On January 1, 2021, Congress passed the Corporate Transparency Act (CTA) as part of the overall 2021 National Defense Authorization Act and under the scope of the Anti-Money Laundering Act of 2020 (AMLA). The passage of the CTA represents one of the more sweeping and comprehensive changes to efforts to combat money laundering, terrorism financing, organized crime, and other financial crimes since the passage of the USA PATRIOT Act in 2001. The AMLA establishes a database as a means to facilitate a voluntary public-private information-sharing partnership among law enforcement agencies, national security agencies, financial institutions, and the Financial Crimes Enforcement Network (FinCEN) of the Department of the Treasury for such purposes. The AMLA requires the Secretary of the Treasury to promulgate regulations that establish procedures for the protection of information shared and exchanged between FinCEN and the private sector, including information permitted to be given to financial institutions pursuant to the AMLA in connection with the AMLA’s purposes.
Within the scope of these AMLA initiatives, the CTA requires (i) the establishment of new federal beneficial ownership reporting requirements for certain U.S. domiciled or active entities, including foreign entities that operate in the U.S., and (ii) FinCEN’s maintenance of a federal database for the beneficial ownership information collected.
These new reporting obligations are significant for all business entities insofar as (i) they may potentially create onerous reporting obligations (particularly for private companies or family offices with numerous operating entities), (ii) they will pose civil and criminal penalties for failures to file required information, and (iii) privacy benefits from using business entities for reasonable and legitimate purposes (such as acquiring undeveloped oil and gas leases, or real estate parcels; or property ownership by public personalities) may be at greater risk notwithstanding the protections contained in the AMLA.
What Entities Will Be “Reporting Companies” Under the CTA?
The term “reporting company” under the CTA means, subject to certain exclusions, “a corporation, limited liability company, or other similar entity” that is (i) created by the filing of a document with the secretary of state or similar office under the laws of a state or 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 the secretary of state or similar office under the laws of a state or Indian tribe.
Scope of “other similar entity” under CTA
The scope of “other similar entity” is expected to follow existing FinCEN’s customer due diligence (CDD) rules under the Bank Secrecy Act applicable to a “legal entity customer.”1 Under the CDD rules, a “legal entity customer” is defined as “a corporation, limited liability company, or other entity that is created by the filing of a public document with a secretary of state or similar office, a general partnership, and any similar entity formed under the laws of a foreign jurisdiction that opens an account.”2 Such entities include “limited partnerships, business trusts that are created by a filing with a state office, any other entity created in this manner, and general partnerships.”3 The CDD rules, and presumably the final CTA rules, would not include sole proprietorships or unincorporated associations even though such businesses may file with the secretary of state in order to, for example, register a trade name or establish a tax account. The reason for this under the CDD rules is that “because neither a sole proprietorship nor an unincorporated association is an entity with legal existence separate from the associated individual or individuals that in effect creates a shield permitting an individual to obscure his or her identity but may be added in future legislation by Congress based on subsequent beneficial ownership reviews and reports.”4
Partnerships and trusts
General partnerships can be created by oral or written agreements and typically are created under state law without the filing of any formation document with a secretary of state or similar office. By contrast, limited partnerships, limited liability partnerships (LLPs), and limited liability limited partnerships (LLLPs) are created with the filing of formation documents with a secretary of state or similar office.
Accordingly, general partnerships that do not require the filing with a secretary of state or similar office would appear to fall outside the original expected scope of reporting companies under the CTA but could be included if FinCEN decides to more closely track current CDD rules.
CDD rules also do not include trusts (other than statutory trusts created by a filing with a secretary of state or similar office), and the CTA contemplates a future study regarding “state partnerships, trusts, or other legal entities.”5 Accordingly, trusts that are not statutory business trusts created by a filing with a secretary of state or similar office should not fall within the scope of CTA beneficial ownership reporting requirements.
Exclusions from reporting company definition
Entities expressly excluded under the CTA from the definition of “reporting company” include, among others:
- issuers with a class of securities registered under Section 12 of the Securities Exchange Act of 1934 (Exchange Act) or required to file supplementary or periodic information under Section 15(d) of the Exchange Act (i.e., public companies with securities listed or quoted on U.S. securities exchanges);
- a “bank,” as defined in either (i) Section 3 of the Federal Deposit Insurance Act, (ii) Section 2(a) of the Investment Company Act of 1940, or (iii) Section 202(a) of the Investment Advisors Act of 1940;
- a federal credit union or state credit union;
- a bank holding company (as defined in Section 2 of the Bank Holding Company Act of 1956) or a savings and loan holding company (as defined in Section 10(a) of the Home Owners Loan Act);
- a broker or dealer, exchange or clearing agency, and other entities registered with the U.S. Securities and Exchange Commission (SEC) under the Exchange Act;
- an entity that is either an investment company (as defined in Section 3 of the Investment Company Act of 1940) or an investment adviser (as defined in Section 202 of the Investment Advisers Act of 1940), in each case that is registered with the SEC under such acts;
- an investment adviser described in Section 203(l) of the Investment Advisers Act that has filed Item 10, Schedule A, and Schedule B of Part 1A of Form ADV, or any successor thereto, with the SEC;
- an insurance company (as defined in Section 2 of the Investment Company Act);
- a public accounting firm registered in accordance with Section 102 of the Sarbanes-Oxley Act of 2002;
- any pooled investment vehicle that is “operated or advised” by a bank, federal credit union or state credit union, registered broker or dealer, or investment company or investment adviser, in each case that is otherwise exempted as a reporting company;
- nonprofit organizations described in Section 501(c) of the Internal Revenue Code of 1986 (the Code) and exempt from tax under Section 501(a) of the Code;
- an entity that (i) employs more than 20 employees on a full-time basis in the United States, (ii) filed in the previous year federal income tax returns in the United States demonstrating more than $5 million in gross receipts or sales in the aggregate, including (a) other entities owned by the entity and (b) other entities through which the entity operates, and (iii) has an operating presence at a physical office in the United States; and
- any corporation, limited liability company, or other similar entity of which the ownership interests are “owned or controlled,” directly or indirectly, by one or more entities described above (other than a “pooled investment vehicle” that is merely “operated or advised” — and not “owned or controlled” — by such other exempt reporting persons).
The CTA also provides for the exclusion of any entity or class of entities that the Secretary of the Treasury, with the written concurrence of the Attorney General and the Secretary of Homeland Security, has by regulation determined should be exempt from CTA beneficial ownership reporting requirements, on the basis that such reporting would not serve the public interest and highly useful in national security, intelligence, and law enforcement efforts under the CTA.
Open Issues for Treasury Rulemaking – Reporting Companies
Issues regarding the definition of “reporting company” and related exclusions that remain subject to Treasury and FinCEN rulemaking include these:
- General partnerships: Will general partnerships be covered in “reporting company” regulations adopted by the Treasury as a “similar entity”? As noted above, general partnerships are not typically formed by the filing of a public document with a secretary of state or similar office. Public notices by secretary of state offices regarding CTA reporting obligations, applicable procedures, and compliance would also appear more difficult than with entities making formation filings with secretary of state or similar offices.
- Other exempt entities: Will FinCEN exercise its discretion in the initial regulations to exempt any other entity or class of entities that the Secretary of the Treasury, with the written concurrence of the Attorney General and the Secretary of Homeland Security, has determined should be exempt from CTA beneficial ownership reporting requirements, on the basis that such reporting would not serve the public interest and highly useful in national security, intelligence, and law enforcement efforts under the CTA?
- Subsidiary exemption: What are the definitions of “owned” and “controlled” as used in the de facto subsidiary exemption for other exempt entities? The CTA excludes entities either owned or controlled, directly or indirectly, but does not specify any levels of ownership or control. We understand that the legislative intent of “owned” does not mean “wholly owned” and that both “owned” and “controlled” may be defined along the lines of some functional control, with a specific level of ownership open to the FinCEN rulemaking. Existing banking and investment adviser law definitions relating to control may include ownership of 25% or more of an entity, so it is possible that such scope may be 50% or less. However, the definitions of ownership and control used for this exemption may differ from definitions used for other inclusive purposes elsewhere under the CTA.
- Large private company exclusion: With respect to large private companies that are excluded based on $5 million of “gross receipts or sales” in the aggregate, what is the intent with respect to inclusion of gross receipts or sales with respect to “other entities owned by the entity” and “other entities through which the entity operates”? “Owned by” does not have a threshold level (or clarify that aggregation of gross receipts or sales would only be pro rata to the extent of ownership interests). We understand that “other entities through which the entity operates” is intended to include any “disregarded entities” for tax purposes. While the CTA uses the terms “gross receipts or sales,” it is possible that FinCEN rulemaking may also clarify such terms to include certain “income” in connection with such determinations.
- Excluded entity filing requirements: Will an entity excluded from the definition of “reporting company” be required to file any forms or certifications with respect to the applicable exemption relied on by such entity from other beneficial ownership reporting? Any such filings by exempt entities regarding their applicable exemption would create an additional reporting burden, and we understand the final form of the CTA was expressly drafted to avoid such obligations by exempt entities. The CTA expressly provides that “in prescribing regulations to provide for the reporting of beneficial ownership information, the Secretary shall, to the greatest extent practicable consistent with the purposes of this title … seek to minimize burdens on reporting companies associated with the collection of beneficial ownership information….”
Who Is a “Beneficial Owner” Required to Be Disclosed?
The CTA defines “beneficial owner” to mean, with respect to an entity, an individual who, directly or indirectly, through any contract, arrangement, understanding, relationships, or otherwise,
- exercises “substantial control” over the entity or
- owns or controls not less than 25% of the “ownership interests” of the entity.
However, the CTA excludes from such definition of “beneficial owner” (i) a minor child (as defined in the state in which the entity is formed), if the information of the parent or guardian of the minor child is reported in accordance with the CTA, (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 reporting person and whose control over the economic benefits from such entity is derived solely from the employment status of the person, (iv) an individual whose only interest in a reporting company is through a right of inheritance, or (v) a creditor of a reporting person, unless the creditor meets the requirements of a “beneficial owner” based on substantial control or ownership or control of not less than 25% of the ownership interests.
As a result, reporting companies will at minimum have to identify someone with substantial control if no one has more than 25% of the ownership interests.
Open Issues for Treasury Rulemaking – Beneficial Ownership
The term “substantial control” is not defined in the CTA and remains subject to definition or guidance in Treasury regulations. By analogy, Section 1010.230(d) of the CDD rules includes two prongs for the definition of “beneficial owner”:
- each individual, if any, who directly or indirectly owned 25% of the equity interests of a legal entity customer (the ownership prong), and
- a single individual with significant responsibility to control, manage, or direct a legal entity customer, including an executive officer or senior manager or any other individual who regularly performs similar functions (the control prong).
We understand legislative intent is for the CTA rules not to include a more expansive definition for “substantial control.”
Similarly, the term “ownership interests” is not defined in the CTA. Instead, the language used mirrors that found in the CDD rules. Again, by analogy, in issuing the CDD rules, FinCEN stated that while it may be challenging to determine whether a particular “ownership interest” qualifies as an “equity interest” (e.g., whether debt securities convertible into equity securities (or similar equity-linked instruments) of a reporting company may constitute “ownership interests” prior to actual conversion), FinCEN deliberately avoided the use of more technical terms of art associated with the exercise of control through ownership. Indeed, in issuing the CDD rules, FinCEN reiterated that it believes the legal entity (and its personnel) are responsible for making this determination to identify beneficial owners.
As a result, given FinCEN’s prior views on ownership interests in the CDD rules, it may be difficult for financial institutions to determine who is required to be reported under the CTA based on ownership of many potential “ownership interests” in reporting companies.
What Beneficial Owner and Applicant Information Is Required to Be Reported?
The CTA requires Treasury regulations to require each reporting company to submit a report to FinCEN including the identity of (i) each beneficial owner of the applicable reporting company and (ii) each applicant with respect to that reporting company, by (a) full legal name, (b) date of birth, (c) current, as of the date on which the report is delivered, residential or business street address, and (d) the unique identifying number from an acceptable identification document or a FinCEN identifier issued in accordance with the CTA.
An “applicant” means any individual who files an application to form a reporting company or registers or files an application to register a reporting company to do business in the United States by filing a document with the secretary of state or similar office under the laws of a state or Indian tribe.
Where an exempt entity has or will have a direct or indirect ownership interest in a reporting company, the reporting company or the applicant will, with respect to the exempt entity, only list the name of the exempt entity and not be required to report the information with respect to the exempt entity otherwise required above.
What is the Required Timing for Treasury Regulations Under the CTA?
The CTA requires the Secretary of the Treasury to promulgate regulations under the CTA not later than one year after the enactment of the CTA (i.e., not later than January 1, 2022).
When Is Beneficial Owner Information Required to Be Reported?
Initial reporting requirements
For any reporting company that has been formed or registered before the effective date of the Treasury regulations prescribed under the CTA, such reporting company is required to submit to FinCEN the required beneficial ownership report not later than two years after the effective date of such Treasury regulations.
For any reporting company formed or registered after the effective date of the Treasury regulations prescribed under the CTA, such reporting company is required to submit to FinCEN the required beneficial ownership report at the time of formation or registration.
With respect to exempt “subsidiary” entities (i.e., “ownership or control” by an exempt entity under subsection (a)(11)(B)(xxii)), such entity is required to submit to FinCEN the required beneficial ownership report at the time such entity no longer meets such subsidiary criteria.
Update reporting requirements
The CTA also requires reporting companies to update any change with respect to any information changed related to beneficial ownership within one year after the date of which there is a change and submit a report that updates the information relating to the change.
How Can CTA Beneficial Ownership Information Be Used?
Federal agencies, state and local law enforcement, foreign countries, financial institutions, and federal functional regulators
The CTA provides that beneficial ownership information reported under the CTA shall be confidential and shall not be disclosed except as authorized by the CTA. Indeed, it appears that a request, through proper protocols, from a federal agency engaged in national security or intelligence activities will likely benefit most readily from this information. On the other hand, disclosure to state, local, and tribal law enforcement is permitted only in those circumstances where a court has authorized the law enforcement agency to seek the information in a criminal or civil investigation.
Law enforcement for foreign countries may get access to the information assuming the request is issued in response to a request for assistance in an investigation or prosecution by the foreign country and complies with the disclosure and use provisions of the treaty, agreement, or convention, publicly disclosing any beneficial ownership information received or limits the use of the information for any purpose other than the authorized investigation or national security or intelligence activity.
Requests made to FinCEN for the beneficial ownership information by a financial institution subject to CDD rule requirements may obtain access, if the reporting company consents, and it is being used for the financial institution with CDD requirements under applicable law.
While financial institutions that have CDD rule requirements may find the potential for access to the FinCEN database a valuable tool, the FinCEN protocols to be established for access to such information remain unclear.
The CTA specifies a number of protocols for the use of beneficial ownership information included in reports and further provides that employees or officers of a requesting agency that violate such protocols, including unauthorized disclosure or use, shall be subject to criminal and civil penalties.
Notwithstanding the limits on use and protocols under the CTA, many entities remain concerned about misuse and breaches of confidentiality with respect to such beneficial ownership information, including cybersecurity breaches.
What Are the Criminal and Civil Penalties for Noncompliance With CTA Reporting?
The CTA provides for civil penalties to the United States of not more than $500 for each day that a violation continues or has not been remedied and fines of up to $10,000 and possible imprisonment of up to two years for any person who willfully (i) provides, or attempts to provide, false or fraudulent beneficial ownership information (including identifying photographs or documents) or (ii) fails to report complete or updated beneficial ownership information to FinCEN.
What Impact Will the CTA Have on Federal Contractors?
The CTA contains new reporting requirements for federal contractors. The CTA requires the Administrator for Federal Procurement Policy to revise the Federal Acquisition Regulation not later than two years following the date of enactment of the CTA to require any contractor or subcontractor subject to the requirement to disclosure beneficial ownership information under the CTA to provide such information to the federal government as part of any bid or proposal for a contract with a value threshold exceeding the simplified acquisition threshold under 41 U.S.C. Section 134 (currently defined as $250,000).6
Legal entities need to pay particular attention to rules that Treasury and FinCEN will establish under the CTA as well as related changes to CDD rules. The effect on legal entities that do not meet one of the exemptions for reporting companies under the CTA include (i) reporting burdens, (ii) potential civil and criminal liabilities for failures to file complete reports when required, and (iii) privacy concerns. Longstanding legal bases for privacy are now competing with national security interests in ways that we have not seen since the implementation of the USA PATRIOT Act that followed the terrorist attacks of September 11, 2001.
While additional guidance and regulation will be forthcoming, the basic framework set forth in the CTA warrants close consideration as new legal entities are formed.
1 “Customer Due Diligence Requirements for Financial Institutions,” 81 Fed. Reg, 29397; 31 CFR Parts 1010, 1020, 1023, 1024, and 1026 (May 11, 2016)
3 See final rule at p. 29412 (May 11, 2016)
4 See final rule at p. 29412 (May 11, 2016)
5 Section 6502(d) of the AMLA expressly provides for the Comptroller General, not later than two years after the effective date of the Treasury’s CTA regulations, to conduct a study and submit to Congress a report including (i) the procedures of states to enable persons to form or register under the laws of the state partnerships, trusts, or other legal entities, (ii) state requirements with respect to disclosures of beneficial owners or beneficiaries of those entities, (iii) an evaluation of whether the lack of beneficial ownership information for partnerships, trusts, or other legal entities raises concerns about the involvement of those entities in terrorism, money laundering, tax evasion, securities fraud, or other misconduct and has impeded investigations into entities suspected of such misconduct, (iv) an evaluation of whether the failure of the United States to require beneficial ownership information for partnerships and trusts formed or registered in the United States has elicited international criticism, and (v) what steps, if any, the United States has taken, is planning to take, or should take in response to any such international criticism.
6 Current amount based on increase contained in Sec. 805 of the National Defense Authorization Act for Fiscal Year 2018, Publ Law 115-91
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