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Corporate Transparency Act: A Primer

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Corporate Transparency Act: A Primer

The Corporate Transparency Act is going to change dramatically the way that founders and investors in privately-held companies interact with each other. The CTA, once implemented, will require roughly 25 million U.S. companies to file a beneficial ownership report with FinCEN, the Financial Crimes Enforcement Network of the U.S. Treasury. Each beneficial ownership report will contained personally-identifiable information (PII) about each of the company’s “company applicants” and “beneficial owners.” FinCEN will maintain a database of beneficial ownership information that will be confidential, but accessible by specific law enforcement agencies pursuant to regulations that FinCEN will adopt. Understanding how the CTA will change the interactions between founders and investors will allow attorneys to modify the contractual relations between those parties in anticipation of the CTA coming into effect.

Presenters

Jonathan Wilson
Partner
Taylor English Duma LLP

Transcript

My name is Jonathan Wilson, and this is my presentation on the Corporate Transparency Act, brought to you by Quimbee. Thank you very much for joining me today. In my presentation today, I'm gonna talk about the Corporate Transparency Act, how it was intended as a solution to fight money laundering, and how it is going to affect corporate governance and the practice of corporate lawyers in the United States. Now by way of background, traditionally in the United States, most companies are formed on an anonymous basis. You file Articles of Incorporation, or Articles of Organization for an LLC with the Secretary of State in the state where you wanna organize. The articles for both corporations and LLCs are very limited in the information they disclose. They might include the number of authorized shares, they would provide the registered address for the corporation, they would indicate the name of the incorporator, but that's it. It wouldn't identify the individuals behind the company, it wouldn't identify the shareholders of the company, and it might not even identify the directors of the corporation until the first annual report filed by the company. So in large measure, up until now, corporations and LLCs in the United States have been anonymous. Well, that is about to change. The Corporate Transparency Act, which was adopted by Congress in December of 2020, once it takes effect, is going to require almost every LLC, corporation and limited partnership to file a beneficial ownership report with the Financial Crimes Enforcement Network of the US treasury that will disclose the beneficial owners of that company. And that is what the Corporate Transparency Act is about, and that is gonna be the focus of our presentation today. So let's go back. We said that the Corporate Transparency Act was intended to fight money laundering. What is money laundering? Well, if you have seen any television shows on organized crime and so on, you think about "Breaking Bad" and other big shows like that, they almost always focus to some degree on money laundering. And money laundering is a huge problem, both in the United States and on an international basis. One United Nations report back in 2020, calculated that the annual amount of money being laundered for illegal purposes is $800 billion, or somewhere between 2% and 5% of global domestic product. Now that is a huge factor, $800 billion a year being laundered by organized crime into the money system. That was one of the reasons behind the change in US law of it, is the Corporate Transparency Act. The other big change is that between the United States and most of the industrialized world in particular, the European Union, the United States was somewhat alone in permitting anonymous corporations. That practice had been outlawed years ago throughout most of the EU, and most of the EU corporations and other entities have to file their capital tables, their table of beneficial ownership, either with the Securities Commissioner or some similar government organization, so that the ultimate beneficial owners of the company are known. And as we said, that has not been the case in the United States up until now. So how exactly does money laundering work, and how is the Corporate Transparency Act intended to stop money laundering? Well, as you'll see, one of the key aspects to almost any form of money laundering is the concept of corporate anonymity. But money laundering has basically four steps to it. The criminal enterprise generates cash or other valuable items as a consequence of their illicit activity. Imagine the pile of cash that gets exchanged at a drug buy deal that you might see in a crime show on TV, for example. Step two, the criminal enterprise has to layer the illegal cash into clean cash that has been derived from some legitimate business. If you think back to the show "Breaking Bad," for example, Jesse was trying to launder his money through the nail salon. They would take the deposits of illegal cash, mix it in with deposits from the legally derived business, and then deposit all that cash into the nail salon's bank account. At that point, the legal business, the nail salon, is going to pay taxes on all the money, even though portions of it were derived from criminal enterprise. And once it's been taxed, it appears, at least from an IRS point of view as if the cash has been legally derived. The third step is called, the destruction of the layering. Once the layering takes place, you go back and you eliminate any evidence that the original source of sum of your cash was illicit enterprise. And then as we said, the accumulated cash after it's been put through the tax system is clean. That's your four steps. There are two primary exploits in the money laundering world. The two exploits are called smurfing and daisy chaining. Now you might know from, having again seen crime TV television shows that there is a $10,000 limit on cash deposits in US banks. And above that $10,000, the bank, the financial institution, has to file a report again with FinCEN, with this division of the US Treasury Department, that indicates that there was this deposit of more than $10,000. Now that law has been in place for many years, it's part of the Bank Secrecy Act in the United States. So criminal enterprises know that they can't make deposits greater than $10,000. So what they sometimes do, is take that pile of cash, again from the illicit enterprise, divide it up into bundles of slightly less than $10,000, get a small army of little players. Those are the smurfs in this example, and have the smurfs go deposit the cash into their own individual bank accounts, and then force the smurfs to make a transfer of cash to the bank account of the criminal enterprise. Later when the criminal enterprise is reviewed, whether it's for tax purposes, or in some other context, all the regulators can see are these inbound transfers of less than $10,000. The criminal enterprise, which is obviously already engaged in crime has no problem lying about the reason for all those transfers, but all the smurfs of course have disappeared, they've closed their accounts, they're not talking, but in this process of taking many individual small deposits and aggregating them into one bank account, the criminal enterprise has layered the cash, has laundered the cash, and that's the process called smurfing. Smurfing is not terribly efficient. You have to have a whole lot of individuals, open up a whole lot of accounts, and inevitably your smurfs get sticky fingers, so from a criminal enterprise point of view, smurfing is not terribly efficient. The more common exploit and the more substantial exploit is called daisy chaining. And as the name suggests, the criminal enterprise creates a number of anonymous corporations, corporations, A, B, and C. And then each of those corporations opens its own bank account. A has a bank account B, and C, and so on. You deposit the cash into bank account A. A then transfers the money to B, B then transfers the money to C. You then go back and you close the bank accounts for A and B, and you dissolve corporations A and B. Now if corporation C gets audited, or is the subject of a subpoena, for example, because law enforcement is trying to track down what they think as a criminal enterprise, the corporation C can say, well, we got this money from corporation B because, we're a consulting business or whatever the surface explanation might be. And there is no corporation B that law enforcement can question. Corporation B was formed anonymously, we don't know who was behind it, we don't know who beneficially owned it. All we know is that it used to be there, and now it's gone, it gave the money to corporation C, and corporation C says it's for a legitimate purpose, and we don't have any evidence that would prove the contrary. So that's daisy chaining, multiple accounts, multiple anonymous corporations, dissolve the corporations after the transfer takes place, and law enforcement is unable to prove that you've been engaged in this daisy chain. Now, it's exactly that kind of exploit that the Corporate Transparency Act is intended to prevent. If there was, for example, a database of all the beneficial owners of all the corporations in the US, there would've been one for corporation A, and there would've been one for corporation B. And then when law enforcement is inquiring about the source of cash in the account for corporation C, law enforcement could go to that database, find out who were the true owners of corporation B, and then have them in and question them, under, you know, appropriate legal circumstances. But there would be no hiding behind the cloak of corporate anonymity. It is that corporate anonymity that the Corporate Transparency Act is intended to prevent. Now, we've talked about how substantial money laundering is. You remember the quotation from the United Nations, that it might be somewhere between 2% and 5% of global GDP. Well, it was just a few years ago that Igor Putin, the cousin of Russian President, Vladimir Putin, successfully pulled off one of the largest money laundering operations in history. He was able to launder more than $20 billion from 19 separately sanctioned Russian banks through more than 732 banks in non Russian countries in order to launder that money for organized crime in Russia and elsewhere. We found it out after the fact, but it was an investigation that took many years to expose, and it just served to instruct the members of Congress, how substantial a problem money laundering was. So after a few years of trying, eventually a bipartisan majority came together in 2020 to adopt the Corporate Transparency Act. It is structured as an amendment to the Bank Secrecy Act, the Bank Secrecy Act being the legislation that originally created FinCEN. FinCEN of course, is the Financial Crimes Enforcement Network of the US Treasury Department. It's been in existence for several decades until the Corporate Transparency Act or CTA , FinCEN was primarily in the business of managing anti-money laundering laws as they related to banks and financial institutions. So we spoke earlier about that $10,000 limit and the report that banks would have to file when they received deposits more than $10,000. Well, those reports prepared by those banks get filed with FinCEN, and FinCEN maintains a database of all those suspicious activity reports. There's also a related concept in the Bank Security Act in which foreign transfers of cash into US institutions also get tracked separately because often international crime is laundering money through those sorts of international transfers. Well, and up until now, FinCEN has also been maintaining a database of those foreign suspicious activity reports. Well, now FinCEN is charged with implementing the Corporate Transparency Act and building this database of beneficial ownership in the United States. So the Corporate Transparency Act itself, how does it work? Well, the first concept to wrap our minds around the Corporate Transparency Act, is what the law calls a reporting company. The CTA defines a reporting company as a corporation, limited liability company or other similar entity that is created by the filing of a document with a secretary of state or a similar office under the law of a state or Indian Tribe, or that is formed under the laws of a foreign country and registered to do business in the United States, by the filing of a document with a secretary of state or a similar office under the laws of a state or an Indian Tribe. So break that down. As it's heard, a reporting company is an entity that is formed by the filing of a document. So that clearly applies to US corporations that are formed by the filing of their Article of Incorporation. It clearly applies to limited liability companies in the United States that are formed by the filing of Articles of Organization for the LLC. It will also apply to limited partnerships in the United States. In almost every state, a limited partnership is formed by the filing of a Certificate of Limited Partnership, again, with the secretary of state. Think about general partnerships for a moment. In some states, a general partnership is formed by the filing of a document, but in some other states, like my home state of Georgia, for example, there is no filing required. This is going to be a tricky loophole in some circumstances to see whether or not your business, if it were a general partnership, formed without the filing of a document is going to be a reporting company or not, as currently written the regulations would not pull something like that into the coverage of the reporting company. Also think about trusts, okay? And in many states, I think most states, a trust can be formed without the filing of a document with a secretary of state. You simply have a trust indenture, a document, that gets signed, and sometimes notarized, then you put it away in your filing cabinet, forget about it, but you legally have a trust. You might fill out some documents with the IRS in order for your trust to get its very own employer identification number or EIN, but no document gets filed with the secretary of state's office. In some other states however, that's not the case. And there are types of trusts that are formed by the filing of a document. The best example of that is the Delaware Statutory Trust, or DST. Delaware Statutory Trusts are created by the filing of a document with the Delaware Secretary of State, so those entities would be covered. Remember, in the definition of reporting company, we bifurcate between entities formed in the US by the filing of a document, and those that are formed outside the United States, but that file a document with the secretary of state when they qualify or register to do business in the United States. This will become a difficult area of law for lawyers who have clients in that particular situation, filing procedures in other countries, of course are quite different, but in almost every state in the union, when you want to qualify to do business in the state, either by hiring employees, owning land, leasing an office, paying sales, tax, any one of those things, you're almost always required to qualify to do business as a foreign corporation that is done by filing a document with the secretary of state, and once you do that, you become a reporting company for purposes of a CTA. So that's the initial coverage of the CTA as it applies to reporting companies. What do reporting companies have to do? Well, if a reporting company is not exempt, and let's put a pin in that, we're gonna talk about exemptions later on. If the reporting company is not exempt, it has to file a beneficial ownership report with FinCEN that identifies a lot of personally identifiable information or PII, with respect to every one of its beneficial owners and with respect to its company applicant. Let's talk about that second category first, company applicant. Now that's a word that we've never used before in the US legal terminology. In the Corporate Transparency Act, the company applicant is defined as the individual natural person who filed the document that created the reporting company, or in the case of a foreign reporting company, the person who filed the document that caused the foreign company to be qualified to do business in the United States. When you look into the draft definitions that we have, that FinCEN has provided in their draft regulations, it says that the company applicant is both the individual who filed that document, as well as the individual who caused the filing of that document, or who ordered the filing of that document. This is going to create some controversy I think, and definitely some confusion, especially for large law firms. So imagine for example, client calls up, client calls partner, client says, "Partner, we need to form new corporation, please go make this happen." Partner then emails associate, gives associate the job of forming this new corporation. Associate perhaps prepares the Articles on Corporation, hands them off to legal secretary or paralegal, and says, "Please file this document with secretary of state." Secretary or paralegal then goes ahead and physically files the document. Who's the company applicant? Well under one reading of the regulations, it could be the legal secretary, the associate, the partner, and the client, all four of them. Because each of one of the four either, was the individual who filed the document, or who caused the filing of the document. So far, our draft regulations from FinCEN do not clarify with any specificity exactly how we apply that. So our best guess today is that all four of the individuals would be treated as company applicants for purposes of the beneficial ownership report. So the beneficial ownership report, of course, covers company applicants. It also covers the beneficial owners. For every one of those company applicants and beneficial owners, the beneficial ownership report is going to have to include some very specific items of personally identifiable information. For every one of those individuals, it will need to include the individual's full legal name, date of birth, their current address, which must be a residential, their home residential address, and then either a unique identifying, and then a unique identifying number, and the document that supports that unique identifying number. In the case of most US persons, an identifying number is probably going to be a driver's license and driver's license number. Other types of acceptable identification include a US passport. So imagine the complexity of pulling all of that data together, home address, date of birth, full legal name, driver's license number, and a photocopy of driver's license. Highly personal information, not the kind of information we ordinarily share with other people, we think of it as a precursor to identity theft, so we keep it confidential. But somehow every reporting company that is not exempt is going to have to pull together all of that data for the company applicants, lawyers, paralegals, and others who are involved in filing a document, and then for every beneficial owner. Now, who is the beneficial owner? Ah, now things get even a little bit more complicated. The statute and the regulations that FinCEN has released so far, defined a beneficial owner as an individual, has to be a natural person, who either owns or controls 25% or more of the reporting company, or who otherwise exercises substantial control over the entity. There are carve outs for certain types of individuals, individuals who would be a beneficial owner, but we are going to exclude them from reporting for a special purpose. Those five categories of excluded entity include; a minor child, we're not gonna include their information, an individual who is acting as a nominee, intermediary, custodian, or agent on behalf of another individual, that other individual of course is going to be covered, we're gonna have to include them. We also will exclude an individual who is acting solely as an employee of a corporation, limited liability company, or other similar entity whose control over or economic benefits from the reporting company are derived solely from the employment status of the person. So imagine for example, corporation X is a shareholder of reporting company. Joe Johnson is the secretary of corporation X, and in that capacity, Joe Johnson signs documents, we would not include Joe Johnson in his personal capacity as a beneficial owner of the reporting company, because he is only an employee of corporation X. Somewhere up above the chain of ownership, however, there will be individual natural persons, their ownership of corporation X could cause them to be beneficial owners of the reporting company. We're also going to exclude, from the definition of beneficial owner, any individual whose only interest in the reporting company is through a right of inheritance. So beneficial owner of a company transfers their shares in reporting company to beneficiary through a will, beneficial owner dies, other individual takes the shares of the reporting company through inheritance, that person who takes by inheritance does not need to file as a beneficial owner, they're gonna be excluded. And finally, the fifth category of excluded beneficial owner is a creditor of a corporation or other reporting company, unless the creditor is a beneficial owner for some other purpose. Often in financings, for example, you'll find that corporation borrows money, shareholders of corporation pledge their stock in corporation to the lender as collateral for the loan. If the loan defaulted, creditor foreclosed on that stock in satisfaction of the loan that was defaulted, corporation would not become a beneficial owner as a consequence of that foreclosure. So the beneficial owners of course then are now individuals with 25% ownership or more, or who exercise substantial control, setting aside the ones who are excluded. So what does substantial control mean? Well, now things really get to be fun. The statute did not give us a whole lot of definition on this term, substantial control. FinCEN in December of 2021 gave us some draft regulations. They were open for comment for about 60 days. The comment period closed up in February and so far, as of the middle of 2022, FinCEN has not told us whether those draft regulations will become final, whether they're going to be modified, or exactly when FinCEN expects to finalize regulations for the CTA. But in the draft regulations that we saw in December of '21, there was a definition of substantial control that really covered the waterfront as it relates to controlling an entity. The regulation said that substantial control would include a service as a senior officer of the reporting company, it would include having the authority over the appointment or removal of any senior officer, it would also include the direction, determination, or substantial influence over important matters affecting the reporting company, including a laundry list of things such as reorganization and merger of the reporting company, major expenditures of the reporting company, termination of lines of business, compensation schemes and incentive programs and other substantial transactions. So let's apply this definition of substantial control to the types of transactions we often see in business. Imagine a limited liability company that might have a handful of different owners. One of those owners, let's say is a corporation. The corporation only owns 20% of the LLC, which is our reporting company. So it's under the 25% threshold, and it would not be a beneficial owner by virtue of the 20% threshold. However, in the written operating agreement for this LLC, there's a paragraph that says major decisions, and that paragraph reads something like, "Not withstanding anything else in this agreement, the limited liability company is not allowed to engage in any of the following transactions without the consent of the corporation that owns the 20%." They effectively have a veto right. And let's assume that laundry list of transactions over which the corporation has a veto right, include things like entering into a merger, acquiring the assets of another company, raising additional funds, borrowing more than so much money, borrowing funds and imposing a lean on the assets of the company. These are our all very typical garden variety minority consent provisions that you often see in the operating agreement for a limited liability company. So, that operating agreement is in place, our corporation, it owns only 20%, but it has a veto right over all those major decisions. I think as those December '21 regulations were drafted, that 20% corporation would have substantial control by virtue of those veto rights. So if we were trying to do a beneficial ownership report for the reporting company, we would need to include the corporation as a beneficial owner, because of its veto rights. But wait you say, the beneficial ownership report doesn't allow us to report the names of corporations, we have to report the names of natural persons. Well then who are the beneficial owners of the corporation who need to be included in the beneficial ownership report of the reporting company? Because they have substantial control by virtue of the corporation's veto rights over the reporting company, you'd have to look up the chain. You would have to go through a beneficial ownership analysis with respect to the corporation to figure out who the natural persons are that have substantial control of that corporation. Because those individuals in turn, have substantial control over the LLC reporting company. That's the heart of it. That's how complicated this will be, because for every entity, every corporation and LLC who is going to have to file beneficial ownership report, lawyers, accountants, and the business people who are in charge of these things are going to have to undertake this substantial control analysis, looking all the way up the chain of ownership. And at each chain, each step in the process, asking themselves who are the natural persons who have substantial control? And those natural persons will then have to have their PII included in the beneficial ownership report for the reporting company when it files. Now, I mentioned earlier, when we talked about the definition of reporting company, and how it related to individuals that were formed by the filing of a document with the secretary of state, that there were some reporting companies that were exempt. Let's talk briefly about what the exemptions are. The exemptions from the duty to file a beneficial ownership report relate very clearly back to the ultimate purpose of the Corporate Transparency Act. Remember the Corporate Transparency Act exists to fight money laundering. Congress wanted to eliminate the idea of anonymous corporations. They wanna know who the individuals are, who stand behind corporations, so that if they suspect that there is money laundering going on, they can identify an individual and bring that person in for questioning. So if there is a business corporation, that is already known to the government or whose beneficial ownership is already a matter of public record somehow, you don't really need to have a beneficial ownership report from that company. And that's where the exemptions come from. The exemptions which are built into the statute itself are roughly 23 different categories of entity, where the beneficial ownership of the entity is already known to the government, or is already a matter of public record. So just to list a few, insurance producers and insurance companies already regulated by state insurance commissioners, they do not have to file beneficial ownership report, they are statutorily exempt. Regulated commodity brokers, pooled investment vehicles. These sorts of specialized security entities that are subject to regulation one way or the other, have their own statutory exemption. Public accounting firms, which is defined not just as an individual who is an accountant, who has a firm, but is an accounting firm who has been licensed by the PCAOB to do accounting for public companies, they go through a rigorous identification and qualification process, public accounting firms are exempt and do not need to file. Public utilities, your power company, your water company, your light company, regulated in each case by a state public service commission or public utility commission, they are exempt. 501 and other charitable entities who are not for profit entities, according to the IRS, which means that they have filled out forms, they've applied for nonprofit status, that nonprofit status has been granted by the IRS, they are also all exempt. Let's talk about some of the more interesting, unique and perhaps problematic exemptions. There is an exemption that FinCEN has called the large operating company exemption. I'm not sure that that's a great word for it, because a lot of these companies are not gonna be so large. I kind of like to call them grandfathered private companies, but whether you call them large private companies or grandfathered private companies, this statutory exemption relates to a company that has three things. Number one, they employ more than 20 employees on a full-time basis, in the United States. Number two, have filed federal income tax in the previous year, demonstrating more than $5 million in gross receipts, including sales that are made to subsidiaries and affiliates, and have a physical office in the United States. Okay, those three things, 20 employees full-time basis, filed federal income tax with $5 million in sales or more, and has a physical office in the United States. If a reporting company meets those three things, it is exempt. Now what's the rationale for this exemption? The rationale is, any company that's that big is gonna be have other documentation that is filing with the government, that's going to allow law enforcement to figure out who's behind the company if they need to do an investigation for money laundering purposes. Imagine your local pizza parlor, for example. Pizza parlor, let's say it has 22 employees, everything from the people who make the pizza, the accountants, the owner, the wait staff, and so on, 20 employees. For every one of those employees, there's gonna be a W2 form, there are going to be employee withholding forms filed every time they run payroll, there's gonna be a fairly robust paper chain, paper trail, audit trail, showing individual human beings, moving money around for the corporation. Those are gonna be the ones who get called in for questioning if there's a money laundering question. This is a pretty substantial pizza parlor, they've filed tax returns that have shown gross receipts more than $5 million. It's a real business, it's not a made up or a sham business. They have a physical office in the United States. Well, the pizza parlor. If we wanna know who's in charge, we could send the FBI down to the pizza parlor, ask the cashier who's the boss, who's in charge here? And get to the bottom of things, conduct an investigation. That's your grandfathered private company, your large private company exemption from the beneficial ownership requirement. I said that this was a potentially problematic exemption, and here's why. For some of the edge examples, you could have a situation where an entity was exempt one year, but not exempt the following year. Let's imagine our pizza parlor has 21 employees, there's a downturn. They have to lay off some of the wait staff. So in their second year of operation, they only have 19 employees. Oh, they're not exempt anymore. Now this formerly exempt entity, which did not do a beneficial ownership report, has to be aware of the fact that it's no longer exempt, and it does now have to file a beneficial ownership report, based on the timing rules, which we're gonna talk about in just a few minutes, this company could be in a lot of trouble if they don't realize the fact that they have lost their exemption, or if they realize that fact too late, and they fail to get their beneficial ownership report filed within the time required. We also mentioned charitable organizations, they are exempt under the CTA. There's also an exemption for wholly owned subsidiaries of otherwise exempt entities. Importantly, this exemption crosses all the different categories of other exemption types. We mentioned public accounting companies are exempt. If a public company, a public accounting company has a wholly owned subsidiary that for example, processes tax returns, or does some other sort of service that wholly owned subsidiary is exempt, regardless of what it does. I might not have mentioned earlier, publicly traded companies, also exempt. In this case, the regulation defines publicly traded as one who is subject to the filing requirements of the Securities Act, Securities and Exchange Act of 1934. So it could be both NASDAQ, NYC, and other companies that are subject to the 34 Act, they are exempt. Many public companies have numerous wholly owned subsidiaries for different purposes. Each one of those wholly owned subsidiary of a public company is gonna be exempt from filing a beneficial ownership report. But, here's a way that could become problematic or troublesome. Imagine publicly traded company has a wholly owned subsidiary, and for business purposes, the public company does a deal with somebody else in which that other partner is going to engage in a joint venture, and as partial consideration for their work, they are going to get a small percentage interest in the formerly wholly owned subsidiary of the public company. Wow, here we go. That wholly owned subsidiary was exempt before, but now, now that a partial interest has been granted to someone else, it is no longer 100% wholly owned by a public company. That subsidiary now has an obligation to file its beneficial ownership report, if the responsible parties are not aware that its status have changed, or sufficiently unaware of the requirements of the Corporate Transparency Act, they might not realize that they have a duty to file, they could fail to file on time, and there are gonna be consequences as a result of that. So we talked about the consequences of failing to file, and missing the deadlines. Let's talk for a minute about what those deadlines are, and how we're gonna keep track of them. We mentioned that the Corporate Transparency Act was adopted by Congress in December of 2020. It was initially vetoed by President Donald Trump, and not long after a bipartisan super majority on the Congress and the Senate overrode President Trump's veto. So the bill became law. It had fairly broad bipartisan support, and it remains a law today. All of the law's requirements, however, are inactive until FinCEN finalizes its regulations. Mentioned earlier that FinCEN has given us some draft regulations that came out in December of 2021, but they have not yet become final. FinCEN has not yet told us when they will become final. But presumably at some point, FinCEN will finalize the regulations, there will probably be some fanfare. I would expect that business television shows are going to talk about all the changes that are gonna come out of this law, and we will eventually have an effective date of the regulations. That effective date is gonna be our marker for many of the timing rules in the CTA. The statute provides, and the draft regulations also say that a beneficial reporting company that exists before the effective data of the regulations does not need to file its first report until the first anniversary of the effective date of the regulations. So let's imagine the effective date was September 1, 2022. Any company in existence before September 1 of '22 would have until September 1 of '23, to get that first report done. Okay, not bad, you'd have 12 months to figure things out, get your ducks in a row, get your report on file. But any entity created after the effective date of those regulations, in like hypothetical, September 2 of '22 or thereafter, that entity has only 14 calendar days from the date that it is formed to get its first report on file. Now, as a practical matter, this is a huge change in procedure. For transactional lawyers like me, it is not uncommon to get working on a deal. Perhaps you have a term sheet and you're just getting started on the transactional documents, you probably have a draft org chart. You might go out and form all the LLCs and corporations required in order to have this new joint venture, this new financing transaction, whatever it might be, file the entities first, we don't even know who the beneficial owners are gonna be yet, but we'll get those documents on file just to check them off our list, get them outta the way. Can't do that anymore. Once these regulations go effective, filing that document with the secretary of state is going to start a 14 calendar day clock ticking by which time the first beneficial ownership report needs to be filed. So that won't work. In the future, once the regs take effect and we have an effective date, transactional lawyers are gonna have to be aware of this requirement, and are going to have to have the beneficial ownership report completed or nearly complete before the articles are filed in order to ensure that the beneficial ownership report is timely. Now what's the penalty for getting it wrong? Well, here's where things really get difficult. There is a statutory $500 per day fine for failing to file a beneficial ownership report when it is due. So in the case of a new deal, somebody slips up and they file their articles early, the deal doesn't get done for another 30 or 40 days. And it's not until sometime after that, that somebody realizes, oh no, we forgot to file the beneficial ownership report, it gets done 90 days after the date of filing, there could be effectively 75 days of $500 fines. But that's only the beginning of it. The $500 per day fine is for an inadvertent failure to file. A willful knowing or intentional failure to file or a willful knowing or intentional file of any filing of any incorrect or misleading information is a felony. This law has some teeth. These teeth makes sense. If you think about the ultimate purpose of the CTA, which is to fight money laundering. Criminal organizations engaged in money laundering are already criminal organizations. They know they're criminal organizations. They don't have a problem lying. They don't have a problem doing things far worse than lying. So if you're going to enforce this law on criminal organizations, as well as all the rest of us, non-criminals, you're gonna have to put some teeth in your law. And that's why the CTA makes it a felony to willfully file false or willfully fail to file the information required in the beneficial ownership report. But wait, it gets worse. We talked about the PII that needs to be included in every reporting company's beneficial ownership report. For every company applicant, and every beneficial owner, that PII includes full legal name, date of birth, residential address, unique identifying number, which is driver's license or passport, and then an image of that driver's license or passport. Imagine a reporting company that successfully files on time it's first beneficial ownership report, which includes all of that information for all of those individuals. The next day, one of those individuals realizes that their driver's license needs to be renewed. They go down to the DMV, have their picture taken, get their nice, shiny, new driver's license. What are the implications of this? Well, the CTA says that any reporting company has a duty to file an amendment to its beneficial ownership report within 30 days after any item of previously reported information changes. So in our hypothetical of a reporting company that files its report and the very next day, one of the beneficial owners gets a new driver's license. If that old driver's license had been included in the image file submitted with the original beneficial ownership report, the company now has 30 days from the date that driver's license was renewed to file an amendment. This is going to be highly problematic. Just imagine how many reporting companies there will be, and all of the individual beneficial owners involved, almost all of whom are gonna have passports and driver's licenses. In many states, your driver's license gets renewed every three, four, five, or six years. So you could very easily have individuals updating driver's licenses with some frequency. How are the individuals going to remember that their driver's license is now a key that triggers a reporting duty on an LLC or corporation where they are a beneficial owner? Very difficult to keep track of that. And even more difficult for the reporting companies themselves to be aware of those sorts of changes in data for all their beneficial owners. Imagine your standard LLC that was formed as part of a structured financing, for example, that have 20 different beneficial owners. The work for structuring the LLC, creating the operating agreement, even preparing that beneficial ownership report was probably done by a team of lawyers at a law firm. Maybe several teams of lawyers at several different law firms. They might know the name of their individual client, they might even have personal relationships with some of the key players at the individual client, but they probably don't have the same sort of personal knowledge of the individuals involved up and down the chain of ownership who would be included in a beneficial ownership report. Those individual lawyers won't have any ability to know when someone's driver's license changes, when someone's passport changes, when someone's home address changes. This law requires the individuals who are covered by the beneficial ownership report to be aware of the need to update their data with all of their LLCs and corporations, and to remember to file the amendment. Remember $500 per day fine if you get it wrong, and risk a felony conviction, if FinCEN thinks that you did it in a willful, intentional, or knowing manner. So it's going to be quite a challenge for lawyers, for business people, for investors, to keep track of these new requirements and to comply with them. The good news is that there is a self harbor, excuse me, a safe harbor and a self-correction mechanism that is built into the statute itself. Again, think back to the purpose of the CTA. Congress wants FinCEN to build the world's biggest database of reporting companies. Importantly, in the draft regulations, FinCEN did a data analysis to try to count how many entities are probably involved in the reporting process. Did a whole bunch of math to count how many corporations are formed every year, looked at each different state, tried to do a head count, tried to exclude how many of those entities are probably exempt, either because they're public, or they're nonprofits, or they're public utilities, or they're otherwise regulated, and so on and so forth. Bottom line is FinCEN's best guess is that there are 25 million entities in the United States who are going to have to file a beneficial ownership report. FinCEN doesn't wanna spend its time running around, imposing $500 per day penalties or sending people to jail for failing to fill out the form the right way. That's not why they exist. They exist to build the world's biggest database so that they can go fight money laundering and find out who the ultimate owners are of organizations that they expect might be laundering money. So the statute has built into it, a safe harbor, and that is, after a beneficial ownership report is filed, if the company within the first 90 days figures out that something was wrong, they're allowed to refile. There's a no harm, no foul rule if you catch the penalty within the first 90 days, or rather if you catch the error within the first 90 days. There's a duty to identify what the error was, and why it was the error made. But apart from that, you're able to turn yourself in, amend the original erroneous filing, and there won't be a fine, there won't be a jail time, there won't be a penalty for that. As you might imagine, the safe harbor only exists for truly accidental failures if FinCEN thinks you're lying about it being an accident, that you may have done something willfully, you're still at risk, so this is not going to excuse anyone's intentional wrongdoing, but this does give you a little bit of leeway for the occasional accidental mistake. Nevertheless, because the penalties can be so severe, you know, we're talking about a felony here, I think that most people are going to pay great attention to these filing deadlines. So what are some of the practical effects of the Corporate Transparency Act, and how is it going to change the practice of transactional lawyers in the United States? Well, number one, I think every transactional lawyer in the United States needs to be aware of the Corporate Transparency Act and what its requirements are. Everything from what is a reporting company, who is exempt, what needs to be included in a beneficial ownership report, and when is the beneficial ownership report required to be filed, when is it required to be amended? These are things that we're all going to have to be very familiar with, because we're gonna have to be describing them over and over again in some cases with all of our clients for the next several years, as we all begin to learn the new status of corporate governance in the United States. Next, almost every private company, whether it's a corporation or LLC, is going to have to adopt a new shareholders agreement, a new operating agreement that includes provisions to accommodate CTA filing. I think every reporting company should identify an individual who is going to be the compliance officer, who's duty, it's going to be to remind everybody about the duty to keep the company updated. They are gonna have to be confidentiality provisions and duty to report provisions included in constituent documents, so that owners of the company, corporation or LLC have a duty to give their PII to the company. And in the usual course of dealing today, that duty doesn't exist. Once you put your money in, you sign your subscription agreement, you become a shareholder of the corporation, your job is done, you don't need to tell the corporation anything. Well, that isn't gonna work anymore. Individual shareholders of a corporation are gonna have a duty to keep their corporations informed about their residential address and all the PII that's included in their report. It's going to be a lot of paperwork for a lot of lawyers to amend the operating agreements and the shareholders agreements of millions of corporations to accommodate that sort of new corporate governance. And finally, on a very practical level, I think that lawyers and business people need to develop new technology systems to keep track of their data and to make it possible for them to facilitate compliance. That's one of the reasons that I put this presentation together, because I am the co-founder of a company called, the "FinCEN Report Company." You can find more information about us on our website, fincenreport.com. That's F-I-N-C-E-Nreport.com. And what we have built, is a software tool that allows lawyers and business owners to collaborate in a secure manner so that they can pull together the data required to file a beneficial ownership report, and to keep that data safely stored. The site is up and running today, and it's free to individuals. You can go out and try it now. Go to fincenreport.com, look for the black button that says, start here, click on that button and create your own free personal account. We're gonna ask for your name, your address, some other personally identifiable information, and that data is gonna get stored in an encrypted format in our system. Our system is hosted by a secure backend provider on an encrypted server, the same sort of encrypted server that banks use when they have their own websites for online banking. So that data is secure. You are gonna own your own individual data, and no one else is going to be able to see it. You'll be able to change it at any time you want, you can disable or delete your account at any time you want. But once you create your individual account, you will be able to use it for every reporting company for whom you are a company applicant or a beneficial owner. So let's imagine you create your free individual account today. You remember next week that you are a member of an LLC. You mentioned this to your co-investors, and everyone decides that they're going to create their own free accounts at fincenreport.com. And then someone says, okay, I'll raise my hand, I will be the reporting person for the LLC, I'm gonna create an account for our LLC. The LLC will create its own account. Again, it's still free. The LLC will then be able to designate, by name and email address, all of the individuals that are the beneficial owners of the company. They will also be able to designate who were the company applicants of that company. The system will then send a message to each of those individuals, beneficial owners and company applicants, asking them if they will give permission to have your LLC include their PII in the LLC's beneficial ownership report. Individuals who say yes will have their data included. And the person who's preparing the report will know that the data has been included, but won't physically be able to read that data. So in your example, they'll know that you've said, yes, they'll know that you've completed all the blanks and that the relevant data for all of your blanks are included in the company report, but they won't actually know your home address, your date of birth, all those other pieces of PII. Once FinCEN gives us final regulations and we're able to file our first beneficial ownership report, the FinCEN Report Company will file that report for you. At this point, we're gonna charge an annual subscription fee to the LLC. The LLC can pay that online with a credit card and then press the button to file the report. We'll then do the rest. The FinCEN Report Company will compile that report, file it with FinCEN, we're gonna get back a filing receipt, we're gonna save all of that in a secure data locker inside the company report. This way, at some point in the future, if the company is successful and there is a strategic exit, and as part of the due diligence process, the acquiring company is going to want to know that the beneficial ownership reports were filed correctly and filed on time, and the data trail, the audit trail will be there in the account to provide as part of due diligence. We talked about how tricky it is when data changes, FinCEN report company takes care of you there as well. After the initial beneficial ownership report is filed, if any individual changes any of their PII fields, home address, driver's license, any of those things, the individual will make the change in their own personal account, all still remains confidential, but the system is then going to automatically notify every reporting company to whom that individual is connected either as a company applicant, or as a beneficial owner. The message will tell the reporting company, this individual has had a change in an item of previously reported information. This triggers a duty on your part to file an amendment. Would you like to file that amendment now? The individual who controls the company account will be able to say yes, our system will automatically compile the amendment, file the amendment with FinCEN, save the receipt, to prove that you filed correctly and on time. If the individual has updated their data within the 30 day window, the company will have plenty of time to file that amendment, and that amendment will be free. That'll be included in the annual subscription fee that has already been paid. That's why we structure this as an annual subscription. The fee starts when you file the first report, and it covers all the amendments you need for an entire period of one year. If the system is working and you wanna continue it, the reporting company will be able to repeat and continue their subscription on each anniversary thereafter. Without this sort of a system, quite frankly, I don't know how lawyers and active business people are going to be able to manage the flow of data. I tell people often that I went out and did a search of the Georgia secretary of state database because I practice here in Atlanta, and I was able to figure out that I was connected to more than 350 LLCs and corporations formed in the state of Georgia. And that doesn't even include all the ones I've done in Delaware, other states around the country. Well, because I've been involved in the formation of those entities, I am a company applicant for hundreds of companies, more than 350 here in Georgia. It would simply not be feasible for me to somehow give out my personal information and driver's license to those 350 corporations, assuming that all of them even remembered that they had a duty to file a beneficial ownership report. The flow of data would just be impossible. Putting it another way, let's imagine that those 350 companies are all aware of this change in the law, and they all write to me, let's say, caught right by email. And they say, "Jonathan Wilson, we need you to file our documents, we've taken the liberty of photocopying all of our driver's licenses, and here they are." Oh my goodness, can you imagine the struggles it would be to try to take that data and save it in sort of in some side of sort of knowledge management system here at the law firm? Hardly any law firms in the US have that sort of a system for the secure storage of data in a protected way. Documents in law firms are stored in a way that can be accessed by anyone in the law firm. So your driver's license would be viewable by every attorney, every paralegal, every staff person in the law firm. That's not secure. You wanna have the data stored, you wanna have it accessible by the right persons, but you don't wanna have it accessible by persons who don't have a need to know it. And that's the solution that the FinCEN Report Company has come up with. The data is encrypted, and safe, and stored. In our service, we create a data field, a compliance trail that shows when and how it was changed, and how it was reported, and when that was. But it's only ever viewable by the individual who created it. The data remains secure in perpetuity, and that's why we created the FinCEN Report Company. So check us out at fincenreport.com, That's F-I-N-C-E-Nreport.com. And if you are interested more information, please reach out to me. Again, my name is Jonathan Wilson, you can reach me at [email protected], and this has been my presentation on the Corporate Transparency Act. I appreciate you attending, I hope this has been helpful, and if you'd have any other questions, feel free to reach out to me, I'd love to hear from you. Thank you very much.

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1h 28s

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