Anonymity of Business Entities … Soon to Be a Thing of the Past?

We have become so used to it that we no longer give it any thought. There is no requirement under Michigan law (as well as most other states’ laws) to disclose the beneficial owners of limited liability companies and corporations. Lawyers, formation agents and business owners routinely sign Articles of Organization as organizers and Articles of Incorporation as incorporators but are under no obligation to disclose their relationship to the entity being formed nor the entities’ beneficial owners. In many cases, such signers never become a beneficial owner or have any active involvement in the entity. Will this regime of anonymity end if H.R. 4450, the Incorporation Transparency and Law Enforcement Assistance Act (the “Bill”), is enacted?

On February 3, 2016 the Bill was introduced to ensure that persons who form corporations or limited liability companies in the United States (hereafter referred to as business entities) disclose the beneficial owners of those entities. The objective is to assist law enforcement in detecting, preventing and punishing terrorism, money laundering and other misconduct these anonymous entities may be involved in. The Bill’s background material indicates that more information about an applicant is required to obtain a driver’s license or open a bank account than is required to form a business entity. The Bill’s sponsors claim that criminals exploit this loophole and that investigation and enforcement of suspected criminal activity by government authorities is severely impacted by their lack of access to beneficial ownership information. In contrast to the U.S., all 28 countries in the European Union are required to have formation agents identify beneficial owners of corporations formed under their laws.

The Bill will require each State to establish a formation system that ensures disclosure of the beneficial owners of newly formed corporations and limited liability companies to the State, including name, address and passport or driver’s license number. The entity is then obligated to update the list of beneficial owners within 60 days of an ownership change. An annual filing with the State is required containing a list of the owners and the required owner information. Licensed formation agents may retain the beneficial ownership information directly rather than provide such information to the State. Interestingly, the Bill specifically prohibits companies from issuing bearer shares-an obvious attempt to further prevent hidden ownership. The information obtained by the State or retained by formation agents is then accessible by State and Federal authorities by way of civil or criminal subpoena or summons. Penalties for noncompliance are set forth in the Bill.

Entities that are exempt from reporting beneficial ownership are required to identify in their applications the specific provisions relied upon to obtain exempted status. However, what about entities in existence at the time the Bill is enacted. Within 2 years after a State’s formation system is amended to comply with the Bill, entities existing on the date of the Bill’s enactment shall be required to comply with the ownership disclosure rules applicable to new entities unless otherwise exempt.

A beneficial owner is a natural person who directly or indirectly exercises control over the business entity or has a substantial interest in or receives substantial economic benefits from the assets of such business entity. The following persons are excluded from the definition of “beneficial owner”: a minor child, a person acting as nominee of another person, an employee whose control or economic benefits stems solely from the employment status of such person, a person who inherits an interest in the entity and a creditor of the entity (unless the creditor has obtained control or an economic interest).

The Bill excludes many business entities from having to disclose their beneficial owners. Most of these are regulated or reporting entities including public companies, insurance companies, banks, brokers and dealers, investment companies and public accounting firms among others. Obviously, governmental authorities have access to information about these types of companies and their owners through other sources. It is interesting though that any business entity that employs more than 20 full-time employees in the U.S., files U.S. income tax returns reporting gross income of more than $5 million and has a physical office in the U.S. is exempt. Although no explanation is given, one can assume that the sponsors of the Bill did not feel that “larger” companies are being used for criminal activities or that hidden ownership is prevalent with such companies. Accordingly, owners of such companies can still remain anonymous. This may be an advantage for companies who secretly own subsidiaries that compete with the parent’s existing customers.

Note that the information that must be assembled resides with the State or a licensed formation agent. What if someone other than a State or Federal governmental authority desired access to this information. The Bill provides that it is up to the State to decide what persons may obtain this information; indeed, nothing prohibits the State from providing beneficial ownership information on its public website (but likely withholding passport and driver’s license numbers). It is fair to say that once this information is collected the potential for it becoming publicly available is significantly heightened.

We pointed out that a person who is acting as a nominee, say an attorney on behalf of his undisclosed client, is not considered a beneficial owner. Does this mean that anyone wishing to avoid the disclosure requirements of the Bill merely needs to appoint an agent or nominee to hold his/her ownership interest. Isn’t this a loophole big enough for a truck to drive through? Even if the lawyer/agent’s information must be disclosed, such lawyer will be prevented from disclosing the client’s name because of attorney/client privilege.

Asset protection planners frequently use limited liability companies as part of a client’s asset protection strategy. Historically, the owners of such companies were not disclosed to the State or available to the client’s creditors. Creditors access to debtor information may significantly change if the Bill is enacted and a State publishes such ownership information. Creditors could then search for debtors who are natural persons by name. While an advantage and time saver, creditors have always had in their arsenal post judgment collection powers including the right to demand a creditor’s examination. Nonetheless, a potential but not intended consequence of the Bill is to make life easier for creditors.

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