What to Know About FinCEN's Proposed Rule to Implement the Beneficial Ownership Information Reporting Requirements of the Corporate Transparency Act

On December 8, 2021, the Financial Crimes Enforcement Network (FinCEN) took a key step toward implementing the highly anticipated beneficial ownership information (BOI) reporting requirements of the Corporate Transparency Act (CTA). The primary purpose of the CTA, enacted as part of the Anti-Money Laundering Act of 2020 (AML Act), is to protect the US financial system from being used for illicit purposes, including preventing corrupt actors, terrorists and criminals from hiding assets in anonymous shell companies. As directed by the CTA, FinCEN issued a Notice of Proposed Rulemaking proposing regulations that would require reporting companies to disclose to FinCEN the identity and other information of every individual who is a beneficial owner and every individual who is a company applicant of the reporting company (Proposed Rule). Ultimately, FinCEN intends to host the collected information in a nationwide beneficial ownership registry and rescind or revise FinCEN's 2016 Customer Due Diligence Rule (CDD Rule), which may alleviate certain onboarding and compliance burdens for financial institutions.

In this Advisory we summarize the types of entities that would have to comply with the Proposed Rule, the information they would have to disclose (including who is a "beneficial owner"), and the timing of the proposed reporting obligations. As we have written previously (here and here), the AML Act (including the CTA) is the most significant overhaul of the Bank Secrecy Act and related anti-money laundering (BSA/AML) laws since the enactment of the USA PATRIOT Act of 2001. In the last section of this Advisory, we summarize the additional rules that FinCEN will propose under the CTA that likely will impact how financial institutions comply with certain elements of their BSA/AML obligations.

What Entities Would Have to Comply With the Proposed Rule?

Generally, the Proposed Rule would apply to corporations, limited liability companies, and other entities created by the filing of formation documents with a secretary of state or similar office of a state or Indian tribe, e.g., most limited partnerships and business trusts. The Proposed Rule would apply equally to companies formed under the law of a foreign country that is registered to do business in any state or tribal jurisdiction.

The CTA exempts a wide array of entities from the definition of "reporting company." The following entities would not have to comply with the BOI reporting requirements under the Proposed Rule: SEC reporting issuers and Exchange Act registered entities; investment companies and investment advisers; securities brokers and dealers; governmental entities; banks, credit unions, and depository institution holding companies; money transmitting businesses; clearing agencies; venture capital fund advisers; insurance companies and state-licensed insurance producers; accounting firms; public utilities; financial market utilities; pooled investment vehicles; Commodity Exchange Act registered entities; and tax-exempt entities and entities assisting tax-exempt entities.

Also exempt from the BOI reporting requirements would be "large operating companies," defined as entities that employ more than 20 full time employees in the US, have an operating presence in the US, and have more than $5 million in annual sales. Subsidiaries of certain exempt entities and inactive entities would also be exempted from the reporting requirements. 

What Information Would Have to be Reported?

Reporting companies would be required to file reports with FinCEN that identify: (1) every individual who is a Beneficial Owner of the entity (defined below) and (2) every individual who filed the application to form the entity or register it to do business, including anyone who directs or controls the filing of the document by another (Company Applicant).

For every Beneficial Owner and Company Applicant, the reporting company would have to identify the full legal name, date of birth, current address, and unique identification number (e.g., a passport or driver’s license number) of the individual. The reporting company would also be required to provide an image of the document containing both the individual's unique identification number and photograph. As a substitute for individuals and legal entities required to provide this information to Reporting Companies, the proposed rule allows for individuals and legal entities to apply for and obtain a "FinCEN identifier," which can then be provided to the Reporting Company in lieu providing personal information.

Who Would be a "Beneficial Owner"?

Consistent with the CTA, a beneficial owner would include any individual who meets at least one of two criteria: an individual who directly or indirectly (1) exercises "substantial control" over the reporting company; or (2) owns or controls at least 25 percent of the "ownership interests" in the reporting company (Beneficial Owner). The Proposed Rule clarifies the CTA by proposing definitions of "substantial control" and "ownership interests," which are not defined in the CTA.

Substantial Control

The Proposed Rule sets forth three indicators of "substantial control": (1) service as a senior officer of the reporting company; (2) authority to appoint or remove any senior officer or dominant majority of the board of directors (or similar body) of the reporting company; and (3) direction, determination or decision of, or substantial influence over important matters affecting the reporting company. The Proposed Rule includes a catch-all control provision ("[a]ny other form of substantial control over the reporting company"), which is meant to convey that substantial control can take forms other than the three specified indicators. 

Significantly, this "control prong" under the Proposed Rule is broader than the control prong under the Customer Due Diligence Rule (CDD Rule) that currently governs required disclosures new legal entity customers must make to their financial institutions. Under the CDD Rule, as a general matter, new legal entity customers must identify only one individual who exercises a "significant degree of control over the entity." The Proposed Rule requires reporting companies to disclose to FinCEN all individuals with substantial control over the entity. The Proposed Rule's divergence from the CDD Rule on the control prong is likely to invite further public comment; however, FinCEN is unlikely to modify this aspect of the Proposed Rule in any material respect in a subsequent final rule. FinCEN noted in the Proposed Rule release that it rejected adopting the CDD Rule's control prong because the CTA mandates that FinCEN rescind and revise portions of the CDD Rule, including the provision on beneficial owners. Also, the failure to identify all individuals with substantial control of the reporting company would undermine the CTA's purpose of preventing bad actors from hiding their assets in anonymous shell companies. 

Ownership Interests

The Proposed Rule provides that "ownership interests" include equity interests in the reporting company and "other types of interests, such as capital or profit interests (including partnership interests) or convertible instruments, warrants or rights, or other options or privileges to acquire equity, capital, or other interests in a reporting company."

As with the control prong, FinCEN is contemplating a definition of "ownership interests" that is broader than the analogous provision in the CDD Rule. For example, under the CDD Rule, assets held in a trust are deemed to be owned by their trustees. Under the Proposed Rule, where ownership interests of a reporting company are held in a trust, an individual would be deemed to have "ownership interests" if the individual is: a trustee with authority to dispose of trust assets; a beneficiary who is the sole permissible recipient of income and principal from the trust or has the right to demand a distribution of or withdraw substantially all of the assets of the trust; or a grantor or settlor who has the right to revoke the trust or otherwise withdraw the assets of the trust. FinCEN acknowledges the complexities concerning the attribution of ownership interests held in trust, and is expressly inviting further comment on this topic.

Exceptions to the Definition of "Beneficial Owner"

A "beneficial owner" would not include categories such as: minors; individuals acting as a nominee, intermediary, custodian, or agent on behalf of another individual; individuals with a future interest in a reporting company through inheritance; and certain creditors of a reporting company.

When Would Reporting Companies be Required to Report to FinCEN?

The Proposed Rule would not take effect until after FinCEN has considered public comments to the Proposed Rule and has issued its final regulation. Comments on the Proposed Rule will close on February 7, 2022.

Once the final regulation is effective, domestic reporting companies created before the effective date of the final regulation would have one year to file their initial BOI report. Reporting companies created after the effective date would have 14 days after their formation to file. The same deadlines would apply to existing and newly registered foreign reporting companies. Reporting companies would have 30 days to file updates to their previously filed reports, and 14 days to correct inaccurate reports after they discover or should have discovered the reported information is inaccurate.

Future Proposed Rules Implementing the CTA

In addition to ushering in the proposed new BOI reporting regime applicable to many domestic and foreign entities operating in the United States, the CTA will, eventually, impact how financial institutions comply with their BSA/AML obligations. For example, the CTA requires FinCEN to rescind and revise portions of the CDD Rule within one year after the effective date of the BOI reporting regulations proposed yesterday. Specifically, the CTA requires FinCEN to rescind 31 CFR 1010.230(b)–(j), which are the beneficial ownership collection requirements that financial institutions have spent years implementing and perfecting. The purpose of the revisions will be to conform the CDD Rule with the CTA, reduce unnecessary or duplicative burdens on financial institutions and their legal entity customers and—in potentially welcome news to financial institutions—account for financial institutions' eventual access to the BOI that will be reported to FinCEN, which the CTA authorizes in certain circumstances (and with the customer’s consent). These CTA provisions will not take effect until FinCEN implements corresponding rules, which FinCEN has yet to propose.

Financial institutions seeking advice on any comment to the Proposed Rule, or seeking assistance with the ongoing BSA/AML reform generally, are encouraged to contact any of the authors of this Advisory or their usual Arnold & Porter contact.

© Arnold & Porter Kaye Scholer LLP 2021 All Rights Reserved. This Advisory is intended to be a general summary of the law and does not constitute legal advice. You should consult with counsel to determine applicable legal requirements in a specific fact situation.