The abuse of company incorporation to commit fraud

1 Chartered Accountants Hall, Moorgate Place, London EC2R 6 EATel: 020 7920 8721 Fax: 020 7920 8545 Email: Limited by Guarantee Registered in England and Wales No. 04327390 Registered Charity No. Paper:01/12 The abuseof companyincorporationto commitfraud IntroductionLimited liability companies are a convenient vehicle for many people to conductbusiness both domestically and in the international marketplace. They can bebeneficial to the economy stimulating growth, creating employment andrejuvenating local can the current regulatory regime for companies which is already considered light touch by some commentators actually facilitate the commission of financialcrime?We know that fraud is on the increase, yet our understanding of the extent to whichlimited companies can be used to facilitate fraud is currently incomplete with fewstatistics available.

2 The abuse of incorporation to commit fraud for example,through phoenix companies, long firm fraud and fraudulent trading can havea profoundly negative impact on the UK economy, ripping off suppliers, creditors,customers and the public suggest that the opportunities to commit this type of crime can be reducedby addressing the shortcomings of the current system of incorporation , and byintroducing new and more stringent requirements for those who operate limitedliability paper summarises the findings of a roundtable convened by the fraud AdvisoryPanel in May 2012 to consider the abuse of incorporation to commit fraud and whatcan be done to combat it. A series of subsequent discussions with other experts shedfurther light on the nature of the business in the UK: The current regulatory regimeThe UK is one of the easiest places in the world to do business,1and the currentGovernment is committed to encouraging enterprise, reducing unnecessary businessregulation, and helping people to set up in up in businessCompanies House (an executive agency of the Department for Business, Innovationand Skills (BIS))3is responsible for the incorporation and, in some cases, thedissolution of limited companies in the UK, and acts as a central repository forpublicly accessible company Paper.

3 01/12 The abuse of company incorporation to commit fraud1 The World Bank (2012) Doing business 2012: doing business in a more transparent world. Available from for Business, Innovation and Skills (2012) About BIS[online]. Available from Also see TheWorld Bank (2012) Doing business 2012: doing business in a more transparent world. Available from House (2012) About us[online]. Available from House (2012) About us [online]. Available from 450,000 new companies are incorporated each year; a figure which has beensteadily increasing since there are almost three million limitedcompanies registered in Great Britain (see table 1).6 There are a number of benefits associated with incorporation . The foremost amongstthese are the following.

4 Separate legal identity:the company is a distinct legal entity, separate from themanagement (directors and company secretary) and its members (shareholders).7 This means that the company may enter contracts and sue and be sued on themwithout reference to the officers of the company or its members. Liability is limited: incorporation limits the financial liability of company officersand members (to the amount unpaid on their shares) and personal assets are notput at risk. Most private companies issue shares as fully paid . This means that ifthings go wrong, a member s only loss is the value of the shares and any loansmade to the company ,8and the directors can rely upon the veil of incorporation (the protection that directors of a company have from limited liability) althoughthis may be lifted in specific Ease of incorporation :setting up a business is a relatively simple process withlittle red tape.

5 It can be done for as little as 1310either directly with CompaniesHouse or via a company formation agent (see box 1).11 No requirement to disclose the legal or beneficial ownership of the company :the true identity of owners or directors of the company may be hidden withcomplete legality behind nominee directors. No minimum capital:companies may be formed without any capital base,funding or for incorporation are subject to examination by Companies House whichincludes ascertaining whether a director is disqualified (it maintains the DisqualifiedDirectors Register)12and whether the same company name is already registered withthem or includes a sensitive or offensive word or Paper: 01/12 The abuse of company incorporation to commit fraud5 Companies House (2012) Annual report and accounts 2011/12.

6 Available from Also see Companies House (2011) Statistical tables on companiesregistration activities 2010/11. Available from House (2012) Annual report and accounts 2011/12. Available from House (2012) incorporation and names (GP1). Version Available from (2012) Advantages of forming a limited company [online]. Available from Lindsay v O Loughnane[2010] EWHC 529 (QB). Available from House (2012) Companies House prices[online]. Available from House (2012) Start a company [online]. Available from House (2012) incorporation and names (GP1). Version Available from public can also challenge names that are similar to company names already registered after obligations and complianceOnce incorporated, all companies (even dormant ones) are expected to comply with a number of annual and ad hoc ( event driven ) requirements set out in theCompanies Act 2006, such as the filing of annual returns and accounts and notifyingchanges to the registered particulars of the company s officers and its to do so can be a criminal offence and may also result in automaticcivil filings with Companies House are subject to basic checks.

7 No checks are made to verify the accuracy of the information submitted or to prevent theappointment of disqualified directors to existing companies as this is considered a matter for the company , not all companies are successful, and those that fail can be struck offthe register and that are no longer in business or incommunication with Companies House are dissolved as part of an ongoingenforcement can also be disqualified by the courts from acting ascompany directors for a maximum period of 15 years for various acts of misconductsuch as involvement in fraudulent activity or trading while insolvent, and their namesare then entered onto the Disqualified Directors the period ofdisqualification has ended the individuals names are removed from the 1: company formation agentsCompany formation agents act on behalf of their clients to incorporatecompanies and often offer other services such as registered office are regulated for anti-money laundering purposes by either HM Revenue& Customs (HMRC) or a recognised supervisory agents can voluntarily join the Association of company RegistrationAgents (ACRA) which is the only recognised trade association for the members comply with a code of professional conduct and account for justover half of all company registrations in the Paper.

8 01/12 The abuse of company incorporation to commit fraud14 Companies House (2012) Life of a company . Part 1: annual requirement (GP2). Available from Also see Companies House (2012) Life of a company . Part 2: event driven filings (GP3). Available House (2012) Life of a company . Part 1: annual requirement (GP2). Available from Also see Companies House (2012) Late filing penalties (GP5). Available House (2012) Strike off, dissolution and restoration (GP4). Available from from Tim Moss (Acting Chief Executive, Companies House).18 The Insolvency Service (2012) Insolvent companies and disqualified directors[online]. Available Laundering Regulations 2007, 3(10). Available from Also seeHM Revenue & Customs (2012) Trust or company service providers and money laundering regulations[online].

9 Availablefrom of company Registration Agents (2012) Homepage[online]. Available from as a vehicle for fraudCompanies may be set up for the principal purpose of committing crime, orsubsequently lend themselves to being used for that purpose, and the currentregistration regime is severely limited in its ability to discern the good from the extreme cases, incorporation is used purely as a front to enable fraud to impact of corporate abuse reverberates throughout the economy and everyonepays the price through higher taxes and the increased cost of purchasing goods andservices. Legitimate businesses also lose out having to write off losses as bad debtand bear the brunt of any reputational fallout. The victims are: the Exchequer, as a revenue collector legitimate businesses, as suppliers, customers, lenders and corporate investors individuals, as customers, investors and manner in which incorporation can be used by criminals to commit fraud cantake many forms, but some of the most common ways that it can be used fornefarious means include the following.

10 Fraudulent trading:21occurs when a company deliberately carries on business forthe purpose of defrauding creditors, often while it is insolvent or being wound up. Long (and short) firm fraud :22occurs when criminals set up a company with the intention of defrauding other legitimate businesses. The business tradeslegitimately for a period of time in order to establish a good reputation and credit history before placing large orders with suppliers and disappearing with the goods. A variation on this is short firm fraud which occurs over a much shorter timeframe. Phoenix company fraud :23occurs when the assets of a failing company aretransferred to a new company (the phoenix company ). The failed company isthen wound up leaving a trail of debts and out-of-pocket creditors behind it.