How to Solve the Shell Company Conundrum

Shell companies can have legitimate uses such as tax structuring or for investment in a foreign market. For decades, however, criminals have also found shell companies, or other opaque or complex corporate structures, to be convenient vehicles for money laundering, financing terrorists, and evading sanctions. 

The ease, speed, and scale at which a shell company or a group of shell companies can be incorporated is staggering. This problem has not been met with a capable solution, or collective of solutions, until now – indeed most banks today are still applying laborious and manual checks to identify the risk of shells within their book, with the majority of illicit shell companies slipping through the net.

The challenge for those in the financial sector is two-fold:

• How to identify shell companies at-scale internally as a prospect to the bank, within the existing customer base, or as a transactional counterparty to their customers.

• How to differentiate between shell companies being used for legitimate reasons and those being utilized for nefarious purposes

The answer to solving the shell company conundrum comes through a combination of areas that, when combined, are proving very effective to detect and prevent the perennial problem of shells within financial crime and fraud:

• Modern technology’s ability to identify shells at scale and prevent their misuse

• Greater data sharing across the public and private sector

• Strengthening corporate transparency requirements

We are witnessing financial institutions embracing Decision Intelligence technologies now available, including entity resolution, graph analytics, and predictive models to effectively (and at scale) identify likely shell companies and high-risk incorporating directors, preventing their further misuse of the financial system.

As governmental compliance demands increase, banks need a means to quickly separate legitimate shell companies from those using shells for unlawful purposes.

Quantexa is finding that shell companies and networks of connected shell companies and directors present very common network shapes that distinguish between a legitimate shell company and one being used for illicit purposes. Moreover, we are finding a lot of success when looking at the social network of the director and how central they are to their network and businesses.

The continuing misuse of shell companies is why there has been a global focus on this area in recent years. A recent flurry of activity has included the release of several guidance papers, including recent updates to FATF guidance, updates in the US to the Beneficial Ownership (Corporate Transparency Act), and Singapore’s focus on shell companies as part of the Collaborative Sharing of ML/TF Information & Cases (COSMIC) platform – which was confirmed in Singapore’s parliament this month and could be live as soon as the second half of 2024.

As governmental and industry body corporate transparency demands increase, banks need a means to quickly identify shells and then separate false positive, legitimate shell companies from those using shells for unlawful purposes. Doing so, however, presents serious challenges.

Key challenges and how to overcome them

Some traditional challenges, such as those below, can be addressed using opportunities presented by advances in technology:

• Looking at single indicators in isolation

Shell companies often demonstrate consistent shapes in terms of their network, such as highly connected directorships and addresses. Indeed, the incorporating directors often leave tell-tale footprints across their network of associated corporate structures. With the right platform, these indicators can be aggregated at a network level and fed into a predictive model to identify a likely shell very accurately. However, most banks lack the means to identify shell company networks and see all of the connections in their totality.

• Largely manual processes

Historically, banks have relied on humans to identify and investigate potential shells, on a per-record basis, restricting financial crime compliance teams from looking at the problem strategically. This results in illicit shell companies slipping through the net.
Banks are now able to identify shells in an automated manner and collate all associated documentation for review. This allows human analysts to focus time on real risk review.

• Not being able to see the bigger picture

Banks have historically been heavily reliant on the KYC record data provided to them by prospective or existing clients to determine if there is a risk of the entity being a shell. Typically, this data is purposefully sparse and/or outdated. To identify the wider environment of interconnected shell companies, it is essential to step back and understand your portfolio’s exposure to them, either as a direct customer or as a counterparty within a transaction. This can only be achieved by identifying shells using external information, such as corporate registry documents, where interconnected addresses and high-risk directors can be identified at scale, including at a country-wide level, if the country has implemented a comprehensive corporate transparency framework.This leads into a common challenge that is being solved through the implementation of more stringent public corporate ownership strategies.

• Sparse or unavailable corporate data at a country level

Until relatively recently, freely available, consistently populated, and regularly refreshed corporate registry information has been a pipedream in most geographies. Indeed, in many jurisdictions, there is still a long way to go. However, FATF’s Mutual Evaluation process has been transformative in providing a consistent guide and standard for countries to uplift the accessibility and transparency of corporate data.In a recent example from the US, the Financial Crimes Enforcement Network (FinCEN) has announced the Corporate Transparency Act (CTA), effective January 2024, which will ensure common standards on who must file a Beneficial Ownership Interest report, what information must be reported, the beneficial owners of the entity, and the company applicants of the entity.The final element of challenge will be solved by greater industry collaboration. 

• Lack of cross-Industry collaboration

The rise of private-public partnerships to combat financial crime is proving effective. The UK’s Joint Money Laundering Intelligence Taskforce (JMLIT), live since 2015, has provided a guiding light for other countries to follow when it comes to the sharing of financial crime intelligence across the banking sector. More recently in Singapore, the COSMIC initiative has a stated objective for the cross-participating-bank sharing of information regarding identified shell companies. 

How to transform your view of risk

Banks are now in a position to successfully take advantage of more available and complete corporate data, plus the technology to use that data to identify shells at scale in an automated manner and share that information with peers. That is a key combination to prevent ongoing misuse of shells within all aspects of financial crime.

Quantexa Contextual Monitoring marks a paradigm shift in how money laundering is detected and dramatically improves investigation controls and processes. Unlike traditional monitoring systems, a contextual monitoring platform uses Entity Resolution to resolve counterparties and better understand the relationships between them by using graph analytics.

The result is a transformational view of risk that provides a clearer understanding of customers, counterparties, and their relationships in real-time. This added context helps to identify hidden risk and generates fewer, more accurate alerts. Institutions can also reduce rising compliance and operational costs, and conduct more effective intelligence-driven risk processes without replacing existing systems.

By applying network analytics, banks can determine whether the entity has any connection (direct or indirect) to criminal activity.

Decision Intelligence in action

Quantexa’s recent work with the UK Cabinet Office to identify parties who had defrauded the government by falsifying information to obtain grants during the pandemic provides an excellent example of how this technology can help bolster public/private partnerships to achieve better results from investigations.

Using an automated model at scale, banks can turn red flagged corporates into a shell company watchlist, potentially at a country-wide or global level.

The potential impact of this in other sectors such as banking is massive. Using an automated model at scale, banks can turn red-flagged corporations into a shell company watchlist, potentially at a country-wide or global level. This could be used to screen against any onboarding customers within the bank, or counterparties within a transaction.

Equally important, this list of “known bad” shell companies and associated directors can be used to screen against your customers and counterparties, enabling an understanding exposure to shells within your customer base.

Where should the technology sit within your financial crime framework?

To identify financial crime faster and more efficiently, banks need to adopt a more effective and automated process to detect likely shell or shelf companies.

Quantexa’s Decision Intelligence (DI) platform is the solution, and it integrates easily into existing ecosystems. This is a new generation of software designed to automate or augment processes – empowering operational teams to make faster and more accurate strategic, tactical, and operational decisions.

With the power of artificial intelligence, the platform connects billions of data points across internal and external data sources to provide a trusted and reusable data hub enriched with vital intelligence about the relationships between people, organizations, events, places, and other real-world entities.

Technology is changing the face of banking’s future

Ultimately, evolving technology provides the banking industry with numerous options and it will take cross-industry collaboration and proactive regulator interaction to determine what a common standard must be.

Moving forward, banks need to collaborate across technology, the data landscape, banking, and regulators to define and implement appropriate controls to detect and prevent the misuse of shell companies and other corporate structures. Quantexa’s DI platform provides the key to making all of this easier.

Future-Proof Your AML Investigations Using Context