Changes in US corporate governance: the Corporate Transparency Act

The Act, adopted by Congress in December 2020, requires every corporation, LLC and limited partnership to file a beneficial ownership report with FinCEN, the Financial Crimes Enforcement Network. The Act is intended to bring US anti-money laundering standards more in line with European standards and will apply both to US companies as well as non-US companies that register to do business in the US. It does this by creating a new national registry of corporate beneficial ownership data. Because this concept is new to US investors, managers and lawyers, the Act’s requirements will be unfamiliar to companies that do business in the US and the attorneys that advise them. 

The Corporate Transparency Act as anti-money laundering

Congress adopted the Act to put US anti-money laundering practices more in line with those in the EU. In the EU and in many other developed countries, national governments maintain a registry of the beneficial ownership of most corporate entities. If national law enforcement suspects money laundering in a financial account, law enforcement can identify the corporate owner of the account and refer to the national registry to identify the beneficial owners of the corporation.

In the US, before the implementation of the Act, there was no such national registry. If US law enforcement suspected money laundering, law enforcement would usually need to subpoena the financial institution’s “know your customer” (or “KYC”) information to identify the beneficial owners of a company. Because that process required law enforcement to have prior cause to suspect a crime – a standard that could later be challenged in court by a criminal defendant – the process was time-consuming. The passage of time often made it possible for illicit actors to abscond and escape detection.

To remedy this situation, the US Congress adopted the Act in order to build a national registry of corporate beneficial ownership. The Act requires each corporation, limited liability company and limited partnership to file a beneficial ownership report with FinCEN. Each beneficial ownership report must identify each beneficial owner of the company and each person (called a “company applicant”) who is responsible for filing the documents that form the entity. FinCEN will compile these reports into a national database. FinCEN will not allow the public to view the national database but will allow law enforcement to access it. 

Defining “beneficial ownership”

The Act defines “beneficial owner” as a person who, directly or indirectly, either (a) own more that 25% of the beneficial interest in the company, or (b) exercises “substantial control” over the company. The Act measures beneficial ownership at the individual level, including an individual’s direct and indirect holdings in the reporting company.

The definition of “substantial control” is more difficult to apply. The proposed regulations define “substantial control” as:

• Service as a senior officer of the reporting company;
  
  
• Authority over the appointment or removal of any senior officer, or a majority or dominant minority of the board of directors (or similar body);
  
  
• Direction, determination, or decision of, or substantial influence over, important matters affecting the reporting company, including but not limited to:
  i. The nature, scope, and attributes of the business of the reporting company, including the sale, lease, mortgage, or other transfer of any principal assets of the reporting company;
  ii. The reorganisation, dissolution, or merger of the reporting company;
  iii. Major expenditures or investments, issuances of any equity, incurrence of any significant debt, or approval of the operating budget of the reporting company;
  iv. The selection or termination of business lines or ventures, or geographic focus, of the reporting company;
  v. Compensation schemes and incentive programs for senior officers;
  vi. The entry into or termination, or the fulfilment or non-fulfilment of significant contracts; and
  vii. Amendments of any substantial governance documents of the reporting company, including the articles of incorporation or similar formation documents, bylaws, and significant policies or procedures; and
  
  
• Any other form of substantial control over the reporting company.

Because this definition of “substantial control” is a facts and circumstances test, nearly every reporting company will need to engage an attorney to determine which individuals have “substantial control”. While every beneficial owner with a 25% or greater stake in the company will need to be included in the company’s report, others, with little or no stake in the company, may also need to be included because of their possession of “substantial control”.

Information required in the beneficial ownership report

Each beneficial ownership report will need to provide identifying information (such as name, date of birth, home address, and a “unique identifying number”) for each beneficial owner and company applicant. Because these kinds of personal data items are sensitive (and their misuse can lead to identity theft) the process that each company will undertake to collect this information and prepare a beneficial ownership report will be sensitive. 

The proposed regulations define a “unique identifying number” as a US driver’s licence or passport (with respect to US residents), or a non-US passport or national identity card (with respect to non-US residents). Along with the unique identifying number, the reporting company must also provide an image of the document that contains both the unique identifying number and a picture of the individual. 

Timing of beneficial ownership reports

Each company’s obligation to file a beneficial ownership report is contingent on the final adoption of implementing regulations by FinCEN. FinCEN is an agency of the US Treasury Department charged with implementing the US Bank Secrecy Act and other laws that fight money laundering. The Act required FinCEN to adopt regulations to implement the Act no later than 31 December 31 2021. FinCEN missed that deadline, however, and issued a proposed regulation on 07 December 2021 that was open for comment until 07 February 2022. FinCEN has not announced whether that proposed regulation will take effect or whether it will issue an amended regulation to take effect at a later date. 

When FinCEN finally implements its regulations as expected at some point during 2022, reporting companies formed after the effective date will need to file their first report within 14 days of their date of formation. Pre-existing companies will have one year from the effective date of the regulations to file their first report. Non-US companies that register to do business in the US (ordinarily by filing an application to do business with the Secretary of State for a US State) prior to the effective date of the regulations, will also have one year to file their first report. Non-US companies that register to do business in the US for the first time after the regulations take effect, will have only 14 days from the date of registration to file their first beneficial ownership report.

After a reporting company files its first beneficial ownership report, the reporting company must file an amendment within thirty calendar days after any change in any information covered by a prior report. For example, if a reporting company reported that it was owned by three individuals (providing the home address and identifying information for each), and one of those individuals changed her residential address, that change would trigger an amendment. 

Exemptions

Because the purpose of the Act is to build a national registry of companies, the Act exempts from its reporting obligations several classes of companies whose beneficial ownership information is already collected by regulators in some other way. The Act exempts publicly traded companies, licensed broker-dealers, licensed insurance companies, chartered banks, certain not-for-profit companies, securities broker-dealers, certain charitable organisations and the wholly-owned subsidiaries of exempt companies. 

Another exemption exists for companies that (a) have a physical presence in the US, (b) have twenty or more employees, and (c) have more than $5 million in revenue each year (as demonstrated in the company’s tax returns). 

While these exemptions will allow some companies to avoid the duty to file a beneficial ownership report, they can also represent a trap for the unwary. Because the Act requires companies to file an amendment within 30 calendar days after a change in status, an exempt company that loses its exemption will have 30 calendar days to file an initial beneficial ownership report after the event that destroys its exemption. Many companies, and the individuals responsible for them, may lose track of this obligation and not realise their duty to file until after the 30-day deadline has passed. 

Enforcement

Because the purpose of the Act is to build a national registry of beneficial ownership, FinCEN’s introduction of its regulations to the public will include educational presentations aimed at promoting awareness of this change in the law. The Act’s creation of a new national registry of beneficial ownership will be an unfamiliar concept for most US investors and company managers. Many will be surprised to learn of their new obligations under this law.

The Act contains significant enforcement powers, however. Companies that fail to file a beneficial ownership report when due will be liable for a USD 500 per day fine. Individuals who provide inaccurate information in a beneficial ownership report will have personal, criminal liability for that failure. A wilful failure to file or a wilfully inaccurate filing can be punished as a felony. The Act also contains penalty multipliers for companies that fail to file, or that file inaccurate reports, in combination with other anti-money laundering crimes. 

The Act’s potential criminal sanctions should give US investors, company managers and their attorneys more than enough reason to give this new law their full attention.

Implications for corporate governance

The duty to file a beneficial ownership report imposed by the Act will require companies to adopt new corporate governance standards. Companies should consider adopting shareholder agreements (for corporations) and operating agreements (for limited liability companies) that obligate the company’s owners to provide their personal data to the company so that the company can file the beneficial ownership report. Because of the sensitivity of this personal data, company owners will want their companies to appoint an individual to serve as the “compliance officer” for this effort. They will want the compliance officer to have a duty to keep all personal data confidential and secure.

Because of the 30-day amendment requirement, corporate governance documents will also need to obligate company owners (and the senior managers who might be beneficial owners by virtue of their “substantial control” over the company) to apprise the company’s compliance officer of any change in their personal data that might trigger the duty to file an amendment. The beneficial ownership report will include each individual’s residential address, a unique identifying number and an image file of the unique identifying number. These types of data often change. People change addresses. In many states, a driver’s’ licence must be renewed every few years. Few people think of these types of changes as a trigger point to alert their companies and fellow investors. Company governance documents will need to build that sense of awareness, so that beneficial owners remember to alert their compliance officers when they change residential address or renew their driver’s licence or passport. 

Preparing for change

Because FinCEN has not yet implemented its proposed regulations, companies cannot yet begin to file their beneficial ownership reports. That change is coming soon, however, so companies and their attorneys should begin to prepare to implement corporate practices that comply with this new law. 

Each company organised or registered to do business in the US should review the Act with counsel and reach a preliminary determination whether the company will be exempt or required to file a beneficial ownership report. If the company will need to file, the company should develop a preliminary review regarding who its beneficial owners will be. The company should identify its “company applicant” and make sure it has that person’s contact details for future use.

Companies should also review their corporate governance documents and consider adopting changes that focus on compliance and the type of data awareness that compliance will require. The Act’s provisions will dramatically change the way investors, company managers and their attorneys think about company governance and the need for data awareness. Implementing these changes will take time and it would be prudent for many to begin that process now. 

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Photo: Photo: Kevin Ruck - stock.adobe.com