Guest Post: Global Shell Games — Experimenting with Untraceable Shell Companies

GAB is delighted to welcome back guest contributor Professor Jason Sharman of Griffith University, Australia, who contributes the following post:

Among the various mechanisms for hiding and laundering large sums of money associated with corruption, shell companies that cannot be linked with their real owners have proved one of the most troublesome. A 2011 Stolen Asset Recovery Initiative report on laundering the proceeds of grand corruption noted that from a total of 213 cases, 150 involved the use of shell companies (or, more rarely, trusts) to launder $56.4 billion. Since 2003, all those governments bound by the standards of the Financial Action Task Force (FATF) have promised to ensure timely access to information on identity of those owning shell companies, and FATF rates member countries according to their compliance and the overall level of risk they present. Despite (or perhaps because of) a renewed stress on tracing shell companies’ beneficial (i.e. real) owners, most recently at the G20 leaders’ summit in my home state of Brisbane, there are good reasons to be skeptical about whether the standards are really enforced.

Frustrated with the poor measurement of policy effectiveness in this area, Michael Findley, Daniel Nielson, and I decided to try a new approach. We ran a real-world experiment to see whether corporate service providers would comply with the rules on client screening, particularly in cases where the client profile raised “red flags.” Our findings, reported in our book Global Shell Games, were both worrying and counter-intuitive.

Our experimental design was actually quite simple. Working with a team of research assistants, we impersonated 21 different (fictitious) identities, and sent thousands of email solicitations to Corporate Service Providers (the business that form, support and on-sell shell companies to individual clients). In these emails, we claimed to be international consultants interested in buying a shell company, and wanting to know what identity documents, if any, the provider required. These providers are the crucial locus of compliance for international rules on beneficial ownership; if they fail to obtain certified official identity documents from clients, the shell companies they sell in effect provide the perfect screen to veil illicit financial activity. And although our emails all claimed to be from international consultants, several of the client profiles were designed to indicate a high likelihood that the prospective clients were actually corrupt officials, money launderers, terrorist financiers or other potentially high-risk individuals.

The logic behind using a rogues’ gallery of 21 fictitious consultants was so that we could test providers’ sensitivity to different levels and kinds of risk by varying the client’s profile. For example, would providers be more concerned with corruption risks or terrorism financing risks? Did changing the wording of the initial approach email to inform providers of international beneficial ownership rules make them any more likely to follow such rules? Did offering to pay a premium if providers waived the requirement for identity documents make them more likely to do so? Because different client profile “treatments” were randomly assigned to hundreds of providers, we could be confident that any variation in the rate of response and compliance (for example, whether providers required certified photo ID from would-be clients) was caused by the differing risk profile in the approach email assigned. (Here we were mimicking the logic of a randomized drug trial, in that the random assignment of the drug treatment and placebo allows researchers to confidently assess the causal effect of the drug independent of all other factors.)

Our findings were distressing, and in some respects surprising:

  • First, the global level of compliance with standards mandating that shell companies be able to be linked with the real people in control was alarmingly low. Around half the replies we received failed to ask for certified photo ID, and a quarter failed to ask for any photo ID at all.
  • Second, for the most part providers did not seem particularly sensitive to the risk profile of the prospective client: the response and compliance rates showed little significant variation even between obviously high- and low-risk client profiles. There were, however, some notable exceptions: providers were chary of terrorism financing risks, and US providers were sensitive to (false) claims that the IRS enforced beneficial ownership standards.
  • Third, it turned out that providers from jurisdictions known as “tax havens” were actually much more rigorous in applying the standards than providers from OECD states–a finding that runs directly against the conventional wisdom on the subject. And providers from developing countries were at least as likely to uphold the rules as providers from wealthy states, again up-ending the usual presumption.
  • Fourth, and related to the above point, there was almost no correspondence between the level of actual compliance among providers in a given jurisdiction and that jurisdiction’s score on the relevant FATF rating. At a time when the FATF is grappling with how to measure the actual effectiveness of its rules in practice, as opposed to dead-letter laws on the books, the problems exposed by our study should provide food for thought.

Few policies are as important in fighting major international corruption as ensuring transparency in beneficial ownership. The G20 has recently released a set of High-Level Principles on Beneficial Ownership Transparency reinforcing this point. Yet at the moment policymakers don’t even seem to know where the real problems lie. We hope that our study does something to shift the discussion on shell companies from hunches to evidence, and from rules on the books to the way things work in practice.

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