FinCEN’s Proposed Rule: The Who, What and When of Beneficial Ownership Reporting under the CTA

In December 2021, the U.S. Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN) issued a notice of proposed rulemaking (the Proposed Rule)[1] to implement the beneficial ownership reporting requirements of the Corporate Transparency Act (CTA). The CTA, which was enacted into law on January 1, 2021 as part of the Anti-Money Laundering Act of 2020,[2] is designed to enhance beneficial ownership transparency in the U.S. in order to “protect the U.S. financial system from illicit use and impede malign actors from abusing legal entities, like shell companies, to conceal proceeds of corrupt and criminal acts.”

Under the CTA, “reporting companies” are required to report certain identifying information regarding the company and its “beneficial owners” and “company applicants” (each term described below) to FinCEN. Currently, companies do not generally need to report this information to federal or state governmental authorities, except under FinCEN’s existing Customer Due Diligence Rule (CDD Rule), which requires covered U.S. financial institutions to collect beneficial ownership information (BOI) from certain legal entity customers in connection with opening new accounts for those customers.

The Proposed Rule, which implements the BOI reporting requirement under the CTA, interprets the CTA broadly and significantly expands the type of entities subject to BOI reporting requirements and the scope of individuals that constitute beneficial owners for whom information must be reported. Specifically, the Proposed Rule addresses the following matters, each of which is described in further detail in this alert.

• Entities required to file reports;
• Information required to be reported;
• Timeframe for filing reports; and
• Penalties for reporting violations.
   

The Proposed Rule contained a number of expansive and potentially subjective terms that may create confusion for some reporting companies when it comes time to comply with the BOI reporting requirements under the CTA, especially given the fact that, for many companies, this will be the first time they are required to collect and report BOI. In light of this, companies should review the CTA and the Proposed Rule to determine if they will be subject to these BOI reporting requirements. Companies that are not exempt from these requirements may wish to begin to take internal steps to facilitate the collection of BOI and ensure compliance with the reporting requirements under the CTA once they go into effect.

Entities Required to File Reports

Definition of Reporting Companies

The BOI reporting requirements under the CTA apply to “reporting companies,” which include foreign and domestic corporations, limited liability companies and other similar entities. The Proposed Rule divides “reporting companies” into two categories: (a) “domestic reporting companies,” which are entities created by the filing of a document with the secretary of state (or similar office) of a jurisdiction in the U.S. and (b) “foreign reporting companies,” which are entities formed under the laws of a foreign jurisdiction that are registered to do business in the U.S.

The Proposed Rule interprets the language “other similar entities” in the CTA to mean any entity that is created (in the case of a domestic reporting company) or registered to do business in the U.S. (in the case of a foreign reporting company) through a filing with a secretary of state (or any similar office) in a U.S. jurisdiction.

Exemptions from Reporting Companies

Exemptions

While FinCEN has the authority to expand the list of entities that are exempt from the definition of “reporting company” in the CTA, the Proposed Rule adopts nearly verbatim the 23 types of exempt entities under the CTA and does not include any additional categories of exempt entities. Importantly, the specific exemptions to the definition of “reporting companies” mainly apply to larger U.S. entities or U.S. regulated-entities. Therefore, small businesses and other entities that are not otherwise subject to federal or state regulations that impose BOI reporting obligations will likely be subject to the reporting requirements under the CTA.

One notable category of exempt entities is for “large operating companies.” Under the Proposed Rule, an entity qualifies as a “large operating company” if it (a) employs more than 20 full-time employees in the U.S.,[4] (b) has filed a federal tax return or, if applicable, consolidated federal tax return[5] recording more than $5 million in gross receipts or sales in the previous year and (c) has an operating presence at a physical office in the U.S.[6] Also, under the Proposed Rule, the direct and indirect wholly-owned subsidiaries of most exempt entities are themselves exempt.

Related Filings

The Proposed Rule does not require purportedly exempt entities to make any filing in order to claim an exemption from the definition of reporting companies. However, in the event that any entity that is deemed not to be a “reporting company” by virtue of any exemptions to that definition no longer meets the criteria for any such exemptions, the entity must file a BOI report with FinCEN within 30 days after the date it ceases to be exempt.

Information Required to be Reported

Under the Proposed Rule, a reporting company is required to submit the following information to FinCEN:

• With respect to the reporting company itself, (a) its full name, (b) any alternative names through which the company engages in business, (c) its business street address, (d) its jurisdiction of formation or registration and (e) its Taxpayer Identification Number (TIN) or, if the company has not yet been issued a TIN, a Dun & Bradstreet Data Universal Numbering System Number or a Legal Entity Identifier; and
• With respect to each beneficial owner and company applicant (each of which is described below) of the reporting company, the individual’s (a) full legal name, (b) date of birth, (c) current residential or business street address and (d) unique identifying number from an acceptable identification document[7] (as well as a scanned copy of this underlying document).
   

The Proposed Rule also includes certain special reporting rules that modify the above default reporting requirements, including:

• If a reporting company or any beneficial owner or company applicant has received a FinCEN identifier (i.e., a unique number assigned to a person by FinCEN), this number can be submitted to FinCEN in lieu of the requested information regarding the reporting company or the individual, as applicable; and
• If an individual would otherwise be a “beneficial owner” by virtue of an ownership interest held directly or indirectly by an exempt entity, the name of the exempt entity (rather than the individual) should be reported.
   

Beneficial Owner

The CTA defines “beneficial owner” as any individual who, directly or indirectly, (a) exercises substantial control over a reporting company or (b) owns or controls at least 25% of the ownership interests of a reporting company. The Proposed Rule defines “substantial control” and “ownership interests” broadly, and FinCEN has not capped the number of beneficial owners a reporting company must report. Therefore, a reporting company would be required to list and provide BOI for each and every individual that satisfies either of the two prongs of the definition of “beneficial ownership,” subject to specific exceptions.[8]

Substantial Control

Under the Proposed Rule, “substantial control” means (a) service as a senior officer of a reporting company, (b) authority over the appointment or removal of any senior officer or dominant majority of the board of directors (or similar governing body) of a reporting company, (c) direction, determination or decision of, or substantial influence over, important mattes of a reporting company or (d) any other form of substantial control over the reporting company. FinCEN describes the first category as capturing those individuals with authority by law, the second and third categories as capturing those individuals with de facto authority and the fourth category as intended to be a catch-all that captures “novel and unorthodox” ways to assert control over a reporting company.

The Proposed Rule provides that an individual can assert “substantial control” over a reporting company through a variety of means, including through the following:

• Board representation;
• Ownership or control of a majority or dominant minority of the voting shares of the reporting company;
• Rights associated with any financing arrangement or interest in a company;
• Control over one or more intermediary entities that, separately or collectively, exercise substantial control over a reporting company;
• Arrangements or financial or business relationships, whether formal or informal, with other individuals or entities acting as nominees; or
• Any other contract, arrangement, understanding, relationship or otherwise.
   

The broad definition of “substantial control” in the Proposed Rule may create considerable challenges for reporting companies that, as a result of the Proposed Rule, would be obligated to report and update the BOI with respect to every individual with “substantial control” over the company. In comparison, the current CDD Rule only requires that the BOI of a single individual with “significant responsibility” to control, manage or direct the entity must be reported.[9] These reporting requirements may be especially burdensome for those reporting companies with complex governance structures, especially in light of the fourth catch-all category of “substantial control,” which would require reporting companies to assess whether there are any idiosyncratic factors that result in other individuals having substantial control over the reporting company.

Ownership Interests

The Proposed Rule also includes an expansive definition of “ownership interests.” While the CDD Rule only considers equity interests in an entity,[10] under the Proposed Rule, “ownership interests” would include equity interests in the reporting company, as well as capital or profit interests, convertible instruments, warrants or rights or other options or privileges to acquire equity, capital or other interests in a reporting company. Under the Proposed Rule, any debt instrument would also be deemed to be an “ownership interest” to the extent it enables the holder to exercise the same rights as one of the specified equity or other interests in the definition of “ownership interests,” including the ability to convert the instrument into one of the specified equity or other interests. “Ownership Interests” means:

(a) any equity, stock, or similar instrument, certificate of interest or participation in any profit sharing agreement, preorganization certificate or subscription, transferable share, voting trust certificate or certificate of deposit for an equity security, interest in a joint venture, or certificate of interest in a business trust, without regard to whether any such instrument is transferable, is classified as stock or anything similar, or represents voting or non-voting shares;

(b) any capital or profit interest in a limited liability company or partnership, including limited and general partnership interests;

(c) any proprietorship interest;

(d) any instrument convertible, with or without consideration, into any instrument described in clauses (a) through (c), any future on any such instrument, or any warrant or right to purchase, sell, or subscribe to a share or interest described in clauses (a) through (c), regardless of whether characterized as debt; or

(e) any put, call, straddle, or other option or privilege of buying or selling any of the items described in clauses (a) through (d) without being bound to do so.

The Proposed Rule provides that an individual may directly or indirectly own or control an ownership interest of a reporting company through a variety of means, including through the following:

• Joint ownership with one or more other persons of an undivided interest in an ownership interest;
• Control of such ownership interest owned by another individual; and
• With regard to a trust or similar arrangement that holds an ownership interest:
  • Acting as a trustee of the trust or other individual (if any) with the authority to dispose of trust assets;
  • Being a beneficiary of the trust who (a) is the sole permissible recipient of income and principal from the trust; or (b) has the right to demand a distribution of or withdraw substantially all of the assets from the trust; or
  • Being a grantor or settlor who has the right to revoke the trust or otherwise withdraw the assets of the trust: (a) through ownership or control of one or more intermediary entities, or ownership or control of the ownership interests of any such entities, that separately or collectively own or control ownership interests of the reporting company; or (b) through any other contract, arrangement, understanding or relationship.
     

Under the Proposed Rule, when determining whether an individual owns or controls 25% or more of the “ownership interests” of a reporting company, the individual’s aggregated ownership interests across all categories of “ownership interests” should be compared to the “undiluted ownership interests” of the reporting company. FinCEN did not provide additional guidance on how the “undiluted ownership interests” of a reporting company should be determined. As a result, this calculation may be particularly challenging for reporting companies with complex capital structures, especially those that involve securities across multiple categories of the definition of “ownership interests.”

Company Applicants

Under the Proposed Rule, reporting companies must also identify the “company applicant,” which includes the individual who files the entity formation documents (in the case of a domestic reporting company) or the individual who files the first registration document allowing the foreign entity to do business in the U.S. (in the case of a foreign reporting company). Furthermore, in order to ensure that each reporting company provides information on the individuals that are responsible for the decision to form or register the reporting company, any individual who directs or controls the filing of any such document by another person (e.g., outside legal counsel) also constitutes a “company applicant” under the Proposed Rule.

Timeframe for Filing Reports

Under the Proposed Rule, the timeframe for filing an initial BOI report with FinCEN depends on when a reporting company is created (in the case of a domestic reporting company) or first registers to do business in the U.S. (in the case of a foreign reporting company). All reporting companies created or first registered to do business in the U.S., as applicable, before the effective date of the final rule will have one year from the effective date to file their respective initial reports with FinCEN. All reporting companies created or first registered to do business in the U.S., as applicable, on or after the effective date of the final rule will have 14 calendar days from the date they were created or first registered to do business in the U.S. to file their respective initial reports with FinCEN.

In the event of any change to any of the BOI that a reporting company previously reported to FinCEN, the reporting company will have 30 calendar days to file an updated report. However, if a reporting company files a report with BOI that was inaccurate at the time of filing, the reporting company must file a report correcting such BOI within 14 calendar days of the date it knew or should have known that the BOI was inaccurate.

Penalties for Reporting Violations

The CTA provides for significant civil and criminal penalties in the event of certain violations of the BOI reporting obligations. Any person that willfully provides or attempts to provide false or fraudulent BOI to FinCEN or willfully fails to report complete or updated BOI to FinCEN, may be liable for a civil penalty of up to $500 for each day a violation continues or has not been cured, and may be fined up to $10,000 and imprisoned for up to two years (or both) for a criminal violation.

The Proposed Rule provides that the term “person” includes any individual, reporting company or other entity. Therefore, individual beneficial owners and company applicants are also potentially liable for such violations of the BOI reporting obligations.

Next Steps

While the comment period during which FinCEN solicited feedback on the Proposed Rule ended on February 7, 2022, it is unclear when FinCEN will publish the final version of the Proposed Rule. FinCEN did not propose an effective date as part of the Proposed Rule, but did indicate that the Proposed Rule is the first of three rulemakings that it plans to release to implement the CTA. The second set of regulations is intended to establish protocols for access to and disclosure of BOI. FinCEN noted that the rulemaking process with respect to these regulations will occur in parallel to the finalization of the Proposed Rule. The third set of regulations is designed to conform the current CDD Rule with the final version of the Proposed Rule. FinCEN is required to make these conforming updates within one year of the publication of the final version of the Proposed Rule.

As noted, the Proposed Rule to implement the BOI reporting requirements under the CTA would significantly expand the universe of entities subject to these reporting requirements and the scope of information these entities are required to report beyond that provided under FinCEN’s existing CDD Rule with respect to customers of financial institutions. In advance of the effective date of the final version of the Proposed Rule, companies that are not exempt from the BOI reporting requirements, as set forth in the Proposed Rule, may wish to begin to take steps to facilitate the collection of BOI and to ensure compliance with the reporting requirements under the CTA once they go into effect.

This article contains general, condensed summaries of actual legal matters, regulations, and opinions for informational purposes. It is not meant to be and should not be construed as legal advice. Readers with particular needs on specific issues should retain the services of competent counsel. For more information, please visit our website at www.williamsmullen.com or contact Pat Tomlinson at 757.473.5305 or via email at ptomlinson@williamsmullen.com.

*Note: Patrick is licensed to practice in New York and the District of Columbia, but not in Virginia.