Corporate Transparency Act Hits a Snag

On March 1, the US District Court in Northern Alabama ruled that the “Corporate Transparency Act is unconstitutional because it exceeds the Constitution’s limits on Congress’ power.” It’s not clear what effect this ruling is going to have on other parties and other jurisdictions.

Congress passed the 2021 National Defense Authorization Act which included a bill called the Corporate Transparency Act (“CTA”). The CTA requires most entities incorporated under State law to disclose personal stakeholder information to the Treasury Department’s criminal enforcement arm.

There are two dozen exemptions, mostly for entities that are otherwise regulated. Many private fund managers have been trying to figure out how the exemptions apply. There is still some uncertainty on these exemptions. For example, registered investment advisers are exempt and private funds listed on Form ADV are exempt. Subsidiaries can be exempt, but FinCEN Seems to want to keep that exemption very narrow.

L. 6. Does a subsidiary whose ownership interests are partially controlled by an exempt entity qualify for the subsidiary exemption?

No. If an exempt entity controls some but not all of the ownership interests of the subsidiary, the subsidiary does not qualify. To qualify, a subsidiary’s ownership interests must be fully, 100 percent owned or controlled by an exempt entity.

A subsidiary whose ownership interests are controlled or wholly owned, directly or indirectly, by certain exempt entities is exempt from the BOI reporting requirements. In this context, control of ownership interests means that the exempt entity entirely controls all of the ownership interests in the reporting company, in the same way that an exempt entity must wholly own all of a subsidiary’s ownership interests for the exemption to apply.

[Issued January 12, 2024] https://www.fincen.gov/boi-faqs#L_6

Back to the case…

The Government argued that it has three sources of constitutional authority for enactment of the CTA. First, the Government argues that Congress has the power to enact the CTA under its foreign affairs powers. The CTA comes from the government’s interest in curbing foreign money laundering and other bad foreign money influences. The second sources is the Commerce Clause authority. Because many entities engage in activities that qualify as or affect “commerce,” the act of corporate formation itself is enough to invoke Congress’ Commerce Clause powers. Third, the Government argued that the CTA is a necessary and proper exercise of Congress’ taxing power, because one purpose of the FinCEN database created by the CTA is to assist in efficient tax administration.

The Court didn’t agree with any of these three arguments.

So now what?

Unless you are Isaac Winkles or the National Small Business Association, the court’s ruling does not apply to you. I suppose if you are in Alabama, you could argue that it might cover you. For the rest of us, who have created a new non-exempt entity in 2024, I think we still have to make that filing it 90 days.

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Anti-Money Laundering Rule for Investment Advisers – Take 3

We’ve been here before. FinCEN proposed anti-money laundering rules for investment advisers in 2003 and 2015. The pushback has been the Custody Rule, which requires a third-party to hold the client assets. That third-party will be doing the AML-KYC review. Those that are doing self-custody fall under existing AML rules.

Since 2015, there has been expansion in the weaponization of the dollar against persons and countries that the United States has issues with. The current hot button being Russian wealth. So, I think the rule is going to end up being promulgated this time.

It’s a lighter version of the rule that would require registered investment advisers and exempt reporting advisers to:

  • implement an AML/CFT program;
  • file certain reports, such as Suspicious Activity Reports, with FinCEN;
  • keep records such as those relating to the transmittal of funds (i.e., comply with the Recordkeeping and Travel Rule); and
  • fulfill other obligations applicable to financial institutions subject to the BSA and FinCEN’s implementing regulations.

It would not require customer identification program requirements. At this time. That requirement is specifically called out for a future joint rulemaking with the SEC.

The rule also proposes to delegate examination authority to the SEC.

The proposal has a 60-day comment period and a 12-month compliance deadline. No need to act currently. I think we’ll need to pencil it in for workplans in the second half of 2024.

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ABA Amends Rule on Client Due Diligence

The American Bar Association House of Delegates adopted a resolution that strengthens a lawyer’s obligation to decide before accepting or maintaining representation whether a client seeks to use the lawyer’s services to further a crime or fraud. This is part of an effort to alleviate concerns about the use of lawyers to facilitate money laundering and other financial crimes.

Kevin Shepherd, the ABA’s Treasurer, said that the U.S. Treasury Department had informed him that a failure to pass the resolution would cause the agency to take immediate regulatory action and to lobby for legislation imposing additional obligations on lawyers.

A few months ago Robert Wise, a New York lawyer, plead guilty to criminal charges stemming from payments he made for Russian oligarch Viktor Vekselberg, to maintain six properties in New York and Florida owned by the Russian billionaire in violation of sanctions.

The resolution adds a new inquiry requirement for lawyers under the ABA Model Rule of Professional Conduct:

(a) A lawyer shall inquire into and assess the facts and circumstances of each representation to determine whether the lawyer may accept or continue the representation. Except as stated in paragraph (c), a lawyer shall not represent a client or, where representation has commenced, shall withdraw from the representation of a client if:

…. (4) the client or prospective client seeks to use or persists in using the lawyer’s services to commit or further a crime or fraud, despite the lawyer’s discussion pursuant to Rules 1.2(d) and 1.4(a)(5) regarding the limitations on the lawyer assisting with the proposed conduct.

The commentary is very direct

[1] Paragraph (a) imposes an obligation on a lawyer to inquire into and assess the facts and circumstances of the representation before accepting it. The obligation imposed by Paragraph (a) continues throughout the representation. A change in the facts and circumstances relating to the representation may trigger a lawyer’s need to make further inquiry and assessment. For example, a client traditionally uses a lawyer to acquire local real estate through the use of domestic limited liability companies, with financing from a local bank. The same client then asks the lawyer to create a multi-tier corporate structure, formed in another state to acquire property in a third jurisdiction, and requests to route the transaction’s funding through the lawyer’s trust account. Another example is when, during the course of a representation, a new party is named or a new entity becomes involved.

We’ve seen the actions FinCEN have taken against title insurance companies under the Real Estate Geographical Targeting Orders.

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The Biden Strategy on Fighting Corruption

Yesterday’s story on FinCEN planning new Real Estate Anti-Money Laundering Regulations is just part of the larger plan of the Biden administration’s plan to fight corruption. For more details check out the recently released United States Strategy on Countering Corruption.

This is full of worthy goals. The stability of the US dollar is big lure for dirty money. I have some concerns about overly weaponizing the dollar internationally for fear that some other currency will take over as the de facto currency of the world. Right now, there are no other good candidates.

As for the details on the White House plan, I focused on how it might directly affect me.

One is the return of the 2015 rulemaking to “prescribe minimum standards for antimoney laundering programs and suspicious activity reporting requirements for certain investment advisor.” This time there is a particular focus on hedge funds, trusts, private equity funds and other vehicles. In particular, it looks like there will some focus on operations of private placements.

The White House is also looking at the gatekeepers to transactions: lawyers, accountants, and registered agents. They may hit with some anti-money laundering requirements, both as recordkeepers and targets for enforcement.

As yesterday’s story on real estate pointed out that it has been a tool for laundering money, the White House strategy includes a focus on digital assets and art. Those are two areas that are believed to be exploited by illicit money.

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FinCEN Sets Foundation for Real Estate Anti-Money Laundering Regulations

The Financial Crimes Enforcement Network (FinCEN) has gotten more active in fighting money laundering. While the last administration mostly focused on putting parties on the sanctions list, the current administration is looking to expand regulatory requirements. One of the several initiative recently launched is targeted at real estate.

On December 8, FinCEN announced an Advance Notice of Proposed Rulemaking on real estate transactions. It’s an advanced notice so there is no text to parse, just areas for discussion. The focus is on recordkeeping and reporting requirements on for people participating in transactions involving non-financed purchases of real estate.

Unlike the Geographic Targeted Orders, this new rulemaking could include commercial real estate. FinCEN recently renewed the Geographic Targeted Orders for all-cash purchases of real estate in Boston; Chicago; Dallas-Fort Worth; Honolulu; Las Vegas; Los Angeles; Miami; New York City; San Antonio; San Diego; San Francisco; and Seattle.

FinCEN is looking for comment on the potential scope of regulations. It has identified a few areas specifically:

  1. Scope of recordkeeping and reporting
  2. Who should be subject to the requirements
  3. Which types of real estate purchases should be covered
  4. Geographic scope of such a requirement,
  5. Appropriate reporting dollar-value threshold.

FinCEN is also looking for general comments on the risk of money laundering and other illicit financial activities in the real estate market and the extent to which any reporting requirements would address that risk. In footnote 76, FinCEN lists a bunch of prosecuted cases in which real estate was a vehicle for money laundering:

  • United States v. Real Property Located in Potomac, Maryland, Commonly Known as 9908 Bentcross Drive, Potomac, MD 20854, Case No. 20-cv-02071, Doc. 1 (D. Md. Jul. 15, 2020) (purchase of property in Potomac, MD)
  • United States v. Raul Torres, Case No. 1:19CR390, Doc. 30 (N.D. Ohio Mar. 30, 2020) (purchase of multiple properties in Cleveland, OH); United States v. Bradley, No. 3:15-cr-00037- 2, 2019 U.S. Dist. LEXIS 141157 (M.D. Tenn. Aug. 20, 2019) (purchase of multiple properties in Wayne County, MI);
  • United States v. Coffman, 859 F. Supp. 2d 871 (E.D. Ky. 2012) (purchases of properties in Kentucky and South Carolina);
  • United States v. Paul Manafort, Case 1:18-cr-00083-TSE, Doc. 14 (E.D. Va. Feb. 26, 2018) (purchase of a property in Virginia);
  • United States v. Miller, 295 F. Supp. 3d 690 (E.D. Va. 2018) (purchase of properties in Virginia and Delaware);
  • Atty. Griev. Comm’n of Md. v. Blair, 188 A.3d 1009 (MD Ct. App. 2018) (purchase of properties in Washington, DC and Maryland);
  • United States v. Patrick Ifediba, et al., Case No. 2:18-cr-00103-RDP-JEO, Doc. 1 (N.D. Ala. Mar. 29, 2018) (purchase of multiple properties in Alabama);
  • United States v. Delgado, 653 F.3d 729 (8th Cir. 2011) (purchase of multiple properties in Kansas City, MO),
  • United States v. Fernandez, 559 F.3d 303 (5th Cir. 2009) (purchase of multiple properties in El Paso, TX);
  • United States v. 10.10 Acres Located on Squires Rd., 386 F. Supp. 2d 613 (M.D.N.C. 2005) (purchase of two properties in North Carolina);
  • State v. Harris, 861 A.2d 165 (Super. Ct. App. Div. 2004) (purchase of multiple properties in a non-GTO-covered jurisdiction in New Jersey);
  • see also Lakshmi Kumar & Kaisa de Bel, “Acres of Money Laundering: Why U.S. Real Estate is a Kleptocrat’s Dream,” Global Financial Integrity, p. 29 (Aug. 2021) (highlighting money laundering cases outside of jurisdictions covered by the Real Estate GTOs)

Comments on the proposed rulemaking must be received on or before February 7, 2022.

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ENABLERS Act

With the release of the Pandora Papers, there is a renewed focus on the illicit movement of money and filling the holes in anti-money laundering rules. “The Washington Post and other news organizations exposed the involvement of political leaders, examined the growth of the industry within the United States and demonstrated how secrecy shields assets from governments, creditors and those abused or exploited by the wealthy and powerful.”

A bipartisan group of lawmakers introduced legislation that would require investment advisers, trust companies, lawyers, art dealers and others to investigate foreign clients seeking to move money and assets into the American financial system. The group got creative with the name of the bill: “Establishing New Authorities for Businesses Laundering and Enabling Risks to Security Act“. Which <surprise> acronyms into the ENABLERS Act.

The ENABLERS ACT would add new groups to the requirements of the Bank Secrecy Act and require rulemaking to implement the requirements. The new groups:

  1. “person engaged in the business of providing investment advice for compensation”
  2. Dealers in art, antiques, or collectibles
  3. Lawyers
  4. Trust companies
  5. Public accountants
  6. Public relations in such a manner as to provide another person anonymity
  7. Third-party payment services

The first category is the most important to me. Investment advisers have been lobbying to stay outside of the Bank Secrecy Act because of the custodian requirements. The client accounts are held at financial institutions that are subject to the Bank Secrecy Act. The success of that argument has been diminishing over the years.

Art dealers are a big one. There is already regulations moving into place to deal with that industry. It’s notorious as a way to move value around illicitly.

Lawyers are tough because of attorney-client privilege. I’m not sure how public accountants fit into the picture.

I wonder what PR firms did to anger the people who wrote this bill.

Of course it’s only a bill. A lot of things will have to happen to get this into law. Congress is not exactly a well-functioning organization right now.

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Fine Art, Money Laundering, and Influence Peddling

The Anti-Money Laundering Act of 2020 brought art dealers under the umbrella of anti-money laundering regulation. Section 6110(a) of the AML Act amends the definition of “financial institution” under the Bank Secrecy Act (BSA) to include persons “engaged in the trade of antiquities” and directs FinCEN to promulgate implementing regulations.

The value of fine art and antiquities are inherently subjective and allow for a wide range of sale prices. The good stuff also weighs significantly less than cash. A painting worth $2.5 million is easier to transport than 275 pounds of $20 bills for the equivalent value. At the freeport in Geneva, you can sell the art without even moving it or paying taxes on the gain.

Now U.S. art dealers will have to file suspicious activities reports for cash transactions.

Into this fray steps Hunter Biden, the President’s son who is looking to sell some of his paintings.

“Everyone should try pushing brushes around. And if someone wants to pay you a half-million for the results: Cash that check.”

https://www.yahoo.com/entertainment/hunter-biden-art-worth-500-110000217.html

This raises the ethical issue of buying Hunter Biden’s artwork in an attempt to influence President Biden. According to the Washington Post story, the White House is trying to craft an ethical wall around the potential purchases to keep them anonymous. It’s a bad spot to have presidential family members selling art that is highly subjective in value into a market that is under scrutiny for anti-money laundering efforts.

The best answer is to just say “no.” Wait three (or seven) years to start selling the art after President Biden is out of office. It looks terrible to be trading on his father’s name and role as president.

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Suspicious Activity Reporting

The Securities and Exchange Commission’s Division of Examinations released a Risk Alert on Compliance Issues Related to Suspicious Activity Monitoring and Reporting at Broker-Dealers. While it spent most of the publication laying out the vague requirements of reporting suspicious activity, it took a sharp turn and listed six types of activities that the SEC would consider suspicious activity that should be reported.

  1. Large deposits of low-priced securities, followed by the near-immediate liquidations of those securities and then wiring out the proceeds.
  2. Patterns of trading activity common to several customers including, but not limited to, the sales of large quantities of low-priced securities of multiple issuers by the customers.
  3. Trading in thinly traded, low-priced securities that resulted in sudden spikes in price or that represented most, if not all, of the securities’ daily trading volumes.
  4. Trading in the stock of issuers that were shell companies or had been subject to trading suspensions or whose affiliates, officers, or other insiders had a history of securities law violations.
  5. Questionable background of customers such as the fact that they were the subject of criminal, civil, or regulatory actions relating to, among other things, securities law violations.
  6. Trading in the stock of issuers for which over-the-counter stock quotation systems had published warnings because the issuers had ceased to comply with their SEC financial reporting obligations or for which the firms relied on a “freely tradeable” legal opinion that was inconsistent with publicly available information.

I found this to be a great reference list.

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Ignoring Iranian Red Flags

There are a few places around the world that you know you can’t do business with. Iran and North Korea have very strict limitations. If it pops up that your business partner wants to ship your products to one of these countries, it’s time to get legal and compliance on the phone before you agree to that sale.

UniControl, Inc., a manufacturer of process controls, airflow pressure switches, boiler controls, and other instrumentation, based in Ohio ran into this problem and violated the Iranian Transactions and Sanctions
Regulations.

From 2013 to 2017, UniControl exported 21 shipments of air pressure switches, valued at $687,189,
to European company that were subsequently reexported the shipments to Iran. U.S. Department of the Treasury’s Office of Foreign Assets Control took action against UniControl because it failed to take appropriate steps in response to multiple warning signs that its goods were being reexported to Iran.

Early in their relationship, one of these European trade partners told UniControl that it had a significant market for UniControl’s goods in Iran and inquired whether UniControl could serve as a supplier. UniControl rightfully said “no.” It otherwise didn’t take any steps to ensure the re-shipment to Iran would not actually happen.

UniControl really screwed up when it entered into a sales representative agreement with a European trade partner that explicitly listed Iran as a target for sales. UniControl employees met with the partner at a trade conference and met with Iranian nationals at the partner’s booth.

The last step was a request from the trade partner to remove the “Made in the USA” label from the products. “The European trade partner explained that the Iranian end-user may have problems with the stated origin of the products.” The company engaged outside counsel to figure out how much trouble it was in. Sadly, it still sent some of the shipments.

What saved the company was largely self-reporting the problem and investing in a more robust compliance program.

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Corporate Transparency Act

I’m not sure what Anti-Money Laundering has to do with the United States military, but Congress included big changes to anti-money laundering law in the National Defense Authorization Act for 2021. After a veto by President Trump and an override by Congress, NDAA has become the law, including Section 6401-6403, the Corporate Transparency Act.

It’s really easy to create a corporation, limited liability company or limited partnership in the United States. There are many, many legal, reasonable and important reasons to be able to do so. From the law enforcement and government sanctions parties, they see the company structure merely as an impediment to their ability to push bad guys out of the US banking system. The government side won and it may have a dramatic impact on the creation and reporting of companies.

The Corporate Transparency Act will require companies to submit a report of their beneficial interest to the U.S. Department of the Treasury’s Financial Crimes and Enforcement Center. For new companies, this information has to be submitted at the time of formation. Existing companies will have to submit this information within two years. All companies will have to update the information for a change of ownership within one year after the change.

The reporting requirement will not apply to all companies, just to any company that fits into the definition of “Reporting Company.” That definition has a lengthy list of companies that are exceptions and fall outside the scope of the Reporting Company definition. Of the twenty-four exceptions, there are some obvious types: public companies, banks, and broker-dealers.

I really wanted to focus on the possible impact on me and private fund managers.

Section 6403 of the NDAA adds a new section 5336 to Title 31 of the US Code. I focused on this exception in 31 USC 5336(a)(11) from the definition of “Reporting Company”:

‘‘(xi) an investment adviser—
(I) described in section 203(l) of the Investment Advisers Act of 1940 (15 U.S.C. 80b–3(l)); and
(II) that has filed Item 10, Schedule A, and Schedule B of Part 1A of Form ADV, or any successor thereto, with the Securities and Exchange Commission;

So registered investment advisors that report their ownership on Form ADV are not Reporting Companies and don’t have to report ownership. Obviously, they are already reporting ownership.

There is an exception for pooled investment vehicles operated or advised by investment advisers:

‘‘(xviii) any pooled investment vehicle that is operated or advised by a person described in clause (iii), (iv), (vii), (x), or (xi)

Although the definition of “pooled investment vehicle” is very specific:

(A) any investment company, as defined in section 3(a) of the Investment Company Act of 1940 (15 U.S.C. 80a–3(a)); or
(B) any company that—
(i) would be an investment company under that section but for the exclusion provided from that definition by paragraph (1) or (7) of section 3(c) of that Act (15 U.S.C. 80a–3(c));
and
(ii) is identified by its legal name by the applicable investment adviser in its Form ADV (or successor form) filed with the Securities and Exchange Commission.

Later, there is a broader exception:

‘‘(xxii) any corporation, limited liability company, or other similar entity of which the ownership interests are owned or controlled, directly or indirectly, by 1 or more entities described in clause (i), (ii), (iii), (iv), (v), (vii), (viii), (ix), (x), (xi), (xii), (xiii), (xiv), (xv), (xvi), (xvii) (xix), or (xxi);

Companies owned or controlled, directly or indirectly, by a registered investment adviser also fall outside the definition of “reporting company.”

This would seem to be good for private fund managers. The funds and fund subsidiaries seem to fall outside the definition of Reporting Company.

There is still a long path until we get to the point of having to do this reporting. FinCEN will have to establish the regulatory framework and the database to hold this information. It’s not clear how the reporting requirement will specifically interact with the various state secretaries of state who are responsible for company formation.

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