Front Company | B2B Finance Glossary
What is a Front Company?
A front company (also known as a front organization) is a fake company created by criminals or fraudsters. The company aims to use it to engage in fraudulent and illegal activities. Front companies are companies that are up and running and that have a physical presence; however, the way that front companies appear to be and the products or services that they seem to be selling are used as a coverup for an illicit, behind-the-scenes business or other forms of criminal activity.
What is the Difference Between a Shell Company, a Shelf Company, and a Front Company?
A shell company is only a company on paper – it is not an active business and does not hold any significant assets. Shell companies in and of themselves are not necessarily illegal. Still, they are often used for illegal activities such as money laundering and financial crimes because they are easy and inexpensive to create.
However, shell companies have some legitimate use cases, such as conducting cross-border transactions or holding the intangible assets of other business entities. Other legitimate use cases for a shell company include a startup using a shell business entity to raise capital or engaging in a hostile takeover of another company.
A shelf company is a company that’s registered but has been left dormant for a long time (ie, “put on a shelf”). Even if the business entity has been deactivated, it still has already gone through the process of business registration and paying any required state fees. If another business or individual wants to skip the time and money it takes to form a new company, that person or company can instead purchase the shelf company that’s already in existence.
On the other hand, a front company is a physical company that’s up and running and aims to cover up illicit financial activity. Therefore, a front company is more than just a shell company because it has a real physical presence that conducts legal business on top of the illegal activity it covers up.
A front company is always designed to cover up the true originator and end user of illegal products or transactions.
Who Sets Up a Front Company?
Front companies are typically run by terrorist organizations, organized crime groups, secret societies, intelligence agencies, banned groups, and political or religious organizations. Illegal paramilitary groups have been known to create front companies to raise money, recruit more members, and spread propaganda.
Drug cartels frequently create front organizations for money laundering and drug trafficking purposes. Front companies make it possible for these illicit groups to launder their income for illegal activities and also cover up other illegal activities taking place, such as illegal gambling, extortion, smuggling, prostitution, and drug and sex trafficking.
Additionally, some corporations set up front companies to have these companies advocate for them. Some pharmaceutical companies have set up artificial patient groups that operate as front companies to pressure healthcare providers and legislators to adopt the pharmaceutical company’s products. Other large corporations have been known to set up front companies to push the organization’s agenda or sway the public’s opinion.
Typical front companies include casinos, gambling houses, construction companies, hair and nail salons, restaurants and bars, clubs, engineering firms, trash-hauling services, and dock-loading enterprises.
Spotting a Front Company
It’s important to understand the differences between shell, shelf, and front companies and use this information to detect the risk of fraudulent and illegal activities. Being able to distinguish how each of these organizations operates is critical because it can help with proper due diligence and knowing when illegal business activities are occurring.
Additionally, knowing what red flags are can be very helpful in detecting front companies and shell companies that are being used for illegal purposes. A red flag is an indicator that something illicit is going on. Here are some examples of what they look like:
- Payments that do not have any particular purpose and just show a contract or invoice number
- The company is selling goods or services that do not match the industry that the company is operating in
- The shell company is making multiple high-value funds transfers that do not have a legitimate purpose tied to the business
- Suspicious addresses and other address-related inconsistencies, such as two different transacting companies that use the same address
- Frequent activities from beneficiaries from high-risk, off-shore financial locations
- The inability to identify wire transfer senders or recipients
- A very large number of beneficiaries are receiving wire transfers from the same recipient