THE ROLE OF DOMESTIC SHELL COMPANIES AND OFF SHORE FINANCIAL CENTRES IN FINANCIAL CRIMES

The term “shell company” generally refers to limited liability companies and other business entities with no significant assets or ongoing business activities. Shell companies – formed for both legitimate and illicit purposes – typically have no physical presence other than a mailing address, employ no one, and produce little to no independent economic value. Shell companies are often formed by individuals and businesses to conduct legitimate transactions, such as domestic and cross-border currency and asset transfers, or to facilitate corporate mergers and reorganizations.

Shell companies can be publicly traded or privately held. Although publicly traded shell companies can be used for illicit purposes, the vulnerability of the shell company is greatly compounded when it is privately held and beneficial ownership can more easily be obscured or hidden. Lack of transparency of beneficial ownership can be a desirable characteristic for some legitimate uses of shell companies, but it is also a serious vulnerability that can make some shell companies ideal vehicles for money laundering and other illicit financial activity.

One of the common uses for a shell company is in the reverse acquisition. The procedure will often involve a simple acquisition of a shell company, with shares of a private company used as consideration. The shell company, which at one point may have been an active company publicly traded on a stock exchange, issues shares to the shareholders of a private company sufficient to give those shareholders a majority interest in the shell company, thereby effectively taking the private company without the usual costs associated with an initial public offering, and giving shareholders of the private company control over the shell company. It should be noted that the shell company in the reverse acquisition is often a formerly active company, not one created solely to be a shell.

The reverse acquisition process has in the past been subject to abuse. For example, if the expected value of the private company is fraudulently exaggerated, investors buying into the company may lose a considerable percentage of their investments when the company turns out to be worth much less. Those who fraudulently promoted the company have at that point already sold their stock and made a handsome profit. These “pump and dump” schemes often involve shell companies with low market capitalization whose stock trades at pennies per share on the “pink sheets”, Over-The-Counter (OTC) Bulletin Board, or other Over-The-Counter trading and information systems. One indicator of this scheme is concentrated trading in normally thinly traded stocks. Ralph A. Lambiase, former president of the North American Securities Administrators Association (NASAA) and director of the Connecticut Division of Securities, noted in 2004 the existence of “a steady stream of fraud and misconduct in the distribution and manipulation of shares of shell companies and the companies that combine with shell companies.”

Some steps have been taken to prevent this type of abuse. For example, the U.S. Securities and Exchange Commission(SEC) adopted rules on June 29, 2005 designed to protect investors in the securities markets from fraud and abuse involving the use of shell companies, while allowing the use of shell companies for legitimate corporate structuring purposes. The SEC’s rules are disclosure-oriented and require the public reporting of information that would then be accessible through the Electronic Data Gathering, Analysis, and Retrieval system (EDGAR). The SEC acknowledged in its rule making that companies and their professional advisors often use shell companies for many legitimate corporate structuring purposes, such as certain change of domicile or business combination transactions.

Shell companies may play a role in common financial crime schemes such as the credit card bust-out, whereby credit is built up on cards using false identities, then phony transactions with cooperating businesses or shell companies are made and the phony charges are received as payments from the unsuspecting credit card companies. Referring to a case involving a foreign national who is suspected of providing bust-out proceeds to terror groups, Federal Bureau Of Investigation (FBI) Intelligence Analyst Joseph Enright said, “one of the co-conspirators in the bust-out case linked to the New York case had an American identity under one name, with which he incorporated shell businesses and obtained checking accounts, and a completely different ‘new name’ under which he obtained a passport from his native country.” Additionally, the complicit businesses may change names, director names, and addresses on official documents to throw investigators off the track.

A technique commonly seen by corporate accountants involves an employee over-invoicing or creating false invoices and pocketing the difference. The director of a nutritional supplement company was convicted of money laundering in 2004. He had set up a shell company and was paying false invoices for the purchase of nutritional supplements. In addition, he received kickback payments from another nutritional supplement company in exchange for purchasing their products. His company was established by a service provider that also provided mail and phone forwarding for the shell company.

The latter example indicates that the individuals or companies that create shell companies may play a significant role even after the shell is created and sold. In fact, a convenient and popular service combines formation with ongoing support.

One Delaware-based service provider provides formation services as well as mail forwarding services, telephone lines, e-mail accounts, and accounting services to file tax returns. A number of suspected shell companies created by this firm appear in Suspicious Activity Reports.

Forming and supporting small companies is neither difficult nor expensive, and requires no special skill other than understanding the laws in the various states. The majority of shell companies sold to foreign interests appear to differ significantly from those used in reverse acquisitions, for example, in that they appear to have been set up solely for purchase and were not “aged” or put on the shelf after some period of actual operation (though they, too, may not be used immediately). This type of shell appears to have few legitimate uses, and can fairly easily be employed to disguise ownership or movement of assets or to facilitate illicit activity.

A report by the U.S. General Accounting Office (now the Government Accountability Office) in 2000 provided information on another service provider whose business provided approximately 2,000 shell companies to clients based in Moscow, Russia. The report did not uncover the purpose of these companies, but did describe some interesting aspects of a phenomenon that appears to be continuing today on a large scale – the use of domestic shell companies to hide the ownership and purpose of billions of dollars in international wire transfers. This phenomenon has been drawing increasing attention both domestically and abroad due to the large amounts of money involved and the secretive nature of the companies and their transactions. The Financial Crimes Enforcement Network has previously examined the use of domestic shell companies in these transactions and has provided input to the Financial Action Task Force (FATF).

Internet searches reveal that numerous service providers advertise services for shell companies, such as resident agent and mail forwarding services. Shell companies may also purchase corporate office service packages in order to establish a more significant local presence. Advertised prices for these packages, which often include a state business license, a local street address and an office that is staffed during business hours, a local telephone listing with a live receptionist, and 24-hour personalized voicemail, range from $900 to $1950 per year in the research sampling. In addition, service providers may offer assistance in opening local and foreign bank accounts for the shell company. For example, in the United States Government Accountability Office (GAO) report cited earlier, it was revealed that two service providers created 236 accounts at two U.S. banks which were the recipients of about $1.4 billion in wire transfers.

Service providers may also sell aged “shelf companies.” Prices for these companies vary depending on the year and state of organization (older companies commanding higher prices), as well as factors such as whether the shelf company has an employee identification number (EIN), received a Paydex score, filed non-activity tax returns, previously had a bank account, or currently maintains a bank account. Advertisements by some service providers contend that the main advantage for purchasing a shelf company is to provide the appearance of longevity to the business, particularly for the purpose of meeting minimum age requirements when obtaining leases, credit, and bank loans.

In order to preserve a client’s anonymity, some service providers promote a variety of nominee services including:

Nominee EIN: Shell companies may obtain an EIN without providing the client’s EIN on the application.

Nominee officers and directors: Service providers may set up nominees for those offices in the shell company that appear on the public record in order to eliminate the client’s name from secretary of state records. In addition, a client can retain ownership and operational control through confidential stock ownership or appointment to offices that do not appear on the public record (e.g., vice president).

Nominee stockholders: The client may use nominee stockholders to create an additional layer of privacy while maintaining control through an irrevocable proxy agreement.

Nominee bank signatory: A nominee appointed as the company accountant accepts instructions from the client.

Offshore Finance Centre: What it means

In its simplest meaning, offshore finance is the provision of financial services by banking institutions and other agents to non-residents. These services include the borrowing of money from non-residents and lending to non-residents. At its broadest, an Offshore Finance Centre(OFC) can be defined as any financial centre where offshore activity takes place. OFCs are centres much smaller in size compared to International Finance Corporations(IFCs) and Resident Foreign Currencies(RFCs). These centres provide specialist and skilled activities, are attractive to major financial institutions and more lightly regulated centres that provide services that are almost entirely tax driven and have very limited resources to support financial intermediation.

Offshore Financial Centres fall under the intense and continuous scrutiny of the various governments and agencies. Low taxation, loose regulations and relaxed compliance norms are all typical features of such centres. In fact, categorization of OFC is a difficult exercise since the process involves subjective conclusions. Reputed organizations like International Monetary Fund(IMF), Organization For Economic Cooperation and Development(OECD), and US Government accountability office have already published list of OFCs, although the lists seem to be not exhaustive. 

Modern economic literature is extensively using the coinage ‘Tax havens’ to describe the offshore financial centres. Many contemporary movies and fictions are posturizing offshore financial centres as settings for shady international deals. Fiscal crimes like benami financial deals, money laundering, and tax evasions are all synonymous with such centres. Many of these allegations are plausible, but most of them are founded on anecdotal rather than systematic evidence. 

The trigger for such allegations is the opaque and sometimes murky working of the OFC’s (at least some among them). The major concern was about the inadequate supervision of financial transactions undertaken by the centres and non-availability of quality data. As a part of their governance exercise, IMF started an assessment program on the working of Offshore Financial Centres in June 2000. The assessment program focused on integrity standards, disclosure norms, regulatory frameworks, and supervision of the centres.

The distinct feature of OFCs is their tax culture. They will uniformly levy nil or minimal corporate taxes. Multinational establishments are utilising this advantage for tax avoidance, a perfectly legal method. But it is a fact that many clever organisations are misusing the facilities for doing ‘tax evasion’, which is legally prohibited. Banking and corporate secrecy offered by these centres will act as a blessing in disguise for such heinous financial crimes.

Different methods are used for tax evasion. In simple terms, earnings from OFCs will be concealed by the entities from their home country authorities to evade tax. Another method is the routing of earnings from the high tax regions through OFCs to evade tax. Transfer price adjustments between the parent company and subsidiaries are cleverly structured by many multinational firms as a tool of tax evasion. This phenomenon is also termed as regulatory arbitrage.

Many OFCs are locations for pass-through financial entities, and they experience exceptionally large volume of portfolio investment deals disproportionate to their income and GDP. For example, Cayman Islands, a prominent offshore centre, is one of the largest capital inflow recipients in the world, despite having the population and income of much lesser than Mumbai (about half in size of geographical area and 5% in size of the population). 

we discussed the benefits and evils of OFCs for the society and economy. There are ample evidences for the manifold contributions of such financial hubs in the development of global economy. The flip-side is the rare misuse of the facilities by a few unscrupulous business entities. The major allegation of ‘financial secrecy practices’ followed by the OFCs is exaggerated accusation. Sovereigns like USA, UK, Hong Kong, Switzerland, and Singapore are all having certain level of financial secrecy, minimal regulations, and preferential tax structures for the non-residents. The abuse of rules can be curtailed by strict enforcement of regulations and enhanced vigilance. Initiatives taken by organisations like Organization For Economic Cooperation And Development(OECD) and Financial Action Task Force (FATF) are helping to a large extent to minimise the abuse of offshore financial hubs.

Financial climate prevailing in the OFCs cannot be experienced in any other economic landscapes around the world. Hence it is no surprise that such financial centres will flourish in future and global economy shall reap the benefits provided by them.

The Hindenburg Research report on the Adani Group which is released in January 2023, a critical analysis of the Indian conglomerate’s financial and operational practices. The report has sparked a heated debate about the business practices of one of India’s largest companies and raises serious questions about the ethics and legality of Adani Group’s operations.

Adani Group is a multinational conglomerate with interests in ports, logistics, agribusiness, energy, real estate, and defence. With revenues of over $11 billion in the fiscal year 2021, the company is a major player in the Indian business world. However, the Hindenburg report alleges that the company has used unethical accounting practices to exceed its wealth and understate its liabilities.

The report also criticizes Adani Group for its environmental practices, accusing the company of engaging in large-scale deforestation, damaging fragile ecosystems, and polluting groundwater and air. The report claims that Adani Group has ignored the concerns of local communities and has not followed environmental regulations.

Albeit the Adani Group of companies has issued several statements in response to the report, denying the allegations and defending its business practices, but failed to adhere to plausible evidence to the allegation raised by one of the opposition party leaders Rahul Gandhi of Indian National Congress party who’s statement questioned as “There is a very simple thing. Who owns the ₹20,000 crores in Adani’s shell companies? It is ‘Benami’. Who owns it”

A possible solution which tackles the “Shell Companies” problem at its root is to examine the laws and requirements which prevent law enforcement and regulatory authorities from conducting effective investigations into the ownership of business entities. Such steps as requiring company formation agents and similar service providers to obtain and maintain records of beneficial ownership for the companies they service could be considered. The information could then be made available at the request of government authorities under appropriate circumstances. In addition, greater transparency in reporting requirements under state law could reduce the value of business entities as vehicles for illicit activity.

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