Podcast - Examining FinCEN FAQs, Proposed Legislation and Other CTA Developments

Alan Granwell: Good afternoon everybody. We're delighted to be here in our third podcast under the Corporate Transparency Act. Today we're going to be talking about a series of important developments which happened in the past few weeks. I first would like to introduce my two colleagues: John Bunge, who is a private wealth partner in our Nashville office, and Michael Titens, who is a corporate partner in our Dallas office. Both of whom are on our corporate transparency team. I'm Alan Granwell, I'm based in Washington, D.C. Since April 15 of the last month, there have been a whole series of developments: frequently asked questions, responses have come out from FinCEN, the Department of Justice has filed various briefs relating to the Alabama case, there was an injunction hearing in the Michigan case, there has been also proposed legislation filed by members of Congress and a committee hearing about how the CTA is going. We're going to cover the high spots of all these different developments. We'll first start with the FAQs. Just by way of background, the FinCEN came out with 17 FAQs, and they were broken up into a series of miscellaneous FAQs, access on beneficial ownership information reporting system and then some very important FAQs on trusts. John is going to highlight the FAQs dealing with trusts. John.

John Bunge: All right, thanks Alan. There were several FAQs, new FAQs regarding trusts, that provide some clarification and some color on what the regulations have been saying, but also still, I think, a lot of questions in the trust area. In the regulations, FinCEN listed three reasons that a person who's a constituent of the trust — whether that's as trustee, as a beneficiary, as a guarantor of the trust or another individual that has a power over the trust — could be reportable and treated as basically owning what the trust owns, in terms of meeting the 25 percent ownership or control test for being a beneficial owner. So, the first was that it's any individual has the power to dispose of trust assets, and the FAQ adds a little bit to that by, I think, the language is more clear that a trustee that doesn't have the power to dispose of trust assets would not be lumped in as owning what the trust owns in that circumstance. So, we deal with a lot of directed trust structures where the trustee doesn't have authority to make investment decisions, or at least one trustee doesn't, and the trustee doesn't have authority to make distribution decisions. [We] call that sometimes an administrative trustee or purely directed trustee. It appears clear from that FAQ that the trustee that's administrative only and doesn't have investment or distribution authority would not be in that category because they don't have the ability to dispose of trust assets. The second prong that from the regulations is a beneficiary who is the sole permissible beneficiary of the trust, or had the right to withdraw the trust assets. That sole permissible beneficiary issue, I think, has become a little bit unclear, because, you know, that's the only example of a beneficiary who only in the beneficiary capacity has beneficial ownership, but it doesn't preclude other ways that a person could have beneficial ownership as a beneficiary. So, I think it leaves the question in some people's mind of, you know, what other types of beneficiaries might be reportable if they were, for example, you know, a beneficiary of a trust that owns 99 percent of the company, and maybe there's two permissible beneficiaries. Would that bring one or both of those beneficiaries into that definition? I think that's just something that's unclear at this point.

Alan Granwell: I think the difficulty is the statement in the response that there could be other instances where they find you to have a beneficiary, but they don't explicate what that means, then you're left with the issue of what you report. And at least I think some people might say, well, because this is a disclosure statute, you take the conservative view and perhaps report everyone in that particular category.

John Bunge: We certainly understand in the area of trusts, the factual circumstances can differ greatly from one trust to another, and from one reporting company to another. I understand why FinCEN does not want to publish definitive guidelines that would apply to every trust, because there's so much difference between them. Unfortunately, what they've done so far is listed some circumstances in which trustees or beneficiaries may need to be reported as beneficial owners, and then just left us with a catch-all, telling us that there may be circumstances where other beneficial owners would also need to be reported. We're keeping an eye on all of FinCEN's guidance in this area, but as of now, we're still in a situation where trusts will continue to need to be evaluated on a case-by-case basis.

Alan Granwell: I guess, John, you also would include a settlor or grantor who has the power to dispose of assets in terms of the ownership rules, and then you could also have substantial control by the various individuals. So, you have to look at both those tasks. But maybe you can really get into this corporate trustee thing, which has really been an interesting development as to how FinCEN views corporate trustees.

John Bunge: The FAQ that starts from FinCEN is how does a reporting company report a corporate trustee as a beneficial owner. There's a couple things going on there. One is that a corporate trustee is typically defined as a bank. Under the statute, if it's supervised and examined by a state regulatory authority over banks or a federal authority, it's going to meet that definition of bank and be exempt. But this answer to this FAQ basically assumes that this corporate trustee is not exempt, and it says, in that case, if it's not exempt, you would actually look through, for example, the trust owns 60 percent of a reporting company and somebody owns, say, 50 percent of the corporate trustee, that you would look through to that ownership of the corporate trustee and that owner of 50 percent of the corporate trustee would actually be deemed to own basically the 30 percent of what's inside the trust. I think that answer is pretty surprising to a lot of people, because that owner of the corporate trustee doesn't actually have a beneficial interest or ownership of that entity that the trust owns. It's only held as trustee in a fiduciary capacity. So, it doesn't make a lot of sense in my mind to look through to the ownership of the corporate trustee without regard to whether that owner of the corporate trustee actually has substantial control, because I think the substantial control is a totally different question that might apply. But we're talking about actual ownership and just rigorously counting percent of ownership and looking through the corporate trustee. It just really does not make sense to me.

Alan Granwell: John, what if you had a corporate entity which is registered as a trust company under state law, would that sort of an animal be treated as a bank or not, as far as you know?

John Bunge: I think that depends. I'm aware of basically unregulated private trust companies allowed in several states. Here in Tennessee, any trust company, even if it's a state-chartered trust company, is supervised by the Department of Financial Institutions. So, I believe that that state-level non-depository trust company would generally still be a bank because it's examined by the state regulator. The only example I can think of a corporate trustee who wouldn't be exempt would be perhaps a foreign corporate trustee would fall in that category, but also an unregulated private trust company.

Alan Granwell: OK. Any other thoughts on the trust FAQs, or is that it from your end?

John Bunge: I think one more is another point of clarification they provided. And you could read the regulations like this already, but they specifically say that the employees or personnel at a corporate trustee could have substantial control, and that does not exclude an exempt corporate trustee. So, the employees of an exempt corporate trustee should still be considered in that question of whether they have substantial control. I think the way that most corporate trustees operate their trust departments would probably make it so that no single individual there would necessarily have substantial control, but it is a question that needs to be looked at. And if, for example, one investment manager with the corporate trustee has voting control and can make unilateral decisions over an LLC that the trust owns, then it would appear that person has substantial control just in their capacity as an employee of the corporate trustee. So, I think that's also surprising some people.

Alan Granwell: It's really the question that, if you're dealing with an exempt corporate trustee, why would you need to report the employees? But that seems to be the way the regulations are framed, not only in the private wealth area, but in the commercial area. And that's something people have criticized in terms of how the whole thing works. We're now going to move over to the briefs that have been filed, both in the Alabama case and the Michigan case, and Michael is going to give us an overview of what's going on in those areas.

Michael Titens: Yes. Thank you Alan. While we are busy helping clients comply with the Corporate Transparency Act, there are others around the country who are bringing challenges against the act in courts in various states. We're aware of cases in Alabama and Michigan, Ohio and Maine. There may be others pending, or if not, there may be others filed in the future. On our last podcast, we talked about the case that was filed in Alabama because notably in that case, the district court judge determined that the Corporate Transparency Act was unconstitutional on the grounds that Congress did not have the power to enact this sort of a law regulating entities upon formation. The government promptly appealed that ruling. And so we are waiting for a follow-up hearing in the appellate court, probably next month on that issue. As a reminder, the court there, the district court there, ruled the CTA unconstitutional because it did not fall within three different areas of congressional power that were being asserted by the government. The first was the government's power to regulate interstate and international and foreign commerce. The second was the government's power to regulate foreign affairs, and the third was the government's power to regulate tax matters. And along with those, the government's power under the Constitution to take all steps or make regulations necessary and proper to carry out those duties. Many people were surprised by the court's narrow interpretation of the Constitution, and the federal government, in their appellate brief, emphasized this point. The federal government argued that the interpretation was much too narrow, and that indeed, the regulations imposed by the Corporate Transparency Act are well within Congress' powers, including its power to regulate commerce, because nearly every entity that is formed is going to be engaging in commerce of one sort or another. The government's power to regulate foreign affairs and national security, because so much of this law is premised on trying to enforce and locate and prosecute persons involved in illicit activities, whether it's drug trafficking or human trafficking or tax evasion or what have you. And thirdly, that it was within the government's power, just simply with respect to taxes, because the information here is being used to try to crack down on people evading taxes through shell companies. The plaintiffs in that case basically argued that the judge got it right. And we'll see. There have been some additional briefs filed by friends of the court, three in particular. There was one filed by the Tax Law Center at NYU supporting the argument that the case was within the government's powers to lay and collect taxes, as the Constitution says, and to do all things that are necessary and proper in order to do that, arguing that this includes the authority not just to collect taxes, but also to collect information necessary for tax collection. And here this law, they say, gives the IRS the data it would need to assess and collect taxes at the correct rates and correct amounts, but also from the correct taxpayers, finding people that may be behind these shell corporations. There was a friend of the court brief filed by a transparency organization that was also, whose principals were also involved in putting the law together. In addition to giving lots of examples of how shell companies have been abused, how this abuse has been prevalent in the United States, they also argue that the CTA is part of a global effort to confront cross-border security risks from corrupt officials and terrorists and drug traffickers and so forth. The CTA addresses national security priorities. The most interesting brief, amicus brief, I think, is the one that was filed by several members of Congress. They argued that shell corporations harm the United States and national security and foreign affairs and interstate commerce in a variety of ways and give some examples. But the main thing these congresspeople seemed to be doing was really wanting to protect the prerogative of Congress here. They pointed out that this law was supported by extensive congressional fact finding, a robust legislative record and that what the Alabama District Court did here really was second guessing Congress' factual findings, which a court is not permitted to do. And so they've argued as well that there was a sound factual basis for Congress' finding that this law was necessary to protect commerce, foreign affairs and its ability to lay taxes. As I mentioned, we expect that case to be argued in June and decided at some point thereafter — whether that is just a few months or much longer will remain to be seen — and then it will go back to the district court for further action. Another case that was filed, which has brought in some briefing on additional issues, is the case in Michigan, where the plaintiffs are challenging the law for many of the same reasons: that it's beyond the power of Congress, that it violates the Fourth and Fifth Amendments to the Constitution. And in that case, we did get the arguments on the Fourth and Fifth Amendment. We got them in the context of the plaintiffs seeking an injunction that would apply just to them, but asking the court to find that the law cannot be enforced against the specific plaintiffs in that case. They made many of the same arguments about the scope of Congress' power. They also elaborated on their Fourth Amendment argument, which is basically that collecting all of this information is an unreasonable search, that the government can't compel disclosure of extensive personal information without a warrant, especially in this context, where that information is being provided to law enforcement agencies. They also made an argument under the Fifth Amendment due process clause that the statute was too vague to be enforceable as a criminal statute, citing terms such as substantial control and all of the confusion and ambiguity about what that might mean. The government responded forcefully, as you might expect, arguing as they did in Alabama that this law is well within Congress' power to enact. With respect to the unreasonable search claim under the Fourth Amendment, the government's argument primarily is that people don't have a reasonable expectation of privacy in the information that's being asked here. It's information they're already disclosing to lots of other government agencies in different contexts, and furthermore, this is a reasonable request given the overriding congressional or regulatory need for the information, similar to a special needs situation you might have, where government has the right to conduct a search at an airport or a border crossing due to the security concerns. This also, the government argued, fell within that special needs exemption to deal with the serious threats the country is facing. They also pushed back on the Fifth Amendment due process argument for a couple of reasons. One, that some of these terms have been found, in other cases, not to be ambiguous, substantial control and the like, and also pointing out that there's not a risk in their view that someone will get caught up in a criminal situation inadvertently under technicalities. Because, in order for there to be a violation of this law, that violation has to be willful, intentional, if you will, and so if somebody is accidentally, inadvertently violating the statute, they're not going to be held liable due to the willfulness standard. Those were the outlines of the arguments in Michigan, and in Michigan, we did get a preliminary reaction from the judge to those arguments, because the judge denied the plaintiffs' request and was not able to conclude that the plaintiffs were likely to be successful on the merits of their claim. So that was encouraging to supporters of the CTA. However, the judge did say, as he was issuing his ruling, that he had not made up his mind of how this case would ultimately be decided. He seemed particularly sympathetic to some of the privacy concerns that were raised by the plaintiffs, and questioned how far the government's authority to collect this type of information might go. He also indicated that he had not made up his mind on the basic commerce clause argument about the government's authority to enact the statute, so for now, no relief to the plaintiffs, but clearly more to come in this Michigan case as well. So we will be continuing to monitor all of these cases. Bottom line, as of now, for nearly everybody, the law remains in effect. The deadlines are still in effect, compliance is still required and we're continuing to help our clients comply with the laws. We expect more developments in the future.

Alan Granwell: Thanks, Mike. You know, I think the plaintiffs in all these cases were particularly hurt by the fact that they had to provide their personal identifiable information to a law enforcement agency. It came out, particularly in the Alabama case, and also irked by the fact that a number of the definitional terms and the beneficial ownership information reporting provisions were somewhat vague. And we can see in actual practice, the numerous questions that come up in terms of the way the regulations are drafted and, sort of, the ambiguity in terms of who, when and how you report. We're now very quickly going to just move to two other areas. First, in Congress at the end of April, there were two bills introduced. One was called the Small Business Red Tape Relief Act of 2024, where the congresspeople who introduced the provisions wanted the Department of the Treasury to report to Congress on a quarterly basis the amount of initial and updated reports filed, and also that FinCEN provide further educational information to potential persons who had to file the various reports. And then, there was a second bill introduced by Senator Tuberville of Alabama and a House of Representatives member called the Repealing Big Brother Overreach Act, and the purpose of that provision is to outright repeal the CTA. We'll see where these two bills go in Congress, but it's unlikely that either may have much traction. And then finally, there was a hearing on April 30 in front of the House Committee on Small Business called "Under the Microscope: Examining FinCEN's Implementation of the Corporate Transparency Act." There were a number of witnesses who complained about the vagueness, the burden on small businesses, the unclarity of the term willfulness and just overall being very unhappy about the reporting provisions for the reasons that John, Michael and I have sort of hinted at during the course of this presentation. We expect there will be more hearings. Also, the director of FinCEN, in a speech just last week, said they're doing everything in their power to inform the public about these reporting obligations, I think in response to this committee hearing, and the director said there have been 1.7 million reports filed. As you may know, FinCEN has estimated that for pre-2024 companies, there are 32 million potential filers, and that for companies formed in 2024 and thereafter, it's 5 million a year going forward. So that's a brief glimpse of what's going on in the CTA area. It's really been frenetic. Clients are trying to puzzle out how to file and answer some of these questions, which are ambiguous, and we will be addressing developments and questions and other aspects of the CTA in a forthcoming podcast. Thank you for your time and attention.