Corporate Transparency Act: Is It More Bark than Bite?

The Corporate Transparency Act has lofty goals to reduce money laundering and the use of shell companies in the United States, but will the Act’s exceptions minimize its effectiveness?

Reporting Requirements and Exceptions

In December 2020, the United States Congress passed the National Defense Authorization Act (NDAA), which includes the Corporate Transparency Act (CTA). The CTA requires companies to file a report with the Financial Crimes Enforcement Network (FinCEN) that discloses the beneficial owners of the company in order to minimize the use of shell companies in the US. However, the extensive reporting exceptions, without regulations yet promulgated, raise questions about the efficacy of the CTA in combating money laundering and whether the CTA is principally a way to shift due diligence burdens from banks and financial services companies to regulators and the businesses themselves.

The CTA requires any corporation, limited liability company, or similar entity to provide details for any individual who owns or controls at least 25 percent of a company. The Act requires new companies to file the information upon formation and existing companies to file within two years of the CTA’s effective date. Companies will have one year to file updated information with FinCEN after a change in beneficial ownership.

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The Act also establishes reporting exclusions for various regulated company types, including banks, publicly traded entities, insurance companies, and investment advisers. While these exceptions seem reasonable, one may question the additional exemption from reporting for companies that:

• employ more than twenty people;
• filed a tax return reporting gross receipts in excess of $5 million, including receipts/sales from:
  • other entities owned by the entity, and
  • other entities through which the entity operates; and
• have a physical presence in the United States.

Practical Implications

The additional exemption may allow for many instances of money laundering to go undetected. Consider the implications of the exemption and the possible loopholes it could create through the following examples of companies that likely would be excluded from reporting:

• A full-service car wash operating at a busy intersection in a large US metropolitan city. The car wash has over twenty full-time employees who wash, dry, and detail vehicles over multiple shifts. The line down the block suggests it would have annual receipts of over $5 million. However, the “cash-only” sign at the entrance raises questions about whether the proceeds come only from the legitimate business or if there is “dirty” money mixed in with the receipts.
• A chain of domestic gas stations is beneficially owned by ABC parent company, which is run behind the scenes by a criminal organization. Each gas station has its own operating location, has filed tax returns that in aggregate total more than $5 million in the past year, and employs several full-time attendants. ABC parent company also has a staff of over twenty employees to handle the accounting, logistics, and staffing needs for the chain. Without requiring disclosure for this business, the CTA would not appear to make it easier to determine that a criminal organization actually runs ABC parent company, using it as a laundry for its non-legal proceeds.

Foreign Ownership

In addition to the exemptions outlined above, it remains unclear how CTA reporting requirements will apply to US entities with foreign ownership interests. The Act does not seem to consider those companies that have a foreign corporate owner who retains more than 25 percent beneficial ownership. The example below outlines a corporate ownership structure that will likely remain opaque, even after the CTA’s implementation:

• An office furniture business incorporated in Delaware has a small operation that ships products throughout the United States. The company employs fifteen people: two office staff, five salespeople, three warehouse employees, and five short-haul truck drivers. The company contracts out long-haul deliveries. The ownership is divided between a US citizen and an entity organized in Russia. Although the US citizen’s information will be disclosed under the CTA, details of the Russian entity will remain unknown, making it impossible to determine if the Russian entity has ties to an individual on the Office of Foreign Assets Control’s Specially Designated Nationals and Blocked Persons List.

Many Questions, Few Answers

The examples above suggest that the loopholes in the CTA will continue to allow illicit transactions to flow through US financial institutions. How many other loopholes will bad actors identify in the Act? Will the Act really expose nefarious foreign beneficial ownership interests from opaque jurisdictions such as the Caymans, Panama, and Switzerland? Or will we rely on more traditional enforcement mechanisms, such as cooperating witnesses, individual subpoenas, or even hacks and leaks a la The Panama Papers?

Notably, the Secretary of the Treasury has been given discretion to add additional exclusions for “classes of entities” that should be exempt because requiring beneficial ownership information would not serve the public interest and would not be “highly useful” in combating money laundering, terrorism financing, proliferation finance, serious tax fraud, and other crimes.

Thus, the question remains: Will the additional exclusions create more loopholes? Or will the Treasury’s forthcoming regulations provide more clarity and transparency?

Enforcement

The CTA provides for civil penalties of $500 per day that the violation continues and criminal fines up to $10,000 and/or imprisonment for up to two years. For newly formed entities, violations for lack of reporting will be fairly clear. However, it is unclear how violations of the law will come to light for existing entities.

• How will the whistleblower provisions in the NDAA apply to the CTA?
• How will FinCEN determine that beneficial ownership changes have occurred in existing entities?
• Further, without public access to the information held by FinCEN, what mechanisms will be in place to confirm that companies report accurate beneficial ownership information?
• What forms of data analytics will the government employ to draw meaning or conclusions from a presumably new, large data set, including whether or how that data connects to other information in the government’s possession?

The CTA is being lauded as one of the largest overhauls of anti-money laundering policy in the United States in the last twenty years. While it appears to represent a step in the right direction, only time will tell how effective it will be.