Locke Lord QuickStudy: Some Key Takeaways From the FinCEN ‎December 7, 2021 Notice of Proposed Rule Making ‎Under the ‎Corporate Transparency Act

As a follow-up to our earlier QuickStudies ‎on the Corporate Transparency Act (“CTA”), ‎Anti-‎Money Laundering Act of 2020 ("AMLA") and art and antiquities under the AMLA, we are providing this QuickStudy to highlight a few of the ‎important takeaways from the December 7, 2021, Financial Crimes Enforcement Network (“FinCEN”) ‎Notice of Proposed Rulemaking (“NPRM”) relating to the implementation of the CTA. Although the ‎final regulations are not yet in effect, companies, their beneficial owners and “company applicants” ‎should begin to collect the necessary information to make their initial FinCEN CTA filings as they ‎become required under the proposed shortened time periods provided in the NPRM.‎

The NPRM clarifies a number of definitions and exemptions contained in the CTA, including, who is ‎a “company applicant” and who must file as a “beneficial owner”. FinCEN’s NPRM makes clear that ‎FinCEN intends to exercise its rule making authority to clarify a number of ambiguities in the CTA ‎and to shape the exemptions to filing beneficial ownership reports with FinCEN that were specifically ‎included in the CTA. However, FinCEN has not used its authority to tailor many of the CTA’s ‎statutory exemptions, nor does the NPRM provide any new exemptions.‎

As discussed in our earlier QuickStudies, Congress enacted the CTA as part of the AMLA to increase ‎transparency by requiring “reporting companies” to file basic information concerning business, ‎‎“beneficial ownership,” and “company applicant” information with FinCEN. Failure to comply with the ‎CTA’s reporting requirements can lead to civil and criminal penalties, including a maximum civil ‎penalty of $500 each day the violation continues (up to $10,000), and imprisonment for up to two ‎years.‎

The CTA and the NPRM demonstrate that FinCEN is targeting information from smaller enterprises, ‎startups and foreign entities registering in the United States to do business. Among the exemptions ‎available under the CTA, are exemptions for entities who are regulated by other government ‎authorities (be they federal or state), such as companies whose shares are publicly traded, banks, ‎insurance companies and producers, brokers or dealers in securities, registered investment ‎companies and advisers, venture capital fund advisers, as well as accounting firms, tax exempt ‎entities (or those assisting tax exempt entities), and special pooled investment funds. ‎

Large operating companies may be exempt from CTA filings with FinCEN. To qualify for the large ‎operating company exemption the enterprise must have each of the following attributes:‎

‎(1) “Employ more than 20 employees on a full-time basis in the United States;”‎

‎(2) have filed Federal income tax returns in the prior year “demonstrating more than ‎‎$5,000,000 in gross receipts or sales in the aggregate,” including receipts or sales from entities ‎owned by the entity and through which the entity operates; and

‎(3) have “an operating presence at a physical office within the United States.”‎

The NPRM also clarifies when a subsidiary of an exempt entity is also exempt from CTA filings ‎limiting the exemption to subsidiaries that are owned entirely by one or more exempt entities. ‎

For enterprises formed after the effective date of the CTA final regulations, the reports will be due to ‎FinCEN 14 days after the date of initial filing with the Secretary of State (or similar authority) or tribal ‎authority.‎

Although the CTA itself would have permitted non-exempt enterprises up to two years to file initial ‎reports, the NPRM provides that the time to file initial reports with FinCEN will be shortened to only ‎one year. Accordingly, if the final regulations adopt the language from the NPRM, initial reports for ‎existing non-exempt entities together with their beneficial owners and company applicants will be ‎required to be filed with FinCEN within one year from the effective date of the regulations.‎

Reports by existing or newly formed non-exempt enterprises are required to contain: (1) the ‎company’s full name; (2) any trade names, fictitious names or D/B/As; (3) business street address; (4) ‎jurisdiction of formation; and (5) IRS taxpayer ID number (TIN) as well as information relating to each ‎beneficial owner and company applicant.‎

The beneficial ownership reports must be filed and updated promptly with respect to each beneficial ‎owner (as defined) following changes in “beneficial ownership” and must include (1) the name of the ‎beneficial owner required to make the report, (2) the person’s birthdate; (3) the person’s address; and ‎‎(4) a unique identifying number from an acceptable identification document, such as a passport or ‎the unique ID number issued by FinCEN to the beneficial owner or company applicant, or both with ‎an image of the applicable document). In contrast to the FinCEN Bank Secrecy Act CDD ‎Rule, which requires legal entity customers to identify only a single individual under the “control ‎prong” of the definition of beneficial owner, the proposed CTA regulations, if adopted in the form in ‎the NPRM, would require beneficial ownership reporting for each individual deemed to exercise ‎substantial control over a reporting company.‎

The term “beneficial owner” is defined by the CTA as “any individual who, directly or indirectly” either: ‎‎(1) “exercises substantial control” over the reporting company; or (2) “owns or controls” at least 25% of ‎the ownership interests of the reporting company. The terms “substantial control” and “ownership ‎interest” are not defined in the CTA. If the final regulations adopted by FinCEN mirror the proposed ‎regulations in the NPRM, then for purposes of the CTA, individuals who own or control 25% or more ‎of the ownership interests of an enterprise, and all senior officers, persons with authority over ‎appointment or removal of senor officers, persons who have the ability to appoint or remove members ‎of the governing authority (i.e., directors, managers or LLCs, general partners, etc.) and persons who ‎can exert substantial influence on material decisions by the enterprise all will be deemed have ‎substantial control of the enterprise and thus will be required to file reports with FinCEN as having ‎‎“substantial control” of the enterprise. Unfortunately, “substantial influence” is also not a defined ‎term. However, the NPRM is clear that the above criteria are not exclusive. Accordingly, FinCEN can ‎exercise broad discretion on a case-by-case basis to decide who is and who is not in “substantial ‎control” of or who exercises “substantial influence” over the enterprise and is thus required to file ‎beneficial ownership reports with FinCEN. ‎

The 25% ownership interests’ trigger for filings is similarly broadly defined. If the final regulations ‎follow the NPRM proposed regulations, the 25% beneficial ownership filing requirement will require ‎the enterprise and all potentially reporting persons to consider ‎

‎(i) all forms of equity in the enterprise as well as capital and profit interests,‎

‎(ii) convertible securities (shares, bonds and notes), and

‎(iii) warrants and other forms of or rights, options or privileges to acquire equity, capital, ‎membership interests, limited liability company interests, partnership interests, economic or other ‎ownership interests.‎

The proposed regulations also give the term “company applicant” a very broad definition for purposes ‎of requiring filings with FinCEN. The definition would cover the individual who filed the application ‎to form the enterprise (be it a certificate or articles of incorporation, certificate of formation, limited ‎partnership certificate or other initiating document) for a non-exempt corporation, limited liability ‎company, or other similar entity under the laws of a State or Tribe. For foreign entities, a ‎company applicant would be the individual who files the application or document that first registers ‎the entity to do business in the United States. It not only includes the actual person that made the ‎filing but also any person who directs or controls the filing of the relevant document by another ‎person or entity. This would include lawyers, persons acting for corporate service companies, ‎accountants, financial planners, etc. to the extent that such persons filed the document or caused it ‎to be filed. In the NPRM, FinCEN specifically identifies and treats lawyers and corporate service ‎companies, as gatekeepers who have knowledge necessary for FinCEN to exercise its regulatory ‎authority and duty to maintain the registry required by the CTA. Thus, where an enterprise uses an ‎attorney, service provider or other person to file the relevant formation document, both the filer and ‎the person who directed or controlled the filing must each file beneficial ownership reports with ‎FinCEN.‎

It can be anticipated that state and tribal authorities such as Secretaries of State and similar ‎authorities that accept filings for new non-exempt enterprises may adopt their own rules and forms, ‎and make their own disclosures directly to FinCEN to enable FinCEN to enforce its regulations. This ‎may result in delays in forming new business that are not exempt from the CTA’s filing requirements ‎once the final FinCEN regulations are effective. ‎

Failure to comply with the CTA’s reporting/filing requirements once the final regulations are in effect ‎can lead to civil and criminal penalties, which may include a maximum civil penalty of $500 each day ‎the violation continues (up to $10,000), and imprisonment for up to two years. Accordingly, it would ‎be prudent to begin to collect the necessary information from the “company applicants”, “beneficial ‎owners” and control persons of existing non-exempt enterprises and from such persons involved in ‎the formation of new enterprises in order to enable timely filing of the necessary reports.‎

The NPRM does not identify a proposed effective date for the final regulations but anticipates that the ‎effective date will be soon after the date the final regulations are published in the Federal Register.‎

The NPRM also advises that further rulemaking will occur with respect to who and how access to the ‎registry will be regulated and limited and conforming regulations under the Banks Secrecy Act ‎applicable to financial institutions.‎

The comment period for the Notice of Proposed Rulemaking ends February 7, 2022.‎