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The override of former President Trump's veto of the National Defense Authorization Act of 2021 resulted in the enactment of broad amendments to the US anti-money laundering regime. Of particular note is the inclusion of the Corporate Transparency Act, which now requires many US entities (and non-US entities registered to do business in the US) to report their beneficial owners to FinCEN, a unit of the US Treasury Department. The law has clear implications for the broader corporate responsibility agenda. It will also add an additional layer of complexity to mergers and acquisitions, structured finance and other corporate transactions that use special purpose vehicles, as well as affect private wealth structures such as closely-held companies and other arrangements that have historically been used to achieve various strategic and privacy objectives.
On January 2, 2021, the Senate voted to override former President Trump's veto of the National Defense Authorization Act of 2021. As a result, some of the most significant amendments to the US anti-money laundering ("AML") regime in recent years became law. Perhaps the most significant amendments were the provisions of `the Corporate Transparency Act' ("CTA"), which mandates the creation of a government-maintained registry of beneficial owners of certain entities formed or registered to do business in the United States. This development is the culmination of a decades-long effort of financial integrity advocates to close a gap that has been recognized as one of the most significant in the US AML regime,1 even after the promulgation of the Financial Crimes Enforcement Network's ("FinCEN") Customer Due Diligence Rule ("CDD Rule").2
Corporate transparency and transparency of beneficial ownership information underlie a broad range of issues related to corporate management of social and governance risk. As the issue of anonymous companies has gained prominence globally so, too, has awareness of the role that beneficial ownership transparency plays in advancing anti-corruption efforts and human rights protection (which are themselves linked), and COVID-19 has increased the corruption and human rights-related risks that companies face. The confluence of the law, new government mandates and other factors, including presidential appointments, could signal a shift in how the US government engages with companies on these issues.
The changes in the CTA will have a profound impact on corporations, limited liability companies and similar entities from all sectors. Because the explicit goal of the legislation was to bring a level of transparency to and discourage the use of "shell" companies that Congress perceived to be the greatest AML risk, several types of entities that have tangible operations (e.g., entities with more than 20 full-time employees) or are already otherwise regulated (e.g., registered investment companies) are exempt from the rule. However, special purpose vehicles ("SPVs") may be particularly affected by the new legislation, and sectors that rely on SPVs—for acquisitions, structured finance, bankruptcy protection or other corporate uses—as well as families or groups that rely on closely-held companies and other arrangements for wealth structuring, privacy and other strategic reasons may feel the impact of this new law most acutely.
SPVs are distinct legal entities created to fulfill a limited, specific transactional purpose. They often are merely a vehicle to hold assets. Because they are not operating entities, they do not have employees or maintain physical offices. Without further context, they can look quite similar to the shell companies that the CTA was designed to address. While regulations to be implemented by the Treasury Secretary will be vital to understanding the CTA's full effect, this article provides an overview of the key features of the CTA and its potential implications for families, businesses and groups that leverage US SPVs, closely-held companies, and related arrangements.
The CTA requires the Treasury Secretary to issue regulations generally requiring corporations, limited liability companies and similar entities formed or registered to do business in the United States ("covered entities") to report and verify the identity of their beneficial owners to FinCEN at the time of their formation and within a year of any changes to their beneficial ownership. Existing covered entities will be given no later than two years from the effective date of the regulations to submit reports on their beneficial owners. New covered entities must report at the time of formation or registration after the effective date of the regulations. Changes in beneficial ownership information must be reported within one year of the change. Congress required the Treasury Secretary to promulgate rules no later than one year from the enactment of the CTA (i.e., January 2, 2022).
- "Beneficial owner" includes any individual, directly or indirectly, through any contract, arrangement, understanding, relationship or otherwise who:
1. Exercises substantial control over the covered entity, or
2. Holds at least 25 percent of the ownership interests of the covered entity.
Note: The CTA does not define "substantial control" and does not describe how ownership interests are to be measured (e.g., whether attribution rules will apply). Forthcoming FinCEN regulations will hopefully provide clarity.3
- Important exemptions from the beneficial owner definition may apply. Notably a beneficial owner does not include:
1. Custodians/agents for an individual, or those acting solely as an employee of an entity.
2. An entity's creditors, unless the creditor holds at least 25 percent of the ownership interests of the covered entity or substantial control.
3. An individual whose only interest in a covered entity is through a "right of inheritance."
4. A minor child if the information of the parent (or guardian) is reported.
- Covered entities must report specific beneficial ownership information. The covered entity must report the identity of each beneficial owner, as well as the individual that files the paperwork to form or register an entity with a state secretary of state or similar office. Reported information will include:
1. Full legal name,
2. Date of birth,
3. Current residential or business street address, and
4. A unique identifying number from an acceptable identity document or a unique identity number generated by FinCEN.
Note: if an exempt entity has (or will have) a direct or indirect ownership in a covered entity, the covered entity must report the legal name of the exempt entity, but not the other information generally required.
- Important exemptions from the beneficial ownership reporting requirement may apply. There are a number of entities exempt from the requirement to report beneficial ownership information—primarily those entities that must already disclose their beneficial owners under other laws or regulations, or those entities deemed not to be viable vehicles for money laundering. Notable exemptions include those for:
1. Public companies: that is, issuers of a class of securities under section 12 of the Securities Exchange Act of 1934 or issuers that are required to file information under section 15(d) of that Act.
2. Any entity that employs more than 20 full-time employees in the United States, filed a federal tax return for the previous year with more than US$5 million in gross receipts or sales (includes subsidiaries and operating affiliates), and operates from a physical US office.
3. Shelf companies: any entity that is in existence for over one year, not engaged in "active business," and not directly or indirectly owned by a non-US person.
4. Certain charitable trusts and charitable split-interest trusts, Internal Revenue Code Section 501(c) charitable organizations and certain related entities.
5. Any pooled investment vehicle that is operated or advised by a bank, registered broker-dealer, registered investment company, or registered investment adviser, among others.
- The creation of a non-public, government-maintained registry. FinCEN will maintain a registry of beneficial ownership data, but access to the registry will be limited to:
|1. Federal government agencies, including those with law enforcement, national security, intelligence and applicable financial regulatory missions||
|2. State, local or tribal law enforcement agencies with an appropriate court order||
|3. Non-US law enforcement via their US federal counterparts||
|4. Financial institutions subject to the CDD Rule, with the covered entity's (i.e., customer's) permission||
As a result, the registry envisioned under the CTA will differ from the publicly accessible national registers required for EU member countries under the fourth and fifth EU AML directives. The establishment of such a registry, nevertheless, is a significant change for the US AML regulatory regime.
- Penalties for non-compliance and misuse. Failure to disclose the required information regarding beneficial ownership (or disclosing inaccurate information) may lead to: (1) US$500 per day in civil monetary penalties, and (2) a fine up of to US$10,000, imprisonment of no more than two years, or both. A safe harbor exists, however, to exempt a person from penalty if the person acting in good faith corrects inaccurate information submitted to FinCEN within 90 days of the inaccurate report. In addition, significant penalties are provided for the misuse of beneficial ownership information, including a fine up to US$250,000, imprisonment of up to five years, or both.
Implications for SPVs
Many SPVs will generally be considered covered entities. However, special purpose acquisition companies, or SPACs, will likely fall under the exemption for public companies, as they are generally publicly traded. Many sponsors of SPVs are exempt from covered entity status because they are, for instance, public companies or financial institutions. Otherwise, sponsors may qualify as covered entities themselves. Such SPVs and non-exempt sponsors will need to develop procedures to ensure that each covered entity both:
1. complies with its reporting responsibilities, initially and on a continuing basis, in a timely manner:
• As a practical matter, a new SPV will generally be a covered entity upon formation and a report will be required.
• After one year and until the SPV is funded, the SPV should likely be exempt as a shelf company (discussed above).
2. has access to all of the necessary information about beneficial owners to ensure it reports such information accurately:
• As it engages in acquisitions, financings or other similar activities: conducts adequate due diligence for prospective beneficial owners, including by looking through indirect owners to find potentially reportable individuals.
• This includes appropriate representations and warranties, specifically in connection with reporting obligations (e.g., parties responsible for reporting, required timing).
Implications for Private Wealth Vehicles and Other Arrangements
Closely-Held Companies and Partnerships
Closely-held companies will also generally be considered covered entities under the CTA. Although partnerships are not explicitly listed in the CTA, given the similarities to a limited liability company, a partnership formed by the filing of a document with a secretary of state is likely to be considered a covered entity once implementing regulations are issued. Some key considerations to keep in mind in addition to the comparable SPV-related considerations discussed above include:
- a closely-held company's beneficial ownership may change frequently. When it does, reporting obligations will follow.
- in the family context, individuals may be unaccustomed to reporting obligations such as those imposed by the CTA and may rely on their accountants and other advisors to handle any filing obligations. However, in the case of entities that do not generate income or merely hold assets, these advisors may be unaware of their existence, so each individual should conduct a thorough review of his or her assets.
As mentioned above, certain charitable trusts and split-interest trusts (such as charitable remainder trusts and charitable lead trusts) are expressly exempt from the covered entity category for purposes of beneficial ownership reporting under the new law. Under FinCEN's existing CDD Rule, statutory trusts are considered legal entities because their formation requires a filing with a state authority similar to a corporation's filing with a state secretary of state. Non-statutory trusts, however, are not considered legal entities because these trusts are the result of contractual arrangements and do not generally require any action by the state. As such, under the existing CDD Rule, FinCEN does not require financial institutions to look through non-statutory trusts to identify beneficiaries.4 The implementing regulations should clarify whether the same approach will apply under the CTA.
No Beneficial Ownership Reporting with Respect to Interests Obtained through Right of Inheritance
|Covered entity under the CTA||Additional covered accounts under current CDD Rule
(presumably some level of similar treatment under the CTA)
Financial institutions still have obligations beyond the CTA's requirements
Lastly, representatives of SPVs and those in the private wealth sector should not expect the financial institutions with whom they interact to cease asking about beneficial ownership. While the CTA obligates FinCEN to revise its CDD Rule to conform to the requirements of the CTA, it does not require that FinCEN completely revoke the rule. Rather, FinCEN must amend the rule to take into account the registry and eliminate any potential redundancies, among other things. However, it will take at least 2–3 years, if not substantially longer, for FinCEN to bring the beneficial ownership registry online. FinCEN will not be able to revise the CDD Rule until it is practical for financial institutions to rely on the registry. However, even with the registry in place, it may not be practical for financial institutions to rely on the registry unless verification through the registry is seamless and contemporaneous with account openings. Moreover, supervisors will still expect a covered financial institution to manage its risks relevant to beneficial ownership of its customers.5 As such, financial institutions may seek information on the beneficial owners of their customers beyond what is required under the CTA.
1 See United States' Progress in Strengthening Measures to Tackle Money Laundering and Terrorist Financing, FATF (2020).
2 31 CFR § 1010.230. The CDD Rule, among other things, requires certain financial institutions to collect and verify the identities of the beneficial owners of their legal entity customers.
3 Under current FinCEN beneficial ownership regulations, beneficial owners include any individual with "significant responsibility to control, manage, or direct a legal entity." Id. § 1010.320(d)(2). Such individuals typically include the chief executive officer, senior manager, chief financial officer, chief operating officer, managing member, general partner, president, vice president, or treasurer. FinCEN may rely on this formulation in developing a "substantial control" standard.
4 In practice, financial institutions typically identify and verify the identity of trustees that act as signatories. Under current guidance, financial institutions may also conduct due diligence on grantors, settlors, trustees, and others that have the authority to direct trustees.
5 See, e.g., Guidance on Obtaining and Retaining Beneficial Ownership Information, FinCEN (Mar. 05, 2010). While the CDD Rule has partially superseded this guidance, the agencies have not formally revoked it.
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