17 September 2013 | Eric Gutierrez and Joseph Stead
Every year, millions of companies are ‘born’, many of uncertain parentage. Nearly two million alone are formed each year in the United States; the United Kingdom with its Overseas Territories is not far behind.
Tracing the hidden owners is difficult, because forming a corporation or ‘limited liability company’ typically requires less information than is needed to obtain a bank account or driver’s license.
Furthermore, ownership is increasingly clouded by thousands of ‘formation agents’ who set up ‘companies’ and put them on the shelf, ready for clients to buy. A Google search of ‘UK formation agents’ reveals websites offering a new company within three hours for £16.99. The cheapest is £12.99.
Needless to say, such a system is wide open to abuse. Terrorists and drug lords hide behind lawfully-registered companies in order to open bank accounts and transact ‘business’ across borders. Corrupt public officials disguise their ill-gotten gains to spend on lavish lifestyles in London, Paris or Zurich.
Phantom firms and shell corporations
But perhaps the greatest abusers of all are those who stash away billions in profits in opaque firms with letter-box addresses, out of sight of the taxman.
Tax and the G8
Such abuses prompted the G8 summit in June to take action, with summit host UK Prime Minister David Cameron announcing the creation of a new register of ’beneficial owners’ – the people who are really in charge – of UK companies.
The summit agreed, however, that such registries should be restricted to tax authorities and law enforcement agencies, although countries would be free to go further and make registries completely open if they so wish.
Beneficial owners in the US
In the US, Congress is to debate a new Bill requiring companies to disclose their beneficial owners. These are defined as actual people, identified by their unique passport number or driver’s licence:
'Who directly or indirectly exercise substantial control over a corporation or limited liability company, or who has a substantial interest in or receives substantial economic benefits from the assets of a corporation or limited liability company.'
With the G8 countries in support, and legislation being drafted, it seems that hidden ownership is now on its way out.
But is it? A deeper look reveals a rough road ahead.
The poison of hidden ownership
To be clear, doing business through limited liability companies is not a right but a privilege, given by states to individuals. Anyone can open a bank account, set up an office and do business. But opening up a ‘limited liability company’ means creating a new legal person which is separate and distinct from its owner and designed to limit their liability.
This allows people to take risks and do business without fear of being personally indebted for the rest of their lives if their firm fails. Thus, the limited liability company and its various forms are seen by some as capitalism’s most important invention.
Business and politics
But limited liability companies are more than just vehicles for business; they can influence politics too. In some cases, they are even given the right to vote.
For example, in the City of London companies are also registered voters. With the ratio there at present - 15,581 business electors and 6,632 resident electors - this gives them considerable political clout.
Sinaloa drug cartel
When ownership is deliberately concealed, the potential for abuse is enormous. Take the case of the Sinaloa drug cartel, one of Mexico’s most murderous organised crime groups. It makes billions of dollars from illicit business.
Because it was difficult to launder the money, the cartel created companies and trusts with hidden owners, which then did business with local currency exchange firms. These, in turn, maintained bank accounts with HSBC.
When US authorities noticed that HSBC-Mexico was exporting more dollars into the United States than most Latin American central banks, alarm bells rang.
US agrees record settlement
Initially, the bank claimed its customers were the currency exchange firms, not the drug lords, but following a US Senate investigation, it agreed a record $1.92 billion settlement over charges that it laundered billions of dollars tied to Latin American drug cartels, 'rogue states', and foreign terrorist organisations.
At least $881m in drug trafficking money alone went through the bank's accounts, but no bank executive was charged or jailed, none of the billions in drug money was seized. And none of the $1.9 billion settlement will go to the victims of the cartel.
A litany of excuses and compromises
If abuse of hidden ownership has been global and widespread, then why hasn’t anything been done about it? The simplest explanation is that it has some immensely powerful backers.
Many claim it is a matter of privacy, arguing that revealing the identity of a company’s true owners could expose the wealthy to fraud, extortion and kidnapping.
In addition, the security of the owners of companies engaged in controversial work, such as firms using animals in research, would be compromised, while elderly company owners could be exposed to aggressive marketing.
Those living under authoritarian regimes, meanwhile, may have good reason to keep their company ownership secret to protect their businesses, and themselves, from grasping despots.
Distortion of market transactions
It is also argued that disclosure of real owners may distort market transactions. For example, if an unknown company bidding to buy land is found to be owned by a multinational supermarket chain, then the price of the land could be jacked up well above its market value by the sellers.
It is also claimed that disclosure of beneficial ownership – particularly for multinationals with complex ownership structures - will increase the cost of doing business.
Companies listed in stock exchanges already provide detailed ownership information, so why collect more information?
Ranged against these misgivings is the indisputable fact that a privilege granted by the state is being abused, and the interests of the state itself threatened.
Privilege brings with it obligations – and states are entitled to protect themselves from damage.
If there are legitimate reasons for concealing ownership, then a system of exemptions could be introduced for which those with concerns would have to apply.
Criminals would be hardly likely to apply, and any that did would be open to challenge.
It can also be argued that market distortions come from hiding, not disclosing information. Isn’t the free market ideal about all parties to a transaction having perfect information?
Cost of declaring ownership
Fears about the costs, meanwhile, are exaggerated. Most businesses are small firms where the beneficial owner is the main shareholder. Simply declaring that fact is hardly onerous.
Companies that do suffer significantly greater costs of compliance are most likely to be ones about which there are concerns in the first place.
Actions to take
Resistance to real change, however, remains fierce. Even the G8 only went so far as to agree the setting up of registries of beneficial owners, not making them public.
Similarly, the Bill to be filed in the US Congress by Senator Carl Levin exempts companies with more than 20 employees or annual turnover of more than US$5 million from disclosing their beneficial owners.
It targets only those small letter-box companies which exist purely to hide the identities of their beneficial owners.
Widespread political support is therefore necessary if the hidden ownership of companies is to be phased out or more effectively regulated.
The UK is now conducting public consultations on its National Action Plan for the Open Government Partnership with a decision due soon on whether the new registers of beneficial ownership will be made public.
Making them public would set a precedent, not only in the EU – where France and Italy seem to be supportive, but Germany is not – but also in the larger OECD, and even within the UN Convention Against Corruption.
Strong UK leadership on this issue will be pivotal. The world is watching how the UK will deliver, and especially if its Overseas Territories – where companies far outnumber the human population – will march in step.