What they are and how they work
Shell companies can be used to commit nearly every type of fraud — from simple billing fraud schemes to complex, multi-jurisdictional money laundering operations. Because they are relatively easy and inexpensive to create, shell companies are an attractive option for both professional criminals and amateur fraudsters. Fraud examiners should understand how shell companies work, how they are used to commit fraud and how to investigate fraud schemes involving shell companies.
Shell companies are used for a wide variety of purposes, both legal and illegal. As a result, there is no universally accepted definition of the term “shell company.” The ACFE’s Fraud Examiners Manual defines shell companies as:
Business entities that typically have no physical presence (other than a mailing address), no employees, and generate little, if any, independent economic value.
Alternatively, in its Benchmark Definition of Foreign Direct Investment, 4th Edition, the Organisation for Economic Co-operation and Development (OECD) defines a shell company as “a company that is formally registered, incorporated, or otherwise legally organised in an economy but which does not conduct any operations in that economy other than in a pass-through capacity. Shells tend to be conduits or holding companies …”
Consequently, shell companies often have:
However, a company with employees, an office or identifiable assets might still be a shell company if it engages in no, or only nominal, business operations.
Depending on the context and the jurisdiction, shell companies might also be called shells, shell corporations, phantom firms, mailbox companies or letterbox companies.
Fraudsters can use shell companies to conceal their crimes. By forming a shell company, a fraudster creates a legal structure that lends legitimacy to illicit transactions and makes fraud harder to detect. Fraudsters commonly funnel profits through shell companies under the pretense of “consulting fees” or sham loans in order to launder money or evade taxes and obfuscate the trail of illicit funds.
Shell companies featured prominently in the Panama Papers, Paradise Papers and Luanda Leaks investigations conducted by the International Consortium of Investigative Journalists (ICIJ), which revealed some of the ways that wealthy individuals and organizations around the world move large quantities of money out of their home jurisdictions — a process sometimes referred to as “offshoring.”
Some countries, or jurisdictions within countries, do not require corporations, partnerships or other business structures to reveal the beneficial ownership of the organization when it is registered. (The term “beneficial owner” refers to the person or entity that actually controls or profits from the shell company. In other words, the beneficial owner is the true owner of the company.) These areas are known as “secrecy jurisdictions.” The lack of transparency in these jurisdictions makes it impossible to identify the ultimate recipient of money or assets paid to or purchased by the organization by simply looking at business registration information.
Individuals who want to create a shell company can file the required paperwork with the company register themselves, but most hire an intermediary instead. In the context of shell companies, an intermediary (also known as an agent) creates a corporation for someone else and acts as the point of contact (i.e., registered agent) for the jurisdiction’s company register. Intermediaries are often lawyers, consultants or companies that provide incorporation services.
This obfuscation helps fraudsters hide assets and funds from court judgments, tax authorities, business partners, spouses during divorces and anyone else attempting to determine an individual’s income, assets or net worth for any reason.
While some fraudsters might create a shell company for a specific scheme or transaction and then dissolve it or let its registration expire, more sophisticated fraud schemes might involve a complex network of various shell companies interacting with one another through purportedly legitimate transactions, services, loans or ownership structures. For example, fraudsters might use nominee directors, and in some instances, other shell companies, to disguise true owners of entities while giving the appearance of legitimacy. Some nominees simply sell their names to fraudsters who use them on company documents. Others actually provide limited services for the shell companies such as processing corporate records, signing for company documents and forwarding mail.
If fraud examiners suspect that an investigation or engagement they’re involved in might feature the use of shell companies to hide assets, there are several strategies they can use to evaluate the legitimacy of a company or identify noteworthy relationships between organizations and individuals relevant to the fraud examination. First, fraud examiners can perform basic, free internet searches using popular search engines to look for an organization’s website, any mention of the organization in news media, or any social media presence. A total lack of internet presence might not be definitive evidence that a purportedly legitimate organization is a shell company, but few legitimate organizations maintain no internet presence in most modern economies.
After performing basic internet searches, fraud examiners should locate the business filing information for the organization, generally held by national company registrars, or in the case of the U.S., individual states’ Secretaries of State. Business filings are public records in most jurisdictions, meaning anyone can access them; however, searching these records is not always free. Although these records will not indicate an individual’s true ownership of an organization, the listed agents, managers, or shareholders should be documented and investigated further. In addition to the government agencies that maintain this information, fraud examiners should check free open-source databases such as corporationwiki.com, opencorporates.com and the ICIJ’s searchable database.
As entities or individuals connected to a shell company are uncovered, fraud examiners should consider using network mapping or data visualization software to illustrate the connections and relationships between individuals and organizations relevant to an engagement or investigation, which might reveal valuable information.
Some aspects of a shell company investigation might require access to nonpublic documents, such as bank statements and other financial documents. Gaining access to these documents generally requires a court order. The process of obtaining a court order can be difficult, expensive and time-consuming, especially if the shell company is incorporated in a foreign jurisdiction. When necessary, however, fraud examiners can and should use the courts to obtain key information. A fraud examiner needs an experienced lawyer to successfully petition a court for nonpublic information. Ideally, the lawyer should be based in the court’s jurisdiction (e.g., a Bahamian lawyer to petition a Bahamian court) or, if not, the lawyer should have experience working with courts and government agencies in the relevant jurisdiction.