“In the modern business world, performing thorough due diligence is not just a best practice, it’s a regulatory necessity.”
— David S. Lee, Partner at Davis Polk & Wardwell LLP,
Working in a financial institution, I often come across people hiding behind the masks of shell companies and executing their evil plans, including fraudulent and criminal activities.
You will be surprised to know that, every year, criminals launder $800 billion to $2 trillion using shell companies. This huge number is equivalent to 2-5% of the global GDP. (Sanctions.io: Sanctions evasion through shell companies)
Sounds extremely concerning, right? To tackle this huge issue, various organizations, prone to the risks concerning these shell companies, have started using Enhanced Due Diligence (EDD). It helps us conduct a more thorough scrutiny of the company’s operations, going beyond basic due diligence.
Curious to know more about it? Let me walk you through some of the major components concerning EDD and how it helps financial institutions, like ours, to identify shell companies.
The Importance of Enhanced Due Diligence
As I hinted in the introduction, dealing with shell companies can be complicated and always involves a risk of fraud and scams. Now, as a solution to avoid these unfortunate events, we utilize enhanced due diligence to ensure that the companies we are going to deal with are legitimate businesses.
Let me give you an example to help you understand it better, imagine you go to the bank to deposit a huge amount of money, and ask them to open a new savings account in your name. They ask you for basic information like your name, address, etc.
But since you are carrying a huge sum of money, they decided to conduct enhanced due diligence to ensure that you are not involved in any kind of illegal activities and if it is okay to open an account for you or not. This will act as a precautionary step for the bank to safeguard themselves and adhere to the regulations at the same time.
Key Indicators of Shell Companies
Now that you know about the importance of EDD, your next question might be, how to identify if the company might be shell or involved in any illicit activities, well for that, I have listed down four key indicators that help us identify shell companies –
We check our customer business’s operational activities, such as active trade, production, tangible assets, and number of employees.
We pay extra attention if the company is involved in any unusual financial activities, like large financial transactions without a clear purpose or unexplained or excessive intercompany transfers.
If a company does not have proper tax filings and audits, then it raises a major red flag.
Many shell companies try to obscure the real company owners with complex ownership structures, this lack of transparency in the ownership and management is usually not a good sign.
DO YOU KNOW? There are various types of shell companies as listed below.
The Legal and Regulatory Framework Supporting EDD
After seeing various cases of shell companies involved in illicit activities, I can tell you that it can very effectively obscure identities and a huge percentage of shell company owners tend to misuse this feature.
It acts like a mask that conceals their real identity from the authorities and helps them get involved in illegal and criminal activities without the risk of getting caught.
That is why various legal and regulatory frameworks have been formed to support EDD and help mitigate financial risks for different institutions. Some of the fundamental elements of these laws are –
Financial Action Task Force (FATF) Recommendations – They work internationally and require financial institutions to carefully conduct customer due diligence or enhanced due diligence (when required).
United Nations (UN) Conventions – This organization also provides an international framework that criminalizes acts like money laundering, bribery, and corruption.
The Role of Technology in EDD
Till now, you must have understood how challenging it can be to identify a shell company, but is there anything that can help in EDD and simplify this process? Well, yes there is, like any other field, technology comes to the rescue, here as well.
The advancement of technology has now become a double-edged sword. In my profession, I regularly get to see cases where cybercriminals use the most advanced resources to execute their plans.
It is obvious that we cannot tackle their attacks with those old traditional methods. In this case, employing technology enables us to quickly uncover any hidden ownership structures, automate scrutiny of high-risk clients, detect suspicious transactions, and comply with rules and regulations.
If you are looking for a solution to support your EDD operations, then, I would suggest Cellbunq. It can help us connect large amounts of business data and effectively screen them for potential risks.
Challenges and Limitations
Identifying shell companies is not an easy task, we faced various challenges and limitations while trying to set up a robust EDD framework in our organization. Some of those challenges were –
Complex Ownership Structure – Identifying the real owners i the most difficult task for our teams dealing with such clients. Due to the lack of transparency, we are required to conduct complex cross-border searches and analyses of multiple jurisdictions.
Unreliable and Incomplete Data – These businesses often provide us with unreliable or incomplete data, even their public records are sometimes sketchy and outdated, which can be really difficult to deal with and increase our work tenfold.
False Documentations – Shell companies often come up to us with fraudulent documents that are altered with such precision that it becomes a struggle for us to cross-check and verify these documents.
FUN FACT Many shell companies don’t have any employees, assets, or even offices. They might exist only on paper—making them “invisible” at first glance. Without proper investigation, it can be hard to spot them!
Why EDD Is Crucial For Financial Security?
In the highly digital and interconnected world, the number of fraudsters and scammers is already on the rise. Shell companies provide them with an even better solution to engage in illegal activities such as money laundering and financial scams, masking their crimes, and offering them an additional layer of protection.
This is where EDD comes into play, it is like a precautional measure that helps financial organizations, banks, and other related entities to safeguard themselves from such criminals and comply with rules and regulations at the same time.
Since the traditional, basic methods are of little to no use in today’s world, Enhanced Due Diligence can effectively help reduce the risk of monetary crimes by thoroughly screening clients, transactions, and ownership structures, improving the overall financial security of institutions and organizations.
