U.S. Department of Treasury Adopts Final Rule on Beneficial Ownership Reporting Requirements Under the Corporate Transparency Act

Beginning on Jan. 1, 2024, most newly formed businesses and many existing businesses will be required to file reports with the Financial Crimes Enforcement Network (FinCEN) of the U.S. Department of Treasury under the Corporate Transparency Act (CTA) and implement regulations adopted on Sept. 30, 2022 (the Beneficial Ownership Rule or the Rule). 87 Fed. Reg. 59,498 (Sept. 30, 2022). FinCEN has indicated that filings will be required to be made electronically once the required registry and additional new regulations concerning the registry are in place. The CTA is part of the Anti-Money Laundering Act of 2020, which itself is part of the 2021 National Defense Authorization Act (NDAA).

The CTA represents the culmination of Congressional efforts to crack down on bad actors who seek to conceal their ownership of business entities through the use of shell companies in order to facilitate illicit activities, such as money laundering, financing of terrorism, human and drug trafficking, and securities fraud. It does this by strengthening the United States financial crimes monitoring systems, filling some of the gaps left by state laws, which generally do not require companies to disclose their owners or those in control. Among the significant provisions in the CTA is the creation of a non-public, secure central registry, the Beneficial Ownership Secure System (BOSS), to be maintained by the Secretary of the Treasury to track the beneficial ownership of entities formed in or registered in the United States. The beneficial ownership information stored in BOSS is confidential and will be disclosed only in limited circumstances. Accordingly, FinCEN will be engaging in additional rulemakings to establish rules for, among other things, who may access beneficial ownership information, for what purposes, and what safeguards will be required to ensure that the information is secured and protected.

The CTA and the Beneficial Ownership Rule create new reporting obligations to FinCEN for certain entities (defined as “reporting companies”) relating to their company applicants, beneficial owners, control persons, and entity structures (each as defined in the CTA and related regulations) and for certain associated individuals. Civil and criminal fines and penalties will be prescribed for failure to comply or for willfully providing false information to FinCEN. Lawyers representing reporting entities will need to be mindful of the requirements of the CTA and related regulations and may face penalties for failure to comply with the reporting requirements.

Background

FinCEN issued an advance notice of proposed rulemaking (ANPRM) on April 5, 2021 to solicit the public’s comment on five open-ended categories of questions pertinent to beneficial ownership reporting requirements, including the clarification of key definitions, the development of reporting procedures, and the establishment of compliance standards for reporting companies. 87 Fed. Reg. 17,557 (April 5, 2021). Two hundred and twenty public comments on the ANPRM were received by the May 5, 2021 deadline and then reviewed and taken into consideration by FinCEN in the drafting of the proposed beneficial ownership reporting requirements set forth in the notice of proposed rulemaking (NPRM) issued on Dec. 8, 2021. 86 Fed. Reg. 69,920 (Dec. 8, 2021). Over 240 public comments on the NPRM were received by the Feb. 7, 2022 deadline, all of which were reviewed and considered in the adoption of the final Rule. Comments on the ANPRM and NPRM were received from a wide array of interested parties, including individuals and organizations comprising, inter alia, members of law enforcement agencies, members of Congress, government officials, groups representing small business interests, corporate transparency advocacy groups, the financial industry, and trade associations.

The Final Rule

FinCEN utilized the public comments on the ANPRM and the NPRM in shaping the Beneficial Ownership Rule to help ensure any burden on reporting companies, including small businesses, is minimal in nature without compromising the Rule’s intended goal of protecting the integrity of the U.S. financial system. The following is a high-level overview of the Beneficial Ownership Rule as adopted on Sept. 30, 2022. It is important to note that FinCEN acknowledges these final regulations do not address every specific circumstance in which beneficial ownership information may be required to be reported and further guidance will be forthcoming.

Reporting Companies

Reporting companies are defined as any corporation, limited liability company, or other “similar entity” that is created by the filing of a document with a Secretary of State or similar office in any state or territory or with a federally recognized Indian Tribe, or formed under the laws of a foreign country and is registered to do business in the United States by a similar filing. A similar entity likely includes a limited partnership or business trust, but might not include a general partnership, sole proprietorship, or joint venture not formed by such a filing. FinCEN has identified varying registration and filing practices among states, coupled with varying state business formation laws, as problematic in crafting an all-encompassing categorical rule and has acknowledged that further guidance will be necessary in specific factual circumstances.

In view of the CTA’s focus being primarily on identifying beneficial ownership and control of start-ups, shell companies, and other entities with limited or no operations, the CTA’s reach does not extend to exempted entities such as publicly traded companies, those in a regulated industry (where beneficial ownership reporting already occurs), wholly owned subsidiaries of exempted entities, investment vehicles operated by investment advisers, tax-exempt organizations, and domestic government entities. Significantly, there is also a “large operating company” exception for an entity that meets all of the following requirements: (i) has more than 20 full-time employees in the United States; (ii) has filed in the previous year a federal income tax return reporting more than $5,000,000 of gross receipts or sales; and (iii) has an operating presence at a physical location in the United States. This large operating company exception would not be available for a newly formed entity, because it would not have filed a tax return in the previous year. The CTA defines the full list of 23 specific types of entities that are exempt from the definition of “reporting company” at 31 U.S.C. 5336(a)(11)(B). Additionally, inactive entities (defined as entities in existence on or prior Jan. 1, 2020 that are not engaged in active business, are not owned by a foreign person, have not undergone a change in ownership in the preceding 12-month period, have not sent or received any funds in excess of $1,000, and do not otherwise hold any assets) are exempt from the Beneficial Ownership Rule.

Timing of Reports

The Beneficial Ownership Rule sets forth initial report deadlines for both reporting companies in existence or registered prior to the effective date of the Rule and reporting companies created or registered on or after the effective date. It also establishes deadlines for the reporting of updated or corrected information since a reporting company’s prior report.

The Rule requires domestic and foreign reporting companies existing as of the Jan. 1, 2024 effective date to submit an initial report within one year of the effective date. For domestic reporting companies created after the effective date and foreign reporting companies registered after the effective date, the Rule requires an initial report to be filed within 30 calendar days after the earlier of the following to occur: (i) the receipt by the reporting company of actual notice that its creation (or registration) has become effective; or (ii) a Secretary of State or similar office first provides public notice of creation (or registration), such as through a publicly accessible and searchable database.

Reporting companies are required to file updated or corrected reports within 30 calendar days after the date on which there is any change to previously reported information, including any change regarding the beneficial owners of the reporting company, the information reported for any beneficial owner, and a reporting company’s eligibility for an exemption from reporting; excluded are any changes related to company applicant(s) and related information, as further discussed below.

If a reporting company previously exempt from filing a report no longer meets the requirements of the exemption, that reporting company has 30 calendar days from the day the exemption ceased to apply to file an initial report. In the same vein, a reporting company must file an updated report in the same 30-calendar-day period if it previously filed beneficial ownership reports and subsequently fell under an exemption.

Information Required To Be Reported

A reporting company is required to report to FinCEN specified information about itself and each of its beneficial owners and company applicants. However, the Beneficial Ownership Rule does not require reporting companies, existing or registered on the Jan. 1, 2024 effective date of the Rule, to identify and report on their company applicants. Further, reporting companies formed or registered after the effective date of the Rule also will not need to update company applicant information after initially registering with FinCEN and disclosing the required information for the company applicant(s); however, reporting companies have an ongoing obligation to correct any inaccurate information previously reported to FinCEN regarding their company applicant(s).

The initial report and any subsequent updated or corrected report must be filed electronically using an online interface currently under development. Reporting companies must certify that the information contained in any report or application (such as an application for a FinCEN identifier, as discussed further below) is true, correct, and complete. FinCEN has acknowledged that while an individual may submit a report on behalf of a reporting company, it is the reporting company that is ultimately responsible for verifying the information contained in the filing.

The information for the reporting company must include:

• Full legal name as well as any trade name or “doing business as” name that it uses (regardless of whether such trade name or “doing business as” name is registered).
• Street address. Reporting companies with a principal place of business in the United States should provide the street address of that principal place of business, while reporting companies with a principal place of business outside of the United States should provide the street address of the primary location in the United States where the reporting company conducts business. The reporting of post office boxes or the address of a company formation agent or other third party is not acceptable.
• State or Tribal jurisdiction of formation, whether domestic or foreign, and, for a foreign reporting company, the state or Tribal jurisdiction where such company first registers.
• IRS Taxpayer Identification Number (TIN) or, in the case of a foreign reporting company without a TIN, a foreign tax identification number.

For beneficial owners and company applicants, the information to be reported must include:

• Full legal name.
• Date of birth.
• Complete current address. In the case of a company applicant who creates or registers companies in the course of such company applicant’s business, the street address (whether domestic or foreign) of such business must be provided. For all other company applicants and all beneficial owners, each individual’s residential street address (whether domestic or foreign) must be provided.
• A unique identifying number from one of the following acceptable sources as well as an image of such source: a non-expired U.S. passport, a non-expired state-issued driver’s license, a non-expired state, local, or Tribal identification document, or a non-expired foreign passport only if an individual does not possess one of the other three forms of documentation. The jurisdiction issuing such identification document must be specified.

An identifying number (a FinCEN ID) will be obtainable from FinCEN for any individual who provides FinCEN with the same information required from a beneficial owner or company applicant. The FinCEN ID can be included in filings with FinCEN and provided to banks and financial institutions to satisfy their “know your customer” obligations under the Bank Secrecy Act (BSA), in lieu of providing full beneficial ownership information for each filing. Individuals that choose to request a FinCEN ID will have an ongoing obligation to update the information provided in the FinCEN ID application, subject to the same timeline and terms as the required updates or corrections to a beneficial ownership information filing by a reporting company cited above. The final Rule does not adopt the use of FinCEN IDs for entities. FinCEN continues to consider issues surrounding this usage and intends to address them prior to the effective date.

Beneficial Owners

A “beneficial owner” is broadly defined to include an individual who directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise, (i) exercises “substantial control” over the reporting company; or (ii) owns or controls not less than 25% of the ownership interests of the reporting company.

The Rule takes an expansive view of who exercises substantial control over a reporting company, including, for example, board members, managers and managing members of an LLC, and executive officers and others exercising direction, or who have substantial influence over important decisions made by a reporting company. Therefore, in addition to those individuals with authority under law or the entity’s governing instrument, persons having the power to elect and remove directors, de facto authority or control, or unorthodox ways to assert control over a reporting company (whether by contract or otherwise) can be considered as having substantial control.‎ This means an individual may be found to exercise substantial control over a reporting company and thus be a beneficial owner for whom information must be provided, through a ‎variety of means, including approval rights or negative covenants associated with a financing arrangement or interest in a company; control over one or more parent or 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 other contract, arrangement, understanding or relationship.‎ A creditor, however, may be excluded from the definition of “beneficial owner” as long as it does not otherwise qualify based on having equity interests in or substantial control of the reporting company. The broad definition of “substantial control” in the Rule can be expected to create challenges in identifying who are beneficial owners and in providing and updating the required beneficial ownership information on an ongoing basis.

In determining whether ownership or control reaches the 25% threshold, the Rule provides that all ownership interests of any class or type and the percentage of ownership interests of the person are aggregated and compared to the aggregate of the undiluted ownership interests of the entity. In the event that this calculation cannot be performed with reasonable certainty, FinCEN has provided a catch-all method of determining percentage of ownership: An individual is deemed to hold 25% or more of the total ownership interests in a reporting company if the individual owns or controls 25% or more of any class or type of ownership interest. FinCEN has adopted a creditor exception intended to exclude true debt instruments and agreements; the creditor exemption is limited to debt instruments intended to secure the right to receive payment or enhance the likelihood of repayment. However, such things as a convertible instrument, a capital or profits interest in an entity, any put, call, straddle, or other right, option, or privilege to subscribe, buy, or acquire equity interests, and other privileges are considered to be ownership interests. FinCEN has not identified what other provisions would move the characterization of debt into an ownership interest. FinCEN has also adopted catch-all language to include any other instrument, contract, arrangement, understanding, relationship, or other mechanism used to establish ownership in the definition of ownership interest.

The Rule also makes clear that someone can be deemed a beneficial owner even without holding an actual ownership interest in the reporting company. For example, a beneficiary of a trust is considered to be a reporting person if the person is the sole beneficiary of the trust or otherwise exercises control. The settlor of a trust, if the settlor has the ability to revoke the trust or withdraw trust assets, is also considered to be a beneficial owner.

There are a few exceptions to the definition of beneficial owner in addition to the above-mentioned creditor exception. Minor children are not subject to reporting if the reporting company discloses the required information regarding the parent or legal guardian of the minor child; however, the reporting company must file an updated beneficial ownership report within 30 calendar days of the minor child reaching the age of majority. Likewise, individuals acting as nominees, intermediaries, custodians, or agents on behalf of another individual are not subject to reporting. Employees of a reporting company are not considered to be beneficial owners of such company as long as they are acting solely as an employee and where their control over or economic benefits from the reporting company come solely from their status as an employee and they are not senior officers exercising substantial control. Individuals with a future or contingent right of inheritance to ownership interests in a reporting company are not deemed beneficial owners; however, beneficial ownership status needs to be reevaluated once the inheritance occurs.

The Rule recognizes the determination of ownership interests will require careful analysis when an entity’s ownership structure is complex, such as when a limited liability company has multiple layers of interests with differing or shifting rights based on, for example, different distribution rights, convertible securities, and put/call rights.

Who Must File

Under the CTA, the “applicant” (a “company applicant” under the Rule) has a reporting obligation, as does the reporting company. A company applicant is defined as any individual who files an application to form or register the reporting company. The Rule narrows the definition of “company applicant” to mean (i) the individual who directly files the document that creates the entity or, in the case of a foreign reporting company, the document that first registers the entity to do business in the United States; and (ii) the individual who is primarily responsible for directing or controlling the filing of the relevant document by another. This will likely mean the individual at the client level who files the document online, and for entities formed by law firms or accounting firms, the person (often a paralegal) and the supervising attorney will also be company applicants whose information must be filed with FinCEN. In providing examples in its discussion of the change from the proposed to the final regulations, FinCEN specifically clarified that attorneys and paralegals who directly file the document and the attorney who oversees the filing are considered company applicants whose information must be provided to FinCEN. This would similarly apply to accountants making filings and employees of service companies used to form entities where the employee is personally involved with the filing (as opposed to a client using software, online tools, or generally applicable written guidance provided by a service company).

Availability of Information

Information filed under the CTA will not be available to the general public, but will be available to state law enforcement authorities and to “a Federal agency engaged in national security, intelligence, or law enforcement activity.” In addition, a reporting company may authorize FinCEN to provide information to a bank or other financial institution to satisfy the bank’s or institution’s “know your customer” or other diligence requirements under the BSA. FinCEN indicated additional regulations will be issued under the CTA and BSA to make filing and “know your customer” requirements consistent. Companies existing prior to January 1, 2024 will not be obligated to report beneficial ownership information to FinCEN under the CTA until Jan. 1, 2025, but filings can be made after Jan. 1, 2024 once online filing is available. However, under FinCEN’s existing Customer Due Diligence Rule under the BSA, covered U.S. financial ‎institutions are already required to collect beneficial ownership information from certain customers in connection with the ‎opening of new accounts for those customers.‎ It is unclear whether states will require any beneficial ownership information to be filed at the state level in addition to the information currently required.

Penalties

Whereas it is the reporting company that is ultimately responsible for verifying the information contained in the filing, any natural person that causes the violation or is a senior officer of the reporting company at the time of the violation are to be held liable for reporting violations. The CTA provides that willful failure to report complete beneficial ownership information to FinCEN or to update that information or willfully provide false beneficial ownership information is subject to a daily civil penalty and a criminal fine and possible imprisonment.

Transition Considerations

In view of the breadth of the information required by the Rule to be reported, in order to insure the ability to comply with the reporting requirements that begin Jan. 1, 2024, it is important that all reporting companies and their counsel begin to identify the parties about whom a filing must be made and to collect the necessary information on an ongoing basis to timely make required filings under the CTA. Such information (and the underlying documentation) must be kept up to date as beneficial ownership changes and control persons join or leave the entity so that on and after the effective date of the Rule, accurate filings can be made timely.

It is expected that reporting companies and professionals who assist reporting companies with compliance will have further guidance. In a fact sheet released with the Beneficial Ownership Rule, FinCEN stated it will develop compliance and guidance documents to assist reporting companies in complying with the Rule and will also issue a Small Entity Compliance Guide to inform small entities about their responsibilities under the Rule. Beneficial Ownership Information Reporting Rule Fact Sheet.

CTA Impact on Lawyers

Since lawyers and law firm employees who assist clients to form and register entities after the effective date of the Rule can be considered a company applicant, it is anticipated that law firms may consider adopting policies addressing the actions they take in forming and registering entities for clients that may become subject to the reporting obligations under the CTA, including procedures for complying with the company applicant reporting requirements.

This article is derived from an overview of the Corporate Transparency Act authored by several editors, including Mr. Goldman, of state-specific limited liability company forms and practice manuals published by Data Trace Publishing Company, which has consented to the repurposing of such content. Mr. Goldman specifically acknowledges the contributions of Barry Bendes and Stanley Keller of the law firm Locke Lord.

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Reprinted with permission from the January 16, 2023 issue of the New Jersey Law Journal. © 2023 ALM Media Properties, LLC. Further duplication without permission is prohibited. All rights reserved. For information, contact 877-257-3382 or reprints@alm.com or visit www.almreprints.com.