US law enforcement agencies recently signalled that they were stepping up enforcement, inter alia, in two ways: (a) as against professional money launderers; and (b) as against shell and shelf companies that law firms flip to clients.
Professional money launderers under scrutiny the FBI explained recently, are accountants, hawalas, lawyers and individuals, as well as banks, that wittingly or unwittingly launder the proceeds of crime. Shell and shelf companies are companies that law firms create and flip (sell) to clients. Both are often used by transnational criminal organizations and for securities fraud and are high risk for money laundering.
Law firms flip shelf and shell companies to clients for upwards of $200,000 each. They flip them sometimes as part of a financing, and sometimes because in the case of shelf companies, they give the appearance to the unsophisticated person of having longevity, and ergo legitimacy. Such companies appear to be a going concern when in reality they have just sat on a shelf for years, engaged in no real business. Shell companies are not aged like shelf companies and the advantage of paying extravagant sums for shell companies to law firms appears to be because they come ready-made with legal and beneficial owners.
When law firms flip shelf and shell companies to clients, often the payment is taken from a retainer held in a law firm’s trust account from the client or from proceeds of a financing, and may be billed as a disbursement.
It is debatable whether the business of flipping of shelf and shell companies to a client constitutes the practice of law, because its the resale of a law firm asset to a client (no different than the flipping of a condo owned by the firm to the client) except at a significant profit of close to $200,000 a pop, often more. It cost the law firm $500 to incorporate a company that is flipped to a client for upwards of $200,000.
If the business of flipping shelf and shell companies is not the practice of law, then the proceeds of the sale cannot be run through a trust account.
To flip a shelf or shell company to a client, a law firm would need to ensure that it explains to the client what it is, how much profit the firm is making off the flip, that it can obtain the same thing (a new company) without some of its perks for $500, and because there is a conflict (the firm is the vendor of an asset flipped to its own client), those rules would need to be complied with.
There appears to be no guidance for lawyers and law firms in respect of the practice of being in the business of flipping shell and shelf companies – thus far, law regulators have not expressed concern in respect of the practice, issued guidance in respect of it, or prohibited the practice.
Law firms should be alert to allowing the firm and its reputation to be abused for financial crime through the flipping of shell and shelf companies to a client. Shelf companies identify the involvement of the firm and there is no way to remove that legacy information. Criminals and fraudsters can take a shelf corporation with the firm legacy information and represent to banks and investors that the law firm partners were part of its business. Technically, they would be right and one wonders why law firms knowingly put themselves at a reputational risk.
The SEC recently filed charges against a lawyer for selling 8 shell companies to 3 related clients and referred to it as a “shell manufacturing” operation, and it may be the first step in exerting pressure on law firms to stop the practice. Big firms in Canada and the US are typically the ones in the shelf and shell flipping business and they typically flip quite a number more than 8 shells a year for $200,000 each to clients. Small law firms tend not to be flippers because it requires a corporate maintenance department.
Lawyers as car salesmen
A New York Times story entitled Panama Papers Show How Lawyers Can Turn a Blind Eye showed how Ramón Fonseca, one of the founders of the Panama law firm Mossack Fonseca, which set up companies where its lawyers acted as beneficial owners, directors and officers for a fee, and which also was in the shell flipping business to clients, bankers and accounting firms, told a reporter that its lawyers did nothing wrong in flipping shells to clients: “we are like a car factory” the lawyer said. Precisely the point. What US law enforcement is driving home with indictments against lawyers for this activity, is are lawyers car salesmen or are they a profession? If the latter, why are they selling cars?
That firm also set up thousands of bank accounts with global banks for thousands of clients as part of the shell service, which is also not the practice of law.
In 2014, this article first called lawyers who flip shell and shelf companies, car salesmen.
It is probably fair to say that regulators may require that law firms exit the shelf and shell flipping business, and if they don’t fast enough, firms may exit that business by US law enforcement pressure or by the public denouncement of the practice. Panama Papers is three years old, though, and nothing has happened yet. Big law firms can earn significantly more money flipping shells to clients than legal services. The lawyer charged by the SEC for flipping shell companies charged the client $2 million for shells, and $200,000 for legal services.
Jail time for shell games
To learn more about the significant financial crime risks of shell and shelf companies, the FBI explains some troubling cases here where drug cartels, human traffickers, sanctions avoiders and Ponzi schemers used shells for financial crime. You can read here about a company that sold over 2,000 shell and shelf companies as a business, some of which later were traced to financial crime. You can also read here on how Canada is a facilitator of the creation of anonymous shells. And here on how what are called “service companies” act as fronts for trusts, shells and foundations. The shell games involve using an offshore country known for lax anti-money laundering law and known for tax evasion to act as the place of incorporation of shells owed by wealthy PEPs, such as Guernsey.
You can read here about an employee of the law firm Mossack Fonseca (the firm which said it was like a car factory), arrested for money laundering and extradited to Germany to face charges of facilitating clients break the law, and here, where the US charged three other employees of that same law firm in connection with criminality, including money laundering and creating sham shells, and here where the two founding lawyers of that law firm were charged. The partners have also been indicted in Brazil for flipping shells that were used to move the proceeds of crime from government corruption, and they have admitted to back-dating corporate records, a practice that they said was an “industry practice”, meaning all lawyers do it as a standard practice.
That shells are used for serious criminality and money laundering is no longer an unknown. Thus far, $1.2 billion in fines and payments from tax evasion have been collected arising from shells associated with the law firm Mossack Fonseca. That firm, however, was often acting on instructions from other law firms all over the world, including Canada. It has said that 90% of its shell business was from law firms and accounting firms – in other words, what they allege is that it was law firms and accounting firms instructing them on shells, among other things, to service clients that in cases were tied to serious criminality. There are more than 230 client files associated with those shells in Canada says the CRA, and it has already made inroads with criminal investigations in several Vancouver files.
This video here highlights the harm the law firm did playing shell games, with the harm ranging from human trafficking, medical fraud and the Syrian refugee crisis, which displaced 30 million people.
FIs concerned about the risk of banking a shelf or shell company that was flipped to a second set of owners, and of the heightened risks for financial and organized crime associated therewith, can adjust due diligence processes to ask clients about the origin of an entity and if they paid money to acquire it (as opposed to normal fees to incorporate a new company). There are 200,000 corporate entities tied to Mossack Forseca still in existence with bank accounts.
There is an argument to be made by legislators that the more lawyers stray from the practice of law and sell goods, like shell and shelf companies to clients, or open bank accounts for them, they undo the argument that lawyers ought to be exempt from anti-money laundering law reporting.