FinCEN’s Beneficial Ownership Reporting Requirements: Key Takeaways and Open Questions

In this Ropes & Gray podcast, partners Ama Adams and Brendan Hanifin, counsel Emerson Siegle, and associate Kurt Fowler discuss FinCEN rulemaking implementing the beneficial ownership reporting requirements of the Corporate Transparency Act. The rule will significantly expand the scope of information that certain legal entities must disclose under U.S. law, and compliance with the rule’s requirements may present particular complexity for traditional tiered holding company structures.

Ama Adams: Hello, and thank you for joining us on this Ropes & Gray podcast. Today, we will be discussing a final rule, titled “Beneficial Ownership Information Reporting Requirements,” that was released by the Financial Crimes Enforcement Network (“FinCEN”) on September 29. I’m Ama Adams, a partner in Ropes & Gray’s anti-corruption and international risk group. Joining me for today’s discussion are Brendan Hanifin, another partner in our anti-corruption and international risk group, counsel Emerson Siegle, and senior associate Kurt Fowler. Kurt, to set the stage for our discussion, would you provide an overview of the Final Rule and its background?

Kurt Fowler: The Final Rule implements the beneficial ownership reporting requirements of the Corporate Transparency Act, which was enacted as part of the landmark Anti-Money Laundering Act of 2020 (or the “AMLA”).

The AMLA, which still is in the process of being implemented, represents the most sweeping overhaul of the U.S. anti-money laundering regime since the passage of the PATRIOT Act in 2001, in the wake of the attacks on September 11. Among other steps, the AMLA requires FinCEN—the primary U.S. anti-money laundering regulator—to (1) establish government-wide priorities in relation to anti-money laundering and counterterrorism financing; and (2) introduce affirmative beneficial owner disclosure requirements for certain corporations, limited liability companies, and similar entities. It’s this latter requirement that the Corporate Transparency Act (or “CTA”) was designed to address.

The reporting requirements of the CTA are intended to expand and modernize the U.S. government’s ability to collect beneficial ownership information to deter money laundering, corruption, tax evasion, fraud, and other financial crime. It is anticipated that the information collected by FinCEN will be available to law enforcement, intelligence, and national security agencies, as well as financial institutions with customers’ consent.

The Final Rule requires “reporting companies” to file reports with FinCEN that provide identifying information of (1) themselves; (2) their “beneficial owners”; and (3) their “company applicants.” Each of these terms is carefully defined.

Brendan Hanifin: As Kurt mentioned, the Final Rule applies to reporting companies. Reporting companies include both (1) domestic entities created by filing a document with a state’s secretary of state and (2) foreign entities registered to do business in a U.S. state. Importantly, though, the Final Rule sets forth 23 exemptions to the definition of reporting company. Entities falling into one of these exemptions are not required to file reports with FinCEN. Key categories of exemptions include:

• Large operating companies, which are defined as entities that (1) employ more than 20 full-time employees in the United States; (2) have an operating presence at a physical office within the United States; and (3) generate more than $5 million in gross sales or receipts. This exemption would capture, among other entities, many of the operating companies in which private equity and venture capital funds are invested.
• Another exemption is for investment companies, investment advisers, and venture capital fund advisers registered with the Securities and Exchange Commission (or “SEC”).
• Another exemption applies to pooled investment vehicles operated or advised by a qualifying bank, credit union, broker-dealer, investment company, investment adviser, or venture capital fund adviser.
• And a final exemption applies to subsidiaries of most—but not all—exempt entities.

Emerson Siegle: Under the new Rule, reporting companies will be required to provide identifying information on their beneficial owners. The term “beneficial owner” means any individual who, directly or indirectly, either (1) owns or controls at least 25% of the ownership interests of a reporting company; or (2) exercises “substantial control” over a reporting company.

Notably, the Rule’s ownership prong reflects a functional approach, designed to capture types of arrangements beyond traditional equity interests, such as convertible instruments and profit interests. The Rule’s substantial control prong encompasses both an objective and a subjective component.

With respect to the objective component, substantial control encompasses any natural person who either (1) serves as a senior officer of a reporting company; or (2) has authority over the appointment or removal of any senior officer or a majority of the board of directors (or similar) of a reporting company.

With respect to the subjective component, substantial control also encompasses any natural person who directs, determines, or has substantial influence over key decisions made by a reporting company. As a practical matter, this subjective component will require reporting companies to undertake fact-based assessments to determine which individuals could be deemed to significantly influence important decisions. Notably, reporting companies are required to provide information on all individuals meeting the substantial control threshold, as opposed to just a single control person.

Ama Adams: In addition to beneficial owners, reporting companies must report information on company applicants, meaning the individual who files the document that creates or registers a reporting company, as well as the individual who is primarily responsible for directing or controlling such filing. In many cases, the company applicant may be an external service provider, such as outside counsel.

Kurt Fowler: For each individual who qualifies as a beneficial owner or company applicant, reporting companies must provide the individual’s full legal name; date of birth; residential address; unique identifying number from a non-expired U.S. passport, state identification document or driver’s license, or foreign passport; and an image of that passport, ID, or driver’s license.

Brendan Hanifin: While the process of identifying individuals who qualify as beneficial owners or company applicants may be cumbersome, reporting companies have a good amount of time before the reporting requirement takes effect. The Final Rule will take effect on January 1, 2024, with a one-year grace period (until January 1, 2025) for covered entities created or registered prior to January 2024.After an initial report has been filed, reporting companies will be required to file updates, within 30 days, of any changes in the reported information. For example, if a reporting company experiences a change in beneficial owner, or a beneficial owner changes their residential address, a report must be filed.

Failure to comply with the Final Rule’s reporting requirements can lead to (1) civil penalties of up to $500 per day; or (2) criminal penalties of up to $10,000 or imprisonment for up to two years.

Emerson Siegle: Perhaps the largest challenge to complying with the Final Rule will be to identify all persons whose information must be disclosed. As I mentioned earlier, beneficial owners include all individuals who either (1) exercise “substantial control” over a reporting company, or (2) own or control at least 25% of the ownership interests of a reporting company.

Ama Adams: The substantial control prong, in particular, may pose challenges for reporting companies, and especially reporting companies with complex control structures. “Substantial control” is defined as including the ability to exercise substantial influence over important decisions of the reporting company. Examples of these important decisions include decisions regarding major expenditures or investments, incurrence of significant debt, approval of the operating budget, and reorganization, dissolution, or merger. All of these decisions are often the subject of minority investor protective provisions. To that end, the Final Rule states that substantial control could arise from board representation or any other contract, arrangement, understanding, or relationship, evidencing FinCEN’s intent that the Rule be interpreted broadly in favor of disclosure.

Kurt Fowler: FinCEN’s introduction to the Final Rule acknowledges that a reporting company may be structured in such a way that multiple individuals exercise equal authority over the company’s decisions, in which case each individual likely would be considered to have substantial control. Taking these points together, it seems plausible that FinCEN may expect reporting companies to disclose board representatives of minority investors whose vote is required to cause or prevent a key decision of the reporting company, even if the investor itself is not subject to a disclosure obligation.

Brendan Hanifin: Even prior to the Rule’s effective date, it is foreseeable that investors—and non-U.S. investors, in particular—may take steps to avoid having their ownership interests disclosed to FinCEN. These steps may include (1) seeking representations regarding an entity’s reporting company status; (2) seeking notice and opt-out rights in the event that the foreign investor’s participation would require disclosure of information on its personnel; or (3) even electing to forego board representation and other rights.

Ama Adams: Another feature of interest in the Final Rule relates to the treatment of holding companies. As mentioned earlier, the Final Rule identifies 23 categories of legal entities that are exempt from the definition of reporting company, including wholly owned subsidiaries of most—but not all—other exempt entities. This exemption does not include subsidiaries of pooled investment vehicles. Many private equity transactions involve holding companies introduced into the ownership chain for a variety of tax, structuring, and other reasons. Based on a plain reading of the Final Rule, many of these vehicles would appear to be reportable.

Kurt Fowler: Another interpretative question arises with respect to the treatment of subsidiary entities that are controlled, but not wholly owned, by an exempt entity. The subsidiary exemption applies to “any entity whose ownership interests are controlled or wholly owned, directly or indirectly by” certain exempt entities. FinCEN considered, but declined, expanding the subsidiary exemption to include all majority-owned subsidiaries. As a result, it is unclear whether the subsidiary exemption would apply, for example, to a joint venture entity two-thirds owned by a public company and one-third owned by a passive foreign investor. In these circumstances, the joint venture would be controlled by the public company, but not wholly owned by it.

Brendan Hanifin: Still another open question relates to the treatment of co-investment vehicles. Private equity sponsors frequently form co-investment vehicles that invest in portfolio companies alongside their funds.

Pooled investment vehicles, which are exempt from the reporting company definition, are defined to include a company that “is identified by its legal name by the applicable investment adviser in its Form ADV” filed with the SEC.

Some private equity sponsors may list such co-investment vehicles in a “miscellaneous” section in their Form ADV. This miscellaneous section is separate from an earlier section in the Form where information on funds is provided.

The Final Rule’s definition of pooled investment vehicle—which includes companies “identified” in the Form ADV—leads to some ambiguity on whether it would capture co-investment vehicles listed in the miscellaneous section. Technically, these vehicles are identified in the Form ADV, however, FinCEN declined to expand the pooled investment vehicle exemption to include related entities used to onboard new outside capital, suggesting that the bureau’s intent was to capture these vehicles.

Emerson Siegle: Thankfully, as Brendan mentioned earlier, the Final Rule does not take effect until January 2024. In the interim, we expect FinCEN to introduce detailed FAQs to address specific factual circumstances. These FAQs may help shine light on some of the more important interpretive questions in the Final Rule, like how broadly to read certain categories of exemptions that Ama, Brendan, and Kurt have touched upon. It will therefore be important for regulated parties to monitor guidance from FinCEN prior to the effective date of the Final Rule.

Ama Adams: Thank you, Brendan, Emerson, and Kurt, for joining me today for this discussion. And thank you to our listeners. For more information regarding the topics discussed today, as well as links to our recent client alerts and analyses, please visit Ropes’ anti-corruption and international risk practice page at www.ropesgray.com. If we can help you to navigate these issues, please do not hesitate to contact us. You can also subscribe and listen our podcasts wherever you listen to podcasts, including on Apple or Spotify. Thanks again for listening.