Countering corruption in the United States

Oleg Deripaska (R) with Russian President Vladimir Putin, Sochi, Sept. 19, 2008. (Photo by Ria Novosti/AFP via Getty Images)

Just six months into his term, President Joe Biden announced that Washington was renewing its commitment to combating corruption in the United States and abroad, declaring that the country would lead the fight “by example and in partnership with allies, civil society, and the private sector.” Six months later, in an attempt to solidify this pledge, his administration unveiled the U.S. Strategy on Countering Corruption, a first-of-its-kind policy focused primarily on establishing tools that protect against illicit finance and corruption. Then, in October 2022, the administration doubled down again; the National Security Strategy it released that month stressed the United States’ critical role in confronting the spread of corruption.

Impressive as all this may sound, the reality of the last few years has been very different: Despite its declared commitment, the United States is actually backsliding in the battle against illicit financial activity. According to the Financial Secrecy Index of 2022. the country has become the world’s most complicit jurisdiction when it comes to obscuring money and investments from the rule of law.

To be fair, this statistic – worrisome as it sounds – is slightly deceptive. The U.S. government is no kleptocracy. It doesn’t engage in grand corruption, and it doesn’t directly profit from illicit financial opportunities, in the manner of, say, the British Virgin Islands or Malta (both of which have historically benefited from a financially secretive banking system for revenue). What the United States does do, however, is offer anonymity, both to its own citizens and to foreign entities seeking to park cash in the country. Though most Americans would be surprised to hear it, in recent years, individuals and organizations with links to some of the world’s most oppressive regimes – such as the Russian arms merchant Viktor Bout, Venezuelan government officials connected to President Nicolás Maduro, and Iran’s Islamic Revolutionary Guard Corps – have all managed to store some of their ill-gotten money in the United States.

This is not a uniquely American problem, of course. Many countries around the world with legitimate banking and business sectors inadvertently allow illicit financial activity to be conducted in their markets. But some of them have done far more than the United States to address the problem. The best example is Denmark. Following several recent money-laundering scandals, Copenhagen swiftly enacted new regulatory measures to prevent criminals from continuing to use the country as a repository for dirty money. Since 2016, Denmark has improved by increasing transparency regarding the true owners of companies and nonfinancial businesses that operate in the Danish market. If the Biden Administration is as serious about fighting corruption as it says it is – and it should be, since the scourge undermines so many of its other foreign policy goals – it should follow Denmark’s example, studying its model and then taking similar, decisive action to clean up the U.S. system.

Woodrow Wilson campaigning to become the Democratic candidate for governor of New Jersey. (Getty Images)

A defective system

The main reason the United States provides sanctuary for so much illicit financial activity lies in the structure of its government. Because it is a highly federated system, with many powers constitutionally reserved for the states, Washington lacks jurisdiction over a number of important professions indirectly related to the business world. It also has no oversight in the creation of certain types of companies that are particularly vulnerable to foreign corruption and illicit finance. These gaps make it easy for state legislatures to open their territories to money laundering, the hiding of assets, and other financial crimes.

Because state governments set the rules concerning the process of forming companies, the federal government lacks the power to supervise this process and monitor the structures and information-disclosure requirements of the entities that result. Washington therefore lacks a mechanism for determining exactly who nominally or actually owns many companies formed in the United States.

This decentralized system has allowed states to compete with one another in a race to the bottom. As the sole supervisors of how corporations are formed in their jurisdictions, state governments are able to scale back regulations in order to boost local business creation and design an inviting environment for domestic and foreign investment; they also make money through the fees they charge for the registration process.

Some inducements various states offer include anonymity, protection from various types of litigation, tax exemptions, and granting corporations registered in their territory the ability to operate elsewhere. Certain nonfinancial businesses are also regulated at the state level. Accountants, lawyers, investment advisers, and experts in the arts and antiquities market are all exempt from key federal legislation, such as the Bank Secrecy Act of 1970 and the USA Patriot Act; those exemptions make it easy for them to advise clients on how to cleanse and invest their dirty money. The same goes for businesses that provide trust and company services, which allow their clients to hire corporate nominees – people who represent the business but are not beneficiaries of that business  – without any background screening program or other anti-money laundering (AML) scrutiny. The U.S. Treasury’s financial intelligence unit, the Financial Crimes Enforcement Network, is barred from touching these nonfinancial advisory firms.

Some inducements states offer include anonymity, protection from litigation, and allowing corporations registered there to operate elsewhere.

To understand what may look on the surface to be a bizarre system that stands at odds with the country’s stated values, it helps to spend a few minutes reviewing the history of U.S. business law. Beginning in the 19th century, numerous American states began removing some of the obstacles to the formation of corporations – a process that, at the time, was considerably more burdensome than it is today. State representatives also successfully battled to keep the federal government from gaining control of or supervision over the process of creating businesses.

The race to deregulate was led by New Jersey, which kicked off the process in the 1870s by allowing the creation of holding companies and permitting businesses registered there to operate outside of the state. Soon, other states, such as Pennsylvania, Maine, and West Virginia, began to follow suit, making similar rules and removing the requirement that businesses identify their beneficiaries. Within a few years, business deregulation had become a competitive industry in the United States. In the early 1910s, New Jersey’s then-Governor, Woodrow Wilson, began to reverse some of his state’s deregulation, but by that point, enough other states had joined the movement that the momentum continued.

Indeed, when New Jersey began to tighten its rules, Delaware quickly took its place. The state offered businesses all the same benefits New Jersey had but added anonymity for privacy, lawsuits, and asset protection. It also offered tax exemptions that resulted in lower business costs and more savings in comparison with other states. Today the state is home to nearly twice as many registered corporations as people. Along with Nevada, New Mexico, and Wyoming, Delaware allows businesses to register a representative instead of their true beneficiaries, which means corporations can hire an intermediary to formally run the company while concealing the identity of the people who actually profit from its work. These states also allow anyone, including oligarchs and other corrupt officials, to create trusts, allowing them to safeguard their finances from litigation, seizure, and tax implications, all with layers of secrecy to avoid detection. For example, trust-friendly states such as Delaware, Nevada, and New Mexico have abolished various forms of tax requirements, strengthened privacy and asset-protection laws, and eradicated rules against perpetuity, allowing trust agreements to never expire.

When New Jersey began to tighten its rules in the 1910s, Delaware quickly took its place.

The deregulation of trusts at the state level has led the industry to blossom in the United States, with Delaware now holding $512 billion in assets and New Hampshire claiming $670 billion. Things are so bad that the United States has become a leading facilitator of financial secrecy, as was revealed by the Pandora Papers – a 2021 report by the International Consortium of Investigative Journalists that exposed a network of offshore companies used to hide criminal and corrupt activity.

States like Delaware have made it much harder for law enforcement officials to crack down on corrupt individuals and organizations that hide their money in the United States. Consider a recent case involving Oleg Deripaska, a Russian oligarch with close connections to President Vladimir Putin. By employing advisers and a network of shell companies opened by family members, Deripaska was able to make several real estate purchases through his corporations without directly linking himself to the properties. In a similar case, in 2016, Igor Makarov, another Russian businessman with connections to Putin, created a trust with an unregulated company in Wyoming that allowed him to hide some of his assets, including a 13-seat private jet, and companies registered in the British Virgin Islands.

Cases such as these, and the laws that give rise to them, have led the Financial Action Task Force (FATF) – an international watchdog group that promotes policies and recommendations to combat the flow and investment of illicit money – to rate the United States as a “non-compliant jurisdiction” in the oversight of beneficial ownership and nonfinancial businesses for nearly two decades now.

Danish Prime Minister Lars Loekke Rasmussen at the International Anti Corruption Conference (IACC) on Oct. 22, 2018 in Copenhagen. (Photo by Philip Davali/AFP via Getty Images)

How the Danes do it

As recently as 2006, the FATF asserted that Denmark suffered from the same deficiencies as the United States does today. In its report that year, the FATF found that Denmark’s nonfinancial sectors did not comply with FATF recommendations. Denmark did require companies to register their beneficial owners, but in a way that opened the door for inaccuracies.

In 2016, however, the publication of the Panama Papers revealed that several financial institutions in Denmark were complicit in money laundering activity. The information contained details on over 300 Danish cases of illicit finance and tax evasion. Shortly after, the FATF announced that Denmark’s anti-money laundering strategy was nonexistent and lacked financial support. After publicly declaring the findings unacceptable, Denmark’s Minister of Economic and Business Affairs, Brian Mikkelsen, began advocating for more robust policies to police the financial sector and business.

In 2017, working with the opposition Social Democrats, Social Liberals, Socialist People’s, and Danish People’s parties, Prime Minister Lars Loekke Rasmussen’s Moderates passed the Danish Companies Act, which established a new registry for company owners. Before the creation of this new database, Denmark did not require companies with foreign ownership or trusts – which, because of their foreign nature, were not recognized as legal companies – to register. The new registry allows Copenhagen to gather information on shareholdings and the management of companies registered in the country, regardless of their origin. In 2017, Denmark also amended its Money Laundering Act to include nonfinancial professions such as lawyers, company service providers, and real estate agents. The new provision verifies potential clients and determines if they are acting on behalf of another person, providing another failsafe confirming that there is no illicit intention. Since these professions have no direct relationship with the financial sector, they do not fall under the purview of Denmark’s financial intelligence unit. But thanks to the amendment of the Money Laundering Act, they are now supervised by the Danish Business Authority. Professionals guilty of neglecting anti-money laundering procedures can be fined, deregistered, or disbarred. As another measure of transparency, these nonfinancial professions are also required to comply with basic due diligence rules, such as vetting and verifying potential clients before formalizing an agreement. Finally, in 2020, Denmark amended its policies to integrate the European Union’s 5th Anti-Money Laundering Directive. To better comply with the EU’s rules, Copenhagen publicized its beneficial ownership registry and enhanced transparency concerning the ownership of trusts.

All these efforts have paid off. In its latest report, the FATF stated that nearly all of Denmark’s shortcomings have been addressed, and the organization ended its monitoring of the country. Last year, the Basel AML Index, an annual assessment that evaluates a country’s ability to control money laundering, corruption, and transparency, ranked Denmark the 11th most effective state globally. And Transparency International ranked Denmark first in its global Corruption Perceptions Index.

Empty reform

Unlike Denmark, in the last decade, the United States’ score on Transparency International’s index has fallen by four points, decreasing from a 73 to a 69, which is not insignificant by their measure. Illicit financial activity affects far more than just the integrity of U.S. markets – important though that is. Financial crime rots institutions from the inside. If left unchecked, it quickly metastasizes and affects a country in other ways. According to Treasury Secretary Janet Yellen, “corrupt actors have for decades anonymously stashed their ill-gotten gains in real estate,” causing dirty money to increase real estate prices in Miami and New York. It has also made taxes in the United States more inequitable. Policies that favor high-income earners who exploit vulnerabilities like the trust industry create an excess of untaxed wealth, shifting more of the burden of regressive tax systems onto lower-income communities.

There is no shortage of congressional support for strengthening the country’s anticorruption efforts, but so far, progress has been slow. In 2021, former Rep. Tom Malinowski, D-N.J., along with current Reps. Maria Salazar, R-Fla., Steve Cohen, D-Tenn., and Joe Wilson, R-S.C., introduced the ENABLERS Act to enforce basic anti-money laundering requirements on unregulated businesses. The legislation came shortly after the Pandora Papers exposed a series of U.S. connections to President Putin that had allowed him to hide some of his dirty money on American soil.

U.S. Department of the Treasury in Washington, D.C. (Photo By Raymond Boyd/Getty Images)

Sens. Ben Cardin, D-Md., and Roger Wicker, R-Miss., recently revamped a piece of legislation imposing Global Magnitsky sanctions on corrupt actors. Despite these advancements, lobbying groups, such as the American Bar Association and the National Federation of Independent Business, have opposed transparency initiatives, claiming that they infringe on privacy rights and states’ ability to govern. Lobbying efforts successfully influenced enough policymakers to block some efforts at reform.

Lobbying groups have opposed transparency initiatives, claiming they infringe on privacy rights and states’ ability to govern.

While the United States appears to be reforming its corporate transparency laws on paper, moreover, nothing is being done to address the larger loopholes in the system. In 2021, for instance, Congress passed the Anti-Money Laundering Act, which contains a statute – the Corporate Transparency Act (CTA) – establishing a registry for beneficial ownership. This legislation could have a revolutionary effect on the fight against corruption in the United States. By collecting information on the beneficial owners and management of entities in the country, the registry has the potential to create a much higher degree of transparency. But there is a major flaw in the CTA that will undermine the efficacy of the new registry. The statute permits companies to circumnavigate the identification of their beneficial owners – they can simply claim they’re unable to disclose that information. And under this law, many types of legal trusts that foster money laundering still don’t have to register with the government because they’re not recognized as businesses.

The Biden Administration needs to get more serious about cracking down on financial crimes. To do so, it should follow Denmark’s model. In some ways, the Scandinavian country faced an easier process, since, unlike the United States, it has a unified political structure. But Washington can still draw several lessons from Copenhagen’s experience.

By following Denmark’s lead, the United States could nullify two tools kleptocrats use to hide their money.

By following Denmark’s lead in adding trusts to its anti-money laundering legislation, in addition to requiring business entities to register without exemption, the United States could nullify two of the most effective tools – company creation and trust arrangements – kleptocrats use to hide their money in the country. The United States should also expand the reach of the Bank Secrecy Act of 1970 and the USA Patriot Act to include nonfinancial businesses, due diligence efforts, and anti-money laundering compliance requirements such as reporting suspicious activity and cooperating with information requests from law enforcement on individuals suspected of money laundering.

Making such changes won’t be easy. Implementing safeguards to counter illicit finance often seems to threaten the concept of free and open markets that Americans hold dear. That apparent tension can make it hard to generate bipartisan support for new measures. The carveouts in the Corporate Transparency Act and the fate of the ENABLERS Act (it failed to pass in the Senate) highlight how many U.S. leaders still think deregulation and opacity are essential for generating economic growth.

Legislators must also remember that most individuals conducting business in the United States are not involved with financial crime or corruption and therefore would have no reason to fear greater scrutiny. The Corporate Transparency Act still permits corporations to be created and managed at the state level, leaving room for states to maintain many of their pro-business policies and regulations – except for measures providing anonymity to trust and business owners that only benefit individuals looking to hide nefarious activity. Meanwhile, imposing regulatory requirements on nonfinancial professions – such as proper background screening processes to confirm that these professions are not assisting shady governments and individuals – should only affect these industries if they’re hoping to attract a corrupt clientele.

The U.S. economy remains, in far too many ways, a kleptocrat’s bank. While maintaining loose regulations might seem to benefit the U.S. economy, doing so comes with a high cost: It helps authoritarians hold on to their power and wealth. It’s therefore high time for the United States to reassess its approach.