New beneficial owner rules force private funds to give up some privacy

A new law that took effect at the beginning of the year will force private fund managers to give up some of their privacy.

Under the Corporate Transparency Act, most companies that aren’t already registered with federal regulators or self-regulatory organizations will have until January 1, 2025, to provide the legal name, address, state identification or passports and a picture of every one of their beneficial owners in the Department of Treasury Financial Crimes Enforcement Network’s new corporate database. Any LLCs formed this year will have 90 days to register with FinCEN.

The new law “will have a significant impact on how most US and non-US entities are formed or registered to do business in the US, serving as a new policy tool to assist government authorities with law enforcement and prosecutorial efforts,” according to a private funds-focused advisory note recently published by legal services firm Maples Group.

Under the CTA, a beneficial owner is anyone who can claim up to 25 percent of a firm’s equity, or who exercises “substantial control” over the company’s operations. There are 23 broad exemptions to the new registration requirements, most of them for firms already registered with another regulator, such as the Securities and Exchange Commission or Commodity Futures Trading Commission, or a self-regulatory organization, such as Financial Industry Regulatory Authority. But those exemptions only apply to holding companies. Potentially, they implicate parent companies, C-suite executives, general partners and even in-house counsel as those having “substantial control.” FinCEN estimates that its database will have nearly 33 million companies when complete.

Registered private fund advisers and firms relying on the SEC’s venture capital exemption are broadly safe from FinCEN’s new beneficial ownership rules. But that leaves potentially thousands of funds that must comply with the new rules, experts warn – including foreign funds registered to do business in any American state and smaller portfolio companies. The rules will land hardest on a small- and mid-sized exempt fund managers, but everyone has a lot of work to do, experts say.

“Every manager has to go through an analysis of their structure,” David Tang, a partner at Dorsey & Whitney, told affiliate title Regulatory Compliance Watch.

The new rules are subject to strict liability, meaning you’re guilty of violations whether you meant to break them or not. Transgressors face up to two years in prison and $500 in fines per day, up to $10,000. The rules also apply to previously state-registered companies whose registrations have lapsed. FinCEN argues that such companies could be revived.

While the “reporting is straightforward,” Maples Group senior vice-president Daniel Grugan said, “the language within the CTA around exemptions and who qualifies as a ‘beneficial owner’ through the ‘ownership interest’ and ‘substantial control’ prongs is very broad and ambiguous.”

And some changes that occur within a PE fund’s lifecycle may require filing updates to be reported within 30 days, noted Grugan. Citing the “many events that may trigger ongoing reporting obligations” and the burden of understanding them, Grugan asserted that the CTA “introduces a major administrative burden that may be difficult to manage without the necessary resources.”

The increase in legal spend could be significant, saying, “managers will need to consider the legal cost of having US counsel analyze each US entity on a case-by-case basis,” Grugan added.

Subsidiaries and owners

Among those firms exempt from the new rules are “large operating companies” that have “an operating presence” in the US, at least 20 full-time employees and have filed a US tax return reporting $5 million or more in gross receipts. However, it’s the dog that doesn’t bark that you’ve got to listen to, experts warn.

“This provision will excuse many portfolio companies and operating companies from any new… reporting requirements,” Kirkland & Ellis partner Norm Champ and his colleagues said in a client alert shortly after the rules were finalized. “That said, because the exemption must be considered separately for each US-domiciled entity in an ownership chain, holding structures that sit ‘above’ a large operating company may not themselves be able to use an exemption.”

Most “subsidiaries” of companies that are exempt under the new rules are themselves exempt. The subsidiaries of pooled investment vehicles aren’t per se exempt, but they might be able to take advantage of other exemptions, experts say. The portfolio companies of exempt reporting advisers, for instance, may have to file ownership reports.

It gets confusing, fast. Wholly owned subsidiaries of companies exempt from the new FinCEN rules are generally exempt from the new reporting requirements, but the subsidiaries of pooled investment funds are “expressly excluded from this protection,” Chad and his colleagues said.

“The apparent result is that even if a private fund entity is exempt under the [pooled investment] exemption, its subsidiaries will still be regarded as reporting companies unless they qualify for a separate exemption. However, if such a subsidiary is required to report, it will only be required to identify the exempt entities that have an ownership interest (not the beneficial owners of those exempt entities),” the lawyers said.

“While many fund entities are likely to qualify for the Pooled Investment Vehicle Exemption, it is important to note that subsidiaries of Pooled Investment Vehicles are not included in the CTA’s Subsidiary of Certain Exempt Entities Exemption,” added Maples Group.

“Therefore, certain special purpose vehicles, alternative investment vehicles, blocker, splitter or aggregator entities not listed on the registered investment advisers’ SEC Form ADV may have to submit BOI Reports if they do not qualify for the pooled investment vehicle exemption (or any other exemption) on their own merits.”

And entities created to serve as general partners or managing members are “not expressly exempt from reporting” under the CTA, according to a note from law firm Akin Gump. This exemption is predicated on the kind of related “ultimate beneficial owner,” or UBO, and corporate registration information a GP has reported to the SEC. Akin noted that “there is no clarity on this yet” from regulators, however.

Maples Group emphasized the importance of identifying the “many events that occur throughout the lifecycle of a private fund that may now have CTA reporting obligations.” Such events may include accepting investors into the funds (ie, removal of the initial limited partner); subscriptions and redemptions; changes in the board of directors; changes in beneficial owners’ personal information (name, residential address, expiration of government identification) or in the event an entity no longer qualifies for pre-determined exemption.”

‘That argument is over’

It hasn’t helped that, while the law is already on the books, FinCEN hasn’t completed its regulatory guidance or even rules proposals on how the new law will be implemented. FinCEN has repeatedly updated its frequently asked questions page. At the end of December, FinCEN announced a webinar to help industry sort out how the new rules will apply to them. It was filled within hours, and regulators have promised to host more in the months ahead.

Whether or not the process is arduous or even painful, it still represents a blow against private funds’ privacy, Akin, Gump partner Brian Daly, said.

“Filling out these forms for FinCEN is going to be a lot faster than filling out an ADV,” he said. “The revolutionary part of this is that there is now going to be somewhere in the federal government a single database that’s indexable, with bunches of different search strings, of every non-exempt corporation formed or operating in the US. And there are of course obvious benefits for law enforcement in that, for combating money laundering and sanctions breaking. But it seems like there’s a very big civil liberties question that was either debated in a subdued manner or that didn’t happen at all, but that argument is past us for now.

“What in-house people should be doing is starting with org charts, maybe circling with colored markers,” Daly added. “That exercise might take 80 percent of the work off the table right off the bat. I don’t think this needs to be done in January, unless you’re creating new entities. But I don’t think you want to wait until next December either. I would want to know what my gaps are by the end of the first quarter next year, so I can get them addressed in the rest of the year.”

The US isn’t alone in passing a law like this. In the UK, the Economic Crime and Corporate Transparency Act will come into force this year. It’s part of a global effort to bring more daylight into world markets. Similar legal reforms have been enacted in Canada, the UK, and throughout the EU.