The Role of Domestic Shell Companies in Financial Crime and Money Laundering

Financial Crimes Enforcement Network The Role of Domestic Shell Companies in Financial Crime and Money Laundering: Limited Liability Companies November 2006 The Role of Domestic Shell Companies in Financial Crime and Money Laundering: Limited Liability Companies addressed are those that relate to the use of shell ► Executive Summary companies to facilitate money laundering and and Key Findings financial crime in general. Key findings By virtue of the ease of formation and the absence of The following key findings demonstrate the ownership disclosure requirements, shell companies vulnerability of shell companies to misuse, and the – generally defined as business entities without active imperative to formulate appropriate responses to business or significant assets – are an attractive address the issue. vehicle for those seeking to launder money or conduct illicit activity. While business entities • Domestic shell companies (LLCs and other generally, and shell companies specifically, have varieties) have some legitimate and legal legitimate commercial uses, this lack of transparency uses, but the ability to abuse such vehicles in the formation process poses vulnerabilities both for illicit activity must be continually domestically and internationally. monitored. The advantages of using these business entities for • Domestic shell companies can be and have legitimate business purposes are in some senses been used as vehicles for common financial outweighed by the potential for abuse presented by crime schemes such as credit card bust outs, some entities, and by the risks to and potential purchasing fraud, and fraudulent loans. deleterious effects on the financial system that result from lack of transparency regarding beneficial • The use of domestic shell companies as ownership. parties in international wire transfers allows for the movement of billions of dollars Although the focus of this paper is on limited liability internationally by unknown beneficial companies, other business entities, including trusts, owners. This could facilitate money business trusts, and corporations, are also vulnerable laundering or terrorist financing. to abuse. The intent is to demonstrate the nature of the vulnerabilities that limited liability companies • Company formation agents and similar present, provide examples of known abuses, and service providers play a central role in the present some specific steps which can be taken to creation and ongoing maintenance and reduce the risk to the financial system while support of domestic shell companies, some preserving the advantages of limited liability of which appear to be used for illicit companies for legitimate business use. purposes domestically and abroad. It is anticipated that attention will be given in the future to studying other business entities which are • Based on our research, states do not appear subject to abuse and illicit use as shell companies or to impose effective accountability to otherwise mask ownership for illicit purposes. safeguards on company formation agents and similar service providers to ensure that This report does not attempt to address tax policy the business entities they create, buy, sell, issues regarding shell companies. The vulnerabilities and support are not violating state laws 2 specifying that the companies be used only assessing, and managing potential risks for lawful and allowable purposes.1 associated with providing financial services to such entities. • There is currently no requirement that these service providers report suspicious activity 2. FinCEN is continuing its outreach efforts involving the shell companies they have and communication with state governments created, bought, sold, or supported, nor are and trade groups for corporate service there requirements or procedures to identify providers to discuss identified beneficial owners in certain jurisdictions if vulnerabilities, and to explore ways to illicit activity is suspected. address vulnerabilities in the state incorporation process, particularly with • Certain domestic jurisdictions, especially respect to the lack of public disclosure and when serviced by corrupt or unwitting transparency regarding beneficial ownership service providers, are particularly appealing of shell companies and similar entities. for the creation of shell companies to be used for illicit purposes. 3. FinCEN is continuing to collect information and studying how best to address the role of • The LLC, particularly when organized in a certain businesses specializing in the state which does not require reporting of formation of business entities in its effort to information on ownership,2 provides an reduce money laundering and related attractive vehicle for a shell company vulnerabilities in the financial system because it can be owned or managed through the promotion of greater anonymously and is inherently vulnerable to transparency. abuse. Steps Forward FinCEN is undertaking three key initiatives to deal with the issues addressed in this report and to mitigate risks posed by shell companies: 1. Concurrent with this report, FinCEN is issuing an advisory to financial institutions highlighting indicators of money laundering and other financial crime involving shell companies, and reminding financial institutions of the importance of identifying, 1 A few states – most notably Delaware – impose “standards of conduct” on persons serving as “registered agents.” For example, the Court of Chancery in Delaware can enjoin a person from serving as a “registered agent” if the person has engaged in criminal conduct or in conduct that is likely to deceive or defraud the public. Service as a “registered agent” forms only part of the services that company formation agents and similar service providers often offer their clients. Moreover, a business entity need not organize or conduct activities in Delaware or any other state that imposes “standards of conduct.” 2 Although some states require the reporting of information on ownership, no state requires the reporting of information on beneficial ownership. An individual may own an LLC indirectly, through nominees and other business entities. The Securities and Exchange Commission (SEC) addresses the potential through the concept of beneficial ownership, which the SEC defines as holding the rights of ownership "directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise." The concept of beneficial ownership would require an LLC – when reporting information – to "look through" nominees and business entities. 3 ► Uses and Abuses of The reverse acquisition process has in the past been Domestic Shell subject to abuse. For example, if the expected value of the private company is fraudulently exaggerated, Companies investors buying into the company may lose a considerable percentage of their investments when the company turns out to be worth much less. Those The term “shell company” generally refers to limited who fraudulently promoted the company have at that liability companies and other business entities with point already sold their stock and made a handsome no significant assets or ongoing business activities. profit. These “pump and dump” schemes often Shell companies – formed for both legitimate and involve shell companies with low market illicit purposes – typically have no physical presence capitalization whose stock trades at pennies per share other than a mailing address, employ no one, and on the “pink sheets” (www.pinksheets.com), OTC produce little to no independent economic value. Bulletin Board, or other over-the-counter trading and Shell companies are often formed by individuals and information systems. One indicator of this scheme is businesses to conduct legitimate transactions, such as concentrated trading in normally thinly traded stocks. domestic and cross-border currency and asset Ralph A. Lambiase, former president of the North transfers, or to facilitate corporate mergers and American Securities Administrators Association reorganizations. (NASAA) and director of the Connecticut Division of Securities, noted in 2004 the existence of “a steady Shell companies can be publicly traded or privately stream of fraud and misconduct in the distribution held. Although publicly traded shell companies can and manipulation of shares of shell companies and be used for illicit purposes, the vulnerability of the the companies that combine with shell companies.”4 shell company is greatly compounded when it is privately held and beneficial ownership can more Some steps have been taken to prevent this type of easily be obscured or hidden. Lack of transparency abuse. For example, the SEC adopted rules on June of beneficial ownership can be a desirable 29, 2005 designed to protect investors in the characteristic for some legitimate uses of shell companies, but it is also a serious vulnerability that can make some shell companies ideal vehicles for money laundering and other illicit financial activity. Shell Company One of the common uses for a shell company is in the Domestic Abuses reverse acquisition.3 The procedure will often involve a simple acquisition of a shell company, with shares of a private company used as consideration. Pump and dump Over invoicing The shell company, which at one point may have Credit card bust out False invoicing been an active company publicly traded on a stock Fraud exchange, issues shares to the shareholders of a private company sufficient to give those shareholders a majority interest in the shell company,

Load more