The role of shell companies in money laundering

Table of Contents

Shell companies are a preferred avenue for financial criminals to hide their crimes. These include money laundering, fraud, evading sanctions, escaping taxes, and many others. To protect yourself from these risks and prevent shell companies from exploiting your business, you need to apply proper AML measures. In this article, let’s understand the role of shell companies in money laundering and other financial crimes.  

The world of shell companies is based on committing the crime and staying undetected. Shell companies are also known as ghost companies. That means they are the vehicles used in the second stage – layering – of money laundering. Layering allows criminals to disguise the origin and place of dirty money. Thus, you must have enough AML measures to prevent the risks of shell companies in money laundering.  

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What are the risks of shell companies in money laundering?

What is a shell company?

A shell company is a company without any physical presence and assets. It is not active in business operations. No services provision. No sale of goods. Moreover, it does not have any significant assets. That is why it is a great technique to hide a firm’s ultimate and real beneficial ownership. Criminals form shell companies to conduct illicit business transactions. 

Shell companies are characterised by:

  • Lack of physical presence 
  • No income 
  • No employees 
  • Occasionally hold bank accounts and investments 
  • Inactive 
  • Complex ownership structure 
  • Nominee directors and shareholders 

Are shell companies legal?

Yes, shell companies are legal even if they are inactive. An individual can form a new company to hold some assets. The newly formed company holds the asset, and that’s its only purpose. It remains inactive and does not conduct sale or purchase transactions.  

What are the legitimate and illegitimate uses of shell companies?

Shell companies and their legitimate use cases

  • To invest in various countries 
  • To raise funds from the international market 
  • To prevent tax lawsuits on assets 
  • To hold funds 
  • To hold assets like bonds, real estate, stocks, etc. 
  • To protect intellectual property rights 
  • To employ tax planning strategies 
  • To facilitate mergers and acquisitions 

Shell companies and their illegitimate use cases

  • To hide dirty money earned from illegal activities 
  • To conceal the identities of beneficial owners 
  • To evade taxes by hiding income in a shell company in a different jurisdiction 
  • To conduct fraud, scam, or a crime 
  • To store washed funds in the shell company’s accounts 
  • To hide assets during mergers and acquisitions or divorces to avoid sharing with others 
  • To finance and exchange dual-use goods with other shell companies, leading to the proliferation of financing 
  • To provide phantom services by raising invoices for services that were never rendered 

The impact of shell companies

  1. Money laundering, terrorist financing, drug trafficking 
  2. Tax evasion 
  3. Market manipulation 
  4. Unfavourable conditions for legitimate businesses 
  5. Fraud 
  6. Corruption 
  7. Illegal payments 

What is the difference between shell, shelf, and front company?

Shell companies have no business activities, significant assets, or employees. They exist on paper but not physically. They are not illegal corporations, but companies use these structures to conduct illicit transactions like money laundering, tax evasion, and concealing beneficial ownership, as well as for legitimate purposes. Trust companies use shell companies as trustees. Companies use shell companies to evade taxes through transfer pricing strategies.  

Shelf companies are incorporated companies. They can or cannot have customers but stay dormant for years with no business activities. The secretaries, shareholders, and directors of a shelf company are inactive.  

A front company is a legal business – a fully functioning company. However, criminals use front companies to hide their illegitimate financial transactions.  

Why are shell companies vulnerable to money laundering?

Shell companies’ vulnerability to money laundering is due to the following reasons: 

Anonymity

The most significant characteristic of shell companies is their anonymity. It keeps the identity of beneficial owners secret and private. This is possible because shell companies are constructed in less-regulated or tax-haven countries. These countries have no mandatory requirements for the disclosure of structure, and shareholding. You can move funds from one country to another without divulging any transaction and ownership details. This is the feature that money launderers leverage to conduct crimes.  

Low cost and easy company formation procedure

Another characteristic that makes shell companies susceptible to money laundering is the low cost and ease of formation. You don’t need to spend much money on its establishment and operations. Moreover, their setup does not involve many steps or hassles of approvals and documentation. Such ease and less-costly company structuring enable money launderers to opt for shell company formation. 

No physical presence

Shell companies do not have a physical presence. They exist only on paper. So, you will find it challenging to trace the company’s whereabouts. This is also one of the reasons why their vulnerability to financial crimes is high.  

Relaxed regulatory rules

Offshore destinations with relaxed rules are preferred destinations for shell companies. These jurisdictions do not restrict a business’s and its owners’ confidentiality, privacy, and anonymity. Strong bank secrecy rules, strict privacy laws, and relaxed regulatory standards make a country a preferred hub for shell companies.  

Superrich use such shell structures to hide their wealth because of relaxed regulations. Also, the creation of shell companies involves fewer regulatory investigations and checks. The absence of or minimal reporting requirements attracts criminals who use shell companies to commit crimes. Even low or no corporate tax rates make a jurisdiction a preferred destination for shell companies.  

A confusing network of several shell companies in different jurisdictions

The network of multiple shell companies in different jurisdictions benefits money launderers. Such a complex network lets one create a chain of several transactions. This structure makes tracing funds’ ownership, source, and destination difficult. Regulatory and investigating authorities have to handle too many jurisdictions and their laws. Also, collaboration between authorities in so many jurisdictions is a big concern. Some jurisdictions might have a vested interest in such schemes, so they don’t help in investigations.  

How do shell companies launder money?

Criminals set up a shell company, invest their proceeds of crime into it and then move funds to their own account by using fake invoices.

Red flags of financial crimes by shell companies to exploit your business

Since shell companies’ risk in money laundering is high, you must be vigilant about their activities. One way of doing that is learning about the red flags of customers’ illicit behaviour. These are the warning signs of suspicious transactions using shell companies. So, you must be aware of these red flags to spot suspicions at the right time and stop the transaction. These red flags include the following: 

  1. Atypical directorship in companies  
  2. Dubious addresses of companies 
  3. Mass registration of many directors, shared names, or addresses indicates the involvement of many shell companies.  
  4. Dormancy of a company for a few years and a sudden rise in presence with a spike in revenues 
  5. Too young or too old beneficial owners like five years or more than 100 years 
  6. Circular ownership of several companies with each other to hide beneficial ownership 
  7. Dubious addresses as address proof of entities 
  8. A mismatch between the company’s registration jurisdiction and the directors’ residency or nationality, specifically involving high-risk jurisdictions 
  9. The home jurisdiction of the shell company is a sanctioned or terrorist country or one with weak AML and other regulatory controls 
  10. Some odd financial anomalies 
  11. Ultimate beneficial ownership is significantly different from the expected 
  12. The company has not undertaken any real business activities 
  13. The formal nominees mentioned for the company are nominated agents for many shell companies 
  14. The nominees are generally the spouses, children, or relatives who do not contribute to the enterprise’s operations 
  15. The shell company conducts many transactions, but none generates income 
  16. It does not contribute to taxes, social benefits, and employee benefits 
  17. One party is the origin and destination of financial benefits in the case of international funds transfer, or the transaction is between two different businesses, but they have the same registration address 
  18. The unnecessary creation or involvement of representative offices or similar delegation services  
  19. Cash transactions, different from the usual payment mode used  
  20. Account signatory executes a large transaction but with no controlling interest in the assets or company 
  21. Involvement of family members in business transactions with no legal business purpose 
  22. Private third parties provide loans, but there is no supporting agreement, interest repayments, or collateral 
  23. Doubtful and questionable relations between parties with no clear explanation by the customer 
  24. Unusual transactions considering the client’s profile, business model, or previous transactions 
  25. The origin and destination of transaction funds involve a foreign jurisdiction with no justified linkage with the client 
  26. The business account used for a transaction is also used for personal transactions like buying assets or other reasons with no linkages to the client’s profile 
  27. Involvement of two or more parties in a transaction with no apparent reason or legal rationale 
  28. Finance from a lender – an individual or a company – without any commercial reason or justification 
  29. Goods or services transacted do not correspond to the sender or receiver’s business profile 
  30. The unwillingness of the party to disclose information on the transaction 
  31. Transactions involving beneficiaries from offshore or high-risk jurisdictions 
  32. Transactions with fake invoices having a shell company’s name as the seller of products 
  33. Complex transactions with multiple layers of buying and selling 
  34. Large volume or value transactions with other ghost companies 

With so many red flags and others, you must keep an open eye on all incoming and outgoing transactions. All these are obscuring the illicit behaviour of the transactions, which you must be aware of. It makes tracing of money laundering and criminals challenging for investigators. However, with proper AML measures and transaction monitoring, you can identify the legal, fair transactions from the illegal, unfair ones.  

How do you prevent shell companies from exploiting your business?

So, now you understand that shell corporations are risky for your business. You must safeguard yourself from these risks to reduce the likelihood of involvement in money laundering activities. You need to be proactive in your efforts to build a resilient business. To protect your business from the risks of shell companies in money laundering, you must apply the following measures: 

KYC

Know your customers. It is a critical way to prevent shell companies from exploiting your business. You must know all the details about your customers, such as: 

  • Business name 
  • Registered business address or residential address 
  • Email address and contact number 
  • Business license number 
  • Nature of business  
  • Business type and structure 
  • Business details like board of directors, date and place of establishment, and annual report 

You must collect proof of all these details. The documentary proof helps you verify your client’s identity. You can identify if your customer is a shell company or not.  

Due diligence

KYC is a fundamental way of knowing your customers. Due diligence involves more intense scrutiny. You must investigate your customers’ funds and wealth further. This will help you detect any linkage with illegal activities.  

Investigate the following about your customers: 

  • Source of funds 
  • Source of wealth 
  • Beneficial ownership (name, address, relation with the firm, national identity, and other details) 
  • The business structure 
  • Payment methods used 
  • Financial statements 
  • Geographical presence 

All these data points help you understand the customer’s background. You can get confirmation on the authenticity of the company’s business operations and business owners, customers, and suppliers. Investigating beneficial ownership and background helps you understand whether the client is a shell company created for illicit reasons. Once you know the beneficial owners and risks associated with them, you can examine any probable involvement of shell companies.  

Customer Risk Assessment

Once you manage to conduct KYC and CDD, you have a decent amount of information on your customers. Now, you can manage to create risk profiles of your customers. Based on this risk profiling, you can categorise customers as high, medium, and low risk.  

The risk profile includes rating your customer based on the risks from their products/services, geographical presence, delivery channels, and transactions. If the customer is high-risk, you need to be more cautious.  

Transaction monitoring

Monitoring shell company transactions is necessary to spot suspicions. By checking transactions, you can spot any shell company’s participation in financial crimes. For this, you must look at the transactional patterns or irregularities in customer behaviour. Also, keep a check on the value and volume of transactions. Lack of transparency or unwillingness to disclose identity or transaction details is a typical red flag of shell companies.  

So, awareness of the red flags of shell companies’ involvement in money laundering is essential. The section above contains warning signs you must be wary of when detecting shell companies’ involvement in illicit transactions.  

Technology solutions

Use technology solutions to perform your business’s AML and risk management strategies. These solutions have the latest advanced technologies, such as the following: 

  • Artificial intelligence 
  • Data Analytics 
  • Blockchain technology 
  • Machine learning 
  • Data mining 

All these technologies help you with accurate sifting and analysis of data. They help you analyse loads of data to verify customers’ identities. These technologies can identify patterns and behavioural characteristics matching potential red flags. Thus, you can identify suspicious transactions and customers linked to shell companies.  

The best part about AI is that it adapts over time to new rules. When new money laundering tactics emerge, or risks evolve, you can update your solution to these new rules. Thus, you can put up an intense fight against money laundering through shell companies. You can devise strategies against the risks of shell companies in money laundering and prevent them from exploiting your business.  

AML compliance program

To prevent shell companies from exploiting your business, you must take a risk-based approach to your AML compliance program. You must develop specific policies, procedures, and internal controls for your business. This framework depends on industry-specific risks and shell companies’ role in money laundering.  

Your framework must include KYC, CDD, and transaction monitoring. It involves continuous monitoring of risks from customers and their transactions. Knowing the risks allows you to take relevant action and stop your business’s exploitation. You must also monitor these AML programs on an ongoing basis to make improvements that bring you closer to AML compliance in UAE.  

Training

Training of frontline employees and compliance teams goes a long way in countering ML/TF risks emanating from shell companies. The training programs should revolve around the identification of UBOs, known red flags, and known ML/TF typologies.  

All these measures help you know who you are dealing with. Thus, you are aware of the risks from your customers and suppliers. Based on your risk appetite, you can decide whether to form a business relationship and transact with them. These measures help you stay vigilant against the risks of shell companies in money laundering.  

If you apply these proactive AML efforts, you can detect the illegal network of shell companies that launder dirty money. Thus, these measures help you prevent shell companies from exploiting your business. You can improve the financial system’s integrity and comply with AML regulations 

AML UAE – your partner for professional AML consulting services

AML UAE can help you design and implement customised solutions to prevent shell companies from exploiting your business. Our AML initiatives strengthen your fight against shell companies and reduce their threats. We can help you: 

  • Know your clients better 
  • Conduct due diligence checks on them 
  • Monitor their transactions on an ongoing basis 
  • Assess risks from shell companies 
  • Design appropriate AML compliance programs 
  • Select and implement the right technology solutions for your business 
  • Conduct training to strengthen your team against ML/TF risks posed by shell companies 

All these measures reduce the risks of shell companies to your business. Thus, with AML UAE’s help, you can prevent shell companies from misusing your business to conduct money laundering activities.  

Enhance your defence against financial crimes,

With AMLUAE’s initiatives to prevent the risks of shell companies
in money laundering.

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About the Author

Pathik Shah

FCA, CAMS, CISA, CS, DISA (ICAI), FAFP (ICAI)

Pathik is a Chartered Accountant with more than 25 years of experience in compliance management, Anti-Money Laundering, tax consultancy, risk management, accounting, system audits, IT consultancy, and digital marketing.

He has extensive knowledge of local and international Anti-Money Laundering rules and regulations. He helps companies with end-to-end AML compliance services, from understanding the AML business-specific risk to implementing the robust AML Compliance framework.