Does the Corporate Transparency Act Pierce the Corporate Veil? Or is it Pointless?

Carl Kemmerer, Senior Product Manager, X-Sight Entity Risk, NICE Actimize
Does the Corporate Transparency Act Pierce the Corporate Veil? Or is it Pointless?

What comes to mind when you hear “innovation” mentioned? People tend to think of technological innovations involving digitalization, software, hardware, APIs, artificial intelligence, and machine learning. However, innovation existed long before the advent of the software industry.

People obsessed with creating wealth have been innovating using less exciting, but systematically more effective legal mechanisms, primarily, through the use of corporate law and corporate legal instruments.

Legal Innovation in Corporate Structures

Two examples of legal innovation occurred in the early years of the United States before the industrial age:

  1. Unlike today, corporations were initially granted charters by states to exist for a specific limited business purpose and for a limited number of years. Initially, only people were legally allowed to own shares of a corporation. Corporate ownership of other corporates was not permissible. During the U.S. crusade towards a capitalistic society, states realized less regulation was the easy and best path toward economic prosperity.
  2. Today, corporations are established for “any lawful purpose” in perpetuity. You are likely to find one or more holding companies from multiple jurisdictions in a corporate ownership structure.

Over time, unlawful actors made use of legal innovations to facilitate their illicit activities. To protect its citizens and economy against illicit activities, the U.S. introduced regulations to lessen the unlawfulness of corporate legal arbitrage opportunities.

U.S. UBO Legislation – A Timeline

  • 2001—the U.S. introduced the Patriot Act. Sections 313 and 319 (b) require U.S. banks to identify beneficial ownership of non-U.S. banks, among other reporting requirements.
  • 2008—the Foreign Account Tax Compliance Act (FATCA) introduced beneficial ownership reporting requirements on U.S. Persons as well as non-U.S. Persons effectively connected to income generated in the U.S.
  • 2008—the U.S. IRS created a unique identifier, the Global Intermediary Identification Number (G.I.I.N.), as an ideal way to identify legal entities for tax reporting purposes. Similarly, both Dodd-Frank, EMIR and MiFID regulations used innovation to streamline corporate reporting requirements for derivative products by introducing the Legal Entity Identification (“LEI”).
  • 2018—FinCEN formally introduced regulatory requirements for covered financial institutions to identify corporate Ultimate Beneficial Ownership or Beneficial Ownership Information (“BOI”) (31 CFR Parts 1010, 1020, 1023, 1024 and 1026) to further strengthen AML controls.

The Corporate Transparency Act – The Latest U.S. UBO Legislation

The U.S. National Defense Authorization Act for Fiscal Year 2021 contains the Anti-Money Laundering Act of 2020, which includes a section called the Corporate Transparency Act (CTA). Acting FinCEN Director Himamauli Das stated “FinCEN is taking aggressive aim at those who would exploit anonymous shell corporations, front companies, and other loopholes to launder the proceeds of crimes, such as corruption, drug and arms trafficking, or terrorist financing.”1 From a bank compliance perspective, this is a significant innovation. It will alleviate FinCEN’s reliance on banks to collect Beneficial Ownership information and rather require companies themselves to report beneficial ownership directly to FinCEN instead.

Impactful items to understand about the CTA:

  • Non-exempt corporations, or firms that share characteristics of a shell company, have the legal and regulatory requirement to report beneficial owners but also the company applicant. The company applicant is the person who files the documentation forming the entity. 
  • Companies must report identifying information on the beneficial owner and applicant to FinCEN including:
    • Full legal name
    • Date of birth
    • Current residential or business street address; and
    • A unique identifying number from an acceptable identification document or a FinCEN identifier 
  • Companies must report identifying information about their company including:
    • Name and any alternative names (DBAs)
    • Business street address
    • Jurisdiction of formation or registration; and
    • A unique identification number such as TIN, EIN, LEI or DUNS 
  • The CTA prohibits the unauthorized disclosure of beneficial ownership information collected by FinCEN. Upon receipt of a request, FinCEN may disclose beneficial ownership information through appropriate protocols, from a:
    • Federal agency engaged in national security, intelligence, or law enforcement activity
    • Non-federal law enforcement agency with specified court authorization
    • Federal agency on behalf of certain foreign requestors under specified conditions
    • Financial institution subject to CDD requirements, with the consent of the reporting company, to facilitate compliance with CDD requirements under applicable law

Under certain circumstances, FinCEN will disclose beneficial ownership information to a federal functional regulator or other appropriate regulatory agency. An example is when the CTA authorizes officers and employees of the Department of the Treasury to access information that’s consistent with their official duties. But releasing it is subject to procedures and safeguards prescribed by the Secretary.

The regulatory innovation to make non-exempt corporations report their beneficial owners or controllers is a massive shift in legal liability away from banks toward corporations, state business registries, and the registration agents who have capitalized on legal loopholes without any accountability of the costs of the illicit activity they facilitated. The FinCEN ID has the potential to become one of the most valuable IDs in the financial sector, even more so than the G.I.I.N identifier and LEI, as it will be the first regulatory unique digital ID for a person and associated with a unique business ID.

While linking UBOs to the legal entities they control solves one problem, the CTA has created another problem that the U.S. needs to resolve with input from the financial community. The CTA ruling expressly states that the previous 2018 CDD rule needs to be updated to answer the following questions:  

  • How will FinCEN securely authorize access to the UBO registry for relevant bank personnel so they can satisfy CDD requirements and link UBOs to specific bank accounts?
  • More importantly, how will the industry maintain timely, accurate, and up-to-date UBO relationships?

New York State’s LLC Transparency Act

The State of New York recently introduced and passed its own UBO requirements, similar to CTA, that could impact the global economy and KYC guidelines moving forward. The LLC Transparency Act, introduced in Senate Bill S8439B, is with the Rules Committee of the New York State Senate, having passed in both the Assembly and Senate. It’s principally focused on shell companies using LLC company formations to purchase real estate assets. Many constituents in affordable housing live in unacceptable conditions, and building owners hide behind LLC companies to avoid accountability.

Impactful items to understand about the CTA:

  • the UBO database will be partially publicly available 
  • Limited Liability Companies that are formed, operating, or transacting in New York are required to report their UBOs. 
  • The definition includes the following specific language “If indirect beneficial ownership is exercised through a trust or similar arrangement which holds or controls, directly or indirectly, twenty-five percent or more of the equity in the limited liability company or exercises substantial control over such company, the limited liability company shall identify as a beneficial owner each natural person serving as: (A) a trustee of the trust, a trust protector, or any other individual with authority, directly or indirectly, to dispose of trust income, assets, or principal; (B) a trust beneficiary with the right, directly or indirectly, to receive, demand, or withdraw any trust income, assets, or principal; and (C) a grantor or settlor with the right, directly or indirectly, to revoke the trust or to receive, demand, or withdraw trust income, assets or principal.”

The same identifiers collected for the CTA are also required for the LLC Transparency act. LLC companies can submit a copy of the Beneficial Ownership information such as company submitted to the federal government pursuant to CTA.

Conclusions

While both beneficial ownership laws are an important step forward toward greater transparency and accountability as measured by FATF, their adoption creates new problems. In a positive step, companies will be reporting their beneficial ownership and banks will no longer carry the primary responsibility. While this will give financial investigators immediate access to beneficial ownership information, financial investigators will have to perform a secondary search to determine the location of each company’s bank accounts. The impact on the newly introduced 2018 CDD rule remains unclear after banks and vendors invested heavily to implement procedures, processes, and digital platforms to satisfy those new requirements.

The biggest gap that the regulation failed to address concerns the enablers that facilitate illicit activities outside of heavily regulated financial institutions. However, the U.S. H.R. 5525 ENABLERS Act, an acronym for “Establishing New Authorities for Businesses Laundering and Enabling Risks to Security” Act, was introduced in October 2021. The liability and cost of fighting financial crime across the world has mostly been placed on financial institutions during the 21st century. FATF and legislators recognize without holding others accountable, the sharpness of financial institution AML programs is dulled. Look for our upcoming blog covering the ENABLERS Act to learn more about the impact it will have on those outside the financial industry.

1 FinCEN Issues Proposed Rule for Beneficial Ownership Reporting to Counter Illicit Finance and Increase Transparency | FinCEN.gov

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