Another Crack in the Protective Shell of Shell Companies

On December 7, 2021, the U.S. Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN) released a Notice of Proposed Rulemaking (NPRM or proposed rule) to implement the beneficial ownership information reporting requirements set forth in Section 6403(a) of the Corporate Transparency Act (CTA), which was enacted as part of the National Defense Authorization Act of Fiscal Year 2021 (NDAA). As we previously reported, prior legislation did not require companies to report the true owners who benefited from their operations but, rather, imposed the obligation on certain financial institutions under the Bank Secrecy Act (“BSA”) to collect such information. With the CTA and the latest proposed rule, however, certain companies will be required to report such information directly to FinCEN. FinCEN is seeking public comment on the proposed rule until February 7, 2022.

As previewed by the proposed legislation in December 2020, the proposed rule requires certain companies to submit to FinCEN a report identifying the beneficial owner of the entity and individuals who have filed an application to form the entity or register it to do business. The proposed rule defines a “beneficial owner” as anyone who meets at least one of two criteria: (1) exercising substantial control over the reporting company; or (2) owning or controlling 25% or more of the ownership interest of the reporting company. Together, this information comprises the “beneficial ownership information” or “BOI,” which FinCEN will record in a database. This proposed definition of “beneficial owner” appears to expand the current definition of “beneficial owner” under the BSA’s Customer Due Diligence rule, which defines “beneficial owner” as: (1) “each individual, if any, who, directly or indirectly, through any contract, arrangement, understanding, relationship or otherwise, owns 25 percent or more of the equity interests of a legal entity customer; and (2) [a] single individual with significant responsibility to control, manage, or direct a legal entity customer.” See 31 C.F.R. § 1010.230(d) (emphasis added).

According to the NPRM, FinCEN’s collection and distribution of this information to law enforcement and other key stakeholders will reduce the ability for “malign actors to obfuscate their activities through the use of anonymous shell and front companies.” The NPRM highlights that a Treasury study “based on a statistically significant sample of adjudicated [Internal Revenue Service] cases from 2016-2019 found [that] legal entities were used in a substantial portion of the reviewed cases to perpetrate tax evasion and fraud.” Moreover, the NPRM states that this information “would support efforts by government authorities and financial institutions to prevent money laundering, terrorist financing, and other illicit activities such as tax evasion.”

The proposed rule requires “reporting companies” – which include any corporation, limited liability company (LLC), or similar entity (with several exclusions as noted below) – to submit BOI to FinCEN identifying the individual’s full legal name, date of birth, current residential or business street address, and a unique identifying number from an acceptable identification document, such as a passport. Although the use of a business street address is permitted, the NPRM states that an individual’s primary residential address is preferred, as it facilitates any potential “follow-up” by law enforcement in the event of an investigation and it facilitates tax administration by identifying where the beneficial owner resides for tax residency purposes.

The proposed rule categorizes reporting companies into two types: (1) domestic reporting companies; and (2) foreign reporting companies. A domestic reporting company is any corporation, LLC, or similar entity that is created by filing a document with a Secretary of State or similar office under the laws of the State (or Indian Tribe). A foreign reporting company, by contrast, is a corporation, LLC, or similar entity that is “formed under the law of a foreign country and registered to do business in the United States (U.S.) by” filing a document with the Secretary of State or similar office under the laws of a State (or Indian Tribe). Companies that have more than 20 full-time employees in the U.S. and make at least $5 million in annual revenue are exempted from the reporting requirements, as are companies that are already subject to supervision or closely regulated by the federal government (e.g., banks, commodity brokers, and registered investment advisors), other publicly traded companies, dormant companies, and any entity owned by an otherwise exempt entity.

NEXT STEPS AND KEY TAKEAWAYS

Although the NPRM is seeking comments to the proposed rule until February 7, 2022, and some changes may be made as a part of those comments, reporting companies should be cognizant of the new reporting requirements if the proposed rule becomes final. For example:

• Any existing domestic reporting companies or foreign reporting companies registered to do business in the U.S. prior to the effective date will need to file their initial reports with FinCEN within a timely fashion and within one year of the effective date (as opposed to within two years as initially prescribed by the CTA).
• Any domestic reporting companies created or foreign reporting companies registered to do business for the first time on or after the effective date must file their reports with FinCEN within 14 calendar days of the date on which they were created or registered, respectively.
• Any change in beneficial ownership that was previously reported to FinCEN must be reported to FinCEN within 30 calendar days (instead of within one year as initially prescribed by the CTA).
• If any information was inaccurate at the time of filing, the proposed rule adds the requirement that the reporting company must file a correct report within 14 calendar days.
• Knowingly failing to provide complete and/or updated information or willfully providing false or fraudulent information, as well as the unauthorized disclosure of information collected under the CTA, can carry substantial civil and criminal penalties, with potential imprisonment.

Winston & Strawn will continue to monitor developments. For further information, please contact the authors or your Winston relationship attorney.