Continuing our Transparency-is-in-Your-Future series, we now turn our focus to the beneficial ownership reporting requirements established in the (i) Corporate Transparency Act (“CTA”) and (ii) related regulations adopted by U.S. Treasury Department’s Financial Crimes Enforcement Network (“FinCEN”).
FinCEN’s final rule is effective January 1, 2024. As this deadline approaches, we thought it would be helpful to take a deeper dive into the final rule to understand its requirements and exemptions. Our current topic is: who is a beneficial owner?
Who is a beneficial owner of a reporting company?
A “beneficial owner” of a reporting company is “any individual who, directly or indirectly, either exercises substantial control over such reporting company (“Substantial Control”) or owns or controls at least 25 percent of the ownership interests of such reporting company” (“25% Ownership”). Each (and every) individual that satisfies either of these two criteria and is not otherwise excluded, must be reported as a beneficial owner. FinCEN notes that at least one individual should satisfy the “substantial control” criterion.
A beneficial owner is not:
(a) a minor child, as defined under the law of the State or Indian tribe in which the reporting company is formed (or in which it is registered for a foreign reporting company); however, the reporting company must still report the required information of a parent or legal guardian of such minor child if such child has either Substantial Control or 25% Ownership;
(b) an individual acting as a nominee, intermediary, custodian or agent on behalf of another individual; however, the reporting company must still report the required information for the individual upon whose behalf such nominee, intermediary, custodian or agent is acting, if such individual has either Substantial Control or 25% Ownership;
(c) an employee, 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, provided that such person is not a senior officer as discussed below;
(d) an individual whose only interest in the reporting company is a future interest through a right of inheritance; however, the definition of ownership interest (discussed below) does broadly include other forms of future interests, options or other arrangements; or
(e) a creditor of such reporting company, who would otherwise constitute a beneficial owner, solely through rights or interests for the payment of a predetermined sum of money, such as a loan covenant or similar right that is intended to secure the right to receive payment or enhance the likelihood of repayment.
What is “Substantial Control”?
An individual exercises Substantial Control over a reporting company, if such individual:
(a) serves as a senior officer (e.g. president, chief financial officer, general counsel, or any other officer, regardless of official title, that performs a similar function);
(b) has authority to appoint or remove a senior officer or a majority of the board of directors or a similar body;
(c) has substantial influence or determines important decisions made by the reporting company; or
(d) has any other form of substantial control over the reporting company.
Examples of clause c (substantial influence over important decisions) include, but are not limited to, whether to (i) sell, lease or mortgage principal company assets, (ii) reorganize, dissolve or merge the company, (iii) amend the corporate governance documents (such as the bylaws, operating agreement or formation documents), (iv) issue equity or incur debt, (v) enter into or terminate substantial contracts, or (vi) expand into new lines of business or geographic areas.
Can Substantial Control be indirectly exercised?
Yes. An individual may exercise Substantial Control over a reporting company, directly or indirectly, including as a trustee of a trust or through control of one or more intermediary entities that separately or collectively exercise substantial control over the reporting company. FinCEN’s final rule also provides direct and indirect exercise of Substantial Control may be through board representation, control of a majority of the voting power, or any other contract, arrangement, understanding, relationship, or otherwise.
What is an “ownership interest”?
An ownership interest is broadly defined to include:
(a) any equity, stock, or similar instrument; preorganization certificate or subscription; or transferable share of, or voting trust certificate or certificate of deposit for, an equity security, interest in a joint venture, or certificate of interest in a business trust; in each such case, without regard to whether any such instrument is transferable, is classified as stock or anything similar, or confers voting power or voting rights;
(b) any capital or profit interest in an entity;
(c) any instrument convertible, with or without consideration, into any share or instrument described in (a) or (b) above, any future on any such instrument, or any warrant or right to purchase, sell, or subscribe to a share or interest described in (a) or (b) above, regardless of whether characterized as debt;
(d) any put, call, straddle, or other option or privilege of buying or selling any of the items described in (a), (b) or (c) above, without being bound to do so, except to the extent that such option or privilege is created and held by a third party or third parties without the knowledge or involvement of the reporting company; or
(e) any other instrument, contract, arrangement, understanding, relationship, or mechanism used to establish ownership.
Before you ask – Yes, indirect ownership or control of ownership interests is covered in the FinCEN final rule as well.
An individual may directly or indirectly own or control an ownership interest of a reporting company through any contract, arrangement, understanding, relationship, or otherwise. For example, indirect ownership may be established through:
(a) joint ownership;
(b) another individual acting as a nominee, intermediary, custodian, or agent on behalf of such individual;
(c) a trust or similar arrangement that holds such ownership interest, either as (i) a trustee of the trust or other individual (if any) with the authority to dispose of trust assets or (ii) a beneficiary who: (x) is the sole permissible recipient of income and principal from the trust, (y) has the right to demand a distribution of or withdraw substantially all of the assets from the trust, or (z) a grantor or settlor who has the right to revoke the trust or otherwise withdraw the assets of the trust; or
(d) ownership or control of one or more intermediary entities, or ownership or control of the ownership interests of any such entities, that separately or collectively own or control ownership interests of the reporting company.
How do I calculate my total ownership interest of a reporting company?
Step 1: Add the total ownership interest that you, directly or indirectly, own or control, presently and treat any options or similar interests as exercised.
Step 2: Divide the sum from Step 1 by the total outstanding ownership interests of the reporting company.
Step 3: Multiply the quotient from Step 2 by 100 to determine your percentage of ownership interest in the reporting company.
Note: For any reporting company that issues capital or profit interests, the individual’s ownership interest is the capital or profit interests calculated as a percentage of the total outstanding capital and profit interests of the reporting company (following the steps as described above).
For any reporting company that issues shares of stock, the applicable percentage of an individual’s ownership is the greater of: (a) the individual’s total combined voting power of all classes of ownership interest as a percentage of total outstanding voting power of all classes of ownership interests entitled to vote, or (b) the individual’s total combined value of the ownership interests as a percentage of the total outstanding value of all classes of ownership interests.
Finally, if the circumstances within the reporting company do not allow the calculations described in the two preceding paragraphs to be determined with reasonable certainty, then any individual who owns or controls 25 percent of more of any class or type of ownership interest should be deemed to own or control 25 percent of more of the reporting company, and thus be reported as a beneficial owner of such reporting company.
In the next few months, each entity that is a reporting company should collect the necessary information for itself and its beneficial owners. To ensure compliance with these regulations, all entities should review their internal procedures and organizational documents. Ideally, an entity’s corporate governance documents (e.g. shareholders’ agreement, operating agreement, partnership agreement, etc.) will require its owners to timely disclose the information required to be provided under the regulations and provide for consequences for failing to do so.