The Corporate Transparency Act (the CTA), a 21-page component of the 1,482-page William M. (Mac) Thornberry Authorization Act, Pub. L. No. 116283 (Jan. 1, 2021), was enacted to respond to entity-enabled concealment by “malign actors . . . to facilitate illicit activity,” including “money laundering, financing of terrorism, proliferation financing, serious tax fraud,” and a number of other criminal and national-security-related activities, CTA § 6402(3) and (4), facilitated by multilayer entity formation, often in multiple jurisdictions. Because states do not require information about beneficial ownership, CTA § 6402(2), the CTA intends to “set a clear Federal standard for incorporation purposes” and “bring the United States into compliance with international antimoney laundering and countering the financing of terrorism standards.” Id. § 6402(5)(A), (E). Section 6403 of the CTA contains all of the substantive provisions: definitions, information reporting, information retention and disclosure and coordination among agencies, notice (including by preenactment entities) of reporting obligations, bearershare prohibitions, a directive for outreach to the regulated, civil and criminal penalties, and a directive to Treasury to prevent evasion by use of taxexempt entities. The “Beneficial Ownership Reporting Requirements” of the CTA amended Title 31 of the U.S. Code to add a new § 5336.
Regardless of the origin of this saying, I recently was reminded of it while re-reading Aristotle’s The Art of Rhetoric (Hugh Lawson-Tancred ed. & trans. Penguin Classics 2004). Lawson-Tancred’s introduction summarizes Aristotle’s analysis that there are three forms of proof in rhetoric: those achieved by argument, those achieved by character, and those achieved by emotion. Id. at 16–17. The parallel is obvious but deserves further exploration.
Rhetoric is the art of written or spoken communication seeking to persuade. Frequently, we read accusations negatively, labeling the speaker as one spouting rhetoric, but such accusations are often misguided. What the speaker often proclaims is the target presenting false arguments. But that is sophistry, not rhetoric. Others use rhetoric as a denouncement of an appeal to emotion. Emotion indeed is a part of rhetoric, but an appeal to emotion is pathos, and true rhetoric involves the trifecta of logos, pathos, and ethos—logic, emotion, and credibility.
Attorneys use rhetoric, albeit only sometimes intentionally, so the historical context is enlightening. In the days of Aristotle (384–322 BC), the Athenian justice system had several remarkable features. For one, the state had no monopoly on prosecution. Any citizen could complain about another. (This, unfortunately, resulted in a form of politicizing as the juries became quick to rule against those Athenians from wealthier neighborhoods and backgrounds.) Id. at 11.
Another feature was the structural size. The ultimate deciding body within the judicial system was known as the Assembly. The Assembly contained about 6,000 people. The Assembly typically had a full agenda, so its members focused on making quick decisions. A solution was to create the Council of Five Hundred to serve as the deliberative body that would listen to arguments and make a recommendation to the Assembly. In this separation of duties, the Council determined facts (i.e., jury) and the Assembly applied the law (i.e., judge).
Except incidentally, the CTA does not serve needs of private parties in pursuing their economic and business interests. The CTA is a compliance regime intended to puncture the anonymity that accompanies the use of state-chartered entities, whose primary purpose historically has been to limit liability exposure and, secondarily, to protect the privacy of equity investors concerning deployment of their ownership interests acquired through investment of capital and otherwise. That secondary objective has become diluted over time, particularly in large part because banks and other financial intermediaries have their own customer identification and reporting obligations. Nonetheless, the vast majority of state-chartered entities are formed as private businesses or as private investment vehicles not subject to federal statutory disclosure obligations, and banks and other reporting intermediaries obtain information secondarily and thus incompletely. Accordingly, it is this segment of state-chartered entities that is principally targeted by the CTA.
Despite the length of the proposing and adopting releases, the regulations implementing the CTA are not themselves voluminous, but because the CTA regime is novel, the proposal and comment process has been demanding. Near year end 2021, Treasury issued a 54-page Federal Register Notice of Proposed Rulemaking, 86 Fed. Reg. 69920–74 (Dec. 8, 2021) (the Proposing Release), which followed an earlier Advanced Notice of Proposed Rulemaking, 86 Fed. Reg. 17557–65 (Apr. 5, 2021). FinCEN adopted final rules 10 months later in 2022. 87 Fed. Reg. 59498–596 (Sept. 29, 2022) (the Adopting Release). FinCEN has pending proposed regulations that address permitted disclosure of beneficial owner information produced under the CTA. 87 Fed. Reg. 77404–87 (Dec. 16, 2022). Despite the length of the accompanying releases, the final rules are relatively brief and mostly address those entities and individuals that must file, add content with respect to those exempted, and establish the content and timing of the reports required to be filed with FinCEN, subject to the civil and criminal penalties for noncompliance. As formally incorporated into CFR, CTA regulations will be designated 31 C.F.R. § 380.xxx.
As a new compliance regime, the CTA creates practice issues that the legal community must address. To take one prominent example, a statutory “Applicant” who establishes a new entity subject to CTA compliance takes on CTA responsibilities and liability exposure that have been the subject of much preimplementation discussion. See 31 U.S.C. § 5336(a)(2) (statutory definition). The Adopting Release, like the Proposing Release, contains multiple references to the identification and the responsibilities of an “applicant.” Given that that term is a trigger for reporting responsibility, law firms are presumably considering client and matter intake procedures. Additionally, because of the consequences of noncompliance, law firms are also addressing the development of CTA compliance provisions in corporate documentation, including formation, corporate proceedings, transaction documents, ordinary course business agreements, and opinions.
A critical element of the CTA and the implementing regulations is the definition of beneficial owner, which is the primary gateway for capturing the parties that must be identified to FinCEN. The CTA requires “each reporting company” to submit a report, CTA § 5336(b)(2)(A), to FinCEN that “shall . . . identify each beneficial owner of the applicable reporting company and each applicant with respect [thereto].” Id. § 5336(b)(2)(A). A person or entity that “directly or indirectly” owns 25 percent of a company’s “ownership interests” or “exercises substantial control” is deemed a beneficial owner. Id. § 5336(a)(3). That definition is quite open-ended and is further defined extensively and broadly in the regulations. 31 C.F.R. § 380(d)(i).
Worth noting especially is the reference in the Adopting Release, 87 Fed. Reg. at 59527, note 181, to the Committee on Foreign Investment in the United States (CFIUS) control provision “formal or informal arrangements to act in concert” as defined in the CFIUS regulations at 31 C.F.R. § 800.208(a). What would constitute “concert” to FinCEN is unclear and, consequently, for evaluation purposes at least, may include episodic, and not merely continuous, mutual engagement. The CFIUS control provision is in fact extensive and both broad and particular in its specifics. Accordingly, FinCEN’s reference at note 151, which also includes a reference to an Exchange Act definition (“similarly important matters”), should be considered as a potential, if not actual, expansion of the CTA regulatory definition. That definition alone includes senior officers, persons having appointment authority respecting senior officers or board control, and persons having “substantial influence over important decisions” of a company. 31 C.F.R. § 380(d)(1)(c).
A reporting company is “a corporation, limited liability company or other similar entity . . . created by . . . [a state or Indian Tribe] filing” or is “formed under the law of a foreign country and registered to do business in the United States [under the laws of a state or Indian Tribe],” except for specified categories of entities that are independently federally regulated, tax exempt, or substantial companies operating in the US, including Securities Act issuers and Exchange Act required filers, broker-dealers, federally regulated banks, credit unions and their holding companies, ’40 Act companies and federally registered investment advisers, insurance companies defined under the Advisers Act, registered or regulated commodity exchanges and commodities market and foreign exchange services, registered accounting firms, public utilities, and nonprofits (subject, however, to limitations). CTA, § 5336(a)(11)(i)–(xx).
Also excepted from the definition of “reporting company,” and arguably the key filter, considering the number of small business and one-off investment capital entities in existence or to be formed in the future, is “any entity” that (i) employs more than 20 fulltime employees in the US and has filed federal tax returns in the “previous year . . . demonstrating more than $5,000,000 in gross receipts or sales” on a consolidated basis and has “an operating presence” in the United States or (ii) is inactive and not owned by “a foreign person.” Id. § 5336(a)(11)(xxi), (xxiii). FinCEN is also authorized “to add exemptions.” Id. § 5336(a)(11)(xxiv). Reporting companies must, within a year, furnish updated information if there is a change that would have required beneficial ownership reporting. 31 U.S.C. § 5336(b)(1)(D).
CTA § 5336(b)(2)(A) requires reporting entities to identify each “beneficial owner . . . and each applicant” by providing:
(i) full legal name;
(ii) date of birth;
(iii) current address; and
(iv) a “unique identification number . . . [which may be a] FinCEN identifier.”
An “acceptable identification document” is an effective US or foreign passport, US state or local ID, or US state driver’s license. Id. § 5336(a)(1). A reporting entity must also name any exempt entity having a “direct or indirect ownership interest.” Id. § 5336(b)(2)(B).
Foreign pooled investment vehicles that, if domestic, would be exempted as financial institutions, or because registered under the ’33, ’34, or one of the ’40 Acts, must file “identification information” for a controlling person. Id. § 5336(b)(2)(C). The regulations exempt a pooled entity (whether domestic or foreign) that would be a reporting company but is advised by a federally regulated bank or credit union; a federally registered broker-dealer, investment company, or investment adviser; and an Advisers Act venture capital fund adviser, which is itself exempt.
The CTA regulations have three main objectives: (i) to provide content to the statutory terms “applicant” and “beneficial owner”; (ii) to set filing deadlines, including those relating to changes in beneficial ownership and corrections to previously filed information; and (iii) to specify the information that must be filed. In addition, there are two innovations: (i) for filers, application for and use of a unique FinCEN identifier, and (ii) obligations of FinCEN concerning confidentiality with respect to collected information and limits on its authority to disclose information to domestic and foreign agencies and to financial institutions. The discussion accompanying the regulations when proposed requested comment on certain issues, encouraging companies to provide “highly useful information” supporting government and financial institutions in preventing money laundering, terrorist financing, tax evasion, and “other illicit activities,” 86 Fed. Reg. at 69921, but left unsaid were consequences or benefits that might follow from participation in information transmission.
As noted above, the regulations in their entirety constitute a single section of C.F.R. Key compliance issues include:
(i) filing deadlines for initial, amended and corrected submissions, commencing January 1, 2024,
(A) thirty days from regulatory effective date for new domestic and foreign entities;
(B) one year for previously formed entities;
(C) thirty days from the date an exempt entity becomes nonexempt;
(D) thirty days from the date of changed circumstances (including estate settlement, loss of exemption, or gain of exemption); and
(E) fourteen days from the date a “reporting company becomes aware . . . that any required information . . . was inaccurate when filed” (plainly much shorter than the statutory 90 days, after which statutory penalties apply);
(ii) content for a reporting company:
(A) name;
(B) trade and d/b/a names;
(C) address;
(D) formation jurisdiction or, for foreign reporting companies, first registration jurisdiction; and
(E) a TIN and EIN and, pending that, a D&B DUNS Number or a Legal Identifier Number.
(iii) content for a beneficial owner or entity applicant:
(A) name;
(B) DOB;
(C) address (business for “applicant” filers; otherwise residential);
(D) unique ID number; and
(E) image of (D).
A reporting company is required to submit the TIN of a consenting beneficial owner. 31 C.F.R. § 1010.380(b)(1)(F). There are certain special rules if, among other things, an individual would be a beneficial owner via an interest held by an exempt entity, is a minor who is a beneficial owner or is a decedent beneficial owner’s beneficiary, or is a foreign pooled investment vehicle. Entities and individuals that obtain a FinCEN number may use that number in lieu of information otherwise required of them in regulatory filings, but a preceding standard filing, containing the information listed above, is necessary to obtain a number. Id. § 1010.380(b)(4).
The regulations add (and somewhat limit) categories of companies exempt from the definition of reporting companies. Id. § 1010.380(c)(2). For example, as noted above, to gain exemption as a “large operating company,” an entity must employ more than 20 “full time employees” in the United States. The definitions of “full time employee” and “United States” are technical and specifically cross-referenced to provisions in 26 and 54 C.F.R. (Labor and Treasury). Further, the $5 million gross hurdle excludes revenues sourced outside the United States “as determined under Federal income tax principles.” Id. § 1010.380(c)(2)(xxi).
Like the provisions addressing the statutory large company exemption, other provisions in subsection (c)(2) of the regulations track, but add eligibility detail to, the statutory exemptions in 22 categories, including, for example, subsidiaries of exempt entities and entities that become “inactive” (if in existence prior to January 1, 2020). Id. § 1010.380(c)(2)(xxii). The regulatory language is critical. Among other things, a beneficial owner (subsection (d)) is anyone who “directly or indirectly exercises substantial control.” Substantial control (subsection (d)(1)), is both extensively detailed, id. § 1010.380(d)(1)(i)–(iii), and open-ended, id. § 1010.380(d)(1)(iv): “Any other form of substantial control over the reporting company.” Likewise, “ownership interests” is both detailed, id. § 1010.380(d)(3)(i)[A]–[E], (ii)[A]–[C], and open-ended, id. § 1010.380(d)(3)(ii), (iii).
The CTA and the implementing regulations impose the primary reporting burden on the “reporting company” and the “applicant.” The statutory, civil, and criminal enforcement provisions and the attendant penalties, however, apply to any “person” willfully providing or attempting to provide “false or fraudulent beneficial ownership information” to FinCEN. 53 U.S.C. § 5336(h). The prudent course would assume that a beneficial owner who provides false information to a reporting company—the vehicle for transmitting beneficial ownership information to FinCEN—is captured by the penalty provisions. There is a statutory safe harbor that provides protection if corrections are submitted to FinCEN within 90 days of the company’s becoming aware of the falsity being corrected. Id. § 5336(h)(C)(i).
For those inclined to reflect on how the CTA and its implementing regulations might affect advice to clients, consider the hypothetical below:
Angel Opportunity LLC (Angel) forms and manages limited partnerships, each having the objective of providing a means for pre-screened Angel investors to participate in early stage investment opportunities identified by Angel. Angel’s portfolio consists of emerging technology companies and companies providing novel approaches to delivery of products and services.
Existing and future limited partnerships are, or will be, owned by some combination of the investors Angel has screened. The investors are US citizens and citizens of other countries, and Angel permits the investors it has screened to invest in each opportunity as limited partners personally or via an entity formed under the laws of the investor’s citizenship. Some of the limited partnerships in Angel’s portfolio have only three or four investor limited partners, others as many as 10. The companies that Angel screens and submits to its investor universe are all US-domiciled.
Angel is paid a flat modest annual participation fee by each investor irrespective of whether an investor invests in any opportunities, plus carry-on distributions to an investor by companies in Angel’s portfolio. Successful investments generally lead to conventional venture fund financings, often through multiple rounds. Angel does not itself participate, but its investors in the company being financed may if permitted by the venture fund. Some companies in Angel’s portfolio are required to salvage value from an unsuccessful company.
Angel expects generally a one- to three-year period, and in some cases longer, before a company it offers to its investors will employ more than 20 people and earn revenues greater than $5 million. Most, but not all, opportunities in which Angel’s investors invest are located in the United States. Value for Angel’s investors in most of Angel’s successful investments are realized through sale of portfolio companies, although in some cases Angel distributes the equity involved to the limited partners invested in a particular company. From time to time, companies in Angel’s portfolio acquire or merge with other companies.
Angel’s in-house counsel asks what procedures and screens she should incorporate to assure compliance with the CTA.
