FinCEN Adopts Final Corporate Transparency Act Rule
A stage scrim is a fabric curtain placed somewhere on a stage. Like a thin window blind, stage lighting determines whether the audience sees what's behind the scrim. When there is lighting in front of the scrim, the audience sees little of what is behind the scrim. But when the front lights are turned off, the audience can see what's behind the scrim.
Depending on the composition of the scrim, what the audience sees when the front lights are turned off can look like dark shadows. Or, the audience may see what’s behind the scrim nearly as clearly as if the scrim weren’t there. Often, what the audience sees is somewhere between shadows and a clear view, producing an other-worldly visual effect.
Scrims also can be used for acoustical purposes to absorb or reflect sound or otherwise alter the aural and visual audience experience. For instance, most opera is performed on stage with the orchestra in a pit below the stage and at least partially in front of the stage. Occasionally, a performance will place the orchestra behind a scrim at the back of the stage. Positioning the orchestra in the rear allows the pit to be covered, so the stage and singers are closer to the audience. In addition to the different visual effect, the balance between the singers and orchestra also will be different when the orchestra is behind the singers.
Many view special purpose limited liability companies (SPE) in real estate transactions like a scrim with front lights on. The public can't see who owns the SPEs, and that causes concern. On September 29, 2022, the Department of Treasury's Financial Crimes Enforcement Network (FinCEN) adopted rules (CTA Rule) requiring certain companies to report their beneficial owners. This article discusses basic requirements under the CTA Rule and how the rule will affect real estate SPEs.
FinCEN’s Concerns about SPEs in Real Estate Transactions
As I wrote in Special Purpose Entities Have Legitimate Uses in Real Estate Investment, most SPEs are used for legitimate business reasons. Nearly all mortgage lenders require them to contain risk to ownership and operation of the real estate the lender is financing. However, as I discussed in Identifying Suspicious Activity in Real Estate Transactions, FinCEN has long been concerned that SPEs may make it easier for criminals to use real estate transactions to launder money.
Concern that SPEs and other companies without substantial operations might conceal unlawful activity, in December 2020, Congress adopted the Corporation Transparency Act (CTA). I discussed the CTA in Corporate Transparency Act May Require Small Business and Real Estate Investments to Report Beneficial Owners.
In December 2021, FinCEN issued a Notice of Proposed Rulemaking (NOPR) proposing rules implementing the CTA's requirement that companies disclose their beneficial owners. FinCEN's September 29 rulemaking finalizes regulations proposed under the NOPR. The CTA Rule is effective January 1, 2024.
The CTA Rule is the first of three rulemakings FinCEN expects to adopt under the CTA. The other two rules will establish who may access information reported under the CTA, safeguards for safeguarding personal information, and modifications to FinCEN’s customer due diligence rule.
What Companies Must File Reports?
The CTA applies to companies without significant operations. The CTA defines "reporting company" as any corporation, limited liability company (LLC), or "similar entity" that is created by a filing with a federal, state, or triable government or authorized to do business in the United States except for entities that:
Large companies with more than 20 full-time employees in the United States that report more than $5 million in gross receipts or sales to the Internal Revenue Service and an operating presence or physical location in the US
entities, such as banks and broker-dealers that are already subject to close federal regulation
certain non-profit and political organizations
entities considered “dormant”
The definition and exemptions are complex, and companies should consult an attorney to determine whether it applies to them.
However, real estate SPEs are likely to be reporting companies. Even if the real estate generates more than $5 million in gross receipts, most SPEs won’t have over 20 full-time employees. That’s because mortgage lenders typically prohibit the property owner from having employees. Most real estate funds will be reporting companies for the same reason; although they may have more than $5 million in gross receipts, rarely will they have over 20 full-time employees.
Required Reporting Under the New Rule
Timing of Reports
The CTA Rule will require newly formed reporting companies to file a report within 30 days of formation or a later date when the reporting company learns a state secretary of state has accepted its filing or makes the reporting company’s formation public. Reporting companies formed before January 1, 2024 must file their reports within one year of the CTA Rule's effective date (i.e., by January 1, 2025). In addition, reporting companies will have 30 days after learning of an inaccuracy or change to file corrected or updated reports.
What Company Information Must Be Reported?
Reporting companies must report the following information:
Company Name – the reporting company’s full legal name and any trade names or DBAs
Address – the street address for the reporting company’s principal place of business in the United States
Formation Jurisdiction – the state, tribal, or foreign jurisdiction where the reporting company was formed. Foreign companies must also report where they are registered in the united states.
Tax Identification Number – all US reporting companies must provide their tax identification number (TIN), usually an Employer Identification Number (EIN). Foreign reporting companies without a TIN may use a foreign tax identification number and the jurisdiction's name.
Who is a Beneficial Owner, and What Beneficial Owner Information Must Be Reported?
The CTA Rule defines a beneficial owner as “any individual who, directly or indirectly, either exercises substantial control over such reporting company or owns or controls at least 25 percent of the ownership interests of such reporting company.” FinCEN expects that every reporting company will have at least one beneficial owner with substantial control, but many companies will have several persons with substantial control.
These individuals have “substantial control”:
Senior officers of the reporting company performing the functions of president, chief financial officer, general counsel, chief executive officer, or chief operating officer
Individuals with authority over the appointment or removal of a senior officer or a majority of the board of directors of the reporting company
Individuals who direct, determine, or have substantial influence over important decisions made by the reporting company (e.g., nature and scope of business, sale, lease, or mortgage of principal assets, reorganization, dissolution, or merger, entering into major contracts, amendment to formation documents, etc.)
The CTA Rule notes that these activities may result in an individual having indirect substantial control:
Board representation
Control over a majority of voting rights
Control over other entities that separately or together have substantial control
Certain contracts, arrangements, arrangements, or understandings
Rights under financing documents
Besides stock or other equity ownership, the following are considered ownership interests:
Capital or profits interests
Ownership of instruments convertible into equity or capital or profits interests
Put, call, straddle, or similar right to buy an ownership interest
Any other “instrument, contract, arrangement, understanding, relationship, or mechanism used to establish ownership”
A trustee with authority to dispose of trust assets where the trust owns an interest in the company
This isn't an exhaustive list, and the CTA Rule's definitions of “substantial control” and “beneficial ownership” are complicated and will depend on the specific reporting company's operations and practices. Therefore, reporting companies should consult with an attorney to determine what individuals must be included in the company's report.
What Information Must Be Reported about Beneficial Owners
A reporting company must report the following information for its beneficial owners:
Name – the full legal name of the beneficial owner. For a minor child, all information should be that of a parent or legal guardian.
Date of Birth – the date of birth of beneficial owners who are individuals
Address – a business that forms a reporting company for use in its business may use its business address, and an individual must report their residential address.
Unique Identifying Number – a unique identification number (i.e., driver’s license number, passport number, or state identification number) and the jurisdiction that issued the number, along with an image of the document showing that identification number
What Companies Should do to Comply with the Rule
The CTA Rule doesn’t take effect until January 1, 2024, and companies existing on that date won’t need to file reports until January 1, 2025. Until then, companies in effect will be performing behind a scrim where their owners can't be seen. However, performers behind the scrim must plan to be in place before the stage lights are turned off, suddenly revealing what’s behind the scrim, and companies should prepare now for the implementation of the rule.
Real estate companies and funds, in particular, need to act now because gathering the required information may be challenging due to the number of investors and the passive nature of their investments. However, all companies that may meet the definition of “reporting company” under the CTA Rule should maintain the following information about individuals considered “beneficial owners” under the CTA:
Collect Information from Owners
Beneficial ownership back to "warm bodies." The CTA Rule requires that reporting companies report indirect ownership interests so that FinCEN knows what individuals own the company.
Dates of birth
Residential addresses
Copies of personal identification, such as driver’s licenses and passports
For new investors, this information can be collected in the initial questionnaire/investment process. The company may need significant investor communications and meetings for existing investors to explain why they must disclose this information.
As sponsors offer new investments, they should include in subscription agreements, offering materials, and entity documents a requirement that investors provide the information required for CTA reporting.
Infrastructure
Companies will need infrastructure to maintain the requested information securely. Since the CTA imposes ongoing reporting requirements, Companies also will need a process for investors to update the information upon ownership changes.
Privacy Policy
Real estate sponsors and other companies should review their privacy policies and, if necessary, update them to disclose that personal information may be disclosed under the CTA.
© 2022 by Elizabeth A. Whitman
Any references to clients or other individuals or their circumstances have been modified and names have been changed to protect confidentiality.
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