The Corporate Transparency Act (CTA) will require millions of U.S. businesses to provide beneficial ownership information to the federal government. Foley Hoag’s Luciano Racco weighs in on who’s impacted, along with the regulation’s value for AML and sanctions compliance programs.
Buried within the 1,400-page National Defense Authorization Act for Fiscal Year 2021 (the NDAA) – enacted on January 1, 2021 after Congress overrode President Trump’s veto – is a much more compact piece of legislation called the Corporate Transparency Act (CTA).
This brief but important law has been lauded as the most significant anti-money laundering reform in a generation. The CTA requires millions of businesses registered to operate in the U.S. to provide beneficial ownership information to the Department of the Treasury’s Financial Crimes and Enforcement Center (FinCEN). The stated goals of the legislation are to help set a clear, federal standard for entity incorporation; protect U.S. national security, as well as interstate and foreign commerce; enable law enforcement efforts to counter money laundering, terrorism financing and other illicit activity; and bring the United States into closer alignment with international standards concerning anti-money laundering and countering terrorism financing.
In practice, the Corporate Transparency Act’s biggest impacts will be on the (mostly) small businesses that will have to comply with the law’s reporting obligations, as well as on criminal enterprises that will likely choose to form or register in some other country. The task for policymakers is to minimize the impact on the former group while keeping the welcome mat in storage for the latter.
Who Must Report Under the Corporate Transparency Act?
The CTA requires a “reporting company” to submit beneficial ownership information along with information on each “applicant” for the reporting company to FinCEN. An entity qualifies as a “reporting company” if it is:
- “a corporation, limited liability company or other similar entity” created under the laws of a U.S. state (including commonwealths, territories or other U.S. possessions) or tribal territory; or
- a non-U.S. entity registered to do business under the laws of a U.S. state or tribal territory.
An “applicant” is defined as any individual who “files an application” to form or register an entity that qualifies as a reporting company.
However, the scope of the CTA’s reporting requirements is significantly narrowed by the exclusion of 23 categories of entities from the definition of “reporting company.” The legislation also grants the Treasury Department authority to exempt additional categories of entities. An entity that falls into one of the categories identified will not be required to submit beneficial ownership information to FinCEN. A simplified list of the 23 exclusions is below, with some of the more significant categories highlighted in bold. Companies should carefully review subparagraph (B) and the definition of “reporting company” for a complete list of requirements associated with each exclusion.
Entities Excluded from CTA Reporting Requirements
Financial Institutions and Other Entities with SEC Reporting Obligations
- Public companies
- Federal and state credit unions
- Bank holding companies
- Money transmitting businesses registered with FinCEN
- Brokers and dealers
- Exchange and clearing agencies
- Any other entity registered with the SEC under the Securities and Exchange Act of 1934
- Certain registered investment companies
- Investment advisers
- Certain entities registered under or covered by the Commodity Exchange Act
- Financial market utilities
- Certain pooled investment vehicles
Other Entities with Significant Public Oversight
- Government entities
- Insurance companies
- Insurance producers with a physical office in the U.S. and that are authorized by a state and subject to insurance commissioner supervision
- Public accounting firms
- Public utilities
- 501(c) nonprofits, 527 political organizations, trusts under paragraphs (1) and (2) of section 4947(a) of the Internal Revenue Code;
- Any entity that:
- employs more than 20 full-time employees in the U.S.,
- has a physical office in the U.S. and
- reported more than $5 million in gross receipts or sales on the previous year’s federal income tax return;
- Any subsidiary or other entity owned or controlled (directly or indirectly) by an entity exempt from reporting requirements (except those owned or controlled by money transmitting businesses; certain pooled investment vehicles; certain entities that operate exclusively to provide financial assistance/hold governance rights over a nonprofit, political organizations and certain trusts; and certain inactive businesses);
- Certain entities that operate exclusively to provide financial assistance/hold governance rights over a nonprofit, political organization or certain trusts;
- Any entity in existence for over one year that is not engaged in active business, not owned by a foreign person, has not in the last 12 months sent or received funds totaling $1,000 and does not otherwise hold any assets.
What Must Be Reported
The CTA requires non-exempt reporting companies to provide “beneficial owner” information, which is defined as “an individual who, directly or indirectly, through any contract, arrangement, understanding, relationship or otherwise”:
- Exercises “substantial control” (an undefined term) over an entity; or
- Owns or controls no less than 25% of the ownership interests of the entity.
A beneficial owner does not include:
- A minor (the information of the parent/guardian must be reported instead);
- An agent/nominee/intermediary/custodian of another individual;
- An employee of the entity with no control or economic benefits beyond the terms of employment;
- An individual whose only interest is through inheritance; or
- A creditor of the reporting company unless the creditor otherwise meets the definition of “beneficial owner.”
For each beneficial owner, the reporting company must provide the following information to FinCEN:
- Full legal name;
- Current address (business or residential);
- Date of birth; and
- Unique identification number (from a passport, driver’s license, other state-issued identification or FinCEN identifier).
The information required is not particularly onerous to gather. Indeed, the Corporate Transparency Act’s biggest impact is based on simply having to provide this information in the first place. Many individuals form business entities to keep ownership interests confidential and may have perfectly valid and legal reasons for doing so. For example, a successful doctor who wants to purchase an investment property may choose to form an LLC to take title to avoid advertising to potentially litigious tenants that their landlord is a wealthy individual. Clearly, however, some individuals have taken advantage of the anonymity provided by establishing or registering businesses in the U.S. to hide involvement in illegal activity. It seems obvious that such individuals may choose to find another jurisdiction to register their business entities to avoid having their previously secret ownership interests exposed to U.S. federal and state law enforcement.
Access to the Information
So does our enterprising doctor have to worry about his secret getting out? No. For now, the beneficial ownership information reported to FinCEN will only be accessible to a very limited scope of individuals and will not be available to the general public. The CTA specifies that FinCEN may only share the information collected with:
- Other federal agencies engaged in national security, intelligence or law enforcement activity;
- State, local or tribal law enforcement agencies pursuant to a court order;
- Certain foreign law enforcement agencies/prosecutors/judges;
- A financial institution, with the consent of the reporting company, in order to facilitate customer due diligence requirements under applicable law; and
- A federal functional regulator or other appropriate regulatory agency.
As a result, those with valid, legal reasons for forming or registering business entities in the U.S. have little to fear from the CTA other than the perhaps bothersome task of remembering to provide beneficial ownership information to FinCEN and keep it current. The veil that shrouds the identify of beneficial owners will only be partially lifted, and those whose motivation for forming or registering a business entity is based on privacy concerns can take some comfort in the relatively small universe of individuals legally authorized to access the information.
However, the risk that there will be a strong temptation for hackers or others motivated by greed (or even those who believe they are acting righteously (think WikiLeaks or the Panama Papers) to illegally access and disseminate this treasure trove of confidential information was clearly on the minds of legislators. The CTA imposes significant penalties for willfully failing to report or update beneficial ownership information or willfully providing false information, including civil penalties of up to $500 per day that the violation continues and criminal fines up to $10,000 and/or two years’ imprisonment. However, disclosing or using beneficial ownership information without authorization is also subject to a $500-per-day civil penalty and an even more severe criminal penalty of up to $250,000 and/or five years’ imprisonment. There are also requirements in the CTA for the Secretary of the Treasury to establish strong information security protections to prevent unauthorized access to the beneficial ownership information.
The limited access to beneficial ownership information, is, however, a disappointment to compliance professionals (apart from those at financial institutions) who will not be able to use the information as a tool to support sanctions screening or other due diligence activities. Even financial institutions may find their access to the information to be of limited value, as it seems unlikely that a customer or prospective customer with something to hide would consent to the release of the information unless the beneficial ownership information provided to FinCEN matches the information separately provided to the financial institution. The act of refusing consent, however, will almost certainly have to be deemed an anti-money laundering red flag by financial institutions. Know your customer/client guidelines will result in financial institutions refusing to do business with persons who will not consent.
The CTA outlines generous timelines for making beneficial ownership reports in some circumstances. While entities created after the effective date of FinCEN’s implementing regulations (FinCEN has until December 31, 2021 to issue such regulations) will have to report beneficial ownership information at the time of formation/registration, entities created before the effective date will have two years from the effective date to report this information. And even after the effective date, entities will have a year to update changes in beneficial ownership information, which, absent a shorter period prescribed by the Treasury’s implementing regulations, means that financial institutions (and the government) could be assessing out-of-date information.
As mentioned above, companies should carefully evaluate whether one of the 23 current reporting exclusions applies to them. Given the nature of the 23 exemptions outlined above – in particular the exemption for entities with more than 20 employees and $5 million in gross receipts/sales – the reporting requirements will be a burden that largely falls on small businesses, including startups, as well as certain trusts and shell and holding companies.
Non-exempt entities will likely want to take two courses of action:
- As mentioned above, the Treasury Department (with the concurrence of the Attorney General and Secretary of Homeland Security) has the authority to exempt additional entities from the reporting requirements. Because the bulk of those subject to the current reporting obligations are startups and other small businesses, individual companies and small business associations should monitor FinCEN’s proposed rules and may wish to provide comments during the rulemaking process on recommendations for additional categories of exempt entities that are highly unlikely to be involved in money laundering or terrorism financing activities. For instance, as many of the exemptions in the CTA itself are based on excluding entities that are already subject to significant public oversight and reporting requirements, it seems likely that business entities related to regulated professions like healthcare workers, lawyers, locksmiths, plumbers, real estate professionals, etc. could argue for an exemption, too.
- Second, non-exempt companies may wish to begin collecting the required information in advance of the reporting deadlines. Companies should also consider what policies and resources will be needed to ensure that changes in beneficial ownership are reported in a timely manner. They may also consider streamlining their structures to reduce regulatory burdens.
The Corporate Transparency Act is an important development that will likely serve as a significant deterrent to forming or registering business entities in the United States by those seeking to conceal ownership information. The CTA’s impact is reduced by the number of reporting exceptions. Among legitimate business entities, the CTA’s regulatory burden will largely fall on small businesses. And the very limited access to the ownership information to be collected means that, outside of financial institutions, the CTA will not serve as a compliance tool for private industry.