The United States Congress, in a significant change to the corporate formation process, is requiring reporting of beneficial ownership of closely held entities, with potential civil and criminal fines and penalties for non-compliance.
Forming a company in the United States typically does not require reporting of the company’s beneficial owners to federal or state authorities, and unless the company is a regulated business, beneficial ownership can generally remain anonymous. Given the lack of reporting requirements, the use of anonymous shell companies has proliferated, which has been viewed by many as a significant impediment to law enforcement’s ability to combat money laundering, terrorism financing and other financial crimes.
To address this long-standing problem, on January 1, 2021, Congress passed the Corporate Transparency Act (the “CTA”) as part of the overall 2021 National Defense Authorization Act. Under the CTA, companies covered by the CTA will now be required to submit beneficial ownership information (including names of individual beneficial owners and other personal information) to the Financial Crimes Enforcement Network (“FinCEN”) of the Department of the Treasury. 
Entities subject to reporting beneficial ownership information under the CTA include closely held U.S. domestic entities (whether formed before or after the effectiveness of the CTA) and foreign entities authorized to do business in the United States (regardless of when authorized), in each case unless an exception under the CTA applies. The beneficial ownership reporting requirements will also extend to individuals engaged to form (i.e., incorporate) a covered entity, which would presumably include lawyers, accountants and other service providers that are not otherwise employed by the company covered by the CTA. The information is intended to be used by U.S. federal and state law enforcement (and by banks in connection with customer due diligence) and will not be disclosable to the public.
The CTA will become effective upon promulgation of final regulations by the Treasury Department no later than January 1, 2022 (i.e., no later than 12-months after Congress’ passage of the CTA). Reporting beneficial ownership will be required at the time of formation of a company, or, for existing companies covered by the CTA, within two years after the issuance of final regulations, and on an ongoing basis by updating the reported information within one year after any changes.
Entities Covered by the CTA
The CTA broadly defines a reporting company subject to the CTA as “a corporation, limited liability company, or other similar entity" that is (a) created by the filing of a document with the secretary of state or similar office under the laws of a state or Indian tribe or (b) formed under the law of a foreign country and registered to do business in the United States by the filing of a document with the secretary of state or similar office under the laws of a state or Indian tribe.” This would include essentially every company doing business in the United States (other than presumably general partnerships, unincorporated business associations and sole proprietorships), unless the entity is exempt under the CTA.
Entities Excluded from the CTA
The CTA exempts entities that fall into one of two broad categories: First, entities that are already required to disclose beneficial ownership information publicly or to federal regulators such as public companies, banks, insurance companies, broker-dealers, investment companies and registered investment advisors, are not required to submit beneficial ownership information to FinCEN. Second, entities that are not typically associated with shell companies such as certain operating companies are exempted. Additionally, the list of exemptions contains a catch-all category, allowing the Treasury Department to exempt new entity types from the reporting requirements on the basis that such reporting would not serve the public interest.
The entities that are expressly excluded under the CTA from the definition of “reporting company” include the following:
- issuers with a class of securities registered under Section 12 of the Securities Exchange Act of 1934 (Exchange Act) or required to file periodic reports under Section 15(d) of the Securities and Exchange Act, of 1934 (the “Exchange Act”) (i.e., public companies with securities listed or quoted on U.S. securities exchanges);
- a “bank,” as defined in either (i) Section 3 of the Federal Deposit Insurance Act, (ii) Section 2(a) of the Investment Company Act of 1940, or (iii) Section 202(a) of the Investment Advisors Act of 1940;
- a federal credit union or state credit union;
- a bank holding company (as defined in Section 2 of the Bank Holding Company Act of 1956) or a savings and loan holding company (as defined in Section 10(a) of the Homeowners Loan Act);
- a broker or dealer, exchange or clearing agency, and other entities registered with the U.S. Securities and Exchange Commission under the Exchange Act;
- an entity that is either an investment company (as defined in Section 3 of the Investment Company Act of 1940) or an investment adviser (as defined in Section 202 of the Investment Advisers Act of 1940), in each case that is registered with the SEC under such acts;
- an investment adviser described in Section 203(l) of the Investment Advisers Act that has filed Item 10, Schedule A, and Schedule B of Part 1A of Form ADV, or any successor thereto, with the SEC;
- an insurance company (as defined in Section 2 of the Investment Company Act);
- a public accounting firm registered in accordance with Section 102 of the Sarbanes-Oxley Act of 2002;
- any pooled investment vehicle that is “operated or advised” by a bank, federal credit union or state credit union, registered broker or dealer, or investment company or investment adviser, in each case that is otherwise exempted as a reporting company;
- nonprofit organizations described in Section 501(c) of the Internal Revenue Code of 1986 (the Code) and exempt from tax under Section 501(a) of the Code;
- an entity that (i) employs more than 20 employees on a full-time basis in the United States, (ii) filed in the previous year federal income tax returns in the United States demonstrating more than $5 million in gross receipts or sales in the aggregate, including (a) other entities owned by the entity and (b) other entities through which the entity operates, and (iii) has an operating presence at a physical office in the United States;
- any corporation, limited liability company, or other similar entity of which the ownership interests are “owned or controlled,” directly or indirectly, by one or more entities described above (other than a “pooled investment vehicle” that is “operated or advised” and not “owned or controlled” by such other exempt reporting persons); and
- any entity or class of entities that the Secretary of the Treasury Department, with the written concurrence of the U.S. Attorney General and the Secretary of Homeland Security, has by regulation determined should be exempt from CTA beneficial ownership reporting requirements, on the basis that such reporting would not serve the public interest or benefit law enforcement.
Definition of a “Beneficial Owner” of an Entity Covered by the CTA
Under the CTA, a “beneficial owner” is defined as “an individual who, directly or indirectly, through any contract, arrangement, understanding, relationships, or otherwise:
- exercises “substantial control” over the entity or
- owns or controls not less than 25% of the “ownership interests” of the entity.”
The CTA excludes from the definition of “beneficial owner” (i) a minor child, if the information of the parent or guardian of the minor child is reported in accordance with the CTA, (ii) an individual acting as a nominee, intermediary, custodian, or agent on behalf of another individual, (iii) an individual acting solely as an employee of a reporting person and whose control over the economic benefits from such entity is derived solely from the employment status of the person, (iv) an individual whose only interest in a reporting company is through a right of inheritance, or (v) a creditor of a reporting person, unless the creditor meets the requirements of a “beneficial owner” based on substantial control or ownership or control of not less than 25% of the ownership interests.
Note the CTA does not define “substantial control” or “ownership interest” of a reporting entity and directs the Treasury Department to adopt regulations defining those terms.
What Beneficial Owner and Applicant Information Is Required to Be Reported?
The CTA mandates that Treasury promulgate regulations to require each reporting company to submit a report to FinCEN including the identity of (i) each beneficial owner of the applicable reporting company and (ii) each applicant with respect to that reporting company, by (a) full legal name, (b) date of birth, (c) current, as of the date on which the report is delivered, residential or business street address, and (d) the unique identifying number from an acceptable identification document (e.g., passport or driver license) or a FinCEN identifier issued in accordance with the CTA.
Beneficial ownership information must also be reported for individuals who file an application to form or register a reporting company to do business in the United States. This would presumably include lawyers, accountants and other service providers engaged as “incorporators”. Note the CTA does not exempt reporting companies formed prior to the enactment of the CTA from the requirement to disclose information regarding the applicant or applicants who formed or registered the reporting company in question.
What is the Required Timing for Treasury Regulations Under the CTA?
The CTA requires the Secretary of the Treasury to promulgate regulations under the CTA not later than one year after the enactment of the CTA (i.e., not later than January 1, 2022).
When Is Beneficial Owner Information Required to Be Reported to FinCEN?
Initial reporting requirements. For any reporting company that has been formed or registered before the effective date of the Treasury regulations to be promulgated under the CTA, not later than two years after the effective date of such Treasury regulations (i.e. on or prior to January 1, 2024). For any reporting company formed or registered after the effective date of such Treasury regulations, at the time of formation or registration.
Ongoing reporting requirements. The CTA also requires reporting companies to update any change with respect to any information changed related to beneficial ownership within one year after the date of a change and submit a report that updates the information relating to the change.
How Can CTA Beneficial Ownership Information Be Used?
The CTA provides that beneficial ownership information reported under the CTA will be confidential and will not be disclosed except as authorized by the CTA. The CTA permits U.S. federal agencies engaged in national security or intelligence activities to access this information without court order. However, disclosure to state, local, and tribal law enforcement is permitted only in those circumstances where a court has authorized the law enforcement agency to seek the information in a criminal or civil investigation. Additionally, law enforcement for foreign countries may obtain access to the information assuming the request is issued in response to a request for assistance in an investigation or prosecution by the foreign country and complies with the disclosure and use provisions of the treaty, agreement, or convention, publicly disclosing any beneficial ownership information received or limits the use of the information for any purpose other than the authorized investigation or national security or intelligence activity.
The CTA specifies a number of protocols for the use of beneficial ownership information included in reports and further provides that employees or officers of a requesting agency that violate such protocols, including unauthorized disclosure or use, will be subject to criminal and civil penalties.
What Are the Criminal and Civil Penalties for Noncompliance with CTA Reporting?
The CTA provides for civil penalties to the United States of not more than $500 for each day that a violation continues or has not been remedied and fines of up to $10,000 and possible imprisonment of up to two years for any person who willfully (i) provides, or attempts to provide, false or fraudulent beneficial ownership information (including identifying photographs or documents) or (ii) fails to report complete or updated beneficial ownership information to FinCEN.
Open Issues for Treasury Rulemaking
As mentioned above, the CTA directs the Treasury Department and FinCen to promulgate rules implementing a number of important provisions of the CTA that we anticipate will have a significant impact on how the CTA applies. Provisions of the CTA that are subject to such rulemaking include the following (i) how to define “other similar entity” for purposes of determining which entities are subject to reporting, (ii) what ownership percentage would be required to avoid separate reporting for subsidiaries, (iii) how to measure the $5.0 million of gross receipts “from other entities owned by the reporting entity” for purposes of the larger private company exception described above, (iv) which persons are deemed to exercise “substantial control” for purposes of determining beneficial ownership reporting (and whether they will include outside directors and managers, as well as holders of preferred stock with corporate approval rights commonly found in venture capital financings) (v) the definition of “ownership interest” for purposes of the 25% ownership test (and whether this would extend to, for example, options, warrants and convertible debt) and (vi) attribution rules for measuring the 25% reporting company ownership interest threshold generally.
The CTA represents a significant change in the corporate formation process in the United States. While many of the definitions, reporting procedures and disclosure protocols are to be implemented by January 1, 2022 by Treasury Department rulemaking, companies operating today that are subject to the CTA should be prepared to provide disclosure of beneficial ownership no later than January 1, 2024 and adopt procedures for ensuring ongoing compliance with the requirement to report any change in beneficial ownership status.
The following types of companies will likely be subject to beneficial ownership disclosure under the CTA:
- Real estate investors and family offices that hold investments in SPV’s.
- Independent sponsors, funds and other investors that are not affiliated with registered investment advisors.
- Newly formed companies, companies with limited operating history and any other operating company employing less than 20 employees on a full-time basis or that earn less than $5.0 million in gross receipts or revenue.
- Companies that operate on a “virtual company” model (such as certain bio-tech companies) and employ less than 20 employees on a full-time basis, regardless of revenue.
- Joint venture entities, unless controlled by entities exempted from the CTA.
- Foreign investors that set up “blocker” or similar vehicles in the U.S. for tax or regulatory purposes.
Finally, even if entities such as funds, lenders and larger operating companies are exempt from reporting under the CTA, beneficial ownership reporting considerations will still be relevant in connection with corporate finance, M&A and other transactions engaged in by such entities. For example, lenders (including mezzanine lenders in the real estate context) that take a security interest in the equity of a borrower that is a reporting company under the CTA will need to report changes to beneficial ownership in the event of foreclosure on the equity. CTA compliance will likely become a standard due diligence item for lenders and corporate acquirors. Governance provisions of operating and partnership agreements may need to be amended to include compliance covenants and potentially identify parties deemed to exercise “substantial control.”
Attorneys at Reitler are actively monitoring the CTA rulemaking process and are available to assist you with any questions you may have regarding this developing significant change to the corporate formation process