Guidance implementing beneficial ownership disclosure rules is on its way

As we rang in the new year, Congress quietly enacted the National Defense Authorization Act (NDAA). This bill primarily involves funding for defense activities, but also includes provisions that create a new beneficial ownership disclosure requirement for companies located in or registered to do business in the United States. This new reporting regime is part of a broader worldwide trend toward increased transparency of legal entity ownership to ease financial crimes enforcement.

The NDAA beneficial ownership reporting doesn’t take effect until regulations are issued, so all attention is now on the U.S. Department of the Treasury (Treasury Department), which has indicated that it expects to issue proposed guidance this summer. This article highlights what we know, what we don’t yet know, and what businesses should be doing now.

What’s happened so far with the beneficial ownership disclosure requirement?

Found within the NDAA, the “Corporate Transparency Act” will require certain businesses to report their beneficial owners and changes in beneficial owners to the U.S. Financial Crimes Enforcement Network (FinCEN), a bureau of the Treasury Department. The passing of this legislation is part of Congress’ continued efforts to modernize U.S. anti-money-laundering laws. Accordingly, legal entities may no longer be able to protect the identities of the beneficial owners of businesses from the government if they are subject to these rules. Congress hopes that the passing of federal legislation in this area will set a clear standard for business ownership reporting and will aid in combating money laundering, fraud, and other financial crimes.

However, businesses still have an opportunity for some relief from these rules both because they won’t be effective until after final rules are issued and because the law exempts many businesses from the requirements. The law requires final regulations to be issued no later than one year after the enactment of the law, which would be Jan. 1, 2022. The regulatory process was initiated in early May 2021 through the issuance of an advanced notice of proposed rulemaking. That notice solicited advanced comments about how best to implement the law. More than 200 comments were submitted by a diverse group of individuals and organizations, including state attorneys general and secretaries of state, Native American tribes, industry and trade associations, individual businesses, banks, and law firms. Subsequent comments from the Treasury Department confirmed that multiple sets of proposed regulations are expected this summer in order to allow final regulations to be completed by the end of 2021.

Congress hopes that the passing of federal legislation in this area will set a clear standard for business ownership reporting and will aid in combating money laundering, fraud, and other financial crimes.

What do we know?

Under the NDAA’s provisions, a “reporting company” must submit a report to FinCEN that identifies each “beneficial owner” of the company. Specifically, under Section 5336(b), each report must include the owner’s full legal name, date of birth, current residential or business street address, and unique identifying number from an acceptable identification document or FinCEN identifier. The definitions of “reporting company” and “beneficial owner” are critical to determining how these rules may impact any particular business. 

Note: The Corporate Transparency Act is codified in Title 31 of the U.S. Code. For clarification, the section references in this article all indicate sections within that title (e.g., 31 U.S.C. Section 5336).

Reporting company

“Reporting company” is defined in Section 5336(a)(11) to include any corporation, limited liability company, or other similar entity that’s created by the filing of a document with a U.S. state or formed under the law of a foreign country if also registered to do business in the United States. However, many exceptions exist, principally for entities where the federal government may already have access to sufficient information to make this new reporting unnecessary.

The exceptions are numerous, but they include certain:

• Operating businesses that have: (a) 20 or more employees, (b) more than $5 million in gross receipts reported on a tax return for the prior year, and (c) an operating presence at a physical U.S. office
• Publicly traded companies and certain other entities registered with the Securities and Exchange Commission
• Governmental or tribal entities
• Banks and credit unions
• Insurance companies, registered investment advisors, registered brokers/dealers, or PCAOB registered public accounting firms
• Public utilities
• Not-for-profit organizations
• Dormant entities with no assets and not owned by foreign persons
• Entities that are “owned or controlled” by entities that are exempt from the reporting company definition (e.g., the subsidiary of a publicly traded corporation)
• Any other entity designated by the Treasury Department

Beneficial owner

Next, the definition of “beneficial owner” under Section 5336(a)(3) includes an individual who “directly or indirectly, through any contract, arrangement, understanding, relationship, or otherwise (i) exercises substantial control over the entity, or (ii) owns or controls 25% or more of the ownership interests of the entity...” The term “substantial control” isn’t defined, so the future Treasury Department regulations will be critical in understanding how this should be determined. Also, specifically excluded from being a beneficial owner is a minor child, an individual acting as an agent on behalf of another, an individual acting solely as an employee of a reporting company, an individual whose only interest in a reporting company is through a right of inheritance, and a creditor of a reporting company that doesn’t otherwise meet the general definition.

Timing of filings

As mentioned above, the effective date of the disclosure regime doesn’t officially commence until the Treasury Department completes final regulations implementing this program. Once the rules become effective, businesses meeting the “reporting company” definition will have up to two years to comply with the filing requirements. On the other hand, newly formed entities after that date must submit the beneficial owner report to FinCEN at the time of formation or registration. In addition, reporting companies will be required to report any changes with respect to their beneficial owners no later than one year after such change.

Once the rules become effective, businesses meeting the “reporting company” definition will have up to two years to comply with the filing requirements.

Use of the information

Beneficial ownership reported to FinCEN will be confidential and may not be publicly disclosed by any officer or employee of the United States. However, FinCEN will be able to disclose such information to federal agencies engaged in national security or federal/state law enforcement. This coincides with Congress’ main priority in passing this legislation to better enforce financial crimes.

Criminal and civil penalties

Any person who violates the beneficial owner disclosure requirements will be liable for a civil penalty of up to $500 for each day the violation continues, and the violator may also be fined up to $10,000 and imprisoned for up to two years. Violations include situations where a person willfully provides false beneficial ownership information or willfully fails to report complete or updated beneficial ownership information.

What don’t we know about the new beneficial ownership disclosure requirement?

Consistent with most new legislation, the beneficial owner disclosure rules come with many unanswered questions. Possibly the greatest of those questions arises from the lack of a more specific definition of “beneficial ownership.” When determining the scope of eligibility under beneficial ownership, businesses will likely have much debate as to what is considered “substantial control.” This can be especially true in situations where the economic rights in a business differ substantially from voting rights (e.g., preferred stock or preferred units in an LLC) or where voting rights differ depending on the issue (e.g., stock that provide one vote per share but permit the appointment of a certain number of board members).

Another similar question arises when businesses must determine whether a change to beneficial ownership has occurred. Again, with the uncertainty as to what is considered “substantial control,” businesses may be left wondering what would be considered a change to such control. An accelerated disclosure based on a change in ownership may be particularly concerning given the frequency of business interest sales, restructurings, or other transfers.

While many of the exceptions from the definition of “reporting company” are listed above, the law is not explicit with respect to the boundaries of certain exceptions. For example, the operating business exception listed above will alleviate the filing burden for the operating businesses and any subsidiaries that are owned or controlled by that business. However, that exception doesn’t appear to extend up the ownership structure to a holding company that owns or controls the operating company. In that context, there may be particular concern about identifying a reporting company within a common, multitiered investment structure. In addition, many of the exceptions include citations to securities laws and other complex federal governmental rules. As such, extensive analysis may be required to determine if a business fits within an exception. So, while certain entities are clearly excluded, many others will have to analyze the Treasury Department regulations before they can make a final determination.

Questions also remain as to how the filing will actually be completed by businesses. The one thing that’s clear is that reporting will take place with FinCEN, but the rules specifically designate the authority to FinCEN to create rules and regulations related to the reporting procedures. For example, FinCEN could choose to leverage the income tax filing process via the IRS to implement this reporting requirement, but due dates of the reporting don’t necessarily align with tax return reporting due dates. The NDAA also provides rules that allow FinCEN to assign unique identifier numbers to persons under this section. Although the procedure of how those numbers will be assigned remains somewhat unclear, this should allow for an easier reporting process for many beneficial owners.

What can you do now?

The initial steps involve an awareness of the new beneficial ownership reporting regime and a preliminary review of how it could apply. That analysis can be updated as soon as proposed regulations are issued. As guidance moves toward its final form, businesses will need to consider what will be expected of them. The first crucial determinations will be whether the business is subject to the reporting requirement and the actual due date for reporting. It’s possible that businesses will need to obtain new information about their direct and indirect owners to satisfy the reporting. Alternatively, businesses that qualify for an exception will need to carefully document why they’re exempt. In any event, it’s expected that businesses will need to consult with legal counsel to determine what’s required under this reporting regime.

Ultimately, it’ll be imperative that businesses carefully review the disclosure requirements in the very near future. This will be especially true when final regulations are unveiled, to determine if reporting will be required under the new rules. In fact, many businesses — most of which had no reporting requirements previously — may be initially alarmed at the overall procedure of reporting and the potential penalties resulting from noncompliance. This will be particularly true for many smaller companies that are unfamiliar with these types of requirements and may be too small to be exempt as operating businesses.

Ultimately, it’ll be imperative that businesses carefully review the disclosure requirements in the very near future.

While many questions related to the requirements remain unanswered, companies should still explore the general rules, and we urge those companies to determine if registration will be imposed upon them as soon as possible. If you have any additional questions on this new beneficial ownership reporting regime, please contact us.