Practitioners Note the Corporate Transparency Act's Potential, But Caution "Wait and See" on Final Rules
The Corporate Transparency Act (CTA) aims to combat money laundering and other illicit activity by reining in the use of anonymous shell companies. Introduced as part of the Anti-Money Laundering Act of 2020 and passed in January 2021, the law requires the U.S. Department of the Treasury's Financial Crimes Enforcement Network (FinCEN) to create a corporate ownership registry to help the government identify the owners of large amounts of wealth, determine whether that wealth was acquired legitimately, and whether it has been appropriately taxed.
In April 2022, Miller & Chevalier lawyers Joseph Rillotta and Ian Herbert hosted a panel discussion on the new law and its requirements featuring Dennis Kihm, section chief of Depository Institutions at FinCEN, Jay R. Nanavati, partner at Kostelanetz & Fink, and Melissa L. Wiley, member at Caplin & Drysdale.
During the event, panelists discussed the reporting obligations that companies will have to follow, possible compliance hurdles, and potential uses for the data FinCEN collects. The CTA rules have yet to be finalized and once they are fully implemented, companies will be expected to comply within a tight timeframe, making it important for legal and compliance professionals to understand the requirements and where the rules currently stand.
The participants largely described the new law as a significant development for anti-money laundering (AML) compliance and enforcement, though they acknowledged that the effectiveness will depend on how the law is implemented.
Rillotta, for example, called it a "potential game changer" that could allow the Internal Revenue Service (IRS) to see who is really behind a corporation. But as Wiley pointed out, how the data can be used by criminal and civil enforcement agencies of the measure will ultimately drive how useful this database is.
Who Must Report?
U.S. and international enforcement agencies want to know the identities of the owners behind opaque corporate entities, such as limited liability corporations, but some U.S. states (such as Delaware, Wyoming, South Dakota, and Nevada) do not require disclosure of ownership information at the time the entity is formed, which works against revenue collection agencies, Nanavati pointed out.
The CTA would, for the first time, impose federal reporting requirements directly on many U.S.-based entities, allowing Treasury to know the names of beneficial owners (people who own or control at least 25 percent of the company or who exercise "substantial control" over the company).
Any LLC, corporation, or similar entity created by a filing document with a secretary of state or registered to do business in the U.S. is considered a "reporting company" and must provide beneficial ownership information to FinCEN.
When asked how FinCEN will let companies know who must comply with the law, panelists were uncertain. But Nanavati surmised that perhaps "when someone goes to their secretary of state's offices to register a company, the state will tell them about the CTA requirements."
The law does provide for 23 exceptions to the definition of "reporting company," including issuers, bankers, credit unions, broker dealers, investment advisors, public accounting firms, charitable trusts and political organizations, other entities registered with the U.S. Securities and Exchange Commission (SEC), and large operating entities with physical presence in the U.S.
According to Herbert, the idea behind the exceptions was to exclude any industries or groups that are regulated by states or other federal governments, since the information is already available in most of these cases.
What Must Be Reported?
Companies that meet CTA requirements must provide information about the company applicant and the entity's beneficial owners – names, dates of birth, addresses, and copies of identification documents. Alternatively, companies and individuals can register for a FinCEN identifier that can be used in place of the identifying information. The FinCEN identifier could help ease reporting company compliance burdens, Herbert said.
The panel discussed potential misunderstandings over who counts as a beneficial owner and how the CTA definines "substantial control." Under the CTA rules, ownership interest and substantial control are broadly defined, which may create challenges for companies trying to comply with the law.
Wiley pointed out that because the rules are so broad, the companies who are trying to comply with the law in good faith are the ones who will face the biggest challenges. She predicted that some companies may worry about ambiguous situations of control, such as a past board member who stays in touch with current members.
"I would hope FinCEN takes that into consideration on the enforcement end," she said.
The overly broad rules could also cause companies to over-report, Herbert noted.
When Must Companies Report?
Companies will have one year after the final rule to give initial reports to FinCEN, though since the rule is not yet final and the database not yet developed, the timeline is uncertain. But panelists agreed that after the rule is finalized, the compliance timeline will be aggressive. Companies created after the rule goes into effect will have 14 days to file from the date they become a reporting company and ownership information will have to be updated within 30 days of changes.
This structure may force companies to build compliance programs to track changes in beneficial ownership, which could be burdensome in some instances. "There's an argument to be made for regular, but less frequent reporting deadlines – like tax day – to ease the burden on companies," Herbert said.
Next Steps for the CTA
FinCEN is in the process of finalizing the rule regarding who must report and what information must be reported. There will be two additional phases of rulemaking related to the beneficial ownership registry. One will address protocols for the retention and disclosure of beneficial ownership information, while the other will revise the existing customer due diligence rule currently imposed on financial institutions.
On the question of how CTA data will be used, the panelists anticipate that data will be broadly accessible to law enforcement and national security officials. "The statute itself lists the government entities that will have access and most are 'no brainers' that people can agree on," Wiley said. "For example, it would be nice to have a database of where Russian oligarchs keep their money that can be sent to the appropriate agencies." However, Wiley noted that it is not yet clear exactly which agencies will have access, or whether and how U.S. agencies will share information with foreign law enforcement.
The rules will also need to specify when banks can access CTA information. Bank access to the database might take some pressure off their reporting duties. Herbert noted that "it might streamline the [customer due diligence] process if banks are required to check the database to get their due diligence information."
How Will Treasury Use the CTA Data?
Rillotta anticipates that the IRS's Criminal Investigations (CI) unit would make significant use of CTA data, since IRS-CI is the biggest user of Bank Secrecy Act (BSA) data.
While the CTA explicity grants law enforcement access to the data, it is unclear what the disclosure implications would be for auditors in a civil context. The CTA database may be useful in helping IRS auditors find money that previously couldn't be located and collected. For example, it could help bolster efforts by the IRS's "Wealth Squad," which focuses on high net-worth individuals and the often complex structures, including closely held entities, that house their assets. As of now, it appears that enforcement personnel throughout the IRS may have access to CTA data – beyond just CI.
"It seems that if [the IRS or a federal law enforcement agency] can make a good case for why they need the information, FinCEN will provide it," Wiley said.
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