The Panama Papers have exposed the largest financial crime scandal of our lifetimes. But what has been uncovered by the Panama Papers is much more dangerous than simply greed and corruption.
For those of you who have been hiding under a rock, the Panama Papers are over 11 million documents leaked from Mossack Fonseca, one of the largest law firms in the world specializing in offshore accounts and incorporation of shell companies. According to these papers, some of which I reviewed personally as a legal collaborator with Fusion Media, over 200,000 international shell companies were formed for over 14,000 clients. Among these were over 140 politicians and their families and over a dozen political leaders and celebrities, including soccer star Lionel Messi.
The common link among these individuals is that they used shell companies and offshore accounts to shield their wealth from their home governments.
The media, politicians and the public are trying to make sense of what the Panama Papers means for (a lack of) regulation. There is grave concern about fairness, international tax schemes and shell companies. A particular focus of the current investigation is the widespread use (and abuse) of anonymous shell companies.
Shell companies are "hollow," meaning that they have no significant assets and may only be identifiable by a name and mailing address. Shell companies can be set up to hide assets from prying eyes. While they have a number of legitimate uses – such as mergers, holding assets during complex transactions and protecting trade secrets – anonymous shell companies are often used for tax evasion, fraud, money laundering and even to fund terrorism.
Oddly missing from the Panama Papers are American individuals. Why is it that high net worth individuals from around the world went to Panama to hide their money and none of them are Americans?
One reason is that the United States has a lower tax burden than Europe for the high net worth individual.
But the biggest reason is that an American has no need to form a shell company in Panama because they can obtain one right here in the United States. And as my research shows, it's incredibly easy to do. Unfortunately, that's something terrorist organizations can take advantage of as well.
How to make a shell company for your cat
The fact is that shell companies are as easy to form in the United States as they are in Panama.
Panama has very few regulations on the formation of shell companies. But neither does the United States. Nearly 2 million corporations and limited liability companies are formed every year in the United States, and most jurisdictions do not require any identity documentation whatsoever.
In fact, Fusion – one of the media companies that had access to Fonseca documents – demonstrated on video that one of its collaborators was able to form a Delaware shell company for her cat. This took only a few minutes, $249 (via credit card) and required no identification documents at all.
Similarly lax regulations exist in Montana, Nevada and Wyoming. These states compete for clients, so there has been a race to the bottom in states wanting to require even less than the others in order to form a shell corporation.
With the ease of incorporation, some may choose to form companies for their pets. Others may decide to create companies to hide assets in for tax evasion or money-laundering purposes. However, even more alarming is that terrorists can easily disguise their true identities from law enforcement through shell companies.
A potential terrorist cannot take a flight to neighboring states without a passport or driver's license, but he can form a shell company without any information in a matter of minutes.
In a high-profile instance of this, for many years Russian arms dealer Viktor Bout used shell corporations to anonymously supply terrorist groups around the globe with major weaponry like tanks and shoulder-file missiles.
Terrorism and offshore financing
The life-blood of an effective terrorist network is financing. And shell companies facilitate the easy distribution of money.
ISIS makes $1 million to $2 million a day in oil production, has obtained over $100 million in ransoms from kidnapping and collects "taxes" from the 6 million people it has gained control over.
And al-Qaida's worldwide operations require $30 million to $50 million per year. The Sept. 11 attacks, for example, cost approximately $500,000.
But not every terrorist attack requires large sums of money. The London transit bombings cost a mere $15,000 and the Paris bombings cost about $10,000 or less. Funding a terrorism enterprise is easily done under the cover of shell companies.
If we want to fight terrorism effectively, we should also be cracking down on terrorism financing. Given the ease and persistence of terrorist financing – particularly using shell companies – a shift in attention on financial regulations that would stop terrorism financing would be a good start.
International regulations do exist to limit the formation of shell companies without a passport or drivers license. The United States and over 180 countries have actually enacted a series of identity reporting requirements. Organizations such as the Financial Action Task Force, the World Bank, the UN and the EU have also taken steps to "blacklist" countries that do not comply. The United States has implemented a host of measures, including the use of "terrorist designations" and Suspicious Activity Reports, to root out and eliminate risks in our financial institutions.
However, none of these regulations have been enacted by Congress, and so they are not binding to U.S. states.
And no one has studied how effective these international standards are on limiting financial crime. Until recently.
A shell game
My co-authors, Mike Findley, Dan Nielson, Jason Sharman, and I conducted a study in University of Pennsylvania Law Review to answer two central questions: First, how easy is it to form an anonymous shell company and, second, how effective are international and domestic regulations at curbing their illegitimate uses.
In the course of our study, we sent emails to thousands of firms around the world and asked for their assistance in forming an anonymous shell company. In some, we posed as low-risk businesses looking for guidance, in others, we posed as terrorists or offered premiums for secrecy. The results were startling.
Most surprising was the fact that some firms were more likely to offer their assistance when we posed as terrorists than when we posed as businesses from wealthy, industrialized nations such as the United States.
Countries like the British Virgin Islands, Cayman Islands and Isle of Man – though widely considered "tax havens" – were among the most compliant countries in the world. That is, they followed international rules and made it difficult to set up shell companies without following proper procedures.
The United States, however, ranked near the bottom. As did – unsurprisingly – Panama. It was easier to form a shell company in the United States than in any other country besides Kenya. Some of the worst offending states were also Delaware, Wyoming and Nevada, though compliance varied greatly as a number of states like Rhode Island and Utah had near-perfect compliance.
Getting serious about terrorist financing
These results demonstrate that we are far from safe from the dangers of tax evasion, money laundering and even terrorist financing. And, in particular, the United States is a key international player in competing to form shell companies for the shadiest of actors.
Indeed, I would argue we have fallen well short of the mark on one of the most important goals in the war on terror: eliminating the network of terrorist financing.
It is clear that current regulations are not particularly effective, as firms are more willing than ever to aid in forming anonymous shell companies.
In order to be effective, countries must get serious about requiring identity documentation when businesses or individuals wish to form shell companies. Sen. Carl Levin, for example, has for a number of years worked to pass the Incorporation Transparency and Law Enforcement Assistance Act, but to no avail.
More effective regulations are only a beginning. To be the most successful, the government will have to work with the financial sector to root out these lines of terrorist financing by enacting implementing regulations within the United States that require identifying documents when forming a shell company. Many European countries and even the tax havens have enacted these laws, and it is time for the United States to do the same.
As noted above, there are many legitimate business purposes for forming shell companies, so they should not be eliminated altogether. But we must become better at identifying clients, accounts and transactions that pose the greatest risk of international crime.
If the Panama Papers serve any purpose, it should be as a lesson to the world that there are worse things that can happen with shell companies than hiding money.