Most of us have probably heard the term ‘shell company’ used in press coverage of political corruption and financial crime. But what exactly is a shell company, and why do people (both legitimate and otherwise) use them?
In this article, we explain what a shell company is, the purposes they can serve (legal and otherwise) and the reasons why shell companies can sometimes be a cause for concern for compliance professionals in regulated businesses.
What is a Shell Company?
A shell company is one that exists only on paper. They don’t make money, nor do they provide any products or services to consumers. They are often created to hold funds and another entity’s financial transactions.
There is no office, no active business operations, nor any employees. They are merely a ‘shell’ of a company with nothing ‘within’ it.
Despite this, these types of company can open bank accounts, engage in financial transactions, purchase real estate and other assets, and be the registered owner of intellectual property such as copyrights and trademarks.
What’s more, shell companies can be established and owned from a different country. Certain countries, including the likes of the Cayman Islands, the Bahamas, Bermuda, the Channel Islands and Switzerland, are particularly popular due to their lax business and tax regulations.
What is the Purpose of a Shell Company?
Shell companies are used for a variety of reasons by both large public companies and private individuals.
Of course, some of these reasons are legitimate and honest. However others exist in legal grey areas, and some are directly linked to criminal financial activity.
They can be used legitimately, for example, by a startup to hold funds being raised before launching, or by businesses to establish operations in another country.
Equally, shell companies can be used as a mechanism for hiding the Ultimate Beneficial Owners (UBOs) of a business by masking the true ownership of assets and wealth to avoid paying tax. They can even be used by individuals to conceal wealth or assets to avoid having them taken over during a merger or acquisition – or even to hide assets from an ex-spouse while navigating the process of a particularly nasty divorce!
Why Can Shell Companies Pose a Risk?
Shell companies contribute directly to the muddying of company structures, making it easier to hide the true source of assets and wealth.
Using these companies in order to perpetrate crime, individuals are able to effectively mask the sources of their wealth, evade tax, hide the profits of crime and finance terrorism.
Shell companies are often used by money launderers as they are relatively easy to set up. Conversely they are difficult for tax authorities and regulators to determine ownership. They are frequently used by those seeking to engage in illegal activities such as funding terrorist organisations without revealing their identity or the funds being traced back to them.
For compliance professionals, determining key information about companies and clients is a critical step in satisfying KYB/C requirements when onboarding clients and complying with AML legislation.
Having clear, accurate information about UBOs, politically exposed persons (PEPs), active directorships, criminal proceedings, involvement in money laundering and adverse media about businesses and individuals is key to avoiding the perpetuation of financial crime. Businesses found to be interacting with sanctioned persons not only expose themselves to regulatory fines but also reputational damage.
Shell companies can make identifying ultimate ownership and involved parties very difficult indeed – especially when companies cross borders and international information sources. However, there are software tools, such as NorthRow’s WorkStation that can support businesses with their due diligence with automated tools to identify high risk individuals that are hiding behind a shell company.