New regulations will require companies to report accurate and up-to-date beneficial ownership information to the U.S. government. Keeping track of changes could prove to be a tall task. Miller & Chevalier’s Ian Herbert talks about what companies can do to stay compliant.
When FinCEN published its final rule regarding beneficial ownership reporting in September 2022, its primary goal was to create a comprehensive database of U.S. companies that could be used to aid government investigations. The Corporate Transparency Act (CTA) was based on the premise that criminal actors use the opacity of shell corporations to hide illicit movements of money.
As acting FinCEN director Himamauli Das said, “This final rule is a significant step forward in our efforts to support national security, intelligence and law enforcement agencies in their work to curb illicit activities.”
Because a primary goal of the registry is to aid government investigations, FinCEN put a premium on keeping the database up to date. FinCEN rejected calls from commenters to require companies to update beneficial ownership once a year as part of a tax return, for example, concluding that doing so would degrade the usefulness of the data. Instead, FinCEN requires companies to update any changes in beneficial ownership information within 30 days of the change.
“FinCEN considers that keeping the database current and accurate is essential to keeping it highly useful, and that allowing reporting companies to wait to update beneficial ownership information for more than 30 days — or allowing them to report updates on only an annual basis — could cause a significant degradation in accuracy and usefulness of the database,” the final rule concluded.
Fair enough — since the goal of the CTA is to ensure that enforcement agencies have accurate information, putting a premium on updating the database is important. However, the consequences of this decision are also significant for companies trying to remain in compliance. At a time when organizational structures are increasingly global and complex, the requirements for keeping that information accurate and up-to-date are growing.
Keeping track of ownership information can be a time-consuming and costly endeavor. In its final rule, FinCEN estimated that requiring annual reports instead of regular updates would have saved approximately $9 billion over the next 10 years.
Let’s consider the burdens and challenges associated with the new beneficial ownership registry and discuss some strategies for developing a compliance structure.
The 2021 Corporate Transparency Act included new reporting requirements that represent the most significant change in the formation of corporations in decades, and while it’s clear that the White House intends to use FinCEN regulations as part of its anti-financial crime pursuits, it may not be clear what that means for small companies.
Corporate Transparency Act: What Is It, and How Will It Affect Small Companies?
Do you have to register at all?
The first question a company must consider is whether it has to register at all. The CTA and its implementing regulations will require many U.S. companies to register with FinCEN and provide detailed information about their beneficial ownership, but there are a number of important exceptions.
Under the CTA, all “reporting companies” must report to FinCEN. Reporting companies are essentially U.S. companies created in the U.S. by filing a document with the secretary of state or foreign entities registered to do business in the U.S. by the filing of a document with the secretary of state. Whether a company is a reporting company, therefore, turns in the first instance on a question of state law: Does the state require the company to file a document with the secretary of state? For example, many general partnerships or trusts will not be reporting companies because in many states, such entities do not file any records with the secretary of state.
If a company is a reporting company, it will need to determine whether it is exempt from reporting. The CTA includes 23 categories of entities that do not have to report, largely because those entities are already regulated by different means.
For example, banks, money services businesses, insurance companies and broker-dealers are all exempt from reporting. In addition, public companies and “large operating companies” are exempt. Finally, any company that is “controlled or wholly owned” by an exempt entity is also exempt thanks to the “subsidiary exemption.” That means that in order to determine whether a company is exempt, the company will need to consider not only the statutory exemptions but also its corporate structure and whether their controlling or owning entities are exempt.
Companies that determine they are exempt from reporting should document the reasons for the exemption and monitor the factual basis for those exemptions, because if the basis changes, those companies will automatically become reporting companies and will need to report to FinCEN.
“Any entity that no longer meets the criteria for any exemption under paragraph (c)(2) of this section shall file a report within 30 calendar days after the date that it no longer meets the criteria for any exemption.”
Thus, a company that determined it did not have to report due to the subsidiary exemption is not exempt from reporting in perpetuity and will have to regularly confirm that it is still controlled or wholly owned by an exempt entity. If the owner sells a portion of the company, that could change the status of the subsidiary, for example.
Reporting isn’t set-it-and-forget-it
The compliance challenges don’t end once the company determines that it must report. Because companies have to update any changes to beneficial ownership within 30 days, companies must also implement processes to monitor changes to beneficial ownership.
A beneficial owner is anyone who owns more than 25 percent of the reporting company or exercises substantial control over the reporting company. Ownership is not just based on stock ownership but can include capital and profit interests, options or other arrangements and is calculated as a percentage of the total interest or the total voting interest.
Substantial control is also defined broadly as someone who (1) serves as a senior officer; (2) has authority to appoint or remove senior officers or members of the board; (3) directs, determines, or has substantial influence over “important decisions made by the reporting company” or (4) has “any other form of substantial control.”
These broad and subjective definitions of beneficial ownership may cause companies to over-report individuals as beneficial owners to ensure they don’t fail to report someone who is later found to have substantial control over the company. But doing that creates additional burdens associated with keeping beneficial ownership information up to date.
If a mom-and-pop business is owned and operated by just “mom” and “pop,” then it will be relatively straightforward to update the registry if mom changes addresses or pop sells his share. If, on the other hand, a reporting company has a complete C-suite, a board of directors and is partially owned by another entity with similar complexity — or a trust with a corporate trustee — the reporting company will have to report any changes about a host of different individuals.
Methods for remaining compliant
Companies have a number of tools that can help them stay in compliance. First, the statute has a built-in mechanism designed to help companies stay in compliance. Companies and individuals can apply for a FinCEN identifier, which is essentially a unique ID for any reporting companies or beneficial owners. Reporting companies can simply list FinCEN identifiers rather than provide all the information required under the regulations (including name, address, date of birth, photo ID, etc.). Then, the individual — not the reporting company — will be responsible for updating information like address and photo ID. The reporting company will still have to decide whether someone is a beneficial owner but will not have to worry about keeping the nitty-gritty details current.
Second, reporting companies will have to develop strong avenues of communication between themselves and their owners and instill in their owners the importance of providing updated information. Though the reporting obligation is technically on the subsidiary reporting company, in reality, it may be difficult for the subsidiary to keep its ownership information up to date without buy-in (and direction) from the owners. Reporting companies with complex ownership structures will need to communicate with their owners to obtain regular confirmation that the ownership and control of those companies hasn’t changed.
Finally, one of the most important tools available — already mentioned above — is to document all decisions about who is considered a beneficial owner and why. Doing so will allow the company to evaluate and reconsider its decisions with the benefit of its prior decision-making process. (In addition, because the CTA includes severe criminal penalties for willfully providing inaccurate information — up to two years in prison — documentation of the company’s analysis could help show that such decisions were not willfully inaccurate).
As these regulations go into effect, which doesn’t happen until 2024 for new entities and 2025 for entities already in existence — companies will develop more tools and strategies for ensuring they stay in compliance. Given the short timeframe for updating any changes, it will be important for companies to develop strategies for keeping beneficial ownership information accurate and up-to-date.
Ian Herbert represents global companies, executives and trustees through government investigations and related litigation at Miller & Chevalier. He has experience advising both individuals and entities, including multinational corporations, offshore trustees and financial services companies on a range of issues, including foreign bribery, tax fraud, money laundering and other financial crimes.
