“Each year, the States allow persons to form nearly 2 million corporations and limited liability companies in this country without knowing – or even asking – who the beneficial owners are behind those corporations.”
In Levin’s introductory statement on this bill, he further quantified the scope of the problem, saying that “FinCEN (the Department of Treasury’s Financial Crimes Enforcement Network) identified 768 incidents of suspicious international wire transfer activity involving U.S. shell companies.” I am certainly not defending criminal activity, and consider myself to be one who supports law enforcement. However, the thing that surprises me about this statement is that FinCEN was able to identify ONLY 768 “suspicious” wire transfers – out of literally tens or even hundreds of millions of transactions?
Remember, he is crafting his words carefully here to generate the greatest impact possible out of the statistics available. Note that he did not say criminal activity, orillegal activity was taking place – he is talking aboutsuspicious activity. Frankly, if that’s the best case he can make, I’m not convinced there is really a problem here.
Nevertheless, here comes the government to rescue us from the risks of people having the temerity to form corporations and limited liability companies to conduct business. This is a bad bill that uses fear-mongering and the flag of “homeland security” to gain manipulated support by other politicians who dare not vote against anything that is presented as an issue of national security. It is poorly conceived, badly written, impossible to implement, and has a long list of unintended consequences. In other words, this is a fairly typical response by people who are far removed from the realities of our economy and business to problems that are manufactured for political purposes. It is frightening that one of them could become President of the United States.
Let me be a little more specific.
1. The Impossible Dream. This bill mandates the disclosure of “beneficial owners” of every privately-held corporation and limited liability company that exists or is created in the United States. This is a quixotic dream. Business in the real world is evidently a bit more complicated than Obama or Levin realize. I sit as a member of a task force created by Nevada Secretary of State Ross Miller on the impacts of proposals such this on Nevada incorporation filings, along with some of the best business lawyers from the top law firms in the state. We have had extensive discussions about what constitutes “beneficial ownership”, and though I am not an attorney, I am left significantly impressed that the best business lawyers have an arsenal of tools available to them that can completely prevent beneficial owners from ever being identified, regardless of this law.
Transactions and ownership can be structured in such a variety of complex ways that those who have the money to pay for the best legal advice will never have their beneficial ownership identified. Because of these real-life complexities, the determination of beneficial ownership is frequently the basis of hotly-contested civil lawsuits in courts across the country between disputed owners, which are subject to strict discovery rules and depend on the determination of disputed assertions and claims. The fact is, that finding the beneficial owners in some instances will require the transparent piercing of layer after layer after layer of formal legal structuring involving a multitude of domestic and foreign corporations, limited liability companies, partnerships and trusts, To think that passing a federal law will somehow simplify that reality is a pipe dream.
Further, the real beneficial ownership can be structured in such a way that it can actively change, depending upon certain mandatory or optional triggering events. So, any “report” of beneficial owners would only be a snapshot reflecting the ownership status in that moment, which may differ profoundly from the ownership status that exists in the moments after the report was made. Trusts are often used as the ultimate tool for holding entity ownership, which presents an entirely different set of challenges. Trust law is clearly established with mountains of legal precedent, with trusts allowing for the namingfuture generations yet unborn as the final beneficial owner. Just how would one report that?
2. The Attorney Full Employment Act. The bill mandates that beneficial ownership – as impossible as it is to determine – must be provided to the state filing office before the state can formally accept and file the articles of incorporation or organization. Senator Levin, Coleman and Obama may be surprised to learn that this is not how business operates in the real world. On occasion, it is true, companies are formed where the ownership is already known and determined. But in a great many instances, a new business venture doesn’t have any owners yet, and the principals have to actually form the business entity so that they can then go out and raise the money to finance it’s operation. That often means that the business has to go out and find owners with financial resources.
To require that the beneficial owners be identified before the entity can be formed is to create an expensive and time-consuming additional step for entrepreneurs and businesses. It means that they have to hire lawyers to negotiate and draft potentially complicated pre-incorporation stock subscriptions agreements to outline the rights, relationships and responsibilities of the various owners as a formal, binding contract between the parties. No intelligent investor would ever agree to committing his resources and time to a new business – and go on record as being an owner – without the contractual guarantees that ensure his position is going to be exactly what he thinks he has agreed to. Normally, this would all happen in the normal course of issuing corporate stock, while the corporation can continue to pursue it’s business purpose, seek other investment, negotiate with vendors, build a website, file trademarks, or patents etc. while those negotiations occur. But under this bill, nothing else can happen until these matters are decided, which can take some time. This is great news for business lawyers, but bad news for the rest of us because it means theminimum cost of business startup will at least quadruple – a process that used to cost $500 to $1,000 will now cost $2,000 to $4,000 on average – and the speed of new business creation will crawl. Somebody else needs to explain to me how that is a good thing.
3. The Unfunded Mandate. The federal government uses unfunded mandates the way an abusive husband exerts control over a spouse. And, make no mistake, it is ALL about federal control. The states, on the other hand, struggling as they are in these economic downturns to balance their own budgets, aren’t so fond of them. Usually, the federal penalty for not complying with an unfunded mandate is that other federal funds – like highway funds – will be pulled from the non-compliant State. If you or I did that, we would be in jail for blackmail. Somehow, those rules don’t apply to Congress. But they should.
In this bill, the mandate for states to comply with requirement to collect beneficial ownership is a very expensive one. When I asked Scott Anderson, Deputy Secretary of State of Nevada over Commercial Recordings about how much it would cost Nevada to comply with this bill, he gave me a ballpark estimate of $10 million. For a state that just announced a forecast of a budget deficit approaching $1 billion, I think it is fair to say that it will difficult for state leaders to make it a priority to throw $10 million at this boondoggle.
Technically, the bill says that states should use existingHomeland Security funding that they receive to cover the tab – so Levin actually believes himself when he claims that this isn’t an unfunded mandate. But let’s be real: that means that the Secretary of State has to fight state and local law enforcement over the allocation of Nevada’s federal Homeland Security funding. Just who do you think will win that argument? Exactly.
4. An Unlevel Field. In Levin’s remarks, he claims that “federal legislation is needed to level the playing field among the States” who compete for corporate filings. This is actually a rational argument. States do compete for incorporation business, and the market does respond to states that offer flexibility, predictability, greater indemnification of individuals, or more favorable tax climates. So, no state that seeks to build its economy is going to volunteer to impose higher reporting and disclosure requirements than it absolutely has to because it will drive their customers away to other, more favorable states. If this principle were not true, Nevada would not be considered to be the favorable incorporation haven that it is today.
But, the bill doesn’t actually force any single state to comply with the requirements yet. It leaves that door open by commissioning a future study (THAT’S JUST WHAT WE NEED! ANOTHER TAXPAYER-SUPPORTED STUDY!) a year after passage to report on which states have complied and which have not. I’m no mystic or prophet, but I think I can predict what they will find in their “study”: No states have complied. And why should they? The early-adopters would be sticking their necks out only to get their heads lopped off. Their business filing revenues will drop, and any favorable reputation for “business friendliness” would be forever scarred. Why volunteer to spend the money to change their existing systems when doing so puts them at a competitive disadvantage with other states? Just how does this mess “level the playing field,” anyway?
5. The Constitutional Question. Again, I am no attorney. Much of what I know of the Constitution of the United States, I owe to a terrific high-school teacher who taught me U.S. history so many years ago (thank you, Mr. Gilbert). But, as simple as I am, I think I understand that the federal government does not have authority to regulate or govern the activities of state legislatures (who determine the state law governing the formation of business entities), or of state constitutional officers – such as the Secretary of State, who in most states is responsible for the systems and procedures for corporate filing. Yet, that is precisely what this bill does.
By definition, in Section 4 of the bill, Levin, Coleman and Obama are attempting to place state filing officers – such as the Nevada Secretary of State – under the regulatory authority of the U.S. Bank Secrecy Act. If you don’t believe me, just read it. Again, I’m no attorney, but they just cannot do that!
There are a couple of interesting legal cases that the good Senators might want to read. In re Lloyds of Texas, 43 F.[2d] 383, the U.S. Supreme Court ruled that “only a sovereign authority can create a corporation.” That’s right, a sovereign authority – like the State of Nevada, or Delaware, or California, or Texas, etc. In other words, the States are sovereign on the issue of incorporation laws, systems, procedures and requirements. The federal government has no authority in this area.
In Luxton v. North River Bridge Co., [153 US 525, 38L.Ed.808] establishes the clear fact that Congress can only have sovereign authority over incorporation requirements in two specific instances: 1) “as appropriate means of executing the powers of government; as, for instance, a bank for the purpose of carrying on the fiscal operations of the United States or a railroad corporation for the purpose of promoting commerce among the States”, and 2) within the District of Columbia or U.S. territories. That’s it!
I don’t know why I expect United States Senators and a presidential candidate to understand basic Constitutional principles that I learned in high school. Maybe they didn’t pay attention in class.
6. The Loophole. I spoke recently with the Government Affairs officer of one of the largest, national incorporation firms, and asked him a question: What percentage of business entities in the United States are represented by a “formation agent” or professional registered agent, as opposed to doing it themselves and self-representing? He estimated that around 90% of all business entities in the United States are “self represented”. This means that while the bill puts all the professional “formation agents” under the regulatory authority of the U.S. Bank Secrecy Act – just like banks and casinos – 9 out of 10 new corporations or limited liability companies are actually formed by individuals who won’t be regulated at all. If this were truly about fighting crime, one easy way to reduce the scrutiny of having a regulated formation agent help you with the process is to simply do it themselves – just like they do today. And yet, they have no trouble imposing the burden of regulatory oversight – with it’s associated potential fines and imprisonment penalties – on an entire industry that represents but a small fraction of business entities in existence. The costs of this regulatory compliance will put many small incorporation firms out of business. In Nevada, a lot of these small firms are protypical “Mom and Pop” operations, frequently run by retirees to supplement their retirement income. I could personally provide a list of dozens of such companies that I know of that would disappear overnight if this bill were approved.
7. The Red Herring. In 2007, the Nevada Legislature gave the Nevada Secretary of State the power to require companies formed in Nevada to disclose ownership records, or answer interrogatories, in the event that a local, state or federal law enforcement agency supplied a summons or subpoena as part of a criminal investigation. Any corporation or limited liability company that failed to comply immediately with the Secretary of State’s request was subject to harsh penalties that include the corporate “death penalty” of revocation of its charter. This was done in response to complaints by law enforcement before the U.S. Senate Permanent Subcommittee on Investigations in November 2006 that they were powerless to access any corporate information.
This bill is also a response to those hearings, and remember that “fighting crime” is supposedly the top objective. For this problem to come to the attention of the U.S. Senate, and inspire this invasive federal legislation, it must be huge. There must be thousands of investigations going on that are being thwarted by our existing incorporation policies, right?
Well, according to the Nevada Secretary of State’s office, since the law was put in effect on July 1st, 2007 the number of requests for ownership information they have received from law enforcement agencies across the countries for the more than 300,000 business entities on file in Nevada is exactly ZERO.
To use a term Sen. Levin likes, that fact makes this bill a bit suspicious, don’t you agree?