In this article, Kroll summarizes the proposed Corporate Transparency Act of 2019 (the Act), which seeks to require persons forming legal entities to report the beneficial ownership of the entities being formed. This article presents why that is important, the impetus for the Act, the proposed requirements and their impact and Kroll’s initial recommendations if passed into law.
The Potential for Entity Abuse and Exploitation
The robust growth of corporations, limited liability corporations and other structured entities has been an outcome of a vibrant economy; however, this condition has also created increased opportunities for exploitation and the growth of illicit activity. For example, the release of the Panama Papers brought to public attention the globally widespread misuse of opaquely-managed entities as instruments for financial crime, including money laundering, corruption and tax evasion.
It is not solely foreign entities that are being used for illicit financial flows. For more than a decade, the United States has been steadily rising as a global hub for financial secrecy—a key facilitator of financial crime. Ease of entity formation, and a lack of proper verification and validation as it relates to corporate structures in the U.S. has allowed for both foreign and U.S.-based entities with both legitimate and illegitimate intent to flourish.
Such lack of transparency around company ownership has long been a way for bad actors across the spectrum—from terrorists to corrupt politicians, business leaders and the wealthy—to finance terrorism and illicit activities, shield transactions with sanctioned states and hide wealth from law enforcement and regulatory bodies throughout the world. Recent examples of this type of activity include:
- In a case ending in $1.3 billion in penalties, a prominent global financial institution violated U.S. economic sanctions for a decade by conducting billions of dollars of transactions for parties in embargoed or otherwise sanctioned jurisdictions.
- For nearly two decades, a state-owned bank avoided U.S. sanctions by using a New York shell company to launder and funnel money to known-terrorist groups like Hamas. Federal authorities ultimately ended up seizing an estimated $1 billion in assets.
- Another global financial institution was recently fined for allegedly helping Russians send money overseas and arrange stock trades. Mirror transactions ran through the bank’s New York office with more than $10 billion moving between Moscow, London and New York.
Beneficial Ownership: Adaptation and Responses to a Globalized Economy
Although the U.S. was one of the first nations to adopt anti-money laundering (AML) legislation, put forth substantive efforts to increase beneficial ownership requirements throughout the globe and launch the Financial Enforcement Network’s (FinCEN) Customer Due Diligence (CDD) Rule, the lack of corporate ownership transparency has continued to plague the U.S. and global partners, making it difficult to verify bad actors and nefarious individuals who may be involved in illicit activities. As such, any jurisdictions seeking to make an impact on this issue should ensure that their compliance and international standards are at the appropriate level to address the risk this issue poses.
This lack of corporate ownership transparency in the U.S. raises the possibility of bad actors taking advantage of our financial and economic systems. Entity formation has historically been within the purview of the individual U.S. states and territories, which have varying formation requirements.
The multitude of entity registration options has had the adverse consequence of incentivizing states to set minimal barriers to entry as they compete for incorporation fees, which can annually generate millions of dollars for state governing bodies. With that in mind, it is not surprising that forming a U.S. corporation or entity typically requires less information than is needed to obtain a bank account or driver’s license today. Given these systemic limitations, the U.S. is reaching a tipping point for action, as the risk is outweighing the established proceeds.
While Europe and individual countries have been pursuing increased transparency, a recent Congressional Research report highlights “gaps” in the U.S. anti-money laundering framework, especially in relation to a “lack of systematic beneficial ownership disclosure.” As other governments impose more stringent rules on entities, illicit activity will continue to flow into the U.S., creating a hub for money laundering and other crimes that may undermine of U.S. national security and the rule of law.
The Corporate Transparency Act of 2019
In recent years, there have been multiple assessments, not only by Financial Action Task Force, but the U.S. Government Accountability Office, Global Finance Integrity and Department of the Treasury, highlighting the lack of transparency around beneficial ownership of U.S. entities. In response, FinCEN released its Customer Due Diligence (CDD) Rule, which took effect in May 2018, mandating that covered financial institutions identify and verify the identity of beneficial owners of legal entity customers. However, many critics argue that the CDD Rule does not go far enough.
To further address concerns over the misuse of corporate entities, the U.S. House of Representatives passed the Corporate Transparency Act of 2019 (the Act) on October 22, 2019. The Act will now face the Senate where it must be approved by simple majority, or over 50%, to pass. If passed by the Senate and then signed by the President, The Act would amend the Bank Secrecy Act (BSA) to compel the Secretary of the Treasury to set minimum reporting requirements for state incorporation practices.
If passed as currently drafted, the Act would require each corporation or LLC applicant to provide FinCEN with the following information about each beneficial owner:
- Full legal name;
- Date of birth;
- Current residential or business street address; and
- Unique identification number from a passport, driver’s license or personal identification card.
The legislation would also require the filing of an annual report of current beneficial owners of the company and any changes in beneficial ownership in the previous year.
For purposes of the Act, the term beneficial owner means any natural person who directly or indirectly, through any contract, arrangement, understanding or relationship:
- Exercises substantial control over the entity;
- Owns at least 25% of the equity interests; or
- Receives substantial economic benefits from the entity’s assets.
The Act would exempt certain entities from the beneficial ownership reporting requirements. Many of these entities already have beneficial ownership mandates, such as financial institutions, accounting firms and tax-exempt organizations. Additionally, due to the unlikelihood of being a vehicle for financial crimes, businesses with 20+ full-time U.S. employees reporting over $5 million in gross U.S. receipts or sales would also be exempt from ultimate beneficial owner reporting requirements.
The legislation includes what are effectively catch-all reporting requirements. Smaller companies are required to report beneficial ownership information while larger corporations are exempt. The caveat is that bigger companies are required to file a separate report explaining why they should be excluded from the reporting requirement. In other words, every corporation or LLC, no matter their revenue or employee count, will be mandated to submit some form of annual report to FinCEN and be subject to the Act’s civil and criminal penalties.
Civil penalties of up to $10,000 have been included in the legislation, as well as criminal fines and imprisonment for up to three years, or both, for persons who knowingly submit false or fraudulent information, willfully fail to provide complete information or for the misuse or unauthorized disclosure of beneficial ownership information. Considering the high global focus on corporate transparency, non-compliance could also result in severe reputational consequences.
Ultimately, the goal of Congressional action is not only to address concerns about the misuse of U.S. corporate entities, but also to strengthen law enforcement investigations, set clear standards for state incorporation practices, bring the U.S. in line with global AML requirements and restore accountability as well as integrity to the corporate framework. Although the information on beneficial owners would not be publicly available, it would ultimately be accessible to law enforcement or a request made by a financial institution with customer consent.
The Act’s language goes a long way to address specifics; however, sections of the Act may need further clarification and modification. The Act does not objectively define beneficial ownership terms such as “indirectly or directly exercises substantial control” or “substantial economic benefit.” Left as-is, this lack of clarity could make seemingly uninvolved individuals and entities liable for violations and accompanied penalties of the Act.
The impact on “formation agents,” or those who assist in the creation of legal entities, such as attorneys, will need to be monitored. Past iterations of the Corporate Transparency Act classified formation agents as financial institutions, making them subject to the BSA’s AML and reporting obligations. The Act in its current version has removed references to formation agents, but the rulemaking authority given to the Department of the Treasury could potentially expand the requirements for businesses and thus widen the scope of potential criminal liability.
The Potential Future State
Congress is motivated to enhance accountability, corporate transparency and beneficial ownership identification, making the Act likely to pass. Diligent individuals and businesses will prepare for its arrival proactively taking into account the standards the Act will hold those accountable to. In doing so, these efforts and commitment will help in the fight against illicit activity and protect all involved in this systematic process from potential violations and penalties.
Next Steps for Consideration
Here are some short-term action items that should be considered by those who form or help form corporations and entities:
- Determine if your organization has beneficial ownership reporting requirements, as set forth in the Act, or if it falls within the class of exempt entities specified in the Act;
- Create a checklist of your FinCEN reporting requirements;
- Identify any and all individuals who would be considered beneficial owners under the Act;
- Ensure that identification documents of each individual considered to be a beneficial owner are current (i.e. non-expired) and/or plan to renew upon expiration;
- Create a risk ranking system to account for variables such as country of origin, services provided, and categorization of risk level within relationships;
- Leverage a “trust-but-verify” approach with supplemental investigatory diligence if information raises red flags;
- Create a process for adhering to reporting mandates, including the individual(s) responsible for collecting beneficial ownership information and filing with FinCEN; and
- Allocate sufficient resources to ensure compliance with the new filing obligation;
- Institute annual monitoring to track compliance requirements.
Compliance obligations centered on corporate transparency will continue to be a primary focus in the U.S. and internationally. It’s critical to anticipate the obligations that may impact your firm or business. For expert advice and assistance in getting your business ahead of what’s required of it, contact one of Kroll’s Compliance experts today.