Introduction: Shareholder Anonymity
American entrepreneurs do not comprehend how lenient corporate law in the United States is as far as tracking the identity of shareholders goes. They realize it in stark fashion, however, if they expand their operations to the old continent, whereupon they are faced with a shockwave of formalities and reporting obligations. It goes the other way too, as their European counterparts are flabbergasted and confused by the lack of a publicly available shareholder register in the United States and the resulting shroud of anonymity cast over company ownership. Arguably, whether corporate transparency is perceived as having an indispensable or burdensome character is dictated by the environment one was brought up in.
Shareholder anonymity is a cornerstone of American corporate legal systems, which seem to do quite well with it. Prominently, the State of Delaware has become probably the most trusted legal environment for incorporation in the world (more about incorporation in Delaware – here) despite the lack of any procedure allowing the identity of the shareholders of Delaware corporations to be verified. The proponents of shareholder anonymity emphasize the nimbleness of this approach, which allows companies to quickly proceed with business transactions, keeps the administration in check by letting the business parties take care of due diligence processes, and prevents the public from peeking into one’s business life.
On the other hand, detractors point out that the lack of oversight opens a way for entities to serve as a façade which can be used to funnel funds out to an untraceable network of entities all over the world. This results in an impediment to effective tax collection and makes business dealings less transparent overall, all to the detriment of public interest and safety.
However interesting it may be, a debate regarding pros and cons of shareholder anonymity may only be of academic importance, if not futile. Unbeknownst to many, the legislative tides on the subject of the “freedom of anonymity” in the United States shifted a while ago and have reached a pivotal point this year. We cannot imagine a better moment to draw attention to the current state of the law, and the game-changing trends in legislation, or to ponder what the future holds for the venerable institution of shareholder anonymity in the United States.
The Current Status and Trends
As of the date of this article, disclosure of shareholder identity is not mandated by any of the major states or federal government at any point of a private entity’s life. Make no mistake, however, as the golden times for shareholder anonymity are certainly gone. For example, bearer shares, i.e. shares which could be transferred simply by passing on the physical stock certificate, were banned by the State of Delaware in 2002, and other states followed suit. No tears were shed for bearer shares, as the historically useful institution was too easily abused, for instance, by the infamous Jho Low. Still, vigilant observers knew that the writing was on the wall for all shareholders preferring to keep their identity anonymous.
The Light Comes From the East
The first wave of changes to the institution of shareholder anonymity was followed by a true tsunami coming from the old world when Directive 2018/843 of the European Parliament and of the Council amending Directive 2015/849 (the “Directive“) was adopted. In accordance with the Directive, every European Union (EU) member state is required to enact legislation imposing mandatory collection of information about the ultimate beneficial owners (UBOs) of the companies that are registered in that member state. The deadline for member states to implement the directive was set for January 10, 2020, and most member states are still in the process of finalizing the new UBO registers. It is important to pause for a moment and emphasize the following: the authorities of EU member states are now not only collecting information about shareholders, which they have been doing for decades, but also about the actual UBOs, and are making this information available to the public.
It begs a question: who is considered a UBO by the Directive? In general, a UBO is an individual who ultimately owns or controls a legal entity through direct or indirect ownership (Article 3.6 (Chapter I) of the Directive). The clear-cut equity threshold is set as over 25% of ownership, however, the definition was meticulously drafted to expose any individuals with a true impact on the entity (Article 3.6(a)(i) (Chapter I) of the Directive). The broad character of the UBO definition is also demonstrated by the Directive’s approach to trusts – an institution traditionally inherent to common law systems. It identifies as UBOs not only trustees, but also settlors, trust beneficiaries, or, if they are unknown, the entire class of persons in whose main interest the trust was set up (Article 3.6(b)(iv) (Chapter I) of the Directive).
The identity of all UBOs is required to be disclosed in centralized registers of EU member states and made available to any member of the general public at any time (Article 30.5(c) (Chapter III) of the Directive). The directive leaves some leeway for the member states to determine what information about the UBOs should be collected, but, at the very least, the name, date of birth, nationality, country of residence, and ownership percentage of each UBO must be made available in the centralized registers (Article 30.5 (Chapter III) of the Directive).
Granted, it is an issue for individuals holding stock in European entities, but is it currently relevant for shareholders of companies incorporated in the United States? Indeed, it can be critical. The abovementioned disclosure obligations mean that a Delaware C Corp. seeking to establish a wholly-owned subsidiary in France has to disclose not only information about the stockholder of the French entity (i.e. the Delaware C Corp.) but also the individual UBOs of the Delaware C Corp. This can be a significant deterrent and a deciding factor in not establishing the French entity at all, as no number of blockers could shield the UBOs of the Delaware C Corp. from public disclosure in the described scenario.
To add insult to injury for all those in favor of keeping their stakes private, all EU service providers who facilitate incorporation of subsidiaries, e.g. attorneys and notaries, are obligated to break down the ownership and structure control of their clients, identify UBOs, and take reasonable measures to verify the identity of UBOs, both when establishing a business relationship and during ongoing cooperation (Article 13.1(b), Article 11 (Chapter II)).
Shareholder Anonymity On Home Soil
All those who think: “oh, it’s the socialist European Union’s shenanigans” are in for a rude awakening. Understandably, no individual state would break ranks in defense of shareholder anonymity, as this could result in a decrease in business authorizations with arguably no real benefit conferred upon such state. Therefore, it took the federal government to initiate a drastic change.
Inspired by the EU directive and prompted by the Financial Action Task Force on Money Laundering, on May 3, 2019, the Corporate Transparency Act of 2019 (the “CTA”) was introduced to “ensure that persons who form corporations or limited liability companies in the United States disclose the beneficial owners of those corporations or limited liability companies”. CTA has already passed the House of Representatives, and it is safe to assume that, sooner or later, it will become law in the Land of the Free. Granted, the CTA is a Democrat-sponsored bill. Nevertheless, the Republican-controlled Senate should not be a factor, given that, based on the voting history in the House of Representatives, the CTA seems to enjoy certain support from the Republicans as well.
If enacted into law, CTA would require the submission of UBO information to the Financial Crimes Enforcement Network (FinCEN), which is run by the U.S. Department of Treasury. The information collected at the time of entity registration in any U.S. state would include the name, date of birth, current address, and driver’s license or passport number of each UBO. Understandably, CTA would require updates to be made to the list of UBOs and a more general report to be filed each year. Interestingly, foreign entities filing authorizations to do business in the United States would also be subject to the CTA requirements, which could have significant implications on how foreign entities structure their activities in the United States.
In fairness, CTA mostly targets companies which have been flying completely under the radar of federal regulators. Therefore, exemptions from registration will be available to the usual untouchables, i.e. banks, Indian tribes, churches, and companies which have filed registration statements with the SEC, as well as any business that employs more than twenty employees on a full-time basis in the United States, files income tax returns demonstrating more than five million dollars in gross receipts or sales, and has an operating presence at a physical office within the United States. A flexible legislative door remains open for the Secretary of the Treasury and the Attorney General of the United States to jointly determine any other subsequent exceptions.
Contrary to the EU registers, the UBO register kept by FinCEN will not be publicly available. However, interested citizens will be able to file a request and obtain information based on the Freedom of Information Act, absent a provision to the contrary in the final version of CTA.
Not to be harbingers of bad news, but there is no point in rushing to incorporate in the United States before CTA comes into force in hope of being grandfathered in, as existing corporations and LLCs will have two years to catch up and disclose the identities of their UBOs to FinCEN. To those who are not willing to comply, CTA provides penalties of a fine or imprisonment for up to three years.
Ending Note; A Prediction About the Future
The powerful and clear anti-shareholder anonymity zeitgeist makes it truly tempting to let the imagination run wild in a Harari-esque fashion. It is safe to assume that anti-money laundering and anti-terrorism measures applied by the U.S. government will also inevitably intensify given the scale of the problem. Ever-growing national debts and budget deficits will require extraordinary measures to be taken once the COVID-19 storm passes and the time comes to estimate the damage done to the economy.
Tax-evaders and international schemes will be there as readily available scapegoats, which will lead to increased pressure on UBO disclosure requirements and enforcement of CTA. Foreign assets will be reached for, as the CTA will be used to identify and reveal foreign members of LLCs registered in the United States who do not realize that they have been having Effectively Connected Income for decades now and owe a small fortune to the IRS. We imagine that enforcement of and compliance with CTA will be ensured by a creative, FATCA-like mechanism.
A fully public register of shareholders and UBOs will be set up one day in the United States akin to those in Europe. One may even dream about a blockchain-based, public register facilitating share transfers with transparency and efficiency. However, what we will probably get instead is a flood of articles with speculations about celebrities and their wealth facilitated by CTA paparazzi. Regardless of how realistic those dreams or nightmares are, the reality is that the days of shareholder anonymity are numbered.
Please mind that this article is neither legal advice nor should be treated as an exhaustive description of all applicable laws.