The Corporate Transparency Act (CTA) was enacted by Congress to counter money laundering, terrorism, and other illicit activity. The CTA, whose initial regulations take effect on January 1, 2024, comes with a host of reporting requirements for approximately 32 million pre-existing private entities in 2024, and five million new reporting entities each year thereafter. Under the CTA, entities, unless exempted, will be required to report basic information about certain of their beneficial owners. These entities were not generally previously required to report beneficial ownership information to the government.
By understanding who is required to disclose information about those who form and own or control the entity, businesses can prepare for these reporting obligations.
During this fast-paced webinar, attendees will gain an understanding of what is required under the CTA, including:
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New steps for forming entities
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Additional obligations during the life cycle of new and existing entities
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Necessary steps existing entities need to take to comply with the new law
To view a recording of this webinar, click here.
Transcript
Jeremy Garvey:
Good morning. My name is Jeremy Garvey. I am a member of the Corporate Practice Group here at Cozen O’Connor. It is my pleasure to welcome you to Cozen O’Connor’s Corporate COffee Break.
Our topic today is the Corporate Transparency Act (CTA), which was enacted by Congress to counter money laundering, terrorism, and other illicit activities. The CTA, whose initial regulations take effect on January 1, 2024, comes with a host of reporting requirements for approximately 32 million pre-existing entities and a projected five million new reporting entities each year after that. Under the CTA, unless an entity is exempt, it will be required to report basic information and certain beneficial ownership information. These entities, as folks probably know, have previously not had to report this type of information to the government.
Our guests today are my colleagues, both of whom are also members of the Cozen O’Connor Corporate Practice Group. Larry Laubach is co-chair of Cozen O’Connor’s Corporate Practice Group. He focuses his practice on M&A and general corporate and securities matters for both public and private companies in a wide variety of industries. He is also a member of the Title 15 Task Force of the Business Law Section of the Pennsylvania Bar Association, which recommends changes and enhancements to corporation and partnership-related laws in Pennsylvania. Larry earned his B.A. in accounting from Franklin & Marshall, where he was magna cum laude and a member of Phi Beta Kappa. He also earned his law degree at the University of Pennsylvania, magna cum laude, where he was on the Penn Law Review and Order of the Coif.
My other colleague, Greg Patton, represents clients in a variety of industries spanning financial services, health care, sports, beverage, and automotive. He also helps early-stage companies and emerging businesses navigate issues related to business formation, general corporate governance, financing, and venture capital transactions. Greg also advises clients on securities law matters, including Regulation D and state securities law compliance. Greg received his J.D. from The George Washington University Law School and his bachelor’s degree in political science from Dartmouth, where he was a three-year letter winner playing football. While attending GW Law, Greg served as a member and coach of the alternative dispute resolution board and volunteered with United Way’s Volunteer Income Tax Assistance Program that offers preparation assistance to low and moderate-income individuals and families.
Thank you both. We have got a lot to cover. Larry, first to you. Many of us--myself included--have probably heard a lot about the CTA, but we haven’t dug into it yet. Given the pending implementation deadline, I think now is the time to really focus. Can you give us a quick overview and help us understand what the CTA is?
Larry Laubach:
Thanks, Jeremy. The CTA is a statute that was adopted on January 1, 2021, as part of the Anti-Money Laundering Act of 2020. It will eventually be enforced by three different regulations. The first regulation deals with the reporting of beneficial ownership information. The final rule was issued on September 30, 2022, and that’s what we’re going to spend our time talking about today.
There will be a second regulation that will be adopted about the beneficial owner information database and who has access to it. There was a proposed rule in December of 2022, and comments were due by February of 2023, but there’s been no final regulation adopted on that subject yet. And finally, there are going to be revisions to the customer due diligence rules. No regulations have been proposed yet. We’re still waiting.
Jeremy Garvey:
What’s the background, and what’s the genesis and the purpose of the CTA?
Larry Laubach:
Many countries already require companies to report their ownership information to combat money laundering. The CTA is being administered by the Financial Crimes Enforcement Network, also known as FinCEN, which is a part of the U.S. Department of Treasury. FinCEN found that there were many legally created shell companies in the United States that were used for illegal purposes. As an example, recently, there were some Russian oligarchs who were subject to sanctions and were prohibited from making investments in the United States, but they attempted to buy real estate and other assets through special purpose entities in the United States that would evade those sanctions. The CTA will address that kind of activity. The requirement to report beneficial ownership information would be used to create a national database that will provide law enforcement agencies and banks with greater insight as to who and what individuals are behind companies in the United States.
Jeremy Garvey:
To dig a little deeper, whose information must get reported?
Greg Patton:
Reporters generally fall into one of three buckets. There are reporting companies, beneficial owners, and company applicants.
Jeremy Garvey:
Help me on the first one. What are reporting companies?
Greg Patton:
For reporting companies, we’re generally talking about domestic or foreign reporting companies. Domestic reporting companies consist of any entity that’s created by filing a document with the secretary of state, or equivalent office under the law of any state or Indian tribe. We’re talking about corporations, LLCs, limited partnerships, and the like. Foreign reporting companies consist of any entity created under foreign law and registered to do business in the United States.
Jeremy Garvey:
There are a host of exceptions for reporting companies. Could you speak to that a little bit? I think that it’s a bit confusing.
Greg Patton:
You’re exactly right, there are 23 exemptions under the regulations, and most of these exemptions are for entities that are otherwise governed or regulated by federal regulation or provide beneficial ownership information to a governmental authority. We are talking about exemptions for securities reporting issuers, as well as public accounting firms, public utilities, banks, credit unions, and similar entities.
Jeremy Garvey:
There are a couple of notable exemptions, such as large operating companies, controlled and wholly-owned entities, which are a little confusing, and then inactive entities. Can you drill down on those for a bit?
Greg Patton:
I’ll start with large operating companies. This is any company that employs more than 20 full-time U.S. employees, has an operating presence at a physical location within the United States, and has over five million dollars in gross U.S. receipts in the prior year, as shown on the prior year’s tax return.
Next, I’ll move on to subsidiaries of certain exempt entities. This is any entity whose ownership interests are controlled or wholly owned—directly or indirectly—by one or more exempt entities. However, there are exceptions to the controlled or wholly owned exemption. Subsidiaries of the following exempt entities are not exempt: money services businesses, pooled investment vehicles, entities assisting tax-exempt entities, and inactive entities. And I’ll point out that this exemption does not apply to parents of exempt companies.
Inactive entities are another large category of exemptions. Here we are talking about any entity that existed on or before January 1, 2020, that is not currently engaged in active business, is not wholly or partially owned by a foreign person directly or indirectly, has not had a change of ownership in the prior 12 months, has not sent or received funds greater than $1,000 in the prior 12 months, and does not hold any asset of any kind, including ownership of another entity.
Just to recap, we’re talking about inactive entities, subsidiaries of certain exempt entities, and large operating companies. Those are the three more prominent of the exemptions.
Jeremy Garvey:
Switching to the second bucket. This is probably the one that I think is getting people most excited—beneficial ownership and beneficial owners. Who are those folks?
Larry Laubach:
I think this is the information that’s really going to be very sensitive to certain people. We’ve never had to disclose this kind of information before to the government. A beneficial owner is any individual--and note it’s an individual, not an entity--who directly or indirectly either exercises substantial control over the reporting company or owns or controls at least 25% of the ownership interest of the reporting company. Let’s drill down a bit on those two tests.
First is the substantial control test. An individual exerts substantial control if that person serves as a senior officer of the reporting company. A senior officer is defined to include the president, the chief executive officer, the chief financial officer, the chief operating officer, and the general counsel. A second category of individual who exercises substantial control is any individual who has the authority to appoint or remove senior officers.
A third category of substantial control, which is very broad, is any individual who either determines, directs, or merely has substantial influence over certain important decisions involving the reporting company. Examples of those important decisions are set forth in the regulation. They include things such as the scope of the business, selling, mortgaging, or leasing assets of the business, dissolutions, mergers, approving major expenditures, and entering into significant contracts. This category is very broad. It applies to an individual who merely has substantial influence over those decisions. As a result, any member of the board of directors or board of managers of a reporting company would be a beneficial owner and would have to report.
Let’s switch now to at least 25% direct or indirect ownership. Ownership is very broadly defined in the regulations. It includes warrants, options, and convertible securities. The test assumes that those securities have been converted into ownership interests, whether or not they’re immediately exercisable or convertible, and whether or not there’s some condition to exercise. They’re all assumed to be outstanding. You also obtain ownership for the purpose of the 25% test if you’re a joint owner or if you have some other person act as your agent or custodian or intermediary, you’re deemed to own those interests. It’s particularly tricky with respect to trusts that are 25% owners of a reporting company. This has caused a lot of concern from an estate planning point of view. If the trust is a 25% owner, you may need to report information about the trustee and perhaps the beneficiary. Maybe even the grantor, depending on the terms of the trust and what the trust instrument provides. Again, we’re talking at a very high level in this presentation, and you’d really need to drill down for specific facts because there are a lot of details in the regulations.
In addition, in order to compute the 25%, there are rather complicated rules for determining the percentage ownership, especially when you have different types of ownership arrangements. For example, if you have a waterfall provision where the interest in and entitlement to assets varies depending on certain facts, there are complicated rules to determine ownership. The bottom line is there’s no limit on the number of beneficial owners that a reporting company may have to report.
Jeremy Garvey:
Like reporting companies, there are also some exceptions. Probably not as interesting, but can you give a quick view of some of the exceptions to beneficial owner?
Larry Laubach:
Sure. A minor child who’s a beneficial owner doesn’t need to report his or her information as long as the minor child’s parent or legal guardian reports that information. As noted earlier, if an individual is acting as a nominee or an agent or a custodian for some other individual, the nominee, agent, or custodian doesn’t need to report. However, the other individual does.
If you’re an employee of a reporting company and acting solely as an employee, and your substantial control or economic benefits are derived solely from the employment status, then you’d be exempt as a beneficial owner, so long as you’re not a senior officer. If you’re a senior officer, it doesn’t matter if it arises from employment, you still have to report. If you’re an individual whose only interest in a reporting company is a future interest that you would obtain through a right of inheritance, you do not need to report as a beneficial owner until that inheritance effectuates itself and you become the owner of the interest.
You may have heard the references to substantial control. You may ask, “Well, it sounds like a lot of banks and other lenders may have that kind of control over reporting companies, do they have to report?” There is a specific exemption for a bona fide creditor so that a bank in a normal loan arrangement wouldn’t have to report as a beneficial owner.
Jeremy Garvey:
The third bucket, this concept of company applicants, I think it’s fairly finite and somewhat unique. Can you help with what the CTA is getting at there?
Larry Laubach:
Company applicant reporting only applies to entities that are formed after the effective date of the regulation. A company applicant is, at least, the individual who actually files the document with the state, and forms the entity, that person is a company applicant. If there’s another individual who is primarily responsible for directing or controlling the individual who files the document, that person is a company applicant as well. For example, in a law firm that formed an entity for a client, if a lawyer directs a paralegal to file the formation documents, both the lawyer and the paralegal will be company applicants, and their information will need to be reported to FinCEN. Please note that a reporting company can have only one or two company applicants.
Jeremy Garvey:
Maybe you can talk a little about an initial report or what reports would look like.
Greg Patton:
A reporting company must file an initial report with FinCEN. That report generally contains a certification that the report itself is true, accurate, and complete. It will also contain some information about the reporting company itself and information about the beneficial owners and company applicants.
With respect to the reporting company, we’re talking about information like the full legal name of the entity, any d/b/a or trade name, the EIN, the country or jurisdiction of formation, and the U.S. street address of the primary location where business is conducted. A lot of the same information is required for beneficial owners as well. But one or two distinctions that I’ll note: instead of an EIN, they’ll have to include an ID number that’s included on either a driver’s license, a passport, or a similar form of identification. In addition to the ID number, you will need to supply an image of the documented ID, such as a passport or a driver’s license. For company applicants, again, a lot of the same information. Full legal name, date of birth, address, ID number, and photo documentation. With respect to these reports, there is an updating requirement. Anytime there’s a change in this information, a report has to be updated or corrected within 30 days of that change. It does place an obligation on the reporting company to monitor those changes and to update accordingly.
Jeremy Garvey:
And probably most importantly, can you quickly hit on the timeframes? As my anxiety rises, when does this all kick in?
Greg Patton:
Absolutely. The effective date is January 1, 2024. Companies created prior to January 1, 2024, have a year to file their initial report. And company applicant information is not required for companies formed prior to this date. Companies created on or after January 1, 2024, have 30 days to file their initial report. It may be worthwhile to think about the effective date when you are forming an entity in early 2024. Just a little food for thought there.
There is also a timeline with respect to updating reports. I mentioned this earlier. Updated or corrected reports must be filed within 30 days of the change. Again, there is an obligation on the reporting company to stay on top of any changes to the relevant information.
Jeremy Garvey:
Can you talk a little bit about penalties and the safe harbor? I think the penalties – this is important to pay attention to because this is where I think it gets a little bit scary.
Greg Patton:
You’re exactly right, Jeremy. First off, failure to report the required information or providing false or fraudulent information is just flat-out unlawful. I think we all expect that, right? Willful violations can lead to penalties up to $500 a day, for any violation that’s not timely remedied. Criminal penalties can lead to penalties of up to $10,000 and up to two years in prison for any violation that’s not remedied.
There is a safe harbor. If you accidentally report any incorrect information or report information you find out isn’t completely accurate, you have 30 days to correct that information from the earlier of when you become aware of the inaccuracy, or when you had a reason to know of the inaccuracy. The safe harbor does provide a little bit of relief. Again, these penalties are significant and new.
Jeremy Garvey:
There’s obviously a group of companies that are most likely to be reporting, and there’s a host of things that are likely to be exempt. But the rules are a little bit tricky. Can you give a practical view of who are the most likely reporting companies here?
Larry Laubach:
I think that’s a really important question, because who is this really going to apply to at this point in time? As Greg mentioned earlier, the large operating company exception will be important, if you don’t have more than 20 employees, and you don’t have at least $5 million of annual U.S. gross receipts as shown in your prior year’s tax return, then you don’t comply. If you form a new entity and it’s not owned by other exempt entities, you will have to report until you get large enough and meet those two tests: and you have to meet both of them.
In addition, if you decide you want to buy a piece of real property as a rental property, or you want to buy a vacation home, and you decide for liability purposes, “I want to put it into an entity to avoid any potential liability if I owned it personally, ” it’s likely that that entity will have to report because it likely won’t get to 20 employees. All of those types of entities will need to report, including single-member LLCs. If you have an investment fund, or a private investment fund that isn’t advised or operated by certain exempt entities set forth in the regulations, you’ll have to report on the beneficial ownership information.
And finally, this is what I think is an example of maybe an oversight by FinCEN. You have the large operating company exception and an exception for controlled or wholly owned subsidiaries of exempt companies. Unfortunately, it doesn’t apply to parents. If you have a privately owned company that has multiple operating businesses in separate subsidiaries, each of the subsidiaries may have 20 employees, but the parent holding company may not have 20 employees. While the subs may be exempt, the parent may not be exempt because it doesn’t meet the 20 employees test. The 20 employees are not computed on a consolidated basis. You look at each individual entity to determine whether it has more than 20 employees.
Jeremy Garvey:
With all that, what should folks be doing now to help prepare? Obviously, there’s some time, given the effective date and existing entities, but obviously, the 30 days are going to kick in for new entities after January 1. What steps can folks start to take now?
Larry Laubach:
There is some time, but it’s time to start thinking about what needs to be done. The first step is to determine which entities are exempt entities, and which ones will have to report. Once you determine that, assuming you’ll have some reporting companies, you need to start developing and preparing to implement a CTA compliance program.
You should look at your corporate structure, identify who the beneficial owners are in those various entities, and start to create an internal database of beneficial ownership information that will include name, residential address, date of birth, and the government-issued ID whose identifier number you’re going to use. I’d start creating that database now for your beneficial owners.
Because that database will contain sensitive information, you need to make sure that it’s very secure and that it doesn’t readily get out to other people. Then you’ll need to decide how you’re going to report that information to FinCEN. Will you do it yourself, or will you hire someone else to do it? A particular issue will be monitoring compliance on a going-forward basis, so if changes occur, you’ll need to become aware of those changes and then report them to FinCEN. For example, if a beneficial owner who is reporting moves his or her home address to another location, that needs to be reported within 30 days. If someone gets married and changes their name, that name change will need to be reported within 30 days. Make sure you’re on top of that. Getting access to that information is really important. In order to get your beneficial owners to report that information, you should consider now amending your applicable agreements, such as LLC agreements, partnership agreements, and shareholders agreements, to require beneficial owners to report the required information if it’s necessary to be provided to FinCEN. That’s something we should now all start thinking about moving forward now.
Jeremy Garvey:
As we try to wrap up, there are, as you mentioned, two proposed regulations that aren’t effective yet, and some guidance yet to come out. What are those about, and what’s the view of when those things might happen?
Larry Laubach:
The second regulation deals with who actually gets access to the beneficial ownership information database. What law enforcement entities can access it? What’s needed to access it? There was a proposed regulation that was issued last December. The period for comment closed in February. We haven’t seen either a final regulation or a revised regulation yet. Hopefully, we’ll see that in the next couple of months.
The third regulation deals with customer due diligence rules, and we haven’t seen anything yet with respect to those rules. Hopefully, that will happen before the end of the year. The regulation that was adopted that we’ve talked about today, there are a lot of questions arising. FinCEN has indicated they likely will issue some sort of frequently asked questions and respond to them to give guidance because there are many uncertainties still in the final regulation about reporting beneficial ownership information.
Jeremy Garvey:
One of the questions we received relates to the exceptions to any of the three buckets: reporting companies, beneficial owners, or the folks that are forming the entities. If an exception applies, it’s just one of the exceptions that has to apply. It isn’t all of the exceptions. So, if you’re one of the large operating companies, you don’t have to report, is that right?
Larry Laubach:
That’s correct, yes. It’s on an entity-by-entity basis.
Jeremy Garvey:
I think the takeaway is now is the time to start to look at this and figure out who may be exempt and to dig in. There are a lot of questions, given corporate structures and given the complexity of some of the waterfalls we see, and various interpretations of those questions, which I think both will be happy to help with.
I’d like to thank Larry and Greg for their contributions. Obviously, this is a topic that is pretty important. We have a number of folks in the Cozen O’Connor client base and friends of the firm who have very complicated corporate structures. Trying to get this right and stay on the right side is going to be important. If you have questions, Larry and Greg or other members of the firm who are on the CTA task force here at Cozen O’Connor will be happy to connect with you and help you out.