Concrete Risk, Invisible Companies: Doing Business in a Minefield of Shell Companies
By Amy D’Avella
Amnesty International recently accused the United Kingdom of failing to prevent a shell company from providing arms to conflict-engulfed South Sudan in violation of the U.K.’s export controls laws.[1] The Financial Crimes Enforcement Network (FINCEN), a bureau of the United States Department of Treasury, defines shell companies as “limited liability companies and other business entities with no significant assets or ongoing business activities.”[2] While they are not always established for illicit conduct, shell companies are often conduits of illegal trade and money laundering. Amnesty International characterized U.K. corporate laws as so weak that they allowed a company named S-Profit Ltd to register as a legal entity that proceeded to enter into a contract to sell arms to South Sudan.[3] In the U.K., negotiating arms transfers to South Sudan is illegal.[4]
The United States does not make the formation of legal shell companies much harder. In fact, the insignificant number of Americans implicated in the notorious Panama Papers leak has been attributed to the ease by which shell companies can be established in the U.S.; Americans do not need to go offshore to conceal their financial assets.[5] While Amnesty International’s report demonstrates government indiscretion regarding shell businesses, it is more often governments who are investigating legitimate companies for illegal transactions. Shell companies are traditionally thought of as a concern for banks who are legally liable for “knowing their customers.”[6] However, laundering through trade is becoming increasingly common and should be addressed beyond the financial sector.[7] The Amnesty International accusation is a startling reminder to companies who could have traded with S-Profit and found themselves potentially in violation of export controls and even anti-bribery laws. Prosecution can pose a serious interruption to business, and consequences include revocation of export privileges and steep fines.[8]
S-Profit serves as a timely prompt for companies and financial institutions to revisit and bolster their third party due diligence programs. The Amnesty International report was released just as U.S. sanctions against Sudan have eased and financial institutions are preparing to implement newly required ongoing customer due diligence procedures by May 11, 2018, as stipulated by FINCEN.[9] Shell companies are not just involved in illicit arms deals, but may also be facilitators of organized crime, embezzlement, tax evasion, bid rigging, asset misappropriation, and other risks of concealed ownership.[10] While no U.S.-origin goods are implicated in the S-Profit investigation as of now, S-Profit could have slipped through the due diligence process of a U.S.-based company given that its headquarters in the U.K. likely wouldn’t have raised initial red flags. However, nearly all U.S.-origin goods are subject to export controls laws which also apply to re-exports.[11] In other words, if goods originated in the U.S. were sold to S-Profit, who then sold them to a sanctioned entity, the original seller could be liable if they cannot prove they did not properly investigate S-Profit.[12] Export controls are strict liability laws, and if it turns out that S-Profit did not intend to be the end-user of U.S. goods, the U.S. seller could be liable even if they did not know S-Profit was a risky customer.[13]
Amnesty International’s report proves what many companies learn by experience, which is that just because an entity is not on a government-managed sanctions list does not mean that it isn’t involved in illegal activities which could expose a trading partner to liability. Since the Panama Papers revelation last year, demonstrating relative ease with which individuals were able to hide their money and even launder it, little has changed in U.S. regulation of shell companies.[14] Companies seeking to avoid liability posed by shell companies must maintain a robust compliance program in order to capture all high-risk, ownership-hidden customers who may be involved in illicit exports even though they evade capture by U.S. government sanctions databases.[15] Going beyond a sanctions checklist comparison for blacklisted entities, companies can protect themselves from law-subverting shell companies by looking out for other red flags such as inconsistencies or vagueness in trade documents and financial flows, connections to government officials, and an obscure or limited number of named corporate officers.[16] As of publication, the U.S. Office of Foreign Asset Control has not listed S-Profit on its blocked entities list. A potential seller would need to do further research to see that S-Profit only had two directors (one also seemingly filling the role of a “nominee director” who is hired by a covert entity to conceal the company’s true leadership) in disparate countries, one director serving as the sole shareholder. [17] This would have indicated to the seller that S-Profit might be portraying itself as the end-user in order to shield the true and illegal end-user, exposing the seller to penalty.
Just because shell companies are permitted to register and do business in the U.S. does not mean that transactions with them will be legal. Even companies outside the financial industry should maintain a rigorous third-party due diligence program to prevent risk by association of unscrupulous shell companies. In fact, the strength of the due diligence system is an element which the U.S. government will evaluate when considering penalties for an export controls violation.[18] Though Congress may help make transparency easier through newly proposed legislation requiring mandatory disclosure of beneficial ownership of all businesses, companies seeking to comply with the law now should not wait to make sure they thoroughly vet their customers.[19] Given the risk of fines and trade restrictions, even an NGO reputation-tarnishing report might be the least of corporate concerns.
[1] UK: Amnesty Exposes Illicit US $46m South Sudan Arms Deal Brokered Under Government’s Nose, Amnesty International (Sept. 27, 2017), https://www.amnesty.org/en/latest/news/2017/09/uk-amnesty-exposes-illicit-us-46m-south-sudan-arms-deal-brokered-under-governments-nose/.
[2] The Role of Domestic Shell Companies in Financial Crime and Money Laundering: Limited Liability Companies, Department of the Treasury, The Financial Crimes Enforcement Network 1, 4 (2006), https://www.fincen.gov/sites/default/files/shared/LLCAssessment_FINAL.pdf.
[3] From London to Juba: A UK-registered company’s role in one of the largest arms deals to South Sudan, Amnesty Int’l 1, 5 (2017), https://www.amnesty.org/en/documents/act30/7115/2017/en/.
[4] Supra note 1.
[5] Jana Kasperkevic, Forget Panama: it’s easier to hide your money in the US than almost anywhere, The Guardian (Apr. 6, 2016, 7:00pm), https://www.theguardian.com/us-news/2016/apr/06/panama-papers-us-tax-havens-delaware.
[6] Alan C. Porter & Tyler Kirk, FinCEN Adopts New Customer Due Diligence Requirements for Financial Institutions, K&L Gates (Jul. 26, 2016), https://www.klgates.com/fincen-adopts-new-customer-due-diligence-requirements-for-financial-institutions-07-26-2016/.
[7] Trade-Based Money Laundering Emerges as a Top Risk for Businesses, PriceWaterhouseCoopers (2015) https://www.pwc.com/us/en/press-releases/2015/trade-based-money-laundering-emerges.html.
[8] Xingjian (Jeff) Zhao, Arti Sangar, Export Controls Laws: Ignorance is not a defense, Diaz, Reus & Targ LLP, https://diazreus.com/compliance-us-export-control-laws-peril/ (last visited Oct. 16, 2017).
[9] FinCEN Releases Final Rule on Beneficial Ownership and Risk-Based Customer Due Diligence, Covington (May 10, 2016), https://www.cov.com/-/media/files/corporate/publications/2016/05/fincen_releases_final_rule_on_beneficial_ownership_and_risk_based_customer_due_diligence.pdf; see also Kimiko de Freytas-Tamura, In Long-Isolated Sudan, ‘Lot of Excitement’ as U.S. Sanctions End, NY Times, (Oct. 7. 2017) https://www.nytimes.com/2017/10/07/world/africa/sudan-sanctions-omar-bashir.html.
[10] Are Your Business Partners Real or a Trojan Horse? Detecting and Preventing Anonymous Shell Companies, Ernst & Young 1, 2 (2016) https://www.ey.com/Publication/vwLUAssets/ey-are-your-business-partners-real-or-a-trojan-horse/$FILE/ey-are-your-business-partners-real-or-a-trojan-horse.pdf.
[11] See Stanley Keller, U.S. Export Laws and Related Trade Sanctions, Harv. L. Sch. Forum on Corp. Governance and Fin. Reg. (Nov. 17, 2012), https://corpgov.law.harvard.edu/2012/11/17/u-s-export-laws-and-related-trade-sanctions/ (defining re-exports as the movement of U.S. goods from one non-U.S. country to another).
[14] Molli Ferrarello, One Year After the Panama Papers Leak, Starting a Shell Corporation in the US May be Easier Than Getting a Library Card, Brookings Now (Apr. 7, 2017), https://www.brookings.edu/blog/brookings-now/2017/04/07/one-year-after-the-panama-papers-leak-starting-a-shell-corporation-in-the-us-may-be-easier-than-getting-a-library-card/.
[15] Zhao & Sanger, supra note 7. (Rule 4.2)
[16] Bribery and Corruption Red Flags, Lockheed Martin (last accessed Oct. 16, 2017), https://www.lockheedmartin.com/us/who-we-are/ethics/anti-corruption/anti-corruption-flags.html,;Counter-Proliferation Investigations: Laws That Govern, 3 The Cornerstone Report: Safeguarding America Through Fin. Investigations 1, 4 (2017) https://www.ice.gov/sites/default/files/documents/Report/2017/CSReport-13-3.pdf.
[17] Amnesty Int’l supra note 3, at 23.
[18] Keller supra note 9.
[19] Press Release, Reps. Maloney and King Join with Law Enforcement and Advocates to Call for End to Shell Company Secrecy (Jun. 28, 2017), https://maloney.house.gov/media-center/press-releases/reps-maloney-and-king-join-with-law-enforcement-and-advocates-to-call.