Portfolio Company Reporting Under the Corporate Transparency Act

Practical Law Article w-042-1711 (Approx. 4 pages)

Portfolio Company Reporting Under the Corporate Transparency Act

by Eddy Moore, Bill Repasky and Max Fournier, Frost Brown Todd LLP, with Practical Law Corporate & Securities

The Corporate Transparency Act

As part of the National Defense Authorization Act of 2020, Congress passed the CTA to increase visibility into entity structures and ownerships to foster the public policy objectives of combatting money laundering, tax fraud, and other nefarious activities.

How Will the CTA Affect Portfolio Companies?

Are Portfolio Companies "Reporting Companies" Under the CTA?

The CTA calls for the creation of a semi-private database maintained by the Treasury Department's Financial Crimes Enforcement Network (FinCEN). This database is to be populated with information submitted by legal entities themselves, if they are a "reporting company," identifying the entities, the entities' beneficial owners, and their associated company applicants.

A "reporting company" is a corporation, limited liability company, or other entity 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. Foreign entities also can be reporting companies.

While the CTA's scope is purposefully broad, there are numerous statutory exemptions. As a rule of thumb, most entities already regulated by a prudent regulator, such as the US Securities and Exchange Commission (SEC), will be exempt from the CTA's disclosure requirements, while most small to medium-sized businesses must comply with the CTA and shoulder the burden of beneficial ownership disclosure.

Many PortCos will be reporting companies under the CTA. A typical PortCo will fall within the CTA's broadly thrown statutory net covering legal entities, and many are structured such that one of the CTA's exemptions will not apply, although all the exemptions should be examined carefully. There are twenty-three statutory exemptions, several of which merit particular attention.

Noteworthy Statutory Exemptions

One is the "large operating company" exemption, which covers PortCos with twenty or more employees operating at a physical location in the United States and whose prior year's tax filings reported gross receipts or sales in excess of $5 million. There are also statutory exemptions for certain investment companies if they are SEC-registered and meet Section 3's definition under the Investment Company Act of 1940 (ICA) (15 U.S.C.A. § 80a-3), and for venture capital fund advisers if they have filed Form ADV (or a successor of that form) with the SEC.

Also, a PortCo wholly owned and operated by another CTA-exempt entity should be able to avoid disclosure to FinCEN under the CTA in most instances. Further, an inactive PortCo, as described in the ICA's implementing regulations, may also be excused from disclosure. The devil is in the details, of course, so counsel should carefully study the details of each exemption.

While this related topic warrants more discussion, we foresee that opinion practice is likely to change as counterparties revise their requirements covering CTA compliance, including potential warranties from legal advisors of an exemption's applicability should a PortCo not disclose.

Who Must Report? What Is Reported?

Each reporting company will be required to make its CTA disclosures to FinCEN. Required filings must be electronically (only) submitted through the BOI E-Filing System, also known as the BOSS system (Beneficial Ownership Secure System) or BOIR system. The three categories of disclosures relate to information about the entity itself, the entity's beneficial owners and, as applicable, the associated company applicants.

A beneficial owner is defined as any individual who directly or indirectly either:

Exercises substantial control over a reporting company.
Owns or controls at least 25% of the ownership interests of a reporting company.

Interpretation of this aspect of the CTA remains in flux. However, individuals with "substantial control" generally means those individuals who:

Serve as a senior officer.
Have authority over the appointment or removal of senior officers (or similar authority concerning a majority of the entity's governing directors).
Direct or have material influence over the entity's important decisions.
Have any other form of substantial control over the reporting company.

As can be imagined, both the ownership and substantial control prongs are rabbit holes that remain for further development, implementing regulations, and FAQs, all of which are either promised or now published by FinCEN. But importantly, unlike the Bank Secrecy Act's beneficial ownership analysis, which limits the "control" person to a single individual, the CTA envisions the disclosure of multiple persons whenever each has substantial control.

Disclosure to FinCEN

For each beneficial owner of a reporting company, the following five items must be disclosed to FinCEN:

The individual's name.
Date of birth.
Current residential or business street address (which cannot be a PO Box or registered agent address).
A unique identifying number and issuing jurisdiction of an acceptable form of personal identification, such as a driver's license or passport.
An image of the identification document used for the above-supplied information.

Reporting companies also must disclose to FinCEN its "company applicants" if the reporting company is formed after January 1, 2024. A company applicant will be either or both the individual who created the documents governing the entity and the individual who filed the formation documents. This can mean that the attorney who drafts the articles of incorporation, for example, and the paralegal who files the articles with a secretary of state's office are both company applicants. However, if a reporting company was formed before January 1, 2024, the company applicant does not need to be disclosed.

Since PortCos rarely have language in place in their governance documents or equity purchase agreements that create an obligation to provide the information now required by the CTA, amendments should be made to allow the PortCo to be fully compliant with the filing requirements.

When to File and How Often

For reporting companies formed before January 1, 2024, the CTA requires the FinCEN filing to be made during the 2024 calendar year, but no later than January 1, 2025. If a reporting company is formed any time in calendar year 2024, the CTA requires disclosures to be made within 90 days of its formation (generally the date of its filing with a secretary of state's office). Thereafter, newly formed reporting companies will have to file within 30 days of formation.

If any of the information previously reported to FinCEN changes, then a revised (updated) filing must be made by the reporting company within 30 days. For example, if a PortCo that is a reporting company experiences a change in executive leadership, or should a material investor change addresses or their name, then FinCEN updated filings must be timely made.

Whether in the initial report or as required to amend previously reported information, reporting companies need to consider strategies for obtaining the needed BOI for each beneficial owner, such as potential modifications to organizational documents, and its CTA permitted options when dealing with non-cooperative or unresponsive beneficial owners.

Timing

Ready or not, the CTA is here and its material new compliance obligations. Per FinCEN's estimates, over thirty-six million reporting companies are expected to file in 2024 alone. Unlike many other federal business statutes, the compliance burden will largely be borne by small to medium-sized businesses, as larger entities will likely find a qualifying exemption. While the CTA is now the law of the land, the exact parameters and legally-consequential meaning of its implementing regulations remains a work in progress. For PortCos, the CTA warrants close attention.

Portfolio Company Reporting Under the Corporate Transparency Act | Practical Law