On April 5, the US Financial Crimes Enforcement Network (“FinCEN”) published an Advance Notice of Proposed Rulemaking (“ANPR”) to implement the Corporate Transparency Act (“CTA”), which was enacted into law as part of the National Defense Authorization Act (“NDAA”) on January 1, 2021. The comment period closes May 5, 2021. The CTA requires certain legal entities, including limited liability companies (“LLCs”), to register with FinCEN and disclose their ultimate, natural person beneficial owners. The registration requirements apply to US corporate entities as well as corporate entities formed outside the United States that are registered to do business in the United States. The reporting and disclosure requirements could be particularly relevant to banks and investment fund structures that use LLCs and other corporate entities in connection with financings and corporate acquisitions.1
Closely held corporate entities, particularly shell companies, have long been identified by domestic and international law enforcement agencies, as well as Congress, as vehicles abused by criminals to engage in a wide range of crimes, including fraud, tax evasion, money laundering, foreign corruption and sanctions violations. In addition, shell companies are often used in terrorist financing schemes. The CTA was written to combat such abuses by requiring companies to register with FinCEN at the time of incorporation (existing companies have a two-year window in which to register) and identify their place of incorporation, substantial natural person owners and control persons. The CTA instructs the secretary of the Treasury to promulgate regulations implementing beneficial ownership reporting requirements within one year of the effective date of the NDAA (January 1, 2022), although FinCEN has indicated that the final regulations will give affected entities additional time in which to come into compliance. While information collected under the CTA will be subject to stringent protection measures, once implemented, FinCEN will maintain a beneficial ownership registry (the “CTA Registry”) accessible to federal, state and tribal law enforcement agencies; financial institution supervisory agencies; and financial institutions that are required by the Bank Secrecy Act (“BSA”) to identify the natural person beneficial owners of their corporate customers. For these institutions, the establishment of the CTA Registry is expected to significantly simplify due diligence processes and reduce administrative burden.
The CTA represents another step in what has been a gradual increase in anti-money laundering transparency standards since the enactment of the “Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism (“USA PATRIOT”) Act in 2001. As a condition for certain non-US banks to maintain US correspondent accounts, section 312 of the USA PATRIOT Act required US financial institutions to obtain beneficial ownership information about those banks, including “the identity of each of the owners of the foreign bank, and the nature and extent of the ownership interest of each such owner.” More recently, in 2016, FinCEN amended the regulations pertaining to Customer Due Diligence (“CDD”) to require financial institutions to identify and collect information on natural persons who directly or indirectly beneficially own 25 percent or more of a legal entity customer.2 In addition, the CDD rule requires the collection of information on control persons, such as those serving in CEO, COO or CFO roles.3 The CTA should alleviate this collection burden and increase transparency with respect to legal entities that are incorporated in the United States but conduct their transactions through non-US banks. Once FinCEN establishes the CTA Registry, the United States will be closer to beneficial ownership information standards that are already in place in the European Union and the United Kingdom.
The Advance Notice of Proposed Rulemaking
In issuing the ANPR, FinCEN is taking a necessary step toward implementation of the CTA by seeking public input on a series of issues that need to be addressed before it can promulgate final regulations.
The CTA defines a “beneficial owner” of an entity as 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 not less than 25 percent of the ownership interests of the entity.4 A “reporting company” subject to the beneficial ownership reporting requirements is defined as a corporation, LLC or other similar entity that is (i) created by the filing of a document with a secretary of state or a similar office under the law of a state or Indian tribe or (ii) formed under the law of a foreign country and registered to do business in the United States by the filing of a document with a secretary of state or a similar office under the laws of a state or Indian tribe.5 One of the issues on which FinCEN seeks comment is how an “other similar entity” is to be defined for purposes of the regulatory definition of a reporting company. Many entities, such as publicly traded companies, regulated banks and broker-dealers, certain pooled investment vehicles, and governmental agencies are exempt from the registration requirements.
The ANPR presents a total of 48 broad questions for comment, many of which have detailed subparts. The questions cover many central aspects of the CTA, including whether definitional terms provided in the CTA itself are sufficiently clear. Among the questions the ANPR raises are whether the definition of “beneficial owner” should adhere to the standards specified in the existing CDD rule and whether there should be further definitions of the terms “control” and “own.” Additionally, the ANPR asks whether “substantial control” should be defined to mean that no reporting company can have more than one beneficial owner who is considered to be in substantial control of the company or whether FinCEN should define that term to allow a reporting company to identify more than one beneficial owner with “substantial control.”
One key question not directly raised in the ANPR is the treatment of “pooled investment entities” under the CTA as compared with the treatment in the current Beneficial Ownership (“BO”) regulation.6 The BO regulation does not define entities that constitute “pooled investment vehicles,” but it provides that pooled investment vehicles that are “operated or advised by,” among others, functionally regulated banks, bank holding companies, investment companies as defined in section 3 of the Investment Company Act of 1940 (“Company Act”), an investment adviser as defined in section 202(a)(11) of the Investment Advisers Act of 1940 and entities registered with the Securities and Exchange Commission under the Securities Exchange Act of 1934 are not “legal entity customers” and therefore not subject to beneficial owner disclosure obligations of the BO regulation.7 Additionally, in FAQ Guidance issued April 3, 2018, FinCEN further explained that because of the way ownership of pooled investment vehicles fluctuates, financial institutions were not required to look through any pooled investment vehicles to determine beneficial ownership.8
Against this precedent, the CTA defines a “pooled investment vehicle” as:
- any investment company, as defined in section 3(a) of the Company Act;9 or
- any company that (i) would be an investment company under that section but for the exclusion provided from that definition by paragraph (1) or (7) of section 3(c) of that Company Act10 and ‘‘(ii) is identified by its legal name by the applicable investment adviser in its Form ADV.”11
Pooled investment vehicles that meet this definition, and that are operated or advised by certain financial institutions (such as banks, registered investment advisers and broker-dealers), are excluded from the definition of “reporting company” and therefore need not disclose beneficial ownership information to FinCEN under the CTA.12
The definition of pooled investment vehicle in the CTA is seemingly more narrow than that in the BO regulation because entities that seek to qualify as such under the CTA not only must be operated or advised by certain financial institutions but also must themselves be SEC-registered investment companies or 3(c)(1) or 3(c)(7) companies. This raises a question as to whether FinCEN will require entities that do not meet the more narrow statutory definition of a pooled investment vehicle in the CTA to register and report despite the more accommodating approach adopted in the BO regulation and related guidance. A similar question is the extent to which special purpose vehicles, organized as bankruptcy remote entities in financings and corporate transactions, will be subject to the registration requirements.
One important area on which public comment is sought is the extent of information that should be required from reporting companies, particularly with respect to the reporting company’s relationship with its parents, subsidiaries, affiliates and beneficial owners. One possibility is whether FinCEN could obtain information for the CTA Registry from sources other than reporting companies, such as existing federal and state registries. From applicants that may regularly file registration information, FinCEN requests comments on filing procedures, including whether batch filing should be permitted. Additionally, FinCEN seeks comment with respect to when reporting companies should be required to update information, such as when there is a change of beneficial ownership, and whether updated information automatically should be sent to financial institutions, law enforcement and other authorized persons that previously requested information on a particular reporting company.
Comment is also sought with respect to steps FinCEN should take to confirm beneficial ownership information and to protect CTA Registry information from misuse—in particular, whether it is sufficient to make misuse of such information subject to existing penalties for violations of the BSA and FinCEN regulations or whether other protections should be put in place and, if so, what those protections should be. The ANPR also seeks comment about ways to ensure that the information collected in the CTA Registry will be useful to financial institutions for purposes of facilitating compliance with AML, anti-terrorism and CDD requirements. But another relevant question is whether financial institutions will be permitted to use information in the CTA Registry for other customer identification purposes and, if so, whether reporting company approval should be obtained in advance.
As with many government initiatives, the CTA Registry offers interesting promise and raises some concerns. For financial institutions, the prospect of a centralized, federally maintained repository of beneficial ownership information offers the possibility of substantially reducing compliance cost and risk. For reporting companies, however, the registration process could be arduous and overly inclusive, covering a potential population of low-risk entities that lack the characteristics of the types of shell companies that gave rise to the CTA. With the close of the comment period less than 30 days away, stakeholders should be sure to weigh in.