The dirty secret in the global effort to combat money laundering: despite the United States positioning itself as a leader in financial regulation, state incorporation laws here create a massive loophole that terrorists, tax evaders, and other nefarious figures can exploit.

The United States has no federal law for business incorporation, leaving each state to chart its own incorporation course as it sees fit. Over the years, that has led to several states—notably Delaware, Nevada, Utah, and Wyoming—attracting the lion’s share of incorporations, thanks to their minimal legal requirements.

From a compliance standpoint, that can create holes when a state allows “beneficial ownership” information—that is, who really controls a company or related bank accounts, even if they do so behind the scenes through a proxy—to remain anonymous and unreported. Delaware, for example, has world renown for its no-questions-asked incorporation process.

Now that loose approach to ownership disclosure is coming into conflict with various anti-money laundering efforts, where Job No. 1 will be to track and report beneficial owners more clearly. Europe’s new AML directive, for example, envisions an online database of beneficial owners within two years.

“It’s a huge problem not just for the United States and its financial institutions, but also for financial institutions around the world that are trying to figure out who owns the U.S. company they are dealing with,” says Ross Delston, a Washington-based lawyer and AML compliance expert.

“In Europe, they joke that the United States is the worldwide center of money laundering because of Delaware,” says Micah Willbrand, director of AML product marketing for NICE Actimize, a provider of compliance and risk management products for the financial services industry.

“It’s a huge problem not just for the United States and its financial institutions, but also for financial institutions around the world.”
Ross Delston, Attorney & AML Compliance Expert

At a hearing last month of the House of Representatives’ task force to investigate terrorism finance, New York County District Attorney Cyrus Vance shared an anecdote that illustrates the problem. An investigator in his office searched the phrase “incorporate Delaware company” and called an incorporation services vendor that appeared in the online results. Putting on her best accent, the investigator claimed to be in France, wanted to incorporate a company in Delaware, but wished to remain anonymous because of “estate issues” in her country. She was told that this would not be a problem and a corporation could be set up in five minutes with little more than a contact person and e-mail address.

“On a near-daily basis we encounter a company or network of companies involved in suspicious activity, but we are unable to glean who is actually controlling and benefiting from those entities, and from their illicit activity,” Vance said. “This is not because the entities are incorporated in an offshore tax haven like the Cayman Islands. That country actually collects beneficial ownership information. Often, that entity is incorporated in the United States because we don’t collect beneficial owner information.”

One recent investigation by Vance’s office into shell companies in New York led to the discovery that Bank Melli, owned by the government of Iran, was the 40 percent owner of an office tower in midtown Manhattan.

“The lack of beneficial ownership information collected by financial institutions has historically posed a systemic vulnerability undermining financial transparency,” says Chip Poncy, founding partner of the Financial Integrity Network, a consulting firm that specializes in illicit finance issues.

In his view, federal legislation is necessary “to require the disclosure and maintenance of meaningful beneficial ownership information in company formation processes.”

Legislative efforts along those lines, however, have failed to gain traction. The most recent attempt was the Incorporation Transparency and Law Enforcement Assistance Act, sponsored by Rep. Carolyn Maloney (D-NY). It would have the Treasury Department issue regulations specifying that if a corporation or limited liability company forms in a state that doesn’t require the disclosure and verification of beneficial ownership information, the business must file that data with the Treasury Department instead.

Efforts like this, however, traditionally face an uphill battle and states would be certain to sue the federal government on a state’s rights issue, Willbrand says.


The following is a selection from the Financial Action Task Force’s 2014 Guidance on Transparency and Beneficial Ownership.
Transparency and beneficial ownership of legal persons
Countries should take measures to prevent the misuse of legal persons for money laundering or terrorist financing. Countries should ensure that there is adequate, accurate and timely information on the beneficial ownership and control of legal persons that can be obtained or accessed in a timely fashion by competent authorities. In particular, countries that have legal persons that are able to issue bearer shares or bearer share warrants, or which allow nominee shareholders or nominee directors, should take effective measures to ensure that they are not misused for money laundering or terrorist financing.
Countries should take measures to prevent the misuse of legal arrangements for money laundering or terrorist financing. In particular, countries should ensure that there is adequate, accurate and timely information on express trusts, including information on the settlor, trustee and beneficiaries, that can be obtained or accessed in a timely fashion by competent authorities.
Characteristics of an effective system
Measures are in place to: prevent legal persons and legal arrangements from being used for criminal purposes; make legal persons and legal arrangements sufficiently transparent; and ensure that accurate and up-to-date basic and beneficial ownership information is available on a timely basis.
Basic information is available publicly, and beneficial ownership information is available to competent authorities. Persons who breach these measures are subject to effective, proportionate and dissuasive sanctions. This results in legal persons and legal arrangements being unattractive for criminals to misuse for money laundering and terrorist financing.
Source: Financial Action Task Force.

Regulatory efforts haven’t fared much better. Last year the Treasury Department’s Financial Crimes Enforcement Network proposed to allow financial institutions to rely on statements from beneficial owners that they are, in fact, the controlling person. That idea has yet to be acted upon.

Outside Pressures

The United States is likely to feel more pressure to resolve its beneficial ownership impasse in coming months. The Financial Action Task Force, an intergovernmental organization founded to combat money laundering, has published new standards to combat money laundering, including identifying and verifying beneficial owners.

Russia was the first country to develop regulations to meet that goal, with a rule that banks cannot on-board corporate customers without knowing the beneficial owner; similar rules are being implemented throughout Asia. In India, every incorporated company must provide beneficial ownership information to a public, government database. The European Union’s Fourth Anti-Money Laundering Directive, published in June, requires EU member states to adopt national laws that implement the FATF recommendations and create a registry of controlling interests.

If the United States remains a hold-out (which would complicate these international efforts in the process) it can expect additional shaming in the very near future. Every five to seven years, FATF conducts a “mutual evaluation” of member countries, comparing their practices and procedures against its international standards. For the United States that process begins in earnest in January.

Meanwhile, banks in the United States are forced to take measures into their own hands. “Right now the largest banks are probably the furthest evolved in thinking about how they are going to do this,” Willbrand says. They have started to develop due diligence processes to determine beneficial ownership at the point of customer on-boarding, tying that work to a broader effort for improved data acquisition. “The area they are really focusing on now is how to collect the data and link people together to find these hidden structures,” he says. “But because they still have data quality issues, that linking is difficult.”

A question banks face is determining what threshold of beneficial ownership should be part of their due diligence. After all, if a company settles on a 25 percent ownership threshold, then a bad actor will just drop his holdings to 23 percent. In response to this concern, and to the Foreign Account Tax Compliance Act, some private wealth managers have drawn a 10 percent line in the sand.

“You probably won’t see the largest of the retail banks do that, however, because it would be far too manual a process,” Willbrand says. Another challenge banks face is assessing monetary ownership versus controlling interests. The CEO of a company may own 1 percent of a company, yet still make decisions that affect how the business operates because the other 99 percent are silent partners.

Delston fears that given the United State’s global business and monetary clout, no serious reforms for beneficial ownership will happen here until a disaster strikes and forces the issue.

“You can’t have either financial crime controls or a sense of security against acts of terrorism without piercing the corporate veil,” he says. “Without having an act of terrorism that is traceable to a corporation with anonymous owners, it is going to be very difficult to change the mindset in the United States.”