As much government as necessary, as little government as possible.” So goes the old classical liberal motto, concisely summarising a blueprint for freedom and security under the law. On the specific issue of public authorities’ access to the financial information of private individuals and firms, the slogan is as relevant as it has ever been. An increasing number of jurisdictions around the world, including the United Kingdom and the European Union, are establishing registers of the ultimate owners of companies and trusts. In many cases, there are no restrictions on who has access to this information. Even in the United States, historically more resistant to beneficial ownership registers, Democratic and Republican legislators have advanced proposals to create one.
The reason ownership registers enjoy broad-based support across the political spectrum is that they can serve many different goals. To conservatives, requiring company owners to register with the government promises to reduce the likelihood that wrongdoers will use “shell corporations” – those with no or only nominal assets and operations – to launder proceeds from illegal activities and to finance terrorism. Those on the political Left, for their part, believe this information will enable the government to collect more tax revenue from mobile high-net-worth individuals and multinational enterprises. Self-described ‘tax justice’ campaigners also relish the prospect of open access to sensitive details about the financial affairs of prominent people and companies.
Unfortunately, a policy’s popularity with politicians and the public is seldom an assurance of its economic desirability or compatibility with the rule of law. Beneficial ownership registers are in fact a heavy-handed way to combat illicit finance. Evidence from the jurisdictions that have registers in place is beginning to show that they pose a considerable burden on law-abiding firms, while failing to uncover those with evil motives. There are ways to more efficiently pursue the fight against crime – entailing lower costs to businesses and taxpayers, and more targeted action on the part of government agencies.
It is not unreasonable for public authorities to collect certain pieces of information about corporate entities under their jurisdiction. In a world of trans-national investment by individuals and firms, knowing the identity of the ultimate owner helps to assess an entity’s tax obligations in each location where it operates. Beneficial ownership information may also be needed to establish who is ultimately liable for the entity’s actions in case lawsuits arise.
The prevention and prosecution of financial crime is another reason cited by advocates of beneficial ownership registers. A 2011 World Bank report on the subject quoted the annual volume of corrupt financial transactions at $40 billion. Clearly, the public also wants governments to curtail the ability of terrorists and other criminals to use the financial system for illicit purposes. Wrongdoers are precisely the sort of people with the greatest incentive to conceal the true owners (and thus the ultimate beneficiaries) of legal entities.
The debate is not over whether any information should be collected. The key policy questions are how much information should be collected, by whom, and when it should be shared with government authorities.
These questions are a matter of principle but also cost-benefit analysis. In a free society, the government must have a legitimate public-interest motivation to request information from private individuals and firms. But even if such public-interest grounds are present, the costs of monitoring might be too high relative to the probable benefits.
For instance, the ability of law enforcement agencies to uncover and prosecute financial crime might conceivably increase if these agencies had to approve every single transfer of funds between people. But the costs of such a policy, in terms of the taxpayer money required to pay for the oversight infrastructure and in the form of a slower, clunkier financial system, would be prohibitive. Not a single liberal democracy has (yet) proposed to guard against potential criminal activity in this way.
Instead, the tendency has been to deputise financial institutions to perform the due diligence work on the state’s behalf, and to report suspicious transactions as they arise. The United States has applied that model since passage of the Bank Secrecy Act (BSA) in 1970, and the EU followed the same template in its first anti-money-laundering directive in 1990.
However, as reporting requirements have grown over the years, the costs to the financial system of acting as an agent of the government have mounted. A 2018 survey of smaller US banks, for example, found BSA-related regulations to be the most onerous. AML/KYC rules are estimated to cost financial institutions between $4.8 billion and $8 billion per annum. In 2018, the entities subject to the BSA and related legislation filed 5,241,847 suspicious activity reports with the Financial Crimes Enforcement Network (FinCEN), the US Treasury’s financial crime division. Yet less than 20% of these reports involved serious national security risks, such as cybercrime, money-laundering, and terrorist financing.
It is also worth noting that the number of money-laundering investigations by US law enforcement has been falling in recent years, even as the number of reports from financial institutions has escalated.
Despite mounting evidence of diminishing returns from AML/KYC regulation, officials have piled on new requirements. Last year, FinCEN’s customer due diligence (CDD) rule came into force, requiring banks, securities and commodities brokers, and other financial intermediaries to verify the beneficial owners of companies as they open their accounts. The CDD rule includes strict look-through provisions that require reporting firms to investigate the ultimate owner, even when the corporate client is owned by another legal entity with which the financial institution has no relationship.
According to the US government’s own impact assessment, the CDD rule will cost financial institutions as much as $1.5 billion over 10 years. This figure may seem trivial relative to the size of US financial markets but note that it is orders of magnitude higher than the annual net earnings of all but the very largest US banks. Even institutions with assets of $10 billion to $250 billion had an average net income of just $682 million in 2018. Because the impact of regulation is not proportional to bank size, the CDD rule may hit the bottom line of some institutions hard.
Indeed, outcry from the financial sector has been a major factor behind legislation to mandate that firms themselves report their beneficial ownership to FinCEN. A bill, currently under discussion, by New York Democratic Congresswoman Carolyn Maloney would require all businesses with fewer than 20 employees or less than $5 million in annual sales to report their ultimate owner to FinCEN, or face fines of up to $10,000 and up to three years’ imprisonment. The bill exempts financial institutions, large businesses, and non-profit organisations from reporting. Still, it would affect at least five million companies employing as many as 20 million Americans. Another estimate puts the number of covered entities at 12 million.
There are several problems with the Maloney bill. First, it would supplement, not replace, the FinCEN CDD rule, duplicating the compliance burden for most firms without any additional benefit. Financial institutions, some of which support this legislation, should worry that it is no guarantee that their own reporting burden will diminish. Second, the bill creates major new compliance costs for a very large number of firms, the vast majority of which have no intent to engage in criminal activity. Third, the bill would not apply to partnerships and trusts, allowing wrongdoers – who are typically acutely aware of legislative loopholes – to potentially escape its reach.
Finally, the information that Maloney and proponents of similar legislation want FinCEN to have is, for the most part, already in the hands of the Internal Revenue Service, the US tax collection agency. Thus, even conceding the claim that beneficial ownership data is crucial for the effective prosecution of illicit financial activity, there is no reason to place the onus of collecting this information on private firms. Government agencies should work together to make appropriate use of the information they have. The IRS already shares sensitive information for specific purposes.
Since 2016, the United Kingdom has required companies to report their ultimate owners – called Persons with Significant Control (PSC) – and made the information accessible to the general public. The EU’s fifth anti-money-laundering directive, a revision of the 1990 law which EU countries must implement by 2020, equally contemplates a public register for EU-domiciled corporations.
Public access to information suggests transparency, which may explain why most people readily accept the public release of beneficial ownership information as an unambiguously good thing. Yet it is hard to justify making sensitive details about the ultimate ownership of firms available to all, without restrictions. The ostensible goal of ownership registers is to allow government authorities to collect taxes and enforce the law. Giving them, not everybody, access to this information is sufficient to achieve this objective.
The UK government’s first regulatory impact assessment on the issue, published in 2002, claimed that a public register would enlist “civil recovery efforts” and “make use of private sector resources”. But it is the job of law enforcement to fight against crime. Outsourcing this task to the private sector does not reduce costs but merely moves them out of the government balance sheet. There are also troubling privacy implications from giving activist groups, who may have an agenda quite different from that of policymakers, access to the ownership data of perfectly law-abiding firms.
Moreover, the public availability of beneficial ownership data may be counterproductive, encouraging companies to underreport or misreport their ultimate owners out of fear that this information might be misused by special interest groups. Preliminary reports on the experience of the UK PSC register suggest that this is a widespread phenomenon, with 3,000 companies reporting their ultimate owner as another company. In addition, there are many data-entry mistakes. Finally, because companies must self-report, there is a risk that law-abiding firms carry the burden of compliance, while law-breaking entities simply avoid the register.
In response to the limited effectiveness of national public beneficial ownership registers, activist organisations are pushing for all countries to adopt them, hoping that a global reporting mandate will be impossible to escape. Britain has been at the forefront of these efforts. Last year, the British government announced it will force its Overseas Territories – which include the Cayman Islands, British Virgin Islands and Bermuda – to have public registers by 2023. Some British MPs want similar requirements for the Crown Dependencies – Jersey, Guernsey and the Isle of Man.
This major intervention is rightly opposed by offshore jurisdictions. There are no obvious benefits to a public register – indeed, the multi-country Financial Action Task Force (FATF), an expert body on global financial crime, does not include a public register in its list of recommendations to member countries. The push appears to be an attempt to reduce offshore competition by publicly shaming those who own entities there, however legitimately and legally.
There is an irony in American and British concerns for transparency from offshore jurisdictions: A 2014 investigation into shell company incorporation found ‘tax havens’ like the Bahamas, the Cayman Islands and Jersey to be much more compliant with FATF standards than America, Canada and the UK. Calling for offshore centres to enact public registers is a clever public relations exercise, but its relationship to transparency and the effective prosecution of financial crime is nebulous.
Beneficial ownership information can be useful for law enforcement. Its collection may even pose little additional compliance burden, if government authorities make efficient use of the data they already have. But beneficial ownership registers, as currently applied in Britain, soon to be applied in the EU and many offshore jurisdictions (against their will), and as proposed to the United States Congress, will involve very significant costs to firms, financial institutions, and privacy protections – for dubious benefit.
Diego Zuluaga is a policy analyst at the Cato Institute’s Center for Monetary and Financial Alternatives.