National DefenseOn January 1, 2021, Congress passed the National Defense Authorization Act for Fiscal Year 2021. Included among its provisions is the Corporate Transparency Act (CTA), which, in short, requires qualifying businesses to disclose so-called “beneficial owners.” The purpose undoubtedly is to root out shell companies that avoid detection, regulation or enforcement through complex, opaque ownership arrangements. While we cannot be certain how enforcement will take shape, companies should be aware of the CTA’s requirements to prepare for its enforcement.

The Problem: Shell Companies Hide Illegal Activity

Law enforcement officials believe that their ability to root out corporate crime of all kinds is hindered because individuals and companies can set up complex ownership structures of assets that hide the true beneficial owners. While forming or having a “shell company” – a business that exists only on paper, with no employees, no physical location and sometimes no disclosure of the owner’s real name – is not in and of itself illegal, it can be used to launder money and evade U.S. law enforcement. Sophisticated shell companies may be owned by a separate company or companies, using a Russian-doll ownership structure that eventually traces back to the ultimate owner, who may or may not be a criminal. The problem for law enforcement is that it is difficult to track back what may be many layers of ownership that have enabled the true owner to remain anonymous. The shell company may either have little legitimate business or no business at all; instead, it merely funnels back to the owners funds that may have been laundered by fraudulent invoices, fudged bookkeeping numbers, made-up accounts receivable or similar illegal yet easy-to-overlook activities that would not raise red flags with the government.

To be sure, while many U.S. companies use shells for legitimate purposes, they are also a favored means of laundering funds that are obtained through illegal activity.

Under the United States Code, “laundering of monetary instruments” is transacting in property while knowing that the property represents the proceeds of an unlawful activity and with the intent to promote or carry on unlawful activity or knowing that the transaction is designed to conceal or disguise the unlawful activity. Most people call it “money laundering” because the process “cleans” the property – usually money – of its illegal history and can be used with less worry that the government will investigate its use. Of course, money laundering does not actually clean the money; it remains tied to its original ill-gotten past, and money laundering is a crime in and of itself.

The Solution: The Corporate Transparency Act

Congress passed the CTA, which then-President Trump vetoed on December 23, 2020. The House of Representatives overrode the veto on December 28, and the Senate followed suit on January 1, 2021. The CTA became law the same day, although its provisions will not become effective until the U.S. Treasury Department promulgates implementing regulations, which is supposed to occur no later than January 1, 2022.

The CTA generally requires shell entities to report their ultimate ownership to the Financial Crimes Enforcement Network (FinCEN), an arm of the federal government, for cataloguing. More specifically, each “reporting company” must provide each “beneficial owner’s” full legal name, date of birth, current residential or business address, and either a unique identifying number from a passport or state-issued ID or a FinCEN identifier number. Because the CTA only affects “beneficial owners” and “reporting companies,” a critical question for businesses is whether they will be deemed to fall into those categories.

A beneficial owner is “an individual who, directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise, exercises substantial control over the entity; or owns or controls not less than 25 percent of the ownership interest of the entity.” A beneficial owner does not include

  • a minor child if the parent or guardian submits reporting information;
  • an individual acting “as a nominee, intermediary, custodian, or agent on behalf of another individual”;
  • “an individual acting solely as an employee” of a business entity who derives an economic benefit solely by virtue of their employment status;
  • an individual whose only interest in the entity was through inheritance; or
  • a creditor of the corporation, unless the creditor meets the requirements of the definition of a beneficial owner.

Because of the definition’s broad language, a shell company will need to trace its ownership outward from the Russian dolls it sits in to arrive back at each individual who either exercises substantial control over the company or possesses at least 25% of its ownership interest.

A reporting company is “a corporation, limited liability company, or other similar entity that is created by the filing of a document with the secretary of state or similar office under the law of a State or Indian Tribe; or formed under the law of a foreign country and registered to do business in the United States by filing a document with a secretary of state or similar office under the laws of a State or Indian Tribe….” A reporting company does not include

  • an issuer, broker, or dealer of securities or entity required to file information under section 15(d) of the Securities Exchange Act of 1934;
  • an entity exercising governmental authority on behalf of the United States or any State, Indian Tribe, or political subdivision;
  • a bank, credit union, bank holding company, or a money transmitting business as defined in various federal laws;
  • an exchange or clearing agency;
  • an investment company or adviser registered with the SEC or under the Investment Advisers Act;
  • an insurance company;
  • a registered entity under the Commodity Exchange Act;
  • a public accounting firm;
  • a public utility company;
  • a financial market utility;
  • a 501(c) nonprofit company, unless the organization loses tax exemption status and fails to cure that defect within 180 days;
  • a charitable or split-interest trust; or
  • other entities not listed here.

Because the new law targets shell companies, a reporting company also does not include an entity that employs more than 20 employees full-time, filed tax returns showing more than $5 million in gross receipts or sales (including receipts and sales of other entities through which that entity operates or owns), and has an operating presence at a physical office in the United States. There is also a grandfather clause that provides preexisting entities two years from the effective date of the act to file the required information.

A person who willfully provides false or fraudulent beneficial ownership information or willfully fails to complete the beneficial ownership information will be liable for a $500 civil penalty each day the violation continues and will suffer a fine of up to $10,000, imprisonment for not more than two years, or both. The CTA provides a liability exception for those who remedy the inaccurate information within 90 days, unless the inaccurate information was provided for purpose of delay and the person had actual knowledge of the inaccuracy. Additionally, a person who knowingly discloses or uses beneficial ownership information they obtain through a report or disclosure made to FinCEN shall be liable for a civil penalty of $500 per day of the violation, and suffer a fine of up to $250,000, imprisonment for not more than five years, or both. If the unauthorized use or disclosure of beneficial information is a part of a pattern of illegal activity involving more than $100,000 in a 12-month period, the fine increases to up to $500,000, and the term of imprisonment increases to not more than 10 years.

The CTA’s clear intended effect is to require those who control or own small companies to file certain identifying information with FinCEN, which can then examine the records to ensure accuracy and alert authorities to anomalous filings. The hope is that this process will permit easier tracking and investigation of these types of companies.

This overview of the CTA is not meant to be comprehensive. The CTA contains many more provisions and subtleties than are provided here, including guidance to regulating authorities. Strict compliance with the CTA is expected, so each business should review the specific requirements that apply to its circumstances.

Conclusion: The CTA is a Good Start on a Long Road

The CTA is a small step on a much longer journey. While its scope is appropriate to begin reining in the use of shell companies, the CTA’s success cannot be measured until long after its effective date. While law enforcement officials view it as an important tool in their efforts to combat money laundering and criminals will likely continue to find new ways of evading detection of ill-gotten gains, businesses that form shell companies for legitimate purposes should pay attention to the CTA’s requirements to avoid unwarranted scrutiny and suspicion.