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On January 2, 2021, as part of an effort to combat money laundering, the Senate passed the Corporate Transparency Act into law. The Corporate Transparency Act mandates private companies to disclose their “beneficial owners” to the Financial Crimes Enforcement Network (FinCEN). FinCEN is a branch of the U.S. Department of Treasury.

While the Corporate Transparency Act applies to companies broadly, Congress especially designed it to target foreign shell companies. The use of anonymous companies abroad has attracted heightened regulatory scrutiny. The law is a culmination of efforts to increase corporate transparency and financial integrity.

Background of the Corporate Transparency Act

Over 2,000 corporations and limited liability companies organize each year in foreign jurisdictions, most of which do not disclose of beneficial ownership information.

Many legitimate businesses, including well-known public companies, set up shell companies to raise funds or complete a merger. Large corporations often set up shell companies to take advantage of favorable tax arrangements. Some common jurisdictions for hosting shell companies include the Cayman Islands, Panama, the British Virgin Islands, Curacao, Bermuda, and Luxembourg.

Anonymous shell companies incorporated in foreign jurisdictions are also the vehicle of choice for illicit financial activities. Moving and hiding illicit wealth, evading national sanctions, and for carrying out other money laundering schemes are among the common uses for such corporate structures.

Representative Carolyn Maloney, a Democrat from New York, was the original lead on the Corporate Transparency Act. The Act passed as part of the National Defense Authorization Act. The Act goes into effect January 1, 2022.

Beneficial Ownership Reporting

Companies that fall within the scope of the Corporate Transparency Act must report certain beneficial ownership information to FinCEN. A beneficial owner is defined as “an individual who, directly or indirectly, (1) exercises substantial control over the entity, or (2) owns or controls not less than 25% of the ownership interests of the entity.” The beneficial ownership information that companies must be report will not be made available to the public.

For each beneficial owner disclosed to FinCEN, the report must contain a full legal name, date of birth, current residential or business address and a valid government identification document.

The Corporate Transparency Act targets foreign shell companies, prime vehicles used to facilitate money laundering. Domestic companies should carefully understand the Corporate Transparency Act, as they may also fall under the law’s purview. There are a number of exemptions from the beneficial reporting requirements of the Corporate Transparency Act. Domestic companies are often able to qualify for an exemption.

The most common exemption from the Corporate Transparency Act applies to entities that already disclose beneficial ownership information under other laws or regulations. For example, U.S. law already requires U.S. public companies to disclose beneficial ownership information under the Securities Exchange Act of 1934. There are other exemptions as well for entities that are unlikely to be money laundering vehicles.

Penalties for Noncompliance

Companies that do not comply with the Corporate Transparency Act face steep penalties. Noncompliance can lead to penalties of up to $500 per day, not to exceed a total amount of $10,000. Aside from substantial monetary fines, certain types of violations can result in prison time. Filing false reports or willfully failing to file under certain circumstances can lead to imprisonment.

Criticisms of the Corporate Transparency Act

Despite the Corporate Transparency Act’s well-intentioned aims, many in the investment community have expressed reservations about the Corporate Transparency Act. In their view, the extensive disclosures required are likely to create substantial administrative burdens for businesses and investors.

The increased reporting requirements are likely to have a disproportionate impact on small business owners. Businesses will likely have to rely even more heavily on lawyers to navigate the Corporate Transparency Act’s complex beneficial ownership disclosure obligations. Companies will need lawyers and other specialists to determine if reporting is required under the Corporate Transparency Act and to prepare the actual filings. While larger businesses can more easily absorb the extra costs, small businesses will suffer.

Another criticism is that the government does not have the staffing to process an increased volume of compliance paperwork. While the goal of cracking down on anti-money activities is commendable, the government has limited resources to enforce compliance.

Only law enforcement and government agencies are entitled to see the information. But another concern revolves around data security. A cybersecurity breach could leak highly sensitive data. There will be procedures to enable foreign government agencies and law enforcement to access the reports. Additionally, the information available on the beneficial ownership reports may satisfy the anti-money laundering (AML) and know-your-customer (KYC) paperwork. Financial institutions must collect this information under government regulations. Using a consent procedure, the banks and other financial institutions could have access to reports from the government. All of these transfers of data make the data more susceptible to hacking and other breaches.