Category: Corporate law

How to Prepare for the Upcoming Filing Deadline Under the Corporate Transparency Act (CTA)

The January 1, 2025 filing deadline under the CTA for filing beneficial ownership information reports (BOI reports) for reporting companies formed prior to January 1, 2024 is rapidly approaching.

January 1, 2025 Filing Deadline

The CTA became effective on January 1, 2024. If you have filed a BOI report in the last 11 months, it may have been in connection with BOI reporting requirements for entities formed in 2024, because any reporting company formed on or after January 1, 2024 is required to submit its initial BOI report within 90 days of the filing of formation documents. However, the CTA’s BOI report requirements also apply to entities formed before 2024 (as well as to entities formed in 2025 and beyond), and the deadline for filing BOI reports for these entities is fast approaching. BOI reports for entities formed before 2024 must be filed by January 1, 2025, and as further discussed below, BOI reports for entities formed on or after January 1, 2025 must be filed within 30 days of the filing of formation documents.

Compliance with the Corporate Transparency Act

Below are several initial steps to take to prepare for this upcoming deadline:

1. Exemptions. Assuming your entity was formed by the filing of a document with a secretary of state or any similar office under the law of a State or Indian Tribe, your entity may be a reporting company subject to the CTA. If so, review the 23 exemptions to being a reporting company and confirm if any of these exemptions apply to any of your entities.

  • An entity formed as noted above that qualifies for any of these 23 exemptions is not required to submit a BOI report to the Financial Crimes Enforcement Network (FinCEN).
  • An entity formed as noted above that does not qualify for any exemption is referred to as a “reporting company” and will be required to submit a BOI report to FinCEN.

2. Entity Records. Review the entity records for each reporting company and confirm that these records reflect accurate, up to date information with respect to the ownership percentages, management, etc. of each entity within the structure.

3. Determine Beneficial Owners. There are two types of reporting company beneficial owners: (i) any individual (natural person) who directly or indirectly owns 25% or more of a reporting company, and (ii) any individual (including any individual who owns 25% or more of the reporting company) who directly or indirectly exercises substantial control over the reporting company. FinCEN expects that every reporting company will be substantially controlled by at least one individual, and therefore will have at least one beneficial owner. There is no maximum number of beneficial owners who must be reported.

4. FinCEN Identifiers. Once the individual(s) who qualify as beneficial owners of any of your reporting companies have been identified, you may obtain FinCEN identifiers for these individuals. Although this step is not required, obtaining a FinCEN identifier will allow you to report an individual’s FinCEN identifier number in lieu of his or her personal beneficial ownership information in the BOI report filed for the reporting company in which he or she has been determined to be a beneficial owner. If/when any beneficial ownership information changes for that individual, the individual will be required to update the beneficial ownership information associated with his or her FinCEN identifier, but each reporting company which this individual is a beneficial owner of will not be required to file a corresponding update (unless an update is required for a separate reason).

5. Prepare to File BOI Reports Sooner Rather than Later. With the January 1, 2025 filing deadline fast approaching and over 32 million entities expected to be impacted by the CTA, we recommend taking the steps to prepare and file BOI reports for your reporting companies as soon as possible. While awareness of the CTA and its requirements continues to grow, people still have questions and concerns regarding how their personal information will be handled, and it can take time to collect the necessary information. Accordingly, identifying any beneficial owners and requesting their beneficial ownership information as soon as possible will help to avoid any last-minute scrambles to prepare and file your reporting companies’ BOI reports. Some have questioned whether BOI reports are subject to disclosure under the Freedom of Information Act (FOIA). FinCEN has pointed out that these reports are exempt from disclosure under FOIA.

6. Reach Out With Questions. We have a team of attorneys, paralegals and support staff that would be happy to help guide you through this process.

The Corporate Transparency Act in 2025 and Beyond

In addition to reporting requirements for reporting companies formed before 2024 and during 2024 as outlined above, all entities formed in 2025 and beyond that qualify as reporting companies will be required to submit BOI reports within 30 days of the filing of formation documents. This is a significantly shorter filing window than what was imposed on entities formed before and during 2024. Accordingly, moving forward, for entities formed in 2025 and beyond, the CTA should be viewed as an additional step in the entity formation process.

The CTA also imposes requirements for updating BOI reports following any changes to the beneficial ownership information reported on a BOI report. Any changes to the beneficial ownership information must be reflected in an updated BOI reports filed with FinCEN no later than 30 days after the date on which the change occurred (note, the same 30-day timeline applies to changes in information submitted by an individual in order to obtain a FinCEN identifier).

© 2010-2024 Allen Matkins Leck Gamble Mallory & Natsis LLP
For more on the CTA, visit the NLR Corporate Business Organizations section.

Post Election – Expect Tax Legislation

I. Introduction

With clear Republican victories in the White House and the Senate, and a very slim majority for either side in the House of Representatives, we can expect tax legislation in the coming year. It is expected that the President elect will likely seek to enact his economic agenda as quickly as possible. While Congress may work for bipartisan support of any such legislation, Congressional Republicans and the Administration have the ability to utilize the filibuster-proof budget reconciliation rules (that eliminate the need for 60 votes in the Senate) to pass such tax legislation. We understand that the advance preparation and work for a 2025 reconciliation bill began in Republican Leadership offices over the summer and will continue through the end of the year.

Key to the current discussions of tax policy are provisions from the 2017 Tax Cuts and Jobs Act (the “TCJA”), a large overhaul of the Internal Revenue Code during President Trump’s first term. The TCJA instituted many significant changes to U.S. tax laws, including cutting the corporate rate, lowering individual income tax rates, and introducing a new deduction for passthrough income. However, due to various reasons, including the arcana of procedural rules of Congress associated with the “reconciliation” procedures, many of these provisions were temporary and scheduled to expire at the end of 2025. Exactly which provisions are to be extended, which to be modified, which to be abandoned and how to budget for each of these provisions, is expected to be a part of the legislative agenda next year. It is important to note that, among certain other items, the reduced corporate tax rate enacted in the TCJA is not scheduled to expire.

The most significant expiring provisions of the TCJA are set forth below.

II. Expiring Provisions

A. Changes to non-corporate tax rates, credits, deductions, exemptions and exclusions

The most significant expiring provisions, at least from a political perspective, are the provisions providing significant adjustments to the various tax rates, credits, deductions and similar provisions mostly applicable to individuals, resulting in a broad-scale reversion to the pre-2017 regime for individual taxpayers. The key changes are the following, generally coming into effect in 2026, if not extended or modified:

  • The lower individual income tax rates in the TCJA will expire, and the top marginal rate will go from 37% to 39.6%;
  • The estate and gift tax exclusion amount will be cut in half to $5 million and then adjusted for inflation, so the estate tax exemption will go from approximately $14 million in 2025 to approximately $7 million in 2026;
  • The standard deduction will revert to pre-TCJA levels (almost half the current standard deduction), although the personal exemption amount (which was set to zero under the TCJA) will return to pre-TCJA levels as well;
  • The deduction for miscellaneous itemized expenses, including unreimbursed employee expenses and tax preparation fees will return, and taxpayers will be able to deduct miscellaneous itemized expenses above 2% of adjusted gross income (“AGI”);
  • The phasing-out of itemized deductions for high income taxpayers will return;
  • The TCJA’s cap on the deductibility of state and local tax will expire, so taxpayers will be able to deduct all state and local income taxes (or sales taxes, if selected by the taxpayer) and property taxes—this may be celebrated by higher-income taxpayers in high tax states, but much of the benefit could be tempered by the return of broader scope of the alternative minimum tax discussed immediately below;
  • The alternative minimum tax (the “AMT”), which under the TCJA was limited to a small number of taxpayers, will return to its pre-TCJA form (which applied to a much larger group of individual taxpayers);
  • The deduction limit for cash charitable deductions will revert to 50% of AGI (as compared the current limit of 60% of AGI);
  • The child tax credit will be cut in half so that the maximum credit is $1,000 per child, the refundable portion of the credit will decline from $1,400 to $1,000, and other various adjustments will apply; and
  • The broader mortgage interest exemption available under the pre-TCJA regime will return.

B. Employment-related provisions

Certain employment-related provisions will also expire, and many pre-TCJA rules will return, generally in 2026, if not extended or modified. The most significant changes are the following:

  • The Work Opportunity Tax Credit, which provides a credit to employers who hire members of certain groups, such as veterans, recipients of various federal welfare benefit programs, and residents of empowerment zones, would expire;
  • Employers who pay wages to employees on family and medical leave are generally eligible currently for a credit for a percentage of 12 weeks of paid leave wages—this credit would expire;
  • The deductibility of employer-provided meal expenses, currently limited to 50 percent of the meal expense, will be eliminated; and
  • The suspension of the exclusion for employer reimbursements for moving expenses for persons other than certain members of the armed services, will be lifted, at which point taxpayers will be able once again to exclude from income qualifying moving expense reimbursements received from an employer.

C. Various business provisions

Multiple provisions designed to create tax benefits or tax reductions for certain business operations or activities are also amongst the set of expiring or changing provisions. Among the key provisions that will change, generally in 2026, if not extended or modified are the following:

  • The TCJA introduced the qualified business income deduction for 20% of qualified passthrough income, excluding specified service trade or business income, and ordinary REIT dividends—this deduction would expire, so passthrough income and ordinary REIT dividends will be taxed at ordinary income rates with no deduction;
  • The TCJA’s bonus depreciation allowance will continue to decline over the next few years: only a 40% immediate deduction in 2025, 20% in 2026, and no bonus depreciation after 2026 (with some exceptions);
  • The special “opportunity zone” rules—whereby taxpayers could defer capital gains if the gains are reinvested in such an opportunity zone and exclude capital gains income after a 10-year holding period—will expire. Similarly, the empowerment zone program’s tax benefits and the New Markets Tax Credit will also expire.

D. International tax provisions

The TCJA also made some significant revisions to the international and cross-border tax rules, many of which will have changes that will automatically trigger in 2025 or 2026. The most material are:

  • The “base erosion and anti-abuse tax” (the “BEAT”) minimum tax rate will increase to 12.5% (from 10%) and the calculation of the modified income tax (on which the BEAT minimum tax rate applies) will be adjusted to eliminate the taxpayer’s ability to benefit from certain tax credits;
  • The deductions applicable to global intangible low-taxed income (“GILTI”) inclusions for corporations will be reduced (resulting in an increase in the amount of tax imposed on such inclusions)—the deductions for most income will drop from 50% to 37.5%;
  • The deduction on “foreign derived intangible income” (“FDII”) will drop from 37.5% to 21.875%; and
  • The oft extended “look through” rule (which did not originate in the TCJA) for dividends, interest, rents and royalties received by a controlled foreign corporation from another related controlled foreign corporation is set to expire.

As one can imagine on reading this long list of expiring tax provisions (and not even taking account the many more minor provisions also set to expire or change which are not included above), the likelihood of a new tax bill to address these provisions is high. Given the nature of the Congressional rules around reconciliation and the nature of budget and tax negotiations, attempts to extend many of these provisions would likely involve the addition of new revenue-raising provisions. As such, the prospects of tax reform in 2025 are high. Proskauer closely monitors legislative developments, and additional tax blog posts will be made as specific tax proposals are moved through Congress.

© 2024 Proskauer Rose LLP.
For more on Tax Legislation, visit the NLR Tax section

The CTA Filing Deadline is Approaching. Is Your BOIR Filed Yet?

The clock is ticking—just 49 days remain until the one-year filing deadline for the Corporate Transparency Act (CTA)! Entities established before January 1, 2024, must submit a beneficial owner information report (BOIR) by December 31, 2024.

The CTA is a new reporting requirement that came into effect on January 1, 2024. The CTA requires any entity created by or registered to do business by the filing of a document with a secretary of state, or another similar office, to report its information and its beneficial owners to the Financial Crimes Enforcement Network (FinCEN), which is a bureau of the United States Treasury. The goal is to decrease money laundering and fraud.

We previously published advisories on the general application of the CTA and its specific application to entities created for estate planning purposes. The rules and guidelines about which we previously reported are largely unchanged. A reporting company still needs to report its legal name, all trades and d/b/a names, address, and beneficial owners. Beneficial owners are those with substantial control or who own or control 25% or more of the reporting company, directly or indirectly. The reporting company needs to report each beneficial owner’s name, date of birth, residential address, and an identifying number and image from one of four acceptable identification documents.

Although the CTA was declared unconstitutional by a federal district court in Alabama, the ruling only prevents the CTA’s enforcement on the parties directly involved in the case. The court did not issue a nationwide ruling to prevent the law from being enforced. Thus, other companies are expected to continue filing BOIRs. The Alabama case is currently on appeal and oral arguments were held at the end of September 2024.

FinCEN has been periodically updating its Frequently Asked Questions to provide some clarification since the CTA became effective. We outline the most relevant guidance below:

General Updates:

  1. Entities that are created before January 1, 2024, even if dissolved sometime in 2024 before the December 31, 2024, deadline, must still report their information and beneficial owners by December 31, 2024.
  2. Entities that are created in 2024 have 90 days to file the BOIR. Entities created on or after January 1, 2025, will have 30 days to file the BOIR. Entities that are created in 2024 but are wound up, dissolved, or otherwise cease to exist must still file the BOIR with FinCEN.
  3. Beneficial ownership is determined in the aggregate. This means that companies need to analyze each beneficial owner to determine if he or she indirectly/directly substantially controls or owns 25% or more of a reporting company. For example, Individual X owns 10% of Company Y. Individual X is also trustee of a trust that owns 20% of Company Y. Individual X needs to be reported as a beneficial owner because he owns an aggregate 30% of the company.
  4. Beneficial owners may now apply for a FinCEN Identifier here. This allows the beneficial owners to report their information to FinCEN directly, obtain an Identifier number, and simply provide the Identifier to those reporting companies of which he or she is a beneficial owner. This prevents a beneficial owner from having to share personal and sensitive information with a company. This also streamlines the process for any change in the beneficial owner’s information. Each beneficial owner can log into FinCEN and simply update the information within 30 days of the change rather than first providing it to the reporting company and then the company filing a new BOIR to update the information.

a. In order to create a FinCEN Identifier, an individual will have to create a login.gov account. This is the account that the federal government is using to streamline many of its services, such as, global entry and applying for federal jobs.

5. Reporting companies may complete and submit a BOIR online here. A company could also submit a PDF of the report at the same link if it chose to complete a paper copy. There is no fee to submit online. There are also many vendors offering a service to assist with the process and submit the report for a fee.

Real Estate/Corporate Updates:

6.FinCEN clarified that the subsidiary exemption applies when a subsidiary’s ownership interests are entirely controlled or wholly owned, directly, or indirectly, by any of the following types of exempt entities: (1) Securities reporting issuer; (2) Governmental authority; (3) Bank; (4) Credit union; (5) Depository institution holding company; (6) Broker or dealer in securities; (7) Other Exchange Act registered entity; (8) Investment company or investment adviser; (9) Venture capital fund adviser; (10) Insurance company; (11) State-licensed insurance producer; (12) Commodity Exchange Act registered entity; (13) Accounting firm; (14) Public utility; (15) Financial market utility; (16) Tax-exempt entity; or (17) Large operating company. Further, if a reporting company’s ownership interests are controlled or wholly owned by more than one exempt entity, the reporting company may still qualify for the subsidiary exemption if the entities are unaffiliated; however, every controlling or owning entity must itself be an exempt entity in order for the reporting company to qualify for the subsidiary exemption.

Trusts and Estates Updates:

7.If there is a corporate trustee, the reporting company will be reporting those individual beneficial owners that indirectly own or control at least 25% of the ownership interests of the reporting company through the ownership in the corporate trustee. This will be determined by multiplying the percentage of ownership of the corporate trustee with the trust’s ownership/control of the reporting company. For example, if Individual A owns 70% of the corporate trustee of a trust, and that trust holds 30% of the reporting company, Individual A holds or controls 21% of the reporting company (70% x 30 = 21). If Individual A owned 90% of the corporate trustee, then it would own/control 27% of the reporting company (90% x 30 = 27) and the company must report Individual A as a beneficial owner. There may be other beneficial owners if someone else at the corporate trustee exercises substantial control over the reporting company.

A reporting company may submit the corporate trustee’s information in lieu of each beneficial owner’s information only if all of these conditions are met:

a. The corporate entity is an exempt entity from the reporting requirements.

b. The individual owns or controls 25% of the reporting company only through the corporate trustee.

c. The individual does not exercise substantial control over the reporting company.

A company can obtain its own FinCEN Identifier when it submits an initial BOIR for its beneficial owner(s). This way, such company may be reported as a beneficial owner, such as a corporate trustee that meets the above requirements. For example, when LLC A reports Individual A as its beneficial owner, LLC A has the option of clicking a button to obtain its own FinCEN Identifier.

8. An individual who has the power to remove a trustee, remove and replace a trustee, and/or appoint an additional trustee is deemed to have substantial control through the power to change the person who makes decisions for the trust, and thereby, the reporting company. While this is not explicit in the Frequently Asked Questions, it is consistent with FinCEN’s position that someone who has the power to remove a senior officer of a reporting company is a beneficial owner.

While this is an extensive list, it is by no means an exhaustive list, and various circumstances not discussed above may change how the CTA applies in a particular case.

Copyright 2024 Goulston & Storrs PC.
For more on the CTA, visit the NLR Corporate Business Organizations section

SEC Brings Multiple Enforcement Actions Relating to Beneficial Ownership and Other Reporting Obligations

On September 25, 2024, the Securities and Exchange Commission (the SEC) announced that it had instituted and settled enforcement actions under Section 13(d), Section 13(g) and Section 16(a) of the Securities Exchange Act of 1934 (as amended, the Exchange Act). The actions involved 21 individuals and entities that allegedly had failed to timely file Schedule 13D or 13G to report beneficial ownership of greater than 5% of the registered equity securities outstanding and/or amendments to such reports, and/or to timely file Form 3, 4 or 5 to report ownership of, and transactions in, registered equity securities by executive officers, directors and greater-than-10% beneficial owners (collectively, insiders). As part of the settlements, individual respondents agreed to pay civil monetary penalties ranging from $10,000 to $200,000, and entities agreed to pay civil penalties ranging from $40,000 to $750,000. As part of the same set of settlements, the SEC also instituted and settled two enforcement actions against public companies for allegedly causing certain of their insiders’ Form 3, 4 or 5 filing failures or for failing to report such filing delinquencies. Just a week earlier, the SEC had announced the institution and settlement of enforcement actions under Section 13(f) and Section 13(h) of the Exchange Act against 11 institutional investment managers that allegedly had failed on a timely basis to file one or more quarterly Form 13F reports and/or periodic Form 13H reports.

The Bottom Line

The foregoing actions are part of an SEC enforcement initiative aimed at ensuring compliance with ownership disclosure and other reporting rules. Insofar as the beneficial ownership and insider actions are concerned, the most recent set of settlements suggest a possible willingness on the SEC’s part to bring enforcement actions even for minor and technical violations. Insofar as the institutional investor enforcement actions, the recent “sweep” appears to mark the first such broad action by the SEC. Notably, for two of the sanctioned institutional investment managers that were based outside the US and where the managers self-reported their errors to the SEC, no monetary penalties were assessed. A third institutional investment manager did not pay a monetary penalty for its Form 13H filing delinquency, which had been self-reported to the agency. Further, the SEC’s public announcement of the settlements indicated that the SEC staff used data analytics to identify the delinquent filings. The SEC has occasionally used various technological solutions to search for late filings and other violations of law in the vast EDGAR database, and as artificial intelligence and similar applications become more widespread and economical, we expect the SEC to make greater use of automated techniques in the future as part of its ongoing filing review process.

The Full Story

5% Beneficial Owners, Insiders and Public Company Issuers

Under Section 13(d)(1) of the Exchange Act and Rule 13d-2(a) promulgated thereunder, any person who acquired beneficial ownership of more than 5% of a public company’s stock must, within 10 calendar days of the relevant acquisition,[1] file an initial set of disclosures on Schedule 13D with the SEC. The beneficial owner must then file updates with the SEC to report any material changes to its position or other facts disclosed in prior filings. Certain investors (mostly passive ones) are eligible to file a simplified set of disclosures on Schedule 13G. The deadline to file a Schedule 13G was also within 10 calendar days of acquiring more than 5% beneficial ownership, but certain institutional investors were permitted to defer disclosing their passive holdings on Schedule 13G until 45 days after the end of the calendar year.[2]

Under Section 16(a) of the Exchange Act and Rule 16a-3 promulgated thereunder, officers and directors of public companies, and any beneficial owners of greater than 10% of stock in a public company, were (and currently are) required to file initial statements of holdings on Form 3 either within 10 calendar days of becoming an insider or on or before the effective date of the initial registration of the stock. Such insiders are then obligated to keep this information current by reporting subsequent transactions on Forms 4 and 5 (in most instances, within two business days of any change). In addition, Section 13(a) of the Exchange Act and Item 405 of Regulation S-K promulgated thereunder require issuers to disclose information regarding delinquent Section 16(a) filings by insiders in their annual reports.

Here, the SEC alleged that 14 persons, who were obligated to file Forms 3/4/5, failed to timely file or update such reports required under Section 16(a), that two public companies caused some of those late filings and/or did not disclose the late filings when required, and that 18 persons who were obligated to file and/or amend Schedules 13D/13G failed to do so timely as required under Sections 13(d) and (g). In most of the non-issuer settlements, there appear to have been repeated failures over multiple issuers, sometimes over several years. However, not all persons settling with the SEC had failures that were repeated or otherwise egregious. Each of two of the matters that settled for $25,000 or less alleged only a few violations (and one of those included two alleged Schedule 13D violations that arguably are supported by a compliance and disclosure interpretation but not by the actual wording of Section 13 and its implementing rules). By contrast, among the 11 beneficial ownership settlements that the SEC announced nearly a year ago, none were below $66,000. This suggests that the SEC may once again be bringing less serious enforcement actions and pursuing even minor infractions.

Institutional Investment Managers

Under Section 13(f) of the Exchange Act and Rule 13f-1 promulgated thereunder, entities with investment discretion over at least $100 million worth of specified US publicly-traded securities (and certain securities exercisable for or convertible into such securities) (institutional investment managers) are required to file quarterly Form 13F reports detailing their ownership of such securities regardless of the percentages owned. Reports can omit certain de minimis positions, though the de minimis level is set quite low so relatively few positions are typically excluded from Form 13F on this basis. The $100 million threshold was originally set in 1975, is not indexed for inflation and has not been adjusted since. Each report for a calendar quarter must be filed no later than 45 calendar days after the end of the preceding quarter.

Under Section 13(h) of the Exchange Act and Rule 13h-1 promulgated thereunder, persons who trade US publicly-traded securities equal to or exceeding two million shares or $20 million during any calendar day, or 20 million shares or $200 million during any calendar month (collectively, large traders) are required to file required Form 13H reports with the SEC. Unlike the beneficial ownership reports and Form 13F, Form 13H reports are confidential and viewable only by the SEC. While the specific reporting thresholds for Form 13F and Form 13H are different, most (but not all) large traders will also be institutional investment managers. But most institutional investment managers will not necessarily be large traders.

The SEC alleged that nine institutional investment managers failed to timely file required Form 13F reports—often over a long period of years. Those nine firms (not including one which was part of the beneficial owner settlements discussed above but had also not filed Form 13F for a number of years) agreed to pay in aggregate more than $3.4 million to settle those cases. Notably, two additional settling parties (both institutional investment managers located outside the US) were not assessed penalties relating to their delinquent Form 13F’s because they self-reported their failure to report directly to the SEC.

Two of the parties settling Form 13F failures also were charged with failing to timely file required Form 13H reports. Because both of these parties self-reported their Form 13H filing failures, neither was assessed a penalty relating to Section 13(h).

[1] The deadlines described here were in effect during the relevant periods in the settled actions. Effective on and after February 5, 2024, the initial Schedule 13D must be filed within five business days of the relevant acquisition.

[2] The deadlines described here were in effect during the relevant periods in the settled actions. Effective on and after September 30, 2024, the filing deadline for an initial Schedule 13G (other than for certain institutional investors) is within 5 business days of the relevant acquisition; certain institutional investors are permitted to delay their initial filing of Schedule 13G to 45 calendar days after the end of relevant calendar quarter.

Copyright © 2024, Hunton Andrews Kurth LLP. All Rights Reserved.
For more on SEC Enforcement Actions, visit the NLR Securities SEC section.

The Corporate Transparency Act Requires Reporting of Beneficial Owners

The Corporate Transparency Act (the “CTA”) became effective on January 1, 2024, requiring many corporations, limited liability companies, limited partnerships, and other entities to register with and report certain information to the Financial Crimes Enforcement Network (“FinCEN”) of the U.S. Department of Treasury (“Treasury”). The CTA marks a substantial increase in the reporting obligations for many U.S. companies, as well as for non-U.S. companies doing business in the United States.

IN SHORT:
Most corporate entities are now required to file a beneficial ownership information report (“BOI Report”) with FinCEN disclosing certain information about the entity and those persons who are “beneficial owners” or who have “substantial control.” BOI Reports for companies owned by trusts and estates may require significant analysis to determine beneficial ownership and substantial control.

The CTA imposes potential penalties on entities that fail to file BOI Reports with FinCEN by the prescribed deadline. For entities formed prior to January 1, 2024, a BOI Report must be filed by January 1, 2025. For entities formed on or after January 1, 2024, but prior to January 1, 2025, a BOI Report must be filed within 90 days of the entity’s formation. For entities formed on or after January 1, 2025, a BOI Report must be filed within 30 days of the entity’s formation.

Entities formed after January 1, 2024, must also report information regarding “company applicants” to FinCEN. If certain information within a BOI Report changes, entities are required to file a supplemental BOI Report within 30 days of such change.

While Winstead’s Wealth Preservation Practice Group will not be directly filing BOI Reports with FinCEN, our attorneys and staff will be available this year, by appointment, to answer questions regarding reporting requirements if scheduled by Friday, November 22, 2024. We strongly recommend that company owners begin analyzing what reporting obligations they may have under the CTA and schedule appointments with their professional advisors now to ensure availability.

BACKGROUND:
Congress passed the CTA in an effort to combat money laundering, fraud, and other illicit activities accomplished through anonymous shell companies. To achieve this objective, most entities operating in the United States will now be required to file BOI Reports with FinCEN.

The CTA applies to U.S. companies and non-U.S. companies registered to operate in the United States that fall within the definition of a “reporting company.” There are certain exceptions specifically enumerated in the CTA, which generally cover entities that are already subject to anti-money laundering requirements, entities registered with the Securities and Exchange Commission or other federal regulatory bodies, and entities that pose a low risk of the illicit activities targeted by the CTA.

REPORTING OBLIGATIONS:
Entity Information. Each reporting company is required to provide FinCEN with the following information:

  1. the legal name of the reporting company;
  2. the mailing address of the reporting company;
  3. the state of formation (or foreign country in which the entity was formed, if applicable) of the reporting company; and
  4. the employer identification number of the reporting company.

Beneficial Owner and Applicant Information. Absent an exemption, each reporting company is also required to provide FinCEN with the following information regarding each beneficial owner and each company applicant:

  1. full legal name;
  2. date of birth;
  3. current residential or business address; and
  4. unique identifying number from a U.S. passport or U.S. state identification (e.g., state-issued driver’s license), a foreign passport, or a FinCEN identifier (i.e., the unique number issued by FinCEN to an individual).

DEFINITIONS:
Reporting Company. A “reporting company” is defined as any corporation, limited liability company, or any other entity created by the filing of a document with a secretary of state or any similar office under the law of a State. Certain entities are exempt from these filing requirements, including, but not limited to:

  1. financial institutions and regulated investment entities;
  2. utility companies;
  3. entities that are described in Section 501(c) of the Internal Revenue Code;
  4. inactive, non-foreign owned entities with no assets; and
  5. sizeable operating companies that employ more than 20 full-time employees in the United States that have filed a United States federal income tax return in the previous year demonstrating more than $5,000,000 in gross receipts or sales.

A reporting company that is not exempt must register with and report all required information to FinCEN by the applicable deadline.

Beneficial Owner. A “beneficial owner” is defined as any individual who, directly or indirectly, (i) exercises substantial control over such reporting company or (ii) owns or controls at least 25% of the ownership interests of such reporting company.

Substantial Control. An individual exercises “substantial control” over a reporting company if the individual (i) serves as a senior officer of the reporting company, (ii) has authority over the appointment or removal of any senior officer or a majority of the board of directors (or the similar body governing such reporting company), or (iii) directs, determines, or has substantial influence over important decisions made by the reporting company, including by reason of such individual’s representation on the board (or other governing body of the reporting company) or control of a majority of the reporting company’s voting power.

Company Applicant. A “company applicant” is any individual who (i) files an application to form the reporting company under U.S. law or (ii) registers or files an application to register the reporting company under the laws of a foreign country to do business in the United States by filing a document with the secretary of state or similar office under U.S. law.

DEADLINES:
Entities Formed Before January 1, 2024. A reporting company that was formed prior to the effective date of the CTA (January 1, 2024) is required to register with FinCEN and file its initial BOI Report by January 1, 2025.

Entities Formed After January 1, 2024, but Before January 1, 2025. A reporting company that was formed after the effective date of the CTA (January 1, 2024), but before January 1, 2025, must register with FinCEN and file its initial BOI Report within 90 calendar days of formation.
Entities Formed After January 1, 2025. A reporting company formed after January 1, 2025, will be required to register with FinCEN and file its initial BOI Report within 30 calendar days of formation.

Supplemental BOI Reports. If any information included in a BOI Report changes, a reporting company must file a supplemental report with FinCEN within 30 days of such change. This includes minor changes, such as an address change or an updated driver’s license for a beneficial owner or someone who has substantial control over the reporting company.

PENALTIES FOR NON-COMPLIANCE:
The CTA and Treasury regulations impose potential civil and criminal liability on reporting companies and company applicants that fail to comply with the CTA’s reporting requirements. Civil penalties for reporting violations include a monetary fine of up to $500 per day that the violation continues unresolved, adjusted for inflation. Criminal penalties include a fine of up to $10,000 and/or two years in prison.

REPORTING REQUIREMENTS RELATED TO TRUSTS AND ESTATES:
When a trust or estate owns at least 25% of a reporting company or exercises substantial control over the reporting company, the BOI Report must generally include (i) the fiduciaries of the trust or estate (i.e., the trustee or executor), (ii) certain individual beneficiaries, and (iii) the settlor or creator of the trust. If the trust agreement gives other individuals certain rights and powers, however, such as a distribution advisor, trust protector, or trust committee member, the reporting company may also be required to disclose such individuals’ information in the BOI Report. Similarly, if a corporate trustee or executor is serving, the BOI Report must contain the names and information of the employees who actually administer the trust or estate on behalf of the corporation. Due to these nuances, it is often necessary to engage in additional analysis when a trust or estate is a beneficial owner of or has substantial control over a reporting company.

CONCLUDING REMARKS:
The CTA and its BOI Report filing requirement are still relatively new, and although FinCEN continues to publish additional guidance, many open questions remain. All companies formed or operating in the United States should carefully review whether they are required to file an initial BOI Report in accordance with the CTA, and take further steps to identify all individuals who must be included in such BOI Report.

© 2024 Winstead PC.
For more news on Corporate Transparency Act Reporting Requirements, visit the NLR Financial Institutions Banking section.

DOJ Announces Changes to Guidance on Corporate Compliance Programs, Updates on Whistleblower Program

In an address this week to the Society of Corporate Compliance and Ethics, Principal Deputy Assistant Attorney General Nicole M. Argentieri of the Department of Justice’s (“DOJ”) Criminal Division, highlighted several updates relevant to corporate compliance programs, including the DOJ’s new whistleblower programs and incentives.

Sufficient Compliance: Updated Areas to Consider

The Evaluation of Corporate Compliance Programs (“ECCP”) is the compass by which the DOJ measures the efficacy of a corporation’s compliance program for potential credit or mitigation in the event an organization is potentially subject to prosecution.[1] Ms. Argentieri highlighted several key updates to the ECCP that the DOJ will now consider when evaluating whether a corporation’s compliance program is “effective” and thus deserving of credit and/or mitigation of criminal penalties.

These new factors include whether:

  • the resources and technology with which a company does business are applied to its compliance program, and whether its compliance program fully considers the risks of any technologies it utilizes (such as generative AI)[2];
  • the company had a culture of “speaking up” and protecting those who report on corporate misdeeds;
  • a company’s compliance department had access to adequate resources and data to perform its job effectively; and
  • a company learned from its past mistakes—and/or the mistakes of other companies.

Encouraging Self-Reporting: Presumptive Declination and Reduced Penalties

In her remarks, Ms. Argentieri stated that the previously announced Whistleblower Awards Program[3] had so far been successful in the eyes of the DOJ, but did not point to any specific case or outcome. Likely, it is too soon for the public to see the fruits of the program, given its nascent state and the time that usually elapses between the initiation of an investigation and its resolution. The DOJ appears to be stating, though, that it is receiving and following up on whistleblower reports already.

This new policy encouraging whistleblowing through financial incentives, however, was combined with an amendment to DOJ’s Corporate Enforcement and Voluntary Self-Disclosure Policy, which provides that there is a presumptive declination to prosecute should a company make a disclosure of wrongdoing within 120 days of receiving an internal report of alleged misconduct and before DOJ contacts the company regarding that matter. In short, DOJ is seeking to incentivize a “race to DOJ” to report potential misconduct – perhaps before the company can even confirm whether the allegation is credible.[4]

Organizations that opt to not take the early self-disclosure route can still reduce any criminal penalties they may face by up to half by fully cooperating with the DOJ in its investigation. Considerations DOJ will factor in when evaluating whether an organization “fully cooperates” include, among other things, how timely the cooperation was and if the company took appropriate remedial action (such as improving compliance programs and disciplining employees). The DOJ continues to emphasize the importance of clawing back compensation and/or reducing compensation and bonuses of wrong-doers (if not also terminating them).[5]

Tipping the Scales

In sum, these programs are clearly intended to materially alter the disclosure calculus of whether a company should disclose misconduct by putting quantifiable incentives on the side of timely disclosure and cooperation, namely declination. Combined with the DOJ’s updates to the ECCP, these programs attempt to bring clarity and consistency to the world of corporate criminal penalties (and possibly how to avoid them altogether). Companies are well-advised to review their existing compliance programs in light of these new incentives and guidance from the DOJ to ensure that they address the new factors enumerated by the DOJ, but also account for increased incentives for corporate whistleblowers.

FOOTNOTES

[1] The U.S. Sentencing Guidelines also define what constitutes an “effective compliance and ethics program” for credit under the guidelines. U.S.S.G. §8B2.1.

[2] This is not the first time, and unlikely to be the last, where DOJ has emphasized the use of AI to enhance corporate compliance. See Lisa Monaco, Deputy Attorney General, Department of Justice, Remarks at the University of Oxford on the Promise and Peril of AI (Feb. 14, 2024).

[3] Under the Criminal Division’s whistleblower pilot program (and like those of other U.S. Attorney’s Offices who have thus far adopted similar programs), whistleblowers are financially rewarded—through criminal forfeiture orders—for bringing forward information on specific alleged violations, so long as that person first reports the misconduct to the company and DOJ has not already learned of it. The Criminal Division’s Pilot Program on Voluntary Self-Disclosure for Individuals also provide culpable individuals who report to receive non-prosecution agreements in exchange for reporting their own conduct and the conduct of the company.

[4] The “race to DOJ” incentivized by these programs may indeed alter the corporate disclosure calculus—by moving up the date for any disclosure in light of the threat that an employee or third-party, aware of any investigation, may choose to report the matter to DOJ. Likewise, it may also change the nature of the internal investigation in ways to limit knowledge of the investigation early-on, like limiting early interviews until documents and data can be reviewed and analyzed.

[5] Indeed, DOJ will permit companies to earn a dollar-for-dollar reduction of a criminal penalty for each dollar a company successfully claws back from a wrong-doer to further incentivize companies to seek to claw back compensation paid.

Copyright © 2024, Sheppard Mullin Richter & Hampton LLP.
For more on the Corporate Compliance Programs, visit the NLR Corporate Business Organizations section

Supreme Court Holds Life Insurance Proceeds Paid to Closely-Held Corporation to Fund Buy-Sell Agreement Increases Estate Tax on Deceased Shareholder’s Estate

In Connelly v. U.S., 144 S.Ct. 1406 (June 6, 2024), the United States Supreme Court upheld an estate tax deficiency of $889,914 in a decision that will impact many families and closely-held businesses. A Buy-Sell Agreement is often used to ensure that a closely-held company will remain within the family after the deaths of its owners or otherwise ensure the continuity of the business after an owner’s death. Many Buy-Sell Agreements, such as the one in Connelly, provide that upon the death of an owner, the surviving owner has the option to purchase the deceased owner’s interest in the company, and if the surviving owner declines, the company must redeem the deceased owner’s interest. To ensure that the company will have funds for the redemption, the company will often obtain life insurance for its owners. For years, planners thought it possible to structure such an arrangement so that life insurance proceeds would not increase the value of the company for estate tax purposes. However, in Connelly, the Court held that the life insurance proceeds paid to a corporation upon the death of a shareholder do increase the value of the corporation’s stock for estate tax purposes and that the corporation’s obligation under a Buy-Sell Agreement to redeem the deceased shareholder’s shares does not offset the life insurance proceeds. Under the Court’s decision, the type of entity does not appear to be relevant, and the holding will equally apply to partnerships and limited liability companies. Thus, if any Buy-Sell Agreement is structured as a redemption funded with entity-owned life insurance, the insurance proceeds may increase the value of the deceased business owner’s interest for estate tax purposes.

In Connelly, two brothers, Michael and Thomas Connelly, owned a business supply corporation. Michael owned 77.18% of the company, and Thomas owned 22.82% of the company. The brothers entered into a Buy-Sell Agreement as described above. The brothers ignored provisions under the agreement that required them to value the company annually and obtain an appraisal upon a shareholder’s death. After Michael’s death in 2013, Thomas and Michael’s son simply agreed to a redemption price of $3 million for Michael’s shares. The company used $3 million of life insurance proceeds to redeem Michael’s shares, and Thomas, as Michael’s executor, reported the value of Michael’s shares as $3 million on Michael’s estate tax return without completing an appraisal. Upon audit of the estate tax return, Thomas belatedly obtained an appraisal that determined the fair market value of 100% of the company at Michael’s death to be $3.86 million, excluding the life insurance proceeds. Based on the valuation of the company at $3.86 million, Thomas argued that the value of Michael’s ownership interest was $3 million ($3.86 million x 77.18%).

Connelly rejects the position of the 11th Circuit Court of Appeals in Blount v. Comm’r., 428 F. 3d 1338 (CA11 2005), that the life insurance proceeds paid to a company are offset by the company’s contractual obligation to redeem a deceased owner’s interest. Rather than allowing an offset for the redemption obligation, the Court focused on the value of the company before and after the redemption. If the entire company was worth $3.86 million, as claimed in Connelly, the value of Michael’s 77.18% would be $3 million and the value of Thomas’ 22.82% would be $860,000. The Court reasoned that upon redemption of Michael’s shares, Michael’s estate would receive $3 million, leaving Thomas with 100% ownership of a company worth $860,000. However, Thomas’ argument meant that post-redemption, 100% of the company that Thomas owned was worth $3.86 million. The Court refused to accept that a company which pays out $3 million to redeem shares was worth the same overall amount before and after the redemption. The Court found that the company’s value should be increased from $3.86 to $6.86 million, accounting for the insurance proceeds, increasing the value of Michael’s ownership from $3 to approximately $5.3 million ($6.86 million × 77.18%). The net result was an additional estate tax of $889,914.

Although the implications of Connelly are wide, there are limitations to the Court’s decision. Connelly will have little impact on a business owner whose estate is well under the estate tax exemption, which is currently $13.61 million for each individual and scheduled to be decreased by 50% in 2026. In addition, the Court did not address the application of Section 2703 of the Internal Revenue Code, which provides in relevant part that the value of a deceased owner’s interest in a business may be established by a Buy-Sell Agreement if certain requirements are met. Perhaps the Court did not review Section 2703 because the shareholders did not follow the valuation terms of the Buy-Sell Agreement and arbitrarily determined the redemption price instead. But because Section 2703 was not addressed in Connelly, it may yet be possible to avoid its impact with a properly structured and adhered to, Buy-Sell Agreement.

The Court also explicitly stated in a footnote that the holding does not mean that a redemption obligation can never decrease a corporation’s value. The Court implies that if a company is required to sell an operating asset to redeem shares, the redemption obligation might reduce the company’s value.

The Court acknowledged that a differently structured Buy-Sell Agreement can avoid the risk that insurance proceeds would increase the value of a deceased shareholder’s shares. Specifically, the Court referenced a “cross-purchase agreement” in which business owners, rather than the company, agree to purchase the others’ ownership upon death using proceeds from non-company owned policies. In addition to avoiding the Connelly result, a cross-purchase agreement provides an increased tax basis for the surviving owners who purchase a deceased owner’s interests. However, the more owners a business has, the more complicated a life insurance-funded cross-purchase will be. Other options to avoid the Connelly result may include a life insurance partnership or limited liability company or creatively structured split-dollar arrangements.

After Connelly, all business owners with Buy-Sell Agreements funded with entity-owned life insurance, or with other entity-owned insurance vehicles (split-dollar plans, key-person life insurance, etc.) should evaluate and consider restructuring their arrangements. In some cases, the restructuring of a Buy-Sell Agreement may require the transfer of life insurance policies which raises other tax issues, such as in-kind corporate distributions, S corporation elections, transfer-for-value rules, and incidents of ownership.

© Polsinelli PC, Polsinelli LLP in California
For more news on Life Insurance and Estate Taxes, visit the NLR Estates & Trusts section.

Filing Requirements Under the Corporate Transparency Act: Stealth Beneficial Owners

The Corporate Transparency Act (“CTA”) requires most entities to file with the Financial Crimes Enforcement Network (“FinCEN,” a Bureau of the U.S. Department of the Treasury) Beneficial Ownership Information (“BOI”) about the individual persons who own and/or control the entities, unless an entity is exempt under the CTA from the filing requirement. There are civil and criminal penalties for failing to comply with this requirement.

A key issue: WHO are the Beneficial Owners?

FinCEN has issued a series of Frequently Asked Questions along with responses providing guidance on the issue of who the beneficial owners are.

Question A-1, issued on March 24, 2023, states that “[BOI] refers to identifying information about the individuals who directly or indirectly own or control a company.”

Question A-2, issued on Sept. 18, 2023: Why do companies have to report beneficial ownership information to the U.S Department of the Treasury? defines the CTA as “…part of the U.S. government’s efforts to make it harder for bad actors to hide or benefit from their ill-gotten gains through shell companies or other opaque ownership structures.”

Question D-1, updated April 18, 2024: Who is a beneficial owner of a reporting company? states that “A beneficial owner is an individual who either directly or indirectly (i) exercises substantial control over a reporting company” and, in referring to Question D-2 (What is substantial control?), “owns or controls at least 25 percent of a reporting company’s ownership interests.”

Question D-1 goes on to note that beneficial owners must be individuals, i.e., natural persons. This guidance is extended by Question D-2 on Substantial Control, where control includes the power of an individual who is an “important decision-maker.” Question D-3 (What are important decisions?) identifies “important decisions” with a pictorial chart of subject matters that FinCEN considers important, such as the type of business, the design of necessary financings, and the structure of the entity. Question D-4 explores ownership interests (again with a pictorial) including equity interests, profit interests, convertible securities, options, or “any other instrument, contract, arrangement, understanding, relationship, or mechanism used to establish ownership.”

Who, in FinCEN’s view, has “substantial control”?

Question D-2 lists four categories of those who have substantial control:

  1. A senior officer, including both executive officers and anyone “who performs a similar function;”
  2. An individual with “authority to appoint or remove certain officers or directors;”
  3. An individual who is an important decision-maker; or
  4. An individual with “any other form of substantial control.”

“Silent partners” and/or other undisclosed principals, including some who may be using the reporting company for nefarious purposes, might be discussed here, but that is not the intended subject of this writing. Rather, this piece is intended to warn businesspersons and their advisers of potential “stealth beneficial owners” – those whose status as beneficial owners is not immediately obvious.

First, consider the typical limited liability company Operating Agreement for an LLC with enough members and distribution of ownership interests so that no member owns over 25% of the LLC’s equity. If the LLC is manager-managed, then the manager(s) is/are Beneficial Owners, but the other members are not. But what if the Operating Agreement requires a majority or super-majority vote to approve certain transactions? Assuming that those transactions are “important” (as discussed in Question D-3), then possessing a potential veto power makes EACH member a beneficial owner. Such contractual limitations on executive power necessarily raise the issue of “beneficial ownership” in corporations, in limited liability companies, and even in limited partnerships where the Limited Partners have power to constrain the general partner (who clearly is a beneficial owner).

Second, consider the very recent amendments to the Delaware General Corporation Law (“DGCL”) in response to the Delaware Chancery Court’s holding in West Palm Beach Firefighters’ Pension Fund v. Moelis & Co (“Moelis”) Feb. 23, 2024. In Moelis, the CEO had a contract with the Company that materially limited the power of the Board of Directors to act in a significant number of matters. Vice Chancellor Travis Laster issued a 133-page opinion finding the agreement was invalid, as it violated the Delaware Law that placed management and governance responsibilities in the Board. Because such arrangements are frequently used in venture capital arrangements as part of raising capital for new enterprises, the Delaware Legislature and the State’s Governor enacted amendments to the DGCL that expressly authorize such contracts. In the Moelis situation itself, Ken Moelis was a major owner and CEO so he would have had to be disclosed as a Beneficial Owner if Moelis & Co. had not been exempt from the filing requirements of the CTA because it is a registered investment bank.

But what of a start-up venture entity where a wealthy venture investor owns a 10% interest in the entity, but has a stockholder agreement that gives him substantial governance rights including the ability to veto or even overrule board decisions? Is that venture investor not a “beneficial owner”? Somewhat even more Baroque, what about the private equity fund controlled by a dominant investor, say William Ackman or Nelson Peltz? If that fund invests in the same start-up entity and holds a 10% interest, but also has a stockholder agreement giving the fund substantial governance rights, isn’t the controlling owner of the fund a “beneficial owner” of the start-up?

Finally, consider financing with a “bankruptcy remote entity” where the Board of that entity includes a contingent director chosen by the finance source. The contingent director does not participate in any part of the governance of the entity unless the entity finds itself in financial distress. The organizational documents of the entity provide that at that point, the contingent director can veto any decision to file for bankruptcy protection. At that point, the contingent director apparently becomes a “beneficial owner” of the entity, with the CTA filing requirements applicable. A more interesting question is whether the contingency arrangement in the organizational documents makes the contingent director a “beneficial owner” from the inception of the financing. Further, with respect to bankruptcy, key questions remain unanswered, such as whether the trustee in a Chapter 7 bankruptcy proceeding or a liquidating trustee in a Chapter 11 bankruptcy proceeding has a reporting obligation under the CTA.

This piece is not intended to identify all the situations that may give rise to “Stealth Beneficial Owners.” Rather, its intent is to raise awareness of the complexities involved in answering the initial question – WHO is a “beneficial owner”?

©2024 Norris McLaughlin P.A., All Rights Reserved

DOJ Implements New Whistleblower Reward Program

Companies who submit healthcare claims to private payors, provide financial services to customers, interact with domestic or foreign public officials, or otherwise operate in highly regulated industries should take note that the Department of Justice (DOJ) has taken another significant step in its ongoing effort to encourage new whistleblowers with information about potential corporate criminal malfeasance to report that information to the government. On August 1, 2024, the DOJ announced its long awaited Corporate Whistleblower Awards Program. The program seeks to fill “gaps” in existing whistleblower programs by providing awards of up to 30% of forfeited proceeds for reporting criminal conduct that is not otherwise covered by an existing system for awarding whistleblowers. The silver lining for companies is that the program incentivizes the whistleblowers to cooperate with the company’s internal compliance function. DOJ also provides for a presumptive declination of criminal charges for companies that self-report to DOJ within 120 days of the time the issue is first raised internally by the whistleblower, providing strong incentives for companies to investigate issues quickly.

The program represents the DOJ’s latest effort to increase the number of voluntary self-disclosures of corporate criminal activity. In January 2023, the DOJ announced its revised Corporate Enforcement and Voluntary Self Disclosure Policy, which sought to expand the incentives for companies to voluntarily self-disclose misconduct, cooperate with DOJ investigations, and take prompt and full remedial measures. The policy’s primary incentive was the prospect of a presumed declination for companies who followed its mandates.

As we discussed in a previous post, efforts to increase voluntary self-disclosures continued in April 2024 when the DOJ launched a Pilot Program on Voluntary Self Disclosures for Individuals. That initiative expanded the scope of potential whistleblowers by including those complicit in wrongdoing, granting them eligibility for immunity from prosecution in return for reporting the activity. In substance, that structure incentivized both individual wrongdoers and the corporations for whom they worked to be the first to report criminal activity. By pitting the would-be whistleblowers and the companies against each other, the DOJ effectively constructed a prisoners’ dilemma where the government stood to benefit regardless of which party acted first.

The program is a different verse from the same hymnal. It offers a different (but more traditional) incentive for whistleblowers – the opportunity for financial reward – while maintaining the goal of increasing the number of voluntary self-disclosures. The program seeks to achieve that objective by motivating those who are aware of misconduct, but perhaps are otherwise unable to qualify for a bounty under the current framework or otherwise uninterested in reporting the activity without a personal benefit.

The Basic Framework

Under the program, eligible individuals who voluntarily provide original information to the government in certain areas of focus and cooperate with the resulting investigation stand to receive 30% of any criminal or civil forfeitures over $1 million in accordance with a defined payment priority. The program lays out a basic structure for determining whether an individual is entitled to an award, but also affords the DOJ substantial discretion in deciding whether to make such awards, and in what amount. The key elements are:

  • Areas of focus – The program identifies four subject matter areas: 1) violations by financial institutions, their insiders and agents involving money laundering, fraud, and fraud against or non-compliance with regulators; 2) foreign corruption and bribery and violations of money laundering statutes; 3) domestic corruption violations including bribes and kickbacks paid to domestic public officials; and 4) healthcare offenses involving private or non-public healthcare benefit programs and fraud against patients, investors or other non-governmental entities in the healthcare industry, or other violations of federal law not covered by the federal False Claims Act (FCA).
  • Eligible individuals – The program excludes several categories of individuals, including those eligible to report under other whistleblower programs and those who “meaningfully participated” in the criminal activity reported (although those who played a “minimal role” can still participate).
  • “Original information” – Essentially, independent non-public knowledge or analysis in the individual’s possession is considered “original” information. Notably, information can be deemed “original” if it “materially adds to the information that the Department already possesses.” Information that the individual has already reported through the company’s internal whistleblower, legal or compliance procedures can still be deemed “original,” provided the individual also reports that information to the government within 120 days of reporting internally. Privileged information is not considered “original” unless the crime, fraud or other exception to state attorney conduct rules apply.
  • “Voluntary” submission – The information must be reported before the DOJ or any federal law enforcement or civil enforcement agency initiates any inquiry relating to the subject matter.
  • “Cooperation” – Individuals who report must also cooperate fully with the DOJ’s investigation, including by participating in interviews, testifying before a grand jury or at trial, producing documents and, if requested, working in a “proactive manner” with federal law enforcement. This could include clandestine activities to gather evidence, such as recording phone calls or wearing a wire.
  • Criteria for determining amount of award – The program lists several factors that could militate in favor of increasing or decreasing the whistleblower’s financial award. Increases may be justified by the significance of the information provided, by the nature and extent of assistance provided, and, notably, by participation in internal compliance programs. Decreases may be appropriate where the reporting individual was a minimal participant in the underlying activity, or where the individual unreasonably delayed reporting, interfered with the company’s internal compliance and reporting systems, or had management or oversight responsibilities over the offices or personnel involved in the conduct.
  • Payment priority – When the victim is an individual, he or she must first be compensated “to the fullest extent possible” before a whistleblower can recover. When the victim is a corporate entity or government agency, the whistleblower jumps the line and is compensated first.
  • Relationship to the Corporate Enforcement and Voluntary Self Disclosure Policy – While the program incentivizes whistleblower reports to the DOJ, a simultaneous amendment to the self-disclosure policy provides that “if a whistleblower makes both an internal report to a company and a whistleblower submission” to the DOJ, companies who self-report that conduct within 120 days of the internal report “will still qualify for a presumption of a declination[.]” This amendment underscores the DOJ’s focus on increasing self-disclosures, inasmuch as it effectively removes the need for them to be truly “voluntary.” A company that receives a complaint through its whistleblower program may still be eligible under the self-disclosure policy even if the individual has already reported the conduct to the DOJ, but it has a limited time to investigate and decide whether to self-report the conduct.

Key Takeaways

Reading the tea leaves, we see several potentially significant takeaways for companies evaluating the program’s likely impact.

  1. As a starting point, companies should evaluate whether and to what extent their operations create new reporting opportunities under the program, and thus necessitate action. That process should involve answering the following questions:
    • Does the company operate in one of the areas of focus? If so, the program creates new opportunities and incentives for whistleblowers, and the company must assess whether it is prepared to address an increase in reports and to recognize that a reporter may have already disclosed information to the DOJ.
    • Is the company publicly traded? If so, the company is already subject to the Sarbanes-Oxley Act (SOX), which should mean that systems are already in place to receive, investigate and determine whether to take action, including potentially making a voluntary self-disclosure. The program provides an opportunity to reassess the efficacy of those systems but should not necessarily require the creation of new ones. Note that even those companies with existing whistleblower programs should consider the need to expand those systems to cover new areas of focus. For example, a company with a SOX whistleblower policy should consider the need to expand its scope to cover domestic corruption violations, which may not otherwise be covered.
    • Does the company submit claims to government payors? If so, it is already subject to the FCA and should already have a system in place to analyze internal compliance concerns. If that system focuses on or prioritizes issues regarding government payors, the company should expand its focus to include claims and conduct regarding private payors, which may now be subject to whistleblower bounties under the program.
  2. For privately held companies operating in the areas of focus that are not subject to the FCA, the program necessitates a thorough and candid assessment of the risk the program creates. Depending on the extent of that danger, companies should consider the following measures:
    • Create, or enhance as necessary, internal reporting mechanisms to receive and evaluate whistleblower reports.
    • Publicize the company’s expectation that employees should promptly report concerns internally about potential violations of law or company policy, making clear that no retaliation will result from reports made in good faith.
    • Design a process for investigating whistleblower reports based on their nature and seriousness. Establish criteria for identifying those that can be investigated by HR, those that require the involvement of in-house counsel, and those that must be handled by outside counsel. If there is any possibility of criminal exposure, ensure an appropriate investigation is conducted and concluded in time to allow the company to determine whether to self-report in the 120-window for a presumptive declination.
  3. All companies should have in place a system for quickly and accurately evaluating whether to voluntarily self-disclose violations. This process is a multi-factor calculus that considers a range of factors, including primarily the merits of the underlying information and the amount of financial loss or gain that resulted. While decision-making in this context varies by situation, one essential element remains constant: the need for accurate information regarding the nature, scope and effect of the underlying conduct.

Only time will tell exactly how the program will impact the number and nature of whistleblower reports. But companies can take practical steps now to gauge whether and to what extent they are likely to be affected and begin installing the measures necessary to minimize the risk that might otherwise result.

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© 2024 Bradley Arant Boult Cummings LLP
For more on Whistleblowers, visit the NLR Criminal Law Business Crimes section

DOJ Launches Corporate Whistleblower Awards Pilot Program

The Department of Justice (“DOJ”) released its Corporate Whistleblower Awards Pilot Program on August 1, 2024. This initiative, which is expected to last three years, aims to enhance corporate crime detection, expand enforcement and prosecution efforts, and encourage reporting by incentivizing whistleblowers with the potential of significant payouts. Going forward, companies should pay close attention to DOJ’s  statements  and  guidance  and assess their existing compliance program to ensure that they are encouraging internal reporting and have procedures in place to quickly investigate, remediate, and potentially disclose misconduct.

For years, the Securities and Exchange Commission, Commodity Futures Trading Commission, and the Financial Crimes Enforcement Network have maintained whistleblower programs. When announcing the DOJ’s Pilot Program last March, Deputy Attorney General Lisa Monaco said these programs, while successful, do not address “the full range of corporate and financial misconduct” that DOJ prosecutes. Monaco emphasized that DOJ’s new program aims to fill the gaps in the existing patchwork. The Pilot Program goes into effect immediately.

Impacting the Pilot Program is DOJ’s recent  amendment  to its Corporate Enforcement and Voluntary Self-Disclosure (“VSD”) Policy. Under the amendment, a company that receives an internal report of misconduct from a whistleblower and reports that misconduct to DOJ within 120 days is eligible for a presumption in favor of declining prosecution. To be eligible for the presumption, the company must also cooperate fully and commit to remediation of the wrongdoing. Along with the whistleblower awards program, this amendment provides DOJ with more tools to encourage companies to strengthen internal reporting systems and to incentivize voluntary self-disclosure of corporate crimes and misconduct.

Foreign and domestic companies should reassess anti-corruption, trade compliance, and other compliance programs and should consider revising existing programs as needed to encourage internal reporting of concerns regarding potential non-compliance with company policies and applicable laws.

Covered Violations 

To qualify for an award, the information provided by a whistleblower must be related to one of the following types of criminal conduct:

  • Violations by financial institutions, their insiders, or agents, including schemes involving money laundering, anti-money laundering compliance violations, registering of money transmitting businesses, fraud statutes, and fraud against or non-compliance with financial institution regulators.
  • Foreign corruption and bribery violations under the Foreign Corrupt Practices Act, the Foreign Extortion Prevention Act, or money laundering statutes.
  • Violations related to the payment of bribes or kickbacks to domestic (U.S.) public officials.
  • Federal health care offenses not covered by the False Claims Act, including federal health care offenses and related crimes involving private or other nonpublic health care benefit programs and health care fraud schemes involving private insurance plans.

Eligibility and Rewards 

  • Whistleblowers may be eligible for an award under the Pilot Program if, alone or jointly with other individuals, the whistleblower provides DOJ with original information, in writing, which leads to criminal or civil forfeiture exceeding $1 million in connection with a successful prosecution, criminal resolution, or civil forfeiture action. The whistleblower must cooperate fully with DOJ’s investigation.
  • Whistleblowers must provide truthful, original, non-public information about corporate misconduct to qualify for potential compensation under the program.
  • Whistleblowers may report suspected misconduct internally before reporting to DOJ but are not required to do so in order to be eligible under the pilot program. If the whistleblower reports the alleged misconduct internally through company reporting channels, they must subsequently report it to DOJ within 120 days. A whistleblower may therefore choose to go directly to DOJ without first reporting through internal channels.
  • Information will not be considered original if it was obtained through communications subject to attorney-client privilege, or if the whistleblower’s principal duties include compliance or audit responsibilities. Whistleblowers who work for third-party firms conducting or supporting internal investigations will also not be eligible for any rewards.
  • Whistleblowers that would be eligible for an award through another U.S. whistleblower, False Claims Act qui tam, or similar program will not be eligible for an award under the Pilot Program if they report the same misconduct. However, DOJ encourages whistleblowers to submit information to multiple programs to allow DOJ and other agencies to decide which program is best suited to address the alleged misconduct.

Whistleblowers are eligible for an award even if they initially report information through their employer’s internal reporting procedures. However, the whistleblower must also report the same information to DOJ within 120 days of making an internal report. Whistleblowers may receive up to 30 percent of the first $100 million in net proceeds forfeited, and up to 5 percent of net proceeds between $100 million and $500 million. There is no award on net proceeds forfeited above $500 million. The maximum potential award is set at $35 million. The payment of any award is subject to DOJ’s discretion. DOJ will take into consideration, among other things, the significance of the information provided and the whistleblower’s cooperation and level of assistance. A whistleblower’s level of culpability, unreasonable delay in reporting, and interference with internal compliance and reporting systems may decrease award amounts. A whistleblower is not eligible for payment if they meaningfully participated in the misconduct or criminal activity. DOJ may, however, determine that a whistleblower is eligible if he or she played a minimal role and any misconduct was “sufficiently limited” in scope.

VSD Policy Amendment 

The VSD Policy amendment provides that, where a whistleblower makes both an internal report and a report to DOJ, a company may qualify for a presumption of declination under the VSD Policy even if the whistleblower reports the misconduct to DOJ before the company does. The company, however, must report the conduct to DOJ within 120 days of receiving the internal report  and  before DOJ contacts the company about the misconduct. Thus, the “declination window” may be shorter than 120 days, as DOJ could reach out before then. The amended VSD Policy and the Pilot Program effectively require companies to swiftly investigate and disclose misconduct to avoid steep penalties and prosecution.

What Companies Can Do Now 

The Pilot Program will be administered by the Criminal Division’s Money Laundering and Asset Recovery Section (“MLARS”). MLARS has taken a leading role in prosecuting foreign corruption and other international crimes in recent years but will likely expand its role into domestic corruption and national security issues as a result of its mandate here. MLARS will certainly place increased focus on the seizure and forfeiture of money.

Companies can take proactive steps to mitigate risk by re-evaluating their voluntary self-disclosure decision making and to improve existing compliance policies and procedures.

A few steps companies can take include:

  1. Clear Policies and Procedures: 
    • Establish clear guidelines and encourage employees to report misconduct.
    • Communicate these policies to all employees through training sessions, handbooks, and regular reminders.
  2. Anonymous Reporting Channels: 
    • Provide confidential or anonymous reporting channels (such as hotlines or online platforms).
  3. Non-Retaliation Assurance: 
    • Assure employees that they will not face retaliation for reporting.
    • Implement strong anti-retaliation policies and enforce them consistently.
  4. Leadership Support: 
    • Leadership should actively promote a culture of integrity and transparency.
  5. Incentives and Recognition: 
    • Consider offering incentives for early reporting or successful outcomes.
    • Recognize and appreciate employees who report misconduct.
  6. Training and Awareness: 
    • Regularly train employees on recognizing red flags and reporting procedures.
    • Foster awareness about the importance of reporting for the company’s well-being.
  7. Testing of Internal Controls: 
  • Ensure that existing compliance policies and procedures are working and are accurately identifying risks and detecting potential misconduct.
  1. Voluntary Disclosure: 
  • Review and strengthen internal investigation policies and procedures.
  • Conduct thorough, timely investigations into alleged misconduct.
  • Companies have 120 days or less to review internal complaints and reports of misconduct and to disclose to DOJ to qualify for declination under the amended VSD Policy.
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For more on Whistleblower Award Programs, visit the NLR Criminal Law Business Crimes section