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06.24.2021 | Legal Advisory

The Corporate Transparency Act (“CTA”) was enacted as part of the Anti-Money Laundering Act of 2020. The purpose of the CTA is to deter anonymous owners of corporations, limited liability companies, and other entities from facilitating illicit activity such as money laundering, financing terrorism, tax fraud, and acts that would harm national security interests.

The CTA requires the Financial Crimes Enforcement Network (“FinCEN”), a unit of the Treasury Department, to maintain a national registry of “beneficial ownership” information collected from certain “reporting companies.” This information will be stored in a federal database for at least five years after the reporting company ceases to exist. The information will not be made public and will only be released to authorized government authorities, pursuant to court order, and to financial institutions that need such information to comply with customer due diligence requirements. §6402(6)(b).[1]

The CTA provides a framework within which the Treasury Department has one year to implement regulations. FinCEN issued an advance notice of proposed rulemaking on April 5, 2021. The comment period ended on May 5, 2021, but FinCEN has yet to make a statement on the process or next steps. 

What Is a “Reporting Company”?

The term “reporting company” includes corporations, limited liability companies, and other similar entities formed by filing with a secretary of state (or a similar office under state law) or formed under the law of a foreign country and registered to do business in the United States. It is unclear whether “other similar entity” includes limited partnerships, limited liability partnerships, or statutory trusts, and the Treasury Department will likely address this in the regulations.

The CTA specifically exempts several types of entities, including governmental entities, certain nonprofits, certain financial institutions subject to federal government supervision such as banks[2], and publicly traded companies. The CTA also exempts entities that: (1) employ 20 or more full-time employees; (2) filed a federal income tax return showing more than $5 million in gross receipts or sales; and (3) have an operating presence at a physical office within the United States. §6403 (a)(11). In addition, an entity will be “grandfathered” and deemed to be exempt if it: (1) was formed over one year prior to January 1, 2021; (2) has not be engaged in active business; (3) is not owned by a foreign person; (4) has had no change of ownership or received or sent funds greater than $1,000 within last year; and (5) does not hold any assets. §6403 (a)(11)(b)(xxiii) and §6403 (b)(2)(E).

Notably, foreign entities are not included in “reporting companies” unless they are qualified to do business in the United States. However, foreign entities may be required to make disclosures if they are a beneficial owner of a reporting company. The CTA can be read to state that an entity can be simultaneously a reporting company and a beneficial owner of another reporting company.

Finally, within two years of the CTA’s enactment, the Administrator for Federal Procurement Policy must revise the Federal Acquisition Regulation such that certain federal contractors and subcontractors that meet the criteria of a reporting company must disclose their beneficial ownership information to the federal government within their bids or proposals. §5336(c)(1).

Distinguishing Between a “Beneficial Owner” and “Applicant”

The term “beneficial owner” refers to an individual who: (1) directly or indirectly (through any contract, arrangement, understanding, relationship, or otherwise) exercises substantial control over the entity; or (2) owns or controls not less than 25 percent of the ownership interests of the entity. Again, the CTA leaves room for the Treasury Department to define the parameters of what constitutes “substantial control,” “25% ownership,” and how the factual nuances of each company will be considered. The definition of “beneficial owners” expressly excludes: minor children; individuals acting as a nominee, intermediary, custodian, or agent on behalf of another individual; an individual acting solely as an employee of a corporation, LLC, or similar entity and whose control over or economic benefits from such entity is derived solely from the person’s employment status; an individual whose only interest in such entity is through right of inheritance; and a creditor of such entity, unless the creditor meets the requirements of “beneficial owner.”

An entity deemed a reporting company must submit a report to FinCEN including the full legal name, date of birth, current address, and a unique identifying number from an acceptable identification document or a FinCEN identifier of any beneficial owner. §6403 (a)(2)(A). For an individual, “acceptable identification document” means (1) a nonexpired U.S. passport; (2) a nonexpired identification document issued by a state government, a local government, or an Indian Tribe; (3) a nonexpired driver’s license[3]; or (4) if an individual does not have one of these documents, a nonexpired passport issued by a foreign government. “FinCEN identifier” means a unique identifying number assigned by FinCEN to a person under the CTA.

Reporting companies must also disclose comparable information for any “applicant.” An “applicant” includes an individual who: (1) files an application to form a corporation, LLC, or other similar entity under state or Indian Tribe law; or (2) registers or files an application to register a corporation, LLC, or other similar entity formed under the laws of a foreign country to do business in the United States by filing a document with the secretary of state or similar office under state or Indian Tribe law. Notably, there is no exemption for lawyers or paralegals that form an entity on behalf of a client. It is unclear whether that person and their affiliated law firm would be implicated. Again, the Treasury will need to define the parameters of “applicant.”

Be Prepared for Reporting Requirements

Any reporting company formed before the effective date of the regulations has two years to submit the beneficial ownership information to FinCEN. §6403 (b)(1)(B). Any reporting company formed after the effective date of the regulations must submit to FinCEN, at the time of formation, a report that contains its beneficial ownership information. §6403 (b)(1)(C). If there is a change with respect to any beneficial ownership information, a reporting company must submit a report to FinCEN updating the information. §6403 (b)(1)(D).

The following are some specific reporting scenarios that may arise:

1. When an exempt entity has direct or indirect ownership interest in a reporting company, the reporting company need only disclose the name of the exempt entity—not information regarding the exempt entity’s beneficial owners. §6403 (b)(2)(B).
2. Certain pooled investment vehicles that are exempt from the reporting, but formed under the laws of a foreign country, must file with FinCEN a written certification that identifies the beneficial owners of the pooled investment vehicles. §6403 (b)(2)(C).
3. If at any time a subsidiary that is owned or controlled, directly or indirectly, by an exempt entity that later fails to meet the criteria to be exempt, it must submit beneficial ownership information to FinCEN. §6403 (b)(2)(D).
4. If an entity that is grandfathered as an exempt entity later fails to meet that criteria, the entity must submit a beneficial owner information report to FinCEN. §6403 (b)(2)(E).

Penalties for Failing to Comply

Any person that willfully provides or attempts to provide false or fraudulent beneficial ownership information or willfully fails to submit a complete and updated report to FinCEN could be subject to a fine of up to $500 for each day that the violation continues (limited to $10,000) and/or imprisonment for up to two years.[4] A safe harbor rule protects individuals from liability if within 90 days, they voluntarily follow procedure and submit a report with correct information. This safe harbor does not apply to persons that submit a report, knowing it contains incorrect information, in efforts to evade reporting requirements. §6403 (b)(3)(B).

CTA’s Effect on Customer Due Diligence Processes Performed by Financial Institutions

The newly enacted CTA overlaps, in part, with a preexisting set of regulations—the Customer Due Diligence Rule (the “CDD Rule”)—which is also aimed at improving financial transparency and preventing criminal and terroristic activities conducted through the use of shell companies. 31 U.S.C. §5336(b)(4) U.S.C. The CDD Rule clarifies and strengthens customer due diligence requirements for certain financial institutions by instructing FinCEN to require such institutions to collect information about entity customers. This information is nearly identical to that which the CTA requires companies to provide directly to FinCEN.

The CDD Rule requires covered financial institutions to establish and maintain written policies and procedures that are reasonably designed to: (1) identify and verify the identity of customers; (2) identify and verify the identity of the beneficial owners of companies opening accounts; (3) understand the nature and purpose of customer relationships to develop customer risk profiles; and (4) conduct ongoing monitoring to identify and report suspicious transactions and, on a risk basis, to maintain and update customer information. In building customer risk profiles, the level of information collected from each customer should be commensurate with the financial institution’s evolving assessment of the level of risk presented by the customer. Institutions should consider collecting information such as: source of funds, type of business, location, and proximity of customer’s residence to place of employment, etc. As a customer presents higher risk, additional information should be sought.

The CTA requires the Treasury Department to revise the CDD Rule within one year of the CTA’s enactment to bring it into conformance with the CTA and to reduce any unnecessary or duplicative requirements. § 6403(d)(1). The CTA recommends that, while revising the CDD, the Treasury Department should consider the access that financial institutions will have to beneficial ownership information filed by reporting companies under the CTA and conform the beneficial ownership information sought under the CDD Rule to the information gathered under the CTA. FinCEN will be able to disclose beneficial ownership information collected under the CTA pursuant to a request by a financial institution, with consent of the reporting company, “to facilitate the compliance of the financial institution with customer due diligence requirements under applicable law.”

Financial institutions will need to continue fulfilling customer due diligence obligations by identifying and verifying beneficial ownership information, even after the CDD Rule is revised. However, revisions to the CDD Rule may change what type of information financial institutions collect and how financial institutions must report that information.   

What’s Next?

Although it is unknown when FinCEN will propose the CTA regulations or when those regulations will become effective, businesses that routinely form the types of entities that will be considered “reporting companies” should begin to develop policies and procedures for the collection of information from the beneficial owners of the reporting companies that will be formed after the CTA regulations become effective. In addition, financial institutions should continue complying with the CDD Rule while remaining alert to any regulatory change that may alter the type of information they must collect and how they must report it.

We are continuing to monitor updates on the CTA and will keep you apprised on future developments. Please do not hesitate to contact one of the authors or your Nutter attorney with any questions you may have on navigating this process.

[1] All citations are to the National Defense Authorization Act for fiscal year 2021 (the “NDAA”).

[2] State-chartered limited purpose trust companies that do not accept FDIC insured deposits would not fall under this exemption.

[3] The CTA does not specify whether this license must be issued by a “Real ID” compliant state.

[4] As written, the CTA does not impose penalties for financial institutions that fail to meet customer due diligence requirements under the Customer Due Diligence Rule. However, as discussed below, the Treasury Department may implement such penalties when promulgating CTA regulations and revising the Customer Due Diligence Rule.

This advisory was prepared by Thomas Curry, Matthew Doring, and Michael Krebs in Nutter’s Corporate and Transactions Department. If you would like additional information, please contact one of the authors or your Nutter attorney at 617.439.2000.

This update is for information purposes only and should not be construed as legal advice on any specific facts or circumstances. Under the rules of the Supreme Judicial Court of Massachusetts, this material may be considered as advertising.