Distributors and their executives often form corporations and other legal entities like limited liability companies (LLCs) for a myriad of purposes, including to avoid disclosing the identity of "beneficial owners" – meaning natural persons who ultimately own, benefit or control legal entities – including for example a trust, foundation, or other legal entity. Generally, the ownership structure let alone the beneficial owner(s) of these legal entities is not readily available, even to investigative sources. The formation of legal entities is a matter of state law, and most states collect very little data about the organizer and other aspects of such entities – especially their beneficial owners. Many distributors know that formation of an LLC under Delaware law, for example, is a smart legal move, because the true (i.e., beneficial) ownership can be buried – equity interests owned by trusts, corporations, or other LLCs for a variety of reasons, including liability protection, estate planning, creditor protection and maintenance of the privacy of beneficial owners.
New Legislation – the Corporate Transparency Act
Congress, however, has recently altered this landscape by legislation known as the Corporate Transparency Act (CTA), whose articulated purpose is to "crack down on anonymous shell companies which have long been the vehicle of choice of money launders, terrorists, and criminals." Despite the stated intent of the CTA, it impacts legitimate businesses engaged in ordinary course transactions and is otherwise legislation of which all distributors should be aware. The National Defense Authorization Act, recently passed over the veto of President Trump, included the CTA. Although enacted for its stated purpose, it requires disclosure in certain circumstances of beneficial ownership of what otherwise would-be anonymous shell companies. Prior to adoption of the CTA, the burden of determining the beneficial owners of corporations and LLCs, for example, fell mainly on financial institutions, which are required to determine the beneficial ownership of their customers through the Bank Security Act’s “know your customer” requirements. Under the CTA, certain “reporting companies” must disclose the beneficial ownership of any legal entity withing certain parameters to a newly created United States database within the U.S. Department of Treasury’s Financial Crimes Enforcement Network (FinCEN).
Companies that Need to Report
The CTA defines a “reporting company” to include any “corporation, limited liability company or other similar entity that is (i) created by the filing of a document with the U.S. State or Indian Tribe, or (ii) formed under the law of a foreign country and registered to do business in the United States…” A reporting company excludes (i) companies already subject to supervision or closely regulated by the federal government (e.g., banks, commodity brokers, registered investment advisors, etc.); (ii) other publicly traded companies; (iii) dormant companies; (iv) companies that (a) employ more than 20 full time employees in the U.S., (b) annually report more than $5,000,000 in gross receipts or sales to the IRS, and (c) have an operating presence at a physical office in the U.S., and (v) an entity owned by another already exempt entity. Exempt entities will have to apply for an exemption from FinCEN.
Information to be Reported
Reporting companies are required to submit specified information to FinCEN on any beneficial owners, including: (i) full legal name, (ii) date of birth, (iii) residential or business address, and (iv) unique identifying members from an acceptable identification document, such as a driver’s license, U.S. passport or other U.S. state-issued identification document. The CTA defines a “beneficial owner” as any individual who (i) owns a 25% equity stake, or (ii) exercises “substantial control” over the reporting company. The CTA does not define “substantial control,” which term will be presumably further detailed in regulations to be promulgated by FinCEN. The following are specifically excluded from the definition of “beneficial owner”: (i) individuals acting as agents, intermediaries, or custodians on behalf of another; (ii) an employee of a reporting company whose control or economic benefit is derived solely from their employment; and (iii) creditors of the reporting company, unless a creditor has “substantial control” or owns 25% or more of the reporting company.
Timing of Reporting
The requirement for reporting companies to submit beneficial ownership information to FinCEN is triggered by the adoption of FinCEN’s implementing regulations at which time all newly formed reporting companies will have to submit the required information. Pre-existing reporting companies will be required to submit the information within 2 years following adoption of the regulations. Reporting companies will need to update beneficial ownership information with FinCEN within one year of any change in the information already reported.
Who Can Access the FinCEN Registry?
The database compiled and maintained by FinCEN will not be publicly available, but the CTA allows FinCEN to disclose beneficial ownership information upon request to: (i) U.S. federal law enforcement agencies; (ii) U.S. federal law enforcement agencies requesting information on behalf of a non-U.S. law enforcement agency; or (iii) with the consent of the reporting company, a financial institution to meet customer due diligence requirements.
Implications for Reporting Companies
US and foreign companies operating in the U.S, should of course review the CTA to determine reporting status. Smaller companies with annual revenue of over $5 million, 20 or more employees, and a physical operation in the US may well need to report.
- Failure of a reporting company to report or submitting false or fraudulent information is subject to $500 per day penalty or a maximum of a $10,000 penalty and up to 2 years imprisonment.
- A safe harbor for submitting inaccurate information if done "voluntarily and promptly" and no later than 90-days from initial reporting.
Distributors are encouraged to direct questions about the CTA, LLCs and other legal matters to me at email@example.com or 312-840-7004.