AMLA Is an Opportunity for Better Financial Regulation

Edoardo Saravalle 

 

On January 1, 2021, Congress passed the Anti-Money Laundering Act (“AMLA”), a sweeping reform of the U.S. anti-money laundering legal framework.[1] Now, regulators should strive for an innovative implementation strategy: they should focus on flexibility and adaptability and avoid rigid rules and formalistic tests. Only by abandoning rule-based approaches in favor of guidance-heavy, flexible approaches will U.S. anti-money laundering policy be able to keep up with this ever-changing threat.

 

The Corporate Transparency Act (“CTA”) is both a key component of AMLA and one of the sections that will require important implementing decisions from regulators. CTA targets “shell companies,” entities doing business without disclosing their “beneficial owners,” that is, the individuals who own or control the entity.[2] Before Congress passed this law, states set the amount of information that companies had to disclose to register in their jurisdiction, and in many, entities did not have to disclose their beneficial owners. Because of this opacity, law enforcement and national security officials often struggled to discover the true owners of corporate entities they were investigating, a challenge highlighted by the broad group of private and public sector officials who endorsed the reform.[3] Under AMLA, entities will report their beneficial owners to the Treasury Department’s Financial Crimes Enforcement Network (FinCEN) which, once it develops to requisite information technology infrastructure, will maintain the data in a federal registry accessible to federal, state, and local law enforcement as well as additional other stakeholders.

 

The legislation offers a two-pronged definition of who constitutes a beneficial owner. Under the act, a beneficial owner is an individual who either “(i) exercises substantial control over the entity; or (ii) owns or controls not less than 25 percent of the ownership interests of the entity.”[4] The Corporate Transparency Act does not define “substantial control” under the first prong, so FinCEN will likely provide a clearer definition through rulemaking or guidance. Choices in this process will clarify the scope of the reform. For example, the definition of “substantial control” will be important for situations where no individual controls more than 25 percent of the relevant company, and where a narrow definition on the first prong could maintain the company anonymous.

 

This definitional process is currently in its early stages. On April 5, 2021, FinCEN issued an Advance Notice of Proposed Rulemaking (“ANPRM”) soliciting comment on CTA implementation. As part of this effort, the agency is seeking comment on whether it should define “substantial control” in the first place and, if yes, whether it should clarify other potential ambiguities, such as whether more than one individual can exercise “substantial control” over the same entity.[5]Additionally, the agency has inquired about whether it should align its “control” definition with other U.S. regulations focused on beneficial ownership.[6]

 

In defining the “control” prong, regulators will choose between two broad schools of thought. On the one hand, FinCEN could adopt a rule-bound, formalistic approach to defining “substantial control.” For example, it could list out types of relationships that constitute control or specific practices that automatically fulfill the prong. It could even offer a numerical threshold for determining “substantial control.” There is some precedent for this approach. In 2016, FinCEN finalized its Customer Due Diligence Requirements for Financial Institutions (“the CDD rule”) which set out financial institutions’ obligations to collect beneficial ownership information about their customers. The CDD rule also contains a “control” prong, and regulators chose to follow a rule-like approach that limits the discretion of both the agency and regulated financial institutions. To exercise control under this prong, one must be a “single individual with significant responsibility to control, manage, or direct a legal entity customer.”[7] The rule then narrows who might qualify for this prong by offering examples including “[a]n executive officer or senior manager (e.g., a Chief Executive Officer, Chief Financial Officer, Chief Operating Officer, Managing Member, General Partner, President, Vice President, or Treasurer)” while leaving some flexibility by broadening it to “[a]ny other individual who regularly performs similar functions.”[8]This specific approach would not apply to the CTA given that the new legislation excludes employees from its beneficial ownership definition. However, the CDD Rule makes clear how regulators might choose a constraining path to the “control” prong.

 

On the other hand, regulators could embrace a more flexible understanding of “substantial control.” Rather than focusing on mechanical tests, this approach would recognize that control can come in different forms and that the final regulation should be open-ended enough to cover all sorts of relationships and practices. Senate Banking Committee Chairman Sherrod Brown makes this case. Describing the new legislation, he argues that “FinCEN is not intended to devise a numerical, narrow, or rigid test [for control].”[9] Instead, it ought to “take into account the myriad ways that an individual may exercise control over an entity while holding minimal or even no formal ownership interest.”[10] In contrast to FinCEN’s list-like approach to determining control under the CDD rule, Senator Brown’s proposal takes a more versatile tack. In his statement, the Senator highlights the different ways in which a beneficial owner can potentially exercise control, including “written and unwritten agreements, arrangements, or understandings, instructions to company directors or officers, letter of wishes, control over personnel decisions, economic pressure on company shareholders or employees, coercion, bribery, threats of bodily harm.”[11] As his comprehensive list suggests, it would be difficult to distill such a broad array of factors to a mechanically applied rule. Only a flexible approach could keep up with unceasing attempts by money launderers to mask their true ownership.

 

Regulators are deciding how to implement the “control” prong at a time when scholars are questioning traditional rule-bound approaches to financial regulation and putting forward models for a more responsive and adaptable regulatory apparatus. For example, Daniel Awrey and Kathryn Judge have highlighted finance’s dynamism as a particular impediment to regulation based on fixed, inflexible rules.[12] Financial entities and practices are constantly evolving with and adapting to changing regulations, so attempts to turn regulation into a “single-shot game” where “a malignancy is identified, alternative treatments are weighed and measured, and the most desirable treatment is enacted into law, fleshed out in regulation, supervised, and enforced” are doomed to fall short.[13] These concerns are especially pronounced when regulators rely on rulemaking rather than guidance for implementation. The rule-making process can be complex and time-consuming, so it can incentivize regulators to make rules once and deter them from updating rules as circumstances change.[14]

 

These worries about inflexible one-shot regulation are especially relevant in a field like anti-money laundering. The bad actors who take advantage of lax beneficial ownership disclosures are adaptable to changing regulatory environments.[15]Flexible regulations would prevent money launderers from simply updating their practices in step with the new rules. Already, in other anti-money laundering regulation contexts, FinCEN has recognized the benefits of avoiding rigid rules in favor of discretion and judgment by both the agency and the regulated entities closest to the illicit activity. In a recent ANPRM, the agency aimed to “provide financial institutions with greater flexibility in the allocation of resources, resulting in the enhanced effectiveness and efficiency of anti-money laundering programs” in the face of “evolving threats of illicit finance.”[16] Choosing the more flexible approach to “substantial control” would fit into FinCEN’s broader commitment to making U.S. AML policy responsive and flexible in the face of new threats.

 

But even beyond the ability of bad actors to adapt to and thwart new anti-money laundering regulations, it may simply be the case that both regulators and regulated entities will not know enough about the specific forms of relationships and activities that they are trying to target. As Senator Brown makes clear, there are innumerable ways for beneficial owners to exercise control over an entity today—and the list is certain to grow tomorrow. This is to be expected. As Jeremy Kessler and Charles Sabel have emphasized, “uncertainty” is an increasingly important factor in regulation: both regulated entities and regulators make decisions either with imperfect or limited information.[17] In the case of money laundering disclosures, financial institutions and regulators have past models for how a beneficial owner might exert control over an entity, but such insights are destined to be lagging and context-specific. Neither group will have a clear, sector-wide understanding of the threat. In light of uncertainty, Kessler and Sabel conclude, agencies will seek “the cooperation of all the actors in a position to learn a way through uncertainty. Under uncertainty such cooperation is likely to be forthcoming as regulators, regulated entities, and the beneficiaries of regulation, jointly ignorant of the risks they may face, share a vulnerability that can motivate joint action.”[18]

 

A rigid rule would not allow the collaborative learning and joint action required under uncertainty. More flexible tools—whether guidance or open-ended rules—might offer an answer. Regulators could embrace the “experimentalist” approach called for by Charles Sabel and William Simon. Rejecting rigid rules, these scholars call for “local adaptation and aggregate learning by combining discretion with duties to report and explain, and by pooling information.”[19] Through this reporting, both the regulators and the regulated entities can learn about the problems they are confronting from multiple perspectives and devise continuously improving responses. Putting this approach in practice for beneficial ownership would entail a broad, open-ended definition of “substantial control.” For example, FinCEN could embrace an approach of iterative guidance documents. It could release a guidance document with Senator Brown’s proposed inclusions while recognizing its non-exhaustive nature. FinCEN could then gradually collect evidence from regulated entities as they act on that list. Finally, pooling this new information and feedback from the regulated entities, the agency will clarify the types of relationships and practices that constitute control—all while leaving open the possibility of further revision.

 

In implementing the CTA, regulators have a dual opportunity. In the short term, they can further U.S. national security by closing a loophole that has previously allowed money launderers, terrorists, and nuclear proliferators to thrive. Over the medium and long terms, they can demonstrate how to build a collaborative, responsive, and adaptive regulatory framework. They should take both opportunities.

 

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[1] Anti-Money Laundering Act of 2020 (“AMLA”), Public Law No.: 116-283, §§ 6001-6511

[2] See, e.g., 17 C.F.R. § 240.13d-3 (2012) (“a beneficial owner of a security includes any person who, directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise has or shares: (1) Voting power which includes the power to vote, or to direct the voting of, such security; and/or, (2) Investment power which includes the power to dispose, or to direct the disposition of, such security.”); Fin. Action Task Force, International Standards on Combating Money Laundering and the Financing of Terrorism & Proliferation: The FATF Recommendations 117 (2020), http://www.fatf-gafi.org/media/%20fatf/documents/recommendations/pdfs/FATFRecommendations.pdf (“Beneficial owner refers to the natural person(s) who ultimately owns or controls a customer and/or the natural person on whose behalf a transaction is being conducted.” (citations omitted)).

[3] FACT Coalition, More Than 100 National Security and Foreign Policy Experts Call on Senators to Tackle Anonymous Shell Companies (Nov. 13, 2019), https://thefactcoalition.org/more-than-100-national-security-and-foreign-policy-experts-call-on-senators-to-tackle-anonymous-shell-companies/.

[4] AMLA §6403(a).

[5] Beneficial Ownership Information Reporting Requirements, 86 Fed. Reg. 17557, 17561–62 (proposed Apr. 5, 2021).

[6] Id.

[7] 31 C.F.R. § 1010.230(d) (2016).

[8] Id.

[9] 166 Cong. Rec. S7310–11 (Dec. 9, 2020) (statement by Sen. Sherrod Brown).

[10] Id.

[11] Id.

[12] Daniel Awrey & Kathryn Judge, Why Financial Regulation Keeps Falling Short, Cornell Law School Legal Studies Research Paper No. 20-03; European Corporate Governance Institute (ECGI) Law Working Paper No. 494/202; Columbia Law & Economics Working Paper No. 617 (2020).

[13] Id. at 45.

[14] Id. at 19 (citing Nicholas Bagley, The Procedure Fetish, 118 Mich. L. Rev. 345 (2019)).

[15] See, e.g., Izabella Kaminska, Why Transaction Laundering Is Turning into a Huge Financial Blindspot, Fin. Times (Mar. 17, 2020), https://www.ft.com/content/95eece33-b789-3255-bf13-6fc19d5c85aa (arguing that new e-commerce fraud “suggests anti-money laundering (AML) and know-your-customer (KYC) regulations . . . may have been entirely ineffective [and] that criminals have an endless capacity to adapt”).

[16] Anti-Money Laundering Program Effectiveness, 85 Fed. Reg. 58023 (proposed Sep. 17, 2020).

[17] Jeremy K. Kessler & Charles F. Sabel, The Uncertain Future of Administrative Law, in The Modern Administrative State: Reconstruction Or Deconstruction? 1, 2, (Mark V. Tushnet, ed.. forthcoming 2021).

[18] Id. at 5.

[19] Charles F. Sabel & William H. Simon, Minimalism and Experimentalism in the Administrative State, 100 Geo. L. J. 53, 78 (2011).