The Corporate Transparency Act, adopted as part of the 2021 National Defense Authorization Act (the “Act”), will require certain business entities (defined as “reporting companies”) to disclose to the U.S. Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN) the identities of their beneficial owners and applicants. FinCEN will use these disclosures to create a national database to combat terrorism and money-laundering schemes which have used business entities to hide the identity of their owners. Reporting will not begin until the Treasury adopts regulations, which the Act mandates must be done by January 1, 2022. Reporting companies formed after the adoption of the regulations will be required to report this information as they are filing for formation.  Existing businesses will have two years from the adoption date to file to report and identify their beneficial owners.  Reporting companies will need to update beneficial ownership information with FinCEN within one year of any change in the reported information. While the Act lets us know that these reports will now have to be made at some point, many questions remain unanswered pending the release of the full regulations by the Treasury.

Who must report?

The Act requires any reporting company to comply with its disclosure requirements. The preliminary definition of a “reporting company” includes corporations, limited liability companies, and other similar entities that are created by filing a document with the secretary of state (or an equivalent office) of any state, or are formed under foreign law and are registered to do business in the United States in a like manner. Questions remain as to whether limited partnerships, trusts, sole proprietorships, or subsidiaries of reporting companies will be considered reporting companies. The Act exempts many categories of businesses from the initial reporting requirement such as companies that are already subject to supervision or close regulation by the federal government such as banks or public companies registered under the Securities Exchange Act; investment companies or advisors registered with the SEC; insurance companies; not-for-profits; and broker-dealers, among others. The Act also contains one broad exemption which applies to companies that 1) employ more than 20 people; 2) filed a tax return reporting gross receipts in excess of $5 million; and 3) have a physical presence in the United States. Subject to any future guidance from the regulations, any new entity setting up shortly after the enactment of the Act will not be able to rely on the broad exemption since these entities will not have a prior year’s tax return by virtue of being a newly formed.

Who is a beneficial owner or applicant?

The Act requires that all “beneficial owners” and “applicants” be disclosed by the reporting company. A “beneficial owner” is defined as an individual who, directly or indirectly, through any contract, arrangement, understanding, relationship or otherwise (i) exercises substantial control over an entity or (ii) owns or controls at least 25% of the ownership interests in an entity. It is unknown how the “25%’ ownership” standard will be measured.  “Beneficial owners” do not include (i) individuals acting as nominees, agents, intermediaries, or custodians for an individual; (ii) a person acting solely as an employee of a reporting company and whose control over or economic benefits from the company are derived solely from their employment status; (iii) creditors of the reporting company (unless the creditor meets either the “substantial control” prong or owns or controls 25% or more of the reporting company), (iv) individuals whose only interest in a covered entity is through a “right of inheritance,” and (v) minor children if the information of the parent (or guardian) is reported. Companies with multi-tiered stock classes or LLCs with multiple classes of interests with differing rights may not be able to fit neatly into a 25% ownership test and will need to wait for the Treasury regulations to provide more guidance. Further, there is no clear guidance on the definition of “substantial control” or whether this control must be direct or indirect, from within the company, or whether a third-party such as legal counsel or lenders would be able to exert the required level of control to become a beneficial owner. FinCEN does have an existing definition of beneficial owner as part of its customer due diligence rules which it could choose to carry over to this Act. If this approach were applied, a shareholder would be considered a beneficial owner if the shareholder owned 25% or more of the equity interest in the corporation or had significant responsibility to control, manage, or direct the corporation as an executive officer, senior manager, or other individual who regularly performs similar functions. Companies will need to wait until the full regulations are released for more guidance.

The Act also requires the company to identify each of its “applicants.” Applicant is defined to include individuals who file the application to form the entity with the state. Again, the regulations will need to provide more concrete guidance, but it is plausible that this would require that the company’s organizer, oftentimes an attorney, be disclosed.

What must be reported and who will have access to the data?

Each reporting company will be required to submit four pieces of information on each beneficial owner or applicant: 1) full legal name; 2) date of birth; 3) current residential or business street address; and 4) a unique identifying number. The identifying number could be a driver’s license or passport number, or the person may request and use a FinCEN identifying number. A reporting company will need to update the information provided to FinCEN within one year of the date of any change in beneficial ownership.

The information will be stored by FinCEN in a private database and will not be accessible to the public. The information will be made available to federal law enforcement agencies and, with court approval, other law enforcement agencies. Foreign law enforcement agents may also obtain the stored information by requesting it from the appropriate federal agency. Lastly, with consent, financial institutions will have access to the database for customer due diligence purposes.

Penalties for failure to report

Willful failure to report complete or updated information is subject to a daily civil penalty of $500 and criminal fines up to $10,000 and/or a maximum of two years in prison. Unauthorized disclosure of any information held in the database, whether by a government employee or by a third-party recipient carries a civil penalty of up to $500 per day that the violation continues and criminal penalties up to $250,000 and/or a maximum of five years in prison. However, a person is exempted from liability if the person acting in good faith corrects inaccurate information submitted to FinCEN within 90 days of the inaccurate report.

What does this mean for our clients?

The Act will impose new legal requirements for the operation and upkeep of many types of business entities with the threat of stiff civil and criminal penalties for noncompliance. Reporting companies will need to review their company structure to ensure that all beneficial owners are accounted for. Reporting companies will also need to review their articles of organization to obtain the name of the company’s organizer/applicant so that his or her identifying information may be reported.

Lenders may at some point require that consent be given by prospective customers to allow them to access the disclosures as a prerequisite to providing credit and to verify the beneficial ownership information they are already required to obtain under the Bank Secrecy Act’s “know your customer” rules for business entity customers.  Lenders may also be forced to take a close look at control rights in the event that these rights are enough to classify them as a beneficial owner.

The passage of the Act serves as a signal to begin preparation for compliance. While the Act itself provides a framework, it still leaves many questions unanswered. Companies will have to wait until the release of the Treasury regulations to know exactly how the Act impacts them. Early planning by those who believe they will be a reporting company will help ensure that future compliance is complete and accurate.

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