Shell Companies and Government Corruption

Shell Companies and the special function to cover the shady business of Government Corruption the global elite, including numerous senior politicians, heads of states, and dictators (Obermayer David Jancsics and Obermaier 2016). Yet, autocrats and their School of Public Affairs, San Diego State cronies extensively use shell companies, not just University Imperial Valley Campus, in tax havens but in the Western world so that they San Diego, CA, USA can hold their illegally accumulated wealth in the financial institutions of democratic countries (Sharman 2017, pp. 73–74). Moreover, corrupt Synonyms politicians and government officials also use domestic shell companies in their home countries Dummy corporation; Front organization; Off- to facilitate illicit transactions (Jancsics 2017). shore company; Stooge; Straw man Shell companies are typically formed and maintained by Corporate Service Providers (CSPs), or intermediary law or accounting firms. Definition Transactions and assets can be tracked back to shell companies established by a CSP but not to A shell company is supposedly an independent, the actual people who indirectly and covertly legal business entity that is used to separate and exercise control over the company. Shell compa- hide the identity of its real owner. The use of shell nies may constitute complex corporate structures companies can be legal when they serve as tech- in which they act as shareholders of another such nical vehicles facilitating complicated business company. One subcategory of shell companies, transactions, but they are often used for illegal called “shelf” companies, includes organizations purposes. kept “on the shelf” for sale later on. Since financial institutions often prefer to do business with companies that have been in existence for a cer- Introduction tain number of years, such appearance of longev- ity may be attractive to buyers who want to use As the Panama Papers leak exposed in 2016, the shell companies to obtain leases, credit, and bank secret world of shell companies is not a small- loans. scale marginal phenomenon, as previously The use of shell companies can be perfectly believed, but a widespread and complex network legal. For example, they might be created for of offshore companies in remote tax havens with mergers and joint ventures by business partners

# Springer International Publishing AG, part of Springer Nature 2018 A. Farazmand (ed.), Global Encyclopedia of Public Administration, Public Policy, and Governance, https://doi.org/10.1007/978-3-319-31816-5_3566-1 2 Shell Companies and Government Corruption to simplify matters or to guarantee impartial legal those in Central Asia, are happy to use them to treatment for the parties in a neutral jurisdiction. facilitate their high-level grand corruption Shell companies can be also used to hold personal (Cooley and Heathershaw 2017). Empirical or family assets to facilitate inheritance or protect research finds that CSPs in wealthy Western coun- against attachment by creditors (Van der Does de tries are the least inclined to comply with interna- Willebois et al. 2011). Furthermore, when buying tional standards (Findley et al. 2014). Domestic property or land, well-known brands often hide laws may also support such behavior. For exam- their identity behind shell companies so they can ple, the United States is among the most tolerant be protected from extortive price increases by the countries when it comes to regulating shell com- owner (Findley et al. 2014, pp. 33). Hollywood panies (Sharman 2017). Here CSPs are under no stars also use shell companies to shield the loca- obligation to establish the true identity of the tion of their residence from the general client who becomes the company owner. The public. Firms, still legally, can create offshore most infamous tax haven states in the USA are shell companies in order to lower their tax bills Nevada, Wyoming, Delaware, and Florida. Some at home. The lucrative business of shell compa- industries are especially vulnerable to corrupt nies in tax havens such as Panama can be traced shell company use. For instance, the US real estate back to the 1920s, but their use has significantly industry makes less than minimal effort to exam- increased since 2005 when the European Union ine the identity and background of property introduced a tax penalizing interest on income buyers behind shell companies (Cooley earned by EU residents in tax havens et al. 2018). (Obermayer and Obermaier 2016, pp. 13). Since We can classify shell companies along two the tax applies to accounts owned by only indi- main dimensions, the location where companies viduals not shell companies, European depositors are formed (offshore vs. onshore shells) and the can shift their assets to such technical vehicles. form of operation (live vs. empty shells). A shell company can hold bank accounts, own assets, and engage in transactions. In many countries, shell companies are cheap and easy to estab- Location: Offshore Versus Onshore lish. Confidentiality is their key advantage. Since they provide convenient vehicles for moving The main advantage of offshore shells for corrupt money secretly, even across national borders or actors is that they are in remote tax haven coun- hiding real owners of assets, they can also be used tries where authorities are typically not too eager for illegal purposes such as laundering money, to investigate suspicious cases. Moreover, Webs evading taxes, financing terrorism, busting inter- of shell companies are often linked together national sanctions, and facilitating corruption. across multiple offshore jurisdictions which This entry chapter discusses the specific phenom- makes obtaining information about them espe- enon when shell companies are used in corrupt cially difficult (Van der Does de Willebois et al. transactions. Here the most important function 2011). The infamous Panama Papers leak in 2016 that a shell company can offer for its corrupt revealed the entire internal database of Mossack shadow owner is providing anonymity while Fonseca, a major Panamanian law firm specializ- simultaneously guaranteeing control over the ing in forming anonymous shell companies shell company and its resources. (Obermayer and Obermaier 2016). It included Despite the popular conceptions that shell the records of 214,000 offshore shell companies, companies exist only in exotic tax havens such names of their true owners, passport scans, bank as Bahamas, Cayman Islands, Liechtenstein, or statements, and email conversations between the Panama, the West has a significant role in hosting CSP and the owner’s representatives. The leak illegal money via shell companies. Surprisingly exposed illegal money movements of several the majority of shell companies are formed in non- prominent figures, for example, the Nicaraguan tax haven Western countries and dictators, such as president Arnoldo “Fat Man” Alemán, who has Shell Companies and Government Corruption 3 been declared one of the 10 most corrupt politi- Domestic shell company arrangements also cians of all time by Transparency International, a enable corrupt political elites to turn public global anti-corruption watchdog. Alemán used resources into private ones under a veil of com- shell companies to channel almost $100 millions plete secrecy. These actors pay particular attention of public funds into his own pocket. The Papers to making their operations seem lawful and had serious political consequences such as the extract money through legal contracts that require resignation of Iceland prime minister, a massive a large number of “clean” shell companies demonstration in Argentina, a small war in (Jancsics 2017). Some of these cases are discussed Azerbaijan, the block of words “Panama Papers” in the next section under the category of live on the Internet by Chinese authorities, and the shells. unpleasant confession of his late father’s decade- long tax evasion by the former British Prime Min- ister, David Cameron. Form of Operation: Empty Versus Live Onshore or domestic shell companies are typ- Shells ically established by corrupt actors in their home country to facilitate corruption. Despite the fact Echoing the mainstream approach of shell com- that political campaign contributions are sup- panies, empty shells do not have real operations, posed to be transparent in most democratic coun- employees, infrastructure, or assets while live tries, domestic shells are frequently used by shells, a less researched phenomenon, are func- powerful corporations to get access to the political tioning entities controlled by shadow owners arena while keeping their identity and affiliation (Jancsics 2017). Most offshore shell companies with politicians secret. For example, in the USA, are empty shells that have no physical presence shell companies are often registered with the sole other than a mailing address, yet onshore or purpose of receiving untraceable and unaccount- domestic versions of these companies also exist. able donations for campaigns of politicians, even This type of shell company is often set up only for presidential candidates (Findley et al. 2014, a single corrupt transaction and then left dormant. pp. 29–30). The most recent example is the shell Empty shells can be established to serve a very company, Essential Consultants LLC, established simple function, receiving bribe cash secretly, for by President Trump’s lawyer Michael Cohen to be instance, in the form of a “consultancy fee.” Cor- able to pay hush money and receive invisible rupt politicians who worked to benefit certain donations from companies such as AT&T and corporations with government contracts are often Novartis in return for “insights into the new paid via this structure (Findley et al. 2014, president.” pp. 100). The establishment of police foundations is a An empty shell can also acquire assets for a relatively new phenomenon in the USA and secret owner. Investigative journalists revealed Canada and can be also conceptualized as a form that nearly half of the most expensive residential of onshore shell company (Walby et al. 2017). properties in the USA are now purchased anony- These foundations operate as private nonprofit mously through shell companies (Story and Saul charities and amass money from private corpora- 2015). For example, in 2014 at the Time Warner tions. Since these organizations are not subject to Center in New York City, 80% of the units were Freedom of Information Act legislation and other purchased by shell companies, 37% by foreigners. transparency requirements that are normal in the Among the foreign owners, we can find top gov- public sector, the identity of donors and the ernment officials and their family members and amount of donated funds are unknown. Such businessmen with close political connections secretive operations may permit transactions in from countries such as Russia, Mexico, India, dark money and potential special police treatment Malaysia, or China. They may not be all crimi- of donors as “insiders” in return for financial nals, but such structure is perfect for hiding assets support. bought with corrupt money. At least 16 foreigners 4 Shell Companies and Government Corruption in the Time Warner Center have been the subject be used to build a clientele network surrounding of government inquiries, either personally or as corrupt politicians. For example, in 2013, the heads of corporations. We can find a similar pat- Hungarian government turned the previously lib- tern in London where in 2015 more than 40,000 eralized tobacco retail business into a state residential and commercial properties were regis- monopoly and then announced a tender for a tered to overseas companies, most of them with 20-year concession of tobacco sales (Jancsics invisible ownership structures incorporated in 2017). In thousands of cases, people linked to secret jurisdictions such as British Virgin Islands, the governing party won tobacco concessions. Jersey, Isle of Man, or Panama. Research finds The official owners and managers of the tender that corrupt senior politicians in post-Soviet coun- winner shell companies were family members, tries such as Kazakhstan and Kyrgyzstan rou- spouses, siblings, parents, parent-in laws, friends, tinely use shell companies to channel rents from or even neighbors of politicians, public servants, state assets to the Western real estate industry or politically connected oligarchs. These visible (Cooley et al. 2018). representatives of the shell company acted on Empty shells are also used as technical vehicles behalf of their shadow principal. to facilitate mainly domestic, corrupt transactions (Jancsics 2017). In this case, they have a switcher function. Corrupt actors allocate public resources Theorizing Shell Companies to a shell company and then change the law which multiplies the value of the resources owned by the Mainly legal and financial aspects dominate the shell company. After that, the company can be academic literature of shell companies. So far, the sold to a third party for extra profit. For example, most comprehensive and rigorous empirical in a well-designed real estate corruption network, research on the topic has studied whether states 26 multistory buildings were sold in an historic and corporations comply with international finan- district in Budapest, Hungary (Jancsics and Javor cial transparency standards (Findley et al. 2014). 2012). The falsely undervalued old buildings Researchers have found that large numbers of were transferred by the local government to shell CSPs recurrently violate international standards companies, and then secretly controlled by the and surprisingly, CSPs selling shell companies mayor and his allies. After the local government from tax havens were significantly more likely to removed the buildings’ historic designations and comply with the rules than service providers in issued demolition and building permits, private rich developed countries such as the USA and the developers bought the shell companies, built UK. However, previous research does not offer a office buildings and residential parks and then development of a theory. sold them at great profit. A possible way to theorize about shell com- In contrast to empty shells, live shell compa- pany corruption is to view the phenomenon as a nies have real business operations. The main rea- specific form of brokerage (Jancsics 2017; Walby son for their existence is that their real owners et al. 2017; Van der Does de Willebois 2011). cannot openly exercise ownership in an operating Brokerage is an informal social mechanism by firm, for example, when politicians are legally which disconnected or isolated actors can interact. banned from having a formal position or shares Here the shell company is a vehicle used to effec- in private business firms. This is usually not a one- tively navigate between legal and illegal realms. time illegal transaction, such as is typical in the The legal action is implemented by the formal case of empty shells, but rather a long-term con- organization yet the visible but fake representative trol over a functioning economic entity. In many (owner or director) acts as a broker, pursuing the live shell cases, the state distributes valuable informal and corrupt agenda of its invisible resources, licenses, concessions, or other monop- shadow owner. This is a type of mediation where olistic market positions to a shell company that a “representative broker” is delegated by another virtually guarantees profit making. Live shells can actor, whether a single individual or a group, to Shell Companies and Government Corruption 5 represent its interests and deal with the outside Interestingly, many countries, even those in the world. developed and democratic West, are reluctant to The sociological aspect of the relationship close this loophole. Scholars are behind in study- between the broker and the hidden beneficial ing and theorizing about the shell company phe- owner is an important but understudied dimension nomenon. In the next few years, we need more of shell companies. In the literature, the broker is interdisciplinary investigation in order to under- mentioned by several different names such as stand this complex and serious social problem. front man, straw man, stróman, nominee director, dummy person, stooge, or patsy. Sometimes brokers are appointed by the CSP in order to appear Cross-References on the public record and to sign the documents placed before them (Obermayer and Obermaier ▶ Corruption 2016, pp. 14–15). For example, Lu Zhang was, ▶ Globalization and Law on paper, the director of SP Trading Company but ▶ Globalization and Predatory Corporations actually worked as a short-order cook at a Burger ▶ Political Corruption King in Auckland. She supplemented her income ▶ Public Corruption with $15 for each document signed by her for the company. It turned out that SP smuggled weapons from North Korea to Iran (Findley et al. 2014, pp. 1). In other cases, especially in live shell References operations, brokers must be trusted which requires some level of social connection between the bro- Cooley A, Heathershaw J (2017) Dictators without borders: power and money in Central Asia. Yale University ker and the shadow owner. Here brokers are typ- Press, London ically relatives, friends, current or former Cooley A, Heathershaw J, Sharman JC (2018) The rise of employees, or business partners (Jancsics 2017). kleptocracy: laundering cash, whitewashing reputa- We can also find unequal power relationship tions. J Democr 29(1):39–53 Findley MG, Nielson DL, Sharman JC (2014) Global shell between these two main actors. In this case, games. Cambridge University Press, New York socially marginalized people, homeless or foreign Jancsics D (2017) Offshoring at home? Domestic use of refugees are chosen as company owners and shell companies for corruption. Public Integrity directors. They are willing to take huge risks for 19(1):4–21 Jancsics D, Javor I (2012) Corrupt governmental networks. a relatively small amount of compensation and Int Public Manage J 15(1):62–99 often fulfill the fall guy function. Obermayer B, Obermaier F (2016) The Panama papers: breaking the story of how the rich and powerful hide their money. Oneworld Publication, London Sharman JC (2017) The despot’s guide to wealth manage- Conclusion ment. Cornell University Press, New York Story L, Saul S (2015) Stream of foreign wealth flows to Using shell companies for illicit purposes is a elite New York real estate. The New York Times, widespread and growing phenomenon. The February 7, 2015 Van der Does de Willebois E, Halter EM, Harrison RA, equivalent of 10% of world GDP is held in off- Park JW, Sharman JC (2011) The puppet masters: how shore tax havens globally. Yet, onshore or domes- the corrupt use legal structures to hide stolen assets and tic shell companies are also heavily used in illegal what to do about it. The World Bank, Washington transactions. The fact that they provide the owner Walby K, Lippert RK, Luscombe A (2017) The police foundation’s rise: Implications of public policing’s with complete anonymity and at the same time dark money. Brit J Criminol 58(4):824–844 Published control over the organization makes shell compa- online in September 2017 nies especially attractive for corrupt actors.