As the 115th United States Congress came to a close, in its final hours, and skipping weeks of political drama for purposes of this post, the legislative body took the unprecedented step and overrode a presidential veto for the first time during the Trump Administration to pass the National Defense Authorization Act for Fiscal Year 2021 (the Defense Act). Included in the Defense Act is the Corporate Transparency Act (the CTA). The CTA, which was initially introduced by the House of Representatives in 2019, seeks to provide appropriate safeguards to identify bad actors engaged in terrorism, money laundering, sex trafficking and other heinous acts through "shell companies" that are not actually engaged in a bona fide business venture but instead are created for the principal purpose of shielding the owners from liability for engaging in illicit behavior and, in many cases, their identities.
The CTA requires the disclosure of the full legal name, current residential or business address, birth date and an identification number for each "beneficial owner" of a U.S. corporation or limited liability company as well as foreign entities that are qualified to do business in the U.S. and Indian Tribes (each, a Reporting Entity), with certain exceptions relating to entities that are already subject to regulatory reporting requirements, including but not limited to highly regulated companies (i.e., financial institutions, broker-dealers and insurance companies), publicly traded companies and entities that are tax-exempt. It is not clear from the CTA whether partnerships and trusts would be included as a Reporting Entity since they are not specifically identified. The CTA defines a beneficial owner as "a natural person who, directly or indirectly, through any contract, arrangement, understanding, relationship or otherwise (i) exercises substantial control over a corporation or limited liability company; (ii) owns 25 percent or more of the equity interests of a corporation or limited liability company; or (iii) receives substantial economic benefits from the assets of a corporation or limited liability company" with certain limited exceptions.
As part of the CTA, each Reporting Entity is required to complete a beneficial ownership statement and file it with the Financial Crimes Enforcement Network of the U.S. Department of Justice (FinCEN) upon the formation of the Reporting Entity or, if the Reporting Entity is already in existence at the time the CTA is enacted, within two years of adoption of underlying regulations. This will impact Reporting Entities that were formed prior to the enactment of the CTA. The filing must also be routinely updated for certain changes in the beneficial owners. It is important to highlight that the beneficial ownership statement is not made available to the public, and FinCEN is only permitted to use the beneficial ownership statement for limited national security and anti-money laundering reasons. Failure to comply with the requirements of the CTA could result in substantial penalties, including fines and imprisonment.
Interestingly, and likely unintentionally, the CTA will have an impact on structures that are routinely used for acquisitions and lending transactions that are fully legitimate. Often in these types of transactions a beneficial owner will form one or more entities depending on the deal structure that could qualify as Reporting Entities and which serve as the contracting party(ies) in an acquisition or a borrower in the lending transaction. These entities are used for a number of valid reasons, including to protect the assets of the beneficial owners/acquirer from unknown liabilities of the target, or to create single purpose entities formed solely to own the collateral securing a loan to protect lenders by insulating the assets of the entity from the financial condition (and any resulting bankruptcy filing) of the equity sponsor or parent entity. Such special purpose vehicles may also be used to maximize available tax benefits and/or minimize negative tax consequences.
Prior to the enactment of the CTA, the personal information of the beneficial owners would generally not be disclosed to any governmental entity, except to the extent a particular jurisdiction requires such information to be included in the routine filings to form and maintain the Reporting Entity or to obtain an employer identification number (EIN) from the Internal Revenue Service. For example, Delaware, which is the most popular jurisdiction to form an entity due to its business-favorable laws, permits limited liability companies to be formed by filing a certificate of formation with only the name of the entity and the registered agent information as well as to file annual reports with little to no personal information about its beneficial owners. Private investors and wealthy individuals that typically engage in acquisitions and financings may think twice before doing so going forward if there is a legitimate concern about having their names and other personal information associated with the Reporting Entity, regardless of the fact that the beneficial ownership statement is not made public.
It remains to be seen whether or not the CTA will have a substantial impact on businesses and investors going forward. The goal of the CTA is clear and appropriate in the realm of identifying and stopping bad actors. However, Reporting Entities will now be required to comply with an extra layer of disclosure which will add time, complexity and expense to routine transactions and entity formation, and the beneficial owners and others responsible for the filings could face potential fines and imprisonment in certain circumstances for failing to comply with the CTA. While the new disclosure requirements of the CTA will impact certain clients, especially small and middle market private corporations and limited liability companies that are most likely to qualify as a Reporting Entity, in the coming years the disclosure obligations may just become more of a routine part of entity formation.
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