What the CTA means for private investment funds and family offices

In September 2022, the US Treasury Department's Financial Crimes Enforcement Network (FinCEN) issued its first of three final rules (the Final Rules) implementing the Corporate Transparency Act’s (CTA) requirements to report beneficial ownership information. The CTA was passed by Congress as part of the Anti-Money Laundering Act of 2020 and its goal is to strengthen the anti-money laundering regime by increasing transparency of entity structures and ownership.

According to FinCEN, the US will be joining at least 30 other countries that have implemented some form of a central registry of beneficial ownership information. FinCEN estimates that there will be roughly 32 million reporting companies in year one, and five million additional reporting companies each year in 2-10.

The Final Rules have important implications for both private investment funds and families depending how each is structured. As further discussed below, it is important that private fund managers undertake an analysis of their compliance and reporting requirements under the Final Rules regarding all entities within their structure. It is also important for families to understand the Final Rules and what compliance and legal risk may be incurred, especially in complex family wealth structures.

Who must report?

The CTA obligates “reporting companies” to file beneficial ownership reports. The CTA defines “reporting company” as a corporation, limited liability company or other similar entity that is created by the filing of a document with a secretary of state or any similar office under the law of a State or Indian tribe. In the case of a non-US company, a company that is admitted and qualified to do business in the US by the filing of a document with a secretary of state or any similar office under the law of a State or Indian tribe, is also reporting company.

It is the filing of the document that is the triggering event for an entity to become a reporting company. Importantly, most trusts can be formed without the filing of a document so most trusts may be exempt under the rules.

What must be reported?

If an entity is a reporting company and does not fall within one of the exemptions, it must file a beneficial ownership report. This report needs to include five types of data (including an image) for each person that is “covered”:

• Individual's full name
• Date of birth
• Current residential address or business street address (a PO box or registered agent address cannot be used)
• A unique identifying number from an acceptable identification document (this could be a FinCEN identifier number or something like a passport number or driver's license number)

Reporting companies must also submit an image of the document that contains the unique identifying number. If anything changes, updated reports must be filed within 30 calendar days after the date of a change concerning the reporting company or its beneficial owners. A change in name, address or the identifying number on a document would trigger an updated report and a new updated image of the document would also need to be submitted.

Who is covered? 

For every company that is a reporting company and required to file, these five pieces of data must be included for every (i) company applicant and (ii) every beneficial owner. FinCEN notes that there is no maximum number of beneficial owners a reporting company must disclose. Therefore, entities must provide beneficial ownership information for each individual that satisfies either prong described below.

The company applicant is the person who filed the document – this could be a lawyer, a paralegal, an accountant – anyone who did the actual formation of the entity. The Final Rule designates the individual primarily responsible for directing or controlling such filing as a company applicant. Note that FinCEN does not require reporting companies created before the January 1, 2024 effective date to report company applicant information.

A ”beneficial owner” is any individual who, directly or indirectly, (i) exercises substantial control over a reporting company or (ii) owns or controls at least 25 percent of the ownership interests of a reporting company. The 25 percent test is relatively straightforward, but substantial control requires looking at the specific facts and circumstances, such as the extent to which the individual can control or influence important decisions or functions of the reporting company. 

FinCEN gave numerous examples and responses to the comments it received in the Final Rules that should be helpful. FinCEN also noted that they plan on coming out with additional guidance and FAQs to help companies better understand what control means.

In the meantime, “substantial control” is broadly defined. An individual exercises substantial control over a reporting company if the individual:

• Serves as a senior officer;
• Has authority over the appointment or removal of any senior officer or a majority of the board of directors (or similar body);
• Directs, determines, or has substantial influence over important decisions; or
• Has any other form of substantial control.

FinCEN gives further guidance such that an individual may directly or indirectly exercise substantial control through:

• Board representation;
• Ownership or control of a majority of the voting power or voting rights;
• Rights associated with any financing arrangement or interest in a company; 
• Control over one or more intermediary entities that separately or collectively exercise substantial control over a reporting company; 
• Arrangements or financial or business relationships, whether formal or informal, with other individuals or entities acting as nominees; or
• Any other contract, arrangement, understanding, relationship, or otherwise.

There are also a few exceptions depending on the type of beneficial owners. For example, if the beneficial owner is a minor child, that fact will get noted on the report, but the five pieces of identifying data for that minor child do not need to be included. However, once that child reaches the age of majority, an updated beneficial ownership report must be submitted with the child's information.

If an individual only has a future interest in a reporting company through a right of inheritance, they will not need to be included. There are also certain rules for intermediaries or others who are acting on another's behalf (i.e., a nominee or custodian).

Who is exempt?

The Final Rules list 23 different categories of exempt entities. Companies that typically are already under substantial oversight by a regulator and that already have to disclose their beneficial ownership information are likely exempt. Public companies with a class of securities registered under the Securities Exchange Act of 1934 are exempt. Banks are exempt, along with savings associations, trust companies, credit unions and bank holding companies. 

Certain large family offices may fall within the exemption made available to “Large Operating Companies.” Under the CTA, an entity is a large operating company if it meets three prongs:

1. employs more than 20 employees on a full-time basis in the US;
2. reported more than US$5m of gross receipts or sales in the previous year on a federal income tax return; and
3. has an operating presence at a physical office in the US.

Another way to qualify for an exemption is if the family office is registered as an investment adviser under Investment Advisers Act of 1940 (the Advisers Act) or takes advantage of the “venture capital fund adviser” exemption under the Advisers Act. This will more often come up in cases of multi-family offices. If the entity is a commodity trading advisor, commodity pool operator or other entity registered with the US Commodity Futures Trading Commission, it would qualify for an exemption. Investment companies themselves are also exempt.

There’s also an exemption for wholly-owned subsidiaries of certain exempt entities. Subsidiaries of money services businesses, pooled investment vehicles and entities that assist a tax-exempt entity, among others, are not eligible for the subsidiary exemption. FinCEN limits this exemption to prevent entities that are only partially owned by exempt entities from shielding all of their beneficial owners. 

Private investment funds

In the funds space, a fund manager registered with the Securities and Exchange Commission (SEC) may be exempt while the fund itself may or may not be. Funds that are operated or advised by a bank, Federal or state credit union, SEC registered broker-dealer, SEC registered investment company or investment adviser or venture capital fund adviser are exempt. FinCEN declined, however, to create a blanket exemption for state-registered investment advisers.

If the fund manager is not registered with the SEC or relying on the venture capital fund exemption, but instead relying on the private fund adviser, foreign private adviser or family office exemptions to the Advisers Act, they will not be exempt entities under the CTA. Further, the fund manager and the fund could be exempt, while the portfolio companies the fund holds investments in may not be. Portfolio companies wholly-owned or controlled by a pooled investment vehicle do not qualify for the subsidiary exemption.

While the subsidiary exemption does apply to wholly-owned subsidiaries of registered investment companies, generally, subsidiaries of private investment funds do not qualify for the exemption. Therefore, some blocker entities, feeder fund entities and similar alternative investment vehicles are likely subject to the reporting requirements of the CTA. 

Private investment funds that are advised by a registered investment adviser and are relying on the Section 3(c)(1) or 3(c)(7) exceptions under the Investment Company Act of 1940 (the Investment Company Act) may be exempt, but subsidiaries of those funds may not be. Further, if the private investment fund is a real estate vehicle instead relying on Section 3(c)(5)(c) under the Investment Company Act, it may not be exempt.

Fund managers and venture capital firms should include research on beneficial owner reports filed or exemptions claimed by any potential portfolio company investment as part of any diligence process. Once an investment is made, relevant updates must also be filed timely. 

Trust considerations

Often, a trust can be formed without the filing of a document so most trusts are not considered reporting companies under the Final Rules. However, note that this is an exception to the rule, not one of the 23 enumerated exemptions. Therefore, if a trust has one or multiple wholly-owned subsidiaries that are not themselves exempt, that subsidiary will likely need to report. 

Also, consider a situation where the trust itself is exempt, but the trust is an owner of a reporting company such as an LLC or a corporation. That LLC or corporation may need to report information about the trust's grantor, beneficiaries and trustees.

Where a trust is a reporting company or owns or controls a reporting company:

• A trustee or other person with authority to dispose of trust assets is considered to have ownership or control. 
• A beneficiary is considered to own or control ownership interests held by the trust if the beneficiary is the sole permissible recipient of trust income and principal OR has the right to demand distribution or withdrawal of substantially all trust assets.
• A grantor or settlor having the right to revoke the trust or withdraw trust assets is considered to own or control ownership interests held in the trust.

One consequence of this is that, depending on the specifics of the trust arrangement, the ownership interests held in trust could be considered simultaneously as owned or controlled by multiple parties in a trust arrangement. Therefore, all of those parties would need to be reported.

Families with intricate wealth structures, particularly those that include trusts, should review their current structure and determine if any updates and/or restructurings should be made.

When do I need to report?

The Final Rules provide that any reporting company formed on or after January 1, 2024 will be required to make an initial report to FinCEN within 30 days of formation, while entities existing prior to January 1, 2024 will have until January 1, 2025 to make an initial report.

While these deadlines may seem quite far off, all companies should evaluate in the interim their corporate governance structures and determine if any changes may want to be made. Any reporting company will need to put in place compliance procedures for filing these reports and also updating them as necessary.

Compliance is also particularly important given the severity of the penalties. The knowing failure to provide complete or updated information or willfully providing false or fraudulent information is punishable by civil penalties of US$500/day and possible criminal penalties of up to two years in prison.