UBOs Often Remain Elusive Despite Repeated Regulatory Efforts

Identifying ultimate beneficial owners (UBOs) remains a central challenge for a number of counter financial crime efforts. As the Pandora Papers highlighted, however, these methods are imperfect at best. Still, we can take the opportunity to reflect on the European regulatory landscape and best practice examples for financial institutions to enhance their systems and controls for preventing financial crime.

There are far too many financial shadows in America that give corruption cover. We need to throw a spotlight on them.

I spoke to the Summit for Democracy about many of the financial measures in the new holistic U.S. gov’t strategy to combat corruption.https://t.co/1YF4tIweRF

— Secretary Janet Yellen (@SecYellen) December 9, 2021

The Puppet Masters

Perhaps the most influential publication regarding the misuse of complex corporate structures was The Puppet Masters. Published in 2011, this paper from the World Bank’s and UNODC’s Stolen Asset Recovery (StAR) Initiative highlights a key concern on UBOs and the potential challenges faced by financial institutions. It is worth quoting from at length:

How can a service provider whose only dealings with a corporate vehicle are to open a bank account, or to provide some other financial service, obtain sufficient information to be able to say with any degree of certainty who the beneficial owner is? The provider may be able to obtain documents showing the corporate structure (such as the register of shareholders and constitutional documents), and he or she may be able to see management board decisions and inspect identification and trust-related documents.

Such a service provider, however, generally will have access to less information than an investigator. Of necessity, the service provider will have to rely on representations by the client and cannot be expected to verify all the information presented. The provider can verify whether the information corresponds with the account activity of a corporate vehicle, but that is about the limit of what the provider can be expected to do.

This absence of information remains a perennial problem. And, since the report was published, its consequences have been repeatedly made manifest, with prominent politicians and other actors across a range of jurisdictions revealed to be using complex, often opaque structures and unorthodox (albeit often legal) tax planning strategies.

The Pandora Papers

The Pandora Papers, released in October 2021 by the International Consortium of Investigative Journalists (ICIJ), coming in the wake of the 2017 Paradise and 2016 Panama Papers, unambiguously underlined this issue.

But these publications also raised other concerns, for example, in relation to a lack of transparency and suspicions surrounding the source of funds. Their findings were compounded by the FinCEN Files (released October 2020), which vividly illustrated weaknesses in the money-laundering defense systems of financial institutions and financial intelligence units (FIUs), with a significant knock-on effect on their ability to deal timely with suspicious activity reports.

Collectively, these leaks have revealed significant deficiencies in financial institutions’ and regulatory bodies’ ability to effectively combat financial crime and can make for bleak reading, despite the fact legislation exists that is intended to address these very deficiencies.

The Legal and Regulatory Landscape in the E.U.

The Fourth E.U. Anti Money Laundering Directive (4AMLD) was ratified by the European Parliament in 2015. In relation to UBOs specifically, 4MLD stipulated that all EU member states were required to keep up-to-date ownership information in central registries. These were to be made easily accessible to authorities, financial institutions and public individuals with a legitimate interest, such as journalists.

The Fifth EU Anti Money Laundering Directive (5AMLD) enhanced some of these provisions, with the relevant requirements applying starting Jan. 10 2020. Such additional measures included:

• The requirement for member states to strengthen their UBO verification mechanisms to ensure the information they carry is accurate and reliable
• The requirement for UBO national registers to be inter-connected at an EU level in order to facilitate cooperation and the exchange of information between member-state authorities

The implementation of these provisions has been inconsistent across the member states, with the European Commission launching infringement procedures against Hungary, the Netherlands, Poland and Spain.

6MLD intended to introduce a more harmonized definition of money laundering offenses, with a corresponding expanded list of 22 predicate offenses and more expansive criminal liability to also cover legal individuals. The UK has opted out of transposing the 6MLD, “primarily due to the fact that many of its requirements are already covered by existing U.K. law.”

Such legislation has been welcome, but its effectiveness remains open to question.

Corporate Ownership Transparency and How to Apply Appropriate Due Diligence

A common motif of the series of Paper leaks is the challenges faced by financial institutions when attempting to ascertain UBOs and the potential misuse of complex corporate structures.

As financial institutions continue to face enhanced public scrutiny and potential regulatory attention, it is important that they allocate competent resources (both human and technological) to their anti-money laundering (AML) programs, evidencing the application of a robust risk-based approach to due diligence.

While there is no shortage of guidance issued by various regulatory bodies, the requirements to which financial institutions and others should adhere is worth highlighting, as the non-exhaustive list below demonstrates:

• Unwrap corporate structures and understand the often complex chain of ownership and differing legal requirements in a range of jurisdictions;
• Identify any political connections, including links to politically exposed persons;
• Ascertain whether there is any sanctions exposure or potential to circumvent sanctions;
• Determine whether the structures make economical or business sense;
• Have in place a clear escalation process;
• Document (and follow) a procedure for de-risking, which may sometime involve termination of client relationships;
• Provide training to staff at all levels, including the board of directors and senior management;
• Engage senior management at all relevant stages of the client relationship (including approving high-risk relationships); and
• Encourage staff at all levels to report any suspicions promptly.

The approaches outlined above provide flexibility for financial institutions to tailor their overall AML/CFT programs to specific risks, and design appropriate controls to mitigate the risks, with consideration given to the organization’s risk appetite.

It’s also worth stressing that timely, quality data underpins a robust due diligence program, enabling financial institutions to identify and respond to issues and risks without delay. However, financial institutions often find inconsistent and dated information hampers their ability to undertake effective due diligence.

As an example, the U.K.’s Companies House has come in for criticism over the years regarding their lack of strong controls when verifying corporate entities. This is aptly illustrated in the case of the company Weight A Minute Ltd, where a former director is named as Jesus Christ, an “Angelic” national residing in “Heaven.”

No government department or financial services firm has the resources to comprehensively verify all information, but having open public registers will provide more efficient access to beneficial ownership data. Companies identifying discrepancies have an obligation to report them and, in time, this may improve data quality.

While there is no one-size-fits-all approach to identifying UBOs, the detrimental impact on society and the ramifications of the reputational damage of failing to do so can be profound. It is up to all of us to help change the narrative and contribute to an ethical business environment.