Shell GamesOne of the more prescient authors I know is Ryan C. Hubbs, a senior manager of fraud investigation and dispute services at Ernst & Young LLP (EY), who, in 2014, wrote an article for Fraud Magazine entitled “Shell Games”. In this piece, Hubbs wrote about how criminals use shell corporations to launder money and perpetuate frauds such as violations of the Foreign Corrupt Practices Act (FCPA). He explained what shell companies are and how certified fraud examiners could assist companies in internal investigations around these issues. His prescience was foretelling the information that would begin to become available with the release of the Panama Papers. Today I will begin a two-part series, where I describe some of the issues raised by Hubbs back in 2014, reporting on information in the Panama Papers and what you can do with the detect prong of your compliance program.

As Hubbs noted “Unfortunately, the landscape of international crime and fraud has changed dramatically in the last quarter century. Shell companies aren’t just for big tax evaders anymore. If your organization is engaging in any type of transaction in today’s economy, shell companies should be a concern. They’re the financial and deception vehicle of choice for some of the most corrupt, dangerous and ruthless individuals and entities in the world. Arms dealers, drug cartels, corrupt politicians, scammers, terrorists and cybercriminals are just a few of the frequent users of shells.”

Fortunately Hubbs provided his insight into how a Chief Compliance Officer (CCO) or compliance practitioner can investigate companies more thoroughly. All of this is not simply about performing adequate due diligence so that you will know with whom you are doing business. Internal corporate investigators need to be aware of how shell corporations are set up to help detect fraud in their own organizations. In his piece Hubbs cited to a Department of Justice (DOJ) Press Release from then Deputy Assistant Attorney General Bruce Swartz around the resolution of the Hewlett-Packard (HP) FCPA resolution for the following, “Hewlett-Packard subsidiaries created a slush fund for bribe payments, set up an intricate web of shell companies and bank accounts to launder money, employed two sets of books to track bribe recipients, and used anonymous e-mail accounts and prepaid mobile telephones to arrange covert meetings to hand over bags of cash.”

Yet it is not simply one shell company that you will need to investigate in any due diligence process. As noted in the New York Times (NYT) piece by Eric Lipton and Julie Creswell, entitled “Documents Show How Wealthy Hid Millions Abroad, the Panamanian law firm of Mossack Fonseca had an entire service line offering for US citizens who wanted to shelter many outside the country. The article cited to one person, William Ponsoldt, who the law firm set up eight shell companies for, “moving at least $134 million through seven banks in six countries.”

Moreover, it appears the Panamanian firm set up entities to specifically help high net worth individuals, in the US, evade taxes. The piece noted, “In 2006, using a secret email account set up by Mossack Fonseca so his correspondence would not be traced by the authorities, a businessman from Washington State asked a common question from among the firm’s potential American clients: “How does a US citizen legally get funds to Panama without the knowledge of the US government and how can those funds be profitably invested without the US government knowing about them?”” Why else would you want to invest funds “without the US government knowing about them”?

Hubbs pointed to three general areas that you should consider in your investigation. The Panama Papers have certainly borne these out. First is to consider shell companies, shelf companies and incorporators. As noted by the services provided Mossack Fonseca, “In many instances, one shell company isn’t enough — fraudsters need a network. Dozens of shells, nominee directors, addresses and fake shareholders might be required to conceal a scheme or criminal plot. Big-time criminal conspirators will utilize shell incorporators to do the heavy lifting and help create a corporate web of disguise that can perplex and confuse the best of investigators. Shells can come in different shapes and sizes, and the jurisdiction in which they reside can help further the concealment.”

The next step is with what Hubbs terms “shelf companies”. He defines these as one formed but not used for a long period of time. This provides the facade of “appearing legitimate and fooling a novice investigator or basic due diligence mechanisms because it appears to have existed longer than it really has. An older shelf could predate any specific areas of concern, which would allow it to engage in business activities when it otherwise shouldn’t.”

The creation of the entity is only the first step though. As Hubbs noted and the NYT article confirmed, the new shell company will need directors and nominees. Hubbs said, “Fraudsters use nominee directors, and in some instances, other shell companies, to disguise true owners of entities while giving the appearance of legitimacy. Some nominees simply sell their names to fraudsters who use them on company documents. Others actually provide limited services for the shell companies such as processing corporate records, signing for company documents and forwarding mail.”

It is these nominee directors who stand as the “linchpins to linking and disguising” criminal cartels and money laundering schemes. As the Times piece noted, “For many of its American clients, Mossack Fonseca offered a how-to guide of sorts on skirting or evading United States tax and financial disclosure laws. These included locating an individual from a “tax-convenient” jurisdiction to be the straw man owner of an offshore account, concealing the true American owner, or encouraging one client it knew was a United States resident to use his foreign passports to open accounts offshore, again to avoid scrutiny from regulators, the documents show.”

Yet the same technique can be used for an individual. As the NYT article reported, “Marianna Olszewski, the New York City-based author of “Live It, Love It, Earn It: A Woman’s Guide to Financial Freedom,” wanted to shift $1 million held by HSBC in Guernsey to a new overseas account. The catch? She did not want her name to appear anywhere near the transaction. Mr. Owens, the Mossack Fonseca lawyer, again offered a solution. Mossack Fonseca would locate what he called a “natural person nominee” in a “tax-convenient” jurisdiction to stand in for Ms. Olszewski as the owner of the account.”

“The Natural Person Trustee is a service which is very sensitive,” Mr. Owens wrote. “We need to hire the Natural Person Nominee, pay him, make him sign lots of documents to cover us, make him sign resignations, make him get some proofs evidencing that he has the economic capacity to place such amount of moneys, letters of reference, proof of domicile, etc., etc.””

The final area of concern from Hubbs is shell incorporation hot spots. He cited to one such address hot spot from a report called “Grave Secrecy” by Global Witness which was noted to be ““103 Sham Peng Tong Plaza” in Victoria, Seychelles. A simple Google search of this address identifies more than 160,000 hits associated with websites, companies and individuals. Another address identified in unrelated criminal filings and sanctions is PO Box 3444 Road Town, Tortola, BVI. A Google search of this address yields more than 600,000 hits. These addresses represent just a few incorporation hot spots. An entity identified with one of these addresses should be a huge red flag.”

Tomorrow I will review some of the areas you can research to help you in investigating and tracking shell companies.


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© Thomas R. Fox, 2016