Ed Long

Ed Long 

Posted Monday December 9, 2013
 

Playing the Shell Game

Playing the Shell Game

Header Photo CC Flickr User Doug88888

“A corporation is a legal person created by state statute that can be used as a fall guy, a servant, a good friend or a decoy. A person you control […] yet cannot be held accountable for its actions. Imagine the possibilities!” - Wyoming Corporate Services promotional copy

For the ninth year in a row New Zealand has managed to bag the top spot on Transparency International’s Corruption Perceptions Index. But the shiny score of 91 (on a par with Denmark), is no cause for complacency: New Zealand, along with many OECD countries, plays host to incidents of large-scale corporate fraud including, in 2009, one of the biggest cases of sanctions-busting arms trafficking in recent history.

Although investigations by an array of authorities and NGOs have thrown up some potential leads, the opaque use of anonymous shell companies to conduct the deal has meant, incredibly, that the only person so far convicted over the deal was a 28-year old Chinese immigrant who, in addition to her main job working in the kitchen at Burger King had taken on what she believed was minor clerical work for a small Auckland firm.

So how did a major arms deal get funneled through the world’s most transparent country? And what can be done by governments and investigators to combat and prosecute crimes hidden in networks of anonymous shell (or ‘phantom’) corporations?

On 12 December 2009, Thai police stormed a cargo plane refuelling at Don Muang airport, Bangkok. Instead of the drilling equipment listed on the manifest, the police uncovered 35 tons of weapons and explosives, including anti-aircraft missiles. The shipment, chartered by a New Zealand company – SP Trading Ltd – originated in North Korea and was bound for Iran: two countries subject to strict US and UN trade sanctions.

The records for SP Trading are still visible in New Zealand’s Companies Office, although the site states that it is in the process of removing the company from the register. The records show the current director as Vanuatu-based Leo Doro Basil Doe, who in February 2010 took over from the original director: our Burger King chef Lu Zhang.

Consent

Summary

Shareholdings

On November 4 2010, Zhang was convicted for making false statements on company registration forms. In addition to SP Trading, she had registered as a nominee director on more than 50 additional companies, reportedly being paid a flat fee of NZ$20 by a high-volume corporate service provider each time she did. In light of the fact that Zhang was clearly unaware of the activities of the companies she ‘directed’, and under some diplomatic pressure from China, the Auckland District Court chose not to impose a penalty.

This judicial dead end arose as a result of what Canada’s Fintrac agency described as “weak company registration laws”. These allow corporate service providers (CSPs) to register companies with only minimal levels of documentation. New Zealand’s system was again exploited in the case of North Carolina-based Wachovia bank, which was revealed to have been using a slate of Auckland shell companies to launder US$479bn for Mexican cocaine cartels.

So is this simply a problem of corporate registers not, in general, holding records of the individuals who truly control the finances and activities of registered companies? UK Prime Minister David Cameron has argued for greater transparency in this area announcing plans to create a public register of beneficial ownership at an Open Government Partnership summit in October this year, and writing to the President of the European Council on the issue.

In general (though with some notable exceptions) the volume of open corporate data on companies registered in developed countries is greater and more readily accessible than those in emerging markets: Papua New Guinea’s corporate registry was only published online last week, for example.

So does this mean that investigators have an easier task in developed nations than in offshore jurisdictions and emerging markets? A study undertaken at Australia’s Griffith University last year draws some surprising conclusions. Although official company registries may be easily searchable in developed countries, the authors found that CSPs in OECD countries were much more likely to be non-compliant in their registration process: either simply not demanding the required notarised identity documents, or actively offering anonymity for a premium.

Figure

This figure, reproduced from the study, shows CSPs based in tax havens were over three times more likely to be compliant than those based in OECD countries. The ‘dodgy shopping count’ represents the estimated number of attempts it would take to solicit a non-compliant response from an incorporating service in each jurisdiction.

Writing emails to over 3,700 service providers around the world, they found that, of those that replied, just under half offered registration services without demanding proper identification. Counter-intuitively, they found that tax havens were the most compliant with international standards and that – on average – service providers in OECD countries were more likely to be non-compliant than those in developing nations. The Cayman Islands, Seychelles, Bahamas and Jersey joined Denmark among the eight jurisdictions where email responses received by the authors were fully compliant with the international standards set by the FATF.

Although law firms tended not to respond to the authors’ questionable solicitations (some of which were deliberately constructed to imply terrorist links) US-based incorporation services jumped at the opportunity, making a higher proportion of non-compliant offers than any global region apart from Kenya. This was especially true for CSPs in Nevada and Delaware.

Again, US State Corporate Registers are in general online and freely provide information, though full ownership and shareholder details can be harder to obtain. The capture below shows a typical example record for Yuralex Corporation – an entity registered in Delaware.

Entity details

The only freely available details are the filing number and the details of the corporate service provider. In fact, the company above was a shell corporation used by convicted Russian arms dealer Viktor Bout as part of a conspiracy to provide weapons to Colombian guerrilla group FARC.

There are moves in the US to improve scrutiny of corporate entities: the Incorporation Transparency and Law Enforcement Assistance Act was reintroduced by Michigan Senator Carl Levin in August. The bill, co-sponsored by Obama before he was elected president, would require states to add a single question about beneficial ownership to their incorporation forms. Despite the vulnerability of the US to being used by criminal organisations, corrupt individuals and terrorist groups through the permissiveness of certain states’ regulatory setup, the Govtrack website gives the bill only a 10% chance of passing the congressional committee, and 3% chance of being enacted.

Conclusion

So what is the lesson for investigators? Firstly that shell companies may cause an investigation to dry up unexpectedly quickly. A shell company may well be used for legitimate purposes, but a company clearly run by an uninvolved nominee director and registered by a high-volume CSP with minimal registration requirements should be cause for concern. Second, that although registration in an offshore jurisdiction probably implies an aversion to paying taxes, the beneficial ownership records may be more trustworthy than those in developed nations generally thought of as transparent. Finally, as urged in the World Bank Stolen Assets Recovery Initiative’s 2011 report ‘The Puppet Masters’, investigators and judicial authorities need the tools and understanding to build transnational cases. The harnessing and mining of insights from open corporate and regulatory data should a key tool in revealing levels of ‘inappropriate complexity’ that can be the hallmark of illegal activity.

Shell image CC 2.0 license by Roberto Verzo

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