Laundering money generated in the drug trade. The United Nations Office on Drugs and Crime estimates that between $800 billion to $2 trillion is laundered annually. Laundering money intended to support terrorism. The International Monetary Fund is concerned about terrorism financing, and proliferation financing, providing funds for nuclear, chemical, or biological weapons. Money that is embezzled or other schemes also must be laundered, that is, if you're a criminal or criminal enterprise.
As of Jan. 1, 2024, domestic and foreign entities registered to do business in the United States must comply with new “beneficial ownership reporting requirements” imposed under the Corporate Transparency Act.
Listen to what veteran attorney Lori Smith of Stradley Ronon has to say about the Act, something 30 million companies will have to follow during the Act's first year. Lori provides insights for business executives and attorneys on key facets of the requirements, potential penalties, and chances for litigation.
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This podcast is the audio companion to the Journal of Emerging Issues in Litigation. The Journal is a collaborative project between HB Litigation Conferences and the vLex Fastcase legal research family, which includes Full Court Press, Law Street Media, and Docket Alarm.
If you have comments, ideas, or wish to participate, please drop me a note at Editor@LitigationConferences.com.
Tom Hagy
Litigation Enthusiast and
Host of the Emerging Litigation Podcast
Home Page
LinkedIn
Laundering money generated in the drug trade. The United Nations Office on Drugs and Crime estimates that between $800 billion to $2 trillion is laundered annually. Laundering money intended to support terrorism. The International Monetary Fund is concerned about terrorism financing, and proliferation financing, providing funds for nuclear, chemical, or biological weapons. Money that is embezzled or other schemes also must be laundered, that is, if you're a criminal or criminal enterprise.
As of Jan. 1, 2024, domestic and foreign entities registered to do business in the United States must comply with new “beneficial ownership reporting requirements” imposed under the Corporate Transparency Act.
Listen to what veteran attorney Lori Smith of Stradley Ronon has to say about the Act, something 30 million companies will have to follow during the Act's first year. Lori provides insights for business executives and attorneys on key facets of the requirements, potential penalties, and chances for litigation.
***
This podcast is the audio companion to the Journal of Emerging Issues in Litigation. The Journal is a collaborative project between HB Litigation Conferences and the vLex Fastcase legal research family, which includes Full Court Press, Law Street Media, and Docket Alarm.
If you have comments, ideas, or wish to participate, please drop me a note at Editor@LitigationConferences.com.
Tom Hagy
Litigation Enthusiast and
Host of the Emerging Litigation Podcast
Home Page
LinkedIn
Welcome to the Emerging Litigation Podcast, a co-production of HB Litigation and critical legal content, custom content for law firms and litigation service providers, and the newly formed VLAC's Fast Case, your World of Legal Intelligence and our friends at LawStreetMedia. I'm your host, tom Hagee, litigation Content Producer and enthusiast and an average bongo player. Contact me if you have an idea for an episode. In addition to often being polite, I'm always looking for new twists on the law, whether it's a new regulation, legislation or an important new opinion, or it could be a development in the world that will test existing law, or anything you're dying to share with other litigators, organizations or individuals. And, if you like what you hear, give us a rating. That always helps. And now here's today's episode In the TV series Breaking Bad, which I may have seen more than once.
Speaker 1:Walter White is making so much money from the manufacture and sale of crystal meth that he has to buy a car wash a largely cash operation to launder all that money. His devoted wife, skylar, is put in charge of the finances. In one episode she brings Walt to a storage facility and introduces him to what could be three or four full-size mattresses stacked in the middle of the unit. She pulls back a bedsheet to reveal neat piles of US currency in a variety of denominations, or, as Jesse Pinkman would call it, fat stacks of cash or a truckload of Cheddar. Yo Walter looks on dumbfounded at this giant pile of money. How much is it? He asks. Skylar, who gave up trying to add it up based on weight, noting each bill weighs about one gram, replied I have no earthly idea. I think she says it's more money than that they could spend in 10 lifetimes, or more money that they could launder with 100 car washes. Critical to that laundering operation was the fact that the car wash, although owned by Mr White, that wasn't a fact that was easily determined. If that's not the way it really was in the show, I'm going to make it up because it fits here. That's what we're going to talk about today.
Speaker 1:Who owns businesses that take part in this kind of activity, or who owns any business? The United Nations Office on Drugs and Crime estimates that 2-5% of the global GDP, or about 8 billion to 2 trillion, is laundered annually. It comes in many flavors. There is laundering to hide ill-gotten gains, like drug trafficking, walter White style, or fraud or embezzlement. There is trade-based money laundering, manipulating invoices or trade financing to disguise the illegal origin of funds. There's the creation of shell companies with no legitimate business other than to launder money, and there's investing dirty money in real estate to integrate those funds into the legal economy, and it goes beyond the kind of sanitizing that Walter undertook at his car wash while Gus Fring was transporting crystal meth on his Los Poyos Armanos trucks. It's not the only dangerous activity that laundering and opaque businesses are used to hide. The International Monetary Fund is concerned about quote terrorism financing and proliferation financing, that is, providing funds or financial services for nuclear, chemical or biological weapons. These crimes can make countries less stable, they say I'd say so which in turn can weaken law and order, governance, regulatory effectiveness, foreign investments and international capital flows. Even Mr White never went that far, but if only he had more time.
Speaker 1:The United States, of course, is a sweet target, and one of the things our government is doing about that was the enactment in 2021 of the Corporate Transparency Act. The Act aims to increase transparency around company ownership in the US to combat financial crimes like this money laundering and terrorism financing that we're talking about. Apparently, knowing the people behind companies, even small businesses like mine or your local carwash or a fried chicken franchise is not as transparent as folks might think. Knowing who's behind the curtain isn't as easily ascertained as some might believe, and by some I mean me. The Corporate Transparency Act adds new reporting requirements for 32 million companies. That will be in the first year after it goes live. The Corporate Transparency Act, which was part of the anti-money laundering act of 2020, is overseen by the US Department of Treasury's Financial Crimes Enforcement Network, or FINCEN. I'm not going to get into it because I'm going to let my guests do that, because she actually knows what this is all about.
Speaker 1:Laurie Smith is chair of the Emerging Companies and Venture Capital Practice at Stradley Ronan and an active member in the firm's health law and mergers and acquisitions groups, among others. This accomplished professional has been a trusted advisor to foreign and domestic companies for more than 30 years, ranging from startups and entrepreneurs to investors and large corporations. Laurie earned her JD with high honors from Duke University School of Law and her BA Magna Cum Laude from the University of Rochester. Now here's my interview with Laurie Smith of Stradley Ronan. I hope you enjoy it. Laurie Smith, thank you very much for talking with me today.
Speaker 2:Pleasure to be here, Tom.
Speaker 1:So we're going to talk about, as I said, the Corporate Transparency Act. Could you start us off and give us a thumbnail of the act and what was the impetus behind it?
Speaker 2:Sure. So the Corporate Transparency Act was enacted in 2021, originally enacted as part of the Anti-Money Laundering Act of 2020, which is part of the National Defense Authorization Act, also for fiscal year 2021. And the idea behind it was really that the US is one of the few countries in the world where you can form entities and nobody can tell who owns them. There's absolutely no disclosure of ownership in any public record. So the government was looking for more transparency in an effort to get behind a lot of shell companies being formed for illegal activity like money laundering, tax fraud and other illicit activities. That's the rationale behind it. Whether or not an implementation that means anything remains to be seen, because if you're already engaging in illicit acts, I'm not sure you're worried about this registration. Well, I consider it.
Speaker 1:So I guess the thing is well, the problem it's trying to address then, obviously, is spotting people who are doing illegal acts, money laundering, et cetera. You said there's no disclosure. Now, is that for my education? Is that you said there's no disclosure of who's behind corporations?
Speaker 2:Correct. When you form a corporation in a state in the United States right now the secretary you file with the secretary of state's office in St Delaware, new York or Pennsylvania and all you have to file is the name of the company, the number of shares you're authorizing and the person who signs that document is called the incorporator, who doesn't have to be an owner it could be a lawyer, it could be anyone you hired to file, and when you file annual reports you do not have to disclose who your offices or directors are. There is really no publicly available information about private companies, but that's just for corporations.
Speaker 2:It's for any entity whether it's a corporation, llc, limited partnership that is formed by filing with a state or federal office of some kind. We just allow for complete non-transparency in terms of formation.
Speaker 1:What types of entities are subject to the reporting requirements and what are the key exemptions built into these requirements?
Speaker 2:Basically, the way they've defined reporting companies is governed by whether or not you're going to have to file a document with a secretary of state or similar office of a state, territory or possession of the United States or any tribal jurisdiction. So that comes up in two categories domestic reporting companies, which are US companies headquartered here, and foreign reporting companies, meaning companies formed in another country that have to register to do business here because they're doing a sufficient amount of business to have a presence in the United States. They will also, when they register to do business, have to file with whatever state they're in where they establish an office.
Speaker 1:And what about exemptions?
Speaker 2:Yeah. So there's 23 exemptions. Most of them relate to regulated companies like banks, insurance companies, registered investment advisors, with a theory behind those being that there is already publicly available information on those types of entities. The two interesting exemptions that we can spend a little bit of time on today are the subsidiary exemptions of exempt entities and the large operating company exemption. The subsidiary exemption applies to any entity that's wholly owned and wholly controlled by an exempt entity. So let's say you're a public company which is an exempt entity because the SEC is already collecting information on you and you have a wholly owned subsidiary. It would also automatically be exempt.
Speaker 2:However, one of the complications of the law is that if it's not wholly owned and controlled by that public company, then it's not automatically exempt. So, for example, I have a client who likes to buy companies and only buy 70% or 80% of that company and 30% they were allowed to continue to be owned by the former owners. That company won't be exempt unless you can find another exemption for it. So even a public company which is nominally exempt under its own exemption may be affiliated with entities that aren't exempt. So the next exemption you would normally look for for that company is something called the large operating company exemption Because the point, as I said before, of this law is to capture the shell companies, the small companies that really are being used just for illicit activity and not to operate a legitimate business. So the large operating company exemption applies to entities that employ more than 20 full-time employees and they have to be full-time employees has an operating presence at a physical office that they lease a rent in the US and isn't shared with any non-affiliated entities and reported in the prior year more than 5 million in gross receipts or sales on their US federal tax return. That is a great exemption for most bigger companies, except that the structures of many of these companies will not allow them to use the exemption.
Speaker 2:A classic example of that is a startup company that may I, as a public company, or a registered investment advisor, venture capital fund which are exempt want to invest in a startup company, that company will not have filed a tax return in the prior year, so it won't qualify.
Speaker 2:It may not have more than 20 employees, so it won't qualify. Or it may not have reached the 5 million in gross receipts for the prior year either and won't qualify. So the other example we've been thinking about is a private, a large private company, and a lot of these companies will put their employees in a single subsidiary for operating purposes and might have other subsidiaries, like an IP holding company, for their intellectual property. So they won't be able to qualify those subsidiaries under the large operating company exemption. If they don't own 100% and can't get the subsidiary exemption, then they don't really have an exemption for those companies because the IP holding company, for example, has no employees. So the exemption it really is going to take a lot of parsing through things and one of the key things to understand is, while there are 23 exemptions, you can't just assume, because the entity at the top of the chain is exempt, that everyone within your organizational structure is going to be exempt.
Speaker 1:And in the next section we'll get a little bit more into the weeds. But I know we talked about we don't want to go too far in. This is a podcast, for God's sakes, but I will refer people and I will put a link with your permission. So, stradley, ronan, you and your colleagues did a webinar a complimentary webinar on the subject, where you get into it more in depth. It looks like you guys go for more than an hour talking about it, so I'll direct people to that, if that's okay with you.
Speaker 2:Yeah, now we get into a lot of the weeds on types of entities and all the details are filing.
Speaker 1:Okay, so the next section we're going to talk about is beneficial owners.
Speaker 2:So the whole point of this law is to get to two categories of people. One are the beneficial owners and the other are the company applicants, the people forming the company. Company applicant piece we won't talk about today. It really is. It relates to only companies formed from January one of this year forward and it's technical. It relates to who's actually doing the filing so that you can find the person who is the intermediary, in effect, between the people behind the company and the company.
Speaker 2:So beneficial owners are the people who own the company and they are technically people who directly or indirectly exercise substantial control over the reporting company or and to know owner control at least 25% of the ownership interest of the reporting company. And ownership interests are defined very, very broadly. So it's not just looking at outstanding stock or LLC interest. They will also look at whether the person is getting 25% or more of the economics of the business. So you could own 10% of equity but because of the way the economics are structured for example, in a complicated partnership where there might be a preferred stock interest that gets a preference to distributions they could be taking out more than 25% of the money but own less than 25%.
Speaker 2:Substantial control is also a pretty complicated definition. We could talk about it for probably an entire half hour, but it's to put it in its simplest form. It's, as I said, it's the senior officers president, cfo, general counsel it is any major decision maker who has control over decisions such as the business plan, hiring and firing those senior officers incurring significant, substantial obligations on behalf of the company. And so it could implicate people who get veto rights through shareholders' agreements and voting agreements and things like that, who don't necessarily own 25%, and then, in the government's ultimate wisdom, they added any other form of substantial control. So lawyers are scratching their heads right now saying, well, what does that mean? Because they said it could happen through anything. It could happen through any contractual relationship.
Speaker 2:So, to give you another example, one of the things we've been thinking about is in the healthcare field, there are corporate practice of medicine laws that don't allow non-physicians to own a medical practice. So what a private equity fund does to buy a physician practice or buy a physician practices is they set up what's called a management services organization and they buy the non-clinical assets of that physician practice. They don't own anything in that entity that the physician owns. However, they control that entity completely, because they have all the back office assets, they own the software, they own all the billing, they have all the non-clinical employees that work for that business and so, if you read this literally, that PE firm is a beneficial owner of the company, the physician practice, in which they don't own anything.
Speaker 1:Nice, and clear. What about you talk about exemptions to this test? Substantial control test.
Speaker 2:Very, very, very limited, because it does cover direct or indirect control. The exemptions are things like minors and minor child and individuals who are truly just nominees or intermediaries. There are some exemptions for lower level employees who don't really have control, like treasurers and secretaries.
Speaker 1:In your webinar, you talked about the final rule, or the access rule. What's that all about?
Speaker 2:So the access rule is really about who can actually get this information from what's called the boss system, where all the information is going to be stored by FinCEN. The final rule right now doesn't really tell you much. The general rule as to who has access is this is really for governmental investigations, so federal agencies involved in national security or intelligence or enforcement, similar state agencies, foreign law enforcement agencies and financial institutions can get the information with customer consent to comply with their own existing Know your Customer rules. The access rule that came out in December didn't add much to what was in the original statute. The only things it really did was it put some language around the security controls that are still in flux that they would like to put in place on two levels. One is at the level of what do we need in order to share this information with these agencies in terms of security of the information that's being disclosed, because all of this is personally identifiable information of the beneficial owners, including things like passports and driver's licenses.
Speaker 2:So they came out with a rule that talks about needing all kinds of assurances from the federal agencies as to their own systems for protecting the security of the information Non-disclosure type agreements and obligations of that sort, and the second layer of that is what kind of safeguards will there be as to further disclosure or use of the information? So just a few days ago, in late January, the FinCEN put out a request for comments on what type of requirements should there be in place in order for any of these agencies to actually get the information. What are the types of requests that we're gonna respond to? The other thing they made clear is that, at least for 2024, we're gonna be in a pilot period where they are not going to be openly sharing this information with any government agency that asks for it. They are going to probably start with one or two federal agencies and see how it goes and try to essentially beta test the system.
Speaker 1:What constitutes a filing? To determine if an entity is a filing entity.
Speaker 2:That is another nuanced thing. So it really it goes to the fact that some states require filings to be formed for some types of entities and other states don't. So corporations are clear. In order to form a corporation or a limited liability company in every state in the United States there is some formal filing a certificate of incorporation, certificate of organization or a certificate of formation but there are other entities that it differs by state. One example is limited liability partnerships, and this is near and dear to Bradley's heart, because we're in two states that have differing laws.
Speaker 2:So in New York, llps one of these limited liability partnerships actually have to form, actually have to file with the Secretary of State to be formed. However, in Pennsylvania, forming an LLP is something you can do after the fact by making an election. So there's a question as to whether an LLP in Pennsylvania is a filing entity that becomes a reporting entity. It could be formed, for example, as a general partnership, which doesn't have a filing in any state General partnerships are not filing entities and then just make an election after the fact. So that's really what we're talking about in terms of what's filing versus not filing. The same issue comes up with different kinds of trusts, like certain states require trusts to file with the Secretary of State or some government agency in the state to be formed and in other states. In other states trusts and other types of trusts can be formed without filings.
Speaker 1:Harry, let's jump out of the act for a bit and talk about, rather, the compliance aspects. What if you don't comply? What are the penalties associated with these reporting requirements?
Speaker 2:So the penalties are $591. The civil penalty? There's civil and criminal penalties. The civil penalty is for willful, grossly negligent noncompliance or to timely update your reports and you do have to update these reports within 30 days of any changes in the information and they have $591 a day. And then there are criminal penalties of up to $10,000 and up to two years of imprisonment. That's just for the filing alone. Then any individual who knowingly discloses this beneficial ownership information after it's been collected without authorization is also subject to a $591 day penalty on and a criminal fine of up to $250,000 in five years imprisonment and the penalty doubles, which I know I'm not really sure how this would work yet but the penalty doubles if the disclosure occurs, um, while if it's done in connection with violating another law. So I guess if you're a money launderer, finally another law and you don't file, then your your penalties are doubled.
Speaker 1:Alright, alright, that's a very busy person, I guess, so what? So okay, so the penalties just down.
Speaker 2:I mean $591 doesn't sound like a ton, but I guess well, if you, you don't catch it for three years, yeah, okay, years, and it's running up.
Speaker 2:Yeah, that's okay, Alright and you know, keeping my time, that this, this applies to and this, I think, is one of the biggest issues. You know, clients of ours, whether it's these big public companies, big private companies, they're gonna be aware of this law because they've got lawyers telling them to be aware of this law. But think about your barber or your gardener who's mowing your lawn, who has a little LLC. You know all these, all these small companies have no idea that they have this requirement to file. They're not paying attention to this so they could be in, they could be in violation, and whether that's willful or grossly negligent, you know who knows okay, so even if my garden may not even be laundering money, he's likely.
Speaker 2:He's likely not go from money. May not be reporting all of his cats, but but, he's not. He was. He's not the target of this law, but unfortunately, the way it's set up, it picks up every, every small business.
Speaker 1:Words of caution to all the, all the gardeners out there. So what, what kind of response are Is coming from the, from the corporate world, and I guess what's the response? And then what should companies be doing right now?
Speaker 2:There was a lot of pushback to the law initially.
Speaker 1:Shocking.
Speaker 2:Yeah, there was, I think, only one actual lawsuit filed by a couple of chambers of commerce and there was a lot of chatter in Congress, including up until December of last year, trying to delay or or Get rid of this law or modify it substantially so that there would be more clarity.
Speaker 2:But to date there's really been no, you know, no significant pushback, or at least no success in pushing back on the law. Janet Yellen is a big supporter of it. She came out with a speech in early in January Talking about how important this law was and that in the first couple of weeks over a hundred thousand companies had already filed. We not quite sure why, because they had had 90 days to file, but People were people were filing well before the. There was enough clarity around the law to to, you know, know exactly what they needed to do. You know, I think they will continue to be pushed back, but I do I think this law is going to be repealed? Probably not. It was adopted during the Trump administration and it's gotten continued support through the Biden administration, so there really does seem to still be some by putting out a significant bipartisan support for continuing to push forward with this.
Speaker 1:Yeah, a lot of companies took action right away. I don't know. I guess it's nothing like prison time to get your attention, I suppose. But maybe they were just you know. Let's just get in line here. Do you do foresee litigation? Do you think those they're going to be suits over this?
Speaker 2:you know, I thought it's hard to tell where this is going. I think that most Companies will try to comply. I think it will be very, very difficult for Fincent to actually use this information In a meaningful way anytime soon. They don't. They don't have the resources that I. You know I've been scratching my head as to how they're going to monitor this and who didn't file. I Guess they could go to every secretary of state's office and and monitor who's formed a new company, but catching the companies that have been in existence for, you know, 10, 20, 30 years, it would take them a lot of work to figure that out.
Speaker 2:You know, I'm not trying to tell people not to comply. I think people should comply to the, you know, if they can, but In terms of whether there will be lawsuits and whether Whether this will be an effective means for the government to actually uncover Information that they need, and therefore that's when there would be lawsuits, you know you come after me for this penalty and I tell you, well, I don't think your law applies to me because I can fit in this exemption and you know your law wasn't clear enough. It's vague, I don't know. You know the I would have thought by now they would have been given a clear answer. By now they would have been. Challenges to the vagueness of the law is unconstitutional. But there haven't been well.
Speaker 1:Laurie Smith, Thank you very much for talking with me about this today.
Speaker 2:No, no problem, Happy to be here today.
Speaker 1:That concludes this episode of the emerging litigation podcast, the co-production of HB litigation, critical legal content, vlex fast case and our friends at LostG Media. I'm Tom Hage, your host, which would explain why I'm talking. Please feel free to reach out to me if you have ideas for a future episode and don't hesitate to share this with clients, colleagues, friends, animals you may have left at home, teenagers you irresponsibly left unsupervised, and certain Classifications of fruits and vegetables, and if you feel so moved, please give us a rating. Those always help. Thank you for listening.