Paying a high price for toothless regulation


OPINION:Bank directors and managers directly responsible for the evasion of Dirt tax paid no price for their crimes – and thus we now have an even worse mess, writes FIONA O'SHEA

THE BANK bailout will cost the taxpayer at least €25 billion, possibly much more. That bill could have been avoided. Ten years ago, in its Dirt report, the Public Accounts Committee (PAC) warned of the close, inappropriate relationship between banks and the State. It said that bank directors were fully responsible for evasion of Dirt (Deposit Interest Retention Tax) which had been “facilitated” over many years by the banks they controlled.

Significantly, Revenue imposed €230 million in tax and penalties on the banks, but hit bank customers for a much larger €640 million.

Nobody went to jail even though Revenue law, then and now, clearly provides for jail sentences of up to five years. The law says that directors and managers “who consent or connive” should be liable to prosecution.

The first major inquiry into impropriety at the banks led to a clamour for tighter regulation. Then taoiseach Bertie Ahern insisted this should be primarily of a voluntary nature. What we got was a form of regulation which, until recently, was toothless. We live with the consequences.

Today, Central Bank governor Prof Patrick Honohan says that those who committed criminal acts in relation to the current banking crisis should face jail if their criminal acts can be proven.

Just 10 years after the Dirt report, another investigation into banking and how it is regulated is under way.

A statutory commission of investigation into the banking crisis will be set up and should report by the end of the year.

Prior to the establishment of that commission, two preliminary reports will be produced. Prof Honohan will report on the performance of the financial regulatory system. Independent experts Klaus Regling and Max Watson are conducting a preliminary investigation into the causes of the banking crisis and the lessons to be learned.

Whether there is any more likelihood of successful criminal prosecutions following this new investigation is questionable.

Some 142 witnesses from the State, its agencies, financial institutions and external auditors gave evidence before the Dirt committee in public sessions. However, while a few of those interviewed had their knuckles slightly rapped, no prosecutions of bankers (or anyone else for that matter) followed from the inquiry.

Frank Daly, then chairman of Revenue and now chairman of Nama, explained to the PAC in 2004 that Revenue had anecdotal information from people that banks had encouraged them to open offshore accounts, but these people were not willing to give evidence in court.

That there were no prosecutions of bankers following the Dirt inquiry was not due to an absence of relevant legislation. Failure to deduct or to pay Dirt carried fines of up to £10,000 and terms of imprisonment of up to five years. In the case of a company, the legislation provides that “any person who is a director, manager, secretary or other officer or member of the committee of management or other controlling authority of the company and who can be shown to have consented or connived at the offence can also be held personally guilty of the offence and subject to proceedings under the section”.

While it may be difficult to prove individual guilt, the committee had no doubts in general, finding that: “From the moment of its February 1986, bankers began to explore means of continuing to pay interest gross on deposits. The use of bogus non-resident accounts – already long established as a means of concealing capital and income from the eyes of Revenue – now took on an added dimension. Bogus non-resident accounts became a route to evading yet another tax, Dirt. Banks facilitated this, as they had long facilitated deposit splitting and bogus non-resident accounts prior to 1986.”

The committee was highly critical of the financial institutions, their representative bodies and the State agencies in their approach to regulation. It expressed surprise that directors of financial institutions did not bring greater weight to bear on the enforcing of ethical standards.

The deliberate exclusion of industry representative bodies from any role in regulation of banking, they said, had negative repercussions for industry standards. They found that “the boards of directors must accept full responsibility for the companies over which they presided and clearly the role of the board and individual directors of financial institutions requires new guidance, vetting and checking by the Central Bank.”

Interesting in this context that Bertie Ahern, who was taoiseach at the time, should say in December 1999 that he believed the Dirt report highlighted the need for further regulation in the banking sector, but that he favoured that as much of the regulation as possible should be of a voluntary nature.

Preparations were under way for the establishment of a new financial regulator when the Dirt report was published.

It could reasonably be expected that this new financial regulatory authority would learn from the findings of the committee in relation to the Central Bank.

The committee was of the view that the Central Bank had an inappropriate and outmoded approach to supervision in the context of the growing sophistication of banking and the changing role of banks. It also found there was an insufficient concern with ethics and supervision other than from the standpoint of a traditional and narrow concern with prudential supervision in the Central Bank.

So, enter the new Financial Regulator in May 2003 with a remit to monitor the financial soundness of individual financial institutions.

However, this did not turn out to be the dawn of a new era of financial regulation. In fact, when Patrick Neary finally resigned as financial regulator in January 2009, it was after many questions had been raised about failings in the very authority that had been set up to improve regulation.

These failings were well illustrated in the report on the directors’ loans at Anglo Irish Bank, which coincided with Neary’s resignation. The report followed an internal investigation by a committee of the Irish Financial Services Regulatory Authority. It pointed to a breakdown in the internal communications, process and regulatory follow-up response of the regulator’s office which had resulted in a failure to take appropriate and timely actions. The directors’ loans could have been identified earlier, according to the report, if Anglo’s quarterly return had been monitored better.

As always, it seems to be the punter who pays. Following the Dirt inquiry, Revenue collected €225 million from the banks, including interest and penalties of €133.5 million. In contrast, the people who had placed their money in bogus non-resident accounts have paid in excess of €640 million to date, including interest and penalties of over €390 million.

Further investigations into the use of offshore accounts and insurance products to evade tax followed. The total sum collected by Revenue to date in special investigations is €2.6 billion. This is a drop in the ocean compared to the black hole of the banks’ drain on the public finances. And while the State continues to pump taxpayers’ money into this gaping hole, small businesses are being shut down for lack of cash-flow and banks are charging more for services.

According to the Dirt committee: “There was a particularly close and inappropriate relationship between banking and the State and its agencies. The evidence suggests that the State and its agencies were perhaps too mindful of the concerns of the banks, and too attentive to their pleas and lobbying.”

It seems that nothing has changed.

In hindsight, the Dirt inquiry represented a great opportunity to introduce new, efficient controls and regulations of Irish banks and financial institutions.

We’re paying a high price for missing this opportunity.

Fiona O’Shea is a tax and communications specialist. She was a principal officer with the Revenue Commissioners. She is an associate member of the Irish Taxation Institute.

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