Corporate Governance, Professional Perspective - CTA Guidance for Legal Counsel Serving Businesses

Corporate Governance, Professional Perspective - CTA Guidance for Legal Counsel Serving Businesses

CTA Guidance for Legal Counsel Serving Businesses

Contributed by Scott H. Novak, Scarinci Hollenbeck

March 2024

The Corporate Transparency Act (CTA), 31 U.S.C. §5336, became effective on January 1, 2024. Under this new provision, if your or your client’s entity is a “reporting company,” as defined under the statute, the entity must file a beneficial owner information (BOI) report with Financial Crimes Enforcement Network (FinCEN). The report identifies the beneficial owners of or those who exercise substantial control over the reporting company. The CTA will affect virtually all small family businesses, including limited liability companies and other entities designed only to hold real estate and not to otherwise conduct any active business activities. Even if an entity has only one owner and is ignored for federal income tax purposes (such as a single-member limited liability company), that entity still will have to file a BOI report with FinCEN.

What entities are exempt from the CTA beneficial owner reporting rules? There are twenty-three types of entities specifically excluded under the law:

• Issuer of classes of securities registered under Section 12 of the Securities Exchange

Act of 1934;

• Governmental authorities;

• Banks, credit unions and depository institutions

• Money transmitting business registered with FinCEN;

• Brokers and dealers in securities;

• Securities exchanges or clearing agencies;

• Other Exchange Act registered entities;

• Investment companies and investment advisers;

• Venture capital fund advisors;

• Insurance companies;

• State licensed insurance providers;

• Commodities Exchange Act registered companies;

• Public accounting firms registered in accordance with section 102 of the Sarbanes-

Oxley Act;

• Public utilities;

• Financial market utility;

• Pooled investment vehicles;

• Tax-exempt entities that are described in Section 501(c) of the Internal Revenue Code;

• Entity assisting a tax-exempt entity;

• Subsidiaries of certain exempt entities;

• Large operating companies meeting specified criteria; and

• Inactive entities meeting specified criteria.

The determinations of who is a beneficial owner of a reporting company and who can be identified as someone who exercises significant control over a reporting company are very broad and appear to be designed to negate the risk of a subgroup who might attempt to claim that they narrowly escape either of the definitions. The definitions consider many types of ownership and control, even if the ownership or control is merely contractual or by agreement. There are five exceptions to the definition of a beneficial owner:

(1) A minor child, but only if a parent or legal guardian’s information is reported in lieu of the minor child’s information. Additionally, once the child reaches the age of majority, that individual’s information must be used.

(2) A nominee, intermediary, custodian, or agent. The beneficial owner’s information must be used.

(3) An employee who is not a senior officer of the reporting company.

(4) An inheritor with a future interest only.

(5) A creditor.

In some instances, it will be simple and obvious to determine who should be identified on an entity’s BOI report. In other instances, that identification could require a legal analysis. For example, some entities have a very sophisticated ownership structure that might include entities and individuals with overlap amongst the beneficial owners or those who exert significant control. Sorting this out can prove to be quite challenging. This is why professionals who are or have been in the business of forming entities for clients, or who represent entities or clients with entities might have spent the latter part of 2023 or the early part of 2024 trying to determine what course of action to take. FinCEN has created an online booklet available here: https://www.fincen.gov/sites/default/files/shared/BOI_Small_Compliance_Guide.v1.1-FINAL.pdf. This booklet is very comprehensive and provides some examples of beneficial ownership determination in more complex circumstances.

An individual may hold ownership interests in a reporting company through a trust. Who might be a beneficial owner when an entity or ownership interest in an entity is held by a trust? A trustee or other individual with the authority to dispose of trust assets, a beneficiary who is the sole permissible recipient of trust income and principal or who has the right to demand a distribution of or withdraw substantially all of the trust assets, and a grantor or settlor who has the right to revoke or otherwise withdraw trust assets.

In 2024, newly formed reporting entities have 90 days from formation to file its BOI report. In 2025, and going forward, they will have 30 days. Note that when reference is made to newly formed reporting entities, the same CTA rules apply to foreign companies first being domesticated in the United States. Reporting entities in existence prior to 2024 have all of 2024 to report. Willful failure to report complete or updated beneficial ownership information to FinCEN, or the willful provision of or attempt to provide false or fraudulent beneficial ownership information may result in civil or criminal penalties. These penalties include civil penalties of up to $500 per day that the violation continues, or criminal penalties including imprisonment for up to two years and/or a fine of up to $10,000. Senior officers of an entity that willfully fails to comply may be held liable for that failure.

If there is a change to the required information about a reporting entity or its beneficial owner(s) subsequent to the filing of the entity’s BOI report, the entity must file an updated BOI report no more than 30 days after the change occurs. Changes that might require an updated BOI report include a new company DBA, a change in beneficial owners, a change to a beneficial owner’s name, address, or identifying document used in the first or an earlier report, or a minor reaching the age of majority. Note that when a beneficial owner dies, the estate has 30 days from the time the estate is settled to report the change in beneficial ownership. There is no requirement to report the termination or dissolution of a reporting company.

If an inaccuracy in a BOI report is discovered by the reporting company, the reporting company has 30 days from discovery to correct the inaccuracy. No penalties will be imposed for an inaccurate report if the inaccuracy is corrected within 90 calendar days of the original filing of the report.

Newly formed companies are required to report its company applicants. Every newly formed company will have at least one and possibly two company applicants. No more than two can be reported. A company applicant must be an individual. It cannot be a company or a legal entity. There are two types of company applicants. One is a direct filer, the person who directly filed the document that created the entity. This individual either electronically or physically filed the document with the secretary of state or similar office. The second type is the individual who was primarily responsible for directing or controlling the filing.

One question that some professionals have been grappling with was answered recently. When a professional files a BOI report on behalf of a client, the professional is attesting to the accuracy of the information in the report. If the client provides incorrect or false information unbeknownst to the professional, will the professional be held liable and penalized under the CTA? That question was posed to Jared Elosta, Senior Regulations Advisor for FinCEN, in a March 12, 2024 webinar entitled, Corporate Transparency Act: A Discussion with FinCEN. His answer was that the professional would only be held liable if he or she knowingly and willfully provided inaccurate, false, or misleading information.

Companies have come into existence that have set up CTA filing services. They charge a fee to do the filing for the professional or the client. These companies are not in the practice of law and will not determine who meets the definition of a beneficial owner under the law. They simply input the information provided to them.

Certified public accountants can find themselves in a difficult position relative to the CTA. They are often the only professionals in touch with client businesses on a regular enough basis to inform the client of their CTA compliance obligations. Many CPAs do not want the responsibility for these client filings and are steering clear of doing them. In addition, the line between doing a simple filing and practicing law can get blurred fairly easily. Many take the position that the determination of who a beneficial owner is tends to be a legal function. CPAs do not want to be accused of practicing law without a license. So, while it may make sense for a CPA to file BOI reports in the most straightforward of circumstances, filing the reports at all might be something that many CPAs simply choose not to do. In those instances, the CPA might refer the client to an attorney or one of the independent filing services.

What about attorneys? There is logic in viewing this in a bifurcated manner. First is setting up new entities for clients. Some firms have taken the position that because of the CTA, they will no longer set up new entities. They are sending their clients elsewhere for this service. However, many attorneys set up businesses for clients as part of their regular practice. Those attorneys may choose to do the filings on behalf of their clients. Alternatively, they might inform the client of the CTA requirements and either leave the client to their own devices or possibly recommend one of the independent filing services. Whether the attorney does the filing or not, the attorney was likely the company applicant. As company applicant, they must provide required information about themselves on the BOI report, whether the attorney does the report, or the report is done by someone else. FinCEN allows for “FinCEN Identifiers” for company applicants and beneficial owners under certain circumstances. As to company applicants, having a FinCEN Identifier can be quite useful. The Identifier is a number given to the company applicant by FinCEN if the Applicant provides all of the necessary information. This alleviates the need to put the full set of information on every BOI report done by the Applicant. In addition, if the company applicant is not completing the BOI report, he or she can simply supply the FinCEN Identifier to whoever is completing the BOI report, rather than giving detailed individual information. This way, in the company applicant portion of the BOI report, whoever is filling out the report can simply enter the FinCEN Identifier number.

The second attorney prong is determining what the attorney’s responsibility is to former clients for whom they set up entities over the years but may have had no contact with for many years. There is no clear answer. The possible answers are easy enough. At one end of the spectrum, a firm could take the position that if a certain amount of time has passed since that work was done and since they were in touch with the client, they have no responsibility. However, most attorney engagements do not end with a letter or email indicating that the work is done, and our engagement is at an end. At the other end of the spectrum is a firm that takes the position that they must contact every client for whom they created an entity, unless the engagement was clearly over, via a letter or email. For some firms, going back and dusting off hundreds or thousands of records going back many years could prove to be a difficult, time-consuming task that might impact what decision the firm makes in this context. The most conservative approach is to develop a firm-wide list of existing and former clients for whom this work was done and send a letter explaining what the CTA is and what the responsibilities of reporting companies are. Who knows? This may even rekindle a long-dormant professional relationship. This same thought process could apply to CPAs who have set up client companies over the years.

Any attorney or firm forming new entities for clients should take a close look at their engagement letters to ensure that they are protected. The client must be informed of the CTA requirements, including the associated time periods. The client must also be made aware that either the firm does not do CTA filings on behalf of their clients, or that the firm will do the filing if asked to do so by the client. A firm could state in the engagement letter that filing is done in every instance that a new entity is created by them, but caution should be exercised where the filing might be automatic. To avoid confusion or duplication, a positive step would appear to be more desirable. Where attorneys are not filing the FinCEN report for their clients, they would be well-advised to have specific language in their engagement letter that indicates that the client has been advised of the requirement to file the report and has agreed that the attorney is not responsible for the filing. Where the client desires the firm do the filing on the client’s behalf, the firm may want to consider an addendum to the engagement letter that the client signs. The addendum might contain language indicating what information is required of the client, how the firm will safeguard the information, such as a government-issued photo id, and a date by which the client must provide all information, otherwise, the firm is no longer responsible for the filing.

For example, one might consider a deadline of ten days before the filing is due for a new entity. The information should not be very difficult to secure in most instances and an attorney should not be put in a position where the information is provided at 9 pm on the 90th day. The addendum might also have a clause that indicates that information being supplied to FinCEN is based on information provided by the client. If that information turns out to be inaccurate, false or fraudulent, the client must hold the firm harmless if the firm is challenged by FinCEN. Finally, the addendum might speak to the client’s responsibility if information changes or is later found to have been inaccurate or mistaken.

For existing clients, a firm doing the filing on behalf of a client may want to consider a new engagement letter with many of the same provisions described above.

A recent federal court decision out of the Northern District of Alabama held that the CTA is unconstitutional. See National Small Business United v. Yellen, No. 5:22-cv-1448-LCB (N.D. Ala. 3/1/24). Is it reasonable to take a wait and see position in light of this decision? The decision applies only to the 65,000 or so businesses that were members of the plaintiff as of March 1, 2024. That means that everyone else is expected to comply. The American Institute of Certified Public Accountants (AICPA) has stated that all other businesses should continue to file their BOI reports, though they continue to push for suspension of the BOI reporting rule. The U.S. Department of Justice has already appealed the decision. FinCEN has indicated that they will respect the court’s decision, but that the decision does not apply to the roughly 32.6 million existing entities who must comply, nor to the approximately 5 million new entities created every year. Copycat suits are to be expected, but the case also provides a roadmap to Congress on how the law could be amended to make it relatively challenge-proof. The wait and see position? Since companies in existence prior to 2024 have until the end of the year to file their BOI reports, they make the decision to wait and see what develops during 2024. But the risk of CTA penalties should be reason enough for newly formed companies to whom that decision does not apply to decide against taking a wait and see position.

While the CTA is an evolving area that will see changes and adjustments as more experience is gained over time, the obligations of reporting companies are clear and the penalties are onerous. Reporting companies are well advised to take the requirements seriously and professionals should consider taking the lead in educating their clients about the CTA, even if the professional will not be doing FinCEN filings.

For additional information see In Focus: Corporate Transparency Act.

Copyright 2024 Bloomberg Industry Group, Inc. (800-372-1033) Reproduced with permission. CTA Guidance for Legal Counsel Serving Businesses.