“Vague, overly broad, and unworkable.” Those were the words ABA president Hilarie Bass used in her February letter to Congress to criticize the definition of “beneficial ownership” that appears in the TITLE Act – a proposed bill that would require those seeking to form a corporation or limited liability company to provide information on the company’s real (or “beneficial”) owners to state governments. The TITLE Act defines a beneficial owner as “each natural person who, directly or indirectly, (i) exercises substantial control over a corporation or limited liability company through ownership interests, voting rights, agreement, or otherwise; or (ii) has a substantial interest in or receives substantial economic benefits from the assets of a corporation or the assets of a limited liability company.” Ms. Bass and other critics assert that this definition is unprecedented, unfair, and unduly vague, making it impossible for regulated entities to understand the scope of their legal obligations and rendering them vulnerable to arbitrary, unpredictable prosecutions.
But Ms. Bass is incorrect: The TITLE’s Act definition of “beneficial ownership,” though “vague” in the sense that it is flexible rather than rigid, is perfectly workable, and aligns with other US laws, European laws, and the G20’s 2015 principles on beneficial ownership. Moreover, the alleged “vagueness” is necessary to prevent the deliberate and predictable “gaming” of the system that would inevitably take place to circumvent a more precise numerical ownership threshold.
First of all, while the ABA and other critics make it sound like the proposed beneficial ownership definition is radical or anomalous in its breadth and open-endedness, in fact the TITLE Act definition exactly mirrors a beneficial ownership definition that already exists in US law—the definition in the National Defense Authorization Act (NDAA), which required the Defense Department to identify the beneficial owners of buildings it rents. True, the NDAA’s beneficial ownership rules have a narrower scope (applying only to a relatively limited number of buildings). But other existing legal provisions, with a much broader scope, use a similar definition. In particular, in 2016 FinCEN (a bureau within the Treasury Department) also promulgated a definition of beneficial ownership in connection with the Bank Secrecy Act—a definition that determines the scope of regulations that apply broadly to banks, securities brokers or dealers, mutual funds, and others. While the FinCEN definition is somewhat different from the definition in the NDAA and the TITLE Act, it is largely comparable. The FinCEN regulation uses a two-pronged definition, considering both “ownership” (both direct and indirect) and “control”. The ownership prong has a specific threshold, defining ownership as “each individual, up to four and as few as zero, who directly or indirectly owns 25% of the equity interests of a legal entity.” The control prong meanwhile mirrors the TITLE act, referring to those with “significant” responsibility to control.
The proposed TITLE Act definition of “beneficial ownership” is also closely aligned with practice in Europe, and with global standards. Both Spain and the UK define a beneficial owner as “natural person or persons who ultimately own or control, directly or indirectly, a percentage of more than 25% of the capital or voting rights of a legal person, or who by other means exercise control, directly or indirectly, over the management of a legal person.” France, Germany, Italy, and the Netherlands have similar definitions. By contrast, the TITLE Act has no fixed percentages. But this makes little practical difference: While the TITLE Act does not require that someone who directly owns 25% of company necessarily be listed as a beneficial owner, as do most European laws, it does not rule out the possibility that someone owning 25% of a company could be a beneficial owner. By the same token, European laws do not exclude the possibility that someone owning under 25% of a corporation might still qualify as a beneficial owner by virtue of indirect ownership and/or control. Moreover, the current US and European definitions are all compatible with the global principles, including, for example, the G20’s 10 High Level Beneficial Ownership Principles, which states that “Countries should have a definition of ‘beneficial owner’ that captures the natural person(s) who ultimately owns or controls the legal person or legal arrangement.”
Now, just because the TITLE Act’s definition aligns with current US and European practice does not doesn’t prove that it is workable and appropriate. The ABA might find the definitions in existing US laws and regulations, and in comparable European laws, equally problematic. But the similarities across different countries exist for a very good reason: “beneficial ownership” doesn’t lend itself to a simple bright-line rule, but instead requires a more flexible, open-ended standard: one that is capable of capturing unforeseen “innovations” by those who might try to game any set of simple rules. If the US were to define a beneficial ownership simply as requiring direct ownership of 25% of a company’s capital rights, it’d be all too easy to avoid the verification and reporting requirements. An individual might ensure he owns 24% of a company’s capital rights while “giving” a friend 24% to own so as to avoid being listed a beneficial owner. The fact that the definition is not precise is not a limitation, it’s an indispensable feature.
The ABA and other critics of the TITLE Act’s definition of beneficial ownership have not only failed to provide a convincing rejoinder to that point, but they have so far failed to offer any alternative definition of beneficial ownership. A cynic might take this as evidence that the ABA is not actually interested in constructive engagement to improve the bill. Indeed, the ABA has consistently opposed similar definitions of beneficial ownership since 2011 without providing much by way of an alternative definition. Putting aside that sort of cynicism, it is still telling that the ABA has not proposed an alternative, more precise and “workable” definition. It is likely that no such definition exists, at least none that would not make circumventing the new requirements trivially easy.
The ABA worries that the open-endedness of the proposed definition would, as Ms. Bass puts it, “subject small businesses and their agents to harsh criminal …penalties for essentially paperwork violations.” I’m inclined to agree that paperwork violations of “vague” laws should not be criminal. Nonetheless, with regard to this particular bill, the ABA’s criticism is misguided. First, the TITLE Act leaves a large degree of discretion to states in deciding what penalties should be imposed for violations, thus leaving open the possibility that states will opt for civil, as opposed to criminal, penalties. Second, given the overarching purpose of the TITLE Act to minimize the ability of “terrorist organizations, drug trafficking organizations, and international organized crime groups” to launder funds in the US, it seems unlikely that well-meaning individuals who innocently misconstrue the law’s meaning would be the obvious targets of federal prosecutions, as compared with those persons already involved in other kinds of criminal activity.
Unless the ABA can articulate an alternative, more precise and “workable” definition, it seems like there are two alternatives: no beneficial ownership reform or reform that relies on a somewhat open-ended definition. As between the two, it’s an easy choice.