Every small business will be required to identify its beneficial owners to the U.S. Treasury under recently enacted federal legislation intended to crack down on the abuse of shell companies. The purpose of the new law is stop the use of shell companies to launder money by drug dealers, terrorists, corrupt politicians and other malign actors through a database that will allow law enforcement to isolate the real parties behind a shell company.
On January 1, 2021, Congress enacted the Corporate Transparency Act (the CTA) as part of the National Defense Authorization Act for Fiscal Year 2021. Under the CTA, certain companies will be required to disclose personal information regarding their beneficial owners to the Financial Crimes Enforcement Network (FinCEN). The legislation states that Congress expects this reporting obligation will help protect vital national security interests, as well as interstate and foreign commerce; bolster efforts to counter money laundering, the financing of terrorism, and other illicit activity; establish a federal standard for incorporation practices; and bring the United States into compliance with international anti-money laundering and countering the financing of terrorism standards.
The CTA is expected to go into effect within the next year following the Treasury Department’s adoption of implementing regulations. Although the implications of the bill will not be fully apparent until the Treasury answers some important questions arising under the CTA in its regulations, we encourage companies to begin familiarizing themselves with the CTA now. We discuss the key features of the CTA in this alert, as well as certain areas of concern that are already evident from the text of the CTA itself. We will provide further analysis after the Treasury regulations are issued.
|Who Must Comply?
Any corporation, limited liability company or “similar entity” that was created by filing a document with a secretary of state or similar office under state or tribal law or was formed under the law of a foreign country and registered to do business in the United States by filing a document with a secretary of state or similar office under state or tribal law.
- Publicly traded companies or companies otherwise subject to reporting requirements under Section 15(d) of the Securities Exchange Act of 1934.
- Companies subject to existing regulatory reporting requirements (e.g. banks, credit unions, bank holding companies, registered securities brokers or dealers, registered investment companies, registered investment advisers, insurance companies and registered public accounting firms).
- Companies owned or controlled by exempt companies.
- Companies employing more than 20 full-time employees in the United States that previously filed federal tax returns demonstrating more than $5 million in gross receipts or sales and that have an operating presence at a physical office in the United States.
- Dormant companies that meet certain conditions.
- Any additional categories of companies exempted by the secretary of the Treasury.
|When Must Companies Comply?
Following the secretary of Treasury’s adoption of regulations implementing the CTA, which must occur by January 1, 2022:
- Companies formed before the secretary of Treasury’s regulations become effective have two years to comply.
- Companies formed after the secretary of Treasury’s regulations become effective must submit the report upon registration.
After the initial FinCEN filing, companies must report any change “in a timely manner” and no later than one year after the date on which the change occurred.
|How Do Companies Comply?
Companies are required to disclose their beneficial owners and applicants to FinCEN via a beneficial ownership statement. A “beneficial owner” is defined in the CTA as an individual who, directly or indirectly, “exercises substantial control over the entity” or “owns or controls not less than 25% of the ownership interests of the entity.” The term “beneficial owner” does not include minors; nominees, intermediaries, custodians or agents; employees; beneficiaries or creditors. “Applicants” generally include any individual filing the application to form or register the reporting company.
The beneficial ownership statements must include:
- The full legal name of each beneficial owner.
- Each beneficial owners’ date of birth.
- The current residential or business street address of each beneficial owner.
- Each beneficial owners’ identification number (e.g. a driver’s license number or passport number).
|Who May Access the Information?
The beneficial ownership statements submitted to FinCEN are not publicly available and will be accessible to the government solely for national security, law enforcement and intelligence purposes.
FinCEN may, upon request, disclose the information to the following parties subject to the secretary of the Treasury’s regulation protocols:
- A federal agency engaged in national security intelligence or other law enforcement activity for use in furtherance of the activity.
- A state, local or tribal law enforcement agency, if a court of competent jurisdiction, including any officer of such court, has authorized the law enforcement agency to seek the information for criminal or civil investigation.
- A federal agency on behalf of a law enforcement agency, prosecutor or judge of another country, including a foreign central authority of competent authority, under an international treaty, agreement or convention, or an official request made by law enforcement, judicial or prosecutorial authorities in a foreign country when no treaty, agreement or convention is available.
- 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.
- A federal functional regulator or other appropriate regulatory agency consistent with agencies expressly permitted to receive such information under the CTA.
|Penalties for Failure to Comply
Civil penalties of up to $500 per day and fines of up to $10,000 or imprisonment for up to two years (or both) for any person who willfully provides, or attempts to provide, false or fraudulent beneficial ownership information to FinCEN, or willfully fails to report complete or updated beneficial ownership information to FinCEN.
Those who submit incorrect information to FinCEN are, however, shielded from these penalties provided they can prove that: (i) they had no knowledge of the inaccuracy; (ii) they were not knowingly trying to evade the CTA requirements; and (iii) the information is corrected within 90 days of the initial filing.
What to Begin Thinking About Now
Due to the exemptions for publicly traded companies and businesses with more than 20 full-time employees in the United States and turnover of more than $5 million, the major burden of the CTA on legitimate business will fall on small businesses. Businesses with fewer than 20 full-time employees or less than $5 million in turnover should begin to think about whether they are able to identify their beneficial owners and, if not, how to create mechanisms to identify those owners. For example, if a major owner is an entity, the business will need to know who the individuals are who control the entity and the business will need the right to obtain the required identifying information for those individuals.
A “beneficial owner” is defined in the CTA as an individual who, directly or indirectly, “owns or controls not less than 25% of the ownership interests of the entity” or “exercises substantial control over the entity.” However, substantial control is not defined in the CTA, leading to potential ambiguity as to whose information must be disclosed in the filing process. Additionally, the CTA lacks specific guidance on how it applies to entities other than “corporation[s], limited liability compan[ies], or other similar entit[ies],” such as trusts and partnerships.
It remains to be seen whether the CTA’s requirement that applicants must be disclosed to FinCEN may have a chilling effect on law firms and other companies that have historically filed certificates of incorporation, articles of formation and similar formation documents on behalf of their clients, which could increase small businesses’ costs of compliance.
The right to request information from FinCEN is limited to law enforcement and financial institutions as described above. An open question is how other parties may react to the CTA. For example, will law firms begin to request a copy of what potential clients have filed under the CTA before undertaking the representation? Will auditors request information on CTA filings before completing an audit? How will due diligence practice change in the context of mergers and acquisitions?
We expect that the secretary of Treasury’s forthcoming adoption of the regulations implementing the CTA will address some of these issues – and will likely raise others.