Incorporation Standards in Banking: A Race to the Bottom

April 10th, 2014

Sometimes—even usually—competition is a good thing. It lowers market prices; it sent a man to the moon; and it’s responsible for thousands of Olympic medals. In many cases, competitions–or races–are responsible for innovation, efficiency, and better performance. In these cases, an individual actor’s pursuit of victory leads to the betterment of society, a market, or a generation of athletes. However, sometimes competitions—or races—instead lead to worse outcomes for society. Often called a “race to the bottom,” these kinds of competitions include, for example, international degradations of environmental and labor standards.

This kind of race also happens in U.S. banking, where individual states’ pursuits of bank deposits have led to a degradation of bank security for the entire nation.

A hypothetical example might show how this would work in another industry. Imagine that airline security were left up to individual states, rather than the federal government. States might choose to adopt different levels of security. For example, some states might require their passengers to provide identification before boarding and pass their bags through x-ray machines to ensure they aren’t trying to transport illicit materials. Other states, though, might think it’s advantageous to reduce their security requirements. They might believe that by reducing screening, they could trim down wait times and attract more passengers to fly through their airports. They might argue this would create more jobs and incomes within their state.

Do you see the problem with this? Of course by reducing security, those states might attract more business travelers, but they might also attract terrorists, who would take advantage of these weak screening procedures. One state’s security gap would open the entire country to risk.

This is exactly what the United States allows, not in aviation, but in banking. Each U.S. state has a different set of incorporation transparency laws. In some states these laws are inclusive. In other states, you need little more than an expired Starbucks gift card to form a corporation. In Delaware and Wyoming, for example, clients can anonymously set up shell corporations (companies that are used exclusively for business transactions and do not have any real assets or operations). Nevada, one of the worst offenders, does not require banks to even request the names of account or company shareholders, nor do they need to share that information with the federal government.  This means it’s easier to set up a corporation in Nevada than it is to get a library card.

Criminals can then use these anonymous shell corporations to access bank accounts, leave authorities unable to track their assets, which leave huge holes in U.S. banking security. It is a result of these holes that Michel De Jesus Haurte was able to defraud Medicare of more than $4.5 million using a fake AIDS clinic in Miami. It is these holes that allowed forty-four members of an Armenian drug cartel to funnel $100 million through 118 shell companies in 25 states. Others who have banked in the United States include: an al-Qaeda fundraising organization, which used a company called Truman Used Auto Parts as a front; Iran, which owned a Manhattan skyscraper; and Viktor Bout, an arms trader nicknamed the “Merchant of Death” for his role in funneling weapons to terrorists, including the  Taliban and al-Qaeda.

One part of the solution lies in a bill introduced by Senator Carl Levin, which is currently under consideration by the Senate Judiciary Committee. The legislation, called the Incorporation Transparency and Law Enforcement Assistance Act, would require those who form corporations and limited liability companies (LLCs) to disclose the beneficial owners at the time companies are formed. The bill would also require states to keep the identities of corporate executives on file with a form of identification better than a library card.


Written by Ann Hollingshead

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