2.1. ML/TF Risks Legal Persons and Arrangements Pose to LFIs
Legal persons and arrangements offer many advantages to illicit actors. Most importantly, however, they could be abused to hide the identity of natural persons and allow bad actors to seek to open an account or carry out a transaction with an LFI under a name other than their own. Weak laws governing the formation of legal persons and arrangements, could allow for bad actors to abuse legal persons and arrangements and enable them to conduct a transaction or transactions almost without the LFI understating the real risks and the involvement of the bad actors—an action that would otherwise be prohibited under the laws of most jurisdictions. This ability to conceal identity has a number of ramifications for financial institutions.
2.1.1. Obscuring Identity/Beneficial Ownership
Individuals can use legal persons and arrangements to obscure or conceal their involvement in a transaction. In many jurisdictions, the individuals who truly own, control, direct, or benefit from a transaction—known as the beneficial owners—are not required to reveal their identities to the authorities. Individuals who are wanted criminals, known terrorist financiers, or connected to heavily sanctioned jurisdictions can form opaque companies in lower-risk jurisdictions and seek financial services under the name of a legal person or arrangement they control.
Even in jurisdictions where legal persons and arrangements are required to report their beneficial ownership, illicit actors can seek to conceal their ownership interest through the use of complex corporate structures, intermediaries, and nominees, as discussed below.
2.1.2. Obscuring the Purpose of an Account or Transaction
Legal persons, particularly businesses, engage in a wide variety of transactions with a wide range of counterparts. Depending on its size and the nature of its business, a legal person customer might be likely to send and receive far larger and more irregular transfers than would an individual—many of them with counterparties that are also legal persons. For example, a company that manufactures for export may send payments to suppliers in a number of foreign jurisdictions, and receive payments from purchasers in different jurisdictions.
The variety and unpredictability of transactions carried out by legal persons can make it more difficult to identify behaviour that is unusual or has no obvious economic purpose. This is especially true when the counterparts are also opaque legal persons or arrangements. For example, a company may seek to reduce its tax burden by claiming that certain transfers are tax-deductible expenses, when in reality they are payments to a legal person with the same beneficial owners as the originating company.
2.1.3. Obscuring Source of Funds or of Wealth
Legal persons can also be abused by individuals seeking to hide the source of an incoming transfer. For example, a politically exposed person (PEP) might receive a transfer that supposedly represents investment returns from a company located in another jurisdiction. Without knowing the beneficial owners of the originating company, it is difficult to say whether the transfer does in fact represent a return on investments, or whether it is in fact a bribe or somehow related to corruption.
The involvement of legal persons and arrangements can also make it more difficult for LFIs to identify a customer’s true source of wealth. A legal person that is represented as a profitable business, for example, may in fact be a shell company that merely passes on income from illicit sources.
2.1.4. Common Typologies of Abuse of Legal Persons and Arrangements
The use of shell companies: Shell companies, commonly defined as companies that have no significant operations or related assets, may have legitimate business purposes. A shell company’s lack of employees and physical presence, however, makes it possible to abuse it as a vehicle for illicit transactions. These features also make it very difficult for law enforcement agencies in jurisdictions where the company operates to investigate its owners and activities.
Case Study: Shell CompaniesA group of individuals conducted an investment fraud scheme which promised victims high returns on an initial investment of USD 35,000. As part of the scheme, the group established a complex web of bank and brokerage accounts and shell companies in the United States and several foreign jurisdictions. The group also opened cash management accounts at brokerages utilizing the shell corporations. Investors were told to send their investment funds to the accounts established utilizing the shell corporation names. Once in this account, the funds were transferred to secondary accounts. From these accounts, the funds were then disbursed to various foreign and domestic accounts and liquidated through the use of checks, debit cards, and ATM cards.
Complex ownership and control structures: Individuals who seek to hide their interest in a company may create multiple layers of ownership and control that make it difficult to identify who really owns and controls the company. For example, a company may be owned by a second legal person, that is in turn owned by three legal persons, that are controlled via a debt financing arrangement. Where directors are required to be reported to the registering authority, a company may name legal persons as directors, further complicating the control structure.
Case Study: Complex OwnershipCompany G was 95% owned by Mr. A and 5% by Mr. B. Company G purchased a power generator from Company K, owned by Company R in the Cayman Islands. Company R was linked to Panamanian Foundation P, which had Mr. A and his spouse as beneficiaries. Company G leased the generator to Company E, receiving amounts cleared by Company L The funds were drawn against Company K’s bank account, and Company G made payments to Company K to settle a debt. The funds were credited to the accounts of Companies S, T and R.
Use of nominee shareholders and directors: Nominee arrangements involve an individual (the nominator) assigning his or her shares or voting rights to a second individual (the nominee) who agrees to act in accordance with the wishes of the nominator. The nominee is listed as the shareholder or director of record, but in fact has no power to direct the company and does not have a legal ownership right over the benefits accruing to the ownership interest, such as dividends. Nominee relationships may be contractual or based on a handshake agreement. Such informal arrangements often involve a nominator and nominee who are close associates or family members.
Case Study: Informal Nominee Shareholders and DirectorsA Russian state agency contracted with Company 1 and Company 2 to perform software development. Neither company had the relevant expertise; they each hired subcontractors to do the work. The majority of funds received by both companies were funnelled into foreign shell companies, invested in real estate, or used to purchase luxury goods. Company 2 had previously been owned by Mr. X, who transferred the ownership to complicit associates. The real estate company that received the investment funds was owned by Mr. X’s daughter. Mr. X also controlled the nominal owners of Company 1, who received a salary from the company. Mr. X was the brother of the director of the state agency’s research department.
Use of intermediaries: Individuals seeking to create complex, opaque corporate structures will often seek out professional intermediaries (lawyers, accountants, and trust and company service providers (TCSPs)) who are experienced in bending and manipulating the rules in the jurisdiction where the legal person or arrangement is formed. Intermediaries may create new legal persons or arrangements, or sell the rights to existing legal persons that appear to have been in operation for some time. These intermediaries may also serve as directors, nominees, or trustees of the resulting legal persons and arrangements.
Case Study: Use of IntermediariesCompanies registered in New Zealand by a Vanuatu-based TCSP operated by New Zealand citizens were suspected of acting as shell companies that facilitated crime in foreign jurisdictions. The TCSP acted as nominee shareholders and provided nominee directors who resided in jurisdictions such as Vanuatu, Panama and the Seychelles. The TCSP also provided a New Zealand-based nominee director to satisfy the legal requirement to have a New Zealand resident director and address. By 2010, the TCSP had registered approximately 2,000 companies in New Zealand on behalf of clients in foreign jurisdictions. Its address, in Auckland, was used as the registered office for most of the companies. Authorities suspect that at least 73 of these companies facilitated crimes in foreign jurisdictions.