First Post in a Two-Post Series on the CTA Implementing Regulations
On September 30, 2022, the Financial Crimes Enforcement Network (“FinCEN”) issued its final rule, Beneficial Ownership Information Reporting Requirements (“Final Rule”), implementing the beneficial ownership reporting requirements of the Corporate Transparency Act (“CTA”).
FinCEN’s September 29, 2022 press release is here; the Final Rule is here; and a summary “fact sheet” regarding the rule is here. The Final Rule largely tracks the December 8, 2021 Notice of Proposed Rulemaking (the “Proposed Rule”), on which we blogged here and here.
The Final Rule requires many corporations, limited liability companies, and other entities created in or registered to do business in the United States to report information (“BOI”) about their beneficial owners — the persons who ultimately own and control the company — to FinCEN. This information will be housed within the forthcoming Beneficial Ownership Secure System (“BOSS”), a non-public database under development by FinCEN.
The Final Rule takes effect on January 1, 2024. In a nutshell, (1) companies subject to the BOI reporting rules (“reporting companies”) created or registered before the effective date will have one year, until January 1, 2025, to file their initial reports of BOI and (2) reporting companies created or registered after the effective date will have 30 days after creation or registration to file their initial reports. In addition to the initial filing obligation, reporting companies will have to file updates within 30 days of a relevant change in their BOI. And, as we discuss, covered companies also will have to report their “company applicants,” which could include lawyers, accountants or other third-party professionals.
The Final Rule will have broad effect. FinCEN estimates that over 32 million initial BOI reports will be filed in the first year of the Final Rule taking effect, and that approximately 5 million initial BOI reports and over 14 million updated reports will be filed in each subsequent year. We summarize here the key provisions of the Final Rule. In our next blog post, we will discuss the Final Rule’s broad definition of the “control” prong regarding who represents a “beneficial owner,” which will result in an expansion of the definition of “beneficial owner” under the existing Customer Due Diligence (“CDD”) rule applicable to banks and other financial institutions (“FIs”).
Implementation of the Corporate Transparency Act
The CTA, enacted as part of the landmark Anti-Money Laundering Act of 2020, aims to establish a new framework for the reporting, maintenance and disclosure of BOI. Congress passed the CTA because it found that the ability to operate through legal entities without requiring the identification of BOI posed an important anti-money laundering (“AML”) and countering the financing of terrorism (“CFT”) risk to the U.S. financial system. The Final Rule addresses only the reporting requirements of BOI. FinCEN still must issue two additional proposed rulemakings under the CTA to (1) address data privacy issues and establish rules for whom may access BOI, and (2) revise and conform FinCEN’s existing CDD rule for covered FIs with the Final Rule.
The Final Rule reflects numerous public comments received by FinCEN in response to the Proposed Rule regarding the broad scope of the regulations, the burdens on reporting companies, including small businesses, and privacy and security concerns with respect to personal identifiable information. The Final Rule largely followed the Proposed Rule, with some changes to the filing requirements discussed below. FinCEN stated that additional guidance via FAQs is forthcoming.
Who Must File a Report?
The Final Rule defines two types of reporting companies: domestic and foreign. Subject to certain exemptions, BOI reporting requirements apply to all domestic entities that are created by filing a document with a secretary of state or other similar office of a State or Indian tribe. FinCEN believes this will exclude many sole proprietorships, general partnerships and trusts, subject to applicable State or tribal law. (FinCEN specifically chose not to expand the definition of “reporting company” to include trusts — despite the urging of some transparency watchdog groups.) The reporting requirements also apply to foreign companies, including corporations, limited liability companies, and other entities formed in a foreign country that have registered to do business in any State or Indian tribal jurisdiction by filing a document with the appropriate office.
The CTA exempts 23 types of entities from the reporting obligations. The Final Rule does not depart from this number and maintains the same exemptions. The most important exemption is for a “large operating company,” defined as a company with an operating presence at a physical office in the U.S., more than 20 full-time employees in the U.S., and more than $5 million in gross receipts or sales reflected on the company’s prior year federal tax returns, excluding gross receipts or sales from sources outside of the U.S. This exemption, and what it does not include, highlights the special interest of the CTA in tracking foreign companies operating in the U.S.
Businesses in heavily regulated industries, such as banks, money transmitters registered with FinCEN and securities brokers, are also exempted under the CTA. Other exemptions include (1) governmental authorities; (2) Section 501(c)(3) tax exempt entities; (3) pooled investment vehicles; (4) inactive entities in existence on or before January 1, 2020, that have no foreign ownership, no assets, no change in ownership during the last 12 months, and have not sent or received funds in excess of $1,000 in the last 12 months; and (5) subsidiaries of most exempted entities — but not, for example, the subsidiary of a licensed money transmitter business.
FinCEN declined to depart from the exemptions in the Proposed Rule even though the CTA allows FinCEN to do so upon approval of the Secretary of the Treasury and the Attorney General. FinCEN stated that it lacks the authority to address concerns regarding unfairness or inherent risk and noted that it would consider additional guidance to clarify specific factual circumstances.
What Information Must be Provided in a Report?
Domestic entities formed or foreign entities registered after January 1, 2024, must file an initial report with FinCEN within 30 days after formation or registration. The Final Rule requires the reporting of both BOI and “company applicant” information of reporting companies.
1. Reporting Companies
The initial report must include the following information about the reporting company:
- Full name and address;
- Trade or fictitious names used;
- Address of the principal place of business;
- Jurisdiction of formation or, in the case of a foreign company, jurisdiction in which first registered; and
- Taxpayer Identification Number (“TIN”), or where a foreign reporting company has not been issued a TIN, a tax identification number issued by a foreign jurisdiction. The requirement for the TIN is a departure from the Proposed Rule, which encouraged, but did not require that reporting companies provide the TIN.
- Beneficial Owners and Company Applicants
The initial report must include the following information about each beneficial owner and the company applicant:
- Full legal name;
- Date of birth;
- Current address;
- A unique identifying number from a non-expired passport, driver’s license, government-issued ID, or identification document issued by a State or local government or tribe; and
- An image of the document showing the unique identifying number.
A FinCEN identifier is a unique number issued by FinCEN to individuals and reporting companies. An individual may submit an application for a FinCEN identifier that contains all of the information that otherwise must be set forth in the initial report about that individual. An individual who has obtained a FinCEN identifier may provide it to the reporting company and the reporting company can include the FinCEN identifier in lieu of the information otherwise required. FinCEN identifiers are subject to the same timelines and requirements regarding updates or corrections to the BOI. Obtaining a FinCEN identifier may reduce the burden of keeping BOI up to date and correct, and mitigate privacy concerns inherent in document retention.
2. Beneficial Owners
Similar to the CDD rule, the Final Rule defines a “beneficial owner” as any individual who, directly or indirectly, owns or controls at least 25% of the ownership interest of the reporting company, or who exercised “substantial control” over the company. The Final Rule includes five exceptions to these two categories, which generally include minor children; agents on behalf of other individuals; employees that are not senior officers; individuals holding future interests through inheritance rights; and creditors.
For purposes of determining whether an individual owns or controls 25% or more of the ownership interests of a reporting company, the Final Rule defines “ownership interest” to include only equity interests, capital or profit interests, proprietorship interests, and instruments convertible or exercisable for the foregoing interests. An individual may own or control an ownership interest through joint ownership with other persons; through a nominee, intermediary, custodian, or agent; through certain trust arrangements; or through ownership or control of intermediary entities that separately or collectively own or control ownership interests of the reporting company.
We will focus on the broad “substantial control” prong of the definition of “beneficial owner” in our next blog post, and its relationship to the existing CDD rule applicable to banks and other FIs.
3. Company Applicants
In addition to beneficial owners, the reporting company’s “company applicant” must also be reported. A company applicant is defined as the individual who directly files the document that creates or registers a domestic or foreign reporting company respectively, as well as the individual who is primarily responsible for directing or controlling such filing. Departing from the Proposed Rule, the requirement to provide BOI for company applicants applies only to reporting companies created or registered on or after the effective date of the Final Rule, January 1, 2024, in order to avoid reporting companies having to track down applicants from many years ago, some of whom may be deceased. To further reduce burdens on reporting companies, the Final Rule requires newly created entities to report applicant information, but they will not be required to update it.
Notably, FinCEN anticipates that lawyers, accountants or other third-party professionals may constitute applicants whose information must be reported: “In many cases, company applicants may be employed by a business formation service or law firm. For example, there may be an attorney primarily responsible for overseeing the preparation and filing of incorporation documents and a paralegal who directly files with a state office to create the reporting company.” According to FinCEN, both the lawyer and the paralegal are “company applicants.”
Each person filing a report must certify that the report is accurate and complete. FinCEN rejected comments to the Proposed Rule that the certification standard should include a requirement regarding knowledge or other such qualification: e.g., persons certifying “to the best of their knowledge after reasonable and diligent inquiry.” This is because FinCEN wants to stress that reporting companies are responsible for accurately identifying their beneficial owners. Persons and companies certifying reports should consider that violations of the CTA carry civil penalties of up to $500 for each day of continuing violations, and up to two years of imprisonment for criminal violations. FinCEN states that it “does not expect that an inadvertent mistake by a reporting company acting in good faith after diligent inquiry would constitute a willfully false or fraudulent violation.” Indeed, it is a given that a good-faith mistake is the antithesis of willfulness or fraud.
Initial Reporting Timeline
A domestic reporting company formed, or a foreign reporting company registered, after January 1, 2024 must file the initial report within 30 calendar days of its actual notice that its creation or registration has become effective. A domestic reporting company formed, or a foreign reporting company registered, prior to January 1, 2024 has one year, until January 1, 2025, to file. Exempt entities that no longer qualify as exempt under the regulation must file a report within 30 calendar days of the date it no longer meets the exemption criteria.
The CTA requires reporting companies to update information in a timely manner, as well as to promptly correct any inaccurate information filed in BOSS. According to the Final Rule, an updated report must be filed within 30 days after there is any change in the information reported to FinCEN, including any change with respect to who is a beneficial owner and any change in the information previously reported for any beneficial owner or company applicant. Additionally, a corrected report must be filed within 30 days after the reporting becomes aware of any inaccuracies. This updating requirement is very broad and likely will create administrative and compliance headaches for reporting companies. As noted, FinCEN estimates that after the first year of the Final Rule taking effect, over 14 million updated reporting forms will be filed annually.
Burden on the Reporting Company
Certain commentators to the Proposed Rule stressed the disparate cost impact the regulations could have on small businesses. Although the Final Rule fails to reduce the scope of covered entities, FinCEN nonetheless claims that it sought to minimize burdens on reporting companies, including small businesses, while providing important beneficial ownership transparency to law enforcement, the intelligence community, regulators, and FIs.
Stating that it expects the majority of reporting companies to have “simple” structures, FinCEN estimates that reporting companies will spend over 126 million hours on compliance during the first year that the Final Rule is in effect, creating estimated compliance costs of almost $23 billion. FinCEN estimates that subsequent years will require reporting companies to spend approximately 35 million hours on compliance, creating approximately $5.6 billion in annual costs. FinCEN justifies this significant cost by stating that the BOI collected will improve law enforcement investigations and, in turn, strengthen national security and financial system integrity. In the words of FinCEN, the Final Rule “has significant benefits that currently are not quantifiable.”
What is Next?
FinCEN must engage in two additional rulemakings to (i) establish rules for who may access beneficial ownership information, for what purposes and what safeguards will be required, and (ii) revise FinCEN’s CDD rule to confirm with the Final Rule. Additional FAQs and guidance should be forthcoming to assist reporting companies in complying with the beneficial ownership reporting requirements.