Shining a Spotlight: US Legislation to Require Disclosure of US Companies' Beneficial Ownership

Last fall, before anyone had even heard of terms like "COVID-19" or "social distancing," Congress was busy working away on wide-sweeping legislation that will have a significant impact on many companies. The House version of the legislation, entitled the "Corporate Transparency Act of 2019," would require many US corporations and limited liability companies (LLCs) to disclose for the first time the identities of their beneficial owners.¹ The Act, which was passed with bipartisan support on October 22, 2019, would require corporations and LLCs to disclose their beneficial owners to the Department of the Treasury. Treasury, in turn, could share information about a company's beneficial owners with law enforcement and financial institutions in certain circumstances. The legislation marks the latest step in a growing effort in the US and abroad to unmask beneficial owners and crack down on the use of "shell companies" for various illicit purposes such as money laundering, trade sanctions evasion, terrorism financing, financial fraud, or other misconduct. The Senate has introduced its own version of the bill, which includes key differences from the House version.²

Assuming some version of the legislation ultimately becomes the law of the land—which seems likely eventually—companies will need to pay close attention. The legislation would impose new reporting obligations, and of course the government would have a much greater ability to pull back the curtain to see who actually owns a particular company. Law enforcement no doubt will jump at having a powerful new tool to help investigate and prosecute all sorts of crimes, ranging from money laundering, to fraud, to violations of US trade sanctions. Companies of all stripes, therefore, would be wise to learn from already regulated sectors (such as the banking world) and invest now in robust Anti-Money Laundering (AML) and Know Your Client (KYC) policies and procedures and sanctions compliance programs to try to limit their exposure to the steep costs of a government investigation and any penalties.

The Corporate Transparency Act of 2019

As noted, the Corporate Transparency Act passed in the House with bipartisan backing, and the White House issued a Statement of Administration Policy expressing support for the legislation.³ If enacted, the bill would require anyone seeking to form a new corporation or LLC in the United States to disclose the beneficial owners of the company to the Treasury Department's Financial Crimes Enforcement Network (FinCEN),⁴ and then to update annually that information. Specifically, the bill would require new companies to disclose each beneficial owner's (1) full legal name; (2) date of birth; (3) current residential or business address; and (4) unique identifying number from a non-expired US passport, a personal identification card issued by a state, Indian Tribe, or local government, or a state driver's license.⁵ The bill also would impose the same reporting requirements on existing corporations and LLCs two years after FinCEN adopts final regulations to implement the legislation.

Subject to certain exceptions, the legislation defines a beneficial owner to be any natural person who directly or indirectly:

• exercises "substantial control" over a corporation or LLC;⁶
• owns 25% or more of the equity of a corporation or LLC; or
• receives "substantial economic benefits" from a corporation or LLC.⁷

The Corporate Transparency Act's reporting requirements would apply mainly to small companies and LLCs, because the legislation exempts from its reporting requirements a variety of regulated, publicly traded, government, and non-profit entities,⁸ as well as any company that (1) employs more than 20 full-time employees in the United States, (2) files US income tax returns reflecting more than $5 million in gross receipts, and (3) has an operating presence at a physical office within the United States.⁹ Companies that are exempt from the disclosure requirements, however, still would be required to submit a written certification to FinCEN that identifies the exemption applicable to the company and provides information to identify the agent making the certification.

FinCEN would be authorized under the legislation to disclose beneficial ownership information, upon request, to (1) domestic law enforcement, (2) a federal agency requesting such information on behalf of a non-US law enforcement agency, or (3) a financial institution (with the customer's consent) for purposes of complying with customer due diligence requirements imposed by law. The beneficial ownership information would not be publicly available, and the bill includes certain privacy provisions to protect the information from unauthorized dissemination.

The House legislation also would impose civil and criminal penalties on persons who knowingly provide FinCEN with false beneficial ownership information or willfully fail to provide complete or updated information. Violators may be subject to a civil penalty of up to $10,000 and may face imprisonment for up to three years. The bill specifies that persons who negligently fail to provide complete or updated beneficial ownership information to FinCEN will not be subject to civil or criminal penalties.

The Senate's TITLE Act

The Senate introduced a similar bill in June 2019, but it includes certain key differences. Senate Bill 1889, the "True Incorporation Transparency for Law Enforcement (TITLE) Act," would mandate that, within three years of the bill's enactment, each state, not FinCEN, adopt an "incorporation system" that requires newly formed corporations and LLCs to report information identifying their beneficial owners to their state of incorporation (or to certify that the company is exempt from the reporting requirements under the bill).¹⁰ Companies also would be required to report any changes in beneficial ownership within 60 days, along with an annual filing requirement.

Under the Senate bill, existing companies within each state would have two years after implementation to comply with the disclosure requirements or to report that they are exempt. The Senate legislation would subject violators to a civil penalty up to $1 million and a criminal penalty of up to three years imprisonment.

The TITLE Act defines a "beneficial owner" as any natural person who, directly or indirectly, (1) "exercises substantial control over a corporation or limited liability company through ownership interests, voting rights, agreement, or otherwise" or (2) "has a substantial interest in or receives substantial economic benefits from the assets of a corporation or the assets of a limited liability company." Unlike the House version, the Senate bill does not draw a bright-line that automatically deems anyone who owns 25 percent of the company's equity to be a beneficial owner.

The TITLE Act would require states to provide the beneficial ownership data to additional entities beyond law enforcement agencies and financial institutions. Upon written request, states would be required to provide the beneficial ownership information within 30 days to (1) a local, state, or federal agency, (2) a congressional committee or subcommittee, (3) a federal agency requesting such information on behalf of another country, (4) FinCEN, or (5) a financial institution (with the customer's consent) for purposes of complying with customer due diligence legal requirements.

Comparison to Existing Disclosure Requirements

Many US companies already are required to disclose beneficial ownership information. For example, the United States currently imposes certain beneficial ownership disclosure requirements on publicly traded companies under Sections 13(d) and 13(g) of the Securities Exchange Act.¹¹ These requirements have grown increasingly more stringent in recent years. In July 2016, for example, FinCEN implemented the Customer Due Diligence Rule (CDD Rule), which amended the Bank Secrecy Act regulations to clarify and strengthen customer due diligence requirements for US banks, mutual funds, brokers or dealers in securities, futures commission merchants, and introducing brokers in commodities.¹² The CDD Rule requires these covered financial institutions to identify and verify the identity of any natural person who owns 25 percent or more of or has "significant responsibility to control, manage, or direct" a company when that company opens an account. It also requires these financial institutions to develop customer risk profiles for the purposes of ongoing monitoring and suspicious transaction reporting.¹³

FinCEN also has the authority to issue "Geographic Targeting Orders" (GTOs), which impose additional recordkeeping and reporting requirements on domestic financial institutions and non-financial businesses in a particular geographic area for up to 180 days to assist regulators and law enforcement agencies in identifying criminal activity. ¹⁴ On May 15, 2019, FinCEN issued GTOs for Boston, Chicago, Dallas Fort Worth, Honolulu, Las Vegas, Los Angeles, Miami, New York City, San Antonio, San Diego, San Francisco, and Seattle. In these metropolitan areas, title insurance companies are required to collect and report to FinCEN information identifying the beneficial owners of legal entities that are used in all-cash purchases of residential real estate worth $300,000 or more. FinCEN has stated that "GTOs continue to provide valuable data" and that their reissuance "will further assist in tracking illicit funds and other criminal or illicit activity, as well as inform FinCEN's future regulatory efforts in this sector."¹⁵

International Beneficial Ownership Transparency Efforts

The trend toward enhanced beneficial ownership disclosure requirements is not limited to the United States. The European Union (EU) has been particularly active in requiring beneficial ownership transparency to support anti-money laundering efforts. In May 2018, the EU adopted the Fifth Anti-Money Laundering Directive, which requires Member States to maintain national registers of beneficial ownership information for certain legal entities.¹⁶ In contrast to the US legislation discussed above, the EU directive provides for public registers disclosing such information. Most European countries have taken steps to set up these registers.¹⁷

Various international bodies also are pushing for enhanced disclosure requirements. In fact, the existing US disclosure regime has come under some criticism as being insufficient. In particular, the international Financial Action Task Force (FATF), of which the United States is a member, has recommended that the United States tighten its anti-money laundering and countering the financing of terrorism (AML/CFT) regime by enhancing its beneficial ownership disclosure requirements. In 2016, FATF issued a report finding that the "lack of timely access to . . . beneficial ownership information remains one of the most fundamental gaps" in US efforts to combat money laundering and terrorist finance.¹⁸

Potential Impact of the US Legislation

If enacted, the US legislation would have a major impact on many US companies' obligations to report their beneficial ownership information and on law enforcement's ability to detect, prevent, and punish money laundering, trade sanctions evasion, financial fraud, and other misconduct involving US corporations and LLCs. The number of US entities that would be impacted by the disclosure requirements would be significant. The Congressional Budget Office (CBO) estimates that there would be as many as 30 million new beneficial ownership filings each year under the Corporate Transparency Act.¹⁹ The CBO did not specify the likely total cost to US businesses to comply with the disclosure requirements, but estimated that it would be "substantial."²⁰ Further, the new reporting requirements would apply primarily to small businesses, because the legislation exempts currently regulated entities (which already have certain reporting obligations) and medium to large companies (which law enforcement can more easily investigate if seeking certain ownership information). While the White House has expressed support for the legislation, it emphasized in its Statement of Administration Policy that improvements to the legislation were needed to "protect[] small businesses from unduly burdensome disclosure requirements."²¹ The Statement, however, states that the Administration looks forward to continuing to engage in a bipartisan fashion with the House and Senate to address the legislation's important objectives of increasing corporate transparency and supporting law enforcement.

Another likely effect of the legislation would be a decrease in the prevalence of US-incorporated shell companies and the practice of using such companies to conduct all-cash transactions, such as real estate purchases. Indeed, studies have determined that, after FinCEN issued GTOs in 2019 requiring the reporting of beneficial ownership information for companies used in all-cash purchases of residential real estate in large cities across the country, all-cash real estate purchases by corporate entities fell by approximately 70 percent nationwide.²²

The enhanced disclosure requirements also could reduce significantly the ability of malign actors to exploit US-incorporated entities for criminal gain. It would increase government authorities' and financial institutions' ability to access such beneficial ownership information to combat money laundering, trade sanctions evasion, and other crimes. Beneficial ownership information would be particularly valuable in the context of trade sanctions administered by the US Department of the Treasury's Office of Foreign Assets Control (OFAC). Under OFAC's sanctions regimes, entities that are owned 50 percent or more by one or more sanctioned persons also are subject to US sanctions, and businesses under US jurisdiction that transact with such sanctioned entities face the possibility of strict liability civil fines as well as criminal penalties. Compliance with OFAC's "50 Percent Rule" requires financial institutions and companies to understand an entity's ownership structure, including its beneficial owners, to avoid violating US sanctions laws. This legislation facilitates financial institutions' and law enforcement's efforts to identify beneficial owners and prevent and punish wrongdoers that try to act behind the veil of a US corporation or LLC.

Law enforcement's expanded access to corporate beneficial ownership data also would increase the importance of companies maintaining comprehensive AML/KYC and trade sanctions policies and procedures to ensure that they are compliant with their legal obligations and to reduce the possibility of transacting with bad counterparties. The government's enhanced access to such information likely would result in a significant increase in money laundering investigations. Further, if increased transparency becomes the norm, then the government may have less tolerance for non-transparent companies and companies that interact with and facilitate the business of a non-transparent entity. Companies of all types, therefore, should enhance their customer due diligence procedures to know with whom they are transacting so that they do not end up unwittingly facilitating money laundering and being caught up in a government investigation.

In addition, there are several practical takeaways regarding this legislation that companies should start considering now: (1) evaluating whether the legislation would apply to them or whether they would meet one of the exemptions (including consulting with counsel to assess whether they have a good argument to be exempted if it is unclear); (2) educating the beneficial owners of the company about the likely new requirements so as to manage their expectations; and (3) gathering the information for disclosure. LLCs are often formed quickly, for example, in connection with a new business opportunity, and the beneficial ownership information would need to be readily accessible. There are always practical hurdles to implementing new legal requirements, and companies should ensure that they are well positioned to effectuate any new requirements.

Conclusion

Although we do not know yet whether the pending legislation will be enacted into law, the legislation's provisions have garnered support from lawmakers on both sides of the aisle and from the White House. The legislation also reflects a growing domestic and international effort to increase transparency of companies' beneficial ownership information. While companies would not have access to the US beneficial ownership data under the currently drafted legislation, government authorities and financial institutions in certain circumstances would have access to that information and could use it effectively in civil and criminal enforcement of money laundering, trade sanctions evasion, financial fraud, and other laws. Companies should ensure that they develop and maintain robust compliance programs to limit their exposure to the steep costs of government investigations or penalties in connection with such enforcement actions.

© Arnold & Porter Kaye Scholer LLP 2020 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.