[co-author: Benjamin Cantor]*

On December 7, 2021, the U.S. Department of the Treasury’s Financial Crimes Enforcement Network (“FinCEN”) proposed new regulations (“Proposed Regulations”)¹ defining and implementing the beneficial ownership reporting requirements of Section 6403 of the Corporate Transparency Act (“Act”).² The Act, enacted on January 1, 2021, as part of the National Defense Authorization Act of 2021, requires FinCEN to promulgate regulations mandating “reporting companies” to disclose the name, date of birth, residential or business address and an identifying number for all of such reporting companies’ “beneficial owners” and “company applicants” to FinCEN, among other requirements.³ The preamble to the Proposed Regulations indicates that the Proposed Regulations are the first of three planned FinCEN rulemakings regarding the Act.

The Proposed Regulations do not set forth a specific effective date. The comment period for these Proposed Regulations runs through February 7, 2022. Once the final version of the regulations becomes effective, any covered reporting company formed or registered before the effective date would have one year from the effective date to comply with the new requirements, and any company formed or registered on or after the effective date would have to file an initial report within 14 days of its formation or registration date.

Definition of “Reporting Company”

The Act defines a “reporting company” as a 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 under the law of a State or Indian tribe (defined in the Proposed Regulations as “domestic reporting company”) or 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 similar office under the law of a State or Indian tribe (defined in the Proposed Regulations as “foreign reporting company”). The Proposed Regulations do not separately define “other similar entity.” With respect to domestic entities, the preamble to the Proposed Regulations notes that state laws may differ on whether certain types of entities – such as general partnerships, other types of trusts and sole proprietorships – are created by a filing with a state or similar office. The preamble indicates that the definition of reporting company would likely include not only corporations and limited liability companies but also limited liability partnerships, limited liability limited partnerships, business trusts, most limited partnerships and any other type of legal or business form created by a filing with a secretary of state or similar office. With respect to foreign entities, the preamble clarifies that the definition of “reporting company” would include entities that may not have been created by the making of a filing in their home jurisdiction but that have made a filing with an office in the U.S. to register to do business as a “foreign” entity.

The Act specifically excludes 23 types of entities from the definition of reporting company and authorizes FinCEN to exempt additional entities. The Proposed Regulations would adopt the statutory language granting the 23 exemptions with some clarifications. The exemptions include mostly regulated entity types that are already required to report beneficial ownership information to the respective regulators, including:

• All SEC reporting issuers,
• Investment companies registered under the Investment Company Act of 1940 (the “Investment Company Act”),
• Investment advisers registered with the SEC under the Investment Advisers Act of 1940 (the “Advisers Act”) and venture capital fund advisers (as described in Section 203(l) of the Advisers Act),
• Brokers or dealers in securities registered with the SEC pursuant to Section 15(a) of the Securities Exchange Act of 1934 (the “Exchange Act”),
• “Pooled investment vehicles”⁴ advised by an exempt entity,
• Banks, credit unions, depository institution holding companies,
• Money transmitting businesses,
• Governmental authorities,
• Securities exchange or clearing agencies, other Exchange Act registered entities,
• Insurance companies and state-licensed insurance producers,
• Commodity Exchange Act registered entities,
• Accounting firms, public utilities, financial market utilities,
• Large operating companies,⁵
• Tax-exempt entities, entities assisting tax-exempt entities, and
• Subsidiaries of certain exempt entities and inactive entities.

Although the Act provides FinCEN with the authority to add to the list of exempt entities, the Proposed Regulations do not add more exemptions to the list but do request comment on whether any entity or class of entities should be added.⁶

Definition of “Beneficial Owner”

The Act defines a “beneficial owner” as any individual who either exercises substantial control over the reporting company or who owns or controls at least 25% of the ownership interests of the reporting company. The Act does not define substantial control or ownership interests. The Proposed Regulations, however, provide that substantial control includes: (i) service as a senior officer, (ii) authority over the appointment or removal of any senior officer or a majority or dominant minority of the board of directors of a reporting company, (iii) direction, determination or decision of, or substantial influence over, important matters affecting the reporting company, or (iv) any other form of substantial control over the reporting company. The Proposed Regulations clarify that an individual may exercise substantial control directly or indirectly through a variety of means and lists some examples.

The Proposed Regulations also provide that ownership interests for the purpose of the 25% ownership or control test include equity interests, capital or profit interests in a limited liability company or partnership, proprietorship interests, instruments convertible into any of the other listed interests, and options. The Proposed Regulations clarify that an individual may directly or indirectly own or control an ownership interest of a reporting company through a variety of means and lists some examples. With respect to trusts, the preamble to the Proposed Regulations states that grantors or settlors “that have retained the right to revoke the trust, or to otherwise withdraw the assets of the trust” would be considered as persons that could have control over an ownership interest. The preamble further notes that a person would also be deemed to have control over an ownership interest owned by a trust if such person is the “permissible recipient of both income and principal from the trust, or has the right to demand a distribution of, or withdraw substantially all of the assets from, the trust.”

The Proposed Regulations would adopt, with certain clarifications, the exclusions in the Act from the definition of beneficial owner for minors, nominees, employees, inheritors and creditors.

Additional Reporting Requirement for Company Applicants

In addition to information about the reporting companies themselves and their beneficial owners, the Act requires a reporting company to report information about every “applicant,” defined as any individual who files a document that creates a domestic reporting company or that first registers a foreign reporting company in the U.S. (defined in the Proposed Regulations as a “company applicant”). Significantly, the Proposed Regulations would include in the definition of “company applicant” a person who directs or controls the filing of such a document by another person. The preamble notes that an “employee of a business formation service or law firm, or an associate, agent, or family member” who files the relevant document on behalf of another person would constitute a company applicant.

Filing Deadlines

The Proposed Regulations clarify the filing deadlines for information reports under the Act:

• A reporting company that has been formed or registered before the effective date of the final regulations would have to file its initial report within one year of the effective date of the final regulations.
• A reporting company that has been formed or registered after the effective date of the final regulations would have to file its initial report within 14 days of its formation or registration date.
• All reporting companies would have to file (i) an updated report within 30 days following a change with respect to any information the reporting company previously submitted to FinCEN and (ii) a corrected report within 14 days after the date on which the reporting company becomes aware or has reason to know that any required information previously submitted was inaccurate when filed and remains inaccurate.

Timing

No proposed effective date for the final regulations was provided. The Act itself is effective on the date the regulations become effective, and the Act specifically prescribed that such regulations should be promulgated no later than January 1, 2022. Comments on the Proposed Regulations, including comments regarding the timing of the effective date, may be submitted until February 7, 2022. The Proposed Regulations do not include a final format or mechanism of reporting, and the preamble indicates that FinCEN has yet to develop reporting protocols and forms.

Potential Impact on Financial Institutions

Although the Proposed Regulations lay the groundwork for implementing the Act’s beneficial ownership registry, the effect on the anti-money laundering program obligations of financial institutions cannot be determined until later FinCEN rulemakings. However, the preamble in some instances foreshadows possible changes to FinCEN’s current beneficial ownership requirements. Noticeably, the preamble highlights certain perceived shortcomings with the current FinCEN Customer Due Diligence ("CDD") Rule and its treatment of an ownership interest held by a trust, stating that the “CDD Rule standard could permit obfuscatory behavior” because it “does not provide transparency with respect to complex ownership structures, extensive use of trusts, voting arrangements among owners, golden shares entitling their owners to voting rights disproportionate to their equity stake, and other mechanisms that can obscure the connection between an individual owner and a reporting company.”

Two other possible changes may result from inconsistencies between the Act and the current CDD Rule. First, the CDD Rule requires that financial institutions collect social security numbers from beneficial owners and control persons. Notably, neither the Act nor the Proposed Regulations require that a person’s social security number be collected. Second, the current CDD Rule’s treatment of natural person beneficial owners who hold their interest in a reporting company indirectly through an exempt or excluded entity contrasts with the Act and the Proposed Regulations in that the Act and Proposed Regulations do not require a reporting entity to look through an exempt entity to identify the ultimate natural person beneficial owner. FinCEN’s current CDD Rule requires an entity to look through any intermediate entity owner to identify any ultimate natural person beneficial owners, even if the intermediate entity is itself excluded. It appears that FinCEN would have to take these inconsistencies into account when it re-writes the CDD Rule as required by the Act.

Footnotes

1) Find link to the Proposed Regulations here and a FinCEN fact sheet here.

2) Find link to the Act here.

3) See our Dechert OnPoint discussing the Act here.

4) A “pooled investment vehicle” is defined as a fund that would be an investment company under the Investment Company Act but for Sections 3(c)(1) or 3(c)(7).

5) The exemption for large operating companies covers any entity that: (1) employs more than 20 full time employees in the U.S., (2) has an operating presence at a physical office within the U.S., and (3) filed a federal income tax return or information return in the U.S. for the previous year demonstrating more than $5,000,000 in gross receipts or sales in the aggregate.

6) The Act permits FinCEN to add to the list of exempt entities if the Secretary of the Treasury, with the written consent of the Attorney General and the Secretary of Homeland Security, makes a finding that beneficial ownership reporting by such entity or class of entities “would not serve the public interest” and “would not be highly useful in national security, intelligence, and law enforcement agency efforts to detect, prevent, or prosecute money laundering, the financing of terrorism, proliferation finance, serious tax fraud, or other crimes.” 31 U.S.C. 5336(a)(11)(B)(xxiv).

*Law Clerk