Delaware tweaks policy to root out dangerous LLCs

Delaware tweaks policy to root out dangerous LLCs
Delaware tweaks policy to root out dangerous LLCs

In a rare move to rein in secretive limited liability companies, Delaware’s secretary of state has tweaked a policy that would require the state’s 1.3 million business entities to be regularly screened against a federal database of terrorists, international drug traffickers and more.

But some open government advocates and watchdog groups say the change doesn’t go far enough to protect Delaware and the rest of the country from tax dodgers, embezzlers, arms dealers and other criminals.

Last month, Delaware State Department leaders said they reviewed the new standards with some of the state’s largest registered agents, who serve as administrative liaisons between Delaware companies and the state. The News Journal was recently notified of the changes  in response to a Freedom of Information Act request.

The revised procedure will require all commercial agents representing more than 50 business entities to conduct quarterly checks, comparing their lists of existing clients against a federal sanctions list updated by the Treasury Department’s Office of Foreign Asset Control. If a match is made, the company is prohibited under federal law from doing business in Delaware or in any other state.

For smaller registered agents, the Delaware State Department will handle the checks, as it does now for about 45,000 business entities, said Kris Knight, Delaware’s deputy secretary of state.

The move comes at a time when open-government advocates are pushing for legislation that would require both the Department of State and registered agents to verify that prospective businesses meet a half-dozen federal security mandates, including not appearing on the OFAC sanctions list.

A recent bill with that purpose introduced by state Rep. John Kowalko, D-Newark, encountered opposition from Delaware Secretary of State Jeffrey Bullock and the Delaware State Bar Association, who called it redundant and impractical.

Lawyers, legislators (and legislators who are lawyers) also took issue that Kowalko introduced the legislation without gaining prior approval from the bar’s influential alternative entities subcommittee. The subcommittee drafts annual amendments to the state’s Limited Liability Company Act, which are usually adopted wholesale by the General Assembly.

Kowalko’s bill is now tabled in the House Judiciary Committee.

Knight said his department’s new screening requirement is not related to Kowalko’s proposal or to recent reports linking Delaware companies to international money laundering schemes.

Registered agents and State Department officials already regularly monitor the OFAC sanctions list and communicate with federal law enforcement officials about suspicious activity, he said. The new standards merely ensure “consistency.”

The changes, which are expected to be put in writing soon, drew immediate praise from Attorney General Matt Denn. Through a spokesman, Delaware’s chief law enforcement officer said his office doesn’t “have the resources or ability to investigate and prosecute international money laundering or terrorism crimes,” leaving it to federal authorities.

Last year, federal agents implicated eight Delaware LLCs in a scheme to steal over $1 billion from the people of Malaysia. Soon after, a Chilean airline was fined for bribing union bosses with $1.15 million funneled through a Delaware LLC.

As recently as last month, a federal grand jury indictment revealed that nine Delaware corporations and limited liability companies helped Donald Trump’s former campaign chairman Paul Manafort and a former campaign official shield from U.S. authorities millions of dollars in payments from the Ukraine. The business entities never appeared on the federal sanctions list.

Nick Wasileski, president of the Delaware Coalition for Open Government, heralded the secretary of state’s recent action as a “positive step” that will “strengthen oversight and help protect Delaware’s business entities from abuse by bad actors.”

Kowalko, meanwhile, accused Bullock’s office of taking a baby step to distract the public from a more pressing issue.

Swift action by the General Assembly will “carry more weight” than a department’s internal policy, he said.

“That’s the last thing I want to do with something this important.”

While no federal law requires OFAC to notify Delaware’s State Department when a Delaware entity appears on the sanctions list, Knight said federal law enforcement officials routinely do so. He couldn’t recall any Delaware business in recent memory that had fallen through the cracks.

Federal law is also silent on how often state officials and registered agents need to consult the sanctions list.

“U.S. persons must use a risk-based approach to make their own determinations as to how to best comply with OFAC’s regulations,” a Treasury Department spokesperson said.

A section of the department’s website, geared to financial institutions, recommends frequent checks. “If a firm only scrubs its database quarterly [for OFAC compliance],” the site reads, “it could be three months too late in freezing targeted assets.”

Knight said his office was comfortable with quarterly checks, at minimum, given the increased workload. Some registered agents check monthly, he said.

Asked how the secretary of state was able to verify that, he replied: “Because they told us they were doing it.”

Kathleen Moore, owner of Delaware Registered Agents and Incorporators LLC, isn’t among them. The small-business owner in Newark said she never checks the federal sanctions list because “we did not have anything mandated that we had to look at that.”

Rather, Moore requires that her foreign clients submit a copy of their passports or another photo ID — “anything showing me it’s a legit company.”

At the opposite end of the spectrum, Greenville-based CSC, one of Delaware’s largest registered agents, “thoroughly” vets potential customers against national and international watch lists and “regularly” screens for ongoing compliance, according to Ian McConnel, the company’s director of Government Affairs.

When pressed, McConnel, Delaware’s former chief deputy attorney general, declined to provide specifics.

Bad for transparency, good for business

National media reports spanning a decade have linked anonymous Delaware LLCs to high-profile financial crimes. Delaware entities have appeared in connection with Russian arms dealer Viktor Bout, Mexican drug lord Joaquin “el Chapo” Guzman and disgraced lobbyist Jack Abramoff.

The World Bank, the federal Financial Crimes Enforcement Network, the global Financial Transparency Coalition and others have blasted Delaware as one of the most desirable locations – on paper – for shell companies. Essentially holding companies for funds, shell businesses are leading vehicles for money laundering, according to federal law enforcement officials.

Delaware leaders point out that the vast majority of businesses flocking here are above bar. The state has a nearly $1.3 billion stake — one-third of its general fund — in keeping companies happy. That means offering maximum flexibility and privacy for company directors and a revered, dedicated court for corporate disputes.

The system keeps taxes low and benefits everyone from the postal clerk to the dry cleaner, according to state Sen. Bryan Townsend, D-Newark.

“Does a small number of bad actors mean we should dramatically change the fundamental legal framework that is a huge part of our economy?” he asked.

A corporate lawyer, Townsend said he has sponsored amendments to the LLC law drafted by his colleagues because they are experts in an evolving field.

Townsend’s employer, Morris James LLP of Wilmington, touts the perks of forming an LLC in Delaware on its website, noting that company members don’t need to be residents or even citizens of the U.S. They simply must adopt a members’ agreement, “which need not be written,” and file a certificate of formation with Bullock’s office.

Historically, Bullock and the Delaware bar have been fiercely protective of the “Delaware advantage.” The First State, along with Nevada and Wyoming, is one of the easiest in which to set up a company and leads the nation in the number of registered companies without physical homes here.

Unlike 25 other states, Delaware doesn’t require even the most basic information from people applying to form LLCs, such as manager names and addresses, according to data from the National Association of Secretaries of State. True company owners are concealed behind a Delaware registered agent, who must keep a company contact in case federal law enforcement agents come knocking at the door.

Missing links

OFAC updates its sanctions list as often as several times a week — and it’s serious business.

As long as an individual or entity remains on the list, their properties and U.S. bank accounts are frozen and Americans are barred from doing business with them.

Not consulting the list could spell financial ruin for a local agent. There are several examples of nonprofit agencies that did business with “do-not-touch” companies, only to be hit with hundreds of thousands of dollars in fines, according to Saskia Rietbroek, an anti-money laundering expert and founder of SanctionsAlert.com.

The paucity of information collected by Delaware makes it difficult to adequately cross-check against the federal sanctions list, according to Rietbroek.

For instance, if a business entity that doesn’t appear on the list is at least 50 percent owned by a listed entity, Americans can still be penalized for doing business with the non-listed entity, she noted.

“So, you need to know who the owners are to be sure,” she said.

In Delaware, that information remains hidden.

The State Department recently denied a News Journal FOIA request for a complete listing of Delaware LLCs. Department spokesman Doug Denison cited a statutory exemption that allows his office to deny bulk data on corporations.

But he noted that the state has enacted meaningful regulations over the years, such as prohibiting companies from issuing bearer shares, which are unregistered stock certificates that allow investors to transfer assets anonymously. The secretary of state also is empowered to audit and discipline registered entities and prohibits them from actively promoting secretive companies engaged in “illicit activities,” Denison said.

Gathering more data at the state level is not the answer, State Department leaders agree.

Said Knight: “Bin Laden is not going to write down that he’s a managing member of an entity.”

Rather than bog down the state with stricter reporting requirements, Bullock supports federal legislation to force American companies to disclose who actually owns them, which, he says, would level the playing field for all states

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