Know Your Client: Should Lawyers Be Regulated Like Financial Institutions?

Corporate secrecy has been a consistent problem in the United States. For a country that has repeatedly urged offshore tax havens to clamp down on bad actors squirreling away illegally obtained money behind the cover of shell companies, the US continues to be one of the most significant enablers of money laundering. Indeed, the US has proven to be fertile ground for money launderers with nearly 2 million shell companies being formed within its borders every year.

There are several reasons why the US continues to be a favored domicile for shell companies. One of the most significant factors is that a large number of states in the US do not require limited liability companies (LLCs) to report their beneficial owners. These non-requirements stand in stark contrast to the comparatively robust beneficial ownership requirements in European countries, including territories such as the Cayman Islands, which have traditionally been considered tax havens.

Last year, the Financial Crimes Enforcement Network’s (FinCEN’s) Final Rule, which requires financial institutions regulated under the Banking Secrecy Act (BSA) to obtain beneficial ownership information of their business customers, went into effect. FinCEN’s Final Rule was, arguably, the first nationwide measure aimed at lifting the lid on corporate secrecy, and protecting the US financial system from the machinations of money launderers hiding behind shell companies.

Over the years, however, both senators and representatives have introduced several bills with the intent to strengthen beneficial ownership requirements at the time of incorporation, specifically in those states where these requirements do not exist. Some of these proposals even went a step further, calling on “formation agents” to be brought under the purview of the BSA. The term “formation agent” can be all encompassing – it could stand for any entity that is involved in the formation of companies, including lawyers, accountants, registered agents, corporate filling services.

This post will take a look at myriad legislative attempts made to bring formation agents, specifically lawyers, under the purview of the BSA. Had the attempts been successful, lawyers, as formation agents, would have been regulated on a par with financial institutions, subject to the full weight of attendant Anti-Money Laundering (AML) requirements.

Corporate Transparency Act (2017)

While beneficial ownership has been a bone of contention between legislators, regulators, lobbyists and politicians for decades, it was the Corporate Transparency Act (2017) that first turned its attention to “formation agents”. Proposed by Representatives Carolyn Maloney and Peter King, the Corporate Transparency Act (2017) sought to hold LLCs and corporations accountable for disclosing the list of their beneficial owners at the time of formation or incorporation.

Specifically, the Corporate Transparency Act (2017) included the creation of a set of standards for the filing of beneficial ownership information. According to the Act, these minimum standards were the following:

(1) A list of beneficial owners

(2) For each beneficial owner, the name, current address, and non-expired U.S. passport or State-issued driver’s license

The Act recognized the lack of uniformity in beneficial ownership requirements across different states in the US. It therefore suggested that an LLC or corporation formed/incorporated in a state would provide beneficial ownership information to the state; if the state’s formation procedures did not meet the minimum requirements, then the company, in question, would have to file beneficial ownership information with FinCEN.

Perhaps the most intriguing element of the Act was its inclusion of “formation agents”. According to the Act, instead of directly collecting beneficial ownership information from LLC and corporations, a state could license formation agents to collect this information on its behalf. However, many legal experts believed that the Act’s definition of formation agents was too broad. The Act defines a formation agent as “any person who, for compensation . . . acts on behalf of another person to form, or assist in the formation of, a corporation or [LLC] under the laws of a State; or . . . purchases, sells, or transfers the public records that form a corporation or [LLC].”

The Corporate Transparency Act (2017) soon caught the attention of the Senate as well, with Senators Ron Wyden and Marco Rubio introducing companion legislation in the upper chamber.

The TITLE Act (2017)

Around the time the Corporate Transparency Act (2017) was introduced, the True Incorporation Transparency for Law Enforcement (TITLE) Act, was brought forth by Senator Sheldon Whitehouse. Like the Corporate Transparency Act (2017), the TITLE Act sought to firm up beneficial ownership requirements at the state level, alongside mandating that professionals hired to form companies – formation agents – conduct due diligence on their clients in the same way that financial institutions conduct customer due diligence (CDD).

Unrealistic expectations?

The introduction of these two Acts disconcerted many, particularly those in the legal profession. According to the American Bar Association (ABA), the changes proposed by the Acts endangered “attorney-client” privilege, besides imposing undue burdens on attorneys. Under BSA’s AML requirements, regulated entities are required to file suspicious activities reports (SARs) on their customers. SAR requirements, according to the ABA, would oblige attorneys to file confidential information about their clients, which, specifically, would undermine attorney-client privilege and erode attorneys’ relationships with their clients.

Further, the ABA argued that heavy reporting requirements under the AML regime were not feasible, requiring unrealistic levels of resource and time allocation. Additionally, the non-compliance fines would prove to be too costly for attorneys and small businesses, it was argued.

Formation agents: Unrealistic to unlikely?

Whilst the earliest iteration of the Corporate Transparency Act (2017) included pivotal passages on treating formation agents as regulated entities, the Act, in its latest incarnation, steers clear of any references to formation agents. While the Corporate Transparency Act (2019), which was re-introduced in early March this year, laid down specific requirements for the disclosure of beneficial ownership information, legal professionals were relieved to learn that they wouldn’t be brought under the purview of the BSA.

Regardless, the issue is still mired in uncertainty; given the push-and-pull of US politics, it would be difficult to say, conclusively, how the discourse will bear out in the future. According to the National Law Review, every country in the European Union requires formation agents to identify the beneficial owners of the corporations formed in those countries. Given that there’s a clear international precedent, it would be interesting to examine what keeps the US from following suit.