On January 1, 2021, the Corporate Transparency Act (“CTA”) was enacted. The CTA authorized the Department of the Treasury's Financial Crimes Enforcement Network (“FinCEN”) to set up a secure beneficial ownership registry for information on entities created in or qualified to do business in the United States and to collect information from entities related to the beneficial ownership of such entities that may be accessed by federal agencies and law enforcement departments (federal, state and local).

On September 29, 2022, FinCEN issued its highly anticipated final rule implementing the beneficial ownership information (“BOI”) reporting requirements of the CTA. The final rule brings about the most significant revisions to the U.S. anti-money laundering/countering the financing of terrorism (“AML/CFT”) compliance framework in more than twenty (20) years, implementing sweeping beneficial ownership disclosure requirements applicable to all U.S. companies and foreign companies doing business with or within the United States.  For closely-held and/or family-owned entities, there will likely be a temptation to think (or hope) that there must be an exemption for small family-owned entities that allows them to avoid compliance with the CTA.  Such thinking would be folly.  The following is a brief summary of key provisions and takeaways from the final rule.

WHO MUST FILE A REPORT UNDER CTA?

Any entity that meets the definition of a “reporting company” must file a BOI report with FinCEN. In particular, FinCEN has identified domestic and foreign companies as reporting companies. The final rule defines a “domestic reporting company” to include “a corporation, limited liability company (LLC), or any entity created by the filing of a document with a secretary of state or any similar office under the law of a state or Indian tribe.”  In commentary on the rule, FinCEN confirmed that the agency expects the rule to include (unless specifically exempted): limited liability partnerships, limited liability limited partnerships, business trusts, and most limited partnerships, as well as corporations and limited liability companies (LLCs). FinCEN noted that “other types of legal entities, including certain trusts, are excluded from the definitions to the extent that they are not created by the filing of a document with a secretary of state or similar office,” which is welcome news in the trust world. Beyond confirmation that certain types of trusts will not be included, FinCEN did not expand the exemptions under the final rule for the twenty-three (23) types of entities identified to be exempted under the CTA.[1] Key exemptions from the BOI reporting requirements continue to include: U.S. Securities and Exchange Commission (SEC) registered issuers, banks and other types of regulated financial institutions, pooled investment vehicles, tax-exempt entities, large operating companies (20+ U.S. employees, U.S. operations, and generating greater than $5 million in annual gross receipt or sales), and inactive entities formed prior to January 1, 2020, without foreign owners and which hold no assets (including ownership interests).

Similarly, a “foreign reporting company” is defined as a “corporation, LLC, or other entity formed under the law of a foreign country that is registered to do business in any state or tribal jurisdiction by the filing of a document with a secretary of state or any similar office.”

Based on the foregoing definitions, FinCEN expects limited liability partnerships, limited liability limited partnerships, business trusts and most limited partnerships to submit BOI reports, considering such entities are generally created by a filing with a secretary of state or similar office. Certain entities are excluded from the definition of a “reporting company” to the extent that they are not created by a filing with a secretary of state or similar office.

WHO ARE BENEFICIAL OWNERS AND COMPANY APPLICANTS?

The CTA requires “reporting companies” to file with FinCEN reports that identify a company's “beneficial owners,” as well as information about “company applicants.”

Beneficial Owners

A “beneficial owner” includes “any individual who, directly or indirectly, either (1) exercises substantial control over a reporting company, or (2) owns or controls at least twenty-five percent (25%) of the ownership interests of a reporting company.” The CTA requires the identification of each beneficial owner of the respective reporting company. As such, all individuals that exercise substantial control and own or control at least twenty-five percent (25%) of the reporting company must be identified. The final rule provides some color as to the definitions of “substantial control” and “ownership interests.”

Substantial Control

Most notably, FinCEN revised the definition of “substantial control” to ensure that reporting companies identify key individuals who direct the actions of such entities. Under the final rule, an individual exercises substantial control over a reporting company if the individual:

1. serves as a senior officer of the reporting company;
2. has authority over the appointment or removal of any senior officer or a majority of the board of directors (or similar body) of the reporting company;
3. directs, determines or has substantial influence over important matters of the reporting company, including, for example, the reorganization, dissolution or merger of the reporting company, the selection or termination of business lines or ventures of the reporting company and the amendment of any governance documents of the reporting company; or
4. has any other form of substantial control over the reporting company.

As reflected above, item 4 above serves as a catch-all provision to address control that may be exercised in less conventional ways with respect to emerging entities with varying governance structures. In other words, this provision is expected to prevent any efforts to circumvent the final rule.

Ownership or Control of Ownership Interests

The final rule establishes standards for determining whether an individual has an ownership interest in a reporting company. An “ownership interest” is defined as any instrument, contract, arrangement, understanding or mechanism used to establish ownership, such as any equity, stock, capital or profit interest. In turn, an individual may directly or indirectly own or control an ownership interest of a reporting company through any contract, arrangement, understanding or relationship, including, for example, joint ownership, certain trust arrangements and acting as an intermediary, custodian or agent on behalf of another.

The definition of “beneficial owner” does not include (1) minor children, (2) individuals acting as nominees, intermediaries, custodians or agents, (3) employees acting solely as employees and not as senior officers, (4) individuals whose only interest in a reporting company is a future interest through a right of inheritance, and (5) creditors of a reporting company.

Company Applicants

The final rule requires the identification of company applicants who are primarily responsible for directing or controlling the filing of the formation documents for the reporting company. The “company applicant” is either (1) 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 within the U.S., or (2) the individual who is primarily responsible for directing or controlling the filing of the relevant document by another. Notably, FinCEN modified this rule to limit the definition of “company applicant” to only one or two individuals.

ARE THERE PENALTIES FOR NON-COMPLIANCE?

While civil and criminal penalties are available under the final rule for violations, unlike most other AML/CTF reporting violations, penalties for violations of the final rule will apply only with regard to willful violations, including willful failure to file, willful provision of false or fraudulent information, or willfully failing to provide complete or updated beneficial ownership information to FinCEN. The final rule does not provide for penalties in the case of negligent or reckless failures.  However, the expansive definition of what may constitute a willful violation under the final rule will include circumstances involving “willful blindness” or “conscious disregard,” expanding the potential for inquiries and enforcement. The final rule also provides for criminal or civil liability for “causing” a violation, significantly expanding the pool of individuals who could be targeted for their role in failures under this rule.

WHEN MUST I BEGIN TO COMPLY WITH THE CTA?

The final rule extends the allowed time frame for reporting companies to disclose their beneficial owners to FinCEN from the fourteen (14) days proposed previously to within thirty (30) days of formation for new entities, or within one (1) year of the final rule's effective date for existing entities.

All companies need a process to comply, document exception decisions, and will need to monitor for necessary updates. All companies formed prior to the rule's effective date, January 1, 2024, should review the rule carefully and develop a process for identifying any required reporting.

Companies and individuals and entities involved in corporate formation should also review the rule carefully in order to develop procedures for vetting newly established entities and determining whether reports are required under this rule. Decisions regarding the application of exemptions to the reporting requirements should be carefully documented. Procedures should include processes for vetting the completeness and accuracy of all disclosures made in reports under the rule.

After an initial report is made, companies will also need a process to monitor changes to ensure that updates are made as required. This includes new filings on behalf of entities that were previously exempt where circumstances negate the exemption, as well as reporting companies where details submitted in the reports may change over time. Reporting companies must submit updated reports within thirty (30) days of any change.

The final rule will go into effect on January 1, 2024. Reporting companies created or registered before January 1, 2024, will have one (1) year (or until January 1, 2025) to file their initial BOI reports. After January 1, 2024, newly formed reporting companies will only have thirty (30) days after receiving notice of creation to file their initial reports.

The final rule is the first of three rulemakings that FinCEN will make for implementing the CTA. The final rule does not address access to the BOI collected and safeguards to ensure that the information is secured and protected, nor does it address required revisions to FinCEN's customer due diligence (“CDD”) rules to incorporate this new process. Given that the final rule will go into effect on January 1, 2024, we would expect at least a rule regarding access to and use of BOI within FinCEN's database and potentially both additional rulemakings within the next year. Reporting companies should pay close attention to those developments in order to tailor their procedures to comply with the CTA prior to January 1, 2024.

For family offices and serial entrepreneurs who routinely use a myriad of separate legal entities for each deal or business venture, the CTA is going require significant leg work to be prepared for the CTA's new requirements.

[1] Entities exempted from CTA compliance include: