Fraud is a crime that impacts lives and businesses across the economy. Accelerated by technology, fraud currently accounts for around 38% of total crime in England and Wales, with £2.46 billion lost by businesses and individuals alone in FY 21/22. It can take many forms, ranging from romance scams, to sprawling international enterprises defrauding governments of public funding. Fraud is a constant risk for governments, both reputationally and by depriving them of vital revenue.
Visibility over fraud is an ongoing challenge for the UK government. A recent House of Commons Select Committee report found that “large gaps still remain in the Government’s understanding of its exposure to fraud and corruption.” It estimated that the government loses up to £28.5 billion every year to undetermined “fraud and error” – on top of the £16 billion lost to tax and benefit fraud. The report called for the UK government to invest in fraud prevention as a strategic priority and “ongoing risk”.
The UK government’s Fraud Strategy is leading a cross-government effort to cut fraud by 10% on 2019 levels by December 2024. Launched in May 2023, the strategy recognised fraud as a threat that puts the UK’s financial reputation at risk, characterising it as an interconnected crime tied to “other serious and organised crime, such as modern slavery, human trafficking and drugs”.
We are fast approaching the UK government’s Global Fraud Summit on 11-12 March 2024. Ahead of this milestone, we have an important opportunity to get to grips with the complexities and scale of fraud today – and empower governments and corporations to act against it.
Splintering in the system
A big part of tackling fraud starts with understanding how criminal actors use legal business structures as a platform for criminal activity. Consider shell companies; corporations without significant business assets or operations. There are many legitimate reasons to create a shell company. The problem is that shell companies are too often a useful legal instrument for bad actors to disguise the true owners of a business, covering up a spectrum of financial crimes such as fraud, tax evasion, and money laundering.
The issue is particularly pressing for the UK. Moody’s Shell Company Indicator research found the UK has almost five million shell company red flags – the highest in the world, ahead of China and the US. Undoubtedly, this result partly reflects the status of the UK financial system, a global leader with an advanced and transparent approach to recording data on companies that are incorporated here.
Nevertheless, legal loopholes in the UK financial system make it attractive for financial crime. A particular concern is how fast and cheap it is to set up a company in the UK. The only requirements are a £12 registration fee, the appointment of one real person who is at least 16 years of age, and the stipulation that the director’s address is not a PO Box.
Moody’s data highlights the different indicators of risks created by shell companies. The UK has the highest number of flags globally for individuals holding an atypical number of directorships. While this can be for legitimate purposes e.g. a lawyer acting as a director during fundraising or merger activity, it can be a signal of corporate opacity, with a single individual in control of multiple companies able to create complex structures to mask illegal activity like money laundering. The UK also ranks highest globally for mass registrations – i.e., many companies registered in a short space of time. Mass registrations can be used to spread assets or transactions across numerous entities, making it more difficult for authorities to trace the flow of money.
These structural weaknesses have real consequences for ordinary people. A recent fraud scheme exposed in January 2023 by The Guardian found more than 150 companies registered at Companies House in the UK, many with ties to China, were targeting people worldwide in ‘romance scams’. These scammers used ‘social engineering’ methods to pretend to be someone else, winning someone’s trust only to then convince that person to transfer money. Victims said the credibility of seeing the company incorporated in the UK helped convince them nothing was wrong.
The trend of Chinese incorporations in the UK is on the rise. According to Moody’s data, Chinese-owned firms with a British incorporation rose by more than 600% post-pandemic.
UK government data highlights that authorised fraud, like romance scams when individuals approve the payment, now account for the majority of fraud. In the last four years there has been a swing away from unauthorised fraud, such as unauthorised withdrawals from banks and credit cards, as criminals adapt to the increasing sophistication of banking technology. This new reality adds complexities for governments in building awareness of evolving criminal methodologies and improving enforcement, as well as for businesses in assessing risk and keeping their operations and customers safe.
Defending the system
There have been concerted efforts in the last 12 months to improve how the UK tackles fraud. The Economic Crime and Corporate Transparency Act became law in October 2023. Under the new ‘Failure to Prevent Fraud’ offence, an organisation will now be liable where a specified fraud offence is committed by an employee or agent acting on the organisation’s behalf. This increases the importance for government and corporate vigilance on the web of direct and indirect risks they face from financial crime.
Nevertheless, faults remain in the system. Companies House includes a list of ‘company formation agents’ – individuals with qualifications to help a business register in the UK. These gatekeepers to the financial system are important in protecting it, but with this responsibility comes the opportunity for illegal activity. Moody’s analysis highlighted that of the 97 firms listed on Companies House that provide these services, 16 were inactive and 3 raised red flags. Several of these listed gatekeeper organisations had not met anti-money laundering standards in the past, signalling the risk of individuals using their expertise in company formation to help bad actors commit financial crime.
Cracking the shell company code
Meeting the UK government’s stated goal to reduce fraud will not be easy. There are vulnerabilities in the system that are leaving loopholes for bad actors. More effective regulation, including data verification, is essential, cutting down on avenues for criminal activity, improving transparency, and securing the stability and function of the economy.
But regulation can lag behind the realities of the financial system. Immediate steps can be taken on fraud with a data-driven approach from governments, at scale. This will help ‘crack open’ structures like shell companies that can mask financial crime and build a comprehensive understanding of risks across the financial system. In the process, we can empower government agencies to take swift action to scrutinise and analyse risk factors, like shell company behaviour, and develop accurate investigations and effective countermeasures against fraud and its beneficiaries.
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