Small Business November 5, 2009, 11:40PM EST

Watchdogs: 'Shell' Schemes Are on the Rise

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The idea for "Watchdogs: 'Shell' Schemes Are on the Rise" came from BusinessWeek reader Gary Bares, the founder and CEO of Verifraud, a fraud risk management company based in Phoenix

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There's a bustling online trade in shell companies. Dozens of Web sites offer to sell existing corporations or limited liability companies, typically registered in states like Delaware, Nevada, Wyoming, or offshore locations, all of which require little disclosure about the actual owners. These include real businesses that have closed but still exist on paper, as well as entities that never had any real operations or significant assets. Sometimes they're marketed as "aged shelf companies", firms that were registered several few years ago to make them appear more established to potential lenders or trading partners. Some sellers advertise that the companies already have credit lines. New shell companies can be had for a few hundred dollars, but buyers pay a premium for aged or off-shore incorporation. Two-year-old entities command over $1,000, and some sites list decades-old entities for sale for tens of thousands of dollars.

Some Shells Are Legitimate

Buyers might want shell companies for legitimate reasons. They're sometimes used in corporate restructurings, mergers, or other deals. But some buyers may seek to use an aged corporation to skirt guidelines that restrict lending to new businesses. In April, responding to concerns raised by the Better Business Bureau, the FDIC alerted bank executives to this risk: "Shell and shelf companies are often formed by individuals and businesses to conduct legitimate transactions. However, they can be and have been used as vehicles for common financial crime schemes such as money laundering, fraudulent loans, and fraudulent purchasing," the agency said in its alert. The regulator noted that sometimes sellers of shelf companies advised buyers to request credit lines under $150,000 to avoid heavy scrutiny from banks.

Small and midsize manufacturers, wholesalers, and distributors are among the most vulnerable to shell company fraud, because they do business on trade terms but can't afford the risk management systems that larger firms and financial institutions use—nor can they absorb the losses. "Our members don't have the margins. They don't have the volume of business any more that they have the luxury of being ripped off," says Mike Mitchell, president and CEO of the Credit Management Assn., an information-sharing group that tries to help B2B companies in California and Nevada prevent fraud. "The risk has gone way up in this environment."

Meanwhile, police in Solon, Ohio, collected the serial numbers for the dozen pieces of IBM (IBM) and Motorola (MOT) retail equipment Agilysys shipped to Manybol. It's likely, based on what fraud experts say, that those goods and untold other equipment the murky company may have ordered from suppliers across the country, are already being resold on the black market.

Tozzi covers small business for BusinessWeek.com.