On December 7, 2021, the Financial Crimes Enforcement Network (“FinCEN”) issued a Notice of Proposed Rulemaking (“NPRM”) to establish regulations that will implement the Corporate Transparency Act (“CTA”). This rulemaking is noteworthy because the CTA imposes new requirements to report beneficial ownership for numerous business entities that never before were subject to any beneficial ownership reporting requirements. The CTA itself exempts many companies from its reporting requirements, including large employers, tax-exempt entities, and already regulated companies, such as securities issuers, banks, insurance companies as well as subsidiaries of most exempt entities. The CTA also provides FinCEN with broad authority to tailor those exemptions and create new ones. Thus, this rulemaking provides an important preview of just which companies will be subject to the CTA. The proposed rules also clarify the timing and required information for reporting. The comment period for the Notice of Proposed Rulemaking is open until February 7, 2022.
Congress enacted the CTA as part of the Anti-Money Laundering Act (“AMLA”)1 of 2020. The AMLA “seeks to strengthen, modernize, and streamline the existing AML regime by promoting innovation, regulatory reform, and industry engagement.”2 As we described in a prior article, the CTA is designed to increase transparency by requiring “reporting companies” to file basic business, “beneficial ownership,” and “company applicant” information with FinCEN. Failure to comply with the CTA’s reporting requirements can lead to civil and criminal penalties, including a maximum civil penalty of $500 each day the violation continues (up to $10,000), and imprisonment for up to two years.
The CTA applies to “reporting companies,” which is broadly defined to include nearly all types of domestic and foreign business entities. However, the CTA provides numerous exemptions from the definition. “Reporting companies” include domestic corporations, limited liability companies, and any other entity created by filing a document with a state or tribal authority. Likewise, “reporting companies” include foreign corporations, limited liability companies, and other entities if they are registered to do business in any state or tribal jurisdiction.
The CTA exempts 23 types of entities from the definition of “reporting company.” In the proposed rules, FinCEN adopts those statutory exemptions with relatively few clarifications. FinCEN chose not to propose any new exemptions, despite its authority under CTA to do so. In general, these entities are exempt because they are already subject to federal or state regulation, so their beneficial owners are typically known to regulators.
Key statutory exemptions include those for large operating companies, securities issuers, banks, insurance companies and producers, brokers or dealers in securities, registered investment companies and advisers, venture capital fund advisers, accounting firms, tax exempt entities (or those assisting tax exempt entities), and special pooled investment funds.
The proposed rules provided much-needed clarification on the “large operating company” exemption, defining it to mean a company that:
(1) “Employs more than 20 employees on a full-time basis in the United States;”
(2) filed Federal income tax returns in the prior year “demonstrating more than $5,000,000 in gross receipts or sales in the aggregate,” including receipts or sales from entities owned by the entity and through which the entity operates; and
(3) “has an operating presence at a physical office within the United States.”3
Although the CTA itself provides an exception for subsidiaries of exempted entities, the proposed rules interpret the exemption narrowly. The statute exempts entities in which “the ownership interests are owned or controlled” by an exempt entity.4 The proposed rules limit this exemption to subsidiaries that are owned entirely by one or more exempt entities. FinCEN noted the reason was to stop partially-owned entities from being exempt and being able to otherwise hide their beneficial owners.5
Under the proposed rules, if a registered company already exists when the regulations become effective, the company will have one year to register. This is a shorter period than the CTA permitted, which provided that FinCEN could allow up to two years to register. If a company is created after the regulations become effective, the company will have 14 days to register with FinCEN. The proposed rules also impose requirements for correcting and updating information with FinCEN.
Reporting companies must disclose basic information, including: (1) the company’s full name; (2) any trade name or D/B/As; (3) business street address; (4) jurisdiction of formation; and (5) IRS taxpayer ID. Reporting companies must report each beneficial owner and company applicant’s: (1) name; (2) birthdate; (3) address; and (4) a unique identifying number from an acceptable identification document, such as a passport or a FinCEN unique ID (and the image of the document).
A “beneficial owner” is defined by the CTA as “any individual who, directly or indirectly” either: (1) “exercises substantial control” over the reporting company; or (2) “owns or controls” at least 25% of the ownership interests of the reporting company. The CTA does not define the terms “substantial control” or “ownership interests” but the regulation proposed by FinCEN clarifies these concepts.
FinCEN has proposed three indicators for “substantial control,”6 all of which aim to identify “the individuals who stand behind the reporting company and direct its actions.”7 The first indicator is service as a senior officer. The second indicator is authority over appointment or removal of any senior officers or a dominant majority of the board of directors or similar body of a reporting company. The third indicator looks to practical influence over important matters of the reporting company, such as the sale, lease, or transfer of major company assets. The proposed regulations also include a catch-all provision, stating that substantial control can take a form not specifically listed in the regulation. Reporting companies should be on guard that this test leaves FinCEN with substantial discretion to decide who qualifies as having “substantial control.”
An individual who owns or controls at least 25 percent of the ownership interests of a reporting company is also a beneficial owner under the CTA. The proposed regulation defines ownership interests as including both equity in the reporting company and interests such as capital or profit interests, convertible instruments, warrants or rights, or other options or privileges to acquire equity, capital, or other ownership interests.
A company applicant is the individual who filed the application to form a corporation, limited liability company, or other similar entity under the laws of a State or Indian Tribe. For foreign entities, a company applicant would be the individual who files the application or document that first registers the entity to do business in the United States. In either case, domestic or foreign, any individual who directs or controls the filing of the relevant document by another is also considered a company applicant. If it is the company applicant’s job to file corporate formation documents, it must provide a business address instead of a residential one.
The proposed rules provide a preview of what FinCEN’s final rules will likely require. Companies therefore should assess now whether they and related entities qualify as reporting companies, and if so, gather the relevant information proactively in a logical and efficient manner. Additionally, these new rules may require subject companies to develop additional internal processes and controls to ensure they remain compliant.
The rules could result in delays in forming new companies. With newly-formed companies having only 14 days to prepare these reports or risk incurring the significant fines and penalties, it could become prudent for companies to ensure they have all the information necessary to file an accurate report. The time, and related costs, necessary to file compliant reports may increase the formation costs of new companies.
Further, be aware that this beneficial ownership rulemaking is only one of three rulemakings that will implement the CTA. The other two still to come will: (1) implement the statute’s protocols for access to and disclosure of the beneficial ownership information; and (2) revise the existing customer due diligence rule.
1 The AMLA was part of the National Defense Authorization Act (“NDAA”) enacted on January 1, 2021.
2 See FinCEN Fact Sheet, The Anti-Money Laundering Act of 2020 (available at https://www.fincen.gov/anti-money-laundering-act-2020).
3 31 Fed. Reg. 69939 (discussing proposed 31 CFR 1010.380(c)(2)(xxi)).
4See 31 U.S.C. § 5336(a)(11)(B)(xxii).
5 31 Fed. Reg. 69940 (discussing proposed 31 CFR 1010.380(c)(2)(xxii)).
6 See 31 C.F.R. § 1010.380(d)(1).
7 Beneficial Ownership Information Reporting Requirements, 86 Fed. Reg. 69920 (proposed Dec. 8, 2021) (to be codified at 31 C.F.R. § 1010.380).