Professor Bainbridge...on law, politics, religion, culture & food

On first glance, the legislation would seem to “commandeer the states” in violation of New York v. United States, 505 U.S. 144 (1992). If it’s passed and litigated, it could be a test of where the Roberts Court will go with the federalism cases.

I run two one-man companies. I’m the sole employee. Just in taxes, between the two I file:

Quarterly reports on withholding to state and to fed;
Monthly withholding to the Fed;
Quarterly withholding on the LLC;
Annual W-2s and W-3s;
monthly sales tax reports and payments;
federal and state unemployment forms, one annual, the other quarterly;
Annual corporate income tax returns to IRS and to State (costs for the accountant are about 1% of gross);
Plus of course the annual fee on the corporation’s registration.

I shudder to think how complex life would become if I hired someone in addition to myself

Guess I have to question the thesis of what is ownership reporting. Or more accurately how lazy are the cops?

If I form a LLC or Corp here in Texas I have to report the owners of said entities as well as any directorships if so utilized. Material changes of holdings have to be reported in the annual report that is filed to the State.

This is the case of, only the mindful are harmed by this legislation.

Since the Federal government is proposing/mandating that the states collect the information, what would be the penalties for non-compliance?

If the state and/or federal authorities have evidence of criminal activity, can’t they already subpoena ownership information?  Presumably this just treats all entities/owners as potential criminals and makes it easy for the state/feds to get such information without a reasonable evidentiary basis.  I’ve represented many entities and their owners over the years who have had legitimate reasons (of course entirely unrelated to criminal activity) to keep ownership confidential.

Several points (I am uncertain if the bill has been published yet, so it might be unfair to comment at this juncture, but I have seen a copy of it):

The concern over lack of transparency in this area is grounded in current criminal data received from state and federal law enforcement agencies, as well as a GAO report (4.06, “Company Formations: Minimal Ownership Information is Collected and Available” – available at http://www.gao.gov) and a Senate Hearing on the issue in November 2006.  Aside from the usual shenanigans facilitated by front companies (money laundering, phony charities used by Islamist groups, and tax evasion), increasingly front companies are cropping up in immigration scams (drivers licenses, visas, hoalas, etc.).

With respect to your (very reasonable) criticisms, I believe the bill does the following:

It requires beneficial ownership information (names and addresses), as currently defined in the CFR for certain classes of bank accounts.  The SARBOX comparison may thus be inapposite—floor debate should suss that out.  If you are correct that it does in fact generate yet more paperwork, then the bill will likely not gain any traction. 

It may pass constitutional muster due to an implicit threat of funding withholding; the bill calls for a GAO study one year after the effective date (2012) to determine compliance, and then only authorizes Congress to revisit the carrot/stick issue.  The bill explicitly precludes the withholding of DHS state grant funds for failure to comply.  Thus, it does not appear to be an unfunded mandate—states may use unallocated DHS grant funds to cover the costs, which shouldn’t entail greater than the cost of changing the current filing form.  Moreover, there is no obligation on the states to actually verify the information provided.  The assumption at this juncture is that the criminal threat will deter false filings.

Your point re: lawbreakers won’t comply is well taken.  As noted above, there is no obligation on the states to verify the information provided.  It remains to be seen how it is enforced—there is a provision criminalizing the submission of false information.  However, as the vast majority of incorporation applications cited for misuse are submitted by attorneys and/or services devoted to business formation (see 4.06 GAO report), the criminal aspect should incentivize those with reputational integrity concerns to be more circumspect when supplying a certification that the information is accurate.

Again, much of these points depend on what makes it out of committee.

There are approximately 6,000,000 million small business employers in this country.

If each one spent just $500 on dealing with this new reporting requirement, the bill for Mr. Levin’s feel-good legislation comes to THREE BILLION DOLLARS.  Every year.

SMG,
perhaps they could offset the cost by eliminating capital gains…

Tie in biometric data with other info collected to ensure people are supplying more correct info, and we are that much closer to having government control of everything…

Which would be bad…

SOX has been bad but are there any initiatives to clean it up?  This bill appears to be more of a piling on than a cleanup.

Blind supporters of businesses need to stop whining about this. This law is a good thing. It’s time that businesses had to suffer from some of the openness that citizens have rightly been forcing on government.

In fact, this law does not go far enough. The law should enforce the same openness on any foreign or global company doing business in the USA or selling their products in the USA. We need to know which foreign businesses are fronts for international criminals.

Mandating that companies comply with this law could be as simple as making companies publish their beneficial owners on a website.

There is nothing wrong with a company being open about who that company is. And if there is something wrong with that company we don’t need them doing business in our country.

"Although the bill apparently will exempt firms subject to SEC registration, there are a substantial number of firms with a large number of shareholders and a somewhat active market (such as those traded on the pink sheets). Their costs of keeping track of their beneficial owners will go up.”

OK, I’m a bit puzzled by this. Are you saying that these companies with large numbers of shareholders don’t have lists of who their shareholders are and how to contact them? I would have thought this would have posed a problem when they tried to pay dividents… Or is there a load of information required by this bill that the companies wouldn’t normally hold? If so, could you tell us what?

Paul—There are two problems with your reasoning.  First, as Prof. B pointed out, regulations like SOX and this one are driving businesses to other countries to look for financing.  Like it or not, high finance is one of the USA’s biggest “industries.” It’s something that for the past 30-40 years or so people from all around the world have been coming here for.  Now those people are going elsewhere (London, for example).  And we lose in prosperity as a result.

Second, if someone is a criminal, what makes you think he will have any qualms about lying on whatever paperwork this law would require?

Edmund—That’s a good question.  The situation is more complicated than you realize because of the difference between “beneficial” stockholders and “record” stockholders.  Record stockholders are the stockholders listed on the records of the company.  Very often (and almost always, in the case of publicly traded companies) the record stockholders are intermediary companies that specialize in holding stock on behalf of the “real” owners, i.e., the beneficial stockholders.  The idea behind this set-up is to save the company the trouble of continually updating its records as its stock is traded.  The intermediary specializes in doing that on its own.  (And typically there are several layers of intermediaries.)

A publicly traded company may have only a handful of record stockholders but over a million beneficial stockholders.  Thus, to gather the names of beneficial owners, a publicly traded company would have to reach down to its record holders and collect beneficial owner information through them.  And such information would be stale the moment it’s collected, since the beneficial owners are constantly trading their stock (actually, what they’re trading are their entitlements to what the intermediaries hold).

If I recall correctly, the UK requires that companies provide beneficial ownership information down to the real person.  In fact, most countries do, since it’s an international standard under the Financial Action Task Force.  If states are going to retain the basis for corporation law in the United States (as opposed to having a federal corporation statute), why shouldn’t individual states require the same kind of information that the Cayman Islands require?

The international handling of beneficial ownership involving corporate vehicles varies considerably. The Financial Action Task Force (FATF) recommendations deal with this issue through a couple of recommendations, including Rec 5 (identification of BO by banks and other financial institutions), Rec 12 (ID of BO by non-financial intermediaries such as trust and corporate service providers-TCSPs), and Rec 33 (availability of BO of corporate vehicles in general). 

The EU, including countries like the UK, have chosen to implement these recommendations through the Third Money Laundering Directive, issued in 2005 although it didn’t go into affect until mid December of 2007.  The EU directive basically created AML obligations for TCSPs including a requirement to identify true beneficial owners of corporate vehicles.  However, it only covers cases where the companies use a TCSP to register a company or serve as a registration.  Companies that directly register with a state corporate registry can continue to only provide nominal ownership information.  To my knowledge, no country currently requires full beneficial ownership information to be collected and verified by the relevant state corporate registry.

As Bainbridge pointed out, a criminal can easily evade unless you close up some of the loopholes, including offshore trust ownership.  However, some of the foreign legislation has addressed these specific vulnerabilities.  For example, in the case of trust ownership, UK law defines the BO of a trust to be a trustee or any beneficiary of more than a 25% stake in the principal of the trust.  In the UK system, a TCSP would need to collect that information and take reasonable efforts to verify that’s correct. Using an offshore vehicle to hide ownership won’t work since you’ll still need to a natural person ID in order for the registration to be processed. 

Since the Levin legislation seems to place the obligation on the states to collect this information rather than on intermediaries, its unclear what verification states will need to do in order to verify BO information is correct.  Also, for this to have any teeth, there would have to be pretty serious criminal penalties associated with providing false information.  Will be interesting to see how the legislation deals with that.

For the record, I am not saying that I support the legislation. I just think it will be hard to evaluate the usefulness of this law for law enforcement until we some the details of how it will work, particularly civil and criminal penalties associated with the law.