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24 Ago 2015

How the Corrupt Hide their Money: Beneficial Ownership and a Prisoner’s Dilemma

Francesco De Simone

Leer este post en español en el blog GobernArte.


In a previous post, I discussed corruption risks in the natural resources sector, and how transparency can help mitigate them. The post discussed the case of the son of an African President, who allegedly stole millions from his country to purchase luxurious properties, including in the US. This begs the question: how can a foreign public official who poses a high risk of corruption be able to launder the proceeds of his crimes in the US?

The answer has a lot to do with a prisoner’s dilemma. Here’s why.

When anti-corruption controls fail, and when the corrupt are successful in their efforts to divert public funds, commit fraud, or solicit bribes, they are still confronted with the challenge of what to do with their loot. Obviously, a corrupt public official has all the incentives to hide from the public the fact that he is becoming rich. This is especially true if this enrichment is inconsistent with his official salary, and if it is happening very quickly, as this could result in scrutiny from the authorities, the media, and the general public.

Money laundering is the process through which criminals re-incorporate the proceeds of their crimes back in the legal economy, to disguise both the illicit origin of the funds and their identity. It usually happens through shell companies. These are companies that have no independent operations, ongoing business, or employees, and are created with the sole purpose of owning an asset (say, a villa with a swimming pool or a yacht). Shell companies are used to disguise the identity of the true ultimate owner of an asset, (technically known as the “beneficial owner”), that is, the person who ultimately benefits from the asset: the guy who swims in the pool and drinks a mojito on the yacht. To be clear, while these corporate structures are frequently used by the corrupt (see for example the FIFA indictment, PDF), they also benefit drugs and arms traffickers, tax evaders, organized crime, and terrorists.

A hypothetical corrupt official looking to launder the proceeds of a bribe might seek the help of a specialist (often known as Corporate Service Provider – CSP) to create a shell company, or even better, a network of shell companies located in different jurisdictions, to own the villa or yacht.

These companies are often set up in somebody else’s name. One option is to use a relative or friend of the public official. But this too can raise questions and red flags. Another strategy is to hire or scam somebody into being the owner of the company. This may be somebody who doesn’t have any contacts at all with the beneficial owner, so that, even in the event of an investigation, he cannot provide any identifying information. Finally, some money launderers rely on CSP who are willing to create companies without collecting any identifying information at all. This makes the beneficial owner almost completely untraceable, even in case of an investigation (see a detailed account, and a fascinating documentary on this topic).

The International Consortium of Investigative Journalists (ICIJ) obtained a leaked database (called Offshore Leaks) of over 100,000 shell companies incorporated in the British Virgin Islands, Cayman Islands, Cook Islands, Singapore, and other jurisdictions, commonly regarded as tax havens, and on their beneficial owners. Journalists at the ICIJ, in partnership with others from several countries, have relied on it to investigate shell companies and their owners in order to document dozens of alleged cases of corruption, embezzlement, fraud, and tax evasion, as the database includes emails and other files connecting high-profile individuals to shell companies (see an example here).

Now, you may think that the use of shell companies and the disguising of their beneficial owners is a practice only possible in small tropical islands, commonly known as tax havens or secrecy jurisdictions. But this is not entirely true. For example, a detailed study (PDF) released by the World Bank’s Stolen Assets Recovery Initiative (StAR) in 2011 revealed that out of a database of 150 grand corruption cases involving a total of 817 shell companies, 102 of these were incorporated in the United States, which topped the list of jurisdictions most frequently used by money launderers.

Indeed, lack of transparency on beneficial ownership is not only a problem of countries traditionally regarded as tax havens. For example, a recent investigations conducted by the New York Times in the US revealed the identities of individuals from around the world who have been purchasing prime real estate in Manhattan worth several million US dollars. These investigations have shown alleged ties between the shell companies used to purchase luxury apartments and homes, and politicians, businessmen and politically connected individuals often suspected of involvement in corrupt deals. U.S. authorities are just beginning to scratch the surface when it comes to curbing money laundering in the real estate sector, as shown by a recent report.

The use of real estate for money laundering has a clear purpose: it’s not that all criminals covet a view over the Hudson or the Thames. Rather, prime real estate can be rented and, once purchased, generates a cash flow that is entirely legitimate.

All this is possible because the US too has struggled to implement adequate legislation on beneficial ownership transparency that could help avoid the use of shell companies to launder illicit funds. Particularly, the states of Delaware, Nevada and Wyoming have been flagged in the media and by advocates for the significant degree of secrecy that they grant to individuals seeking to hide their identity.

Beneficial ownership has become so central to the international efforts to prevent money laundering and illicit financial flows that the G7 has repeatedly committed to increasing transparency in this area, including at its most recent Summit in Germany (PDF). Various countries have stated their will to create registries of beneficial ownership information, that is, to establish the legal obligation for whoever incorporates a company to disclose to authorities the ultimate beneficial owner and to record his or her name in a public registry. However, with few exceptions, little action has followed.

For Latin American and the Caribbean this is a key issue. The region is vulnerable to illicit flows from corruption, drug trafficking, and organized crime. Some countries in the region have been under scrutiny by the Financial Action Task Force (FATF). On the other hand, there has also been a strong commitment to improve, as shown, for example, by the case of Nicaragua, which was recently removed from the FATF Gray List, also with technical assistance from the IDB.

What about the prisoner’s dilemma? Many countries, not only in the LAC region, have been reluctant to be the first to act and adopt a beneficial ownership registry, because they see this as a possible competitive disadvantage. Why should a small Pacific or Caribbean island be the first to establish a beneficial ownership registry, and risk losing foreign business, if the US or the UK don’t have one?

But what if this logic were reversed? What if Latin American and Caribbean countries were among the first in the world to implement a beneficial ownership registry? The way I see it, this could be a terrific opportunity for countries in the region to reaffirm their commitment to anti-corruption at a very delicate time, while at the same time anticipating many OECD countries and presenting themselves as leaders in one of the most critical areas of anti-corruption policy.

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