In late 2020, anticorruption and transparency advocates scored a major victory: the passage of the U.S. Corporate Transparency Act (CTA), which requires U.S. corporations, limited liability companies, and “other similar entities” to disclose the identities of their true beneficial owners to the U.S. Treasury Department’s Financial Crimes Enforcement Network (FinCEN). FinCEN is currently in the process of drafting regulations to implement the CTA. One of the key questions FinCEN is considering concerns the scope of the CTA’s coverage—in particular whether trusts should be considered “similar entities” to which the CTA’s disclosure obligations apply.
The answer ought to be a resounding yes. As the recent revelations from the International Consortium of Investigative Journalists (ICIJ) stories on the so-called Pandora Papers has made all too clear, trusts are prime vehicles for kleptocrats, organized crime groups, and others who want to hide their illicit assets. To be sure, trusts have legitimate uses, such as estate planning, charitable giving, and certain (lawful) strategic business purposes. But the potential for abuse means that it is essential to increase transparency and oversight of trusts.
To understand the role that trusts play in illicit finance, and why application of the CTA’s disclosure requirements to trusts is so crucial, it’s important first to understand the basics of how trusts operate. At the most fundamental level, a trust involves three parties: (1) the settlor creates the trust and provides its assets (which might be money, real estate, shares in a company, or something else); (2) the trustee holds legal title to the trust and is responsible for managing its assets; (3) the beneficiary receives the benefits of the trust, often though not always in the form of periodic distributions of income. For example, a grandmother (the settlor) might set up a trust, with her son (the trustee) managing the trust’s assets for the benefit of her grandchild (the beneficiary), who would receive an allowance every month.
Unfortunately, the trust mechanism is also attractive to would-be money launderers. Trusts are not only extremely flexible, but they also offer a substantial degree of secrecy. For one thing, in contrast to corporations and limited liability companies, the formation of a trust typically does not require filing incorporation documents with the state. Even without the CTA’s beneficial ownership disclosure requirement, the incorporation process typically reveals useful information about a company, including the (alleged) purpose of its business, its location, and its legal address. By contrast, a trust is a contractual agreement between the settlor and the trustee, and the formation of a trust in most jurisdictions generally does not require the filing of any documents with the state or indeed any action by the government.
Furthermore, the legal separation between ownership of the trust (which rests in the trustee) and the trust’s settlor and beneficiaries creates an additional barrier to figuring out who really created, controls, or benefits from a trust. Even when a trustee’s identity is available, trustees may be bound by confidentiality arrangements—which some jurisdictions permit—that bar the trustee from revealing the trust’s settlors or beneficiaries. This secrecy problem is exacerbated when the trustee itself is a company: Because some trust companies act as trustees for hundreds or even thousands of trusts, it can be difficult or impossible to infer a trust’s settlor or beneficiary from the identity of the trustee. Similarly, even when it is possible to identify a trust’s beneficiary, that beneficiary might be another corporate vehicle—possibly another trust—which adds another layer of opacity to the trust’s ownership structure. And if the trust is created by an attorney, the attorney-client privilege creates an additional barrier to transparency.
To illustrate why trusts are an attractive tool for money laundering, consider a stylized example in which a politician (P) wants to solicit a $10 million bribe from a construction company (C) in return for ensuring that the company receives a lucrative government contract. How would P and C arrange this transaction? The simplest way would be for C to pay P in cash, but that would be difficult given the large sum involved. C could transfer the money to P’s bank account, but the banks, which are subject to suspicious activity reporting requirements, would likely flag the transaction, and might even decline to process it. Setting up a trust is an attractive alternative: P can first contact a trust company to establish a trust (T), for which the trust company will act as trustee. P might be the settlor, but P might also have the trust company supply a “dummy settlor”—someone within the company willing to act as the settlor of the trust. (P might also make use of certain trust arrangements—such as use of a protector or a letter of wishes—that allow P to maintain a degree of control over how T’’s assets are used, without claiming legal ownership.) The beneficiaries of this trust would be P’s spouse and children. The assets of this trust would be shares in a dummy company (D) set up by P (or her associates). Meanwhile, C sets up a special purpose vehicle (S) to hold the $10 million. (As far as an outside observer can tell, these assets were generated by C’s past business transactions.) C then executes a phony “consulting” contract with D (the shares of which are held by T), and C arranges to transfer funds from S to D. This consultancy contract appears legitimate, so C’s bank transfers the funds. But transferring the money to D is actually a transfer of that money to T, which owns all the shares in D. And because P’s family are the beneficiaries of T, they can receive that money as distributions from the T, though those payouts could be delayed, and T could have many other assets in addition to shares in D.
This arrangement makes it easier for P and C to disguise the bribe and to launder the illicit payments. Even if law enforcement or other investigators suspect some form of wrongdoing, the secrecy associated with trusts can make it more difficult to follow the money—especially since, as noted above, some jurisdictions offer secrecy protections that make it immensely difficult and sometimes practically impossible to trace the proceeds given to the beneficiaries to the person who really controls the trust. Connecting the $10 million paid by C to the assets received from the trust by P’s family members is even more difficult if the trust company offers to provide a “dummy settlor,” and if the jurisdiction where T is formed allows the identity of the beneficiaries to be kept secret—unknown to anyone but the trustee and the settlor—until ownership of the assets is transferred to them. In short, the secrecy associated with trusts allows the settlor to benefit from illicit funds while obscuring her personal connection to those assets.
In order to prevent the use of trusts to facilitate criminal activities, accurate and adequate beneficial ownership information must be made readily available to government agencies. A trust’s beneficial owners ought to be understood as all natural persons who exert substantial influence over the trust and/or enjoy its benefits, regardless of their technical legal status (settlor, trustee, beneficiary, or none of the above). In the above example, if the trust company, acting as trustee, were obligated to collect and report information on T’s beneficial owner, then investigators would know that P is T’s beneficial owner, and this would make it substantially easier for government investigators to trace the initial bribe payment (from S to D) back to P. (Doing so would be even easier if D is also covered by beneficial ownership reporting requirements, as P would be the beneficial owner of D, in that P is the beneficial owner of T, which owns and therefore controls D.)
FinCEN should therefore follow the Financial Action Task Force’s recommendation that governments require every trustee to obtain the identities of settlor, other trustee(s), and beneficiaries—and, if any of these are legal entities, the identities of the actual human beings who are the true beneficial owners of those entities—as well as any other person who exercises ultimate effective control over the trust. (The EU’s 5th Anti Money Laundering Directive embraces a version of this approach, requiring every party to the trust, as well as any other individual with control, to be registered as a beneficial owner.) In the context of the rulemaking on implementing the CTA, this means that FinCEN should explicitly define “other similar entities” as including trusts, and to treat the beneficial owners of a trust’s settlors, trustees, and beneficiaries all as counting as beneficial owners of the trust itself. And FinCEN should not limit the application of the CTA only to those entities that must register or file documentation with a state or tribal chartering authority (as some commenters have urged, see here and here), because, as noted above, many jurisdictions don’t require the filing of documentation to create a trust.
The purpose of the CTA is to ensure the government can identify individuals using legal entities to conduct illicit activities within the United States. As the Pandora Papers has made abundantly clear, trusts are one such legal entity. FinCEN has the opportunity—and obligation—to implement specific and defined regulations in order to advance the CTA’s core objectives. Kleptocrats (and their lawyers and accountants) are sophisticated and will scour the details of CTA and FinCEN’s regulations in search of potential workarounds. Leaving “other similar entities” either undefined or without explicitly covering trusts (as well as other entities susceptible to abuse, like partnerships and foundations) would therefore be a grave error.