Implementation of Beneficial Ownership Reporting Obligations; Expanded CDD Rule Forthcoming
On September 29, 2022, the U.S. Department of Treasury’s Financial Crimes Enforcement Network (“FinCEN”) issued a final rule implementing the Beneficial Ownership Information Reporting Requirements (the “BOI Rule”),1Beneficial Ownership Information Reporting Requirements, 87 Fed. Reg. 59,498 (Sept. 30, 2022), available at: https://www.govinfo.gov/content/pkg/FR-2022-09-30/pdf/2022-21020.pdf. pursuant to the Corporate Transparency Act (“CTA”). As discussed in our previous client alerts,2See FinCEN Requests Comments on Beneficial Ownership Reporting Requirement; FinCEN’s Request for Information Moves U.S. Towards Modernization Of BSA/AML Regime (Dec. 17, 2021), available at: https://www.kslaw.com/news-and-insights/fincen-requests-comments-on-beneficial-ownership-reporting-requirement-fincens-request-for-information-moves-us-towards-modernization-of-bsaaml-regime. the passage of the William M. Thornberry National Defenses Authorization Act for Fiscal Year 2021 (“NDAA”), which included the CTA and the Anti-Money Laundering Act of 2020 (“AMLA”), reflects the U.S. government’s commitment to combat corruption, money laundering, terrorist financing, tax fraud, and other illicit activities. The BOI rule is intended to help “stop criminal actors, including oligarchs, kleptocrats, drug traffickers, human traffickers, and those who would use anonymous shell companies to hide their illicit proceeds.”3FinCEN Issues Final Rule for Beneficial Ownership Reporting to Support Law Enforcement Efforts, Counter Illicit Finance, and Increase Transparency (Sept. 29, 2022), available at: https://www.fincen.gov/news/news-releases/fincen-issues-final-rule-beneficial-ownership-reporting-support-law-enforcement.
Keeping with this objective, the CTA requires U.S.-incorporated and U.S.-registered corporations, limited liability companies (“LLCs”), and similar entities (“Reporting Companies”) to report information about their beneficial owner(s) and individual company applicant(s) to FinCEN. This reporting requirement, however, is subject to a significant list of exceptions. Additionally, the CTA tasked the Department of Treasury, through FinCEN, to promulgate and issue regulations governing the procedural standards for reporting such information. On December 7, 2021, FinCEN issued a Notice of Proposed Rule Making requesting public comments on a proposed rule implementing the CTA.4Beneficial Ownership Information Reporting Requirements, 86 Fed. Reg. 69,920 (Dec. 8, 2021), available at: https://www.govinfo.gov/content/pkg/FR-2021-12-08/pdf/2021-26548.pdf. FinCEN issued the BOI Rule after reviewing over 240 public comments.587 Fed. Reg. 59,498, 59,509. “This final rule,” said Acting FinCEN Director Himamauli Das, “is a significant step forward in our efforts to support national security, intelligence, and law enforcement agencies in their work to curb illicit activities.”
A. Types of Reporting Companies
The BOI Rule recognizes two types of Reporting Companies: domestic and foreign. A domestic reporting company is a corporation, LLC, or any entity created by the filing of a document with a secretary of state or any similar office under the law of a state or Indian tribe. A foreign reporting company is a corporation, LLC, or other entity formed under the law of a foreign country that is registered to do business in any state or tribal jurisdiction by the filing of a document with a secretary of state or any similar office. Private funds managed by a small private fund adviser, state-regulated adviser, or offshore private fund registered to conduct business in one or more states, may be subject to reporting requirements.
B. Exempted Entities from Reporting Companies
The BOI Rule exempts 23 categories of entities from the definition of “Reporting Company,” as they are already subject to substantial federal and/or state regulations that mandate beneficial ownership reporting or are in regulated industries, such as banks, credit unions, broker-dealers, registered investment advisers, and money service businesses. The BOI Rule also excludes from its final regulations, entities that: (i) employ more than 20 full-time employees in the United States; (ii) have an operating presence at a physical office in the United States; and (iii) have filed a federal income tax return in the United States demonstrating more than $5 million in gross receipts or sales.
Notably, the BOI Rule excludes certain trusts from the definition of “Reporting Company” to the extent that they are not created by the filing of a document with a secretary of state or similar office. FinCEN recognizes that, in most states, the creation of certain types of trusts, as well as sole proprietorships and general partnerships, typically do not involve the filings of such a formation document, and therefore will not be considered reporting companies under the final rule.
C. Required Disclosure in a BOI Report
The BOI Rule requires Reporting Companies to identify themselves and report four pieces of information to FinCEN about their beneficial owners and company applicants: 1) full legal name, 2) date of birth, 3) current address, and 4) a unique identifying number from a non-expired and government-issued identification document (and the image of such document).
Alternatively, an individual may obtain a “FinCEN Identifier” number by providing these four pieces of information directly to FinCEN. In lieu of providing the above-referenced information about an individual beneficial owner or company applicant, a Reporting Company may include this individual’s “FinCEN Identifier” in its BOI report to FinCEN.
D. Two-Prong Definition of Beneficial Owners
The BOI Rule adopts a two-prong definition of a beneficial owner: a beneficial owner is any individual who, directly or indirectly, either 1) exercises substantial control over a reporting company, or 2) owns or controls at least 25 percent of the ownership interests of the reporting company. Each reporting company will be required to identify as a beneficial owner any individual who satisfies either of these two prongs of the definition. FinCEN expects that a reporting company will identify at least one beneficial owner under the “substantial control” component.
The BOI Rule largely adopts the three indicators of “substantial control” in the proposed rule, with some clarifying changes. Substantial control is obtained by someone who:
(a) Serves as a senior officer of the reporting company;
(b) Has authority over the appointment or removal of any senior officer or a majority of the board of directors (or similar body); or
(c) Directs, determines, or has substantial influence over important decisions (including a list of seven types of decisions) made by the reporting company.
The BOI Rule also retains the catch-all provision of the “substantial control” definition from the proposed rule aimed to close the loopholes that allow corporate structures that purposefully obscure beneficial owners.
As for “ownership interests,” FinCEN expects most reporting companies will have simple ownership structures. Thus, it would be a straightforward process to calculate, determine, and report their beneficial owners. When dealing with more complicated legal entities, such as certain trusts, the final rule provides that ownership interests of a Reporting Company can be held in a trust. In this circumstance, the BOI Rule identifies the trustee as an individual who will be deemed to control trust assets for the purpose of determining which individuals own or control 25 percent of the ownership interests of the reporting company. The final rule also identifies circumstances in which ownership interests held in trust will be considered as owned or controlled by a beneficiary, such as when the beneficiary is the sole recipient of income from the trust, or has the right to demand a distribution of, or withdraw substantially all, the assets in the trust. Trust assets will be considered owned or controlled by a grantor or settlor if such individual or entity has the right to revoke the trust or withdraw its assets. Thus, subject to the specifics of the trust arrangement, the ownership interests held in a trust could be considered owned or controlled by multiple parties.
The BOI Rule exempts these five types of individuals from the definition of “beneficial owner”:
1) A minor child, as defined under the law of the State or Indian tribe in which a domestic reporting company is created or a foreign reporting company is first registered, provided the reporting company reports the required information of a parent or legal guardian of the minor;
2) An individual acting as a nominee, intermediary, custodian, or agent on behalf of another individual;
3) An employee of a reporting company, acting solely as an employee, whose substantial control over or economic benefits from such entity are derived solely from the employment status of the employee;
4) An individual whose only interest in a reporting company is a future interest through a right of inheritance; and
5) A creditor of a reporting company.
E. Two Types of Company Applicants
The final rule recognizes two persons as a company applicant: 1) for a domestic reporting company, the individual who directly files the document that creates the domestic reporting company; and 2) for a foreign reporting company, the individual who directly files the document that first registers the foreign reporting company. In both cases, the company applicant is the individual who is primarily responsible for directing or controlling such filing if more than one individual is involved in the filing of the document.
F. Limited Access to the BOI Reports
Given the sensitivity of the BOI reports, the CTA imposes strict access restrictions on the data FinCEN collects under the BOI Rule. FinCEN may disclose BOI reports in limited circumstances to a statutorily defined group of governmental authorities and financial institutions. For example:
- Federal agencies may only obtain access to BOI reports in furtherance of national security, intelligence, or law enforcement activity.
- For state, local, and Tribal law enforcement agencies, there must be a valid court order authorizing the agency to seek BOI as part of a criminal or civil investigation.
- Foreign government access is limited to requests made by foreign law enforcement agencies, prosecutors, and judges in specified circumstances.
- Financial institutions may, with the consent of the reporting company, obtain BOI reports to help them comply with customer due diligence requirements under applicable law.
- Regulators of financial institutions may obtain BOI reports that have been provided to the financial institutions they regulate for the purpose of performing regulatory oversight that is specific to those financial institutions.6Id. at 59,507.
FinCEN has indicated that it would engage in additional rulemaking to establish rules for who may access the BOI reports, for what purposes, and what safeguards will be required to ensure that the information is secured and protected.
G. Impact on the Customer Due Diligence Rule
The BOI Rule’s definition of beneficial ownership, particularly its “substantial control” prong, is significantly broader than that under the customer due diligence (“CDD”) rule.7See Customer Due Diligence Requirements for Financial Institutions, 81 Fed. Reg. 29,398 (May 11, 2016), available at: https://www.govinfo.gov/content/pkg/FR-2016-05-11/pdf/2016-10567.pdf. Published on May 11, 2016, the CDD Rule applies to a list of covered financial institutions, requiring them to know the identities of their legal entity customers at the account opening stage as well as the individuals who own or control those entities, i.e., their beneficial owners.
The CDD Rule similarly reflects the two-prong definition of beneficial ownership. While its Ownership prong requires the disclosure of an individual has at least 25 percent ownership interest in a legal entity, its Control prong is limited to: 1) an individual that has significant responsibility to control, manage, or direct a legal entity customer; or 2) any other individual who regularly performs similar functions. Such inquiries are significantly narrower than the “substantial control” prong discussed previously in Section D.
FinCEN has indicated its intention to revise the 2016 CDD Rule through a future rulemaking process that will provide the public with an opportunity to comment on the effect of the BOI Rule on financial institutions’ CDD obligations.
H. Consequences of Non-Compliance
Failure to comply with the CTA reporting requirements may result in substantial fines or even criminal conviction and prison time. It is a violation of the law for any person to willfully provide, or attempt to provide, false or fraudulent beneficial ownership information to FinCEN. It is also illegal to willfully fail to report complete or updated beneficial ownership information to FinCEN. Violating the reporting requirements of the CTA can result in civil penalties of $500 for each day that the violation continues (up to $10,000) and criminal penalties of imprisonment of up to two years. Further, unauthorized disclosure or use of the submitted beneficial ownership information is punishable by civil penalties of $500 for each day the violation continues (up to $250,000) and criminal penalties of imprisonment of up to 5 years.8See 31 U.S.C. § 5336.
The CTA does include a safe harbor provision from the civil and criminal penalties if the person who submitted the incorrect information submits a report containing corrected information no later than 90 days after their original submission, provided that the person unintentionally submitted the incorrect information initially. Additionally, the safe harbor provision excuses any person who unknowingly discloses or uses the confidential information.
I. Effective Date of the BOI Rule
The BOI Rule becomes effective on January 1, 2024. Reporting Companies created or registered before January 1, 2024, will have one year (until January 1, 2025) to file their initial reports. Reporting companies created or registered after January 1, 2024, will have 30 days after creation or registration to file their initial reports. Once the initial report has been filed, both existing and new reporting companies will have to file updates within 30 days of a change in their BOI. FinCEN extended this window to 30 days from the 14 days set forth in the proposed regulations.
J. Looking Ahead
As noted above, FinCEN will engage in additional rulemakings to implement the BOI Rule, including establishing rules governing access to the BOI reports and making conforming changes to the CDD rule. Additionally, FinCEN will need to develop the infrastructure to administer the BOI requirements, such as the information technology system that will store the beneficial ownership information, as well as develop compliance and guidance documents to assist reporting companies in complying with the rule. Finally, FinCEN intends to conduct extensive outreach to stakeholders, including industry associations and secretaries of state, to ensure the effective implementation of the rule.