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Expanded Beneficial Ownership Reporting and AML Duties Under the Corporate Transparency Act

Second of a Two-Part Blog: Anti-Money Laundering Programs Coming to the Legal Profession?

Yesterday, we began our discussion of the proposed Corporate Transparency Act of 2017 (the “Act”), and observed that, if passed, the Act would represent another chapter in the domestic and global campaign to increase transparency in financial transactions through information gathering by private parties and expanded requirements for Anti-Money Laundering (“AML”) reporting. Today, we summarize the details of this complex legislation, focusing in particular on two significant ways in which the Act would amend the Bank Secrecy Act (“BSA”):

  • Requiring regulations to establish minimum standards for State procedures regarding the formation of legal entities such as corporations and limited liability companies (“LLCs”) and the identification of the beneficial owners of such entities when they are formed.

  • Adding “formation agents” – i.e., those who assist in the creation of legal entities – to the BSA’s definition of a “financial institution” which is subject to the BSA’s reporting and AML obligations. This new definition potentially applies to a broad swath of businesses and individuals previously not regulated directly by the BSA, including certain attorneys.

man, spying, window, AML, BSA

Beneficial Ownership Reporting Under the Act

The Act would amend the BSA to direct the U.S. Department of the Treasury to issue regulations establishing minimum standards for State formation procedures. The standards would include requiring corporations and LLCs under the laws of the State to file information about their beneficial owners with either the State or a “formation agent” (as discussed below) and complying with certain information sharing, disclosure, and record retention requirements. Under the Act, if a State’s formation procedures do not meet these minimum standards, then corporations and LLCs formed in that State would be required to provide the Financial Crimes Enforcement Network (“FinCEN”) with the same degree of information that would be required in a State with satisfactory procedures.  Thus, if a State does not satisfy the Act’s minimum standards for disclosure and transparency, then anyone forming a legal entity in that State must report directly to FinCEN.  The practical effect would be: States no longer would be able to offer anonymity to the beneficial owners of legal entities. Accordingly, the hallmark and driving force of this portion of the Act is the minimum standard which it would set for the States’ collection of beneficial ownership information. Specifically, and unless a legal entity is exempt, the Act would require corporations and LLCs formed under the laws of a State to provide the State or a formation agent with: (1) a list of beneficial owners; and (2) for each beneficial owner, the name, current address, and non-expired U.S. passport or State-issued driver’s license number (collectively, “Beneficial Ownership Information”). Absent an exception, a person is a “beneficial owner” under the Act if the person, directly or indirectly, either (1) “exercises substantial control over” or (2) “has a substantial interest in or receives substantial economic benefits from the assets of” a corporation or LLC. (Note that the Act uses a different definition than FinCEN’s final CDD rule, which defines “beneficial owner” to mean “each individual who owns, directly or indirectly, 25 percent or more of the equity interests of the entity, and one individual with significant responsibility to control, manage, or direct the entity.” The Act lacks a bright-line threshold of 25 percent for the definition’s ownership prong, and to that extent is both more ambiguous and potentially broader. See our practical guide and discussion of FinCEN’s final CDD rule hereand here.) The Act also would require corporations and LLCs to annually file Beneficial Ownership Information with the State and to update Beneficial Ownership Information not later than 60 days after the date of any change thereto. To meet the qualifying standard, States would be required to retain Beneficial Ownership Information relating to each corporation or LLC for at least 5 years after the date that the corporation or LLC terminates under the laws of the State. Beneficial Ownership Information collected by a State would have to be provided by the State in response to (1) a government subpoena or summons; (2) a written request by FinCEN; (3) a written request made by a financial institution, with customer consent, as part of the institution’s compliance with its due diligence requirements under the BSA or other laws; or (4) a written request by a Federal agency on behalf of another country under an international treaty.

corporations, LLCs, beneficial ownership disclosure

As noted, the Act exempts certain legal entities from the definition of corporations and LLCs subject to the beneficial ownership disclosure obligations. Exempt entities include registered issuers of securities; depository institutions; credit unions; bank holding companies; registered broker dealers; registered investment companies and investment advisors; insurance companies; public accounting firms; public utilities; tax-exempt organizations; and “any business concern” with over 20 full-time employees, filed U.S. income tax returns reporting over $5 million in gross receipts, and an operating physical presence and office in the United States.  In other words, if the government already can keep track of you, or if you are big enough to clearly represent a “legitimate” business rather than a possible shell company, then you are exempt. The Act imposes civil penalties of up to $10,000 and criminal penalties of up to three years in prison for those who:

  • knowingly provide, or attempt to provide, false or fraudulent Beneficial Ownership Information;

  • willfully fail to provide complete or updated Beneficial Ownership Information; or

  • knowingly disclose the existence of a subpoena, summons, or other request for Beneficial Ownership Information, except under certain limited circumstances.

Formation Agents – A Whole New Class of Persons Subject to the BSA

A significant aspect of the Act is its treatment of “formation agents.” In lieu of having to directly collect Beneficial Ownership Information from corporations and LLCs, the Act would permit a State to establish a formal licensing system, which must meet certain requirements, whereby “formation agents” could be licensed to collect the Information on the State’s behalf. More importantly, the Act would amend the BSA’s definition of a “financial institution” under 31 U.S.C. § 5312(a)(2) to include formation agents. Specifically, the Act defines a “formation agent” as “anyperson who, for compensation . . . acts on behalf of another person to form, or assist in the formation of, a corporation or [LLC] under the laws of a State; or . . . purchases, sells, or transfers the public records that form a corporation or [LLC].” (emphasis added). This definition is incredibly broad and potentially could apply to a host of businesses and individuals that provide entity formation services, including, for example, registered agents, corporate filing services, accountants, and lawyers. By including formation agents under the BSA’s definition of a “financial institution,” the Act could subject businesses and individuals previously not regulated directly by the BSA to AML and reporting obligations. Although the Act leaves it in the hands of the Treasury to limit potentially the “formation agent” definition through its rulemaking, the text of the proposed statute itself contains no such limits.

Lawyers With AML Duties?

In regards to attorneys involved in forming corporations and LLCs, the Act has an interesting wrinkle. The Act provides that, within 120 days of its enactment, the Secretary of the Treasury must publish proposed regulations requiring “formation agents” to “establish anti-money laundering programs under subsection (h) of section 5318” of the BSA.  That means that the Act will require that formation agents be subject to the burden of creating and maintaining an AML program; designating an AML compliance officer; having an ongoing AML employee training program; and undergoing independent testing of the AML program.  However, “any attorney or law firm” is exempt from the anticipated Section 5318(h) regulations . . . but only if the attorney or law firm “uses a paid formation agent operating within the United States to form the corporation or limited liability company.”  Thus, if a lawyer or law firm directly performs the formation of entities, then they must have an effective AML program, just like a bank.  If the law firm instead uses a third party, then the third party will have to maintain an AML policy. Someone involved in the formation process must perform AML.  The goal of this exception seems to prevent the use of attorney-client privilege and the attorney work product doctrine from cloaking the details of the formation process – an alleged tactic at issue in the Panama Papers scandal. Finally, using a third party does not necessarily divest a business entirely of any potential legal risk, as users of third-party vendors have discovered in a variety of contexts.  Law firms involved in forming entities still may find themselves on a legal hook, even if the third-party formation agent is the business which is directly subject to an AML program obligation. In addition, the BSA imposes lots of other potential duties other than “just” AML programs under Section 5318(h) – such as the duty (after FinCEN finalizes the relevant regulation specific to the particular financial institution) to file needed Suspicious Activity Reports (“SARs”). The Act contains no exceptions for lawyers in regards to these other obligations under the BSA, and the existence of the limited exception for lawyers noted above means that the crafters of the Act clearly have considered that lawyers can be subject to the BSA as “formation agents.”  Of course, the notion of U.S. lawyers having to file SARs in regards to their own clients is anathema to traditional concepts of confidentiality and the duty of loyalty in the U.S. legal profession.

Of course, the notion of U.S. lawyers having to file SARs in regards to their own clients is anathema to traditional concepts of confidentiality and the duty of loyalty in the U.S. legal profession.

As noted in a guest blog here by attorney Bruce Zagaris, growing international trends have led the Task Force on Gatekeeper Regulation and the Profession of the American Bar Association (“ABA”) to consider a new Model Rule of Professional Conduct that would impose basic “client due diligence” requirements on U.S. lawyers to determine whether their clients are engaging in money laundering or terrorist financing. These international trends, noted in the first installment of this blog series, include the Financial Action Task Force (“FATF”), an intergovernmental body which makes and oversees compliance with international money laundering standards, generally giving high marks to the U.S. for AML efforts, but also finding that the U.S. is “non-compliant” when compared to other countries in regards to gatekeepers and entity transparency.  The European Parliament also has examined the concept of lawyers as gatekeepers. However, a Model Rule of Professional Conduct creating ethical standards for due diligence procedures is quite different, and much less onerous, than actual legislation and regulation requiring concrete reports to the government under threat of potential civil and criminal sanction. Indeed, the ABA Task Force on Gatekeeper Regulation and the Profession has indicated strongly that it opposes “gatekeeper legislation” such as the Corporate Transparency Act and similar proposed legislation. The Task Force summarizes the reasons for its opposition as follows:

  • The bills would undermine the attorney-client privilege, the confidential lawyer-client relationship, and traditional state court regulation of the legal profession.

  • The bills would also impose burdensome, costly, and unworkable beneficial ownership reporting requirements on small businesses, their lawyers, and states.

  • The burdensome and intrusive new reporting requirements in the legislation are unnecessary because the federal government, financial institutions, and the legal profession have developed other more effective tools.The Act is merely proposed legislation and might never be enacted. Further, even if the Act is passed, FinCEN still would have to propose and finalize supporting regulations, which could be more nuanced and less categorical. Nonetheless, the potential AML obligations of perceived gatekeepers – such as attorneys, formation agents, accountants, real estate agents, and trust and company service providers – represents a conversation which does not seem to be going away.

Copyright © by Ballard Spahr LLP

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About this Author

Juliana Gerrick, consumer finance law, finance associate, Ballard Spahr, Washington DC
Associate

Juliana Gerrick is an associate in the Business and Finance Department and a member of the Consumer Financial Services Group. Her practice focuses on providing regulatory advice to clients on state and federal consumer finance laws. She regularly assists clients with a range of compliance and transactional issues relating to the Truth in Lending Act (TILA), Equal Credit Opportunity Act (ECOA), Americans with Disabilities Act (ADA), Servicemembers Civil Relief Act (SCRA), Fair Credit Reporting Act (FCRA), Fair Debt Collection Practices Act (FDCPA), Electronic Fund Transfer Act (EFTA),...

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 Peter D. Hardy, Ballard Spahr, Philadelphia lawyer, White Collar Defense lawyer, Internal Investigations, Consumer Financial Services, Privacy and Data Security, Tax
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Peter Hardy advises corporations and individuals in a range of industries against allegations of misconduct—including tax fraud, money laundering, Bank Secrecy Act, mortgage fraud and lending law violations, securities fraud, health care fraud, public corruption, Foreign Corrupt Practices Act violations, and identity theft and data breach.

Mr. Hardy has extensive trial and appellate court experience. He oversees internal investigations, advises in potential disclosures to the Internal Revenue Service, and has litigated complex criminal matters at the trial and appellate levels. He also counsels clients through every stage of a tax controversy – from audit through administrative appeal to litigation and collection.

Before entering private practice, Mr. Hardy spent more than a decade as a federal prosecutor. He served as an Assistant U.S. Attorney in Philadelphia, where he focused on fraud and tax cases. He also served as a trial attorney for the Department of Justice’s Tax Division in Washington, D.C., where he tried cases in a number of federal districts and helped write the Department's Criminal Tax Manual.

A national thought leader on the subject of criminal tax and money laundering law, Mr. Hardy is the author of  Criminal Tax, Money Laundering, and Bank Secrecy Act Litigation, a well-reviewed and comprehensive legal treatise on the litigation of criminal tax, money laundering, and Bank Secrecy Act cases, published by Bloomberg BNA. He also serves as an adjunct professor at Villanova University School of Law, where he teaches a class on criminal and civil tax penalties in the graduate law program.

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