Company Formations: Minimal Ownership Information Is Collected
and Available (07-APR-06, GAO-06-376).
Companies form the basis of most commercial and entrepreneurial
activities in market-based economies; however, "shell" companies,
which have no operations, can be used for illicit purposes such
as laundering money. Some states have been criticized for
requiring minimal ownership information to form a U.S. company,
raising concerns about the ease with which companies may be used
for illicit purposes. In this report, GAO describes (1) the kinds
of information each of the 50 states and the District of Columbia
and third party agents collect on companies, (2) law enforcement
concerns about the use of companies to hide illicit activity and
how company information from states and agents helps or hinders
investigations, and (3) implications of requiring states or
agents to collect company ownership information.
-------------------------Indexing Terms-------------------------
REPORTNUM: GAO-06-376
ACCNO: A51199
TITLE: Company Formations: Minimal Ownership Information Is
Collected and Available
DATE: 04/07/2006
SUBJECT: Crime prevention
Crimes
Data collection
Federal/state relations
Law enforcement
Reporting requirements
Limited partnerships
Business records
Business
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GAO-06-376
* Report to the Permanent Subcommittee on Investigations, Committee on
Homeland Security and Governmental Affairs, U.S. Senate
* April 2006
* COMPANY FORMATIONS
* Minimal Ownership Information Is Collected and Available
* Contents
* Results in Brief
* Background
* Types of Companies
* Corporations and LLCs
* Most States Collect Limited Information on Company Ownership and
Management
* Information States Collect on Company Ownership
* Information States Require on Company Management
* States May Also Collect Other Information
* State Officials Reported That They Generally Reviewed
Documents for Basic Information but Did Not Verify the
Information
* Agents Facilitate Company Formation but Are Not Required to
Collect Ownership Information or Verify Information on Clients
* Company Formation Agents and Agents for Service of Process
Play Different Roles
* Few States Verify Information from or Otherwise Oversee
Agents
* Agents We Talked with Said They Generally Do Not Collect
Ownership and Management Information on Companies Because
States Do Not Require Them to Collect It
* Agents Are Not Required to Verify Information in Company
Filings, but a Few Do
* Law Enforcement Officials Can Obtain Some Company Information
from States and Agents, but a Lack of Ownership Information
Obstructs Some Investigations
* Law Enforcement Officials Are Concerned about the Use of
U.S. Shell Companies to Facilitate Criminal Activity
* Information from Company Filings and Agents Is Available and
Useful to Law Enforcement, but Is Often Too Limited to Solve
Cases
* More Company Ownership Information Could Be Useful to Law
Enforcement, but Concerns Exist about Collecting It
* States and Agents Acknowledged Benefits of Having Additional
Information on Company Ownership but Raised Concerns about
Collecting It
* State Officials and Others Were Concerned about Privacy
Issues
* Two Foreign Jurisdictions Have Had Mixed Experiences with
Requiring the Collection of Company Ownership Information
* Other Potential Sources of Company Information May Be
Available, but Obtaining Information from These Sources May
Also Be Challenging
* Internal Company Documents
* Financial Institutions
* IRS
* Observations
* Agency Comments and Our Evaluation
* Objectives, Scope, and Methodology
* Company Formation and Reporting Documents Can Be Submitted in a
Variety of Ways
* Company Formation Fees
* Information on Company Formation Documents
* GAO Contact and Staff Acknowledgments
* Glossary
* Agent for service of process
* Articles of incorporation
* Articles of association or articles of organization
* Bearer security
* Beneficial owner
* Certificate of existence
* Company formation agent
* Corporate veil
* Piercing the corporate veil
* Corporation
* S corporation
* C corporation
* Director
* Dummy (or nominee) director
* Limited liability
* Limited liability company (LLC)
* Manager-managed company
* Member (LLC)
* Member-managed company
* Nominee
* Officer
* Partnership
* Limited partnership
* Limited liability partnership (LLP)
* Limited liability limited partnership (LLLP)
* Service of process
* Sole proprietorship
Report to the Permanent Subcommittee on Investigations, Committee on
Homeland Security and Governmental Affairs, U.S. Senate
April 2006
COMPANY FORMATIONS
Minimal Ownership Information Is Collected and Available
Contents
Tables
Figures
April 7, 2006Letter
The Honorable Norm Coleman Chairman The Honorable Carl Levin Ranking
Minority Member Permanent Subcommittee on Investigations Committee on
Homeland Security and Governmental Affairs United States Senate
Companies-business entities that conduct a variety of commercial
activities and hold a variety of assets-form the basis of most commercial
and entrepreneurial activities in market-based economies. Companies in the
United States play an essential and legitimate role in the country's
economic system. They provide a wide variety of services that range from
the provision of necessary utilities and investment services to retail
sales of items such as clothing and furniture. Companies can also be set
up that act as "shell" companies and conduct either no business or minimal
business. Shell companies are used for legitimate purposes; for example,
they may be formed to obtain financing prior to starting operations.
However, government and international reports indicate that shell
companies have become popular tools for facilitating criminal activity in
the United States and internationally and can be involved in fraud and
corruption or used for illicit purposes such as laundering money,
financing terrorism, hiding and shielding assets from creditors, and
engaging in questionable tax practices.2 Such schemes can conceal money
movements that range from 1, a few thousand to many millions of dollars.
Using U.S. shell companies for such activities can be appealing because of
the perceived legitimacy of U.S. companies in international commerce and
the potential for concealing the identity of the beneficial owners behind
the legal entity. The beneficial owners are the persons who ultimately own
and control a company.3 For example, a shareholder of a corporation could
be a beneficial owner. State statutes have traditionally provided for the
privacy of the identities of company owners and limited liability, which
protects them against lawsuits and protects their personal assets.
However, shell companies can provide beneficial owners with the means to
conduct illegal activities while hiding the owners' identity and
involvement. Also, company formation agents who help individuals form
companies may facilitate the formation of these shell companies, further
shielding the identity of the individuals controlling the company. Law
enforcement agencies investigating cases in which such companies may have
been used for illicit purposes often need to know who the owners are in
order to determine responsibility for criminal actions.
In a previous investigation of foreign individuals laundering money
through U.S. corporations formed in Delaware, we found that the state
required very limited information when a company is formed.4 The potential
paucity of the information required when forming a company in the United
States has raised concerns about the ease with which companies may be used
for illicit purposes, particularly since the September 11, 2001, terrorist
attacks. Given these concerns, you asked us to determine what types of
information are routinely obtained and made available regarding the
ownership of nonpublicly traded companies formed in each state.5
Specifically, this report will describe
1.the kinds of information-including ownership information-that the 50
states and the District of Columbia collect during company formation and
the states' efforts to review and verify the information;
2.the roles of third-party agents, such as company formation agents, and
the kinds of information they collect on company ownership;
3.the role of shell companies in facilitating criminal activity, the
availability of company ownership information to law enforcement, and the
usefulness of such information in investigating shell companies; and
4.the potential effects of requiring states, agents, or both to collect
company ownership information.
Individuals can choose a variety of business structures when forming a
company. The scope of this report covers corporations and limited
liability companies (LLC) because corporations have historically been the
dominant business form and LLCs have recently grown in popularity. We
refer to corporations and LLCs collectively as "companies" unless
otherwise specified.
To address the objectives, we conducted a survey of officials from all of
the states and the District of Columbia on their company formation and
periodic reporting practices and cross-checked the responses against our
review of state statutes, company formation forms, and state Web sites.
Each of the 50 states and the District of Columbia responded to our
survey. We also called and visited selected states to obtain further
information about certain practices. In addition, we interviewed academics
who have done research in the area, companies that provide filing and
related services for businesses, law firms, financial institutions, state
and industry associations, and state law enforcement agencies.
Furthermore, we talked with officials from two jurisdictions outside of
the United States that have recently implemented regulations for company
formation agents.6 We also spoke with officials from federal agencies in
the Department of Homeland Security (DHS), including Immigration and
Customs Enforcement (ICE); Department of Justice (Justice), including the
Criminal Division, Drug Enforcement Agency (DEA), Federal Bureau of
Investigation (FBI), and a U.S. Attorneys office and the Executive Office
of the U.S. Attorneys (EOUSA); and Department of the Treasury (Treasury),
including the Financial Crimes Enforcement Network (FinCEN), Internal
Revenue Service (IRS), and Office of Foreign Assets Control (OFAC).
We conducted our work from May 2005 through March 2006 in Arizona,
Delaware, Florida, Maryland, Nevada, New York, Oregon, Virginia, and
Washington, D.C., in accordance with generally accepted government
auditing standards. A more extensive discussion of our scope and
methodology appears in appendix I. The report also includes a glossary of
terms. The survey and a more complete tabulation of state-by-state and
aggregated results can be viewed at http://w GAO-06-377SP
ww.gao.gov/cgi-bin/getrpt? . We provided a draft of this report to DHS,
Justice, and Treasury. Justice and Treasury provided technical comments on
the report that were incorporated, as appropriate.
Results in Brief
Most states do not require companies to provide ownership information at
formation or in periodic reports. Similarly, states usually do not require
information on other individuals who manage a company, including corporate
officers and directors and LLC managers, on company formation documents,
but most states require this information on periodic reports. However,
these individuals may not be the owners of the company. States typically
require basic information on company formation documents, such as the name
of the company and the name and address of a contact where tax and other
legal notices for the company should be sent. However, some may require
other types of information, such as the company's principal office address
or a statement of purpose. Almost all state officials reported that they
screen filings for the presence of statutorily required information, but
none reported screening names against criminal watch lists or verifying
the identities of company officials provided in company formation or
periodic report filings. Some officials said they do not take these steps
because they do not have the legal authority or means to perform them.
Third-party agents may submit formation and other documents on behalf of a
company, but the agents seldom collect ownership information or verify the
information they collect. Individuals may also submit their own company
filing documents. Company formation agents file required documents with a
state for individuals or their representatives, while agents for service
of process receive legal and tax documents on behalf of a
company.7 Although these agents provide different services, one company
may serve in both capacities. Some state statutes have basic requirements
regulating agents for service of process, such as state residency, but
otherwise there is little oversight of either type of agent and no
verification of the information they provide. For example, some states may
require the agent for service of process to have a local address but do
not check to see whether the address is valid. Wyoming is the one state we
found that requires agents for service of process to register yearly to
discourage agents from providing false information and to have the
information available if the agent is under investigation. Agents
generally collect billing information and the information required by
state statute for company formation but generally do not collect any
additional information on ownership or management of the companies they
represent. Agents are generally not required to verify information from
clients, although some agents we spoke with may request additional
information or verify the identity of international clients by requiring
copies of passports. In some circumstances, a legal firm may be the
contact for a company, and the agent may not interact with anyone
affiliated with the company being formed.
Law enforcement officials are concerned about the use of shell companies
in the United States that enable individuals to conceal their identities
and conduct criminal activity and have encountered difficulties in
investigating these shell companies because they cannot determine the
owners of the companies. Quantifying the magnitude of the use of shell
companies used in crimes is difficult because creating a shell company is
not a crime but rather can be a method for hiding criminal activity.
However, law enforcement officials told us they are seeing many
investigations within the United States and in other countries where
individuals have used U.S. shell companies to facilitate illicit activity
involving billions of dollars. Most of the law enforcement officials we
interviewed said that when they need company information, they obtain some
information from state Web sites and company filings, and some said they
also requested information from agents. Some law enforcement officials
noted that the information available from states had proven helpful
because names on the documents generated additional leads. However, some
officials said that the information states collected was limited in
revealing who owned and controlled the company and that cases had been
closed because of insufficient information. For example, an Immigration
and Customs Enforcement (ICE) official provided an example of a
Nevada-based corporation that received 3,774 suspicious wire transfers
totaling $81 million over a period of approximately 2 years. However, the
case was not prosecuted because ICE could not identify the beneficial
owner of the corporation.
Although law enforcement officials noted that information on owners was
useful in some cases, state officials, agents, and others we interviewed
said that collecting company ownership information could be problematic.
For instance, if states or agents collected such information, the cost of
filings and the time needed to approve them could increase, potentially
slowing down business dealings or even derailing them. A few states and
some agents also said they might lose business to other states, countries,
or agents that had less stringent requirements, a consequence two foreign
jurisdictions experienced after regulating agents and requiring collection
of ownership information. Further, state officials and agents pointed out
the difficulties of collecting information when companies are being formed
or on periodic reports since ownership can change frequently. In addition,
state officials and agents expressed concerns about maintaining privacy
when making public information about legitimate businesses that
historically has been protected. State officials, agents, and other
experts in the field suggested internal company records, financial
institutions, and the IRS as alternative sources of ownership information
for law enforcement investigations. However, collecting information from
these sources could present many of the same difficulties.
Background
States historically have had jurisdiction over the way business entities
within their boundaries are formed and over reporting requirements for
these entities. Statutes and requirements vary from state to state. In
general, however, forming a company involves certain steps. Initially, a
company principal or someone acting on the company's behalf submits
formation documents to the appropriate state office-usually a division of
the secretary of state's office-but in some cases to a different state
agency.8 All formation documents filed with the state are matters of
public record and are available to anyone. Documents may be submitted in
person, by mail or, increasingly, online. A minimal amount of basic
information generally is required to form a company, although these
requirements also vary from state to state. Generally, the documents must
give the company's name, an address where official notices can be sent to
the company, share information for corporations, and the names and
signatures of the persons incorporating (see fig. 1). State officials
generally check to see that the documents supply the information required
by statute. Fees vary by state from $25 to $1,000, and the process can
take anywhere from 5 minutes to 60 days.9 See appendix II for more
information on how formation documents are submitted and on the company
formation fees in each state. Expedited services, available in some
states, decrease processing times but may require an additional fee. Most
states also require companies to file annual or biennial reports in order
to stay in good standing, for a fee ranging from $5 to $500.10
Figure 1: How Companies Are Typically Formed
aShare information applies only to corporations.
bIn two states, New Mexico and Nebraska, the filing fee for corporations
was a range. The median was calculated using the lowest fee in the range.
Types of Companies
Businesses may be incorporated or unincorporated. A corporation is a legal
entity that exists independently of its shareholders-that is, its owners
or investors-and that limits their liability for business debts and
obligations and protects their personal assets. For example, the owners of
a small store may desire limited liability protection in case a customer
is accidentally injured inside the store and decides to sue. In this
hypothetical case, the owners' personal assets, such as their home and
retirement savings, generally would not be subject to any award if the
customer won the lawsuit. Limited liability means that owners or
shareholders in a business entity are personally responsible only for the
amount they have invested in the business, while the corporation itself is
responsible for the debts and other obligations it incurs. The exception
occurs when a court "pierces the corporate veil," or disregards the legal
entity that is the corporation, and holds the owners, shareholders, and
sometimes the officers and directors responsible for the corporation's
acts and obligations.11 In contrast, the owners of unincorporated
businesses, such as partnerships and sole proprietorships, are generally
liable for all debts and liabilities incurred by their businesses.
However, these types of businesses also offer tax advantages that
corporations do not.12
The limited liability company (LLC) is a fairly new business form that is
a hybrid of the corporation and the partnership. Wyoming passed the first
law permitting formation of LLCs in 1977, and Florida followed suit in
1982. By the mid-1990s, all states had enacted LLC statutes. Like a
corporation, an LLC protects its owners, which are referred to as members,
from some debts and obligations; like partnerships and sole
proprietorships, however, it may confer certain tax advantages.13 In
addition, LLCs can choose a more flexible management structure than
corporations. Table 1 shows the key characteristics of the different types
of U.S. businesses.
Table 1: Basic Types of U.S. Businesses
Business form Key characteristics
Corporation An artificial construct (usually a business
entity) created by law that acts as a separate
and distinct legal entity apart from its owners
and that has other legal rights, such as the
ability to issue stock.
C corporation (for tax Generally, any corporation that is not an S
purposes) corporation.
S corporation (for tax A small business corporation that elects to be
purposes) taxed as an S corporation under the federal tax
code. The taxable income of an S corporation is
passed through to the shareholders and taxed at
the shareholder level.
Limited liability company A company that offers its owners (members) some
(LLC) protection from responsibility for the company's
debts and obligations. An LLC may have only one
member and may be managed by its members or
managers.
Partnership An association of two or more persons who
jointly own and conduct a business and agree to
share the profits and losses of the business.
Limited partnership A partnership consisting of one or more limited
partners who contribute capital to and share in
the profits of the partnership but who are
responsible for the company's debts only up to
the amount of their contribution and one or more
general partners who control the business and
are personally liable for its debts.
Limited liability A partnership in which the participants are not
partnership responsible for negligent acts committed by
other partners or by employees not under the
partner's supervision. Certain businesses
(typically law firms or accounting firms) are
allowed to register under state statutes as this
type of partnership.
Limited liability limited A partnership in which general and limited
partnership partners are not responsible for the
partnership's debts and obligations.
Sole proprietorship A business operated by one person who owns all
assets and is responsible for all of the
liabilities.
Sources: Black's Law Dictionary (8th ed. 2004); Uniform Limited Liability
Company Act, S: 202(a) (1996); 26 U.S.C. S:S: 1361, 1363 and 1366; Uniform
Limited Partnership Act 2001 Refs.; and Annos., Prefatory Note (Main Vol.
2003).
Corporations and LLCs
Historically, the corporation has been the dominant business form, but
recently the LLC has become increasingly popular. According to our survey,
8,908,519 corporations and 3,781,875 LLCs were on file nationwide in 2004.
That same year, a total of 869,693 corporations and 1,068,989 LLCs were
formed. Figure 2 shows the number of corporations and LLCs formed in each
state in 2004. Five states-California, Delaware, Florida, New York, and
Texas-were responsible for 415,011 (47.7 percent) of the corporations and
310,904 (29.1 percent) of the LLCs. As shown in figure 3, Florida was the
top formation state for both corporations (170,207 formed) and LLCs
(100,070) in 2004. New York had the largest number of corporations on file
in 2004 (862,647) and Delaware the largest number of LLCs (273,252). Data
from the International Association of Commercial Administrators (IACA)
shows that from 2001 to 2004, the number of LLCs formed increased
rapidly-by 92.3 percent-although the number of corporations formed
increased only 3.6 percent.14
Figure 2: Domestic Corporations and LLCs Formed in States in 2004
Figure 3: Number of Domestic Corporations and LLCs Formed in the Top Five
States in 2004
Most States Collect Limited Information on Company Ownership and
Management
Most states do not require ownership information at the time a company is
formed, and while most states require corporations and LLCs to file annual
or biennial reports, few states require ownership information on these
reports. Similarly, only a handful of states mandate that companies list
the names of company managers on formation documents, although many
require managers' information on periodic reports. States may require
other types of information on company formation documents, but typically
they do not ask for more than the name of the company and the name and
address of the agent for service of process (where legal notices for the
company should be sent). Most states conduct a cursory review of the
information submitted on these filings, but none of the states verify the
identities of company officials or screen names against federal criminal
records or watch lists.
Information States Collect on Company Ownership
The owners of a company are, in the case of a corporation, the
shareholders of that corporation and in the case of an LLC, the members of
that LLC.15 According to our survey results, none of the states collect
ownership information in the formation documents-articles of
incorporation-for corporations (see fig. 4). State statutes generally do,
however, require corporations to prepare and maintain lists of
shareholders that, unlike formation documents, are not filed with the
state or part of the public record.16
With respect to LLCs, states generally require a manager-managed LLC to
name the designated manager instead of a member on the formation
document-articles of organization. However, the manager is not necessarily
an owner of the LLC.17 LLCs usually prepare and maintain operating
agreements that name the owners, members, and their financial interests in
the company, but these operating agreements are not filed with the state
or part of the public record. According to our survey results, four
states-Alabama, Arizona, Connecticut, and New Hampshire-request some
ownership information when an LLC is formed.18 For example, in Alabama,
the formation documents must list the names and mailing addresses of the
initial members of an LLC. A Connecticut official said that either a
member's or a manager's name was required on the articles of organization.
In New Hampshire, a member or manager is required to sign the articles of
organization. Arizona statutes mandate that manager managed LLCs must list
on formation documents the name and address of each member owning more
than a 20 percent interest and that member-managed LLCs must list all
members' names and addresses. Depending on the management structure of an
LLC, ownership information may be included on the formation documents in
more states. If an LLC is managed by its members, some states require the
LLC to provide the name and address of at least one member on the
formation document.
Most states require corporations and LLCs to file periodic-annual or
biennial-reports, but not many states require ownership information on
these reports (see fig. 4).19 With respect to corporations, three states
(Alaska, Arizona, and Maine) indicated on our survey that the name of at
least one owner was required on corporations' periodic reports. In Alaska,
any person owning more than a 5 percent interest in a corporation must be
listed on the periodic report, according to a state official. An official
from Arizona said the state requires that corporate periodic reports list
the names and addresses of shareholders owning more than 20 percent of
company stock. In Maine, statutes require that periodic reports include
the names and addresses of shareholders of a corporation only if there are
no directors.
With respect to LLCs, our survey showed that five states require LLCs to
list at least one member on their periodic reports.20 As with
corporations, Alaska requires the name and address of any person owning
more than a 5 percent interest in an LLC to be listed on the company's
periodic report. A state official told us that LLCs in Kansas are required
to list on their periodic reports the names and post office addresses of
members owning at least 5 percent of the capital in the company.21
Connecticut and New Hampshire require either a manager or at least one
member name on their periodic reports. Maine requires the name and
business or residential address of each manager, or if there are no
managers, each member with a street address on the periodic report.
Finally, in states that require a manager's or managing member's name on
periodic reports, the reports for member-managed LLCs might include a
member's name.
Figure 4: Ownership Information Required in Articles and Periodic Reports
aNew Mexico and Arkansas did not respond to some of our survey questions.
Arkansas responded on our survey that a member's address is not required
for LLC articles or reports. However, the state did not respond to the
question asking whether the address of an owner of a corporation is
required on articles or reports. We found from our legal review that
Arkansas does not require the address of an owner on articles or periodic
reports. New Mexico did not respond to our survey questions on the
information required about owners or members. Our legal review found that
New Mexico does not require corporations to list the name or address of an
owner on articles or periodic reports. For LLCs, we found that New Mexico
does not require member names and addresses on formation documents or
periodic reports.
Information States Require on Company Management
Less than half of the states require the names and addresses of company
management or directors on company formation documents. Management may
include officers-chief executive officers, secretaries, and treasurers-who
help direct a corporation's day-to-day operations, as well as managers or
managing members of LLCs.22 Directors serve on the governing board of a
corporation and are responsible for making important business decisions,
especially those that legally bind the corporation. Two states require
officers' names and addresses on company formation documents, 10 states
require the names of directors, and 9 states require the addresses of
directors (see fig. 5) . Some states have additional information
requirements for company formations. For instance, our review of state
statutes found that Louisiana does not require information on directors on
the incorporation documents, but does require directors' names and
addresses on an initial report that must be filed with the incorporation
documents. We also found that Oklahoma requires the names and addresses of
the directors only if the persons incorporating the company are not
responsible for its operations after the incorporation documents are
filed. More states require management information on LLCs. Nineteen states
require the names of managers or managing members on formation documents,
and 18 states require their addresses.23
Most states require the names and addresses of corporate officers and
directors and of managers of LLCs on periodic reports (see fig. 5). For
corporations, 47 states require the names of officers on periodic reports,
and 46 states require officers' addresses. Thirty-eight states require
directors' names and 37 require directors' addresses. For LLCs, 28 states
require the manager's or managing member's name, and 27 states require
their addresses. However, even if states require disclosure of directors'
names, those listed may not be the individuals who are truly directing the
company because in some cases, the individuals could be nominee directors
that act only as instructed by the beneficial owner of the company.24
Also, managers may or may not be owners of the LLC.
Figure 5: Management Information Required in Articles and Periodic Reports
aInformation on officers applies only to corporations.
bNew Mexico did not respond to some of our survey questions. New Mexico
did respond that corporate directors' names and addresses are required for
both articles and reports, but did not respond to the questions about the
names and addresses of LLC managers/managing members. However, we found in
our review of state statutes that New Mexico does not require LLC manager
names and addresses on formation documents or periodic reports.
cNew Jersey responded on the survey that the names and addresses of
corporate directors are required for reports only and that the names and
addresses of LLC managers/managing members are not required for articles
or reports. However, our review of state statutes found that the names and
addresses of corporate directors are also required on articles and that
the names and addresses of LLC managers/managing members are required on
reports. We were unable to clarify this discrepancy with New Jersey state
officials. Utah responded to the survey that the names and addresses of
corporate officers and directors are required on articles; however, our
review of state forms found that this information is optional.
States May Also Collect Other Information
States may also ask for other general information about a company,
including its name; the name and address of the agent for service of
process (where legal notices for the company should be sent); and for
corporations, information about the number and types of shares the company
will issue. Appendix III shows the type of information that each state
collects on formation documents. Many states specify that the agent's
address must be a physical street address and not a post office box. In
addition, a majority of the states include on their formation documents
space for an individual to sign as the incorporator (in the case of a
corporation) or organizer (in the case of an LLC) of the company.25 The
incorporator or organizer may be the agent who is forming the company on
behalf of the owners or it may be an individual affiliated with the
company being formed. Most states permit an individual or entity to serve
as incorporator without regard to state residency or later participation
in the company, but at least two states require that the incorporator be
associated with the company in some way. For example, the articles of
incorporation for Arkansas and California state that if a newly
incorporated company has chosen initial officers or directors, one or more
of them must sign as the incorporator. Otherwise, an unaffiliated
individual can sign as the incorporator.
Many states require a brief statement of purpose or a principal office
address in order to form a corporation or LLC.26 In reviewing state
statutes and state forms, we found that 20 states require a statement on
the purpose of a corporation and 16 require a statement of purpose for
LLCs on formation documents. In some states that ask for a statement of
purpose, a general statement such as "the purpose of the corporation is to
engage in any lawful act or activity..." is sufficient. Alaska requires an
additional form that discloses the North American Industry Classification
System (NAICS) number that most closely describes the activities of a
corporation.27 Fourteen states require a principal office address to form
a corporation, and 23 states require a principal office address to form an
LLC. The principal office generally means either the address of the
company's place of business or its mailing address. Therefore, even in
states where a principal office address is required, this address may not
indicate the company's actual place of business. For example, Arizona's
form asks for a known place of business in Arizona, but the instructions
for the form state that this address may be in care of the address of the
company's agent.
Some states have unique requirements for information on newly forming
companies. For example, the articles of incorporation forms for Louisiana,
Rhode Island, and South Dakota must be notarized. Similarly, an attorney
licensed to practice in South Carolina must sign company formation
documents in that state. Private sector officials told us that more states
used to require a notary's signature on company formation documents, but
that most had repealed this provision. A Louisiana state official said
that requiring a notary's signature was a "historical" decision and,
despite an effort to change the law, was likely to remain a requirement.
A few states (Louisiana, Massachusetts, Mississippi, and Pennsylvania)
also require a federal taxpayer identification number (TIN) on some
company formation documents.28 Kansas requests a TIN on formation
documents, but it is not required by statute. Louisiana and Massachusetts
state officials told us that even though a TIN is required, company
formation documents are not rejected if it is not included. These states
originally used the TIN as a tracking number for filings. For instance,
the Kansas Department of Revenue uses the information to match companies
in its database. A Massachusetts official said that the state was moving
away from using TINs in all cases and now assigns a private unique
identification number to each company for tracking purposes. While the
requirement to include a TIN is still in place for LLCs in Massachusetts,
it was recently deleted from the corporation statute because the Secretary
of State's office received many complaints about this number being
publicly available on filing documents.
Forty-two states reported on our survey that their information
requirements for persons or entities from outside the United States
forming a U.S. company were the same as for U.S. citizens. Those states
that say there was a difference also said that the difference was simply
that proof of the company's existence had to be included and that
documents had to be translated into English. For example, Minnesota and
North Carolina commented that if an entity from another country was
applying to conduct business in those states, the entity must provide
proof of good standing or a document certifying that the company existed
in the original country.29 Alaska is the only state that requires the name
and address of each alien affiliate or a statement on the articles of
incorporation that there are no alien affiliates. An "alien affiliate" is
an individual from another country who has some ownership or control of a
company or an entity controlled by an individual or a corporation from
another country.30 An Alaska state official said that this information was
originally required to identify offshore fisheries and their owners.
State Officials Reported That They Generally Reviewed Documents for Basic
Information but Did Not Verify the Information
Nearly all of the states reported that they reviewed filings for the
required information and fees and checked to see if the proposed name was
available (see table 2). In Arizona, for example, state officials said
that the main reasons filings were rejected were that required
information, such as the agent's address or signature or the type of
management structure of an LLC, was missing and that the company name was
not distinguishable from an existing entity's name. Other state officials
said they also rejected filings because they were missing key information,
the company name was not available, or the fee was not included. Many
states also reported that they reviewed filings to ensure compliance with
state laws.31 In Virginia, for instance, filings are reviewed for more
than just the required information. An attorney in the state office
reviews all formation filings for substantive issues. For example,
Virginia law requires that shareholders elect directors, and state
officials said that they would reject a filing if the articles stated that
the company's directors would be chosen by a different method.
None of the states reported verifying the identities of incorporators or
company officials or using federal criminal records or watch lists to
screen names. State officials gave several reasons for not taking this
step when reviewing formation documents. In interviews and on the survey,
many state officials emphasized that their role was authorized by statute
as only administrative, not investigative. In fact, 45 states reported
that they did not have investigative authority to take action if they
identified information that could indicate criminal activity, although
some state officials said they can refer suspicious activity to law
enforcement. Only two states-Colorado and North Carolina-reported that
they did have investigative authority.32 Further, two states noted that
their state statutes required them to file formation documents as long as
the documents contained the required information. In addition, one state
official said that states did not have the resources to verify the
information submitted on formation documents and other officials commented
on the survey that verification would significantly increase the costs and
workloads of their offices. Another stated that the staff would not know
how to determine the validity of information individuals provided to
verify their identity.
While states do not verify the identities of individuals listed on company
formation documents, an individual may be charged with perjury in some
states if law enforcement officials find in the course of an investigation
that an individual submitted false information on a company filing. We
found in our review of state forms that 10 states note the penalties for
providing false information on their company formation documents. One
state official provided an example of a case in which state law
enforcement officials charged two individuals with, among other things,
perjury for providing false information about an agent on articles of
incorporation.
Table 2: Steps States Take to Review Articles of
Incorporation/Organization and Periodic Reports
Corporations LLCs
Processing Articles Reports Both Not Articles Reports Both Not
steps only only performed only only performed
or no
or no
response response
Review for 47 0 3 1 45 0 2 4
availability
of company
names
Review for 11 39 0 1 16 2 31 2
presence of
information
and fees
Determine 10 1 35 5 16 2 28 5
whether
submitted
information is
in compliance
with state law
Verify with 0 0 0 51 0 0 0 51
picture IDs
the identities
of
incorporators,
directors, or
officers
Use federal 0 0 0 51 0 0 0 51
criminal
records or
watch lists to
screen names
of
incorporators,
directors, or
officers
Direct staff 2 0 4 45 3 0 3 45
to look for
suspicious
activity or
fraud in
filings
Source: GAO survey of state officials responsible for company formation.
A few states reported that they directed staff to look for suspicious
activity or fraud in company filings. For example, an official in Alabama
told us that staff who reviewed filings looked for anything out of the
ordinary, such as a bank from another country that wanted to form a
company in Alabama but would not provide the required information. An
official in Missouri said that despite not having a formal procedure or
policy for reviewing filings for suspicious activity, staff were trained
to look for things that were out of the ordinary. Such things might
include discrepancies like two signatures of the same name with different
handwriting. However, most states reported that they did not direct staff
to look for suspicious information. According to an official in Alaska,
the state has no formal mechanism for identifying or reporting suspicious
information. The official said that staff would notice unusual fictitious
names on filings, but with a filing fee of $250 in Alaska, this type of
activity was rare. Two state officials told us that when staff noticed
something unusual, they typically contacted the applicant for an
explanation but still usually filed the documents. If something appeared
especially unusual, they referred the issue to state or local law
enforcement or the Department of Homeland Security. One official said his
office had
never received a response from law enforcement about issues that had been
forwarded.
Agents Facilitate Company Formation but Are Not Required to Collect
Ownership Information or Verify Information on Clients
The roles of company formation agents and agents for service of process
differ, as do the state statutes that govern them.33 Company formation
agents submit documents on a company's behalf, and agents for service of
process receive legal and tax documents for clients. Most states do little
to oversee these agents and do not verify information about them. Further,
states generally do not require agents to collect information on company
ownership or management or to verify the information they collect. The
agents we interviewed generally collect only contact information and any
information required by the states and do not verify the information. In
some circumstances-primarily with international clients and clients
requesting special services-some agents may verify a client's identity.
Company Formation Agents and Agents for Service of Process Play Different
Roles
Company formation agents are firms that help individuals form companies by
filing required formation documents and other paperwork with the
appropriate state agencies. Although individuals may file their own
formation documents directly, a company formation agent can facilitate the
process. Agents for service of process can be either persons or entities
that are designated to receive important tax and legal documents on behalf
of businesses. For example, if a company is being sued, the agents for
service of process will accept the legal paperwork and forward it to their
company contacts. Historically, the role of agents was to ensure companies
had a presence in each state they operated in and were able to be reached.
Our review of state statutes showed that almost all states require
companies to designate an agent for service of process on company
formation
documents.34 These agents may provide other services, such as filing
amendments and periodic reports, assisting with mergers and acquisitions,
obtaining certificates of good standing, and conducting other public
record searches. Agents may also provide assistance in setting up bank
accounts or providing directors, although only a couple of the 12 agents
we contacted said that they would provide these services, and then only in
special situations.35 According to a few agents we interviewed, large
companies are more likely to hire agents, especially large companies that
need an agent for service of process in multiple states.
Most states have basic requirements for agents for service of process.
Forty-six states indicated on our survey that they required agents for
service of process to have a physical address in the state (not a post
office box) where documents could be received, while seven states required
agents to keep specific office hours. Individuals serving as agents for
service of process generally must be state residents or have a state
address, but firms acting as agents generally must be authorized to do
business in the state and must have filed company formation documents. A
few states have additional requirements for agents. For example, in Maine,
an agent must be a natural person, while in Louisiana, a professional law
corporation or partnership may serve as the agent.36 In Virginia, agents
for service of process must be individuals who are both a resident and an
officer of the company being formed, members of the state bar, or
companies authorized to do business in the state, and must specify their
qualification on the company formation documents.
Few States Verify Information from or Otherwise Oversee Agents
We found limited incidences of state oversight of agents. A few state
officials we spoke with reported checking company formation documents to
ensure that agents had a local address, but in general they did not check
to see whether the address was valid. One state official said the office
verified addresses only in special cases. Delaware reviews its agents'
addresses if several hundred transactions occur from the same address to
ensure it is an actual address and not a post office box. In addition,
Delaware is unique in allowing approximately 40 agents to have direct
access to the state's database to enter or access company information. The
state contracts with these agents, and in return they must meet certain
guidelines and pay access fees. The state reserves the right to terminate
these contracts at any time but thus far has not done so because of
nefarious behavior. State officials in Florida and Wyoming told us that
they checked their records to ensure that companies acting as agents for
service of process were authorized to conduct business in the state.
Thirty-nine states said they did not track the number of agents for
service of process operating in the state and 36 did not have an official
listing of agents. However, a couple of states have registration
requirements for operating within their boundaries. Wyoming requires
agents serving more than five corporations to register with the state
annually, under a law that was enacted after some agents gave false
addresses for their offices, according to a state official. To register,
agents must pay a $25 annual fee and complete a form each January giving
contact information, including a physical and mailing address, and
indicating whether the applicant or any company principal has ever been
convicted of a felony. The state official said that the office kept the
information on file in case an agent was investigated. California law
requires any corporation serving as an agent for service of process to
file a certificate with the Secretary of State's office and to list the
California address where process can be served and the name of each
employee authorized to accept process. Seventeen states indicated on the
survey that they provide the names of all or some agents on a Web site,
and 6 states reported having some requirements for agents wanting to be
listed on the Web site.37 For example, Delaware requires a business to
have been operating for at least 1 year, to be in good standing, and to
serve more than 50 clients.
Although the notion is controversial, some state officials and agents said
that some level of uniform registration or certification in the industry
might be desirable, for several reasons. One agent told us that the few
agents who do not follow the current rules give the industry a bad name
and that regulation would eliminate some of these agents. Another agent
felt that registration would create some standards in the industry and
provide some legitimacy for firms conducting business in international
jurisdictions that require registration. However, some agents felt that
regulation would be difficult if not detrimental to the industry. One
agent felt that if the industry were regulated, individuals would avoid
using agents and form their companies themselves. Another agent believed
that the costs associated with meeting standards could be high enough to
drive smaller firms out of business. In either case, both agents that
supported and opposed regulation said that the industry should be involved
in efforts to develop some type of registration or regulation that would
affect their business.
Agents We Talked with Said They Generally Do Not Collect Ownership and
Management Information on Companies Because States Do Not Require Them to
Collect It
Agents we spoke with generally collected only contact information and the
information required by a state for company formation documents or
periodic reports. This information may include contact names for billing
and for forwarding service of process, annual reports, or tax
notifications. These agents said they may have only one contact name for a
company. According to several agents, they rarely collect information on
ownership since states do not require it. In general, agents said they
collect the names and addresses of officers and managers, if required, and
when serving as an incorporator, agents may collect information on the
company directors or shareholders, even if it is not required. This
information allows agents to resign as incorporators and pass on the
authority to conduct business to the new company principals. Depending on
the size of the company, the directors and the officers may also be the
owners, but one agent told us that he did not try to determine if they
were. Several agents also told us that they do not always work directly
with the principals of the company because the agents interact directly
with law firms or transact a large part of their business online, and
therefore may not have access to additional information not required by
the state. One agent also noted that collecting ownership information was
not necessary to doing his job.
Even if agents collect information such as the names of officers and
directors, a few agents said that they might not keep records of the
information. For example, two agents told us that their firms did not keep
a database of company information, in part because company documents filed
with the state are part of the public record. Because the information is
public, one agent felt it was not necessary to bear the additional cost of
storing it internally. According to our review of state statutes, some
states have record retention requirements that oblige corporations to make
shareholder lists or the stock ledger available at the registered office
within the state (which may be the agent's office), although the
requirements vary by state. For example, in Nevada, the registered office
is required to keep the stock ledger or a file listing the location of the
ledger, and in New Mexico, a list of shareholders must be available at a
company's registered office 10 days prior to a shareholders' meeting.
Agents Are Not Required to Verify Information in Company Filings, but a
Few Do
States generally do not require agents to verify the information collected
from clients, and few agents we interviewed do. In general, agents told us
they do not verify the validity of names or addresses provided, screen
names against watch lists, or require picture identification of company
officials. The extent of agents' verification might include checking that
the minimum statutory requirements have been met, researching an address
if a client's mail is returned, or comparing a credit card address to a
company's address. One agent said that his firm generally relied on the
information that it received and that in general did not feel a need to
question the information, although another agent said that his firm might
request additional information to assess risk if something about a
potential client seemed suspicious.
Two agents with whom we spoke indicated that they collected additional
information that could be used to verify the identity of clients, often
when working with international clients, although the choice to verify
information did not appear to be based on a formal risk assessment. These
agents said they might check names against caller identification systems
on their telephones or against the Office of Foreign Assets Control (OFAC)
list of Specially Designated Nationals and Blocked Persons.38 One agent
said that her firm created a document to collect additional information
from clients from unfamiliar countries. This agent's document was based in
part on federal standards for financial institutions from the USA PATRIOT
ACT.39 On the document, the agent asks for a federal tax identification
number (TIN); company ownership information; information from the company
Web site; e-mail addresses; and, for individuals, identification, proof of
occupation, and citizenship status.
Another agent we interviewed in Delaware asked for identification and used
a specific agreement with certain international clients. In some cases,
international agents contact the Delaware agent for assistance in forming
U.S. companies for their clients in other countries. According to this
agreement, international agents must verify the identity of an individual
wishing to form a company through the Delaware agent by requiring their
client to provide the principals' names, addresses, dates and places of
birth, nationalities, and occupations, as well as certified copies of
their passports, proof of address, and a reference letter from a bank.40
This agent also required a client requesting mail forwarding services to
provide additional information, such as a Social Security number, in
addition to the information required by the U.S. Postal Service on its
mail forwarding form. The agent said the firm collected this information
to screen potential clients and protect the firm and that it would stop
representing a client if the client generated a significant amount of
service of process, complaints, or visits from investigative agents. In
general, the agent felt the additional requirements were not burdensome.
Another agent noted that any extra time added to the process was a result
of the time required for the client to provide the information.
In addition, a few other agents said that they used the OFAC list to
screen names on formation documents or on other documents required for
other services provided by their company, although several agents told us
they were not aware of the OFAC list. A few agents we interviewed in
Delaware used commercially available software to screen client names
against the OFAC list, a step strongly encouraged by the Secretary of
State. However, one agent told us that his staff had never gotten a match
on the list. One agent felt that running checks on the names listed on
company documents could add time to the process but would likely not be a
burden. Other agents found the list difficult to use and saw using it as a
potentially costly endeavor. OFAC officials reported that they had also
heard from agents that screening names against the OFAC list would result
in increases in the time and cost of the process, which could lead to a
loss in business.
Law Enforcement Officials Can Obtain Some Company Information from States
and Agents, but a Lack of Ownership Information Obstructs Some
Investigations
Law enforcement officials are concerned about the use of U.S. shell
companies to facilitate or hide criminal activity. Law enforcement
officials we interviewed noted that they often used the information
available from states in investigating shell companies that were suspected
of criminal activities and said that, in some cases, the names of officers
and directors on company filings had generated additional leads. However,
officials also said that the information states collected was limited,
noting that it could provide a place to start but that some cases had been
closed because of insufficient information on beneficial owners.
Law Enforcement Officials Are Concerned about the Use of U.S. Shell
Companies to Facilitate Criminal Activity
Law enforcement officials and other reports indicate that shell companies
have become popular tools for facilitating criminal activity, particularly
laundering money.41 In December 2005, several agencies of the federal
government, including the Departments of the Treasury, Justice and
Homeland Security, issued the first governmentwide analysis of money
laundering in the United States, which described, among other things, how
shell companies can be used to launder money. Shell companies can aid
criminals in conducting illegal activities by providing an appearance of
legitimacy-for example, an artificial source of income or proof of the
type of transactions legitimate companies conduct. Shell companies can
also provide access to the U.S. financial system through U.S. bank
accounts or offshore accounts in banks that have a correspondent
relationship with a U.S. bank.42 For example, in a Financial Crimes
Enforcement Network (FinCEN) December 2005 enforcement action, FinCEN
determined, among other things, that the New York branch of ABM AMRO, a
banking institution, did not have an adequate anti-money-laundering
program and had failed to monitor approximately 20,000 funds
transfers-with an aggregate value of approximately $3.2 billion-involving
the accounts of U.S. shell companies and institutions in Russia or other
former republics of the Soviet Union.43
Determining a precise number of criminal cases involving the use of shell
companies to hide illicit activity is difficult because forming such
companies is not a crime but rather is sometimes used as a method for
moving money that may be associated with a crime. Therefore, the use of
shell companies for illicit activities is not tracked by law enforcement
or
government agencies.44 However, law enforcement officials told us they are
seeing a wide range of indicators that suggest the increased use of U.S.
shell companies for illicit activities.
o FinCEN officials told us they see many suspicious activity reports (SAR)
filed by financial institutions that potentially implicated shell
companies in the United States. For example, FinCEN reported in the U.S.
Money Laundering Threat Assessment that financial institutions filed 397
SARs between April 1996 and January 2004 involving shell companies, East
European countries, and correspondent bank accounts. The aggregate amount
of activity reported in these SARs totaled almost $4 billion.
o Justice officials said that law enforcement officials from other
countries have asked the United States to help them track down the
individuals that had formed U.S. shell companies to hide illicit activity,
but the lack of ownership information is obstructing their investigations.
For example, a review by Justice of requests for legal assistance in 2005
from Russia and Ukraine found 30 requests for assistance from Russian
authorities and 75 requests from Ukraine authorities involving U.S. shell
companies. These requests typically ask for assistance in identifying
individuals associated with the U.S. companies. However, Justice's
attempts to gather information in response to these requests on the
companies are obstructed by the lack of information maintained by states
and agents. These requests often involve serious crimes occurring in other
countries but implicate a U.S. company. For example, in early 2006, one
request was seeking information on a U.S. corporation allegedly used to
smuggle a toxic controlled substance between two Eurasian countries
because the name of the U.S. corporation was on the foreign customs
papers.
o OFAC expressed concerns that shell companies can be used to facilitate
transactions with targets (individuals, entities, or countries) of U.S.
economic sanctions. In one example, during the period when the United
States maintained sanctions against Yugoslavia (Serbia and Montenegro), a
U.S. company formation agent filed incorporation papers for a Serbian
entity, which then opened bank accounts in the United States as a U.S.
company to transfer money through the United States.
o The FBI told us they currently have over 100 ongoing cases investigating
market manipulation and that the majority of these cases involve the use
of shell companies. One closed case, for example, involved the sale of
fraudulent private placement offerings to the investing public. The
convicted individuals used U.S. shell companies to give investors the
impression that they were investing in legitimate companies, but instead
the individuals stole the investors' proceeds. In some cases, individuals
have used shell companies to pump up the price of a stock and then sell
their entire position in the stock while legitimate investors are left
with worthless stock.
o The FBI has also expressed concern about the use of third-party agents
to form thousands of shell companies in the United States for criminals
operating in other countries; the criminals then use the shell companies
to open U.S. bank accounts. The FBI believes that U.S. shell companies are
being used to launder as much as $36 billion from the former Soviet Union.
An FBI analysis of the use of these third-party agents found that they
often register the shell company using nominee officers to keep the
foreign beneficial owner anonymous and use companies created at an earlier
date-"aged shelf companies"-to give banks and regulatory authorities the
impression the company has longevity.
Law enforcement officials provided us with examples of cases involving the
use of U.S. shell companies. According to a Department of Justice report
on Russian money movements, many of the investigations involving shell
companies use common schemes to launder money and conceal money movements.
In a "fictitious services" scheme, the criminals enter into a contract
with a company purportedly offering an intangible service, such as
consulting. The consulting company is actually a shell company owned by
the criminals, so that payments for consulting services are actually
payments into a bank account under their control. In one case involving a
fictitious services scheme, a former public official from the Russian
Federation allegedly helped to unlawfully divert international nuclear
assistance funds that were intended to upgrade the safety of nuclear power
plants operating in Russia and several former republics of the Soviet
Union. The indictment stated that the suspects formed shell companies in
Pennsylvania and Delaware that received the nuclear assistance payments
and then diverted over $15 million of this money to corporate bank
accounts. Ultimately the money was allegedly transferred to other personal
bank accounts in the United States and other countries and the transfers
concealed behind fictitious business contracts. The subjects of the
indictment allegedly used at least $9 million to fund business investments
and loans for their personal enrichment.
IRS investigations have also uncovered the use of U.S. shell companies in
tax evasion schemes. In one tax evasion case, two co-conspirators used
nominee names to open bank accounts and form U.S. corporations in Florida
to hide their assets and income to avoid tax liabilities. One
co-conspirator was sentenced to 10 years in prison and ordered to pay $1.6
million in restitution. The other co-conspirator was sentenced to 25 years
imprisonment for his involvement in the tax evasion scheme, as well as a
related investment fraud scheme.
ICE officials also told us they have encountered the use of U.S. shell
companies in their investigations. ICE officials interviewed a third-party
agent who had registered approximately 2,000 companies for international
clients. The registrations took place mostly in Oregon, but also in
Arkansas, Colorado, Idaho, Iowa, Kentucky, Montana, South Dakota,
Washington, and West Virginia. The investigation was prompted by a bank
that had reported suspicious transactions in an account of one of the
companies registered by this agent. This case was subsequently closed
because the agent moved from the area and could not be found.
Information from Company Filings and Agents Is Available and Useful to Law
Enforcement, but Is Often Too Limited to Solve Cases
Law enforcement officials obtain some company information from states and
agents through a variety of methods. Our review of states' Web sites found
that 46 states provide some company information online for free, but that
states post different amounts of company information on their Web sites.45
For instance, Virginia officials told us that while the name of the
incorporator is on the articles of incorporation, it is not added to the
on line database. In addition, Delaware lists only the company name and
the name and address of the agent online, while Florida makes copies of
all documents available with all of the information they contain,
including names of directors and managers. Given the variations in what is
available online, law enforcement officials may request paper copies of
filings that could provide more information. Law enforcement officials may
also obtain company information from agents, although some law enforcement
officials said they do not usually request information from agents because
too little would be available, and one state law enforcement official said
the agents might tell their clients about the investigation. Some agents
told us they usually collect the same information as the state, but other
agents and law enforcement officials indicated that agents might have
additional information that could be useful in investigations, such as
contact addresses and methods of payment.
While ownership information is typically not available from states or
agents, some law enforcement officials said the names of officers and
directors and other information on forms could be helpful in some
investigations. If ownership information is not available, law enforcement
officials said that the names of officers and directors-even false
names-could provide productive leads. In addition, law enforcement
officials said that other information, such as addresses, could be
investigated and also might provide productive leads.
In other cases, though ownership information is not required, the actual
owners may include personal information on the state's documents. For
example, IRS investigated four people in Michigan who formed 15 shell
corporations in Michigan and Indiana. Using these shell companies, the
co-conspirators established 37 lines of credit at a bank and charged a
number of large purchases, including real property, several luxury cars,
jewelry, boats, and a motor home. The bank incurred losses of
approximately $9.6 million. The IRS investigators found key pieces of
evidence, including the identity of the co-conspirators, on the articles
of incorporation and annual reports maintained by the states where the
corporations were formed. Two of the co-conspirators were sentenced to 45
months and 51 months in prison and ordered to pay $327,500 and $2.8
million in restitution, respectively. In another IRS case, a man in Texas
used numerous identities and corporations formed in Delaware, Nevada, and
Texas to sell or license a new software program to investment groups. He
received about $12.5 million from investors but never delivered the
product to any of the groups. The man used the corporations to hide his
identity and to provide a legitimate face to his fraudulent activities. He
also used the companies to open bank accounts to launder the money
obtained from investors. IRS investigators found from state documents that
he had incorporated the companies himself and often included his
co-conspirators as officers or directors. The man was sentenced to 40
years in prison.
In some cases, law enforcement officials have evidence of a crime but
cannot connect an individual to the criminal action without ownership
information. For example, an Arizona law enforcement official charged with
helping investigate an environmental spill that caused $800,000 in damage
said that the investigators could not prove who was responsible for the
damage because the suspect had created a complicated corporate structure
involving multiple company formations.46 ICE officials described a subject
who allegedly used an agent to establish a Nevada-based corporation that
in almost 2 years received 3,774 wire transfers totaling $81 million from
locations such as the Bahamas, British Virgin Islands, Latvia, and Russia.
However, ICE could not identify the suspect as the beneficial owner of the
corporation because other people had handled the transactions. These cases
were not prosecuted because investigators could not identify critical
ownership information. Most of the law enforcement officials we
interviewed said they had also worked on cases that reached dead ends
because of the lack of U.S. company ownership information.
More Company Ownership Information Could Be Useful to Law Enforcement, but
Concerns Exist about Collecting It
State officials, agents, and others we interviewed said that collecting
company ownership information could be useful to law enforcement and other
interested parties. As we have discussed, investigations can be closed
because of a lack of information, such as the names of the beneficial
owners of a company. But if states or agents collected additional
information on companies, filing times could increase, and a few states
worried that costs could increase and company start-ups could be deterred.
Further, information collected when companies were being formed might not
be complete or up to date, as officers and directors might not have been
chosen and the ownership could change after the company was formed. In
addition, including such information in public records could cause
concerns about privacy and related issues. State officials, agents, and
other experts in the field suggested internal company records, financial
institutions, and the IRS as alternative sources that might already be
collecting this information. However, obtaining information from these
sources also has limitations because the information may not be up to date
or available.
States and Agents Acknowledged Benefits of Having Additional Information
on Company Ownership but Raised Concerns about Collecting It
Collecting ownership information when companies are formed could have some
positive impacts for law enforcement as well as members of the public
searching for this information. As shown in figure 6, 21 states in our
survey said that if more ownership information were collected at company
formation, that additional information would be available to law
enforcement and the public. And as we have discussed, law enforcement
investigations can benefit from knowing who owns and controls a company. A
couple of state officials said that collecting such information would also
allow them to be more responsive to consumer demands they have received
for this information. For example, officials in Arizona and the District
of Columbia told us that they often received phone calls from the public
asking for ownership information they could not provide. In addition, one
agent suggested that requiring agents to collect more ownership
information could discourage dishonest individuals from using agents and
could reduce the number of unscrupulous individuals in the industry.
State officials and agents noted that collecting additional information
could increase filing times, and a few were concerned about other negative
effects. Our survey showed that 29 states reported that the time needed to
review and approve formations would increase if information on ownership
was collected, since more data would need to be recorded in their
databases (see fig. 6). A few states calculated that they would incur
additional costs in modifying their forms, databases, and online filing
systems to accommodate the new requirements. One state official said the
extra time that would be required to review filings would reduce the
benefits of electronic filing. Agents we interviewed also said that
collecting and storing ownership information would increase the time
necessary to provide their services and raise costs for both themselves
and their clients. Other agents said that collecting and verifying
ownership information would be difficult because they may have contact
only with law firms and not company officials when a company is formed.
State officials and others also noted that individuals could easily
provide false names if ownership information were required without being
verified.
Figure 6: Implications of All of the States Collecting Information on
Company Ownership
Our survey results showed that in nearly half the states (23), officials
thought the number of companies formed in their jurisdictions would stay
about the same if all of the states collected this additional information
(see fig. 6). But some state officials and others we interviewed said that
if the requirements were not uniform, states with the most stringent
requirements could lose business to other states or even countries,
potentially losing state revenue. Some state officials noted the
importance of the fees generated from company formations to state general
revenue funds. For example, a Delaware official said that 22 percent of
the state's revenue comes from the company formation business. Also,
Nevada and Oregon officials stated that their offices were
revenue-generating offices for the state. State officials, agents, and
industry experts commented that states would be unlikely to pass
comparable laws because state officials have such different opinions about
the amount of information that should be disclosed.47 As a result,
individuals could form companies in states where the requirements were
easiest to follow. Agents also expressed concern that they could lose
business if they collected ownership information, because individuals
might be more likely to form their own companies and serve as their own
agents.
Individuals forming businesses could also be affected by new requirements
for collecting company information. Some officials noted that the
additional time required to review filings could slow down and might
derail business dealings. One state official commented that such
requirements would create a burden for honest business people who would
have provided accurate information in the first place but would not deter
criminals, who would provide false information in any case. According to a
report on the use of companies for illicit purposes, requiring companies
to disclose up front and to update ownership information may impose
significant costs, particularly on small businesses.48 A few state and
some private sector officials noted that an increase in the time and costs
involved in forming a company might reduce the number of companies formed,
because entrepreneurs and investors might be less likely to take the risks
involved in forming or investing in new companies.
Some state officials also noted that to change the information
requirements, state legislatures would have to pass new legislation and
grant company formation offices new authority. A few states indicated that
collecting additional information would require higher fees that would
also need to be set by their state legislatures. State officials also
noted that since they are administrative agencies, they generally do not
have the authority to question or verify the information provided on the
forms and would need additional authority from state legislatures to do
so.
State and private sector officials pointed out that ownership information
collected at formation or on periodic reports might not be complete or up
to date. Information collected at formation, for instance, might not be
useful because ownership information can change frequently throughout the
year. For example, an official from Delaware commented that many privately
held LLCs and corporations in Delaware and other states may have thousands
of shareholders and LLC members that buy and sell shares and memberships
on a daily basis. Another state official commented that collecting this
information at formation would not be useful without requiring that it be
updated frequently. In addition, since LLCs can be owned by individuals or
other businesses, even if states required LLCs to list a member name, the
name provided may not be that of an individual but another company.
Disclosing ownership information on periodic reports, however, could mean
that a year or more would pass before it was collected-too long to be of
use in many investigations. In addition, we found that some states do not
require these reports.49 Further, once it is formed, a shell company being
used for illicit purposes in the United States or other countries may not
file required periodic reports. Law enforcement officials told us that
many companies under investigation for suspected criminal activities had
been dissolved by the states in which they were formed for failing to
submit periodic reports.
State Officials and Others Were Concerned about Privacy Issues
State officials, agents, and other industry experts said the need for
access to information on companies must be weighed against privacy issues.
Company owners may want to maintain their privacy in part because state
statutes have traditionally provided this privacy and in part to avoid
lawsuits against them in their personal capacity. Some business owners may
also seek to protect personal assets through corporations and LLCs. One
state law enforcement official also noted that if more information were
easily available, criminals and con artists could take advantage of it. He
noted that information available on official Web sites was sometimes used
to target companies for scams. For example, the official described a case
in which an individual sent letters that appeared to be from a secretary
of state's office to companies listed on the state Web site, telling the
recipients that they were to file their annual meeting minutes with the
state, although no such requirement existed. The individual offered to
provide filing services for a fee, and collected the fees from companies,
but did not forward any minutes to the state. Providing more easily
accessible information to the public could result in more such activities.
Business owners might be more willing to provide ownership information if
it were not disclosed in the public record. Some state officials we
interviewed said that since all information filed with their office is a
matter of public record, keeping some information private would require
new legislative authority. The officials added that storing new
information would be a challenge because their data systems are not set up
to maintain confidential information. However, one official from Maryland
said that keeping some information private would not be a problem since
the office that accepted company formation and periodic report filings
also handled tax filings and already had procedures for keeping
information such as taxpayer identification numbers confidential. An
official in Oregon also told us that the Corporations Division office had
recently enacted procedures to keep some information private in cases such
as domestic abuse. Individuals can petition the state to have information
removed from databases available online and redacted in the paper file,
but it is still available to law enforcement. The Arizona Corporation
Commission also tries to remove Social Security numbers from its Web site
if applicants include them on their paper forms, but maintains the
information on paper forms.50
Two Foreign Jurisdictions Have Had Mixed Experiences with Requiring the
Collection of Company Ownership Information
Because states do not typically collect and verify ownership information
and because state and private sector officials could not quantify the
extent of the possible costs of taking these steps, we reviewed the
experiences of Jersey and Isle of Man in implementing the regulation of
firms that provide services such as company formation (company service
providers).51 Fewer companies are formed in both jurisdictions, especially
by local residents, than in the United States, and the number of company
service providers is much smaller.52 However, some of the concerns states
and agents expressed about increased regulation also have been born out in
Jersey and the Isle of Man, although officials also pointed to certain
benefits of collecting ownership information and the new regulatory
regime. Company service providers in both jurisdictions must be licensed,
and are subject to periodic monitoring and inspections by government
agencies. In both of these jurisdictions, company service providers are
required to conduct due diligence to verify the identity of their clients
and obtain company ownership information to form a new company. The
ownership information is not maintained in the public record, but is kept
at the registry in Jersey and with company service providers in Isle of
Man and is available only to law enforcement.
Despite strong initial resistance, the company service provider industry
in these two jurisdictions is now perceived as successful because licensed
companies have continued to remain profitable. In addition, one company
service provider told us that the regulations have instilled a degree of
professionalism in the company service provider industry. Further, law
enforcement officials can obtain information about company ownership when
they need it.
However, government and private sector officials told us that implementing
these regulations was a significant challenge. Both jurisdictions
experienced consolidation in the company service provider industry. Some
companies merged, and others moved to locations with fewer requirements or
went out of business because they either did not want to comply with the
new regulations or could not charge fees high enough to cover due
diligence costs. One company service provider said the time required to
form a company increased, as the due diligence requirements company
service providers must follow can take weeks to complete depending on the
client, though once documents are submitted to the Jersey or Isle of Man
registry offices, formations are finished in 48 hours or less. The
workload of company service providers has also increased. One company
service provider told us that the company had increased its staff by 25
percent to 30 percent because of the requirement that the company verify
customer information. Fewer companies are formed in Isle of Man, according
to an Isle of Man official. Before the regulations, Isle of Man had 40,000
incorporated entities, but it now has 35,000. Finally, because ownership
is fluid, it is a challenge to keep the information up to date. In Isle of
Man, the responsibility for keeping information up to date lies with the
company service providers. In Jersey, ownership information is updated on
annual reports.
Other Potential Sources of Company Information May Be Available, but
Obtaining Information from These Sources May Also Be Challenging
State officials, agents, and others told us that some other sources of
company ownership information that law enforcement officials could access
existed, including internal company documents, financial institutions, and
the IRS.
Internal Company Documents
Our review of state statutes found that all states require corporations to
prepare a list of shareholders, typically before the mandatory annual
shareholder meeting, and that almost all states require that this list be
maintained at the corporation's principal or registered office.53 Industry
experts told us that LLCs also usually prepare and maintain operating
agreements that generally name the members and outline their financial
interests.54 These documents are generally not public record, but law
enforcement officials can subpoena them to obtain ownership information,
and ICE officials in one field office said they always looked at LLC
operating agreements during an investigation. However, accessing these
lists may be problematic, and the documents themselves might not be
accurate or even exist. For example, law enforcement officials said that
shell companies may not prepare these documents and that U.S. officials
may not have access to them if the company is located in another country.
In addition, law enforcement officials may not want to request these
documents in order to avoid tipping off a company about an investigation.
Industry experts also cautioned that even these internal documents may not
reveal the true beneficial owners of a company. For example, the list
could include nominee shareholders, which would reduce the usefulness of
the shareholder list because the shareholder on record may not be the
beneficial owner.55 In addition, shareholders could sell their stock and
not register the sale with the company; in such cases, the new owners
would not be known. Shareholders could also sell their stock before the
filing date and then buy it back after the filing date to avoid being
listed. Further, in states that allow bearer shares, the owners' names are
anonymous because bearer share certificates do not contain the names of
the shareholders.56 Therefore, while law enforcement authorities could
obtain lists of shareholders from companies by subpoena, further
investigation might still be needed to find the true beneficial owners.
Financial Institutions
Financial institutions may also have ownership information on some
companies. Customer Identification Program (CIP) requirements implemented
by the USA PATRIOT ACT in 2001 establish minimum standards for financial
institutions to follow when verifying the identity of their customers in
connection with the opening of an account.57 Under these standards,
financial institutions must collect the name of the company, its physical
address (for instance, its principal place of business), and an ID number,
such as the tax identification number. The regulations also mandate that
financial institutions develop risk-based procedures for verifying the
identity of each customer to the extent that doing so is reasonable. For
example, representatives from financial institutions told us that they
typically requested a company's articles of incorporation when a new
account was opened to verify that the entity existed. One representative
said that his institution also checked names against the OFAC list and
requested photo identification from all signers on the account. Industry
representatives noted that institutions may also compare the customer
information with information obtained from a consumer reporting agency,
public database, or other sources. Finally, based on a risk assessment,
the institution may obtain information about individuals with authority or
control over the account in order to verify their identities.58
Representatives of financial institutions told us that although they are
not required to obtain ownership information in all cases, they may
investigate high-risk applicants to uncover the ultimate beneficial
owners. These applicants may include casinos, companies that are not
listed on world stock exchanges, companies with complex structures, or
companies from certain high-risk countries.59 For such applicants,
financial institutions may ask about information such as beneficial owners
and officers of the company. Financial industry representatives said that
conducting the necessary due diligence on a company absorbs time and
resources, because institutions must sometimes peel back layers of
corporations or hire private investigators to find the actual beneficial
owner or owners of a company.
One financial institution we interviewed collects the name, date of birth,
and tax identification number of all individuals with ownership and
control of a corporation or LLC. However, officials from some institutions
told us that obtaining such information on all applicants would be an
added burden to an industry that is already subject to numerous
regulations. Some industry officials also said that financial institutions
may not want to request ownership information in all cases for fear of
losing a customer. In addition, industry representatives noted that
collecting ownership information at financial institutions might not
always be useful or available, because ownership might change after the
account was opened and not all companies opened bank or brokerage
accounts. Furthermore, Department of Justice officials noted that, in some
instances, the financial activity of a shell company under investigation
does not involve U.S. financial institutions. Finally, correspondent
accounts create opportunities to hide the identities of the account
holders from the banks themselves. A foreign bank can open a correspondent
account with a U.S. bank to avoid bearing the costs of licensing,
staffing, and operating its own offices in the United States. Many of the
largest international banks serve as correspondents for thousands of other
banks. The USA PATRIOT ACT requires financial institutions that provide
correspondent accounts to foreign banks to maintain records of the foreign
bank's owners and of the name and address of an agent in the United States
designated to accept service of process for the foreign bank for records
regarding the correspondent account.60 However, law enforcement and
industry representatives told us that the foreign banks may commingle
funds from many different customers into one correspondent account, making
it difficult for U.S. banks to identify the individuals with access to the
account.61
IRS
IRS was mentioned as another potential source of company ownership
information for law enforcement, but IRS officials pointed to several
limitations with this data. First, IRS may not have information on all
companies formed. The agency collects company ownership information on
certain forms, such as the application for an employer identification
number (EIN) (SS-4).62 Form SS-4 requires the name and tax identification
number (such as the Social Security number) of the principal officer if
the business is a corporation, or general partner if it is a partnership,
or owner if it is an entity that is disregarded as separate from its owner
(disregarded
entity), such as a single member LLC.63 Disregarded entities owned by a
corporation enter the corporation's name and EIN. However, not all LLCs
are required to have EINs.64 In addition, the name of an owner may be on
the form LLCs file to select how they will be taxed. IRS also currently
collects some general ownership information, including an identifying
number, name, and address, on certain LLCs on separate schedules that the
company files with the IRS.65 For LLCs that are taxed as partnerships,
this form specifies whether members are member-managers or another type of
member of an LLC and reports the member's share of the company profits,
losses, and capital. But if an LLC has only one member, the individual
reports income on an individual tax return.66 In addition, IRS classifies
certain LLCs as corporations for tax purposes, and others may choose to be
classified as corporations.67 Ownership information is available for LLCs
that are classified as corporations and file as S corporations, but
generally not for those that are taxed as C corporations.68
Second, IRS officials reported that the ownership information the agency
collected may not be complete or up to date. As we have discussed, the
agency does not have information on every company, because some companies
do not request or need EINs. In addition, some EINs become inactive after
a certain period, dropping off the IRS database. For example, Department
of Justice officials told us that U.S. shell companies being used in
foreign criminal activity are sometimes inactive in the United States. In
addition, ownership information on LLCs owned by foreign individuals or
entities would only be available if the LLC obtained an EIN for income
that was subject to tax in the United States. Further, data gathered on
IRS forms may not always be accurate. In a recent report, we found that
data transcription errors made by IRS staff entering data into a database
and invalid taxpayer identification numbers submitted by companies lowered
the accuracy of these data.69 IRS officials also noted that the
information collected might not always be useful in finding the ultimate
beneficial owner of a company, because another entity could be listed as
the owner, requiring further investigation to identify the true owner.
Finally, IRS officials said that the information in the agency's records
might not be up to date because IRS was not always notified when ownership
changed.
Third, law enforcement officials could have difficulty accessing IRS
taxpayer information. As part of the administration of federal tax laws,
IRS investigators can use IRS data in their investigations of tax and
related statutes, but access by other federal and state law enforcement is
restricted by 26 U.S.C. S: 6103.70 IRS officials said that federal law
enforcement officials can access IRS information provided by taxpayers (or
their representatives) when a federal court issues an ex parte order.71
Under 26 U.S.C. S: 6103(i)(1), the federal law enforcement agency
requesting the information through an ex parte order must show that it is
engaged in preparation for a judicial, administrative or grand jury
proceeding to enforce a federal criminal statute or that the investigation
may result in such a proceeding.72 Information IRS receives from a source
other than taxpayers (or their representatives), such as taxpayers'
employers or banks, can be obtained without a court order.73 Moreover, in
certain limited situations, there are additional provisions currently in
the tax code providing for disclosure of such information relating to
criminal or terrorist
activities or emergency circumstances.74 State law enforcement officials
can access IRS information for enforcement of state tax laws when IRS has
sharing agreements with state taxing authorities.75 Law enforcement
officials can also obtain IRS information with the taxpayer's consent.76
Officials in one ICE field office told us that they have obtained IRS
information; however, officials in another ICE field office said that
obtaining this information was difficult. IRS officials commented that
collecting additional ownership and control information on IRS documents
would provide IRS investigators with more detail when conducting
investigations but that the agency's ability to collect and verify such
information would depend on the availability of resources.
Observations
States and agents collect a variety of information when individuals form
companies, but most state statutes do not require that they collect or
verify information on ownership. Therefore, minimal information is
collected on the owners of these companies. During our review, we
encountered a variety of legitimate concerns about the merits of
collecting ownership information on companies formed in the United States.
Many of these concerns reflected conflicting interests. On the one hand,
federal law enforcement agencies were concerned about the lack of
information, because criminals can easily use U.S. shell companies to mask
the identities of those engaged in illegal activities. From a law
enforcement perspective, having more information would make using U.S.
shell companies for illicit activities harder and give investigators more
information to use in pursuing the actual owners. In addition, since U.S.
shell companies are used in criminal activity abroad because of their
perceived legitimacy, collecting more information when a company is formed
could improve the integrity of the company formation process in the United
States. On the other hand, states and agents were concerned about
increased costs, potential revenue losses, and privacy protection.
Collecting more information would require more time and resources and
could reduce the number of start-ups. Approving applications could take
longer, potentially creating obstacles for those forming companies for
legitimate business purposes. And importantly, because information on
companies is currently part of the public record, requiring certain
information on ownership could be considered a threat to the current
system, which values the protection of privacy and individuals' personal
assets.
Any requirement that states, agents, or both collect more ownership
information on certain types of companies would need to balance these
conflicting concerns. Further, such a requirement would need to be
uniformly applied in all U.S. jurisdictions. If it were not, those wanting
to set up shell companies for illicit activities would simply move to the
jurisdiction that presented the fewest obstacles, undermining the intent
of the requirement.
Agency Comments and Our Evaluation
We provided a draft of this report to the Departments of Justice, Homeland
Security, and the Treasury. Justice and Treasury provided technical
comments that were incorporated into the report, where appropriate.
As agreed with your offices, unless you publicly announce its contents
earlier, we plan no further distribution of this report until 30 days from
the report date. At that time, we will send copies to the Departments of
Justice, Homeland Security, and the Treasury; and interested congressional
committees. We will also make copies available to others on request. In
addition, the report will be available at no charge on GAO's Web site at h
ttp://www.gao.gov. The survey and a more complete tabulation of
state-by-state and aggregated results can be viewed at http://w
ww.gao.gov/cgi-bin/getrpt?GAO-06-377SP.
me at (202) 512-8678 or j [email protected]. Contact points for our Offices
of Congressional Relations and Public Affairs may be found on the last
page of this report. GAO staff who made major contributions to this report
are listed in appendix IV.
Yvonne D. Jones Director, Financial Markets and Community Investment
Objectives, Scope, and Methodology Appendix I
This report describes states' company formation and reporting requirements
and the information that is routinely obtained and made available to the
public and law enforcement officials regarding ownership of nonpublicly
traded corporations and limited liability companies (LLC) formed in each
state given concerns about the potential for using companies for illicit
purposes. Specifically, this report discusses
1.the kinds of information-including ownership information-that the 50
states and the District of Columbia collect during company formation and
the states' efforts to review and verify it;
2.the roles of third-party agents, such as company formation agents, and
the kinds of information they collect on company ownership;
3.the role of shell companies in facilitating criminal activity, the
availability of company ownership information to law enforcement, and the
usefulness of such information in investigating shell companies; and
4.the potential effects of requiring states, agents, or both to collect
company ownership information.
To respond to the first objective and describe the ways company formation
and periodic reporting documents can be filed, we conducted a Web-based
survey of the 50 states and the District of Columbia on formation and
reporting practices. We worked to develop the questionnaire with social
science survey specialists. Because these were not sample surveys, there
are no sampling errors. However, the practical difficulties of conducting
any survey may introduce errors, commonly referred to as nonsampling
errors. For example, differences in how a particular question is
interpreted, in the sources of information that are available to
respondents, or in how the data are entered into a database can introduce
unwanted variability into the survey results. We took steps in the
development of the questionnaires, the data collection, and data analysis
to minimize these nonsampling errors. For example, prior to administering
the survey, we pretested the content and format of the questionnaires with
state officials in Florida, Maine, Maryland, Virginia, and Washington,
D.C., to determine whether (1) the survey questions were clear, (2) the
terms used were precise, (3) respondents were able to provide the
information we were seeking, and (4) the questions were unbiased. An
official from the International Association of Commercial Administrators
(IACA) also reviewed a draft of the survey. We made changes to the content
and format of the final questionnaires based on pretest results. We sent
the finalized survey to contacts responsible for company filings in
secretary of state offices (or their equivalents) in all 50 states and the
District of Columbia. See Survey of State Officials Responsible for
Company Formation, GAO-06-377SP , for the final version of the survey and
state-by-state results. We received survey responses from each of the 50
states and the District of Columbia. In that these were Web-based surveys
whereby respondents entered their responses directly into our database,
the possibility of data entry error was minimized. We also performed
computer analyses to identify inconsistencies in responses and other
indications of error. We contacted survey respondents as needed to correct
errors and verify responses. In addition, a second independent analyst
verified that the computer programs used to analyze the data were written
correctly.
To test the reliability of survey data, we compared state responses on our
survey with data states provided to IACA in its 2005 annual report of
jurisdictions for four key variables-the number of LLCs and corporations
filed in 2004 and the total number on file. The data were markedly the
same, with very high correlations and no significant differences in mean
values. Based on this testing, we believe our reporting of the trends
based on the number of corporations and LLCs to be reliable. We also
corroborated the survey results with information we collected from a
systematic review of state Web sites and state statutes. Where we found a
discrepancy on key variables, we contacted the relevant state official for
clarification of the state's requirement. Our review of the state
corporation statutes included analysis of provisions regarding company
formation, registered agents, shareholder identification, requirements for
record keeping, and periodic reporting. In addition, we reviewed
provisions in state LLC statutes relating to company formation, periodic
reporting, and registered agents. We also reviewed the content of company
formation forms and other information available on state Web sites. The
data collected from our review of state statutes and Web sites is as of
October 2005. We also visited Arizona, Delaware, Florida, Nevada, and
Oregon to conduct in-depth interviews with state officials about practices
in these states. We selected these states because of the number of
companies formed there or unique practices we identified from the
statutes, forms, or survey responses.
To respond to the second objective and describe the roles of third-party
agents, we interviewed academics with expertise in corporate and LLC law,
selected professional agents, and state officials. In selecting agents to
interview, we interviewed only companies that act as agents for service of
process for more than one client. We chose a range of large national
companies (three) as well as midsize or small companies (nine). We
interviewed selected agents about the information they collect on
companies and analyzed survey results on states' requirements regarding
oversight of these agents. We also interviewed officials from the National
Public Records Research Association, an association that represents
companies providing corporate services and public records research, and
the Nevada Resident Agent Association, which represents a number of
resident agents in Nevada. In addition, we reviewed state statutes for
requirements regarding becoming an agent for service of process.
To respond to the third objective and determine what information states
and agents make available to law enforcement and the public, we reviewed
company formation and periodic reporting forms on state Web sites and
reviewed state Web sites for the type of information made available online
and other methods individuals may use to obtain information. In addition,
we interviewed selected state officials and agents about the methods they
use to provide information. We also interviewed selected state and federal
law enforcement officials about their experiences in obtaining company
information from states to aid their investigations, including officials
from the following state and federal agencies: the Arizona Attorney
General, Drug Enforcement Agency, Federal Bureau of Investigation, the
Florida Attorney General, Immigration and Customs Enforcement, Internal
Revenue Service/Criminal Investigations, Financial Crimes Enforcement
Network, U.S. Attorneys Office, and Office of Foreign Assets Control.
To respond to the fourth objective and determine the implications of
requiring states or agents to collect company ownership information, we
analyzed survey results and interviewed selected state officials and a
range of professional agents. To determine how other jurisdictions have
implemented regimes requiring collection of ownership information, we
interviewed officials from Jersey and Isle of Man, which require the
collection of this information, about the implications of implementing
these requirements. Jersey and Isle of Man are two of a small number of
jurisdictions that require disclosure of beneficial ownership information
when a company is formed. We also reviewed an Organization for Economic
Co-operation and Development report describing requirements in one of the
jurisdictions. To determine other potential sources of company
information, we asked academics, agents, state officials, law enforcement
officials, and representatives of professional associations their
perspectives on where this information could be obtained. We also reviewed
state statutes on requirements for company record keeping. In addition, we
interviewed representatives of selected financial institutions and the IRS
about the company information they typically collect.
We conducted our work from May 2005 through March 2006 in Arizona,
Delaware, Florida, Maryland, Nevada, New York, Oregon, Virginia, and
Washington, D.C. We performed our work in accordance with generally
accepted government auditing standards.
Company Formation and Reporting Documents Can Be Submitted in a Variety of
Ways Appendix II
Company formation and reporting documents can be submitted in person or by
mail, and many states also accept filings by fax. Review and approval
times can depend on how documents are submitted. For example, a District
of Columbia official told us that a formation document submitted in person
could be approved in 15 minutes, but a document that was mailed might not
be approved for 10 to 15 days. Most states reported that documents
submitted in person or by mail were approved within 1 to 5 business days,
although a few reported that the process took more than 10 days. Officials
in Arizona, for example, told us that it typically took the office 60 days
to approve formation documents because of the volume of filings the office
received.
In 36 states, company formation documents, reporting documents, or both
can be submitted through electronic filing (fig. 7 shows the states that
provide a Web site for filing formation documents or periodic reports).1
In addition, some officials indicated that they would like or were
planning to offer electronic filing in the future. Of the 36 states that
allow electronic filing, 23 or more reported a moderate or greater benefit
in the following areas as a result of electronic filing:
o less paperwork;
o reduced staff time for recording and processing filings;
o less need to store paper records;
o electronic transfer of filing fees; and
o built-in edit and data reliability checks.
State officials also commented that they had seen their error or rejection
rates fall, and had been able to improve their customer service with
electronic filing. States said that there were some or moderate costs
associated with electronic filing, such as increased expenses for
technology (hardware and software) and staff training. Overall, according
to our survey, 28 of the 36 states that offer electronic filing reported
that the benefits exceeded the costs.
Figure 7: States That Provide a Web Site for Filing Formation or Periodic
Report Filings
Company Formation Fees
As shown in table 3, in many cases states charge the same or nearly the
same fee for forming a corporation or an LLC. In others, such as Illinois,
the fee is substantially different for the two business forms. We found
that in two states, Nebraska and New Mexico, the fee for forming a
corporation may fall into a range. In these cases, the actual fee charged
depends on the number of shares the new corporation will have. As stated
earlier, the median company formation fee is $95, and fees for filing
periodic reports range from $5 to $500.
Table 3: State Company Formation Fees as of November 2005
State LLCs Corporations
Alabama $75 $40
Alaska 250 250
Arizona 50 60
Arkansas 50 50
California 70 100
Colorado 125 125
Connecticut 60 150
Delaware 90 50
District of Columbia 150 89
Florida 125 79
Georgia 100 100
Hawaii 50 50
Idaho 100 100
Illinois 500 150
Indiana 90 90
Iowa 50 50
Kansas 165 90
Kentucky 40 40
Louisiana 75 60
Maine 175 145
Maryland 100 100
Massachusetts 500 275
Michigan 50 60
Minnesota 135 135
Mississippi 50 50
Missouri 105 58
State LLCs Corporations
Montana 70 70
Nebraska 100 60-300
Nevada 75 75
New Hampshire 100 50
New Jersey 125 125
New Mexico 50 100-1,000
New York 200 125
North Carolina 125 125
North Dakota 125 80
Ohio 125 125
Oklahoma 100 50
Oregon 50 50
Pennsylvania 125 125
Rhode Island 150 230
South Carolina 110 135
South Dakota 125 125
Tennessee 300 100
Texas 200 300
Utah 52 52
Vermont 75 75
Virginia 100 25
Washington 175 175
West Virginia 100 50
Wisconsin 170 100
Wyoming 100 100
Source: GAO analysis of state Web sites.
Thirty states reported offering expedited service for an additional fee.
Of those, most responded that with expedited service, filings were
approved either the same day or the day after an application was filed.
Two states reported having several expedited service options. Nevada
offers 24-hour expedited service for an additional $125 above the normal
filing fees, 2-hour service for an extra $500, and 1-hour, or "while you
wait," service for an extra $1,000. Delaware offers same day service for
$100, next day service for $50, 2-hour service for $500, and 1-hour
service for $1,000.
Information on Company Formation Documents Appendix III
This appendix includes a table of the information states require in their
company formation documents for corporations and LLCs. As shown in figure
8, states collect different information on their company formation
documents. Most states require the company name, agent name and address,
and the name and signature of the incorporator or organizer, and for
corporations, information about the number and types of shares the
corporation will issue. The requirements for the company's purpose,
principal address, and names and addresses of owners and management are
not as consistent across the states.
Figures 9 and 10 are examples of company formation documents from two
states that have different information requirements.
Figure 8: Key Information Required on Articles of
Incorporation/Organization
aAlthough state statutes may not require this information, some states
request or require this information be included on the company formation
documents.
bInformation on number and type of shares and officer names and addresses
applies only to corporations.
cNew Mexico and Arkansas did not respond to some of our survey questions.
However, we found from our legal review that Arkansas does not require the
address of a beneficial owner on articles or periodic reports. Our legal
review also found that New Mexico does require corporations to list the
names and addresses of directors, but not officers or beneficial owners on
articles of incorporation. For LLCs, we found that New Mexico does not
require the names and addresses of members or managers on formation
documents.
Figure 9: Sample Articles of Incorporation Form for a Corporation
Figure 10: Sample Articles of Organization Form for an LLC
GAO Contact and Staff Acknowledgments Appendix IV
Yvonne D. Jones, (202) 512-8678 or j [email protected]
In addition to the contact named above, Kay Kuhlman (Assistant Director),
LaKeshia Allen, Todd M. Anderson, Carolyn Boyce, Emily Chalmers, William
R. Chatlos, Jennifer DuBord, Marc Molino, Jill M. Naamane, and Linda Rego
made key contributions to this report.
Glossary
Agent for service of process
A person or entity authorized to accept service of process or other
important tax and legal documents on behalf of a business. Agents for
service of process may be known as registered agents, resident agents,
statutory agents, or clerks in different states.
Articles of incorporation
A corporate formation document setting forth basic terms governing the
corporation's existence. The articles are filed in most states with the
secretary of state during the formation process. This document is called a
"certificate of incorporation" for corporations formed in Connecticut,
Delaware, New Jersey, New York and Oklahoma; "articles of organization"
for corporations formed in Massachusetts; and a "charter" for corporations
formed in Tennessee.
Articles of association or articles of organization
A governing document legally creating a nonstock organization, similar to
"articles of incorporation" described above for incorporated entities.
This document is called a "certificate of formation" for limited liability
companies formed in Mississippi, New Hampshire, New Jersey, and
Washington, and a "certificate of organization" for limited liability
companies formed in Pennsylvania.
Bearer security
An unregistered security payable to the holder. For instance, a bearer
stock certificate is owned by the person legally holding (in possession
of) the certificate even when no one else knows who holds the certificate.
Bearer shares may be bought, sold, or exchanged in complete privacy.
Beneficial owner
Shareholders with the power to buy or sell their shares in the company,
but who are not registered or reflected in the company's records as the
owners. A beneficial owner is the natural person who ultimately owns or
exercises effective control over a legal entity, transaction, or
arrangement.
Certificate of existence
A certificate issued by a state official as conclusive evidence that a
corporation is in existence or authorized to transact business in that
state. The certificate generally sets forth the corporation's name, and
that it is duly incorporated under the law of that state or authorized to
transact business in that state; that all fees, taxes and penalties owed
to that state have been paid; and that the corporation's most recent
annual report has been filed, and articles of dissolution have not been
filed. Also may be known as a certificate of good standing or certificate
of authorization.
Company formation agent
A person or business that acts as an agent for others by filing documents
with officials of the selected jurisdiction for the formation of legal
business entities. Such agents may also act, or arrange for another person
to act, as a director or secretary of a company, a partner of a
partnership, or a nominee shareholder for another person. Other business
services may also be provided, such as providing a registered office, or a
business, correspondence, or administrative address for a company.
Corporate veil
The legal doctrine of separating the acts of a corporation from the acts
of its shareholders, which prevents the shareholders from being held
personally liable for the acts of the corporation.
Piercing the corporate veil
An equitable doctrine where the separate existence of a corporation is
disregarded by the law and the shareholders are held responsible for the
acts and obligations of the corporation. This doctrine has also been used
in certain circumstances to impose liability on corporate officers and
directors. Piercing the corporate veil is justified only in extraordinary
circumstances where a court finds that a unity of interest and ownership
between an individual and a corporation exists to such an extent that
recognizing a separate existence between the two would result in an
injustice. In such cases, a court may disregard the corporate entity and
impose personal liability on the individual.
Corporation
An artificial being (usually a business entity) created by law that
provides authority for the entity to act as a separate and distinct legal
person apart from its owners and provides other legal rights, such as the
right to exist indefinitely and to issue stock.
Federal law classifies corporations created by state law into S
corporations and C corporations for purposes of federal income taxes as
follows:
S corporation
A small business corporation that elects to be taxed as an S corporation
under the federal tax code.1 The taxable income of an S corporation is
passed through to the shareholders and taxed at the shareholder level.
C corporation
A corporation that is not an S corporation.
Director
A person elected or appointed to serve as a member of the board of
directors for a corporation, which generally manages the corporation and
its officers.
Dummy (or nominee) director
A member of a corporation's board of directors who is a mere figurehead
and who has no true control over the corporation. Typically, a nominee
director may have no knowledge of the business affairs or accounts, may
not exercise independent control of or influence over the business, and
may not act unless instructed to act by the beneficial owner.
Limited liability
Liability restricted by law or contract, such as the liability of the
owners of a business entity for only the capital invested in the business.
Limited liability company (LLC)
A company whose owners (members) have limited liability (see "limited
liability") and that is managed either by managers or its members. An LLC
consists of one or more members (see "member").
Manager-managed company
A limited liability company that designates in its articles of
organization that it is a manager-managed company. In this type of LLC,
each member is not generally an agent of the LLC solely because of being a
member of the LLC. Rather, each manager is such an agent.
Member (LLC)
An owner of an LLC interest; similar to a shareholder in a corporation.
Member-managed company
A limited liability company that does not designate in its articles of
organization that it is a manager-managed company. In this type of LLC,
each member is an agent of the LLC and may generally act on behalf of the
LLC for the purpose of the LLC's business.
Nominee
An individual or entity designated to act on behalf of another, such as a
nominee director acting on behalf of a beneficial owner (see "beneficial
owner"). Most often in offshore tax avoidance schemes, the nominee may
pretend to be the owner of an entity, asset, or transaction to provide a
veil of secrecy as to the beneficial owner's involvement.
Officer
A person elected or appointed by a corporation's board of directors to
manage and oversee the day-to-day operations of the organization, such as
a chief executive officer, chief financial officer, chief administrative
officer, and secretary.
Partnership
An association of two or more persons jointly owning and conducting a
business together where the individuals agree to share the profits and
losses of the business.
Limited partnership
A partnership consisting of one or more limited partners who contribute
capital to and share in the profits of the partnership, but whose
liability for partnership debts is limited to the amount of their
contribution and one or more general partners who control the business and
are personally liable for the debts of the partnership.
Limited liability partnership (LLP)
A partnership where a partner is not liable for the negligent acts
committed by other partners or by employees not under the partner's
supervision. Certain businesses (typically law firms or accounting firms)
are allowed to register under state statutes as this type of partnership.
Limited liability limited partnership (LLLP)
A partnership where general and limited partners are not liable for the
partnership's debts and obligations because of their status as a partner.
Service of process
The delivery of legal process or other legal notice, such as a writ,
citation, summons, or a complaint or other pleading filed in a civil court
matter.
Sole proprietorship
A business where one person owns all of the business assets, operates the
business, and is responsible for all of the liabilities of the business in
a personal capacity.
(250242)
www.gao.gov/cgi-bin/getrpt? GAO-06-376 .
To view the full product, including the scope
and methodology, click on the link above. To view the results of GAO's
survey of state officials responsible for company formations, click:
www.gao.gov/cgi-bin/getrpt? GAO-06-377SP . For more information, contact
Yvonne Jones at (202) 512-8678 or [email protected].
Highlights of GAO-06-376 , a report to the Permanent Subcommittee on
Investigations, Committee on Homeland Security and Governmental Affairs,
U.S. Senate
April 2006
COMPANY FORMATIONS
Minimal Ownership Information Is Collected and Available
Companies form the basis of most commercial and entrepreneurial activities
in market-based economies; however, "shell" companies, which have no
operations, can be used for illicit purposes such as laundering money.
Some states have been criticized for requiring minimal ownership
information to form a U.S. company, raising concerns about the ease with
which companies may be used for illicit purposes. In this report, GAO
describes (1) the kinds of information each of the 50 states and the
District of Columbia and third party agents collect on companies, (2) law
enforcement concerns about the use of companies to hide illicit activity
and how company information from states and agents helps or hinders
investigations, and (3) implications of requiring states or agents to
collect company ownership information.
What GAO Recommends
While not making recommendations, GAO observes that if a requirement to
collect company ownership information is considered, it would be useful
for policymakers to consider (1) options that balance the conflicting
concerns among states, agents, and law enforcement agencies; and (2)
uniformly applying any such requirement to all states or agents.
Most states do not require ownership information at the time a company is
formed, and while most states require corporations and limited liability
companies (LLC) to file annual or biennial reports, few states require
ownership information on these reports. With respect to the formation of
LLCs, four states require some information on members, who are owners of
the LLC. Some states require companies to list the names and addresses of
directors, officers or managers on filings, but these persons may not own
the company. Nearly all states screen company filings for statutorily
required information, but none verify the identities of company officials.
Third-party agents may submit formation documents to the state on a
company's behalf, usually collecting only billing and statutorily required
information for formations. These agents generally do not collect any
information on owners of the companies they represent, and instances where
agents told us they verified some information were rare.
Federal law enforcement officials are concerned that criminals are
increasingly using U.S. shell companies to conceal their identity and
illicit activities. Though the magnitude of the problem is difficult to
measure, officials said U.S. shell companies are appearing in more
investigations in the United States and other countries. Officials told us
that the information states collect has been helpful in some cases because
names on the documents, such as names of directors, generated additional
leads. However, some officials said that the information was limited and
that cases had been closed because the owners could not be identified.
State officials and agents said that collecting company ownership
information could be problematic. Some state officials and agents noted
that collecting such information could increase the cost of company
filings and the time needed to approve them. Some officials said that if
they had additional requirements, companies would go to other states or
jurisdictions. Finally, officials and agents expressed concerns about
compromising individuals' privacy because owner information disclosed on
company filings would be part of the public record, which has not
historically been the case for private companies.
Information Collected on Ownership and Management at Formation
*** End of document. ***