Ownership Vs Control: FATF Targets Soft Power

Some well-meaning initiatives have unintended consequences. This was the case when in 2012, opening the debate on the need for registration of beneficial owners, the FATF offered a helpful suggestion: “A controlling ownership interest depends on the ownership structure of the company. It may be based on a threshold, eg any person owning more than a certain percentage of the company (eg 25 per cent)”.[3]

That “eg” provided the basis for the evolution of a global industry in beneficial ownership avoidance. It is just the work of a moment for an offshore lawyer or wealth manager to make sure that no-one owns more than 24.99 per cent of any structure, thereby eliminating registration requirements altogether. That same footnote is still to be found in the November 2023 updated FATF Recommendations.

It is perhaps too late now to turn the tide, because so many jurisdictions have already adopted the 25 per cent threshold, but in March 2023, the FATF offered an alternative strategy: Not ownership, whether controlling or not, but control in its own right. It has targeted soft power.

FATF 40 Recommendations (2012, amended November 2023)

The FATF Recommendations (International Standards on Combating Money Laundering and the Financing of Terrorism & Proliferation)[4] are recognised as the global anti-money laundering and counter-terrorist financing standard.

The FATF describes their scope as follows:

“The FATF Recommendations set out a comprehensive and consistent framework of measures which countries should implement in order to combat money laundering and terrorist financing, as well as the financing of proliferation of weapons of mass destruction. Countries have diverse legal, administrative, and operational frameworks, and different financial systems, and so cannot take identical measures to counter these threats. The FATF Recommendations, therefore, set an international standard, which countries should implement through measures adapted to their particular circumstances”.[5]

The heart of the matter is contained in FATF Recommendation 24:

Transparency And Beneficial Ownership Of Legal Persons

Countries should assess the risks of misuse of legal persons for money laundering or terrorist financing and take measures to prevent their misuse. Countries should ensure that there is adequate, accurate and up-to-date information on the beneficial ownership and control of legal persons that can be obtained or accessed rapidly and efficiently by competent authorities, through either a register of beneficial ownership or an alternative mechanism. Countries should not permit legal persons to issue new bearer shares or bearer share warrants, and take measures to prevent the misuse of existing bearer shares and bearer share warrants. Countries should take effective measures to ensure that nominee shareholders and directors are not misused for money laundering or terrorist financing. Countries should consider facilitating access to beneficial ownership and control information by financial institutions and DNFBPs (Designated Non-Financial Business or Professions) undertaking the requirements set out in Recommendations 10 (Customer Due Diligence) and 22 (DNFBP Customer Due Diligence).

Recommendation 10 contains detailed guidance on customer due diligence and record keeping. It was here in 2012 that the seemingly innocuous suggestion of a 25 per cent threshold was first made. This illustrative example of a 25 per cent threshold has taken on a life of its own, and has become the globally accepted threshold below which a person is not considered to be a “beneficial owner” of a company.

Ownership Vs Control

The FATF did however have a fall-back strategy, perhaps recognising the inherent weakness of an ownership-based transparency initiative. In its Guidelines on Transparency and Beneficial Ownership (October 2014) it commented: [6]

“The FATF definition of beneficial owner in the context of legal persons must be distinguished from the concepts of legal ownership and control. […] [A]n essential element of the FATF definition of beneficial owner is that it extends beyond legal ownership and control to consider the notion of ultimate (actual) ownership and control. In other words, the FATF definition focuses on the natural (not legal) persons who actually own and take advantage of capital or assets of the legal person; as well as on those who really exert effective control over it (whether or not they occupy formal positions within that legal person), rather than just the (natural or legal) persons who are legally (on paper) entitled to do so.”

So far, so good, but the paragraph then continued, re-introducing an element of ownership as a necessary component of control, rather than use a stand-alone definition of controller as being a person having no ownership rights of any kind.

“For example, if a company is legally owned by a second company (according to its corporate registration information), the beneficial owners are actually the natural persons who are behind that second company, or ultimate holding company in the chain of ownership, and who are controlling it. Likewise, persons listed in the corporate registration information as holding controlling positions within the company, but who are actually acting on behalf of someone else, cannot be considered beneficial owners [7] because they are ultimately being used by someone else to exercise effective control over the company.”

Everything in the 2014 FATF approach therefore depended on ownership or on control analogous to ownership.

Guidance On Beneficial Ownership Of Legal Persons (March 2023)

A decade on, and the FATF’s thinking has evolved, recognising that control is an indication of beneficial ownership equally determinative to mere “ownership” itself. In March 2023, it introduced its ‘Guidance on Beneficial Ownership of Legal Persons’.[8] The FATF recognises the breadth of the means by which beneficial ownership may be obscured:

3. Beneficial ownership information can be obscured through, for example, shell companies, complex ownership and control structures involving many layers of shares registered in the name of other legal persons, bearer shares and bearer share warrants, unrestricted use of legal persons as directors, formal nominee shareholders and directors where the identity of the nominator is undisclosed, informal nominee shareholders and directors, such as close associates and family.[9]

The FATF now gives equal weight to ownership and control in determining ‘beneficial ownership’:

35. Legal ownership and beneficial ownership over a legal person are two separate concepts. A natural person may be considered a beneficial owner on the basis that he/she is the ultimate owner/controller of a legal person, either through his/her ownership interests or through exercising ultimate effective control through other means. While legal ownership and beneficial ownership can overlap, the legal title or controlling shareholding of a company may be in the name of an individual or a legal person other than the beneficial owner who ultimately controls the entity, directly or indirectly. Accordingly, individuals who exercise ultimate control over a legal person should be identified as beneficial owners, regardless of whether they own shares above any specified minimum ownership threshold.

36. Countries should consider various types of ownership interests and ways to exercise control over a legal person that exists within their jurisdiction, pursuant to commercial and administrative law, including voting rights, economic rights, convertible stock or outstanding debt that is convertible into voting equity. They should also consider ownership interests and ways to exercise control as the two aspects may have evolved in practice.[10]

Specifically, the FATF acknowledges that a simple 25 per cent ownership threshold as a test to determine beneficial ownership is inadequate, and that although 25 per cent should be regarded as a maximum threshold, not excluding lower percentages if felt to be more effective:

37. Countries may use an ownership threshold to determine beneficial ownership based on ownership interests, eg any natural persons whose direct or indirect ownership reaches a certain percentage of shares in a company. Such a threshold should not exceed a maximum of 25 per cent. Countries may consider combined ownership interests (eg shareholders working together). […]

42. Sometimes, ownership interests can be so diversified that there is no single shareholder, whether acting alone or together with other shareholders, who exercises control of the legal person through ownership. For example, if a threshold of 20 per cent is adopted (based on the jurisdiction’s assessment of risk), a company with as few as six shareholders can have no shareholder owning a share above the minimum threshold, then no shareholder would fall under the reporting requirements based only on the application of an ownership threshold.[11]

Control by means other than direct ownership is also explored in the Guidance:

• Weighted voting rights may be given to certain classes of shares which allows them to control a company even though their percentage of ownership of the company is below the 25 per cent threshold.
• An individual may be given power to appoint senior company management (people whom they therefore may influence).
• A lender to the company may have the right on the occurrence of some future event or at a given time to convert that loan into shares, those shares then giving them control of the company - a kind of beneficial owner-in-waiting.
• Where a shareholder is itself a company, the management of that corporate shareholder has indirect influence over the company in which it holds shares.
• Simple close personal relations, and connections to relatives or associates, must not be discounted - influencing someone who in turn can influence the company is control at one remove.

The FATF understands nevertheless that: “These cases are harder to detect and will in practice be less relevant with routine collection of beneficial ownership information by a registry, agency, or other body”. [12]

Reflections

To what extent legislation introduced worldwide in response to the FATF’s 25 per cent threshold test will now be amended on a country-by-country basis to include, independently, “control” as a litmus test remains to be seen. Soft power – the highly nuanced ability to control – is inherently difficult to define and to police. By contrast, whether a 25 per cent threshold has been crossed is a simple binary observation – it either has, or it has not. It requires no particularly sophisticated bureaucratic or lawyer-driven regulatory infrastructure.

And what of commercial expectations and political expediency? For governments eager to expand, and certainly not to discourage their domestic fiduciary and financial services sectors, the allure of the status quo may prove to be a powerful disincentive to reform.[13]

[1] Financial Action Task Force <https://www.fatf-gafi.org/en/the-fatf/what-we-do.html> (accessed 2 March 2024)

[2] All FATF materials quoted in this article are Copyright © FATF/OECD. All rights reserved.

[3] Interpretive Note to Recommendation 10 (Customer Due Diligence), The FATF Recommendations (2012, as amended November 2023) 67 fn 37 <https://www.fatf-gafi.org/publications/fatfrecommendations/documents/fatf-recommendations.html> (accessed 2 March 2024)

[4] The FATF Recommendations (2012, as amended November 2023) <https://www.fatf-gafi.org/publications/fatfrecommendations/documents/fatf-recommendations.html> (accessed 2 March 2024)

[5] The FATF Recommendations (2012, as amended February 2023) Introduction 7 <https://www.fatf-gafi.org/publications/fatfrecommendations/documents/fatf-recommendations.html> (accessed 2 March 2024)

[6] Financial Action Task Force, ‘FATF Guidance on Transparency and Beneficial Ownership’ (October 2014) para 15 <https://www.fatf-gafi.org/content/dam/fatf-gafi/guidance/Guidance-transparency-beneficial-ownership.pdf.coredownload.pdf> (accessed 2 March 2024)

[7] As a matter of corporate law, directors are not, in their capacity as such, beneficial owners of a company – they merely manage and control the company. The FATF seemed reluctant to abandon its flawed “ownership” model even at this level.

[8] Guidance on Beneficial Ownership of Legal Persons (March 2023) <https://www.fatf-gafi.org/en/publications/Fatfrecommendations/Guidance-Beneficial-Ownership-Legal-Persons.html> (accessed 2 March 2024)

[9] Guidance on Beneficial Ownership of Legal Persons (March 2023) para 3 4 <https://www.fatf-gafi.org/en/publications/Fatfrecommendations/Guidance-Beneficial-Ownership-Legal-Persons.html> (accessed 2 March 2024)

[10] Guidance on Beneficial Ownership of Legal Persons (March 2023) paras 35 and 36 16 <https://www.fatf-gafi.org/en/publications/Fatfrecommendations/Guidance-Beneficial-Ownership-Legal-Persons.html> (accessed 2 March 2024)

[11] Guidance on Beneficial Ownership of Legal Persons (March 2023) paras 37 and 42 16, 18 <https://www.fatf-gafi.org/en/publications/Fatfrecommendations/Guidance-Beneficial-Ownership-Legal-Persons.html> (accessed 2 March 2024)

[12] Guidance on Beneficial Ownership of Legal Persons (March 2023) para 45 18-19 <https://www.fatf-gafi.org/en/publications/Fatfrecommendations/Guidance-Beneficial-Ownership-Legal-Persons.html> (accessed 2 March 2024)

[13] A detailed discussion of beneficial ownership reporting and avoidance strategies is in Paul Beckett, Beneficial Ownership and Legal Responsibility: Concealment, Avoidance and Impunity (Routledge, London and New York, 2024).

Advocate Paul Beckett
Paul is a Lawyer and Academic, specialising in company, commercial and trust law; banking and fund management; cryptocurrencies and the blockchain; fraud, bribery, white collar crime, anti-money laundering and financial services regulation; commercial arbitration; business immigration; and domestic and international human rights (civil, political, economic, social and cultural rights). Recent publications include 'European Cross-Border Estate Planning' (Isle of Man chapter) (Sweet & Maxwell, London, first published 1995, current edition 2022), and 'Digest of Commercial Laws of the World' (Isle of Man chapter, co-author) (Thomson Reuters, USA, 2016, current edition 2022). His latest book is 'An Anatomy of Tax Havens: Europe, the Caribbean and the United States of America' (De Gruyter, Berlin. Published 6 November 2023). Upcoming is 'Beneficial Ownership and Legal Responsibility: Concealment, Avoidance and Impunity' (Routledge, London/New York. In preparation, publication due Spring 2024).