Discreet Delaware: Why Corporate Secrecy and Money Laundering Have Thrived in the US

Until 2017, the number of business entities in the state of Delaware exceeded its population – over one million businesses were registered in the state where the total population was 950,000. From Fortune 500 companies to Limited Liability Companies (LLCs) that turn up little to no results on Google, Delaware was – and remains to this day – the preferred domicile for American and foreign companies. Indeed, Delaware seems to possess a remarkable talent for drawing in anyone interested in setting up a company, and enriching itself from their presence – the state makes over $1 Billion in annual revenue from registering companies for as little as $90 (2016), directly, and, indirectly, keeps lawyers and accountants perennially busy and employed.

Indeed, Delaware is to business entities what London real estate is to oligarchs – a most coveted address. Of course, there are compelling reasons why:

• There is the favorable tax structure; there’s no sales tax in Delaware; neither does it levy a state-level inheritance tax, nor does it impose a personal property tax.
• There is also the favorable legal environment: Most corporate and business disputes are resolved in Delaware’s Chancery Court, which is rooted in the traditions of equity law and adjudicates on cases without the presence of juries.

But there’s more to it than meets the eye.

The Delaware Brand of Discretion

Recently, Delaware was in the headlines after the Justice Department accused Paul Manafort, former campaign manager of US President Donald Trump, of dodging taxes on payments for his political consultation work in Ukraine; the aforementioned payments were concealed from US authorities by being routed through nine LLCs that he had set up in Delaware, as per the indictment. The monies, which numbered in millions of dollars, were used by Manafort to allegedly finance a “lavish lifestyle” which included prime real estate acquisitions.

The Manafort controversy beckoned questions about how Manafort was able to reportedly circumvent tax authorities, and threw harsh light on Delaware’s long history of enabling money laundering.

In the popular imagination, it was places such as the Cayman Islands where kleptocrats, tax evaders, money launderers, corrupt politicians, and bad actors would squirrel away their capital. As it happens, it’s US states such as Delaware, Wyoming, Nevada and Oregon that have bested the plush and exotic offshore havens, traditionally associated with money laundering, as the preferred place to set up shell companies.

Why does Delaware exert such a gravitational pull on shell companies?

It so happens that it’s easier to set up a company in Delaware than get a library card. This has everything to do with Delaware’s beneficial ownership requirements (more specifically, the lack thereof). Delaware, like many other US states, has no beneficial ownership requirements at the state level. Indeed, registering a company there does not require the disclosure of the identities of the beneficial owners of the company. Instead of disclosing their own identities, owners can – for as little as $50 – hire a registered agent to represent the company on their behalf. It’s the reason why LLCs registered in Delaware routinely crop up in investigations on some of the most high profile investigations: From former drug kingpin el Chapo, to Vikor Bout, reputedly, the world’s largest arms trafficker, to Michael Cohen, Trump’s former lawyer, who allegedly made hush payments via a Delaware-listed company in the runup to the 2016 presidential campaign.

The aforementioned cases are outliers in that law enforcement was able to successfully nab the criminals; however, the majority of investigations needs to be abandoned because the money trail turns cold after landing up in Delaware and other states where beneficial ownership information is not a requirement. According to Cyrus Vance Jr., District Attorney for New York County, NY.

On a near-daily basis we encounter a company or network of companies involved in suspicious activity, but we are unable to glean who is actually controlling and benefiting from those entities, and from their illicit activity. In other words, we can’t identify the criminal.

It is hard to ignore the irony here; since the early 2000s, the US has been calling on other governments to lift the proverbial veil on corporate secrecy. But so far, its own track record has been catastrophic: Last year, it was second only to Switzerland, in a list of the largest tax havens in the world.

In comparison, other nations have done better; in 2016, the UK became the first EU country to announce the creation of a public beneficial ownership register. Since then, it has also prevailed upon its overseas territories, some of which are known tax havens, to comply with the new requirements, despite considerable opposition. A crucial piece of detail here is that these registers are truly public – access to beneficial ownership is open to anyone, without requiring a subpoena.

Can the FinCEN Final Rule lift the veil on US corporate secrecy?

Since May 2018, it is incumbent on regulated entities in the United States, such as financial institutions, to “identify and verify the identity of the beneficial owners of all legal entity customers[*](other than those that are excluded) at the time a new account is opened (other than accounts that are exempted)”, as per the Financial Crimes Enforcement Network (FinCEN) Final Rule.

*By “legal entity customers”, FinCEN is referring to a corporation, an LLC or any entity registered with a state.

In many ways, the FinCen Final Rule was a watershed moment – a significant change which required that a company disclose the identity of its owners, besides necessitating the verification of the professed identity of beneficial owners. The rule makes is significantly more difficult for individuals to take advantage of the US financial system by hiding under the anonymous cover of shell companies.

It’s important to note here that the onus on collecting beneficial ownership information and subsequently verifying it is on the obligated entity. If the obligated entity fails to obtain and verify this information, along with fulfilling other customer due diligence (CDD) requirements as part of the Customer Identification Program (CIP), it would run the risk of non-compliance, which could precipitate undesirable outcomes such as regulatory fines, reputational damage etc. The implementation of the FinCEN Final Rule did have its detractors; notably, lawyers, compliance professionals, law makers and, indeed, bankers have argued for its dissolution, citing the additional burden that would have to be sustained by banks and other entities covered by the rule.

Disclose beneficial owners at the time of incorporation? Not quite

There are also those who believe that the FinCEN Rule isn’t enough to fight the misuse of shell companies; some lawmakers do recognize its importance, but see it only as “a remedial step”. Observers believe that beneficial owners of a company should be disclosed to a state or federal business register right at the point when the company is incorporated. Indeed, many lawmakers have, over the years, campaigned for the creation of public business registers, in the vein of the beneficial ownership registers in the UK and Europe.

The idea first gathered steam over a decade ago; under Senator Carl Levin, a long advocate of anti-corporate secrecy, the Incorporation Transparency and Law Enforcement Assistance Act was introduced. The bill, which mandated the compulsory disclosure of beneficial owners to the business register in the state of incorporation, was inert for many years, on account of considerable opposition, particularly from the Delaware congressional committee and National Association of Secretaries of State (NASS).

Parties opposed to the collection of beneficial ownership information have long stated that it was the responsibility of the IRS (Internal Revenue Service); NASS, for instance, has in the past, stated that the IRS already collects beneficial ownership information on Form SS-4, which asks for a responsible party to be identified. Those on the other side of the issue, however, have stated that the form does not actually identify beneficial owners because shell companies could simply list the CFO or the CEO of the company as the responsible party, without necessarily identifying the owners of the company, notwithstanding the fact that not all companies file with the IRS.

More recently, Congress proposed the creation of a national directory of beneficial owners of legal entities in early 2018, as part of the Counter Terrorism and Illicit Finance Act (CTIFA). According to the National Law Review, the creation of the national directory would have represented the most significant overhaul to the Bank Secrecy Act (BSA), since the PATRIOT Act of 2001.

The beneficial ownership rules outlined in the CTIFA did have strong support; in fact, even Delaware gave its critical backing to the Act. In mid-2018, the CTIFA was amended and its beneficial ownership rules were excised from the act. The elimination of arguably the most passage in the act did not go unnoticed. Whilst supporters of the excision cited FinCen Final Rule as an effective solution to the opacity of beneficial ownership information, critics, which included both lawmakers and law enforcement, spoke out, arguing that the CTIFA was effectively useless without its most key ingredient.

According to Steven D’Antuono, section chief of the FBI’s Financial Crimes Section, while FinCEN’s Final Rule did have its merits, the “the [current] lack of an obligation to collect beneficial ownership information at the time of company formation is a significant gap.”