FinCEN Proposes Rules Implementing Corporate Ownership Requirements Under Corporate Transparency Act to Fill Gaps in U.S. Anti-Money Laundering Laws

On December 7, 2021, FinCEN issued a notice of proposed rulemaking regarding a proposal to implement part of the CTA, which was enacted earlier this year. The proposed rule would require each “domestic reporting company” and each “foreign reporting company” (each, a “reporting company”), such as a corporation, limited liability company, or other entity created by or registered to do business by filing a document with a secretary of state or similar official of a state or tribe, to file reports with FinCEN that identify each “beneficial owner” of such reporting company and each “applicant” who has filed an application to form or register the entity to do business.

The proposed rule generally targets smaller, lightly regulated entities, while providing exemptions for public companies, large operating companies, and certain types of regulated entities whose ownership and control is generally known to governmental authorities.

When are the reports due, and what information is required to be in them?

Reporting companies formed or registered on or after the effective date of the proposed rule will be required to submit an initial report to FinCEN within 14 days of their formation or registration.

Reporting companies formed or registered before the effective date of the proposed rule will be required to file a report with FinCEN within one year after the effective date.

Corrections to reports must be filed within 14 days of the date an inaccuracy became known or should have been known. If a corrected report is filed within 90 days of the inaccurate report’s filing, the remediation will satisfy the CTA’s safe harbor from civil and criminal penalties for inaccurate reports (unless the inaccuracy was filed with actual knowledge and for the purposes of evasion).

Reporting companies will also be required to file updated reports within 30 days of a change of beneficial ownership or other information previously reported to FinCEN, such as information about a given beneficial owner. Likewise, an entity that becomes a reporting company because it no longer meets the criteria for an exemption must file a report within 30 days of the change. Reporting companies and exempt entities should consider how they will implement compliance infrastructure and controls to monitor changes and submit updated reports.

The following information must be provided in the report:

For the reporting company:

• Full name;
• Any trade name or “doing business as” name;
• Business street address;^[1]
• Jurisdiction of formation; and
• Taxpayer identification number (TIN) or, if a TIN has not been issued, either a Dun & Bradstreet Data Universal Numbering System (DUNS) Number or (2) a Legal Entity Identifier (LEI).

For each beneficial owner and applicant:

• Full name;
• Date of birth;
• Residential address the individual uses for tax residency purposes (or business address, if the individual is an applicant filing formation or registration documents in the course of such individual’s business, such as a corporate or formation agent);
• A unique identifying number from a non-expired U.S. passport, driver’s license, or other identification document issued by a state, local, or tribal government, or if none of those is available then a passport issued by a foreign government; and
• A legible or recognizable image of the document from which the unique identifying number was obtained, which image must include both the unique identifying number and a photograph of the individual.

FinCEN Identifier

As an alternative to providing information to a reporting company, an individual may obtain a unique identification number called a “FinCEN identifier” by providing FinCEN the same identifying information the individual otherwise would have provided. Similarly, a reporting company may obtain a FinCEN identifier after filing its first report with FinCEN. Once an individual has obtained a FinCEN identifier, the FinCEN identifier can be shared with a reporting company, and the reporting company can report the FinCEN identifier instead of the personal information specified above. Similarly, if an individual is or may be a beneficial owner of a reporting company through an interest held in an entity that has obtained a FinCEN identifier, the reporting company may include such entity’s FinCEN identifier in its report in lieu of obtaining personal information.

What is a “domestic reporting company” and what is a “foreign reporting company”?

The proposed rule defines a “domestic reporting company” as a corporation, limited liability company, or other entity that is created by the filing of a document with a secretary of state or a similar official of a state or tribe. A “foreign reporting company” is defined as a corporation, limited liability company, or other entity formed under the law of a foreign country and registered to do business in the United States by the filing of a document with a secretary of state or a similar official of a state or tribe.

Limited partnerships and statutory trusts will generally fall within the definition of domestic reporting company because they are created by filing a certificate of limited partnership or a certificate of trust with a secretary of state or a similar official of a state or tribe.

General partnerships and non-statutory trusts will generally fall outside the definition of domestic reporting company because there is no formation filing with a secretary of state or a similar official of a state or tribe.

Are there any exemptions from the definition of “reporting company”?

The proposed rule exempts certain regulated entities or entities that are already subject to disclosure requirements concerning their beneficial ownership and certain large entities from the definition of reporting entity (an “exempt entity”). The list of exempt entities includes:

• An issuer with a class of securities registered under Section 12 or subject to Section 15(d) of the Securities Exchange Act of 1934, as amended (e.g., public reporting companies);
• An entity established under the laws of the U.S., tribe, state, or political subdivision that exercises governmental authority on behalf of the U.S. or any such tribe, state, or political subdivision;
• Banks, savings associations, trust companies, credit unions, bank holding companies, and savings and loan holding companies;
• A “money transmitting business” registered with FinCEN (e.g., a registered money services business, such as a money transmitter, check casher, issuer or seller of traveler’s checks, provider of pre-paid access, or dealer in foreign exchange);
• Securities brokers or dealers registered with the Securities and Exchange Commission (SEC);
• Exchanges or clearing agencies registered with the SEC;
• Investment companies and investment advisers registered with the SEC;
• Other entities registered with the SEC under the Securities Exchange Act of 1934;
• Venture capital fund advisers that have reported their beneficial ownership information to the SEC on form ADV;
• Insurance companies;
• State-licensed insurance producers;
• Futures commission merchants, introducing brokers, swap dealers, major swap participants, commodity pool operators, commodity trading advisers, retail foreign exchange dealers, and registered entities under Section 1a of the Commodity Exchange Act registered with the Commodity Futures Trading Commission;
• Public accounting firms;
• Certain public utilities;
• Financial market utilities;
• Pooled investment vehicles operated by certain exempt entities (see discussion below);
• Certain non-profit and other tax exempt organizations, and certain entities that operate exclusively to provide financial assistance to, or hold governance rights over them;
• Businesses that employ more than 20 employees on a full-time basis, which typically means employees working either a minimum of 30 hours a week or 130 hours a month, in the U.S., reported more than $5 million of gross receipts or sales in the previous year on a Federal income tax return, and have physical presence (i.e., an office) in the U.S. (i.e., a large operating company);
• Wholly-owned subsidiaries of exempt entities;
• Certain inactive entities that were in existence on or before January 1, 2020, do not engage in an active business or hold assets, are not owned directly or indirectly by a foreign person, have not experienced a change in ownership in the preceding 12 months, and have not sent or received funds in an amount greater than $1,000 in the preceding 12 months; and
• Any additional entities exempted by the secretary of the treasury, attorney general, and secretary of homeland security through regulation. 

The proposed rule does not require exempt entities to make any filing to claim an exemption, but FinCEN has invited public comment on whether it should permit exempt entities to voluntarily file an exemption certification.

Who is a “beneficial owner”?

The proposed rule defines a “beneficial owner” as an individual who, directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise (i) exercises substantial control over a reporting company, or (ii) owns or controls 25% or more of the ownership interests of the reporting company. All beneficial owners must be reported, and FinCEN expects that each reporting company will have at least one beneficial owner. It is important to note that, under the substantial control prong, an ownership interest is not required to qualify a person as a “beneficial owner.”

Substantial Control

Instead of providing a concrete definition of “substantial control,” the proposed rule takes an expansive approach by listing three non-exclusive indicators that may constitute “substantial control.” Those indicators include: (i) service as a senior officer of a reporting company (i.e., president, secretary, treasurer, chief financial officer, general counsel, chief executive officer, chief operating officer, or any other officer regardless of official title, who performs a similar function); (ii) authority over the appointment or removal of any senior officer or a majority or dominant minority of the board of directors (or similar body) of a reporting company; and (iii) direction, determination, or decision of, or substantial influence over, important matters of a reporting company.^[2]  Ordinary execution of day-to-day managerial decisions with respect to one part of a reporting company’s assets or employees alone would not cause the decision-maker to have substantial control. Each reporting company will need to consider who directs, determines, and decides important matters affecting the company.

It is also important to note that control can be exercised both directly or indirectly. An individual may directly or indirectly exercise substantial control over a reporting company through a variety of means, including through 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 through any other contract, arrangement, understanding, relationship, or otherwise.

Ownership Interests

The proposed rule also takes an expansive and fact-specific approach to what qualifies as “ownership interest.” To determine if an individual owns or controls 25% or more of the ownership interests of the reporting company, the reporting company should aggregate any interests an individual has in the company compared to the undiluted ownership interests of the company. “Ownership interests” include both equity (including stock, certificates of interest or participation in 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 trusts), capital or profit interests, proprietorship interests, convertible instruments; warrants or rights, and options or privileges to acquire or sell a share or interest in a reporting company as well as any put, call, straddle, or other option or privilege of buying any of ownership interest in a reporting company. 

For new forms of distributed ownership enabled by blockchain networks, such as a Decentralized Autonomous Organization (DAO), governance token holders may be deemed beneficial owners.  If a DAO is seeking to register as a reporting company in any jurisdiction in order to seek the benefits of limited liability, these rules would apply but may prove impossible to comply with both in an initial filing and in ongoing filings as governance tokens rapidly change hands and many holders are likely to be anonymous or unknown to the reporting company. Tokens that are digital representations of an interest in the issuing company would also be ownership interests, but other types of tokens are less likely to be depending on their function and attributes.

Direct or indirect ownership may take the form of joint ownership or control of interests owned by another individual. With respect to interests held in a trust, a trustee or other person with authority to dispose of trust assets is considered to have ownership or control. A beneficiary is considered to own or control ownership interests held by the trust if the beneficiary is the sole permissible recipient of trust income and principal or has the right to demand distribution or withdrawal or substantially all trust assets. A grantor or settler having the right to revoke the trust or withdraw trust assets is also considered to own or control ownership interests held in the trust.

A person may also have ownership or control of ownership interests through ownership or control of one or more intermediary entities or through contracts, arrangements, understandings, or relationships. The proposed rule does not clearly explain (i) when ownership or control of an intermediate entity would result in indirect ownership or control of ownership interests in a reporting company; (ii) how such ownership or control should be measured when held through intermediary entities or when a person owns a specific class or series of securities; or (iii) what types of relationships or arrangements will result in ownership or control.

FinCEN stated that it “believes that entities are already aware of their own ownership structures, regardless of complexity, and should be able to readily identify their beneficial owners.”  However, it does not address how existing reporting companies should (i) identify persons who may be beneficial owners through indirect ownership or control, including through trusts, intermediary entities or other arrangements unknown to the reporting company, and (ii) obtain identifying information concerning such persons or recognize changes in beneficial ownership or changes in information concerning a beneficial owner (such as a change of address).

Certain individuals are excluded from the definition of beneficial owner:

• A minor child (as determined under state law), if the information of the parent or guardian of the minor child is reported;
• An individual acting as a nominee, intermediary, custodian, or agent on behalf of another individual;
• An individual acting solely as an employee of an entity, who is not also a senior officer;
• An individual whose only interest in an entity is through a future right of inheritance (as opposed to a present interest that person already acquired through inheritance); and
• Certain creditors (excluding those for debts that arise from the capital interest, value, or profits in a company; those having an equity kicker; and those having the ability to convert debt into an ownership interest).

Who is an “applicant”?

In the case of a domestic reporting company, an “applicant” is the individual that files the document that forms a corporation, limited liability company, or other entity by filing a document with a secretary of state or similar official.

In the case of a foreign reporting company, an “applicant” is the individual that first registers the entity to do business in the U.S. by filing a document with a secretary of state or similar official.

In each case, an individual who directs or controls the filing of a document by another person is deemed to be an applicant. This requirement is intended to ensure that the individual responsible for the decision to form or register a reporting company is also identified, because the actual filer of formation documents or registrations is often an employee of a business formation service, law firm, or other agent acting on behalf of the responsible individual.

What requirements apply to pooled investment vehicles seeking an exemption? Do different rules apply to foreign pooled investment vehicles?

A “pooled investment vehicle” operated by a depository institution or credit union; broker or dealer, investment company, investment adviser, or other entity registered with the SEC under the Securities Exchange Act of 1934, or venture capital fund adviser that has reported beneficial ownership information to the SEC on Form ADV is exempt from the definition of “reporting company” and consequently is not required to report their beneficial ownership to FinCEN.

A pooled investment vehicle formed under the laws of a foreign country is nonetheless deemed a reporting company, but its reporting obligation is limited to reporting information only with respect to the individual having the greatest authority over the strategic management of the entity. The proposed rule does not indicate how that determination would be made.

The proposed rule defines a “pooled investment vehicle” as any investment company (as defined in Section 3(a) of the Investment Company Act of 1940, as amended), or any company that would be an investment company but for the exclusions provided by Section 3(c)(1) or Section 3(c)(7) of the Investment Company Act and that is identified by its legal name by the applicable investment adviser in its Form ADV. The rule does not explain how a pooled investment vehicle operated by an exempt entity that is not an investment adviser and not required to file a Form ADV (such as a bank) could qualify under this definition. 

Bank-maintained common trust funds and collective investment funds, which rely on Section 3(c)(3) and Section 3(c)(11) of the Investment Company Act, respectively, are typically organized as common law trusts and not created by a filing with a similar official of a state or tribe, so these types of funds also should not be treated as reporting companies, albeit for these different reasons.

Other types of funds, such as real estate funds that do not fall within the definition of investment company in Section 3(a) of the Investment Company Act or that may rely upon Section 3(c)(5)(C) or Section 3(c)(6) of the Investment Company Act do not qualify for this exemption. Sponsors of funds that do not qualify as pooled investment vehicles should consider updating subscription documentation to require subscribers to provide information needed to comply with the CTA.

What reporting requirements apply to exempt entities?

If an exempt entity has a direct or indirect ownership interest in a reporting company, the reporting company is required to identify the exempt entity in its report submitted to FinCEN but is not required to report information with respect to the exempt entity’s beneficial owners. 

Entities that are wholly owned, directly or indirectly, by exempt entities are not required to report their beneficial ownership information to FinCEN.

Are there any penalties for violating the requirements of the proposed rule?

The proposed rule makes it unlawful to willfully provide, or attempt to provide, false or fraudulent beneficial ownership information, including a false or fraudulent identifying photograph or document, to FinCEN, or to willfully fail to report complete or updated beneficial ownership information to FinCEN. A person provides or attempts to provide information to FinCEN if it does so directly or indirectly, including by providing information to another person for purposes of a report. A person fails to report complete or updated information if it directs or controls another person with respect to any such failure or is in substantial control of a reporting company when it fails to report complete or updated information. Under the CTA, a person that violates these requirements can be subject to civil penalties of up to $500 for each day the violation continues or has not been remedied and may be fined not more than $10,000, imprisoned for not more than two years, or both.

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^[1]FinCEN believes that this requirement precludes the reporting of an address of a formation agent or other third-party representative, and indicated that P.O. boxes would also be precluded.

^[2]Such “important matters” include those affecting the nature, scope, and attributes of the entity’s business (including sale, lease, mortgage, or other transfer of any principal assets); reorganization, dissolution, or merger of the entity; major expenditures or investments, equity issuances, incurrence of significant debt, or approval of operating budget of entity; selection or termination of business lines, ventures, or geographic focus; compensation schemes and incentive programs for senior officers; entry into, termination, fulfillment, or nonfulfillment of significant contracts, amendments of substantial governance documents (e.g., articles of incorporation, bylaws, significant policies or procedures), and “any other form of substantial control.”