Beneficial Owner and Entity Registration Legislation to Combat Money Laundering
Comprehensive summary of the implications for US and non-US entities
How the legislation reaches beneficial owners worldwide
Impacts Funds, and M&A and other transactions
What is the CTA?
The Corporate Transparency Act is a federal law designed to help law enforcement investigate potential money laundering by requiring millions of U.S. and non-U.S. entities that meet the criteria and are not exempt (described below) (“Reporting Company”) to file a form with the U.S. Financial Crimes Enforcement Network (“FinCEN”) identifying, among other information, the natural persons who are beneficial owners of the entity. The FinCEN rule requires disclosure of the beneficial owner information (“BOI”) for both beneficial owners themselves as well as the person who controls or facilitated the formation of the entity.
Designed to combat the use of shell companies for criminal purposes, the rules target smaller, lightly regulated entities that may not be subject to other beneficial ownership reporting requirements. Approximately 30 million entities are caught within the scope of the reporting requirements, reaching across borders to beneficial owners all over the globe. It impacts funds and portfolio companies, operating companies doing business in the United States, and gives rise to special considerations in M&A deals and transaction structures that use SPVs or involve roll-ups and mergers. Additionally, attorneys who assist with the formation of an entity may need to file a report as a “company applicant.”
What the CTA is not.
It is not a publicly-available database of beneficial ownership.
FinCEN is only authorized to disclose beneficial ownership information to a limited group of requestors and only for certain purposes that relate to law enforcement and national security, and to disclose such information to federal, state and local law enforcement with court authorization, to financial institutions to comply with legally mandated customer due diligence and to the federal agencies that regulate those institutions, to the US Department of Treasury, and to certain foreign agencies requesting information through a US federal agency for law enforcement, national security or intelligence purposes.
A diverse universe of entities and businesses worldwide are impacted.
Despite the 23 exemptions described below, due to the nature and type of entities targeted, the reach of the law is broad and includes entities with complex ownership structures, such as certain types of funds and partnerships which may find it difficult to interpret and apply the Act’s broad and subjective provisions. Foreign companies active in the United States may be disproportionately impacted because the exemptions are based on a company’s US operations and regulatory status, and because a truly foreign entity is captured simply if it does business in the United States as a branch office or otherwise by virtue of having registered to do business as a “foreign” (meaning not formed by that State) entity within any state.
Specific examples of businesses that require a CTA applicability review include:
- Private Investment Fund Managers – the rules pertaining to these entities are quite complex, as some entities trigger filing and some do not. Private funds must do an entity-by-entity analysis within their portfolios.
- Family Offices that do not operate through an entity that is otherwise exempt.
- Portfolio companies that are reporting companies must also keep track of their beneficial owners because changes may trigger an updated filing requirement.
- Non-public companies doing business through US entities.
- Special Purpose Acquisition Vehicles.
- Real estate investment entities.
IDENTIFYING ENTITIES THAT MEET THE “REPORTING ENTITY” CRITERIA.
The law sets forth different criteria for domestic and non-US entities.
A domestic Reporting Company is a corporation, limited liability company, or other entity created by the filing of a document with a secretary of state or similar office under the law of a U.S. state or Indian tribe, including Limited Liability Partnerships. Sole proprietorships, certain trusts, and general partners that are not created through a filing with a State agency are not Reporting Companies. Business license registration alone does not quality an entity as a Reporting Company.
A foreign Reporting Company is a corporation, limited liability company or other entity formed under the law of a foreign country and registered to do business in any State or tribal jurisdiction by the filing of a document with a secretary of state or similar office. Foreign entities formed without a filing under their local laws become Reporting Companies when they register to do business in the United States, thus catching foreign businesses that operate a US branch office.
Exemptions from “Reporting Company” definition
There are 23 categories of exemptions, dominated by entities that are otherwise already regulated in the United States; there are only limited circumstances in which a foreign entity would fit within an exemption.
- Securities reporting issuer. Any issuer of securities that is either an issuer of a class of securities under section 12 of the Securities Exchange Act or that is required to file reports under section 15(d) of the Securities Exchange Act.
- Governmental authority. Any entity that is a federal, state, or local government or the government of an Indian tribe.
- Bank. Any bank, as defined in the Federal Deposit Insurance Act, the Investment Company Act of 1940 or the Investment Advisers Act of 1940.
- Credit union. Any Federal credit union or State credit union.
- Depository institution holding company. Any bank holding company or any savings and loan holding company.
- Money services business. Any money transmitting business or money services business registered with FinCEN.
- SEC registered broker or dealer.
- SEC registered securities exchange or clearing agency.
- Other Exchange Act registered entity. Any other entity that is not a public issuer of securities, a broker dealer or a securities exchange or clearing agency that is registered with the SEC.
- SEC registered investment company or investment adviser.
- Venture capital fund advisers that meet certain criteria.[1]
- State regulated insurance company.
- State-licensed insurance producer operating at a physical office within the United States.
- CFTC registrants (Commodity Exchange Act registered entity, such as futures commission brokers, introducing brokers, commodity pool operators, commodity trading advisors, retail foreign exchange dealers, swap dealers and major swap participants registered with the CFTC.
- Public Accounting firm registered under the Sarbanes-Oxley Act.
- Public utility that provides telecommunications services, electrical power, natural gas, or water and sewer services within the United States.
- Financial market utility designated by the Financial Stability Oversight Council under section 804 of the Payment, Clearing, and Settlement Supervision Act.
- Pooled investment vehicle (PIV). Any pooled investment vehicle that is operated or advised by a bank, credit union, registered broker or dealer, registered investment company or investment advisor, companies that would be an investment company but for Section 3(c)(1) or 3(c)(7) of the 40 Act and that are or will be reported on their adviser’s Form ADV, which may not capture the full scope of investment vehicles operated or advised by these types of entities. There are layered rules that impact PIVs and such structures require close scrutiny. (see special considerations below)
- Certain Tax-exempt entities under the Internal Revenue Code Section 501(c) (non-profits), 527(a) (political organizations), or 4927(a) (non-exempt charitable trusts and split-interest trusts).
- Certain “US-centric entities” assisting or formed to govern, a tax-exempt entity. “US-centric entity” meaning the entity itself is US, beneficially owned or controlled by a US citizen or permanent resident, and derives majority of its funding from US persons.
- Large operating company. Any entity that (a) employees more than 20 full time employees in the U.S., (b) has an operating presence at a physical office in the U.S. that is distinct from the place of business of any other unaffiliated entity, and (c) reporting $5,000,000 or more in gross receipts or sales from US sources on its last federal income tax return, including revenues of other entities owned by the entity or through which it operates.
- Subsidiary of certain exempt entities, if wholly owned by another exempt entity, except that subsidiaries of exempt money service businesses, pooled investment vehicles, entities that assist tax exempt organizations and inactive entities would not be exempt.
- Inactive entity. Any entity that (i) was in existence on or before January 1, 2020, (ii) is not engaged in active business, (iii) is not owned, directly or indirectly, wholly or partially, by a foreign person, (iv) have not experienced any change in ownership in the prior 12-month period,(v) has not sent or received more than $1,000 in the preceding twelve months, and (vi) does not hold any assets in the US or abroad, including any ownership interest in any corporation, LLC or similar entity.
Entities that sit between an individual that qualifies as a Beneficial Owner and the Reporting Company are not reported. However, in certain circumstances the intermediate entity may file in lieu of individual Beneficial Owners.
Special considerations for limited partners of funds
Limited partners of a sponsor fund that holds interest in a Reporting Company will be subject to beneficial ownership reporting if the fund owns 25% or more of the Reporting Company.
If, however, the sponsor fund itself is exempt (for example, it fits within the PIV Exemption), then the limited partners of the fund will likely not need to be reported whether or not they surpass the 25% threshold.
IDENTIFYING BENEFICIAL OWNERS and COMPANY APPLICANTS
Beneficial ownership analysis considers both ownership and control, and allows certain exemptions, and the rules set forth methodologies for calculating beneficial ownership.
FinCEN defines “beneficial owner” as any individual who, directly or indirectly, either
- owns or controls at least 25% of the ownership interests of the reporting company; or
- exercises substantial control over the reporting company.
Ownership test
The ownership test requires an entity-by-entity evaluation of the fully diluted cap table or profits data of each entity in a corporate structure to identify beneficial owners, through the following instruments:
- Equity, Stock, or Voting Rights – Any interest classified as stock or anything similar, regardless of whether it confers voting power or voting rights, and even if the interest is transferable and not vested.
- Capital or Profits Interest – Any interest in the assets or profits of an LLC, which is similar to stock in a corporation (“unit”).
- Convertible Instruments – convertible into equity, stock, or voting rights, or capital or profit interest.
- Options or other privilege.
- Catch All – any other instrument, contract, arrangement, understanding, relationship, or mechanism establishing ownership.
Calculating Ownership Interests
The methodology involves creating a cap table for the Reporting Company to analyze the number of shares (or units of ownership interest) owned by each owner, and percentage of each class or type of shares (or other securities) owned by each owner. Also, if a particular owner itself is an entity, a cap table analysis must be conducted for each such entity owner until all potential ultimate 25% or more natural person owners are identified.
There are rules to be applied regarding the attribution ownership in an entity to a natural person, including how to evaluate and attribute ownership in situations impacted by contractual control, joint ownership, ownership held as nominee or custodian, and interests held in trust.
The cap table must be created on a fully diluted basis, as if all options and convertible securities had been converted, even if the interests have not yet vested or are not yet exercisable.
The methodology varies by type of entity, and is calculated as of the current date; however, options and similar instruments are treated as exercised.
Methodology:
Reporting Companies that issue shares of stock
Requires evaluating the person’s ownership based upon a combined voting power analysis, and combined value of ownership interest.
The ownership percentage is the greater of (1) the total combined voting power of all classes of ownership interests of the individual as a percentage of total outstanding voting power of all classes of ownership interests entitled to vote, and (2) the total combined value of the ownership interests of the individual as a percentage of the total outstanding value of all classes of ownership interests.
Reporting Companies that issue capital/profits interests
Calculate the person’s capital plus profits interest as a percentage of total outstanding capital and profits interest.
This method applies to entities treated as partnerships for federal income tax purposes. Any entity that is taxed as a partnership is subject to an additional set of analyses depending on whether the partners’ respective “Voting Percentage” and “Value Percentage” of ownership can be determined “with reasonable certainty” without regard to external factors such as a valuation or profitability. If external factors are relevant, the rules prescribe that the “percentage of class” calculations of the cap table will be determinative.
Catch All: If the facts and circumstances do not permit the calculations described in either above to be performed with “reasonable certainty”, any individual who owns or controls 25 percent or more of any class or type of ownership interest of a Reporting Company shall be deemed to own or control 25 percent or more of the ownership interests of the Reporting Company.
Substantial Control test – Fact based, case-by-case, entity-by-entity analysis
This test involves analysis of a swath of entity documents: constituent and governing documents, such as articles of incorporation and bylaws or any analogous document such as an LLC operating agreement; any document that can indicate the wielding of control such as a shareholders’ agreement, voting agreement, voting trust; employment agreements involving senior officers of the corporation; and any other contract or arrangement that affects the corporation’s decision-making.
For any reporting company that is not a corporation or LLC, the constituent documents will include any document that involves or affects the reporting company’s decision-making.
The following persons are deemed a Beneficial Owner for reporting purposes:
- Senior officers. FinCEN has explicitly included the president, CEO, CFO, COO, general counsel/chief legal officer, or “any other person, regardless of title, who performs similar functions” to be a Beneficial Owner. Officers who only perform ministerial functions, like a secretary or treasurer, or officers of a subsidiary may not necessarily have the requisite control to be considered a Beneficial Owner.
- A person with the authority to appoint or remove a senior officer or a majority of the board of directors or similar governing body.
- A person who directs, determines, or has substantial influence over important decisions made by the reporting company, including decisions regarding the company’s:
- Business, such as the nature, scope, and attributes of the business, lines of business, or geographic focus; or key operations decisions such as entering into, fulfilling or terminating significant contracts; or
- Finances, such as the disposition, sale, lease, mortgage, or other transfer of principal assets; reorganization, dissolution, or merger; major expenditures or investments, issuances of any equity, incurrence of any significant debt, or approval of the operating budget; or
- Structure, such as amendments to the governance documents, compensation schemes and incentive programs for senior officers.
A broad catch-all captures any other form of substantial control over the Reporting Company.
Beneficial Owner Exclusion Test
Certain individuals are excluded from the definition of Beneficial Owner, and may be excluded from the report.
- A minor child (report parent or guardian PII)
- An individual acting as a nominee, intermediary, custodian, or agent on behalf of another individual;
- An employee of a reporting company, acting solely as an employee (not including senior officer), whose substantial control over or economic benefits from such entity are derived solely from the employment status of the employee;
- Future inheritors – An individual whose only interest in a reporting company is a future interest through a right of inheritance;
- A creditor of a reporting company.
IDENTIFYING COMPANY APPLICANT
“Company Applicants” must also file a BOI report, and includes persons who directly file the document creating the company, or in the case of a foreign company, the individual who directly files the document that first registers the foreign company, and the individual who directs or controls filing of document creating the company. At least one person must report, but no more than two individuals are required to be identified. Companies or legal entities cannot be Company Applicants.
Examples of Company Applicants include the attorney or paralegal primarily responsible for overseeing the preparation and filing of incorporation documents and/or who directly files them with a state office; business owner who prepares business formation documents for its own reporting company, as well as an agent directed by such individual to file the documents. Business formation services have a separate set of rules.
THE INFORMATION REQUIRED FOR THE BENEFICIAL OWNERSHIP REPORT
The required information is akin to the KYC information typically collected for AML compliance.
- Full legal name
- Any trade name or “doing business as” name
- Complete current address
- The state or jurisdictions of the reporting company’s formation
- The reporting company’s US taxpayer identification number (TIN)
Each Beneficial Owner must disclose:
- Full legal name
- Date of birth
- Residential street address
- A unique identifying number (which may be a non-expired U.S. passport, a non-expired identification document, such as a driver’s license, and an image file of the document that provides the unique identifying number.
CURRENT STATUS OF IMPLEMENTATION, FILING DEADLINES, PENALTIES
Filing Deadlines
- Reporting Companies that existed prior to January 1, 2024 must file no later than January 1, 2025.
- Reporting Companies formed between January 1, 2024 and January 1, 2025 must file no later than 90-days after the entity is recognized in the filing jurisdiction.
- Reporting Companies formed or registered from January 1, 2025 onward must file no later than 30-days after the entity is recognized in the filing jurisdiction. States are enacting their own legislation (such as New York, see below) which may impose a State filing requirement on a faster timeline.
Updates: “30 day amendment Rule”
If there are any changes or corrections to a BOI previously filed, an updated BOI must be filed within 30 days of the change. Changes that must be reported include:
For a Registered Company
- New DBA
- New address
- New CEO
- Correct error in previous filing
Currently company dissolution or termination does not trigger filing an updated report.
For a Beneficial Owner
- New drivers’ license
- New address
- Change in 25% ownership
- Transition from minor to age of majority
- Settlement of the estate of deceased beneficial owner
Impact of the Federal Court Case that Declared the CTA Unconstitutional
On March 1, 2024, the U.S. District Court for the Northern District of Alabama held that the CTA is unconstitutional as beyond Congress’s authority. The Court acknowledged that the CTA was designed to stop U.S. and non-U.S. entities from engaging in money laundering, tax avoidance, and other criminal activities, but ruled that the reporting requirements were not sufficiently tailored to be within Congress’s Constitutional legislative powers to regulate foreign affairs and national security, interstate commerce, and impose taxes. The Court also found that and that the CTA impinged on the powers traditionally held by state governments over the formation of new companies. The Court suggested how Congress might amend the CTA to fit within the Constitution’s Commerce Clause.
This does not mean that the law is not in effect. The court ruled the law unconstitutional but only enjoined its enforcement against the specific plaintiffs in the case. FinCEN issued a statement declaring that the law remains in effect for all reporting companies who are not plaintiffs.[2] The U.S. government appealed, and may seek a stay of the district court’s ruling pending the appeal, which would pause the effect of the ruling until the federal appellate court (Eleventh Circuit) decides the case.
Given the unsettled status, entities that trigger the Reporting Company criteria should gather the necessary information and be prepared to make a timely filing.
Criminal and Civil Penalties for failure to file
The law provides that it is unlawful to willfully provide or attempt to provide false or fraudulent BOI, and to unlawful to willfully fail to report complete or updated BOI. Penalties apply to individuals, Reporting Companies, and other entities if culpable, and can include:
- Criminal penalties of up to $10,000, and up to 2 years in prison, or both
- Civil Penalties of up to $500 per day.
- Possible liability for the person causing the failure to report or the senior officer at the time of the failure.
CONSIDERATIONS FOR PRIVATE FUNDS, ADVISORS AND VENTURE CAPITAL FUNDS
Uncertainty abounds as to the exempt status of certain entities in fund structures
Fund structures often include LLPs, which are non-exempt entities that may trigger a filing requirement. There is no specific exemption for family offices as such. Only investment advisors that are registered with the SEC under the Investment Advisors Act of 1940 are exempt. Consequently, the following are NOT exempt under the Registered Investment Advisor exemption (unless another exemption applies):
- “private fund advisers” exempt from SEC registration under Section 203(m) of the Advisers Act because they advise solely private funds that have a total of less than $150 million in assets under management in the U.S.,
- state registered investment advisers, or
- any holding company or upstream entity that directly or indirectly owns the investment adviser. Therefore, these categories of entities will be subject to the CTA.
There is no express exemption for entities that are established to serve as general partners of a limited partnership or managing members in a limited liability company. However, a case-by-case analysis can be done to determine if a particular entity may fit within the SEC no-action letter guidance allowing such vehicles to rely upon the investment adviser’s registration with the SEC provided that certain conditions are met. The CTA exemption may extend to such entities.
There is also uncertainty as to how carry vehicles and co-investment vehicles may be treated in fund structures. Case-by-case analysis is required of venture capital fund advisers and pooled investment vehicles, particularly foreign pooled vehicles which are carved out of the exemption and must provide a report albeit a more limited report to FinCEN of the BOI of the individual who exercises substantial control over the legal entity (unless another exemption applies). However, such entities must be registered to do business in the U.S. to be subject to the CTA, hence if a foreign pooled investment vehicles is not registered in the U.S. then it is not subject to the CTA.
There is no blanket exemption for subsidiaries of exempted pooled investment vehicles. In the adopting release, FinCEN noted “While distinct legal entities that are wholly owned by exempted pooled investment vehicles may be integrally related to the administration of those pooled investment vehicles, whether they are exempt from the reporting requirements of the CTA depends on whether they themselves, in their own right, meet the criteria of an exemption. FinCEN declines to provide a blanket expansion of this exemption to include all entities related to a pooled investment vehicles or any subsidiary entity that would be used as a vehicle to onboard new outside capital or assets.” Therefore, it is necessary to analyze each subsidiary of a pooled investment vehicle to ascertain whether an exemption applies.
CTA IN M&A, PRIVATE EQUITY, JOINT VENTURES AND OTHER STRATEGIC TRANSACTIONS
M&A and other strategic transactions frequently involve special purpose vehicles, which may or may not be exempt. A deal-by-deal analysis is required.
SPVs may be able to rely on the subsidiary exemption, which will depend on the nature of the parent’s status as a Registered Company. However, subsidiaries of a parent entity exempt under the Pooled Investment Vehicle (PIV) Exemption are not eligible for the Subsidiary Exemption. So, a newly formed SPV that is wholly owned and controlled by a financial buyer—for example, a private equity fund entity that is exempt under the PIV Exemption—will likely be a Reporting Company unless the entity can claim the Subsidiary Exemption on another basis (e.g., where ownership interest in the SPV is controlled by an exempt registered investment advisor, likely not the case for a non-US PE fund). On the other hand, a newly formed SPV that is wholly owned and controlled by a strategic buyer—for example, a public company or a company exempt under the Large Operating Company Exemption—may be exempt.
Holding companies with no independent operations will likely not be exempt because, if it is a subsidiary of a fund, it will not qualify for the Subsidiary Exemption and as a holding company because it is not downstream in an ownership chain from an exempt entity, and it likely does not have enough employees (20 in the US) to qualify for the large company exemption.
A joint venture entity potentially may be able to rely upon an exemption of its parents.
With respect to any entities newly formed in connection with an M&A transaction (for example, an acquisition vehicle, merger subsidiary, holding company, or blocker entity), the Company Applicants will often be (1) the third-party corporate service provider who files the document and (2) a member of the legal deal team who directs such filing.
Impacts on M&A Deal Structure and Documents
An SPV, such as a merger subsidiary that is the non-surviving entity in a merger transaction effective before such entity’s filing deadline, under the current rule, likely need not file on the deadline because it would be filing historical information that is not true on the date of filing.
Interim period filings and post-closing covenants may need to be addressed if information must be updated.
Collateral documents including rollover agreements, employment agreements, operating agreements, and shareholder agreements may need to be amended to address BOI filing requirements and require officers, directors and significant shareholders to provide BOI so that the company can collect, track, compile, and update the information in a timely fashion.
Due Diligence needs to be added concerning corporate policies and proof of compliance.
HOW WE CAN ASSIST YOUR CLIENTS
The law is broad, complex and subjective. The updating requirement imposes a need for new corporate policies and procedures for monitoring changes. We can assist your clients:
- Review existing corporate organizational charts and entities, and review every entity in the corporate structure to identify reporting companies.
- Assess whether an exemption applies.
- Assist with determining who are the beneficial owners subject to reporting.
- Develop internal polices and best practices for the formation of new entities going forward.
- Develop compliance policies for the monitoring of a Registered Company as well as tracking beneficial owner changes that may trigger the filing of an updated BOI report within 30 days of an event.
- Ensure that directors and officers understand their responsibilities and liability exposure.
- Keep your clients apprised of FinCEN updates.
[1] Any investment adviser that is described in section 203(l) of the Investment Advisers Act of 1940 (15 U.S.C. 80b–3(l)); and Has filed Item 10, Schedule A, and Schedule B of Part 1A of Form ADV, or any successor thereto, with the Securities and Exchange Commission.
[2] FinCEN issued a statement declaring “The Justice Department, on behalf of the Department of the Treasury, filed a Notice of Appeal on March 11, 2024. While this litigation is ongoing, FinCEN will continue to implement the Corporate Transparency Act as required by Congress, while complying with the court’s order. Other than the particular individuals and entities subject to the court’s injunction, as specified below, reporting companies are still required to comply with the law and file beneficial ownership reports as provided in FinCEN’s regulations.”
