Substantial Control Under the Corporate Transparency Act - Part 2

In Part 1, I wrote how FinCEN's proposed regulations to implement the Corporate Transparency Act contained some ambiguous concepts that would prove challenging for corporate boards.

In particular, FinCEN's proposed regulation defines "beneficial owner" to mean (a) any individual who beneficially owns more than 25% of the company, and (b) any person who has "substantial control" over the company. The ambiguity arises from the definition of "substantial control" which has the potential to include some (but perhaps not all) "senior officers" of the company as well as some (but perhaps not all) members of the board of directors.

Because of this ambiguity, I wrote that many companies will adopt an overly broad approach, including all senior officers and all board members within the scope of "beneficial owner" in order to avoid omitting an individual. The CTA provides that willfully filing an inaccurate report may be a felony, so individuals involved in the filing process will have an incentive to over-disclose to avoid sanction. 

But how can companies implement these requirements?  

Most reporting companies under the CTA should consider adopting a shareholders agreement that includes rules for collecting and reporting the PII that the CTA requires the company to file for beneficial owners. (Because the CTA also applies to LLCs and limited partnerships, these entities will want to amend their operating agreements and limited partnership agreements in a similar fashion.) 

The CTA has strict deadlines for when beneficial ownership reports are due. Companies formed after the regulations take effect will have only 14 days to file their first report. Companies in existence before the regulations take effect will have one year to file their first report. After a first report is filed, a reporting company has only 30 days to file an amended report if any information covered by the prior report (such as the address of a beneficial owner) becomes inaccurate. Most U.S. companies today do not have systems in place to keep tabs on their board members, officers and controlling shareholders' personal information.  

A model shareholders agreement would need to have the following elements:

1. A statement of policy that the company intends to comply with the CTA and to file the beneficial ownership reports when they are due;

2. Each board member, senior officer and major shareholder is obligated to provide their personal information to the company for CTA filing purposes;

3. Each board member, senior officer and major shareholder is obligated to notify the company promptly of any change in their personal information that was included in a prior company beneficial ownership report; 

4. The company should designate an individual to serve as the company's compliance officer to implement a system to collect personal information from board members, senior officers and major shareholders;

5. The company's compliance officer should bear the primary responsibility to file the company's beneficial ownership reports as they are due and should report to the board periodically on the company's compliance with its CTA duties. 

Implementing a change in corporate governance of this type will pose challenges for the company because board members and major shareholders have not previously had a duty to keep the company informed of changes in their personal information.  

To incentivize compliance, the shareholders agreement might contain indemnification provisions that require non-compliant beneficial owners to indemnify the company for the costs (and FinCEN penalties) resulting from any non-compliance that stems from the beneficial owner's failure to report changes in personal information on time. 

It will also be challenging for the company's compliance officer to collect and retain securely the personal information of the company's board members, senior officers and major shareholders.  Few company's have an IT system in place to collect and store this kind of sensitive information.  Company leaders will need to find or develop new tools to manage this compliance obligation. 

Update: FinCEN issues its Final Rule on beneficial ownership reports under the Corporate Transparency Act on September 29, 2022.  Portions of this post may be superseded by the Final Rule.