The predicate crime of fraud is a growing global trend. Here, Directors from Moody’s discuss how shell companies can be used to facilitate financial crime
According to the FBI Internet Crime Complaint Center, in 2023 they received a record number of complaints from the American public: 880,418 complaints, with potential losses exceeding $12.5 billion. This is nearly a 10% increase in complaints, representing a 22% increase in losses, compared to 2022.
From 2018 to 2023, more than 666,000 unique, global fraud-related events were added to Moody’s Grid risk database from thousands of adverse media and regulatory sources. There were 10.7% more fraud-related events in 2023 than in 2022, and 28% more compared with 2018.
The proceeds of fraud need to be laundered, and one way to achieve this is to use one or multiple shell companies to obscure the origins of the funds and those behind operations.
Identifying risks associated with the misuse of shell companies
Fraud, as well as other predicate crimes like trafficking, sanctions evasion, and bribery, generates illicit funds that need to be laundered into the legitimate economy. Shell companies can be a favored money laundering tool of criminal actors. These entities used for nefarious purposes often look legitimate on paper while ultimately obscuring risky business conduct.
It is important to note, though, that shell companies are not illegal; in fact, they serve several useful purposes. For example, they can be used in mergers or acquisitions. However, their use by criminals, usually through a practice of “layering” shell companies to create a complex network of ownership across jurisdictions, can create complications for anti-money laundering (AML) analysts and investigators.
This is why governments worldwide continue to focus on addressing financial crime and illicit financial flows, including shell companies for money laundering, through regulation and tools such as beneficial ownership registries.
Shell companies used for illegal purposes can be discovered and reported, leveraging ownership registries and other datasets. However, a significant and detailed effort is often required when deliberate attempts are made to obfuscate the picture of ownership.
Data on shell companies may also become stale over time as illicit entities are dissolved or abandoned when discovered. Relevant counterparty analysis can be performed during transaction monitoring, but this essentially occurs after the financial crime has taken place and criminals are already accessing the financial system.
To help understand the scope and scale of risk associated with the misuse of shell companies, Moody’s conducted a study using our extensive global corporate data to uncover formation patterns and identifiers of risky corporate behaviors.
Seven indicators of shell company risk
Patterns of suspicious corporate behavior can be identified through datasets to illuminate opaque corporate structures and hidden connections. Risk and compliance teams, as well as financial intelligence units and law enforcement, can examine beneficial ownership and criminal networks through analysis of certain flags associated with these behaviors.
Moody’s examined typologies within seven indicators of risk:
- Circular ownership: Ownership structures can be obscured through complex, interconnected ownership loops. Criminals can exploit this to conceal their true level of ownership or control over an entity.
- Jurisdictional risk disparity: This occurs when the nationality or residency of an individual director or beneficial owner differs from the company’s registration, especially in high-risk jurisdictions.
- Financial anomalies: When operating revenues are significantly out of kilter with the number of employees registered to an entity, it can raise questions.
- Mass registration: Registration patterns indicate mass or bulk creation within a specific date window, and sometimes to one specific address, which may indicate risk.
- Directorships: Patterns of current and previous directorships, mass directorships, and associations with inactive companies may trigger investigation.
- Dormancy: Companies that have been dormant for more than five years within their history indicate risk.
- Outlier age of key individuals: Impossibly young or old company owners are a flag for analysts. Moody’s identified more than 2,000 entities as having a director aged 123+.
Moody’s used these seven indicators and applied them to its dataset to report on indications of shell company- related risk. As of November 2023; there are around 19 million entities that raised one of the seven flags, more than 900,000 companies raised two or more flags, with the most common double flag combination being outlier directorships and mass registrations.
Enhancing detection of shell company risk to address fraud
In the ever-evolving landscape of financial crime, the use of shell companies to launder money poses a significant risk to the global economy, which governments continue to try and address.
With the rise in fraud and increasingly sophisticated criminal networks, there is also a need for innovative ways to analyze and understand the corporate structures bad actors are leveraging.
Automating access to beneficial ownership registries for entity verification is an initial step investigators can take. Introducing the use of key indicators associated with patterns of risky corporate behavior is another.
Each element associated with an entity can help form a picture of risk, including the presence of a shell company, whether that’s ownership data, a pattern of behavior, or an anomaly or outlier. Analysts and investigators can then use this unified view to fuel their work and help curb the rising tide of global fraud.
This work is licensed under Creative Commons Attribution-NonCommercial-NoDerivatives 4.0 International.
