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Transforming the Veil of Private Company Ownership: A Closer Look

This article discussed the Financial Crimes Enforcement Network's (FinCEN) proposed beneficial ownership reporting requirements for private companies. This proposal was put forward in December 2021 and was officially sanctioned in October 2022. It was a significant undertaking to analyze this substantial piece of legislation. These recently enforced FinCEN regulations support the directives of the Corporate Transparency Act, which was put into law in October 2019. These mandates establish new federal filing prerequisites applicable to a myriad of entities, including operating companies, holding companies, and LLCs among others. The primary objective of these regulations is to bolster FinCEN's efforts to safeguard national security and the financial system by offering crucial data to national security, intelligence, and law enforcement agencies.

Delving into the Corporate Transparency Act of 2019

The Corporate Transparency Act compels small corporations and limited liability companies to divulge information about their beneficial owners. In accordance with the Act, a beneficial owner is defined as an individual who (i) exercises substantial control over a corporation or limited liability company, (ii) owns 25% or more of the interest in a corporation or limited liability company, or (iii) garners substantial economic benefits from the assets of a corporation or limited liability company.

The Act explicitly demands that entities filing to form a corporation or limited liability company submit beneficial ownership data to FinCEN. The Act is not without repercussions; failing to provide complete or updated data, or providing false or fraudulent information can result in a penalty and up to three years of imprisonment.

This beneficial ownership data will be incorporated into a national corporate ownership database. The enactment of the Act will necessitate regulations governing who can access this database, the permissible reasons for access, and the measures required to guarantee the data's security and protection.

Insights into FinCEN Beneficial Ownership Reporting Rules

The FinCEN Beneficial Ownership Information Reporting Requirements rule, or BOI Rule, is an extensive document spanning 330 pages. The rule aims to enhance the abilities of FinCEN and other agencies to defend U.S. national security and the financial system and provide vital data to national security, intelligence, and law enforcement agencies, state, local, and tribal officials, and financial institutions to impede illicit financing activities. The rule opens with a detailed discussion on the use of corporate entities to disguise beneficial owners and carry out illegal activities, including money laundering, tax fraud, and terrorist financing. I will omit summarizing this portion of the release, but for those with an interest, it provides a compelling read.

Identifying Entities Required to Report Under the BOI

The rule has a broad application, impacting any entity, both domestic or foreign, including corporations, limited liability companies, and any entity formed with (or registered to do business with) any secretary of state or a similar office of a state or Native American tribe. A domestic BOI reporting company would consist of any entity that is established by filing a document with a secretary of state or a similar office within the U.S. A foreign reporting company would be any entity established under foreign law that is registered to conduct business within the U.S.

A total of twenty-three types of entities are exempt from these requirements as they are deemed to be already subject to significant federal or state regulation. The list of exempted entities includes SEC reporting companies, insurance companies, banks, and subsidiaries of exempt entities provided that no other non-exempt individual falls within the general definition of a beneficial owner. Furthermore, there's an exemption for “large operating entities”, defined as a company that: (i) employs more than 20 full-time employees in the U.S.; (ii) submitted a tax return the previous year showing over $5 million in gross receipts; and (iii) has a physical operating presence within the U.S.

Breaking Down Information to be Reported

Entities falling under BOI must report information pertaining to the company itself, its beneficial owners, and the person or persons who filed the application to establish the entity or register it to conduct business in a specific state or jurisdiction. In the case of a foreign reporting company, a company applicant would be the person who files the first document registering the entity to conduct business in the U.S. Entities established prior to the effective date of January 1, 2024, won't be required to provide information on the company applicant—i.e., the person or persons that formed the company or registered it to conduct business in the U.S. The rule also demands the identification of any individual who directs or controls the filing of the relevant documents by another person, such as an attorney supervising a paralegal.

Reported information on the company includes: (i) the full name of the company; (ii) any trade name or “doing business as” name of the company; (iii) business street address; (iv) the state or tribal jurisdiction of formation or, for a foreign entity, where such company first registers to conduct business; and (v) an IRS tax ID number or, if not issued at the time of reporting, either a Dun & Bradstreet Data Universal Numbering System (DUNS) Number or a Legal Entity Identifier (LEI).

Details to be reported concerning beneficial owners includes: (i) the individual’s full legal name; (ii) date of birth; (iii) current residential or business street address; and (iv) a unique identifying number from an acceptable identification document, like a passport.

Upon request and subject to certain conditions, individuals may also be issued a FinCEN identifying number. All BOI companies will be assigned a FinCEN identifying number upon filing their initial report.

Reports must be certified for their accuracy and completeness. While a report may be filed by an individual on behalf of a company, the company is ultimately responsible for the filing. This also applies to the certification. The company will be required to make the certification, and any individual who files the report as an agent of the company will certify on behalf of the reporting company.

Within the rule, a “beneficial owner” is defined to include any individual who: (i) exercises direct or indirect substantial control over a company; or (ii) owns or controls at least 25% of the ownership interests in a company.

"Substantial control" is defined as: (i) a senior officer (excluding a corporate secretary or treasurer who only perform ministerial functions); (ii) having authority over the appointment or removal of a senior officer; or (iii) direction, determination or decision of, or substantial influence over important decisions made by the company. The final rule includes a list of non-exclusive indicators of substantial control. The final rule is intended to be comprehensive, covering all types of control persons, either direct or indirect, and to encompass complex arrangements.

Similarly, “ownership interests” is intended to be comprehensive and encompassing – including, for example, profit sharing, convertible equity instruments, privileges analogous to ownership, convertible debt, and more. FinCEN recognizes that the calculation can be quite challenging, such as with a SAFE or other convertible instrument that is based on and valued on future events. To provide clarity, FinCEN has endeavored to identify specific scenarios where individuals can be considered to own or control ownership interests of a reporting company held in different manners such as trusts or convertible instruments.

The formula is very different than for federal securities law purposes, with the calculation always being on a fully diluted basis. The present value of a contingent interest is irrelevant to the calculation of percentage of ownership interests. For example, if the exercise of an option or similar interest at the present time would result in an individual holding 26% of the profit interests in an entity, the individual would be deemed to own or control 25% or more of the ownership interests in the reporting company even if the value of those profit interests is indeterminate or negligible at the present time. Once it is determined that ownership is over the threshold 25%, the owner must be reported, but the actual percentage ownership need not be disclosed.

There are five exemptions to the definition of a beneficial owner, including: (i) minors, as long as a parent or guardian’s information is reported; (ii) nominees and intermediaries, where the actual control person would be reported; (iii) an individual whose only interest in a company is a future interest through a right of inheritance; (iv) employees (though they may still be a control person); and (v) creditors (though they may be an owner if the debt is convertible).

Control Over Information Access

Given the sensitive nature of the reported information, the CTA imposes rigorous confidentiality, security, and access restrictions on the data collected by FinCEN. FinCEN is permitted to disclose reported BOI in limited circumstances to a statutorily defined group of governmental authorities and financial institutions. For instance, federal agencies may only gain access to BOI when it will be used to support a national security, intelligence, or law enforcement activity. For state, local, and tribal law enforcement agencies, a court of competent jurisdiction must authorize the agency to seek BOI as part of a criminal or civil investigation, similar to a search warrant. Foreign government access is limited to requests made by foreign law enforcement agencies, prosecutors, and judges under specific circumstances.

With the consent of the reporting company, FinCEN may also disclose BOI to financial institutions to aid them in complying with customer due diligence requirements under applicable law. Finally, a financial institution’s regulator can obtain BOI that has been provided to a financial institution it regulates for the purpose of performing regulatory oversight that is specific to that financial institution.

The CTA instructs the Secretary of the Treasury to maintain BOI “in a secure, non-public database, using information security methods and techniques that are appropriate to protect non-classified information security systems at the highest security level.” To implement this requirement, FinCEN has been developing the Beneficial Ownership Secure System (BOSS) to receive, store, and maintain BOI. However, FinCEN will need to implement rules, controls, and procedures to further ensure the protection and confidentiality of the information and that access is only obtained as statutorily directed.

Timing of Reports/Compliance

The compliance effective date for the new rule is January 1, 2024, though entities subject to its provisions that were created before January 1, 2024, will have one year (until January 1, 2025) to file their initial reports. Entities created after January 1, 2024, will have 30 days after receiving confirmation of creation from their respective secretary of state or similar office, to file.

FinCEN has not yet published the reporting forms but will seek comment on the same prior to effectiveness.

Updated or corrected reports must be filed within 30 calendar days 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, as well as any change with respect to information reported for any particular beneficial owner or applicant. Apart from the obvious changes, professionals should remember the duty to update when a beneficial owner is deceased, new ownership transfers to heirs and descendants , or when a previously minor child beneficial owner reaches the age of majority.

Furthermore, the final rule does not adopt a good faith or other standard concerning the requirements to update or correct reports. The CTA places the reporting responsibility on reporting companies, and this responsibility includes the obligation to report accurately. The CTA also mandates reporting companies to update information when it changes.

Penalties for Non-Compliance

The Act enforces stringent penalties for non-compliance. The failure to provide complete or updated information, or the provision of false or fraudulent information can result in severe repercussions, including a hefty fine and up to three years of incarceration.

Conclusion

With the enforcement of the new rules, private companies can no longer operate under the veil of secrecy. Transparency in ownership structure is now the norm, and it represents a significant stride in the prevention of financial crimes. Despite the stringent reporting requirements and potential penalties for non-compliance, the rule also provides an increased level of confidence in the US financial system for all stakeholders, from investors to law enforcement agencies.

The complexities of the rule necessitate that all entities within its purview be aware of its provisions and ensure compliance. While the rule may appear to be a significant burden for many businesses, ultimately, it is a part of the broader aim to enhance the integrity and transparency of business operations in the United States.

This critical shift towards transparency in private company ownership, brought about by the Corporate Transparency Act and FinCEN's BOI Rule, is indeed a game-changer. The days of private company ownership secrecy are behind us, and it's time for businesses to adapt to the new normal.