Company Formations: Minimal Ownership Information Is Collected	 
and Available (14-NOV-06, GAO-07-196T). 			 
                                                                 
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.						 
-------------------------Indexing Terms------------------------- 
REPORTNUM:   GAO-07-196T					        
    ACCNO:   A63325						        
  TITLE:     Company Formations: Minimal Ownership Information Is     
Collected and Available 					 
     DATE:   11/14/2006 
  SUBJECT:   Crime prevention					 
	     Crimes						 
	     Data collection					 
	     Federal/state relations				 
	     Law enforcement					 
	     Reporting requirements				 
	     Business						 
	     Business records					 
	     Limited partnerships				 

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GAO-07-196T

   

     * [1]Background
     * [2]States and Agents Generally Do Not Collect or Verify Informa
     * [3]Lack of Ownership Information Can Obstruct Law Enforcement I
     * [4]More Company Ownership Information Could Be Useful to Law En
     * [5]Concluding Remarks
     * [6]Staff Contacts and Acknowledgments
     * [7]Appendix I: The Number of Corporations and LLCs Formed in th
     * [8]Appendix II: Company Formation and Reporting Documents Can B

          * [9]Order by Mail or Phone

Testimony

Before the Permanent Subcommittee on Investigations, Committee on Homeland
Security and Governmental Affairs, U.S. Senate

United States Government Accountability Office

GAO

For Release on Delivery Expected at 2:30 p.m. EST

Tuesday, November 14, 2006

COMPANY FORMATIONS

Minimal Ownership Information Is Collected and Available

Statement of Yvonne D. Jones, Director Financial Markets and Community
Investment

GAO-07-196T

Mr. Chairman and Members of the Subcommittee:

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.^1 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.^2 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.^3

1GAO, Company Formations: Minimal Information Is Collected and Available,
[10]GAO-06-376 (Washington, D.C.: April 7, 2006).

^2See U.S. Departments of Treasury, Justice, Homeland Security, et al,
U.S. Money Laundering Threat Assessment Working Group, U.S. Money
Laundering Threat Assessment (Washington, D.C.: December 2005); and
Organization for Economic Co-operation and Development (OECD), Behind the
Corporate Veil: Using Corporate Entities for Illicit Purposes (Paris:
2001).

In summary:

           o 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.

           o 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.^4 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.

           o 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.
			  
			  Background

           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.
			  
			  States and Agents Generally Do Not Collect or Verify Information
			  on Company Ownership and Management

           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.^5 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.^6 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.

^3The survey and a complete tabulation of state-by-state and aggregated
results can be viewed at http://www.gao.gov/cgi-bin/getrpt?
[11]GAO-06-377SP . Third-party agents include company formation agents who
help individuals form companies 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 with only a
few clients to thousands of clients.

^4Creating a shell company is not a crime but rather can be a method for
hiding criminal activity. When we refer to "shell companies" in this
statement, we mean U.S. companies that do not conduct any legitimate
activity.

^5In response to a question on requirements for LLC member information, a
Connecticut official said that either a member's or a manager's name was
required on the articles of incorporation. In New Hampshire, a member or
manager is required to sign the articles of organization. One state did
not respond to the survey question on providing names of owners of
corporations, and two states did not respond to the question on the
addresses of owners.

^6The five states are Alaska, Connecticut, Kansas, Maine, and New
Hampshire. One state did not respond to this survey question.

Figure 1: States Requiring Ownership Information in Articles and Periodic
Reports

Note: Arkansas and New Mexico omitted responses to certain questions on
our survey. Arkansas responded that LLC member information is not required
on articles or reports. We found from our legal review that Arkansas does
not require the address of a corporation's owner on articles or periodic
reports. Our legal review also 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.

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.^7 For LLCs, 19 states require some information on the
managers or managing members on formation documents.^8 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.

^7A nominee director may be an individual who is located where the
business was formed and may sign official documents for the business on
behalf of the beneficial owner. Typically, the nominee director will have
no knowledge of the business affairs or accounts, cannot control or
influence the business, and will not act unless instructed to by the
beneficial owner.

^8One state did not respond to this survey question.

Figure 2: States Requiring Management Names or Addresses in Articles and
Periodic Reports

Note: New Mexico responded on our survey that information on corporate
officers is required on reports and information on directors is required
for both articles and reports, but did not respond to the questions about
the names and addresses of LLC managers/managing members. We found in our
legal review that New Mexico does not require this information on LLC
filings.

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.^9 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.

^9We do not have information on the extent of this legal review in all of
the states that responded that they conduct such a review.

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.^10

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.

^10OFAC is an office within the U.S. Department of the Treasury that
administers and enforces economic and trade sanctions based on U.S.
foreign policy and national security goals, as well as a master list of
"Specially Designated Nationals and Blocked Persons" (SDN) that includes
numerous foreign agents and front organizations, terrorists, terrorist
organizations, and narcotics traffickers. All U.S. persons, both
individuals and entities, are responsible for ensuring they do not do
business with a person or entity listed on the SDN list. Undertaking any
type of business or financial transaction with a person or entity on this
list is illegal under federal law.

Lack of Ownership Information Can Obstruct Law Enforcement Investigations

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.^11 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.^12

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.

^11A correspondent account is an account that a foreign bank opens at a
U.S. bank to gain access to the U.S. financial system and 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.

^12See U.S. Departments of Treasury, Justice, Homeland Security, et al,
U.S. Money Laundering Threat Assessment Working Group, U.S. Money
Laundering Threat Assessment (Washington, D.C.: December 2005).

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.^13 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.

^13Dispersing assets among as many different types of entities and
jurisdictions as possible is also a way to protect assets. The goal of
this approach is to create complex structures that, in effect, provide
multiple protective trenches around assets, making it challenging and
burdensome to pursue. See GAO, Environmental Liabilities: EPA Should Do
More to Ensure That Liable Parties Meet Their Cleanup Obligations,
[12]GAO-05-658 (Washington, D.C.: Aug. 17, 2005).

More Company Ownership Information Could Be Useful to Law Enforcement, but
Concerns Exist about Collecting It

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:

           o 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.^14

           o 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.

           o 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.

           o 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.^15 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.^16
           Also, according to industry experts, LLCs usually prepare and
           maintain operating agreements as well.^17 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.^18 In states that
           allow bearer shares, companies may not even list the names of the
           shareholders.^19 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.^20 In addition, financial institutions must
           also develop risk-based procedures for verifying the identity of
           each customer.^21 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.
			  
			  Concluding Remarks

           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.
			  
			  Staff Contacts and Acknowledgments

           For further information regarding this testimony, please contact
           me at (202) 512-8678 or [email protected] . Individuals making
           contributions to this testimony include Kay Kuhlman, Assistant
           Director; Emily Chalmers; Jennifer DuBord; Marc Molino; Jill
           Naamane; and Linda Rego.
			  
			  Appendix I: The Number of Corporations and LLCs Formed in the
			  United States

           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.^1

14State officials and others also noted that individuals could easily
provide false names if ownership information were required without being
verified.

^15Our review of state statutes indicated that 14 states do not require
periodic reports for LLCs and that 3 did not require them for
corporations. In 3 states (Alabama, New Jersey, and Oklahoma), the annual
report is submitted to a different office, such as the department of
revenue, than the office that handles formation filings. In addition,
biennial reports were required to be filed by corporations in 7 states and
by LLCs in 5 states.

^16Delaware, Kansas, and Oklahoma statutes do not expressly state that a
corporation is required to maintain a list of shareholders, but
shareholders must be able to extract information on shareholders from
corporate documents maintained by the corporation.

^17Some states may not require written operating agreements. If there is
no operating agreement, the LLC follows default provisions of the LLC act
of the state where the company was formed.

^18With publicly traded shares, nominees (e.g., shares registered in the
names of stockbrokers) are commonly and legitimately used to facilitate
the clearance and settlement of trades. Nominee shareholders can also be
used in privately held companies to shield beneficial ownership
information.

^19According to the U.S. Money Laundering Threat Assessment, Nevada and
Wyoming allow the use of bearer shares, which accord ownership of a
company to the person who possesses the share certificate.

^20Pub. L. No. 107-56, 115 Stat. 272 (Oct. 26, 2001). Section 326 of the
USA PATRIOT ACT directs Treasury and the federal financial regulators to
adopt customer identification program requirements for all "financial
institutions," which is defined broadly to encompass a variety of
entities, including, among others, (1) banks that are subject to
regulation by one of the federal banking regulators, as well as credit
unions that are not federally insured, private banks, and trust companies;
(2) securities broker dealers; (3) futures commission merchants and
introducing brokers; and (4) mutual funds. See 31 U.S.C. S 5312; 31 C.F.R.
part 103.

^21See GAO, USA PATRIOT ACT: Additional Guidance Could Improve
Implementation of Regulations Related to Customer Identification and
Information Sharing Procedures, [14]GAO-05-412 (Washington, D.C.: May 6,
2005).

Concluding Remarks

Staff Contacts and Acknowledgments

Appendix I: The Number of Corporations and LLCs Formed in the United
States

^1IACA is a professional association for government administrators of
business organization and secured transaction record systems at the state,
provincial, and national level in any jurisdiction. The IACA data include
domestic, foreign, and professional companies. Domestic companies are
those doing business in the same state in which they are incorporated or
formed. Foreign companies do business in a state, but they are
incorporated or formed in another jurisdiction, either in another U.S.
state or a foreign country. Professional corporations may include
professional services, such as those performed by doctors, dentists and
attorneys. Combining figures for these different types of companies
overestimates the number of companies formed under the state statutes
examined in this report, which covers only domestic companies. Some states
did not report data to IACA.

Figure 3: Domestic Corporations and LLCs Formed in U.S. States in 2004

Appendix II: Company Formation and Reporting Documents Can Be Submitted in
a Variety of Ways

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).^1
In addition, some officials indicated that they would like or were
planning to offer electronic filing in the future.

^1Electronic filing includes the ability to file a document through a Web
site, e-mail, or fax. Five states reported that they offer e-mail filing
for company formation documents, and 4 states reported that they offer
e-mail filing for periodic reports. In addition, 27 states reported that
they accept formation or periodic report filings by fax.

Figure 4: States That Provide a Web Site for Filing Formation or Periodic
Report Filings

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.

Table 1: 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 
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.

(250325)

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www.gao.gov/cgi-bin/getrpt?GAO-07-196T .

To view the full product click on the link above. For more information,
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Highlights of [22]GAO-07-196T , a testimony to Permanent Subcommittee on
Investigations, Committee on Homeland Security and Governmental Affairs,
U.S. Senate

November 14, 2006

COMPANY FORMATIONS

Minimal Ownership Information Is Collected and Available

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.

[23]What GAO Recommends

While not making recommendations, GAO observes that any requirement to
collect company ownership information must take into consideration (1) the
conflicting concerns of states, law enforcement agencies, and other
parties about collecting such information and (2) the need to uniformly
apply any requirement in all states.

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
(see figure). 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.

Information Collected on Ownership and Management at Formation

References

Visible links

  10. http://www.gao.gov/cgi-bin/getrpt?GAO-06-376
  11. http://www.gao.gov/cgi-bin/getrpt?GAO-06-377SP
  12. http://www.gao.gov/cgi-bin/getrpt?GAO-05-658
  14. http://www.gao.gov/cgi-bin/getrpt?GAO-05-412
  22. http://www.gao.gov/cgi-bin/getrpt?GAO-07-196T
  
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