife’s name who was owner of another sixteen properties in British Columbia, the latter subsequently transferred by her husband to his mother’s name.27 Another divorce case involved a wife living in the luxury matrimonial home in Vancouver for six years, all the while enjoying an annual maintenance of $260,000 paid by her absentee husband. According to the latter’s testimony, the funds were obtained from family and friends. His own subsistence, evidence of which he failed to establish before the Canadian court by withholding tax and financial records, amounted to a modest annual income of $19,000.29

B. Real estate

The most visible beneficiary of the housing craze in British Columbia, the real estate sector, has understandably been hesitant to comment on the sources and transfer of foreign investment feeding the industry.29 It had markedly under-reported the volume of real estate purchases by Chinese investors, maintaining it was impossible to appraise the size of the market, and denying the glaring fact of the “empty house” phenomenon, until early 2016, when scandals would rock the sector. Even so, less than a handful of realtors have come forward admitting the real estate firms’ preference of masking the magnitude of the phenomenon and favouring municipal inaction.30

Hierarchically organized, the real estate sector in British Columbia comprises several bodies tasked with overseeing licensed realtors and governed by the Real Estate Council of B.C. Out of its 16 members, only three are provincial government appointees.31 While the Council’s mandate is consumer protection, it has independently carried the responsibility for licensing individuals and brokerages engaged in real estate sales, rental and strata property management as well as enforcing entry qualifications, investigating complaints against licensees and imposing disciplinary sanctions in compliance with the relevant provincial legislation.32 Another pertinent regulatory body consists of the regional real estate boards attending to inter-industry disputes between realtors, which keeps the results of the hearings confidential.33

In early 2016, a media report on so-called “shadow flipping” – a method designed to increase the price of a property and at the same time avoid paying the legally required property taxes – has drawn fire to the real estate governing bodies. Albeit legal because permitted under the “contract assignment” regulatory provision,34 shadow flipping is perceived as highly exceptionable and unethical. Not surprisingly, the convenience of contract assignment has spurred further instances of unprofessional conduct. Use of middlemen or dual agency, whereby a real estate agent acts on behalf of both seller and buyer,35 was laid bare. It gave rise to concerns regarding conflict of interest, withholding full disclosure and involving false and misleading advertisement. As well it described “predatory”36 sales practices comprising undue pressure to sell and buy,37 deliberately inducing price inflations, and in one case ─ even threats of physical violence against a disputing buyer.38

Cascading media reports exposing irregularities, perceived misconduct, unethical practices by single realtors and shady routine business by real estate firms have undermined the public trust in the industry and the government’s oversight, and propelled vehement criticism also from trade insiders faulting both the Real Estate Council for leniency in dealing with unprofessional conduct by realtors39 and the Real Estate Board of Greater Vancouver.40 Eventually, the provincial government, long in denial of the issues plaguing the sector, was compelled to establish an independent real estate panel to examine the allegations.41 The resulting damning report set in motion a governance reform process beginning with the institution of direct governmental oversight over the real estate industry in British Columbia.42

C. Accountants and lawyers

Several Canadian accountants and real property and tax lawyers have been drawing attention to the inadequacy of Canada’s tax regime in face of the new circumstances wherein massive capital flight from China has been channelled through spouses and children.43 Frequently, housemakers, students, or corporations (and purchasers’ self-representation as “business persons”) listed in real estate records as property owners have served to conceal the identity of the actual real estate buyer and seller.44 According to the CRA, any person with a primary residence in Canada must file resident tax returns and report income, and non-resident ownership of real estate property is not exempted from capital gains levies and other taxes on profits accruing from such proprietorship. Therefore, when an owner of a home valued over $1 million reports no earned income (housemaker, student), or when an owner claims to be non-resident but fails to produce a tax return from the foreign jurisdiction, Canada loses income.45 This is also the case when foreign legal ownership is transferred within the family or to shareholders within a corporation.46 While the real estate self-governing authority maintained that it conducted investigations have been underway, it rarely implemented sanctions.47 Moreover, availing themselves of these loopholes requires resort to the knowledge possessed by lawyers and accountants. Canada has yet to legislate a provision barring lawyers from invoking solicitor-client privilege, and prohibit various accountancy practices in order to counter these gaps.

D. Politicians and political parties

The perception of corruption in the residential real estate market owes also to media revelations of private and corporate donations to political parties at all levels of government associated with the real estate sector. Media accounts have pointed at cases involving the Liberal Party of Canada. Notably, a significant donation preceding the 2015 federal election was made to the party by a residential property developer in British Columbia. The developer’s name was listed along with other Chinese nationals suspected as fugitives wanted on corruption charges by the Chinese government.48 The same person made donations also to the Mayor of Vancouver and Metro Vancouver region’s municipal politicians including the Mayor of the City of Richmond.49

At the provincial level, the surfacing of data on donations to the Liberal Party in Ontario and British Columbia have given rise to criticism of impropriety and unleashed heated debates in both media and the public.50 British Columbia’s ruling Liberal Party has been in the habit of organizing exclusive, closed fundraising events for select wealthy invitees – corporate executives in the natural resources, real estate, and other lucrative economic sectors in the province,51 with contributions ranging from $5000-$20000 per person.52 Carried out throughout the term of government, these events are separate from fundraising during an election campaign period. For these fundraising efforts, the premier was compensated by her party with a $277,000 “stipend” out of the funds collected during four years since she assumed her premiership.53 The province’s most noted real estate magnate, who had been entrusted by the party with the fundraising, bragged to the media of helping raise nearly $5 million during his four years of service.54 In response to concerns about the residential real estate squeeze, he urged Vancouverites to renounce the single family home dream,55 and suggested the premier invest in a transit system to improve transportation from the suburbs into Vancouver rather than encourage housing affordability in the city.56

A perception of conflict of interest due to the almost intimate relationship between the city, real estate developers and realtors in Vancouver, has long preceded the current housing market crisis. Coinciding with the revelations on provincial Liberal Party fundraising, the same director of fund raising for the premier is reported to also figure among of the most powerful financial backers of the Mayor of Vancouver.57

That politicians have been promoting exponential growth in the residential real estate sector is not surprising. Growth secures political rewards in the form of electoral votes, and indirect beneficiaries are numerous: Homeowners who benefit from the rising prices of their homes, realtors, financial institutions, developers, construction and related trades and suppliers, lawyers, accountants and others whose profits have swelled beyond imagination. This may also explain the politicians’ reluctance to study the impact of foreign investment on the residential real estate market, thereby signalling that the city, province, and country were open for business.58 Indeed, rather than join efforts with other urban metropolitan centres experiencing similar pressures, they preferred the competition.

A brief conclusion

The year 2016 marked a turning point in the public discussion concerning the residential real estate in Canada. Following the establishment of provincial governmental oversight on the real-estate sector in British Columbia; the introduction of a 15 per cent tax on foreign real estate purchases;59 and a steep penalty on “empty houses” in Vancouver (subject to voluntary reporting),60 the home-buying frenzy has moved eastward to Toronto. Yet 2017 is an election year in British Columbia and current policies may change. It also remains to be seen whether the federal fiscal and financial policies, including limitations on mortgage purchases (applicable to residents and foreigners),61 and the Canada-China agreement to negotiate an extradition treaty62 will prove effective. Notably, the three levels of government did little if anything to target the indirect demand for the funds pouring in to, and driving the unsustainable growth in, the residential real estate market,

Thus, it is left for the media, through the perseverance of its diligent journalists, to continue to flag the self-perpetuating spiral originating in the strong incentive to benefit from investors awash with funds seeking safekeeping of, and fast and speculative profit-making from, residential real estate. While law enforcement agencies are bound by the limits of a porous law and a lack of human resources, relevant research and reform proposals by concerned organizations (e.g. Transparency International Canada), and new case law regarding solicitor-client privilege and maintenance of rules of books and records of account may stimulate executive and legislative corrections.

Noemi Gal-Or is Chair of the CBA National International Law Section. Contact