In the United States of America, what do a small restaurant owner, a real estate developer who wants to keep properties separate, a mom-and-pop store with fewer than 20 employees and a drug cartel shell company all have in common? Under a new federal law, they all will need to report the individual ownership of their businesses to the government or face stiff penalties.
For decades, privacy of ownership was a battle fought at the state level in the context of entity formation and annual reports. Over time, fewer and fewer states required disclosure of owner identities to any meaningful degree. Federal regulation of banks and other financial services firms, however, has gone in just the opposite direction, requiring these regulated entities to make increasingly intrusive inquiries into owner identities. And SEC regulations have long required self-disclosure by entities and individuals who directly or indirectly own more than a 5% stake in a public company.
The CTA. On January 1, 2021, Congress enacted the sprawling 4,517-page National Defense Authorization Act for Fiscal Year 2021 (the “NDAA”) into law. As part of the NDAA, Congress established the Corporate Transparency Act (the “CTA”), at Section 6401 et seq. The stated purposes behind the CTA are to create clear federal standards, protect national security interests, better enable national security, intelligence, and law enforcement agencies to counter money laundering efforts, and bring the United States into conformity with worldwide anti-money laundering standards. Congress noted that “more than 2,000,000 corporations and limited liability companies are being formed…each year” and that “malign actors seek to conceal their ownership of corporations, limited liability companies, or other similar entities to facilitate illicit activity including money laundering, the financing of terrorism, proliferation (of weapons of mass destruction) financing, serious tax fraud, human and drug trafficking, counterfeiting, piracy, securities fraud, financial fraud, and acts of foreign corruption.”
The CTA requires all corporations, limited liability companies, and other similar entities registered to do business in the United States (“Reporting Companies”), except those entities exempt from reporting (discussed below), to identify their beneficial owners at the time of registration to the Financial Crimes Enforcement Network ("FinCEN”), a bureau of the Treasury Department which collects and analyzes information about financial transactions in order to combat money laundering, terrorist financing and other financial crimes. The requirements are not limited, however, to new entities. Pursuant to the CTA, any Reporting Company that has been formed or registered before the effective date of the CTA must, in a timely manner, and not later than 2 years after regulations are promulgated file the requisite report with FinCen. Further, Reporting Companies will also need to update relevant information within 1 year of any change to its beneficial ownership.
Disclosure Requirements. In pertinent part, the Act requires Reporting Companies to provide certain information regarding the “beneficial owners” to FinCen who will then maintain a national registry of the beneficial ownership information. “Beneficial Owner” is defined within the CTA as follows: with respect to a Reporting Company, an individual who, directly or indirectly, through any contract, arrangement, understanding, relationship or otherwise - (i) exercises substantial control over the entity; or (ii) owns or controls not less than 25 percent of the ownership interests of the entity. A “beneficial owner” does not include (i) a minor child; (ii) individuals acting as nominees; (iii) individuals acting solely as employees; (iv) individuals whose only interest is through a right of inheritance; and (v) a creditor of a Reporting Company.”
Each report to FinCEN must include the following information for each Beneficial Owner: (i) full legal name; (ii) date of birth; (iii) current (as of the date on which the report is delivered) residential or business street address; and (iv) unique identifying number from an acceptable identification document (i.e. valid state issued driver’s license number, passport number, social security number, etc.).
Note that since the CTA is only supposed to facilitate law enforcement agencies in their efforts to eliminate the loopholes that criminal actors use to move money within U.S. financial and banking institutions, Congress, recognizing the sensitivity of the reported information, intends to make this information accessible only by authorized government authorities and certain financial institutions. FinCen is required to store the information in a secure private database. Access to this secure database will be available by request only from (1) a federal law enforcement agency; (2) a state, local, or tribal law enforcement agency (if authorized by a court order); (3) a federal agency on behalf of a foreign country (if the request is pursuant to an international agreement); or (4) a financial institution for customer due diligence purposes and if authorized by the Reporting Company.
Exempt Entities. The following entities are not Reporting Companies and will not be required to submit information regarding their beneficial owners: (i) closely regulated businesses (i.e. banking institutions, broker-dealers, investment advisors, etc.); (ii) publicly traded companies; (iii) dormant entities as defined in the NDAA; (iv) tax exempt entities; (v) taxable entities with more than 20 employees, a physical office in the United States, and $5 million or more in gross receipts; (vi) entities that are owned or controlled by an otherwise exempt entity; and (vii) any other entity FinCEN may determine on an ongoing basis.
Penalties. Failure to adhere to the reporting requirements of the CTA can lead to both criminal and civil penalties for any party that files an application for the formation of a Reporting Company. Any person who willfully provides, or attempts to provide, false or fraudulent information, or willfully fails to report complete or updated beneficial ownership information is subject to civil penalties of not more than $500 for each day the violation continues and may be fined not more than $10,000, imprisoned for not more than 2 years, or both. Negligent violations of the Act will not subject a party to civil or criminal penalties if the violating party, in accordance with the regulations voluntarily and promptly, but not later than 90 days after the submission of such report, submits a supplemental report containing corrected information.
Effective Date. The CTA is effective upon the promulgation of the regulations by the Secretary of the Treasury. These regulations must be promulgated within one year of the enactment of the NDAA. Until the regulations are drafted, there are many missing details regarding the implementation, administration, and application of the CTA and its impact on businesses.
While enhanced reporting to aid in the curtailment of illegal activities is necessary, the CTA provisions appear to have much broader application, intended or not. The CTA has a potentially costly impact on small businesses that are already reeling as a result of the global pandemic. Many small businesses do not seek advice on formation due to cost concerns, and thus may not be aware of the new requirements and related penalties. Hopefully, when regulations are promulgated there will be additional considerations and exemptions for small business owners who are not the focus of law enforcement.
 Note that this may include any business that routinely forms companies on behalf of third parties. The Act says it applies to any individual who files an application to form a company. Hopefully, implementing regulations will further define who an applicant is for purposes of the CTA and whether it covers, service companies, attorneys or other professional who routinely assist clients in business formations.