Demystifying ubo compliance transparency vs compliance

Overview

In the growing – and ever more intricate - world of global finance, money laundering remains one of the most pervasive and challenging issues. A crime in itself – and an enabler of the most serious organised crimes in the world – money laundering is where illicit funds are channelled through layers of seemingly banal transactions and entities in order to hide the original ownership and source of profits to make them appear legitimate.

And at the heart of most money laundering activities are shell companies.

In this whitepaper we will look at the ways in which shell companies are exploited by financial criminals, and how being able to identify the ultimate beneficial owner (UBO) of a shell company is the key to preventing some of the most common money laundering and fraud techniques.

What are shell companies?

Shell companies are corporate entities with no active business operations or any significant assets. Shell companies have no office, no employees and do not produce any tangible products or services. They are not illegal; in fact, they are used perfectly legitimately for a wide range of different purposes, for example, facilitating others and acquisitions, holding asserts and managing risks.

The key characteristics of shell companies are that they are simple, anonymous and flexible; their structure allows the UBO to remain anonymous in records, effectively freeing themselves from being audited.

What are legitimate uses for shell companies?

The main reasons why someone might set up a shell company are:

• To raise capital for their business - They can be used to hold funds prior to setting up a new limited or any other type of company, for example, if they are closing an existing company, and want to redistribute its assets.

• To invest in foreign markets – someone could register the company in the country they want to invest or trade in, allowing them to do so without being a citizen of that country.
• To conduct a hostile takeover or merger – shell companies enable anonymity so can be used to takeover a company anonymously, without the CEO or board of directors knowing.
• To conceal their identity – if someone wanted to invest in a lucrative market in a dangerous country, they might want to do so anonymously to avoid risk.
• To protect business assets – a shell company set up in a different country can protect assets from any risks in the UBO’s home country
  
  
  

Why are shell companies used by money launderers?

Like most useful tools, when placed in the wrong hands, shell companies can be manipulated for illicit gain. As outlined above, shell companies are highly flexible, very simple, and – most importantly – anonymous. It is the very characteristics that make them useful that also make them attractive to money launderers.

Money laundering has three distinct stages: placement, layering and integration.

• Placement: The illegally gained cash is placed into the banking system.

• Layering: The cash is channelled through a complex series of transactions and entities to hide where it came from.
• Integration: it is now a legitimate part of the global economy as it can no longer be easily attributed to illegal activity.
  
  

It is the layering stage of money laundering to which shell companies are integral. Layering can involve dozens, even hundreds of shell companies to make the journey of the illegal cash so complicated and convoluted that it can’t be traced back to where it came from.

How can firms tell if shell companies are cleaning dirty cash?

The key to Know Your Business (KYB) checks within a firm’s anti-money laundering and compliance procedures is transparency.

Given that shell companies are at the heart of a huge number of money laundering operations, it is imperative that regulated firms have robust due diligence processes in place so they can find out everything they can about a shell company before entering into a business relationship with them. And one of the most important – if not the most important – pieces of information a firm needs to discover is who the ultimate beneficial owner (UBO) of that shell company is.

What is a UBO?

A UBO - Ultimate Beneficial Owner - is the individual who ultimately benefits from a company or asset or has ultimate effective control over it. This is even if they’re not formally named as the business owner – which is almost always the case with a shell company.

The definition of a UBO, or the UBO meaning, varies by jurisdiction but is generally defined as someone who owns 10% or more of a company’s shares and 10% or more of the company’s voting rights.

The EU’s 4thMoney Laundering Directive (4MLD) also addressed the definition of UBO, stating that anyone who has over 25% of the shares or voting rights in a legal entity must clearly be considered a UBO.

The 4MLD also mandated that all senior managing officials could be treated as UBOs, if it couldn’t be confirmed that they met any of the other criteria.

The UBO is not the same as the legal owner – this is the ‘official’ owner of a business, asset, or property on paper while the UBO is the person who is entitled to any benefits the business brings.

Often the UBO and the legal owner are the same, but when it comes to money laundering, the business will often be registered under a different legal owner from the ultimate beneficial owner(s) to obscure the UBO’s links with the activity or to avoid paying tax – which are obviously both illegal.

Identifying a UBO – transparency vs compliance

To fully understand the customer – and the risk they pose to your business - you need to know who the UBO is, which means finding the person sitting at the top of the corporate tree when the most likely do not want to be found.

Identifying the UBO is not just vital for compliance – and the protection of the business - but after ever increasing UBO-centred regulation, is a legal requirement.

Back in 2006 FATF (Financial Action Task Force) added UBO as a key AML measure. In 2013, it issued revised recommendation that emphasised UBO transparency, and these were intensified further in 2016 and 2021.

The US Treasury’s Financial Crimes Enforcement Network (FinCEN) then added a final rule to their Corporate Transparency Act which made UBO a reporting requirement as of January 1 2024.

In the UK, any business that does not assess the UBOs of those it has dealings runs the risk of non-compliance with AML regulations and customer due diligence standards, which could lead to huge financial penalties and up to 14 years in prison.

The 4th and 5th Anti-Money Laundering Directives require Member States to establish a central UBO registry for corporate and other legal entities incorporated within their territory. In theory, this should simplify the UBO compliance process – and in the UK, there is unrestricted access to this register.

1. It is easy to detect

The key to money laundering is anonymity; fraudsters are using fake and stolen IDs to set up legitimate accounts by which they funnel their illegitimate gains, or they are hiding behind layers and layers of seemingly banal transactions and entities to avoid raising any suspicions. Any businesses relying on gut instincts or experience to spot anything ‘dodgy’ are putting themselves and their businesses are huge risk.

2. Money laundering is not my responsibility

‘Money laundering is one of those crimes that happens to someone else’ is a common belief, but of course, it is not true. It can happen anywhere, and in fact, money launderers like to focus on areas where they know there will be less oversight, and where they can operate with relative anonymity. They will also target any processes where there are lots of different businesses and checks – being done by different people – as there are more likely to be gaps and mistakes made.

3. AML is just a box-ticking exercise

One of the biggest misconceptions about AML is that it is simply a ‘box ticking’ exercise. That you need to go through the motions, appear to be doing what you need, and the regulator will leave you alone. But it is this attitude that money launderers love – they want the checks to be halfhearted, to be a glance at a passport and then move on. That’s why regulated firms need to ensure they go beyond box-ticking and take every opportunity they have to protect their businesses – and their legitimate customers – from financial crime.

4. Physical document checks are more reliable than automatic checks

It is understandable that for many, documents hold a psychological advantage because they are physical – you can see them, hold them in your hand. However, in the technologically advanced age that we live in, with advances in image software, AI and other technology, it is possible to forge bank statements, passports, driving licenses and payslips so it is virtually undetectable, even to the trained eye.

However, following a Court of Justice of the European Union (CJEU) ruling that such a register ‘violates fundamental EU privacy and personal data protection rights’ this is no longer the case in EU states. There is a similar issue in the US whereby a proposed FinCEN rule seeks to prevent banks from distributing registry information anywhere, internally or to affiliates and foreign divisions.

Striking the right balance between transparency and privacy has delayed the implementation of the registers, and is likely to remain a persistent challenge, the consequence of which is that finding UBO details is incredibly difficult, especially when the organisation and individual is actively hiding their true identity.

How do you find a UBO?

Due to the clear challenges at play when it comes to access to UBO information – with arguments that transparency around UBOs for compliance is a violation of personal data while at the same time, regulators are advocating the need for more stringent UBO checks to prevent money laundering -identifying the UBO of an entity remains incredibly difficult for regulated firms.

A UBO check is part of a wider three-step KYB check which includes verifying the existence of the business and identifying those with significant control:

• Verify the business

The first step of a KYB check – and therefore, a UBO check - is to ensure that the business exists, and that its financial activities are legal and legitimate and will involve gathering basic information about the business, including its name and address and basic contact information, proof of incorporation or registration as well as annual returns and statements, and Profit and Loss (P&L) information.

• Find the people behind the business

The next step is to find the individuals involved in the business, including details about the ownership structure and any UBO, which, as explained through this Whitepaper, is a critical step both in terms of determining the ownership structure of the business, and the source of its funds.

• Verify the people behind the businessStep 2 should have identified each of the key stakeholders in the business, including the UBO(s). The final part of the KYB/UBO check is to verify the individuals identified, screen them for sanctions and PEPs and run enhanced due diligence on any matches.
  

By running checks on both the business and the UBOs, the regulated firm can get a full picture of the company and everyone who stands to gain from it. With this information, the firm can then make an informed decision about whether or not to enter into a business relationship with that company.

How SmartSearch can help with UBO checks

UBO identification is easy with SmartSearch thanks to the platform’s market leading KYB solution.

SmartSearch’s cloud-based compliance platform can run full KYB checks in a matter of minutes. SmartSearch is fully integrated with Experian’s industryleading ultimate beneficial owner database, meaning clients can use the platform to identify potential UBOs. The SmartSearch UBO check can find:

• Individual UBOs – this identifies any individuals within the corporate structure with more than 10% of the total shares or voting rights.
• Director UBOs – this identifies if any of the individual UBOs are also directors.
• Additional entities – this identified any other companies in the structure which have a share in the business.
  
  

Once the individual UBOs, director UBOs and additional entities have been successfully identified, the SmartSearch platform can run a full AML check on that individual or entity – including sanctions and PEP screening and full customer due diligence – to ensure you know everything you need to know before you go into business with them.