Company Formations: Minimal Ownership Information Is Collected and Available
Published: 2006-11-14T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: Companies, which are the basis of most commercial activities in market-based economies, may be used for illicit as well as legitimate purposes. Because companies can be used to hide activities such as money laundering, some states have been criticized for requiring too little information about companies when they are formed, especially concerning owners. This testimony draws on GAO's April 2006 report Company Formations: Minimal Ownership Information Is Collected and Available (GAO-06-376), which addressed (1) the information states and other parties collect on companies, (2) law enforcement concerns about the role of companies in illicit activities and the information available on owners, and (3) the implications of collecting more ownership information. GAO surveyed all 50 states and the District of Columbia, reviewed state laws, and interviewed a variety of industry, law enforcement, and other government officials.
section_title: What GAO Found
paragraphs: Most states do not require ownership information at the time a company is formed or on the annual and biennial reports most corporations and limited liability companies (LLC) must file. Four of the 50 states and the District of Columbia require some information on members (owners) of LLCs. Some states require companies to list information on directors, officers, or managers, but these persons are not always owners. Nearly all states screen company filings for statutorily required information such as the company's name and an address where official notices can be sent, but no states verify the identities of company officials. Third-party agents may submit formation documents for a company but usually collect only billing and statutorily required information and rarely verify it. Federal law enforcement officials are concerned that criminals are increasingly using U.S. "shell" companies--companies with generally no operations--to conceal their identities and illicit activities. Though the magnitude of the problem is hard to measure, officials said that such companies are increasingly involved in criminal investigations at home and abroad. The information states collect on companies has been helpful in some cases, as names on the documents can generate additional leads. But some officials said that available information was limited and that they had closed cases because the owners of a company under investigation could not be identified. State officials and agents said that collecting company ownership information could be problematic. Some noted that collecting such information could increase the cost and time involved in approving company formations. A few states and agents said that they might lose business to other states, countries, or agents that had less stringent requirements. Finally, officials and agents were concerned about compromising individuals' privacy, as information on company filings that had historically been protected would become part of the public record.

section_title: Letter
paragraphs: I appreciate the opportunity to participate in today’s hearing on company  formation practices among the states. My testimony, which is based on our  April 2006 report to this subcommittee, will provide an overview of the  information about the owners of nonpublicly traded companies that is  routinely collected and made available by the 50 states and the District of  Columbia. As you know, the majority of companies in the United States  are legitimate businesses that carry out an array of vital activities and are  the backbone of our economy. However, companies can also be used for  illicit purposes, such as laundering money or shielding assets from  creditors. For example, government and international reports have said  that “shell” companies—companies with generally no operations—have  become popular tools for facilitating criminal activity because the persons  controlling the company are not easily identifiable. State statutes, which  have historically governed the company formation process, generally  provide for the privacy of the identities of company owners. This privacy  may protect owners and their assets in the event of a lawsuit, but it can  also be used to conceal the identity of the beneficial owners, or the  persons who ultimately own and control a business entity.
In my statement today, I will address three main points. First, I will  describe the ownership information that states collect on companies and  their efforts to review and verify it. Next, I will discuss the concerns of law  enforcement agencies about how companies can be used to hide illicit  activity and how information on those companies, or the lack of it, can  affect investigations. Finally, I will discuss the implications of requiring  that states and others collect information on the owners of companies  formed in each state. Our report, and this testimony, is based on extensive  audit work that included a survey of officials from all of the states and the  District of Columbia, a review of state statutes and company formation  forms, and interviews with academics, third-party agents, law firms,  financial institutions, law enforcement, and other state and federal  officials.
Most states do not require companies or third-party agents that represent  them to provide ownership information at formation or in periodic reports.  Similarly, states usually do not require information on company  management, such as corporate officers and directors and limited liability  company (LLC) managers, in the company formation documents, but most  states require this information on periodic reports. Third-party agents that  submit formation documents to the state on a company’s behalf usually  collect only information they need to bill the company for their services  and statutorily required information. The information they collect  generally does not include information on company owners. States and  agents are generally not required to verify any information on company  ownership or management or to screen names against criminal watch lists,  although almost all state officials reported that they screen filings for the  presence of statutorily required information such as the company name  and an address where official notices can be sent. With rare exceptions,  the agents we spoke with did not request additional information on  company owners or verify clients’ identity.
Law enforcement officials we spoke with were concerned about the use of  shell companies in the United States that enable individuals to conceal  their identities and conduct criminal activity. These officials said that they  have also had difficulty investigating U.S. shell companies that were being  used for illicit purposes because they could not identify the owners.  Quantifying the magnitude of the criminal use of shell companies is  difficult, but law enforcement officials told us about investigations, both  domestic and international, that have involved such companies and the  movement of billions of dollars. The law enforcement officials we  interviewed said that they had obtained some company information from  company formation documents or periodic reports and occasionally from  agents during investigations and that this information had generated  additional leads. But some officials noted that the information available  from the states often did not reveal who owned the company and that  cases had been closed because owners could not be traced.
State officials, agents, and others we interviewed said that collecting  company ownership information could be problematic, for several  reasons. For example, state officials told us that the costs and time  involved in approving company formations could increase, potentially  slowing down or derailing business dealings. In addition, a few states and  agents said they might lose business to other jurisdictions with less  stringent requirements. State officials and agents also expressed concerns  about maintaining the privacy of the owners of legitimate businesses that  historically had been protected from public scrutiny. State officials,  agents, and other experts in the field suggested that internal company  records, financial institutions, and the Internal Revenue Service (IRS)  could be alternative sources of ownership information for law  enforcement investigations, but we found that using these sources could  also be problematic.
subsections: section_title: Background
paragraphs: The company formation process is governed and executed at the state  level. Formation documents are generally filed with a secretary of state’s  office and are commonly called articles of incorporation (for  corporations) or articles of organization (for LLCs). These documents,  which set out the basic terms governing the company’s existence, are  matters of public record. According to our survey results, in 2004, 869,693  corporations and 1,068,989 LLCs were formed in the United States. See  appendix I for information on the numbers of corporations and LLCs  formed in each state. Appendix II includes information on states’ company  formation processing times and fees.
Although specific requirements vary, states require minimal information  on formation documents. Generally, the formation documents, or articles,  must give the company’s name, an address where official notices can be  sent, share information (for corporations), and the names and signatures  of the persons incorporating. States may also ask for a statement on the  purpose of the company and a principal office address on the articles.  Most states also require companies to file periodic reports to remain  active. These reports are generally filed either annually or biennially.
Although individuals may submit their own company filing documents,  third-party agents may also play a role in the process. Third-party agents  include both company formation agents, who file the required documents  with a state on behalf of individuals or their representatives, and agents  for service of process, who receive legal and tax documents on behalf of a  company. Agents can be individuals or companies operating in one state  or nationally. They may have only a few clients or thousands of clients. As  a result, the incorporator or organizer listed on a company’s formation  documents may be the agent who is forming the company on behalf of the  owners or an individual affiliated with the company being formed.
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. Management may include  officers—chief executive officers, secretaries, and treasurers—who help  direct a corporation’s day-to-day operations. LLCs are unincorporated  businesses whose members are considered the owners, and either  members acting as managers or outside managers hired by the company  take responsibility for making decisions. Beneficial owners of  corporations or LLCs are the individuals who ultimately own and control  the business entity.
section_title: States and Agents Generally Do Not Collect or Verify Information on Company Ownership and Management
paragraphs: Our survey revealed that most states do not collect information on  company ownership (see fig. 1). No state collects ownership information  on formation documents for corporations, and only four—Alabama,  Arizona, Connecticut, and New Hampshire—request some ownership  information on LLCs. Most states require corporations and LLCs to file  periodic reports, but these reports generally do not include ownership  information. Three states (Alaska, Arizona, and Maine) require in certain  cases the name of at least one owner on periodic reports from  corporations, and five states require companies to list at least one member  on periodic reports from LLCs. However, if an LLC has members that are  acting as managers of the company (managing members), ownership  information may be available on the formation documents or periodic  reports in states that require manager information to be listed.
States usually do not require information on company management in the  formation documents, but most states require this information on periodic  reports (see fig. 2). Less than half of the states require the names and  addresses of company management on company formation documents.  Two states require some information on officers on company formation  documents, and 10 require some information on directors. However,  individuals named as directors may be nominee directors who act only as  instructed by the beneficial owner. For LLCs, 19 states require some  information on the managers or managing members on formation  documents. Most states require the names and addresses of corporate  officers and directors and of managers of LLCs on periodic reports. For  corporations, 47 states require some information about the corporate  officers, and 38 states require some information on directors on periodic  reports. For LLCs, 28 states require some information about managers or  managing members on the periodic reports.
In addition to states, third-party agents may also have an opportunity to  collect ownership or management information when a company is formed.  Third-party agents we spoke with generally said that beyond contact  information for billing the company and for forwarding legal and tax  documents, they collect only the information states require for company  formation documents or periodic reports. Several agents told us that they  rarely collected information on ownership because the states do not  require it. Further, one agent said it was not necessary to doing the job. In  general, agents said that they also collected only the management  information that states required. However, if they were serving as the  incorporator, agents would need to collect the names of managers in order  to officially pass on the authority to conduct business to the new company  principals. A few agents said that even when they collected information on  company ownership and management, they might not keep records of it, in  part because company documents filed with the state are part of the public  record. One agent said that he did not need to bear the additional cost of  storing such information.
According to our survey, states do not verify the identities of the  individuals listed on the formation documents or screen names using  federal criminal records or watch lists. Nearly all of the states reported  that they review filings for the required information, fees, and availability  of the proposed company name. Many states also reported that they  review filings to ensure compliance with state laws, and a few states  reported that they direct staff to look for suspicious activity or fraud in  company filings. However, most states reported they did not have the  investigative authority to take action if they identified suspicious  information. For example, if something appeared especially unusual, two  state officials said that they referred the issue to state or local law  enforcement or the Department of Homeland Security. While states do not  verify the identities of individuals listed on company formation  documents, 10 states reported having the authority to assess 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.
In addition, our survey shows that states do not require agents to verify the  information collected from their clients. Most states have basic  requirements for agents for service of process, but overall states exercise  limited oversight of agents. Most states indicated on our survey that agents  for service of process must meet certain requirements, such as having a  physical address in the state or being a state resident. However, a couple  of states have registration requirements for agents operating within their  boundaries. Under a law that was enacted after some agents gave false  addresses for their offices, Wyoming requires agents serving more than  five corporations to register with the state annually. 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. Delaware has a contractual relationship with  approximately 40 agents that allows them, for a fee and under set  guidelines, access to the state’s database to enter or find company  information.
Agents we interviewed said that since states do not require them to, they  generally do not verify or screen names against watch lists or require  picture identification of company officials. One agent said that his firm  generally relied on the information that it received and in general did not  feel a need to question the information. However, we found a few  exceptions. One agent collected a federal tax identification number (TIN),  company ownership information, and individual identification and  citizenship status from clients from unfamiliar countries. Another agent  we interviewed required detailed information on company principals,  certified copies of their passports, proof of address, and a reference letter  from a bank from certain international clients. A few agents said that they  used the Office of Foreign Assets Control (OFAC) list to screen names on  formation documents or on other documents required for other services  provided by their company.
The agents said they took these additional steps for different reasons. One  agent wanted to protect the agency, while other agents said that the  Delaware Secretary of State encouraged using the OFAC list to screen  names. One agent felt the additional requirements were not burdensome.  However, some agents found the OFAC list difficult to use and saw using it  as a potentially costly endeavor. OFAC officials told us that they had also  heard similar concerns from agents.
section_title: Lack of Ownership Information Can Obstruct Law Enforcement Investigations
paragraphs: Law enforcement officials and others have indicated that shell companies  have become popular tools for facilitating criminal activity, particularly  laundering money. A December 2005 report issued by several federal  agencies, including the Departments of Homeland Security, Justice, and  the Treasury, analyzed the role shell companies may play in laundering  money in the United States. Shell companies can aid criminals in  conducting illegal activities by providing an appearance of legitimacy and  may provide access to the U.S. financial system through correspondent  bank accounts. For example, the Financial Crimes Enforcement Network  (FinCEN) found in a December 2005 enforcement action 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.  But determining the extent of the criminal use of U.S. shell companies is  difficult. Shell companies are not tracked by law enforcement agencies  because simply forming them is not a crime. However, law enforcement  officials told us that information they had seen suggested that U.S. shell  companies were increasingly being used for illicit activities. For example,  FinCEN officials told us they had seen many suspicious activity reports  (SAR) filed by financial institutions that potentially implicated U.S. shell  companies. One report cited hundreds of SARs filed between April 1996  and January 2006 that involved shell companies and resulted in almost $4  billion in activity.
During investigations of suspicious activity, law enforcement officials may  obtain some company information from agents or states, either from  state’s Internet sites or by requesting copies of filings. According to some  law enforcement officials we spoke with, information on the forms, such  as the names and addresses of officers and directors, might provide  productive leads, even without explicit ownership information. Law  enforcement officials also sometimes obtain additional company  information, such as contact addresses and methods of payment, from  agents, although one state law enforcement official said the agents might  tell their clients about the investigation. In some cases, the actual owners  may include their personal information on official documents. For  example, in an 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, provide a  legitimate face to his fraudulent activities, and open bank accounts to  launder the investors’ money. IRS investigators found from state  documents that he had incorporated the companies himself and often  included his coconspirators as officers or directors. The man was  sentenced to 40 years in prison.
In other cases, law enforcement officials may have evidence of a crime but  may not be able to connect an individual to the criminal action without  ownership information. For example, an Arizona law enforcement official  who was helping to investigate an environmental spill that caused $800,000  in damage said that investigators could not prove who was responsible for  the damage because the suspect had created a complicated corporate  structure involving multiple company formations. This case was not  prosecuted because investigators could not identify critical ownership  information. Most of the officials we interviewed said they had also  worked on cases that reached dead ends because of the lack of ownership  information.
section_title: More Company Ownership Information Could Be Useful to Law Enforcement, but Concerns Exist about Collecting It
paragraphs: States and agents recognized the positive impacts of collecting ownership  information when companies are formed. As previously noted, law  enforcement investigations could benefit by knowing who owns and  controls a company. In addition, a few state officials said that they could  be more responsive to consumer demands for this information if it were  on file. 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.
However, state officials and agents we surveyed and interviewed indicated  that collecting and verifying ownership information could have negative  effects. These could include:  Increased time, costs, and workloads for state offices and agents: Many  states reported that the time needed to review and approve company  formations would increase and said that states would incur costs for  modifying forms and data systems. Further, officials said that states did  not have the resources and staff did not have the skills to verify the  information submitted on formation documents.
Derailed business dealings: 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, particularly  small businesses. One state official commented that such requirements  would create a burden for honest business people but would not deter  criminals.
Lost state revenue: Some state officials and others we interviewed felt that  if all state information requirements were not uniform, the states with the  most stringent requirements could lose business to other states or even  countries, reducing state revenues.
Lost business for agents: Individuals might be more likely to form their  own companies and serve as their own agents. Agents also indicated that it  might be difficult to collect and verify information on company owners  because they often were in contact only with law firms and not company  officials during the formation process.
In addition, some state officials noted that any change in requirements for  obtaining or verifying information, or the fees charged for company  formation, would require state legislatures to pass new legislation and  grant company formation offices new authority. Further, 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  because it could change frequently. Finally, as noted, some states do not  require periodic reports, and law enforcement officials noted that a shell  company being used for illicit purposes might not file required periodic  reports in any case. 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. In addition, since a company can be owned by another  company, the name provided may not be that of an individual, but another  company.
We also found that state officials, agents, and other industry experts felt  that the need to access information on companies must be weighed  against privacy issues. Company owners may want to maintain their  privacy, in part because state statutes have traditionally permitted this  privacy 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 and target companies for scams. Although business  owners might be more willing to provide ownership information if it would  not be 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 were not set up to maintain  confidential information. However, a few states described procedures in  which certain information could be redacted from the public record or  from online databases.
In our review, state officials, agents, and other experts in the field  identified three other potential sources of company ownership  information, but each of these sources also has drawbacks.
First, company ownership information may be available in internal  company documents. According to our review of state statutes, internal  company documents, such as lists of shareholders for corporations, are  required in all states for corporations. Also, according to industry  experts, LLCs usually prepare and maintain operating agreements as well.  These documents are generally not public records, but law enforcement  officials can subpoena them to obtain ownership information. However,  accessing these lists may be problematic, and the documents themselves  might not be accurate and might not reveal the true beneficial owners of a  company. In some cases, the documents may not 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, the shareholder list  could include nominee shareholders and may not reflect any changes in  shareholders. In states that allow bearer shares, companies may not even  list the names of the shareholders. Finally, law enforcement officials may  not want to request these documents in order to avoid tipping off a  company about an investigation.
Second, we were told that financial institutions may have ownership  information on some companies. The Uniting and Strengthening America  by Providing Appropriate Tools Required to Intercept and Obstruct  Terrorism (USA PATRIOT ACT) Act of 2001 established minimum  standards for financial institutions to follow when verifying the identity of  their customers. For customers that are companies, this information  includes the name of the company, its physical address (for instance, its  principal place of business), and an identifying number such as the tax  identification number. In addition, financial institutions must also  develop risk-based procedures for verifying the identity of each  customer. However, according to financial services industry  representatives, conducting due diligence on a company absorbs time and  resources, could be an added burden to an industry that is already subject  to numerous regulations, and may result in losing a customer. Industry  representatives also noted that ownership information might change after  the account was opened and that not all companies open bank or  brokerage accounts. Finally, correspondent accounts could create  opportunities to hide the identities of the account holders from the banks  themselves.
Finally, the Internal Revenue Service was mentioned as another potential  source of company ownership information for law enforcement, but IRS  officials pointed to several limitations with their agency’s data. First, IRS  may not have information on all companies formed. For example, not all  companies are required to submit tax forms that include company  ownership information. Second, IRS officials reported that the ownership  information the agency collects might not be complete or up to date and  the owner listed could be another company. Third, law enforcement  officials could have difficulty accessing IRS taxpayer information, since  access by federal and state law enforcement agencies outside of IRS  investigations is restricted by law. IRS officials commented that collecting  additional ownership and management information on IRS documents  would provide IRS investigators with more detail, but their ability to  collect and verify such information would depend on the availability of  resources.
section_title: Concluding Remarks
paragraphs: In preparing our April 2006 report, we encountered a variety of legitimate  concerns about the merits of collecting ownership information on  companies formed in the United States. On the one hand, federal law  enforcement agencies were concerned about the existing lack of  information, because criminals can easily use shell companies to mask the  identities of those engaged in illegal activities. From a law enforcement  perspective, having more information on company ownership would make  using shell companies for illicit activities harder, give investigators more  information to use in pursuing the actual owners, and 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 owners’ privacy if information requirements  were increased. Collecting more information and approving applications  would require more time and resources, possibly reducing the number of  business startups and 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 would need to balance these conflicting concerns and be  uniformly applied in all U.S. jurisdictions. Otherwise, those wanting to set  up shell companies for illicit activities could simply move to the  jurisdiction that presented the fewest obstacles, undermining the intent of  the requirement.
Mr. Chairman, this concludes my prepared statement. I would be happy to  respond to any questions that you or other members of the committee may  have at this time.
section_title: Staff Contacts and Acknowledgments
paragraphs: For further information regarding this testimony, please contact me at  (202) 512-8678 or jonesy@gao.gov. Individuals making contributions to this  testimony include Kay Kuhlman, Assistant Director; Emily Chalmers;  Jennifer DuBord; Marc Molino; Jill Naamane; and Linda Rego.
section_title: Appendix I: The Number of Corporations and LLCs Formed in the United States
paragraphs: Historically, the corporation has been the dominant business form, but  recently the limited liability company (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 3 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. 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) show 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.
section_title: Appendix II: Company Formation and Reporting Documents Can Be Submitted in a Variety of Ways
paragraphs: 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. 4 shows the states that  provide a Web site for filing formation documents or periodic reports). In  addition, some officials indicated that they would like or were planning to  offer electronic filing in the future.
As shown in table 1, 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. The median company  formation fee is $95, and fees for filing periodic reports range from $5 to  $500.
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.
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