The Corporate Transparency Act and FinCEN Regulation

The Pandora Papers

Release of the Pandora Papers in 2021 (11.9 million documents published by the International Consortium of Investigative Journalists) exposed an international financial system awash in dirty money. Prime ministers, dictators, celebrities, arms dealers, oligarchs, and billionaires remain as determined as ever to move cash to places where the origin of funds is not questioned, taxes are low or non-existent, and one’s identity can be effectively concealed.

The Pandora Papers came five years after a previous and similar report, the Pulitzer-prize winning Panama Papers. These, however, exposed the files of just one law firm in Panama. The Pandora Papers were a much bigger story, encompassing 14 offshore providers, thousands of beneficial owners of shell companies and trusts, and spanning the period from 1996 through 2020. The finance ministers of Pakistan and Brazil were (and perhaps still are) siphoning money out of their countries and parking it offshore, often in the United States.

Acquiring American real estate, along with purchase of art and antiquities, are the preferred destinations for much of this international cash. Baker McKenzie, the largest law firm in the U.S., has been instrumental in creating vehicles (shell companies and trusts) to move this money.

Reverberations of the Pandora Papers and the Panama Papers will continue to be felt in legislation and government enforcement for years to come. The Corporate Transparency Act and FinCEN regulations are a direct result of this investigative journalism.

The Corporate Transparency Act

The Corporate Transparency Act (CTA, 31 U.S.C. Sec. 5336) was passed in 2021 and then handed off to the Treasury Department for rulemaking. The Financial Crimes Enforcement Network (FinCEN), an arm of the Treasury Department, is charged with the writing and implementation of rules and regulations to enforce the CTA.

FinCEN has declared that one of its ultimate goals “is to combat, to the broadest extent possible, the proliferation of anonymous shell companies that facilitate the flow and sheltering of illicit money in the United States.” In 2016, the New York Times claimed that nearly half of the luxury real estate in the city was purchased by anonymous shell companies, many of which are used by money launderers, terrorists, and criminals to conceal profits by investing in U.S. real estate.

While the goals of the CTA are laudable in broad strokes, the specific rules promulgated by FinCEN overreach in ways that invade individual privacy and civil liberties. Several questions arise. Since when is it the federal government’s role to achieve transparency in real estate transactions? And why is transparency now an absolute good? Do legitimate privacy concerns of law-abiding citizens make them presumptive money launderers?

White House Strategy on Countering Corruption

In 2021, the Biden White House issued a policy document entitled the “United States Strategy on Countering Corruption” (www.whitehouse.gov) which provides for a whole-of-government approach to opposing corruption both within the U.S. and abroad. Along with FinCEN in the Treasury Department, other anti-corruption task forces are established within the State Department, USAID, and the Commerce Department. The theme is one of urgent national security. As the document states, “The U.S Government will continue to study the weaponization of corruption to understand its use and impacts on the United States, other democracies, and countries around the world, as well as how to thwart and build resilience against this evolving threat.” The Strategy also declares that the government will enhance enforcement of a related statute, the Foreign Corrupt Practices Act.

While corruption and money laundering are undoubtedly expensive to society and morally reprehensible, FinCEN’s declaration that these practices are weapons that threaten our national security is over the top. One has the impression that authors of both the White House Strategy and the new FinCEN regulations were aware of entering new and intrusive territory. The extreme language used may be an attempt to encourage Americans to accept the federalization of real estate transactions and erosion of personal privacy without a fight.

Amidst the moralizing, it is worth remembering what this is really about: tax revenue and the expansion of federal power. FinCEN is set to receive a large funding increase which will undoubtedly feed the creation of yet more regulations. The evolution of the Consumer Financial Protection Bureau is an instructive example.

GEOGRAPHIC TARGETING ORDERS (GTOs)

Do GTOs work?

For several years and continuing today, FinCEN has issued geographic targeting orders in specific areas of the country where money laundering is common in the luxury residential real estate market. Current GTOs are in effect for the metropolitan areas of Boston; Chicago; Dallas-Fort Worth; Honolulu; Las Vegas; Los Angeles; Miami; New York City; San Antonio; San Diego; San Francisco; and Seattle. GTOs are supposed to be short-term in duration (up to 180 days) but as a practical matter may be extended by the agency at will.

GTOs home in on transactions involving a corporation or LLC, especially companies formed offshore, that purchase residential properties for $300,000 or more using cash money or cashier’s

check. Oddly, GTOs do not presently include transactions accomplished solely by wire transfer even if the wire transfer originates from a bank in a tax haven.

Overall, the results have been disappointing. GTOs have not had the hoped-for effect mostly because cash-laundering transactions have simply migrated to commercial deals and venues outside existing geographical parameters.

GTO Reporting Requirements

A title company involved in a covered transaction must complete and submit a currency transaction report (CTR) on IRS/FinCEN form 401 along with IRS/FinCEN form 8300 if applicable (“Report of Cash Payments Over $10,000 Received in a Trade or Business”). The CTR requires disclosure of the identity of the purchaser and any beneficial owner controlling 25% or more of the entity involved. The title company must also obtain valid government-issued identification from the parties. Not surprisingly, about a third of transactions targeted by GTOs involve persons or entities that were previously the subject of suspicious activity reports.

As mentioned, wire transfer transactions are not subject to GTOs. There are other loopholes. For instance, what if a title company is not utilized as an escrow agent to close the transaction? There is no FinCEN form 8300 generated or filed.

The reality of GTO reporting is that it has fallen short of capturing all cash purchases of U.S. luxury properties by shell companies, particularly as offshore purchasers have begun to shift into commercial properties in smaller cities and towns. The local car wash or strip center could be owned (indirectly) by a genocidal African dictator and the locals would never know.

Beyond GTOs: The New FinCEN Rules

In its 2021 Notice of Proposed Rulemaking, FinCEN states its intention to expand enforcement beyond the limits of present GTOs: “Money laundering vulnerabilities exist throughout the United States real estate market. These vulnerabilities are not limited to any particular sector. Although in recent years FinCEN has focused its information collection efforts on non-financed purchases of residential real estate by shell companies, FinCEN clearly believes that other areas of the real estate market, including commercial real estate, may merit regulatory coverage.

It is a matter of great frustration to FinCEN that the United States has for years been considered the land of opportunity when it comes to laundering cash using real estate. Accordingly, FinCEN seeks to establish a “regulatory process for new real estate sector reporting requirements to curb illicit finance.” New rules will restrict “the ability of illicit actors to launder criminal proceeds through the purchase of real estate [which] threatens U.S. national security and the integrity of the U.S. financial system.” (See FinCEN’s press release of December 6, 2021.)

FINCEN REPORTING RULES

Existing BSA/AML Reporting Regime

Before discussing beneficial ownership reporting, it is worth noting that there is an existing mandatory reporting regime already in place (arising from the USA Patriot Act and the Bank Secrecy Act) and it is extensive. Banks and title companies have staff dedicated to compliance and reporting, often referred to as BSA/AML (Bank Secrecy Act/Anti-Money Laundering) compliance officers.

FinCEN already requires that these institutions file currency transaction reports (CTRs) as well as suspicious activity reports (SARS) in any transaction that lacks economic sense or has no apparent lawful business purpose; where a purchase or sale generates little to no revenue or is conducted without regard to high fees or penalties; involves the purchase of real estate without regard for the property’s condition, location, assessed value, or sale price; involves funding that far exceeds the purchaser’s wealth, comes from an unknown origin, or is derived from unconnected individuals or companies; is conducted in an irregular manner; or includes a request by the participants to alter records (pertaining to assessed value, for instance).

The beneficial ownership rule is a significant escalation of these existing requirements, which will continue to apply.

FinCEN Beneficial Ownership Reporting Rule

FinCEN Beneficial Ownership Information Reporting Requirements are found in 31 CFR Part 1010. These rules require disclosure of personal information on the beneficial owners of all state-registered entities such as corporations, LLCs, and limited partnerships (Beneficial Owner Information Reports or BOIs). The rule commences with the following introduction:

Illicit actors frequently use corporate structures such as shell and front companies to obfuscate their identities and launder their ill-gotten gains through the U.S. financial system. Not only do such acts undermine U.S. national security, but they also threaten U.S. economic prosperity: shell and front companies can shield beneficial owners’ identities and allow criminals to illegally access and transact in the U.S. economy, while creating an uneven playing for small U.S. business engaged in legitimate activity. . . .

Few jurisdictions in the United States, however, require legal entities to disclose information about their beneficial owners or individuals who take the steps to create an entity. . . . This lack of transparency creates opportunities for criminals, terrorists, and other illicit actors to remain anonymous while facilitating fraud, drug trafficking, corruption, tax evasion, organized crime, or other illicit activity through legal entities in the United States.

The beneficial ownership reporting rules require federal self-reporting by everyone who forms an LLC, corporation, or other registered entity in any American state, which is a huge change. Previously there was only a limited third-party reporting requirement for banks and title companies.

Who must report and what must be reported?

Company applicants and persons including senior officers who are part of reporting companies are required to report beneficial owner information (including those having substantial control) to FinCEN (31 CFR Sec. 1010.380). These are all defined terms in the rule.

Reporting companies are corporations, limited liability companies, or similar entities that are created by the filing of a document with a secretary of state or a similar office (31 U.S. Code Sec. 5336 (a)(11)). There is now a distinctly federal component to entity formation, an area that has long been the preserve of the states. Registered entities formed both in the U.S. and abroad (regardless of their date of formation) are considered to be reporting companies with reporting obligations.

A beneficial owner is defined as any individual who directly or indirectly exercises substantial control over an entity or owns at least a 25% interest. A reporting company will always have at least one owner who has substantial control even if no individual holds a 25% or greater ownership interest. There are five exceptions: (1) a minor so long as the reporting company provides information about the minor’s parent or legal guardian; (2) an individual acting as a nominee, intermediary, custodian, or agent on behalf of another individual (perhaps exercising a power of attorney); (3) an employee, acting solely in an employee capacity and not as a senior officer (defined below) whose substantial control over or economic benefits from such entity are derived solely from his or her employment status (effectively an exception for clerical and support personnel); (4) an individual whose only interest is an inheritance-based future interest; and (5) a creditor (31 C.F.R. Sec. 1010.380(d)(3)).

The definition of substantial control is broad enough to encompass direct and indirect de facto control and cannot be circumvented by manipulation of job titles or descriptions of corporate function. In other words, being overly-clever with the documentation (and who is named as what) in order to conceal substantial control from FinCEN or avoid reporting would be a violation.

A person includes any individual, reporting company, or other entity.

A company applicant is anyone who directs or controls the filing of entity-formation documents, whether for oneself or for another. This is true whether or not the company applicant has any control over or beneficial interest in the entity. A comparable state-law term would be the organizer of the entity and would include lawyers and paralegals.

A senior officer of a reporting company is any individual holding the position or exercising the authority of a president, chief financial officer, general counsel, chief executive officer, chief operating officer, or any other officer, regardless of official title, who performs a similar function. A senior officer is always deemed to have substantial control.

Exceptions to FinCEN Reporting

There are exemptions to the FinCEN reporting requirement for securities reporting issuers; government authorities; banks and credit unions; depository holding companies; money services businesses; brokers and dealers in securities; securities exchanges and clearing agencies; Exchange Act registered entities; investment companies and investment advisers; venture capital fund advisors; insurance companies; state-licensed insurance providers; commodity Exchange Act registered entities; public accounting firms; public utilities; financial market utilities; pooled investment vehicles; tax-exempt entities and entities assisting a tax-exempt entity; subsidiaries of certain exempt entities; and inactive entities. Also exempt are “large operating companies,” defined by the Internal Revenue Code as companies with more than 20 full time employees, an operating presence in a physical office within the United States, and $5 million in gross receipts or sales from US sources.

Note that the entities on the exemptions list tend to be both larger and already subject to extensive federal regulation.

Reporting by Entities Formed after January 1, 2024

For entities newly-formed during the calendar year 2024, an initial FinCEN report must be submitted within 90 days of the date of the entity’s formation. Starting January 1, 2025, the reporting period is 30 days.

A reporting company must file a supplemental report within 30 days of becoming aware that information in the initial report was inaccurate or has changed. This is an ongoing, indefinite requirement for the reporting of updates and corrections that is intended to maintain the accuracy of the FinCEN database.

Reporting by Entities Formed before January 1, 2024

Entities formed before January 1, 2024 are still reporting companies with reporting obligations. The difference is that companies formed before January 1, 2024 have a year to file the initial BOI Report (i.e., by January 1, 2025) instead of just 30 days.

Reporting companies formed before January 1, 2024 are not required to report information about company applicants who were involved in their formation.

The same continuing obligation to report updates and corrections applies to these existing entities after the initial report is filed.

Disclosure of Individuals’ Idenitying Information

The initial report to FinCEN regarding newly-formed entities must supply pertinent identifying information about:

(1) the reporting company;
(2) the company applicant(s);
(3) beneficial owner(s) who own at least a 25% interest; and
(4) individuals exercising substantial control (directly or indirectly).

Information must include full legal name and any assumed names; date of birth, if an individual; current address (residence address if an individual); and a unique identifying number from an acceptable identification document such a drivers’ license or passport that includes an image. Detailed BOI reporting requirements are found at 31C.F.R. Part 1010.

Note the broadness of the substantial control requirement. This potentially includes not just managers, officers, and board members but also others (such as investors or promoters) who exercise substantial control from behind the scenes.

Additional Reporting: Deputizing the Gatekeepers

FinCEN’s goal is to reach title insurance companies, real estate agents and brokers, law firms, settlement and closing agents, and other persons or entities that collect information and maintain records regarding non-financed (cash) purchases of real estate. The agency states: “Once finalized, these proposed regulations will affect a large number of entities doing business in the United States,” an understatement if there ever was one.

FinCEN seeks to deputize transactional gatekeepers who will now be burdened with due diligence and reporting requirements that were previously unheard of, at least at a non-institutional level. The White House Strategy on Countering Corruption also zeros in on “various service providers, incorporators, and others willing to be hired as registered agents or who act as nominees” as well as anyone who assists in creating “opaque corporate vehicles.”

In the view of FinCEN and the White House Strategy document, all such persons should be compelled to perform pre-engagement due diligence on their clients. That would include investigating their clients’ incomes and the origin of cash funds. The existence of “corrupt actors” would then need to be reported to the authorities by means of suspicious activities reports (SARS).

Self-Reporting by LLCs and Corporations

Even small-business LLCs and single-member corporations will be expected to self-report key information to FinCEN including the names and addresses of persons who have substantial control or any beneficial owner who owns or controls 25% or more of a reporting company. This goes far beyond existing reporting requirements that now apply to lenders and title companies. The self-reporting requirements will significantly burden ordinary people (not lawyers, accountants, or title professionals by training) who form new businesses and engage in real estate transactions. The CTA may be one of the least business-friendly statutes ever passed in the United States. It is not a tweak or an adjustment. It is a sledgehammer.

New Federal Database

The reporting rule laments the absence of information on persons forming U.S. entities: “The United States does not currently have a centralized or complete store of information about who owns and creates legal entities with the Unities States. The data readily available to law enforcement are limited to the information required to be reported” at the entity formation stage. FinCEN believes this situation to be unacceptable, so it intends to create a national database—in defiance of over two hundred years of states independently handling this responsibility.

Information collected pursuant to FinCEN reporting will be held in a protected federal computer facility available only to government agencies including law enforcement—which is to say that huge chunks of data will inevitably be leaked, hacked, or otherwise find their way into both the public domain and the hands of foreign intelligence services (think China).

Treasury Secretary Janet Yellen calls all of this a “dramatic step forward” in achieving beneficial ownership transparency in the case of “malign” actors and entities participating in real estate transactions. Such is the righteous tone and tenor of the new reporting, data collection, and enforcement regime.

The Customer Due Diligence Rule

The Customer Due Diligence Rule (CDD rule, 81 FR 29398) states that covered financial institutions (such as banks and title companies) must have customer identification programs (CIPs) to verify the identity of customers; identify the beneficial owners of companies opening accounts; understand the nature and purpose of customer relationships to develop customer risk profiles; conduct ongoing monitoring to identify and report suspicious transactions; and, on a risk basis, maintain and update customer information. With respect to the requirement to obtain beneficial ownership information, financial institutions will have to verify the identity of any individual who owns 25 percent or more of a legal entity or exercises substantial control over it.

VIOLATIONS OF THE
CORPORATE TRANSPARENCY ACT

Civil and Criminal Penalties

Violations of the CTA fall into two general categories: first, reporting violations, including failure to report and false or fraudulent reporting; and second, knowing and unauthorized use or release of beneficial ownership information.

As to reporting violations: “It shall be unlawful for any person to willfully provide, or attempt to provide, false or fraudulent beneficial ownership information, including a false or fraudulent identifying photograph or document, to FinCEN in accordance with this section, or to willfully fail to report complete or updated beneficial ownership information to FinCEN in accordance with this section” (31 CFR Sec. 1010.380(g)). Elements of the offense are: (1) the person or entity is a reporting company that is required to report; (2) there is a failure to report to FinCEN; and (3) a person causes the failure to report or is a senior officer of the reporting company at the time.

Reporting violations (including false reports and failure to file or update FinCEN reports) can result in a fine of $500 per day up to $10,000 and/or up to two years in federal prison (31 U.S.C. Sec. 5336(h)(2) and (3)(A)).

Violations relating to knowing misuse or unauthorized release of beneficial ownership information are harsher and can result in the same daily fine up to $250,000 and/or a prison term of up to ten years (31 U.S.C. Sec. 5336(h)(2) and (3)(B)).

Civil and Criminal Forfeiture by FinCEN

The practice of civil and criminal forfeiture by law enforcement, often accomplished without charges or suit ever being filed, is already out of control in the United States. Confiscating cash, vehicles, guns, and houses from suspects is the main financial lifeline for many police and sheriffs’ departments across the country. These practices resemble the arbitrary confiscatory practices of third-world authoritarians and clearly violate the 14th Amendment due-process clause. To their shame, American courts have looked away.

Expect FinCEN to take forfeiture to the next level. Federal law (18 U.S.C. Section 981) allows the U.S. Treasury to seize any property, real or personal, involved in a transaction involving money-laundering. In its 2021 NPRM, FinCEN literally boasts that previous forfeitures have yielded “luxury properties in New York City, Los Angeles, Beverly Hills, and London, mostly titled in the name of shell companies, as well as paintings by Van Gogh, Money, Picasso, a yacht, several items of extravagant jewelry, and numerous other items of personal property.” A theme is apparent: in your hands, these things are extravagant; but by transferring them to the government, the result is justice—even if the owner is never accused or convicted of a crime.

IMPACT ON LAWYERS AND LLC FORMATION

It is hard to overstate the impact of FinCEN regulation on business lawyers who form entities for their clients. An attorney acting as organizer of an LLC is now more than a mere agent acting on behalf of his principal. An attorney-organizer is now a company applicant and an integral part of the creation of a new entity/reporting company. By requiring that the attorney’s name be included in the initial report, FinCEN is implicitly suggesting that it may view an attorney as an accomplice if intentional irregularities occur in the entity-formation process. This will make lawyers more cautious about signing formation documents on behalf of their clients as the company’s organizer—a state-law term that is substantially identical to company applicant.

Since the attorney-organizer must be identified in the initial FinCEN report, the lawyer’s name will be forever linked (perhaps suspiciously) in a federal law-enforcement database to the beneficial owners of the new entity.

Organizing and Reporting for LLCs

Will lawyers want to serve as organizers anymore? It is likely that many law firms will now refuse to file LLC and corporate formations unless the client provides all necessary beneficial ownership information to the law firm in advance. This is part of the growing trend that will increasingly require that gatekeepers perform their own internal due diligence on their clients.

As to the initial FinCEN report by the entity being formed, lawyers have two choices: (1) they can instruct the client how to do it himself (and provide the client with the lawyer’s FinCEN number); or (2) they can prepare the initial FinCEN report on behalf of the client.

Do lawyers involved in the LLC formation process qualify as beneficial owners?

Not usually. FinCEN states the following in the FAQS section of its website (www.fincen.gov/boi-faqs#M3): “Lawyers who provide general legal services are not considered beneficial owners because ordinary, arms-length advisory or other third-party professional services to a reporting company are not considered to be substantial control. . . . In addition, a lawyer or accountant who is designated as an agent of the reporting company may qualify for the ‘nominee, intermediary, custodian, or agent’ exception from the beneficial owner definition. However, [a lawyer] who holds the position of general counsel in a reporting company is a ‘senior officer’ of that company and is therefore a beneficial owner.”

What about an attorney’s continuing duties to FinCEN?

Extensive explanation and advice on the nature and extent of FinCEN reporting is now a mandatory part of an attorney’s duties. However, continuing representation relating to FinCEN is another matter. Lawyers must be careful to let clients know that, unless their terms of engagement provide otherwise, ongoing duties and representation relating to FinCEN (particularly the obligation to amend reports) is not included within the scope of initial entity-formation. Some clients will inevitably conclude that because an attorney formed their new LLC he is also indefinitely responsible for all matters relating to FinCEN. This will need to be clarified.

The Client as Suspect

Will lawyers now have to implement the kind of know-your-customer (KYC) rules that banks impose upon new depositors? In order to accomplish this, will law firms now be required to have an anti-money-laundering compliance officer on staff? Will they be required to file suspicious activity reports (SARS) against their own clients? Must law offices now fear raids on their files by the feds? Under the new FinCEN rules, the answer to all of these questions could be a disturbing yes.

The Lawyer as Federal Agent

For lawyers, any government requirement to report suspicious clients (meaning anyone buying real estate with cash, who is less-than-forthcoming as to the source of his funds, or used an offshore entity) would be particularly odious. It would violate not only the attorney-client privilege but is contrary to historical norms and core ethics of the profession. It could also be a violation of the client’s sixth amendment right to counsel.

Standards promulgated by the American Bar Association (ABA Opinion 491) require a lawyer to decline representation of a client “where facts known to the lawyer establish a high probability that a client seeks to use the lawyer’s services for criminal or fraudulent activity.” Most lawyers already know this and willingly comply.

We will have to see how SARS requirements and FinCEN regulation evolve in the context of attorneys.

IMPACT ON LLC FILINGS
WITH THE TEXAS SECRETARY OF STATE

No BOI Collected by the State

The Secretary of State has committed to staying out of the FinCEN data collection business entirely. The following appears on the agency’s website:

The beneficial ownership information required by the CTA should only be submitted directly to FinCEN through its online Beneficial Ownership Secure System (BOSS) [and not to the Secretary of State].. The Texas Secretary of State cannot determine whether a particular entity is required to file a BOI report and will not be involved in the collection of beneficial ownership information. To protect your privacy and avoid delays in processing documents submitted to this office, you should not include beneficial ownership information when forming or registering an entity to transact business in this state.

LLC Governing Documents

LLC governing documents may need to be modified to accommodate the CTA and FinCEN regulation. Business lawyers may want to include provisions relating to CTA compliance, particularly in the company agreement. This might include designation of a CTA compliance officer, the minimum contents of required reports, and a procedure for preserving and protecting CTA data.

ADDITIONAL IMPACTS OF BOI REPORTING

Federal Power

Beneficial ownership reporting and the inevitable expansion of rules and enforcement related to it will have significant effects:

(1) a broad expansion in the scope and extent of entity-formation information reported to the federal government, including personal information on individual participants;

(2) a shift from the states to Washington as the primary collector and holder of information on beneficial ownership of real estate-related entities;

(3) a move toward the federalization of real estate transactions;

(4) discouraging (and eventually prohibiting) the use of cash; and

(5) eliminating previously lawful means for private property owners to use registered entities and trusts to achieve anonymity.

Impact on Privacy in Real Estate and Business Formation

More pervasive FinCEN enforcement will inevitably impact both entity formations and real estate transactions, especially attempts to create a measure of anonymity by otherwise legal means. Going forward, it may be the case that a buyer of real estate seeking to either pay cash or remain out of public view (by not being directly named in the real property records) may for either reason be culpable of suspicious behavior and therefore reportable to the government.

Consider that for a moment. Seeking legitimate privacy in one’s business and real estate dealings by using entities that are entirely legal will inevitably be viewed as suspicious—especially if transactions are handled in cash or by cashier’s check. This is all being done in the name of transparency, a goal to which no one is allowed to object.

FinCEN invokes terms like corrupt and ill-gotten gains and exploitation to justify a crusade to cleanse the market of dirty money invested by bad people. Needless to say, achieving and maintaining privacy in entity structuring and real estate investment becomes a challenging project in such an environment.

Impact on Trusts in Real Estate Transactions

FinCEN’s beneficial ownership rules apply broadly to individuals and legal entities such as LLCs, corporations, limited partnerships, and the like. As FinCEN’s reach expands, however, a collision with trusts is inevitable. Will FinCEN require trusts engaged in real estate transactions to make public disclosure of the identity of their principals? Are trusts reporting companies?

The answer for now is no. Trusts do not fall within the category of registered entities such as LLCs or corporations that must file formation documents with the state. A trust agreement is a private document that need not be filed or recorded anywhere. As a result, trusts, including those that hold real estate, have traditionally enjoyed a high degree of confidentiality.

Law professors will tell you that a trust is not a legal entity, registered or otherwise, nor is it a legal person. A trust is a contractual arrangement between a trustor, a trustee, and a beneficiary. However, in practice, trusts often act like legal entities. They buy and sell real estate; they have bank accounts; they sue and get sued. A trust can obtain an EIN number and file its own tax return. Trusts can also embed themselves within an LLC and act as member and manager, a common anonymity device.

Under present FinCEN rules, a trust must be reported as a beneficial owner if it exercises substantial control or own 25% or more of a registered entity such as an LLC. But what if FinCEN decides to take this a step further and require disclosure of the identity of the principals behind the trust? Applying transparency rules to trusts would be a logical extension of FinCEN’s penetration of the real estate industry. Eventually, trusts will fall within the agency’s purview and a new NPRM will be issued. When that happens, anonymity-favorable jurisdictions like South Dakota will lose some of their appeal.

COURT CHALLENGES TO THE CTA

The Alabama Case

On March 1, 2024, a federal court in Alabama ruled that the Corporate Transparency Act is unconstitutional (National Small Business United et al v. Yellen et al, No. 5:2022CV01448 – Document 51 (N.D. Ala. 2024)). The judge stated that the CTA “exceeds the Constitution’s limits on the legislative branch and lacks a sufficient nexus to any enumerated power to be a necessary or proper means of achieving Congress’ policy goals.”

Note that this is a federal district court case that applies only to the 65,000-plus members of National Small Business Association, which is the plaintiff in the case. The CTA (and beneficial ownership reporting requirements) are not invalidated in any other respect.

Many business lawyers have been of the opinion that the CTA constituted government overreach, so this case is no surprise. The Justice Department is appealing the ruling. Until the appeal is complete (and it may reach the Supreme Court) he constitutionality of the CTA will remain in doubt.

On a practical level, the only clarity at this point is that if an LLC is a member of the NSBA it does not need to comply with FinCEN beneficial ownership reporting requirements. So the Alabama ruling is limited in scope to members of the NSBA. All others are still required to file BOI reports.

FinCEN’s Position

On its website (https://www.fincen.gov/boi), FinCEN makes the following statement regarding the Alabama case: “The Justice Department, on behalf of the Department of the Treasury, filed a Notice of Appeal on March 11, 2024. While this litigation is ongoing, FinCEN will continue to implement the Corporate Transparency Act as required by Congress, while complying with the court’s order. Other than the particular individuals and entities subject to the court’s injunction, as specified below, reporting companies are still required to comply with the law and file beneficial ownership reports as provided in FinCEN’s regulations.”

While the government’s appeal is pending, it is prudent for an LLC to: (1) file the FinCEN report as currently required (go to https://boiefiling.fincen.gov which is the website established for this purpose); or (2) join the NSBA whose members (for now and only for now) are exempt from beneficial ownership reporting requirements.

FUTURE RELATED LEGISLATION

The Enablers Act: Proposed But Not Yet Passed

The Enablers Act is a bipartisan measure introduced in the House of Representatives as a response to the Pandora Papers and the whole transparency trend. It parallels the Corporate Transparency Act and FinCEN regulation, both in its emphasis on the invasive collection of personal information and on its targeting of gatekeepers.

The Enablers Act would amend the Bank Secrecy Act’s definition of financial institutions to add: (1) investment advisors; (2) art and antiquities dealers; (3) attorneys and notaries involved in financial activity or related administrative activity on behalf of another person (e.g., a client); (4) a trust company or service provider including persons who assist in forming business entities or providing such entities with a registered office or address (this clearly includes business and corporate attorneys and anyone acting as a registered agent); (5) CPAs; (6) public relations firms; and (7) third-party loan payment services, including payment processors, check consolidators, and cash vault service providers.

KYC obligations and other compliance requirements would be imposed on all of these gatekeepers including BSA/AML compliance programs and filing of SARS against suspicious clients.

The Enablers Act has for now been blocked by the U.S. Senate. However, it will almost certainly reappear in some form and become law, since it so clearly aligns with two significant trends: (1) the imposition of transparency upon worldwide financial transactions, especially those involving cash and foreign persons; and (2) a determined effort on the part of Washington to forcibly convert local real estate professionals into agents of federal law enforcement.

Regulation Tends to Expand

The Corporate Transparency Act is justified by its proponents as a matter of national security and a way to protect the U.S. real estate market from exploitation by criminals and corrupt officials. In a manner reminiscent of the USA Patriot Act, however, FinCEN regulation and enforcement already enthusiastically surpass the initial mandate. It is reasonable to expect that legal challenges will continue.