Tackling beneficial ownership in shell companies
December 2019 | TALKINGPOINT | FRAUD & CORRUPTION
Financier Worldwide Magazine
December 2019 Issue
FW discusses tackling beneficial ownership in shell companies with David Sowden, Tom Townson and James Pomeroy at Grant Thornton (UK) LLP.
FW: Could you provide an overview of the role shell companies play in enabling money laundering and other illicit activities? How far has the use of shell companies transformed from providing limited liability, to facilitating illegitimate usage?
Sowden: The current parlance is to refer to ‘hiding assets in plain sight’ and to operating shell companies with the help of ‘straw men’. This encapsulates the changing way in which shell companies are used. The Financial Action Task Force (FATF) report ‘Concealment of Beneficial Ownership’ highlighted the fact that increased global trade in a borderless commercial environment is now a major challenge for individual jurisdictions. The ability to easily and quickly move funds around the global economy has meant that such shell companies can be used as a conduit for transferring the proceeds of criminal conduct, rather than simply being a place in which such proceeds are hidden. While the blatant use of such companies continues in the usual high-risk jurisdictions, as recently highlighted by Transparency International in its ‘Hiding in Plain Sight’ report, it should be noted that the UK is also used for such companies, as it provides a veneer of respectability for funds transfers.
Townson: The term ‘shell companies’ is particularly suitable in that it suggests that the company or trust that has been formed has no real substance or purpose, other than to be the entry point, conduit or home for illicit funds. The ‘shell’ has the veneer of authenticity that is designed to obscure any malign purpose that any reasonable inquiry or investigation would discover was for illegitimate usage. While many would argue that ‘shell’ companies can serve a legitimate purpose – associated with tax planning, estate management, pension provision and the protection of commercial interests that require secrecy – there is a growing number of people who do not. A number of non-governmental organisations (NGOs), such as Transparency International and Global Witness, and investigative journalists have made it their business to make transparent what has previously been a murky subject. Fuelled by data provided by whistleblowers and a desire by legislators to create environments that are hostile to illicit funds, NGOs have successfully moved the debate to a place where the activity of ‘shell’ companies is, and will continue to be, subject to greater scrutiny than ever before.
Pomeroy: To many, the term ‘shell company’ immediately connotes a structure designed with certain negative attributes in mind, such as obfuscation, ambiguity and outright fraud. While there are, of course, genuine commercial uses for these entities, many are, in reality, used regularly to facilitate money laundering and a variety of economic crimes. In many cases of international fraud, these types of entities and structures are deployed with the aim of complicating the asset tracing and recovery process when the music inevitably stops, by placing an additional burden of time, cost and complexity upon victims and investigators. The degree to which any given jurisdiction has historically enabled the privacy features of these companies, which are central to their appeal among wrongdoers, has helped shape the reputation of those jurisdictions as prominent offshore financial centres, or onshore jurisdictions of convenience. But there are jurisdictional options for bad actors. Growing pressure from larger onshore jurisdictions like the US and UK, as well as the regulatory recommendations introduced in recent years, have impacted the role that shell companies are able to play in certain jurisdictions. It has become riskier and more difficult to conduct one’s illicit activities in jurisdictions where these recommendations have been more rigorously implemented. In response, fraudsters, money launderers and corrupt actors have been forced to become more creative using extensive layering of multiple shell companies, using multiple jurisdictions and shifting their structures to territories that have been less willing or able to clamp down.
“The current regulatory regime assumes that criminals, to some extent, play by the rules, which they, unsurprisingly, do not.”
FW: In what ways can a shell company disguise the identity of who controls and benefits from that company, i.e., the beneficial owner? What is generally the extent of disclosure required?
Sowden: The dilemma faced by the owners of criminal property is to sufficiently distance their portrayed ownership of the company and any property passing through it, while at the same time continuing to exercise control over and enjoy the benefits of ownership. Consequently, the extent to which a shell company can truly disguise the real beneficial owner will depend upon the sophistication of the intermediaries who assist with the disguise, the ability to give a financial transaction sufficient credibility that it appears entirely normal for the stated purpose of the company, and the jurisdiction where the company is incorporated and where it states it operates. This is often where the role of the ‘straw men’ comes in – that is, individuals who are informal shareholders and directors, including family members, friends and business associates. The use of such identifiable individuals, rather than the traditional trust and corporate service provider’s nominee companies, means that the question of for whom the trust and corporate service provider acts is removed.
Townson: Financial services companies are required to ascertain the ultimate beneficial owner of a company or trust. More importantly, they are required to ask who is ultimately in ‘control’ – a far wider and more difficult question to address without robust understanding of a business’s operations and history. The regulations in most jurisdictions support firms’ enquiries in order to answer the ‘control’ question, by requiring the regulated firm to ascertain the ‘purpose of the account’ and the key actors involved, especially where they represent a greater degree of financial crime risk. Supplemented with open source data, firms are expected to build a picture of their customers that enables them to make risk-based decisions as to how to treat them – whether to subject them to enhanced monitoring, to refuse to take them on as clients or, in the case of an existing customer, to cease to act. There are, however, flaws in this approach. The current regulatory regime assumes that criminals, to some extent, play by the rules, which they, unsurprisingly, do not. Bad actors are known to use third parties, even including regulated firms, that are less aware of their legal obligations and less committed to transparency than others – what used to be called ‘turning a blind eye’. Some criminals are happy to use a cooperative ‘patsy’ in the course of obfuscating their beneficial ownership, but this does present risks for the criminals if a relationship breaks down. In the words of Saul Goodman – the fictional expert money laundering lawyer of ‘Breaking Bad’ fame – “Everyone needs a Danny”.
Pomeroy: When the bad actors set out to create these structures, they are not always thinking that they will keep the identity of who controls or benefits from that company secret forever. Sometimes, the goal may be to muddy the waters as much as possible and to make the asset recovery process as complicated and expensive as they can. Despite FATF recommendations that countries should “rapidly and constructively” cooperate with each other in the exchange of basic and beneficial ownership information, in practice such cooperation takes time. Whether using a country-to-country request for mutual legal assistance or civil asset recovery mechanisms, when a shell is owned by a shell that is owned by a shell, each layer poses an additional hurdle that takes time and costs money to overcome. Furthermore, while it can be possible to gain visibility into the documented basic and beneficial ownership that serves as the formal record of a company, in practice we often find in reality there is a parallel and informal structure where beneficial ownership and control actually sit with an individual who does not appear on the formal record.
FW: What steps are countries taking to change beneficial ownership requirements? How are bad actors seeking to circumvent or exploit the drive for transparency?
Sowden: The work undertaken by MoneyVal and Transparency International has increased the pressure on jurisdictions to have robust procedures in place to identify and keep up-to-date information regarding ultimate beneficial owners. Key to this being effective is the control and regulation of trust and corporate service providers. As such, we are seeing increased activity in these types of entities from the enforcement divisions of financial regulators, with a rise in the number of active inspections. As far as bad actors are concerned, the problem remains that dishonest individuals will look for dishonest ways to circumvent any controls established by regulators. A recent case prosecuted in Guernsey highlighted the difficulties faced by anyone maintaining a public register. In this instance, individuals were paid to act as the declared beneficial owners of numerous companies incorporated in several jurisdictions around the world and were even primed with the requisite answers in case they were contacted by the regulatory relevant authority.
Townson: The UK government is taking steps to implement the so-called 5th Anti-Money Laundering Directive which seeks, for those jurisdictions that are signatories, to make beneficial ownership more transparent than it ever has been before. To that end, the UK government is expecting to improve the reliability and availability of transparent beneficial information to firms. Supporting the building of a public register will be a ‘duty to correct’ on the part of firms which will be required to make submissions where information on the register is thought to be incorrect. Supposing that such a register can be delivered – in what are currently quite tight time frames – there is also the question as to how far such a regulatory innovation will be supported by offshore jurisdictions, such as Jersey, Guernsey, the Isle of Man, the Cayman Islands, the British Virgin Islands (BVI) and others. Some of those jurisdictions already have registers that are available on demonstration of a ‘legitimate interest’ – but are resistant to the notion that ‘transparency’ always trumps the desire for ‘secrecy’. Even with a verified publicly available register, there is still a danger that witting or even unwitting third parties can be used to ‘front’ the beneficial ownership of any entity. This is compounded by the current ease with which companies can be formed at relatively low cost. Bad actors will likely be able to take advantage of the difficulties that will be encountered as regulators seek to apply rules that do not lend themselves to easy practical application.
Pomeroy: In the past, there have been situations where less scrupulous companies have taken advantage of the resource challenges that regulators often face, for example by burying questionable transactions among countless legitimate transactions, flooding the regulator with suspicious activity reports (SARs) and overreporting transactions in such volumes in the hope that the bad ones will go undetected. As more prominent and better funded offshore financial centres apply more and more rigour to their beneficial ownership requirements, bad actors will continue to find alternative jurisdictions where the rules and enforcement are more relaxed.
“Sometimes, the goal may be to muddy the waters as much as possible and to make the asset recovery process as complicated and expensive as they can.”
FW: Issued in the wake of the 2015 Panama Papers scandal, how would you gauge the impact of the Financial Crimes Enforcement Network’s Beneficial Ownership Rule? How is the Rule assisting authorities in combating financial crime?
Sowden: The Beneficial Ownership Rule introduced the requirements to look not only at the strict ownership test but also the control test. The ownership test addresses the position whereby shares in a company are split into numerous small holdings such that no one single shareholding would be above the reporting limits. The control test addresses the problem of the use of nominees. From our experience, the introduction of the Beneficial Ownership Rule goes some way in addressing the use of complex multijurisdictional structures to deliberately conceal the true beneficial ownership of an asset. We have seen instances where several trust and corporate service providers have been used in order that no one such provider would have oversight of the whole of the ultimate beneficial owner’s activities. The introduction of the rule puts increased pressure on trust and corporate service providers to ask the difficult questions and obtain a full and complete understanding of their clients’ financial affairs.
Townson: Addressing the concept of control is a more difficult question for regulated firms to answer. It requires a more in-depth knowledge of a client than has previously been explicitly required but gets to the heart of what it really means to know your client. We are often asked about the real necessity for these types of rules. Our standard response is “who doesn’t want to know their client?”, which seems obvious, but is less obvious to a sizeable minority of firms we come across in our work. We have noticed that with the popularity of whistleblowing and regulators’ increasing desire to rely on intervention that is ‘intelligence led’, firms are in the very uncomfortable position where their regulators know more about their clients than they do. For a regulated firm this is an extremely dangerous position to be in, in that if it is not properly addressed it can lead to a very rapid loss of confidence in a firm’s ability to manage financial crime risk. Making beneficial ownership more transparent is only likely to add fuel to this particular fire.
FW: How important a role do central registers of beneficial owners have to play in providing transparency? To what extent do registers verify the accuracy of the data received?
Sowden: From experience investigating money laundering and economic crime offshore, the position is generally that the regulators do have registers of beneficial owners. The question in these jurisdictions is more about whether these registers should be made public or not. Indeed, the recent MoneyVal report on Jersey complimented the jurisdiction on what had earlier been referred to as “the Jersey Model” in the World Bank report ‘The Puppet Masters – How the Corrupt Use Legal Structures to Hide Stolen Assets and What to Do About It’, recognising that the jurisdiction had a high level of vetting and evaluation, together with a high standard of regulation of the trust and corporate service providers. The importance attached to having such robust and verified registers is clearly seen in the offshore jurisdictions as now essential and the assessments made by MoneyVal and others is critical in highlighting the steps taken to meet international expectations. Of course, the challenge is to keep the information on such registers valid, not only at the time of creation, but on an ongoing basis. From our experience there is more to do. In a recent example, we identified that although an individual was on the register in respect of several companies, they were not linked as being the same person.
Townson: In the UK, there is an ongoing debate about the issue of verification. Policymakers seem divided about the extent to which a central register, run by a government department, should be responsible for organising the verification of information – whether on the company, the directors or the presenters of information to the register – submitted to the register. There is arguably a conflict between government policy objectives: making the UK a ‘great place to do business’ versus making the UK a hostile place for the proceeds of economic crime. Where policy suggestions are ill-thought-out, the risk exists that neither objective will be served. The UK Department for Business, Energy and Industrial Strategy (BEIS) has recently closed a consultation which asks a series of difficult questions on the topic, which will undoubtedly lead to further development of the policy approach. It will be interesting to see how the approach will be developed and who will be required to shoulder any additional associated costs.
Pomeroy: Onshore and offshore jurisdictions around the world vary widely in the nature and extent of information that is maintained in central registers. Public policy weighs in on what information should be made available to the public, or how limitations can be applied to offer some level of protection of individual privacy, such as disabling reverse lookups to find all properties or companies associated with an individual, as opposed to searching a particular subject property or company. Different jurisdictions will, of course, weigh these concerns differently. In most jurisdictions, beneficial ownership information is already maintained in some capacity, whether in a central registry or with a designated representative. The key issue then becomes who can have access to that information and by what means. The availability of this information is crucial to those in pursuit of the proceeds of crime and corruption and should be accessible through a competent authority or judicial request. It is commonly asserted that keepers of the registers should be adequately resourced so they can verify the accuracy of the information provided by companies. However, in many smaller jurisdictions that premise is simply not likely to be possible given the numbers of companies registered in countries with relatively small populations. The argument for making beneficial owner data public so as to be ‘crowd verified’ is an interesting thought, however. In practice, there are likely to be offsetting negative implications, the public policy debate being chief among them. While the public policy debate around open access continues, a distributed approach to data integrity may be the short-term answer, using the information obtained by financial institutions to maintain the integrity of the register.
“As far as bad actors are concerned, the problem remains that dishonest individuals will look for dishonest ways to circumvent any controls established by regulators.”
FW: What essential advice would you offer to financial institutions in terms of evaluating the effectiveness and adequacy of their processes and procedures around beneficial ownership?
Sowden: The identification of the ultimate beneficial owner should be considered an ongoing process. Requirements under the Beneficial Ownership Rule mean that continual monitoring will be required. In particular, where there are large, complex, multi-entity structures with constantly changing shareholdings and key management, the ownership and control rules will need to be monitored to identify changes which may trigger a change in status of an individual, meaning they fall within the definition of an ultimate beneficial owner. As such, financial institutions will need to ensure that their procedures are robust and flexible enough to identify such changes. Ultimately, this will require a combination of technology and personal client relationship management.
Townson: Quite a few jurisdictions require regulated firms to conduct an annual review of their financial crime framework – which necessarily includes a firm’s approach to beneficial ownership – whereas others require a periodic review, the length of the period being decided by the firm itself. Often these reviews are required to be independent – a function which can sometimes be fulfilled by using a firm’s own internal audit function. In our experience, it is far better for a firm to invest in a review of its financial crime framework rather than being required to undertake one by a regulator because of an ‘event’. In the former circumstance, the firm is demonstrating that it is in control of its own affairs and cares about the outcomes that financial crime framework is there to promote. Where such reviews are engaged in because of an ‘irregularity’, this can tend to lead to a loss of confidence in the senior management of a firm and more invasive, time consuming and costly investigations.
Pomeroy: A risk-based approach to managing and monitoring clients enables financial institutions to appropriately address accounts in the international sector or with complex structures with foreign ownership. Where financial institutions run into difficulties accessing information about international clients, using independent external service providers can help satisfy customer due diligence requirements. Jurisdictions that have demonstrated an ongoing and iterative approach to risk assessment have been looked upon favourably by the FATF in its mutual evaluation reviews, even where resource constraints and deficiencies in financial analysis have been noted.
FW: How do you expect the methods deployed to tackle beneficial ownership in shell companies to evolve in the months and years ahead?
Townson: While there is ongoing discussion about the extent to which jurisdictions should have public registers of ultimate beneficial owners, all jurisdictions should ensure that the quality of the information held is accurate and up-to-date, regardless of whether such registers are eventually made publicly accessible or not. The scrutiny required, in addressing the question of the use of shell companies, will mean that they will become increasingly the focus of the various financial regulators around the world. We are seeing financial regulators taking this seriously and, in some instances, are having their funding increased accordingly. Transparency has become the watchword for the anti-financial crime community, and this is reflected in the type of legislation and regulation that is currently being developed. Firms should expect to be required to engage in greater scrutiny of beneficial owners and third parties and in turn to receive greater scrutiny themselves.
Pomeroy: External pressures will continue to push offshore financial centres to tighten their beneficial ownership regimes. How British Overseas Territories choose to address the UK legislation, asking them to make their registers public, could have a significant impact on jurisdictions such as BVI and the Cayman Islands as continuing beacons for offshore companies, and could signal to other countries that these pressures will continue to spread globally. Like financial institutions, service providers of all types should be employing an iterative approach to verifying the beneficial owner information that is presented to them. They should not be relying solely on what is provided as direct evidence by their customer, but, on a risk-ranked basis, perform enhanced due diligence on certain customers in order to be satisfied that the information provided is complete and accurate.
David Sowden is a recognised expert forensic accountant on the UK National Crime Agency (NCA) database. He has worked with leading prosecution authorities such as the Serious Fraud Office (SFO), the NCA, the Crown Prosecution Service (CPS) and the NHS Counter Fraud and Security Management Services. Such cases have involved allegations of fraud, corruption, theft, false accounting and money laundering. He has acted on high profile sensitive cases involving politically exposed persons, involving corrupt payments. He can be contacted on +44 (0)11 3200 2552 or by email: david.sowden@uk.gt.com.
Tom Townson has over 20 years’ experience as a practitioner and as a consultant to financial service firms in the financial crime arena, covering fraud, anti-money laundering (AML), sanctions, AB&C and conduct issues. He has led a number of globally significant programmes concerned with advising on building, reviewing or improving financial crime frameworks primarily at firms subject to intensive regulatory scrutiny involving multiple jurisdictions and regulators. He can be contacted on +44 (0)20 7865 2175 or by email: thomas.f.townson@uk.gt.com.
James Pomeroy is an associate director with Grant Thornton in the British Virgin Islands, where he heads the firm’s forensic services practice. He has over 24 years’ experience in forensic accounting, investigations, financial auditing, insolvency and international asset recovery, with a focus on Caribbean jurisdictions for the past 17 years. He can be contacted on +1 (284) 346 5589 or by email: james.a.pomeroy@uk.gt.com.
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