[Q&A] North American corporate-formation laws make it easy for white-collar criminals to cover their tracks.
Reuters recently released an investigative report on the formation of shell corporations in the U.S. midwest, which suggests that the number of American shell corporations used for financial crime is much higher than previously believed. Many shell companies are created by organizations devoted to incorporation, and are then left to sit for up to decades in order to amass credibility. The Mark spoke with Jason Sharman, who is preparing a report for the World Bank on corporate-formation law around the world.
THE MARK: What are shell corporations, and what illegal purposes can they be used for?
JASON SHARMAN: A shell corporation is just the legal form of a company that does not engage in any substantive business. So it doesn’t have any employees, and doesn’t make any goods or produce any services. It’s owned by a legal person, but only on forms.
Shell corporations are very useful for breaking the link between any transaction and the real, living, breathing person behind it, so pretty much any profit-driven crime can make use of shell companies. Profit-driven crimes are mostly international or organized crimes – things like money laundering, fraud, tax evasion, all sorts of corruption offenses, or even financial terrorism. Shell companies can be helpful in separating criminals from the actual proceeds of the crime, making it harder for investigators to make the link between them.
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I hasten to add that shell companies have a lot of legitimate, legal uses as well. Probably a large majority of shell companies are used for things that are above board. But there has been a history of consumer scams such as pyramid schemes or boiler-room scams that make use of shell companies. The shell company is used as a conduit to funnel money from the scam victims off to the person who’s really behind it; the only recourse the scam victims often have is against the shell corporation, which has no assets.
Also, a shell corporation may do a similar sort of thing where it can be used to borrow money that can never be repaid. The legal chain stops with the shell corporation, and therefore creditors are left paying out of pocket. They can’t get the loan money back.
THE MARK: What is it about U.S. law that makes shell corporations a bigger problem in the States?
SHARMAN: The big problem with shell corporations in general is that you can’t link the legal person back to the real, live, breathing person who’s making the actual decisions – who’s referred to as the “beneficial owner.” The problem with U.S. corporations, and also Canadian companies, is that, when these companies default, there is no requirement to find out who the beneficial owner is. Really, up until May of this year, Osama bin Laden could have been forming U.S. limited liability companies with gay abandon, and no one would have been the wiser. Anywhere you have that lack of a beneficial ownership requirement, you have problems with these anonymous or untraceable shell corporations.
The U.S. has a particularly big problem with this because there are, of course, so many corporations formed. There are about two million corporations formed every year in the United States, and there’s a total of about 15 million that are active at any one time. Even if only a small proportion of those are used for nefarious or criminal purposes, that’s still a lot, and you can do a great deal of damage with them.
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There are two problems with U.S. shell corporations: First, they’re cheap – they cost as little as a few hundred dollars; and second, they have this air of respectability, because the U.S. is the world’s biggest financial system. While shell companies from jurisdictions like the Cayman Islands or Panama might attract suspicion, U.S. shell companies have a rather undeserved reputation of being above board and well-regulated.
THE MARK: How could the U.S. and Canada amend their laws to make it harder for people to use shell companies for illegal purposes?
SHARMAN: The laws need to be amended to require corporations to establish the identity of a beneficial owner. A lot of other countries have done this – particularly small, tax-haven jurisdictions. So it’s not impossible to do – it’s not even that expensive – and it’s nothing more than what the U.S. and Canadian governments have promised to do in various international agreements that they’ve signed. Both governments have signed anti-money-laundering agreements. Unfortunately, however, at the moment, neither country is living up to the international obligations that it has made on that front.
THE MARK: Where is the resistance to these changes coming from?
SHARMAN: Company formation in the United States, at least, is a responsibility of the 50 states, rather than the federal government. Some of these states gain a reasonable amount of revenue from company formation. Those would be places like Delaware, Wyoming, and Nevada. The states are facing tough economic times at the moment, and want every dollar of revenue they can get. The American states and Canadian provinces have been in a sort of race to the bottom to see who can offer the laxest regulations and ask the fewest questions.
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There’s a business logic to keeping standards low, both for the businesses that form shell companies and for the state and (I’m guessing) provincial governments. Governments are afraid that if standards are raised, it will mean more regulation – and, of course, someone will have to pay for that (probably state governments), and, conceivably, there will be less business as shady customers go elsewhere.
THE MARK: How do shell companies in the U.S compare to shell companies in countries like the Cayman Islands?
SHARMAN: I think there’s an interesting double standard, at the moment, in terms of international regulations. In the last 10 years, the small, tax-haven jurisdictions have had pretty robust pressure applied to them by the big states, and by international organizations. There’s actually been a lot of progress in making sure that shell companies can be linked to the beneficial owner in a lot of small Caribbean islands, in South Pacific islands, and in places in Europe like Liechtenstein. Where you see no such pressure being applied – in countries like the United States, but also, to a lesser extent, in Canada and New Zealand – there’s really been no progress in tightening up those standards. As long as that double standard continues to exist, we’ll have a tough time moving forward on the big policy issues we care about, like corruption and financial terrorism.