New Rules On Corporate Secrecy Have Glaring Loopholes

Dave Johnson

The Treasury Department released a new rule and several proposals last week that they said are intended to address the problem of corruption and dirty money in secret U.S. shell companies.

A White House news release announced what it called “several important steps to combat money laundering, corruption, and tax evasion, and called upon Congress to take additional action to address these critical issues.” (A White House fact sheet is available here.)

The new rules at first glance appear strong. But after examining the details, several watchdog groups are warning that the new regulations and proposals leave open several glaring loopholes, and even practically provide instructions for how to get around the regulations.

The New Rules

Reuters has the story on the new rules, in” U.S. issues rule requiring banks to identify shell company owners“:

The Obama administration is issuing a long-delayed rule requiring the financial industry to identify the real owners of companies and proposing a bill that would require companies to report the identities of their owners to the federal government, U.S. officials said on Thursday.

The Customer Due Diligence (CDD) rule, in the works since 2012, and the proposed legislation are meant to hinder criminals from using shell companies to hide ownership and launder money, finance terror, and commit other threats to the global financial system.

[. . .] The final CDD rule will require banks, brokers, mutual funds and other financial institutions to collect and verify the identities of the real people, or “beneficial owners,” who own and control companies when those companies open accounts.

The new rule requires banks to do more checking to find out who owns corporations that are getting bank accounts, so “shell corporations” can’t hide their owners. According to the White House, the rule will require “financial institutions to know and verify the identities of the natural persons (also known as beneficial owners) who own, control, and profit from companies when those companies open accounts.”

Proposed Laws

The Treasury Department is also asking Congress for a law that sets up a central registry tracking who owns corporations, with companies required to provide this information when incorporating. Now there is no such requirement or registry so law enforcement and tax collections are stymied.

According to the Reuters report:

The Treasury is also proposing a regulation that would increase requirements for some foreign-owned companies operating in the United States to report information to the government, which officials said would prevent the use of those companies for tax avoidance purposes.

In addition, the Justice Department is proposing amendments that would strengthen its ability to pursue foreign corruption cases, including issuing subpoenas for records in money laundering investigations, obtaining overseas records, and using classified information in civil cases.

However, there is stronger legislation already before Congress. David Dayen reports at Salon, in “The Obama administration’s Panama Papers misfire: Why new rules to curtail global tax avoidance could actually make things worse“:

But this legislation already exists. The Incorporation Transparency and Law Enforcement Assistance Act, which has bipartisan sponsors in the House, would do everything the White House claims to want, requiring states and the Treasury Department to collect beneficial ownership information at the time of incorporation, and make that information available to law enforcement. It’s unclear why the Administration would need to rewrite what already has been written, and since they’ve released nothing official about their own draft legislation, it creates suspicions that they are trying to undermine the current effort in Congress, with analogous flaws to the Treasury rule.

Loopholes

The new rules exclude existing shell corporations. Shruti J. Shah, vice president of programs and operations at Transparency International-USA, explains, “The rules also do not extend the requirement to collect beneficial ownership information of accounts established before the rules’ implementation date, creating a major gap in the information collected.”

So if people are already using shell companies for “money laundering, corruption, and tax evasion” (and never mind financing terrorism, running fraud scams or storing the gains from crimes) they can keep doing so with impunity.

The new rule requiring financial institutions to get names of people or entities owning 25 percent or more of a corporation and the name of one manager (president or chief executive) is like an instruction manual telling shell corporations to register claiming five owners or entities with 20 percent each. They can stay secret. Or they can use trusts, which can continue to hide their beneficiaries. (For more on this see Financial Times, “US tax havens: The new Switzerland.”)

As for the significant manager, Bloomberg reports, in “Obama’s Disclosure Rule for Shell Companies Weak, Advocates Say“:

If all banks have to find out about their account-holders is one person with managerial control, “that could be a law-firm employee,” Elise Bean, former chief counsel for the U.S. Senate Permanent Subcommittee on Investigations, said during the call. “That could be someone in the British Virgin Islands, someone in the Isle of Man, and that’s really a problem.”

Quartz also quotes Bean, in “A design flaw in Obama’s new Panama Papers rule could help shell companies dodge cops and taxes“:

The internationally accepted definition of beneficial owner—the actual human who truly gains from the company’s equity—is altered in the law. Under the new rules, anyone who owns less than 25 percent of the company need not be reported, and the appointed president of a shell company can be listed as the beneficial owner.

“That’s kind of the opposite of what the term as has always meant,” Elise Bean, the former chief counsel of the Senate Permanent Subcommittee on Investigations, told reporters last week. “At Mossack Fonseca, they could say, ‘I’m appointing my law firm employee the president of the shell company, and now under US rules, I can name my employee the beneficial owner of that company.’ That just doesn’t make sense.”

That “law-firm employee” could be, for example, an employee of the firm registering the shell corporation.

In addition, the banks are given two years before they begin checking corporations, giving criminals time to shift and adjust their corporations and funds accordingly.

“Weak”

Bloomberg explains the concerns of watchdog groups:

The advocacy groups raised concerns about the rule’s requirement for naming the person who exercises managerial control over a company, rather than the person with effective control. Under the rule, financial institutions must obtain the names of anyone who owns 25 percent or more of an entity and the name of one person who has significant managerial control, such as a president or chief executive.

That means a group of five criminals could comply with the rule, access the U.S. financial systems and still remain anonymous, if they each took a 20 percent share in a shell company and then hired a nominee to be its president, Ostfeld said.

However,

The U.S. Treasury Department, which finalized the rule on Thursday, disputed that criticism. “A nominee or lawyer working on behalf of a company would not satisfy the requirements,” the agency said in an emailed statement. The rule calls for naming a person with “significant responsibility to control, manage or direct the company,” the statement said.

The Financial Accountability and Corporate Transparency (FACT) Coalition released a statement that read in part:

“The loopholes in the final Treasury rule allow banks to open accounts for companies without having any idea of the identity of the people who ultimately own or control that company. Without this critical information, banks can’t determine whether the people behind the company are on a sanctions list, a drug kingpin list, or are public officials who may be stealing from their countries treasury or trying to stash their bribe money in U.S. banks,” noted Heather Lowe, legal counsel and director of government affairs at Global Financial Integrity.

Mark Hays, a senior policy adviser at Global Witness, adds: “The rule will allow criminals to list managers of shell companies—for example, an employee of a law firm such as Mossack Fonseca, the Panamanian company exposed in the Panama Papers—as the ‘beneficial owner’ of a company.”

Transparency International-USA expresses their concerns in a news release:

While TI-USA supports the efforts of the U.S. Treasury and specifically FinCEN’s efforts to address the need to collect beneficial owner information on the natural persons behind legal entities, the rule has significant gaps.

The rules do not sufficiently capture those who can control an anonymous company because in the definition of “control,” it conflates senior management and executive officers of corporate entities with the beneficial owners. Often officials named in leadership positions in anonymous companies are figureheads and control of the entity is exercised through other means– a problem highlighted by the recently released Panama Papers. TI-USA proposes that financial institutions focus on capturing information about individuals who exercise control of the legal entity for their due diligence purposes.

The rules also do not extend the requirement to collect beneficial ownership information to accounts established before the rules’ implementation date, creating a major gap in information collected.

Watchdog groups – and law enforcement – have been asking for a crackdown on corporate secrecy for years. The Obama administration sat on these rules. Then after the Panama Papers leak publicized the extent of the problem, they issued rules that many say could actually make the problem worse. What is going on?

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