Tuesday, April 25, 2006

GAO Report on the Use of Shell Companies

The Government Accountability Office (GAO) issued a report (link below) to the Senate Permanent Investigations Subcommittee on the use of shell companies to facilitate criminal activity, and assessing whether greater disclosure requirements would assist law enforcement.  Corporations and Limited Liability Companies (LLC) can be formed quite easily in all states, often on-line, and the disclosure of the owners and organizers of the entity usually is quite minimal, with no checking by the states.  The Report notes:

Law enforcement officials are concerned about the use of shell companies in the United States that enable individuals to conceal their identities and conduct criminal activity and have encountered difficulties in investigating these shell companies because they cannot determine the owners of the companies. Quantifying the magnitude of the use of shell companies used in crimes is difficult because creating a shell company is not a crime but rather can be a method for hiding criminal activity. However, law enforcement officials told us they are seeing many investigations within the United States and in other countries where individuals have used U.S. shell companies to facilitate illicit activity involving billions of dollars. Most of the law enforcement officials we interviewed said that when they need company information, they obtain some information from state Web sites and company filings, and some said they also requested information from agents. Some law enforcement officials noted that the information available from states had proven helpful because names on the documents generated additional leads. However, some officials said that the information states collected was limited in revealing who owned and controlled the company and that cases had been closed because of insufficient information. For example, an Immigration and Customs Enforcement (ICE) official provided an example of a Nevada-based corporation that received 3,774 suspicious wire transfers totaling $81 million over a period of approximately 2 years. However, the case was not prosecuted because ICE could not identify the beneficial owner of the corporation.

The Report notes that requiring greater disclosure raises potential privacy concerns, and mandating state review of the filings would be costly without preventing much of the illegal activity. 

The use, or misuse, of a business organization to engage in wrongdoing is nothing new, and the fact that a corporation or LLC can be used as a front for illegal activity does not mean there is anything wrong with the current system for creating such organizations.  Enhanced disclosure rules do not mean that truthful information will be supplied, and the large number of such entities means that ongoing monitoring costs would be significant because misconduct is not necessarily centered on the formation of the corporation or LLC but its subsequent use.  The wall hit in the ICE case discussed in the GAO Report was not just a function of the system for creating such entities, but also a reflection of the ease with which accounts can be set up and used at financial institutions to transfer funds without detection.  Pointing to the state statutes that facilitate the formation of corporations and LLCs as a cause of the problem with the use of shell companies is a bit like blaming a robbery on the jewelry or money taken.  While a bit more disclosure of the organizers might prove helpful, these entities -- like anything else -- can be used to facilitate a crime regardless of whose name is on the documents.  (ph)

Download gao_report_company_formations.pdf


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