Senators See Dangers in Shell Corporations, LLCs
Two different forms of corporate charters — shell corporations and limited liability corporations (LLCs) — have recently come under intense scrutiny because of their usefulness in money laundering and other criminal activity.
Shell corporations are chartered under laws specifically designed to provide a heightened form of privacy and anonymity to the persons who control the corporations. These entities are chartered in only a few states that openly compete with each other to provide the strongest privacy protections for shell corporations’ owners.
LLCs, on the other hand, are more common business entities that are routinely chartered in large numbers by all 50 states. The relative informality of the LLC charter makes it attractive to small business owners seeking a simple and effective way to obtain the benefits of a corporate charter.
Until recently, concern about the abuse of anonymous corporate charters to hide money laundering or other criminal activities focused largely on shell corporations. Recently, however, attention has also turned to LLCs as potential avenues for abuse. This article will deal with the perceived problems with both types of corporation.
Shell Corporations
Because shell corporations enable the true owners of a business to disguise their identities, they may be a hazard to national security, two senior senators believe. Banking Committee Chairman Richard Shelby (R-Ala.) and ranking member Paul Sarbanes (D-Md.) have both complained that shell corporations, which are chartered by only a few states, are opening up dangerous loopholes in the laws designed to prevent money laundering and terrorist financing activities.
Shelby and Sarbanes expressed their concerns about shell corporations at Banking Committee hearings on money laundering conducted early this month. At those hearings, Stuart Levey, under secretary of the Treasury for terrorism and financial intelligence, warned that corporate vehicles such as shell corporations could be dangerous. Citing the government’s Money Laundering Threat Assessment document (see Pratt’s Anti-Money Laundering Update, February 2006), Levey said:
“Criminals and money launderers have exploited corporate vehicles and trusts to disguise beneficial ownership and hide their activities. When state registries impose minimal information requirements and exercise lax oversight over the shell companies and trusts they register, it can be difficult or impossible for financial institutions to verify who is using a commercial account and for what purpose.”
Picking up on Levey’s theme, Shelby warned, “We cannot afford to let the states create a loophole that’s being used to abuse our financial system or to aid and abet money laundering, criminal activity [or] terrorist financing in any way.” Sarbanes added, “If the states are going to provide, in effect a loophole, then we have a serious problem on our hands.”
Levey agreed that his department shares the concerns the two senators expressed. He noted that the structure of shell corporations can make it harder for law enforcement agents to establish the legality of the corporations’ activities. Levey added that the administration wants to respect the role of the states in this area and is trying to work out voluntary arrangements with state governments to address this problem.
The two senators seemed less sympathetic with state sensitivities, however, insisting that the national interest in stopping money laundering and terrorist financing should take precedence over the states’ authority to charter corporations. “The federal government has responsibility for the security of the nation,” Shelby told reporters following the hearing.
Limited Liability Corporations
Separately, the Government Accountability Office (GAO) prepared a report on LLCs. This report, which was prepared at the request of Sens. Carl Levin (D-Mich.) and Norm Coleman (R-Minn.) respectively, the ranking Democrat and Chairman of the Permanent Subcommittee on Investigations, reviewed the legal requirements in all 50 states to set up LLCs and for the first time equated LLCs with shell corporations as potentially useful entities for money laundering and other criminal activities.
The report found that all 50 states routinely incorporate new non-publicly traded LLCs without obtaining and verifying the identity of the owners, and that the absence of this company ownership information impedes law enforcement.
The GAO report also found that:
- None of the 50 states routinely requires applicants who want to form a new corporation to disclose who will own the corporation; most states do not require ownership information for LLCs.
- Third-party agents who submit company formation papers and annual reports are not required to and do not collect or verify company ownership information.
- The absence of company ownership information enables individuals, including foreigners, to conceal their identities while operating as U.S. companies.
- Law enforcement is hindered by the absence of company ownership information.
LLCs Compared with Shell Corporations
The failure of states to collect company ownership information creates a risk that criminals will set up and use U.S. companies for money laundering, tax evasion, terrorist financing, or other crimes, the GAO warned.
The agency reported that law enforcement officials are seeing an increase in the use of anonymous U.S. corporations for illicit activities. The GAO report provided the following examples of law enforcement investigations that involved U.S. shell companies:
- FinCEN found that, between April 1996 and January 2004, financial institutions filed 397 SARs, concerning a total of almost $4 billion that involved transactions among U.S. shell companies, East European countries, and U.S. bank accounts.
- The FBI told GAO that U.S. shell companies are being used to launder as much as $36 billion from the former Soviet Union. The FBI also reported that they have 103 open cases investigating market manipulation, most of which involve U.S. shell companies.
- Immigration and Customs Enforcement (ICE) officials reported a Nevada-based corporation received more than 3,700 suspicious wire transfers totaling $81 million over two years, but the case was not prosecuted because ICE was unable to identify the corporation’s owners.
- The Internal Revenue Service uncovered a scheme involving two individuals who set up shell companies in Florida to hide assets from taxation. One was sentenced to 10 years and ordered to pay $1.6 million in restitution, while the other was sentenced to 25 years.
- A Department of Justice report revealed that Russian officials used shell companies in Pennsylvania and Delaware to unlawfully divert and launder $15 million in international aid intended to upgrade the safety of former Soviet nuclear power plants.
Domestic, Offshore Secrecy Compared
The GAO report observes that some offshore jurisdictions renowned as havens of corporate secrecy, such as the Isle of Man and Jersey, currently require company formation agents to obtain and verify company ownership information to a greater extent that some states do. But these traditional financial secrecy havens erect other barriers to law enforcement.
“Some offshore jurisdictions get company ownership information, but use corporate secrecy laws to make it tough for U.S. law enforcement to get the information,” said Levin. “Here at home, states provide law enforcement with company documents, but those documents don’t identify company owners. Anonymous U.S. shell companies engaging in criminal activity present a major problem for law enforcement, so we cannot continue to ignore this problem. The security risk and criminal threat posed by anonymous shell companies mean we need to work with law enforcement, the states, and others to address this problem in a reasonable and cost-effective way.”
Senators Concerned
“The ease with which shell companies can be set up for illicit purposes is troubling, yet we need to consider the legitimate business interests and privacy concerns with protecting ownership information,” said Coleman. “We need to find the right balance among individual rights, state rights, and legitimate law enforcement objectives.”
“We ought to know who is behind U.S. companies doing business in our country, but right now we don’t,” Levin said. “The result is that anonymous non-publicly traded companies are able to engage in illegal activities such as money laundering or other crimes, knowing that U.S. law enforcement has no ready way to identify the company owners. Today people have to supply more information to get a driver’s license than to form a company.”
“Companies form the basis of this country’s economic system, providing valuable goods and services,” Coleman said. “However, some individuals abuse the system and hide their identity behind shell companies that conduct no business except to facilitate criminal activity under the radar of law enforcement agencies. We need to take a closer look to identify the magnitude of this problem.”
This article first appeared in the April issue of Pratt’s Anti-Money Laundering Update. Click here for more information about this publication.
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