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July 25, 2017

The legitimacy of shell companies has been exhaustively debated due to the heightened regulatory and financial risk in the lack of ownership transparency, the ability to evade tax obligations, and the ease to conceal illegal financial activity.

“A year ago… the 11.5 million leaked documents known as the Panama Papers implicated hundreds of wealthy individuals and public officials from around the globe in transferring funds to anonymously owned offshore business entities known as shell corporations. While this practice isn’t technically illegal, many clients of Mossack Fonseca, the Panamanian firm at the center of the controversy, used the anonymous accounts associated with these organizations to conduct illegal activities including tax evasion, money laundering, and dodging sanctions. One year later, it is still legal and permissible for corporations in America to be anonymously owned.” (Ferrarello, 2017)

With the recent influx of concern about offshore accounts and the aforementioned Panama Papers, there is a renewed interest in shell and shelf companies. In order to understand the full scope of how both criminal and legitimate organizations use these entity structures for illicit purposes, one must first differentiate between these two corporate vehicles.

The Financial Crimes Enforcement Network (FinCEN, 2016) states that shell companies ”[refer] to non-publicly traded corporations, limited liability companies (LLCs), and trusts that typically have no physical presence (other than a mailing address) and generate little to no independent economic value. Most shell companies are formed by individuals and businesses for legitimate purposes, such as to hold stock or intangible assets of another business entity or to facilitate domestic and cross-border currency and asset transfers and corporate mergers” (FinCEN, 2006). Similarly, shelf companies are simply companies that may have previously had economic activity, but are transaction-dormant, and may be sold to another entity with an interest in companies with a legitimate legal and financial history.

The difference between these corporate vehicles is minimal, but they serve a dual-use purpose with the ability to conduct legitimate and illegitimate business activities at the whim of their beneficial or controlling owner. The vulnerabilities of shell and shelf companies are compounded due to their often-complex formation structures, appearance of legitimacy, and lack of transparency of the business purpose of fiscal activity.

Innovative Technology – Innovative Criminal Activities

The landscape of banking has changed drastically in the last 15 years, and with innovative banking technology and access to the international markets, shell and shelf companies (referred to interchangeably as “shell” herein) have become ideal conduits to facilitate financial activities worldwide. Providing financial services to shell companies involves varying degrees of risk due to their appeal as a money laundering typology (mostly because of the real or perceived appearance of legitimacy) per the Financial Action Task Force (FATF, 2014). However, despite the susceptibility to facilitate illicit activities, there have been few considerations given to the potential merits of these entity structures.  Shell companies can serve legitimate business purposes and are often essential for facilitating corporate mergers, creditor protection, joint ventures, estate planning, deferral of income taxes, and organizing profit sharing agreements. While the benefits of shell companies are often necessary to facilitate investments and business transactions, the effort in preventing such entity structures from being used as vessels to launder ill-gotten gains is a burden on global financial systems, compliance officers, and regulators. This is especially true in developing economic regions that are susceptible to shell company risk and have fewer resources with which they can regulate illegal use.

Shell companies are often a party (willingly or unknowingly) to the facilitation of corruption, money laundering, tax evasion, bribery and corruption, human trafficking, and drug smuggling. With such an extensive list of predicate offenses, one would assume that stricter regulations to govern loopholes within the AML/CFT regulations would be rigorously enforced and scrutinized. However, despite the prolific use of shell companies and their connectivity to both legitimate financial systems and criminal activities, there have been minimal efforts to mitigate their inherent risks in scale. The recent Ultimate Beneficial Ownership (UBO) rule enacted by FinCEN may help curb that risk, but only if implemented more effectively than other AML rules by financial institutions.

Nominee Incorporation Services Firms – Is it too easy to do business in the US?

Over 2 million corporations are established each year in the United States. More importantly, the accessibility to obtain pre-established shell companies is as simple as a click of the mouse. Numerous nominee incorporation services (NIS) advertise and market a plethora of services for the formation, incorporation, and operation of shell companies online. These NIS firms provide the mechanism to aid individuals in the concealment of their identity and true business purpose, thus limiting the capacity for authorities to obtain beneficial ownership and other vital due diligence information.

In many instances, NIS firms provide a boutique service catered to individuals seeking anonymity, accessibility, and minimal scrutiny from regulators.  Comparatively, these same services are also offered by gatekeepers such as accountants, auditors, lawyers, and various financial intermediaries. The ease and accessibility with which gatekeepers can create and dissolve corporate vehicles is dependent on the needs of their clientele, but rarely difficult. Nevertheless, the lack of customer due diligence and oversight has allowed NIS firms and gate keepers to flourish largely unregulated, posing significant AML risk.

Through the purchase of corporate service packages, individuals can obtain a level of perceived authenticity overnight by acquiring an established company with a physical presence, regulatory documents, credit history, and accessibility to a credit line. These packages often provide nominee shareholders, a company secretary, professional directors, mail forwarding services, a virtual corporate address and a live receptionist, federal tax identification numbers, and an attorney to represent the company. In addition, NIS firms may aid their clients in establishing local and foreign bank accounts, credit card merchant accounts, and provide regulatory documents such as the Certificate of Incorporation, and Articles of Association. These services, technically legal in many cases, may be attractive to those individuals seeking to launder funds or finance terrorism and can also include:

  • Established corporate credit
  • Immediate credibility based on the age of the company
  • The required regulatory Customer Due Diligence (CDD) documents for Know Your Customer: tax identification number, Certificate of Incorporation, Memorandum and Articles of Association, The Resolution of the Board of Directors, etc.)
  • Registered agent services meeting regulatory requirements under the Bank Secrecy Act (BSA)
  • Annual compliance services which include periodic reviews, audits, and financial reports for the bank review during the opening stages of an account
  • Nominee services to maximize anonymity of ownership

NIS firms and their intermediaries play a central role in the ongoing formation and ongoing maintenance of shell companies by maintaining an air of legitimacy, yet there has historically been minimal regulatory oversight that mandates the disclosure of suspicious activities for these companies. This lack of regulatory oversight coupled with the absence of ownership disclosure requirements pose vulnerabilities to legal, financial, banking, and trade activities on a global scale.

How to Mitigate the Risk

In order to promote financial transparency and reduce the risks that shell companies pose, customer due diligence should, by best practice and regulation, include:

  • comprehensive UBO disclosures (addressed in part by recent UBO-related legislation in the US and Europe),
  • monitored transaction activity, and
  • investigations of NIS-affiliated shell companies

Further, firms that operate in jurisdictions that provide the means to obscure beneficial ownership and business activity should be subject to further scrutiny by their transacting partners and compliance personnel. A central customer clearing authority may be an additional long term answer as well.

For now, however, compliance professionals are best served in limiting their risk of facilitating illegal shell company activity through thorough risk assessments, effective customer onboarding and due diligence, and training compliance personnel how to identify shell company risk factors and behavior.


References

Alvarez & Marsal. (2017). Concept: TSA for the Financial Industry. Retrieved from https://www.alvarezandmarsal.com/insights/concept-tsa-financial-industry

FATF. (2014). Transparency and Beneficial Ownership. Retrieved from http://www.fatf-gafi.org/media/fatf/documents/reports/Guidance-transparency-beneficial-ownership.pdf

Ferrarello, M. (2017, April 7). One year after the Panama Papers leak, starting a shell corporation in the US may be easier than getting a library card. Brookings. Retrieved from https://www.brookings.edu/blog/brookings-now/2017/04/07/one-year-after-the-panama-papers-leak-starting-a-shell-corporation-in-the-us-may-be-easier-than-getting-a-library-card/

FinCEN. (2006, November 9). Potential Money Laundering Risks Related to Shell Companies. Retrieved from https://www.fincen.gov/resources/statutes-regulations/guidance/potential-money-laundering-risks-related-shell-companies

FinCEN. (2016, May 10). FinCEN Releases Final Rule on Beneficial Ownership and Risk-Based Customer Due Diligence. Retrieved from https://www.cov.com/-/media/files/corporate/publications/2016/05/fincen_releases_final_rule_on_beneficial_ownership_and_risk_based_customer_due_diligence.pdf

Google. (n.d.). Retrieved from https://www.google.com/search?q=Nominee+Incorporation+Services&rlz=1C1CHBD_enUS720US720&oq=Nominee+Incorporation+Services&aqs=chrome..69i57.336j0j7&sourceid=chrome&ie=UTF-8

The International Consortium of Investigative Journalists. (2017, July 1). Retrieved from The Panama Papers: https://panamapapers.icij.org/