The Systemic FinTech Revolution

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Fiscal 2018 has been a momentous year for US financial technology (FinTech) organizations. On July 31, 2018, the Office of the Comptroller of the Currency (OCC) began the process of accepting applications from non-depository FinTech companies for a special purpose national bank charter. Such action has been spurred by the Trump administration’s call for a regulatory climate that supports financial technology and innovation, mandated by the US Treasury Department under Executive Order 13772. The OCC’s special purpose charter allows FinTech Companies to have nationwide operations as opposed to needing state-by-state licensing per transactions. FinTech companies that qualify cannot obtain FDIC deposit insurance, as the most glaring requirement revolves around the non depository nature of all FinTech banking transactions.

All FinTech companies under this umbrella may participate in lending services and facilitating payments without any need to partner with traditional banks. Financial policy under the National Bank Act will now govern FinTech companies that fall under his new banking status. Specifically, reporting requirements which pertain to the Dodd-Frank Act, “CAMELS” supervision and all legal lending limits now count for FinTech companies. Such inclusion of FinTech into mainstream banking compliance marks an important turning point in our financial system, one where we finally recognize FinTech as a systemically important financial entity that is rapidly changing the fabric of both microeconomic lending and macroeconomic advancement.

Professor Saule T. Omarova of Cornell Law School (CLS) has delineated concrete insight into impacts of FinTech’s systemic importance. Financial experts, governments and policymakers have only recognized the longevity of financial technology in the last five years. For most, early FinTech was considered purely disruptive in a democratizing fashion: providing unorthodox financial solutions to outlier demographics such as lending to less wealthy demographics, or providing currency alternatives to speculative renegade traders. However, the advent of Blockchain technology’s wide reach into countless industries has propelled FinTech as innovative, stabilizing and fostering of long term growth. Policymakers are now realizing that disruptive does not mean destabilizing!

Omarova’s CLS whitepaper “New Tech v. New Deal: Fintech As A Systemic Phenomenon” makes the point to not trivialize the impact which FinTech has on the financial system. As stated, FinTech’s systemic and vastly growing influence on the structure and velocity of global payments cannot be ignored. According to Omarova, global financial policymakers have thus far treated the issues that challenge FinTech – cybersecurity, regulatory governance, legal obscurity, transactional accountability – as natural glitches to be naturally worked out in the private market. However, as Omarova so rightly says “money and power are two sides of the same coin…Finance is, and always will be, a matter of utmost and direct public policy significance.” FinTech commands systemic power, and it is best to include FinTech players in the wider audience of finance. Long standing behemoths such as Goldman Sachs have been savvy in the adoption of financial technologies such as bitcoin derivatives trading. Institutions such as the OCC must recognize the same.

Debevoise & Plimpton LLP via the Columbia Law School Blue Sky Blog examined further changes to the US regulatory framework, recommended by the US Department of Treasury, which will aid further financial technology innovation in the mainstream financial system. These are as follows:

  • The creation of a FinTech Industry Advisory Panel comprising both state and federal agencies to pilot regulatory sandboxes for early stage FinTech companies. Regulatory sandboxes are common in the United Kingdom, and allows regulators practical insight into growing financial technology.
  • Marketplace Lending, where banks will be fully identified as the official lender of loans originated, even if these loans are sold to multiple third parties. In this manner, financial accountability is easily identified.
  • Clarity in regards to the Federal Reserve Board’s definition of “control” within the Bank Holding Company (BHC) Act. Specifically, the definition must clarify and support BHC permissible investment activities in financial technology.
  • Third-Party Oversight, where compliance checks along the bank supply chain has led to an over abundance of costs. There needs to be blanket standardization of such costs.
  • Regulators need to provide more consistent and facilitating rules pertaining to credit modeling and data without impeding accuracy and privacy.
  • The standardization and flexibility of payments and transmitter requirements are uppermost to ensure systemic flow within the financial system under FinTech, as financial technology continues to capture a huge bulk of the payments sector.

These recommendations from the US Department of Treasury come under the auspices of Executive Order 13772, and support US financial system growth and innovation. State and Federal policymakers must continue to harmonize regulatory framework to harness the systemic power of US financial technology.

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Emerging Markets Infrastructure Project Investment: Issues and Opportunities

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Global investment in real estate and infrastructure projects are on the rise. Preqin’s 2018 Infrastructure Fund Manager Outlook notes that institutional investors have heavily invested in the infrastructure asset class for solid diversification and stable returns. Indeed, the report ascertains aggregate asset under management (AUM) quadrupled from US$99bn to US$418bn over the past decade. The industry is expected to increase exponentially over the next decade. Globally, North America and Europe present the most viable of real estate and infrastructure opportunities. However, a bundle of emerging markets economies follow a close third. Global emerging markets infrastructure investments are currently fueled by Asia Pacific’s growth as opposed to other developing regions. Total deal value for the Asia Pacific amounted to roughly US$50bn over the past five years, with more dry powder allocated to projects within Asia.

Feasible emerging market infrastructure projects usually have a Public Private Partnership (PPP) structure, especially for risk mitigation. As we had examined in US Infrastructure: A Case for Public Private Partnerships, PPPs are beneficial as the private entity internalizes life-cycle costs during the majority building phase of new projects, while the project is listed as public investments on the government balance sheet. Purely public sector projects tend to be inefficient, and have full political risk, while purely private projects may have higher returns, but would not have the accountability of check and balance which sovereign involvement brings. Even so, there are many challenges which investors, financiers, and infrastructure fund managers must take into consideration primarily for emerging markets.

Challenges Faced:

The Macquarie Group is one of the global leaders in asset management with US$356bn AUM, and is considered to be the top global infrastructure finance advisor as at 2017. The Group has dispensed significant pain points and mitigating factors with regards to project investment in emerging markets. Most issues stem from long standing bureaucracy, lack of transparency, corruption, geopolitical and cross border risks. Highlights are follows:

Bid and Post-Bid Processes:

In short, red tape from every conceivable side of the project is challenging at best. Emerging markets tend to have delays in bid preparation, unclear bid guidelines, erratic time to submit request for proposals, and restrictive bid processes which place heavy tariffs on the build-operators of the project. In addition, project ‘hand-holding’ requires higher cost of bid bonds and of additional advisors, planners, quantity surveyors and numerous government officers. In addition, deciding on the best commercial funding structure for the PPP would most likely not be as clear or timely as with developed country projects. For instance, financing default from the private side of the PPP may lead to immediate freezing of project assets, as opposed to debt coverage negotiation.

Terms of Concession Agreements:

Land Acquisition is one of the most troublesome components of the project process in emerging markets. The land surveying, land release, ground approvals and resource rights processes, especially in real estate type transactions, take an inordinate amount of time. The best PPP investment projects that may circumvent this onerous component would be public works and transport type projects, where the government already has clear ownership of the sites in question, with full government use of site resources. Also, there is a huge communication gap in terms of the types of environmental and regulatory requirements needed for all emerging markets projects. As the Macquarie Group states, most delays in their infrastructure portfolio stems from having to backtrack and fulfill regulations that were not mentioned from pre-bid inception onwards.

FOREX Challenges:

Forex issues come in second only to land acquisition challenges in emerging market PPP project fulfillment. This is by no means theoretical as I am currently battling this challenge. In many parts of LATAM & the Caribbean multi-million infrastructure developments are offered a mere US$200.00 a day by Central Banks due to paucity in supply and treasury mismanagement. From an investment perspective, Forex volatility for projects denominated in local currencies may create lower yields due to cross border risks, and hedging for many emerging markets currencies is not available.

Macroeconomic Inefficiencies:

In addition to the Macquarie Group’s points supported above, project developers and financiers know that labor supply, labor quality, labor laws, as well as tariffs on materials, material supplies and weather factors are extremely dictating of successful project fulfillment. Most emerging markets may seem to have a dearth of labor supply. However, educated construction labor may be hard to find, and to keep. Many viable emerging market infrastructure projects that have been fully funded have stalled indefinitely due to a lack of both construction and management labor. Unfortunately with PPPs government policy would require local labor to be sourced, creating a chicken and egg situation.

Solutions Presented:

Emerging market project development, financing and investment fit in with high risk, high reward appetite. Yet as we mentioned before prudent infrastructure investments give solid returns and add practical diversification to portfolios. Therefore emerging markets project financing and investments are not to be avoided, but to be mitigated. Successful project investment takes a great deal of sovereign and macroeconomic research, whether per project or via an infrastructure fund. The Macquarie Group pinpoints several requirements needed for investor comfort when it comes to infrastructure investing, and especially for emerging market conditions.

  1. Stable Political Environment:

    Note that a stable political environment will not mitigate red tape. However, mitigated political risk allows PPP projects to be safeguarded against event risks such as coups, and freezing of foreign investments.

  2. Stable Economy with Growth Potential:

    Overall a stable economy with high credit rating gives comfort of low default risk. However, it is necessary to delve further into macroeconomic variables such as labor and capital intensive predilections. Does the country have stringent union interests? Does the country’s labor have the educative capacity to cost effectively get PPP projects done? Are there punitive tariffs on capital intensive projects? It is necessary to ensure the emerging market country accounted for PPP infrastructure projects in its annual budget, broken down by sectors such as transport, seaports, utilities etc.

  3. Open and Transparent and PPP Bid Process:

    Is the country’s public procurement and bid processes in line with international standards and policy frameworks? What is the track record of successful PPP projects in terms of pre-bid to completion timeline? It is necessary to be in close contact with the country’s department of public works, transport and infrastructure to get a detailed log of such a track record before investing in any project, or in any fund.

  4. Stable Financial Market:

    This one is tricky for actual returns, especially as most emerging market projects are structured in local currencies. If investing in an infrastructure fund, the risk is mitigated. If there is direct investment in the PPP project, the risk is heightened, no matter how stable the financial market is. And don’t be fooled by oil-based emerging market countries. One would believe that such countries would have strong cross border Forex capabilities. However, if the projects are non-energy infrastructure, FX paucity and volatility can still be an issue. It’s necessary to examine the country’s central bank and its monetary policy beforehand.

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Family office growth and governance

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Family offices are powerful, a financial force to contend with. Even many in the financial world have yet to understand the family office’s sheer influence, especially when retail investing, private equity and venture capitalism have the limelight. The family office has deliberately preferred to remain relatively incognito when it comes to announcing investment and wealth management strategies.

The family office serves as wealth and trust management of high net worth families. Families can be defined as multi-generation family businesses, as well as high net worth individuals who may have come into inheritance or independent net worth. The family office can comprise an individual, department or separate firm whose sole objective is wealth management and legacy planning for the family. The single family offices (SFO) serves the investment needs of one family while the multifamily office (MFO) is structured much like an asset management firm, providing customized wealth management and planning to a larger number of families and high net worth individuals. This explanation may sound simple; rest assured, the family office structure is one of the most complex in the entire investing sphere.

Family offices are on the rise, and institutional investors are feeling the effects. U.S. Bank’s Ascent Private Capital Management has coined the term “insti-viduals” to describe the marked increase in family office dealflow usually presented to traditional institutionals such as pension funds. And why should the finance industry be surprised? We have had constant challenges with U.S. public pension funds and alternative investors such as hedge funds metting out disappointing returns. While traditional institutionals and hedge funds are very regulated, family offices do not have to register with regulators once investment advice is kept within ten generations of ancestry.

According to Campden Research’s most recent family office report, family offices hold more than US$4 trillion of assets, and the global average for assets under management (AUM) comprises US$921 million. Family offices are fast approaching the alternative investment cumulative AUM of US$5.7 trillion, albeit with much less sensastionalism. Indeed, The Wall Street Journal reports that since 2011 three dozen hedge funds have converted into family offices. The symbiosis between family offices and private equity is also strong and growing, where family offices are taking higher stakes in private equity deals.

Such astounding growth demands a inherent need for continuity. We are confident that the family office is stepping in to fill investment gaps left by failing institutionals and alternative investors. Upon exclusive study of the Family Office Exchange’s FOX Guide to the Family Office, The Family Office Club’s Family Office Report and Trusts & Estates’ expert panel discussion of The Famiy Advancement Sustainability Trust (FAST), we suggest beneficial processes for family offices. In this regard, measures of internal policy ensure family office longevity and legacy.

The Family Office Exchange (FOX) stipulates critical management issues faced by family offices:

  • Goals for the Family and Roles for the Family Office: Ultimately, family investment, philanthropic and legacy objectives dictate the family office’s focus. Issues are further subdivided by:
    • Ownership and Governance;
    • Scope of Services and Delivery Process;
    • Cost of Offices and Allocation of Fees;
    • Operating Structure and Management Talent;
    • Network of Internal and External Advisors;
    • Communications and Client Reporting;
    • Back Office Systems and Procedures.

FOX Family Office Benchmarking™ provided surveyed data from its family office membership concerning family office risk perception. Most families are initially worried about financial and operational challenges. Business risks such as talent acquisition, operating structure, and investment advisory comprise a hefty 37% of the families’ risk perception. Economic and financial risks comprise 26% of risk concern. However, when it came to actual family challenges such as legacy continuity, the family risk perception measured a mere 7%. Via Trusts & Estates’ Family Advancement Sustainability Trust (FAST) analysis, the risk reality shows quite the opposite.

On examining the quantitative and qualitative data of family business challenges affecting the family office, roughly 60% of disruptions and failure stemmed from family communications and generational problems, while only 3% of issues arose from financial and investment advisory challenges. Talent and advisory acquisition in the financial industry does not pose a threat to the family office in our current workforce environment. The Institutional Investor reports a marked increase in hedge fund managers either leaving lagging funds to manage family offices, or converting hedge funds into family offices for streamlined clientele. Private banking divisions at Citigroup, Morgan Stanley and J.P. Morgan have dedicated top senior bankers to be primarily responsible for multifamily office dictates. Family offices have a wealth of investment and estate talent to choose from. Given the flexible regulatory nature of a family office, top talent once constrained in the institutional arena may find room to expand expertise for the family office. In short, it is truly the “Ownership and Governance” issue that needs prioritized attention.

FAMILY OFFICE GOVERNANCE

As with any enterprise, family office governance policies need to be formulated long before execution of any financial and operational implementation. Family offices are in need of much more qualitative guidelines for business and wealth continuity. The Family Office Club based out of Key Biscayne, Florida gives specific insight into structuring family office ownership and governance guidelines via The Family Office Report. Remember, unlike standardized business or investment firms, each family office would have highly tailored objectives, so customization of certain objectives and criteria would be necessary. However, this framework helps with organizational structure across the board. Key components are as follows:

  1. Mission, Vision, & Goals:

    The mission is the starting point for what The Family Office Club coins “The Family Compass.” Family businesses may already have commercial mission and vision statements. However, the family office is responsible for management of the actual family’s qualitative mission, vision and goals. These are high level objectives for wealth creation, succession, philanthropy and legacy.

  2. Ethics & Values Policy:

    The ethics and values policy defines what is acceptable to the family’s core values when it comes to external talent, vendor transactions, business acquisitions, paths of philanthropy, and internal code of conduct. The ethics and values policy covers all issues of compliance such as money laundering, insider trading and bribery concerns. This policy should be reviewed consistently in strategy sessions with both family and external professionals within the family office.

  3. Investment Mandate:

    As expected, this mandate delineates family office investment governance. The investment mandate sets the investment criteria and asset class composition of investments for the family office. All taxation, income growth, wealth creation strategies, liquidity concerns and payout requirements must be detailed in this mandate. According to the Family Office Club, the Chief Investment Officer is responsible for the creation of this mandate, along with input from the CEO and vested family members. The mandate can be revised on a monthly basis. Quantitative social capital investments and philanthropic endowment strategies should be included in this mandate, if applicable. This mandate also aids the family office in shareholder activist campaigns when the need arises.

  4. Key Performance Indicators:

    Key Performance Indicators (KPIs) are highly detailed and action specific dictates per each member of the family office. Measurable outcomes are expected for involved family members and external hires. We would suggest broad KPIs be set for all external vendors, businesses and asset managers who deal with the family office. The Family Office Club suggests creation of at least three KPIs per member, as well as three “smart numbers” comprised of various KPIs for the entire family office.

  5. Systems & Processes:

    Systems & Processes here covers the details needed for organizational continuity within the family office. Where the ethics and values policy or strategic plan may deal with broad succession planning, systems and processes deal with the documenting of detailed processes carried out per member, so that in the case of natural causes or termination, talent or legacy replacement can occur without severe disruption to actual procedures. According to the Family Office Club, each member may add to a mini-process book, which then should be reviewed by selected family office executives.

In addition to the governance policies stated above, the family office will greatly benefit from the creation of a Family Advancement Sustainability Trust (FAST). The FAST is a brainchild of Marvin E. Blum, JD, Thomas C. Rogerson, Gary V. Post, JD of the Blum Firm. The FAST has the structure of a directed trust, but encompasses more than the typical mandate for disbursement of funds to heirs or philanthropic beneficiaries. In the authors’ own words, the FAST is “A pool of funds to invest in the family members—in the family relations, development, and advancement—rather than just distribute to the family members.” The FAST comprises four committees: the Trust Protector Committee, the Investment Committee, the Distribution Committee and the overall Administrative Trustee. Both family members and outside professionals within the family office comprise these bodies. The FAST is primarily for continued family education, family cohesiveness and legacy in both qualitative and quantitative concerns.

The family office has existed across geographies and dynasties, quietly providing funding and making investments long before our global banking system came into play. Modern day family offices are now formalized, and are stepping in to fill investment gaps that are fast being created by lagging institutional and alternative investors. Thus, it is of utmost importance that existing and newly created family offices implement solid governance practices to ensure financial, operational and legacy continuity.

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The Looming Public Pension Fund Crisis

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The United States’ public pension funds are in a terrible predicament. As of August 2017, Bloomberg reported that 43 out of 50 States have had a disturbing increase in their funding ratio gaps, with only District of Columbia being overfunded out of all 50 states. The PEW Charitable Trusts reports that overall, the public pension fund system is underfunded by more than US trillion, with a record number of Baby Boomers going into retirement. These events spur not only financial, but social crises. If retirees have learnt no wealth creation and preservation techniques other than a dependence on pensions, the U.S. may face a widening of socioeconomic strata en masse.

Initially we blame local and state governments for failing to meet tax dollar fund contributions, and rightly so. Wayne Winegarden, Sr. Fellow at the Pacific Research Institute, states that from 2001 to 2015 total state contributions only met 88% of total nationwide contribution requirements. Full contribution is not expected in the short term, due to increased pension liabilities. States such as Oregon, Minnesota and Colorado have funding ratios gaps of more than 10%; Minnesota’s funding ratio worsened by a whopping 26.6% for FY 2016. That is terrifying from an economic standpoint, filled with nationwide implications reminiscent of Detroit’s 2013 bankruptcy filing. As Winegarden clearly points out, there are three fiscal policies that can mitigate worsening funding gaps:

  1. Cut promised pensions;
  2. Levy future tax increases;
  3. Reduce future government spending.

In addition to these fiscal mitigating policies, public pension funds need to adjust fund return expectations. From the late 1990s to 2000 both private and public pension funds had similar return projections approximating 8%. However, while private pension funds have adjusted fund expectations to consider the tech crash and Great Recession repercussions, public pension funds by and large have not. Indeed, private pension funds now have an adjusted return of approximately 5%, while public pension funds still have expected returns of 8%. Yet, the funding ratio gap widens for 86% the United States’ public pension system.

Second to consider is the change in asset allocation within public pension funds over the past decade. Public pension funds have made a marked shift to alternative investments for portfolio diversification, which have heightened risk and reward implications. The Pew Charitable Trusts (PEW) April 2017 report, State Public Pension Funds Increase Use of Complex Investments, give a thorough overview of issues and challenges regarding the state pension fund system. According to the PEW report, public pension funds have undertaken a stronger portion of alternative investments within fund portfolios that require customized expertise, different from stock and bond management. From a governance perspective, the PEW report states that overall most public pension fund boards may have been lacking in expertise to be part of investment decisions of such complex caliber.

The PEW Charitable Trusts report does not purport that alternative asset allocation is the reason behind our failing public pension system. The PEW report relates that there was no solid correlation between the use of alternative investments and fund performance. However, the PEW report found that pension funds with “long-standing alternative investment programs” outperformed similar funds that made trigger decisions to add alternative investments to the portfolio, where the original strategy consisted of mainly conservative investment vehicles. For instance, the Washington Department of Retirement Systems (WDRS) has one of the strongest track records in fund performance, and has had an alternative investment strategy since 1981, with 36% alternative asset allocation. Conversely, the South Carolina Retirement System (SCRS) quickly changed its fund portfolio to 31% of high yield alternative investments based on a 2007 state stipulation, with 10 year returns decreasing from 8% to 5%, even with a higher risk/reward objective. In addition, public pension fund valuation reporting for both fixed-income, public equity, and alternative investment portfolios has led to confusion in fund performance evaluations.

Third and the most insidious issue is the gargantuan rise in investment fees which public pension funds have faced. The PEW Charitable Trusts clearly delineates that public pension fund allocation to alternative investment vehicles has increased fund investment fees to aggregate US$10 billion as of 2014. Reported fees as a percentage of total assets have increased by 30% to date. And, these figures pertain to reported fees. Unreported performance fees carve a hefty portion of gross fund returns and can remain undisclosed depending on state fee disclosure requirements. According to the PEW report, unreported fees may amount to US$4 billion per annum. Public pension funds need to invest in higher yielding assets, since on the fiscal side contributions are sorely lacking. However, if total investment fees outweigh net returns, we have a further exacerbated public pension liability position.

The PEW Charitable Trusts give specific recommendations to begin the process of effective internal governance within the public pension fund system. Highlights of these recommendations are as follows:

  1. Public pension investments now have higher risk in portfolios comprising bond, stocks and alternative investments. Investment policy statements must be made fully accessible online for all stakeholders. All statements must fully disclose investment strategies.
    1. Include performance results by asset class, to highlight the performance and cost of all utilized investment strategies.
  2. Performance reporting is extremely inconsistent within state public pension funds. Some states report gross of fees, while others report net of fees. All public pension funds should report both net and gross of fees regardless of positive or negative returns.
  3. Public pension funds do not report comprehensive undisclosed fees such as carried interest. Include line itemization of fees paid to individual investment managers in comprehensive fee reporting.
  4. Most public pension funds report returns in a 5 to 10 year window. It is recommended to increase fund performance reporting to a 20 year horizon to get a fuller understanding of long-term strategies.

A combination of strong fiscal and governance policies at the state and local level are immediately needed to restructure the public pension fund system, and curb the worsening funding ratios over 43 of all 50 states. Public pension funds need to fully admit the glaring issue of underfunding, and possibly look to successful funds such the Oklahoma Teachers Retirement System or the Washington Department of Retirement Systems for replication of certain investment strategies. State and local overspending on aesthetics and mismanagement needs to be curbed and channeled into the basics, such as pension fund contributions. We cannot depend solely on the U.S. federal government to prevent such a financial catastrophe as possible public pensions default. It is up to the state and local governments to take a long, hard look at current mismanagement and ineffective governance, and bring pension contributions back to positive. We cannot have a replay of Detroit’s 2013 pension fiasco pan out over 43 states.

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The FATCA Debacle Requires Repeal

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In April 2017, U.S. Senator Rand Paul (R-KY) finally brought efforts to repeal the Foreign Account Tax Compliance Act (FATCA) to U.S. Congress. Senator Paul further testified before the U.S. House Oversight and Government Reform Committee’s Government Operations Subcommittee on the benefits of FATCA repeal. According to Senator Paul, “FATCA disregards the Fourth Amendment and privacy rights by requiring the bulk collection of innocent Americans’ financial records.” FATCA, enacted in March 2010 to December 2012, purportedly serves to detect, document and collect taxation on non-US financial assets of U.S. citizens and legal U.S. immigrants. According to the IRS, over nine million U.S. corporate entities and individuals fall under FATCA reporting requirements. FATCA has been supposedly introduced to provide transparency in international tax policy, especially pertaining to traditional offshore private banking activity. In 2015, the now infamous leak of Mossack Fonseca’s Panama Papers further exacerbated banking privacy laws, forcing an even more punitive FATCA enforcement regarding offshore transactions.

Good governance requires transparency. However, should transparency hold a country’s citizens to reporting ransom without taking context into play? Most U.S. citizens holding accounts abroad may have professional duties that require a foreign checking account, or that requires dual signature on guardianship accounts with parents, children and other family members. Not all offshore accounts are created to hold nameless shell companies such as was exposed via the Panama Papers fiasco. Yet, U.S. citizens under onerous FATCA reporting pay a heavy price in both documentation and in dollar amount. Since 2010 the international offshore community has found it nightmarishly difficult to handle new U.S. clients that may cause bureaucratic and legal issues with the IRS. Chapter 4 of Code Sec. 1471, FATCA, demands that IRS withholding agents garnish a whopping 30% of foreign financial institution income concerning U.S. citizen accounts, even on minor reporting errors.

The FATCA reporting process is confusing at best. The FBAR filing, also known as the Report of Foreign Bank Accounts, FinCEN Form 114 or TD F90.22-1, is not the only filing that is due to the IRS. The majority of fined U.S. taxpayers fall under this unfortunate category. All U.S. citizens with non-U.S. financial assets must also file Form 8938, which is the Statement of Specialized Foreign Financial Assets. As confirmed by Parent & Parent LLP, IRS penalties for non-filing are as follows:

  • A non-willful penalty, not to exceed US$10,000, may be imposed on any taxpayer who violates or causes any violation of the FBAR filing and record keeping requirements;
  • A willful penalty may be imposed on any taxpayer who willfully fails to file the FBAR, with the cap on the penalty being the greater of US$100,000 or 50% of the balance in the account at the time of the violation.

As we see, IRS penalties are enforced regardless of intention, and can also be implemented if the filer has all documents correctly submitted, but may be one day late.   It is noteworthy that any account in question need not be active and running over with funds to be penalized. In other words, Grandma’s account opened for her dual citizenship grandchild abroad, with no more than US$1500 in total, will be up for an IRS fine of up to US$10,000 if reporting errors are unintentionally made.

In addition, while the statute of limitations for FBAR penalties is 6 years, the statute for Form 8938 is limitless, and applies to an individual’s entire tax return. Specifically, this means the IRS can choose to conduct yearly audits on the faulted individual for an entire life span. The need for tax governance and transparency should not amount to such legal punishment, especially for individual clients.

Double taxation and or double tax reporting under FATCA have made U.S. citizens residing abroad vulnerable to legal shenanigans. And contrary to popular sentiment large corporations and multi-billionaires are not being punished as harshly as are U.S. expats, U.S. professionals abroad, and U.S. citizens who have foreign families with regular accounts abroad. As Parent & Parent LLP satirically stated, a foreign drug lord with stacks of cash parked offshore is safe tax-wise in comparison the average U.S. citizen affected by FATCA’s punitive international tax dictates. Senator Rand Paul and Congressman Mark Meadows (R-NC) have recommended the following steps to U.S. Treasury Secretary Steve Mnuchin regarding FATCA repeal:

  • To introduce the issuance of a Statement of Administration that welcomes the FATCA repeal not only as a stand-alone tax problem, but as an integral part of the total tax reform package to be drafted and enacted by the Trump Administration.
  • To cease and desist the signing of any new intergovernmental agreements (IGAs) enforcing FATCA reporting until the U.S. House can review and act on the FATCA repeal bill.
  • To review existing IGAs under the U.S. Treasury’s jurisdiction, and to declare invalid ab initio any IGA that the U.S. Treasury deem unfit upon examination.
  • To grant temporary compliance to foreign financial institutions that have been found unfairly impacted by FATCA dictates until full review by the U.S. Treasury.
  • To instruct the IRS on granting provisional ‘mercy’ to U.S. individual taxpayers who especially have not willfully made errors on FATCA reporting.

We applaud Senator Paul and Congressman Meadows in their endeavors to repeal FATCA and redefine such an abysmal international tax policy that serves to burden the U.S. individual taxpayer involved in international banking. In addition, U.S. citizens involved in long term financial transactions abroad should seek U.S. legal counsel in regards to FATCA reporting, and not leave such documentation solely up to the discretion of a foreign financial institution or a foreign CPA.

 

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