Corporate Transparency Act: The Coming Federal Reporting Requirements for Smaller Businesses — Episode 3

Please note: The below information was published prior to the Corporate Transparency Act (CTA) went into effect and certain final regulations and guidance may be outdated. For the most current information on the CTA, please refer to our Primer here and our FAQs here.  

Episode 3 – Information Required to be Reported and Who is a “Beneficial Owner”

Episode 1 in our series outlined the purpose behind the Corporate Transparency Act (“CTA”) and Episode 2 described what constitutes a “Reporting Company” under the CTA. In this episode, we will look at the information itself that must be reported and “Beneficial Owners” under the CTA.

1. Information Required to be Reported

 

The party required to report the information to FinCEN is the Reporting Company and it must disclose information about: (1) the Reporting Company itself; (2) its current “Beneficial Owners;” and (3) the “Applicants” who made the formation filing.  Each one of these words have definitions under the CTA, which need to be understood carefully in order to comply with the requirements of this act.

Under the Proposed Rule, a Reporting Company is required to submit the following information to FinCEN:

• With respect to the Reporting Company itself the following information is required to be reported: (a) the entity’s full name; (b) any alternative names through which the entity engages in business (like a dba or fictitious name); (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.
• With respect to each “Beneficial Owner,” which will be covered in this episode, and each “Company Applicant” of the Company, which will be defined in greater detail in our next episode,  the following information is required to be reported:  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 (as well as a scanned copy of the actual identification document itself).  The “unique identifying number” can come from one of the following identification documents:

1. Non-Expired Passport;

2. A non-expired identification document issued to the individual by a state or local government;

3. A non-expired driver’s license

Note that the actual copies of the passports and drivers licenses themselves need to be delivered as part of the disclosure.

2. Key Reporting Persons

 

a. “Beneficial Owner”

The CTA defines “Beneficial Owner” using a two-prong definition, either of which may be true, to describe a Beneficial Owner.   A Beneficial Owner is any individual who, directly or indirectly, either:

(1) exercises “Substantial Control” over a Reporting Company; or

(2) owns or controls at least 25% of the ownership interests of a Reporting Company.

The Proposed Rule defines “Substantial Control” and “Ownership Interests” very 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 these two prongs of the definition, subject to specific exceptions.

(1) “Substantial Control”

Under the Proposed Rule, “Substantial Control” means any of the following: (a) service as a senior officer, regardless of title, 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 matters 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 (de jure authority), 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. (86 Fed Reg 69933-34)

The Proposed Rule provides that an individual can assert “substantial control” over a Reporting Company through a variety of means, including through the following direct or indirect activities or offices (CFR §1010.380 (d) (1) (G) (iv)):

• Ownership or control of a majority or dominant minority of the voting shares of the Reporting -Company;
• Board representation;
• 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. This may implicate financial institutions in banking arrangements; or
• Any other contract, arrangement, understanding, relationship or otherwise, which could include voting agreements and proxies.
• “Any other form of substantial control over the Reporting Company”

An example of how broad and vague the proposed regulations are:  “Substantial Control” over a Reporting Company can include a senior officer of the company who “…provides direction, determination, or decision of, or substantial influence over, important matters affecting the Reporting Company… reorganization, dissolution, or merger of the Reporting Company; major expenditures or investments, issuances of any equity, incurrence of any significant debt or approval of the operating budget of the Reporting Company” CFR §1010.380 (d) (1).

If a party has that power, whether they have an ownership interest, as in shares of stock or membership interests, is irrelevant. They are a beneficial owner for purposes of reporting. This substantial control would presumably include management agreements, buy-sell arrangements, arrangements and agreements regarding veto powers over board of director, or managers decisions involving entity governance or other significant decision making.

(2) “Ownership Interests”

The Proposed Rule also includes an expansive definition of “Ownership Interests.” While the CDD Rule only considers equity interests in an entity, under the Proposed Rule, “ownership interests” would include equity interests in the Reporting Company, as well as capital or profit interests, rights afforded to holders of convertible instruments, warrants or rights or options to acquire equity or other interests in a Reporting Company.

Under the Proposed Rule, any debt instrument could 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. With such an expansive definition, expertise will be required from lawyers and accountants to parse the definitions to determine, who, in fact, has Ownership Interests as defined in the CTA and its regulations.

“Ownership Interests” as provided in 86 CFR 1010.380 (d) (3) (86 Fed Reg 69973) 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, any 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 interest in 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 any obligation to participate or exercise the actual right.

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.”

3. Reporting Changes in Beneficial Owner Information

 

After the report of Beneficial Ownership is filed with FinCEN, the job isn’t over.   Challenges constantly face Reporting Companies under the CTA when there are changes to the information filed with FinCEN, pertaining to the Beneficial Owners, which will be inevitable.  The CTA statute provides that the deadline for updating filed information established by regulations must be “in a timely manner” but not later than one year after there was a change in the information.

FinCEN, however, is proposing a 30-calendar-day deadline after the date on which there is any change with respect to any information previously submitted to FinCEN, including any change with respect to who is a Beneficial Owner of a Reporting Company.  This means that an updated report needs to be filed within 30 calendar days after the date on which there is any change with respect to any information previously submitted to FinCEN.  This not only includes changes to the Beneficial Owners but also includes any change with respect to information reported for any particular Beneficial Owner.  For example, the Reporting Company must report each time a beneficial owner dies or is redeemed, partially or completely,  buys, sells, exercises an option to purchase any shares of the Reporting Company, makes a change in his or her address, or makes any change to his or her driver’s license or passport if either of these documents were used to identify a Beneficial Owner, including the loss or reissuance of these documents.

Reporting Companies and their advisors will need to be on the alert constantly for changes in Beneficial Owners, each of their ownership stakes, and the Beneficial Owners’ filing information itself, while also ensuring the changes are filed with FinCen within the 30-day time limit.

Next Episode 4:   Who Are the “Company Applicants” Under the CTA and What Information About Them Will Need to be Reported?