Say you’re a Swiss bank and you want to launder some money for high-net-worth clients.

Here’s one way: Start by placing large quantities of the funds into a brokerage account at the bank under the name of a shell corporation.

Then, conduct multiple financial transactions with the funds, confusing the true source of the money. Once the transactions “wash” the money, it can be spent out of the brokerage account as simply as writing a check or using a credit card.


Photo: Serdar Yagci/Getty Images

Wealthy clients will pay handsomely for this activity. Not only do they get access to funds laundered through the banking system, but by placing the money offshore in a shell corporation, they can avoid taxation in their host country. “Money laundering is tax evasion in process,” said John Cassara, a 26-year intelligence and law enforcement official and former special agent for the Treasury Department. “Shell companies make it more complicated to figure out who that money belongs to and where it’s going.”

UBS, the giant Swiss bank that self-appointed investigator Chris DiIorio suspected was part of the kind of penny-stock manipulation that wiped out his penny-stock investment in 2006, has a checkered history with these types of activities.

The bank entered into a deferred prosecution agreement with the Justice Department over cross-border activities for its clients in February 2009, paying a $780 million fine. UBS admitted that it established secret accounts for roughly 17,000 wealthy American clients “in the name of offshore companies, allowing United States taxpayers to evade reporting requirements and trade in securities as well as other financial transactions (including … using credit or debit cards linked to the offshore company accounts).”


Department of Justice press release.

Source: U.S. Department of Justice.

The government dismissed criminal charges against UBS in 2010, claiming the bank had fully dismantled its cross-border tax evasion activity.

DiIorio believes UBS never stopped. Years of digging through public records and connecting dots led him to that conclusion.

But this is also where DiIorio’s accusations get considerably harder to substantiate, and his theories start to multiply, sometimes even contradicting one another.

His suppositions up to this point come with swaths of data that bolster them. From this point onward, DiIorio’s main argument is the absence of alternate explanations.

Here, however, is the way DiIorio thinks it worked — and continues to work: UBS clients use their brokerage accounts to invest in penny stocks issued by companies that appear to conduct no business activity and have no revenue potential — all they do is issue billions of shares of stock. These stocks, he figures, are the same ones Knight Capital is naked shorting: selling shares it doesn’t really have.

UBS’s clients, according to DiIorio, purchase the penny stocks because they know they will drop in price. That way, they can use capital losses to offset any capital gains in the brokerage account, “resulting in a reduction in their reported income-tax liability and the underpayment of millions in taxes,” according to DiIorio’s 2013 complaint to the SEC.

That happens at the same time that the money placed in the brokerage account is being commingled with the various trades, he argues — effectively laundering it.


Photo: Artiom Muhaciov/Getty Images

The IRS rarely suspects trading in equity markets is a vehicle for money laundering or tax evasion, because it assumes stock investors are trying to make money. “It’s a lot more efficient than stuffing diamonds into toothpaste,” DiIorio says.

In fact, illicit financial flows through brokerage accounts are rarely scrutinized at all. “In federal law enforcement, we have skilled people, but we have a whole lot of people in there, they don’t get the securities markets,” said Cassara, the former Treasury agent. “They don’t get trade-based money laundering. The bad guys know this so they pile on the layering.”

He cited statistics from Raymond Baker, president of the research group Global Financial Integrity, that indicate money-laundering enforcement fails 99.9 percent of the time. “I use his line, total failure is only a [decimal] point away.”

DiIorio argues that client losses from the drops in value of the penny stocks are a small price to pay for the layering activity and tax avoidance. That’s if they’re even losses at all. Because if the stock shares never really existed, maybe the payments never happened either.

In fact, DiIorio also alleges that many of the transactions go through outside hedge funds, which convert promissory notes from the penny stock companies into equity, in private stock offerings. (The CEO of E Mobile tried to sell DiIorio a private placement back in 2006, you may recall.)

Normally, a company issues a promissory note in return for cash — the note representing a promise to pay it back later, plus interest. But some notes, called convertible promissory notes, are also convertible to stock.

DiIorio claims that in some cases, penny stock issuing companies were simply creating convertible promissory notes as a way of issuing more stock. The funds from these investments never appeared on the balance sheet of the companies — suggesting that no money changed hands for the purchase of the note, which was then converted to stock. That would make the losses merely on-paper losses: a classic tax evasion play.

One example DiIorio provides comes from FreeSeas, the shipping company referenced earlier (see The Penny Stock Chronicles, Part 3). It engaged in four convertible promissory note sales with stated values of between $500,000 and $600,000 in five months in 2015, with Alderbrook Ship Finance Ltd. (April), Casern Holdings Ltd. (June), the AMVS Value Fund (July), and Casern again (September). Alderbrook Ship Finance didn’t exist until two days before the sale; AMVS had a lifespan of four days before it purchased FreeSeas’s promissory note. The two companies share the same Toronto address and the same director, Justine Kerrivan of Ber Tov Capital. And despite all the cash flow, FreeSeas only had $20,000 cash on hand at the end of 2015, per its annual SEC filing.

“FreeSeas is a structured tax evasion/money laundering scam being perpetrated on the investing public as we speak,” DiIorio wrote in an email to SEC officials last September.

A contact for Casern, a company incorporated in the British Virgin Islands (a location notorious for shell corporations), did not respond to a request for comment. Ber Tov Capital, the company that apparently set up Alderbrook and AMVS, also declined to comment.

DiIorio jumps back and forth in his claims. Sometimes he says there’s no money changing hands, just a bunch of paper losses. Sometimes he says there are some losses, but less than the tax liability avoided. And sometimes he says the losses are real, but worth the cost in exchange for laundering large sums of money. To DiIorio, it’s all variations on the same basic scheme: using sham companies and stock manipulation to generate losses on purpose, tailored to clients’ individual needs.

The Intercept asked UBS about all of these allegations. The only response, from Director of Media Relations Peter Stack, came in a single line: “UBS applies strict due diligence and anti-money-laundering standards to all its business.”

Collateral Damage

DiIorio’s initial investment in 2006 — where the on-paper value dropped from $1.3 million to next to nothing in a matter of months — was a fluke, he now believes. Sure, naked shorting rips off investors, but that’s not the true aim. In his view, penny stocks like FreeSeas or NewLead or Colorado Goldfields were structured tax evasion vehicles for the benefit of unknown people with money looking to hide their activities.

He was unlucky enough to be collateral damage.

The theory has an internal logic to it but is based on a fair bit of speculation. While trading activity can be used to launder money, some experts argue there are far simpler ways to do so instead of actually losing a share of the money to throw regulators off the trail.

For example, Jack Blum, a former U.S. Senate investigator and white-collar crime expert, suggests that launderers can more easily wire money through international markets, use bogus tax shelters, or even lend themselves money to buy property while falsifying the records of the transfer. (“Each case requires a small book to explain,” he said.)

And none of those tactics involves actually losing money intentionally. Even in his complaint to the SEC, DiIorio acknowledged that he was “alleging a massive and nefarious conspiracy based, at least in part, on circumstantial evidence.” And in a separate complaint, he admitted that he does not have the taxpayer records that would be critical to pinpointing the scheme.

But John Cassara found the theory relatively plausible. “People do what they know,” he said. “If you’re talking about financiers that work in a world I can’t relate to, for them it may be, let’s construct this financial instrument, this trade, I’ll work with my guy, a wink and a nod and it’s done.”

Furthermore, many of the facts DiIorio based the alleged conspiracy on checked out. There was an array of penny stocks that kept undergoing reverse splits. Knight and UBS did trade in them. Knight’s balance sheet appeared to expand strangely, including an increase in the “sold not yet purchased” liability. And UBS had a history of helping its clients evade taxes, often through shell corporations.

UBS’s admission and fine in 2009 came only after whistleblower Bradley Birkenfeld, a former UBS banker, divulged the schemes that the bank used to encourage American citizens to dodge their taxes. But Birkenfeld’s information exposed the undeclared bank accounts. “How did the cash get there, and how do they get the cash back?” DiIorio said. “I explained how.”


Bradley Birkenfeld.

Photo: Bloomberg/Getty Images

DiIorio added UBS to his list of claims with the SEC. The list would grow over the years to take in several of the microcap stocks the bank traded, such as FreeSeas and NewLead. DiIorio amended his initial complaint in November 2011 and continued to send dozens of emails directly to SEC officials, including Chief of the Office of the Whistleblower Sean McKessy and even Chair Mary Schapiro. But the SEC remained mute.

The SEC wouldn’t answer our questions, either. And through spokesperson Sophie Sohn, Knight also declined to comment for this story.

And then something happened that changed DiIorio’s entire perception of how the securities regulators were dealing with his claims. He went from thinking that the SEC and its counterparts just didn’t understand the sophisticated scheme — to believing they were waving it through.