Corruption, Corporate Vehicle, and where does the beneficial owner hide?
Beirut, 8th April 2017
By: Bachir El Nakib, Senior Consultant, Compliance Alert (LLC)
Corruption, like a disease, is eating away at the foundation of people’s faith in government. It undermines the stability and security of nations. So it is a development challenge in more ways than one: it directly affects development assistance, but it also undermines the preconditions for growth and equity.
David Cameron announced in May 2016 steps to end the secret ownership of property in the UK by foreigners: For the first time, Cameron said in statement, " foreign companies that already hold or want to buy a property in the UK will be forced to reveal who really owns them." Any foreign company that wants to buy UK property or bid for central government contract has to join a new public register of beneficial ownership information. The disclosure rules apply to companies that already own property in the UK and to new buyers." The New register for foreign companies will mean corrupt individuals and countries will no longer be able to move, launder, and hide illicit funds through London's property market, and will not benefit from our public funds," the PM's statement said. France, the Netherlands, Nigeria and Afghanistan have agreed to launch their own public registers of true company ownership, and Australia, New Zealand, Jordan, Indonesia, and Georgia have agreed to take the initial steps toward making similar arrangements. A recent EU directive has also proposed the due diligence banks must undertake to establish beneficial ownership.
In recent years, the issue of the misuse of corporate entities for illicit purposes has drawn increasing attention from policy makers and other authorities. While corporate entities have been credited for their immense contribution to rising prosperity in market-based economies, there has been growing concern that these vehicles may be misused for illicit purposes, such as money laundering, bribery and corruption, shielding assets from creditors, illicit tax practices, market fraud, and other illicit activities. Perhaps more worrisome is the risk that the misuse of corporate entities may threaten financial stability from a market integrity perspective.
Corporate vehicles are legal entities through which a wide variety of commercial activities are conducted and assets are held.
They are the basis of most commercial and entrepreneurial activities in market-based economies and have contributed immensely to the prosperity and globalisation that have occurred over the last half century. Today, the rapid flows of private capital, ideas, technology, and goods and services involve corporate vehicles at virtually every level. While corporate vehicles play an essential role in the global economic system, these entities may, under certain conditions, be misused for illicit purposes, including money laundering, bribery/corruption, hiding and shielding assets from creditors, illicit tax practices, self-dealing/defrauding assets/diversion of assets, market fraud and circumvention of disclosure requirements, and other forms of illicit behaviour.
The mechanisms for obtaining beneficial ownership and control information fall into three broad categories –
1) primary reliance on an up front disclosure to the authorities,
2) primary reliance on intermediaries (such as company formation agents, trust companies, registered agents, lawyers, notaries, trustees, and companies supplying nominee shareholders, directors and officers) involved in the formation and management of corporate vehicles (“corporate service providers”) to maintain beneficial ownership and control information (“Intermediary Option”), and
3) primary reliance on an investigative system. Provided that there is full adherence to the Fundamental Objectives discussed above, each jurisdiction may tailor and/or combine these three options to fit local conditions, legal systems, and practices.
The concept of “Beneficial Ownership” originated in the United Kingdom. During the development of trust law, the following distinction between two types of ownership—“legal ownership” and “beneficial ownership”—was introduced:
The legal ownership of the trust-property is in the trustee, but he holds it not for his own benefit but for that of the cestui que trustent or the beneficiaries. On the creation of a trust in the strict sense as it was developed by equity, the full ownership in the trust property was split into two constituent elements, which became vested in different persons: the “legal ownership” in the trustee, and what became to be called the “beneficial ownership” in the cestui que trust [that is, the beneficiary].
Although the term “Beneficial Owner” currently is applied in a wide variety of situations that do not involve trusts, the essence of the concept—as referring to the person who ultimately controls an asset and can benefit from it—remains the same. Indeed, in discussions with investigators, the typical response to the question of how to find the beneficial owner is the simple answer so oft en heard in criminal investigations: “Find out who benefits.”
The image of someone absent, temporarily abroad but able to retake his lands at any time, provides a helpful illustration of the idea of beneficial ownership, because it reveals not only that he is the one who benefits but also that he is the one who exercises control in the end—not directly and overtly, but indirectly and covertly, invisible to the outside world. This characteristic is essential to the concept of beneficial ownership, certainly as it applies to criminal situations. The beneficial owner may not be on the scene, and it may appear that the lands belong to someone else. However, in the final analysis, they are his.
The Origin of the Trust
Although the precise historic origins of the trust are uncertain, they were in use in the 12th century during the time of the Crusades:
Typically the warrior would be away from England for some years and therefore needed his land tended in his absence. It was essential that the person who was left in charge could exercise all of the powers of the legal owner of that land, such as deciding who would farm which part of the land and collecting taxes. However, the crusader wanted to ensure that he would be able to recover all of his rights of ownership when he returned from the war. Consequently, the idea of split ownership of the property emerged, whereby the crusader was treated as the owner of the land by the courts of equity and the person left in charge was treated by the common-law courts as being owner of the land.
Defining Beneficial Ownership: The Theory
The internationally accepted definition of beneficial ownership, which may usefully serve as the starting point of this discussion, is the one given by the FATF. It reads as follows:
“Beneficial owner refers to the natural person(s) who ultimately owns or controls a customer and/or the person on whose behalf a transaction is being conducted. It also incorporates those persons who exercise ultimate effective control over a legal person or arrangement.”
Before discussing the details and implications of this definition, it is useful to clarify a terminological point, specifically the use of the terms “customer” and “transaction” in the first sentence of the definition. The FATF definition was developed in the context of a bank or other service provider dealing with a prospective customer and having an obligation to establish the identity of that potential customer’s beneficial owner before carrying out any transactions on its behalf. The definition does not intend to suggest that the “customer” is a natural person.
Natural Person versus Legal Person
The first noteworthy (and only unequivocal) element in the definition is that a beneficial owner is always a natural person—a legal person cannot, by definition, be a beneficial owner. The definition therefore also speaks of “ultimate” control: A legal person never can be the ultimate controller—ownership by a legal person is itself always controlled by a natural person.
Beneficial Vs Legal Ownership
The defining characteristic of the beneficial owner of an asset is that he holds a degree of control over the asset that allows him to benefit from it. Whether he is the legal owner (that is, holds legal title to it) is irrelevant. The essence of beneficial ownership is precisely not ownership in the ordinary sense of the word—but rather control. Control and legal title oft en will lie in the same hands, but in the sorts of situations addressed in this report, that oft en is not the case. It is important, therefore, not to confuse beneficial ownership with legal ownership.
Control - What Is It and Who Has It?
The definition speaks of “the natural person(s) who ultimately . . . controls a customer.”
The concept of control is a difficult one, given the manifold ways in which it can be exercised. What does exercising control of a corporate vehicle mean, exactly? Who ultimately controls a corporate vehicle? The answers to these questions depend on the situation.
The legal form and actual structure of the corporate vehicle provide a useful starting point, but they do not give us the whole answer. Let us consider who may be said to exercise ultimate control in a number of diff erent corporate vehicles.
* In 2002, the government of Kenya invited bids to replace its passport printing system. Despite receiving a bid for €6 million from a French fi rm, the Kenyan government signed a contract for fi ve times that amount (€31.89 million) with Anglo-Leasing and Finance Ltd., an unknown U.K. shell company, whose registered address was a post offi ce box in Liverpool. The Kenyan government’s decision was taken despite the fact that Anglo-Leasing proposed to subcontract the actual work to the French company. Material leaked to the press by whistle-blowers suggested that corrupt senior politicians planned to pocket the excess funds from the deal. Attempts to investigate these allegations were frustrated, however, when it proved impossible to fi nd out who really controlled Anglo-Leasing.
* In March 2010, Daimler AG and three of its subsidiaries resolved charges related to a Foreign Corrupt Practices Act (FCPA) investigation in the U.S. In part, Daimler AG’s Russian subsidiary, Daimler Chrysler Automotive Russia SAO (DCAR), which is now known as Mercedes-Benz Russia SAO, pleaded guilty to one count of conspiracy to bribe foreign offi cials and one count of bribery of foreign offi cials. The Statement of Facts agreed to by Daimler as part of the Deferred Prosecution Agreement in US v. Daimler AG noted that “DCAR and DAIMLER made over €3 million [US$4,057,500] in improper payments to Russian government offi cials employed at their Russian governmental customers, their designees or third-party shell companies that provided no legitimate services to DAIMLER or DCAR with the understanding that thecfunds would be passed on, in whole or in part, to Russian government officials.” The Statement of Facts details 25 sets of improper payments involving (in addition to cash payments) payments to bank accounts held in Latvia, Switzerland, the United States and unnamed jurisdictions; the accounts were held in the name of some of the 27 involved companies (16 named and 11 unnamed) registered or having addresses in 7 different jurisdictions: the Bahamas; Costa Rica; Cyprus; Ireland; Seychelles; United Kingdom; and in United States in California, Delaware and Florida.
A Signifi cant Challenge
Both the Anglo-Leasing and Daimler AG scandals described above graphically illustrate the central role played by corporate vehicles (companies, trusts, foundations, and others) in concealing the abuse of public trust for private fi nancial gain. In neither case has any individual or company been convicted of a corruption off ense, despite the millions—even billions—of dollars of illicit payments allegedly involved.
Control in Companies
Analysis of 150 grand corruption cases shows that the main type of corporate vehicle used to conceal beneficial ownership is the company, so let us consider this vehicle first. In a company limited by shares, three groups of people might arguably qualify as having ultimate control:
* a corporate vehicle was misused to hide the money trail;
* the corporate vehicle in question was a company or corporation;
* the proceeds and instruments of corruption consisted of funds in a bank account; and
* in cases where the ownership information was available, the corporate vehicle in question was established or managed by a professional intermediary.
Experience over the past 10 years has shown that imposing due diligence requirements on paper is not enough. Countries need to devote adequate resources to eff ectively policing compliance, including supervising service providers and imposing civil or criminal penalties for noncompliance. The evidence analyzed in this study shows that TCSPs in certain financial centers more typically considered “onshore” actually exercise less strict due diligence than jurisdictions identified as offshore financial centers (OFCs).
In countries where intermediaries are not subject to CDD requirements, other ways to ensure benefi cial ownership identifi cation, although second best, nonetheless may prove useful and eff ective. Under such circumstances, the obvious institution to maintain beneficial ownership information is the company registry (under the conditions described above). How policy makers choose to define beneficial ownership for the purposes of company registration will depend on the level of expertise of company registry staff . Disentangling who, in a particularly complicated structure, qualifies as the beneficial owner may require signifi cant corporate legal expertise, which may not always be available. In such cases, a formal definition (for example, a natural person holding more than 25 percent of the shares, or a natural person holding the most shares) may be more practicable.
Another obstacle to obtaining information about a particular corporate vehicle is that the relevant documentation may be deliberately dispersed across diff erent jurisdictions. Collecting information on a particular legal entity that is incorporated or formed under the laws of Country A but administered from Country B oft en entails first submitting a request in Country A and then submitting a request in Country B.
To avoid having to obtain information from diff erent countries—with all the loss of time and resources that entails—countries should ensure that a resident person maintains beneficial ownership information on any entity incorporated under its laws.
That requirement could be achieved in various ways—for example, by imposing the obligation on a resident director or other corporate offi cer, or on a resident registered agent or a service provider. That person should receive all financial documentation relating to the legal entity. Th is obligation would not aff ect the obligation requiring the service provider (who may well be located in another jurisdiction) to also maintain this information. Certainly, if this service provider is undertaking the daily administration or management of the corporate vehicle, he or she is likely to have more current information.
Companies that have issued bearer shares and bearer-share warrants continue to be problematic in terms of transparency of ownership and control of corporate vehicles. The person in legal possession of the physical shares is deemed to be their owner and thus the owner of the company. The problem is knowing who owns the shares at any given point in time. Many countries have immobilized these shares—eff ectively rendering them registered shares—without disrupting legitimate business. No legitimate rationale exists for perpetuating bearer shares and similar bearer instruments.
Why Due Diligence Is Not Enough
The challenge thrown down by those who wish to deceive ultimately calls for a response by those seeking to unmask that deceit. Eff orts to counter the misuse of corporate vehicles have, in recent years, focused on introducing new laws and regulations.
Although this certainly forms an important part of an eff ective response to grand corruption, it is by no means enough. Similarly, prevention and information gathering by service providers or company registries, although vital, on their own are insufficient.
A company registry, aft er all, oft en will not contain the most current information, and a service provider can undertake only so much due diligence. As one compliance officer noted, “Any due diligence system can be beaten.”
(1) See Alastair Hudson, Equity and Trusts, 4th ed. (London: Cavendish Publishing, 2005), p. 35.
(2) Lord Diplock in Ayerst (Inspector of Taxes) v C&K (Construction) Ltd, H.L. (1975) S.T.C. 345. BOX
(3) © 2011 Th e International Bank for Reconstruction and Development / Th e World Bank/ The Puppet Masters by (1) Emile van der Does de Willebois, (2) Emily M. Halter, (3) Robert A. Harrison, (4) Ji Won Park, (5) J. C. Sharman