Nowhere to Hide: The Corporate Transparency Act Seeks to Unmask the Beneficial Owners of Shell Companies

Jack McBreen

Senior Editor

Loyola University Chicago School of Law, JD 2023

In January of 2021, Congress adopted substantial changes to the nation’s anti-money-laundering laws, including enacting a new federal statute, the Corporate Transparency Act (CTA or Act), that will establish a centralized database of corporate beneficial ownership. The CTA mandates that by 2025 (or, in some cases, by 2024) all domestic and foreign companies doing business in the U.S. must provide information about the true beneficiaries of their operations by complying with new reporting requirements. The legislation is designed to capture information on an estimated 32 million companies that operate in unregulated areas or are too small to trigger disclosure obligations under other federal laws yet can be used by criminals, terrorists, and other bad actors to hide money laundering and other illicit financial activities. The Treasury Department’s Financial Crimes Enforcement Network bureau (FinCEN) explained the need for a beneficial ownership database, stating, “Illicit actors frequently use corporate structures such as shell and front companies to obfuscate their identities and launder their ill-gotten gains through the U.S. financial system. Not only do such acts undermine U.S. national security, but they also threaten U.S. economic prosperity: shell and front companies can shield beneficial owners’ identities and allow criminals to illegally access and transact in the U.S. economy, while creating an uneven playing field for small U.S. businesses engaged in legitimate activity.” FinCEN issued its final rule on the CTA’s reporting requirements on September 29, 2022. Although the regulations resolve many of the issues that arose after the Act’s passage, a number of compliance challenges and questions still remain.

Which companies are obligated to report?

Under the final rule, “reporting companies” are defined broadly as all domestic and foreign corporations, limited liability companies, and other entities created or registered to do business by the filing of a document with a secretary of state or any similar office under the laws of a U.S. state or Indian tribe. Although the Act casts a wide net, it also establishes some 23 categories of exemptions, ostensibly to exclude entities already obligated to disclose their beneficial ownership under existing federal laws. Some of the major exemptions include issuers of securities registered with the Securities and Exchange Commission, financial institutions (including domestic banks and bank holding companies), investment companies and advisors, insurance companies, public accounting firms registered pursuant to the Sarbanes-Oxley Act of 2002, certain tax-exempt entities, and “large operating companies” with a U.S. presence. A large operating company is defined as one that employs more than 20 full-time employees in the U.S., maintains a physical operating presence in the U.S. and filed a federal income tax return for the previous year showing more than $5 million in revenue.

The final rule also clarifies that no filing obligation is imposed upon exempt entities, including any obligation to affirmatively claim an exemption. However, should an exempt entity cease to qualify for an exemption, it must file the requisite information within 30 calendar days thereafter.

What information must be reported?

Reporting companies are required to furnish information on: (1) the reporting company itself; (2) each “beneficial owner” of the reporting company; and (3) the “company applicant(s).”

  • A reporting company must provide its full legal name, any trade or d/b/a names under which it does business, its business street address, its jurisdiction of formation or registration, and its IRS taxpayer identification number or equivalent foreign tax identification number.
  • With respect to each beneficial owner and company applicant, a reporting company must disclose the individual’s full legal name, date of birth, current business or residential street address, and a unique identifying number from an acceptable identification document, such as a valid U.S. passport or driver’s license. A scanned copy of the identification document must also be provided.
  • An individual may apply for a FinCEN identifier – a unique identifying number assigned by FinCEN – which can be used in lieu of providing beneficial ownership information to a reporting company. To obtain a FinCEN identifier, an individual must submit an application to FinCEN and furnish the same information required by the Act.

The final rule defines a “beneficial owner” as any individual who, directly or indirectly, either exercises “substantial control” over the reporting company or owns or controls at least 25% of its “ownership interests.” An individual has substantial control if he or she: (1) serves as a senior officer of the company; (2) has authority to appoint or remove any senior officer or a majority of the board of directors; (3) directs, determines, or has substantial influence over important company decisions (for example, dissolution or merger, major expenditures or investments, equity issuances); or (4) has any other form of substantial control (a catch-all provision). The term “ownership interest” is also defined expansively and covers virtually all instruments, contracts, arrangements, and other mechanisms used to establish ownership, including capital or profit interests, convertible instruments, and puts, calls or other similar options.

A “company applicant” is the individual primarily responsible for filing the document that forms the reporting company and, in the case of a foreign company, the individual primarily responsible for filing the document that first registers the reporting company to do business in the U.S.

Deadlines and penalties for violations

Any reporting company created or registered before January 1, 2024 must file a report no later than January 1, 2025. Reporting companies created or registered after January 1, 2024 must file a report within 30 calendar days of their creation or registration. If there is any change with respect to the reported information or if an entity no longer meets the criteria for any exemption, a corrected or updated report must be filed within 30 calendar days. Failure to comply with the reporting rules can result in civil penalties of up to $500 per day or criminal penalties of up to $10,000 in fines and imprisonment for two years.

Certain issues remain

Although the final rule on the CTA settled many of the basic questions concerning what information must be reported and who must report it, a number of issues remain. For example, FinCEN needs to address in future rulemaking who will have access to the information gathered in the beneficial ownership database, for what purpose the data can be used, and what measures will be put in place to safeguard the sensitive information. FinCEN estimates the infrastructure to support the massive database will cost $82 million in fiscal year 2023 and approximately $35.6 million in annual maintenance costs thereafter. The bureau is already behind in terms of its timeline for launching the database according to Himamauli Das, the acting director of FinCEN, who told a House Committee that his department lacked the necessary staffing and money to implement the legislation. As a result, Congress authorized a one-time infusion of funding to FinCEN in May of 2022 as part of its military aid package in support of Ukraine. The CTA also requires FinCEN to issue regulations amending its customer due diligence rule – which imposes a similar obligation upon financial institutions to collect beneficial ownership information – to bring it into alignment with the new CTA reporting rules.

A challenge from small businesses

In November of last year, the National Small Business Association filed a lawsuit to block implementation of the CTA in a U.S. district court in Alabama. The new legislation has been criticized by various business groups as being too complex and costly for small businesses despite FinCEN’s estimates that an initial ownership report would cost most companies no more than $85 to prepare. The suit, which was filed against the Treasury Department, Treasury Secretary Janet Yellen and Mr. Das, challenges the constitutionality of the law, alleging it infringes on state sovereignty, privacy and due process rights. Plaintiffs argue that, although Congress has been granted the power to regulate commerce, the mere formation of a company is not itself a commercial activity.