Corporate Transparency Act, Its Loopholes and a Comparison With LODR

[By Shivesh Didwania]

The author is a student of Maharashtra National Law University, Mumbai.

 

Introduction

Corporate Transparency Act (hereinafter ‘CTA’) was brought forth by the Congress of the USA on 1 January, 2021. CTA is a part of the Anti-Money Laundering Act of 2020. Financial Crimes Enforcement Network of the Department of the Treasury (hereinafter ‘FinCEN’) finalized the guidelines for implementation of the CTA on 30 September, 2022. The CTA will come into force from 1 January, 2024 for new companies and from 1 January, 2025 for the already existing companies. The objective of the enactment is to is to fight money laundering, tax evasions, etc. by the way of mandatory corporate reporting which will enhance corporate transparency. However, the CTA has been hailed as a ‘seismic shift’ towards achieving a better version of corporate transparency in the USA. It will help in curtailing the illegality that is carried on by the activities of shell companies.[i]

In India, such corporate reporting which is mandatory for the companies is governed and regulated by the Securities and Exchange Board of India’s Listing Obligations and Disclosure Requirements (hereinafter ‘LODR’) 2015. The objective of these regulations is to make transparency an intrinsic part of the Indian corporate regime. The objective of this article is to make the reader aware of the new legislation – the CTA of the USA and the loopholes that it suffers from. It will be followed by a comparison of the CTA with the existing regime of LODR in India.

Corporate Transparency Act: What does it entail?

The USA had a weak legal regime to tackle the transparency with regard to the beneficial ownership information. The CTA creates a federal framework for the information relating to the beneficial ownership in the USA.[ii] The CTA creates a rule for a ‘reporting company’ to disclose beneficial owners of the company.[iii] The company is required to disclose this information to the FinCEN, which will maintain a central registry.[iv] The information is to be provided on an annual basis. If there is a change in the ownership structure which needs to be reported, then the company must intimate the change to the FinCEN within period of thirty days.[v]

FinCEN, in turn, shares the information with investigation authorities as and when the need arises. These authorities may very well include any federal enforcement agency or may also include any overseas law enforcement bodies who have made request to a federal enforcement agency. However, there are stringent safeguards to ensure the data protection and privacy concerns.[vi]

Beneficial owners according to the CTA

Beneficial owners are persons/ entities that directly or indirectly have a substantial control over the reporting company; or which hold at least 25% in the reporting company. Substantial control essentially means that the entity/person has an intrinsic role to play in decision making in the affairs of the reporting company. This means that the person/entity holds a substantial control over the main company. It is important to note that ‘substantial control’ is not defined adequately in the CTA. A senior officer of a reporting company will also be said to have a substantial control over the affairs of the reporting company. Moreover, a person having control over the appointment or removal of the senior officer or the majority of the board of directors will also be said to have a substantial control over the reporting company.[vii] However, this interpretation of substantial control is not exhaustive in nature.[viii] Moreover, persons/ entities are beneficial owners irrespective of their citizenship or residency.[ix]

However, serious data privacy and confidentiality aspects may arise when the requesting party is a foreign agency. It may be justified when it is under a treaty between USA and the requesting country. However, it will be a matter of concern when the request is not made in furtherance of a treaty.[x] Beneficial owner may also include a person/ entity that receive substantial economic benefits from the assets of the reporting company. This wide definition or, as some people argue, lack of a proper definition opens the gate for the FinCEN to include numerous actors within the ambit of the CTA.[xi]

CTA is not free from loopholes

The CTA has been lauded as a land and mark step towards tackling corporate shell crimes. However, this legislation is also not without flaws. One of the problems that this mechanism may face is the time period of reporting the information. This mechanism may require the companies to report the required data on an annual basis which may, in turn, lead to untimely and non-updated information.[xii] Another problem is that this mechanism does not lay down rules for entities like trusts.[xiii] These bodies may take advantage if they are kept outside the regime of the CTA.

The information demanded is to be kept confidential and only the prescribed government agencies can access the same. However, there are arguments that whether the CTA really promotes transparency if the beneficial ownership information is highly confidential and secretive.[xiv] The scope of financial institutions to which information may be shared is also a restricted one and includes only a certain class of institutions as governed by the CTA.[xv] Access to the information can only be acquired so as to ensure requirements relating to the customer due diligence (CDD).[xvi] This might pacify the concerns of the companies that may be worried about the horizon of the disclosure of the beneficial ownership information. There can be serious privacy concerns about the data that is reported by the reporting company. The question posed may be that whether the right of a reporting company to keep its data confidential is greater than the importance of tracking the illegality pursued by shell companies.[xvii]

Another major problem is that companies may have reservations in declaring the information which might be available in the public domain.[xviii] They may be concerned about the extent of information that the CTA might effectively demand. This criticism will be present for a very long time because the USA might very well be equipped to keep such information in its central register but a company may not want such information to be disclosed even when it is complying completely with the legal requirements.[xix]

The CTA also provides exemptions to various entities from disclosing the required information. The companies which are publicly listed or in which over twenty USA employees are hired permanently or which has a tangible office in the USA are not required to report the required information. Moreover, private companies, LLCs, etc. which do not hold ownership interest in some other companies are exempt from the requirements of the CTA. Private trusts and entities that do not raise concerns regarding transparency such as banking entities, credit unions, some public accounting firms, insurance companies, etc. are also not included within the definition of reporting companies.[xx] Companies with federal income tax return of $5 million gross receipts or sales are also exempt. Moreover, a subsidiary company of most (not all) exempt companies are also exempt from reporting the information required by the CTA. Critics have highlighted that these exemptions, which cover as many as 11% of all USA entities, are too broad to not include shell companies.[xxi]

A Brief Comparison of CTA with the LODR

The first point of comparison between CTA and LODR is the process of enforcing these regulations. CTA is to become effective from 1 January, 2024 for new companies and from 1 January, 2025 for the already existing companies. However, LODR was not implemented in this manner. LODR was implemented in a manner in which ninety days were given to the entities to comply with these regulations. A second point which can be observed is that LODR talks about disclosures of a general nature that are required to be made by the listed entities. However, CTA lays down a framework for disclosures with respect to beneficial ownership information. Therefore, the scope of LODR can be said to be broader than the scope of CTA. LODR includes many obligations that a listed entity needs to fulfil. Further, under CTA, the entities need to report to the FinCEN disclosing the required information. However, under the regime of LODR, the required disclosures are to be displayed on the website of the concerned entity or to be reflected in the annual report.

We have seen the definition of beneficial owner under the CTA above. In comparison to the definition of beneficial owner in the regime of CTA, a related party under LODR is defined as a person/ entity, belonging to the promoter group of the listed entity, that holds at least 20% of the shareholding in the listed entity. It is very important to note that from April 1, 2023, this 20% requirements changed to 10% which means that a person holding 10% of the shares may qualify as a related party under the regime of LODR. With respect to a change, CTA requires that the entities inform the FinCEN within thirty days from the date of such change in the ownership structure. However, LODR requires that the companies make the disclosure within a period of twenty-four hours from the occurrence of the event or information.[xxii]

Another point of comparison is the way by which the reported information is available. Now, LODR requires certain information to be shared on the listed company’s website. Thus, it becomes easier for concerned parties to access the information that is mandated under LODR. The information is available in searchable formats in an online manner.[xxiii] On the other hand, under the regime of CTA, the disclosed information is highly secured and is accessible only via a process to specified agencies as discussed above. The disclosed information under CTA is unavailable to the public at large. LODR unlike CTA, gives examples of events that are required to be reported to the stock exchanges. These events do not require any test of materiality and include acquisitions, reversion in ratings, agreements, change in directors and key managerial staff, result of board meetings, corporate debt restructuring, filing of winding up application, etc. Under LODR, there is another list which lays down several events to which the rule of disclosure in a blanket manner but is contingent on the test of materiality. However, it has to be kept in mind that these lists are exhaustive in nature.[xxiv] Companies are required to intimate the stock exchanges regarding material developments in regard to the covered events.[xxv] Moreover, both these legislations are not without ambiguity. There are a lot of provisions which are contentious or the meaning of which is not very clear.

A point of similarity which can be observed is that under LODR, related party is given a wide meaning so as to put as many entities/ persons as possible under its domain.[xxvi] Similarly, beneficial owner under CTA is also given a broad meaning so as to ensure that as many entities as possible and practical may fall in its domain, as we have seen above.

Conclusion

The CTA is a legislation which is enacted with the objective of making USA a country with enhanced corporate transparency. It is very important to keep in mind that this type of legislation is a landmark step for transparency with regard to the corporate beneficial ownership in the USA. There are also serious concerns regarding the maintenance of the digital valuable data which will be reported by the reporting companies under the CTA.[xxvii] It is also argued that by the time of the enforcement of the legislation, several loopholes will be fixed. However, it will be very interesting to see how the CTA pans out and what is its effect once it comes into force in the USA. As we have seen, CTA and LODR both are common in the aspect that they both require some disclosures to be made by the entities. However, LODR is not restricted to such disclosure requirements as we have seen above. Conclusively, it can be said that both these mechanisms act as stepping stones to achieve the dream of corporate transparency.

 

[i] Brendan O’ Leary, The Corporate Transparency Act: A Step toward Broken Shells, 47 J. Legis. 137 (2021).

[ii] Dominic Thomas-James, The United States Corporate Transparency Act: A review, 42(9) Comp. Law 302-303 (2021).

[iii] Paul Michael Gilmour, The US Corporate Transparency Act: Critiquing beneficial ownership disclosure requirements in the United States, 43(1) Comp. Law 16-17 (2022).

[iv] Ibid.

[v] Glenn G. Fox, Raj A. Malviya, Michael A. Breslow & Kevin L. Shepherd, Joining the Global Community in the Fight against Financial Secrecy: Congress Enacts the Corporate Transparency Act to Mandate Benefit Ownership Reporting in the United States, 48 ACTEC L.J. 58 (2022).

[vi] Dominic Thomas-James, supra note 2.

[vii] Glenn G. Fox, Raj A. Malviya, Michael A. Breslow & Kevin L. Shepherd, supra note 5, at 56.

[viii] Ibid.

[ix] Diane Ring, The 2021 Corporate Transparency Act: The next Frontier of U.S. Tax Transparency and Data Debates, 18 PITT. TAX REV. 262 (2021).

[x] Ibid.

[xi] Brendan O’ Leary, supra note 1, at 138.

[xii] Dominic Thomas-James, supra note 2.

[xiii] Ibid.

[xiv] Paul Michael Gilmour, supra note 3.

[xv] Ibid.

[xvi] Ibid.

[xvii] Brendan O’ Leary, supra note 1, at 153.

[xviii] Dominic Thomas-James, supra note 2.

[xix] D.J. Solove, “I’ve Got Nothing to Hide” and Other Misunderstandings of Privacy, 44(4) San Diego L. Rev. 745, (2008).

[xx] Glenn G. Fox, Raj A. Malviya, Michael A. Breslow & Kevin L. Shepherd, supra note 5, at 55.

[xxi] Paul Michael Gilmour, supra note 3.

[xxii] Anuja Saraswat & Sukrati Gupta, Redeveloping Whistleblowing Policy in India: A Fight for Better Corporate Governance, 3 INT’l J.L. MGMT. & HUMAN 1359 (2020).

[xxiii] Ankita Agarwal, SEBI (LODR) (Amendment) Regulations, 2018: A Route to Achieving a Global Level Corporate Governance Structure in India, 7 Supremo Amicus 37 (2018).

[xxiv] Varun Mansinghka & Kastubh Madhavan, Disclosure Obligations of Listed Companies in India: The Past, the Present and the Future, 2016 INT’l Bus. L.J. 327 (2016).

[xxv] Ibid.

[xxvi] Ankita Agarwal, supra note 23, at 38.

[xxvii] Diane Ring, supra note 9, at 264.

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