Shell Companies and Money Laundering

Shell companies are business entities that are often used by money launderers to hide illegal funds and the identity of beneficial owners. 

In 2016, the Panama Papers exposed the extent to which shell companies were being used to launder money in jurisdictions around the world. The AML threat posed by shell companies is significant: the leaked documents revealed that shell companies had been set up in a variety of low regulation jurisdictions such as the British Virgin Island and the Cayman Islands, with many of those enterprises linked to prominent political officials and their families. Responding to the leak, global tax authorities were able to recover around $500 million and pursue a number of criminal prosecutions against firms and individuals involved.   

In the United States, some estimates suggest that the misuse of shell companies costs the country around $70 billion per year. Given the scale of the threat to the legitimate financial system, it is important that firms understand the AML risk that shell companies pose and are able to detect customers that are attempting to use them to launder money. 

Shell Company AML Red Flags

The anonymity associated with shell companies and the deliberate efforts by criminals to avoid regulatory scrutiny can make AML compliance challenging. Accordingly, AML compliance teams should be familiar with red flag characteristics that indicate when a shell company may be being used to launder money. Those red flags include:

• Difficulties in obtaining information about the originators or beneficiaries of transactions or transfers. 
• A company that exhibits transaction activity inconsistent with its business profile, including unusually high volumes of transactions or sporadic bursts of transactions.
• Payments that have no clear or stated purpose or that do not involve any discernible goods or services.
• Multiple high-value transfers between known shell companies.
• Payments that are only identifiable via reference to a contract or invoice. 
• Transactions involving goods and services that do not match the profile of the companies sending or receiving them. 
• Transactions that involve two separate companies registered to the same address or companies that provide only the address of their registered agent.
• A single company sending wire transfers to an unusually large number of beneficiaries. 
• Transactions that frequently involve beneficiaries in high-risk jurisdictions or off-shore financial destinations. 

How to Comply

In order to comply with domestic regulations and the recommendations of the Financial Action Task Force (FATF), firms must put risk-based AML programs in place to deal with the AML threat posed by shell companies. In practice, this means that firms must gather information about, and perform risk assessments on, their customers in order to determine a proportionate AML response. 

In determining whether customers are attempting to misuse shell companies to launder money, a firm’s AML response should focus on UBO, business relationships, and transactional activity. Compliance teams should seek to aggregate data from a variety of sources to map connections between entities, reveal ownership and understand transactional flows. With that in mind, an AML program should include the following features and measures:

• Customer due diligence: Firms should verify the identities of their customers through appropriate customer due diligence (CDD). The process should include verifying the beneficial ownership of customer entities so that their status as shell companies can be established. 
• Transaction monitoring: Shell companies may be identified from the types of transaction in which they engage. Unusual transaction patterns or transactions involving high risk countries may indicate misuse of a shell company to launder money.
• Sanctions screening: Customers that appear on international sanctions lists may seek to use shell companies to access the legitimate financial system. AML teams must screen customers against the relevant international sanctions lists, such as OFAC’s Specially Designated Nationals and Blocked Persons list or the UN’s Consolidated List.
• PEP screening: Politically exposed persons (PEP) represent a higher AML risk and may use shell companies as a way of evading CDD measures. PEP status should be monitored on an ongoing basis. 
• Adverse media monitoring: Ownership of shell companies often generates adverse media and can indicate a change in a customer’s risk profile. Accordingly, firms should monitor for adverse stories from traditional screen and print media and online sources. 

In the wake of the Panama Papers, financial authorities are taking steps to prevent the use of shell companies to launder money. In the United States, for example, the Corporate Transparency Act (CTA) was introduced in 2019 to crack down on the anonymity associated with shell companies. Under the CTA, companies must report their ultimate beneficial ownership to the Financial Crimes Enforcement Network (FinCEN) upon their formation. The CTA defines beneficial owners as natural persons that: 

• Hold substantial control of a corporation or LLC
• Own 25% or more of a company’s equity
• Receive substantial financial benefits from their company’s assets

In order to manage the data collection and analysis obligations required to identify shell company misuse, firms may seek to integrate a range of smart technology, such as artificial intelligence and machine learning tools. In addition to the automated speed and efficiency that it brings to the compliance process, smart technology also enables firms to better adapt to changes in legislation such as the CTA and to new criminal methodologies.