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Senate Committee Hears from OCC, FinCEN and FBI on Risks Posed by Anonymous Corporate Structures

Testimony Supports Bill Requiring States to Collect Beneficial Ownership Information at Entity Formation

As we have blogged, the proposed Corporate Transparency Act of 2019 (the “Act”) seeks to ensure that persons who form legal entities in the U.S. disclose the beneficial owners of those entities. Specifically, the Act would amend the Bank Secrecy Act (“BSA”) to compel the Secretary of Treasury to set minimum standards for state incorporation practices. Thus, applicants forming a corporation or LLC would be required to report beneficial ownership information directly to FinCEN, and to continuously update such information.

If passed, the Act would build significantly upon FinCEN’s May 11, 2018 regulation regarding beneficial ownership (“the BO Rule,” about which we blog frequently and have provided practical tips for compliance here and here). Very generally, the BO Rule requires covered financial institutions to identify and verify the identities of the beneficial owners of legal entity customers at account opening. The issue of beneficial ownership is at the heart of current global anti-money laundering efforts to enhance the transparency of financial transactions.

On May 21, the U.S. Senate Committee on Banking, Housing and Urban Affairs, held a hearing entitled: “Combating Illicit Financing by Anonymous Shell Companies Through the Collection of Beneficial Ownership Information.” This hearing, which provided fuel for passage of the Act, featured the exact same trio of speakers who had appeared before the Committee during a November 2018 hearing on “Combating Money Laundering and Other Forms of Illicit Finance: Regulator and Law Enforcement Perspectives on Reform,” which pertained to a broader set of potential changes to the BSA. The speakers were:

  • Grovetta Gardineer, Senior Deputy Comptroller for Bank Supervision Policy and Community Affairs at the Office of the Comptroller of the Currency (“OCC”) (written remarks here)
  • Kenneth A. Blanco, Director of FinCEN (written remarks here); and
  • Steven D’Antuono, Acting Deputy Assistant Director of the FBI (written remarks here).

Unlike the broader November 2018 hearing, which featured some distinct tensions between certain positions of the OCC and those of FinCEN and the FBI, this hearing reflected close alignment amongst the speakers. Every speaker stressed the advantages to be reaped by law enforcement, regulators and the public if a national database of beneficial owners was required and created. Only the OCC acknowledged the need to consider the issue and sometimes competing concern of the regulatory burden imposed on financial institutions by the current BSA/AML regime, and even the OCC seemed to assume that a national database on beneficial ownership would represent only a boon to financial institutions, as opposed to yet more data – however helpful – to be absorbed and acted upon to the satisfaction of regulators. None of the speakers addressed some of the potential ambiguities and problems inherent in the current language of the Act, such as the fact that the Act lacks precision and fails to define the critical terms “exercises substantial control” or “substantial interest,” both of which drive the determination of who represents a beneficial owner.

The Committee Chair: The U.S. Needs to Crack Down on Shell Companies

In his remarks, U.S. Senator Mike Crapo (R-Idaho), the Committee Chairperson, referenced a second, upcoming hearing focusing on industry perspectives, and noted that, “[c]learly, the vast majority of anonymous corporate vehicles used today serve legitimate purposes and are formed with no criminal intent whatsoever. Therefore, we must bear in mind the amount of burden which may befall an overwhelming majority of small business owners.” Despite this nod to the regulatory burden facing industry, the May 21 hearing was decidedly focused on law enforcement. As both Director Blanco and D’Antuono would do during their testimony, Senator Crapo alluded to the fact that the international community has criticized the U.S. as a potential haven for money laundering and tax evasion by observing that organizations such as the Financial Action Task Force (“FATF”) “have identified not only a high potential for [the abuse of anonymous corporate vehicles], but have also identified far too many open investigations involving anonymous shells connected to money laundering, terrorist financing, corruption, weapons proliferation, sanctions evasion and a host of other threats.” After making the de riguer reference to the “Panama Papers” and “Paradise Papers” scandals, which rested on the alleged misuse of opaque entity structures to hide beneficial ownership, Senator Crapo offered a critique of the limits of FinCEN’s BO Rule:

But, the rule’s strengths and weaknesses are a product of its design to focus collection requirements for beneficial ownership information only on certain financial institutions.

The rule mainly helps financial institutions to mitigate risk, and the information received can provide some help to assist law enforcement in identifying criminal assets, accounts and national security threats from those who use the financial system.

The rule, however, does not reach all of the general population of millions of new corporate vehicles formed each year to operate in this country, nor especially those new corporations which are exported overseas that will never see an American financial institution, but still benefit from an American address.

Senator Crapo’s remarks set the tone, and the government speakers followed suit.

The OCC: Protecting the Financial System While Capping Regulatory Burden

In her remarks, Gardineer noted two competing concerns: (i) protecting the financial system from criminals who seek to exploit it for illegal purposes, particularly through the use of legal entities to shield their identities and illegal conduct; and (ii) not increasing the already large AML/BSA compliance burden on banks. To that end, Gardineer repeatedly stated the OCC supports a “standardized approach” for the verification of beneficial ownership data such as the establishment of “a consistent, nationwide requirement for legal entities to provide accurate beneficial ownership information” or “a centralized database for the maintenance of beneficial ownership information.”

In the OCC’s view, although the BO Rule has moved banks to create processes for collecting and verifying beneficial ownership information, it also has created challenges and costs for banks while leaving significant gaps. These challenges and costs relate to verifying beneficial ownership information, recordkeeping, training, and updating information. Collecting information on foreign legal entities is particularly challenging, even though the need is greater, because cross-border transactions can present a greater risk of money laundering and terrorist financing.

Gardineer stated that, due to the lack of reliable sources or databases, the biggest challenge with implementation of the BO Rule has been with the banks’ ability to verify the information their legal entity customers provide regarding beneficial ownership. Because states or tribal governments generally do not collect beneficial ownership information, “there is no consistent system banks can access and rely upon to verify that the ownership and control information obtained from their customers are accurate.”

Moreover, in the OCC’s view, the BO Rule’s “inflexible threshold” requiring banks to identify only persons who own 25% or more of a legal entity, allows “bad actors” to structure their ownership level below the 25% threshold in order to remain anonymous. The OCC would support “a consistent, nationwide requirement that cannot be easily circumvented.” However the OCC offered no suggestion as to what that requirement should be (other than implying it should be less than 25%).

The OCC also called out the recordkeeping burden imposed on banks by the Rule, in particular the Rule’s requirement that banks re-confirm beneficial ownership information for a legal entity customer each time that customer opens a new account, regardless of the associated risk.

In the OCC’s view, the way to address these challenges, as stated previously, is to establish “a consistent, nationwide requirement for legal entities to provide accurate beneficial ownership information” or “a centralized database for the maintenance of beneficial ownership information.” Upon formation, the legal entity would provide beneficial ownership information in “a consistent format” and the information would be updated on a regular basis. There would be several benefits to such a system. First, it would allow law enforcement to focus on substantive investigations, rather than spending time on obtaining and verifying beneficial ownership information. Second, it would reduce the regulatory burden on banks by providing them with an easier and more efficient method for verifying beneficial ownership information. Third, a central database would allow banks to spend less time on “training, reporting and processing paperwork.” Finally, legal entity customers would benefit by not having to supply their banks with the often burdensome and duplicative information currently required.

The OCC sees the BO Rule as only a partial step toward achieving the dual objectives of identifying anonymous beneficial owners who could be engaging in criminal conduct and supporting law enforcement in their fight to protect the integrity of our financial system. Banks alone cannot meet these enforcement goals – there must be other sources of “meaningful, accurate and timely information.” For this reason, the OCC supports the establishment of a “consistent, nationwide system” for legal entities to provide beneficial ownership information.

FinCEN: National Security is Linked to Beneficial Ownership Information

In his remarks, FinCEN Director Blanco declared that a lack of clear information identifying the bad “actors behind front companies” has turned shell corporations into mechanisms to “hide, support, prolong, [and] foster” criminal enterprises related to financial Ponzi schemes, narcotics, arms, and drug trafficking, financing of terrorist organizations, and kleptocrats’ efforts to retain and use their illicit gains. According to Director Blanco, the use of shell corporations thwarts law enforcement efforts to disrupt these global threats and identify sanctions evaders which would ultimately incentivize a change in bad behaviors. With clearer information, the Office of Foreign Asset Control (“OFAC”) and FinCEN could more effectively secure the nation and achieve foreign policy goals. The purpose of Director Blanco’s remarks were clear – to stress to the Committee the extent and variety of instances in which shell corporations are used to hide and launder assets – and more particularly the plight of victims of schemes hidden behind a corporate veil.

Director Blanco did not dwell on regulatory nuance. He began with an anecdote about a Russian arms dealer known as the “The Merchant of Death,” who sold weapons to terrorist organizations (specifically FARC), with the help of at least 12 shell corporations in Texas, Florida and Delaware. Shell corporations were used to hide nearly $1.2 billion in assets stolen from elderly investors during the course of a Ponzi scheme. And kleptocrats, such as Alejandro Andrade Cedeno, allegedly hid over $1 billion in bribes which he channeled through U.S. shell corporations.

For Director Blanco, the issue of collecting beneficial ownership information at the formation of a corporation is a question of national security and safety of United States citizens. “Opaque corporate structures such as shell corporations facilitate anonymous access to the financial system for every type of criminal and terrorist activity.” Director Blanco noted that FinCEN’s BO Rule was a crucial first step in closing a “national security gap,” but urged that such information must be gathered at the corporate formation stage – it is indeed the second critical step.

Such a database would all law enforcement to “follow the money” — a tactic that has, according to Director Blanco, resulted in the uncovering of criminal organizations that threaten the rule of law and integrity of the global financial system. Speaking from his experience as a former prosecutor, Director Blanco noted how the existence of a repository of information regarding shell companies’ true owners would save law enforcement resources, prevent the flight of assets, and destruction of evidence.

Finally, collaboration with foreign counterparts according to Director Blanco is vital to combatting sophisticated white-collar criminals. Although the U.S. should be able to provide beneficial ownership information, our current process, which is long and drawn-out, has been identified by FATF as one of the most critical gaps in the United States’ compliance with its standards. The lack of beneficial ownership slows investigations and leads to resource- and time-intensive processes which ultimately hinder international investigations. Director Blanco noted that many of our allies have begun to collect beneficial ownership information at the incorporation stage and have made such information accessible to law enforcement. In contrast, our lack of global leadership in this arena is to Director Blanco, “perplexing.”

The FBI: Investigations are Stymied by Lack of Beneficial Ownership Information

Acting Deputy Assistant Director of the FBI Steven M. D’Antuono echoed the law enforcement benefit of such a repository. As with Director Blanco’s remarks, D’Antuono focused on the resource intensive nature of the current process for identifying beneficial owners – and the concern that criminals exploit this time-consuming and costly process to conceal nefarious activities and delay or handicap ongoing investigations. Currently, the identification of beneficial owners is a slow-moving legal process that may traverse multiple jurisdictions.

D’Antuono began by noting the near complete lack of transparency into beneficial ownership in the United States has led FATF to highlight (in multiple assessments) the various money laundering vulnerabilities faced by the United States. For instance in FATF’s Guidance on Transparency and Beneficial Ownership, it found that countries should take measures to prevent the misuse “legal persons” such as shell companies, corporate structures, and other entity structures, and ensure that legal persons are sufficiently “transparent.” FATF urged countries to institute programs that allowed for adequate, accurate, and timely information on beneficial owners that can be accessed judiciously and without impediments.

Additionally, the 2016 Mutual Evaluation Report (“MER”), referenced in Director Blanco’s comments, stated that “serious gaps in the legal framework prevent access to accurate beneficial ownership information in a timely manner,” and that “fundamental improvements are needed in these areas.”

D’Antuono also referenced the National Money Laundering Risk Assessment authored by the Department of Treasury which observed that the use of legal entities constitute a significant money laundering risk especially when ownership trails lead overseas and involve numerous layers. Moreover, the assessment noted that U.S. law enforcement agencies have no systematic way to obtain information on beneficial owners of legal entities. The ease with which companies can be incorporated under state law, and how little information is generally required about companies’ owners or activities, raises concern about a lack of transparency.” These impediments result in a resource intensive process, which unnecessarily delays important investigations and ultimately, attracts bad actors to the United States.

D’Antuono’s proposed solution is the same as Director Blanco’s – entities should be required to disclose beneficial ownership information and a central repository of that information should be maintained and be made available to law enforcement and regulators. And like Director Blanco, D’Antuono made a point to demonstrate that access to true owner information of legal entities is the norm among our allies. He pointed to the European Union (“EU”)’s Fourth Anti-Money Laundering Directive, which requires EU member states to hold accurate and current information on beneficial ownership. D’Antuono described the role of a central register, and noted that the EU’s Fifth Money Laundering Directive requires public access to such data with some exceptions and addresses the necessity of sharing information between member states.

Unlike Director Blanco, D’Antuono made explicit that the lack of access to beneficial ownership information has hindered investigations, including the investigation into kleptocracies and forfeitures of illegally gotten gains from such investigations titled mostly in the name of shell companies. He also described investigations into political corruption, some of which were revealed in the Panama Papers as clients of the former law firm Mossack Fonseca. Mossack Fonseca allegedly opened thousands of shell companies for various individuals, many of whom they could not identify and who turned out to be international narcotics traffickers. Moreover, D’Antuono noted that Mossack Fonseca opened accounts for Americans or individuals involved with U.S. based commerce. And Mossack Fonseca as a law firm allegedly helped to obscure the names of true beneficial owners.

Finally, D’Antuono pointed out the wide range of criminal enterprises that shell companies help to conceal and further, including:

  • sanctions evasion by a Chinese national who used U.S. businesses to facilitate the supply of military and metallurgical items to Iran;
  • crimes against children/human trafficking involving Backpage.com and the concealment of receipt of money from people purchasing ads;
  • investment fraud which given the convoluted nature of the interrelated shell companies allowed the schemers to dissipate assets during a multi-year investigation; and
  • drug trafficking involving the purchase and sale of race horses.
Copyright © by Ballard Spahr LLP

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Moskow, Delaware, Partner, litigation
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Beth Moskow-Schnoll is Managing Partner of the firm's Delaware office and concentrates her practice on white-collar litigation, regulatory enforcement and compliance, and complex civil litigation, with an emphasis on banking and other financial services litigation.

She has tried to verdict dozens of cases in federal district court. She also has successfully briefed and argued multiple cases before the Third Circuit Court of Appeals. Ms. Moskow-Schnoll has convinced the government to decline prosecution of clients in matters involving allegations...

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Priya Roy, Attorney, Ballard Spahr
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Ms. Roy focuses her practice on white collar defense, regulatory compliance and complex civil litigation. She conducts internal investigations and advises and defends companies and individuals facing criminal and civil investigation, and has participated in negotiations with the U.S. Department of Justice and federal regulatory authorities. Ms. Roy's practice includes counseling clients in Anti-Money Laundering and Bank Secrecy Act matters, as well as matters involving allegations of tax fraud, violations of the False Claims Act and Anti-Kickback Statute, violations of the Food, Drug and Cosmetics Act, securities violations, and other fraud and regulatory offenses. Ms. Roy is a frequent contributor to Money Laundering Watch, Ballard Spahr's blog focused exclusively on money laundering issues.

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 Peter D. Hardy, Ballard Spahr, Philadelphia lawyer, White Collar Defense lawyer, Internal Investigations, Consumer Financial Services, Privacy and Data Security, Tax
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Peter Hardy advises corporations and individuals in a range of industries against allegations of misconduct—including tax fraud, money laundering, Bank Secrecy Act, mortgage fraud and lending law violations, securities fraud, health care fraud, public corruption, Foreign Corrupt Practices Act violations, and identity theft and data breach.

Mr. Hardy has extensive trial and appellate court experience. He oversees internal investigations, advises in potential disclosures to the Internal Revenue Service, and has litigated complex criminal matters at the trial and appellate levels. He...

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