FACTI Background Paper: Beneficial Ownership

The United Nations High-Level Panel on International Financial Accountability, Transparency and Integrity for Achieving the 2030 Agenda Financing for Sustainable Development (FACTI) is developing reforms to tax and anticorruption laws, asset recovery rules, beneficial ownership disclosure requirements, and other international norms to staunch the outflow of illicit funds from developing nations and speed the return of corrupt monies held abroad (preliminary report here).

A critical issue the panel will address is the reforms necessary to ensure corrupt officials cannot use a corporation, trust, or other legally created entity – a “legal person” in lawyer-speak — to hide their wrongdoing.  Those investigating corruption, money laundering, tax evasion, and other financial crimes must be able to identify the real, natural person – the beneficial owner – behind a legal person if we are to curb the massive theft of assets from poor nations. In his background paper for the panel, Andres Knobel of the Tax Justice Network explains how criminals use legal persons to shield their wrongdoing and the measures required to end these abuses.  Most importantly, his condemnation of the injustice of the current laws governing legal persons serves as a powerful prod to action. His summary of the paper is below and the full text here.

Beneficial ownership: more than transparency, it’s about justice

The Panama Papers revealed the involvement of many public figures in offshore legal vehicles causing turmoil all over the world. But the real scandal wasn’t the data that was revealed. Rather, the scandal was the fact that we needed a leak to obtain data that should have been available in the first place.

Legal persons such as companies, also referred to as juristic persons, are considered a “legal fiction”. They do not exist in nature. Their most “physical” feature may be the paper containing the company statute or the trust deed that describes and determines the creation and object of the legal vehicle.

Legal persons are called “persons” because they are treated by the law as if they were natural persons: they may use the courts, own assets, enter contracts, etc. Nevertheless, legal persons are not really natural persons. They do not need to eat or breathe. They may own a mansion in Paris, a penthouse in Manhattan, a yacht in the Greek islands or a private jet. But it isn’t the paper containing the trust deed or the company statute who sleeps in the mansion, enjoys the view to Central Park or flies the jet to a party in Dubai. That is done and enjoyed by the natural persons who either own, control or benefit from those legal persons. But if natural persons will ultimately use and benefit the corporate assets, why use legal vehicles in the first place?

Ronald Coase explained in “The Nature of the Firm” that organising as a firm (and hiring people) is more efficient for an entrepreneur than acting as an individual and signing multiple contracts with everyone, because each contract entails transaction costs. Of course, that applies if the legal vehicle will actually do something. Legal vehicles, however, may be used as passive holdings of real estate or financial assets, without needing to sign any contract. They may also be used to commit financial crimes. In these cases, the abuse of legal vehicles by natural persons is explained by the fact that natural persons may choose to hide behind the legal vehicle in bad times (when taxes or debts are owed or when a crime has been committed), but not in good times: when it comes to enjoying the corporate profits and assets.

Yet society was even more generous with legal vehicles.. Based on the assumption that legal vehicles are necessary to create jobs and economic growth, or to protect vulnerable people, society even granted many of them limited liability. This means that investors and entrepreneurs could engage in risky business. If things went well, they would reap the benefits with the sky as the limit. If things went bad, their losses would be capped. No personal wealth would be touched, only the legal vehicle’s capital. The same applied to the use of trusts, which allow money to be isolated from the economy, to serve a specific purpose, such as to care for vulnerable people.

Unfortunately, when writing the laws society forgot to require that this original public benefit goal should be present. Instead, legal personality, limited liability and asset protection is usually achieved by merely incorporating or creating a legal vehicle. There is no check or enforcement on whether a job, service or product will be created or whether a vulnerable person will be benefitted. As an example, here is an extract from a Harvard Law Review paper on trusts:

Trusts can also pass use and enjoyment of wealth on to beneficiaries while shielding the wealth from the beneficiaries’ creditors and from judgments in divorce. “If you don’t own it,” the saying goes, “nobody can take it away from you.” All of these benefits can be coupled with essentially complete control allocated according to the grantor’s wishes. (…) This makes the total package effectively indistinguishable from property owned outright in terms of the benefits provided, but without important downsides property ownership entails, such as greater exposure to taxes, creditors, and vengeful ex-spouses.

In very abusive cases, courts may intervene and “pierce the corporate veil” or declare the trust a sham, but it will take a lot of time, effort and money, without any guarantee of success.

So, what does society ask in return? To know who the owners of legal vehicles are. It isn’t very clear if declaring ownership is the price to enjoy legal personality and limited liability, or rather a way for the State to protect private property. Otherwise (if no ownership is declared), how would law enforcement know who an asset or legal vehicle belongs to?

Yet “ownership” has its own fiction called “legal ownership”. It goes like this. You want to know the legal owner? I’ll tell you who the owner is: another company. And who owns that other company? Yet another company. And so on.

We now live in a world where we don’t know who owns what, how they afforded it in the first place and what they are doing with it. Companies awarded government contracts or extractive licenses could just as much be owned by some honest person or by the very same minister approving the contract. We simply cannot know it. Even when major (with a capital M) money laundering scandals involving billions of dollars are discovered (e.g. the alleged Russian and Moldovan Laundromats or the Danske bank scandal) we can’t recover the money because we don’t know where it ended and who has it.

The system is rigged, but not everything is lost. The first, basic step is to dismantle the secrecy surrounding legal vehicles and their assets. This is called beneficial ownership transparency: revealing the natural persons who ultimately and effectively own, control or benefit from legal vehicles.

This paper explains how secrecy is achieved, how perfect beneficial ownership transparency would reveal most of the financial crimes and abuses, and how our legal frameworks can be fixed to get closer to that ideal transparency scenario.

9 thoughts on “FACTI Background Paper: Beneficial Ownership

  1. Thanks for this post! The paper diagnoses the problems that lack of beneficial ownership disclosure pose in a compelling way and particularly on the privacy issue, one of the main areas of concern. From a U.S. perspective, I am not optimistic that Congress can muster the political will to implement beneficial ownership in the near-term, especially given the Senate’s lack of progress on H.R.2513 and S.2563, but perhaps there may be progress in the future.

  2. I echo the above sentiment– corporate veils have existed since corporations have. This post outlines all the problems associated with fictional personhood and makes a compelling case as to why we should certainly strive towards dismantling legal vehicles, but I doubt that there will be enough will to dismantle what is now a cornerstone of economies around the globe. Creating an LLC or shell corporation is practically rote– even victims of abuse are suggested to create a shell corporation for major real estate purchases in order to protect their identity. It’s easy to distinguish egregious manipulation from legitimate uses in practice, but I’m not so convinced that it’ll be easy to do so in the law.

  3. My primary concern with the beneficial ownership transparency is that it does not provide much incentive to adopt it. While the U.S. may wish to address it, there are undoubtedly other countries in the world with corrupt leaders who rely on complex shell companies and corporate layouts to profit while also attempting to maintain a pristine image to its citizens and the rest of the world. They would clearly not surrender that benefit. The FACTI report mentions using sanctions to induce compliance, but I agree with the report that economic penalties would be ineffective because presumably, the effect of the penalties is spread across the entire country while the possible upside for the corrupt leader to continue creating shell companies is concentrated and lucrative.

    Even if there is pressure from the UN for reform, the results would be murky for exactly the same reason Jaylia mentioned above: the law may not be effective at discerning the positive benefits from creating shell companies from the sinister purposes.

  4. Hi all and thank you for your comments. These are all good points and I don’t expect the job to be easy, nor that it will happen immediately. Still, we have to start somewhere and improve it along the way. The Tax Justice Network has been advocating many policies, eg beneficial ownership, automatic exchange of information, country-by-country reporting for more than 15 years. Many said they were never going to happen, but now all three issues have become mainstream issues (though not yet implemented as we had expected).

    As for beneficial ownership, TJN’s Financial Secrecy Index has been assessing countries’ beneficial ownership since 2011. It was only in 2015 that we saw the first countries do something about it, and by 2020 more than 80 jurisdictions already had laws requiring beneficial ownership data to be registered with a government authority. Some have really good open registers, including the UK, Denmark, Luxembourg and Ecuador. Of course, there’s still a lot more to go and many loopholes to fix (eg verification, trusts), but BO transparency has clearly become an issue most countries are dealing with and working on.

    It’s very unfortunate that the US hasn’t done this yet, but the EU has, and the FATF and the OECD are pushing most countries to work on it. If major financial centres like the US were to adopt it, they would push everyone else to follow and to do it properly, just as the US required every country in the world to collect and exchange banking data after passing FATCA. By the same token, in many countries, companies care more about the FCPA than their own local anti-corruption laws.

    We are optimistic though, based on the high number of countries that are now working on BO transparency. Many countries first establish a BO register for companies or legal persons, but as a second step, they work on increasing access (eg public access) or scope (eg trusts). Then they work on other issues, eg verification to ensure the data will be (more) accurate.

    As for sanctions, we believe that preventing an entity from being incorporated/have legal validity or banning banks from engaging with these non-compliant entities, is much better than a fine that can sometimes be very low.

    We are now also working on issues around disregarding foreign secretive entities, limited liability and how to address complex ownership chains. To sum up, there’s still a lot more to do, but we are optimistic that many countries are (slowly) improving.

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