Behind the front men: the beneficial ownership debate

Part of the Bailiwick of Guernsey, the Channel Island of Sark is just over two square miles in size. Most of its income nowadays derives from tourists. Yetuntil the late 1990s, the island was better known for the so-called “Sark Lark”. Between them, the island’s 600 residents held some 15,000 directorships, far too many to indicate genuine day-to-day involvement.

Yet Sark was one of many jurisdictions in which individuals made a good living by selling their names as nominees, asking few if any questions about the real owners of companies.

A huge industry has developed to handle the needs of individuals and organisations seeking privacy – whether for legitimate or illegitimate reasons. It has been estimated that between $1tn and $4tn in untraced assets have left China since 2000, much via offshore structures 1. In 2011, a World Bank report found that 70 percent of the largest corruption cases between 1980 and 2010 involved the use of shell companies2. Notably many of the companies were not “offshore” but were located in the United Kingdom or the United States, countries that still permit the use of nominees and corporate directors 3.

More recent initiatives by the European Union4, OECD5, G86 and G20 7 groups of countries aim to promote transparency to curb issues such as tax evasion, money laundering, corruption, trafficking and terrorist financing. Bilateral tax treaties, the US Foreign Account Tax Compliance Act (FATCA) and whistleblowers have all contributed to an increase in transparency. The Financial Action Task Force (FATF)8 and the European Network on Debt and Development (Eurodad)9, together with many leading non-governmental organisations (NGOs), have argued that major changes are needed to lift the veil of secrecy on beneficial ownership of companies, trusts, foundations and other legal entities.

The challenges relating to disclosure of beneficial ownership and control are however numerous and include some of the following examples:

  • Nominees frequently act as “straw men”, that is to say they have no executive authority over the affairs of a client’s business but merely charge for use of their name on official documents. Nominees may not even know the identity of the beneficial owner or true director. It is typical for a nominee to grant a general power of attorney to a real director, or to provide a blank, undated resignation letter permitting them to be removed at any time. Similarly, a proxy owner may provide an undated or post-dated share transfer document to the true beneficial owner, or in certain circumstances the shares will be in bearer form. In addition, for added layers of secrecy, established off-the-shelf companies may be used as intermediary owners or the beneficiary may approach the registration agent via a proxy intermediary, such as a friend or relative. Such mechanisms afford a very high level of anonymity and deniability, since official records bear no relation to the actual ownership or control.
  • Nominal ownership is subject to issues such as identify fraud, the use of sham directors/owners, or entirely fictional characters. In one example Global Witness, the NGO, found that a UK company which held accounts at AsiaUniversalBank in Kyrgyzstan was owned by a Russian individual who had actually died several years before the company was registered. According to Global Witness, his identity had been used to mask the real owner of a company that appeared to have $700 million flowing through its accounts, despite doing no business in the UK and failing to file accounts with UK Companies House as required10. In a second example, a Latvia-based individual named Eriks Vanagels, reportedly a “well known Russian banker”, has appeared as a director of numerous companies including a number of UK companies allegedly linked to shipments of weapons to Sudan in around 2008 (at a time of civil war). Investigative journalists subsequently tracked down Mr Vanagels – not a banker but a former Soviet Union lathe operator – who is now a semi-blind pensioner who reportedly spends most of his time drinking alcohol11.
  • Some countries extend secrecy beyond just the use of nominees: the Marshall Islands, Vanuatu and Liberia do not even require certain types of companies to register12.
  • Most countries do not record who beneficially owns and controls an organisation and even if they do, the information is not generally a matter of public record. Furthermore, beneficial ownership records would only be effective if updated regularly as changes occur. Whilst the G8 and the EU Parliament have pushed for greater disclosure of beneficial ownership data via corporate registers, there has been a reluctance amongst many individual states to take such a step, either on commercial grounds or due to concerns over undue intrusion into private affairs. Even where the will exists for the creation of registers of beneficial owners, a compromise position may involve restricting data access to select government bodies.
  • Meaningful sanctions for non-compliance would be required, rather than small administrative penalties that will not deter serious criminals. A poor quality register of beneficial owners might not only be ineffective – there is a risk that regulated institutions could subsequently rely on this data without undertaking their own independent checks into beneficial ownership. Most corporate registries do not validate or investigate the data they receive with a consequent risk that even this “primary” data may not be entirely accurate.
  • The use of nominee structures is not illegal and in some circumstances, such as ownership of public listed companies, nominees perform an important role to create efficiency and reduce transaction costs. Commentators such as Eurodad and the UK Confederation of British Industry (CBI) have argued that there is a valid reason for not including institutional nominees as part of beneficial ownership disclosure requirements for public listed companies given the costs and difficulties involved in identifying ultimate beneficiaries 13. Provided this applies solely to regulated institutional nominees, this may be workable, but risks remain if a general blanket exclusion is applied to publicly listed companies, some of which trade on lightly-regulated exchanges and/or with a low level of free float.
  • In some circumstances, particular legal structures have emerged to get round the problem of restrictions on ownership. One example is the Variable Interest Entity (VIE) structure, which was developed to allow foreign investors to access certain types of Chinese companies 14. Through a complex legal structure, generally involving Cayman Islands intermediary companies, foreign investors attain a right to participate in future revenue streams but without a formal ownership entitlement. Although technically this avoids breaching local Chinese laws on company ownership, neither is it strictly legal – but use of VIEs is established and to date Chinese authorities have tolerated their existence.

It is clear there is now a strong consensus on the need for greater transparency over beneficial ownership, given the widespread abuse of shell companies, nominees and offshore structures in facilitating various types of criminal activities. The European Union and the United States are pushing for greater disclosure – and even China, itself in the midst of a high profile anti-corruption drive, is supportive of these moves. Yet many difficulties lie ahead, not least the need to tackle substantial vested interests in the West and elsewhere in maintaining the status quo. Corrupt individuals are innovative and will be likely find ways to mitigate the loss of privacy, but if Europe and the United States can take a lead in promoting transparency of beneficial ownership, ultimately it will become harder, more costly and more risky for criminals to shift assets to developed nations, and enjoy their wealth in peace.

1 The Guardian, 21 January 2014
2 Stolen Asset Recovery Initiative, Puppet masters: how the corrupt use legal structures to hide stolen assets and what to do about it, 2011
3 UK company law stipulates that directors are responsible for the company’s affairs, whether or not they act as nominees
4 Including the Fourth EU Directive on Money Laundering and proposals by the EU Parliament for an EU-wide register of beneficial ownership
5 Standard for automatic exchange of information, July 2014
6 G8 action plan principles to prevent the misuse of companies and legal arrangements, June 2013
7 2015-16 G20 anti-corruption action plan, November 2014
8 FATF Guidance: Transparency and Beneficial Ownership, October 2014
9 Secret structures, hidden crimes: urgent steps to address hidden ownership, money laundering, and tax evasion from developing countries, Eurodad, January 2014
10 Grave Secrecy, Global Witness, June 2012
11 Re: Baltica, Dirty Money, A Farm of Directors, October 2012
12 Secret structures, hidden crimes: urgent steps to address hidden ownership, money laundering, and tax evasion from developing countries, Eurodad, January 2014
13 CBI response to the BIS discussion paper on ‘Transparency and Trust’, September 2013
14 Online information services such as Alibaba and Baidu are examples of Chinese companies that have used the VIE structure to overcome restrictions on foreign ownership
Posted in Due diligence