Corporate Transparency Act – Beneficial Ownership of Shell Corporations Must Be Disclosed

On January 1, 2021, Congress overrode the President’s veto of the National Defense Authorization Act for Fiscal Year 2021 (“NDAA”), here.  Among the provisions of the NDAA was TITLE LXIV–ESTABLISHING BENEFICIAL OWNERSHIP INFORMATION REPORTING REQUIREMENTS (§§ 6401-6403), which is called and may be cited as “Corporate Transparency Act” (§ 6401).  The CTA adds 31 USC § 5336, titled Beneficial Ownership Information Reporting Requirements.

First I will provide a high level summary (with some links), and Second some brief comments.  I will refer to the provisions by the short name by the initialism CTA for the Corporate Transparency Act.

High Level Summary 

(Vox 1/4/2021), here, Landmark Bill Ending Anonymous U.S. Companies Is Enacted

(FactCoalition 1/1/21), here; and Morris Pearl, Congress just passed the most important anti-corruption reform in decades, but hardly anyone knows about it

(Fortune 12/26/20), here): Certain corporations (non traded or with a small level of activity) will have to register their beneficial ownership with Treasury which will incorporate the information into a database that may be accessed by law enforcement agencies.  Prior to this, there was no federal requirement and states usually did not require that beneficial ownership be disclosed.  The CTA does not prohibit otherwise anonymous shell companies; it just requires that the ownership be disclosed to Treasury.  

As noted in the Vox article, however, some compromises were made:

Clark Gascoigne

This is, of course, a compromise, right? If I could have waved a magic wand, this is not the bill I would have written.

 But it is a compromise with integrity. Most importantly, the definition of who is a “beneficial owner” in the bill is very strong and will truly identify the ultimate owners of the companies. That’s a big deal.

 Now, it doesn’t solve all of our money-laundering problems. One big exemption in this is that while it applies to corporations, limited liability companies, it does not apply to trusts or partnerships.

 Partnerships are generally considered lower risk, but trusts are a major issue, particularly because the vast majority of trusts in the United States don’t actually register with their legal contracts.

 So you will still be able to set up a trust that could potentially be abused for money laundering after this. That’s something that we’re going to have to take a look at. There are studies that the Government Accountability Office and Treasury Department are going to have to do on the risks posed by trusts. The bill mandates those studies, and hopefully we’ll be able to address that down the road.

 There’s also some concerns around pooled investment vehicles, like hedge funds and private equity funds, that are operated or advised by a registered investment adviser. Law enforcement will be able to tie the fund to the investment adviser, and they’ll know the beneficial ownership information for the investment adviser, but they won’t know it for the fund itself.

 There is a big concern around that because you’ve got trillions of dollars in money going into these private pooled investment funds that could potentially pose some risk for money laundering.

 Jen Kirby

When it comes to those pooled investments, just to make sure I’m understanding this: So if I have dirty money, and I am putting it into this fund with a lot of other investments, it basically muddies the waters. You know who’s managing the fund, but you have no way to pull out each investment, correct?

 Clark Gascoigne

Correct, yeah.

The Fortune article says:

 Currently [before the Act is implemented], the U.S. is the easiest place in the world to form an anonymous shell company that can be used for money laundering, crime, and corruption. 

* * * *

Many issues plaguing our nation and the international community have some connection to anonymous shell companies, which act as the perfect financial getaway vehicles. After all, given how effectively anonymous shell companies mask perpetrators’ finances—authorities often watch their investigations go cold as soon as they run into one of these shell companies—what criminal network wouldn’t take full advantage of all that secrecy?

Those using and abusing anonymous shells to cloak themselves in anonymity run the gamut. From tax cheats hiding their finances and bleeding local coffers dry to drug cartels flooding American streets with opiates turning to anonymous shells to launder their profits, a wide range of criminal forces have used anonymous companies to mask their tracks.

Clamping down on anonymous shell companies won’t solve economic inequality—most of the very rich are people who take advantage of perfectly legal loopholes in the law—but it will increase fairness by making everyone follow the rules that most hard-working honest Americans already follow.

It will also curb a wide variety of international criminality and wrongdoing that currently flows through the American financial system. The people and companies responsible for ongoing environmental devastation around the world often hide their environmental crimes behind anonymous shell companies, like the European company Norsudtimber, which covers up illegal logging activity in the Democratic Republic of the Congo in a web of anonymous shells. So do repressive regimes abroad, from Moscow to Pyongyang to Damascus, who use anonymous shell corporations to avoid sanctions and bankroll their authoritarian efforts.

Environmental criminals, authoritarian regimes, tax evaders and financial criminals, drug traffickers, wildlife poachers, and gun runners—all those responsible for the most heinous crimes have turned to anonymous shell companies. And all too often, given the outsize role America has played in producing anonymous shell companies, the entities at the heart of these criminal networks are produced here in the U.S.

The pending bill outlawing anonymous shell companies in the U.S. will help solve these problems. Not only will it prevent criminal actors from abusing American financial secrecy tools to expand their own illicit empires, but it will also be the biggest anti-corruption step the U.S. has taken in decades.

Executive Summary

The U.S. Congress recently passed the Corporate Transparency Act (“CTA”) as part of the 2021 National Defense Authorization Act. The CTA requires certain corporations, limited liability companies and other similar entities (including privately held business entities) to report their direct and indirect human beneficial ownership information to the U.S. Department of Treasury. The CTA is intended to combat the use of “shell” companies in the commission of money laundering, financial fraud and other domestic and international illicit activity and corrupt practices. However, the reach of the CTA is much broader, and includes incorporators, organizers, financial institutions and others dealing with many U.S. business entities, including with regard to existing business entities formed prior to the CTA’s enactment.

Context

Under the CTA, reporting companies[1] must provide the Financial Crimes Enforcement Network of the Department of the Treasury (“FinCEN”) a report identifying each applicant (i.e., incorporator or organizer) and each human beneficial owner who, directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise (i) exercises substantial control over the reporting company, or (ii) owns or controls not less than 25 percent of the ownership interests of the reporting company. Such identification must include the applicant’s or beneficial owner’s (1) full legal name; (2) date of birth; (3) current residential or business street address; and (4) an unique identifying number from a prescribed identification document (such as a driver’s license) or a FinCEN issued identifier number. The reporting company information is to be held in a FinCEN database and is to be accessible by certain governmental agencies and financial institutions. The CTA also establishes corresponding reporting, records retention and information dissemination requirements, obligations and safeguards of the Department of Treasury.

Analysis

What is a “reporting company?”

A reporting company is a corporation, limited liability company or other similar entity that is (i) created by the filing of a document with a Secretary of State or a similar office of an Indian Tribe; or (ii) formed under the law of a foreign country and registered to do business in the United States by the filing of a document with a Secretary of State or a similar office of an Indian Tribe, provided that it does not fall within specific excluded categories. Thus, the determination of whether an entity is a “reporting company” is, to large degree, made by negative implication (i.e., certain entities are expressly excepted from the reach of the CTA). Those excepted entities, in general terms, include the following:

  1. publicly traded or public reporting companies registered with the SEC;
  2. governmental or quasi-governmental entities;
  3. banks;
  4. credit unions;
  5. bank or savings and loan holding companies;
  6. money service businesses or MSBs;
  7. securities brokers or securities dealers;
  8. securities exchanges or clearing securities agencies;
  9. entities otherwise registered with the SEC;
  10. investment companies and investment advisers registered with the SEC;
  11. investment adviser control persons;
  12. insurance companies;
  13. insurance producer entities with an operating presence at a physical office in the US;
  14. registered commodity exchange or registered futures trading entities;
  15. Sarbanes-Oxley Act registered public accounting firms;
  16. public utilities;
  17. financial market utilities;
  18. pooled investment vehicles;
  19. certain IRC § 501(c) entities;
  20. certain entities owned exclusively by U.S. persons that operate exclusively to provide financial assistance to, or hold governance rights over, certain IRC § 501(c) entities;
  21. U.S. physically located, 21+ employee businesses generating more than $5MM in annual gross receipts;
  22. subsidiary entities owned only by entities excluded from being a reporting company;
  23. certain un-capitalized entities without activity or foreign owners; and
  24. certain entities expressly exempted by future Treasury regulation.

The common denominator among the excepted entities is that they generally have existing public disclosure obligations that limit their utility to bad actors in the commission of money laundering, financial fraud and other domestic and international illicit activity and corrupt practices.

Deemed reporting companies include all entities not otherwise excepted that:

(1) have 20 or fewer full-time employees or

(2) have $5,000,000 or less in gross receipts and sales in the aggregate (including from subsidiaries and other entities through which the subject entity operates) or

(3) do not have an operating presence at a physical office location within the United States.

Missing any one of these three thresholds will sweep an entity into the reporting company regime and subject it to compliance with the CTA reporting obligations.

A short list of such possible reporting company entities include:

  1. family offices;
  2. subsidiaries within a portfolio;
  3. joint ventures;
  4. “main street” and “mom and pop” businesses;
  5. accounting firms that are not registered under the Sarbanes-Oxley Act with limited “owners” or limited revenue or only a virtual presence;
  6. law firms and other professional businesses with limited “owners” or limited revenue or only a virtual presence; and
  7. certain nonprofit entities not falling within the included exclusions (and nonprofit entities that lose their IRC § 501(c) designation).

Who is Considered to Be a “Beneficial Owner?”

“Beneficial owner,” with respect to an entity, refers to an individual who, directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise (i) exercises substantial control over the entity; or (ii) owns or controls not less than 25 percent of the ownership interests of the entity.

However, the following individuals are excluded from constituting a “beneficial owner” of an entity: (i) a minor child, if the information of the parent or guardian of the minor child is properly reported, (ii) an individual acting as a nominee, intermediary, custodian, or agent on behalf of another individual, (iii) an individual acting solely as an employee of a corporation, limited liability company, or other similar entity and whose control over or economic benefits from such entity is derived solely from the employment status of the person, (iv) an individual whose only interest in a corporation, limited liability company, or other similar entity is through a right of inheritance; or (v) a creditor of a corporation, limited liability company, or other similar entity, unless the creditor exercises substantial control over the entity.

Who is an “Applicant?”

“Applicant” refers to an individual who (A) files an application to form a corporation, limited liability company, or other similar entity under the laws of a State or Indian Tribe (e.g., an incorporator or organizer); or (B) registers or files an application to register a corporation, limited liability company, or other similar entity formed under the laws of a foreign country to do business in the United States by filing a document with the Secretary of State or similar office of an Indian Tribe.

What Beneficial Ownership Information Is Required To Be Reported?

Each report delivered under the CTA in accordance with the Regulations (see below) is required to identify each beneficial owner of the reporting company, and each applicant acting with respect to that reporting company, by his or her (i) full legal name; (ii) date of birth; (iii) current, as of the date on which the report is delivered, residential or business street address; and (iv) an unique identifying number from an acceptable identification document or a FinCEN Identifier (the “Required Information”).

When Will Reporting Companies Be Required to Begin Reporting Under the CTA?

The reporting of beneficial ownership information is to occur in accordance with regulations (the “Regulations”) to be promulgated by the Secretary of the Treasury prior to January 1, 2022. Under those Regulations, each reporting company will be required to submit to FinCEN a report that contains the Required Information as described above.

All reporting companies formed or registered after the Effective Date of the Regulations will be required, at the time of formation or registration, to submit to FinCEN a report that contains the Required Information.

Meanwhile, all reporting companies formed or registered prior to the Effective Date will be required, “in a timely manner,” and not later than two (2) years after the Effective Date, to submit to FinCEN a report that contains the Required Information. It bears note that there is no “grandfathering” of previously formed entities, and conceivably this will sweep in all existing entities not otherwise fitting within a reporting company exemption.

What Ongoing Obligation Exists to Keep the Reported Required Information Current?

All reporting companies have an ongoing obligation to, in a timely manner, and not later than one (1) year after the date on which there is a change with respect to any Required Information submitted in a report to FinCEN, to submit to FinCEN a report that updates the information relating to the change.

To Whom May FinCEN Disclose Beneficial Ownership Information?

FinCEN may disclose beneficial ownership information upon receipt of a request, through appropriate protocols, from federal agencies engaged in national security, intelligence, or law enforcement activity, for use in furtherance of such activity, or from a State, local, or Tribal law enforcement agency, if a court of competent jurisdiction has authorized the law enforcement agency to seek the information in a criminal or civil investigation.

FinCEN may also disclose beneficial ownership information upon a request from a federal agency on behalf of a law enforcement agency, prosecutor, or judge of another country, including a foreign central authority, under an international treaty, agreement, convention, or official request made by law enforcement, judicial, or prosecutorial authorities in trusted foreign countries when no treaty, agreement, or convention is available.

Further, FinCEN may disclose beneficial ownership information upon receipt of a request from a financial institution subject to customer due diligence requirements, with the consent of the reporting company, to facilitate the compliance of the financial institution with customer due diligence requirements under applicable law.

What Civil and Criminal Penalties Exist for Failure to Properly Comply with the CTA Reporting Requirements?

The CTA makes it unlawful for any person to willfully provide, or attempt to provide, false or fraudulent beneficial ownership information, including a false or fraudulent identifying photograph or document, to FinCEN, or to willfully fail to report complete or updated beneficial ownership information to FinCEN in complying with the CTA. Any person committing a reporting violation is liable to the United States for a civil penalty of not more than $500 for each day that the violation continues or has not been remedied; and may be fined not more than $10,000, imprisoned for not more than 2 years, or both.

Notwithstanding the foregoing, a person may not be subject to civil or criminal penalty as outlined above if the person has reason to believe that any report submitted by the person in accordance with the CTA contains inaccurate information, and in accordance with the Regulations, voluntarily and promptly, and in no case later than 90 days after the date on which the person submitted the report, submits a subsequent report containing corrected information. Further, FinCEN is required to provide assistance to any person seeking to submit a corrected report in accordance with such safe harbor provisions. However, a person will not be exempt from penalty if, at the time the person submits a report, the person acted for the purpose of evading the reporting requirements under the CTA, and has actual knowledge that any information contained in the report is inaccurate.

What Civil and Criminal Penalties Exist for Improper Disclosure or Use of Beneficial Ownership Information?

Except as authorized by the CTA, it is unlawful for any person to knowingly disclose or knowingly use the beneficial ownership information obtained by the person through a report submitted to FinCEN under the CTA, or a disclosure made by FinCEN for any unauthorized disclosure or use. Any person making an unauthorized disclosure or use that violates the CTA is liable to the United States for a civil penalty of not more than $500 for each day that the violation continues or has not been remedied; and may be fined not more than $250,000, or imprisoned for not more than 5 years, or both. However, if such violation is committed while violating another law of the United States or as part of a pattern of any illegal activity involving more than $100,000 in a 12-month period, such person may be fined not more than $500,000, imprisoned for not more than 10 years, or both.

Conclusion

Business owners, incorporator and organizers should be mindful of these new disclosure requirements, and monitor FinCEN’s progress on promulgating the regulations contemplated under the CTA. All business owners potentially subject to these new disclosure requirements should create a compliance process related to beneficial ownership intake, monitoring and disclosure to ensure that all information required under the CTA may be and will be timely reported to FinCEN, and to begin conditioning their investors for this new reporting regime. Beneficial ownership information compliance will need to be added to all reporting companies checklists to ensure compliance and avoid civil and criminal penalties.

For financial institutions, the FinCEN database has the potential to substantially lessen the burden of customer due diligence (“know your customer” or “KYC”), but financial institutions will need to continue to implement a robust customer due diligence program. Financial institutions will also need to protect against the unauthorized disclosure of information obtained from the FinCEN database to avoid possible civil and criminal penalties and civil claims.

Polsinelli will continue to monitor and evaluate the effects the new CTA beneficial ownership disclosure requirements will have on new and existing business entities as regulations are promulgated and other guidance is provided by the Unites States Department of the Treasury and its Financial Crimes Enforcement Network.


[1] It is important to note that these are “reporting companies” as defined in the CTA only, and not “reporting companies” obligated to file reports under Sections 13 or 15(d) of the Securities Exchange Act. Ironically, reporting companies under the CTA sweep in many “private” business entities not previously subject to federal disclosure obligations.

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