If you drive a few miles west of downtown Wilmington, Delaware to the tree-filled suburb of Woodland Park, you might find yourself passing the Little Falls Center. Behind the modern, if a bit dull, exterior of 2711 Centerville Road is Suite 400, the official address for Vial Company. Vial Company shares an address with and was registered by “The Company Corporation” which is another name for the Corporation Services Company, one of the largest corporate service providers in the country. Vial Company has no website, no real place of business, no apparent commercial activity, and public records make it impossible to know who owns it. Vial Company is an anonymous shell company.
Viktor Anatoljevitch Bout is currently serving a twenty-five-year sentence in U.S. federal prison. He is known as the “Merchant of Death” or the “Lord of War” depending on whom you ask. Bout is an arms dealer. In 2004, he was placed on a United Nations travel ban list for shipping weapons to convicted war criminal and former dictator of Liberia, Charles Taylor. Taylor was not the only dictator Bout served through his weapons trafficking empire. Throughout his career, Bout supplied arms to both sides of the civil war in Angola, transported and supplied arms to Rwandan soldiers who were fighting in the Eastern Congo, and leased cargo planes to Muammar Qaddafi.
How Bout ended up in United States custody is a fascinating and at times deeply troubling story. In 2004, pursuant to a United Nations Security Council resolution, Bout was placed under the U.S. sanctions regime on Liberia. But it was not until almost a year later that the Office of Foreign Assets Control (OFAC), the United States government agency in charge of sanctions enforcement, placed Bout’s companies under sanction. Among those thirty companies was one registered in Wilmington, Delaware called Vial Company.
When procurement experts in the U.S. Department of Defense searched the newly sanctioned entities in their databases, they found something highly disturbing. Bout’s companies had been delivering frozen food and tents to U.S. troops in Baghdad while they were engaged in fighting the war in Iraq. All told, the U.S. government paid Bout’s organization up to $60 million. U.S. taxpayers funded the “Merchant of Death,” all through the veil of secrecy provided by anonymous companies. According to Nicholas Schmidle, a New Yorker reporter who interviewed Bout in August 2014, that money helped Bout’s empire “get back on its feet” after years of targeting by U.S. and international authorities. Bout could not travel outside Russia without getting picked up by INTERPOL but he was free to profit off the Defense Department and government contractors.
Bout was finally arrested on March 6th, 2008 after a Drug Enforcement Agency (DEA) sting in Thailand recorded him offering to sell anti-aircraft missiles to DEA agents posing as members of the Colombian FARC guerilla group, planning to use them to kill U.S. troops. After a long extradition battle, in 2011 he was tried and convicted in federal court of conspiracy to kill U.S. nationals, conspiracy to kill federal officers, conspiracy to acquire anti-aircraft missiles, and conspiracy to provide material support to a foreign terrorist organization.
Bout’s arms trafficking empire was built on anonymous shell companies. These companies, run by his accountant Richard Chichakli, allowed Bout to launder his gains and spend them around the world. Bout registered his companies all over the world, from Côte d’Ivoire to the United Arab Emirates to Kazakhstan. He registered three companies in Gibraltar, a notorious United Kingdom tax haven. Yet of all the countries Bout used for his secretive empire, the one he seemed to like the most was the United States, a country with arguably the strongest anti-money laundering enforcement in the world—a country that had been hunting him for years. Bout used at least eleven U.S. companies located in Texas, Florida, and Delaware to launder millions of dollars from his arms trafficking empire‚including Vial Company.
It turns out, Bout is far from unique. According to a 2011 World Bank survey of “grand corruption” cases, the United States was the leading jurisdiction for the incorporation of shell companies used in “grand corruption” cases. Viktor Bout’s decision to use the United States for his arms-dealing empire was the same decision criminals and kleptocrats were making all over the world.
On the surface, this fact should seem strange. The United States generally has a reputation for the most aggressive anti-money laundering enforcement in the world. The U.S. has numerous law enforcement agencies tasked with combating money laundering, including the Financial Crimes Enforcement Network, the Office of Foreign Assets Control, the Federal Bureau of Investigation, the Internal Revenue Service’s investigations arm, the Secret Service, Homeland Security Investigations, Immigration and Customs Enforcement, among others. The Justice Department aggressively prosecutes money laundering. From October 2017 to September 2018, the federal government brought money laundering charges against almost 800 defendants. In its 2016 evaluation of the U.S., The Financial Action Task Force (FATF)—the international body tasked with monitoring compliance with global anti-money laundering standards—rated the U.S.’s financial intelligence and money laundering investigation and prosecution capacities “substantial,” its second-highest rating.
The U.S. also aggressively enforces its tax laws abroad. This effort is best exemplified by the U.S. crackdown on Swiss banking secrecy and the story of banker Bradley Birkenfeld as chronicled by journalist Oliver Bullough in his recent book Moneyland. Birkenfeld, an American working for the bank UBS in Switzerland, marketed his ability to use Swiss banking laws to help rich Americans avoid taxes. But in 2007, he flipped on his employer to U.S. prosecutors. The investigation eventually implicated multiple Swiss banks, including UBS and Credit Suisse. As a result of this scandal, Congress passed the Foreign Account Tax Compliance Act (FATCA). The goal was to prevent U.S. persons from dodging taxes by using foreign financial institutions. Since the legislation was enacted in 2010, the United States has reached agreements with 113 countries and jurisdictions to ensure they comply with the law. Soon after the U.S. passed FATCA, the rest of the rich world followed suit. The Organization for Economic Cooperation and Development (OECD) implemented the “Common Reporting Standard” (CRS) in 2013, a system for the automatic exchange of tax information between countries.
But, while the United States may have inspired the CRS, it did not sign on. While the United States insists that countries automatically share financial information about Americans with funds abroad, the U.S. is under no obligation to automatically share the same information about foreigners’ assets in the United States. Financial transparency is a one-way street. As Bullough puts it, “The United States has bullied the rest of the world into scrapping financial secrecy, but ha[sn’t] applied the same standards to itself.” The result of this gap in U.S. standards has been a kind of financial backflow in which anonymous money has seeped back into the United States from the countries it is policing abroad. Professionals in the field of international tax law are well aware of this force driving their business. Bruce Zagari, a Washington-based lawyer at international law firm Berliner, Corcoran & Rowe, told the Financial Times, “I think the US is already the world’s largest offshore center. It has done a real good job disabling competition from Swiss banks.” The problem driven by FATCA highlights a paradox in U.S. anti-money laundering enforcement: despite proactive prosecutors, able financial intelligence authorities, and a foreign policy apparatus dedicated to cracking down on transnational crime and global kleptocracy, the United States has been failing to secure its system at home.
Much of this problem has its roots in a key component of the U.S. governmental system: federalism. In the United States, there is no solely federal incorporation system. Each state sets its own standard for what it takes to make a corporation. The result is that in every state in the union, it requires more personal identity information to obtain a library card than to create a company. This fragmented system allows corporate service providers like the one that Viktor Bout used to sell anonymous companies to their clients, affording them the secrecy they need to launder money.
In fact, my research has revealed that these companies that create other companies often have remarkable control over how states decide the rules for how companies are formed. In two of the most notoriously secretive U.S. states, Delaware and Nevada, corporate service provider lobbyists wield a significant amount of influence over corporate law-making and incorporation regulation. Their lobbying seems to have made these two states the most secretive and friendly to money laundering in the nation. Competition between these two states for incorporation revenues locks them in a struggle for supremacy that results in more secrecy and more corrupt money flowing into the United States. If Delaware stops marketing secrecy, corporate service providers will move their business to Nevada or one of the many other states getting into the game.
The results of this political process are stark. According to research by an international team of experts on anonymous shell companies, Delaware and Nevada are two of the jurisdictions where it is the easiest to obtain the anonymous companies money launderers like best. Those states are in fact significantly less transparent than famous tax havens like the British Virgin Islands.
But if this is a state problem, it would be easy to assume the solution could also come from the states. Maybe those ‘laboratories of democracy’ can cook up the solution to the problem they created. Yet the fundamental forces at play in the secrecy game make state-driven change impossible. The competition between states like Delaware and Nevada sets up a classic commitment problem. If one state unilaterally reforms, it immediately begins to lose incorporation revenue to the state that did not reform. As Nevada Senator Tick Segerblom explained to the Las Vegas Review-Journal, “We are known as the Delaware of the West…We don’t want to make changes and shoot ourselves in the foot unless other states make the same changes.” Delaware legislators have similarly expressed opposition to unilateral reform. The Delaware Senate passed a resolution embracing federal reform noting that only a federal solution can “[maintain] Delaware’s corporate tax revenue stream and [protect] Delaware’s corporate brand.” Senior political leaders in both of these states have no interest in unilaterally disarming by forbidding anonymous shell companies. Given these incentives, a grand state compact on transparency without federal intervention seems unlikely. If there will be no state compact, the only solution remaining is a federal solution.
Even if consensus solutions like beneficial ownership transparency are enacted by the federal government, the river of dirty money will likely continue to flow into the U.S. The money laundering problem corporate service provider lobbying in part created will not be solved with simple transparency. Financial secrecy is like whack-a-mole; criminals will find new legal vehicles and new entities to hide ill-gotten funds.
But this ingenuity can also be a kleptocrat’s weakness if the U.S. takes the right policy step. Kleptocrats always need help with complexities of corporate structuring and financial accounting, often from the very corporate service providers and law firms that are lobbying state governments. This simple fact creates a potential weak link in grand corruption enterprises, one that governments can exploit. In order to fully tackle the anonymous shell company problem, we must regulate these professional enablers of crime and corruption.
Work has already been done on how to approach this problem. A Financial Action Task Force (FATF) and Egmont Group report outlined how “specialists and professional intermediaries” including lawyers, accountants, and corporate service providers were involved in the majority of the 106 case studies of beneficial ownership concealment for criminal means the report cataloged. Both the 2015 and 2018 National Money Laundering Risk Assessments from the Department of the Treasury warned of the money laundering risks from financial professionals. The Hudson Institute’s Kleptocracy Initiative has outlined how professionals like lawyers, corporate service providers, and financial service providers need stricter regulation to counter money laundering. Democracy expert Larry Diamond proposes regulating these enablers as one of his measures to save contemporary democracy from kleptocracy and corruption in his recent book Ill Winds. The European Union has long taken precautions against the involvement of professionals in money laundering. The EU’s first anti-money laundering directive issued in 1991 applied EU anti-money laundering standards to “those professions and undertakings whose activities are particularly likely to be used for money laundering purposes.” The U.S. has continually failed to impose the same standards on these professionals as it does on banking institutions, despite the fact they are often just as central to money laundering and terrorist financing schemes.
Many professionals, even in well-established firms with otherwise sterling reputations, feel very comfortable exploiting this loophole in the U.S. anti-money laundering system. An undercover sting conducted by anti-corruption campaign organization Global Witness alarmingly found that top New York law firms were very willing to help a fake kleptocrat launder his money using U.S. shell companies. As the leader of the campaign explained:
[W]e feel like our worst fears were confirmed, yet it was still striking to see how uniformly the lawyers documented in that investigation were all too willing to give advice on how to structure company ownership in a way that would evade or skirt anti-money laundering rules or monitoring.
In real grand corruption and criminal cases, these enablers often claim they were unaware of the criminal activities of their clients. But this is often not the case. These enablers work closely with these criminals. It is their job to understand the needs of their client and tailor their services to these needs. The idea that an accountant, someone who is trained to identify financial malfeasance; a lawyer, who is an expert in what is legal and illegal; and a corporate service provider who is an expert by practice in the normal behaviors of businesses, cannot identify the warning signs of criminality is a proposition that is absurd on its face.
If the ignorance defense fails, these professionals claim that any attempt to probe into criminal behavior would breach their client’s privacy. This defense is most often employed by lawyers who jealously guard against any attempt to weaken attorney-client privilege rights. This is certainly a legitimate concern in the abstract. But if this right is granted in this particular case, all society gains is a right for wealthy people to structure their assets in full secrecy from the government. Furthermore, this particular privacy right would give professionals carte blanche to suborn criminal behavior. Granting this right results in gains for the very few who can afford to structure their wealth and losses for the many who lose out from the bad actors who use this right to steal, defraud, and corrupt our governments.
The solution is simple, in theory: these professionals should be required to submit suspicious activity reports (SARs) when they come across behavior that displays warning signs for money laundering. This is the same requirement applied to banks by the USA PATRIOT Act in 2001. Under such a regulation, if a professional received a suspicious solicitation for the incorporation of a shell company like the ones the authors of Global Shell Games sent for their study, the corporate service provider or attorney would be required to file a SAR with law enforcement who could investigate further. Regulators should also impose stiff penalties on professionals who fail to conduct adequate due diligence, allowing their services to be used to launder money.
Indeed, some states have already enacted a version of this solution to some effect. But the moment cries out for more states to follow suit. If the regulatory incentives remain as they are today, those who create U.S. shell companies will continue to carve out legal havens from favorable state governments. Comprehensive regulation of these intermediaries of corruption is the only thing that can break the cycle of influence that pushes states like Delaware and Nevada to foster anonymity.
In 1934, Justice Louis Brandeis wrote, “It is one of the happy incidents of the federal system that a single courageous state may, if its citizens choose, serve as a laboratory; and try novel social and economic experiments without risk to the rest of the country” (52 S.Ct. 371, 76 L.Ed. 747 (1932) at 57). In modern application of this quote, it often seems that the “laboratory” element is emphasized to the detriment of its prerequisite: the collective choice of democratic citizens. The unifying theme of the development of secrecy in all jurisdictions is that it is led by a small clique of professionals who hope to profit off the result. In neither Delaware nor Nevada did a large mass of their populations, much less a majority, rise up and demand that the legislature make their home state a corporate secrecy haven. Corporate secrecy in its first iteration has always been about the profits of a few, not rights and benefits for the many.
The cost of these laboratory laws has been great. By innovating on corporate secrecy, states like Delaware and Nevada have not just risked the rest of the country, they have risked the entire world. They have tunneled a gaping hole in the domestic laws of any country concerned with preventing corruption, fraud, tax evasion, drug trafficking, terrorism, and all the other ills facilitated by anonymous shell companies. But even though the American people did not choose secrecy—unwittingly delegating their democratic power to state bar associations and corporate service provider lobbyists—only the choice of the American people can end secrecy.