The U.S.’s New Law To “Ban” Shell Companies

The new U.S. Corporate Transparency Act (CTA), which passed in late 2020 as part of the National Defense Authorization Act, makes seemingly significant changes to the information required when incorporating a company in the U.S.

While the legislation is a significant step in the right direction and should be applauded, it can be viewed more as a means of reducing the current level of money laundering, tax evasion, and limiting the scope of debtor evasion of judgments, rather than a significant step toward extinguishing it.

This is partly because U.S. authorities are starting from such a low baseline that a significant improvement is easy to make. Like most ultimate beneficial owner (UBO) legislation, the devil is in the details, not just of the legislation, but in its practical implementation.

Purpose of the CTA

In many states within the U.S., it is all too easy to open a shell company to hold assets and pass-through funds without informing the authorities of the true ownership structure behind it.

As noted in the legislation (sec. 6402, Sense of Congress), the aim is to prevent U.S. companies from being used for nefarious purposes, such as:

“The financing of terrorism, proliferation financing, serious tax fraud, human and drug trafficking, counterfeiting, piracy, securities fraud, financial fraud, and acts of foreign corruption, harming the national security interests of the United States and allies of the United States.”

Now, those incorporating in the U.S. will largely need to provide details of true UBOs to certain agencies with supervisory duties, and to institutions with anti-money laundering obligations at the incorporation stage. If this ownership subsequently changes, there is an obligation to update these records. This duty to update information regularly is important to ensure the register is kept up-to-date and that a nominee is not put forward initially, with the shares then transferred shortly thereafter to a true UBO.

With the above aim in mind, it is unsurprising that I expect the legislation will fail to achieve its purpose from a practical perspective. It is a good start at closing the net on those who abuse the corporate structure system. It is also important to note that there are some exceptions to the legislation.

What is a UBO under the CTA?

In section 5336(3) of the CTA, it defines a UBO widely:

“The term ‘beneficial owner’—

‘‘(A) means, concerning an entity, an individual who, directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise— ‘‘(i) exercises substantial control over the entity; or

‘‘(ii) owns or controls not less than 25 percent of the ownership interests of the entity; and

‘‘(B) does not include—

‘‘(i) a minor child, as defined in the State in which the entity is formed if the information of the parent or guardian of the minor child is reported by this section;

‘‘(ii) an individual acting as a nominee, intermediary, custodian, or agent on behalf of another individual;

‘‘(iii) an individual acting solely as an employee of a corporation, limited liability company, or other similar entity and whose control over or economic benefits from such entity is derived solely from the employment status of the person;

‘‘(iv) an individual whose only interest in a corporation, limited liability company, or other similar entity is through a right of inheritance; or

‘‘(v) a creditor of a corporation, limited liability company, or other similar entity, unless the creditor meets the requirements of subparagraph (A).”

The definition is wide enough to cover persons who own and control a U.S. corporation through a layered structure — allowing those investigating the UBO to look through any corporate shareholders that are put forward. It is also important that the definition looks through any contractual arrangements, removing the loophole that the shareholding be held on trust for the UBO and expressly excludes nominees being put forward as an acceptable person as UBO.

However, the most obvious issue will be determining whether persons put forward are genuine UBOs. For instance, if two persons control an entity, it will be caught under the legislation as they own more than 25% of the shares. However, if they were to add three nominees, the reporting obligation will fall away. The question is: how will those policing the legislation know this has occurred if there is no reporting obligation, and will they have the manpower even if they did hold the information?

Information the UBO needs to provide

The information each UBO will need to provide to FinCEN is:

• (i) full legal name;
• (ii) date of birth;
• (iii) current, as of the date on which the report is delivered, residential or business street address; and
• (iv) the unique identifying number from an acceptable identification document; or
• (v) A FinCEN identifier.

Section 5336 expands on what is deemed to be an acceptable identification document:

“(A) a non-expired passport issued by the United States;

(B) a non-expired identification document issued by a State, local government, or Indian Tribe to the individual acting for identification of that individual;

(C) a non-expired driver’s license issued by a State; or

(D) if the individual does not have a document described in subparagraph (A), (B), or (C), a non-expired passport issued by a foreign government.”

While on the face of it there appears little room to avoid providing accurate details, I still expect nefarious persons who seek to remain anonymous will offer up nominees or use false identification to conceal their true identity. FinCEN will either need increased manpower or a computer system capable of analyzing the information provided.

Consequences for failing to comply

Failing to comply with the legislation will lead to fines of up to $10,000 and up to two years in prison. However, there is discretion here, as you would expect, for those deemed to have innocently erred when providing information. The success of the legislation will depend on the level of successful enforcement.

My view is that the financial penalties seem to be an inadequate deterrent to those seeking to launder millions of dollars, while the possibility of criminal prosecution is a useful deterrent. How easy it will be to implement against persons outside the jurisdiction is unclear.

Limitations of the CTA

The limitations of the CTA are hidden in the exceptions to the legislation and, as touched on above, the practical problems of supervision that I envision developing.

There are numerous exceptions to the requirement to provide UBO information, including:

1. If an interest in the company derives from an inheritance, then there is no need to make a report;
2. If the company has revenues of over $5 million, employs more than 20 people, and has a physical office in the U.S.;
3. If the company is operating in an already highly regulated area such as banking;
4. Certain nonprofit organizations.

The third exception is easily understood since there will already be significant oversight into certain regulated entities, such as banks, investment companies, and insurance companies.

The practical limitations of policing the information are of more concern to international asset tracing practitioners such as myself and my team. The “Sense of Congress” section within the legislation noted that there are more than two million incorporations in the U.S. each year. For the legislation to be effective, it must apply to the vast majority of these incorporations each year. The question is: Who will ensure the information provided is accurate?

If the answer is FinCEN alone, then I fear the legislation will have little success in flushing out genuine criminal practices. This is not because those working at FinCEN do a bad job, but as we have seen from the FinCEN leak during 2020, it is already overwhelmed with suspicious activity reports.

This new legislation will only make FinCEN’s role harder and, consequently, less effective unless significant funding is provided. What the U.S. government should avoid is a system like England’s, where it appears almost all UBO information is unverified due to a lack of personnel at Companies House. The abuse of this system has been well-publicized and I have commented on the absurd example of ridiculous names that have passed through the system unchecked.

So, who should provide the funding to ensure the legislation is properly implemented? Will the average U.S. taxpayer want to pay for the additional personnel and associated expenses to review company incorporation data? Equally, charging hundreds of dollars for each incorporation may stifle genuine entrepreneurs, a central pillar of an aspirational U.S. society.

While this legislation is to be welcomed, it will not silence those seeking to open public registers of all UBOs of companies — a topic that is gaining ever-increasing momentum. As I have previously commented, I expect such public registers will merely make authorities’ roles harder, since those seeking to abuse the corporate structure will continue to do so with the aid of nominees regardless of the legislation in place.

However, the new CTA, if implemented properly, may be sufficient to stem the tide for a while and will no doubt reduce the abuse of U.S. corporate structures.

Source: Martin Kenney, CFE | Managing Partner of Martin Kenney & Co. Solicitors

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