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Unanswered Questions on the Corporate Transparency Act

Martin A. Schwartz

The National Defense Authorization Act for 2021 enacted on January 1, 2021 contains Title LXI, the Corporate Transparency Act (“Act”). It institutes new reporting requirements for legal entities with few employees and limited purposes.

The Act requires reporting to the Financial Crimes Enforcement Network of the Department of the Treasury (“FinCEN”)   by so-called “reporting companies.” Reporting is required for the names of individuals having an ownership interest of 25% or more of the equity or “substantial control” of  the legal entity. The report must furnish for such individuals their date of birth, residence or business address  and governmental identification number such as a driver’s license or passport. The reporting must be made for U.S. entities and for foreign entities qualifying to do business in the United States  if they have 20 or less employees and $5,000,000 or less in gross receipts but the Act contains numerous exceptions such as for financial institutions, insurance companies or an institution otherwise regulated under some federal or state act. The information reported is not intended to be a generally available public record.

The Act requires FinCEN to adopt regulations for reporting within one year from the adoption of the Act or January 1, 2022. Prior to the adoption of the regulations, no reporting is required. Upon adoption, reporting for entities formed both prior to or following the regulations will be required. The reporting period for entities formed subsequent to the adoption of the regulations will be at the time of formation. Existing entities at the time the regulations are adopted will have a period of two years to report. Any changes in reporting information will need to be made in one year from the changes.

One can only wonder whether these extensive report requirements with the costs involved will achieve the desired objective. The implicit assumption seems to be that criminals, those who break the law, will comply with the reporting law. However, the Act leaves many open questions:

(a)    Who is the “Beneficial Owner”?  Who is the “beneficial owner” of the reporting company? If the reporting company is owned by another entity which in turn is owned by a third entity, is the beneficial owner the owner of the reporting company or the owner of the top tier holding company? The Act defines “beneficial owner” as the beneficial owner of the reporting company. It does not use the term the “individual” who is the beneficial owner of the reporting company. However, the disclosures contemplate individuals. Banks in response to existing federal mandates require disclosure of the ultimate individual beneficial owners and can assume this requirement will be clarified in the FinCEN regulations?

(b)   Liability  of the “Reporting Company”.  Who will ultimately be reporting for the “reporting company?” Typically, new entities are formed by attorneys and corporate  service companies (“Incorporators”). So in almost all cases the “reporting company” will be the attorneys or service companies forming the entities for which a report has to be submitted. In many cases, the identity of the beneficial owner or owners is unknown to the Incorporators. If the information provided to the attorneys or service providers proves to be inaccurate, will the Incorporators face the statutory penalties? How can the Incorporators insulate themselves from liability? Would such Incorporators need to obtain an affidavit from the beneficial owners? This may be difficult in many situations where the new entity is needed on a short fuse for a pending transaction. Would such an affidavit work as a shield if it proved to be false?

(c)    Reporting Company Disclosure. What is the affect of the Act  upon the Incorporators? The Act imposes  the same reporting requirements as it does for the reporting company on the Incorporators. So the same information as to beneficial ownership and control as to each of the individuals holding beneficial interests in the Incorporators would apply. This would result in law firms reporting on any lawyer who holds a 25% or more equity interest in the firm or has “substantial control” over the firm. In larger law firms run by a management committee, would each of the members of such committees need to report? What does this type of reporting accomplish other than to increase legal bills?

(d)   The End of the GTOs?  If FinCEN will be obtaining ownership information through the Act, it seems unnecessary to continue to impose reporting requirements on title insurance companies and their agents through Geographical Targeting Orders adopted by FinCEN several years ago.. This is not addressed in the Act but we assume will be addressed in the regulations.

There seems to be no limitation to the lookback period for reporting. Therefore all companies formed many years ago that are still active will be required to report. This will represent a challenge especially for those parent companies with a substantial number of separate single asset companies. Substantial penalties are imposed for noncompliance, $500 per day for a violation up to $10,000  and two years of imprisonment, so  monitoring of the adoption of the regulations and accumulating the necessary reporting information will be essential for those companies required to report and for the people responsible for such reporting.

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