Will the Corporate Transparency Act Smother the Cannabis Industry?
Whatever the true intention of the Corporate Transparency Act and its Beneficial Ownership Interest reporting requirements, there is no doubt that there will be some companies that will suffer. Not because they are doing anything illegal, but because of the unknown regulatory aspects of their businesses. One prominent one is the cannabis industry which in many states has not only been a game changer but a driver of significant state revenue. That being said, there is no national policy on cannabis yet—it is still illegal—as it is in many states. So perhaps it won’t kill the industry, but in some ways it may suffer.
FROM CANNABIS BUSINESS EXECUTIVE / BY STEVE SCHAIN
Mandating “true owners’ identity disclosure” to prevent using shell companies to conceal criminal revenue, the Corporate Transparency Act creates myriad cannabis industry headaches.
Mandating “true owners’ identity disclosure” to prevent using shell companies to conceal criminal revenue, the Corporate Transparency Act, 31 U.S.C. Section 5336, et. seq. (CTA) creates myriad cannabis industry headaches.
The CTA requires business entities to file information on their “beneficial owners” with the Financial Crimes Enforcement Network (FinCEN) of the U.S. Department of Treasury, which, in turn, may disclose it to domestic and foreign law enforcement agencies, prosecutors, judges and financial institutions.
Because it imposes onerous reporting requirements, impedes entity formation and modification, encumbers investors, and enhances investigative and prosecutorial likelihood, the Corporate Transparency Act may stifle the cannabis industry’s operations and growth.
Money Laundering and the Corporate Transparency Act
Money Laundering and Beneficial Ownership
Money laundering is the process of illegally concealing the origin of money generated by, or used to fund, illegal activities like terrorism and sex trafficking. Engaging in financial transactions to hide money’s identity, source, or destination requires “shell companies” or “beneficial ownership” disguising the launderers’ identities and converting funds into seemingly have been derived from a legitimate source.
Enabling companies to maintain privacy regarding their ownership and control, small to midsized corporations, limited liability companies, and limited partnerships’ (hereafter, collectively referred to as midsized entities) information has only been demanded by state governments, in that, when forming, filings are required identifying entity’s name, registered agent and registered office (e.g., articles of incorporation filed with state corporation’s bureau).
Forming the federal government’s first stab at regulating business entity formation, the Corporate Transparency Act requires subject entities to file a report listing its beneficial owners’ information with FinCEN, imposes stringent penalties for willful noncompliance and unauthorized disclosures, and creates a “beneficial ownership information database” enabling FinCEN to crack down on anonymous money-launderer-concealing shell companies.
Corporate Transparency Act Overview
On Jan. 1, 2021, the Corporate Transparency Act was enacted and, on Sept. 30, 2022, final regulations were implemented (hereafter, collectively referred to as CTA Law) requiring domestic and foreign midsized entities, called reporting companies, to file beneficial ownership information (BOI) with the FinCEN. Taking effect on Jan. 1, 2024 (effective date), the CTA Law requires all reporting companies to report information on: the reporting company; all beneficial owners; and the company applicant filing the entity-creating document.
Reporting Companies
FinCEN estimates that there are 32 million existing reporting companies defined as: created by a filing with a federal, state or tribal governmental entity; or formed in a foreign country that is registered to do business in the U.S.. Exempted from the “reporting company” definition are entities already subject to state or federal supervision and reporting including: public companies issuing securities; licensed securities brokers and dealers; banks and credit unions; insurance companies, governmental agencies; venture-capital fund advisers; public utilities; pooled investment vehicles; accounting firms and specified tax-exempt entities and entities assisting an exempted tax-exempt entity; and entities registered and subject to reporting requirements under the Securities Exchange Act of 1934, the Investment Advisors Act of 1940, the Investment Company Act of 1940, the Commodity Exchange Act, and the Paying, Clearing, or the Settlement Supervision Act of 2010.
Also exempt from the CTA reporting requirements are: Large operating companies with 20 or more full-time U.S. employees, having a physical “operating” office in the United States, and, in the prior year’s tax return, reporting more than $5 million in gross sales; and inactive businesses in existence before Jan. 1, 2020, which are not actively engaged in business nor owned by a foreign person, have had no ownership change—nor sent or received funds greater than $1,000—in the last 12 months, and not otherwise holding any assets.
Beneficial Owners and Company Applicant
A beneficial owner is anyone exercising “substantial control” over, or owning/controlling 25% or more of, the reporting company.
One has “substantial control” of the reporting company if: serving as a senior officer; having the ability to appoint or remove any senior officer or a majority of the board of directors; having the ability to direct, decide or substantially influence important matters; or having any other form of substantial control. Substantial control can be exercised either directly or indirectly through board representation, control of a majority of the voting power, rights associated with a financing arrangement, control over one or more intermediary entities, financial or business relationships or other contract or arrangement.
The CTA Law broadly defines an individual’s “ownership interest” to include whether vested or not: traditional stock ownership and membership and partner interests; capital or profits interests; convertible instruments; and put, call or other option rights.
A “company applicant” is any individual filing the entity-creating-document” including both the actual filer and anyone directing/controlling the document’s filing (e.g., if attorney directs paralegal to file reporting company’s incorporation articles, both are subject to CTA reporting requirements).
Reportable Beneficial Owner Information and Deadlines
The reporting company’s initial report must include for:
The reporting company: full legal, trade and “doing business as” names; principal place of business or primary business location’s street address; jurisdiction where formed or registered; and IRS taxpayer identification number; and
Each beneficial owner and company applicant for each reporting company created or registered on or after Jan. 1, 2024: full legal name; date of birth; beneficial owner’s residential street address and company applicant’s business address; unique identifying number from a nonexpired passport, identification document issued by a state, local government or Indian Tribe, or driver’s license, and an image of document from which unique identifying number is obtained.
A reporting company’s initial report filing due date hinges on when it was registered with those existing: before the effective date required to file before Dec. 31, 2024; and after the effective date are required to file within 30 days of creation.
If filed information is inaccurate or a status change occurs, the reporting company must file an updated report within 30 days. Thus, whenever there is a change in a beneficial owner’s information or in the beneficial owners of a reporting company (e.g., change of a senior officer of the company), an updated report must be submitted.
Penalties
Failure to timely file a “CTA Law required report” may result in both civil and criminal penalties.
Under the Corporate Transparency Act, it is unlawful for any person to: knowingly provide, false or fraudulent beneficial ownership information; or willfully failing to file or provide complete or updated BOI. A violation of the filing requirements can result in the imposition of a $500 per day civil penalty; and, upon conviction, imprisonment for not more than three years.
Corporate Transparency Act’s Impact on Cannabis Industry
Marijuana-Related Businesses and Criminal/Civil Exposure
Marijuana-related business (MRBs) take two forms, “plant touching” and “nonplant touching.”
First, businesses which “manufacture, distribute, or dispense marijuana” or literally touch cannabis at some point along the supply chain are deemed “plant touching.” “FIN-2014-G001: BSA Expectations Regarding Marijuana-Related Businesses,” FinCEN, Feb. 14, 2014. Licensed by the state, plant touching MRBs include: cultivating, harvesting, processing/extracting, testing, packaging, disposing, transporting, and dispensing. See, U.S. Senate, “S. 1726: Marijuana Businesses Access to Banking Act of 2015,” July 9, 2015; Representatives, H. R. 2076, April 28, 2015.
Further, any entity having a financial or controlling interest (regardless of ownership percentage) in a plant touching MRB, including “investment” or “management” shell companies that may be seeking “to conceal or disguise involvement in marijuana-related business activity,” are deemed plant touching MRB’s. See, “FIN-2014-G001: BSA Expectations Regarding Marijuana-Related Businesses,” FinCEN, Feb. 14, 2014.
Second, businesses providing products and services to plant touching MRBs but not directly “manufacturing, distributing, or dispensing marijuana” are labeled “nonplant touching” and include: banking, payment processing and armored car services; commercial real estate (landlord and property management); professional services (accounting, consulting, legal, lobbying and insurance); testing and lab services; construction, plumbing and electrical; and cultivation packaging and supplies.
The Comprehensive Drug Abuse Prevention and Control Act of 1970, 21 U.S.C. Sections 801, Et. Seq (1970) (Controlled Substance Act) lists marijuana next to heroin as a Schedule I controlled substance having “a high potential for abuse” and for which there’s “no currently accepted medical use in treatment” and “a lack of accepted safety for use” “under medical supervision.” The Controlled Substance Act prohibits marijuana’s manufacture, distribution, dispensation and possession and, pursuant to the U.S. Constitution’s supremacy clause, state laws conflicting with federal law are generally preempted and void. See, U.S. Const., Art. VI, cl. 2; Wickard v. Filburn, 317 U.S. 111, 124 (1942)(”No form of state activity can constitutionally thwart the regulatory power granted by the commerce clause to Congress.”).
This federal prohibition creates criminal and civil exposure. First, depending on amount of cannabis possessed, cultivated or sold, the Controlled Substance Act impose penalties ranging from incarceration of 15 days to life and fines of $1,000 to $1 million. Second, because working together to distribute drugs to a third party forms a “conspiracy” in violation of 21 U.S.C. Section 846, anyone “furthering sales” (e.g., dispensary’s landlord) faces conspiracy exposure. Third, one whom knowingly leases property for purpose of “distributing a controlled substance” may be deemed to be “maintaining a drug premise” in violation of 21 U.S.C. Section 856 subject criminal (up to 20 years incarceration and fines up to $500,000 for individuals and $2 million for an entity) and civil (forfeiture of gross receipts earned from leased space) penalties.
CTA’s Cannabis Industry Impact
Because existing and prospective marijuana-related businesses are often standalone midsized entities with under $5 million in income and fewer than 20 employees, most fall within the Corporate Transparency Act’s ambit creating havoc.
First, already among the nation’s most highly regulated and penalized industries, the Corporate Transparency Act’s reporting obligations will deplete an already overburdened cannabis industry sector’s resources.
Second, because it imposes profound transparency and reporting requirements, the CTA will impede cannabis entity formation and deter investment. Because of the Industry’s onerous tax scheme, funding scarcity, and vulnerability to fluid competitive application requirements (e.g., “residency,” “capital/liquidity,” “diversity, equity and inclusion”), marijuana-related businesses must be nimble and fluid. Rapid investor entrance and exit, “C-level Executive” deck shuffling, and complex interrelated entity enterprise structure are the norm and trigger the CTA Law. Reporting requirements will burden these stretched-thin start-ups already mired in this rapidly evolving industry’s on-the-job-training culture and impair their ability to modify, expand and merge the enterprise’s constituent components.
The Corporate Transparency Act requirements will also encumber investment. Beyond forcing investors to provide confidential information and identifiers (and endure exposure to CTA Law penalties and reputational risk), confusion will ensue as to hybrid debt/equity funding and what compliance is triggered and when.
Third, CTA compliance may subject information providers to investigative/prosecutorial exposure and impair MRBs ability to obtain banking. The Corporate Transparency Act’s empowers FinCEN to share a company’s beneficial ownership information with “federal, state, local and tribal officials, as well as certain foreign officials” for the purposes of “authorized activities related to national security, intelligence and law enforcement.” Because to a hammer everything’s a nail, FinCEN’s “BOI information sharing” will bring information providers to domestic/foreign law enforcement’s attention and subject them to criminal and civil investigations and actions.
Further, because FinCEN may disclose beneficial ownership information to a financial institution to facilitate banks customer due diligence requirements, marijuana-related businesses may get flagged and be impeded in obtaining and retaining depository services.