FinCEN - the Financial Crimes Enforcement Network - recently announced its Advance Notice of Public Rulemaking (the "ANPRM") to implement the beneficial ownership reporting requirements of the Corporate Transparency Act of 2020 (the "CTA").
The ANPRM does not include a proposed regulation, but rather lists 48 separate questions on which FinCEN is inviting public comment. There are at least three questions in this list of 48 that are especially surprising.
No One Knows What "Substantial Control" Means
Question 3.c. of the ANPRM asks commenters to suggest a definition for the term "substantial control". Under the CTA, covered entities must disclose (a) persons who beneficially own 25% or more of the covered entity, and (b) persons who are in "substantial control" of the covered entity. Surprisingly, Congress did not define the term "substantial control" in the statute itself. (I say "surprisingly" because it ought to have been obvious to the drafters of the law that if the law is going to require disclosure of "a" and "b" it is going to be necessary to define "b".)
A likely source for the definition of "substantial control" is our securities laws. The regulations promulgated by the SEC under the Securities Act of 1933 define “control (including the terms controlling, controlled by and under common control with) [as] the possession, direct or indirect, of the power to direct or cause the direction of the management and policies of a person, whether through the ownership of voting securities, by contract, or otherwise.” SEC Rule 405, 17 CFR 230.405.
In practice, though, the SEC and securities lawyers have come to view as a "facts and circumstances" test, requiring parties to look at all the factors that might give one person "control" over an issuer of securities. Factors can include (i) whether a person is an officer or director of the issuer, (ii) whether a person has the power to veto certain corporate actions, (iii) whether a person is a member of a "control group" that, collectively, has the power to control the management of the issuer, and (iv) the level of ownership that a person has, with 10% ownership representing a "red flag" that signals the potential for control. Because these facts and circumstances require the exercise of discretion, practitioners owner simplify these factors into a 10% ownership test, and simply presume that control is at issue for any person who owns 10% of more of an issuer's stock. This presumption also aligns neatly with other SEC rules (such as reporting requirements under the Securities and Exchange Act of 1934 and proxy rules) that relate to persons owning 10% or more.
If FinCEN adopts regulations that treat "substantial control" as synonymous with "control" (as used in the SEC context) then the CTA's reporting obligations may be extended to any owner of 10% or more of a covered entity (rather than the 25% level captured in the headlines).
No One Knows What an "Applicant" Is
The CTA also requires identification of the "applicant" who submits the beneficial ownership report on behalf of the covered entity. This term is also not defined in the statute an in question 4 of the ANPRM, FinCEN solicits comments on what this term might mean.
When business persons form a new company, the task of filing the relevant paperwork with the Secretary of State is often delegated to the law firm hired to handle the new company. The law firm will involve at least one attorney, and perhaps other paralegals or legal secretaries.
If a law firm prepares a beneficial ownership report for a client, is the "applicant" (a) the law firm, (b) at least one of the attorneys, or (c) the paralegal or secretary who physically prepares the application? We hope that FinCEN will adopt an easy-to-apply rule that avoids the need for every attorney, paralegal and legal secretary employed on behalf of a client corporation to file their personal details with every beneficial ownership report.
Even Exempt Companies May be Required to File
Early analysis of the CTA suggested that, while there are roughly 20 million private companies in the U.S., there were broad categories of exemption that might relieve many of these companies from having to file a beneficial ownership report.
In question 9 of the ANPRM, however, FinCEN invites comment on what procedure covered entities should follow to submit information to FinCEN in order to "validate" their claim of an exemption.
If every company in the U.S. is required to file some kind of documentation with FinCEN to validate a possible exemption, then the reporting obligations of the CTA become even broader than previously imagined. In that scenario, every company (whether exempt or not) would either file a beneficial ownership report or would file some other documentation to validate a claim of exemption.
Since exemptions are based on particular facts that can change over time, and the CTA contemplates that previously exempt entities may need to file a beneficial ownership report if their exempt status changes, this will effectively require every company in the U.S. to file something with FinCEN on a period basis to confirm either its beneficial ownership or exempt status.
Attorneys, investors and business owners should monitor the FinCEN rulemaking process as these issues take shape. Implementing the CTA is going to have a significant impact on record-keeping and compliance obligations on nearly every U.S. business.