Criminals employ several means to launder money and make it appear from legitimate origins although obtained illegitimately. One of the most common ways they achieve this is through shell companies which they use as a legal front to “wash” illegally obtained funds. Shell companies in money laundering have become a key part of the operations as criminals have found ways to take advantage of low AML-regulated jurisdictions to set up a business and launder money.
Organisations today, need to be able to spot such entities, to ensure they don’t become a party to money laundering and protect themselves from the negative impact of conducting transactions for such entities.
What is a Shell Company?
A shell company is a term often used to refer to legal entities with no active business operation or significant assets, hence the name “shell”. The name, Shell, describes their hollow nature and they are also referred to as ghost companies since they do not have any operations.
Although they do not have any operations, shell companies often conduct transactions like regular entities for legitimate or illegitimate purposes. They usually don't:
- Have any physical address or office,
- Have any staff
- Generate revenue
- Have any ongoing activities
However, they have a board of directors and stakeholders who incorporate the company and may occasionally hold investments or bank accounts for transactions.
Although shell companies can be registered anywhere in the world, shell companies are mostly incorporated in jurisdictions with lax laws. Areas with weak regulations, low corporate taxes and strengthened privacy laws are the most attractive to such companies. Examples of such countries are Switzerland and the British Virgin Islands, the Cayman Islands, Cyprus, etc.
Are Shell Companies Legal?
Shell companies are generally legal. However, it is mostly seen as illegal due to its design which makes it attractive for criminals to take advantage of when laundering money. For example, an individual may create a shell company to hold his or her property assets. This means that the company owns the assets, which is completely legal.
It could generally be used for the following legitimate purposes:
- Asset management: using shell companies to hold assets separate from their personal or other business activities
- Protect intellectual properties: establishing a separate legal entity to safeguard intellectual properties
- Strategic tax payments: shell companies may be used to obtain tax benefits and lower rates from different regions. However, this act is highly controversial.
Ultimately, shell companies are generally legal. However, depending on the way they are used, they could quickly become illegal entities. Criminals largely use shell companies today which is why they are so often linked to fraudulent activities.
The Misuse of Shell Companies for Money Laundering
The simplicity and anonymity afforded by shell companies make them very attractive for criminal activities. It creates a loophole for hiding beneficial ownership and real intentions, which criminals can take advantage of to stay under the radar and facilitate criminal transactions.
With these benefits, shell companies can hide illegal money and avoid anti-money laundering laws and taxes among others. Regulatory authorities today are creating new laws to combat this loophole by mandating businesses to run verification checks. This is why organisations are now mandated to verify key information like business incorporation details, beneficial ownership, financial sources and more as part of their corporate KYC process.
How do Shell Companies Launder Money? Real-life Examples
One of the most prominent real-life examples of shell companies used in money laundering operations is the Danske Bank scandal. From 2007 to 2015, Danske Bank's Estonian branch was a hotspot for laundering approximately $230 billion in suspicious transactions.
A significant portion of these transactions was funnelled through a network of shell companies. The process unfolded as follows:
- Creation of Shell Companies: Criminals established numerous shell companies in jurisdictions with weak regulatory oversight. These entities typically had no physical presence, employees, or legitimate business operations.
- Opening Bank Accounts: The shell companies opened bank accounts at Danske Bank’s Estonian branch. Due to inadequate due diligence and weak compliance checks, these accounts were approved without thorough verification of the companies' activities or the sources of their funds.
- Layering Transactions: The shell companies conducted a series of complex transactions, transferring large sums of money among themselves. These transfers, involving multiple currencies and jurisdictions, obscured the original source of the funds, making them difficult to trace.
- Integration: Finally, the laundered funds were integrated into the legitimate economy by purchasing assets such as real estate, luxury goods, and investments in businesses. By this stage, the illicit origins of the money were effectively concealed.
Other Methods of Using Shell Companies in Money Laundering
The Danske Bank case is a notable instance, but there are various other methods by which shell companies facilitate money laundering:
1. Trade-Based Money Laundering (TBML):
Shell companies manipulate trade invoices, over-invoicing or under-invoicing goods and services to transfer value across borders. This technique disguises the illicit transfer of money as a legitimate trade.
2. Real Estate Transactions:
Shell companies buy high-value real estate properties. These transactions mask the true ownership and source of funds. Properties can be bought and sold multiple times at inflated prices to further launder money.
3. Offshore Accounts:
Shell companies are often set up in offshore jurisdictions known for banking secrecy and minimal regulatory requirements. These offshore accounts can hold significant sums of illicit money, which can move through the global financial system with little scrutiny.
4. Investment Vehicles:
Shell companies invest laundered money into legitimate businesses or financial instruments, such as stocks, bonds, or trust funds. These investments yield legitimate returns, further integrating illicit funds into the economy.
5. Loans and Mortgages:
Shell companies provide loans or mortgages to related parties or businesses. Repayment of these loans appears as legitimate financial activity, while the actual purpose is to disguise the movement of illicit funds.
How to Identify a Shell Company
Shell companies are usually characterised by the following:
1. Complex Layers of Ownership Structure
Shell companies are usually layered with one shell company owning several owners, creating a deep layer of ownership structure. This makes it difficult to track the original owners.
2. Nominated Direction and Shareholders
Shell company's directors and shareholders are usually nominated individuals who lend their official names and information but do not have any real ownership of the company. They are just used as a front to protect the real beneficial owners, creating a separate layer of ownership.
3. Little or No Activities
Shell companies have little or no activities and mostly exist on paper. This makes it difficult to investigate them.
Shell Company Red Flags of Money Laundering
Some of the key red flags that may be an indication of money laundering activities by a shell company include:
- The company has no physical office or employees. It exists only on paper or has a minimal physical presence.
- The company’s ownership structure is complex and opaque, involving multiple layers of other companies or trusts, often in different jurisdictions.
- The company frequently deposits or withdraws large amounts of cash without a clear business rationale.
- The company engages in high-value transactions or trades that are inconsistent with its stated business activities.
- The company has been recently incorporated but engages in large or complex transactions shortly after establishment.
- The company has a significant number of clients or business partners from high-risk jurisdictions.
- Payments are made or received from third parties not clearly related to the transaction.
What are the AML measures for Combating Money Laundering with Shell Companies?
Organisations need to conduct business verification and customer due diligence (CDD) on key stakeholders of a shell company for AML compliance. This helps them obtain key company documentation like legal name, address and business structure to verify their ownership structure and understand the nature of its transactions.
Smile ID business verification solution empowers organisations to achieve this quickly and accurately. Also, organisations can easily detect suspicious entities and spot fraudulent shell companies by performing ID verification, government KYC verification and AML checks on relevant stakeholders.
Book a free demo today to learn more.
