New Disclosure Rules Favor Oligarchy Over Small Business

This article was reported and first published by The Lever.

As of Jan. 1, small businesses must report who owns and controls the company to financial regulators or face stiff penalties. The disclosure is required under a new anti-money laundering law designed to curb tax fraud and terrorism financing.

But while mom-and-pop cafes and hardware store owners are now busy filling out the disclosure paperwork, many investment vehicles flagged by law enforcement agencies are exempted from those same disclosure rules after Wall Street firms spent millions lobbying on the matter. 

Early versions of what became the Corporate Transparency Act did not include the special carve-out. But the final legislation had a line exempting pooled investment vehicles. That means venture capital funds, hedge funds and private equity funds are not required to report their ownership information, even though the FBI has said such opaque entities are among those used in criminal money laundering.

This loophole undermines “anticorruption, counterproliferation, and counterterrorism programs,” Senators Sheldon Whitehouse (D-R.I.) and Elizabeth Warren (D-Mass.) wrote in a 2022 letter to the Treasury Department and the U.S. Securities and Exchange Commission (SEC), which is responsible for regulating the securities markets and protecting investors.

Congress included the Corporate Transparency Act, originally sponsored by Rep. Carolyn Maloney (D-NY), in a defense spending bill and passed the legislation with bipartisan support in January 2021. This happened amid growing concerns over financial crimes following scandals like revelations of corruption and money laundering within the FIFA soccer association and the Panama Papers exposé detailing widespread international corruption.

In a 2022 letter, lawmakers from both parties urged the Treasury Department to accelerate the implementation of the law, saying delays would “undermine American efforts to respond to Russia’s war against Ukraine, and hinder broader efforts to protect the U.S. financial system against the threat of illicit finance.”

According to lobbying records, the American Investment Council (AIC), an advocacy organization for private equity firms, spent $22 million trying to influence legislators over the past decade. In the two years leading up to the passage of the Corporate Transparency Act — and its inclusion of the loophole — the group lobbied directly on the legislation and related matters. AIC later boasted that it “worked with Members of Congress and their staffs to help craft these exemptions.”

Once the law passed, the Treasury Department was charged with issuing detailed rules and requirements for companies to comply with the statute. At the time, transparency groups urged regulators to issue as narrow an exemption as possible. But AIC pressed Treasury’s regulators to apply the exemption not merely to pooled investment vehicles’ parent companies, but also to the firms’ complex web of “subsidiaries and affiliates.” 

As justification, the group insisted that the lifespan of a private equity fund is usually 10 to 12 years, meaning it takes that much time to gather money from investors, invest that money into businesses, and sell those businesses for a profit. “Criminals would prefer quick access to their ill-gotten gains,” AIC wrote. The group also noted that since there typically are “restrictions on cash withdrawals during the fund lifespan,” private equity funds are “unattractive for money laundering.”

The final rules, issued by the Biden treasury department at the end of 2023, clarified that the Corporate Transparency Act exemption extended to subsidiaries of banks, venture capital funds, and investment companies. 

AIC did not respond to a request for comment. 

Layers Of Secrecy

The government’s new rules requiring companies to disclose their “beneficial owners” — people who have substantial, although sometimes obscured, control over the business — are aimed at tracking bad actors who use shell companies to shield their identities and unlawful gains. In recent years, regulators have found that criminals are laundering money through U.S. businesses — meaning money they make through illegal activities, like drug trafficking or extortion, is deposited or invested into the financial system so it appears to have come from a legitimate source. Essentially, the dirty money is “laundered” to make it appear clean.  

Starting this year, most small businesses must provide their beneficial ownership information to the U.S. Department of Treasury’s Financial Crimes Enforcement Network (FinCEN)’s online database. Those who willfully fail to submit a report, or provide fraudulent information, are subject to a fine of $500 per day, up to $10,000 per violation, and up to two years in jail. As of Jan. 8, Treasury Secretary Janet Yellen said that 100,000 firms have added their information to the database. 

While some Republican lawmakers have slammed the Corporate Transparency Act for imposing “overly complex and burdensome red tape on American small business,” money laundering experts hail the act as the most important anti-money laundering law in decades.

“The Corporate Transparency Act is the most meaningful act of our time for financial security,” said Erica Hanichak, government affairs director at the Financial Accountability and Corporate Transparency (FACT) Coalition, a nonpartisan alliance that is working towards a fair tax system.

Much of the financial sector including banks, mutual funds, credit unions, broker-dealers — even casinos and pawn shops — are already required to abide by specific anti-money laundering rules enacted after the Sept. 11, 2001 terrorist attacks, which heightened concerns around terrorist financing. That included the Patriot Act, which requires financial institutions to establish anti-money laundering programs that detect illicit money and prevent these funds from entering the U.S. financial system.  

However, the Treasury Department temporarily exempted investment companies from these rules in 2002. The department planned to first tackle other financial sectors and then move onto private investment companies. 

Nevertheless, the two-decade-old exemption still stands today, thereby allowing hedge funds, private equity funds, and other pooled investment vehicles to bypass anti-money laundering laws. Consequently, such funds can accept and manage massive sums of cash without knowing who their investors are — an appealing arrangement to those who wish to invest money while remaining anonymous. 

A leaked FBI bulletin from 2020 also revealed that criminal actors “likely use the private placement of funds, including investments offered by hedge funds and private equity firms to launder money, circumventing traditional anti-money laundering (AML) programs.”

For example, Russian oligarch and member of Russia’s upper house of parliament Suleiman Kerimov formed a Delaware-based trust that held over $1 billion worth of assets. Kerimov’s funds were invested in “large public and private U.S. companies and managed by a series of U.S. investment firms and facilitators,” according to a statement by the Treasury Department, which blocked these funds in 2022.  

The Treasury Department last attempted to close this loophole in 2015, but the private investment industry pushed back. AIC — then called the Private Equity Growth Capital Council — contended that “pooled investment vehicles that do not offer investors an opportunity to redeem their interests present negligible risks of money laundering.”

Other investment groups like the Association for Corporate Growth also argued that anti-money laundering policies would “impose significant costs upon advisers to private equity funds and other illiquid pooled investment vehicles but not prevent or deter money laundering in any meaningful way.” 

The Treasury Department’s 2015 attempt to scrutinize private funds failed — yet by that point, what would become the Corporate Transparency Act was already taking shape. 

Former Sen. Carl Levin (D-Mich.) raised concerns about people creating businesses without identifying the owners back in 2008 when he introduced the Incorporation Transparency and Law Enforcement Assistance Act. The bill would have required U.S. corporations and limited liability companies to disclose their owners in order to prevent illicit financial activities. Notably, it did not specifically exclude investment companies.

After Levin’s legislation stalled, various iterations of anti-money laundering bills continued to be proposed in Congress, leading to the introduction of the Anti-Money Laundering Act of 2020, which included the Corporate Transparency Act. 

Along the way, the investment industry has continually lobbied on the matter. Since 2013, AIC has spent more than $22 million on lobbying related to the regulation of private equity, the Corporate Transparency Act, and company ownership. 

In 2021, when the Corporate Transparency Act finally passed, the financial industry won a victory: lawmakers included a provision that carved out investment companies from disclosure requirements. 

When the specific rules defining the exemption were being crafted, pro-transparency groups urged regulators to keep the carve-out as narrow as possible. 

In a 2022 comment to FinCEN the FACT Coalition asked regulators to limit the carve-out’s purview and include language in the final rule stating that the exemption of pooled investment vehicles was “both unusual and high risk.” They also wrote that, “Neither Congress nor FinCEN has offered any merit-based justification for the exemption, and none seems relevant. Multiple factors indicate that the pooled investment vehicle exemption poses a high risk of money laundering and terrorist financing.”

Josh Rudolph, fellow for malign finance at the German Marshall Fund of the United States, a public-policy think tank, also urged the exemption to be narrowly defined, writing to FinCEN that “pooled investment vehicles — the most troubling of the 23 exemptions in the [Corporate Transparency Act] — should only be exempt if they are operated or advised by regulated financial institutions,” meaning they are supervised and subject to periodic examination by a state or federal agency. 

Neither the narrow definition, nor a warning about the exemption’s risks, were included in the final rule.

FinCEN did not provide a comment. 

Additional Pressure

To address ongoing gaps in federal anti-money laundering laws, some states are beginning to tackle the issue of private investment transparency on their own.

“There’s kind of this other undercurrent of state-level transparency legislation that’s happening now on the heels of the Corporate Transparency Act,” said William Quick, an attorney and expert in Corporate Transparency Act compliance at Kansas City-based Polsinelli Law Firm. 

In 2023, New York passed the LLC Transparency Act, which will create a database where limited liability companies must report the names of their owners. However, Gov. Kathy Hochul (D) amended the legislation, eliminating the measure that would have required ownership data to be available to the public. Instead, only state regulators and law enforcement can access this information. 

Last December, the Biden administration also released timelines for a variety of anti-money laundering initiatives. Along with increased transparency of business ownership under the Corporate Transparency Act, the Treasury Department plans to release new anti-money laundering safeguards, which include addressing “the risks associated with investment advisers” — companies or people who make investment recommendations for clients. 

Details on these rules should be made public early this year, and AIC may have already started pushing back. According to lobbying records, the company is once again spending lobbying money related to “legislation affecting the regulation of private equity, including proposed legislation related to regulation of investment advisers.” 

Hanichak says the implementation of the Corporate Transparency Act allows the U.S. to begin to catch up with other countries — but she added there are still issues that need to be addressed. “The rest of the world largely has already moved forward with these types of disclosures,” she said, “and the United States has fallen behind.”