Siren Songs From Offshore

In Greek Mythology, sirens were dangerous creatures that were part woman, part bird, and lived on a flowery island. Passing sailors were compelled by the sirens’ enchanting music and voices to shipwreck on the island’s rocky coast. From this story, the term ‘siren song’ came to refer to an appeal that is hard to resist but that, if heeded, will lead to a bad result.

When navigating the murky waters of offshore finance, sirens are financial advisors who lure customers with promises they cannot deliver – for example low risk investments that are assured to provide high returns; or lower tax bills through secret accounts. Many smart, experienced and sophisticated investors have fallen for what can be a very seductive sales pitch.

Conflicts of Interest
Most people have a very limited knowledge regarding offshore investments, and count on their financial advisor to tell them what they need to know to make a wise decision. However, the vast majority of financial advisors are paid commissions from product and service providers. This creates a significant conflict of interest – where the consumer is relying on objective advice from an advisor that is being paid to sell products. Abuse stemming from this type of arrangement is the reason that governments in the UK, India, and Australia are taking steps to ban commissions for financial advisors.

Secrecy Disappearing
One relatively common misconception about offshore finance is that bank secrecy enables clients to avoid taxes. Some advisors claim that tax havens and offshore financial institutions will not succumb to pressure to report account information to tax authorities. The reality is different.
Lichtenstein, for example, is a tax haven that has long prided itself on ‘rock solid’ privacy laws. Nonetheless, in 2008, a clerk at Lichtenstein's LGT Bank broke those laws and sold a DVD of client account information to tax authorities around the world. Between pressure from high-tax governments and breaches caused by rogue employees, tax saving and asset protection strategies that rely on bank secrecy are fast becoming obsolete.

Foreign Real Estate
The idea of owning a house or apartment in an exotic country is one that appeals to many. To make the sales pitch more enticing, a number of foreign real estate promoters use glossy brochures and flashy websites to promise impressive returns within a relatively short period of time. One recently caught in my spam filter advertised a 205% return on investment for a development in Phuket, Thailand.
Projections like this usually rely on the “greater fool theory” – buying real estate not because you believe that it is worth the price, but because you believe that you will be able to sell the real estate to someone else for an even better price. Property values do not always rise, and a number of investors end up stuck with property worth much less than what they paid for it.

‘Offshore Investment Plans’
‘Offshore investment plans’ are another type of investment to watch out for. These are investment-linked life insurance policies, sold by large numbers of unregulated ‘independent financial advisors’ in Shanghai and throughout China. Promoted as a way to save for retirement with promises of tax free returns, people sign up for terms as long as 20 to 30 years.
The tax benefits of these plans actually depend on the investor’s circumstances, where they are living, where their tax residence is, and so forth. For Americans, taxes could be a big problem. For people that return home to somewhere in Europe, these would oftentimes become tax deferred, and then taxable as income once you start taking distributions. It’s unnecessarily risky for anyone to lock themselves into an offshore financial product for 20 to 30 years when so much can change - for themselves and even tax laws.
The reason these investments are so frequently recommended by financial advisors is because they are tied to some of the highest commissions in the industry. Investment-linked life insurance is an extremely profitable product for the insurance industry (profits come through fees and charges). Investment and insurance products that are more profitable (i.e. more expensive to the investor), are naturally tied to higher commissions for the advisors recommending them. Unfortunately, commissions create a strong financial incentive for advisors to hide or misrepresent anything that could lessen the chance of a sale – which becomes particularly troublesome in an unregulated environment. Most investors I come across in one of these investments have a number of misconceptions about how their investment works in regards to tax treatment and fees.

Lack of Transparency
Relatively unregulated, the offshore industry suffers from a general lack of transparency. Often, there is very little real and substantiated information available about the investments and strategies being sold. When people realize that they have been taken advantage of – often years into the investment - they are frequently too embarrassed to talk about it, even though there are sometimes steps that can be taken to meaningfully improve their situation. Depending on nationality and where they have been living, investors may have also been breaking tax laws along the way. Whatever happens in these types of situations, the buyer usually has no recourse against the seller.
Depending on the goals you are trying to accomplish, investing offshore may be worth considering. No matter your goals, offshore investments need to be approached with due caution. Operating in a regulatory blind-spot, some advisors take advantage of a customer’s limited knowledge to mis-sell investments.
Never underestimate the importance of transparency, regulation, and understanding how your advisor is paid. Offshore opportunities may sound incredibly attractive, but the rules of smart, responsible investing have not changed.

Tony Noto, CFA, CFP (USA) is a fee-only financial planner at Noto Financial Planning, a division of Diacron Shanghai.