Passed by Congress on Jan. 1, 2021, as part of the National Defense Authorization Act of 2021, the Corporate Transparency Act (the CTA; codified in 31 U.S.C. § 5336) requires certain businesses formed in or registered to do business in the United States to report beneficial ownership information to the Financial Crimes Enforcement Network (FinCEN). The CTA’s primary policy objective is to stem the use of shell companies to facilitate the movement and sheltering of illicit funds in the United States.
The CTA requires reporting companies to report to FinCEN the name, date of birth, current address, and unique identifying number (from an acceptable identification document such as a driver’s license or passport) for each applicant and beneficial owner.
Definition of “Reporting Company”
A “reporting company” is any non-exempt corporation, limited liability company, or similar entity that is created under the laws of any state or formed under the laws of a foreign country and registered in any state. This includes any entity that is created by filing with the secretary of state of a state or territory in the US, such as corporations, LLCs, limited partnerships, and limited liability partnerships.
There are a number of categories of exemptions, such as:
- publicly traded companies
- governmental entities
- banks
- credit unions
- money transmitting businesses
- broker-dealers
- exchanges or clearing agencies
- investment advisers registered with the SEC
- investment advisers exempt under the venture capital adviser exemption and that is current with its exempt reporting adviser filings
- insurance companies and insurance producers
- commodity pool operators, commodity trading advisors, and other entities registered with the CFTC
- public accounting firms registered under Sarbanes-Oxley
- public utilities
- financial market utilities
- private funds advised by a registered investment adviser or venture capital fund adviser
- non-profit organizations and their affiliates
- any company that has (i) more than 20 full-time employees in the U.S., (ii) a physical office in the U.S., and (iii) more than $5 million in gross receipts or sales in the aggregate
- inactive entities, which is limited to entities in existence for over 1 year, that are not engaged in active business, have no foreign owners, receipts in the last 12 months of less than $1,000, no assets, and were in existence on or before January 1, 2020
- companies wholly owned by other exempt entities (other than if those exempt entities are money-transmitting businesses, private funds, or inactive entities)
What is most notable about the list of exemptions is that most small businesses and startups are not included, which means that the cost of compliance will fall on businesses with the least resources.
Definition of “Applicant”
An “applicant” is the person who actually makes the initial filing to form the business with the Secretary of State (which could potentially include many attorneys, acting for their clients) or anyone who directs that such filing be made.
Definition of “Beneficial Owner”
A “beneficial owner” is any individual who directly or indirectly exercises “substantial control” over a reporting company (but excluding a person whose control is derived strictly from employment) or owns or controls a 25% or more “ownership interest” in a reporting company. It will be the company’s responsibility to collect the information from individuals who meet these criteria, including from persons who may have an indirect interest in the company. There may also be some complex and subjective judgments involved in determining who meets these criteria.
“Substantial control” can mean any of the following:
- Service as a senior officer (such as president, secretary, treasurer, chief financial officer, general counsel, chief executive officer, or chief operating officer)
- Authority over the appointment or removal of any senior officer or a majority or dominant minority of the board of directors (or similar body)
- Direction, determination, or decision of, or substantial influence over, important matters affecting the company; and
- Any other form of substantial control over the reporting company.
Penalties
Further, failing to report under the CTA, or knowingly reporting false information, is punishable by a $500/day fine and/or a criminal penalty of up to $10,000 in fines and up to two years imprisonment. Therefore, businesses will need to take their reporting obligations under the CTA seriously.
Timeline for Implementing the CTA
The CTA will take effect on a date determined in the final FinCEN regulations. FinCEN intends to promulgate the regulations in three phases. A proposed rule was released for the first phase on Dec. 7, 2021, (available here) and the remaining two phases have yet to be acted upon. FinCEN has not yet given any guidance on when they intend to make the reporting obligations effective, stating “The effective date for the final reporting rule will also turn on several additional factors, such as: (1) How long reporting companies, and small businesses in particular, need to comply with the new rules; (2) the time needed for secretaries of state and Tribal authorities to understand the new requirements and to update their websites and other documentation to notify reporting companies of their obligations under the CTA; and (3) the anticipated timeline for [the third phase of rulemaking], which is triggered by the effective date of the final reporting rule.”
Once the Corporate Transparency Act is in effect, as provided in the proposed regulations, reporting companies formed before the effective date of the final regulation would have a year to file their initial reports; reporting companies created or registered after the effective date would have 14 days after their formation to file. Upon a change in beneficial ownership, reporting companies would have 30 days to file updates to their previously filed reports.
The requirements of the Corporate Transparency Act will have a significant impact on the practice of formation and compliance for business entities that do not fit within an exemption, including most startups and small businesses. Entities that have complex ownership structures, with multiple tiers, will likely be most significantly impacted. Businesses should begin thinking about adding provisions to governing documents related to requiring owners to provide the required information.
An annotated version of the Corporate Transparency Act, including the proposed regulations, can be found here.
This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.
