Tackling shell companies: Limiting the opportunities to hide proceeds of corruption
Shell companies that cannot be traced back to their owners are one of the most important mechanisms by which corrupt officials transfer illicit wealth from developing countries.
This process damages these countries’ development prospects. Clear international standards mandate that the real owners of all companies should be traceable, but this is often not enforced. Development agencies and developing country governments should work to prioritise more effective regulation of shell companies
Tackling shell companies: Limiting the opportunities to hide proceeds of corruption Shell companies that cannot be traced back to their owners are one of the most important mechanisms by which corrupt officials transfer illicit wealth from developing countries. This process damages these countries’ development prospects. Clear international standards
mandate that the real owners of all companies should be traceable, but this is often not enforced. Development agencies and developing country governments should work to prioritise more effective regulation of shell companies.
Large-scale corruption by senior political officials is a serious obstacle to development. Much of the money stolen is transferred overseas. Recent research strongly indicates that untraceable shell companies are the most common means of facilitating grand corruption, also known as kleptocracy.
Thus it is important to be able to link shell companies with their real owners, because companies that cannot be traced back to their real owners act as a “corporate veil” that conceals the process and proceeds of corruption. Although no single reform by itself can stop major corruption, ensuring corporate transparency would greatly aid the fight against the looting of developing countries.
This brief has four aims: first, to explain what shell companies
are and how they are used to transfer wealth from developing countries; second, to summarise the state of play in the global regulation of shell companies; third, to do the same for key jurisdictions; and lastly, to set forth recommendations on how development agencies and their partners can help prioritise this policy issue.
What are shell companies?
All companies have a legal personality, meaning that like actual individual persons, they can own property, hold bank accounts, engage in transactions, sue and be sued. Most of the companies we interact with on a day-to-day basis engage in the production of goods or the provision of services; they have employees, equipment, and a physical location. Shell companies, however, are just legal personalities; they do not produce any goods or services. They are identities that canbe created or annulled by legal fiat within days, at a cost of between a few hundred and a few thousand dollars.
The majority of shell companies are used for legitimate purposes. For example, imagine that a Chinese business wants to raise capital by being listed on a US or British stock exchange. Firms from China and most other developing countries, however, are barred from listing on the New
York and London exchanges. The business may form a foreign shell company that is allowed to list, and then pass the capital raised from the foreign shell company through to the operating business in China (Sharman 2012). In this way, investment flows from the developed to the developing world. More generally, allowing the formation of companies efficiently and cheaply helps individuals access the formal economy, while the limited liability that companies provide can protect small entrepreneurs from personal bankruptcy should their business fail.
Yet the combination of legal personality, intangibility, and
disposability means that the shell company becomes a very useful mechanism for those seeking to conceal criminal funds, including the proceeds of corruption. In particular, where transactions are booked or assets held in the name of a shell company, rather than in the criminal’s own name, this obscures the trail from a given crime to the funds that result.
Such a situation presents regulators and law enforcement agencies with the challenge of “looking through” the shell company to find the real person in control. For example, if suspicious funds were passed through a corporate bank account opened in the name of a shell company, investigators need to find out the real individual or individuals who control the company, referred to as the “beneficial owners.” If the shell company cannot be linked back to its beneficial owners, the investigation often fails.
Although there are other means by which to launder corruption funds, shell companies are the most frequently used. The nongovernmental organisation Global Witness points out, “‘Shell’ companies . . . are key to the outflow of corrupt money that keeps poor countries poor. Those who
loot state funds through corruption or deprive their state
of revenues through tax evasion need more than a bank
corruption
2
they need to hide their identity behind a corporate front”
(2012, 4). Research conducted under the Stolen Asset
Recovery (StAR) Initiative, a joint effort of the World
Bank and the United Nations Office
on Drugs and Crime, confirms this
conclusion. It notes that of the 150
cases of grand corruption analysed,
the vast majority involved the use
of a shell company to hide the illicit
wealth (Does de Willebois et al. 2011,
2). Shell companies featured much
more often in this role than any other
sort of legal entity or arrangement,
such as trusts, partnerships, or foundations (for this
reason, this brief focuses only on companies and not on
these other forms).
The shell companies in question were rarely set up by the
corrupt officials themselves. Rather, they were purchased
through professional intermediaries and businesses that
specialise in setting up and then selling shell companies,
collectively referred to as corporate service providers
(CSPs). A CSP can provide shell companies registered in
many different jurisdictions, not just the one in which the
CSP happens to be located.
How shell companies are used to
transfer wealth from the developing
world
Along with international interbank wire transfers, shell
companies are the most common means by which looted
wealth and corruption proceeds are transferred from
the developing to the developed world. The example
of Equatorial Guinea is particularly egregious, but it is
indicative of mechanisms used in many other cases as well.
Equatorial Guinea, a small, oil-rich nation in West
Africa, is perhaps the most blatant single example of the
development consequences of grand corruption. Per
capita, Equatorial Guinea is one of the richest countries in
the world, considerably richer than the United States (de
la Baume 2012). Yet according to the most recent figures
available, 76.8 per cent of the population lives under the
United Nations poverty line (Holmes 2009), and a majority
lack access to clean water. The country ranks 136 of 186
on the UN Human Development Index, and it has the
largest gap of any country in the world between its score
on that index and its per capita gross domestic product.
In terms of human rights, Freedom House regularly places
Equatorial Guinea in the “worst of the worst” category.
Teodorin Obiang is a government minister and vice
president of Equatorial Guinea. He is also the son and
heir apparent of Teodoro Obiang, the country’s president.
Obiang Junior’s official annual salary is $60,000 (US
Senate 2010, 21), but between 2004 and 2008 he used
shell companies formed by American lawyers to transfer
more than $100 million from Equatorial Guinea to the
United States. These funds were spent on assets including
a $30 million mansion in Malibu, California, a $38
million private jet, and $1.1 million of Michael Jackson
memorabilia. He also purchased an $80 million mansion
in Paris with furnishings valued at $50 million (Silverstein
2011, 1; US Senate 2010, 7; de la Baume 2012). In addition to
misappropriated oil wealth, most of this money
came from bribes extracted from foreign timber firms
by Obiang in his capacity as minister of forestry. A US
Department of Justice memo noted,
“The prosecutors suspect that most,
if not all, of (. . .) Obiang’s assets are
derived from extortion, bribery or
the misappropriation of public funds”
(cited in Global Witness 2009, 13).
To avoid US prohibitions on the receipt
of corruption proceeds, Obiang did
not hold these assets in his own name.
Instead he used shell companies: Sweetwater Malibu LLC
(registered in California) to hold the mansion, and Ebony
Shine International Ltd. (British Virgin Islands) for the
private jet. After US banks closed Obiang’s accounts on
suspicion that his funds were the proceeds of corruption,
Obiang and his lawyer relied more heavily on a set of
other shell companies to try to hide the true origins of the
money (Global Witness 2009; US Senate 2010). Money was
remitted to the United States from Obiang’s companies in
Equatorial Guinea via France, further obscuring the trail.
This case illustrates both the severe development
consequences of grand corruption and the key role that
shell companies play. It also fits the general pattern in
which shell companies are used as channels to receive
bribes from foreign firms (in this case, oil and logging
interests), as well as to directly embezzle state funds, and
then to move the proceeds out of the developing country
in question to developed countries. Although Obiang is
currently facing actions by the US and French governments
to seize the proceeds of his corruption, it is far from certain
that these efforts will be successful.
Shell company regulation in multilateral
venues
The most important international standard setter for the
regulation of shell companies is the Financial Action Task
Force (FATF) on money laundering. In the last few years the
FATF has been explicitly directed by the G20 to prioritise
the interlinked issues of the beneficial ownership of shell
companies and the laundering of corruption proceeds.
The international standards that govern shell companies
in relation to the question of beneficial ownership are
clear. FATF Recommendation 24 states: “Countries should
take measures to prevent the misuse of legal persons [i.e.,
companies] for money laundering or terrorist financing.
Countries should ensure that there is adequate, accurate
and timely information on the beneficial ownership and
control of legal persons that can be obtained or accessed
in a timely fashion by competent authorities” (FATF 2012).
This standard has been endorsed by a wide variety of
international organisations, including the United Nations,
and by over 180 countries.
In principle, there are two ways to obtain access to
information on beneficial ownership. The first is to require
the government offices that receive and issue formal
company documents, called company registries, to collect
and hold on file proof of identity for the relevant beneficial
owners (e.g., certified or notarised copies of passports).
U4 BRIEF
December 2012 No 10
Tackling shell companies: Limiting the opportunities to hide proceeds of corruption
3
At present, however, only one registry (Jersey, a British
Crown dependency) is known to perform this function,
and thus there are doubts as to how well this would work
in practice. Especially in developing countries, registries
struggle to fulfil their existing duties and are ill equipped to
undertake the demanding task of checking and recording
beneficial ownership.
This leaves the second option:
regulating the corporate service
providers. Some countries require
CSPs to collect proof of identity
from customers (again, notarised or
certified copies of government-issued
photo identity documents), hold this
information for five years, and provide
it to regulators and law enforcement
officials on request. The advantage of
this system is that it has been shown
to work in practice. When faced with
this requirement, CSPs really do
collect the information, which is then
available to the authorities (Does de
Willebois et al. 2011; Findley, Nielson, and Sharman 2012).
Furthermore, the cost of regulation in this case tends to be
passed on to the customers buying shell companies, rather
than to taxpayers at large.
Unfortunately, however, it seems that few countries
effectively comply with the rule on beneficial ownership,
and so shell companies that cannot be traced back to
the beneficial owners are in practice readily available
to corrupt officials (Does de Willebois et al. 2011).
This reflects the facts that, as noted, registries do not hold beneficial ownership information, and CSPs are completely unregulated in many countries, leaving them free to provide shell companies with no questions asked.
A study in which the authors impersonated fictitious consultants and then approached more than 4,000
CSPs found that over a quarter of them were willing to provide shell companies without the proper identification
documents, or in many cases without any documents at
all. Significantly, providers in developed countries were
less likely to meet international standards than those in
tax havens or developing countries (Findley, Nielson, and Sharman 2012).Shell company regulation in key jurisdictions
The United States has great influence on the content and enforcement of international standards on corporate
transparency. Approximately 2 million companies are
formed in the United States every year, although only
a minority of these are shell companies. Importantly,
company registration takes place at the state rather than
federal level, and few if any states require the collection
of beneficial ownership information. Senator Carl Levin of
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