States battle Levin effort to unmask beneficial owners, as US agencies make historic funding offer

United States law enforcement agencies and prosecutors believe so strongly in a law that would help uncover the true beneficial owners of corporations formed in the various states that they have taken the unprecedented step of offering to fund state expenses with federal forfeiture funds.

To facilitate passage of the legislation, the Treasury and Justice Departments have offered $30 million in forfeiture funds over three years to defray the expenses the states say would result from the legislation.

“The Treasury Department and DOJ believe in this legislation so strongly that they have offered forfeiture funds,” says Clark Gascoigne, communications director of the anti-corruption advocacy group Global Financial Integrity, in Washington, DC.

“As far as we know, this is the first time they’ve ever done this,” he adds.

The legislation that is the focus of these unparalleled steps is a bill that US Senator Carl Levin, of Michigan, is once again proposing, which has previously met its demise because of strong opposition by the secretaries of state of the various states and powerful business groups, such as the US Chamber of Commerce. Called the Incorporation Transparency and Law Enforcement Assistance Act, it would require states to gather information on a corporation’s beneficial owners during the company formation process.

Levin is no stranger to financial crime legislation. If financial criminals were asked to name the person who has done more to disrupt their operations and caused the greatest scrutiny of financial institution, governmental and corporate efforts to combat them, the senator would undoubtedly be near the top of the list.

As chairman of the US Senate Permanent Subcommittee on Investigations, he has arguably written more bills that became law, uncovered more corruption and incompetence, awakened more regulators, and stimulated more government action against financial crime than anyone in the past 40 years.

Now, for the third time in four years, the persistent Levin is proposing the Incorporation Transparency Act.

Secretaries of state administer lucrative corporate formation process

The focus of Levin’s bill is on the states. Usually, each state has a Secretary of State who administers the process of forming corporations and other legal entities in the state. It is a duty that is not without its financial rewards for state treasuries. Hundreds of millions of dollars are paid annually by persons and organizations that establish corporations and other organizations. The Secretaries of State do not wish to jeopardize or lose that revenue.

Since Sen. Levin first introduced the Incorporation Transparency Act in 2008, one of whose cosponsors was then-Senator Barack Obama, of Illinois, some of the earliest and staunchest opponents have been the states. Secretaries of state paint the proposed legislation as expensive. They say the bill is an unnecessary federal meddling that would overly complicate business formation without producing useful information for enforcement or regulatory purposes.

Federal and state law enforcement agencies and associations are strong backers of the bill. The Department of Homeland Security, Justice Department,  say the law will help law enforcement unmask the real beneficiaries behind fronts and shell companies and more effectively trace money and paper trails during investigations.

The Levin bill was introduced in 2009 and 2011 only to languish in committee in the face of intense resistance by the National Association of Secretaries of State (NASS) and business groups, such as the US Chamber of Commerce.

Secretaries of state, business groups have been constant opponents

Last month, the NASS issued a report reaffirming the opposition to a federal law requiring the collection of beneficial owner information at the point of incorporation. The report has received little notice. The NASS provides details on its ongoing struggle with federal agencies over efforts to unmask beneficial owners of US business entities and their financial accounts.

Now, as Levin prepares to mark up the Incorporation Act in the Senate on November 15, the standard opponents are lining up again to oppose the bill.

Lax state rules make it easy to hide beneficial owners

States play a central role in controlling access to corporate beneficial ownership information because they manage the corporate formation process. There are no federal laws regulating incorporation. Information-gathering requirements vary widely from state to state. About two million companies are formed annually in the US.

No state requires persons forming corporations to name beneficial owners at the time of formation. Several states, such as Delaware, Nevada and Wyoming, allow incorporation that provides almost complete anonymity.

This makes US corporations an attractive vehicle for diverse financial criminals. In a recent example, Ponzi schemer Scott Rothstein, of South Florida, used 85 corporations formed in various states to disguise his connection to funds he stole as part of a sophisticated $1.2 billion fraud and money laundering scheme. He also used the corporations to hide his ownership of properties.

Enforcement and regulatory agencies often express frustration at the dearth of corporate beneficial owner information. In 2008, Michael Chertoff, the-then Secretary of the Department of Homeland Security, pointed to “countless investigations, where the criminal targets utilize shell corporations, the lack of law enforcement’s ability to gain access to true beneficial ownership information slows, confuses or impedes the efforts by investigators to follow criminal proceeds.”

States say financial criminals will easily dodge reporting requirements

The NASS acknowledges the potential for abuse in anonymous corporations, but doubts that requiring states to collect beneficial owner information will deter financial criminals.

“Our members are very skeptical that money launderers, tax evaders, and criminal gangs will provide accurate information to states when forming companies,” says Kay Stimpson, the NASS communications director in Washington, DC, said. She adds that imposing new information-gathering obligations on states will harm legitimate businesses while financial criminals continue to evade detection.

The September report, by the NASS Company Formation Task Force, urges “federal leaders to focus on tracking corporate entity ownership information through federal tax filings and customer due diligence efforts by financial institutions.”

NASS says a tax form captures beneficial owners, but critics disagree

The NASS says IRS Form SS-4 is an effective replacement for Levin’s bill. The form, called the Application for Employer Identification Number, must be filed by most US businesses. It was revised in 2010 to capture much of the information that Levin’s bill would require to be captured.

IRS Form SS-4 requires corporations to name a “responsible party,” described as “the person who has a level of control over… the funds or assets in the entity that… enables the individual… to control, manage, or direct the entity.”

This “responsible party” is not necessarily intended to be the beneficial owner, says Clark Gascogne, communications director at the anti-corruption advocacy group, Global Financial Integrity, in Washington, DC.

“The IRS SS-4 form requires companies to list the person who handles payroll. That’s not the beneficial owner,” he says, noting that he was told at a recent meeting with Treasury Department and IRS officials that Form SS-4 was not intended to capture corporate beneficial owner information.

Law enforcement faces obstacles in accessing IRS form

The NASS argues that corporate beneficial owner information that is included in the IRS SS-4 form or the Bank Secrecy Act Report of Foreign Bank and Financial Accounts, or FBAR, which is filed with the US Treasury Department if a foreign bank account is involved. The FBAR must be submitted by US persons that hold more than $10,000 in a non-US account at any point in a calendar year.

Most IRS tax forms are kept strictly confidential by the IRS and cannot be shared with law enforcement without special permission. The IRS Form SS-4 can be accessed by federal enforcement agencies in limited circumstances. The FBAR, which is not an IRS form, is more readily accessible by other agencies.

The IRS SS-4 form’s instructions state the IRS can “disclose [the form’s] information to… federal and state agencies to enforce federal nontax criminal laws, and to federal law enforcement and intelligence agencies to combat terrorism.”

Bill provides standardized approach to beneficial owner information

Under Levin’s bill, states would be required to provide law enforcement agencies with corporate beneficial owner information in response to a subpoena or summons.

The law would also require all states to collect standardized beneficial ownership information at the point of incorporation, including name, address and driver’s license or passport numbers for all of a corporation’s beneficial owners.

States worry that federal funds will not materialize

NASS frets that the states have no guarantee promised federal funds will materialize. Even if they do, it says, the changes imposed by the law are drastic and difficult to implement.

“We believe that [Levin and his allies] are oversimplifying the changes in store for the states,” says Stimpson. “They say it would just be a matter of adding one line on a form, but there’s 10 different new filings we’ve identified that would now be required from businesses based on this law. We’re very concerned about what this means for business formation in the US.”

Incorporation services are highly lucrative for many states. Nevada earned $147 million from company formation fees and business licenses in 2010. Delaware, the main incorporation center in the US and legal home of more than 900,000 corporations, earned $859 million from business entity fees and taxes in 2011, or 24% of total revenue that year.

States say financial institutions should bear brunt of duties

Earlier this year, the US Financial Crimes Enforcement Network issued an Advance Notice of Proposed Rulemaking that would require certain US financial institutions to identify and verify the beneficial owners of accounts, including corporate accounts.

NASS welcomes this measure, and says the information gathered by institutions will be an effective supplement for the beneficial owner data collected by IRS reporting forms. It says most financial institutions already have due diligence procedures to capture beneficial owner information on high-risk corporations, and are better-equipped and funded to ferret out corporate beneficial owners.

Financial institutions complain that the failure to obtain beneficial owner information during corporate formation dooms their efforts to uncover the real owners behind corporations.

“Until… states are required to obtain and verify beneficial ownership information at the time of entity formation, it is practically impossible… to reliably verify the accuracy and completeness of beneficial ownership information related to most entities,” said the Investment Company Institute, a trade association for US investment firms, in a letter to FinCEN earlier this year commenting on the proposed beneficial owner regulations.

Their concerns were echoed by other industry groups, such as the American Bankers Association, and anti-corruption organizations like Global Witness and Global Financial Integrity, which support Levin’s bill.

If Levin fails to pass the Incorporation Act before December 2012, the bill will once again die in committee. That would leave the new Congress that takes office in January 2013, including many new members elected on November 6, 2012, with this important issue on its agenda.