Shell corporations are legitimate, legal entities that do not possess actual assets or run business operations. They function as transactional vehicles for a variety of firms and for a myriad of purposes. Generally, they are used to obtain financing, maintain control over a conglomerate company, allow firms more favorable tax treatment, and occasionally facilitate money laundering as well as other illegal activities.

Structure
Shell companies are non-traded corporations, meaning that they are not listed on any stock exchanges for buying and selling by investors. Most exist in name only, other than as a mailing address, and on paper as a registered financial entity. To become a shell corporation, an interested party must first file with the U.S. Securities and Exchanges Commission (SEC). Examples are limited liability companies (LLCs) and trusts, provided that they are not comprised of any physical properties. In a sense, any startup firm that files with the SEC is technically a shell corporation.

SEE: The SEC: A Brief History Of Regulation

Legal Uses
As mentioned, the vast majority of shell corporations serve legitimate purposes, such as to hold stock or intangible assets of another business entity, or to facilitate domestic and cross-border currency and asset transfers and corporate mergers, as explained by the Department of the Treasury Financial Crimes Enforcement Network. For instance, many micro-cap companies fall under the category of shell corporations, as they typically have limited assets and frequently trade in volumes lower than average. Many Internet startups are categorically shell companies. They can also usefully protect trade secrets or safeguard directors from kidnappers or busybodies.

An example of a legal use of a shell corporation could be when a company interacts financially with another company. However, if "Company A" does not want to be associated with "Company B," as a result of "Company B" having a poor reputation, they can create a shell corporation through which the transaction can be disguised.

Not So Legal Uses
However, all too often are shell corporations involved in illegal activities. In May of this year, the SEC suspended trading of 379 inactive companies that were vulnerable to reverse mergers and other potential fraud schemes. These companies have the essential characteristic of being able to obscure the true ownership of an asset. Throw in the added benefit of a general lack of transparency of the financial dealings within the shell company industry (these companies are delinquent in their public disclosures) and it stands to reason that individuals and businesses would abuse those benefits.

SEE: A Guide To Spotting A Reverse Merger

A commonly cited abuse of the shell corporation model is money laundering. When money is obtained through an illegal means, it is critically important that there are significant buffers to prevent the funds from discovery. A shell corporation is ideal for this purpose. By obscuring both the ownership of the shell corporation and its activities, it is relatively simple to conceal the true origin and intent of large amounts of funds. Not that we would know, of course.

The SEC is highly aware of the questionable nature of the shell corporation structure, actively monitoring the shell corporation space. In fact, the SEC requires shell corporations to publicly disclose information in situations that have the potential to mislead investors, such as mergers of private firms with shell corporations.

Difference from Special Purpose Entities (SPEs)
A special purpose entity (SPE) is very similar to a shell corporation and yet markedly different. Much like shell corporations, special purpose entities are legal entities filed with the U.S. Securities and Exchanges Commission. SPEs are utilized in many of the same ways that shell corporations are: to portray a more favorable company position than that which is true. However, in contrast to shell corporations, SPEs are used by firms to minimize their financial risks through the allocation of assets to the special purpose entities. In this way, a public firm can insulate itself from exposure to more risky business ventures and also from liability to the projects therein.

The Bottom Line
Shell corporations are used for many purposes, some legal and others not so much. While potentially hazardous financial entities, shell corporations play an important role in markets around the world. Given their international stature and prospects for growth, rigorous regulation strategies must be employed to ensure economic stability and investor safety within the space.

Related Articles
  1. Investing News

    Obama Wants to Double Wall Street Regulation

    President Obama wants to double the budgets of the SEC and the CFTC over the next five years.
  2. Taxes

    Why People Renounce Their U.S Citizenship

    This year, the highest number of Americans ever took the irrevocable step of giving up their citizenship. Here's why.
  3. Personal Finance

    What it Takes to Get a Green Card

    Grounds for getting a green card include having family members in the U.S., being a certain type of refugee or specialized worker, or winning a lottery.
  4. Investing News

    ABC's Madoff Miniseries Explores His Charm, Smarm

    An ABC miniseries on Ponzi scheme king Bernie Madoff gets inside the head of a man who was, in fact, not too big to fail.
  5. Career Education & Resources

    Laws & Regulations To Know Before Changing the Name of Your Business

    Discover some of the most important steps you need to take after making a decision to change your legally established business name.
  6. Personal Finance

    Passport Procrastinators: This Year, Renew Early!

    Millions of passports issued nearly 10 years ago when the Western Hemisphere Travel Initiative became law are expiring. Expect backlogs; leave extra time.
  7. Economics

    Why Enron Collapsed

    Enron’s collapse is a classic example of greed gone wrong.
  8. Stock Analysis

    From Shampoo to Soup, Unilever Has it Covered (UL)

    Open your fridge, your pantry, your bathroom cabinet and you'll find the Unilever logo. Here's how the company got so enormous.
  9. Financial Advisor Technology

    Advisors: What to Know Before You Text

    Texting is becoming more popular between clients and financial professionals, but compliance can be tricky. Here's what to know before advisors text.
  10. Term

    Understanding Rule 144A

    Rule 144A is an SEC rule that changes the two-year holding period requirement on privately placed securities.
RELATED FAQS
  1. What is the Writ of Mandamus?

    A writ of mandamus is a court order issued by a judge at a petitioner’s request compelling someone to execute a duty he is ... Read Full Answer >>
  2. Are UTMA accounts escheatable?

    Like most financial assets held by institutions such as banks and investment firms, UTMA accounts can be escheated by state ... Read Full Answer >>
  3. What is the SEC's escheatment process?

    The U.S. Securities and Exchange Commission (SEC) does not have its own escheatment process. Rather, the SEC notes that the ... Read Full Answer >>
  4. Can the IRS audit you after a refund?

    The U.S. Internal Revenue Service (IRS) can audit tax returns even after it has issued a tax refund to a taxpayer. According ... Read Full Answer >>
  5. How does escheatment impact a company?

    In recent years, state governments have become increasingly aggressive in enforcing escheatment laws. As a result, many businesses ... Read Full Answer >>
  6. What happens if property is wrongfully escheated?

    If your financial accounts, such as bank, investment or savings accounts, are declared dormant and the managing financial ... Read Full Answer >>
Hot Definitions
  1. Black Swan

    An event or occurrence that deviates beyond what is normally expected of a situation and that would be extremely difficult ...
  2. Inverted Yield Curve

    An interest rate environment in which long-term debt instruments have a lower yield than short-term debt instruments of the ...
  3. Socially Responsible Investment - SRI

    An investment that is considered socially responsible because of the nature of the business the company conducts. Common ...
  4. Presidential Election Cycle (Theory)

    A theory developed by Yale Hirsch that states that U.S. stock markets are weakest in the year following the election of a ...
  5. Super Bowl Indicator

    An indicator based on the belief that a Super Bowl win for a team from the old AFL (AFC division) foretells a decline in ...
Trading Center