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Steps to tackle international fraud adopted at OECD summit

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By Lucy Komisar
Earth Times News Service, May 18, 2001

In the first salvo of an international effort to disable the system of shell companies used widely by criminals, corrupt officials, and tax cheats, the OECD Council of Ministers on May 10th adopted a report on what countries should do to pierce shell company secrecy. Called “Misuse of Corporate Vehicles for Illicit Purposes,” it is part of a campaign by the world’s financial powers against the illicit offshore bank and corporate secrecy system. It was written by OECD Steering Group on Corporate Governance made up of experts from member countries’ finance and securities ministries.

The experts say that countries should secure beneficial ownership information on corporate vehicles through up-front disclosure; through requiring disclosures by lawyers, company formation agents and banks; or by investigative methods in cases where the system has proved able to get information.

The report, coordinated by Stilpon Nestor, head of the OECD corporate affairs division, was undertaken a year ago at the request of the Financial Stability Forum Working Group on Offshore Financial Centres. The FSF was set up by the G-7 in 1999 to deal with issues raised by the Asian crisis and the crash of Long-term Capital Management. G-7 ministers believe that the use of secret offshore companies and bank accounts and the attendant lack of transparency contributed to those debacles. They fear that the movement of funds through non-transparent webs undermines the international financial system, which can be attacked through secret corporate vehicles used for money laundering, financial frauds, securities frauds, banking frauds, and corporate frauds.

Shell companies exist in several dozen “offshore” jurisdictions that permit them to hide the names of their true owners. They have no operational role other than to carry out criminal activities, hide money from law enforcers, evade court judgments and cheat tax authorities. They are designed to conceal the origin and destination of goods in international trade and to evade taxes by hiding profits and assets. They are essential to illicit drug, arms and people traffickers.

Also called international business corporations or private investment companies, they are often dormant companies are purchased “off the shelf ‘ from banks, lawyers, accountants or secretarial firms so they can have a “history” — “ABC Corp., founded in 1970.” They must operate outside the jurisdictions where they are incorporated.

There are more than three million anonymous corporations that control a growing share of international capital. Little is known about their holdings because they are not required to file financial reports. Incorporated as legal entities with limited liability, they commonly use bearer shares and nominee shareholders and directors provided by the incorporating firm.

Bearer share companies in secrecy havens are owned by “the bearer of shares”–no name supplied even to the registration office. The ownership of the company passes with the certificate. There are as many as 25 bearer share countries, including Grand Cayman, Curacao, Panama, Gibralter, Belize, Pacific Naru, and Vanuatu.

Secret trusts do not identify either the grantors or beneficiaries, leaving real control in the hands of a “trust protector” who is not identified in the trust instrument. The courts of the trust jurisdiction are barred by law from hearing claims against the assets of the trust. Many also have a “flee clause” which requires the trustee to transfer the assets to another jurisdiction in case of law enforcement inquiries or service of writs.

The G-7 ministers asked the OECD to look at ways to identify the beneficial ownership of corporations, trusts, limited partnerships and other corporate vehicles that are neither owned publicly nor in the financial markets where they would be scrutinized by financial regulators.

The steering group on corporate governance looked at three elements:

how secret corporate vehicles are misused for illicit purposes, including money laundering, tax evasion, tax fraud, corporate fraud, and other corporate governance abuses,

the mechanisms countries use to identify beneficial owners, and

how information on beneficial ownership can be shared among authorities domestically and internationally when there are suspicious activities.

The report says that beneficial ownership of companies should be either maintained or readily obtainable by authorities; the systems and mechanisms used to obtain beneficial ownership should have high integrity and adequate supervision; and there should be mechanisms to share information about beneficial ownership among law enforcement authorities.

Based on those standards, countries will have three options. The first is to obtain beneficial ownership information with up-front disclosure. Experts think this is the best option when the jurisdiction does not have adequate reach because it’s not a very big commercial center or because the offshore sector is bigger than the commercial center.

Nestor said, “The issue is the suitability conditions for the options. A country cannot rely on investigative methods if it can’t show that it has an investigative mechanism that is effective, efficient and strong enough to obtain beneficial ownership information whenever needed.”

The report says, “Primary reliance on an up front disclosure system would be appropriate in jurisdictions with 1) a generally weak investigative system, 2) high proportion of non-resident ownership of corporate vehicles (particularly those owned by individuals or by shell corporations), 3) high proportion of shell companies or asset holding companies, and 4) anonymity-enhancing instruments. That means all offshore centers.

The second is to rely on a system that makes intermediaries, including lawyers and company formation agents, responsible for maintaining beneficial owners. The report says that would be appropriate “in jurisdictions with 1) adequate investigative mechanisms to effectively monitor compliance by corporate service providers with their obligation to obtain beneficial ownership and control information and 2) a sufficient number of corporate service providers with suitable experience and adequate resources to undertake the collection and maintenance of beneficial ownership and control information.

And the third is to rely on investigative methods if a country has a proven system that works. The third option would be appropriate “in jurisdictions where 1) the authorities possess strong compulsory powers and capacity to obtain beneficial ownership and control information, 2) there is a reliable history of enforcement, 3) the judicial system functions effectively and efficiently, and 4) beneficial ownership and control information is likely to be available within the jurisdiction.”

No matter what system is adopted, he said, it has to be effective and adequately supervised and with high integrity. “Beneficial ownership should be obtained in a timely manner. Saying ‘I have this information somewhere but I can’t get to it’ is not a good answer.”

He said, “In a place like the U.S. even though you don’t have in most states this up-front disclosure, if there’s a suspicion of illicit behavior, you can go to a judge, he would issue a subpoena, and you would be required to provide this information. That is not the case in a very great number of jurisdictions. In Delaware, a judge can get to this information; in Curacao, they can’t. You have to take into account what every legal system can and can’t do.”

Nestor said this work is expected to be helpful to other fora, such as the Financial Action Task Force and the OECD Working Group on Bribery, which are discussing abuses that are committed via secret corporate vehicles. He said, “We are coordinating what’s been done in the areas of anticorruption and bribery, financial fraud and money laundering, and tax evasion.”

Explaining the G-7’s concern, Nestor said, “If one looks at the Maxwell case in the UK, one sees how corporate fraud can undermine the financial system.” The late newspaper magnate used shell companies to loot his employees’ pension system. “When huge sums are being diverted that rightfully belong to pensioners, expropriated for the users of a fraudster, people lose their trust in the financial system. They take their money out of the pension system and put it under the mattress, and the whole system falls apart. Big frauds impact on investor confidence, whether passive pensioners or active investors in stocks or holders of bank accounts.”

He added, “In Russia, widespread corporate fraud is perceived as crippling the financial markets of the country. People don’t want to invest. People get their money into out of Russia into offshore bank accounts.” He explained, “You see this type of arrangement where transfer pricing companies in offshore centers expropriate money from shareholders.” In transfer pricing, managers set up a secret “trading company” offshore, route purchases and sales through it, and rake off the profits, cheating shareholders and tax authorities.

The technique is used widely. The official of an international investigations firm says the latest idea is to open up offshore companies in series of three’s. “Throw in Cayman and Panama; sprinkle with Aruba or Curacao,” he says. “Money launderers set up a British Virgin Islands corporation, open a bank account in Curacao, airfreight the money to Aruba, have that wire transferred. In days, it’s been through three jurisdictions, and there are no records. You can convert profits to losses, put money in phony loans, buy businesses without people knowing who you are, and evade all laws regulating money. If authorities looking into a loan to the company want to find out who owns it, lawyers say, ‘That’s protected by secrecy law.’ “

He says most Latin American companies in international trade use shell accounts. “If I have a Colombian company that imports Mercedes trucks from Germany, the company ordering the trucks will be registered in the British Virgin Islands or Curacao. The order will be made by the Dewey, Cheathem and Howe Company; no Colombian firm will handle invoices. Colombian tax authorities won’t know how much business they’re doing.”

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